b'This text was adapted by The Saylor Foundation under a Creative\nCommons Attribution-NonCommercial-ShareAlike 3.0 License without\nattribution as requested by the work\xe2\x80\x99s original creator or licensee.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n1\n\n\x0cPreface\nOur goal is to provide students with a textbook that is up to date and comprehensive in its coverage\nof legal and regulatory issues\xe2\x80\x94and organized to permit instructors to tailor the materials to their\nparticular approach. This book engages students by relating law to everyday events with which they\nare already familiar (or with which they are familiarizing themselves in other business courses) and\nby its clear, concise, and readable style. (An earlier business law text by authors Lieberman and\nSiedel was hailed \xe2\x80\x9cthe best written text in a very crowded field.\xe2\x80\x9d)\nThis textbook provides context and essential concepts across the entire range of legal issues with\nwhich managers and business executives must grapple. The text provides the vocabulary and legal\nacumen necessary for businesspeople to talk in an educated way to their customers, employees,\nsuppliers, government officials\xe2\x80\x94and to their own lawyers.\nTraditional publishers often create confusion among customers in the text selection process by\noffering a huge array of publications. Once a text is selected, customers might still have to customize\nthe text to meet their needs. For example, publishers usually offer books that include either case\nsummaries or excerpted cases, but some instructors prefer to combine case summaries with a few\nexcerpted cases so that students can experience reading original material. Likewise, the manner in\nwhich most conventional texts incorporate video is cumbersome because the videos are contained in\na separate library, which makes access more complicating for instructors and students.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n2\n\n\x0cChapter 1\n\nIntroduction to Law and Legal Systems\nLEARNING OBJECTIVES\nAfter reading this chapter, you should be able to do the following:\n1.\n\nDistinguish different philosophies of law\xe2\x80\x94schools of legal thought\xe2\x80\x94and explain their relevance.\n\n2.\n\nIdentify the various aims that a functioning legal system can serve.\n\n3.\n\nExplain how politics and law are related.\n\n4.\n\nIdentify the sources of law and which laws have priority over other laws.\n\n5.\n\nUnderstand some basic differences between the US legal system and other legal systems.\n\nLaw has different meanings as well as different functions. Philosophers have considered issues of\njustice and law for centuries, and several different approaches, or schools of legal thought, have\nemerged. In this chapter, we will look at those different meanings and approaches and will consider\nhow social and political dynamics interact with the ideas that animate the various schools of legal\nthought. We will also look at typical sources of \xe2\x80\x9cpositive law\xe2\x80\x9d in the United States and how some of\nthose sources have priority over others, and we will set out some basic differences between the US\nlegal system and other legal systems.\n\n1.1 What Is Law?\nLaw is a word that means different things at different times. Black\xe2\x80\x99s Law Dictionary says that law is\n\n\xe2\x80\x9ca body of rules of action or conduct prescribed by controlling authority, and having binding legal\nforce. That which must be obeyed and followed by citizens subject to sanctions or legal consequence\nis a law.\xe2\x80\x9d [1]\n\nFunctions of the Law\nIn a nation, the law can serve to (1) keep the peace, (2) maintain the status quo, (3) preserve individual\nrights, (4) protect minorities against majorities, (5) promote social justice, and (6) provide for orderly\nsocial change. Some legal systems serve these purposes better than others. Although a nation ruled by an\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n3\n\n\x0cauthoritarian government may keep the peace and maintain the status quo, it may also oppress minorities\nor political opponents (e.g., Burma, Zimbabwe, or Iraq under Saddam Hussein). Under colonialism,\nEuropean nations often imposed peace in countries whose borders were somewhat arbitrarily created by\nthose same European nations. Over several centuries prior to the twentieth century, empires were built by\nSpain, Portugal, Britain, Holland, France, Germany, Belgium, and Italy. With regard to the functions of\nthe law, the empire may have kept the peace\xe2\x80\x94largely with force\xe2\x80\x94but it changed the status quo and\nseldom promoted the native peoples\xe2\x80\x99 rights or social justice within the colonized nation.\nIn nations that were former colonies of European nations, various ethnic and tribal factions have\nfrequently made it difficult for a single, united government to rule effectively. In Rwanda, for example,\npower struggles between Hutus and Tutsis resulted in genocide of the Tutsi minority. (Genocide is the\ndeliberate and systematic killing or displacement of one group of people by another group. In 1948, the\ninternational community formally condemned the crime of genocide.) In nations of the former Soviet\nUnion, the withdrawal of a central power created power vacuums that were exploited by ethnic leaders.\nWhen Yugoslavia broke up, the different ethnic groups\xe2\x80\x94Croats, Bosnians, and Serbians\xe2\x80\x94fought bitterly\nfor home turf rather than share power. In Iraq and Afghanistan, the effective blending of different groups\nof families, tribes, sects, and ethnic groups into a national governing body that shares power remains to be\nseen.\n\nLaw and Politics\nIn the United States, legislators, judges, administrative agencies, governors, and presidents make law,\nwith substantial input from corporations, lobbyists, and a diverse group of nongovernment organizations\n(NGOs) such as the American Petroleum Institute, the Sierra Club, and the National Rifle Association. In\nthe fifty states, judges are often appointed by governors or elected by the people. The process of electing\nstate judges has become more and more politicized in the past fifteen years, with growing campaign\ncontributions from those who would seek to seat judges with similar political leanings.\nIn the federal system, judges are appointed by an elected official (the president) and confirmed by other\nelected officials (the Senate). If the president is from one party and the other party holds a majority of\nSenate seats, political conflicts may come up during the judges\xe2\x80\x99 confirmation processes. Such a division\nhas been fairly frequent over the past fifty years.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n4\n\n\x0cIn most nation-states (as countries are called in international law), knowing who has power to make and\nenforce the laws is a matter of knowing who has political power; in many places, the people or groups that\nhave military power can also command political power to make and enforce the laws. Revolutions are\ndifficult and contentious, but each year there are revolts against existing political-legal authority; an\naspiration for democratic rule, or greater \xe2\x80\x9crights\xe2\x80\x9d for citizens, is a recurring theme in politics and law.\n\nKEY TAKEAWAY\n\nLaw is the result of political action, and the political landscape is vastly different from nation to nation.\nUnstable or authoritarian governments often fail to serve the principal functions of law.\n\nEXERCISES\n\n1.\n\nConsider Burma (named Myanmar by its military rulers). What political rights do you have that the\naverage Burmese citizen does not?\n\n2.\n\nWhat is a nongovernment organization, and what does it have to do with government? Do you contribute\nto (or are you active in) a nongovernment organization? What kind of rights do they espouse, what kind\nof laws do they support, and what kind of laws do they oppose?\n\n[1] Black\xe2\x80\x99s Law Dictionary, 6th ed., s.v. \xe2\x80\x9claw.\xe2\x80\x9d\n\n1.2 Schools of Legal Thought\n\nLEARNING OBJECTIVES\n\n1.\n\nDistinguish different philosophies of law\xe2\x80\x94schools of legal thought\xe2\x80\x94and explain their relevance.\n\n2.\n\nExplain why natural law relates to the rights that the founders of the US political-legal system found\nimportant.\n\n3.\n\nDescribe legal positivism and explain how it differs from natural law.\n\n4.\n\nDifferentiate critical legal studies and ecofeminist legal perspectives from both natural law and legal\npositivist perspectives.\n\nThere are different schools (or philosophies) concerning what law is all about. Philosophy of law is\nalso called jurisprudence, and the two main schools arelegal positivism and natural law. Although\nthere are others (see Section 1.2.3 "Other Schools of Legal Thought"), these two are the most\ninfluential in how people think about the law.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n5\n\n\x0cLegal Positivism: Law as Sovereign Command\nAs legal philosopher John Austin concisely put it, \xe2\x80\x9cLaw is the command of a sovereign.\xe2\x80\x9d Law is only law,\nin other words, if it comes from a recognized authority and can be enforced by that authority,\nor sovereign\xe2\x80\x94such as a king, a president, or a dictator\xe2\x80\x94who has power within a defined area or territory.\nPositivism is a philosophical movement that claims that science provides the only knowledge precise\nenough to be worthwhile. But what are we to make of the social phenomena of laws?\nWe could examine existing statutes\xe2\x80\x94executive orders, regulations, or judicial decisions\xe2\x80\x94in a fairly precise\nway to find out what the law says. For example, we could look at the posted speed limits on most US\nhighways and conclude that the \xe2\x80\x9ccorrect\xe2\x80\x9d or \xe2\x80\x9cright\xe2\x80\x9d speed is no more than fifty-five miles per hour. Or we\ncould look a little deeper and find out how the written law is usually applied. Doing so, we might conclude\nthat sixty-one miles per hour is generally allowed by most state troopers, but that occasionally someone\ngets ticketed for doing fifty-seven miles per hour in a fifty-five miles per hour zone. Either approach is\nempirical, even if not rigorously scientific. The first approach, examining in a precise way what the rule\nitself says, is sometimes known as the \xe2\x80\x9cpositivist\xe2\x80\x9d school of legal thought. The second approach\xe2\x80\x94which\nrelies on social context and the actual behavior of the principal actors who enforce the law\xe2\x80\x94is akin to the\n\xe2\x80\x9clegal realist\xe2\x80\x9d school of thought (see Section 1.2.3 "Other Schools of Legal Thought").\nPositivism has its limits and its critics. New Testament readers may recall that King Herod, fearing the\nbirth of a Messiah, issued a decree that all male children below a certain age be killed. Because it was the\ncommand of a sovereign, the decree was carried out (or, in legal jargon, the decree was \xe2\x80\x9cexecuted\xe2\x80\x9d).\nSuppose a group seizes power in a particular place and commands that women cannot attend school and\ncan only be treated medically by women, even if their condition is life-threatening and women doctors are\nfew and far between. Suppose also that this command is carried out, just because it is the law and is\nenforced with a vengeance. People who live there will undoubtedly question the wisdom, justice, or\ngoodness of such a law, but it is law nonetheless and is generally carried out. To avoid the law\xe2\x80\x99s impact, a\ncitizen would have to flee the country entirely. During the Taliban rule in Afghanistan, from which this\nexample is drawn, many did flee.\nThe positive-law school of legal thought would recognize the lawmaker\xe2\x80\x99s command as legitimate;\nquestions about the law\xe2\x80\x99s morality or immorality would not be important. In contrast, the natural-law\nschool of legal thought would refuse to recognize the legitimacy of laws that did not conform to natural,\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n6\n\n\x0cuniversal, or divine law. If a lawmaker issued a command that was in violation of natural law, a citizen\nwould be morally justified in demonstrating civil disobedience. For example, in refusing to give up her\nseat to a white person, Rosa Parks believed that she was refusing to obey an unjust law.\n\nNatural Law\nThe natural-law school of thought emphasizes that law should be based on a universal moral order.\nNatural law was \xe2\x80\x9cdiscovered\xe2\x80\x9d by humans through the use of reason and by choosing between that which is\ngood and that which is evil. Here is the definition of natural law according to the Cambridge Dictionary of\nPhilosophy: \xe2\x80\x9cNatural law, also called the law of nature in moral and political philosophy, is an objective\nnorm or set of objective norms governing human behavior, similar to the positive laws of a human ruler,\nbut binding on all people alike and usually understood as involving a superhuman legislator.\xe2\x80\x9d\n\n[1]\n\nBoth the US Constitution and the United Nations (UN) Charter have an affinity for the natural-law\noutlook, as it emphasizes certain objective norms and rights of individuals and nations. The US\nDeclaration of Independence embodies a natural-law philosophy. The following short extract should\nprovide some sense of the deep beliefs in natural law held by those who signed the document.\n\nThe Unanimous Declaration of the Thirteen United States of America\nJuly 4, 1776\nWhen in the Course of human events, it becomes necessary for one people to dissolve the political\nbands which have connected them with another, and to assume among the powers of the earth,\nthe separate and equal station to which the Laws of Nature and of Nature\xe2\x80\x99s God entitle them, a\ndecent respect to the opinions of mankind requires that they should declare the causes which\nimpel them to the separation.\nWe hold these truths to be self-evident, that all men are created equal, that they are endowed by\ntheir Creator with certain unalienable Rights, that among these are Life, Liberty and the Pursuit\nof Happiness. That to secure these rights, Governments are instituted among Men, deriving their\njust powers from the consent of the governed.\xe2\x80\xa6\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n7\n\n\x0cThe natural-law school has been very influential in American legal thinking. The idea that certain rights,\nfor example, are \xe2\x80\x9cunalienable\xe2\x80\x9d (as expressed in the Declaration of Independence and in the writings of\nJohn Locke) is consistent with this view of the law. Individuals may have \xe2\x80\x9cGod-given\xe2\x80\x9d or \xe2\x80\x9cnatural\xe2\x80\x9d rights\nthat government cannot legitimately take away. Government only by consent of the governed is a natural\noutgrowth of this view.\nCivil disobedience\xe2\x80\x94in the tradition of Henry Thoreau, Mahatma Gandhi, or Martin Luther King Jr.\xe2\x80\x94\nbecomes a matter of morality over \xe2\x80\x9cunnatural\xe2\x80\x9d law. For example, in his \xe2\x80\x9cLetter from Birmingham Jail,\xe2\x80\x9d\nMartin Luther King Jr. claims that obeying an unjust law is not moral and that deliberately disobeying an\nunjust law is in fact a moral act that expresses \xe2\x80\x9cthe highest respect for law\xe2\x80\x9d: \xe2\x80\x9cAn individual who breaks a\nlaw that conscience tells him is unjust, and who willingly accepts the penalty of imprisonment in order to\narouse the conscience of the community over its injustice, is in reality expressing the highest respect for\nlaw.\xe2\x80\xa6One who breaks an unjust law must do so openly, lovingly, and with a willingness to accept the\npenalty.\xe2\x80\x9d\n\n[2]\n\nLegal positivists, on the other hand, would say that we cannot know with real confidence what \xe2\x80\x9cnatural\xe2\x80\x9d\nlaw or \xe2\x80\x9cuniversal\xe2\x80\x9d law is. In studying law, we can most effectively learn by just looking at what the written\nlaw says, or by examining how it has been applied. In response, natural-law thinkers would argue that if\nwe care about justice, every law and every legal system must be held accountable to some higher standard,\nhowever hard that may be to define.\nIt is easier to know what the law \xe2\x80\x9cis\xe2\x80\x9d than what the law \xe2\x80\x9cshould be.\xe2\x80\x9d Equal employment laws, for example,\nhave specific statutes, rules, and decisions about racial discrimination. There are always difficult issues of\ninterpretation and decision, which is why courts will resolve differing views. But how can we know the\nmore fundamental \xe2\x80\x9cought\xe2\x80\x9d or \xe2\x80\x9cshould\xe2\x80\x9d of human equality? For example, how do we know that \xe2\x80\x9call men\nare created equal\xe2\x80\x9d (from the Declaration of Independence)? Setting aside for the moment questions about\nthe equality of women, or that of slaves, who were not counted as men with equal rights at the time of the\ndeclaration\xe2\x80\x94can the statement be empirically proven, or is it simply a matter of a priori knowledge? (A\npriori means \xe2\x80\x9cexisting in the mind prior to and independent of experience.\xe2\x80\x9d) Or is the statement about\nequality a matter of faith or belief, not really provable either scientifically or rationally? The dialogue\nbetween natural-law theorists and more empirically oriented theories of \xe2\x80\x9cwhat law is\xe2\x80\x9d will raise similar\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n8\n\n\x0cquestions. In this book, we will focus mostly on the law as it is, but not without also raising questions\nabout what it could or should be.\n\nOther Schools of Legal Thought\nThe historical school of law believes that societies should base their legal decisions today on the examples\nof the past. Precedent would be more important than moral arguments.\nThe legal realist school flourished in the 1920s and 1930s as a reaction to the historical school. Legal\nrealists pointed out that because life and society are constantly changing, certain laws and doctrines have\nto be altered or modernized in order to remain current. The social context of law was more important to\nlegal realists than the formal application of precedent to current or future legal disputes. Rather than\nsuppose that judges inevitably acted objectively in applying an existing rule to a set of facts, legal realists\nobserved that judges had their own beliefs, operated in a social context, and would give legal decisions\nbased on their beliefs and their own social context.\nThe legal realist view influenced the emergence of the critical legal studies (CLS) school of thought. The\n\xe2\x80\x9cCrits\xe2\x80\x9d believe that the social order (and the law) is dominated by those with power, wealth, and influence.\nSome Crits are clearly influenced by the economist Karl Marx and also by distributive justice theory\n(see Chapter 2 "Corporate Social Responsibility and Business Ethics"). The CLS school believes the\nwealthy have historically oppressed or exploited those with less wealth and have maintained social control\nthrough law. In so doing, the wealthy have perpetuated an unjust distribution of both rights and goods in\nsociety. Law is politics and is thus not neutral or value-free. The CLS movement would use the law to\noverturn the hierarchical structures of domination in the modern society.\nRelated to the CLS school, yet different, is the ecofeminist school of legal thought. This school\nemphasizes\xe2\x80\x94and would modify\xe2\x80\x94the long-standing domination of men over both women and the rest of\nthe natural world. Ecofeminists would say that the same social mentality that leads to exploitation of\nwomen is at the root of man\xe2\x80\x99s exploitation and degradation of the natural environment. They would say\nthat male ownership of land has led to a \xe2\x80\x9cdominator culture,\xe2\x80\x9d in which man is not so much a steward of\nthe existing environment or those \xe2\x80\x9csubordinate\xe2\x80\x9d to him but is charged with making all that he controls\neconomically \xe2\x80\x9cproductive.\xe2\x80\x9d Wives, children, land, and animals are valued as economic resources, and legal\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n9\n\n\x0csystems (until the nineteenth century) largely conferred rights only to men with land. Ecofeminists would\nsay that even with increasing civil and political rights for women (such as the right to vote) and with some\nnations\xe2\x80\x99 recognizing the rights of children and animals and caring for the environment, the legacy of the\npast for most nations still confirms the preeminence of \xe2\x80\x9cman\xe2\x80\x9d and his dominance of both nature and\nwomen.\n\nKEY TAKEAWAY\n\nEach of the various schools of legal thought has a particular view of what a legal system is or what it\nshould be. The natural-law theorists emphasize the rights and duties of both government and the\ngoverned. Positive law takes as a given that law is simply the command of a sovereign, the political power\nthat those governed will obey. Recent writings in the various legal schools of thought emphasize longstanding patterns of domination of the wealthy over others (the CLS school) and of men over women\n(ecofeminist legal theory).\n\n1.\n\nEXERCISES\n\nVandana Shiva draws a picture of a stream in a forest. She says that in our society the stream is seen as\nunproductive if it is simply there, fulfilling the need for water of women\xe2\x80\x99s families and communities, until\nengineers come along and tinker with it, perhaps damming it and using it for generating hydropower. The\nsame is true of a forest, unless it is replaced with a monoculture plantation of a commercial species. A\nforest may very well be productive\xe2\x80\x94protecting groundwater; creating oxygen; providing fruit, fuel, and\ncraft materials for nearby inhabitants; and creating a habitat for animals that are also a valuable resource.\nShe criticizes the view that if there is no monetary amount that can contribute to gross domestic product,\nneither the forest nor the river can be seen as a productive resource. Which school of legal thought does\nher criticism reflect?\n\n2.\n\nAnatole France said, \xe2\x80\x9cThe law, in its majesty, forbids rich and poor alike from sleeping under bridges.\xe2\x80\x9d\nWhich school of legal thought is represented by this quote?\n\n3.\n\nAdolf Eichmann was a loyal member of the National Socialist Party in the Third Reich and worked hard\nunder Hitler\xe2\x80\x99s government during World War II to round up Jewish people for incarceration\xe2\x80\x94and\neventual extermination\xe2\x80\x94at labor camps like Auschwitz and Buchenwald. After an Israeli \xe2\x80\x9cextraction\nteam\xe2\x80\x9d took him from Argentina to Israel, he was put on trial for \xe2\x80\x9ccrimes against humanity.\xe2\x80\x9d His defense\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n10\n\n\x0cwas that he was \xe2\x80\x9cjust following orders.\xe2\x80\x9d Explain why Eichmann was not an adherent of the natural-law\nschool of legal thought.\n4.\n\n[1] Cambridge Dictionary of Philosophy, s.v. \xe2\x80\x9cnatural law.\xe2\x80\x9d\n\n5.\n\n[2] Martin Luther King Jr., \xe2\x80\x9cLetter from Birmingham Jail.\xe2\x80\x9d\n\n1.3 Basic Concepts and Categories of US Positive Law\nLEARNING OBJECTIVES\n\n1.\n\nIn a general way, differentiate contract law from tort law.\n\n2.\n\nConsider the role of law in supporting ethical norms in our society.\n\n3.\n\nUnderstand the differing roles of state law and federal law in the US legal system.\n\n4.\n\nKnow the difference between criminal cases and civil cases.\n\nMost of what we discuss in this book is positive law\xe2\x80\x94US positive law in particular. We will also\nconsider the laws and legal systems of other nations. But first, it will be useful to cover some basic\nconcepts and distinctions.\n\nLaw: The Moral Minimums in a Democratic Society\nThe law does not correct (or claim to correct) every wrong that occurs in society. At a minimum, it aims to\ncurb the worst kind of wrongs, the kinds of wrongs that violate what might be called the \xe2\x80\x9cmoral\nminimums\xe2\x80\x9d that a community demands of its members. These include not only violations of criminal law\n(see Chapter 6 "Criminal Law") but also torts (see Chapter 7 "Introduction to Tort Law") and broken\npromises (see Chapter 8 "Introduction to Contract Law"). Thus it may be wrong to refuse to return a\nphone call from a friend, but that wrong will not result in a viable lawsuit against you. But if a phone (or\nthe Internet) is used to libel or slander someone, a tort has been committed, and the law may allow the\ndefamed person to be compensated.\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n11\n\n\x0cThere is a strong association between what we generally think of as ethical behavior and what the laws\nrequire and provide. For example, contract law upholds society\xe2\x80\x99s sense that promises\xe2\x80\x94in general\xe2\x80\x94should\nbe kept. Promise-breaking is seen as unethical. The law provides remedies for broken promises (in breach\nof contract cases) but not for all broken promises; some excuses are accepted when it would be reasonable\nto do so. For tort law, harming others is considered unethical. If people are not restrained by law from\nharming one another, orderly society would be undone, leading to anarchy. Tort law provides for\ncompensation when serious injuries or harms occur. As for property law issues, we generally believe that\nprivate ownership of property is socially useful and generally desirable, and it is generally protected (with\nsome exceptions) by laws. You can\xe2\x80\x99t throw a party at my house without my permission, but my right to do\nwhatever I want on my own property may be limited by law; I can\xe2\x80\x99t, without the public\xe2\x80\x99s permission,\noperate an incinerator on my property and burn heavy metals, as toxic ash may be deposited throughout\nthe neighborhood.\n\nThe Common Law: Property, Torts, and Contracts\nEven before legislatures met to make rules for society, disputes happened and judges decided them. In\nEngland, judges began writing down the facts of a case and the reasons for their decision. They often\nresorted to deciding cases on the basis of prior written decisions. In relying on those prior decisions, the\njudge would reason that since a current case was pretty much like a prior case, it ought to be decided the\nsame way. This is essentially reasoning by analogy. Thus the use of precedent in common-law cases came\ninto being, and a doctrine of stare decisis (pronounced STAR-ay-de-SIGH-sus) became accepted in\nEnglish courts. Stare decisis means, in Latin, \xe2\x80\x9clet the decision stand.\xe2\x80\x9d\nMost judicial decisions that don\xe2\x80\x99t apply legislative acts (known as statutes) will involve one of three areas\nof law\xe2\x80\x94property, contract, or tort. Property law deals with the rights and duties of those who can legally\nown land (real property), how that ownership can be legally confirmed and protected, how property can\nbe bought and sold, what the rights of tenants (renters) are, and what the various kinds of \xe2\x80\x9cestates\xe2\x80\x9d in\nland are (e.g., fee simple, life estate, future interest, easements, or rights of way). Contract law deals with\nwhat kinds of promises courts should enforce. For example, should courts enforce a contract where one of\nthe parties was intoxicated, underage, or insane? Should courts enforce a contract where one of the\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n12\n\n\x0cparties seemed to have an unfair advantage? What kind of contracts would have to be in writing to be\nenforced by courts? Tort law deals with the types of cases that involve some kind of harm and or injury\nbetween the plaintiff and the defendant when no contract exists. Thus if you are libeled or a competitor\nlies about your product, your remedy would be in tort, not contract.\nThe thirteen original colonies had been using English common law for many years, and they continued to\ndo so after independence from England. Early cases from the first states are full of references to alreadydecided English cases. As years went by, many precedents were established by US state courts, so that\ntoday a judicial opinion that refers to a seventeenth- or eighteenth-century English common-law case is\nquite rare.\nCourts in one state may look to common-law decisions from the courts of other states where the reasoning\nin a similar case is persuasive. This will happen in \xe2\x80\x9ccases of first impression,\xe2\x80\x9d a fact pattern or situation\nthat the courts in one state have never seen before. But if the supreme court in a particular state has\nalready ruled on a certain kind of case, lower courts in that state will always follow the rule set forth by\ntheir highest court.\n\nState Courts and the Domain of State Law\nIn the early years of our nation, federal courts were not as active or important as state courts. States had\njurisdiction (the power to make and enforce laws) over the most important aspects of business life. The\npower of state law has historically included governing the following kinds of issues and claims:\n\xe2\x80\xa2\n\nContracts, including sales, commercial paper, letters of credit, and secured transactions\n\n\xe2\x80\xa2\n\nTorts\n\n\xe2\x80\xa2\n\nProperty, including real property, bailments of personal property (such as when you check your coat\nat a theater or leave your clothes with a dry cleaner), trademarks, copyrights, and the estates of\ndecedents (dead people)\n\n\xe2\x80\xa2\n\nCorporations\n\n\xe2\x80\xa2\n\nPartnerships\n\n\xe2\x80\xa2\n\nDomestic matters, including marriage, divorce, custody, adoption, and visitation\n\n\xe2\x80\xa2\n\nSecurities law\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n13\n\n\x0c\xe2\x80\xa2\n\nEnvironmental law\n\n\xe2\x80\xa2\n\nAgency law, governing the relationship between principals and their agents.\n\n\xe2\x80\xa2\n\nBanking\n\n\xe2\x80\xa2\n\nInsurance\n\nOver the past eighty years, however, federal law has become increasingly important in many of these\nareas, including banking, securities, and environmental law.\n\nCivil versus Criminal Cases\nMost of the cases we will look at in this textbook are civil cases. Criminal cases are certainly of interest to\nbusiness, especially as companies may break criminal laws. A criminal case involves a governmental\ndecision\xe2\x80\x94whether state or federal\xe2\x80\x94to prosecute someone (named as a defendant) for violating society\xe2\x80\x99s\nlaws. The law establishes a moral minimum and does so especially in the area of criminal laws; if you\nbreak a criminal law, you can lose your freedom (in jail) or your life (if you are convicted of a capital\noffense). In a civil action, you would not be sent to prison; in the worst case, you can lose property\n(usually money or other assets), such as when Ford Motor Company lost a personal injury case and the\njudge awarded $295 million to the plaintiffs or when Pennzoil won a $10.54 billion verdict against Texaco\n(see Chapter 7 "Introduction to Tort Law").\nSome of the basic differences between civil law and criminal law cases are illustrated in Table 1.1\n"Differences between Civil and Criminal Cases".\nTable 1.1 Differences between Civil and Criminal Cases\n\nCivil Cases\n\nCriminal Cases\n\nParties\n\nPlaintiff brings case; defendant must answer or lose Prosecutor brings case; defendant may\nby default\nremain silent\n\nProof\n\nPreponderance of evidence\n\nBeyond a reasonable doubt\n\nReason\n\nTo settle disputes peacefully, usually between\nprivate parties\n\nTo maintain order in society\nTo punish the most blameworthy\nTo deter serious wrongdoing\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n14\n\n\x0cCivil Cases\nRemedies Money damages (legal remedy)\n\nCriminal Cases\nFines, jail, and forfeitures\n\nInjunctions (equitable remedy)\nSpecific performance (equity)\nRegarding plaintiffs and prosecutors, you can often tell a civil case from a criminal case by looking at the\ncaption of a case going to trial. If the government appears first in the caption of the case (e.g., U.S. v.\nLieberman, it is likely that the United States is prosecuting on behalf of the people. The same is true of\ncases prosecuted by state district attorneys (e.g., State v. Seidel). But this is not a foolproof formula.\nGovernments will also bring civil actions to collect debts from or settle disputes with individuals,\ncorporations, or other governments. Thus U.S. v. Mayer might be a collection action for unpaid taxes,\nor U.S. v. Canada might be a boundary dispute in the International Court of Justice. Governments can be\nsued, as well; people occasionally sue their state or federal government, but they can only get a trial if the\ngovernment waives its sovereign immunity and allows such suits. Warner v. U.S., for example, could be a\nclaim for a tax refund wrongfully withheld or for damage caused to the Warner residence by a sonic boom\nfrom a US Air Force jet flying overhead.\n\nSubstance versus Procedure\nMany rules and regulations in law are substantive, and others are procedural. We are used to seeing laws\nas substantive; that is, there is some rule of conduct or behavior that is called for or some action that is\nproscribed (prohibited). The substantive rules tell us how to act with one another and with the\ngovernment. For example, all of the following are substantive rules of law and provide a kind of command\nor direction to citizens:\n\xe2\x80\xa2\n\nDrive not more than fifty-five miles per hour where that speed limit is posted.\n\n\xe2\x80\xa2\n\nDo not conspire to fix prices with competitors in the US market.\n\n\xe2\x80\xa2\n\nDo not falsely represent the curative effects of your over-the-counter herbal remedy.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n15\n\n\x0c\xe2\x80\xa2\n\nDo not drive your motor vehicle through an intersection while a red traffic signal faces the direction\nyou are coming from.\n\n\xe2\x80\xa2\n\nDo not discriminate against job applicants or employees on the basis of their race, sex, religion, or\nnational origin.\n\n\xe2\x80\xa2\n\nDo not discharge certain pollutants into the river without first getting a discharge permit.\n\nIn contrast, procedural laws are the rules of courts and administrative agencies. They tell us how to\nproceed if there is a substantive-law problem. For example, if you drive fifty-three miles per hour in a\nforty mile-per-hour zone on Main Street on a Saturday night and get a ticket, you have broken a\nsubstantive rule of law (the posted speed limit). Just how and what gets decided in court is a matter of\nprocedural law. Is the police officer\xe2\x80\x99s word final, or do you get your say before a judge? If so, who goes\nfirst, you or the officer? Do you have the right to be represented by legal counsel? Does the hearing or trial\nhave to take place within a certain time period? A week? A month? How long can the state take to bring its\ncase? What kinds of evidence will be relevant? Radar? (Does it matter what kind of training the officer has\nhad on the radar device? Whether the radar device had been tested adequately?) The officer\xe2\x80\x99s personal\nobservation? (What kind of training has he had, how is he qualified to judge the speed of a car, and other\nquestions arise.) What if you unwisely bragged to a friend at a party recently that you went a hundred\nmiles an hour on Main Street five years ago at half past three on a Tuesday morning? (If the prosecutor\nknows of this and the \xe2\x80\x9cfriend\xe2\x80\x9d is willing to testify, is it relevant to the charge of fifty-three in a forty-mileper-hour zone?)\nIn the United States, all state procedural laws must be fair, since the due process clause of the Fourteenth\nAmendment directs that no state shall deprive any citizen of \xe2\x80\x9clife, liberty, or property,\xe2\x80\x9d without due\nprocess of law. (The $200 fine plus court costs is designed to deprive you of property, that is, money, if\nyou violate the speed limit.) Federal laws must also be fair, because the Fifth Amendment to the US\nConstitution has the exact same due process language as the Fourteenth Amendment. This suggests that\nsome laws are more powerful or important than others, which is true. The next section looks at various\ntypes of positive law and their relative importance.\n\nKEY TAKEAWAY\n\nIn most legal systems, like that in the United States, there is a fairly firm distinction between criminal law\n(for actions that are offenses against the entire society) and civil law (usually for disputes between\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n16\n\n\x0cindividuals or corporations). Basic ethical norms for promise-keeping and not harming others are reflected\nin the civil law of contracts and torts. In the United States, both the states and the federal government\nhave roles to play, and sometimes these roles will overlap, as in environmental standards set by both\nstates and the federal government.\n\n1.\n\nEXERCISES\n\nJenna gets a ticket for careless driving after the police come to investigate a car accident she had with you\non Hanover Boulevard. Your car is badly damaged through no fault of your own. Is Jenna likely to face\ncriminal charges, civil charges, or both?\n\n2.\n\nJenna\xe2\x80\x99s ticket says that she has thirty days in which to respond to the charges against her. The thirty days\nconforms to a state law that sets this time limit. Is the thirty-day limit procedural law or substantive law?\n\n1.4 Sources of Law and Their Priority\n\nLEARNING OBJECTIVES\n\n1.\n\nDescribe the different sources of law in the US legal system and the principal institutions that create\nthose laws.\n\n2.\n\nExplain in what way a statute is like a treaty, and vice versa.\n\n3.\n\nExplain why the Constitution is \xe2\x80\x9cprior\xe2\x80\x9d and has priority over the legislative acts of a majority, whether in\nthe US Congress or in a state legislature.\n\n4.\n\nDescribe the origins of the common-law system and what common law means.\n\nSources of Law\nIn the United States today, there are numerous sources of law. The main ones are (1) constitutions\xe2\x80\x94both\nstate and federal, (2) statutes and agency regulations, and (3) judicial decisions. In addition, chief\nexecutives (the president and the various governors) can issue executive orders that have the effect of law.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n17\n\n\x0cIn international legal systems, sources of law include treaties (agreements between states or countries)\nand what is known as customary international law (usually consisting of judicial decisions from national\ncourt systems where parties from two or more nations are in a dispute).\nAs you might expect, these laws sometimes conflict: a state law may conflict with a federal law, or a\nfederal law might be contrary to an international obligation. One nation\xe2\x80\x99s law may provide one\nsubstantive rule, while another nation\xe2\x80\x99s law may provide a different, somewhat contrary rule to apply. Not\nall laws, in other words, are created equal. To understand which laws have priority, it is essential to\nunderstand the relationships between the various kinds of law.\n\nConstitutions\nConstitutions are the foundation for a state or nation\xe2\x80\x99s other laws, providing the country\xe2\x80\x99s legislative,\nexecutive, and judicial framework. Among the nations of the world, the United States has the oldest\nconstitution still in use. It is difficult to amend, which is why there have only been seventeen amendments\nfollowing the first ten in 1789; two-thirds of the House and Senate must pass amendments, and threefourths of the states must approve them.\nThe nation\xe2\x80\x99s states also have constitutions. Along with providing for legislative, executive, and judicial\nfunctions, state constitutions prescribe various rights of citizens. These rights may be different from, and\nin addition to, rights granted by the US Constitution. Like statutes and judicial decisions, a constitution\xe2\x80\x99s\nspecific provisions can provide people with a \xe2\x80\x9ccause of action\xe2\x80\x9d on which to base a lawsuit (see Section\n1.4.3 "Causes of Action, Precedent, and " on \xe2\x80\x9ccauses of action\xe2\x80\x9d). For example, California\xe2\x80\x99s constitution\nprovides that the citizens of that state have a right of privacy. This has been used to assert claims against\nbusinesses that invade an employee\xe2\x80\x99s right of privacy. In the case of Virginia Rulon-Miller, her employer,\nInternational Business Machines (IBM), told her to stop dating a former colleague who went to work for a\ncompetitor. When she refused, IBM terminated her, and a jury fined the company for $300,000 in\ndamages. As the California court noted, \xe2\x80\x9cWhile an employee sacrifices some privacy rights when he enters\nthe workplace, the employee\xe2\x80\x99s privacy expectations must be balanced against the employer\xe2\x80\x99s\ninterests.\xe2\x80\xa6[T]he point here is that privacy, like the other unalienable rights listed first in our\nConstitution\xe2\x80\xa6is unquestionably a fundamental interest of our society.\xe2\x80\x9d\n\n[1]\n\nStatutes and Treaties in Congress\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n18\n\n\x0cIn Washington, DC, the federal legislature is known as Congress and has both a House of Representatives\nand a Senate. The House is composed of representatives elected every two years from various districts in\neach state. These districts are established by Congress according to population as determined every ten\nyears by the census, a process required by the Constitution. Each state has at least one district; the most\npopulous state (California) has fifty-two districts. In the Senate, there are two senators from each state,\nregardless of the state\xe2\x80\x99s population. Thus Delaware has two senators and California has two senators, even\nthough California has far more people. Effectively, less than 20 percent of the nation\xe2\x80\x99s population can\nsend fifty senators to Washington.\nMany consider this to be antidemocratic. The House of Representatives, on the other hand, is directly\nproportioned by population, though no state can have less than one representative.\nEach Congressional legislative body has committees for various purposes. In these committees, proposed\nbills are discussed, hearings are sometimes held, and bills are either reported out (brought to the floor for\na vote) or killed in committee. If a bill is reported out, it may be passed by majority vote. Because of the\nprocedural differences between the House and the Senate, bills that have the same language when\nproposed in both houses are apt to be different after approval by each body. A conference committee will\nthen be held to try to match the two versions. If the two versions differ widely enough, reconciliation of\nthe two differing versions into one acceptable to both chambers (House and Senate) is more difficult.\nIf the House and Senate can agree on identical language, the reconciled bill will be sent to the president\nfor signature or veto. The Constitution prescribes that the president will have veto power over any\nlegislation. But the two bodies can override a presidential veto with a two-thirds vote in each chamber.\nIn the case of treaties, the Constitution specifies that only the Senate must ratify them. When the Senate\nratifies a treaty, it becomes part of federal law, with the same weight and effect as a statute passed by the\nentire Congress. The statutes of Congress are collected in codified form in the US Code. The code is\navailable online at http://uscode.house.gov.\n\nDelegating Legislative Powers: Rules by Administrative Agencies\nCongress has found it necessary and useful to create government agencies to administer various laws\n(see Chapter 5 "Administrative Law"). The Constitution does not expressly provide for administrative\nagencies, but the US Supreme Court has upheld the delegation of power to create federal agencies.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n19\n\n\x0cExamples of administrative agencies would include the Occupational Safety and Health Administration\n(OSHA), the Environmental Protection Agency (EPA), and the Federal Trade Commission (FTC).\nIt is important to note that Congress does not have unlimited authority to delegate its lawmaking powers\nto an agency. It must delegate its authority with some guidelines for the agency and cannot altogether\navoid its constitutional responsibilities (see Chapter 5 "Administrative Law").\nAgencies propose rules in the Federal Register, published each working day of the year. Rules that are\nformally adopted are published in the Code of Federal Regulations, or CFR, available online\nathttp://www.access.gpo.gov/nara/cfr/cfr-table-search.html.\n\nState Statutes and Agencies: Other Codified Law\nStatutes are passed by legislatures and provide general rules for society. States have legislatures\n(sometimes called assemblies), which are usually made up of both a senate and a house of representatives.\nLike the federal government, state legislatures will agree on the provisions of a bill, which is then sent to\nthe governor (acting like the president for that state) for signature. Like the president, governors often\nhave a veto power. The process of creating and amending, or changing, laws is filled with political\nnegotiation and compromise.\nOn a more local level, counties and municipal corporations or townships may be authorized under a\nstate\xe2\x80\x99s constitution to create or adopt ordinances. Examples of ordinances include local building codes,\nzoning laws, and misdemeanors or infractions such as skateboarding or jaywalking. Most of the more\nunusual laws that are in the news from time to time are local ordinances. For example, in Logan County,\nColorado, it is illegal to kiss a sleeping woman; in Indianapolis, Indiana, and Eureka, Nebraska, it is a\ncrime to kiss if you have a mustache. But reportedly, some states still have odd laws here and there.\nKentucky law proclaims that every person in the state must take a bath at least once a year, and failure to\ndo so is illegal.\n\nJudicial Decisions: The Common Law\nCommon law consists of decisions by courts (judicial decisions) that do not involve interpretation of\nstatutes, regulations, treaties, or the Constitution. Courts make such interpretations, but many cases are\ndecided where there is no statutory or other codified law or regulation to be interpreted. For example, a\nstate court deciding what kinds of witnesses are required for a valid will in the absence of a rule (from a\nstatute) is making common law.\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n20\n\n\x0cUnited States law comes primarily from the tradition of English common law. By the time England\xe2\x80\x99s\nAmerican colonies revolted in 1776, English common-law traditions were well established in the colonial\ncourts. English common law was a system that gave written judicial decisions the force of law throughout\nthe country. Thus if an English court delivered an opinion as to what constituted the common-law crime\nof burglary, other courts would stick to that decision, so that a common body of law developed throughout\nthe country. Common law is essentially shorthand for the notion that a common body of law, based on\npast written decisions, is desirable and necessary.\nIn England and in the laws of the original thirteen states, common-law decisions defined crimes such as\narson, burglary, homicide, and robbery. As time went on, US state legislatures either adopted or modified\ncommon-law definitions of most crimes by putting them in the form of codes or statutes. This legislative\nability\xe2\x80\x94to modify or change common law into judicial law\xe2\x80\x94points to an important phenomenon: the\npriority of statutory law over common law. As we will see in the next section, constitutional law will have\npriority over statutory law.\n\nPriority of Laws\nThe Constitution as Preemptive Force in US Law\nThe US Constitution takes precedence over all statutes and judicial decisions that are inconsistent. For\nexample, if Michigan were to decide legislatively that students cannot speak ill of professors in statesponsored universities, that law would be void, since it is inconsistent with the state\xe2\x80\x99s obligation under the\nFirst Amendment to protect free speech. Or if the Michigan courts were to allow a professor to bring a\nlawsuit against a student who had said something about him that was derogatory but not defamatory, the\nstate\xe2\x80\x99s judicial system would not be acting according to the First Amendment. (As we will see in Chapter 7\n"Introduction to Tort Law", free speech has its limits; defamation was a cause of action at the time the\nFirst Amendment was added to the Constitution, and it has been understood that the free speech rights in\nthe First Amendment did not negate existing common law.)\n\nStatutes and Cases\nStatutes generally have priority, or take precedence, over case law (judicial decisions). Under commonlaw judicial decisions, employers could hire young children for difficult work, offer any wage they wanted,\nand not pay overtime work at a higher rate. But various statutes changed that. For example, the federal\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n21\n\n\x0cFair Labor Standards Act (1938) forbid the use of oppressive child labor and established a minimum pay\nwage and overtime pay rules.\n\nTreaties as Statutes: The \xe2\x80\x9cLast in Time\xe2\x80\x9d Rule\nA treaty or convention is considered of equal standing to a statute. Thus when Congress ratified the North\nAmerican Free Trade Agreement (NAFTA), any judicial decisions or previous statutes that were\ninconsistent\xe2\x80\x94such as quotas or limitations on imports from Mexico that were opposite to NAFTA\ncommitments\xe2\x80\x94would no longer be valid. Similarly, US treaty obligations under the General Agreement\non Tariffs and Trade (GATT) and obligations made later through the World Trade Organization (WTO)\nwould override previous federal or state statutes.\nOne example of treaty obligations overriding, or taking priority over, federal statutes was the tunadolphin dispute between the United States and Mexico. The Marine Mammal Protection Act amendments\nin 1988 spelled out certain protections for dolphins in the Eastern Tropical Pacific, and the United States\nbegan refusing to allow the importation of tuna that were caught using \xe2\x80\x9cdolphin-unfriendly\xe2\x80\x9d methods\n(such as purse seining). This was challenged at a GATT dispute panel in Switzerland, and the United\nStates lost. The discussion continued at the WTO under its dispute resolution process. In short, US\nenvironmental statutes can be ruled contrary to US treaty obligations.\nUnder most treaties, the United States can withdraw, or take back, any voluntary limitation on its\nsovereignty; participation in treaties is entirely elective. That is, the United States may \xe2\x80\x9cunbind\xe2\x80\x9d itself\nwhenever it chooses. But for practical purposes, some limitations on sovereignty may be good for the\nnation. The argument goes something like this: if free trade in general helps the United States, then it\nmakes some sense to be part of a system that promotes free trade; and despite some temporary setbacks,\nthe WTO decision process will (it is hoped) provide far more benefits than losses in the long run. This\nargument invokes utilitarian theory (that the best policy does the greatest good overall for society) and\nDavid Ricardo\xe2\x80\x99s theory of comparative advantage.\nUltimately, whether the United States remains a supporter of free trade and continues to participate as a\nleader in the WTO will depend upon citizens electing leaders who support the process. Had Ross Perot\nbeen elected in 1992, for example, NAFTA would have been politically (and legally) dead during his term\nof office.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n22\n\n\x0cCauses of Action, Precedent, and Stare Decisis\nNo matter how wrong someone\xe2\x80\x99s actions may seem to you, the only wrongs you can right in a court are\nthose that can be tied to one or more causes of action. Positive law is full of cases, treaties, statutes,\nregulations, and constitutional provisions that can be made into a cause of action. If you have an\nagreement with Harold Hill that he will purchase seventy-six trombones from you and he fails to pay for\nthem after you deliver, you will probably feel wronged, but a court will only act favorably on your\ncomplaint if you can show that his behavior gives you a cause of action based on some part of your state\xe2\x80\x99s\ncontract law. This case would give you a cause of action under the law of most states; unless Harold Hill\nhad some legal excuse recognized by the applicable state\xe2\x80\x99s contract law\xe2\x80\x94such as his legal incompetence,\nhis being less than eighteen years of age, his being drunk at the time the agreement was made, or his claim\nthat the instruments were trumpets rather than trombones or that they were delivered too late to be of use\nto him\xe2\x80\x94you could expect to recover some compensation for his breaching of your agreement with him.\nAn old saying in the law is that the law does not deal in trifles, or unimportant issues (in Latin, de minimis\nnon curat lex). Not every wrong you may suffer in life will be a cause to bring a court action. If you are\nstood up for a Saturday night date and feel embarrassed or humiliated, you cannot recover anything in a\ncourt of law in the United States, as there is no cause of action (no basis in the positive law) that you can\nuse in your complaint. If you are engaged to be married and your spouse-to-be bolts from the wedding\nceremony, there are some states that do provide a legal basis on which to bring a lawsuit. \xe2\x80\x9cBreach of\npromise to marry\xe2\x80\x9d is recognized in several states, but most states have abolished this cause of action,\neither by judicial decision or by legislation. Whether a runaway bride or groom gives rise to a valid cause\nof action in the courts depends on whether the state courts still recognize and enforce this nowdisappearing cause of action.\nYour cause of action is thus based on existing laws, including decided cases. How closely your case \xe2\x80\x9cfits\xe2\x80\x9d\nwith a prior decided case raises the question of precedent.\nAs noted earlier in this chapter, the English common-law tradition placed great emphasis on precedent\nand what is called stare decisis. A court considering one case would feel obliged to decide that case in a\nway similar to previously decided cases. Written decisions of the most important cases had been spread\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n23\n\n\x0cthroughout England (the common \xe2\x80\x9crealm\xe2\x80\x9d), and judges hoped to establish a somewhat predictable,\nconsistent group of decisions.\nThe English legislature (Parliament) was not in the practice of establishing detailed statutes on crimes,\ntorts, contracts, or property. Thus definitions and rules were left primarily to the courts. By their nature,\ncourts could only decide one case at a time, but in doing so they would articulate holdings, or general\nrules, that would apply to later cases.\nSuppose that one court had to decide whether an employer could fire an employee for no reason at all.\nSuppose that there were no statutes that applied to the facts: there was no contract between the employer\nand the employee, but the employee had worked for the employer for many years, and now a younger\nperson was replacing him. The court, with no past guidelines, would have to decide whether the employee\nhad stated a \xe2\x80\x9ccause of action\xe2\x80\x9d against the employer. If the court decided that the case was not legally\nactionable, it would dismiss the action. Future courts would then treat similar cases in a similar way. In\nthe process, the court might make a holding that employers could fire employees for any reason or for no\nreason. This rule could be applied in the future should similar cases come up.\nBut suppose that an employer fired an employee for not committing perjury (lying on the witness stand in\na court proceeding); the employer wanted the employee to cover up the company\'s criminal or unethical\nact. Suppose that, as in earlier cases, there were no applicable statutes and no contract of employment.\nCourts relying on a holding or precedent that \xe2\x80\x9cemployers may fire employees for any reason or no reason\xe2\x80\x9d\nmight rule against an employee seeking compensation for being fired for telling the truth on the witness\nstand. Or it might make an exception to the general rule, such as, \xe2\x80\x9cEmployers may generally discharge\nemployees for any reason or for no reason without incurring legal liability; however, employers will incur\nlegal liability for firing an employee who refuses to lie on behalf of the employer in a court proceeding.\xe2\x80\x9d\nIn each case (the general rule and its exception), the common-law tradition calls for the court to explain\nthe reasons for its ruling. In the case of the general rule, \xe2\x80\x9cfreedom of choice\xe2\x80\x9d might be the major reason.\nIn the case of the perjury exception, the efficiency of the judicial system and the requirements of\ncitizenship might be used as reasons. Because the court\xe2\x80\x99s \xe2\x80\x9creasons\xe2\x80\x9d will be persuasive to some and not to\nothers, there is inevitably a degree of subjectivity to judicial opinions. That is, reasonable people will\ndisagree as to the persuasiveness of the reasoning a court may offer for its decision.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n24\n\n\x0cWritten judicial opinions are thus a good playing field for developing critical thinking skills by identifying\nthe issue in a case and examining the reasons for the court\xe2\x80\x99s previous decision(s), or holding.\nWhat has the court actually decided, and why? Remember that a court, especially the US Supreme Court,\nis not only deciding one particular case but also setting down guidelines (in its holdings) for federal and\nstate courts that encounter similar issues. Note that court cases often raise a variety of issues or questions\nto be resolved, and judges (and attorneys) will differ as to what the real issue in a case is. A holding is the\ncourt\xe2\x80\x99s complete answer to an issue that is critical to deciding the case and thus gives guidance to the\nmeaning of the case as a precedent for future cases.\nBeyond the decision of the court, it is in looking at the court\xe2\x80\x99s reasoning that you are most likely to\nunderstand what facts have been most significant to the court and what theories (schools of legal thought)\neach trial or appellate judge believes in. Because judges do not always agree on first principles (i.e., they\nsubscribe to different schools of legal thought), there are many divided opinions in appellate opinions and\nin each US Supreme Court term.\n\nKEY TAKEAWAY\n\nThere are different sources of law in the US legal system. The US Constitution is foundational; US statutory\nand common law cannot be inconsistent with its provisions. Congress creates statutory law (with the\nsignature of the president), and courts will interpret constitutional law and statutory law. Where there is\nneither constitutional law nor statutory law, the courts function in the realm of common law. The same is\ntrue of law within the fifty states, each of which also has a constitution, or foundational law.\nBoth the federal government and the states have created administrative agencies. An agency only has the\npower that the legislature gives it. Within the scope of that power, an agency will often create regulations\n(see Chapter 5 "Administrative Law"), which have the same force and effect as statutes. Treaties are never\nnegotiated and concluded by states, as the federal government has exclusive authority over relations with\nother nation-states. A treaty, once ratified by the Senate, has the same force and effect as a statute\npassed by Congress and signed into law by the president.\nConstitutions, statutes, regulations, treaties, and court decisions can provide a legal basis in the positive\nlaw. You may believe you have been wronged, but for you to have a right that is enforceable in court, you\nmust have something in the positive law that you can point to that will support a cause of action against\nyour chosen defendant.\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n25\n\n\x0cEXERCISES\n1.\n\nGive one example of where common law was overridden by the passage of a federal statute.\n\n2.\n\nHow does common law change or evolve without any action on the part of a legislature?\n\n3.\n\nLindsey Paradise is not selected for her sorority of choice at the University of Kansas. She has spent all her\ntime rushing that particular sorority, which chooses some of her friends but not her. She is disappointed\nand angry and wants to sue the sorority. What are her prospects of recovery in the legal system? Explain.\n\n[1] Rulon-Miller v. International Business Machines Corp., 162 Cal. App.3d 241, 255 (1984).\n\n1.5 Legal and Political Systems of the World\nLEARNING OBJECTIVE\n\n1.\n\nDescribe how the common-law system differs from the civil-law system.\n\nOther legal and political systems are very different from the US system, which came from English\ncommon-law traditions and the framers of the US Constitution. Our legal and political traditions are\ndifferent both in what kinds of laws we make and honor and in how disputes are resolved in court.\n\nComparing Common-Law Systems with Other Legal Systems\nThe common-law tradition is unique to England, the United States, and former colonies of the British\nEmpire. Although there are differences among common-law systems (e.g., most nations do not permit\ntheir judiciaries to declare legislative acts unconstitutional; some nations use the jury less frequently), all\nof them recognize the use of precedent in judicial cases, and none of them relies on the comprehensive,\nlegislative codes that are prevalent in civil-law systems.\n\nCivil-Law Systems\nThe main alternative to the common-law legal system was developed in Europe and is based in Roman\nand Napoleonic law. A civil-law or code-law system is one where all the legal rules are in one or more\ncomprehensive legislative enactments. During Napoleon\xe2\x80\x99s reign, a comprehensive book of laws\xe2\x80\x94a code\xe2\x80\x94\nwas developed for all of France. The code covered criminal law, criminal procedure, noncriminal law and\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n26\n\n\x0cprocedure, and commercial law. The rules of the code are still used today in France and in other\ncontinental European legal systems. The code is used to resolve particular cases, usually by judges without\na jury. Moreover, the judges are not required to follow the decisions of other courts in similar cases. As\nGeorge Cameron of the University of Michigan has noted, \xe2\x80\x9cThe law is in the code, not in the cases.\xe2\x80\x9d He\ngoes on to note, \xe2\x80\x9cWhere several cases all have interpreted a provision in a particular way, the French\ncourts may feel bound to reach the same result in future cases, under the doctrine of jurisprudence\nconstante. The major agency for growth and change, however, is the legislature, not the courts.\xe2\x80\x9d\nCivil-law systems are used throughout Europe as well as in Central and South America. Some nations in\nAsia and Africa have also adopted codes based on European civil law. Germany, Holland, Spain, France,\nand Portugal all had colonies outside of Europe, and many of these colonies adopted the legal practices\nthat were imposed on them by colonial rule, much like the original thirteen states of the United States,\nwhich adopted English common-law practices.\nOne source of possible confusion at this point is that we have already referred to US civil law in contrast to\ncriminal law. But the European civil law covers both civil and criminal law.\nThere are also legal systems that differ significantly from the common-law and civil-law systems. The\ncommunist and socialist legal systems that remain (e.g., in Cuba and North Korea) operate on very\ndifferent assumptions than those of either English common law or European civil law. Islamic and other\nreligion-based systems of law bring different values and assumptions to social and commercial relations.\nFor the Islamic and Middle Eastern law, seehttp://www.soas.ac.uk/library/subjects/law/region/islamic.\n\nKEY TAKEAWAY\n\nLegal systems vary widely in their aims and in the way they process civil and criminal cases. Common-law\nsystems use juries, have one judge, and adhere to precedent. Civil-law systems decide cases without a\njury, often use three judges, and often render shorter opinions without reference to previously decided\ncases.\n\n1.\n\nEXERCISE\n\nUse the Internet to identify some of the better-known nations with civil-law systems. Which Asian nations\ncame to adopt all or part of civil-law traditions, and why?\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n27\n\n\x0c1.6 A Sample Case\nPreliminary Note to Students\n\nTitle VII of the Civil Rights Act of 1964 is a federal statute that applies to all employers whose\nworkforce exceeds fifteen people. The text of Title VII says that\n(a) it shall be an unlawful employment practice for an employer\xe2\x80\x94\n(1) to fail or refuse to hire or to discharge any individual, or otherwise to discriminate against\nany individual with respect to his compensation, terms, conditions, or privileges of employment,\nbecause of such individual\xe2\x80\x99s race, color, religion, sex, or natural origin.\n\nAt common law\xe2\x80\x94where judges decide cases without reference to statutory guidance\xe2\x80\x94employers\nwere generally free to hire and fire on any basis they might choose, and employees were generally\nfree to work for an employer or quit an employer on any basis they might choose (unless the\nemployer and the employee had a contract). This rule has been called \xe2\x80\x9cemployment at will.\xe2\x80\x9d State\nand federal statutes that prohibit discrimination on any basis (such as the prohibitions on\ndiscrimination because of race, color, religion, sex, or national origin in Title VII) are essentially\nlegislative exceptions to the common-law employment-at-will rule.\nIn the 1970s, many female employees began to claim a certain kind of sex discrimination: sexual\nharassment. Some women were being asked to give sexual favors in exchange for continued\nemployment or promotion (quid pro quo sexual harassment) or found themselves in a working\nenvironment that put their chances for continued employment or promotion at risk. This form of\nsexual discrimination came to be called \xe2\x80\x9chostile working environment\xe2\x80\x9d sexual harassment.\nNotice that the statute itself says nothing about sexual harassment but speaks only in broad terms\nabout discrimination \xe2\x80\x9cbecause of\xe2\x80\x9d sex (and four other factors). Having set the broad policy, Congress\nleft it to employees, employers, and the courts to fashion more specific rules through the process of\ncivil litigation.\nThis is a case from our federal court system, which has a trial or hearing in the federal district court,\nan appeal to the Sixth Circuit Court of Appeals, and a final appeal to the US Supreme Court. Teresa\nHarris, having lost at both the district court and the Sixth Circuit Court of Appeals, here has\npetitioned for a writ of certiorari (asking the court to issue an order to bring the case to the Supreme\nCourt), a petition that is granted less than one out of every fifty times. The Supreme Court, in other\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n28\n\n\x0cwords, chooses its cases carefully. Here, the court wanted to resolve a difference of opinion among\nthe various circuit courts of appeal as to whether or not a plaintiff in a hostile-working-environment\nclaim could recover damages without showing \xe2\x80\x9csevere psychological injury.\xe2\x80\x9d\nHarris v. Forklift Systems\n510 U.S. 17 (U.S. Supreme Court 1992)\n\nJUDGES: O\xe2\x80\x99CONNOR, J., delivered the opinion for a unanimous Court. SCALIA, J., and\nGINSBURG, J., filed concurring opinions.\nJUSTICE O\xe2\x80\x99CONNOR delivered the opinion of the Court.\nIn this case we consider the definition of a discriminatorily \xe2\x80\x9cabusive work environment\xe2\x80\x9d (also known\nas a \xe2\x80\x9chostile work environment\xe2\x80\x9d) under Title VII of the Civil Rights Act of 1964, 78 Stat. 253, as\namended, 42 U.S.C. \xc2\xa7 2000e et seq. (1988 ed., Supp. III).\nI\nTeresa Harris worked as a manager at Forklift Systems, Inc., an equipment rental company, from\nApril 1985 until October 1987. Charles Hardy was Forklift\xe2\x80\x99s president.\nThe Magistrate found that, throughout Harris\xe2\x80\x99 time at Forklift, Hardy often insulted her because of\nher gender and often made her the target of unwanted sexual innuendoes. Hardy told Harris on\nseveral occasions, in the presence of other employees, \xe2\x80\x9cYou\xe2\x80\x99re a woman, what do you know\xe2\x80\x9d and \xe2\x80\x9cWe\nneed a man as the rental manager\xe2\x80\x9d; at least once, he told her she was \xe2\x80\x9ca dumbass woman.\xe2\x80\x9d Again in\nfront of others, he suggested that the two of them \xe2\x80\x9cgo to the Holiday Inn to negotiate [Harris\xe2\x80\x99s]\nraise.\xe2\x80\x9d Hardy occasionally asked Harris and other female employees to get coins from his front pants\npocket. He threw objects on the ground in front of Harris and other women, and asked them to pick\nthe objects up. He made sexual innuendoes about Harris\xe2\x80\x99 and other women\xe2\x80\x99s clothing.\nIn mid-August 1987, Harris complained to Hardy about his conduct. Hardy said he was surprised\nthat Harris was offended, claimed he was only joking, and apologized. He also promised he would\nstop, and based on this assurance Harris stayed on the job. But in early September, Hardy began\nanew: While Harris was arranging a deal with one of Forklift\xe2\x80\x99s customers, he asked her, again in\nfront of other employees, \xe2\x80\x9cWhat did you do, promise the guy\xe2\x80\xa6some [sex] Saturday night?\xe2\x80\x9d On\nOctober 1, Harris collected her paycheck and quit.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n29\n\n\x0cHarris then sued Forklift, claiming that Hardy\xe2\x80\x99s conduct had created an abusive work environment\nfor her because of her gender. The United States District Court for the Middle District of Tennessee,\nadopting the report and recommendation of the Magistrate, found this to be \xe2\x80\x9ca close case,\xe2\x80\x9d but held\nthat Hardy\xe2\x80\x99s conduct did not create an abusive environment. The court found that some of Hardy\xe2\x80\x99s\ncomments \xe2\x80\x9coffended [Harris], and would offend the reasonable woman,\xe2\x80\x9d but that they were not \xe2\x80\x9cso\nsevere as to be expected to seriously affect [Harris\xe2\x80\x99s] psychological well-being. A reasonable woman\nmanager under like circumstances would have been offended by Hardy, but his conduct would not\nhave risen to the level of interfering with that person\xe2\x80\x99s work performance.\n\xe2\x80\x9cNeither do I believe that [Harris] was subjectively so offended that she suffered injury.\xe2\x80\xa6Although\nHardy may at times have genuinely offended [Harris], I do not believe that he created a working\nenvironment so poisoned as to be intimidating or abusive to [Harris].\xe2\x80\x9d\nIn focusing on the employee\xe2\x80\x99s psychological well-being, the District Court was following Circuit\nprecedent. See Rabidue v. Osceola Refining Co., 805 F.2d 611, 620 (CA6 1986), cert. denied, 481 U.S.\n1041, 95 L. Ed. 2d 823, 107 S. Ct. 1983 (1987). The United States Court of Appeals for the Sixth\nCircuit affirmed in a brief unpublished decision\xe2\x80\xa6reported at 976 F.2d 733 (1992).\nWe granted certiorari, 507 U.S. 959 (1993), to resolve a conflict among the Circuits on whether\nconduct, to be actionable as \xe2\x80\x9cabusive work environment\xe2\x80\x9d harassment (no quid pro quo harassment\nissue is present here), must \xe2\x80\x9cseriously affect [an employee\xe2\x80\x99s] psychological well-being\xe2\x80\x9d or lead the\nplaintiff to \xe2\x80\x9csuffer injury.\xe2\x80\x9d Compare Rabidue (requiring serious effect on psychological well-being);\nVance v. Southern Bell Telephone & Telegraph Co., 863 F.2d 1503, 1510 (CA11 1989) (same); and\nDownes v. FAA, 775 F.2d 288, 292 (CA Fed. 1985) (same), with Ellison v. Brady, 924 F.2d 872, 877\xe2\x80\x93\n878 (CA9 1991) (rejecting such a requirement).\nII\nTitle VII of the Civil Rights Act of 1964 makes it \xe2\x80\x9can unlawful employment practice for an\nemployer\xe2\x80\xa6to discriminate against any individual with respect to his compensation, terms,\nconditions, or privileges of employment, because of such individual\xe2\x80\x99s race, color, religion, sex, or\nnational origin.\xe2\x80\x9d 42 U.S.C. \xc2\xa7 2000e-2(a)(1). As we made clear in Meritor Savings Bank, FSB v.\nVinson, 477 U.S. 57 (1986), this language \xe2\x80\x9cis not limited to \xe2\x80\x98economic\xe2\x80\x99 or \xe2\x80\x98tangible\xe2\x80\x99 discrimination.\nThe phrase \xe2\x80\x98terms, conditions, or privileges of employment\xe2\x80\x99 evinces a congressional intent \xe2\x80\x98to strike\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n30\n\n\x0cat the entire spectrum of disparate treatment of men and women\xe2\x80\x99 in employment,\xe2\x80\x9d which includes\nrequiring people to work in a discriminatorily hostile or abusive environment. Id., at 64, quoting Los\nAngeles Dept. of Water and Power v. Manhart, 435 U.S. 702, 707, n.13, 55 L. Ed. 2d 657, 98 S. Ct.\n1370 (1978). When the workplace is permeated with \xe2\x80\x9cdiscriminatory intimidation, ridicule, and\ninsult,\xe2\x80\x9d 477 U.S. at 65, that is \xe2\x80\x9csufficiently severe or pervasive to alter the conditions of the victim\xe2\x80\x99s\nemployment and create an abusive working environment,\xe2\x80\x9d Title VII is violated.\nThis standard, which we reaffirm today, takes a middle path between making actionable any conduct\nthat is merely offensive and requiring the conduct to cause a tangible psychological injury. As we\npointed out in Meritor, \xe2\x80\x9cmere utterance of an\xe2\x80\xa6epithet which engenders offensive feelings in an\nemployee,\xe2\x80\x9d does not sufficiently affect the conditions of employment to implicate Title VII. Conduct\nthat is not severe or pervasive enough to create an objectively hostile or abusive work environment\xe2\x80\x94\nan environment that a reasonable person would find hostile or abusive\xe2\x80\x94is beyond Title VII\xe2\x80\x99s\npurview. Likewise, if the victim does not subjectively perceive the environment to be abusive, the\nconduct has not actually altered the conditions of the victim\xe2\x80\x99s employment, and there is no Title VII\nviolation.\nBut Title VII comes into play before the harassing conduct leads to a nervous breakdown. A\ndiscriminatorily abusive work environment, even one that does not seriously affect employees\xe2\x80\x99\npsychological well-being, can and often will detract from employees\xe2\x80\x99 job performance, discourage\nemployees from remaining on the job, or keep them from advancing in their careers. Moreover, even\nwithout regard to these tangible effects, the very fact that the discriminatory conduct was so severe\nor pervasive that it created a work environment abusive to employees because of their race, gender,\nreligion, or national origin offends Title VII\xe2\x80\x99s broad rule of workplace equality. The appalling conduct\nalleged in Meritor, and the reference in that case to environments \xe2\x80\x9c\xe2\x80\x98so heavily polluted with\ndiscrimination as to destroy completely the emotional and psychological stability of minority group\nworkers,\xe2\x80\x99\xe2\x80\x9d Id., at 66, quoting Rogers v. EEOC, 454 F.2d 234, 238 (CA5 1971), cert. denied, 406 U.S.\n957,32 L. Ed. 2d 343, 92 S. Ct. 2058 (1972), merely present some especially egregious examples of\nharassment. They do not mark the boundary of what is actionable.\nWe therefore believe the District Court erred in relying on whether the conduct \xe2\x80\x9cseriously affected\nplaintiff\xe2\x80\x99s psychological well-being\xe2\x80\x9d or led her to \xe2\x80\x9csuffer injury.\xe2\x80\x9d Such an inquiry may needlessly\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n31\n\n\x0cfocus the fact finder\xe2\x80\x99s attention on concrete psychological harm, an element Title VII does not\nrequire. Certainly Title VII bars conduct that would seriously affect a reasonable person\xe2\x80\x99s\npsychological well-being, but the statute is not limited to such conduct. So long as the environment\nwould reasonably be perceived, and is perceived, as hostile or abusive, Meritor, supra, at 67, there is\nno need for it also to be psychologically injurious.\nThis is not, and by its nature cannot be, a mathematically precise test. We need not answer today all\nthe potential questions it raises, nor specifically address the Equal Employment Opportunity\nCommission\xe2\x80\x99s new regulations on this subject, see 58 Fed. Reg. 51266 (1993) (proposed 29 CFR \xc2\xa7\xc2\xa7\n1609.1, 1609.2); see also 29 CFR \xc2\xa7 1604.11 (1993). But we can say that whether an environment is\n\xe2\x80\x9chostile\xe2\x80\x9d or \xe2\x80\x9cabusive\xe2\x80\x9d can be determined only by looking at all the circumstances. These may include\nthe frequency of the discriminatory conduct; its severity; whether it is physically threatening or\nhumiliating, or a mere offensive utterance; and whether it unreasonably interferes with an\nemployee\xe2\x80\x99s work performance. The effect on the employee\xe2\x80\x99s psychological well-being is, of course,\nrelevant to determining whether the plaintiff actually found the environment abusive. But while\npsychological harm, like any other relevant factor, may be taken into account, no single factor is\nrequired.\nIII\nForklift, while conceding that a requirement that the conduct seriously affect psychological wellbeing is unfounded, argues that the District Court nonetheless correctly applied the Meritor\nstandard. We disagree. Though the District Court did conclude that the work environment was not\n\xe2\x80\x9cintimidating or abusive to [Harris],\xe2\x80\x9d it did so only after finding that the conduct was not \xe2\x80\x9cso severe\nas to be expected to seriously affect plaintiff\xe2\x80\x99s psychological well-being,\xe2\x80\x9d and that Harris was not\n\xe2\x80\x9csubjectively so offended that she suffered injury,\xe2\x80\x9d ibid. The District Court\xe2\x80\x99s application of these\nincorrect standards may well have influenced its ultimate conclusion, especially given that the court\nfound this to be a \xe2\x80\x9cclose case.\xe2\x80\x9d\nWe therefore reverse the judgment of the Court of Appeals, and remand the case for further\nproceedings consistent with this opinion.\nSo ordered.\nNote to Students\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n32\n\n\x0cThis was only the second time that the Supreme Court had decided a sexual harassment case. Many\nfeminist legal studies scholars feared that the court would raise the bar and make hostile-workingenvironment claims under Title VII more difficult to win. That did not happen. When the question to be\ndecided is combined with the court\xe2\x80\x99s decision, we get the holding of the case. Here, the question that the\ncourt poses, plus its answer, yields a holding that \xe2\x80\x9cAn employee need not prove severe psychological\ninjury in order to win a Title VII sexual harassment claim.\xe2\x80\x9d This holding will be true until such time as the\ncourt revisits a similar question and answers it differently. This does happen, but happens rarely.\n\nCASE QUESTIONS\n\n1.\n\nIs this a criminal case or a civil-law case? How can you tell?\n\n2.\n\nIs the court concerned with making a procedural rule here, or is the court making a statement about the\nsubstantive law?\n\n3.\n\nIs this a case where the court is interpreting the Constitution, a federal statute, a state statute, or the\ncommon law?\n\n4.\n\nIn Harris v. Forklift, what if the trial judge does not personally agree that women should have any rights to\nequal treatment in the workplace? Why shouldn\xe2\x80\x99t that judge dismiss the case even before trial? Or should\nthe judge dismiss the case after giving the female plaintiff her day in court?\n\n5.\n\nWhat was the employer\xe2\x80\x99s argument in this case? Do you agree or disagree with it? What if those who\nlegislated Title VII gave no thought to the question of seriousness of injury at all?\n\n1.7 Summary and Exercises\nSummary\n\nThere are differing conceptions of what law is and of what law should be. Laws and legal systems differ\nworldwide. The legal system in the United States is founded on the US Constitution, which is itself\ninspired by natural-law theory and the idea that people have rights that cannot be taken by government\nbut only protected by government. The various functions of the law are done well or poorly depending on\nwhich nation-state you look at. Some do very well in terms of keeping order, while others do a better job\nof allowing civil and political freedoms. Social and political movements within each nation greatly affect\nthe nature and quality of the legal system within that nation.\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n33\n\n\x0cThis chapter has familiarized you with a few of the basic schools of legal thought, such as natural law,\npositive law, legal realism, and critical legal studies. It has also given you a brief background in common\nlaw, including contracts, torts, and criminal law. The differences between civil and criminal cases,\nsubstance and procedure, and the various sources of law have also been reviewed. Each source has a\ndifferent level of authority, starting with constitutions, which are primary and will negate any lower-court\nlaws that are not consistent with its principles and provisions. The basic differences between the common\nlaw and civil law (continental, or European) systems of law are also discussed.\n\nEXERCISES\n\n1.\n\nWhat is the common law? Where do the courts get the authority to interpret it and to change it?\n\n2.\n\nAfter World War II ended in 1945, there was an international tribunal at Nuremberg that prosecuted\nvarious officials in Germany\xe2\x80\x99s Third Reich who had committed \xe2\x80\x9ccrimes against humanity.\xe2\x80\x9d Many of them\nclaim that they were simply \xe2\x80\x9cfollowing orders\xe2\x80\x9d of Adolf Hitler and his chief lieutenants. What law, if any,\nhave they violated?\n\n3.\n\nWhat does stare decisis mean, and why is it so basic to common-law legal tradition?\n4.\n\nIn the following situations, which source of law takes priority, and why?\na.\n\nThe state statute conflicts with the common law of that state.\n\nb.\n\nA federal statute conflicts with the US Constitution.\n\nc.\n\nA common-law decision in one state conflicts with the US Constitution.\n\nd.\n\nA federal statute conflicts with a state constitution.\n\n1.\n\nThe source of law that is foundational in the US legal system is\n\na.\n\nSELF-TEST QUESTIONS\n\nthe common law\nb.\n\nstatutory law\n\nc.\n\nconstitutional law\n\nd.\n\nadministrative law\n\n\xe2\x80\x9cLaw is the command of a sovereign\xe2\x80\x9d represents what school of legal thought?\na.\n\ncivil law\nb.\n\nconstitutional law\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n34\n\n\x0cc.\n\nnatural law\n\nd.\n\necofeminist law\n\ne.\n\npositive law\nWhich of the following kinds of law are most often found in state law rather than federal law?\n\na.\n\ntorts and contracts\nb.\n\nbankruptcy\n\nc.\n\nmaritime law\n\nd.\n\ninternational law\n\nWhere was natural law discovered?\na.\n\nin nature\nb.\n\nin constitutions and statutes\n\nc.\n\nin the exercise of human reason\n\nd.\n\nin the Wall Street Journal\n\nWolfe is a state court judge in California. In the case of Riddick v. Clouse, which involves a\ncontract dispute, Wolfe must follow precedent. She establishes a logical relationship between the\nRiddick case and a case decided by the California Supreme Court,Zhu v. Patel Enterprises, Inc. She\ncompares the facts of Riddick to the facts in Zhu and to the extent the facts are similar, applies the\nsame rule to reach her decision. This is\na.\n\ndeductive reasoning\nb.\n\nfaulty reasoning\n\nc.\n\nlinear reasoning\n\nd.\n\nreasoning by analogy\n\nMoore is a state court judge in Colorado. In the case of Cassidy v. Seawell, also a contract\ndispute, there is no Colorado Supreme Court or court of appeals decision that sets forth a rule that\ncould be applied. However, the California case of Zhu v. Patel Enterprises, Inc.is \xe2\x80\x9cvery close\xe2\x80\x9d on\nthe facts and sets forth a rule of law that could be applied to the Cassidy case. What process must\nMoore follow in considering whether to use the Zhu case as precedent?\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n35\n\n\x0ca.\n\nMoore is free to decide the case any way he wants, but he may not look at decisions and reasons\n\nin similar cases from other states.\nb.\n\nMoore must wait for the Colorado legislature and the governor to pass a law that\naddresses the issues raised in the Cassidy case.\n\nc.\n\nMoore must follow the California case if that is the best precedent.\n\nd.\n\nMoore may follow the California case if he believes that it offers the best reasoning for\na similar case.\n\n1.\n\nc\n\n2.\n\ne\n\n3.\n\na\n\n4.\n\nc\n\n5.\n\nd\n\n6.\n\nd\n\nSELF-TEST ANSWERS\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n36\n\n\x0cChapter 2\n\nCorporate Social Responsibility and Business Ethics\nA great society is a society in which [leaders] of business think greatly about their functions.\nAlfred North Whitehead\n\nLEARNING OBJECTIVES\n\nAfter reading this chapter, you should be able to do the following:\n1.\n\nDefine ethics and explain the importance of good ethics for business people and business organizations.\n\n2.\n\nUnderstand the principal philosophies of ethics, including utilitarianism, duty-based ethics, and virtue\nethics.\n\n3.\n\nDistinguish between the ethical merits of various choices by using an ethical decision model.\n\n4.\n\nExplain the difference between shareholder and stakeholder models of ethical corporate governance.\n\n5.\n\nExplain why it is difficult to establish and maintain an ethical corporate culture in a business organization.\n\nFew subjects are more contentious or important as the role of business in society, particularly,\nwhether corporations have social responsibilities that are distinct from maximizing shareholder\nvalue. While the phrase \xe2\x80\x9cbusiness ethics\xe2\x80\x9d is not oxymoronic (i.e., a contradiction in terms), there is\nplenty of evidence that businesspeople and firms seek to look out primarily for themselves. However,\nbusiness organizations ignore the ethical and social expectations of consumers, employees, the\nmedia, nongovernment organizations (NGOs), government officials, and socially responsible\ninvestors at their peril. Legal compliance alone no longer serves the long-term interests of many\ncompanies, who find that sustainable profitability requires thinking about people and the planet as\nwell as profits.\nThis chapter has a fairly modest aim: to introduce potential businesspeople to the differences\nbetween legal compliance and ethical excellence by reviewing some of the philosophical perspectives\nthat apply to business, businesspeople, and the role of business organizations in society.\n\n2.1 What Is Ethics?\n\nLEARNING OBJECTIVES\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n37\n\n\x0c1.\n\nExplain how both individuals and institutions can be viewed as ethical or unethical.\n\n2.\n\nExplain how law and ethics are different, and why a good reputation can be more important than legal\ncompliance.\n\nMost of those who write about ethics do not make a clear distinction between ethics and morality.\nThe question of what is \xe2\x80\x9cright\xe2\x80\x9d or \xe2\x80\x9cmorally correct\xe2\x80\x9d or \xe2\x80\x9cethically correct\xe2\x80\x9d or \xe2\x80\x9cmorally desirable\xe2\x80\x9d in\nany situation is variously phrased, but all of the words and phrases are after the same thing: what act\nis \xe2\x80\x9cbetter\xe2\x80\x9d in a moral or ethical sense than some other act? People sometimes speak of morality as\nsomething personal but view ethics as having wider social implications. Others see morality as the\nsubject of a field of study, that field being ethics. Ethics would be morality as applied to any number\nof subjects, including journalistic ethics, business ethics, or the ethics of professionals such as\ndoctors, attorneys, and accountants. We will venture a definition of ethics, but for our purposes,\nethics and morality will be used as equivalent terms.\n\nPeople often speak about the ethics or morality of individuals and also about the morality or ethics of\ncorporations and nations. There are clearly differences in the kind of moral responsibility that we can\nfairly ascribe to corporations and nations; we tend to see individuals as having a soul, or at least a\nconscience, but there is no general agreement that nations or corporations have either. Still, our\nordinary use of language does point to something significant: if we say that some nations are \xe2\x80\x9cevil\xe2\x80\x9d\nand others are \xe2\x80\x9ccorrupt,\xe2\x80\x9d then we make moral judgments about the quality of actions undertaken by\nthe governments or people of that nation. For example, if North Korea is characterized by the US\npresident as part of an \xe2\x80\x9caxis of evil,\xe2\x80\x9d or if we conclude that WorldCom or Enron acted \xe2\x80\x9cunethically\xe2\x80\x9d in\ncertain respects, then we are making judgments that their collective actions are morally deficient.\nIn talking about morality, we often use the word good; but that word can be confusing. If we say that\nMicrosoft is a \xe2\x80\x9cgood company,\xe2\x80\x9d we may be making a statement about the investment potential of\nMicrosoft stock, or their preeminence in the market, or their ability to win lawsuits or appeals or to\ninfluence administrative agencies. Less likely, though possibly, we may be making a statement about\nthe civic virtue and corporate social responsibility of Microsoft. In the first set of judgments, we use\nthe word good but mean something other than ethical or moral; only in the second instance are we\nusing the word good in its ethical or moral sense.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n38\n\n\x0cA word such as good can embrace ethical or moral values but also nonethical values. If I like Daniel\nand try to convince you what a \xe2\x80\x9cgood guy\xe2\x80\x9d he is, you may ask all sorts of questions: Is he goodlooking? Well-off? Fun to be with? Humorous? Athletic? Smart? I could answer all of those questions\nwith a yes, yet you would still not know any of his moral qualities. But if I said that he was honest,\ncaring, forthright, and diligent, volunteered in local soup kitchens, or tithed to the church, many\npeople would see Daniel as having certain ethical or moral qualities. If I said that he keeps the\nGolden Rule as well as anyone I know, you could conclude that he is an ethical person. But if I said\nthat he is \xe2\x80\x9calways in control\xe2\x80\x9d or \xe2\x80\x9calways at the top of his game,\xe2\x80\x9d you would probably not make\ninferences or assumptions about his character or ethics.\nThere are three key points here:\n1.\n\nAlthough morals and ethics are not precisely measurable, people generally have similar reactions\nabout what actions or conduct can rightly be called ethical or moral.\n\n2. As humans, we need and value ethical people and want to be around them.\n3. Saying that someone or some organization is law-abiding does not mean the same as saying a person\nor company is ethical.\n\nHere is a cautionary note: for individuals, it is far from easy to recognize an ethical problem, have a\nclear and usable decision-making process to deal it, and then have the moral courage to do what\xe2\x80\x99s\nright. All of that is even more difficult within a business organization, where corporate employees\nvary in their motivations, loyalties, commitments, and character. There is no universally accepted\nway for developing an organization where employees feel valued, respected, and free to openly\ndisagree; where the actions of top management are crystal clear; and where all the employees feel\nloyal and accountable to one another.\nBefore talking about how ethics relates to law, we can conclude that ethics is the study of morality\xe2\x80\x94\n\xe2\x80\x9cright\xe2\x80\x9d and \xe2\x80\x9cwrong\xe2\x80\x9d\xe2\x80\x94in the context of everyday life, organizational behaviors, and even how society\noperates and is governed.\n\nHow Do Law and Ethics Differ?\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n39\n\n\x0cThere is a difference between legal compliance and moral excellence. Few would choose a professional\nservice, health care or otherwise, because the provider had a record of perfect legal compliance, or always\nfollowing the letter of the law. There are many professional ethics codes, primarily because people realize\nthat law prescribes only a minimum of morality and does not provide purpose or goals that can mean\nexcellent service to customers, clients, or patients.\nBusiness ethicists have talked for years about the intersection of law and ethics. Simply put, what is legal\nis not necessarily ethical. Conversely, what is ethical is not necessarily legal. There are lots of legal\nmaneuvers that are not all that ethical; the well-used phrase \xe2\x80\x9clegal loophole\xe2\x80\x9d suggests as much.\nHere are two propositions about business and ethics. Consider whether they strike you as true or whether\nyou would need to know more in order to make a judgment.\n\xe2\x80\xa2\n\nIndividuals and organizations have reputations. (For an individual, moral reputation is most often\ntied to others\xe2\x80\x99 perceptions of his or her character: is the individual honest, diligent, reliable, fair, and\ncaring? The reputation of an organization is built on the goodwill that suppliers, customers, the\ncommunity, and employees feel toward it. Although an organization is not a person in the usual sense,\nthe goodwill that people feel about the organization is based on their perception of its better qualities\nby a variety of stakeholders: customers or clients, suppliers, investors, employees, government\nofficials).\n\n\xe2\x80\xa2\n\nThe goodwill of an organization is to a great extent based on the actions it takes and on whether the\nactions are favorably viewed. (This goodwill is usually specifically counted in the sale of a business as\nan asset that the buyer pays for. While it is difficult to place a monetary value on goodwill, a firm\xe2\x80\x99s\ngood reputation will generally call for a higher evaluation in the final accounting before the sale. Legal\ntroubles or a reputation for having legal troubles will only lessen the price for a business and will even\nlessen the value of the company\xe2\x80\x99s stock as bad legal news comes to the public\xe2\x80\x99s attention.)\n\nAnother reason to think about ethics in connection with law is that the laws themselves are meant to\nexpress some moral view. If there are legal prohibitions against cheating the Medicare program, it is\nbecause people (legislators or their agents) have collectively decided that cheating Medicare is wrong. If\nthere are legal prohibitions against assisting someone to commit suicide, it is because there has been a\ngroup decision that doing so is immoral. Thus the law provides some important cues as to what society\nregards as right or wrong.\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n40\n\n\x0cFinally, important policy issues that face society are often resolved through law, but it is important to\nunderstand the moral perspectives that underlie public debate\xe2\x80\x94as, for example, in the continuing\ncontroversies over stem-cell research, medical use of marijuana, and abortion. Some ethical perspectives\nfocus on rights, some on social utility, some on virtue or character, and some on social justice. People\nconsciously (or, more often, unconsciously) adopt one or more of these perspectives, and even if they\ncompletely agree on the facts with an opponent, they will not change their views. Fundamentally, the\ndifference comes down to incompatible moral perspectives, a clash of basic values. These are hot-button\nissues because society is divided, not so much over facts, but over basic values. Understanding the varied\nmoral perspectives and values in public policy debates is a clarifying benefit in following or participating\nin these important discussions.\n\nWhy Should an Individual or a Business Entity Be Ethical?\nThe usual answer is that good ethics is good business. In the long run, businesses that pay attention to\nethics as well as law do better; they are viewed more favorably by customers. But this is a difficult claim to\nmeasure scientifically, because \xe2\x80\x9cthe long run\xe2\x80\x9d is an indistinct period of time and because there are as yet\nno generally accepted criteria by which ethical excellence can be measured. In addition, life is still lived in\nthe short run, and there are many occasions when something short of perfect conduct is a lot more\nprofitable.\nSome years ago, Royal Dutch/Shell (one of the world\xe2\x80\x99s largest companies) found that it was in deep\ntrouble with the public for its apparent carelessness with the environment and human rights. Consumers\nwere boycotting and investors were getting frightened, so the company took a long, hard look at its ethic\nof short-term profit maximization. Since then, changes have been made. The CEO told one group of\nbusiness ethicists that the uproar had taken them by surprise; they thought they had done everything\nright, but it seemed there was a \xe2\x80\x9cghost in the machine.\xe2\x80\x9d That ghost was consumers, NGOs, and the media,\nall of whom objected to the company\xe2\x80\x99s seeming lack of moral sensitivity.\nThe market does respond to unethical behavior. In Section 2.4 "Corporations and Corporate Governance",\nyou will read about the Sears Auto Centers case. The loss of goodwill toward Sears Auto Centers was real,\neven though the total amount of money lost cannot be clearly accounted for. Years later, there are people\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n41\n\n\x0cwho will not go near a Sears Auto Center; the customers who lost trust in the company will never return,\nand many of their children may avoid Sears Auto Centers as well.\nThe Arthur Andersen story is even more dramatic. A major accounting firm, Andersen worked closely\nwith Enron in hiding its various losses through creative accounting measures. Suspiciously, Andersen\xe2\x80\x99s\nHouston office also did some shredding around the clock, appearing to cover up what it was doing for\nEnron. A criminal case based on this shredding resulted in a conviction, later overturned by the Supreme\nCourt. But it was too late. Even before the conviction, many clients had found other accounting firms that\nwere not under suspicion, and the Supreme Court\xe2\x80\x99s reversal came too late to save the company. Even\nwithout the conviction, Andersen would have lost significant market share.\nThe irony of Andersen as a poster child for overly aggressive accounting practices is that the man who\nfounded the firm built it on integrity and straightforward practices. \xe2\x80\x9cThink straight, talk straight\xe2\x80\x9d was the\ncompany\xe2\x80\x99s motto. Andersen established the company\xe2\x80\x99s reputation for integrity over a hundred years ago\nby refusing to play numbers games for a potentially lucrative client.\nMaximizing profits while being legally compliant is not a very inspiring goal for a business. People in an\norganization need some quality or excellence to strive for. By focusing on pushing the edge of what is\nlegal, by looking for loopholes in the law that would help create short-term financial gain, companies have\noften learned that in the long term they are not actually satisfying the market, the shareholders, the\nsuppliers, or the community generally.\n\nKEY TAKEAWAY\n\nLegal compliance is not the same as acting ethically. Your reputation, individually or corporately, depends\non how others regard your actions. Goodwill is hard to measure or quantify, but it is real nonetheless and\ncan best be protected by acting ethically.\n\n1.\n\nEXERCISES\n\nThink of a person who did something morally wrong, at least to your way of thinking. What was it?\nExplain to a friend of yours\xe2\x80\x94or a classmate\xe2\x80\x94why you think it was wrong. Does your friend agree? Why or\nwhy not? What is the basic principle that forms the basis for your judgment that it was wrong?\n\n2.\n\nThink of a person who did something morally right, at least to your way of thinking. (This is not a matter\nof finding something they did well, like efficiently changing a tire, but something good.) What was it?\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n42\n\n\x0cExplain to a friend of yours\xe2\x80\x94or a classmate\xe2\x80\x94why you think it was right. Does your friend agree? Why or\nwhy not? What is the basic principle that forms the basis for your judgment that it was right?\n3.\n\nThink of an action by a business organization (sole proprietor, partnership, or corporation) that was legal\nbut still strikes you as wrong. What was it? Why do you think it was wrong?\n\n4.\n\nThink of an act by an individual or a corporation that is ethical but not legal. Compare your answer with\nthose of your classmates: were you more likely to find an example from individual action or corporate\naction? Do you have any thoughts as to why?\n\n2.2 Major Ethical Perspectives\n\nLEARNING OBJECTIVES\n\n1.\n\nDescribe the various major theories about ethics in human decision making.\n\n2.\n\nBegin considering how the major theories about ethics apply to difficult choices in life and business.\n\nThere are several well-respected ways of looking at ethical issues. Some of them have been around\nfor centuries. It is important to know that many who think a lot about business and ethics have\ndeeply held beliefs about which perspective is best. Others would recommend considering ethical\nproblems from a variety of different perspectives. Here, we take a brief look at (1) utilitarianism, (2)\ndeontology, (3) social justice and social contract theory, and (4) virtue theory. We are leaving out\nsome important perspectives, such as general theories of justice and \xe2\x80\x9crights\xe2\x80\x9d and feminist thought\nabout ethics and patriarchy.\n\nUtilitarianism\nUtilitarianism is a prominent perspective on ethics, one that is well aligned with economics and the freemarket outlook that has come to dominate much current thinking about business, management, and\neconomics. Jeremy Bentham is often considered the founder of utilitarianism, though John Stuart Mill\n(who wrote On Liberty and Utilitarianism) and others promoted it as a guide to what is good.\nUtilitarianism emphasizes not rules but results. An action (or set of actions) is generally deemed good or\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n43\n\n\x0cright if it maximizes happiness or pleasure throughout society. Originally intended as a guide for\nlegislators charged with seeking the greatest good for society, the utilitarian outlook may also be practiced\nindividually and by corporations.\nBentham believed that the most promising way to obtain agreement on the best policies for a society\nwould be to look at the various policies a legislature could pass and compare the good and bad\nconsequences of each. The right course of action from an ethical point of view would be to choose the\npolicy that would produce the greatest amount of utility, or usefulness. In brief, the utilitarian principle\nholds that an action is right if and only if the sum of utilities produced by that action is greater than the\nsum of utilities from any other possible act.\nThis statement describes \xe2\x80\x9cact utilitarianism\xe2\x80\x9d\xe2\x80\x94which action among various options will deliver the\ngreatest good to society? \xe2\x80\x9cRule utilitarianism\xe2\x80\x9d is a slightly different version; it asks, what rule or principle,\nif followed regularly, will create the greatest good?\nNotice that the emphasis is on finding the best possible results and that the assumption is that we can\nmeasure the utilities involved. (This turns out to be more difficult that you might think.) Notice also that\n\xe2\x80\x9cthe sum total of utilities\xe2\x80\x9d clearly implies that in doing utilitarian analysis, we cannot be satisfied if an act\nor set of acts provides the greatest utility to us as individuals or to a particular corporation; the test is,\ninstead, whether it provides the greatest utility to society as a whole. Notice that the theory does not tell us\nwhat kinds of utilities may be better than others or how much better a good today is compared with a\ngood a year from today.\nWhatever its difficulties, utilitarian thinking is alive and well in US law and business. It is found in such\ndiverse places as cost-benefit analysis in administrative and regulatory rules and calculations,\nenvironmental impact studies, the majority vote, product comparisons for consumer information,\nmarketing studies, tax laws, and strategic planning. In management, people will often employ a form of\nutility reasoning by projecting costs and benefits for plan X versus plan Y. But the issue in most of these\ncost-benefit analyses is usually (1) put exclusively in terms of money and (2) directed to the benefit of the\nperson or organization doing the analysis and not to the benefit of society as a whole.\nAn individual or a company that consistently uses the test \xe2\x80\x9cWhat\xe2\x80\x99s the greatest good for me or the\ncompany?\xe2\x80\x9d is not following the utilitarian test of the greatest good overall. Another common failing is to\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n44\n\n\x0csee only one or two options that seem reasonable. The following are some frequent mistakes that people\nmake in applying what they think are utilitarian principles in justifying their chosen course of action:\n1.\n\nFailing to come up with lots of options that seem reasonable and then choosing the one that has the\ngreatest benefit for the greatest number. Often, a decision maker seizes on one or two alternatives\nwithout thinking carefully about other courses of action. If the alternative does more good than harm,\nthe decision maker assumes it\xe2\x80\x99s ethically okay.\n\n2. Assuming that the greatest good for you or your company is in fact the greatest good for all\xe2\x80\x94that is,\nlooking at situations subjectively or with your own interests primarily in mind.\n3. Underestimating the costs of a certain decision to you or your company. The now-classic Ford Pinto\ncase demonstrates how Ford Motor Company executives drastically underestimated the legal costs of\nnot correcting a feature on their Pinto models that they knew could cause death or injury. General\nMotors was often taken to task by juries that came to understand that the company would not recall\nor repair known and dangerous defects because it seemed more profitable not to. In 2010, Toyota\nlearned the same lesson.\n4. Underestimating the cost or harm of a certain decision to someone else or some other group of\npeople.\n5.\n\nFavoring short-term benefits, even though the long-term costs are greater.\n\n6. Assuming that all values can be reduced to money. In comparing the risks to human health or safety\nagainst, say, the risks of job or profit losses, cost-benefit analyses will often try to compare apples to\noranges and put arbitrary numerical values on human health and safety.\n\nRules and Duty: Deontology\nIn contrast to the utilitarian perspective, the deontological view presented in the writings of Immanuel\nKant purports that having a moral intent and following the right rules is a better path to ethical conduct\nthan achieving the right results. A deontologist like Kant is likely to believe that ethical action arises from\ndoing one\xe2\x80\x99s duty and that duties are defined by rational thought. Duties, according to Kant, are not\nspecific to particular kinds of human beings but are owed universally to all human beings. Kant therefore\nuses \xe2\x80\x9cuniversalizing\xe2\x80\x9c as a form of rational thought that assumes the inherent equality of all human beings.\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n45\n\n\x0cIt considers all humans as equal, not in the physical, social, or economic sense, but equal before God,\nwhether they are male, female, Pygmy, Eskimoan, Islamic, Christian, gay, straight, healthy, sick, young, or\nold.\nFor Kantian thinkers, this basic principle of equality means that we should be able to universalize any\nparticular law or action to determine whether it is ethical. For example, if you were to consider\nmisrepresenting yourself on a resume for a particular job you really wanted and you were convinced that\ndoing so would get you that job, you might be very tempted to do so. (What harm would it be? you might\nask yourself. When I have the job, I can prove that I was perfect for it, and no one is hurt, while both the\nemployer and I are clearly better off as a result!) Kantian ethicists would answer that your chosen course\nof action should be a universal one\xe2\x80\x94a course of action that would be good for all persons at all times.\nThere are two requirements for a rule of action to be universal: consistency and reversibility. Consider\nreversibility: if you make a decision as though you didn\xe2\x80\x99t know what role or position you would have after\nthe decision, you would more likely make an impartial one\xe2\x80\x94you would more likely choose a course of\naction that would be most fair to all concerned, not just you. Again, deontology requires that we put duty\nfirst, act rationally, and give moral weight to the inherent equality of all human beings.\nIn considering whether to lie on your resume, reversibility requires you to actively imagine both that you\nwere the employer in this situation and that you were another well-qualified applicant who lost the job\nbecause someone else padded his resume with false accomplishments. If the consequences of such an\nexercise of the imagination are not appealing to you, your action is probably not ethical.\nThe second requirement for an action to be universal is the search for consistency. This is more abstract.\nA deontologist would say that since you know you are telling a lie, you must be willing to say that lying, as\na general, universal phenomenon, is acceptable. But if everyone lied, then there would be no point to\nlying, since no one would believe anyone. It is only because honesty works well for society as a whole and\nis generally practiced that lying even becomes possible! That is, lying cannot be universalized, for it\ndepends on the preexistence of honesty.\nSimilar demonstrations can be made for actions such as polluting, breaking promises, and committing\nmost crimes, including rape, murder, and theft. But these are the easy cases for Kantian thinkers. In the\ngray areas of life as it is lived, the consistency test is often difficult to apply. If breaking a promise would\nsave a life, then Kantian thought becomes difficult to apply. If some amount of pollution can allow\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n46\n\n\x0cemployment and the harm is minimal or distant, Kantian thinking is not all that helpful. Finally, we\nshould note that the well-known Golden Rule, \xe2\x80\x9cDo unto others as you would have them do unto you,\xe2\x80\x9d\nemphasizes the easier of the two universalizing requirements: practicing reversibility (\xe2\x80\x9cHow would I like it\nif someone did this to me?\xe2\x80\x9d).\n\nSocial Justice Theory and Social Contract Theory\nSocial justice theorists worry about \xe2\x80\x9cdistributive justice\xe2\x80\x9d\xe2\x80\x94that is, what is the fair way to distribute goods\namong a group of people? Marxist thought emphasizes that members of society should be given goods to\naccording to their needs. But this redistribution would require a governing power to decide who gets what\nand when. Capitalist thought takes a different approach, rejecting any giving that is not voluntary. Certain\neconomists, such as the late Milton Friedman (see the sidebar in Section 2.4 "Corporations and Corporate\nGovernance") also reject the notion that a corporation has a duty to give to unmet needs in society,\nbelieving that the government should play that role. Even the most dedicated free-market capitalist will\noften admit the need for some government and some forms of welfare\xe2\x80\x94Social Security, Medicare,\nassistance to flood-stricken areas, help for AIDs patients\xe2\x80\x94along with some public goods (such as defense,\neducation, highways, parks, and support of key industries affecting national security).\nPeople who do not see the need for public goods (including laws, court systems, and the government\ngoods and services just cited) often question why there needs to be a government at all. One response\nmight be, \xe2\x80\x9cWithout government, there would be no corporations.\xe2\x80\x9d Thomas Hobbes believed that people in\na \xe2\x80\x9cstate of nature\xe2\x80\x9d would rationally choose to have some form of government. He called this\nthe social contract, where people give up certain rights to government in exchange for security and\ncommon benefits. In your own lives and in this course, you will see an ongoing balancing act between\nhuman desires for freedom and human desires for order; it is an ancient tension. Some commentators\nalso see a kind of social contract between corporations and society; in exchange for perpetual duration\nand limited liability, the corporation has some corresponding duties toward society. Also, if a corporation\nis legally a \xe2\x80\x9cperson,\xe2\x80\x9d as the Supreme Court reaffirmed in 2010, then some would argue that if this\ncorporate person commits three felonies, it should be locked up for life and its corporate charter revoked!\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n47\n\n\x0cModern social contract theorists, such as Thomas Donaldson and Thomas Dunfee (Ties that Bind, 1999),\nobserve that various communities, not just nations, make rules for the common good. Your college or\nschool is a community, and there are communities within the school (fraternities, sororities, the folks\nbehind the counter at the circulation desk, the people who work together at the university radio station,\nthe sports teams, the faculty, the students generally, the gay and lesbian alliance) that have rules, norms,\nor standards that people can buy into or not. If not, they can exit from that community, just as we are free\n(though not without cost) to reject US citizenship and take up residence in another country.\nDonaldson and Dunfee\xe2\x80\x99s integrative social contracts theory stresses the importance of studying the rules\nof smaller communities along with the larger social contracts made in states (such as Colorado or\nCalifornia) and nation-states (such as the United States or Germany). Our Constitution can be seen as a\nfundamental social contract.\nIt is important to realize that a social contract can be changed by the participants in a community, just as\nthe US Constitution can be amended. Social contract theory is thus dynamic\xe2\x80\x94it allows for structural and\norganic changes. Ideally, the social contract struck by citizens and the government allows for certain\nfundamental rights such as those we enjoy in the United States, but it need not. People can give up\nfreedom-oriented rights (such as the right of free speech or the right to be free of unreasonable searches\nand seizures) to secure order (freedom from fear, freedom from terrorism). For example, many citizens in\nRussia now miss the days when the Kremlin was all powerful; there was less crime and more equality and\npredictability to life in the Soviet Union, even if there was less freedom.\nThus the rights that people have\xe2\x80\x94in positive law\xe2\x80\x94come from whatever social contract exists in the\nsociety. This view differs from that of the deontologists and that of the natural-law thinkers such as\nGandhi, Jesus, or Martin Luther King Jr., who believed that rights come from God or, in less religious\nterms, from some transcendent moral order.\nAnother important movement in ethics and society is the communitarian outlook. Communitarians\nemphasize that rights carry with them corresponding duties; that is, there cannot be a right without a\nduty. Interested students may wish to explore the work of Amitai Etzioni. Etzioni was a founder of the\nCommunitarian Network, which is a group of individuals who have come together to bolster the moral,\nsocial, and political environment. It claims to be nonsectarian, nonpartisan, and international in scope.\nThe relationship between rights and duties\xe2\x80\x94in both law and ethics\xe2\x80\x94calls for some explanations:\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n48\n\n\x0c1.\n\nIf you have a right of free expression, the government has a duty to respect that right but can put\nreasonable limits on it. For example, you can legally say whatever you want about the US president,\nbut you can\xe2\x80\x99t get away with threatening the president\xe2\x80\x99s life. Even if your criticisms are strong and\ninsistent, you have the right (and our government has the duty to protect your right) to speak freely.\nIn Singapore during the 1990s, even indirect criticisms\xe2\x80\x94mere hints\xe2\x80\x94of the political leadership were\nenough to land you in jail or at least silence you with a libel suit.\n\n2. Rights and duties exist not only between people and their governments but also between individuals.\nYour right to be free from physical assault is protected by the law in most states, and when someone\nwalks up to you and punches you in the nose, your rights\xe2\x80\x94as set forth in the positive law of your\nstate\xe2\x80\x94have been violated. Thus other people have a duty to respect your rights and to not punch you\nin the nose.\n3. Your right in legal terms is only as good as your society\xe2\x80\x99s willingness to provide legal remedies\nthrough the courts and political institutions of society.\nA distinction between basic rights and nonbasic rights may also be important. Basic rights may include\nsuch fundamental elements as food, water, shelter, and physical safety. Another distinction is between\npositive rights (the right to bear arms, the right to vote, the right of privacy) and negative rights (the right\nto be free from unreasonable searches and seizures, the right to be free of cruel or unusual punishments).\nYet another is between economic or social rights (adequate food, work, and environment) and political or\ncivic rights (the right to vote, the right to equal protection of the laws, the right to due process).\n\nAristotle and Virtue Theory\nVirtue theory, or virtue ethics, has received increasing attention over the past twenty years, particularly in\ncontrast to utilitarian and deontological approaches to ethics. Virtue theory emphasizes the value of\nvirtuous qualities rather than formal rules or useful results. Aristotle is often recognized as the first\nphilosopher to advocate the ethical value of certain qualities, or virtues, in a person\xe2\x80\x99s character. As LaRue\nHosmer has noted, Aristotle saw the goal of human existence as the active, rational search for excellence,\nand excellence requires the personal virtues of honesty, truthfulness, courage, temperance, generosity,\nand high-mindedness. This pursuit is also termed \xe2\x80\x9cknowledge of the good\xe2\x80\x9d in Greek philosophy.\nSaylor URL: http://www.saylor.org/books\n\n[1]\n\nSaylor.org\n49\n\n\x0cAristotle believed that all activity was aimed at some goal or perceived good and that there must be some\nranking that we do among those goals or goods. Happiness may be our ultimate goal, but what does that\nmean, exactly? Aristotle rejected wealth, pleasure, and fame and embraced reason as the distinguishing\nfeature of humans, as opposed to other species. And since a human is a reasoning animal, happiness must\nbe associated with reason. Thus happiness is living according to the active (rather than passive) use of\nreason. The use of reason leads to excellence, and so happiness can be defined as the active, rational\npursuit of personal excellence, or virtue.\nAristotle named fourteen virtues: (1) courage, particularly in battle; (2) temperance, or moderation in\neating and drinking; (3) liberality, or spending money well; (4) magnificence, or living well; (5) pride, or\ntaking pleasure in accomplishments and stature; (6) high-mindedness, or concern with the noble rather\nthan the petty; (7) unnamed virtue, which is halfway between ambition and total lack of effort; (8)\ngentleness, or concern for others; (9) truthfulness; (10) wit, or pleasure in group discussions; (11)\nfriendliness, or pleasure in personal conduct; (12) modesty, or pleasure in personal conduct; (13)\nrighteous indignation, or getting angry at the right things and in the right amounts; and (14) justice.\nFrom a modern perspective, some of these virtues seem old-fashioned or even odd. Magnificence, for\nexample, is not something we commonly speak of. Three issues emerge: (1) How do we know what a virtue\nis these days? (2) How useful is a list of agreed-upon virtues anyway? (3) What do virtues have to do with\ncompanies, particularly large ones where various groups and individuals may have little or no contact\nwith other parts of the organization?\nAs to the third question, whether corporations can \xe2\x80\x9chave\xe2\x80\x9d virtues or values is a matter of lively debate. A\ncorporation is obviously not the same as an individual. But there seems to be growing agreement that\norganizations do differ in their practices and that these practices are value driven. If all a company cares\nabout is the bottom line, other values will diminish or disappear. Quite a few books have been written in\nthe past twenty years that emphasize the need for businesses to define their values in order to be\ncompetitive in today\xe2\x80\x99s global economy.\n\n[2]\n\nAs to the first two questions regarding virtues, a look at Michael Josephson\xe2\x80\x99s core values may prove\nhelpful.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n50\n\n\x0cJosephson\xe2\x80\x99s Core Values Analysis and Decision Process\nMichael Josephson, a noted American ethicist, believes that a current set ofcore values has been\nidentified and that the values can be meaningfully applied to a variety of personal and corporate\ndecisions.\nTo simplify, let\xe2\x80\x99s say that there are ethical and nonethical qualities among people in the United States.\nWhen you ask people what kinds of qualities they admire in others or in themselves, they may say wealth,\npower, fitness, sense of humor, good looks, intelligence, musical ability, or some other quality. They may\nalso value honesty, caring, fairness, courage, perseverance, diligence, trustworthiness, or integrity. The\nqualities on the second list have something in common\xe2\x80\x94they are distinctively ethical characteristics. That\nis, they are commonly seen as moral or ethical qualities, unlike the qualities on the first list. You can be,\nlike the Athenian Alcibiades, brilliant but unprincipled, or, like some political leaders today, powerful but\ndishonest, or wealthy but uncaring. You can, in short, have a number of admirable qualities (brilliance,\npower, wealth) that are not per se virtuous. Just because Harold is rich or good-looking or has a good\nsense of humor does not mean that he is ethical. But if Harold is honest and caring (whether he is rich or\npoor, humorous or humorless), people are likely to see him as ethical.\nAmong the virtues, are any especially important? Studies from the Josephson Institute of Ethics in\nMarina del Rey, California, have identified six core valuesin our society, values that almost everyone\nagrees are important to them. When asked what values people hold dear, what values they wish to be\nknown by, and what values they wish others would exhibit in their actions, six values consistently turn up:\n(1) trustworthiness, (2) respect, (3) responsibility, (4) fairness, (5) caring, and (6) citizenship.\nNote that these values are distinctly ethical. While many of us may value wealth, good looks, and\nintelligence, having wealth, good looks, and intelligence does not automatically make us virtuous in our\ncharacter and habits. But being more trustworthy (by being honest and by keeping promises) does make\nus more virtuous, as does staying true to the other five core values.\nNotice also that these six core values share something in common with other ethical values that are less\nuniversally agreed upon. Many values taught in the family or in places of worship are not generally agreed\non, practiced, or admired by all. Some families and individuals believe strongly in the virtue of saving\nmoney or in abstaining from alcohol or sex prior to marriage. Others clearly do not, or at least don\xe2\x80\x99t act on\ntheir beliefs. Moreover, it is possible to have and practice core ethical values even if you take on heavy\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n51\n\n\x0cdebt, knock down several drinks a night, or have frequent premarital sex. Some would dispute this, saying\nthat you can\xe2\x80\x99t really lead a virtuous life if you get into debt, drink heavily, or engage in premarital sex. But\nthe point here is that since people do disagree in these areas, the ethical traits of thrift, temperance, and\nsexual abstinence do not have the unanimity of approval that the six core values do.\nThe importance of an individual\xe2\x80\x99s having these consistent qualities of character is well known. Often we\nremember the last bad thing a person did far more than any or all previous good acts. For example, Eliot\nSpitzer and Bill Clinton are more readily remembered by people for their last, worst acts than for any good\nthey accomplished as public servants. As for a company, its good reputation also has an incalculable value\nthat when lost takes a great deal of time and work to recover. Shell, Nike, and other companies have\ndiscovered that there is a market for morality, however difficult to measure, and that not paying attention\nto business ethics often comes at a serious price. In the past fifteen years, the career of ethics and\ncompliance officer has emerged, partly as a result of criminal proceedings against companies but also\nbecause major companies have found that reputations cannot be recovered retroactively but must be\npursued proactively. For individuals, Aristotle emphasized the practice of virtue to the point where virtue\nbecomes a habit. Companies are gradually learning the same lesson.\n\nKEY TAKEAWAY\n\nThroughout history, people have pondered what it means \xe2\x80\x9cto do what is right.\xe2\x80\x9d Some of the main answers\nhave come from the differing perspectives of utilitarian thought; duty-based, or deontological, thought;\nsocial contract theory; and virtue ethics.\n\nEXERCISES\n\nXYZ Motor Corporation begins to get customer complaints about two models of its automobiles.\nCustomers have had near-death experiences from sudden acceleration; they would be driving along a\nhighway at normal speed when suddenly the car would begin to accelerate, and efforts to stop the\nacceleration by braking fail to work. Drivers could turn off the ignition and come to a safe stop, but XYZ\ndoes not instruct buyers of its cars to do so, nor is this a common reaction among drivers who experience\nsudden acceleration.\nInternal investigations of half a dozen accidents in US locations come to the conclusion that the accidents\nare not being caused by drivers who mistake the gas pedal for the brake pedal. In fact, there appears to be\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n52\n\n\x0ca possible flaw in both models, perhaps in a semiconductor chip, that makes sudden acceleration happen.\nInterference by floor mats and poorly designed gas pedals do not seem to be the problem.\nIt is voluntary to report these incidents to the National Highway Traffic and Safety Administration (NHTSA),\nbut the company decides that it will wait awhile and see if there are more complaints. Recalling the two\nmodels so that local dealers and their mechanics could examine them is also an option, but it would be\nextremely costly. Company executives are aware that quarterly and annual profit-and-loss statements, on\nwhich their bonuses depend, could be decisively worse with a recall. They decide that on a cost-benefit\nbasis, it makes more sense to wait until there are more accidents and more data. After a hundred or more\naccidents and nearly fifteen fatalities, the company institutes a selective recall, still not notifying NHTSA,\nwhich has its own experts and the authority to order XYZ to do a full recall of all affected models.\nExperts have advised XYZ that standard failure-analysis methodology requires that the company obtain\nabsolutely every XYZ vehicle that has experienced sudden acceleration, using microscopic analysis of all\ncritical components of the electronic system. The company does not wish to take that advice, as it would\nbe\xe2\x80\x94as one top executive put it\xe2\x80\x94\xe2\x80\x9ctoo time-consuming and expensive.\xe2\x80\x9d\n1.\n\nCan XYZ\xe2\x80\x99s approach to this problem be justified under utilitarian theory? If so, how? If not, why not?\n\n2.\n\nWhat would Kant advise XYZ to do? Explain.\n\n3.\n\nWhat would the \xe2\x80\x9cvirtuous\xe2\x80\x9d approach be for XYZ in this situation?\n4.\n\n[1] LaRue Tone Hosmer, Moral Leadership in Business (Chicago: Irwin Professional Publishing, 1994), 72.\n\n5.\n\n[2] James O\xe2\x80\x99Toole and Don Mayer, eds., Good Business: Exercising Effective and Ethical\nLeadership (London: Routledge, 2010).\n\n2.3 An Ethical Decision Model\n\nLEARNING OBJECTIVE\n\n1.\n\nUnderstand one model for ethical decision making: a process to arrive at the most ethical option for an\nindividual or a business organization, using a virtue ethics approach combined with some elements of\nstakeholder analysis and utilitarianism.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n53\n\n\x0cJosephson\xe2\x80\x99s Core Values Model\nOnce you recognize that there is a decision that involves ethical judgment, Michael Josephson would first\nhave you ask as many questions as are necessary to get a full background on the relevant facts. Then,\nassuming you have all the needed information, the decision process is as follows:\n1.\n\nIdentify the stakeholders. That is, who are the potential gainers and losers in the various decisions\nthat might be made here?\n\n2. Identify several likely or reasonable decisions that could be made.\n3. Consider which stakeholders gain or lose with each decision.\n4. Determine which decision satisfies the greatest number of core values.\n5.\n\nIf there is no decision that satisfies the greatest number of core values, try to determine which\ndecision delivers the greatest good to the various stakeholders.\n\nIt is often helpful to identify who (or what group) is the most important stakeholder, and why. In Milton\nFriedman\xe2\x80\x99s view, it will always be the shareholders. In the view of John Mackey, the CEO of Whole Foods\nMarket, the long-term viability and profitability of the organization may require that customers come\nfirst, or, at times, some other stakeholder group (see \xe2\x80\x9cConscious Capitalism\xe2\x80\x9d in Section 2.4 "Corporations\nand Corporate Governance").\n\nThe Core Values\nHere are the core values and their subcomponents as developed by the Josephson Institute of Ethics.\nTrustworthiness: Be honest\xe2\x80\x94tell the truth, the whole truth, and nothing but the truth; be\nsincere, forthright; don\xe2\x80\x99t deceive, mislead, or be tricky with the truth; don\xe2\x80\x99t cheat or steal, and\ndon\xe2\x80\x99t betray a trust. Demonstrate integrity\xe2\x80\x94stand up for what you believe, walk the walk as well\nas talking the talk; be what you seem to be; show commitment and courage. Be loyal\xe2\x80\x94stand by\nyour family, friends, co-workers, community, and nation; be discreet with information that\ncomes into your hands; don\xe2\x80\x99t spread rumors or engage in harmful gossip; don\xe2\x80\x99t violate your\nprinciples just to win friendship or approval; don\xe2\x80\x99t ask a friend to do something that is\nwrong. Keep promises\xe2\x80\x94keep your word, honor your commitments, and pay your debts; return\nwhat you borrow.\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n54\n\n\x0cRespect: Judge people on their merits, not their appearance; be courteous, polite, appreciative,\nand accepting of differences; respect others\xe2\x80\x99 right to make decisions about their own lives; don\xe2\x80\x99t\nabuse, demean, mistreat anyone; don\xe2\x80\x99t use, manipulate, exploit, or take advantage of others.\nResponsibility: Be accountable\xe2\x80\x94think about the consequences on yourself and others likely to\nbe affected before you act; be reliable; perform your duties; take responsibility for the\nconsequences of your choices; set a good example and don\xe2\x80\x99t make excuses or take credit for other\npeople\xe2\x80\x99s work. Pursue excellence: Do your best, don\xe2\x80\x99t quit easily, persevere, be diligent, make all\nyou do worthy of pride. Exercise self-restraint\xe2\x80\x94be disciplined, know the difference between what\nyou have a right to do and what is right to do.\nFairness: Treat all people fairly, be open-minded; listen; consider opposing viewpoints; be\nconsistent; use only appropriate considerations; don\xe2\x80\x99t let personal feelings improperly interfere\nwith decisions; don\xe2\x80\x99t take unfair advantage of mistakes; don\xe2\x80\x99t take more than your fair share.\nCaring: Show you care about others through kindness, caring, sharing, compassion, and\nempathy; treat others the way you want to be treated; don\xe2\x80\x99t be selfish, mean, cruel, or insensitive\nto others\xe2\x80\x99 feelings.\nCitizenship: Play by the rules, obey laws; do your share, respect authority, stay informed, vote,\nprotect your neighbors, pay your taxes; be charitable, help your community; protect the\nenvironment, conserve resources.\nWhen individuals and organizations confront ethical problems, the core values decision model offered by\nJosephson generally works well (1) to clarify the gains and losses of the various stakeholders, which then\nraises ethical awareness on the part of the decision maker and (2) to provide a fairly reliable guide as to\nwhat the most ethical decision would be. In nine out of ten cases, step 5 in the decision process is not\nneeded.\nThat said, it does not follow that students (or managers) would necessarily act in accord with the results of\nthe core values decision process. There are many psychological pressures and organizational constraints\nthat place limits on people both individually and in organizations. These pressures and constraints tend to\ncompromise ideal or the most ethical solutions for individuals and for organizations. For a business, one\nessential problem is that ethics can cost the organization money or resources, at least in the short term.\nDoing the most ethical thing will often appear to be something that fails to maximize profits in the short\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n55\n\n\x0cterm or that may seem pointless because if you or your organization acts ethically, others will not, and\nsociety will be no better off, anyway.\n\nKEY TAKEAWAY\n\nHaving a step-by-step process to analyze difficult moral dilemmas is useful. One such process is offered\nhere, based on the core values of trustworthiness, caring, respect, fairness, responsibility, and citizenship.\n\nEXERCISE\n\n1.\n\nConsider XYZ in the exercises for Section 2.2.5 "Josephson\xe2\x80\x99s Core Values Analysis and Decision\nProcess" and use the core values decision-making model. What are XYZ\xe2\x80\x99s options when they first notice\nthat two of their models are causing sudden acceleration incidents that put their customers at risk? Who\nare the stakeholders? What options most clearly meet the criteria for each of the core values?\n\n2.4 Corporations and Corporate Governance\nLEARNING OBJECTIVES\n\n1.\n\nExplain the basic structure of the typical corporation and how the shareholders own the company and\nelect directors to run it.\n\n2.\n\nUnderstand how the shareholder profit-maximization model is different from stakeholder theory.\n\n3.\n\nDiscern and describe the ethical challenges for corporate cultures.\n\n4.\n\nExplain what conscious capitalism is and how it differs from stakeholder theory.\n\nLegal Organization of the Corporation\nFigure 2.1 Corporate Legal Structure\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n56\n\n\x0cFigure 2.1 "Corporate Legal Structure", though somewhat oversimplified, shows the basic legal structure\nof a corporation under Delaware law and the laws of most other states in the United States. Shareholders\nelect directors, who then hire officers to manage the company. From this structure, some very basic\nrealities follow. Because the directors of a corporation do not meet that often, it\xe2\x80\x99s possible for the officers\nhired (top management, or the \xe2\x80\x9cC-suite\xe2\x80\x9d) to be selective of what the board knows about, and directors are\nnot always ready and able to provide the oversight that the shareholders would like. Nor does the law\nrequire officers to be shareholders, so that officers\xe2\x80\x99 motivations may not align with the best interests of the\ncompany. This is the \xe2\x80\x9cagency problem\xe2\x80\x9d often discussed in corporate governance: how to get officers and\nother top management to align their own interests with those of the shareholders. For example, a CEO\nmight trade insider information to the detriment of the company\xe2\x80\x99s shareholders. Even board members are\nsusceptible to misalignment of interest; for example, board members might resist hostile takeover bids\nbecause they would likely lose their perks (short for perquisites) as directors, even though the tender offer\nwould benefit stockholders. Among other attempted realignments, the use of stock options was an\nattempt to make managers more attentive to the value of company stock, but the law of unintended\nconsequences was in full force; managers tweaked and managed earnings in the bubble of the 1990s bull\nmarket, and \xe2\x80\x9cmanaging by numbers\xe2\x80\x9d became an epidemic in corporations organized under US corporate\nlaw. The rights of shareholders can be bolstered by changes in state and federal law, and there have been\nsome attempts to do that since the late 1990s. But as owners, shareholders have the ultimate power to\nreplace nonperforming or underperforming directors, which usually results in changes at the C-suite level\nas well.\n\nShareholders and Stakeholders\nThere are two main views about what the corporation\xe2\x80\x99s duties are. The first view\xe2\x80\x94maximizing profits\xe2\x80\x94is\nthe prevailing view among business managers and in business schools. This view largely follows the idea\nof Milton Friedman that the duty of a manager is to maximize return on investment to the owners. In\nessence, managers\xe2\x80\x99 legally prescribed duties are those that make their employment possible. In terms of\nthe legal organization of the corporation, the shareholders elect directors who hire managers, who have\nlegally prescribed duties toward both directors and shareholders. Those legally prescribed duties are a\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n57\n\n\x0creflection of the fact that managers are managing other people\xe2\x80\x99s money and have a moral duty to act as a\nresponsible agent for the owners. In law, this is called the manager\xe2\x80\x99s fiduciary duty. Directors have the\nsame duties toward shareholders. Friedman emphasized the primacy of this duty in his writings about\ncorporations and social responsibility.\n\nMaximizing Profits: Milton Friedman\nEconomist Milton Friedman is often quoted as having said that the only moral duty a corporation has is to\nmake the most possible money, or to maximize profits, for its stockholders. Friedman\xe2\x80\x99s beliefs are noted\nat length (see sidebar on Friedman\xe2\x80\x99s article from the New York Times), but he asserted in a now-famous\n1970 article that in a free society, \xe2\x80\x9cthere is one and only one social responsibility of business: to use its\nresources and engage in activities designed to increase its profits as long as it stays within the rules of the\ngame, which is to say, engages in open and free competition without deception and fraud.\xe2\x80\x9d What follows is\na major portion of what Friedman had to say in 1970.\n\n\xe2\x80\x9cThe Social Responsibility of Business Is to Increase Its Profits\xe2\x80\x9d\nMilton Friedman, New York Times Magazine, September 13, 1970\nWhat does it mean to say that \xe2\x80\x9cbusiness\xe2\x80\x9d has responsibilities? Only people can have\nresponsibilities. A corporation is an artificial person and in this sense may have artificial\nresponsibilities, but \xe2\x80\x9cbusiness\xe2\x80\x9d as a whole cannot be said to have responsibilities, even in this\nvague sense.\xe2\x80\xa6\nPresumably, the individuals who are to be responsible are businessmen, which means individual\nproprietors or corporate executives.\xe2\x80\xa6In a free enterprise, private-property system, a corporate\nexecutive is an employee of the owners of the business. He has direct responsibility to his\nemployers. That responsibility is to conduct the business in accordance with their desires, which\ngenerally will be to make as much money as possible while conforming to the basic rules of the\nsociety, both those embodied in law and those embodied in ethical custom.\xe2\x80\xa6\n\xe2\x80\xa6[T]he manager is that agent of the individuals who own the corporation or establish the\neleemosynary institution, and his primary responsibility is to them\xe2\x80\xa6\nOf course, the corporate executive is also a person in his own right. As a person, he may have\nother responsibilities that he recognizes or assumes voluntarily\xe2\x80\x94to his family, his conscience, his\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n58\n\n\x0cfeeling of charity, his church, his clubs, his city, his country. He may feel impelled by these\nresponsibilities to devote part of his income to causes he regards as worthy, to refuse to work for\nparticular corporations, even to leave his job\xe2\x80\xa6But in these respects he is acting as a principal, not\nan agent; he is spending his own money or time or energy, not the money of his employers or the\ntime or energy he has contracted to devote to their purposes. If these are \xe2\x80\x9csocial responsibilities,\xe2\x80\x9d\nthey are the social responsibilities of individuals, not of business.\nWhat does it mean to say that the corporate executive has a \xe2\x80\x9csocial responsibility\xe2\x80\x9d in his capacity\nas businessman? If this statement is not pure rhetoric, it must mean that he has to act in some\nway that is not in the interest of his employers. For example, that he is to refrain from increasing\nthe price of the product in order to contribute to the social objective of preventing inflation, even\nthough a price increase would be in the best interests of the corporation. Or that he is to make\nexpenditures on reducing pollution beyond the amount that is in the best interests of the\ncorporation or that is required by law in order to contribute to the social objective of improving\nthe environment. Or that, at the expense of corporate profits, he is to hire \xe2\x80\x9chardcore\xe2\x80\x9d unemployed\ninstead of better qualified available workmen to contribute to the social objective of reducing\npoverty.\nIn each of these cases, the corporate executive would be spending someone else\xe2\x80\x99s money for a\ngeneral social interest. Insofar as his actions\xe2\x80\xa6reduce returns to stockholders, he is spending their\nmoney. Insofar as his actions raise the price to customers, he is spending the customers\xe2\x80\x99 money.\nInsofar as his actions lower the wages of some employees, he is spending their money.\nThis process raises political questions on two levels: principle and consequences. On the level of\npolitical principle, the imposition of taxes and the expenditure of tax proceeds are governmental\nfunctions. We have established elaborate constitutional, parliamentary, and judicial provisions to\ncontrol these functions, to assure that taxes are imposed so far as possible in accordance with the\npreferences and desires of the public.\xe2\x80\xa6\nOthers have challenged the notion that corporate managers have no real duties except toward the owners\n(shareholders). By changing two letters in shareholder, stakeholder theorists widened the range of people\nand institutions that a corporation should pay moral consideration to. Thus they contend that a\ncorporation, through its management, has a set of responsibilities toward nonshareholder interests.\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n59\n\n\x0cStakeholder Theory\nStakeholders of a corporation include its employees, suppliers, customers, and the community.\nStakeholder is a deliberate play on the word shareholder, to emphasize that corporations have obligations\nthat extend beyond the bottom-line aim of maximizing profits. A stakeholder is anyone who most would\nagree is significantly affected (positively or negatively) by the decision of another moral agent.\nThere is one vital fact about corporations: the corporation is a creation of the law. Without law (and\ngovernment), corporations would not have existence. The key concept for corporations is the legal fact of\nlimited liability. The benefit of limited liability for shareholders of a corporation meant that larger pools of\ncapital could be aggregated for larger enterprises; shareholders could only lose their investments should\nthe venture fail in any way, and there would be no personal liability and thus no potential loss of personal\nassets other than the value of the corporate stock. Before New Jersey and Delaware competed to make\nincorporation as easy as possible and beneficial to the incorporators and founders, those who wanted the\nbenefits of incorporation had to go to legislatures\xe2\x80\x94usually among the states\xe2\x80\x94to show a public purpose\nthat the company would serve.\nIn the late 1800s, New Jersey and Delaware changed their laws to make incorporating relatively easy.\nThese two states allowed incorporation \xe2\x80\x9cfor any legal purpose,\xe2\x80\x9d rather than requiring some public\npurpose. Thus it is government (and its laws) that makes limited liability happen through the corporate\nform. That is, only through the consent of the state and armed with the charter granted by the state can a\ncorporation\xe2\x80\x99s shareholders have limited liability. This is a right granted by the state, a right granted for\ngood and practical reasons for encouraging capital and innovation. But with this right comes a related\nduty, not clearly stated at law, but assumed when a charter is granted by the state: that the corporate form\nof doing business is legal because the government feels that it socially useful to do so.\nImplicitly, then, there is a social contract between governments and corporations: as long as corporations\nare considered socially useful, they can exist. But do they have explicit social responsibilities? Milton\nFriedman\xe2\x80\x99s position suggests that having gone along with legal duties, the corporation can ignore any\nother social obligations. But there are others (such as advocates of stakeholder theory) who would say that\na corporation\xe2\x80\x99s social responsibilities go beyond just staying within the law and go beyond the\ncorporation\xe2\x80\x99s shareholders to include a number of other important stakeholders, those whose lives can be\naffected by corporate decisions.\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n60\n\n\x0cAccording to stakeholder theorists, corporations (and other business organizations) must pay attention\nnot only to the bottom line but also to their overall effect on the community. Public perception of a\ncompany\xe2\x80\x99s unfairness, uncaring, disrespect, or lack of trustworthiness often leads to long-term failure,\nwhatever the short-term successes or profits may be. A socially responsible corporation is likely to\nconsider the impact of its decisions on a wide range of stakeholders, not just shareholders. As Table 2.1\n"The Stakes of Various Stakeholders" indicates, stakeholders have very different kinds of interests\n(\xe2\x80\x9cstakes\xe2\x80\x9d) in the actions of a corporation.\nTable 2.1 The Stakes of Various Stakeholders\n\nManagers\nDirectors who\nown stock\nOwnership\n\nThe value of the organization has a direct impact on the wealth of these\nstakeholders.\nShareholders\nSalaried\nmanagers\nCreditors\nSuppliers\nEmployees\n\nEconomic\nDependence\n\nStakeholders can be economically dependent without having\nownership. Each of these stakeholders relies on the corporation in\nsome way for financial well-being.\n\nLocal\ncommunities\nCommunities\n\nSocial Interests\n\nThese stakeholders are not directly linked to the organization but have Government\nan interest in making sure the organization acts in a socially responsible\nMedia\nmanner.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n61\n\n\x0cCorporate Culture and Codes of Ethics\nA corporation is a \xe2\x80\x9cperson\xe2\x80\x9d capable of suing, being sued, and having rights and duties in our legal system.\n(It is a legal or juridical person, not a natural person, according to our Supreme Court.) Moreover, many\ncorporations have distinct cultures and beliefs that are lived and breathed by its members. Often, the\nculture of a corporation is the best defense against individuals within that firm who may be tempted to\nbreak the law or commit serious ethical misdeeds.\nWhat follows is a series of observations about corporations, ethics, and corporate culture.\n\nEthical Leadership Is Top-Down\nPeople in an organization tend to watch closely what the top managers do and say. Regardless of\nmanagers\xe2\x80\x99 talk about ethics, employees quickly learn what speech or actions are in fact rewarded. If the\nCEO is firm about acting ethically, others in the organization will take their cues from him or her. People\nat the top tend to set the target, the climate, the beliefs, and the expectations that fuel behavior.\n\nAccountability Is Often Weak\nClever managers can learn to shift blame to others, take credit for others\xe2\x80\x99 work, and move on before\n\xe2\x80\x9cfunny numbers\xe2\x80\x9d or other earnings management tricks come to light.\n\n[1]\n\nAgain, we see that the manager is\n\noften an agent for himself or herself and will often act more in his or her self-interest than for the\ncorporate interest.\n\nKilling the Messenger\nWhere organizations no longer function, inevitably some employees are unhappy. If they call attention to\nproblems that are being covered up by coworkers or supervisors, they bring bad news. Managers like to\nhear good news and discourage bad news. Intentionally or not, those who told on others, or blew the\nwhistle, have rocked the boat and become unpopular with those whose defalcations they report on and\nwith the managers who don\xe2\x80\x99t really want to hear the bad news. In many organizations, \xe2\x80\x9ckilling the\nmessenger\xe2\x80\x9d solves the problem. Consider James Alexander at Enron Corporation, who was deliberately\n[2]\n\nshut out after bringing problems to CEO Ken Lay\xe2\x80\x99s attention. When Sherron Watkins sent Ken Lay a\nletter warning him about Enron\xe2\x80\x99s accounting practices, CFO Andrew Fastow tried to fire her.\n\n[3]\n\nEthics Codes\nWithout strong leadership and a willingness to listen to bad news as well as good news, managers do not\nhave the feedback necessary to keep the organization healthy. Ethics codes have been put in place\xe2\x80\x94partly\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n62\n\n\x0cin response to federal sentencing guidelines and partly to encourage feedback loops to top management.\nThe best ethics codes are aspirational, or having an ideal to be pursued, not legalistic or compliance\ndriven. The Johnson & Johnson ethics code predated the Tylenol scare and the company\xe2\x80\x99s oft-celebrated\ncorporate response.\n\n[4]\n\nThe corporate response was consistent with that code, which was lived and\n\nmodeled by the top of the organization.\nIt\xe2\x80\x99s often noted that a code of ethics is only as important as top management is willing to make it. If the\ncode is just a document that goes into a drawer or onto a shelf, it will not effectively encourage good\nconduct within the corporation. The same is true of any kind of training that the company undertakes,\nwhether it be in racial sensitivity or sexual harassment. If the message is not continuously reinforced, or\n(worse yet) if the message is undermined by management\xe2\x80\x99s actions, the real message to employees is that\nviolations of the ethics code will not be taken seriously, or that efforts to stop racial discrimination or\nsexual harassment are merely token efforts, and that the important things are profits and performance.\nThe ethics code at Enron seems to have been one of those \xe2\x80\x9c3-P\xe2\x80\x9d codes that wind up sitting on shelves\xe2\x80\x94\n\xe2\x80\x9cPrint, Post, and Pray.\xe2\x80\x9d Worse, the Enron board twice suspended the code in 1999 to allow outside\npartnerships to be led by a top Enron executive who stood to gain financially from them.\n\n[5]\n\nEthics Hotlines and Federal Sentencing Guidelines\nThe federal sentencing guidelines were enacted in 1991. The original idea behind these guidelines was for\nCongress to correct the lenient treatment often given to white-collar, or corporate, criminals. The\nguidelines require judges to consider \xe2\x80\x9caggravating and mitigating\xe2\x80\x9d factors in determining sentences and\nfines. (While corporations cannot go to jail, its officers and managers certainly can, and the corporation\nitself can be fined. Many companies will claim that it is one bad apple that has caused the problem; the\nguidelines invite these companies to show that they are in fact tending their orchard well. They can show\nthis by providing evidence that they have (1) a viable, active code of ethics; (2) a way for employees to\nreport violations of law or the ethics code; and (3) an ethics ombudsman, or someone who oversees the\ncode.\nIn short, if a company can show that it has an ongoing process to root out wrongdoing at all levels of the\ncompany, the judge is allowed to consider this as a major mitigating factor in the fines the company will\npay. Most Fortune 500 companies have ethics hotlines and processes in place to find legal and ethical\nproblems within the company.\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n63\n\n\x0cManaging by the Numbers\nIf you manage by the numbers, there is a temptation to lie about those numbers, based on the need to get\nstock price ever higher. At Enron, \xe2\x80\x9c15 percent a year or better earnings growth\xe2\x80\x9d was the mantra. Jeffrey\nPfeffer, professor of organizational behavior at Stanford University, observes how the belief that \xe2\x80\x9cstock\nprice is all that matters\xe2\x80\x9d has been hardwired into the corporate psyche. It dictates not only how people\njudge the worth of their company but also how they feel about themselves and the work that they are\ndoing. And, over time, it has clouded judgments about what is acceptable corporate behavior.\n\n[6]\n\nManaging by Numbers: The Sears Auto Center Story\nIf winning is the most important thing in your life, then you must be prepared to do anything to\nwin.\n\xe2\x80\x94Michael Josephson\nMost people want to be winners or associate with winners. As humans, our desire to associate with those\nwho have status provides plenty of incentive to glorify winners and ignore losers. But if an individual, a\nteam, or a company does whatever it takes to win, then all other values are thrown out in the goal to win\nat all costs. The desire of some people within Sears & Roebuck Company\xe2\x80\x99s auto repair division to win by\ngaining higher profits resulted in the situation portrayed here.\nSears Roebuck & Company has been a fixture in American retailing throughout the twentieth\ncentury. At one time, people in rural America could order virtually anything (including a house)\nfrom Sears. Not without some accuracy, the company billed itself as \xe2\x80\x9cthe place where Americans\nshop.\xe2\x80\x9d But in 1992, Sears was charged by California authorities with gross and deliberate fraud\nin many of its auto centers.\nThe authorities were alerted by a 50 percent increase in consumer complaints over a three-year\nperiod. New Jersey\xe2\x80\x99s division of consumer affairs also investigated Sears Auto Centers and found\nthat all six visited by investigators had recommended unnecessary repairs. California\xe2\x80\x99s\ndepartment of consumer affairs found that Sears had systematically overcharged by an average\nof $223 for repairs and routinely billed for work that was not done. Sears Auto Centers were the\nlargest providers of auto repair services in the state.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n64\n\n\x0cThe scam was a variant on the old bait-and-switch routine. Customers received coupons in the\nmail inviting them to take advantage of hefty discounts on brake jobs. When customers came in\nto redeem their coupons, sales staffers would convince them to authorize additional repairs. As a\nmanagement tool, Sears had also established quotas for each of their sales representatives to\nmeet.\nUltimately, California got Sears to settle a large number of lawsuits against it by threatening to\nrevoke Sears\xe2\x80\x99 auto repair license. Sears agreed to distribute $50 coupons to nearly a million\ncustomers nationwide who had obtained certain services between August 1, 1990, and January\n31, 1992. Sears also agreed to pay $3.5 million to cover the costs of various government\ninvestigations and to contribute $1.5 million annually to conduct auto mechanic training\nprograms. It also agreed to abandon its repair service quotas. The entire settlement cost Sears\n$30 million. Sears Auto Center sales also dropped about 15 to 20 percent after news of the\nscandal broke.\nNote that in boosting sales by performing unnecessary services, Sears suffered very bad publicity. Losses\nwere incalculable. The short-term gains were easy to measure; long-term consequences seldom are. The\ncase illustrates a number of important lessons:\n\xe2\x80\xa2\n\nPeople generally choose short-term gains over potential long-term losses.\n\n\xe2\x80\xa2\n\nPeople often justify the harm to others as being minimal or \xe2\x80\x9cnecessary\xe2\x80\x9d to achieve the desired sales\nquota or financial goal.\n\n\xe2\x80\xa2\n\nIn working as a group, we often form an \xe2\x80\x9cus versus them\xe2\x80\x9d mentality. In the Sears case, it is likely that\nSears \xe2\x80\x9cinsiders\xe2\x80\x9d looked at customers as \xe2\x80\x9coutsiders,\xe2\x80\x9d effectively treating them (in Kantian terms) as\nmeans rather than ends in themselves. In short, outsiders were used for the benefit of insiders.\n\n\xe2\x80\xa2\n\nThe long-term losses to Sears are difficult to quantify, while the short-term gains were easy to\nmeasure and (at least for a brief while) quite satisfying financially.\n\n\xe2\x80\xa2\n\nSears\xe2\x80\x99 ongoing rip-offs were possible only because individual consumers lacked the relevant\ninformation about the service being offered. This lack of information is a market failure, since many\nconsumers were demanding more of Sears Auto Center services than they would have (and at a higher\nprice) if relevant information had been available to them earlier. Sears, like other sellers of goods and\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n65\n\n\x0cservices, took advantage of a market system, which, in its ideal form, would not permit such\ninformation distortions.\n\xe2\x80\xa2\n\nPeople in the organization probably thought that the actions they took were necessary.\n\nNoting this last point, we can assume that these key people were motivated by maximizing profits and had\nlost sight of other goals for the organization.\nThe emphasis on doing whatever is necessary to win is entirely understandable, but it is not ethical. The\ntemptation will always exist\xe2\x80\x94for individuals, companies, and nations\xe2\x80\x94to dominate or to win and to write\nthe history of their actions in a way that justifies or overlooks the harm that has been done. In a way, this\nfits with the notion that \xe2\x80\x9cmight makes right,\xe2\x80\x9d or that power is the ultimate measure of right and wrong.\n\nConscious Capitalism\nOne effort to integrate the two viewpoints of stakeholder theory and shareholder primacy is the conscious\ncapitalism movement. Companies that practice conscious capitalism embrace the idea that profit and\nprosperity can and must go hand in hand with social justice and environmental stewardship. They operate\nwith a holistic or systems view. This means that they understand that all stakeholders are connected and\ninterdependent. They reject false trade-offs between stakeholder interests and strive for creative ways to\nachieve win-win-win outcomes for all.\n\n[7]\n\nThe \xe2\x80\x9cconscious business\xe2\x80\x9d has a purpose that goes beyond maximizing profits. It is designed to maximize\nprofits but is focused more on its higher purpose and does not fixate solely on the bottom line. To do so, it\nfocuses on delivering value to all its stakeholders, harmonizing as best it can the interests of consumers,\npartners, investors, the community, and the environment. This requires that company managers take a\n\xe2\x80\x9cservant leadership\xe2\x80\x9d role, serving as stewards to the company\xe2\x80\x99s deeper purpose and to the company\xe2\x80\x99s\nstakeholders.\nConscious business leaders serve as such stewards, focusing on fulfilling the company\xe2\x80\x99s purpose,\ndelivering value to its stakeholders, and facilitating a harmony of interests, rather than on personal gain\nand self-aggrandizement. Why is this refocusing needed? Within the standard profit-maximizing model,\ncorporations have long had to deal with the \xe2\x80\x9cagency problem.\xe2\x80\x9d Actions by top-level managers\xe2\x80\x94acting on\nbehalf of the company\xe2\x80\x94should align with the shareholders, but in a culture all about winning and money,\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n66\n\n\x0cmanagers sometimes act in ways that are self-aggrandizing and that do not serve the interests of\nshareholders. Laws exist to limit such self-aggrandizing, but the remedies are often too little and too late\nand often catch only the most egregious overreaching. Having a culture of servant leadership is a much\nbetter way to see that a company\xe2\x80\x99s top management works to ensure a harmony of interests.\n[1] See Robert Jackall, Moral Mazes: The World of Corporate Managers (New York: Oxford University Press, 1988).\n[2] John Schwartz, \xe2\x80\x9cAn Enron Unit Chief Warned, and Was Rebuffed,\xe2\x80\x9d New York Times, February 20, 2002.\n[3] Warren Bennis, \xe2\x80\x9cA Corporate Fear of Too Much Truth,\xe2\x80\x9d New York Times, February 17, 2002.\n[4] University of Oklahoma Department of Defense Joint Course in Communication, Case Study: The Johnson &\nJohnson Tylenol Crisis, accessed April 5,\n2011,http://www.ou.edu/deptcomm/dodjcc/groups/02C2/Johnson%20&20Johnson.htm.\n[5] FindLaw, Report of Investigation by the Special Investigative Committee of the Board of Directors of Enron Corp.,\nFebruary 1, 2002, accessed April 5, 2011,http://news.findlaw.com/wsj/docs/enron/sicreport.\n[6] Steven Pearlstein, \xe2\x80\x9cDebating the Enron Effect,\xe2\x80\x9d Washington Post, February 17, 2002.\n[7] Milton Friedman, John Mackey, and T. J. Rodgers, \xe2\x80\x9cRethinking the Social Responsibility of Business,\xe2\x80\x9d\nReason.com, October 2005,http://reason.com/archives/2005/10/01/rethinking-the-social-responsi.\n\n2.5 Summary and Exercises\nSummary\n\nDoing good business requires attention to ethics as well as law. Understanding the long-standing\nperspectives on ethics\xe2\x80\x94utilitarianism, deontology, social contract, and virtue ethics\xe2\x80\x94is helpful in sorting\nout the ethical issues that face us as individuals and businesses. Each business needs to create or maintain\na culture of ethical excellence, where there is ongoing dialogue not only about the best technical practices\nbut also about the company\xe2\x80\x99s ethical challenges and practices. A firm that has purpose and passion\nbeyond profitability is best poised to meet the needs of diverse stakeholders and can best position itself\nfor long-term, sustainable success for shareholders and other stakeholders as well.\n\nEXERCISES\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n67\n\n\x0c1.\na.\n\nConsider again Milton Friedman\xe2\x80\x99s article.\nWhat does Friedman mean by \xe2\x80\x9cethical custom\xe2\x80\x9d?\nb.\n\nIf the laws of the society are limiting the company\xe2\x80\x99s profitability, would the company be\nwithin its rights to disobey the law?\n\nc.\n\nWhat if the law is \xe2\x80\x9con the books,\xe2\x80\x9d but the company could count on a lack of\nenforcement from state officials who were overworked and underpaid? Should the\ncompany limit its profits? Suppose that it could save money by discharging a pollutant\ninto a nearby river, adversely affecting fish and, potentially, drinking water supplies for\ndownstream municipalities. In polluting against laws that aren\xe2\x80\x99t enforced, is it still\nacting \xe2\x80\x9cwithin the rules of the game\xe2\x80\x9d? What if almost all other companies in the\nindustry were saving money by doing similar acts?\n\nConsider again the Harris v. Forklift case at the end of Chapter 1 "Introduction to Law and Legal\nSystems". The Supreme Court ruled that Ms. Harris was entitled to be heard again by the federal\ndistrict court, which means that there would be a trial on her claim that Mr. Hardy, owner of\nForklift Systems, had created a \xe2\x80\x9chostile working environment\xe2\x80\x9d for Ms. Harris. Apart from the legal\naspects, did he really do anything unethical? How can you tell?\na.\nb.\n\nWhich of his actions, if any, were contrary to utilitarian thinking?\n\nIf Kant were his second-in-command and advising him on ethical matters, would he have\napproved of Mr. Hardy\xe2\x80\x99s behavior? Why or why not?\nConsider the behaviors alleged by Ms. Harris and assume for a moment that they are all true. In\n\nterms of core values, which of these behaviors are not consistent with the core values Josephson points\nto? Be specific.\nAssume that Forklift Systems is a large public corporation and that the CEO engages in these kinds of\nbehaviors. Assume also that the board of directors knows about it. What action should the board take,\nand why?\nAssume that the year is 1963, prior to the passage of the Civil Rights Act of 1964 and the Title VII\nprovisions regarding equal employment opportunity that prohibit discrimination based on sex. So,\nMr. Hardy\xe2\x80\x99s actions are not illegal, fraudulent, or deceitful. Assume also that he heads a large\npublic company and that there is a large amount of turnover and unhappiness among the women\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n68\n\n\x0cwho work for the company. No one can sue him for being sexist or lecherous, but are his actions\nconsistent with maximizing shareholder returns? Should the board be concerned?\nNotice that this question is really a stand-in for any situation faced by a company today regarding\nits CEO where the actions are not illegal but are ethically questionable. What would conscious\ncapitalism tell a CEO or a board to do where some group of its employees are regularly harassed\nor disadvantaged by top management?\n\nSELF-TEST QUESTIONS\n\n1.\na.\n\nMilton Friedman would have been most likely to agree to which of the following statements?\nThe purpose of the corporation is to find a path to sustainable corporate profits by paying\n\ncareful attention to key stakeholders.\nb.\n\nThe business of business is business.\n\nc.\n\nThe CEO and the board should have a single-minded focus on delivering maximum value\nto shareholders of the business.\n\nd.\n\nAll is fair in love, war, and business.\n\nMilton Friedman meant (using the material quoted in this chapter) that companies should\na.\n\nFind a path to sustainable profits by looking at the interconnected needs and desires of all the\n\nstakeholders.\nb.\n\nAlways remember that the business of business is business.\n\nc.\n\nRemind the CEO that he or she has one duty: to maximize shareholder wealth by any\nmeans possible.\n\nd.\n\nMaximize shareholder wealth by engaging in open competition without fraud or deceit.\n\nWhat are some key drawbacks to utilitarian thinking at the corporate level?\na.\n\nThe corporation may do a cost-benefit analysis that puts the greatest good of the firm above all\n\nother considerations.\nb.\n\nIt is difficult to predict future consequences; decision makers in for-profit organizations\nwill tend to overestimate the upside of certain decisions and underestimate the\ndownside.\n\nc.\n\nShort-term interests will be favored over long-term consequences.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n69\n\n\x0cd.\n\nall of the above\n\ne.\n\na and b only\n\nWhich ethical perspective would allow that under certain circumstances, it might be ethical to lie\nto a liar?\na.\n\ndeontology\nb.\n\nvirtue ethics\n\nc.\n\nutilitarianism\n\nd.\n\nall of the above\n\nUnder conscious capitalism,\na.\n\nVirtue ethics is ignored.\nb.\n\nShareholders, whether they be traders or long-term investors, are always the first and\nlast consideration for the CEO and the board.\n\nc.\n\nMaximizing profits comes from a focus on higher purposes and harmonizing the\ninterests of various stakeholders.\n\nd.\n\n1.\n\nc\n\n2.\n\nd\n\n3.\n\nd\n\n4.\n\nc\n\n5.\n\nc\n\nKantian duties take precedence over cost-benefit analyses.\n\nSELF-TEST ANSWERS\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n70\n\n\x0cChapter 3\n\nCourts and the Legal Process\nLEARNING OBJECTIVES\nAfter reading this chapter, you should be able to do the following:\n1.\n\nDescribe the two different court systems in the United States, and explain why some cases can be filed in\neither court system.\n\n2.\n\nExplain the importance of subject matter jurisdiction and personal jurisdiction and know the difference\nbetween the two.\n\n3.\n\nDescribe the various stages of a civil action: from pleadings, to discovery, to trial, and to appeals.\n\n4.\n\nDescribe two alternatives to litigation: mediation and arbitration.\n\nIn the United States, law and government are interdependent. The Constitution establishes the basic\nframework of government and imposes certain limitations on the powers of government. In turn, the\nvarious branches of government are intimately involved in making, enforcing, and interpreting the\nlaw. Today, much of the law comes from Congress and the state legislatures. But it is in the courts\nthat legislation is interpreted and prior case law is interpreted and applied.\nAs we go through this chapter, consider the case of Harry and Kay Robinson. In which court should\nthe Robinsons file their action? Can the Oklahoma court hear the case and make a judgment that will\nbe enforceable against all of the defendants? Which law will the court use to come to a decision? Will\nit use New York law, Oklahoma law, federal law, or German law?\n\nRobinson v. Audi\nHarry and Kay Robinson purchased a new Audi automobile from Seaway Volkswagen, Inc. (Seaway), in\nMassena, New York, in 1976. The following year the Robinson family, who resided in New York, left that\nstate for a new home in Arizona. As they passed through Oklahoma, another car struck their Audi in the\nrear, causing a fire that severely burned Kay Robinson and her two children. Later on, the Robinsons\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n71\n\n\x0cbrought a products-liability action in the District Court for Creek County, Oklahoma, claiming that their\ninjuries resulted from the defective design and placement of the Audi\xe2\x80\x99s gas tank and fuel system. They\nsued numerous defendants, including the automobile\xe2\x80\x99s manufacturer, Audi NSU Auto Union\nAktiengesellschaft (Audi); its importer, Volkswagen of America, Inc. (Volkswagen); its regional\ndistributor, World-Wide Volkswagen Corp. (World-Wide); and its retail dealer, Seaway.\nShould the Robinsons bring their action in state court or in federal court? Over which of the defendants\nwill the court have personal jurisdiction?\n\n3.1 The Relationship between State and Federal Court Systems\nin the United States\nLEARNING OBJECTIVES\n\n1.\n\nUnderstand the different but complementary roles of state and federal court systems.\n\n2.\n\nExplain why it makes sense for some courts to hear and decide only certain kinds of cases.\n\n3.\n\nDescribe the difference between a trial court and an appellate court.\n\nAlthough it is sometimes said that there are two separate court systems, the reality is more complex.\nThere are, in fact, fifty-two court systems: those of the fifty states, the local court system in the\nDistrict of Columbia, and the federal court system. At the same time, these are not entirely separate;\nthey all have several points of contact.\nState and local courts must honor both federal law and the laws of the other states. First, state courts\nmust honor federal law where state laws are in conflict with federal laws (under the supremacy\nclause of the Constitution; see Chapter 4 "Constitutional Law and US Commerce"). Second, claims\narising under federal statutes can often be tried in the state courts, where the Constitution or\nCongress has not explicitly required that only federal courts can hear that kind of claim. Third, under\nthe full faith and credit clause, each state court is obligated to respect the final judgments of courts in\nother states. Thus a contract dispute resolved by an Arkansas court cannot be relitigated in North\nDakota when the plaintiff wants to collect on the Arkansas judgment in North Dakota. Fourth, state\ncourts often must consider the laws of other states in deciding cases involving issues where two\nstates have an interest, such as when drivers from two different states collide in a third state. Under\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n72\n\n\x0cthese circumstances, state judges will consult their own state\xe2\x80\x99s case decisions involving conflicts of\nlaws and sometimes decide that they must apply another state\xe2\x80\x99s laws to decide the case (see Table 3.1\n"Sample Conflict-of-Law Principles").\nAs state courts are concerned with federal law, so federal courts are often concerned with state law\nand with what happens in state courts. Federal courts will consider state-law-based claims when a\ncase involves claims using both state and federal law. Claims based on federal laws will permit the\nfederal court to take jurisdiction over the whole case, including any state issues raised. In those\ncases, the federal court is said to exercise \xe2\x80\x9cpendent jurisdiction\xe2\x80\x9d over the state claims. Also, the\nSupreme Court will occasionally take appeals from a state supreme court where state law raises an\nimportant issue of federal law to be decided. For example, a convict on death row may claim that the\nstate\xe2\x80\x99s chosen method of execution using the injection of drugs is unusually painful and involves\n\xe2\x80\x9ccruel and unusual punishment,\xe2\x80\x9d raising an Eighth Amendment issue.\nThere is also a broad category of cases heard in federal courts that concern only state legal issues\xe2\x80\x94\nnamely, cases that arise between citizens of different states. The federal courts are permitted to hear\nthese cases under their so-called diversity of citizenship jurisdiction (or diversity jurisdiction). A\ncitizen of New Jersey may sue a citizen of New York over a contract dispute in federal court, but if\nboth were citizens of New Jersey, the plaintiff would be limited to the state courts. The Constitution\nestablished diversity jurisdiction because it was feared that local courts would be hostile toward\npeople from other states and that they would need separate courts. In 2009, nearly a third of all\nlawsuits filed in federal court were based on diversity of citizenship. In these cases, the federal courts\nwere applying state law, rather than taking federal question jurisdiction, where federal law provided\nthe basis for the lawsuit or where the United States was a party (as plaintiff or defendant).\nWhy are there so many diversity cases in federal courts? Defense lawyers believe that there is\nsometimes a \xe2\x80\x9chome-court advantage\xe2\x80\x9d for an in-state plaintiff who brings a lawsuit against a\nnonresident in his local state court. The defense attorney is entitled to ask for removal to a federal\ncourt where there is diversity. This fits with the original reason for diversity jurisdiction in the\nConstitution\xe2\x80\x94the concern that judges in one state court would favor the in-state plaintiff rather than\na nonresident defendant. Another reason there are so many diversity cases is that plaintiffs\xe2\x80\x99\nattorneys know that removal is common and that it will move the case along faster by filing in federal\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n73\n\n\x0ccourt to begin with. Some plaintiffs\xe2\x80\x99 attorneys also find advantages in pursuing a lawsuit in federal\ncourt. Federal court procedures are often more efficient than state court procedures, so that federal\ndockets are often less crowded. This means a case will get to trial faster, and many lawyers enjoy the\nhigher status that comes in practicing before the federal bench. In some federal districts, judgments\nfor plaintiffs may be higher, on average, than in the local state court. In short, not only law but also\nlegal strategy factor into the popularity of diversity cases in federal courts.\n\nState Court Systems\nThe vast majority of civil lawsuits in the United States are filed in state courts. Two aspects of civil\nlawsuits are common to all state courts: trials and appeals. A court exercising a trial function\nhas original jurisdiction\xe2\x80\x94that is, jurisdiction to determine the facts of the case and apply the law to them.\nA court that hears appeals from the trial court is said to have appellate jurisdiction\xe2\x80\x94it must accept the\nfacts as determined by the trial court and limit its review to the lower court\xe2\x80\x99s theory of the applicable law.\n\nLimited Jurisdiction Courts\nIn most large urban states and many smaller states, there are four and sometimes five levels of courts. The\nlowest level is that of the limited jurisdiction courts. These are usually county or municipal courts with\noriginal jurisdiction to hear minor criminal cases (petty assaults, traffic offenses, and breach of peace,\namong others) and civil cases involving monetary amounts up to a fixed ceiling (no more than $10,000 in\nmost states and far less in many states). Most disputes that wind up in court are handled in the 18,000plus limited jurisdiction courts, which are estimated to hear more than 80 percent of all cases.\nOne familiar limited jurisdiction court is the small claims court, with jurisdiction to hear civil cases\ninvolving claims for amounts ranging between $1,000 and $5,000 in about half the states and for\nconsiderably less in the other states ($500 to $1,000). The advantage of the small claims court is that its\nprocedures are informal, it is often located in a neighborhood outside the business district, it is usually\nopen after business hours, and it is speedy. Lawyers are not necessary to present the case and in some\nstates are not allowed to appear in court.\n\nGeneral Jurisdiction Courts\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n74\n\n\x0cAll other civil and criminal cases are heard in the general trial courts, or courts of general jurisdiction.\nThese go by a variety of names: superior, circuit, district, or common pleas court (New York calls its\ngeneral trial court the supreme court). These are the courts in which people seek redress for incidents\nsuch as automobile accidents and injuries, or breaches of contract. These state courts also prosecute those\naccused of murder, rape, robbery, and other serious crimes. The fact finder in these general jurisdiction\ncourts is not a judge, as in the lower courts, but a jury of citizens.\nAlthough courts of general jurisdiction can hear all types of cases, in most states more than half involve\nfamily matters (divorce, child custody disputes, and the like). A third were commercial cases, and slightly\nover 10 percent were devoted to car accident cases and other torts (as discussed in Chapter 7\n"Introduction to Tort Law").\nMost states have specialized courts that hear only a certain type of case, such as landlord-tenant disputes\nor probate of wills. Decisions by judges in specialized courts are usually final, although any party\ndissatisfied with the outcome may be able to get a new trial in a court of general jurisdiction. Because\nthere has been one trial already, this is known as a trial de novo. It is not an appeal, since the case\nessentially starts over.\n\nAppellate Courts\nThe losing party in a general jurisdiction court can almost always appeal to either one or two higher\ncourts. These intermediate appellate courts\xe2\x80\x94usually called courts of appeal\xe2\x80\x94have been established in\nforty states. They do not retry the evidence, but rather determine whether the trial was conducted in a\nprocedurally correct manner and whether the appropriate law was applied. For example, the appellant\n(the losing party who appeals) might complain that the judge wrongly instructed the jury on the meaning\nof the law, or improperly allowed testimony of a particular witness, or misconstrued the law in question.\nThe appellee (who won in the lower court) will ask that the appellant be denied\xe2\x80\x94usually this means that\nthe appellee wants the lower-court judgment affirmed. The appellate court has quite a few choices: it can\naffirm, modify, reverse, or reverse and remand the lower court (return the case to the lower court for\nretrial).\nThe last type of appeal within the state courts system is to the highest court, the state supreme court,\nwhich is composed of a single panel of between five and nine judges and is usually located in the state\ncapital. (The intermediate appellate courts are usually composed of panels of three judges and are situated\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n75\n\n\x0cin various locations around the state.) In a few states, the highest court goes by a different name: in New\nYork, it is known as the court of appeals. In certain cases, appellants to the highest court in a state have\nthe right to have their appeals heard, but more often the supreme court selects the cases it wishes to hear.\nFor most litigants, the ruling of the state supreme court is final. In a relatively small class of cases\xe2\x80\x94those\nin which federal constitutional claims are made\xe2\x80\x94appeal to the US Supreme Court to issue\na writ of certiorari remains a possibility.\n\nThe Federal Court System\nDistrict Courts\nThe federal judicial system is uniform throughout the United States and consists of three levels. At the\nfirst level are the federal district courts, which are the trial courts in the federal system. Every state has\none or more federal districts; the less populous states have one, and the more populous states (California,\nTexas, and New York) have four. The federal court with the heaviest commercial docket is the US District\nCourt for the Southern District of New York (Manhattan). There are forty-four district judges and fifteen\nmagistrates in this district. The district judges throughout the United States commonly preside over all\nfederal trials, both criminal and civil.\n\nCourts of Appeal\nCases from the district courts can then be appealed to the circuit courts of appeal, of which there are\nthirteen (Figure 3.1 "The Federal Judicial Circuits"). Each circuit oversees the work of the district courts in\nseveral states. For example, the US Court of Appeals for the Second Circuit hears appeals from district\ncourts in New York, Connecticut, and Vermont. The US Court of Appeals for the Ninth Circuit hears\nappeals from district courts in California, Oregon, Nevada, Montana, Washington, Idaho, Arizona, Alaska,\nHawaii, and Guam. The US Court of Appeals for the District of Columbia Circuit hears appeals from the\ndistrict court in Washington, DC, as well as from numerous federal administrative agencies (see Chapter 5\n"Administrative Law"). The US Court of Appeals for the Federal Circuit, also located in Washington, hears\nappeals in patent and customs cases. Appeals are usually heard by three-judge panels, but sometimes\nthere will be a rehearing at the court of appeals level, in which case all judges sit to hear the case \xe2\x80\x9cen\nbanc.\xe2\x80\x9d\nThere are also several specialized courts in the federal judicial system. These include the US Tax Court,\nthe Court of Customs and Patent Appeals, and the Court of Claims.\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n76\n\n\x0cUnited States Supreme Court\nOverseeing all federal courts is the US Supreme Court, in Washington, DC. It consists of nine justices\xe2\x80\x94the\nchief justice and eight associate justices. (This number is not constitutionally required; Congress can\nestablish any number. It has been set at nine since after the Civil War.) The Supreme Court has selective\ncontrol over most of its docket. By law, the cases it hears represent only a tiny fraction of the cases that are\nsubmitted. In 2008, the Supreme Court had numerous petitions (over 7,000, not including thousands of\npetitions from prisoners) but heard arguments in only 87 cases. The Supreme Court does not sit in panels.\nAll the justices hear and consider each case together, unless a justice has a conflict of interest and must\nwithdraw from hearing the case.\nFigure 3.1 The Federal Judicial Circuits\n\nFederal judges\xe2\x80\x94including Supreme Court justices\xe2\x80\x94are nominated by the president and must be\nconfirmed by the Senate. Unlike state judges, who are usually elected and preside for a fixed term of years,\nfederal judges sit for life unless they voluntarily retire or are impeached.\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n77\n\n\x0cKEY TAKEAWAY\nTrial courts and appellate courts have different functions. State trial courts sometimes hear cases with\nfederal law issues, and federal courts sometimes hear cases with state law issues. Within both state and\nfederal court systems, it is useful to know the different kinds of courts and what cases they can decide.\n\nEXERCISES\n\n1.\n\nWhy all of this complexity? Why don\xe2\x80\x99t state courts hear only claims based on state law, and federal courts\nonly federal-law-based claims?\n\n2.\n\nWhy would a plaintiff in Iowa with a case against a New Jersey defendant prefer to have the case heard in\nIowa?\n\n3.\n\nJames, a New Jersey resident, is sued by Jonah, an Iowa resident. After a trial in which James appears and\nvigorously defends himself, the Iowa state court awards Jonah $136,750 dollars in damages for his tort\nclaim. In trying to collect from James in New Jersey, Jonah must have the New Jersey court certify the\nIowa judgment. Why, ordinarily, must the New Jersey court do so?\n\n3.2 The Problem of Jurisdiction\n\nLEARNING OBJECTIVES\n\n1.\n\nExplain the concept of subject matter jurisdiction and distinguish it from personal jurisdiction.\n\n2.\n\nUnderstand how and where the US Constitution provides a set of instructions as to what federal courts\nare empowered by law to do.\n\n3.\n\nKnow which kinds of cases must be heard in federal courts only.\n\n4.\n\nExplain diversity of citizenship jurisdiction and be able to decide whether a case is eligible for diversity\njurisdiction in the federal courts.\n\nJurisdiction is an essential concept in understanding courts and the legal system. Jurisdiction is a\ncombination of two Latin words: juris (law) and diction(to speak). Which court has the power \xe2\x80\x9cto\nspeak the law\xe2\x80\x9d is the basic question of jurisdiction.\nThere are two questions about jurisdiction in each case that must be answered before a judge will\nhear a case: the question of subject matter jurisdiction and the question of personal jurisdiction. We\nwill consider the question of subject matter jurisdiction first, because judges do; if they determine,\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n78\n\n\x0con the basis of the initial documents in the case (the \xe2\x80\x9cpleadings\xe2\x80\x9d), that they have no power to hear\nand decide that kind of case, they will dismiss it.\n\nThe Federal-State Balance: Federalism\nState courts have their origins in colonial era courts. After the American Revolution, state courts\nfunctioned (with some differences) much like they did in colonial times. The big difference after 1789 was\nthat state courts coexisted with federal courts. Federalism was the system devised by the nation\xe2\x80\x99s founders\nin which power is shared between states and the federal government. This sharing requires a division of\nlabor between the states and the federal government. It is Article III of the US Constitution that spells out\nthe respective spheres of authority (jurisdiction) between state and federal courts.\nTake a close look at Article III of the Constitution. (You can find a printable copy of the Constitution\nat http://www.findlaw.com.) Article III makes clear that federal courts are courts of limited power or\njurisdiction. Notice that the only kinds of cases federal courts are authorized to deal with have strong\nfederal connections. For example, federal courts have jurisdiction when a federal law is being used by the\nplaintiff or prosecutor (a \xe2\x80\x9cfederal question\xe2\x80\x9d case) or the case arises \xe2\x80\x9cin admiralty\xe2\x80\x9d (meaning that the\nproblem arose not on land but on sea, beyond the territorial jurisdiction of any state, or in navigable\nwaters within the United States). Implied in this list is the clear notion that states would continue to have\ntheir own laws, interpreted by their own courts, and that federal courts were needed only where the issues\nraised by the parties had a clear federal connection. The exception to this is diversity jurisdiction,\ndiscussed later.\nThe Constitution was constructed with the idea that state courts would continue to deal with basic kinds\nof claims such as tort, contract, or property claims. Since states sanction marriages and divorce, state\ncourts would deal with \xe2\x80\x9cdomestic\xe2\x80\x9d (family) issues. Since states deal with birth and death records, it stands\nto reason that paternity suits, probate disputes, and the like usually wind up in state courts. You wouldn\xe2\x80\x99t\ngo to the federal building or courthouse to get a marriage license, ask for a divorce, or probate a will: these\nmatters have traditionally been dealt with by the states (and the thirteen original colonies before them).\nMatters that historically get raised and settled in state court under state law include not only domestic and\nprobate matters but also law relating to corporations, partnerships, agency, contracts, property, torts, and\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n79\n\n\x0ccommercial dealings generally. You cannot get married or divorced in federal court, because federal\ncourts have no jurisdiction over matters that are historically (and are still) exclusively within the domain\nof state law.\nIn terms of subject matter jurisdiction, then, state courts will typically deal with the kinds of disputes just\ncited. Thus if you are Michigan resident and have an auto accident in Toledo with an Ohio resident and\nyou each blame each other for the accident, the state courts would ordinarily resolve the matter if the\ndispute cannot otherwise be settled. Why state courts? Because when you blame one another and allege\nthat it\xe2\x80\x99s the other person\xe2\x80\x99s fault, you have the beginnings of a tort case, with negligence as a primary\nelement of the claim, and state courts have routinely dealt with this kind of claim, from British colonial\ntimes through Independence and to the present. (See also Chapter 7 "Introduction to Tort Law" of this\ntext.) People have had a need to resolve this kind of dispute long before our federal courts were created,\nand you can tell from Article III that the founders did not specify that tort or negligence claims should be\nhandled by the federal courts. Again, federal courts are courts of limited jurisdiction, limited to the kinds\nof cases specified in Article III. If the case before the federal court does not fall within one of those\ncategories, the federal court cannot constitutionally hear the case because it does not have subject matter\njurisdiction.\nAlways remember: a court must have subject matter jurisdiction to hear and decide a case. Without it, a\ncourt cannot address the merits of the controversy or even take the next jurisdictional step of figuring out\nwhich of the defendants can be sued in that court. The question of which defendants are appropriately\nbefore the court is a question of personal jurisdiction.\nBecause there are two court systems, it is important for a plaintiff to file in the right court to begin with.\nThe right court is the one that has subject matter jurisdiction over the case\xe2\x80\x94that is, the power to hear and\ndecide the kind of case that is filed. Not only is it a waste of time to file in the wrong court system and be\ndismissed, but if the dismissal comes after the filing period imposed by the\napplicable statute of limitations, it will be too late to refile in the correct court system. Such cases will be\nroutinely dismissed, regardless of how deserving the plaintiff might be in his quest for justice. (The\nplaintiff\xe2\x80\x99s only remedy at that point would be to sue his lawyer for negligence for failing to mind the clock\nand get to the right court in time!)\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n80\n\n\x0cExclusive Jurisdiction in Federal Courts\nWith two court systems, a plaintiff (or the plaintiff\xe2\x80\x99s attorney, most likely) must decide whether to file a\ncase in the state court system or the federal court system. Federal courts have exclusive jurisdiction over\ncertain kinds of cases. The reason for this comes directly from the Constitution. Article III of the US\nConstitution provides the following:\nThe judicial Power shall extend to all Cases, in Law and Equity, arising under this Constitution,\nthe Laws of the United States, and Treaties made, or which shall be made, under their Authority;\nto all Cases affecting Ambassadors, other public Ministers and Consuls; to all Cases of admiralty\nand maritime Jurisdiction; to Controversies to which the United States shall be a Party; to\nControversies between two or more States; between a State and Citizens of another State;\nbetween Citizens of different States; between Citizens of the same State claiming Lands under\nGrants of different States, and between a State, or the Citizens thereof, and foreign States,\nCitizens or Subjects.\nBy excluding diversity cases, we can assemble a list of the kinds of cases that can only be heard in federal\ncourts. The list looks like this:\n1.\n\nSuits between states. Cases in which two or more states are a party.\n\n2. Cases involving ambassadors and other high-ranking public figures. Cases arising between foreign\nambassadors and other high-ranking public officials.\n3. Federal crimes. Crimes defined by or mentioned in the US Constitution or those defined or punished\nby federal statute. Such crimes include treason against the United States, piracy, counterfeiting,\ncrimes against the law of nations, and crimes relating to the federal government\xe2\x80\x99s authority to\nregulate interstate commerce. However, most crimes are state matters.\n4. Bankruptcy. The statutory procedure, usually triggered by insolvency, by which a person is relieved of\nmost debts and undergoes a judicially supervised reorganization or liquidation for the benefit of the\nperson\xe2\x80\x99s creditors.\n5.\na.\n\nPatent, copyright, and trademark cases\nPatent. The exclusive right to make, use, or sell an invention for a specified period (usually\n\nseventeen years), granted by the federal government to the inventor if the device or process is novel,\nuseful, and nonobvious.\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n81\n\n\x0cb. Copyright. The body of law relating to a property right in an original work of authorship (such as a\nliterary, musical, artistic, photographic, or film work) fixed in any tangible medium of expression,\ngiving the holder the exclusive right to reproduce, adapt, distribute, perform, and display the work.\nc.\n\nTrademark. A word, phrase, logo, or other graphic symbol used by a manufacturer or seller to\ndistinguish its product or products from those of others.\nAdmiralty. The system of laws that has grown out of the practice of admiralty courts: courts that\nexercise jurisdiction over all maritime contracts, torts, injuries, and offenses.\nAntitrust. Federal laws designed to protect trade and commerce from restraining monopolies,\nprice fixing, and price discrimination.\nSecurities and banking regulation. The body of law protecting the public by regulating the\nregistration, offering, and trading of securities and the regulation of banking practices.\nOther cases specified by federal statute. Any other cases specified by a federal statute where\nCongress declares that federal courts will have exclusive jurisdiction.\n\nConcurrent Jurisdiction\nWhen a plaintiff takes a case to state court, it will be because state courts typically hear that kind of case\n(i.e., there is subject matter jurisdiction). If the plaintiff\xe2\x80\x99s main cause of action comes from a certain\nstate\xe2\x80\x99s constitution, statutes, or court decisions, the state courts have subject matter jurisdiction over the\ncase. If the plaintiff\xe2\x80\x99s main cause of action is based on federal law (e.g., Title VII of the Civil Rights Act of\n1964), the federal courts have subject matter jurisdiction over the case. But federal courts will also have\nsubject matter jurisdiction over certain cases that have only a state-based cause of action; those cases are\nones in which the plaintiff(s) and the defendant(s) are from different states and the amount in\ncontroversy is more than $75,000. State courts can have subject matter jurisdiction over certain cases that\nhave only a federal-based cause of action. The Supreme Court has now made clear that state courts\nhave concurrent jurisdiction of any federal cause of action unless Congress has given exclusive jurisdiction\nto federal courts.\nIn short, a case with a federal question can be often be heard in either state or federal court, and a case\nthat has parties with a diversity of citizenship can be heard in state courts or in federal courts where the\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n82\n\n\x0ctests of complete diversity and amount in controversy are met. (See Note 3.18 "Summary of Rules on\nSubject Matter Jurisdiction".)\nWhether a case will be heard in a state court or moved to a federal court will depend on the parties. If a\nplaintiff files a case in state trial court where concurrent jurisdiction applies, a defendant may (or may\nnot) ask that the case be removed to federal district court.\n\nSummary of Rules on Subject Matter Jurisdiction\n1.\n\nA court must always have subject matter jurisdiction, and personal jurisdiction over at least one\ndefendant, to hear and decide a case.\n\n2. A state court will have subject matter jurisdiction over any case that is not required to be brought in a\nfederal court.\nSome cases can only be brought in federal court, such as bankruptcy cases, cases involving federal crimes,\npatent cases, and Internal Revenue Service tax court claims. The list of cases for exclusive federal\njurisdiction is fairly short. That means that almost any state court will have subject matter jurisdiction\nover almost any kind of case. If it\xe2\x80\x99s a case based on state law, a state court will always have subject matter\njurisdiction.\n3. A federal court will have subject matter jurisdiction over any case that is either based on a federal law\n(statute, case, or US Constitution)\nOR\nA federal court will have subject matter jurisdiction over any case based on state law where the parties are\n(1) from different states and (2) the amount in controversy is at least $75,000.\n(1) The different states requirement means that no plaintiff can have permanent residence in a state\nwhere any defendant has permanent residence\xe2\x80\x94there must be complete diversity of citizenship as\nbetween all plaintiffs and defendants.\n(2) The amount in controversy requirement means that a good-faith estimate of the amount the plaintiff\nmay recover is at least $75,000.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n83\n\n\x0cNOTE: For purposes of permanent residence, a corporation is considered a resident where it is\nincorporated AND where it has a principal place of business.\n4. In diversity cases, the following rules apply.\n(1) Federal civil procedure rules apply to how the case is conducted before and during trial and any\nappeals, but\n(2) State law will be used as the basis for a determination of legal rights and responsibilities.\n(a) This \xe2\x80\x9cchoice of law\xe2\x80\x9d process is interesting but complicated. Basically, each state has its own set of\njudicial decisions that resolve conflict of laws. For example, just because A sues B in a Texas court, the\nTexas court will not necessarily apply Texas law. Anna and Bobby collide and suffer serious physical\ninjuries while driving their cars in Roswell, New Mexico. Both live in Austin, and Bobby files a lawsuit in\nAustin. The court there could hear it (having subject matter jurisdiction and personal jurisdiction over\nBobby) but would apply New Mexico law, which governs motor vehicle laws and accidents in New Mexico.\nWhy would the Texas judge do that?\n(b) The Texas judge knows that which state\xe2\x80\x99s law is chosen to apply to the case can make a decisive\ndifference in the case, as different states have different substantive law standards. For example, in a\nbreach of contract case, one state\xe2\x80\x99s version of the Uniform Commercial Code may be different from\nanother\xe2\x80\x99s, and which one the court decides to apply is often exceedingly good for one side and dismal for\nthe other. In Anna v. Bobby, if Texas has one kind of comparative negligence statute and New Mexico has\na different kind of comparative negligence statute, who wins or loses, or how much is awarded, could well\ndepend on which law applies. Because both were under the jurisdiction of New Mexico\xe2\x80\x99s laws at the time,\nit makes sense to apply New Mexico law.\n(3) Why do some nonresident defendants prefer to be in federal court?\n(a) In the state court, the judge is elected, and the jury may be familiar with or sympathetic to the \xe2\x80\x9clocal\xe2\x80\x9d\nplaintiff.\n(b) The federal court provides a more neutral forum, with an appointed, life-tenured judge and a wider\npool of potential jurors (drawn from a wider geographical area).\n(4) If a defendant does not want to be in state court and there is diversity, what is to be done?\n(a) Make a motion for removal to the federal court.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n84\n\n\x0c(b) The federal court will not want to add to its caseload, or docket, but must take the case unless there\nis not complete diversity of citizenship or the amount in controversy is less than $75,000.\nTo better understand subject matter jurisdiction in action, let\xe2\x80\x99s take an example. Wile E. Coyote wants a\nfederal judge to hear his products-liability action against Acme, Inc., even though the action is based on\nstate law. Mr. Coyote\xe2\x80\x99s attorney wants to \xe2\x80\x9cmake a federal case\xe2\x80\x9d out of it, thinking that the jurors in the\nfederal district court\xe2\x80\x99s jury pool will understand the case better and be more likely to deliver a \xe2\x80\x9chigh value\xe2\x80\x9d\nverdict for Mr. Coyote. Mr. Coyote resides in Arizona, and Acme is incorporated in the state of Delaware\nand has its principal place of business in Chicago, Illinois. The federal court in Arizona can hear and\ndecide Mr. Coyote\xe2\x80\x99s case (i.e., it has subject matter jurisdiction over the case) because of diversity of\ncitizenship. If Mr. Coyote was injured by one of Acme\xe2\x80\x99s defective products while chasing a roadrunner in\nArizona, the federal district court judge would hear his action\xe2\x80\x94using federal procedural law\xe2\x80\x94and decide\nthe case based on the substantive law of Arizona on product liability.\nBut now change the facts only slightly: Acme is incorporated in Delaware but has its principal place of\nbusiness in Phoenix, Arizona. Unless Mr. Coyote has a federal law he is using as a basis for his claims\nagainst Acme, his attempt to get a federal court to hear and decide the case will fail. It will fail because\nthere is not complete diversity of citizenship between the plaintiff and the defendant.\n\nRobinson v. Audi\nNow consider Mr. and Mrs. Robinson and their products-liability claim against Seaway Volkswagen and\nthe other three defendants. There is no federal products-liability law that could be used as a cause of\naction. They are most likely suing the defendants using products-liability law based on common-law\nnegligence or common-law strict liability law, as found in state court cases. They were not yet Arizona\nresidents at the time of the accident, and their accident does not establish them as Oklahoma residents,\neither. They bought the vehicle in New York from a New York\xe2\x80\x93based retailer. None of the other\ndefendants is from Oklahoma.\nThey file in an Oklahoma state court, but how will they (their attorney or the court) know if the state court\nhas subject matter jurisdiction? Unless the case is required to be in a federal court (i.e., unless the federal\ncourts have exclusive jurisdiction over this kind of case), any state court system will have subject matter\njurisdiction, including Oklahoma\xe2\x80\x99s state court system. But if their claim is for a significant amount of\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n85\n\n\x0cmoney, they cannot file in small claims court, probate court, or any court in Oklahoma that does not have\nstatutory jurisdiction over their claim. They will need to file in a court of general jurisdiction. In short,\neven filing in the right court system (state versus federal), the plaintiff must be careful to find the court\nthat has subject matter jurisdiction.\nIf they wish to go to federal court, can they? There is no federal question presented here (the claim is\nbased on state common law), and the United States is not a party, so the only basis for federal court\njurisdiction would be diversity jurisdiction. If enough time has elapsed since the accident and they have\nestablished themselves as Arizona residents, they could sue in federal court in Oklahoma (or elsewhere),\nbut only if none of the defendants\xe2\x80\x94the retailer, the regional Volkswagen company, Volkswagen of North\nAmerica, or Audi (in Germany) are incorporated in or have a principal place of business in Arizona. The\nfederal judge would decide the case using federal civil procedure but would have to make the appropriate\nchoice of state law. In this case, the choice of conflicting laws would most likely be Oklahoma, where the\naccident happened, or New York, where the defective product was sold.\nTable 3.1 Sample Conflict-of-Law Principles\n\nSubstantive Law Issue\n\nLaw to be Applied\n\nLiability for injury caused by tortious conduct\n\nState in which the injury was inflicted\n\nReal property\n\nState where the property is located\n\nPersonal Property: inheritance\n\nDomicile of deceased (not location of property)\n\nContract: validity\n\nState in which contract was made\n\nContract: breach\n\nState in which contract was to be performed*\n\n*Or, in many states, the state with the most significant contacts with the contractual activities\nNote: Choice-of-law clauses in a contract will ordinarily be honored by judges in state and federal courts.\n\nLegal Procedure, Including Due Process and Personal Jurisdiction\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n86\n\n\x0cIn this section, we consider how lawsuits are begun and how the court knows that it has both subject\nmatter jurisdiction and personal jurisdiction over at least one of the named defendants.\nThe courts are not the only institutions that can resolve disputes. In Section 3.8 "Alternative Means of\nResolving Disputes", we will discuss other dispute-resolution forums, such as arbitration and mediation.\nFor now, let us consider how courts make decisions in civil disputes. Judicial decision making in the\ncontext of litigation (civil lawsuits) is a distinctive form of dispute resolution.\nFirst, to get the attention of a court, the plaintiff must make a claim based on existing laws. Second, courts\ndo not reach out for cases. Cases are brought to them, usually when an attorney files a case with the right\ncourt in the right way, following the various laws that govern all civil procedures in a state or in the federal\nsystem. (Most US states\xe2\x80\x99 procedural laws are similar to the federal procedural code.)\nOnce at the court, the case will proceed through various motions (motions to dismiss for lack of\njurisdiction, for example, or insufficient service of process), the proofs (submission of evidence), and the\narguments (debate about the meaning of the evidence and the law) of contesting parties.\nThis is at the heart of the adversary system, in which those who oppose each other may attack the other\xe2\x80\x99s\ncase through proofs and cross-examination. Every person in the United States who wishes to take a case\nto court is entitled to hire a lawyer. The lawyer works for his client, not the court, and serves him as an\nadvocate, or supporter. The client\xe2\x80\x99s goal is to persuade the court of the accuracy and justness of his\nposition. The lawyer\xe2\x80\x99s duty is to shape the evidence and the argument\xe2\x80\x94the line of reasoning about the\nevidence\xe2\x80\x94to advance his client\xe2\x80\x99s cause and persuade the court of its rightness. The lawyer for the\nopposing party will be doing the same thing, of course, for her client. The judge (or, if one is sitting, the\njury) must sort out the facts and reach a decision from this cross-fire of evidence and argument.\nThe method of adjudication\xe2\x80\x94the act of making an order or judgment\xe2\x80\x94has several important features.\nFirst, it focuses the conflicting issues. Other, secondary concerns are minimized or excluded altogether.\nRelevance is a key concept in any trial. The judge is required to decide the questions presented at the trial,\nnot to talk about related matters. Second, adjudication requires that the judge\xe2\x80\x99s decision be reasoned, and\nthat is why judges write opinions explaining their decisions (an opinion may be omitted when the verdict\ncomes from a jury). Third, the judge\xe2\x80\x99s decision must not only be reasoned but also be responsive to the\ncase presented: the judge is not free to say that the case is unimportant and that he therefore will ignore it.\nUnlike other branches of government that are free to ignore problems pressing upon them, judges must\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n87\n\n\x0cdecide cases. (For example, a legislature need not enact a law, no matter how many people petition it to do\nso.) Fourth, the court must respond in a certain way. The judge must pay attention to the parties\xe2\x80\x99\narguments and his decision must result from their proofs and arguments. Evidence that is not presented\nand legal arguments that are not made cannot be the basis for what the judge decides. Also, judges are\nbound by standards of weighing evidence: the burden of proof in a civil case is generally a \xe2\x80\x9cpreponderance\nof the evidence.\xe2\x80\x9d\nIn all cases, the plaintiff\xe2\x80\x94the party making a claim and initiating the lawsuit (in a criminal case the\nplaintiff is the prosecution)\xe2\x80\x94has the burden of proving his case. If he fails to prove it, the defendant\xe2\x80\x94the\nparty being sued or prosecuted\xe2\x80\x94will win.\nCriminal prosecutions carry the most rigorous burden of proof: the government must prove its case\nagainst the defendant beyond a reasonable doubt. That is, even if it seems very likely that the defendant\ncommitted the crime, as long as there remains some reasonable doubt\xe2\x80\x94perhaps he was not clearly\nidentified as the culprit, perhaps he has an alibi that could be legitimate\xe2\x80\x94the jury must vote to acquit\nrather than convict.\nBy contrast, the burden of proof in ordinary civil cases\xe2\x80\x94those dealing with contracts, personal injuries,\nand most of the cases in this book\xe2\x80\x94is a preponderance of the evidence, which means that the plaintiff\xe2\x80\x99s\nevidence must outweigh whatever evidence the defendant can muster that casts doubts on the plaintiff\xe2\x80\x99s\nclaim. This is not merely a matter of counting the number of witnesses or of the length of time that they\ntalk: the judge in a trial without a jury (a bench trial), or the jury where one is impaneled, must apply the\npreponderance of evidence test by determining which side has the greater weight of credible, relevant\nevidence.\nAdjudication and the adversary system imply certain other characteristics of courts. Judges must be\nimpartial; those with a personal interest in a matter must refuse to hear it. The ruling of a court, after all\nappeals are exhausted, is final. This principle is known as res judicata (Latin for \xe2\x80\x9cthe thing is decided\xe2\x80\x9d),\nand it means that the same parties may not take up the same dispute in another court at another time.\nFinally, a court must proceed according to a public set of formal procedural rules; a judge cannot make up\nthe rules as he goes along. To these rules we now turn.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n88\n\n\x0cHow a Case Proceeds\nComplaint and Summons\nBeginning a lawsuit is simple and is spelled out in the rules of procedure by which each court system\noperates. In the federal system, the plaintiff begins a lawsuit by filing a complaint\xe2\x80\x94a document clearly\nexplaining the grounds for suit\xe2\x80\x94with the clerk of the court. The court\xe2\x80\x99s agent (usually a sheriff, for state\ntrial courts, or a US deputy marshal, in federal district courts) will then serve the defendant with the\ncomplaint and a summons. The summons is a court document stating the name of the plaintiff and his\nattorney and directing the defendant to respond to the complaint within a fixed time period.\nThe timing of the filing can be important. Almost every possible legal complaint is governed by a federal\nor state statute of limitations, which requires a lawsuit to be filed within a certain period of time. For\nexample, in many states a lawsuit for injuries resulting from an automobile accident must be filed within\ntwo years of the accident or the plaintiff forfeits his right to proceed. As noted earlier, making a correct\ninitial filing in a court that has subject matter jurisdiction is critical to avoiding statute of limitations\nproblems.\n\nJurisdiction and Venue\nThe place of filing is equally important, and there are two issues regarding location. The first is subject\nmatter jurisdiction, as already noted. A claim for breach of contract, in which the amount at stake is $1\nmillion, cannot be brought in a local county court with jurisdiction to hear cases involving sums of up to\nonly $1,000. Likewise, a claim for copyright violation cannot be brought in a state superior court, since\nfederal courts have exclusive jurisdiction over copyright cases.\nThe second consideration is venue\xe2\x80\x94the proper geographic location of the court. For example, every\ncounty in a state might have a superior court, but the plaintiff is not free to pick any county. Again, a\nstatute will spell out to which court the plaintiff must go (e.g., the county in which the plaintiff resides or\nthe county in which the defendant resides or maintains an office).\n\nService of Process and Personal Jurisdiction\nThe defendant must be \xe2\x80\x9cserved\xe2\x80\x9d\xe2\x80\x94that is, must receive notice that he has been sued. Service can be done\nby physically presenting the defendant with a copy of the summons and complaint. But sometimes the\ndefendant is difficult to find (or deliberately avoids the marshal or other process server). The rules spell\nout a variety of ways by which individuals and corporations can be served. These include using US Postal\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n89\n\n\x0cService certified mail or serving someone already designated to receive service of process. A corporation\nor partnership, for example, is often required by state law to designate a \xe2\x80\x9cregistered agent\xe2\x80\x9d for purposes of\ngetting public notices or receiving a summons and complaint.\nOne of the most troublesome problems is service on an out-of-state defendant. The personal jurisdiction\nof a state court over persons is clear for those defendants found within the state. If the plaintiff claims that\nan out-of-state defendant injured him in some way, must the plaintiff go to the defendant\xe2\x80\x99s home state to\nserve him? Unless the defendant had some significant contact with the plaintiff\xe2\x80\x99s state, the plaintiff may\nindeed have to. For instance, suppose a traveler from Maine stopped at a roadside diner in Montana and\nordered a slice of homemade pie that was tainted and caused him to be sick. The traveler may not simply\nreturn home and mail the diner a notice that he is suing it in a Maine court. But if out-of-state defendants\nhave some contact with the plaintiff\xe2\x80\x99s state of residence, there might be grounds to bring them within the\njurisdiction of the plaintiff\xe2\x80\x99s state courts. In Burger King v. Rudzewicz, Section 3.9 "Cases", the federal\ncourt in Florida had to consider whether it was constitutionally permissible to exercise personal\njurisdiction over a Michigan franchisee.\nAgain, recall that even if a court has subject matter jurisdiction, it must also have personal jurisdiction\nover each defendant against whom an enforceable judgment can be made. Often this is not a problem; you\nmight be suing a person who lives in your state or regularly does business in your state. Or a nonresident\nmay answer your complaint without objecting to the court\xe2\x80\x99s \xe2\x80\x9cin personam\xe2\x80\x9d (personal) jurisdiction. But\nmany defendants who do not reside in the state where the lawsuit is filed would rather not be put to the\ninconvenience of contesting a lawsuit in a distant forum. Fairness\xe2\x80\x94and the due process clause of the\nFourteenth Amendment\xe2\x80\x94dictates that nonresidents should not be required to defend lawsuits far from\ntheir home base, especially where there is little or no contact or connection between the nonresident and\nthe state where a lawsuit is brought.\n\nSummary of Rules on Personal Jurisdiction\n1.\n\nOnce a court determines that it has subject matter jurisdiction, it must find at least one defendant\nover which it is \xe2\x80\x9cfair\xe2\x80\x9d (i.e., in accord with due process) to exercise personal jurisdiction.\n\n2. If a plaintiff sues five defendants and the court has personal jurisdiction over just one, the case can be\nheard, but the court cannot make a judgment against the other four.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n90\n\n\x0c1.\n\nBut if the plaintiff loses against defendant 1, he can go elsewhere (to another state or states) and sue\ndefendants 2, 3, 4, or 5.\n\n2. The court\xe2\x80\x99s decision in the first lawsuit (against defendant 1) does not determine the liability of the\nnonparticipating defendants.\nThis involves the principle of res judicata, which means that you can\xe2\x80\x99t bring the same action against the\nsame person (or entity) twice. It\xe2\x80\x99s like the civil side of double jeopardy. Res means \xe2\x80\x9cthing,\xe2\x80\x9d and judicata\nmeans \xe2\x80\x9cadjudicated.\xe2\x80\x9d Thus the \xe2\x80\x9cthing\xe2\x80\x9d has been \xe2\x80\x9cadjudicated\xe2\x80\x9d and should not be judged again. But, as to\nnonparticipating parties, it is not over. If you have a different case against the same defendant\xe2\x80\x94one that\narises out of a completely different situation\xe2\x80\x94that case is not barred by res judicata.\n3. Service of process is a necessary (but not sufficient) condition for getting personal jurisdiction over a\nparticular defendant (see rule 4).\n1.\n\nIn order to get a judgment in a civil action, the plaintiff must serve a copy of the complaint and a\nsummons on the defendant.\n\n2. There are many ways to do this.\n\xef\x82\xa7\n\nThe process server personally serves a complaint on the defendant.\n\n\xef\x82\xa7\n\nThe process server leaves a copy of the summons and complaint at the residence of the defendant, in\nthe hands of a competent person.\n\n\xef\x82\xa7\n\nThe process server sends the summons and complaint by certified mail, return receipt requested.\n\n\xef\x82\xa7\n\nThe process server, if all other means are not possible, notifies the defendant by publication in a\nnewspaper having a minimum number of readers (as may be specified by law).\n\n4. In addition to successfully serving the defendant with process, a plaintiff must convince the court that\nexercising personal jurisdiction over the defendant is consistent with due process and any statutes in\nthat state that prescribe the jurisdictional reach of that state (the so-called long-arm statutes). The\nSupreme Court has long recognized various bases for judging whether such process is fair.\n1.\n\nConsent. The defendant agrees to the court\xe2\x80\x99s jurisdiction by coming to court, answering the\ncomplaint, and having the matter litigated there.\n\n2. Domicile. The defendant is a permanent resident of that state.\n3. Event. The defendant did something in that state, related to the lawsuit, that makes it fair for the state\nto say, \xe2\x80\x9cCome back and defend!\xe2\x80\x9d\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n91\n\n\x0c4. Service of process within the state will effectively provide personal jurisdiction over the nonresident.\nAgain, let\xe2\x80\x99s consider Mrs. Robinson and her children in the Audi accident. She could file a lawsuit\nanywhere in the country. She could file a lawsuit in Arizona after she establishes residency there. But\nwhile the Arizona court would have subject matter jurisdiction over any products-liability claim (or any\nclaim that was not required to be heard in a federal court), the Arizona court would face an issue of \xe2\x80\x9cin\npersonam jurisdiction,\xe2\x80\x9d or personal jurisdiction: under the due process clause of the Fourteenth\nAmendment, each state must extend due process to citizens of all of the other states. Because fairness is\nessential to due process, the court must consider whether it is fair to require an out-of-state defendant to\nappear and defend against a lawsuit that could result in a judgment against that defendant.\nAlmost every state in the United States has a statute regarding personal jurisdiction, instructing judges\nwhen it is permissible to assert personal jurisdiction over an out-of-state resident. These are called longarm statutes. But no state can reach out beyond the limits of what is constitutionally permissible under\nthe Fourteenth Amendment, which binds the states with its proviso to guarantee the due process rights of\nthe citizens of every state in the union. The \xe2\x80\x9cminimum contacts\xe2\x80\x9d test in Burger King v.\nRudzewicz (Section 3.9 "Cases") tries to make the fairness mandate of the due process clause more\nspecific. So do other tests articulated in the case (such as \xe2\x80\x9cdoes not offend traditional notions of fair play\nand substantial justice\xe2\x80\x9d). These tests are posed by the Supreme Court and heeded by all lower courts in\norder to honor the provisions of the Fourteenth Amendment\xe2\x80\x99s due process guarantees. These tests are in\naddition to any state long-arm statute\xe2\x80\x99s instructions to courts regarding the assertion of personal\njurisdiction over nonresidents.\n\nChoice of Law and Choice of Forum Clauses\nIn a series of cases, the Supreme Court has made clear that it will honor contractual choices of parties in a\nlawsuit. Suppose the parties to a contract wind up in court arguing over the application of the contract\xe2\x80\x99s\nterms. If the parties are from two different states, the judge may have difficulty determining which law to\napply (see Table 3.1 "Sample Conflict-of-Law Principles"). But if the contract says that a particular state\xe2\x80\x99s\nlaw will be applied if there is a dispute, then ordinarily the judge will apply that state\xe2\x80\x99s law as a rule of\ndecision in the case. For example, Kumar Patel (a Missouri resident) opens a brokerage account with\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n92\n\n\x0cGoldman, Sachs and Co., and the contractual agreement calls for \xe2\x80\x9cany disputes arising under this\nagreement\xe2\x80\x9d to be determined \xe2\x80\x9caccording to the laws of the state of New York.\xe2\x80\x9d When Kumar claims in a\nMissouri court that his broker is \xe2\x80\x9cchurning\xe2\x80\x9d his account, and, on the other hand, Goldman, Sachs claims\nthat Kumar has failed to meet his margin call and owes $38,568.25 (plus interest and attorney\xe2\x80\x99s fees), the\njudge in Missouri will apply New York law based on the contract between Kumar and Goldman, Sachs.\nOrdinarily, a choice-of-law clause will be accompanied by a choice-of-forum clause. In a choice-of-forum\nclause, the parties in the contract specify which court they will go to in the event of a dispute arising under\nthe terms of contract. For example, Harold (a resident of Virginia) rents a car from Alamo at the Denver\nInternational Airport. He does not look at the fine print on the contract. He also waives all collision and\nother insurance that Alamo offers at the time of his rental. While driving back from Telluride Bluegrass\nFestival, he has an accident in Idaho Springs, Colorado. His rented Nissan Altima is badly damaged. On\nreturning to Virginia, he would like to settle up with Alamo, but his insurance company and Alamo cannot\ncome to terms. He realizes, however, that he has agreed to hear the dispute with Alamo in a specific court\nin San Antonio, Texas. In the absence of fraud or bad faith, any court in the United States is likely to\nuphold the choice-of-form clause and require Harold (or his insurance company) to litigate in San\nAntonio, Texas.\n\nKEY TAKEAWAY\n\nThere are two court systems in the United States. It is important to know which system\xe2\x80\x94the state court\nsystem or the federal court system\xe2\x80\x94has the power to hear and decide a particular case. Once that is\nestablished, the Constitution compels an inquiry to make sure that no court extends its reach unfairly to\nout-of-state residents. The question of personal jurisdiction is a question of fairness and due process to\nnonresidents.\n\n1.\n\nEXERCISES\n\nThe Constitution specifies that federal courts have exclusive jurisdiction over admiralty claims. Mr. and\nMrs. Shute have a claim against Carnival Cruise lines for the negligence of the cruise line. Mrs. Shute\nsustained injuries as a result of the company\xe2\x80\x99s negligence. Mr. and Mrs. Shute live in the state of\nWashington. Can they bring their claim in state court? Must they bring their claim in federal court?\n\n2.\n\nCongress passed Title VII of the Civil Rights Act of 1964. In Title VII, employers are required not to\ndiscriminate against employees on the basis of race, color, sex, religion, or national origin. In passing Title\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n93\n\n\x0cVII, Congress did not require plaintiffs to file only in federal courts. That is, Congress made no statement\nin Title VII that federal courts had \xe2\x80\x9cexclusive jurisdiction\xe2\x80\x9d over Title VII claims. Mrs. Harris wishes to sue\nForklift Systems, Inc. of Nashville, Tennessee, for sexual harassment under Title VII. She has gone through\nthe Equal Employment Opportunity Commission process and has a right-to-sue letter, which is required\nbefore a Title VII action can be brought to court. Can she file a complaint that will be heard by a state\ncourt?\n3.\n\nMrs. Harris fails to go to the Equal Employment Opportunity Commission to get her right-to-sue letter\nagainst Forklift Systems, Inc. She therefore does not have a viable Title VII cause of action against Forklift.\nShe does, however, have her rights under Tennessee\xe2\x80\x99s equal employment statute and various court\ndecisions from Tennessee courts regarding sexual harassment. Forklift is incorporated in Tennessee and\nhas its principal place of business in Nashville. Mrs. Harris is also a citizen of Tennessee. Explain why, if\nshe brings her employment discrimination and sexual harassment lawsuit in a federal court, her lawsuit\nwill be dismissed for lack of subject matter jurisdiction.\n\n4.\n\nSuppose Mr. and Mrs. Robinson find in the original paperwork with Seaway Volkswagen that there is a\ncontractual agreement with a provision that says \xe2\x80\x9call disputes arising between buyer and Seaway\nVolkswagen will be litigated, if at all, in the county courts of Westchester County, New York.\xe2\x80\x9d Will the\nOklahoma court take personal jurisdiction over Seaway Volkswagen, or will it require the Robinsons to\nlitigate their claim in New York?\n\n3.3 Motions and Discovery\n\nLEARNING OBJECTIVES\n\n1.\n\nExplain how a lawsuit can be dismissed prior to any trial.\n\n2.\n\nUnderstand the basic principles and practices of discovery before a trial.\n\nThe early phases of a civil action are characterized by many different kinds of motions and a complex\nprocess of mutual fact-finding between the parties that is known as discovery. A lawsuit will start\nwith the pleadings (complaint and answer in every case, and in some cases a counterclaim by the\ndefendant against the plaintiff and the plaintiff\xe2\x80\x99s reply to the defendant\xe2\x80\x99s counterclaim). After the\npleadings, the parties may make various motions, which are requests to the judge. Motions in the\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n94\n\n\x0cearly stages of a lawsuit usually aim to dismiss the lawsuit, to have it moved to another venue, or to\ncompel the other party to act in certain ways during the discovery process.\n\nInitial Pleadings, and Motions to Dismiss\nThe first papers filed in a lawsuit are called the pleadings. These include the plaintiff\xe2\x80\x99s complaint and then\n(usually after thirty or more days) the answer or response from the defendant. The answer may be\ncoupled with a counterclaim against the plaintiff. (In effect, the defendant becomes the plaintiff for the\nclaims she has against the original plaintiff.) The plaintiff may reply to any counterclaim by the defendant.\nState and federal rules of civil procedure require that the complaint must state the nature of the plaintiff\xe2\x80\x99s\nclaim, the jurisdiction of the court, and the nature of the relief that is being asked for (usually an award of\nmoney, but sometimes an injunction, or a declaration of legal rights). In an answer, the defendant will\noften deny all the allegations of the complaint or will admit to certain of its allegations and deny others.\nA complaint and subsequent pleadings are usually quite general and give little detail. Cases can be decided\non the pleadings alone in the following situations: (1) If the defendant fails to answer the complaint, the\ncourt can enter a default judgment, awarding the plaintiff what he seeks. (2) The defendant can move to\ndismiss the complaint on the grounds that the plaintiff failed to \xe2\x80\x9cstate a claim on which relief can be\ngranted,\xe2\x80\x9d or on the basis that there is no subject matter jurisdiction for the court chosen by the plaintiff,\nor on the basis that there is no personal jurisdiction over the defendant. The defendant is saying, in effect,\nthat even if all the plaintiff\xe2\x80\x99s allegations are true, they do not amount to a legal claim that can be heard by\nthe court. For example, a claim that the defendant induced a woman to stop dating the plaintiff (a socalled alienation of affections cause of action) is no longer actionable in US state courts, and any court will\ndismiss the complaint without any further proceedings. (This type of dismissal is occasionally still called a\ndemurrer.)\nA third kind of dismissal can take place on a motion for summary judgment. If there is no triable question\nof fact or law, there is no reason to have a trial. For example, the plaintiff sues on a promissory note and,\nat deposition (an oral examination under oath), the defendant admits having made no payment on the\nnote and offers no excuse that would be recognizable as a reason not to pay. There is no reason to have a\ntrial, and the court should grant summary judgment.\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n95\n\n\x0cDiscovery\nIf there is a factual dispute, the case will usually involve some degree of discovery, where each party tries\nto get as much information out of the other party as the rules allow. Until the 1940s, when discovery\nbecame part of civil procedure rules, a lawsuit was frequently a game in which each party hid as much\ninformation as possible and tried to surprise the other party in court.\nBeginning with a change in the Federal Rules of Civil Procedure adopted by the Supreme Court in 1938\nand subsequently followed by many of the states, the parties are entitled to learn the facts of the case\nbefore trial. The basic idea is to help the parties determine what the evidence might be, who the potential\nwitnesses are, and what specific issues are relevant. Discovery can proceed by several methods. A party\nmay serve an interrogatory on his adversary\xe2\x80\x94a written request for answers to specific questions. Or a\nparty may depose the other party or a witness. A deposition is a live question-and-answer session at which\nthe witness answers questions put to him by one of the parties\xe2\x80\x99 lawyers. His answers are recorded\nverbatim and may be used at trial. Each party is also entitled to inspect books, documents, records, and\nother physical items in the possession of the other. This is a broad right, as it is not limited to just\nevidence that is admissible at trial. Discovery of physical evidence means that a plaintiff may inspect a\ncompany\xe2\x80\x99s accounts, customer lists, assets, profit-and-loss statements, balance sheets, engineering and\nquality-control reports, sales reports, and virtually any other document.\nThe lawyers, not the court, run the discovery process. For example, one party simply makes a written\ndemand, stating the time at which the deposition will take place or the type of documents it wishes to\ninspect and make copies of. A party unreasonably resisting discovery methods (whether depositions,\nwritten interrogatories, or requests for documents) can be challenged, however, and judges are often\nbrought into the process to push reluctant parties to make more disclosure or to protect a party from\nirrelevant or unreasonable discovery requests. For example, the party receiving the discovery request can\napply to the court for a protective order if it can show that the demand is for privileged material (e.g., a\nparty\xe2\x80\x99s lawyers\xe2\x80\x99 records are not open for inspection) or that the demand was made to harass the opponent.\nIn complex cases between companies, the discovery of documents can run into tens of millions of pages\nand can take years. Depositions can consume days or even weeks of an executive\xe2\x80\x99s time.\n\nKEY TAKEAWAY\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n96\n\n\x0cMany cases never get to trial. They are disposed of by motions to dismiss or are settled after extensive\ndiscovery makes clear to the parties the strengths and weaknesses of the parties to the dispute.\n\nEXERCISES\n\n1.\n\nMrs. Robinson (in the Volkswagen Audi case) never establishes residency in Arizona, returns to New York,\nand files her case in federal district court in New York, alleging diversity jurisdiction. Assume that the\ndefendants do not want to have the case heard in federal court. What motion will they make?\n\n2.\n\nUnder contributory negligence, the negligence of any plaintiff that causes or contributes to the injuries a\nplaintiff complains of will be grounds for dismissal. Suppose that in discovery, Mr. Ferlito in Ferlito v.\nJohnson & Johnson (Section 3.9 "Cases") admits that he brought the cigarette lighter dangerously close to\nhis costume, saying, \xe2\x80\x9cYes, you could definitely say I was being careless; I had a few drinks under my belt.\xe2\x80\x9d\nAlso, Mrs. Ferlito admits that she never reads product instructions from manufacturers. If the case is\nbrought in a state where contributory negligence is the law, on what basis can Johnson & Johnson have\nthe case dismissed before trial?\n\n3.4 The Pretrial and Trial Phase\n\nLEARNING OBJECTIVES\n\n1.\n\nUnderstand how judges can push parties into pretrial settlement.\n\n2.\n\nExplain the meaning and use of directed verdicts.\n\n3.\n\nDistinguish a directed verdict from a judgment n.o.v. (\xe2\x80\x9cnotwithstanding the verdict\xe2\x80\x9d).\n\nAfter considerable discovery, one of the parties may believe that there is no triable issue of law or fact\nfor the court to consider and may file a motion with the court for summary judgment. Unless it is\nvery clear, the judge will deny a summary judgment motion, because that ends the case at the trial\nlevel; it is a \xe2\x80\x9cfinal order\xe2\x80\x9d in the case that tells the plaintiff \xe2\x80\x9cno\xe2\x80\x9d and leaves no room to bring another\nlawsuit against the defendant for that particular set of facts (res judicata). If the plaintiff successfully\nappeals a summary judgment motion, the case will come back to the trial court.\nPrior to the trial, the judge may also convene the parties in an effort to investigate the possibilities of\nsettlement. Usually, the judge will explore the strengths and weaknesses of each party\xe2\x80\x99s case with the\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n97\n\n\x0cattorneys. The parties may decide that it is more prudent or efficient to settle than to risk going to\ntrial.\n\nPretrial Conference\nAt various times during the discovery process, depending on the nature and complexity of the case, the\ncourt may hold a pretrial conference to clarify the issues and establish a timetable. The court may also\nhold a settlement conference to see if the parties can work out their differences and avoid trial altogether.\nOnce discovery is complete, the case moves on to trial if it has not been settled. Most cases are settled\nbefore this stage; perhaps 85 percent of all civil cases end before trial, and more than 90 percent of\ncriminal prosecutions end with a guilty plea.\n\nTrial\nAt trial, the first order of business is to select a jury. (In a civil case of any consequence, either party can\nrequest one, based on the Sixth Amendment to the US Constitution.) The judge and sometimes the\nlawyers are permitted to question the jurors to be sure that they are unbiased. This questioning is known\nas the voir dire (pronounced vwahr-DEER). This is an important process, and a great deal of thought goes\ninto selecting the jury, especially in high-profile cases. A jury panel can be as few as six persons, or as\nmany as twelve, with alternates selected and sitting in court in case one of the jurors is unable to continue.\nIn a long trial, having alternates is essential; even in shorter trials, most courts will have at least two\nalternate jurors.\nIn both criminal and civil trials, each side has opportunities to challenge potential jurors for cause. For\nexample, in the Robinsons\xe2\x80\x99 case against Audi, the attorneys representing Audi will want to know if any\nprospective jurors have ever owned an Audi, what their experience has been, and if they had a similar\nproblem (or worse) with their Audi that was not resolved to their satisfaction. If so, the defense attorney\ncould well believe that such a juror has a potential for a bias against her client. In that case, she could use\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n98\n\n\x0ca challenge for cause, explaining to the judge the basis for her challenge. The judge, at her discretion,\ncould either accept the for-cause reason or reject it.\nEven if an attorney cannot articulate a for-cause reason acceptable to the judge, he may use one of several\nperemptory challenges that most states (and the federal system) allow. A trial attorney with many years of\nexperience may have a sixth sense about a potential juror and, in consultation with the client, may decide\nto use a peremptory challenge to avoid having that juror on the panel.\nAfter the jury is sworn and seated, the plaintiff\xe2\x80\x99s lawyer makes an opening statement, laying out the\nnature of the plaintiff\xe2\x80\x99s claim, the facts of the case as the plaintiff sees them, and the evidence that the\nlawyer will present. The defendant\xe2\x80\x99s lawyer may also make an opening statement or may reserve his right\nto do so at the end of the plaintiff\xe2\x80\x99s case.\nThe plaintiff\xe2\x80\x99s lawyer then calls witnesses and presents the physical evidence that is relevant to her proof.\nThe direct testimony at trial is usually far from a smooth narration. The rules of evidence (that govern the\nkinds of testimony and documents that may be introduced at trial) and the question-and-answer format\ntend to make the presentation of evidence choppy and difficult to follow.\nAnyone who has watched an actual televised trial or a television melodrama featuring a trial scene will\nappreciate the nature of the trial itself: witnesses are asked questions about a number of issues that may\nor may not be related, the opposing lawyer will frequently object to the question or the form in which it is\nasked, and the jury may be sent from the room while the lawyers argue at the bench before the judge.\nAfter direct testimony of each witness is over, the opposing lawyer may conduct cross-examination. This\nis a crucial constitutional right; in criminal cases it is preserved in the Constitution\xe2\x80\x99s Sixth Amendment\n(the right to confront one\xe2\x80\x99s accusers in open court). The formal rules of direct testimony are then relaxed,\nand the cross-examiner may probe the witness more informally, asking questions that may not seem\nimmediately relevant. This is when the opposing attorney may become harsh, casting doubt on a witness\xe2\x80\x99s\ncredibility, trying to trip her up and show that the answers she gave are false or not to be trusted. This use\nof cross-examination, along with the requirement that the witness must respond to questions that are at\nall relevant to the questions raised by the case, distinguishes common-law courts from those of\nauthoritarian regimes around the world.\nFollowing cross-examination, the plaintiff\xe2\x80\x99s lawyer may then question the witness again: this is called\nredirect examination and is used to demonstrate that the witness\xe2\x80\x99s original answers were accurate and to\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n99\n\n\x0cshow that any implications otherwise, suggested by the cross-examiner, were unwarranted. The crossexaminer may then engage the witness in re-cross-examination, and so on. The process usually stops after\ncross-examination or redirect.\nDuring the trial, the judge\xe2\x80\x99s chief responsibility is to see that the trial is fair to both sides. One big piece of\nthat responsibility is to rule on the admissibility of evidence. A judge may rule that a particular question is\nout of order\xe2\x80\x94that is, not relevant or appropriate\xe2\x80\x94or that a given document is irrelevant. Where the\nattorney is convinced that a particular witness, a particular question, or a particular document (or part\nthereof) is critical to her case, she may preserve an objection to the court\xe2\x80\x99s ruling by saying \xe2\x80\x9cexception,\xe2\x80\x9d in\nwhich case the court stenographer will note the exception; on appeal, the attorney may cite any number of\nexceptions as adding up to the lack of a fair trial for her client and may request a court of appeals to order\na retrial.\nFor the most part, courts of appeal will not reverse and remand for a new trial unless the trial court\njudge\xe2\x80\x99s errors are \xe2\x80\x9cprejudicial,\xe2\x80\x9d or \xe2\x80\x9can abuse of discretion.\xe2\x80\x9d In short, neither party is entitled to a perfect\ntrial, but only to a fair trial, one in which the trial judge has made only \xe2\x80\x9charmless errors\xe2\x80\x9d and not\nprejudicial ones.\nAt the end of the plaintiff\xe2\x80\x99s case, the defendant presents his case, following the same procedure just\noutlined. The plaintiff is then entitled to present rebuttal witnesses, if necessary, to deny or argue with the\nevidence the defendant has introduced. The defendant in turn may present \xe2\x80\x9csurrebuttal\xe2\x80\x9d witnesses.\nWhen all testimony has been introduced, either party may ask the judge for a directed verdict\xe2\x80\x94a verdict\ndecided by the judge without advice from the jury. This motion may be granted if the plaintiff has failed to\nintroduce evidence that is legally sufficient to meet her burden of proof or if the defendant has failed to do\nthe same on issues on which she has the burden of proof. (For example, the plaintiff alleges that the\ndefendant owes him money and introduces a signed promissory note. The defendant cannot show that the\nnote is invalid. The defendant must lose the case unless he can show that the debt has been paid or\notherwise discharged.)\nThe defendant can move for a directed verdict at the close of the plaintiff\xe2\x80\x99s case, but the judge will usually\nwait to hear the entire case until deciding whether to do so. Directed verdicts are not usually granted,\nsince it is the jury\xe2\x80\x99s job to determine the facts in dispute.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n100\n\n\x0cIf the judge refuses to grant a directed verdict, each lawyer will then present a closing argument to the\njury (or, if there is no jury, to the judge alone). The closing argument is used to tie up the loose ends, as\nthe attorney tries to bring together various seemingly unrelated facts into a story that will make sense to\nthe jury.\nAfter closing arguments, the judge will instruct the jury. The purpose of jury instruction is to explain to\nthe jurors the meaning of the law as it relates to the issues they are considering and to tell the jurors what\nfacts they must determine if they are to give a verdict for one party or the other. Each lawyer will have\nprepared a set of written instructions that she hopes the judge will give to the jury. These will be tailored\nto advance her client\xe2\x80\x99s case. Many a verdict has been overturned on appeal because a trial judge has\nwrongly instructed the jury. The judge will carefully determine which instructions to give and often will\nuse a set of pattern instructions provided by the state bar association or the supreme court of the state.\nThese pattern jury instructions are often safer because they are patterned after language that appellate\ncourts have used previously, and appellate courts are less likely to find reversible error in the instructions.\nAfter all instructions are given, the jury will retire to a private room and discuss the case and the answers\nrequested by the judge for as long as it takes to reach a unanimous verdict. Some minor cases do not\nrequire a unanimous verdict. If the jury cannot reach a decision, this is called a hung jury, and the case\nwill have to be retried. When a jury does reach a verdict, it delivers it in court with both parties and their\nlawyers present. The jury is then discharged, and control over the case returns to the judge. (If there is no\njury, the judge will usually announce in a written opinion his findings of fact and how the law applies to\nthose facts. Juries just announce their verdicts and do not state their reasons for reaching them.)\n\nPosttrial Motions\nThe losing party is allowed to ask the judge for a new trial or for a judgment notwithstanding the verdict\n(often called a judgment n.o.v., from the Latinnon obstante veredicto). A judge who decides that a\ndirected verdict is appropriate will usually wait to see what the jury\xe2\x80\x99s verdict is. If it is favorable to the\nparty the judge thinks should win, she can rely on that verdict. If the verdict is for the other party, he can\ngrant the motion for judgment n.o.v. This is a safer way to proceed because if the judge is reversed on\nappeal, a new trial is not necessary. The jury\xe2\x80\x99s verdict always can be restored, whereas without a jury\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n101\n\n\x0cverdict (as happens when a directed verdict is granted before the case goes to the jury), the entire case\nmust be presented to a new jury. Ferlito v. Johnson & Johnson (Section 3.9 "Cases") illustrates the\njudgment n.o.v. process in a case where the judge allowed the case to go to a jury that was overly\nsympathetic to the plaintiffs.\nRule 50(b) of the Federal Rules of Civil Procedure provides the authorization for federal judges making a\njudgment contrary to the judgment of the jury. Most states have a similar rule.\nRule 50(b) says,\nWhenever a motion for a directed verdict made at the close of all the evidence is denied or for any\nreason is not granted, the court is deemed to have submitted the action to the jury subject to a\nlater determination of the legal questions raised by the motion. Not later than 10 days after entry\nof judgment, a party who has moved for a directed verdict may move to have the verdict and any\njudgment entered thereon set aside and to have judgment entered in accordance with the party\xe2\x80\x99s\nmotion for a directed verdict.\xe2\x80\xa6[A] new trial may be prayed for in the alternative. If a verdict was\nreturned the court may allow the judgment to stand or may reopen the judgment and either\norder a new trial or direct the entry of judgment as if the requested verdict had been directed.\n\nKEY TAKEAWAY\n\nThe purpose of a trial judge is to ensure justice to all parties to the lawsuit. The judge presides, instructs\nthe jury, and may limit who testifies and what they testify about what. In all of this, the judge will usually\ncommit some errors; occasionally these will be the kinds of errors that seriously compromise a fair trial for\nboth parties. Errors that do seriously compromise a fair trial for both parties are prejudicial, as opposed to\nharmless. The appeals court must decide whether any errors of the trial court judge are prejudicial or not.\nIf a judge directs a verdict, that ends the case for the party who hasn\xe2\x80\x99t asked for one; if a judge grants\njudgment n.o.v., that will take away a jury verdict that one side has worked very hard to get. Thus a judge\nmust be careful not to unduly favor one side or the other, regardless of his or her sympathies.\n\nEXERCISES\n\n1.\n\nWhat if there was not a doctrine of res judicata? What would the legal system be like?\n\n2.\n\nWhy do you think cross-examination is a \xe2\x80\x9cright,\xe2\x80\x9d as opposed to a \xe2\x80\x9cgood thing\xe2\x80\x9d? What kind of judicial\nsystem would not allow cross-examination of witnesses as a matter of right?\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n102\n\n\x0c3.5 Judgment, Appeal, and Execution\n\nLEARNING OBJECTIVES\n\n1.\n\nUnderstand the posttrial process\xe2\x80\x94how appellate courts process appeals.\n\n2.\n\nExplain how a court\xe2\x80\x99s judgment is translated into relief for the winning party.\n\nJudgment or Order\nAt the end of a trial, the judge will enter an order that makes findings of fact (often with the help of a jury)\nand conclusions of law. The judge will also make a judgment as to what relief or remedy should be given.\nOften it is an award of money damages to one of the parties. The losing party may ask for a new trial at\nthis point or within a short period of time following. Once the trial judge denies any such request, the\njudgment\xe2\x80\x94in the form of the court\xe2\x80\x99s order\xe2\x80\x94is final.\n\nAppeal\nIf the loser\xe2\x80\x99s motion for a new trial or a judgment n.o.v. is denied, the losing party may appeal but must\nordinarily post a bond sufficient to ensure that there are funds to pay the amount awarded to the winning\nparty. In an appeal, the appellant aims to show that there was some prejudicial error committed by the\ntrial judge. There will be errors, of course, but the errors must be significant (i.e., not harmless). The basic\nidea is for an appellate court to ensure that a reasonably fair trial was provided to both sides. Enforcement\nof the court\xe2\x80\x99s judgment\xe2\x80\x94an award of money, an injunction\xe2\x80\x94is usually stayed (postponed) until the\nappellate court has ruled. As noted earlier, the party making the appeal is called the appellant, and the\nparty defending the judgment is the appellee (or in some courts, the petitioner and the respondent).\nDuring the trial, the losing party may have objected to certain procedural decisions by the judge. In\ncompiling a record on appeal, the appellant needs to show the appellate court some examples of mistakes\nmade by the judge\xe2\x80\x94for example, having erroneously admitted evidence, having failed to admit proper\nevidence that should have been admitted, or having wrongly instructed the jury. The appellate court must\ndetermine if those mistakes were serious enough to amount to prejudicial error.\nAppellate and trial procedures are different. The appellate court does not hear witnesses or accept\nevidence. It reviews the record of the case\xe2\x80\x94the transcript of the witnesses\xe2\x80\x99 testimony and the documents\nreceived into evidence at trial\xe2\x80\x94to try to find a legal error on a specific request of one or both of the\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n103\n\n\x0cparties. The parties\xe2\x80\x99 lawyers prepare briefs (written statements containing the facts in the case), the\nprocedural steps taken, and the argument or discussion of the meaning of the law and how it applies to\nthe facts. After reading the briefs on appeal, the appellate court may dispose of the appeal without\nargument, issuing a written opinion that may be very short or many pages. Often, though, the appellate\ncourt will hear oral argument. (This can be months, or even more than a year after the briefs are filed.)\nEach lawyer is given a short period of time, usually no more than thirty minutes, to present his client\xe2\x80\x99s\ncase. The lawyer rarely gets a chance for an extended statement because he is usually interrupted by\nquestions from the judges. Through this exchange between judges and lawyers, specific legal positions can\nbe tested and their limits explored.\nDepending on what it decides, the appellate court will affirm the lower court\xe2\x80\x99s\njudgment, modify it, reverse it, or remand it to the lower court for retrial or other action directed by the\nhigher court. The appellate court itself does not take specific action in the case; it sits only to rule on\ncontested issues of law. The lower court must issue the final judgment in the case. As we have already\nseen, there is the possibility of appealing from an intermediate appellate court to the state supreme court\nin twenty-nine states and to the US Supreme Court from a ruling from a federal circuit court of appeal. In\ncases raising constitutional issues, there is also the possibility of appeal to the Supreme Court from the\nstate courts.\nLike trial judges, appellate judges must follow previous decisions, or precedent. But not every previous\ncase is a precedent for every court. Lower courts must respect appellate court decisions, and courts in one\nstate are not bound by decisions of courts in other states. State courts are not bound by decisions of\nfederal courts, except on points of federal law that come from federal courts within the state or from a\nfederal circuit in which the state court sits. A state supreme court is not bound by case law in any other\nstate. But a supreme court in one state with a type of case it has not previously dealt with may find\npersuasive reasoning in decisions of other state supreme courts.\nFederal district courts are bound by the decisions of the court of appeals in their circuit, but decisions by\none circuit court are not precedents for courts in other circuits. Federal courts are also bound by decisions\nof the state supreme courts within their geographic territory in diversity jurisdiction cases. All courts are\nbound by decisions of the US Supreme Court, except the Supreme Court itself, which seldom reverses\nitself but on occasion has overturned its own precedents.\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n104\n\n\x0cNot everything a court says in an opinion is a precedent. Strictly speaking, only the exact holding is\nbinding on the lower courts. A holding is the theory of the law that applies to the particular circumstances\npresented in a case. The courts may sometimes declare what they believe to be the law with regard to\npoints that are not central to the case being decided. These declarations are called dicta (the\nsingular, dictum), and the lower courts do not have to give them the same weight as holdings.\n\nJudgment and Order\nWhen a party has no more possible appeals, it usually pays up voluntarily. If not voluntarily, then the\nlosing party\xe2\x80\x99s assets can be seized or its wages or other income garnished to satisfy the judgment. If the\nfinal judgment is an injunction, failure to follow its dictates can lead to a contempt citation, with a fine or\njail time imposed.\n\nKEY TAKEAWAY\nThe process of conducting a civil trial has many aspects, starting with pleadings and continuing with\nmotions, discovery, more motions, pretrial conferences, and finally the trial itself. At all stages, the rules of\ncivil procedure attempt to give both sides plenty of notice, opportunity to be heard, discovery of relevant\ninformation, cross-examination, and the preservation of procedural objections for purposes of appeal. All\nof these rules and procedures are intended to provide each side with a fair trial.\n\nEXERCISES\n\n1.\n\nMrs. Robinson has a key witness on auto safety that the judge believes is not qualified as an expert. The\njudge examines the witness while the jury is in the jury room and disqualifies him from testifying. The jury\ndoes not get to hear this witness. Her attorney objects. She loses her case. What argument would you\nexpect Mrs. Robinson\xe2\x80\x99s attorney to make in an appeal?\n\n2.\n\nWhy don\xe2\x80\x99t appellate courts need a witness box for witnesses to give testimony under oath?\n3.\n\nA trial judge in Nevada is wondering whether to enforce a surrogate motherhood contract.\nPenelope Barr, of Reno, Nevada, has contracted with Reuben and Tina Goldberg to bear the in\nvitro fertilized egg of Mrs. Goldberg. After carrying the child for nine months, Penelope gives birth,\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n105\n\n\x0cbut she is reluctant to give up the child, even though she was paid $20,000 at the start of the\ncontract and will earn an additional $20,000 on handing over the baby to the Goldbergs. (Barr was\nan especially good candidate for surrogate motherhood: she had borne two perfect children and\nat age 28 drinks no wine, does not smoke or use drugs of any kind, practices yoga, and maintains a\nlargely vegetarian diet with just enough meat to meet the needs of the fetus within.)\nThe Goldbergs have asked the judge for an order compelling Penelope to give up the baby, who\nwas five days old when the lawsuit was filed. The baby is now a month old as the judge looks in\nvain for guidance from any Nevada statute, federal statute, or any prior case in Nevada that\naddressed the issue of surrogate motherhood. He does find several well-reasoned cases, one from\nNew Jersey, one from Michigan, and one from Oregon. Are any of these \xe2\x80\x9cprecedent\xe2\x80\x9d that he must\nfollow? May he adopt the reasoning of any of these courts, if he should find that reasoning\npersuasive?\n\n3.6 When Can Someone Bring a Lawsuit?\n\nLEARNING OBJECTIVES\n\n1.\n\nExplain the requirements for standing to bring a lawsuit in US courts.\n\n2.\n\nDescribe the process by which a group or class of plaintiffs can be certified to file a class action case.\n\nAlmost anyone can bring a lawsuit, assuming they have the filing fee and the help of an attorney. But\nthe court may not hear it, for a number of reasons. There may be no case or controversy, there may\nbe no law to support the plaintiff\xe2\x80\x99s claim, it may be in the wrong court, too much time might have\nlapsed (a statute of limitations problem), or the plaintiff may not have standing.\n\nCase or Controversy: Standing to Sue\nArticle III of the US Constitution provides limits to federal judicial power. For some cases, the Supreme\nCourt has decided that it has no power to adjudicate because there is no \xe2\x80\x9ccase or controversy.\xe2\x80\x9d For\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n106\n\n\x0cexample, perhaps the case has settled or the \xe2\x80\x9creal parties in interest\xe2\x80\x9d are not before the court. In such a\ncase, a court might dismiss the case on the grounds that the plaintiff does not have \xe2\x80\x9cstanding\xe2\x80\x9d to sue.\nFor example, suppose you see a sixteen-wheel moving van drive across your neighbor\xe2\x80\x99s flower bed,\ndestroying her beloved roses. You have enjoyed seeing her roses every summer, for years. She is forlorn\nand tells you that she is not going to raise roses there anymore. She also tells you that she has decided not\nto sue, because she has made the decision to never deal with lawyers if at all possible. Incensed, you\ndecide to sue on her behalf. But you will not have standing to sue because your person or property was not\ndirectly injured by the moving van. Standing means that only the person whose interests are directly\naffected has the legal right to sue.\nThe standing doctrine is easy to understand in straightforward cases such as this but is often a fairly\ncomplicated matter. For example, can fifteen or more state attorneys general bring a lawsuit for a\ndeclaratory judgment that the health care legislation passed in 2010 is unconstitutional? What particular\ninjury have they (or the states) suffered? Are they the best set of plaintiffs to raise this issue? Time\xe2\x80\x94and\nthe Supreme Court\xe2\x80\x94will tell.\n\nClass Actions\nMost lawsuits concern a dispute between two people or between a person and a company or other\norganization. But it can happen that someone injures more than one person at the same time. A driver\nwho runs a red light may hit another car carrying one person or many people. If several people are injured\nin the same accident, they each have the right to sue the driver for the damage that he caused them. Could\nthey sue as a group? Usually not, because the damages would probably not be the same for each person,\nand different facts would have to be proved at the trial. Plus, the driver of the car that was struck might\nhave been partially to blame, so the defendant\xe2\x80\x99s liability toward him might be different from his liability\ntoward the passengers.\nIf, however, the potential plaintiffs were all injured in the same way and their injuries were identical, a\nsingle lawsuit might be a far more efficient way of determining liability and deciding financial\nresponsibility than many individual lawsuits.\nHow could such a suit be brought? All the injured parties could hire the same lawyer, and she could\npresent a common case. But with a group numbering more than a handful of people, it could become\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n107\n\n\x0coverwhelmingly complicated. So how could, say, a million stockholders who believed they were cheated by\na corporation ever get together to sue?\nBecause of these types of situations, there is a legal procedure that permits one person or a small group of\npeople to serve as representatives for all others. This is the class action. The class action is provided for in\nthe Federal Rules of Civil Procedure (Rule 23) and in the separate codes of civil procedure in the states.\nThese rules differ among themselves and are often complex, but in general anyone can file a class action in\nan appropriate case, subject to approval of the court. Once the class is \xe2\x80\x9ccertified,\xe2\x80\x9d or judged to be a legally\nadequate group with common injuries, the lawyers for the named plaintiffs become, in effect, lawyers for\nthe entire class.\nUsually a person who doesn\xe2\x80\x99t want to be in the class can decide to leave. If she does, she will not be\nincluded in an eventual judgment or settlement. But a potential plaintiff who is included in the class\ncannot, after a final judgment is awarded, seek to relitigate the issue if she is dissatisfied with the\noutcome, even though she did not participate at all in the legal proceeding.\n\nKEY TAKEAWAY\n\nAnyone can file a lawsuit, with or without the help of an attorney, but only those lawsuits where a plaintiff\nhas standing will be heard by the courts. Standing has become a complicated question and is used by the\ncourts to ensure that civil cases heard are being pursued by those with tangible and particular injuries.\nClass actions are a way of aggregating claims that are substantially similar and arise out of the same facts\nand circumstances.\n\n1.\n\nEXERCISE\n\nFuchs Funeral Home is carrying the body of Charles Emmenthaler to its resting place at Forest\nLawn Cemetery. Charles\xe2\x80\x99s wife, Chloe, and their two children, Chucky and Clarice, are following\nthe hearse when the coffin falls on the street, opens, and the body of Charles Emmenthaler falls\nout. The wife and children are shocked and aggrieved and later sue in civil court for damages.\nAssume that this is a viable cause of action based on \xe2\x80\x9cnegligent infliction of emotional distress\xe2\x80\x9d in\nthe state of California and that Charles\xe2\x80\x99s brother, sister-in-law, and multiple cousins also were in\nthe funeral procession and saw what happened. The brother of Charles, Kingston Emmenthaler,\nalso sees his brother\xe2\x80\x99s body on the street, but his wife, their three children, and some of Charles\xe2\x80\x99s\nother cousins do not.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n108\n\n\x0cCharles was actually emotionally closest to Kingston\xe2\x80\x99s oldest son, Nestor, who was studying\nabroad at the time of the funeral and could not make it back in time. He is as emotionally\ndistraught at his uncle\xe2\x80\x99s passing as anyone else in the family and is especially grieved over the\ndescription of the incident and the grainy video shot by one of the cousins on his cell phone. Who\nhas standing to sue Fuchs Funeral Home, and who does not?\n\n3.7 Relations with Lawyers\n\nLEARNING OBJECTIVES\n\n1.\n\nUnderstand the various ways that lawyers charge for services.\n\n2.\n\nDescribe the contingent fee system in the United States.\n\n3.\n\nKnow the difference between the American rule and the British rule with regard to who pays attorneys\xe2\x80\x99\nfees.\n\nLegal Fees\nLawyers charge for their services in one of three different ways: flat rate, hourly rate, and contingent fee.\nA flat rate is used usually when the work is relatively routine and the lawyer knows in advance\napproximately how long it will take her to do the job. Drawing a will or doing a real estate closing are\nexamples of legal work that is often paid a flat rate. The rate itself may be based on a percentage of the\nworth of the matter\xe2\x80\x94say, 1 percent of a home\xe2\x80\x99s selling price.\nLawyers generally charge by the hour for courtroom time and for ongoing representation in commercial\nmatters. Virtually every sizable law firm bills its clients by hourly rates, which in large cities can range\nfrom $300 for an associate\xe2\x80\x99s time to $500 and more for a senior partner\xe2\x80\x99s time.\nA contingent fee is one that is paid only if the lawyer wins\xe2\x80\x94that is, it is contingent, or depends upon, the\nsuccess of the case. This type of fee arrangement is used most often in personal injury cases (e.g.,\nautomobile accidents, products liability, and professional malpractice). Although used quite often, the\ncontingent fee is controversial. Trial lawyers justify it by pointing to the high cost of preparing for such\nlawsuits. A typical automobile accident case can cost at least ten thousand dollars to prepare, and a\ncomplicated products-liability case can cost tens of thousands of dollars. Few people have that kind of\nmoney or would be willing to spend it on the chance that they might win a lawsuit. Corporate and\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n109\n\n\x0cprofessional defendants complain that the contingent fee gives lawyers a license to go big game hunting,\nor to file suits against those with deep pockets in the hopes of forcing them to settle.\nTrial lawyers respond that the contingent fee arrangement forces them to screen cases and weed out cases\nthat are weak, because it is not worth their time to spend the hundreds of hours necessary on such cases if\ntheir chances of winning are slim or nonexistent.\n\nCosts\nIn England and in many other countries, the losing party must pay the legal expenses of the winning\nparty, including attorneys\xe2\x80\x99 fees. That is not the general rule in this country. Here, each party must pay\nmost of its own costs, including (and especially) the fees of lawyers. (Certain relatively minor costs, such\nas filing fees for various documents required in court, are chargeable to the losing side, if the judge\ndecides it.) This type of fee structure is known as the American rule (in contrast to the British rule).\nThere are two types of exceptions to the American rule. By statute, Congress and the state legislatures\nhave provided that the winning party in particular classes of cases may recover its full legal costs from the\nloser\xe2\x80\x94for example, the federal antitrust laws so provide and so does the federal Equal Access to Justice\nAct. The other exception applies to litigants who either initiate lawsuits in bad faith, with no expectation\nof winning, or who defend them in bad faith, in order to cause the plaintiff great expense. Under these\ncircumstances, a court has the discretion to award attorneys\xe2\x80\x99 fees to the winner. But this rule is not\ninfinitely flexible, and courts do not have complete freedom to award attorneys\xe2\x80\x99 fees in any amount, but\nonly "reasonable" attorney\'s fees.\n\nKEY TAKEAWAY\n\nLitigation is expensive. Getting a lawyer can be costly, unless you get a lawyer on a contingent fee. Not all\nlegal systems allow contingent fees. In many legal systems, the loser pays attorneys\xe2\x80\x99 fees for both parties.\n\nEXERCISES\n\n1.\n\nMrs. Robinson\xe2\x80\x99s attorney estimates that they will recover a million dollars from Volkswagen in the Audi\nlawsuit. She has Mrs. Robinson sign a contract that gives her firm one-third of any recovery after the\nfirm\xe2\x80\x99s expenses are deducted. The judge does in fact award a million dollars, and the defendant pays. The\nfirm\xe2\x80\x99s expenses are $100,000. How much does Mrs. Robinson get?\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n110\n\n\x0c2.\n\nHarry Potter brings a lawsuit against Draco Malfoy in Chestershire, England, for slander, a form of\ndefamation. Potter alleges that Malfoy insists on calling him a mudblood. Ron Weasley testifies, as does\nNeville Chamberlain. But Harry loses, because the court has no conception of wizardry and cannot make\nsense of the case at all. In dismissing the case, however, who (under English law) will bear the costs of the\nattorneys who have brought the case for Potter and defended the matter for Malfoy?\n\n3.8 Alternative Means of Resolving Disputes\nLEARNING OBJECTIVES\n\n1.\n\nUnderstand how arbitration and mediation are frequently used alternatives to litigation.\n\n2.\n\nDescribe the differences between arbitration and mediation.\n\n3.\n\nExplain why arbitration is final and binding.\n\nDisputes do not have to be settled in court. No law requires parties who have a legal dispute to seek\njudicial resolution if they can resolve their disagreement privately or through some other public\nforum. In fact, the threat of a lawsuit can frequently motivate parties toward private negotiation.\nFiling a lawsuit may convince one party that the other party is serious. Or the parties may decide that\nthey will come to terms privately rather than wait the three or four years it can frequently take for a\ncase to move up on the court calendar.\n\nArbitration\nBeginning around 1980, a movement toward alternative dispute resolution began to gain force throughout\nthe United States. Bar associations, other private groups, and the courts themselves wanted to find\nquicker and cheaper ways for litigants and potential litigants to settle certain types of quarrels than\nthrough the courts. As a result, neighborhood justice centers or dispute resolution centers have sprung up\nin communities. These are where people can come for help in settling disputes, of both civil and criminal\nnature, that should not consume the time and money of the parties or courts in lengthy proceedings.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n111\n\n\x0cThese alternative forums use a variety of methods, including arbitration, mediation, and conciliation, to\nbring about agreement or at least closure of the dispute. These methods are not all alike, and their\ndifferences are worth noting.\nArbitration is a type of adjudication. The parties use a private decision maker, the arbitrator, and the rules\nof procedure are considerably more relaxed than those that apply in the courtroom. Arbitrators might be\nretired judges, lawyers, or anyone with the kind of specialized knowledge and training that would be\nuseful in making a final, binding decision on the dispute. In a contractual relationship, the parties can\ndecide even before a dispute arises to use arbitration when the time comes. Or parties can decide after a\ndispute arises to use arbitration instead of litigation. In a predispute arbitration agreement (often part of a\nlarger contract), the parties can spell out the rules of procedure to be used and the method for choosing\nthe arbitrator. For example, they may name the specific person or delegate the responsibility of choosing\nto some neutral person, or they may each designate a person and the two designees may jointly pick a\nthird arbitrator.\nMany arbitrations take place under the auspices of the American Arbitration Association, a private\norganization headquartered in New York, with regional offices in many other cities. The association uses\npublished sets of rules for various types of arbitration (e.g., labor arbitration or commercial arbitration);\nparties who provide in contracts for arbitration through the association are agreeing to be bound by the\nassociation\xe2\x80\x99s rules. Similarly, the National Association of Securities Dealers provides arbitration services\nfor disputes between clients and brokerage firms. International commercial arbitration often takes place\nthrough the auspices of the International Chamber of Commerce. A multilateral agreement known as the\nConvention on the Recognition and Enforcement of Arbitral Awards provides that agreements to\narbitrate\xe2\x80\x94and arbitral awards\xe2\x80\x94will be enforced across national boundaries.\nArbitration has two advantages over litigation. First, it is usually much quicker, because the arbitrator\ndoes not have a backlog of cases and because the procedures are simpler. Second, in complex cases, the\nquality of the decision may be higher, because the parties can select an arbitrator with specialized\nknowledge.\nUnder both federal and state law, arbitration is favored, and a decision rendered by an arbitrator is\nbinding by law and may be enforced by the courts. The arbitrator\xe2\x80\x99s decision is final and binding, with very\nfew exceptions (such as fraud or manifest disregard of the law by the arbitrator or panel of arbitrators).\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n112\n\n\x0cSaying that arbitration is favored means that if you have agreed to arbitration, you can\xe2\x80\x99t go to court if the\nother party wants you to arbitrate. Under the Federal Arbitration Act, the other party can go to court and\nget a stay against your litigation and also get an order compelling you to go to arbitration.\n\nMediation\nUnlike adjudication, mediation gives the neutral party no power to impose a decision. The mediator is a\ngo-between who attempts to help the parties negotiate a solution. The mediator will communicate the\nparties\xe2\x80\x99 positions to each other, will facilitate the finding of common ground, and will suggest outcomes.\nBut the parties have complete control: they may ignore the recommendations of the mediator entirely,\nsettle in their own way, find another mediator, agree to binding arbitration, go to court, or forget the\nwhole thing!\n\nKEY TAKEAWAY\n\nLitigation is not the only way to resolve disputes. Informal negotiation between the disputants usually\ncomes first, but both mediation and arbitration are available. Arbitration, though, is final and binding.\nOnce you agree to arbitrate, you will have a final, binding arbitral award that is enforceable through the\ncourts, and courts will almost never allow you to litigate after you have agreed to arbitrate.\n\nEXERCISES\n\n1.\n\nWhen Mrs. Robinson buys her Audi from Seaway, there is a paragraph in the bill of sale, which both the\ndealer and Mrs. Robinson sign, that says, \xe2\x80\x9cIn the event of any complaint by customer/buyer against\nSeaway regarding the vehicle purchased herein, such complaint shall not be litigated, but may only be\narbitrated under the rules of the American Arbitration Association and in accordance with New York law.\xe2\x80\x9d\nMrs. Robinson did not see the provision, doesn\xe2\x80\x99t like it, and wants to bring a lawsuit in Oklahoma against\nSeaway. What result?\n\n2.\n\nHendrik Koster (Netherlands) contracts with Automark, Inc. (a US company based in Illinois) to supply\nAutomark with a large quantity of valve cap gauges. He does, and Automark fails to pay. Koster thinks he\nis owed $66,000. There is no agreement to arbitrate or mediate. Can Koster make Automark mediate or\narbitrate?\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n113\n\n\x0c3.\n\nSuppose that there is an agreement between Koster and Automark to arbitrate. It says, \xe2\x80\x9cThe parties agree\nto arbitrate any dispute arising under this agreement in accordance with the laws of the Netherlands and\nunder the auspices of the International Chamber of Commerce\xe2\x80\x99s arbitration facility.\xe2\x80\x9d The International\nChamber of Commerce has arbitration rules and will appoint an arbitrator or arbitral panel in the event\nthe parties cannot agree on an arbitrator. The arbitration takes place in Geneva. Koster gets an arbitral\naward for $66,000 plus interest. Automark does not participate in any way. Will a court in Illinois enforce\nthe arbitral award?\n\n3.9 Cases\nBurger King v. Rudzewicz\nBurger King Corp. v. Rudzewicz\n471 U.S. 462 (U.S. Supreme Court 1985)\n\nSummary\nBurger King Corp. is a Florida corporation with principal offices in Miami. It principally conducts\nrestaurant business through franchisees. The franchisees are licensed to use Burger King\xe2\x80\x99s trademarks\nand service marks in standardized restaurant facilities. Rudzewicz is a Michigan resident who, with a\npartner (MacShara) operated a Burger King franchise in Drayton Plains, Michigan. Negotiations for\nsetting up the franchise occurred in 1978 largely between Rudzewicz, his partner, and a regional office of\nBurger King in Birmingham, Michigan, although some deals and concessions were made by Burger King\nin Florida. A preliminary agreement was signed in February of 1979. Rudzewicz and MacShara assumed\noperation of an existing facility in Drayton Plains and MacShara attended prescribed management\ncourses in Miami during the four months following Feb. 1979.\nRudzewicz and MacShara bought $165,000 worth of restaurant equipment from Burger King\xe2\x80\x99s Davmor\nIndustries division in Miami. But before the final agreements were signed, the parties began to disagree\nover site-development fees, building design, computation of monthly rent, and whether Rudzewicz and\nMacShara could assign their liabilities to a corporation they had formed. Negotiations took place between\nRudzewicz, MacShara, and the Birmingham regional office; but Rudzewicz and MacShara learned that the\nregional office had limited decision-making power and turned directly to Miami headquarters for their\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n114\n\n\x0cconcerns. The final agreement was signed by June 1979 and provided that the franchise relationship was\ngoverned by Florida law, and called for payment of all required fees and forwarding of all relevant notices\nto Miami headquarters.\nThe Drayton Plains restaurant did fairly well at first, but a recession in late 1979 caused the franchisees to\nfall far behind in their monthly payments to Miami. Notice of default was sent from Miami to Rudzewicz,\nwho nevertheless continued to operate the restaurant as a Burger King franchise. Burger King sued in\nfederal district court for the southern district of Florida. Rudzewicz contested the court\xe2\x80\x99s personal\njurisdiction over him, since he had never been to Florida.\nThe federal court looked to Florida\xe2\x80\x99s long arm statute and held that it did have personal jurisdiction over\nthe non-resident franchisees, and awarded Burger King a quarter of a million dollars in contract damages\nand enjoined the franchisees from further operation of the Drayton Plains facility. Franchisees appealed\nto the 11th Circuit Court of Appeals and won a reversal based on lack of personal jurisdiction. Burger King\npetitioned the Supreme Ct. for a writ of certiorari.\nJustice Brennan delivered the opinion of the court.\nThe Due Process Clause protects an individual\xe2\x80\x99s liberty interest in not being subject to the binding\njudgments of a forum with which he has established no meaningful \xe2\x80\x9ccontacts, ties, or relations.\xe2\x80\x9d\nInternational Shoe Co. v. Washington. By requiring that individuals have \xe2\x80\x9cfair warning that a particular\nactivity may subject [them] to the jurisdiction of a foreign sovereign,\xe2\x80\x9d the Due Process Clause \xe2\x80\x9cgives a\ndegree of predictability to the legal system that allows potential defendants to structure their primary\nconduct with some minimum assurance as to where that conduct will and will not render them liable to\nsuit.\xe2\x80\x9d\xe2\x80\xa6\nWhere a forum seeks to assert specific jurisdiction over an out-of-state defendant who has not consented\nto suit there, this \xe2\x80\x9cfair warning\xe2\x80\x9d requirement is satisfied if the defendant has \xe2\x80\x9cpurposefully directed\xe2\x80\x9d his\nactivities at residents of the forum, and the litigation results from alleged injuries that \xe2\x80\x9carise out of or\nrelate to\xe2\x80\x9d those activities, Thus \xe2\x80\x9c[t]he forum State does not exceed its powers under the Due Process\nClause if it asserts personal jurisdiction over a corporation that delivers its products into the stream of\ncommerce with the expectation that they will be purchased by consumers in the forum State\xe2\x80\x9d and those\nproducts subsequently injure forum consumers. Similarly, a publisher who distributes magazines in a\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n115\n\n\x0cdistant State may fairly be held accountable in that forum for damages resulting there from an allegedly\ndefamatory story.\xe2\x80\xa6\n\xe2\x80\xa6[T]he constitutional touchstone remains whether the defendant purposefully established \xe2\x80\x9cminimum\ncontacts\xe2\x80\x9d in the forum State.\xe2\x80\xa6In defining when it is that a potential defendant should \xe2\x80\x9creasonably\nanticipate\xe2\x80\x9d out-of-state litigation, the Court frequently has drawn from the reasoning of Hanson v.\nDenckla, 357 U.S. 235, 253 (1958):\nThe unilateral activity of those who claim some relationship with a nonresident defendant cannot\nsatisfy the requirement of contact with the forum State. The application of that rule will vary\nwith the quality and nature of the defendant\xe2\x80\x99s activity, but it is essential in each case that there be\nsome act by which the defendant purposefully avails itself of the privilege of conducting activities\nwithin the forum State, thus invoking the benefits and protections of its laws.\nThis \xe2\x80\x9cpurposeful availment\xe2\x80\x9d requirement ensures that a defendant will not be haled into a jurisdiction\nsolely as a result of \xe2\x80\x9crandom,\xe2\x80\x9d \xe2\x80\x9cfortuitous,\xe2\x80\x9d or \xe2\x80\x9cattenuated\xe2\x80\x9d contacts, or of the \xe2\x80\x9cunilateral activity of\nanother party or a third person,\xe2\x80\x9d [Citations] Jurisdiction is proper, however, where the contacts\nproximately result from actions by the defendant himself that create a \xe2\x80\x9csubstantial connection\xe2\x80\x9d with the\nforum State. [Citations] Thus where the defendant \xe2\x80\x9cdeliberately\xe2\x80\x9d has engaged in significant activities\nwithin a State, or has created \xe2\x80\x9ccontinuing obligations\xe2\x80\x9d between himself and residents of the forum, he\nmanifestly has availed himself of the privilege of conducting business there, and because his activities are\nshielded by \xe2\x80\x9cthe benefits and protections\xe2\x80\x9d of the forum\xe2\x80\x99s laws it is presumptively not unreasonable to\nrequire him to submit to the burdens of litigation in that forum as well.\nJurisdiction in these circumstances may not be avoided merely because the defendant did not physically\nenter the forum State. Although territorial presence frequently will enhance a potential defendant\xe2\x80\x99s\naffiliation with a State and reinforce the reasonable foreseeability of suit there, it is an inescapable fact of\nmodern commercial life that a substantial amount of business is transacted solely by mail and wire\ncommunications across state lines, thus obviating the need for physical presence within a State in which\nbusiness is conducted. So long as a commercial actor\xe2\x80\x99s efforts are \xe2\x80\x9cpurposefully directed\xe2\x80\x9d toward residents\nof another State, we have consistently rejected the notion that an absence of physical contacts can defeat\npersonal jurisdiction there.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n116\n\n\x0cOnce it has been decided that a defendant purposefully established minimum contacts within the forum\nState, these contacts may be considered in light of other factors to determine whether the assertion of\npersonal jurisdiction would comport with \xe2\x80\x9cfair play and substantial justice.\xe2\x80\x9d International Shoe Co. v.\nWashington, 326 U.S., at 320. Thus courts in \xe2\x80\x9cappropriate case[s]\xe2\x80\x9d may evaluate \xe2\x80\x9cthe burden on the\ndefendant,\xe2\x80\x9d \xe2\x80\x9cthe forum State\xe2\x80\x99s interest in adjudicating the dispute,\xe2\x80\x9d \xe2\x80\x9cthe plaintiff\xe2\x80\x99s interest in obtaining\nconvenient and effective relief,\xe2\x80\x9d \xe2\x80\x9cthe interstate judicial system\xe2\x80\x99s interest in obtaining the most efficient\nresolution of controversies,\xe2\x80\x9d and the \xe2\x80\x9cshared interest of the several States in furthering fundamental\nsubstantive social policies.\xe2\x80\x9d These considerations sometimes serve to establish the reasonableness of\njurisdiction upon a lesser showing of minimum contacts than would otherwise be required. [Citations]\nApplying these principles to the case at hand, we believe there is substantial record evidence supporting\nthe District Court\xe2\x80\x99s conclusion that the assertion of personal jurisdiction over Rudzewicz in Florida for the\nalleged breach of his franchise agreement did not offend due process.\xe2\x80\xa6\nIn this case, no physical ties to Florida can be attributed to Rudzewicz other than MacShara\xe2\x80\x99s brief\ntraining course in Miami. Rudzewicz did not maintain offices in Florida and, for all that appears from the\nrecord, has never even visited there. Yet this franchise dispute grew directly out of \xe2\x80\x9ca contract which had a\nsubstantial connection with that State.\xe2\x80\x9d Eschewing the option of operating an independent local\nenterprise, Rudzewicz deliberately \xe2\x80\x9creach[ed] out beyond\xe2\x80\x9d Michigan and negotiated with a Florida\ncorporation for the purchase of a long-term franchise and the manifold benefits that would derive from\naffiliation with a nationwide organization. Upon approval, he entered into a carefully structured 20-year\nrelationship that envisioned continuing and wide-reaching contacts with Burger King in Florida. In light\nof Rudzewicz\xe2\x80\x99 voluntary acceptance of the long-term and exacting regulation of his business from Burger\nKing\xe2\x80\x99s Miami headquarters, the \xe2\x80\x9cquality and nature\xe2\x80\x9d of his relationship to the company in Florida can in\nno sense be viewed as \xe2\x80\x9crandom,\xe2\x80\x9d \xe2\x80\x9cfortuitous,\xe2\x80\x9d or \xe2\x80\x9cattenuated.\xe2\x80\x9d Rudzewicz\xe2\x80\x99 refusal to make the\ncontractually required payments in Miami, and his continued use of Burger King\xe2\x80\x99s trademarks and\nconfidential business information after his termination, caused foreseeable injuries to the corporation in\nFlorida. For these reasons it was, at the very least, presumptively reasonable for Rudzewicz to be called to\naccount there for such injuries.\n\xe2\x80\xa6Because Rudzewicz established a substantial and continuing relationship with Burger King\xe2\x80\x99s Miami\nheadquarters, received fair notice from the contract documents and the course of dealing that he might be\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n117\n\n\x0csubject to suit in Florida, and has failed to demonstrate how jurisdiction in that forum would otherwise be\nfundamentally unfair, we conclude that the District Court\xe2\x80\x99s exercise of jurisdiction pursuant to Fla. Stat.\n48.193(1)(g) (Supp. 1984) did not offend due process. The judgment of the Court of Appeals is accordingly\nreversed, and the case is remanded for further proceedings consistent with this opinion.\nIt is so ordered.\n\nCASE QUESTIONS\n\n1.\n\nWhy did Burger King sue in Florida rather than in Michigan?\n\n2.\n\nIf Florida has a long-arm statute that tells Florida courts that it may exercise personal jurisdiction over\nsomeone like Rudzewicz, why is the court talking about the due process clause?\n\n3.\n\nWhy is this case in federal court rather than in a Florida state court?\n\n4.\n\nIf this case had been filed in state court in Florida, would Rudzewicz be required to come to Florida?\nExplain.\n\nFerlito v. Johnson & Johnson\nFerlito v. Johnson & Johnson Products, Inc.\n771 F. Supp. 196 (U.S. District Ct., Eastern District of Michigan 1991)\nGadola, J.\nPlaintiffs Susan and Frank Ferlito, husband and wife, attended a Halloween party in 1984 dressed as\nMary (Mrs. Ferlito) and her little lamb (Mr. Ferlito). Mrs. Ferlito had constructed a lamb costume for her\nhusband by gluing cotton batting manufactured by defendant Johnson & Johnson Products (\xe2\x80\x9cJJP\xe2\x80\x9d) to a\nsuit of long underwear. She had also used defendant\xe2\x80\x99s product to fashion a headpiece, complete with ears.\nThe costume covered Mr. Ferlito from his head to his ankles, except for his face and hands, which were\nblackened with Halloween paint. At the party Mr. Ferlito attempted to light his cigarette by using a butane\nlighter. The flame passed close to his left arm, and the cotton batting on his left sleeve ignited. Plaintiffs\nsued defendant for injuries they suffered from burns which covered approximately one-third of Mr.\nFerlito\xe2\x80\x99s body.\nFollowing a jury verdict entered for plaintiffs November 2, 1989, the Honorable Ralph M. Freeman\nentered a judgment for plaintiff Frank Ferlito in the amount of $555,000 and for plaintiff Susan Ferlito in\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n118\n\n\x0cthe amount of $ 70,000. Judgment was entered November 7, 1989. Subsequently, on November 16, 1989,\ndefendant JJP filed a timely motion for judgment notwithstanding the verdict pursuant to Fed.R.Civ.P.\n50(b) or, in the alternative, for new trial. Plaintiffs filed their response to defendant\xe2\x80\x99s motion December\n18, 1989; and defendant filed a reply January 4, 1990. Before reaching a decision on this motion, Judge\nFreeman died. The case was reassigned to this court April 12, 1990.\nMOTION FOR JUDGMENT NOTWITHSTANDING THE VERDICT\nDefendant JJP filed two motions for a directed verdict, the first on October 27, 1989, at the close of\nplaintiffs\xe2\x80\x99 proofs, and the second on October 30, 1989, at the close of defendant\xe2\x80\x99s proofs. Judge Freeman\ndenied both motions without prejudice. Judgment for plaintiffs was entered November 7, 1989; and\ndefendant\xe2\x80\x99s instant motion, filed November 16, 1989, was filed in a timely manner.\nThe standard for determining whether to grant a j.n.o.v. is identical to the standard for evaluating a\nmotion for directed verdict:\nIn determining whether the evidence is sufficient, the trial court may neither weigh the evidence, pass on\nthe credibility of witnesses nor substitute its judgment for that of the jury. Rather, the evidence must be\nviewed in the light most favorable to the party against whom the motion is made, drawing from that\nevidence all reasonable inferences in his favor. If after reviewing the evidence\xe2\x80\xa6the trial court is of the\nopinion that reasonable minds could not come to the result reached by the jury, then the motion for\nj.n.o.v. should be granted.\nTo recover in a \xe2\x80\x9cfailure to warn\xe2\x80\x9d product liability action, a plaintiff must prove each of the following four\nelements of negligence: (1) that the defendant owed a duty to the plaintiff, (2) that the defendant violated\nthat duty, (3) that the defendant\xe2\x80\x99s breach of that duty was a proximate cause of the damages suffered by\nthe plaintiff, and (4) that the plaintiff suffered damages.\nTo establish a prima facie case that a manufacturer\xe2\x80\x99s breach of its duty to warn was a proximate cause of\nan injury sustained, a plaintiff must present evidence that the product would have been used differently\nhad the proffered warnings been given.\n\n[1]\n\n[Citations omitted] In the absence of evidence that a warning\n\nwould have prevented the harm complained of by altering the plaintiff\xe2\x80\x99s conduct, the failure to warn\ncannot be deemed a proximate cause of the plaintiff\xe2\x80\x99s injury as a matter of law. [In accordance with\nprocedure in a diversity of citizenship case, such as this one, the court cites Michigan case law as the basis\nfor its legal interpretation.]\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n119\n\n\x0c\xe2\x80\xa6\nA manufacturer has a duty \xe2\x80\x9cto warn the purchasers or users of its product about dangers associated with\nintended use.\xe2\x80\x9d Conversely, a manufacturer has no duty to warn of a danger arising from an unforeseeable\nmisuse of its product. [Citation] Thus, whether a manufacturer has a duty to warn depends on whether\nthe use of the product and the injury sustained by it are foreseeable. Gootee v. Colt Industries Inc., 712\nF.2d 1057, 1065 (6th Cir. 1983); Owens v. Allis-Chalmers Corp., 414 Mich. 413, 425, 326 N.W.2d 372\n(1982). Whether a plaintiff\xe2\x80\x99s use of a product is foreseeable is a legal question to be resolved by the court.\nTrotter, supra. Whether the resulting injury is foreseeable is a question of fact for the jury.\n\n[2]\n\nThomas v.\n\nInternational Harvester Co., 57 Mich. App. 79, 225 N.W.2d 175 (1974).\nIn the instant action no reasonable jury could find that JJP\xe2\x80\x99s failure to warn of the flammability of cotton\nbatting was a proximate cause of plaintiffs\xe2\x80\x99 injuries because plaintiffs failed to offer any evidence to\nestablish that a flammability warning on JJP\xe2\x80\x99s cotton batting would have dissuaded them from using the\nproduct in the manner that they did.\nPlaintiffs repeatedly stated in their response brief that plaintiff Susan Ferlito testified that \xe2\x80\x9cshe would\nnever again use cotton batting to make a costume\xe2\x80\xa6However, a review of the trial transcript reveals that\nplaintiff Susan Ferlito never testified that she would never again use cotton batting to make a costume.\nMore importantly, the transcript contains no statement by plaintiff Susan Ferlito that a flammability\nwarning on defendant JJP\xe2\x80\x99s product would have dissuaded her from using the cotton batting to construct\nthe costume in the first place. At oral argument counsel for plaintiffs conceded that there was no\ntestimony during the trial that either plaintiff Susan Ferlito or her husband, plaintiff Frank J. Ferlito,\nwould have acted any different if there had been a flammability warning on the product\xe2\x80\x99s package. The\nabsence of such testimony is fatal to plaintiffs\xe2\x80\x99 case; for without it, plaintiffs have failed to prove\nproximate cause, one of the essential elements of their negligence claim.\nIn addition, both plaintiffs testified that they knew that cotton batting burns when it is exposed to flame.\nSusan Ferlito testified that she knew at the time she purchased the cotton batting that it would burn if\nexposed to an open flame. Frank Ferlito testified that he knew at the time he appeared at the Halloween\nparty that cotton batting would burn if exposed to an open flame. His additional testimony that he would\nnot have intentionally put a flame to the cotton batting shows that he recognized the risk of injury of\nwhich he claims JJP should have warned. Because both plaintiffs were already aware of the danger, a\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n120\n\n\x0cwarning by JJP would have been superfluous. Therefore, a reasonable jury could not have found that\nJJP\xe2\x80\x99s failure to provide a warning was a proximate cause of plaintiffs\xe2\x80\x99 injuries.\nThe evidence in this case clearly demonstrated that neither the use to which plaintiffs put JJP\xe2\x80\x99s product\nnor the injuries arising from that use were foreseeable. Susan Ferlito testified that the idea for the\ncostume was hers alone. As described on the product\xe2\x80\x99s package, its intended uses are for cleansing,\napplying medications, and infant care. Plaintiffs\xe2\x80\x99 showing that the product may be used on occasion in\nclassrooms for decorative purposes failed to demonstrate the foreseeability of an adult male encapsulating\nhimself from head to toe in cotton batting and then lighting up a cigarette.\nORDER\nNOW, THEREFORE, IT IS HEREBY ORDERED that defendant JJP\xe2\x80\x99s motion for judgment\nnotwithstanding the verdict is GRANTED.\nIT IS FURTHER ORDERED that the judgment entered November 2, 1989, is SET ASIDE.\nIT IS FURTHER ORDERED that the clerk will enter a judgment in favor of the defendant JJP.\n\nCASE QUESTIONS\n\n1.\n\nThe opinion focuses on proximate cause. As we will see in Chapter 7 "Introduction to Tort Law", a\nnegligence case cannot be won unless the plaintiff shows that the defendant has breached a duty and\nthat the defendant\xe2\x80\x99s breach has actually and proximately caused the damage complained of. What,\nexactly, is the alleged breach of duty by the defendant here?\n\n2.\n\nExplain why Judge Gadola reasoning that JJP had no duty to warn in this case. After this case, would they\nthen have a duty to warn, knowing that someone might use their product in this way?\n3.\n\n[1] By \xe2\x80\x9cprima facie case,\xe2\x80\x9d the court means a case in which the plaintiff has presented all the basic\nelements of the cause of action alleged in the complaint. If one or more elements of proof are missing,\nthen the plaintiff has fallen short of establishing a prima facie case, and the case should be dismissed\n(usually on the basis of a directed verdict).\n\n4.\n\n[2] Note the division of labor here: questions of law are for the judge, while questions of \xe2\x80\x9cfact\xe2\x80\x9d are for the\njury. Here, \xe2\x80\x9cforeseeability\xe2\x80\x9d is a fact question, while the judge retains authority over questions of law. The\ndivision between questions of fact and questions of law is not an easy one, however.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n121\n\n\x0cChapter 4\n\nConstitutional Law and US Commerce\nLEARNING OBJECTIVES\nAfter reading this chapter, you should be able to do the following:\n1.\n\nExplain the historical importance and basic structure of the US Constitution.\n\n2.\n\nKnow what judicial review is and what it represents in terms of the separation of powers between the\nexecutive, legislative, and judicial branches of government.\n\n3.\n\nLocate the source of congressional power to regulate the economy under the Constitution, and explain\nwhat limitations there are to the reach of congressional power over interstate commerce.\n\n4.\n\nDescribe the different phases of congressional power over commerce, as adjudged by the US Supreme\nCourt over time.\n\n5.\n\nExplain what power the states retain over commerce, and how the Supreme Court may sometimes limit\nthat power.\n\n6.\n\nDescribe how the Supreme Court, under the supremacy clause of the Constitution, balances state and\nfederal laws that may be wholly or partly in conflict.\n\n7.\n\nExplain how the Bill of Rights relates to business activities in the United States.\n\nThe US Constitution is the foundation for all of US law. Business and commerce are directly affected\nby the words, meanings, and interpretations of the Constitution. Because it speaks in general terms,\nits provisions raise all kinds of issues for scholars, lawyers, judges, politicians, and commentators.\nFor example, arguments still rage over the nature and meaning of \xe2\x80\x9cfederalism,\xe2\x80\x9d the concept that\nthere is shared governance between the states and the federal government. The US Supreme Court is\nthe ultimate arbiter of those disputes, and as such it has a unique role in the legal system. It has\nassumed the power of judicial review, unique among federal systems globally, through which it can\nstrike down federal or state statutes that it believes violate the Constitution and can even void the\npresident\xe2\x80\x99s executive orders if they are contrary to the Constitution\xe2\x80\x99s language. No knowledgeable\ncitizen or businessperson can afford to be ignorant of its basic provisions.\n\n4.1 Basic Aspects of the US Constitution\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n122\n\n\x0cLEARNING OBJECTIVES\n1.\n\nDescribe the American values that are reflected in the US Constitution.\n\n2.\n\nKnow what federalism means, along with separation of powers.\n\n3.\n\nExplain the process of amending the Constitution and why judicial review is particularly significant.\n\nThe Constitution as Reflecting American Values\nIn the US, the one document to which all public officials and military personnel pledge their unswerving\nallegiance is the Constitution. If you serve, you are asked to \xe2\x80\x9csupport and defend\xe2\x80\x9d the Constitution\n\xe2\x80\x9cagainst all enemies, foreign and domestic.\xe2\x80\x9d The oath usually includes a statement that you swear that this\noath is taken freely, honestly, and without \xe2\x80\x9cany purpose of evasion.\xe2\x80\x9d This loyalty oath may be related to a\ntime\xe2\x80\x94fifty years ago\xe2\x80\x94when \xe2\x80\x9cun-American\xe2\x80\x9d activities were under investigation in Congress and the press;\nthe fear of communism (as antithetical to American values and principles) was paramount. As you look at\nthe Constitution and how it affects the legal environment of business, please consider what basic values it\nmay impart to us and what makes it uniquely American and worth defending \xe2\x80\x9cagainst all enemies, foreign\nand domestic.\xe2\x80\x9d\nIn Article I, the Constitution places the legislature first and prescribes the ways in which representatives\nare elected to public office. Article I balances influence in the federal legislature between large states and\nsmall states by creating a Senate in which the smaller states (by population) as well as the larger states\nhave two votes. In Article II, the Constitution sets forth the powers and responsibilities of the branch\xe2\x80\x94the\npresidency\xe2\x80\x94and makes it clear that the president should be the commander in chief of the armed forces.\nArticle II also gives states rather than individuals (through the Electoral College) a clear role in the\nelection process. Article III creates the federal judiciary, and the Bill of Rights, adopted in 1791, makes\nclear that individual rights must be preserved against activities of the federal government. In general, the\nidea of rights is particularly strong.\nThe Constitution itself speaks of rights in fairly general terms, and the judicial interpretation of various\nrights has been in flux. The \xe2\x80\x9cright\xe2\x80\x9d of a person to own another person was notably affirmed by the\nSupreme Court in the Dred Scott decision in 1857.\n\n[1]\n\nThe \xe2\x80\x9cright\xe2\x80\x9d of a child to freely contract for long,\n\ntedious hours of work was upheld by the court in Hammer v. Dagenhart in 1918. Both decisions were\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n123\n\n\x0clater repudiated, just as the decision that a woman has a \xe2\x80\x9cright\xe2\x80\x9d to an abortion in the first trimester of\npregnancy could later be repudiated if Roe v. Wade is overturned by the Supreme Court.\n\n[2]\n\nGeneral Structure of the Constitution\nLook at the Constitution. Notice that there are seven articles, starting with Article I (legislative powers),\nArticle II (executive branch), and Article III (judiciary). Notice that there is no separate article for\nadministrative agencies. The Constitution also declares that it is \xe2\x80\x9cthe supreme Law of the Land\xe2\x80\x9d (Article\nVI). Following Article VII are the ten amendments adopted in 1791 that are referred to as the Bill of\nRights. Notice also that in 1868, a new amendment, the Fourteenth, was adopted, requiring states to\nprovide \xe2\x80\x9cdue process\xe2\x80\x9d and \xe2\x80\x9cequal protection of the laws\xe2\x80\x9d to citizens of the United States.\n\nFederalism\nThe partnership created in the Constitution between the states and the federal government is\ncalled federalism. The Constitution is a document created by the states in which certain powers are\ndelegated to the national government, and other powers are reserved to the states. This is made explicit in\nthe Tenth Amendment.\n\nSeparation of Powers and Judicial Review\nBecause the Founding Fathers wanted to ensure that no single branch of the government, especially the\nexecutive branch, would be ascendant over the others, they created various checks and balances to ensure\nthat each of the three principal branches had ways to limit or modify the power of the others. This is\nknown as the separation of powers. Thus the president retains veto power, but the House of\nRepresentatives is entrusted with the power to initiate spending bills.\nPower sharing was evident in the basic design of Congress, the federal legislative branch. The basic power\nimbalance was between the large states (with greater population) and the smaller ones (such as\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n124\n\n\x0cDelaware). The smaller ones feared a loss of sovereignty if they could be outvoted by the larger ones, so\nthe federal legislature was constructed to guarantee two Senate seats for every state, no matter how small.\nThe Senate was also given great responsibility in ratifying treaties and judicial nominations. The net effect\nof this today is that senators from a very small number of states can block treaties and other important\nlegislation. The power of small states is also magnified by the Senate\xe2\x80\x99s cloture rule, which currently\nrequires sixty out of one hundred senators to vote to bring a bill to the floor for an up-or-down vote.\nBecause the Constitution often speaks in general terms (with broad phrases such as \xe2\x80\x9cdue process\xe2\x80\x9d and\n\xe2\x80\x9cequal protection\xe2\x80\x9d), reasonable people have disagreed as to how those terms apply in specific cases. The\nUnited States is unique among industrialized democracies in having a Supreme Court that reserves for\nitself that exclusive power to interpret what the Constitution means. The famous case of Marbury v.\nMadison began that tradition in 1803, when the Supreme Court had marginal importance in the new\nrepublic. The decision in Bush v. Gore, decided in December of 2000, illustrates the power of the court to\nshape our destiny as a nation. In that case, the court overturned a ruling by the Florida Supreme Court\nregarding the way to proceed on a recount of the Florida vote for the presidency. The court\xe2\x80\x99s ruling was\npurportedly based on the \xe2\x80\x9cequal protection of the laws\xe2\x80\x9d provision in the Fourteenth Amendment.\nFrom Marbury to the present day, the Supreme Court has articulated the view that the US Constitution\nsets the framework for all other US laws, whether statutory or judicially created. Thus any statute (or\nportion thereof) or legal ruling (judicial or administrative) in conflict with the Constitution is not\nenforceable. And as the Bush v. Gore decision indicates, the states are not entirely free to do what they\nmight choose; their own sovereignty is limited by their union with the other states in a federal sovereign.\nIf the Supreme Court makes a \xe2\x80\x9cbad decision\xe2\x80\x9d as to what the Constitution means, it is not easily\noverturned. Either the court must change its mind (which it seldom does) or two-thirds of Congress and\nthree-fourths of the states must make an amendment (Article V).\nBecause the Supreme Court has this power of judicial review, there have been many arguments about how\nit should be exercised and what kind of \xe2\x80\x9cphilosophy\xe2\x80\x9d a Supreme Court justice should have. President\nRichard Nixon often said that a Supreme Court justice should \xe2\x80\x9cstrictly construe\xe2\x80\x9d the Constitution and not\nadd to its language. Finding law in the Constitution was \xe2\x80\x9cjudicial activism\xe2\x80\x9d rather than \xe2\x80\x9cjudicial restraint.\xe2\x80\x9d\nThe general philosophy behind the call for \xe2\x80\x9cstrict constructionist\xe2\x80\x9d justices is that legislatures make laws in\naccord with the wishes of the majority, and so unelected judges should not make law according to their\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n125\n\n\x0cown views and values. Nixon had in mind the 1960s Warren court, which \xe2\x80\x9cfound\xe2\x80\x9d rights in the\nConstitution that were not specifically mentioned\xe2\x80\x94the right of privacy, for example. In later years, critics\nof the Rehnquist court would charge that it \xe2\x80\x9cfound\xe2\x80\x9d rights that were not specifically mentioned, such as\nthe right of states to be free from federal antidiscrimination laws. See, for example, Kimel v. Florida\nBoard of Regents, or the Citizens United v. Federal Election Commission case (Section 4.6.5), which held\nthat corporations are \xe2\x80\x9cpersons\xe2\x80\x9d with \xe2\x80\x9cfree speech rights\xe2\x80\x9d that include spending unlimited amounts of\nmoney in campaign donations and political advocacy.\n\n[3]\n\nBecause Roe v. Wade has been so controversial, this chapter includes a seminal case on \xe2\x80\x9cthe right of\nprivacy,\xe2\x80\x9d Griswold v. Connecticut, Section 4.6.1. Was the court was correct in recognizing a \xe2\x80\x9cright of\nprivacy\xe2\x80\x9d in Griswold? This may not seem like a \xe2\x80\x9cbusiness case,\xe2\x80\x9d but consider: the manufacture and\ndistribution of birth control devices is a highly profitable (and legal) business in every US state. Moreover,\nGriswold illustrates another important and much-debated concept in US constitutional law: substantive\ndue process (see Section 4.5.3 "Fifth Amendment"). The problem of judicial review and its proper scope is\nbrought into sharp focus in the abortion controversy. Abortion became a lucrative service business\nafter Roe v. Wade was decided in 1973. That has gradually changed, with state laws that have limited\nrather than overruled Roe v. Wade and with persistent antiabortion protests, killings of abortion doctors,\nand efforts to publicize the human nature of the fetuses being aborted. The key here is to understand that\nthere is no explicit mention in the Constitution of any right of privacy. As Justice Harry Blackmun argued\nin his majority opinion inRoe v. Wade,\nThe Constitution does not explicitly mention any right of privacy. In a line of decisions, however,\nthe Court has recognized that a right of personal privacy or a guarantee of certain areas or zones\nof privacy, does exist under the Constitution.\xe2\x80\xa6[T]hey also make it clear that the right has some\nextension to activities relating to marriage\xe2\x80\xa6procreation\xe2\x80\xa6contraception\xe2\x80\xa6family\nrelationships\xe2\x80\xa6and child rearing and education.\xe2\x80\xa6The right of privacy\xe2\x80\xa6is broad enough to\nencompass a woman\xe2\x80\x99s decision whether or not to terminate her pregnancy.\nIn short, justices interpreting the Constitution wield quiet yet enormous power through judicial review. In\ndeciding that the right of privacy applied to a woman\xe2\x80\x99s decision to abort in the first trimester, the\nSupreme Court did not act on the basis of a popular mandate or clear and unequivocal language in the\nConstitution, and it made illegal any state or federal legislative or executive action contrary to its\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n126\n\n\x0cinterpretation. Only a constitutional amendment or the court\xe2\x80\x99s repudiation of Roe v. Wade as a precedent\ncould change that interpretation.\n\nKEY TAKEAWAY\nThe Constitution gives voice to the idea that people have basic rights and that a civilian president is also\nthe commander in chief of the armed forces. It gives instructions as to how the various branches of\ngovernment must share power and also tries to balance power between the states and the federal\ngovernment. It does not expressly allow for judicial review, but the Supreme Court\xe2\x80\x99s ability to declare\nwhat laws are (or are not) constitutional has given the judicial branch a kind of power not seen in other\nindustrialized democracies.\n\n1.\n\nEXERCISES\n\nSuppose the Supreme Court declares that Congress and the president cannot authorize the indefinite\ndetention of terrorist suspects without a trial of some sort, whether military or civilian. Suppose also that\nthe people of the United States favor such indefinite detention and that Congress wants to pass a law\nrebuking the court\xe2\x80\x99s decision. What kind of law would have to be passed, by what institutions, and by\nwhat voting percentages?\n\n2.\n\nWhen does a prior decision of the Supreme Court deserve overturning? Name one decision of the\nSupreme Court that you think is no longer \xe2\x80\x9cgood law.\xe2\x80\x9d Does the court have to wait one hundred years to\noverturn its prior case precedents?\n3.\n\n[1] In Scott v. Sanford (the Dred Scott decision), the court states that Scott should remain a slave, that as a\nslave he is not a citizen of the United States and thus not eligible to bring suit in a federal court, and that\nas a slave he is personal property and thus has never been free.\n\n4.\n\n[2] Roe v. Wade, 410 US 113 (1973).\n\n5.\n\n[3] Kimel v. Florida Board of Regents, 528 US 62 (2000).\n\n4.2 The Commerce Clause\n\nLEARNING OBJECTIVES\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n127\n\n\x0c1.\n\nName the specific clause through which Congress has the power to regulate commerce. What,\nspecifically, does this clause say?\n\n2.\n\nExplain how early decisions of the Supreme Court interpreted the scope of the commerce clause and how\nthat impacted the legislative proposals and programs of Franklin Delano Roosevelt during the Great\nDepression.\n\n3.\n\nDescribe both the wider use of the commerce clause from World War II through the 1990s and the\nlimitations the Supreme Court imposed in Lopezand other cases.\n\nFirst, turn to Article I, Section 8. The commerce clause gives Congress the exclusive power to make\nlaws relating to foreign trade and commerce and to commerce among the various states. Most of the\nfederally created legal environment springs from this one clause: if Congress is not authorized in the\nConstitution to make certain laws, then it acts unconstitutionally and its actions may be ruled\nunconstitutional by the Supreme Court. Lately, the Supreme Court has not been shy about ruling acts\nof Congress unconstitutional.\nHere are the first five parts of Article I, Section 8, which sets forth the powers of the federal\nlegislature. The commerce clause is in boldface. It is short, but most federal legislation affecting\nbusiness depends on this very clause:\n\nSection 8\n[Clause 1] The Congress shall have Power To lay and collect Taxes, Duties, Imposts and Excises,\nto pay the Debts and provide for the common Defence and general Welfare of the United States;\nbut all Duties, Imposts and Excises shall be uniform throughout the United States;\n[Clause 2] To borrow Money on the credit of the United States;\n[Clause 3] To regulate Commerce with foreign Nations, and among the several\nStates, and with the Indian Tribes;\n[Clause 4] To establish a uniform Rule of Naturalization, and uniform Laws on the subject of\nBankruptcies throughout the United States;\n[Clause 5] To coin Money, regulate the Value thereof, and of foreign Coin, and fix the Standard of\nWeights and Measures;\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n128\n\n\x0cEarly Commerce Clause Cases\nFor many years, the Supreme Court was very strict in applying the commerce clause: Congress could only\nuse it to legislate aspects of the movement of goods from one state to another. Anything else was deemed\nlocal rather than national. For example, In Hammer v. Dagenhart, decided in 1918, a 1916 federal statute\nhad barred transportation in interstate commerce of goods produced in mines or factories employing\nchildren under fourteen or employing children fourteen and above for more than eight hours a day. A\ncomplaint was filed in the US District Court for the Western District of North Carolina by a father in his\nown behalf and on behalf of his two minor sons, one under the age of fourteen years and the other\nbetween fourteen and sixteen years, who were employees in a cotton mill in Charlotte, North Carolina.\nThe father\xe2\x80\x99s lawsuit asked the court to enjoin (block) the enforcement of the act of Congress intended to\nprevent interstate commerce in the products of child labor.\nThe Supreme Court saw the issue as whether Congress had the power under the commerce clause to\ncontrol interstate shipment of goods made by children under the age of fourteen. The court found that\nCongress did not. The court cited several cases that had considered what interstate commerce could be\nconstitutionally regulated by Congress. In Hipolite Egg Co. v. United States, the Supreme Court had\nsustained the power of Congress to pass the Pure Food and Drug Act, which prohibited the introduction\ninto the states by means of interstate commerce impure foods and drugs.\n\n[1]\n\nIn Hoke v. United States, the\n\nSupreme Court had sustained the constitutionality of the so-called White Slave Traffic Act of 1910,\nwhereby the transportation of a woman in interstate commerce for the purpose of prostitution was\nforbidden. In that case, the court said that Congress had the power to protect the channels of interstate\ncommerce: \xe2\x80\x9cIf the facility of interstate transportation can be taken away from the demoralization of\nlotteries, the debasement of obscene literature, the contagion of diseased cattle or persons, the impurity of\nfood and drugs, the like facility can be taken away from the systematic enticement to, and the enslavement\nin prostitution and debauchery of women, and, more insistently, of girls.\xe2\x80\x9d\n\n[2]\n\nIn each of those instances, the Supreme Court said, \xe2\x80\x9c[T]he use of interstate transportation was necessary\nto the accomplishment of harmful results.\xe2\x80\x9d In other words, although the power over interstate\ntransportation was to regulate, that could only be accomplished by prohibiting the use of the facilities of\ninterstate commerce to effect the evil intended. But in Hammer v. Dagenhart, that essential element was\nlacking. The law passed by Congress aimed to standardize among all the states the ages at which children\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n129\n\n\x0ccould be employed in mining and manufacturing, while the goods themselves are harmless. Once the\nlabor is done and the articles have left the factory, the \xe2\x80\x9clabor of their production is over, and the mere fact\nthat they were intended for interstate commerce transportation does not make their production subject to\nfederal control under the commerce power.\xe2\x80\x9d\nIn short, the early use of the commerce clause was limited to the movement of physical goods between\nstates. Just because something might enter the channels of interstate commerce later on does not make it\na fit subject for national regulation. The production of articles intended for interstate commerce is a\nmatter of local regulation. The court therefore upheld the result from the district and circuit court of\nappeals; the application of the federal law was enjoined. Goods produced by children under the age of\nfourteen could be shipped anywhere in the United States without violating the federal law.\n\nFrom the New Deal to the New Frontier and the Great Society:1930s\xe2\x80\x931970\nDuring the global depression of the 1930s, the US economy saw jobless rates of a third of all workers, and\nPresident Roosevelt\xe2\x80\x99s New Deal program required more active federal legislation. Included in the New\nDeal program was the recognition of a \xe2\x80\x9cright\xe2\x80\x9d to form labor unions without undue interference from\nemployers. Congress created the National Labor Relations Board (NLRB) in 1935 to investigate and to\nenjoin employer practices that violated this right.\nIn NLRB v. Jones & Laughlin Steel Corporation, a union dispute with management at a large steelproducing facility near Pittsburgh, Pennsylvania, became a court case. In this case, the NLRB had charged\nthe Jones & Laughlin Steel Corporation with discriminating against employees who were union members.\nThe company\xe2\x80\x99s position was that the law authorizing the NLRB was unconstitutional, exceeding\nCongress\xe2\x80\x99s powers. The court held that the act was narrowly constructed so as to regulate industrial\nactivities that had the potential to restrict interstate commerce. The earlier decisions under the commerce\nclause to the effect that labor relations had only an indirect effect on commerce were effectively reversed.\nSince the ability of employees to engage in collective bargaining (one activity protected by the act) is \xe2\x80\x9can\nessential condition of industrial peace,\xe2\x80\x9d the national government was justified in penalizing corporations\nengaging in interstate commerce that \xe2\x80\x9crefuse to confer and negotiate\xe2\x80\x9d with their workers. This was,\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n130\n\n\x0chowever, a close decision, and the switch of one justice made this ruling possible. Without this switch, the\nNew Deal agenda would have been effectively derailed.\n\nThe Substantial Effects Doctrine: World War II to the 1990s\nSubsequent to NLRB v. Jones & Laughlin Steel Corporation, Congress and the courts generally accepted\nthat even modest impacts on interstate commerce were \xe2\x80\x9creachable\xe2\x80\x9d by federal legislation. For example,\nthe case of Wickard v. Filburn, from 1942, represents a fairly long reach for Congress in regulating what\nappear to be very local economic decisions (Section 4.6.2).\nWickard established that \xe2\x80\x9csubstantial effects\xe2\x80\x9d in interstate commerce could be very local indeed! But\ncommerce clause challenges to federal legislation continued. In the 1960s, the Civil Rights Act of 1964 was\nchallenged on the ground that Congress lacked the power under the commerce clause to regulate what\nwas otherwise fairly local conduct. For example, Title II of the act prohibited racial discrimination in\npublic accommodations (such as hotels, motels, and restaurants), leading to the famous case\nof Katzenbach v. McClung(1964).\nOllie McClung\xe2\x80\x99s barbeque place in Birmingham, Alabama, allowed \xe2\x80\x9ccolored\xe2\x80\x9d people to buy takeout at the\nback of the restaurant but not to sit down with \xe2\x80\x9cwhite\xe2\x80\x9d folks inside. The US attorney sought a court order\nto require Ollie to serve all races and colors, but Ollie resisted on commerce clause grounds: the federal\ngovernment had no business regulating a purely local establishment. Indeed, Ollie did not advertise\nnationally, or even regionally, and had customers only from the local area. But the court found that some\n42 percent of the supplies for Ollie\xe2\x80\x99s restaurant had moved in the channels of interstate commerce. This\nwas enough to sustain federal regulation based on the commerce clause.\n\n[3]\n\nFor nearly thirty years following, it was widely assumed that Congress could almost always find some\ninterstate commerce connection for any law it might pass. It thus came as something of a shock in 1995\nwhen the Rehnquist court decided U.S. v. Lopez. Lopez had been convicted under a federal law that\nprohibited possession of firearms within 1,000 feet of a school. The law was part of a twenty-year trend\n(roughly 1970 to 1990) for senators and congressmen to pass laws that were tough on crime. Lopez\xe2\x80\x99s\nlawyer admitted that Lopez had had a gun within 1,000 feet of a San Antonio school yard but challenged\nthe law itself, arguing that Congress exceeded its authority under the commerce clause in passing this\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n131\n\n\x0clegislation. The US government\xe2\x80\x99s Solicitor General argued on behalf of the Department of Justice to the\nSupreme Court that Congress was within its constitutional rights under the commerce clause because\neducation of the future workforce was the foundation for a sound economy and because guns at or near\nschool yards detracted from students\xe2\x80\x99 education. The court rejected this analysis, noting that with the\ngovernment\xe2\x80\x99s analysis, an interstate commerce connection could be conjured from almost anything.\nLopez went free because the law itself was unconstitutional, according to the court.\nCongress made no attempt to pass similar legislation after the case was decided. But in passing\nsubsequent legislation, Congress was often careful to make a record as to why it believed it was addressing\na problem that related to interstate commerce. In 1994, Congress passed the Violence Against Women Act\n(VAWA), having held hearings to establish why violence against women on a local level would impair\ninterstate commerce. In 1994, while enrolled at Virginia Polytechnic Institute (Virginia Tech), Christy\nBrzonkala alleged that Antonio Morrison and James Crawford, both students and varsity football players\nat Virginia Tech, had raped her. In 1995, Brzonkala filed a complaint against Morrison and Crawford\nunder Virginia Tech\xe2\x80\x99s sexual assault policy. After a hearing, Morrison was found guilty of sexual assault\nand sentenced to immediate suspension for two semesters. Crawford was not punished. A second hearing\nagain found Morrison guilty. After an appeal through the university\xe2\x80\x99s administrative system, Morrison\xe2\x80\x99s\npunishment was set aside, as it was found to be \xe2\x80\x9cexcessive.\xe2\x80\x9d Ultimately, Brzonkala dropped out of the\nuniversity. Brzonkala then sued Morrison, Crawford, and Virginia Tech in federal district court, alleging\nthat Morrison\xe2\x80\x99s and Crawford\xe2\x80\x99s attack violated 42 USC Section 13981, part of the VAWA), which provides\na federal civil remedy for the victims of gender-motivated violence. Morrison and Crawford moved to\ndismiss Brzonkala\xe2\x80\x99s suit on the ground that Section 13981\xe2\x80\x99s civil remedy was unconstitutional. In\ndismissing the complaint, the district court found that that Congress lacked authority to enact Section\n13981 under either the commerce clause or the Fourteenth Amendment, which Congress had explicitly\nidentified as the sources of federal authority for the VAWA. Ultimately, the court of appeals affirmed, as\ndid the Supreme Court.\nThe Supreme Court held that Congress lacked the authority to enact a statute under the commerce clause\nor the Fourteenth Amendment because the statute did not regulate an activity that substantially affected\ninterstate commerce nor did it redress harm caused by the state. Chief Justice William H. Rehnquist\nwrote for the court that \xe2\x80\x9cunder our federal system that remedy must be provided by the Commonwealth of\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n132\n\n\x0cVirginia, and not by the United States.\xe2\x80\x9d Dissenting, Justice Stephen G. Breyer argued that the majority\nopinion \xe2\x80\x9cillustrates the difficulty of finding a workable judicial Commerce Clause touchstone.\xe2\x80\x9d Justice\nDavid H. Souter, dissenting, noted that VAWA contained a \xe2\x80\x9cmountain of data assembled by\nCongress\xe2\x80\xa6showing the effects of violence against women on interstate commerce.\xe2\x80\x9d\nThe absence of a workable judicial commerce clause touchstone remains. In 1996, California voters\npassed the Compassionate Use Act, legalizing marijuana for medical use. California\xe2\x80\x99s law conflicted with\nthe federal Controlled Substances Act (CSA), which banned possession of marijuana. After the Drug\nEnforcement Administration (DEA) seized doctor-prescribed marijuana from a patient\xe2\x80\x99s home, a group of\nmedical marijuana users sued the DEA and US Attorney General John Ashcroft in federal district court.\nThe medical marijuana users argued that the CSA\xe2\x80\x94which Congress passed using its constitutional power\nto regulate interstate commerce\xe2\x80\x94exceeded Congress\xe2\x80\x99s commerce clause power. The district court ruled\nagainst the group, but the Ninth Circuit Court of Appeals reversed and ruled the CSA unconstitutional\nbecause it applied to medical marijuana use solely within one state. In doing so, the Ninth Circuit relied\non U.S. v. Lopez (1995) and U.S. v. Morrison (2000) to say that using medical marijuana did not\n\xe2\x80\x9csubstantially affect\xe2\x80\x9d interstate commerce and therefore could not be regulated by Congress.\nBut by a 6\xe2\x80\x933 majority, the Supreme Court held that the commerce clause gave Congress authority to\nprohibit the local cultivation and use of marijuana, despite state law to the contrary. Justice John Paul\nStevens argued that the court\xe2\x80\x99s precedents established Congress\xe2\x80\x99s commerce clause power to regulate\npurely local activities that are part of a \xe2\x80\x9cclass of activities\xe2\x80\x9d with a substantial effect on interstate\ncommerce. The majority argued that Congress could ban local marijuana use because it was part of such a\nclass of activities: the national marijuana market. Local use affected supply and demand in the national\nmarijuana market, making the regulation of intrastate use \xe2\x80\x9cessential\xe2\x80\x9d to regulating the drug\xe2\x80\x99s national\nmarket.\nNotice how similar this reasoning is to the court\xe2\x80\x99s earlier reasoning in Wickard v. Filburn (Section 4.6.2).\nIn contrast, the court\xe2\x80\x99s conservative wing was adamant that federal power had been exceeded. Justice\nClarence Thomas\xe2\x80\x99s dissent in Gonzalez v. Raich stated that Raich\xe2\x80\x99s local cultivation and consumption of\nmarijuana was not \xe2\x80\x9cCommerce\xe2\x80\xa6among the several States.\xe2\x80\x9d Representing the \xe2\x80\x9coriginalist\xe2\x80\x9d view that the\nConstitution should mostly mean what the Founders meant it to mean, he also said that in the early days\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n133\n\n\x0cof the republic, it would have been unthinkable that Congress could prohibit the local cultivation,\npossession, and consumption of marijuana.\n\nKEY TAKEAWAY\n\nThe commerce clause is the basis on which the federal government regulates interstate economic activity.\nThe phrase \xe2\x80\x9cinterstate commerce\xe2\x80\x9d has been subject to differing interpretations by the Supreme Court\nover the past one hundred years. There are certain matters that are essentially local or intrastate, but the\nrange of federal involvement in local matters is still considerable.\n\nEXERCISES\n\n1.\n\nWhy would Congress have power under the Civil Rights Act of 1964 to require restaurants and hotels to\nnot discriminate against interstate travelers on the basis of race, color, sex, religion, or national origin?\nSuppose the Holiday Restaurant near I-80 in Des Moines, Iowa, has a sign that says, \xe2\x80\x9cWe reserve the right\nto refuse service to any Muslim or person of Middle Eastern descent.\xe2\x80\x9d Suppose also that the restaurant is\nvery popular locally and that only 40 percent of its patrons are travelers on I-80. Are the owners of the\nHoliday Restaurant in violation of the Civil Rights Act of 1964? What would happen if the owners resisted\nenforcement by claiming that Title II of the act (relating to \xe2\x80\x9cpublic accommodations\xe2\x80\x9d such as hotels,\nmotels, and restaurants) was unconstitutional?\n\n2.\n\nIf the Supreme Court were to go back to the days of Hammer v. Dagenhart and rule that only goods and\nservices involving interstate movement could be subject to federal law, what kinds of federal programs\nmight be lacking a sound basis in the commerce clause? \xe2\x80\x9cObamacare\xe2\x80\x9d? Medicare? Homeland security?\nSocial Security? What other powers are granted to Congress under the Constitution to legislate for the\ngeneral good of society?\n3.\n\n[1] Hipolite Egg Co. v. United States, 220 US 45 (1911).\n\n4.\n\n[2] Hoke v. United States, 227 US 308 (1913).\n\n5.\n\n[3] Katzenbach v. McClung, 379 US 294 (1964).\n\n4.3 Dormant Commerce Clause\n\nLEARNING OBJECTIVES\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n134\n\n\x0c1.\n\nUnderstand that when Congress does not exercise its powers under the commerce clause, the Supreme\nCourt may still limit state legislation that discriminates against interstate commerce or places an undue\nburden on interstate commerce.\n\n2.\n\nDistinguish between \xe2\x80\x9cdiscrimination\xe2\x80\x9d dormant-commerce-clause cases and \xe2\x80\x9cundue burden\xe2\x80\x9d dormantcommerce-clause cases.\n\nCongress has the power to legislate under the commerce clause and often does legislate. For\nexample, Congress might say that trucks moving on interstate highways must not be more than\nseventy feet in length. But if Congress does not exercise its powers and regulate in certain areas (such\nas the size and length of trucks on interstate highways), states may make their own rules. States may\ndo so under the so-called historic police powers of states that were never yielded up to the federal\ngovernment.\nThese police powers can be broadly exercised by states for purposes of health, education, welfare,\nsafety, morals, and the environment. But the Supreme Court has reserved for itself the power to\ndetermine when state action is excessive, even when Congress has not used the commerce clause to\nregulate. This power is claimed to exist in the dormant commerce clause.\nThere are two ways that a state may violate the dormant commerce clause. If a state passes a law that\nis an \xe2\x80\x9cundue burden\xe2\x80\x9d on interstate commerce or that \xe2\x80\x9cdiscriminates\xe2\x80\x9d against interstate commerce, it\nwill be struck down. Kassel v. Consolidated Freightways, in Section 4.7 "Summary and Exercises", is\nan example of a case where Iowa imposed an undue burden on interstate commerce by prohibiting\ndouble trailers on its highways. [1] Iowa\xe2\x80\x99s prohibition was judicially declared void when the Supreme\nCourt judged it to be an undue burden.\nDiscrimination cases such as Hunt v. Washington Apple Advertising Commission (Section 4.6 "Cases")\npose a different standard. The court has been fairly inflexible here: if one state discriminates in its\ntreatment of any article of commerce based on its state of origin, the court will strike down the law.\nFor example, in Oregon Waste Systems v. Department of Environmental Quality,the state wanted to\nplace a slightly higher charge on waste coming from out of state. [2] The state\xe2\x80\x99s reasoning was that instate residents had already contributed to roads and other infrastructure and that tipping fees at\nwaste facilities should reflect the prior contributions of in-state companies and residents. Out-ofstate waste handlers who wanted to use Oregon landfills objected and won their dormant commerce\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n135\n\n\x0cclause claim that Oregon\xe2\x80\x99s law discriminated \xe2\x80\x9con its face\xe2\x80\x9d against interstate commerce. Under the\nSupreme Court\xe2\x80\x99s rulings, anything that moves in channels of interstate commerce is \xe2\x80\x9ccommerce,\xe2\x80\x9d\neven if someone is paying to get rid of something instead of buying something.\nThus the states are bound by Supreme Court decisions under the dormant commerce clause to do\nnothing that differentiates between articles of commerce that originate from within the state from\nthose that originate elsewhere. If Michigan were to let counties decide for themselves whether to take\ngarbage from outside of the county or not, this could also be a discrimination based on a place of\norigin outside the state. (Suppose, for instance, each county were to decide not to take waste from\noutside the county; then all Michigan counties would effectively be excluding waste from outside of\nMichigan, which is discriminatory.) [3]\nThe Supreme Court probably would uphold any solid waste requirements that did not differentiate\non the basis of origin. If, for example, all waste had to be inspected for specific hazards, then the law\nwould apply equally to in-state and out-of-state garbage. Because this is the dormant commerce\nclause, Congress could still act (i.e., it could use its broad commerce clause powers) to say that states\nare free to keep out-of-state waste from coming into their own borders. But Congress has declined to\ndo so. What follows is a statement from one of the US senators from Michigan, Carl Levin, in 2003,\nregarding the significant amounts of waste that were coming into Michigan from Toronto, Canada.\n\nDealing with Unwelcome Waste\nSenator Carl Levin, January 2003\nMichigan is facing an intolerable situation with regard to the importation of waste from other\nstates and Canada.\nCanada is the largest source of waste imports to Michigan. Approximately 65 truckloads of waste\ncome in to Michigan per day from Toronto alone, and an estimated 110\xe2\x80\x93130 trucks come in from\nCanada each day.\nThis problem isn\xe2\x80\x99t going to get any better. Ontario\xe2\x80\x99s waste shipments are growing as the Toronto\narea signs new contracts for waste disposal here and closes its two remaining landfills. At the\nbeginning of 1999, the Toronto area was generating about 2.8 million tons of waste annually,\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n136\n\n\x0cabout 700,000 tons of which were shipped to Michigan. By early this year, barring unforeseen\ndevelopments, the entire 2.8 million tons will be shipped to Michigan for disposal.\nWhy can\xe2\x80\x99t Canada dispose of its trash in Canada? They say that after 20 years of searching they\nhave not been able to find a suitable Ontario site for Toronto\xe2\x80\x99s garbage. Ontario has about\n345,000 square miles compared to Michigan\xe2\x80\x99s 57,000 square miles. With six times the land mass,\nthat argument is laughable.\nThe Michigan Department of Environmental Quality estimates that, for every five years of\ndisposal of Canadian waste at the current usage volume, Michigan is losing a full year of landfill\ncapacity. The environmental impacts on landfills, including groundwater contamination, noise\npollution and foul odors, are exacerbated by the significant increase in the use of our landfills\nfrom sources outside of Michigan.\nI have teamed up with Senator Stabenow and Congressman Dingell to introduce legislation that\nwould strengthen our ability to stop shipments of waste from Canada.\nWe have protections contained in a 17 year-old international agreement between the U.S. and\nCanada called the Agreement Concerning the Transboundary Movement of Hazardous Waste.\nThe U.S. and Canada entered into this agreement in 1986 to allow the shipment of hazardous\nwaste across the U.S./Canadian border for treatment, storage or disposal. In 1992, the two\ncountries decided to add municipal solid waste to the agreement. To protect both countries, the\nagreement requires notification of shipments to the importing country and it also provides that\nthe importing country may withdraw consent for shipments. Both reasons are evidence that these\nshipments were intended to be limited. However, the agreement\xe2\x80\x99s provisions have not been\nenforced by the United States.\nCanada could not export waste to Michigan without the 1986 agreement, but the U.S. has not\nimplemented the provisions that are designed to protect the people of Michigan. Although those of\nus that introduced this legislation believe that the Environmental Protection Agency has the\nauthority to enforce this agreement, they have not done so. Our bill would require the EPA\n[Environmental Protection Agency] to enforce the agreement.\nIn order to protect the health and welfare of the citizens of Michigan and our environment, we\nmust consider the impact of the importation of trash on state and local recycling efforts, landfill\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n137\n\n\x0ccapacity, air emissions, road deterioration resulting from increased vehicular traffic and public\nhealth and the environment.\nOur bill would require the EPA to consider these factors in determining whether to accept imports\nof trash from Canada. It is my strong view that such a review should lead the EPA to say \xe2\x80\x9cno\xe2\x80\x9d to\nthe status quo of trash imports.\n\nKEY TAKEAWAY\n\nWhere Congress does not act pursuant to its commerce clause powers, the states are free to legislate on\nmatters of commerce under their historic police powers. However, the Supreme Court has set limits on\nsuch powers. Specifically, states may not impose undue burdens on interstate commerce and may not\ndiscriminate against articles in interstate commerce.\n\nEXERCISES\n\n1.\n\nSuppose that the state of New Jersey wishes to limit the amount of hazardous waste that enters into its\nlandfills. The general assembly in New Jersey passes a law that specifically forbids any hazardous waste\nfrom entering into the state. All landfills are subject to tight regulations that will allow certain kinds of\nhazardous wastes originating in New Jersey to be put in New Jersey landfills but that impose significant\ncriminal fines on landfill operators that accept out-of-state hazardous waste. The Baldessari Brothers\nLandfill in Linden, New Jersey, is fined for taking hazardous waste from a New York State transporter and\nappeals that ruling on the basis that New Jersey\xe2\x80\x99s law is unconstitutional. What is the result?\n\n2.\n\nThe state of Arizona determines through its legislature that trains passing through the state cannot be\nlonger than seventy cars. There is some evidence that in Eastern US states longer trains pose some safety\nhazards. There is less evidence that long trains are a problem in Western states. Several major railroads\nfind the Arizona legislation costly and burdensome and challenge the legislation after applied-for permits\nfor longer trains are denied. What kind of dormant commerce clause challenge is this, and what would it\ntake for the challenge to be successful?\n3.\n\n[1] Kassell v. Consolidated Freightways, 450 US 662 (1981).\n\n4.\n\n[2] Oregon Waste Systems v. Department of Environmental Quality, 511 US 93 (1994).\n\n5.\n\n[3] Fort Gratiot Sanitary Landfill v. Michigan Dep\xe2\x80\x99t of Natural Resources, 504 US 353 (1992).\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n138\n\n\x0c4.4 Preemption: The Supremacy Clause\n\nLEARNING OBJECTIVES\n\n1.\n\nUnderstand the role of the supremacy clause in the balance between state and federal power.\n\n2.\n\nGive examples of cases where state legislation is preempted by federal law and cases where state\nlegislation is not preempted by federal law.\n\nWhen Congress does use its power under the commerce clause, it can expressly state that it wishes to\nhave exclusive regulatory authority. For example, when Congress determined in the 1950s to\npromote nuclear power (\xe2\x80\x9catoms for peace\xe2\x80\x9d), it set up the Nuclear Regulatory Commission and\nprovided a limitation of liability for nuclear power plants in case of a nuclear accident. The states\nwere expressly told to stay out of the business of regulating nuclear power or the movement of\nnuclear materials. Thus Rochester, Minnesota, or Berkeley, California, could declare itself a nuclearfree zone, but the federal government would have preempted such legislation. If Michigan wished to\nset safety standards at Detroit Edison\xe2\x80\x99s Fermi II nuclear reactor that were more stringent than the\nfederal Nuclear Regulatory Commission\xe2\x80\x99s standards, Michigan\xe2\x80\x99s standards would be preempted and\nthus be void.\nEven where Congress does not expressly preempt state action, such action may be impliedly preempted. States cannot constitutionally pass laws that interfere with the accomplishment of the\npurposes of the federal law. Suppose, for example, that Congress passes a comprehensive law that\nsets standards for foreign vessels to enter the navigable waters and ports of the United States. If a\nstate creates a law that sets standards that conflict with the federal law or sets standards so\nburdensome that they interfere with federal law, the doctrine of preemption will (in accordance\nwith the supremacy clause) void the state law or whatever parts of it are inconsistent with federal\nlaw.\nBut Congress can allow what might appear to be inconsistencies; the existence of federal statutory\nstandards does not always mean that local and state standards cannot be more stringent. If\nCalifornia wants cleaner air or water than other states, it can set stricter standards\xe2\x80\x94nothing in the\nClean Water Act or Clean Air Act forbids the state from setting stricter pollution standards. As the\nauto industry well knows, California has set stricter standards for auto emissions. Since the 1980s,\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n139\n\n\x0cmost automakers have made both a federal car and a California car, because federal Clean Air Act\nemissions restrictions do not preempt more rigorous state standards.\nLarge industries and companies actually prefer regulation at the national level. It is easier for a large\ncompany or industry association to lobby in Washington, DC, than to lobby in fifty different states.\nAccordingly, industry often asks Congress to put preemptive language into its statutes. The tobacco\nindustry is a case in point.\nThe cigarette warning legislation of the 1960s (where the federal government required warning\nlabels on cigarette packages) effectively preempted state negligence claims based on failure to warn.\nWhen the family of a lifetime smoker who had died sued in New Jersey court, one cause of action was\nthe company\xe2\x80\x99s failure to warn of the dangers of its product. The Supreme Court reversed the jury\xe2\x80\x99s\naward based on the federal preemption of failure to warn claims under state law. [1]\n\nThe Supremacy Clause\nArticle VI\nThis Constitution, and the Laws of the United States which shall be made in Pursuance thereof;\nand all Treaties made, or which shall be made, under the Authority of the United States, shall be\nthe supreme Law of the Land; and the Judges in every State shall be bound thereby, any Thing in\nthe Constitution or Laws of any State to the Contrary notwithstanding.\n\nThe preemption doctrine derives from the supremacy clause of the Constitution, which states that the\n\xe2\x80\x9cConstitution and the Laws of the United States\xe2\x80\xa6shall be the supreme Law of the Land\xe2\x80\xa6any Thing\nin the Constitutions or Laws of any State to the Contrary notwithstanding.\xe2\x80\x9d This means of course,\nthat any federal law\xe2\x80\x94even a regulation of a federal agency\xe2\x80\x94would control over any conflicting state\nlaw.\nPreemption can be either express or implied. When Congress chooses to expressly preempt state law,\nthe only question for courts becomes determining whether the challenged state law is one that the\nfederal law is intended to preempt. Implied preemption presents more difficult issues. The court has\nto look beyond the express language of federal statutes to determine whether Congress has \xe2\x80\x9coccupied\nthe field\xe2\x80\x9d in which the state is attempting to regulate, or whether a state law directly conflicts with\nfederal law, or whether enforcement of the state law might frustrate federal purposes.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n140\n\n\x0cFederal \xe2\x80\x9coccupation of the field\xe2\x80\x9d occurs, according to the court in Pennsylvania v. Nelson (1956),\nwhen there is \xe2\x80\x9cno room\xe2\x80\x9d left for state regulation. Courts are to look to the pervasiveness of the\nfederal scheme of regulation, the federal interest at stake, and the danger of frustration of federal\ngoals in making the determination as to whether a challenged state law can stand.\nIn Silkwood v. Kerr-McGee (1984), the court, voting 5\xe2\x80\x934, found that a $10 million punitive damages\naward (in a case litigated by famed attorney Gerry Spence) against a nuclear power plant was not\nimpliedly preempted by federal law. Even though the court had recently held that state regulation of\nthe safety aspects of a federally licensed nuclear power plant was preempted, the court drew a\ndifferent conclusion with respect to Congress\xe2\x80\x99s desire to displace state tort law\xe2\x80\x94even though the tort\nactions might be premised on a violation of federal safety regulations.\nCipollone v. Liggett Group (1993) was a closely watched case concerning the extent of an express\n\npreemption provision in two cigarette labeling laws of the 1960s. The case was a wrongful death\naction brought against tobacco companies on behalf of Rose Cipollone, a lung cancer victim who had\nstarted smoking cigarette in the 1940s. The court considered the preemptive effect on state law of a\nprovision that stated, \xe2\x80\x9cNo requirement based on smoking and health shall be imposed under state\nlaw with respect to the advertising and promotion of cigarettes.\xe2\x80\x9d The court concluded that several\ntypes of state tort actions were preempted by the provision but allowed other types to go forward.\n\nKEY TAKEAWAY\n\nIn cases of conflicts between state and federal law, federal law will preempt (or control) state law because\nof the supremacy clause. Preemption can be express or implied. In cases where preemption is implied, the\ncourt usually finds that compliance with both state and federal law is not possible or that a federal\nregulatory scheme is comprehensive (i.e., \xe2\x80\x9coccupies the field\xe2\x80\x9d) and should not be modified by state\nactions.\n\n1.\n\nEXERCISES\n\nFor many years, the United States engaged in discussions with friendly nations as to the reciprocal use of\nports and harbors. These discussions led to various multilateral agreements between the nations as to the\nconfiguration of oceangoing vessels and how they would be piloted. At the same time, concern over oil\nspills in Puget Sound led the state of Washington to impose fairly strict standards on oil tankers and\nrequirements for the training of oil tanker pilots. In addition, Washington\xe2\x80\x99s state law imposed many other\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n141\n\n\x0crequirements that went above and beyond agreed-upon requirements in the international agreements\nnegotiated by the federal government. Are the Washington state requirements preempted by federal\nlaw?\n2.\n\nThe Federal Arbitration Act of 1925 requires that all contracts for arbitration be treated as any other\ncontract at common law. Suppose that the state of Alabama wishes to protect its citizens from a variety\nof arbitration provisions that they might enter into unknowingly. Thus the legislation provides that all\npredispute arbitration clauses be in bold print, that they be of twelve-point font or larger, that they be\nclearly placed within the first two pages of any contract, and that they have a separate signature line\nwhere the customer, client, or patient acknowledges having read, understood, and signed the arbitration\nclause in addition to any other signatures required on the contract. The legislation does preserve the right\nof consumers to litigate in the event of a dispute arising with the product or service provider; that is, with\nthis legislation, consumers will not unknowingly waive their right to a trial at common law. Is the Alabama\nlaw preempted by the Federal Arbitration Act?\n\n[1] Cippolone v. Liggett Group, 505 US 504 (1993).\n\n4.5 Business and the Bill of Rights\n\nLEARNING OBJECTIVES\n\n1.\n\nUnderstand and describe which articles in the Bill of Rights apply to business activities and how they\napply.\n\n2.\n\nExplain the application of the Fourteenth Amendment\xe2\x80\x94including the due process clause and the equal\nprotection clause\xe2\x80\x94to various rights enumerated in the original Bill of Rights.\n\nWe have already seen the Fourteenth Amendment\xe2\x80\x99s application in Burger King v. Rudzewicz (Section\n3.9 "Cases"). In that case, the court considered whether it was constitutionally correct for a court to\nassert personal jurisdiction over a nonresident. The states cannot constitutionally award a judgment\nagainst a nonresident if doing so would offend traditional notions of fair play and substantial justice.\nEven if the state\xe2\x80\x99s long-arm statute would seem to allow such a judgment, other states should not\ngive it full faith and credit (see Article V of the Constitution). In short, a state\xe2\x80\x99s long-arm statute\ncannot confer personal jurisdiction that the state cannot constitutionally claim.\nThe Bill of Rights (the first ten amendments to the Constitution) was originally meant to apply to\nfederal actions only. During the twentieth century, the court began to apply selected rights to state\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n142\n\n\x0caction as well. So, for example, federal agents were prohibited from using evidence seized in violation\nof the Fourth Amendment, but state agents were not, until Mapp v. Ohio (1960), when the court\napplied the guarantees (rights) of the Fourth Amendment to state action as well. In this and in\nsimilar cases, the Fourteenth Amendment\xe2\x80\x99s due process clause was the basis for the court\xe2\x80\x99s action.\nThe due process clause commanded that states provide due process in cases affecting the life, liberty,\nor property of US citizens, and the court saw in this command certain \xe2\x80\x9cfundamental guarantees\xe2\x80\x9d that\nstates would have to observe. Over the years, most of the important guarantees in the Bill of Rights\ncame to apply to state as well as federal action. The court refers to this process as selective\nincorporation.\nHere are some very basic principles to remember:\n1.\n\nThe guarantees of the Bill of Rights apply only to state and federal government action. They do not\nlimit what a company or person in the private sector may do. For example, states may not impose\ncensorship on the media or limit free speech in a way that offends the First Amendment, but your\nboss (in the private sector) may order you not to talk to the media.\n\n2. In some cases, a private company may be regarded as participating in \xe2\x80\x9cstate action.\xe2\x80\x9d For example, a\nprivate defense contractor that gets 90 percent of its business from the federal government has been\nheld to be public for purposes of enforcing the constitutional right to free speech (the company had a\nrule barring its employees from speaking out in public against its corporate position). It has even been\nargued that public regulation of private activity is sufficient to convert the private into public activity,\nthus subjecting it to the requirements of due process. But the Supreme Court rejected this extreme\nview in 1974 when it refused to require private power companies, regulated by the state, to give\ncustomers a hearing before cutting off electricity for failure to pay the bill.\n\n[1]\n\n3. States have rights, too. While \xe2\x80\x9cstates rights\xe2\x80\x9d was a battle cry of Southern states before the Civil War,\nthe question of what balance to strike between state sovereignty and federal union has never been\nsimple. In Kimel v. Florida, for example, the Supreme Court found in the words of the Eleventh\nAmendment a basis for declaring that states may not have to obey certain federal statutes.\n\nFirst Amendment\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n143\n\n\x0cIn part, the First Amendment states that \xe2\x80\x9cCongress shall make no law\xe2\x80\xa6abridging the freedom of speech,\nor of the press.\xe2\x80\x9d The Founding Fathers believed that democracy would work best if people (and the press)\ncould talk or write freely, without governmental interference. But the First Amendment was also not\nintended to be as absolute as it sounded. Oliver Wendell Holmes\xe2\x80\x99s famous dictum that the law does not\npermit you to shout \xe2\x80\x9cFire!\xe2\x80\x9d in a crowded theater has seldom been answered, \xe2\x80\x9cBut why not?\xe2\x80\x9d And no one in\n1789 thought that defamation laws (torts for slander and libel) had been made unconstitutional.\nMoreover, because the apparent purpose of the First Amendment was to make sure that the nation had a\ncontinuing, vigorous debate over matters political, political speech has been given the highest level of\nprotection over such other forms of speech as (1) \xe2\x80\x9ccommercial speech,\xe2\x80\x9d (2) speech that can and should be\nlimited by reasonable \xe2\x80\x9ctime, place, and manner\xe2\x80\x9d restrictions, or (3) obscene speech.\nBecause of its higher level of protection, political speech can be false, malicious, mean-spirited, or even a\npack of lies. A public official in the United States must be prepared to withstand all kinds of false\naccusations and cannot succeed in an action for defamation unless the defendant has acted with \xe2\x80\x9cmalice\xe2\x80\x9d\nand \xe2\x80\x9creckless disregard\xe2\x80\x9d of the truth. Public figures, such as CEOs of the largest US banks, must also be\nprepared to withstand accusations that are false. In any defamation action, truth is a defense, but a\ndefamation action brought by a public figure or public official must prove that the defendant not only has\nhis facts wrong but also lies to the public in a malicious way with reckless disregard of the truth.\nCelebrities such as Lindsay Lohan and Jon Stewart have the same burden to go forward with a defamation\naction. It is for this reason that the National Enquirer writes exclusively about public figures, public\nofficials, and celebrities; it is possible to say many things that aren\xe2\x80\x99t completely true and still have the\nprotection of the First Amendment.\nPolitical speech is so highly protected that the court has recognized the right of people to support political\ncandidates through campaign contributions and thus promote the particular viewpoints and speech of\nthose candidates. Fearing the influence of money on politics, Congress has from time to time placed\nlimitations on corporate contributions to political campaigns. But the Supreme Court has had mixed\nreactions over time. Initially, the court recognized the First Amendment right of a corporation to donate\nmoney, subject to certain limits.\n\n[2]\n\nIn another case, Austin v. Michigan Chamber of Commerce (1990), the\n\nMichigan Campaign Finance Act prohibited corporations from using treasury money for independent\nexpenditures to support or oppose candidates in elections for state offices. But a corporation could make\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n144\n\n\x0csuch expenditures if it set up an independent fund designated solely for political purposes. The law was\npassed on the assumption that \xe2\x80\x9cthe unique legal and economic characteristics of corporations necessitate\nsome regulation of their political expenditures to avoid corruption or the appearance of corruption.\xe2\x80\x9d\nThe Michigan Chamber of Commerce wanted to support a candidate for Michigan\xe2\x80\x99s House of\nRepresentatives by using general funds to sponsor a newspaper advertisement and argued that as a\nnonprofit organization, it was not really like a business firm. The court disagreed and upheld the Michigan\nlaw. Justice Marshall found that the chamber was akin to a business group, given its activities, linkages\nwith community business leaders, and high percentage of members (over 75 percent) that were business\ncorporations. Furthermore, Justice Marshall found that the statute was narrowly crafted and\nimplemented to achieve the important goal of maintaining integrity in the political process. But as you\nwill see in Citizens United v. Federal Election Commission (Section 4.6 "Cases"), Austin was overruled;\ncorporations are recognized as \xe2\x80\x9cpersons\xe2\x80\x9d with First Amendment political speech rights that cannot be\nimpaired by Congress or the states without some compelling governmental interest with restrictions on\nthose rights that are \xe2\x80\x9cnarrowly tailored.\xe2\x80\x9d\n\nFourth Amendment\nThe Fourth Amendment says, \xe2\x80\x9call persons shall be secure in their persons, houses, papers, and effects\nfrom unreasonable searches and seizures, and no warrants shall issue, but upon probable cause, before a\nmagistrate and upon Oath, specifically describing the persons to be searched and places to be seized.\xe2\x80\x9d\nThe court has read the Fourth Amendment to prohibit only those government searches or seizures that\nare \xe2\x80\x9cunreasonable.\xe2\x80\x9d Because of this, businesses that are in an industry that is \xe2\x80\x9cclosely regulated\xe2\x80\x9d can be\nsearched more frequently and can be searched without a warrant. In one case, an auto parts dealer at a\njunkyard was charged with receiving stolen auto parts. Part of his defense was to claim that the search\nthat found incriminating evidence was unconstitutional. But the court found the search reasonable,\nbecause the dealer was in a \xe2\x80\x9cclosely regulated industry.\xe2\x80\x9d\nIn the 1980s, Dow Chemical objected to an overflight by the US Environmental Protection Agency (EPA).\nThe EPA had rented an airplane to fly over the Midland, Michigan, Dow plant, using an aerial mapping\ncamera to photograph various pipes, ponds, and machinery that were not covered by a roof. Because the\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n145\n\n\x0ccourt\xe2\x80\x99s precedents allowed governmental intrusions into \xe2\x80\x9copen fields,\xe2\x80\x9d the EPA search was ruled\nconstitutional. Because the literal language of the Fourth Amendment protected \xe2\x80\x9cpersons, houses, papers,\nand effects,\xe2\x80\x9d anything searched by the government in \xe2\x80\x9copen fields\xe2\x80\x9d was reasonable. (The court\xe2\x80\x99s opinion\nsuggested that if Dow had really wanted privacy from governmental intrusion, it could have covered the\npipes and machinery that were otherwise outside and in open fields.)\nNote again that constitutional guarantees like the Fourth Amendment apply to governmental action. Your\nemployer or any private enterprise is not bound by constitutional limits. For example, if drug testing of all\nemployees every week is done by government agency, the employees may have a cause of action to object\nbased on the Fourth Amendment. However, if a private employer begins the same kind of routine drug\ntesting, employees have no constitutional arguments to make; they can simply leave that employer, or\nthey may pursue whatever statutory or common-law remedies are available.\n\nFifth Amendment\nThe Fifth Amendment states, \xe2\x80\x9cNo person shall be\xe2\x80\xa6deprived of life, liberty, or property, without due\nprocess of law; nor shall private property be taken for public use, without just compensation.\xe2\x80\x9d\nThe Fifth Amendment has three principal aspects: procedural due process, the takings clause,\nand substantive due process. In terms of procedural due process, the amendment prevents government\nfrom arbitrarily taking the life of a criminal defendant. In civil lawsuits, it is also constitutionally essential\nthat the proceedings be fair. This is why, for example, the defendant in Burger King v. Rudzewicz had a\nserious constitutional argument, even though he lost.\nThe takings clause of the Fifth Amendment ensures that the government does not take private property\nwithout just compensation. In the international setting, governments that take private property engage in\nwhat is called expropriation. The standard under customary international law is that when governments\ndo that, they must provide prompt, adequate, and effective compensation. This does not always happen,\nespecially where foreign owners\xe2\x80\x99 property is being expropriated. The guarantees of the Fifth Amendment\n(incorporated against state action by the Fourteenth Amendment) are available to property owners where\nstate, county, or municipal government uses the power of eminent domain to take private property for\npublic purposes. Just what is a public purpose is a matter of some debate. For example, if a city were to\ncondemn economically viable businesses or neighborhoods to construct a baseball stadium with public\nmoney to entice a private enterprise (the baseball team) to stay, is a public purpose being served?\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n146\n\n\x0cIn Kelo v. City of New London, Mrs. Kelo and other residents fought the city of New London, in its\nattempt to use powers of eminent domain to create an industrial park and recreation area that would have\nPfizer & Co. as a principal tenant.\n\n[3]\n\nThe city argued that increasing its tax base was a sufficient public\n\npurpose. In a very close decision, the Supreme Court determined that New London\xe2\x80\x99s actions did not\nviolate the takings clause. However, political reactions in various states resulted in a great deal of new\nstate legislation that would limit the scope of public purpose in eminent domain takings and provide\nadditional compensation to property owners in many cases.\nIn addition to the takings clause and aspects of procedural due process, the Fifth Amendment is also the\nsource of what is called substantive due process. During the first third of the twentieth century, the\nSupreme Court often nullified state and federal laws using substantive due process. In 1905, for example,\nin Lochner v. New York, the Supreme Court voided a New York statute that limited the number of hours\nthat bakers could work in a single week. New York had passed the law to protect the health of employees,\nbut the court found that this law interfered with the basic constitutional right of private parties to freely\ncontract with one another. Over the next thirty years, dozens of state and federal laws were struck down\nthat aimed to improve working conditions, secure social welfare, or establish the rights of unions.\nHowever, in 1934, during the Great Depression, the court reversed itself and began upholding the kinds of\nlaws it had struck down earlier.\nSince then, the court has employed a two-tiered analysis of substantive due process claims. Under the first\ntier, legislation on economic matters, employment relations, and other business affairs is subject to\nminimal judicial scrutiny. This means that a law will be overturned only if it serves no rational\ngovernment purpose. Under the second tier, legislation concerning fundamental liberties is subject to\n\xe2\x80\x9cheightened judicial scrutiny,\xe2\x80\x9d meaning that a law will be invalidated unless it is \xe2\x80\x9cnarrowly tailored to\nserve a significant government purpose.\xe2\x80\x9d\nThe Supreme Court has identified two distinct categories of fundamental liberties. The first category\nincludes most of the liberties expressly enumerated in the Bill of Rights. Through a process known as\nselective incorporation, the court has interpreted the due process clause of the Fourteenth Amendment to\nbar states from denying their residents the most important freedoms guaranteed in the first ten\namendments to the federal Constitution. Only the Third Amendment right (against involuntary\nquartering of soldiers) and the Fifth Amendment right to be indicted by a grand jury have not been made\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n147\n\n\x0capplicable to the states. Because these rights are still not applicable to state governments, the Supreme\nCourt is often said to have \xe2\x80\x9cselectively incorporated\xe2\x80\x9d the Bill of Rights into the due process clause of the\nFourteenth Amendment.\nThe second category of fundamental liberties includes those liberties that are not expressly stated in the\nBill of Rights but that can be seen as essential to the concepts of freedom and equality in a democratic\nsociety. These unstated liberties come from Supreme Court precedents, common law, moral philosophy,\nand deeply rooted traditions of US legal history. The Supreme Court has stressed that he\nword liberty cannot be defined by a definitive list of rights; rather, it must be viewed as a rational\ncontinuum of freedom through which every aspect of human behavior is protected from arbitrary\nimpositions and random restraints. In this regard, as the Supreme Court has observed, the due process\nclause protects abstract liberty interests, including the right to personal autonomy, bodily integrity, selfdignity, and self-determination.\nThese liberty interests often are grouped to form a general right to privacy, which was first recognized\nin Griswold v. Connecticut (Section 4.6.1), where the Supreme Court struck down a state statute\nforbidding married adults from using, possessing, or distributing contraceptives on the ground that the\nlaw violated the sanctity of the marital relationship. According to Justice Douglas\xe2\x80\x99s plurality opinion, this\npenumbra of privacy, though not expressly mentioned in the Bill of Rights, must be protected to establish\na buffer zone or breathing space for those freedoms that are constitutionally enumerated.\nBut substantive due process has seen fairly limited use since the 1930s. During the 1990s, the Supreme\nCourt was asked to recognize a general right to die under the doctrine of substantive due process.\nAlthough the court stopped short of establishing such a far-reaching right, certain patients may exercise a\nconstitutional liberty to hasten their deaths under a narrow set of circumstances. In Cruzan v. Missouri\nDepartment of Health, the Supreme Court ruled that the due process clause guarantees the right of\ncompetent adults to make advanced directives for the withdrawal of life-sustaining measures should they\nbecome incapacitated by a disability that leaves them in a persistent vegetative state.\n\n[4]\n\nOnce it has been\n\nestablished by clear and convincing evidence that a mentally incompetent and persistently vegetative\npatient made such a prior directive, a spouse, parent, or other appropriate guardian may seek to terminate\nany form of artificial hydration or nutrition.\n\nFourteenth Amendment: Due Process and Equal Protection Guarantees\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n148\n\n\x0cThe Fourteenth Amendment (1868) requires that states treat citizens of other states with due process.\nThis can be either an issue of procedural due process (as in Section 3.9 "Cases", Burger King v.\nRudzewicz) or an issue of substantive due process. For substantive due process, consider what happened\nin an Alabama court not too long ago.\n\n[5]\n\nThe plaintiff, Dr. Ira Gore, bought a new BMW for $40,000 from a dealer in Alabama. He later discovered\nthat the vehicle\xe2\x80\x99s exterior had been slightly damaged in transit from Europe and had therefore been\nrepainted by the North American distributor prior to his purchase. The vehicle was, by best estimates,\nworth about 10 percent less than he paid for it. The distributor, BMW of North America, had routinely\nsold slightly damaged cars as brand new if the damage could be fixed for less than 3 percent of the cost of\nthe car. In the trial, Dr. Gore sought $4,000 in compensatory damages and also punitive damages. The\nAlabama trial jury considered that BMW was engaging in a fraudulent practice and wanted to punish the\ndefendant for a number of frauds it estimated at somewhere around a thousand nationwide. The jury\nawarded not only the $4,000 in compensatory damages but also $4 million in punitive damages, which\nwas later reduced to $2 million by the Alabama Supreme Court. On appeal to the US Supreme Court, the\ncourt found that punitive damages may not be \xe2\x80\x9cgrossly excessive.\xe2\x80\x9d If they are, then they violate\nsubstantive due process. Whatever damages a state awards must be limited to what is reasonably\nnecessary to vindicate the state\xe2\x80\x99s legitimate interest in punishment and deterrence.\n\xe2\x80\x9cEqual protection of the laws\xe2\x80\x9d is a phrase that originates in the Fourteenth Amendment, adopted in 1868.\nThe amendment provides that no state shall \xe2\x80\x9cdeny to any person within its jurisdiction the equal\nprotection of the laws.\xe2\x80\x9d This is the equal protection clause. It means that, generally speaking,\ngovernments must treat people equally. Unfair classifications among people or corporations will not be\npermitted. A well-known example of unfair classification would be race discrimination: requiring white\nchildren and black children to attend different public schools or requiring \xe2\x80\x9cseparate but equal\xe2\x80\x9d public\nservices, such as water fountains or restrooms. Yet despite the clear intent of the 1868 amendment,\n\xe2\x80\x9cseparate but equal\xe2\x80\x9d was the law of the land until Brown v. Board of Education (1954).\n\n[6]\n\nGovernments make classifications every day, so not all classifications can be illegal under the equal\nprotection clause. People with more income generally pay a greater percentage of their income in taxes.\nPeople with proper medical training are licensed to become doctors; people without that training cannot\nbe licensed and commit a criminal offense if they do practice medicine. To know what classifications are\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n149\n\n\x0cpermissible under the Fourteenth Amendment, we need to know what is being classified. The court has\ncreated three classifications, and the outcome of any equal protection case can usually be predicted by\nknowing how the court is likely to classify the case:\n\xe2\x80\xa2\n\nMinimal scrutiny: economic and social relations. Government actions are usually upheld if there is a\nrational basis for them.\n\n\xe2\x80\xa2\n\nIntermediate scrutiny: gender. Government classifications are sometimes upheld.\n\n\xe2\x80\xa2\n\nStrict scrutiny: race, ethnicity, and fundamental rights. Classifications based on any of these are\nalmost never upheld.\n\nUnder minimal scrutiny for economic and social regulation, laws that regulate economic or social issues\nare presumed valid and will be upheld if they are rationally related to legitimate goals of government. So,\nfor example, if the city of New Orleans limits the number of street vendors to some rational number (more\nthan one but fewer than the total number that could possibly fit on the sidewalks), the local ordinance\nwould not be overturned as a violation of equal protection.\nUnder intermediate scrutiny, the city of New Orleans might limit the number of street vendors who are\nmen. For example, suppose that the city council decreed that all street vendors must be women, thinking\nthat would attract even more tourism. A classification like this, based on sex, will have to meet a sterner\ntest than a classification resulting from economic or social regulation. A law like this would have to\nsubstantially relate to important government objectives. Increasingly, courts have nullified government\nsex classifications as societal concern with gender equality has grown. (See Shannon Faulkner\xe2\x80\x99s case\nagainst The Citadel, an all-male state school.)\n\n[7]\n\nSuppose, however, that the city of New Orleans decided that no one of Middle Eastern heritage could\ndrive a taxicab or be a street vendor. That kind of classification would be examined with strict scrutiny to\nsee if there was any compelling justification for it. As noted, classifications such as this one are almost\nnever upheld. The law would be upheld only if it were necessary to promote a compelling state interest.\nVery few laws that have a racial or ethnic classification meet that test.\nThe strict scrutiny test will be applied to classifications involving racial and ethnic criteria as well as\nclassifications that interfere with a fundamental right. In Palmore v. Sidoti, the state refused to award\n[8]\n\ncustody to the mother because her new spouse was racially different from the child. This practice was\ndeclared unconstitutional because the state had made a racial classification; this was presumptively\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n150\n\n\x0cinvalid, and the government could not show a compelling need to enforce such a classification through its\nlaw. An example of government action interfering with a fundamental right will also receive strict\nscrutiny. When New York State gave an employment preference to veterans who had been state residents\nat the time of entering the military, the court declared that veterans who were new to the state were less\nlikely to get jobs and that therefore the statute interfered with the right to travel, which was deemed a\nfundamental right.\n\n[9]\n\nKEY TAKEAWAY\n\nThe Bill of Rights, through the Fourteenth Amendment, largely applies to state actions. The Bill of Rights\nhas applied to federal actions from the start. Both the Bill of Rights and the Fourteenth Amendment apply\nto business in various ways, but it is important to remember that the rights conferred are rights against\ngovernmental action and not the actions of private enterprise.\n\nEXERCISES\n\n1.\n\nJohn Hanks works at ProLogis. The company decides to institute a drug-testing policy. John is a good and\nlongtime employee but enjoys smoking marijuana on the weekends. The drug testing will involve urine\nsamples and, semiannually, a hair sample. It is nearly certain that the drug-testing protocol that ProLogis\nproposes will find that Hanks is a marijuana user. The company has made it clear that it will have zero\ntolerance for any kind of nonprescribed controlled substances. John and several fellow employees wish to\ngo to court to challenge the proposed testing as \xe2\x80\x9can unreasonable search and seizure.\xe2\x80\x9d Can he possibly\nsucceed?\n\n2.\n\nLarry Reed, majority leader in the Senate, is attacked in his reelection campaign by a series of ads\nsponsored by a corporation (Global Defense, Inc.) that does not like his voting record. The corporation is\nupset that Reed would not write a special provision that would favor Global Defense in a defense\nappropriations bill. The ads run constantly on television and radio in the weeks immediately preceding\nelection day and contain numerous falsehoods. For example, in order to keep the government running\nfinancially, Reed found it necessary to vote for a bill that included a last-minute rider that defunded a\nsmall government program for the handicapped, sponsored by someone in the opposing party that\nwanted to privatize all programs for the handicapped. The ad is largely paid for by Global Defense and\ndepicts a handicapped child being helped by the existing program and large letters saying \xe2\x80\x9cDoes Larry\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n151\n\n\x0cReed Just Not Care?\xe2\x80\x9d The ad proclaims that it is sponsored by Citizens Who Care for a Better Tomorrow. Is\nthis protected speech? Why or why not? Can Reed sue for defamation? Why or why not?\n3.\n\n[1] Jackson v. Metropolitan Edison Co., 419 US 345 (1974).\n\n4.\n\n[2] Buckley v. Valeo, 424 US 1 (1976).\n\n5.\n\n[3] Kelo v. City of New London, 545 US 469 (2005).\n\n6.\n\n[4] Cruzan v. Missouri Department of Health, 497 US 261 (1990).\n\n7.\n\n[5] BMW of North America, Inc. v. Gore, 517 U.S. 559 (1996)\n\n8.\n\n[6] Plessy v. Ferguson, 163 US 537 (1896).\n\n9.\n\n[7] United States v. Virginia, 518 US 515 (1996).\n\n10. [8] Palmore v. Sidoti, 466 US 429 (1984).\n11. [9] Atty. Gen. of New York v. Soto-Lopez, 476 US 898 (1986).\n\n4.6 Cases\nGriswold v. Connecticut\nGriswold v. Connecticut\n381 U.S. 479 (U.S. Supreme Court 1965)\nA nineteenth-century Connecticut law made the use, possession, or distribution of birth control devices\nillegal. The law also prohibited anyone from giving information about such devices. The executive\ndirector and medical director of a planned parenthood association were found guilty of giving out such\ninformation to a married couple that wished to delay having children for a few years. The directors\nwere fined $100 each.\nThey appealed throughout the Connecticut state court system, arguing that the state law violated\n(infringed) a basic or fundamental right of privacy of a married couple: to live together and have sex\ntogether without the restraining power of the state to tell them they may legally have intercourse but\nnot if they use condoms or other birth control devices. At each level (trial court, court of appeals, and\nConnecticut Supreme Court), the Connecticut courts upheld the constitutionality of the convictions.\nPlurality Opinion by Justice William O. Douglass\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n152\n\n\x0cWe do not sit as a super legislature to determine the wisdom, need, and propriety of laws that touch\neconomic problems, business affairs, or social conditions. The [Connecticut] law, however, operates\ndirectly on intimate relation of husband and wife and their physician\xe2\x80\x99s role in one aspect of that relation.\n[Previous] cases suggest that specific guarantees in the Bill of Rights have penumbras, formed by\nemanations from those guarantees that help give them life and substance.\xe2\x80\xa6Various guarantees create\nzones of privacy. The right of association contained in the penumbra of the First Amendment is one.\xe2\x80\xa6The\nThird Amendment in its prohibition against the quartering of soldiers \xe2\x80\x9cin any house\xe2\x80\x9d in time of peace\nwithout the consent of the owner is another facet of that privacy. The Fourth Amendment explicitly\naffirms the \xe2\x80\x9cright of the people to be secure in their persons, houses, papers and effects, against\nunreasonable searches and seizures.\xe2\x80\x9d The Fifth Amendment in its Self-Incrimination Clause enables the\ncitizen to create a zone of privacy which the government may not force him to surrender to his detriment.\nThe Ninth Amendment provides: \xe2\x80\x9cThe enumeration in the Constitution, of certain rights, shall not be\nconstrued to deny or disparage others retained by the people.\xe2\x80\x9d\nThe Fourth and Fifth Amendments were described\xe2\x80\xa6as protection against all governmental invasions \xe2\x80\x9cof\nthe sanctity of a man\xe2\x80\x99s home and the privacies of life.\xe2\x80\x9d We recently referred in Mapp v. Ohio\xe2\x80\xa6to the\nFourth Amendment as creating a \xe2\x80\x9cright to privacy, no less important than any other right carefully and\nparticularly reserved to the people.\xe2\x80\x9d\n[The law in question here], in forbidding the use of contraceptives rather than regulating their\nmanufacture or sale, seeks to achieve its goals by having a maximum destructive impact on [the marital]\nrelationship. Such a law cannot stand.\xe2\x80\xa6Would we allow the police to search the sacred precincts of\nmarital bedrooms for telltale signs of the use of contraceptives? The very idea is repulsive to the notions of\nprivacy surrounding the marital relationship.\nWe deal with a right of privacy older than the Bill of Rights\xe2\x80\x94older than our political parties, older than\nour school system. Marriage is a coming together for better or for worse, hopefully enduring, and intimate\nto the degree of being sacred. It is an association that promotes a way of life, not causes; a harmony in\nliving, not political faiths; a bilateral loyalty, not commercial or social projects. Yet it is an association for\nas noble a purpose as any involved in our prior decisions.\nMr. Justice Stewart, whom Mr. Justice Black joins, dissenting.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n153\n\n\x0cSince 1879 Connecticut has had on its books a law which forbids the use of contraceptives by anyone. I\nthink this is an uncommonly silly law. As a practical matter, the law is obviously unenforceable, except in\nthe oblique context of the present case. As a philosophical matter, I believe the use of contraceptives in the\nrelationship of marriage should be left to personal and private choice, based upon each individual\xe2\x80\x99s moral,\nethical, and religious beliefs. As a matter of social policy, I think professional counsel about methods of\nbirth control should be available to all, so that each individual\xe2\x80\x99s choice can be meaningfully made. But we\nare not asked in this case to say whether we think this law is unwise, or even asinine. We are asked to hold\nthat it violates the United States Constitution. And that I cannot do.\nIn the course of its opinion the Court refers to no less than six Amendments to the Constitution: the First,\nthe Third, the Fourth, the Fifth, the Ninth, and the Fourteenth. But the Court does not say which of these\nAmendments, if any, it thinks is infringed by this Connecticut law.\n\xe2\x80\xa6\nAs to the First, Third, Fourth, and Fifth Amendments, I can find nothing in any of them to invalidate this\nConnecticut law, even assuming that all those Amendments are fully applicable against the States. It has\nnot even been argued that this is a law \xe2\x80\x9crespecting an establishment of religion, or prohibiting the free\nexercise thereof.\xe2\x80\x9d And surely, unless the solemn process of constitutional adjudication is to descend to the\nlevel of a play on words, there is not involved here any abridgment of \xe2\x80\x9cthe freedom of speech, or of the\npress; or the right of the people peaceably to assemble, and to petition the Government for a redress of\ngrievances.\xe2\x80\x9d No soldier has been quartered in any house. There has been no search, and no seizure.\nNobody has been compelled to be a witness against himself.\nThe Court also quotes the Ninth Amendment, and my Brother Goldberg\xe2\x80\x99s concurring opinion relies\nheavily upon it. But to say that the Ninth Amendment has anything to do with this case is to turn\nsomersaults with history. The Ninth Amendment, like its companion the Tenth, which this Court held\n\xe2\x80\x9cstates but a truism that all is retained which has not been surrendered,\xe2\x80\x9d United States v. Darby, 312 U.S.\n100, 124, was framed by James Madison and adopted by the States simply to make clear that the adoption\nof the Bill of Rights did not alter the plan that the Federal Government was to be a government of express\nand limited powers, and that all rights and powers not delegated to it were retained by the people and the\nindividual States. Until today no member of this Court has ever suggested that the Ninth Amendment\nmeant anything else, and the idea that a federal court could ever use the Ninth Amendment to annul a law\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n154\n\n\x0cpassed by the elected representatives of the people of the State of Connecticut would have caused James\nMadison no little wonder.\nWhat provision of the Constitution, then, does make this state law invalid? The Court says it is the right of\nprivacy \xe2\x80\x9ccreated by several fundamental constitutional guarantees.\xe2\x80\x9d With all deference, I can find no such\ngeneral right of privacy in the Bill of Rights, in any other part of the Constitution, or in any case ever\nbefore decided by this Court.\nAt the oral argument in this case we were told that the Connecticut law does not \xe2\x80\x9cconform to current\ncommunity standards.\xe2\x80\x9d But it is not the function of this Court to decide cases on the basis of community\nstandards. We are here to decide cases \xe2\x80\x9cagreeably to the Constitution and laws of the United States.\xe2\x80\x9d It is\nthe essence of judicial duty to subordinate our own personal views, our own ideas of what legislation is\nwise and what is not. If, as I should surely hope, the law before us does not reflect the standards of the\npeople of Connecticut, the people of Connecticut can freely exercise their true Ninth and Tenth\nAmendment rights to persuade their elected representatives to repeal it. That is the constitutional way to\ntake this law off the books.\n\n1.\n\nCASE QUESTIONS\n\nWhich opinion is the strict constructionist opinion here\xe2\x80\x94Justice Douglas\xe2\x80\x99s or that of Justices Stewart and\nBlack?\n\n2.\n\nWhat would have happened if the Supreme Court had allowed the Connecticut Supreme Court decision to\nstand and followed Justice Black\xe2\x80\x99s reasoning? Is it likely that the citizens of Connecticut would have\npersuaded their elected representatives to repeal the law challenged here?\n\nWickard v. Filburn\nWickard v. Filburn\n317 U.S. 111 (U.S. Supreme Court 1942)\nMr. Justice Jackson delivered the opinion of the Court.\nMr. Filburn for many years past has owned and operated a small farm in Montgomery County, Ohio,\nmaintaining a herd of dairy cattle, selling milk, raising poultry, and selling poultry and eggs. It has been\nhis practice to raise a small acreage of winter wheat, sown in the Fall and harvested in the following July;\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n155\n\n\x0cto sell a portion of the crop; to feed part to poultry and livestock on the farm, some of which is sold; to use\nsome in making flour for home consumption; and to keep the rest for the following seeding.\nHis 1941 wheat acreage allotment was 11.1 acres and a normal yield of 20.1 bushels of wheat an acre. He\nsowed, however, 23 acres, and harvested from his 11.9 acres of excess acreage 239 bushels, which under\nthe terms of the Act as amended on May 26, 1941, constituted farm marketing excess, subject to a penalty\nof 49 cents a bushel, or $117.11 in all.\nThe general scheme of the Agricultural Adjustment Act of 1938 as related to wheat is to control the\nvolume moving in interstate and foreign commerce in order to avoid surpluses and shortages and the\nconsequent abnormally low or high wheat prices and obstructions to commerce. [T]he Secretary of\nAgriculture is directed to ascertain and proclaim each year a national acreage allotment for the next crop\nof wheat, which is then apportioned to the states and their counties, and is eventually broken up into\nallotments for individual farms.\nIt is urged that under the Commerce Clause of the Constitution, Article I, \xc2\xa7 8, clause 3, Congress does not\npossess the power it has in this instance sought to exercise. The question would merit little consideration\nsince our decision in United States v. Darby, 312 U.S. 100, sustaining the federal power to regulate\nproduction of goods for commerce, except for the fact that this Act extends federal regulation to\nproduction not intended in any part for commerce but wholly for consumption on the farm.\n\nKassel v. Consolidated Freightways Corp.\nKassel v. Consolidated Freightways Corp.\n450 U.S. 662 (U.S. Supreme Court 1981)\nJUSTICE POWELL announced the judgment of the Court and delivered an opinion, in which JUSTICE\nWHITE, JUSTICE BLACKMUN, and JUSTICE STEVENS joined.\nThe question is whether an Iowa statute that prohibits the use of certain large trucks within the State\nunconstitutionally burdens interstate commerce.\n\nI\nAppellee Consolidated Freightways Corporation of Delaware (Consolidated) is one of the largest common\ncarriers in the country: it offers service in 48 States under a certificate of public convenience and necessity\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n156\n\n\x0cissued by the Interstate Commerce Commission. Among other routes, Consolidated carries commodities\nthrough Iowa on Interstate 80, the principal east-west route linking New York, Chicago, and the west\ncoast, and on Interstate 35, a major north-south route.\nConsolidated mainly uses two kinds of trucks. One consists of a three-axle tractor pulling a 40-foot twoaxle trailer. This unit, commonly called a single, or \xe2\x80\x9csemi,\xe2\x80\x9d is 55 feet in length overall. Such trucks have\nlong been used on the Nation\xe2\x80\x99s highways. Consolidated also uses a two-axle tractor pulling a single-axle\ntrailer which, in turn, pulls a single-axle dolly and a second single-axle trailer. This combination, known\nas a double, or twin, is 65 feet long overall. Many trucking companies, including Consolidated,\nincreasingly prefer to use doubles to ship certain kinds of commodities. Doubles have larger capacities,\nand the trailers can be detached and routed separately if necessary. Consolidated would like to use 65-foot\ndoubles on many of its trips through Iowa.\nThe State of Iowa, however, by statute, restricts the length of vehicles that may use its highways. Unlike all\nother States in the West and Midwest, Iowa generally prohibits the use of 65-foot doubles within its\nborders.\n\xe2\x80\xa6\nBecause of Iowa\xe2\x80\x99s statutory scheme, Consolidated cannot use its 65-foot doubles to move commodities\nthrough the State. Instead, the company must do one of four things: (i) use 55-foot singles; (ii) use 60-foot\ndoubles; (iii) detach the trailers of a 65-foot double and shuttle each through the State separately; or (iv)\ndivert 65-foot doubles around Iowa. Dissatisfied with these options, Consolidated filed this suit in the\nDistrict Court averring that Iowa\xe2\x80\x99s statutory scheme unconstitutionally burdens interstate commerce.\nIowa defended the law as a reasonable safety measure enacted pursuant to its police power. The State\nasserted that 65-foot doubles are more dangerous than 55-foot singles and, in any event, that the law\npromotes safety and reduces road wear within the State by diverting much truck traffic to other states.\nIn a 14-day trial, both sides adduced evidence on safety and on the burden on interstate commerce\nimposed by Iowa\xe2\x80\x99s law. On the question of safety, the District Court found that the \xe2\x80\x9cevidence clearly\nestablishes that the twin is as safe as the semi.\xe2\x80\x9d 475 F.Supp. 544, 549 (SD Iowa 1979). For that reason,\n\xe2\x80\x9cthere is no valid safety reason for barring twins from Iowa\xe2\x80\x99s highways because of their\nconfiguration.\xe2\x80\xa6The evidence convincingly, if not overwhelmingly, establishes that the 65-foot twin is as\nsafe as, if not safer than, the 60-foot twin and the 55-foot semi.\xe2\x80\xa6\xe2\x80\x9d\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n157\n\n\x0c\xe2\x80\x9cTwins and semis have different characteristics. Twins are more maneuverable, are less sensitive to wind,\nand create less splash and spray. However, they are more likely than semis to jackknife or upset. They can\nbe backed only for a short distance. The negative characteristics are not such that they render the twin less\nsafe than semis overall. Semis are more stable, but are more likely to \xe2\x80\x98rear-end\xe2\x80\x99 another vehicle.\xe2\x80\x9d\nIn light of these findings, the District Court applied the standard we enunciated in Raymond Motor\nTransportation, Inc. v. Rice, 434 U.S. 429 (1978), and concluded that the state law impermissibly\nburdened interstate commerce: \xe2\x80\x9c[T]he balance here must be struck in favor of the federal interests.\nThe total effect of the law as a safety measure in reducing accidents and casualties is so slight and\nproblematical that it does not outweigh the national interest in keeping interstate commerce free from\ninterferences that seriously impede it.\xe2\x80\x9d\nThe Court of Appeals for the Eighth Circuit affirmed. 612 F.2d 1064 (1979). It accepted the District Court\xe2\x80\x99s\nfinding that 65-foot doubles were as safe as 55-foot singles. Id. at 1069. Thus, the only apparent safety\nbenefit to Iowa was that resulting from forcing large trucks to detour around the State, thereby reducing\noverall truck traffic on Iowa\xe2\x80\x99s highways. The Court of Appeals noted that this was not a constitutionally\npermissible interest. It also commented that the several statutory exemptions identified above, such as\nthose applicable to border cities and the shipment of livestock, suggested that the law, in effect, benefited\nIowa residents at the expense of interstate traffic. Id. at 1070-1071. The combination of these exemptions\nweakened the presumption of validity normally accorded a state safety regulation. For these reasons, the\nCourt of Appeals agreed with the District Court that the Iowa statute unconstitutionally burdened\ninterstate commerce.\nIowa appealed, and we noted probable jurisdiction. 446 U.S. 950 (1980). We now affirm.\n\nII\nIt is unnecessary to review in detail the evolution of the principles of Commerce Clause adjudication. The\nClause is both a \xe2\x80\x9cprolific \xe2\x80\x98 of national power and an equally prolific source of conflict with legislation of the\nstate[s].\xe2\x80\x9d H. P. Hood & Sons, Inc. v. Du Mond, 336 U.S. 525, 336 U.S. 534 (1949). The Clause permits\nCongress to legislate when it perceives that the national welfare is not furthered by the independent\nactions of the States. It is now well established, also, that the Clause itself is \xe2\x80\x9ca limitation upon state power\neven without congressional implementation.\xe2\x80\x9d Hunt v. Washington Apple Advertising Comm\xe2\x80\x99n, 432 U.S.\n333 at 350 (1977). The Clause requires that some aspects of trade generally must remain free from\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n158\n\n\x0cinterference by the States. When a State ventures excessively into the regulation of these aspects of\ncommerce, it \xe2\x80\x9ctrespasses upon national interests,\xe2\x80\x9d Great A&P Tea Co. v. Cottrell, 424 U.S. 366, 424 U.S.\n373 (1976), and the courts will hold the state regulation invalid under the Clause alone.\nThe Commerce Clause does not, of course, invalidate all state restrictions on commerce. It has long been\nrecognized that, \xe2\x80\x9cin the absence of conflicting legislation by Congress, there is a residuum of power in the\nstate to make laws governing matters of local concern which nevertheless in some measure affect\ninterstate commerce or even, to some extent, regulate it.\xe2\x80\x9d Southern Pacific Co. v. Arizona, 325 U.S. 761\n(1945).\nThe extent of permissible state regulation is not always easy to measure. It may be said with confidence,\nhowever, that a State\xe2\x80\x99s power to regulate commerce is never greater than in matters traditionally of local\nconcern. Washington Apple Advertising Comm\xe2\x80\x99n, supra at 432 U.S. 350. For example, regulations that\ntouch upon safety\xe2\x80\x94especially highway safety\xe2\x80\x94are those that \xe2\x80\x9cthe Court has been most reluctant to\ninvalidate.\xe2\x80\x9d Raymond, supra at 434 U.S. 443 (and other cases cited). Indeed, \xe2\x80\x9cif safety justifications are\nnot illusory, the Court will not second-guess legislative judgment about their importance in comparison\nwith related burdens on interstate commerce.\xe2\x80\x9d Raymond, supra at 434 U.S. at 449. Those who would\nchallenge such bona fide safety regulations must overcome a \xe2\x80\x9cstrong presumption of validity.\xe2\x80\x9d Bibb v.\nNavajo Freight Lines, Inc., 359 U.S. 520 at (1959).\nBut the incantation of a purpose to promote the public health or safety does not insulate a state law from\nCommerce Clause attack. Regulations designed for that salutary purpose nevertheless may further the\npurpose so marginally, and interfere with commerce so substantially, as to be invalid under the\nCommerce Clause. In the Court\xe2\x80\x99s recent unanimous decision in Raymond we declined to \xe2\x80\x9caccept the\nState\xe2\x80\x99s contention that the inquiry under the Commerce Clause is ended without a weighing of the\nasserted safety purpose against the degree of interference with interstate commerce.\xe2\x80\x9d This \xe2\x80\x9cweighing\xe2\x80\x9d by a\ncourt requires\xe2\x80\x94and indeed the constitutionality of the state regulation depends on\xe2\x80\x94\xe2\x80\x9ca sensitive\nconsideration of the weight and nature of the state regulatory concern in light of the extent of the burden\nimposed on the course of interstate commerce.\xe2\x80\x9d Id. at 434 U.S. at 441; accord, Pike v. Bruce Church, Inc.,\n397 U.S. 137 at 142 (1970);Bibb, supra, at 359 U.S. at 525-530.\n\nIII\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n159\n\n\x0cApplying these general principles, we conclude that the Iowa truck length limitations unconstitutionally\nburden interstate commerce.\nIn Raymond Motor Transportation, Inc. v. Rice, the Court held that a Wisconsin statute that precluded\nthe use of 65-foot doubles violated the Commerce Clause. This case is Raymond revisited. Here, as\nin Raymond, the State failed to present any persuasive evidence that 65-foot doubles are less safe than 55foot singles. Moreover, Iowa\xe2\x80\x99s law is now out of step with the laws of all other Midwestern and Western\nStates. Iowa thus substantially burdens the interstate flow of goods by truck. In the absence of\ncongressional action to set uniform standards, some burdens associated with state safety regulations must\nbe tolerated. But where, as here, the State\xe2\x80\x99s safety interest has been found to be illusory, and its\nregulations impair significantly the federal interest in efficient and safe interstate transportation, the state\nlaw cannot be harmonized with the Commerce Clause.\n\nA\nIowa made a more serious effort to support the safety rationale of its law than did Wisconsin in Raymond,\nbut its effort was no more persuasive. As noted above, the District Court found that the \xe2\x80\x9cevidence clearly\nestablishes that the twin is as safe as the semi.\xe2\x80\x9d The record supports this finding. The trial focused on a\ncomparison of the performance of the two kinds of trucks in various safety categories. The evidence\nshowed, and the District Court found, that the 65-foot double was at least the equal of the 55-foot single in\nthe ability to brake, turn, and maneuver. The double, because of its axle placement, produces less splash\nand spray in wet weather. And, because of its articulation in the middle, the double is less susceptible to\ndangerous \xe2\x80\x9coff-tracking,\xe2\x80\x9d and to wind.\nNone of these findings is seriously disputed by Iowa. Indeed, the State points to only three ways in which\nthe 55-foot single is even arguably superior: singles take less time to be passed and to clear intersections;\nthey may back up for longer distances; and they are somewhat less likely to jackknife.\nThe first two of these characteristics are of limited relevance on modern interstate highways. As the\nDistrict Court found, the negligible difference in the time required to pass, and to cross intersections, is\ninsignificant on 4-lane divided highways, because passing does not require crossing into oncoming traffic\nlanes, Raymond, 434 U.S. at 444, and interstates have few, if any, intersections. The concern over backing\ncapability also is insignificant, because it seldom is necessary to back up on an interstate. In any event, no\nevidence suggested any difference in backing capability between the 60-foot doubles that Iowa permits\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n160\n\n\x0cand the 65-foot doubles that it bans. Similarly, although doubles tend to jackknife somewhat more than\nsingles, 65-foot doubles actually are less likely to jackknife than 60-foot doubles.\nStatistical studies supported the view that 65-foot doubles are at least as safe overall as 55-foot singles and\n60-foot doubles. One such study, which the District Court credited, reviewed Consolidated\xe2\x80\x99s comparative\naccident experience in 1978 with its own singles and doubles. Each kind of truck was driven 56 million\nmiles on identical routes. The singles were involved in 100 accidents resulting in 27 injuries and one\nfatality. The 65-foot doubles were involved in 106 accidents resulting in 17 injuries and one fatality. Iowa\xe2\x80\x99s\nexpert statistician admitted that this study provided \xe2\x80\x9cmoderately strong evidence\xe2\x80\x9d that singles have a\nhigher injury rate than doubles. Another study, prepared by the Iowa Department of Transportation at the\nrequest of the state legislature, concluded that \xe2\x80\x9c[s]ixty-five foot twin trailer combinations have not been\nshown by experiences in other states to be less safe than 60-foot twin trailer\ncombinations or conventional tractor-semitrailers.\xe2\x80\x9d\nIn sum, although Iowa introduced more evidence on the question of safety than did Wisconsin\nin Raymond, the record as a whole was not more favorable to the State.\n\nB\nConsolidated, meanwhile, demonstrated that Iowa\xe2\x80\x99s law substantially burdens interstate commerce.\nTrucking companies that wish to continue to use 65-foot doubles must route them around Iowa or detach\nthe trailers of the doubles and ship them through separately. Alternatively, trucking companies must use\nthe smaller 55-foot singles or 65-foot doubles permitted under Iowa law. Each of these options engenders\ninefficiency and added expense. The record shows that Iowa\xe2\x80\x99s law added about $12.6 million each year to\nthe costs of trucking companies.\nConsolidated alone incurred about $2 million per year in increased costs.\nIn addition to increasing the costs of the trucking companies (and, indirectly, of the service to\nconsumers), Iowa\xe2\x80\x99s law may aggravate, rather than, ameliorate, the problem of highway accidents. Fiftyfive-foot singles carry less freight than 65-foot doubles. Either more small trucks must be used to carry the\nsame quantity of goods through Iowa or the same number of larger trucks must drive longer distances to\nbypass Iowa. In either case, as the District Court noted, the restriction requires more highway miles to be\ndriven to transport the same quantity of goods. Other things being equal, accidents are proportional to\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n161\n\n\x0cdistance traveled. Thus, if 65-foot doubles are as safe as 55-foot singles, Iowa\xe2\x80\x99s law tends to increase the\nnumber of accidents and to shift the incidence of them from Iowa to other States.\n\n[IV. Omitted]\nV\nIn sum, the statutory exemptions, their history, and the arguments Iowa has advanced in support of its\nlaw in this litigation all suggest that the deference traditionally accorded a State\xe2\x80\x99s safety judgment is not\nwarranted. See Raymond, supra at 434 U.S. at 444-447. The controlling factors thus are the findings of\nthe District Court, accepted by the Court of Appeals, with respect to the relative safety of the types of\ntrucks at issue, and the substantiality of the burden on interstate commerce.\nBecause Iowa has imposed this burden without any significant countervailing safety interest, its statute\nviolates the Commerce Clause. The judgment of the Court of Appeals is affirmed.\nIt is so ordered.\n\n1.\n\nCASE QUESTIONS\n\nUnder the Constitution, what gives Iowa the right to make rules regarding the size or configuration of\ntrucks upon highways within the state?\n\n2.\n\nDid Iowa try to exempt trucking lines based in Iowa, or was the statutory rule nondiscriminatory as to the\norigin of trucks that traveled on Iowa highways?\n\n3.\n\nAre there any federal size or weight standards noted in the case? Is there any kind of truck size or weight\nthat could be limited by Iowa law, or must Iowa simply accept federal standards or, if none, impose no\nstandards at all?\n\nHunt v. Washington Apple Advertising Commission\nHunt v. Washington Apple Advertising Commission\n432 U.S. 33 (U.S. Supreme Court 1977)\nMR. CHIEF JUSTICE BURGER delivered the opinion of the Court.\nIn 1973, North Carolina enacted a statute which required, inter alia, all closed containers of apples sold,\noffered for sale, or shipped into the State to bear \xe2\x80\x9cno grade other than the applicable U.S. grade or\nstandard.\xe2\x80\x9d\xe2\x80\xa6Washington State is the Nation\xe2\x80\x99s largest producer of apples, its crops accounting for\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n162\n\n\x0capproximately 30% of all apples grown domestically and nearly half of all apples shipped in closed\ncontainers in interstate commerce. [Because] of the importance of the apple industry to the State, its\nlegislature has undertaken to protect and enhance the reputation of Washington apples by establishing a\nstringent, mandatory inspection program [that] requires all apples shipped in interstate commerce to be\ntested under strict quality standards and graded accordingly. In all cases, the Washington State grades\n[are] the equivalent of, or superior to, the comparable grades and standards adopted by the [U.S. Dept. of]\nAgriculture (USDA).\n[In] 1972, the North Carolina Board of Agriculture adopted an administrative regulation, unique in the 50\nStates, which in effect required all closed containers of apples shipped into or sold in the State to display\neither the applicable USDA grade or a notice indicating no classification. State grades were expressly\nprohibited. In addition to its obvious consequence\xe2\x80\x94prohibiting the display of Washington State apple\ngrades on containers of apples shipped into North Carolina\xe2\x80\x94the regulation presented the Washington\napple industry with a marketing problem of potentially nationwide significance. Washington apple\ngrowers annually ship in commerce approximately 40 million closed containers of apples, nearly 500,000\nof which eventually find their way into North Carolina, stamped with the applicable Washington State\nvariety and grade. [Compliance] with North Carolina\xe2\x80\x99s unique regulation would have required\nWashington growers to obliterate the printed labels on containers shipped to North Carolina, thus giving\ntheir product a damaged appearance. Alternatively, they could have changed their marketing practices to\naccommodate the needs of the North Carolina market, i.e., repack apples to be shipped to North Carolina\nin containers bearing only the USDA grade, and/or store the estimated portion of the harvest destined for\nthat market in such special containers. As a last resort, they could discontinue the use of the preprinted\ncontainers entirely. None of these costly and less efficient options was very attractive to the industry.\nMoreover, in the event a number of other States followed North Carolina\xe2\x80\x99s lead, the resultant inability to\ndisplay the Washington grades could force the Washington growers to abandon the State\xe2\x80\x99s expensive\ninspection and grading system which their customers had come to know and rely on over the 60-odd\nyears of its existence.\xe2\x80\xa6\nUnsuccessful in its attempts to secure administrative relief [with North Carolina], the Commission\ninstituted this action challenging the constitutionality of the statute. [The] District Court found that the\nNorth Carolina statute, while neutral on its face, actually discriminated against Washington State growers\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n163\n\n\x0cand dealers in favor of their local counterparts [and] concluded that this discrimination [was] not justified\nby the asserted local interest\xe2\x80\x94the elimination of deception and confusion from the marketplace\xe2\x80\x94arguably\nfurthered by the [statute].\n\xe2\x80\xa6\n[North Carolina] maintains that [the] burdens on the interstate sale of Washington apples were far\noutweighed by the local benefits flowing from what they contend was a valid exercise of North Carolina\xe2\x80\x99s\n[police powers]. Prior to the statute\xe2\x80\x99s enactment,\xe2\x80\xa6apples from 13 different States were shipped into North\nCarolina for sale. Seven of those States, including [Washington], had their own grading systems which,\nwhile differing in their standards, used similar descriptive labels (e.g., fancy, extra fancy, etc.). This\nmultiplicity of inconsistent state grades [posed] dangers of deception and confusion not only in the North\nCarolina market, but in the Nation as a whole. The North Carolina statute, appellants claim, was enacted\nto eliminate this source of deception and confusion. [Moreover], it is contended that North Carolina\nsought to accomplish this goal of uniformity in an evenhanded manner as evidenced by the fact that its\nstatute applies to all apples sold in closed containers in the State without regard to their point of origin.\n[As] the appellants properly point out, not every exercise of state authority imposing some burden on the\nfree flow of commerce is invalid, [especially] when the State acts to protect its citizenry in matters\npertaining to the sale of foodstuffs. By the same token, however, a finding that state legislation furthers\nmatters of legitimate local concern, even in the health and consumer protection areas, does not end the\ninquiry. Rather, when such state legislation comes into conflict with the Commerce Clause\xe2\x80\x99s overriding\nrequirement of a national \xe2\x80\x9ccommon market,\xe2\x80\x9d we are confronted with the task of effecting an\naccommodation of the competing national and local interests. We turn to that task.\nAs the District Court correctly found, the challenged statute has the practical effect of not only burdening\ninterstate sales of Washington apples, but also discriminating against them. This discrimination takes\nvarious forms. The first, and most obvious, is the statute\xe2\x80\x99s consequence of raising the costs of doing\nbusiness in the North Carolina market for Washington apple growers and dealers, while leaving those of\ntheir North Carolina counterparts unaffected. [This] disparate effect results from the fact that North\nCarolina apple producers, unlike their Washington competitors, were not forced to alter their marketing\npractices in order to comply with the statute. They were still free to market their wares under the USDA\ngrade or none at all as they had done prior to the statute\xe2\x80\x99s enactment. Obviously, the increased costs\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n164\n\n\x0cimposed by the statute would tend to shield the local apple industry from the competition of Washington\napple growers and dealers who are already at a competitive disadvantage because of their great distance\nfrom the North Carolina market.\nSecond, the statute has the effect of stripping away from the Washington apple industry the competitive\nand economic advantages it has earned for itself through its expensive inspection and grading system. The\nrecord demonstrates that the Washington apple-grading system has gained nationwide acceptance in the\napple trade. [The record] contains numerous affidavits [stating a] preference [for] apples graded under\nthe Washington, as opposed to the USDA, system because of the former\xe2\x80\x99s greater consistency, its\nemphasis on color, and its supporting mandatory inspections. Once again, the statute had no similar\nimpact on the North Carolina apple industry and thus operated to its benefit.\nThird, by prohibiting Washington growers and dealers from marketing apples under their State\xe2\x80\x99s grades,\nthe statute has a leveling effect which insidiously operates to the advantage of local apple producers.\n[With] free market forces at work, Washington sellers would normally enjoy a distinct market advantage\nvis-\xc3\xa0-vis local producers in those categories where the Washington grade is superior. However, because of\nthe statute\xe2\x80\x99s operation, Washington apples which would otherwise qualify for and be sold under the\nsuperior Washington grades will now have to be marketed under their inferior USDA counterparts. Such\n\xe2\x80\x9cdowngrading\xe2\x80\x9d offers the North Carolina apple industry the very sort of protection against competing outof-state products that the Commerce Clause was designed to prohibit. At worst, it will have the effect of an\nembargo against those Washington apples in the superior grades as Washington dealers withhold them\nfrom the North Carolina market. At best, it will deprive Washington sellers of the market premium that\nsuch apples would otherwise command.\nDespite the statute\xe2\x80\x99s facial neutrality, the Commission suggests that its discriminatory impact on\ninterstate commerce was not an unintended by-product, and there are some indications in the record to\nthat effect. The most glaring is the response of the North Carolina Agriculture Commissioner to the\nCommission\xe2\x80\x99s request for an exemption following the statute\xe2\x80\x99s passage in which he indicated that before\nhe could support such an exemption, he would \xe2\x80\x9cwant to have the sentiment from our apple\nproducers since they were mainly responsible for this legislation being passed.\xe2\x80\x9d [Moreover], we find it\nsomewhat suspect that North Carolina singled out only closed containers of apples, the very means by\nwhich apples are transported in commerce, to effectuate the statute\xe2\x80\x99s ostensible consumer protection\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n165\n\n\x0cpurpose when apples are not generally sold at retail in their shipping containers. However, we need not\nascribe an economic protection motive to the North Carolina Legislature to resolve this case; we conclude\nthat the challenged statute cannot stand insofar as it prohibits the display of Washington State grades\neven if enacted for the declared purpose of protecting consumers from deception and fraud in the\nmarketplace.\n\xe2\x80\xa6\nFinally, we note that any potential for confusion and deception created by the Washington grades was not\nof the type that led to the statute\xe2\x80\x99s enactment. Since Washington grades are in all cases equal or superior\nto their USDA counterparts, they could only \xe2\x80\x9cdeceive\xe2\x80\x9d or \xe2\x80\x9cconfuse\xe2\x80\x9d a consumer to his benefit, hardly a\nharmful result.\nIn addition, it appears that nondiscriminatory alternatives to the outright ban of Washington State grades\nare readily available. For example, North Carolina could effectuate its goal by permitting out-of-state\ngrowers to utilize state grades only if they also marked their shipments with the applicable USDA label. In\nthat case, the USDA grade would serve as a benchmark against which the consumer could evaluate the\nquality of the various state grades.\xe2\x80\xa6\n[The court affirmed the lower court\xe2\x80\x99s holding that the North Carolina statute was unconstitutional.]\n\nCASE QUESTIONS\n\n1.\n\nWas the North Carolina law discriminatory on its face? Was it, possibly, an undue burden on interstate\ncommerce? Why wouldn\xe2\x80\x99t it be?\n\n2.\n\nWhat evidence was there of discriminatory intent behind the North Carolina law? Did that evidence even\nmatter? Why or why not?\n\nCitizens United v. Federal Election Commission\nCitizens United v. Federal Election Commission\n588 U.S. ____; 130 S.Ct. 876 (U.S. Supreme Court 2010)\nJustice Kennedy delivered the opinion of the Court.\nFederal law prohibits corporations and unions from using their general treasury funds to make\nindependent expenditures for speech defined as an \xe2\x80\x9celectioneering communication\xe2\x80\x9d or for speech\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n166\n\n\x0cexpressly advocating the election or defeat of a candidate. 2 U.S.C. \xc2\xa7441b. Limits on electioneering\ncommunications were upheld in McConnell v. Federal Election Comm\xe2\x80\x99n, 540 U.S. 93, 203\xe2\x80\x93209 (2003).\nThe holding of McConnell rested to a large extent on an earlier case, Austin v. Michigan Chamber of\nCommerce, 494 U.S. 652 (1990). Austin had held that political speech may be banned based on the\nspeaker\xe2\x80\x99s corporate identity.\nIn this case we are asked to reconsider Austin and, in effect, McConnell. It has been noted that\n\xe2\x80\x9cAustin was a significant departure from ancient First Amendment principles,\xe2\x80\x9d Federal Election Comm\xe2\x80\x99n\nv. Wisconsin Right to Life, Inc., 551 U.S. 449, 490 (2007) (WRTL) (Scalia, J., concurring in part and\nconcurring in judgment). We agree with that conclusion and hold that stare decisis does not compel the\ncontinued acceptance of Austin. The Government may regulate corporate political speech through\ndisclaimer and disclosure requirements, but it may not suppress that speech altogether. We turn to the\ncase now before us.\n\nI\nA\nCitizens United is a nonprofit corporation. It has an annual budget of about $12 million. Most of its funds\nare from donations by individuals; but, in addition, it accepts a small portion of its funds from for-profit\ncorporations.\nIn January 2008, Citizens United released a film entitled Hillary: The Movie. We refer to the film\nas Hillary. It is a 90-minute documentary about then-Senator Hillary Clinton, who was a candidate in the\nDemocratic Party\xe2\x80\x99s 2008 Presidential primary elections. Hillary mentions Senator Clinton by name and\ndepicts interviews with political commentators and other persons, most of them quite critical of Senator\nClinton.\xe2\x80\xa6\nIn December 2007, a cable company offered, for a payment of $1.2 million, to make Hillary available on a\nvideo-on-demand channel called \xe2\x80\x9cElections \xe2\x80\x9908.\xe2\x80\x9d\xe2\x80\xa6Citizens United was prepared to pay for the video-ondemand; and to promote the film, it produced two 10-second ads and one 30-second ad for Hillary. Each\nad includes a short (and, in our view, pejorative) statement about Senator Clinton, followed by the name\nof the movie and the movie\xe2\x80\x99s Website address. Citizens United desired to promote the video-on-demand\noffering by running advertisements on broadcast and cable television.\n\nB\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n167\n\n\x0cBefore the Bipartisan Campaign Reform Act of 2002 (BCRA), federal law prohibited\xe2\x80\x94and still does\nprohibit\xe2\x80\x94corporations and unions from using general treasury funds to make direct contributions to\ncandidates or independent expenditures that expressly advocate the election or defeat of a candidate,\nthrough any form of media, in connection with certain qualified federal elections.\xe2\x80\xa6BCRA \xc2\xa7203 amended\n\xc2\xa7441b to prohibit any \xe2\x80\x9celectioneering communication\xe2\x80\x9d as well. An electioneering communication is\ndefined as \xe2\x80\x9cany broadcast, cable, or satellite communication\xe2\x80\x9d that \xe2\x80\x9crefers to a clearly identified candidate\nfor Federal office\xe2\x80\x9d and is made within 30 days of a primary or 60 days of a general election. \xc2\xa7434(f)(3)(A).\nThe Federal Election Commission\xe2\x80\x99s (FEC) regulations further define an electioneering communication as\na communication that is \xe2\x80\x9cpublicly distributed.\xe2\x80\x9d 11 CFR \xc2\xa7100.29(a)(2) (2009). \xe2\x80\x9cIn the case of a candidate\nfor nomination for President\xe2\x80\xa6publicly distributed means\xe2\x80\x9d that the communication \xe2\x80\x9c[c]an be received by\n50,000 or more persons in a State where a primary election\xe2\x80\xa6is being held within 30 days.\xe2\x80\x9d 11 CFR\n\xc2\xa7100.29(b)(3)(ii). Corporations and unions are barred from using their general treasury funds for express\nadvocacy or electioneering communications. They may establish, however, a \xe2\x80\x9cseparate segregated fund\xe2\x80\x9d\n(known as a political action committee, or PAC) for these purposes. 2 U.S.C. \xc2\xa7441b(b)(2). The moneys\nreceived by the segregated fund are limited to donations from stockholders and employees of the\ncorporation or, in the case of unions, members of the union. Ibid.\n\nC\nCitizens United wanted to make Hillary available through video-on-demand within 30 days of the 2008\nprimary elections. It feared, however, that both the film and the ads would be covered by \xc2\xa7441b\xe2\x80\x99s ban on\ncorporate-funded independent expenditures, thus subjecting the corporation to civil and criminal\npenalties under \xc2\xa7437g. In December 2007, Citizens United sought declaratory and injunctive relief against\nthe FEC. It argued that (1) \xc2\xa7441b is unconstitutional as applied to Hillary; and (2) BCRA\xe2\x80\x99s disclaimer and\ndisclosure requirements, BCRA \xc2\xa7\xc2\xa7201 and 311, are unconstitutional as applied to Hillary and to the three\nads for the movie.\nThe District Court denied Citizens United\xe2\x80\x99s motion for a preliminary injunction, and then granted the\nFEC\xe2\x80\x99s motion for summary judgment.\n\xe2\x80\xa6\nThe court held that \xc2\xa7441b was facially constitutional under McConnell, and that \xc2\xa7441b was constitutional\nas applied to Hillary because it was \xe2\x80\x9csusceptible of no other interpretation than to inform the electorate\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n168\n\n\x0cthat Senator Clinton is unfit for office, that the United States would be a dangerous place in a President\nHillary Clinton world, and that viewers should vote against her.\xe2\x80\x9d 530 F. Supp. 2d, at 279. The court also\nrejected Citizens United\xe2\x80\x99s challenge to BCRA\xe2\x80\x99s disclaimer and disclosure requirements. It noted that \xe2\x80\x9cthe\nSupreme Court has written approvingly of disclosure provisions triggered by political speech even though\nthe speech itself was constitutionally protected under the First Amendment.\xe2\x80\x9d Id. at 281.\n\nII\n[Omitted: the court considers whether it is possible to reject the BCRA without declaring certain\nprovisions unconstitutional. The court concludes it cannot find a basis to reject the BCRA that does not\ninvolve constitutional issues.]\n\nIII\nThe First Amendment provides that \xe2\x80\x9cCongress shall make no law\xe2\x80\xa6abridging the freedom of speech.\xe2\x80\x9d\nLaws enacted to control or suppress speech may operate at different points in the speech process.\xe2\x80\xa6The\nlaw before us is an outright ban, backed by criminal sanctions. Section 441b makes it a felony for all\ncorporations\xe2\x80\x94including nonprofit advocacy corporations\xe2\x80\x94either to expressly advocate the election or\ndefeat of candidates or to broadcast electioneering communications within 30 days of a primary election\nand 60 days of a general election. Thus, the following acts would all be felonies under \xc2\xa7441b: The Sierra\nClub runs an ad, within the crucial phase of 60 days before the general election, that exhorts the public to\ndisapprove of a Congressman who favors logging in national forests; the National Rifle Association\npublishes a book urging the public to vote for the challenger because the incumbent U.S. Senator supports\na handgun ban; and the American Civil Liberties Union creates a Web site telling the public to vote for a\nPresidential candidate in light of that candidate\xe2\x80\x99s defense of free speech. These prohibitions are classic\nexamples of censorship.\nSection 441b is a ban on corporate speech notwithstanding the fact that a PAC created by a corporation\ncan still speak. PACs are burdensome alternatives; they are expensive to administer and subject to\nextensive regulations. For example, every PAC must appoint a treasurer, forward donations to the\ntreasurer promptly, keep detailed records of the identities of the persons making donations, preserve\nreceipts for three years, and file an organization statement and report changes to this information within\n10 days.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n169\n\n\x0cAnd that is just the beginning. PACs must file detailed monthly reports with the FEC, which are due at\ndifferent times depending on the type of election that is about to occur.\xe2\x80\xa6\nPACs have to comply with these regulations just to speak. This might explain why fewer than 2,000 of the\nmillions of corporations in this country have PACs. PACs, furthermore, must exist before they can speak.\nGiven the onerous restrictions, a corporation may not be able to establish a PAC in time to make its views\nknown regarding candidates and issues in a current campaign.\nSection 441b\xe2\x80\x99s prohibition on corporate independent expenditures is thus a ban on speech. As a\n\xe2\x80\x9crestriction on the amount of money a person or group can spend on political communication during a\ncampaign,\xe2\x80\x9d that statute \xe2\x80\x9cnecessarily reduces the quantity of expression by restricting the number of issues\ndiscussed, the depth of their exploration, and the size of the audience reached.\xe2\x80\x9d Buckley v. Valeo, 424 U.S.\n1 at 19 (1976).\xe2\x80\xa6\nSpeech is an essential mechanism of democracy, for it is the means to hold officials accountable to the\npeople. See Buckley, supra, at 14\xe2\x80\x9315 (\xe2\x80\x9cIn a republic where the people are sovereign, the ability of the\ncitizenry to make informed choices among candidates for office is essential.\xe2\x80\x9d) The right of citizens to\ninquire, to hear, to speak, and to use information to reach consensus is a precondition to enlightened selfgovernment and a necessary means to protect it. The First Amendment \xe2\x80\x9c\xe2\x80\x98has its fullest and most urgent\napplication\xe2\x80\x99 to speech uttered during a campaign for political office.\xe2\x80\x9d\nFor these reasons, political speech must prevail against laws that would suppress it, whether by design or\ninadvertence. Laws that burden political speech are \xe2\x80\x9csubject to strict scrutiny,\xe2\x80\x9d which requires the\nGovernment to prove that the restriction \xe2\x80\x9cfurthers a compelling interest and is narrowly tailored to\nachieve that interest.\xe2\x80\x9d\n\xe2\x80\xa6\nThe Court has recognized that First Amendment protection extends to corporations. This protection has\nbeen extended by explicit holdings to the context of political speech. Under the rationale of these\nprecedents, political speech does not lose First Amendment protection \xe2\x80\x9csimply because its source is a\ncorporation.\xe2\x80\x9d Bellotti, supra, at 784. The Court has thus rejected the argument that political speech of\ncorporations or other associations should be treated differently under the First Amendment simply\nbecause such associations are not \xe2\x80\x9cnatural persons.\xe2\x80\x9d\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n170\n\n\x0cThe purpose and effect of this law is to prevent corporations, including small and nonprofit corporations,\nfrom presenting both facts and opinions to the public. This makes Austin\xe2\x80\x99s antidistortion rationale all the\nmore an aberration. \xe2\x80\x9c[T]he First Amendment protects the right of corporations to petition legislative and\nadministrative bodies.\xe2\x80\x9d Bellotti, 435 U.S., at 792, n. 31.\xe2\x80\xa6\nEven if \xc2\xa7441b\xe2\x80\x99s expenditure ban were constitutional, wealthy corporations could still lobby elected\nofficials, although smaller corporations may not have the resources to do so. And wealthy individuals and\nunincorporated associations can spend unlimited amounts on independent expenditures. See, e.g., WRTL,\n551 U.S., at 503\xe2\x80\x93504 (opinion of Scalia, J.) (\xe2\x80\x9cIn the 2004 election cycle, a mere 24 individuals contributed\nan astounding total of $142 million to [26 U.S.C. \xc2\xa7527 organizations]\xe2\x80\x9d). Yet certain disfavored\nassociations of citizens\xe2\x80\x94those that have taken on the corporate form\xe2\x80\x94are penalized for engaging in the\nsame political speech.\nWhen Government seeks to use its full power, including the criminal law, to command where a person\nmay get his or her information or what distrusted source he or she may not hear, it uses censorship to\ncontrol thought. This is unlawful. The First Amendment confirms the freedom to think for ourselves.\nWhat we have said also shows the invalidity of other arguments made by the Government. For the most\npart relinquishing the anti-distortion rationale, the Government falls back on the argument that corporate\npolitical speech can be banned in order to prevent corruption or its appearance.\xe2\x80\xa6\nWhen Congress finds that a problem exists, we must give that finding due deference; but Congress may\nnot choose an unconstitutional remedy. If elected officials succumb to improper influences from\nindependent expenditures; if they surrender their best judgment; and if they put expediency before\nprinciple, then surely there is cause for concern. We must give weight to attempts by Congress to seek to\ndispel either the appearance or the reality of these influences. The remedies enacted by law, however,\nmust comply with the First Amendment; and, it is our law and our tradition that more speech, not less, is\nthe governing rule. An outright ban on corporate political speech during the critical preelection period is\nnot a permissible remedy. Here Congress has created categorical bans on speech that are asymmetrical to\npreventing quid pro quo corruption.\nOur precedent is to be respected unless the most convincing of reasons demonstrates that adherence to it\nputs us on a course that is sure error. \xe2\x80\x9cBeyond workability, the relevant factors in deciding whether to\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n171\n\n\x0cadhere to the principle of stare decisis include the antiquity of the precedent, the reliance interests at\nstake, and of course whether the decision was well reasoned.\xe2\x80\x9d [citing prior cases]\nThese considerations counsel in favor of rejecting Austin, which itself contravened this Court\xe2\x80\x99s earlier\nprecedents in Buckley and Bellotti. \xe2\x80\x9cThis Court has not hesitated to overrule decisions offensive to the\nFirst Amendment.\xe2\x80\x9dWRTL, 551 U.S., at 500 (opinion of Scalia, J.). \xe2\x80\x9c[S]tare decisis is a principle of policy\nand not a mechanical formula of adherence to the latest decision.\xe2\x80\x9dHelvering v. Hallock, 309 U.S. 106 at\n119 (1940).\nAustin is undermined by experience since its announcement. Political speech is so ingrained in our\nculture that speakers find ways to circumvent campaign finance laws. See, e.g., McConnell, 540 U.S., at\n176\xe2\x80\x93177 (\xe2\x80\x9cGiven BCRA\xe2\x80\x99s tighter restrictions on the raising and spending of soft money, the incentives\xe2\x80\xa6to\nexploit [26 U.S.C. \xc2\xa7527] organizations will only increase\xe2\x80\x9d). Our Nation\xe2\x80\x99s speech dynamic is changing, and\ninformative voices should not have to circumvent onerous restrictions to exercise their First Amendment\nrights. Speakers have become adept at presenting citizens with sound bites, talking points, and scripted\nmessages that dominate the 24-hour news cycle. Corporations, like individuals, do not have monolithic\nviews. On certain topics corporations may possess valuable expertise, leaving them the best equipped to\npoint out errors or fallacies in speech of all sorts, including the speech of candidates and elected officials.\nRapid changes in technology\xe2\x80\x94and the creative dynamic inherent in the concept of free expression\xe2\x80\x94\ncounsel against upholding a law that restricts political speech in certain media or by certain speakers.\nToday, 30-second television ads may be the most effective way to convey a political message. Soon,\nhowever, it may be that Internet sources, such as blogs and social networking Web sites, will provide\ncitizens with significant information about political candidates and issues. Yet, \xc2\xa7441b would seem to ban a\nblog post expressly advocating the election or defeat of a candidate if that blog were created with\ncorporate funds. The First Amendment does not permit Congress to make these categorical distinctions\nbased on the corporate identity of the speaker and the content of the political speech.\nDue consideration leads to this conclusion: Austin should be and now is overruled. We return to the\nprinciple established in Buckley and Bellotti that the Government may not suppress political speech on\nthe basis of the speaker\xe2\x80\x99s corporate identity. No sufficient governmental interest justifies limits on the\npolitical speech of nonprofit or for-profit corporations.\n\n[IV. Omitted]\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n172\n\n\x0cV\nWhen word concerning the plot of the movie Mr. Smith Goes to Washington reached the circles of\nGovernment, some officials sought, by persuasion, to discourage its distribution. See Smoodin,\n\xe2\x80\x9cCompulsory\xe2\x80\x9d Viewing for Every Citizen: Mr. Smith and the Rhetoric of Reception, 35 Cinema Journal 3,\n19, and n. 52 (Winter 1996) (citing Mr. Smith Riles Washington, Time, Oct. 30, 1939, p. 49); Nugent,\nCapra\xe2\x80\x99s Capitol Offense, N. Y. Times, Oct. 29, 1939, p. X5. Under Austin, though, officials could have done\nmore than discourage its distribution\xe2\x80\x94they could have banned the film. After all, it, like Hillary, was\nspeech funded by a corporation that was critical of Members of Congress. Mr. Smith Goes to\nWashington may be fiction and caricature; but fiction and caricature can be a powerful force.\nModern day movies, television comedies, or skits on YouTube.com might portray public officials or public\npolicies in unflattering ways. Yet if a covered transmission during the blackout period creates the\nbackground for candidate endorsement or opposition, a felony occurs solely because a corporation, other\nthan an exempt media corporation, has made the \xe2\x80\x9cpurchase, payment, distribution, loan, advance,\ndeposit, or gift of money or anything of value\xe2\x80\x9d in order to engage in political speech. 2 U.S.C.\n\xc2\xa7431(9)(A)(i). Speech would be suppressed in the realm where its necessity is most evident: in the public\ndialogue preceding a real election. Governments are often hostile to speech, but under our law and our\ntradition it seems stranger than fiction for our Government to make this political speech a crime. Yet this\nis the statute\xe2\x80\x99s purpose and design.\nSome members of the public might consider Hillary to be insightful and instructive; some might find it to\nbe neither high art nor a fair discussion on how to set the Nation\xe2\x80\x99s course; still others simply might\nsuspend judgment on these points but decide to think more about issues and candidates. Those choices\nand assessments, however, are not for the Government to make. \xe2\x80\x9cThe First Amendment underwrites the\nfreedom to experiment and to create in the realm of thought and speech. Citizens must be free to use new\nforms, and new forums, for the expression of ideas. The civic discourse belongs to the people, and the\nGovernment may not prescribe the means used to conduct it.\xe2\x80\x9d McConnell, supra, at 341 (opinion of\nKennedy, J.).\nThe judgment of the District Court is reversed with respect to the constitutionality of 2 U.S.C. \xc2\xa7441b\xe2\x80\x99s\nrestrictions on corporate independent expenditures. The case is remanded for further proceedings\nconsistent with this opinion.\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n173\n\n\x0cIt is so ordered.\n\n1.\n\nCASE QUESTIONS\n\nWhat does the case say about disclosure? Corporations have a right of free speech under the First\nAmendment and may exercise that right through unrestricted contributions of money to political parties\nand candidates. Can the government condition that right by requiring that the parties and candidates\ndisclose to the public the amount and origin of the contribution? What would justify such a disclosure\nrequirement?\n\n2.\n\nAre a corporation\xe2\x80\x99s contributions to political parties and candidates tax deductible as a business expense?\nShould they be?\n\n3.\n\nHow is the donation of money equivalent to speech? Is this a strict construction of the Constitution to\nhold that it is?\n\n4.\n\nBased on the Court\xe2\x80\x99s description of the Austin case, what purpose do you think the Austin court was\ntrying to achieve by limiting corporate campaign contributions? Was that purpose consistent (or\ninconsistent) with anything in the Constitution, or is the Constitution essentially silent on this issue?\n\n4.7 Summary and Exercises\nSummary\n\nThe US. Constitution sets the framework for all other laws of the United States, at both the federal and the\nstate level. It creates a shared balance of power between states and the federal government (federalism)\nand shared power among the branches of government (separation of powers), establishes individual rights\nagainst governmental action (Bill of Rights), and provides for federal oversight of matters affecting\ninterstate commerce and commerce with foreign nations. Knowing the contours of the US legal system is\nnot possible without understanding the role of the US Constitution.\nThe Constitution is difficult to amend. Thus when the Supreme Court uses its power of judicial review to\ndetermine that a law is unconstitutional, it actually shapes what the Constitution means. New meanings\nthat emerge must do so by the process of amendment or by the passage of time and new appointments to\nthe court. Because justices serve for life, the court changes its philosophical outlook slowly.\nThe Bill of Rights is an especially important piece of the Constitutional framework. It provides legal\ncauses of action for infringements of individual rights by government, state or federal. Through the due\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n174\n\n\x0cprocess clause of the Fifth Amendment and the Fourteenth Amendment, both procedural and (to some\nextent) substantive due process rights are given to individuals.\n\nEXERCISES\n\n1.\n\nFor many years, the Supreme Court believed that \xe2\x80\x9ccommercial speech\xe2\x80\x9d was entitled to less\nprotection than other forms of speech. One defining element of commercial speech is that its\ndominant theme is to propose a commercial transaction. This kind of speech is protected by the\nFirst Amendment, but the government is permitted to regulate it more closely than other forms of\nspeech. However, the government must make reasonable distinctions, must narrowly tailor the\nrules restricting commercial speech, and must show that government has a legitimate goal that\nthe law furthers.\nEdward Salib owned a Winchell\xe2\x80\x99s Donut House in Mesa, Arizona. To attract customers, he\ndisplayed large signs in store windows. The city ordered him to remove the signs because they\nviolated the city\xe2\x80\x99s sign code, which prohibited covering more than 30 percent of a store\xe2\x80\x99s windows\nwith signs. Salib sued, claiming that the sign code violated his First Amendment rights. What was\nthe result, and why?\n\n2.\n\nJennifer is a freshman at her local public high school. Her sister, Jackie, attends a nearby private high\nschool. Neither school allows them to join its respective wrestling team; only boys can wrestle at either\nschool. Do either of them have a winning case based on the equal protection clause of the Fourteenth\nAmendment?\n\n3.\n\nThe employees of the US Treasury Department that work the border crossing between the United States\nand Mexico learned that they will be subject to routine drug testing. The customs bureau, which is a\ndivision of the treasury department, announces this policy along with its reasoning: since customs agents\nmust routinely search for drugs coming into the United States, it makes sense that border guards must\nthemselves be completely drug-free. Many border guards do not use drugs, have no intention of using\ndrugs, and object to the invasion of their privacy. What is the constitutional basis for their objection?\n\n4.\n\nHappy Time Chevrolet employs Jim Bydalek as a salesman. Bydalek takes part in a Gay Pride March in Los\nAngeles, is interviewed by a local news camera crew, and reports that he is gay and proud of it. His\nemployer is not, and he is fired. Does he have any constitutional causes of action against his employer?\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n175\n\n\x0c5.\n\nYou begin work at the Happy-Go-Lucky Corporation on Halloween. On your second day at work, you wear\na political button on your coat, supporting your choice for US senator in the upcoming election. Your boss,\nwho is of a different political persuasion, looks at the button and says, \xe2\x80\x9cTake that stupid button off or\nyou\xe2\x80\x99re fired.\xe2\x80\x9d Has your boss violated your constitutional rights?\n\n6.\n\nDavid Lucas paid $975,000 for two residential parcels on the Isle of Palms near Charleston, South\nCarolina. His intention was to build houses on them. Two years later, the South Carolina legislature\npassed a statute that prohibited building beachfront properties. The purpose was to leave the dunes\nsystem in place to mitigate the effects of hurricanes and strong storms. The South Carolina Coastal\nCommission created the rules and regulations with substantial input from the community and from\nexperts and with protection of the dune system primarily in mind. People had been building on the\nshoreline for years, with harmful results to localities and the state treasury. When Lucas applied for\npermits to build two houses near the shoreline, his permits were rejected. He sued, arguing that the\nSouth Carolina legislation had effectively \xe2\x80\x9ctaken\xe2\x80\x9d his property. At trial, South Carolina conceded that\nbecause of the legislation, Lucas\xe2\x80\x99s property was effectively worth zero. Has there been a taking under the\nFifth Amendment (as incorporated through the Fourteenth Amendment), and if so, what should the state\nowe to Lucas? Suppose that Lucas could have made an additional $1 million by building a house on each\nof his parcels. Is he entitled to recover his original purchase price or his potential profits?\n\nSELF-TEST QUESTIONS\n\n1.\n\nHarvey filed a suit against the state of Colorado, claiming that a Colorado state law violates the\ncommerce clause. The court will agree if the statute\n\na.\n\nplaces an undue burden on interstate commerce\nb.\n\npromotes the public health, safety, morals, or general welfare of Colorado\n\nc.\n\nregulates economic activities within the state\xe2\x80\x99s borders\n\nd.\n\na and b\n\ne.\n\nb and c\n\nThe state legislature in Maine enacts a law that directly conflicts with a federal law. Mapco\nIndustries, located in Portland, Maine, cannot comply with both the state and the federal law.\na.\n\nBecause of federalism, the state law will have priority, as long as Maine is using its police\n\npowers.\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n176\n\n\x0cb.\n\nBecause there\xe2\x80\x99s a conflict, both laws are invalid; the state and the federal government\nwill have to work out a compromise of some sort.\n\nc.\n\nThe federal law preempts the state law.\n\nd.\n\nBoth laws govern concurrently.\n\nHannah, who lives in Ada, is the owner of Superior Enterprises, Inc. She believes that certain\nactions in the state of Ohio infringe on her federal constitutional rights, especially those found in\nthe Bill of Rights. Most of these rights apply to the states under\na.\n\nthe supremacy clause\nb.\n\nthe protection clause\n\nc.\n\nthe due process clause of the Fourteenth Amendment\n\nd.\n\nthe Tenth Amendment\n\nMinnesota enacts a statute that bans all advertising that is in \xe2\x80\x9cbad taste,\xe2\x80\x9d \xe2\x80\x9cvulgar,\xe2\x80\x9d or\n\xe2\x80\x9cindecent.\xe2\x80\x9d In Michigan, Aaron Calloway and his brother, Clarence \xe2\x80\x9cCab\xe2\x80\x9d Calloway, create unique\nbeer that they decide to call Old Fart Ale. In their marketing, the brothers have a label in which an\nolder man in a dirty T-shirt is sitting in easy chair, looking disheveled and having a three-day\ngrowth of stubble on his chin. It appears that the man is in the process of belching. He is also\nholding a can of Old Fart Ale. The Minnesota liquor commission orders all Minnesota restaurants,\nbars, and grocery stores to remove Old Fart Ale from their shelves. The state statute and the\ncommission\xe2\x80\x99s order are likely to be held by a court to be\na.\n\na violation of the Tenth Amendment\nb.\n\na violation of the First Amendment\n\nc.\n\na violation of the Calloways\xe2\x80\x99 right to equal protection of the laws\n\nd.\n\na violation of the commerce clause, since only the federal laws can prevent an article of\ncommerce from entering into Minnesota\xe2\x80\x99s market\n\nRaunch Unlimited, a Virginia partnership, sells smut whenever and wherever it can. Some of its\nmaterial is \xe2\x80\x9cobscene\xe2\x80\x9d (meeting the Supreme Court\xe2\x80\x99s definition under Miller v. California) and\nincludes child pornography. North Carolina has a statute that criminalizes obscenity. What are\npossible results if a store in Raleigh, North Carolina, carries Raunch merchandise?\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n177\n\n\x0ca.\n\nThe partners could be arrested in North Carolina and may well be convicted.\nb.\n\nThe materials in Raleigh may be the basis for a criminal conviction.\n\nc.\n\nThe materials are protected under the First Amendment\xe2\x80\x99s right of free speech.\n\nd.\n\nThe materials are protected under state law.\n\ne.\n\na and b\n\n1.\n\na\n\n2.\n\nc\n\n3.\n\nc\n\n4.\n\nb\n\n5.\n\ne\n\nSELF-TEST ANSWERS\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n178\n\n\x0cChapter 5\n\nAdministrative Law\nLEARNING OBJECTIVES\nAfter reading this chapter, you should be able to do the following:\n1.\n\nUnderstand the purpose served by federal administrative agencies.\n\n2.\n\nKnow the difference between executive branch agencies and independent agencies.\n\n3.\n\nUnderstand the political control of agencies by the president and Congress.\n\n4.\n\nDescribe how agencies make rules and conduct hearings.\n\n5.\n\nDescribe how courts can be used to challenge administrative rulings.\n\nFrom the 1930s on, administrative agencies, law, and procedures have virtually remade our\ngovernment and much of private life. Every day, business must deal with rules and decisions of state\nand federal administrative agencies. Informally, such rules are often called regulations, and they\ndiffer (only in their source) from laws passed by Congress and signed into law by the president. The\nrules created by agencies are voluminous: thousands of new regulations pour forth each year. The\noverarching question of whether there is too much regulation\xe2\x80\x94or the wrong kind of regulation\xe2\x80\x94of\nour economic activities is an important one but well beyond the scope of this chapter, in which we\noffer an overview of the purpose of administrative agencies, their structure, and their impact on\nbusiness.\n\n5.1 Administrative Agencies: Their Structure and Powers\nLEARNING OBJECTIVES\n\n1.\n\nExplain the reasons why we have federal administrative agencies.\n\n2.\n\nExplain the difference between executive branch agencies and independent agencies.\n\n3.\n\nDescribe the constitutional issue that questions whether administrative agencies could have authority to\nmake enforceable rules that affect business.\n\nWhy Have Administrative Agencies?\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n179\n\n\x0cThe US Constitution mentions only three branches of government: legislative, executive, and judicial\n(Articles I, II, and III). There is no mention of agencies in the Constitution, even though federal agencies\nare sometimes referred to as \xe2\x80\x9cthe fourth branch of government.\xe2\x80\x9d The Supreme Court has recognized the\nlegitimacy of federal administrative agencies to make rules that have the same binding effect as statutes\nby Congress.\nMost commentators note that having agencies with rule-making power is a practical necessity: (1)\nCongress does not have the expertise or continuity to develop specialized knowledge in various areas (e.g.,\ncommunications, the environment, aviation). (2) Because of this, it makes sense for Congress to set forth\nbroad statutory guidance to an agency and delegate authority to the agency to propose rules that further\nthe statutory purposes. (3) As long as Congress makes this delegating guidance sufficiently clear, it is not\ndelegating improperly. If Congress\xe2\x80\x99s guidelines are too vague or undefined, it is (in essence) giving away\nits constitutional power to some other group, and this it cannot do.\n\nWhy Regulate the Economy at All?\nThe market often does not work properly, as economists often note. Monopolies, for example, happen in\nthe natural course of human events but are not always desirable. To fix this, well-conceived and\nobjectively enforced competition law (what is called antitrust law in the United States) is needed.\nNegative externalities must be \xe2\x80\x9cfixed,\xe2\x80\x9d as well. For example, as we see in tort law (Chapter 7 "Introduction\nto Tort Law"), people and business organizations often do things that impose costs (damages) on others,\nand the legal system will try\xe2\x80\x94through the award of compensatory damages\xe2\x80\x94to make fair adjustments. In\nterms of the ideal conditions for a free market, think of tort law as the legal system\xe2\x80\x99s attempt to\ncompensate for negative externalities: those costs imposed on people who have not voluntarily consented\nto bear those costs.\nIn terms of freedoms to enter or leave the market, the US constitutional guarantees of equal protection\ncan prevent local, state, and federal governments from imposing discriminatory rules for commerce that\nwould keep minorities, women, and gay people from full participation in business. For example, if the\nsmall town of Xenophobia, Colorado, passed a law that required all business owners and their employees\nto be Christian, heterosexual, and married, the equal protection clause (as well as numerous state and\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n180\n\n\x0cfederal equal opportunity employment laws) would empower plaintiffs to go to court and have the law\nstruck down as unconstitutional.\nKnowing that information is power, we will see many laws administered by regulatory agencies that seek\nto level the playing field of economic competition by requiring disclosure of the most pertinent\ninformation for consumers (consumer protection laws), investors (securities laws), and citizens (e.g., the\ntoxics release inventory laws in environmental law).\n\nIdeal Conditions for a Free Market\n1.\n\nThere are many buyers and many sellers, and none of them has a substantial share of the market.\n\n2. All buyers and sellers in the market are free to enter the market or leave it.\n3. All buyers and all sellers have full and perfect knowledge of what other buyers and sellers are up to,\nincluding knowledge of prices, quantity, and quality of all goods being bought or sold.\n4. The goods being sold in the market are similar enough to each other that participants do not have\nstrong preferences as to which seller or buyer they deal with.\n5.\n\nThe costs and benefits of making or using the goods that are exchanged in the market are borne only\nby those who buy or sell those goods and not by third parties or people \xe2\x80\x9cexternal\xe2\x80\x9d to the market\ntransaction. (That is, there are no \xe2\x80\x9cexternalities.\xe2\x80\x9d)\n\n6. All buyers and sellers are utility maximizers; each participant in the market tries to get as much as\npossible for as little as possible.\n7.\n\nThere are no parties, institutions, or governmental units regulating the price, quantity, or quality of\nany of the goods being bought and sold in the market.\n\nIn short, some forms of legislation and regulation are needed to counter a tendency toward consolidation\nof economic power (Chapter 28 "Antitrust Law") and discriminatory attitudes toward certain individuals\nand groups (Chapter 30 "Employment Law") and to insist that people and companies clean up their own\nmesses and not hide information that would empower voluntary choices in the free market.\nBut there are additional reasons to regulate. For example, in economic systems, it is likely for natural\nmonopolies to occur. These are where one firm can most efficiently supply all of the good or service.\nHaving duplicate (or triplicate) systems for supplying electricity, for example, would be inefficient, so\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n181\n\n\x0cmost states have a public utilities commission to determine both price and quality of service. This is direct\nregulation.\nSometimes destructive competition can result if there is no regulation. Banking and insurance are good\nexamples of this. Without government regulation of banks (setting standards and methods), open and\nfierce competition would result in widespread bank failures. That would erode public confidence in banks\nand business generally. The current situation (circa 2011) of six major banks that are \xe2\x80\x9ctoo big to fail\xe2\x80\x9d is,\nhowever, an example of destructive noncompetition.\nOther market imperfections can yield a demand for regulation. For example, there is a need to regulate\nfrequencies for public broadcast on radio, television, and other wireless transmissions (for police, fire,\nnational defense, etc.). Many economists would also list an adequate supply of public goods as something\nthat must be created by government. On its own, for example, the market would not provide public goods\nsuch as education, a highway system, lighthouses, a military for defense.\nTrue laissez-faire capitalism\xe2\x80\x94a market free from any regulation\xe2\x80\x94would not try to deal with market\nimperfections and would also allow people to freely choose products, services, and other arrangements\nthat historically have been deemed socially unacceptable. These would include making enforceable\ncontracts for the sale and purchase of persons (slavery), sexual services, \xe2\x80\x9cstreet drugs\xe2\x80\x9d such as heroin or\ncrack cocaine, votes for public office, grades for this course in business law, and even marriage\npartnership.\nThus the free market in actual terms\xe2\x80\x94and not in theory\xe2\x80\x94consists of commerce legally constrained by\nwhat is economically desirable and by what is socially desirable as well. Public policy objectives in the\nsocial arena include ensuring equal opportunity in employment, protecting employees from unhealthy or\nunsafe work environments, preserving environmental quality and resources, and protecting consumers\nfrom unsafe products. Sometimes these objectives are met by giving individuals statutory rights that can\nbe used in bringing a complaint (e.g., Title VII of the Civil Rights Act of 1964, for employment\ndiscrimination), and sometimes they are met by creating agencies with the right to investigate and\nmonitor and enforce statutory law and regulations created to enforce such law (e.g., the Environmental\nProtection Agency, for bringing a lawsuit against a polluting company).\n\nHistory of Federal Agencies\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n182\n\n\x0cThrough the commerce clause in the US Constitution, Congress has the power to regulate trade between\nthe states and with foreign nations. The earliest federal agency therefore dealt with trucking and railroads,\nto literally set the rules of the road for interstate commerce. The first federal agency, the Interstate\nCommerce Commission (ICC), was created in 1887. Congress delegated to the ICC the power to enforce\nfederal laws against railroad rate discrimination and other unfair pricing practices. By the early part of\nthis century, the ICC gained the power to fix rates. From the 1970s through 1995, however, Congress\npassed deregulatory measures, and the ICC was formally abolished in 1995, with its powers transferred to\nthe Surface Transportation Board.\nBeginning with the Federal Trade Commission (FTC) in 1914, Congress has created numerous other\nagencies, many of them familiar actors in American government. Today more than eighty-five federal\nagencies have jurisdiction to regulate some form of private activity. Most were created since 1930, and\nmore than a third since 1960. A similar growth has occurred at the state level. Most states now have\ndozens of regulatory agencies, many of them overlapping in function with the federal bodies.\n\nClassification of Agencies\nIndependent agencies are different from federal executive departments and other executive agencies by\ntheir structural and functional characteristics. Most executive departments have a single director,\nadministrator, or secretary appointed by the president of the United States. Independent agencies almost\nalways have a commission or board consisting of five to seven members who share power over the agency.\nThe president appoints the commissioners or board subject to Senate confirmation, but they often serve\nwith staggered terms and often for longer terms than a usual four-year presidential term. They cannot be\nremoved except for \xe2\x80\x9cgood cause.\xe2\x80\x9d This means that most presidents will not get to appoint all the\ncommissioners of a given independent agency. Most independent agencies have a statutory requirement\nof bipartisan membership on the commission, so the president cannot simply fill vacancies with members\nof his own political party.\nIn addition to the ICC and the FTC, the major independent agencies are the Federal Communications\nCommission (1934), Securities and Exchange Commission (1934), National Labor Relations Board (1935),\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n183\n\n\x0cand Environmental Protection Agency (1970). See Note 5.4 "Ideal Conditions for a Free Market" in the\nsidebar.\nBy contrast, members of executive branch agencies serve at the pleasure of the president and are therefore\nfar more amenable to political control. One consequence of this distinction is that the rules that\nindependent agencies promulgate may not be reviewed by the president or his staff\xe2\x80\x94only Congress may\ndirectly overrule them\xe2\x80\x94whereas the White House or officials in the various cabinet departments may\noversee the work of the agencies contained within them (unless specifically denied the power by\nCongress).\n\nPowers of Agencies\nAgencies have a variety of powers. Many of the original statutes that created them, like the Federal\nCommunications Act, gave them licensing power. No party can enter into the productive activity covered\nby the act without prior license from the agency\xe2\x80\x94for example, no utility can start up a nuclear power\nplant unless first approved by the Nuclear Regulatory Commission. In recent years, the move toward\nderegulation of the economy has led to diminution of some licensing power. Many agencies also have the\nauthority to set the rates charged by companies subject to the agency\xe2\x80\x99s jurisdiction. Finally, the agencies\ncan regulate business practices. The FTC has general jurisdiction over all business in interstate commerce\nto monitor and root out \xe2\x80\x9cunfair acts\xe2\x80\x9d and \xe2\x80\x9cdeceptive practices.\xe2\x80\x9d The Securities and Exchange Commission\n(SEC) oversees the issuance of corporate securities and other investments and monitors the practices of\nthe stock exchanges.\nUnlike courts, administrative agencies are charged with the responsibility of carrying out a specific\nassignment or reaching a goal or set of goals. They are not to remain neutral on the various issues of the\nday; they must act. They have been given legislative powers because in a society growing ever more\ncomplex, Congress does not know how to legislate with the kind of detail that is necessary, nor would it\nhave the time to approach all the sectors of society even if it tried. Precisely because they are to do what\ngeneral legislative bodies cannot do, agencies are specialized bodies. Through years of experience in\ndealing with similar problems they accumulate a body of knowledge that they can apply to accomplish\ntheir statutory duties.\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n184\n\n\x0cAll administrative agencies have two different sorts of personnel. The heads, whether a single\nadministrator or a collegial body of commissioners, are political appointees and serve for relatively\nlimited terms. Below them is a more or less permanent staff\xe2\x80\x94the bureaucracy. Much policy making\noccurs at the staff level, because these employees are in essential control of gathering facts and presenting\ndata and argument to the commissioners, who wield the ultimate power of the agencies.\n\nThe Constitution and Agencies\nCongress can establish an agency through legislation. When Congress gives powers to an agency, the\nlegislation is known as an enabling act. The concept that Congress can delegate power to an agency is\nknown as the delegation doctrine. Usually, the agency will have all three kinds of power: executive,\nlegislative, and judicial. (That is, the agency can set the rules that business must comply with, can\ninvestigate and prosecute those businesses, and can hold administrative hearings for violations of those\nrules. They are, in effect, rule maker, prosecutor, and judge.) Because agencies have all three types of\ngovernmental powers, important constitutional questions were asked when Congress first created them.\nThe most important question was whether Congress was giving away its legislative power. Was the\nseparation of powers violated if agencies had power to make rules that were equivalent to legislative\nstatutes?\nIn 1935, in Schechter Poultry Corp. v. United States, the Supreme Court overturned the National\nIndustrial Recovery Act on the ground that the congressional delegation of power was too broad.\n\n[1]\n\nUnder\n\nthe law, industry trade groups were granted the authority to devise a code of fair competition for the\nentire industry, and these codes became law if approved by the president. No administrative body was\ncreated to scrutinize the arguments for a particular code, to develop evidence, or to test one version of a\ncode against another. Thus it was unconstitutional for the Congress to transfer all of its legislative powers\nto an agency. In later decisions, it was made clear that Congress could delegate some of its legislative\npowers, but only if the delegation of authority was not overly broad.\nStill, some congressional enabling acts are very broad, such as the enabling legislation for the\nOccupational Safety and Health Administration (OSHA), which is given the authority to make rules to\nprovide for safe and healthful working conditions in US workplaces. Such a broad initiative power gives\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n185\n\n\x0cOSHA considerable discretion. But, as noted in Section 5.2 "Controlling Administrative Agencies", there\nare both executive and judicial controls over administrative agency activities, as well as ongoing control by\nCongress through funding and the continuing oversight of agencies, both in hearings and through\nsubsequent statutory amendments.\n\nKEY TAKEAWAY\n\nCongress creates administrative agencies through enabling acts. In these acts, Congress must delegate\nauthority by giving the agency some direction as to what it wants the agency to do. Agencies are usually\ngiven broad powers to investigate, set standards (promulgating regulations), and enforce those standards.\nMost agencies are executive branch agencies, but some are independent.\n\nEXERCISES\n\n1.\n\nExplain why Congress needs to delegate rule-making authority to a specialized agency.\n\n2.\n\nExplain why there is any need for interference in the market by means of laws or regulations.\n\n[1] Schechter Poultry Corp. v. United States, 295 US 495 (1935).\n\n5.2 Controlling Administrative Agencies\n\nLEARNING OBJECTIVES\n\n1.\n\nUnderstand how the president controls administrative agencies.\n\n2.\n\nUnderstand how Congress controls administrative agencies.\n\n3.\n\nUnderstand how the courts can control administrative agencies.\n\nDuring the course of the past seventy years, a substantial debate has been conducted, often in shrill\nterms, about the legitimacy of administrative lawmaking. One criticism is that agencies are\n\xe2\x80\x9ccaptured\xe2\x80\x9d by the industry they are directed to regulate. Another is that they overregulate, stifling\nindividual initiative and the ability to compete. During the 1960s and 1970s, a massive outpouring of\nfederal law created many new agencies and greatly strengthened the hands of existing ones. In the\nlate 1970s during the Carter administration, Congress began to deregulate American society, and\nderegulation increased under the Reagan administration. But the accounting frauds of WorldCom,\nEnron, and others led to the Sarbanes-Oxley Act of 2002, and the financial meltdown of 2008 has\nled to reregulation of the financial sector. It remains to be seen whether the Deepwater Horizon oil\nblowout of 2010 will lead to more environmental regulations or a rethinking on how to make\nagencies more effective regulators.\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n186\n\n\x0cAdministrative agencies are the focal point of controversy because they are policy-making bodies,\nincorporating facets of legislative, executive, and judicial power in a hybrid form that fits uneasily at\nbest in the framework of American government (see Figure 5.1 "Major Administrative Agencies of the\nUnited States"). They are necessarily at the center of tugging and hauling by the legislature, the\nexecutive branch, and the judiciary, each of which has different means of exercising political control\nover them. In early 1990, for example, the Bush administration approved a Food and Drug\nAdministration regulation that limited disease-prevention claims by food packagers, reversing a\nposition by the Reagan administration in 1987 permitting such claims.\nFigure 5.1 Major Administrative Agencies of the United States\n\nLegislative Control\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n187\n\n\x0cCongress can always pass a law repealing a regulation that an agency promulgates. Because this is a timeconsuming process that runs counter to the reason for creating administrative bodies, it happens rarely.\nAnother approach to controlling agencies is to reduce or threaten to reduce their appropriations. By\nretaining ultimate control of the purse strings, Congress can exercise considerable informal control over\nregulatory policy.\n\nExecutive Control\nThe president (or a governor, for state agencies) can exercise considerable control over agencies that are\npart of his cabinet departments and that are not statutorily defined as independent. Federal agencies,\nmoreover, are subject to the fiscal scrutiny of the Office of Management and Budget (OMB), subject to the\ndirect control of the president. Agencies are not permitted to go directly to Congress for increases in\nbudget; these requests must be submitted through the OMB, giving the president indirect leverage over\nthe continuation of administrators\xe2\x80\x99 programs and policies.\n\nJudicial Review of Agency Actions\nAdministrative agencies are creatures of law and like everyone else must obey the law. The courts have\njurisdiction to hear claims that the agencies have overstepped their legal authority or have acted in some\nunlawful manner.\nCourts are unlikely to overturn administrative actions, believing in general that the agencies are better\nsituated to judge their own jurisdiction and are experts in rulemaking for those matters delegated to them\nby Congress. Some agency activities are not reviewable, for a number of reasons. However, after a\nbusiness (or some other interested party) has exhausted all administrative remedies, it may seek judicial\nreview of a final agency decision. The reviewing court is often asked to strike down or modify agency\nactions on several possible bases (seeSection 5.5.2 "Strategies for Obtaining Judicial Review" on\n\xe2\x80\x9cStrategies for Obtaining Judicial Review\xe2\x80\x9d).\n\nKEY TAKEAWAY\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n188\n\n\x0cAdministrative agencies are given unusual powers: to legislate, investigate, and adjudicate. But these\npowers are limited by executive and legislative controls and by judicial review.\n\nEXERCISES\n\n1.\n\nFind the website of the Consumer Product Safety Commission (CPSC). Identify from that site a product\nthat has been banned by the CPSC for sale in the United States. What reasons were given for its exclusion\nfrom the US market?\n\n2.\n\nWhat has Congress told the CPSC to do in its enabling act? Is this a clear enough mandate to guide the\nagency? What could Congress do if the CPSC does something that may be outside of the scope of its\npowers? What can an affected business do?\n\n5.3 The Administrative Procedure Act\n\nLEARNING OBJECTIVES\n\n1.\n\nUnderstand why the Administrative Procedure Act was needed.\n\n2.\n\nUnderstand how hearings are conducted under the act.\n\n3.\n\nUnderstand how the act affects rulemaking by agencies.\n\nIn 1946, Congress enacted the Administrative Procedure Act (APA). This fundamental statute detailed\nfor all federal administrative agencies how they must function when they are deciding cases or\nissuing regulations, the two basic tasks of administration. At the state level, the Model State\nAdministrative Procedure Act, issued in 1946 and revised in 1961, has been adopted in twenty-eight\nstates and the District of Columbia; three states have adopted the 1981 revision. The other states\nhave statutes that resemble the model state act to some degree.\n\nTrial-Type Hearings\nDeciding cases is a major task of many agencies. For example, the Federal Trade Commission (FTC) is\nempowered to charge a company with having violated the Federal Trade Commission Act. Perhaps a seller\nis accused of making deceptive claims in its advertising. Proceeding in a manner similar to a court, staff\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n189\n\n\x0ccounsel will prepare a case against the company, which can defend itself through its lawyers. The case is\ntried before an administrative law judge (ALJ), formerly known as an administrative hearing examiner.\nThe change in nomenclature was made in 1972 to enhance the prestige of ALJs and more accurately\nreflect their duties. Although not appointed for life as federal judges are, the ALJ must be free of\nassignments inconsistent with the judicial function and is not subject to supervision by anyone in the\nagency who carries on an investigative or prosecutorial function.\nThe accused parties are entitled to receive notice of the issues to be raised, to present evidence, to argue,\nto cross-examine, and to appear with their lawyers. Ex parte (eks PAR-tay) communications\xe2\x80\x94contacts\nbetween the ALJ and outsiders or one party when both parties are not present\xe2\x80\x94are prohibited. However,\nthe usual burden-of-proof standard followed in a civil proceeding in court does not apply: the ALJ is not\nbound to decide in favor of that party producing the more persuasive evidence. The rule in most\nadministrative proceedings is \xe2\x80\x9csubstantial evidence,\xe2\x80\x9d evidence that is not flimsy or weak, but is not\nnecessarily overwhelming evidence, either. The ALJ in most cases will write an opinion. That opinion is\nnot the decision of the agency, which can be made only by the commissioners or agency head. In effect,\nthe ALJ\xe2\x80\x99s opinion is appealed to the commission itself.\nCertain types of agency actions that have a direct impact on individuals need not be filtered through a fullscale hearing. Safety and quality inspections (grading of food, inspection of airplanes) can be made on the\nspot by skilled inspectors. Certain licenses can be administered through tests without a hearing (a test for\na driver\xe2\x80\x99s license), and some decisions can be made by election of those affected (labor union elections).\n\nRulemaking\nTrial-type hearings generally impose on particular parties liabilities based on past or present facts.\nBecause these cases will serve as precedents, they are a partial guide to future conduct by others. But they\ndo not directly apply to nonparties, who may argue in a subsequent case that their conduct does not fit\nwithin the holding announced in the case. Agencies can affect future conduct far more directly by\nannouncing rules that apply to all who come within the agency\xe2\x80\x99s jurisdiction.\nThe acts creating most of the major federal agencies expressly grant them authority to engage in\nrulemaking. This means, in essence, authority to legislate. The outpouring of federal regulations has been\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n190\n\n\x0cimmense. The APA directs agencies about to engage in rulemaking to give notice in\nthe<em class="emphasis">Federal Register</em class="emphasis"> of their intent to do so. The Federal\nRegister is published daily, Monday through Friday, in Washington, DC, and contains notice of various\nactions, including announcements of proposed rulemaking and regulations as adopted. The notice must\nspecify the time, place, and nature of the rulemaking and offer a description of the proposed rule or the\nissues involved. Any interested person or organization is entitled to participate by submitting written\n\xe2\x80\x9cdata, views or arguments.\xe2\x80\x9d Agencies are not legally required to air debate over proposed rules, though\nthey often do so.\nThe procedure just described is known as \xe2\x80\x9cinformal\xe2\x80\x9d rulemaking. A different procedure is required for\n\xe2\x80\x9cformal\xe2\x80\x9d rulemaking, defined as those instances in which the enabling legislation directs an agency to\nmake rules \xe2\x80\x9con the record after opportunity for an agency hearing.\xe2\x80\x9d When engaging in formal rulemaking,\nagencies must hold an adversary hearing.\nAdministrative regulations are not legally binding unless they are published. Agencies must publish in\nthe Federal Register the text of final regulations, which ordinarily do not become effective until thirty\ndays later. Every year the annual output of regulations is collected and reprinted in\nthe<em class="emphasis">Code of Federal Regulations (CFR)</em class="emphasis">, a multivolume\npaperback series containing all federal rules and regulations keyed to the fifty titles of the US Code (the\ncompilation of all federal statutes enacted by Congress and grouped according to subject).\n\nKEY TAKEAWAY\n\nAgencies make rules that have the same effect as laws passed by Congress and the president. But such\nrules (regulations) must allow for full participation by interested parties. The Administrative Procedure Act\n(APA) governs both rulemaking and the agency enforcement of regulations, and it provides a process for\nfair hearings.\n\n1.\n\nEXERCISES\n\nGo to http://www.regulations.gov/search/Regs/home.html#home. Browse the site. Find a topic that\ninterests you, and then find a proposed regulation. Notice how comments on the proposed rule are\ninvited.\n\n2.\n\nWhy would there be a trial by an administrative agency? Describe the process.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n191\n\n\x0c5.4 Administrative Burdens on Business Operations\nLEARNING OBJECTIVES\n\n1.\n\nDescribe the paperwork burden imposed by administrative agencies.\n\n2.\n\nExplain why agencies have the power of investigation, and what limits there are to that power.\n\n3.\n\nExplain the need for the Freedom of Information Act and how it works in the US legal system.\n\nThe Paperwork Burden\nThe administrative process is not frictionless. The interplay between government agency and private\nenterprise can burden business operations in a number of ways. Several of these are noted in this section.\nDeciding whether and how to act are not decisions that government agencies reach out of the blue. They\nrely heavily on information garnered from business itself. Dozens of federal agencies require corporations\nto keep hundreds of types of records and to file numerous periodic reports. The Commission on Federal\nPaperwork, established during the Ford administration to consider ways of reducing the paperwork\nburden, estimated in its final report in 1977 that the total annual cost of federal paperwork amounted to\n$50 billion and that the 10,000 largest business enterprises spent $10 billion annually on paperwork\nalone. The paperwork involved in licensing a single nuclear power plant, the commission said, costs\nupward of $15 million.\nNot surprisingly, therefore, businesses have sought ways of avoiding requests for data. Since the 1940s,\nthe Federal Trade Commission (FTC) has collected economic data on corporate performance from\nindividual companies for statistical purposes. As long as each company engages in a single line of\nbusiness, data are comparable. When the era of conglomerates began in the 1970s, with widely divergent\ntypes of businesses brought together under the roof of a single corporate parent, the data became useless\nfor purposes of examining the competitive behavior of different industries. So the FTC ordered dozens of\nlarge companies to break out their economic information according to each line of business that they\ncarried on. The companies resisted, but the US Court of Appeals for the District of Columbia Circuit,\nwhere much of the litigation over federal administrative action is decided, directed the companies to\ncomply with the commission\xe2\x80\x99s order, holding that the Federal Trade Commission Act clearly permits the\nagency to collect information for investigatory purposes.\n\nSaylor URL: http://www.saylor.org/books\n\n[1]\n\nSaylor.org\n192\n\n\x0cIn 1980, responding to cries that businesses, individuals, and state and local governments were being\nswamped by federal demands for paperwork, Congress enacted the Paperwork Reduction Act. It gives\npower to the federal Office of Management and Budget (OMB) to develop uniform policies for\ncoordinating the gathering, storage, and transmission of all the millions of reports flowing in each year to\nthe scores of federal departments and agencies requesting information. These reports include tax and\nMedicare forms, financial loan and job applications, questionnaires of all sorts, compliance reports, and\ntax and business records. The OMB was given the power also to determine whether new kinds of\ninformation are needed. In effect, any agency that wants to collect new information from outside must\nobtain the OMB\xe2\x80\x99s approval.\n\nInspections\nNo one likes surprise inspections. A section of the Occupational Safety and Health Act of 1970 empowers\nagents of the Occupational Safety and Health Administration (OSHA) to search work areas for safety\nhazards and for violations of OSHA regulations. The act does not specify whether inspectors are required\nto obtain search warrants, required under the Fourth Amendment in criminal cases. For many years, the\ngovernment insisted that surprise inspections are not unreasonable and that the time required to obtain a\nwarrant would defeat the surprise element. The Supreme Court finally ruled squarely on the issue in 1978.\nIn Marshall v. Barlow\xe2\x80\x99s, Inc., the court held that no less than private individuals, businesses are entitled\nto refuse police demands to search the premises unless a court has issued a search warrant.\n\n[2]\n\nBut where a certain type of business is closely regulated, surprise inspections are the norm, and no\nwarrant is required. For example, businesses with liquor licenses that might sell to minors are subject to\nboth overt and covert inspections (e.g., an undercover officer may \xe2\x80\x9csearch\xe2\x80\x9d a liquor store by sending an\nunderage patron to the store). Or a junkyard that specializes in automobiles and automobile parts may\nalso be subject to surprise inspections, on the rationale that junkyards are highly likely to be active in the\nresale of stolen autos or stolen auto parts.\n\n[3]\n\nIt is also possible for inspections to take place without a search warrant and without the permission of the\nbusiness. For example, the Environmental Protection Agency (EPA) wished to inspect parts of the Dow\nChemical facility in Midland, Michigan, without the benefit of warrant. When they were refused, agents of\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n193\n\n\x0cthe EPA obtained a fairly advanced aerial mapping camera and rented an airplane to fly over the Dow\nfacility. Dow went to court for a restraining order against the EPA and a request to have the EPA turn over\nall photographs taken. But the Supreme Court ruled that the areas photographed were \xe2\x80\x9copen fields\xe2\x80\x9d and\nnot subject to the protections of the Fourth Amendment.\n\n[4]\n\nAccess to Business Information in Government Files\nIn 1966, Congress enacted the Freedom of Information Act (FOIA), opening up to the citizenry many of\nthe files of the government. (The act was amended in 1974 and again in 1976 to overcome a tendency of\nmany agencies to stall or refuse access to their files.) Under the FOIA, any person has a legally enforceable\nright of access to all government documents, with nine specific exceptions, such as classified military\nintelligence, medical files, and trade secrets and commercial or financial information if \xe2\x80\x9cobtained from a\nperson and privileged or confidential.\xe2\x80\x9d Without the trade-secret and financial-information exemptions,\nbusiness competitors could, merely by requesting it, obtain highly sensitive competitive information\nsitting in government files.\nA federal agency is required under the FOIA to respond to a document request within ten days. But in\npractice, months or even years may pass before the government actually responds to an FOIA request.\nRequesters must also pay the cost of locating and copying the records. Moreover, not all documents are\navailable for public inspection. Along with the trade-secret and financial-information exemptions, the\nFOIA specifically exempts the following:\n\xe2\x80\xa2\n\nrecords required by executive order of the president to be kept secret in the interest of national\ndefense or public policy\n\n\xe2\x80\xa2\n\nrecords related solely to the internal personnel rules and practice of an agency\n\n\xe2\x80\xa2\n\nrecords exempted from disclosure by another statute\n\n\xe2\x80\xa2\n\ninteragency memos or decisions reflecting the deliberative process\n\n\xe2\x80\xa2\n\npersonnel files and other files that if disclosed, would constitute an unwarranted invasion of personal\nprivacy\n\n\xe2\x80\xa2\n\ninformation compiled for law enforcement purposes\n\n\xe2\x80\xa2\n\ngeological information concerning wells\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n194\n\n\x0cNote that the government may provide such information but is not required to provide such information;\nit retains discretion to provide information or not.\nRegulated companies are often required to submit confidential information to the government. For these\ncompanies, submitting such information presents a danger under the FOIA of disclosure to competitors.\nTo protect information from disclosure, the company is well advised to mark each document as privileged\nand confidential so that government officials reviewing it for a FOIA request will not automatically\ndisclose it. Most agencies notify a company whose data they are about to disclose. But these practices are\nnot legally required under the FOIA.\n\nKEY TAKEAWAY\nGovernment agencies, in order to do their jobs, collect a great deal of information from businesses. This\ncan range from routine paperwork (often burdensome) to inspections, those with warrants and those\nwithout. Surprise inspections are allowed for closely regulated industries but are subject to Fourth\nAmendment requirements in general. Some information collected by agencies can be accessed using the\nFreedom of Information Act.\n\n1.\n\nEXERCISES\n\nGive two examples of a closely regulated industry. Explain why some warrantless searches would be\nallowed.\n\n2.\n\nFind out why FOIA requests often take months or years to accomplish.\n3.\n\n[1] In re FTC Line of Business Report Litigation, 595 F.2d 685 (D.C. Cir. 1978).\n\n4.\n\n[2] Marshall v. Barlow\xe2\x80\x99s, Inc., 436 US 307 (1978).\n\n5.\n\n[3] New York v. Burger, 482 US 691 (1987).\n\n6.\n\n[4] Dow Chemical Co. v. United States Environmental Protection Agency, 476 US 227 (1986).\n\n5.5 The Scope of Judicial Review\n\nLEARNING OBJECTIVES\n\n1.\n\nDescribe the \xe2\x80\x9cexhaustion of remedies\xe2\x80\x9d requirement.\n\n2.\n\nDetail various strategies for obtaining judicial review of agency rules.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n195\n\n\x0c3.\n\nExplain under what circumstances it is possible to sue the government.\n\nNeither an administrative agency\xe2\x80\x99s adjudication nor its issuance of a regulation is necessarily final.\nMost federal agency decisions are appealable to the federal circuit courts. To get to court, the\nappellant must overcome numerous complex hurdles. He or she must have standing\xe2\x80\x94that is, be in\nsome sense directly affected by the decision or regulation. The case must be ripe for review;\nadministrative remedies such as further appeal within the agency must have been exhausted.\n\nExhaustion of Administrative Remedies\nBefore you can complain to court about an agency\xe2\x80\x99s action, you must first try to get the agency to\nreconsider its action. Generally, you must have asked for a hearing at the hearing examiner level, there\nmust have been a decision reached that was unfavorable to you, and you must have appealed the decision\nto the full board. The full board must rule against you, and only then will you be heard by a court. The\nbroadest exception to this exhaustion of administrative remedies requirement is if the agency had no\nauthority to issue the rule or regulation in the first place, if exhaustion of remedies would be impractical\nor futile, or if great harm would happen should the rule or regulation continue to apply. Also, if the agency\nis not acting in good faith, the courts will hear an appeal without exhaustion.\n\nStrategies for Obtaining Judicial Review\nOnce these obstacles are cleared, the court may look at one of a series of claims. The appellant might\nassert that the agency\xe2\x80\x99s action was ultra vires (UL-truh VI-reez)\xe2\x80\x94beyond the scope of its authority as set\ndown in the statute. This attack is rarely successful. A somewhat more successful claim is that the agency\ndid not abide by its own procedures or those imposed upon it by the Administrative Procedure Act.\nIn formal rulemaking, the appellant also might insist that the agency lacked substantial evidence for the\ndetermination that it made. If there is virtually no evidence to support the agency\xe2\x80\x99s findings, the court\nmay reverse. But findings of fact are not often overturned by the courts.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n196\n\n\x0cLikewise, there has long been a presumption that when an agency issues a regulation, it has the authority\nto do so: those opposing the regulation must bear a heavy burden in court to upset it. This is not a\nsurprising rule, for otherwise courts, not administrators, would be the authors of regulations.\nNevertheless, regulations cannot exceed the scope of the authority conferred by Congress on the agency.\nIn an important 1981 case before the Supreme Court, the issue was whether the secretary of labor, acting\nthrough the Occupational Health and Safety Administration (OSHA), could lawfully issue a standard\nlimiting exposure to cotton dust in the workplace without first undertaking a cost-benefit analysis. A\ndozen cotton textile manufacturers and the American Textile Manufacturers Institute, representing 175\ncompanies, asserted that the cotton dust standard was unlawful because it did not rationally relate the\nbenefits to be derived from the standard to the costs that the standard would impose. See Section 5.6\n"Cases", American Textile Manufacturers Institute v. Donovan.\nIn summary, then, an individual or a company may (after exhaustion of administrative remedies)\nchallenge agency action where such action is the following:\n\xe2\x80\xa2\n\nnot in accordance with the agency\xe2\x80\x99s scope of authority\n\n\xe2\x80\xa2\n\nnot in accordance with the US Constitution or the Administrative Procedure Act\n\n\xe2\x80\xa2\n\nnot in accordance with the substantial evidence test\n\n\xe2\x80\xa2\n\nunwarranted by the facts\n\n\xe2\x80\xa2\n\narbitrary, capricious, an abuse of discretion, or otherwise not in accord with the law\n\nSection 706 of the Administrative Procedure Act sets out those standards. While it is difficult to show that\nan agency\xe2\x80\x99s action is arbitrary and capricious, there are cases that have so held. For example, after the\nReagan administration set aside a Carter administration rule from the National Highway Traffic and\nSafety Administration on passive restraints in automobiles, State Farm and other insurance companies\nchallenged the reversal as arbitrary and capricious. Examining the record, the Supreme Court found that\nthe agency had failed to state enough reasons for its reversal and required the agency to review the record\nand the rule and provide adequate reasons for its reversal. State Farm and other insurance companies\nthus gained a legal benefit by keeping an agency rule that placed costs on automakers for increased\npassenger safety and potentially reducing the number of injury claims from those it had insured.\n\n[1]\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n197\n\n\x0cSuing the Government\nIn the modern administrative state, the range of government activity is immense, and administrative\nagencies frequently get in the way of business enterprise. Often, bureaucratic involvement is wholly\nlegitimate, compelled by law; sometimes, however, agencies or government officials may overstep their\nbounds, in a fit of zeal or spite. What recourse does the private individual or company have?\nMainly for historical reasons, it has always been more difficult to sue the government than to sue private\nindividuals or corporations. For one thing, the government has long had recourse to the doctrine of\nsovereign immunity as a shield against lawsuits. Yet in 1976, Congress amended the Administrative\nProcedure Act to waive any federal claim to sovereign immunity in cases of injunctive or other\nnonmonetary relief. Earlier, in 1946, in the Federal Tort Claims Act, Congress had waived sovereign\nimmunity of the federal government for most tort claims for money damages, although the act contains\nseveral exceptions for specific agencies (e.g., one cannot sue for injuries resulting from fiscal operations of\nthe Treasury Department or for injuries stemming from activities of the military in wartime). The act also\ncontains a major exception for claims \xe2\x80\x9cbased upon [an official\xe2\x80\x99s] exercise or performance or the failure to\nexercise or perform a discretionary function or duty.\xe2\x80\x9d This exception prevents suits against parole boards\nfor paroling dangerous criminals who then kill or maim in the course of another crime and suits against\nofficials whose decision to ship explosive materials by public carrier leads to mass deaths and injuries\nfollowing an explosion en route.\n\n[2]\n\nIn recent years, the Supreme Court has been stripping away the traditional immunity enjoyed by many\ngovernment officials against personal suits. Some government employees\xe2\x80\x94judges, prosecutors,\nlegislators, and the president, for example\xe2\x80\x94have absolute immunity against suit for official actions. But\nmany public administrators and government employees have at best a qualified immunity. Under a\nprovision of the Civil Rights Act of 1871 (so-called Section 1983 actions), state officials can be sued in\nfederal court for money damages whenever \xe2\x80\x9cunder color of any state law\xe2\x80\x9d they deprive anyone of his\nrights under the Constitution or federal law. In Bivens v. Six Unknown Federal Narcotics Agents, the\nSupreme Court held that federal agents may be sued for violating the plaintiff\xe2\x80\x99s Fourth Amendment rights\n[3]\n\nagainst an unlawful search of his home. Subsequent cases have followed this logic to permit suits for\nviolations of other constitutional provisions. This area of the law is in a state of flux, and it is likely to\ncontinue to evolve.\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n198\n\n\x0cSometimes damage is done to an individual or business because the government has given out erroneous\ninformation. For example, suppose that Charles, a bewildered, disabled navy employee, is receiving a\nfederal disability annuity. Under the regulations, he would lose his pension if he took a job that paid him\nin each of two succeeding years more than 80 percent of what he earned in his old navy job. A few years\nlater, Congress changed the law, making him ineligible if he earned more than 80 percent in anyone year.\nFor many years, Charles earned considerably less than the ceiling amount. But then one year he got the\nopportunity to make some extra money. Not wishing to lose his pension, he called an employee relations\nspecialist in the US Navy and asked how much he could earn and still keep his pension. The specialist\ngave him erroneous information over the telephone and then sent him an out-of-date form that said\nCharles could safely take on the extra work. Unfortunately, as it turned out, Charles did exceed the salary\nlimit, and so the government cut off his pension during the time he earned too much. Charles sues to\nrecover his lost pension. He argues that he relied to his detriment on false information supplied by the\nnavy and that in fairness the government should be estopped from denying his claim.\nUnfortunately for Charles, he will lose his case. In Office of Personnel Management v. Richmond, the\nSupreme Court reasoned that it would be unconstitutional to permit recovery.\n\n[4]\n\nThe appropriations\n\nclause of Article I says that federal money can be paid out only through an appropriation made by law.\nThe law prevented this particular payment to be made. If the court were to make an exception, it would\npermit executive officials in effect to make binding payments, even though unauthorized, simply by\nmisrepresenting the facts. The harsh reality, therefore, is that mistakes of the government are generally\nheld against the individual, not the government, unless the law specifically provides for recompense (as,\nfor example, in the Federal Tort Claims Act just discussed).\n\nKEY TAKEAWAY\n\nAfter exhausting administrative remedies, there are numerous grounds for seeking judicial review of an\nagency\xe2\x80\x99s order or of a final rule. While courts defer to agencies to some degree, an agency must follow its\nown rules, comply with the Administrative Procedure Act, act within the scope of its delegated authority,\navoid acting in an arbitrary manner, and make final rules that are supported by substantial evidence.\n\nEXERCISES\n\n1.\n\nWhy would US courts require that someone seeking judicial review of an agency order first exhaust\nadministrative remedies?\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n199\n\n\x0c2.\n\nOn the Internet, find a case where someone has successfully sued the US government under the Federal\nTort Claims Act. What kind of case was it? Did the government argue sovereign immunity? Does sovereign\nimmunity even make sense to you?\n3.\n\n[1] Motor Vehicle Manufacturers\xe2\x80\x99 Assn. v. State Farm Mutual Ins., 463 US 29 (1983).\n\n4.\n\n[2] Dalehite v. United States, 346 US 15 (1953).\n\n5.\n\n[3] Bivens v. Six Unknown Federal Narcotics Agents, 403 US 388 (1971).\n\n6.\n\n[4] Office of Personnel Management v. Richmond, 110 S. Ct. 2465 (1990).\n\n5.6 Cases\nMarshall v. Barlow\xe2\x80\x99s, Inc.\nMarshall v. Barlow\xe2\x80\x99s, Inc.\n436 U.S. 307 (U.S. Supreme Court 1978)\nMR. JUSTICE WHITE delivered the opinion of the Court.\nSection 8(a) of the Occupational Safety and Health Act of 1970 (OSHA or Act) empowers agents of the\nSecretary of Labor (Secretary) to search the work area of any employment facility within the Act\xe2\x80\x99s\njurisdiction. The purpose of the search is to inspect for safety hazards and violations of OSHA regulations.\nNo search warrant or other process is expressly required under the Act.\nOn the morning of September 11, 1975, an OSHA inspector entered the customer service area of Barlow\xe2\x80\x99s,\nInc., an electrical and plumbing installation business located in Pocatello, Idaho. The president and\ngeneral manager, Ferrol G. \xe2\x80\x9cBill\xe2\x80\x9d Barlow, was on hand; and the OSHA inspector, after showing his\ncredentials, informed Mr. Barlow that he wished to conduct a search of the working areas of the business.\nMr. Barlow inquired whether any complaint had been received about his company. The inspector\nanswered no, but that Barlow\xe2\x80\x99s, Inc., had simply turned up in the agency\xe2\x80\x99s selection process. The inspector\nagain asked to enter the nonpublic area of the business; Mr. Barlow\xe2\x80\x99s response was to inquire whether the\ninspector had a search warrant.\nThe inspector had none. Thereupon, Mr. Barlow refused the inspector admission to the employee area of\nhis business. He said he was relying on his rights as guaranteed by the Fourth Amendment of the United\nStates Constitution.\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n200\n\n\x0cThree months later, the Secretary petitioned the United States District Court for the District of Idaho to\nissue an order compelling Mr. Barlow to admit the inspector. The requested order was issued on\nDecember 30, 1975, and was presented to Mr. Barlow on January 5, 1976. Mr. Barlow again refused\nadmission, and he sought his own injunctive relief against the warrantless searches assertedly permitted\nby OSHA.\xe2\x80\xa6The Warrant Clause of the Fourth Amendment protects commercial buildings as well as\nprivate homes. To hold otherwise would belie the origin of that Amendment, and the American colonial\nexperience.\nAn important forerunner of the first 10 Amendments to the United States Constitution, the Virginia Bill of\nRights, specifically opposed \xe2\x80\x9cgeneral warrants, whereby an officer or messenger may be commanded to\nsearch suspected places without evidence of a fact committed.\xe2\x80\x9d The general warrant was a recurring point\nof contention in the Colonies immediately preceding the Revolution. The particular offensiveness it\nengendered was acutely felt by the merchants and businessmen whose premises and products were\ninspected for compliance with the several parliamentary revenue measures that most irritated the\ncolonists.\xe2\x80\xa6\n***\nThis Court has already held that warrantless searches are generally unreasonable, and that this rule\napplies to commercial premises as well as homes. In Camara v. Municipal Court, we held:\n[E]xcept in certain carefully defined classes of cases, a search of private property without proper\nconsent is \xe2\x80\x98unreasonable\xe2\x80\x99 unless it has been authorized by a valid search warrant.\nOn the same day, we also ruled: As we explained in Camara, a search of private houses is\npresumptively unreasonable if conducted without a warrant. The businessman, like the occupant\nof a residence, has a constitutional right to go about his business free from unreasonable official\nentries upon his private commercial property. The businessman, too, has that right placed in\njeopardy if the decision to enter and inspect for violation of regulatory laws can be made and\nenforced by the inspector in the field without official authority evidenced by a warrant. These\nsame cases also held that the Fourth Amendment prohibition against unreasonable searches\nprotects against warrantless intrusions during civil as well as criminal investigations. The\nreason is found in the \xe2\x80\x9cbasic purpose of this Amendment\xe2\x80\xa6[which] is to safeguard the privacy and\nsecurity of individuals against arbitrary invasions by governmental officials.\xe2\x80\x9d If the government\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n201\n\n\x0cintrudes on a person\xe2\x80\x99s property, the privacy interest suffers whether the government\xe2\x80\x99s motivation\nis to investigate violations of criminal laws or breaches of other statutory or regulatory\nstandards.\xe2\x80\xa6\n[A]n exception from the search warrant requirement has been recognized for \xe2\x80\x9cpervasively regulated\nbusiness[es],\xe2\x80\x9d United States v. Biswell, 406 U.S. 311, 316 (1972), and for \xe2\x80\x9cclosely regulated\xe2\x80\x9d industries\n\xe2\x80\x9clong subject to close supervision and inspection,\xe2\x80\x9d Colonnade Catering Corp. v. United States, 397 U.S.\n72, 74, 77 (1970). These cases are indeed exceptions, but they represent responses to relatively unique\ncircumstances. Certain industries have such a history of government oversight that no reasonable\nexpectation of privacy could exist for a proprietor over the stock of such an enterprise. Liquor\n(Colonnade) and firearms (Biswell) are industries of this type when an entrepreneur embarks upon such a\nbusiness, he has voluntarily chosen to subject himself to a full arsenal of governmental regulation.\n***\nThe clear import of our cases is that the closely regulated industry of the type involved\nin Colonnade and Biswell is the exception. The Secretary would make it the rule. Invoking the WalshHealey Act of 1936, 41 U.S.C. \xc2\xa7 35 et seq., the Secretary attempts to support a conclusion that all\nbusinesses involved in interstate commerce have long been subjected to close supervision of employee\nsafety and health conditions. But\xe2\x80\xa6it is quite unconvincing to argue that the imposition of minimum\nwages and maximum hours on employers who contracted with the Government under the Walsh-Healey\nAct prepared the entirety of American interstate commerce for regulation of working conditions to the\nminutest detail. Nor can any but the most fictional sense of voluntary consent to later searches be found in\nthe single fact that one conducts a business affecting interstate commerce. Under current practice and\nlaw, few businesses can be conducted without having some effect on interstate commerce.\n***\nThe critical fact in this case is that entry over Mr. Barlow\xe2\x80\x99s objection is being sought by a Government\nagent. Employees are not being prohibited from reporting OSHA violations. What they observe in their\ndaily functions is undoubtedly beyond the employer\xe2\x80\x99s reasonable expectation of privacy. The Government\ninspector, however, is not an employee. Without a warrant he stands in no better position than a member\nof the public. What is observable by the public is observable, without a warrant, by the Government\ninspector as well. The owner of a business has not, by the necessary utilization of employees in his\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n202\n\n\x0coperation, thrown open the areas where employees alone are permitted to the warrantless scrutiny of\nGovernment agents. That an employee is free to report, and the Government is free to use, any evidence of\nnoncompliance with OSHA that the employee observes furnishes no justification for federal agents to\nenter a place of business from which the public is restricted and to conduct their own warrantless search.\n***\n[The District Court judgment is affirmed.]\n\nCASE QUESTIONS\n\n1.\n\nState, as briefly and clearly as possible, the argument that Barlow\xe2\x80\x99s is making in this case.\n\n2.\n\nWhy would some industries or businesses be \xe2\x80\x9cclosely regulated\xe2\x80\x9d? What are some of those businesses?\n\n3.\n\nThe Fourth Amendment speaks of \xe2\x80\x9cpeople\xe2\x80\x9d being secure in their \xe2\x80\x9cpersons, houses, papers, and effects.\xe2\x80\x9d\nWhy would the Fourth Amendment apply to a business, which is not in a \xe2\x80\x9chouse\xe2\x80\x9d?\n\n4.\n\nIf the Fourth Amendment does not distinguish between closely regulated industries and those that are\nnot, why does the court do so?\n\nAmerican Textile Manufacturers Institute v. Donovan\nAmerican Textile Manufacturers Institute v. Donovan\n452 U.S. 490 (1981)\nJUSTICE BRENNAN delivered the opinion of the Court.\nCongress enacted the Occupational Safety and Health Act of 1970 (Act) \xe2\x80\x9cto assure so far as possible every\nworking man and woman in the Nation safe and healthful working conditions.\xe2\x80\xa6\xe2\x80\x9cThe Act authorizes the\nSecretary of Labor to establish, after notice and opportunity to comment, mandatory nationwide\nstandards governing health and safety in the workplace. In 1978, the Secretary, acting through the\nOccupational Safety and Health Administration (OSHA), promulgated a standard limiting occupational\nexposure to cotton dust, an airborne particle byproduct of the preparation and manufacture of cotton\nproducts, exposure to which produces a \xe2\x80\x9cconstellation of respiratory effects\xe2\x80\x9d known as \xe2\x80\x9cbyssinosis.\xe2\x80\x9d This\ndisease was one of the expressly recognized health hazards that led to passage of the Act.\nPetitioners in these consolidated cases representing the interests of the cotton industry, challenged the\nvalidity of the \xe2\x80\x9cCotton Dust Standard\xe2\x80\x9d in the Court of Appeals for the District of Columbia Circuit\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n203\n\n\x0cpursuant to \xc2\xa7 6 (f) of the Act, 29 U.S.C. \xc2\xa7 655 (f). They contend in this Court, as they did below, that the\nAct requires OSHA to demonstrate that its Standard reflects a reasonable relationship between the costs\nand benefits associated with the Standard. Respondents, the Secretary of Labor and two labor\norganizations, counter that Congress balanced the costs and benefits in the Act itself, and that the Act\nshould therefore be construed not to require OSHA to do so. They interpret the Act as mandating that\nOSHA enact the most protective standard possible to eliminate a significant risk of material health\nimpairment, subject to the constraints of economic and technological feasibility.\nThe Court of Appeals held that the Act did not require OSHA to compare costs and benefits.\nWe granted certiorari, 449 U.S. 817 (1980), to resolve this important question, which was presented but\nnot decided in last Term\xe2\x80\x99s Industrial Union Dept. v. American Petroleum Institute, 448 U.S. 607 (1980),\nand to decide other issues related to the Cotton Dust Standard.\n***\nNot until the early 1960\xe2\x80\x99s was byssinosis recognized in the United States as a distinct occupational hazard\nassociated with cotton mills. In 1966, the American Conference of Governmental Industrial Hygienists\n(ACGIH), a private organization, recommended that exposure to total cotton dust be limited to a\n\xe2\x80\x9cthreshold limit value\xe2\x80\x9d of 1,000 micrograms per cubic meter of air (1,000 g/m3.) averaged over an 8-hour\nworkday. See 43 Fed. Reg. 27351, col. 1 (1978). The United States Government first regulated exposure to\ncotton dust in 1968, when the Secretary of Labor, pursuant to the Walsh-Healey Act, 41 U.S.C. 35 (e),\npromulgated airborne contaminant threshold limit values, applicable to public contractors, that included\nthe 1,000 g/m3 limit for total cotton dust. 34 Fed. Reg. 7953 (1969). Following passage of the Act in 1970,\nthe 1,000 g/m3. standard was adopted as an \xe2\x80\x9cestablished Federal standard\xe2\x80\x9d under 6 (a) of the Act, 84 Stat.\n1593, 29 U.S.C. 655 (a), a provision designed to guarantee immediate protection of workers for the period\nbetween enactment of the statute and promulgation of permanent standards.\nThat same year, the Director of the National Institute for Occupational Safety and Health (NIOSH),\npursuant to the Act, 29 U.S.C. \xc2\xa7\xc2\xa7 669(a)(3), 671 (d)(2), submitted to the Secretary of Labor a\nrecommendation for a cotton dust standard with a permissible exposure limit (PEL) that \xe2\x80\x9cshould be set at\nthe lowest level feasible, but in no case at an environmental concentration as high as 0.2 mg lint-free\ncotton dust/cu m,\xe2\x80\x9d or 200 g/m3. of lint-free respirable dust. Several months later, OSHA published an\nAdvance Notice of Proposed Rulemaking, 39 Fed.Reg. 44769 (1974), requesting comments from\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n204\n\n\x0cinterested parties on the NIOSH recommendation and other related matters. Soon thereafter, the Textile\nWorker\xe2\x80\x99s Union of America, joined by the North Carolina Public Interest Research Group, petitioned the\nSecretary, urging a more stringent PEL of 100 g/m3.\nOn December 28, 1976, OSHA published a proposal to replace the existing federal standard on cotton dust\nwith a new permanent standard, pursuant to \xc2\xa7 6(b)(5) of the Act, 29 U.S.C. \xc2\xa7 655(b)(5). 41 Fed.Reg.\n56498. The proposed standard contained a PEL of 200 g/m3 of vertical elutriated lint-free respirable\ncotton dust for all segments of the cotton industry. Ibid. It also suggested an implementation strategy for\nachieving the PEL that relied on respirators for the short term and engineering controls for the long-term.\nOSHA invited interested parties to submit written comments within a 90-day period.\n***\nThe starting point of our analysis is the language of the statute itself. Section 6(b)(5) of the Act, 29 U.S.C.\n\xc2\xa7 655(b)(5) (emphasis added), provides:\nThe Secretary, in promulgating standards dealing with toxic materials or harmful physical\nagents under this subsection, shall set the standard which most adequately assures, to the\nextent feasible, on the basis of the best available evidence, that no employee will suffer material\nimpairment of health or functional capacity even if such employee has regular exposure to the\nhazard dealt with by such standard for the period of his working life. Although their\ninterpretations differ, all parties agree that the phrase \xe2\x80\x9cto the extent feasible\xe2\x80\x9d contains the critical\nlanguage in \xc2\xa7 6(b)(5) for purposes of these cases.\nThe plain meaning of the word \xe2\x80\x9cfeasible\xe2\x80\x9d supports respondents\xe2\x80\x99 interpretation of the statute. According to\nWebster\xe2\x80\x99s Third New International Dictionary of the English Language 831 (1976), \xe2\x80\x9cfeasible\xe2\x80\x9d means\n\xe2\x80\x9ccapable of being done, executed, or effected.\xe2\x80\x9d In accord, the Oxford English Dictionary 116 (1933)\n(\xe2\x80\x9cCapable of being done, accomplished or carried out\xe2\x80\x9d); Funk & Wagnalls New \xe2\x80\x9cStandard\xe2\x80\x9d Dictionary of\nthe English Language 903 (1957) (\xe2\x80\x9cThat may be done, performed or effected\xe2\x80\x9d). Thus, \xc2\xa7 6(b)(5) directs the\nSecretary to issue the standard that \xe2\x80\x9cmost adequately assures\xe2\x80\xa6that no employee will suffer material\nimpairment of health,\xe2\x80\x9d limited only by the extent to which this is \xe2\x80\x9ccapable of being done.\xe2\x80\x9d In effect then,\nas the Court of Appeals held, Congress itself defined the basic relationship between costs and benefits, by\nplacing the \xe2\x80\x9cbenefit\xe2\x80\x9d of worker health above all other considerations save those making attainment of this\n\xe2\x80\x9cbenefit\xe2\x80\x9d unachievable. Any standard based on a balancing of costs and benefits by the Secretary that\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n205\n\n\x0cstrikes a different balance than that struck by Congress would be inconsistent with the command set forth\nin \xc2\xa7 6(b)(5). Thus, cost-benefit analysis by OSHA is not required by the statute because feasibility analysis\nis.\nWhen Congress has intended that an agency engage in cost-benefit analysis, it has clearly indicated such\nintent on the face of the statute. One early example is the Flood Control Act of 1936, 33 U.S.C. \xc2\xa7 701:\n[T]he Federal Government should improve or participate in the improvement of navigable waters\nor their tributaries, including watersheds thereof, for flood control purposes if the benefits to\nwhomsoever they may accrue are in excess of the estimated costs, and if the lives and\nsocial security of people are otherwise adversely affected. (emphasis added)\nA more recent example is the Outer Continental Shelf Lands Act Amendments of 1978, providing that\noffshore drilling operations shall use the best available and safest technologies which the Secretary\ndetermines to be economically feasible, wherever failure of equipment would have a significant effect on\nsafety, health, or the environment, except where the Secretary determines that the incremental benefits\nare clearly insufficient to justify the incremental costs of using such technologies.\nThese and other statutes demonstrate that Congress uses specific language when intending that an agency\nengage in cost-benefit analysis. Certainly in light of its ordinary meaning, the word \xe2\x80\x9cfeasible\xe2\x80\x9d cannot be\nconstrued to articulate such congressional intent. We therefore reject the argument that Congress\nrequired cost-benefit analysis in \xc2\xa7 6(b)(5).\n\nCASE QUESTIONS\n\n1.\n\nWhat is byssinosis? Why should byssinosis be anything that the textile companies are responsible for,\nethically or legally? If it is well-known that textile workers get cotton dust in their systems and develop\nbrown lung, don\xe2\x80\x99t they nevertheless choose to work there and assume the risk of all injuries?\n\n2.\n\nBy imposing costs on the textile industry, what will be the net effect on US textile manufacturing jobs?\n\n3.\n\nHow is byssinosis a \xe2\x80\x9cnegative externality\xe2\x80\x9d that is not paid for by either the manufacturer or the consumer\nof textile products? How should the market, to be fair and efficient, adjust for these negative\nexternalities other than by setting a reasonable standard that shares the burden between manufacturers\nand their employees? Should all the burden be on the manufacturer?\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n206\n\n\x0c5.7 Summary and Exercises\nSummary\n\nAdministrative rules and regulations constitute the largest body of laws that directly affect business.\nThese regulations are issued by dozens of federal and state agencies that regulate virtually every aspect of\nmodern business life, including the natural environment, corporate finance, transportation,\ntelecommunications, energy, labor relations, and trade practices. The administrative agencies derive their\npower to promulgate regulations from statutes passed by Congress or state legislatures.\nThe agencies have a variety of powers. They can license companies to carry on certain activities or prohibit\nthem from doing so, lay down codes of conduct, set rates that companies may charge for their services,\nand supervise various aspects of business.\n\n1.\n\nEXERCISES\n\nThe Equal Employment Opportunity Commission seeks data about the racial composition of Terrific\nTextiles\xe2\x80\x99 labor force. Terrific refuses on the grounds that inadvertent disclosure of the numbers might\ncause certain \xe2\x80\x9celements\xe2\x80\x9d to picket its factories. The EEOC takes Terrific to court to get the data. What is\nthe result?\n\n2.\n\nIn order to police the profession, the state legislature has just passed a law permitting the State Plumbers\xe2\x80\x99\nAssociation the power to hold hearings to determine whether a particular plumber has violated the\nplumbing code of ethics, written by the association. Sam, a plumber, objects to the convening of a\nhearing when he is accused by Roger, a fellow plumber, of acting unethically by soliciting business from\nRoger\xe2\x80\x99s customers. Sam goes to court, seeking to enjoin the association\xe2\x80\x99s disciplinary committee from\nholding the hearing. What is the result? How would you argue Sam\xe2\x80\x99s case? The association\xe2\x80\x99s case?\n\n3.\n\nAssume that the new president of the United States was elected overwhelmingly by pledging in his\ncampaign to \xe2\x80\x9cdo away with bureaucrats who interfere in your lives.\xe2\x80\x9d The day he takes the oath of office\nhe determines to carry out his pledge. Discuss which of the following courses he may lawfully follow: (a)\nFire all incumbent commissioners of federal agencies in order to install new appointees. (b) Demand that\nall pending regulations being considered by federal agencies be submitted to the White House for review\nand redrafting, if necessary. (c) Interview potential nominees for agency positions to determine whether\ntheir regulatory philosophy is consistent with his.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n207\n\n\x0c4.\n\nDewey owned a mine in Wisconsin. He refused to allow Department of Labor agents into the mine to\nconduct warrantless searches to determine whether previously found safety violations had been\ncorrected. The Federal Mine Safety and Health Amendments Act of 1977 authorizes four warrantless\ninspections per year. Is the provision for warrantless inspections by this agency constitutional?\n\n5.\n\n[1]\n\nIn determining the licensing requirements for nuclear reactors, the Nuclear Regulatory Commission (NRC)\nadopted a zero-release assumption: that the permanent storage of certain nuclear waste would have no\nsignificant environmental impact and that potential storage leakages should not be a factor discussed in\nthe appropriate environmental impact statement (EIS) required before permitting construction of a\nnuclear power plant. This assumption is based on the NRC\xe2\x80\x99s belief that technology would be developed to\nisolate the wastes from the environment, and it was clear from the record that the NRC had \xe2\x80\x9cdigested a\nmassive material and disclosed all substantial risks\xe2\x80\x9d and had considered that the zero-release assumption\nwas uncertain. There was a remote possibility of contamination by water leakage into the storage facility.\nAn environmental NGO sued, asserting that the NRC had violated the regulations governing the EIS by\narbitrarily and capriciously ignoring the potential contamination. The court of appeals agreed, and the\npower plant appealed. Had the NRC acted arbitrarily and capriciously?\n\n[2]\n\nSELF-TEST QUESTIONS\n\n1.\na.\n\nMost federal administrative agencies are created by\nan executive order by the president\nb.\n\na Supreme Court decision\n\nc.\n\nthe passage of enabling legislation by Congress, signed by the president\n\nd.\n\na and c\n\nThe Federal Trade Commission, like most administrative agencies of the federal government, is\npart of\na.\n\nthe executive branch of government\nb.\n\nthe legislative branch of government\n\nc.\n\nthe judicial branch of government\n\nd.\n\nthe administrative branch of government\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n208\n\n\x0cIn the Clean Water Act, Congress sets broad guidelines, but it is the Environmental Protection\nAgency that proposes rules to regulate industrial discharges. Where do proposed rules originally\nappear?\na.\n\nin the Congressional record\nb.\n\nin the Federal Register\n\nc.\n\nin the Code of Federal Regulations\n\nd.\n\nin the United States code service\n\nThe legal basis for all administrative law, including regulations of the Federal Trade Commission,\nis found in\na.\n\nthe Administrative Procedure Act\nb.\n\nthe US Constitution\n\nc.\n\nthe commerce clause\n\nd.\n\nnone of the above\n\nThe Federal Trade Commission, like other administrative agencies, has the power to\na.\n\nissue proposed rules\n\n1.\n\nc\n\n2.\n\na\n\n3.\n\nb\n\n4.\n\nb\n\n5.\n\ne\n\nb.\n\nundertake investigations of firms that may have violated FTC regulations\n\nc.\n\nprosecute firms that have violated FTC regulations\n\nd.\n\nnone of the above\n\ne.\n\nall of the above\n\nSELF-TEST ANSWERS\n\n6.\n\n[1] Donovan v. Dewey, 452 US 594 (1981).\n\n7.\n\n[2] Baltimore Gas and Electric Co. v. Natural Resources Defense Council Inc., 462 US 87 (1983).\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n209\n\n\x0cChapter 6\n\nCriminal Law\nLEARNING OBJECTIVES\nAfter reading this chapter, you should be able to do the following:\n1.\n\nExplain how criminal law differs from civil law.\n\n2.\n\nCategorize the various types of crimes and define the most serious felonies.\n\n3.\n\nDiscuss and question the criminal \xe2\x80\x9cintent\xe2\x80\x9d of a corporation.\n\n4.\n\nExplain basic criminal procedure and the rights of criminal defendants.\n\nAt times, unethical behavior by businesspeople can be extreme enough that society will respond by\ncriminalizing certain kinds of activities. Ponzi schemes, arson, various kinds of fraud, embezzlement,\nracketeering, foreign corrupt practices, tax evasion, and insider trading are just a few. A corporation\ncan face large fines, and corporate managers can face both fines and jail sentences for violating\ncriminal laws. This chapter aims to explain how criminal law differs from civil law, to discuss various\ntypes of crimes, and to relate the basic principles of criminal procedure.\n\n6.1 The Nature of Criminal Law\nCriminal law is the most ancient branch of the law. Many wise observers have tried to define and\nexplain it, but the explanations often include many complex and subtle distinctions. A traditional\ncriminal law course would include a lot of discussions on criminal intent, the nature of criminal\nversus civil responsibility, and the constitutional rights accorded the accused. But in this chapter, we\nwill consider only the most basic aspects of intent, responsibility, and constitutional rights.\nUnlike civil actions, where plaintiffs seek compensation or other remedies for themselves, crimes\ninvolve \xe2\x80\x9cthe state\xe2\x80\x9d (the federal government, a state government, or some subunit of state\ngovernment). This is because crimes involve some \xe2\x80\x9charm to society\xe2\x80\x9d and not just harm to certain\nindividuals. But \xe2\x80\x9charm to society\xe2\x80\x9d is not always evident in the act itself. For example, two friends of\nyours at a party argue, take the argument outside, and blows are struck; one has a bloody nose and\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n210\n\n\x0cimmediately goes home. The crimes of assault and battery have been committed, even though no one\nelse knows about the fight and the friends later make up. By contrast, suppose a major corporation\npublicly announces that it is closing operations in your community and moving operations to\nSoutheast Asia. There is plenty of harm to society as the plant closes down and no new jobs take the\nplace of the company\xe2\x80\x99s jobs. Although the effects on society are greater in the second example, only\nthe first example is a crime.\nCrimes are generally defined by legislatures, in statutes; the statutes describe in general terms the\nnature of the conduct they wish to criminalize. For government punishment to be fair, citizens must\nhave clear notice of what is criminally prohibited. Ex post facto laws\xe2\x80\x94laws created \xe2\x80\x9cafter the fact\xe2\x80\x9d to\npunish an act that was legal at the time\xe2\x80\x94are expressly prohibited by the US Constitution. Overly\nvague statutes can also be struck down by courts under a constitutional doctrine known as \xe2\x80\x9cvoid for\nvagueness.\xe2\x80\x9d\nWhat is considered a crime will also vary from society to society and from time to time. For example,\nwhile cocaine use was legal in the United States at one time, it is now a controlled substance, and\nunauthorized use is now a crime. Medical marijuana was not legal fifty years ago when its use began\nto become widespread, and in some states its use or possession was a felony. Now, some states make\nit legal to use or possess it under some circumstances. In the United States, you can criticize and\nmake jokes about the president of the United States without committing a crime, but in many\ncountries it is a serious criminal act to criticize a public official.\nAttitudes about appropriate punishment for crimes will also vary considerably from nation to nation.\nUganda has decreed long prison sentences for homosexuals and death to repeat offenders. In Saudi\nArabia, the government has proposed to deliberately paralyze a criminal defendant who criminally\nassaulted someone and unintentionally caused the victim\xe2\x80\x99s paralysis. Limits on punishment are set\nin the United States through the Constitution\xe2\x80\x99s prohibition on \xe2\x80\x9ccruel or unusual punishments.\xe2\x80\x9d\nIt is often said that ignorance of the law is no excuse. But there are far too many criminal laws for\nanyone to know them all. Also, because most people do not actually read statutes, the question of\n\xe2\x80\x9ccriminal intent\xe2\x80\x9d comes up right away: if you don\xe2\x80\x99t know that the legislature has made driving\nwithout a seat belt fastened a misdemeanor, you cannot have intended to harm society. You might\neven argue that there is no harm to anyone but yourself!\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n211\n\n\x0cThe usual answer to this is that the phrase \xe2\x80\x9cignorance of the law is no excuse\xe2\x80\x9d means that society\n(through its elected representatives) gets to decide what is harmful to society, not you. Still, you may\nask, \xe2\x80\x9cIsn\xe2\x80\x99t it my choice whether to take the risk of failing to wear a seat belt? Isn\xe2\x80\x99t this a victimless\ncrime? Where is the harm to society?\xe2\x80\x9d A policymaker or social scientist may answer that your\ninjuries, statistically, are generally going to be far greater if you don\xe2\x80\x99t wear one and that your choice\nmay actually impose costs on society. For example, you might not have enough insurance, so that a\npublic hospital will have to take care of your head injuries, injuries that would likely have been\navoided by your use of a seat belt.\nBut, as just noted, it is hard to know the meaning of some criminal laws. Teenagers hanging around\nthe sidewalks on Main Street were sometimes arrested for \xe2\x80\x9cloitering.\xe2\x80\x9d The constitutional void-forvagueness doctrine has led the courts to overturn statutes that are not clear. For example, \xe2\x80\x9cvagrancy\xe2\x80\x9d\nwas long held to be a crime, but US courts began some forty years ago to overturn vagrancy and\n\xe2\x80\x9csuspicious person\xe2\x80\x9d statutes on the grounds that they are too vague for people to know what they are\nbeing asked not to do.\nThis requirement that criminal statutes not be vague does not mean that the law always defines\ncrimes in ways that can be easily and clearly understood. Many statutes use terminology developed\nby the common-law courts. For example, a California statute defines murder as \xe2\x80\x9cthe unlawful killing\nof a human being, with malice aforethought.\xe2\x80\x9d If no history backed up these words, they would be\nunconstitutionally vague. But there is a rich history of judicial decisions that provides meaning for\nmuch of the arcane language like \xe2\x80\x9cmalice aforethought\xe2\x80\x9d strewn about in the statute books.\nBecause a crime is an act that the legislature has defined as socially harmful, the parties involved\ncannot agree among themselves to forget a particular incident, such as a barroom brawl, if the\nauthorities decide to prosecute. This is one of the critical distinctions between criminal and civil law.\nAn assault is both a crime and a tort. The person who was assaulted may choose to forgive his\nassailant and not to sue him for damages. But he cannot stop the prosecutor from bringing an\nindictment against the assailant. (However, because of crowded dockets, a victim that declines to\npress charges may cause a busy prosecutor to choose to not to bring an indictment.)\nA crime consists of an act defined as criminal\xe2\x80\x94an actus reus\xe2\x80\x94and the requisite \xe2\x80\x9ccriminal intent.\xe2\x80\x9d\nSomeone who has a burning desire to kill a rival in business or romance and who may actually intend\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n212\n\n\x0cto murder but does not act on his desire has not committed a crime. He may have a \xe2\x80\x9cguilty mind\xe2\x80\x9d\xe2\x80\x94\nthe translation of the Latin phrase mens rea\xe2\x80\x94but he is guilty of no crime. A person who is forced to\ncommit a crime at gunpoint is not guilty of a crime, because although there was an act defined as\ncriminal\xe2\x80\x94an actus reus\xe2\x80\x94there was no criminal intent.\n\nKEY TAKEAWAY\n\nCrimes are usually defined by statute and constitute an offense against society. In each case, there must\nbe both an act and some mens rea (criminal intent).\n\nEXERCISES\n\n1.\n\nOther than deterring certain kinds of conduct, what purpose does the criminal law serve?\n\n2.\n\nWhy is ignorance of the law no excuse? Why shouldn\xe2\x80\x99t it be an excuse, when criminal laws can be\ncomplicated and sometimes ambiguous?\n\n6.2 Types of Crimes\n\nLEARNING OBJECTIVES\n\n1.\n\nCategorize various types of crimes.\n\n2.\n\nName and define the major felonies in criminal law.\n\n3.\n\nExplain how white-collar crime differs from other crimes.\n\n4.\n\nDefine a variety of white-collar crimes.\n\nMost classifications of crime turn on the seriousness of the act. In general, seriousness is defined by\nthe nature or duration of the punishment set out in the statute. A felony is a crime punishable\n(usually) by imprisonment of more than one year or by death. (Crimes punishable by death are\nsometimes known as capital crimes; they are increasingly rare in the United States.) The major\nfelonies include murder, rape, kidnapping, armed robbery, embezzlement, insider trading, fraud,\nand racketeering. All other crimes are usually known as misdemeanors, petty offenses, or infractions.\nAnother way of viewing crimes is by the type of social harm the statute is intended to prevent or\ndeter, such as offenses against the person, offenses against property, and white-collar crime.\n\nOffenses against the Person\nHomicide\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n213\n\n\x0cHomicide is the killing of one person by another. Not every killing is criminal. When the law permits one\nperson to kill another\xe2\x80\x94for example, a soldier killing an enemy on the battlefield during war, or a killing in\nself-defense\xe2\x80\x94the death is considered the result of justifiable homicide. An excusable homicide, by\ncontrast, is one in which death results from an accident in which the killer is not at fault.\nAll other homicides are criminal. The most severely punished form is murder, defined as homicide\ncommitted with \xe2\x80\x9cmalice aforethought.\xe2\x80\x9d This is a term with a very long history. Boiled down to its\nessentials, it means that the defendant had the intent to kill. A killing need not be premeditated for any\nlong period of time; the premeditation might be quite sudden, as in a bar fight that escalates in that\nmoment when one of the fighters reaches for a knife with the intent to kill.\nSometimes a homicide can be murder even if there is no intent to kill; an intent to inflict great bodily\nharm can be murder if the result is the death of another person. A killing that takes place while a felony\n(such as armed robbery) is being committed is also murder, whether or not the killer intended any harm.\nThis is the so-called felony murder rule. Examples are the accidental discharge of a gun that kills an\ninnocent bystander or the asphyxiation death of a fireman from smoke resulting from a fire set by an\narsonist. The felony murder rule is more significant than it sounds, because it also applies to the\naccomplices of one who does the killing. Thus the driver of a getaway car stationed a block away from the\nscene of the robbery can be convicted of murder if a gun accidentally fires during the robbery and\nsomeone is killed. Manslaughter is an act of killing that does not amount to murder. Voluntary\nmanslaughter is an intentional killing, but one carried out in the \xe2\x80\x9csudden heat of passion\xe2\x80\x9d as the result of\nsome provocation. An example is a fight that gets out of hand. Involuntary manslaughter entails a lesser\ndegree of willfulness; it usually occurs when someone has taken a reckless action that results in death\n(e.g., a death resulting from a traffic accident in which one driver recklessly runs a red light).\n\nAssault and Battery\nOrdinarily, we would say that a person who has struck another has \xe2\x80\x9cassaulted\xe2\x80\x9d him. Technically, that is\na battery\xe2\x80\x94the unlawful application of force to another person. The force need not be violent. Indeed, a\nman who kisses a woman is guilty of a battery if he does it against her will. The other person may consent\nto the force. That is one reason why surgeons require patients to sign consent forms, giving the doctor\npermission to operate. In the absence of such a consent, an operation is a battery. That is also why football\nplayers are not constantly being charged with battery. Those who agree to play football agree to submit to\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n214\n\n\x0cthe rules of the game, which of course include the right to tackle. But the consent does not apply to all acts\nof physical force: a hockey player who hits an opponent over the head with his stick can be prosecuted for\nthe crime of battery.\nCriminal assault is an attempt to commit a battery or the deliberate placing of another in fear of receiving\nan immediate battery. If you throw a rock at a friend, but he manages to dodge it, you have committed an\nassault. Some states limit an assault to an attempt to commit a battery by one who has a \xe2\x80\x9cpresent ability\xe2\x80\x9d\nto do so. Pointing an unloaded gun and threatening to shoot would not be an assault, nor, of course, could\nit be a battery. The modem tendency, however, is to define an assault as an attempt to commit a battery by\none with an apparent ability to do so.\nAssault and battery may be excused. For example, a bar owner (or her agent, the bouncer) may use\nreasonable force to remove an unruly patron. If the use of force is excessive, the bouncer can be found\nguilty of assault and battery, and a civil action could arise against the bar owner as well.\n\nOffenses against Property\nTheft: Larceny, Robbery, Embezzlement, False Pretenses\nThe concept of theft is familiar enough. Less familiar is the way the law has treated various aspects of the\nact of stealing. Criminal law distinguishes among many different crimes that are popularly known as theft.\nMany technical words have entered the language\xe2\x80\x94burglary, larceny, robbery\xe2\x80\x94but are often used\ninaccurately. Brief definitions of the more common terms are discussed here.\nThe basic crime of stealing personal property is larceny. By its old common-law definition, still in use\ntoday, larceny is the wrongful \xe2\x80\x9ctaking and carrying away of the personal property of another with intent to\nsteal the same.\xe2\x80\x9d\nThe separate elements of this offense have given rise to all kinds of difficult cases. Take the theft of fruit,\nfor example, with regard to the essential element of \xe2\x80\x9cpersonal property.\xe2\x80\x9d If a man walking through an\norchard plucks a peach from a tree and eats it, he is not guilty of larceny because he has not taken away\npersonal property (the peach is part of the land, being connected to the tree). But if he picks up a peach\nlying on the ground, he is guilty of larceny. Or consider the element of \xe2\x80\x9ctaking\xe2\x80\x9d or \xe2\x80\x9ccarrying away.\xe2\x80\x9d\nSneaking into a movie theater without paying is not an act of larceny (though in most states it is a criminal\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n215\n\n\x0cact). Taking electricity by tapping into the power lines of an electric utility was something that baffled\njudges late in the nineteenth century because it was not clear whether electricity is a \xe2\x80\x9csomething\xe2\x80\x9d that can\nbe taken. Modern statutes have tended to make clear that electricity can be the object of larceny. Or\nconsider the element of an \xe2\x80\x9cintent to steal the same.\xe2\x80\x9d If you borrow your friend\xe2\x80\x99s BMW without his\npermission in order to go to the grocery store, intending to return it within a few minutes and then do\nreturn it, you have not committed larceny. But if you meet another friend at the store who convinces you\nto take a long joyride with the car and you return hours later, you may have committed larceny.\nA particular form of larceny is robbery, which is defined as larceny from a person by means of violence or\nintimidation.\nLarceny involves the taking of property from the possession of another. Suppose that a person legitimately\ncomes to possess the property of another and wrongfully appropriates it\xe2\x80\x94for example, an automobile\nmechanic entrusted with your car refuses to return it, or a bank teller who is entitled to temporary\npossession of cash in his drawer takes it home with him. The common law had trouble with such cases\nbecause the thief in these cases already had possession; his crime was in assuming ownership. Today,\nsuch wrongful conversion, known as embezzlement, has been made a statutory offense in all states.\nStatutes against larceny and embezzlement did not cover all the gaps in the law. A conceptual problem\narises in the case of one who is tricked into giving up his title to property. In larceny and embezzlement,\nthe thief gains possession or ownership without any consent of the owner or custodian of the property.\nSuppose, however, that an automobile dealer agrees to take his customer\xe2\x80\x99s present car as a trade-in. The\ncustomer says that he has full title to the car. In fact, the customer is still paying off an installment loan\nand the finance company has an interest in the old car. If the finance company repossesses the car, the\ncustomer\xe2\x80\x94who got a new car at a discount because of his false representation\xe2\x80\x94cannot be said to have\ntaken the new car by larceny or embezzlement. Nevertheless, he tricked the dealer into selling, and the\ndealer will have lost the value of the repossessed car. Obviously, the customer is guilty of a criminal act;\nthe statutes outlawing it refer to this trickery as the crime of false pretenses, defined as obtaining\nownership of the property of another by making untrue representations of fact with intent to defraud.\nA number of problems have arisen in the judicial interpretation of false-pretense statutes. One concerns\nwhether the taking is permanent or only temporary. The case of State v. Mills (Section 6.7 "Cases") shows\nthe subtle questions that can be presented and the dangers inherent in committing \xe2\x80\x9ca little fraud.\xe2\x80\x9d\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n216\n\n\x0cIn the Mills case, the claim was that a mortgage instrument dealing with one parcel of land was used\ninstead for another. This is a false representation of fact. Suppose, by contrast, that a person\nmisrepresents his state of mind: \xe2\x80\x9cI will pay you back tomorrow,\xe2\x80\x9d he says, knowing full well that he does\nnot intend to. Can such a misrepresentation amount to false pretenses punishable as a criminal offense?\nIn most jurisdictions it cannot. A false-pretense violation relates to a past event or existing fact, not to a\nstatement of intention. If it were otherwise, anyone failing to pay a debt might find himself facing criminal\nprosecution, and business would be less prone to take risks.\nThe problem of proving intent is especially difficult when a person has availed himself of the services of\nanother without paying. A common example is someone leaving a restaurant without paying for the meal.\nIn most states, this is specifically defined in the statutes as theft of services.\n\nReceiving Stolen Property\nOne who engages in receiving stolen property with knowledge that it is stolen is guilty of a felony or\nmisdemeanor, depending on the value of the property. The receipt need not be personal; if the property is\ndelivered to a place under the control of the receiver, then he is deemed to have received it. \xe2\x80\x9cKnowledge\xe2\x80\x9d\nis construed broadly: not merely actual knowledge, but (correct) belief and suspicion (strong enough not\nto investigate for fear that the property will turn out to have been stolen) are sufficient for conviction.\n\nForgery\nForgery is false writing of a document of legal significance (or apparent legal significance!) with intent to\ndefraud. It includes the making up of a false document or the alteration of an existing one. The writing\nneed not be done by hand but can be by any means\xe2\x80\x94typing, printing, and so forth. Documents commonly\nthe subject of forgery are negotiable instruments (checks, money orders, and the like), deeds, receipts,\ncontracts, and bills of lading. The forged instrument must itself be false, not merely contain a falsehood. If\nyou fake your neighbor\xe2\x80\x99s signature on one of his checks made out to cash, you have committed forgery.\nBut if you sign a check of your own that is made out to cash, knowing that there is no money in your\nchecking account, the instrument is not forged, though the act may be criminal if done with the intent to\ndefraud.\nThe mere making of a forged instrument is unlawful. So is the \xe2\x80\x9cuttering\xe2\x80\x9d (or presentation) of such an\ninstrument, whether or not the one uttering it actually forged it. The usual example of a false signature is\nby no means the only way to commit forgery. If done with intent to defraud, the backdating of a\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n217\n\n\x0cdocument, the modification of a corporate name, or the filling in of lines left blank on a form can all\nconstitute forgery.\n\nExtortion\nUnder common law, extortion could only be committed by a government official, who corruptly collected\nan unlawful fee under color of office. A common example is a salaried building inspector who refuses to\nissue a permit unless the permittee pays him. Under modern statutes, the crime of extortion has been\nbroadened to include the wrongful collection of money or something else of value by anyone by means of a\nthreat (short of a threat of immediate physical violence, for such a threat would make the demand an act\nof robbery). This kind of extortion is usually called blackmail. The blackmail threat commonly is to expose\nsome fact of the victim\xe2\x80\x99s private life or to make a false accusation about him.\n\nOffenses against Habitation and Other Offenses\nBurglary\nBurglary is not a crime against property. It is defined as \xe2\x80\x9cthe breaking and entering of the dwelling of\nanother in the nighttime with intent to commit a felony.\xe2\x80\x9d The intent to steal is not an issue: a man who\nsneaks into a woman\xe2\x80\x99s home intent on raping her has committed a burglary, even if he does not carry out\nthe act. The student doing critical thinking will no doubt notice that the definition provides plenty of room\nfor argument. What is \xe2\x80\x9cbreaking\xe2\x80\x9d? (The courts do not require actual destruction; the mere opening of a\nclosed door, even if unlocked, is enough.) What is entry? When does night begin? What kind of intent?\nWhose dwelling? Can a landlord burglarize the dwelling of his tenant? (Yes.) Can a person burglarize his\nown home? (No.)\n\nArson\nUnder common law, arson was the malicious burning of the dwelling of another. Burning one\xe2\x80\x99s own house\nfor purposes of collecting insurance was not an act of arson under common law. The statutes today make\nit a felony intentionally to set fire to any building, whether or not it is a dwelling and whether or not the\npurpose is to collect insurance.\n\nBribery\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n218\n\n\x0cBribery is a corrupt payment (or receipt of such a payment) for official action. The payment can be in cash\nor in the form of any goods, intangibles, or services that the recipient would find valuable. Under common\nlaw, only a public official could be bribed. In most states, bribery charges can result from the bribe of\nanyone performing a public function.\nBribing a public official in government procurement (contracting) can result in serious criminal charges.\nBribing a public official in a foreign country to win a contract can result in charges under the Foreign\nCorrupt Practices Act.\n\nPerjury\nPerjury is the crime of giving a false oath, either orally or in writing, in a judicial or other official\nproceeding (lies made in proceedings other than courts are sometimes termed \xe2\x80\x9cfalse swearing\xe2\x80\x9d). To be\nperjurious, the oath must have been made corruptly\xe2\x80\x94that is, with knowledge that it was false or without\nsincere belief that it was true. An innocent mistake is not perjury. A statement, though true, is perjury if\nthe maker of it believes it to be false. Statements such as \xe2\x80\x9cI don\xe2\x80\x99t remember\xe2\x80\x9d or \xe2\x80\x9cto the best of my\nknowledge\xe2\x80\x9d are not sufficient to protect a person who is lying from conviction for perjury. To support a\ncharge of perjury, however, the false statement must be \xe2\x80\x9cmaterial,\xe2\x80\x9d meaning that the statement is relevant\nto whatever the court is trying to find out.\n\nWhite-Collar Crime\nWhite-collar crime, as distinguished from \xe2\x80\x9cstreet crime,\xe2\x80\x9d refers generally to fraud-related acts carried out\nin a nonviolent way, usually connected with business. Armed bank robbery is not a white-collar crime, but\nembezzlement by a teller or bank officer is. Many white-collar crimes are included within the statutory\ndefinitions of embezzlement and false pretenses. Most are violations of state law. Depending on how they\nare carried out, many of these same crimes are also violations of federal law.\nAny act of fraud in which the United States postal system is used or which involves interstate phone calls\nor Internet connections is a violation of federal law. Likewise, many different acts around the buying and\nselling of securities can run afoul of federal securities laws. Other white-collar crimes include tax fraud;\nprice fixing; violations of food, drug, and environmental laws; corporate bribery of foreign companies;\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n219\n\n\x0cand\xe2\x80\x94the newest form\xe2\x80\x94computer fraud. Some of these are discussed here; others are covered in later\nchapters.\n\nMail and Wire Fraud\nFederal law prohibits the use of the mails or any interstate electronic communications medium for the\npurpose of furthering a \xe2\x80\x9cscheme or artifice to defraud.\xe2\x80\x9d The statute is broad, and it is relatively easy for\nprosecutors to prove a violation. The law also bans attempts to defraud, so the prosecutor need not show\nthat the scheme worked or that anyone suffered any losses. \xe2\x80\x9cFraud\xe2\x80\x9d is broadly construed: anyone who\nuses the mails or telephone to defraud anyone else of virtually anything, not just of money, can be\nconvicted under the law. In one case, a state governor was convicted of mail fraud when he took bribes to\ninfluence the setting of racing dates. The court\xe2\x80\x99s theory was that he defrauded the citizenry of its right to\nhis \xe2\x80\x9chonest and faithful services\xe2\x80\x9d as governor.\n\n[1]\n\nViolations of Antitrust Law\nIn Chapter 23 "Corporation: General Characteristics and Formation", Chapter 24 "Legal Aspects of\nCorporate Finance", and Chapter 25 "Corporate Powers and Management", we consider the fundamentals\nof antitrust law, which for the most part affects the business enterprise civilly. But violations of Section 1\nof the Sherman Act, which condemns activities in \xe2\x80\x9crestraint of trade\xe2\x80\x9d (including price fixing), are also\ncrimes.\n\nViolations of the Food and Drug Act\nThe federal Food, Drug, and Cosmetic Act prohibits any person or corporation from sending into\ninterstate commerce any adulterated or misbranded food, drug, cosmetics, or related device. For example,\nin a 2010 case, Allergen had to pay a criminal fine for marketing Botox as a headache or pain reliever, a\nuse that had not been approved by the Food and Drug Administration. Unlike most criminal statutes,\nwillfulness or deliberate misconduct is not an element of the act. As the United States v. Park case\n(Section 6.7 "Cases") shows, an executive can be held criminally liable even though he may have had no\npersonal knowledge of the violation.\n\nEnvironmental Crimes\nMany federal environmental statutes have criminal provisions. These include the Federal Water Pollution\nControl Act (commonly called the Clean Water Act); the Rivers and Harbors Act of 1899 (the Refuse Act);\nthe Clean Air Act; the Federal Insecticide, Fungicide, and Rodenticide Act (FIFRA); the Toxic Substances\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n220\n\n\x0cControl Act (TSCA); and the Resource Conservation and Recovery Act (RCRA). Under the Clean Water\nAct, for example, wrongful discharge of pollutants into navigable waters carries a fine ranging from\n$2,500 to $25,000 per day and imprisonment for up to one year. \xe2\x80\x9cResponsible corporate officers\xe2\x80\x9d are\nspecifically included as potential defendants in criminal prosecutions under the act. They can include\nofficers who have responsibility over a project where subcontractors and their employees actually caused\nthe discharge.\n\n[2]\n\nViolations of the Foreign Corrupt Practices Act\nAs a byproduct of Watergate, federal officials at the Securities and Exchange Commission and the Internal\nRevenue Service uncovered many instances of bribes paid by major corporations to officials of foreign\ngovernments to win contracts with those governments. Congress responded in 1977 with the Foreign\nCorrupt Practices Act, which imposed a stringent requirement that the disposition of assets be accurately\nand fairly accounted for in a company\xe2\x80\x99s books and records. The act also made illegal the payment of bribes\nto foreign officials or to anyone who will transmit the money to a foreign official to assist the payor (the\none offering and delivering the money) in getting business.\n\nViolations of the Racketeering Influenced and Corrupt Organizations Act\nIn 1970 Congress enacted the Racketeering Influenced and Corrupt Organizations Act (RICO), aimed at\nending organized crime\xe2\x80\x99s infiltration into legitimate business. The act tells courts to construe its language\nbroadly \xe2\x80\x9cto effectuate its remedial purpose,\xe2\x80\x9d and many who are not part of organized crime have been\nsuccessfully prosecuted under the act. It bans a \xe2\x80\x9cpattern of racketeering,\xe2\x80\x9d defined as the commission of at\nleast two acts within ten years of any of a variety of already-existing crimes, including mail, wire, and\nsecurities fraud. The act thus makes many types of fraud subject to severe penalties.\n\nComputer Crime\nComputer crime generally falls into four categories: (1) theft of money, financial instruments, or property;\n(2) misappropriation of computer time; (3) theft of programs; and (4) illegal acquisition of information.\nThe main federal statutory framework for many computer crimes is the Computer Fraud and Abuse Act\n(CFAA; see Table 6.1 "Summary of Provisions of the Computer Fraud and Abuse Act"). Congress only\nprohibited computer fraud and abuse where there was a federal interest, as where computers of the\ngovernment were involved or where the crime was interstate in nature.\nTable 6.1 Summary of Provisions of the Computer Fraud and Abuse Act\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n221\n\n\x0cObtaining national security information\n\nSec. (a)(1)\n\n10 years maximum (20 years second\noffense)\n\nTrespassing in a government computer\n\nSec. (a)(3)\n\n1 year (5)\n\nCompromising the confidentiality of a computer\n\nSec. (a)(2)\n\n1 year (10)\n\nAccessing a computer to defraud and obtain\nvalue\n\nSec. (a)4\n\n5 years (10)\n\nIntentional access and reckless damage\n\n(a)(5)(A)(ii) 5 years (20)\n\nTrafficking in passwords\n\n(a)(6)\n\n1 year (10)\n\nKEY TAKEAWAY\nOffenses can be against persons, against property, or against public policy (as when you bribe a public\nofficial, commit perjury, or use public goods such as the mails or the Internet to commit fraud, violate\nantitrust laws, or commit other white-collar crimes).\n\nEXERCISES\n\n1.\n\nWhich does more serious harm to society: street crimes or white-collar crimes?\n\n2.\n\nWhy are various crimes so difficult to define precisely?\n\n3.\n\nHungry Harold goes by the home of Juanita Martinez. Juanita has just finished baking a cherry pie and\nsets it in the open windowsill to cool. Harold smells the pie from the sidewalk. It is twilight; while still\nlight, the sun has officially set. Harold reaches into the window frame and removes the pie. Technically,\nhas Harold committed burglary? What are the issues here based on the definition of burglary?\n\n4.\n\nWhat is fraud? How is it different from dishonesty? Is being dishonest a criminal offense? If so, have you\nbeen a criminal already today?\n5.\n\n[1] United States v. Isaacs, 493 F.2d 1124 (7th Cir. 1974), cert. denied, 417 US 976 (1974).\n\n6.\n\n[2] U.S. v. Hanousek, 176 F.3d 1116 (9th Cir. 1999).\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n222\n\n\x0c6.3 The Nature of a Criminal Act\n\nLEARNING OBJECTIVES\n\n1.\n\nUnderstand how it is possible to commit a criminal act without actually doing anything that you think\nmight be criminal.\n\n2.\n\nAnalyze and explain the importance of intention in criminal law and criminal prosecutions.\n\n3.\n\nExplain how a corporation can be guilty of a crime, even though it is a corporation\xe2\x80\x99s agents that commit\nthe crime.\n\nTo be guilty of a crime, you must have acted. Mental desire or intent to do so is insufficient. But what\nconstitutes an act? This question becomes important when someone begins to commit a crime, or\ndoes so in association with others, or intends to do one thing but winds up doing something else.\n\nAttempt\nIt is not necessary to commit the intended crime to be found guilty of a criminal offense. An attempt to\ncommit the crime is punishable as well, though usually not as severely. For example, Brett points a gun at\nAshley, intending to shoot her dead. He pulls the trigger but his aim is off, and he misses her heart by four\nfeet. He is guilty of an attempt to murder. Suppose, however, that earlier in the day, when he was\npreparing to shoot Ashley, Brett had been overheard in his apartment muttering to himself of his\nintention, and that a neighbor called the police. When they arrived, he was just snapping his gun into his\nshoulder holster.\nAt that point, courts in most states would not consider him guilty of an attempt because he had not passed\nbeyond the stage of preparation. After having buttoned his jacket he might have reconsidered and put the\ngun away. Determining when the accused has passed beyond mere preparation and taken an actual step\ntoward perpetrating the crime is often difficult and is usually for the jury to decide.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n223\n\n\x0cImpossibility\nWhat if a defendant is accused of attempting a crime that is factually impossible? For example, suppose\nthat men believed they were raping a drunken, unconscious woman, and were later accused of attempted\nrape, but defended on the grounds of factual impossibility because the woman was actually dead at the\ntime sexual intercourse took place? Or suppose that a husband intended to poison his wife with\nstrychnine in her coffee, but put sugar in the coffee instead? The \xe2\x80\x9cmens rea\xe2\x80\x9d or criminal intent was there,\nbut the act itself was not criminal (rape requires a live victim, and murder by poisoning requires the use of\npoison). States are divided on this, but thirty-seven states have ruled out factual impossibility as a defense\nto the crime of attempt.\nLegal impossibility is different, and is usually acknowledged as a valid defense. If the defendant completes\nall of his intended acts, but those acts do not fulfill all the required elements of a crime, there could be a\nsuccessful \xe2\x80\x9cimpossibility\xe2\x80\x9d defense. If Barney (who has poor sight), shoots at a tree stump, thinking it is his\nneighbor, Ralph, intending to kill him, has he committed an attempt? Many courts would hold that he has\nnot. But the distinction between factual impossibility and legal impossibility is not always clear, and the\ntrend seems to be to punish the intended attempt.\n\nConspiracy\nUnder both federal and state laws, it is a separate offense to work with others toward the commission of a\ncrime. When two or more people combine to carry out an unlawful purpose, they are engaged in a\nconspiracy. The law of conspiracy is quite broad, especially when it is used by prosecutors in connection\nwith white-collar crimes. Many people can be swept up in the net of conspiracy, because it is unnecessary\nto show that the actions they took were sufficient to constitute either the crime or an attempt. Usually, the\nprosecution needs to show only (1) an agreement and (2) a single overt act in furtherance of the\nconspiracy. Thus if three people agree to rob a bank, and if one of them goes to a store to purchase a gun\nto be used in the holdup, the three can be convicted of conspiracy to commit robbery. Even the purchase\nof an automobile to be used as the getaway car could support a conspiracy conviction.\nThe act of any one of the conspirators is imputed to the other members of the conspiracy. It does not\nmatter, for instance, that only one of the bank robbers fired the gun that killed a guard. All can be\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n224\n\n\x0cconvicted of murder. That is so even if one of the conspirators was stationed as a lookout several blocks\naway and even if he specifically told the others that his agreement to cooperate would end \xe2\x80\x9cjust as soon as\nthere is shooting.\xe2\x80\x9d\n\nAgency and Corporations\nA person can be guilty of a crime if he acts through another. Again, the usual reason for \xe2\x80\x9cimputing\xe2\x80\x9d the\nguilt of the actor to another is that both were engaged in a conspiracy. But imputation of guilt is not\nlimited to a conspiracy. The agent may be innocent even though he participates. A corporate officer\ndirects a junior employee to take a certain bag and deliver it to the officer\xe2\x80\x99s home. The employee\nreasonably believes that the officer is entitled to the bag. Unbeknownst to the employee, the bag contains\nmoney that belongs to the company, and the officer wishes to keep it. This is not a conspiracy. The\nemployee is not guilty of larceny, but the officer is, because the agent\xe2\x80\x99s act is imputed to him.\nSince intent is a necessary component of crime, an agent\xe2\x80\x99s intent cannot be imputed to his principal if the\nprincipal did not share the intent. The company president tells her sales manager, \xe2\x80\x9cGo make sure our\nbiggest customer renews his contract for next year\xe2\x80\x9d\xe2\x80\x94by which she meant, \xe2\x80\x9cDon\xe2\x80\x99t ignore our biggest\ncustomer.\xe2\x80\x9d Standing before the customer\xe2\x80\x99s purchasing agent, the sales manager threatens to tell the\npurchasing agent\xe2\x80\x99s boss that the purchasing agent has been cheating on his expense account, unless he\nsigns a new contract. The sales manager could be convicted of blackmail, but the company president could\nnot.\nCan a corporation be guilty of a crime? For many types of crimes, the guilt of individual employees may be\nimputed to the corporation. Thus the antitrust statutes explicitly state that the corporation may be\nconvicted and fined for violations by employees. This is so even though the shareholders are the ones who\nultimately must pay the price\xe2\x80\x94and who may have had nothing to do with the crime nor the power to stop\nit. The law of corporate criminal responsibility has been changing in recent years. The tendency is to hold\nthe corporation liable under criminal law if the act has been directed by a responsible officer or group\nwithin the corporation (the president or board of directors).\n\nKEY TAKEAWAY\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n225\n\n\x0cAlthough proving the intent to commit a crime (the mens rea) is essential, the intent can be established by\ninference (circumstantially). Conspirators may not actually commit a crime, for example, but in preparing\nfor a criminal act, they may be guilty of the crime of conspiracy. Certain corporate officers, as well, may\nnot be directly committing criminal acts but may be held criminally responsible for acts of their agents and\ncontractors.\n\nEXERCISES\n\n1.\n\nGive an example of how someone can intend to commit a crime but fail to commit one.\n\n2.\n\nDescribe a situation where there is a conspiracy to commit a crime without the crime actually taking\nplace.\n\n3.\n\nCreate a scenario based on current events where a corporation could be found guilty of committing a\ncrime even though the CEO, the board of directors, and the shareholders have not themselves done a\ncriminal act.\n\n6.4 Responsibility\n1.\n\nLEARNING OBJECTIVES\n\nExplain why criminal law generally requires that the defendant charged with a crime have criminal\n"intent."\n\n2.\n\nKnow and explain the possible excuses relating to responsibility that are legally recognized by courts,\nincluding lack of capacity.\n\nIn General\nThe mens rea requirement depends on the nature of the crime and all the circumstances surrounding the\nact. In general, though, the requirement means that the accused must in some way have intended the\ncriminal consequences of his act. Suppose, for example, that Charlie gives Gabrielle a poison capsule to\nswallow. That is the act. If Gabrielle dies, is Charlie guilty of murder? The answer depends on what his\nstate of mind was. Obviously, if he gave it to her intending to kill her, the act was murder.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n226\n\n\x0cWhat if he gave it to her knowing that the capsule was poison but believing that it would only make her\nmildly ill? The act is still murder, because we are all liable for the consequences of any intentional act that\nmay cause harm to others. But suppose that Gabrielle had asked Harry for aspirin, and he handed her two\npills that he reasonably believed to be aspirin (they came from the aspirin bottle and looked like aspirin)\nbut that turned out to be poison, the act would not be murder, because he had neither intent nor a state of\nknowledge from which intent could be inferred.\nNot every criminal law requires criminal intent as an ingredient of the crime. Many regulatory codes\ndealing with the public health and safety impose strict requirements. Failure to adhere to such\nrequirements is a violation, whether or not the violator had mens rea. The United States v.\nPark case, Section 6.7 "Cases", a decision of the US Supreme Court, shows the different considerations\ninvolved in mens rea.\n\nExcuses That Limit or Overcome Responsibility\nMistake of Fact and Mistake of Law\nOrdinarily, ignorance of the law is not an excuse. If you believe that it is permissible to turn right on a red\nlight but the city ordinance prohibits it, your belief, even if reasonable, does not excuse your violation of\nthe law. Under certain circumstances, however, ignorance of law will be excused. If a statute imposes\ncriminal penalties for an action taken without a license, and if the government official responsible for\nissuing the license formally tells you that you do not need one (though in fact you do), a conviction for\nviolating the statute cannot stand. In rare cases, a lawyer\xe2\x80\x99s advice, contrary to the statute, will be held to\nexcuse the client, but usually the client is responsible for his attorney\xe2\x80\x99s mistakes. Otherwise, as it is said,\nthe lawyer would be superior to the law.\nIgnorance or mistake of fact more frequently will serve as an excuse. If you take a coat from a restaurant,\nbelieving it to be yours, you cannot be convicted of larceny if it is not. Your honest mistake of fact negates\nthe requisite intent. In general, the rule is that a mistaken belief of fact will excuse criminal responsibility\nif (1) the belief is honestly held, (2) it is reasonable to hold it, and (3) the act would not have been criminal\nif the facts were as the accused supposed them to have been.\n\nEntrapment\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n227\n\n\x0cOne common technique of criminal investigation is the use of an undercover agent or decoy\xe2\x80\x94the\npoliceman who poses as a buyer of drugs from a street dealer or the elaborate \xe2\x80\x9csting\xe2\x80\x9d operations in which\nostensibly stolen goods are \xe2\x80\x9csold\xe2\x80\x9d to underworld \xe2\x80\x9cfences.\xe2\x80\x9d Sometimes these methods are the only way by\nwhich certain kinds of crime can be rooted out and convictions secured.\nBut a rule against entrapment limits the legal ability of the police to play the role of criminals. The police\nare permitted to use such techniques to detect criminal activity; they are not permitted to do so to\ninstigate crime. The distinction is usually made between a person who intends to commit a crime and one\nwho does not. If the police provide the former with an opportunity to commit a criminal act\xe2\x80\x94the sale of\ndrugs to an undercover agent, for example\xe2\x80\x94there is no defense of entrapment. But if the police knock on\nthe door of one not known to be a drug user and persist in a demand that he purchase drugs from them,\nfinally overcoming his will to resist, a conviction for purchase and possession of drugs can be overturned\non the ground of entrapment.\n\nOther Excuses\nA number of other circumstances can limit or excuse criminal liability. These include compulsion (a gun\npointed at one\xe2\x80\x99s head by a masked man who apparently is unafraid to use the weapon and who demands\nthat you help him rob a store), honest consent of the \xe2\x80\x9cvictim\xe2\x80\x9d (the quarterback who is tackled), adherence\nto the requirements of legitimate public authority lawfully exercised (a policeman directs a towing\ncompany to remove a car parked in a tow-away zone), the proper exercise of domestic authority (a parent\nmay spank a child, within limits), and defense of self, others, property, and habitation. Each of these\nexcuses is a complex subject in itself.\n\nLack of Capacity\nA further defense to criminal prosecution is the lack of mental capacity to commit the crime. Infants and\nchildren are considered incapable of committing a crime; under common law any child under the age of\nseven could not be prosecuted for any act. That age of incapacity varies from state to state and is now\nusually defined by statutes. Likewise, insanity or mental disease or defect can be a complete defense.\nIntoxication can be a defense to certain crimes, but the mere fact of drunkenness is not ordinarily\nsufficient.\n\nSaylor URL: http://www.saylor.org/books\n\nKEY TAKEAWAY\n\nSaylor.org\n228\n\n\x0cIn the United States, some crimes can be committed by not following strict regulatory requirements for\nhealth, safety, or the environment. The law does provide excuses from criminal liability for mistakes of\nfact, entrapment, and lack of capacity.\n\nEXERCISES\n\n1.\n\nDescribe several situations in which compulsion, consent, or other excuses take away criminal liability.\n\n2.\n\nYour employee is drunk on the job and commits the crime of assault and battery on a customer. He claims\nlack of capacity as an excuse. Should the courts accept this excuse? Why or why not?\n\n6.5 Procedure\n1.\n\nLEARNING OBJECTIVES\n\nDescribe the basic steps in pretrial criminal procedure that follow a government\'s determination to arrest\nsomeone for an alleged criminal act.\n\n2.\n\nDescribe the basic elements of trial and posttrial criminal procedure.\n\nThe procedure for criminal prosecutions is complex. Procedures will vary from state to state. A\ncriminal case begins with an arrest if the defendant is caught in the act or fleeing from the scene; if\nthe defendant is not caught, a warrant for the defendant\xe2\x80\x99s arrest will issue. The warrant is issued by a\njudge or a magistrate upon receiving a complaint detailing the charge of a specific crime against the\naccused. It is not enough for a police officer to go before a judge and say, \xe2\x80\x9cI\xe2\x80\x99d like you to arrest\nBonnie because I think she\xe2\x80\x99s just murdered Clyde.\xe2\x80\x9d She must supply enough information to satisfy\nthe magistrate that there is probable cause (reasonable grounds) to believe that the accused\ncommitted the crime. The warrant will be issued to any officer or agency that has power to arrest the\naccused with warrant in hand.\nThe accused will be brought before the magistrate for a preliminary hearing. The purpose of the\nhearing is to determine whether there is sufficient reason to hold the accused for trial. If so, the\naccused can be sent to jail or be permitted to make bail. Bail is a sum of money paid to the court to\nsecure the defendant\xe2\x80\x99s attendance at trial. If he fails to appear, he forfeits the money.\nConstitutionally, bail can be withheld only if there is reason to believe that the accused will flee the\njurisdiction.\nOnce the arrest is made, the case is in the hands of the prosecutor. In the fifty states, prosecution is a\nfunction of the district attorney\xe2\x80\x99s office. These offices are usually organized on a county-by-county\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n229\n\n\x0cbasis. In the federal system, criminal prosecution is handled by the office of the US attorney, one of\nwhom is appointed for every federal district.\nFollowing the preliminary hearing, the prosecutor must either file aninformation (a document stating\nthe crime of which the person being held is accused) or ask the grand jury for an indictment. The\ngrand jury consists of twenty-three people who sit to determine whether there is sufficient evidence\nto warrant a prosecution. It does not sit to determine guilt or innocence. The indictment is the grand\njury\xe2\x80\x99s formal declaration of charges on which the accused will be tried. If indicted, the accused\nformally becomes a defendant.\nThe defendant will then be arraigned, that is, brought before a judge to answer the accusation in the\nindictment. The defendant may plead guilty or not guilty. If he pleads not guilty, the case will be tried\nbefore a jury (sometimes referred to as a petit jury). The jury cannot convict unless it finds the\ndefendant guilty beyond a reasonable doubt.\nThe defendant might have pleaded guilty to the offense or to a lesser charge (often referred to as a\n\xe2\x80\x9clesser included offense\xe2\x80\x9d\xe2\x80\x94simple larceny, for example, is a lesser included offense of robbery\nbecause the defendant may not have used violence but nevertheless stole from the victim). Such a\nplea is usually arranged through plea bargaining with the prosecution. In return for the plea, the\nprosecutor promises to recommend to the judge that the sentence be limited. The judge most often,\nbut not always, goes along with the prosecutor\xe2\x80\x99s recommendation.\nThe defendant is also permitted to file a plea of nolo contendere (no contest) in prosecutions for\ncertain crimes. In so doing, he neither affirms nor denies his guilt. He may be sentenced as though he\nhad pleaded guilty, although usually a nolo plea is the result of a plea bargain. Why plead nolo? In\nsome offenses, such as violations of the antitrust laws, the statutes provide that private plaintiffs may\nuse a conviction or a guilty plea as proof that the defendant violated the law. This enables a plaintiff\nto prove liability without putting on witnesses or evidence and reduces the civil trial to a hearing\nabout the damages to plaintiff. The nolo plea permits the defendant to avoid this, so that any plaintiff\nwill have to not only prove damages but also establish civil liability.\nFollowing a guilty plea or a verdict of guilt, the judge will impose a sentence after presentencing\nreports are written by various court officials (often, probation officers). Permissible sentences are\nspelled out in statutes, though these frequently give the judge a range within which to work (e.g.,\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n230\n\n\x0ctwenty years to life). The judge may sentence the defendant to imprisonment, a fine, or both, or may\ndecide to suspend sentence (i.e., the defendant will not have to serve the sentence as long as he stays\nout of trouble).\nSentencing usually comes before appeal. As in civil cases, the defendant, now convicted, has the right\nto take at least one appeal to higher courts, where issues of procedure and constitutional rights may\nbe argued.\n\nKEY TAKEAWAY\n\nCriminal procedure in US courts is designed to provide a fair process to both criminal defendants and to\nsociety. The grand jury system, prosecutorial discretion, plea bargains, and appeals for lack of a fair trial\nare all part of US criminal procedure.\n\n1.\n\nEXERCISES\n\nHarold is charged with the crime of assault with a deadly weapon with intent to kill or inflict serious bodily\ninjury. It is a more serious crime than simple assault. Harold\xe2\x80\x99s attorney wants the prosecutor to give\nHarold a break, but Harold is guilty of at least simple assault and may also have had the intent to kill.\nWhat is Harold\xe2\x80\x99s attorney likely to do?\n\n2.\n\nKumar was driving his car, smoking marijuana, and had an accident with another vehicle. The other driver\nwas slightly injured. When the officer arrived, she detected a strong odor of marijuana in Kumar\xe2\x80\x99s car and\na small amount of marijuana in the glove compartment. The other driver expects to bring a civil action\nagainst Kumar for her injuries after Kumar\xe2\x80\x99s criminal case. What should Kumar plead in the criminal\ncase\xe2\x80\x94careless driving or driving under the influence?\n\n6.6 Constitutional Rights of the Accused\n\nLEARNING OBJECTIVES\n\n1.\n\nDescribe the most significant constitutional rights of defendants in US courts, and name the source of\nthese rights.\n\n2.\n\nExplain the Exclusionary rule and the reason for its existence.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n231\n\n\x0cSearch and Seizure\nThe rights of those accused of a crime are spelled out in four of the ten constitutional amendments that\nmake up the Bill of Rights (Amendments Four, Five, Six, and Eight). For the most part, these\namendments have been held to apply to both the federal and the state governments. The Fourth\nAmendment says in part that \xe2\x80\x9cthe right of the people to be secure in their persons, houses, papers, and\neffects, against unreasonable searches and seizures, shall not be violated.\xe2\x80\x9d Although there are numerous\nand tricky exceptions to the general rule, ordinarily the police may not break into a person\xe2\x80\x99s house or\nconfiscate his papers or arrest him unless they have a warrant to do so. This means, for instance, that a\npoliceman cannot simply stop you on a street corner and ask to see what is in your pockets (a power the\npolice enjoy in many other countries), nor can your home be raided without probable cause to believe that\nyou have committed a crime. What if the police do search or seize unreasonably?\nThe courts have devised a remedy for the use at trial of the fruits of an unlawful search or seizure.\nEvidence that is unconstitutionally seized is excluded from the trial. This is the so-called exclusionary\nrule, first made applicable in federal cases in 1914 and brought home to the states in 1961.\nThe exclusionary rule is highly controversial, and there are numerous exceptions to it. But it remains\ngenerally true that the prosecutor may not use evidence willfully taken by the police in violation of\nconstitutional rights generally, and most often in the violation of Fourth Amendment rights. (The fruits of\na coerced confession are also excluded.)\n\nDouble Jeopardy\nThe Fifth Amendment prohibits the government from prosecuting a person twice for the same offense.\nThe amendment says that no person shall be \xe2\x80\x9csubject for the same offence to be twice put in jeopardy of\nlife or limb.\xe2\x80\x9d If a defendant is acquitted, the government may not appeal. If a defendant is convicted and\nhis conviction is upheld on appeal, he may not thereafter be reprosecuted for the same crime.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n232\n\n\x0cSelf-Incrimination\nThe Fifth Amendment is also the source of a person\xe2\x80\x99s right against self-incrimination (no person \xe2\x80\x9cshall be\ncompelled in any criminal case to be a witness against himself\xe2\x80\x9d). The debate over the limits of this right\nhas given rise to an immense literature. In broadest outline, the right against self-incrimination means\nthat the prosecutor may not call a defendant to the witness stand during trial and may not comment to the\njury on the defendant\xe2\x80\x99s failure to take the stand. Moreover, a defendant\xe2\x80\x99s confession must be excluded\nfrom evidence if it was not voluntarily made (e.g., if the police beat the person into giving a confession).\nIn Miranda v. Arizona, the Supreme Court ruled that no confession is admissible if the police have not\nfirst advised a suspect of his constitutional rights, including the right to have a lawyer present to advise\nhim during the questioning.\n\n[1]\n\nThese so-called Miranda warnings have prompted scores of follow-up cases\n\nthat have made this branch of jurisprudence especially complex.\n\nSpeedy Trial\nThe Sixth Amendment tells the government that it must try defendants speedily. How long a delay is too\nlong depends on the circumstances in each case. In 1975, Congress enacted the Speedy Trial Act to give\npriority to criminal cases in federal courts. It requires all criminal prosecutions to go to trial within\nseventy-five days (though the law lists many permissible reasons for delay).\n\nCross-Examination\nThe Sixth Amendment also says that the defendant shall have the right to confront witnesses against him.\nNo testimony is permitted to be shown to the jury unless the person making it is present and subject to\ncross-examination by the defendant\xe2\x80\x99s counsel.\n\nAssistance of Counsel\nThe Sixth Amendment guarantees criminal defendants the right to have the assistance of defense counsel.\nDuring the eighteenth century and before, the British courts frequently refused to permit defendants to\nhave lawyers in the courtroom during trial. The right to counsel is much broader in this country, as the\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n233\n\n\x0cresult of Supreme Court decisions that require the state to pay for a lawyer for indigent defendants in\nmost criminal cases.\n\nCruel and Unusual Punishment\nPunishment under the common law was frequently horrifying. Death was a common punishment for\nrelatively minor crimes. In many places throughout the world, punishments still persist that seem cruel\nand unusual, such as the practice of stoning someone to death. The guillotine, famously in use during and\nafter the French Revolution, is no longer used, nor are defendants put in stocks for public display and\nhumiliation. In pre-Revolutionary America, an unlucky defendant who found himself convicted could face\nbrutal torture before death.\nThe Eighth Amendment banned these actions with the words that \xe2\x80\x9ccruel and unusual punishments [shall\nnot be] inflicted.\xe2\x80\x9d Virtually all such punishments either never were enacted or have been eliminated from\nthe statute books in the United States. Nevertheless, the Eighth Amendment has become a source of\ncontroversy, first with the Supreme Court\xe2\x80\x99s ruling in 1976 that the death penalty, as haphazardly applied\nin the various states, amounted to cruel and unusual punishment. Later Supreme Court opinions have\nmade it easier for states to administer the death penalty. As of 2010, there were 3,300 defendants on\ndeath row in the United States. Of course, no corporation is on death row, and no corporation\xe2\x80\x99s charter\nhas ever been revoked by a US state, even though some corporations have repeatedly been indicted and\nconvicted of criminal offenses.\n\nPresumption of Innocence\nThe most important constitutional right in the US criminal justice system is the presumption of\ninnocence. The Supreme Court has repeatedly cautioned lower courts in the United States that juries must\nbe properly instructed that the defendant is innocent until proven guilty. This is the origin of the \xe2\x80\x9cbeyond\nall reasonable doubt\xe2\x80\x9d standard of proof and is an instruction given to juries in each criminal case. The\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n234\n\n\x0cFifth Amendment notes the right of \xe2\x80\x9cdue process\xe2\x80\x9d in federal proceedings, and the Fourteenth Amendment\nrequires that each state provide \xe2\x80\x9cdue process\xe2\x80\x9d to defendants.\n\nKEY TAKEAWAY\n\nThe US Constitution provides several important protections for criminal defendants, including a\nprohibition on the use of evidence that has been obtained by unconstitutional means. This would include\nevidence seized in violation of the Fourth Amendment and confessions obtained in violation of the Fifth\nAmendment.\n\n1.\n\nEXERCISES\n\nDo you think it is useful to have a presumption of innocence in criminal cases? What if there were not a\npresumption of innocence in criminal cases?\n\n2.\n\nDo you think public humiliation, public execution, and unusual punishments would reduce the amount of\ncrime? Why do you think so?\n\n3.\n\n\xe2\x80\x9cDue process\xe2\x80\x9d is another phrase for \xe2\x80\x9cfairness.\xe2\x80\x9d Why should the public show fairness toward criminal\ndefendants?\n\n[1] Miranda v. Arizona, 384 US 436 (1966).\n\n6.7 Cases\nFalse Pretenses\nState v. Mills\n96 Ariz. 377, 396 P.2d 5 (Ariz. 1964)\nLOCKWOOD, VICE CHIEF JUSTICE\nDefendants appeal from a conviction on two counts of obtaining money by false pretenses in violation of\nAR.S. \xc2\xa7\xc2\xa7 13-661.A3. and 13-663.A1. The material facts, viewed \xe2\x80\x9c\xe2\x80\xa6in the light most favorable to sustaining\nthe conviction,\xe2\x80\x9d are as follows: Defendant William Mills was a builder and owned approximately 150\nhomes in Tucson in December, 1960. Mills conducted his business in his home. In 1960 defendant\nWinifred Mills, his wife, participated in the business generally by answering the telephone, typing, and\nreceiving clients who came to the office.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n235\n\n\x0cIn December 1960, Mills showed the complainant, Nathan Pivowar, a house at 1155 Knox Drive and\nanother at 1210 Easy Street, and asked Pivowar if he would loan money on the Knox Drive house. Pivowar\ndid not indicate at that time whether he would agree to such a transaction. Later in the same month\nNathan Pivowar told the defendants that he and his brother, Joe Pivowar, would loan $5,000 and $4,000\non the two houses. Three or four days later Mrs. Mills, at Pivowar\xe2\x80\x99s request, showed him these homes\nagain.\nMills had prepared two typed mortgages for Pivowar. Pivowar objected to the wording, so in Mills\xe2\x80\x99 office\nMrs. Mills retyped the mortgages under Pivowar\xe2\x80\x99s dictation. After the mortgages had been recorded on\nDecember 31, 1960, Pivowar gave Mills a bank check for $5,791.87, some cash, and a second mortgage\nformerly obtained from Mills in the approximate sum of $3,000. In exchange Mills gave Pivowar two\npersonal notes in the sums of $5,250.00 and $4,200.00 and the two mortgages as security for the loan.\nAlthough the due date for Mills\xe2\x80\x99 personal notes passed without payment being made, the complainant did\nnot present the notes for payment, did not demand that they be paid, and did not sue upon them. In 1962\nthe complainant learned that the mortgages which he had taken as security in the transaction were not\nfirst mortgages on the Knox Drive and Easy Street properties. These mortgages actually covered two\nvacant lots on which there were outstanding senior mortgages. On learning this, Pivowar signed a\ncomplaint charging the defendants with the crime of theft by false pretenses.\nOn appeal defendants contend that the trial court erred in denying their motion to dismiss the\ninformation. They urge that a permanent taking of property must be proved in order to establish the\ncrime of theft. Since the complainant had the right to sue on the defendants\xe2\x80\x99 notes, the defendants assert\nthat complainant cannot be said to have been deprived of his property permanently. Defendants\nmisconceive the elements of the crime of theft by false pretenses. Stated in a different form, their\nargument is that although the complainant has parted with his cash, a bank check, and a second\nmortgage, the defendants intend to repay the loan.\nDefendants admit that the proposition of law which they assert is a novel one in this jurisdiction.\nRespectable authority in other states persuades us that their contention is without merit. A creditor has a\nright to determine for himself whether he wishes to be a secured or an unsecured creditor. In the former\ncase, he has a right to know about the security. If he extends credit in reliance upon security which is\nfalsely represented to be adequate, he has been defrauded even if the debtor intends to repay the debt. His\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n236\n\n\x0cposition is now that of an unsecured creditor. At the very least, an unreasonable risk of loss has been\nforced upon him by reason of the deceit. This risk which he did not intend to assume has been imposed\nupon him by the intentional act of the debtor, and such action constitutes an intent to defraud.\n***\nThe cases cited by defendants in support of their contention are distinguishable from the instant case in\nthat they involved theft by larceny. Since the crime of larceny is designed to protect a person\xe2\x80\x99s possessory\ninterest in property whereas the crime of false pretenses protects one\xe2\x80\x99s title interest, the requirement of a\npermanent deprivation is appropriate to the former. Accordingly, we hold that an intent to repay a loan\nobtained on the basis of a false representation of the security for the loan is no defense.\n***\nAffirmed in part, reversed in part, and remanded for resentencing.\n\nCASE QUESTIONS\n\n1.\n\nFalse pretenses is a crime of obtaining ownership of property of another by making untrue\nrepresentations of fact with intent to defraud. What were the untrue representations of fact made by\nMills?\n\n2.\n\nConcisely state the defendant\xe2\x80\x99s argument as to why Pivowar has not been deprived of any property.\n\n3.\n\nIf Pivowar had presented the notes and Mills had paid, would a crime have been committed?\n\nWhite-Collar Crimes\nUnited States v. Park\n421 U.S. 658 (1975)\nMR. CHIEF JUSTICE BURGER delivered the opinion of the Court.\nWe granted certiorari to consider whether the jury instructions in the prosecution of a corporate officer\nunder \xc2\xa7 301 (k) of the Federal Food, Drug, and Cosmetic Act, 52 Stat. 1042, as amended, 21 U.S.C. \xc2\xa7 331\n(k), were appropriate under United States v. Dotterweich, 320 U.S. 277 (1943). Acme Markets, Inc., is a\nnational retail food chain with approximately 36,000 employees, 874 retail outlets, 12 general\nwarehouses, and four special warehouses. Its headquarters, including the office of the president,\nrespondent Park, who is chief executive officer of the corporation, are located in Philadelphia,\nPennsylvania. In a five-count information filed in the United States District Court for the District of\nMaryland, the Government charged Acme and respondent with violations of the Federal Food, Drug, and\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n237\n\n\x0cCosmetic Act. Each count of the information alleged that the defendants had received food that had been\nshipped in interstate commerce and that, while the food was being held for sale in Acme\xe2\x80\x99s Baltimore\nwarehouse following shipment in interstate commerce, they caused it to be held in a building accessible to\nrodents and to be exposed to contamination by rodents. These acts were alleged to have resulted in the\nfood\xe2\x80\x99s being adulterated within the meaning of 21 U.S.C. \xc2\xa7\xc2\xa7 342 (a)(3) and (4), in violation of 21 U.S.C. \xc2\xa7\n331 (k).\nAcme pleaded guilty to each count of the information. Respondent pleaded not guilty. The evidence at\ntrial demonstrated that in April 1970 the Food and Drug Administration (FDA) advised respondent by\nletter of insanitary conditions in Acme\xe2\x80\x99s Philadelphia warehouse. In 1971 the FDA found that similar\nconditions existed in the firm\xe2\x80\x99s Baltimore warehouse. An FDA consumer safety officer testified concerning\nevidence of rodent infestation and other insanitary conditions discovered during a 12-day inspection of\nthe Baltimore warehouse in November and December 1971. He also related that a second inspection of the\nwarehouse had been conducted in March 1972. On that occasion the inspectors found that there had been\nimprovement in the sanitary conditions, but that \xe2\x80\x9cthere was still evidence of rodent activity in the building\nand in the warehouses and we found some rodent-contaminated lots of food items.\xe2\x80\x9d\nThe Government also presented testimony by the Chief of Compliance of the FDA\xe2\x80\x99s Baltimore office, who\ninformed respondent by letter of the conditions at the Baltimore warehouse after the first inspection.\nThere was testimony by Acme\xe2\x80\x99s Baltimore division vice president, who had responded to the letter on\nbehalf of Acme and respondent and who described the steps taken to remedy the insanitary conditions\ndiscovered by both inspections. The Government\xe2\x80\x99s final witness, Acme\xe2\x80\x99s vice president for legal affairs\nand assistant secretary, identified respondent as the president and chief executive officer of the company\nand read a bylaw prescribing the duties of the chief executive officer. He testified that respondent\nfunctioned by delegating \xe2\x80\x9cnormal operating duties\xe2\x80\x9d including sanitation, but that he retained \xe2\x80\x9ccertain\nthings, which are the big, broad, principles of the operation of the company and had \xe2\x80\x9cthe responsibility of\nseeing that they all work together.\xe2\x80\x9d\nAt the close of the Government\xe2\x80\x99s case in chief, respondent moved for a judgment of acquittal on the\nground that \xe2\x80\x9cthe evidence in chief has shown that Mr. Park is not personally concerned in this Food and\nDrug violation.\xe2\x80\x9d The trial judge denied the motion, stating that United States v. Dotterweich, 320 U.S. 277\n(1943), was controlling.\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n238\n\n\x0cRespondent was the only defense witness. He testified that, although all of Acme\xe2\x80\x99s employees were in a\nsense under his general direction, the company had an \xe2\x80\x9corganizational structure for responsibilities for\ncertain functions\xe2\x80\x9d according to which different phases of its operation were \xe2\x80\x9cassigned to individuals who,\nin turn, have staff and departments under them.\xe2\x80\x9d He identified those individuals responsible for\nsanitation, and related that upon receipt of the January 1972 FDA letter, he had conferred with the vice\npresident for legal affairs, who informed him that the Baltimore division vice president \xe2\x80\x9cwas investigating\nthe situation immediately and would be taking corrective action and would be preparing a summary of the\ncorrective action to reply to the letter.\xe2\x80\x9d Respondent stated that he did not \xe2\x80\x9cbelieve there was anything [he]\ncould have done more constructively than what [he] found was being done.\xe2\x80\x9d\nOn cross-examination, respondent conceded that providing sanitary conditions for food offered for sale to\nthe public was something that he was \xe2\x80\x9cresponsible for in the entire operation of the company\xe2\x80\x9d and he\nstated that it was one of many phases of the company that he assigned to \xe2\x80\x9cdependable subordinates.\xe2\x80\x9d\nRespondent was asked about and, over the objections of his counsel, admitted receiving, the April 1970\nletter addressed to him from the FDA regarding insanitary conditions at Acme\xe2\x80\x99s Philadelphia warehouse.\nHe acknowledged that, with the exception of the division vice president, the same individuals had\nresponsibility for sanitation in both Baltimore and Philadelphia. Finally, in response to questions\nconcerning the Philadelphia and Baltimore incidents, respondent admitted that the Baltimore problem\nindicated the system for handling sanitation \xe2\x80\x9cwasn\xe2\x80\x99t working perfectly\xe2\x80\x9d and that as Acme\xe2\x80\x99s chief executive\nofficer he was \xe2\x80\x9cresponsible for any result which occurs in our company.\xe2\x80\x9d\nAt the close of the evidence, respondent\xe2\x80\x99s renewed motion for a judgment of acquittal was denied. The\nrelevant portion of the trial judge\xe2\x80\x99s instructions to the jury challenged by respondent is set out in the\nmargin. Respondent\xe2\x80\x99s counsel objected to the instructions on the ground that they failed fairly to reflect\nour decision in United States v. Dotterweich supra, and to define \xe2\x80\x9c\xe2\x80\x98responsible relationship.\xe2\x80\x99\xe2\x80\x9d The trial\njudge overruled the objection. The jury found respondent guilty on all counts of the information, and he\nwas subsequently sentenced to pay a fine of $50 on each count. The Court of Appeals reversed the\nconviction and remanded for a new trial.\n***\nThe question presented by the Government\xe2\x80\x99s petition for certiorari in United States v. Dotterweich, and\nthe focus of this Court\xe2\x80\x99s opinion, was whether the manager of a corporation, as well as the corporation\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n239\n\n\x0citself, may be prosecuted under the Federal Food, Drug, and Cosmetic Act of 1938 for the introduction of\nmisbranded and adulterated articles into interstate commerce. In Dotterweich, a jury had disagreed as to\nthe corporation, a jobber purchasing drugs from manufacturers and shipping them in interstate\ncommerce under its own label, but had convicted Dotterweich, the corporation\xe2\x80\x99s president and general\nmanager. The Court of Appeals reversed the conviction on the ground that only the drug dealer, whether\ncorporation or individual, was subject to the criminal provisions of the Act, and that where the dealer was\na corporation, an individual connected therewith might be held personally only if he was operating the\ncorporation as his \xe2\x80\x98alter ego.\xe2\x80\x99\nIn reversing the judgment of the Court of Appeals and reinstating Dotterweich\xe2\x80\x99s conviction, this Court\nlooked to the purposes of the Act and noted that they \xe2\x80\x9ctouch phases of the lives and health of people\nwhich, in the circumstances of modern industrialism, are largely beyond self-protection. It observed that\nthe Act is of \xe2\x80\x9ca now familiar type\xe2\x80\x9d which \xe2\x80\x9cdispenses with the conventional requirement for criminal\nconduct-awareness of some wrongdoing: In the interest of the larger good it puts the burden of acting at\nhazard upon a person otherwise innocent but standing in responsible relation to a public danger. Central\nto the Court\xe2\x80\x99s conclusion that individuals other than proprietors are subject to the criminal provisions of\nthe Act was the reality that the only way in which a corporation can act is through the individuals, who act\non its behalf.\n***\nThe Court recognized that, because the Act dispenses with the need to prove \xe2\x80\x9cconsciousness of\nwrongdoing,\xe2\x80\x9d it may result in hardship even as applied to those who share \xe2\x80\x9cresponsibility in the business\nprocess resulting in\xe2\x80\x9d a violation.\xe2\x80\xa6The rule that corporate employees who have \xe2\x80\x9ca responsible share in the\nfurtherance of the transaction which the statute outlaws\xe2\x80\x9d are subject to the criminal provisions of the Act\nwas not formulated in a vacuum. Cf. Morissette v. United States, 342 U.S. 246, 258 (1952). Cases under\nthe Federal Food and Drugs Act of 1906 reflected the view both that knowledge or intent were not\nrequired to be proved in prosecutions under its criminal provisions, and that responsible corporate agents\ncould be subjected to the liability thereby imposed.\n***\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n240\n\n\x0cThe rationale of the interpretation given the Act in Dotterweich\xe2\x80\xa6has been confirmed in our subsequent\ncases. Thus, the Court has reaffirmed the proposition that the public interest in the purity of its food is so\ngreat as to warrant the imposition of the highest standard of care on distributors.\nThus Dotterweich and the cases which have followed reveal that in providing sanctions which reach and\ntouch the individuals who execute the corporate mission\xe2\x80\x94and this is by no means necessarily confined to\na single corporate agent or employee\xe2\x80\x94the Act imposes not only a positive duty to seek out and remedy\nviolations when they occur but also, and primarily, a duty to implement measures that will insure that\nviolations will not occur. The requirements of foresight and vigilance imposed on responsible corporate\nagents are beyond question demanding, and perhaps onerous, but they are no more stringent than the\npublic has a right to expect of those who voluntarily assume positions of authority in business enterprises\nwhose services and products affect the health and well-being of the public that supports them.\n***\nReading the entire charge satisfies us that the jury\xe2\x80\x99s attention was adequately focused on the issue of\nrespondent\xe2\x80\x99s authority with respect to the conditions that formed the basis of the alleged violations.\nViewed as a whole, the charge did not permit the jury to find guilt solely on the basis of respondent\xe2\x80\x99s\nposition in the corporation; rather, it fairly advised the jury that to find guilt it must find respondent \xe2\x80\x9chad\na responsible relation to the situation,\xe2\x80\x9d and \xe2\x80\x9cby virtue of his position\xe2\x80\xa6had\xe2\x80\xa6authority and responsibility\xe2\x80\x9d\nto deal with the situation.\nThe situation referred to could only be \xe2\x80\x9cfood\xe2\x80\xa6held in unsanitary conditions in a warehouse with the result\nthat it consisted, in part, of filth or\xe2\x80\xa6may have been contaminated with filth.\xe2\x80\x9d\nOur conclusion that the Court of Appeals erred in its reading of the jury charge suggests as well our\ndisagreement with that court concerning the admissibility of evidence demonstrating that respondent was\nadvised by the FDA in 1970 of insanitary conditions in Acme\xe2\x80\x99s Philadelphia warehouse. We are satisfied\nthat the Act imposes the highest standard of care and permits conviction of responsible corporate officials\nwho, in light of this standard of care, have the power to prevent or correct violations of its provisions.\n***\nReversed.\n\nSaylor URL: http://www.saylor.org/books\n\nCASE QUESTIONS\n\nSaylor.org\n241\n\n\x0c1.\n\nDid Park have criminal intent to put adulterated food into commerce? If not, how can Park\xe2\x80\x99s conduct be\ncriminalized?\n\n2.\n\nTo get a conviction, what does the prosecutor have to show, other than that Park was the CEO of Acme\nand therefore responsible for what his company did or didn\xe2\x80\x99t do?\n\n6.8 Summary and Exercises\nSummary\n\nCriminal law is that branch of law governing offenses against society. Most criminal law requires a specific\nintent to commit the prohibited act (although a very few economic acts, made criminal by modern\nlegislation, dispense with the requirement of intent). In this way, criminal law differs from much of civil\nlaw\xe2\x80\x94for example, from the tort of negligence, in which carelessness, rather than intent, can result in\nliability.\nMajor crimes are known as felonies. Minor crimes are known as misdemeanors. Most people have a\ngeneral notion about familiar crimes, such as murder and theft. But conventional knowledge does not\nsuffice for understanding technical distinctions among related crimes, such as larceny, robbery, and false\npretenses. These distinctions can be important because an individual can be found guilty not merely for\ncommitting one of the acts defined in the criminal law but also for attempting or conspiring to commit\nsuch an act. It is usually easier to convict someone of attempt or conspiracy than to convict for the main\ncrime, and a person involved in a conspiracy to commit a felony may find that very little is required to put\nhim into serious trouble.\nOf major concern to the business executive is white-collar crime, which encompasses a host of offenses,\nincluding bribery, embezzlement, fraud, restraints of trade, and computer crime. Anyone accused of crime\nshould know that they always have the right to consult with a lawyer and should always do so.\n\nEXERCISES\n\n1.\n\nBill is the chief executive of a small computer manufacturing company that desperately needs funds to\ncontinue operating. One day a stranger comes to Bill to induce him to take part in a cocaine smuggling\ndeal that would net Bill millions of dollars. Unbeknownst to Bill, the stranger is an undercover policeman.\nBill tells the stranger to go away. The stranger persists, and after five months of arguing and cajoling, the\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n242\n\n\x0cstranger wears down Bill\xe2\x80\x99s will to resist. Bill agrees to take delivery of the cocaine and hands over a down\npayment of $10,000 to the undercover agent, who promptly arrests him for conspiracy to violate the\nnarcotics laws. What defenses does Bill have?\n2.\n\nYou are the manager of a bookstore. A customer becomes irritated at having to stand in line and begins to\nshout at the salesclerk for refusing to wait on him. You come out of your office and ask the customer to\ncalm down. He shouts at you. You tell him to leave. He refuses. So you and the salesclerk pick him up and\nshove him bodily out the door. He calls the police to have you arrested for assault. Should the police\narrest you? Assuming that they do, how would you defend yourself in court?\n\n3.\n\nMarilyn is arrested for arson against a nuclear utility, a crime under both state and federal law. She is\nconvicted in state court and sentenced to five years in jail. Then the federal government decides to\nprosecute her for the same offense. Does she have a double-jeopardy defense against the federal\nprosecution?\n\n4.\n\nTectonics, a US corporation, is bidding on a project in Nigeria, and its employee wins the bid by secretly\ngiving $100,000 to the Nigerian public official that has the most say about which company will be\nawarded the contract. The contract is worth $80 million, and Tectonics expects to make at least $50\nmillion on the project. Has a crime under US law been committed?\n\n5.\n\nSuppose that the CEO of Tectonics, Ted Nelson, is not actually involved in bribery of the Nigerian public\nofficial Adetutu Adeleke. Instead, suppose that the CFO, Jamie Skillset, is very accomplished at insulating\nboth top management and the board of directors from some of the \xe2\x80\x9coperational realities\xe2\x80\x9d within the\ncompany. Skillset knows that Whoopi Goldmine, a Nigerian employee of Tectonics, has made the deal\nwith Adeleke and secured the contract for Tectonics. Is it possible that Nelson, as well as Skillset, can be\nfound guilty of a crime?\n\n6.\n\nYou have graduated from college and, after working hard for ten years, have scraped enough money\ntogether to make a down payment on a forty-acre farm within driving distance to the small city where\nyou work in Colorado. In town at lunch one day, you run into an old friend from high school, Hayley Mills,\nwho tells you that she is saving her money to start a high-end consignment shop in town. You allow her to\nhave a room in your house for a few months until she has enough money to go into business. Over the\nfollowing weeks, however, you realize that old acquaintances from high school are stopping by almost\ndaily for short visits. When you bring this up to Hayley, she admits that many old friends are now relying\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n243\n\n\x0con her for marijuana. She is not a licensed caregiver in Colorado and is clearly violating the law. Out of\nloyalty, you tell her that she has three weeks to move out, but you do not prevent her from continuing\nsales while she is there. What crime have you committed?\n7.\n\nThe Center Art Galleries\xe2\x80\x94Hawaii sells artwork, and much of it involves art by the famous surrealist\npainter Salvador Dali. The federal government suspected the center of selling forged Dali artwork and\nobtained search warrants for six locations controlled by the center. The warrants told the executing\nofficer to seize any items that were \xe2\x80\x9cevidence of violations of federal criminal law.\xe2\x80\x9d The warrants did not\ndescribe the specific crime suspected, nor did the warrants limit the seizure of items solely to Dali artwork\nor suspected Dali forgeries. Are these search warrants valid?\n\n[1]\n\nSELF-TEST QUESTIONS\n\n1.\n\nJared has made several loans to debtors who have declared bankruptcy. These are unsecured\nclaims. Jared \xe2\x80\x9cdoctors\xe2\x80\x9d the documentation to show amounts owed that are higher than the\ndebtors actually owe. Later, Jared is charged with the federal criminal offense of filing false claims.\nThe standard (or \xe2\x80\x9cburden\xe2\x80\x9d) of proof that the US attorney must meet in the prosecution is\na.\n\nbeyond all doubt\n\nb.\n\nbeyond a reasonable doubt\n\nc.\n\nclear and convincing evidence\n\nd.\n\na preponderance of the evidence\nJethro, a businessman who resides in Atlanta, creates a disturbance at a local steakhouse and is\narrested for being drunk and disorderly. Drunk and disorderly is a misdemeanor under Georgia\nlaw. A misdemeanor is a crime punishable by imprisonment for up to\n\na.\n\none year\nb.\n\ntwo years\n\nc.\n\nfive years\n\nd.\n\nnone of the above\n\nYuan is charged with a crime. To find him guilty, the prosecutor must show\na.\n\nactus reus and mens rea\nb.\n\nmens rea only\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n244\n\n\x0cc.\n\nthe performance of a prohibited act\n\nd.\n\nnone of the above\n\nKira works for Data Systems Ltd. and may be liable for larceny if she steals\na.\n\na competitor\xe2\x80\x99s trade secrets\nb.\n\ncompany computer time\n\nc.\n\nthe use of Data Systems\xe2\x80\x99 Internet for personal business\n\nd.\n\nany of the above\n\nCandace is constructing a new office building that is near its completion. She offers Paul $500 to\noverlook certain things that are noncompliant with the city\xe2\x80\x99s construction code. Paul accepts the\nmoney and overlooks the violations. Later, Candace is charged with the crime of bribery. This\noccurred when\na.\n\nCandace offered the bribe.\n\n1.\n\nb\n\n2.\n\na\n\n3.\n\na\n\n4.\n\nd\n\n5.\n\na\n\nb.\n\nPaul accepted the bribe.\n\nc.\n\nPaul overlooked the violations.\n\nd.\n\nnone of the above\n\nSELF-TEST ANSWERS\n\n[1] Center Art Galleries\xe2\x80\x94Hawaii, Inc. v. United States, 875 F.2d 747 (9th Cir. 1989).\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n245\n\n\x0cChapter 7\n\nIntroduction to Tort Law\nLEARNING OBJECTIVES\nAfter reading this chapter, you should be able to do the following:\n1.\n\nKnow why most legal systems have tort law.\n\n2.\n\nIdentify the three kinds of torts.\n\n3.\n\nShow how tort law relates to criminal law and contract law.\n\n4.\n\nUnderstand negligent torts and defenses to claims of negligence.\n\n5.\n\nUnderstand strict liability torts and the reasons for them in the US legal system.\n\nIn civil litigation, contract and tort claims are by far the most numerous. The law attempts to adjust\nfor harms done by awarding damages to a successful plaintiff who demonstrates that the defendant\nwas the cause of the plaintiff\xe2\x80\x99s losses. Torts can be intentional torts, negligent torts, or strict liability\ntorts. Employers must be aware that in many circumstances, their employees may create liability in\ntort. This chapter explains the different kind of torts, as well as available defenses to tort claims.\n\n7.1 Purpose of Tort Laws\n\nLEARNING OBJECTIVES\n\n1.\n\nExplain why a sound market system requires tort law.\n\n2.\n\nDefine a tort and give two examples.\n\n3.\n\nExplain the moral basis of tort liability.\n\n4.\n\nUnderstand the purposes of damage awards in tort.\n\nDefinition of Tort\nThe term tort is the French equivalent of the English word wrong. The word tort is also derived from the\nLatin word tortum, which means twisted or crooked or wrong, in contrast to the word rectum, which\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n246\n\n\x0cmeans straight (rectitude uses that Latin root). Thus conduct that is twisted or crooked and not straight is\na tort. The term was introduced into the English law by the Norman jurists.\nLong ago, tort was used in everyday speech; today it is left to the legal system. A judge will instruct a jury\nthat a tort is usually defined as a wrong for which the law will provide a remedy, most often in the form of\nmoney damages. The law does not remedy all \xe2\x80\x9cwrongs.\xe2\x80\x9d The preceding definition of tort does not reveal\nthe underlying principles that divide wrongs in the legal sphere from those in the moral sphere. Hurting\nsomeone\xe2\x80\x99s feelings may be more devastating than saying something untrue about him behind his back; yet\nthe law will not provide a remedy for saying something cruel to someone directly, while it may provide a\nremedy for "defaming" someone, orally or in writing, to others.\nAlthough the word is no longer in general use, tort suits are the stuff of everyday headlines. More and\nmore people injured by exposure to a variety of risks now seek redress (some sort of remedy through the\ncourts). Headlines boast of multimillion-dollar jury awards against doctors who bungled operations,\nagainst newspapers that libeled subjects of stories, and against oil companies that devastate entire\necosystems. All are examples of tort suits.\nThe law of torts developed almost entirely in the common-law courts; that is, statutes passed by\nlegislatures were not the source of law that plaintiffs usually relied on. Usually, plaintiffs would rely on the\ncommon law (judicial decisions). Through thousands of cases, the courts have fashioned a series of rules\nthat govern the conduct of individuals in their noncontractual dealings with each other. Through\ncontracts, individuals can craft their own rights and responsibilities toward each other. In the absence of\ncontracts, tort law holds individuals legally accountable for the consequences of their actions. Those who\nsuffer losses at the hands of others can be compensated.\nMany acts (like homicide) are both criminal and tortious. But torts and crimes are different, and the\ndifference is worth noting. A crime is an act against the people as a whole. Society punishes the murderer;\nit does not usually compensate the family of the victim. Tort law, on the other hand, views the death as a\nprivate wrong for which damages are owed. In a civil case, the tort victim or his family, not the state,\nbrings the action. The judgment against a defendant in a civil tort suit is usually expressed in monetary\nterms, not in terms of prison times or fines, and is the legal system\xe2\x80\x99s way of trying to make up for the\nvictim\xe2\x80\x99s loss.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n247\n\n\x0cKinds of Torts\nThere are three kinds of torts: intentional torts, negligent torts, and strict liability torts. Intentional torts\narise from intentional acts, whereas unintentional torts often result from carelessness (e.g., when a\nsurgical team fails to remove a clamp from a patient\xe2\x80\x99s abdomen when the operation is finished). Both\nintentional torts and negligent torts imply some fault on the part of the defendant. In strict liability torts,\nby contrast, there may be no fault at all, but tort law will sometimes require a defendant to make up for\nthe victim\xe2\x80\x99s losses even where the defendant was not careless and did not intend to do harm.\n\nDimensions of Tort Liability\nThere is a clear moral basis for recovery through the legal system where the defendant has been careless\n(negligent) or has intentionally caused harm. Using the concepts that we are free and autonomous beings\nwith basic rights, we can see that when others interfere with either our freedom or our autonomy, we will\nusually react negatively. As the old saying goes, \xe2\x80\x9cYour right to swing your arm ends at the tip of my nose.\xe2\x80\x9d\nThe law takes this even one step further: under intentional tort law, if you frighten someone by swinging\nyour arms toward the tip of her nose, you may have committed the tort of assault, even if there is no actual\ntouching (battery).\nUnder a capitalistic market system, rational economic rules also call for no negative externalities. That is,\nactions of individuals, either alone or in concert with others, should not negatively impact third parties.\nThe law will try to compensate third parties who are harmed by your actions, even as it knows that a\nmoney judgment cannot actually mend a badly injured victim.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n248\n\n\x0cFigure 7.1 Dimensions of Tort Liability\n\nDimensions of Tort: Fault\nTort principles can be viewed along different dimensions. One is the fault dimension. Like criminal law,\ntort law requires a wrongful act by a defendant for the plaintiff to recover. Unlike criminal law, however,\nthere need not be a specific intent. Since tort law focuses on injury to the plaintiff, it is less concerned than\ncriminal law about the reasons for the defendant\xe2\x80\x99s actions. An innocent act or a relatively innocent one\nmay still provide the basis for liability. Nevertheless, tort law\xe2\x80\x94except for strict liability\xe2\x80\x94relies on\nstandards of fault, or blameworthiness.\nThe most obvious standard is willful conduct. If the defendant (often called the tortfeasor\xe2\x80\x94i.e., the one\ncommitting the tort) intentionally injures another, there is little argument about tort liability. Thus all\ncrimes resulting in injury to a person or property (murder, assault, arson, etc.) are also torts, and the\nplaintiff may bring a separate lawsuit to recover damages for injuries to his person, family, or property.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n249\n\n\x0cMost tort suits do not rely on intentional fault. They are based, rather, on negligent conduct that in the\ncircumstances is careless or poses unreasonable risks of causing damage. Most automobile accident and\nmedical malpractice suits are examples of negligence suits.\nThe fault dimension is a continuum. At one end is the deliberate desire to do injury. The middle ground is\noccupied by careless conduct. At the other end is conduct that most would consider entirely blameless, in\nthe moral sense. The defendant may have observed all possible precautions and yet still be held liable.\nThis is called strict liability. An example is that incurred by the manufacturer of a defective product that is\nplaced on the market despite all possible precautions, including quality-control inspection. In many\nstates, if the product causes injury, the manufacturer will be held liable.\n\nDimensions of Tort: Nature of Injury\nTort liability varies by the type of injury caused. The most obvious type is physical harm to the person\n(assault, battery, infliction of emotional distress, negligent exposure to toxic pollutants, wrongful death)\nor property (trespass, nuisance, arson, interference with contract). Mental suffering can be redressed if it\nis a result of physical injury (e.g., shock and depression following an automobile accident). A few states\nnow permit recovery for mental distress alone (a mother\xe2\x80\x99s shock at seeing her son injured by a car while\nboth were crossing the street). Other protected interests include a person\xe2\x80\x99s reputation (injured by\ndefamatory statements or writings), privacy (injured by those who divulge secrets of his personal life), and\neconomic interests (misrepresentation to secure an economic advantage, certain forms of unfair\ncompetition).\n\nDimensions of Tort: Excuses\nA third element in the law of torts is the excuse for committing an apparent wrong. The law does not\ncondemn every act that ultimately results in injury.\nOne common rule of exculpation is assumption of risk. A baseball fan who sits along the third base line\nclose to the infield assumes the risk that a line drive foul ball may fly toward him and strike him. He will\nnot be permitted to complain in court that the batter should have been more careful or that management\nshould have either warned him or put up a protective barrier.\nAnother excuse is negligence of the plaintiff. If two drivers are careless and hit each other on the highway,\nsome states will refuse to permit either to recover from the other. Still another excuse is consent: two\nboxers in the ring consent to being struck with fists (but not to being bitten on the ear).\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n250\n\n\x0cDamages\nSince the purpose of tort law is to compensate the victim for harm actually done, damages are usually\nmeasured by the extent of the injury. Expressed in money terms, these include replacement of property\ndestroyed, compensation for lost wages, reimbursement for medical expenses, and dollars that are\nsupposed to approximate the pain that is suffered. Damages for these injuries are\ncalled compensatory damages.\nIn certain instances, the courts will permit an award of punitive damages. As the word punitive implies,\nthe purpose is to punish the defendant\xe2\x80\x99s actions. Because a punitive award (sometimes called exemplary\ndamages) is at odds with the general purpose of tort law, it is allowable only in aggravated situations. The\nlaw in most states permits recovery of punitive damages only when the defendant has deliberately\ncommitted a wrong with malicious intent or has otherwise done something outrageous.\nPunitive damages are rarely allowed in negligence cases for that reason. But if someone sets out\nintentionally and maliciously to hurt another person, punitive damages may well be appropriate. Punitive\ndamages are intended not only to punish the wrongdoer, by exacting an additional and sometimes heavy\npayment (the exact amount is left to the discretion of jury and judge), but also to deter others from similar\nconduct. The punitive damage award has been subject to heavy criticism in recent years in cases in which\nit has been awarded against manufacturers. One fear is that huge damage awards on behalf of a multitude\nof victims could swiftly bankrupt the defendant. Unlike compensatory damages, punitive damages are\ntaxable.\n\nKEY TAKEAWAY\n\nThere are three kinds of torts, and in two of them (negligent torts and strict liability torts), damages are\nusually limited to making the victim whole through an enforceable judgment for money damages. These\ncompensatory damages awarded by a court accomplish only approximate justice for the injuries or\nproperty damage caused by a tortfeasor. Tort laws go a step further toward deterrence, beyond\ncompensation to the plaintiff, in occasionally awarding punitive damages against a defendant. These are\nalmost always in cases where an intentional tort has been committed.\n\nEXERCISES\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n251\n\n\x0c1.\n\nWhy is deterrence needed for intentional torts (where punitive damages are awarded) rather than\nnegligent torts?\n\n2.\n\nWhy are costs imposed on others without their consent problematic for a market economy? What if the\nlaw did not try to reimpose the victim\xe2\x80\x99s costs onto the tortfeasor? What would a totally nonlitigious\nsociety be like?\n\n7.2 Intentional Torts\n\nLEARNING OBJECTIVES\n\n1.\n\nDistinguish intentional torts from other kinds of torts.\n\n2.\n\nGive three examples of an intentional tort\xe2\x80\x94one that causes injury to a person, one that causes injury to\nproperty, and one that causes injury to a reputation.\n\nThe analysis of most intentional torts is straightforward and parallels the substantive crimes already\ndiscussed in Chapter 6 "Criminal Law". When physical injury or damage to property is caused, there\nis rarely debate over liability if the plaintiff deliberately undertook to produce the harm. Certain\nother intentional torts are worth noting for their relevance to business.\n\nAssault and Battery\nOne of the most obvious intentional torts is assault and battery. Both criminal law and tort law serve to\nrestrain individuals from using physical force on others. Assault is (1) the threat of immediate harm or\noffense of contact or (2) any act that would arouse reasonable apprehension of imminent harm. Battery is\nunauthorized and harmful or offensive physical contact with another person that causes injury.\nOften an assault results in battery, but not always. In Western Union Telegraph Co. v. Hill, for example,\nthe defendant did not touch the plaintiff\xe2\x80\x99s wife, but the case presented an issue of possible assault even\nwithout an actual battery; the defendant employee attempted to kiss a customer across the countertop,\ncouldn\'t quite reach her, but nonetheless created actionable fear (or, as the court put it, \xe2\x80\x9capprehension\xe2\x80\x9d)\non the part of the plaintiff\'s wife. It is also possible to have a battery without an assault. For example, if\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n252\n\n\x0csomeone hits you on the back of the head with an iron skillet and you didn\xe2\x80\x99t see it coming, there is a\nbattery but no assault. Likewise, if Andrea passes out from drinking too much at the fraternity party and a\nstranger (Andre) kisses her on the lips while she is passed out, she would not be aware of any threat of\noffensive contact and would have no apprehension of any harm. Thus there has been no tort of assault,\nbut she could allege the tort of battery. (The question of what damages, if any, would be an interesting\nargument.)\nUnder the doctrine of transferred intent, if Draco aims his wand at Harry but Harry ducks just in time and\nthe impact is felt by Hermione instead, English law (and American law) would transfer Draco\xe2\x80\x99s intent\nfrom the target to the actual victim of the act. Thus Hermione could sue Draco for battery for any damages\nshe had suffered.\n\nFalse Imprisonment\nThe tort of false imprisonment originally implied a locking up, as in a prison, but today it can occur if a\nperson is restrained in a room or a car or even if his or her movements are restricted while walking down\nthe street. People have a right to be free to go as they please, and anyone who without cause deprives\nanother of personal freedom has committed a tort. Damages are allowed for time lost, discomfort and\nresulting ill health, mental suffering, humiliation, loss of reputation or business, and expenses such as\nattorneys\xe2\x80\x99 fees incurred as a result of the restraint (such as a false arrest). But as the case of Lester v.\nAlbers Super Markets, Inc. (Section 7.5 "Cases") shows, the defendant must be shown to have restrained\nthe plaintiff in order for damages to be allowed.\n\nIntentional Infliction of Emotional Distress\nUntil recently, the common-law rule was that there could be no recovery for acts, even though\nintentionally undertaken, that caused purely mental or emotional distress. For a case to go to the jury, the\ncourts required that the mental distress result from some physical injury. In recent years, many courts\nhave overthrown the older rule and now recognize the so-called new tort. In an employment context,\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n253\n\n\x0chowever, it is rare to find a case where a plaintiff is able to recover. The most difficult hurdle is proving\nthat the conduct was \xe2\x80\x9cextreme\xe2\x80\x9d or \xe2\x80\x9coutrageous.\xe2\x80\x9d\nIn an early California case, bill collectors came to the debtor\xe2\x80\x99s home repeatedly and threatened the\ndebtor\xe2\x80\x99s pregnant wife. Among other things, they claimed that the wife would have to deliver her child in\nprison. The wife miscarried and had emotional and physical complications. The court found that the\nbehavior of the collection company\xe2\x80\x99s two agents was sufficiently outrageous to prove the tort of\nintentional infliction of emotional distress. In Roche v. Stern (New York), the famous cable television talk\nshow host Howard Stern had tastelessly discussed the remains of Deborah Roche, a topless dancer and\ncable access television host.\n\n[1]\n\nThe remains had been brought to Stern\xe2\x80\x99s show by a close friend of Roche,\n\nChaunce Hayden, and a number of crude comments by Stern and Hayden about the remains were\nvideotaped and broadcast on a national cable television station. Roche\xe2\x80\x99s sister and brother sued Howard\nStern and Infinity broadcasting and were able to get past the defendant\xe2\x80\x99s motion to dismiss to have a jury\nconsider their claim.\nA plaintiff\xe2\x80\x99s burden in these cases is to show that the mental distress is severe. Many states require that\nthis distress must result in physical symptoms such as nausea, headaches, ulcers, or, as in the case of the\npregnant wife, a miscarriage. Other states have not required physical symptoms, finding that shame,\nembarrassment, fear, and anger constitute severe mental distress.\n\nTrespass and Nuisance\nTrespass is intentionally going on land that belongs to someone else or putting something on someone\nelse\xe2\x80\x99s property and refusing to remove it. This part of tort law shows how strongly the law values the rights\nof property owners. The right to enjoy your property without interference from others is also found in\ncommon law of nuisance. There are limits to property owners\xe2\x80\x99 rights, however. In Katko v. Briney, for\nexample, the plaintiff was injured by a spring gun while trespassing on the defendant\xe2\x80\x99s property.\n\n[2]\n\nThe\n\ndefendant had set up No Trespassing signs after ten years of trespassing and housebreaking events, with\nthe loss of some household items. Windows had been broken, and there was \xe2\x80\x9cmessing up of the property\nin general.\xe2\x80\x9d The defendants had boarded up the windows and doors in order to stop the intrusions and\nfinally had set up a shotgun trap in the north bedroom of the house. One defendant had cleaned and oiled\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n254\n\n\x0chis 20-gauge shotgun and taken it to the old house where it was secured to an iron bed with the barrel\npointed at the bedroom door. \xe2\x80\x9cIt was rigged with wire from the doorknob to the gun\xe2\x80\x99s trigger so would fire\nwhen the door was opened.\xe2\x80\x9d The angle of the shotgun was adjusted to hit an intruder in the legs. The\nspring could not be seen from the outside, and no warning of its presence was posted.\nThe plaintiff, Katko, had been hunting in the area for several years and considered the property\nabandoned. He knew it had long been uninhabited. He and a friend had been to the house and found\nseveral old bottles and fruit jars that they took and added to their collection of antiques. When they made\na second trip to the property, they entered by removing a board from a porch window. When the plaintiff\nopened the north bedroom door, the shotgun went off and struck him in the right leg above the ankle\nbone. Much of his leg was blown away. While Katko knew he had no right to break and enter the house\nwith intent to steal bottles and fruit jars, the court held that a property owner could not protect an\nunoccupied boarded-up farmhouse by using a spring gun capable of inflicting death or serious injury.\nIn Katko, there is an intentional tort. But what if someone trespassing is injured by the negligence of the\nlandowner? States have differing rules about trespass and negligence. In some states, a trespasser is only\nprotected against the gross negligence of the landowner. In other states, trespassers may be owed the duty\nof due care on the part of the landowner. The burglar who falls into a drained swimming pool, for\nexample, may have a case against the homeowner unless the courts or legislature of that state have made\nit clear that trespassers are owed the limited duty to avoid gross negligence. Or a very small child may\nwander off his own property and fall into a gravel pit on a nearby property and suffer death or serious\ninjury; if the pit should (in the exercise of due care) have been filled in or some barrier erected around it,\nthen there was negligence. But if the state law holds that the duty to trespassers is only to avoid gross\nnegligence, the child\xe2\x80\x99s family would lose, unless the state law makes an exception for very young\ntrespassers. In general, guests, licensees, and invitees are owed a duty of due care; a trespasser may not be\nowed such a duty, but states have different rules on this.\n\nIntentional Interference with Contractual Relations\nTortious interference with a contract can be established by proving four elements:\n1.\n\nThere was a contract between the plaintiff and a third party.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n255\n\n\x0c2. The defendant knew of the contract.\n3. The defendant improperly induced the third party to breach the contract or made performance of the\ncontract impossible.\n4. There was injury to the plaintiff.\nIn a famous case of contract interference, Texaco was sued by Pennzoil for interfering with an agreement\nthat Pennzoil had with Getty Oil. After complicated negotiations between Pennzoil and Getty, a takeover\nshare price was struck, a memorandum of understanding was signed, and a press release announced the\nagreement in principle between Pennzoil and Getty. Texaco\xe2\x80\x99s lawyers, however, believed that Getty oil was\n\xe2\x80\x9cstill in play,\xe2\x80\x9d and before the lawyers for Pennzoil and Getty could complete the paperwork for their\nagreement, Texaco announced it was offering Getty shareholders an additional $12.50 per share over\nwhat Pennzoil had offered.\nTexaco later increased its offer to $228 per share, and the Getty board of directors soon began dealing\nwith Texaco instead of Pennzoil. Pennzoil decided to sue in Texas state court for tortious interference with\na contract. After a long trial, the jury returned an enormous verdict against Texaco: $7.53 billion in actual\ndamages and $3 billion in punitive damages. The verdict was so large that it would have bankrupted\nTexaco. Appeals from the verdict centered on an obscure rule of the Securities and Exchange Commission\n(SEC), Rule 10(b)-13, and Texaco\xe2\x80\x99s argument was based on that rule and the fact that the contract had not\nbeen completed. If there was no contract, Texaco could not have legally interfered with one. After the SEC\nfiled a brief that supported Texaco\xe2\x80\x99s interpretation of the law, Texaco agreed to pay $3 billion to Pennzoil\nto dismiss its claim of tortious interference with a contract.\n\nMalicious Prosecution\nMalicious prosecution is the tort of causing someone to be prosecuted for a criminal act, knowing that\nthere was no probable cause to believe that the plaintiff committed the crime. The plaintiff must show that\nthe defendant acted with malice or with some purpose other than bringing the guilty to justice. A mere\ncomplaint to the authorities is insufficient to establish the tort, but any official proceeding will support the\nclaim\xe2\x80\x94for example, a warrant for the plaintiff\xe2\x80\x99s arrest. The criminal proceeding must terminate in the\nplaintiff\xe2\x80\x99s favor in order for his suit to be sustained.\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n256\n\n\x0cA majority of US courts, though by no means all, permit a suit for wrongful civil proceedings. Civil\nlitigation is usually costly and burdensome, and one who forces another to defend himself against baseless\naccusations should not be permitted to saddle the one he sues with the costs of defense. However,\nbecause, as a matter of public policy, litigation is favored as the means by which legal rights can be\nvindicated\xe2\x80\x94indeed, the Supreme Court has even ruled that individuals have a constitutional right to\nlitigate\xe2\x80\x94the plaintiff must meet a heavy burden in proving his case. The mere dismissal of the original\nlawsuit against the plaintiff is not sufficient proof that the suit was unwarranted. The plaintiff in a suit for\nwrongful civil proceedings must show that the defendant (who was the plaintiff in the original suit) filed\nthe action for an improper purpose and had no reasonable belief that his cause was legally or factually\nwell grounded.\n\nDefamation\nDefamation is injury to a person\xe2\x80\x99s good name or reputation. In general, if the harm is done through the\nspoken word\xe2\x80\x94one person to another, by telephone, by radio, or on television\xe2\x80\x94it is called slander. If the\ndefamatory statement is published in written form, it is called libel.\nThe Restatement (Second) of Torts defines a defamatory communication as one that \xe2\x80\x9cso tends to harm the\nreputation of another as to lower him in the estimation of the community or to deter third persons from\nassociating or dealing with him.\xe2\x80\x9d\n\n[3]\n\nA statement is not defamatory unless it is false. Truth is an absolute defense to a charge of libel or slander.\nMoreover, the statement must be \xe2\x80\x9cpublished\xe2\x80\x9d\xe2\x80\x94that is, communicated to a third person. You cannot be\nlibeled by one who sends you a letter full of false accusations and scurrilous statements about you unless a\nthird person opens it first (your roommate, perhaps). Any living person is capable of being defamed, but\nthe dead are not. Corporations, partnerships, and other forms of associations can also be defamed, if the\nstatements tend to injure their ability to do business or to garner contributions.\nThe statement must have reference to a particular person, but he or she need not be identified by name. A\nstatement that \xe2\x80\x9cthe company president is a crook\xe2\x80\x9d is defamatory, as is a statement that \xe2\x80\x9cthe major\nnetwork weathermen are imposters.\xe2\x80\x9d The company president and the network weathermen could show\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n257\n\n\x0cthat the words were aimed at them. But statements about large groups will not support an action for\ndefamation (e.g., \xe2\x80\x9call doctors are butchers\xe2\x80\x9d is not defamatory of any particular doctor).\nThe law of defamation is largely built on strict liability. That a person did not intend to defame is\nordinarily no excuse; a typographical error that converts a true statement into a false one in a newspaper,\nmagazine, or corporate brochure can be sufficient to make out a case of libel. Even the exercise of due care\nis usually no excuse if the statement is in fact communicated. Repeating a libel is itself a libel; a libel\ncannot be justified by showing that you were quoting someone else. Though a plaintiff may be able to\nprove that a statement was defamatory, he is not necessarily entitled to an award of damages. That is\nbecause the law contains a number of privileges that excuse the defamation.\nPublishing false information about another business\xe2\x80\x99s product constitutes the tort of slander of quality, or\ntrade libel. In some states, this is known as the tort of product disparagement. It may be difficult to\nestablish damages, however. A plaintiff must prove that actual damages proximately resulted from the\nslander of quality and must show the extent of the economic harm as well.\n\nAbsolute Privilege\nStatements made during the course of judicial proceedings are absolutely privileged, meaning that they\ncannot serve as the basis for a defamation suit. Accurate accounts of judicial or other proceedings are\nabsolutely privileged; a newspaper, for example, may pass on the slanderous comments of a judge in\ncourt. \xe2\x80\x9cJudicial\xe2\x80\x9d is broadly construed to include most proceedings of administrative bodies of the\ngovernment. The Constitution exempts members of Congress from suits for libel or slander for any\nstatements made in connection with legislative business. The courts have constructed a similar privilege\nfor many executive branch officials.\n\nQualified Privilege\nAbsolute privileges pertain to those in the public sector. A narrower privilege exists for private citizens. In\ngeneral, a statement that would otherwise be actionable is held to be justified if made in a reasonable\nmanner and for a reasonable purpose. Thus you may warn a friend to beware of dealing with a third\nperson, and if you had reason to believe that what you said was true, you are privileged to issue the\nwarning, even though false. Likewise, an employee may warn an employer about the conduct or character\nof a fellow or prospective employee, and a parent may complain to a school board about the competence\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n258\n\n\x0cor conduct of a child\xe2\x80\x99s teacher. There is a line to be drawn, however, and a defendant with nothing but an\nidle interest in the matter (an \xe2\x80\x9cofficious intermeddler\xe2\x80\x9d) must take the risk that his information is wrong.\nIn 1964, the Supreme Court handed down its historic decision in New York Times v. Sullivan, holding\nthat under the First Amendment a libel judgment brought by a public official against a newspaper cannot\nstand unless the plaintiff has shown \xe2\x80\x9cactual malice,\xe2\x80\x9d which in turn was defined as \xe2\x80\x9cknowledge that [the\n[4]\n\nstatement] was false or with a reckless disregard of whether it was false or not.\xe2\x80\x9d In subsequent cases, the\ncourt extended the constitutional doctrine further, applying it not merely to government officials but\nto public figures, people who voluntarily place themselves in the public eye or who involuntarily find\nthemselves the objects of public scrutiny. Whether a private person is or is not a public figure is a difficult\nquestion that has so far eluded rigorous definition and has been answered only from case to case. A CEO\nof a private corporation ordinarily will be considered a private figure unless he puts himself in the public\neye\xe2\x80\x94for example, by starring in the company\xe2\x80\x99s television commercials.\n\nInvasion of Privacy\nThe right of privacy\xe2\x80\x94the right \xe2\x80\x9cto be let alone\xe2\x80\x9d\xe2\x80\x94did not receive judicial recognition until the twentieth\ncentury, and its legal formulation is still evolving. In fact there is no single right of privacy. Courts and\ncommentators have discerned at least four different types of interests: (1) the right to control the\nappropriation of your name and picture for commercial purposes, (2) the right to be free of intrusion on\nyour \xe2\x80\x9cpersonal space\xe2\x80\x9d or seclusion, (3) freedom from public disclosure of embarrassing and intimate facts\nof your personal life, and (4) the right not to be presented in a \xe2\x80\x9cfalse light.\xe2\x80\x9d\n\nAppropriation of Name or Likeness\nThe earliest privacy interest recognized by the courts was appropriation of name or likeness: someone else\nplacing your photograph on a billboard or cereal box as a model or using your name as endorsing a\nproduct or in the product name. A New York statute makes it a misdemeanor to use the name, portrait, or\npicture of any person for advertising purposes or for the purposes of trade (business) without first\nobtaining written consent. The law also permits the aggrieved person to sue and to recover damages for\nunauthorized profits and also to have the court enjoin (judicially block) any further unauthorized use of\nthe plaintiff\xe2\x80\x99s name, likeness, or image. This is particularly useful to celebrities.\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n259\n\n\x0cBecause the publishing and advertising industries are concentrated heavily in New York, the statute plays\nan important part in advertising decisions made throughout the country. Deciding what \xe2\x80\x9ccommercial\xe2\x80\x9d or\n\xe2\x80\x9ctrade\xe2\x80\x9d purposes are is not always easy. Thus a newsmagazine may use a baseball player\xe2\x80\x99s picture on its\ncover without first obtaining written permission, but a chocolate manufacturer could not put the player\xe2\x80\x99s\npicture on a candy wrapper without consent.\n\nPersonal Space\nOne form of intrusion upon a person\xe2\x80\x99s solitude\xe2\x80\x94trespass\xe2\x80\x94has long been actionable under common law.\nPhysical invasion of home or other property is not a new tort. But in recent years, the notion of intrusion\nhas been broadened considerably. Now, taking photos of someone else with your cell phone in a locker\nroom could constitute invasion of the right to privacy. Reading someone else\xe2\x80\x99s mail or e-mail could also\nconstitute an invasion of the right to privacy. Photographing someone on a city street is not tortious, but\nsubsequent use of the photograph could be. Whether the invasion is in a public or private space, the\namount of damages will depend on how the image or information is disclosed to others.\n\nPublic Disclosure of Embarassing Facts\nCirculation of false statements that do injury to a person are actionable under the laws of defamation.\nWhat about true statements that might be every bit as damaging\xe2\x80\x94for example, disclosure of someone\xe2\x80\x99s\nincome tax return, revealing how much he earned? The general rule is that if the facts are truly private\nand of no \xe2\x80\x9clegitimate\xe2\x80\x9d concern to the public, then their disclosure is a violation of the right to privacy. But\na person who is in the public eye cannot claim the same protection.\n\nFalse Light\nA final type of privacy invasion is that which paints a false picture in a publication. Though false, it might\nnot be libelous, since the publication need contain nothing injurious to reputation. Indeed, the publication\nmight even glorify the plaintiff, making him seem more heroic than he actually is. Subject to the First\nAmendment requirement that the plaintiff must show intent or extreme recklessness, statements that put\na person in a false light, like a fictionalized biography, are actionable.\n\nKEY TAKEAWAY\n\nThere are many kinds of intentional torts. Some of them involve harm to the physical person or to his or\nher property, reputation or feelings, or economic interests. In each case of intentional tort, the plaintiff\nmust show that the defendant intended harm, but the intent to harm does not need to be directed at a\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n260\n\n\x0cparticular person and need not be malicious, as long as the resulting harm is a direct consequence of the\ndefendant\xe2\x80\x99s actions.\n\nEXERCISES\n\n1.\n\nName two kinds of intentional torts that could result in damage to a business firm\xe2\x80\x99s bottom line.\n\n2.\n\nName two kinds of intentional torts that are based on protection of a person\xe2\x80\x99s property.\n\n3.\n\nWhy are intentional torts more likely to result in a verdict not only for compensatory damages but also for\npunitive damages?\n4.\n\n[1] Roche v. Stern, 675 N.Y.S.2d 133 (1998).\n\n5.\n\n[2] Katko v. Briney, 183 N.W.2d 657 (Iowa 1971).\n\n6.\n\n[3] Restatement (Second) of Torts, Section 559 (1965).\n\n7.\n\n[4] Times v. Sullivan, 376 US 254 (1964).\n\n7.3 Negligence\n\nLEARNING OBJECTIVES\n\n1.\n\nUnderstand how the duty of due care relates to negligence.\n\n2.\n\nDistinguish between actual and proximate cause.\n\n3.\n\nExplain the primary defenses to a claim of negligence.\n\nElements of Negligence\nPhysical harm need not be intentionally caused. A pedestrian knocked over by an automobile does not\nhurt less because the driver intended no wrong but was merely careless. The law imposes a duty of care on\nall of us in our everyday lives. Accidents caused by negligence are actionable.\nDetermining negligence is not always easy. If a driver runs a red light, we can say that he is negligent\nbecause a driver must always be careful to ascertain whether the light is red and be able to stop if it is.\nSuppose that the driver was carrying a badly injured person to a nearby hospital and that after slowing\ndown at an intersection, went through a red light, blowing his horn, whereupon a driver to his right,\nseeing him, drove into the intersection anyway and crashed into him. Must one always stop at a red light?\nIs proof that the light was red always proof of negligence? Usually, but not always: negligence is an\nabstract concept that must always be applied to concrete and often widely varying sets of circumstances.\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n261\n\n\x0cWhether someone was or was not negligent is almost always a question of fact for a jury to decide. Rarely\nis it a legal question that a judge can settle.\nThe tort of negligence has four elements: (1) a duty of due care that the defendant had, (2)\nthe breach of the duty of due care, (3) connection between cause and injury, and (4) actual damage or loss.\nEven if a plaintiff can prove each of these aspects, the defendant may be able to show that the law excuses\nthe conduct that is the basis for the tort claim. We examine each of these factors below.\n\nStandard of Care\nNot every unintentional act that causes injury is negligent. If you brake to a stop when you see a child dart\nout in front of your car, and if the noise from your tires gives someone in a nearby house a heart attack,\nyou have not acted negligently toward the person in the house. The purpose of the negligence standard is\nto protect others against the risk of injury that foreseeably would ensue from unreasonably dangerous\nconduct.\nGiven the infinite variety of human circumstances and conduct, no general statement of a reasonable\nstandard of care is possible. Nevertheless, the law has tried to encapsulate it in the form of the famous\nstandard of \xe2\x80\x9cthe reasonable man.\xe2\x80\x9d This fictitious person \xe2\x80\x9cof ordinary prudence\xe2\x80\x9d is the model that juries\nare instructed to compare defendants with in assessing whether those defendants have acted negligently.\nAnalysis of this mythical personage has baffled several generations of commentators. How much\nknowledge must he have of events in the community, of technology, of cause and effect? With what\nphysical attributes, courage, or wisdom is this nonexistent person supposedly endowed? If the defendant\nis a person with specialized knowledge, like a doctor or an automobile designer, must the jury also treat\nthe \xe2\x80\x9creasonable man\xe2\x80\x9d as having this knowledge, even though the average person in the community will\nnot? (Answer: in most cases, yes.)\nDespite the many difficulties, the concept of the reasonable man is one on which most negligence cases\nultimately turn. If a defendant has acted \xe2\x80\x9cunreasonably under the circumstances\xe2\x80\x9d and his conduct posed\nan unreasonable risk of injury, then he is liable for injury caused by his conduct. Perhaps in most\ninstances, it is not difficult to divine what the reasonable man would do. The reasonable man stops for\ntraffic lights and always drives at reasonable speeds, does not throw baseballs through windows, performs\nsurgical operations according to the average standards of the medical profession, ensures that the floors of\nhis grocery store are kept free of fluids that would cause a patron to slip and fall, takes proper precautions\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n262\n\n\x0cto avoid spillage of oil from his supertanker, and so on. The "reasonable man" standard imposes hindsight\non the decisions and actions of people in society; the circumstances of life are such that courts may\nsometimes impose a standard of due care that many people might not find reasonable.\n\nDuty of Care and Its Breach\nThe law does not impose on us a duty to care for every person. If the rule were otherwise, we would all, in\nthis interdependent world, be our brothers\xe2\x80\x99 keepers, constantly unsure whether any action we took might\nsubject us to liability for its effect on someone else. The law copes with this difficulty by limiting the\nnumber of people toward whom we owe a duty to be careful.\nIn general, the law imposes no obligation to act in a situation to which we are strangers. We may pass the\ndrowning child without risking a lawsuit. But if we do act, then the law requires us to act carefully. The\nlaw of negligence requires us to behave with due regard for the foreseeable consequences of our actions in\norder to avoid unreasonable risks of injury.\nDuring the course of the twentieth century, the courts have constantly expanded the notion of\n\xe2\x80\x9cforeseeability,\xe2\x80\x9d so that today many more people are held to be within the zone of injury than was once the\ncase. For example, it was once believed that a manufacturer or supplier owed a duty of care only to\nimmediate purchasers, not to others who might use the product or to whom the product might be resold.\nThis limitation was known as the rule of privity. And users who were not immediate purchasers were said\nnot to be in privity with a supplier or manufacturer. In 1916, Judge Benjamin N. Cardozo, then on the\nNew York Court of Appeals, penned an opinion in a celebrated case that exploded the theory of privity,\nthough it would take half a century before the last state\xe2\x80\x94Mississippi in 1966\xe2\x80\x94would fall in line.\nDetermining a duty of care can be a vexing problem. Physicians, for example, are bound by principles of\nmedical ethics to respect the confidences of their patients. Suppose a patient tells a psychiatrist that he\nintends to kill his girlfriend. Does the physician then have a higher legal duty to warn prospective victim?\nThe California Supreme Court has said yes.\n\n[1]\n\nEstablishing a breach of the duty of due care where the defendant has violated a statute or municipal\nordinance is eased considerably with the doctrine of negligence per se, a doctrine common to all US state\ncourts. If a legislative body sets a minimum standard of care for particular kinds of acts to protect a\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n263\n\n\x0ccertain set of people from harm and a violation of that standard causes harm to someone in that set, the\ndefendant is negligent per se. If Harvey is driving sixty-five miles per hour in a fifty-five-mile-per-hour\nzone when he crashes into Haley\xe2\x80\x99s car and the police accident report establishes that or he otherwise\nadmits to going ten miles per hour over the speed limit, Haley does not have to prove that Harvey has\nbreached a duty of due care. She will only have to prove that the speeding was an actual and proximate\ncause of the collision and will also have to prove the extent of the resulting damages to her.\n\nCausation: Actual Cause and Proximate Cause\n\xe2\x80\x9cFor want of a nail, the kingdom was lost,\xe2\x80\x9d as the old saying has it. Virtually any cause of an injury can be\ntraced to some preceding cause. The problem for the law is to know when to draw the line between causes\nthat are immediate and causes too remote for liability reasonably to be assigned to them. In tort theory,\nthere are two kinds of causes that a plaintiff must prove: actual cause and proximate\ncause. Actual cause (causation in fact) can be found if the connection between the defendant\xe2\x80\x99s act and the\nplaintiff\xe2\x80\x99s injuries passes the \xe2\x80\x9cbut for\xe2\x80\x9d test: if an injury would not have occurred \xe2\x80\x9cbut for\xe2\x80\x9d the defendant\xe2\x80\x99s\nconduct, then the defendant is the cause of the injury. Still, this is not enough causation to create liability.\nThe injuries to the plaintiff must also be foreseeable, or not \xe2\x80\x9ctoo remote,\xe2\x80\x9d for the defendant\xe2\x80\x99s act to create\nliability. This is proximate cause: a cause that is not too remote or unforseeable.\nSuppose that the person who was injured was not one whom a reasonable person could have expected to\nbe harmed. Such a situation was presented in one of the most famous US tort cases, Palsgraf v. Long\nIsland Railroad (Section 7.5 "Cases"), which was decided by Judge Benjamin Cardozo. Although Judge\nCardozo persuaded four of his seven brethren to side with his position, the closeness of the case\ndemonstrates the difficulty that unforeseeable consequences and unforeseeable plaintiffs present.\n\nDamages\nFor a plaintiff to win a tort case, she must allege and prove that she was injured. The fear that she might\nbe injured in the future is not a sufficient basis for a suit. This rule has proved troublesome in medical\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n264\n\n\x0cmalpractice and industrial disease cases. A doctor\xe2\x80\x99s negligent act or a company\xe2\x80\x99s negligent exposure of a\nworker to some form of contamination might not become manifest in the body for years. In the meantime,\nthe tort statute of limitations might have run out, barring the victim from suing at all. An increasing\nnumber of courts have eased the plaintiff\xe2\x80\x99s predicament by ruling that the statute of limitations does not\nbegin to run until the victim discovers that she has been injured or contracted a disease.\nThe law allows an exception to the general rule that damages must be shown when the plaintiff stands in\ndanger of immediate injury from a hazardous activity. If you discover your neighbor experimenting with\nexplosives in his basement, you could bring suit to enjoin him from further experimentation, even though\nhe has not yet blown up his house\xe2\x80\x94and yours.\n\nProblems of Proof\nThe plaintiff in a tort suit, as in any other, has the burden of proving his allegations.\nHe must show that the defendant took the actions complained of as negligent, demonstrate the\ncircumstances that make the actions negligent, and prove the occurrence and extent of injury. Factual\nissues are for the jury to resolve. Since it is frequently difficult to make out the requisite proof, the law\nallows certain presumptions and rules of evidence that ease the plaintiff\xe2\x80\x99s task, on the ground that without\nthem substantial injustice would be done. One important rule goes by the Latin phrase res ipsa loquitur,\nmeaning \xe2\x80\x9cthe thing speaks for itself.\xe2\x80\x9d The best evidence is always the most direct evidence: an eyewitness\naccount of the acts in question. But eyewitnesses are often unavailable, and in any event they frequently\ncannot testify directly to the reasonableness of someone\xe2\x80\x99s conduct, which inevitably can only be inferred\nfrom the circumstances.\nIn many cases, therefore, circumstantial evidence (evidence that is indirect) will be the only evidence or\nwill constitute the bulk of the evidence. Circumstantial evidence can often be quite telling: though no one\nsaw anyone leave the building, muddy footprints tracing a path along the sidewalk are fairly conclusive.\nRes ipsa loquitur is a rule of circumstantial evidence that permits the jury to draw an inference of\nnegligence. A common statement of the rule is the following: \xe2\x80\x9cThere must be reasonable evidence of\nnegligence but where the thing is shown to be under the management of the defendant or his servants,\nand the accident is such as in the ordinary course of things does not happen if those who have the\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n265\n\n\x0cmanagement use proper care, it affords reasonable evidence, in the absence of explanation by the\ndefendants, that the accident arose from want of care.\xe2\x80\x9d\n\n[2]\n\nIf a barrel of flour rolls out of a factory window and hits someone, or a soda bottle explodes, or an airplane\ncrashes, courts in every state permit juries to conclude, in the absence of contrary explanations by the\ndefendants, that there was negligence. The plaintiff is not put to the impossible task of explaining\nprecisely how the accident occurred. A defendant can always offer evidence that he acted reasonably\xe2\x80\x94for\nexample, that the flour barrel was securely fastened and that a bolt of lightning, for which he was not\nresponsible, broke its bands, causing it to roll out the window. But testimony by the factory employees\nthat they secured the barrel, in the absence of any further explanation, will not usually serve to rebut the\ninference. That the defendant was negligent does not conclude the inquiry or automatically entitle the\nplaintiff to a judgment. Tort law provides the defendant with several excuses, some of which are discussed\nbriefly in the next section.\n\nExcuses\nThere are more excuses (defenses) than are listed here, but contributory negligence or comparative\nnegligence, assumption of risk, and act of God are among the principal defenses that will completely or\npartially excuse the negligence of the defendant.\n\nContributory and Comparative Negligence\nUnder an old common-law rule, it was a complete defense to show that the plaintiff in a negligence suit\nwas himself negligent. Even if the plaintiff was only mildly negligent, most of the fault being chargeable to\nthe defendant, the court would dismiss the suit if the plaintiff\xe2\x80\x99s conduct contributed to his injury. In a few\nstates today, this rule of contributory negligence is still in effect. Although referred to as negligence, the\nrule encompasses a narrower form than that with which the defendant is charged, because the plaintiff\xe2\x80\x99s\nonly error in such cases is in being less careful of himself than he might have been, whereas the defendant\nis charged with conduct careless toward others. This rule was so manifestly unjust in many cases that\nmost states, either by statute or judicial decision, have changed to some version\nof comparative negligence. Under the rule of comparative negligence, damages are apportioned according\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n266\n\n\x0cto the defendant\xe2\x80\x99s degree of culpability. For example, if the plaintiff has sustained a $100,000 injury and\nis 20 percent responsible, the defendant will be liable for $80,000 in damages.\n\nAssumption of Risk\nRisk of injury pervades the modern world, and plaintiffs should not win a lawsuit simply because they\ntook a risk and lost. The law provides, therefore, that when a person knowingly takes a risk, he or she\nmust suffer the consequences.\nThe assumption of risk doctrine comes up in three ways. The plaintiff may have formally agreed with the\ndefendant before entering a risky situation that he will relieve the defendant of liability should injury\noccur. (\xe2\x80\x9cYou can borrow my car if you agree not to sue me if the brakes fail, because they\xe2\x80\x99re worn and I\nhaven\xe2\x80\x99t had a chance to replace them.\xe2\x80\x9d) Or the plaintiff may have entered into a relationship with the\ndefendant knowing that the defendant is not in a position to protect him from known risks (the fan who is\nhit by a line drive in a ballpark). Or the plaintiff may act in the face of a risky situation known in advance\nto have been created by the defendant\xe2\x80\x99s negligence (failure to leave, while there was an opportunity to do\nso, such as getting into an automobile when the driver is known to be drunk).\nThe difficulty in many cases is to determine the dividing line between subjectivity and objectivity. If the\nplaintiff had no actual knowledge of the risk, he cannot be held to have assumed it. On the other hand, it is\neasy to claim that you did not appreciate the danger, and the courts will apply an objective standard of\ncommunity knowledge (a \xe2\x80\x9cbut you should have known\xe2\x80\x9d test) in many situations. When the plaintiff has no\nreal alternative, however, assumption of risk fails as a defense (e.g., a landlord who negligently fails to\nlight the exit to the street cannot claim that his tenants assumed the risk of using it).\nAt the turn of the century, courts applied assumption of risk in industrial cases to bar relief to workers\ninjured on the job. They were said to assume the risk of dangerous conditions or equipment. This rule has\nbeen abolished by workers\xe2\x80\x99 compensation statutes in most states.\n\nAct of God\nTechnically, the rule that no one is responsible for an \xe2\x80\x9cact of God,\xe2\x80\x9d or force majeure as it is sometimes\ncalled, is not an excuse but a defense premised on a lack of causation. If a force of nature caused the harm,\nthen the defendant was not negligent in the first place. A marina, obligated to look after boats moored at\nits dock, is not liable if a sudden and fierce storm against which no precaution was possible destroys\nsomeone\xe2\x80\x99s vessel. However, if it is foreseeable that harm will flow from a negligent condition triggered by\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n267\n\n\x0ca natural event, then there is liability. For example, a work crew failed to remove residue explosive gas\nfrom an oil barge. Lightning hit the barge, exploded the gas, and injured several workmen. The plaintiff\nrecovered damages against the company because the negligence consisted in the failure to guard against\nany one of a number of chance occurrences that could ignite the gas.\n\n[3]\n\nVicarious Liability\nLiability for negligent acts does not always end with the one who was negligent. Under certain\ncircumstances, the liability is imputed to others. For example, an employer is responsible for the\nnegligence of his employees if they were acting in the scope of employment. This rule of vicarious liability\nis often called respondeat superior, meaning that the higher authority must respond to claims brought\nagainst one of its agents. Respondeat superior is not limited to the employment relationship but extends\nto a number of other agency relationships as well.\nLegislatures in many states have enacted laws that make people vicariously liable for acts of certain people\nwith whom they have a relationship, though not necessarily one of agency. It is common, for example, for\nthe owner of an automobile to be liable for the negligence of one to whom the owner lends the car. Socalled dram shop statutes place liability on bar and tavern owners and others who serve too much alcohol\nto one who, in an intoxicated state, later causes injury to others. In these situations, although the injurious\nact of the drinker stemmed from negligence, the one whom the law holds vicariously liable (the bartender)\nis not himself necessarily negligent\xe2\x80\x94the law is holding him strictly liable, and to this concept we now\nturn.\n\nKEY TAKEAWAY\n\nThe most common tort claim is based on the negligence of the defendant. In each negligence claim, the\nplaintiff must establish by a preponderance of the evidence that (1) the defendant had a duty of due care,\n(2) the defendant breached that duty, (3) that the breach of duty both actually and approximately has\ncaused harm to the plaintiff, and (4) that the harm is measurable in money damages.\nIt is also possible for the negligence of one person to be imputed to another, as in the case of respondeat\nsuperior, or in the case of someone who loans his automobile to another driver who is negligent and\ncauses injury. There are many excuses (defenses) to claims of negligence, including assumption of risk and\ncomparative negligence. In those few jurisdictions where contributory negligence has not been modified\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n268\n\n\x0cto comparative negligence, plaintiffs whose negligence contributes to their own injuries will be barred\nfrom any recovery.\n\nEXERCISES\n\n1.\n\nExplain the difference between comparative negligence and contributory negligence.\n\n2.\n\nHow is actual cause different from probable cause?\n\n3.\n\nWhat is an example of assumption of risk?\n\n4.\n\nHow does res ipsa loquitur help a plaintiff establish a case of negligence?\n5.\n\n[1] Tarasoff v. Regents of University of California, 551 P.2d 334 (Calif. 1976).\n\n6.\n\n[2] Scott v. London & St. Katherine Docks Co., 3 H. & C. 596, 159 Eng.Rep. 665 (Q.B. 1865).\n\n7.\n\n[3] Johnson v. Kosmos Portland Cement Co., 64 F.2d 193 (6th Cir. 1933).\n\n7.4 Strict Liability\n\nLEARNING OBJECTIVES\n\n1.\n\nUnderstand how strict liability torts differ from negligent torts.\n\n2.\n\nUnderstand the historical origins of strict liability under common law.\n\n3.\n\nBe able to apply strict liability concepts to liability for defective products.\n\n4.\n\nDistinguish strict liability from absolute liability, and understand the major defenses to a lawsuit in\nproducts-liability cases.\n\nHistorical Basis of Strict Liability: Animals and Ultrahazardous Activities\nTo this point, we have considered principles of liability that in some sense depend upon the \xe2\x80\x9cfault\xe2\x80\x9d of the\ntortfeasor. This fault is not synonymous with moral blame.\nAside from acts intended to harm, the fault lies in a failure to live up to a standard of reasonableness or\ndue care. But this is not the only basis for tort liability. Innocent mistakes can be a sufficient basis. As we\nhave already seen, someone who unknowingly trespasses on another\xe2\x80\x99s property is liable for the damage\nthat he does, even if he has a reasonable belief that the land is his. And it has long been held that someone\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n269\n\n\x0cwho engages in ultrahazardous (or sometimes, abnormally dangerous) activities is liable for damage that\nhe causes, even though he has taken every possible precaution to avoid harm to someone else.\nLikewise, the owner of animals that escape from their pastures or homes and damage neighboring\nproperty may be liable, even if the reason for their escape was beyond the power of the owner to stop (e.g.,\na fire started by lightning that burns open a barn door). In such cases, the courts invoke the principle of\nstrict liability, or, as it is sometimes called, liability without fault. The reason for the rule is explained\nin Klein v. Pyrodyne Corporation (Section 7.5 "Cases").\n\nStrict Liability for Products\nBecause of the importance of products liability, this text devotes an entire chapter to it (Chapter 17\n"Products Liability"). Strict liability may also apply as a legal standard for products, even those that are\nnot ultrahazardous. In some national legal systems, strict liability is not available as a cause of action to\nplaintiffs seeking to recover a judgment of products liability against a manufacturer, wholesaler,\ndistributor, or retailer. (Some states limit liability to the manufacturer.) But it is available in the United\nStates and initially was created by a California Supreme Court decision in the 1962 case of Greenman v.\nYuba Power Products, Inc.\nIn Greenman, the plaintiff had used a home power saw and bench, the Shopsmith, designed and\nmanufactured by the defendant. He was experienced in using power tools and was injured while using the\napproved lathe attachment to the Shopsmith to fashion a wooden chalice. The case was decided on the\npremise that Greenman had done nothing wrong in using the machine but that the machine had a defect\nthat was \xe2\x80\x9clatent\xe2\x80\x9d (not easily discoverable by the consumer). Rather than decide the case based on\nwarranties, or requiring that Greenman prove how the defendant had been negligent, Justice Traynor\nfound for the plaintiff based on the overall social utility of strict liability in cases of defective products.\nAccording to his decision, the purpose of such liability is to ensure that the \xe2\x80\x9ccost of injuries resulting from\ndefective products is borne by the manufacturers\xe2\x80\xa6rather than by the injured persons who are powerless\nto protect themselves.\xe2\x80\x9d\nToday, the majority of US states recognize strict liability for defective products, although some states limit\nstrict liability actions to damages for personal injuries rather than property damage. Injured plaintiffs\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n270\n\n\x0chave to prove the product caused the harm but do not have to prove exactly how the manufacturer was\ncareless. Purchasers of the product, as well as injured guests, bystanders, and others with no direct\nrelationship with the product, may sue for damages caused by the product.\nThe Restatement of the Law of Torts, Section 402(a), was originally issued in 1964. It is a widely accepted\nstatement of the liabilities of sellers of goods for defective products. The Restatement specifies six\nrequirements, all of which must be met for a plaintiff to recover using strict liability for a product that the\nplaintiff claims is defective:\n1.\n\nThe product must be in a defective condition when the defendant sells it.\n\n2. The defendant must normally be engaged in the business of selling or otherwise distributing the\nproduct.\n3. The product must be unreasonably dangerous to the user or consumer because of its defective\ncondition.\n4. The plaintiff must incur physical harm to self or to property by using or consuming the product.\n5.\n\nThe defective condition must be the proximate cause of the injury or damage.\n\n6. The goods must not have been substantially changed from the time the product was sold to the time\nthe injury was sustained.\nSection 402(a) also explicitly makes clear that a defendant can be held liable even though the defendant\nhas exercised \xe2\x80\x9call possible care.\xe2\x80\x9d Thus in a strict liability case, the plaintiff does not need to show \xe2\x80\x9cfault\xe2\x80\x9d\n(or negligence).\nFor defendants, who can include manufacturers, distributors, processors, assemblers, packagers, bottlers,\nretailers, and wholesalers, there are a number of defenses that are available, including assumption of risk,\nproduct misuse and comparative negligence, commonly known dangers, and the knowledgeable-user\ndefense. We have already seen assumption of risk and comparative negligence in terms of negligence\nactions; the application of these is similar in products-liability actions.\nUnder product misuse, a plaintiff who uses a product in an unexpected and unusual way will not recover\nfor injuries caused by such misuse. For example, suppose that someone uses a rotary lawn mower to trim\na hedge and that after twenty minutes of such use loses control because of its weight and suffers serious\ncuts to his abdomen after dropping it. Here, there would be a defense of product misuse, as well as\ncontributory negligence. Consider the urban (or Internet) legend of Mervin Gratz, who supposedly put his\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n271\n\n\x0cWinnebago on autopilot to go back and make coffee in the kitchen, then recovered millions after his\nWinnebago turned over and he suffered serious injuries. There are multiple defenses to this alleged\naction; these would include the defenses of contributory negligence, comparative negligence, and product\nmisuse. (There was never any such case, and certainly no such recovery; it is not known who started this\nlegend, or why.)\nAnother defense against strict liability as a cause of action is the knowledgeable user defense. If the\nparents of obese teenagers bring a lawsuit against McDonald\xe2\x80\x99s, claiming that its fast-food products are\ndefective and that McDonald\xe2\x80\x99s should have warned customers of the adverse health effects of eating its\nproducts, a defense based on the knowledgeable user is available. In one case, the court found that the\nhigh levels of cholesterol, fat, salt, and sugar in McDonald\xe2\x80\x99s food is well known to users. The court stated,\n\xe2\x80\x9cIf consumers know (or reasonably should know) the potential ill health effects of eating at McDonald\xe2\x80\x99s,\nthey cannot blame McDonald\xe2\x80\x99s if they, nonetheless, choose to satiate their appetite with a surfeit of\nsupersized McDonald\xe2\x80\x99s products.\xe2\x80\x9d\n\n[1]\n\nKEY TAKEAWAY\n\nCommon-law courts have long held that certain activities are inherently dangerous and that those who\ncause damage to others by engaging in those activities will be held strictly liable. More recently, courts in\nthe United States have applied strict liability to defective products. Strict liability, however, is not absolute\nliability, as there are many defenses available to defendants in lawsuits based on strict liability, such as\ncomparative negligence and product abuse.\n\n1.\n\nEXERCISES\n\nSomeone says, \xe2\x80\x9cStrict liability means that you\xe2\x80\x99re liable for whatever you make, no matter what the\nconsumer does with your product. It\xe2\x80\x99s a crazy system.\xe2\x80\x9d Respond to and refute this statement.\n\n2.\n\nWhat is the essential difference between strict liability torts and negligent torts? Should the US legal\nsystem even allow strict liability torts? What reasons seem persuasive to you?\n\n[1] Pellman v. McDonald\xe2\x80\x99s Corp., 237 F.2d 512 (S.D.N.Y. 2003).\n\n7.5 Cases\nIntentional Torts: False Imprisonment\nLester v. Albers Super Markets, Inc.\n94 Ohio App. 313, 114 N.E.2d 529 (Ohio 1952)\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n272\n\n\x0cFacts: The plaintiff, carrying a bag of rolls purchased at another store, entered the defendant\xe2\x80\x99s grocery\nstore to buy some canned fruit. Seeing her bus outside, she stepped out of line and put the can on the\ncounter. The store manager intercepted her and repeatedly demanded that she submit the bag to be\nsearched. Finally she acquiesced; he looked inside and said she could go. She testified that several people\nwitnessed the scene, which lasted about fifteen minutes, and that she was humiliated. The jury awarded\nher $800. She also testified that no one laid a hand on her or made a move to restrain her from leaving by\nany one of numerous exits.\n***\nMATTHEWS, JUDGE.\nAs we view the record, it raises the fundamental question of what is imprisonment. Before any need for a\ndetermination of illegality arises there must be proof of imprisonment. In 35 Corpus Juris Secundum\n(C.J.S.), False Imprisonment, \xc2\xa7 II, pages 512\xe2\x80\x9313, it is said: \xe2\x80\x9cSubmission to the mere verbal direction of\nanother, unaccompanied by force or by threats of any character, cannot constitute a false imprisonment,\nand there is no false imprisonment where an employer interviewing an employee declines to terminate the\ninterview if no force or threat of force is used and false imprisonment may not be predicated on a person\xe2\x80\x99s\nunfounded belief that he was restrained.\xe2\x80\x9d\nMany cases are cited in support of the text.\n***\nIn Fenn v. Kroger Grocery & Baking Co., Mo. Sup., 209 S.W. 885, 887, the court said:\nA case was not made out for false arrest. The plaintiff said she was intercepted as she started to\nleave the store; that Mr. Krause stood where she could not pass him in going out. She does not say\nthat he made any attempt to intercept her. She says he escorted her back to the desk, that he\nasked her to let him see the change.\n\xe2\x80\xa6She does not say that she went unwillingly\xe2\x80\xa6Evidence is wholly lacking to show that she was\ndetained by force or threats. It was probably a disagreeable experience, a humiliating one to her,\nbut she came out victorious and was allowed to go when she desired with the assurance of Mr.\nKrause that it was all right. The demurrer to the evidence on both counts was properly sustained.\nThe result of the cases is epitomized in 22 Am.Jur. 368, as follows:\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n273\n\n\x0cA customer or patron who apparently has not paid for what he has received may be detained for\na reasonable time to investigate the circumstances, but upon payment of the demand, he has the\nunqualified right to leave the premises without restraint, so far as the proprietor is concerned,\nand it is false imprisonment for a private individual to detain one for an unreasonable time, or\nunder unreasonable circumstances, for the purpose of investigating a dispute over the payment\nof a bill alleged to be owed by the person detained for cash services.\n***\nFor these reasons, the judgment is reversed and final judgment entered for the defendant-appellant.\n\nCASE QUESTIONS\n\n1.\n\nThe court begins by saying what false imprisonment is not. What is the legal definition of false\nimprisonment?\n\n2.\n\nWhat kinds of detention are permissible for a store to use in accosting those that may have been\nshoplifting?\n\n3.\n\nJody broke up with Jeremy and refused to talk to him. Jeremy saw Jody get into her car near the business\nschool and parked right behind her so she could not move. He then stood next to the driver\xe2\x80\x99s window for\nfifteen minutes, begging Jody to talk to him. She kept saying, \xe2\x80\x9cNo, let me leave!\xe2\x80\x9d Has Jeremy committed\nthe tort of false imprisonment?\n\nNegligence: Duty of Due Care\nWhitlock v. University of Denver\n744 P.2d 54 (Supreme Court of Colorado1987)\nOn June 19, 1978, at approximately 10:00 p.m., plaintiff Oscar Whitlock suffered a paralyzing injury while\nattempting to complete a one-and-three-quarters front flip on a trampoline. The injury rendered him a\nquadriplegic. The trampoline was owned by the Beta Theta Pi fraternity (the Beta house) and was situated\non the front yard of the fraternity premises, located on the University campus. At the time of his injury,\nWhitlock was twenty years old, attended the University of Denver, and was a member of the Beta house,\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n274\n\n\x0cwhere he held the office of acting house manager. The property on which the Beta house was located was\nleased to the local chapter house association of the Beta Theta Pi fraternity by the defendant University of\nDenver.\nWhitlock had extensive experience jumping on trampolines. He began using trampolines in junior high\nschool and continued to do so during his brief tenure as a cadet at the United States Military Academy at\nWest Point, where he learned to execute the one-and-three-quarters front flip. Whitlock testified that he\nutilized the trampoline at West Point every other day for a period of two months. He began jumping on\nthe trampoline owned by the Beta house in September of 1977. Whitlock recounted that in the fall and\nspring prior to the date of his injury, he jumped on the trampoline almost daily. He testified further that\nprior to the date of his injury, he had successfully executed the one-and-three-quarters front flip between\nseventy-five and one hundred times.\nDuring the evening of June 18 and early morning of June 19, 1978, Whitlock attended a party at the Beta\nhouse, where he drank beer, vodka and scotch until 2:00 a.m. Whitlock then retired and did not awaken\nuntil 2:00 p.m. on June 19. He testified that he jumped on the trampoline between 2:00 p.m. and 4:00\np.m., and again at 7:00 p.m. At 10:00 p.m., the time of the injury, there again was a party in progress at\nthe Beta house, and Whitlock was using the trampoline with only the illumination from the windows of\nthe fraternity house, the outside light above the front door of the house, and two street lights in the area.\nAs Whitlock attempted to perform the one-and-three-quarters front flip, he landed on the back of his\nhead, causing his neck to break.\nWhitlock brought suit against the manufacturer and seller of the trampoline, the University, the Beta\nTheta Pi fraternity and its local chapter, and certain individuals in their capacities as representatives of\nthe Beta Theta Pi organizations. Whitlock reached settlements with all of the named defendants except\nthe University, so only the negligence action against the University proceeded to trial. The jury returned a\nverdict in favor of Whitlock, assessing his total damages at $ 7,300,000. The jury attributed twenty-eight\npercent of causal negligence to the conduct of Whitlock and seventy-two percent of causal negligence to\nthe conduct of the University. The trial court accordingly reduced the amount of the award against the\nUniversity to $ 5,256,000.\nThe University moved for judgment notwithstanding the verdict, or, in the alternative, a new trial. The\ntrial court granted the motion for judgment notwithstanding the verdict, holding that as a matter of law,\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n275\n\n\x0cno reasonable jury could have found that the University was more negligent than Whitlock, and that the\njury\xe2\x80\x99s monetary award was the result of sympathy, passion or prejudice.\nA panel of the court of appeals reversed\xe2\x80\xa6by a divided vote. Whitlock v. University of Denver, 712 P.2d\n1072 (Colo. App. 1985). The court of appeals held that the University owed Whitlock a duty of due care to\nremove the trampoline from the fraternity premises or to supervise its use.\xe2\x80\xa6The case was remanded to\nthe trial court with orders to reinstate the verdict and damages as determined by the jury. The University\nthen petitioned for certiorari review, and we granted that petition.\n\nII.\nA negligence claim must fail if based on circumstances for which the law imposes no duty of care upon the\ndefendant for the benefit of the plaintiff. [Citations] Therefore, if Whitlock\xe2\x80\x99s judgment against the\nUniversity is to be upheld, it must first be determined that the University owed a duty of care to take\nreasonable measures to protect him against the injury that he sustained.\nWhether a particular defendant owes a legal duty to a particular plaintiff is a question of law. [Citations]\n\xe2\x80\x9cThe court determines, as a matter of law, the existence and scope of the duty\xe2\x80\x94that is, whether the\nplaintiff\xe2\x80\x99s interest that has been infringed by the conduct of the defendant is entitled to legal protection.\xe2\x80\x9d\n[Citations] In Smith v. City & County of Denver, 726 P.2d 1125 (Colo. 1986), we set forth several factors to\nbe considered in determining the existence of duty in a particular case:\nWhether the law should impose a duty requires consideration of many factors including, for\nexample, the risk involved, the foreseeability and likelihood of injury as weighed against the\nsocial utility of the actor\xe2\x80\x99s conduct, the magnitude of the burden of guarding against injury or\nharm, and the consequences of placing the burden upon the actor.\n\xe2\x80\xa6A court\xe2\x80\x99s conclusion that a duty does or does not exist is \xe2\x80\x9can expression of the sum total of those\nconsiderations of policy which lead the law to say that the plaintiff is [or is not] entitled to protection.\xe2\x80\x9d\n\xe2\x80\xa6\nWe believe that the fact that the University is charged with negligent failure to act rather than negligent\naffirmative action is a critical factor that strongly militates against imposition of a duty on the University\nunder the facts of this case. In determining whether a defendant owes a duty to a particular plaintiff, the\nlaw has long recognized a distinction between action and a failure to act\xe2\x80\x94\xe2\x80\x9cthat is to say, between active\nmisconduct working positive injury to others [misfeasance] and passive inaction or a failure to take steps\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n276\n\n\x0cto protect them from harm [nonfeasance].\xe2\x80\x9d W. Keeton, \xc2\xa7 56, at 373. Liability for nonfeasance was slow to\nreceive recognition in the law. \xe2\x80\x9cThe reason for the distinction may be said to lie in the fact that by\n\xe2\x80\x98misfeasance\xe2\x80\x99 the defendant has created a new risk of harm to the plaintiff, while by \xe2\x80\x98nonfeasance\xe2\x80\x99 he has\nat least made his situation no worse, and has merely failed to benefit him by interfering in his\naffairs.\xe2\x80\x9d Id. The Restatement (Second) of Torts \xc2\xa7 314 (1965) summarizes the law on this point as follows:\nThe fact that an actor realizes or should realize that action on his part is necessary for another\xe2\x80\x99s\naid or protection does not of itself impose upon him a duty to take such action.\nImposition of a duty in all such cases would simply not meet the test of fairness under contemporary\nstandards.\nIn nonfeasance cases the existence of a duty has been recognized only during the last century in situations\ninvolving a limited group of special relationships between parties. Such special relationships are\npredicated on \xe2\x80\x9csome definite relation between the parties, of such a character that social policy justifies\nthe imposition of a duty to act.\xe2\x80\x9d W. Keeton, \xc2\xa7 56, at 374. Special relationships that have been recognized\nby various courts for the purpose of imposition of a duty of care include common carrier/passenger,\ninnkeeper/guest, possessor of land/invited entrant, employer/employee, parent/child, and\nhospital/patient.See Restatement (Second) of Torts \xc2\xa7 314 A (1965); 3 Harper and James, \xc2\xa7 18.6, at 722\xe2\x80\x93\n23. The authors of the Restatement (Second) of Torts \xc2\xa7 314 A, comment b (1965), state that \xe2\x80\x9cthe law\nappears\xe2\x80\xa6to be working slowly toward a recognition of the duty to aid or protect in any relation of\ndependence or of mutual dependence.\xe2\x80\x9d\n\xe2\x80\xa6\n\nIII.\nThe present case involves the alleged negligent failure to act, rather than negligent action. The plaintiff\ndoes not complain of any affirmative action taken by the University, but asserts instead that the\nUniversity owed to Whitlock the duty to assure that the fraternity\xe2\x80\x99s trampoline was used only under\nsupervised conditions comparable to those in a gymnasium class, or in the alternative to cause the\ntrampoline to be removed from the front lawn of the Beta house.\xe2\x80\xa6If such a duty is to be recognized, it\nmust be grounded on a special relationship between the University and Whitlock. According to the\nevidence, there are only two possible sources of a special relationship out of which such a duty could arise\nin this case: the status of Whitlock as a student at the University, and the lease between the University and\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n277\n\n\x0cthe fraternity of which Whitlock was a member. We first consider the adequacy of the student-university\nrelationship as a possible basis for imposing a duty on the University to control or prohibit the use of the\ntrampoline, and then examine the provisions of the lease for that same purpose.\n\nA.\nThe student-university relationship has been scrutinized in several jurisdictions, and it is generally agreed\nthat a university is not an insurer of its students\xe2\x80\x99 safety. [Citations] The relationship between a university\nand its students has experienced important change over the years. At one time, college administrators and\nfaculties stood in loco parentis to their students, which created a special relationship \xe2\x80\x9cthat imposed a duty\non the college to exercise control over student conduct and, reciprocally, gave the students certain rights\nof protection by the college.\xe2\x80\x9d Bradshaw, 612 F.2d at 139. However, in modern times there has evolved a\ngradual reapportionment of responsibilities from the universities to the students, and a corresponding\ndeparture from the in loco parentis relationship. Id. at 139\xe2\x80\x9340. Today, colleges and universities are\nregarded as educational institutions rather than custodial ones. Beach, 726 P.2d at 419 (contrasting\ncolleges and universities with elementary and high schools).\n\xe2\x80\xa6\n\xe2\x80\xa6By imposing a duty on the University in this case, the University would be encouraged to exercise more\ncontrol over private student recreational choices, thereby effectively taking away much of the\nresponsibility recently recognized in students for making their own decisions with respect to private\nentertainment and personal safety. Such an allocation of responsibility would \xe2\x80\x9cproduce a repressive and\ninhospitable environment, largely inconsistent with the objectives of a modern college\neducation.\xe2\x80\x9d Beach, 726 P.2d at 419.\nThe evidence demonstrates that only in limited instances has the University attempted to impose\nregulations or restraints on the private recreational pursuits of its students, and the students have not\nlooked to the University to assure the safety of their recreational choices. Nothing in the University\xe2\x80\x99s\nstudent handbook, which contains certain regulations concerning student conduct, reflects an effort by\nthe University to control the risk-taking decisions of its students in their private recreation.\xe2\x80\xa6Indeed,\nfraternity and sorority self-governance with minimal supervision appears to have been fostered by the\nUniversity.\n\xe2\x80\xa6\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n278\n\n\x0cAside from advising the Beta house on one occasion to put the trampoline up when not in use, there is no\nevidence that the University officials attempted to assert control over trampoline use by the fraternity\nmembers. We conclude from this record that the University\xe2\x80\x99s very limited actions concerning safety of\nstudent recreation did not give Whitlock or the other members of campus fraternities or sororities any\nreason to depend upon the University for evaluation of the safety of trampoline use.\xe2\x80\xa6Therefore, we\nconclude that the student-university relationship is not a special relationship of the type giving rise to a\nduty of the University to take reasonable measures to protect the members of fraternities and sororities\nfrom risks of engaging in extra-curricular trampoline jumping.\nThe plaintiff asserts, however, that we should recognize a duty of the University to take affirmative action\nto protect fraternity members because of the foreseeability of the injury, the extent of the risks involved in\ntrampoline use, the seriousness of potential injuries, and the University\xe2\x80\x99s superior knowledge concerning\nthese matters. The argument in essence is that a duty should spring from the University\xe2\x80\x99s natural interest\nin the welfare and safety of its students, its superior knowledge of the nature and degree of risk involved\nin trampoline use, and its knowledge of the use of trampolines on the University campus. The evidence\namply supports a conclusion that trampoline use involves risks of serious injuries and that the potential\nfor an injury such as that experienced by Whitlock was foreseeable. It shows further that prior injuries\nresulting from trampoline accidents had been reported to campus security and to the student clinic, and\nthat University administrators were aware of the number and severity of trampoline injuries nationwide.\nThe record, however, also establishes through Whitlock\xe2\x80\x99s own testimony that he was aware of the risk of\nan accident and injury of the very nature that he experienced.\xe2\x80\xa6\nWe conclude that the relationship between the University and Whitlock was not one of dependence with\nrespect to the activities at issue here, and provides no basis for the recognition of a duty of the University\nto take measures for protection of Whitlock against the injury that he suffered.\n\nB.\nWe next examine the lease between the University and the fraternity to determine whether a special\nrelationship between the University and Whitlock can be predicated on that document. The lease was\nexecuted in 1929, extends for a ninety-nine year term, and gives the fraternity the option to extend the\nterm for another ninety-nine years. The premises are to be occupied and used by the fraternity \xe2\x80\x9cas a\nfraternity house, clubhouse, dormitory and boarding house, and generally for religious, educational, social\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n279\n\n\x0cand fraternal purposes.\xe2\x80\x9d Such occupation is to be \xe2\x80\x9cunder control of the tenant.\xe2\x80\x9d (emphasis added) The\nannual rental at all times relevant to this case appears from the record to be one dollar. The University has\nthe obligation to maintain the grounds and make necessary repairs to the building, and the fraternity is to\nbear the cost of such maintenance and repair.\n\xe2\x80\xa6\nWe conclude that the lease, and the University\xe2\x80\x99s actions pursuant to its rights under the lease, provide no\nbasis of dependence by the fraternity members upon which a special relationship can be found to exist\nbetween the University and the fraternity members that would give rise to a duty upon the University to\ntake affirmative action to assure that recreational equipment such as a trampoline is not used under\nunsafe conditions.\n\nIV.\nConsidering all of the factors presented, we are persuaded that under the facts of this case the University\nof Denver had no duty to Whitlock to eliminate the private use of trampolines on its campus or to\nsupervise that use. There exists no special relationship between the parties that justifies placing a duty\nupon the University to protect Whitlock from the well-known dangers of using a trampoline. Here, a\nconclusion that a special relationship existed between Whitlock and the University sufficient to warrant\nthe imposition of liability for nonfeasance would directly contravene the competing social policy of\nfostering an educational environment of student autonomy and independence.\nWe reverse the judgment of the court of appeals and return this case to that court with directions to\nremand it to the trial court for dismissal of Whitlock\xe2\x80\x99s complaint against the University.\n\nCASE QUESTIONS\n\n1.\n\nHow are comparative negligence numbers calculated by the trial court? How can the jury say that the\nuniversity is 72 percent negligent and that Whitlock is 28 percent negligent?\n\n2.\n\nWhy is this not an assumption of risk case?\n\n3.\n\nIs there any evidence that Whitlock was contributorily negligent? If not, why would the court engage in\ncomparative negligence calculations?\n\nNegligence: Proximate Cause\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n280\n\n\x0cPalsgraf v. Long Island R.R.\n248 N.Y. 339,162 N.E. 99 (N.Y. 1928)\nCARDOZO, Chief Judge\nPlaintiff was standing on a platform of defendant\xe2\x80\x99s railroad after buying a ticket to go to Rockaway Beach.\nA train stopped at the station, bound for another place. Two men ran forward to catch it. One of the men\nreached the platform of the car without mishap, though the train was already moving. The other man,\ncarrying a package, jumped aboard the car, but seemed unsteady as if about to fall. A guard on the car,\nwho had held the door open, reached forward to help him in, and another guard on the platform pushed\nhim from behind. In this act, the package was dislodged, and fell upon the rails. It was a package of small\nsize, about fifteen inches long, and was covered by a newspaper. In fact it contained fireworks, but there\nwas nothing in its appearance to give notice of its contents. The fireworks when they fell exploded. The\nshock of\xc2\xb7 the explosion threw down some scales at the other end of the platform many feet away. The\nscales struck the plaintiff, causing injuries for which she sues.\nThe conduct of the defendant\xe2\x80\x99s guard, if a wrong in its relation to the holder of the package, was not a\nwrong in its relation to the plaintiff, standing far away. Relatively to her it was not negligence at all.\nNothing in the situation gave notice that the falling package had in it the potency of peril to persons thus\nremoved. Negligence is not actionable unless it involves the invasion of a legally protected interest, the\nviolation of a right. \xe2\x80\x9cProof of negligence in the air, so to speak, will not do.\xe2\x80\xa6If no hazard was apparent to\nthe eye of ordinary vigilance, an act innocent and harmless, at least to outward seeming, with reference to\nher, did not take to itself the quality of a tort because it happened to be a wrong, though apparently not\none involving the risk of bodily insecurity, with reference to someone else.\xe2\x80\xa6The plaintiff sues in her own\nright for a wrong personal to her, and not as the vicarious beneficiary of a breach of duty to another.\nA different conclusion will involve us, and swiftly too, in a maze of contradictions. A guard stumbles over\na package which has been left upon a platform.\nIt seems to be a bundle of newspapers. It turns out to be a can of dynamite. To the eye of ordinary\nvigilance, the bundle is abandoned waste, which may be kicked or trod on with impunity. Is a passenger at\nthe other end of the platform protected by the law against the unsuspected hazard concealed beneath the\nwaste? If not, is the result to be any different, so far as the distant passenger is concerned, when the guard\nstumbles over a valise which a truckman or a porter has left upon the walk?\xe2\x80\xa6The orbit of the danger as\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n281\n\n\x0cdisclosed to the eye of reasonable vigilance would be the orbit of the duty. One who jostles one\xe2\x80\x99s neighbor\nin a crowd does not invade the rights of others standing at the outer fringe when the unintended contact\ncasts a bomb upon the ground. The wrongdoer as to them is the man who carries the bomb, not the one\nwho explodes it without suspicion of the danger. Life will have to be made over, and human nature\ntransformed, before prevision so extravagant can be accepted as the norm of conduct, the customary\nstandard to which behavior must conform.\nThe argument for the plaintiff is built upon the shifting meanings of such words as \xe2\x80\x9cwrong\xe2\x80\x9d and\n\xe2\x80\x9cwrongful\xe2\x80\x9d and shares their instability. For what the plaintiff must show is a \xe2\x80\x9cwrong\xe2\x80\x9d to herself; i.e., a\nviolation of her own right, and not merely a \xe2\x80\x9cwrong\xe2\x80\x9d to someone else, nor conduct \xe2\x80\x9cwrongful\xe2\x80\x9d because\nunsocial, but not a \xe2\x80\x9cwrong\xe2\x80\x9d to anyone. We are told that one who drives at reckless speed through a\ncrowded city street is guilty of a negligent act and therefore of a wrongful one, irrespective of the\nconsequences.\nNegligent the act is, and wrongful in the sense that it is unsocial, but wrongful and unsocial in relation to\nother travelers, only because the eye of vigilance perceives the risk of damage. If the same act were to be\ncommitted on a speedway or a race course, it would lose its wrongful quality. The risk reasonably to be\nperceived defines the duty to be obeyed, and risk imports relation; it is risk to another or to others within\nthe range of apprehension. This does not mean, of course, that one who launches a destructive force is\nalways relieved of liability, if the force, though known to be destructive, pursues an unexpected\npath.\xe2\x80\xa6Some acts, such as shooting are so imminently dangerous to anyone who may come within reach of\nthe missile however unexpectedly, as to impose a duty of prevision not far from that of an insurer. Even\ntoday, and much oftener in earlier stages of the law, one acts sometimes at one\xe2\x80\x99s peril.\xe2\x80\xa6These cases aside,\nwrong-is defined in terms of the natural or probable, at least when unintentional.\xe2\x80\xa6Negligence, like risk, is\nthus a term of relation.\nNegligence in the abstract, apart from things related, is surely not a tort, if indeed it is understandable at\nall.\xe2\x80\xa6One who seeks redress at law does not make out a cause of action by showing without more that\nthere has been damage to his person. If the harm was not willful, he must show that the act as to him had\npossibilities of danger so many and apparent as to entitle him to be protected against the doing of it\nthough the harm was unintended.\n***\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n282\n\n\x0cThe judgment of the Appellate Division and that of the Trial Term should be reversed, and the complaint\ndismissed, with costs in all courts.\n\nCASE QUESTIONS\n\n1.\n\nIs there actual cause in this case? How can you tell?\n\n2.\n\nWhy should Mrs. Palsgraf (or her insurance company) be made to pay for injuries that were caused by the\nnegligence of the Long Island Rail Road?\n\n3.\n\nHow is this accident not foreseeable?\n\nKlein v. Pyrodyne Corporation\nKlein v. Pyrodyne Corporation\n810 P.2d 917 (Supreme Court of Washington 1991)\nPyrodyne Corporation (Pyrodyne) is a licensed fireworks display company that contracted to display\nfireworks at the Western Washington State Fairgrounds in Puyallup, Washington, on July 4,1987. During\nthe fireworks display, one of the mortar launchers discharged a rocket on a horizontal trajectory parallel\nto the earth. The rocket exploded near a crowd of onlookers, including Danny Klein. Klein\xe2\x80\x99s clothing was\nset on fire, and he suffered facial burns and serious injury to his eyes. Klein sued Pyrodyne for strict\nliability to recover for his injuries. Pyrodyne asserted that the Chinese manufacturer of the fireworks was\nnegligent in producing the rocket and therefore Pyrodyne should not be held liable. The trial court applied\nthe doctrine of strict liability and held in favor of Klein. Pyrodyne appealed.\nSection 519 of the Restatement (Second) of Torts provides that any party carrying on an \xe2\x80\x9cabnormally\ndangerous activity\xe2\x80\x9d is strictly liable for ensuing damages. The public display of fireworks fits this\ndefinition. The court stated: \xe2\x80\x9cAny time a person ignites rockets with the intention of sending them aloft to\nexplode in the presence of large crowds of people, a high risk of serious personal injury or property\ndamage is created. That risk arises because of the possibility that a rocket will malfunction or be\nmisdirected.\xe2\x80\x9d Pyrodyne argued that its liability was cut off by the Chinese manufacturer\xe2\x80\x99s negligence. The\ncourt rejected this argument, stating, \xe2\x80\x9cEven if negligence may properly be regarded as an intervening\ncause, it cannot function to relieve Pyrodyne from strict liability.\xe2\x80\x9d\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n283\n\n\x0cThe Washington Supreme Court held that the public display of fireworks is an abnormally dangerous\nactivity that warrants the imposition of strict liability.\nAffirmed.\n\n1.\n\nCASE QUESTIONS\n\nWhy would certain activities be deemed ultrahazardous or abnormally dangerous so that strict liability is\nimposed?\n\n2.\n\nIf the activities are known to be abnormally dangerous, did Klein assume the risk?\n\n3.\n\nAssume that the fireworks were negligently manufactured in China. Should Klein\xe2\x80\x99s only remedy be against\nthe Chinese company, as Pyrodyne argues? Why or why not?\n\n7.6 Summary and Exercises\nSummary\n\nThe principles of tort law pervade modern society because they spell out the duties of care that we owe\neach other in our private lives. Tort law has had a significant impact on business because modern\ntechnology poses significant dangers and the modern market is so efficient at distributing goods to a wide\nclass of consumers.\nUnlike criminal law, tort law does not require the tortfeasor to have a specific intent to commit the act for\nwhich he or she will be held liable to pay damages. Negligence\xe2\x80\x94that is, carelessness\xe2\x80\x94is a major factor in\ntort liability. In some instances, especially in cases involving injuries caused by products, a no-fault\nstandard called strict liability is applied.\nWhat constitutes a legal injury depends very much on the circumstances. A person can assume a risk or\nconsent to the particular action, thus relieving the person doing the injury from tort liability. To be liable,\nthe tortfeasor must be the proximate cause of the injury, not a remote cause. On the other hand, certain\npeople are held to answer for the torts of another\xe2\x80\x94for example, an employer is usually liable for the torts\nof his employees, and a bartender might be liable for injuries caused by someone to whom he sold too\nmany drinks. Two types of statutes\xe2\x80\x94workers\xe2\x80\x99 compensation and no-fault automobile insurance\xe2\x80\x94have\neliminated tort liability for certain kinds of accidents and replaced it with an immediate insurance\npayment plan.\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n284\n\n\x0cAmong the torts of particular importance to the business community are wrongful death and personal\ninjury caused by products or acts of employees, misrepresentation, defamation, and interference with\ncontractual relations.\n\nEXERCISES\n\n1.\n\nWhat is the difference in objectives between tort law and criminal law?\n\n2.\n\nA woman fell ill in a store. An employee put the woman in an infirmary but provided no medical care for\nsix hours, and she died. The woman\xe2\x80\x99s family sued the store for wrongful death. What arguments could\nthe store make that it was not liable? What arguments could the family make? Which seem the stronger\narguments? Why?\n\n3.\n\nThe signals on a railroad crossing are defective. Although the railroad company was notified of the\nproblem a month earlier, the railroad inspector has failed to come by and repair them. Seeing the all-clear\nsignal, a car drives up and stalls on the tracks as a train rounds the bend. For the past two weeks the car\nhad been stalling, and the driver kept putting off taking the car to the shop for a tune-up. As the train\nrounds the bend, the engineer is distracted by a conductor and does not see the car until it is too late to\nstop. Who is negligent? Who must bear the liability for the damage to the car and to the train?\n\n4.\n\nSuppose in the Katko v. Briney case (Section 7.2 "Intentional Torts") that instead of setting such a device,\nthe defendants had simply let the floor immediately inside the front door rot until it was so weak that\nanybody who came in and took two steps straight ahead would fall through the floor and to the cellar.\nWill the defendant be liable in this case? What if they invited a realtor to appraise the place and did not\nwarn her of the floor? Does it matter whether the injured person is a trespasser or an invitee?\n\n5.\n\nPlaintiff\xe2\x80\x99s husband died in an accident, leaving her with several children and no money except a valid\ninsurance policy by which she was entitled to $5,000. Insurance Company refused to pay, delaying and\nrefusing payment and meanwhile \xe2\x80\x9cinviting\xe2\x80\x9d Plaintiff to accept less than $5,000, hinting that it had a\ndefense. Plaintiff was reduced to accepting housing and charity from relatives. She sued the insurance\ncompany for bad-faith refusal to settle the claim and for the intentional infliction of emotional distress.\nThe lower court dismissed the case. Should the court of appeals allow the matter to proceed to trial?\n\nSELF-TEST QUESTIONS\n\n1.\na.\n\nCatarina falsely accuses Jeff of stealing from their employer. The statement is defamatory only if\na third party hears it\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n285\n\n\x0cb.\n\nNick suffers severe emotional distress as a result\n\nc.\n\nthe statement is the actual and proximate cause of his distress\n\nd.\n\nthe statement is widely circulated in the local media and on Twitter\n\nGarrett files a suit against Colossal Media Corporation for defamation. Colossal has said that\nGarrett is a \xe2\x80\x9csleazy, corrupt public official\xe2\x80\x9d (and provided some evidence to back the claim). To\nwin his case, Garrett will have to show that Colossal acted with\na.\n\nmalice\nb.\n\nill will\n\nc.\n\nmalice aforethought\n\nd.\n\nactual malice\n\nBig Burger begins a rumor, using social media, that the meat in Burger World is partly composed\nof ground-up worms. The rumor is not true, as Big Burger well knows. Its intent is to get some\ncustomers to shift loyalty from Burger World to Big Burger. Burger World\xe2\x80\x99s best cause of action\nwould be\na.\n\ntrespass on the case\nb.\n\nnuisance\n\nc.\n\nproduct disparagement\n\nd.\n\nintentional infliction of emotional distress\n\nWilfred Phelps, age 65, is driving his Nissan Altima down Main Street when he suffers the first\nseizure of his life. He loses control of his vehicle and runs into three people on the sidewalk.\nWhich statement is true?\na.\n\nHe is liable for an intentional tort.\nb.\n\nHe is liable for a negligent tort.\n\nc.\n\nHe is not liable for a negligent tort.\n\nd.\n\nHe is liable under strict liability, because driving a car is abnormally dangerous.\n\nJonathan carelessly bumps into Amanda, knocking her to the ground. He has committed the tort\nof negligence\na.\n\nonly if Amanda is injured\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n286\n\n\x0c1.\n\na\n\n2.\n\nd\n\n3.\n\nc\n\n4.\n\nc\n\n5.\n\na\n\nb.\n\nonly if Amanda is not injured\n\nc.\n\nwhether or not Amanda is injured\n\nSELF-TEST ANSWERS\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n287\n\n\x0cChapter 8\n\nIntroduction to Contract Law\nLEARNING OBJECTIVES\nAfter reading this chapter, you should understand the following:\n1.\n\nWhy and how contract law has developed\n\n2.\n\nWhat a contract is\n\n3.\n\nWhat topics will be discussed in the contracts chapter of this book\n\n4.\n\nWhat the sources of contract law are\n\n5.\n\nHow contracts are classified (basic taxonomy)\n\n8.1 General Perspectives on Contracts\n\nLEARNING OBJECTIVES\n\n1.\n\nExplain contract law\xe2\x80\x99s cultural roots: how it has evolved as capitalism has evolved.\n\n2.\n\nUnderstand that contracts serve essential economic purposes.\n\n3.\n\nDefine contract.\n\n4.\n\nUnderstand the basic issues in contract law.\n\nThe Role of Contracts in Modern Society\nContract is probably the most familiar legal concept in our society because it is so central to the essence of\nour political, economic, and social life. In common parlance, contract is used interchangeably\nwith agreement, bargain, undertaking, or deal. Whatever the word, the concept it embodies is our notion\nof freedom to pursue our own lives together with others. Contract is central because it is the means by\nwhich a free society orders what would otherwise be a jostling, frenetic anarchy.\nSo commonplace is the concept of contract\xe2\x80\x94and our freedom to make contracts with each other\xe2\x80\x94that it is\ndifficult to imagine a time when contracts were rare, when people\xe2\x80\x99s everyday associations with one\nanother were not freely determined. Yet in historical terms, it was not so long ago that contracts were\nrare, entered into if at all by very few: that affairs should be ordered based on mutual assent was mostly\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n288\n\n\x0cunknown. In primitive societies and in feudal Europe, relationships among people were largely fixed;\ntraditions spelled out duties that each person owed to family, tribe, or manor. People were born into an\nascribed position\xe2\x80\x94a status (not unlike the caste system still existing in India)\xe2\x80\x94and social mobility was\nlimited. Sir Henry Maine, a nineteenth-century British historian, wrote that \xe2\x80\x9cthe movement of the\nprogressive societies has\xe2\x80\xa6been a movement from status to contract.\xe2\x80\x9d\n\n[1]\n\nThis movement was not\n\naccidental\xe2\x80\x94it developed with the emerging industrial order. From the fifteenth to the nineteenth century,\nEngland evolved into a booming mercantile economy, with flourishing trade, growing cities, an expanding\nmonetary system, the commercialization of agriculture, and mushrooming manufacturing. With this\nevolution, contract law was created of necessity.\nContract law did not develop according to a conscious plan, however. It was a response to changing\nconditions, and the judges who created it frequently resisted, preferring the imagined quieter pastoral life\nof their forefathers. Not until the nineteenth century, in both the United States and England, did a fullfledged law of contracts arise together with, and help create, modern capitalism.\nModern capitalism, indeed, would not be possible without contract law. So it is that in planned\neconomies, like those of the former Soviet Union and precapitalistic China, the contract did not determine\nthe nature of an economic transaction. That transaction was first set forth by the state\xe2\x80\x99s planning\nauthorities; only thereafter were the predetermined provisions set down in a written contract. Modern\ncapitalism has demanded new contract regimes in Russia and China; the latter adopted its Revised\nContract Law in 1999.\nContract law may be viewed economically as well as culturally. In An Economic Analysis of Law, Judge\nRichard A. Posner (a former University of Chicago law professor) suggests that contract law performs\nthree significant economic functions. First, it helps maintain incentives for individuals to exchange goods\nand services efficiently. Second, it reduces the costs of economic transactions because its very existence\nmeans that the parties need not go to the trouble of negotiating a variety of rules and terms already\nspelled out. Third, the law of contracts alerts the parties to troubles that have arisen in the past, thus\nmaking it easier to plan the transactions more intelligently and avoid potential pitfalls.\n\nSaylor URL: http://www.saylor.org/books\n\n[2]\n\nSaylor.org\n289\n\n\x0cThe Definition of Contract\nAs usual in the law, the legal definition of contract is formalistic. The Restatement (Second) of Contracts\n(Section 1) says, \xe2\x80\x9cA contract is a promise or a set of promises for the breach of which the law gives a\nremedy, or the performance of which the law in some way recognizes as a duty.\xe2\x80\x9d Similarly, the Uniform\nCommercial Code says, \xe2\x80\x9c\xe2\x80\x98Contract\xe2\x80\x99 means the total legal obligation which results from the parties\xe2\x80\x99\nagreement as affected by this Act and any other applicable rules of law.\xe2\x80\x9d\n\n[3]\n\nAs operational definitions,\n\nthese two are circular; in effect, a contract is defined as an agreement that the law will hold the parties to.\nMost simply, a contract is a legally enforceable promise. This implies that not every promise or agreement\ncreates a binding contract; if every promise did, the simple definition set out in the preceding sentence\nwould read, \xe2\x80\x9cA contract is a promise.\xe2\x80\x9d But\xe2\x80\x94again\xe2\x80\x94a contract is not simply a promise: it is a legally\nenforceable promise. The law takes into account the way in which contracts are made, by whom they are\nmade, and for what purposes they are made. For example, in many states, a wager is unenforceable, even\nthough both parties \xe2\x80\x9cshake\xe2\x80\x9d on the bet. We will explore these issues in the chapters to come.\n\nOverview of the Contracts Chapter\nAlthough contract law has many wrinkles and nuances, it consists of four principal inquiries, each of\nwhich will be taken up in subsequent chapters:\n1.\na.\n\nDid the parties create a valid contract? Four elements are necessary for a valid contract:\nMutual assent (i.e., offer and acceptance), Chapter 9 "The Agreement"\n\nb. Real assent (no duress, undue influence, misrepresentation, mistake, or incapacity), Chapter 10 "Real\nAssent"\nc.\n\nConsideration, Chapter 11 "Consideration"\n\nd. Legality, Chapter 12 "Legality"\nWhat does the contract mean, and is it in the proper form to carry out this meaning? Sometimes\ncontracts need to be in writing (or evidenced by some writing), or they can\xe2\x80\x99t be enforced. Sometimes it\nisn\xe2\x80\x99t clear what the contract means, and a court has to figure that out. These problems are taken up\nin Chapter 13 "Form and Meaning".\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n290\n\n\x0cDo persons other than the contracting parties have rights or duties under the contract? Can the\nright to receive a benefit from the contract be assigned, and can the duties be delegated so that a new\nperson is responsible? Can persons not a party to the contract sue to enforce its terms? These\nquestions are addressed in Chapter 14 "Third-Party Rights".\nHow do contractual duties terminate, and what remedies are available if a party has breached the\ncontract? These issues are taken up in Chapter 15 "Discharge of Obligations" and Chapter 16\n"Remedies".\nTogether, the answers to these four basic inquiries determine the rights and obligations of contracting\nparties.\n\nKEY TAKEAWAY\n\nContract law developed when the strictures of feudalism dissipated, when a person\xe2\x80\x99s position in society\ncame to be determined by personal choice (by mutual agreement) and not by status (by how a person was\nborn). Capitalism and contract law have developed together, because having choices in society means that\npeople decide and agree to do things with and to each other, and those agreements bind the parties; the\nagreements must be enforceable.\n\nEXERCISES\n\n1.\n\nWhy is contract law necessary in a society where a person\xe2\x80\x99s status is not predetermined by birth?\n\n2.\n\nContract law serves some economic functions. What are they?\n3.\n\n[1] Sir Henry Maine, Ancient Law (1869), 180\xe2\x80\x9382.\n\n4.\n\n[2] Richard A. Posner, Economic Analysis of Law (New York: Aspen, 1973).\n\n5.\n\n[3] Uniform Commercial Code, Section 1-201(11).\n\n8.2 Sources of Contract Law\n\nLEARNING OBJECTIVES\n\n1.\n\nUnderstand that contract law comes from two sources: judges (cases) and legislation.\n\n2.\n\nKnow what the Restatement of Contracts is.\n\n3.\n\nRecognize the Convention on Contracts for the International Sale of Goods.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n291\n\n\x0cThe most important sources of contract law are state case law and state statutes (though there are\nalso many federal statutes governing how contracts are made by and with the federal government).\n\nCase Law\nLaw made by judges is called case law. Because contract law was made up in the common-law courtroom\nby individual judges as they applied rules to resolve disputes before them, it grew over time to formidable\nproportions. By the early twentieth century, tens of thousands of contract disputes had been submitted to\nthe courts for resolution, and the published opinions, if collected in one place, would have filled dozens of\nbookshelves. Clearly this mass of material was too unwieldy for efficient use. A similar problem also had\ndeveloped in the other leading branches of the common law.\nDisturbed by the profusion of cases and the resulting uncertainty of the law, a group of prominent\nAmerican judges, lawyers, and law teachers founded the American Law Institute (ALI) in 1923 to attempt\nto clarify, simplify, and improve the law. One of the ALI\xe2\x80\x99s first projects, and ultimately one of its most\nsuccessful, was the drafting of the Restatement of the Law of Contracts, completed in 1932. A revision\xe2\x80\x94\nthe Restatement (Second) of Contracts\xe2\x80\x94was undertaken in 1964 and completed in 1979. Hereafter,\nreferences to \xe2\x80\x9cthe Restatement\xe2\x80\x9d pertain to the Restatement (Second) of Contracts.\nThe Restatements\xe2\x80\x94others exist in the fields of torts, agency, conflicts of laws, judgments, property,\nrestitution, security, and trusts\xe2\x80\x94are detailed analyses of the decided cases in each field. These analyses\nare made with an eye to discerning the various principles that have emerged from the courts, and to the\nmaximum extent possible, the Restatements declare the law as the courts have determined it to be. The\nRestatements, guided by a reporter (the director of the project) and a staff of legal scholars, go through\nseveral so-called tentative drafts\xe2\x80\x94sometimes as many as fifteen or twenty\xe2\x80\x94and are screened by various\ncommittees within the ALI before they are eventually published as final documents.\nThe Restatement (Second) of Contracts won prompt respect in the courts and has been cited in\ninnumerable cases. The Restatements are not authoritative, in the sense that they are not actual judicial\nprecedents; but they are nevertheless weighty interpretive texts, and judges frequently look to them for\nguidance. They are as close to \xe2\x80\x9cblack letter\xe2\x80\x9d rules of law as exist anywhere in the American common-law\nlegal system.\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n292\n\n\x0cCommon law, case law (the terms are synonymous), governs contracts for the sale of real estate and\nservices. \xe2\x80\x9cServices\xe2\x80\x9d refer to acts or deeds (like plumbing, drafting documents, driving a car) as opposed to\nthe sale of property.\n\nStatutory Law: The Uniform Commercial Code\nCommon-law contract principles govern contracts for real estate and services. Because of the historical\ndevelopment of the English legal system, contracts for the sale of goods came to be governed by a different\nbody of legal rules. In its modern American manifestation, that body of rules is an important statute: the\nUniform Commercial Code (UCC), especially Article 2, which deals with the sale of goods.\n\nHistory of the UCC\nA bit of history is in order. Before the UCC was written, commercial law varied, sometimes greatly, from\nstate to state. This first proved a nuisance and then a serious impediment to business as the American\neconomy became nationwide during the twentieth century. Although there had been some uniform laws\nconcerned with commercial deals\xe2\x80\x94including the Uniform Sales Act, first published in 1906\xe2\x80\x94few were\nwidely adopted and none nationally. As a result, the law governing sales of goods, negotiable instruments,\nwarehouse receipts, securities, and other matters crucial to doing business in an industrial market\neconomy was a crazy quilt of untidy provisions that did not mesh well from state to state.\nThe UCC is a model law developed by the ALI and the National Conference of Commissioners on Uniform\nState Laws; it has been adopted in one form or another by the legislatures in all fifty states, the District of\nColumbia, and the American territories. It is a \xe2\x80\x9cnational\xe2\x80\x9d law not enacted by Congress\xe2\x80\x94it is not federal\nlaw but uniform state law.\nInitial drafting of the UCC began in 1942 and was ten years in the making, involving the efforts of\nhundreds of practicing lawyers, law teachers, and judges. A final draft, promulgated by the ALI, was\nendorsed by the American Bar Association and published in 1951. Various revisions followed in different\nstates, threatening the uniformity of the UCC. The ALI responded by creating a permanent editorial board\nto oversee future revisions. In one or another of its various revisions, the UCC has been adopted in whole\nor in part in all American jurisdictions. The UCC is now a basic law of relevance to every business and\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n293\n\n\x0cbusiness lawyer in the United States, even though it is not entirely uniform because different states have\nadopted it at various stages of its evolution\xe2\x80\x94an evolution that continues still.\n\nOrganization of the UCC\nThe UCC consists of nine major substantive articles; each deals with separate though related subjects. The\narticles are as follows:\n\xe2\x80\xa2\n\nArticle 1: General Provisions\n\n\xe2\x80\xa2\n\nArticle 2: Sales\n\n\xe2\x80\xa2\n\nArticle 2A: Leases\n\n\xe2\x80\xa2\n\nArticle 3: Commercial Paper\n\n\xe2\x80\xa2\n\nArticle 4: Bank Deposits and Collections\n\n\xe2\x80\xa2\n\nArticle 4A: Funds Transfers\n\n\xe2\x80\xa2\n\nArticle 5: Letters of Credit\n\n\xe2\x80\xa2\n\nArticle 6: Bulk Transfers\n\n\xe2\x80\xa2\n\nArticle 7: Warehouse Receipts, Bills of Lading, and Other Documents of Title\n\n\xe2\x80\xa2\n\nArticle 8: Investment Securities\n\n\xe2\x80\xa2\n\nArticle 9: Secured Transactions\n\nArticle 2 deals only with the sale of goods, which the UCC defines as \xe2\x80\x9call things\xe2\x80\xa6which are movable at the\ntime of identification to the contract for sale other than the money in which the price is to be paid.\xe2\x80\x9d\n\n[1]\n\nThe\n\nonly contracts and agreements covered by Article 2 are those relating to the present or future sale of\ngoods.\nArticle 2 is divided in turn into six major parts: (1) Form, Formation, and Readjustment of Contract; (2)\nGeneral Obligation and Construction of Contract; (3) Title, Creditors, and Good Faith Purchasers; (4)\nPerformance; (5) Breach, Repudiation, and Excuse; and (6) Remedies. These topics will be discussed\nin(Reference mayer_1.0-ch17 not found in Book), (Reference mayer_1.0-ch18 not found in\nBook), (Reference mayer_1.0-ch19 not found in Book), Chapter 17 "Products Liability", and (Reference\nmayer_1.0-ch21 not found in Book).\nFigure 8.1 Sources of Law\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n294\n\n\x0cInternational Sales Law\nThe Convention on Contracts for the International Sale of Goods\nAConvention on Contracts for the International Sale of Goods (CISG)was approved in 1980 at a\ndiplomatic conference in Vienna. (A convention is a preliminary agreement that serves as the basis for a\nformal treaty.) The CISG has been adopted by more than forty countries, including the United States.\nThe CISG is significant for three reasons. First, it is a uniform law governing the sale of goods\xe2\x80\x94in effect,\nan international Uniform Commercial Code. The major goal of the drafters was to produce a uniform law\nacceptable to countries with different legal, social, and economic systems. Second, although provisions in\nthe CISG are generally consistent with the UCC, there are significant differences. For instance, under the\nCISG, consideration (discussed in Chapter 11 "Consideration") is not required to form a contract, and\nthere is no Statute of Frauds (a requirement that certain contracts be evidenced by a writing). Third, the\nCISG represents the first attempt by the US Senate to reform the private law of business through its treaty\npowers, for the CISG preempts the UCC. The CISG is not mandatory: parties to an international contract\nfor the sale of goods may choose to have their agreement governed by different law, perhaps the UCC, or\nperhaps, say, Japanese contract law. The CISG does not apply to contracts for the sale of (1) ships or\naircraft, (2) electricity, or (3) goods bought for personal, family, or household use, nor does it apply (4)\nwhere the party furnishing the goods does so only incidentally to the labor or services part of the contract.\n\nKEY TAKEAWAY\n\nJudges have made contract law over several centuries by deciding cases that create, extend, or change the\ndeveloping rules affecting contract formation, performance, and enforcement. The rules from the cases\nhave been abstracted and organized in the Restatements of Contracts. To facilitate interstate commerce,\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n295\n\n\x0ccontract law for many commercial transactions\xe2\x80\x94especially the sale of goods\xe2\x80\x94not traditionally within the\npurview of judges has been developed by legal scholars and presented for the states to adopt as the\nUniform Commercial Code. There is an analogous Convention on Contracts for the International Sale of\nGoods, to which the United States is a party.\n\nEXERCISES\n\n1.\n\nHow do judges make contract law?\n\n2.\n\nWhat is the Restatement of the Law of Contracts, and why was it necessary?\n\n3.\n\nWhy was the Uniform Commercial Code developed, and by whom?\n\n4.\n\nWho adopts the UCC as governing law?\n\n5.\n\nWhat is the Convention on Contracts for the International Sale of Goods?\n\n[1] Uniform Commercial Code, Section 2-105.\n\n8.3 Basic Taxonomy of Contracts\n\nLEARNING OBJECTIVES\n\n1.\n\nUnderstand that contracts are classified according to the criteria of explicitness, mutuality, enforceability,\nand degree of completion and that some noncontract promises are nevertheless enforceable under the\ndoctrine of promissory estoppel.\n\n2.\n\nKeep your eyes (and ears) alert to the use of suffixes (word endings) in legal terminology that express\nrelationships between parties.\n\nSome contracts are written, some oral; some are explicit, some not. Because contracts can be formed,\nexpressed, and enforced in a variety of ways, a taxonomy of contracts has developed that is useful in\ngrouping together like legal consequences. In general, contracts are classified along four different\ndimensions: explicitness, mutuality, enforceability, and degree of completion. Explicitness is the\ndegree to which the agreement is manifest to those not party to it. Mutuality takes into account\nwhether promises are given by two parties or only one. Enforceability is the degree to which a given\ncontract is binding. Completion considers whether the contract is yet to be performed or whether the\nobligations have been fully discharged by one or both parties. We will examine each of these concepts\nin turn.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n296\n\n\x0cExplicitness\nExpress Contract\nAn express contract is one in which the terms are spelled out directly. The parties to an express contract,\nwhether it is written or oral, are conscious that they are making an enforceable agreement. For example,\nan agreement to purchase your neighbor\xe2\x80\x99s car for $5,500 and to take title next Monday is an express\ncontract.\n\nImplied Contract (Implied in Fact)\nAn implied contract is one that is inferred from the actions of the parties. When parties have not\ndiscussed terms, an implied contract exists if it is clear from the conduct of both parties that they intended\nthere be one. A delicatessen patron who asks for a turkey sandwich to go has made a contract and is\nobligated to pay when the sandwich is made. By ordering the food, the patron is implicitly agreeing to the\nprice, whether posted or not.\nThe distinction between express and implied contracts has received a degree of notoriety in the so-called\npalimony cases, in which one member of an unmarried couple seeks a division of property after a longstanding live-together relationship has broken up. When a married couple divorces, their legal marriage\ncontract is dissolved, and financial rights and obligations are spelled out in a huge body of domestic\nrelations statutes and judicial decisions. No such laws exist for unmarried couples. However, about onethird of the states recognize common-law marriage, under which two people are deemed to be married if\nthey live together with the intent to be married, regardless of their failure to have obtained a license or\ngone through a ceremony. Although there is no actual contract of marriage (no license), their behavior\nimplies that the parties intended to be treated as if they were married.\n\nQuasi-Contract\nA quasi-contract (implied in law) is\xe2\x80\x94unlike both express and implied contracts, which embody an actual\nagreement of the parties\xe2\x80\x94an obligation said to be \xe2\x80\x9cimposed by law\xe2\x80\x9d in order to avoid unjust enrichment of\none person at the expense of another. A quasi-contract is not a contract at all; it is a fiction that the courts\ncreated to prevent injustice. Suppose, for example, that the local lumberyard mistakenly delivers a load of\nlumber to your house, where you are repairing your deck. It was a neighbor on the next block who ordered\nthe lumber, but you are happy to accept the load for free; since you never talked to the lumberyard, you\nfigure you need not pay the bill. Although it is true there is no contract, the law implies a contract for the\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n297\n\n\x0cvalue of the material: of course you will have to pay for what you got and took. The existence of this\nimplied contract does not depend on the intention of the parties.\n\nMutuality\nBilateral Contract\nThe typical contract is one in which the parties make mutual promises. Each is both promisor and\npromisee; that is, each pledges to do something, and each is the recipient of such a pledge. This type of\ncontract is called a bilateral contract.\n\nUnilateral Contract\nMutual promises are not necessary to constitute a contract. Unilateral contracts, in which one party\nperforms an act in exchange for the other party\xe2\x80\x99s promise, are equally valid. An offer of a reward\xe2\x80\x94for\ncatching a criminal or for returning a lost cat\xe2\x80\x94is an example of a unilateral contract: there is an offer on\none side, and the other side accepts by taking the action requested.\nFigure 8.2 Bilateral and Unilateral Contracts\n\nEnforceability\nVoid\nNot every agreement between two people is a binding contract. An agreement that is lacking one of the\nlegal elements of a contract is said to be avoid contract\xe2\x80\x94that is, not a contract at all. An agreement that is\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n298\n\n\x0cillegal\xe2\x80\x94for example, a promise to commit a crime in return for a money payment\xe2\x80\x94is void. Neither party\nto a void \xe2\x80\x9ccontract\xe2\x80\x9d may enforce it.\n\nVoidable\nBy contrast, a voidable contract is one that may become unenforceable by one party but can be enforced\nby the other. For example, a minor (any person under eighteen, in most states) may \xe2\x80\x9cavoid\xe2\x80\x9d a contract\nwith an adult; the adult may not enforce the contract against the minor if the minor refuses to carry out\nthe bargain. But the adult has no choice if the minor wishes the contract to be performed. (A contract may\nbe voidable by both parties if both are minors.)\nOrdinarily, the parties to a voidable contract are entitled to be restored to their original condition.\nSuppose you agree to buy your seventeen-year-old neighbor\xe2\x80\x99s car. He delivers it to you in exchange for\nyour agreement to pay him next week. He has the legal right to terminate the deal and recover the car, in\nwhich case you will of course have no obligation to pay him. If you have already paid him, he still may\nlegally demand a return to the status quo ante (previous state of affairs). You must return the car to him;\nhe must return the cash to you.\nA voidable contract remains a valid contract until it is voided. Thus a contract with a minor remains in\nforce unless the minor decides he or she does not wish to be bound by it. When the minor reaches\nmajority, he or she may \xe2\x80\x9cratify\xe2\x80\x9d the contract\xe2\x80\x94that is, agree to be bound by it\xe2\x80\x94in which case the contract\nwill no longer be voidable and will thereafter be fully enforceable.\n\nUnenforceable\nAn unenforceable contract is one that some rule of law bars a court from enforcing. For example, Tom\nowes Pete money, but Pete has waited too long to collect it and the statute of limitations has run out. The\ncontract for repayment is unenforceable and Pete is out of luck, unless Tom makes a new promise to pay\nor actually pays part of the debt. (However, if Pete is holding collateral as security for the debt, he is\nentitled to keep it; not all rights are extinguished because a contract is unenforceable.) A debt becomes\nunenforceable, too, when the debtor declares bankruptcy.\nA bit more on enforceability is in order. A promise or what seems to be a promise is usually enforceable\nonly if it is otherwise embedded in the elements necessary to make that promise a contract. Those\nelements are mutual assent, real assent, consideration, capacity, and legality. Sometimes, though, people\nsay things that seem like promises, and on which another person relies. In the early twentieth century,\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n299\n\n\x0ccourts began, in some circumstances, to recognize that insisting on the existence of the traditional\nelements of contract to determine whether a promise is enforceable could work an injustice where there\nhas been reliance. Thus developed the equitable doctrine of promissory estoppel, which has become an\nimportant adjunct to contract law. The Restatement (Section 90) puts it this way: \xe2\x80\x9cA promise which the\npromisor should reasonably expect to induce action or forbearance on the party of the promisee or a third\nperson and which does induce such action or forbearance is binding if injustice can be avoided only by\nenforcement of the promise. The remedy granted for breach may be limited as justice requires.\xe2\x80\x9d\nTo be \xe2\x80\x9cestopped\xe2\x80\x9d means to be prohibited from denying now the validity of a promise you made before.\nThe doctrine has an interesting background. In 1937, High Trees House Ltd. (a British corporation) leased\na block of London apartments from Central London Properties. As World War II approached, vacancy\nrates soared because people left the city. In 1940 the parties agreed to reduce the rent rates by half, but no\nterm was set for how long the reduction would last. By mid-1945, as the war was ending, occupancy was\nagain full, and Central London sued for the full rental rates from June on. The English court, under Judge\nAlfred Thompson Denning (1899\xe2\x80\x931999), had no difficulty finding that High Trees owed the full amount\nonce full occupancy was again achieved, but Judge Denning went on. In an aside (called a dicta\xe2\x80\x94a\nstatement \xe2\x80\x9cby the way\xe2\x80\x9d\xe2\x80\x94that is, not necessary as part of the decision), he mused about what would have\nhappened if in 1945 Central London had sued for the full-occupancy rate back to 1940. Technically, the\n1940 amendment to the 1937 contract was not binding on Central London\xe2\x80\x94it lacked consideration\xe2\x80\x94and\nCentral London could have reached back to demand full-rate payment. But Judge Denning said that High\nTrees would certainly have relied on Central London\xe2\x80\x99s promise that a reduced-rate rent would be\nacceptable, and that would have been enough to bind it, to prevent it from acting inconsistently with the\npromise. He wrote, \xe2\x80\x9cThe courts have not gone so far as to give a cause of action in damages for the breach\nof such a promise, but they have refused to allow the party making it to act inconsistently with it.\xe2\x80\x9d\n\n[1]\n\nIn the years since, though, courts have gone so far as to give a cause of action in damages for various\nnoncontract promises. Contract protects agreements; promissory estoppel protects reliance, and that\xe2\x80\x99s a\nsignificant difference. The law of contracts continues to evolve.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n300\n\n\x0cDegree of Completion\nAn agreement consisting of a set of promises is called an executory contract before any promises are\ncarried out. Most executory contracts are enforceable. If John makes an agreement to deliver wheat to\nHumphrey and does so, the contract is called a partially executed contract: one side has performed, the\nother has not. When John pays for the wheat, the contract is fully performed. A contract that has been\ncarried out fully by both parties is called an executed contract.\n\nTerminology: Suffixes Expressing Relationships\nAlthough not really part of the taxonomy of contracts (i.e., the orderly classification of the subject), an\naspect of contractual\xe2\x80\x94indeed, legal\xe2\x80\x94terminology should be highlighted here. Suffixes (the end syllables\nof words) in the English language are used to express relationships between parties in legal terminology.\nHere are examples:\n\xe2\x80\xa2\n\nOfferor. One who makes an offer.\n\n\xe2\x80\xa2\n\nOfferee. One to whom an offer is made.\n\n\xe2\x80\xa2\n\nPromisor. One who makes a promise.\n\n\xe2\x80\xa2\n\nPromisee. One to whom a promise is made.\n\n\xe2\x80\xa2\n\nObligor. One who makes and has an obligation.\n\n\xe2\x80\xa2\n\nObligee. One to whom an obligation is made.\n\n\xe2\x80\xa2\n\nTransferor. One who makes a transfer.\n\n\xe2\x80\xa2\n\nTransferee. One to whom a transfer is made.\n\nKEY TAKEAWAY\n\nContracts are described and thus defined on the basis of four criteria: explicitness (express, implied, or\nquasi-contracts), mutuality (bilateral or unilateral), enforceability (void, voidable, unenforceable), and\ndegree of completion (executory, partially executed, executed). Legal terminology in English often\ndescribes relationships between parties by the use of suffixes, to which the eye and ear must pay\nattention.\n\nSaylor URL: http://www.saylor.org/books\n\nEXERCISES\n\nSaylor.org\n301\n\n\x0c1.\n\nAble writes to Baker: \xe2\x80\x9cI will mow your lawn for $20.\xe2\x80\x9d If Baker accepts, is this an express or implied\ncontract?\n\n2.\n\nAble telephones Baker: \xe2\x80\x9cI will mow your lawn for $20.\xe2\x80\x9d Is this an express or implied contract?\n\n3.\n\nWhat is the difference between a void contract and a voidable one?\n\n4.\n\nCarr staples this poster to a utility pole: \xe2\x80\x9c$50 reward for the return of my dog, Argon.\xe2\x80\x9d Describe this in\ncontractual terms regarding explicitness, mutuality, enforceability, and degree of completion.\n\n5.\n\nIs a voidable contract always unenforceable?\n\n6.\n\nContractor bids on a highway construction job, incorporating Guardrail Company\xe2\x80\x99s bid into its overall bid\nto the state. Contractor cannot accept Guardrail\xe2\x80\x99s offer until it gets the nod from the state. Contractor\ngets the nod from the state, but before it can accept Guardrail\xe2\x80\x99s offer, the latter revokes it. Usually a\nperson can revoke an offer any time before it is accepted. Can Guardrail revoke its offer in this case?\n\n[1] Central London Property Trust Ltd. v. High Trees House Ltd. (1947) KB 130.\n\n8.4 Cases\nExplicitness: Implied Contract\nRoger\xe2\x80\x99s Backhoe Service, Inc. v. Nichols\n681 N.W.2d 647 (Iowa 2004)\nCarter, J.\nDefendant, Jeffrey S. Nichols, is a funeral director in Muscatine.\xe2\x80\xa6In early 1998 Nichols decided to build a\ncrematorium on the tract of land on which his funeral home was located. In working with the Small\nBusiness Administration, he was required to provide drawings and specifications and obtain estimates for\nthe project. Nichols hired an architect who prepared plans and submitted them to the City of Muscatine\nfor approval. These plans provided that the surface water from the parking lot would drain onto the\nadjacent street and alley and ultimately enter city storm sewers. These plans were approved by the city.\nNichols contracted with Roger\xe2\x80\x99s [Backhoe Service, Inc.] for the demolition of the foundation of a building\nthat had been razed to provide room for the crematorium and removal of the concrete driveway and\nsidewalk adjacent to that foundation. Roger\xe2\x80\x99s completed that work and was paid in full.\nAfter construction began, city officials came to the jobsite and informed Roger\xe2\x80\x99s that the proposed\ndrainage of surface water onto the street and alley was unsatisfactory. The city required that an effort be\nmade to drain the surface water into a subterranean creek, which served as part of the city\xe2\x80\x99s storm sewer\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n302\n\n\x0csystem. City officials indicated that this subterranean sewer system was about fourteen feet below the\nsurface of the ground.\xe2\x80\xa6Roger\xe2\x80\x99s conveyed the city\xe2\x80\x99s mandate to Nichols when he visited the jobsite that\nsame day.\nIt was Nichols\xe2\x80\x99 testimony at trial that, upon receiving this information, he advised\xe2\x80\xa6Roger\xe2\x80\x99s that he was\nrefusing permission to engage in the exploratory excavation that the city required. Nevertheless, it\nappears without dispute that for the next three days Roger\xe2\x80\x99s did engage in digging down to the\nsubterranean sewer system, which was located approximately twenty feet below the surface. When the\nunderground creek was located, city officials examined the brick walls in which it was encased and\ndetermined that it was not feasible to penetrate those walls in order to connect the surface water drainage\nwith the underground creek. As a result of that conclusion, the city reversed its position and once again\ngave permission to drain the surface water onto the adjacent street and alley.\n[T]he invoices at issue in this litigation relate to charges that Roger\xe2\x80\x99s submitted to Nichols for the three\ndays of excavation necessary to locate the underground sewer system and the cost for labor and materials\nnecessary to refill the excavation with compactable materials and attain compaction by means of a\ntamping process.\xe2\x80\xa6The district court found that the charges submitted on the\xe2\x80\xa6invoices were fair and\nreasonable and that they had been performed for Nichols\xe2\x80\x99 benefit and with his tacit approval.\xe2\x80\xa6\nThe court of appeals\xe2\x80\xa6concluded that a necessary element in establishing an implied-in-fact contract is\nthat the services performed be beneficial to the alleged obligor. It concluded that Roger\xe2\x80\x99s had failed to\nshow that its services benefited Nichols.\xe2\x80\xa6\nIn describing the elements of an action on an implied contract, the court of appeals stated in [Citation],\nthat the party seeking recovery must show:\n(1) the services were carried out under such circumstances as to give the recipient reason to\nunderstand:\n(a) they were performed for him and not some other person, and\n(b) they were not rendered gratuitously, but with the expectation of compensation from the\nrecipient; and\n(2) the services were beneficial to the recipient.\nIn applying the italicized language in [Citation] to the present controversy, it was the conclusion of the\ncourt of appeals that Roger\xe2\x80\x99s\xe2\x80\x99 services conferred no benefit on Nichols. We disagree. There was substantial\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n303\n\n\x0cevidence in the record to support a finding that, unless and until an effort was made to locate the\nsubterranean sewer system, the city refused to allow the project to proceed. Consequently, it was\nnecessary to the successful completion of the project that the effort be made. The fact that examination of\nthe brick wall surrounding the underground creek indicated that it was unfeasible to use that source of\ndrainage does not alter the fact that the project was stalemated until drainage into the underground creek\nwas fully explored and rejected. The district court properly concluded that Roger\xe2\x80\x99s\xe2\x80\x99 services conferred a\nbenefit on Nichols.\xe2\x80\xa6\nDecision of court of appeals vacated; district court judgment affirmed.\n\nCASE QUESTIONS\n\n1.\n\nWhat facts must be established by a plaintiff to show the existence of an implied contract?\n\n2.\n\nWhat argument did Nichols make as to why there was no implied contract here?\n\n3.\n\nHow would the facts have to be changed to make an express contract?\n\nMutuality of Contract: Unilateral Contract\nSouthTrust Bank v. Williams\n775 So.2d 184 (Ala. 2000)\nCook, J.\nSouthTrust Bank (\xe2\x80\x9cSouthTrust\xe2\x80\x9d) appeals from an order denying its motion to compel arbitration of an\naction against it by checking-account customers Mark Williams and Bessie Daniels. We reverse and\nremand.\nDaniels and Williams began their relationship with SouthTrust in 1981 and 1995, respectively, by\nexecuting checking-account \xe2\x80\x9csignature cards.\xe2\x80\x9d The signature card each customer signed contained a\n\xe2\x80\x9cchange-in-terms\xe2\x80\x9d clause. Specifically, when Daniels signed her signature card, she \xe2\x80\x9cagree[d] to be subject\nto the Rules and Regulations as may now or hereafter be adopted by the Bank.\xe2\x80\x9d (Emphasis\nadded.)\xe2\x80\xa6[Later,] SouthTrust added paragraph 33 to the regulations:\xe2\x80\xa6\nARBITRATION OF DISPUTES. You and we agree that the transactions in your account involve\n\xe2\x80\x98commerce\xe2\x80\x99 under the Federal Arbitration Act (\xe2\x80\x98FAA\xe2\x80\x99). ANY CONTROVERSY OR CLAIM\nBETWEEN YOU AND US\xe2\x80\xa6WILL BE SETTLED BY BINDING ARBITRATION UNDER THE FAA.\xe2\x80\xa6\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n304\n\n\x0cThis action\xe2\x80\xa6challenges SouthTrust\xe2\x80\x99s procedures for paying overdrafts, and alleges that SouthTrust\nengages in a \xe2\x80\x9cuniform practice of paying the largest check(s) before paying multiple smaller checks\xe2\x80\xa6[in\norder] to generate increased service charges for [SouthTrust] at the expense of [its customers].\xe2\x80\x9d\nSouthTrust filed a \xe2\x80\x9cmotion to stay [the] lawsuit and to compel arbitration.\xe2\x80\x9d It based its motion on\nparagraph 33 of the regulations. [T]he trial court\xe2\x80\xa6entered an order denying SouthTrust\xe2\x80\x99s motion to\ncompel arbitration. SouthTrust appeals.\xe2\x80\xa6\nWilliams and Daniels contend that SouthTrust\xe2\x80\x99s amendment to the regulations, adding paragraph 33, was\nineffective because, they say, they did not expressly assent to the amendment. In other words, they object\nto submitting their claims to arbitration because, they say, when they opened their accounts, neither the\nregulations nor any other relevant document contained an arbitration provision. They argue that \xe2\x80\x9cmere\nfailure to object to the addition of a material term cannot be construed as an acceptance of it.\xe2\x80\x9d\xe2\x80\xa6They\ncontend that SouthTrust could not unilaterally insert an arbitration clause in the regulations and make it\nbinding on depositors like them.\nSouthTrust, however, referring to its change-of-terms clause insists that it \xe2\x80\x9cnotified\xe2\x80\x9d Daniels and Williams\nof the amendment in January 1997 by enclosing in each customer\xe2\x80\x99s \xe2\x80\x9caccount statement\xe2\x80\x9d a complete copy\nof the regulations, as amended. Although it is undisputed that Daniels and Williams never affirmatively\nassented to these amended regulations, SouthTrust contends that their assent was evidenced by their\nfailure to close their accounts after they received notice of the amendments.\xe2\x80\xa6Thus, the disposition of this\ncase turns on the legal effect of Williams and Daniels\xe2\x80\x99s continued use of the accounts after the regulations\nwere amended.\nWilliams and Daniels argue that \xe2\x80\x9c[i]n the context of contracts between merchants [under the UCC], a\nwritten confirmation of an acceptance may modify the contract unless it adds a material term, and\narbitration clauses are material terms.\xe2\x80\x9d\xe2\x80\xa6\nWilliams and Daniels concede\xe2\x80\x94as they must\xe2\x80\x94\xe2\x80\xa6that Article 2 governs \xe2\x80\x9ctransactions in goods,\xe2\x80\x9d and,\nconsequently, that it is not applicable to the transactions in this case. Nevertheless, they argue:\nIt would be astonishing if a Court were to consider the addition of an arbitration clause a\nmaterial alteration to a contract between merchants, who by definition are sophisticated in the\ntrade to which the contract applies, but not hold that the addition of an arbitration clause is a\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n305\n\n\x0cmaterial alteration pursuant to a change-of-terms clause in a contract between one sophisticated\nparty, a bank, and an entire class of less sophisticated parties, its depositors.\xe2\x80\xa6\nIn response, SouthTrust states that \xe2\x80\x9cbecause of the \xe2\x80\x98at-will\xe2\x80\x99 nature of the relationship, banks by necessity\nmust contractually reserve the right to amend their deposit agreements from time to time.\xe2\x80\x9d In so stating,\nSouthTrust has precisely identified the fundamental difference between the transactions here and those\ntransactions governed by [Article 2].\nContracts for the purchase and sale of goods are essentially bilateral and executory in nature. See\n[Citation] \xe2\x80\x9cAn agreement whereby one party promises to sell and the other promises to buy a thing at a\nlater time\xe2\x80\xa6is a bilateral promise of sale or contract to sell\xe2\x80\x9d.\xe2\x80\xa6\xe2\x80\x9c[A] unilateral contract results from an\nexchange of a promise for an act; a bilateral contract results from an exchange of promises.\xe2\x80\x9d\xe2\x80\xa6Thus, \xe2\x80\x9cin a\nunilateral contract, there is no bargaining process or exchange of promises by parties as in a bilateral\ncontract.\xe2\x80\x9d [Citation] \xe2\x80\x9c[O]nly one party makes an offer (or promise) which invites performance by another,\nand performance constitutes both acceptance of that offer and consideration.\xe2\x80\x9d Because \xe2\x80\x9ca \xe2\x80\x98unilateral\ncontract\xe2\x80\x99 is one in which no promisor receives promise as consideration for his promise,\xe2\x80\x9d only one party is\nbound.\xe2\x80\xa6The difference is not one of semantics but of substance; it determines the rights and\nresponsibilities of the parties, including the time and the conditions under which a cause of action accrues\nfor a breach of the contract.\nThis case involves at-will, commercial relationships, based upon a series of unilateral transactions. Thus,\nit is more analogous to cases involving insurance policies, such as [Citations]. The common thread\nrunning through those cases was the amendment by one of the parties to a business relationship of a\ndocument underlying that relationship\xe2\x80\x94without the express assent of the other party\xe2\x80\x94to require the\narbitration of disputes arising after the amendment.\xe2\x80\xa6\nThe parties in [the cited cases], like Williams and Daniels in this case, took no action that could be\nconsidered inconsistent with an assent to the arbitration provision. In each case, they continued the\nbusiness relationship after the interposition of the arbitration provision. In doing so, they implicitly\nassented to the addition of the arbitration provision.\xe2\x80\xa6\nReversed and remanded.\n\n1.\n\nCASE QUESTIONS\n\nWhy did the plaintiffs think they should not be bound by the arbitration clause?\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n306\n\n\x0c2.\n\nThe court said this case involved a unilateral contract. What makes it that, as opposed to a bilateral\ncontract?\n\n3.\n\nWhat should the plaintiffs have done if they didn\xe2\x80\x99t like the arbitration requirement?\n\nUnilateral Contract and At-Will Employment\nWoolley v. Hoffmann-La Roche, Inc.\n491 A.2d 1257 (N.J. 1985)\nWilntz, C. J.\nPlaintiff, Richard Woolley, was hired by defendant, Hoffmann-La Roche, Inc., in October 1969, as an\nEngineering Section Head in defendant\xe2\x80\x99s Central Engineering Department at Nutley. There was no\nwritten employment contract between plaintiff and defendant. Plaintiff began work in mid-November\n1969. Sometime in December, plaintiff received and read the personnel manual on which his claims are\nbased.\n[The company\xe2\x80\x99s personnel manual had eight pages;] five of the eight pages are devoted to \xe2\x80\x9ctermination.\xe2\x80\x9d\nIn addition to setting forth the purpose and policy of the termination section, it defines \xe2\x80\x9cthe types of\ntermination\xe2\x80\x9d as \xe2\x80\x9clayoff,\xe2\x80\x9d \xe2\x80\x9cdischarge due to performance,\xe2\x80\x9d \xe2\x80\x9cdischarge, disciplinary,\xe2\x80\x9d \xe2\x80\x9cretirement\xe2\x80\x9d and\n\xe2\x80\x9cresignation.\xe2\x80\x9d As one might expect, layoff is a termination caused by lack of work, retirement a\ntermination caused by age, resignation a termination on the initiative of the employee, and discharge due\nto performance and discharge, disciplinary, are both terminations for cause. There is no category set forth\nfor discharge without cause. The termination section includes \xe2\x80\x9cGuidelines for discharge due to\nperformance,\xe2\x80\x9d consisting of a fairly detailed procedure to be used before an employee may be fired for\ncause. Preceding these definitions of the five categories of termination is a section on \xe2\x80\x9cPolicy,\xe2\x80\x9d the first\nsentence of which provides: \xe2\x80\x9cIt is the policy of Hoffmann-La Roche to retain to the extent consistent with\ncompany requirements, the services of all employees who perform their duties efficiently and effectively.\xe2\x80\x9d\nIn 1976, plaintiff was promoted, and in January 1977 he was promoted again, this latter time to Group\nLeader for the Civil Engineering, the Piping Design, the Plant Layout, and the Standards and Systems\nSections. In March 1978, plaintiff was directed to write a report to his supervisors about piping problems\nin one of defendant\xe2\x80\x99s buildings in Nutley. This report was written and submitted to plaintiff\xe2\x80\x99s immediate\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n307\n\n\x0csupervisor on April 5, 1978. On May 3, 1978, stating that the General Manager of defendant\xe2\x80\x99s Corporate\nEngineering Department had lost confidence in him, plaintiff\xe2\x80\x99s supervisors requested his resignation.\nFollowing this, by letter dated May 22, 1978, plaintiff was formally asked for his resignation, to be\neffective July 15, 1978.\nPlaintiff refused to resign. Two weeks later defendant again requested plaintiff\xe2\x80\x99s resignation, and told him\nhe would be fired if he did not resign. Plaintiff again declined, and he was fired in July.\nPlaintiff filed a complaint alleging breach of contract.\xe2\x80\xa6The gist of plaintiff\xe2\x80\x99s breach of contract claim is\nthat the express and implied promises in defendant\xe2\x80\x99s employment manual created a contract under which\nhe could not be fired at will, but rather only for cause, and then only after the procedures outlined in the\nmanual were followed. Plaintiff contends that he was not dismissed for good cause, and that his firing was\na breach of contract.\nDefendant\xe2\x80\x99s motion for summary judgment was granted by the trial court, which held that the\nemployment manual was not contractually binding on defendant, thus allowing defendant to terminate\nplaintiff\xe2\x80\x99s employment at will. The Appellate Division affirmed. We granted certification.\nThe employer\xe2\x80\x99s contention here is that the distribution of the manual was simply an expression of the\ncompany\xe2\x80\x99s \xe2\x80\x9cphilosophy\xe2\x80\x9d and therefore free of any possible contractual consequences. The former\nemployee claims it could reasonably be read as an explicit statement of company policies intended to be\nfollowed by the company in the same manner as if they were expressed in an agreement signed by both\nemployer and employees.\xe2\x80\xa6\nThis Court has long recognized the capacity of the common law to develop and adapt to current\nneeds.\xe2\x80\xa6The interests of employees, employers, and the public lead to the conclusion that the common law\nof New Jersey should limit the right of an employer to fire an employee at will.\nIn order for an offer in the form of a promise to become enforceable, it must be accepted. Acceptance will\ndepend on what the promisor bargained for: he may have bargained for a return promise that, if given,\nwould result in a bilateral contract, both promises becoming enforceable. Or he may have bargained for\nsome action or nonaction that, if given or withheld, would render his promise enforceable as a unilateral\ncontract. In most of the cases involving an employer\xe2\x80\x99s personnel policy manual, the document is prepared\nwithout any negotiations and is voluntarily distributed to the workforce by the employer. It seeks no\nreturn promise from the employees. It is reasonable to interpret it as seeking continued work from the\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n308\n\n\x0cemployees, who, in most cases, are free to quit since they are almost always employees at will, not simply\nin the sense that the employer can fire them without cause, but in the sense that they can quit without\nbreaching any obligation. Thus analyzed, the manual is an offer that seeks the formation of a unilateral\ncontract\xe2\x80\x94the employees\xe2\x80\x99 bargained-for action needed to make the offer binding being their continued\nwork when they have no obligation to continue.\nThe unilateral contract analysis is perfectly adequate for that employee who was aware of the manual and\nwho continued to work intending that continuation to be the action in exchange for the employer\xe2\x80\x99s\npromise; it is even more helpful in support of that conclusion if, but for the employer\xe2\x80\x99s policy manual, the\nemployee would have quit. See generally M. Petit, \xe2\x80\x9cModern Unilateral Contracts,\xe2\x80\x9d 63 Boston Univ. Law\nRev. 551 (1983) (judicial use of unilateral contract analysis in employment cases is widespread).\n\xe2\x80\xa6All that this opinion requires of an employer is that it be fair. It would be unfair to allow an employer to\ndistribute a policy manual that makes the workforce believe that certain promises have been made and\nthen to allow the employer to renege on those promises. What is sought here is basic honesty: if the\nemployer, for whatever reason, does not want the manual to be capable of being construed by the court as\na binding contract, there are simple ways to attain that goal. All that need be done is the inclusion in a\nvery prominent position of an appropriate statement that there is no promise of any kind by the employer\ncontained in the manual; that regardless of what the manual says or provides, the employer promises\nnothing and remains free to change wages and all other working conditions without having to consult\nanyone and without anyone\xe2\x80\x99s agreement; and that the employer continues to have the absolute power to\nfire anyone with or without good cause.\nReversed and remanded for trial.\n\nCASE QUESTIONS\n\n1.\n\nWhat did Woolley do to show his acceptance of the terms of employment offered to him?\n\n2.\n\nIn part of the case not included here, the court notes that Mr. Woolley died \xe2\x80\x9cbefore oral arguments on\nthis case.\xe2\x80\x9d How can there be any damages if the plaintiff has died? Who now has any case to pursue?\n\n3.\n\nThe court here is changing the law of employment in New Jersey. It is making case law, and the rule here\narticulated governs similar future cases in New Jersey. Why did the court make this change? Why is it\nrelevant that the court says it would be easy for an employer to avoid this problem?\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n309\n\n\x0c8.5 Summary and Exercises\nSummary\n\nContract law developed as the status-centered organization of feudal society faded and people began to\nmake choices about how they might order their lives. In the capitalistic system, people make choices about\nhow to interact with others, and\xe2\x80\x94necessarily\xe2\x80\x94those choices expressed as promises must be binding and\nenforceable.\nThe two fundamental sources of contract law are (1) the common law as developed in the state courts and\nas summarized in the Restatement (Second) of Contracts and (2) the Uniform Commercial Code for the\nsale of goods. In general, the UCC is more liberal than the common law in upholding the existence of a\ncontract.\nTypes of contracts can be distinguished by four criteria: (1) express and implied, including quasi-contracts\nimplied by law; (2) bilateral and unilateral; (3) enforceable and unenforceable; and (4) completed\n(executed) and uncompleted (executory). To understand contract law, it is necessary to master these\ndistinctions and their nuances.\n\nEXERCISES\n\n1.\na.\n\nMr. and Mrs. Smith, an elderly couple, had no relatives. When Mrs. Smith became ill,\nthe Smiths asked a friend, Henrietta, to help with various housekeeping chores,\nincluding cleaning and cooking. Although the Smiths never promised to pay her,\nHenrietta performed the chores for eighteen months. Henrietta now claims that she is\nentitled to the reasonable value of the services performed. Is she correct? Explain.\n\nb.\n\nAssume instead that the Smiths asked Mrs. Smith\xe2\x80\x99s sister, Caroline, who lived nearby, to\nhelp with the housekeeping. After eighteen months, Caroline claims she is entitled to\nthe reasonable value of the services performed. Is she correct? Explain.\n\nA letter from Bridge Builders Inc. to the Allied Steel Company stated, \xe2\x80\x9cWe offer to purchase 10,000\ntons of No. 4 steel pipe at today\xe2\x80\x99s quoted price for delivery two months from today. Your acceptance\nmust be received in five days.\xe2\x80\x9d Does Bridge Builders intend to create a bilateral or a unilateral contract?\nWhy?\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n310\n\n\x0cRoscoe\xe2\x80\x99s barber persuaded him to try a new hair cream called Sansfree, which the barber applied to\nRoscoe\xe2\x80\x99s hair and scalp. The next morning Roscoe had a very unpleasant rash along his hairline. Upon\ninvestigation he discovered that the rash was due to an improper chemical compound in Sansfree. If\nRoscoe filed a breach of contract action against the barber, would the case be governed by the Uniform\nCommercial Code or common law? Explain.\nRachel entered into a contract to purchase a 2004 Dodge from Hanna, who lived in the neighboring\napartment. When a dispute arose over the terms of the contract, Hanna argued that, because neither she\nnor Rachel was a merchant, the dispute should be decided under general principles of common law.\nRachel, on the other hand, argued that Hanna was legally considered to be a merchant because she sold\nthe car for profit and that, consequently, the sale was governed by the Uniform Commercial Code. Who is\ncorrect? Explain.\nLee and Michelle decided to cohabit. When they set up house, Michelle gave up her career, and Lee\npromised to share his earnings with her on a fifty-fifty basis. Several years later they ended their\nrelationship, and when Lee failed to turn over half of his earnings, Michelle filed suit on the basis of Lee\xe2\x80\x99s\npromise. What kind of contract would Michelle allege that Lee had breached? Explain.\nHarry and Wilma were divorced in 2008, and Harry was ordered in the divorce decree to pay his exwife $10,000. In 2009 and 2010 Harry was hospitalized, incurring $3,000 in bills. He and Wilma discussed\nthe matter, and Wilma agreed to pay the bill with her own money, even though Harry still owed her\n$5,000 from the divorce decree. When Harry died in late 2010, Wilma made a claim against his estate for\n$8,000 (the $3,000 in medical bills and the $5,000 from the decree), but the estate was only willing to pay\nthe $5,000 from the decree, claiming she had paid the hospital bill voluntarily and had no contract for\nrepayment. Is the estate correct? Explain.\nLouie, an adult, entered into a contract to sell a case of scotch whiskey to Leroy, a minor. Is the\ncontract void or voidable? Explain.\nJames Mann owned a manufacturing plant that assembled cell phones. A CPA audit determined\nthat several phones were missing. Theft by one or more of the workers was suspected.\nAccordingly, under Mann\xe2\x80\x99s instructions, the following sign was placed in the employees\xe2\x80\x99 cafeteria:\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n311\n\n\x0cReward. We are missing phones. I want all employees to watch for thievery. A reward of\n$500 will be paid for information given by any employee that leads to the apprehension of\nemployee thieves.\n\xe2\x80\x94James Mann\nWaldo, a plant employee, read the notice and immediately called Mann, stating, \xe2\x80\x9cI accept your\noffer. I promise to watch other employees and provide you with the requested information.\xe2\x80\x9d Has\na contract been formed? Explain.\nAlmost every day Sally took a break at lunch and went to the International News Stand\xe2\x80\x94a magazine\nstore\xe2\x80\x94to browse the newspapers and magazines and chat with the owner, Conrad. Often she bought a\nmagazine. One day she went there, browsed a bit, and took a magazine off the rack. Conrad was busy\nwith three customers. Sally waved the magazine at Conrad and left the store with it. What kind of a\ncontract, if any, was created?\nJoan called Devon Sand & Gravel and ordered two \xe2\x80\x9cboxes\xe2\x80\x9d (dump-truck loads) of gravel to be spread\non her rural driveway by the \xe2\x80\x9cshoot and run\xe2\x80\x9d method: the tailgate is partially opened, the dump-truck\nbed is lifted, and the truck moves down the driveway spreading gravel as it goes. The driver mistakenly\ngraveled the driveway of Joan\xe2\x80\x99s neighbor, Watson, instead of Joan\xe2\x80\x99s. Is Devon entitled to payment by\nWatson? Explain.\n\n1.\na.\n\nSELF-TEST QUESTIONS\n\nAn implied contract\nmust be in writing\n\nb.\n\nis one in which the terms are spelled out\n\nc.\n\nis one inferred from the actions of the parties\n\nd.\n\nis imposed by law to avoid an unjust result\n\ne.\n\nmay be avoided by one party\nThe Convention on Contracts for the International Sale of Goods is\n\na.\n\nan annual meeting of international commercial purchasing agents.\nb.\n\ncontract law used in overseas US federal territories\n\nc.\n\na customary format or template for drafting contracts\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n312\n\n\x0cd.\n\na kind of treaty setting out international contract law, to which the United States is a\nparty\n\ne.\n\nthe organization that develops uniform international law\n\nAn unenforceable contract is\na.\n\nvoid, not a contract at all\nb.\n\none that a court will not enforce for either side because of a rule of law\n\nc.\n\nunenforceable by one party but enforceable by the other\n\nd.\n\none that has been performed by one party but not the other\n\ne.\n\ntoo indefinite to be valid\n\nBetty Baker found a bicycle apparently abandoned near her house. She took it home and spent\n$150 repairing and painting it, after which Carl appeared and proved his ownership of it. Under\nwhat theory is Betty able to get reimbursed for her expenditures?\na.\n\nexpress contract\nb.\n\nimplied contract\n\nc.\n\napparent or quasi-contract\n\nd.\n\nexecutory contract\n\ne.\n\nnone: she will not get reimbursed\n\nAlice discusses with her neighbor Bob her plan to hire Woodsman to cut three trees on her side\nof their property line, mentioning that she can get a good deal because Woodsman is now\nbetween jobs. Bob says, \xe2\x80\x9cOh, don\xe2\x80\x99t do that. My brother is going to cut some trees on my side, and\nhe can do yours too for free.\xe2\x80\x9d Alice agrees. But Bob\xe2\x80\x99s brother is preoccupied and never does the\njob. Three weeks later Alice discovers Woodsman\xe2\x80\x99s rates have risen prohibitively. Under what\ntheory does Alice have a cause of action against Bob?\na.\n\nexpress contract\nb.\n\npromissory estoppel\n\nc.\n\nquasi-contract\n\nd.\n\nimplied contract\n\ne.\n\nnone: she has no cause of action against Bob\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n313\n\n\x0cSELF-TEST ANSWERS\n1.\n\nc\n\n2.\n\nd\n\n3.\n\nc\n\n4.\n\nc\n\n5.\n\nb\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n314\n\n\x0cChapter 9\n\nThe Agreement\nLEARNING OBJECTIVES\nAfter reading this chapter, you should understand the following:\n1.\n\nWhat a contract offer is, and what proposals are not offers\n\n2.\n\nHow an offer is communicated\n\n3.\n\nHow definite the offer needs to be\n\n4.\n\nHow long an offer is good for\n\n5.\n\nHow an offer is accepted, who can accept it, and when acceptance is effective\n\nIn this chapter, we begin the first of the four broad inquiries of contract law mentioned in Chapter 8\n"Introduction to Contract Law": Did the parties create a valid contract? The answer is not always\nobvious; the range of factors that must be taken into account can be large, and their relationships\nsubtle. Since businesspeople frequently conduct contract negotiations without the assistance of a\nlawyer, it is important to attend to the nuances in order to avoid legal trouble at the outset. Whether\na contract has been formed depends in turn on whether\n1.\n\nthe parties reached an agreement (the focus of this chapter);\n\n2. consideration was present;\n3. the agreement was legal; and\n4. the parties entered into the contract of their own free will, with knowledge of the facts, and with the\ncapacity to make a contract.\n\nFactors 2, 3, and 4 are the subjects of subsequent chapters.\n\n9.1 The Agreement in General\n\nLEARNING OBJECTIVES\n\n1.\n\nRecognize that not all agreements or promises are contracts.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n315\n\n\x0c2.\n\nUnderstand that whether a contract exists is based on an objective analysis of the parties\xe2\x80\x99 interaction, not\non a subjective one.\n\nThe Significance of Agreement\nThe core of a legal contract is the agreement between the parties. This is not a necessary ingredient; in\nCommunist nations, contracts were (or are, in the few remaining Communist countries) routinely\nnegotiated between parties who had the terms imposed on them. But in the West, and especially in the\nUnited States, agreement is of the essence. That is not merely a matter of convenience; it is at the heart of\nour philosophical and psychological beliefs. As the great student of contract law Samuel Williston put it,\n\xe2\x80\x9cIt was a consequence of the emphasis laid on the ego and the individual will that the formation of a\ncontract should seem impossible unless the wills of the parties concurred. Accordingly we find at the end\nof the eighteenth century, and the beginning of the nineteenth century, the prevalent idea that there must\nbe a \xe2\x80\x9cmeeting of the minds\xe2\x80\x9d (a new phrase) in order to form a contract.\xe2\x80\x9d\n\n[1]\n\nAlthough agreements may take any form, including unspoken conduct between the parties, they are\n[2]\n\nusually structured in terms of an offer and an acceptance. These two components will be the focus of our\ndiscussion. Note, however, that not every agreement, in the broadest sense of the word, need consist of an\noffer and an acceptance, and that it is entirely possible, therefore, for two persons to reach agreement\nwithout forming a contract. For example, people may agree that the weather is pleasant or that it would be\npreferable to go out for Chinese food rather than to see a foreign film; in neither case has a contract been\nformed. One of the major functions of the law of contracts is to sort out those agreements that are legally\nbinding\xe2\x80\x94those that are contracts\xe2\x80\x94from those that are not.\n\nThe Objective Test\nIn interpreting agreements, courts generally apply an objective standard(outwardly, as an observer would\ninterpret; not subjectively). The Restatement (Second) of Contracts defines agreement as a\n\xe2\x80\x9cmanifestation of mutual assent by two or more persons to one another.\xe2\x80\x9d\n\n[3]\n\nThe Uniform Commercial\n\nCode defines agreement as \xe2\x80\x9cthe bargain of the parties in fact as found in their language or by implication\nfrom other circumstances including course of dealing or usage of trade or course of performance.\xe2\x80\x9d\n\nSaylor URL: http://www.saylor.org/books\n\n[4]\n\nThe\n\nSaylor.org\n316\n\n\x0ccritical question is what the parties said or did, not what they thought they said or did, or not what\nimpression they thought they were making.\nThe distinction between objective and subjective standards crops up occasionally when one person claims\nhe spoke in jest. The vice president of a company that manufactured punchboards, used in gambling,\ntestified to the Washington State Game Commission that he would pay $100,000 to anyone who found a\n\xe2\x80\x9ccrooked board.\xe2\x80\x9d Barnes, a bartender, who had purchased two boards that were crooked some time\nbefore, brought one to the company office and demanded payment. The company refused, claiming that\nthe statement was made in jest (the audience at the commission hearing had laughed when the offer was\nmade). The court disagreed, holding that it was reasonable to interpret the pledge of $100,000 as a means\nof promoting punchboards:\n[I]f the jest is not apparent and a reasonable hearer would believe that an offer was being made,\nthen the speaker risks the formation of a contract which was not intended. It is the objective\nmanifestations of the offeror that count and not secret, unexpressed intentions. If a party\xe2\x80\x99s words\nor acts, judged by a reasonable standard, manifest an intention to agree in regard to the matter\nin question, that agreement is established, and it is immaterial what may be the real but\nunexpressed state of the party\xe2\x80\x99s mind on the subject.\n\n[5]\n\nLucy v. Zehmer (Section 9.4.1 "Objective Intention" at the end of the chapter) illustrates that a party\xe2\x80\x99s real\nstate of mind must be expressed to the other party, rather than in an aside to one\xe2\x80\x99s spouse.\n\nKEY TAKEAWAY\n\nFundamentally, a contract is a legally binding \xe2\x80\x9cmeeting of the minds\xe2\x80\x9d between the parties. It is not the\nunexpressed intention in the minds of the parties that determines whether there was \xe2\x80\x9ca meeting.\xe2\x80\x9d The\ntest is objective: how would a reasonable person interpret the interaction?\n\nEXERCISES\n\n1.\n\nFor the purposes of determining whether a party had a contractual intention, why do courts employ an\nobjective rather than a subjective test?\n\n2.\n\nWhat is the relationship between \xe2\x80\x9cthe emphasis laid on the ego and the individual will\xe2\x80\x9d in modern times\n(Williston) and the concept of the contractual agreement?\n3.\n\n[1] Samuel Williston, \xe2\x80\x9cFreedom of Contract,\xe2\x80\x9d Cornell Law Quarterly 6 (1921), 365.\n\n4.\n\n[2] Uniform Commercial Code, Section 2-204(1).\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n317\n\n\x0c5.\n\n[3] Uniform Commercial Code, Section 3.\n\n6.\n\n[4] Uniform Commercial Code, Section 1-201(3).\n\n7.\n\n[5] Barnes v. Treece, 549 P.2d 1152 (Wash. App. 1976).\n\n9.2 The Offer\n\nLEARNING OBJECTIVES\n\n1.\n\nKnow the definition of offer.\n\n2.\n\nRecognize that some proposals are not offers.\n\n3.\n\nUnderstand the three essentials of an offer: intent, communication, and definiteness.\n\n4.\n\nKnow when an offer expires and can no longer be accepted.\n\nOffer and acceptance may seem to be straightforward concepts, as they are when two people meet\nface-to-face. But in a commercial society, the ways of making offers and accepting them are nearly\ninfinite. A retail store advertises its merchandise in the newspaper. A seller makes his offer by mail\nor over the Internet. A telephone caller states that his offer will stand for ten days. An offer leaves\nopen a crucial term. An auctioneer seeks bids. An offeror gives the offeree a choice. All these\nsituations can raise tricky questions, as can corresponding situations involving acceptances.\n\nThe Definition of Offer\nThe Restatement defines offer as \xe2\x80\x9cthe manifestation of willingness to enter into a bargain, so made as to\njustify another person in understanding that his assent to that bargain is invited and will conclude\nit.\xe2\x80\x9d\n\n[1]\n\nTwo key elements are implicit in that definition: the offer must be communicated, and it must be\n\ndefinite. Before considering these requirements, we examine the threshold question of whether an offer\nwas intended. Let us look at proposals that may look like, but are not, offers.\n\nProposals That Are Not Offers\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n318\n\n\x0cAdvertisements\nMost advertisements, price quotations, and invitations to bid are not construed as offers. A notice in the\nnewspaper that a bicycle is on sale for $800 is normally intended only as an invitation to the public to\ncome to the store to make a purchase. Similarly, a statement that a seller can \xe2\x80\x9cquote\xe2\x80\x9d a unit price to a\nprospective purchaser is not, by itself, of sufficient definiteness to constitute an offer; quantity, time of\ndelivery, and other important factors are missing from such a statement. Frequently, in order to avoid\nconstruction of a statement about price and quantity as an offer, a seller or buyer may say, \xe2\x80\x9cMake me an\noffer.\xe2\x80\x9d Such a statement obviously suggests that no offer has yet been made. This principle usually applies\nto invitations for bids (e.g., from contractors on a building project). Many forms used by sales\nrepresentatives as contracts indicate that by signing, the customer is making an offer to be accepted by the\nhome office and is not accepting an offer made by the sales representative.\nAlthough advertisements, price quotations, and the like are generally not offers, the facts in each case are\nimportant. Under the proper circumstances, an advertised statement can be construed as an offer, as\nshown in the well-known Lefkowitz case (Section 9.4.2 "Advertisements as Offers" at the end of the\nchapter), in which the offended customer acted as his own lawyer and pursued an appeal to the Minnesota\nSupreme Court against a Minneapolis department store that took back its advertised offer.\nDespite the common-law rule that advertisements are normally to be considered invitations rather than\noffers, legislation and government regulations may offer redress. For many years, retail food stores have\nbeen subject to a rule, promulgated by the Federal Trade Commission (FTC), that goods advertised as\n\xe2\x80\x9cspecials\xe2\x80\x9d must be available and must be sold at the price advertised. It is unlawful for a retail chain not to\nhave an advertised item in each of its stores and in sufficient quantity, unless the advertisement\nspecifically states how much is stocked and which branch stores do not carry it. Many states have enacted\nconsumer protection statutes that parallel the FTC rule.\n\nInvitations to Bid\nInvitations to bid are also not generally construed as offers. An auctioneer does not make offers but\nsolicits offers from the crowd: \xe2\x80\x9cMay I have an offer?\xe2\x80\x94$500? $450? $450! I have an offer for $450. Do I\nhear $475? May I have an offer?\xe2\x80\x9d\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n319\n\n\x0cCommunication\nA contract is an agreement in which each party assents to the terms of the other party. Without mutual\nassent there cannot be a contract, and this implies that the assent each person gives must be with\nreference to that of the other. If Toni places several alternative offers on the table, only one of which can\nbe accepted, and invites Sandy to choose, no contract is formed if Sandy says merely, \xe2\x80\x9cI accept your\nterms.\xe2\x80\x9d Sandy must specify which offer she is assenting to.\nFrom this general proposition, it follows that no contract can be legally binding unless an offer is in fact\ncommunicated to the offeree. If you write an e-mail to a friend with an offer to sell your car for a certain\nsum and then get distracted and forget to send it, no offer has been made. If your friend coincidentally emails you the following day and says that she wants to buy your car and names the same sum, no contract\nhas been made. Her e-mail to you is not an acceptance, since she did not know of your offer; it is, instead,\nan offer or an invitation to make an offer. Nor would there have been a contract if you had sent your\ncommunication and the two e-mails crossed in cyberspace. Both e-mails would be offers, and for a valid\ncontract to be formed, it would still be necessary for one of you to accept the other\xe2\x80\x99s offer. An offer is not\neffective until it is received by the offeree (and that\xe2\x80\x99s also true of a revocation of the offer, and a rejection\nof the offer by the offeree).\nThe requirement that an offer be communicated does not mean that every term must be communicated.\nYou call up your friend and offer to sell him your car. You tell him the price and start to tell him that you\nwill throw in the snow tires but will not pay for a new inspection, and that you expect to keep the car\nanother three weeks. Impatiently, he cuts you off and says, \xe2\x80\x9cNever mind about all that; I\xe2\x80\x99ll accept your\noffer on whatever terms you want.\xe2\x80\x9d You and he have a contract.\nThese principles apply to unknown offers of reward. An offer of a reward constitutes a unilateral contract\nthat can be made binding only by performing the task for which the reward is offered. Suppose that\nBonnie posts on a tree a sign offering a reward for returning her missing dog. If you saw the sign, found\nthe dog, and returned it, you would have fulfilled the essentials of the offer. But if you chanced upon the\ndog, read the tag around its neck, and returned it without ever having been aware that a reward was\noffered, then you have not responded to the offer, even if you acted in the hope that the owner would\nreward you. There is no contractual obligation.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n320\n\n\x0cIn many states, a different result follows from an offer of a reward by a governmental entity. Commonly,\nlocal ordinances provide that a standing reward of, say, $1,000 will be paid to anyone providing\ninformation that leads to the arrest and conviction of arsonists. To collect the reward, it is not necessary\nfor a person who does furnish local authorities with such information to know that a reward ordinance\nexists. In contract terms, the standing reward is viewed as a means of setting a climate in which people\nwill be encouraged to act in certain ways in the expectation that they will earn unknown rewards. It is also\npossible to view the claim to a reward as noncontractual; the right to receive it is guaranteed, instead, by\nthe local ordinance.\nAlthough a completed act called for by an unknown private offer does not give rise to a contract, partial\nperformance usually does. Suppose Apex Bakery posts a notice offering a one-week bonus to all bakers\nwho work at least six months in the kitchen. Charlene works two months before discovering the notice on\nthe bulletin board. Her original ignorance of the offer will not defeat her claim to the bonus if she\ncontinues working, for the offer serves as an inducement to complete the performance called for.\n\nDefiniteness\nThe common law reasonably requires that an offer spell out the essential proposed terms with\nsufficient definiteness\xe2\x80\x94certainty of terms that enables a court to order enforcement or measure damages\nin the event of a breach. As it has often been put, \xe2\x80\x9cThe law does not make contracts for the parties; it\nmerely enforces the duties which they have undertaken\xe2\x80\x9d (Simpson, 1965, p. 19). Thus a supposed promise\nto sell \xe2\x80\x9csuch coal as the promisor may wish to sell\xe2\x80\x9d is not an enforceable term because the seller, the coal\ncompany, undertakes no duty to sell anything unless it wishes to do so. Essential terms certainly include\nprice and the work to be done. But not every omission is fatal; for example, as long as a missing term can\nbe fixed by referring to some external standard\xe2\x80\x94such as \xe2\x80\x9cno later than the first frost\xe2\x80\x9d\xe2\x80\x94the offer is\nsufficiently definite.\nIn major business transactions involving extensive negotiations, the parties often sign a preliminary\n\xe2\x80\x9cagreement in principle\xe2\x80\x9d before a detailed contract is drafted. These preliminary agreements may be\ndefinite enough to create contract liability even though they lack many of the terms found in a typical\ncontract. For example, in a famous 1985 case, a Texas jury concluded that an agreement made \xe2\x80\x9cin\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n321\n\n\x0cprinciple\xe2\x80\x9d between the Pennzoil Company and the Getty Oil Company and not entirely finished was\nbinding and that Texaco had unlawfully interfered with their contract. As a result, Texaco was held liable\nfor over $10 billion, which was settled for $3 billion after Texaco went into bankruptcy.\nOffers that state alternatives are definitive if each alternative is definite. David offers Sheila the\nopportunity to buy one of two automobiles at a fixed price, with delivery in two months and the choice of\nvehicle left to David. Sheila accepts. The contract is valid. If one of the cars is destroyed in the interval\nbefore delivery, David is obligated to deliver the other car. Sometimes, however, what appears to be an\noffer in the alternative may be something else. Charles makes a deal to sell his business to Bernie. As part\nof the bargain, Charles agrees not to compete with Bernie for the next two years, and if he does, to pay\n$25,000. Whether this is an alternative contract depends on the circumstances and intentions of the\nparties. If it is, then Charles is free to compete as long as he pays Bernie $25,000. On the other hand, the\nintention might have been to prevent Charles from competing in any event; hence a court could order\npayment of the $25,000 as damages for a breach and still order Charles to refrain from competition until\nthe expiration of the two-year period.\n\nThe UCC Approach\nThe Uniform Commercial Code (UCC) is generally more liberal in its approach to definiteness than is the\ncommon law\xe2\x80\x94at least as the common law was interpreted in the heyday of classical contract doctrine.\nSection 2-204(3) states the rule: \xe2\x80\x9cEven though one or more terms are left open, a contract for sale does\nnot fail for indefiniteness if the parties have intended to make a contract and there is a reasonably certain\nbasis for giving an appropriate remedy.\xe2\x80\x9d\nThe drafters of the UCC sought to give validity to as many contracts as possible and grounded that validity\non the intention of the parties rather than on formalistic requirements. As the official comment to Section\n2-204(3) notes, \xe2\x80\x9cIf the parties intend to enter into a binding agreement, this subsection recognizes that\nagreement as valid in law, despite missing terms, if there is any reasonably certain basis for granting a\nremedy.\xe2\x80\xa6Commercial standards on the point of \xe2\x80\x98indefiniteness\xe2\x80\x99 are intended to be applied.\xe2\x80\x9d Other\nsections of the UCC spell out rules for filling in such open provisions as price, performance, and\nremedies.\n\n[2]\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n322\n\n\x0cOne of these sections, Section 2-306(1), provides that a contract term under which a buyer agrees to\npurchase the seller\xe2\x80\x99s entire output of goods (an \xe2\x80\x9coutputs contract\xe2\x80\x9d) or a seller agrees to meet all the\nbuyer\xe2\x80\x99s requirements (a \xe2\x80\x9crequirements\xe2\x80\x9d or \xe2\x80\x9cneeds\xe2\x80\x9d contract) means output or requirements that occur in\ngood faith. A party to such a contract cannot offer or demand a quantity that is \xe2\x80\x9cunreasonably\ndisproportionate\xe2\x80\x9d to a stated estimate or past quantities.\n\nDuration of Offer\nAn offer need not be accepted on the spot. Because there are numerous ways of conveying an offer and\nnumerous contingencies that may be part of the offer\xe2\x80\x99s subject matter, the offeror might find it necessary\nto give the offeree considerable time to accept or reject the offer. By the same token, an offer cannot\nremain open forever, so that once given, it never lapses and cannot be terminated. The law recognizes\nseven ways by which the offer can expire (besides acceptance, of course): revocation, rejection by the\nofferee, counteroffer, acceptance with counteroffer, lapse of time, death or insanity of a person or\ndestruction of an essential term, and illegality. We will examine each of these in turn.\n\nRevocation\nPeople are free to make contracts and, in general, to revoke them.\n\nRevocability\nThe general rule, both in common law and under the UCC, is that the offeror may revoke his or her offer\nat any time before acceptance, even if the offer states that it will remain open for a specified period of\ntime. Neil offers Arlene his car for $5,000 and promises to keep the offer open for ten days. Two days\nlater, Neil calls Arlene to revoke the offer. The offer is terminated, and Arlene\xe2\x80\x99s acceptance thereafter,\nthough within the ten days, is ineffective. But if Neil had sent his revocation (the taking back of an offer\nbefore it is accepted) by mail, and if Arlene, before she received it, had telephoned her acceptance, there\nwould be a contract, since revocation is effective only when the offeree actually receives it. There is an\nexception to this rule for offers made to the public through newspaper or like advertisements. The offeror\nmay revoke a public offering by notifying the public by the same means used to communicate the offer. If\nno better means of notification is reasonably available, the offer is terminated even if a particular offeree\nhad no actual notice.\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n323\n\n\x0cRevocation may be communicated indirectly. If Arlene had learned from a friend that Neil had sold his car\nto someone else during the ten-day period, she would have had sufficient notice. Any attempt to accept\nNeil\xe2\x80\x99s offer would have been futile.\n\nIrrevocable Offers\nNot every type of offer is revocable. One type of offer that cannot be revoked is the option contract (the\npromisor explicitly agrees for consideration to limit his right to revoke). Arlene tells Neil that she cannot\nmake up her mind in ten days but that she will pay him $25 to hold the offer open for thirty days. Neil\nagrees. Arlene has an option to buy the car for $5,000; if Neil should sell it to someone else during the\nthirty days, he will have breached the contract with Arlene. Note that the transactions involving Neil and\nArlene consist of two different contracts. One is the promise of a thirty-day option for the promise of $25.\nIt is this contract that makes the option binding and is independent of the original offer to sell the car for\n$5,000. The offer can be accepted and made part of an independent contract during the option period.\nPartial performance of a unilateral contract creates an option. Although the option is not stated explicitly,\nit is recognized by law in the interests of justice. Otherwise, an offeror could induce the offeree to go to\nexpense and trouble without ever being liable to fulfill his or her part of the bargain. Before the offeree\nbegins to carry out the contract, the offeror is free to revoke the offer. But once performance begins, the\nlaw implies an option, allowing the offeree to complete performance according to the terms of the offer. If,\nafter a reasonable time, the offeree does not fulfill the terms of the offer, then it may be revoked.\n\nRevocability under the UCC\nThe UCC changes the common-law rule for offers by merchants. Under Section 2-205, a firm offer (a\nwritten and signed promise by a merchant to hold an offer to buy or sell goods for some period of time) is\nirrevocable. That is, an option is created, but no consideration is required. The offer must remain open for\nthe time period stated or, if no time period is given, for a reasonable period of time, which may not exceed\nthree months.\n\nIrrevocability by Law\nBy law, certain types of offers may not be revoked (statutory irrevocability), despite the absence of\nlanguage to that effect in the offer itself. One major category of such offers is that of the contractor\nsubmitting a bid to a public agency. The general rule is that once the period of bidding opens, a bidder on\na public contract may not withdraw his or her bid unless the contracting authority consents. The\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n324\n\n\x0ccontractor who purports to withdraw is awarded the contract based on the original bid and may be sued\nfor damages for nonperformance.\n\nRejection by the Offeree\nRejection (a manifestation of refusal to agree to the terms of an offer) of the offer is effective when the\nofferor receives it. A subsequent change of mind by the offeree cannot revive the offer. Donna calls Chuck\nto reject Chuck\xe2\x80\x99s offer to sell his lawn mower. Chuck is then free to sell it to someone else. If Donna\nchanges her mind and calls Chuck back to accept after all, there still is no contract, even if Chuck has\nmade no further effort to sell the lawn mower. Having rejected the original offer, Donna, by her second\ncall, is not accepting but making an offer to buy. Suppose Donna had written Chuck to reject, but on\nchanging her mind, decided to call to accept before the rejection letter arrived. In that case, the offer\nwould have been accepted.\n\nCounteroffer\nA counteroffer, a response that varies the terms of an offer, is a rejection. Jones offers Smith a small\nparcel of land for $10,000 and says the offer will remain open for one month. Smith responds ten days\nlater, saying he will pay $5,000. Jones\xe2\x80\x99s original offer has thereby been rejected. If Jones now declines\nSmith\xe2\x80\x99s counteroffer, may Smith bind Jones to his original offer by agreeing to pay the full $10,000? He\nmay not, because once an original offer is rejected, all the terms lapse. However, an inquiry by Smith as to\nwhether Jones would consider taking less is not a counteroffer and would not terminate the offer.\n\nAcceptance with Counteroffer\nThis is not really an acceptance at all but is a counteroffer: an acceptance that changes the terms of the\noffer is a counteroffer and terminates the offer. The common law imposes a mirror image rule: the\nacceptance must match the offer in all its particulars or the offer is rejected. However, if an acceptance\nthat requests a change or an addition to the offer does not require the offeror\xe2\x80\x99s assent, then the acceptance\nis valid. The broker at Friendly Real Estate offers you a house for $320,000. You accept but include in\nyour acceptance \xe2\x80\x9cthe vacant lot next door.\xe2\x80\x9d Your acceptance is a counteroffer, which serves to terminate\nthe original offer. If, instead, you had said, \xe2\x80\x9cIt\xe2\x80\x99s a deal, but I\xe2\x80\x99d prefer it with the vacant lot next door,\xe2\x80\x9d then\nthere is a contract because you are not demanding that the broker abide by your request. If you had said,\n\xe2\x80\x9cIt\xe2\x80\x99s a deal, and I\xe2\x80\x99d also like the vacant lot next door,\xe2\x80\x9d you have a contract, because the request for the lot\nis a separate offer, not a counteroffer rejecting the original proposal.\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n325\n\n\x0cThe UCC and Counteroffers\nThe UCC is more liberal than the common law in allowing contracts to be formed despite counteroffers\nand in incorporating the counteroffers into the contracts. This UCC provision is necessary because the use\nof routine forms for contracts is very common, and if the rule were otherwise, much valuable time would\nbe wasted by drafting clauses tailored to the precise wording of the routine printed forms. A buyer and a\nseller send out documents accompanying or incorporating their offers and acceptances, and the\nprovisions in each document rarely correspond precisely. Indeed, it is often the case that one side\xe2\x80\x99s form\ncontains terms favorable to it but inconsistent with terms on the other side\xe2\x80\x99s form. Section 2-207 of the\nUCC attempts to resolve this \xe2\x80\x9cbattle of the forms\xe2\x80\x9d by providing that additional terms or conditions in an\nacceptance operate as such unless the acceptance is conditioned on the offeror\xe2\x80\x99s consent to the new or\ndifferent terms. The new terms are construed as offers but are automatically incorporated in any contract\nbetween merchants for the sale of goods unless \xe2\x80\x9c(a) the offer expressly limits acceptance to the terms of\nthe offer; (b) [the terms] materially alter it; or (c) notification of objection to them has already been given\nor is given within a reasonable time after notice of them is received.\xe2\x80\x9d\nAn example of terms that become part of the contract without being expressly agreed to are clauses\nproviding for interest payments on overdue bills. Examples of terms that would materially alter the\ncontract and hence need express approval are clauses that negate the standard warranties that sellers give\nbuyers on their merchandise.\nFrequently, parties use contract provisions to prevent the automatic introduction of new terms. A typical\nseller\xe2\x80\x99s provision is as follows:\nAmendments\nAny modification of this document by the Buyer, and all additional or different terms included in\nBuyer\xe2\x80\x99s purchase order or any other document responding to this offer, are hereby objected to.\nBY ORDERING THE GOODS HERE FOR SHIPMENT, BUYER AGREES TO ALL THE TERMS\nAND CONDITIONS CONTAINED ON BOTH SIDES OF THIS DOCUMENT.\nSection 2-207 of the UCC, liberalizing the mirror image rule, is pervasive, covering all sorts of contracts,\nfrom those between industrial manufacturers to those between friends.\n\nLapse of Time\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n326\n\n\x0cOffers are not open-ended; they lapse after some period of time. An offer may contain its own specific\ntime limitation\xe2\x80\x94for example, \xe2\x80\x9cuntil close of business today.\xe2\x80\x9d\nIn the absence of an expressly stated time limit, the common-law rule is that the offer expires at the end of\na \xe2\x80\x9creasonable\xe2\x80\x9d time. Such a period is a factual question in each case and depends on the particular\ncircumstances, including the nature of the service or property being contracted for, the manner in which\nthe offer is made, and the means by which the acceptance is expected to be made. Whenever the contract\ninvolves a speculative transaction\xe2\x80\x94the sale of securities or land, for instance\xe2\x80\x94the time period will depend\non the nature of the security and the risk involved. In general, the greater the risk to the seller, the shorter\nthe period of time. Karen offers to sell Gary a block of oil stocks that are fluctuating rapidly hour by hour.\nGary receives the offer an hour before the market closes; he accepts by fax two hours after the market has\nopened the next morning and after learning that the stock has jumped up significantly. The time period\nhas lapsed if Gary was accepting a fixed price that Karen set, but it may still be open if the price is market\nprice at time of delivery. (Under Section 41 of the Restatement, an offer made by mail is \xe2\x80\x9cseasonably\naccepted if an acceptance is mailed at any time before midnight on the day on which the offer is\nreceived.\xe2\x80\x9d)\nFor unilateral contracts, both the common law and the UCC require the offeree to notify the offeror that\nhe has begun to perform the terms of the contract. Without notification, the offeror may, after a\nreasonable time, treat the offer as having lapsed.\n\nDeath or Insanity of the Offeror\nThe death or insanity of the offeror prior to acceptance terminates the offer; the offer is said to die with\nthe offeror. (Notice, however, that the death of a party to a contract does not necessarily terminate the\ncontract: the estate of a deceased person may be liable on a contract made by the person before death.)\n\nDestruction of Subject Matter Essential to the Offer\nDestruction of something essential to the contract also terminates the offer. You offer to sell your car, but\nthe car is destroyed in an accident before your offer is accepted; the offer is terminated.\n\nPostoffer Illegality\nA statute making unlawful the object of the contract will terminate the offer if the statute takes effect after\nthe offer was made. Thus an offer to sell a quantity of herbal weight-loss supplements will terminate if the\nFood and Drug Administration outlaws the sale of such supplements.\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n327\n\n\x0cKEY TAKEAWAY\nAn offer is a manifestation of willingness to enter into a contract, effective when received. It must be\ncommunicated to the offeree, be made intentionally (according to an objective standard), and be definite\nenough to determine a remedy in case of breach. An offer terminates in one of seven ways: revocation\nbefore acceptance (except for option contracts, firm offers under the UCC, statutory irrevocability, and\nunilateral offers where an offeree has commenced performance); rejection; counteroffer; acceptance with\ncounteroffer; lapse of time (as stipulated or after a reasonable time); death or insanity of the offeror\nbefore acceptance or destruction of subject matter essential to the offer; and postoffer illegality.\n\nEXERCISES\n\n1.\n\nWhy is it said an offer is a \xe2\x80\x9cmanifestation\xe2\x80\x9d of willingness to enter into a contract? How could willingness\nbe \xe2\x80\x9cmanifested\xe2\x80\x9d?\n\n2.\n\nWhich kind of standard is used to determine whether a person has made an offer\xe2\x80\x94subjective or\nobjective?\n\n3.\n\nIf Sandra posts a written notice offering \xe2\x80\x9cto the kitchen staff at Coldwater Bay (Alaska) transportation to\nSeattle at the end of the fishing season,\xe2\x80\x9d and if David, one of the maintenance workers, says to her, \xe2\x80\x9cI\naccept your offer of transportation to Seattle,\xe2\x80\x9d is there a contract?\n\n4.\n\nWhat are the seven ways an offer can terminate?\n5.\n\n[1] Restatement (Second) of Contracts, Section 24.\n\n6.\n\n[2] Chiefly, Uniform Commercial Code, Sections 2-305 through 2-310.\n\n9.3 The Acceptance\n\nLEARNING OBJECTIVES\n\n1.\n\nDefine acceptance.\n\n2.\n\nUnderstand who may accept an offer.\n\n3.\n\nKnow when the acceptance is effective.\n\n4.\n\nRecognize when silence is acceptance.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n328\n\n\x0cGeneral Definition of Acceptance\nTo result in a legally binding contract, an offer must be accepted by the offeree. Just as the law helps\ndefine and shape an offer and its duration, so the law governs the nature and manner of acceptance. The\nRestatement defines acceptance of an offer as \xe2\x80\x9ca manifestation of assent to the terms thereof made by the\n[1]\n\nofferee in a manner invited or required by the offer.\xe2\x80\x9d The assent may be either by the making of a mutual\npromise or by performance or partial performance. If there is doubt about whether the offer requests a\nreturn promise or a return act, the Restatement, Section 32, provides that the offeree may accept with\neither a promise or performance. The Uniform Commercial Code (UCC) also adopts this view; under\nSection 2-206(1)(a), \xe2\x80\x9can offer to make a contract shall be construed as inviting acceptance in any manner\nand by any medium reasonable in the circumstances\xe2\x80\x9d unless the offer unambiguously requires a certain\nmode of acceptance.\n\nWho May Accept?\nThe identity of the offeree is usually clear, even if the name is unknown. The person to whom a promise is\nmade is ordinarily the person whom the offeror contemplates will make a return promise or perform the\nact requested. But this is not invariably so. A promise can be made to one person who is not expected to\ndo anything in return. The consideration necessary to weld the offer and acceptance into a legal contract\ncan be given by a third party. Under the common law, whoever is invited to furnish consideration to the\nofferor is the offeree, and only an offeree may accept an offer. A common example is sale to a minor.\nGeorge promises to sell his automobile to Bartley, age seventeen, if Bartley\xe2\x80\x99s father will promise to pay\n$3,500 to George. Bartley is the promisee (the person to whom the promise is made) but not the offeree;\nBartley cannot legally accept George\xe2\x80\x99s offer. Only Bartley\xe2\x80\x99s father, who is called on to pay for the car, can\naccept, by making the promise requested. And notice what might seem obvious: a promise to perform as\nrequested in the offer is itself a binding acceptance.\n\nWhen Is Acceptance Effective?\nAs noted previously, an offer, a revocation of the offer, and a rejection of the offer are not effective until\nreceived. The same rule does not always apply to the acceptance.\n\nInstantaneous Communication\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n329\n\n\x0cOf course, in many instances the moment of acceptance is not in question: in face-to-face deals or\ntransactions negotiated by telephone, the parties extend an offer and accept it instantaneously during the\ncourse of the conversation. But problems can arise in contracts negotiated through correspondence.\n\nStipulations as to Acceptance\nOne common situation arises when the offeror stipulates the mode of acceptance (e.g., return mail, fax, or\ncarrier pigeon). If the offeree uses the stipulated mode, then the acceptance is deemed effective when sent.\nEven though the offeror has no knowledge of the acceptance at that moment, the contract has been\nformed. Moreover, according to the Restatement, Section 60, if the offeror says that the offer can be\naccepted only by the specified mode, that mode must be used. (It is said that \xe2\x80\x9cthe offeror is the master of\nthe offer.\xe2\x80\x9d)\nIf the offeror specifies no particular mode, then acceptance is effective when transmitted, as long as the\nofferee uses a reasonable method of acceptance. It is implied that the offeree can use the same means used\nby the offeror or a means of communication customary to the industry.\n\nThe \xe2\x80\x9cMailbox Rule\xe2\x80\x9d\nThe use of the postal service is customary, so acceptances are considered effective when mailed,\nregardless of the method used to transmit the offer. Indeed, the so-called mailbox rule has a lineage\ntracing back more than one hundred years to the English courts.\n\n[2]\n\nThe mailbox rule may seem to create particular difficulties for people in business, since the acceptance is\neffective even though the offeror is unaware of the acceptance, and even if the letter is lost and never\narrives. But the solution is the same as the rationale for the rule. In contracts negotiated through\ncorrespondence, there will always be a burden on one of the parties. If the rule were that the acceptance is\nnot effective until received by the offeror, then the offeree would be on tenterhooks, rather than the other\nway around, as is the case with the present rule. As between the two, it seems fairer to place the burden on\nthe offeror, since he or she alone has the power to fix the moment of effectiveness. All the offeror need do\nis specify in the offer that acceptance is not effective until received.\nIn all other cases\xe2\x80\x94that is, when the offeror fails to specify the mode of acceptance and the offeree uses a\nmode that is not reasonable\xe2\x80\x94acceptance is deemed effective only when received.\n\nAcceptance \xe2\x80\x9cOutruns\xe2\x80\x9d Rejection\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n330\n\n\x0cWhen the offeree sends a rejection first and then later transmits a superseding acceptance, the \xe2\x80\x9ceffective\nwhen received\xe2\x80\x9d rule also applies. Suppose a seller offers a buyer two cords of firewood and says the offer\nwill remain open for a week. On the third day, the buyer writes the seller, rejecting the offer. The following\nevening, the buyer rethinks his firewood needs, and on the morning of the fifth day, he sends an e-mail\naccepting the seller\xe2\x80\x99s terms. The previously mailed letter arrives the following day. Since the letter had not\nyet been received, the offer had not been rejected. For there to be a valid contract, the e-mailed acceptance\nmust arrive before the mailed rejection. If the e-mail were hung up in cyberspace, although through no\nfault of the buyer, so that the letter arrived first, the seller would be correct in assuming the offer was\nterminated\xe2\x80\x94even if the e-mail arrived a minute later. In short, where \xe2\x80\x9cthe acceptance outruns the\nrejection\xe2\x80\x9d the acceptance is effective. See Figure 9.1.\n\nFigure 9.1\n\nWhen Is Communication Effective?\n\nElectronic Communications\nElectronic communications have, of course, become increasingly common. Many contracts are negotiated\nby e-mail, accepted and \xe2\x80\x9csigned\xe2\x80\x9d electronically. Generally speaking, this does not change the rules. The\nUniform Electronic Transactions Act (UETA) was promulgated (i.e., disseminated for states to adopt) in\n1999. It is one of a number of uniform acts, like the Uniform Commercial Code. As of June 2010, fortyseven states and the US Virgin Islands had adopted the statute. The introduction to the act provides that\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n331\n\n\x0c\xe2\x80\x9cthe purpose of the UETA is to remove barriers to electronic commerce by validating and effectuating\nelectronic records and signatures.\xe2\x80\x9d\na.\n\n[3]\n\nIn general, the UETA provides the following:\n\nA record or signature may not be denied legal effect or enforceability solely because it is in\n\nelectronic form.\nb. A contract may not be denied legal effect or enforceability solely because an electronic record was\nused in its formation.\nc.\n\nIf a law requires a record to be in writing, an electronic record satisfies the law.\n\nd. If a law requires a signature, an electronic signature satisfies the law.\nThe UETA, though, doesn\xe2\x80\x99t address all the problems with electronic contracting. Clicking on a computer\nscreen may constitute a valid acceptance of a contractual offer, but only if the offer is clearly\ncommunicated. In Specht v. Netscape Communications Corp., customers who had downloaded a free\nonline computer program complained that it effectively invaded their privacy by inserting into their\nmachines \xe2\x80\x9ccookies\xe2\x80\x9d; they wanted to sue, but the defendant said they were bound to arbitration.\n\n[4]\n\nThey\n\nhad clicked on the Download button, but hidden below it were the licensing terms, including the\narbitration clause. The federal court of appeals held that there was no valid acceptance. The court said,\n\xe2\x80\x9cWe agree with the district court that a reasonably prudent Internet user in circumstances such as these\nwould not have known or learned of the existence of the license terms before responding to defendants\xe2\x80\x99\ninvitation to download the free software, and that defendants therefore did not provide reasonable notice\nof the license terms. In consequence, the plaintiffs\xe2\x80\x99 bare act of downloading the software did not\nunambiguously manifest assent to the arbitration provision contained in the license terms.\xe2\x80\x9d\nIf a faxed document is sent but for some reason not received or not noticed, the emerging law is that the\nmailbox rule does not apply. A court would examine the circumstances with care to determine the reason\nfor the nonreceipt or for the offeror\xe2\x80\x99s failure to notice its receipt. A person has to have fair notice that his\nor her offer has been accepted, and modern communication makes the old-fashioned mailbox rule\xe2\x80\x94that\nacceptance is effective upon dispatch\xe2\x80\x94problematic.\n\n[5]\n\nSilence as Acceptance\nGeneral Rule: Silence Is Not Acceptance\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n332\n\n\x0cOrdinarily, for there to be a contract, the offeree must make some positive manifestation of assent to the\nofferor\xe2\x80\x99s terms. The offeror cannot usually word his offer in such a way that the offeree\xe2\x80\x99s failure to\nrespond can be construed as an acceptance.\n\nExceptions\nThe Restatement, Section 69, gives three situations, however, in which silence can operate as an\nacceptance. The first occurs when the offeree avails himself of services proffered by the offeror, even\nthough he could have rejected them and had reason to know that the offeror offered them expecting\ncompensation. The second situation occurs when the offer states that the offeree may accept without\nresponding and the offeree, remaining silent, intends to accept. The third situation is that of previous\ndealings, in which only if the offeree intends not to accept is it reasonable to expect him to say so.\nAs an example of the first type of acceptance by silence, assume that a carpenter happens by your house\nand sees a collapsing porch. He spots you in the front yard and points out the deterioration. \xe2\x80\x9cI\xe2\x80\x99m a\nprofessional carpenter,\xe2\x80\x9d he says, \xe2\x80\x9cand between jobs. I can fix that porch for you. Somebody ought to.\xe2\x80\x9d You\nsay nothing. He goes to work. There is an implied contract, with the work to be done for the carpenter\xe2\x80\x99s\nusual fee.\nTo illustrate the second situation, suppose that a friend has left her car in your garage. The friend sends\nyou a letter in which she offers you the car for $4,000 and adds, \xe2\x80\x9cIf I don\xe2\x80\x99t hear from you, I will assume\nthat you have accepted my offer.\xe2\x80\x9d If you make no reply, with the intention of accepting the offer, a\ncontract has been formed.\nThe third situation is illustrated by Section 9.4.3 "Silence as Acceptance", a well-known decision made by\nJustice Oliver Wendell Holmes Jr. when he was sitting on the Supreme Court of Massachusetts.\n\nKEY TAKEAWAY\n\nWithout an acceptance of an offer, no contract exists, and once an acceptance is made, a contract is\nformed. If the offeror stipulates how the offer should be accepted, so be it. If there is no stipulation, any\nreasonable means of communication is good. Offers and revocations are usually effective upon receipt,\nwhile an acceptance is effective on dispatch. The advent of electronic contracting has caused some\nmodification of the rules: courts are likely to investigate the facts surrounding the exchange of offer and\nacceptance more carefully than previously. But the nuances arising because of the mailbox rule and\nacceptance by silence still require close attention to the facts.\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n333\n\n\x0cEXERCISES\n1.\n\nRudy puts this poster, with a photo of his dog, on utility poles around his neighborhood: \xe2\x80\x9c$50 reward for\nthe return of my lost dog.\xe2\x80\x9d Carlene doesn\xe2\x80\x99t see the poster, but she finds the dog and, after looking at the\ntag on its collar, returns the dog to Rudy. As she leaves his house, her eye falls on one of the posters, but\nRudy declines to pay her anything. Why is Rudy correct that Carlene has no legal right to the reward?\n\n2.\n\nHow has the UCC changed the common law\xe2\x80\x99s mirror image rule, and why?\n\n3.\n\nWhen is an offer generally said to be effective? A rejection of an offer? A counteroffer?\n\n4.\n\nHow have modern electronic communications affected the law of offer and acceptance?\n\n5.\n\nWhen is silence considered an acceptance?\n6.\n\n[1] Restatement (Second) of Contracts, Section 24.\n\n7.\n\n[2] Adams v. Lindsell, 1 Barnewall & Alderson 681 (K.B. 1818).\n\n8.\n\n[3] The National Conference of Commissioners on Uniform State Laws, Uniform Electronic Transactions\nAct (1999) (Denver: National Conference of Commissioners on Uniform State Laws, 1999), accessed March\n29, 2011,http://www.law.upenn.edu/bll/archives/ulc/fnact99/1990s/ueta99.pdf.\n\n9.\n\n[4] Specht v. Netscape Communications Corp., 306 F.3d 17 (2d Cir. 2002).\n\n10. [5] See, for example, Clow Water Systems Co. v. National Labor Relations Board, 92 F.3d 441 (6th Cir.\n1996).\n\n9.4 Cases\nObjective Intention\nLucy v. Zehmer\n84 S.E.2d 516 (Va. 1954)\nBuchanan, J.\nThis suit was instituted by W. O. Lucy and J. C. Lucy, complainants, against A. H. Zehmer and Ida S.\nZehmer, his wife, defendants, to have specific performance of a contract by which it was alleged the\nZehmers had sold to W. O. Lucy a tract of land owned by A. H. Zehmer in Dinwiddie county containing\n471.6 acres, more or less, known as the Ferguson farm, for $50,000. J. C. Lucy, the other complainant, is\na brother of W. O. Lucy, to whom W. O. Lucy transferred a half interest in his alleged purchase.\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n334\n\n\x0cThe instrument sought to be enforced was written by A. H. Zehmer on December 20, 1952, in these words:\n\xe2\x80\x9cWe hereby agree to sell to W. O. Lucy the Ferguson farm complete for $50,000.00, title satisfactory to\nbuyer,\xe2\x80\x9d and signed by the defendants, A. H. Zehmer and Ida S. Zehmer.\nThe answer of A. H. Zehmer admitted that at the time mentioned W. O. Lucy offered him $50,000 cash\nfor the farm, but that he, Zehmer, considered that the offer was made in jest; that so thinking, and both he\nand Lucy having had several drinks, he wrote out \xe2\x80\x9cthe memorandum\xe2\x80\x9d quoted above and induced his wife\nto sign it; that he did not deliver the memorandum to Lucy, but that Lucy picked it up, read it, put it in his\npocket, attempted to offer Zehmer $5 to bind the bargain, which Zehmer refused to accept, and realizing\nfor the first time that Lucy was serious, Zehmer assured him that he had no intention of selling the farm\nand that the whole matter was a joke. Lucy left the premises insisting that he had purchased the farm.\xe2\x80\xa6\nIn his testimony Zehmer claimed that he \xe2\x80\x9cwas high as a Georgia pine,\xe2\x80\x9d and that the transaction \xe2\x80\x9cwas just a\nbunch of two doggoned drunks bluffing to see who could talk the biggest and say the most.\xe2\x80\x9d That claim is\ninconsistent with his attempt to testify in great detail as to what was said and what was done.\xe2\x80\xa6\nIf it be assumed, contrary to what we think the evidence shows, that Zehmer was jesting about selling his\nfarm to Lucy and that the transaction was intended by him to be a joke, nevertheless the evidence shows\nthat Lucy did not so understand it but considered it to be a serious business transaction and the contract\nto be binding on the Zehmers as well as on himself. The very next day he arranged with his brother to put\nup half the money and take a half interest in the land. The day after that he employed an attorney to\nexamine the title. The next night, Tuesday, he was back at Zehmer\xe2\x80\x99s place and there Zehmer told him for\nthe first time, Lucy said, that he wasn\xe2\x80\x99t going to sell and he told Zehmer, \xe2\x80\x9cYou know you sold that place\nfair and square.\xe2\x80\x9d After receiving the report from his attorney that the title was good he wrote to Zehmer\nthat he was ready to close the deal.\nNot only did Lucy actually believe, but the evidence shows he was warranted in believing, that the contract\nrepresented a serious business transaction and a good faith sale and purchase of the farm.\nIn the field of contracts, as generally elsewhere, \xe2\x80\x9cWe must look to the outward expression of a person as\nmanifesting his intention rather than to his secret and unexpressed intention. The law imputes to a person\nan intention corresponding to the reasonable meaning of his words and acts.\xe2\x80\x9d\nAt no time prior to the execution of the contract had Zehmer indicated to Lucy by word or act that he was\nnot in earnest about selling the farm. They had argued about it and discussed its terms, as Zehmer\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n335\n\n\x0cadmitted, for a long time. Lucy testified that if there was any jesting it was about paying $50,000 that\nnight. The contract and the evidence show that he was not expected to pay the money that night. Zehmer\nsaid that after the writing was signed he laid it down on the counter in front of Lucy. Lucy said Zehmer\nhanded it to him. In any event there had been what appeared to be a good faith offer and a good faith\nacceptance, followed by the execution and apparent delivery of a written contract. Both said that Lucy put\nthe writing in his pocket and then offered Zehmer $5 to seal the bargain. Not until then, even under the\ndefendants\xe2\x80\x99 evidence, was anything said or done to indicate that the matter was a joke. Both of the\nZehmers testified that when Zehmer asked his wife to sign he whispered that it was a joke so Lucy\nwouldn\xe2\x80\x99t hear and that it was not intended that he should hear.\nThe mental assent of the parties is not requisite for the formation of a contract. If the words or other acts\nof one of the parties have but one reasonable meaning, his undisclosed intention is immaterial except\nwhen an unreasonable meaning which he attaches to his manifestations is known to the other party.\n\xe2\x80\x9c* * * The law, therefore, judges of an agreement between two persons exclusively from those expressions\nof their intentions which are communicated between them. * * *.\xe2\x80\x9d [Citation]\nAn agreement or mutual assent is of course essential to a valid contract but the law imputes to a person an\nintention corresponding to the reasonable meaning of his words and acts. If his words and acts, judged by\na reasonable standard, manifest an intention to agree, it is immaterial what may be the real but\nunexpressed state of his mind.\nSo a person cannot set up that he was merely jesting when his conduct and words would warrant a\nreasonable person in believing that he intended a real agreement.\nWhether the writing signed by the defendants and now sought to be enforced by the complainants was the\nresult of a serious offer by Lucy and a serious acceptance by the defendants, or was a serious offer by Lucy\nand an acceptance in secret jest by the defendants, in either event it constituted a binding contract of sale\nbetween the parties.\xe2\x80\xa6\nReversed and remanded.\n\n1.\n\nCASE QUESTIONS\n\nWhat objective evidence was there to support the defendants\xe2\x80\x99 contention that they were just kidding\nwhen they agreed to sell the farm?\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n336\n\n\x0c2.\n\nSuppose the defendants really did think the whole thing was a kind of joke. Would that make any\ndifference?\n\n3.\n\nAs a matter of public policy, why does the law use an objective standard to determine the seriousness of\nintention, instead of a subjective standard?\n\n4.\n\nIt\xe2\x80\x99s 85 degrees in July and 5:00 p.m., quitting time. The battery in Mary\xe2\x80\x99s car is out of juice, again. Mary\nsays, \xe2\x80\x9cArrgh! I will sell this stupid car for $50!\xe2\x80\x9d Jason, walking to his car nearby, whips out his checkbook\nand says, \xe2\x80\x9cIt\xe2\x80\x99s a deal. Leave your car here. I\xe2\x80\x99ll give you a ride home and pick up your car after you give me\nthe title.\xe2\x80\x9d Do the parties have a contract?\n\nAdvertisements as Offers\nLefkowitz v. Great Minneapolis Surplus Store\n86 N.W.2d 689 (Minn. 1957)\nMurphy, Justice.\nThis is an appeal from an order of the Municipal Court of Minneapolis denying the motion of the\ndefendant for amended findings of fact, or, in the alternative, for a new trial. The order for judgment\nawarded the plaintiff the sum of $138.50 as damages for breach of contract.\nThis case grows out of the alleged refusal of the defendant to sell to the plaintiff a certain fur piece which it\nhad offered for sale in a newspaper advertisement. It appears from the record that on April 6, 1956, the\ndefendant published the following advertisement in a Minneapolis newspaper:\nSaturday 9 A.M. Sharp\n3 Brand New Fur Coats Worth to $100.00\nFirst Come\nFirst Served\n$1 Each\n[The $100 coat would be worth about $800 in 2010 dollars.] On April 13, the defendant again published\nan advertisement in the same newspaper as follows:\nSaturday 9 A.M.\n2 Brand New Pastel Mink 3-Skin Scarfs\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n337\n\n\x0cSelling for. $89.50\nOut they go Saturday. Each\xe2\x80\xa6$1.00\n1 Black Lapin Stole Beautiful, worth $139.50\xe2\x80\xa6$1.00\nFirst Come First Served\nThe record supports the findings of the court that on each of the Saturdays following the publication of the\nabove-described ads the plaintiff was the first to present himself at the appropriate counter in the\ndefendant\xe2\x80\x99s store and on each occasion demanded the coat and the stole so advertised and indicated his\nreadiness to pay the sale price of $1. On both occasions, the defendant refused to sell the merchandise to\nthe plaintiff, stating on the first occasion that by a \xe2\x80\x9chouse rule\xe2\x80\x9d the offer was intended for women only and\nsales would not be made to men, and on the second visit that plaintiff knew defendant\xe2\x80\x99s house rules.\nThe trial court properly disallowed plaintiff\xe2\x80\x99s claim for the value of the fur coats since the value of these\narticles was speculative and uncertain. The only evidence of value was the advertisement itself to the effect\nthat the coats were \xe2\x80\x9cWorth to $100.00,\xe2\x80\x9d how much less being speculative especially in view of the price for\nwhich they were offered for sale. With reference to the offer of the defendant on April 13, 1956, to sell the\n\xe2\x80\x9c1 Black Lapin Stole * * * worth $139.50 * * *\xe2\x80\x9d the trial court held that the value of this article was\nestablished and granted judgment in favor of the plaintiff for that amount less the $1 quoted purchase\nprice.\n1.\n\nThe defendant contends that a newspaper advertisement offering items of merchandise for sale at a\nnamed price is a \xe2\x80\x9cunilateral offer\xe2\x80\x9d which may be withdrawn without notice. He relies upon authorities\nwhich hold that, where an advertiser publishes in a newspaper that he has a certain quantity or\nquality of goods which he wants to dispose of at certain prices and on certain terms, such\nadvertisements are not offers which become contracts as soon as any person to whose notice they may\ncome signifies his acceptance by notifying the other that he will take a certain quantity of them. Such\nadvertisements have been construed as an invitation for an offer of sale on the terms stated, which\noffer, when received, may be accepted or rejected and which therefore does not become a contract of\nsale until accepted by the seller; and until a contract has been so made, the seller may modify or\nrevoke such prices or terms. [Citations]\n\n\xe2\x80\xa6On the facts before us we are concerned with whether the advertisement constituted an offer, and, if so,\nwhether the plaintiff\xe2\x80\x99s conduct constituted an acceptance.\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n338\n\n\x0cThere are numerous authorities which hold that a particular advertisement in a newspaper or circular\nletter relating to a sale of articles may be construed by the court as constituting an offer, acceptance of\nwhich would complete a contract. [Citations]\nThe test of whether a binding obligation may originate in advertisements addressed to the general public\nis \xe2\x80\x9cwhether the facts show that some performance was promised in positive terms in return for something\nrequested.\xe2\x80\x9d 1 Williston, Contracts (Rev. ed.) s 27.\nThe authorities above cited emphasize that, where the offer is clear, definite, and explicit, and leaves\nnothing open for negotiation, it constitutes an offer, acceptance of which will complete the contract.\xe2\x80\xa6\nWhether in any individual instance a newspaper advertisement is an offer rather than an invitation to\nmake an offer depends on the legal intention of the parties and the surrounding circumstances. [Citations]\nWe are of the view on the facts before us that the offer by the defendant of the sale of the Lapin fur was\nclear, definite, and explicit, and left nothing open for negotiation. The plaintiff having successfully\nmanaged to be the first one to appear at the seller\xe2\x80\x99s place of business to be served, as requested by the\nadvertisement, and having offered the stated purchase price of the article, he was entitled to performance\non the part of the defendant. We think the trial court was correct in holding that there was in the conduct\nof the parties a sufficient mutuality of obligation to constitute a contract of sale.\n2. The defendant contends that the offer was modified by a \xe2\x80\x9chouse rule\xe2\x80\x9d to the effect that only women\nwere qualified to receive the bargains advertised. The advertisement contained no such restriction.\nThis objection may be disposed of briefly by stating that, while an advertiser has the right at any time\nbefore acceptance to modify his offer, he does not have the right, after acceptance, to impose new or\narbitrary conditions not contained in the published offer. [Citations]\nAffirmed.\n\n1.\n\nCASE QUESTIONS\n\nIf the normal rule is that display advertisements in newspapers and the like are not offers, but rather\ninvitations to make an offer, why was this different? Why did the court hold that this was an offer?\n\n2.\n\nWhat is the rationale for the rule that a display ad is usually not an offer?\n\n3.\n\nIf a newspaper display advertisement reads, \xe2\x80\x9cThis offer is good for two weeks,\xe2\x80\x9d is it still only an invitation\nto make an offer, or is it an offer?\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n339\n\n\x0c4.\n\nIs a listing by a private seller for the sale of a trailer on Craigslist or in the weekly classified advertisements\nan offer or an invitation to make an offer?\n\nSilence as Acceptance\nHobbs v.Massasoit Whip Co.\n33 N.E. 495 (Mass. 1893)\nHolmes, J.\nThis is an action for the price of eel skins sent by the plaintiff to the defendant, and kept by the defendant\nsome months, until they were destroyed. It must be taken that the plaintiff received no notice that the\ndefendant declined to accept the skins. The case comes before us on exceptions to an instruction to the\njury that, whether there was any prior contract or not, if skins are sent to the defendant, and it sees fit,\nwhether it has agreed to take them or not, to lie back, and to say nothing, having reason to suppose that\nthe man who has sent them believes that it is taking them, since it says nothing about it, then, if it fails to\nnotify, the jury would be warranted in finding for the plaintiff.\nStanding alone, and unexplained, this proposition might seem to imply that one stranger may impose a\nduty upon another, and make him a purchaser, in spite of himself, by sending goods to him, unless he will\ntake the trouble, and bear the expense, of notifying the sender that he will not buy. The case was argued\nfor the defendant on that interpretation. But, in view of the evidence, we do not understand that to have\nbeen the meaning of the judge and we do not think that the jury can have understood that to have been his\nmeaning. The plaintiff was not a stranger to the defendant, even if there was no contract between them.\nHe had sent eel skins in the same way four or five times before, and they had been accepted and paid for.\nOn the defendant\xe2\x80\x99s testimony, it was fair to assume that if it had admitted the eel skins to be over 22\ninches in length, and fit for its business, as the plaintiff testified and the jury found that they were, it\nwould have accepted them; that this was understood by the plaintiff; and, indeed, that there was a\nstanding offer to him for such skins.\nIn such a condition of things, the plaintiff was warranted in sending the defendant skins conforming to\nthe requirements, and even if the offer was not such that the contract was made as soon as skins\ncorresponding to its terms were sent, sending them did impose on the defendant a duty to act about them;\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n340\n\n\x0cand silence on its part, coupled with a retention of the skins for an unreasonable time, might be found by\nthe jury to warrant the plaintiff in assuming that they were accepted, and thus to amount to an\nacceptance. [Citations] The proposition stands on the general principle that conduct which imports\nacceptance or assent is acceptance or assent, in the view of the law, whatever may have been the actual\nstate of mind of the party\xe2\x80\x94a principle sometimes lost sight of in the cases. [Citations]\nExceptions overruled.\n\nCASE QUESTIONS\n\n1.\n\nWhat is an eel, and why would anybody make a whip out of its skin?\n\n2.\n\nWhy did the court here deny the defendant\xe2\x80\x99s assertion that it never accepted the plaintiff\xe2\x80\x99s offer?\n\n3.\n\nIf it reasonably seems that silence is acceptance, does it make any difference what the offeree really\nintended?\n\n9.5 Summary and Exercises\nSummary\n\nWhether a legally valid contract was formed depends on a number of factors, including whether the\nparties reached agreement, whether consideration was present, and whether the agreement was legal.\nAgreement may seem like an intuitive concept, but intuition is not a sufficient guide to the existence of\nagreement in legal terms. The most common way of examining an agreement for legal sufficiency is by\ndetermining whether a valid offer and acceptance were made.\nAn offer is a manifestation of willingness to enter into a bargain such that it would be reasonable for\nanother individual to conclude that assent to the offer would complete the bargain. Offers must be\ncommunicated and must be definite; that is, they must spell out terms to which the offeree can assent.\nAn important aspect of the offer is its duration. An offer can expire in any one of several ways: (1)\nrejection, (2) counteroffer, (3) acceptance with counteroffer, (4) lapse of time, (5) death or insanity of the\nofferor or destruction of an essential term, (6) illegality, and (7) revocation. No understanding of\nagreement is complete without a mastery of these conditions.\nTo constitute an agreement, an offer must be accepted.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n341\n\n\x0cThe offeree must manifest his assent to the terms of the offer in a manner invited or required by the offer.\nComplications arise when an offer is accepted indirectly through correspondence. Although offers and\nrevocations of offers are not effective until received, an acceptance is deemed accepted when sent if the\nofferee accepts in the manner specified by the offeror. But the nuances that arise because of the mailbox\nrule and acceptance by silence require close attention to the circumstances of each agreement.\n\nEXERCISES\n\n1.\n\nSarah\xe2\x80\x99s student apartment was unfurnished. She perused Doug\xe2\x80\x99s List, an online classified ad service (for\nnonmerchants), and saw this advertisement: \xe2\x80\x9cMoving. For sale: a very nice brown leather couch, almost\nnew, $600.\xe2\x80\x9d There was an accompanying photo and contact information. Sarah e-mailed the contact,\nsaying she wanted to buy the couch. Does Sarah have a contract with the seller? Explain.\n\n2.\n\nSeller called Buyer on the telephone and offered to sell his used stereo. Buyer agreed to buy it without\nasking the price. The next day Buyer changed her mind and attempted to back out of the agreement. Do\nthe parties have a contract? Explain.\n\n3.\n\nOn August 1, Ernie wrote to Elsie offering to sell Elsie his car for $7,600, and he promised to hold the offer\nopen for ten days. On August 4 Ernie changed his mind; he sent Elsie a letter revoking the offer. On\nAugust 5 Elsie e-mailed Ernie, accepting the offer. Ernie\xe2\x80\x99s letter of revocation arrived on August 6. Is there\na contract? Explain.\n\n4.\n\nOn August 1 Grover visited a local electronics shop to purchase a new television. He saw one he liked but\nwasn\xe2\x80\x99t sure if he could afford the $750. The store owner agreed to write up and sign an offer stating that\nit would be held open for ten days, which he did. On August 2 the owner changed his mind and sent\nGrover an e-mail revoking the offer, which Grover received immediately. On August 3 Grover sent a reply\ne-mail accepting the original offer. Is there a contract? Explain.\n5.\n\nAcme Corporation sent the following letter, here set out in its entirety:\nJanuary 2, 2012\nAcme Corporation\nWe hereby offer you 100 Acme golden widgets, size 6. This offer will be good for 10 days.\n[Signed] Roberta Acme\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n342\n\n\x0cOwner, Acme Corporation\nIs this offer irrevocable for the time stated? Explain.\n6.\n\nOn November 26, Joe wrote to Kate offering to purchase a farm that she owned. Upon receiving the letter\non November 28, Kate immediately sent Joe a letter of acceptance. However, shortly after mailing the\nletter, Kate had second thoughts and called Joe to advise him that she was rejecting his offer. The call was\nmade before Joe received the letter of acceptance. Has a contract been formed? Why?\n\n7.\n\nOn a busy day just before April 15, Albert Accountant received a call from a local car dealer. The dealer\nsaid, \xe2\x80\x9cHi, Mr. Accountant. Now, while you have income from doing clients\xe2\x80\x99 taxes, I have an excellent offer\nfor you. You can buy a new Buick Century automobile completely loaded for $36,000. Al, I know you\xe2\x80\x99re\nbusy. If I don\xe2\x80\x99t hear from you by the end of the day, I\xe2\x80\x99ll assume you want the car.\xe2\x80\x9d Albert, distracted, did\nnot respond immediately, and the dealer hung up. Then followed an exhausting day of working with\nanxiety-ridden tax clients. Albert forgot about the conversation. Two days later a statement arrived from\nthe dealer, with instructions on how Albert should pick up the car at the dealership. Is there a contract?\nExplain.\n\n8.\n\nMr. and Mrs. Mitchell, the owners of a small secondhand store, attended an auction where they bought a\nused safe for $50. The safe, part of the Sumstad estate, had a locked compartment inside, a fact the\nauctioneer mentioned. After they bought the safe, the Mitchells had a locksmith open the interior\ncompartment; it contained $32,000 in cash. The locksmith called the police, who impounded the safe, and\na lawsuit ensued between the Mitchells and the Sumstad estate to determine the ownership of the cash.\nWho should get it, and why?\n\n9.\n\nIvan Mestrovic, an internationally renowned artist, and his wife lived for years in a house in Indiana. Ivan\ndied in 1982. His widow remained in the house for some years; upon her death the contents of the house\nwere willed to her children. When the Wilkens bought the house from the estate, it was very cluttered. A\nbank representative (the executor of the estate) said, \xe2\x80\x9cYou can clean it yourself and keep whatever items\nyou want, or we\xe2\x80\x94as executor of Mrs. Mestrovic\xe2\x80\x99s estate\xe2\x80\x94will hire a rubbish removal service to dispose\nof it.\xe2\x80\x9d The Wilkens opted to clean it up themselves, and amid the mess, behind sofas and in odd closets,\nwere six apparently valuable paintings by Mestrovic. The estate claimed them; the Wilkens claimed them.\nWho gets the paintings, and why?\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n343\n\n\x0c10. David Kidd\xe2\x80\x99s dog bit Mikaila Sherrod. On June 14, 2010, the Kidds offered to settle for $32,000. On July 12\nthe Sherrods sued the Kidds. On July 20 the Kidds bumped their offer up to $34,000. The suit was subject\nto mandatory arbitration, which proceeded on April 28, 2011. On May 5 the arbitrator awarded the\nSherrods $25,000. On May 9 the Sherrods wrote to the Kidds and purported to accept their last offer of\n$34,000, made the year before. The Sherrods\xe2\x80\x99 attorney moved to enforce that purported $34,000\n\xe2\x80\x9csettlement agreement.\xe2\x80\x9d The court concluded that the offer was properly accepted because it had not\nbeen withdrawn and entered judgment against the Kidds for $34,000. The Kidds appealed. What result\nshould obtain on appeal, and why?\n\n1.\n\n[1]\n\nSELF-TEST QUESTIONS\n\nIn interpreting agreements for the purpose of establishing whether a valid contract exists, courts\ngenerally apply\n\na.\n\nsubjective standards\nb.\n\nobjective standards\n\nc.\n\neither a subjective or an objective standard\n\nd.\n\nnone of the above\n\nA valid offer must be\na.\n\nwritten\nb.\n\nwritten and intended\n\nc.\n\ncommunicated by letter\n\nd.\n\ncommunicated and definite\nAn offer\n\na.\n\nmust specify time, place, and manner of acceptance\nb.\n\nmust be accepted immediately to be valid\n\nc.\n\nneed not be accepted immediately\n\nd.\n\ncan only be accepted by the same means it was made\n\nAn offer generally\na.\n\nis rejected by a counteroffer\nb.\n\ncan be revoked if the offeror changes his or her mind\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n344\n\n\x0cc.\n\ncan lapse after a reasonable period of time\n\nd.\n\ninvolves all of the above\n\nAn acceptance is generally considered effective\na.\n\nwhen a letter is received by the offeror\n\n1.\n\nb\n\n2.\n\nd\n\n3.\n\nc\n\n4.\n\nd\n\nb.\n\nwhen a letter is mailed\n\nc.\n\nwhen the offeree is silent\n\nd.\n\nonly when the acceptance is transmitted in writing\n\nSELF-TEST ANSWERS\n\n5.\n\nb\n[1] Sherrod ex rel. Cantone v. Kidd, 155 P.3d 976 (Wash. Ct. App., 2007).\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n345\n\n\x0cChapter 10\n\nReal Assent\nLEARNING OBJECTIVES\nAfter reading this chapter, you should understand the following:\n1.\n\nContracts require \xe2\x80\x9ca meeting of the minds\xe2\x80\x9d between competent parties, and if there is no such\n\xe2\x80\x9cmeeting,\xe2\x80\x9d the agreement is usually voidable.\n\n2.\n\nParties must enter the contract voluntarily, without duress or undue influence.\n\n3.\n\nMisrepresentation or fraud, when proven, vitiates a contract.\n\n4.\n\nA mistake may make a contract voidable.\n\n5.\n\nParties to a contract must have capacity\xe2\x80\x94that is, not labor under infancy, intoxication, or insanity.\n\nWe turn to the second of the four requirements for a valid contract. In addition to manifestation of\nassent, a party\xe2\x80\x99s assent must be real; he or she must consent to the contract freely, with adequate\nknowledge, and must have capacity. The requirement of real assent raises the following major\nquestions:\n1.\n\nDid the parties enter into the contract of their own free will, or was one forced to agree under duress\nor undue influence?\n\n2. Did the parties enter into the contract with full knowledge of the facts, or was one or both led to the\nagreement through fraud or mistake?\n3. Did both parties have the capacity to make a contract?\n\n10.1 Duress and Undue Influence\n\nLEARNING OBJECTIVES\n\n1.\n\nRecognize that if a person makes an agreement under duress (being forced to enter a contract against his\nor her will), the agreement is void.\n\n2.\n\nUnderstand what undue influence is and what the typical circumstances are when it arises to make a\ncontract voidable.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n346\n\n\x0cDuress\nWhen a person is forced to do something against his or her will, that person is said to have been the victim\nof duress\xe2\x80\x94compulsion. There are two types of duress: physical duress and duress by improper threat. A\ncontract induced by physical violence is void.\n\nPhysical Duress\nIf a person is forced into entering a contract on threat of physical bodily harm, he or she is the victim\nof physical duress. It is defined by the Restatement (Second) of Contracts in Section 174: \xe2\x80\x9cIf conduct that\nappears to be a manifestation of assent by a party who does not intend to engage in that conduct is\nphysically compelled by duress, the conduct is not effective as a manifestation of assent.\xe2\x80\x9d\nComment (a) to Section 174 provides in part, \xe2\x80\x9cThis Section involves an application of that principle to\nthose relatively rare situations in which actual physical force has been used to compel a party to appear\nto assent to a contract.\xe2\x80\xa6The essence of this type of duress is that a party is compelled by physical force to\ndo an act that he has no intention of doing. He is, it is sometimes said, \xe2\x80\x98a mere mechanical instrument.\xe2\x80\x99\nThe result is that there is no contract at all, or a \xe2\x80\x98void contract\xe2\x80\x99 as distinguished from a voidable one\xe2\x80\x9d\n(emphasis added).\nThe Restatement is undoubtedly correct that there are \xe2\x80\x9crelatively rare situations in which actual physical\nforce\xe2\x80\x9d is used to compel assent to a contract. Extortion is a crime.\n\nDuress by Threat\nThe second kind of duress is duress by threat; it is more common than physical duress. Here the\nperpetrator threatens the victim, who feels there is no reasonable alternative but to assent to the contract.\nIt renders the contract voidable. This rule contains a number of elements.\nFirst, the threat must be improper. Second, there must be no reasonable alternative. If, for example, a\nsupplier threatens to hold up shipment of necessary goods unless the buyer agrees to pay more than the\ncontract price, this would not be duress if the buyer could purchase identical supplies from someone else.\nThird, the test for inducement is subjective. It does not matter that the person threatened is unusually\ntimid or that a reasonable person would not have felt threatened. The question is whether the threat in\nfact induced assent by the victim. Such facts as the victim\xe2\x80\x99s belief that the threatener had the ability to\ncarry out the threat and the length of time between the threat and assent are relevant in determining\nwhether the threat did prompt the assent.\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n347\n\n\x0cThere are many types of improper threats that might induce a party to enter into a contract: threats to\ncommit a crime or a tort (e.g., bodily harm or taking of property), to instigate criminal prosecution, to\ninstigate civil proceedings when a threat is made in bad faith, to breach a \xe2\x80\x9cduty of good faith and fair\ndealing under a contract with the recipient,\xe2\x80\x9d or to disclose embarrassing details about a person\xe2\x80\x99s private\nlife.\nJack buys a car from a local used-car salesman, Mr. Olson, and the next day realizes he bought a lemon.\nHe threatens to break windows in Olson\xe2\x80\x99s showroom if Olson does not buy the car back for $2,150, the\npurchase price. Mr. Olson agrees. The agreement is voidable, even though the underlying deal is fair, if\nOlson feels he has no reasonable alternative and is frightened into agreeing. Suppose Jack knows that\nOlson has been tampering with his cars\xe2\x80\x99 odometers, a federal offense, and threatens to have Olson\nprosecuted if he will not repurchase the car. Even though Olson may be guilty, this threat makes the\nrepurchase contract voidable, because it is a misuse for personal ends of a power (to go to the police)\ngiven each of us for other purposes. If these threats failed, suppose Jack then tells Olson, \xe2\x80\x9cI\xe2\x80\x99m going to\nhaul you into court and sue your pants off.\xe2\x80\x9d If Jack means he will sue for his purchase price, this is not an\nimproper threat, because everyone has the right to use the courts to gain what they think is rightfully\ntheirs. But if Jack meant that he would fabricate damages done him by a (falsely) claimed odometer\nmanipulation, that would be an improper threat. Although Olson could defend against the suit, his\nreputation would suffer in the meantime from his being accused of odometer tampering.\nA threat to breach a contract that induces the victim to sign a new contract could be improper. Suppose\nthat as part of the original purchase price, Olson agrees to make all necessary repairs and replace all failed\nparts for the first ninety days. At the end of one month, the transmission dies, and Jack demands a\nreplacement. Olson refuses to repair the car unless Jack signs a contract agreeing to buy his next car from\nOlson. Whether this threat is improper depends on whether Jack has a reasonable alternative; if a\nreplacement transmission is readily available and Jack has the funds to pay for it, he might have an\nalternative in suing Olson in small claims court for the cost. But if Jack needs the car immediately and he\nis impecunious, then the threat would be improper and the contract voidable. A threat to breach a\ncontract is not necessarily improper, however. It depends on whether the new contract is fair and\nequitable because of unanticipated circumstances. If, for example, Olson discovers that he must purchase\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n348\n\n\x0ca replacement transmission at three times the anticipated cost, his threat to hold up work unless Jack\nagrees to pay for it might be reasonable.\n\nUndue Influence\nThe Restatement of Contracts (Second) characterizes undue influence as \xe2\x80\x9cunfair persuasion.\xe2\x80\x9d\n\n[1]\n\nIt is a\n\nmilder form of duress than physical harm or threats. The unfairness does not lie in any\nmisrepresentation; rather, it occurs when the victim is under the domination of the persuader or is one\nwho, in view of the relationship between them, is warranted in believing that the persuader will act in a\nmanner detrimental to the victim\xe2\x80\x99s welfare if the victim fails to assent. It is the improper use of trust or\npower to deprive a person of free will and substitute instead another\xe2\x80\x99s objective. Usually the fact pattern\ninvolves the victim being isolated from receiving advice except from the persuader. Falling within this rule\nare situations where, for example, a child takes advantage of an infirm parent, a doctor takes advantage of\nan ill patient, or a lawyer takes advantage of an unknowledgeable client. If there has been undue\ninfluence, the contract is voidable by the party who has been unfairly persuaded. Whether the relationship\nis one of domination and the persuasion is unfair is a factual question. The answer hinges on a host of\nvariables, including \xe2\x80\x9cthe unfairness of the resulting bargain, the unavailability of independent advice, and\nthe susceptibility of the person persuaded.\xe2\x80\x9d\n\n[2]\n\nSee Section 10.5.1 "Undue Influence", Hodge v. Shea.\n\nKEY TAKEAWAY\n\nA contract induced by physical duress\xe2\x80\x94threat of bodily harm\xe2\x80\x94is void; a contract induced by improper\nthreats\xe2\x80\x94another type of duress\xe2\x80\x94is voidable. Voidable also are contracts induced by undue influence,\nwhere a weak will is overborne by a stronger one.\n\nEXERCISES\n\n1.\n\nWhat are the two types of duress?\n\n2.\n\nWhat are the elements necessary to support a claim of undue influence?\n3.\n\n[1] Restatement (Second) of Contracts, Section 177.\n\n4.\n\n[2] Restatement (Second) of Contracts, Section 177(b).\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n349\n\n\x0c10.2 Misrepresentation\n\nLEARNING OBJECTIVES\n\n1.\n\nUnderstand the two types of misrepresentation: fraudulent and nonfraudulent.\n\n2.\n\nDistinguish between fraudulent misrepresentation in the execution and fraudulent misrepresentation in\nthe inducement.\n\n3.\n\nKnow the elements necessary to prove fraudulent and nonfraudulent misrepresentation.\n\n4.\n\nRecognize the remedies for misrepresentation.\n\nGeneral Description\nThe two types of misrepresentation are fraudulent and nonfraudulent. Within the former are fraud in the\nexecution and fraud in the inducement. Within the latter are negligent misrepresentation and innocent\nmisrepresentation.\nMisrepresentation is a statement of fact that is not consistent with the truth. If misrepresentation is\nintentional, it is fraudulent misrepresentation; if it is not intentional, it is nonfraudulent\nmisrepresentation, which can be either negligent or innocent.\nIn further taxonomy, courts distinguish between fraud in the execution and fraud in the\ninducement. Fraud in the execution is defined by the Restatement as follows: \xe2\x80\x9cIf a misrepresentation as to\nthe character or essential terms of a proposed contract induces conduct that appears to be a manifestation\nof assent by one who neither knows nor has reasonable opportunity to know of the character or essential\nterms of the proposed contract, his conduct is not effective as a manifestation of assent.\xe2\x80\x9d\n\n[1]\n\nFor example,\n\nAlphonse and Gaston decide to sign a written contract incorporating terms to which they have agreed. It is\nproperly drawn up, and Gaston reads it and approves it. Before he can sign it, however, Alphonse\nshrewdly substitutes a different version to which Gaston has not agreed. Gaston signs the substitute\nversion. There is no contract. There has been fraud in the execution.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n350\n\n\x0cFraud in the inducement is more common. It involves some misrepresentation about the subject of the\ncontract that induces assent. Alphonse tells Gaston that the car Gaston is buying from Alphonse has just\nbeen overhauled\xe2\x80\x94which pleases Gaston\xe2\x80\x94but it has not been. This renders the contract voidable.\n\nFraudulent Misrepresentation\nNecessary to proving fraudulent misrepresentation (usually just \xe2\x80\x9cfraud,\xe2\x80\x9d though technically \xe2\x80\x9cfraud\xe2\x80\x9d is the\ncrime and \xe2\x80\x9cfraudulent misrepresentation\xe2\x80\x9d is the civil wrong) is a misstatement of fact that is intentionally\nmade and justifiably relied upon.\n\nMisstatement of Fact\nAgain, generally, any statement not in accord with the facts (a fact is something amenable to testing as\ntrue) is a misrepresentation. Falsity does not depend on intent. A typist\xe2\x80\x99s unnoticed error in a letter\n(inadvertently omitting the word \xe2\x80\x9cnot,\xe2\x80\x9d for example, or transposing numbers) can amount to a\nmisrepresentation on which the recipient may rely (it is not fraudulent misrepresentation). A half-truth\ncan amount to a misrepresentation, as, for example, when the seller of a hotel says that the income is from\nboth permanent and transient guests but fails to disclose that the bulk of the income is from single-night\nstopovers by seamen using the hotel as a brothel.\n\n[2]\n\nConcealment\nAnother type of misrepresentation is concealment. It is an act that is equivalent to a statement that the\nfacts are to the contrary and that serves to prevent the other party from learning the true statement of\naffairs; it is hiding the truth. A common example is painting over defects in a building\xe2\x80\x94by concealing the\ndefects, the owner is misrepresenting the condition of the property. The act of concealment need not be\ndirect; it may consist of sidetracking the other party from gaining necessary knowledge by, for example,\nconvincing a third person who has knowledge of the defect not to speak. Concealment is always a\nmisrepresentation.\n\nNondisclosure\nA more passive type of concealment is nondisclosure. Although generally the law imposes no obligation\non anyone to speak out, nondisclosure of a fact can operate as a misrepresentation under certain\ncircumstances. This occurs, for example, whenever the other party has erroneous information, or, as Reed\nv. King (Section 10.5.2 "Misrepresentation by Concealment") shows, where the nondisclosure amounts to\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n351\n\n\x0ca failure to act in good faith, or where the party who conceals knows or should know that the other side\ncannot, with reasonable diligence, discover the truth.\nIn a remarkable 1991 case out of New York, a New York City stockbroker bought an old house upstate\n(basically anyplace north of New York City) in the village of Nyack, north of New York City, and then\nwanted out of the deal when he discovered\xe2\x80\x94the defendant seller had not told him\xe2\x80\x94that it was \xe2\x80\x9chaunted.\xe2\x80\x9d\nThe court summarized the facts: \xe2\x80\x9cPlaintiff, to his horror, discovered that the house he had recently\ncontracted to purchase was widely reputed to be possessed by poltergeists [ghosts], reportedly seen by\ndefendant seller and members of her family on numerous occasions over the last nine years. Plaintiff\npromptly commenced this action seeking rescission of the contract of sale. Supreme Court reluctantly\ndismissed the complaint, holding that plaintiff has no remedy at law in this jurisdiction.\xe2\x80\x9d\nThe high court of New York ruled he could rescind the contract because the house was \xe2\x80\x9chaunted as a\nmatter of law\xe2\x80\x9d: the defendant had promoted it as such on village tours and in Reader\xe2\x80\x99s Digest. She had\nconcealed it, and no reasonable buyer\xe2\x80\x99s inspection would have revealed the \xe2\x80\x9cfact.\xe2\x80\x9d The dissent basically\nhooted, saying, \xe2\x80\x9cThe existence of a poltergeist is no more binding upon the defendants than it is upon this\ncourt.\xe2\x80\x9d\n\n[3]\n\nStatement Made False by Subsequent Events\nIf a statement of fact is made false by later events, it must be disclosed as false. For example, in idle\nchatter one day, Alphonse tells Gaston that he owns thirty acres of land. In fact, Alphonse owns only\ntwenty-seven, but he decided to exaggerate a little. He meant no harm by it, since the conversation had no\nimport. A year later, Gaston offers to buy the \xe2\x80\x9cthirty acres\xe2\x80\x9d from Alphonse, who does not correct the\nimpression that Gaston has. The failure to speak is a nondisclosure\xe2\x80\x94presumably intentional, in this\nsituation\xe2\x80\x94that would allow Gaston to rescind a contract induced by his belief that he was purchasing\nthirty acres.\n\nStatements of Opinion\nAn opinion, of course, is not a fact; neither is sales puffery. For example, the statements \xe2\x80\x9cIn my opinion\nthis apple is very tasty\xe2\x80\x9d and \xe2\x80\x9cThese apples are the best in the county\xe2\x80\x9d are not facts; they are not expected\nto be taken as true. Reliance on opinion is hazardous and generally not considered justifiable.\nIf Jack asks what condition the car is in that he wishes to buy, Mr. Olson\xe2\x80\x99s response of \xe2\x80\x9cGreat!\xe2\x80\x9d is not\nordinarily a misrepresentation. As the Restatement puts it: \xe2\x80\x9cThe propensity of sellers and buyers to\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n352\n\n\x0cexaggerate the advantages to the other party of the bargains they promise is well recognized, and to some\nextent their assertions must be discounted.\xe2\x80\x9d\n\n[4]\n\nVague statements of quality, such as that a product is\n\n\xe2\x80\x9cgood,\xe2\x80\x9d ought to suggest nothing other than that such is the personal judgment of the opinion holder.\nDespite this general rule, there are certain exceptions that justify reliance on opinions and effectively\nmake them into facts. Merely because someone is less astute than the one with whom she is bargaining\ndoes not give rise to a claim of justifiable reliance on an unwarranted opinion. But if the person is\ninexperienced and susceptible or gullible to blandishments, the contract can be voided, as illustrated\nin Vokes v. Arthur Murray, Inc. in Section 10.5.3 "Misrepresentation by Assertions of Opinion".\n\nMisstatement of Law\nIncorrect assertions of law usually do not give rise to any relief, but sometimes they do. An assertion that\n\xe2\x80\x9cthe city has repealed the sales tax\xe2\x80\x9d or that a court has cleared title to a parcel of land is a statement of\nfact; if such assertions are false, they are governed by the same rules that govern misrepresentations of\nfact generally. An assertion of the legal consequences of a given set of facts is generally an opinion on\nwhich the recipient relies at his or her peril, especially if both parties know or assume the same facts.\nThus, if there is a lien on a house, the seller\xe2\x80\x99s statement that \xe2\x80\x9cthe courts will throw it out, you won\xe2\x80\x99t be\nbothered by it\xe2\x80\x9d is an opinion. A statement that \xe2\x80\x9cyou can build a five-unit apartment on this property\xe2\x80\x9d is\nnot actionable because, at common law, people are supposed to know what the local and state laws are,\nand nobody should rely on a layperson\xe2\x80\x99s statement about the law. However, if the statement of law is\nmade by a lawyer or real estate broker, or some other person on whom a layperson may justifiably rely,\nthen it may be taken as a fact and, if untrue, as the basis for a claim of misrepresentation. (Assertions\nabout foreign laws are generally held to be statements of fact, not opinion.)\n\nAssertions of Intention\nUsually, assertions of intention are not considered facts. The law allows considerable leeway in the\nhonesty of assertions of intention. The Restatement talks in terms of \xe2\x80\x9ca misrepresentation of\nintention\xe2\x80\xa6consistent with reasonable standards of fair dealing.\xe2\x80\x9d\n\n[5]\n\nThe right to misstate intentions is\n\nuseful chiefly in the acquisition of land; the cases permit buyers to misrepresent the purpose of the\nacquisition so as not to arouse the suspicion of the seller that the land is worth considerably more than his\nasking price. To be a misrepresentation that will permit rescission, an assertion of intention must be false\nat the time made; that is, the person asserting an intention must not then have intended it. That later he\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n353\n\n\x0cor she does not carry out the stated intention is not proof that there was no intention at the time asserted.\nMoreover, to render a contract voidable, the false assertion of intention must be harmful in some way to\nother interests of the recipient. Thus, in the common example, the buyer of land tells the seller that he\nintends to build a residence on the lot, but he actually intends to put up a factory and has lied because he\nknows that otherwise the seller will not part with it because her own home is on an adjacent lot. The\ncontract is voidable by the seller. So a developer says, as regards the picturesque old barn on the property,\n\xe2\x80\x9cI\xe2\x80\x99ll sure try to save it,\xe2\x80\x9d but after he buys the land he realizes it would be very expensive (and in the way),\nso he does not try to save it. No misrepresentation.\n\nIntentionally Made Misrepresentation\nThe second element necessary to prove fraud is that the misrepresentation was intentionally made. A\nmisrepresentation is intentionally made \xe2\x80\x9cif the maker intends his assertion to induce a party to manifest\nhis assent and the maker (a) knows or believes that the assertion is not in accord with the facts, or (b)\ndoes not have the confidence that he states or implies in the truth of the assertion, or (c) knows that he\ndoes not have the basis that he states or implies for the assertion.\xe2\x80\x9d\n\n[6]\n\nThe question of intent often has practical consequences in terms of the remedy available to the plaintiff. If\nthe misrepresentation is fraudulent, the plaintiff may, as an alternative to avoiding the contract, recover\ndamages. Some of this is discussed in Section 10.2.4 "Remedies" and more fully in Chapter 16 "Remedies",\nwhere we see that some states would force the plaintiff to elect one of these two remedies, whereas other\nstates would allow the plaintiff to pursue both remedies (although only one type of recovery would\neventually be allowed). If the misrepresentation is not intentional, then the common law allowed the\nplaintiff only the remedy of rescission. But the Uniform Commercial Code (UCC), Section 2-721, allows\nboth remedies in contracts for the sale of goods, whether the misrepresentation is fraudulent or not, and\ndoes not require election of remedies.\n\nReliance\nThe final element necessary to prove fraud is reliance by the victim. He or she must show that the\nmisrepresentation induced assent\xe2\x80\x94that is, he or she relied on it. The reliance need not be solely on the\nfalse assertion; the defendant cannot win the case by demonstrating that the plaintiff would have assented\nto the contract even without the misrepresentation. It is sufficient to avoid the contract if the plaintiff\nweighed the assertion as one of the important factors leading him to make the contract, and he believed it\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n354\n\n\x0cto be true. The person who asserts reliance to avoid a contract must have acted in good faith and\nreasonably in relying on the false assertion. Thus if the victim failed to read documents given him that\ntruly stated the facts, he cannot later complain that he relied on a contrary statement, as, for example,\nwhen the purchaser of a car dealership was told the inventory consisted of new cars, but the supporting\npapers, receipt of which he acknowledged, clearly stated how many miles each car had been driven. If Mr.\nOlson tells Jack that the car Jack is interested in is \xe2\x80\x9ca recognized classic,\xe2\x80\x9d and if Jack doesn\xe2\x80\x99t care a whit\nabout that but buys the car because he likes its tail fins, he will have no case against Mr. Olson when he\nfinds out the car is not a classic: it didn\xe2\x80\x99t matter to him, and he didn\xe2\x80\x99t rely on it.\nOrdinarily, the person relying on a statement need not verify it independently. However, if verification is\nrelatively easy, or if the statement is one that concerns matters peculiarly within the person\xe2\x80\x99s purview, he\nor she may not be held to have justifiably relied on the other party\xe2\x80\x99s false assertion. Moreover, usually the\nrule of reliance applies to statements about past events or existing facts, not about the occurrence of\nevents in the future.\n\nNonfraudulent Misrepresentation\nNonfraudulent misrepresentation may also be grounds for some relief. There are two types: negligent\nmisrepresentation and innocent misrepresentation.\n\nNegligent Misrepresentation\nWhere representation is caused by carelessness, it is negligent misrepresentation. To prove it, a plaintiff\nmust show a negligent misstatement of fact that is material and justifiably relied upon.\n\nNegligent\nAs an element of misrepresentation, \xe2\x80\x9cnegligent\xe2\x80\x9d here means the party who makes the representation was\ncareless. A potential buyer of rural real estate asks the broker if the neighborhood is quiet. The broker\nassures her it is. In fact, the neighbors down the road have a whole kennel of hunting hounds that bark a\nlot. The broker didn\xe2\x80\x99t know that; she just assumed the neighborhood was quiet. That is negligence: failure\nto use appropriate care.\n\nMisstatement of Fact\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n355\n\n\x0cWhether a thing is a fact may be subject to the same general analysis used in discussing fraudulent\nmisrepresentation. (A person could negligently conceal a fact, or negligently give an opinion, as in legal\nmalpractice.)\n\nMateriality\nA material misrepresentation is one that \xe2\x80\x9cwould be likely to induce a reasonable person to manifest his\nassent\xe2\x80\x9d or that \xe2\x80\x9cthe maker knows\xe2\x80\xa6would be likely to induce the recipient to do so.\xe2\x80\x9d\n\n[7]\n\nAn honestly\n\nmistaken statement that the house for sale was built in 1922 rather than 1923 would not be the basis for\navoiding the contract because it is not material unless the seller knew that the buyer had sentimental or\nother reasons for purchasing a house built in 1922.\nWe did not mention materiality as an element of fraud; if the misrepresentation is fraudulent, the victim\ncan avoid the contract, no matter the significance of the misrepresentation. So although materiality is not\ntechnically required for fraudulent misrepresentation, it is usually a crucial factor in determining whether\nthe plaintiff did rely. Obviously, the more immaterial the false assertion, the less likely it is that the victim\nrelied on it to his detriment. This is especially the case when the defendant knows that he does not have\nthe basis that he states for an assertion but believes that the particular point is unimportant and therefore\nimmaterial. And of course it is usually not worth the plaintiff\xe2\x80\x99s while to sue over an immaterial fraudulent\nmisrepresentation. Consequently, for practical purposes, materiality is an important consideration in\nmost cases. Reed v. King (Section 10.5.2 "Misrepresentation by Concealment") discusses materiality (as\nwell as nondisclosure).\n\nJustifiable Reliance\nThe issues here for negligent misrepresentation are the same as those set out for fraudulent\nmisrepresentation.\nNegligent misrepresentation implies culpability and is usually treated the same as fraudulent\nmisrepresentation; if the representation is not fraudulent, however, it cannot be the basis for rescission\nunless it is also material.\n\nInnocent Misrepresentation\nThe elements necessary to prove innocent misrepresentation are, reasonably enough, based on what we\xe2\x80\x99ve\nlooked at so far, as follows: an innocent misstatement of fact that is material and justifiably relied upon.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n356\n\n\x0cIt is not necessary here to go over the elements in detail. The issues are the same as previously discussed,\nexcept now the misrepresentation is innocent. The plaintiffs purchased the defendants\xe2\x80\x99 eighteen-acre\nparcel on the defendants\xe2\x80\x99 representation that the land came with certain water rights for irrigation, which\nthey believed was true. It was not true. The plaintiffs were entitled to rescission on the basis of innocent\nmisrepresentation.\n\n[8]\n\nRemedies\nRemedies will be taken up in Chapter 16 "Remedies", but it is worth noting the difference between\nremedies for fraudulent misrepresentation and remedies for nonfraudulent misrepresentation.\nFraudulent misrepresentation has traditionally given the victim the right to rescind the contract promptly\n(return the parties to the before-contract status)or affirm it and bring an action for damages caused by the\n[9]\n\nfraud, but not both. The UCC (Section 2-721) has rejected the \xe2\x80\x9celection of remedies\xe2\x80\x9d doctrine; it allows\ncumulative damages, such that the victim can both return the goods and sue for damages. And this is the\nmodern trend for fraudulent misrepresentation: victims may first seek damages, and if that does not make\nthem whole, they may seek rescission.\n\n[10]\n\nIn egregious cases of fraud where the defendant has undertaken\n\na pattern of such deceit, the rare civil remedy of punitive damages may be awarded against the defendant.\nOne further note: the burden of proof for fraudulent misrepresentation is that it must be proved not just\n\xe2\x80\x9cby a preponderance of the evidence,\xe2\x80\x9d as in the typical civil case, but rather \xe2\x80\x9cby clear, cogent, and\nconvincing evidence\xe2\x80\x9d; the fact finder must believe the claim of fraud is very probably true.\n\n[11]\n\nKEY TAKEAWAY\n\nMisrepresentation may be of two types: fraudulent (in the execution or in the inducement) and\nnonfraudulent (negligent or innocent). Each type has different elements that must be proved, but in\ngeneral there must be a misstatement of fact by some means that is intentionally made (for fraud),\nmaterial (for nonfraudulent), and justifiably relied upon.\n\nEXERCISES\n\n1.\n\nDistinguish between fraudulent misrepresentation and nonfraudulent misrepresentation, between fraud\nin the execution and fraud in the inducement, and between negligent and innocent misrepresentation.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n357\n\n\x0c2.\n\nList the elements that must be shown to prove the four different types of misrepresentation noted in\nExercise 1.\n\n3.\n\nWhat is the difference between the traditional common-law approach to remedies for fraud and the\nUCC\xe2\x80\x99s approach?\n4.\n\n[1] Restatement (Second) of Contracts, Section 163.\n\n5.\n\n[2] Ikeda v. Curtis, 261 P.2d 684 (Wash. 1951).\n\n6.\n\n[3] Stambovsky v. Ackley, 169 A.D.2d 254 (N.Y. 1991).\n\n7.\n\n[4] Restatement (Second) of Contracts, Section 168(d).\n\n8.\n\n[5] Restatement (Second) of Contracts, Section 171(1).\n\n9.\n\n[6] Restatement (Second) of Contracts, Section 162(1).\n\n10. [7] Restatement (Second) of Contracts, Section 162(2).\n11. [8] Lesher v. Strid, 996 P.2d 988 (Or. Ct. App. 2000).\n12. [9] Merritt v. Craig, 753 A.2d 2 (Md. Ct. App. 2000).\n13. [10] Ehrman v. Mann, 979 So.2d 1011 (Fla. Ct. App. 2008).\n14. [11] Kirkham v. Smith, 23 P.3d 10 (Wash. Ct. App. 2001).\n\n10.3 Mistake\n\nLEARNING OBJECTIVES\n\n1.\n\nRecognize under what circumstances a person may be relieved of a unilateral mistake.\n\n2.\n\nRecognize when a mutual mistake will be grounds for relief, and the types of mutual mistakes.\n\nIn discussing fraud, we have considered the ways in which trickery by the other party makes a\ncontract void or voidable. We now examine the ways in which the parties might \xe2\x80\x9ctrick\xe2\x80\x9d themselves by\nmaking assumptions that lead them mistakenly to believe that they have agreed to something they\nhave not. A mistake is \xe2\x80\x9ca belief about a fact that is not in accord with the truth.\xe2\x80\x9d [1]\n\nMistake by One Party\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n358\n\n\x0cUnilateral Mistake\nWhere one party makes a mistake, it is a unilateral mistake. The rule: ordinarily, a contract is not voidable\nbecause one party has made a mistake about the subject matter (e.g., the truck is not powerful enough to\nhaul the trailer; the dress doesn\xe2\x80\x99t fit).\n\nExceptions\nIf one side knows or should know that the other has made a mistake, he or she may not take advantage of\nit. A person who makes the mistake of not reading a written document will usually get no relief, nor will\nrelief be afforded to one whose mistake is caused by negligence (a contractor forgets to add in the cost of\ninsulation) unless the negligent party would suffer unconscionable hardship if the mistake were not\ncorrected. Courts will allow the correction of drafting errors in a contract (\xe2\x80\x9creformation\xe2\x80\x9d) in order to make\nthe contract reflect the parties\xe2\x80\x99 intention.\n\n[2]\n\nMutual Mistake\nIn the case of mutual mistake\xe2\x80\x94both parties are wrong about the subject of the contract\xe2\x80\x94relief may be\ngranted.\nThe Restatement sets out three requirements for successfully arguing mutual mistake.\n\n[3]\n\nThe party\n\nseeking to avoid the contract must prove that\n1.\n\nthe mistake relates to a \xe2\x80\x9cbasic assumption on which the contract was made,\xe2\x80\x9d\n\n2. the mistake has a material effect on the agreed exchange of performances,\n3. the party seeking relief does not bear the risk of the mistake.\nBasic assumption is probably clear enough. In the famous \xe2\x80\x9ccow case,\xe2\x80\x9d the defendant sold the plaintiff a\ncow\xe2\x80\x94Rose of Abalone\xe2\x80\x94believed by both to be barren and thus of less value than a fertile cow (a promising\nyoung dairy cow in 2010 might sell for $1,800).\n\n[4]\n\nJust before the plaintiff was to take Rose from the\n\ndefendant\xe2\x80\x99s barn, the defendant discovered she was \xe2\x80\x9clarge with calf\xe2\x80\x9d; he refused to go on with the\ncontract. The court held this was a mutual mistake of fact\xe2\x80\x94\xe2\x80\x9ca barren cow is substantially a different\ncreature than a breeding one\xe2\x80\x9d\xe2\x80\x94and ruled for the defendant. That she was infertile was \xe2\x80\x9ca basic\nassumption,\xe2\x80\x9d but\xe2\x80\x94for example\xe2\x80\x94that hay would be readily available to feed her inexpensively was not, and\nhad hay been expensive, that would not have vitiated the contract.\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n359\n\n\x0cMaterial Effect on the Agreed-to Exchange of Performance\n\xe2\x80\x9cMaterial effect on the agreed-to exchange of performance\xe2\x80\x9d means that because of the mutual mistake,\nthere is a significant difference between the value the parties thought they were exchanging compared\nwith what they would exchange if the contract were performed, given the standing facts. Again, in the cow\ncase, had the seller been required to go through with the deal, he would have given up a great deal more\nthan he anticipated, and the buyer would have received an unagreed-to windfall.\n\nParty Seeking Relief Does Not Bear the Risk of the Mistake\nAssume a weekend browser sees a painting sitting on the floor of an antique shop. The owner says, \xe2\x80\x9cThat\nold thing? You can have it for $100.\xe2\x80\x9d The browser takes it home, dusts it off, and hangs it on the wall. A\nyear later a visitor, an expert in art history, recognizes the hanging as a famous lost El Greco worth $1\nmillion. The story is headlined; the antique dealer is chagrined and claims the contract for sale should be\nvoided because both parties mistakenly thought they were dickering over an \xe2\x80\x9cold, worthless\xe2\x80\x9d painting. The\ncontract is valid. The owner is said to bear the risk of mistake because he contracted with conscious\nawareness of his ignorance: he knew he didn\xe2\x80\x99t know what the painting\xe2\x80\x99s possible value might be, but he\ndidn\xe2\x80\x99t feel it worthwhile to have it appraised. He gambled it wasn\xe2\x80\x99t worth much, and lost.\n\nKEY TAKEAWAY\n\nA mistake may be unilateral, in which case no relief will be granted unless the other side knows of the\nmistake and takes advantage of it. A mistake may be mutual, in which case relief may be granted if it is\nabout a basic assumption on which the contract was made, if the mistake has a material effect on the\nagreed-to exchange, and if the person adversely affected did not bear the risk of the mistake.\n\nEXERCISES\n\n1.\n\nWhy is relief usually not granted for unilateral mistakes? When is relief granted for them?\n\n2.\n\nIf there is a mutual mistake, what does the party seeking relief have to show to avoid the contract?\n3.\n\n[1] Restatement (Second) of Contracts, Section 151.\n\n4.\n\n[2] Sikora v. Vanderploeg, 212 S.W.3d 277 (Tenn. Ct. App. 2006).\n\n5.\n\n[3] Restatement (Second) of Contracts, Section 152.\n\n6.\n\n[4] Sherwood v. Walker, 33 N.W. 919 (1887).\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n360\n\n\x0c10.4 Capacity\n\nLEARNING OBJECTIVES\n\n1.\n\nUnderstand that infants may avoid their contracts, with limitations.\n\n2.\n\nUnderstand that insane or intoxicated people may avoid their contracts, with limitations.\n\n3.\n\nUnderstand the extent to which contracts made by mentally ill persons are voidable, void, or effectively\nenforceable.\n\n4.\n\nRecognize that contracts made by intoxicated persons may be voidable.\n\nA contract is a meeting of minds. If someone lacks mental capacity to understand what he is\nassenting to\xe2\x80\x94or that he is assenting to anything\xe2\x80\x94it is unreasonable to hold him to the consequences\nof his act. At common law there are various classes of people who are presumed to lack the requisite\ncapacity. These include infants (minors), the mentally ill, and the intoxicated.\n\nMinors (or \xe2\x80\x9cInfants\xe2\x80\x9d)\nThe General Rule\nThe general rule is this: minors (or more legalistically \xe2\x80\x9cinfants\xe2\x80\x9d) are in most states persons younger than\nseventeen years old; they can avoid their contracts, up to and within a reasonable time after reaching\nmajority, subject to some exceptions and limitations. The rationale here is that infants do not stand on an\nequal footing with adults, and it is unfair to require them to abide by contracts made when they have\nimmature judgment.\nThe words minor and infant are mostly synonymous, but not exactly, necessarily. In a state where the\nlegal age to drink alcohol is twenty-one, a twenty-year-old would be a minor, but not an infant, because\ninfancy is under eighteen. A seventeen-year-old may avoid contracts (usually), but an eighteen-year-old,\nwhile legally bound to his contracts, cannot legally drink alcohol. Strictly speaking, the better term for one\nwho may avoid his contracts is infant, even though, of course, in normal speaking we think of an infant as\na baby.\nThe age of majority (when a person is no longer an infant or a minor) was lowered in all states except\nMississippi during the 1970s (to correspond to the Twenty-Sixth Amendment, ratified in 1971,\nguaranteeing the right to vote at eighteen) from twenty-one to either eighteen or nineteen. Legal rights for\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n361\n\n\x0cthose under twenty-one remain ambiguous, however. Although eighteen-year-olds may assent to binding\ncontracts, not all creditors and landlords believe it, and they may require parents to cosign. For those\nunder twenty-one, there are also legal impediments to holding certain kinds of jobs, signing certain kinds\nof contracts, marrying, leaving home, and drinking alcohol. There is as yet no uniform set of rules.\nThe exact day on which the disability of minority vanishes also varies. The old common-law rule put it on\nthe day before the twenty-first birthday. Many states have changed this rule so that majority commences\non the day of the eighteenth birthday.\nAn infant\xe2\x80\x99s contract is voidable, not void. An infant wishing to avoid the contract need do nothing positive\nto disaffirm. The defense of infancy to a lawsuit is sufficient; although the adult cannot enforce the\ncontract, the infant can (which is why it is said to be voidable, not void).\n\nExceptions and Complications\nThere are exceptions and complications here. We call out six of them.\n\nNecessities\nFirst, as an exception to the general rule, infants are generally liable for the reasonable cost of necessities\n(for the reason that denying them the right to contract for necessities would harm them, not protect\nthem). At common law, a necessity was defined as food, medicine, clothing, or shelter. In recent years,\nhowever, the courts have expanded the concept, so that in many states today, necessities include property\nand services that will enable the infant to earn a living and to provide for those dependent on him. If the\ncontract is executory, the infant can simply disaffirm. If the contract has been executed, however, the\ninfant must face more onerous consequences. Although he will not be required to perform under the\ncontract, he will be liable under a theory of \xe2\x80\x9cquasi-contract\xe2\x80\x9d for the reasonable value of the necessity.\nIn Gastonia Personnel Corp. v. Rogers, an emancipated infant, nineteen years old (before the age of\nminority was reduced), needed employment; he contracted with a personnel company to find him a job,\nfor which it would charge him a fee.\n\n[1]\n\nThe company did find him a job, and when he attempted to\n\ndisaffirm his liability for payment on the grounds of infancy, the North Carolina court ruled against him,\nholding that the concepts of necessities \xe2\x80\x9cshould be enlarged to include such\xe2\x80\xa6services as are reasonable\nand necessary to enable the infant to earn the money required to provide the necessities of life for\nhimself\xe2\x80\x9d and his dependents.\n\nNonvoidable Contracts\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n362\n\n\x0cSecond, state statutes variously prohibit disaffirmation for such contracts as insurance, education or\nmedical care, bonding agreements, stocks, or bank accounts. In addition, an infant will lose her power to\navoid the contract if the rights of third parties intervene. Roberta, an infant, sells a car to Oswald; Oswald,\nin turn, shortly thereafter sells it to Byers, who knows nothing of Roberta. May Roberta\xe2\x80\x94still an infant\xe2\x80\x94\nrecover it from Byers? No: the rights of the third party have intervened. To allow the infant seller recovery\nin this situation would undermine faith in commercial transactions.\n\nMisrepresentation of Age\nA third exception involves misrepresentation of age. Certainly, that the adult reasonably believed the\ninfant was an adult is of no consequence in a contract suit. In many states, an infant may misrepresent his\nage and disaffirm in accordance with the general rule. But it depends. If an infant affirmatively lies about\nhis age, the trend is to deny disaffirmation. A Michigan statute, for instance, prohibits an infant from\ndisaffirming if he has signed a \xe2\x80\x9cseparate instrument containing only the statement of age, date of signing\nand the signature.\xe2\x80\x9d And some states estop him from claiming to be an infant even if he less expressly\nfalsely represented himself as an adult. Estoppel is a refusal by the courts on equitable grounds to allow a\nperson to escape liability on an otherwise valid defense; unless the infant can return the consideration, the\ncontract will be enforced. It is a question of fact how far a nonexpress (an implied) misrepresentation will\nbe allowed to go before it is considered so clearly misleading as to range into the prohibited area. Some\nstates hold the infant liable for damages for the tort of misrepresentation, but others do not. As William\nProsser, the noted torts scholar, said of cases paying no attention to an infant\xe2\x80\x99s lying about his age, \xe2\x80\x9cThe\neffect of the decisions refusing to recognize tort liability for misrepresentation is to create a privileged\nclass of liars who are a great trouble to the business world.\xe2\x80\x9d\n\n[2]\n\nRatification\nFourth, when the infant becomes an adult, she has two choices: she may ratify the contract or disaffirm it.\nShe may ratify explicitly; no further consideration is necessary. She may also do so by implication\xe2\x80\x94for\ninstance, by continuing to make payments or retaining goods for an unreasonable period of time. If the\nchild has not disaffirmed the contract while still an infant, she may do so within a reasonable time after\nreaching majority; what is a \xe2\x80\x9creasonable time\xe2\x80\x9d depends on the circumstances.\n\nDuty to Return Consideration Received\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n363\n\n\x0cFifth, in most cases of disavowal, the infant\xe2\x80\x99s only obligation is to return the goods (if he still has them) or\nrepay the consideration (unless it has been dissipated); he does have to account for what he wasted,\nconsumed, or damaged during the contract. But since the age of majority has been lowered to eighteen or\nnineteen, when most young people have graduated from high school, some courts require, if appropriate\nto avoid injustice to the adult, that the infant account for what he got. (In Dodson v. Shrader, the supreme\ncourt of Tennessee held that an infant would\xe2\x80\x94if the contract was fair\xe2\x80\x94have to pay for the pickup truck he\nbought and wrecked.)\n\n[3]\n\nTort Connected with a Contract\nSixth, the general rule is that infants are liable for their torts (e.g., assault, trespass, nuisance, negligence)\nunless the tort suit is only an indirect method of enforcing a contract. Henry, age seventeen, holds himself\nout to be a competent mechanic. He is paid $500 to overhaul Baker\xe2\x80\x99s engine, but he does a careless job\nand the engine is seriously damaged. He offers to return the $500 but disaffirms any further contractual\nliability. Can Baker sue him for his negligence, a tort? No, because such a suit would be to enforce the\ncontract.\n\nPersons Who Are Mentally Ill or Intoxicated\nMentally Ill Persons\nThe general rule is that a contract made by person who is mentally ill is voidable by the person when she\nregains her sanity, or, as appropriate, by a guardian. If, though, a guardian has been legally appointed for\na person who is mentally ill, any contract made by the mentally ill person is void, but may nevertheless be\nratified by the ward (the incompetent person who is under a guardianship) upon regaining sanity or by\nthe guardian.\n\n[4]\n\nHowever, if the contract was for a necessity, the other party may have a valid claim against the estate of\nthe one who is mentally ill in order to prevent unjust enrichment. In other cases, whether a court will\nenforce a contract made with a person who is mentally ill depends on the circumstances. Only if the\nmental illness impairs the competence of the person in the particular transaction can the contract be\navoided; the test is whether the person understood the nature of the business at hand. Upon avoidance,\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n364\n\n\x0cthe mentally ill person must return any property in her possession. And if the contract was fair and the\nother party had no knowledge of the mental illness, the court has the power to order other relief.\n\nIntoxicated Persons\nIf a person is so drunk that he has no awareness of his acts, and if the other person knows this, there is no\ncontract. The intoxicated person is obligated to refund the consideration to the other party unless he\ndissipated it during his drunkenness. If the other person is unaware of his intoxicated state, however, an\noffer or acceptance of fair terms manifesting assent is binding.\nIf a person is only partially inebriated and has some understanding of his actions, \xe2\x80\x9cavoidance depends on\na showing that the other party induced the drunkenness or that the consideration was inadequate or that\nthe transaction departed from the normal pattern of similar transactions; if the particular transaction is\none which a reasonably competent person might have made, it cannot be avoided even though entirely\nexecutor.\xe2\x80\x9d\n\n[5]\n\nA person who was intoxicated at the time he made the contract may nevertheless\n\nsubsequently ratify it. Thus where Mervin Hyland, several times involuntarily committed for alcoholism,\nexecuted a promissory note in an alcoholic stupor but later, while sober, paid the interest on the past-due\nnote, he was denied the defense of intoxication; the court said he had ratified his contract.\n\n[6]\n\nIn any event,\n\nintoxicated is a disfavored defense on public policy grounds.\n\nKEY TAKEAWAY\n\nInfants may generally disaffirm their contracts up to majority and within a reasonable time afterward, but\nthe rule is subject to some exceptions and complications: necessities, contracts made nonvoidable by\nstatute, misrepresentation of age, extent of duty to return consideration, ratification, and a tort connected\nwith the contract are among these exceptions.\nContracts made by insane or intoxicated people are voidable when the person regains competency. A\ncontract made by a person under guardianship is void, but the estate will be liable for necessities. A\ncontract made while insane or intoxicated may be ratified.\n\nEXERCISES\n\n1.\n\nIvar, an infant, bought a used car\xe2\x80\x94not a necessity\xe2\x80\x94for $9,500. Seller took advantage of Ivar\xe2\x80\x99s infancy:\nthe car was really worth only $5,500. Can Ivar keep the car but disclaim liability for the $4,000 difference?\n\n2.\n\nIf Ivar bought the car and it was a necessity, could he disclaim liability for the $4,000?\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n365\n\n\x0c3.\n\nAlice Ace found her adult son\xe2\x80\x99s Christmas stocking; Mrs. Ace herself had made it fifty years before. It was\nconsiderably deteriorated. Isabel, sixteen, handy with knitting, agreed to reknit it for $100, which Mrs.\nAce paid in advance. Isabel, regrettably, lost the stocking. She returned the $100 to Mrs. Ace, who was\nvery upset. May Mrs. Ace now sue Isabel for the loss of the stocking (conversion) and emotional distress?\n\n4.\n\nWhy is voluntary intoxication a disfavored defense?\n5.\n\n[1] Gastonia Personnel Corp. v. Rogers, 172 S.E.2d 19 (N.C. 1970).\n\n6.\n\n[2] William L. Prosser, Handbook of the Law of Torts, 4th ed. (St. Paul, MN: West, 1971), 999.\n\n7.\n\n[3] Dodson v. Shrader, 824 S.W.2d 545 (Tenn. 1992).\n\n8.\n\n[4] Restatement (Second) of Contracts, Section 13.\n\n9.\n\n[5] Restatement (Second) of Contracts, Section 16(b).\n\n10. [6] First State Bank of Sinai v. Hyland, 399 N.W.2d 894 (S.D. 1987).\n\n10.5 Cases\nUndue Influence\nHodge v. Shea\n168 S.E.2d 82 (S.C. 1969)\nBrailsford, J.\nIn this equitable action the circuit court decreed specific performance of a contract for the sale of land,\nand the defendant has appealed. The plaintiff is a physician, and the contract was prepared and executed\nin his medical office on August 19, 1965. The defendant had been plaintiff\xe2\x80\x99s patient for a number of years.\nOn the contract date, he was seventy-five years of age, was an inebriate of long standing, and was afflicted\nby grievous chronic illnesses, including arteriosclerosis, cirrhosis of the liver, neuritises, arthritis of the\nspine and hip and varicose veins of the legs. These afflictions and others required constant medication\nand frequent medical attention, and rendered him infirm of body and mind, although not to the point of\nincompetency to contract.\nDuring the period immediately before and after August 19, 1965, George A. Shea, the defendant, was\nsuffering a great deal of pain in his back and hip and was having difficulty in voiding. He was attended\nprofessionally by the plaintiff, Dr. Joseph Hodge, either at the Shea home, at the doctor\xe2\x80\x99s office or in the\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n366\n\n\x0chospital at least once each day from August 9 through August 26, 1965, except for August 17. The contract\nwas signed during the morning of August 19. One of Dr. Hodge\xe2\x80\x99s frequent house calls was made on the\nafternoon of that day, and Mr. Shea was admitted to the hospital on August 21, where he remained until\nAugust 25.\nMr. Shea was separated from his wife and lived alone. He was dependent upon Dr. Hodge for house calls,\nwhich were needed from time to time. His relationship with his physician, who sometimes visited him as a\nfriend and occasionally performed non-professional services for him, was closer than ordinarily arises\nfrom that of patient and physician.\xe2\x80\xa6\n\xe2\x80\x9cWhere a physician regularly treats a chronically ill person over a period of two years, a confidential\nrelationship is established, raising a presumption that financial dealings between them are fraudulent.\xe2\x80\x9d\n[Citation]\nA 125 acre tract of land near Mr. Shea\xe2\x80\x99s home, adjacent to land which was being developed as residential\nproperty, was one of his most valuable and readily salable assets. In 1962, the developer of this contiguous\nland had expressed to Mr. Shea an interest in it at $1000.00 per acre. A firm offer of this amount was\nmade in November, 1964, and was refused by Mr. Shea on the advice of his son-in-law that the property\nwas worth at least $1500.00 per acre. Negotiations between the developer and Mr. Ransdell commenced\nat that time and were in progress when Mr. Shea, at the instance of Dr. Hodge and without consulting Mr.\nRansdell or anyone else, signed the contract of August 19, 1965. Under this contract Dr. Hodge claims the\nright to purchase twenty choice acres of the 125 acre tract for a consideration calculated by the circuit\ncourt to be the equivalent of $361.72 per acre. The market value of the land on the contract date has been\nfixed by an unappealed finding of the master at $1200.00 per acre.\xe2\x80\xa6\nThe consideration was expressed in the contract between Dr. Hodge and Mr. Shea as follows:\nThe purchase price being (Cadillac Coupe DeVille 6600) & $4000.00 Dollars, on the following\nterms: Dr. Joseph Hodge to give to Mr. George Shea a new $6600 coupe DeVille Cadillac which is\nto be registered in name of Mr. George A. Shea at absolutely no cost to him. In return, Mr. Shea\nwill give to Dr. Joe Hodge his 1964 Cadillac coupe DeVille and shall transfer title of this vehicle to\nDr. Hodge. Further, Dr. Joseph Hodge will pay to Mr. George A. Shea the balance of $4000.00\nfor the 20 acres of land described above subject to survey, title check, less taxes on purchase of\nvehicle.\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n367\n\n\x0cDr. Hodge was fully aware of Mr. Shea\xe2\x80\x99s financial troubles, the liens on his property and his son-in-law\xe2\x80\x99s\nefforts in his behalf. He was also aware of his patient\xe2\x80\x99s predilection for new Cadillacs. Although he was not\nobligated to do so until the property was cleared of liens, which was not accomplished until the following\nJune, Dr. Hodge hastened to purchase a 1965 Cadillac Coupe DeVille and delivered it to Mr. Shea on the\nday after his discharge from the hospital on August 25, 1965. If he acted in haste in an effort to fortify\nwhat he must have realized was a dubious contract, he has so far succeeded.\xe2\x80\xa6\nThe case at hand is attended by gross inadequacy of consideration, serious impairment of the grantor\xe2\x80\x99s\nmentality from age, intemperance and disease, and a confidential relationship between the grantee and\ngrantor. Has the strong presumption of vitiating unfairness arising from this combination of\ncircumstances been overcome by the evidence? We must conclude that it has not. The record is devoid of\nany evidence suggesting a reason, compatible with fairness, for Mr. Shea\xe2\x80\x99s assent to so disadvantageous a\nbargain. Disadvantageous not only because of the gross disparity between consideration and value, but\nbecause of the possibility that the sale would impede the important negotiations in which Mr. Ransdell\nwas engaged. Unless his memory failed him, Mr. Shea knew that his son-in-law expected to sell the 125\nacre tract for about $1500.00 per acre as an important step toward raising sufficient funds to satisfy the\ntax and judgment liens against the Shea property. These circumstances furnish strong evidence that Mr.\nShea\xe2\x80\x99s assent to the contract, without so much as notice to Mr. Ransdell, was not the product of a\ndeliberate Exercise of an informed judgment.\xe2\x80\xa6\nFinally, on this phase of the case, it would be naive not to recognize that the 1965 Cadillac was used to\nentice a highly susceptible old man into a hard trade. Mr. Shea was fatuously fond of new Cadillacs, but\nwas apparently incapable of taking care of one. His own 1964 model (he had also had a 1963 model) had\nbeen badly abused. According to Dr. Hodge, it \xe2\x80\x98smelled like a toilet. * * * had several fenders bumped,\nbullet holes in the top and the car was just filthy * * *. It was a rather foul car.\xe2\x80\x99\xe2\x80\xa6Knowing the condition of\nMr. Shea\xe2\x80\x99s car, his financial predicament and the activities of his son-in-law in his behalf, Dr. Hodge used\nthe new automobile as a means of influencing Mr. Shea to agree to sell. The means was calculated to\nbecloud Mr. Shea\xe2\x80\x99s judgment, and, under the circumstances, its use was unfair.\xe2\x80\xa6\nReversed and remanded.\n\n1.\n\nCASE QUESTIONS\n\nWhy is it relevant that Mr. Shea was separated from his wife and lived alone?\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n368\n\n\x0c2.\n\nWhy is it relevant that it was his doctor who convinced him to sell the real estate?\n\n3.\n\nWhy did the doctor offer the old man a Cadillac as part of the deal?\n\n4.\n\nGenerally speaking, if you agree to sell your real estate for less than its real value, that\xe2\x80\x99s just a unilateral\nmistake and the courts will grant no relief. What\xe2\x80\x99s different here?\n\nMisrepresentation by Concealment\nReed v. King\n193 Cal. Rptr. 130 (Calif. Ct. App. 1983)\nBlease, J.\nIn the sale of a house, must the seller disclose it was the site of a multiple murder? Dorris Reed purchased\na house from Robert King. Neither King nor his real estate agents (the other named defendants) told Reed\nthat a woman and her four children were murdered there ten years earlier. However, it seems \xe2\x80\x9ctruth will\ncome to light; murder cannot be hid long.\xe2\x80\x9d (Shakespeare, Merchant of Venice, Act II, Scene II.) Reed\nlearned of the gruesome episode from a neighbor after the sale. She sues seeking rescission and damages.\nKing and the real estate agent defendants successfully demurred to her first amended complaint for\nfailure to state a cause of action. Reed appeals the ensuing judgment of dismissal. We will reverse the\njudgment.\n\nFacts\nWe take all issuable facts pled in Reed\xe2\x80\x99s complaint as true. King and his real estate agent knew about the\nmurders and knew the event materially affected the market value of the house when they listed it for sale.\nThey represented to Reed the premises were in good condition and fit for an \xe2\x80\x9celderly lady\xe2\x80\x9d living alone.\nThey did not disclose the fact of the murders. At some point King asked a neighbor not to inform Reed of\nthat event. Nonetheless, after Reed moved in neighbors informed her no one was interested in purchasing\nthe house because of the stigma. Reed paid $76,000, but the house is only worth $65,000 because of its\npast.\xe2\x80\xa6\n\nDiscussion\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n369\n\n\x0cDoes Reed\xe2\x80\x99s pleading state a cause of action? Concealed within this question is the nettlesome problem of\nthe duty of disclosure of blemishes on real property which are not physical defects or legal impairments to\nuse.\nNumerous cases have found non-disclosure of physical defects and legal impediments to use of real\nproperty are material. [Citation] However, to our knowledge, no prior real estate sale case has faced an\nissue of non-disclosure of the kind presented here. Should this variety of ill-repute be required to be\ndisclosed? Is this a circumstance where \xe2\x80\x9cnon-disclosure of the fact amounts to a failure to act in good faith\nand in accordance with reasonable standards of fair dealing [?]\xe2\x80\x9d (Rest.2d Contracts, \xc2\xa7 161, subd. (b).)\nThe paramount argument against an affirmative conclusion is it permits the camel\xe2\x80\x99s nose of unrestrained\nirrationality admission to the tent. If such an \xe2\x80\x9cirrational\xe2\x80\x9d consideration is permitted as a basis of\nrescission the stability of all conveyances will be seriously undermined. Any fact that might disquiet the\nenjoyment of some segment of the buying public may be seized upon by a disgruntled purchaser to void a\nbargain. In our view, keeping this genie in the bottle is not as difficult a task as these arguments assume.\nWe do not view a decision allowing Reed to survive a demurrer in these unusual circumstances as\nendorsing the materiality of facts predicating peripheral, insubstantial, or fancied harms.\nThe murder of innocents is highly unusual in its potential for so disturbing buyers they may be unable to\nreside in a home where it has occurred. This fact may foreseeably deprive a buyer of the intended use of\nthe purchase. Murder is not such a common occurrence that buyers should be charged with anticipating\nand discovering this disquieting possibility. Accordingly, the fact is not one for which a duty of inquiry\nand discovery can sensibly be imposed upon the buyer.\nReed alleges the fact of the murders has a quantifiable effect on the market value of the premises. We\ncannot say this allegation is inherently wrong and, in the pleading posture of the case, we assume it to be\ntrue. If information known or accessible only to the seller has a significant and measureable effect on\nmarket value and, as is alleged here, the seller is aware of this effect, we see no principled basis for making\nthe duty to disclose turn upon the character of the information. Physical usefulness is not and never has\nbeen the sole criterion of valuation. Stamp collections and gold speculation would be insane activities if\nutilitarian considerations were the sole measure of value.\nReputation and history can have a significant effect on the value of realty. \xe2\x80\x9cGeorge Washington slept here\xe2\x80\x9d\nis worth something, however physically inconsequential that consideration may be. Ill-repute or \xe2\x80\x9cbad will\xe2\x80\x9d\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n370\n\n\x0cconversely may depress the value of property. Failure to disclose such a negative fact where it will have a\nforseeably depressing effect on income expected to be generated by a business is tortuous. [Citation] Some\ncases have held that unreasonable fears of the potential buying public that a gas or oil pipeline may\nrupture may depress the market value of land and entitle the owner to incremental compensation in\neminent domain.\nWhether Reed will be able to prove her allegation the decade-old multiple murder has a significant effect\non market value we cannot determine. If she is able to do so by competent evidence she is entitled to a\nfavorable ruling on the issues of materiality and duty to disclose. Her demonstration of objective tangible\nharm would still the concern that permitting her to go forward will open the floodgates to rescission on\nsubjective and idiosyncratic grounds.\xe2\x80\xa6\nThe judgment is reversed.\n\nCASE QUESTIONS\n\n1.\n\nWhy is it relevant that the plaintiff was \xe2\x80\x9can elderly lady living alone\xe2\x80\x9d?\n\n2.\n\nHow did Mrs. Reed find out about the gruesome fact here?\n\n3.\n\nWhy did the defendants conceal the facts?\n\n4.\n\nWhat is the concern about opening \xe2\x80\x9cfloodgates to rescission on subjective and idiosyncratic grounds\xe2\x80\x9d?\n\n5.\n\nWhy did George Washington sleep in so many places during the Revolutionary War?\n\n6.\n\nDid Mrs. Reed get to rescind her contract and get out of the house as a result of this case?\n\nMisrepresentation by Assertions of Opinion\nVokes v. Arthur Murray, Inc.\n212 S.2d. 906 (Fla. 1968)\nPierce, J.\nThis is an appeal by Audrey E. Vokes, plaintiff below, from a final order dismissing with prejudice, for\nfailure to state a cause of action, her fourth amended complaint, hereinafter referred to as plaintiff\xe2\x80\x99s\ncomplaint.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n371\n\n\x0cDefendant Arthur Murray, Inc., a corporation, authorizes the operation throughout the nation of dancing\nschools under the name of \xe2\x80\x9cArthur Murray School of Dancing\xe2\x80\x9d through local franchised operators, one of\nwhom was defendant J. P. Davenport whose dancing establishment was in Clearwater.\nPlaintiff Mrs. Audrey E. Vokes, a widow of 51 years and without family, had a yen to be \xe2\x80\x9can accomplished\ndancer\xe2\x80\x9d with the hopes of finding \xe2\x80\x9cnew interest in life.\xe2\x80\x9d So, on February 10, 1961, a dubious fate, with the\nassist of a motivated acquaintance, procured her to attend a \xe2\x80\x9cdance party\xe2\x80\x9d at Davenport\xe2\x80\x99s \xe2\x80\x9cSchool of\nDancing\xe2\x80\x9d where she whiled away the pleasant hours, sometimes in a private room, absorbing his\naccomplished sales technique, during which her grace and poise were elaborated upon and her rosy future\nas \xe2\x80\x9can excellent dancer\xe2\x80\x9d was painted for her in vivid and glowing colors. As an incident to this interlude,\nhe sold her eight 1/2-hour dance lessons to be utilized within one calendar month therefrom, for the sum\nof $14.50 cash in hand paid, obviously a baited \xe2\x80\x9ccome-on.\xe2\x80\x9d\nThus she embarked upon an almost endless pursuit of the terpsichorean art during which, over a period of\nless than sixteen months, she was sold fourteen \xe2\x80\x9cdance courses\xe2\x80\x9d totaling in the aggregate 2302 hours of\ndancing lessons for a total cash outlay of $31,090.45 [about $220,000 in 2010 dollars] all at Davenport\xe2\x80\x99s\ndance emporium. All of these fourteen courses were evidenced by execution of a written \xe2\x80\x9cEnrollment\nAgreement-Arthur Murray\xe2\x80\x99s School of Dancing\xe2\x80\x9d with the addendum in heavy black print, \xe2\x80\x9cNo one will be\ninformed that you are taking dancing lessons. Your relations with us are held in strict confidence\xe2\x80\x9d, setting\nforth the number of \xe2\x80\x9cdancing lessons\xe2\x80\x9d and the \xe2\x80\x9clessons in rhythm sessions\xe2\x80\x9d currently sold to her from\ntime to time, and always of course accompanied by payment of cash of the realm.\nThese dance lesson contracts and the monetary consideration therefore of over $31,000 were procured\nfrom her by means and methods of Davenport and his associates which went beyond the unsavory, yet\nlegally permissible, perimeter of \xe2\x80\x9csales puffing\xe2\x80\x9d and intruded well into the forbidden area of undue\ninfluence, the suggestion of falsehood, the suppression of truth, and the free Exercise of rational\njudgment, if what plaintiff alleged in her complaint was true. From the time of her first contact with the\ndancing school in February, 1961, she was influenced unwittingly by a constant and continuous barrage of\nflattery, false praise, excessive compliments, and panegyric encomiums, to such extent that it would be\nnot only inequitable, but unconscionable, for a Court exercising inherent chancery power to allow such\ncontracts to stand.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n372\n\n\x0cShe was incessantly subjected to overreaching blandishment and cajolery. She was assured she had \xe2\x80\x9cgrace\nand poise\xe2\x80\x9d; that she was \xe2\x80\x9crapidly improving and developing in her dancing skill\xe2\x80\x9d; that the additional\nlessons would \xe2\x80\x9cmake her a beautiful dancer, capable of dancing with the most accomplished dancers\xe2\x80\x9d;\nthat she was \xe2\x80\x9crapidly progressing in the development of her dancing skill and gracefulness\xe2\x80\x9d, etc., etc. She\nwas given \xe2\x80\x9cdance aptitude tests\xe2\x80\x9d for the ostensible purpose of \xe2\x80\x9cdetermining\xe2\x80\x9d the number of remaining\nhours of instructions needed by her from time to time.\nAt one point she was sold 545 additional hours of dancing lessons to be entitled to an award of the\n\xe2\x80\x9cBronze Medal\xe2\x80\x9d signifying that she had reached \xe2\x80\x9cthe Bronze Standard\xe2\x80\x9d, a supposed designation of dance\nachievement by students of Arthur Murray, Inc.\xe2\x80\xa6At another point, while she still had over 1,000 unused\nhours of instruction she was induced to buy 151 additional hours at a cost of $2,049.00 to be eligible for a\n\xe2\x80\x9cStudent Trip to Trinidad\xe2\x80\x9d, at her own expense as she later learned.\xe2\x80\xa6\nFinally, sandwiched in between other lesser sales promotions, she was influenced to buy an additional 481\nhours of instruction at a cost of $6,523.81 in order to \xe2\x80\x9cbe classified as a Gold Bar Member, the ultimate\nachievement of the dancing studio.\xe2\x80\x9d\nAll the foregoing sales promotions, illustrative of the entire fourteen separate contracts, were procured by\ndefendant Davenport and Arthur Murray, Inc., by false representations to her that she was improving in\nher dancing ability, that she had excellent potential, that she was responding to instructions in dancing\ngrace, and that they were developing her into a beautiful dancer, whereas in truth and in fact she did not\ndevelop in her dancing ability, she had no \xe2\x80\x9cdance aptitude,\xe2\x80\x9d and in fact had difficulty in \xe2\x80\x9chearing that\nmusical beat.\xe2\x80\x9d The complaint alleged that such representations to her \xe2\x80\x9cwere in fact false and known by the\ndefendant to be false and contrary to the plaintiff\xe2\x80\x99s true ability, the truth of plaintiff\xe2\x80\x99s ability being fully\nknown to the defendants, but withheld from the plaintiff for the sole and specific intent to deceive and\ndefraud the plaintiff and to induce her in the purchasing of additional hours of dance lessons.\xe2\x80\x9d It was\naverred that the lessons were sold to her \xe2\x80\x9cin total disregard to the true physical, rhythm, and mental\nability of the plaintiff.\xe2\x80\x9d In other words, while she first exulted that she was entering the \xe2\x80\x9cspring of her life\xe2\x80\x9d,\nshe finally was awakened to the fact there was \xe2\x80\x9cspring\xe2\x80\x9d neither in her life nor in her feet.\nThe complaint prayed that the Court decree the dance contracts to be null and void and to be cancelled,\nthat an accounting be had, and judgment entered against, the defendants \xe2\x80\x9cfor that portion of the\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n373\n\n\x0c$31,090.45 not charged against specific hours of instruction given to the plaintiff.\xe2\x80\x9d The Court held the\ncomplaint not to state a cause of action and dismissed it with prejudice. We disagree and reverse.\nIt is true that \xe2\x80\x9cgenerally a misrepresentation, to be actionable, must be one of fact rather than of opinion.\xe2\x80\x9d\n[Citations] But this rule has significant qualifications, applicable here. It does not apply where there is a\nfiduciary relationship between the parties, or where there has been some artifice or trick employed by the\nrepresentor, or where the parties do not in general deal at \xe2\x80\x9carm\xe2\x80\x99s length\xe2\x80\x9d as we understand the phrase, or\nwhere the representee does not have equal opportunity to become apprised of the truth or falsity of the\nfact represented. [Citation] As stated by Judge Allen of this Court in [Citation]:\n\xe2\x80\x9c* * * A statement of a party having * * * superior knowledge may be regarded as a statement of fact\nalthough it would be considered as opinion if the parties were dealing on equal terms.\xe2\x80\x9d\xe2\x80\xa6\nIn [Citation] it was said that \xe2\x80\x9c* * * what is plainly injurious to good faith ought to be considered as a fraud\nsufficient to impeach a contract.\xe2\x80\x9d\xe2\x80\xa6 [Reversed.]\n\nCASE QUESTIONS\n\n1.\n\nWhat was the motivation of the \xe2\x80\x9cmotivated acquaintance\xe2\x80\x9d in this case?\n\n2.\n\nWhy is it relevant that Mrs. Vokes was a \xe2\x80\x9cwidow of 51 years and without family\xe2\x80\x9d?\n\n3.\n\nHow did the defendant J. P. Davenport entice her into spending a lot of money on dance lessons?\n\n4.\n\nWhat was the defendants\xe2\x80\x99 defense as to why they should not be liable for misrepresentation, and why\nwas that defense not good?\n\n5.\n\nWould you say the court here is rather condescending to Mrs. Vokes, all things considered?\n\nMutual Mistake\nKonic International Corporation v. Spokane Computer Services, Inc.,\n708 P.2d 932 (Idaho 1985)\nThe magistrate found the following facts. David Young, an employee of Spokane Computer, was instructed\nby his employer to investigate the possibility of purchasing a surge protector, a device which protects\ncomputers from damaging surges of electrical current. Young\xe2\x80\x99s investigation turned up several units\npriced from $50 to $200, none of which, however, were appropriate for his employer\xe2\x80\x99s needs. Young then\ncontacted Konic. After discussing Spokane Computer\xe2\x80\x99s needs with a Konic engineer, Young was referred\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n374\n\n\x0cto one of Konic\xe2\x80\x99s salesmen. Later, after deciding on a certain unit, Young inquired as to the price of the\nselected item. The salesman responded, \xe2\x80\x9cfifty-six twenty.\xe2\x80\x9d The salesman meant $5,620. Young in turn\nthought $56.20.\nThe salesman for Konic asked about Young\xe2\x80\x99s authority to order the equipment and was told that Young\nwould have to get approval from one of his superiors. Young in turn prepared a purchase order for $56.20\nand had it approved by the appropriate authority. Young telephoned the order and purchase order\nnumber to Konic who then shipped the equipment to Spokane Computer. However, because of internal\nprocessing procedures of both parties the discrepancy in prices was not discovered immediately. Spokane\nComputer received the surge protector and installed it in its office. The receipt and installation of the\nequipment occurred while the president of Spokane Computer was on vacation. Although the president\xe2\x80\x99s\nfather, who was also chairman of the board of Spokane Computer, knew of the installation, he only\ninquired as to what the item was and who had ordered it. The president came back from vacation the day\nafter the surge protector had been installed and placed in operation and was told of the purchase. He\nimmediately ordered that power to the equipment be turned off because he realized that the equipment\ncontained parts which alone were worth more than $56 in value. Although the president then told Young\nto verify the price of the surge protector, Young failed to do so. Two weeks later, when Spokane Computer\nwas processing its purchase order and Konic\xe2\x80\x99s invoice, the discrepancy between the amount on the invoice\nand the amount on the purchase order was discovered. The president of Spokane Computer then\ncontacted Konic, told Konic that Young had no authority to order such equipment, that Spokane\nComputer did not want the equipment, and that Konic should remove it. Konic responded that Spokane\nComputer now owned the equipment and if the equipment was not paid for, Konic would sue for the\nprice. Spokane Computer refused to pay and this litigation ensued.\nBasically what is involved here is a failure of communication between the parties. A similar failure to\ncommunicate arose over 100 years ago in the celebrated case of Raffles v. Wichelhaus, [Citation] which\nhas become better known as the case of the good ship \xe2\x80\x9cPeerless.\xe2\x80\x9d In Peerless, the parties agreed on a sale\nof cotton which was to be delivered from Bombay by the ship \xe2\x80\x9cPeerless.\xe2\x80\x9d In fact, there were two ships\nnamed \xe2\x80\x9cPeerless\xe2\x80\x9d and each party, in agreeing to the sale, was referring to a different ship. Because the\nsailing time of the two ships was materially different, neither party was willing to agree to shipment by the\n\xe2\x80\x9cother\xe2\x80\x9d Peerless. The court ruled that, because each party had a different ship in mind at the time of the\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n375\n\n\x0ccontract, there was in fact no binding contract. The Peerless rule later was incorporated into section 71 of\nthe Restatement of Contracts and has now evolved into section 20 of Restatement (Second) of Contracts\n(1981). Section 20 states in part:\n(1) There is no manifestation of mutual assent to an exchange if the parties attach materially\ndifferent meanings to their manifestations and\n(a) neither knows or has reason to know the meaning attached by the other.\nComment (c) to Section 20 further explains that \xe2\x80\x9ceven though the parties manifest mutual assent to the\nsame words of agreement, there may be no contract because of a material difference of understanding as\nto the terms of the exchange.\xe2\x80\x9d Another authority, Williston, discussing situations where a mistake will\nprevent formation of a contract, agrees that \xe2\x80\x9cwhere a phrase of contract\xe2\x80\xa6is reasonably capable of different\ninterpretations\xe2\x80\xa6there is no contract.\xe2\x80\x9d [Citation]\nIn the present case, both parties attributed different meanings to the same term, \xe2\x80\x9cfifty-six twenty.\xe2\x80\x9d Thus,\nthere was no meeting of the minds of the parties. With a hundred fold difference in the two prices,\nobviously price was a material term. Because the \xe2\x80\x9cfifty-six twenty\xe2\x80\x9d designation was a material term\nexpressed in an ambiguous form to which two meanings were obviously applied, we conclude that no\ncontract between the parties was ever formed. Accordingly, we do not reach the issue of whether Young\nhad authority to order the equipment.\n[Affirmed.]\n\nCASE QUESTIONS\n\n1.\n\nWhy is it reasonable to say that no contract was made in this case?\n\n2.\n\nA discrepancy in price of one hundred times is, of course, enormous. How could such an egregious\nmistake have occurred by both parties? In terms of running a sensible business, how could this kind of\nmistake be avoided before it resulted in expensive litigation?\n\n10.6 Summary and Exercises\nSummary\n\nNo agreement is enforceable if the parties did not enter into it (1) of their own free will, (2) with adequate\nknowledge of the terms, and (3) with the mental capacity to appreciate the relationship.\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n376\n\n\x0cContracts coerced through duress will void a contract if actually induced through physical harm and will\nmake the contract voidable if entered under the compulsion of many types of threats. The threat must be\nimproper and leave no reasonable alternative, but the test is subjective\xe2\x80\x94that is, what did the person\nthreatened actually fear, not what a more reasonable person might have feared.\nMisrepresentations may render an agreement void or voidable. Among the factors to be considered are\nwhether the misrepresentation was deliberate and material; whether the promisee relied on the\nmisrepresentation in good faith; whether the representation was of fact, opinion, or intention; and\nwhether the parties had a special relationship.\nSimilarly, mistaken beliefs, not induced by misrepresentations, may suffice to avoid the bargain. Some\nmistakes on one side only make a contract voidable. More often, mutual mistakes of facts will show that\nthere was no meeting of the minds.\nThose who lack capacity are often entitled to avoid contract liability. Although it is possible to state the\ngeneral rule, many exceptions exist\xe2\x80\x94for example, in contracts for necessities, infants will be liable for the\nreasonable value of the goods purchased.\n\n1.\n\nEXERCISES\n\nEulrich, an auto body mechanic who had never operated a business, entered into a Snap-On Tools\nfranchise agreement. For $22,000 invested from his savings and the promise of another $22,000 from the\nsale of inventory, he was provided a truck full of tools. His job was to drive around his territory and sell\nthem. The agreement allowed termination by either party; if Eulrich terminated, he was entitled to resell\nto Snap-On any new tools he had remaining. When he complained that his territory was not profitable,\nhis supervisors told him to work it harder, that anybody could make money with Snap-On\xe2\x80\x99s marketing\nsystem. (In fact, the evidence was the system made money for the supervisors and little for dealers;\ndealers quickly failed and were replaced by new recruits.) Within several months Eulrich was out of\nmoney and desperate. He tried to \xe2\x80\x9ccheck in\xe2\x80\x9d his truck to get money to pay his household bills and\nuninsured medical bills for his wife; the supervisors put him off for weeks. On the check-in day, the\nexhausted Eulrich\xe2\x80\x99s supervisors berated him for being a bad businessman, told him no check would be\nforthcoming until all the returned inventory was sold, and presented him with a number of papers to sign,\nincluding a \xe2\x80\x9cTermination Agreement\xe2\x80\x9d whereby he agreed to waive any claims against Snap-On; he was\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n377\n\n\x0cnot aware that was what he had signed. He sued to rescind the contract and for damages. The defendants\nheld up the waiver as a defense. Under what theory might Eulrich recover?\n2.\n\n[1]\n\nChauncey, a college student, worked part-time in a restaurant. After he had worked for several months,\nthe owner of the restaurant discovered that Chauncey had stolen $2,000 from the cash register. The\nowner called Chauncey\xe2\x80\x99s parents and told them that if they did not sign a note for $2,000, he would\ninitiate criminal proceedings against Chauncey. The parents signed and delivered the note to the owner\nbut later refused to pay. May the owner collect on the note? Why?\n\n3.\n\nA restaurant advertised a steak dinner that included a \xe2\x80\x9cjuicy, great-tasting steak, a fresh crisp salad, and a\nwarm roll.\xe2\x80\x9d After reading the ad, Clarence visited the restaurant and ordered the steak dinner. The steak\nwas dry, the lettuce in the salad was old and limp with brown edges, and the roll was partly frozen. May\nClarence recover from the restaurant on the basis of misrepresentation? Why?\n\n4.\n\nBert purchased Ernie\xe2\x80\x99s car. Before selling the car, Ernie had stated to Bert, \xe2\x80\x9cThis car runs well and is\nreliable. Last week I drove the car all the way from Seattle to San Francisco to visit my mother and back\nagain to Seattle.\xe2\x80\x9d In fact, Ernie was not telling the truth: he had driven the car to San Francisco to visit his\nparamour, not his mother. Upon discovery of the truth, may Bert avoid the contract? Why?\n\n5.\n\nRandolph enrolled in a business law class and purchased a new business law textbook from the local\nbookstore. He dropped the class during the first week and sold the book to his friend Scott. Before\nmaking the sale, Randolph told Scott that he had purchased the book new and had owned it for one\nweek. Unknown to either Randolph or Scott, the book was in fact a used one. Scott later discovered some\nunderlining in the middle of the book and attempted to avoid the contract. Randolph refused to refund\nthe purchase price, claiming that he had not intentionally deceived his friend. May Scott avoid the\ncontract? Why?\n\n6.\n\nLangstraat was seventeen when he purchased a motorcycle. When applying for insurance, he signed a\n\xe2\x80\x9cNotice of Rejection,\xe2\x80\x9d declining to purchase uninsured motorist coverage. He was involved in an accident\nwith an uninsured motorist and sought to disaffirm his rejection of the uninsured motorist coverage on\nthe basis of infancy. May he do so?\n\n7.\n\nWaters was attracted to Midwest Supply by its advertisements for doing federal income taxes. The ads\nstated \xe2\x80\x9cguaranteed accurate tax preparation.\xe2\x80\x9d Waters inquired about amending past returns to obtain\nrefunds. Midwest induced him to apply for and receive improper refunds. When Waters was audited, he\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n378\n\n\x0cwas required to pay more taxes, and the IRS put tax liens on his wages and bank accounts. In fact,\nMidwest hired people with no knowledge about taxes at all; if a customer inquired about employees\xe2\x80\x99\nqualifications, Midwest\xe2\x80\x99s manual told the employees to say, \xe2\x80\x9cMidwest has been preparing taxes for\ntwenty years.\xe2\x80\x9d The manual also instructed office managers never to refer to any employee as a\n\xe2\x80\x9cspecialist\xe2\x80\x9d or \xe2\x80\x9ctax expert,\xe2\x80\x9d but never to correct any news reporters or commentators if they referred to\nemployees as such. What cause of action has Waters, and for what remedies?\n8.\n\nMutschler Grain Company (later Jamestown Farmers Elevator) agreed to sell General Mills 30,000\nbushels of barley at $1.22 per bushel. A dispute arose: Mutschler said that transportation was to\nbe by truck but that General Mills never ordered any trucks to pick up the grain; General Mills said\nthe grain was to be shipped by rail (railcars were in short supply). Nine months later, after\nMutschler had delivered only about one-tenth the contracted amount, the price of barley was\nover $3.00 per bushel. Mutschler defaulted on, and then repudiated, the contract. Fred Mutschler\nthen received this telephone call from General Mills: \xe2\x80\x9cWe\xe2\x80\x99re General Mills, and if you don\xe2\x80\x99t deliver\nthis grain to us, why we\xe2\x80\x99ll have a battery of lawyers in there tomorrow morning to visit you, and\nthen we are going to the North Dakota Public Service (Commission); we\xe2\x80\x99re going to the\nMinneapolis Grain Exchange and we\xe2\x80\x99re going to the people in Montana and there will be no more\nMutschler Grain Company. We\xe2\x80\x99re going to take your license.\xe2\x80\x9d\nMutchsler then shipped 22,000 bushels of barley at the $1.22 rate and sued General Mills for the\ndifference between that price and the market price of over $3.00. Summary judgment issued for\nGeneral Mills. Upon what basis might Mutschler Grain appeal?\n\n9.\n\nDuke decided to sell his car. The car\xe2\x80\x99s muffler had a large hole in it, and as a result, the car made a loud\nnoise. Before showing the car to potential buyers, Duke patched the hole with muffler tape to quiet it.\nPerry bought the car after test-driving it. He later discovered the faulty muffler and sought to avoid the\ncontract, claiming fraud. Duke argued that he had not committed fraud because Perry had not asked\nabout the muffler and Duke had made no representation of fact concerning it. Is Duke correct? Decide\nand explain.\n\n10. At the end of the term at college, Jose, talking in the library with his friend Leanne, said, \xe2\x80\x9cI\xe2\x80\x99ll sell you my\nbusiness law notes for $25.\xe2\x80\x9d Leanne agreed and paid him the money. Jose then realized he\xe2\x80\x99d made a\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n379\n\n\x0cmistake in that he had offered his notes when he meant to offer his book. Leanne didn\xe2\x80\x99t want the book;\nshe had a book. She wanted the notes. Would Leanne have a cause of action against Jose if he refused to\ndeliver the notes? Decide and explain.\n\nSELF-TEST QUESTIONS\n\n1.\na.\n\nMisrepresentation that does not go to the core of a contract is\nfraud in the execution\nb.\n\nfraud in the inducement\n\nc.\n\nundue influence\n\nd.\n\nan example of mistake\n\nIn order for a misrepresentation to make a contract voidable,\na.\n\nit must have been intentional\nb.\n\nthe party seeking to void must have relied on the misrepresentation\n\nc.\n\nit must always be material\n\nd.\n\nnone of the above is required\n\nA mistake by one party will not invalidate a contract unless\na.\n\nthe other party knew of the mistake\nb.\n\nthe party making the mistake did not read the contract closely\n\nc.\n\nthe parties to the contract had never done business before\n\nd.\n\nthe party is mistaken about the law\n\nUpon reaching the age of majority, a person who entered into a contract to purchase goods\nwhile a minor may\na.\n\nratify the contract and keep the goods without paying for them\nb.\n\ndisaffirm the contract and keep the goods without paying for them\n\nc.\n\navoid paying for the goods by keeping them without ratifying or disaffirming the\ncontract\n\nd.\n\nnone of these\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n380\n\n\x0cSeller does not disclose to Buyer that the foundation of a house is infested with termites. Upon\npurchasing the house and remodeling part of the basement, Buyer discovers the termites. Has\nBuyer a cause of action against Seller?\na.\n\nyes\nb.\n\n1.\n\na\n\n2.\n\nd\n\n3.\n\na\n\n4.\n\ne\n\nno\n\nSELF-TEST ANSWERS\n\n5.\n\nb\n[1] Eulrich v. Snap-On Tools Corp., 853 P.2d 1350 (Or. Ct. App. 1993).\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n381\n\n\x0cChapter 11\n\nConsideration\nLEARNING OBJECTIVES\nAfter reading this chapter, you should understand the following:\n1.\n\nWhat \xe2\x80\x9cconsideration\xe2\x80\x9d is in contract law, what it is not, and what purposes it serves\n\n2.\n\nHow the sufficiency of consideration is determined\n\n3.\n\nIn what common situations an understanding of consideration is important\n\n4.\n\nWhat promises are enforceable without consideration\n\n11.1 General Perspectives on Consideration\nLEARNING OBJECTIVES\n\n1.\n\nUnderstand what \xe2\x80\x9cconsideration\xe2\x80\x9d is in contract law.\n\n2.\n\nRecognize what purposes the doctrine serves.\n\n3.\n\nUnderstand how the law determines whether consideration exists.\n\n4.\n\nKnow the elements of consideration.\n\nThe Purpose of Consideration\nThis chapter continues our inquiry into whether the parties created a valid contract. In Chapter 9 "The\nAgreement", we saw that the first requisite of a valid contract is an agreement: offer and acceptance. In\nthis chapter, we assume that agreement has been reached and concentrate on one of its crucial aspects:\nthe existence of consideration. Which of the following, if any, is a contract?\n1.\n\nBetty offers to give a book to Lou. Lou accepts.\n\n2. Betty offers Lou the book in exchange for Lou\xe2\x80\x99s promise to pay twenty-five dollars. Lou accepts.\n3. Betty offers to give Lou the book if Lou promises to pick it up at Betty\xe2\x80\x99s house. Lou agrees.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n382\n\n\x0cIn American law, only the second situation is a binding contract, because only that contract\ncontains consideration, a set of mutual promises in which each party agrees to give up something to the\nbenefit of the other. This chapter will explore the meaning and rationale of that statement.\nThe question of what constitutes a binding contract has been answered differently throughout history and\nin other cultures. For example, under Roman law, a contract without consideration was binding if certain\nformal requirements were met. And in the Anglo-American tradition, the presence of a seal\xe2\x80\x94the wax\nimpression affixed to a document\xe2\x80\x94was once sufficient to make a contract binding without any other\nconsideration. The seal is no longer a substitute for consideration, although in some states it creates a\npresumption of consideration; in forty-nine states, the Uniform Commercial Code (UCC) has abolished\nthe seal on contracts for the sale of goods. (Louisiana has not adopted UCC Article 2.)\nWhatever its original historical purposes, and however apparently arcane, the doctrine of consideration\nserves some still-useful purposes. It provides objective evidence for asserting that a contract exists; it\ndistinguishes between enforceable and unenforceable bargains; and it is a check against rash,\nunconsidered action, against thoughtless promise making.\n\n[1]\n\nA Definition of Consideration\nConsideration is said to exist when the promisor receives some benefit for his promise and the promisee\ngives up something in return; it is the bargained-for price you pay for what you get. That may seem simple\nenough. But as with much in the law, the complicating situations are never very far away. The\n\xe2\x80\x9csomething\xe2\x80\x9d that is promised or delivered cannot be just anything, such as a feeling of pride, warmth,\namusement, or friendship; it must be something known as a legal detriment\xe2\x80\x94an act, forbearance, or a\npromise of such from the promisee. The detriment need not be an actual detriment; it may in fact be a\nbenefit to the promisee, or at least not a loss. The detriment to one side is usually a legal benefit to the\nother, but the detriment to the promisee need not confer a tangible benefit on the promisor; the promisee\ncan agree to forego something without that something being given to the promisor. Whether\nconsideration is legally sufficient has nothing to do with whether it is morally or economically adequate to\nmake the bargain a fair one. Moreover, legal consideration need not even be certain; it can be a promise\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n383\n\n\x0ccontingent on an event that may never happen. Consideration is a legal concept, and it centers on the\ngiving up of a legal right or benefit.\nConsideration has two elements. The first, as just outlined, is whether the promisee has incurred a legal\ndetriment\xe2\x80\x94given up something, paid some \xe2\x80\x9cprice,\xe2\x80\x9d though it may be, for example, the promise to do\nsomething, like paint a house. (Some courts\xe2\x80\x94although a minority\xe2\x80\x94take the view that a bargained-for\nlegal benefit to the promisor is sufficient consideration.) The second element is whether the legal\ndetriment was bargained for: did the promisor specifically intend the act, forbearance, or promise in\nreturn for his promise? Applying this two-pronged test to the three examples given at the outset of the\nchapter, we can easily see why only in the second is there legally sufficient consideration. In the first, Lou\nincurred no legal detriment; he made no pledge to act or to forbear from acting, nor did he in fact act or\nforbear from acting. In the third example, what might appear to be such a promise is not really so. Betty\nmade a promise on a condition that Lou comes to her house; the intent clearly is to make a gift.\n\nKEY TAKEAWAY\n\nConsideration is\xe2\x80\x94with some exceptions\xe2\x80\x94a required element of a contract. It is the bargained-for giving\nup of something of legal value for something in return. It serves the purposes of making formal the\nintention to contract and reducing rash promise making.\n\nEXERCISES\n\n1.\n\nAlice promises to give her neighbor a blueberry bush; the neighbor says, \xe2\x80\x9cThank you!\xe2\x80\x9d Subsequently, Alice\nchanges her mind. Is she bound by her promise?\n\n2.\n\nWhy, notwithstanding its relative antiquity, does consideration still serve some useful purposes?\n\n3.\n\nIdentify the exchange of consideration in this example: A to B, \xe2\x80\x9cI will pay you $800 if you paint my\ngarage.\xe2\x80\x9d B to A, \xe2\x80\x9cOkay, I\xe2\x80\x99ll paint your garage for $800.\xe2\x80\x9d\n\n[1] Lon L. Fuller, \xe2\x80\x9cConsideration and Form,\xe2\x80\x9d Columbia Law Review 41 (1941): 799.\n\n11.2 Legal Sufficiency\n\nLEARNING OBJECTIVES\n\n1.\n\nKnow in general what \xe2\x80\x9clegal sufficiency\xe2\x80\x9d means when examining consideration.\n\n2.\n\nRecognize how the concept operates in such common situations as threat of litigation, and accord and\nsatisfaction.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n384\n\n\x0c3.\n\nUnderstand why illusory promises are unenforceable, and how courts deal with needs, outputs, and\nexclusive dealings contracts.\n\nThe Concept of Legal Sufficiency\nAs suggested in Section 11.1 "General Perspectives on Consideration", what is required in contract is the\nexchange of a legal detriment and a legal benefit; if that happens, the consideration is said to\nhave legal sufficiency.\n\nActual versus Legal Detriment\nSuppose Phil offers George $500 if George will quit smoking for one year. Is Phil\xe2\x80\x99s promise binding?\nBecause George is presumably benefiting by making and sticking to the agreement\xe2\x80\x94surely his health will\nimprove if he gives up smoking\xe2\x80\x94how can his act be considered a legal detriment? The answer is that there\nis forbearance on George\xe2\x80\x99s part: George is legally entitled to smoke, and by contracting not to, he suffers a\nloss of his legal right to do so. This is a legal detriment; consideration does not require an actual\ndetriment.\n\nAdequacy of Consideration\nScrooge offers to buy Caspar\xe2\x80\x99s motorcycle, worth $700, for $10 and a shiny new fountain pen (worth $5).\nCaspar agrees. Is this agreement supported by adequate consideration? Yes, because both have agreed to\ngive up something that is theirs: Scrooge, the cash and the pen; Caspar, the motorcycle. Courts are not\ngenerally concerned with the economic adequacy of the consideration but instead with whether it is\npresent. As Judge Richard A. Posner puts it, \xe2\x80\x9cTo ask whether there is consideration is simply to inquire\nwhether the situation is one of exchange and a bargain has been struck. To go further and ask whether the\nconsideration is adequate would require the court to do what\xe2\x80\xa6it is less well equipped to do than the\nparties\xe2\x80\x94decide whether the price (and other essential terms) specified in the contract are\nreasonable.\xe2\x80\x9d\n\n[1]\n\nIn short, \xe2\x80\x9ccourts do not inquire into the adequacy of consideration.\xe2\x80\x9d\n\nOf course, normally, parties to contracts will not make such a one-sided deal as Scrooge and Caspar\xe2\x80\x99s. But\nthere is a common class of contracts in which nominal consideration\xe2\x80\x94usually one dollar\xe2\x80\x94is recited in\nprinted forms. Usually these are option contracts, in which \xe2\x80\x9cin consideration of one dollar in hand paid\nand receipt of which is hereby acknowledged\xe2\x80\x9d one party agrees to hold open the right of the other to make\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n385\n\n\x0ca purchase on agreed terms. The courts will enforce these contracts if the dollar is intended \xe2\x80\x9cto support a\nshort-time option proposing an exchange on fair terms.\xe2\x80\x9d\n\n[2]\n\nIf, however, the option is for an unreasonably\n\nlong period of time and the underlying bargain is unfair (the Restatement gives as an example a ten-year\noption permitting the optionee to take phosphate rock from a widow\xe2\x80\x99s land at a per-ton payment of only\none-fourth the prevailing rate), then the courts are unlikely to hold that the nominal consideration makes\nthe option irrevocable.\nBecause the consideration on such option contracts is nominal, its recital in the written instrument is\nusually a mere formality, and it is frequently never paid; in effect, the recital of nominal consideration is\nfalse. Nevertheless, the courts will enforce the contract\xe2\x80\x94precisely because the recital has become a\nformality and nobody objects to the charade. Moreover, it would be easy enough to upset an option based\non nominal consideration by falsifying oral testimony that the dollar was never paid or received. In a\ncontest between oral testimonies where the incentive to lie is strong and there is a written document\nclearly incorporating the parties\xe2\x80\x99 agreement, the courts prefer the latter. However, asSection 11.4.1\n"Consideration for an Option", Board of Control of Eastern Michigan University v. Burgess,\ndemonstrates, the state courts are not uniform on this point, and it is a safe practice always to deliver the\nconsideration, no matter how nominal.\n\nApplications of the Legal Sufficiency Doctrine\nThis section discusses several common circumstances where the issue of whether the consideration\nproffered (offered up) is adequate.\n\nThreat of Litigation: Covenant Not to Sue\nBecause every person has the legal right to file suit if he or she feels aggrieved, a promise to refrain from\ngoing to court is sufficient consideration to support a promise of payment or performance. In Dedeaux v.\nYoung, Dedeaux purchased property and promised to make certain payments to Young, the broker.\n\n[3]\n\nBut\n\nDedeaux thereafter failed to make these payments, and Young threatened suit; had he filed papers in\ncourt, the transfer of title could have been blocked. To keep Young from suing, Dedeaux promised to pay a\n5 percent commission if Young would stay out of court. Dedeaux later resisted paying on the ground that\nhe had never made such a promise and that even if he had, it did not amount to a contract because there\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n386\n\n\x0cwas no consideration from Young. The court disagreed, holding that the evidence supported Young\xe2\x80\x99s\ncontention that Dedeaux had indeed made such a promise and upholding Young\xe2\x80\x99s claim for the\ncommission because \xe2\x80\x9ca request to forbear to exercise a legal right has been generally accepted as sufficient\nconsideration to support a contract.\xe2\x80\x9d If Young had had no grounds to sue\xe2\x80\x94for example, if he had\nthreatened to sue a stranger, or if it could be shown that Dedeaux had no obligation to him originally\xe2\x80\x94\nthen there would have been no consideration because Young would not have been giving up a legal right.\nA promise to forebear suing in return for settlement of a dispute is called\na covenant not to sue (covenant is another word for agreement).\n\nAccord and Satisfaction Generally\nFrequently, the parties to a contract will dispute the meaning of its terms and conditions, especially the\namount of money actually due. When the dispute is genuine (and not the unjustified attempt of one party\nto avoid paying a sum clearly due), it can be settled by the parties\xe2\x80\x99 agreement on a fixed sum as the\namount due. This second agreement, which substitutes for the disputed first agreement, is called an\naccord, and when the payment or other term is discharged, the completed second contract is known as\nanaccord and satisfaction. A suit brought for an alleged breach of the original contract could be defended\nby citing the later accord and satisfaction.\nAn accord is a contract and must therefore be supported by consideration. Suppose Jan owes Andy\n$7,000, due November 1. On November 1, Jan pays only $3,500 in exchange for Andy\xe2\x80\x99s promise to release\nJan from the remainder of the debt. Has Andy (the promisor) made a binding promise? He has not,\nbecause there is no consideration for the accord. Jan has incurred no detriment; she has received\nsomething (release of the obligation to pay the remaining $3,500), but she has given up nothing. But if\nJan and Andy had agreed that Jan would pay the $3,500 on October 25, then there would be\nconsideration; Jan would have incurred a legal detriment by obligating herself to make a payment earlier\nthan the original contract required her to. If Jan had paid the $3,500 on November 11 and had given Andy\nsomething else agreed to\xe2\x80\x94a pen, a keg of beer, a peppercorn\xe2\x80\x94the required detriment would also be\npresent.\nLet\xe2\x80\x99s take a look at some examples of the accord and satisfaction principle. The dispute that gives rise to\nthe parties\xe2\x80\x99 agreement to settle by an accord and satisfaction may come up in several typical ways: where\nthere is an unliquidated debt; a disputed debt; an \xe2\x80\x9cin-full-payment check\xe2\x80\x9d for less than what the creditor\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n387\n\n\x0cclaims is due; unforeseen difficulties that give rise to a contract modification, or a novation; or a\ncomposition among creditors. But no obligation ever arises\xe2\x80\x94and no real legal dispute can arise\xe2\x80\x94where a\nperson promises a benefit if someone will do that which he has a preexisting obligation to, or where a\nperson promises a benefit to someone not to do that which the promisee is already disallowed from doing,\nor where one makes an illusory promise.\n\nSettling an Unliquidated Debt\nAn unliquidated debt is one that is uncertain in amount. Such debts frequently occur when people consult\nprofessionals in whose offices precise fees are rarely discussed, or where one party agrees, expressly or by\nimplication, to pay the customary or reasonable fees of the other without fixing the exact amount. It is\ncertain that a debt is owed, but it is not certain how much. (A liquidated debt, on the other hand, is one\nthat is fixed in amount, certain. A debt can be liquidated by being written down in unambiguous terms\xe2\x80\x94\n\xe2\x80\x9cIOU $100\xe2\x80\x9d\xe2\x80\x94or by being mathematically ascertainable\xe2\x80\x94$1 per pound of ice ordered and 60 pounds\ndelivered; hence the liquidated debt is $60.)\nHere is how the matter plays out: Assume a patient goes to the hospital for a gallbladder operation. The\ncost of the operation has not been discussed beforehand in detail, although the cost in the metropolitan\narea is normally around $8,000. After the operation, the patient and the surgeon agree on a bill of\n$6,000. The patient pays the bill; a month later the surgeon sues for another $2,000. Who wins? The\npatient: he has forgone his right to challenge the reasonableness of the fee by agreeing to a fixed amount\npayable at a certain time. The agreement liquidating the debt is an accord and is enforceable. If, however,\nthe patient and the surgeon had agreed on an $8,000 fee before the operation, and if the patient\narbitrarily refused to pay this liquidated debt unless the surgeon agreed to cut her fee in half, then the\nsurgeon would be entitled to recover the other half in a lawsuit, because the patient would have given no\nconsideration\xe2\x80\x94given up nothing, \xe2\x80\x9csuffered no detriment\xe2\x80\x9d\xe2\x80\x94for the surgeon\xe2\x80\x99s subsequent agreement to cut\nthe fee.\n\nSettling a Disputed Debt\nA disputed debt arises where the parties did agree on (liquidated) the price or fee but subsequently get\ninto a dispute about its fairness, and then settle. When this dispute is settled, the parties have given\nconsideration to an agreement to accept a fixed sum as payment for the amount due. Assume that in the\ngallbladder case the patient agrees in advance to pay $8,000. Eight months after the operation and as a\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n388\n\n\x0cresult of nausea and vomiting spells, the patient undergoes a second operation; the surgeons discover a\nsurgical sponge embedded in the patient\xe2\x80\x99s intestine. The patient refuses to pay the full sum of the original\nsurgeon\xe2\x80\x99s bill; they settle on $6,000, which the patient pays. This is a binding agreement because\nsubsequent facts arose to make legitimate the patient\xe2\x80\x99s quarrel over his obligation to pay the full bill. As\nlong as the dispute is based in fact and is not trumped up, as long as the promisee is acting in good faith,\nthen consideration is present when a disputed debt is settled.\n\nThe \xe2\x80\x9cIn-Full-Payment\xe2\x80\x9d Check Situation\nTo discharge his liquidated debt for $8,000 to the surgeon, the patient sends a check for $6,000 marked\n\xe2\x80\x9cpayment in full.\xe2\x80\x9d The surgeon cashes it. There is no dispute. May the surgeon sue for the remaining\n$2,000? This may appear to be an accord: by cashing the check, the surgeon seems to be agreeing with\nthe patient to accept the $6,000 in full payment. But consideration is lacking. Because the surgeon is\nowed more than the face amount of the check, she causes the patient no legal detriment by accepting the\ncheck. If the rule were otherwise, debtors could easily tempt hard-pressed creditors to accept less than the\namount owed by presenting immediate cash. The key to the enforceability of a \xe2\x80\x9cpayment in full\xe2\x80\x9d legend is\nthe character of the debt. If unliquidated, or if there is a dispute, then \xe2\x80\x9cpayment in full\xe2\x80\x9d can serve as\naccord and satisfaction when written on a check that is accepted for payment by a creditor. But if the debt\nis liquidated and undisputed, there is no consideration when the check is for a lesser amount. (However, it\nis arguable that if the check is considered to be an agreement modifying a sales contract, no consideration\nis necessary under Uniform Commercial Code (UCC) Section 2-209.)\n\nUnforeseen Difficulties\nAn unforeseen difficulty arising after a contract is made may be resolved by an accord and satisfaction,\ntoo. Difficulties that no one could foresee can sometimes serve as catalyst for a further promise that may\nappear to be without consideration but that the courts will enforce nevertheless. Suppose Peter contracts\nto build Jerry a house for $390,000. While excavating, Peter unexpectedly discovers quicksand, the\nremoval of which will cost an additional $10,000. To ensure that Peter does not delay, Jerry promises to\npay Peter $10,000 more than originally agreed. But when the house is completed, Jerry reneges on his\npromise. Is Jerry liable? Logically perhaps not: Peter has incurred no legal detriment in exchange for the\n$10,000; he had already contracted to build the house. But most courts would allow Peter to recover on\nthe theory that the original contract was terminated, or modified, either by mutual agreement or by an\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n389\n\n\x0cimplied condition that the original contract would be discharged if unforeseen difficulties developed. In\nshort, the courts will enforce the parties\xe2\x80\x99 own mutual recognition that the unforeseen conditions had\nmade the old contract unfair. The parties either have modified their original contract (which requires\nconsideration at common law) or have given up their original contract and made a new one (called\na novation).\nIt is a question of fact whether the new circumstance is new and difficult enough to make a preexisting\nobligation into an unforeseen difficulty. Obviously, if Peter encounters only a small pocket of quicksand\xe2\x80\x94\nsay two gallons\xe2\x80\x99 worth\xe2\x80\x94he would have to deal with it as part of his already-agreed-to job. If he encounters\nas much quicksand as would fill an Olympic-sized swimming pool, that\xe2\x80\x99s clearly unforeseen, and he\nshould get extra to deal with it. Someplace between the two quantities of quicksand there is enough of the\nstuff so that Peter\xe2\x80\x99s duty to remove it is outside the original agreement and new consideration would be\nneeded in exchange for its removal.\n\nCreditors\xe2\x80\x99 Composition\nA creditors\xe2\x80\x99 composition may give rise to debt settlement by an accord and satisfaction. It is an agreement\nwhereby two or more creditors of a debtor consent to the debtor\xe2\x80\x99s paying them pro rata shares of the debt\ndue in full satisfaction of their claims. A composition agreement can be critically important to a business\nin trouble; through it, the business might manage to stave off bankruptcy. Even though the share accepted\nis less than the full amount due and is payable after the due date so that consideration appears to be\nlacking, courts routinely enforce these agreements. The promise of each creditor to accept a lesser share\nthan that owed in return for getting something is taken as consideration to support the promises of the\nothers. A debtor has $3,000 on hand. He owes $3,000 each to A, B, and C. A, B, and C agree to accept\n$1,000 each and discharge the debtor. Each creditor has given up $2,000 but in return has at least\nreceived something, the $1,000. Without the composition, one might have received the entire amount\nowed her, but the others would have received nothing.\n\nPreexisting Duty\nNot amenable to settlement by an accord and satisfaction is the situation where a party has\na preexisting duty and he or she is offered a benefit to discharge it. When the only consideration offered\nthe promisor is an act or promise to act to carry out a preexisting duty, there is no valid contract.\nAs Denney v. Reppert(Section 11.4.2 "Consideration: Preexisting Obligation") makes clear, the promisee\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n390\n\n\x0csuffers no legal detriment in promising to undertake that which he is already obligated to do. Where a\nperson is promised a benefit not to do that which he is already disallowed from doing, there is no\nconsideration. David is sixteen years old; his uncle promises him $50 if he will refrain from smoking. The\npromise is not enforceable: legally, David already must refrain from smoking, so he has promised to give\nup nothing to which he had a legal right. As noted previously, the difficulty arises where it is unclear\nwhether a person has a preexisting obligation or whether such unforeseen difficulties have arisen as to\nwarrant the recognition that the parties have modified the contract or entered into a novation. What if\nPeter insists on additional payment for him to remove one wheelbarrow full of quicksand from the\nexcavation? Surely that\xe2\x80\x99s not enough \xe2\x80\x9cunforeseen difficulty.\xe2\x80\x9d How much quicksand is enough?\n\nIllusory Promises\nNot every promise is a pledge to do something. Sometimes it is an illusory promise, where the terms of the\ncontract really bind the promisor to give up nothing, to suffer no detriment. For example, Lydia offers to\npay Juliette $10 for mowing Lydia\xe2\x80\x99s lawn. Juliette promises to mow the lawn if she feels like it. May\nJuliette enforce the contract? No, because Juliette has incurred no legal detriment; her promise is illusory,\nsince by doing nothing she still falls within the literal wording of her promise. The doctrine that such\nbargains are unenforceable is sometimes referred to as the rule of mutuality of obligation: if one party to a\ncontract has not made a binding obligation, neither is the other party bound. Thus if A contracts to hire B\nfor a year at $6,000 a month, reserving the right to dismiss B at any time (an \xe2\x80\x9coption to cancel\xe2\x80\x9d clause),\nand B agrees to work for a year, A has not really promised anything; A is not bound to the agreement, and\nneither is B.\nThe illusory promise presents a special problem in agreements for exclusive dealing, outputs, and needs\ncontracts.\n\nExclusive Dealing Agreement\nIn an exclusive dealing agreement, one party (the franchisor) promises to deal solely with the other party\n(the franchisee)\xe2\x80\x94for example, a franchisor-designer agrees to sell all of her specially designed clothes to a\nparticular department store (the franchisee). In return, the store promises to pay a certain percentage of\nthe sales price to the designer. On closer inspection, it may appear that the store\xe2\x80\x99s promise is illusory: it\npays the designer only if it manages to sell dresses, but it may sell none. The franchisor-designer may\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n391\n\n\x0ctherefore attempt to back out of the deal by arguing that because the franchisee is not obligated to do\nanything, there was no consideration for her promise to deal exclusively with the store.\nCourts, however, have upheld exclusive dealing contracts on the theory that the franchisee has an\nobligation to use reasonable efforts to promote and sell the product or services. This obligation may be\nspelled out in the contract or implied by its terms. In the classic statement of this concept, Judge\nBenjamin N. Cardozo, then on the New York Court of Appeals, in upholding such a contract, declared:\nIt is true that [the franchisee] does not promise in so many words that he will use reasonable\nefforts to place the defendant\xe2\x80\x99s endorsements and market her designs. We think, however, that\nsuch a promise is fairly to be implied. The law has outgrown its primitive stage of formalism\nwhen the precise word was the sovereign talisman, and every slip was fatal. It takes a broader\nview today. A promise may be lacking, and yet the whole writing may be \xe2\x80\x9cinstinct with an\nobligation,\xe2\x80\x9d imperfectly expressed.\xe2\x80\xa6His promise to pay the defendant one-half of the profits and\nrevenues resulting from the exclusive agency and to render accounts monthly was a promise to\nuse reasonable efforts to bring profits and revenues into existence.\n\n[4]\n\nThe UCC follows the same rule. In the absence of language specifically delineating the seller\xe2\x80\x99s or buyer\xe2\x80\x99s\nduties, an exclusive dealing contract under Section 2-306(2) imposes \xe2\x80\x9can obligation by the seller to use\nbest efforts to supply the goods and by the buyer to use best efforts to promote their sale.\xe2\x80\x9d\n\nOutputs Contracts and Needs Contracts\nA similar issue arises with outputs contracts and needs contracts. In an outputs contract, the seller\xe2\x80\x94say a\ncoal company\xe2\x80\x94agrees to sell its entire yearly output of coal to an electric utility. Has it really agreed to\nproduce and sell any coal at all? What if the coal-mine owner decides to shut down production to take a\nyear\xe2\x80\x99s vacation\xe2\x80\x94is that a violation of the agreement? Yes. The law imposes upon the seller here a duty to\nproduce and sell a reasonable amount. Similarly, if the electric utility contracted to buy all its\nrequirements of coal from the coal company\xe2\x80\x94a needs contract\xe2\x80\x94could it decide to stop operation entirely\nand take no coal? No, it is required to take a reasonable amount.\n\nKEY TAKEAWAY\n\nCourts do not inquire into the adequacy of consideration, but (with some exceptions) do require the\npromisor to incur a legal detriment (the surrender of any legal right he or she possesses\xe2\x80\x94to give up\nsomething) in order to receive the bargained-for benefit. The surrender of the right to sue is a legal\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n392\n\n\x0cdetriment, and the issue arises in analyzing various kinds of dispute settlement agreements (accord and\nsatisfaction): the obligation to pay the full amount claimed by a creditor on a liquidated debt, an\nunliquidated debt, and a disputed debt. Where unforeseen difficulties arise, an obligor will be entitled to\nadditional compensation (consideration) to resolve them either because the contract is modified or\nbecause the parties have entered into a novation, but no additional consideration is owing to one who\nperforms a preexisting obligation or forbears from performing that which he or she is under a legal duty\nnot to perform. If a promisor gives an illusory promise, he or she gives no consideration and no contract is\nformed; but exclusive dealing agreements, needs contracts, and outputs contracts are not treated as\nillusory.\n\nEXERCISES\n\n1.\n\nWhat is meant by \xe2\x80\x9clegally sufficient\xe2\x80\x9d consideration?\n\n2.\n\nWhy do courts usually not \xe2\x80\x9cinquire into the adequacy of consideration\xe2\x80\x9d?\n\n3.\n\nHow can it be said there is consideration in the following instances: (a) settlement of an unliquidated\ndebt? (b) settlement of a disputed debt? (c) a person agreeing to do more than originally contracted for\nbecause of unforeseen difficulties? (d) a creditor agreeing with other creditors for each of them to accept\nless than they are owed from the debtor?\n\n4.\n\nWhy is there no consideration where a person demands extra compensation for that which she is already\nobligated to do, or for forbearing to do that which she already is forbidden from doing?\n\n5.\n\nWhat is the difference between a contract modification and a novation?\n\n6.\n\nHow do courts resolve the problem that a needs or outputs contract apparently imposes no detriment\xe2\x80\x94\nno requirement to pass any consideration to the other side\xe2\x80\x94on the promisor?\n7.\n\n[1] Richard A. Posner, Economic Analysis of Law (New York: Aspen, 1973), 46.\n\n8.\n\n[2] Restatement (Second) of Contracts, Section 87(b).\n\n9.\n\n[3] Dedeaux v. Young, 170 So.2d 561 (1965).\n\n10. [4] Otis F. Wood v. Lucy, Lady Duff-Gordon, 118 N.E. 214 (1917).\n\n11.3 Promises Enforceable without Consideration\nLEARNING OBJECTIVE\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n393\n\n\x0c1.\n\nUnderstand the exceptions to the requirement of consideration.\n\nFor a variety of policy reasons, courts will enforce certain types of promises even though\nconsideration may be absent. Some of these are governed by the Uniform Commercial Code (UCC);\nothers are part of the established common law.\n\nPromises Enforceable without Consideration at Common Law\nPast Consideration\nOrdinarily, past consideration is not sufficient to support a promise. By past consideration, the courts\nmean an act that could have served as consideration if it had been bargained for at the time but that was\nnot the subject of a bargain. For example, Mrs. Ace\xe2\x80\x99s dog Fluffy escapes from her mistress\xe2\x80\x99s condo at dusk.\nRobert finds Fluffy, sees Mrs. Ace, who is herself out looking for her pet, and gives Fluffy to her. She says,\n\xe2\x80\x9cOh, thank you for finding my dear dog. Come by my place tomorrow morning and I\xe2\x80\x99ll give you fifty\ndollars as a reward.\xe2\x80\x9d The next day Robert stops by Mrs. Ace\xe2\x80\x99s condo, but she says, \xe2\x80\x9cWell, I don\xe2\x80\x99t know.\nFluffy soiled the carpet again last night. I think maybe a twenty-dollar reward would be plenty.\xe2\x80\x9d Robert\ncannot collect the fifty dollars. Even though Mrs. Ace might have a moral obligation to pay him and honor\nher promise, there was no consideration for it. Robert incurred no legal detriment; his contribution\xe2\x80\x94\nfinding the dog\xe2\x80\x94was paid out before her promise, and his past consideration is invalid to support a\ncontract. There was no bargained-for exchange.\nHowever, a valid consideration, given in the past to support a promise, can be the basis for another, later\ncontract under certain circumstances. These occur when a person\xe2\x80\x99s duty to act for one reason or another\nhas become no longer binding. If the person then makes a new promise based on the unfulfilled past duty,\nthe new promise is binding without further consideration. Three types of cases follow.\n\nPromise Revived after Statute of Limitations Has Passed\nA statute of limitations is a law requiring a lawsuit to be filed within a specified period of years. For\nexample, in many states a contract claim must be sued on within six years; if the plaintiff waits longer\nthan that, the claim will be dismissed, regardless of its merits. When the time period set forth in the\nstatute of limitations has lapsed, the statute is said to have \xe2\x80\x9crun.\xe2\x80\x9d If a debtor renews a promise to pay or\nacknowledges a debt after the running of a statute of limitations, then under the common law the promise\nis binding, although there is no consideration in the usual sense. In many states, this promise or\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n394\n\n\x0cacknowledgment must be in writing and signed by the debtor. Also, in many states, the courts will imply a\npromise or acknowledgment if the debtor makes a partial payment after the statute has run.\n\nVoidable Duties\nSome promises that might otherwise serve as consideration are voidable by the promisor, for a variety of\nreasons, including infancy, fraud, duress, or mistake. But a voidable contract does not automatically\nbecome void, and if the promisor has not avoided the contract but instead thereafter renews his promise,\nit is binding. For example, Mr. Melvin sells his bicycle to Seth, age thirteen. Seth promises to pay Mr.\nMelvin one hundred dollars. Seth may repudiate the contract, but he does not. When he turns eighteen, he\nrenews his promise to pay the one hundred dollars. This promise is binding. (However, a promise made\nup to the time he turned eighteen would not be binding, since he would still have been a minor.)\n\nPromissory Estoppel\nWe examined the meaning of this forbidding phrase in Chapter 8 "Introduction to Contract Law" (recall\nthe English High Trees case). It represents another type of promise that the courts will enforce without\nconsideration. Simply stated, promissory estoppel means that the courts will stop the promisor from\nclaiming that there was no consideration. The doctrine of promissory estoppel is invoked in the interests\nof justice when three conditions are met: (1) the promise is one that the promisor should reasonably\nexpect to induce the promisee to take action or forbear from taking action of a definite and substantial\ncharacter; (2) the action or forbearance is taken; and (3) injustice can be avoided only by enforcing the\npromise. (The complete phraseology is \xe2\x80\x9cpromissory estoppel with detrimental reliance.\xe2\x80\x9d)\nTimko served on the board of trustees of a school. He recommended that the school purchase a building\nfor a substantial sum of money, and to induce the trustees to vote for the purchase, he promised to help\nwith the purchase and to pay at the end of five years the purchase price less the down payment. At the end\nof four years, Timko died. The school sued his estate, which defended on the ground that there was no\nconsideration for the promise. Timko was promised or given nothing in return, and the purchase of the\nbuilding was of no direct benefit to him (which would have made the promise enforceable as a unilateral\ncontract). The court ruled that under the three-pronged promissory estoppel test, Timko\xe2\x80\x99s estate was\nliable.\n\n[1]\n\nCases involving pledges of charitable contributions have long been troublesome to courts. Recognizing the\nnecessity to charitable institutions of such pledges, the courts have also been mindful that a mere pledge\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n395\n\n\x0cof money to the general funds of a hospital, university, or similar institution does not usually induce\nsubstantial action but is, rather, simply a promise without consideration. When the pledge does prompt a\ncharitable institution to act, promissory estoppel is available as a remedy. In about one-quarter of the\nstates, another doctrine is available for cases involving simple pledges: the \xe2\x80\x9cmutual promises\xe2\x80\x9d theory,\nwhereby the pledges of many individuals are taken as consideration for each other and are binding against\neach promisor. This theory was not available to the plaintiff in Timko because his was the only promise.\n\nMoral Obligation\nThe Restatement allows, under some circumstances, the enforcement of past-consideration contracts. It\nprovides as follows in Section 86, \xe2\x80\x9cPromise for Benefit Received\xe2\x80\x9d:\nA promise made in recognition of a benefit previously received by the promisor from the\npromisee is binding to the extent necessary to prevent injustice.\nA promise is not binding under Subsection (1)\nif the promisee conferred the benefit as a gift or for other reasons the promisor has not been\nunjustly enriched; or\nto the extent that its value is disproportionate to the benefit.\n\nPromises Enforceable without Consideration by Statute\nWe have touched on several common-law exceptions to the consideration requirement. Some also are\nprovided by statute.\n\nUnder the UCC\nThe UCC permits one party to discharge, without consideration, a claim or right arising out of an alleged\nbreach of contract by the other party. This is accomplished by delivering to the other party a signed\nwritten waiver or renunciation.\n\n[2]\n\nThis provision applies to any contract governed by the UCC and is not\n\nlimited to the sales provisions of Article 2.\nThe UCC also permits a party to discharge the other side without consideration when there is no breach,\nand it permits parties to modify their Article 2 contract without consideration.\n\n[3]\n\nThe official comments to\n\nthe UCC section add the following: \xe2\x80\x9cHowever, modifications made thereunder must meet the test of good\nfaith imposed by this Act. The effective use of bad faith to escape performance on the original contract\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n396\n\n\x0cterms is barred, and the extortion of a \xe2\x80\x9cmodification\xe2\x80\x9d without legitimate commercial reason is ineffective\nas a violation of the duty of good faith.\xe2\x80\x9d\nSeller agrees to deliver a ton of coal within seven days. Buyer needs the coal sooner and asks Seller to\ndeliver within four days. Seller agrees. This promise is binding even though Seller received no additional\nconsideration beyond the purchase price for the additional duty agreed to (the duty to get the coal to\nBuyer sooner than originally agreed). The UCC allows a merchant\xe2\x80\x99s firm offer, signed, in writing, to bind\nthe merchant to keep the offer to buy or sell open without consideration.\n\n[4]\n\nThis is the UCC\xe2\x80\x99s equivalent of\n\na common-law option, which, as you recall, does require consideration.\nSection 1-207 of the UCC allows a party a reservation of rights while performing a contract. This section\nraises a difficult question when a debtor issues an in-full-payment check in payment of a disputed debt. As\nnoted earlier in this chapter, because under the common law the creditor\xe2\x80\x99s acceptance of an in-fullpayment check in payment of a disputed debt constitutes an accord and satisfaction, the creditor cannot\ncollect an amount beyond the check. But what if the creditor, in cashing the check, reserves the right\n(under Section 1-207) to sue for an amount beyond what the debtor is offering? The courts are split on the\nissue: regarding the sale of goods governed by the UCC, some courts allow the creditor to sue for the\nunpaid debt notwithstanding the check being marked \xe2\x80\x9cpaid in full,\xe2\x80\x9d and others do not.\n\nBankruptcy\nBankruptcy is, of course, federal statutory law. The rule here regarding a promise to pay after the\nobligation is discharged is similar to that governing statutes of limitations. Traditionally, a promise to\nrepay debts after a bankruptcy court has discharged them makes the debtor liable once again. This\ntraditional rule gives rise to potential abuse; after undergoing the rigors of bankruptcy, a debtor could be\nbadgered by creditors into reaffirmation, putting him in a worse position than before, since he must wait\nsix years before being allowed to avail himself of bankruptcy again.\nThe federal Bankruptcy Act includes certain procedural protections to ensure that the debtor knowingly\nenters into a reaffirmation of his debt. Among its provisions, the law requires the debtor to have\nreaffirmed the debt before the debtor is discharged in bankruptcy; he then has sixty days to rescind his\nreaffirmation. If the bankrupt party is an individual, the law also requires that a court hearing be held at\nwhich the consequences of his reaffirmation must be explained, and reaffirmation of certain consumer\ndebts is subject to court approval if the debtor is not represented by an attorney.\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n397\n\n\x0cInternational Contracts\nContracts governed by the Convention on Contracts for the International Sale of Goods (as mentioned\nin Chapter 8 "Introduction to Contract Law") do not require consideration to be binding.\n\nKEY TAKEAWAY\nThere are some exceptions to the consideration requirement. At common law, past consideration doesn\xe2\x80\x99t\ncount, but no consideration is necessary in these cases: where a promise barred by the statute of\nlimitations is revived, where a voidable duty is reaffirmed, where there has been detrimental reliance on a\npromise (i.e., promissory estoppel), or where a court simply finds the promisor has a moral obligation to\nkeep the promise.\nUnder statutory law, the UCC has several exceptions to the consideration requirement. No consideration is\nneeded to revive a debt discharged in bankruptcy, and none is called for under the Convention on\nContracts for the International Sale of Goods.\n\n1.\n\nEXERCISES\n\nMelba began work for Acme Company in 1975 as a filing clerk. Thirty years later she had risen to be\ncomptroller. At a thirty-year celebration party, her boss, Mr. Holder, said, \xe2\x80\x9cMelba, I hope you work here\nfor a long time, and you can retire at any time, but if you decide to retire, on account of your years of\ngood service, the company will pay you a monthly pension of $2,000.\xe2\x80\x9d Melba continued to work for\nanother two years, then retired. The company paid the pension for three years and then, in an economic\ndownturn, stopped. When Melba sued, the company claimed it was not obligated to her because the\npension was of past consideration. What will be the result?\n\n2.\n\nWhat theories are used to enforce charitable subscriptions?\n\n3.\n\nWhat are the elements necessary for the application of the doctrine of promissory estoppel?\n\n4.\n\nUnder what circumstances does the Restatement employ moral obligation as a basis for enforcing an\notherwise unenforceable contract?\n\n5.\n\nPromises unenforceable because barred by bankruptcy or by the running of the statute of limitations can\nbe revived without further consideration. What do the two circumstances have in common?\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n398\n\n\x0c6.\n\nUnder the UCC, when is no consideration required where it would be in equivalent situations at common\nlaw?\n7.\n\n[1] Estate of Timko v. Oral Roberts Evangelistic Assn., 215 N.W.2d 750 (Mich. App. 1974).\n\n8.\n\n[2] Uniform Commercial Code, Section 1-107.\n\n9.\n\n[3] Uniform Commercial Code, Sections 2-209(4) and 2-209(1).\n\n10. [4] Uniform Commercial Code, Section 2-205.\n\n11.4 Cases\n\nConsideration for an Option\nBoard of Control of Eastern Michigan University v. Burgess\n206 N.W.2d 256 (Mich. 1973)\nBurns, J.\nOn February 15, 1966, defendant signed a document which purported to grant to plaintiff a 60-day option\nto purchase defendant\xe2\x80\x99s home. That document, which was drafted by plaintiff\xe2\x80\x99s agent, acknowledged\nreceipt by defendant of \xe2\x80\x9cOne and no/100 ($1.00) Dollar and other valuable consideration.\xe2\x80\x9d Plaintiff\nconcedes that neither the one dollar nor any other consideration was ever paid or even tendered to\ndefendant. On April 14, 1966, plaintiff delivered to defendant written notice of its intention to exercise the\noption. On the closing date defendant rejected plaintiff\xe2\x80\x99s tender of the purchase price. Thereupon, plaintiff\ncommenced this action for specific performance.\nAt trial defendant claimed that the purported option was void for want of consideration, that any\nunderlying offer by defendant had been revoked prior to acceptance by plaintiff, and that the agreed\npurchase price was the product of fraud and mutual mistake. The trial judge concluded that no fraud was\ninvolved, and that any mutual mistake was not material. He also held that defendant\xe2\x80\x99s acknowledgment of\nreceipt of consideration bars any subsequent contention to the contrary. Accordingly, the trial judge\nentered judgment for plaintiff.\nOptions for the purchase of land, if based on valid consideration, are contracts which may be specifically\nenforced. [Citations] Conversely, that which purports to be an option, but which is not based on valid\nconsideration, is not a contract and will not be enforced. [Citations] One dollar is valid consideration for\nan option to purchase land, provided the dollar is paid or at least tendered. [Citations] In the instant case\ndefendant received no consideration for the purported option of February 15, 1966.\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n399\n\n\x0cA written acknowledgment of receipt of consideration merely creates a rebuttable presumption that\nconsideration has, in fact, passed. Neither the parol evidence rule nor the doctrine of estoppel bars the\npresentation of evidence to contradict any such acknowledgment. [Citation]\nIt is our opinion that the document signed by defendant on February 15, 1966, is not an enforceable\noption, and that defendant is not barred from so asserting.\nThe trial court premised its holding to the contrary on Lawrence v. McCalmont\xe2\x80\xa6(1844). That case is\nsignificantly distinguishable from the instant case. Mr. Justice Story held that \xe2\x80\x98(t)he guarantor\nacknowledged the receipt of one dollar, and is now estopped to deny it.\xe2\x80\x99 However, in reliance upon the\nguaranty substantial credit had been extended to the guarantor\xe2\x80\x99s sons. The guarantor had received\neverything she bargained for, save one dollar. In the instant case defendant claims that she never received\nany of the consideration promised her.\nThat which purports to be an option for the purchase of land, but which is not based on valid\nconsideration, is a simple offer to sell the same land. [Citation] An option is a contract collateral to an\noffer to sell whereby the offer is made irrevocable for a specified period. [Citation] Ordinarily, an offer is\nrevocable at the will of the offeror. Accordingly, a failure of consideration affects only the collateral\ncontract to keep the offer open, not the underlying offer.\nA simple offer may be revoked for any reason or for no reason by the offeror at any time prior to its\nacceptance by the offeree. [Citation] Thus, the question in this case becomes, \xe2\x80\x98Did defendant effectively\nrevoke her offer to sell before plaintiff accepted that offer?\xe2\x80\x99\xe2\x80\xa6\nDefendant testified that within hours of signing the purported option she telephoned plaintiff\xe2\x80\x99s agent and\ninformed him that she would not abide by the option unless the purchase price was increased. Defendant\nalso testified that when plaintiff\xe2\x80\x99s agent delivered to her on April 14, 1966, plaintiff\xe2\x80\x99s notice of its intention\nto exercise the purported option, she told him that \xe2\x80\x98the option was off\xe2\x80\x99.\nPlaintiff\xe2\x80\x99s agent testified that defendant did not communicate to him any dissatisfaction until sometime in\nJuly, 1966.\nIf defendant is telling the truth, she effectively revoked her offer several weeks before plaintiff accepted\nthat offer, and no contract of sale was created. If plaintiff\xe2\x80\x99s agent is telling the truth, defendant\xe2\x80\x99s offer was\nstill open when plaintiff accepted that offer, and an enforceable contract was created. The trial judge\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n400\n\n\x0cthought it unnecessary to resolve this particular dispute. In light of our holding the dispute must be\nresolved.\nAn appellate court cannot assess the credibility of witnesses. We have neither seen nor heard them testify.\n[Citation] Accordingly, we remand this case to the trial court for additional findings of fact based on the\nrecord already before the court.\xe2\x80\xa6\nReversed and remanded for proceedings consistent with this opinion. Costs to defendant.\n\nCASE QUESTIONS\n\n1.\n\nWhy did the lower court decide the option given by the defendant was valid?\n\n2.\n\nWhy did the appeals court find the option invalid?\n\n3.\n\nThe case was remanded. On retrial, how could the plaintiff (the university) still win?\n\n4.\n\nIt was not disputed that the defendant signed the purported option. Is it right that she should get out of it\nmerely because she didn\xe2\x80\x99t really get the $1.00?\n\nConsideration: Preexisting Obligation\nDenney v. Reppert\n432 S.W.2d 647 (Ky. 1968)\nR. L. Myre, Sr., Special Commissioner.\nThe sole question presented in this case is which of several claimants is entitled to an award for\ninformation leading to the apprehension and conviction of certain bank robbers.\xe2\x80\xa6\nOn June 12th or 13th, 1963, three armed men entered the First State Bank, Eubank, Kentucky, and with a\ndisplay of arms and threats robbed the bank of over $30,000 [about $208,000 in 2010 dollars]. Later in\nthe day they were apprehended by State Policemen Garret Godby, Johnny Simms and Tilford Reppert,\nplaced under arrest, and the entire loot was recovered. Later all of the prisoners were convicted and\nGarret Godby, Johnny Simms and Tilford Reppert appeared as witnesses at the trial.\nThe First State Bank of Eubank was a member of the Kentucky Bankers Association which provided and\nadvertised a reward of $500.00 for the arrest and conviction of each bank robber. Hence the outstanding\nreward for the three bank robbers was $1,500.00 [about $11,000 in 2010 dollars]. Many became\nclaimants for the reward and the Kentucky State Bankers Association being unable to determine the\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n401\n\n\x0cmerits of the claims for the reward asked the circuit court to determine the merits of the various claims\nand to adjudge who was entitled to receive the reward or share in it. All of the claimants were made\ndefendants in the action.\nAt the time of the robbery the claimants Murrell Denney, Joyce Buis, Rebecca McCollum and Jewell\nSnyder were employees of the First State Bank of Eubank and came out of the grueling situation with\ngreat credit and glory. Each one of them deserves approbation and an accolade. They were vigilant in\ndisclosing to the public and the peace officers the details of the crime, and in describing the culprits, and\ngiving all the information that they possessed that would be useful in capturing the robbers. Undoubtedly,\nthey performed a great service. It is in the evidence that the claimant Murrell Denney was conspicuous\nand energetic in his efforts to make known the robbery, to acquaint the officers as to the personal\nappearance of the criminals, and to give other pertinent facts.\nThe first question for determination is whether the employees of the robbed bank are eligible to receive or\nshare in the reward. The great weight of authority answers in the negative. [Citation] states the rule\nthusly:\n\xe2\x80\x98To the general rule that, when a reward is offered to the general public for the performance of\nsome specified act, such reward may be claimed by any person who performs such act, is the\nexception of agents, employees and public officials who are acting within the scope of their\nemployment or official duties. * * *.\xe2\x80\x99\xe2\x80\xa6\nAt the time of the robbery the claimants Murrell Denney, Joyce Buis, Rebecca McCollum, and Jewell\nSnyder were employees of the First State Bank of Eubank. They were under duty to protect and conserve\nthe resources and moneys of the bank, and safeguard every interest of the institution furnishing them\nemployment. Each of these employees exhibited great courage, and cool bravery, in a time of stress and\ndanger. The community and the county have recompensed them in commendation, admiration and high\npraise, and the world looks on them as heroes. But in making known the robbery and assisting in\nacquainting the public and the officers with details of the crime and with identification of the robbers,\nthey performed a duty to the bank and the public, for which they cannot claim a reward.\nThe claims of Corbin Reynolds, Julia Reynolds, Alvie Reynolds and Gene Reynolds also must fail.\nAccording to their statements they gave valuable information to the arresting officers. However, they did\nnot follow the procedure as set forth in the offer of reward in that they never filed a claim with the\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n402\n\n\x0cKentucky Bankers Association. It is well established that a claimant of a reward must comply with the\nterms and conditions of the offer of reward. [Citation]\nState Policemen Garret Godby, Johnny Simms and Tilford Reppert made the arrest of the bank robbers\nand captured the stolen money. All participated in the prosecution. At the time of the arrest, it was the\nduty of the state policemen to apprehend the criminals. Under the law they cannot claim or share in the\nreward and they are interposing no claim to it.\nThis leaves the defendant, Tilford Reppert the sole eligible claimant. The record shows that at the time of\nthe arrest he was a deputy sheriff in Rockcastle County, but the arrest and recovery of the stolen money\ntook place in Pulaski County. He was out of his jurisdiction, and was thus under no legal duty to make the\narrest, and is thus eligible to claim and receive the reward. In [Citation] it was said:\n\xe2\x80\x98It is * * * well established that a public officer with the authority of the law to make an arrest\nmay accept an offer of reward or compensation for acts or services performed outside of his\nbailiwick or not within the scope of his official duties. * * *.\xe2\x80\x99\xe2\x80\xa6\nIt is manifest from the record that Tilford Reppert is the only claimant qualified and eligible to receive the\nreward. Therefore, it is the judgment of the circuit court that he is entitled to receive payment of the\n$1,500.00 reward now deposited with the Clerk of this Court.\nThe judgment is affirmed.\n\nCASE QUESTIONS\n\n1.\n\nWhy did the Bankers Association put the resolution of this matter into the court\xe2\x80\x99s hands?\n\n2.\n\nSeveral claimants came forward for the reward; only one person got it. What was the difference between\nthe person who got the reward and those who did not?\n\nConsideration: Required for Contract Modification\nGross v. Diehl Specialties International, Inc.\n776 S.W.2d 879 (Missouri Ct. App. 1989)\nSmith, J.\nPlaintiff appeals from a jury verdict and resultant judgment for defendant in a breach of employment\ncontract case.\xe2\x80\xa6\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n403\n\n\x0cPlaintiff was employed under a fifteen year employment contract originally executed in 1977 between\nplaintiff and defendant. Defendant, at that time called Dairy Specialties, Inc., was a company in the\nbusiness of formulating ingredients to produce non-dairy products for use by customers allergic to cow\xe2\x80\x99s\nmilk. Plaintiff successfully formulated [Vitamite]\xe2\x80\xa6for that usage.\nThereafter, on August 24, 1977, plaintiff and defendant corporation entered into an employment contract\nemploying plaintiff as general manager of defendant for fifteen years. Compensation was established at\n$14,400 annually plus cost of living increases. In addition, when 10% of defendant\xe2\x80\x99s gross profits\nexceeded the annual salary, plaintiff would receive an additional amount of compensation equal to the\ndifference between his compensation and 10% of the gross profits for such year. On top of that plaintiff\nwas to receive a royalty for the use of each of his inventions and formulae of 1% of the selling price of all of\nthe products produced by defendant using one or more of plaintiff\xe2\x80\x99s inventions or formulae during the\nterm of the agreement. That amount was increased to 2% of the selling price following the term of the\nagreement. The contract further provided that during the term of the agreement the inventions and\nformulae would be owned equally by plaintiff and defendant and that following the term of the agreement\nthe ownership would revert to plaintiff. During the term of the agreement defendant had exclusive rights\nto use of the inventions and formulae and after the term of agreement a non-exclusive right of use.\nAt the time of the execution of the contract, sales had risen from virtually nothing in 1976 to $750,000\nannually from sales of Vitamite and a chocolate flavored product formulated by plaintiff called Chocolite.\n[Dairy\xe2\x80\x99s owner] was in declining health and in 1982 desired to sell his company. At that time yearly sales\nwere $7,500,000. [Owner] sold the company to the Diehl family enterprises for 3 million dollars.\nPrior to sale Diehl insisted that a new contract between plaintiff and defendant be executed or Diehl\nwould substantially reduce the amount to be paid for [the company]. A new contract was executed August\n24, 1982. It reduced the expressed term of the contract to 10 years, which provided the same expiration\ndate as the prior contract. It maintained the same base salary of $14,400 effective September 1982,\nthereby eliminating any cost of living increases incurred since the original contract. The 10% of gross\nprofit provision remained the same. The new contract provided that plaintiff\xe2\x80\x99s inventions and formula\nwere exclusively owned by defendant during the term of the contract and after its termination. The 1%\nroyalty during the term of the agreement remained the same, but no royalties were provided for after the\nterm of the agreement. No other changes were made in the agreement. Plaintiff received no compensation\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n404\n\n\x0cfor executing the new contract. He was not a party to the sale of the company by [Owner] and received\nnothing tangible from that sale.\nAfter the sale plaintiff was given the title and responsibilities of president of defendant with additional\nduties but no additional compensation. In 1983 and 1984 the business of the company declined severely\nand in October 1984, plaintiff\xe2\x80\x99s employment with defendant was terminated by defendant. This suit\nfollowed.\xe2\x80\xa6\nWe turn now to the court\xe2\x80\x99s holding that the 1982 agreement was the operative contract. Plaintiff contends\nthis holding is erroneous because there existed no consideration for the 1982 agreement. We agree. A\nmodification of a contract constitutes the making of a new contract and such new contract must be\nsupported by consideration. [Citation] Where a contract has not been fully performed at the time of the\nnew agreement, the substitution of a new provision, resulting in a modification of the obligations\non both sides, for a provision in the old contract still unperformed is sufficient consideration for the new\ncontract. While consideration may consist of either a detriment to the promisee or a benefit to the\npromisor, a promise to carry out an already existing contractual duty does not constitute consideration.\n[Citation]\nUnder the 1982 contract defendant assumed no detriment it did not already have. The term of the\ncontract expired on the same date under both contracts. Defendant undertook no greater obligations than\nit already had. Plaintiff on the other hand received less than he had under the original contract. His base\npay was reduced back to its amount in 1977 despite the provision in the 1977 contract for cost of living\nadjustments. He lost his equal ownership in his formulae during the term of the agreement and his\nexclusive ownership after the termination of the agreement. He lost all royalties after termination of the\nagreement and the right to use and license the formulae subject to defendant\xe2\x80\x99s right to non-exclusive use\nupon payment of royalties. In exchange for nothing, defendant acquired exclusive ownership of the\nformulae during and after the agreement, eliminated royalties after the agreement terminated, turned its\nnon-exclusive use after termination into exclusive use and control, and achieved a reduction in plaintiff\xe2\x80\x99s\nbase salary. Defendant did no more than promise to carry out an already existing contractual duty. There\nwas no consideration for the 1982 agreement.\nDefendant asserts that consideration flowed to plaintiff because the purchase of defendant by the Diehls\nmight not have occurred without the agreement and the purchase provided plaintiff with continued\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n405\n\n\x0cemployment and a financially viable employer. There is no evidence to support this contention. Plaintiff\nhad continued employment with the same employer under the 1977 agreement. Nothing in the 1982\nagreement provided for any additional financial protection to plaintiff. The essence of defendant\xe2\x80\x99s\nposition is that [the owner] received more from his sale of the company because of the new agreement\nthan he would have without it. We have difficulty converting [the owner\xe2\x80\x99s] windfall into a benefit to\nplaintiff.\n[Remanded to determine how much plaintiff should receive.]\n\nCASE QUESTIONS\n\n1.\n\nWhy did the court determine that Plaintiff\xe2\x80\x99s postemployment benefits should revert to those in his\noriginal contract instead being limited to those in the modified contract?\n\n2.\n\nWhat argument did Defendant make as to why the terms of the modified contract should be valid?\n\n11.5 Summary and Exercises\nSummary\n\nMost agreements\xe2\x80\x94including contract modification at common law (but not under the Uniform\nCommercial Code [UCC])\xe2\x80\x94are not binding contracts in the absence of what the law terms\n\xe2\x80\x9cconsideration.\xe2\x80\x9d Consideration is usually defined as a \xe2\x80\x9clegal detriment\xe2\x80\x9d\xe2\x80\x94an act, forbearance, or a\npromise. The act can be the payment of money, the delivery of a service, or the transfer of title to property.\nConsideration is a legal concept in that it centers on the giving up of a legal right or benefit.\nAn understanding of consideration is important in many commonplace situations, including those in\nwhich (1) a debtor and a creditor enter into an accord that is later disputed, (2) a duty is preexisting, (3) a\npromise is illusory, and (4) creditors agree to a composition.\nSome promises are enforceable without consideration. These include certain promises under the UCC and\nother circumstances, including (1) contracts barred by the statute of limitations, (2) promises by a\nbankrupt to repay debts, and (3) situations in which justice will be served by invoking the doctrine of\npromissory estoppel. Determining whether an agreement should be upheld despite the lack of\nconsideration, technically defined, calls for a diligent assessment of the factual circumstances.\n\nEXERCISES\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n406\n\n\x0c1.\n\nHornbuckle purchased equipment from Continental Gin (CG) for $6,300. However, after some of the\nequipment proved defective, Hornbuckle sent CG a check for $4,000 marked \xe2\x80\x9cby endorsement this check\nis accepted in full payment,\xe2\x80\x9d and CG endorsed and deposited the check. May CG force Hornbuckle to pay\nthe remaining $2,300? Why?\n\n2.\n\nJoseph Hoffman alleged that Red Owl Stores promised him that it would build a store building in Chilton,\nWisconsin, and stock it with merchandise for Hoffman to operate in return for Hoffman\xe2\x80\x99s investment of\n$18,000. The size, cost, design, and layout of the store building was not discussed, nor were the terms of\nthe lease as to rent, maintenance, and purchase options. Nevertheless, in reliance on Red Owl\xe2\x80\x99s promise,\nthe Hoffmans sold their bakery and grocery store business, purchased the building site in Chilton, and\nrented a residence there for the family. The deal was never consummated: a dispute arose, Red Owl did\nnot build the store, and it denied liability to Hoffman on the basis that its promise to him was too\nindefinite with respect to all details for a contract to have resulted. Is Hoffman entitled to some relief? On\nwhat theory?\n\n3.\n\nRaquel contracted to deliver one hundred widgets to Sam on December 15, for which he would pay\n$4,000. On November 25, Sam called her and asked if she could deliver the widgets on December 5.\nRaquel said she could, and she promised delivery on that day. Is her promise binding? Why?\n\n4.\n\nRichard promised to have Darlene\xe2\x80\x99s deck awning constructed by July 10. On June 20, Darlene called him\nand asked if he could get the job done by July 3, in time for Independence Day. Richard said he could, but\nhe failed to do so, and Darlene had to rent two canopies at some expense. Darlene claims that because\nRichard breached his promise, he is liable for the cost of awning rental. Is she correct\xe2\x80\x94was his promise\nbinding? Why?\n\n5.\n\nSeller agreed to deliver gasoline to Buyer at $3.15 per gallon over a period of one year. By the sixth\nmonth, gasoline had increased in price over a dollar a gallon. Although Seller had gasoline available for\nsale, he told Buyer the price would have to increase by that much or he would be unable to deliver. Buyer\nagreed to the increase, but when billed, refused to pay the additional amount. Is Buyer bound by the\npromise? Explain.\n\n6.\n\nMontbanks\xe2\x80\x99s son, Charles, was seeking an account executive position with Dobbs, Smith & Fogarty, Inc., a\nlarge brokerage firm. Charles was independent and wished no interference by his well-known father. The\nfirm, after several weeks\xe2\x80\x99 deliberation, decided to hire Charles. They made him an offer on April 12, 2010,\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n407\n\n\x0cand Charles accepted. Montbanks, unaware that his son had been hired and concerned that he might not\nbe, mailed a letter to Dobbs on April 13 in which he promised to give the brokerage firm $150,000 in\ncommission business if the firm would hire his son. The letter was received by Dobbs, and the firm wishes\nto enforce it against Montbanks. May Dobbs enforce the promise? Why?\n7.\n\nIn 1869, William E. Story promised his nephew, William E. Story II (then sixteen years old), $5,000 (about\n$120,000 in today\xe2\x80\x99s money) if \xe2\x80\x9cWillie\xe2\x80\x9d would abstain from drinking alcohol, smoking, swearing, and\nplaying cards or billiards for money until the nephew reached twenty-one years of age. All of these were\nlegally permissible activities for the teenager at that time in New York State. Willie accepted his uncle\xe2\x80\x99s\npromise and did refrain from the prohibited acts until he turned twenty-one. When the young man asked\nfor the money, his uncle wrote to him that he would honor the promise but would rather wait until Willie\nwas older before delivering the money, interest added on. Willie agreed. Subsequently, Willie assigned\nthe right to receive the money to one Hamer (Willie wanted the money sooner), and Story I died without\nmaking any payment. The estate, administered by Franklin Sidway, refused to pay, asserting there was no\nbinding contract due to lack of consideration: the boy suffered no \xe2\x80\x9cdetriment,\xe2\x80\x9d and the uncle got no\nbenefit. The trial court agreed with the estate, and the plaintiff appealed. Should the court on appeal\naffirm or reverse? Explain.\n\n8.\n\nHarold Pearsall and Joe Alexander were friends for over twenty-five years. About twice a week, they\nbought what they called a package: a half-pint of vodka, orange juice, two cups, and two lottery tickets.\nThey went to Alexander\xe2\x80\x99s house to watch TV, drink screwdrivers, and scratch the lottery tickets. The two\nhad been sharing tickets and screwdrivers since the Washington, DC, lottery began. On the evening in\nissue, Pearsall bought the package and asked Alexander, \xe2\x80\x9cAre you in on it?\xe2\x80\x9d Alexander said yes. Pearsall\nasked for his half of the purchase price, but Alexander had no money. A few hours later, Alexander,\nhaving come by some funds of his own, bought another package. He handed one ticket to Pearsall, and\nthey both scratched the tickets; Alexander\xe2\x80\x99s was a $20,000 winner. When Pearsall asked for his share,\nAlexander refused to give him anything. Are the necessary elements of offer, acceptance, and\nconsideration present here so as to support Pearsall\xe2\x80\x99s assertion the parties had a contract?\n\n9.\n\nDefendant, Lee Taylor, had assaulted his wife, who took refuge in the house of Plaintiff, Harrington. The\nnext day, Taylor gained access to the house and began another assault upon his wife. Mrs. Taylor knocked\nhim down with an axe and was on the point of cutting his head open or decapitating him while he was\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n408\n\n\x0clying on the floor when Plaintiff intervened and caught the axe as it was descending. The blow intended\nfor Defendant fell upon Harrington\xe2\x80\x99s hand, mutilating it badly, but saving Defendant\xe2\x80\x99s life. Subsequently,\nDefendant orally promised to pay Plaintiff her damages but, after paying a small sum, failed to pay\nanything more. Is Harrington entitled to enforce Taylor\xe2\x80\x99s entire promise?\n10. White Sands Forest Products (Defendant) purchased logging equipment from Clark Corporation (Plaintiff)\nunder an installment contract that gave Plaintiff the right to repossess and resell the equipment if\nDefendant defaulted on the contract. Defendant did default and agreed to deliver the equipment to\nPlaintiff if Plaintiff would then discharge Defendant from further obligation. Plaintiff accepted delivery\nand resold the equipment, but the sale left a deficiency (there was still money owing by Defendant).\nPlaintiff then sued for the deficiency, and Defendant set up as a defense the accord and satisfaction. Is\nthe defense good?\n\n1.\n\nSELF-TEST QUESTIONS\n\nConsideration\na.\n\ncan consist of a written acknowledgment of some benefit received, even if in fact the\n\nbenefit is not delivered\nb.\n\ncannot be nominal in amount\n\nc.\n\nis a bargained-for act, forbearance, or promise from the promisee\n\nd.\n\nis all of the above\nAn example of valid consideration is a promise\n\na.\n\nby a seventeen-year-old to refrain from drinking alcohol\nb.\n\nto refrain from going to court\n\nc.\n\nto cook dinner if the promisor can get around to it\n\nd.\n\nto repay a friend for the four years of free legal advice he had provided\nAn unliquidated debt is a debt\n\na.\n\none is not able to pay\nb.\n\nnot yet paid\n\nc.\n\nof uncertain amount\n\nd.\n\nthat is unenforceable debt\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n409\n\n\x0cThe rule that if one party to a contract has not made a binding obligation, the other party is not\nbound is called\na.\n\nrevocation\nb.\n\nmutuality of obligation\n\nc.\n\naccord and satisfaction\n\nd.\n\nestoppel\nExamples of promises enforceable without consideration include\n\na.\n\nan agreement modifying a sales contract\n\n1.\n\nc\n\n2.\n\nb\n\n3.\n\nc\n\n4.\n\nb\n\n5.\n\nd\n\nb.\n\na promise to pay a debt after the statute of limitations has run\n\nc.\n\na debtor\xe2\x80\x99s promise to repay a debt that has been discharged in bankruptcy\n\nd.\n\nall of the above\n\nSELF-TEST ANSWERS\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n410\n\n\x0cChapter 12\n\nLegality\n\nLEARNING OBJECTIVES\nAfter reading this chapter, you should understand the following:\n1.\n\nThe types of contracts (bargains) that are deemed illegal\n\n2.\n\nHow courts deal with disputes concerning illegal contracts\n\n3.\n\nUnder what circumstances courts will enforce otherwise illegal contracts\n\n12.1 General Perspectives on Illegality\n\nLEARNING OBJECTIVES\n\n1.\n\nUnderstand why courts refuse to enforce illegal agreements.\n\n2.\n\nRecognize the rationale behind exceptions to the rule.\n\nWe have discussed the requirements of mutual assent, real assent, and consideration. We now turn\nto the fourth of the five requirements for a valid contract: the legality of the underlying bargain. The\nbasic rule is that courts will not enforce an illegal bargain. (The term illegal bargain is better\nthan illegal contract because a contract is by definition a legal agreement, but the latter terminology\nprevails in common usage.) Why should this be? Why should the courts refuse to honor contracts\nmade privately by people who presumably know what they are doing\xe2\x80\x94for example, a wager on the\nWorld Series or a championship fight? Two reasons are usually given. One is that refusal to enforce\nhelps discourage unlawful behavior; the other is that honoring such contracts would demean the\njudiciary. Are these reasons valid? Yes and no, in the opinion of one contracts scholar:\n[D]enying relief to parties who have engaged in an illegal transaction\xe2\x80\xa6helps to effectuate the\npublic policy involved by discouraging the conduct that is disapproved. Mere denial of\ncontractual and quasi-contractual remedy [however] rarely has a substantial effect in\ndiscouraging illegal conduct. A man who is hired to perform a murder is not in the least deterred\nby the fact that the courts are not open to him to collect his fee. Such a man has other methods of\nenforcement, and they are in fact more effective than legal process. The same is true in varying\ndegrees where less heinous forms of illegal conduct are involved. Even in the matter of usury it\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n411\n\n\x0cwas found that mere denial of enforcement was of little value in the effort to eliminate the loan\nshark. And restraints of trade were not curbed to an appreciable extent until contracts in\nrestraint of trade were made criminal.\nIn most instances, then, the protection of the good name of the judicial institution must provide\nthe principal reason for the denial of a remedy to one who has trafficked in the forbidden. This is,\nmoreover, a very good reason. The first duty of an institution is to preserve itself, and if the\ncourts to any appreciable extent busied themselves with \xe2\x80\x9cjustice among thieves,\xe2\x80\x9d the\ncommunity\xe2\x80\xa6would be shocked and the courts would be brought into disrepute.\n\n[1]\n\nStrictly enforced, the rule prohibiting courts from ordering the parties to honor illegal contracts is\nharsh. It means that a promisee who has already performed under the contract can neither obtain\nperformance of the act for which he bargained nor recover the money he paid or the value of the\nperformance he made. The court will simply leave the parties where it finds them, meaning that one\nof the parties will have received an uncompensated benefit.\nNot surprisingly, the severity of the rule against enforcement has led courts to seek ways to moderate\nits impact, chiefly by modifying it according to the principle of restitution. In general, restitution\nrequires that one who has conferred a benefit or suffered a loss should not unfairly be denied\ncompensation.\nPursuing this notion, the courts have created several exceptions to the general rule. Thus a party who\nis excusably ignorant that his promise violates public policy and a party who is not equally in the\nwrong may recover. Likewise, when a party \xe2\x80\x9cwould otherwise suffer a forfeiture that is\ndisproportionate in relation to the contravention of public policy involved,\xe2\x80\x9d restitution will be\nallowed. [2]Other exceptions exist when the party seeking restitution withdraws from the transaction\ncontemplated in the contract before the illegal purpose has been carried out and when \xe2\x80\x9callowing the\nclaim would put an end to a continuing situation that is contrary to the public interest.\xe2\x80\x9d [3] An\nexample of the latter situation occurs when two bettors place money in the hands of a stakeholder. If\nthe wager is unlawful, the loser of the bet has the right to recover his money from the stakeholder\nbefore it is paid out to the winner.\nThough by and large courts enforce contracts without considering the worth or merits of the bargain\nthey incorporate, freedom of contract can conflict with other public policies. Tensions arise between\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n412\n\n\x0cthe desire to let people pursue their own ends and the belief that certain kinds of conduct should not\nbe encouraged. Thus a patient may agree to be treated by an herbalist, but state laws prohibit\nmedical care except by licensed physicians. Law and public policies against usury, gambling,\nobstructing justice, bribery, corrupt influence, perjury, restraint of trade, impairment of domestic\nrelations, and fraud all significantly affect the authority and willingness of courts to enforce\ncontracts.\nIn this chapter, we will consider two types of illegality: (1) that which results from a bargain that\nviolates a statute and (2) that which the courts deem contrary to public policy, even though not\nexpressly set forth in statutes.\n\nKEY TAKEAWAY\n\nCourts refuse to enforce illegal bargains notwithstanding the basic concept of freedom to contract\nbecause they do not wish to reward illegal behavior or sully themselves with adjudication of that which is\nforbidden to undertake. However, fairness sometimes compels courts to make exceptions.\n\nEXERCISES\n\n1.\n\nWhy is illegal contract a contradiction in terms?\n\n2.\n\nWhy do courts refuse to enforce contracts (or bargains) made by competent adults if the contracts harm\nno third party but are illegal?\n3.\n\n[1] Harold C. Havighurst, review of Corbin on Contracts, by Arthur L. Corbin, Yale Law Journal 61 (1952):\n1143, 1144\xe2\x80\x9345.\n\n4.\n\n[2] Restatement (Second) of Contracts, Section 197(b).\n\n5.\n\n[3] Restatement (Second) of Contracts, Section 197(b).\n\n12.2 Agreements in Violation of Statute\n\nLEARNING OBJECTIVES\n\n1.\n\nUnderstand that various types of bargains may be made illegal by statute, including gambling, some\nservice-for-fee agreements involving unlicensed practitioners, and usury.\n\n2.\n\nRecognize that while gambling contracts are often illegal, some agreements that might appear to involve\ngambling are not.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n413\n\n\x0cOverview\nAny bargain that violates the criminal law\xe2\x80\x94including statutes that govern extortion, robbery,\nembezzlement, forgery, some gambling, licensing, and consumer credit transactions\xe2\x80\x94is illegal. Thus\ndetermining whether contracts are lawful may seem to be an easy enough task. Clearly, whenever the\nstatute itself explicitly forbids the making of the contract or the performance agreed upon, the bargain\n(such as a contract to sell drugs) is unlawful. But when the statute does not expressly prohibit the making\nof the contract, courts examine a number of factors, as discussed in Section 12.5.1 "Extension of Statutory\nIllegality Based on Public Policy" involving the apparently innocent sale of a jewelry manufacturing firm\nwhose real business was making marijuana-smoking paraphernalia.\n\nTypes of Bargains Made Illegal by Statute\nGambling Contracts\nAll states have regulations affecting gambling (wagering) contracts because gambling tends to be an\nantiutilitarian activity most attractive to those who can least afford it, because gambling tends to reinforce\nfatalistic mind-sets fundamentally incompatible with capitalism and democracy, because gambling can be\naddictive, and because gambling inevitably attracts criminal elements lured by readily available money.\nWith the spread of antitax enthusiasms over the last thirty-some years, however, some kinds of gambling\nhave been legalized and regulated, including state-sponsored lotteries. Gambling is betting on an outcome\nof an event over which the bettors have no control where the purpose is to play with the risk.\nBut because the outcome is contingent on events that lie outside the power of the parties to control does\nnot transform a bargain into a wager. For example, if a gardener agrees to care for the grounds of a\nseptuagenarian for life in return for an advance payment of $10,000, the uncertainty of the date of the\nlandowner\xe2\x80\x99s death does not make the deal a wager. The parties have struck a bargain that accurately\nassesses, to the satisfaction of each, the risks of the contingency in question. Likewise, the fact that an\nagreement is phrased in the form of a wager does not make it one. Thus a father says to his daughter, \xe2\x80\x9cI\xe2\x80\x99ll\nbet you can\xe2\x80\x99t get an A in organic chemistry. If you do, I\xe2\x80\x99ll give you $50.\xe2\x80\x9d This is a unilateral contract, the\nconsideration to the father being the daughter\xe2\x80\x99s achieving a good grade, a matter over which she has\ncomplete control.\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n414\n\n\x0cDespite the general rule against enforcing wagers, there are exceptions, most statutory but some rooted in\nthe common law. The common law permits the sale or purchase of securities: Sally invests $6,000 in\nstock in Acme Company, hoping the stock will increase in value, though she has no control over the firm\xe2\x80\x99s\nmanagement. It is not called gambling; it is considered respectable risk taking in the capitalist system, or\n\xe2\x80\x9centrepreneurialism.\xe2\x80\x9d (It really is gambling, though, similar to horse-race gambling.) But because there\nare speculative elements to some agreements, they are subject to state and federal regulation.\nInsurance contracts are also speculative, but unless one party has no insurable interest (a concern for the\nperson or thing insured) in the insured, the contract is not a wager. Thus if you took out a life insurance\ncontract on the life of someone whose name you picked out of the phone book, the agreement would be\nvoid because you and the insurance company would have been gambling on a contingent event. (You bet\nthat the person would die within the term of the policy, the insurance company that she would not.) If,\nhowever, you insure your spouse, your business partner, or your home, the contingency does not make the\npolicy a wagering agreement because you will have suffered a direct loss should it occur, and the\nagreement, while compensating for a possible loss, does not create a new risk just for the \xe2\x80\x9cgame.\xe2\x80\x9d\n\nSunday Contracts\nAt common law, contracts entered into on Sundays, as well as other commercial activities, were valid and\nenforceable. But a separate, religious tradition that traces to the Second Commandment frowned on work\nperformed on \xe2\x80\x9cthe Lord\xe2\x80\x99s Day.\xe2\x80\x9d In 1781 a New Haven city ordinance banning Sunday work was printed on\nblue paper, and since that time such laws have been known as blue laws. The first statewide blue law was\nenacted in the United States in 1788; it prohibited travel, work, sports and amusements, and the carrying\non of any business or occupation on Sundays. The only exceptions in most states throughout most of the\nnineteenth century were mutual promises to marry and contracts of necessity or charity. As the Puritan\nfervor wore off, and citizens were, more and more, importuned to consider themselves \xe2\x80\x9cconsumers\xe2\x80\x9d in a\ncapitalistic economic system, the laws have faded in importance and are mostly repealed, moribund, or\nunenforced. Washington State, up until 2008, completely prohibited hard alcohol sales on Sunday, and all\nliquor stores were closed, but subsequently the state\xe2\x80\x94desperate for tax revenue\xe2\x80\x94relaxed the prohibition.\n\nUsury\nA usury statute is one that sets the maximum allowable interest that may be charged on a loan; usury is\ncharging illegal interest rates. Formerly, such statutes were a matter of real importance because the\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n415\n\n\x0cpenalty levied on the lender\xe2\x80\x94ranging from forfeiture of the interest, or of both the principal and the\ninterest, or of some part of the principal\xe2\x80\x94was significant. But usury laws, like Sunday contract laws, have\nbeen relaxed to accommodate an ever-more-frenzied consumer society. There are a number of\ntransactions to which the laws do not apply, varying by state: small consumer loans, pawn shop loans,\npayday loans, and corporate loans. In Marquette v. First Omaha Service Corp., the Supreme Court ruled\nthat a national bank could charge the highest interest rate allowed in its home state to customers living\nanywhere in the United States, including states with restrictive interest caps.\n\n[1]\n\nThus it was that in 1980\n\nCitibank moved its credit card headquarters from cosmopolitan New York City to the somewhat less\ncosmopolitan Sioux Falls, South Dakota. South Dakota had recently abolished its usury laws, and so, as\nfar as credit-card interest rates, the sky was the limit. That appealed to Citibank and a number of other\nfinancial institutions, and to the state: it became a major player in the US financial industry, garnering\nmany jobs.\n\n[2]\n\nLicensing Statutes\nTo practice most professions and carry on the trade of an increasing number of occupations, states require\nthat providers of services possess licenses\xe2\x80\x94hairdressers, doctors, plumbers, real estate brokers, and egg\ninspectors are among those on a long list. As sometimes happens, though, a person may contract for the\nservices of one who is unlicensed either because he is unqualified and carrying on his business without a\nlicense or because for technical reasons (e.g., forgetting to mail in the license renewal application) he does\nnot possess a license at the moment. Robin calls Paul, a plumber, to install the pipes for her new kitchen.\nPaul, who has no license, puts in all the pipes and asks to be paid. Having discovered that Paul is\nunlicensed, Robin refuses to pay. May Paul collect?\nTo answer the question, a three-step analysis is necessary. First, is a license required? Some occupations\nmay be performed without a license (e.g., lawn mowing). Others may be performed with or without\ncertain credentials, the difference lying in what the professional may tell the public. (For instance, an\naccountant need not be a certified public accountant to carry on most accounting functions.) Let us\nassume that the state requires everyone who does any sort of plumbing for pay to have a valid license.\nThe second step is to determine whether the licensing statute explicitly bars recovery by someone who has\nperformed work while unlicensed. Some do; many others contain no specific provision on the point.\nStatutes that do bar recovery must of course govern the courts when they are presented with the question.\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n416\n\n\x0cIf the statute is silent, courts must, in the third step of the analysis, distinguish between \xe2\x80\x9cregulatory\xe2\x80\x9d and\n\xe2\x80\x9crevenue\xe2\x80\x9d licenses. A regulatory license is intended to protect the public health, safety, and welfare. To\nobtain these licenses, the practitioner of the art must generally demonstrate his or her abilities by taking\nsome sort of examination, like the bar exam for lawyers or the medical boards for doctors. A plumber\xe2\x80\x99s or\nelectrician\xe2\x80\x99s licensing requirement might fall into this category. A revenue license generally requires no\nsuch examination and is imposed for the sake of raising revenue and to ensure that practitioners register\ntheir address so they can be found if a disgruntled client wants to serve them legal papers for a lawsuit.\nSome revenue licenses, in addition to requiring registration, require practitioners to demonstrate that\nthey have insurance. A license to deliver milk, open to anyone who applies and pays the fee, would be an\nexample of a revenue license. (In some states, plumbing licenses are for revenue purposes only.)\nGenerally speaking, failure to hold a regulatory license bars recovery, but the absence of a revenue or\nregistration license does not\xe2\x80\x94the person may obtain the license and then move to recover. See Section\n12.5.2 "Unlicensed Practitioner Cannot Collect Fee" for an example of a situation in which the state statute\ndemands practitioners be licensed.\n\nKEY TAKEAWAY\n\nGambling, interest rates, and Sunday contracts are among the types of contracts that have, variously, been\nsubject to legislative illegality. Laws may require certain persons to have licenses in order to practice a\ntrade or profession. Whether an unlicensed person is barred from recovering a fee for service depends on\nthe language of the statute and the purpose of the requirement: if it is a mere revenue-raising or\nregistration statute, recovery will often be allowed. If the practitioner is required to prove competency, no\nrecovery is possible for an unlicensed person.\n\nEXERCISES\n\n1.\n\nList the typical kinds of contracts made illegal by statute.\n\n2.\n\nWhy are some practitioners completely prohibited from collecting a fee for service if they don\xe2\x80\x99t have a\nlicense, and others allowed to collect the fee after they get the license?\n\n3.\n\nIf no competency test is required, why do some statutes require the practitioner to be licensed?\n4.\n\n[1] Marquette v. First Omaha Service Corp., 439 US 299 (1978).\n\n5.\n\n[2] See Thomas M. Reardon, \xe2\x80\x9cT. M. Reardon\xe2\x80\x99s first-hand account of Citibank\xe2\x80\x99s move to South\nDakota,\xe2\x80\x9d NorthWestern Financial Review, September 15, 2004, accessed March 1,\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n417\n\n\x0c2011, http://www.allbusiness.com/finance-insurance/1022315-1.html. Mr. Reardon was a member of the\nSouth Dakota Bankers\xe2\x80\x99 Association.\n\n12.3 Bargains Made Illegal by Common Law\nLEARNING OBJECTIVE\n\n1.\n\nUnderstand what contracts or bargains have been declared illegal by courts.\n\nOverview\nPublic policy is expressed by courts as well as legislatures. In determining whether to enforce a contract\nwhere there is no legislative dictate, courts must ordinarily balance the interests at stake. To strike the\nproper balance, courts must weigh the parties\xe2\x80\x99 expectations, the forfeitures that would result from denial\nof enforcement, and the public interest favoring enforcement against these factors: the strength of the\npolicy, whether denying enforcement will further the policy, the seriousness and deliberateness of the\nviolation, and how direct the connection is between the misconduct and the contractual term to be\nenforced.\n\n[1]\n\nTypes of Bargains Made Illegal by Common Law\nCommon-Law Restraint of Trade\nOne of the oldest public policies evolved by courts is the common-law prohibition against restraint of\ntrade. From the early days of industrialism, the courts took a dim view of ostensible competitors who\nagreed among themselves to fix prices or not to sell in each other\xe2\x80\x99s territories. Since 1890, with the\nenactment of the Sherman Act, the law of restraint of trade has been absorbed by federal and state\nantitrust statutes. But the common-law prohibition still exists. Though today it is concerned almost\nexclusively with promises not to compete in sales of businesses and employment contracts, it can arise in\nother settings. For example, George\xe2\x80\x99s promise to Arthur never to sell the parcel of land that Arthur is\nselling to him is void because it unreasonably restrains trade in the land.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n418\n\n\x0cThe general rule is one of reason: not every restraint of trade is unlawful; only unreasonable ones are. As\nthe Restatement puts it, \xe2\x80\x9cEvery promise that relates to business dealings or to a professional or other\ngainful occupation operates as a restraint in the sense that it restricts the promisor\xe2\x80\x99s future activity. Such\na promise is not, however, unenforceable, unless the restraint that it imposes is unreasonably detrimental\nto the smooth operation of a freely competitive private economy.\xe2\x80\x9d\n\n[2]\n\nAn agreement that restrains trade\n\nwill be construed as unreasonable unless it is ancillary to a legitimate business interest and is no greater\nthan necessary to protect the legitimate interest. Restraint-of-trade cases usually arise in two settings: (1)\nthe sale of a business and an attendant agreement not to compete with the purchasers and (2) an\nemployee\xe2\x80\x99s agreement not to compete with the employer should the employee leave for any reason.\n\nSale of a Business\nA first common area where a restraint-of-trade issue may arise is with the sale of a business. Regina sells\nher lingerie store to Victoria and promises not to establish a competing store in town for one year. Since\nVictoria is purchasing Regina\xe2\x80\x99s goodwill (the fact that customers are used to shopping at her store), as\nwell as her building and inventory, there is clearly a property interest to be protected. And the\ngeographical limitation (\xe2\x80\x9cin town\xe2\x80\x9d) is reasonable if that is where the store does business. But if Regina had\nagreed not to engage in any business in town, or to wait ten years before opening up a new store, or not to\nopen up a new store anywhere within one hundred miles of town, she could avoid the noncompetition\nterms of the contract because the restraint in each case (nature, duration, and geographic area of\nrestraint) would have been broader than necessary to protect Victoria\xe2\x80\x99s interest. Whether the courts will\nuphold an agreement not to compete depends on all the circumstances of the particular case, as the\nConnecticut barber in discovered.\n\nEmployment Noncompete Agreements\nA second common restraint-of-trade issue arises with regard to noncompete agreements in employment\ncontracts. As a condition of employment by the research division of a market research firm, Bruce, a\nproduct analyst, is required to sign an agreement in which he promises, for a period of one year after\nleaving the company, not to \xe2\x80\x9cengage, directly or indirectly, in any business competing with the company\nand located within fifty miles of the company\xe2\x80\x99s main offices.\xe2\x80\x9d The principal reason recited in the\nagreement for this covenant not to compete is that by virtue of the employment, Bruce will come to learn a\nvariety of internal secrets, including client lists, trade or business secrets, reports, confidential business\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n419\n\n\x0cdiscussions, ongoing research, publications, computer programs, and related papers. Is this agreement a\nlawful restraint of trade?\nHere both the property interest of the employer and the extent of the restraint are issues. Certainly an\nemployer has an important competitive interest in seeing that company information not walk out the door\nwith former employees. Nevertheless, a promise by an employee not to compete with his or her former\nemployer is scrutinized carefully by the courts, and an injunction (an order directing a person to stop\ndoing what he or she should not do) will be issued cautiously, partly because the prospective employee is\nusually confronted with a contract of adhesion (take it or leave it) and is in a weak bargaining position\ncompared to the employer, and partly because an injunction might cause the employee\xe2\x80\x99s unemployment.\nMany courts are not enthusiastic about employment noncompete agreements. The California Business\nand Professions Code provides that \xe2\x80\x9cevery contract by which anyone is restrained from engaging in a\nlawful profession, trade, or business of any kind is to that extent void.\xe2\x80\x9d\n\n[3]\n\nAs a result of the statute, and to\n\npromote entrepreneurial robustness, California courts typically interpret the statute broadly and refuse to\nenforce noncompete agreements. Other states are less stingy, and employers have attempted to avoid the\nstrictures of no-enforcement state rulings by providing that their employment contracts will be\ninterpreted according to the law of a state where noncompetes are favorably viewed.\nIf a covenant not to compete is ruled unlawful, the courts can pursue one of three courses by way of\nremedy. A court can refuse to enforce the entire covenant, freeing the employee to compete thenceforth.\nThe court could delete from the agreement only that part that is unreasonable and enforce the remainder\n(the \xe2\x80\x9cblue pencil\xe2\x80\x9d rule). In some states, the courts have moved away from this rule and have actually taken\nto rewriting the objectionable clause themselves. Since the parties intended that there be some form of\nrestriction on competition, a reasonable modification would achieve a more just result.\n\n[4]\n\nUnconscionable Contracts\nCourts may refuse to enforce unconscionable contracts, those that are very one-sided, unfair, the product\nof unequal bargaining power, or oppressive; a court may find the contract divisible and enforce only the\nparts that are not unconscionable.\nThe common-law rule is reflected in Section 208 of the Restatement: \xe2\x80\x9cIf a contract or term thereof is\nunconscionable at the time the contract is made a court may refuse to enforce the contract, or may enforce\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n420\n\n\x0cthe remainder of the contract without the unconscionable term, or may so limit the application of any\nunconscionable term as to avoid any unconscionable result.\xe2\x80\x9d\nAnd the Uniform Commercial Code (UCC) (again, of course, a statute, not common law) provides a\nsimilar rule in Section 2-302(1): \xe2\x80\x9cIf the court as a matter of law finds the contract or any clause of the\ncontract to have been unconscionable at the time it was made the court may refuse to enforce the contract,\nor it may enforce the remainder of the contract without the unconscionable clause, or it may so limit the\napplication of any unconscionable clause as to avoid any unconscionable result.\xe2\x80\x9d\nUnconscionable is not defined in the Restatement or the UCC, but cases have given gloss to the meaning,\nas in , Williams v. Walker-Thomas Furniture Co., a well-known early interpretation of the section by the\nDC Court of Appeals.\nUnconscionability may arise procedurally or substantively. A term is procedurally unconscionable if it is\nimposed upon the \xe2\x80\x9cweaker\xe2\x80\x9d party because of fine or inconspicuous print, unexpected placement in the\ncontract, lack of opportunity to read the term, lack of education or sophistication that precludes\nunderstanding, or lack of equality of bargaining power. Substantive unconscionability arises where the\naffected terms are oppressive and harsh, where the term deprives a party of any real remedy for breach.\nMost often\xe2\x80\x94but not always\xe2\x80\x94courts find unconscionable contracts in the context of consumer transactions\nrather than commercial transactions. In the latter case, the assumption is that the parties tend to be\nsophisticated businesspeople able to look out for their own contract interests.\n\nExculpatory Clauses\nThe courts have long held that public policy disfavors attempts to contract out of tort\nliability. Exculpatory clauses that exempt one party from tort liability to the other for harm caused\nintentionally or recklessly are unenforceable without exception. A contract provision that exempts a party\nfrom tort liability for negligence is unenforceable under two general circumstances: (1) when it \xe2\x80\x9cexempts\nan employer from liability to an employee for injury in the course of his employment\xe2\x80\x9d or (2) when it\nexempts one charged with a duty of public service and who is receiving compensation from liability to one\nto whom the duty is owed.\n\n[5]\n\nContract terms with offensive exculpatory clauses may be considered\n\nsomewhat akin to unconscionability.\nPut shortly, exculpatory clauses are OK if they are reasonable. Put not so shortly, exculpatory clauses will\ngenerally be held valid if (1) the agreement does not involve a business generally thought suitable for\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n421\n\n\x0cpublic regulation (a twenty-kilometer bicycle race, for example, is probably not one thought generally\nsuitable for public regulation, whereas a bus line is); (2) the party seeking exculpation is not performing a\nbusiness of great importance to the public or of practical necessity for some members of the public; (3) the\nparty does not purport to be performing the service to just anybody who comes along (unlike the bus\nline); (4) the parties are dealing at arms\xe2\x80\x99 length, able to bargain about the contract; (5) the person or\nproperty of the purchaser is not placed under control of the seller, subject to his or his agent\xe2\x80\x99s\ncarelessness; or (6) the clause is conspicuous and clear.\n\n[6]\n\nObstructing the Administration of Justice or Violating a Public Duty\nIt is well established under common law that contracts that would interfere with the administration of\njustice or that call upon a public official to violate a public duty are void and unenforceable. Examples of\nsuch contracts are numerous: to conceal or compound a crime, to pay for the testimony of a witness in\ncourt contingent on the court\xe2\x80\x99s ruling, to suppress evidence by paying a witness to leave the state, or to\ndestroy documents. Thus, in an unedifying case in Arkansas, a gambler sued a circuit court judge to\nrecover $1,675 allegedly paid to the judge as protection money, and the Arkansas Supreme Court affirmed\nthe dismissal of the suit, holding, \xe2\x80\x9cThe law will not aid either party to the alleged illegal and void\ncontract\xe2\x80\xa6\xe2\x80\x98but will leave them where it finds them, if they have been equally cognizant of the\nillegality.\xe2\x80\x99\xe2\x80\x9d\n\n[7]\n\nAlso in this category are bribes, agreements to obstruct or delay justice (jury tampering,\n\nabuse of the legal process), and the like.\n\nFamily Relations\nAnother broad area in which public policy intrudes on private contractual arrangements is that of\nundertakings between couples, either prior to or during marriage. Marriage is quintessentially a\nrelationship defined by law, and individuals have limited ability to change its scope through legally\nenforceable contracts. Moreover, marriage is an institution that public policy favors, and agreements that\nunreasonably restrain marriage are void. Thus a father\xe2\x80\x99s promise to pay his twenty-one-year-old daughter\n$100,000 if she refrains from marrying for ten years would be unenforceable. However, a promise in a\npostnuptial (after marriage) agreement that if the husband predeceases the wife, he will provide his wife\nwith a fixed income for as long as she remains unmarried is valid because the offer of support is related to\nthe need. (Upon remarriage, the need would presumably be less pressing.) Property settlements before,\nduring, or upon the breakup of a marriage are generally enforceable, since property is not considered to\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n422\n\n\x0cbe an essential incident of marriage. But agreements in the form of property arrangements that tend to be\ndetrimental to marriage are void\xe2\x80\x94for example, a prenuptial (premarital) contract in which the wife-to-be\nagrees on demand of the husband-to-be to leave the marriage and renounce any claims upon the\nhusband-to-be at any time in the future in return for which he will pay her $100,000. Separation\nagreements are not considered detrimental to marriage as long as they are entered after or in\ncontemplation of immediate separation; but a separation agreement must be \xe2\x80\x9cfair\xe2\x80\x9d under the\ncircumstances, and judges may review them upon challenge. Similarly, child custody agreements are not\nleft to the whim of the parents but must be consistent with the best interest of the child, and the courts\nretain the power to examine this question.\nThe types of contracts or bargains that might be found illegal are innumerable, limited only by the\ningenuity of those who seek to overreach.\n\nKEY TAKEAWAY\n\nCourts will not enforce contracts that are, broadly speaking, contrary to public policy. These include some\nnoncompete agreements, exculpatory clauses, unconscionable bargains, contracts to obstruct the public\nprocess or justice, and contracts interfering with family relations.\n\nEXERCISES\n\n1.\n\nWhy are employment noncompete agreements viewed less favorably than sale-of-business noncompete\nagreements?\n\n2.\n\nCan a person by contract exculpate herself from liability for gross negligence? For ordinary negligence?\n\n3.\n\nA parking lot agreement says the parking lot is \xe2\x80\x9cnot responsible for loss of contents or damage to the\nvehicle.\xe2\x80\x9d Is that acceptable? Explain.\n\n4.\n\nA valet parking lot agreement\xe2\x80\x94where the car owner gives the keys to the attendant who parks the car\xe2\x80\x94\nhas the same language as that for the lot in Exercise 3. Is that acceptable? Explain.\n5.\n\n[1] Restatement (Second) of Contracts, Section 178.\n\n6.\n\n[2] Restatement (Second) of Contracts, Section 186(a).\n\n7.\n\n[3] California Business and Professions Code, Section 16600.\n\n8.\n\n[4] Raimondo v. Van Vlerah, 325 N.E.2d 544 (Ohio 1975).\n\n9.\n\n[5] Restatement (Second) of Contracts, Section 195.\n\n10. [6] Henrioulle v. Marin Ventures, Inc., 573 P.2d 465 (Calif. 1978).\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n423\n\n\x0c11. [7] Womack v. Maner, 301 S.W.2d 438 (Ark. 1957).\n\n12.4 Effect of Illegality and Exceptions\n\nLEARNING OBJECTIVES\n\n1.\n\nRecognize that courts will not enforce illegal bargains.\n\n2.\n\nKnow that there are exceptions to that rule.\n\nEffect of Illegality\nThe general rule is this: courts will not enforce illegal bargains. The parties are left where the court found\nthem, and no relief is granted: it\xe2\x80\x99s a hands-off policy. The illegal agreement is void, and that a wrongdoer\nhas benefited to the other\xe2\x80\x99s detriment does not matter.\nFor example, suppose a specialty contractor, statutorily required to have a license, constructs a waterslide\nfor Plaintiff, when the contractor knew or should have known he was unlicensed. Plaintiff discovers the\nimpropriety and refuses to pay the contractor $80,000 remaining on the deal. The contractor will not get\npaid.\n\n[1]\n\nIn another example, a man held himself out to be an architect in a jurisdiction requiring that\n\narchitects pass a test to be licensed. He was paid $80,000 to design a house costing $900,000. The\nproject was late and over budget, and the building violated relevant easement building-code rules. The\nunlicensed architect was not allowed to keep his fee.\n\n[2]\n\nExceptions\nAs always in the law, there are exceptions. Of relevance here are situations where a court might permit\none party to recover: party withdrawing before performance, party protected by statute, party not equally\nat fault, excusable ignorance, and partial illegality.\n\nParty Withdrawing before Performance\nSamantha and Carlene agree to bet on a soccer game and deliver their money to the stakeholder.\nSubsequently, but before the payout, Carlene decides she wants out; she can get her money from the\nstakeholder. Ralph hires Jacob for $5,000 to arrange a bribe of a juror. Ralph has a change of heart; he\ncan get his money from Jacob.\n\nParty Protected by Statute\nAn airline pilot, forbidden by federal law from working overtime, nevertheless does so; she would be\nentitled to payment for the overtime worked. Securities laws forbid the sale or purchase of unregistered\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n424\n\n\x0cofferings\xe2\x80\x94such a contract is illegal; the statute allows the purchaser rescission (return of the money paid).\nAn attorney (apparently unwittingly) charged his client beyond what the statute allowed for procuring for\nthe client a government pension; the pensioner could get the excess from the attorney.\n\nParty Not Equally at Fault\nOne party induces another to make an illegal contract by undue influence, fraud, or duress; the victim can\nrecover the consideration conveyed to the miscreant if possible.\n\nExcusable Ignorance\nA woman agrees to marry a man not knowing that he is already married; bigamy is illegal, the marriage is\nvoid, and she may sue him for damages. A laborer is hired to move sealed crates, which contain\nmarijuana; it is illegal to ship, sell, or use marijuana, but the laborer is allowed payment for his services.\n\nPartial Illegality\nA six-page employment contract contains two paragraphs of an illegal noncompete agreement. The illegal\npart is thrown out, but the legal parts are enforceable.\n\nKEY TAKEAWAY\n\nThere are a number of exceptions to the general rule that courts give no relief to either party to an illegal\ncontract. The rule may be relaxed in cases where justice would be better served than by following the\nstricture of hands off.\n\nEXERCISES\n\n1.\n\nWhen, in general, will a court allow a party relief from an illegal contract (or bargain)?\n\n2.\n\nA and B engage in a game of high-stakes poker under circumstances making the game illegal in the\njurisdiction. A owes B $5,000 when A loses. When A does not pay, B sues. Does B get the money? What if\nA had paid B the $5,000 and then sued to get it back?\n3.\n\n[1] Pacific Custom Pools, Inc. v. Turner Construction, 94 Cal. Rptr. 2d 756 (Calif. 2000).\n\n4.\n\n[2] Ransburg v. Haase, 586 N.E. 2d 1295 (Ill. Ct. App. 1992).\n\n12.5 Cases\n\nExtension of Statutory Illegality Based on Public Policy\nBovard v. American Horse Enterprises\n247 Cal. Rptr. 340 (Calif. 1988)\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n425\n\n\x0c[Bovard sued Ralph and American Horse Enterprises (a corporation) to recover on promissory\nnotes that were signed when Ralph purchased the corporation, ostensibly a jewelry-making\nbusiness. The trial court dismissed Bovard\xe2\x80\x99s complaint.]\nPuglia, J.\nThe court found that the corporation predominantly produced paraphernalia used to smoke marijuana\n[roach clips and bongs] and was not engaged significantly in jewelry production, and that Bovard had\nrecovered the corporate machinery through self-help [i.e., he had repossessed it]. The parties do not\nchallenge these findings. The court acknowledged that the manufacture of drug paraphernalia was not\nitself illegal in 1978 when Bovard and Ralph contracted for the sale of American Horse Enterprises, Inc.\nHowever, the court concluded a public policy against the manufacture of drug paraphernalia was implicit\nin the statute making the possession, use and transfer of marijuana unlawful. The trial court held the\nconsideration for the contract was contrary to the policy of express law, and the contract was therefore\nillegal and void. Finally, the court found the parties were in pari delicto [equally at fault] and thus with\nrespect to their contractual dispute should be left as the court found them.\nThe trial court concluded the consideration for the contract was contrary to the policy of the law as\nexpressed in the statute prohibiting the possession, use and transfer of marijuana. Whether a contract is\ncontrary to public policy is a question of law to be determined from the circumstances of the particular\ncase. Here, the critical facts are not in dispute. Whenever a court becomes aware that a contract is illegal,\nit has a duty to refrain from entertaining an action to enforce the contract. Furthermore the court will not\npermit the parties to maintain an action to settle or compromise a claim based on an illegal contract.\xe2\x80\xa6\n[There are several] factors to consider in analyzing whether a contract violates public policy: \xe2\x80\x9cBefore\nlabeling a contract as being contrary to public policy, courts must carefully inquire into the nature of the\nconduct, the extent of public harm which may be involved, and the moral quality of the conduct of the\nparties in light of the prevailing standards of the community [Citations]\xe2\x80\x9d\nThese factors are more comprehensively set out in the Restatement Second of Contracts section 178:\n(1) A promise or other term of an agreement is unenforceable on grounds of public policy if\nlegislation provides that it is unenforceable or the interest in its enforcement is clearly\noutweighed in the circumstances by a public policy against the enforcement of such terms.\n(2) In weighing the interest in the enforcement of a term, account is taken of\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n426\n\n\x0c(a) the parties\xe2\x80\x99 justified expectations,\n(b) any forfeiture that would result if enforcement were denied, and\n(c) any special public interest in the enforcement of the particular term.\n(3) In weighing a public policy against enforcement of a term, account is taken of\n(a) the strength of that policy as manifested by legislation or judicial decisions,\n(b) the likelihood that a refusal to enforce the term will further that policy,\n(c) the seriousness of any misconduct involved and the extent to which it was deliberate, and\n(d) the directness of the connection between that misconduct and the term.\nApplying the Restatement test to the present circumstances, we conclude the interest in enforcing this\ncontract is very tenuous. Neither party was reasonably justified in expecting the government would not\neventually act to geld American Horse Enterprises, a business harnessed to the production of\nparaphernalia used to facilitate the use of an illegal drug. Moreover, although voidance of the contract\nimposed a forfeiture on Bovard, he did recover the corporate machinery, the only assets of the business\nwhich could be used for lawful purposes, i.e., to manufacture jewelry. Thus, the forfeiture was\nsignificantly mitigated if not negligible. Finally, there is no special public interest in the enforcement of\nthis contract, only the general interest in preventing a party to a contract from avoiding a debt.\nOn the other hand, the Restatement factors favoring a public policy against enforcement of this contract\nare very strong. As we have explained, the public policy against manufacturing paraphernalia to facilitate\nthe use of marijuana is strongly implied in the statutory prohibition against the possession, use, etc., of\nmarijuana, a prohibition which dates back at least to 1929.\xe2\x80\xa6Obviously, refusal to enforce the instant\ncontract will further that public policy not only in the present circumstances but by serving notice on\nmanufacturers of drug paraphernalia that they may not resort to the judicial system to protect or advance\ntheir business interests. Moreover, it is immaterial that the business conducted by American Horse\nEnterprises was not expressly prohibited by law when Bovard and Ralph made their agreement since both\nparties knew that the corporation\xe2\x80\x99s products would be used primarily for purposes which were expressly\nillegal. We conclude the trial court correctly declared the contract contrary to the policy of express law and\ntherefore illegal and void.\n\n1.\n\nCASE QUESTIONS\n\nWhy did the court think it was significant that Bovard had repossessed the jewelry-making equipment?\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n427\n\n\x0c2.\n\nWhat did Bovard want in this case?\n\n3.\n\nIf it was not illegal to make bongs and roach clips, why did the court determine that this contract should\nnot be enforced?\n\nUnlicensed Practitioner Cannot Collect Fee\nVenturi & Company v. Pacific Malibu Development Corp.\n172 Cal.App.4th 1417 (Calif. Ct. App. 2009)\nRubin, J.\nIn June 2003, plaintiff Venturi & Company LLC and defendant Pacific Malibu Development Corp. entered\ninto a contract involving development of a high-end resort on undeveloped property on the Bahamian\nisland of Little Exuma. Under the contract, plaintiff agreed to serve as a financial advisor and find\nfinancing for the Little Exuma project.\xe2\x80\xa6[P]laintiff was entitled to some payment under the contract even\nif plaintiff did not secure financing for the project [called a success fee].\nAfter signing the contract, plaintiff contacted more than 60 potential sources of financing for the\nproject.\xe2\x80\xa6[I]n the end, defendants did not receive financing from any source that plaintiff had identified.\nDefendants terminated the contract in January 2005. Two months earlier, however, defendants had\nsigned a [financing agreement] with the Talisker Group. Plaintiff was not involved in defendants\xe2\x80\x99\nnegotiations with the Talisker Group.\xe2\x80\xa6Nevertheless, plaintiff claimed the contract\xe2\x80\x99s provision for a\nsuccess fee entitled plaintiff to compensation following the [agreement]. When defendants refused to pay\nplaintiff\xe2\x80\x99s fee, plaintiff sued defendants for the fee and for the reasonable value of plaintiff\xe2\x80\x99s services.\nDefendants moved for summary judgment. They argued plaintiff had provided the services of a real estate\nbroker by soliciting financing for the Little Exuma project yet did not have a broker\xe2\x80\x99s license. Thus,\ndefendants asserted\xe2\x80\xa6the Business and Professions Code barred plaintiff from receiving any compensation\nas an unlicensed broker.\xe2\x80\xa6Plaintiff opposed summary judgment. It argued that one of its managing\nprincipals, Jane Venturi, had a real estate sales license and was employed by a real estate broker (whom\nplaintiff did not identify) when defendants had signed their term sheet with the Talisker Group, the\ndocument that triggered plaintiff\xe2\x80\x99s right to a fee.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n428\n\n\x0cThe court entered summary judgment for defendants. The court found plaintiff had acted as a real estate\nbroker when working on the Little Exuma project. The court pointed, however, to plaintiff\xe2\x80\x99s lack of\nevidence that Jane Venturi\xe2\x80\x99s unnamed broker had employed or authorized her to work on the\nproject.\xe2\x80\xa6[Summary judgment was issued in favor of defendants, denying plaintiff any recovery.] This\nappeal followed.\nThe court correctly ruled plaintiff could not receive compensation for providing real estate broker services\nto defendants because plaintiff was not a licensed broker. (Section 11136 [broker\xe2\x80\x99s license required to\ncollect compensation for broker services].) But decisions such as Lindenstadt[Citation] establish that the\ncourt erred in denying plaintiff compensation to the extent plaintiff\xe2\x80\x99s services were not those of a real\nestate broker. In Lindenstadt, the parties entered into 25 to 30 written agreements in which the plaintiff\npromised to help the defendant find businesses for possible acquisition. After the plaintiff found a number\nof such businesses, the defendant refused to compensate the plaintiff. The defendant cited the plaintiff\xe2\x80\x99s\nperformance of broker\xe2\x80\x99s services without a license as justifying its refusal to pay. On appeal, the appellate\ncourt rejected the defendant\xe2\x80\x99s sweeping contention that the plaintiff\xe2\x80\x99s unlicensed services\nfor some business opportunities meant the plaintiff could not receive compensation for any business\nopportunity. Rather, the appellate court directed the trial court to examine individually each business\nopportunity to determine whether the plaintiff acted as an unlicensed broker for that transaction or\ninstead provided only services for which it did not need a broker\xe2\x80\x99s license.\nLikewise here, the contract called for plaintiff to provide a range of services, some apparently requiring a\nbroker\xe2\x80\x99s license, others seemingly not. Moreover, and more to the point, plaintiff denied having been\ninvolved in arranging, let alone negotiating, defendants\xe2\x80\x99 placement of Securities with the Talisker Group\nfor which plaintiff claimed a \xe2\x80\x9csuccess fee\xe2\x80\x9d under the contract\xe2\x80\x99s provision awarding it a fee even if it had no\nrole in procuring the financing. Thus, triable issues existed involving the extent to which plaintiff provided\neither unlicensed broker services or, alternatively, non-broker services for which it did not need a license.\n(Accord: [Citation] [severability allowed partial enforcement of personal manager employment contract\nwhen license required for some, but not all, services rendered under the contract].)\n[T]he contract here\xe2\x80\xa6envisioned plaintiff directing its efforts toward many potential sources of financing.\nAs to some of those sources, plaintiff may have crossed the line into performing broker services. But for\nother sources, plaintiff may have provided only financial and marketing advice for which it did not need a\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n429\n\n\x0cbroker\xe2\x80\x99s license. (See, e.g. [Citation] [statute barring unlicensed contractor from receiving fees for some\nservices did not prohibit recovery for work not within scope of licensing statute].) And finally, as to the\nTalisker Group, plaintiff may have provided even less assistance than financial and marketing advice,\ngiven that plaintiff denied involvement with the group. Whether plaintiff crossed the line into providing\nbroker services is thus a triable issue of fact that we cannot resolve on summary judgment.\n\xe2\x80\xa6Plaintiff\xe2\x80\xa6did not have a broker\xe2\x80\x99s license, and therefore was not entitled to compensation for broker\xe2\x80\x99s\nservices. Plaintiff contends it was properly licensed because one of its managers, Jane Venturi, obtained a\nreal estate sales license in February 2004. Thus, she, and plaintiff claims by extension itself, were licensed\nwhen defendants purportedly breached the contract by refusing to pay plaintiff months later for the\nTalisker Group placement. Jane Venturi\xe2\x80\x99s sales license was not, however, sufficient; only a licensed broker\nmay provide broker services. A sales license does not permit its holder to represent another unless the\nsalesperson acts under a broker\xe2\x80\x99s authority.\nThe judgment for defendants is vacated, and the trial court is directed to enter a new order denying\ndefendants\xe2\x80\x99 motion for summary judgment.\xe2\x80\xa6\n\nCASE QUESTIONS\n\n1.\n\nWhy did the plaintiff think it should be entitled to full recovery under the contract, including for services\nrendered as a real estate broker? Why did the court deny that?\n\n2.\n\nEven if the plaintiff were not a real estate broker, why would that mean it could not recover for real\nestate services provided to the defendant?\n\n3.\n\nThe appeals court remanded the case; what did it suggest the plaintiff should recover on retrial?\n\nUnconscionability\nWilliams v. Walker-Thomas Furniture Co.\n350 F.2d 445 (D.C. Ct. App. 1965)\nWright, J.\nAppellee, Walker-Thomas Furniture Company, operates a retail furniture store in the District of\nColumbia. During the period from 1957 to 1962 each appellant in these cases purchased a number of\nhousehold items from Walker-Thomas, for which payment was to be made in installments. The terms of\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n430\n\n\x0ceach purchase were contained in a printed form contract which set forth the value of the purchased item\nand purported to lease the item to appellant for a stipulated monthly rent payment. The contract then\nprovided, in substance, that title would remain in Walker-Thomas until the total of all the monthly\npayments made equaled the stated value of the item, at which time appellants could take title. In the event\nof a default in the payment of any monthly installment, Walker-Thomas could repossess the item.\nThe contract further provided that \xe2\x80\x98the amount of each periodical installment payment to be made by\n(purchaser) to the Company under this present lease shall be inclusive of and not in addition to the\namount of each installment payment to be made by (purchaser) under such prior leases, bills or accounts;\nand all payments now and hereafter made by (purchaser) shall be credited pro rata on all outstanding\nleases, bills and accounts due the Company by (purchaser) at the time each such payment is made.\xe2\x80\x99 The\neffect of this rather obscure provision was to keep a balance due on every item purchased until the balance\ndue on all items, whenever purchased, was liquidated. As a result, the debt incurred at the time of\npurchase of each item was secured by the right to repossess all the items previously purchased by the\nsame purchaser, and each new item purchased automatically became subject to a security interest arising\nout of the previous dealings.\nOn May 12, 1962, appellant Thorne purchased an item described as a daveno, three tables, and two lamps,\nhaving total stated value of $391.11 [about $2,800 in 2011 dollars]. Shortly thereafter, he defaulted on his\nmonthly payments and appellee sought to replevy [repossess] all the items purchased since the first\ntransaction in 1958. Similarly, on April 17, 1962, appellant Williams bought a stereo set of stated value of\n$514.95 [about $3,600 in 2011 dollars]. She too defaulted shortly thereafter, and appellee sought to\nreplevy all the items purchased since December, 1957. The Court of General Sessions granted judgment\nfor appellee. The District of Columbia Court of Appeals affirmed, and we granted appellants\xe2\x80\x99 motion for\nleave to appeal to this court.\nAppellants\xe2\x80\x99 principal contention, rejected by both the trial and the appellate courts below, is that these\ncontracts, or at least some of them, are unconscionable and, hence, not enforceable. [In its opinion the\nlower court said:]\nThe record reveals that prior to the last purchase appellant had reduced the balance in her\naccount to $164. The last purchase, a stereo set, raised the balance due to $678. Significantly, at\nthe time of this and the preceding purchases, appellee was aware of appellant\xe2\x80\x99s financial position.\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n431\n\n\x0cThe reverse side of the stereo contract listed the name of appellant\xe2\x80\x99s social worker and her $218\nmonthly stipend from the government. Nevertheless, with full knowledge that appellant had to\nfeed, clothe and support both herself and seven children on this amount, appellee sold her a $514\nstereo set.\nWe cannot condemn too strongly appellee\xe2\x80\x99s conduct. It raises serious questions of sharp practice\nand irresponsible business dealings. A review of the legislation in the District of Columbia\naffecting retail sales and the pertinent decisions of the highest court in this jurisdiction disclose,\nhowever, no ground upon which this court can declare the contracts in question contrary to\npublic policy. We note that were the Maryland Retail Installment Sales Act\xe2\x80\xa6or its equivalent, in\nforce in the District of Columbia, we could grant appellant appropriate relief. We think Congress\nshould consider corrective legislation to protect the public from such exploitive contracts as were\nutilized in the case at bar.\nWe do not agree that the court lacked the power to refuse enforcement to contracts found to be\nunconscionable. In other jurisdictions, it has been held as a matter of common law that unconscionable\ncontracts are not enforceable. While no decision of this court so holding has been found, the notion that\nan unconscionable bargain should not be given full enforcement is by no means novel.\xe2\x80\xa6\nSince we have never adopted or rejected such a rule, the question here presented is actually one of first\nimpression.\xe2\x80\xa6[W]e hold that where the element of unconscionability is present at the time a contract is\nmade, the contract should not be enforced.\nUnconscionability has generally been recognized to include an absence of meaningful choice on the part of\none of the parties together with contract terms which are unreasonably favorable to the other party.\nWhether a meaningful choice is present in a particular case can only be determined by consideration of all\nthe circumstances surrounding the transaction. In many cases the meaningfulness of the choice is negated\nby a gross inequality of bargaining power. The manner in which the contract was entered is also relevant\nto this consideration. Did each party to the contract, considering his obvious education or lack of it, have a\nreasonable opportunity to understand the terms of the contract, or were the important terms hidden in a\nmaze of fine print and minimized by deceptive sales practices? Ordinarily, one who signs an agreement\nwithout full knowledge of its terms might be held to assume the risk that he has entered a one-sided\nbargain. But when a party of little bargaining power, and hence little real choice, signs a commercially\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n432\n\n\x0cunreasonable contract with little or no knowledge of its terms, it is hardly likely that his consent, or even\nan objective manifestation of his consent, was ever given to all the terms. In such a case the usual rule that\nthe terms of the agreement are not to be questioned should be abandoned and the court should consider\nwhether the terms of the contract are so unfair that enforcement should be withheld.\xe2\x80\xa6\nIn determining reasonableness or fairness, the primary concern must be with the terms of the contract\nconsidered in light of the circumstances existing when the contract was made. The test is not simple, nor\ncan it be mechanically applied. The terms are to be considered \xe2\x80\x98in the light of the general commercial\nbackground and the commercial needs of the particular trade or case.\xe2\x80\x99 Corbin suggests the test as being\nwhether the terms are \xe2\x80\x98so extreme as to appear unconscionable according to the mores and business\npractices of the time and place.\xe2\x80\x99 We think this formulation correctly states the test to be applied in those\ncases where no meaningful choice was exercised upon entering the contract. So ordered.\nDanaher, J. (dissenting):\n[The lower] court\xe2\x80\xa6made no finding that there had actually been sharp practice. Rather the appellant\nseems to have known precisely where she stood.\nThere are many aspects of public policy here involved. What is a luxury to some may seem an outright\nnecessity to others. Is public oversight to be required of the expenditures of relief funds? A washing\nmachine, e.g., in the hands of a relief client might become a fruitful source of income. Many relief clients\nmay well need credit, and certain business establishments will take long chances on the sale of items,\nexpecting their pricing policies will afford a degree of protection commensurate with the risk. Perhaps a\nremedy when necessary will be found within the provisions of the D.C. \xe2\x80\x9cLoan Shark\xe2\x80\x9d law, [Citation].\nI mention such matters only to emphasize the desirability of a cautious approach to any such problem,\nparticularly since the law for so long has allowed parties such great latitude in making their own contracts.\nI dare say there must annually be thousands upon thousands of installment credit transactions in this\njurisdiction, and one can only speculate as to the effect the decision in these cases will have.\n\nCASE QUESTIONS\n\n1.\n\nDid the court here say that cross-collateral contracts are necessarily unconscionable?\n\n2.\n\nWhy is it relevant that the plaintiff had seven children and was on welfare?\n\n3.\n\nWhy did the defendant have a cross-collateral clause in the contract? What would happen if no such\nclauses were allowed?\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n433\n\n\x0c4.\n\nWhat are the elements of unconscionability that the court articulates?\n\n12.6 Summary and Exercises\nSummary\n\nIn general, illegal contracts are unenforceable. The courts must grapple with two types of illegalities: (1)\nstatutory violations and (2) violations of public policy not expressly declared unlawful by statute. The\nformer include gambling contracts, contracts with unlicensed professionals, and Sunday contracts.\nContracts that violate public policy include many types of covenants not to compete. No general rule for\ndetermining their legality can be given, except to say that the more rigid their restrictions against working\nor competing, the less likely they will withstand judicial scrutiny. Other types of agreements that may\nviolate public policy and hence are unenforceable include provisions that waive tort liability and contracts\nthat interfere with family relationships.\nThe exceptions to the rule that illegal agreements will not be enforced and that courts leave the parties\nwhere they are generally involve situations where the hands-off approach would lead to an unfair result:\nwhere the parties are not equally at fault, where one is excusably ignorant or withdraws before\nperformance, or where one is protected by a statute. A court may sometimes divide a contract, enforcing\nthe legal part and not the illegal part.\n\n1.\n\nEXERCISES\n\nHenrioulle was an unemployed widower with two children who received public assistance from the Marin\nCounty (California) Department of Social Services. There was a shortage of housing for low-income\nresidents in Marin County. He entered into a lease agreement on a printed form by which the landlord\ndisclaimed any liability for any injury sustained by the tenants anywhere on the property. Henrioulle\nfractured his wrist when he tripped on a rock on the common stairs in the apartment building. The\nlandlord had been having a hard time keeping the area clean. Is the disclaimer valid? Explain.\n2.\n\nAlbert Bennett, an amateur cyclist, entered a bicycle race sponsored by the United States Cycling\nFederation. He signed a release exculpating the federation for liability: \xe2\x80\x9cI further understand that\nserious accidents occasionally occur during bicycle racing and that participants in bicycle racing\noccasionally sustain mortal or serious personal injuries, and/or property damage, as a\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n434\n\n\x0cconsequence thereof. Knowing the risks of bicycle racing, nevertheless I hereby agree to assume\nthose risks and to release and hold harmless all the persons or entities mentioned above who\n(through negligence or carelessness) might otherwise be liable to me (or my heirs or assigns) for\ndamages.\xe2\x80\x9d\nDuring the race, Bennett was hit by an automobile that had been allowed on the otherwise\nblocked-off street by agents of the defendant. Bennett sued; the trial court dismissed the case on\nsummary judgment. Bennett appealed. What was the decision on appeal?\n3.\n\nRamses owned an industrial supply business. He contracted to sell the business to Tut. Clause VI\nof their Agreement of Sale provided as follows: \xe2\x80\x9cIn further consideration for the purchase, Ramses\nagrees that he shall not compete, either directly or indirectly, in the same business as is conducted\nby the corporation in its established territory.\xe2\x80\x9d\nTwo months after the sale, Ramses opened a competing business across the street from the\nbusiness now owned by Tut, who brought suit, asking the court to close Ramses\xe2\x80\x99s business on the\nbasis of Clause VI. What should the court decide? Why?\n\n4.\n\nAfter taking a business law class at State U, Elke entered into a contract to sell her business law book to a\nclassmate, Matthew, for $45. As part of the same contract, she agreed to prepare a will for Matthew\xe2\x80\x99s\nmother for an additional $110. Elke prepared the will and sent the book to Matthew, but he refused to\npay her. Is she entitled to any payment? Explain.\n\n5.\n\nElmo, a door-to-door salesman, entered into a contract to sell the Wilson family $320 worth of household\nproducts on credit. The Wilsons later learned that Elmo had failed to purchase a city license to make\ndoor-to-door sales and refused to pay him. May Elmo collect from the Wilsons? Why?\n\n6.\n\nGardner purchased from Singer a sewing machine ($700) and three vacuums (about $250 each), one after\nthe other, on Singer\xe2\x80\x99s \xe2\x80\x9c1 to 36 month plan.\xe2\x80\x9d Gardner defaulted after paying a total of $400 on account,\nand Singer sued to repossess all the purchases. Gardner defended by claiming the purchase plan was\nunconscionable and pointed to the Williams case (Section 12.5.3 "Unconscionability") as controlling law\n(that cross-collateral contracts are unconscionable). The trial court ruled for Gardner; Singer appealed.\nWhat was the result on appeal?\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n435\n\n\x0c7.\n\nBlubaugh leased a large farm combine from John Deere Leasing by signing an agreement printed on very\nlightweight paper. The back side of the form was \xe2\x80\x9cwritten in such fine, light print as to be nearly\nillegible.\xe2\x80\xa6The court was required to use a magnifying glass.\xe2\x80\x9d And the wording was \xe2\x80\x9cunreasonably\ncomplex,\xe2\x80\x9d but it contained terms much in John Deere\xe2\x80\x99s favor. When Blubaugh defaulted, John Deere\nrepossessed the combine, sold it for more than he had paid, and sued him for additional sums in\naccordance with the default clauses on the back side of the lease. Blubaugh defended by asserting the\nclauses were unconscionable. Is this a case of procedural, substantive, or no unconscionability? Decide.\n\n8.\n\nSara Hohe, a fifteen-year-old junior at Mission Bay High School in San Diego, was injured during a campus\nhypnotism show sponsored by the PTSA as a fund-raiser for the senior class. Hypnotism shows had been\nheld annually since 1980, and Sara had seen the previous year\xe2\x80\x99s show. She was selected at random from a\ngroup of many volunteers. Her participation in the \xe2\x80\x9cMagic of the Mind Show\xe2\x80\x9d was conditioned on signing\ntwo release forms. Hohe\xe2\x80\x99s father signed a form entitled \xe2\x80\x9cMission Bay High School PTSA Presents Dr. Karl\nSanto.\xe2\x80\x9d Hohe and her father both signed a form titled \xe2\x80\x9cKarl Santo Hypnotist,\xe2\x80\x9d releasing Santo and the\nschool district from all liability. During the course of the show, while apparently hypnotized, Hohe slid\nfrom her chair and also fell to the floor about six times and was injured. She, through her father, then\nsued the school district. The Hohes claimed the release was contrary to public policy; the trial court\ndismissed the suit on summary judgment. Was the release contrary to public policy? Decide.\n\n9.\n\nIn 1963 the Southern Railway Company was disturbed by an order issued by the Interstate Commerce\nCommission, a federal agency, which would adversely affect the firm\xe2\x80\x99s profit by some $13 million [about\n$90 million in 2011 dollars]. Southern hired a lawyer, Robert Troutman, who was a friend of President\nJohn F. Kennedy, to lobby the president that the latter might convince the attorney general, Robert\nKennedy, to back Southern\xe2\x80\x99s position in a lawsuit against the ICC. It worked; Southern won. Southern then\nrefused to pay Troutman\xe2\x80\x99s bill in the amount of $200,000 [about $14 million in 2011 dollars] and moved\nfor summary judgment dismissing Troutman\xe2\x80\x99s claim, asserting\xe2\x80\x94among other things\xe2\x80\x94that contracts\nwhereby one person is hired to use his influence with a public official are illegal bargains. Should\nsummary judgment issue? Decide.\n\n10. Buyer, representing himself to be experienced in timber negotiations, contracted to buy the timber on\nSeller\xe2\x80\x99s land. The first $11,500 would go to Buyer, the next $2,000 would go to Seller, and the rest would\nbe divided fifty-fifty after costs of removal of the timber. Buyer said the timber would be worth $18,000\xe2\x80\x93\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n436\n\n\x0c$20,000. When Seller discovered the timber was in fact worth more than $50,000, he sued, claiming the\ncontract was unconscionable. How should the court rule?\n\nSELF-TEST QUESTIONS\n\n1.\n\nGambling contracts are\na.\n\nalways unenforceable\n\nb.\n\nenforceable if written\n\nc.\n\nin effect enforceable in certain situations involving the sale of securities\n\nd.\n\nalways enforceable when made with insurance companies\nIn State X, plumbers must purchase a license but do not have to pass an examination. This is an\nexample of\n\na.\n\na regulatory license\nb.\n\na revenue license\n\nc.\n\nboth a and b\n\nd.\n\nneither a nor b\n\nA contract to pay a lobbyist to influence a public official is generally illegal.\na.\n\ntrue\nb.\n\nfalse\nExculpatory clauses are sometimes enforceable when they relieve someone from liability for\n\na.\n\nan intentional act\nb.\n\nrecklessness\n\nc.\n\nnegligence\n\nd.\n\nall of the above\n\nAn employee\xe2\x80\x99s promise not to compete with the employer after leaving the company\na.\n\nis never enforceable because it restrains trade\nb.\n\nis always enforceable if in writing\n\nc.\n\nis always enforceable\n\nd.\n\nis enforceable if related to the employer\xe2\x80\x99s property interests\n\nSELF-TEST ANSWERS\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n437\n\n\x0c1.\n\nc\n\n2.\n\nb\n\n3.\n\nb\n\n4.\n\nc\n\n5.\n\nd\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n438\n\n\x0cChapter 13\n\nForm and Meaning\nLEARNING OBJECTIVES\nAfter reading this chapter, you should understand the following:\n1.\n\nWhat kinds of contracts must be evidenced by some writing under the Statute of Frauds, what the\nexceptions to the requirements are, and what satisfies a writing requirement\n\n2.\n\nWhat effect prior or contemporaneous \xe2\x80\x9cside\xe2\x80\x9d agreements have on a written contract\n\n3.\n\nHow a contract is to be interpreted if its meaning is disputed\n\nIn four chapters, we have focused on the question of whether the parties created a valid contract and\nhave examined the requirements of (1) agreement (offer and acceptance), (2) real consent (free will,\nknowledge, and capacity), (3) consideration, and (4) legality. Assuming that these requirements have\nbeen met, we now turn to the form and meaning of the contract itself. Does the contract have to be in\na written form, and\xe2\x80\x94if there is a dispute\xe2\x80\x94what does the contract mean?\n\n13.1 The Statute of Frauds\n\nLEARNING OBJECTIVES\n\n1.\n\nKnow which contracts are required to be evidenced by some writing to be enforceable.\n\n2.\n\nUnderstand the exceptions to that requirement.\n\n3.\n\nRecognize what the writing requirement means.\n\n4.\n\nUnderstand the effect of noncompliance with the Statute of Frauds.\n\nOverview of the Statute of Frauds\nThe general rule is this: a contract need not be in writing to be enforceable. An oral agreement to pay a\nhigh-fashion model $2 million to pose for photographs is as binding as if the language of the deal were\nprinted on vellum and signed in the presence of twenty bishops. For three centuries, however, a large\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n439\n\n\x0cexception grew up around the Statute of Frauds, first enacted in England in 1677 under the formal name\n\xe2\x80\x9cAn Act for the Prevention of Frauds and Perjuries.\xe2\x80\x9d The Statute of Frauds requires that some contracts be\nevidenced by a writing, signed by the party to be bound. The English statute\xe2\x80\x99s two sections dealing with\ncontracts read as follows:\n[Sect. 4]\xe2\x80\xa6no action shall be brought\n1.\n\nwhereby to charge any executor or administrator upon any special promise, to answer damages\nout of his own estate;\n\n2. or whereby to charge the defendant upon any special promise to answer for the debt, default or\nmiscarriages of another person;\n3. or to charge any person upon any agreement made upon consideration of marriage;\n4. or upon any contract or sale of lands, tenements or hereditaments, or any interest in or\nconcerning them;\n5.\n\nor upon any agreement that is not to be performed within the space of one year from the making\nthereof;\nunless the agreement upon which such action shall be brought, or some memorandum or note\nthereof, shall be in writing, and signed by the party to be charged therewith, or some other\nperson thereunto by him lawfully authorized.\n[Sect. 17]\xe2\x80\xa6no contract for the sale of any goods, wares and merchandizes, for the price of ten\npounds sterling or upwards, shall be allowed to be good, except the buyer shall accept part of the\ngoods so sold, and actually receive the same, or give something in earnest to bind the bargain or\nin part of payment, or that some note or memorandum in writing of the said bargain be made\nand signed by the parties to be charged by such contract, or their agents thereunto lawfully\nauthorized.\n\nAs may be evident from the title of the act and its language, the general purpose of the law is to provide\nevidence, in areas of some complexity and importance, that a contract was actually made. To a lesser\ndegree, the law serves to caution those about to enter a contract and \xe2\x80\x9cto create a climate in which parties\noften regard their agreements as tentative until there is a signed writing.\xe2\x80\x9d\n\n[1]\n\nNotice, of course, that this is\n\na statute; it is a legislative intrusion into the common law of contracts. The name of the act is somewhat\nunfortunate: insofar as it deals with fraud at all, it does not deal with fraud as we normally think of it. It\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n440\n\n\x0ctries to avoid the fraud that occurs when one person attempts to impose on another a contract that never\nwas agreed to.\nThe Statute of Frauds has been enacted in form similar to the seventeenth-century act in every state but\nMaryland and New Mexico, where judicial decisions have given it legal effect, and Louisiana. With minor\nexceptions in Minnesota, Wisconsin, North Carolina, and Pennsylvania, the laws all embrace the same\ncategories of contracts that are required to be in writing. Early in the twentieth century, Section 17 was\nreplaced by a section of the Uniform Sales Act, and this in turn has now been replaced by provisions in the\nUniform Commercial Code (UCC).\nFigure 13.1 Contracts Required to Be in Writing\n\nHowever ancient, the Statute of Frauds is alive and well in the United States. Today it is used as a\ntechnical defense in many contract actions, often with unfair results: it can be used by a person to wriggle\nout of an otherwise perfectly fine oral contract (it is said then to be used \xe2\x80\x9cas a sword instead of a shield\xe2\x80\x9d).\nConsequently, courts interpret the law strictly and over the years have enunciated a host of exceptions\xe2\x80\x94\nmaking what appears to be simple quite complex. Indeed, after more than half a century of serious\nscholarly criticism, the British Parliament repealed most of the statute in 1954. As early as 1885, a British\njudge noted that \xe2\x80\x9cin the vast majority of cases [the statute\xe2\x80\x99s] operation is simply to enable a man to break\na promise with impunity because he did not write it down with sufficient formality.\xe2\x80\x9d A proponent of the\nrepeal said on the floor of the House of Commons that \xe2\x80\x9cfuture students of law will, I hope, have their\nlabours lightened by the passage of this measure.\xe2\x80\x9d In the United States, students have no such reprieve\nfrom the Statute of Frauds, to which we now turn for examination.\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n441\n\n\x0cTypes of Contracts Required in Writing and the Exceptions\nPromises to Pay the Debt of Another\nThe rule: a promise to pay the debt of another person must be evidenced by some writing if it is a\n\xe2\x80\x9ccollateral promise of suretyship (or \xe2\x80\x98guaranty\xe2\x80\x99).\xe2\x80\x9d A collateral promise is one secondary or ancillary to\nsome other promise. A surety or guarantor (the terms are essentially synonymous) is one who promises to\nperform upon the default of another. Consider this:\nA and B agree to pay C.\nHere, both A and B are making a direct promise to pay C. Although A is listed first, both are promising to\npay C. Now consider this:\nB agrees to pay C if A does not.\nHere it is clear that there must be another agreement somewhere for A to pay C, but that is not contained\nin this promise. Rather, B is making an agreement with C that is collateral\xe2\x80\x94on the side\xe2\x80\x94to the promise A\nis making to C. Sometimes the other agreement somewhere for A to pay C is actually in the same\ndocument as B\xe2\x80\x99s promise to pay C if A does not. That does not make B\xe2\x80\x99s promise a direct promise as\nopposed to a collateral one.\nSuppose Lydia wishes to purchase on credit a coat at Miss Juliette\xe2\x80\x99s Fine Furs. Juliette thinks Lydia\xe2\x80\x99s\ncreditworthiness is somewhat shaky. So Lydia\xe2\x80\x99s friend Jessica promises Miss Juliette\xe2\x80\x99s that if the store\nwill extend Lydia credit, Jessica will pay whatever balance is due should Lydia default. Jessica is a surety\nfor Lydia, and the agreement is subject to the Statute of Frauds; an oral promise will not be\nenforceable.\n\n[2]\n\nSuppose Jessica very much wants Lydia to have the coat, so she calls the store and says,\n\n\xe2\x80\x9cSend Lydia the fur, and I will pay for it.\xe2\x80\x9d This agreement does not create a suretyship, because Jessica is\nprimarily liable: she is making a direct promise to pay. To fall within the Statute of Frauds, the surety\nmust back the debt of another person to a third-party promisee (also known as the obligee of the principal\ndebtor). The \xe2\x80\x9cdebt,\xe2\x80\x9d incidentally, need not be a money obligation; it can be any contractual duty. If Lydia\nhad promised to work as a cashier on Saturdays at Miss Juliette\xe2\x80\x99s in return for the coat, Jessica could\nbecome surety to that obligation by agreeing to work in Lydia\xe2\x80\x99s place if she failed to show up. Such a\npromise would need to be in writing to be enforceable.\nThe exception: the main purpose doctrine. The main purpose doctrine is a major exception to the surety\nprovision of the Statute of Frauds. It holds that if the promisor\xe2\x80\x99s principal reason for acting as surety is to\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n442\n\n\x0csecure her own economic advantage, then the agreement is not bound by the Statute of Frauds writing\nrequirement. Suppose, in the previous example, that Jessica is really the one who wants the fur coat but\ncannot, for reasons of prudence, let it be known that she has bought one. So she proposes that Lydia \xe2\x80\x9cbuy\xe2\x80\x9d\nit for her and that she will guarantee Lydia\xe2\x80\x99s payments. Since the main purpose of Jessica\xe2\x80\x99s promise is to\nadvance her own interests, an oral agreement is binding. Normally, the main purpose rule comes into play\nwhen the surety desires a financial advantage to herself that cannot occur unless she provides some\nsecurity. For example, the board chairman of a small company, who also owns all the voting stock, might\nguarantee a printer that if his company defaulted in paying the bill for desperately needed catalogs, he\nwould personally pay the bill. If his main purpose in giving the guarantee was to get the catalogues printed\nin order to stave off bankruptcy, and thus to preserve his own interest in the company, he would be bound\nby an oral agreement.\n\n[3]\n\nThe same principle can be used to bind other creditors to oral agreements, as the\n\nbank discovered in Section 13.4.1 "The Statute of Frauds\xe2\x80\x99 Main Purpose Doctrine"(Wilson Floors).\n\nAgreements of Executor or Administrator\nThe rule: the promise by an executor or administrator of an estate to answer personally for the debt or\nother duty of the deceased is analogous to the surety provision\xe2\x80\x94it must be evidenced by some writing if it\nis to be enforced over an objection by the would-be obligor. For an agreement to be covered by the statute,\nthere must have been an obligation before the decedent\xe2\x80\x99s death. Thus if the executor arranges for a\nfuneral and guarantees payment should the estate fail to pay the fee, an oral contract is binding, because\nthere was no preexisting obligation. If, however, the decedent has made his own arrangements and signed\na note obligating his estate to pay, the executor\xe2\x80\x99s promise to guarantee payment would be binding only if\nwritten.\nThe exception: the main purpose exception to the surety provision applies to this section of the Statute\nof Frauds as well as to the \xe2\x80\x9cpromises to pay the debts of another\xe2\x80\x9d section, noted earlier.\n\nThe Marriage Provision\nThe rule: if any part of the marriage or the promise to marry consists also of a promise to exchange some\nconsideration, the Statute of Frauds requires that part to be evidenced by some writing.\n\n[4]\n\nMutual\n\npromises to marry are not within the rule. John and Sally exchange promises to marry; the promise would\nnot be unenforceable for failure to be evidenced by some writing. (Of course courts are very unlikely to\nforce anybody to keep a promise to marry; the point is, the Statute of Frauds doesn\xe2\x80\x99t apply). But if Sally\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n443\n\n\x0cunderstands John to say, \xe2\x80\x9cIf you marry me, I will deed to you my property in the Catskill Mountains,\xe2\x80\x9d the\npart about the property would need to be evidenced by some writing to be enforced over John\xe2\x80\x99s denial.\nThe Statute of Frauds governs such promises regardless of who makes them. Suppose John\xe2\x80\x99s father had\nsaid, \xe2\x80\x9cIf you marry Sally and settle down, I will give you $1 million,\xe2\x80\x9d and John agrees and marries Sally.\nThe father\xe2\x80\x99s promise is not enforceable unless written, if he denies it.\nSometimes couples\xe2\x80\x94especially rich people like movie stars\xe2\x80\x94execute written property settlement\nagreements to satisfy the statute, stipulating how their assets will be treated upon marriage or upon\ndivorce or death. If done before marriage, they are called prenuptial (premarital) agreements; if after\nmarriage, postnuptial (after marriage) agreements (\xe2\x80\x9cprenupts\xe2\x80\x9d and \xe2\x80\x9cpostnupts\xe2\x80\x9d in lawyer lingo).\nThe exception: there is no \xe2\x80\x9cnamed\xe2\x80\x9d exception here, but courts are free to make equitable adjustments of\nproperty of the marriage to avoid an injustice.\nThe factors to be considered in the division of the marital estate are set forth at [Citation], which\nstates, inter alia [among other things], that the court shall finally and equitably apportion the\nproperty of the parties, however and whenever acquired. The statute vests wide discretion in the\ndistrict court. [Citation]. The court is free to adopt any reasonable valuation of marital property\nwhich is supported by the record.\n\n[5]\n\nContracts Affecting an Interest in Real Estate\nThe rule: almost all contracts involving an interest in real estate are subject to the Statute of Frauds. \xe2\x80\x9cAn\ninterest in land\xe2\x80\x9d is a broad description, including the sale, mortgaging, and leasing of real property\n(including homes and buildings); profits from the land; the creation of easements; and the establishment\nof other interests through restrictive covenants and agreements concerning use. Short-term leases, usually\nfor a term of one year or less, are exempt from the provision.\nThe exception: the part performance doctrine. The name here is a misnomer, because it is a doctrine of\nreliance, and the acts taken in reliance on the contract are not necessarily partial performances under it.\nAs in all such cases, the rationale is that it is unjust not to give the promisee specific performance if he or\nshe acted in reasonable reliance on the contract and the promisor has continued to manifest assent to its\nterms. An oral contract to sell land is not binding simply because the buyer has paid the purchase price;\npayment is not by itself reliance, and if the seller refuses to transfer title, the buyer may recover the\npurchase price. However, if the buyer has taken possession and made improvements on the property,\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n444\n\n\x0ccourts will usually say the case is out of the statute, and the party claiming an oral contract can attempt to\nprove the existence of the oral contract.\n\nThe One-Year Rule\nThe rule: any agreement that cannot be performed within one year from its making must be evidenced\nby some writing to be enforceable. The purpose of this part is perhaps more obvious than most of the\nstatute\xe2\x80\x99s provisions: memories fade regarding the terms of oral contracts made long ago; people die;\ndisputes are not uncommon. Notice the critical time frame is not how long it will take to perform the\ncontract, but how long from the time it is made until performance is complete. If a contract is made on\nJanuary 1 for a house to be constructed starting on June 1 and to be completed on February 1 of the next\nyear, the performance will be completed in eight months from the time it was begun, but thirteen months\nfrom the time the contract was made. It falls within the statute.\nThe exception: the possibility test. The statute\xe2\x80\x99s one-year rule has been universally interpreted to mean\na contract that is impossible to be fully performed within one year; if there is even the slightest chance of\ncarrying out the agreement completely within the year, an oral contract is enforceable. Thus an oral\nagreement to pay a sum of money on a date thirteen months hence is within the statute and not\nenforceable, but one calling for payment \xe2\x80\x9cwithin thirteen months\xe2\x80\x9d would be enforceable, since it is\npossible under the latter contract to pay in less than a year. Because in many cases strict application of the\nstatute would dictate harsh results, the courts often strain for an interpretation that finds it possible to\nperform the agreement within the year. Courts will even hold that because any person may die within the\nyear, a contract without a fixed term may be fully performed in under a year and does not, therefore, fall\nwithin the statute.\n\nUnder the UCC\nThe rule: contracts for the sale of goods in an amount greater than $500 must be evidenced by some\nwriting to be enforceable. Section 2-201 of the UCC requires all contracts for the sale of goods for the price\nof $500 or more to be in writing, but oral agreements for the sale of goods valued at less than $500 are\nfully enforceable without exception.\n\nOther Writing Requirements\nIn addition to these requirements, the UCC provides that agreements for the sale of securities (e.g., most\nstocks and bonds) usually need to be evidenced by a writing, and agreements for property not included in\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n445\n\n\x0c[6]\n\nthe sales or securities articles of the UCC that exceed $5,000 in value need to be so evidenced. Included\nhere would be intangible property such as rights to royalties and to mortgage payments, and other rights\ncreated by contract. And in many states, other statutes require a writing for several different kinds of\ncontracts. These include agreements to pay commissions to real estate brokers, to make a will, to pay\ndebts already discharged in bankruptcy, to arbitrate rather than litigate, to make loans, and to make\ninstallment contracts.\n\nExceptions under the UCC\nThere are four exceptions to the UCC\xe2\x80\x99s Statute of Frauds requirement that are relevant here.\n\nThe Ten-Day-Reply Doctrine\nThis provides that, as between merchants, if an oral agreement is reached and one party sends the other a\nwritten statement confirming it, the other party has ten days to object in writing or the agreement is\nenforceable.\n\n[7]\n\n\xe2\x80\x9cSpecially Manufactured Goods\xe2\x80\x9d\nThis exception provides that a seller who has manufactured goods to the buyer\xe2\x80\x99s specifications or who has\nmade \xe2\x80\x9ceither a substantial beginning of their manufacture or commitments for their procurement\xe2\x80\x9d will\nnot be stuck if the buyer repudiates, assuming that the goods are unsuitable for sale to others.\n\n[8]\n\nThe \xe2\x80\x9cAdmission\xe2\x80\x9d Exception\nThis exception arises\xe2\x80\x94reasonably enough\xe2\x80\x94when the party against whom enforcement is sought admits in\ntestimony or legal papers that a contract was in fact made.\n\n[9]\n\nHowever, the admission will not permit\n\nenforcement of all claimed terms of the contract; enforcement is limited to the quantity of goods\nadmitted.\n\nThe \xe2\x80\x9cPayment or Delivery and Acceptance\xe2\x80\x9d Exception\nThe UCC provides that an oral contract for goods in excess of $500 will be upheld if payment has already\nbeen made and accepted, or if the goods have been received and accepted.\n\n[10]\n\nSufficiency of the Required Writing\nAt Common Law\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n446\n\n\x0cWe have been careful not to say \xe2\x80\x9cthe contract needs to be in writing.\xe2\x80\x9d We have said, \xe2\x80\x9ca contractual\nintention must be evidenced by some writing, signed by the party to be bound.\xe2\x80\x9d A signed contract is not\nrequired. What is required in most states, following the wording of the original statute, is that there be at\nleast some memorandum or note concerning the agreement\xe2\x80\x94a logical consequence of the statute\xe2\x80\x99s\npurpose to evidence the making of the contract. The words need not appear in a formal document; they\nare sufficient in any form in a will, or on a check or receipt, or in longhand on the back of an envelope\xe2\x80\x94so\nlong as the document is signed by the party to be charged (i.e., the party being sued on the contract).\nAlthough the writing need not contain every term, it must recite the subject matter of the contract. It need\nnot do so, however, in terms comprehensible to those who were not party to the negotiations; it is enough\nif it is understandable in context. A written agreement to buy a parcel of land is usually sufficiently\ndefinitive if it refers to the parcel in such a way that it could be mistaken for no other\xe2\x80\x94for example,\n\xe2\x80\x9cseller\xe2\x80\x99s land in Tuscaloosa,\xe2\x80\x9d assuming that the seller owned only one parcel there. Beyond the subject\nmatter, the essential terms of promises to be performed must be written out; all details need not be. If an\nessential term is missing, it cannot be enforced, unless it can be inferred or imposed by rule of law. A\nwritten contract for the sale of land containing every term but the time for payment, which the parties\norally agreed would be upon delivery of the deed, is sufficient. (A contract that omitted the selling price\nwould not be.)\nThe parties must be named in the writing in a manner sufficient to identify them. Their whole names need\nnot be given if initials or some other reference makes it inescapable that the writing does concern the\nactual parties. Reference to the agent of a party identifies the party. Possession of the writing may even be\nsufficient: if a seller gives a memorandum of an oral agreement for the sale of his land, stating all the\nterms, to the buyer, the latter may seek specific performance even though the writing omits to name or\ndescribe him or his agent.\n\n[11]\n\nIn a few states, consideration for the promise must be stated in writing, even if the consideration has\nalready been given. Consequently, written contracts frequently contain such language as \xe2\x80\x9cfor value\nreceived.\xe2\x80\x9d But in most states, failure to refer to consideration already given is unnecessary: \xe2\x80\x9cthe prevailing\nview is that error or omission in the recital of past events does not affect the sufficiency of a\nmemorandum.\xe2\x80\x9d\n\n[12]\n\nThe situation is different, however, when the consideration is a return promise yet to\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n447\n\n\x0cbe performed. Usually the return promise is an essential term of the agreement, and failure to state it will\nvitiate the writing.\n\nUnder the UCC\nIn contracts for the sale of goods, the writing must be signed by the party to be charged, and the parties\nmust be sufficiently identified.\n\n[13]\n\nBut consideration, including the selling price, need not be set forth for\n\nthe memorandum to meet the requirements of the UCC (\xe2\x80\x9ca writing is not insufficient because it omits or\nincorrectly states a term agreed upon\xe2\x80\x9d), though obviously it makes sense to do so whenever possible. By\ncontrast, UCC Sections 1-206 and 3-319 concerning intangible personal property and investment\nsecurities require \xe2\x80\x9ca defined or stated price.\xe2\x80\x9d\n\nElectronic Communications\nOne of the primary purposes of the Electronic Signatures in Global and National Commerce Act, S. 761,\npopularly referred to as ESign, is to repeal state law requirements for written instruments as they apply to\nelectronic agreements and to make almost anything reasonably indicative of a signature good enough\nelectronically.\n\n[14]\n\nIt provides the following:\n\nNotwithstanding any statute, regulation, or other rule of law [other than subsequent parts of this\nsame statute], with respect to any transactions in or affecting interstate or foreign commerce\xe2\x80\x94\n1.\n\na signature, contract, or other record relating to such transaction may not be denied legal effect,\nvalidity or enforceability solely because it is in electronic form; and\n\n2. a contract relating to such transaction may not be denied legal effect, validity or enforceability\nsolely because an electronic signature or electronic record was used in its formation.\xe2\x80\xa6\nThe term \xe2\x80\x9ctransaction\xe2\x80\x9d means an action or set of actions relating to the conduct of a business,\nconsumer or commercial affairs between two or more persons, including any of the following\ntypes of conduct\xe2\x80\x94\n1.\n\nthe sale, lease, exchange, or other disposition of [personal property and intangibles]\n\n2. the sale, lease, exchange or other disposition of any interest in real property, or any combination\nthereof.\nThe term \xe2\x80\x9celectronic signature\xe2\x80\x9d means an electronic sound, symbol, or process, attached to or\nlogically associated with a contract or other record and executed or adopted by a person with the\nintent to sign the record.\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n448\n\n\x0cEffect of Noncompliance and Exceptions; Oral Rescission\nThe basic rule is that contracts governed by the Statute of Frauds are unenforceable if they are not\nsufficiently written down. If the agreement contains several promises, the unenforceability of one will\ngenerally render the others unenforceable also.\nThe Statute of Frauds can work injustices. In addition to the exceptions already noted, there are some\ngeneral exceptions.\n\nFull Performance\nFirst, certainly, if the contract has been performed fully by both sides, its unenforceability under the\nstatute is moot. Having fulfilled its function (neither side having repudiated the contract), the agreement\ncannot be rescinded on the ground that it should have been, but was not, reduced to writing.\n\nDetrimental Reliance\nSecond, some relief may be granted to one who has relied on an oral contract to her detriment (similar to\nthe part performance doctrine mentioned already). For a partially performed contract unenforceable\nunder the Statute of Frauds, restitution may be available. Suppose George agrees orally to landscape\nArthur\xe2\x80\x99s fifteen acres, in return for which George is to receive title to one acre at the far end of the lot.\nGeorge is not entitled to the acre if Arthur defaults, but he may recover for the reasonable value of the\nservices he has performed up to the time of repudiation. Somewhat related, if one side has reasonably and\nforeseeably relied upon a promise in such a way that injustice can only be avoided by enforcing it, some\ncourts will use promissory estoppel to preclude the necessity of a writing, but the connection between the\nalleged oral contract and the detrimental reliance must be convincing.\n\nOral Rescission\nThird, most contracts required to be in writing may be rescinded orally. The new agreement is treated in\neffect as a modification of the old one, and since a complete rescission will not usually trigger any action\nthe statute requires to be in writing, the rescission becomes effective in the absence of any signed\nmemorandum.\nSome agreements, however, may not be rescinded orally. Those that by their terms preclude oral\nrescission are an obvious class. Under the UCC, certain agreements for the sale of goods may not be orally\nrescinded, depending on the circumstances. For instance, if title has already passed to the buyer under a\nwritten agreement that satisfies the statute, the contract can be rescinded only by a writing. Contracts for\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n449\n\n\x0cthe sale of land are another class of agreements that generally may not be orally rescinded. If title has\nalready been transferred, or if there has been a material change of position in reliance on the contract,\noral agreements to rescind are unenforceable. But a contract that remains wholly executory, even though\nenforceable because in writing, may be rescinded orally in most states.\n\nContract Modification\nFourth, contracts governed by the Statute of Frauds may be modified orally if the resulting contract, taken\nas a whole, falls outside the statute. The same rule applies under the UCC.\n\n[15]\n\nThus a written contract for\n\nthe sale of a new bicycle worth $1,200 may be orally modified by substituting the sale of a used bicycle\nworth $450, but not by substituting the sale of a used bike worth $600. The modified contract effectively\nrescinds the original contract.\n\nKEY TAKEAWAY\n\nThe Statute of Frauds, an ancient legislative intrusion into common-law contracts, requires that certain\ncontracts be evidenced by some writing, signed by the party to be bound, to be enforceable. Among those\naffected by the statute are contracts for an interest in real estate, contracts that by their terms cannot be\nperformed within one year, contracts whereby one person agrees to pay the debt of another, contracts\ninvolving the exchange of consideration upon promise to marry (except mutual promises to marry), and,\nunder the UCC, contracts in an amount greater than $500. For each contract affected by the statute, there\nare various exceptions intended to prevent the statute from being used to avoid oral contracts when it is\nvery likely such were in fact made.\nThe writing need not be a contract; anything in writing, signed by the person to be bound, showing\nadequate contractual intention will take the matter out of the statute and allow a party to attempt to\nshow the existence of the oral contract.\nThere may be relief under restitution or promissory estoppel. Contracts affected by the statute can usually\nbe orally rescinded. Any contract can be modified or rescinded; if the new oral contract as modified does\nnot fall within the statute, the statute does not apply.\n\nEXERCISES\n\n1.\n\nWhat is the purpose of the Statute of Frauds?\n\n2.\n\nWhat common-law contracts are affected by it, and what are the exceptions?\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n450\n\n\x0c3.\n\nHow does the UCC deal with the Statute of Frauds?\n\n4.\n\nHow is the requirement of the statute satisfied?\n\n5.\n\nContracts can always be modified. How does the Statute of Frauds play with contract modification?\n6.\n\n[1] Restatement (Second) of Contracts, Chapter 5 "Administrative Law", statutory note.\n\n7.\n\n[2] Of course, if Jessica really did orally promise Miss Juliette\xe2\x80\x99s to pay in case Lydia didn\xe2\x80\x99t, it would be bad\nfaith to lie about it. The proper course for Jessica is not to say, \xe2\x80\x9cHa, ha, I promised, but it was only oral, so\nI\xe2\x80\x99m not bound.\xe2\x80\x9d Jessica should say, \xe2\x80\x9cI raise the Statute of Frauds as a defense.\xe2\x80\x9d\n\n8.\n\n[3] Stuart Studio, Inc. v. National School of Heavy Equipment, Inc., 214 S.E.2d 192 (N.C. 1975).\n\n9.\n\n[4] Restatement (Second) of Contracts, Section 125.\n\n10. [5] In re Marriage of Rada, 402, 869 P.2d 254 (Mont. 1994).\n11. [6] Uniform Commercial Code, Sections 8-319 and 1-206.\n12. [7] Uniform Commercial Code, Section 2-201(2).\n13. [8] Uniform Commercial Code, Section 2-201(3)(a).\n14. [9] Uniform Commercial Code, Section 2-201(3)(b).\n15. [10] Uniform Commercial Code, Section 2-20l(3)(c).\n16. [11] Restatement (Second) of Contracts, Section 207(f).\n17. [12] Restatement (Second) of Contracts, Section 207(h).\n18. [13] Uniform Commercial Code, Section 2-210(1).\n19. [14] Electronic Signatures in Global and National Commerce Act, 15 U.S.C. \xc2\xa7 96, 106th Congress (2000).\n20. [15] Uniform Commercial Code, Section 2-209(3).\n\n13.2 The Parol Evidence Rule\n\nLEARNING OBJECTIVES\n\n1.\n\nUnderstand the purpose and operation of the parol evidence rule, including when it applies and when it\ndoes not.\n\n2.\n\nKnow how the Uniform Commercial Code (UCC) deals with evidence to show a contract\xe2\x80\x99s meaning.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n451\n\n\x0cThe Purpose of the Rule\nUnlike Minerva sprung forth whole from the brow of Zeus in Greek mythology, contracts do not appear at\na stroke memorialized on paper. Almost invariably, negotiations of some sort precede the concluding of a\ndeal. People write letters, talk by telephone, meet face-to-face, send e-mails, and exchange thoughts and\nviews about what they want and how they will reciprocate. They may even lie and cajole in duplicitous\nways, making promises they know they cannot or will not keep in order not to kill the contract talks. In\nthe course of these discussions, they may reach tentative agreements, some of which will ultimately be\nreflected in the final contract, some of which will be discarded along the way, and some of which perhaps\nwill not be included in the final agreement but will nevertheless not be contradicted by it. Whether any\nweight should be given to these prior agreements is a problem that frequently arises.\n\nParol Evidence at Common-Law\nThe Rule\nThe rule at common law is this: a written contract intended to be the parties\xe2\x80\x99 complete understanding\ndischarges all prior or contemporaneous promises, statements, or agreements that add to, vary, or conflict\nwith it.\nThe parol evidence rule (parol means oral; it is related to parliament and parly\xe2\x80\x94talking) is a substantive\nrule of law that operates to bar the introduction of evidence intended to show that the parties had agreed\nto something different from what they finally arrived at and wrote down. It applies to prior written as well\nas oral discussions that don\xe2\x80\x99t make it into the final written agreement. Though its many apparent\nexceptions make the rule seem difficult to apply, its purposes are simple: to give freedom to the parties to\nnegotiate without fear of being held to the consequences of asserting preliminary positions, and to give\nfinality to the contract.\nThe rule applies to all written contracts, whether or not the Statute of Frauds requires them to be in\nwriting. The Statute of Frauds gets to whether there was a contract at all; the parol evidence rule says,\ngranted there was a written contract, does it express the parties\xe2\x80\x99 understanding? But the rule is concerned\nonly with events that transpired before the contract in dispute was signed. It has no bearing on\nagreements reached subsequently that may alter the terms of an existing contract.\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n452\n\n\x0cThe Exemptions and Exceptions\nDespite its apparent stringency, the parol evidence rule does not negate all prior agreements or\nstatements, nor preclude their use as evidence. A number of situations fall outside the scope of the rule\nand hence are not technically exceptions to it, so they are better phrased as exemptions (something not\nwithin the scope of a rule).\n\nNot an Integrated Contract\nIf the parties never intended the written contract to be their full understanding\xe2\x80\x94if they intended it to be\npartly oral\xe2\x80\x94then the rule does not apply. If the document is fully integrated, no extrinsic evidence will be\npermitted to modify the terms of the agreement, even if the modification is in addition to the existing\nterms, rather than a contradiction of them. If the contract is partially integrated, prior consistent\nadditional terms may be shown. It is the duty of the party who wants to exclude the parol evidence to\nshow the contract was intended to be integrated. That is not always an easy task. To prevent a party later\nfrom introducing extrinsic evidence to show that there were prior agreements, the contract itself can\nrecite that there were none. Here, for example, is the final clause in the National Basketball Association\nUniform Player Contract: \xe2\x80\x9cThis agreement contains the entire agreement between the parties and there\nare no oral or written inducements, promises or agreements except as contained herein.\xe2\x80\x9d Such a clause is\nknown as a merger clause.\n\nVoid or Voidable Contracts\nParol evidence is admissible to show the existence of grounds that would cause the contract to be void.\nSuch grounds include illegality, fraud, duress, mistake, and lack of consideration. And parol evidence is\nallowed to show evidence of lack of contractual capacity. Evidence of infancy, incompetency, and so on\nwould not change the terms of the contract at all but would show it was voidable or void.\n\nContracts Subject to a Condition Precedent\nWhen the parties orally agree that a written contract is contingent on the occurrence of an event or some\nother condition (a condition precedent), the contract is not integrated and the oral agreement may be\nintroduced. The classic case is that of an inventor who sells in a written contract an interest in his\ninvention. Orally, the inventor and the buyer agree that the contract is to take effect only if the buyer\xe2\x80\x99s\nengineer approves the invention. (The contract was signed in advance of approval so that the parties\nwould not need to meet again.) The engineer did not approve it, and in a suit for performance, the court\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n453\n\n\x0cpermitted the evidence of the oral agreement because it showed \xe2\x80\x9cthat in fact there never was any\nagreement at all.\xe2\x80\x9d\n\n[1]\n\nNote that the oral condition does not contradict a term of the written contract; it\n\nnegates it. The parol evidence rule will not permit evidence of an oral agreement that is inconsistent with\na written term, for as to that term the contract is integrated.\n\nUntrue Recital or Errors\nThe parol evidence rule does not prevent a showing that a fact stated in a contract is untrue. The rule\ndeals with prior agreements; it cannot serve to choke off inquiry into the facts. Thus the parol evidence\nrule will not bar a showing that one of the parties is a minor, even if the contract recites that each party is\nover eighteen. Nor will it prevent a showing that a figure in the contract had a typographical error\xe2\x80\x94for\nexample, a recital that the rate charged will be the plumber\xe2\x80\x99s \xe2\x80\x9cusual rate of $3 per hour\xe2\x80\x9d when both parties\nunderstood that the usual rate was in fact $30 per hour. A court would allow reformation(correction) of\nsuch errors.\n\nAmbiguity\nTo enforce a contract, its terms must be understood, so parol evidence would be allowed, but a claim of\nambiguity cannot be used to alter, vary, or change the contract\xe2\x80\x99s meaning.\n\nPostcontract Modification\nOrdinarily, an additional consistent oral term may be shown only if the contract was partially integrated.\nThe parol evidence rule bars evidence of such a term if the contract was fully integrated. However, when\nthere is additional consideration for the term orally agreed, it lies outside the scope of the\nintegrated contract and may be introduced. In effect, the law treats each separate consideration as\ncreating a new contract; the integrated written document does not undercut the separate oral agreement,\nas long as they are consistent. Buyer purchases Seller\xe2\x80\x99s business on a contract; as part of the agreement,\nSeller agrees to stay on for three weeks to help Buyer \xe2\x80\x9clearn the ropes.\xe2\x80\x9d Buyer realizes she is not yet\nprepared to go on her own. She and Seller then agree that Seller will stay on as a salaried employee for five\nmore weeks. Buyer cannot use the parol evidence rule to preclude evidence of the new agreement: it is a\npostcontract modification supported by new consideration. Similarly, parties could choose to rescind a\npreviously made contract, and the parol evidence rule would not bar evidence of that.\n\nThe UCC Approach\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n454\n\n\x0cUnder Section 2-202 of the UCC, a course of dealing, a usage of trade, or a course of performance can be\nintroduced as evidence to explain or supplement any written contract for the sale of goods.\nA course of dealing is defined as \xe2\x80\x9ca sequence of previous conduct between the parties to a particular\ntransaction which is fairly to be regarded as establishing a common basis of understanding for\ninterpreting their expressions and other conduct.\xe2\x80\x9d A usage of trade is \xe2\x80\x9cany practice or method of dealing\nhaving such regularity of observance in a place, vocation or trade as to justify an expectation that it will be\nobserved with respect to the transaction in question.\xe2\x80\x9d A course of performance is the conduct of a party in\nresponse to a contract that calls for repeated action (e.g., a purchase agreement for a factory\xe2\x80\x99s monthly\noutput, or an undertaking to wash a neighbor\xe2\x80\x99s car weekly).\n\nKEY TAKEAWAY\n\nThe parol evidence rule is intended to preserve \xe2\x80\x9cthe four corners\xe2\x80\x9d of the contract: it generally prohibits\nthe introduction of contemporaneous oral or written elements of negotiation that did not get included in\nthe written contract, subject to a number of exemptions.\nThe UCC allows evidence of course of dealing, course of performance, or usage of trade to give meaning to\nthe contract.\n\nEXERCISES\n\n1.\n\nWhat is the purpose of the parol evidence rule?\n\n2.\n\nHow does it operate to crystallize the intention of the contracting parties?\n\n3.\n\nTo what kinds of contract issues does the rule not apply?\n\n4.\n\nWhat \xe2\x80\x9chelp\xe2\x80\x9d does the UCC give to fleshing out the parties\xe2\x80\x99 contractual understanding?\n\n[1] Pym v. Campbell, 119 Eng. Rep. 903 (Q.B. 1856).\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n455\n\n\x0c13.3 Interpretation of Agreements: Practicalities versus\nLegalities\nLEARNING OBJECTIVES\n\n1.\n\nUnderstand the purpose of contractual interpretation.\n\n2.\n\nKnow the tools courts use to interpret contracts.\n\n3.\n\nRecognize that in everyday life, businesspeople tolerate oral contracts or poorly written ones, but a\nwriting remains useful.\n\nThe General Problem and the Purpose of Contractual Interpretation\nThe General Problem\nAs any reader knows, the meaning of words depends in part on context and in part on the skill and care of\nthe writer. As Justice Oliver Wendell Holmes Jr. once succinctly noted, \xe2\x80\x9cA word is not a crystal,\ntransparent and unchanged; it is the skin of a living thought and may vary greatly in color and content\naccording to the circumstances and the time in which it is used.\xe2\x80\x9d\n\n[1]\n\nWords and phrases can be ambiguous,\n\neither when they stand alone or when they take on a different coloration from words and phrases near\nthem. A writer can be careless and contradict himself without intending to; people often read hurriedly\nand easily miss errors that a more deliberate perusal might catch. Interpretation difficulties can arise for\nany of a number of reasons: a form contract might contain language that is inconsistent with provisions\nspecifically annexed; the parties might use jargon that is unclear; they might forget to incorporate a\nnecessary term; assumptions about prior usage or performance, unknown to outsiders like judges, might\ncolor their understanding of the words they do use. Because ambiguities do arise, courts are frequently\ncalled on to give content to the words on paper.\n\nThe Basic Rule of Interpretation\nCourts attempt to give meaning to the parties\xe2\x80\x99 understanding when they wrote the contract.\nThe intention of the parties governs, and if their purpose in making the contract is known or can be\nascertained from all the circumstances, it will be given great weight in determining the meaning of an\nobscure, murky, or ambiguous provision or a pattern of conduct. A father tells the college bookstore that\nin consideration of its supplying his daughter, a freshman, with books for the coming year, he will\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n456\n\n\x0cguarantee payment of up to $350. His daughter purchases books totaling $400 the first semester, and he\npays the bill. Midway through the second semester, the bookstore presents him with a bill for an\nadditional $100, and he pays that. At the end of the year, he refuses to pay a third bill for $150. A court\ncould construe his conduct as indicating a purpose to ensure that his daughter had whatever books she\nneeded, regardless of cost, and interpret the contract to hold him liable for the final bill.\n\nTools of Interpretation\nThe policy of uncovering purpose has led to a number of tools of judicial interpretation:\n\xe2\x80\xa2\n\nMore specific terms or conduct are given more weight than general terms or unremarkable conduct.\nThus a clause that is separately negotiated and added to a contract will be counted as more significant\nthan a standard term in a form contract.\n\n\xe2\x80\xa2\n\nA writing is interpreted as a whole, without undue attention to one clause.\n\n\xe2\x80\xa2\n\nCommon words and terms are given common meaning; technical terms are given their technical\nmeaning.\n\n\xe2\x80\xa2\n\nIn the range of language and conduct that helps in interpretation, the courts prefer the following\nitems in the order listed: express terms, course of performance, course of dealing, and usage of trade.\n\n\xe2\x80\xa2\n\nIf an amount is given in words and figures that differ, the words control.\n\n\xe2\x80\xa2\n\nWriting controls over typing; typing controls over printed forms.\n\n\xe2\x80\xa2\n\nAmbiguities are construed against the party that wrote the contract.\n\nIn this chapter, we have considered a set of generally technical legal rules that spell out the consequences\nof contracts that are wholly or partially oral or that, if written, are ambiguous or do not contain every term\nagreed upon. These rules fall within three general headings: the Statute of Frauds, the parol evidence rule,\nand the rules of interpretation. Obviously, the more attention paid to the contract before it is formally\nagreed to, the fewer the unforeseen consequences. In general, the conclusion is inescapable that a written\ncontract will avoid a host of problems. Writing down an agreement is not always sensible or practical, but\nit can probably be done more often than it is. Writing almost fifty years ago\xe2\x80\x94and it is still true\xe2\x80\x94a law\nprofessor studying business practices noted the following:\nBusinessmen often prefer to rely on \xe2\x80\x9ca man\xe2\x80\x99s word\xe2\x80\x9d in a brief letter, a handshake or \xe2\x80\x9ccommon\nhonesty and decency\xe2\x80\x9d\xe2\x80\x94even when the transaction involves exposure to serious risks. Seven\nlawyers from law firms with business practices were interviewed. Five thought that businessmen\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n457\n\n\x0coften entered contracts with only a minimal degree of advanced planning. They complained that\nbusinessmen desire to \xe2\x80\x9ckeep it simple and avoid red tape\xe2\x80\x9d even where large amounts of money\nand significant risks are involved.\xe2\x80\xa6Another said that businessmen when bargaining often talk\nonly in pleasant generalities, think they have a contract, but fail to reach agreement on any of the\nhard, unpleasant questions until forced to do so by a lawyer.\n\n[2]\n\nWritten contracts do not, to be sure, guarantee escape from disputes and litigation. Sometimes\nambiguities are not seen; sometimes they are necessary if the parties are to reach an agreement at all.\nRather than back out of the deal, it may be worth the risk to one or both parties deliberately to go along\nwith an ambiguous provision and hope that it never arises to be tested in a dispute that winds up in court.\nNevertheless, it is generally true that a written contract has at least three benefits over oral ones, even\nthose that by law are not required to be in writing. (1) The written contract usually avoids ambiguity. (2) It\ncan serve both as a communications device and as a device for the allocation of power, especially within\nlarge companies. By alerting various divisions to its formal requirements, the contract requires the sales,\ndesign, quality-control, and financial departments to work together. By setting forth requirements that\nthe company must meet, it can place the power to take certain actions in the hands of one division or\nanother. (3) Finally, should a dispute later arise, the written contract can immeasurably add to proof both\nof the fact that a contract was agreed to and of what its terms were.\n\nKEY TAKEAWAY\n\nIt is not uncommon for the meaning of a contract to be less than entirely clear. When called upon to\ninterpret the meaning of a contract, courts try to give it the meaning the parties intended when they made\nit. Various tools of interpretation are used.\nBusinesspeople usually do not like to seem overbearing; they do not wish to appear untrusting; they often\ndislike unpleasantries. Therefore it is not uncommon for even big deals to be sealed with a handshake. But\nit\xe2\x80\x99s a trade-off, because a written contract has obvious benefits, too.\n\nEXERCISES\n\n1.\n\nWhy do courts fairly frequently have to interpret the meaning of contracts?\n\n2.\n\nWhat is the purpose of contractual interpretation?\n\n3.\n\nWhat tools do the courts use in interpreting contracts?\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n458\n\n\x0c4.\n\nWhat is the social \xe2\x80\x9ccost\xe2\x80\x9d of insisting upon a written contract in a business setting? What are the benefits\nof the contract?\n5.\n\n[1] Towne v. Eisner, 245 US 418, 425 (1917).\n\n6.\n\n[2] Stewart Macaulay, \xe2\x80\x9cNon-contractual Relations in Business: A Preliminary Study,\xe2\x80\x9dAmerican Sociological\nReview 28, no. 1 (1963): 58\xe2\x80\x9359.\n\n13.4 Cases\n\nThe Statute of Frauds\xe2\x80\x99 Main Purpose Doctrine\nWilson Floors Co. v. Sciota Park, Ltd., and Unit, Inc.\n377 N.E.2d 514 (1978)\nSweeny, J.\nIn December of 1971, Wilson Floors Company (hereinafter \xe2\x80\x9cWilson\xe2\x80\x9d) entered into a contract with Unit,\nInc. (hereinafter \xe2\x80\x9cUnit\xe2\x80\x9d), a Texas corporation to furnish and install flooring materials for \xe2\x80\x9cThe Cliffs\xe2\x80\x9d\nproject, a development consisting of new apartments and an office building to be located in Columbus,\nOhio. Unit\xe2\x80\xa6was the general manager for the project. The Pittsburgh National Bank (hereinafter the\nbank), as the construction lender for the project, held mortgages on The Cliffs property security for\nconstruction loans which the bank had made to Unit.\nAs the work progressed on the project Unit fell behind in making payments to Wilson for its completed\nwork in the spring of 1973. At that time, the project was approximately two-thirds completed, the first\nmortgage money of seven million dollars having been fully dispersed by the bank to Unit. Appellant\n[Wilson] thereupon stopped work in May of 1973 and informed Unit that it would not continue until\npayments were forthcoming. On May 15, 1973, the bank conducted a meeting with the subcontractors in\nThe Cliffs project, including Wilson.\nAt the meeting, the bank sought to determine whether it would be beneficial at that stage of the project to\nlend more money to Unit, foreclose on the mortgage and hire a new contractor to complete the work, or\ndo nothing. Subcontractors were requested to furnish the bank an itemized account of what Unit owed\nthem, and a cost estimate of future services necessary to complete their job contracts. Having reviewed\nthe alternatives, the bank determined that it would be in its best interest to provide additional financing\nfor the project. The bank reasoned that to foreclose on the mortgage and hire a new contractor at this\nstage of construction would result in higher costs.\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n459\n\n\x0cThere is conflicting testimony in regard to whether the bank made assurances to Wilson at this meeting\nthat it would be paid for all work to be rendered on the project. However, after the May meeting, Wilson,\nalong with the other subcontractors, did return to work.\nPayments from Unit again were not forthcoming, resulting in a second work stoppage. The bank then\narranged another meeting to be conducted on June 28, 1973.\nAt this second meeting, there is conflicting testimony concerning the import of the statements made by\nthe bank representative to the subcontractors. The bank representative who spoke at the meeting testified\nat trial that he had merely advised the subcontractors that adequate funds would be available to complete\nthe job. However, two representatives of Wilson, also in attendance at the meeting, testified that the bank\nrepresentative had assured Wilson that if it returned to work, it would be paid.\nAfter the meeting, Wilson returned to work and continued to submit its progress billings to Unit for\npayment. Upon completion of its portion of The Cliffs project, Wilson submitted its final invoice of\n$15,584.50 to Unit. This amount was adjusted downward to $15,443.06 upon agreement of Unit and\nWilson. However, Wilson was not paid this amount.\nAs a result of nonpayment, Wilson filed suit\xe2\x80\xa6against Unit and the bank to recover the $15,443.06 [about\n$60,700 in 2010 dollars]. On September 26, 1975, Wilson and Unit stipulated that judgment for the sum\nof $15,365.84, plus interest, be entered against Unit. When Unit failed to satisfy the judgment, appellant\nproceeded with its action against the bank. [The trial court decided in favor of Wilson, but the\nintermediate appellate court reversed the trial court decision.]\xe2\x80\xa6[The Ohio statute of frauds provides]:\nNo action shall be brought whereby to charge the defendant, upon a special promise, to answer\nfor the debt, default, or miscarriage of another person\xe2\x80\xa6unless the agreement\xe2\x80\xa6or some\nmemorandum thereof, is in writing and signed by the party to be charged.\xe2\x80\xa6\nIn paragraph one of Crawford v. Edison [an 1887 Ohio case], however, this court stated:\nWhen the leading object of the promisor is, not to answer for another, but to subserve some\npecuniary or business purpose of his own, involving a benefit to himself\xe2\x80\xa6his promise is not\nwithin the statute of frauds, although it may be in form a promise to pay the debt of another and\nits performance may incidentally have the effect of extinguishing that liability.\xe2\x80\xa6\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n460\n\n\x0cSo long as the promisor undertakes to pay the subcontractor whatever his services are worth irrespective\nof what he may owe the general contractor and so long as the main purpose of the promisor is to further\nhis own business or pecuniary interest, the promise is enforceable.\xe2\x80\xa6\nThe facts in the instant case reflect that the bank made its guarantee to Wilson to subserve its own\nbusiness interest of reducing costs to complete the project. Clearly, the bank induced Wilson to remain on\nthe job and rely on its credit for future payments. To apply the statute of frauds and hold that the bank\nhad no contractual duty to Wilson despite its oral guarantees would not prevent the wrong which the\nstatute\xe2\x80\x99s enactment was to prevent, but would in reality effectuate a wrong.\nTherefore, this court affirms the finding of the Court of Common Pleas that the verbal agreement made by\nthe bank is enforceable by Wilson, and reverses the judgment of the Court of Appeals.\n\nCASE QUESTIONS\n\n1.\n\nThe exception to the Statute of Frauds in issue here is the main purpose doctrine. How does this doctrine\nrelate to the concept of promissory estoppel?\n\n2.\n\nWhat was the main purpose behind the bank\xe2\x80\x99s purported promise?\n\nThe Statute of Frauds\xe2\x80\x99 One-Year Rule\nIacono v. Lyons\n16 S.W.3d 92 (Texas Ct. App. 2000)\nO\xe2\x80\x99Connor, J.\nMary Iacono, the plaintiff below and appellant here, appeals from a take-nothing summary judgment\nrendered in favor of Carolyn Lyons, the defendant below and appellee here. We reverse and remand.\nThe plaintiff [Iacono] and defendant [Lyons] had been friends for almost 35 years. In late 1996, the\ndefendant invited the plaintiff to join her on a trip to Las Vegas, Nevada. There is no dispute that the\ndefendant paid all the expenses for the trip, including providing money for gambling.\nThe plaintiff contended she was invited to Las Vegas by the defendant because the defendant thought the\nplaintiff was lucky. Sometime before the trip, the plaintiff had a dream about winning on a Las Vegas slot\nmachine. The plaintiff\xe2\x80\x99s dream convinced her to go to Las Vegas, and she accepted the defendant\xe2\x80\x99s offer to\nsplit \xe2\x80\x9c50-50\xe2\x80\x9d any gambling winnings.\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n461\n\n\x0cIn February 1997, the plaintiff and defendant went to Las Vegas. They started playing the slot machines at\nCaesar\xe2\x80\x99s Palace. The plaintiff contends that, after losing $47, the defendant wanted to leave to see a show.\nThe plaintiff begged the defendant to stay, and the defendant agreed on the condition that she (the\ndefendant) put the coins into the machines because doing so took the plaintiff too long. (The plaintiff, who\nsuffers from advanced rheumatoid arthritis, was in a wheelchair.) The plaintiff agreed, and took the\ndefendant to a dollar slot machine that looked like the machine in her dream. The machine did not pay on\nthe first try. The plaintiff then said, \xe2\x80\x9cJust one more time,\xe2\x80\x9d and the defendant looked at the plaintiff and\nsaid, \xe2\x80\x9cThis one\xe2\x80\x99s for you, Puddin.\xe2\x80\x9d\nThe slot machine paid $1,908,064. The defendant refused to share the winnings with the plaintiff, and\ndenied they had an agreement to split any winnings. The defendant told Caesar\xe2\x80\x99s Palace she was the sole\nwinner and to pay her all the winnings.\nThe plaintiff sued the defendant for breach of contract. The defendant moved for summary judgment on\nthe grounds that any oral agreement was unenforceable under the statute of frauds or was voidable for\nlack of consideration. The trial court rendered summary judgment in favor of the defendant.\xe2\x80\xa6\n[Regarding the \xe2\x80\x9cconsideration\xe2\x80\x9d argument:] The defendant asserted the agreement, if any, was voidable\nbecause there was no consideration. The defendant contended the plaintiff\xe2\x80\x99s only contribution was the\nplaintiff\xe2\x80\x99s dream of success in Las Vegas and her \xe2\x80\x9cluck.\xe2\x80\x9d The plaintiff asserted the defendant bargained\nwith her to go to Las Vegas in return for intangibles that the defendant thought the plaintiff offered (good\nluck and the realization of the dream). The plaintiff said she gave up her right to remain in Houston in\nreturn for the agreement to split any winnings. The plaintiff also asserted the agreement was an exchange\nof promises.\n\xe2\x80\xa6The plaintiff alleged she promised to share one-half of her winnings with the defendant in exchange for\nthe defendant\xe2\x80\x99s promise to share one-half of her winnings with the plaintiff. These promises, if made,\nrepresent the respective benefits and detriments, or the bargained for exchange, necessary to satisfy the\nconsideration requirement. See [Citation] (when no other consideration is shown, mutual obligations by\nthe parties to the agreement will furnish sufficient consideration to constitute a binding\ncontract).\xe2\x80\xa6[Regarding the Statute of Frauds argument:] The defendant asserted the agreement, if any,\nwas unenforceable under the statute of frauds because it could not be performed within one year. There is\nno dispute that the winnings were to be paid over a period of 20 years.\xe2\x80\xa6\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n462\n\n\x0c[The statute] does not apply if the contract, from its terms, could possibly be performed within a year\xe2\x80\x94\nhowever improbable performance within one year may be. [Citations] [It bars] only oral contracts that\ncannot be completed within one year. [Citation] (If the agreement, either by its terms or by the nature of\nthe required acts, cannot be performed within one year, it falls within the statute of frauds and must be in\nwriting).\nTo determine the applicability of the statute of frauds with indefinite contracts, this Court may use any\nreasonably clear method of ascertaining the intended length of performance. [Citation] The method is\nused to determine the parties\xe2\x80\x99 intentions at the time of contracting. The fact that the entire performance\nwithin one year is not required, or expected, will not bring an agreement within the\nstatute. See [Citations].\nAssuming without deciding that the parties agreed to share their gambling winnings, such an agreement\npossibly could have been performed within one year. For example, if the plaintiff and defendant had won\n$200, they probably would have received all the money in one pay-out and could have split the winnings\nimmediately. Therefore, the defendant was not entitled to summary judgment based on her affirmative\ndefense of the statute of frauds.\nWe reverse the trial court\xe2\x80\x99s judgment and remand for further proceedings.\n\nCASE QUESTIONS\n\n1.\n\nThe defendant contended there was no consideration to support her alleged promise to split the winnings\nfifty-fifty. What consideration did the court find here?\n\n2.\n\nThe defendant contended that the Statute of Frauds\xe2\x80\x99 one-year rule prohibited the plaintiff from\nattempting to prove the existence of the alleged oral contract to split the winnings. What reasoning did\nthe court give here as to why the statute did not apply?\n\n3.\n\nAfter this case, the court remanded the matter to the lower court. What has to happen there before\nplaintiff gets her money?\n\nThe Parol Evidence Rule: Postcontract Modification\nHampden Real Estate, Inc. v. Metropolitan Management Group, Inc.\n142 Fed. Appx. 600 (Fed. Ct. App. Pa. 2005)\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n463\n\n\x0cCowen, J.\n[The court has jurisdiction based on diversity of citizenship.]\nHampden Real Estate sold Metropolitan Management a residential property pursuant to an Agreement of\nSale (the \xe2\x80\x9cSale Agreement\xe2\x80\x9d). The Sale Agreement provided that the property would be sold for $3.7\nmillion, that Metropolitan would assume Hampden\xe2\x80\x99s mortgage on the building, and that Hampden would\nreceive a credit in the amount of $120,549.78\xe2\x80\x94the amount being held in escrow pursuant to the mortgage\n(the \xe2\x80\x9cEscrow Account Credit\xe2\x80\x9d).\nBetween the execution of the Sale Agreement and the closing, the parties negotiated certain adjustments\nto the purchase price to compensate for required repairs. During these negotiations, the parties reviewed\na draft and final Settlement Statement (the \xe2\x80\x9cSettlement Statement\xe2\x80\x9d), prepared by the closing agent, which\ndid not list the Escrow Account Credit among the various debits and credits. A few weeks after the closing,\nHampden demanded payment of the Escrow Account Credit.\nFollowing Metropolitan\xe2\x80\x99s refusal to pay the Escrow Account Credit, Hampden filed a complaint claiming\nbreach of contract, unjust enrichment, and conversion. Metropolitan brought counterclaims for breach of\ncontract, unjust enrichment, and fraudulent or negligent misrepresentation. Hampden brought a partial\nmotion for summary judgment as to the breach of contract claim, which was granted and its unjust\nenrichment and conversion claims were dismissed as moot.\xe2\x80\xa6\nThe District Court correctly determined that the threshold issue is the role of the Settlement Statement,\n\xe2\x80\x9cbased on both the intent of the parties and the custom and usage of the document.\xe2\x80\x9d However, the Court\nrefused to consider extrinsic or parol evidence to determine the intent of the parties, reasoning that the\nparol evidence rule precluded such consideration absent ambiguity in the written contract. We find that\nthe District Court misapplied the rule. The parol evidence rule seeks to preserve the integrity of written\nagreements by precluding the introduction of contemporaneous or prior declarations to alter the meaning\nof written agreements. [Citation] The rule does not apply, however, where a party seeks to introduce\nevidence of subsequent oral modifications. See[Citation:] a \xe2\x80\x9cwritten agreement may be modified by a\nsubsequent written or oral agreement and this modification may be shown by writings or by words or by\nconduct or by all three. In such a situation the parol evidence rule is inapplicable.\xe2\x80\x9d Here, the parol\nevidence rule does not preclude testimony regarding the parties\xe2\x80\x99 intention to alter the final purchase price\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n464\n\n\x0cby executing a Settlement Statement, after the execution of the Sale Agreement, which omitted the Escrow\nAccount Credit.\nThe cases cited by Hampden are not to the contrary as each involved the admissibility of prior\nnegotiations to demonstrate misrepresentations made in the inducement of the contract. As example, the\ncourt in [Citation], held that \xe2\x80\x9c[i]f a party contends that a writing is not an accurate expression of the\nagreement between the parties, and that certain provisions were omitted therefrom, the parol evidence\nrule does not apply.\xe2\x80\x9d (Permitting the introduction of parol evidence to establish that the contract omitted\nprovisions which appellees represented would be included in the writing).\xe2\x80\xa6\nThe District Court further held that the integration clause contained in the written contract supports the\nconclusion that the Settlement Statement, which mentioned neither the Escrow Account Credit nor that it\nwas amending the Sale Agreement, is not a modification of the Sale Agreement. The Court explained that\nthe outcome might be different if the Settlement Statement mentioned \xe2\x80\x9cthe escrow credit but provided\ndifferent details, but as the [Settlement Statement] in this case simply ignored the escrow credit, and both\nparties agree that there were no oral discussions regarding the escrow credit, the [Settlement Statement]\ncannot be said to modify the escrow credit provision in the Agreement of Sale.\xe2\x80\x9d We disagree.\nIt is well-settled law in Pennsylvania that a \xe2\x80\x9cwritten contract which is not for the sale of goods may be\nmodified orally, even when the contract provides that modifications may only be made in writing.\xe2\x80\x9d\n[Citition] \xe2\x80\x9cThe modification may be accomplished either by words or conduct,\xe2\x80\x9d [Citation] demonstrating\nthat the parties intended to waive the requirement that amendments be made in writing. [Citation] An\noral modification of a written contract must be proven by \xe2\x80\x9cclear, precise and convincing evidence.\xe2\x80\x9d\n[Citation] Viewing the evidence in the light most favorable to Metropolitan, we find that the District Court\nerred in concluding that there was insufficient evidence in the record to raise a genuine issue of material\nfact as to whether the parties intended to orally modify the Sale Agreement. Metropolitan introduced a\nSettlement Statement which omitted the Escrow Account Credit, while listing all other debits and credits\nand submitted an affidavit from its President who \xe2\x80\x9creviewed the Draft Settlement Statement and\nunderstood that the Escrow Account Credit had been omitted as part of the ongoing negotiations between\nthe parties concerning the amount of the credit to which Metropolitan was entitled\xe2\x80\x9d due to the poor\ncondition of the property.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n465\n\n\x0cAccordingly, the District Court erred in granting summary judgment in favor of Hampden. At a minimum,\nthere was a triable issue of fact concerning whether the Settlement Statement was intended to modify the\nprior written Sale Agreement and serve as the final and binding manifestation of the purchase price.\nSpecifically, whether the parties intended to exclude the Escrow Account Credit from the purchase price\nas part of the negotiations to address Hampden\xe2\x80\x99s failure to maintain the property.\n[Reversed and remanded.]\n\n1.\n\nCASE QUESTIONS\n\nThe contract had an integration clause. Why didn\xe2\x80\x99t that bar admission of the subsequent oral\nmodification to the contract?\n\n2.\n\nWhat rule of law was the plaintiff relying on in support of its contention that the original agreement\nshould stand?\n\n3.\n\nWhat rule of law was the defendant relying on in support of its contention that the original agreement\nhad been modified?\n\n4.\n\nAccording to the defendant, how had the original agreement been modified, and why?\n\n13.5 Summary and Exercises\nSummary\n\nIn an economic system mostly governed by contract, parties may not only make the kinds of deals they\nwish but may make them in any form they wish\xe2\x80\x94with some significant exceptions. The most significant\nissue of form in contract law is whether the contract must be written or may be oral and still be\nenforceable. The question can be answered by paying close attention to the Statute of Frauds and court\ndecisions interpreting it. In general, as we have seen, the following types of contracts must be in writing:\ninterests in real property, promises to pay the debt of another, certain agreements of executors and\nadministrators, performances that cannot be completed within one year, sale of goods for $500 or more,\nand sale of securities. There are exceptions to all these rules.\nAnother significant rule that permeates contract law is the parol evidence rule: prior statements,\nagreements, or promises, whether oral or written, made during the negotiation process are often\ndischarged by a subsequent written agreement. No matter what you were promised before you signed on\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n466\n\n\x0cthe dotted line, you are stuck if you sign an integrated agreement without the promise. Again, of course,\nexceptions lie in wait for the unwary: Is the agreement only partially integrated? Are there grounds to\ninvalidate the entire agreement? Is the contract subject to an oral condition? Is a fact recited in the\ncontract untrue?\nContracts are not always clear and straightforward. Often they are murky and ambiguous. Interpreting\nthem when the parties disagree is for the courts. To aid them in the task, the courts over the years have\ndeveloped a series of guidelines such as these: Does the agreement have a plain meaning on its face? If\nthere is an ambiguity, against whom should it be construed? Are there usages of trade or courses of\ndealing or performance that would help explain the terms?\n\nEXERCISES\n\n1.\n\nPlaintiff\xe2\x80\x99s and Defendant\xe2\x80\x99s cars crashed. Plaintiff hired an attorney, who negotiated with Defendant\xe2\x80\x99s\ninsurance adjuster. Plaintiff\xe2\x80\x99s attorney claimed he and the adjuster reached an oral settlement, but the\ninsurance company refused to honor it and filed for summary judgment, raising the Statute of Frauds\xe2\x80\x99\nsuretyship provision as a defense: a promise by one person (the insurance company here) to pay the\ndebts of another (the insured) must be evidenced by some writing, and there was no writing. Is the\ndefense good? Explain.\n\n2.\n\nPlaintiff Irma Kozlowski cohabited with Defendant Thaddeus Kozlowski for fifteen years without marriage.\nShe repeatedly asked him specifically about her financial situation should he predecease her, and he\nassured her\xe2\x80\x94she said\xe2\x80\x94that he would arrange to provide for her for the rest of her life. She had provided\nthe necessary household services and emotional support to permit him to successfully pursue his business\ncareer; she had performed housekeeping, cleaning, and shopping services and had run the household and\nraised the children, her own as well as his. When they separated and she was \xe2\x80\x9cliterally forced out of the\nhouse,\xe2\x80\x9d she was sixty-three years old and had no means or wherewithal for survival. When she sued, he\nraised the Statute of Frauds\xe2\x80\x99 one-year rule as a defense. Is the defense good?\n\n3.\n\n[1]\n\nCarlson purchased a parcel of real estate that was landlocked. Carlson called his neighbor, Peterson, and\nasked if he could use an abandoned drive on Peterson\xe2\x80\x99s property to travel to his (Carlson\xe2\x80\x99s) property from\nthe highway. Peterson said, \xe2\x80\x9cSure, anytime.\xe2\x80\x9d Later the two became engaged in a dispute, and Peterson\nblocked the drive. May Carlson enforce Peterson\xe2\x80\x99s promise that he could use the drive \xe2\x80\x9canytime\xe2\x80\x9d? Why?\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n467\n\n\x0c4.\n\nSilverman, who was elderly and somewhat disabled, lived alone on a farm. Silverman called Burch and\nsaid, \xe2\x80\x9cBurch, if you will move in with me and help me take care of the farm, it will be yours when I die.\xe2\x80\x9d\nBurch did as Silverman requested and on Silverman\xe2\x80\x99s death two years later, claimed the farm on the basis\nof their oral agreement, but the estate resisted. Is Burch entitled to the farm? Why?\n\n5.\n\nOn February 12, Sally was hired to manage a company for a period of one year. She reported for work on\nFebruary 26 but was fired two weeks later. She sued the owner of the company for breach of their oneyear oral contract. May she recover? Why?\n\n6.\n\nBaker entered into an oral contract to sell her car to Clyde for $8,600. She delivered the car to Clyde, but\nClyde refused to pay and now wants to return the car. Is the contract enforceable? Why?\n\n7.\n\nWayne, a building contractor, built a new house and offered it for sale. A young couple accepted the\noffer, and the parties entered into an oral agreement covering all the terms of sale. The couple later tried\nto back out of the agreement. Wayne filed suit, and during the trial, the couple admitted making the\ncontract. Is the contract enforceable? Why?\n\n8.\n\nPlaintiff leased commercial space from Defendant for a florist shop. After the lease was signed, Plaintiff\nlearned that the county code allowed only one freestanding sign on the property, and one was already\nup, advertising Defendant\xe2\x80\x99s business. Plaintiff claimed Defendant breached the lease by not providing\nthem space for a sign; Defendant pointed to the lease, paragraph 16 of which provided that \xe2\x80\x9cTenant shall\nnot erect or install any sign\xe2\x80\xa6without written consent of the Landlord.\xe2\x80\x9d But Plaintiff claimed Defendant\nsaid during negotiations he could have a sign, evidence Defendant objected to based on the parol\nevidence rule. Defendant admitted that during negotiations he told Plaintiff that despite paragraph 16, he\ncould have a sign (but not freestanding); that despite language in the lease requiring renovation plans to\nbe in writing, they did not have to be. Defendant also testified that the written form lease he used was\nnot drafted specifically for this property, and that although the lease required attachments of exhibits,\nthere were no attachments. Is Plaintiff barred by the parol evidence rule from showing that Defendant\nsaid he could have a freestanding sign?\n\n9.\n\nOn March 1, 2010, Milton talked to Harriet and, as Harriet claimed, said, \xe2\x80\x9cI will hire you as sales manager\nfor one year at a salary of $57,000. You start next Monday, March 8.\xe2\x80\x9d Harriet agreed. Four months later\nMilton discharged Harriet and she sued, claiming breach of employment contract. Is the alleged contract\nenforceable?\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n468\n\n\x0c10. Al Booth\xe2\x80\x99s Inc. sued Boyd-Scarp (a contractor) and James Rathmann for nonpayment following delivery of\nvarious appliances to Rathmann\xe2\x80\x99s new home being built by Boyd-Scarp. Booth\xe2\x80\x99s was aware that BoydScarp was having financial problems and allegedly contacted Rathmann prior to delivery, asking him to\nguarantee payment. Evidence was adduced that Rathmann orally promised to pay in the event the builder\ndid not and that the goods were then delivered. Rathmann denied any such promise, raising the Statute\nof Frauds, and Al Booth\xe2\x80\x99s sued. Will Al Booth\xe2\x80\x99s prevail?\n\nSELF-TEST QUESTIONS\n\n1.\n\nAs a general rule\na.\n\ncontracts do not have to be in writing to be enforceable\n\nb.\n\ncontracts that can be performed in one year must be in writing\n\nc.\n\nall oral contracts are unenforceable\n\nd.\n\na suretyship agreement need not be in writing to be enforceable\nAn exception to the UCC Statute of Frauds provision is\n\na.\n\nthe one-year rule\nb.\n\nthe reply doctrine\n\nc.\n\nexecutor agreements\n\nd.\n\nall of the above\n\nRules that require certain contracts to be in writing are found in\na.\n\nstate statutory law\nb.\n\nthe UCC\n\nc.\n\nthe Statute of Frauds\n\nd.\n\nall of the above\n\nThe parol evidence rule\na.\n\napplies only when contracts must be in writing\nb.\n\ndoes not apply to real estate contracts\n\nc.\n\nstates that a written contract discharges all prior or contemporaneous promises that\nadd to, vary, or conflict with it\n\nd.\n\nis designed to hold parties to promises they made during negotiations\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n469\n\n\x0cA merger clause\na.\n\nis required when goods are sold for $500 or more\n\n1.\n\na\n\n2.\n\nb\n\n3.\n\nd\n\n4.\n\nc\n\nb.\n\nis used when two parcels of real estate are sold in the same contract\n\nc.\n\ninvalidates a contract for the sale of securities\n\nd.\n\nevidences an intention that the written contract is the parties\xe2\x80\x99 full understanding\n\nSELF-TEST ANSWERS\n\n5.\n\nd\n[1] Kozlowski v. Kozlowski, 395 A.2d 913 (N.J. 1978).\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n470\n\n\x0cChapter 14\n\nThird-Party Rights\nLEARNING OBJECTIVES\nAfter reading this chapter, you should understand the following:\n1.\n\nHow an assignment of contract rights is made and how it operates\n\n2.\n\nWhat a delegation of duties is and how it operates\n\n3.\n\nUnder what circumstances a person not a party to a contract can enforce it\n\nTo this point, we have focused on the rights and duties of the two parties to the contract. In this\nchapter, we turn our attention to contracts in which outsiders acquire rights or duties or both. Three\ntypes of outsiders merit examination:\n1.\n\nAssignees (outsiders who acquire rights after the contract is made)\n\n2. Delegatees (outsiders who acquire duties after the contract is made)\n3. Third-party beneficiaries (outsiders who acquire rights when the original contract is made)\n\n14.1 Assignment of Contract Rights\n\nLEARNING OBJECTIVES\n\n1.\n\nUnderstand what an assignment is and how it is made.\n\n2.\n\nRecognize the effect of the assignment.\n\n3.\n\nKnow when assignments are not allowed.\n\n4.\n\nUnderstand the concept of assignor\xe2\x80\x99s warranties.\n\nThe Concept of a Contract Assignment\nContracts create rights and duties. By an assignment, an obligee (one who has the right to receive a\ncontract benefit) transfers a right to receive a contract benefit owed by the obligor (the one who has a duty\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n471\n\n\x0cto perform) to a third person (assignee); the obligee then becomes an assignor (one who makes an\nassignment).\nThe Restatement (Second) of Contracts defines an assignment of a right as \xe2\x80\x9ca manifestation of the\nassignor\xe2\x80\x99s intention to transfer it by virtue of which the assignor\xe2\x80\x99s right to performance by the obligor is\nextinguished in whole or in part and the assignee acquires the right to such performance.\xe2\x80\x9d\n\n[1]\n\nThe one who\n\nmakes the assignment is both an obligee and a transferor. The assignee acquires the right to receive the\ncontractual obligations of the promisor, who is referred to as the obligor (see Figure 14.1 "Assignment of\nRights"). The assignor may assign any right unless (1) doing so would materially change the obligation of\nthe obligor, materially burden him, increase his risk, or otherwise diminish the value to him of the\noriginal contract; (2) statute or public policy forbids the assignment; or (3) the contract itself precludes\nassignment. The common law of contracts and Articles 2 and 9 of the Uniform Commercial Code (UCC)\ngovern assignments. Assignments are an important part of business financing, such as factoring.\nA factor is one who purchases the right to receive income from another.\nFigure 14.1 Assignment of Rights\n\nMethod of Assignment\nManifesting Assent\nTo effect an assignment, the assignor must make known his intention to transfer the rights to the third\nperson. The assignor\xe2\x80\x99s intention must be that the assignment is effective without need of any further\naction or any further manifestation of intention to make the assignment. In other words, the assignor\nmust intend and understand himself to be making the assignment then and there; he is not promising to\nmake the assignment sometime in the future.\nUnder the UCC, any assignments of rights in excess of $5,000 must be in writing, but otherwise,\nassignments can be oral and consideration is not required: the assignor could assign the right to the\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n472\n\n\x0cassignee for nothing (not likely in commercial transactions, of course). Mrs. Franklin has the right to\nreceive $750 a month from the sale of a house she formerly owned; she assigns the right to receive the\nmoney to her son Jason, as a gift. The assignment is good, though such a gratuitous assignment is usually\nrevocable, which is not the case where consideration has been paid for an assignment.\n\nAcceptance and Revocation\nFor the assignment to become effective, the assignee must manifest his acceptance under most\ncircumstances. This is done automatically when, as is usually the case, the assignee has given\nconsideration for the assignment (i.e., there is a contract between the assignor and the assignee in which\nthe assignment is the assignor\xe2\x80\x99s consideration), and then the assignment is not revocable without the\nassignee\xe2\x80\x99s consent. Problems of acceptance normally arise only when the assignor intends the assignment\nas a gift. Then, for the assignment to be irrevocable, either the assignee must manifest his acceptance or\nthe assignor must notify the assignee in writing of the assignment.\n\nNotice\nNotice to the obligor is not required, but an obligor who renders performance to the assignor without\nnotice of the assignment (that performance of the contract is to be rendered now to the assignee) is\ndischarged. Obviously, the assignor cannot then keep the consideration he has received; he owes it to the\nassignee. But if notice is given to the obligor and she performs to the assignor anyway, the assignee can\nrecover from either the obligor or the assignee, so the obligor could have to perform twice, as in Exercise 2\nat the chapter\xe2\x80\x99s end, Aldana v. Colonial Palms Plaza. Of course, an obligor who receives notice of the\nassignment from the assignee will want to be sure the assignment has really occurred. After all, anybody\ncould waltz up to the obligor and say, \xe2\x80\x9cI\xe2\x80\x99m the assignee of your contract with the bank. From now on, pay\nme the $500 a month, not the bank.\xe2\x80\x9d The obligor is entitled to verification of the assignment.\n\nEffect of Assignment\nGeneral Rule\nAn assignment of rights effectively makes the assignee stand in the shoes of the assignor. He gains all the\nrights against the obligor that the assignor had, but no more. An obligor who could avoid the assignor\xe2\x80\x99s\nattempt to enforce the rights could avoid a similar attempt by the assignee. Likewise, under UCC Section\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n473\n\n\x0c9-318(1), the assignee of an account is subject to all terms of the contract between the debtor and the\ncreditor-assignor. Suppose Dealer sells a car to Buyer on a contract where Buyer is to pay $300 per month\nand the car is warranted for 50,000 miles. If the car goes on the fritz before then and Dealer won\xe2\x80\x99t fix it,\nBuyer could fix it for, say, $250 and deduct that $250 from the amount owed Dealer on the next\ninstallment (called a setoff). Now, if Dealer assigns the contract to Assignee, Assignee stands in Dealer\xe2\x80\x99s\nshoes, and Buyer could likewise deduct the $250 from payment to Assignee.\n\nExceptions\nThe \xe2\x80\x9cshoe rule\xe2\x80\x9d does not apply to two types of assignments. First, it is inapplicable to the sale of a\nnegotiable instrument to a holder in due course (covered in detail (Reference mayer_1.0-ch23 not found\nin Book)). Second, the rule may be waived: under the UCC and at common law, the obligor may agree in\nthe original contract not to raise defenses against the assignee that could have been raised against the\nassignor.\n\n[2]\n\nWhile a waiver of defenses makes the assignment more marketable from the assignee\xe2\x80\x99s point\n\nof view, it is a situation fraught with peril to an obligor, who may sign a contract without understanding\nthe full import of the waiver. Under the waiver rule, for example, a farmer who buys a tractor on credit\nand discovers later that it does not work would still be required to pay a credit company that purchased\nthe contract; his defense that the merchandise was shoddy would be unavailing (he would, as used to be\nsaid, be \xe2\x80\x9chaving to pay on a dead horse\xe2\x80\x9d).\nFor that reason, there are various rules that limit both the holder in due course and the waiver rule.\nCertain defenses, the so-called real defenses (infancy, duress, and fraud in the execution, among others),\nmay always be asserted. Also, the waiver clause in the contract must have been presented in good faith,\nand if the assignee has actual notice of a defense that the buyer or lessee could raise, then the waiver is\nineffective. Moreover, in consumer transactions, the UCC\xe2\x80\x99s rule is subject to state laws that protect\nconsumers (people buying things used primarily for personal, family, or household purposes), and many\nstates, by statute or court decision, have made waivers of defenses ineffective in such\nconsumer transactions. Federal Trade Commission regulations also affect the ability of many sellers to\npass on rights to assignees free of defenses that buyers could raise against them. Because of these various\nlimitations on the holder in due course and on waivers, the \xe2\x80\x9cshoe rule\xe2\x80\x9d will not govern in consumer\ntransactions and, if there are real defenses or the assignee does not act in good faith, in business\ntransactions as well.\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n474\n\n\x0cWhen Assignments Are Not Allowed\nThe general rule\xe2\x80\x94as previously noted\xe2\x80\x94is that most contract rights are assignable. But there are\nexceptions. Five of them are noted here.\n\nMaterial Change in Duties of the Obligor\nWhen an assignment has the effect of materially changing the duties that the obligor must perform, it is\nineffective. Changing the party to whom the obligor must make a payment is not a material change of duty\nthat will defeat an assignment, since that, of course, is the purpose behind most assignments. Nor will a\nminor change in the duties the obligor must perform defeat the assignment.\nSeveral residents in the town of Centerville sign up on an annual basis with the Centerville Times to\nreceive their morning paper. A customer who is moving out of town may assign his right to receive the\npaper to someone else within the delivery route. As long as the assignee pays for the paper, the\nassignment is effective; the only relationship the obligor has to the assignee is a routine delivery in\nexchange for payment. Obligors can consent in the original contract, however, to a subsequent assignment\nof duties. Here is a clause from the World Team Tennis League contract: \xe2\x80\x9cIt is mutually agreed that the\nClub shall have the right to sell, assign, trade and transfer this contract to another Club in the League, and\nthe Player agrees to accept and be bound by such sale, exchange, assignment or transfer and to faithfully\nperform and carry out his or her obligations under this contract as if it had been entered into by the Player\nand such other Club.\xe2\x80\x9d Consent is not necessary when the contract does not involve a personal\nrelationship.\n\nAssignment of Personal Rights\nWhen it matters to the obligor who receives the benefit of his duty to perform under the contract, then the\nreceipt of the benefit is a personal right that cannot be assigned. For example, a student seeking to earn\npocket money during the school year signs up to do research work for a professor she admires and with\nwhom she is friendly. The professor assigns the contract to one of his colleagues with whom the student\ndoes not get along. The assignment is ineffective because it matters to the student (the obligor) who the\nperson of the assignee is. An insurance company provides auto insurance covering Mohammed Kareem, a\nsixty-five-year-old man who drives very carefully. Kareem cannot assign the contract to his seventeen-\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n475\n\n\x0cyear-old grandson because it matters to the insurance company who the person of its insured is. Tenants\nusually cannot assign (sublet) their tenancies without the landlord\xe2\x80\x99s permission because it matters to the\nlandlord who the person of their tenant is. Section 14.4.1 "Nonassignable Rights", Nassau Hotel Co. v.\nBarnett & Barse Corp., is an example of the nonassignability of a personal right.\n\nAssignment Forbidden by Statute or Public Policy\nVarious federal and state laws prohibit or regulate some contract assignment. The assignment of future\nwages is regulated by state and federal law to protect people from improvidently denying themselves\nfuture income because of immediate present financial difficulties. And even in the absence of statute,\npublic policy might prohibit some assignments.\n\nContracts That Prohibit Assignment\nAssignability of contract rights is useful, and prohibitions against it are not generally favored. Many\ncontracts contain general language that prohibits assignment of rights or of \xe2\x80\x9cthe contract.\xe2\x80\x9d Both the\nRestatement and UCC Section 2-210(3) declare that in the absence of any contrary circumstances, a\nprovision in the agreement that prohibits assigning \xe2\x80\x9cthe contract\xe2\x80\x9d bars \xe2\x80\x9conly the delegation to the\nassignee of the assignor\xe2\x80\x99s performance.\xe2\x80\x9d\n\n[3]\n\nIn other words, unless the contract specifically prohibits\n\nassignment of any of its terms, a party is free to assign anything except his or her own duties.\nEven if a contractual provision explicitly prohibits it, a right to damages for breach of the whole contract is\nassignable under UCC Section 2-210(2) in contracts for goods. Likewise, UCC Section 9-318(4) invalidates\nany contract provision that prohibits assigning sums already due or to become due. Indeed, in some\nstates, at common law, a clause specifically prohibiting assignment will fail. For example, the buyer and\nthe seller agree to the sale of land and to a provision barring assignment of the rights under the contract.\nThe buyer pays the full price, but the seller refuses to convey. The buyer then assigns to her friend the\nright to obtain title to the land from the seller. The latter\xe2\x80\x99s objection that the contract precludes such an\nassignment will fall on deaf ears in some states; the assignment is effective, and the friend may sue for the\ntitle.\n\nFuture Contracts\nThe law distinguishes between assigning future rights under an existing contract and assigning rights that\nwill arise from a future contract. Rights contingent on a future event can be assigned in exactly the same\nmanner as existing rights, as long as the contingent rights are already incorporated in a contract. Ben has\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n476\n\n\x0ca long-standing deal with his neighbor, Mrs. Robinson, to keep the latter\xe2\x80\x99s walk clear of snow at twenty\ndollars a snowfall. Ben is saving his money for a new printer, but when he is eighty dollars shy of the\npurchase price, he becomes impatient and cajoles a friend into loaning him the balance. In return, Ben\nassigns his friend the earnings from the next four snowfalls. The assignment is effective. However, a right\nthat will arise from a future contract cannot be the subject of a present assignment.\n\nPartial Assignments\nAn assignor may assign part of a contractual right, but only if the obligor can perform that part of his\ncontractual obligation separately from the remainder of his obligation. Assignment of part of a payment\ndue is always enforceable. However, if the obligor objects, neither the assignor nor the assignee may sue\nhim unless both are party to the suit. Mrs. Robinson owes Ben one hundred dollars. Ben assigns fifty\ndollars of that sum to his friend. Mrs. Robinson is perplexed by this assignment and refuses to pay until\nthe situation is explained to her satisfaction. The friend brings suit against Mrs. Robinson. The court\ncannot hear the case unless Ben is also a party to the suit. This ensures all parties to the dispute are\npresent at once and avoids multiple lawsuits.\n\nSuccessive Assignments\nIt may happen that an assignor assigns the same interest twice (see Figure 14.2 "Successive\nAssignments"). With certain exceptions, the first assignee takes precedence over any subsequent assignee.\nOne obvious exception is when the first assignment is ineffective or revocable. A subsequent assignment\nhas the effect of revoking a prior assignment that is ineffective or revocable. Another exception: if in good\nfaith the subsequent assignee gives consideration for the assignment and has no knowledge of the prior\nassignment, he takes precedence whenever he obtains payment from, performance from, or a judgment\nagainst the obligor, or whenever he receives some tangible evidence from the assignor that the right has\nbeen assigned (e.g., a bank deposit book or an insurance policy).\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n477\n\n\x0cSome states follow the different English rule: the first assignee to give notice to the obligor has priority,\nregardless of the order in which the assignments were made. Furthermore, if the assignment falls within\nthe filing requirements of UCC Article 9 (see (Reference mayer_1.0-ch28 not found in Book)), the first\nassignee to file will prevail.\n\nFigure 14.2 Successive Assignments\n\nAssignor\xe2\x80\x99s Warranties\nAn assignor has legal responsibilities in making assignments. He cannot blithely assign the same interests\npell-mell and escape liability. Unless the contract explicitly states to the contrary, a person who assigns a\nright for value makes certain assignor\xe2\x80\x99s warranties to the assignee: that he will not upset the assignment,\nthat he has the right to make it, and that there are no defenses that will defeat it. However, the assignor\ndoes not guarantee payment; assignment does not by itself amount to a warranty that the obligor is\nsolvent or will perform as agreed in the original contract. Mrs. Robinson owes Ben fifty dollars. Ben\nassigns this sum to his friend. Before the friend collects, Ben releases Mrs. Robinson from her obligation.\nThe friend may sue Ben for the fifty dollars. Or again, if Ben represents to his friend that Mrs. Robinson\nowes him (Ben) fifty dollars and assigns his friend that amount, but in fact Mrs. Robinson does not owe\nBen that much, then Ben has breached his assignor\xe2\x80\x99s warranty. The assignor\xe2\x80\x99s warranties may be express\nor implied.\n\nKEY TAKEAWAY\n\nGenerally, it is OK for an obligee to assign the right to receive contractual performance from the obligor to\na third party. The effect of the assignment is to make the assignee stand in the shoes of the assignor,\ntaking all the latter\xe2\x80\x99s rights and all the defenses against nonperformance that the obligor might raise\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n478\n\n\x0cagainst the assignor. But the obligor may agree in advance to waive defenses against the assignee, unless\nsuch waiver is prohibited by law.\nThere are some exceptions to the rule that contract rights are assignable. Some, such as personal rights,\nare not circumstances where the obligor\xe2\x80\x99s duties would materially change, cases where assignability is\nforbidden by statute or public policy, or, with some limits, cases where the contract itself prohibits\nassignment. Partial assignments and successive assignments can happen, and rules govern the resolution\nof problems arising from them.\nWhen the assignor makes the assignment, that person makes certain warranties, express or implied, to\nthe assignee, basically to the effect that the assignment is good and the assignor knows of no reason why\nthe assignee will not get performance from the obligor.\n\nEXERCISES\n\n1.\n\nIf Able makes a valid assignment to Baker of his contract to receive monthly rental payments from\nTenant, how is Baker\xe2\x80\x99s right different from what Able\xe2\x80\x99s was?\n\n2.\n\nAble made a valid assignment to Baker of his contract to receive monthly purchase payments from Carr,\nwho bought an automobile from Able. The car had a 180-day warranty, but the car malfunctioned within\nthat time. Able had quit the auto business entirely. May Carr withhold payments from Baker to offset the\ncost of needed repairs?\n\n3.\n\nAssume in the case in Exercise 2 that Baker knew Able was selling defective cars just before his (Able\xe2\x80\x99s)\nwithdrawal from the auto business. How, if at all, does that change Baker\xe2\x80\x99s rights?\n\n4.\n\nWhy are leases generally not assignable? Why are insurance contracts not assignable?\n5.\n\n[1] Restatement (Second) of Contracts, Section 317(1).\n\n6.\n\n[2] Uniform Commercial Code, Section 9-206.\n\n7.\n\n[3] Restatement (Second) of Contracts, Section 322.\n\n14.2 Delegation of Duties\n\nLEARNING OBJECTIVES\n\n1.\n\nKnow what a delegation of duty is.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n479\n\n\x0c2.\n\nRecognize how liability remains on the delegator following a delegation.\n\n3.\n\nUnderstand what duties may not be delegated.\n\nBasic Rules Regarding Delegation\nGeneral Rule\nTo this point, we have been considering the assignment of the assignor\xe2\x80\x99s rights (usually, though not solely,\nto money payments). But in every contract, a right connotes a corresponding duty, and these may be\ndelegated. A delegation is the transfer to a third party of the duty to perform under a contract. The one\nwho delegates is the delegator. Because most obligees are also obligors, most assignments of rights will\nsimultaneously carry with them the delegation of duties. Unless public policy or the contract itself bars the\ndelegation, it is legally enforceable.\nIn most states, at common law, duties must be expressly delegated. Under Uniform Commercial Code\n(UCC) Section 2-210(4) and in a minority of states at common law (as illustrated in Section 14.4.2\n"Assignment Includes Delegation",Rose v. Vulcan Materials Co.), an assignment of \xe2\x80\x9cthe contract\xe2\x80\x9d or of\n\xe2\x80\x9call my rights under the contract\xe2\x80\x9d is not only an assignment of rights but also a delegation of duties to be\nperformed; by accepting the assignment, the delegatee (one to whom the delegation is made) implies a\npromise to perform the duties. (See Figure 14.3 "Delegation of Duties")\nFigure 14.3 Delegation of Duties\n\nEffect on Obligor\nAn obligor who delegates a duty (and becomes a delegator) does not thereby escape liability for\nperforming the duty himself. The obligee of the duty may continue to look to the obligor for performance\nunless the original contract specifically provides for substitution by delegation. This is a big difference\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n480\n\n\x0cbetween assignment of contract rights and delegation of contract duties: in the former, the assignor is\ndischarged (absent breach of assignor\xe2\x80\x99s warranties); in the latter, the delegator remains liable. The obligee\n(again, the one to whom the duty to perform flows) may also, in many cases, look to the delegatee,\nbecause the obligee becomes an intended beneficiary of the contract between the obligor and the\ndelegatee, as discussed in Section 14.3 "Third-Party Beneficiaries". Of course, the obligee may\nsubsequently agree to accept the delegatee and discharge the obligor from any further responsibility for\nperforming the duty. A contract among three persons having this effect is called a novation; it is a new\ncontract. Fred sells his house to Lisa, who assumes his mortgage. Fred, in other words, has delegated the\nduty to pay the bank to Lisa. If Lisa defaults, Fred continues to be liable to the bank, unless in the original\nmortgage agreement a provision specifically permitted any purchaser to be substituted without recourse\nto Fred, or unless the bank subsequently accepts Lisa and discharges Fred.\n\nNondelegable Duties\nPersonal Services\nPersonal services are not delegable. If the contract is such that the promisee expects the obligor personally\nto perform the duty, the obligor may not delegate it. Suppose the Catskill Civic Opera Association hires a\nfamous singer to sing in its production of Carmen and the singer delegates the job to her understudy. The\ndelegation is ineffective, and performance by the understudy does not absolve the famous singer of\nliability for breach.\nMany duties may be delegated, however. Indeed, if they could not be delegated, much of the world\xe2\x80\x99s work\nwould not get done. If you hire a construction company and an architect to design and build your house to\ncertain specifications, the contractor may in turn hire individual craftspeople\xe2\x80\x94plumbers, electricians, and\nthe like\xe2\x80\x94to do these specialized jobs, and as long as they are performed to specification, the contract\nterms will have been met. If you hired an architecture firm, though, you might not be contracting for the\nspecific services of a particular individual in that firm.\n\nPublic Policy\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n481\n\n\x0cPublic policy may prohibit certain kinds of delegations. A public official, for example, may not delegate\nthe duties of her office to private citizens, although various statutes generally permit the delegation of\nduties to her assistants and subordinates.\n\nDelegations Barred by Contract\nAs we have already noted, the contract itself may bar assignment. The law generally disfavors restricting\nthe right to assign a benefit, but it will uphold a contract provision that prohibits delegation of a duty.\nThus, as we have seen, UCC Section 2-210(3) states that in a contract for sale of goods, a provision against\nassigning \xe2\x80\x9cthe contract\xe2\x80\x9d is to be construed only as a prohibition against delegating the duties.\n\nKEY TAKEAWAY\n\nThe duty to perform a contractual obligation may usually be delegated to a third party. Such delegation,\nhowever, does not discharge the delegator, who remains liable on the contract absent a novation.\nSome duties may not be delegated: personal services cannot be, and public policy or the contract itself\nmay bar delegation.\n\nEXERCISES\n\n1.\n\nWhat is the difference between an assignment and a delegation?\n\n2.\n\nUnder what circumstances is the delegator discharged from liability on the contract?\n\n14.3 Third-Party Beneficiaries\n\nLEARNING OBJECTIVES\n\n1.\n\nKnow what a third-party beneficiary is, and what the types of such beneficiaries are.\n\n2.\n\nRecognize the rights obtained by third-party beneficiaries.\n\n3.\n\nUnderstand when the public might be a third-party beneficiary of government contracts.\n\nThe fundamental issue with third-party beneficiaries gets to this: can a person who is not a party to a\ncontract sue to enforce its terms?\n\nThe General Rule\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n482\n\n\x0cThe general rule is this: persons not a party to a contract cannot enforce its terms; they are said to\nlack privity, a private, face-to-face relationship with the contracting parties. But if the persons are\nintended to benefit from the performance of a contract between others, then they can enforce it: they are\nintended beneficiaries.\n\nTwo Types of Third-Party Beneficiaries\nIn the vocabulary of the Restatement, a third person whom the parties to the contract intend to benefit is\nan intended beneficiary\xe2\x80\x94that is, one who is entitled under the law of contracts to assert a right arising\nfrom a contract to which he or she is not a party. There are two types of intended beneficiaries.\n\nCreditor Beneficiary\nA creditor beneficiary is one to whom the promisor agrees to pay a debt of the promisee. For example, a\nfather is bound by law to support his child. If the child\xe2\x80\x99s uncle (the promisor) contracts with the father\n(the promisee) to furnish support for the child, the child is a creditor beneficiary and could sue the uncle.\nOr again, suppose Customer pays Ace Dealer for a new car, and Ace delegates the duty of delivery to Beta\nDealer. Ace is now a debtor: he owes Customer something: a car. Customer is a creditor; she is owed\nsomething: a car. When Beta performs under his delegated contract with Ace, Beta is discharging the debt\nAce owes to Customer. Customer is a creditor beneficiary of Dealers\xe2\x80\x99 contract and could sue either one for\nnondelivery. She could sue Ace because she made a contract with him, and she could sue Beta because\xe2\x80\x94\nagain\xe2\x80\x94she was intended to benefit from the performance of Dealers\xe2\x80\x99 agreement.\n\nDonee Beneficiary\nThe second type of intended beneficiary is a donee beneficiary. When the promisee is not indebted to the\nthird person but intends for him or her to have the benefit of the promisor\xe2\x80\x99s performance, the third\nperson is a donee beneficiary (and the promise is sometimes called a gift promise). For example, an\ninsurance company (the promisor) promises to its policyholder (the promisee), in return for a premium,\nto pay $100,000 to his wife on his death; this makes the wife a donee beneficiary (see Figure 14.1\n"Assignment of Rights"). The wife could sue to enforce the contract although she was not a party to it. Or\nif Able makes a contract with Woodsman for the latter to cut the trees in Able\xe2\x80\x99s backyard as a Christmas\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n483\n\n\x0cgift to Able\xe2\x80\x99s uphill Neighbor (so that Neighbor will have a view), Neighbor could sue Woodsman for\nbreach of the contract.\nIf a person is not an intended beneficiary\xe2\x80\x94not a creditor or donee beneficiary\xe2\x80\x94then he or she is said to be\nonly an incidental beneficiary, and that person has no rights. So if Able makes the contract with\nWoodsman not to benefit Neighbor but for Able\xe2\x80\x99s own benefit, the fact that the tree removal would benefit\nNeighbor does not make Neighbor an intended beneficiary.\nThe beneficiary\xe2\x80\x99s rights are always limited by the terms of the contract. A failure by the promisee to\nperform his part of the bargain will terminate the beneficiary\xe2\x80\x99s rights if the promisee\xe2\x80\x99s lapse terminates\nhis own rights, absent language in the contract to the contrary. If Able makes the contract as a gift to\nNeighbor but doesn\xe2\x80\x99t make the required down payment to Woodsman, Neighbor\xe2\x80\x99s claim fails. In a suit by\nthe beneficiary, the promisor may avail himself of any defense he could have asserted against the\npromisee. Woodsman may defend himself against Neighbor\xe2\x80\x99s claim that Woodsman did not do the whole\njob by showing that Able didn\xe2\x80\x99t make full payment for the work.\n\nModification of the Beneficiary\xe2\x80\x99s Rights\nConferring rights on an intended beneficiary is relatively simple. Whether his rights can be modified or\nextinguished by subsequent agreement of the promisor and promisee is a more troublesome issue. The\ngeneral rule is that the beneficiary\xe2\x80\x99s rights may be altered as long as there has been\nnovesting of rights (the rights have not taken effect). The time at which the beneficiary\xe2\x80\x99s rights vest differs\namong jurisdictions: some say immediately, some say when the beneficiary assents to the receipt of the\ncontract right, some say the beneficiary\xe2\x80\x99s rights don\xe2\x80\x99t vest until she has detrimentally relied on the right.\nThe Restatement says that unless the contract provides that its terms cannot be changed without the\nbeneficiary\xe2\x80\x99s consent, the parties may change or rescind the benefit unless the beneficiary has sued on the\npromise, has detrimentally relied, or has assented to the promise at the request of one of the\nparties.\n\n[1]\n\nSome contracts provide that the benefit never vests; for example, standard insurance policies\n\ntoday reserve to the insured the right to substitute beneficiaries, to borrow against the policy, to assign it,\nand to surrender it for cash.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n484\n\n\x0cGovernment Contracts\nThe general rule is that members of the public are only incidental beneficiaries of contracts made by the\ngovernment with a contractor to do public works. It is not illogical to see a contract between the\ngovernment and a company pledged to perform a service on behalf of the public as one creating rights in\nparticular members of the public, but the consequences of such a view could be extremely costly because\neveryone has some interest in public works and government services.\nA restaurant chain, hearing that the county was planning to build a bridge that would reroute commuter\ntraffic, might decide to open a restaurant on one side of the bridge; if it let contracts for construction only\nto discover that the bridge was to be delayed or canceled, could it sue the county\xe2\x80\x99s contractor? In general,\nthe answer is that it cannot. A promisor under contract to the government is not liable for the\nconsequential damages to a member of the public arising from its failure to perform (or from a faulty\nperformance) unless the agreement specifically calls for such liability or unless the promisee (the\ngovernment) would itself be liable and a suit directly against the promisor would be consistent with the\ncontract terms and public policy. When the government retains control over litigation or settlement of\nclaims, or when it is easy for the public to insure itself against loss, or when the number and amount of\nclaims would be excessive, the courts are less likely to declare individuals to be intended beneficiaries. But\nthe service to be provided can be so tailored to the needs of particular persons that it makes sense to view\nthem as intended beneficiaries\xe2\x80\x94in the case, for example, of a service station licensed to perform\nemergency road repairs, as in Section 14.4.3 "Third party Beneficiaries and Foreseeable\nDamages", Kornblut v. Chevron Oil Co.\n\nKEY TAKEAWAY\n\nGenerally, a person who is not a party to a contract cannot sue to enforce its terms. The exception is if the\nperson is an intended beneficiary, either a creditor beneficiary or a donee beneficiary. Such third parties\ncan enforce the contract made by others but only get such rights as the contract provides, and\nbeneficiaries are subject to defenses that could be made against their benefactor.\nThe general rule is that members of the public are not intended beneficiaries of contracts made by the\ngovernment, but only incidental beneficiaries.\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n485\n\n\x0cEXERCISES\n1.\n\nWhat are the two types of intended beneficiaries?\n\n2.\n\nSmith contracted to deliver a truck on behalf of Truck Sales to Byers, who had purchased it from Truck\nSales. Smith was entitled to payment by Byers for the delivery. The truck was defective. May Byers\nwithhold payment from Smith to offset the repair costs?\n\n3.\n\nWhy is the public not usually considered an intended beneficiary of contracts made by the government?\n\n[1] Restatement (Second) of Contracts, Section 311.\n\n14.4 Cases\nNonassignable Rights\nNassau Hotel Co. v. Barnett & Barse Corporation\n147 N.Y.S. 283 (1914)\nMcLaughlin, J.\nPlaintiff owns a hotel at Long Beach, L. I., and on the 21st of November, 1912, it entered into a written\nagreement with the individual defendants Barnett and Barse to conduct the same for a period of\nyears.\xe2\x80\xa6Shortly after this agreement was signed, Barnett and Barse organized the Barnett & Barse\nCorporation with a capital stock of $10,000, and then assigned the agreement to it. Immediately following\nthe assignment, the corporation went into possession and assumed to carry out its terms. The plaintiff\nthereupon brought this action to cancel the agreement and to recover possession of the hotel and\nfurniture therein, on the ground that the agreement was not assignable. [Summary judgment in favor of\nthe plaintiff, defendant corporation appeals.]\nThe only question presented is whether the agreement was assignable. It provided, according to the\nallegations of the complaint, that the plaintiff leased the property to Barnett and Barse with all its\nequipment and furniture for a period of three years, with a privilege of five successive renewals of three\nyears each. It expressly provided:\n\xe2\x80\x98That said lessees\xe2\x80\xa6become responsible for the operation of the said hotel and for the upkeep and\nmaintenance thereof and of all its furniture and equipment in accordance with the terms of this\nagreement and the said lessees shall have the exclusive possession, control and management thereof. * * *\nThe said lessees hereby covenant and agree that they will operate the said hotel at all times in a first-class\nbusiness-like manner, keep the same open for at least six (6) months of each year, * * *\xe2\x80\x99 and \xe2\x80\x98in lieu of\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n486\n\n\x0crental the lessor and lessees hereby covenant and agree that the gross receipts of such operation shall be,\nas received, divided between the parties hereto as follows: (a) Nineteen per cent. (19%) to the lessor. * * *\nIn the event of the failure of the lessees well and truly to perform the covenants and agreements herein\ncontained,\xe2\x80\x99 they should be liable in the sum of $50,000 as liquidated damages. That \xe2\x80\x98in consideration and\nupon condition that the said lessees shall well and faithfully perform all the covenants and agreements by\nthem to be performed without evasion or delay the said lessor for itself and its successors, covenants and\nagrees that the said lessees, their legal representatives and assigns may at all times during said term and\nthe renewals thereof peaceably have and enjoy the said demised premises.\xe2\x80\x99 And that \xe2\x80\x98this agreement shall\ninure to the benefit of and bind the respective parties hereto, their personal representatives, successors\nand assigns.\xe2\x80\x99\nThe complaint further alleges that the agreement was entered into by plaintiff in reliance upon the\nfinancial responsibility of Barnett and Barse, their personal character, and especially the experience of\nBarnett in conducting hotels; that, though he at first held a controlling interest in the Barnett & Barse\nCorporation, he has since sold all his stock to the defendant Barse, and has no interest in the corporation\nand no longer devotes any time or attention to the management or operation of the hotel.\n\xe2\x80\xa6[C]learly\xe2\x80\xa6the agreement in question was personal to Barnett and Barse and could not be assigned by\nthem without the plaintiff\xe2\x80\x99s consent. By its terms the plaintiff not only entrusted them with the care and\nmanagement of the hotel and its furnishings\xe2\x80\x94valued, according to the allegations of the complaint, at\nmore than $1,000,000\xe2\x80\x94but agreed to accept as rental or compensation a percentage of the gross receipts.\nObviously, the receipts depended to a large extent upon the management, and the care of the property\nupon the personal character and responsibility of the persons in possession. When the whole agreement is\nread, it is apparent that the plaintiff relied, in making it, upon the personal covenants of Barnett and\nBarse. They were financially responsible. As already said, Barnett had had a long and successful\nexperience in managing hotels, which was undoubtedly an inducing cause for plaintiff\xe2\x80\x99s making the\nagreement in question and for personally obligating them to carry out its terms.\nIt is suggested that because there is a clause in the agreement to the effect that it should \xe2\x80\x98inure to the\nbenefit of and bind the respective parties hereto, their personal representatives and assigns,\xe2\x80\x99 that Barnett\nand Barse had a right to assign it to the corporation. But the intention of the parties is to be gathered, not\nfrom one clause, but from the entire instrument [Citation] and when it is thus read it clearly appears that\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n487\n\n\x0cBarnett and Barse were to personally carry out the terms of the agreement and did not have a right to\nassign it. This follows from the language used, which shows that a personal trust or confidence was\nreposed by the plaintiff in Barnett and Barse when the agreement was made.\nIn [Citation] it was said: \xe2\x80\x9cRights arising out of contract cannot be transferred if they\xe2\x80\xa6involve a relation of\npersonal confidence such that the party whose agreement conferred those rights must have intended them\nto be exercised only by him in whom he actually confided.\xe2\x80\x9d\nThis rule was applied in [Citation] the court holding that the plaintiff\xe2\x80\x94the assignee\xe2\x80\x94was not only\ntechnically, but substantially, a different entity from its predecessor, and that the defendant was not\nobliged to entrust its money collected on the sale of the presses to the responsibility of an entirely\ndifferent corporation from that with which it had contracted, and that the contract could not be assigned\nto the plaintiff without the assent of the other party to it.\nThe reason which underlies the basis of the rule is that a party has the right to the benefit contemplated\nfrom the character, credit, and substance of him with whom he contracts, and in such case he is not bound\nto recognize\xe2\x80\xa6an assignment of the contract.\nThe order appealed from, therefore, is affirmed.\n\nCASE QUESTIONS\n\n1.\n\nThe corporation created to operate the hotel was apparently owned and operated by the same two men\nthe plaintiff leased the hotel to in the first place. What objection would the plaintiff have to the corporate\nentity\xe2\x80\x94actually, of course, a legal fiction\xe2\x80\x94owning and operating the hotel?\n\n2.\n\nThe defendants pointed to the clause about the contract inuring to the benefit of the parties \xe2\x80\x9cand\nassigns.\xe2\x80\x9d So the defendants assigned the contract. How could that not be allowed by the contract\xe2\x80\x99s own\nterms?\n\n3.\n\nWhat is the controlling rule of law upon which the outcome here depends?\n\nAssignment Includes Delegation\nRose v. Vulcan Materials Co.\n194 S.E.2d 521 (N.C. 1973)\nHuskins, J.\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n488\n\n\x0c\xe2\x80\xa6Plaintiff [Rose], after leasing his quarry to J. E. Dooley and Son, Inc., promised not to engage in the\nrock-crushing business within an eight-mile radius of [the city of] Elkin for a period of ten years. In return\nfor this promise, J. E. Dooley and Son, Inc., promised, among other things, to furnish plaintiff stone f.o.b.\nthe quarry site at Cycle, North Carolina, at stipulated prices for ten years.\xe2\x80\xa6\nBy a contract effective 23 April 1960, Vulcan Materials Company, a corporation\xe2\x80\xa6, purchased the stone\nquarry operations and the assets and obligations of J. E. Dooley and Son, Inc.\xe2\x80\xa6[Vulcan sent Rose a letter,\npart of which read:]\nMr. Dooley brought to us this morning the contracts between you and his companies, copies of\nwhich are attached. This is to advise that Vulcan Materials Company assumes all phases of these\ncontracts and intends to carry out the conditions of these contracts as they are stated.\nIn early 1961 Vulcan notified plaintiff that it would no longer sell stone to him at the prices set out in [the\nagreement between Rose and Dooley] and would thereafter charge plaintiff the same prices charged all of\nits other customers for stone. Commencing 11 May 1961, Vulcan raised stone prices to the plaintiff to a\nlevel in excess of the prices specified in [the Rose-Dooley agreement].\nAt the time Vulcan increased the prices of stone to amounts in excess of those specified in [the RoseDooley contract], plaintiff was engaged in his ready-mix cement business, using large quantities of stone,\nand had no other practical source of supply. Advising Vulcan that he intended to sue for breach of\ncontract, he continued to purchase stone from Vulcan under protest.\xe2\x80\xa6\nThe total of these amounts over and above the prices specified in [the Rose-Dooley contract] is\n$25,231.57, [about $152,000 in 2010 dollars] and plaintiff seeks to recover said amount in this action.\nThe [Rose-Dooley] agreement was an executory bilateral contract under which plaintiff\xe2\x80\x99s promise not to\ncompete for ten years gained him a ten-year option to buy stone at specified prices. In most states, the\nassignee of an executory bilateral contract is not liable to anyone for the nonperformance of the assignor\xe2\x80\x99s\nduties thereunder unless he expressly promises his assignor or the other contracting party to perform, or\n\xe2\x80\x98assume,\xe2\x80\x99 such duties.\xe2\x80\xa6These states refuse to imply a promise to perform the duties, but if the assignee\nexpressly promises his assignor to perform, he is liable to the other contracting party on a third-party\nbeneficiary theory. And, if the assignee makes such a promise directly to the other contracting party upon\na consideration, of course he is liable to him thereon. [Citation]\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n489\n\n\x0cA minority of states holds that the assignee of an executory bilateral contract under a general assignment\nbecomes not only assignee of the rights of the assignor but also delegatee of his duties; and that, absent a\nshowing of contrary intent, the assignee impliedly promises the assignor that he will perform the duties so\ndelegated. This rule is expressed in Restatement, Contracts, s 164 (1932) as follows:\n(1) Where a party under a bilateral contract which is at the time wholly or partially executory on\nboth sides purports to assign the whole contract, his action is interpreted, in the absence of\ncircumstances showing a contrary intention, as an assignment of the assignor\xe2\x80\x99s rights under the\ncontract and a delegation of the performance of the assignor\xe2\x80\x99s duties.\n(2) Acceptance by the assignee of such an assignment is interpreted, in the absence of\ncircumstances showing a contrary intention, as both an assent to become an assignee of the\nassignor\xe2\x80\x99s rights and as a promise to the assignor to assume the performance of the\nassignor\xe2\x80\x99s duties.\xe2\x80\x99 (emphasis added)\nWe\xe2\x80\xa6adopt the Restatement rule and expressly hold that the assignee under a general assignment of an\nexecutory bilateral contract, in the absence of circumstances showing a contrary intention, becomes the\ndelegatee of his assignor\xe2\x80\x99s duties and impliedly promises his assignor that he will perform such duties.\nThe rule we adopt and reaffirm here is regarded as the more reasonable view by legal scholars and\ntextwriters. Professor Grismore says:\nIt is submitted that the acceptance of an assignment in this form does presumptively import a\ntacit promise on the part of the assignee to assume the burdens of the contract, and that this\npresumption should prevail in the absence of the clear showing of a contrary intention. The\npresumption seems reasonable in view of the evident expectation of the parties. The assignment\non its face indicates an intent to do more than simply to transfer the benefits assured by the\ncontract. It purports to transfer the contract as a whole, and since the contract is made up of both\nbenefits and burdens both must be intended to be included.\xe2\x80\xa6Grismore, Is the Assignee of a\nContract Liable for the Nonperformance of Delegated Duties? 18 Mich.L.Rev. 284 (1920).\nIn addition, with respect to transactions governed by the Uniform Commercial Code, an assignment of a\ncontract in general terms is a delegation of performance of the duties of the assignor, and its acceptance\nby the assignee constitutes a promise by him to perform those duties. Our holding in this case maintains a\ndesirable uniformity in the field of contract liability.\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n490\n\n\x0cWe further hold that the other party to the original contract may sue the assignee as a third-party\nbeneficiary of his promise of performance which he impliedly makes to his assignor, under the rule above\nlaid down, by accepting the general assignment. Younce v. Lumber Co., [Citation] (1908), holds that\nwhere the assignee makes an express promise of performance to his assignor, the other contracting party\nmay sue him for breach thereof. We see no reason why the same result should not obtain where the\nassignee breaches his promise of performance implied under the rule of Restatement s 164. \xe2\x80\x98That the\nassignee is liable at the suit of the third party where he expressly assumes and promises to perform\ndelegated duties has already been decided in a few cases (citing Younce). If an express promise will\nsupport such an action it is difficult to see why a tacit promise should not have the same effect.\xe2\x80\x99 Grismore,\nsupra. Parenthetically, we note that such is the rule under the Uniform Commercial Code, [2-210].\nWe now apply the foregoing principles to the case at hand. The contract of 23 April 1960, between\ndefendant and J. E. Dooley and Son, Inc., under which, as stipulated by the parties, \xe2\x80\x98the defendant\npurchased the assets and obligations of J. E. Dooley and Son, Inc.,\xe2\x80\x99 was a general assignment of all the\nassets and obligations of J. E. Dooley and Son, Inc., including those under [the Rose-Dooley contract].\nWhen defendant accepted such assignment it thereby became delegatee of its assignor\xe2\x80\x99s duties under it\nand impliedly promised to perform such duties.\nWhen defendant later failed to perform such duties by refusing to continue sales of stone to plaintiff at the\nprices specified in [the Rose-Dooley contract], it breached its implied promise of performance and\nplaintiff was entitled to bring suit thereon as a third-party beneficiary.\nThe decision\xe2\x80\xa6is reversed with directions that the case be certified to the Superior Court of Forsyth County\nfor reinstatement of the judgment of the trial court in accordance with this opinion.\n\nCASE QUESTIONS\n\n1.\n\nWhy did Rose need the crushed rock from the quarry he originally leased to Dooley?\n\n2.\n\nWhat argument did Vulcan make as to why it should not be liable to sell crushed rock to Rose at the price\nset out in the Rose-Dooley contract?\n\n3.\n\nWhat rule did the court here announce in deciding that Vulcan was required to sell rock at the price set\nout in the Rose-Dooley contract? That is, what is the controlling rule of law in this case?\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n491\n\n\x0cThird party Beneficiaries and Foreseeable Damages\nKornblut v. Chevron Oil Co.\n62 A.D.2d 831 (N.Y. 1978)\nHopkins, J.\nThe plaintiff-respondent has recovered a judgment after a jury trial in the sum of $519,855.98 [about $1.9\nmillion in 2010 dollars] including interest, costs and disbursements, against Chevron Oil Company\n(Chevron) and Lawrence Ettinger, Inc. (Ettinger) (hereafter collectively referred to as defendants) for\ndamages arising from the death and injuries suffered by Fred Kornblut, her husband. The case went to the\njury on the theory that the decedent was the third-party beneficiary of a contract between Chevron and\nthe New York State Thruway Authority and a contract between Chevron and Ettinger.\nOn the afternoon of an extremely warm day in early August, 1970 the decedent was driving northward on\nthe New York State Thruway. Near Sloatsburg, New York, at about 3:00 p.m., his automobile sustained a\nflat tire. At the time the decedent was accompanied by his wife and 12-year-old son. The decedent waited\nfor assistance in the 92 degree temperature.\nAfter about an hour a State Trooper, finding the disabled car, stopped and talked to the decedent. The\ntrooper radioed Ettinger, which had the exclusive right to render service on the Thruway under an\nassignment of a contract between Chevron and the Thruway Authority. Thereafter, other State Troopers\nreported the disabled car and the decedent was told in each instance that he would receive assistance\nwithin 20 minutes.\nHaving not received any assistance by 6:00 p.m., the decedent attempted to change the tire himself. He\nfinally succeeded, although he experienced difficulty and complained of chest pains to the point that his\nwife and son were compelled to lift the flat tire into the trunk of the automobile. The decedent drove the\ncar to the next service area, where he was taken by ambulance to a hospital; his condition was later\ndiagnosed as a myocardial infarction. He died 28 days later.\nPlaintiff sued, inter alia, Chevron and Ettinger alleging in her complaint causes of action sounding in\nnegligence and breach of contract. We need not consider the issue of negligence, since the Trial Judge\ninstructed the jury only on the theory of breach of contract, and the plaintiff has recovered damages for\nwrongful death and the pain and suffering only on that theory.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n492\n\n\x0cWe must look, then, to the terms of the contract sought to be enforced. Chevron agreed to provide \xe2\x80\x9crapid\nand efficient roadside automotive service on a 24-hour basis from each gasoline service station facility for\nthe areas\xe2\x80\xa6when informed by the authority or its police personnel of a disabled vehicle on the Thruway\xe2\x80\x9d.\nChevron\xe2\x80\x99s vehicles are required \xe2\x80\x9cto be used and operated in such a manner as will produce adequate\nservice to the public, as determined in the authority\xe2\x80\x99s sole judgment and discretion\xe2\x80\x9d. Chevron specifically\ncovenanted that it would have \xe2\x80\x9csufficient roadside automotive service vehicles, equipment and personnel\nto provide roadside automotive service to disabled vehicles within a maximum of thirty (30) minutes from\nthe time a call is assigned to a service vehicle, subject to unavoidable delays due to extremely adverse\nweather conditions or traffic conditions.\xe2\x80\x9d\xe2\x80\xa6\nIn interpreting the contract, we must bear in mind the circumstances under which the parties bargained.\nThe New York Thruway is a limited access toll highway, designed to move traffic at the highest legal\nspeed, with the north and south lanes separated by green strips. Any disabled vehicle on the road\nimpeding the flow of traffic may be a hazard and inconvenience to the other users. The income realized\nfrom tolls is generated from the expectation of the user that he will be able to travel swiftly and smoothly\nalong the Thruway. Consequently, it is in the interest of the authority that disabled vehicles will be\nrepaired or removed quickly to the end that any hazard and inconvenience will be minimized. Moreover,\nthe design and purpose of the highway make difficult, if not impossible, the summoning of aid from\ngarages not located on the Thruway. The movement of a large number of vehicles at high speed creates a\nrisk to the operator of a vehicle who attempts to make his own repairs, as well as to the other users. These\nconsiderations clearly prompted the making of contracts with service organizations which would be\nlocated at points near in distance and time on the Thruway for the relief of distressed vehicles.\nThus, it is obvious that, although the authority had an interest in making provision for roadside calls\nthrough a contract, there was also a personal interest of the user served by the contract. Indeed, the\ncontract provisions regulating the charges for calls and commanding refunds be paid directly to the user\nfor overcharges, evince a protection and benefit extended to the user only. Hence, in the event of an\novercharge, the user would be enabled to sue on the contract to obtain a recovery.\xe2\x80\xa6Here the contract\ncontemplates an individual benefit for the breach running to the user.\xe2\x80\xa6\nBy choosing the theory of recovery based on contract, it became incumbent on the plaintiff to show that\nthe injury was one which the defendants had reason to foresee as a probable result of the breach, under\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n493\n\n\x0cthe ancient doctrine of Hadley v Baxendale [Citation], and the cases following it\xe2\x80\xa6in distinction to the\nrequirement of proximate cause in tort actions.\xe2\x80\xa6\nThe death of the decedent on account of his exertion in the unusual heat of the midsummer day in\nchanging the tire cannot be said to have been within the contemplation of the contracting parties as a\nreasonably foreseeable result of the failure of Chevron or its assignee to comply with the contract.\xe2\x80\xa6\nThe case comes down to this, then, in our view: though the decedent was the intended beneficiary to sue\nunder certain provisions of the contract\xe2\x80\x94such as the rate specified for services to be rendered\xe2\x80\x94he was not\nthe intended beneficiary to sue for consequential damages arising from personal injury because of a\nfailure to render service promptly. Under these circumstances, the judgment must be reversed and the\ncomplaint dismissed, without costs or disbursements.\n[Martuscello, J., concurred in the result but opined that the travelling public was not an intended\nbeneficiary of the contract.]\n\nCASE QUESTIONS\n\n1.\n\nChevron made two arguments as to why it should not be liable for Mr. Kornblut\xe2\x80\x99s death. What were they?\n\n2.\n\nObviously, when Chevron made the contract with the New York State Thruway Authority, it did not know\nMr. Kornblut was going to be using the highway. How could he, then, be an intended beneficiary of the\ncontract?\n\n3.\n\nWhy was Chevron not found liable for Mr. Kornblut\xe2\x80\x99s death when, clearly, had it performed the contract\nproperly, he would not have died?\n\n14.5 Summary and Exercises\nSummary\n\nThe general rule that the promisee may assign any right has some exceptions\xe2\x80\x94for example, when the\npromisor\xe2\x80\x99s obligation would be materially changed. Of course the contract itself may prohibit assignment,\nand sometimes statutes preclude it. Knowing how to make the assignment effective and what the\nconsequences of the assignment are on others is worth mastering. When, for example, does the assignee\nnot stand in the assignor\xe2\x80\x99s shoes? When may a future right be assigned?\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n494\n\n\x0cDuties, as well as rights, may be transferred to third parties. Most rights (promises) contained in contracts\nhave corresponding duties (also expressed as promises). Often when an entire contract is assigned, the\nduties go with it; the transferee is known, with respect to the duties, as the delegatee. The transferor\nhimself does not necessarily escape the duty, however. Moreover, some duties are nondelegable, such as\npersonal promises and those that public policy require to be carried out by a particular official. Without\nthe ability to assign rights and duties, much of the modern economy would grind to a halt.\nThe parties to a contract are not necessarily the only people who acquire rights or duties under it. One\nmajor category of persons acquiring rights is third-party beneficiaries. Only intended beneficiaries acquire\nrights under the contract, and these are of two types: creditor and donee beneficiaries. The rules for\ndetermining whether rights have been conferred are rather straightforward; determining whether rights\ncan subsequently be modified or extinguished is more troublesome. Generally, as long as the contract\ndoes not prohibit change and as long as the beneficiary has not relied on the promise, the change may be\nmade.\n\n1.\n\nEXERCISES\n\nThe Dayton Country Club offered its members various social activities. Some members were entitled, for\nadditional payment, to use the golf course, a coveted amenity. Golfing memberships could not be\ntransferred except upon death or divorce, and there was a long waiting list in this special category; if a\nperson at the top of the list declined, the next in line was eligible. Golfing membership rules were drawn\nup by a membership committee. Magness and Redman were golfing members. They declared bankruptcy,\nand the bankruptcy trustee sought, in order to increase the value of their debtors\xe2\x80\x99 estates, to assume and\nsell the golfing memberships to members on the waiting list, other club members, or the general public,\nprovided the persons joined the club. The club asserted that under relevant state law, it was \xe2\x80\x9cexcused\nfrom rendering performance to an entity other than the debtor\xe2\x80\x9d\xe2\x80\x94that is, it could not be forced to accept\nstrangers as members. Can these memberships be assigned?\n\n2.\n\nTenant leased premises in Landlord\xe2\x80\x99s shopping center, agreeing in the lease \xe2\x80\x9cnot to assign, mortgage,\npledge, or encumber this lease in whole or in part.\xe2\x80\x9d Under the lease, Tenant was entitled to a\nconstruction allowance of up to $11,000 after Tenant made improvements for its uses. Prior to the\ncompletion of the improvements, Tenant assigned its right to receive the first $8,000 of the construction\nallowance to Assignee, who, in turn, provided Tenant $8,000 to finance the construction. Assignee\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n495\n\n\x0cnotified Landlord of the assignment, but when the construction was complete, Landlord paid Tenant\nanyway; when Assignee complained, Landlord pointed to the nonassignment clause. Assignee sued\nLandlord. Who wins?\n3.\n\n[1]\n\nMarian contracted to sell her restaurant to Billings for $400,000. The contract provided that Billings would\npay $100,000 and sign a note for the remainder. Billings sold the restaurant to Alice, who agreed to\nassume responsibility for the balance due on the note held by Marian. But Alice had difficulties and\ndeclared bankruptcy. Is Billings still liable on the note to Marian?\n4.\n\nYellow Cab contracted with the Birmingham Board of Education to transport physically\nhandicapped students. The contract provided, \xe2\x80\x9cYellow Cab will transport the physically\nhandicapped students of the School System\xe2\x80\xa6and furnish all necessary vehicles and personnel and\nwill perform all maintenance and make all repairs to the equipment to keep it in a safe and\nefficient operating condition at all times.\xe2\x80\x9d\nYellow Cab subcontracted with Metro Limousine to provide transportation in connection with its\ncontract with the board. Thereafter, Metro purchased two buses from Yellow Cab to use in\ntransporting the students. DuPont, a Metro employee, was injured when the brakes on the bus\nthat he was driving failed, causing the bus to collide with a tree. DuPont sued Yellow Cab, alleging\nthat under its contract with the board, Yellow Cab had a nondelegable duty to properly maintain\nthe bus so as to keep it in a safe operating condition; that that duty flowed to him as an intended\nthird-party beneficiary of the contract; and that Yellow Cab had breached the contract by failing to\nproperly maintain the bus. Who wins?\n\n5.\n\n[2]\n\nJoan hired Groom to attend to her herd of four horses at her summer place in the high desert. The job\nwas too much for Groom, so he told Tony that he (Groom) would pay Tony, who claimed expertise in\ncaring for horses, to take over the job. Tony neglected the horses in hot weather, and one of them\nneeded veterinarian care for dehydration. Is Groom liable?\n\n6.\n\nRensselaer Water Company contracted with the city to provide water for business, domestic, and firehydrant purposes. While the contract was in effect, a building caught on fire; the fire spread to Plaintiff\xe2\x80\x99s\n(Moch Co.\xe2\x80\x99s) warehouse, destroying it and its contents. The company knew of the fire but was unable to\nsupply adequate water pressure to put it out. Is the owner of the warehouse able to maintain a claim\nagainst the company for the loss?\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n496\n\n\x0c7.\n\nRusty told Alice that he\xe2\x80\x99d do the necessary overhaul on her classic car for $5,000 during the month of\nMay, and that when the job was done, she should send the money to his son, Jim, as a graduation\npresent. He confirmed the agreement in writing and sent a copy to Jim. Subsequently, Rusty changed his\nmind. What right has Jim?\n\n8.\n\nFox Brothers agreed to convey to Clayton Canfield Lot 23 together with a one-year option to purchase Lot\n24 in a subdivision known as Fox Estates. The agreement contained no prohibitions, restrictions, or\nlimitations against assignments. Canfield paid the $20,000 and took title to Lot 23 and the option to Lot\n24. Canfield thereafter assigned his option rights in Lot 24 to the Scotts. When the Scotts wanted to\nexercise the option, Fox Brothers refused to convey the property to them. The Scotts then brought suit\nfor specific performance. Who wins?\n\n9.\n\nRollins sold Byers, a businessperson, a flatbed truck on a contract; Rollins assigned the contract to Frost,\nand informed Byers of the assignment. Rollins knew the truck had problems, which he did not reveal to\nByers. When the truck needed $3,200 worth of repairs and Rollins couldn\xe2\x80\x99t be found, Byers wanted to\ndeduct that amount from payments owed to Frost, but Frost insisted he had a right to payment. Upon\ninvestigation, Byers discovered that four other people in the state had experienced similar situations with\nRollins and with Frost as Rollins\xe2\x80\x99s assignee. What recourse has Byers?\n\n10. Merchants and resort owners in the San Juan Islands in Washington State stocked extra supplies, some\nperishable, in anticipation of the flood of tourists over Labor Day. They suffered inconvenience and\nmonetary damage due to the union\xe2\x80\x99s Labor Day strike of the state ferry system, in violation of its\ncollective bargaining agreement with the state and of a temporary restraining order. The owners sued the\nunion for damages for lost profits, attorney fees, and costs, claiming the union should be liable for\nintentional interference with contractual relations (the owners\xe2\x80\x99 relations with their would-be customers).\nDo the owners have a cause of action?\n\nSELF-TEST QUESTIONS\n\n1.\n\nA creditor beneficiary is\na.\n\nthe same as a donee beneficiary\n\nb.\n\na third-party beneficiary\n\nc.\n\nan incidental beneficiary\n\nd.\n\nnone of the above\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n497\n\n\x0cAssignments are not allowed\na.\n\nfor rights that will arise from a future contract\nb.\n\nwhen they will materially change the duties that the obligor must perform\n\nc.\n\nwhere they are forbidden by public policy\n\nd.\n\nfor any of the above\nWhen an assignor assigns the same interest twice,\n\na.\n\nthe subsequent assignee generally takes precedence\nb.\n\nthe first assignee generally takes precedence\n\nc.\n\nthe first assignee always takes precedence\n\nd.\n\nthe assignment violates public policy\n\nFactoring\na.\n\nis an example of delegation of duties\nb.\n\ninvolves using an account receivable as collateral for a loan\n\nc.\n\ninvolves the purchase of a right to receive income from another\n\nd.\n\nis all of the above\nPersonal promises\n\na.\n\nare always delegable\n\n1.\n\nb\n\n2.\n\nd\n\n3.\n\nb\n\n4.\n\nc\n\n5.\n\nb\n6.\n\nb.\n\nare generally not delegable\n\nc.\n\nare delegable if not prohibited by public policy\n\nd.\n\nare delegable if not barred by the contract\n\nSELF-TEST ANSWERS\n\n[1] Aldana v. Colonial Palms Plaza, Inc., 591 So.2d 953 (Fla. Ct. App., 1991).\n\n7. [2] DuPont v. Yellow Cab Co. of Birmingham, Inc., 565 So.2d 190 (Ala. 1990).\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n498\n\n\x0cChapter 15\n\nDischarge of Obligations\nLEARNING OBJECTIVES\nAfter reading this chapter, you should understand the following:\n1.\n\nWhat is meant by discharge of contract obligations\n\n2.\n\nHow contract obligations are discharged\n\n15.1 Discharge of Contract Duties\n\nLEARNING OBJECTIVES\n\n1.\n\nUnderstand how performance, partial performance, or no performance may discharge contractual\nobligations.\n\n2.\n\nRecognize what rights accrue to the nonbreaching party when the other side announces, before the time\nfor performance, that performance will not be forthcoming\xe2\x80\x94anticipatory breach.\n\n3.\n\nUnderstand the concept of the right to adequate assurances, and the consequences if no such assurances\nare forthcoming.\n\nA person is liable to perform agreed-to contract duties until or unless he or she is discharged. If the\nperson fails to perform without being discharged, liability for damages arises. Here we deal with the\nsecond-to-the-last of the four broad themes of contract law: how contract duties are discharged.\n\nDischarge by Performance (or Nonperformance) of the Duty\nA contract can be discharged by complete performance or material nonperformance of the contractual\nduty. Note, in passing, that the modern trend at common law (and explicit under the Uniform\nCommercial Code [UCC], Section 1-203) is that the parties have a good-faith duty to perform to each\nother. There is in every contract \xe2\x80\x9can implied covenant of good faith\xe2\x80\x9d (honesty in fact in the transaction)\nthat the parties will deal fairly, keep their promises, and not frustrate the other party\xe2\x80\x99s reasonable\nexpectations of what was given and what received.\n\nFull Performance\nFull performance of the contractual obligation discharges the duty. If Ralph does a fine job of plumbing\nBetty\xe2\x80\x99s new bathroom, she pays him. Both are discharged.\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n499\n\n\x0cNonperformance, Material Breach\nIf Ralph doesn\xe2\x80\x99t do any work at all on Betty\xe2\x80\x99s bathroom, or almost none, then Betty owes him nothing.\nShe\xe2\x80\x94the nonbreaching party\xe2\x80\x94is discharged, and Ralph is liable for breach of contract.\nUnder UCC Section 2-106(4), a party that ends a contract breached by the other party is said to have\neffected a cancellation. The cancelling party retains the right to seek a remedy for breach of the whole\ncontract or any unperformed obligation. The UCC distinguishes cancellation from termination, which\noccurs when either party exercises a lawful right to end the contract other than for breach. When a\ncontract is terminated, all executory duties are discharged on both sides, but if there has been a partial\nbreach, the right to seek a remedy survives.\n\n[1]\n\nSubstantial Performance\nLogically, anything less than full performance, even a slight deviation from what is owed, is sufficient to\nprevent the duty from being discharged and can amount to a breach of contract. So if Ralph does all the\nplumbing for Betty\xe2\x80\x99s new bathroom except hook up the toilet feed, he has not really \xe2\x80\x9cplumbed the new\nbathroom.\xe2\x80\x9d He has only plumbed part of it. At classic common law, that was it: either you did the thing\nyou promised completely or you had materially breached. But under modern theories, an ameliorative\ndoctrine has developed, called substantial performance: if one side has substantially, but not completely,\nperformed, so that the other side has received a benefit, the nonbreaching party owes something for the\nvalue received. The Restatement (Second) of Contracts puts it this way:\n\n[2]\n\nSubstantial Performance.\nIn an important category of disputes over failure of performance, one party asserts the right to\npayment on the ground that he has completed his performance, while the other party refuses to\npay on the ground that there is an uncured material failure of performance.\xe2\x80\xa6In such cases it is\ncommon to state the issue\xe2\x80\xa6in terms of whether there has been substantial performance.\xe2\x80\xa6If there\nhas been substantial although not full performance, the building contractor has a claim for the\nunpaid balance and the owner has a claim only for damages. If there has not been substantial\nperformance, the building contractor has no claim for the unpaid balance, although he may have\na claim in restitution.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n500\n\n\x0cThe contest here is between the one who claims discharge by the other\xe2\x80\x99s material breach and the one who\nasserts there has been substantial performance. What constitutes substantial performance is a question of\nfact, as illustrated in Section 15.2.1 "Substantial Performance; Conditions Precedent",TA Operating Corp.\nv. Solar Applications Engineering, Inc. The doctrine has no applicability where the breaching party\nwillfully failed to follow the contract, as where a plumber substitutes a different faucet for the one\nordered; installation of the incorrect faucet is a breach, even if it is of equal or greater value than the one\nordered.\nUnder the UCC, there is no such thing as substantial performance. Section 2-601 requires that the goods\ndelivered according to the contract be the exact things ordered\xe2\x80\x94that there be a perfect tender (unless the\nparties agree otherwise).\n\nAnticipatory Breach and Demand for Reasonable Assurances\nWhen a promisor announces before the time his performance is due that he will not perform, he is said to\nhave committed an anticipatory breach (or repudiation). Of course a person cannot fail to perform a duty\nbefore performance is due, but the law allows the promisee to treat the situation as a material breach that\ngives rise to a claim for damages and discharges the obligee from performing duties required of him under\nthe contract. The common-law rule was first recognized in the well-known 1853 British case Hochster v.\nDe La Tour. In April, De La Tour hired Hochster as his courier, the job to commence in June. In May, De\nLa Tour changed his mind and told Hochster not to bother to report for duty. Before June, Hochster\nsecured an appointment as courier to Lord Ashburton, but that job was not to begin until July. Also in\nMay, Hochster sued De La Tour, who argued that he should not have to pay Hochster because Hochster\nhad not stood ready and willing to begin work in June, having already agreed to work for Lord Ashburton.\nThe court ruled for the plaintiff Hochster:\n[I]t is surely much more rational, and more for the benefit of both parties, that, after the\nrenunciation of the agreement by the defendant, the plaintiff should be at liberty to consider\nhimself absolved from any future performance of it, retaining his right to sue for any damage he\nhas suffered from the breach of it. Thus, instead of remaining idle and laying out money in\npreparations which must be useless, he is at liberty to seek service under another employer,\nwhich would go in mitigation of the damages to which he would otherwise be entitled for a\nbreach of the contract. It seems strange that the defendant, after renouncing the contract, and\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n501\n\n\x0cabsolutely declaring that he will never act under it, should be permitted to object that faith is\ngiven to his assertion, and that an opportunity is not left to him of changing his mind.\n\n[3]\n\nAnother type of anticipatory breach consists of any voluntary act by a party that destroys, or seriously\nimpairs, that party\xe2\x80\x99s ability to perform the promise made to the other side. If a seller of land, having\nagreed to sell a lot to one person at a date certain, sells it instead to a third party before that time, there is\nan anticipatory breach. If Carpenter announces in May that instead of building Owner\xe2\x80\x99s deck in July, as\nagreed, he is going on a trip to Europe, there is an anticipatory breach. In the first instance, there would\nbe no point to showing up at the lawyer\xe2\x80\x99s office when the date arrives to await the deed, so the law gives a\nright to sue when the land is sold to the other person. In the second instance, there would be no point to\nwaiting until July, when indeed Carpenter does not do the job, so the law gives the right to sue when the\nfuture nonperformance is announced.\nThese same general rules prevail for contracts for the sale of goods under UCC Section 2-610.\nRelated to the concept of anticipatory breach is the idea that the obligee has a right to demand reasonable\nassurances from the obligor that contractual duties will be performed. If the obligee makes such\nademand for reasonable assurances and no adequate assurances are forthcoming, the obligee may assume\nthat the obligor will commit an anticipatory breach, and consider it so. That is, after making the contract,\nthe obligee may come upon the disquieting news that the obligor\xe2\x80\x99s ability to perform is shaky. A change in\nfinancial condition occurs, an unknown claimant to rights in land appears, a labor strike arises, or any of a\nnumber of situations may crop up that will interfere with the carrying out of contractual duties. Under\nsuch circumstances, the obligee has the right to a demand for reasonable assurance that the obligor will\nperform as contractually obligated. The general reason for such a rule is given in UCC Section 2-609(1),\nwhich states that a contract \xe2\x80\x9cimposes an obligation on each party that the other\xe2\x80\x99s expectation of receiving\ndue performance will not be impaired.\xe2\x80\x9d Moreover, an obligee would be foolish not to make alternative\narrangements, if possible, when it becomes obvious that his original obligor will be unable to perform.\nThe obligee must have reasonable grounds to believe that the obligor will breach. The fear must be that of\na failure of performance that would amount to a total breach; a minor defect that can be cured and that at\nmost would give rise to an offset in price for damages will not generally support a demand for assurances.\nUnder UCC Section 2-609(1), the demand must be in writing, but at common law the demand may be oral\nif it is reasonable in view of the circumstances. If the obligor fails within a reasonable time to give\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n502\n\n\x0cadequate assurance, the obligee may treat the failure to do so as an anticipatory repudiation, or she may\nwait to see if the obligor might change his mind and perform.\n\nKEY TAKEAWAY\n\nContracts can be discharged by performance: complete performance discharges both sides; material\nbreach discharges the breaching party, who has a right to claim damages; substantial performance\nobligates the promisee to pay something for the benefit conferred but is a breach. A party may demand\nreasonable assurances of performance, which, if not forthcoming, may be treated as an anticipatory\nbreach (or repudiation).\n\nEXERCISES\n\n1.\n\nWhat types of performance discharge a contractual obligation?\n\n2.\n\nUnder the UCC, what is the difference between cancellation and termination of a contract?\n\n3.\n\nWhat is an anticipatory breach, and under what circumstances can a party claim it?\n\nDischarge by Conditions\n\nLEARNING OBJECTIVES\n\n1.\n\nUnderstand the concept of conditions in a contract.\n\n2.\n\nRecognize that conditions can be classified on the basis of how they are created, their effect on the duty\nto perform, the essentialness of timely performance, or performance to someone\xe2\x80\x99s satisfaction.\n\nUsually contracts consist of an exchange of promises\xe2\x80\x94a pledge or commitment by each party that\nsomebody will or will not do something. Andy\xe2\x80\x99s promise to cut Anne\xe2\x80\x99s lawn \xe2\x80\x9cover the weekend\xe2\x80\x9d in return\nfor Anne\xe2\x80\x99s promise to pay twenty-five dollars is a commitment to have the lawn mowed by Sunday night\nor Monday morning. Andy\xe2\x80\x99s promise \xe2\x80\x9cnot to tell anyone what I saw you doing Saturday night\xe2\x80\x9d in return\nfor Anne\xe2\x80\x99s promise to pay one hundred dollars is a commitment that an event (the revealing of a secret)\nwill not occur. These promises are known as independent or absolute or unconditional, because their\nperformance does not depend on any outside event. Such promises, if contractually binding, create a\npresent duty to perform (or a duty to perform at the time stated).\nHowever, it is common that the obligation to perform a contract is conditioned (or conditional).\nA condition is an event the happening or nonhappening of which gives rise to a duty to perform (or\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n503\n\n\x0cdischarges a duty to perform). Conditions may be express or implied; they may also be precedent,\nconcurrent, subsequent, or to the satisfaction of a party.\n\nConditions Classified Based on How They Are Created\nExpress conditions are stated in words in the contract, orally or written. Andy promises to mow Anne\xe2\x80\x99s\nlawn \xe2\x80\x9cprovided it doesn\xe2\x80\x99t rain.\xe2\x80\x9d \xe2\x80\x9cProvided it doesn\xe2\x80\x99t rain\xe2\x80\x9d is an express condition. If rain comes, there is\nno duty to cut the lawn, and Andy\xe2\x80\x99s failure to do so is not a breach of promise. Express conditions are\nusually introduced by language such as \xe2\x80\x9cprovided that,\xe2\x80\x9d \xe2\x80\x9cif,\xe2\x80\x9d \xe2\x80\x9cwhen,\xe2\x80\x9d \xe2\x80\x9cassuming that,\xe2\x80\x9d \xe2\x80\x9cas soon as,\xe2\x80\x9d\n\xe2\x80\x9cafter,\xe2\x80\x9d and the like. Implied conditions are unexpressed but understood to be part of the contract. If Mr.\nOlson guarantees Jack\xe2\x80\x99s used car for ninety days, it is implied that his obligation to fix any defects doesn\xe2\x80\x99t\narise until Jack lets him know the car is defective. If Ralph is hired to plumb Betty\xe2\x80\x99s new bathroom, it is\nimplied that Betty\xe2\x80\x99s duty to pay is conditioned on Ralph\xe2\x80\x99s completion of the job.\n\nConditions Classified Based on Their Effect on Duty to Perform\nA condition precedent is a term in a contract (express or implied) that requires performance only in the\nevent something else happens first. Jack will buy a car from Mr. Olson if Jack gets financing. \xe2\x80\x9cIf Jack gets\nfinancing\xe2\x80\x9d is a condition precedent. A concurrent condition arises when the duty to perform the contract\nis simultaneous: the promise of a landowner to transfer title to the purchaser and the purchaser to tender\npayment to the seller. The duty of each to perform is conditioned on the performance by the other. (As a\npractical matter, of course, somebody has to make the first move, proffering deed or tendering the check.)\nA condition that terminates an already existing duty of performance is known as a condition subsequent.\nRalph agrees to do preventive plumbing maintenance on Deborah Dairy\xe2\x80\x99s milking equipment for as long\nas David Dairy, Deb\xe2\x80\x99s husband, is stationed overseas. When David returns, Ralph\xe2\x80\x99s obligation to do the\nmaintenance (and Deb\xe2\x80\x99s duty to pay him) terminates.\n\nCondition of Timeliness\nIf, as often occurs, it does not matter a great deal whether a contract is performed exactly on time, failure\nto do so is not a material breach, and the promisee has to accept the performance and deduct any losses\ncaused by the delay. If, though, it makes a difference to the promisee whether the promisor acts on time,\nthen it is said that \xe2\x80\x9ctime is of the essence.\xe2\x80\x9d Time as a condition can be made explicit in a clause reciting\nthat time is of the essence. If there is no express clause, the courts will read it in when the purpose of the\ncontract was clearly to provide for performance at or by a certain time, and the promisee will gain little\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n504\n\n\x0cfrom late performance. But even express clauses are subject to a rule of reason, and if the promisor would\nsuffer greatly by enforcement of the clause (and the promisee would suffer only slightly or not at all from a\nrefusal to invoke it), the courts will generally excuse the untimely performance, as long as it was\ncompleted within a reasonable time. A builder\xe2\x80\x99s failure to finish a house by July 1 will not discharge the\nbuyer\xe2\x80\x99s obligation to pay if the house is finished a week or even a month later, although the builder will be\nliable to the buyer for expenses incurred because of the lateness (storage charges for furniture, costs for\nhousing during the interim, extra travel, and the like).\n\nCondition That a Party Must Be Satisfied\n\xe2\x80\x9cYou must be satisfied or your money back\xe2\x80\x9d is a common advertisement. A party to a contract can require\nthat he need not pay or otherwise carry out his undertaking unless satisfied by the obligor\xe2\x80\x99s performance,\nor unless a third party is satisfied by the performance.\nParties may contract to perform to one side\xe2\x80\x99s personal satisfaction. Andy tells Anne, a prospective client,\nthat he will cut her hair better than her regular hairdresser, and that if she is not satisfied, she need not\npay him. Andy cuts her hair, but Anne frowns and says, \xe2\x80\x9cI don\xe2\x80\x99t like it.\xe2\x80\x9d Assume that Andy\xe2\x80\x99s work is\nexcellent. Whether Anne must pay depends on the standard for judging to be employed\xe2\x80\x94a standard of\nobjective or subjective satisfaction. The objective standard is that which would satisfy the reasonable\npurchaser. Most courts apply this standard when the contract involves the performance of a mechanical\njob or the sale of a machine whose performance is capable of objective measurement. So even if the\nobligee requires performance to his \xe2\x80\x9cpersonal satisfaction,\xe2\x80\x9d the courts will hold that the obligor has\nperformed if the service performed or the goods produced are in fact satisfactory. By contrast, if the goods\nor services contracted for involve personal judgment and taste, the duty to pay will be discharged if the\nobligee states personal (subjective) dissatisfaction. No reason at all need be given, but it must be for a\ngood-faith reason, not just to escape payment.\nThe duty to make a contract payment may be conditioned on the satisfaction of a third party. Building\ncontracts frequently make the purchaser\xe2\x80\x99s duty to pay conditional on the builder\xe2\x80\x99s receipt of an architect\xe2\x80\x99s\ncertificate of compliance with all contractual terms; road construction contracts often require that the\nwork be done \xe2\x80\x9cto the satisfaction of the County Engineer.\xe2\x80\x9d These conditions can be onerous. The builder\nhas already erected the structure and cannot \xe2\x80\x9creturn\xe2\x80\x9d what he has done. Nevertheless, because the\npurchaser wants assurance that the building (obviously a major purchase) or road meets his\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n505\n\n\x0cspecifications, the courts will hold the contractor to the condition unless it is impossible to provide a\ncertificate (e.g., architect may have died) or the architect has acted in bad faith, or the purchaser has\nsomehow prevented the certificate from issuing. The third party\xe2\x80\x99s refusal to issue a certificate needs to be\nreasonable.\n\nKEY TAKEAWAY\n\nParties may, expressly or implicitly, condition the requirement for contractual performance on the\nhappening or nonhappening of an event, or on timeliness. They may condition performance on\nsatisfaction to one of the parties to the contract or to the satisfaction of a third party; in any event,\ndissatisfaction must be in good faith.\n\nEXERCISES\n\n1.\n\nWhat is \xe2\x80\x9cconditioned\xe2\x80\x9d by a condition in a contract?\n\n2.\n\nWhat conditions are based on how they are made?\n\n3.\n\nWhat conditions are based on their effect on the duty of performance?\n\n4.\n\nWhat typical situations involve performance to a party\xe2\x80\x99s satisfaction?\n\nDischarge by Agreement of the Parties\n\nLEARNING OBJECTIVE\n\n1.\n\nRecognize that there are various ways the parties may agree between themselves to terminate mutual\nobligations under the contract.\n\nParties are free to agree to almost any contract they want, and they are free to agree to end the contract\nwhenever they want. There are several ways this is done.\n\nMutual Rescission\nThe parties may agree to give up the duties to perform, called mutual rescission. This may be by a formal\nwritten release saying the obligor is discharged upon delivery of the writing or upon occurrence of a\ncondition. Or an obligation may be discharged by a contract not to sue about it.\nThe Restatement terms this an agreement of rescission.\n\n[4]\n\nAn agreement to rescind will be given effect\n\neven though partial performance has been made or one or both parties have a claim for partial breach.\nThe agreement need not be in writing or even expressed in words. By their actions, such as failure to take\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n506\n\n\x0csteps to perform or enforce, the parties may signal their mutual intent to rescind. Andy starts to mow\nAnne\xe2\x80\x99s lawn as they agreed. He begins the job, but it is unbearably hot. She sees how uncomfortable he is\nand readily agrees with him when he says, \xe2\x80\x9cWhy don\xe2\x80\x99t we just forget the whole thing?\xe2\x80\x9d Andy\xe2\x80\x99s duty to\nfinish mowing is discharged, as is Anne\xe2\x80\x99s duty to pay Andy, either for the whole job or for the part he has\ndone.\nBusiness executives live by contracts, but they do not necessarily die by them. A sociologist who studied\nbusiness behavior under contract discovered a generation ago\xe2\x80\x94and it is still valid\xe2\x80\x94that in the great\nmajority of cases in which one party wishes to \xe2\x80\x9ccancel an order,\xe2\x80\x9d the other party permits it without\nrenegotiation, even though the cancellation amounts to a repudiation of a contract. As one lawyer was\nquoted as saying,\nOften business[people] do not feel they have \xe2\x80\x9ca contract\xe2\x80\x9d\xe2\x80\x94rather they have an \xe2\x80\x9corder.\xe2\x80\x9d They\nspeak of \xe2\x80\x9ccancelling the order\xe2\x80\x9d rather than \xe2\x80\x9cbreaching our contract.\xe2\x80\x9d When I began practice I\nreferred to order cancellations as breaches of contract, but my clients objected since they do not\nthink of cancellation as wrong. Most clients, in heavy industry at least, believe that there is a\nright to cancel as part of the buyer-seller relationship. There is a widespread attitude that one\ncan back out of any deal within some very vague limits. Lawyers are often surprised by this\nattitude.\n\n[5]\n\nThis attitude is understandable. People who depend for their economic survival on continuing\nrelationships will be loath to react to every change in plans with a lawsuit. The legal consequences of most\nof these cancellations are an agreement of rescission. Under UCC Section 2-720, the use of a word like\n\xe2\x80\x9ccancellation\xe2\x80\x9d or \xe2\x80\x9crescission\xe2\x80\x9d does not by itself amount to a renunciation of the right to sue for breach of a\nprovision that occurred before the rescission. If the parties mean to discharge each other fully from all\nduties owed, they must say so explicitly. Actions continue to speak more loudly than words, however, and\nin law, so can inactions. Legal rights under contracts may be lost by both parties if they fail to act; by\nabandoning their claims, they can affect rescission.\n\nWaiver\nA second means of discharge is by waiver, whereby a party voluntarily gives up a right she has under a\ncontract but doesn\xe2\x80\x99t give up the entire right to performance by the other side. Tenant is supposed to pay\nrent on the first of the month, but because his employer pays on the tenth, Tenant pays Landlady on that\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n507\n\n\x0cday. If Landlady accepts the late payment without objection, she has waived her right to insist on payment\nby the first of the month, unless the lease provides that no waiver occurs from the acceptance of any late\npayments. SeeSection 15.2.2 "Waiver of Contract Rights; Nonwaiver Provisions", Minor v. Chase Auto\nFinance Corporation. A \xe2\x80\x9cwaiver\xe2\x80\x9d is permission to deviate from the contract; a \xe2\x80\x9crelease\xe2\x80\x9d means to let go of\nthe whole thing.\n\nSubstituted Agreement\nDischarge by substituted agreement is a third way of mutual rescission. The parties may enter into\na novation, either a new contract or one whereby a new person is substituted for the original obligor, and\nthe latter is discharged. If Mr. Olson is obligated to deliver a car to Jack, Jack and Mr. Olson may agree\nthat Dewey Dealer should deliver the car to Jack instead of Mr. Olson; the latter is discharged by this\nnovation. A substituted agreement may also simply replace the original one between the original parties.\n\nAccord and Satisfaction\nDischarge by accord and satisfaction is a fourth way of mutual rescission. Here the parties to a contract\n(usually a disputed one) agree to substitute some performance different from what was originally agreed,\nand once this new agreement is executed, the original contract (as well as the more recent accord) is\nsatisfied. But before then, the original agreement is only suspended: if the obligor does not satisfy the\naccord, the other side can sue on the original obligation or on the accord.\n\nKEY TAKEAWAY\n\nParties to a contract may agree to give it up. This may be by mutual rescission, release, waiver, novation,\nsubstituted agreement, or accord and satisfaction.\n\nEXERCISES\n\n1.\n\nHow does mutual rescission discharge a common-law contract without apparent new consideration?\n\n2.\n\nWhat is the difference between a substituted agreement and a novation?\n\n3.\n\nWhat happens if the parties negotiate an accord and satisfaction and one side fails to perform it?\n\n4.\n\nIf an obligee accepts performance from the obligor that deviates from the contract, under what\ncircumstances can the obligee nevertheless insist on strict compliance in the future?\n\nDischarge When Performance Becomes Impossible or Very Difficult\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n508\n\n\x0cLEARNING OBJECTIVE\n1.\n\nRecognize that there are several circumstances when performance of the contract becomes variously\nimpossible, very difficult, or useless, and that these may give rise to discharge.\n\nThere are at least five circumstances in which parties may be discharged from contractual obligations\nbecause performance is impossible, difficult, or useless.\n\nOverview\nEvery contract contains some element of risk: the buyer may run out of money before he can pay; the\nseller may run out of goods before he can deliver; the cost of raw materials may skyrocket, throwing off\nthe manufacturer\xe2\x80\x99s fine financial calculations. Should the obligor\xe2\x80\x99s luck run out, he is stuck with the\nconsequences\xe2\x80\x94or, in the legal phrase, his liability is strict: he must either perform or risk paying damages\nfor breach of contract, even if his failure is due to events beyond his control. Of course, an obligor can\nalways limit his liability through the contract itself. Instead of obligating himself to deliver one million\nunits, he can restrict his obligation to \xe2\x80\x9cone million units or factory output, whichever is less.\xe2\x80\x9d Instead of\nguaranteeing to finish a job by a certain date, he can agree to use his \xe2\x80\x9cbest efforts\xe2\x80\x9d to do so. Similarly,\ndamages in the event of breach can be limited. A party can even include a clause canceling the contract in\nthe event of an untoward happening. But if these provisions are absent, the obligor is generally held to the\nterms of his bargain.\nExceptions include the concepts of impossibility, impracticability, and frustration of purpose.\n\nImpossibility\nIf performance is impossible, the duty is discharged. The categories here are death or incapacity of a\npersonal services contractor, destruction of a thing necessary for performance, and performance\nprohibited by government order.\n\nDeath or Incapacity of a Personal Services Contractor\nIf Buyer makes a contract to purchase a car and dies before delivery, Buyer\xe2\x80\x99s estate could be held liable; it\nis not impossible (for the estate) to perform. The estate of a painter hired to do a portrait cannot be sued\nfor damages because the painter died before she could complete the work.\n\nDestruction or Deterioration of a Thing Necessary for Performance\nWhen a specific object is necessary for the obligor\xe2\x80\x99s performance, its destruction or deterioration making\nits use impracticable (or its failure to come into existence) discharges the obligor\xe2\x80\x99s duty. Diane\xe2\x80\x99s Dyers\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n509\n\n\x0ccontracts to buy the annual wool output of the Sheepish Ranch, but the sheep die of an epidemic disease\nbefore they can be shorn. Since the specific thing for which the contract was made has been destroyed,\nSheepish is discharged from its duty to supply Diane\xe2\x80\x99s with wool, and Diane\xe2\x80\x99s has no claim against the\nRanch. However, if the contract had called for a quantity of wool, without specifying that it was to be from\nSheepish\xe2\x80\x99s flock, the duty would not be discharged; since wool is available on the open market, Sheepish\ncould buy that and resell it to Diane\xe2\x80\x99s.\n\nPerformance Prohibited by Government Regulation or Order\nWhen a government promulgates a rule after a contract is made, and the rule either bars performance or\nwill make it impracticable, the obligor\xe2\x80\x99s duty is discharged. An obligor is not required to break the law and\nrisk the consequences. Financier Bank contracts to sell World Mortgage Company certain collateralized\nloan instruments. The federal government, in a bank reform measure, prohibits such sales. The contract is\ndischarged. If the Supreme Court later declared the prohibition unconstitutional, World Mortgage\xe2\x80\x99s duty\nto buy (or Financier Bank\xe2\x80\x99s to sell) would not revive.\n\nImpracticability\nLess entirely undoable than impossibility, but still grounds for discharge, are common-law\nimpracticability and its relative, commercial impracticability.\n\nCommon-Law Impracticability\nImpracticability is said to exist when there is a radical departure from the circumstances that the parties\nreasonably contemplated would exist at the time they entered into the contract; on such facts, the courts\nmight grant relief. They will do so when extraordinary circumstances (often called \xe2\x80\x9cacts of God\xe2\x80\x9d or \xe2\x80\x9cforce\nmajeure\xe2\x80\x9d) make it unjust to hold a party liable for performance. Although the justification for judicial\nrelief could be found in an implied condition in all contracts that extraordinary events shall not occur, the\nRestatement eschews so obvious a bootstrap logic and adopts the language of UCC Section 2-615(a),\nwhich states that the crux of the analysis is whether the nonoccurrence of the extraordinary circumstance\nwas \xe2\x80\x9ca basic assumption on which the contract was made.\xe2\x80\x9d\n\n[6]\n\nIf it was\xe2\x80\x94if, that is, the parties assumed that\n\nthe circumstance would not occur\xe2\x80\x94then the duty is discharged if the circumstance later does occur.\nIn one well-known case, Autry v. Republic Productions, the famous cowboy movie star Gene Autry had a\ncontract to perform to the defendant. He was drafted into the army in 1942; it was temporarily, at least,\nimpossible for him to perform his movie contractual obligations incurred prior to his service. When he\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n510\n\n\x0cwas discharged in 1945, he sued to be relieved of the prewar obligations. The court took notice that there\nhad been a long interruption in Autry\xe2\x80\x99s career and of \xe2\x80\x9cthe great decrease in the purchasing power of the\ndollar\xe2\x80\x9d\xe2\x80\x94postwar inflation\xe2\x80\x94and determined that to require him to perform under the old contract\xe2\x80\x99s terms\nwould work a \xe2\x80\x9csubstantial hardship\xe2\x80\x9d on him. A world war is an extraordinary circumstance. The\ntemporary impossibility had transformed into impracticability.\n\n[7]\n\nImpracticability refers to the performance, not to the party doing it. Only if the performance is\nimpracticable is the obligor discharged. The distinction is between \xe2\x80\x9cthe thing cannot be done\xe2\x80\x9d and \xe2\x80\x9cI\ncannot do it.\xe2\x80\x9d The former refers to that which is objectively impracticable, and the latter to that which is\nsubjectively impracticable. That a duty is subjectively impracticable does not excuse it if the circumstances\nthat made the duty difficult are not extraordinary. A buyer is liable for the purchase price of a house, and\nhis inability to raise the money does not excuse him or allow him to escape from a suit for damages when\nthe seller tenders the deed.\n\n[8]\n\nIf Andy promises to transport Anne to the football stadium for ten dollars,\n\nhe cannot wriggle out of his agreement because someone smashed into his car (rendering it inoperable) a\nhalf hour before he was due to pick her up. He could rent a car or take her in a taxi, even though that will\ncost considerably more than the sum she agreed to pay him. But if the agreement was that he would\ntransport her in his car, then the circumstances make his performance objectively impracticable\xe2\x80\x94the\nequivalent of impossible\xe2\x80\x94and he is excused.\n\nCommercial Impracticability\n[9]\n\nThis common-law concept of impracticability has been adopted by the UCC. When performance cannot\nbe undertaken except with extreme difficulty or at highly unreasonable expense, it might be excused on\nthe theory of commercial impracticability. However, \xe2\x80\x9cimpracticable\xe2\x80\x9d (the action is impossible) is not the\nsame as \xe2\x80\x9cimpractical\xe2\x80\x9d (the action would yield an insufficient return or would have little practical value).\nThe courts allow a considerable degree of fluctuation in market prices, inflation, weather, and other\neconomic and natural conditions before holding that an extraordinary circumstance has occurred. A\nmanufacturer that based its selling price on last year\xe2\x80\x99s costs for raw materials could not avoid its contracts\nby claiming that inflation within the historical range had made it difficult or unprofitable to meet its\ncommitments. Examples of circumstances that could excuse might be severe limitations of supply due to\nwar, embargo, or a natural disaster. Thus a shipowner who contracted with a purchaser to carry goods to a\nforeign port would be excused if an earthquake destroyed the harbor or if war broke out and the military\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n511\n\n\x0cauthorities threatened to sink all vessels that entered the harbor. But if the shipowner had planned to\nsteam through a canal that is subsequently closed when a hostile government seizes it, his duty is not\ndischarged if another route is available, even if the route is longer and consequently more expensive.\n\nFrustration of Purpose\nIf the parties made a basic assumption, express or implied, that certain circumstances would not arise, but\nthey do arise, then a party is discharged from performing his duties if his principal purpose in making the\ncontract has been \xe2\x80\x9csubstantially frustrated.\xe2\x80\x9d This is not a rule of objective impossibility. It operates even\nthough the parties easily might be able to carry out their contractual duties.\nThe frustration of purpose doctrine comes into play when circumstances make the value of one party\xe2\x80\x99s\nperformance virtually worthless to the other. This rule does not permit one party to escape a contract\nsimply because he will make less money than he had planned or because one potential benefit of the\ncontract has disappeared. The purpose that is frustrated must be the core of the contract, known and\nunderstood by both parties, and the level of frustration must be severe; that is, the value of the contract to\nthe party seeking to be discharged must be destroyed or nearly destroyed.\nThe classic illustration of frustration of purpose is the litigation that gave birth to the rule: the so-called\ncoronation cases. In 1901, when King Edward VII was due to be crowned following the death of Queen\nVictoria, a parade route was announced for the coronation. Scores of people rented rooms in buildings\nthat lined the streets of the route to watch the grand spectacle. But the king fell ill, and the procession was\ncanceled. Many expectant viewers failed to pay, and the building owners took them to court; many lessees\nwho had paid took the owners to court to seek refunds. The court declared that the lessees were not liable\nbecause the purpose of the contract had been frustrated by the king\xe2\x80\x99s illness.\nSupervening government regulations (though here different from illegality), floods that destroy buildings\nin which an event was to take place, and business failures may all contribute to frustration of purpose. But\nthere can be no general rule: the circumstances of each case are determinative. Suppose, for example, that\na manufacturer agrees to supply a crucial circuit board to a computer maker who intends to sell his\nmachine and software to the government for use in the international space station\xe2\x80\x99s ventilation systems.\nAfter the contract is made but before the circuit boards are delivered, the government decides to scrap\nthat particular space station module. The computer manufacturer writes the circuit board maker,\ncanceling the contract. Whether the manufacturer is discharged depends on the commercial prospects for\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n512\n\n\x0cthe computer and the circuit board. If the circuit board can be used only in the particular computer, and it\nin turn is only of use on the space station, the duty to take the boards is discharged. But if the computer\ncan be sold elsewhere, or the circuit boards can be used in other computers that the manufacturer makes,\nit is liable for breach of contract, since its principal purpose\xe2\x80\x94selling computers\xe2\x80\x94is not frustrated.\nAs before, the parties can provide in the contract that the duty is absolute and that no supervening event\nshall give rise to discharge by reason of frustration of purpose.\n\nKEY TAKEAWAY\n\nThe obligations to perform under a contract cannot be dismissed lightly, but a person\xe2\x80\x99s duty to perform a\ncontract duty may be discharged if it becomes impossible or very difficult to do it. This includes\nimpossibility, common-law impracticability, commercial impracticability under the UCC, and frustration of\npurpose.\n\nEXERCISES\n\n1.\n\nIf it is possible to perform a contract, why might a party be excused because of frustration of purpose?\n\n2.\n\nWhat is the difference between impractical and impracticable?\n\n3.\n\nHow would supervening government regulation be different from supervening illegality?\n\nOther Methods of Discharge\n\nLEARNING OBJECTIVES\n\n1.\n\nRecognize when alteration, power of avoidance, the statute of limitations, and bankruptcy discharge\nparties from contracts.\n\n2.\n\nIn addition to performance (or lack of it), agreement of the parties, the happening or nonhappening of\nconditions, and variations on the theme of impossibility, there are several other ways contract duties may\nbe discharged.\n\nCancellation, Destruction, or Surrender\nAn obligee may unilaterally discharge the obligor\xe2\x80\x99s duty toward him by canceling, destroying, or\nsurrendering the written document embodying the contract or other evidence of the duty. No\nconsideration is necessary; in effect, the obligee is making a gift of the right that he possesses. No\nparticular method of cancellation, destruction, or surrender is necessary, as long as the obligee manifests\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n513\n\n\x0chis intent that the effect of his act is to discharge the duty. The entire document can be handed over to the\nobligor with the words, \xe2\x80\x9cHere, you don\xe2\x80\x99t owe me anything.\xe2\x80\x9d The obligee can tear the paper into pieces and\ntell the obligor that he has done so because he does not want anything more. Or he can mutilate the\nsignatures or cross out the writing.\n\nPower of Avoidance\nA contractual duty can be discharged if the obligor can avoid the contract. As discussed in Chapter 10\n"Real Assent", a contract is either void or can be avoided if one of the parties lacked capacity (infancy,\ninsanity); if there has been duress, undue influence, misrepresentation, or mistake; or the contract is\ndetermined to be unconscionable. Where a party has a power of avoidance and exercises it, that party is\ndischarged from further obligation.\n\nStatute of Limitations\nWhen an obligor has breached a contract, the obligee has the right to sue in court for a remedy. But that\nright does not last forever. Every state has statutes of limitations that establish time periods within which\nthe suit must be brought (different time periods are spelled out for different types of legal wrongs:\ncontract breach, various types of torts, and so on). The time period for contract actions under most\nstatutes of limitations ranges between two and six years. The UCC has a fouryear statute of limitations.\n\n[10]\n\nThe period begins to run from the day on which the suit could have been\n\nfiled in court\xe2\x80\x94for example, from the moment of contract breach. An obligee who waits until after the\nstatute has run\xe2\x80\x94that is, does not seek legal relief within the period prescribed by the statute of\nlimitations\xe2\x80\x94is barred from going to court thereafter (unless she is under some incapacity like infancy),\nbut the obligor is not thereby discharged. The effect is simply that the obligee has no legal remedy. If the\nparties have a continuing relationship, the obligee might be able to recoup\xe2\x80\x94for example, by applying a\npayment for another debt to the one barred by the statute, or by offsetting a debt the obligee owes to the\nobligor.\n\nBankruptcy\nUnder the federal bankruptcy laws as discussed in (Reference mayer_1.0-ch30 not found in Book), certain\nobligations are discharged once a court declares a debtor to be bankrupt. The law spells out the particular\ntypes of debts that are canceled upon bankruptcy.\n\nKEY TAKEAWAY\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n514\n\n\x0cContract duties may be discharged by cancellation, destruction, or surrender of the written contract; by\nthe running of the statute of limitations; or by bankruptcy.\n[1] Uniform Commercial Code, Section 2-106(3).\n[2] Restatement (Second) of Contracts, Section 237(d).\n[3] Hochster v. De La Tour, 2 Ellis & Blackburn 678 (Q.B. 1853).\n[4] Restatement (Second) of Contracts, Section 283.\n[5] Stewart Macaulay, \xe2\x80\x9cNon-contractual Relations in Business: A Preliminary Study,\xe2\x80\x9dAmerican Sociological\nReview 28, no. 1 (1963): 55, 61.\n[6] Restatement (Second) of Contracts, Section 261.\n[7] Autry v. Republic Productions, 180 P.2d 144 (Calif. 1947).\n[8] Christy v. Pilkinton, 273 S.W.2d 533 (Ark. 1954).\n[9] Uniform Commercial Code, Section 2-615.\n[10] Uniform Commercial Code, Section 2-725.\n\n15.2 Cases\nSubstantial Performance; Conditions Precedent\nTA Operating Corp. v. Solar Applications Engineering, Inc.\n191 S.W.3d 173 (Tex. Ct. App. 2005)\nTA Operating Corporation, a truck stop travel center company, contracted with Solar Applications\nEngineering, Inc. to construct a prototype multi-use truck stop in San Antonio for a fixed price of\n$3,543,233.\xe2\x80\xa6\n[When the project was near] completion, TA sent Solar a \xe2\x80\x9cpunch list\xe2\x80\x9d of items that needed to be finished\nto complete the building. Solar disputed several items on the list and delivered a response to TA listing the\nitems Solar would correct.\xe2\x80\xa6Solar began work on the punch list items and filed a lien affidavit [a property\nthat carries a lien can be forced into sale by the creditor in order to collect what is owed] against the\nproject on October 2, 2000 in the amount of $472,392.77. TA understood the lien affidavit to be a request\nfor final payment.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n515\n\n\x0cOn October 18, 2000, TA sent notice to Solar that Solar was in default for not completing the punch list\nitems, and for failing to keep the project free of liens. TA stated in the letter that Solar was not entitled to\nfinal payment until it completed the remainder of the punch list items and provided documentation that\nliens filed against the project had been paid.\xe2\x80\xa6Solar acknowledged at least two items on the punch list had\nnot been completed, and submitted a final application for payment in the amount of $472,148,77.\xe2\x80\xa6TA\nrefused to make final payment, however, contending that Solar had not complied with section 14.07 of the\ncontract, which expressly made submission of a [lien-release] affidavit a condition precedent to final\npayment:\xe2\x80\xa6\nThe final Application for Payment shall be accompanied by:\xe2\x80\xa6complete and legally effective\nreleases or waivers\xe2\x80\xa6of all lien rights arising out of or liens filed in connection with the work.\nAlthough Solar did not comply with this condition precedent to final payment, Solar sued TA for breach of\ncontract under the theory of substantial performance.\xe2\x80\xa6TA [asserts that] the doctrine of substantial\nperformance does not excuse Solar\xe2\x80\x99s failure to comply with an express condition precedent to final\npayment.\xe2\x80\xa6\nThe first issue we must resolve is whether the doctrine of substantial performance excuses the breach of\nan express condition precedent to final payment that is unrelated to completion of the building. TA\nacknowledges that Solar substantially performed its work on the project, but contends its duty to pay was\nnot triggered until Solar pleaded or proved it provided TA with documentation of complete and legally\neffective releases or waivers of all liens filed against the project.\xe2\x80\xa6TA contends that when the parties have\nexpressly conditioned final payment on submission of [a liens-release] affidavit, the owner\xe2\x80\x99s duty to pay is\nnot triggered until the contractor pleads or proves it complied with the condition precedent.\nSolar contends that although it did not submit [a liens-release] affidavit in accordance with the contract, it\nmay still recover under the contract pursuant to the substantial performance doctrine. Solar argues that to\nhold otherwise would bring back the common law tradition that the only way for a contractor to recover\nunder a contract is full, literal performance of the contract\xe2\x80\x99s terms.\xe2\x80\xa6\nWhile the common law did at one time require strict compliance with the terms of a contract, this rule has\nbeen modified for building or construction contracts by the doctrine of substantial performance.\n\xe2\x80\x9cSubstantial performance\xe2\x80\x9d was defined by the Texas [court] in [Citation]:\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n516\n\n\x0cTo constitute substantial compliance the contractor must have in good faith intended to comply\nwith the contract, and shall have substantially done so in the sense that the defects are not\npervasive, do not constitute a deviation from the general plan contemplated for the work, and are\nnot so essential that the object of the parties in making the contract and its purpose cannot\nwithout difficulty, be accomplished by remedying them. Such performance permits only such\nomissions or deviation from the contract as are inadvertent and unintentional, are not due to bad\nfaith, do not impair the structure as a whole, and are remediable without doing material damage\nto other parts of the building in tearing down and reconstructing.\n\xe2\x80\xa6The doctrine of substantial performance recognizes that the contractor has not completed construction,\nand therefore is in breach of the contract. Under the doctrine, however, the owner cannot use the\ncontractor\xe2\x80\x99s failure to complete the work as an excuse for non-payment. \xe2\x80\x9cBy reason of this rule a\ncontractor who has in good faith substantially performed a building contract is permitted to sue under the\ncontract, substantial performance being regarded as full performance, so far as a condition precedent to a\nright to recover thereunder is concerned.\xe2\x80\x9d [Citation]\xe2\x80\xa6\nSolar argues that by agreeing substantial performance occurred, TA acknowledged that Solar was in \xe2\x80\x9cfull\ncompliance\xe2\x80\x9d with the contract and any express conditions to final payment did not have to be met.\n[Citation]: \xe2\x80\x9c[a] finding that a contract has been substantially completed is the legal equivalent of full\ncompliance, less any offsets for remediable defects.\xe2\x80\x9d Solar argues that TA may not expressly provide for\nsubstantial performance in its contract and also insist on strict compliance with the conditions precedent\nto final payment. We disagree. While the substantial performance doctrine permits contractors to sue\nunder the contract, it does not ordinarily excuse the non-occurrence of an express condition precedent:\nThe general acceptance of the doctrine of substantial performance does not mean that the parties\nmay not expressly contract for literal performance of the contract terms.\xe2\x80\xa6Stated otherwise, if the\nterms of an agreement make full or strict performance an express condition precedent to\nrecovery, then substantial performance will not be sufficient to enable recovery under the\ncontract.\n15 Williston on Contracts \xc2\xa7 44.53 (4th Ed.2000) (citing Restatement (Second) of Contracts, \xc2\xa7 237, cmt. d\n(1981)).\xe2\x80\xa6\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n517\n\n\x0cTA, seeking protection from double liability and title problems, expressly conditioned final payment on\nSolar\xe2\x80\x99s submission of a [liens-release] affidavit. Solar did not dispute that it was contractually obligated to\nsubmit the affidavit as a condition precedent to final payment, and it was undisputed at trial that\n$246,627.82 in liens had been filed against the project. Though the doctrine of substantial performance\npermitted Solar to sue under the contract, Solar did not plead or prove that it complied with the express\ncondition precedent to final payment. Had Solar done so, it would have been proper to award Solar the\ncontract balance minus the cost of remediable defects. While we recognize the harsh results occasioned\nfrom Solar\xe2\x80\x99s failure to perform this express condition precedent, we recognize that parties are free to\ncontract as they choose and may protect themselves from liability by requesting literal performance of\ntheir conditions for final payment.\xe2\x80\xa6\n[T]he trial court erred in awarding Solar the contract balance [as] damages, and we render judgment that\nSolar take nothing on its breach of contract claim.\n\nCASE QUESTIONS\n\n1.\n\nWhy did Solar believe it was entitled to the contract balance here?\n\n2.\n\nWhy did the court determine that Solar should not have been awarded the contract damages that it\nclaimed, even though it substantially complied?\n\n3.\n\nHow has the common law changed in regard to demanding strict compliance with a contract?\n\nWaiver of Contract Rights; Nonwaiver Provisions\nMinor v. Chase Auto Finance Corporation\n\xe2\x80\x94S.W.3d\xe2\x80\x94\xe2\x80\x94, 2010 WL 2006401 (Ark. 2010)\nSheffield, J.\nWe have been asked to determine whether non-waiver and no-unwritten-modifications clauses in a\n[contract] preclude a creditor from waiving future strict compliance with the agreement by accepting late\npayments.\xe2\x80\xa6\nAppellant Mose Minor (Minor) entered into a Simple Interest Motor Vehicle Contract and Security\nAgreement with Appellee Chase Auto Finance Corporation (Chase) to finance the purchase of a 2003\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n518\n\n\x0cToyota Tundra. By the terms of the agreement, Minor was to make sixty-six payments of $456.99 on the\nfourteenth of each month.\xe2\x80\xa6The agreement also included the following relevant provisions:\nG. Default: If you\xe2\x80\xa6default in the performance of any promise you make in this contract or any\nother contract you have with us, including, but not limited to, failing to make any payments when\ndue, or become insolvent, or file any proceeding under the U.S. Bankruptcy Code,\xe2\x80\xa6we may at our\noption and without notice or demand (1) declare all unpaid sums immediately due and payable\nsubject to any right of reinstatement as required by law (2) file suit against you for all unpaid\nsums (3) take immediate possession of the vehicle (4) exercise any other legal or equitable\nremedy.\xe2\x80\xa6Our remedies are cumulative and taking of any action shall not be a waiver or prohibit\nus from pursuing any other remedy. You agree that upon your default we shall be entitled to\nrecover from you our reasonable collection costs, including, but not limited to, any attorney\xe2\x80\x99s fee.\nIn addition, if we repossess the vehicle, you grant to us and our agents permission to enter upon\nany premises where the vehicle is located. Any repossession will be performed peacefully.\xe2\x80\xa6\nJ. Other Agreements of Buyer:\xe2\x80\xa6(2) You agree that if we accept moneys in sums less than those\ndue or make extensions of due dates of payments under this contract, doing so will not be a\nwaiver of any later right to enforce the contract terms as written.\xe2\x80\xa6(12) All of the agreements\nbetween us and you are set forth in this contract and no modification of this contract shall be\nvalid unless it is made in writing and signed by you and us.\xe2\x80\xa6\nK. Delay in Enforcement: We can delay or waive enforcement of any of our rights under this\ncontract without losing them.\nMinor\xe2\x80\x99s first payment was late, as were several subsequent payments. At times he failed to make any\npayment for months. Chase charged a late fee for each late payment, and sent several letters requesting\npayment and offering to assist Minor with his account. Chase also warned Minor that continued failure to\nmake payments would result in Chase exercising its legal options available under the agreement,\nincluding repossession of the vehicle.\xe2\x80\xa6At one point, Minor fell so far behind in his payments that Chase\nwas on the verge of repossessing the vehicle. However\xe2\x80\xa6the parties agreed to a two-month extension of the\nagreement.\xe2\x80\xa6The extension agreement indicated that all other terms and conditions of the original\ncontract would remain the same.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n519\n\n\x0cOn November 2, 2004, Minor filed for Law \xe2\x80\x9cbankruptcy [after which] Chase sent Minor a letter\nacknowledging that Minor\xe2\x80\x99s debt to Chase had been discharged in bankruptcy. The letter further stated\nthat Chase still had a valid lien on the vehicle, and if Minor wished to keep the vehicle, he would have to\ncontinue to make payments to Chase. Otherwise, Chase would repossess the vehicle.\xe2\x80\xa6\nOn September 28, 2006, a repossession agent\xe2\x80\xa6arrived at Minor\xe2\x80\x99s home some time in the afternoon to\nrepossess the vehicle.\xe2\x80\xa6[Notwithstanding Minor\xe2\x80\x99s insistence that the agent stop] the agent removed\nMinor\xe2\x80\x99s possessions from the vehicle and towed it away. Chase sold the vehicle. The amount of the\npurchase price was reflected on Minor\xe2\x80\x99s account.\xe2\x80\xa6\nOn January 7, 2008, Minor filed a complaint against Chase [alleging] that, during the course of the\ncontract, the parties had altered the provisions of the contract regarding Chase\xe2\x80\x99s right to repossess the\nvehicle and Chase had waived the right to strictly enforce the repossession clause. Minor further claimed\nthat the repossession agent committed trespass and repossessed the vehicle forcibly, without Minor\xe2\x80\x99s\npermission, and through trickery and deceit, in violation of [state law]. Also, Minor asserted that he was\nnot in default on his payments, pursuant to the repayment schedule, at the time Chase authorized\nrepossession. Therefore, according to Minor, Chase committed conversion, and breached the Arkansas\nDeceptive Trade Practices Act [Citation], and enhanced by Arkansas Code Annotated section 4-88-202,\nbecause Minor is an elderly person. Minor sought compensatory and punitive damages.\xe2\x80\xa6\nAfter hearing these arguments, the circuit court ruled that Minor had presented no evidence that the\nconduct of Chase or the repossession agent constituted grounds for punitive damages; that by the express\nterms of the contract Chase\xe2\x80\x99s acceptance of late payments did not effect a waiver of its rights in the future;\nthat at the time of repossession, Minor was behind in his payments and in breach of the contract; that\nChase had the right under the contract to repossess the vehicle and did not commit conversion; and that\nthere was no evidence to support a claim that Chase had violated the Arkansas Deceptive Trade Practices\nAct.\xe2\x80\xa6\n[W]e affirm our previous decisions that when a contract does not contain a non-waiver and a nounwritten-modification provision and the creditor has established a course of dealing in accepting late\npayments from the debtor, the creditor waives its right to insist on strict compliance with the contract and\nmust give notice to the debtor that it will no longer accept late payments before it can declare default of\nthe debt. However, we announce today that, if a contract includes non-waiver and no-unwrittenSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n520\n\n\x0cmodification clauses, the creditor, in accepting late payments, does not waive its right under the contract\nto declare default of the debt, and need not give notice that it will enforce that right in the event of future\nlate payments.\xe2\x80\xa6\nIn arriving at this conclusion, we adhere to the principle that \xe2\x80\x9ca [contract] is effective according to its\nterms between the parties.\xe2\x80\x9d\xe2\x80\xa6We have long held that non-waiver clauses are legal and\nvalid. See [Citations] Also, [the Arkansas UCC 2-209(2)] declares that no-unwritten-modification\nprovisions are binding.\nWe acknowledge that there is a difference of opinion amongst the courts in other jurisdictions over the\neffect of non-waiver and no-unwritten-modification clauses.\xe2\x80\xa6\nWe concur with the Supreme Court of Indiana\xe2\x80\x99s decision in [Citation], that a rule providing that nonwaiver clauses could themselves be waived by the acceptance of late payments is \xe2\x80\x9cillogical, since the very\nconduct which the [non-waiver] clause is designed to permit[,] acceptance of late payment[,] is turned\naround to constitute waiver of the clause permitting the conduct.\xe2\x80\x9d We also agree that the approach of\njurisdictions that require creditors who have accepted late payments in the past to notify debtors that they\nexpect strict compliance in the future, despite the existence of a non-waiver provision in the contract, is\nnot \xe2\x80\x9csound.\xe2\x80\x9d Such a rule, we recognize, \xe2\x80\x9cbegs the question of validity of the non-waiver clause.\xe2\x80\x9d Finally,\nour holding is in line with the Indiana Supreme Court\xe2\x80\x99s ruling that it would enforce the provisions of the\ncontract, since the parties had agreed to them, and that it would not require the creditor to give notice,\nbecause the non-waiver clause placed the [creditor] in the same position as one who had never accepted a\nlate payment. [Citations]\xe2\x80\xa6\nCertified question answered; remanded to court of appeals.\n\nCASE QUESTIONS\n\n1.\n\nWhat is a nonwaiver clause?\n\n2.\n\nWhy did Mose think his late payments were not grounds for repossession of his truck?\n\n3.\n\nWhy would a creditor accept late payments instead of immediately repossessing the collateral?\n\n4.\n\nWhy did Mose lose?\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n521\n\n\x0cImpossibility as a Defense\nParker v. Arthur Murray, Inc.\n295 N.E.2d 487 (Ill. Ct. App. 1973)\nStamos, J.\nThe operative facts are not in dispute. In November, 1959 plaintiff went to the Arthur Murray Studio in\nOak Park to redeem a certificate entitling him to three free dancing lessons. At that time he was a 37 yearold college-educated bachelor who lived alone in a one-room attic apartment in Berwyn, Illinois. During\nthe free lessons the instructor told plaintiff he had \xe2\x80\x98exceptional potential to be a fine and accomplished\ndancer\xe2\x80\x99 and generally encouraged further participation. Plaintiff thereupon signed a contract for 75 hours\nof lessons at a cost of $1000. At the bottom of the contract were the bold-type words, \xe2\x80\x98NONCANCELABLE, NEGOTIABLE CONTRACT.\xe2\x80\x99 This initial encounter set the pattern for the future\nrelationship between the parties. Plaintiff attended lessons regularly. He was praised and encouraged\nregularly by the instructors, despite his lack of progress. Contract extensions and new contracts for\nadditional instructional hours were executed. Each written extension contained the bold-type words,\n\xe2\x80\x98NON-CANCELABLE CONTRACT,\xe2\x80\x99 and each written contract contained the bold-type words, \xe2\x80\x98NONCANCELABLE NEGOTIABLE CONTRACT.\xe2\x80\x99 Some of the agreements also contained the bold-type\nstatement, \xe2\x80\x98I UNDERSTAND THAT NO REFUNDS WILL BE MADE UNDER THE TERMS OF THIS\nCONTRACT.\xe2\x80\x99\nOn September 24, 1961 plaintiff was severely injured in an automobile collision, rendering him incapable\nof continuing his dancing lessons. At that time he had contracted for a total of 2734 hours of lessons, for\nwhich he had paid $24,812.80 [about $176,000 in 2010 dollars]. Despite written demand defendants\nrefused to return any of the money, and this suit in equity ensued. At the close of plaintiff\xe2\x80\x99s case the trial\njudge dismissed the fraud count (Count II), describing the instructors\xe2\x80\x99 sales techniques as merely \xe2\x80\x98a\nmatter of pumping salesmanship.\xe2\x80\x99 At the close of all the evidence a decree was entered under Count I in\nfavor of plaintiff for all prepaid sums, plus interest, but minus stipulated sums attributable to completed\nlessons.\nPlaintiff was granted rescission on the ground of impossibility of performance. The applicable legal\ndoctrine is expressed in the Restatement of Contracts, s 459, as follows:\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n522\n\n\x0cA duty that requires for its performance action that can be rendered only by the promisor or\nsome other particular person is discharged by his death or by such illness as makes the necessary\naction by him impossible or seriously injurious to his health, unless the contract indicates a\ncontrary intention or there is contributing fault on the part of the person subject to the duty.\xe2\x80\xa6\nDefendants do not deny that the doctrine of impossibility of performance is generally applicable to the\ncase at bar. Rather they assert that certain contract provisions bring this case within the Restatement\xe2\x80\x99s\nlimitation that the doctrine is inapplicable if \xe2\x80\x98the contract indicates a contrary intention.\xe2\x80\x99 It is contended\nthat such bold type phrases as \xe2\x80\x98NON-CANCELABLE CONTRACT,\xe2\x80\x99 \xe2\x80\x98NON-CANCELABLE NEGOTIABLE\nCONTRACT\xe2\x80\x99 and \xe2\x80\x98I UNDERSTAND THAT NO REFUNDS WILL BE MADE UNDER THE TERMS OF\nTHIS CONTRACT\xe2\x80\x99 manifested the parties\xe2\x80\x99 mutual intent to waive their respective rights to invoke the\ndoctrine of impossibility. This is a construction which we find unacceptable. Courts engage in the\nconstruction and interpretation of contracts with the sole aim of determining the intention of the parties.\nWe need rely on no construction aids to conclude that plaintiff never contemplated that by signing a\ncontract with such terms as \xe2\x80\x98NON-CANCELABLE\xe2\x80\x99 and \xe2\x80\x98NO REFUNDS\xe2\x80\x99 he was waiving a remedy expressly\nrecognized by Illinois courts. Were we also to refer to established tenets of contractual construction, this\nconclusion would be equally compelled. An ambiguous contract will be construed most strongly against\nthe party who drafted it. [Citation] Exceptions or reservations in a contract will, in case of doubt or\nambiguity, be construed least favorably to the party claiming the benefit of the exceptions or reservations.\nAlthough neither party to a contract should be relieved from performance on the ground that good\nbusiness judgment was lacking, a court will not place upon language a ridiculous construction. We\nconclude that plaintiff did not waive his right to assert the doctrine of impossibility.\nPlaintiff\xe2\x80\x99s Count II, which alleged fraud and sought punitive damages, was dismissed by the trial judge at\nthe close of plaintiff\xe2\x80\x99s case. It is contended on appeal that representations to plaintiff that he had\n\xe2\x80\x98exceptional potential to be a fine and accomplished dancer,\xe2\x80\x99 that he had \xe2\x80\x98exceptional potential\xe2\x80\x99 and that\nhe was a \xe2\x80\x98natural born dancer\xe2\x80\x99 and a \xe2\x80\x98terrific dancer\xe2\x80\x99 fraudulently induced plaintiff to enter into the\ncontracts for dance lessons.\nGenerally, a mere expression of opinion will not support an action for fraud. [Citation] In addition,\nmisrepresentations, in order to constitute actionable fraud, must pertain to present or pre-existing facts,\nrather than to future or contingent events, expectations or probabilities. [Citation] Whether particular\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n523\n\n\x0clanguage constitutes speculation, opinion or averment of fact depends upon all the attending facts and\ncircumstances of the case. [Citation] Mindful of these rules, and after carefully considering the\nrepresentations made to plaintiff, and taking into account the business relationship of the parties as well\nas the educational background of plaintiff, we conclude that the instructors\xe2\x80\x99 representations did not\nconstitute fraud. The trial court correctly dismissed Count II. We affirm.\nAffirmed.\n\nCASE QUESTIONS\n\n1.\n\nWhy is it relevant that the plaintiff was \xe2\x80\x9ca bachelor who lived alone in a one-room attic apartment\xe2\x80\x9d?\n\n2.\n\nThe contract here contained a \xe2\x80\x9cno cancellation\xe2\x80\x9d clause; how did the court construe the contract to allow\ncancellation?\n\n3.\n\nPlaintiff lost on his claim of fraud (unlike Mrs. Vokes in the similar case inChapter 10 "Real Assent" against\nanother franchisee of Arthur Murray, Inc.). What defense was successful?\n\n4.\n\nWhat is the controlling rule of law here?\n\n15.3 Summary and Exercises\nSummary\n\nThe law of contracts has various rules to determine whether obligations have been discharged. Of course,\nif both parties have fully performed the contract, duties will have terminated. But many duties are subject\nto conditions, including conditions precedent and subsequent, conditions requiring approval of the\npromisee or someone else, and clauses that recite time to be of the essence.\nA contract obligation may be discharged if the promisor has not received the benefit of the promisee\xe2\x80\x99s\nobligation. In some cases, failure to carry out the duty completely will discharge the corresponding\nobligation (material breach); in other cases, the substantial performance doctrine will require the other\nparty to act.\nA contract may have terminated because one of the parties tells the other in advance that he will not carry\nout his obligations; this is called anticipatory breach. The right to adequate assurance allows one party to\ndetermine whether the contract will be breached by the other party.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n524\n\n\x0cThere are other events, too, that may excuse performance: impracticability (including the UCC rules\ngoverning impracticability in contracts for the sale of goods), death or incapacity of the obligor,\ndestruction of the thing necessary for the performance, government prohibition, frustration of purpose,\nand power of avoidance.\nFinally, note that not all obligations are created by contract, and the law has rules to deal with discharge\nof duties in general. Thus, in the appropriate cases, the obligee may cancel or surrender a written contract,\nmay enter into an accord, may agree to rescind the agreement, or may release the obligor. Or the obligor\nmay show a material alteration in the contract, may become bankrupt, or may plead the statute of\nlimitations\xe2\x80\x94that is, plead that the obligee waited too long to sue. Or the parties may, by word or deed,\nmutually abandon the agreement. In all these ways, duties may be discharged.\n\nEXERCISES\n\n1.\n\nTheresa hired Contractor to construct a large office building. Theresa\xe2\x80\x99s duty to pay Contractor was\nconditioned on receipt of a statement from her architect that the building complied with the terms of the\ncontract. Contractor completed the building but used the wrong color fixtures in the bathrooms. The\narchitect refused to approve the work, but under state law, Contractor was considered to have\nsubstantially performed the contract. Is he entitled to payment, less damages for the improper fixtures?\nExplain.\n\n2.\n\nIn early 1987, Larry McLanahan submitted a claim to Farmers Insurance for theft of his 1985 Lamborghini\nwhile it was on consignment for sale in the Los Angeles area. The car had sustained extensive damage,\nwhich McLanahan had his mechanic document. The insurance policy contained this language: \xe2\x80\x9cAllow us to\ninspect and appraise the damaged vehicle before its repair or disposal.\xe2\x80\x9d But after considerable delay by\nFarmers, McLanahan sold the car to a cash buyer without notifying Farmers. He then sued Farmers for its\nrefusal to pay for damages to his car. Upon what legal theory did Farmers get a summary judgment in its\nfavor?\n\n3.\n\nPlaintiff sold a tavern to Defendants. Several months later, Defendants began to experience severe\nproblems with the septic tank system. They informed Plaintiff of the problem and demanded the return\nof their purchase money. Plaintiff refused. Defendants took no formal action against Plaintiff at that time,\nand they continued to operate the tavern and make their monthly payments under the contract. Some\nmonths later, Defendants met with state officials from the Departments of Environmental Quality, Health,\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n525\n\n\x0cand Liquor Control Commission. The officials warned Defendants that because of the health hazards\nposed by the septic tank problems, Defendants\xe2\x80\x99 licenses might not be renewed. As a result, Defendants\ndecided to close the tavern and attempt to reopen when the septic tank was repaired. Defendants\nadvertised a going-out-of-business sale. The purpose of the sale was to deplete the tavern\xe2\x80\x99s inventory\nbefore closing. Plaintiff learned about the sale and discovered that Defendants had removed certain\npersonal property from the tavern. He sued the Defendants, claiming, among other things, that they had\nanticipatorily breached their contract with him, though he was receiving payments on time. Did the\nDefendants\xe2\x80\x99 actions amount to an anticipatory breach?\n4.\n\n[1]\n\nJulius, a manufacturer of neckties, contracted to supply neckties to a wholesaler. When Julius\xe2\x80\x99s factory\nburned, he failed to supply any, and the wholesaler sued. Is Julius excused from performance by\nimpossibility?\n\n5.\n\nThe Plaintiff (a development corporation) contracted to buy Defendant\xe2\x80\x99s property for $1.8 million. A term\nin the contract read: \xe2\x80\x9cThe sale\xe2\x80\xa6shall be closed at the office of Community Title Company on May 16th at\n10:00 am.\xe2\x80\xa6Time is of the essence in this contract.\xe2\x80\x9d Defendant appeared at the office at 10:00 a.m. on the\nday designated, but the Plaintiff\xe2\x80\x99s agent was not there. Defendant waited for twenty minutes, then left.\nPlaintiff\xe2\x80\x99s agent arrived at 10:30 a.m. and announced that he would not have funds for payment until 1:30\np.m., but Defendant refused to return; she had already made other arrangements to finance her purchase\nof other real estate. Plaintiff sued Defendant for specific performance. Who wins, and why?\n\n6.\n\nA contract between the Koles and Parker-Yale provided for completion of the Koles\xe2\x80\x99s condominium unit\nwithin 180 days. It also authorized the Koles to make written changes in the plans and specifications.\nConstruction was not completed within the 180-day period, and the Koles, prior to completion, sent a\nletter to Parker-Yale rescinding the contract. Were the Koles within their rights to rescind the contract?\n\n7.\n\nPlaintiff contracted to buy Defendant\xe2\x80\x99s commercial property for $1,265,000. Under the terms of the\nagreement, Defendant paid $126,000 as an earnest-money deposit, which would be retained by Plaintiff\nas liquidated damages if Defendant failed to close by the deadline. Tragically, Defendant\xe2\x80\x99s husband died\nfour days before the closing deadline, and she was not able to close by the deadline. She was relying on\nher husband\xe2\x80\x99s business to assist her in obtaining the necessary financing to complete the purchase, and\nafter his death, she was not able to obtain it. Plaintiff sued for the $126,000; Defendant argued that the\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n526\n\n\x0cpurpose of the contract was frustrated due to the untimely death of her husband. Is this a good\nargument?\n8.\n\nBuyer contracted to buy Seller\xe2\x80\x99s house for $290,000; the contract included a representation by Buyer\n\xe2\x80\x9cthat he has sufficient cash available to complete this purchase.\xe2\x80\x9d Buyer was a physician who practiced\nwith his uncle. He had received assurances from his uncle of a loan of $200,000 in order to finance the\npurchase. Shortly after the contract was executed, the uncle was examined by a cardiologist, who found\nhis coronary arteries to be dangerously clogged. As a result, the uncle immediately had triple bypass\nsurgery. After the operation, he told Buyer that his economic future was now uncertain and that\ntherefore it was impossible for him to finance the house purchase. Meanwhile, Seller, who did not know\nof Buyer\xe2\x80\x99s problem, committed herself to buy a house in another state and accepted employment there\nas well. Buyer was unable to close; Seller sued. Buyer raised as a defense impossibility or impracticability\nof performance. Is the defense good?\n\n9.\n\nPursuant to a contract for the repair and renovation of a swimming pool owned by Defendant (City of Fort\nLauderdale), Plaintiff commenced the work, which included resurfacing the inside of the pool, and had\nprogressed almost to completion. Overnight, vandals damaged the work Plaintiff had done inside the\npool, requiring that part of the work be redone. Plaintiff proceeded to redo the work and billed\nDefendant, who paid the contract price but refused to pay for the additional work required to repair the\ndamage. Did the damage constitute destruction of subject matter discharging Plaintiff from his obligation\nto complete the job without getting paid extra?\n\n10. Apache Plaza (the landlord) leased space to Midwest Savings to construct a bank building in Apache\xe2\x80\x99s\nshopping mall, based on a prototype approved by Apache. Midwest constructed the building and used it\nfor twelve years until it was destroyed by a tornado. Midwest submitted plans for a new building to\nApache, but Apache rejected the plans because the new building was larger and had less glass than the\nold building or the prototype. Midwest built it anyway. Its architect claimed that certain changes in the\nstructure of the new building were required by new regulations and building codes, but he admitted that\na building of the stipulated size could have been constructed in compliance with the applicable codes.\nApache claimed $210,000 in damages over the term of the lease because the new building consumed\nmore square feet of mall space and required more parking. Midwest claimed it had substantially complied\nwith the lease requirements. Is this a good defense?\nSaylor URL: http://www.saylor.org/books\n\n[2]\n\nSaylor.org\n527\n\n\x0cSELF-TEST QUESTIONS\n1.\na.\n\nA condition precedent\nis a condition that terminates a duty\nb.\n\nis always within the control of one of the parties\n\nc.\n\nis an event giving rise to performance\n\nd.\n\nis a condition that follows performance\n\nIf Al and Betty have an executory contract, and if Betty tells Al that she will not be fulfilling her\nside of the bargain,\na.\n\nAl must wait until the date of performance to see if Betty in fact performs\nb.\n\nAl can sue immediately for full contract damages\n\nc.\n\nAl can never sue because the contract was executory when Betty notified him of nonperformance\n\nd.\n\nnone of the above\nJack contracts with Anne to drive her to the airport Wednesday afternoon in his specially\ndesigned stretch limousine. On Wednesday morning Jack\xe2\x80\x99s limousine is hit by a drunken driver,\nand Jack is unable to drive Anne. This is an example of\n\na.\n\nimpossibility of performance\nb.\n\nfrustration of purpose\n\nc.\n\ndischarge by merger\n\nd.\n\nnone of the above\n\nJack is ready and willing to drive Anne to the airport. But Anne\xe2\x80\x99s flight is cancelled, and she\nrefuses to pay. This is an example of\na.\n\nimpracticability of performance\nb.\n\nfrustration of purpose\n\nc.\n\ndischarge of merger\n\nd.\n\nnone of the above\n\nRescission is\na.\n\nthe discharge of one party to a contract through substitution of a third person\nb.\n\nan agreement to settle for substitute performance\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n528\n\n\x0cc.\n\na mutual agreement between parties to a contract to discharge each other\xe2\x80\x99s\ncontractual duties\n\nd.\n\n1.\n\nc\n\n2.\n\nb\n\n3.\n\na\n\n4.\n\nb\n\n5.\n\nc\n\nnone of the above\n\nSELF-TEST ANSWERS\n\n6.\n\n[1] Crum v. Grant, 692 P.2d 147 (Or. App., 1984).\n\n7.\n\n[2] Apache Plaza, Ltd. v. Midwest Sav. Ass\xe2\x80\x99n, 456 N.W.2d 729 (Minn. App. 1990).\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n529\n\n\x0cChapter 16\n\nRemedies\n\nLEARNING OBJECTIVES\nAfter reading this chapter, you should understand the following:\n1.\n\nThe basic theory of contract remedies, and why courts don\xe2\x80\x99t just order the promisor to perform as\npromised\n\n2.\n\nThe interests that are protected by contract remedies\n\n3.\n\nThe types of legal remedies\n\n4.\n\nThe types of equitable remedies\n\n5.\n\nThe limitations on remedies\n\nWe come at last to the question of remedies. A valid agreement has been made, the promisor\xe2\x80\x99s duties\nhave not been discharged; he or she has breached the contract. When one party has failed to\nperform, what are the rights of the parties? Or when the contract has been avoided because of\nincapacity or misrepresentation and the like, what are the rights of the parties after disaffirmance?\nThese questions form the focus of this chapter. Remedies for breach of contracts for the sale of goods\nwill be considered separately, in (Reference mayer_1.0-ch18 not found in Book).\n\n16.1 Theory of Contract Remedies\n\nLEARNING OBJECTIVES\n\n1.\n\nUnderstand the basic purpose of remedies.\n\n2.\n\nRecognize that there are two general categories of remedies: legal and equitable.\n\n3.\n\nSee that courts do not simply order obligors to keep their promise but instead allow them to breach and\nthe nonbreaching party to have remedies for that breach.\n\nPurpose of Remedies\nThe fundamental purpose of remedies in noncriminal cases is not to punish the breaching party but\xe2\x80\x94if\npossible\xe2\x80\x94to put the nonbreaching party in the position he or she would have been in had there been no\nbreach. Or, as is said, the purpose is to make the nonbreaching party whole.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n530\n\n\x0cThere are two general categories of remedies\xe2\x80\x94legal and equitable. In the category of legal remedies\nare damages. Damages are money paid by one party to another; there are several types of damages. In the\ncategory of equitable remedies are these three: specific performance, which means a person is ordered to\ndeliver a unique thing (land or a unique personal property, such as a painting or an antique\ncar); injunction, a judicial order directing a person to stop doing what he or she should not do (such as\ncompeting with a former employer in violation of a noncompete agreement); and restitution, which\nmeans putting the parties back into the position they were in before the contract was made.\n\nParties Have the Power\xe2\x80\x94but Not the Right\xe2\x80\x94to Breach\nIn view of the importance given to the intention of the parties in forming and interpreting contracts, it\nmay seem surprising that the remedy for every breach is not a judicial order that the obligor carry out his\nor her undertakings. But it is not. Of course, some duties cannot be performed after a breach, because\ntime and circumstances will have altered their purpose and rendered many worthless. Still, there are\nnumerous occasions on which it would be theoretically possible for courts to order the parties to carry out\ntheir contracts, yet the courts will not do it. In 1897, Justice Oliver Wendell Holmes Jr. declared in a\nfamous line that \xe2\x80\x9cthe duty to keep a contract at common law means a prediction that you must pay\ndamages if you do not keep it.\xe2\x80\x9d By that, he meant simply that the common law looks more toward\ncompensating the promisee for his or her loss than toward compelling the promisor to perform. Indeed,\nthe law of remedies often provides the parties with an incentive to break the contract. In short, the\npromisor has a choice: perform or pay.\nThe logic of this position is clear in many typical cases. The computer manufacturer orders specially\ndesigned circuit boards, then discovers before the circuits are made that a competitor has built a better\nmachine and destroyed his market. The manufacturer cancels the order. It would make little economic\nsense for the circuit board maker to fabricate the boards if they could not be used elsewhere. A damage\nremedy to compensate the maker for out-of-pocket loss or lost profits is sensible; a judicial decree forcing\nthe computer manufacturer to pay for and take delivery of the boards would be wasteful.\nIn general and if possible, the fundamental purpose of contract remedies is to put the nonbreaching party\nin the position it would have been in had there been no breach.\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n531\n\n\x0cKEY TAKEAWAY\nRemedies are intended to make the nonbreaching party whole. The two categories of remedies for breach\nof contract are legal and equitable. In the legal category are damages; in the equitable category are\nspecific performance, injunctions, and restitution. The law does not force a party to perform; he or she\nalways has the power (though not the right) to breach, and may do so if it is economically more\nadvantageous to breach and suffer the consequence than to perform. Remedies, though, are not (usually)\nintended to punish the breaching party.\n\n1.\n\nEXERCISES\n\nRemedies are not supposed to punish the breaching party, generally. In what circumstances might\npunishment be a remedy, and what is that called?\n\n2.\n\nWhat is the difference between legal and equitable remedies?\n\n3.\n\nWhy shouldn\xe2\x80\x99t people be forced to perform as they contracted, instead of giving them the power to\nbreach and then be required to pay damages?\n\n16.2 Promisee\xe2\x80\x99s Interests Protected by Contract\nLEARNING OBJECTIVE\n\n1.\n\nUnderstand that the nonbreaching party to a contract has certain expectations that contract remedies\nseek to fulfill to make the nonbreaching party whole.\n\nContract remedies serve to protect three different interests: an expectation interest, a reliance\ninterest, and a restitution interest. A promisee will have one of these and may have two or all three.\nAn expectation interest is the benefit for which the promisee bargained, and the remedy is to put him\nin a position as good as that which he would have been in had the contract been performed.\nA reliance interest is the loss suffered by relying on the contract and taking actions consistent with the\nexpectation that the other party will abide by it; the remedy is reimbursement that restores the\npromisee to his position before the contract was made. A restitution interestis that which restores to\nthe promisee any benefit he conferred on the promisor. These interests do not dictate the outcome\naccording to a rigid formula; circumstances and the nature of the contract, as usual, will play a large\nrole. But in general, specific performance is a remedy that addresses the expectation interest,\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n532\n\n\x0cmonetary damages address all three interests, and, not surprisingly, restitution addresses the\nrestitution interest.\nConsider some simple examples. A landowner repudiates an executory contract with a builder to\nconstruct a garage on her property for $100,000. The builder had anticipated a $10,000 profit (the\ngarage would have cost him $90,000 to build). What can he expect to recover in a lawsuit against the\nowner? The court will not order the garage to be built; such an order would be wasteful, since the\nowner no longer wants it and may not be able to pay for it. Instead, the court will look to the builder\xe2\x80\x99s\nthree possible interests. Since the builder has not yet started his work, he has given the owner\nnothing, and therefore has no restitution interest. Nor has he any reliance interest, since we are\nassuming that he has not paid out any money for supplies, hired a work crew, or advanced money to\nsubcontractors. But he anticipated a profit, and so he has an expectation interest of $10,000.\nNow suppose that the builder had dug out the foundation and poured concrete, at a cost of $15,000.\nHis expectation interest has become $25,000 (the difference between $100,000 and $75,000, the\nmoney he will save by not having to finish the job). His reliance interest is $15,000, because this is\nthe amount he has already spent. He may also have a restitution interest, depending on how much\nthe foundation of the house is worth to the owner. (The value could be more or less than the sum of\nmoney actually expended to produce the foundation; for example, the builder might have had to pay\nhis subcontractors for a greater share of the job than they had completed, and those sums therefore\nwould not be reflected in the worth of the foundation.)\nNormally, the promisee will choose which of the three interests to pursue. As is to be expected, the\nchoice hinges on the circumstances of the case, his feelings, and the amount at stake.\n\nKEY TAKEAWAY\n\nA nonbreaching party might have one or more interests that the law seeks to realize: expectation,\nreliance, and restitution.\n\nEXERCISES\n\n1.\n\nWhat is the expectation interest? The reliance interest? The restitution interest?\n\n2.\n\nHow are these concepts useful in understanding contract remedies?\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n533\n\n\x0c16.3 Legal Remedies: Damages\n\nLEARNING OBJECTIVES\n\n1.\n\nUnderstand what is meant when it is said that damages are a legal remedy (as opposed to an equitable\nremedy).\n\n2.\n\nUnderstand the names and purposes of the six types of remedies.\n\n3.\n\nKnow when liquidated damages will be allowed.\n\n4.\n\nRecognize the circumstances that might allow punitive damages.\n\nOverview\nThe promisee, whom we will hereafter refer to as the nonbreaching party, has the right to damages (a\nmoney award), if that is required to make her whole, whenever the other party has breached the contract,\nunless, of course, the contract itself or other circumstances suspend or discharge that right.\nDamages refers to money paid by one side to the other; it is a legal remedy. For historical and political\nreasons in the development of the English legal system, the courts of law were originally only able to grant\nmonetary relief. If a petitioner wanted something other than money, recourse to a separate system of\nequity was required. The courtrooms and proceedings for each were separate. That actual separation is\nlong gone, but the distinction is still recognized; a judge may be said to be \xe2\x80\x9csitting in law\xe2\x80\x9d or \xe2\x80\x9csitting in\nequity,\xe2\x80\x9d or a case may involve requests for both money and some action. We take up the legal remedies of\ndamages first.\n\nTypes of Damages\nThere are six different types of damages: compensatory, incidental, consequential, nominal, liquidated,\nand (sometimes) punitive.\n\nCompensatory Damages\nDamages paid to directly compensate the nonbreaching party for the value of what was not done or\nperformed are compensatory damages. Sometimes calculating that value of the promisor\xe2\x80\x99s performance is\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n534\n\n\x0ceasy\xe2\x80\x94for example, when the nonbreaching party has ascertainable costs and profits, as in the case of the\nbuilder who would have earned $10,000 profit on a $100,000 house. When the performance is a service,\na useful measure of loss is what it would cost to substitute performance by someone else. But the\ncalculation is frequently difficult, especially when the performance is a service that is not easily\nduplicated. If Rembrandt breached a contract to paint your portrait, the loss could not be measured\nsimply by inquiring how much Van Gogh would charge to do the same thing. Nevertheless, in theory,\nwhatever net value would ultimately have been conferred on the nonbreaching party is the proper\nmeasure of compensatory damages. An author whose publisher breaches its contract to publish the book\nand who cannot find another publisher is entitled to lost royalties (if ascertainable) plus the value that\nwould have accrued from her enhanced reputation.\nSince the nonbreaching party usually has obligations under the contract also, a breach by the other party\ndischarges his duty to perform and may result in savings. Or he may have made substitute arrangements\nand realized at least a partial profit on the substitution. Or, as in the case of the builder, he may have\npurchased goods intended for the job that can be used elsewhere. In all these situations, the losses he has\navoided\xe2\x80\x94savings, profits, or value of goods\xe2\x80\x94are subtracted from the losses incurred to arrive at the net\ndamages. The nonbreaching party may recover his actual losses, not more. Suppose an employer breaches\na contract with a prospective employee who was to begin work for a year at a salary of $35,000. The\nemployee quickly finds other, similar work at a salary of $30,000. Aside from whatever he might have had\nto spend searching for the job (incidental damages), his compensatory damages are limited to $5,000, the\ndifference between what he would have earned and what he is earning.\nLost volume can be a troublesome problem in calculating damages. This problem arises when the\nnonbreaching party, a supplier of goods or services, enters a second contract when the buyer repudiates.\nThe question is whether the second contract is a substituted performance or an additional one. If it is\nsubstituted, damages may be little or nothing; if additional, the entire expectation interest may be\nrecovered. An automobile dealer contracts to sell a car in his inventory. Shortly before the deal is closed,\nthe buyer calls up and repudiates the contract. The dealer then sells the car to someone else. If the dealer\ncan show that he could have sold an identical car to the second purchaser regardless of what the first\npurchaser did, then the second sale stands on its own and cannot be used to offset the net profit\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n535\n\n\x0crecoverable from the first purchaser. The factual inquiry in lost volume cases is whether the nonbreaching\nparty would have engaged in the second transaction if the breach had never occurred.\n\nIncidental Damages\nIn addition to compensatory damages, the nonbreaching party may recoverincidental damages. Incidental\nloss includes expenditures that the nonbreaching party incurs in attempting to minimize the loss that\nflows from the breach. To arrange for substitute goods or services, the nonbreaching party might have to\npay a premium or special fees to locate another supplier or source of work.\n\nConsequential Damages\nA consequential loss is addressed with consequential damages. These are damages incurred by the\nnonbreaching party without action on his part because of the breach. For example, if Ralph does a poor\njob of plumbing Betty\xe2\x80\x99s bathroom and the toilet leaks, damaging the floor, the downstairs ceiling, and the\ndownstairs rug, Ralph would owe for those loses in consequential damages. Or, again, lost sales stemming\nfrom a failure to fix a manufacturer\xe2\x80\x99s machine in time or physical and property injury due to a defective\nmachine sold by the promisor would be addressed with consequential damages. Note, however, that one\nobvious, and often large, expenditure occasioned by a breach\xe2\x80\x94namely, legal expenses in bringing a\nlawsuit to remedy the particular breach\xe2\x80\x94is not an element of damages, unless the contract explicitly\nstates that it is, and cannot be charged to the defendant. There is one situation, however, in which legal\ncosts can be added to damages: when the breach causes the nonbreaching party to be involved in a lawsuit\nwith someone else. Consequential damages will not be allowed if those damages are not foreseeable. This\nissue is taken up in .\n\nNominal Damages\nIn the situation where there has been a breach but the nonbreaching party has really suffered no loss or\ncannot prove what his loss is, he is entitled tonominal damages. Ricardo contracts to buy a new car from a\ndealer; the dealer breaches the contract. Ricardo finds and buys the same car from another dealer at the\nsame price that the first one was to sell it for. Ricardo has suffered nominal damages: five dollars,\nperhaps.\n\nLiquidated Damages\nPrecisely because damages are sometimes difficult to assess, the parties themselves may specify how\nmuch should be paid in the event of a breach. Courts will enforce a liquidated damages provision as long\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n536\n\n\x0cas the actual amount of damages is difficult to ascertain (in which case proof of it is simply made at trial)\nand the sum is reasonable in light of the expected or actual harm. If the liquidated sum is unreasonably\nlarge, the excess is termed a penalty and is said to be against public policy and unenforceable. , Watson v.\nIngram, illustrates liquidated damages.\n\nPunitive Damages\nPunitive damages are those awarded for the purpose of punishing a defendant in a civil action, in which\ncriminal sanctions are of course unavailable. They are proper in cases in which the defendant has acted\nwillfully and maliciously and are thought to deter others from acting similarly. Since the purpose of\ncontract law is compensation, not punishment, punitive damages have not traditionally been awarded,\nwith one exception\xe2\x80\x94when the breach of contract is also a tort for which punitive damages may be\nrecovered. Punitive damages are permitted in the law of torts (in all but four states) when the behavior is\nmalicious or willful (reckless conduct causing physical harm, deliberate defamation of one\xe2\x80\x99s character, a\nknowingly unlawful taking of someone\xe2\x80\x99s property), and some kinds of contract breach are also tortious.\nFor example, when a creditor holding collateral as security under a contract for a loan sells the collateral\nto a good-faith purchaser for value even though the debtor was not in default, he has breached the\ncontract and committed the tort of conversion; punitive damages may be awarded, assuming the behavior\nwas willful and not merely mistaken.\nPunitive damages are not fixed by law. The judge or jury may award at its discretion whatever sum is\nbelieved necessary to redress the wrong or deter like conduct in the future. This means that a richer\nperson may be slapped with much heavier punitive damages than a poorer one in the appropriate case.\nBut the judge in all cases may remit (reduce) some or all of a punitive damage award if he or she considers\nit excessive.\n\nKEY TAKEAWAY\n\nAs the purpose of contract remedies is, in general, to make the nonbreaching party whole, the law allows\nseveral types of damages (money paid) to reflect the losses suffered by the nonbreaching party.\nCompensatory damages compensate for the special loss suffered; consequential damages compensate for\nthe foreseeable consequences of the breach; incidental damages compensate for the costs of keeping any\nmore damages from occurring; nominal damages are awarded if the actual amount cannot be shown or\nthere are no actual damages; liquidated damages are agreed to in advance where the actual amount is\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n537\n\n\x0cdifficult to ascertain, and they are allowed if not a penalty; and punitive damages may sometimes be\nallowed if the breaching party\xe2\x80\x99s behavior is an egregious tort, an outrage.\n\nEXERCISES\n\n1.\n\nWhat is the difference between a legal remedy and an equitable remedy?\n\n2.\n\nWhat types of remedies are there, and what purpose does each serve?\n\n3.\n\nWhat must be shown if liquidated damages are to be allowed?\n\n4.\n\nUnder what circumstances may punitive damages be allowed?\n\n16.4 Equitable Remedies\n\nLEARNING OBJECTIVES\n\n1.\n\nKnow when equitable (as opposed to legal) remedies will be allowed.\n\n2.\n\nUnderstand the different types of equitable remedies: specific performance, injunction, and restitution.\n\nOverview\nReally the only explanation for the differences between law and equity is to be found in the history and\npolitics of England dating to the twelfth century, but in practical terms, the distinctions are notable. First,\njuries are not used in equitable cases. Second, equity relies less on precedent and more on the sense that\njustice should be served. Third, and of most significance, where what is sought by the nonbreaching party\nis not money\xe2\x80\x94that is, where there is no adequate legal remedy\xe2\x80\x94equity may afford relief. In equity a\nperson may get a judge to order the breaching party to deliver some actual property, or to stop doing\nsomething that he should not do, or to return the consideration the nonbreaching party gave so as to\nreturn the parties to the precontract status (specific performance, injunction, and restitution,\nrespectively).\n\nTypes of Remedies in Equity\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n538\n\n\x0cThere are three types of equitable remedies: specific performance, injunction, and restitution.\n\nSpecific Performance\nSpecific performance is a judicial order to the promisor that he undertake the performance to which\nhe obligated himself in a contract. Specific performance is an alternative remedy to damages and may be\nissued at the discretion of the court, subject to a number of exceptions. Emily signs a contract to sell\nCharlotte a gold samovar, a Russian antique of great sentimental value because it once belonged to\nCharlotte\xe2\x80\x99s mother. Emily then repudiates the contract while still executory. A court may properly grant\nCharlotte an order of specific performance against Emily.\nOnce students understand the basic idea of specific performance, they often want to pounce upon it as the\nsolution to almost any breach of contract. It seems reasonable that the nonbreaching party could ask a\ncourt to simply require the promisor to do what she promised she would. But specific performance is a\nvery limited remedy: it is only available for breach of contract to sell a unique item, that is, a unique item\nof personal property (the samovar), or a parcel of real estate (all real estate is unique). But if the item is\nnot unique, so that the nonbreaching party can go out and buy another one, then the legal remedy of\nmoney damages will solve the problem. And specific performance will never be used to force a person to\nperform services against his will, which would be involuntary servitude. A person may be forced to stop\ndoing that which he should not do (injunction), but not forced to do what he will not do.\n\nInjunction\nAn injunction is the second type of equitable remedy available in contract (it is also available in tort). It\nis a court order directing a person to stop doing that which she should not do. For example, if an employer\nhas a valid noncompete contract with an employee, and the employee, in breach of that contract,\nnevertheless undertakes to compete with his former employer, a court may enjoin (issue an order of\ninjunction), directing the former employee to stop such competition. A promise by a person not to do\nsomething\xe2\x80\x94in this example, not to compete\xe2\x80\x94is called a negative covenant (a covenant is a promise in a\ncontract, itself a contract). Or if Seller promises to give Buyer the right of first refusal on a parcel of real\nestate or a unique work of art, but Seller, in breach of a written promise, offers the thing to a third party, a\ncourt may enjoin Seller from selling it to the third party. If a person violates an injunction, he may be held\nin contempt of court and put in jail for a while. Madison Square Garden v. Carnera Corporation, , is a\nclassic case involving injunctions for breach of contract.\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n539\n\n\x0cRestitution\nThe third type of equitable relief is restitution. Restitution is a remedy applicable to several different\ntypes of cases: those in which the contract was avoided because of incapacity or misrepresentation, those\nin which the other party breached, and those in which the party seeking restitution breached. As the word\nimplies, restitution is a restoring to one party of what he gave to the other. Therefore, only to the extent\nthat the injured party conferred a benefit on the other party may the injured party be awarded restitution.\nThe point is, a person who breaches a contract should not suffer a punishment, and the nonbreaching\nparty should not be unjustly enriched.\n\nTotal Nonperformance by Breaching Party\nThe nonbreaching party is always entitled to restitution in the event of total breach by nonperformance or\nrepudiation, unless both parties have performed all duties except for payment by the other party of a\ndefinite sum of money for the injured party\xe2\x80\x99s performance.\n\n[1]\n\nCalhoun, a contractor, agrees to build\n\n$3,000 worth of fences for only $2,000 and completes the construction. Arlene, the landowner, refuses to\npay. Calhoun\xe2\x80\x99s only right is to get the $2,000; he does not have a restitution right to $2,500, the market\nprice of his services (or $3,000, the amount by which her property increased in value); he is entitled,\ninstead, only to $2,000, his contract price. Had Arlene repudiated prior to completion, however, Calhoun\nwould then have been entitled to restitution based either on the market price of the work or on the\namount by which he enhanced her property. If the one party breaches, the nonbreaching party is generally\nentitled to restitution of property that can be returned. Arlene gives Calhoun a valuable Ming vase in\nreturn for his promise to construct the fences. Upon Calhoun\xe2\x80\x99s breach, Arlene is entitled to specific\nrestitution of the vase.\nMeasuring restitution interest can be problematic. The courts have considerable discretion to award\neither what it would have cost to hire someone else to do the work that the nonbreaching party performed\n(generally, the market price of the service) or the value that was added to the property of the party in\nbreach by virtue of the claimant\xe2\x80\x99s performance. Calhoun, the contractor, agrees to construct ten fences\naround Arlene\xe2\x80\x99s acreage at the market price of $25,000. After erecting three, Calhoun has performed\nservices that would cost $7,500, market value. Assume that he has increased the value of Arlene\xe2\x80\x99s grounds\nby $8,000. If Arlene repudiated, there are two measures of Calhoun\xe2\x80\x99s restitution interest: $8,000, the\nvalue by which the property was enhanced, or $7,500, the amount it would have cost Arlene to hire\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n540\n\n\x0csomeone else to do the work. Which measure to use depends on who repudiated the contract and for what\nreason. In some cases, the enhancement of property or wealth measurement could lead to an award vastly\nexceeding the market price for the service. In such cases, the smaller measure is used. For a doctor\nperforming lifesaving operations on a patient, restitution would recover only the market value of the\ndoctor\xe2\x80\x99s services\xe2\x80\x94not the monetary value of the patient\xe2\x80\x99s life.\n\nPart Performance and Then Breach\nA party who has substantially performed and then breached is entitled to restitution of a benefit conferred\non the injured party, if the injured party has refused (even though justifiably) to complete his own\nperformance owing to the other\xe2\x80\x99s breach. Since the party in breach is liable to the injured party for\ndamages for loss, this rule comes into play only when the benefit conferred is greater than the amount the\nnonbreaching party has lost. Arlene agrees to sell her property to Calhoun for $120,000, and Calhoun\nmakes a partial payment of $30,000. He then repudiates. Arlene turns around and sells the property to a\nthird party for $110,000. Calhoun\xe2\x80\x94the breaching party\xe2\x80\x94can get his money back, less the damages Arlene\nsuffered as a result of his breach. He gets $30,000 minus the $10,000 loss Arlene incurred. He gets\n$20,000 in restitution. Otherwise Arlene would be enriched by Calhoun\xe2\x80\x99s breach: she\xe2\x80\x99d get $140,000 in\ntotal for real estate worth $120,000. But if he gets $20,000 of his $30,000 back, she receives $110,000\nfrom the third party and $10,000 from Calhoun, so she gets $120,000 total (plus, we hope, incidental\ndamages, at least).\n\nRestitution in Other Cases\nUpon repudiation of an oral contract governed by the Statute of Frauds, the nonbreaching party is not\nentitled to her expectation interest, but she may recover in restitution unless the purpose of the statute\nwould be frustrated. When one party avoids a contract owing to lack of capacity, mistake,\nmisrepresentation, duress, or the like, she is entitled to restitution for benefit conferred on the other\nparty. Restitution is also available if a contract duty is discharged or never arises because (1) performance\nwas impracticable, (2) the purpose of the contract was frustrated, (3) a condition did not occur, or (4) a\nbeneficiary disclaimed his benefit.\n\nKEY TAKEAWAY\n\nEquitable remedies for breach of contract are available when legal remedies won\xe2\x80\x99t make the nonbreaching\nparty whole. The equitable remedies are specific performance (an order directing a person to deliver to\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n541\n\n\x0cthe buyer the unique thing the seller contracted to sell), injunction (an order directing a person to stop\ndoing that which he should not do), and restitution (the return by one party of the benefit conferred on\nhim when the contract is not performed, to the extent necessary to avoid imposing a penalty on the\nbreaching party).\n\n1.\n\nEXERCISES\n\nBuyer contracts to buy a 1941 four-door Cadillac convertible from Seller for $75,000. Seller, having found\na Third Party who will pay $85,000 for the car, refuses to sell to Buyer. What is Buyer\xe2\x80\x99s remedy?\n\n2.\n\nAssume Third Party had paid the $85,000 and Seller was ordered to sell to Buyer. What is Third Party\xe2\x80\x99s\nremedy?\n\n3.\n\nProfessor Smith contracts to teach business law at State University for the academic year. After the first\nterm is over, she quits. Can State University get an order of specific performance or an injunction\nrequiring Professor Smith to return for the second term?\n\n4.\n\nNow suppose that the reason Professor Smith quit work at State University is because she got a better job\nat Central University, fifteen miles away. Can State University get an injunction prohibiting her from\n\nteaching at Central University?\n[1] Restatement (Second) of Contracts, Section 373.\n\n16.5 Limitations on Contract Remedies\n\nLEARNING OBJECTIVES\n\n1.\n\nUnderstand that there are various rules that limit recovery for the nonbreaching party in a contract case.\n\n2.\n\nKnow how these concepts serve to limit contract remedies: foreseeability, mitigation of damages,\ncertainty of damages, loss of power of avoidance, election of remedies, and agreement of the parties.\n\nOverview\nWe have observed that the purpose of remedies in contract law is, where possible, to put the nonbreaching\nparty in as good a position as he would have been in had there been no breach. There are, however,\nseveral limitations or restrictions affecting when a person can claim remedies, in both law (damages) and\nequity. Of course the contract itself may\xe2\x80\x94if not unconscionable\xe2\x80\x94limit remedies. Beyond that, the\nnonbreaching party must be able to articulate with some degree of certainty what her damages are; the\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n542\n\n\x0cdamages must be foreseeable; the nonbreaching party must have made a reasonable effort to mitigate the\ndamages; she must sometime elect to go with one remedy and forgo another; she cannot seek to avoid a\ncontract if she has lost the power to do so. We turn to these points.\n\nForeseeability\nIf the damages that flow from a breach of contract lack foreseeability, they will not be recoverable.\nFailures to act, like acts themselves, have consequences. As the old fable has it, \xe2\x80\x9cFor want of a nail, the\nkingdom was lost.\xe2\x80\x9d To put a nonbreaching party in the position he would have been in had the contract\nbeen carried out could mean, in some cases, providing compensation for a long chain of events. In many\ncases, that would be unjust, because a person who does not anticipate a particular event when making a\ncontract will not normally take steps to protect himself (either through limiting language in the contract\nor through insurance). The law is not so rigid; a loss is not compensable to the nonbreaching party unless\nthe breaching party, at the time the contract was made, understood the loss was foreseeable as a probable\nresult of his breach.\nOf course, the loss of the contractual benefit in the event of breach is always foreseeable. A company that\nsigns an employment contract with a prospective employee knows full well that if it breaches, the\nemployee will have a legitimate claim to lost salary. But it might have no reason to know that the\nemployee\xe2\x80\x99s holding the job for a certain length of time was a condition of his grandfather\xe2\x80\x99s gift of $1\nmillion.\nThe leading case, perhaps the most studied case, in all the common law is Hadley v. Baxendale, decided\nin England in 1854. Joseph and Jonah Hadley were proprietors of a flour mill in Gloucester. In May 1853,\nthe shaft of the milling engine broke, stopping all milling. An employee went to Pickford and Company, a\ncommon carrier, and asked that the shaft be sent as quickly as possible to a Greenwich foundry that would\nuse the shaft as a model to construct a new one. The carrier\xe2\x80\x99s agent promised delivery within two days.\nBut through an error, the shaft was shipped by canal rather than by rail and did not arrive in Greenwich\nfor seven days. The Hadleys sued Joseph Baxendale, managing director of Pickford, for the profits they\nlost because of the delay. In ordering a new trial, the Court of Exchequer ruled that Baxendale was not\nliable because he had had no notice that the mill was stopped:\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n543\n\n\x0cWhere two parties have made a contract which one of them has broken, the damages which the\nother party ought to receive in respect of such breach of contract should be such as may fairly\nand reasonably be considered either arising naturally, i.e., according to the usual course of\nthings, from such breach of contract itself, or such as may reasonably be supposed to have been\nin the contemplation of both parties, at the time they made the contract, as the probable result of\nthe breach of it.\n\n[1]\n\nThus when the party in breach has not known and has had no reason to know that the contract entailed a\nspecial risk of loss, the burden must fall on the nonbreaching party. As we have seen, damages\nattributable to losses that flow from events that do not occur in the ordinary course of events are known as\nconsequential or special damages. The exact amount of a loss need not be foreseeable; it is the nature of\nthe event that distinguishes between claims for ordinary or consequential damages. A repair shop agrees\nto fix a machine that it knows is intended to be resold. Because it delays, the sale is lost. The repair shop,\nknowing why timeliness of performance was important, is liable for the lost profit, as long as it was\nreasonable. It would not be liable for an extraordinary profit that the seller could have made because of\ncircumstances peculiar to the particular sale unless they were disclosed.\nThe special circumstances need not be recited in the contract. It is enough for the party in breach to have\nactual knowledge of the loss that would occur through his breach. Moreover, the parol evidence rule\n(Chapter 13 "Form and Meaning") does not bar introduction of evidence bearing on the party\xe2\x80\x99s knowledge\nbefore the contract was signed. So the lesson to a promisee is that the reason for the terms he bargains for\nshould be explained to the promisor\xe2\x80\x94although too much explanation could kill a contract. A messenger\nwho is paid five dollars to deliver a letter across town is not likely to undertake the mission if he is told in\nadvance that his failure for any reason to deliver the letter will cost the sender $1 million, liability to be\nplaced on the messenger.\nActual knowledge is not the only criterion, because the standard of foreseeability is objective, not\nsubjective. That means that if the party had reason to know\xe2\x80\x94if a reasonable person would have\nunderstood\xe2\x80\x94that a particular loss was probable should he breach, then he is liable for damages. What one\nhas reason to know obviously depends on the circumstances of the case, the parties\xe2\x80\x99 prior dealings, and\nindustry custom. A supplier selling to a middleman should know that the commodity will be resold and\nthat delay or default may reduce profits, whereas delay in sale to an end user might not. If it was\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n544\n\n\x0cforeseeable that the breach might cause the nonbreaching party to be sued, the other party is liable for\nlegal fees and a resulting judgment or the cost of a settlement.\nEven though the breaching party may have knowledge, the courts will not always award full consequential\ndamages. In the interests of fairness, they may impose limitations if such an award would be manifestly\nunfair. Such cases usually crop up when the parties have dealt informally and there is a considerable\ndisproportion between the loss caused and the benefit the nonbreaching party had agreed to confer on the\nparty who breached. The messenger may know that a huge sum of money rides on his prompt delivery of a\nletter across town, but unless he explicitly contracted to bear liability for failure to deliver, it is unlikely\nthat the courts would force him to ante up $1 million when his fee for the service was only five dollars.\nEBWS, LLC v. Britly Corp., Section 16.6.1 "Consequential Damages", is a case that represents a modern\napplication of the rule of Hadley v. Baxendale on the issue of foreseeability of consequential damages.\n\nMitigation of Damages\nContract law encourages the nonbreaching party to avoid loss wherever possible; this is\ncalled mitigation of damages. The concept is a limitation on damages in law. So there can be no recovery if\nthe nonbreaching party had an opportunity to avoid or limit losses and failed to take advantage of it. Such\nan opportunity exists as long as it does not impose, in the Restatement\xe2\x80\x99s words, an \xe2\x80\x9cundue risk, burden or\nhumiliation.\xe2\x80\x9d\n\n[2]\n\nThe effort to mitigate need not be successful. As long as the nonbreaching party makes a\n\nreasonable, good-faith attempt to mitigate his losses, damages are recoverable.\nMitigation crops up in many circumstances. Thus a nonbreaching party who continues to perform after\nnotice that the promisor has breached or will breach may not recover for expenses incurred in continuing\nto perform. And losses from the use of defective goods delivered in breach of contract are not\ncompensable if the nonbreaching party knew before use that they were defective. Often the nonbreaching\nparty can make substitute arrangements\xe2\x80\x94find a new job or a new employee, buy substitute goods or sell\nthem to another buyer\xe2\x80\x94and his failure to do so will limit the amount of damages he will recover from the\nparty who breaches. Under the general rule, failure to mitigate when possible permits the promisor to\ndeduct from damages the amount of the loss that the nonbreaching party could have avoided. When there\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n545\n\n\x0cis a readily ascertainable market price for goods, damages are equal to the difference between the contract\nprice and the market price.\nA substitute transaction is not just any possible arrangement; it must be suitable under the circumstances.\nFactors to be considered include the similarity, time, and place of performance, and whether the\ndifference between the contracted-for and substitute performances can be measured and compensated. A\nprospective employee who cannot find substitute work within her field need not mitigate by taking a job\nin a wholly different one. An advertising salesperson whose employment is repudiated need not mitigate\nby taking a job as a taxi driver. When the only difference between the original and the substitute\nperformances is price, the nonbreaching party must mitigate, even if the substitute performer is the\noriginal promisor.\nThe nonbreaching party must mitigate in timely fashion, but each case is different. If it is clear that the\npromisor has unconditionally repudiated before performance is due, the nonbreaching party must begin\nto mitigate as soon as practicable and should not wait until the day performance is due to look for an\nalternative.\nAs long as the nonbreaching party makes a reasonable effort to mitigate, the success of that effort is not an\nissue in assessing damages. If a film producer\xe2\x80\x99s original cameraman breaches the contract, and if the\nproducer had diligently searched for a substitute cameraman, who cost $150 extra per week and it later\ncame to light that the producer could have hired a cameraman for $100, the company is entitled\nnevertheless to damages based on the higher figure. Shirley MacLaine v. Twentieth Century-Fox\nCorporation, Section 16.6.4 "Limitation on Damages: Mitigation of Damages", is a well-known case\ninvolving mitigation of damages.\n\nCertainty of Damages\nA party can recover only that amount of damage in law which can be proved with reasonable certainty.\nEspecially troublesome in this regard are lost profits and loss of goodwill. Alf is convinced that next spring\nthe American public will be receptive to polka-dotted belts with his name monogrammed in front. He\narranges for a garment factory to produce 300,000 such belts, but the factory, which takes a large deposit\nfrom him in advance, misplaces the order and does not produce the belts in time for the selling season.\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n546\n\n\x0cWhen Alf discovers the failure, he cannot raise more money to go elsewhere, and his project fails. He\ncannot recover damages for lost profits because the number is entirely speculative; no one can prove how\nmuch he would have made, if anything. He can, instead, seek restitution of the monies advanced. If he had\nrented a warehouse to store the belts, he would also be able to recover his reliance interest.\nProof of lost profits is not always difficult: a seller can generally demonstrate the profit he would have\nmade on the sale to the buyer who has breached. The problem is more difficult, as Alf\xe2\x80\x99s case demonstrates,\nwhen it is the seller who has breached. A buyer who contracts for but does not receive raw materials,\nsupplies, and inventory cannot show definitively how much he would have netted from the use he planned\nto make of them. But he is permitted to prove how much money he has made in the past under similar\ncircumstances, and he may proffer financial and market data, surveys, and expert testimony to support\nhis claim. When proof of profits is difficult or impossible, the courts may grant a nonmonetary award,\nsuch as specific performance.\n\nLoss of Power of Avoidance\nYou will recall that there are several circumstances when a person may avoid a contract: duress, undue\ninfluence, misrepresentation (fraudulent, negligent, or innocent), or mistake. But a party may lose the\nright to avoid, and thus the right to any remedy, in several ways.\n\nDelay\nIf a party is the victim of fraud, she must act promptly to rescind at common law, or she will lose the right\nand her remedy will be limited to damages in tort. (This is discussed a bit more in Section 16.5.7 "Election\nof Remedies".)\n\nAffirmation\nAn infant who waits too long to disaffirm (again, delay) will have ratified the contract, as will one who\xe2\x80\x94\nnotwithstanding being the victim of duress, undue influence, mistake, or any other grounds for\navoidance\xe2\x80\x94continues to operate under the contract with full knowledge of his right to avoid. Of course the\ndisability that gave rise to the power of avoidance must have passed before affirmation works.\n\nRights of Third Parties\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n547\n\n\x0cThe intervening rights of third parties may terminate the power to avoid. For example, Michelle, a minor,\nsells her watch to Betty Buyer. Up to and within a reasonable time after reaching majority, Michelle could\navoid\xe2\x80\x94disaffirm\xe2\x80\x94the contract. But if, before that time, Betty sells the watch to a third party, Michelle\ncannot get it back from the third party. Similarly, Salvador Seller sells his car to Bill Buyer, who pays for it\nwith a bad check. If the check bounces, Salvador can rescind the deal\xe2\x80\x94Bill\xe2\x80\x99s consideration (the money\nrepresented by the check) has failed: Salvador could return the check and get his car back. But if, before\nthe check from Bill bounces, Bill in turn sells the car to Pat Purchaser, Salvador cannot avoid the contract.\nPat gets to keep the car. There are some exceptions to this rule.\n\nAgreement of the Parties Limiting Remedies\nCertainly it is the general rule that parties are free to enter into any kind of a contract they want, so long as\nit is not illegal or unconscionable. The inclusion into the contract of a liquidated damages clause\xe2\x80\x94\nmentioned previously\xe2\x80\x94is one means by which the parties may make an agreement affecting damages. But\nbeyond that, as we saw in Chapter 12 "Legality", it is very common for one side to limit its liability, or for\none side to agree that it will pursue only limited remedies against the other in case of breach. Such agreeto limitations on the availability of remedies are generally OK provided they are conspicuous, bargainedfor, and not unconscionable. In consumer transactions, courts are more likely to find a contracted-for\nlimitation of remedies unconscionable than in commercial transactions, and under the Uniform\nCommercial Code (UCC) there are further restrictions on contractual remedy limitations.\nFor example, Juan buys ten bags of concrete to make a counter and stand for his expensive new barbecue.\nThe bags have this wording in big print: \xe2\x80\x9cAttention. Our sole liability in case this product is defective will\nbe to provide you with a like quantity of nondefective material. We will not be liable for any other\ndamages, direct or indirect, express or implied.\xe2\x80\x9d That\xe2\x80\x99s fine. If the concrete is defective, the concrete top\nbreaks, and Juan\xe2\x80\x99s new barbecue is damaged, he will get nothing but some new bags of good concrete. He\ncould have shopped around to find somebody who would deliver concrete with no limitation on liability.\nAs it is, his remedies are limited by the agreement he entered into.\n\nElection of Remedies\nAt Common Law\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n548\n\n\x0cAnother limitation on remedies\xe2\x80\x94at common law\xe2\x80\x94is the concept of election of remedies. The nature of a\nloss resulting from a contract breach may be such as to entitle one party to a choice among two or more\nmeans to redress the grievance, where the choices are mutually exclusive.\nAt classic common law, a person who was defrauded had an election of remedies: she could, immediately\nupon discovering the fraud, rescind, or she could retain the item (real estate or personal property) and\nattempt to remedy the fraudulently defective performance by suing for damages, but not both. Buyer\npurchases real estate from Seller for $300,000 and shortly discovers that Seller fraudulently\nmisrepresented the availability of water. Buyer spends $60,000 trying to drill wells. Finally he gives up\nand sues Seller for fraud, seeking $360,000. Traditionally at common law, he would not get it. He should\nhave rescinded upon discovery of the fraud. Now he can only get $60,000 in damages in tort.\n\n[3]\n\nThe\n\npurpose of the election of remedies doctrine is to prevent the victim of fraud from getting a double\nrecovery, but it has come under increasing criticism. Here is one court\xe2\x80\x99s observation: \xe2\x80\x9cA host of\ncommentators support elimination of the election of remedies doctrine. A common theme is that the\ndoctrine substitutes labels and formalism for inquiry into whether double recovery results in fact. The\nrigid doctrine goes to the other extreme, actually resulting in the under compensation of fraud victims and\nthe protection of undeserving wrongdoers.\xe2\x80\x9d\n\n[4]\n\nUnder the UCC\nThe doctrine of election of remedy has been rejected by the UCC, which means that the remedies are\ncumulative in nature. According to Section 2-703(1): \xe2\x80\x9cWhether the pursuit of one remedy bars another\ndepends entirely on the facts of the individual case.\xe2\x80\x9d UCC, Section 2-721, provides that neither demand for\nrescission of the contract in the case of misrepresentation or fraud, nor the return or rejection of goods,\nbars a claim for damages or any other remedy permitted under the UCC for nonfraudulent breach (we will\nexamine remedies for breach of sales contracts in (Reference mayer_1.0-ch18 not found in Book)).\n\nTort versus Contract\nFrequently a contract breach may also amount to tortious conduct. A physician warrants her treatment as\nperfectly safe but performs the operation negligently, scarring the patient for life. The patient could sue\nfor malpractice (tort) or for breach of warranty (contract). The choice involves at least four\nconsiderations:\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n549\n\n\x0c1.\n\nStatute of limitations. Most statutes of limitations prescribe longer periods for contract than for tort\nactions.\n\n2. Allowable damages. Punitive damages are more often permitted in tort actions, and certain kinds of\ninjuries are compensable in tort but not in contract suits\xe2\x80\x94for example, pain and suffering.\n3. Expert testimony. In most cases, the use of experts would be the same in either tort or contract suits,\nbut in certain contract cases, the expert witness could be dispensed with, as, for example, in a contract\ncase charging that the physician abandoned the patient.\n4. Insurance coverage. Most policies do not cover intentional torts, so a contract theory that avoids the\nelement of willfulness would provide the plaintiff with a surer chance of recovering money damages.\n\nLegal versus Extralegal Remedies\nA party entitled to a legal remedy is not required to pursue it. Lawsuits are disruptive not merely to the\nindividuals involved in the particular dispute but also to the ongoing relationships that may have grown\nup around the parties, especially if they are corporations or other business enterprises. Buyers must\nusually continue to rely on their suppliers, and sellers on their buyers. Not surprisingly, therefore, many\nbusinesspeople refuse to file suits even though they could, preferring to settle their disputes privately or\neven to ignore claims that they might easily press. Indeed, the decision whether or not to sue is not one for\nthe lawyer but for the client, who must analyze a number of pros and cons, many of them not legal ones at\nall.\n\nKEY TAKEAWAY\nThere are several limitations on the right of an aggrieved party to get contract remedies for a breach\nbesides any limitations fairly agreed to by the parties. The damages suffered by the nonbreaching party\nmust be reasonably foreseeable. The nonbreaching party must make a reasonable effort to mitigate\ndamages, or the amount awarded will be reduced by the damages that could have been avoided. The\nparty seeking damages must be able to explain within reason how much loss he has suffered as a result of\nthe breach. If he cannot articulate with any degree of certainty\xe2\x80\x94if the damages are really speculative\xe2\x80\x94he\nwill be entitled to nominal damages and that\xe2\x80\x99s all. There are circumstances in which a party who could\nhave got out of a contractual obligation\xe2\x80\x94avoided it\xe2\x80\x94loses the power to do so, and her remedy of\navoidance is lost. Not infrequently, a person will enter into a contract for services or goods that contains a\nlimitation on her right to damages in case the other side breaches. That\xe2\x80\x99s all right unless the limitation is\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n550\n\n\x0cunconscionable. Sometimes parties are required to make an election of remedies: to choose among two or\nmore possible bases of recovery. If the remedies are really mutually exclusive and one is chosen, the\naggrieved party loses the right to pursue the others. And of course a person is always free not to pursue\nany remedy at all for breach of contract; that may be strategically or economically smart in some\ncircumstances.\n\nEXERCISES\n\n1.\n\nWhen one party to a contract breaches, what duty, if any, is then imposed on the other party?\n\n2.\n\nA chef who has never owned her own restaurant sues a contractor who failed to finish building the chef\xe2\x80\x99s\nfirst restaurant on time. She presents evidence of the profits made by similar restaurants that have been\nin business for some time. Is this good evidence of the damages she has suffered by the delay? To what\ndamages is she entitled?\n\n3.\n\nRebecca, seventeen years and ten months old, buys a party dress for $300. She wears it to the junior\nprom but determines it doesn\xe2\x80\x99t look good on her. She puts it in her closet and forgets about it until six\nmonths later, when she decides to return it to the store. Is she now entitled to the remedy of rescission?\n\n4.\n\nWhat is the difference between rescission and restitution?\n\n5.\n\nWhy are parties sometimes required to make an election of remedies?\n6.\n\n[1] Hadley v. Baxendale (1854), 9 Ex. 341, 354, 156 Eng.Rep. 145, 151.\n\n7.\n\n[2] Restatement (Second) of Contracts, Section 350.\n\n8.\n\n[3] Merritt v. Craig, 746 A.2d 923 (Md. 2000).\n\n9.\n\n[4] Head & Seemann, Inc. v. Gregg, 311 N.W.2d 667 (Wis. App. 1981).\n\n16.6 Cases\nConsequential Damages\nEBWS, LLC v. Britly Corp.\n928 A.2d 497 (Vt. 2007)\nReiber, C.J.\nThe Ransom family owns Rock Bottom Farm in Strafford, Vermont, where Earl Ransom owns a dairy\nherd and operates an organic dairy farm. In 2000, the Ransoms decided to build a creamery on-site to\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n551\n\n\x0cprocess their milk and formed EBWS, LLC to operate the dairy-processing plant and to market the plant\xe2\x80\x99s\nproducts. In July 2000, Earl Ransom, on behalf of EBWS, met with Britly\xe2\x80\x99s president to discuss building\nthe creamery.\xe2\x80\xa6In January 2001, EBWS and Britly entered into a contract requiring Britly to construct a\ncreamery building for EBWS in exchange for $160,318.\xe2\x80\xa6The creamery was substantially completed by\nApril 15, 2001, and EBWS moved in soon afterward. On June 5, 2001, EBWS notified Britly of alleged\ndefects in construction. [EBWS continued to use the creamery pending the necessity to vacate it for three\nweeks when repairs were commenced].\nOn September 12, 2001, EBWS filed suit against Britly for damages resulting from defective design and\nconstruction.\xe2\x80\xa6\nFollowing a three-day trial, the jury found Britly had breached the contract and its express warranty, and\nawarded EBWS: (1) $38,020 in direct damages, and (2) $35,711 in consequential damages.\xe2\x80\xa6\n\xe2\x80\xa6The jury\xe2\x80\x99s award to EBWS included compensation for both direct and consequential damages that\nEBWS claimed it would incur while the facility closed for repairs. Direct damages [i.e., compensatory\ndamages] are for \xe2\x80\x9closses that naturally and usually flow from the breach itself,\xe2\x80\x9d and it is not necessary that\nthe parties actually considered these damages. [Citation]. In comparison, special or consequential\ndamages \xe2\x80\x9cmust pass the tests of causation, certainty and foreseeability, and, in addition, be reasonably\nsupposed to have been in the contemplation of both parties at the time they made the contract.\xe2\x80\x9d\n\xe2\x80\xa6The court ruled that EBWS could not recover for lost profits because it was not a going concern at the\ntime the contract was entered into, and profits were too speculative. The court concluded, however, that\nEBWS could submit evidence of other business losses, including future payment for unused milk and staff\nwages.\xe2\x80\xa6\nAt trial, Huyffer, the CEO of EBWS, testified that during a repairs closure the creamery would be required\nto purchase milk from adjacent Rock Bottom Farm, even though it could not process this milk. She\nadmitted that such a requirement was self-imposed as there was no written output contract between\nEBWS and the farm to buy milk. In addition, Huyffer testified that EBWS would pay its employees during\nthe closure even though EBWS has no written contract to pay its employees when they are not working.\nThe trial court allowed these elements of damages to be submitted to the jury, and the jury awarded\nEBWS consequential damages for unused milk and staff wages.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n552\n\n\x0cOn appeal, Britly contends that because there is no contractual or legal obligation for EBWS to purchase\nmilk or pay its employees, these are not foreseeable damages. EBWS counters that it is common\nknowledge that cows continue to produce milk, even if the processing plant is not working, and thus it is\nforeseeable that this loss would occur. We conclude that these damages are not the foreseeable result of\nBritly\xe2\x80\x99s breach of the construction contract and reverse the award.\xe2\x80\xa6\n[W]e conclude that\xe2\x80\xa6it is not reasonable to expect Britly to foresee that its failure to perform under the\ncontract would result in this type of damages. While we are sympathetic to EBWS\xe2\x80\x99s contention that the\ncows continue to produce milk, even when the plant is closed down, this fact alone is not enough to\ndemonstrate that buying and dumping milk is a foreseeable result of Britly\xe2\x80\x99s breach of the construction\ncontract. Here, the milk was produced by a separate and distinct entity, Rock Bottom Farm, which sold\nthe milk to EBWS.\xe2\x80\xa6\nSimilarly, EBWS maintained no employment agreements with its employees obligating it to pay wages\nduring periods of closure for repairs, dips in market demand, or for any other reason. Any losses EBWS\nmight suffer in the future because it chooses to pay its employees during a plant closure for repairs would\nbe a voluntary expense and not in Britly\xe2\x80\x99s contemplation at the time it entered the construction contract.\nIt is not reasonable to expect Britly to foresee losses incurred as a result of agreements that are informal in\nnature and carry no legal obligation on EBWS to perform. \xe2\x80\x9c[P]arties are not presumed to know the\ncondition of each other\xe2\x80\x99s affairs nor to take into account contracts with a third party that is not\ncommunicated.\xe2\x80\x9d [Citation] While it is true that EBWS may have business reasons to pay its employees\neven without a contractual obligation, for example, to ensure employee loyalty, no evidence was\nintroduced at trial by EBWS to support a sound rationale for such considerations. Under these\ncircumstances, this business decision is beyond the scope of what Britly could have reasonably foreseen as\ndamages for its breach of contract.\xe2\x80\xa6\nIn addition, the actual costs of the wages and milk are uncertain.\xe2\x80\xa6[T]he the milk and wages here are\nfuture expenses, for which no legal obligation was assumed by EBWS, and which are separate from the\nterms of the parties\xe2\x80\x99 contract. We note that at the time of the construction contract EBWS had not yet\nbegun to operate as a creamery and had no history of buying milk or paying employees. See [Citation]\n(explaining that profits for a new business are uncertain and speculative and not recoverable). Thus, both\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n553\n\n\x0cthe cost of the milk and the number and amount of wages of future employees that EBWS might pay in\nthe event of a plant closure for repairs are uncertain.\nAward for consequential damages is reversed.\xe2\x80\xa6\n\nCASE QUESTIONS\n\n1.\n\nWhy, according to EBWS\xe2\x80\x99s CEO, would EBWS be required to purchase milk from adjacent Rock Bottom\nFarm, even though it could not process this milk?\n\n2.\n\nSurely it is well known in Vermont dairy country that dairy farmers can\xe2\x80\x99t simply stop milking cows when\nno processing plant is available to take the milk\xe2\x80\x94the cows will soon stop producing. Why was EBWS then\nnot entitled to those damages which it will certainly suffer when the creamery is down for repairs?\n\n3.\n\nBritly (the contractor) must have known EBWS had employees that would be idled when the creamery\nshut down for repairs. Why was it not liable for their lost wages?\n\n4.\n\nWhat could EBWS have done at the time of contracting to protect itself against the damages it would\nincur in the event the creamery suffered downtime due to faulty construction?\n\nLiquidated Damages\nWatson v. Ingram\n881 P.2d 247 (Wash. 1994)\nJohnson, J.\n\xe2\x80\xa6In the summer of 1990, Wayne Watson offered to buy James Ingram\xe2\x80\x99s Bellingham home for $355,000,\nwith a $15,000 [about $24,000 in 2010 dollars] earnest money deposit.\xe2\x80\xa6\nUnder the agreement, the entire amount of the purchase price was due in cash on or before December 3,\n1990.\xe2\x80\xa6The agreement required Watson to pay a $15,000 earnest money deposit into escrow at Kelstrup\nRealty, and provided that \xe2\x80\x9c[i]n the event of default by Buyer, earnest money shall be forfeited to Seller as\nliquidated damages, unless Seller elects to seek actual damages or specific performance. Lastly, the\nagreement contained a provision entitled \xe2\x80\x9cBUYER\xe2\x80\x99S REPRESENTATIONS,\xe2\x80\x9d which stated, \xe2\x80\x9cBuyer\nrepresents that buyer has sufficient funds available to close this sale in accordance with this agreement,\nand is not relying on any contingent source of funds unless otherwise set forth in this agreement\xe2\x80\x9d.\xe2\x80\xa6\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n554\n\n\x0cOn November 10, 1990, Watson sent a written proposal to Ingram seeking to modify the original\nagreement. The proposed modification would have allowed Watson to defer paying $54,000 of the\n$355,000 sale price for between 6 and 12 months after the scheduled December closing date. In exchange,\nIngram would receive a second lien position on certain real estate Watson owned.\nAccording to Ingram, the November 10 proposal was the first time he realized Watson did not have\nfinancing readily available for the purchase of the house. Ingram notified Watson on November 12, 1990,\nthat he would not agree to modify the original agreement and intended to strictly enforce its terms.\nIngram was involved in a child custody suit in California and wanted to move to that state as soon as\npossible.\xe2\x80\xa6[Further efforts by Ingram to sell to third parties and by Watson to get an extension from\nIngram failed.]\nIn September 1991, Ingram finally sold the house to a third party for $355,000, the same price that\nWatson had agreed to pay in December 1990.\nIngram and Watson each sought to recover Watson\xe2\x80\x99s $15,000 earnest money held in escrow. On\nDecember 4, 1990, Ingram wrote to Kelstrup Realty, indicating he was entitled to the $15,000 earnest\nmoney in escrow because Watson had defaulted. In January 1991, Watson filed this action to recover the\nearnest money, alleging it amounted to a penalty and Ingram had suffered no actual damages.\xe2\x80\xa6\nThe trial court found the earnest money \xe2\x80\x9cwas clearly intended by both parties to be non-refundable\xe2\x80\x9d if\nWatson defaulted and determined $15,000 was \xe2\x80\x9ca reasonable forecast by [Ingram and Watson] of\ndamages that would be incurred by [Ingram] if [Watson] failed to complete the purchase\xe2\x80\x9d. The court\nentered judgment in favor of Ingram for the amount of the earnest money plus interest. The court also\nawarded Ingram his attorney fees pursuant to the parties\xe2\x80\x99 agreement. The Court of Appeals, Division One,\naffirmed. Watson now appeals to this court.\nThis case presents a single issue for review: whether the parties\xe2\x80\x99 contract provision requiring Watson to\nforfeit a $15,000 nonrefundable earnest money deposit is enforceable as liquidated damages. Liquidated\ndamages clauses are favored in Washington, and courts will uphold them if the sums involved do not\namount to a penalty or are otherwise unlawful. [Citation] To determine whether liquidated damages\nclauses are enforceable, Washington courts have applied a 2-part test from the Restatement of\nContracts.\xe2\x80\xa6Liquidated damages clauses are upheld if the following two factors are satisfied:\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n555\n\n\x0cFirst, the amount fixed must be a reasonable forecast of just compensation for the harm that is\ncaused by the breach. Second, the harm must be such that it is incapable or very difficult of\nascertainment.\nThe question before this court is whether this test is to be applied as of the time of contract formation\n(prospectively) or as of the time of trial (retrospectively). We have previously held, the \xe2\x80\x9c[r]easonableness\nof the forecast will be judged as of the time the contract was entered\xe2\x80\x9d. [Citations]\nIn contrast, a prior Division One opinion relied upon by Petitioner held the reasonableness of the estimate\nof damages and the difficulty of ascertainment of harm should be measured as of the time of trial, and\nearnest money agreements should not be enforceable as liquidated damages if the nonbreaching party\ndoes not suffer actual damage. [Citations]\nWe\xe2\x80\xa6adopt the date of contract formation as the proper timeframe for evaluating the Restatement test.\nThe prospective approach concentrates on whether the liquidated sum represents a reasonable prediction\nof the harm to the seller if the buyer breaches the agreement, and ignores actual damages except as\nevidence of the reasonableness of the estimate of potential damage.\nWe believe this approach better fulfills the underlying purposes of liquidated damages clauses and gives\ngreater weight to the parties\xe2\x80\x99 expectations. Liquidated damages permit parties to allocate business and\nlitigation risks. Even if the estimates of damages are not exact, parties can allocate and quantify those\nrisks and can negotiate adjustments to the contract price in light of the allocated risks. Under the\nprospective approach, courts will enforce the parties\xe2\x80\x99 allocation of risk so long as the forecasts appear\nreasonable when made. [Citations]\nIn addition to permitting parties to allocate risks, liquidated damages provisions lend certainty to the\nparties\xe2\x80\x99 agreements and permit parties to resolve disputes efficiently in the event of a breach. Rather than\nlitigating the amount of actual damages, the nonbreaching party must only establish the reasonableness of\nthe agreement. The prospective approach permits parties to rely on their stipulated amounts without\nhaving to precisely establish damages at trial. In contrast, if the reasonableness of the amount is judged\nretrospectively, against the damage actually suffered, the \xe2\x80\x9cparties must fully litigate (at great expense and\ndelay) that which they sought not to litigate.\xe2\x80\x9d [Citation].\nPetitioner argues the prospective approach treats buyers unfairly because it permits sellers to retain\nearnest money deposits even when the seller suffers no actual damage, and this violates the principle that\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n556\n\n\x0ccontract damages should be compensatory only. He further contends that by evaluating parties\xe2\x80\x99 liquidated\ndamages agreements against actual damages established at trial, courts can most effectively determine\nwhether such agreements were reasonable and fair.\nWe disagree. As this court has previously explained, \xe2\x80\x9c[w]e are loath to interfere with the rights of parties\nto contract as they please between themselves [Citations] It is not the role of the court to enforce contracts\nso as to produce the most equitable result. The parties themselves know best what motivations and\nconsiderations influenced their bargaining, and, while, \xe2\x80\x9c[t]he bargain may be an unfortunate one for the\ndelinquent party,\xe2\x80\xa6it is not the duty of courts of common law to relieve parties from the consequences of\ntheir own improvidence\xe2\x80\xa6\xe2\x80\x9d [Citations]\nThe retrospective approach fails to give proper weight to the parties\xe2\x80\x99 negotiations. At the time of contract\nformation, unpredictable market fluctuations and variations in possible breaches make it nearly\nimpossible for contracting parties to predict \xe2\x80\x9cprecisely or within a narrow range the amount of damages\nthat would flow from breach.\xe2\x80\x9d [Citations]. However, against this backdrop of uncertainty, the negotiated\nliquidated damages sum represents the parties\xe2\x80\x99 best estimate of the value of the breach and permits the\nparties to allocate and incorporate these risks in their negotiations. Under the prospective approach, a\ncourt will uphold the parties\xe2\x80\x99 agreed upon liquidated sum so long as the amount represents a reasonable\nattempt to compensate the nonbreaching party. On the other hand, if the reasonableness of a liquidated\ndamages provision is evaluated under a retrospective approach, the parties cannot confidently rely on\ntheir agreement because the liquidated sum will not be enforced if, at trial, it is not a close approximation\nof the damage suffered or if no actual damages are proved.\xe2\x80\xa6\nHaving adopted the date of contract formation as the proper timeframe for evaluating the Restatement\ntest, the Restatement\xe2\x80\x99s second requirement loses independent significance. The central inquiry is whether\nthe specified liquidated damages were reasonable at the time of contract formation.\xe2\x80\xa6\nWe also agree with the Court of Appeals that in the context of real estate agreements, a requirement that\ndamages be difficult to prove at trial would undermine the very purposes of the liquidated damage\nprovision: \xe2\x80\x9ccertainty, assurance that the contract will be performed, and avoidance of litigation\xe2\x80\x9d.\n[Citation] It would \xe2\x80\x9cencourage litigation in virtually every case in which the sale did not close, regardless\nof whether the earnest money deposit was a reasonable estimate of the seller\xe2\x80\x99s damages.\xe2\x80\x9d [Citation]\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n557\n\n\x0cIn sum, so long as the agreed upon earnest money agreement, viewed prospectively, is a reasonable\nprediction of potential damage suffered by the seller, the agreement should be enforced \xe2\x80\x9cwithout regard to\nthe retrospective calculation of actual damages or the ease with which they may be proved\xe2\x80\x9d. The\nprospective difficulty of estimating potential damage is a factor to be used in assessing the reasonableness\nof the earnest money agreement\xe2\x80\xa6\nThe decision of the Court of Appeals is affirmed.\n\nCASE QUESTIONS\n\n1.\n\nWhat does the court here mean when it says that liquidated damages clauses allow the parties to\n\xe2\x80\x9callocate and incorporate the risks [of the transaction] in their negotiations\xe2\x80\x9d?\n\n2.\n\nWhy is it relevant that the plaintiff Ingram was engaged in a child-custody dispute and wanted to move to\nCalifornia as soon as possible?\n\n3.\n\nWhat, in plain language, is the issue here?\n\n4.\n\nHow does the court\xe2\x80\x99s resolution of the issue seem to the court the better analysis?\n\n5.\n\nWhy did the plaintiff get to keep the $15,000 when he really suffered no damages?\n\n6.\n\nExpress the controlling rule of law out of this case.\n\nInjunctions and Negative Covenants\nMadison Square Garden Corporation v. Carnera\n52 F.2d 47 (2d Cir. Ct. App. 1931)\nChase, J.\nOn January 13, 1931, the plaintiff and defendant by their duly authorized agents entered into the following\nagreement in writing:\n1. Carnera agrees that he will render services as a boxer in his next contest (which contest,\nhereinafter called the \xe2\x80\x98First Contest.\xe2\x80\x99\xe2\x80\xa6\n9. Carnera shall not, pending the holding of the First Contest, render services as a boxer in any\nmajor boxing contest, without the written permission of the Garden in each case had and\nobtained. A major contest is understood to be one with Sharkey, Baer, Campolo, Godfrey, or like\ngrade heavyweights, or heavyweights who shall have beaten any of the above subsequent to the\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n558\n\n\x0cdate hereof. If in any boxing contest engaged in by Carnera prior to the holding of the First\nContest, he shall lose the same, the Garden shall at its option, to be exercised by a two weeks\xe2\x80\x99\nnotice to Carnera in writing, be without further liability under the terms of this agreement to\nCarnera. Carnera shall not render services during the continuance of the option referred to in\nparagraph 8 hereof for any person, firm or corporation other than the Garden. Carnera shall,\nhowever, at all times be permitted to engage in sparring exhibitions in which no decision is\nrendered and in which the heavy weight championship title is not at stake, and in which Carnera\nboxes not more than four rounds with any one opponent.\xe2\x80\x99\xe2\x80\xa6\nThereafter the defendant, without the permission of the plaintiff, written or otherwise, made a contract to\nengage in a boxing contest with the Sharkey mentioned in paragraph 9 of the agreement above quoted,\nand by the terms thereof the contest was to take place before the first contest mentioned in the\ndefendant\xe2\x80\x99s contract with the plaintiff was to be held.\nThe plaintiff then brought this suit to restrain the defendant from carrying out his contract to box\nSharkey, and obtained the preliminary injunction order, from which this appeal was taken. Jurisdiction is\nbased on diversity of citizenship and the required amount is involved.\nThe District Court has found on affidavits which adequately show it that the defendant\xe2\x80\x99s services are\nunique and extraordinary. A negative covenant in a contract for such personal services is enforceable by\ninjunction where the damages for a breach are incapable of ascertainment. [Citations]\nThe defendant points to what is claimed to be lack of consideration for his negative promise, in that the\ncontract is inequitable and contains no agreement to employ him. It is true that there is no promise in so\nmany words to employ the defendant to box in a contest with Stribling or Schmeling, but the agreement\nread as a whole binds the plaintiff to do just that, provided either Stribling or Schmeling becomes the\ncontestant as the result of the match between them and can be induced to box the defendant. The\ndefendant has agreed to \xe2\x80\x98render services as a boxer\xe2\x80\x99 for the plaintiff exclusively, and the plaintiff has\nagreed to pay him a definite percentage of the gate receipts as his compensation for so doing. The promise\nto employ the defendant to enable him to earn the compensation agreed upon is implied to the same force\nand effect as though expressly stated. [Citations] The fact that the plaintiff\xe2\x80\x99s implied promise is\nconditioned, with respect to the contest with the winner of the Stribling-Schmeling match, upon the\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n559\n\n\x0cconsent of that performer, does not show any failure of consideration for the defendant\xe2\x80\x99s promise,\n[Citation].\nAs we have seen, the contract is valid and enforceable. It contains a restrictive covenant which may be\ngiven effect. Whether a preliminary injunction shall be issued under such circumstances rests in the\nsound discretion of the court. [Citation] The District Court, in its discretion, did issue the preliminary\ninjunction.\xe2\x80\xa6\nOrder affirmed.\n\n1.\n\nCASE QUESTIONS\n\nWhy did the plaintiff not want the defendant to engage in any boxing matches until and except the ones\narranged by the plaintiff?\n\n2.\n\nWhat assertion did the defendant make as to why his promise was not enforceable? Why wasn\xe2\x80\x99t that\nargument accepted by the court?\n\n3.\n\nIf the defendant had refused to engage in a boxing match arranged by the plaintiff, would a court force\nhim to do what he had promised?\n\nLimitation on Damages: Mitigation of Damages\nShirley MacLaine Parker v. Twentieth Century-Fox Film Corporation\n474 P.2d 689 (Cal. 1970)\nBurke, Justice.\nDefendant Twentieth Century-Fox Film Corporation appeals from a summary judgment granting to\nplaintiff the recovery of agreed compensation under a written contract for her services as an actress in a\nmotion picture. As will appear, we have concluded that the trial court correctly ruled in plaintiff\xe2\x80\x99s favor\nand that the judgment should be affirmed.\nPlaintiff is well known as an actress.\xe2\x80\xa6Under the contract, dated August 6, 1965, plaintiff was to play the\nfemale lead in defendant\xe2\x80\x99s contemplated production of a motion picture entitled \xe2\x80\x9cBloomer Girl.\xe2\x80\x9d The\ncontract provided that defendant would pay plaintiff a minimum \xe2\x80\x9cguaranteed compensation\xe2\x80\x9d of\n$53,571.42 per week for 14 weeks commencing May 23, 1966, for a total of $750,000 [about $5,048,000\nin 2010 dollars]. Prior to May 1966 defendant decided not to produce the picture and by a letter dated\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n560\n\n\x0cApril 4, 1966, it notified plaintiff of that decision and that it would not \xe2\x80\x9ccomply with our obligations to you\nunder\xe2\x80\x9d the written contract.\nBy the same letter and with the professed purpose \xe2\x80\x9cto avoid any damage to you,\xe2\x80\x9d defendant instead\noffered to employ plaintiff as the leading actress in another film tentatively entitled \xe2\x80\x9cBig Country, Big\nMan\xe2\x80\x9d (hereinafter, \xe2\x80\x9cBig Country\xe2\x80\x9d). The compensation offered was identical, as were 31 of the 34\nnumbered provisions or articles of the original contract. Unlike \xe2\x80\x9cBloomer Girl,\xe2\x80\x9d however, which was to\nhave been a musical production, \xe2\x80\x9cBig Country\xe2\x80\x9d was a dramatic \xe2\x80\x9cwestern type\xe2\x80\x9d movie. \xe2\x80\x9cBloomer Girl\xe2\x80\x9d was\nto have been filmed in California; \xe2\x80\x9cBig Country\xe2\x80\x9d was to be produced in Australia. Also, certain terms in the\nproffered contract varied from those of the original. Plaintiff was given one week within which to accept;\nshe did not and the offer lapsed. Plaintiff then commenced this action seeking recovery of the agreed\nguaranteed compensation.\nThe complaint sets forth two causes of action. The first is for money due under the contract; the second,\nbased upon the same allegations as the first, is for damages resulting from defendant\xe2\x80\x99s breach of contract.\nDefendant in its answer admits the existence and validity of the contract, that plaintiff complied with all\nthe conditions, covenants and promises and stood ready to complete the performance, and that defendant\nbreached and \xe2\x80\x9canticipatorily repudiated\xe2\x80\x9d the contract. It denies, however, that any money is due to\nplaintiff either under the contract or as a result of its breach, and pleads as an affirmative defense to both\ncauses of action plaintiff\xe2\x80\x99s allegedly deliberate failure to mitigate damages, asserting that she\nunreasonably refused to accept its offer of the leading role in \xe2\x80\x9cBig Country.\xe2\x80\x9d\nPlaintiff moved for summary judgment\xe2\x80\xa6[T]he motion was granted\xe2\x80\xa6for $750,000 plus interest\xe2\x80\xa6in\nplaintiff\xe2\x80\x99s favor. This appeal by defendant followed.\xe2\x80\xa6\nThe general rule is that the measure of recovery by a wrongfully discharged employee is the amount of\nsalary agreed upon for the period of service, less the amount which the employer affirmatively proves the\nemployee has earned or with reasonable effort might have earned from other employment. [Citation]\nHowever, before projected earnings from other employment opportunities not sought or accepted by the\ndischarged employee can be applied in mitigation, the employer must show that the other employment\nwas comparable, or substantially similar, to that of which the employee has been deprived; the employee\xe2\x80\x99s\nrejection of or failure to seek other available employment of a different or inferior kind may not be\nresorted to in order to mitigate damages. [Citations]\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n561\n\n\x0cIn the present case defendant has raised no issue of reasonableness of efforts by plaintiff to obtain other\nemployment; the sole issue is whether plaintiff\xe2\x80\x99s refusal of defendant\xe2\x80\x99s substitute offer of \xe2\x80\x9cBig Country\xe2\x80\x9d\nmay be used in mitigation. Nor, if the \xe2\x80\x9cBig Country\xe2\x80\x9d offer was of employment different or inferior when\ncompared with the original \xe2\x80\x9cBloomer Girl\xe2\x80\x9d employment, is there an issue as to whether or not plaintiff\nacted reasonably in refusing the substitute offer. Despite defendant\xe2\x80\x99s arguments to the contrary, no case\ncited or which our research has discovered holds or suggests that reasonableness is an element of a\nwrongfully discharged employee\xe2\x80\x99s option to reject, or fail to seek, different or inferior employment lest the\npossible earnings therefrom be charged against him in mitigation of damages.\nApplying the foregoing rules to the record in the present case, with all intendments in favor of the party\nopposing the summary judgment motion\xe2\x80\x94here, defendant\xe2\x80\x94it is clear that the trial court correctly ruled\nthat plaintiff\xe2\x80\x99s failure to accept defendant\xe2\x80\x99s tendered substitute employment could not be applied in\nmitigation of damages because the offer of the \xe2\x80\x9cBig Country\xe2\x80\x9d lead was of employment both different and\ninferior, and that no factual dispute was presented on that issue. The mere circumstance that \xe2\x80\x9cBloomer\nGirl\xe2\x80\x9d was to be a musical review calling upon plaintiff\xe2\x80\x99s talents as a dancer as well as an actress, and was to\nbe produced in the City of Los Angeles, whereas \xe2\x80\x9cBig Country\xe2\x80\x9d was a straight dramatic role in a \xe2\x80\x9cWestern\nType\xe2\x80\x9d story taking place in an opal mine in Australia, demonstrates the difference in kind between the two\nemployments; the female lead as a dramatic actress in a western style motion picture can by no stretch of\nimagination be considered the equivalent of or substantially similar to the lead in a song-and-dance\nproduction.\nAdditionally, the substitute \xe2\x80\x9cBig Country\xe2\x80\x9d offer proposed to eliminate or impair the director and\nscreenplay approvals accorded to plaintiff under the original \xe2\x80\x9cBloomer Girl\xe2\x80\x9d contract, and thus\nconstituted an offer of inferior employment. No expertise or judicial notice is required in order to hold\nthat the deprivation or infringement of an employee\xe2\x80\x99s rights held under an original employment contract\nconverts the available \xe2\x80\x9cother employment\xe2\x80\x9d relied upon by the employer to mitigate damages, into inferior\nemployment which the employee need not seek or accept. [Citation]\nIn view of the determination that defendant failed to present any facts showing the existence of a factual\nissue with respect to its sole defense\xe2\x80\x94plaintiff\xe2\x80\x99s rejection of its substitute employment offer in mitigation\nof damages\xe2\x80\x94we need not consider plaintiff\xe2\x80\x99s further contention that for various reasons, including the\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n562\n\n\x0cprovisions of the original contract set forth in footnote 1, Ante, plaintiff was excused from attempting to\nmitigate damages.\nThe judgment is affirmed.\n\nCASE QUESTIONS\n\n1.\n\nWhy did Ms. MacLaine refuse to accept the employment opportunity offered by the defendant?\n\n2.\n\nWhy did the defendant think it should not be liable for any damages as a result of its admitted breach of\nthe original contract?\n\n3.\n\nWho has the burden of proof on mitigation issues\xe2\x80\x94who has to show that no mitigation occurred?\n\n4.\n\nExpress the controlling rule of law out of this case.\n\n16.7 Summary and Exercises\nSummary\n\nContract remedies serve to protect three different interests: an expectation interest (the benefit bargained\nfor), a reliance interest (loss suffered by relying on the contract), and a restitution interest (benefit\nconferred on the promisor). In broad terms, specific performance addresses the expectation interest,\nmonetary damages address all three, and restitution addresses the restitution interest.\nThe two general categories of remedies are legal and equitable. In the former category are compensatory,\nconsequential, incidental, nominal, liquated, and (rarely) punitive damages. In the latter category\xe2\x80\x94if legal\nremedies are inadequate\xe2\x80\x94are specific performance, injunction, and restitution.\nThere are some limitations or restrictions on the availability of damages: they must pass the tests of\nforeseeability and certainty. They must be reasonably mitigated, if possible. And liquidated damages must\nbe reasonable\xe2\x80\x94not a penalty. In some situations, a person can lose the remedy of rescission\xe2\x80\x94the power to\navoid a contract\xe2\x80\x94when the rights of third parties intervene. In some cases a person is required to make an\nelection of remedies: to choose one remedy among several, and when the one is chosen, the others are not\navailable any more.\n\nSaylor URL: http://www.saylor.org/books\n\nEXERCISES\n\nSaylor.org\n563\n\n\x0c1.\n\nOwner of an auto repair shop hires Contractor to remodel his shop but does not mention that two days\nafter the scheduled completion date, Owner is to receive five small US Army personnel carrier trucks for\nservice, with a three-week deadline to finish the job and turn the trucks over to the army. The contract\nbetween Owner and the army has a liquidated damages clause calling for $300 a day for every day trucks\nare not operable after the deadline. Contractor is five days late in finishing the remodel. Can Owner claim\nthe $1,500 as damages against Contractor as a consequence of the latter\xe2\x80\x99s tardy completion of the\ncontract? Explain.\n\n2.\n\nInventor devised an electronic billiard table that looked like a regular billiard table, but when balls\ndropped into the pocket, various electronic lights and scorekeeping devices activated. Inventor\ncontracted with Contractor to manufacture ten prototypes and paid him $50,000 in advance, on a total\nowing of $100,000 ($10,000 for each completed table). After the tables were built to accommodate\nelectronic fittings, Inventor repudiated the contract. Contractor broke the ten tables up, salvaged $1,000\nof wood for other billiard tables, and used the rest for firewood. The ten intact tables, without\nelectronics, could have been sold for $500 each ($5,000 total). Contractor then sued Inventor for the\nprofit Contractor would have made had Inventor not breached. To what, if anything, is Contractor entitled\nby way of damages and why?\n\n3.\n\nCalvin, a promising young basketball and baseball player, signed a multiyear contract with a professional\nbasketball team after graduating from college. After playing basketball for one year, he decided he would\nrather play baseball and breached his contract with the basketball team. What remedy could the team\nseek?\n\n4.\n\nTheresa leased a one-bedroom apartment from Landlady for one year at $500 per month. After three\nmonths, she vacated the apartment. A family of five wanted to rent the apartment, but Landlady refused.\nThree months later\xe2\x80\x94six months into what would have been Theresa\xe2\x80\x99s term\xe2\x80\x94Landlady managed to rent\nthe apartment to Tenant for $400 per month. How much does Theresa owe, and why?\n5.\n\nPlaintiff, a grocery store, contracted with Defendant, a burglar alarm company, for Defendant to\nsend guards to Plaintiff\'s premises and to notify the local police if the alarm was activated. The\ncontract had this language: \xe2\x80\x9cIt is agreed that the Contractor is not an insurer, that the payments\nhere are based solely on the value of the service in the maintenance of the system described, that\nit is impracticable and extremely difficult to fix the actual damages, if any, which may proximately\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n564\n\n\x0cresult from a failure to perform its services, and in case of failure to perform such services and a\nresulting loss, its liability shall be limited to $500 as liquidated damages, and not as a penalty, and\nthis liability shall be exclusive.\xe2\x80\x9d\nA burglary took place and the alarm was activated, but Defendant failed to respond promptly. The\nburglars left with $330,000. Is the liquidated damages clause\xe2\x80\x94the limitation on Plaintiff\xe2\x80\x99s right to\nrecover\xe2\x80\x94valid?\n6.\n\nThe decedent, father of the infant Plaintiff, was killed in a train accident. Testimony showed he was a\ngood and reliable man. Through a representative, the decedent\xe2\x80\x99s surviving child, age five, recovered\njudgment against the railroad (Defendant). Defendant objected to expert testimony that inflation would\nprobably continue at a minimum annual rate of 5 percent for the next thirteen years (until the boy\nattained his majority), which was used to calculate the loss in support money caused by the father\xe2\x80\x99s\ndeath. The calculations, Defendant said, were unreasonably speculative and uncertain, and damages must\nbe proven with reasonable certainty. Is the testimony valid?\n\n7.\n\nPlaintiff produced and directed a movie for Defendant, but contrary to their agreement, Plaintiff was not\ngiven screen credit in the edited film (his name was not shown). The film was screened successfully for\nnearly four years. Plaintiff then sued (1) for damages for loss of valuable publicity or advertising because\nhis screen credits were omitted for the years and (2) for an injunction against future injuries. The jury\nawarded Plaintiff $25,000 on the first count. On the second count, the court held Plaintiff should be able\nto \xe2\x80\x9cmodify the prints in his personal possession to include his credits.\xe2\x80\x9d But Plaintiff appealed, claiming\nthat Defendant still had many unmodified prints in its possession and that showing those films would\ncause future damages. What remedy is available to Plaintiff?\n\n8.\n\n[1]\n\nIn 1929 Kerr Steamship Company, Inc. (Plaintiff), delivered to Defendant, the Radio Corporation of\nAmerica (RCA), a fairly long telegram\xe2\x80\x94in code\xe2\x80\x94to be transmitted to Manila, Philippine Islands, with\ninstructions about loading one of Kerr\xe2\x80\x99s ships. By mistake, the telegraph was mislaid and not delivered. As\na result of the failure to transmit it, the cargo was not loaded and the freight was lost in an amount of\n$6,675.29 [about $84,000 in 2010 dollars], profit that would have been earned if the message had been\ncarried. Plaintiff said that because the telegram was long and because the sender was a ship company,\nRCA personnel should have known it was important information dealing with shipping and therefore RCA\nshould be liable for the consequential damages flowing from the failure to send it. Is RCA liable?\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n565\n\n\x0c9.\n\nDefendant offered to buy a house from Plaintiff. She represented, verbally and in writing, that she had\n$15,000 to $20,000 of equity in another house and would pay this amount to Plaintiff after selling it. She\nknew, however, that she had no such equity. Relying on these intentionally fraudulent representations,\nPlaintiff accepted Defendant\xe2\x80\x99s offer to buy, and the parties entered into a land contract. After taking\noccupancy, Defendant failed to make any of the contract payments. Plaintiff\xe2\x80\x99s investigation then revealed\nthe fraud. Based on the fraud, Plaintiff sought rescission, ejectment, and recovery for five months of lost\nuse of the property and out-of-pocket expenses. Defendant claimed that under the election of remedies\ndoctrine, Plaintiff seller could not both rescind the contract and get damages for its breach. How should\nthe court rule?\n\n10. Buyers contracted to purchase a house being constructed by Contractor. The contract contained this\nclause: \xe2\x80\x9cContractor shall pay to the owners or deduct from the total contract price $100.00 per day as\nliquidated damages for each day after said date that the construction is not completed and accepted by\nthe Owners and Owners shall not arbitrarily withhold acceptance.\xe2\x80\x9d Testimony established the rental value\nof the home at $400\xe2\x80\x93$415 per month. Is the clause enforceable?\n\nSELF-TEST QUESTIONS\n\n1.\na.\n\nContract remedies protect\na restitution interest\nb.\n\na reliance interest\n\nc.\n\nan expectation interest\n\nd.\n\nall of the above\n\nA restitution interest is\na.\n\nthe benefit for which the promisee bargained\nb.\n\nthe loss suffered by relying on the contract\n\nc.\n\nthat which restores any benefit one party conferred on the other\n\nd.\n\nnone of the above\n\nWhen breach of contract caused no monetary loss, the plaintiff is entitled to\na.\n\nspecial damages\nb.\n\nnominal damages\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n566\n\n\x0cc.\n\nconsequential damages\n\nd.\n\nno damages\n\nDamages attributable to losses that flow from events that do not occur in the ordinary course of\nevents are\na.\n\nincidental damages\nb.\n\nliquidated damages\n\nc.\n\nconsequential damages\n\nd.\n\npunitive damages\n\nRestitution is available\na.\n\nwhen the contract was avoided because of incapacity\n\n1.\n\nd\n\n2.\n\nc\n\n3.\n\nb\n\n4.\n\nc\n\n5.\n\nd\n\nb.\n\nwhen the other party breached\n\nc.\n\nwhen the party seeking restitution breached\n\nd.\n\nall of the above\n\nSELF-TEST ANSWERS\n\n[1] Tamarind Lithography Workshop v. Sanders, 193 Cal. Rptr. 409 (Calif. Ct. App., 1983).\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n567\n\n\x0cChapter 17\n\nProducts Liability\nLEARNING OBJECTIVES\nAfter reading this chapter, you should understand the following:\n1.\n\nHow products-liability law allocates the costs of a consumer society\n\n2.\n\nHow warranty theory works in products liability, and what its limitations are\n\n3.\n\nHow negligence theory works, and what its problems are\n\n4.\n\nHow strict liability theory works, and what its limitations are\n\n5.\n\nWhat efforts are made to reform products-liability law, and why\n\n17.1 Introduction: Why Products-Liability Law Is Important\nLEARNING OBJECTIVES\n\n1.\n\nUnderstand why products-liability law underwent a revolution in the twentieth century.\n\n2.\n\nRecognize that courts play a vital role in policing the free enterprise system by adjudicating how the true\ncosts of modern consumer culture are allocated.\n\n3.\n\nKnow the names of the modern causes of action for products-liability cases.\n\nIn previous chapters, we discussed remedies generally. In this chapter, we focus specifically on\nremedies available when a defective product causes personal injury or other damages. Products\nliability describes a type of claim, not a separate theory of liability. Products liability has strong\nemotional overtones\xe2\x80\x94ranging from the prolitigation position of consumer advocates to the\nconservative perspective of the manufacturers.\n\nHistory of Products-Liability Law\nThe theory of caveat emptor\xe2\x80\x94let the buyer beware\xe2\x80\x94that pretty much governed consumer law from the\nearly eighteenth century until the early twentieth century made some sense. A horse-drawn buggy is a\nfairly simple device: its workings are apparent; a person of average experience in the 1870s would know\nwhether it was constructed well and made of the proper woods. Most foodstuffs 150 years ago were grown\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n568\n\n\x0cat home and \xe2\x80\x9cput up\xe2\x80\x9d in the home kitchen or bought in bulk from a local grocer, subject to inspection and\nsampling; people made home remedies for coughs and colds and made many of their own clothes. Houses\nand furnishings were built of wood, stone, glass, and plaster\xe2\x80\x94familiar substances. Entertainment was a\nbook or a piano. The state of technology was such that the things consumed were, for the most part,\ncomprehensible and\xe2\x80\x94very important\xe2\x80\x94mostly locally made, which meant that the consumer who suffered\ndamages from a defective product could confront the product\xe2\x80\x99s maker directly. Local reputation is a\npowerful influence on behavior.\nThe free enterprise system confers great benefits, and no one can deny that: materialistically, compare the\nimage sketched in the previous paragraph with circumstances today. But those benefits come with a cost,\nand the fundamental political issue always is who has to pay. Consider the following famous passage from\nUpton Sinclair\xe2\x80\x99s great novel The Jungle. It appeared in 1906. He wrote it to inspire labor reform; to his\ndismay, the public outrage focused instead on consumer protection reform. Here is his description of the\nsausage-making process in a big Chicago meatpacking plant:\nThere was never the least attention paid to what was cut up for sausage; there would come all the\nway back from Europe old sausage that had been rejected, and that was moldy and white\xe2\x80\x94it\nwould be dosed with borax and glycerin, and dumped into the hoppers, and made over again for\nhome consumption. There would be meat that had tumbled out on the floor, in the dirt and\nsawdust, where the workers had tramped and spit uncounted billions of consumption germs.\nThere would be meat stored in great piles in rooms; and the water from leaky roofs would drip\nover it, and thousands of rats would race about on it. It was too dark in these storage places to\nsee well, but a man could run his hand over these piles of meat and sweep off handfuls of the\ndried dung of rats. These rats were nuisances, and the packers would put poisoned bread out for\nthem; they would die, and then rats, bread, and meat would go into the hoppers together. This is\nno fairy story and no joke; the meat would be shoveled into carts, and the man who did the\nshoveling would not trouble to lift out a rat even when he saw one\xe2\x80\x94there were things that went\ninto the sausage in comparison with which a poisoned rat was a tidbit. There was no place for the\nmen to wash their hands before they ate their dinner, and so they made a practice of washing\nthem in the water that was to be ladled into the sausage. There were the butt-ends of smoked\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n569\n\n\x0cmeat, and the scraps of corned beef, and all the odds and ends of the waste of the plants, that\nwould be dumped into old barrels in the cellar and left there.\nUnder the system of rigid economy which the packers enforced, there were some jobs that it only\npaid to do once in a long time, and among these was the cleaning out of the waste barrels. Every\nspring they did it; and in the barrels would be dirt and rust and old nails and stale water\xe2\x80\x94and\ncartload after cartload of it would be taken up and dumped into the hoppers with fresh meat, and\nsent out to the public\xe2\x80\x99s breakfast. Some of it they would make into \xe2\x80\x9csmoked\xe2\x80\x9d sausage\xe2\x80\x94but as the\nsmoking took time, and was therefore expensive, they would call upon their chemistry\ndepartment, and preserve it with borax and color it with gelatin to make it brown. All of their\nsausage came out of the same bowl, but when they came to wrap it they would stamp some of it\n\xe2\x80\x9cspecial,\xe2\x80\x9d and for this they would charge two cents more a pound.\n\n[1]\n\nIt became clear from Sinclair\xe2\x80\x99s expos\xc3\xa9 that associated with the marvels of then-modern meatpacking and\ndistribution methods was food poisoning: a true cost became apparent. When the true cost of some\nmoney-making enterprise (e.g., cigarettes) becomes inescapably apparent, there are two possibilities.\nFirst, the legislature can in some way mandate that the manufacturer itself pay the cost; with the\nmeatpacking plants, that would be the imposition of sanitary food-processing standards. Typically,\nCongress creates an administrative agency and gives the agency some marching orders, and then the\nagency crafts regulations dictating as many industry-wide reform measures as are politically possible.\nSecond, the people who incur damages from the product (1) suffer and die or (2) access the machinery of\nthe legal system and sue the manufacturer. If plaintiffs win enough lawsuits, the manufacturer\xe2\x80\x99s insurance\ncompany raises rates, forcing reform (as with high-powered muscle cars in the 1970s); the business goes\nbankrupt; or the legislature is pressured to act, either for the consumer or for the manufacturer.\nIf the industry has enough clout to blunt\xe2\x80\x94by various means\xe2\x80\x94a robust proconsumer legislative response\nso that government regulation is too lax to prevent harm, recourse is had through the legal system. Thus\nfor all the talk about the need for tort reform (discussed later in this chapter), the courts play a vital role in\npolicing the free enterprise system by adjudicating how the true costs of modern consumer culture are\nallocated.\nObviously the situation has improved enormously in a century, but one does not have to look very far to\nfind terrible problems today. Consider the following, which occurred in 2009\xe2\x80\x9310:\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n570\n\n\x0c\xe2\x80\xa2\n\nIn the United States, Toyota recalled 412,000 passenger cars, mostly the Avalon model, for steering\nproblems that reportedly led to three accidents.\n\n\xe2\x80\xa2\n\nPortable baby recliners that are supposed to help fussy babies sleep better were recalled after the\ndeath of an infant: the Consumer Product Safety Commission announced the recall of 30,000 Nap\nNanny recliners made by Baby Matters of Berwyn, Pennsylvania.\n\n\xe2\x80\xa2\n\nMore than 70,000 children and teens go to the emergency room each year for injuries and\ncomplications from medical devices. Contact lenses are the leading culprit, the first detailed national\nestimate suggests.\n\n\xe2\x80\xa2\n\nSmith and Noble recalled 1.3 million Roman shades and roller shades after a child was nearly\nstrangled: the Consumer Product Safety Commission says a five-year-old boy in Tacoma, Washington,\nwas entangled in the cord of a roller shade in May 2009.\n\n\xe2\x80\xa2\n\n[2]\n\nThe Consumer Product Safety Commission reported that 4,521 people were killed in the United States\nin consumer-product-related incidences in 2009, and millions of people visited hospital emergency\nrooms from consumer-product-related injuries.\n\n\xe2\x80\xa2\n\n[3]\n\nReports about the possibility that cell-phone use causes brain cancer continue to be hotly debated.\nCritics suggest that the studies minimizing the risk were paid for by cell-phone manufacturers.\n\n[4]\n\nProducts liability can also be a life-or-death matter from the manufacturer\xe2\x80\x99s perspective. In 2009,\nBloomberg BusinessWeek reported that the costs of product safety for manufacturing firms can be\nenormous: \xe2\x80\x9cPeanut Corp., based in Lynchberg, Va., has been driven into bankruptcy since health officials\nlinked tainted peanuts to more than 600 illnesses and nine deaths. Mattel said the first of several toy\nrecalls it announced in 2007 cut its quarterly operating income by $30 million. Earlier this decade, Ford\nMotor spent roughly $3 billion replacing 10.6 million potentially defective Firestone tires.\xe2\x80\x9d\n\n[5]\n\nBusinesses\n\ncomplain, with good reason, about the expenses associated with products-liability problems.\n\nCurrent State of the Law\nAlthough the debate has been heated and at times simplistic, the problem of products liability is complex\nand most of us regard it with a high degree of ambivalence. We are all consumers, after all, who profit\ngreatly from living in an industrial society. In this chapter, we examine the legal theories that underlie\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n571\n\n\x0cproducts-liability cases that developed rapidly in the twentieth century to address the problems of\nproduct-caused damages and injuries in an industrial society.\nIn the typical products-liability case, three legal theories are asserted\xe2\x80\x94a contract theory and two tort\ntheories. The contract theory is warranty, governed by the UCC, and the two tort theories\nare negligence andstrict products liability, governed by the common law. See Figure 17.1 "Major Products\nLiability Theories".\nFigure 17.1 Major Products Liability Theories\n\nKEY TAKEAWAY\nAs products became increasingly sophisticated and potentially dangerous in the twentieth century, and as\nthe separation between production and consumption widened, products liability became a very important\nissue for both consumers and manufacturers. Millions of people every year are adversely affected by\ndefective products, and manufacturers and sellers pay huge amounts for products-liability insurance and\ndamages. The law has responded with causes of action that provide a means for recovery for productsliability damages.\n\nEXERCISES\n\n1.\n\nHow does the separation of production from consumption affect products-liability issues?\n\n2.\n\nWhat other changes in production and consumption have caused the need for the development of\nproducts-liability law?\n\n3.\n\nHow can it be said that courts adjudicate the allocation of the costs of a consumer-oriented economy?\n4.\n\n[1] Upton Sinclair, The Jungle (New York: Signet Classic, 1963), 136.\n\n5.\n\n[2] FindLaw, AP reports, http://news.findlaw.com/legalnews/us/pl.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n572\n\n\x0c6.\n\n[3] US Consumer Product Safety Commission, 2009 Report to the President and the Congress, accessed\nMarch 1, 2011,http://www.cpsc.gov/cpscpub/pubs/reports/2009rpt.pdf.\n\n7.\n\n[4] Matt Hamblen, \xe2\x80\x9cNew Study Warns of Cell Phone Dangers,\xe2\x80\x9d Computerworld US, August 9, 2009,\naccessed March 1, 2011, http://news.techworld.com/personal-tech/3200539/new-study-warns-of-cellphone-dangers.\n\n8.\n\n[5] Michael Orey, \xe2\x80\x9cTaking on Toy Safety,\xe2\x80\x9d BusinessWeek, March 6, 2009, accessed March 1,\n2011,http://www.businessweek.com/managing/content/mar2009/ca2009036_271002.htm.\n\n17.2 Warranties\n\nLEARNING OBJECTIVES\n\n1.\n\nRecognize a UCC express warranty and how it is created.\n\n2.\n\nUnderstand what is meant under the UCC by implied warranties, and know the main types of implied\nwarranties: merchantability, fitness for a particular purpose, and title.\n\n3.\n\nKnow that there are other warranties: against infringement and as may arise from usage of the trade.\n\n4.\n\nSee that there are difficulties with warranty theory as a cause of action for products liability; a federal law\nhas addressed some of these.\n\nThe UCC governs express warranties and various implied warranties, and for many years it was the\nonly statutory control on the use and meanings of warranties. In 1975, after years of debate, Congress\npassed and President Gerald Ford signed into law the Magnuson-Moss Act, which imposes certain\nrequirements on manufacturers and others who warrant their goods. We will examine both the UCC\nand the Magnuson-Moss Act.\n\nTypes of Warranties\nExpress Warranties\nAn express warranty is created whenever the seller affirms that the product will perform in a certain\nmanner. Formal words such as \xe2\x80\x9cwarrant\xe2\x80\x9d or \xe2\x80\x9cguarantee\xe2\x80\x9d are not necessary. A seller may create an express\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n573\n\n\x0cwarranty as part of the basis for the bargain of sale by means of (1) an affirmation of a fact or promise\nrelating to the goods, (2) a description of the goods, or (3) a sample or model. Any of these will create an\nexpress warranty that the goods will conform to the fact, promise, description, sample, or model. Thus a\nseller who states that \xe2\x80\x9cthe use of rustproof linings in the cans would prevent discoloration and\nadulteration of the Perform solution\xe2\x80\x9d has given an express warranty, whether he realized it or\nnot.\n\n[1]\n\nClaims of breach of express warranty are, at base, claims of misrepresentation.\n\nBut the courts will not hold a manufacturer to every statement that could conceivably be interpreted to be\nan express warranty. Manufacturers and sellers constantly \xe2\x80\x9cpuff\xe2\x80\x9d their products, and the law is content to\nlet them inhabit that gray area without having to make good on every claim. UCC 2-313(2) says that \xe2\x80\x9can\naffirmation merely of the value of the goods or a statement purporting to be merely the seller\xe2\x80\x99s opinion or\ncommendation of the goods does not create a warranty.\xe2\x80\x9d Facts do.\nIt is not always easy, however, to determine the line between an express warranty and a piece of puffery. A\nsalesperson who says that a strawberry huller is \xe2\x80\x9cgreat\xe2\x80\x9d has probably puffed, not warranted, when it turns\nout that strawberries run through the huller look like victims of a massacre. But consider the classic cases\nof the defective used car and the faulty bull. In the former, the salesperson said the car was in \xe2\x80\x9cA-1 shape\xe2\x80\x9d\nand \xe2\x80\x9cmechanically perfect.\xe2\x80\x9d In the latter, the seller said not only that the bull calf would \xe2\x80\x9cput the buyer on\nthe map\xe2\x80\x9d but that \xe2\x80\x9chis father was the greatest living dairy bull.\xe2\x80\x9d The car, carrying the buyer\xe2\x80\x99s sevenmonth-old child, broke down while the buyer was en route to visit her husband in the army during World\nWar II. The court said that the salesperson had made an express warranty.\n\n[2]\n\nThe bull calf turned out to be\n\nsterile, putting the farmer on the judicial rather than the dairy map. The court said the seller\xe2\x80\x99s spiel was\ntrade talk, not a warranty that the bull would impregnate cows.\n\n[3]\n\nIs there any qualitative difference between these decisions, other than the quarter century that separates\nthem and the different courts that rendered them? Perhaps the most that can be said is that the more\nspecific and measurable the statement\xe2\x80\x99s standards, the more likely it is that a court will hold the seller to a\nwarranty, and that a written statement is easier to construe as a warranty than an oral one. It is also\npossible that courts look, if only subliminally, at how reasonable the buyer was in relying on the\nstatement, although this ought not to be a strict test. A buyer may be unreasonable in expecting a car to\nget 100 miles to the gallon, but if that is what the seller promised, that ought to be an enforceable\nwarranty.\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n574\n\n\x0cThe CISG (Article 35) provides, \xe2\x80\x9cThe seller must deliver goods which are of the quantity,\nquality and description required by the contract and which are contained or packaged in\nthe manner required by the contract. [And the] goods must possess the qualities of goods\nwhich the seller has held out to the buyer as a sample or model.\xe2\x80\x9d\n\nImplied Warranties\nExpress warranties are those over which the parties dickered\xe2\x80\x94or could have. Express warranties go to the\nessence of the bargain. An implied warranty, by contrast, is one that circumstances alone, not specific\nlanguage, compel reading into the sale. In short, an implied warranty is one created by law, acting from an\nimpulse of common sense.\n\nImplied Warranty of Merchantability\nSection 2-314 of the UCC lays down the fundamental rule that goods carry an\nimplied warranty of merchantability if sold by a merchant-seller. What is merchantability? Section 2314(2) of the UCC says that merchantable goods are those that conform at least to the following six\ncharacteristics:\n1.\n\nPass without objection in the trade under the contract description\n\n2. In the case of fungible goods, are of fair average quality within the description\n3. Are fit for the ordinary purposes for which such goods are used\n4. Run, within the variations permitted by the agreement, of even kind, quality, and quantity within each\nunit and among all units involved\n5.\n\nAre adequately contained, packaged, and labeled as the agreement may require\n\n6. Conform to the promise or affirmations of fact made on the container or label if any\nFor the purposes of Section 2-314(2)(c) of the UCC, selling and serving food or drink for consumption on\nor off the premises is a sale subject to the implied warranty of merchantability\xe2\x80\x94the food must be \xe2\x80\x9cfit for\nthe ordinary purposes\xe2\x80\x9d to which it is put. The problem is common: you bite into a cherry pit in the cherryvanilla ice cream, or you choke on the clam shells in the chowder. Is such food fit for the ordinary\npurposes to which it is put? There are two schools of thought. One asks whether the food was natural as\nprepared. This view adopts the seller\xe2\x80\x99s perspective. The other asks what the consumer\xe2\x80\x99s reasonable\nexpectation was.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n575\n\n\x0cThe first test is sometimes said to be the \xe2\x80\x9cnatural-foreign\xe2\x80\x9d test. If the substance in the soup is natural to\nthe substance\xe2\x80\x94as bones are to fish\xe2\x80\x94then the food is fit for consumption. The second test, relying on\nreasonable expectations, tends to be the more commonly used test.\nThe Convention provides (Article 35) that \xe2\x80\x9cunless otherwise agreed, the goods sold are fit\nfor the purposes for which goods of the same description would ordinarily be used.\xe2\x80\x9d\n\nFitness for a Particular Purpose\nSection 2-315 of the UCC creates another implied warranty. Whenever a seller, at the time she contracts to\nmake a sale, knows or has reason to know that the buyer is relying on the seller\xe2\x80\x99s skill or judgment to\nselect a product that is suitable for the particular purpose the buyer has in mind for the goods to be sold,\nthere is an implied warranty that the goods are fit for that purpose. For example, you go to a hardware\nstore and tell the salesclerk that you need a paint that will dry overnight because you are painting your\nfront door and a rainstorm is predicted for the next day. The clerk gives you a slow-drying oil-based paint\nthat takes two days to dry. The store has breached an implied warranty of fitness for particular purpose.\nNote the distinction between \xe2\x80\x9cparticular\xe2\x80\x9d and \xe2\x80\x9cordinary\xe2\x80\x9d purposes. Paint is made to color and when dry to\nprotect a surface. That is its ordinary purpose, and had you said only that you wished to buy paint, no\nimplied warranty of fitness would have been breached. It is only because you had a particular purpose in\nmind that the implied warranty arose. Suppose you had found a can of paint in a general store and told\nthe same tale, but the proprietor had said, \xe2\x80\x9cI don\xe2\x80\x99t know enough about that paint to tell you anything\nbeyond what\xe2\x80\x99s on the label; help yourself.\xe2\x80\x9d Not every seller has the requisite degree of skill and knowledge\nabout every product he sells to give rise to an implied warranty. Ultimately, each case turns on its\nparticular circumstances: \xe2\x80\x9cThe Convention provides (Article 35): [The goods must be] fit for\nany particular purpose expressly or impliedly made known to the seller at the time of the\nconclusion of the contract, except where the circumstances show that the buyer did not\nrely, or that it was unreasonable for him to rely, on the seller\xe2\x80\x99s skill and judgment.\xe2\x80\x9d\n\nOther Warranties\nArticle 2 contains other warranty provisions, though these are not related specifically to products liability.\nThus, under UCC, Section 2-312, unless explicitly excluded, the seller warrants he is conveying good\ntitle that is rightfully his and that the goods are transferred free of any security interest or other lien or\nencumbrance. In some cases (e.g., a police auction of bicycles picked up around campus and never\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n576\n\n\x0cclaimed), the buyer should know that the seller does not claim title in himself, nor that title will\nnecessarily be good against a third party, and so subsection (2) excludes warranties in these\ncircumstances. But the circumstances must be so obvious that no reasonable person would suppose\notherwise.\nIn Menzel v. List, an art gallery sold a painting by Marc Chagall that it purchased in Paris.\n\n[4]\n\nThe painting\n\nhad been stolen by the Germans when the original owner was forced to flee Belgium in the 1930s. Now in\nthe United States, the original owner discovered that a new owner had the painting and successfully sued\nfor its return. The customer then sued the gallery, claiming that it had breached the implied warranty of\ntitle when it sold the painting. The court agreed and awarded damages equal to the appreciated value of\nthe painting. A good-faith purchaser who must surrender stolen goods to their true owner has a claim for\nbreach of the implied warranty of title against the person from whom he bought the goods.\nA second implied warranty, related to title, is that the merchant-seller warrants the goods are free of any\nrightful claim by a third person that the seller has infringed his rights (e.g., that a gallery has not\ninfringed a copyright by selling a reproduction). This provision only applies to a seller who regularly deals\nin goods of the kind in question. If you find an old print in your grandmother\xe2\x80\x99s attic, you do not warrant\nwhen you sell it to a neighbor that it is free of any valid infringement claims.\nA third implied warranty in this context involves the course of dealing or usage of trade. Section 2-314(3)\nof the UCC says that unless modified or excluded implied warranties may arise from a course of dealing or\nusage of trade. If a certain way of doing business is understood, it is not necessary for the seller to state\nexplicitly that he will abide by the custom; it will be implied. A typical example is the obligation of a dog\ndealer to provide pedigree papers to prove the dog\xe2\x80\x99s lineage conforms to the contract.\n\nProblems with Warranty Theory\nIn General\nIt may seem that a person asserting a claim for breach of warranty will have a good chance of success\nunder an express warranty or implied warranty theory of merchantability or fitness for a particular\npurpose. In practice, though, claimants are in many cases denied recovery. Here are four general\nproblems:\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n577\n\n\x0c\xe2\x80\xa2\n\nThe claimant must prove that there was a sale.\n\n\xe2\x80\xa2\n\nThe sale was of goods rather than real estate or services.\n\n\xe2\x80\xa2\n\nThe action must be brought within the four-year statute of limitations under Article 2-725, when the\ntender of delivery is made, not when the plaintiff discovers the defect.\n\n\xe2\x80\xa2\n\nUnder UCC, Section 2-607(3)(a) and Section 2A-516(3)(a), which covers leases, the claimant who fails\nto give notice of breach within a reasonable time of having accepted the goods will see the suit\ndismissed, and few consumers know enough to do so, except when making a complaint about a\npurchase of spoiled milk or about paint that wouldn\xe2\x80\x99t dry.\n\nIn addition to these general problems, the claimant faces additional difficulties stemming directly from\nwarranty theory, which we take up later in this chapter.\n\nExclusion or Modification of Warranties\nThe UCC permits sellers to exclude or disclaim warranties in whole or in part. That\xe2\x80\x99s reasonable, given\nthat the discussion here is about contract, and parties are free to make such contracts as they see fit. But a\nnumber of difficulties can arise.\n\nExclusion of Express Warranties\nThe simplest way for the seller to exclude express warranties is not to give them. To be sure, Section 2316(1) of the UCC forbids courts from giving operation to words in fine print that negate or limit express\nwarranties if doing so would unreasonably conflict with express warranties stated in the main body of the\ncontract\xe2\x80\x94as, for example, would a blanket statement that \xe2\x80\x9cthis contract excludes all warranties express or\nimplied.\xe2\x80\x9d The purpose of the UCC provision is to prevent customers from being surprised by unbargainedfor language.\n\nExclusion of Implied Warranties in General\nImplied warranties can be excluded easily enough also, by describing the product with language such as\n\xe2\x80\x9cas is\xe2\x80\x9d or \xe2\x80\x9cwith all faults.\xe2\x80\x9d Nor is exclusion simply a function of what the seller says. The buyer who has\neither examined or refused to examine the goods before entering into the contract may not assert an\nimplied warranty concerning defects an inspection would have revealed.\nThe Convention provides a similar rule regarding a buyer\xe2\x80\x99s rights when he has failed to\ninspect the goods (Article 35): \xe2\x80\x9cThe seller is not liable\xe2\x80\xa6for any lack of conformity of the\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n578\n\n\x0cgoods if at the time of the conclusion of the contract the buyer knew or could not have been\nunaware of such lack of conformity.\xe2\x80\x9d\n\nImplied Warranty of Merchantability\nSection 2-316(2) of the UCC permits the seller to disclaim or modify the implied warranty of\nmerchantability, as long as the statement actually mentions \xe2\x80\x9cmerchantability\xe2\x80\x9d and, if it is written, is\n\xe2\x80\x9cconspicuous.\xe2\x80\x9d Note that the disclaimer need not be in writing, and\xe2\x80\x94again\xe2\x80\x94all implied warranties can be\nexcluded as noted.\n\nImplied Warranty of Fitness\nSection 2-316(2) of the UCC permits the seller also to disclaim or modify an implied warranty of fitness.\nThis disclaimer or modification must be in writing, however, and must be conspicuous. It need not\nmention fitness explicitly; general language will do. The following sentence, for example, is sufficient to\nexclude all implied warranties of fitness: \xe2\x80\x9cThere are no warranties that extend beyond the description on\nthe face of this contract.\xe2\x80\x9d\nHere is a standard disclaimer clause found in a Dow Chemical Company agreement: \xe2\x80\x9cSeller warrants that\nthe goods supplied here shall conform to the description stated on the front side hereof, that it will convey\ngood title, and that such goods shall be delivered free from any lawful security interest, lien, or\nencumbrance. SELLER MAKES NO WARRANTY OF MERCHANTABILITY OR FITNESS FOR A\nPARTICULAR USE. NOR IS THERE ANY OTHER EXPRESS OR IMPLIED WARRANTY.\xe2\x80\x9d\n\nConflict between Express and Implied Warranties\nExpress and implied warranties and their exclusion or limitation can often conflict. Section 2-317 of the\nUCC provides certain rules for deciding which should prevail. In general, all warranties are to be\nconstrued as consistent with each other and as cumulative. When that assumption is unreasonable, the\nparties\xe2\x80\x99 intention governs the interpretation, according to the following rules: (a) exact or technical\nspecifications displace an inconsistent sample or model or general language of description; (b) a sample\nfrom an existing bulk displaces inconsistent general language of description; (c) express warranties\ndisplace inconsistent implied warranties other than an implied warranty of fitness for a particular\npurpose. Any inconsistency among warranties must always be resolved in favor of the implied warranty of\nfitness for a particular purpose. This doesn\xe2\x80\x99t mean that warranty cannot be limited or excluded altogether.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n579\n\n\x0cThe parties may do so. But in cases of doubt whether it or some other language applies, the implied\nwarranty of fitness will have a superior claim.\n\nThe Magnuson-Moss Act and Phantom Warranties\nAfter years of debate over extending federal law to regulate warranties, Congress enacted the MagnusonMoss Federal Trade Commission Warranty Improvement Act (more commonly referred to as the\nMagnuson-Moss Act) and President Ford signed it in 1975. The act was designed to clear up confusing and\nmisleading warranties, where\xe2\x80\x94as Senator Magnuson put it in introducing the bill\xe2\x80\x94\xe2\x80\x9cpurchasers of\nconsumer products discover that their warranty may cover a 25-cent part but not the $100 labor charge or\nthat there is full coverage on a piano so long as it is shipped at the purchaser\xe2\x80\x99s expense to the\nfactory.\xe2\x80\xa6There is a growing need to generate consumer understanding by clearly and conspicuously\ndisclosing the terms and conditions of the warranty and by telling the consumer what to do if his\nguaranteed product becomes defective or malfunctions.\xe2\x80\x9d The Magnuson-Moss Act only applies to\nconsumer products (for household and domestic uses); commercial purchasers are presumed to be\nknowledgeable enough not to need these protections, to be able to hire lawyers, and to be able to include\nthe cost of product failures into the prices they charge.\nThe act has several provisions to meet these consumer concerns; it regulates the content of warranties and\nthe means of disclosing those contents. The act gives the Federal Trade Commission (FTC) the authority\nto promulgate detailed regulations to interpret and enforce it. Under FTC regulations, any written\nwarranty for a product costing a consumer more than ten dollars must disclose in a single document and\nin readily understandable language the following nine items of information:\n1.\n\nThe identity of the persons covered by the warranty, whether it is limited to the original purchaser or\nfewer than all who might come to own it during the warranty period.\n\n2. A clear description of the products, parts, characteristics, components, or properties covered, and\nwhere necessary for clarity, a description of what is excluded.\n3. A statement of what the warrantor will do if the product fails to conform to the warranty, including\nitems or services the warranty will pay for and, if necessary for clarity, what it will not pay for.\n4. A statement of when the warranty period starts and when it expires.\n5.\n\nA step-by-step explanation of what the consumer must do to realize on the warranty, including the\nnames and addresses of those to whom the product must be brought.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n580\n\n\x0c6. Instructions on how the consumer can be availed of any informal dispute resolution mechanism\nestablished by the warranty.\n7.\n\nAny limitations on the duration of implied warranties\xe2\x80\x94since some states do not permit such\nlimitations, the warranty must contain a statement that any limitations may not apply to the\nparticular consumer.\n\n8. Any limitations or exclusions on relief, such as consequential damages\xe2\x80\x94as above, the warranty must\nexplain that some states do not allow such limitations.\n9. The following statement: \xe2\x80\x9cThis warranty gives you specific legal rights, and you may also have other\nrights which vary from state to state.\xe2\x80\x9d\nIn addition to these requirements, the act requires that the warranty be labeled either a full or limited\nwarranty. A full warranty means (1) the defective product or part will be fixed or replaced for free,\nincluding removal and reinstallation; (2) it will be fixed within a reasonable time; (3) the consumer need\nnot do anything unreasonable (like shipping the piano to the factory) to get warranty service; (4) the\nwarranty is good for anyone who owns the product during the period of the warranty; (5) the consumer\ngets money back or a new product if the item cannot be fixed within a reasonable number of attempts. But\nthe full warranty may not cover the whole product: it may cover only the hard drive in the computer, for\nexample; it must state what parts are included and excluded. A limited warranty is less inclusive. It may\ncover only parts, not labor; it may require the consumer to bring the product to the store for service; it\nmay impose a handling charge; it may cover only the first purchaser. Both full and limited warranties may\nexclude consequential damages.\nDisclosure of the warranty provisions prior to sale is required by FTC regulations; this can be done in a\nnumber of ways. The text of the warranty can be attached to the product or placed in close conjunction to\nit. It can be maintained in a binder kept in each department or otherwise easily accessible to the\nconsumer. Either the binders must be in plain sight or signs must be posted to call the prospective buyer\xe2\x80\x99s\nattention to them. A notice containing the text of the warranty can be posted, or the warranty itself can be\nprinted on the product\xe2\x80\x99s package or container.\nPhantom warranties are addressed by the Magnuson-Moss Act. As we have seen, the UCC permits the\nseller to disclaim implied warranties. This authority often led sellers to give what were called phantom\nwarranties\xe2\x80\x94that is, the express warranty contained disclaimers of implied warranties, thus leaving the\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n581\n\n\x0cconsumer with fewer rights than if no express warranty had been given at all. In the words of the\nlegislative report of the act, \xe2\x80\x9cThe bold print giveth, and the fine print taketh away.\xe2\x80\x9d The act abolished\nthese phantom warranties by providing that if the seller gives a written warranty, whether express or\nimplied, he cannot disclaim or modify implied warranties. However, a seller who gives a limited warranty\ncan limit implied warranties to the duration of the limited warranty, if the duration is reasonable.\nA seller\xe2\x80\x99s ability to disclaim implied warranties is also limited by state law in two ways. First, by\namendment to the UCC or by separate legislation, some states prohibit disclaimers whenever consumer\nproducts are sold.\n\n[5]\n\nSecond, the UCC at 2-302 provides that unconscionable contracts or clauses will not\n\nbe enforced. UCC 2-719(3) provides that limitation of damages for personal injury in the sale of\n\xe2\x80\x9cconsumer goods is prima facie unconscionable, but limitation of damages where the loss is commercial is\nnot.\xe2\x80\x9d (Unconscionability was discussed in Chapter 12 "Legality".)\nA first problem with warranty theory, then, is that it\xe2\x80\x99s possible to disclaim or limit the warranty. The worst\nabuses of manipulative and tricky warranties are eliminated by the Magnuson-Moss Act, but there are\nseveral other reasons that warranty theory is not the panacea for claimants who have suffered damages or\ninjuries as a result of defective products.\n\nPrivity\nA second problem with warranty law (after exclusion and modification of warranties) is that of privity.\nPrivity is the legal term for the direct connection between the seller and buyer, the two contracting parties.\nFor decades, the doctrine of privity has held that one person can sue another only if they are in privity.\nThat worked well in the days when most commerce was local and the connection between seller and buyer\nwas immediate. But in a modern industrial (or postindustrial) economy, the product is transported\nthrough a much larger distribution system, as depicted in Figure 17.2 "Chain of Distribution". Two\nquestions arise: (1) Is the manufacturer or wholesaler (as opposed to the retailer) liable to the buyer under\nwarranty theory? and (2) May the buyer\xe2\x80\x99s family or friends assert warranty rights?\nFigure 17.2 Chain of Distribution\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n582\n\n\x0cHorizontal Privity\nSuppose Carl Consumer buys a new lamp for his family\xe2\x80\x99s living room. The lamp is defective: Carl gets a\nserious electrical shock when he turns it on. Certainly Carl would be covered by the implied warranty of\nmerchantability: he\xe2\x80\x99s in direct privity with the seller. But what if Carl\xe2\x80\x99s spouse Carlene is injured? She\ndidn\xe2\x80\x99t buy the lamp; is she covered? Or suppose Carl\xe2\x80\x99s friend David, visiting for an afternoon, gets zapped.\nIs David covered? This gets to horizontal privity, noncontracting parties who suffer damages from\ndefective goods, such as nonbuyer users, consumers, and bystanders. Horizontal privity determines to\nwhose benefit the warranty \xe2\x80\x9cflows\xe2\x80\x9d\xe2\x80\x94who can sue for its breach. In one of its rare instances of\nnonuniformity, the UCC does not dictate the result. It gives the states three choices, labeled in Section 2318 as Alternatives A, B, and C.\nAlternative A says that a seller\xe2\x80\x99s warranty extends \xe2\x80\x9cto any natural person who is in the family or\nhousehold of his buyer or who is a guest in his home\xe2\x80\x9d provided (1) it is reasonable to expect the person\nsuffering damages to use, consume, or be affected by the goods and (2) the warranty extends only to\ndamages for personal injury.\nAlternative B \xe2\x80\x9cextends to any natural person who may reasonably be expected to use, consume, or be\naffected by the goods, and who is injured in person by breach of the warranty.\xe2\x80\x9d It is less restrictive than\nthe first alternative: it extends protection to people beyond those in the buyer\xe2\x80\x99s home. For example, what\nif Carl took the lamp to a neighbor\xe2\x80\x99s house to illuminate a poker table: under Alternative B, anybody at the\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n583\n\n\x0cneighbor\xe2\x80\x99s house who suffered injury would be covered by the warranty. But this alternative does not\nextend protection to organizations; \xe2\x80\x9cnatural person\xe2\x80\x9d means a human being.\nAlternative C is the same as B except that it applies not only to any \xe2\x80\x9cnatural person\xe2\x80\x9d but \xe2\x80\x9cto any person\nwho is injured by breach of the warranty.\xe2\x80\x9d This is the most far-reaching alternative because it provides\nredress for damage to property as well as for personal injury, and it extends protection to corporations\nand other institutional buyers.\nOne may incidentally note that having three different alternatives for when third-party nonpurchasers can\nsue a seller or manufacturer for breach of warranty gives rise to unintended consequences. First, different\noutcomes are produced among jurisdictions, including variations in the common law. Second, the great\npurpose of the Uniform Commercial Code in promoting national uniformity is undermined. Third, battles\nover choice of law\xe2\x80\x94where to file the lawsuit\xe2\x80\x94are generated.\nUCC, Section 2A-216, provides basically the same alternatives as applicable to the leasing of goods.\n\nVertical Privity\nThe traditional rule was that remote selling parties were not liable: lack of privity was a defense by the\nmanufacturer or wholesaler to a suit by a buyer with whom these entities did not themselves contract. The\nbuyer could recover damages from the retailer but not from the original manufacturer, who after all made\nthe product and who might be much more financially able to honor the warranty. The UCC takes no\nposition here, but over the last fifty years the judicial trend has been to abolish\nthis vertical privity requirement. (SeeFigure 17.2 "Chain of Distribution"; the entities in the distribution\nchain are those in vertical privity to the buyer.) It began in 1958, when the Michigan Supreme Court\noverturned the old theory in an opinion written by Justice John D. Voelker (who also wrote the\nnovel Anatomy of a Murder, under the pen name Robert Traver).\n\n[6]\n\nContributory Negligence, Comparative Negligence, and Assumption of Risk\nAfter disclaimers and privity issues are resolved, other possible impediments facing the plaintiff in a\nproducts-liability warranty case are issues of assumption of the risk, contributory negligence, and\ncomparative negligence (discussed inChapter 7 "Introduction to Tort Law" on torts).\nCourts uniformly hold that assumption of risk is a defense for sellers against a claim of breach of\nwarranty, while there is a split of authority over whether comparative and contributory negligence are\ndefenses. However, the courts\xe2\x80\x99 use of this terminology is often conflicting and confusing. The ultimate\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n584\n\n\x0cquestion is really one of causation: was the seller\xe2\x80\x99s breach of the warranty the cause of the plaintiff\xe2\x80\x99s\ndamages?\nThe UCC is not markedly helpful in clearing away the confusion caused by years of discussion of\nassumption of risk and contributory negligence. Section 2-715(2)(b) of the UCC says that among the forms\nof consequential damage for which recovery can be sought is \xe2\x80\x9cinjury to person or property proximately\nresulting from any breach of warranty\xe2\x80\x9d (emphasis added). But \xe2\x80\x9cproximately\xe2\x80\x9d is a troublesome word.\nIndeed, ultimately it is a circular word: it means nothing more than that the defendant must have been a\ndirect enough cause of the damages that the courts will impose liability. Comment 5 to this section says,\n\xe2\x80\x9cWhere the injury involved follows the use of goods without discovery of the defect causing the damage,\nthe question of \xe2\x80\x98proximate\xe2\x80\x99 turns on whether it was reasonable for the buyer to use the goods without such\ninspection as would have revealed the defects. If it was not reasonable for him to do so, or if he did in fact\ndiscover the defect prior to his use, the injury would not proximately result from the breach of warranty.\xe2\x80\x9d\nObviously if a sky diver buys a parachute and then discovers a few holes in it, his family would not likely\nprevail in court when they sued to recover for his death because the parachute failed to function after he\njumped at 5,000 feet. But the general notion that it must have been reasonable for a buyer to use goods\nwithout inspection can make a warranty case difficult to prove.\n\nKEY TAKEAWAY\n\nA first basis of recovery in products-liability theory is breach of warranty. There are two types of\nwarranties: express and implied. Under the implied category are three major subtypes: the implied\nwarranty of merchantability (only given by merchants), the implied warranty of fitness for a particular\npurpose, and the implied warranty of title. There are a number of problems with the use of warranty\ntheory: there must have been a sale of the goods; the plaintiff must bring the action within the statute of\nlimitations; and the plaintiff must notify the seller within a reasonable time. The seller may\xe2\x80\x94within the\nconstraints of the Magnuson-Moss Act\xe2\x80\x94limit or exclude express warranties or limit or exclude implied\nwarranties. Privity, or lack of it, between buyer and seller has been significantly eroded as a limitation in\nwarranty theory, but lack of privity may still affect the plaintiff\xe2\x80\x99s recovery; the plaintiff\xe2\x80\x99s assumption of the\nrisk in using defective goods may preclude recovery.\n\nEXERCISES\n\n1.\n\nWhat are the two main types of warranties and the important subtypes?\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n585\n\n\x0c2.\n\nWho can make each type of warranty?\n\n3.\n\nWhat general problems does a plaintiff have in bringing a products-liability warranty case?\n\n4.\n\nWhat problems are presented concerning exclusion or manipulative express warranties, and how does\nthe Magnuson-Moss Act address them?\n\n5.\n\nHow are implied warranties excluded?\n\n6.\n\nWhat is the problem of lack of privity, and how does modern law deal with it?\n7.\n\n[1] Rhodes Pharmacal Co. v. Continental Can Co., 219 N.E.2d 726 (Ill. 1976).\n\n8.\n\n[2] Wat Henry Pontiac Co. v. Bradley, 210 P.2d 348 (Okla. 1949).\n\n9.\n\n[3] Frederickson v. Hackney, 198 N.W. 806 (Minn. 1924).\n\n10. [4] Menzel v. List, 246 N.E.2d 742 (N.Y. 1969).\n11. [5] A number of states have special laws that limit the use of the UCC implied warranty disclaimer rules in\nconsumer sales. Some of these appear in amendments to the UCC and others are in separate statutes.\nThe broadest approach is that of the nine states that prohibit the disclaimer of implied warranties in\nconsumer sales (Massachusetts, Connecticut, Maine, Vermont, Maryland, the District of Columbia, West\nVirginia, Kansas, Mississippi, and, with respect to personal injuries only, Alabama). There is a difference in\nthese states whether the rules apply to manufacturers as well as retailers.\n12. [6] Spence v. Three Rivers Builders & Masonry Supply, Inc., 90 N.W.2d 873 (Mich. 1958).\n\n17.3 Negligence\n\nLEARNING OBJECTIVES\n\n1.\n\nRecognize how the tort theory of negligence may be of use in products-liability suits.\n\n2.\n\nUnderstand why negligence is often not a satisfactory cause of action in such suits: proof of it may be\ndifficult, and there are powerful defenses to claims of negligence.\n\nNegligence is the second theory raised in the typical products-liability case. It is a tort theory (as\ncompared to breach of warranty, which is of course a contract theory), and it does have this\nadvantage over warranty theory: privity is never relevant. A pedestrian is struck in an intersection by\na car whose brakes were defectively manufactured. Under no circumstances would breach of\nwarranty be a useful cause of action for the pedestrian\xe2\x80\x94there is no privity at all. Negligence is\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n586\n\n\x0cconsidered in detail in the Chapter 7 "Introduction to Tort Law" on torts; it basically means lack of\ndue care.\n\nTypical Negligence Claims: Design Defects and Inadequate Warnings\nNegligence theory in products liability is most useful in two types of cases: defective design and defective\nwarnings.\n\nDesign Defects\nManufacturers can be, and often are, held liable for injuries caused by products that were defectively\ndesigned. The question is whether the designer used reasonable care in designing a product reasonably\nsafe for its foreseeable use. The concern over reasonableness and standards of care are elements of\nnegligence theory.\nDefective-design cases can pose severe problems for manufacturing and safety engineers. More safety\nmeans more cost. Designs altered to improve safety may impair functionality and make the product less\ndesirable to consumers. At what point safety comes into reasonable balance with performance, cost, and\ndesirability (see Figure 17.3 "The Reasonable Design Balance") is impossible to forecast accurately, though\nsome factors can be taken into account. For example, if other manufacturers are marketing comparable\nproducts whose design are intrinsically safer, the less-safe products are likely to lose a test of\nreasonableness in court.\nFigure 17.3 The Reasonable Design Balance\n\nWarning Defects\nWe noted that a product may be defective if the manufacturer failed to warn the user of potential dangers.\nWhether a warning should have been affixed is often a question of what is reasonably foreseeable, and the\nfailure to affix a warning will be treated as negligence. The manufacturer of a weed killer with poisonous\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n587\n\n\x0cingredients is certainly acting negligently when it fails to warn the consumer that the contents are\npotentially lethal.\nThe law governing the necessity to warn and the adequacy of warnings is complex. What is reasonable\nturns on the degree to which a product is likely to be misused and, as the disturbing Laaperi case (Section\n17.6.3 "Failure to Warn") illustrates, whether the hazard is obvious.\n\nProblems with Negligence Theory\nNegligence is an ancient cause of action and, as was discussed in the torts chapter, it carries with it a\nnumber of well-developed defenses. Two categories may be mentioned: common-law defenses and\npreemption.\n\nCommon-Law Defenses against Negligence\nAmong the problems confronting a plaintiff with a claim of negligence in products-liability suits (again,\nthese concepts are discussed in the torts chapter) are the following:\n\xe2\x80\xa2\n\nProving negligence at all: just because a product is defective does not necessarily prove the\nmanufacturer breached a duty of care.\n\n\xe2\x80\xa2\n\nProximate cause: even if there was some negligence, the plaintiff must prove her damages flowed\nproximately from that negligence.\n\n\xe2\x80\xa2\n\nContributory and comparative negligence: the plaintiff\xe2\x80\x99s own actions contributed to the damages.\n\n\xe2\x80\xa2\n\nSubsequent alteration of the product: generally the manufacturer will not be liable if the product has\nbeen changed.\n\n\xe2\x80\xa2\n\nMisuse or abuse of the product: using a lawn mower to trim a hedge or taking too much of a drug are\nexamples.\n\n\xe2\x80\xa2\n\nAssumption of the risk: knowingly using the product in a risky way.\n\nPreemption\nPreemption (or \xe2\x80\x9cpre-emption\xe2\x80\x9d) is illustrated by this problem: suppose there is a federal standard\nconcerning the product, and the defendant manufacturer meets it, but the standard is not really very\nprotective. (It is not uncommon, of course, for federal standard makers of all types to be significantly\ninfluenced by lobbyists for the industries being regulated by the standards.) Is it enough for the\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n588\n\n\x0cmanufacturer to point to its satisfaction of the standard so that such satisfaction preempts (takes over)\nany common-law negligence claim? \xe2\x80\x9cWe built the machine to federal standards: we can\xe2\x80\x99t be liable. Our\ncompliance with the federal safety standard is an affirmative defense.\xe2\x80\x9d\nPreemption is typically raised as a defense in suits about (1) cigarettes, (2) FDA-approved medical devices,\n(3) motor-boat propellers, (4) pesticides, and (5) motor vehicles. This is a complex area of law. Questions\ninevitably arise as to whether there was federal preemption, express or implied. Sometimes courts find\npreemption and the consumer loses; sometimes the courts don\xe2\x80\x99t find preemption and the case goes\nforward. According to one lawyer who works in this field, there has been \xe2\x80\x9cincreasing pressure on both the\nregulatory and congressional fronts to preempt state laws.\xe2\x80\x9d That is, the usual defendants (manufacturers)\npush Congress and the regulatory agencies to state explicitly in the law that the federal standards preempt\nand defeat state law.\n\n[1]\n\nKEY TAKEAWAY\n\nNegligence is a second possible cause of action for products-liability claimants. A main advantage is that\nno issues of privity are relevant, but there are often problems of proof; there are a number of robust\ncommon-law defenses, and federal preemption is a recurring concern for plaintiffs\xe2\x80\x99 lawyers.\n\nEXERCISES\n\n1.\n\nWhat two types of products-liability cases are most often brought under negligence?\n\n2.\n\nHow could it be said that merely because a person suffers injury as the result of a defective product,\nproof of negligence is not necessarily made?\n\n3.\n\nWhat is \xe2\x80\x9cpreemption\xe2\x80\x9d and how is it used as a sword to defeat products-liability plaintiffs?\n\n[1] C. Richard Newsome and Andrew F. Knopf, \xe2\x80\x9cFederal Preemption: Products Lawyers Beware,\xe2\x80\x9d Florida Justice\nAssociation Journal, July 27, 2007, accessed March 1,\n2011,http://www.newsomelaw.com/resources/articles/federal-preemption-products-lawyers-beware.\n\n17.4 Strict Liability in Tort\n\nLEARNING OBJECTIVES\n\n1.\n\nKnow what \xe2\x80\x9cstrict products liability\xe2\x80\x9d means and how it differs from the other two products-liability\ntheories.\n\n2.\n\nUnderstand the basic requirements to prove strict products liability.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n589\n\n\x0c3.\n\nSee what obstacles to recovery remain with this doctrine.\n\nThe warranties grounded in the Uniform Commercial Code (UCC) are often ineffective in assuring\nrecovery for a plaintiff\xe2\x80\x99s injuries. The notice requirements and the ability of a seller to disclaim the\nwarranties remain bothersome problems, as does the privity requirement in those states that\ncontinue to adhere to it.\nNegligence as a products-liability theory obviates any privity problems, but negligence comes with a\nnumber of familiar defenses and with the problems of preemption.\nTo overcome the obstacles, judges have gone beyond the commercial statutes and the ancient\nconcepts of negligence. They have fashioned a tort theory of products liability based on the principle\nof strict products liability. One court expressed the rationale for the development of the concept as\nfollows: \xe2\x80\x9cThe rule of strict liability for defective products is an example of necessary paternalism\njudicially shifting risk of loss by application of tort doctrine because [the UCC] scheme fails to\nadequately cover the situation. Judicial paternalism is to loss shifting what garlic is to a stew\xe2\x80\x94\nsometimes necessary to give full flavor to statutory law, always distinctly noticeable in its result,\noverwhelmingly counterproductive if excessive, and never an end in itself.\xe2\x80\x9d [1]Paternalism or not,\nstrict liability has become a very important legal theory in products-liability cases.\n\nStrict Liability Defined\nThe formulation of strict liability that most courts use is Section 402A of the Restatement of Torts\n(Second), set out here in full:\n(1) One who sells any product in a defective condition unreasonably dangerous to the user or\nconsumer or to his property is subject to liability for physical harm thereby caused to the ultimate\nuser or consumer, or to his property, if\n(a) the seller is engaged in the business of selling such a product, and\n(b) it is expected to and does reach the user or consumer without substantial change in the\ncondition in which it is sold.\n(2) This rule applies even though\n(a) the seller has exercised all possible care in the preparation and sale of his product, and\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n590\n\n\x0c(b) the user or consumer has not bought the product from or entered into any contractual\nrelation with the seller.\nSection 402A of the Restatement avoids the warranty booby traps. It states a rule of law not governed by\nthe UCC, so limitations and exclusions in warranties will not apply to a suit based on the Restatement\ntheory. And the consumer is under no obligation to give notice to the seller within a reasonable time of\nany injuries. Privity is not a requirement; the language of the Restatement says it applies to \xe2\x80\x9cthe user or\nconsumer,\xe2\x80\x9d but courts have readily found that bystanders in various situations are entitled to bring\nactions under Restatement, Section 402A. The formulation of strict liability, though, is limited to physical\nharm. Many courts have held that a person who suffers economic loss must resort to warranty law.\nStrict liability avoids some negligence traps, too. No proof of negligence is required. See .\n\nFigure 17.4 Major Difference between Warranty and Strict Liability\n\nSection 402A Elements\nProduct in a Defective Condition\nSales of goods but not sales of services are covered under the Restatement, Section 402A. Furthermore,\nthe plaintiff will not prevail if the product was safe for normal handling and consumption when sold. A\nglass soda bottle that is properly capped is not in a defective condition merely because it can be broken if\nthe consumer should happen to drop it, making the jagged glass dangerous. Chocolate candy bars are not\ndefective merely because you can become ill by eating too many of them at once. On the other hand, a\nseller would be liable for a product defectively packaged, so that it could explode or deteriorate and\nchange its chemical composition. A product can also be in a defective condition if there is danger that\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n591\n\n\x0ccould come from an anticipated wrongful use, such as a drug that is safe only when taken in limited doses.\nUnder those circumstances, failure to place an adequate dosage warning on the container makes the\nproduct defective.\nThe plaintiff bears the burden of proving that the product is in a defective condition, and this burden can\nbe difficult to meet. Many products are the result of complex feats of engineering. Expert witnesses are\nnecessary to prove that the products were defectively manufactured, and these are not always easy to\ncome by. This difficulty of proof is one reason why many cases raise the failure to warn as the dispositive\nissue, since in the right case that issue is far easier to prove. The Anderson case (detailed in the exercises\nat the end of this chapter) demonstrates that the plaintiff cannot prevail under strict liability merely\nbecause he was injured. It is not the fact of injury that is dispositive but the defective condition of the\nproduct.\n\nUnreasonably Dangerous\nThe product must be not merely dangerous but unreasonably dangerous. Most products have\ncharacteristics that make them dangerous in certain circumstances. As the Restatement commentators\nnote, \xe2\x80\x9cGood whiskey is not unreasonably dangerous merely because it will make some people drunk, and\nis especially dangerous to alcoholics; but bad whiskey, containing a dangerous amount of fuel oil, is\nunreasonably dangerous.\xe2\x80\xa6Good butter is not unreasonably dangerous merely because, if such be the case,\nit deposits cholesterol in the arteries and leads to heart attacks; but bad butter, contaminated with\npoisonous fish oil, is unreasonably dangerous.\xe2\x80\x9d\n\n[2]\n\nUnder Section 402A, \xe2\x80\x9cthe article sold must be\n\ndangerous to an extent beyond that which would be contemplated by the ordinary consumer who\npurchases it, with the ordinary knowledge common to the community as to its characteristics. \xe2\x80\x9d\nEven high risks of danger are not necessarily unreasonable. Some products are unavoidably unsafe; rabies\nvaccines, for example, can cause dreadful side effects. But the disease itself, almost always fatal, is worse.\nA product is unavoidably unsafe when it cannot be made safe for its intended purpose given the present\nstate of human knowledge. Because important benefits may flow from the product\xe2\x80\x99s use, its producer or\nseller ought not to be held liable for its danger.\nHowever, the failure to warn a potential user of possible hazards can make a product defective under\nRestatement, Section 402A, whether unreasonably dangerous or even unavoidably unsafe. The dairy\nfarmer need not warn those with common allergies to eggs, because it will be presumed that the person\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n592\n\n\x0cwith an allergic reaction to common foodstuffs will be aware of them. But when the product contains an\ningredient that could cause toxic effects in a substantial number of people and its danger is not widely\nknown (or if known, is not an ingredient that would commonly be supposed to be in the product), the lack\nof a warning could make the product unreasonably dangerous within the meaning of Restatement, Section\n402A. Many of the suits brought by asbestos workers charged exactly this point; \xe2\x80\x9cThe utility of an\ninsulation product containing asbestos may outweigh the known or foreseeable risk to the insulation\nworkers and thus justify its marketing. The product could still be unreasonably dangerous, however, if\nunaccompanied by adequate warnings. An insulation worker, no less than any other product user, has a\nright to decide whether to expose himself to the risk.\xe2\x80\x9d\n\n[3]\n\nThis rule of law came to haunt the Manville\n\nCorporation: it was so burdened with lawsuits, brought and likely to be brought for its sale of asbestos\xe2\x80\x94a\nknown carcinogen\xe2\x80\x94that it declared bankruptcy in 1982 and shucked its liability.\n\n[4]\n\nEngaged in the Business of Selling\nRestatement, Section 402A(1)(a), limits liability to sellers \xe2\x80\x9cengaged in the business of selling such a\nproduct.\xe2\x80\x9d The rule is intended to apply to people and entities engaged in business, not to casual one-time\nsellers. The business need not be solely in the defective product; a movie theater that sells popcorn with a\nrazor blade inside is no less liable than a grocery store that does so. But strict liability under this rule does\nnot attach to a private individual who sells his own automobile. In this sense, Restatement, Section 402A,\nis analogous to the UCC\xe2\x80\x99s limitation of the warranty of merchantability to the merchant.\nThe requirement that the defendant be in the business of selling gets to the rationale for the whole\nconcept of strict products liability: businesses should shoulder the cost of injuries because they are in the\nbest position to spread the risk and distribute the expense among the public. This same policy has been\nthe rationale for holding bailors and lessors liable for defective equipment just as if they had been\nsellers.\n\n[5]\n\nReaches the User without Change in Condition\nRestatement, Section 402A(1)(b), limits strict liability to those defective products that are expected to and\ndo reach the user or consumer without substantial change in the condition in which the products are sold.\nA product that is safe when delivered cannot subject the seller to liability if it is subsequently mishandled\nor changed. The seller, however, must anticipate in appropriate cases that the product will be stored;\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n593\n\n\x0cfaulty packaging or sterilization may be the grounds for liability if the product deteriorates before being\nused.\n\nLiability Despite Exercise of All Due Care\nStrict liability applies under the Restatement rule even though \xe2\x80\x9cthe seller has exercised all possible care in\nthe preparation and sale of his product.\xe2\x80\x9d This is the crux of \xe2\x80\x9cstrict liability\xe2\x80\x9d and distinguishes it from the\nconventional theory of negligence. It does not matter how reasonably the seller acted or how exemplary is\na manufacturer\xe2\x80\x99s quality control system\xe2\x80\x94what matters is whether the product was defective and the user\ninjured as a result. Suppose an automated bottle factory manufactures 1,000 bottles per hour under\nexacting standards, with a rigorous and costly quality-control program designed to weed out any bottles\nshowing even an infinitesimal amount of stress. The plant is \xe2\x80\x9cstate of the art,\xe2\x80\x9d and its computerized\nquality-control operation is the best in the world. It regularly detects the one out of every 10,000 bottles\nthat analysis has shown will be defective. Despite this intense effort, it proves impossible to weed out\nevery defective bottle; one out of one million, say, will still escape detection. Assume that a bottle, filled\nwith soda, finds its way into a consumer\xe2\x80\x99s home, explodes when handled, sends glass shards into his eye,\nand blinds him. Under negligence, the bottler has no liability; under strict liability, the bottler will be\nliable to the consumer.\n\nLiability without Contractual Relation\nUnder Restatement, Section 402A(2)(b), strict liability applies even though the user has not purchased\nthe product from the seller nor has the user entered into any contractual relation with the seller. In short,\nprivity is abolished and the injured user may use the theory of strict liability against manufacturers and\nwholesalers as well as retailers. Here, however, the courts have varied in their approaches; the trend has\nbeen to allow bystanders recovery. The Restatement explicitly leaves open the question of the bystander\xe2\x80\x99s\nright to recover under strict liability.\n\nProblems with Strict Liability\nStrict liability is liability without proof of negligence and without privity. It would seem that strict liability\nis the \xe2\x80\x9choly grail\xe2\x80\x9d of products-liability lawyers: the complete answer. Well, no, it\xe2\x80\x99s not the holy grail. It is\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n594\n\n\x0ccertainly true that 402A abolishes the contractual problems of warranty. Restatement, Section 402A,\nComment m, says,\nThe rule stated in this Section is not governed by the provisions of the Uniform Commercial Code,\nas to warranties; and it is not affected by limitations on the scope and content of warranties, or\nby limitation to \xe2\x80\x9cbuyer\xe2\x80\x9d and \xe2\x80\x9cseller\xe2\x80\x9d in those statutes. Nor is the consumer required to give notice\nto the seller of his injury within a reasonable time after it occurs, as provided by the Uniform Act.\nThe consumer\xe2\x80\x99s cause of action does not depend upon the validity of his contract with the person\nfrom whom he acquires the product, and it is not affected by any disclaimer or other agreement,\nwhether it be between the seller and his immediate buyer, or attached to and accompanying the\nproduct into the consumer\xe2\x80\x99s hands. In short, \xe2\x80\x9cwarranty\xe2\x80\x9d must be given a new and different\nmeaning if it is used in connection with this Section. It is much simpler to regard the liability here\nstated as merely one of strict liability in tort.\nInherent in the Restatement\xe2\x80\x99s language is the obvious point that if the product has been altered, losses\ncaused by injury are not the manufacturer\xe2\x80\x99s liability. Beyond that there are still some limitations to strict\nliability.\n\nDisclaimers\nComment m specifically says the cause of action under Restatement, Section 402A, is not affected by\ndisclaimer. But in nonconsumer cases, courts have allowed clear and specific disclaimers. In 1969, the\nNinth Circuit observed: \xe2\x80\x9cInKaiser Steel Corp. the [California Supreme Court] court upheld the dismissal\nof a strict liability action when the parties, dealing from positions of relatively equal economic strength,\ncontracted in a commercial setting to limit the defendant\xe2\x80\x99s liability. The court went on to hold that in this\nsituation the strict liability cause of action does not apply at all. In reaching this conclusion, the court\nin Kaiser reasoned that strict liability \xe2\x80\x98is designed to encompass situations in which the principles of sales\nwarranties serve their purpose \xe2\x80\x9cfitfully at best.\xe2\x80\x9d\xe2\x80\x99 [Citation]\xe2\x80\x9d It concluded that in such commercial settings\nthe UCC principles work well and \xe2\x80\x9cto apply the tort doctrines of products liability will displace the\nstatutory law rather than bring out its full flavor.\xe2\x80\x9d\n\n[6]\n\nPlaintiff\xe2\x80\x99s Conduct\nConduct by the plaintiff herself may defeat recovery in two circumstances.\n\nAssumption of Risk\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n595\n\n\x0cCourts have allowed the defense of assumption of the risk in strict products-liability cases. A plaintiff\nassumes the risk of injury, thus establishing defense to claim of strict products liability, when he is aware\nthe product is defective, knows the defect makes the product unreasonably dangerous, has reasonable\nopportunity to elect whether to expose himself to the danger, and nevertheless proceeds to make use of\nthe product. The rule makes sense.\n\nMisuse or Abuse of the Product\nWhere the plaintiff does not know a use of the product is dangerous but nevertheless uses for an incorrect\npurpose, a defense arises, but only if such misuse was not foreseeable. If it was, the manufacturer should\nwarn against that misuse. In Eastman v. Stanley Works, a carpenter used a framing hammer to drive\n[7]\n\nmasonry nails; the claw of the hammer broke off, striking him in the eye. He sued. The court held that\nwhile a defense does exist \xe2\x80\x9cwhere the product is used in a capacity which is unforeseeable by the\nmanufacturer and completely incompatible with the product\xe2\x80\x99s design\xe2\x80\xa6misuse of a product suggests a use\nwhich was unanticipated or unexpected by the product manufacturer, or unforeseeable and unanticipated\n[but] it was not the case that reasonable minds could only conclude that appellee misused the [hammer].\nThough the plaintiff\xe2\x80\x99s use of the hammer might have been unreasonable, unreasonable use is not a\ndefense to a strict product-liability action or to a negligence action.\xe2\x80\x9d\n\nLimited Remedy\nThe Restatement says recovery under strict liability is limited to \xe2\x80\x9cphysical harm thereby caused to the\nultimate user or consumer, or to his property,\xe2\x80\x9d but not other losses and not economic losses. In Atlas Air\nv. General Electric, a New York court held that the \xe2\x80\x9ceconomic loss rule\xe2\x80\x9d (no recovery for economic losses)\nbarred strict products-liability and negligence claims by the purchaser of a used airplane against the\nairplane engine manufacturer for damage to the plane caused by an emergency landing necessitated by\nengine failure, where the purchaser merely alleged economic losses with respect to the plane itself, and\nnot damages for personal injury (recovery for damage to the engine was allowed).\n\n[8]\n\nBut there are exceptions. In Duffin v. Idaho Crop Imp. Ass\xe2\x80\x99n, the court recognized that a party generally\nowes no duty to exercise due care to avoid purely economic loss, but if there is a \xe2\x80\x9cspecial relationship\xe2\x80\x9d\n[9]\n\nbetween the parties such that it would be equitable to impose such a duty, the duty will be imposed. \xe2\x80\x9cIn\nother words, there is an extremely limited group of cases where the law of negligence extends its\nprotections to a party\xe2\x80\x99s economic interest.\xe2\x80\x9d\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n596\n\n\x0cThe Third Restatement\nThe law develops. What seemed fitting in 1964 when the Restatement (Second) announced the state of the\ncommon-law rules for strict liability in Section 402A seemed, by 1997, not to be tracking common law\nentirely closely. The American Law Institute came out with the Restatement (Third) in that year. The\nRestatement changes some things. Most notably it abolishes the \xe2\x80\x9cunreasonably dangerous\xe2\x80\x9d test and\nsubstitutes a \xe2\x80\x9crisk-utility test.\xe2\x80\x9d That is, a product is not defective unless its riskiness outweighs its utility.\nMore important, the Restatement (Third), Section 2, now requires the plaintiff to provide a reasonable\nalternative design to the product in question. In advancing a reasonable alternative design, the plaintiff is\nnot required to offer a prototype product. The plaintiff must only show that the proposed alternative\ndesign exists and is superior to the product in question. The Restatement (Third) also makes it more\ndifficult for plaintiffs to sue drug companies successfully. One legal scholar commented as follows on the\nRestatement (Third):\nThe provisions of the Third Restatement, if implemented by the courts, will establish a degree of\nfairness in the products liability arena. If courts adopt the Third Restatement\xe2\x80\x99s elimination of the\n\xe2\x80\x9cconsumer expectations test,\xe2\x80\x9d this change alone will strip juries of the ability to render decisions\nbased on potentially subjective, capricious and unscientific opinions that a particular product\ndesign is unduly dangerous based on its performance in a single incident. More important,\nplaintiffs will be required to propose a reasonable alternative design to the product in question.\nSuch a requirement will force plaintiffs to prove that a better product design exists other than in\nthe unproven and untested domain of their experts\xe2\x80\x99 imaginations.\n\n[10]\n\nOf course some people put more faith in juries than is evident here. The new Restatement has been\nadopted by a few jurisdictions and some cases the adopting jurisdictions incorporate some of its ideas, but\ncourts appear reluctant to abandon familiar precedent.\n\nKEY TAKEAWAY\n\nBecause the doctrines of breach of warranty and negligence did not provide adequate relief to those\nsuffering damages or injuries in products-liability cases, beginning in the 1960s courts developed a new\ntort theory: strict products liability, restated in the Second Restatement, section 402A. Basically the\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n597\n\n\x0cdoctrine says that if goods sold are unreasonably dangerous or defective, the merchant-seller will be liable\nfor the immediate property loss and personal injuries caused thereby. But there remain obstacles to\nrecovery even under this expanded concept of liability: disclaimers of liability have not completely been\ndismissed, the plaintiff\xe2\x80\x99s conduct or changes to the goods may limit recovery, and\xe2\x80\x94with some\nexceptions\xe2\x80\x94the remedies available are limited to personal injury (and damage to the goods themselves);\neconomic loss is not recoverable. Almost forty years of experience with the Second Restatement\xe2\x80\x99s section\non strict liability has seen changes in the law, and the Third Restatement introduces those, but it has not\nbeen widely accepted yet.\n\n1.\n\nEXERCISES\n\nWhat was perceived to be inadequate about warranty and negligence theories that necessitated the\ndevelopment of strict liability?\n\n2.\n\nBriefly describe the doctrine.\n\n3.\n\nWhat defects in goods render their sellers strictly liable?\n\n4.\n\nWho counts as a liable seller?\n\n5.\n\nWhat obstacles does a plaintiff have to overcome here, and what limitations are there to recovery?\n6.\n\n[1] Kaiser Steel Corp. v. Westinghouse Electric Corp., 127 Cal. Rptr. 838 (Cal. 1976).\n\n7.\n\n[2] Restatement (Second) of Contracts, Section 402A(i).\n\n8.\n\n[3] Borel v. Fibreboard Paper Products Corp., 493 F.Zd 1076 (5th Cir. 1973).\n\n9.\n\n[4] In re Johns-Manville Corp., 36 R.R. 727 (So. Dist. N.Y. 1984).\n\n10. [5] Martin v. Ryder Rental, Inc., 353 A.2d 581 (Del. 1976).\n11. [6] Idaho Power Co. v. Westinghouse Electric Corp., 596 F.2d 924, 9CA (1979).\n12. [7] Eastman v. Stanley Works, 907 N.E.2d 768 (Ohio App. 2009).\n13. [8] Atlas Air v. General Electric, 16 A.D.3d 444 (N.Y.A.D. 2005).\n14. [9] Duffin v. Idaho Crop Imp. Ass\xe2\x80\x99n, 895 P.2d 1195 (Idaho 1995).\n15. [10] Quinlivan Wexler LLP, \xe2\x80\x9cThe 3rd Restatement of Torts\xe2\x80\x94Shaping the Future of Products Liability Law,\xe2\x80\x9d\nJune 1, 1999, accessed March 1, 2011,http://library.findlaw.com/1999/Jun/1/127691.html.\n\n17.5 Tort Reform\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n598\n\n\x0cLEARNING OBJECTIVES\n1.\n\nSee why tort reform is advocated, why it is opposed, and what interests take each side.\n\n2.\n\nUnderstand some of the significant state reforms in the last two decades.\n\n3.\n\nKnow what federal reforms have been instituted.\n\nThe Cry for Reform\nIn 1988, The Conference Board published a study that resulted from a survey of more than 500 chief\nexecutive officers from large and small companies regarding the effects of products liability on their firms.\nThe study concluded that US companies are less competitive in international business because of these\neffects and that products-liability laws must be reformed. The reform effort has been under way ever\nsince, with varying degrees of alarms and finger-pointing as to who is to blame for the \xe2\x80\x9ctort crisis,\xe2\x80\x9d if there\neven is one. Business and professional groups beat the drums for tort reform as a means to guarantee\n\xe2\x80\x9cfairness\xe2\x80\x9d in the courts as well as spur US economic competitiveness in a global marketplace, while\nplaintiffs\xe2\x80\x99 attorneys and consumer advocates claim that businesses simply want to externalize costs by\ndenying recovery to victims of greed and carelessness.\nEach side vilifies the other in very unseemly language: probusiness advocates call consumer-oriented\nstates \xe2\x80\x9cjudicial hell-holes\xe2\x80\x9d and complain of \xe2\x80\x9cwell-orchestrated campaign[s] by tort lawyer lobbyists and\nallies to undo years of tort reform at the state level,\xe2\x80\x9d\n\xe2\x80\x9cscant evidence\xe2\x80\x9d of any tort abuse.\n\n[2]\n\n[1]\n\nwhile pro-plaintiff interests claim that there is\n\nIt would be more amusing if it were not so shrill and partisan.\n\nPerhaps the most one can say with any certainty is that peoples\xe2\x80\x99 perception of reality is highly colored by\ntheir self-interest. In any event, there have been reforms (or, as the detractors say, \xe2\x80\x9cdeforms\xe2\x80\x9d).\n\nState Reforms\nProdded by astute lobbying by manufacturing and other business trade associations, state legislatures\nresponded to the cries of manufacturers about the hardships that the judicial transformation of the\nproducts-liability lawsuit ostensibly worked on them. Most state legislatures have enacted at least one of\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n599\n\n\x0csome three dozen \xe2\x80\x9creform\xe2\x80\x9d proposal pressed on them over the last two decades. Some of these measures\ndo little more than affirm and clarify case law. Among the most that have passed in several states are\noutlined in the next sections.\n\nStatutes of Repose\nPerhaps nothing so frightens the manufacturer as the occasional reports of cases involving products that\nwere fifty or sixty years old or more at the time they injured the plaintiff. Many states have addressed this\nproblem by enacting the so-called statute of repose. This statute establishes a time period, generally\nranging from six to twelve years; the manufacturer is not liable for injuries caused by the product after\nthis time has passed.\n\nState-of-the-Art Defense\nSeveral states have enacted laws that prevent advances in technology from being held against the\nmanufacturer. The fear is that a plaintiff will convince a jury a product was defective because it did not use\ntechnology that was later available. Manufacturers have often failed to adopt new advances in technology\nfor fear that the change will be held against them in a products-liability suit. These new statutes declare\nthat a manufacturer has a valid defense if it would have been technologically impossible to have used the\nnew and safer technology at the time the product was manufactured.\n\nFailure to Warn\nSince it is often easier to prove that an injury resulted because the manufacturer failed to warn against a\ncertain use than it is to prove an injury was caused by a defective design, manufacturers are subjected to a\nconsiderable degree of hindsight. Some of the state statutes limit the degree to which the failure to warn\ncan be used to connect the product and the injury. For example, the manufacturer has a valid defense if it\nwould have been impossible to foresee that the consumer might misuse the product in a certain way.\n\nComparative Fault for Consumer Misuse\nContributory negligence is generally not a defense in a strict liability action, while assumption of risk is. In\nstates that have enacted so-called comparative fault statutes, the user\xe2\x80\x99s damages are pegged to the\npercentage of responsibility for the injury that the defendant bears. Thus if the consumer\xe2\x80\x99s misuse of the\nproduct is assessed as having been 20 percent responsible for the accident (or for the extent of the\ninjuries), the consumer is entitled to only 80 percent of damages, the amount for which the defendant\nmanufacturer is responsible.\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n600\n\n\x0cCriminal Penalties\nNot all state reform is favorable to manufacturers. Under the California Corporate Criminal Liability Act,\nwhich took effect twenty years ago, companies and managers must notify a state regulatory agency if they\nknow that a product they are selling in California has a safety defect, and the same rule applies under\ncertain federal standards, as Toyota executives were informed by their lawyers following alarms about\nsudden acceleration in some Toyota automobiles. Failure to provide notice may result in corporate and\nindividual criminal liability.\n\nFederal Reform\nPiecemeal reform of products-liability law in each state has contributed to the basic lack of uniformity\nfrom state to state, giving it a crazy-quilt effect. In the nineteenth century, this might have made little\ndifference, but today most manufacturers sell in the national market and are subjected to the varying\nrequirements of the law in every state. For years there has been talk in and out of Congress of enacting a\nfederal products-liability law that would include reforms adopted in many states, as discussed earlier. So\nfar, these efforts have been without much success.\nCongressional tort legislation is not the only possible federal action to cope with products-related injuries.\nIn 1972, Congress created the Consumer Product Safety Commission (CPSC) and gave the commission\nbroad power to act to prevent unsafe consumer products. The CPSC can issue mandatory safety standards\ngoverning design, construction, contents, performance, packaging, and labeling of more than 10,000\nconsumer products. It can recall unsafe products, recover costs on behalf of injured consumers, prosecute\nthose who violate standards, and require manufacturers to issue warnings on hazardous products. It also\nregulates four federal laws previously administered by other departments: the Flammable Fabrics Act, the\nHazardous Substances Act, the Poison Prevention Packaging Act, and the Refrigerator Safety Act. In its\nearly years, the CPSC issued standards for bicycles, power mowers, television sets, architectural glass,\nextension cords, book matches, pool slides, and space heaters. But the list of products is long, and the\nCPSC\xe2\x80\x99s record is mixed: it has come under fire for being short on regulation and for taking too long to\npromulgate the relatively few safety standards it has issued in a decade.\n\nKEY TAKEAWAY\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n601\n\n\x0cBusiness advocates claim the American tort system\xe2\x80\x94products-liability law included\xe2\x80\x94is broken and\ncorrupted by grasping plaintiffs\xe2\x80\x99 lawyers; plaintiffs\xe2\x80\x99 lawyers say businesses are greedy and careless and\nneed to be smacked into recognition of its responsibilities to be more careful. The debate rages on, decade\nafter decade. But there have been some reforms at the state level, and at the federal level the Consumer\nProduct Safety Act sets out standards for safe products and requires recalls for defective ones. It is\nregularly castigated for (1) being officious and meddling or (2) being too timid.\n\nEXERCISES\n\n1.\n\nWhy is it so difficult to determine if there really is a \xe2\x80\x9ctort crisis\xe2\x80\x9d in the United States?\n\n2.\n\nWhat reforms have been made to state tort law?\n\n3.\n\nWhat federal legislation affects consumer safety?\n4.\n\n[1] American Tort Reform Association website, accessed March 1, 2011,http://www.atra.org.\n\n5.\n\n[2] http://www.shragerlaw.com/html/legal_rights.html.\n\n17.6 Cases\nImplied Warranty of Merchantability and the Requirement of a \xe2\x80\x9cSale\xe2\x80\x9d\nSheeskin v. Giant Food, Inc.\n318 A.2d 874 (Md. App. 1974)\nDavidson, J.\nEvery Friday for over two years Nathan Seigel, age 73, shopped with his wife at a Giant Food Store. This\ncomplex products liability case is before us because on one of these Fridays, 23 October 1970, Mr. Seigel\nwas carrying a six-pack carton of Coca-Cola from a display bin at the Giant to a shopping cart when one or\nmore of the bottles exploded. Mr. Seigel lost his footing, fell to the floor and was injured.\nIn the Circuit Court for Montgomery County, Mr. Seigel sued both the Giant Food, Inc., and the\nWashington Coca-Cola Bottling Company, Inc., for damages resulting from their alleged negligence and\nbreach of an implied warranty. At the conclusion of the trial Judge Walter H. Moorman directed a verdict\nin favor of each defendant.\xe2\x80\xa6\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n602\n\n\x0cIn an action based on breach of warranty it is necessary for the plaintiff to show the existence of the\nwarranty, the fact that the warranty was broken and that the breach of warranty was the proximate cause\nof the loss sustained. [UCC] 2-314.\xe2\x80\xa6The retailer, Giant Food, Inc., contends that appellant failed to prove\nthat an implied warranty existed between himself and the retailer because he failed to prove that there\nwas a sale by the retailer to him or a contract of sale between the two. The retailer maintains that there\nwas no sale or contract of sale because at the time the bottles exploded Mr. Seigel had not yet paid for\nthem. We do not agree.\n[UCC] 2-314(1) states in pertinent part:\nUnless excluded or modified, a warranty that the goods shall be merchantable is implied in a\ncontract for their sale if the seller is a merchant with respect to goods of that\nkind.\n\n[1]\n\n(emphasis added)\n\nThus, in order for the implied warranties of 2-314 to be applicable there must be a \xe2\x80\x9ccontract for sale.\xe2\x80\x9d In\nMaryland it has been recognized that neither a completed \xe2\x80\x98sale\xe2\x80\x99 nor a fully executed contract for sale is\nrequired. It is enough that there be in existence an executory contract for sale.\xe2\x80\xa6\nHere, the plaintiff has the burden of showing the existence of the warranty by establishing that at the time\nthe bottles exploded there was a contract for their sale existing between himself and the Giant. [Citation]\nMr. Titus, the manager of the Giant, testified that the retailer is a \xe2\x80\x9cself-service\xe2\x80\x9d store in which \xe2\x80\x9cthe only\nway a customer can buy anything is to select it himself and take it to the checkout counter.\xe2\x80\x9d He stated that\nthere are occasions when a customer may select an item in the store and then change his mind and put the\nitem back. There was no evidence to show that the retailer ever refused to sell an item to a customer once\nit had been selected by him or that the retailer did not consider himself bound to sell an item to the\ncustomer after the item had been selected. Finally, Mr. Titus said that an employee of Giant placed the\nsix-pack of Coca-Cola selected by Mr. Seigel on the shelf with the purchase price already stamped upon it.\nMr. Seigel testified that he picked up the six-pack with the intent to purchase it.\nWe think that there is sufficient evidence to show that the retailer\xe2\x80\x99s act of placing the bottles upon the\nshelf with the price stamped upon the six-pack in which they were contained manifested an intent to offer\nthem for sale, the terms of the offer being that it would pass title to the goods when Mr. Seigel presented\nthem at the check-out counter and paid the stated price in cash. We also think that the evidence is\nsufficient to show that Mr. Seigel\xe2\x80\x99s act of taking physical possession of the goods with the intent to\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n603\n\n\x0cpurchase them manifested an intent to accept the offer and a promise to take them to the checkout\ncounter and pay for them there.\n[UCC] 2-206 provides in pertinent part:\n(1) Unless otherwise unambiguously indicated by the language or circumstances\n(a) An offer to make a contract shall be construed as inviting acceptance in any manner and by\nany medium reasonable in the circumstances.\xe2\x80\xa6\nThe Official Comment 1 to this section states:\nAny reasonable manner of acceptance is intended to be regarded as available unless the offeror\nhas made quite clear that it will not be acceptable.\nIn our view the manner by which acceptance was to be accomplished in the transaction herein involved\nwas not indicated by either language or circumstances. The seller did not make it clear that acceptance\ncould not be accomplished by a promise rather than an act. Thus it is equally reasonable under the terms\nof this specific offer that acceptance could be accomplished in any of three ways: 1) by the act of delivering\nthe goods to the check-out counter and paying for them; 2) by the promise to pay for the goods as\nevidenced by their physical delivery to the check-out counter; and 3) by the promise to deliver the goods\nto the check-out counter and to pay for them there as evidenced by taking physical possession of the goods\nby their removal from the shelf.\nThe fact that customers, having once selected goods with the intent to purchase them, are permitted by\nthe seller to return them to the shelves does not preclude the possibility that a selection of the goods, as\nevidenced by taking physical possession of them, could constitute a reasonable mode of acceptance.\nSection 2-106(3) provides:\n\xe2\x80\x9cTermination\xe2\x80\x9d occurs when either party pursuant to a power created by agreement or law puts\nan end to the contract otherwise then for its breach. On \xe2\x80\x9ctermination\xe2\x80\x9d all obligations which are\nstill executory on both sides are discharged but any right based on prior breach or performance\nsurvives.\nHere the evidence that the retailer permits the customer to \xe2\x80\x9cchange his mind\xe2\x80\x9d indicates only an\nagreement between the parties to permit the consumer to end his contract with the retailer irrespective of\na breach of the agreement by the retailer. It does not indicate that an agreement does not exist prior to the\nexercise of this option by the consumer.\xe2\x80\xa6\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n604\n\n\x0cHere Mr. Seigel testified that all of the circumstances surrounding his selection of the bottles were\nnormal; that the carton in which the bottles came was not defective; that in lifting the carton from the\nshelf and moving it toward his basket the bottles neither touched nor were touched by anything other than\nhis hand; that they exploded almost instantaneously after he removed them from the shelf; and that as a\nresult of the explosion he fell injuring himself. It is obvious that Coca-Cola bottles which would break\nunder normal handling are not fit for the ordinary use for which they were intended and that the\nrelinquishment of physical control of such a defective bottle to a consumer constitutes a breach of\nwarranty. Thus the evidence was sufficient to show that when the bottles left the retailer\xe2\x80\x99s control they did\nnot conform to the representations of the warranty of merchantability, and that this breach of the\nwarranty was the cause of the loss sustained.\xe2\x80\xa6\n[Judgment in favor of Giant Foods is reversed and the case remanded for a new trial. Judgment in favor of\nthe bottler is affirmed because the plaintiff failed to prove that the bottles were defective when they were\ndelivered to the retailer.]\n\nCASE QUESTIONS\n\n1.\n\nWhat warranty did the plaintiff complain was breached here?\n\n2.\n\nBy displaying the soda pop, the store made an offer to its customers. How did the court say such offers\nmight be accepted?\n\n3.\n\nWhy did the court get into the discussion about \xe2\x80\x9ctermination\xe2\x80\x9d of the contract?\n\n4.\n\nWhat is the controlling rule of law applied in this case?\n\nStrict Liability and Bystanders\nEmbs v. Pepsi-Cola Bottling Co. of Lexington, Kentucky, Inc.\n528 S.W.2d 703 (Ky. 1975)\nJukowsky, J.\nOn the afternoon of July 25, 1970 plaintiff-appellant entered the self-service retail store operated by the\ndefendant-appellee, Stamper\xe2\x80\x99s Cash Market, Inc., for the purpose of \xe2\x80\x9cbuying soft drinks for the kids.\xe2\x80\x9d She\nwent to an upright soft drink cooler, removed five bottles and placed them in a carton. Unnoticed by her, a\ncarton of Seven-Up was sitting on the floor at the edge of the produce counter about one foot from where\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n605\n\n\x0cshe was standing. As she turned away from the cooler she heard an explosion that sounded \xe2\x80\x9clike a\nshotgun.\xe2\x80\x9d When she looked down she saw a gash in her leg, pop on her leg, green pieces of a bottle on the\nfloor and the Seven-Up carton in the midst of the debris. She did not kick or otherwise come into contact\nwith the carton of Seven-Up prior to the explosion. Her son, who was with her, recognized the green\npieces of glass as part of a Seven-Up bottle.\nShe was immediately taken to the hospital by Mrs. Stamper, a managing agent of the store. Mrs. Stamper\ntold her that a Seven-Up bottle had exploded and that several bottles had exploded that week. Before\nleaving the store Mrs. Stamper instructed one of her children to clean up the mess. Apparently, all of the\nphysical evidence went out with the trash. The location of the Seven-Up carton immediately before the\nexplosion was not a place where such items were ordinarily kept.\xe2\x80\xa6\nWhen she rested her case, the defendants-appellees moved for a directed verdict in their favor. The trial\ncourt granted the motion on the grounds that the doctrine of strict product liability in tort does not extend\nbeyond users and consumers and that the evidence was insufficient to permit an inference by a reasonably\nprudent man that the bottle was defective or if it was, when it became so.\nIn [Citation] we adopted the view of strict product liability in tort expressed in Section 402 A of the\nAmerican Law Institute\xe2\x80\x99s Restatement of Torts 2d.\n\n402 A. Special Liability of Seller of Product for Physical Harm to User\nor Consumer\n(1) One who sells any product in a defective condition unreasonably dangerous to the user or to\nhis property is subject to liability for physical harm thereby caused to the ultimate user or\nconsumer, or to his property, if\n(a) the seller is engaged in the business of selling such a product, and\n(b) it is expected to and does reach the user or consumer without substantial change in the\ncondition in which it was sold.\n(2) The rule stated in Subsection (1) applies although\n(a) the seller has exercised all possible care in the preparation and sale of his product, and\n(b) the user or consumer has not bought the product from or entered into any contractual\nrelation with the seller.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n606\n\n\x0cComment f on that section makes it abundantly clear that this rule applies to any person engaged in the\nbusiness of supplying products for use or consumption, including any manufacturer of such a product and\nany wholesale or retail dealer or distributor.\nComment c points out that on whatever theory, the justification for the rule has been said to be that the\nseller, by marketing his product for use and consumption, has undertaken and assumed a special\nresponsibility toward any member of the consuming public who may be injured by it; that the public has\nthe right to and does expect that reputable sellers will stand behind their goods; that public policy\ndemands that the burden of accidental injuries caused by products intended for consumption be placed\nupon those who market them, and be treated as a cost of production against which liability insurance can\nbe obtained; and that the consumer of such products is entitled to the maximum of protection at the\nhands of someone, and the proper persons to afford it are those who market the products.\nThe caveat to the section provides that the Institute expresses no opinion as to whether the rule may not\napply to harm to persons other than users or consumers. Comment on caveat o states the Institute\nexpresses neither approval nor disapproval of expansion of the rule to permit recovery by casual\nbystanders and others who may come in contact with the product, and admits there may be no essential\nreason why such plaintiffs should not be brought within the scope of protection afforded, other than they\ndo not have the same reasons for expecting such protection as the consumer who buys a marketed\nproduct, and that the social pressure which has been largely responsible for the development of the rule\nhas been a consumer\xe2\x80\x99s pressure, and there is not the same demand for the protection of casual\nstrangers.\xe2\x80\xa6\nThe caveat articulates the essential point: Once strict liability is accepted, bystander recovery is fait\naccompli.\nOur expressed public policy will be furthered if we minimize the risk of personal injury and property\ndamage by charging the costs of injuries against the manufacturer who can procure liability insurance and\ndistribute its expense among the public as a cost of doing business; and since the risk of harm from\ndefective products exists for mere bystanders and passersby as well as for the purchaser or user, there is\nno substantial reason for protecting one class of persons and not the other. The same policy requires us to\nmaximize protection for the injured third party and promote the public interest in discouraging the\nmarketing of products having defects that are a menace to the public by imposing strict liability upon\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n607\n\n\x0cretailers and wholesalers in the distributive chain responsible for marketing the defective product which\ninjures the bystander. The imposition of strict liability places no unreasonable burden upon sellers\nbecause they can adjust the cost of insurance protection among themselves in the course of their\ncontinuing business relationship.\nWe must not shirk from extending the rule to the manufacturer for fear that the retailer or middleman\nwill be impaled on the sword of liability without regard to fault. Their liability was already established\nunder Section 402 A of the Restatement of Torts 2d. As a matter of public policy the retailer or\nmiddleman as well as the manufacturer should be liable since the loss for injuries resulting from defective\nproducts should be placed on those members of the marketing chain best able to pay the loss, who can\nthen distribute such risk among themselves by means of insurance and indemnity agreements.\n[Citation]\xe2\x80\xa6\nThe result which we reach does not give the bystander a \xe2\x80\x9cfree ride.\xe2\x80\x9d When products and consumers are\nconsidered in the aggregate, bystanders, as a class, purchase most of the same products to which they are\nexposed as bystanders. Thus, as a class, they indirectly subsidize the liability of the manufacturer,\nmiddleman and retailer and in this sense do pay for the insurance policy tied to the product.\xe2\x80\xa6\nFor the sake of clarity we restate the extension of the rule. The protections of Section 402 A of the\nRestatement of Torts 2d extend to bystanders whose injury from the defective product is reasonably\nforeseeable.\xe2\x80\xa6\nThe judgment is reversed and the cause is remanded to the Clark Circuit Court for further proceedings\nconsistent herewith.\nStephenson, J. (dissenting):\nI respectfully dissent from the majority opinion to the extent that it subjects the seller to liability. Every\nrule of law in my mind should have a rational basis. I see none here.\nLiability of the seller to the user, or consumer, is based upon warranty. Restatement, Second, Torts s\n403A. To extend this liability to injuries suffered by a bystander is to depart from any reasonable basis\nand impose liability by judicial fiat upon an otherwise innocent defendant. I do not believe that the\nexpression in the majority opinion which justifies this rule for the reason that the seller may procure\nliability insurance protection is a valid legal basis for imposing liability without fault. I respectfully\ndissent.\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n608\n\n\x0cCASE QUESTIONS\n1.\n\nWhy didn\xe2\x80\x99t the plaintiff here use warranty as a theory of recovery, as Mr. Seigel did in the previous case?\n\n2.\n\nThe court offers a rationale for the doctrine of strict products liability. What is it?\n\n3.\n\nRestatement, Section 402A, by its terms extends protection \xe2\x80\x9cto the ultimate user or consumer,\xe2\x80\x9d but Mrs.\nEmbs [plaintiff-appellant] was not that. What rationale did the court give for expanding the protection\nhere?\n\n4.\n\nAmong the entities in the vertical distribution chain\xe2\x80\x94manufacturer, wholesaler, retailer\xe2\x80\x94who is liable\nunder this doctrine?\n\n5.\n\nWhat argument did Judge Stephenson have in dissent? Is it a good one?\n\n6.\n\nWhat is the controlling rule of law developed in this case?\n\nFailure to Warn\nLaaperi v. Sears, Roebuck & Co., Inc.\n787 F.2d 726 C.A.1 (Mass. 1986)\nCampbell, J.\nIn March 1976, plaintiff Albin Laaperi purchased a smoke detector from Sears. The detector,\nmanufactured by the Pittway Corporation, was designed to be powered by AC (electrical) current. Laaperi\ninstalled the detector himself in one of the two upstairs bedrooms in his home.\nEarly in the morning of December 27, 1976, a fire broke out in the Laaperi home. The three boys in one of\nthe upstairs bedrooms were killed in the blaze. Laaperi\xe2\x80\x99s 13-year-old daughter Janet, who was sleeping in\nthe other upstairs bedroom, received burns over 12 percent of her body and was hospitalized for three\nweeks.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n609\n\n\x0cThe uncontroverted testimony at trial was that the smoke detector did not sound an alarm on the night of\nthe fire. The cause of the fire was later found to be a short circuit in an electrical cord that was located in a\ncedar closet in the boys\xe2\x80\x99 bedroom. The Laaperi home had two separate electrical circuits in the upstairs\nbedrooms: one which provided electricity to the outlets and one which powered the lighting fixtures. The\nsmoke detector had been connected to the outlet circuit, which was the circuit that shorted and cut off.\nBecause the circuit was shorted, the AC-operated smoke detector received no power on the night of the\nfire. Therefore, although the detector itself was in no sense defective (indeed, after the fire the charred\ndetector was tested and found to be operable), no alarm sounded.\nLaaperi brought this diversity action against defendants Sears and Pittway, asserting negligent design,\nnegligent manufacture, breach of warranty, and negligent failure to warn of inherent dangers. The parties\nagreed that the applicable law is that of Massachusetts. Before the claims went to the jury, verdicts were\ndirected in favor of defendants on all theories of liability other than failure to warn.\xe2\x80\xa6\nLaaperi\xe2\x80\x99s claim under the failure to warn theory was that he was unaware of the danger that the very short\ncircuit which might ignite a fire in his home could, at the same time, incapacitate the smoke detector. He\ncontended that had he been warned of this danger, he would have purchased a battery-powered smoke\ndetector as a back-up or taken some other precaution, such as wiring the detector to a circuit of its own, in\norder better to protect his family in the event of an electrical fire.\nThe jury returned verdicts in favor of Laaperi in all four actions on the failure to warn claim. The jury\nassessed damages in the amount of $350,000 [$1,050,000, or about $3,400,000 in 2010 dollars] each of\nthe three actions brought on behalf of the deceased sons, and $750,000 [about $2,500,000 in 2010\ndollars] in the action brought on behalf of Janet Laaperi. The defendants\xe2\x80\x99 motions for directed verdict and\njudgment notwithstanding the verdict were denied, and defendants appealed.\nDefendants ask us to declare that the risk that an electrical fire could incapacitate an AC-powered smoke\ndetector is so obvious that the average consumer would not benefit from a warning. This is not a trivial\nargument; in earlier\xe2\x80\x94some might say sounder\xe2\x80\x94days, we might have accepted it.\xe2\x80\xa6 Our sense of the\ncurrent state of the tort law in Massachusetts and most other jurisdictions, however, leads us to conclude\nthat, today, the matter before us poses a jury question; that \xe2\x80\x9cobviousness\xe2\x80\x9d in a situation such as this would\nbe treated by the Massachusetts courts as presenting a question of fact, not of law. To be sure, it would be\nobvious to anyone that an electrical outage would cause this smoke detector to fail. But the average\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n610\n\n\x0cpurchaser might not comprehend the specific danger that a fire-causing electrical problem can\nsimultaneously knock out the circuit into which a smoke detector is wired, causing the detector to fail at\nthe very moment it is needed. Thus, while the failure of a detector to function as the result of an electrical\nmalfunction due, say, to a broken power line or a neighborhood power outage would, we think, be obvious\nas a matter of law, the failure that occurred here, being associated with the very risk\xe2\x80\x94fire\xe2\x80\x94for which the\ndevice was purchased, was not, or so a jury could find.\xe2\x80\xa6\nFinally, defendants contend that the award of $750,000 [$2.5 million in 2010 dollars] in damages to\nJanet Laaperi was excessive, and should have been overturned by the district court.\xe2\x80\xa6\nJanet Laaperi testified that on the night of the fire, she woke up and smelled smoke. She woke her friend\nwho was sleeping in her room, and they climbed out to the icy roof of the house. Her father grabbed her\nfrom the roof and took her down a ladder. She was taken to the hospital. Although she was in \xe2\x80\x9cmild\ndistress,\xe2\x80\x9d she was found to be \xe2\x80\x9calert, awake, [and] cooperative.\xe2\x80\x9d Her chest was clear. She was diagnosed as\nhaving first and second degree burns of her right calf, both buttocks and heels, and her left lower back, or\napproximately 12 percent of her total body area. She also suffered from a burn of her tracheobronchial\nmucosa (i.e., the lining of her airway) due to smoke inhalation, and multiple superficial lacerations on her\nright hand.\nThe jury undoubtedly, and understandably, felt a great deal of sympathy for a young girl who, at the age of\n13, lost three brothers in a tragic fire. But by law the jury was only permitted to compensate her for those\ndamages associated with her own injuries. Her injuries included fright and pain at the time of and after\nthe fire, a three-week hospital stay, some minor discomfort for several weeks after discharge, and a\npermanent scar on her lower back. Plaintiff has pointed to no cases, and we have discovered none, in\nwhich such a large verdict was sustained for such relatively minor injuries, involving no continuing\ndisability.\nThe judgments in favor of Albin Laaperi in his capacity as administrator of the estates of his three sons are\naffirmed. In the action on behalf of Janet Laaperi, the verdict of the jury is set aside, the judgment of the\ndistrict court vacated, and the cause remanded to that court for a new trial limited to the issue of\ndamages.\n\nSaylor URL: http://www.saylor.org/books\n\nCASE QUESTIONS\n\nSaylor.org\n611\n\n\x0c1.\n\nThe \xe2\x80\x9cC.A. 1\xe2\x80\x9d under the title of the case means it is a US Court of Appeals case from the First Circuit in\nMassachusetts. Why is this case in federal court?\n\n2.\n\nWhy does the court talk about its \xe2\x80\x9csense of the current state of tort law in Massachusetts\xe2\x80\x9d and how this\ncase \xe2\x80\x9cwould be treated by the Massachusetts courts,\xe2\x80\x9d as if it were not in the state at all but somehow\noutside?\n\n3.\n\nWhat rule of law is in play here as to the defendants\xe2\x80\x99 liability?\n\n4.\n\nThis is a tragic case\xe2\x80\x94three boys died in a house fire. Speaking dispassionately\xe2\x80\x94if not heartlessly\xe2\x80\x94\nthough, did the fire actually cost Mr. Laaperi, or did he lose $3.4 million (in 2010 dollars) as the result of\nhis sons\xe2\x80\x99 deaths? Does it make sense that he should become a millionaire as a result? Who ends up paying\nthis amount? (The lawyers\xe2\x80\x99 fees probably took about half.)\n\n5.\n\nIs it likely that smoke-alarm manufactures and sellers changed the instructions as a result of this case?\n\n[1] Uniform Commercial Code, Section 2-316.\n\n17.7 Summary and Exercises\nSummary\n\nProducts liability describes a type of claim\xe2\x80\x94for injury caused by a defective product\xe2\x80\x94and not a separate\ntheory of liability. In the typical case, three legal doctrines may be asserted: (1) warranty, (2) negligence,\nand (3) strict liability.\nIf a seller asserts that a product will perform in a certain manner or has certain characteristics, he has\ngiven an express warranty, and he will be held liable for damages if the warranty is breached\xe2\x80\x94that is, if\nthe goods do not live up to the warranty. Not every conceivable claim is an express warranty; the courts\npermit a certain degree of \xe2\x80\x9cpuffing.\xe2\x80\x9d\nAn implied warranty is one created by law. Goods sold by a merchant-seller carry an implied warranty of\nmerchantability, meaning that they must possess certain characteristics, such as being of average quality\nfor the type described and being fit for the ordinary purposes for which they are intended.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n612\n\n\x0cAn implied warranty of fitness for a particular purpose is created whenever a seller knows or has reason to\nknow that the buyer is relying on the seller\xe2\x80\x99s knowledge and skill to select a product for the buyer\xe2\x80\x99s\nparticular purposes.\nUnder UCC Article 2, the seller also warrants that he is conveying good title and that the goods are free of\nany rightful claim by a third person.\nUCC Article 2 permits sellers to exclude or disclaim warranties in whole or in part. Thus a seller may\nexclude express warranties. He may also disclaim many implied warranties\xe2\x80\x94for example, by noting that\nthe sale is \xe2\x80\x9cas is.\xe2\x80\x9d The Magnuson-Moss Act sets out certain types of information that must be included in\nany written warranty. The act requires the manufacturer or seller to label the warranty as either \xe2\x80\x9cfull\xe2\x80\x9d or\n\xe2\x80\x9climited\xe2\x80\x9d depending on what types of defects are covered and what the customer must do to obtain repair\nor replacement. The act also abolishes \xe2\x80\x9cphantom warranties.\xe2\x80\x9d\nPrivity once stood as a bar to recovery in suits brought by those one or more steps removed in the\ndistribution chain from the party who breached a warranty. But the nearly universal trend in the state\ncourts has been to abolish privity as a defense.\nBecause various impediments stand in the way of warranty suits, courts have adopted a tort theory of\nstrict liability, under which a seller is liable for injuries resulting from the sale of any product in a\ndefective condition if it is unreasonably dangerous to the user or consumer. Typical issues in strict liability\ncases are these: Is the defendant a seller engaged in the business of selling? Was the product sold in a\ndefective condition? Was it unreasonably dangerous, either on its face or because of a failure to warn? Did\nthe product reach the consumer in an unchanged condition? Strict liability applies regardless of how\ncareful the seller was and regardless of his lack of contractual relation with the consumer or user.\nManufacturers can also be held liable for negligence\xe2\x80\x94most often for faulty design of products and\ninadequate warnings about the hazards of using the product.\nThe products-liability revolution prompted many state legislatures to enact certain laws limiting to some\ndegree the manufacturer\xe2\x80\x99s responsibility for defective products. These laws include statutes of repose and\nprovide a number of other defenses.\n\n1.\n\nEXERCISES\n\nRalph\xe2\x80\x99s Hardware updated its accounting system and agreed to purchase a computer system from a\nmanufacturer, Bits and Bytes (BB). During contract negotiations, BB\xe2\x80\x99s sales representative promised that\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n613\n\n\x0cthe system was \xe2\x80\x9cA-1\xe2\x80\x9d and \xe2\x80\x9cperfect.\xe2\x80\x9d However, the written contract, which the parties later signed,\ndisclaimed all warranties, express and implied. After installation the computer produced only random\nnumbers and letters, rather than the desired accounting information. Is BB liable for breaching an express\nwarranty? Why?\n2.\n\nKate owned a small grocery store. One day John went to the store and purchased a can of chip dip that\nwas, unknown to Kate or John, adulterated. John became seriously ill after eating the dip and sued Kate\nfor damages on the grounds that she breached an implied warranty of merchantability. Is Kate liable?\nWhy?\n\n3.\n\nCarrie visited a neighborhood store to purchase some ham, which a salesperson cut by machine in the\nstore. The next day she made a ham sandwich. In eating the sandwich, Carrie bit into a piece of cartilage\nin the ham. As a result, Carrie lost a tooth, had to undergo root canal treatments, and must now wear a\nfull-coverage crown to replace the tooth. Is the store liable for the damage? Why?\n\n4.\n\nClarence, a business executive, decided to hold a garage sale. At the sale, his neighbor Betty mentioned to\nClarence that she was the catcher on her city-league baseball team and was having trouble catching\nknuckleball pitches, which required a special catcher\xe2\x80\x99s mitt. Clarence pulled an old mitt from a pile of\nitems that were on sale and said, \xe2\x80\x9cHere, try this.\xe2\x80\x9d Betty purchased the mitt but discovered during her next\ngame that it didn\xe2\x80\x99t work. Has Clarence breached an express or implied warranty? Why?\n\n5.\n\nSarah purchased several elegant picture frames to hang in her dorm room. She also purchased a package\nof self-sticking hangers. Late one evening, while Sarah was studying business law in the library, the\nhangers came loose and her frames came crashing to the floor. After Sarah returned to her room and\ndiscovered the rubble, she examined the box in which the hangers were packaged and found the\nfollowing language: \xe2\x80\x9cThere are no warranties except for the description on this package and specifically\nthere is NO IMPLIED WARRANTY OF MERCHANTABILITY.\xe2\x80\x9d Assuming the hangers are not of fair, average,\nordinary quality, would the hanger company be liable for breaching an implied warranty of\nmerchantability? Why?\n\n6.\n\nA thirteen-year-old boy received a Golfing Gizmo\xe2\x80\x94a device for training novice golfers\xe2\x80\x94as a gift from his\nmother. The label on the shipping carton and the cover of the instruction booklet urged players to \xe2\x80\x9cdrive\nthe ball with full power\xe2\x80\x9d and further stated: \xe2\x80\x9cCOMPLETELY SAFE BALL WILL NOT HIT PLAYER.\xe2\x80\x9d But while\nusing the device, the boy was hit in the eye by the ball. Should lack of privity be a defense to the\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n614\n\n\x0cmanufacturer? The manufacturer argued that the Gizmo was a \xe2\x80\x9ccompletely safe\xe2\x80\x9d training device only\nwhen the ball is hit squarely, and\xe2\x80\x94the defendant argued\xe2\x80\x94plaintiffs could not reasonably expect the\nGizmo to be \xe2\x80\x9ccompletely safe\xe2\x80\x9d under all circumstances, particularly those in which the player hits beneath\nthe ball. What legal argument is this, and is it valid?\n7.\n\nA bank repossessed a boat and sold it to Donald. During the negotiations with Donald, Donald stated that\nhe wanted to use the boat for charter service in Florida. The bank officers handling the sale made no\nrepresentations concerning the boat during negotiations. Donald later discovered that the boat was\ndefective and sued the bank for breach of warranty. Is the bank liable? Why?\n\n8.\n\nTom Anderson, the produce manager at the Thriftway Market in Pasco, Washington, removed a box of\nbananas from the top of a stack of produce. When he reached for a lug of radishes that had been under\nthe bananas, a six-inch spider\xe2\x80\x94Heteropoda venatoria, commonly called a banana spider\xe2\x80\x94leaped from\nsome wet burlap onto his left hand and bit him. Nine months later he died of heart failure. His wife\nbrought an action against Associated Grocers, parent company of Thriftway Market, on theories of (1)\nstrict products liability under Restatement, Section 402(a); (2) breach of the implied warranty of\nmerchantability; and (3) negligence. The trial court ruled against the plaintiff on all three theories. Was\nthat a correct ruling? Explain.\n\n9.\n\nA broken water pipe flooded a switchboard at RCA\xe2\x80\x99s office. The flood tripped the switchboard circuit\nbreakers and deactivated the air-conditioning system. Three employees were assigned to fix it: an\nelectrical technician with twelve years on-the-job training, a licensed electrician, and an electrical\nengineer with twenty years of experience who had studied power engineering in college. They switched\non one of the circuit breakers, although the engineer said he knew that one was supposed to test the\noperation of a wet switchboard before putting it back into use. There was a \xe2\x80\x9csnap\xe2\x80\x9d and everyone ran\nfrom the room up the stairs and a \xe2\x80\x9cbig ball of fire\xe2\x80\x9d came after them up the stairs. The plaintiffs argued\nthat the manufacturer of the circuit breaker had been negligent in failing to give RCA adequate warnings\nabout the circuit breakers. How should the court rule, and on what theory should it rule?\n\n10. Plaintiff\xe2\x80\x99s business was to convert vans to RVs, and for this purpose it had used a 3M adhesive to laminate\ncarpeting to the van walls. This adhesive, however, failed to hold the fabric in place in hot weather, so\nPlaintiff approached Northern Adhesive Co., a manufacturer of adhesives, to find a better one. Plaintiff\ntold Northern why it wanted the adhesive, and Northern\xe2\x80\x94Defendant\xe2\x80\x94sent several samples to Plaintiff to\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n615\n\n\x0cexperiment with. Northern told Plaintiff that one of the adhesives, Adhesive 7448, was \xe2\x80\x9ca match\xe2\x80\x9d for the\n3M product that previously failed. Plaintiff tested the samples in a cool plant and determined that\nAdhesive 7448 was better than the 3M product. Defendant had said nothing except that \xe2\x80\x9cwhat they\nwould ship would be like the sample. It would be the same chemistry.\xe2\x80\x9d Plaintiff used the adhesive during\nthe fall and winter; by spring complaints of delamination came in: Adhesive 7448 failed just as the 3M\nproduct had. Over 500 vans had to be repaired. How should the court rule on Plaintiff\xe2\x80\x99s claims of breach\nof (1) express warranty, (2) implied warranty of merchantability, and (3) implied warranty of fitness for a\nparticular purpose?\n\n1.\na.\n\nSELF-TEST QUESTIONS\n\nIn a products-liability case\nonly tort theories are typically asserted\nb.\n\nboth tort and contract theories are typically asserted\n\nc.\n\nstrict liability is asserted only when negligence is not asserted\n\nd.\n\nbreach of warranty is not asserted along with strict liability\n\nAn implied warranty of merchantability\na.\n\nis created by an express warranty\nb.\n\nis created by law\n\nc.\n\nis impossible for a seller to disclaim\n\nd.\n\ncan be disclaimed by a seller only if the disclaimer is in writing\n\nA possible defense to breach of warranty is\na.\n\nlack of privity\nb.\n\nabsence of an express warranty\n\nc.\n\ndisclaimer of implied warranties\n\nd.\n\nall of the above\nUnder the strict liability rule in Restatement, Section 402A, the seller is liable for all injuries\nresulting from a product\n\na.\n\neven though all possible care has been exercised\nb.\n\nregardless of the lack of a contract with the user\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n616\n\n\x0cc.\n\nin both of the above situations\n\nd.\n\nin none of the above situations\nAn individual selling her car could be liable\n\na.\n\nfor breaching the implied warranty of merchantability\nb.\n\nunder the strict liability theory\n\nc.\n\nfor breaching the implied warranty of fitness\n\nd.\n\nunder two of the above\n\n1.\n\nb\n\n2.\n\nb\n\n3.\n\nd\n\n4.\n\nc\n\n5.\n\nd\n\nSELF-TEST ANSWERS\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n617\n\n\x0cChapter 18\n\nRelationships between Principal and Agent\nLEARNING OBJECTIVES\nAfter reading this chapter, you should understand the following:\n1.\n\nWhy agency is important, what an agent is, and the types of agents\n\n2.\n\nWhat an independent contractor is\n\n3.\n\nThe duties owed by the agent to the principal\n\n4.\n\nThe duties owed by the principal to the agent\n\n18.1 Introduction to Agency and the Types of Agents\nLEARNING OBJECTIVES\n\n1.\n\nUnderstand why agency law is important.\n\n2.\n\nRecognize the recurring legal issues in agency law.\n\n3.\n\nKnow the types of agents.\n\n4.\n\nUnderstand how the agency relationship is created.\n\nIntroduction to Agency Law\nWhy Is Agency Law Important, and What Is an Agent?\nAn agent is a person who acts in the name of and on behalf of another, having been given and assumed\nsome degree of authority to do so. Most organized human activity\xe2\x80\x94and virtually all commercial activity\xe2\x80\x94\nis carried on through agency. No corporation would be possible, even in theory, without such a concept.\nWe might say \xe2\x80\x9cGeneral Motors is building cars in China,\xe2\x80\x9d for example, but we can\xe2\x80\x99t shake hands with\nGeneral Motors. \xe2\x80\x9cThe General,\xe2\x80\x9d as people say, exists and works through agents. Likewise, partnerships\nand other business organizations rely extensively on agents to conduct their business. Indeed, it is not an\nexaggeration to say that agency is the cornerstone of enterprise organization. In a partnership each\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n618\n\n\x0cpartner is a general agent, while under corporation law the officers and all employees are agents of the\ncorporation.\nThe existence of agents does not, however, require a whole new law of torts or contracts. A tort is no less\nharmful when committed by an agent; a contract is no less binding when negotiated by an agent. What\ndoes need to be taken into account, though, is the manner in which an agent acts on behalf of his principal\nand toward a third party.\n\nRecurring Issues in Agency Law\nSeveral problematic fact scenarios recur in agency, and law has developed in response.\n\nJohn Alden\nConsider John Alden (1599\xe2\x80\x931687), one of the most famous agents in American literature. He is said to\nhave been the first person from the Mayflower to set foot on Plymouth Rock in 1620; he was a carpenter,\na cooper (barrel maker), and a diplomat. His agency task\xe2\x80\x94of interest here\xe2\x80\x94was celebrated in Henry\nWadsworth Longfellow\xe2\x80\x99s \xe2\x80\x9cThe Courtship of Miles Standish.\xe2\x80\x9d He was to woo Priscilla Mullins (d. 1680),\n\xe2\x80\x9cthe loveliest maiden of Plymouth,\xe2\x80\x9d on behalf of Captain Miles Standish, a valiant soldier who was too shy\nto propose marriage. Standish turned to John Alden, his young and eloquent prot\xc3\xa9g\xc3\xa9, and beseeched\nAlden to speak on his behalf, unaware that Alden himself was in love with Priscilla. Alden accepted his\ncaptain\xe2\x80\x99s assignment, despite the knowledge that he would thus lose Priscilla for himself, and sought out\nthe lady. But Alden was so tongue-tied that his vaunted eloquence fell short, turned Priscilla cold toward\nthe object of Alden\xe2\x80\x99s mission, and eventually led her to turn the tables in one of the most famous lines in\nAmerican literature and poetry: \xe2\x80\x9cWhy don\xe2\x80\x99t you speak for yourself, John?\xe2\x80\x9d John eventually did: the two\nwere married in 1623 in Plymouth.\n\nRecurring Issues in Agency\nLet\xe2\x80\x99s analyze this sequence of events in legal terms\xe2\x80\x94recognizing, of course, that this example is an\nanalogy and that the law, even today, would not impose consequences on Alden for his failure to carry out\nCaptain Standish\xe2\x80\x99s wishes. Alden was the captain\xe2\x80\x99s agent: he was specifically authorized to speak in his\nname in a manner agreed on, toward a specified end, and he accepted the assignment in consideration of\nthe captain\xe2\x80\x99s friendship. He had, however, a conflict of interest. He attempted to carry out the assignment,\nbut he did not perform according to expectations. Eventually, he wound up with the prize himself. Here\nare some questions to consider, the same questions that will recur throughout the discussion of agency:\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n619\n\n\x0c\xe2\x80\xa2\n\nHow extensive was John\xe2\x80\x99s authority? Could he have made promises to Priscilla on the captain\xe2\x80\x99s\nbehalf\xe2\x80\x94for example, that Standish would have built her a fine house?\n\n\xe2\x80\xa2\n\nCould he, if he committed a tort, have imposed liability on his principal? Suppose, for example, that\nhe had ridden at breakneck speed to reach Priscilla\xe2\x80\x99s side and while en route ran into and injured a\npedestrian on the road. Could the pedestrian have sued Standish?\n\n\xe2\x80\xa2\n\nSuppose Alden had injured himself on the journey. Would Standish be liable to Alden?\n\n\xe2\x80\xa2\n\nIs Alden liable to Standish for stealing the heart of Priscilla\xe2\x80\x94that is, for taking the \xe2\x80\x9cprofits\xe2\x80\x9d of the\nenterprise for himself?\n\nAs these questions suggest, agency law often involves three parties\xe2\x80\x94the principal, the agent, and a third\nparty. It therefore deals with three different relationships: between principal and agent, between principal\nand third party, and between agent and third party. These relationships can be summed up in a simple\ndiagram (see Figure 18.1 "Agency Relationships").\nFigure 18.1 Agency Relationships\n\nIn this chapter, we will consider the principal-agent side of the triangle. In the next chapter we will turn to\nrelationships involving third parties.\n\nTypes of Agents\nThere are five types of agents.\n\nGeneral Agent\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n620\n\n\x0cThe general agent possesses the authority to carry out a broad range of transactions in the name and on\nbehalf of the principal. The general agent may be the manager of a business or may have a more limited\nbut nevertheless ongoing role\xe2\x80\x94for example, as a purchasing agent or as a life insurance agent authorized\nto sign up customers for the home office. In either case, the general agent has authority to alter the\nprincipal\xe2\x80\x99s legal relationships with third parties. One who is designated a general agent has the authority\nto act in any way required by the principal\xe2\x80\x99s business. To restrict the general agent\xe2\x80\x99s authority, the\nprincipal must spell out the limitations explicitly, and even so the principal may be liable for any of the\nagent\xe2\x80\x99s acts in excess of his authority.\nNormally, the general agent is a business agent, but there are circumstances under which an individual\nmay appoint a general agent for personal purposes. One common form of a personal general agent is the\nperson who holds another\xe2\x80\x99s power of attorney. This is a delegation of authority to another to act in his\nstead; it can be accomplished by executing a simple form, such as the one shown in Figure 18.2 "General\nPower of Attorney". Ordinarily, the power of attorney is used for a special purpose\xe2\x80\x94for example, to sell\nreal estate or securities in the absence of the owner. But a person facing a lengthy operation and\nrecuperation in a hospital might give a general power of attorney to a trusted family member or friend.\nFigure 18.2 General Power of Attorney\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n621\n\n\x0cSpecial Agent\nThe special agent is one who has authority to act only in a specifically designated instance or in a\nspecifically designated set of transactions. For example, a real estate broker is usually a special agent hired\nto find a buyer for the principal\xe2\x80\x99s land. Suppose Sam, the seller, appoints an agent Alberta to find a buyer\nfor his property. Alberta\xe2\x80\x99s commission depends on the selling price, which, Sam states in a letter to her,\n\xe2\x80\x9cin any event may be no less than $150,000.\xe2\x80\x9d If Alberta locates a buyer, Bob, who agrees to purchase the\nproperty for $160,000, her signature on the contract of sale will not bind Sam. As a special agent, Alberta\nhad authority only to find a buyer; she had no authority to sign the contract.\n\nAgency Coupled with an Interest\nAn agent whose reimbursement depends on his continuing to have the authority to act as an agent is said\nto have an agency coupled with an interest if he has a property interest in the business. A literary or\nauthor\xe2\x80\x99s agent, for example, customarily agrees to sell a literary work to a publisher in return for a\npercentage of all monies the author earns from the sale of the work. The literary agent also acts as a\ncollection agent to ensure that his commission will be paid. By agreeing with the principal that the agency\nis coupled with an interest, the agent can prevent his own rights in a particular literary work from being\nterminated to his detriment.\n\nSubagent\nTo carry out her duties, an agent will often need to appoint her own agents. These appointments may or\nmay not be authorized by the principal. An insurance company, for example, might name a general agent\nto open offices in cities throughout a certain state. The agent will necessarily conduct her business\nthrough agents of her own choosing. These agents are subagents of the principal if the general agent had\nthe express or implied authority of the principal to hire them. For legal purposes, they are agents of both\nthe principal and the principal\xe2\x80\x99s general agent, and both are liable for the subagent\xe2\x80\x99s conduct although\nnormally the general agent agrees to be primarily liable (see Figure 18.3 "Subagent").\nFigure 18.3 Subagent\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n622\n\n\x0cServant\nThe final category of agent is the servant. Until the early nineteenth century, any employee whose work\nduties were subject to an employer\xe2\x80\x99s control was called a servant; we would not use that term so broadly\nin modern English. The Restatement (Second) of Agency, Section 2, defines a servant as \xe2\x80\x9can agent\nemployed by a master [employer] to perform service in his affairs whose physical conduct in the\nperformance of the service is controlled or is subject to the right to control by the master.\xe2\x80\x9d\n\nIndependent Contractor\nNot every contract for services necessarily creates a master-servant relationship. There is an important\ndistinction made between the status of a servant and that of an independent contractor. According to the\nRestatement (Second) of Agency, Section 2, \xe2\x80\x9can independent contractor is a person who contracts with\nanother to do something for him but who is not controlled by the other nor subject to the other\xe2\x80\x99s right to\ncontrol with respect to his physical conduct in the performance of the undertaking.\xe2\x80\x9d As the name implies,\nthe independent contractor is legally autonomous. A plumber salaried to a building contractor is an\nemployee and agent of the contractor. But a plumber who hires himself out to repair pipes in people\xe2\x80\x99s\nhomes is an independent contractor. If you hire a lawyer to settle a dispute, that person is not your\nemployee or your servant; she is an independent contractor. The terms \xe2\x80\x9cagent\xe2\x80\x9d and \xe2\x80\x9cindependent\ncontractor\xe2\x80\x9d are not necessarily mutually exclusive. In fact, by definition, \xe2\x80\x9c\xe2\x80\xa6 an independent contractor is\nan agent in the broad sense of the term in undertaking, at the request of another, to do something for the\nother. As a general rule the line of demarcation between an independent contractor and a servant is not\nclearly drawn.\xe2\x80\x9d\n\n[1]\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n623\n\n\x0cThis distinction between agent and independent contractor has important legal consequences for\ntaxation, workers\xe2\x80\x99 compensation, and liability insurance. For example, employers are required to withhold\nincome taxes from their employees\xe2\x80\x99 paychecks. But payment to an independent contractor, such as the\nplumber for hire, does not require such withholding. Deciding who is an independent contractor is not\nalways easy; there is no single factor or mechanical answer. In Robinson v. New York Commodities Corp.,\nan injured salesman sought workers\xe2\x80\x99 compensation benefits, claiming to be an employee of the New York\nCommodities Corporation.\n\n[2]\n\nBut the state workmen\xe2\x80\x99s compensation board ruled against him, citing a\n\nvariety of factors. The claimant sold canned meats, making rounds in his car from his home. The company\ndid not establish hours for him, did not control his movements in any way, and did not reimburse him for\nmileage or any other expenses or withhold taxes from its straight commission payments to him. He\nreported his taxes on a form for the self-employed and hired an accountant to prepare it for him. The\ncourt agreed with the compensation board that these facts established the salesman\xe2\x80\x99s status as an\nindependent contractor.\nThe factual situation in each case determines whether a worker is an employee or an independent\ncontractor. Neither the company nor the worker can establish the worker\xe2\x80\x99s status by agreement. As the\nNorth Dakota Workmen\xe2\x80\x99s Compensation Bureau put it in a bulletin to real estate brokers, \xe2\x80\x9cIt has come to\nthe Bureau\xe2\x80\x99s attention that many employers are requiring that those who work for them sign \xe2\x80\x98independent\ncontractor\xe2\x80\x99 forms so that the employer does not have to pay workmen\xe2\x80\x99s compensation premiums for his\nemployees. Such forms are meaningless if the worker is in fact an employee.\xe2\x80\x9d Vizcaino v. Microsoft\nCorporation, discussed in Section 18.3.2 "Employee versus Independent Contractor", examines the\ndistinction.\nIn addition to determining a worker\xe2\x80\x99s status for tax and compensation insurance purposes, it is\nsometimes critical for decisions involving personal liability insurance policies, which usually exclude from\ncoverage accidents involving employees of the insureds. General Accident Fire & Life Assurance Corp v.\nPro Golf Association\n\n[3]\n\ninvolved such a situation. The insurance policy in question covered members of\n\nthe Professional Golfers Association. Gerald Hall, a golf pro employed by the local park department, was\nafforded coverage under the policy, which excluded \xe2\x80\x9cbodily injury to any employee of the insured arising\nout of and in the course of his employment by the insured.\xe2\x80\x9d That is, no employee of Hall\xe2\x80\x99s would be\ncovered (rather, any such person would have coverage under workers\xe2\x80\x99 compensation statutes). Bradley\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n624\n\n\x0cMartin, age thirteen, was at the golf course for junior league play. At Hall\xe2\x80\x99s request, he agreed to retrieve\nor \xe2\x80\x9cshag\xe2\x80\x9d golf balls to be hit during a lesson Hall was giving; he was\xe2\x80\x94as Hall put it\xe2\x80\x94to be compensated\n\xe2\x80\x9ceither through golf instructions or money or hotdogs or whatever.\xe2\x80\x9d During the course of the lesson, a golf\nball hit by Hall hit young Martin in the eye. If Martin was an employee, the insurance company would be\nliable; if he was not an employee, the insurance company would not liable. The trial court determined he\nwas not an employee. The evidence showed: sometimes the boys who \xe2\x80\x9cshagged\xe2\x80\x9d balls got paid, got golfing\ninstructions, or got food, so the question of compensation was ambiguous. Martin was not directed in how\nto perform (the admittedly simple) task of retrieving golf balls, no control was exercised over him, and no\nequipment was required other than a bag to collect the balls: \xe2\x80\x9cWe believe the evidence is susceptible of\ndifferent inferences.\xe2\x80\xa6We cannot say that the decision of the trial court is against the manifest weight of\nthe evidence.\xe2\x80\x9d\n\nCreation of the Agency Relationship\nThe agency relationship can be created in two ways: by agreement (expressly) or by operation of law\n(constructively or impliedly).\n\nAgency Created by Agreement\nMost agencies are created by contract. Thus the general rules of contract law covered in Chapter 8\n"Introduction to Contract Law" through Chapter 16 "Remedies" govern the law of agency. But agencies\ncan also be created without contract, by agreement. Therefore, three contract principles are especially\nimportant: the first is the requirement for consideration, the second for a writing, and the third concerns\ncontractual capacity.\n\nConsideration\nAgencies created by consent\xe2\x80\x94agreement\xe2\x80\x94are not necessarily contractual. It is not uncommon for one\nperson to act as an agent for another without consideration. For example, Abe asks Byron to run some\nerrands for him: to buy some lumber on his account at the local lumberyard. Such a\ngratuitous agency gives rise to no different results than the more common contractual agency.\n\nFormalities\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n625\n\n\x0cMost oral agency contracts are legally binding; the law does not require that they be reduced to writing. In\npractice, many agency contracts are written to avoid problems of proof. And there are situations where an\nagency contract must be in writing: (1) if the agreed-on purpose of the agency cannot be fulfilled within\none year or if the agency relationship is to last more than one year; (2) in many states, an agreement to\npay a commission to a real estate broker; (3) in many states, authority given to an agent to sell real estate;\nand (4) in several states, contracts between companies and sales representatives.\nEven when the agency contract is not required to be in writing, contracts that agents make with third\nparties often must be in writing. Thus Section 2-201 of the Uniform Commercial Code specifically requires\ncontracts for the sale of goods for the price of five hundred dollars or more to be in writing and \xe2\x80\x9csigned by\nthe party against whom enforcement is sought or by his authorized agent.\xe2\x80\x9d\n\nCapacity\nA contract is void or voidable when one of the parties lacks capacity to make one. If both principal and\nagent lack capacity\xe2\x80\x94for example, a minor appoints another minor to negotiate or sign an agreement\xe2\x80\x94\nthere can be no question of the contract\xe2\x80\x99s voidability. But suppose only one or the other lacks capacity.\nGenerally, the law focuses on the principal. If the principal is a minor or otherwise lacks capacity, the\ncontract can be avoided even if the agent is fully competent. There are, however, a few situations in which\nthe capacity of the agent is important. Thus a mentally incompetent agent cannot bind a principal.\n\nAgency Created by Operation of Law\nMost agencies are made by contract, but agency also may arise impliedly or apparently.\n\nImplied Agency\nIn areas of social need, courts have declared an agency to exist in the absence of an agreement. The agency\nrelationship then is said to have been implied \xe2\x80\x9cby operation of law.\xe2\x80\x9d Children in most states may purchase\nnecessary items\xe2\x80\x94food or medical services\xe2\x80\x94on the parent\xe2\x80\x99s account. Long-standing social policy deems it\ndesirable for the head of a family to support his dependents, and the courts will put the expense on the\nfamily head in order to provide for the dependents\xe2\x80\x99 welfare. The courts achieve this result by supposing\nthe dependent to be the family head\xe2\x80\x99s agent, thus allowing creditors to sue the family head for the debt.\nImplied agencies also arise where one person behaves as an agent would and the \xe2\x80\x9cprincipal,\xe2\x80\x9d knowing that\nthe \xe2\x80\x9cagent\xe2\x80\x9d is behaving so, acquiesces, allowing the person to hold himself out as an agent. Such are the\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n626\n\n\x0cbasic facts in Weingart v. Directoire Restaurant, Inc. in Section 18.3.1 "Creation of Agency: Liability of\nParent for Contracts Made by \xe2\x80\x9cAgent\xe2\x80\x9d Child".\n\nApparent Agency\nSuppose Arthur is Paul\xe2\x80\x99s agent, employed through October 31. On November 1, Arthur buys materials at\nLumber Yard\xe2\x80\x94as he has been doing since early spring\xe2\x80\x94and charges them to Paul\xe2\x80\x99s account. Lumber Yard,\nnot knowing that Arthur\xe2\x80\x99s employment terminated the day before, bills Paul. Will Paul have to pay? Yes,\nbecause the termination of the agency was not communicated to Lumber Yard. It appeared that Arthur\nwas an authorized agent. This issue is discussed further in Chapter 19 "Liability of Principal and Agent;\nTermination of Agency".\n\nKEY TAKEAWAY\nAn agent is one who acts on behalf of another. Many transactions are conducted by agents so acting. All\ncorporate transactions, including those involving governmental organizations, are so conducted because\ncorporations cannot themselves actually act; they are legal fictions. Agencies may be created expressly,\nimpliedly, or apparently. Recurring issues in agency law include whether the \xe2\x80\x9cagent\xe2\x80\x9d really is such, the\nscope of the agent\xe2\x80\x99s authority, and the duties among the parties. The five types of agents include: general\nagent, special agent, subagent, agency coupled with an interest, and servant (or employee). The\nindependent contractor is not an employee; her activities are not specifically controlled by her client, and\nthe client is not liable for payroll taxes, Social Security, and the like. But it is not uncommon for an\nemployer to claim workers are independent contractors when in fact they are employees, and the cases\nare often hard-fought on the facts.\n\nEXERCISES\n\n1.\n\nWhy is agency law especially important in the business and government context?\n\n2.\n\nWhat are the five types of agents?\n\n3.\n\nWhat distinguishes an employee from an independent contractor?\n\n4.\n\nWhy do employers frequently try to pass off employees as independent contractors?\n5.\n\n[1] 1. Flick v. Crouch, 434 P.2d 256, 260 (OK, 1967).\n\n6.\n\n[2] Robinson v. New York Commodities Corp., 396 N.Y.S.2d 725, App. Div. (1977).\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n627\n\n\x0c7.\n\n[3] General Accident Fire & Life Assurance Corp v. Pro Golf Association, 352 N.E.2d 441 (Ill. App. 1976).\n\n18.2 Duties between Agent and Principal\n\nLEARNING OBJECTIVES\n\n1.\n\nUnderstand that the agent owes the principal two types of duties: a special duty\xe2\x80\x94the fiduciary duty\xe2\x80\x94and\nother general duties as recognized in agency law.\n\n2.\n\nRecognize that the principal owes the agent duties: contract, tort, and workers\xe2\x80\x99 compensation.\n\nAgent\xe2\x80\x99s Duty to Principal\nThe agent owes the principal duties in two categories: the fiduciary duty and a set of general duties\nimposed by agency law. But these general duties are not unique to agency law; they are duties owed by any\nemployee to the employer.\n\nFiduciary Duty\nIn a nonagency contractual situation, the parties\xe2\x80\x99 responsibilities terminate at the border of the contract.\nThere is no relationship beyond the agreement. This literalist approach is justified by the more general\nprinciple that we each should be free to act unless we commit ourselves to a particular course.\nBut the agency relationship is more than a contractual one, and the agent\xe2\x80\x99s responsibilities go beyond the\nborder of the contract. Agency imposes a higher duty than simply to abide by the contract terms. It\nimposes a fiduciary duty. The law infiltrates the contract creating the agency relationship and reverses the\ngeneral principle that the parties are free to act in the absence of agreement. As a fiduciary of the\nprincipal, the agent stands in a position of special trust. His responsibility is to subordinate his selfinterest to that of his principal. The fiduciary responsibility is imposed by law. The absence of any clause\nin the contract detailing the agent\xe2\x80\x99s fiduciary duty does not relieve him of it. The duty contains several\naspects.\n\nDuty to Avoid Self-Dealing\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n628\n\n\x0cA fiduciary may not lawfully profit from a conflict between his personal interest in a transaction and his\nprincipal\xe2\x80\x99s interest in that same transaction. A broker hired as a purchasing agent, for instance, may not\nsell to his principal through a company in which he or his family has a financial interest. The penalty for\nbreach of fiduciary duty is loss of compensation and profit and possible damages for breach of trust.\n\nDuty to Preserve Confidential Information\nTo further his objectives, a principal will usually need to reveal a number of secrets to his agent\xe2\x80\x94how\nmuch he is willing to sell or pay for property, marketing strategies, and the like. Such information could\neasily be turned to the disadvantage of the principal if the agent were to compete with the principal or\nwere to sell the information to those who do. The law therefore prohibits an agent from using for his own\npurposes or in ways that would injure the interests of the principal, information confidentially given or\nacquired. This prohibition extends to information gleaned from the principal though unrelated to the\nagent\xe2\x80\x99s assignment: \xe2\x80\x9c[A]n agent who is told by the principal of his plans, or who secretly examines books\nor memoranda of the employer, is not privileged to use such information at his principal\xe2\x80\x99s\nexpense.\xe2\x80\x9d\n\n[1]\n\nNor may the agent use confidential information after resigning his agency. Though he is free,\n\nin the absence of contract, to compete with his former principal, he may not use information learned in\nthe course of his agency, such as trade secrets and customer lists. Section 18.3.3 "Breach of Fiduciary\nDuty", Bacon v. Volvo Service Center, Inc., deals with an agent\xe2\x80\x99s breach of the duty of confidentiality.\n\nOther Duties\nIn addition to fiduciary responsibility (and whatever special duties may be contained in the specific\ncontract) the law of agency imposes other duties on an agent. These duties are not necessarily unique to\nagents: a nonfiduciary employee could also be bound to these duties on the right facts.\n\nDuty of Skill and Care\nAn agent is usually taken on because he has special knowledge or skills that the principal wishes to tap.\nThe agent is under a legal duty to perform his work with the care and skill that is \xe2\x80\x9cstandard in the locality\nfor the kind of work which he is employed to perform\xe2\x80\x9d and to exercise any special skills, if these are\ngreater or more refined than those prevalent among those normally employed in the community. In short,\nthe agent may not lawfully do a sloppy job.\n\n[2]\n\nDuty of Good Conduct\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n629\n\n\x0cIn the absence of an agreement, a principal may not ordinarily dictate how an agent must live his private\nlife. An overly fastidious florist may not instruct her truck driver to steer clear of the local bar on his way\nhome from delivering flowers at the end of the day. But there are some jobs on which the personal habits\nof the agent may have an effect. The agent is not at liberty to act with impropriety or notoriety, so as to\nbring disrepute on the business in which the principal is engaged. A lecturer at an antialcohol clinic may\nbe directed to refrain from frequenting bars. A bank cashier who becomes known as a gambler may be\nfired.\n\nDuty to Keep and Render Accounts\nThe agent must keep accurate financial records, take receipts, and otherwise act in conformity to standard\nbusiness practices.\n\nDuty to Act Only as Authorized\nThis duty states a truism but is one for which there are limits. A principal\xe2\x80\x99s wishes may have been stated\nambiguously or may be broad enough to confer discretion on the agent. As long as the agent acts\nreasonably under the circumstances, he will not be liable for damages later if the principal ultimately\nrepudiates what the agent has done: \xe2\x80\x9cOnly conduct which is contrary to the principal\xe2\x80\x99s manifestations to\nhim, interpreted in light of what he has reason to know at the time when he acts,\xe2\x80\xa6subjects the agent to\nliability to the principal.\xe2\x80\x9d\n\n[3]\n\nDuty Not to Attempt the Impossible or Impracticable\nThe principal says to the agent, \xe2\x80\x9cKeep working until the job is done.\xe2\x80\x9d The agent is not obligated to go\nwithout food or sleep because the principal misapprehended how long it would take to complete the job.\nNor should the agent continue to expend the principal\xe2\x80\x99s funds in a quixotic attempt to gain business, sign\nup customers, or produce inventory when it is reasonably clear that such efforts would be in vain.\n\nDuty to Obey\nAs a general rule, the agent must obey reasonable directions concerning the manner of performance.\nWhat is reasonable depends on the customs of the industry or trade, prior dealings between agent and\nprincipal, and the nature of the agreement creating the agency. A principal may prescribe uniforms for\nvarious classes of employees, for instance, and a manufacturing company may tell its sales force what\nsales pitch to use on customers. On the other hand, certain tasks entrusted to agents are not subject to the\nprincipal\xe2\x80\x99s control; for example, a lawyer may refuse to permit a client to dictate courtroom tactics.\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n630\n\n\x0cDuty to Give Information\nBecause the principal cannot be every place at once\xe2\x80\x94that is why agents are hired, after all\xe2\x80\x94much that is\nvital to the principal\xe2\x80\x99s business first comes to the attention of agents. If the agent has actual notice or\nreason to know of information that is relevant to matters entrusted to him, he has a duty to inform the\nprincipal. This duty is especially critical because information in the hands of an agent is, under most\ncircumstances, imputed to the principal, whose legal liabilities to third persons may hinge on receiving\ninformation in timely fashion. Service of process, for example, requires a defendant to answer within a\ncertain number of days; an agent\xe2\x80\x99s failure to communicate to the principal that a summons has been\nserved may bar the principal\xe2\x80\x99s right to defend a lawsuit. The imputation to the principal of knowledge\npossessed by the agent is strict: even where the agent is acting adversely to the principal\xe2\x80\x99s interests\xe2\x80\x94for\nexample, by trying to defraud his employer\xe2\x80\x94a third party may still rely on notification to the agent, unless\nthe third party knows the agent is acting adversely.\n\n\xe2\x80\x9cShop Rights\xe2\x80\x9d Doctrine\nIn Grip Nut Co. v. Sharp, Sharp made a deal with Grip Nut Company that in return for a salary and\nbonuses as company president, he would assign to the company any inventions he made.\n\n[4]\n\nWhen the five-\n\nyear employment contract expired, Sharp continued to serve as chief executive officer, but no new\ncontract was negotiated concerning either pay or rights to inventions. During the next ten years, Sharp\ninvented a number of new products and developed new machinery to manufacture them; patent rights\nwent to the company. However, he made one invention with two other employees and they assigned the\npatent to him. A third employee invented a safety device and also assigned the patent to Sharp. At one\ntime, Sharp\xe2\x80\x99s son invented a leakproof bolt and a process to manufacture it; these, too, were assigned to\nSharp. These inventions were developed in the company\xe2\x80\x99s plants at its expense.\nWhen Sharp died, his family claimed the rights to the inventions on which Sharp held assignments and\nsued the company, which used the inventions, for patent infringement. The family reasoned that after the\nexpiration of the employment contract, Sharp was employed only in a managerial capacity, not as an\ninventor. The court disagreed and invoked the shop rights doctrine, under which an invention \xe2\x80\x9cdeveloped\nand perfected in [a company\xe2\x80\x99s] plant with its time, materials, and appliances, and wholly at its expense\xe2\x80\x9d\nmay be used by the company without payment of royalties: \xe2\x80\x9cBecause the servant uses his master\xe2\x80\x99s time,\nfacilities and materials to attain a concrete result, the employer is entitled to use that which embodies his\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n631\n\n\x0cown property and to duplicate it as often as he may find occasion to employ similar appliances in his\nbusiness.\xe2\x80\x9d The company would have been given complete ownership of the patents had there been an\nexpress or implied (e.g., the employee is hired to make inventions) contract to this effect between Sharp\nand the company.\n\nPrincipal\xe2\x80\x99s Duty to Agent\nIn this category, we may note that the principal owes the agent duties in contract, tort, and\xe2\x80\x94statutorily\xe2\x80\x94\nworkers\xe2\x80\x99 compensation law.\n\nContract Duties\nThe fiduciary relationship of agent to principal does not run in reverse\xe2\x80\x94that is, the principal is not the\nagent\xe2\x80\x99s fiduciary. Nevertheless, the principal has a number of contractually related obligations toward his\nagent.\n\nGeneral Contract Duties\nThese duties are analogues of many of the agent\xe2\x80\x99s duties that we have just examined. In brief, a principal\nhas a duty \xe2\x80\x9cto refrain from unreasonably interfering with [an agent\xe2\x80\x99s] work.\xe2\x80\x9d\n\n[5]\n\nThe principal is allowed,\n\nhowever, to compete with the agent unless the agreement specifically prohibits it. The principal has a duty\nto inform his agent of risks of physical harm or pecuniary loss that inhere in the agent\xe2\x80\x99s performance of\nassigned tasks. Failure to warn an agent that travel in a particular neighborhood required by the job may\nbe dangerous (a fact unknown to the agent but known to the principal) could under common law subject\nthe principal to a suit for damages if the agent is injured while in the neighborhood performing her job. A\nprincipal is obliged to render accounts of monies due to agents; a principal\xe2\x80\x99s obligation to do so depends\non a variety of factors, including the degree of independence of the agent, the method of compensation,\nand the customs of the particular business. An agent\xe2\x80\x99s reputation is no less valuable than a principal\xe2\x80\x99s,\nand so an agent is under no obligation to continue working for one who sullies it.\n\nEmployment at Will\nUnder the traditional \xe2\x80\x9cemployment-at-will\xe2\x80\x9d doctrine, an employee who is not hired for a specific period\ncan be fired at any time, for any reason (except bad reasons: an employee cannot be fired, for example, for\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n632\n\n\x0creporting that his employer\xe2\x80\x99s paper mill is illegally polluting groundwater). This doctrine, which has been\nmuch criticized, is discussed in Chapter 32 "International Law".\n\nDuty to Indemnify\nAgents commonly spend money pursuing the principal\xe2\x80\x99s business. Unless the agreement explicitly\nprovides otherwise, the principal has a duty to indemnify or reimburse the agent. A familiar form of\nindemnity is the employee expense account.\n\nTort and Workers\xe2\x80\x99 Compensation Duties\nThe employer owes the employee\xe2\x80\x94any employee, not just agents\xe2\x80\x94certain statutorily imposed tort and\nworkers\xe2\x80\x99 compensation duties.\n\nBackground to Workers\xe2\x80\x99 Compensation\nAndy, who works in a dynamite factory, negligently stores dynamite in the wrong shed. Andy warns his\nfellow employee Bill that he has done so. Bill lights up a cigarette near the shed anyway, a spark lands on\nthe ground, the dynamite explodes, and Bill is injured. May Bill sue his employer to recover damages? At\ncommon law, the answer would be no\xe2\x80\x94three times no. First, the \xe2\x80\x9cfellow-servant\xe2\x80\x9d rule would bar recovery\nbecause the employer was held not to be responsible for torts committed by one employee against\nanother. Second, Bill\xe2\x80\x99s failure to heed Andy\xe2\x80\x99s warning and his decision to smoke near the dynamite\namounted to contributory negligence. Hence even if the dynamite had been negligently stored by the\nemployer rather than by a fellow employee, the claim would have been dismissed. Third, the courts might\nhave held that Bill had \xe2\x80\x9cassumed the risk\xe2\x80\x9d: since he was aware of the dangers, it would not be fair to\nsaddle the employer with the burden of Bill\xe2\x80\x99s actions.\nThe three common-law rules just mentioned ignited intense public fury by the turn of the twentieth\ncentury. In large numbers of cases, workers who were mutilated or killed on the job found themselves and\ntheir families without recompense. Union pressure and grass roots lobbying led to\nworkers\xe2\x80\x99 compensation acts\xe2\x80\x94statutory enactments that dramatically overhauled the law of torts as it\naffected employees.\n\nThe System in General\nWorkers\xe2\x80\x99 compensation is a no-fault system. The employee gives up the right to sue the employer (and, in\nsome states, other employees) and receives in exchange predetermined compensation for a job-related\ninjury, regardless of who caused it. This trade-off was felt to be equitable to employer and employee: the\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n633\n\n\x0cemployee loses the right to seek damages for pain and suffering\xe2\x80\x94which can be a sizable portion of any\njury award\xe2\x80\x94but in return he can avoid the time-consuming and uncertain judicial process and assure\nhimself that his medical costs and a portion of his salary will be paid\xe2\x80\x94and paid promptly. The employer\nmust pay for all injuries, even those for which he is blameless, but in return he avoids the risk of losing a\nbig lawsuit, can calculate his costs actuarially, and can spread the risks through insurance.\nMost workers\xe2\x80\x99 compensation acts provide 100 percent of the cost of a worker\xe2\x80\x99s hospitalization and\nmedical care necessary to cure the injury and relieve him from its effects. They also provide for payment\nof lost wages and death benefits. Even an employee who is able to work may be eligible to receive\ncompensation for specific injuries. Part of the table of benefits for specific injuries under the Kansas\nstatute is shown in Note 18.16 "Kansas Workers\xe2\x80\x99 Compensation Benefits for Specific Injuries".\n\nKansas Workers\xe2\x80\x99 Compensation Benefits for Specific Injuries\nArticle 5.\xe2\x80\x94Workers\xe2\x80\x99 Compensation\n44-510d. Compensation for certain permanent partial disabilities; schedule. If there is an award of\npermanent disability as a result of the injury there shall be a presumption that disability existed\nimmediately after the injury and compensation is to be paid for not to exceed the number of weeks\nallowed in the following schedule:\n(1) For loss of a thumb, 60 weeks.\n(2) For the loss of a first finger, commonly called the index finger, 37 weeks.\n(3) For the loss of a second finger, 30 weeks.\n(4) For the loss of a third finger, 20 weeks.\n(5) For the loss of a fourth finger, commonly called the little finger, 15 weeks.\n(6) Loss of the first phalange of the thumb or of any finger shall be considered to be equal to the loss of\n1/2 of such thumb or finger, and the compensation shall be 1/2 of the amount specified above. The loss of\nthe first phalange and any part of the second phalange of any finger, which includes the loss of any part of\nthe bone of such second phalange, shall be considered to be equal to the loss of 2/3 of such finger and the\ncompensation shall be 2/3 of the amount specified above. The loss of the first phalange and any part of\nthe second phalange of a thumb which includes the loss of any part of the bone of such second phalange,\nshall be considered to be equal to the loss of the entire thumb. The loss of the first and second phalanges\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n634\n\n\x0cand any part of the third proximal phalange of any finger, shall be considered as the loss of the entire\nfinger. Amputation through the joint shall be considered a loss to the next higher schedule.\n(7) For the loss of a great toe, 30 weeks.\n(8) For the loss of any toe other than the great toe, 10 weeks.\n(9) The loss of the first phalange of any toe shall be considered to be equal to the loss of 1/2 of such toe\nand the compensation shall be 1/2 of the amount above specified.\n(10) The loss of more than one phalange of a toe shall be considered to be equal to the loss of the entire\ntoe.\n(11) For the loss of a hand, 150 weeks.\n(12) For the loss of a forearm, 200 weeks.\n(13) For the loss of an arm, excluding the shoulder joint, shoulder girdle, shoulder musculature or any\nother shoulder structures, 210 weeks, and for the loss of an arm, including the shoulder joint, shoulder\ngirdle, shoulder musculature or any other shoulder structures, 225 weeks.\n(14) For the loss of a foot, 125 weeks.\n(15) For the loss of a lower leg, 190 weeks.\n(16) For the loss of a leg, 200 weeks.\n(17) For the loss of an eye, or the complete loss of the sight thereof, 120 weeks.\nSource:http://www.kslegislature.org/li/statute/044_000_0000_chapter/044_005_0000_article/044_\n005_0010d_section/044_005_0010d_k/.\nThe injured worker is typically entitled to two-thirds his or her average pay, not to exceed some specified\nmaximum, for two hundred weeks. If the loss is partial (like partial loss of sight), the recovery is decreased\nby the percentage still usable.\n\nCoverage\nAlthough workers\xe2\x80\x99 compensation laws are on the books of every state, in two states\xe2\x80\x94New Jersey and\nTexas\xe2\x80\x94they are not compulsory. In those states the employer may decline to participate, in which event\nthe employee must seek redress in court. But in those states permitting an employer election, the old\ncommon-law defenses (fellow-servant rule, contributory negligence, and assumption of risk) have been\nstatutorily eliminated, greatly enhancing an employee\xe2\x80\x99s chances of winning a suit. The incentive is\ntherefore strong for employers to elect workers\xe2\x80\x99 compensation coverage.\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n635\n\n\x0cThose frequently excluded are farm and domestic laborers and public employees; public employees,\nfederal workers, and railroad and shipboard workers are covered under different but similar laws. The\ntrend has been to include more and more classes of workers. Approximately half the states now provide\ncoverage for household workers, although the threshold of coverage varies widely from state to state.\nSome use an earnings test; other states impose an hours threshold. People who fall within the domestic\ncategory include maids, baby-sitters, gardeners, and handymen but generally not plumbers, electricians,\nand other independent contractors.\n\nPaying for Workers\xe2\x80\x99 Compensation\nThere are three general methods by which employers may comply with workers\xe2\x80\x99 compensation laws. First,\nthey may purchase employer\xe2\x80\x99s liability and workers\xe2\x80\x99 compensation policies through private commercial\ninsurance companies. These policies consist of two major provisions: payment by the insurer of all claims\nfiled under workers\xe2\x80\x99 compensation and related laws (such as occupational disease benefits) and coverage\nof the costs of defending any suits filed against the employer, including any judgments awarded. Since\nworkers\xe2\x80\x99 compensation statutes cut off the employee\xe2\x80\x99s right to sue, how can such a lawsuit be filed? The\nanswer is that there are certain exceptions to the ban: for instance, a worker may sue if the employer\ndeliberately injures an employee.\nThe second method of compliance with workers\xe2\x80\x99 compensation laws is to insure through a state fund\nestablished for the purpose. The third method is to self-insure. The laws specify conditions under which\ncompanies may resort to self-insurance, and generally only the largest corporations qualify to do so. In\nshort, workers\xe2\x80\x99 compensation systems create a tax on employers with which they are required (again, in\nmost states) to buy insurance. The amount the employer has to pay for the insurance depends on the\nnumber and seriousness of claims made\xe2\x80\x94how dangerous the work is. For example, Washington State\xe2\x80\x99s\n2011 proposed hourly rates for employers to purchase insurance include these items: for egg and poultry\nfarms, $1.16 per hour; shake and shingle mills, $18.06 per hour; asphalt paving, $2.87 per hour; lawn care\nmaintenance, $1.22 per hour; plastic products manufacturing, $0.87 per hour; freight handling, $1.81 per\nhour; supermarkets, $0.76; restaurants, $0.43; entertainers and dancers, $7.06; colleges and universities,\n$0.31.\n\n[6]\n\nRecurring Legal Issues\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n636\n\n\x0cThere are a number of legal issues that recur in workers\xe2\x80\x99 compensation cases. The problem is, from the\nemployer\xe2\x80\x99s point of view, that the cost of buying insurance is tied to the number of claims made. The\nemployer therefore has reason to assert the injured employee is not eligible for compensation. Recurring\nlegal issues include the following:\n\xe2\x80\xa2\n\nIs the injury work related? As a general rule, on-the-job injuries are covered no matter what their\nrelationship to the employee\xe2\x80\x99s specific duties. Although injuries resulting from drunkenness or\nfighting are not generally covered, there are circumstances under which they will be, as Section 18.3.2\n"Employee versus Independent Contractor" shows.\n\n\xe2\x80\xa2\n\nIs the injured person an employee? Courts are apt to be liberal in construing statutes to include those\nwho might not seem to be employed. InBetts v. Ann Arbor Public Schools, a University of Michigan\nstudent majoring in physical education was a student teacher in a junior high school.\n\n[7]\n\nDuring a four-\n\nmonth period, he taught two physical education courses. On the last day of his student teaching, he\nwalked into the locker room and thirty of his students grabbed him and tossed him into the swimming\npool. This was traditional, but he \xe2\x80\x9cdidn\xe2\x80\x99t feel like going in that morning\xe2\x80\x9d and put up a struggle that\nended with a whistle on an elastic band hitting him in the eye, which he subsequently lost as a result\nof the injury. He filed a workers\xe2\x80\x99 compensation claim. The school board argued that he could not be\nclassified as an employee because he received no pay. Since he was injured by students\xe2\x80\x94not\nconsidered agents of the school\xe2\x80\x94he would probably have been unsuccessful in filing a tort suit; hence\nthe workers\xe2\x80\x99 compensation claim was his only chance of recompense. The state workers\xe2\x80\x99\ncompensation appeal board ruled against the school on the ground that payment in money was not\nrequired: \xe2\x80\x9cPlaintiff was paid in the form of training, college credits towards graduation, and meeting\nof the prerequisites of a state provisional certificate.\xe2\x80\x9d The state supreme court affirmed the award.\n\xe2\x80\xa2\n\nHow palpable must the \xe2\x80\x9cinjury\xe2\x80\x9d be? A difficult issue is whether a worker is entitled to compensation\nfor psychological injury, including cumulative trauma. Until the 1970s, insurance companies and\ncompensation boards required physical injury before making an award. Claims that job stresses led to\nnervous breakdowns or other mental disorders were rejected. But most courts have liberalized the\ndefinition of injury and now recognize that psychological trauma can be real and that job stress can\nbring it on, as shown by the discussion of Wolfe v. Sibley, Lindsay & Curr Co. in Section 18.3.4\n"Workers\xe2\x80\x99 Compensation: What \xe2\x80\x9cInjuries\xe2\x80\x9d Are Compensable?".\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n637\n\n\x0cKEY TAKEAWAY\nThe agent owes the principal two categories of duties: fiduciary and general. The fiduciary duty is the duty\nto act always in the interest of the principal; the duty here includes that to avoid self-dealing and to\npreserve confidential information. The general duty owed by the agent encompasses the sorts of\nobligations any employee might have: the duty of skill and care, of good conduct, to keep and render\naccounts, to not attempt the impossible or impracticable, to obey, and to give information. The shop rights\ndoctrine provides that inventions made by an employee using the employer\xe2\x80\x99s resources and on the\nemployer\xe2\x80\x99s time belong to the employer.\nThe principal owes the agent duties too. These may be categorized as contract and tort duties. The\ncontract duties are to warn the agent of hazards associated with the job, to avoid interfering with the\nagent\xe2\x80\x99s performance of his job, to render accounts of money due the agent, and to indemnify the agent\nfor business expenses according to their agreement. The tort duty owed by the principal to the agent\xe2\x80\x94\nemployee\xe2\x80\x94is primarily the statutorily imposed duty to provide workers\xe2\x80\x99 compensation for injuries\nsustained on the job. In reaction to common-law defenses that often exonerated the employer from\nliability for workers\xe2\x80\x99 injuries, the early twentieth century saw the rise of workers\xe2\x80\x99 compensation statutes.\nThese require the employer to provide no-fault insurance coverage for any injury sustained by the\nemployee on the job. Because the employer\xe2\x80\x99s insurance costs are claims rated (i.e., the cost of insurance\ndepends on how many claims are made), the employer scrutinizes claims. A number of recurring legal\nissues arise: Is the injury work related? Is the injured person an employee? What constitutes an \xe2\x80\x9cinjury\xe2\x80\x9d?\n\nEXERCISES\n\n1.\n\nJudge Learned Hand, a famous early-twentieth-century jurist (1872\xe2\x80\x931961), said, \xe2\x80\x9cThe fiduciary duty is not\nthe ordinary morals of the marketplace.\xe2\x80\x9d How does the fiduciary duty differ from \xe2\x80\x9cthe ordinary morals of\nthe marketplace\xe2\x80\x9d? Why does the law impose a fiduciary duty on the agent?\n\n2.\n\nWhat are the nonfiduciary duties owed by the agent to the principal?\n\n3.\n\nWhat contract duties are owed by the principal to the agent?\n\n4.\n\nWhy were workers\xe2\x80\x99 compensation statutes adopted in the early twentieth century?\n\n5.\n\nHow do workers\xe2\x80\x99 compensation statutes operate, and how are the costs paid for?\n6.\n\n[1] Restatement (Second) of Agency, Section 395.\n\n7.\n\n[2] Restatement (Second) of Agency, Section 379.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n638\n\n\x0c8.\n\n[3] Restatement (Second) of Agency, Section 383.\n\n9.\n\n[4] Grip Nut Co. v. Sharp, 150 F.2d 192 (7th Cir. 1945).\n\n10. [5] Restatement (Second) of Agency, Section 434.\n11. [6] Washington State Department of Labor & Industries, Rates for Workers\xe2\x80\x99 Compensation, Proposed 2011\nRates,http://www.lni.wa.gov/ClaimsIns/Insurance/RatesRisk/Check/RatesHistory.\n12. [7] Betts v. Ann Arbor Public Schools, 271 N.W.2d 498 (Mich. 1978).\n\n18.3 Cases\n\nCreation of Agency: Liability of Parent for Contracts Made by \xe2\x80\x9cAgent\xe2\x80\x9d Child\nWeingart v. Directoire Restaurant, Inc.\n333 N.Y.S.2d 806 (N.Y., 1972)\nKASSEL, J.\nThe issue here is whether defendant restaurant by permitting an individual to park patrons\xe2\x80\x99 cars thereby\nheld him out as its \xe2\x80\x9cemployee\xe2\x80\x9d for such purposes. Admittedly, this individual, one Buster Douglas, is not\nits employee in the usual sense but with the knowledge of defendant, he did station himself in front of its\nrestaurant, wore a doorman\xe2\x80\x99s uniform and had been parking its customers\xe2\x80\x99 autos. The parties stipulated\nthat if he were held to be defendant\xe2\x80\x99s employee, this created a bailment between the parties [and the\n\xe2\x80\x9cemployer\xe2\x80\x9d would have to rebut a presumption of negligence if the customer\xe2\x80\x99s property was not returned\nto the customer].\nOn April 20, 1968, at about 10 P.M., plaintiff drove his 1967 Cadillac Coupe de Ville to the door of the\nDirectoire Restaurant at 160 East 48th Street in Manhattan. Standing in front of the door was Buster\nDouglas, dressed in a self-supplied uniform, comprised of a regular doorman\xe2\x80\x99s cap and matching jacket.\nPlaintiff gave the keys to his vehicle to Douglas and requested that he park the car. He gave Douglas a\n$1.00 tip and received a claim check. Plaintiff then entered defendant\xe2\x80\x99s restaurant, remained there for\napproximately 45 minutes and when he departed, Douglas was unable to locate the car which was never\nreturned to plaintiff.\nAt the time of this occurrence, the restaurant had been open for only nine days, during which time\nplaintiff had patronized the restaurant on at least one prior occasion.\nDefendant did not maintain any sign at its entrance or elsewhere that it would provide parking for its\ncustomers (nor, apparently, any sign warning to the contrary).\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n639\n\n\x0cBuster Douglas parked cars for customers of defendant\xe2\x80\x99s restaurant and at least three or four other\nrestaurants on the block. He stationed himself in front of each restaurant during the course of an evening\nand was so engaged during the evening of April 20, 1968. Defendant clearly knew of and did not object to\nDouglas\xe2\x80\x99 activities outside its restaurant. Defendant\xe2\x80\x99s witness testified at an examination before trial:\nQ. Did anybody stand outside your restaurant in any capacity whatsoever?\nA. There was a man out there parking cars for the block, but he was in no way connected with us\nor anything like that. He parked cars for the Tamburlaine and also for the Chateau Madrid,\nNepentha and a few places around the block.\nQ. Did you know that this gentleman was standing outside your restaurant?\nA. Yes, I knew he was there.\nQ. How did you know that he was standing outside your restaurant?\nA. Well, I knew the man\xe2\x80\x99s face because I used to work in a club on 55th Street and he was there.\nWhen we first opened up here, we didn\xe2\x80\x99t know if we would have a doorman or have parking\nfacilities or what we were going to do at that time. We just let it hang and I told this Buster,\nBuster was his name, that you are a free agent and you do whatever you want to do. I am\ntending bar in the place and what you do in the street is up to you, I will not stop you, but we are\nnot hiring you or anything like that, because at that time, we didn\xe2\x80\x99t know what we were going to\nuse the parking lot or get a doorman and put on a uniform or what.\nThese facts establish to the court\xe2\x80\x99s satisfaction that, although Douglas was not an actual employee of the\nrestaurant, defendant held him out as its authorized agent or \xe2\x80\x9cemployee\xe2\x80\x9d for the purpose of parking its\ncustomers\xe2\x80\x99 cars, by expressly consenting to his standing, in uniform, in front of its door to receive\ncustomers, to park their cars and issue receipts therefor\xe2\x80\x94which services were rendered without charge to\nthe restaurant\xe2\x80\x99s customers, except for any gratuity paid to Douglas. Clearly, under these circumstances,\napparent authority has been shown and Douglas acted within the scope of this authority.\nPlaintiff was justified in assuming that Douglas represented the restaurant in providing his services and\nthat the restaurant had placed him there for the convenience of its customers. A restaurateur knows that\nthis is the impression created by allowing a uniformed attendant to so act. Facility in parking is often a\ncritical consideration for a motorist in selecting a restaurant in midtown Manhattan, and the Directoire\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n640\n\n\x0cwas keenly aware of this fact as evidenced by its testimony that the management was looking into various\nother possibilities for solving customers\xe2\x80\x99 parking problems.\nThere was no suitable disclaimer posted outside the restaurant that it had no parking facilities or that\nentrusting one\xe2\x80\x99s car to any person was at the driver\xe2\x80\x99s risk. It is doubtful that any prudent driver would\nentrust his car to a strange person on the street, if he thought that the individual had no authorization\nfrom the restaurant or club or had no connection with it, but was merely an independent operator with\nquestionable financial responsibility.\nThe fact that Douglas received no compensation directly from defendant is not material. Each party\nderived a benefit from the arrangement: Douglas being willing to work for gratuities from customers, and\nthe defendant, at no cost to itself, presenting the appearance of providing the convenience of free parking\nand doorman services to its patrons. In any case, whatever private arrangements existed between the\nrestaurant and Douglas were never disclosed to the customers.\nEven if such person did perform these services for several restaurants, it does not automatically follow\nthat he is a freelance entrepreneur, since a shared employee working for other small or moderately sized\nrestaurants in the area would seem a reasonable arrangement, in no way negating the authority of the\nattendant to act as doorman and receive cars for any one of these places individually.\nThe case most analogous to the instant one is Klotz v. El Morocco [Citation, 1968], and plaintiff here\nrelies on it. That case similarly involved the theft of a car parked by a uniformed individual standing in\nfront of defendant\xe2\x80\x99s restaurant who, although not employed by it, parked vehicles for its patrons with the\nrestaurant\xe2\x80\x99s knowledge and consent. Defendant here attempts to distinguish this case principally upon the\nground that the parties in El Morocco stipulated that the \xe2\x80\x98doorman\xe2\x80\x99 was an agent or employee of the\ndefendant acting within the scope of his authority. However, the judge made an express finding to that\neffect: \xe2\x80\x98* * * there was sufficient evidence in plaintiff\xe2\x80\x99s case on which to find DiGiovanni, the man in the\nuniform, was acting within the scope of his authority as agent of defendant.\xe2\x80\x9d Defendant here also points to\nthe fact that in KlotzDiGiovanni placed patrons\xe2\x80\x99 car keys on a rack inside El Morocco; however, this is\nonly one fact to be considered in finding a bailment and is, to me, more relevant to the issue of the degree\nof care exercised.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n641\n\n\x0cWhen defendant\xe2\x80\x99s agent failed to produce plaintiff\xe2\x80\x99s automobile, a presumption of negligence arose which\nnow requires defendant to come forward with a sufficient explanation to rebut this presumption.\n[Citation] The matter should be set down for trial on the issues of due care and of damages.\n\nCASE QUESTIONS\n\n1.\n\nBuster Douglas was not the restaurant\xe2\x80\x99s employee. Why did the court determine his negligence could\nnevertheless be imputed to the restaurant?\n\n2.\n\nThe plaintiff in this case relied on Klotz, very similar in facts, in which the car-parking attendant was found\nto be an employee. The defendant, necessarily, needed to argue that the cases were not very similar.\nWhat argument did the defendant make? What did the court say about that argument?\n\n3.\n\nThe restaurant here is a bailee\xe2\x80\x94it has rightful possession of the plaintiff\xe2\x80\x99s (bailor\xe2\x80\x99s) property, the car. If\nthe car is not returned to the plaintiff a rebuttable presumption of negligence arises. What does that\nmean?\n\nEmployee versus Independent Contractor\nVizcaino v. Microsoft Corp.\n97 F.3d 1187 (9th Cir. 1996)\nReinhardt, J.\nLarge corporations have increasingly adopted the practice of hiring temporary employees or\nindependent contractors as a means of avoiding payment of employee benefits, and thereby increasing\ntheir profits. This practice has understandably led to a number of problems, legal and otherwise. One of\nthe legal issues that sometimes arises is exemplified by this lawsuit. The named plaintiffs, who were\nclassified by Microsoft as independent contractors, seek to strip that label of its protective covering and\nto obtain for themselves certain benefits that the company provided to all of its regular or permanent\nemployees. After certifying the named plaintiffs as representatives of a class of \xe2\x80\x9ccommon-law\nemployees,\xe2\x80\x9d the district court granted summary judgment to Microsoft on all counts. The\nplaintiffs\xe2\x80\xa6now appeal as to two of their claims: a) the claim\xe2\x80\xa6that they are entitled to savings benefits\nunder Microsoft\xe2\x80\x99s Savings Plus Plan (SPP); and b) that\xe2\x80\xa6they are entitled to stock-option benefits under\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n642\n\n\x0cMicrosoft\xe2\x80\x99s Employee Stock Purchase Plan (ESPP). In both cases, the claims are based on their\ncontention that they are common-law employees.\nMicrosoft, one of the country\xe2\x80\x99s fastest growing and most successful corporations and the world\xe2\x80\x99s largest\nsoftware company, produces and sells computer software internationally. It employs a core staff of\npermanent employees. It categorizes them as \xe2\x80\x9cregular employees\xe2\x80\x9d and offers them a wide variety of\nbenefits, including paid vacations, sick leave, holidays, short-term disability, group health and life\ninsurance, and pensions, as well as the two benefits involved in this appeal. Microsoft supplements its\ncore staff of employees with a pool of individuals to whom it refuses to pay fringe benefits. It previously\nclassified these individuals as \xe2\x80\x9cindependent contractors\xe2\x80\x9d or \xe2\x80\x9cfreelancers,\xe2\x80\x9d but prior to the filing of the\naction began classifying them as \xe2\x80\x9ctemporary agency employees.\xe2\x80\x9d Freelancers were hired when Microsoft\nneeded to expand its workforce to meet the demands of new product schedules. The company did not, of\ncourse, provide them with any of the employee benefits regular employees receive.\nThe plaintiffs\xe2\x80\xa6performed services as software testers, production editors, proofreaders, formatters and\nindexers. Microsoft fully integrated the plaintiffs into its workforce: they often worked on teams along\nwith regular employees, sharing the same supervisors, performing identical functions, and working the\nsame core hours. Because Microsoft required that they work on site, they received admittance card keys,\noffice equipment and supplies from the company.\nFreelancers and regular employees, however, were not without their obvious distinctions. Freelancers\nwore badges of a different color, had different electronic-mail addresses, and attended a less formal\norientation than that provided to regular employees. They were not permitted to assign their work to\nothers, invited to official company functions, or paid overtime wages. In addition, they were not paid\nthrough Microsoft\xe2\x80\x99s payroll department. Instead, they submitted invoices for their services, documenting\ntheir hours and the projects on which they worked, and were paid through the accounts receivable\ndepartment.\nThe plaintiffs were told when they were hired that, as freelancers, they would not be eligible for benefits.\nNone has contended that Microsoft ever promised them any benefits individually. All eight named\nplaintiffs signed [employment agreements] when first hired by Microsoft or soon thereafter. [One]\nincluded a provision that states that the undersigned \xe2\x80\x9cagrees to be responsible for all federal and state\ntaxes, withholding, social security, insurance and other benefits.\xe2\x80\x9d The [other one] states that \xe2\x80\x9cas an\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n643\n\n\x0cIndependent Contractor to Microsoft, you are self-employed and are responsible to pay all your own\ninsurance and benefits.\xe2\x80\x9d Eventually, the plaintiffs learned of the various benefits being provided to regular\nemployees from speaking with them or reading various Microsoft publications concerning employee\nbenefits.\nIn 1989 and 1990, the Internal Revenue Service (IRS)[,]\xe2\x80\xa6applying common-law principles defining the\nemployer-employee relationship, concluded that Microsoft\xe2\x80\x99s freelancers were not independent contractors\nbut employees for withholding and employment tax purposes, and that Microsoft would thereafter be\nrequired to pay withholding taxes and the employer\xe2\x80\x99s portion of Federal Insurance Contribution Act\n(FICA) tax. Microsoft agreed.\xe2\x80\xa6\nAfter learning of the IRS rulings, the plaintiffs sought various employee benefits, including those now at\nissue: the ESPP and SPP benefits. The SPP\xe2\x80\xa6is a cash or deferred salary arrangement under \xc2\xa7 401k of the\nInternal Revenue Code that permits Microsoft\xe2\x80\x99s employees to save and invest up to fifteen percent of their\nincome through tax-deferred payroll deductions.\xe2\x80\xa6Microsoft matches fifty percent of the employee\xe2\x80\x99s\ncontribution in any year, with [a maximum matching contribution]. The ESPP\xe2\x80\xa6permits employees to\npurchase company stock [with various rules].\nMicrosoft rejected the plaintiffs\xe2\x80\x99 claims for benefits, maintaining that they were independent contractors\nwho were personally responsible for all their own benefits.\xe2\x80\xa6\nThe plaintiffs brought this action, challenging the denial of benefits.\nMicrosoft contends that the extrinsic evidence, including the [employment agreements], demonstrates its\nintent not to provide freelancers or independent contractors with employee benefits[.]\xe2\x80\xa6We have no doubt\nthat the company did not intend to provide freelancers or independent contractors with employee\nbenefits, and that if the plaintiffs had in fact been freelancers or independent contractors, they would not\nbe eligible under the plan. The plaintiffs, however, were not freelancers or independent contractors. They\nwere common-law employees, and the question is what, if anything, Microsoft intended with respect to\npersons who were actually common-law employees but were not known to Microsoft to be such. The fact\nthat Microsoft did not intend to provide benefits to persons who it thought were freelancers or\nindependent contractors sheds little or no light on that question.\xe2\x80\xa6\nMicrosoft\xe2\x80\x99s argument, drawing a distinction between common-law employees on the basis of the manner\nin which they were paid, is subject to the same vice as its more general argument. Microsoft regarded the\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n644\n\n\x0cplaintiffs as independent contractors during the relevant period and learned of their common-lawemployee status only after the IRS examination. They were paid through the accounts receivable\ndepartment rather than the payroll department because of Microsoft\xe2\x80\x99s mistaken view as to their legal\nstatus. Accordingly, Microsoft cannot now contend that the fact that they were paid through the accounts\nreceivable department demonstrates that the company intended to deny them the benefits received by all\ncommon-law employees regardless of their actual employment status. Indeed, Microsoft has pointed to no\nevidence suggesting that it ever denied eligibility to any employees, whom it understood to be commonlaw employees, by paying them through the accounts receivable department or otherwise.\nWe therefore construe the ambiguity in the plan against Microsoft and hold that the plaintiffs are eligible\nto participate under the terms of the SPP.\n[Next, regarding the ESPP] we hold that the plaintiffs\xe2\x80\xa6are covered by the specific provisions of the ESPP.\nWe apply the \xe2\x80\x9cobjective manifestation theory of contracts,\xe2\x80\x9d which requires us to \xe2\x80\x9cimpute an intention\ncorresponding to the reasonable meaning of a person\xe2\x80\x99s words and acts.\xe2\x80\x9d [Citation] Through its\nincorporation of the tax code provision into the plan, Microsoft manifested an objective intent to make all\ncommon-law employees, and hence the plaintiffs, eligible for participation. The ESPP specifically\nprovides:\nIt is the intention of the Company to have the Plan qualify as an \xe2\x80\x9cemployee stock purchase plan\xe2\x80\x9d\nunder Section 423 of the Internal Revenue Code of 1954. The provisions of the Plan shall,\naccordingly, be construed so as to extend and limit participation in a manner consistent with the\nrequirements of that Section of the Code. (emphasis added)\n[T]he ESPP, when construed in a manner consistent with the requirements of \xc2\xa7 423, extends participation\nto all common-law employees not covered by one of the express exceptions set forth in the plan.\nAccordingly, we find that the ESPP, through its incorporation of \xc2\xa7 423, expressly extends eligibility for\nparticipation to the plaintiff class and affords them the same options to acquire stock in the corporation as\nall other employees.\nMicrosoft next contends that the [employment agreements] signed by the plaintiffs render them ineligible\nto participate in the ESPP. First, the label used in the instruments signed by the plaintiffs does not control\ntheir employment status. Second, the employment instruments, if construed to exclude the plaintiffs from\nreceiving ESPP benefits, would conflict with the plan\xe2\x80\x99s express incorporation of \xc2\xa7 423. Although Microsoft\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n645\n\n\x0cmay have generally intended to exclude individuals who were in fact independent contractors, it could\nnot, consistent with its express intention to extend participation in the ESPP to all common-law\nemployees, have excluded the plaintiffs. Indeed, such an exclusion would defeat the purpose of including \xc2\xa7\n423 in the plan, because the exclusion of common-law employees not otherwise accepted would result in\nthe loss of the plan\xe2\x80\x99s tax qualification.\nFinally, Microsoft maintains that the plaintiffs are not entitled to ESPP benefits because the terms of the\nplan were never communicated to them and they were therefore unaware of its provisions when they\nperformed their employment services.\xe2\x80\xa6In any event, to the extent that knowledge of an offer of benefits is\na prerequisite, it is probably sufficient that Microsoft publicly promulgated the plan. In [Citation], the\nplaintiff was unaware of the company\xe2\x80\x99s severance plan until shortly before his termination. The Oklahoma\nSupreme Court concluded nonetheless that publication of the plan was \xe2\x80\x9cthe equivalent of constructive\nknowledge on the part of all employees not specifically excluded.\xe2\x80\x9d\nWe are not required to rely, however, on the [this] analysis or even on Microsoft\xe2\x80\x99s own unwitting\nconcession. There is a compelling reason, implicit in some of the preceding discussion, that requires us to\nreject the company\xe2\x80\x99s theory that the plaintiffs\xe2\x80\x99 entitlement to ESPP benefits is defeated by their previous\nlack of knowledge regarding their rights. It is \xe2\x80\x9cwell established\xe2\x80\x9d that an optionor may not rely on an\noptionee\xe2\x80\x99s failure to exercise an option when he has committed any act or failed to perform any duty\n\xe2\x80\x9ccalculated to cause the optionee to delay in exercising the right.\xe2\x80\x9d [Citation] \xe2\x80\x9c[T]he optionor may not\nmake statements or representations calculated to cause delay, [or] fail to furnish [necessary]\ninformation.\xe2\x80\xa6\xe2\x80\x9d Similarly, \xe2\x80\x9c[I]t is a principle of fundamental justice that if a promisor is himself the cause\nof the failure of performance, either of an obligation due him or of a condition upon which his own\nliability depends, he cannot take advantage of the failure.\xe2\x80\x9d [Citation]\xe2\x80\xa6\nApplying these principles, we agree with the magistrate judge, who concluded that Microsoft, which\ncreated a benefit to which the plaintiffs were entitled, could not defend itself by arguing that the plaintiffs\nwere unaware of the benefit, when its own false representations precluded them from gaining that\nknowledge. Because Microsoft misrepresented both the plaintiffs\xe2\x80\x99 actual employment status and their\neligibility to participate in the ESPP, it is responsible for their failure to know that they were covered by\nthe terms of the offer. It may not now take advantage of that failure to defeat the plaintiffs\xe2\x80\x99 rights to ESPP\nbenefits. Thus, we reject Microsoft\xe2\x80\x99s final argument.\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n646\n\n\x0cConclusion\nFor the reasons stated, the district court\xe2\x80\x99s grant of summary judgment in favor of Microsoft and denial of\nsummary judgment in favor of the plaintiffs is REVERSED and the case REMANDED for the\ndetermination of any questions of individual eligibility for benefits that may remain following issuance of\nthis opinion and for calculation of the damages or benefits due the various class members.\n\nCASE QUESTIONS\n\n1.\n\nIn a 1993 Wall Street Journal article, James Bovard asserted that the IRS \xe2\x80\x9cis carrying out a sweeping\ncampaign to slash the number of Americans permitted to be self-employed\xe2\x80\x94and to punish the\ncompanies that contract with them\xe2\x80\xa6IRS officials indicate that more than half the nation\xe2\x80\x99s self-employed\nshould no longer be able to work for themselves.\xe2\x80\x9d Why did Microsoft want these employees to \xe2\x80\x9cbe able\nto work for themselves\xe2\x80\x9d?\n\n2.\n\nWhy did the employees accept employment as independent contractors?\n\n3.\n\nIt seems unlikely that the purpose of the IRS\xe2\x80\x99s campaign was really to keep people from working for\nthemselves, despite Mr. Bovard\xe2\x80\x99s assumption. What was the purpose of the campaign?\n\n4.\n\nWhy did the IRS and the court determine that these \xe2\x80\x9cindependent contractors\xe2\x80\x9d were in fact employees?\n\nBreach of Fiduciary Duty\nBacon v. Volvo Service Center, Inc.\n597 S.E.2d 440 (Ga. App. 2004)\nSmith, J.\n[This appeal is] taken in an action that arose when two former employees left an existing business and\nbegan a new, competing business.\xe2\x80\xa6Bacon and Johnson, two former employees of Volvo Service Center,\nInc. (VSC), and the new company they formed, South Gwinnett Volvo Service, Ltd. (SGVS), appeal from\nthe trial court\xe2\x80\x99s denial of their motion for judgment notwithstanding the jury\xe2\x80\x99s verdict in favor of VSC.\xe2\x80\xa6\nVSC filed suit against appellants, alleging a number of claims arising from the use by Bacon, who had\nbeen a service technician at VSC, of VSC\xe2\x80\x99s customer list, and his soliciting Johnson, a service writer, and\nanother VSC employee to join SGVS. SGVS moved for a directed verdict on certain claims at the close of\nplaintiff\xe2\x80\x99s evidence and at the close of the case, which motions were denied. The jury was asked to respond\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n647\n\n\x0cto specific interrogatories, and it found for VSC and against all three appellants on VSC\xe2\x80\x99s claim for\nmisappropriation of trade secrets. The jury also found for plaintiff against Bacon for breach of fiduciary\nduty,\xe2\x80\xa6tortious interference with business relations, employee piracy, and conversion of corporate assets.\nThe jury awarded VSC attorney fees, costs, and exemplary damages stemming from the claim for\nmisappropriation of trade secrets. Judgment was entered on the jury\xe2\x80\x99s verdict, and appellants\xe2\x80\x99 motion for\nj.n.o.v. was denied. This appeal ensued. We find that VSC did not meet its burden of proof as to the claims\nfor misappropriation of trade secrets, breach of fiduciary duty, or employee piracy, and the trial court\nshould have granted appellants\xe2\x80\x99 motion for j.n.o.v.\nConstrued to support the jury\xe2\x80\x99s verdict, the evidence of record shows that Bacon was a technician at VSC\nwhen he decided to leave and open a competing business. Before doing so, he printed a list of VSC\xe2\x80\x99s\ncustomers from one of VSC\xe2\x80\x99s two computers. Computer access was not password restricted, was easy to\nuse, and was used by many employees from time to time.\nAbout a year after he left VSC, Bacon gave Johnson and another VSC employee an offer of employment at\nhis new Volvo repair shop, which was about to open. Bacon and Johnson advertised extensively, and the\ncustomer list was used to send flyers to some VSC customers who lived close to the new shop\xe2\x80\x99s location.\nThese activities became the basis for VSC\xe2\x80\x99s action against Bacon, Johnson, and their new shop, SGVS.\xe2\x80\xa6\n1. The Georgia Trade Secrets Act of 1990, [Citation], defines a \xe2\x80\x9ctrade secret\xe2\x80\x9d as\ninformation, without regard to form, including, but not limited to,\xe2\x80\xa6a list of actual or potential\ncustomers or suppliers which is not commonly known by or available to the public and which\ninformation:\n(A) Derives economic value, actual or potential, from not being generally known to, and not\nbeing readily ascertainable by proper means by, other persons who can obtain economic value\nfrom its disclosure or use; and\n(B) Is the subject of efforts that are reasonable under the circumstances to maintain its secrecy.\nIf an employer does not prove both prongs of this test, it is not entitled to protection under the Act. Our\nSupreme Court held in [Citation, 1991] for instance, that information was not a trade secret within the\nmeaning of the Act because no evidence showed that the employer \xe2\x80\x9cmade reasonable efforts under the\ncircumstances\xe2\x80\xa6to maintain the confidentiality of the information it sought to protect.\xe2\x80\x9d\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n648\n\n\x0cWhile a client list may be subject to confidential treatment under the Georgia Trade Secrets Act, the\ninformation itself is not inherently confidential. Customers are not trade secrets. Confidentiality is\nafforded only where the customer list is not generally known or ascertainable from other sources and was\nthe subject of reasonable efforts to maintain its secrecy.\xe2\x80\xa6\nHere, VSC took no precautions to maintain the confidentiality of its customer list. The information was on\nboth computers, and it was not password-protected. Moreover, the same information was available to the\ntechnicians through the repair orders, which they were permitted to retain indefinitely while Bacon was\nemployed there. Employees were not informed that the information was confidential. Neither Bacon nor\nJohnson was required to sign a confidentiality agreement as part of his employment.\nBecause no evidence was presented from which the jury could have concluded that VSC took any steps,\nmuch less reasonable ones, to protect the confidentiality of its customer list, a material requirement for\ntrade secret status was not satisfied. The trial court should have granted appellants\xe2\x80\x99 motion for j.n.o.v.\n2. To prove tortious interference with business relations, \xe2\x80\x9ca plaintiff must show defendant: (1) acted\nimproperly and without privilege, (2) acted purposely and with malice with the intent to injure, (3)\ninduced a third party or parties not to enter into or continue a business relationship with the plaintiff, and\n(4) caused plaintiff financial injury.\xe2\x80\x9d [Citation] But \xe2\x80\x9c[f]air competition is always legal.\xe2\x80\x9d [Citations] Unless\nan employee has executed a valid non-compete or non-solicit covenant, he is not barred from soliciting\ncustomers of his former employer on behalf of a new employer. [Citation]\nNo evidence was presented that Bacon acted \xe2\x80\x9cimproperly,\xe2\x80\x9d that any of VSC\xe2\x80\x99s former customers switched\nto SGVS because of any improper act by Bacon, or that these customers would have continued to\npatronize VSC but for Bacon\xe2\x80\x99s solicitations. Therefore, it was impossible for a jury to calculate VSC\xe2\x80\x99s\nfinancial damage, if any existed.\n3. With regard to VSC\xe2\x80\x99s claim for breach of fiduciary duty, \xe2\x80\x9c[a]n employee breaches no fiduciary duty to\nthe employer simply by making plans to enter a competing business while he is still employed. Even\nbefore the termination of his agency, he is entitled to make arrangements to compete and upon\ntermination of employment immediately compete.\xe2\x80\x9d [Citation] He cannot solicit customers for a rival\nbusiness or do other, similar acts in direct competition with his employer\xe2\x80\x99s business before his\nemployment ends. But here, no evidence was presented to rebut the evidence given by Bacon and Johnson\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n649\n\n\x0cthat they engaged in no such practices before their employment with VSC ended. Even assuming,\ntherefore, that a fiduciary relationship existed, no evidence was presented showing that it was breached.\n4. The same is true for VSC\xe2\x80\x99s claim for employee piracy. The evidence simply does not show that any\nemployees of VSC were solicited for SGVS before Bacon left VSC\xe2\x80\x99s employ.\xe2\x80\xa6\nJudgment reversed.\n\nCASE QUESTIONS\n\n1.\n\nWhy was it determined that the defendants were not liable for any breach of trade secrecy?\n\n2.\n\nWhat would have been necessary to show tortious interference with business relations?\n\n3.\n\nThe evidence was lacking that there was any breach of fiduciary duty. What would have been necessary\nto show that?\n\n4.\n\nWhat is \xe2\x80\x9cemployee piracy\xe2\x80\x9d? Why was it not proven?\n\nWorkers\xe2\x80\x99 Compensation: What \xe2\x80\x9cInjuries\xe2\x80\x9d Are Compensable?\nWolfe v. Sibley, Lindsay & Curr Co.\n330 N.E.2d 603 (N.Y. 1975)\nWachtler, J.\nThis appeal involves a claim for workmen\xe2\x80\x99s compensation benefits for the period during which the\nclaimant was incapacitated by severe depression caused by the discovery of her immediate supervisor\xe2\x80\x99s\nbody after he had committed suicide.\nThe facts as adduced at a hearing before the Workmen\xe2\x80\x99s Compensation Board are uncontroverted. The\nclaimant, Mrs. Diana Wolfe, began her employment with the respondent department store, Sibley,\nLindsay & Curr Co. in February, 1968. After working for some time as an investigator in the security\ndepartment of the store she became secretary to Mr. John Gorman, the security director. It appears from\nthe record that as head of security, Mr. Gorman was subjected to intense pressure, especially during the\nChristmas holidays. Mrs. Wolfe testified that throughout the several years she worked at Sibley\xe2\x80\x99s Mr.\nGorman reacted to this holiday pressure by becoming extremely agitated and nervous. She noted,\nhowever, that this anxiety usually disappeared when the holiday season was over. Unfortunately, Mr.\nGorman\xe2\x80\x99s nervous condition failed to abate after the 1970 holidays.\xe2\x80\xa6\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n650\n\n\x0cDespite the fact that he followed Mrs. Wolfe\xe2\x80\x99s advice to see a doctor, Mr. Gorman\xe2\x80\x99s mental condition\ncontinued to deteriorate. On one occasion he left work at her suggestion because he appeared to be so\nnervous. This condition persisted until the morning of June 9, 1971 when according to the claimant, Mr.\nGorman looked much better and even smiled and \xe2\x80\x98tousled her hair\xe2\x80\x99 when she so remarked.\nA short time later Mr. Gorman called her on the intercom and asked her to call the police to room 615.\nMrs. Wolfe complied with this request and then tried unsuccessfully to reach Mr. Gorman on the\nintercom. She entered his office to find him lying in a pool of blood caused by a self-inflicted gunshot\nwound in the head. Mrs. Wolfe became extremely upset and was unable to continue working that day.\nShe returned to work for one week only to lock herself in her office to avoid the questions of her fellow\nworkers. Her private physician perceiving that she was beset by feelings of guilt referred her to a\npsychiatrist and recommended that she leave work, which she did. While at home she ruminated about\nher guilt in failing to prevent the suicide and remained in bed for long periods of time staring at the\nceiling. The result was that she became unresponsive to her husband and suffered a weight loss of 20\npounds. Her psychiatrist, Dr. Grinols diagnosed her condition as an acute depressive reaction.\nAfter attempting to treat her in his office Dr. Grinols realized that the severity of her depression mandated\nhospitalization. Accordingly, the claimant was admitted to the hospital on July 9, 1971 where she\nremained for two months during which time she received psychotherapy and medication. After she was\ndischarged, Dr. Grinols concluded that there had been no substantial remission in her depression and\nruminative guilt and so had her readmitted for electroshock treatment. These treatments lasted for three\nweeks and were instrumental in her recovery. She was again discharged and, in mid-January, 1972,\nresumed her employment with Sibley, Lindsay & Curr.\nMrs. Wolfe\xe2\x80\x99s claim for workmen\xe2\x80\x99s compensation was granted by the referee and affirmed by the\nWorkmen\xe2\x80\x99s Compensation Board. On appeal the Appellate Division reversed citing its opinions in\n[Citations], [concluding]\xe2\x80\xa6that mental injury precipitated solely by psychic trauma is not compensable as\na matter of law. We do not agree with this conclusion.\nWorkmen\xe2\x80\x99s compensation, as distinguished from tort liability which is essentially based on fault, is\ndesigned to shift the risk of loss of earning capacity caused by industrial accidents from the worker to\nindustry and ultimately the consumer. In light of its beneficial and remedial character the Workmen\xe2\x80\x99s\nCompensation Law should be construed liberally in favor of the employee [Citation].\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n651\n\n\x0cLiability under the act is predicated on accidental injury arising out of and in the course of\nemployment.\xe2\x80\xa6Applying these concepts to the case at bar we note that there is no issue raised concerning\nthe causal relationship between the occurrence and the injury. The only testimony on this matter was\ngiven by Dr. Grinols who stated unequivocally that the discovery of her superior\xe2\x80\x99s body was the competent\nproducing cause of her condition. Nor is there any question as to the absence of physical impact.\nAccordingly, the focus of our inquiry is whether or not there has been an accidental injury within the\nmeaning of the Workmen\xe2\x80\x99s Compensation Law.\nSince there is no statutory definition of this term we turn to the relevant decisions. These may be divided\ninto three categories: (1) psychic trauma which produces physical injury, (2) physical impact which\nproduces psychological injury, and (3) psychic trauma which produces psychological injury. As to the first\nclass our court has consistently recognized the principle that an injury caused by emotional stress or\nshock may be accidental within the purview of the compensation law. [Citation] Cases falling into the\nsecond category have uniformly sustained awards to those incurring nervous or psychological disorders as\na result of physical impact [Citation]. As to those cases in the third category the decisions are not as\nclear.\xe2\x80\xa6\nWe hold today that psychological or nervous injury precipitated by psychic trauma is compensable to the\nsame extent as physical injury. This determination is based on two considerations. First, as noted in the\npsychiatric testimony there is nothing in the nature of a stress or shock situation which ordains physical\nas opposed to psychological injury. The determinative factor is the particular vulnerability of an individual\nby virtue of his physical makeup. In a given situation one person may be susceptible to a heart attack\nwhile another may suffer a depressive reaction. In either case the result is the same\xe2\x80\x94the individual is\nincapable of functioning properly because of an accident and should be compensated under the\nWorkmen\xe2\x80\x99s Compensation Law.\nSecondly, having recognized the reliability of identifying psychic trauma as a causative factor of injury in\nsome cases and the reliability by identifying psychological injury as a resultant factor in other cases, we\nsee no reason for limiting recovery in the latter instance to cases involving physical impact. There is\nnothing talismanic about physical impact.\nWe would note in passing that this analysis reflects the view of the majority of jurisdictions in this country\nand England. [Citations]\xe2\x80\xa6\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n652\n\n\x0cAccordingly, the order appealed from should be reversed and the award to the claimant reinstated, with\ncosts.\n\nCASE QUESTIONS\n\n1.\n\nWhy did the appeals court deny workers\xe2\x80\x99 compensation benefits for Wolfe?\n\n2.\n\nOn what reasoning did the New York high court reverse?\n\n3.\n\nThere was a dissent in this case (not included here). Judge Breitel noted that the evidence was that Mrs.\nWolfe had a psychological condition such that her trauma \xe2\x80\x9ccould never have occurred unless she, to begin\nwith, was extraordinarily vulnerable to severe shock at or away from her place of employment or one\nproduced by accident or injury to those close to her in employment or in her private life.\xe2\x80\x9d The judge\nworried that \xe2\x80\x9cone can easily call up a myriad of commonplace occupational pursuits where employees are\noften exposed to the misfortunes of others which may in the mentally unstable evoke precisely the\nsymptoms which this claimant suffered.\xe2\x80\x9d He concluded, \xe2\x80\x9cIn an era marked by examples of overburdening\nof socially desirable programs with resultant curtailment or destruction of such programs, a realistic\nassessment of impact of doctrine is imperative. An overburdening of the compensation system by\ninjudicious and open-ended expansion of compensation benefits, especially for costly, prolonged, and\noften only ameliorative psychiatric care, cannot but threaten its soundness or that of the enterprises\nupon which it depends.\xe2\x80\x9d What is the concern here?\n\n18.4 Summary and Exercises\nSummary\n\nAn agent is one who acts on behalf of another. The law recognizes several types of agents, including (1) the\ngeneral agent, one who possesses authority to carry out a broad range of transactions in the name of and\non behalf of the principal; (2) the special agent, one with authority to act only in a specifically designated\ninstance or set of transactions; (3) the agent whose agency is coupled with an interest, one who has a\nproperty interest in addition to authority to act as an agent; (4) the subagent, one appointed by an agent\nwith authority to do so; and (5) the servant (\xe2\x80\x9cemployee\xe2\x80\x9d in modern English), one whose physical conduct\nis subject to control of the principal.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n653\n\n\x0cA servant should be distinguished from an independent contractor, whose work is not subject to the\ncontrol of the principal. The difference is important for purposes of taxation, workers\xe2\x80\x99 compensation, and\nliability insurance.\nThe agency relationship is usually created by contract, and sometimes governed by the Statute of Frauds,\nbut some agencies are created by operation of law.\nAn agent owes his principal the highest duty of loyalty, that of a fiduciary. The agent must avoid selfdealing, preserve confidential information, perform with skill and care, conduct his personal life so as not\nto bring disrepute on the business for which he acts as agent, keep and render accounts, and give\nappropriate information to the principal.\nAlthough the principal is not the agent\xe2\x80\x99s fiduciary, the principal does have certain obligations toward the\nagent\xe2\x80\x94for example, to refrain from interfering with the agent\xe2\x80\x99s work and to indemnify. The employer\xe2\x80\x99s\ncommon-law tort liability toward his employees has been replaced by the workers\xe2\x80\x99 compensation system,\nunder which the employee gives up the right to sue for damages in return for prompt payment of medical\nand job-loss expenses. Injuries must have been work related and the injured person must have been an\nemployee. Courts today allow awards for psychological trauma in the absence of physical injury.\n\nEXERCISES\n\n1.\n\nA woman was involved in an automobile accident that resulted in the death of a passenger in her car.\nAfter she was charged with manslaughter, her attorney agreed to work with her insurance company\xe2\x80\x99s\nclaims adjuster in handling the case. As a result of the agreement, the woman gave a statement about the\naccident to the claims adjuster. When the prosecuting attorney demanded to see the statement, the\nwoman\xe2\x80\x99s attorney refused on the grounds that the claims adjuster was his\xe2\x80\x94the attorney\xe2\x80\x99s\xe2\x80\x94agent, and\ntherefore the statement was covered by the attorney-client privilege. Is the attorney correct? Why?\n\n2.\n\nA local hotel operated under a franchise agreement with a major hotel chain. Several customers charged\nthe banquet director of the local hotel with misconduct and harassment. They sued the hotel chain (the\nfranchisor) for acts committed by the local hotel (the franchisee), claiming that the franchisee was the\nagent of the franchisor. Is an agency created under these circumstances? Why?\n\n3.\n\nA principal hired a mortgage banking firm to obtain a loan commitment of $10,000,000 from an insurance\ncompany for the construction of a shopping center. The firm was promised a fee of $50,000 for obtaining\nthe commitment. The firm was successful in arranging for the loan, and the insurance company, without\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n654\n\n\x0cthe principal\xe2\x80\x99s knowledge, agreed to pay the firm a finder\xe2\x80\x99s fee. The principal then refused to pay the firm\nthe promised $50,000, and the firm brought suit to recover the fee. May the firm recover the fee? Why?\n4.\n\nBased on his experience working for the CIA, a former CIA agent published a book about certain CIA\nactivities in South Vietnam. The CIA did not approve of the publication of the book although, as a\ncondition of his employment, the agent had agreed not to publish any information relating to the CIA\nwithout specific approval of the agency. The government brought suit against the agent, claiming that all\nthe agent\xe2\x80\x99s profits from publishing the book should go to the government. Assuming that the government\nsuffered only nominal damages because the agent published no classified information, will the\ngovernment prevail? Why?\n\n5.\n\nUpon graduation from college, Edison was hired by a major chemical company. During the time when he\nwas employed by the company, Edison discovered a synthetic oil that could be manufactured at a very\nlow cost. What rights, if any, does Edison\xe2\x80\x99s employer have to the discovery? Why?\n\n6.\n\nA US company hired MacDonald to serve as its resident agent in Bolivia. MacDonald entered into a\ncontract to sell cars to Bolivia and personally guaranteed performance of the contract as required by\nBolivian law. The cars delivered to Bolivia were defective, and Bolivia recovered a judgment of $83,000\nfrom MacDonald. Must the US company reimburse MacDonald for this amount? Explain.\n\n7.\n\nAccording to the late Professor William L. Prosser, \xe2\x80\x9cThe theory underlying the workmen\xe2\x80\x99s compensation\nacts never has been stated better than in the old campaign slogan, \xe2\x80\x98The cost of the product should bear\nthe blood of the workman.\xe2\x80\x99\xe2\x80\x9d What is meant by this statement?\n\n8.\n\nAn employee in a Rhode Island foundry inserted two coins in a coin-operated coffee machine in the\ncompany cafeteria. One coin stuck in the machine, and the worker proceeded to \xe2\x80\x9cwhack\xe2\x80\x9d the machine\nwith his right arm. The arm struck a grate near the machine, rupturing the biceps muscle and causing a 10\npercent loss in the use of the arm. Is the worker entitled to workers\xe2\x80\x99 compensation? Explain.\n\n9.\n\nPaulson engaged Arthur to sell Paul\xe2\x80\x99s restored 1948 Packard convertible to Byers for $23,000. A few days\nlater, Arthur saw an advertisement showing that Collector was willing to pay $30,000 for a 1948 Packard\nconvertible in \xe2\x80\x9crestored\xe2\x80\x9d condition. Arthur sold the car to Byers, and subsequently Paulson learned of\nCollector\xe2\x80\x99s interest. What rights, if any, has Paulson against Arthur?\n\nSELF-TEST QUESTIONS\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n655\n\n\x0c1.\n\nOne who has authority to act only in a specifically designated instance or in a specifically\ndesignated set of transactions is called\na.\n\na subagent\n\nb.\n\na general agent\n\nc.\n\na special agent\n\nd.\n\nnone of the above\nAn agency relationship may be created by\n\na.\n\ncontract\nb.\n\noperation of law\n\nc.\n\nan oral agreement\n\nd.\n\nall of the above\nAn agent\xe2\x80\x99s duty to the principal includes\n\na.\n\nthe duty to indemnify\nb.\n\nthe duty to warn of special dangers\n\nc.\n\nthe duty to avoid self dealing\n\nd.\n\nall of the above\n\nA person whose work is not subject to the control of the principal, but who arranges to perform\na job for him is called\na.\n\na subagent\nb.\n\na servant\n\nc.\n\na special agent\n\nd.\n\nan independent contractor\nAn employer\xe2\x80\x99s liability for employees\xe2\x80\x99 on-the-job injuries is generally governed by\n\na.\n\ntort law\nb.\n\nthe workers\xe2\x80\x99 compensation system\n\nc.\n\nSocial Security\n\nd.\n\nnone of the above\n\nSELF-TEST ANSWERS\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n656\n\n\x0c1. c\n2. d\n3. c\n4. d\n5. b\n\nChapter 19\n\nLiability of Principal and Agent; Termination of Agency\nLEARNING OBJECTIVES\nAfter reading this chapter, you should understand the following:\n1.\n\nThe principal\xe2\x80\x99s liability in contract\n\n2.\n\nThe principal\xe2\x80\x99s liability in tort\n\n3.\n\nThe principal\xe2\x80\x99s criminal liability\n\n4.\n\nThe agent\xe2\x80\x99s personal liability in tort and contract\n\n5.\n\nHow agency relationships are terminated\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n657\n\n\x0cIn Chapter 18 "Relationships between Principal and Agent" we considered the relationships between\nagent and principal. Now we turn to relationships between third parties and the principal or agent.\nWhen the agent makes a contract for his principal or commits a tort in the course of his work, is the\nprincipal liable? What is the responsibility of the agent for torts committed and contracts entered\ninto on behalf of his principal? How may the relationship be terminated so that the principal or agent\nwill no longer have responsibility toward or liability for the acts of the other? These are the questions\naddressed in this chapter.\n\n19.1 Principal\xe2\x80\x99s Contract Liability\n\nLEARNING OBJECTIVES\n\n1.\n\nUnderstand that the principal\xe2\x80\x99s liability depends on whether the agent was authorized to make the\ncontract.\n\n2.\n\nRecognize how the agent\xe2\x80\x99s authority is acquired: expressly, impliedly, or apparently.\n\n3.\n\nKnow that the principal may also be liable\xe2\x80\x94even if the agent had no authority\xe2\x80\x94if the principal ratifies\nthe agent\xe2\x80\x99s contract after the fact.\n\nPrincipal\xe2\x80\x99s Contract Liability Requires That Agent Had Authority\nThe key to determining whether a principal is liable for contracts made by his agent is authority: was the\nagent authorized to negotiate the agreement and close the deal? Obviously, it would not be sensible to\nhold a contractor liable to pay for a whole load of lumber merely because a stranger wandered into the\nlumberyard saying, \xe2\x80\x9cI\xe2\x80\x99m an agent for ABC Contractors; charge this to their account.\xe2\x80\x9d To be liable, the\nprincipal must have authorized the agent in some manner to act in his behalf, and that authorization must\nbe communicated to the third party by the principal.\n\nTypes of Authority\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n658\n\n\x0cThere are three types of authority: express, implied, and apparent (see Figure 19.1 "Types of Authority").\nWe will consider each in turn.\n\nExpress Authority\nThe strongest form of authority is that which is expressly granted, often in written form. The principal\nconsents to the agent\xe2\x80\x99s actions, and the third party may then rely on the document attesting to the agent\xe2\x80\x99s\nauthority to deal on behalf of the principal. One common form of express authority is the standard\nsignature card on file with banks allowing corporate agents to write checks on the company\xe2\x80\x99s credit. The\nprincipal bears the risk of any wrongful action of his agent, as demonstrated in Allen A. Funt Productions,\nInc. v. Chemical Bank.\n\n[1]\n\nAllen A. Funt submitted to his bank through his production company various\n\ncertificates permitting his accountant to use the company\xe2\x80\x99s checking accounts.\n\n[2]\n\nIn fact, for several years\n\nthe accountant embezzled money from the company by writing checks to himself and depositing them in\nhis own account. The company sued its bank, charging it with negligence, apparently for failing to monitor\nthe amount of money taken by the accountant. But the court dismissed the negligence complaint, citing a\nstate statute based on the common-law agency principle that a third party is entitled to rely on the express\nauthorization given to an agent; in this case, the accountant drew checks on the account within the\nmonetary limits contained in the signature cards on file with the bank. Letters of introduction and work\norders are other types of express authority.\n\nFigure 19.1 Types of Authority\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n659\n\n\x0cImplied Authority\nNot every detail of an agent\xe2\x80\x99s work can be spelled out. It is impossible to delineate step-by-step the duties\nof a general agent; at best, a principal can set forth only the general nature of the duties that the agent is\nto perform. Even a special agent\xe2\x80\x99s duties are difficult to describe in such detail as to leave him without\ndiscretion. If express authority were the only valid kind, there would be no efficient way to use an agent,\nboth because the effort to describe the duties would be too great and because the third party would be\nreluctant to deal with him.\nBut the law permits authority to be \xe2\x80\x9cimplied\xe2\x80\x9d by the relationship of the parties, the nature and customs of\nthe business, the circumstances surrounding the act in question, the wording of the agency contract, and\nthe knowledge that the agent has of facts relevant to the assignment. The general rule is that the agent has\nimplied or \xe2\x80\x9cincidental\xe2\x80\x9d authority to perform acts incidental to or reasonably necessary to carrying out the\ntransaction. Thus if a principal instructs her agent to \xe2\x80\x9cdeposit a check in the bank today,\xe2\x80\x9d the agent has\nauthority to drive to the bank unless the principal specifically prohibits the agent from doing so.\nThe theory of implied authority is especially important to business in the realm of the business manager,\nwho may be charged with running the entire business operation or only a small part of it. In either event,\nthe business manager has a relatively large domain of implied authority. He can buy goods and services;\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n660\n\n\x0chire, supervise, and fire employees; sell or junk inventory; take in receipts and pay debts; and in general,\ndirect the ordinary operations of the business. The full extent of the manager\xe2\x80\x99s authority depends on the\ncircumstances\xe2\x80\x94what is customary in the particular industry, in the particular business, and among the\nindividuals directly concerned.\nOn the other hand, a manager does not have implicit authority to undertake unusual or extraordinary\nactions on behalf of his principal. In the absence of express permission, an agent may not sell part of the\nbusiness, start a new business, change the nature of the business, incur debt (unless borrowing is integral\nto the business, as in banking, for example), or move the business premises. For example, the owner of a\nhotel appoints Andy manager; Andy decides to rename the hotel and commissions an artist to prepare a\nnew logo for the hotel\xe2\x80\x99s stationery. Andy has no implied authority to change the name or to commission\nthe artist, though he does have implied authority to engage a printer to replenish the stationery supply\xe2\x80\x94\nand possibly to make some design changes in the letterhead.\nEven when there is no implied authority, in an emergency the agent may act in ways that would in the\nnormal course require specific permission from the principal. If unforeseen circumstances arise and it is\nimpracticable to communicate with the principal to find out what his wishes would be, the agent may do\nwhat is reasonably necessary in order to prevent substantial loss to his principal. During World War II,\nEastern Wine Corporation marketed champagne in a bottle with a diagonal red stripe that infringed the\ntrademark of a French producer. The French company had granted licenses to an American importer to\nmarket its champagne in the United States. The contract between producer and importer required the\nlatter to notify the French company whenever a competitor appeared to be infringing its rights and to\nrecommend steps by which the company could stop the infringement. The authority to institute suit was\nnot expressly conferred, and ordinarily the right to do so would not be inferred. Because France was under\nGerman occupation, however, the importer was unable to communicate with the producer, its principal.\nThe court held that the importer could file suit to enjoin Eastern Wine from continuing to display the\ninfringing red diagonal stripe, since legal action was \xe2\x80\x9cessential to the preservation of the principal\xe2\x80\x99s\nproperty.\xe2\x80\x9d\n\n[3]\n\nThe rule that a person\xe2\x80\x99s position can carry with it implied authority is fundamental to American business\npractice. But outside the United States this rule is not applicable, and the business executive traveling\nabroad should be aware that in civil-law countries it is customary to present proof of authority to transact\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n661\n\n\x0ccorporate business\xe2\x80\x94usually in the form of a power of attorney. This is not always an easy task. Not only\nmust the power of the traveling executive be shown but the right of the corporate officer back in the\nUnited States to delegate authority must also be proven.\n\nApparent Authority\nIn the agency relationship, the agent\xe2\x80\x99s actions in dealing with third parties will affect the legal rights of the\nprincipal. What the third party knows about the agency agreement is irrelevant to the agent\xe2\x80\x99s legal\nauthority to act. That authority runs from principal to agent. As long as an agent has authorization, either\nexpress or implied, she may bind the principal legally. Thus the seller of a house may be ignorant of the\nbuyer\xe2\x80\x99s true identity; the person he supposes to be the prospective purchaser might be the agent of an\nundisclosed principal. Nevertheless, if the agent is authorized to make the purchase, the seller\xe2\x80\x99s ignorance\nis not a ground for either seller or principal to void the deal.\nBut if a person has no authority to act as an agent, or an agent has no authority to act in a particular way,\nis the principal free from all consequences? The answer depends on whether or not the agent\nhas apparent authority\xe2\x80\x94that is, on whether or not the third person reasonably believes from the\nprincipal\xe2\x80\x99s words, written or spoken, or from his conduct that he has in fact consented to the agent\xe2\x80\x99s\nactions. Apparent authority is a manifestation of authority communicated to the third person; it runs from\nprincipal to third party, not to the agent.\nApparent authority is sometimes said to be based on the principle of estoppel. Estoppel is the doctrine\nthat a person will not now be allowed to deny a promise or assertion she previously made where there has\nbeen detrimental reliance on that promise or assertion. Estoppel is commonly used to avoid injustice. It\nmay be a substitute for the requirement of consideration in contract (making the promise of a gift\nenforceable where the donee has relied upon the promise), and it is sometimes available to circumvent the\nrequirement of a writing under the Statute of Frauds.\nApparent authority can arise from prior business transactions. On July 10, Meggs sold to Buyer his\nbusiness, the right to use the trade name Rose City Sheet Metal Works, and a list of suppliers he had used.\nThree days later, Buyer began ordering supplies from Central Supply Company, which was on Meggs\xe2\x80\x99s list\nbut with which Meggs had last dealt four years before. On September 3, Central received a letter from\nMeggs notifying it of Meggs\xe2\x80\x99s sale of the business to Buyer. Buyer failed to pay Central, which sued Meggs.\nThe court held that Rose City Sheet Metal Works had apparent authority to buy on Meggs\xe2\x80\x99s credit; Meggs\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n662\n\n\x0c[4]\n\nwas liable for supplies purchased between July 10 and September 3. In such cases, and in cases\ninvolving the firing of a general manager, actual notice should be given promptly to all customers. See the\ndiscussion ofKanavos v. Hancock Bank & Trust Company in Section 19.4.1 "Implied Authority".\n\nRatification\nEven if the agent possessed no actual authority and there was no apparent authority on which the third\nperson could rely, the principal may still be liable if he ratifies or adopts the agent\xe2\x80\x99s acts before the third\nperson withdraws from the contract. Ratification usually relates back to the time of the undertaking,\ncreating authority after the fact as though it had been established initially. Ratification is a voluntary act\nby the principal. Faced with the results of action purportedly done on his behalf but without authorization\nand through no fault of his own, he may affirm or disavow them as he chooses. To ratify, the principal may\ntell the parties concerned or by his conduct manifest that he is willing to accept the results as though the\nact were authorized. Or by his silence he may find under certain circumstances that he has ratified. Note\nthat ratification does not require the usual consideration of contract law. The principal need be promised\nnothing extra for his decision to affirm to be binding on him. Nor does ratification depend on the position\nof the third party; for example, a loss stemming from his reliance on the agent\xe2\x80\x99s representations is not\nrequired. In most situations, ratification leaves the parties where they expected to be, correcting the\nagent\xe2\x80\x99s errors harmlessly and giving each party what was expected.\n\nKEY TAKEAWAY\n\nThe principal is liable on an agent\xe2\x80\x99s contract only if the agent was authorized by the principal to make the\ncontract. Such authority is express, implied, or apparent. Express means made in words, orally or in\nwriting; implied means the agent has authority to perform acts incidental to or reasonably necessary to\ncarrying out the transaction for which she has express authority. Apparent authority arises where the\nprincipal gives the third party reason to believe that the agent had authority. The reasonableness of the\nthird party\xe2\x80\x99s belief is based on all the circumstances\xe2\x80\x94all the facts. Even if the agent has no authority, the\nprincipal may, after the fact, ratify the contract made by the agent.\n\nEXERCISES\n\n1.\n\nCould express authority be established by silence on the part of the principal?\n\n2.\n\nWhy is the concept of implied authority very important in business situations?\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n663\n\n\x0c3.\n\nWhat is the rationale for the doctrine of apparent authority\xe2\x80\x94that is, why would the law impose a\ncontract on a \xe2\x80\x9cprincipal\xe2\x80\x9d when in fact there was no principal-agent relationship with the \xe2\x80\x9cagent\xe2\x80\x9d at all?\n4.\n\n[1] Allen A. Funt Productions, Inc. v. Chemical Bank, 405 N.Y.S.2d 94 (1978).\n\n5.\n\n[2] Allen Funt (1914\xe2\x80\x9399) was an American television producer, director, and writer, best known as the\ncreator and host of Candid Camera from the 1940s to 1980s, which was broadcast as either a regular\nshow or a series of specials. Its most notable run was from 1960 to 1967 on CBS.\n\n6.\n\n[3] G. H. Mumm Champagne v. Eastern Wine Corp., 52 F.Supp. 167 (S.D.N.Y. 1943).\n\n7.\n\n[4] Meggs v. Central Supply Co., 307 N.E.2d 288 (Ind. App. 1974).\n\n19.2 Principal\xe2\x80\x99s Tort and Criminal Liability\nLEARNING OBJECTIVES\n\n1.\n\nUnderstand in what circumstances a principal will be vicariously liable for torts committed by employees.\n\n2.\n\nRecognize the difference between agents whose tort and criminal liability may be imputed to the\nemployer and those whose liability will not be so imputed.\n\n3.\n\nKnow when the principal will be vicariously liable for intentional torts committed by the agent.\n\n4.\n\nExplain what is meant by \xe2\x80\x9cthe scope of employment,\xe2\x80\x9d within which the agent\xe2\x80\x99s actions may be attributed\nto the principal and without which they will not.\n\n5.\n\nName special cases of vicarious liability.\n\n6.\n\nDescribe the principal\xe2\x80\x99s liability for crimes committed by the agent.\n\nPrincipal\xe2\x80\x99s Tort Liability\nThe Distinction between Direct and Vicarious Liability\nWhen is the principal liable for injuries that the agent causes another to suffer?\n\nDirect Liability\nThere is a distinction between torts prompted by the principal himself and torts of which the principal\nwas innocent. If the principal directed the agent to commit a tort or knew that the consequences of the\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n664\n\n\x0cagent\xe2\x80\x99s carrying out his instructions would bring harm to someone, the principal is liable. This is an\napplication of the general common-law principle that one cannot escape liability by delegating an\nunlawful act to another. The syndicate that hires a hitman is as culpable of murder as the man who pulls\nthe trigger. Similarly, a principal who is negligent in his use of agents will be held liable for their\nnegligence. This rule comes into play when the principal fails to supervise employees adequately, gives\nfaulty directions, or hires incompetent or unsuitable people for a particular job. Imposing liability on the\nprincipal in these cases is readily justifiable since it is the principal\xe2\x80\x99s own conduct that is the underlying\nfault; the principal here is directly liable.\n\nVicarious Liability\nBut the principle of liability for one\xe2\x80\x99s agent is much broader, extending to acts of which the principal had\nno knowledge, that he had no intention to commit nor involvement in, and that he may in fact have\nexpressly prohibited the agent from engaging in. This is the principle of respondeat superior (\xe2\x80\x9clet the\nmaster answer\xe2\x80\x9d) or the master-servant doctrine, which imposes on the\nprincipal vicarious liability (vicarious means \xe2\x80\x9cindirectly, as, by, or through a substitute\xe2\x80\x9d) under which the\nprincipal is responsible for acts committed by the agent within the scope of the employment (see ).\nFigure 19.2 Principal\xe2\x80\x99s Tort Liability\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n665\n\n\x0cThe modern basis for vicarious liability is sometimes termed the \xe2\x80\x9cdeep pocket\xe2\x80\x9d theory: the principal\n(usually a corporation) has deeper pockets than the agent, meaning that it has the wherewithal to pay for\nthe injuries traceable one way or another to events it set in motion. A million-dollar industrial accident is\nwithin the means of a company or its insurer; it is usually not within the means of the agent\xe2\x80\x94employee\xe2\x80\x94\nwho caused it.\nThe \xe2\x80\x9cdeep pocket\xe2\x80\x9d of the defendant-company is not always very deep, however. For many small\nbusinesses, in fact, the principle of respondeat superior is one of life or death. One example was the\nclosing in San Francisco of the much-beloved Larraburu Brothers Bakery\xe2\x80\x94at the time, the world\xe2\x80\x99s second\nlargest sourdough bread maker. The bakery was held liable for $2 million in damages after one of its\ndelivery trucks injured a six-year-old boy. The bakery\xe2\x80\x99s insurance policy had a limit of $1.25 million, and\nthe bakery could not absorb the excess. The Larraburus had no choice but to cease operations.\n(Seehttp://www.outsidelands.org/larraburu.php.)\nRespondeat superior raises three difficult questions: (1) What type of agents can create tort liability for\nthe principal? (2) Is the principal liable for the agent\xe2\x80\x99s intentional torts? (3) Was the agent acting within\nthe scope of his employment? We will consider these questions in turn.\n\nAgents for Whom Principals Are Vicariously Liable\nIn general, the broadest liability is imposed on the master in the case of tortious physical conduct by a\nservant, as discussed in . If the servant acted within the scope of his employment\xe2\x80\x94that is, if the servant\xe2\x80\x99s\nwrongful conduct occurred while performing his job\xe2\x80\x94the master will be liable to the victim for damages\nunless, as we have seen, the victim was another employee, in which event the workers\xe2\x80\x99 compensation\nsystem will be invoked. Vicarious tort liability is primarily a function of the employment relationship and\nnot agency status.\nOrdinarily, an individual or a company is not vicariously liable for the tortious acts of independent\ncontractors. The plumber who rushes to a client\xe2\x80\x99s house to repair a leak and causes a traffic accident does\nnot subject the homeowner to liability. But there are exceptions to the rule. Generally, these exceptions\nfall into a category of duties that the law deems nondelegable. In some situations, one person is obligated\nto provide protection to or care for another. The failure to do so results in liability whether or not the\nharm befell the other because of an independent contractor\xe2\x80\x99s wrongdoing. Thus a homeowner has a duty\nto ensure that physical conditions in and around the home are not unreasonably dangerous. If the owner\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n666\n\n\x0chires an independent contracting firm to dig a sewer line and the contractor negligently fails to guard\npassersby against the danger of falling into an open trench, the homeowner is liable because the duty of\ncare in this instance cannot be delegated. (The contractor is, of course, liable to the homeowner for any\ndamages paid to an injured passerby.)\n\nLiability for Agent\xe2\x80\x99s Intentional Torts\nIn the nineteenth century, a principal was rarely held liable for intentional wrongdoing by the agent if the\nprincipal did not command the act complained of. The thought was that one could never infer authority to\ncommit a willfully wrongful act. Today, liability for intentional torts is imputed to the principal if the\nagent is acting to further the principal\xe2\x80\x99s business. See the very disturbing Lyon v. Carey in .\n\nDeviations from Employment\nThe general rule is that a principal is liable for torts only if the servant committed them \xe2\x80\x9cin the scope of\nemployment.\xe2\x80\x9d But determining what this means is not easy.\n\nThe \xe2\x80\x9cScope of Employment\xe2\x80\x9d Problem\nIt may be clear that the person causing an injury is the agent of another. But a principal cannot be\nresponsible for every act of an agent. If an employee is following the letter of his instructions, it will be\neasy to determine liability. But suppose an agent deviates in some way from his job. The classic test of\nliability was set forth in an 1833 English case, Joel v. Morrison.\n\n[1]\n\nThe plaintiff was run over on a highway\n\nby a speeding cart and horse. The driver was the employee of another, and inside was a fellow employee.\nThere was no question that the driver had acted carelessly, but what he and his fellow employee were\ndoing on the road where the plaintiff was injured was disputed. For weeks before and after the accident,\nthe cart had never been driven in the vicinity in which the plaintiff was walking, nor did it have any\nbusiness there. The suggestion was that the employees might have gone out of their way for their own\npurposes. As the great English jurist Baron Parke put it, \xe2\x80\x9cIf the servants, being on their master\xe2\x80\x99s business,\ntook a detour to call upon a friend, the master will be responsible.\xe2\x80\xa6But if he was going on a frolic of his\nown, without being at all on his master\xe2\x80\x99s business, the master will not be liable.\xe2\x80\x9d In applying this test, the\ncourt held the employer liable.\nThe test is thus one of degree, and it is not always easy to decide when a detour has become so great as to\nbe transformed into a frolic. For a time, a rather mechanical rule was invoked to aid in making the\ndecision. The courts looked to the servant\xe2\x80\x99s purposes in \xe2\x80\x9cdetouring.\xe2\x80\x9d If the servant\xe2\x80\x99s mind was fixed on\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n667\n\n\x0caccomplishing his own purposes, then the detour was held to be outside the scope of employment; hence\nthe tort was not imputed to the master. But if the servant also intended to accomplish his master\xe2\x80\x99s\npurposes during his departure from the letter of his assignment, or if he committed the wrong while\nreturning to his master\xe2\x80\x99s task after the completion of his frolic, then the tort was held to be within the\nscope of employment.\nThis test is not always easy to apply. If a hungry deliveryman stops at a restaurant outside the normal\nlunch hour, intending to continue to his next delivery after eating, he is within the scope of employment.\nBut suppose he decides to take the truck home that evening, in violation of rules, in order to get an early\nstart the next morning. Suppose he decides to stop by the beach, which is far away from his route. Does it\nmake a difference if the employer knows that his deliverymen do this?\n\nThe Zone of Risk Test\nCourt decisions in the last forty years have moved toward a different standard, one that looks to the\nforeseeability of the agent\xe2\x80\x99s conduct. By this standard, an employer may be held liable for his employee\xe2\x80\x99s\nconduct even when devoted entirely to the employee\xe2\x80\x99s own purposes, as long as it was foreseeable that the\nagent might act as he did. This is the \xe2\x80\x9czone of risk\xe2\x80\x9d test. The employer will be within the zone of risk for\nvicarious liability if the employee is where she is supposed to be, doing\xe2\x80\x94more or less\xe2\x80\x94what she is\nsupposed to be doing, and the incident arose from the employee\xe2\x80\x99s pursuit of the employer\xe2\x80\x99s interest\n(again, more or less). That is, the employer is within the zone of risk if the servant is in the place within\nwhich, if the master were to send out a search party to find a missing employee, it would be reasonable to\nlook. See Section 4, Cockrell v. Pearl River Valley Water Supply Dist.\n\nSpecial Cases of Vicarious Liability\nVicarious liability is not limited to harm caused in the course of an agency relationship. It may also be\nimposed in other areas, including torts of family members, and other torts governed by statute or\nregulation. We will examine each in turn.\n\nUse of Automobiles\nA problem commonly arises when an automobile owner lends his vehicle to a personal friend, someone\nwho is not an agent, and the borrower injures a third person. Is the owner liable? In many states, the\nowner is not liable; in other states, however, two approaches impose liability on the owner.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n668\n\n\x0cThe first approach is legislative: owner\xe2\x80\x99s consent statutes make the owner liable when the automobile is\nbeing driven with his consent or knowledge. The second approach to placing liability on the owner is\njudicial and known as the family purpose doctrine. Under this doctrine, a family member who negligently\ninjures someone with the car subjects the owner to liability if the family member was furthering family\npurposes. These are loosely defined to include virtually every use to which a child, for example, might put\na car. In a Georgia case, Dixon v. Phillips, the father allowed his minor son to drive the car but expressly\nforbade him from letting anyone else do so.\n\n[2]\n\nNevertheless, the son gave the wheel to a friend and a\n\ncollision occurred while both were in the car. The court held the father liable because he made the car\navailable for the pleasure and convenience of his son and other family members.\n\nTorts of Family Members\nAt common law, the husband was liable for the torts of his wife, not because she was considered an agent\nbut because she was considered to be an extension of him. \xe2\x80\x9cHusband and wife were only one person in\nlaw,\xe2\x80\x9d\n\n[3]\n\nsays Holmes, and any act of the wife was supposed to have been done at the husband\xe2\x80\x99s direction\n\n(to which Mr. Dickens\xe2\x80\x99s Mr. Bumble responded, in the memorable line, \xe2\x80\x9cIf the law supposes that, the law\n[4]\n\nis a ass\xe2\x80\x94a idiot\xe2\x80\x9d ). This ancient view has been abrogated by statute or by court ruling in all the states, so\nthat now a wife is solely responsible for her own torts unless she in fact serves as her husband\xe2\x80\x99s agent.\nUnlike wives, children are not presumed at common law to be agents or extensions of the father so that\nnormally parents are not vicariously liable for their children\xe2\x80\x99s torts. However, they can be held liable for\nfailing to control children known to be dangerous.\nMost states have statutorily changed the common-law rule, making parents responsible for willful or\nmalicious tortious acts of their children whether or not they are known to be mischief-makers. Thus the\nIllinois Parental Responsibility Law provides the following: \xe2\x80\x9cThe parent or legal guardian of an\nunemancipated minor who resides with such parent or legal guardian is liable for actual damages for the\nwillful or malicious acts of such minor which cause injury to a person or property.\xe2\x80\x9d\n\n[5]\n\nSeveral other states\n\nimpose a monetary limit on such liability.\n\nOther Torts Governed by Statute or Regulation\nThere are certain types of conduct that statutes or regulation attempt to control by placing the burden of\nliability on those presumably in a position to prevent the unwanted conduct. An example is the\n\xe2\x80\x9cDramshop Act,\xe2\x80\x9d which in many states subjects the owner of a bar to liability if the bar continues to serve\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n669\n\n\x0can intoxicated patron who later is involved in an accident while intoxicated. Another example involves the\nsale of adulterated or short-weight foodstuffs: the employer of one who sells such may be liable, even if\nthe employer did not know of the sales.\n\nPrincipal\xe2\x80\x99s Criminal Liability\nAs a general proposition, a principal will not be held liable for an agent\xe2\x80\x99s unauthorized criminal acts if the\ncrimes are those requiring specific intent. Thus a department store proprietor who tells his chief buyer to\nget the \xe2\x80\x9cbest deal possible\xe2\x80\x9d on next fall\xe2\x80\x99s fashions is not liable if the buyer steals clothes from the\nmanufacturer. A principal will, however, be liable if the principal directed, approved, or participated in\nthe crime. Cases here involve, for example, a corporate principal\xe2\x80\x99s liability for agents\xe2\x80\x99 activity in antitrust\nviolations\xe2\x80\x94price-fixing is one such violation.\nThere is a narrow exception to the broad policy of immunity. Courts have ruled that under certain\nregulatory statutes and regulations, an agent\xe2\x80\x99s criminality may be imputed to the principal, just as civil\nliability is imputed under Dramshop Acts. These include pure food and drug acts, speeding ordinances,\nbuilding regulations, child labor rules, and minimum wage and maximum hour legislation. Misdemeanor\ncriminal liability may be imposed upon corporations and individual employees for the sale or shipment of\nadulterated food in interstate commerce, notwithstanding the fact that the defendant may have had no\nactual knowledge that the food was adulterated at the time the sale or shipment was made.\n\nKEY TAKEAWAY\n\nThe principal will be liable for the employee\xe2\x80\x99s torts in two circumstances: first, if the principal was directly\nresponsible, as in hiring a person the principal knew or should have known was incompetent or dangerous;\nsecond, if the employee committed the tort in the scope of business for the principal. This is the masterservant doctrine or respondeat superior. It imposes vicarious liability on the employer: the master\n(employer) will be liable if the employee was in the zone of activity creating a risk for the employer (\xe2\x80\x9czone\nof risk\xe2\x80\x9d test), that is\xe2\x80\x94generally\xe2\x80\x94if the employee was where he was supposed to be, when he was\nsupposed to be there, and the incident arose out of the employee\xe2\x80\x99s interest (however perverted) in\npromoting the employer\xe2\x80\x99s business.\nSpecial cases of vicarious liability arise in several circumstances. For example, the owner of an automobile\nmay be liable for torts committed by one who borrows it, or if it is\xe2\x80\x94even if indirectly\xe2\x80\x94used for family\npurposes. Parents are, by statute in many states, liable for their children\xe2\x80\x99s torts. Similarly by statute, the\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n670\n\n\x0csellers and employers of sellers of alcohol or adulterated or short-weight foodstuffs may be liable. The\nemployer of one who commits a crime is not usually liable unless the employer put the employee up to\nthe crime or knew that a crime was being committed. But some prophylactic statutes impose liability on\nthe employer for the employee\xe2\x80\x99s crime\xe2\x80\x94even if the employee had no intention to commit it\xe2\x80\x94as a means\nto force the employer to prevent such actions.\n\nEXERCISES\n\n1.\n\nWhat is the difference between direct and vicarious employer tort liability?\n\n2.\n\nWhat is meant by the \xe2\x80\x9czone of risk\xe2\x80\x9d test?\n\n3.\n\nUnder what circumstances will an employer be liable for intentional torts of the employee?\n\n4.\n\nWhen will the employer be liable for an employee\xe2\x80\x99s criminal acts?\n5.\n\n[1] Joel v. Morrison, 6 Carrington & Payne 501.\n\n6.\n\n[2] Dixon v. Phillips, 217 S.E.2d 331 (Ga. 1975).\n\n7.\n\n[3] O.W. Holmes, Agency, 4 Harvard Law Rev. 353 (1890\xe2\x80\x9391).\n\n8.\n\n[4] Charles Dickens, Oliver Twist, (London: 1838), chap 51.\n\n9.\n\n[5] Ill. Rev. Stat. (2005), chapter 70, paragraph\n51.http://law.justia.com/illinois/codes/2005/chapter57/2045.html.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n671\n\n\x0c19.3 Agent\xe2\x80\x99s Personal Liability for Torts and Contracts;\nTermination of Agency\nLEARNING OBJECTIVES\n\n1.\n\nUnderstand the agent\xe2\x80\x99s personal liability for tort.\n\n2.\n\nUnderstand the agent\xe2\x80\x99s personal liability for contract.\n\n3.\n\nRecognize the ways the agency relationship is terminated.\n\nAgent\xe2\x80\x99s Personal Liability for Torts and Contracts\nTort Liability\nThat a principal is held vicariously liable and must pay damages to an injured third person does not\nexcuse the agent who actually committed the tortious acts. A person is always liable for his or her own\ntorts (unless the person is insane, involuntarily intoxicated, or acting under extreme duress). The agent is\npersonally liable for his wrongful acts and must reimburse the principal for any damages the principal was\nforced to pay, as long as the principal did not authorize the wrongful conduct. The agent directed to\ncommit a tort remains liable for his own conduct but is not obliged to repay the principal. Liability as an\nagent can be burdensome, sometimes perhaps more burdensome than as a principal. The latter normally\npurchases insurance to cover against wrongful acts of agents, but liability insurance policies frequently do\nnot cover the employee\xe2\x80\x99s personal liability if the employee is named in a lawsuit individually. Thus\ndoctors\xe2\x80\x99 and hospitals\xe2\x80\x99 malpractice policies protect a doctor from both her own mistakes and those of\nnurses and others that the doctor would be responsible for; nurses, however, might need their own\ncoverage. In the absence of insurance, an agent is at serious risk in this lawsuit-conscious age. The risk is\nnot total. The agent is not liable for torts of other agents unless he is personally at fault\xe2\x80\x94for example, by\nnegligently supervising a junior or by giving faulty instructions. For example, an agent, the general\nmanager for a principal, hires Brown as a subordinate. Brown is competent to do the job but by failing to\nexercise proper control over a machine negligently injures Ted, a visitor to the premises. The principal\nand Brown are liable to Ted, but the agent is not.\n\nContract Liability\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n672\n\n\x0cIt makes sense that an agent should be liable for her own torts; it would be a bad social policy indeed if a\nperson could escape tort liability based on her own fault merely because she acted in an agency capacity. It\nalso makes sense that\xe2\x80\x94as is the general rule\xe2\x80\x94an agent is not liable on contracts she makes on the\nprincipal\xe2\x80\x99s behalf; the agent is not a party to a contract made by the agent on behalf of the principal. No\npublic policy would be served by imposing liability, and in many cases it would not make sense. Suppose\nan agent contracts to buy $25 million of rolled aluminum for a principal, an airplane manufacturer. The\nagent personally could not reasonably perform such contract, and it is not intended by the parties that she\nshould be liable. (Although the rule is different in England, where an agent residing outside the country is\nliable even if it is clear that he is signing in an agency capacity.) But there are three exceptions to this rule:\n(1) if the agent is undisclosed or partially disclosed, (2) if the agent lacks authority or exceeds it, or (3) if\nthe agent entered into the contract in a personal capacity. We consider each situation.\n\nAgent for Undisclosed or Partially Disclosed Principal\nAn agent need not, and frequently will not, inform the person with whom he is negotiating that he is\nacting on behalf of a principal. The secret principal is usually called an \xe2\x80\x9cundisclosed principal.\xe2\x80\x9d Or the\nagent may tell the other person that he is acting as an agent but not disclose the principal\xe2\x80\x99s name, in\nwhich event the principal is \xe2\x80\x9cpartially disclosed.\xe2\x80\x9d To understand the difficulties that may occur, consider\nthe following hypothetical but common example. A real estate developer known for building amusement\nparks wants to acquire several parcels of land to construct a new park. He wants to keep his identity secret\nto hold down the land cost. If the landowners realized that a major building project was about to be\nlaunched, their asking price would be quite high. So the developer obtains two options to purchase land by\nusing two secret agents\xe2\x80\x94Betty and Clem.\nBetty does not mention to sellers that she is an agent; therefore, to those sellers the developer is an\nundisclosed principal. Clem tells those with whom he is dealing that he is an agent but refuses to divulge\nthe developer\xe2\x80\x99s name or his business interest in the land. Thus the developer is, to the latter sellers, a\npartially disclosed principal. Suppose the sellers get wind of the impending construction and want to back\nout of the deal. Who may enforce the contracts against them?\nThe developer and the agents may sue to compel transfer of title. The undisclosed or partially disclosed\nprincipal may act to enforce his rights unless the contract specifically prohibits it or there is a\nrepresentation that the signatories are not signing for an undisclosed principal. The agents may also bring\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n673\n\n\x0csuit to enforce the principal\xe2\x80\x99s contract rights because, as agents for an undisclosed or partially disclosed\nprincipal, they are considered parties to their contracts.\nNow suppose the developer attempts to call off the deal. Whom may the sellers sue? Both the developer\nand the agents are liable. That the sellers had no knowledge of the developer\xe2\x80\x99s identity\xe2\x80\x94or even that there\nwas a developer\xe2\x80\x94does not invalidate the contract. If the sellers first sue agent Betty (or Clem), they may\nstill recover the purchase price from the developer as long as they had no knowledge of his identity prior\nto winning the first lawsuit. The developer is discharged from liability if, knowing his identity, the\nplaintiffs persist in a suit against the agents and recover a judgment against them anyway. Similarly, if the\nseller sues the principal and recovers a judgment, the agents are relieved of liability. The seller thus has a\n\xe2\x80\x9cright of election\xe2\x80\x9d to sue either the agent or the undisclosed principal, a right that in many states may be\nexercised any time before the seller collects on the judgment.\n\nLack of Authority in Agent\nAn agent who purports to make a contract on behalf of a principal, but who in fact has no authority to do\nso, is liable to the other party. The theory is that the agent has warranted to the third party that he has the\nrequisite authority. The principal is not liable in the absence of apparent authority or ratification. But the\nagent does not warrant that the principal has capacity. Thus an agent for a minor is not liable on a\ncontract that the minor later disavows unless the agent expressly warranted that the principal had\nattained his majority. In short, the implied warranty is that the agent has authority to make a deal, not\nthat the principal will necessarily comply with the contract once the deal is made.\n\nAgent Acting on Own Account\nAn agent will be liable on contracts made in a personal capacity\xe2\x80\x94for instance, when the agent personally\nguarantees repayment of a debt. The agent\xe2\x80\x99s intention to be personally liable is often difficult to determine\non the basis of his signature on a contract. Generally, a person signing a contract can avoid personal\nliability only by showing that he was in fact signing as an agent. If the contract is signed \xe2\x80\x9cJones, Agent,\xe2\x80\x9d\nJones can introduce evidence to show that there was never an intention to hold him personally liable. But\nif he signed \xe2\x80\x9cJones\xe2\x80\x9d and neither his agency nor the principal\xe2\x80\x99s name is included, he will be personally\nliable. This can be troublesome to agents who routinely indorse checks and notes. There are special rules\ngoverning these situations, which are discussed in (Reference mayer_1.0-ch25 not found in Book) dealing\nwith commercial paper.\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n674\n\n\x0cTermination of Agency\nThe agency relationship is not permanent. Either by action of the parties or by law, the relationship will\neventually terminate.\n\nBy Act of the Parties\nCertainly the parties to an agency contract can terminate the agreement. As with the creation of the\nrelationship, the agreement may be terminated either expressly or implicitly.\n\nExpress Termination\nMany agreements contain specified circumstances whose occurrence signals the end of the agency. The\nmost obvious of these circumstances is the expiration of a fixed period of time (\xe2\x80\x9cagency to terminate at the\nend of three months\xe2\x80\x9d or \xe2\x80\x9con midnight, December 31\xe2\x80\x9d). An agreement may also terminate on the\naccomplishment of a specified act (\xe2\x80\x9con the sale of the house\xe2\x80\x9d) or following a specific event (\xe2\x80\x9cat the\nconclusion of the last horse race\xe2\x80\x9d).\nMutual consent between the parties will end the agency. Moreover, the principal may revoke the agency or\nthe agent may renounce it; such are vocation or renunciation of agency would be an express termination.\nEven a contract that states the agreement is irrevocable will not be binding, although it can be the basis\nfor a damage suit against the one who breached the agreement by revoking or renouncing it. As with any\ncontract, a person has the power to breach, even in absence of the right to do so. If the agency is coupled\nwith an interest, however, so that the authority to act is given to secure an interest that the agent has in\nthe subject matter of the agency, then the principal lacks the power to revoke the agreement.\n\nImplied Termination\nThere are a number of other circumstances that will spell the end of the relationship by implication.\nUnspecified events or changes in business conditions or the value of the subject matter of the agency\nmight lead to a reasonable inference that the agency should be terminated or suspended; for example, the\nprincipal desires the agent to buy silver but the silver market unexpectedly rises and silver doubles in\nprice overnight. Other circumstances that end the agency include disloyalty of the agent (e.g., he accepts\nan appointment that is adverse to his first principal or embezzles from the principal), bankruptcy of the\nagent or of the principal, the outbreak of war (if it is reasonable to infer that the principal, knowing of the\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n675\n\n\x0cwar, would not want the agent to continue to exercise authority), and a change in the law that makes a\ncontinued carrying out of the task illegal or seriously interferes with it.\n\nBy Operation of Law\nAside from the express termination (by agreement of both or upon the insistence of one), or the necessary\nor reasonable inferences that can be drawn from their agreements, the law voids agencies under certain\ncircumstances. The most frequent termination by operation of law is the death of a principal or an agent.\nThe death of an agent also terminates the authority of subagents he has appointed, unless the principal\nhas expressly consented to the continuing validity of their appointment. Similarly, if the agent or principal\nloses capacity to enter into an agency relationship, it is suspended or terminated. The agency terminates if\nits purpose becomes illegal.\nEven though authority has terminated, whether by action of the parties or operation of law, the principal\nmay still be subject to liability. Apparent authority in many instances will still exist; this is\ncalled lingering authority. It is imperative for a principal on termination of authority to notify all those\nwho may still be in a position to deal with the agent. The only exceptions to this requirement are when\ntermination is effected by death, loss of the principal\xe2\x80\x99s capacity, or an event that would make it impossible\nto carry out the object of the agency.\n\nKEY TAKEAWAY\nA person is always liable for her own torts, so an agent who commits a tort is liable; if the tort was in the\nscope of employment the principal is liable too. Unless the principal put the agent up to committing the\ntort, the agent will have to reimburse the principal. An agent is not generally liable for contracts made; the\nprincipal is liable. But the agent will be liable if he is undisclosed or partially disclosed, if the agent lacks\nauthority or exceeds it, or, of course, if the agent entered into the contract in a personal capacity.\nAgencies terminate expressly or impliedly or by operation of law. An agency terminates expressly by the\nterms of the agreement or mutual consent, or by the principal\xe2\x80\x99s revocation or the agent\xe2\x80\x99s renunciation. An\nagency terminates impliedly by any number of circumstances in which it is reasonable to assume one or\nboth of the parties would not want the relationship to continue. An agency will terminate by operation of\nlaw when one or the other party dies or becomes incompetent, or if the object of the agency becomes\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n676\n\n\x0cillegal. However, an agent may have apparent lingering authority, so the principal, upon termination of the\nagency, should notify those who might deal with the agent that the relationship is severed.\n\nEXERCISES\n\n1.\n\nPauline, the owner of a large bakery business, wishes to expand her facilities by purchasing the adjacent\nproperty. She engages Alice as an agent to negotiate the deal with the property owner but instructs her\nnot to tell the property owner that she\xe2\x80\x94Alice\xe2\x80\x94is acting as an agent because Pauline is concerned that\nthe property owner would demand a high price. A reasonable contract is made. When the economy\nsours, Pauline decides not to expand and cancels the plan. Who is liable for the breach?\n\n2.\n\nPeter, the principal, instructs his agent, Alice, to tour England and purchase antique dining room furniture\nfor Peter\xe2\x80\x99s store. Alice buys an antique bed set. Who is liable, Peter or Alice? Suppose the seller did not\nknow of the limit on Alice\xe2\x80\x99s authority and sells the bed set to Alice in good faith. What happens when\nPeter discovers he owes the seller for the set?\n\n3.\n\nUnder what circumstances will the agency terminate expressly?\n\n4.\n\nAgent is hired by Principal to sell a new drug, Phobbot. Six months later, as it becomes apparent that\nPhobbot has nasty side effects (including death), the Food and Drug Administration orders the drug pulled\nfrom the shelves. Agent\xe2\x80\x99s agency is terminated; what terminology is appropriate to describe how?\n\n5.\n\nPrincipal engages Agent to buy lumber, and in that capacity Agent deals with several large timber owners.\nAgent\xe2\x80\x99s contract ends on July 31; on August 1, Agent buys $150,000 worth of lumber from a seller with\nwhom he had dealt previously on Principal\xe2\x80\x99s behalf. Who is liable and why?\n\n19.4 Cases\nImplied Authority\nKanavos v. Hancock Bank & Trust Company\n439 N.E.2d 311 (Mass. 1982)\nKASS, J.\nAt the close of the plaintiff\xe2\x80\x99s evidence, the defendant moved for a directed verdict, which the trial judge\nallowed. The judge\xe2\x80\x99s reason for so doing was that the plaintiff, in his contract action, failed to introduce\nsufficient evidence tending to prove that the bank officer who made the agreement with which the plaintiff\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n677\n\n\x0csought to charge the bank had any authority to make it. Upon review of the record we are of opinion that\nthere was evidence which, if believed, warranted a finding that the bank officer had the requisite authority\nor that the bank officer had apparent authority to make the agreement in controversy. We therefore\nreverse the judgment.\nFor approximately ten years prior to 1975, Harold Kanavos and his brother borrowed money on at least\ntwenty occasions from the Hancock Bank & Trust Company (the Bank), and, during that period, the loan\nofficer with whom Kanavos always dealt was James M. Brown. The aggregate loans made by the Bank to\nKanavos at any given time went as high as $800,000.\nOver that same decade, Brown\xe2\x80\x99s responsibilities at the Bank grew, and he had become executive vicepresident. Brown was also the chief loan officer for the Bank, which had fourteen or fifteen branches in\naddition to its head office. Physically, Brown\xe2\x80\x99s office was at the head office, toward the rear of the main\nbanking floor, opposite the office of the president\xe2\x80\x94whose name was Kelley. Often Brown would tell\nKanavos that he had to check an aspect of a loan transaction with Kelley, but Kelley always backed Brown\nup on those occasions.\xe2\x80\xa6\n[The plaintiff, Harold Kanavos, entered into an agreement with the defendant Bank whereby stock owned\nby the Kanavos brothers was sold to the Bank and the plaintiff was given an option to repurchase the\nstock. Kanavos\xe2\x80\x99 suit against the Bank was based on an amendment to the agreement offered by Brown.]\nKanavos was never permitted to introduce in evidence the terms of the offer Brown made. That offer was\ncontained in a writing, dated July 16, 1976, on bank letterhead, which read as follows: \xe2\x80\x9cThis letter is to\nconfirm our conversation regarding your option to re-purchase the subject property. In lieu of your not\nexercising your option, we agree to pay you $40,000 representing a commission upon our sale of the\nsubject property, and in addition, will give you the option to match the price of sale of said property to\nextend for a 60 day period from the time our offer is received.\xe2\x80\x9d Brown signed the letter as executive vicepresident. The basis of exclusion was that the plaintiff had not established the authority of Brown to make\nwith Kanavos the arrangement memorialized in the July 16, 1976, letter.\nWhether Brown\xe2\x80\x99s job description impliedly authorized the right of last refusal or cash payment\nmodification is a question of how, in the circumstances, a person in Brown\xe2\x80\x99s position could reasonably\ninterpret his authority. Whether Brown had apparent authority to make the July 16, 1976, modification is\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n678\n\n\x0ca question of how, in the circumstances, a third person, e.g., a customer of the Bank such as Kanavos,\nwould reasonably interpret Brown\xe2\x80\x99s authority in light of the manifestations of his principal, the Bank.\nTitles of office generally do not establish apparent authority. Brown\xe2\x80\x99s status as executive vice-president\nwas not, therefore, a badge of apparent authority to modify agreements to which the Bank was a party.\nTrappings of office, e.g., office and furnishing, private secretary, while they may have some tendency to\nsuggest executive responsibility, do not without other evidence provide a basis for finding apparent\nauthority. Apparent authority is drawn from a variety of circumstances. Thus in Federal Nat. Bank v.\nO\xe2\x80\x99Connell\xe2\x80\xa6(1940), it was held apparent authority could be found because an officer who was a director,\nvice-president and treasurer took an active part in directing the affairs of the bank in question and was\nseen by third parties talking with customers and negotiating with them. In Costonis v. Medford Housing\nAuthy.\xe2\x80\xa6(1961), the executive director of a public housing authority was held to have apparent authority to\nvary specifications on the basis of the cumulative effect of what he had done and what the authority\nappeared to permit him to do.\nIn the instant case there was evidence of the following variety of circumstances: Brown\xe2\x80\x99s title of executive\nvice-president; the location of his office opposite the president; his frequent communications with the\npresident; the long course of dealing and negotiations; the encouragement of Kanavos by the president to\ndeal with Brown; the earlier amendment of the agreement by Brown on behalf of the Bank on material\npoints, namely the price to be paid by the Bank for the shares and the repurchase price; the size of the\nBank (fourteen or fifteen branches in addition to the main office); the secondary, rather than\nfundamental, nature of the change in the terms of the agreement now repudiated by the Bank, measured\nagainst the context of the overall transaction; and Brown\xe2\x80\x99s broad operating authority\xe2\x80\xa6all these added\ntogether would support a finding of apparent authority. When a corporate officer, as here, is allowed to\nexercise general executive responsibilities, the \xe2\x80\x9cpublic expectation is that the corporation should be bound\nto engagements made on its behalf by those who presume to have, and convincingly appear to have, the\npower to agree.\xe2\x80\x9d [Citation] This principle does not apply, of course, where in the business context, the\nrequirement of specific authority is presumed, e.g., the sale of a major asset by a corporation or a\ntransaction which by its nature commits the corporation to an obligation outside the scope of its usual\nactivity. The modification agreement signed by Brown and dated July 16, 1976, should have been admitted\nin evidence, and a verdict should not have been directed.\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n679\n\n\x0cJudgment reversed.\n\nCASE QUESTIONS\n\n1.\n\nWhy are \xe2\x80\x9ctitles of office\xe2\x80\x9d insufficient to establish apparent authority?\n\n2.\n\nWhy are \xe2\x80\x9ctrappings of office\xe2\x80\x9d insufficient to establish apparent authority?\n\n3.\n\nWhat is the relationship between apparent authority and estoppel? Who is estopped to do what, and\nwhy?\n\nEmployer\xe2\x80\x99s Liability for Employee\xe2\x80\x99s Intentional Torts: Scope of Employment\nLyon v. Carey\n533 F.2d 649 (Cir. Ct. App. DC 1976)\nMcMillan, J.:\nCorene Antoinette Lyon, plaintiff, recovered a $33,000.00 verdict [about $142,000 in 2010 dollars] in the\nUnited States District Court for the District of Columbia before Judge Barrington T. Parker and a jury,\nagainst the corporate defendants, George\xe2\x80\x99s Radio and Television Company, Inc., and Pep Line Trucking\nCompany, Inc. The suit for damages arose out of an assault, including rape, committed with a knife and\nother weapons upon the plaintiff on May 9, 1972, by Michael Carey, a nineteen-year-old deliveryman for\nPep Line Trucking Company, Inc. Three months after the trial, Judge Parker set aside the verdict and\nrendered judgment for both defendants notwithstanding the verdict. Plaintiff appealed.\xe2\x80\xa6\nAlthough the assault was perhaps at the outer bounds of respondeat superior, the case was properly one\nfor the jury. Whether the assault in this case was the outgrowth of a job-related controversy or simply a\npersonal adventure of the deliveryman, was a question for the jury. This was the import of the trial judge\xe2\x80\x99s\ninstructions. The verdict as to Pep Line should not have been disturbed.\nIrene Lyon bought a mattress and springs for her bed from the defendant George\xe2\x80\x99s Radio and Television\nCompany, Inc. The merchandise was to be delivered on May 9, 1972. Irene Lyon had to be at work and the\nplaintiff [Irene\xe2\x80\x99s sister] Corene Lyon, had agreed to wait in her sister\xe2\x80\x99s apartment to receive the delivery.\nA C.O.D. balance of $13.24 was due on the merchandise, and Irene Lyon had left a check for $13.24 to\ncover that balance. Plaintiff had been requested by her sister to \xe2\x80\x9cwait until the mattress and the springs\ncame and to check and make sure they were okay.\xe2\x80\x9d\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n680\n\n\x0cPlaintiff, fully clothed, answered the door. Her description of what happened is sufficiently brief and\nunqualified that it will bear repeating in full. She testified, without objection, as follows:\nI went to the door, and I looked in the peephole, and I asked who was there. The young man told\nme he was a delivery man from George\xe2\x80\x99s. He showed me a receipt, and it said, \xe2\x80\x98George\xe2\x80\x99s.\xe2\x80\x99 He said\nhe [needed cash on delivery\xe2\x80\x94COD], so I let him in, and I told him to bring the mattress upstairs\nand he said, \xe2\x80\x98No,\xe2\x80\x99 that he wasn\xe2\x80\x99t going to lug them upstairs, and he wanted the COD first, and I\ntold him I wanted to see the mattress and box springs to make sure they were okay, and he said\nno, he wasn\xe2\x80\x99t going to lug them upstairs [until he got the check].\nSo this went back and forwards and so he was getting angry, and I told him to wait right here\nwhile I go get the COD. I went to the bedroom to get the check, and I picked it up, and I turned\naround and he was right there.\nAnd then I was giving him the check and then he told me that his boss told him not to accept a\ncheck, that he wanted cash money, and that if I didn\xe2\x80\x99t give him cash money, he was going to take\nit on my ass, and he told me that he was no delivery man, he was a rapist and then he threw me\non the bed.\n[The Court] Talk louder, young lady, the jury can\xe2\x80\x99t hear you.\n[The witness] And then he threw me on the bed, and he had a knife to my throat.\n[Plaintiff\xe2\x80\x99s attorney] Then what happened?\nAnd then he raped me.\nPlaintiff\xe2\x80\x99s pre-trial deposition was a part of the record on appeal, and it shows that Carey raped plaintiff at\nknife point; that then he chased her all over the apartment with a knife and scissors and cut plaintiff in\nnumerous places on her face and body, beat and otherwise attacked her. All of the physical injury other\nthan the rape occurred after rather than before the rape had been accomplished.\xe2\x80\xa6\n[Carey was convicted of rape and sent to prison. The court determined that George\xe2\x80\x99s was properly\ndismissed because Pep Line, Carey\xe2\x80\x99s employer, was an independent contractor over which George\xe2\x80\x99s had\nno control.]\nThe principal question, therefore, is whether the evidence discloses any other basis upon which a jury\ncould reasonably find Pep Line, the employer of Carey, liable for the assault.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n681\n\n\x0cMichael Carey was in the employment of the defendant Pep Line as a deliveryman. He was authorized to\nmake the delivery of the mattress and springs plaintiff\xe2\x80\x99s sister had bought. He gained access to the\napartment only upon a showing of the delivery receipt for the merchandise. His employment\ncontemplated that he visit and enter that particular apartment. Though the apartment was not owned by\nnor in the control of his employer, it was nevertheless a place he was expected by his employer to enter.\nAfter Carey entered, under the credentials of his employment and the delivery receipt, a dispute arose\nnaturally and immediately between him and the plaintiff about two items of great significance in\nconnection with his job. These items were the request of the plaintiff, the customer\xe2\x80\x99s agent, to inspect the\nmattress and springs before payment (which would require their being brought upstairs before the\npayment was made), and Carey\xe2\x80\x99s insistence on getting cash rather than a check.\nThe dispute arose out of the very transaction which had brought Carey to the premises, and, according to\nthe plaintiff\xe2\x80\x99s evidence, out of the employer\xe2\x80\x99s instructions to get cash only before delivery.\nOn the face of things, Pep Line Trucking Company, Inc. is liable, under two previous decisions of the\nCourt of Appeals for the District of Columbia Circuit. [Citation (1953)] held a taxi owner liable for\ndamages (including a broken leg) sustained by a customer who had been run over by the taxi in pursuit of\na dispute between the driver and the customer about a fare. [Citation (1939)], held a restaurant owner\nliable to a restaurant patron who was beaten with a stick by a restaurant employee, after a disagreement\nover the service. The theory was that:\nIt is well established that an employer may be held responsible in tort for assaults committed by\nan employee while he is acting within the scope of his employment, even though he may act\nwantonly and contrary to his employer\xe2\x80\x99s instructions. [Citations] \xe2\x80\x9c\xe2\x80\xa6having placed [the\nemployee] in charge and committed the management of the business to his care, defendants may\nnot escape liability either on the ground of his infirmity of temperament or because, under the\ninfluence of passion aroused by plaintiff\xe2\x80\x99s threat to report the circumstances, he went beyond the\nordinary line of duty and inflicted the injury shown in this case. [Citations]\xe2\x80\x9d\nMunick v. City of Durham ([Citation], Supreme Court of North Carolina, 1921), though not a binding\nprecedent, is informative and does show that the theory of liability advanced by the plaintiff is by no\nmeans recent in origin. The plaintiff, Munick, a Russian born Jew, testified that he went to the Durham,\nNorth Carolina city water company office on April 17, 1919, and offered to pay his bill with \xe2\x80\x9cthree paper\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n682\n\n\x0cdollars, one silver dollar, and fifty cents in pennies.\xe2\x80\x9d The pennies were in a roll \xe2\x80\x9clike the bank fixes them.\xe2\x80\x9d\nThe clerk gave a receipt and the plaintiff prepared to leave the office. The office manager came into the\nroom, saw the clerk counting the pennies, became enraged at the situation, shoved the pennies onto the\nfloor and ordered Munick to pick them up. Bolton, the manager, \xe2\x80\x9clocked the front door and took me by\nthe jacket and called me \xe2\x80\x98God damned Jew,\xe2\x80\x99 and said, \xe2\x80\x98I want only bills.\xe2\x80\x99 I did not say anything and he hit\nme in the face. I did not resist, and the door was locked and I could not get out.\xe2\x80\xa6\xe2\x80\x9d With the door locked,\nBolton then repeatedly choked and beat the plaintiff, finally extracted a bill in place of the pennies, and\nordered him off the premises with injuries including finger marks on his neck that could be seen for eight\nor ten days. Bolton was convicted of unlawful assault [but the case against the water company was\ndismissed].\nThe North Carolina Supreme Court (Clark, C. J.) reversed the trial court\xe2\x80\x99s dismissal and held that the case\nshould have gone to the jury. The court\xe2\x80\xa6said [Citation]:\n\xe2\x80\x9c\xe2\x80\x98It is now fully established that corporations may be held liable for negligent and malicious torts,\nand that responsibility will be imputed whenever such wrongs are committed by their employees\nand agents in the course of their employment and within its scope * * * in many of the cases, and\nin reliable textbooks * * * \xe2\x80\x98course of employment\xe2\x80\x99 is stated and considered as sufficiently inclusive;\nbut, whether the one or the other descriptive term is used, they have the same significance in\nimporting liability on the part of the principal when the agent is engaged in the work that its\nprincipal has employed or directed him to do and * * * in the effort to accomplish it. When such\nconduct comes within the description that constitutes an actionable wrong, the corporation\nprincipal, as in other cases of principal and agent, is liable not only for \xe2\x80\x98the act itself, but for the\nways and means employed in the performance thereof.\xe2\x80\x99\n\xe2\x80\x9cIn 1 Thompson, Negligence, s 554, it is pointed out that, unless the above principle is maintained:\n\xe2\x80\x9c\xe2\x80\x98It will always be more safe and profitable for a man to conduct his business vicariously than in\nhis own person. He would escape liability for the consequences of many acts connected with his\nbusiness, springing from the imperfections of human nature, because done by another, for which\nhe would be responsible if done by himself. Meanwhile, the public, obliged to deal or come in\ncontact with his agent, for injuries done by them must be left wholly without redress. He might\ndelegate to persons pecuniarily irresponsible the care of large factories, of extensive mines, of\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n683\n\n\x0cships at sea, or of railroad trains on land, and these persons, by the use of the extensive power\nthus committed to them, might inflict wanton and malicious injuries on third persons, without\nother restraint than that which springs from the imperfect execution of the criminal laws. A\ndoctrine so fruitful of mischief could not long stand unshaken in an enlightened jurisprudence.\xe2\x80\x99\nThis court has often held the master liable, even if the agent was willful, provided it was\ncommitted in the course of his employment. [Citation]\xe2\x80\x9d\n\xe2\x80\x9cThe act of a servant done to effect some independent purpose of his own and not with reference\nto the service in which he is employed, or while he is acting as his own master for the time being,\nis not within the scope of his employment so as to render the master liable therefor. In these\ncircumstances the servant alone is liable for the injury inflicted.\xe2\x80\x9d [Citation].\xe2\x80\xa6\xe2\x80\x9dThe general idea is\nthat the employee at the time of doing the wrongful act, in order to fix liability on the employer,\nmust have been acting in behalf of the latter and not on his own account [Citation].\xe2\x80\x9d\nThe principal physical (as opposed to psychic) damage to the plaintiff is a number of disfiguring knife\nwounds on her head, face, arms, breasts and body. If the instrumentalities of assault had not included\nrape, the case would provoke no particular curiosity nor interest because it comes within all the classic\nrequirements for recovery against the master. The verdict is not attacked as excessive, and could not be\nexcessive in light of the physical injuries inflicted.\nIt may be suggested that [some of the cases discussed] are distinguishable because in each of those cases\nthe plaintiff was a business visitor on the defendant\xe2\x80\x99s \xe2\x80\x9cpremises.\xe2\x80\x9d\xe2\x80\xa6Home delivery customers are usually\nin their homes, sometimes alone; and deliveries of merchandise may expose householders to one-on-one\nconfrontations with deliverymen. It would be a strange rule indeed which, while allowing recovery for\nassaults committed in \xe2\x80\x9cthe store,\xe2\x80\x9d would deny a master\xe2\x80\x99s liability for an assault committed on a lone\nwoman in her own home, by a deliveryman required by his job to enter the home.\xe2\x80\xa6\nIf, as in [one case discussed], the assault was not motivated or triggered off by anything in the\nemployment activity but was the result of only propinquity and lust, there should be no liability. However,\nif the assault, sexual or otherwise, was triggered off or motivated or occasioned by a dispute over the\nconduct then and there of the employer\xe2\x80\x99s business, then the employer should be liable.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n684\n\n\x0cIt is, then, a question of fact for the trier of fact, rather than a question of law for the court, whether the\nassault stemmed from purely and solely personal sources or arose out of the conduct of the employer\xe2\x80\x99s\nbusiness; and the trial judge so instructed the jury.\nIt follows that, under existing decisions of the District of Columbia Circuit, plaintiff has made out a case\nfor the jury against Pep Line Trucking, Inc. unless the sexual character of one phase of the assault bars her\nfrom recovery for damages from all phases of the assault.\nWe face, then, this question: Should the entire case be taken from the jury because, instead of a rod of\nwood (as in [one case]), in addition to weapons of steel (as in [one case, a knife]); and in addition to his\nhands (as in [the third case, regarding the dispute about the pennies]), Carey also employed a sexual\nweapon, a rod of flesh and blood in the pursuit of a job-related controversy?\nThe answer is, No. It is a jury\xe2\x80\x99s job to decide how much of plaintiff\xe2\x80\x99s story to believe, and how much if any\nof the damages were caused by actions, including sexual assault, which stemmed from job-related sources\nrather than from purely personal origins.\xe2\x80\xa6\nThe judgment is affirmed as to the defendant George\xe2\x80\x99s and reversed as to the defendant Pep Line\nTrucking Company, Inc.\n\nCASE QUESTIONS\n\n1.\n\nWhat triggered the dispute here?\n\n2.\n\nThe court observes, \xe2\x80\x9cOn the face of things, Pep Line Trucking Company, Inc. is liable.\xe2\x80\x9d But there are two\nissues that give the court cause for more explanation. (1) Why does the court discuss the point that the\nassault did not occur on the employer\xe2\x80\x99s premises? (2) Why does the court mention that the knife assault\nhappened after the rape?\n\n3.\n\nIt is difficult to imagine that a sexual assault could be anything other than some \xe2\x80\x9cpurely and solely\npersonal\xe2\x80\x9d gratification, unrelated to the employer\xe2\x80\x99s business. How did the court address this?\n\n4.\n\nWhat is the controlling rule of law as to the employer\xe2\x80\x99s liability for intentional torts here?\n\n5.\n\nWhat does the court mean when it says, \xe2\x80\x9cthe assault was perhaps at the outer bounds of respondeat\nsuperior\xe2\x80\x9d?\n\n6.\n\nWould the jury think about who had the \xe2\x80\x9cdeep pocket\xe2\x80\x9d here? Who did have it?\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n685\n\n\x0cEmployer\xe2\x80\x99s Liability for Employee\xe2\x80\x99s Intentional Torts: Scope of Employment\nCockrell v. Pearl River Valley Water Supply Dist.\n865 So.2d 357 (Miss. 2004)\nThe Pearl River Valley Water Supply District (\xe2\x80\x9cDistrict\xe2\x80\x9d) was granted summary judgment pursuant to the\nMississippi Tort Claims Act (MTCA) dismissing with prejudice all claims asserted against it by Sandra\nCockrell. Cockrell appeals the ruling of the circuit court citing numerous errors. Finding the motion for\nsummary judgment was properly granted in favor of the District, this Court affirms the final judgment\nentered by the Circuit Court of Rankin County.\n\nFacts and Proceedings in the Trial Court\nOn June 28, 1998, Sandra Cockrell was arrested for suspicion of driving under the influence of alcohol by\nOfficer Joey James who was employed as a security patrol officer with the Reservoir Patrol of the Pearl\nRiver Valley Water Supply District. Officer James then transported Cockrell to the Reservoir Patrol office\nand administered an intoxilyzer test. The results of the test are not before us; however, we do know that\nafter the test was administered, Officer James apologized to Cockrell for arresting her, and he assured her\nthat he would prepare her paperwork so that she would not have to spend much time in jail. As they were\nleaving the Reservoir Patrol office, Officer James began asking Cockrell personal questions such as where\nshe lived, whether she was dating anyone and if she had a boyfriend. Officer James then asked Cockrell\nfor her cell phone number so that he could call and check on her. As they were approaching his patrol car\nfor the trip to the Rankin County jail, Officer James informed Cockrell that she should be wearing\nhandcuffs; however, he did not handcuff Cockrell, and he allowed her to ride in the front seat of the patrol\ncar with him. In route to the jail, Cockrell became emotional and started crying. As she was fixing her\nmakeup using the mirror on the sun visor, Officer James pulled his patrol car into a church parking lot\nand parked the car. He then pulled Cockrell towards him in an embrace and began stroking her back and\nhair telling her that things would be fine. Cockrell told Officer James to release her, but he continued to\nembrace her for approximately five minutes before continuing on to the jail.\nOn June 30, 1998, Cockrell returned to the Reservoir Patrol office to retrieve her driver\xe2\x80\x99s license. Officer\nJames called Cockrell into his office and discussed her DUI charge with her. As she was leaving, Officer\nJames grabbed her from behind, turned her around, pinned both of her arms behind her and pulled her to\nhis chest. When Officer James bent down to kiss her, she ducked her head, thus causing Officer James to\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n686\n\n\x0cinstead kiss her forehead. When Officer James finally released Cockrell, she ran out of the door and drove\naway. [Subsequently, Cockrell\xe2\x80\x99s attorney threatened civil suit against Patrol; James was fired in October\n1998.]\nOn September 22, 1999, Cockrell filed a complaint for damages against the District alleging that on the\nnights of June 28 and June 30, 1998, Officer James was acting within the course and scope of his\nemployment with the District and that he acted with reckless disregard for her emotional well-being and\nsafety.\xe2\x80\xa6On April 2, 2002, the District filed its motion for summary judgment alleging that there was no\ngenuine issue of material fact regarding Cockrell\xe2\x80\x99s claim of liability. The motion alleged that the conduct\ndescribed by Cockrell was outside the course and scope of Officer James\xe2\x80\x99s public employment as he was\nintending to satisfy his lustful urges. Cockrell responded to the motion arguing that the misconduct did\noccur in the course and scope of Officer James\xe2\x80\x99s employment with the District and also that the\nmisconduct did not reach the level of a criminal offense such that the District could be found not liable\nunder the MTCA.\nThe trial court entered a final judgment granting the District\xe2\x80\x99s motion for summary judgment and\ndismissing the complaint with prejudice. The trial court found that the District could not be held liable\nunder the MTCA for the conduct of Officer James which was both criminal and outside the course and\nscope of his employment. Cockrell\xe2\x80\xa6appeal[ed].\n\nDiscussion\nSummary judgment is granted in cases where there is \xe2\x80\x9cno genuine issue as to any material fact and that\nthe moving party is entitled to a judgment as a matter of law.\xe2\x80\x9d\xe2\x80\xa6\nCockrell contends there is a genuine issue of material of fact regarding whether Officer James was acting\nin the course and scope of his employment with the District during the incidents which occurred on the\nnights of June 28 and June 30, 1998. Cockrell argues Officer James\xe2\x80\x99s conduct, although inappropriate,\ndid not rise to the level of criminal conduct. Cockrell contends Officer James\xe2\x80\x99s action of hugging Cockrell\nwas similar to an officer consoling a victim of a crime. Cockrell does admit that Officer James\xe2\x80\x99s action of\nkissing her is more difficult to view as within the course and scope of his employment\xe2\x80\xa6\nThe District argues that although Officer James acted within the course and scope of his duties when he\narrested Cockrell, his later conduct, which was intended to satisfy his lustful desires, was outside the\nscope of his employment with it.\xe2\x80\xa6\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n687\n\n\x0c\xe2\x80\x9cMississippi law provides that an activity must be in furtherance of the employer\xe2\x80\x99s business to be within\nthe scope and course of employment.\xe2\x80\x9d [Citation] To be within the course and scope of employment, an\nactivity must carry out the employer\xe2\x80\x99s purpose of the employment or be in furtherance of the employer\xe2\x80\x99s\nbusiness. [Citations] Therefore, if an employee steps outside his employer\xe2\x80\x99s business for some reason\nwhich is not related to his employment, the relationship between the employee and the employer \xe2\x80\x9cis\ntemporarily suspended and this is so \xe2\x80\x98no matter how short the time and the [employer] is not liable for\n[the employee\xe2\x80\x99s] acts during such time.\xe2\x80\x99\xe2\x80\x9d \xe2\x80\x9cAn employee\xe2\x80\x99s personal unsanctioned recreational endeavors\nare beyond the course and scope of his employment.\xe2\x80\x9d [Citation]\n[In one case cited,] Officer Kerry Collins, a Jackson Police officer, was on duty when he came upon the\nparked car of L.T., a minor, and her boyfriend, who were about to engage in sexual activity. [Citation]\nOfficer Collins instructed L.T. to take her boyfriend home, and he would follow her to make sure she\nfollowed his orders. After L.T. dropped off her boyfriend, Officer Collins continued to follow her until he\npulled L.T. over. Officer Collins then instructed L.T. to follow him to his apartment or else he would\ninform L.T.\xe2\x80\x99s parents of her activities. L.T. followed Officer Collins to his apartment where they engaged\nin sexual activity. Upon returning home, L.T. told her parents everything that had happened. L.T. and her\nparents filed suit against Officer Collins, the City of Jackson and the Westwood Apartments, where Officer\nCollins lived rent free in return for his services as a security guard.\xe2\x80\xa6The district court granted summary\njudgment in favor of the City finding that Officer Collins acted outside the course and scope of his\nemployment with the Jackson Police Department. [Citation]\nIn [Citation] the plaintiff sued the Archdiocese of New Orleans for damages that allegedly resulted from\nhis sexual molestation by a Catholic priest. The Fifth Circuit found that the priest was not acting within\nthe course and scope of his employment. The Fifth Circuit held that \xe2\x80\x9csmoking marijuana and engaging in\nsexual acts with minor boys\xe2\x80\x9d in no way furthered the interests of his employer.\nThe Southern District of Mississippi and the Fifth Circuit, applying Mississippi law, have held that sexual\nmisconduct falls outside the course and scope of employment. There is no question that Officer James was\nwithin the course and scope of his employment when he first stopped Cockrell for suspicion of driving\nunder the influence of alcohol. However, when Officer James diverted from his employment for personal\nreasons, he was no longer acting in the furtherance of his employer\xe2\x80\x99s interests\xe2\x80\xa6Therefore, the District\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n688\n\n\x0ccannot be held liable\xe2\x80\xa6for the misconduct of Officer James which occurred outside the course and scope of\nhis employment.\nAffirmed.\n\n1.\n\nCASE QUESTIONS\n\nHow can this case and Lyon v. Carey (Section 19.4.2 "Employer\xe2\x80\x99s Liability for Employee\xe2\x80\x99s Intentional Torts:\nScope of Employment") be reconciled? Both involve an agent\xe2\x80\x99s unacceptable behavior\xe2\x80\x94assault\xe2\x80\x94but\nin Lyon the agent\xe2\x80\x99s actions were imputed to the principal, and in Cockrell the agent\xe2\x80\x99s actions were not\nimputed to the principal.\n\n2.\n\nWhat is the controlling rule of law governing the principal\xe2\x80\x99s liability for the agent\xe2\x80\x99s actions?\n\n3.\n\nThe law governing the liability of principals for acts of their agents is well settled. Thus the cases turn on\nthe facts. Who decides what the facts are in a lawsuit?\n\n19.5 Summary and Exercises\nSummary\n\nA contract made by an agent on behalf of the principal legally binds the principal. Three types of authority\nmay bind the principal: (1) express authority\xe2\x80\x94that which is actually given and spelled out, (2) implied\nauthority\xe2\x80\x94that which may fairly be inferred from the parties\xe2\x80\x99 relationship and which is incidental to the\nagent\xe2\x80\x99s express authority, and (3) apparent authority\xe2\x80\x94that which reasonably appears to a third party\nunder the circumstances to have been given by the principal. Even in the absence of authority, a principal\nmay ratify the agent\xe2\x80\x99s acts.\nThe principal may be liable for tortious acts of the agent but except under certain regulatory statutes may\nnot be held criminally liable for criminal acts of agents not prompted by the principal. Under the doctrine\nof respondeat superior, a principal is generally liable for acts by a servant within the scope of employment.\nA principal usually will not be held liable for acts of nonservant agents that cause physical damage,\nalthough he will be held liable for nonphysical torts, such as misrepresentation. The principal will not be\nheld liable for tortious acts of independent contractors, although the principal may be liable for injuries\nresulting from his failure to act in situations in which he was not legally permitted to delegate a duty to\nact. Whenever an agent is acting to further the principal\xe2\x80\x99s business interests, the principal will be held\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n689\n\n\x0cvicariously liable for the agent\xe2\x80\x99s intentional torts. What constitutes scope of employment is not easy to\ndetermine; the modern trend is to hold a principal liable for the conduct of an agent if it was foreseeable\nthat the agent might act as he did.\nMost states have special rules of vicarious liability for special situations; for example, liability of an\nautomobile owner for use by another. Spouses are not vicariously liable for each other, nor are parents for\nchildren, except for failing to control children known to be dangerous.\nIn general, an agent is not personally liable on contracts he has signed on behalf of a principal. This\ngeneral rule has several exceptions recognized in most states: (1) when the agent is serving an undisclosed\nor partially disclosed principal, (2) when the agent lacks authority or exceeds his authority, and (3) if the\nagent entered into the contract in a personal capacity.\nThe agency relationship may be terminated by mutual consent, by express agreement of the parties that\nthe agency will end at a certain time or on the occurrence of a certain event, or by an implied agreement\narising out of the circumstances in each case. The agency may also be unilaterally revoked by the\nprincipal\xe2\x80\x94unless the agency is coupled with an interest\xe2\x80\x94or renounced by the agent. Finally, the agency\nwill terminate by operation of law under certain circumstances, such as death of the principal or agent.\n\nEXERCISES\n\n1.\n\nParke-Bernet Galleries, acting as agent for an undisclosed principal, sold a painting to Weisz. Weisz later\ndiscovered that the painting was a forgery and sued Parke-Bernet for breach of contract. In defense,\nParke-Bernet argued that as a general rule, agents are not liable on contracts made for principals. Is this a\ngood defense? Explain.\n\n2.\n\nLynch was the loan officer at First Bank. Patterson applied to borrow $25,000. Bank policy required that\nLynch obtain a loan guaranty from Patterson\xe2\x80\x99s employer, a milk company. The manager of the milk\ncompany visited the bank and signed a guaranty on behalf of the company. The last paragraph of the\nguaranty stated, \xe2\x80\x9cThis guaranty is signed by an officer having legal right to bind the company through\nauthorization of the Board of Directors.\xe2\x80\x9d Should Lynch be satisfied with this guaranty? Would he be\nsatisfied if the president of the milk company, who was also a director, affirmed that the manager had\nauthority to sign the guaranty? Explain.\n\n3.\n\nRalph owned a retail meat market. Ralph\xe2\x80\x99s agent Sam, without authority but purporting to act on Ralph\xe2\x80\x99s\nbehalf, borrowed $7,500 from Ted. Although he never received the money, Ralph repaid $700 of the\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n690\n\n\x0calleged loan and promised to repay the rest. If Sam had no authority to make the loan, is Ralph liable?\nWhy?\n4.\n\nA guest arrived early one morning at the Hotel Ohio. Clemens, a person in the hotel office who appeared\nto be in charge, walked behind the counter, registered the guest, gave him a key, and took him to his\nroom. The guest also checked valuables (a diamond pin and money) with Clemens, who signed a receipt\non behalf of the hotel. Clemens in fact was a roomer at the hotel, not an employee, and had no authority\nto act on behalf of the hotel. When Clemens absconded with the valuables, the guest sued the hotel. Is\nthe hotel liable? Why?\n\n5.\n\nA professional basketball player punched an opposing player in the face during the course of a game. The\nopponent, who was seriously injured, sued the owner of the team for damages. A jury awarded the player\n$222,000 [about $800,000 in 2010 dollars] for medical expenses, $200,000 [$700,000] for physical pain,\n$275,000 [$963,000] for mental anguish, $1,000,000 [$3.5 million] for lost earnings, and $1,500,000 [$5.2\nmillion] in punitive damages (which was $500,000 more than requested by the player). The jury also\nawarded $50,000 [$150,000] to the player\xe2\x80\x99s wife for loss of companionship. If we assume that the player\nwho threw the punch acted out of personal anger and had no intention to further the business, how\ncould the damage award against his principal be legally justified?\n\n6.\n\nA doctor in a University of Chicago hospital seriously assaulted a patient in an examining room. The\npatient sued the hospital on the theory that the doctor was an agent or employee of the hospital and the\nassault occurred within the hospital. Is the hospital liable for the acts of its agent? Why?\n\n7.\n\nHector was employed by a machine shop. One day he made a delivery for his employer and proceeded\nback to the shop. When he was four miles from the shop and on the road where it was located, he turned\nleft onto another road to visit a friend. The friend lived five miles off the turnoff. On the way to the\nfriend\xe2\x80\x99s house, Hector caused an accident. The injured person sued Hector\xe2\x80\x99s employer. Is the employer\nliable? Discuss.\n\n8.\n\nA fourteen-year-old boy, who had no driver\xe2\x80\x99s license, took his parents\xe2\x80\x99 car without permission and caused\nan automobile accident. A person injured in the accident sued the boy\xe2\x80\x99s parents under the relevant\nstate\xe2\x80\x99s Parental Responsibility Law (mentioned in Section 19.2.1 "Principal\xe2\x80\x99s Tort Liability"). Are the\nparents liable? Discuss.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n691\n\n\x0c9.\n\nIn the past decades the Catholic Church has paid out hundreds of millions of dollars in damage awards to\npeople\xe2\x80\x94mostly men\xe2\x80\x94who claimed that when they were boys and teenagers they were sexually abused\nby their local parish priests, often on Church premises. That is, the men claimed they had been victims of\nchild rape. Obviously, such behavior is antithetical to any reasonable standard of clergy behavior: the\npriests could not have been in the scope of employment. How is the Church liable?\n\nSELF-TEST QUESTIONS\n\n1.\n\nAuthority that legally may bind the principal includes\na.\n\nimplied authority\n\nb.\n\nexpress authority\n\nc.\n\napparent authority\n\nd.\n\nall of the above\nAs a general rule, a principal is not\n\na.\n\nliable for tortious acts of an agent, even when the principal is negligent\nb.\n\nliable for acts of a servant within the scope of employment\n\nc.\n\ncriminally liable for acts of the agent\n\nd.\n\nliable for nondelegable duties performed by independent contractors\nAn agent may be held personally liable on contracts signed on behalf of a principal when\n\na.\n\nthe agent is serving an undisclosed or partially disclosed principal\nb.\n\nthe agent exceeds his authority\n\nc.\n\nthe agent entered into the contract in a personal capacity\n\nd.\n\nall of the above are true\nAn agency relationship may be terminated by\n\na.\n\nan implied agreement arising out of the circumstances\nb.\n\nmutual consent of parties\n\nc.\n\ndeath of the principal or agent\n\nd.\n\nall of the above\n\nThe principal\xe2\x80\x99s liability for the agent\xe2\x80\x99s acts of which the principal had no knowledge or intention\nto commit is called\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n692\n\n\x0ca.\n\ncontract liability\nb.\n\nimplied liability\n\nc.\n\nrespondeat superior\n\nd.\n\nall of the above\n\n1.\n\nd\n\n2.\n\nc\n\n3.\n\nd\n\n4.\n\nc\n\n5.\n\nb\n\nSELF-TEST ANSWERS\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n693\n\n\x0cChapter 20\n\nPartnerships: General Characteristics and Formation\nLEARNING OBJECTIVES\nAfter reading this chapter, you should understand the following:\n1.\n\nThe importance of partnership and the present status of partnership law\n\n2.\n\nThe extent to which a partnership is an entity\n\n3.\n\nThe tests that determine whether a partnership exists\n\n4.\n\nPartnership by estoppel\n\n5.\n\nPartnership formation\n\n20.1 Introduction to Partnerships and Entity Theory\nLEARNING OBJECTIVES\n\n1.\n\nDescribe the importance of partnership.\n\n2.\n\nUnderstand partnership history.\n\n3.\n\nIdentify the entity characteristics of partnerships.\n\nImportance of Partnership Law\nIt would be difficult to conceive of a complex society that did not operate its businesses through\norganizations. In this chapter we study partnerships, limited partnerships, and limited liability\ncompanies, and we touch on joint ventures and business trusts.\nWhen two or more people form their own business or professional practice, they usually consider\nbecoming partners. Partnership law defines a partnership as \xe2\x80\x9cthe association of two or more persons to\ncarry on as co-owners a business for profit\xe2\x80\xa6whether or not the persons intend to form a\npartnership.\xe2\x80\x9d\n\n[1]\n\nIn 2011, there were more than three million business firms in the United States as\n\npartnerships (see Table 20.1 "Selected Data: Number of US Partnerships, Limited Partnerships, and\nLimited Liability Companies", showing data to 2006), and partnerships are a common form of\norganization among accountants, lawyers, doctors, and other professionals. When we use the word\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n694\n\n\x0cpartnership, we are referring to the general business partnership. There are also limited partnerships\nand limited liability partnerships, which are discussed in Chapter 22 "Hybrid Business Forms".\nTable 20.1 Selected Data: Number of US Partnerships, Limited Partnerships, and Limited Liability\nCompanies\n\n2003\n\n2004\n\n2005\n\n2006\n\nTotal number of active partnerships\n\n2,375,375\n\n2,546,877\n\n2,763,625\n\n2,947,116\n\nNumber of partners\n\n14,108,458 15,556,553 16,211,908 16,727,803\n\nNumber of limited partnerships\n\n378,921\n\n402,238\n\n413,712\n\n432,550\n\nNumber of partners\n\n6,262,103\n\n7,023,921\n\n6,946,986\n\n6,738,737\n\nNumber of limited liability companies 1,091,502\n\n1,270,236\n\n1,465,223\n\n1,630,161\n\nNumber of partners\n\n4,949,808\n\n5,640,146\n\n6,361,958\n\n4,226,099\n\nSource: IRS, http://www.irs.gov/pub/irs-soi/09sprbul.pdf.\nPartnerships are also popular as investment vehicles. Partnership law and tax law permit an investor to\nput capital into a limited partnership and realize tax benefits without liability for the acts of the general\npartners.\nEven if you do not plan to work within a partnership, it can be important to understand the law that\ngoverns it. Why? Because it is possible to become someone\xe2\x80\x99s partner without intending to or even\nrealizing that a partnership has been created. Knowledge of the law can help you avoid partnership\nliability.\n\nHistory of Partnership Law\nThrough the Twentieth Century\nPartnership is an ancient form of business enterprise, and special laws governing partnerships date as far\nback as 2300 BC, when the Code of Hammurabi explicitly regulated the relations between partners.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n695\n\n\x0cPartnership was an important part of Roman law, and it played a significant role in the law merchant, the\ninternational commercial law of the Middle Ages.\nIn the nineteenth century, in both England and the United States, partnership was a popular vehicle for\nbusiness enterprise. But the law governing it was jumbled. Common-law principles were mixed with\nequitable standards, and the result was considerable confusion. Parliament moved to reduce the\nuncertainty by adopting the Partnership Act of 1890, but codification took longer in the United States. The\nCommissioners on Uniform State Laws undertook the task at the turn of the twentieth century. The\nUniform Partnership Act (UPA), completed in 1914, and the Uniform Limited Partnership Act (ULPA),\ncompleted in 1916, were the basis of partnership law for many decades. UPA and ULPA were adopted by\nall states except Louisiana.\n\nThe Current State of Partnership Law\nDespite its name, UPA was not enacted uniformly among the states; moreover, it had some shortcomings.\nSo the states tinkered with it, and by the 1980s, the National Conference of Commissioners on Uniform\nLaws (NCCUL) determined that a revised version was in order. An amended UPA appeared in 1992, and\nfurther amendments were promulgated in 1993, 1994, 1996, and 1997. The NCCUL reports that thirtynine states have adopted some version of the revised act. This chapter will discuss the Revised Uniform\nPartnership Act (RUPA) as promulgated in 1997, but because not all jurisdictions have not adopted it,\nwhere RUPA makes significant changes, the original 1914 UPA will also be considered.\n\n[2]\n\nThe NCCUL\n\nobserves in its \xe2\x80\x9cprefatory note\xe2\x80\x9d to the 1997 act: \xe2\x80\x9cThe Revised Act is largely a series of \xe2\x80\x98default rules\xe2\x80\x99 that\ngovern the relations among partners in situations they have not addressed in a partnership agreement.\nThe primary focus of RUPA is the small, often informal, partnership. Larger partnerships generally have a\npartnership agreement addressing, and often modifying, many of the provisions of the partnership act.\xe2\x80\x9d\n\n[3]\n\nEntity Theory\nMeaning of \xe2\x80\x9cLegal Entity\xe2\x80\x9d\nA significant difference between a partnership and most other kinds of business organization relates to\nwhether, and the extent to which, the business is a legal entity. A legal entity is a person or group that the\nlaw recognizes as having legal rights, such as the right to own and dispose of property, to sue and be sued,\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n696\n\n\x0cand to enter into contracts; the entity theory is the concept of a business firm as a legal person, with\nexistence and accountability separate from its owners. When individuals carry out a common enterprise\nas partners, a threshold legal question is whether the partnership is a legal entity. The common law said\nno. In other words, under the common-law theory, a partnership was but a convenient name for an\naggregate of individuals, and the rights and duties recognized and imposed by law are those of the\nindividual partners. By contrast, the mercantile theory of the law merchant held that a partnership is a\nlegal entity that can have rights and duties independent of those of its members.\nDuring the drafting of the 1914 UPA, a debate raged over which theory to adopt. The drafters resolved the\ndebate through a compromise. In Section 6(1), UPA provides a neutral definition of partnership (\xe2\x80\x9can\nassociation of two or more persons to carry on as co-owners a business for profit\xe2\x80\x9d) and retained the\ncommon-law theory that a partnership is an aggregation of individuals\xe2\x80\x94the aggregate theory.\nRUPA moved more toward making partnerships entities. According to the NCCUL, \xe2\x80\x9cThe Revised Act\nenhances the entity treatment of partnerships to achieve simplicity for state law purposes, particularly in\nmatters concerning title to partnership property. RUPA does not, however, relentlessly apply the entity\napproach. The aggregate approach is retained for some purposes, such as partners\xe2\x80\x99 joint and several\nliability.\xe2\x80\x9d\n\n[4]\n\nSection 201(a) provides, \xe2\x80\x9cA partnership is an entity distinct from its partners.\xe2\x80\x9d\n\n[5]\n\nEntity Characteristics of a Partnership\nUnder RUPA, then, a partnership has entity characteristics, but the partners remain guarantors of\npartnership obligations, as always\xe2\x80\x94that is the partners\xe2\x80\x99 joint and several liability noted in the previous\nparagraph (and discussed further in Chapter 21 "Partnership Operation and Termination"). This is a very\nimportant point and a primary weakness of the partnership form: all partners are, and each one of them\nis, ultimately personally liable for the obligations of the partnership, without limit, which includes\npersonal and unlimited liability. This personal liability is very distasteful, and it has been abolished,\nsubject to some exceptions, with limited partnerships and limited liability companies, as discussed\nin Chapter 22 "Hybrid Business Forms". And, of course, the owners of corporations are also not generally\nliable for the corporation\xe2\x80\x99s obligations, which is a major reason for the corporate form\xe2\x80\x99s popularity.\n\nFor Accounting Purposes\nUnder both versions of the law, the partnership may keep business records as if it were a separate entity,\nand its accountants may treat it as such for purposes of preparing income statements and balance sheets.\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n697\n\n\x0cFor Purposes of Taxation\nUnder both versions of the law, partnerships are not taxable entities, so they do not pay income taxes.\nInstead, each partner\xe2\x80\x99s distributive share, which includes income or other gain, loss, deductions, and\ncredits, must be included in the partner\xe2\x80\x99s personal income tax return, whether or not the share is actually\ndistributed.\n\nFor Purposes of Litigation\nIn litigation, the aggregate theory causes some inconvenience in naming and serving partnership\ndefendants: under UPA, lawsuits to enforce a partnership contract or some other right must be filed in the\nname of all the partners. Similarly, to sue a partnership, the plaintiff must name and sue each of the\npartners. This cumbersome procedure was modified in many states, which enacted special statutes\nexpressly permitting suits by and against partnerships in the firm name. In suits on a claim in federal\ncourt, a partnership may sue and be sued in its common name. The move by RUPA to make partnerships\nentities changed very little. Certainly it provides that \xe2\x80\x9ca partnership may sue and be sued in the name of\nthe partnership\xe2\x80\x9d\xe2\x80\x94that\xe2\x80\x99s handy where the plaintiff hopes for a judgment against the partnership, without\nrecourse to the individual partners\xe2\x80\x99 personal assets.\n\n[6]\n\nBut a plaintiff must still name the partnership and\n\nthe partners individually to have access to both estates, the partnership and the individuals\xe2\x80\x99: \xe2\x80\x9cA judgment\nagainst a partnership is not by itself a judgment against a partner. A judgment against a partnership may\nnot be satisfied from a partner\xe2\x80\x99s assets unless there is also a judgment against the partner.\xe2\x80\x9d\n\n[7]\n\nFor Purposes of Owning Real Estate\nAggregate theory concepts bedeviled property co-ownership issues, so UPA finessed the issue by stating\nthat partnership property, real or personal, could be held in the name of the partners as \xe2\x80\x9ctenants in\npartnership\xe2\x80\x9d\xe2\x80\x94a type of co-ownership\xe2\x80\x94or it could be held in the name of the partnership.\n\n[8]\n\nUnder RUPA,\n\n\xe2\x80\x9cproperty acquired by the partnership is property of the partnership and not of the partners.\xe2\x80\x9d\n\n[9]\n\nBut RUPA\n\nis no different from UPA in practical effect. The latter provides that \xe2\x80\x9cproperty originally brought into the\npartnership stock or subsequently acquired by purchase\xe2\x80\xa6on account of the partnership, is partnership\nproperty.\xe2\x80\x9d\n\n[10]\n\nUnder either law, a partner may bring onto the partnership premises her own property, not\n\nacquired in the name of the partnership or with its credit, and it remains her separate property. Under\nneither law can a partner unilaterally dispose of partnership property, however labeled, for the obvious\nreason that one cannot dispose of another\xe2\x80\x99s property or property rights without permission.\nSaylor URL: http://www.saylor.org/books\n\n[11]\n\nAnd keep\nSaylor.org\n698\n\n\x0cin mind that partnership law is the default: partners are free to make up partnership agreements as they\nlike, subject to some limitations. They are free to set up property ownership rules as they like.\n\nFor Purposes of Bankruptcy\nUnder federal bankruptcy law\xe2\x80\x94state partnership law is preempted\xe2\x80\x94a partnership is an entity that may\nvoluntarily seek the haven of a bankruptcy court or that may involuntarily be thrust into a bankruptcy\nproceeding by its creditors. The partnership cannot discharge its debts in a liquidation proceeding under\nChapter 7 of the bankruptcy law, but it can be rehabilitated under Chapter 11 (see (Reference mayer_1.0ch30 not found in Book)).\n\nKEY TAKEAWAY\n\nPartnership law is very important because it is the way most small businesses are organized and because it\nis possible for a person to become a partner without intending to. Partnership law goes back a long way,\nbut in the United States, most states\xe2\x80\x94but not all\xe2\x80\x94have adopted the Revised Uniform Partnership Act\n(RUPA, 1997) over the previous Uniform Partnership Act, originally promulgated in 1914. One salient\nchange made by RUPA is to directly announce that a partnership is an entity: it is like a person for\npurposes of accounting, litigation, bankruptcy, and owning real estate. Partnerships do not pay taxes; the\nindividual partners do. But in practical terms, what RUPA does is codify already-existing state law on these\nmatters, and partners are free to organize their relationship as they like in the partnership agreement.\n\nEXERCISES\n\n1.\n\nWhen was UPA set out for states to adopt? When was RUPA promulgated for state adoption?\n\n2.\n\nWhat does it mean to say that the partnership act is the \xe2\x80\x9cdefault position\xe2\x80\x9d? For what types of partnership\nis UPA (or RUPA) likely to be of most importance?\n\n3.\n\nWhat is the aggregate theory of partnership? The entity theory?\n4.\n\n[1] Revised Uniform Partnership Act, Section 202(a).\n\n5.\n\n[2] NCCUSL, Uniform Law Commission, \xe2\x80\x9cActs: Partnership\nAct,\xe2\x80\x9dhttp://www.nccusl.org/Act.aspx?title=Partnership%20Act. The following states haveadopted the\nRUPA: Alabama, Alaska, Arizona, Arkansas, California, Colorado, Delaware, District of Columbia, Florida,\nHawaii, Idaho, Illinois, Iowa, Kansas, Kentucky, Maine, Maryland, Minnesota, Mississippi, Montana,\nNebraska, Nevada, New Jersey, New Mexico, North Dakota, Oklahoma, Oregon, Puerto Rico, South\nDakota (substantially similar), Tennessee, Texas (substantially similar), US Virgin Islands, Vermont,\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n699\n\n\x0cVirginia, and Washington. Connecticut, West Virginia, and Wyoming adopted the 1992 or 1994 version.\nHere are the states that have not adopted RUPA (Louisiana never adopted UPA at all): Georgia, Indiana,\nMassachusetts, Michigan, Mississippi, New Hampshire, New York, North Carolina, Ohio, Pennsylvania,\nRhode Island, and Wisconsin.\n6.\n\n[3] University of Pennsylvania Law School, Biddle Law Library, \xe2\x80\x9cUniform Partnership Act (1997),\xe2\x80\x9d NCCUSL\nArchives,http://www.law.upenn.edu/bll/archives/ulc/fnact99/1990s/upa97fa.pdf.\n\n7.\n\n[4] University of Pennsylvania Law School, Biddle Law Library, \xe2\x80\x9cUniform Partnership Act (1997),\xe2\x80\x9d NCCUSL\nArchives,http://www.law.upenn.edu/bll/archives/ulc/fnact99/1990s/upa97fa.pdf.\n\n8.\n\n[5] RUPA, Section 201(a).\n\n9.\n\n[6] RUPA, Section 307(a).\n\n10. [7] RUPA, Section 307(c).\n11. [8] Uniform Partnership Act, Section 25(1); UPA, Section 8(3).\n12. [9] RUPA, Section 203.\n13. [10] UPA, Section 8(1).\n14. [11] UPA, Sections 9(3)(a) and 25; RUPA, Section 302.\n\n20.2 Partnership Formation\n\nLEARNING OBJECTIVES\n\n1.\n\nDescribe the creation of an express partnership.\n\n2.\n\nDescribe the creation of an implied partnership.\n\n3.\n\nIdentify tests of partnership existence.\n\n4.\n\nUnderstand partnership by estoppel.\n\nCreation of an Express Partnership\nCreation in General\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n700\n\n\x0cThe most common way of forming a partnership is expressly\xe2\x80\x94that is, in words, orally or in writing. Such a\npartnership is called an express partnership. If parties have an express partnership with no partnership\nagreement, the relevant law\xe2\x80\x94the Uniform Partnership Act (UPA) or the Revised Uniform Partnership Act\n(RUPA)\xe2\x80\x94applies the governing rules.\nAssume that three persons have decided to form a partnership to run a car dealership. Able contributes\n$250,000. Baker contributes the building and space in which the business will operate. Carr contributes\nhis services; he will manage the dealership.\nThe first question is whether Able, Baker, and Carr must have a partnership agreement. As should be clear\nfrom the foregoing discussion, no agreement is necessary as long as the tests of partnership are met.\nHowever, they ought to have an agreement in order to spell out their rights and duties among themselves.\nThe agreement itself is a contract and should follow the principles and rules spelled out in Chapter 8\n"Introduction to Contract Law" through Chapter 16 "Remedies" of this book. Because it is intended to\ngovern the relations of the partners toward themselves and their business, every partnership contract\nshould set forth clearly the following terms: (1) the name under which the partners will do business; (2)\nthe names of the partners; (3) the nature, scope, and location of the business; (4) the capital contributions\nof each partner; (5) how profits and losses are to be divided; (6) how salaries, if any, are to be determined;\n(7) the responsibilities of each partner for managing the business; (8) limitations on the power of each\npartner to bind the firm; (9) the method by which a given partner may withdraw from the partnership;\n(10) continuation of the firm in the event of a partner\xe2\x80\x99s death and the formula for paying a partnership\ninterest to his heirs; and (11) method of dissolution.\n\nSpecific Issues of Concern\nIn forming a partnership, three of these items merit special attention. And note again that if the parties do\nnot provide for these in their agreement, RUPA will do it for them as the default.\n\nWho Can Be a Partner?\nAs discussed earlier in this chapter, a partnership is not limited to a direct association between human\nbeings but may also include an association between other entities, such as corporations or even\npartnerships themselves.\n\n[1]\n\nFamily members can be partners, and partnerships between parents and\n\nminor children are lawful, although a partner who is a minor may disaffirm the agreement.\n\nWritten versus Oral Agreements\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n701\n\n\x0cIf the business cannot be performed within one year from the time that the agreement is entered into, the\npartnership agreement should be in writing to avoid invalidation under the Statute of Frauds. Most\npartnerships have no fixed term, however, and are partnerships \xe2\x80\x9cat will\xe2\x80\x9d and therefore not covered by the\nStatute of Frauds.\n\nValidity of the Partnership Name\nAble, Baker, and Carr decide that it makes good business sense to choose an imposing, catchy, and wellknown name for their dealership\xe2\x80\x94General Motors Corporation. There are two reasons why they cannot\ndo so. First, their business is a partnership, not a corporation, and should not be described as one.\nSecond, the name is deceptive because it is the name of an existing business. Furthermore, if not\nregistered, the name would violate the assumed or fictitious name statutes of most states. These require\nthat anyone doing business under a name other than his real name register the name, together with the\nnames and addresses of the proprietors, in some public office. (Often, the statutes require the proprietors\nto publish this information in the newspapers when the business is started.) As Loomis v.\nWhitehead in Section 20.3.2 "Creation of a Partnership: Registering the Name" shows, if a business fails\nto comply with the statute, it could find that it will be unable to file suit to enforce its contracts.\n\nCreation of Implied Partnership\nAn implied partnership exists when in fact there are two or more persons carrying on a business as coowners for profit. For example, Carlos decides to paint houses during his summer break. He gathers some\nmaterials and gets several jobs. He hires Wally as a helper. Wally is very good, and pretty soon both of\nthem are deciding what jobs to do and how much to charge, and they are splitting the profits. They have\nan implied partnership, without intending to create a partnership at all.\n\nTests of Partnership Existence\nBut how do we know whether an implied partnership has been created? Obviously, we know if there is an\nexpress agreement. But partnerships can come into existence quite informally, indeed, without any\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n702\n\n\x0cformality\xe2\x80\x94they can be created accidentally. In contrast to the corporation, which is the creature of\nstatute, partnership is a catchall term for a large variety of working relationships, and frequently,\nuncertainties arise about whether or not a particular relationship is that of partnership. The law can\nreduce the uncertainty in advance only at the price of severely restricting the flexibility of people to\nassociate. As the chief drafter of the Uniform Partnership Act (UPA, 1914) explained,\nAll other business associations are statutory in origin. They are formed by the happening of an\nevent designated in a statute as necessary to their formation. In corporations this act may be the\nissuing of a charter by the proper officer of the state; in limited partnerships, the filing by the\nassociates of a specified document in a public office. On the other hand, an infinite number of\ncombinations of circumstances may result in co-ownership of a business. Partnership is the\nresiduum, including all forms of co-ownership, of a business except those business associations\norganized under a specific statute.\n\n[2]\n\nFigure 20.1 Partnership Tests\n\nBecause it is frequently important to know whether a partnership exists (as when a creditor has dealt with\nonly one party but wishes to also hold others liable by claiming they were partners, see Section 20.3.1\n"Tests of Partnership Existence", Chaiken v. Employment Security Commission), a number of tests have\nbeen established that are clues to the existence of a partnership (seeFigure 20.1 "Partnership Tests"). We\nreturn to the definition of a partnership: \xe2\x80\x9cthe association of two or more persons to carry on as co-owners\na business for profit[.]\xe2\x80\x9d The three elements are (1) the association of persons, (2) as co-owners, (3) for\nprofit.\n\nAssociation of Persons\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n703\n\n\x0cThis element is pretty obvious. A partnership is a contractual agreement among persons, so the persons\ninvolved need to have capacity to contract. But RUPA does not provide that only natural persons can be\npartners; it defines person as follows: \xe2\x80\x9c\xe2\x80\x98Person\xe2\x80\x99 means an individual, corporation, business trust, estate,\ntrust, partnership, association, joint venture, government, governmental subdivision, agency, or\ninstrumentality, or any other legal or commercial entity.\xe2\x80\x9d\n\n[3]\n\nThus unless state law precludes it, a\n\ncorporation can be a partner in a partnership. The same is true under UPA.\n\nCo-owners of a Business\nIf what two or more people own is clearly a business\xe2\x80\x94including capital assets, contracts with employees\nor agents, an income stream, and debts incurred on behalf of the operation\xe2\x80\x94a partnership exists. A\ntougher question arises when two or more persons co-own property. Do they automatically become\npartners? The answer can be important: if one of the owners while doing business pertinent to the\nproperty injures a stranger, the latter could sue the other owners if there is a partnership.\nCo-ownership comes in many guises. The four most common are joint tenancy, tenancy in common,\ntenancy by the entireties, and community property. In joint tenancy, the owners hold the property under a\nsingle instrument, such as a deed, and if one dies, the others automatically become owners of the\ndeceased\xe2\x80\x99s share, which does not descend to his heirs. Tenancy in common has the reverse rule: the\nsurvivor tenants do not take the deceased\xe2\x80\x99s share. Each tenant in common has a distinct estate in the\nproperty. The tenancy by the entirety and community property (in community-property states) forms of\nownership are limited to spouses, and their effects are similar to that of joint tenancy. These concepts are\ndiscussed in more detail in relation to real property in (Reference mayer_1.0-ch34 not found in Book).\nSuppose a husband and wife who own their home as tenants by the entirety (or community property)\ndecide to spend the summer at the seashore and rent their home for three months. Is their co-ownership\nsufficient to establish that they are partners? The answer is no. By UPA Section 7(2) and RUPA Section\n202(b)(1), the various forms of joint ownership by themselves do not establish partnership, whether or\nnot the co-owners share profits made by the use of the property. To establish a partnership, the ownership\nmust be of a business, not merely of property.\n\nSharing of Profits\nThere are two aspects to consider with regard to profits: first, whether the business is for-profit, and\nsecond, whether there is a sharing of the profit.\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n704\n\n\x0cBusiness for Profit\nUnincorporated nonprofit organizations (UNAs) cannot be partnerships. The paucity of coherent law\ngoverning these organizations gave rise in 2005 to the National Conference of Commissioners of Uniform\nLaws\xe2\x80\x99 promulgation of the Revised Uniform Unincorporated Nonprofit Association Act (RUUNAA). The\nprefatory note to this act says, \xe2\x80\x9cRUUNAA was drafted with small informal associations in mind. These\ninformal organizations are likely to have no legal advice and so fail to consider legal and organizational\nquestions, including whether to incorporate. The act provides better answers than the common law for a\nlimited number of legal problems\xe2\x80\xa6There are probably hundreds of thousands of UNAs in the United\nStates including unincorporated nonprofit philanthropic, educational, scientific and literary clubs,\nsporting organizations, unions, trade associations, political organizations, churches, hospitals, and\ncondominium and neighborhood associations.\xe2\x80\x9d\n\n[4]\n\nAt least twelve states have adopted RUUNAA or its\n\npredecessor.\n\nSharing the Profit\nWhile co-ownership does not establish a partnership unless there is a business, a business by itself is not a\npartnership unless co-ownership is present. Of the tests used by courts to determine co-ownership,\nperhaps the most important is sharing of profits. Section 202(c) of RUPA provides that \xe2\x80\x9ca person who\nreceives a share of the profits of a business is presumed to be a partner in the business,\xe2\x80\x9d but this\npresumption can be rebutted by showing that the share of the profits paid out was (1) to repay a debt; (2)\nwages or compensation to an independent contractor; (3) rent; (4) an annuity, retirement, or health\nbenefit to a representative of a deceased or retired partner; (5) interest on a loan, or rights to income,\nproceeds, or increase in value from collateral; or (5) for the sale of the goodwill of a business or other\nproperty. Section 7(4) of UPA is to the same effect.\n\nOther Factors\nCourts are not limited to the profit-sharing test; they also look at these factors, among others: the right to\nparticipate in decision making, the duty to share liabilities, and the manner in which the business is\noperated. Section 20.3.1 "Tests of Partnership Existence", Chaiken v. Employment Security Commission,\nillustrates how these factors are weighed in court.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n705\n\n\x0cCreation of Partnership by Estoppel\nOrdinarily, if two people are not legally partners, then third parties cannot so regard them. For example,\nMr. Tot and Mr. Tut own equal shares of a house that they rent but do not regard it as a business and are\nnot in fact partners. They do have a loose \xe2\x80\x9cunderstanding\xe2\x80\x9d that since Mr. Tot is mechanically adept, he\nwill make necessary repairs whenever the tenants call. On his way to the house one day to fix its boiler,\nMr. Tot injures a pedestrian, who sues both Mr. Tot and Mr. Tut. Since they are not partners, the\npedestrian cannot sue them as if they were; hence Mr. Tut has no partnership liability.\nSuppose that Mr. Tot and Mr. Tut happened to go to a lumberyard together to purchase materials that Mr.\nTot intended to use to add a room to the house. Short of cash, Mr. Tot looks around and espies Mr. Tat,\nwho greets his two friends heartily by saying within earshot of the salesman who is debating whether to\nextend credit, \xe2\x80\x9cWell, how are my two partners this morning?\xe2\x80\x9d Messrs. Tot and Tut say nothing but smile\nfaintly at the salesman, who mistakenly but reasonably believes that the two are acknowledging the\npartnership. The salesman knows Mr. Tat well and assumes that since Mr. Tat is rich, extending credit to\nthe \xe2\x80\x9cpartnership\xe2\x80\x9d is a \xe2\x80\x9csure thing.\xe2\x80\x9d Messrs. Tot and Tut fail to pay. The lumberyard is entitled to collect\nfrom Mr. Tat, even though he may have forgotten completely about the incident by the time suit is filed.\nUnder Uniform Partnership Act Section 16(1), Mr. Tat would be liable for the debt as being part of\na partnership by estoppel. The Revised Uniform Partnership Act is to the same effect:\nSection 308. Liability of Purported Partner.\n(a) If a person, by words or conduct, purports to be a partner, or consents to being represented\nby another as a partner, in a partnership or with one or more persons not partners, the\npurported partner is liable to a person to whom the representation is made, if that person,\nrelying on the representation, enters into a transaction with the actual or purported partnership.\nPartnership by estoppel has two elements: (1) a representation to a third party that there is in fact a\npartnership and (2) reliance by the third party on the representation. See Section 20.3.3 "Partnership by\nEstoppel", Chavers v. Epsco, Inc., for an example of partnership by estoppel.\n\nKEY TAKEAWAY\n\nA partnership is any two or more persons\xe2\x80\x94including corporate persons\xe2\x80\x94carrying on a business as coowners for profit. A primary test of whether a partnership exists is whether there is a sharing of profits,\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n706\n\n\x0cthough other factors such as sharing decision making, sharing liabilities, and how the business is operated\nare also examined.\nMost partnerships are expressly created. Several factors become important in the partnership agreement,\nwhether written or oral. These include the name of the business, the capital contributions of each partner,\nprofit sharing, and decision making. But a partnership can also arise by implication or by estoppel, where\none has held herself as a partner and another has relied on that representation.\n\nEXERCISES\n\n1.\n\nWhy is it necessary\xe2\x80\x94or at least useful\xe2\x80\x94to have tests to determine whether a partnership exists?\n\n2.\n\nWhat elements of the business organization are examined to make this determination?\n\n3.\n\nJacob rents farmland from Davis and pays Davis a part of the profits from the crop in rent. Is Davis a\npartner? What if Davis offers suggestions on what to plant and when? Now is he a partner?\n\n4.\n\nWhat elements should be included in a written partnership agreement?\n\n5.\n\nWhat is an implied partnership?\n\n6.\n\nWhat is a partnership by estoppel, and why are its \xe2\x80\x9cpartners\xe2\x80\x9d estopped to deny its existence?\n7.\n\n[1] A joint venture\xe2\x80\x94sometimes known as a joint adventure, coadventure, joint enterprise, joint\nundertaking, syndicate, group, or pool\xe2\x80\x94is an association of persons to carry on a particular task until\ncompleted. In essence, a joint venture is a \xe2\x80\x9ctemporary partnership.\xe2\x80\x9d In the United States, the use of joint\nventures began with the railroads in the late 1800s. Throughout the middle part of the twentieth century\njoint ventures were common in the manufacturing sector. By the late 1980s, they increasingly appeared in\nboth manufacturing and service industries as businesses looked for new, competitive strategies. They are\naggressively promoted on the Internet: \xe2\x80\x9cJoint Ventures are in, and if you\xe2\x80\x99re not utilizing this strategic\nweapon, chances are your competition is, or will soon be, using this to their advantage.\xe2\x80\xa6possibly against\nyou!\xe2\x80\x9d (Scott Allen, \xe2\x80\x9cJoint Venturing 101,\xe2\x80\x9d About.com\nEntrepreneurs,http://entrepreneurs.about.com/od/beyondstartup/a/jointventures.htm).As a riskavoiding device, the joint venture allows two or more firms to pool their differing expertise so that neither\nneeds to \xe2\x80\x9clearn the ropes\xe2\x80\x9d from the beginning; neither needs the entire capital to start the\nenterprise.Partnership rules generally apply, although the relationship of the joint venturers is closer to\nthat of special than general agency as discussed in Chapter 18 "Relationships between Principal and\nAgent". Joint venturers are fiduciaries toward one another. Although no formality is necessary, the\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n707\n\n\x0cassociates will usually sign an agreement. The joint venture need have no group name, though it may\nhave one. Property may be owned jointly. Profits and losses will be shared, as in a partnership, and each\nassociate has the right to participate in management. Liability is unlimited.Sometimes two or more\nbusinesses will form a joint venture to carry out a specific task\xe2\x80\x94prospecting for oil, building a nuclear\nreactor, doing basic scientific research\xe2\x80\x94and will incorporate the joint venture. In that case, the resulting\nbusiness\xe2\x80\x94known as a \xe2\x80\x9cjoint venture corporation\xe2\x80\x9d\xe2\x80\x94is governed by corporation law, not the law of\npartnership, and is not a joint venture in the sense described here. Increasingly, companies are forming\njoint ventures to do business abroad; foreign investors or governments own significant interests in these\njoint ventures. For example, in 1984 General Motors entered into a joint venture with Toyota to revive\nGM\xe2\x80\x99s shuttered Fremont, California, assembly plant to create New United Motor Manufacturing, Inc.\n(NUMMI). For GM the joint venture was an opportunity to learn about lean manufacturing from the\nJapanese company, while Toyota gained its first manufacturing base in North America and a chance to\ntest its production system in an American labor environment. Until May 2010, when the copartnership\nended and the plant closed, NUMMI built an average of six thousand vehicles a week, or nearly eight\nmillion cars and trucks. These vehicles were the Chevrolet Nova (1984\xe2\x80\x9388), the Geo Prizm (1989\xe2\x80\x9397), the\nChevrolet Prizm (1998\xe2\x80\x932002), and the Hilux (1991\xe2\x80\x9395, predecessor of the Tacoma), as well as the Toyota\nVoltz, the Japanese right-hand-drive version of the Pontiac Vibe. The latter two were based on the Toyota\nMatrix. Paul Stenquist, \xe2\x80\x9cGM and Toyota\xe2\x80\x99s Joint Venture Ends in California,\xe2\x80\x9d New York Times, April 2,\n2010, http://wheels.blogs.nytimes.com/2010/04/02/g-m-and-toyotas-joint-venture-ends-in-california.\n8.\n\n[2] W. D. Lewis, \xe2\x80\x9cThe Uniform Partnership Act,\xe2\x80\x9d Yale Law Journal 24 (1915): 617, 622.\n\n9.\n\n[3] RUPA, Section 101(10).\n\n10. [4] Revised Uniform Unincorporated Nonprofit Associations\nAct,http://www.abanet.org/intlaw/leadership/policy/RUUNAA_Final_08.pdf.\n\n20.3 Cases\nTests of Partnership Existence\nChaiken v. Employment Security Commission\n274 A.2d 707 (Del. 1971)\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n708\n\n\x0cSTOREY, J.\nThe Employment Security Commission, hereinafter referred to as the Commission, levied an involuntary\nassessment against Richard K. Chaiken, complainant, hereinafter referred to as Chaiken, for not filing his\nunemployment security assessment report. Pursuant to the same statutory section, a hearing was held\nand a determination made by the Commission that Chaiken was the employer of two barbers in his barber\nshop and that he should be assessed as an employer for his share of unemployment compensation\ncontributions. Chaiken appealed the Commission\xe2\x80\x99s decision.\xe2\x80\xa6\nBoth in the administrative hearing and in his appeal brief Chaiken argues that he had entered into\npartnership agreements with each of his barbers and, therefore, was and is not subject to unemployment\ncompensation assessment. The burden is upon the individual assessed to show that he is outside the\nambit of the statutory sections requiring assessment. If Chaiken\xe2\x80\x99s partnership argument fails he has no\nsecondary position and he fails to meet his burden.\nChaiken contends that he and his \xe2\x80\x9cpartners\xe2\x80\x9d:\n1.\n\nproperly registered the partnership name and names of partners in the prothonotary\xe2\x80\x99s office, in\naccordance with [the relevant statute],\n\n[1]\n\n2. properly filed federal partnership information returns and paid federal taxes quarterly on an\nestimated basis, and\n3. duly executed partnership agreements.\nOf the three factors, the last is most important. Agreements of \xe2\x80\x9cpartnership\xe2\x80\x9d were executed between\nChaiken and Mr. Strazella, a barber in the shop, and between Chaiken and Mr. Spitzer, similarly situated.\nThe agreements were nearly identical. The first paragraph declared the creation of a partnership and the\nlocation of business. The second provided that Chaiken would provide barber chair, supplies, and licenses,\nwhile the other partner would provide tools of the trade. The paragraph also declared that upon\ndissolution of the partnership, ownership of items would revert to the party providing them. The third\nparagraph declared that the income of the partnership would be divided 30% for Chaiken, 70% for\nStrazella; 20% for Chaiken and 80% for Spitzer. The fourth paragraph declared that all partnership policy\nwould be decided by Chaiken, whose decision was final. The fifth paragraph forbade assignment of the\nagreement without permission of Chaiken. The sixth paragraph required Chaiken to hold and distribute\nall receipts. The final paragraph stated hours of work for Strazella and Spitzer and holidays.\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n709\n\n\x0cThe mere existence of an agreement labeled \xe2\x80\x9cpartnership\xe2\x80\x9d agreement and the characterization of\nsignatories as \xe2\x80\x9cpartners\xe2\x80\x9d docs not conclusively prove the existence of a partnership. Rather, the intention\nof the parties, as explained by the wording of the agreement, is paramount.\nA partnership is defined as an association of two or more persons to carry on as co-owners a business for\nprofit. As co-owners of a business, partners have an equal right in the decision making process. But this\nright may be abrogated by agreement of the parties without destroying the partnership concept, provided\nother partnership elements are present.\nThus, while paragraph four reserves for Chaiken all right to determine partnership policy, it is not\nstanding alone, fatal to the partnership concept. Co-owners should also contribute valuable consideration\nfor the creation of the business. Under paragraph two, however, Chaiken provides the barber chair (and\nimplicitly the barber shop itself), mirror, licenses and linen, while the other partners merely provide their\ntools and labor\xe2\x80\x94nothing more than any barber-employee would furnish. Standing alone, however, mere\ncontribution of work and skill can be valuable consideration for a partnership agreement.\nPartnership interests may be assignable, although it is not a violation of partnership law to prohibit\nassignment in a partnership agreement. Therefore, paragraph five on assignment of partnership interests\ndoes not violate the partnership concept. On the other hand, distribution of partnership assets to the\npartners upon dissolution is only allowed after all partnership liabilities are satisfied. But paragraph two\nof the agreement, in stating the ground rules for dissolution, makes no declaration that the partnership\nassets will be utilized to pay partnership expenses before reversion to their original owners. This\ndeficiency militates against a finding in favor of partnership intent since it is assumed Chaiken would have\ninserted such provision had he thought his lesser partners would accept such liability. Partners do accept\nsuch liability, employees do not.\nMost importantly, co-owners carry on \xe2\x80\x9ca business for profit.\xe2\x80\x9d The phrase has been interpreted to mean\nthat partners share in the profits and the losses of the business. The intent to divide the profits is an\nindispensable requisite of partnership. Paragraph three of the agreement declares that each partner shall\nshare in the income of the business. There is no sharing of the profits, and as the agreement is drafted,\nthere are no profits. Merely sharing the gross returns does not establish a partnership. Nor is the sharing\nof profits prima facie evidence of a partnership where the profits received are in payment of wages.\nThe failure to share profits, therefore, is fatal to the partnership concept here.\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n710\n\n\x0cEvaluating Chaiken\xe2\x80\x99s agreement in light of the elements implicit in a partnership, no partnership intent\ncan be found. The absence of the important right of decision making or the important duty to share\nliabilities upon dissolution individually may not be fatal to a partnership. But when both are absent,\ncoupled with the absence of profit sharing, they become strong factors in discrediting the partnership\nargument. Such weighing of the elements against a partnership finding compares favorably with Fenwick\nv. Unemployment Compensation Commission, which decided against the partnership theory on similar\nfacts, including the filing of partnership income tax forms.\nIn addition, the total circumstances of the case taken together indicate the employer-employee\nrelationship between Chaiken and his barbers. The agreement set forth the hours of work and days off\xe2\x80\x94\nunusual subjects for partnership agreements. The barbers brought into the relationship only the\nequipment required of all barber shop operators. And each barber had his own individual \xe2\x80\x9cpartnership\xe2\x80\x9d\nwith Chaiken. Furthermore, Chaiken conducted all transactions with suppliers, and purchased licenses,\ninsurance, and the lease for the business property in his own name. Finally, the name \xe2\x80\x9cRichard\xe2\x80\x99s Barber\nShop\xe2\x80\x9d continued to be used after the execution of the so-called partnership agreements. [The\nCommission\xe2\x80\x99s decision is affirmed.]\n\nCASE QUESTIONS\n\n1.\n\nWhy did the unemployment board sue Chaiken?\n\n2.\n\nWhy did Chaiken set up this \xe2\x80\x9cpartnership\xe2\x80\x9d?\n\n3.\n\nWhat factors did the court examine to determine whether there was a partnership here? Which one was\nthe most important?\n\n4.\n\nWhy would it be unusual in a partnership agreement to set forth the hours of work and days off?\n\nCreation of a Partnership: Registering the Name\nLoomis v. Whitehead\n183 P.3d 890 (Nev. 2008)\nPer Curiam.\nIn this appeal, we address whether [Nevada Revised Statute] NRS 602.070 bars the partners of an\nunregistered fictitious name partnership from bringing an action arising out of a business agreement that\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n711\n\n\x0cwas not made under the fictitious name. [The statute] prohibits persons who fail to file an assumed or\nfictitious name certificate from suing on any contract or agreement made under the assumed or fictitious\nname. We conclude that it does not bar the partners from bringing the action so long as the partners did\nnot conduct the business or enter into an agreement under the fictitious name or otherwise mislead the\nother party into thinking that he was doing business with some entity other than the partners themselves.\n\nBackground Facts\nAppellants Leroy Loomis and David R. Shanahan raised and sold cattle in Elko County, Nevada. Each of\nthe appellants had certain responsibilities relating to the cattle business. Loomis supplied the livestock\nand paid expenses, while Shanahan managed the day-to-day care of the cattle. Once the cattle were\nreadied for market and sold, Loomis and Shanahan would share the profits equally. While Loomis and\nShanahan often called themselves the 52 Cattle Company, they had no formal partnership agreement and\ndid not file an assumed or fictitious name certificate in that name. Loomis and Shanahan bring this appeal\nafter an agreement entered into with respondent Jerry Carr Whitehead failed.\nIn the fall of 2003, Shanahan entered into a verbal agreement with Whitehead, a rancher, through\nWhitehead\xe2\x80\x99s ranch foreman to have their cattle wintered at Whitehead\xe2\x80\x99s ranch. Neither Loomis nor\nWhitehead was present when the ranch foreman made the deal with Shanahan, but the parties agree that\nthere was no mention of the 52 Cattle Company at the time they entered into the agreement or anytime\nduring the course of business thereafter. Shanahan and Loomis subsequently alleged that their cattle were\nmalnourished and that a number of their cattle died from starvation that winter at Whitehead\xe2\x80\x99s ranch.\nWhitehead denied these allegations.\n\nSuit against Whitehead\nThe following summer, Shanahan and Loomis sued Whitehead, claiming negligence and breach of\ncontract. Later, well into discovery, Whitehead was made aware of the existence of the 52 Cattle Company\nwhen Shanahan stated in his deposition that he did not actually own any of the cattle on Whitehead\xe2\x80\x99s\nranch. In his deposition, he described the partnership arrangement. At about the same time, Whitehead\nlearned that the name \xe2\x80\x9c52 Cattle Company\xe2\x80\x9d was not registered with the Elko County Clerk.\nWhitehead then filed a motion for partial summary judgment, asserting that, pursuant to NRS 602.070,\nLoomis and Shanahan\xe2\x80\x99s failure to register their fictitiously named partnership with the county clerk\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n712\n\n\x0cbarred them from bringing a legal action. The district court agreed with Whitehead, granted the motion,\nand dismissed Loomis and Shanahan\xe2\x80\x99s claims. Loomis and Shanahan timely appealed.\n\nDiscussion\nThe district court found that Loomis and Shanahan conducted business under a fictitious name without\nfiling a fictitious name certificate with the Elko County Clerk as required by NRS 602.010.\n\n[2]\n\nThe district\n\ncourt therefore concluded that, pursuant to NRS 602.070, they were barred from bringing an action\nagainst Whitehead because they did not file a fictitious name certificate for the 52 Cattle Company.\n\n[3]\n\nLoomis and Shanahan contend that the district court erred in granting partial summary judgment\nbecause they did not enter into a contract with Whitehead under the name of the 52 Cattle Company, and\nthey did not conduct business with Whitehead under that name. Loomis and Shanahan argue that NRS\n602.070 is not applicable to their action against Whitehead because they did not mislead Whitehead into\nthinking that he was doing business with anyone other than them. We agree.\xe2\x80\xa6\nWhen looking at a statute\xe2\x80\x99s language, this court is bound to follow the statute\xe2\x80\x99s plain meaning, unless the\nplain meaning was clearly not intended. Here, in using the phrase \xe2\x80\x9cunder the assumed or fictitious name,\xe2\x80\x9d\nthe statute clearly bars bringing an action when the claims arise from a contract, transaction, or business\nconducted beneath the banner of an unregistered fictitious name. However, NRS 602.070 does not apply\nto individual partners whose transactions or business with another party were not performed under the\nfictitious name.\nHere, Whitehead knew that Shanahan entered into the oral contract under his own name. He initially\nthought that Shanahan owned the cattle and Loomis had \xe2\x80\x9csome type of interest.\xe2\x80\x9d Shanahan did not enter\ninto the contract under the fictitious \xe2\x80\x9c52 Cattle Company\xe2\x80\x9d name. Moreover, Whitehead does not allege\nthat he was misled by either Loomis or Shanahan in any way that would cause him to think he was doing\nbusiness with the 52 Cattle Company. In fact, Whitehead did not know of the 52 Cattle Company until\nShanahan mentioned it in his deposition. Under these circumstances, when there simply was no\nindication that Loomis and Shanahan represented that they were conducting business as the 52 Cattle\nCompany and no reliance by Whitehead that he was doing business with the 52 Cattle Company, NRS\n602.070 does not bar the suit against Whitehead.\nWe therefore reverse the district court\xe2\x80\x99s partial summary judgment in this instance and remand for trial\nbecause, while the lawsuit between Loomis and Whitehead involved partnership business, the transaction\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n713\n\n\x0cat issue was not conducted and the subsequent suit was not maintained under the aegis of the fictitiously\nnamed partnership.\n\n1.\n\nCASE QUESTIONS\n\nThe purpose of the fictitious name statute might well be, as the court here describes it, \xe2\x80\x9cto prevent fraud\nand to give the public information about those entities with which they conduct business.\xe2\x80\x9d But that\xe2\x80\x99s not\nwhat the statute says; it says nobody can sue on a cause of action arising out of business conducted under\na fictitious name if the name is not registered. The legislature determined the consequence of failure to\nregister. Should the court disregard the statute\xe2\x80\x99s plain, unambiguous meaning?\n\n2.\n\nThat was one of two arguments by the dissent in this case. The second one was based on this problem:\nShanahan and Loomis agreed that the cattle at issue were partnership cattle bearing the \xe2\x80\x9c52\xe2\x80\x9d brand. That\nis, the cows werenot Shanahan\xe2\x80\x99s; they were the partnership\xe2\x80\x99s. When Whitehead moved to dismiss\nShanahan\xe2\x80\x99s claim\xe2\x80\x94again, because the cows weren\xe2\x80\x99t Shanahan\xe2\x80\x99s\xe2\x80\x94Shanahan conceded that but for the\nexistence of the partnership he would have no claim against Whitehead. If there is no claim against the\ndefendant except insofar as he harmed the partnership business (the cattle), how could the majority\nassert that claims against Whitehead did not arise out of \xe2\x80\x9cthe business\xe2\x80\x9d conducted under 52 Cattle\nCompany? Who has the better argument, the majority or the dissent?\n\n3.\n\nHere is another problem along the same lines but with a different set of facts and a Uniform Partnership\nAct (UPA) jurisdiction (i.e., pre\xe2\x80\x93Revised Uniform Partnership Act [RUPA]). Suppose the plaintiffs had a\npartnership (as they did here), but the claim by one was that the other partner had stolen several head of\ncattle, and UPA was in effect so that the partnership property was owned as \xe2\x80\x9ctenant in partnership\xe2\x80\x9d\xe2\x80\x94the\ncattle would be owned by the partners as a whole. A person who steals his own property cannot be\ncriminally liable; therefore, a partner cannot be guilty of stealing (or misappropriating) firm property.\nThus under UPA there arise anomalous cases, for example, inPeople v. Zinke, 555 N.E.2d 263 (N.Y. 1990),\nwhich is a criminal case, Zinke embezzled over a million dollars from his own investment firm but the\nprosecutor\xe2\x80\x99s case against him was dismissed because, the New York court said, \xe2\x80\x9cpartners cannot be\nprosecuted for stealing firm property.\xe2\x80\x9d If the partnership is a legal entity, as under RUPA, how is this\nresult changed?\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n714\n\n\x0cPartnership by Estoppel\nChavers v. Epsco, Inc.\n98 S.W.3d 421 (Ark. 2003)\nHannah, J.\nAppellants Reggie Chavers and Mark Chavers appeal a judgment entered against them by the Craighead\nCounty Circuit Court. Reggie and Mark argue that the trial court erred in holding them liable for a\ncompany debt based upon partnership by estoppel because the proof was vague and insufficient and there\nwas no detrimental reliance on the part of a creditor. We hold that the trial court was not clearly\nerroneous in finding liability based upon partnership by estoppel. Accordingly, we affirm.\n\nFacts\nGary Chavers operated Chavers Welding and Construction (\xe2\x80\x9cCWC\xe2\x80\x9d), a construction and welding business,\nin Jonesboro. Gary\xe2\x80\x99s sons Reggie Chavers and Mark Chavers joined their father in the business after\ngraduating from high school. Gary, Mark, and Reggie maintain that CWC was a sole proprietorship owned\nby Gary, and that Reggie and Mark served only as CWC employees, not as CWC partners.\nIn February 1999, CWC entered into an agreement with Epsco, Inc. (\xe2\x80\x9cEpsco\xe2\x80\x9d), a staffing service, to\nprovide payroll and employee services for CWC. Initially, Epsco collected payments for its services on a\nweekly basis, but later, Epsco extended credit to CWC. Melton Clegg, President of Epsco, stated that his\ndecision to extend credit to CWC was based, in part, on his belief that CWC was a partnership.\nCWC\xe2\x80\x99s account with Epsco became delinquent, and Epsco filed a complaint against Gary, Reggie, and\nMark, individually, and doing business as CWC, to recover payment for the past due account. Gary\ndischarged a portion of his obligation to Epsco due to his filing for bankruptcy. Epsco sought to recover\nCWC\xe2\x80\x99s remaining debt from Reggie and Mark. After a hearing on March 7, 2002, the trial court issued a\nletter opinion, finding that Reggie and Mark \xe2\x80\x9crepresented themselves to [Epsco] as partners in an existing\npartnership and operated in such a fashion to give creditors in general, and Epsco in particular, the\nimpression that such creditors/potential creditors were doing business with a partnership.\xe2\x80\xa6\xe2\x80\x9d On May 21,\n2002, the trial court entered an order stating that Reggie and Mark were partners by estoppel as relates to\nEpsco. The trial court found that Reggie and Mark were jointly and severally liable for the debt of CWC in\nthe amount of $80,360.92. In addition, the trial court awarded Epsco pre-judgment interest at the rate of\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n715\n\n\x0csix percent, post-judgment interest at the rate of ten percent, and attorney\xe2\x80\x99s fees in the amount of\n$8,036.92.\n[The relevant Arkansas statute provides]:\n(1) When a person, by words spoken or written or by conduct, represents himself, or consents to\nanother representing him to any one, as a partner in an existing partnership or with one (1) or\nmore persons not actual partners, he is liable to any person to whom such representation has\nbeen made, who has, on the faith of such representation, given credit to the actual or apparent\npartnership, and if he has made such representation or consented to its being made in a public\nmanner, he is liable to that person, whether the representation has or has not been made or\ncommunicated to that person so giving credit by or with the knowledge of the apparent partner\nmaking the representation or consenting to it being made.\n(a) When a partnership liability results, he is liable as though he were an actual member of the\npartnership.\nWe have long recognized the doctrine of partnership by estoppel. [Citation, 1840], the court stated that\nthey who hold themselves out to the world as partners in business or trade, are to be so regarded\nas to creditors and third persons; and the partnership may be established by any evidence\nshowing that they so hold themselves out to the public, and were so regarded by the trading\ncommunity.\nFurther, we have stated that \xe2\x80\x9c[p]artnerships may be proved by circumstantial evidence; and evidence will\nsometimes fix a joint liability, where persons are charged as partners, in a suit by a third person, when\nthey are not, in fact, partners as between themselves.\xe2\x80\x9d [Citation, 1843.]\nIn [Citation, 1906], the court noted that\n[a] person who holds himself out as a partner of a firm is estopped to deny such representation,\nnot only as to those as to whom the representation was directly made, but as to all others who\nhad knowledge of such holding out and in reliance thereon sold goods to the firm.\xe2\x80\xa6\nIn addition, \xe2\x80\x9cif the party himself puts out the report that he is a partner, he will be liable to all those\nselling goods to the firm on the faith and credit of such report.\xe2\x80\x9d [Citation] When a person holds himself\nout as a member of partnership, any one dealing with the firm on the faith of such representation is\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n716\n\n\x0centitled to assume the relation continues until notice of some kind is given of its discontinuance.\n[Citations]\nIn [Citation, 1944], the court wrote:\nIt is a thoroughly well-settled rule that persons who are not as between themselves partners, or\nas between whom there is in fact no legal partnership, may nevertheless become subject to the\nliabilities of partners, either by holding themselves out as partners to the public and the world\ngenerally or to particular individuals, or by knowingly or negligently permitting another person\nto do so. All persons who hold themselves out, or knowingly permit others to hold them out, to the\npublic as partners, although they are not in partnership, become bound as partners to all who\ndeal with them in their apparent relation.\nThe liability as a partner of a person who holds himself out as a partner, or permits others to do\nso, is predicated on the doctrine of estoppel and on the policy of the law seeking to prevent frauds\non those who lend their money on the apparent credit of those who are held out as partners. One\nholding himself out as a partner or knowingly permitting himself to be so held out is estopped\nfrom denying liability as a partner to one who has extended credit in reliance thereon, although\nno partnership has in fact existed.\nIn the present case, the trial court cited specific examples of representations made by Reggie and Mark\nindicating that they were partners of CWC, including correspondence to Epsco, checks written to Epsco,\nbusiness cards distributed to the public, and credit applications. We will discuss each in turn.\n\nThe Faxed Credit References\nEpsco argues that Plaintiff\xe2\x80\x99s Exhibit # 1, a faxed list of credit references, clearly indicates that Gary was\nthe owner and that Reggie and Mark were partners in the business. The fax lists four credit references,\nand it includes CWC\xe2\x80\x99s contact information. The contact information lists CWC\xe2\x80\x99s telephone number, fax\nnumber, and federal tax number. The last two lines of the contact information state: \xe2\x80\x9cGary Chavers\nOwner\xe2\x80\x9d and \xe2\x80\x9cReggie Chavers and Mark Chavers Partners.\xe2\x80\x9d\nGary testified that he did not know that the list of credit references was faxed to Epsco. In addition, he\ntestified that his signature was not at the bottom of the fax. He testified that his former secretary might\nhave signed his name to the fax; however, he stated that he did not authorize his secretary to sign or fax a\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n717\n\n\x0clist of credit references to Epsco. Moreover, Gary testified that the first time he saw the list of credit\nreferences was at the bench trial.\nThis court gives deference to the superior position of the trial judge to determine the credibility of the\nwitnesses and the weight to be accorded their testimony. [Citations] Though there was a dispute\nconcerning whether Gary faxed the list to Epsco, the trial court found that Epsco received the faxed credit\nreferences from CWC and relied on CWC\xe2\x80\x99s statement that Reggie and Mark were partners. The trial\ncourt\xe2\x80\x99s finding is not clearly erroneous.\n\nThe Fax Cover Sheet\nAt trial, Epsco introduced Plaintiff\xe2\x80\x99s Exhibit # 2, a fax cover sheet from \xe2\x80\x9cChavers Construction\xe2\x80\x9d to Epsco.\nThe fax cover sheet was dated July 19, 2000. The fax cover sheet contained the address, telephone\nnumber, and fax number of the business. Listed under this information was \xe2\x80\x9cGary, Reggie, or Mark\nChavers.\xe2\x80\x9d Epsco argues that Gary, Reggie, and Mark are all listed on the fax cover sheet, and that this\nindicates that they were holding themselves out to the public as partners of the business. The trial court\xe2\x80\x99s\nfinding that the fax cover sheet indicated that Reggie and Mark were holding themselves out as partners\nof CWC is not clearly erroneous.\n\nThe Epsco Personnel Credit Application\nEpsco introduced Plaintiff\xe2\x80\x99s Exhibit # 9, a personnel credit application, which was received from CWC.\nAdams testified that the exhibit represented a completed credit application that she received from CWC.\nThe type of business checked on the credit application is \xe2\x80\x9cpartnership.\xe2\x80\x9d Adams testified that the\napplication showed the company to be a partnership, and that this information was relied upon in\nextending credit. Clegg testified that he viewed the credit application which indicated that CWC was a\npartnership, and that his decision to extend credit to CWC was based, in part, on his belief that CWC was\na partnership. Gary denied filling out the credit application form.\nIt was within the trial court\xe2\x80\x99s discretion to find Adams\xe2\x80\x99s and Clegg\xe2\x80\x99s testimony more credible than Gary\xe2\x80\x99s\ntestimony and to determine that Epsco relied on the statement of partnership on the credit application\nbefore extending credit to CWC. The trial court\xe2\x80\x99s finding concerning the credit application is not clearly\nerroneous.\n\nThe Checks to Epsco\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n718\n\n\x0cEpsco argues that Plaintiff\xe2\x80\x99s Exhibit # 3 and Plaintiff\xe2\x80\x99s Exhibit # 11, checks written to Epsco showing the\nCWC account to be in the name of \xe2\x80\x9cGary A. or Reggie J. Chavers,\xe2\x80\x9d indicates that Reggie was holding\nhimself out to be a partner of CWC. Plaintiff\xe2\x80\x99s Exhibit # 3 was signed by Gary, and Plaintiff\xe2\x80\x99s Exhibit # 11\nwas signed by Reggie. The checks are evidence that Reggie was holding himself out to the public as a\npartner of CWC, and Epsco could have detrimentally relied on the checks before extending credit to CWC.\nThe trial court was not clearly erroneous in finding that the checks supported a finding of partnership by\nestoppel.\n\nThe Business Card\nEpsco introduced Plaintiff\xe2\x80\x99s Exhibit # 4, a business card that states \xe2\x80\x9cChavers Welding, Construction &\nCrane Service.\xe2\x80\x9d Listed on the card as \xe2\x80\x9cowners\xe2\x80\x9d are Gary Chavers and Reggie Chavers. Gary testified that\nthe business cards were printed incorrectly, and that Reggie\xe2\x80\x99s name should not have been included as an\nowner. He also testified that some of the cards might have been handed out, and that it was possible that\nhe might have given one of the cards to a business listed as one of CWC\xe2\x80\x99s credit references on Plaintiff\xe2\x80\x99s\nExhibit # 1.\nThe business card listing Reggie as an owner indicates that Reggie was holding himself out as a partner.\nAs we stated in [Citation] when a person holds himself out as a member of partnership, any one dealing\nwith the firm on the faith of such representation is entitled to assume the relation continues until notice of\nsome kind is given of its discontinuance. There is no indication that Reggie ever informed any person who\nreceived a business card that the business relationship listed on the card was incorrect or had been\ndiscontinued. The trial court\xe2\x80\x99s finding concerning the business card is not clearly erroneous.\n\nThe Dealership Application\nEpsco introduced Plaintiff\xe2\x80\x99s Exhibit # 5, an application form from \xe2\x80\x9cChavers Welding,\xe2\x80\x9d signed by Reggie,\nseeking a dealership from Sukup Manufacturing. The application, dated January 23, 1997, lists \xe2\x80\x9cGary &\nReggie Chavers\xe2\x80\x9d as owners of \xe2\x80\x9cChavers Welding.\xe2\x80\x9d The application is signed by Reggie. Reggie admits that\nhe signed the dealership application and represented that he was an owner of \xe2\x80\x9cChavers Welding,\xe2\x80\x9d but he\ndismisses his statement of ownership as mere \xe2\x80\x9cpuffery\xe2\x80\x9d on his part. Epsco argues that instead, the\napplication shows that Reggie was holding himself out to the public as being a partner. The trial court\xe2\x80\x99s\ndetermination that Reggie\xe2\x80\x99s dealership application supports a finding of partnership by estoppel is not\nclearly erroneous.\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n719\n\n\x0cIn sum, the trial court was not clearly erroneous in finding that Reggie and Mark held themselves out as\npartners of CWC and that Epsco detrimentally relied on the existence of the partnership before extending\ncredit to CWC. The appellants argue that even if we find Reggie liable based upon partnership by estoppel,\nthere was scant proof of Mark being liable based upon partnership by estoppel. We disagree. We are\naware that some examples of holding out cited in the trial court\xe2\x80\x99s order pertain only to Reggie. However,\nthe representations attributed to both Reggie and Mark are sufficient proof to support the trial court\xe2\x80\x99s\nfinding that both Reggie and Mark are estopped from denying liability to Epsco.\nAffirmed.\n\nCASE QUESTIONS\n\n1.\n\nWhat is the rationale for the doctrine of partnership by estoppel?\n\n2.\n\nGary and Reggie claimed the evidence brought forth to show the existence of a partnership was\nunconvincing. How credible were their claims?\n3.\n\n[1] The word prothonotary means first notary of the court. The prothonotary is the keeper of the civil\nrecords for the court system. The office is responsible for the creation, maintenance, and certification of\nmatters pending or determined by the court. The office is also responsible for certain reporting and\ncollection duties to state agencies.\n\n4.\n\n[2] NRS 602.010(1): \xe2\x80\x9cEvery person doing business in this state under an assumed or fictitious name that is\nin any way different from the legal name of each person who owns an interest in the business must file\nwith the county clerk of each county in which the business is being conducted a certificate containing the\ninformation required by NRS 602.020.\xe2\x80\x9d\n\n5.\n\n[3] NRS 602.070: \xe2\x80\x9cNo action may be commenced or maintained by any person\xe2\x80\xa6upon or on account of any\ncontract made or transaction had under the assumed or fictitious name, or upon or on account of any\ncause of action arising or growing out of the business conducted under that name, unless before the\ncommencement of the action the certificate required by NRS 602.010 has been filed.\xe2\x80\x9d\n\n20.4 Summary and Exercises\nSummary\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n720\n\n\x0cThe basic law of partnership is found in the Uniform Partnership Act and Revised Uniform Partnership\nAct. The latter has been adopted by thirty-five states. At common law, a partnership was not a legal entity\nand could not sue or be sued in the partnership name. Partnership law defines a partnership as \xe2\x80\x9can\nassociation of two or more persons to carry on as co-owners a business for profit.\xe2\x80\x9d The Uniform\nPartnership Act (UPA) assumes that a partnership is an aggregation of individuals, but it also applies a\nnumber of rules characteristic of the legal entity theory. The Revised Uniform Partnership Act (RUPA)\nassumes a partnership is an entity, but it applies one crucial rule characteristic of the aggregate theory:\nthe partners are ultimately liable for the partnership\xe2\x80\x99s obligations. Thus a partnership may keep business\nrecords as if it were a legal entity, may hold real estate in the partnership name, and may sue and be sued\nin federal court and in many state courts in the partnership name.\nPartnerships may be created informally. Among the clues to the existence of a partnership are (1) coownership of a business, (2) sharing of profits, (3) right to participate in decision making, (4) duty to\nshare liabilities, and (5) manner in which the business is operated. A partnership may also be formed by\nimplication; it may be formed by estoppel when a third party reasonably relies on a representation that a\npartnership in fact exists.\nNo special rules govern the partnership agreement. As a practical matter, it should sufficiently spell out\nwho the partners are, under what name they will conduct their business, the nature and scope of the\nbusiness, capital contributions of each partner, how profits are to be divided, and similar pertinent\nprovisions. An oral agreement to form a partnership is valid unless the business cannot be performed\nwholly within one year from the time that the agreement is made. However, most partnerships have no\nfixed terms and hence are \xe2\x80\x9cat-will\xe2\x80\x9d partnerships not subject to the Statute of Frauds.\n\nEXERCISES\n\n1.\n\nAble, Baker, and Carr own, as partners, a warehouse. The income from the warehouse during the current\nyear is $300,000, two-thirds of which goes to Able. Who must file a tax return listing this as income, the\npartnership or Able? Who pays the tax, the partnership or Able?\n\n2.\n\nThe Havana Club operated in Salt Lake City under a lease running to defendant Dale Bowen, who owned\nthe equipment, furnishings, and inventory. He did not himself work in operating the club. He made an\noral agreement with Frances Cutler, who had been working for him as a bartender, that she take over the\nmanagement of the club. She was to have the authority and the responsibility for the entire active\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n721\n\n\x0cmanagement and operation: to purchase the supplies, pay the bills, keep the books, hire and fire\nemployees, and do whatever else was necessary to run the business. As compensation, the arrangement\nwas for a down-the-middle split; each was to receive $300 per week plus one half of the net profits. This\nwent on for four years until the city took over the building for a redevelopment project. The city offered\nBowen $30,000 as compensation for loss of business while a new location was found for the club. Failing\nto find a suitable location, the parties decided to terminate the business. Bowen then contended he was\nentitled to the entire $30,000 as the owner, Cutler being an employee only. She sued to recover half as a\npartner. What was the result? Decide and discuss.\n3.\n\nRaul, a business student, decided to lease and operate an ice cream stand during his summer vacation.\nBecause he could not afford rent payments, his lessor agreed to take 30 percent of the profits as rent and\nprovide the stand and the parcel of real estate on which it stood. Are the two partners?\n\n4.\n\nAble, Baker, and Carr formed the ABC Partnership in 2001. In 2002 Able gave her three sons, Duncan,\nEldon, and Frederick, a gift of her 41 percent interest in the partnership to provide money to pay for their\ncollege expenses. The sons reported income from the partnership on their individual tax returns, and the\npartnership reported the payment to them on its information return. The sons were listed as partners on\nunaudited balance sheets in 2003, and the 2004 income statement listed them as partners. The sons\nnever requested information about the management of the firm, never attended any meetings or voted,\nand never attempted to withdraw the firm\xe2\x80\x99s money or even speak with the other partners about the firm.\nTwo of the sons didn\xe2\x80\x99t know where the firm was located, but they all once received \xe2\x80\x9cmanagement fees\xe2\x80\x9d\ntotaling $3,000, without any showing of what the \xe2\x80\x9cfees\xe2\x80\x9d were for. In 2005, the partnership incurred\nliability for pension-fund contributions to an employee, and a trustee for the fund asserted that Able\'s\nsons were personally liable under federal law for the money owing because they were partners. The sons\nmoved for summary judgment denying liability. How should the court rule?\n\n5.\n\nThe Volkmans wanted to build a house and contacted David McNamee for construction advice. He told\nthem that he was doing business with Phillip Carroll. Later the Volkmans got a letter from McNamee on\nstationery that read \xe2\x80\x9cDP Associates,\xe2\x80\x9d which they assumed was derived from the first names of David and\nPhillip. At the DP Associates office McNamee introduced Mr. Volkman to Carroll, who said to Volkman, \xe2\x80\x9cI\nhope we\xe2\x80\x99ll be working together.\xe2\x80\x9d At one point during the signing process a question arose and McNamee\nsaid, \xe2\x80\x9cI will ask Phil.\xe2\x80\x9d He returned with the answer to the question. After the contract was signed but\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n722\n\n\x0cbefore construction began, Mr. Volkman visited the DP Associates office where the two men chatted;\nCarroll said to him, \xe2\x80\x9cI am happy that we will be working with you.\xe2\x80\x9d The Volkmans never saw Carroll on the\nconstruction site and knew of no other construction supervised by Carroll. They understood they were\npurchasing Carroll\xe2\x80\x99s services and construction expertise through DP Associates. During construction, Mr.\nVolkman visited the DP offices several times and saw Carroll there. During one visit, Mr. Volkman\nexpressed concerns about delays and expressed the same to Carroll, who replied, \xe2\x80\x9cDon\xe2\x80\x99t worry. David will\ntake care of it.\xe2\x80\x9d But David did not, and the Volkmans sued DP Associates, McNamee, and Carroll. Carroll\nasserted he could not be liable because he and McNamee were not partners. The trial court dismissed\nCarroll on summary judgment; the Volkmans appealed. How should the court rule on appeal?\n6.\n\nWilson and VanBeek want to form a partnership. Wilson is seventeen and VanBeek is twenty-two. May\nthey form a partnership? Explain.\n\n7.\n\nDiane and Rachel operate a restaurant at the county fair every year to raise money for the local 4-H Club.\nThey decide together what to serve, what hours to operate, and generally how to run the business. Do\nthey have a partnership?\n\n1.\n\nSELF-TEST QUESTIONS\n\nThe basic law of partnership is currently found in\na.\n\ncommon law\n\nb.\n\nconstitutional law\n\nc.\n\nstatutory law\n\nd.\n\nnone of the above\nExistence of a partnership may be established by\n\na.\n\nco-ownership of a business for profit\nb.\n\nestoppel\n\nc.\n\na formal agreement\n\nd.\n\nall of the above\nWhich is false?\n\na.\n\nAn oral agreement to form a partnership is valid.\nb.\n\nMost partnerships have no fixed terms and are thus not subject to the Statute of Frauds.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n723\n\n\x0cc.\n\nStrict statutory rules govern partnership agreements.\n\nd.\n\nA partnership may be formed by estoppel.\nPartnerships\n\na.\n\nare not taxable entities\nb.\n\nmay buy, sell, or hold real property in the partnership name\n\nc.\n\nmay file for bankruptcy\n\nd.\n\nhave all of the above characteristics\nPartnerships\n\na.\n\nare free to select any name not used by another partnership\n\n1.\n\nc\n\n2.\n\nd\n\n3.\n\nc\n\n4.\n\nd\n\n5.\n\nc\n\nb.\n\nmust include the partners\xe2\x80\x99 names in the partnership name\n\nc.\n\ncan be formed by two corporations\n\nd.\n\ncannot be formed by two partnerships\n\nSELF-TEST ANSWERS\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n724\n\n\x0cChapter 21\n\nPartnership Operation and Termination\nLEARNING OBJECTIVES\nAfter reading this chapter, you should understand the following:\n1.\n\nThe operation of a partnership, including the relations among partners and relations between partners\nand third parties\n\n2.\n\nThe dissolution and winding up of a partnership\n\n21.1 Operation: Relations among Partners\nLEARNING OBJECTIVES\n\n1.\n\nRecognize the duties partners owe each other: duties of service, loyalty, care, obedience, information,\nand accounting.\n\n2.\n\nIdentify the rights that partners have, including the rights to distributions of money, to management, to\nchoice of copartners, to property of the partnership, to assign partnership interest, and to enforce duties\nand rights.\n\nMost of the rules discussed in this section apply unless otherwise agreed, and they are really\nintended for the small firm. [1] The Uniform Partnership Act (UPA) and the Revised Uniform\nPartnership Act (RUPA) do not dictate what the relations among partners must be; the acts supply\nrules in the event that the partners have not done so for themselves. In this area, it is especially\nimportant for the partners to elaborate their agreement in writing. If the partners should happen to\ncontinue their business beyond the term fixed for it in their agreement, the terms of the agreement\ncontinue to apply.\n\nDuties Partners Owe Each Other\nAmong the duties partners owe each other, six may be called out here: (1) the duty to serve, (2) the duty of\nloyalty, (3) the duty of care, (4) the duty of obedience, (5) the duty to inform copartners, and (6) the duty\nto account to the partnership. These are all very similar to the duty owed by an agent to the principal, as\npartnership law is based on agency concepts.\n\n[2]\n\nDuty to Serve\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n725\n\n\x0cUnless otherwise agreed, expressly or impliedly, a partner is expected to work for the firm. The\npartnership, after all, is a profit-making co-venture, and it would not do for one to loaf about and still\nexpect to get paid. For example, suppose Joan takes her two-week vacation from the horse-stable\npartnership she operates with Sarah and Sandra. Then she does not return for four months because she\nhas gone horseback riding in the Southwest. She might end up having to pay if the partnership hired a\nsubstitute to do her work.\n\nDuty of Loyalty\nIn general, this requires partners to put the firm\xe2\x80\x99s interests ahead of their own. Partners are fiduciaries as\nto each other and as to the partnership, and as such, they owe a fiduciary duty to each other and the\npartnership. Judge Benjamin Cardozo, in an often-quoted phrase, called the fiduciary duty \xe2\x80\x9csomething\nstricter than the morals of the market place. Not honesty alone, but the punctilio of an honor the most\n[3]\n\nsensitive, is then the standard of behavior.\xe2\x80\x9d Breach of the fiduciary duty gives rise to a claim for\ncompensatory, consequential, and incidental damages; recoupment of compensation; and\xe2\x80\x94rarely\xe2\x80\x94\npunitive damages. See , Gilroy v. Conway, for an example of breach of fiduciary duty.\n\nApplication of the Fiduciary Standard to Partnership Law\nUnder UPA, all partners are fiduciaries of each other\xe2\x80\x94they are all principals and agents of each other\xe2\x80\x94\nthough the word fiduciary was not used except in the heading to Section 21. The section reads, \xe2\x80\x9cEvery\npartner must account to the partnership for any benefit, and hold as trustee for it any profits derived by\nhim without the consent of the other partners from any transaction connected with the formation,\nconduct, or liquidation of the partnership or from any use by him of its property.\xe2\x80\x9d\nSection 404 of RUPA specifically provides that a partner has a fiduciary duty to the partnership and other\npartners. It imposes the fiduciary standard on the duty of loyalty in three circumstances:\n(1) to account to the partnership and hold as trustee for it any property, profit, or benefit derived\nby the partner in the conduct and winding up of the partnership business or derived from a use\nby the partner of partnership property, including the appropriation of a partnership\nopportunity;\n(2) to refrain from dealing with the partnership in the conduct or winding up of the partnership\nbusiness as or on behalf of a party having an interest adverse to the partnership; and\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n726\n\n\x0c(3) to refrain from competing with the partnership in the conduct of the partnership business\nbefore the dissolution of the partnership.\n\nLimits on the Reach of the Fiduciary Duty\nThis sets out a fairly limited scope for application of the fiduciary standard, which is reasonable because\npartners do not delegate open-ended control to their copartners. Further, there are some specific limits on\nhow far the fiduciary duty reaches (which means parties are held to the lower standard of \xe2\x80\x9cgood faith\xe2\x80\x9d).\nHere are two examples. First, RUPA\xe2\x80\x94unlike UPA\xe2\x80\x94does not extend to the formation of the partnership;\nComment 2 to RUPA Section 404 says that would be inappropriate because then the parties are \xe2\x80\x9creally\ndealing at arm\xe2\x80\x99s length.\xe2\x80\x9d Second, fiduciary duty doesn\xe2\x80\x99t apply to a dissociated partner (one who leaves the\nfirm\xe2\x80\x94discussed in ) who can immediately begin competing without the others\xe2\x80\x99 consent; and it doesn\xe2\x80\x99t\napply if a partner violates the standard \xe2\x80\x9cmerely because the partner\xe2\x80\x99s conduct furthers the partner\xe2\x80\x99s own\n[4]\n\ninterest.\xe2\x80\x9d Moreover, the partnership agreement may eliminate the duty of loyalty so long as that is not\n\xe2\x80\x9cmanifestly unreasonable.\xe2\x80\x9d\n\n[5]\n\nActivities Affected by the Duty of Loyalty\nThe duty of loyalty means, again, that partners must put the firm\xe2\x80\x99s interest above their own. Thus it is\nheld that a partner\n\xe2\x80\xa2\n\nmay not compete with the partnership,\n\n\xe2\x80\xa2\n\nmay not make a secret profit while doing partnership business,\n\n\xe2\x80\xa2\n\nmust maintain the confidentiality of partnership information.\n\nThis is certainly not a comprehensive list, and courts will determine on a case-by-case basis whether the\nduty of loyalty has been breached.\n\nDuty of Care\nStemming from its roots in agency law, partnership law also imposes a duty of care on partners. Partners\nare to faithfully serve to the best of their ability. Section 404 of RUPA imposes the fiduciary standard on\nthe duty of care, but rather confusingly: how does the \xe2\x80\x9cpunctilio of an honor the most sensitive\xe2\x80\x9d\xe2\x80\x94as Judge\nCardozo described that standard\xe2\x80\x94apply when under RUPA Section 404(c) the \xe2\x80\x9cthe duty of care\xe2\x80\xa6is\nlimited to refraining from engaging in grossly negligent or reckless conduct, intentional misconduct, or a\nknowing violation of law\xe2\x80\x9d? Recognize that a person can attend to business both loyally and negligently.\nFor example, Alice Able, a partner in a law firm who is not very familiar with the firm\xe2\x80\x99s computerized\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n727\n\n\x0cbookkeeping system, attempts to trace a missing check and in so doing erases a month\xe2\x80\x99s worth of records.\nShe has not breached her duty of care: maybe she was negligent, but not grossly negligent under RUPA\nSection 404(c). The partnership agreement may reduce the duty of care so long as it is not \xe2\x80\x9cunreasonably\nreduce[d]\xe2\x80\x9d; it may increase the standard too.\n\n[6]\n\nDuty of Obedience\nThe partnership is a contractual relationship among the partners; they are all agents and principals of\neach other. Expressly or impliedly that means no partner can disobey the partnership agreement or fail to\nfollow any properly made partnership decision. This includes the duty to act within the authority\nexpressly or impliedly given in the partnership agreement, and a partner is responsible to the other\npartners for damages or losses arising from unauthorized activities.\n\nDuty to Inform Copartners\nAs in the agency relationship, a partner is expected to inform copartners of notices and matters coming to\nher attention that would be of interest to the partnership.\n\nDuty to Account\nThe partnership\xe2\x80\x94and necessarily the partners\xe2\x80\x94have a duty to allow copartners and their agents access to\nthe partnership\xe2\x80\x99s books and records and to provide \xe2\x80\x9cany information concerning the partnership\xe2\x80\x99s\nbusiness and affairs reasonably required for the proper exercise of the partner\xe2\x80\x99s rights and duties under\nthe partnership agreement [or this Act].\xe2\x80\x9d\n\n[7]\n\nThe fiduciary standard is imposed upon the duty to account\n\nfor \xe2\x80\x9cit any property, profit, or benefit derived by [a] partner,\xe2\x80\x9d as noted in RUPA Section 404.\n\n[8]\n\nThe Rights That Partners Have in a Partnership\nNecessarily, for every duty owed there is a correlative right. So, for example, if a partner has a duty to\naccount, the other partners and the partnership have a right to an accounting. Beyond that, partners have\nrecognized rights affecting the operation of the partnership.\nHere we may call out the following salient rights: (1) to distributions of money, (2) to management, (3) to\nchoose copartners, (4) to property of the partnership, (5) to assign partnership interest, and (6) to enforce\nduties and rights.\n\nRights to Distributions\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n728\n\n\x0cThe purpose of a partnership is ultimately to distribute \xe2\x80\x9cmoney or other property from a partnership to a\npartner in the partner\xe2\x80\x99s capacity.\xe2\x80\x9d\n\n[9]\n\nThere are, however, various types of money distributions, including\n\nprofits (and losses), indemnification, capital, and compensation.\n\nRight to Profits (and Losses)\nProfits and losses may be shared according to any formula on which the partners agree. For example, the\npartnership agreement may provide that two senior partners are entitled to 35 percent each of the profit\nfrom the year and the two junior partners are entitled to 15 percent each. The next year the percentages\nwill be adjusted based on such things as number of new clients garnered, number of billable hours, or\namount of income generated. Eventually, the senior partners might retire and each be entitled to 2\npercent of the firm\xe2\x80\x99s income, and the previous junior partners become senior, with new junior partners\nadmitted.\nIf no provision is stated, then under RUPA Section 401(b), \xe2\x80\x9ceach partner is entitled to an equal share of\nthe partnership profits and is chargeable with a share of the partnership losses in proportion to the\npartner\xe2\x80\x99s share of the profits.\xe2\x80\x9d Section 18(a) of the Uniform Partnership Act is to the same effect. The right\nto share in the profits is the reason people want to \xe2\x80\x9cmake partner\xe2\x80\x9d: a partner will reap the benefits of\nother partners\xe2\x80\x99 successes (and pay for their failures too). A person working for the firm who is not a\npartner is an associate and usually only gets only a salary.\n\nRight to Indemnification\nA partner who incurs liabilities in the normal course of business or to preserve its business or property is\nentitled to indemnification (UPA Section 18(b), RUPA Section 401(c)). The liability is a loan owing to the\npartner by the firm.\n\nRight to Return of Capital Contribution\nWhen a partner joins a partnership, she is expected to make a capital contribution to the firm; this may be\ndeducted from her share of the distributed profit and banked by the firm in its capital account. The law\nprovides that \xe2\x80\x9cthe partnership must reimburse a partner for an advance of funds beyond the amount of\nthe partner\xe2\x80\x99s agreed capital contribution, thereby treating the advance as a loan.\xe2\x80\x9d\n\n[10]\n\nA partner may get a\n\nreturn of capital under UPA after creditors are paid off if the business is wound down and terminated.\n\n[11]\n\nRight to Compensation\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n729\n\n\x0cSection 401(d) of RUPA provides that \xe2\x80\x9ca partner is not entitled to remuneration for services performed for\nthe partnership, except for reasonable compensation for services rendered in winding up the business of\nthe partnership\xe2\x80\x9d; UPA Section 18(f) is to the same effect. A partner gets his money from the firm by\nsharing the profits, not by a salary or wages.\n\nRight to Management\nAll partners are entitled to share equally in the management and conduct of the business, unless the\npartnership agreement provides otherwise.\n\n[12]\n\nThe partnership agreement could be structured to delegate\n\nmore decision-making power to one class of partners (senior partners) than to others (junior partners), or\nit may give more voting weight to certain individuals. For example, perhaps those with the most\nexperience will, for the first four years after a new partner is admitted, have more voting weight than the\nnew partner.\n\nRight to Choose Partners\nA business partnership is often analogized to a marriage partnership. In both there is a relationship of\ntrust and confidence between (or among) the parties; in both the poor judgment, negligence, or\ndishonesty of one can create liabilities on the other(s). In a good marriage or good partnership, the\npartners are friends, whatever else the legal relationship imposes. Thus no one is compelled to accept a\npartner against his or her will. Section 401(i) of RUPA provides, \xe2\x80\x9cA person may become a partner only\nwith the consent of all of the partners.\xe2\x80\x9d UPA Section 18(g) is to the same effect; the doctrine is called\ndelectus personae. The freedom to select new partners, however, is not absolute. In 1984, the Supreme\nCourt held that Title VII of the Civil Rights Act of 1964\xe2\x80\x94which prohibits discrimination in employment\nbased on race, religion, national origin, or sex\xe2\x80\x94applies to partnerships.\n\n[13]\n\nRight to Property of the Partnership\nPartners are the owners of the partnership, which might not include any physical property; that is, one\npartner could contribute the building, furnishings, and equipment and rent those to the partnership (or\nthose could count as her partnership capital contribution and become the partnership\xe2\x80\x99s). But partnership\nproperty consists of all property originally advanced or contributed to the partnership or subsequently\nacquired by purchase or contribution. Unless a contrary intention can be shown, property acquired with\npartnership funds is partnership property, not an individual partner\xe2\x80\x99s: \xe2\x80\x9cProperty acquired by a\npartnership is property of the partnership and not of the partners individually.\xe2\x80\x9d\nSaylor URL: http://www.saylor.org/books\n\n[14]\n\nSaylor.org\n730\n\n\x0cRights in Specific Partnership Property: UPA Approach\nSuppose that Able, who contributed the building and grounds on which the partnership business is\nconducted, suddenly dies. Who is entitled to her share of the specific property, such as inventory, the\nbuilding, and the money in the cash register\xe2\x80\x94her husband and children, or the other partners, Baker and\nCarr? Section 25(1) of UPA declares that the partners hold the partnership property\nas tenants in partnership. As spelled out in Section 25(2), the specific property interest of a tenant in\npartnership vests in the surviving partners, not in the heirs. But the heirs are entitled to the deceased\npartner\xe2\x80\x99s interest in the partnership itself, so that while Baker and Carr may use the partnership property\nfor the benefit of the partnership without consulting Able\xe2\x80\x99s heirs, they must account to her heirs for her\nproper share of the partnership\xe2\x80\x99s profits.\n\nRights in Specific Property: RUPA Approach\nSection 501 of RUPA provides, \xe2\x80\x9cA partner is not a co-owner of partnership property and has no interest in\npartnership property which can be transferred, either voluntarily or involuntarily.\xe2\x80\x9d Partnership property\nis owned by the entity; UPA\xe2\x80\x99s concept of tenants in partnership is abolished in favor of adoption of the\nentity theory. The result, however, is not different.\n\nRight to Assign Partnership Interest\nOne of the hallmarks of the capitalistic system is that people should be able to dispose of their property\ninterests more or less as they see fit. Partnership interests may be assigned to some extent.\n\nVoluntary Assignment\nAt common law, assignment of a partner\xe2\x80\x99s interest in the business\xe2\x80\x94for example, as a mortgage in return\nfor a loan\xe2\x80\x94would result in a legal dissolution of the partnership. Thus in the absence of UPA, which\nchanged the law, Baker\xe2\x80\x99s decision to mortgage his interest in the car dealership in return for a $20,000\nloan from his bank would mean that the three\xe2\x80\x94Able, Baker, and Carr\xe2\x80\x94were no longer partners. Section\n27 of UPA declares that assignment of an interest in the partnership neither dissolves the partnership nor\nentitles the assignee \xe2\x80\x9cto interfere in the management or administration of the partnership business or\naffairs, or to require any information or account of partnership transactions, or to inspect the partnership\nbooks.\xe2\x80\x9d The assignment merely entitles the assignee to receive whatever profits the assignor would have\nreceived\xe2\x80\x94this is the assignor\xe2\x80\x99s transferable interest.\n\nSaylor URL: http://www.saylor.org/books\n\n[15]\n\nUnder UPA, this interest is assignable.\n\n[16]\n\nSaylor.org\n731\n\n\x0cUnder RUPA, the same distinction is made between a partner\xe2\x80\x99s interest in the partnership and a partner\xe2\x80\x99s\ntransferable interest. The Official Comment to Section 101 reads as follows: \xe2\x80\x9c\xe2\x80\x98Partnership interest\xe2\x80\x99 or\n\xe2\x80\x98partner\xe2\x80\x99s interest in the partnership\xe2\x80\x99 is defined to mean all of a partner\xe2\x80\x99s interests in the partnership,\nincluding the partner\xe2\x80\x99s transferable interest and all management and other rights. A partner\xe2\x80\x99s\n\xe2\x80\x98transferable interest\xe2\x80\x99 is a more limited concept and means only his share of the profits and losses and\nright to receive distributions, that is, the partner\xe2\x80\x99s economic interests.\xe2\x80\x9d\n\n[17]\n\nThis transferable interest is assignable under RUPA 503 (unless the partners agree to restrict transfers,\nSection 103(a)). It does not, by itself, cause the dissolution of the partnership; it does not entitle the\ntransferee to access to firm information, to participate in running the firm, or to inspect or copy the\nbooks. The transferee is entitled to whatever distributions the transferor partner would have been entitled\nto, including, upon dissolution of the firm, the net amounts the transferor would have received had there\nbeen no assignment.\nRUPA Section 101(b)(3) confers standing on a transferee to seek a judicial dissolution and winding up of\nthe partnership business as provided in Section 801(6), thus continuing the rule of UPA Section 32(2).\nBut under RUPA 601(4)(ii), the other partners may by unanimous vote expel a partner who has made \xe2\x80\x9ca\ntransfer of all or substantially all of that partner\xe2\x80\x99s transferable interest in the partnership, other than a\ntransfer for security purposes [as for a loan].\xe2\x80\x9d Upon a creditor foreclosure of the security interest, though,\nthe partner may be expelled.\n\nInvoluntary Assignment\nIt may be a misnomer to describe an involuntary assignment as a \xe2\x80\x9cright\xe2\x80\x9d; it might better be thought of as a\nconsequence of the right to own property. In any event, if a partner is sued in his personal capacity and a\njudgment is rendered against him, the question arises: may the judgment creditor seize partnership\nproperty? Section 28 of UPA and RUPA Section 504 permit a judgment creditor to obtain\na charging order, which charges the partner\xe2\x80\x99s interest in the partnership with obligation to satisfy the\njudgment. The court may appoint a receiver to ensure that partnership proceeds are paid to the judgment\ncreditor. But the creditor is not entitled to specific partnership property. The partner may always pay off\nthe debt and redeem his interest in the partnership. If the partner does not pay off the debt, the holder of\nthe charging order may acquire legal ownership of the partner\xe2\x80\x99s interest. That confers upon the judgment\ncreditor an important power: he may, if the partnership is one at will, dissolve the partnership and claim\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n732\n\n\x0cthe partner\xe2\x80\x99s share of the assets. For that reason, the copartners might wish to redeem the interest\xe2\x80\x94pay\noff the creditor\xe2\x80\x94in order to preserve the partnership. As with the voluntary assignment, the assignee of an\ninvoluntary assignment does not become a partner. See .\nFigure 21.1 Property Rights\n\nRight to Enforce Partnership Rights\nThe rights and duties imposed by partnership law are, of course, valueless unless they can be enforced.\nPartners and partnerships have mechanisms under the law to enforce them.\n\nRight to Information and Inspection of Books\nWe noted in of this chapter that partners have a duty to account; the corollary right is the right to access\nbooks and records, which is usually very important in determining partnership rights. Section 403(b) of\nRUPA provides, \xe2\x80\x9cA partnership shall provide partners and their agents and attorneys access to its books\nand records. It shall provide former partners and their agents and attorneys access to books and records\npertaining to the period during which they were partners. The right of access provides the opportunity to\ninspect and copy books and records during ordinary business hours. A partnership may impose a\nreasonable charge, covering the costs of labor and material, for copies of documents furnished.\xe2\x80\x9d\n\n[18]\n\nSection 19 of UPA is basically in accord. This means that without demand\xe2\x80\x94and for any purpose\xe2\x80\x94the\npartnership must provide any information concerning its business and affairs reasonably required for the\nproper exercise of the partner\xe2\x80\x99s rights and duties under the partnership agreement or the act; and on\ndemand, it must provide any other information concerning the partnership\xe2\x80\x99s business and affairs, unless\nthe demand is unreasonable or improper.\n\n[19]\n\nGenerally, the partnership agreement cannot deny the right\n\nto inspection.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n733\n\n\x0cThe duty to account mentioned in of this chapter normally means that the partners and the partnership\nshould keep reasonable records so everyone can tell what is going on. A formal accounting under UPA is\ndifferent.\nUnder UPA Section 22, any partner is entitled to a formal account (or accounting) of the partnership\naffairs under the following conditions:\n1.\n\nIf he is wrongfully excluded from the partnership business or possession of its property by his\ncopartners;\n\n2. If the right exists under the terms of any agreement;\n3. If a partner profits in violation of his fiduciary duty (as per UPA 22); and\n4. Whenever it is otherwise just and reasonable.\nAt common law, partners could not obtain an accounting except in the event of dissolution. But from an\nearly date, equity courts would appoint a referee, auditor, or special master to investigate the books of a\nbusiness when one of the partners had grounds to complain, and UPA broadened considerably the right to\nan accounting. The court has plenary power to investigate all facets of the business, evaluate claims,\ndeclare legal rights among the parties, and order money judgments against any partner in the wrong.\nUnder RUPA Section 405, this \xe2\x80\x9caccounting\xe2\x80\x9d business is somewhat modified. Reflecting the entity theory,\nthe partnership can sue a partner for wrongdoing, which is not allowed under UPA. Moreover, to quote\nfrom the Official Comment, RUPA \xe2\x80\x9cprovides that, during the term of the partnership, partners may\nmaintain a variety of legal or equitable actions, including an action for an accounting, as well as a final\naction for an accounting upon dissolution and winding up. It reflects a new policy choice that partners\nshould have access to the courts during the term of the partnership to resolve claims against the\npartnership and the other partners, leaving broad judicial discretion to fashion appropriate remedies[,\nand] an accounting is not a prerequisite to the availability of the other remedies a partner may have\nagainst the partnership or the other partners.\xe2\x80\x9d\n\n[20]\n\nKEY TAKEAWAY\n\nPartners have important duties in a partnership, including (1) the duty to serve\xe2\x80\x94that is, to devote herself\nto the work of the partnership; (2) the duty of loyalty, which is informed by the fiduciary standard: the\nobligation to act always in the best interest of the partnership and not in one\xe2\x80\x99s own best interest; (3) the\nduty of care\xe2\x80\x94that is, to act as a reasonably prudent partner would; (4) the duty of obedience not to\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n734\n\n\x0cbreach any aspect of the agreement or act without authority; (5) the duty to inform copartners; and (6)\nthe duty to account to the partnership.\nPartners also have rights. These include the rights (1) to distributions of money, including profits (and\nlosses), indemnification, and return of capital contribution (but not a right to compensation); (2) to\nmanagement; (3) to choose copartners; (4) to property of the partnership, and no partner has any rights to\nspecific property; (5) to assign (voluntarily or involuntarily) the partnership interest; and (6) to enforce\nduties and rights by suits in law or equity. (Under RUPA, a formal accounting is not first required.)\n\nEXERCISES\n\n1.\n\nWhat is the \xe2\x80\x9cfiduciary duty,\xe2\x80\x9d and why is it imposed on some partners\xe2\x80\x99 actions with the partnership?\n\n2.\n\nDistinguish between ownership of partnership property under UPA as opposed to under RUPA.\n\n3.\n\nCarlos obtained a judgment against Pauline, a partner in a partnership, for negligently crashing her car\ninto Carlos\xe2\x80\x99s while she was not in the scope of partnership business. Carlos wants to satisfy the judgment\nfrom her employer. How can Carlos do that?\n\n4.\n\nWhat is the difference between the duty to account and a formal partnership accounting?\n\n5.\n\nWhat does it mean to say a partnership interest has been involuntarily assigned?\n6.\n\n[1] \xe2\x80\x9cThe basic mission of RUPA is to serve the small firm. Large partnerships can fend for themselves by\ndrafting partnership agreements that suit their special needs.\xe2\x80\x9d Donald J. Weidner, \xe2\x80\x9cRUPA and Fiduciary\nDuty: The Texture of Relationship,\xe2\x80\x9d Law and Contemporary Problems 58, no. 2 (1995): 81, 83.\n\n7.\n\n[2] Revised Uniform Partnership Act, Section 404, Comment 3: \xe2\x80\x9cIndeed, the law of partnership reflects the\nbroader law of principal and agent, under which every agent is a fiduciary.\xe2\x80\x9d\n\n8.\n\n[3] Meinhard v. Salmon, 164 N.E. 545 (N.Y. 1928).\n\n9.\n\n[4] RUPA, Section 503(b)(2); RUPA, Section 404 (e).\n\n10. [5] RUPA, Section 103(2)(c).\n11. [6] RUPA, Section 103(2)(d); RUPA, Section 103.\n12. [7] UPA, Sections 19 and 20; RUPA, Section 403.\n13. [8] RUPA, Section 404(1).\n14. [9] RUPA, Section 101(3).\n15. [10] UPA, Section 18(c); RUPA, Section 401(d).\n16. [11] UPA, Section 40(b); RUPA, Section 807(b).\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n735\n\n\x0c17. [12] UPA, Section 18(e); RUPA, Section 401(f).\n18. [13] Hishon v. King & Spalding, 467 U.S. 69 (1984).\n19. [14] RUPA, Section 203; UPA, Sections 8(1) and 25.\n20. [15] UPA, Section 26.\n21. [16] UPA, Section 27.\n22. [17] RUPA, Official Comment to Section 101.\n23. [18] RUPA Section 403(b).\n24. [19] RUPA, Section 403(c)(1); RUPA, Section 403(c)(2).\n25. [20] RUPA Official Comment 2, Section 405(b).\n\n21.2 Operation: The Partnership and Third Parties\nLEARNING OBJECTIVES\n\n1.\n\nUnderstand the partners\xe2\x80\x99 and partnership\xe2\x80\x99s contract liability.\n\n2.\n\nUnderstand the partners\xe2\x80\x99 and partnership\xe2\x80\x99s tort and criminal liability.\n\n3.\n\nDescribe the partners\xe2\x80\x99 and partnership\xe2\x80\x99s tax liability.\n\nBy express terms, the law of agency applies to partnership law. Every partner is an agent of the\npartnership for the purpose of its business. Consequently, the following discussion will be a review of\nagency law, covered in Chapter 20 "Partnerships: General Characteristics and Formation" as it\napplies to partnerships. The Revised Uniform Partnership Act (RUPA) adds a few new wrinkles to\nthe liability issue.\n\nContract Liability\nLiability of the Partnership\nRecall that an agent can make contracts on behalf of a principal under three types of authority: express,\nimplied, and apparent. Express authority is that explicitly delegated to the agent, implied authority is\nthat necessary to the carrying out of the express authority, and apparent authority is that which a third\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n736\n\n\x0cparty is led to believe has been conferred by the principal on the agent, even though in fact it was not or it\nwas revoked. When a partner has authority, the partnership is bound by contracts the partner makes on\nits behalf. Section 21.4.2 "Partnership Authority, Express or Apparent", Hodge v. Garrett, discusses all\nthree types of authority.\n\nThe General Rule\nSection 305 of RUPA restates agency law: \xe2\x80\x9cA partnership is liable for loss or injury, or for a penalty\nincurred, as a result of a wrongful act or omission, or other actionable conduct, of a partner acting in the\nordinary course\xe2\x80\x9d\n\n[1]\n\nof partnership business or with its authority. The ability of a partner to bind the\n\npartnership to contract liability is problematic, especially where the authority is apparent: the firm denies\nliability, lawsuits ensue, and unhappiness generally follows.\nBut the firm is not liable for an act not apparently in the ordinary course of business, unless the act was\nauthorized by the others.\n\n[2]\n\nSection 401(j) of RUPA requires the unanimous consent of the partners for a\n\ngrant of authority outside the ordinary course of business, unless the partnership agreement provides\notherwise.\nUnder the Uniform Partnership Act (UPA) Section 9(3), the firm is not liable for five actions that no single\npartner has implied or apparent authority to do, because they are not \xe2\x80\x9cin the ordinary course of\npartnership.\xe2\x80\x9d These actions are: (1) assignment of partnership property for the benefit of creditors, (2)\ndisposing of the firm\xe2\x80\x99s goodwill (selling the right to do business with the firm\xe2\x80\x99s clients to another\nbusiness), (3) actions that make it impossible to carry on the business, (4) confessing a judgment against\nthe partnership, and (5) submitting a partnership claim or liability. RUPA omits that section, leaving it to\nthe courts to decide the outer limits of the agency power of a partner. In any event, unauthorized actions\nby a partner may be ratified by the partnership.\n\nPartnership \xe2\x80\x9cStatements\xe2\x80\x9d\nNew under RUPA is the ability of partnerships, partners, or even nonpartners to issue and file\n\xe2\x80\x9cstatements\xe2\x80\x9d that announce to the world the establishment or denial of authority. The goal here is to\ncontrol the reach of apparent authority. There are several kinds of statements authorized.\nA statement of partnership authority is allowed by RUPA Section 303. It specifies the names of the\npartners authorized, or not authorized, to enter into transactions on behalf of the partnership and any\nother matters. The most important goal of the statement of authority is to facilitate the transfer of real\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n737\n\n\x0cproperty held in the name of the partnership. A statement must specify the names of the partners\nauthorized to execute an instrument transferring that property.\nA statement of denial, RUPA Section 304, operates to allow partners (and persons named as partners) an\nopportunity to deny any fact asserted in a statement of partnership authority.\nA statement of dissociation, RUPA Section 704, may be filed by a partnership or a dissociated partner,\ninforming the world that the person is no longer a partner. This tells the world that the named person is\nno longer in the partnership.\nThere are three other statements authorized: a statement of qualification establishes that the partnership\nhas satisfied all conditions precedent to the qualification of the partnership as a limited liability\npartnership; a statement of foreign qualification means a limited liability partnership is qualified and\nregistered to do business in a state other than that in which it is originally registered; and a statement of\namendment or cancellation of any of the foregoing.\n\n[3]\n\nLimited liability partnerships are taken up\n\nin Chapter 22 "Hybrid Business Forms".\nGenerally, RUPA Section 105 allows partnerships to file these statements with the state secretary of state\xe2\x80\x99s\noffice; those affecting real estate need to be filed with (or also with) the local county land recorder\xe2\x80\x99s office.\nThe notices bind those who know about them right away, and they are constructive notice to the world\nafter ninety days as to authority to transfer real property in the partnership\xe2\x80\x99s name, as to dissociation, and\nas to dissolution. However, as to other grants or limitations of authority, \xe2\x80\x9conly a third party who knows or\nhas received a notification of a partner\xe2\x80\x99s lack of authority in an ordinary course transaction is bound.\xe2\x80\x9d\n\n[4]\n\nSince RUPA is mostly intended to provide the rules for the small, unsophisticated partnership, it is\nquestionable whether these arcane \xe2\x80\x9cstatements\xe2\x80\x9d are very often employed.\n\nPersonal Liability of Partners, in General\nIt is clear that the partnership is liable for contracts by authorized partners, as discussed in the preceding\nparagraphs. The bad thing about the partnership as a form of business organization is that it imposes\nliability on the partners personally and without limit. Section 306 of RUPA provides that \xe2\x80\x9call partners are\nliable jointly and severally for all obligations of the partnership unless otherwise agreed by the claimant or\nprovided by law.\xe2\x80\x9d\n\n[5]\n\nSection 13 of UPA is in accord.\n\nLiability of Existing Partners\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n738\n\n\x0cContract liability is joint and several: that is, all partners are liable (\xe2\x80\x9cjoint\xe2\x80\x9d) and each is \xe2\x80\x9cseveral.\xe2\x80\x9d (We\nusually do not use several in modern English to mean \xe2\x80\x9ceach\xe2\x80\x9d; it\xe2\x80\x99s an archaic usage.) But\xe2\x80\x94and here\xe2\x80\x99s the\nintrusion of entity theory\xe2\x80\x94generally RUPA requires the judgment creditor to exhaust the partnership\xe2\x80\x99s\nassets before going after the separate assets of a partner. Thus under RUPA the partners\nare guarantors of the partnership\xe2\x80\x99s liabilities.\n\n[6]\n\nUnder UPA, contract liability is joint only, not also several. This means the partners must be sued in a\njoint action brought against them all. A partner who is not named cannot later be sued by a creditor in a\nseparate proceeding, though the ones who were named could see a proportionate contribution from the\nones who were not.\n\nLiability of Incoming Partners\nUnder RUPA Section 306(b), a new partner has no personal liability to existing creditors of the\npartnership, and only her capital investment in the firm is at risk for the satisfaction of existing\npartnership debts. Sections 17 and 41(7) of UPA are in accord. But, again, under either statute a new\npartner\xe2\x80\x99s personal assets are at risk with respect to partnership liabilities incurred after her admission as a\npartner. This is a daunting prospect, and it is the reason for the invention of hybrid forms of business\norganization: limited partnerships, limited liability companies, and limited liability partnerships. The\ncorporate form, of course, also (usually) obviates the owners\xe2\x80\x99 personal liability.\n\nTort and Criminal Liability\nPartnership Liability for Torts\nThe rules affecting partners\xe2\x80\x99 tort liability (discussed in Section 21.2.1 "Contract Liability") and those\naffecting contract liability are the same. Section 13 of UPA says the partnership is liable for \xe2\x80\x9cany wrongful\nact or omission of any partner acting in the ordinary course of the business of the partnership or with the\n[7]\n\nauthority of his co-partners.\xe2\x80\x9d A civil \xe2\x80\x9cwrongful act\xe2\x80\x9d is necessarily either a tort or a breach of contract, so\nno distinction is made between them. (Section 305 of RUPA changed the phraseology slightly by adding\nafter any wrongful act or omission the words or other actionable conduct; this makes the partnership\nliable for its partner\xe2\x80\x99s no-fault torts.) That the principal should be liable for its agents\xe2\x80\x99 wrongdoings is of\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n739\n\n\x0ccourse basic agency law. RUPA does expand liability by allowing a partner to sue during the term of the\npartnership without first having to get out of it, as is required under UPA.\nFor tortious acts, the partners are said to be jointly and severally liable under both UPA and RUPA, and\nthe plaintiff may separately sue one or more partners. Even after winning a judgment, the plaintiff may\nsue other partners unnamed in the original action. Each and every partner is separately liable for the\nentire amount of the debt, although the plaintiff is not entitled to recover more than the total of his\ndamages. The practical effect of the rules making partners personally liable for partnership contracts and\ntorts can be huge. In his classic textbook Economics, Professor Paul Samuelson observed that unlimited\nliability \xe2\x80\x9creveals why partnerships tend to be confined to small, personal enterprises.\xe2\x80\xa6When it becomes a\nquestion of placing their personal fortunes in jeopardy, people are reluctant to put their capital into\ncomplex ventures over which they can exercise little control.\xe2\x80\xa6In the field of investment banking, concerns\nlike JPMorgan Chase used to advertise proudly \xe2\x80\x98not incorporated\xe2\x80\x99 so that their creditors could have extra\nassurance. But even these concerns have converted themselves into corporate entities.\xe2\x80\x9d\n\n[8]\n\nPartners\xe2\x80\x99 Personal Liability for Torts\nOf course, a person is always liable for his own torts. All partners are also liable for any partner\xe2\x80\x99s tort\ncommitted in the scope of partnership business under agency law, and this liability is\xe2\x80\x94again\xe2\x80\x94personal\nand unlimited, subject to RUPA\xe2\x80\x99s requirement that the judgment creditor exhaust the partnership\xe2\x80\x99s assets\nbefore going after the separate assets of the partners. The partner who commits a tort or breach of trust\nmust indemnify the partnership for losses paid to the third party.\n\n[9]\n\nLiability for Crimes\nCriminal liability is generally personal to the miscreant. Nonparticipating copartners are ordinarily not\nliable for crimes if guilty intent is an element. When guilty intent is not an element, as in certain\nregulatory offenses, all partners may be guilty of an act committed by a partner in the course of the\nbusiness.\n\nLiability for Taxes\nCorporate income gets taxed twice under federal law: once to the corporation and again to the\nshareholders who receive income as dividends. However, the partnership\xe2\x80\x99s income \xe2\x80\x9cpasses through\xe2\x80\x9d the\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n740\n\n\x0cpartnership and is distributed to the partners under the conduit theory. When partners get income from\nthe firm they have to pay tax on it, but the partnership pays no tax (it files an information return). This is\nperceived to be a significant advantage of the partnership form.\n\nKEY TAKEAWAY\n\nThe partnership is generally liable for any contract made by a partner with authority express, implied, or\napparent. Under RUPA the firm, partners, or even nonpartners may to some extent limit their liability by\nfiling \xe2\x80\x9cstatements\xe2\x80\x9d with the appropriate state registrar; such statements only affect those who know of\nthem, except that a notice affecting the right of a partner to sell real estate or regarding dissociation or\ndissolution is effective against the world after ninety days.\nAll partners are liable for contracts entered into and torts committed by any partner acting in or\napparently in the normal course of business. This liability is personal and unlimited, joint and several\n(although under UPA contract liability it is only joint). Incoming partners are not liable, in contract or in\ntort, for activities predating their arrival, but their capital contribution is at risk. Criminal liability is\ngenerally personal unless the crime requires no intention.\n\nEXERCISES\n\n1.\n\nWhat is the partnership\xe2\x80\x99s liability for contracts entered into by its partners?\n\n2.\n\nWhat is the personal liability of partners for breach of a contract made by one of the partnership\xe2\x80\x99s\nmembers?\n\n3.\n\nWhy would people feel more comfortable knowing that JPMorgan Bank\xe2\x80\x94Morgan was at one time the\nrichest man in the United States\xe2\x80\x94was a partnership and not a corporation?\n\n4.\n\nWhat is the point of RUPA\xe2\x80\x99s \xe2\x80\x9cstatements\xe2\x80\x9d? How can they be of use to a partner who has, for example,\nretired and is no longer involved in the firm?\n\n5.\n\nUnder what circumstances is the partnership liable for crimes committed by its partners?\n\n6.\n\nHow is a partnership taxed more favorably than a corporation?\n7.\n\n[1] RUPA Section 305.\n\n8.\n\n[2] RUPA, Section 301(2); UPA, Section 9(2).\n\n9.\n\n[3] RUPA, Section 1001(d); RUPA, Section 1102.\n\n10. [4] RUPA, Section 303, Comment 3.\n11. [5] RUPA, Section 306.\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n741\n\n\x0c12. [6] RUPA Section 306.\n13. [7] UPA, Section 13.\n14. [8] Paul A. Samuelson, Economics (New York: McGraw-Hill, 1973), 106.\n15. [9] RUPA, Section 405(a).\n\n21.3 Dissolution and Winding Up\n\nLEARNING OBJECTIVES\n\n1.\n\nUnderstand the dissolution of general partnerships under the Uniform Partnership Act (UPA).\n\n2.\n\nUnderstand the dissociation and dissolution of general partnerships under the Revised Uniform\nPartnership Act (RUPA).\n\n3.\n\nExplain the winding up of partnerships under UPA and RUPA.\n\nIt is said that a partnership is like a marriage, and that extends to its ending too. It\xe2\x80\x99s easier to get into\na partnership than it is to get out of it because legal entanglements continue after a person is no\nlonger a partner. The rules governing \xe2\x80\x9cgetting out\xe2\x80\x9d of a partnership are different under the Revised\nUniform Partnership Act (RUPA) than under the Uniform Partnership Act (UPA). We take up UPA\nfirst.\n\nDissolution of Partnerships under UPA\nDissolution, in the most general sense, means a separation into component parts.\n\nMeaning of Dissolution under UPA\nPeople in business are sometimes confused about the meaning of dissolution. It does not mean the\ntermination of a business. It has a precise legal definition, given in UPA Section 29: \xe2\x80\x9cThe dissolution of a\npartnership is the change in the relation of the partners caused by any partner ceasing to be associated in\nthe carrying on as distinguished from the winding up of the business.\xe2\x80\x9d The partnership is not necessarily\nterminated on dissolution; rather, it continues until the winding up of partnership affairs is completed,\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n742\n\n\x0cand the remaining partners may choose to continue on as a new partnership if they want.\n\n[1]\n\nBut, again,\n\nunder UPA the partnership dissolves upon the withdrawal of any partner.\n\nCauses of Dissolution\nPartnerships can dissolve for a number of reasons.\n\n[2]\n\nIn Accordance with the Agreement\nThe term of the partnership agreement may have expired or the partnership may be at will and one of the\npartners desires to leave it. All the partners may decide that it is preferable to dissolve rather than to\ncontinue. One of the partners may have been expelled in accordance with a provision in the agreement. In\nnone of these circumstances is the agreement violated, though its spirit surely might have been. Professor\nSamuelson calls to mind the example of William Dean Howells\xe2\x80\x99s Silas Lapham, who forces his partner to\nsell out by offering him an ultimatum: \xe2\x80\x9cYou may buy me out or I\xe2\x80\x99ll buy you out.\xe2\x80\x9d The ultimatum was given\nat a time when the partner could not afford to buy Lapham out, so the partner had no choice.\n\nIn Violation of the Agreement\nDissolution may also result from violation of the agreement, as when the partners decide to discharge a\npartner though no provision permits them to do so, or as when a partner decides to quit in violation of a\nterm agreement. In the former case, the remaining partners are liable for damages for wrongful\ndissolution, and in the latter case, the withdrawing partner is liable to the remaining partners the same\nway.\n\nBy Operation of Law\nA third reason for dissolution is the occurrence of some event, such as enactment of a statute, that makes\nit unlawful to continue the business. Or a partner may die or one or more partners or the entire\npartnership may become bankrupt. Dissolution under these circumstances is said to be by operation of\nlaw.\n\n[3]\n\nBy Court Order\nFinally, dissolution may be by court order. Courts are empowered to dissolve partnerships when \xe2\x80\x9con\napplication by or for a partner\xe2\x80\x9d a partner is shown to be a lunatic, of unsound mind, incapable of\nperforming his part of the agreement, \xe2\x80\x9cguilty of such conduct as tends to affect prejudicially the carrying\non of the business,\xe2\x80\x9d or otherwise behaves in such a way that \xe2\x80\x9cit is not reasonably practicable to carry on\nthe business in partnership with him.\xe2\x80\x9d A court may also order dissolution if the business can only be\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n743\n\n\x0ccarried on at a loss or whenever equitable. In some circumstances, a court will order dissolution upon the\napplication of a purchaser of a partner\xe2\x80\x99s interest.\n\n[4]\n\nEffect of Dissolution on Authority\nFor the most part, dissolution terminates the authority of the partners to act for the partnership. The only\nsignificant exceptions are for acts necessary to wind up partnership affairs or to complete transactions\nbegun but not finished at the time of dissolution.\n\n[5]\n\nNotwithstanding the latter exception, no partner can\n\nbind the partnership if it has dissolved because it has become unlawful to carry on the business or if the\npartner seeking to exercise authority has become bankrupt.\n\nAfter Dissolution\nAfter a partnership has dissolved, it can follow one of two paths. It can carry on business as a new\npartnership, or it can wind up the business and cease operating (see Figure 21.2 "Alternatives Following\nUPA Dissolution").\nFigure 21.2 Alternatives Following UPA Dissolution\n\nForming a New Partnership\nIn order to carry on the business as a new partnership, there must be an agreement\xe2\x80\x94preferably as part of\nthe original partnership agreement but maybe only after dissolution (and maybe oral)\xe2\x80\x94that upon\ndissolution (e.g., if a partner dies, retires, or quits) the others will regroup and carry on.\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n744\n\n\x0cUnder UPA the remaining partners have the right to carry on when (1) the dissolution was in\ncontravention of the agreement, (2) a partner was expelled according to the partnership agreement, or (3)\nall partners agree to carry on.\n\n[6]\n\nWhether the former partner dies or otherwise quits the firm, the noncontinuing one or his, her, or its legal\nrepresentative is entitled to an accounting and to be paid the value of the partnership interest, less\ndamages for wrongful dissolution.\n\n[7]\n\nThe firm may need to borrow money to pay the former partner or her\n\nestate; or, in the case of a deceased partner, the money to pay the former partner is obtained through a life\ninsurance buyout policy.\nPartnerships routinely insure the lives of the partners, who have no ownership interests in the insurance\npolicies. The policies should bear a face amount equal to each partner\xe2\x80\x99s interest in the partnership and\nshould be adjusted as the fortunes of the partnership change. Proceeds of the insurance policy are used on\ndeath to pay the purchase price of the interest inherited by the deceased\xe2\x80\x99s estate. If the insurance policy\npays out more than the interest at stake, the partnership retains the difference. If the policy pays out less,\nthe partnership agrees to pay the difference in installments.\nAnother set of issues arises when the partnership changes because an old partner departs and a new one\njoins. Suppose that Baker leaves the car dealership business and his interest is purchased by Alice, who is\nthen admitted to the partnership. Assume that when Baker left, the business owed Mogul Parts Company\n$5,000 and Laid Back Upholsterers $4,000. After Baker left and Alice joined, Mogul sells another $5,000\nworth of parts to the firm on credit, and Sizzling Radiator Repair, a new creditor, advances $3,000 worth\nof radiator repair parts. These circumstances pose four questions.\nFirst, do creditors of the old partnership remain creditors of the new partnership? Yes.\n\n[8]\n\nSecond, does Baker, the old partner, remain liable to the creditors of the old partnership? Yes.\n\n[9]\n\nThat\n\ncould pose uncomfortable problems for Baker, who may have left the business because he lost interest in\nit and wished to put his money elsewhere. The last thing he wants is the threat of liability hanging over his\nhead when he can no longer profit from the firm\xe2\x80\x99s operations. That is all the more true if he had a falling\nout with his partners and does not trust them. The solution is given in UPA Section 36(2), which says that\nan old partner is discharged from liability if the creditors and the new partnership agree to discharge him.\nThird, is Alice, the new partner, liable to creditors of the old partnership? Yes, but only to the extent of her\ncapital contribution.\n\n[10]\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n745\n\n\x0cFourth, is Baker, the old partner, liable for debts incurred after his withdrawal from the partnership?\nSurprisingly, yes, unless Baker takes certain action toward old and new creditors. He must provide actual\nnotice that he has withdrawn to anyone who has extended credit in the past. Once he has done so, he has\nno liability to these creditors for credit extended to the partnership thereafter. Of course, it would be\ndifficult to provide notice to future creditors, since at the time of withdrawal they would not have had a\nrelationship with the partnership. To avoid liability to new creditors who knew of the partnership, the\nsolution required under UPA Section 35(l)(b)(II) is to advertise Baker\xe2\x80\x99s departure in a general circulation\nnewspaper in the place where the partnership business was regularly carried on.\n\nWinding Up and Termination\nBecause the differences between UPA\xe2\x80\x99s and RUPA\xe2\x80\x99s provisions for winding up and termination are not as\nsignificant as those between their provisions for dissolution, the discussion for winding up and\ntermination will cover both acts at once, following the discussion of dissociation and dissolution under\nRUPA.\n\nDissociation and Dissolution of Partnerships under RUPA\nComment 1 to RUPA Section 601 is a good lead-in to this section. According to the comment, RUPA\ndramatically changes the law governing partnership breakups and dissolution. An entirely new concept,\n\xe2\x80\x9cdissociation,\xe2\x80\x9d is used in lieu of UPA term \xe2\x80\x9cdissolution\xe2\x80\x9d to denote the change in the relationship caused by\na partner\xe2\x80\x99s ceasing to be associated in the carrying on of the business. \xe2\x80\x9cDissolution\xe2\x80\x9d is retained but with a\ndifferent meaning. The entity theory of partnership provides a conceptual basis for continuing the firm\nitself despite a partner\xe2\x80\x99s withdrawal from the firm.\nUnder UPA, the partnership is an aggregate, a collection of individuals; upon the withdrawal of any\nmember from the collection, the aggregate dissolves. But because RUPA conforms the partnership as an\nentity, there is no conceptual reason for it to dissolve upon a member\xe2\x80\x99s withdrawal. \xe2\x80\x9cDissociation\xe2\x80\x9d occurs\nwhen any partner ceases to be involved in the business of the firm, and \xe2\x80\x9cdissolution\xe2\x80\x9d happens when RUPA\nrequires the partnership to wind up and terminate; dissociation does not necessarily cause dissolution.\n\nDissociation\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n746\n\n\x0cDissociation, as noted in the previous paragraph, is the change in relations caused by a partner\xe2\x80\x99s\nwithdrawal from the firm\xe2\x80\x99s business.\n\nCauses of Dissociation\nDissociation is caused in ten possible ways: (1) a partner says she wants out; (2) an event triggers\ndissociation as per the partnership agreement; (3) a partner is expelled as per the agreement; (4) a\npartner is expelled by unanimous vote of the others because it is unlawful to carry on with that partner,\nbecause that partner has transferred to a transferee all interest in the partnership (except for security\npurposes), or because a corporate partner\xe2\x80\x99s or partnership partner\xe2\x80\x99s existence is effectively terminated;\n(5) by a court order upon request by the partnership or another partner because the one expelled has been\ndetermined to have misbehaved (engaged in serious wrongful conduct, persists in abusing the agreement,\nacts in ways making continuing the business impracticable); (6) the partner has declared bankruptcy; (7)\nthe partner has died or had a guardian appointed, or has been adjudicated as incompetent; (8) the partner\nis a trust whose assets are exhausted; (9) the partner is an estate and the estate\xe2\x80\x99s interest in the\npartnership has been entirely transferred; (10) the partner dies or, if the partner is another partnership or\na corporation trust or estate, that entity\xe2\x80\x99s existence is terminated.\n\n[11]\n\nEffect of Dissociation\nAfter a partner dissociates, the partner\xe2\x80\x99s right to participate in management terminates. (However, if the\ndissociation goes on to dissolution and winding up, partners who have not wrongfully caused the\ndissociation may participate in winding-up activities.)\n\n[12]\n\nThe dissociated partner\xe2\x80\x99s duty of loyalty and\n\ncare terminates; the former partner may compete with the firm, except for matters arising before the\ndissociation.\n\n[13]\n\nWhen partners come and go, as they do, problems may arise. What power does the dissociated partner\nhave to bind the partnership? What power does the partnership have to impose liability on the dissociated\none? RUPA provides that the dissociated partner loses any actual authority upon dissociation, and his or\nher apparent authority lingers for not longer than two years if the dissociated one acts in a way that would\nhave bound the partnership before dissociation, provided the other party (1) reasonably believed the\ndissociated one was a partner, (2) did not have notice of the dissociation, and (3) is not deemed to have\nconstructive notice from a filed \xe2\x80\x9cstatement of dissociation.\xe2\x80\x9d\n\nSaylor URL: http://www.saylor.org/books\n\n[14]\n\nThe dissociated partner, of course, is liable\n\nSaylor.org\n747\n\n\x0cfor damages to the partnership if third parties had cause to think she was still a partner and the\npartnership became liable because of that; she is liable to the firm as an unauthorized agent.\n\n[15]\n\nA partner\xe2\x80\x99s dissociation does nothing to change that partner\xe2\x80\x99s liability for predissociation\nobligations.\n\n[16]\n\nFor postdissociation liability, exposure is for two years if at the time of entering into the\n\ntransaction the other party (1) reasonably believed the dissociated one was a partner, (2) didn\xe2\x80\x99t have\nnotice of the dissociation, and (3) is not deemed to have constructive notice from a filed \xe2\x80\x9cstatement of\ndissociation.\xe2\x80\x9d For example, Baker withdraws from the firm of Able, Baker, and Carr. Able contracts with\nHydroLift for a new hydraulic car lift that costs $25,000 installed. HydroLift is not aware at the time of\ncontracting that Baker is disassociated and believes she is still a partner. A year later, the firm not having\nbeen paid, HydroLift sues Able, Baker, and Carr and the partnership. Baker has potential liability. Baker\ncould have protected herself by filing a \xe2\x80\x9cstatement of dissociation,\xe2\x80\x9d or\xe2\x80\x94better\xe2\x80\x94the partnership agreement\nshould provide that the firm would file such statements upon the dissociation of any partner (and if it\ndoes not, it would be liable to her for the consequences).\n\nDissolution\nDissociation does not necessarily cause dissolution (see the discussion later in this section of how the firm\ncontinues after a dissociation); dissolution and winding up happen only for the causes stated in RUPA\nSection 801, discussed in the following paragraphs.\n\nCauses of Dissolution\nThere are three causes of dissolution: (1) by act of the partners\xe2\x80\x94some dissociations do trigger dissolution;\n(2) by operation of law; or (3) by court order. The partnership agreement may change or eliminate the\ndissolution trigger as to (1); dissolution by the latter two means cannot be tinkered with.\n\n[17]\n\n(1) Dissolution by act of the partners may occur as follows:\n\xe2\x80\xa2\n\nAny member of an at-will partnership can dissociate at any time, triggering dissolution and\nliquidation. The partners who wish to continue the business of a term partnership, though, cannot be\nforced to liquidate the business by a partner who withdraws prematurely in violation of the\npartnership agreement. In any event, common agreement formats for dissolution will provide for\nbuilt-in dispute resolution, and enlightened partners often agree to such mechanisms in advance to\navoid the kinds of problems listed here.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n748\n\n\x0c\xe2\x80\xa2\n\nAny partnership will dissolve upon the happening of an event the partners specified would cause\ndissolution in their agreement. They may change their minds, of course, agree to continue, and amend\nthe partnership agreement accordingly.\n\n\xe2\x80\xa2\n\nA term partnership may be dissolved before its term expires in three ways. First, if a partner\ndissociated by death, declaring bankruptcy, becoming incapacitated, or wrongfully dissociates, the\npartnership will dissolve if within ninety days of that triggering dissociation at least half the\nremaining partners express their will to wind it up. Second, the partnership may be dissolved if the\nterm expires. Third, it may be dissolved if all the partners agree to amend the partnership agreement\nby expressly agreeing to dissolve.\n\n(2) Dissolution will happen in some cases by operation of law if it becomes illegal to continue the\nbusiness, or substantially all of it. For example, if the firm\xe2\x80\x99s business was the manufacture and\ndistribution of trans fats and it became illegal to do that, the firm would dissolve.\n\n[18]\n\nThis cause of\n\ndissolution is not subject to partnership agreement.\n(3) Dissolution by court order can occur on application by a partner. A court may declare that it is, for\nvarious reasons specified in RUPA Section 801(5), no longer reasonably practicable to continue operation.\nAlso, a court may order dissolution upon application by a transferee of a partner\xe2\x80\x99s transferable interest or\nby a purchaser at a foreclosure of a charging order if the court determines it is equitable. For example, if\nCreditor gets a charging order against Paul Partner and the obligation cannot reasonably be paid by the\nfirm, a court could order dissolution so Creditor would get paid from the liquidated assets of the firm.\n\nEffect of Dissolution\nA partnership continues after dissolution only for the purpose of winding up its business. The partnership\nis terminated when the winding up of its business is completed.\n\n[19]\n\nHowever, before winding up is\n\ncompleted, the partners\xe2\x80\x94except any wrongfully dissociating\xe2\x80\x94may agree to carry on the partnership, in\nwhich case it resumes business as if dissolution never happened.\n\n[20]\n\nContinuing after Dissociation\nDissociation, again, does not necessarily cause dissolution. In an at-will partnership, the death (including\ntermination of an entity partner), bankruptcy, incapacity, or expulsion of a partner will not cause\ndissolution.\n\n[21]\n\nIn a term partnership, the firm continues if, within ninety days of an event triggering\n\ndissociation, fewer than half the partners express their will to wind up. The partnership agreement may\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n749\n\n\x0cprovide that RUPA\xe2\x80\x99s dissolution-triggering events, including dissociation, will not trigger dissolution.\nHowever, the agreement cannot change the rules that dissolution is caused by the business becoming\nillegal or by court order. Creditors of the partnership remain as before, and the dissociated partner is\nliable for partnership obligations arising before dissociation.\nSection 701 of RUPA provides that if the firm continues in business after a partner dissociates, without\nwinding up, then the partnership must purchase the dissociated partner\xe2\x80\x99s interest; RUPA Section 701(b)\nexplains how to determine the buyout price. It is the amount that would have been distributed to the\ndissociated partner if, on the date of dissociation, the firm\xe2\x80\x99s assets were sold \xe2\x80\x9cat a price equal to the\ngreater of the liquidation value or the value based on a sale of the entire business as a going concern,\xe2\x80\x9d\nminus damages for wrongful dissociation. A wrongful dissociater may have to wait a while to get paid in\nfull, unless a court determines that immediate payment \xe2\x80\x9cwill not cause an undue hardship to the\npartnership,\xe2\x80\x9d but the longest nonwrongful dissociaters need to wait is 120 days.\n\n[22]\n\nA dissociated partner\n\ncan sue the firm to determine the buyout price and the court may assess attorney\xe2\x80\x99s, appraiser\xe2\x80\x99s, and\nexpert\xe2\x80\x99s fees against a party the court finds \xe2\x80\x9cacted arbitrarily, vexatiously, or in bad faith.\xe2\x80\x9d\n\n[23]\n\nWinding Up the Partnership under UPA and RUPA\nIf the partners decide not to continue the business upon dissolution, they are obliged to wind up the\nbusiness. The partnership continues after dissolution only for the purpose of winding up its business,\nafter which it is terminated.\n\n[24]\n\nWinding up entails concluding all unfinished business pending at the date\n\nof dissolution and payment of all debts. The partners must then settle accounts among themselves in\norder to distribute the remaining assets. At any time after dissolution and before winding up is completed,\nthe partners (except a wrongfully dissociated one) can stop the process and carry on the business.\nUPA and RUPA are not significantly different as to winding up, so they will be discussed together. Two\nissues are discussed here: who can participate in winding up and how the assets of the firm are distributed\non liquidation.\n\nWho Can Participate in Winding Up\nThe partners who have not wrongfully dissociated may participate in winding up the partnership\nbusiness. On application of any partner, a court may for good cause judicially supervise the winding up.\nSaylor URL: http://www.saylor.org/books\n\n[25]\n\nSaylor.org\n750\n\n\x0cSettlement of Accounts among Partners\nDetermining the priority of liabilities can be problematic. For instance, debts might be incurred to both\noutside creditors and partners, who might have lent money to pay off certain accounts or for working\ncapital.\nAn agreement can spell out the order in which liabilities are to be paid, but if it does not, UPA Section\n40(a) and RUPA Section 807(1) rank them in this order: (1) to creditors other than partners, (2) to\npartners for liabilities other than for capital and profits, (3) to partners for capital contributions, and\nfinally (4) to partners for their share of profits (see Figure 21.3 "Priority Partnership Liabilities under\nRUPA"). However, RUPA eliminates the distinction between capital and profits when the firm pays\npartners what is owed to them; RUPA Section 807(b) speaks simply of the right of a partner to a\nliquidating distribution.\n\nFigure 21.3 Priority Partnership Liabilities under RUPA\n\nPartners are entitled to share equally in the profits and surplus remaining after all liabilities, including\nthose owed to partners, are paid off, although the partnership agreement can state a different share\xe2\x80\x94for\nexample, in proportion to capital contribution. If after winding up there is a net loss, whether capital or\notherwise, each partner must contribute toward it in accordance with his share in the profits, had there\nbeen any, unless the agreement states otherwise. If any of the partners is insolvent or refuses to contribute\nand cannot be sued, the others must contribute their own share to pay off the liabilities and in addition\nmust contribute, in proportion to their share of the profits, the additional amount necessary to pay the\nliabilities of their defaulting partners.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n751\n\n\x0cIn the event of insolvency, a court may take possession of both partnership property and individual assets\nof the partners; this again is a big disadvantage to the partnership form.\nThe estate of a deceased partner is credited or liable as that partner would have been if she were living at\nthe time of the distribution.\n\nKEY TAKEAWAY\n\nUnder UPA, the withdrawal of any partner from the partnership causes dissolution; the withdrawal may be\ncaused in accordance with the agreement, in violation of the agreement, by operation of law, or by court\norder. Dissolution terminates the partners\xe2\x80\x99 authority to act for the partnership, except for winding up, but\nremaining partners may decide to carry on as a new partnership or may decide to terminate the firm. If\nthey continue, the old creditors remain as creditors of the new firm, the former partner remains liable for\nobligations incurred while she was a partner (she may be liable for debts arising after she left, unless\nproper notice is given to creditors), and the former partner or her estate is entitled to an accounting and\npayment for the partnership interest. If the partners move to terminate the firm, winding up begins.\nUnder RUPA, a partner who ceases to be involved in the business is dissociated, but dissociation does not\nnecessarily cause dissolution. Dissociation happens when a partner quits, voluntarily or involuntarily;\nwhen a partner dies or becomes incompetent; or on request by the firm or a partner upon court order for\na partner\xe2\x80\x99s wrongful conduct, among other reasons. The dissociated partner loses actual authority to bind\nthe firm but remains liable for predissociation obligations and may have lingering authority or lingering\nliability for two years provided the other party thought the dissociated one was still a partner; a notice of\ndissociation will, after ninety days, be good against the world as to dissociation and dissolution. If the firm\nproceeds to termination (though partners can stop the process before its end), the next step is dissolution,\nwhich occurs by acts of partners, by operation of law, or by court order upon application by a partner if\ncontinuing the business has become untenable. After dissolution, the only business undertaken is to wind\nup affairs. However, the firm may continue after dissociation; it must buy out the dissociated one\xe2\x80\x99s\ninterest, minus damages if the dissociation was wrongful.\nIf the firm is to be terminated, winding up entails finishing the business at hand, paying off creditors, and\nsplitting the remaining surplus or liabilities according the parties\xe2\x80\x99 agreement or, absent any, according to\nthe relevant act (UPA or RUPA).\n\nSaylor URL: http://www.saylor.org/books\n\nEXERCISES\nSaylor.org\n752\n\n\x0c1.\n\nUnder UPA, what is the effect on the partnership of a partner\xe2\x80\x99s ceasing to be involved in the business?\n\n2.\n\nCan a person no longer a partner be held liable for partnership obligations after her withdrawal? Can such\na person incur liability to the partnership?\n\n3.\n\nWhat obligation does a partnership or its partners owe to a partner who wrongfully terminates the\npartnership agreement?\n\n4.\n\nWhat bearing does RUPA\xe2\x80\x99s use of the term dissociate have on the entity theory that informs the revised\nact?\n\n5.\n\nWhen a partnership is wound up, who gets paid first from its assets? If the firm winds up toward\ntermination and has inadequate assets to pay its creditors, what recourse, if any, do the creditors have?\n6.\n\n[1] UPA, Section 30.\n\n7.\n\n[2] UPA, Section 31.\n\n8.\n\n[3] UPA, Section 31.\n\n9.\n\n[4] UPA, Section 32.\n\n10. [5] UPA, Section 33.\n11. [6] UPA, Sections 37 and 38.\n12. [7] UPA, Section 38.\n13. [8] UPA, Section 41(1).\n14. [9] UPA, Section 36(1).\n15. [10] UPA, Section 17.\n16. [11] RUPA, Section 601.\n17. [12] RUPA. Sections 603(b) and 804(a).\n18. [13] RUPA, Section 603(b)(3).\n19. [14] RUPA, Section 603(b)(1).\n20. [15] RUPA, Section 702.\n21. [16] RUPA, Section 703(a).\n22. [17] RUPA, Section 103.\n23. [18] Trans fats are hydrogenated vegetable oils; the process of hydrogenation essentially turns the oils\ninto semisolids, giving them a higher melting point and extending their shelf life but, unfortunately, also\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n753\n\n\x0cclogging consumers\xe2\x80\x99 arteries and causing heart disease. California banned their sale effective January 1,\n2010; other jurisdictions have followed suit.\n24. [19] RUPA, Section 802.\n25. [20] RUPA, Section 802(b).\n26. [21] RUPA, Sections 601 and 801.\n27. [22] RUPA, Section 701(e).\n28. [23] RUPA, Section 701(h)(4)(i).\n29. [24] UPA, Section 30; RUPA, Section 802(a).\n30. [25] UPA, Section 37; RUPA, Section 803(a).\n\n21.4 Cases\n\nBreach of Partnership Fiduciary Duty\nGilroy v. Conway\n391 N.W. 2d 419 (Mich. App. 1986)\nPETERSON, J.\nDefendant cheated his partner and appeals from the trial court\xe2\x80\x99s judgment granting that partner a\nremedy.\nPlaintiff was an established commercial photographer in Kalamazoo who also had a partnership interest\nin another photography business, Colonial Studios, in Coldwater. In 1974, defendant became plaintiff\xe2\x80\x99s\npartner in Colonial Studios, the name of which was changed to Skylight Studios. Under the partnership\nagreement, defendant was to be the operating manager of the partnership, in return for which he would\nhave a guaranteed draw. Except for the guaranteed draw, the partnership was equal in ownership and the\nsharing of profits.\nPrior to defendant\xe2\x80\x99s becoming a partner, the business had acquired a small contractual clientele of schools\nfor which the business provided student portrait photographs. The partners agreed to concentrate on this\ntype of business, and both partners solicited schools with success. Gross sales, which were $40,000 in\n1974, increased every year and amounted to $209,085 in 1980 [about $537,000 in 2011 dollars].\nIn the spring of 1981, defendant offered to buy out plaintiff and some negotiations followed. On June 25,\n1981, however, plaintiff was notified by the defendant that the partnership was dissolved as of July 1,\n1981. Plaintiff discovered that defendant: had closed up the partnership\xe2\x80\x99s place of business and opened up\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n754\n\n\x0chis own business; had purchased equipment and supplies in preparation for commencing his own\nbusiness and charged them to the partnership; and had taken with him the partnership employees and\nmost of its equipment.\nDefendant had also stolen the partnership\xe2\x80\x99s business. He had personally taken over the business of some\ncustomers by telling them that the partnership was being dissolved; in other cases he simply took over\npartnership contracts without telling the customers that he was then operating on his own. Plaintiff also\nlearned that defendant\xe2\x80\x99s deceit had included the withdrawal, without plaintiff\xe2\x80\x99s knowledge, of partnership\nfunds for defendant\xe2\x80\x99s personal use in 1978 in an amount exceeding $11,000 [about $36,000 in 2011\ndollars].\nThe trial judge characterized the case as a \xe2\x80\x9cclassic study of greed\xe2\x80\x9d and found that defendant had in effect\nappropriated the business enterprise, holding that defendant had \xe2\x80\x9cknowingly and willfully violated his\nfiduciary relationship as a partner by converting partnership assets to his use and, in doing so, literally\ndestroying the partnership.\xe2\x80\x9d He also found that the partnership could have been sold as a going business\non June 30, 1981, and that after a full accounting, it had a value on that date of $94,596 less accounts\npayable of $17,378.85, or a net value of $77,217.15. The division thereof after adjustments for plaintiff\xe2\x80\x99s\npositive equity or capital resulted in an award to plaintiff for his interest in the business of $53,779.46\n[about $126,000 in 2011 dollars].\xe2\x80\xa6\nPlaintiff also sought exemplary [punitive] damages. Count II of the complaint alleged that defendant\xe2\x80\x99s\nconduct constituted a breach of defendant\xe2\x80\x99s fiduciary duty to his partner under \xc2\xa7\xc2\xa7 19-22 of the Uniform\nPartnership Act, and Count III alleged conversion of partnership property. Each count contained\nallegations that defendant\xe2\x80\x99s conduct was willful, wanton and in reckless disregard of plaintiff\xe2\x80\x99s rights and\nthat such conduct had caused injury to plaintiff\xe2\x80\x99s feelings, including humiliation, indignity and a sense of\nmoral outrage. The prayer for relief sought exemplary damages therefore.\nPlaintiff\xe2\x80\x99s testimony on the point was brief. He said:\nThe effect of really the whole situation, and I think it was most apparent when I walked into the\nempty building, was extreme disappointment and really total outrage at the fact that something\nthat I had given the utmost of my talent and creativity, energy, and whatever time was necessary\nto build, was totally destroyed and there was just nothing of any value that was left.\xe2\x80\xa6My\nbusiness had been stolen and there wasn\xe2\x80\x99t a thing that I could do about it. And to me, that was\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n755\n\n\x0cvery humiliating that one day I had something that I had worked 10 years on, and the next day I\nhad absolutely nothing of any value.\nAs noted above, the trial judge found that defendant had literally destroyed the partnership by knowingly\nand willfully converting partnership assets in violation of his fiduciary duty as a partner. He also found\nthat plaintiff had suffered a sense of outrage, indignity and humiliation and awarded him $10,000\n[$23,000 in 2011 dollars] as exemplary damages.\nDefendant appeals from that award, asserting that plaintiff\xe2\x80\x99s cause of action arises from a breach of the\npartnership contract and that exemplary damages may not be awarded for breach of that contract.\xe2\x80\xa6\nIf it were to be assumed that a partner\xe2\x80\x99s breach of his fiduciary duty or appropriation of partnership\nequipment and business contract to his own use and profit are torts, it is clear that the duty breached\narises from the partnership contract. One acquires the property interest of a co-tenant in partnership only\nby the contractual creation of a partnership; one becomes a fiduciary in partnership only by the\ncontractual undertaking to become a partner. There is no tortious conduct here existing independent of\nthe breach of the partnership contract.\nNeither do we see anything in the Uniform Partnership Act to suggest that an aggrieved partner is entitled\nto any remedy other than to be made whole economically. The act defines identically the partnership\nfiduciary duty and the remedy for its breach, i.e., to account:\nSec. 21. (1) Every partner must account to the partnership for any benefit, and hold as trustee for\nit any profits derived by him without the consent of the other partners from any transaction\nconnected with the formation, conduct, or liquidation of the partnership or from any use by him\nof its property.\nSo, the cases involving a partner\xe2\x80\x99s breach of the fiduciary duty to their partners have been concerned\nsolely with placing the wronged partners in the economic position that they would have enjoyed but for\nthe breach.\n[Judgment for plaintiff affirmed, as modified with regard to damages.]\n\nCASE QUESTIONS\n\n1.\n\nFor what did the court award the plaintiff $53,000?\n2.\n\nThe court characterizes the defendant as having \xe2\x80\x9ccheated his partner\xe2\x80\x9d\xe2\x80\x94that is, Conway\ncommitted fraud. (Gilroy said his business had been \xe2\x80\x9cstolen.\xe2\x80\x9d) Fraud is a tort. Punitive damages\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n756\n\n\x0cmay be awarded against a tortfeasor, even in a jurisdiction that generally disallows punitive\ndamages in contract. In fact, punitive damages are sometimes awarded for breach of the\npartnership fiduciary duty. In Cadwalader, Wickersham & Taft v. Beasley, 728 So.2d 253 (Florida\nCt. App., 1998), a New York law firm was found to have wrongfully expelled a partner lawyer,\nBeasley, from membership in its Palm Beach, Florida, offices. New York law controlled. The trial\ncourt awarded Beasley $500,000 in punitive damages. The appeals court, construing the same\nUPA as the court construed in Gilroy, said:\nUnder New York law, the nature of the conduct which justifies an award of punitive\ndamages is conduct having a high degree of moral culpability, or, in other words, conduct\nwhich shows a \xe2\x80\x9cconscious disregard of the rights of others or conduct so reckless as to\namount to such disregard.\xe2\x80\x9d\xe2\x80\xa6[S]ince the purpose of punitive damages is to both punish the\nwrongdoer and deter others from such wrongful behavior, as a matter of policy, courts\nhave the discretion to award punitive damages[.]\xe2\x80\xa6[The defendant] was participating in a\nclandestine plan to wrongfully expel some partners for the financial gain of other partners.\nSuch activity cannot be said to be honorable, much less to comport with the \xe2\x80\x9cpunctilio of an\nhonor.\xe2\x80\x9d Because these findings establish that [the defendant] consciously disregarded the\nrights of Beasley, we affirm the award of punitive damages.\nAs a matter of social policy, which is the better ruling, the Michigan court\xe2\x80\x99s in Gilroy or the Florida\ncourt\xe2\x80\x99s in Cadwalader?\n\nPartnership Authority, Express or Apparent\nHodge v Garrett\n614 P.2d 420 (Idaho 1980)\nBistline, J.\n[Plaintiff] Hodge and defendant-appellant Rex E. Voeller, the managing partner of the Pay-Ont Drive-In\nTheatre, signed a contract for the sale of a small parcel of land belonging to the partnership. That parcel,\nalthough adjacent to the theater, was not used in theater operations except insofar as the east 20 feet were\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n757\n\n\x0cnecessary for the operation of the theater\xe2\x80\x99s driveway. The agreement for the sale of land stated that it was\nbetween Hodge and the Pay-Ont Drive-In Theatre, a partnership. Voeller signed the agreement for the\npartnership, and written changes as to the footage and price were initialed by Voeller. (The trial court\nfound that Hodge and Voeller had orally agreed that this 20 foot strip would be encumbered by an\neasement for ingress and egress to the partnership lands.)\nVoeller testified that he had told Hodge prior to signing that Hodge would have to present him with a plat\nplan which would have to be approved by the partners before the property could be sold. Hodge denied\nthat a plat plan had ever been mentioned to him, and he testified that Voeller did not tell him that the\napproval of the other partners was needed until after the contract was signed. Hodge also testified that he\noffered to pay Voeller the full purchase price when he signed the contract, but Voeller told him that that\nwas not necessary.\nThe trial court found that Voeller had actual and apparent authority to execute the contract on behalf of\nthe partnership, and that the contract should be specifically enforced. The partners of the Pay-Ont DriveIn Theatre appeal, arguing that Voeller did not have authority to sell the property and that Hodge knew\nthat he did not have that authority.\nAt common law one partner could not, \xe2\x80\x9cwithout the concurrence of his copartners, convey away the real\nestate of the partnership, bind his partners by a deed, or transfer the title and interest of his copartners in\nthe firm real estate.\xe2\x80\x9d [Citation] This rule was changed by the adoption of the Uniform Partnership\nAct.\xe2\x80\xa6[citing the statute].\nThe meaning of these provisions was stated in one text as follows:\n\xe2\x80\x9cIf record title is in the partnership and a partner conveys in the partnership name, legal title\npasses. But the partnership may recover the property (except from a bona fide purchaser from\nthe grantee) if it can show (A) that the conveying partner was not apparently carrying on\nbusiness in the usual way or (B) that he had in fact no authority and the grantee had knowledge\nof that fact. The burden of proof with respect to authority is thus on the partnership.\xe2\x80\x9d [Citation]\nThus this contract is enforceable if Voeller had the actual authority to sell the property, or, even if Voeller\ndid not have such authority, the contract is still enforceable if the sale was in the usual way of carrying on\nthe business and Hodge did not know that Voeller did not have this authority.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n758\n\n\x0cAs to the question of actual authority, such authority must affirmatively appear, \xe2\x80\x9cfor the authority of one\npartner to make and acknowledge a deed for the firm will not be presumed.\xe2\x80\xa6\xe2\x80\x9d [Citation] Although such\nauthority may be implied from the nature of the business, or from similar past transactions [Citation],\nnothing in the record in this case indicates that Voeller had express or implied authority to sell real\nproperty belonging to the partnership. There is no evidence that Voeller had sold property belonging to\nthe partnership in the past, and obviously the partnership was not engaged in the business of buying and\nselling real estate.\nThe next question, since actual authority has not been shown, is whether Voeller was conducting the\npartnership business in the usual way in selling this parcel of land such that the contract is binding under\n[the relevant section of the statute] i.e., whether Voeller had apparent authority. Here the evidence\nshowed, and the trial court found:\n1.\n\n\xe2\x80\x9cThat the defendant, Rex E. Voeller, was one of the original partners of the Pay-Ont Drive In Theatre;\nthat the other defendants obtained their partnership interest by inheritance upon the death of other\noriginal partners; that upon the death of a partner the partnership affairs were not wound up, but\ninstead, the partnership merely continued as before, with the heirs of the deceased partner owning\ntheir proportionate share of the partnership interest.\n\n2. \xe2\x80\x9cThat at the inception of the partnership, and at all times thereafter, Rex E. Voeller was the exclusive,\nmanaging partner of the partnership and had the full authority to make all decisions pertaining to the\npartnership affairs, including paying the bills, preparing profit and loss statements, income tax\nreturns and the ordering of any goods or services necessary to the operation of the business.\xe2\x80\x9d\nThe court made no finding that it was customary for Voeller to sell real property, or even personal\nproperty, belonging to the partnership. Nor was there any evidence to this effect. Nor did the court discuss\nwhether it was in the usual course of business for the managing partner of a theater to sell real property.\nYet the trial court found that Voeller had apparent authority to sell the property. From this it must be\ninferred that the trial court believed it to be in the usual course of business for a partner who has exclusive\ncontrol of the partnership business to sell real property belonging to the partnership, where that property\nis not being used in the partnership business. We cannot agree with this conclusion. For a theater,\n\xe2\x80\x9ccarrying on in the usual way the business of the partnership,\xe2\x80\x9d [Citation to relevant section of the statute]\nmeans running the operations of the theater; it does not mean selling a parcel of property adjacent to the\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n759\n\n\x0ctheater. Here the contract of sale stated that the land belonged to the partnership, and, even if Hodge\nbelieved that Voeller as the exclusive manager had authority to transact all business for the firm, Voeller\nstill could not bind the partnership through a unilateral act which was not in the usual business of the\npartnership. We therefore hold that the trial court erred in holding that this contract was binding on the\npartnership.\nJudgment reversed. Costs to appellant.\n\n1.\n\nCASE QUESTIONS\n\nWhat was the argument that Voeller had actual authority? What did the court on appeal say about that\nargument?\n\n2.\n\nWhat was the argument that Voeller had apparent authority? What did the court on appeal say about\nthat argument? To rephrase the question, what facts would have been necessary to confer on Voeller\napparent authority?\n\nPartnership Bound by Contracts Made by a Partner on Its Behalf; Partners\xe2\x80\x99\nDuties to Each Other; Winding Up\nLong v. Lopez\n115 S.W.3d 221 (Texas App. 2003)\nHolman, J.\nWayne A. Long [plaintiff at the trial court] sued Appellee Sergio Lopez to recover from him, jointly and\nseverally, his portion of a partnership debt that Long had paid. After a bench trial, the trial court ruled\nthat Long take nothing from Appellee. We reverse and render, and remand for calculation of attorney\xe2\x80\x99s\nfees in this suit and pre- and post-judgment interest.\nLong testified that in September 1996, Long, Lopez, and Don Bannister entered into an oral partnership\nagreement in which they agreed to be partners in Wood Relo (\xe2\x80\x9cthe partnership\xe2\x80\x9d), a trucking business\nlocated in Gainesville, Texas. Wood Relo located loads for and dispatched approximately twenty trucks it\nleased from owner-operators.\xe2\x80\xa6\nThe trial court found that Long, Lopez, and Bannister formed a partnership, Wood Relo, without a written\npartnership agreement. Lopez does not contest these findings.\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n760\n\n\x0cLong testified that to properly conduct the partnership\xe2\x80\x99s business, he entered into an office equipment\nlease with IKON Capital Corporation (\xe2\x80\x9cIKON\xe2\x80\x9d) on behalf of the partnership. The lease was a thirty-month\ncontract under which the partnership leased a telephone system, fax machine, and photocopier at a rate of\n$577.91 per month. The lease agreement was between IKON and Wood Relo; the \xe2\x80\x9cauthorized signer\xe2\x80\x9d was\nlisted as Wayne Long, who also signed as personal guarantor.\nLong stated that all three partners were authorized to buy equipment for use by the partnership. He\ntestified that the partners had agreed that it was necessary for the partnership to lease the equipment and\nthat on the day the equipment was delivered to Wood Relo\xe2\x80\x99s office, Long was the only partner at the\noffice; therefore, Long was the only one available to sign the lease and personal guaranty that IKON\nrequired. [The partnership disintegrated when Bannister left and he later filed for bankruptcy.]\xe2\x80\xa6Long\ntestified that when Bannister left Wood Relo, the partnership still had \xe2\x80\x9cquite a few\xe2\x80\x9d debts to pay,\nincluding the IKON lease.\xe2\x80\xa6\nEventually, IKON did repossess all the leased equipment. Long testified that he received a demand letter\nfrom IKON, requesting payment by Wood Relo of overdue lease payments and accelerating payment of\nthe remaining balance of the lease. IKON sought recovery of past due payments in the amount of\n$2,889.55 and accelerated future lease payments in the amount of $11,558.20, for a total of $14,447.75,\nplus interest, costs, and attorney\xe2\x80\x99s fees, with the total exceeding $16,000. Long testified that he advised\nLopez that he had received the demand letter from IKON.\nUltimately, IKON filed a lawsuit against Long individually and d/b/a Wood Relo, but did not name Lopez\nor Bannister as parties to the suit. Through his counsel, Long negotiated a settlement with IKON for a\ntotal of $9,000. An agreed judgment was entered in conjunction with the settlement agreement providing\nthat if Long did not pay the settlement, Wood Relo and Long would owe IKON $12,000.\nAfter settling the IKON lawsuit, Long\xe2\x80\x99s counsel sent a letter to Lopez and Bannister regarding the\nsettlement agreement, advising them that they were jointly and severally liable for the $9,000 that\nextinguished the partnership\xe2\x80\x99s debt to IKON, plus attorney\xe2\x80\x99s fees.\xe2\x80\xa6\nThe trial court determined that Long was not entitled to reimbursement from Lopez because Long was not\nacting for the partnership when he settled IKON\xe2\x80\x99s claim against the partnership. The court based its\nconclusion on the fact that Long had no \xe2\x80\x9capparent authority with respect to lawsuits\xe2\x80\x9d and had not notified\nLopez of the IKON lawsuit.\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n761\n\n\x0cAnalysis\nTo the extent that a partnership agreement does not otherwise specify, the provisions of the Texas Revised\nPartnership Act govern the relations of the partners and between the partners and the partnership.\n[Citations] Under the Act, each partner has equal rights in the management and conduct of the business\nof a partnership. With certain inapplicable exceptions, all partners are liable jointly and severally for all\ndebts and obligations of the partnership unless otherwise agreed by the claimant or provided by law. A\npartnership may be sued and may defend itself in its partnership name. Each partner is an agent of the\npartnership for the purpose of its business; unless the partner does not have authority to act for the\npartnership in a particular matter and the person with whom the partner is dealing knows that the\npartner lacks authority, an act of a partner, including the execution of an instrument in the partnership\nname, binds the partnership if \xe2\x80\x9cthe act is for apparently carrying on in the ordinary course: (1) the\npartnership business.\xe2\x80\x9d [Citation] If the act of a partner is not apparently for carrying on the partnership\nbusiness, an act of a partner binds the partnership only if authorized by the other partners. [Citation]\nThe extent of authority of a partner is determined essentially by the same principles as those measuring\nthe scope of the authority of an agent. [Citation] As a general rule, each partner is an agent of the\npartnership and is empowered to bind the partnership in the normal conduct of its business. [Citation]\nGenerally, an agent\xe2\x80\x99s authority is presumed to be coextensive with the business entrusted to his care.\n[Citations] An agent is limited in his authority to such contracts and acts as are incident to the\nmanagement of the particular business with which he is entrusted. [Citation]\n\nWinding Up the Partnership\nA partner\xe2\x80\x99s duty of care to the partnership and the other partners is to act in the conduct and winding up\nof the partnership business with the care an ordinarily prudent person would exercise in similar\ncircumstances. [Citation] During the winding up of a partnership\xe2\x80\x99s business, a partner\xe2\x80\x99s fiduciary duty to\nthe other partners and the partnership is limited to matters relating to the winding up of the partnership\xe2\x80\x99s\naffairs. [Citation]\nLong testified that he entered into the settlement agreement with IKON to save the partnership a\nsubstantial amount of money. IKON\xe2\x80\x99s petition sought over $16,000 from the partnership, and the\nsettlement agreement was for $9,000; therefore, Long settled IKON\xe2\x80\x99s claim for 43% less than the amount\nfor which IKON sued the partnership.\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n762\n\n\x0cBoth Long and Lopez testified that the partnership \xe2\x80\x9cfell apart,\xe2\x80\x9d \xe2\x80\x9cvirtually was dead,\xe2\x80\x9d and had to move\nelsewhere.\xe2\x80\xa6The inability of the partnership to continue its trucking business was an event requiring the\npartners to wind up the affairs of the partnership. See [Citation]\xe2\x80\xa6\nThe Act provides that a partner winding up a partnership\xe2\x80\x99s business is authorized, to the extent\nappropriate for winding up, to perform the following in the name of and for and on behalf of the\npartnership:\n(1) prosecute and defend civil, criminal, or administrative suits;\n(2) settle and close the partnership\xe2\x80\x99s business;\n(3) dispose of and convey the partnership\xe2\x80\x99s property;\n(4) satisfy or provide for the satisfaction of the partnership\xe2\x80\x99s liabilities;\n(5) distribute to the partners any remaining property of the partnership; and\n(6) perform any other necessary act. [Citation]\nLong accrued the IKON debt on behalf of the partnership when he secured the office equipment for\npartnership operations, and he testified that he entered into the settlement with IKON when the\npartnership was in its final stages and the partners were going their separate ways. Accordingly, Long was\nauthorized by the Act to settle the IKON lawsuit on behalf of the partnership.\xe2\x80\xa6\n\nLopez\xe2\x80\x99s Liability for the IKON Debt\nIf a partner reasonably incurs a liability in excess of the amount he agreed to contribute in properly\nconducting the business of the partnership or for preserving the partnership\xe2\x80\x99s business or property, he is\nentitled to be repaid by the partnership for that excess amount. [Citation] A partner may sue another\npartner for reimbursement if the partner has made such an excessive payment. [Citation]\nWith two exceptions not applicable to the facts of this case, all partners are liable jointly and severally for\nall debts and obligations of the partnership unless otherwise agreed by the claimant or provided by law.\nBecause Wood Relo was sued for a partnership debt made in the proper conduct of the partnership\nbusiness, and Long settled this claim in the course of winding up the partnership, he could maintain an\naction against Lopez for reimbursement of Long\xe2\x80\x99s disproportionate payment. [Citations]\n\nAttorneys\xe2\x80\x99 Fees\nLong sought to recover the attorney\xe2\x80\x99s fees expended in defending the IKON claim, and attorney\xe2\x80\x99s fees\nexpended in the instant suit against Lopez. Testimony established that it was necessary for Long to\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n763\n\n\x0cemploy an attorney to defend the action brought against the partnership by IKON; therefore, the\nattorney\xe2\x80\x99s fees related to defending the IKON lawsuit on behalf of Wood Relo are a partnership debt for\nwhich Lopez is jointly and severally liable. As such, Long is entitled to recover from Lopez one-half of the\nattorney\xe2\x80\x99s fees attributable to the IKON lawsuit. The evidence established that reasonable and necessary\nattorney\xe2\x80\x99s fees to defend the IKON lawsuit were $1725. Therefore, Long is entitled to recover from Lopez\n$862.50.\nLong also seeks to recover the attorney\xe2\x80\x99s fees expended pursuing the instant lawsuit. See [Texas statute\ncitation] (authorizing recovery of attorney\xe2\x80\x99s fees in successful suit under an oral contract); see also\n[Citation] (holding attorney\xe2\x80\x99s fees are recoverable by partner under because action against other partner\nwas founded on partnership agreement, which was a contract). We agree that Long is entitled to recover\nreasonable and necessary attorney\xe2\x80\x99s fees incurred in bringing the instant lawsuit. Because we are\nremanding this case so the trial court can determine the amount of pre- and post-judgment interest to be\nawarded to Long, we also remand to the trial court the issue of the amount of attorney\xe2\x80\x99s fees due to Long\nin pursuing this lawsuit against Lopez for collection of the amount paid to IKON on behalf of the\npartnership.\n\nConclusion\nWe hold the trial court erred in determining that Long did not have authority to act for Wood Relo in\ndefending, settling, and paying the partnership debt owed by Wood Relo to IKON. Lopez is jointly and\nseverally liable to IKON for $9,000, which represents the amount Long paid IKON to defend and\nextinguish the partnership debt. We hold that Lopez is jointly and severally liable to Long for $1725,\nwhich represents the amount of attorney\xe2\x80\x99s fees Long paid to defend against the IKON claim. We further\nhold that Long is entitled to recover from Lopez reasonable and necessary attorney\xe2\x80\x99s fees in pursuing the\ninstant lawsuit.\nWe reverse the judgment of the trial court. We render judgment that Lopez owes Long $5362.50 (one-half\nof the partnership debt to IKON plus one-half of the corresponding attorney\xe2\x80\x99s fees). We remand the case\nto the trial court for calculation of the amount of attorney\xe2\x80\x99s fees owed by Lopez to Long in the instant\nlawsuit, and calculation of pre- and post-judgment interest.\n\nCASE QUESTIONS\n\n1.\n\nWhy did the trial court determine that Lopez owed Long nothing?\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n764\n\n\x0c2.\n\nAbsent a written partnership agreement, what rules control the operation and winding up of the\npartnership?\n\n3.\n\nWhy did the appeals court determine that Long did have authority to settle the lawsuit with IKON?\n\n4.\n\nLopez was not named by IKON when it sued Long and the partnership. Why did the court determine that\ndid not matter, that Lopez was still liable for one-half the costs of settling that case?\n\n5.\n\nWhy was Long awarded compensation for the attorneys\xe2\x80\x99 fees expended in dealing with the IKON matter\nand in bringing this case?\n\nDissolution under RUPA\nHorizon/CMS Healthcare Corp. v. Southern Oaks Health Care, Inc.\n732 So.2d 1156 (Fla. App. 1999)\nGoshorn, J.\nHorizon is a large, publicly traded provider of both nursing home facilities and management for nursing\nhome facilities. It wanted to expand into Osceola County in 1993. Southern Oaks was already operating in\nOsceola County[.]\xe2\x80\xa6Horizon and Southern Oaks decided to form a partnership to own the proposed [new]\nfacility, which was ultimately named Royal Oaks, and agreed that Horizon would manage both the\nSouthern Oaks facility and the new Royal Oaks facility. To that end, Southern Oaks and Horizon entered\ninto several partnership and management contracts in 1993.\nIn 1996, Southern Oaks filed suit alleging numerous defaults and breaches of the twenty-year\nagreements.\xe2\x80\xa6[T]he trial court found largely in favor of Southern Oaks, concluding that Horizon breached\nits obligations under two different partnership agreements [and that] Horizon had breached several\nmanagement contracts. Thereafter, the court ordered that the partnerships be dissolved, finding that \xe2\x80\x9cthe\nparties to the various agreements which are the subject of this lawsuit are now incapable of continuing to\noperate in business together\xe2\x80\x9d and that because it was dissolving the partnerships, \xe2\x80\x9cthere is no entitlement\nto future damages.\xe2\x80\xa6\xe2\x80\x9d In its cross appeal, Southern Oaks asserts that because Horizon unilaterally and\nwrongfully sought dissolution of the partnerships, Southern Oaks should receive a damage award for the\nloss of the partnerships\xe2\x80\x99 seventeen remaining years\xe2\x80\x99 worth of future profits. We reject its argument.\nSouthern Oaks argues Horizon wrongfully caused the dissolution because the basis for dissolution cited\nby the court is not one of the grounds for which the parties contracted. The pertinent contracts provided\nin section 7.3 \xe2\x80\x9cCauses of Dissolution\xe2\x80\x9d: \xe2\x80\x9cIn addition to the causes for dissolution set forth in Section 7.2(c),\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n765\n\n\x0cthe Partnership shall be dissolved in the event that:\xe2\x80\xa6(d) upon thirty (30) days prior written notice to the\nother Partner, either Partner elects to dissolve the Partnership on account of an Irreconcilable Difference\nwhich arises and cannot, after good faith efforts, be resolved.\xe2\x80\xa6\xe2\x80\x9d\nSouthern Oaks argues that what Horizon relied on at trial as showing irreconcilable differences\xe2\x80\x94the\ndecisions of how profits were to be determined and divided\xe2\x80\x94were not \xe2\x80\x9cgood faith differences of opinion,\xe2\x80\x9d\nnor did they have \xe2\x80\x9ca material and adverse impact on the conduct of the Partnerships\xe2\x80\x99 Business.\xe2\x80\x9d Horizon\xe2\x80\x99s\nrefusal to pay Southern Oaks according to the terms of the contracts was not an \xe2\x80\x9cirreconcilable difference\xe2\x80\x9d\nas defined by the contract, Southern Oaks asserts, pointing out that Horizon\xe2\x80\x99s acts were held to be\nbreaches of the contracts. Because there was no contract basis for dissolution, Horizon\xe2\x80\x99s assertion of\ndissolution was wrongful, Southern Oaks concludes.\nSouthern Oaks contends further that not only were there no contractual grounds for dissolution,\ndissolution was also wrongful under the Florida Statutes. Southern Oaks argues that pursuant to section\n[of that statute] Horizon had the power to dissociate from the partnership, but, in the absence of contract\ngrounds for the dissociation, Horizon wrongfully dissociated. It asserts that it is entitled to lost future\nprofits under Florida\xe2\x80\x99s partnership law.\xe2\x80\xa6\nWe find Southern Oaks\xe2\x80\x99 argument without merit. First, the trial court\xe2\x80\x99s finding that the parties are\nincapable of continuing to operate in business together is a finding of \xe2\x80\x9cirreconcilable differences,\xe2\x80\x9d a\npermissible reason for dissolving the partnerships under the express terms of the partnership agreements.\nThus, dissolution was not \xe2\x80\x9cwrongful,\xe2\x80\x9d assuming there can be \xe2\x80\x9cwrongful\xe2\x80\x9d dissolutions, and Southern Oaks\nwas not entitled to damages for lost future profits. Additionally, the partnership contracts also permit\ndissolution by \xe2\x80\x9cjudicial decree.\xe2\x80\x9d Although neither party cites this provision, it appears that pursuant\nthereto, the parties agreed that dissolution would be proper if done by a trial court for whatever reason\nthe court found sufficient to warrant dissolution.\nSecond, even assuming the partnership was dissolved for a reason not provided for in the partnership\nagreements, damages were properly denied. Under RUPA, it is clear that wrongful dissociation triggers\nliability for lost future profits. See [RUPA:] \xe2\x80\x9cA partner who wrongfully dissociates is liable to the\npartnership and to the other partners for damages caused by the dissociation. The liability is in addition\nto any other obligation of the partner to the partnership or to the other partners.\xe2\x80\x9d However, RUPA\ndoes not contain a similar provision for dissolution; RUPA does not refer to the dissolutions as rightful or\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n766\n\n\x0cwrongful. [RUPA sets out] \xe2\x80\x9cEvents causing dissolution and winding up of partnership business,\xe2\x80\x9d [and]\noutlines the events causing dissolution without any provision for liability for damages.\xe2\x80\xa6[RUPA]\nrecognizes judicial dissolution:\nA partnership is dissolved, and its business must be wound up, only upon the occurrence of any of\nthe following events:\xe2\x80\xa6\n(5) On application by a partner, a judicial determination that:\n(a) The economic purpose of the partnership is likely to be unreasonably frustrated;\n(b) Another partner has engaged in conduct relating to the partnership business which makes it\nnot reasonably practicable to carry on the business in partnership with such partner; or\n(c) It is not otherwise reasonably practicable to carry on the partnership business in conformity\nwith the partnership agreement[.]\xe2\x80\xa6\nParagraph (5)(c) provides the basis for the trial court\xe2\x80\x99s dissolution in this case. While \xe2\x80\x9creasonably\npracticable\xe2\x80\x9d is not defined in RUPA, the term is broad enough to encompass the inability of partners to\ncontinue working together, which is what the court found.\nCertainly the law predating RUPA allowed for recovery of lost profits upon the wrongful dissolution of a\npartnership. See e.g., [Citation]: \xe2\x80\x9cA partner who assumes to dissolve the partnership before the end of the\nterm agreed on in the partnership articles is liable, in an action at law against him by his co-partner for\nthe breach of the agreement, to respond in damages for the value of the profits which the plaintiff would\notherwise have received.\xe2\x80\x9d\nHowever, RUPA brought significant changes to partnership law, among which was the adoption of the\nterm \xe2\x80\x9cdissociation.\xe2\x80\x9d Although the term is undefined in RUPA, dissociation appears to have taken the place\nof \xe2\x80\x9cdissolution\xe2\x80\x9d as that word was used pre-RUPA. \xe2\x80\x9cDissolution\xe2\x80\x9d under RUPA has a different meaning,\nalthough the term is undefined in RUPA. It follows that the pre-RUPA cases providing for future damages\nupon wrongful dissolution are no longer applicable to a partnership dissolution. In other words a\n\xe2\x80\x9cwrongful dissolution\xe2\x80\x9d referred to in the pre-RUPA case law is now, under RUPA, known as \xe2\x80\x9cwrongful\ndissociation.\xe2\x80\x9d Simply stated, under [RUPA], only when a partner dissociatesand the dissociation is\nwrongful can the remaining partners sue for damages. When a partnership is dissolved, RUPA\xe2\x80\xa6provides\nthe parameters of liability of the partners upon dissolution.\xe2\x80\xa6\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n767\n\n\x0c[Citation]: \xe2\x80\x9cDissociation is not a condition precedent to dissolution.\xe2\x80\xa6Most dissolution events are\ndissociations. On the other hand, it is not necessary to have a dissociation to cause a dissolution and\nwinding up.\xe2\x80\x9d\nSouthern Oaks\xe2\x80\x99 attempt to bring the instant dissolution under the statute applicable to dissociation is\nrejected. The trial court ordered dissolution of the partnership, not the dissociation of Horizon for\nwrongful conduct. There no longer appears to be \xe2\x80\x9cwrongful\xe2\x80\x9d dissolution\xe2\x80\x94either dissolution is provided\nfor by contract or statute or the dissolution was improper and the dissolution order should be reversed. In\nthe instant case, because the dissolution either came within the terms of the partnership agreements or\n[RUPA] (judicial dissolution where it is not reasonably practicable to carry on the partnership business),\nSouthern Oaks\xe2\x80\x99 claim for lost future profits is without merit. Affirmed.\n\nCASE QUESTIONS\n\n1.\n\nUnder RUPA, what is a dissociation? What is a dissolution?\n\n2.\n\nWhy did Southern Oaks claim there was no contractual basis for dissolution, notwithstanding the\ndetermination that Horizon had breached the partnership agreement and the management contract?\n\n3.\n\nGiven those findings, what did Southern Oaks not get at the lower-court trial that it wanted on this\nappeal?\n\n4.\n\nWhy didn\xe2\x80\x99t Southern Oaks get what it wanted on this appeal?\n\n21.5 Summary and Exercises\nSummary\n\nMost of the Uniform Partnership Act (UPA) and Revised Uniform Partnership Act (RUPA) rules apply\nonly in the absence of agreement among the partners. Under both, unless the agreement states otherwise,\npartners have certain duties: (1) the duty to serve\xe2\x80\x94that is, to devote themselves to the work of the\npartnership; (2) the duty of loyalty, which is informed by the fiduciary standard: the obligation to act\nalways in the best interest of the partnership and not in one\xe2\x80\x99s own best interest; (3) the duty of care\xe2\x80\x94that\nis, to act as a reasonably prudent partner would; (4) the duty of obedience not to breach any aspect of the\nagreement or act without authority; (5) the duty to inform copartners; and (6) the duty to account to the\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n768\n\n\x0cpartnership. Ordinarily, partners operate through majority vote, but no act that contravenes the\npartnership agreement itself can be undertaken without unanimous consent.\nPartners\xe2\x80\x99 rights include rights (1) to distributions of money, including profits (and losses) as per the\nagreement or equally, indemnification, and return of capital contribution (but not a right to\ncompensation); (2) to management as per the agreement or equally; (3) to choose copartners; (4) to\nproperty of the partnership, but no partner has any rights to specific property (under UPA the partners\nown property as tenants in partnership; under RUPA the partnership as entity owns property, but it will\nbe distributed upon liquidation); (5) to assign (voluntarily or involuntarily) the partnership interest; the\nassignee does not become a partner or have any management rights, but a judgment creditor may obtain a\ncharging order against the partnership; and (6) to enforce duties and rights by suits in law or equity\n(under RUPA a formal accounting is not required).\nUnder UPA, a change in the relation of the partners dissolves the partnership but does not necessarily\nwind up the business. Dissolution may be voluntary, by violation of the agreement, by operation of law, or\nby court order. Dissolution terminates the authority of the partners to act for the partnership. After\ndissolution, a new partnership may be formed.\nUnder RUPA, a change in the relation of the partners is a dissociation, leaving the remaining partners\nwith two options: continue on; or wind up, dissolve, and terminate. In most cases, a partnership may buy\nout the interest of a partner who leaves without dissolving the partnership. A term partnership also will\nnot dissolve so long as at least one-half of the partners choose to remain. When a partner\xe2\x80\x99s dissociation\ntriggers dissolution, partners are allowed to vote subsequently to continue the partnership.\nWhen a dissolved partnership is carried on as a new one, creditors of the old partnership remain creditors\nof the new one. A former partner remains liable to the creditors of the former partnership. A new partner\nis liable to the creditors of the former partnership, bur only to the extent of the new partner\xe2\x80\x99s capital\ncontribution. A former partner remains liable for debts incurred after his withdrawal unless he gives\nproper notice of his withdrawal; his actual authority terminates upon dissociation and apparent authority\nafter two years.\nIf the firm is to be terminated, it is wound up. The assets of the partnership include all required\ncontributions of partners, and from the assets liabilities are paid off (1) to creditors and (2) to partners on\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n769\n\n\x0ctheir accounts. Under RUPA, nonpartnership creditors share equally with unsatisfied partnership\ncreditors in the personal assets of their debtor-partners.\n\nEXERCISES\n\n1.\n\nAnne and Barbara form a partnership. Their agreement specifies that Anne will receive two-thirds of the\nprofit and Barbara will get one-third. The firm suffers a loss of $3,000 the first year. How are the losses\ndivided?\n\n2.\n\nTwo lawyers, Glenwood and Higgins, formed a partnership. Glenwood failed to file Client\xe2\x80\x99s paperwork on\ntime in a case, with adverse financial consequences to Client. Is Higgins liable for Glenwood\xe2\x80\x99s\nmalpractice?\n\n3.\n\nWhen Client in Exercise 2 visited the firm\xe2\x80\x99s offices to demand compensation from Glenwood, the two got\ninto an argument. Glenwood became very agitated; in an apparent state of rage, he threw a law book at\nClient, breaking her nose. Is Higgins liable?\n\n4.\n\nAssume Glenwood from Exercise 2 entered into a contract on behalf of the firm to buy five computer\ngames. Is Higgins liable?\n\n5.\n\nGrosberg and Goldman operated the Chatham Fox Hills Shopping Center as partners. They agreed that\nGoldman would deposit the tenants\xe2\x80\x99 rental checks in an account in Grosberg\xe2\x80\x99s name at First Bank.\nWithout Grosberg\xe2\x80\x99s knowledge or permission, Goldman opened an account in both their names at Second\nBank, into which Goldman deposited checks payable to the firm or the partners. He indorsed each check\nby signing the name of the partnership or the partners. Subsequently, Goldman embezzled over $100,000\nof the funds. Second Bank did not know Grosberg and Goldman were partners. Grosberg then sued\nSecond Bank for converting the funds by accepting checks on which Grosberg\xe2\x80\x99s or the partnership\xe2\x80\x99s\nindorsement was forged. Is Second Bank liable? Discuss.\n\n6.\n\nPearson Collings, a partner in a criminal defense consulting firm, used the firm\xe2\x80\x99s phones and computers to\noperate a side business cleaning carpets. The partnership received no compensation for the use of its\nequipment. What claim would the other partners have against Collings?\n\n7.\n\nFollis, Graham, and Hawthorne have a general partnership, each agreeing to split losses 20 percent, 20\npercent, and 60 percent, respectively. While on partnership business, Follis negligently crashes into a\nvictim, causing $100,000 in damages. Follis declares bankruptcy, and the firm\xe2\x80\x99s assets are inadequate to\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n770\n\n\x0cpay the damages. Graham says she is liable for only $20,000 of the obligation, as per the agreement. Is\nshe correct?\n8.\n\nIngersoll and Jackson are partners; Kelly, after much negotiation, agreed to join the firm effective\nFebruary 1. But on January 15, Kelly changed his mind. Meanwhile, however, the other two had already\narranged for the local newspaper to run a notice that Kelly was joining the firm. The notice ran on\nFebruary 1. Kelly did nothing in response. On February 2, Creditor, having seen the newspaper notice,\nextended credit to the firm. When the firm did not pay, Creditor sought to have Kelly held liable as a\npartner. Is Kelly liable?\n\n1.\na.\n\nSELF-TEST QUESTIONS\n\nUnder UPA, a partner is generally entitled to a formal accounting of partnership affairs\nwhenever it is just and reasonable\nb.\n\nif a partner is wrongfully excluded from the business by copartners\n\nc.\n\nif the right exists in the partnership agreement\n\nd.\n\nall of the above\n\nDonners, Inc., a partner in CDE Partnership, applies to Bank to secure a loan and assigns to Bank\nits partnership interest. After the assignment, which is true?\na.\n\nBank steps into Donners\xe2\x80\x99s shoes as a partner.\nb.\n\nBank does not become a partner but has the right to participate in the management of\nthe firm to protect its security interest until the loan is paid.\n\nc.\n\nBank is entitled to Donners\xe2\x80\x99s share of the firm\xe2\x80\x99s profits.\n\nd.\n\nBank is liable for Donners\xe2\x80\x99s share of the firm\xe2\x80\x99s losses.\n\ne.\n\nNone of these is true.\n\nWhich of these requires unanimous consent of the partners in a general partnership?\na.\n\nthe assignment of a partnership interest\nb.\n\nthe acquisition of a partnership debt\n\nc.\n\nagreement to be responsible for the tort of one copartner\n\nd.\n\nadmission of a new partner\n\ne.\n\nagreement that the partnership should stand as a surety for a third party\xe2\x80\x99s obligation\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n771\n\n\x0cPaul Partner (1) bought a computer and charged it to the partnership\xe2\x80\x99s account; (2) cashed a\nfirm check and used the money to buy a computer in his own name; (3) brought from home a\ncomputer and used it at the office. In which scenario does the computer become partnership\nproperty?\na.\n\n1 only\nb.\n\n1 and 2\n\nc.\n\n1, 2, and 3\n\nThat partnerships are entities under RUPA means they have to pay federal income tax in their\nown name.\na.\n\ntrue\nb.\n\nfalse\n\nThat partnerships are entities under RUPA means the partners are not personally liable for the\nfirm\xe2\x80\x99s debts beyond their capital contributions.\na.\n\ntrue\nb.\n\n1.\n\nd\n\n2.\n\nc\n\n3.\n\nd\n\n4.\n\nb\n\n5.\n\na\n\n6.\n\nb\n\nfalse\n\nSELF-TEST ANSWERS\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n772\n\n\x0cChapter 22\n\nHybrid Business Forms\nLEARNING OBJECTIVES\nAfter reading this chapter, you should understand the following:\n1.\n\nThe limited partnership\n\n2.\n\nThe limited liability company\n\n3.\n\nOther hybrid business forms: the sub-S corporation, limited liability partnerships, and limited liability\nlimited partnerships\n\nThis chapter provides a bridge between the partnership and the corporate form. It explores several\ntypes of associations that are hybrid forms\xe2\x80\x94that is, they share some aspects of partnerships and\nsome of corporations. Corporations afford the inestimable benefit of limited liability, partnerships\nthe inestimable benefit of limited taxation. Businesspeople always seek to limit their risk and their\ntaxation.\nAt base, whether to allow businesspeople and investors to grasp the holy grail of limited liability is a\npolitical issue. When we say a person is \xe2\x80\x9cirresponsible,\xe2\x80\x9d it means he (or she, or it) does not take\nresponsibility for his harmful actions; the loss is borne by others. Politically speaking, there is an\nincentive to allow businesspeople insulation from liability: it encourages them to take risks and\ninvest, thus stimulating economic activity and forestalling unemployment. So the political trade-off\nwith allowing various inventive forms of business organization is between providing business actors\nwith the security that they will lose only their calculable investment, thus stimulating the economy,\nversus the \xe2\x80\x9cmoral hazard\xe2\x80\x9d of allowing them to emerge mostly unscathed from their own harmful or\nfoolish activities, thus externalizing resulting losses upon others. Some people feel that during the\nrun-up to the \xe2\x80\x9cGreat Recession\xe2\x80\x9d of 2007\xe2\x80\x9309, the economic system allowed too much risk taking.\nWhen the risky investments collapsed, though, instead of forcing the risk takers to suffer loss, the\ngovernment intervened\xe2\x80\x94it \xe2\x80\x9cbailed them out,\xe2\x80\x9d as they say, putting the consequences of the failed\nrisks on the taxpayer.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n773\n\n\x0cThe risk-averseness and inventiveness of businesspeople is seemingly unlimited, as is investors\xe2\x80\x99 urge\nto make profits through others\xe2\x80\x99 efforts with as little risk as possible. The rationale for the invention of\nthese hybrid business forms, then, is (1) risk reduction and (2) tax reduction. Here we take up the\nmost common hybrid types first: limited partnerships and limited liability companies. Then we cover\nthem in the approximate chronological order of their invention: sub-S corporations, limited liability\npartnerships, and limited liability limited partnerships. All these forms are entities.\n\n22.1 Limited Partnerships\n\nLEARNING OBJECTIVES\n\nUnderstand the following aspects of the limited partnership:\n1.\n\nGoverning law and definition\n\n2.\n\nCreation and capitalization\n\n3.\n\nControl and compensation\n\n4.\n\nLiabilities\n\n5.\n\nTaxation\n\n6.\n\nTermination\n\nGoverning Law and Definition\nThe limited partnership is attractive because of its treatment of taxation and its imposition of limited\nliability on its limited partners.\n\nGoverning Law\nThe original source of limited partnership law is the Uniform Limited Partnership Act (ULPA), which was\ndrafted in 1916. A revised version, the Revised Uniform Limited Partnership Act (RULPA), was adopted\nby the National Conference of Commissioners on Uniform Laws in 1976 and further amended in 1985 and\nin 2001.\nThe 2001 act was\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n774\n\n\x0cdrafted for a world in which limited liability partnerships and limited liability companies can\nmeet many of the needs formerly met by limited partnerships. This Act therefore targets two\ntypes of enterprises that seem largely beyond the scope of LLPs and LLCs: (i) sophisticated,\nmanager-entrenched commercial deals whose participants commit for the long term, and (ii)\nestate planning arrangements (family limited partnerships). The Act accordingly assumes that,\nmore often than not, people utilizing it will want (1) strong centralized management, strongly\nentrenched, and (2) passive investors with little control over or right to exit the entity. The Act\xe2\x80\x99s\nrules, and particularly its default rules, have been designed to reflect these assumptions.\n\n[1]\n\nAll states except Louisiana adopted the 1976 or 1985 act\xe2\x80\x94most opting for the 1985 version\xe2\x80\x94and sixteen\nstates have adopted the 2001 version. The acts may be properly referred to with a hyphen: \xe2\x80\x9cULPA-1985,\xe2\x80\x9d\nor \xe2\x80\x9cULPA-2001\xe2\x80\x9d; the word revised has been dropped. Here, we mainly discuss ULPA-1985. The Uniform\nPartnership Act (UPA) or the Revised Uniform Partnership Act (RUPA) also applies to limited\npartnerships except where it is inconsistent with the limited partnership statutes. The ULPA-2001 is not\nso much related to UPA or RUPA as previous versions were.\n\nDefinition\nA limited partnership (LP) is defined as \xe2\x80\x9ca partnership formed by two or more persons under the laws of a\nState and having one or more general partners and one or more limited partners.\xe2\x80\x9d\n\n[2]\n\nThe form tends to be\n\nattractive in business situations that focus on a single or limited-term project, such as making a movie or\ndeveloping real estate; it is also widely used by private equity firms.\n\nCreation and Capitalization\nUnlike a general partnership, a limited partnership is created in accordance with the state statute\nauthorizing it. There are two categories of partners: limited and general. The limited partners capitalize\nthe business and the general partners run it.\n\nCreation\nThe act requires that the firm\xe2\x80\x99s promoters file a certificate of limited partnership with the secretary of\nstate; if they do not, or if the certificate is substantially defective, a general partnership is created. The\ncertificate must be signed by all general partners. It must include the name of the limited partnership\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n775\n\n\x0c(which must include the words limited partnership so the world knows there are owners of the firm who\nare not liable beyond their contribution) and the names and business addresses of the general partners. If\nthere are any changes in the general partners, the certificate must be amended. The general partner may\nbe, and often is, a corporation. Having a general partner be a corporation achieves the goal of limited\nliability for everyone, but it is somewhat of a \xe2\x80\x9cclunky\xe2\x80\x9d arrangement. That problem is obviated in the\nlimited liability company, discussed in Section 22.2 "Limited Liability Companies". Here is an example of\na limited partnership operating\nagreement:http://www.wyopa.com/Articles%20of%20limited%20partnership.htm.\nAny natural person, partnership, limited partnership (domestic or foreign), trust, estate, association, or\ncorporation may become a partner of a limited partnership.\n\nCapitalization\nThe money to capitalize the business typically comes mostly from the limited partners, who may\nthemselves be partnerships or corporations. That is, the limited partners use the business as an\ninvestment device: they hope the managers of the firm (the general partners) will take their contributions\nand give them a positive return on it. The contributions may be money, services, or property, or promises\nto make such contributions in the future.\n\nControl and Compensation\nControl\nControl is not generally shared by both classes of partners.\n\nGeneral Partners\nThe control of the limited partnership is in the hands of the general partners, which may\xe2\x80\x94as noted\xe2\x80\x94be\npartnerships or corporations.\n\nLimited Partners\nUnder ULPA-1985 and its predecessors, a limited partner who exercised any significant control would\nincur liability like a general partner as to third parties who believed she was one (the \xe2\x80\x9ccontrol rule\xe2\x80\x9d).\nHowever, among the things a limited partner could do that would not risk the loss of insulation from\npersonal liability were these \xe2\x80\x9csafe harbors\xe2\x80\x9d:\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n776\n\n\x0c\xe2\x80\xa2\n\nActing as an agent, employee, or contractor for the firm; or being an officer, director, or shareholder\nof a corporate general partner\n\n\xe2\x80\xa2\n\nConsulting with the general partner of the firm\n\n\xe2\x80\xa2\n\nRequesting or attending a meeting of partners\n\n\xe2\x80\xa2\n\nBeing a surety for the firm\n\n\xe2\x80\xa2\n\nVoting on amendments to the agreement, on dissolution or winding up the partnership, on loans to\nthe partnership, on a change in its nature of business, on removing or admitting a general or limited\npartner\n\nHowever, see Section 22.3.3 "Limited Liability Limited Partnerships" for how this \xe2\x80\x9ccontrol rule\xe2\x80\x9d has been\nabolished under ULPA-2001.\nGeneral partners owe fiduciary duties to other general partners, the firm, and the limited partners; limited\npartners who do not exercise control do not owe fiduciary duties. See Figure 22.1 "The Limited\nPartnership under ULPA-1985".\nFigure 22.1 The Limited Partnership under ULPA-1985\n\nThe partnership agreement may specify which general or limited partners have the right to vote on any\nmatter, but if the agreement grants limited partners voting rights beyond the \xe2\x80\x9csafe harbor,\xe2\x80\x9d a court may\nabolish that partner\xe2\x80\x99s limited liability.\n\nAssignment of Partnership Rights\nLimited partnership interests may be assigned in whole or in part; if in whole, the assignor ceases to be a\npartner unless otherwise agreed. An assignment is usually made as security for a loan. The assignee\nbecomes a new limited partner only if all the others consent or if provided for in the certificate; the\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n777\n\n\x0cassignment does not cause dissolution. The happy ease with which a limited partner can divest himself of\nthe partnership interest makes the investment in the firm here more like that in a corporation than in a\ngeneral partnership.\n\nInspection of Books\nLimited partners have the right to inspect the firm\xe2\x80\x99s books and records, they may own competing\ninterests, they may be creditors of the firm, and they may bring derivative suits on the firm\xe2\x80\x99s behalf. They\nmay not withdraw their capital contribution if that would impair creditors\xe2\x80\x99 rights.\n\nAddition of New Partners\nUnless the partnership agreement provides otherwise (it usually does), the admission of additional\nlimited partners requires the written consent of all. A general partner may withdraw at any time with\nwritten notice; if withdrawal is a violation of the agreement, the limited partnership has a right to claim of\ndamages. A limited partner can withdraw any time after six months\xe2\x80\x99 notice to each general partner, and\nthe withdrawing partner is entitled to any distribution as per the agreement or, if none, to the fair value of\nthe interest based on the right to share in distributions.\n\nCompensation\nWe noted in discussing partnerships that the partners are not entitled to \xe2\x80\x9ccompensation,\xe2\x80\x9d that is, payment\nfor their work; they are entitled to a share of the profits. For limited partnerships, the rule is a bit\ndifferent.\n\nGeneral Partners\nOften, general partners are paid for their management work on a sliding scale, receiving a greater share of\neach dollar of cash flow as the limited partners\xe2\x80\x99 cash distributions rise, thus giving the general partner an\nincentive to increase limited-partner distributions.\n\nLimited Partners\nProfits or losses are shared as agreed in the certificate or, if there is no agreement, in accordance with the\npercentages of capital contributions made.\n\nLiabilities\nLiability is not shared.\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n778\n\n\x0cGeneral Partners\nThe general partners are liable as in a general partnership, and they have the same fiduciary duty and\nduty of care as partners in a general partnership. However, see the discussion in Section 22.3.3 "Limited\nLiability Limited Partnerships" of the newest type of LP, the limited liability limited partnership (triple\nLP), where the general partner is also afforded limited liability under ULPA-2001.\n\nLimited Partners\nThe limited partners are only liable up to the amount of their capital contribution, provided the surname\nof the limited partner does not appear in the partnership name (unless his name is coincidentally the\nsame as that of one of the general partners whose name does appear) and provided the limited partner\ndoes not participate in control of the firm. See Section 22.4.1 "Limited Partnerships: Limited Partners\xe2\x80\x99\nLiability for Managing Limited Partnership" for a case that highlights liability issues for partners.\nWe have been discussing ULPA-1985 here. But in a world of limited liability companies, limited liability\npartnerships, and limited liability limited partnerships, \xe2\x80\x9cthe control rule has become an anachronism\xe2\x80\x9d;\nULPA-2001 \xe2\x80\x9cprovides a full, status-based liability shield for each limited partner, \xe2\x80\x98even if the limited\npartner participates in the management and control of the limited partnership.\xe2\x80\x99\n\n[3]\n\nThe section thus\n\neliminates the so-called control rule with respect to personal liability for entity obligations and brings\n[4]\n\nlimited partners into parity with LLC members, LLP partners and corporate shareholders.\xe2\x80\x9d And as will\nbe noted in Partnerships \xe2\x80\x9cunder ULPA-2001 the general partner is also shielded from liability.\n\nTaxation\nAssuming the limited partnership meets a minimum number of criteria related to limited liability,\ncentralized management, duration, and transferability of ownership, it can enjoy the benefits of passthrough taxation; otherwise it will be taxed as a corporation. Pass-through (\xe2\x80\x9cconduit\xe2\x80\x9d) taxation is usually\nvery important to partners.\n\nTermination\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n779\n\n\x0cThe limited partnership\xe2\x80\x99s termination involves the same three steps as in a general partnership: (1)\ndissolution, (2) winding up, and (3) termination.\n\nDissolution\nDissolution of a limited partnership is the first step toward termination (but termination does not\nnecessarily follow dissolution). The limited partners have no power to dissolve the firm except on court\norder, and the death or bankruptcy of a limited partner does not dissolve the firm. The following events\nmay cause dissolution: (1) termination of the partnership as per the certificate\xe2\x80\x99s provisions; (2)\ntermination upon an event specified in the partnership agreement; (3) the unanimous written consent of\nthe partners; (4) the withdrawal of a general partner, unless at least one remains and the agreement says\none is enough, or if within ninety days all partners agree to continue; (5) an event that causes the business\nto be illegal; and (6) judicial decree of dissolution when it is not reasonable to carry on. If the agreement\nhas no term, its dissolution is not triggered by some agreed-to event, and none of the other things listed\ncause dissolution.\nDissolution requires the filing of a certificate of cancellation with the state if winding up commences.\n\nWinding Up\nGeneral partners who have not wrongfully dissolved the partnership may wind it up, and so may the\nlimited partners if all the general partners have wrongfully dissolved the firm. Any partner or that\nperson\xe2\x80\x99s legal representative can petition a court for winding up, with cause.\nUpon winding up, the assets are distributed (1) to creditors, including creditor-partners, not including\nliabilities for distributions of profit; (2) to partners and ex-partners to pay off unpaid distributions; (3) to\npartners as return of capital contributions, unless otherwise agreed; and (4) to partners for partnership\ninterests in proportion as they share in distributions, unless otherwise agreed. No distinction is made\nbetween general and limited partners\xe2\x80\x94they share equally, unless otherwise agreed. When winding up is\ncompleted, the firm is terminated.\nIt is worth reiterating the part about \xe2\x80\x9cunless otherwise agreed\xe2\x80\x9d: people who form any kind of a business\norganization\xe2\x80\x94partnership, a hybrid form, or corporations\xe2\x80\x94can to a large extent choose to structure their\nrelationship as they see fit. Any aspect of the company\xe2\x80\x99s formation, operation, or ending that is not\nincluded in an agreement flops into the default provisions of the relevant law.\n\nKEY TAKEAWAY\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n780\n\n\x0cA limited partnership is a creature of statute: it requires filing a certificate with the state because it confers\non some of its members the marvel of limited liability. It is an investment device composed of one or more\ngeneral partners and one or more limited partners; limited partners may leave with six months\xe2\x80\x99 notice and\nare entitled to an appropriate payout. The general partner is liable as a partner is a general partnership;\nthe limited partners\xe2\x80\x99 liability is limited to the loss of their investment, unless they exercise so much control\nof the firm as to become general partners. The general partner is paid, and the general and limited\npartners split profit as per the agreement or, if none, in the proportion as they made capital contributions.\nThe firm is usually taxed like a general partnership: it is a conduit for the partners\xe2\x80\x99 income. The firm is\ndissolved upon the end of its term, upon an event specified in the agreement, or in several other\ncircumstances, but it may have indefinite existence.\n\nEXERCISES\n\n1.\n\nWhy does the fact that the limited liability company provides limited liability for some of its members\nmean that a state certificate must be filed?\n\n2.\n\nWhat liability has the general partner? The limited partner?\n\n3.\n\nHow easy is it for the limited partner to dispose of (sell) her partnership interest?\n4.\n\n[1] \xe2\x80\x9cUniform Limited Partnership Act (2001), Prefatory Note,\xe2\x80\x9d NCCUSL\nArchives,http://www.law.upenn.edu/bll/archives/ulc/ulpa/final2001.pdf.\n\n5.\n\n[2] ULPA, Section 102(11).\n\n6.\n\n[3] ULPA-2001, Section 303.\n\n7.\n\n[4] Official Comment to Uniform Limited Partnership Act 2001, Section 303.\n\n22.2 Limited Liability Companies\n\nLEARNING OBJECTIVES\n\n1.\n\nUnderstand the history and law governing limited liability companies (LLCs).\n\n2.\n\nIdentify the creation and capitalization of an LLC.\n\n3.\n\nUnderstand control and compensation of a firm.\n\n4.\n\nRecognize liabilities in the LLC form.\n\n5.\n\nExplain the taxation of an LLC.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n781\n\n\x0c6.\n\nIdentify how LLCs are terminated.\n\nHistory and Law Governing Limited Liability Companies\nHistory of the Limited Liability Company\nThe limited liability company (LLC) gained sweeping popularity in the late twentieth century because it\ncombines the best aspects of partnership and the best aspects of corporations: it allows all its owners\n(members) insulation from personal liability and pass-through (conduit) taxation. The first efforts to form\nLLCs were thwarted by IRS rulings that the business form was too much like a corporation to escape\ncorporate tax complications. Tinkering by promoters of the LLC concept and flexibility by the IRS solved\nthose problems in interesting and creative ways.\nCorporations have six characteristics: (1) associates, (2) an objective to carry on a business and divide the\ngains, (3) continuity of life, (4) centralized management, (5) limited liability, and (6) free transferability of\ninterests. Partnerships also, necessarily, have the first two corporate characteristics; under IRS rulings, if\nthe LLC is not to be considered a corporation for tax purposes, it must lack at least one-half of the\nremaining four characteristics of a corporation: the LLC, then, must lack two of these corporate\ncharacteristics (otherwise it will be considered a corporation): (1) limited liability, (2) centralized\nmanagement, (3) continuity of life, or (4) free transferability of interests. But limited liability is essential\nand centralized management is necessary for passive investors who don\xe2\x80\x99t want to be involved in decision\nmaking, so pass-through taxation usually hinges on whether an LLC has continuity of life and free\ntransferability of accounts. Thus it is extremely important that the LLC promoters avoid the corporate\ncharacteristics of continuity of life and free transferability of interests.\nWe will see how the LLC can finesse these issues.\n\nGoverning Law\nAll states have statutes allowing the creation of LLCs, and while a Uniform Limited Liability Company Act\nhas been promulgated, only eight states have adopted it as of January 2011. That said, the LLC has\nbecome the entity of choice for many businesses.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n782\n\n\x0cCreation and Capitalization\nCreation of the LLC\nAn LLC is created according to the statute of the state in which it is formed. It is required that the LLC\nmembers file a \xe2\x80\x9ccertificate of organization\xe2\x80\x9d with the secretary of state, and the name must indicate that it\nis a limited liability company. Partnerships and limited partnerships may convert to LLCs; the partners\xe2\x80\x99\nprevious liability under the other organizational forms is not affected, but going forward, limited liability\nis provided. The members\xe2\x80\x99 operating agreement spells out how the business will be run; it is subordinate\nto state and federal law. Unless otherwise agreed, the operating agreement can be amended only by\nunanimous vote. The LLC is an entity. Foreign LLCs must register with the secretary of state before doing\nbusiness in a \xe2\x80\x9cforeign\xe2\x80\x9d state, or they cannot sue in state courts.\nAs compared with corporations, the LLC is not a good form if the owners expect to have multiple investors\nor to raise money from the public. The typical LLC has relatively few members (six or seven at most), all of\nwhom usually are engaged in running the firm.\nMost early LLC statutes, at least, prohibited their use by professionals. That is, practitioners who need\nprofessional licenses, such as certified public accountants, lawyers, doctors, architects, chiropractors, and\nthe like, could not use this form because of concern about what would happen to the standards of practice\nif such people could avoid legitimate malpractice claims. For that reason, the limited liability partnership\nwas invented.\n\nCapitalization\nCapitalization is like a partnership: members contribute capital to the firm according to their agreement.\nAs in a partnership, the LLC property is not specific to any member, but each has a personal property\ninterest in general. Contributions may be in the form of cash, property or services rendered, or a promise\nto render them in the future.\n\nControl and Compensation\nControl\nThe LLC operating agreement may provide for either a member-managed LLC or a manager-managed\n(centralized) LLC. If the former, all members have actual and apparent authority to bind the LLC to\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n783\n\n\x0ccontracts on its behalf, as in a partnership, and all members\xe2\x80\x99 votes have equal weight unless otherwise\nagreed. Member-managers have duty of care and a fiduciary duty, though the parameters of those duties\nvary from state to state. If the firm is manager managed, only managers have authority to bind the firm;\nthe managers have the duty of care and fiduciary duty, but the nonmanager members usually do not.\nSome states\xe2\x80\x99 statutes provide that voting is based on the financial interests of the members. Most statutes\nprovide that any extraordinary firm decisions be voted on by all members (e.g., amend the agreement,\nadmit new members, sell all the assets prior to dissolution, merge with another entity). Members can\nmake their own rules without the structural requirements (e.g., voting rights, notice, quorum, approval of\nmajor decisions) imposed under state corporate law.\nIf the firm has a centralized manager system, it gets a check in its \xe2\x80\x9ccorporate-like\xe2\x80\x9d box, so it will need to\nmake sure there are enough noncorporate-like attributes to make up for this one. If it looks too much like\na corporation, it will be taxed like one.\nOne of the real benefits of the LLC as compared with the corporation is that no annual meetings are\nrequired, and no minutes need to be kept. Often, owners of small corporations ignore these formalities to\ntheir peril, but with the LLC there are no worries about such record keeping.\n\nCompensation\nDistributions are allocated among members of an LLC according to the operating agreement; managing\npartners may be paid for their services. Absent an agreement, distributions are allocated among members\nin proportion to the values of contributions made by them or required to be made by them. Upon a\nmember\xe2\x80\x99s dissociation that does not cause dissolution, a dissociating member has the right to distribution\nas provided in the agreement, or\xe2\x80\x94if no agreement\xe2\x80\x94the right to receive the fair value of the member\xe2\x80\x99s\ninterest within a reasonable time after dissociation. No distributions are allowed if making them would\ncause the LLC to become insolvent.\n\nLiability\nThe great accomplishment of the LLC is, again, to achieve limited liability for all its members: no general\npartner hangs out with liability exposure.\n\nLiability to Outsiders\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n784\n\n\x0cMembers are not liable to third parties for contracts made by the firm or for torts committed in the scope\nof business (but of course a person is always liable for her own torts), regardless of the owner\xe2\x80\x99s level of\nparticipation\xe2\x80\x94unlike a limited partnership, where the general partner is liable. Third parties\xe2\x80\x99 only\nrecourse is as against the firm\xe2\x80\x99s property. See Puleo v. Topel, (see Section 22.4.2 "Liability Issues in\nLLCs"), for an analysis of owner liability in an LLC.\n\nInternal Liabilities\nUnless the operating agreement provides otherwise, members and managers of the LLC are generally not\nliable to the firm or its members except for acts or omissions constituting gross negligence, intentional\nmisconduct, or knowing violations of the law. Members and managers, though, must account to the firm\nfor any personal profit or benefit derived from activities not consented to by a majority of disinterested\nmembers or managers from the conduct of the firm\xe2\x80\x99s business or member\xe2\x80\x99s or managers use of firm\nproperty\xe2\x80\x94which is the same as in partnership law.\n\nTaxation\nAssuming the LLC is properly formed so that it is not too much like a corporation, it will\xe2\x80\x94upon its\nmembers\xe2\x80\x99 election\xe2\x80\x94be treated like a partnership for tax purposes.\n\nTermination\nTermination, loosely speaking, refers either to how the entity\xe2\x80\x99s life as a business ends (continuity of life)\nor to how a member\xe2\x80\x99s interest in the firm ends\xe2\x80\x94that is, how freely the interest is transferable.\n\nContinuity of Life\nThe first step in the termination of the LLC is dissolution, though dissolution is not necessarily followed\nby termination.\n\nDissolution and Winding Up\nThe IRS has determined that continuity of life does not exist \xe2\x80\x9cif the death, insanity, bankruptcy,\nretirement, resignation, or expulsion of any member will cause a dissolution of the organization,\xe2\x80\x9d\n\nSaylor URL: http://www.saylor.org/books\n\n[1]\n\nand\n\nSaylor.org\n785\n\n\x0cthat if one of these events occurs, the entity may continue only with the members\xe2\x80\x99 unanimous consent.\nDissolution may occur even if the business is continued by the remaining members.\nThe typical LLC statute provides that an LLC will dissolve upon (1) expiration of the LLC\xe2\x80\x99s term as per its\nagreement; (2) events specified in the agreement; (3) written consent of all members; (4) an \xe2\x80\x9cevent of\ndissociation\xe2\x80\x9d of a member, unless within ninety days of the event all remaining members agree to\ncontinue, or the right to continue is stated in the LLC; (5) the entry of a judicial decree of dissolution; (6) a\nchange in membership that results in there being fewer than two members; or (7) the expiration of two\nyears after the effective date of administrative dissolution.\nAnd an \xe2\x80\x9cevent of dissociation\xe2\x80\x9d is typically defined as (1) a member\xe2\x80\x99s voluntary withdrawal, (2) her\nassignment of the entire LLC interest, (3) her expulsion, (4) her bankruptcy, (5) her becoming\nincompetent, (6) dissolution of an entity member (as an LLC, limited partnership, or corporation), or (7)\nany other event specified in the agreement.\nThus under most statutes\xe2\x80\x99 default position, if a member dies, becomes insane or bankrupt, retires, resigns,\nor is expelled, the LLC will dissolve unless within ninety days the rest of the members unanimously agree\nto continue. And by this means the firm does not have continuity of life. Some states provide\nopportunities for even more flexibility regarding the \xe2\x80\x9cunanimous\xe2\x80\x9d part. In the mid-1990s, the IRS issued\nrevenue rulings (as opposed to regulations) that it would be enough if a \xe2\x80\x9cmajority in interest\xe2\x80\x9d of\nremaining partners agreed to continue the business, and the \xe2\x80\x9cflexible\xe2\x80\x9d statute states adopted this\npossibility (the ones that did not are called \xe2\x80\x9cbulletproof\xe2\x80\x9d statutes). \xe2\x80\x9cMajority in interests\xe2\x80\x9d means a\nmajority of profits and capital.\nIf the firm does dissolve, some states require public filings to that effect. If dissolution leads to winding\nup, things progress as in a general partnership: the business at hand is finished, accounts are rendered,\nbills paid, assets liquidated, and remaining assets are distributed to creditors (including member and\nmanager creditors, but not for their shares in profits); to members and past members for unpaid\ndistributions; to members for capital contributions; and to members as agreed or in proportion to\ncontributions made. Upon dissolution, actual authority of members or managers terminates except as\nneeded to wind up; members may have apparent authority, though, unless the third party had notice of\nthe dissolution.\n\nFree Transferability of Interest\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n786\n\n\x0cAgain, the problem here is that if a member\xe2\x80\x99s interest in the LLC is as freely transferable as a\nshareholder\xe2\x80\x99s interest in a corporation (an owner can transfer all attributes of his interest without the\nothers\xe2\x80\x99 consent), the LLC will probably be said to have a check mark in the \xe2\x80\x9ccorporate-like\xe2\x80\x9d box: too many\nof those and the firm will not be allowed pass-through taxation. Thus the trick for the LLC promoters is to\nlimit free transferability enough to pass the test of not being a corporation, but not limit so much as to\nmake it really difficult to divest oneself of the interest (then it\xe2\x80\x99s not a very liquid or desirable investment).\nSome states\xe2\x80\x99 LLC statutes have as the default rule that the remaining members must unanimously consent\nto allow an assignee or a transferee of a membership interest to participate in managing the LLC. Since\nthis prevents a member from transferring all attributes of the interest (the right to participate in\nmanagement isn\xe2\x80\x99t transferred or assigned), the LLC formed under the default provision will not have \xe2\x80\x9cfree\ntransferability of interest.\xe2\x80\x9d But if the LLC agreement allows majority consent for the transfer of all\nattributes, that also would satisfy the requirement that there not be free transferability of interests. Then\nwe get into the question of how to define \xe2\x80\x9cmajority\xe2\x80\x9d: by number of members or by value of their\nmembership? And what if only the managing partners need to consent? Or if there are two classes of\nmembership and the transfer of interests in one class requires the consent of the other? The point is that\npeople keep pushing the boundaries to see how close their LLC can come to corporation-like status\nwithout being called a corporation.\nStatutes for LLCs allow other business entities to convert to this form upon application.\n\nKEY TAKEAWAY\n\nThe limited liability company has become the entity of choice for many businesspeople. It is created by\nstate authority that, upon application, issues the \xe2\x80\x9ccertificate of organization.\xe2\x80\x9d It is controlled either by\nmanagers or by members, it affords its members limited liability, and it is taxed like a partnership. But\nthese happy results are obtained only if the firm lacks enough corporate attributes to escape being labeled\nas a corporation. To avoid too much \xe2\x80\x9ccorporateness,\xe2\x80\x9d the firm\xe2\x80\x99s certificate usually limits its continuity of\nlife and the free transferability of interest. The ongoing game is to finesse these limits: to make them as\nnonconstraining as possible, to get right up to the line to preserve continuity, and to make the interest as\nfreely transferable as possible.\n\nSaylor URL: http://www.saylor.org/books\n\nEXERCISES\n\nSaylor.org\n787\n\n\x0c1.\n\nWhat are the six attributes of a corporation? Which are automatically relevant to the LLC? Which two\ncorporate attributes are usually dropped in an LLC?\n\n2.\n\nWhy does the LLC not want to be treated like a corporation?\n\n3.\n\nWhy does the name of the LLC have to include an indication that it is an LLC?\n\n4.\n\nHow did LLCs finesse the requirement that they not allow too-free transferability of the interest?\n[1] Treasury Regulation, \xc2\xa7 301.7701-2(b)(1).\n\n22.3 Other Forms\n1.\n\nLEARNING OBJECTIVE\n\nRecognize other business forms: sub-S corporations, limited liability partnerships, and limited liability\nlimited partnerships.\n\nSub-S Corporation\nHistory\nThe sub-S corporation or the S corporation gets its name from the IRS Code, Chapter 1, Subchapter S. It\nwas authorized by Congress in 1958 to help small corporations and to stem the economic and cultural\ninfluence of the relatively few, but increasingly powerful, huge multinational corporations. According to\nthe website of an S corporation champion, \xe2\x80\x9ca half century later, S corporations are the most popular\ncorporate structure in America. The IRS estimates that there were 4.5 million S corporation owners in the\nUnited States in 2007\xe2\x80\x94about twice the number of C [standard] corporations.\xe2\x80\x9d\n\n[1]\n\nCreation and Capitalization\nThe S corporation is a regular corporation created upon application to the appropriate secretary of state\xe2\x80\x99s\noffice and operated according to its bylaws and shareholders\xe2\x80\x99 agreements. There are, however, some limits\non how the business is set up, among them the following:\n\xe2\x80\xa2\n\nIt must be incorporated in the United States.\n\n\xe2\x80\xa2\n\nIt cannot have more than one hundred shareholders (a married couple counts as one shareholder).\n\n\xe2\x80\xa2\n\nThe only shareholders are individuals, estates, certain exempt organizations, or certain trusts.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n788\n\n\x0c\xe2\x80\xa2\n\nOnly US citizens and resident aliens may be shareholders.\n\n\xe2\x80\xa2\n\nThe corporation has only one class of stock.\n\n\xe2\x80\xa2\n\nWith some exceptions, it cannot be a bank, thrift institution, or insurance company.\n\n\xe2\x80\xa2\n\nAll shareholders must consent to the S corporation election.\n\n\xe2\x80\xa2\n\nIt is capitalized as is a regular corporation.\n\nLiability\nThe owners of the S corporation have limited liability.\n\nTaxation\nTaxation is the crux of the matter. The S corporation pays no corporate income tax (unless it has a lot of\npassive income). The S corporation\xe2\x80\x99s shareholders include on their personal income statements, and pay\ntax on, their share of the corporation\xe2\x80\x99s separately stated items of income, deduction, and loss. That is, the\nS corporation avoids the dreaded double taxation of corporate income.\n\nTransferability of Ownership\nS corporations\xe2\x80\x99 shares can be bought or sold via share purchase agreements, and all changes in the\nownership are reflected in the share ledger in the corporate minute book.\n\nLimited Liability Partnerships\nBackground\nIn 1991, Texas enacted the first limited liability partnership (LLP) statute, largely in response to the\nliability that had been imposed on partners in partnerships sued by government agencies in relation to\nmassive savings and loan failures in the 1980s.\n\n[2]\n\n(Here we see an example of the legislature allowing\n\nbusiness owners to externalize the risks of business operation.) More broadly, the success of the limited\nliability company attracted the attention of professionals like accountants, lawyers, and doctors who\nsought insulation from personal liability for the mistakes or malpractice of their partners. Their wish was\ngranted with the adoption in all states of statutes authorizing the creation of the limited liability\npartnership in the early 1990s. Most partnership law under the Revised Uniform Partnership Act applies\nto LLPs.\n\nCreation\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n789\n\n\x0cMembers of a partnership (only a majority is required) who want to form an LLP must file with the\nsecretary of state; the name of the firm must include \xe2\x80\x9climited liability partnership\xe2\x80\x9d or \xe2\x80\x9cLLP\xe2\x80\x9d to notify the\npublic that its members will not stand personally for the firm\xe2\x80\x99s liabilities.\n\nLiability\nAs noted, the purpose of the LLP form of business is to afford insulation from liability for its members. A\ntypical statute provides as follows: \xe2\x80\x9cAny obligation of a partnership incurred while the partnership is a\nlimited liability partnership, whether arising in contract, tort or otherwise, is solely the obligation of the\npartnership. A partner is not personally liable, directly or indirectly, by way of indemnification,\ncontribution, assessment or otherwise, for such an obligation solely by reason of being or so acting as a\npartner.\xe2\x80\x9d\n\n[3]\n\nHowever, the statutes vary. The early ones only allowed limited liability for negligent acts and retained\nunlimited liability for other acts, such as malpractice, misconduct, or wrongful acts by partners,\nemployees, or agents. The second wave eliminated all these as grounds for unlimited liability, leaving only\nbreaches of ordinary contract obligation. These two types of legislation are called partial shield statutes.\nThe third wave of LLP legislation offered full shield protection\xe2\x80\x94no unlimited liability at all. Needless to\nsay, the full-shield type has been most popular and most widely adopted. Still, however, many statutes\nrequire specified amounts of professional malpractice insurance, and partners remain fully liable for their\nown negligence or for wrongful acts of those in the LLP whom they supervise.\nIn other respects, the LLP is like a partnership.\n\nLimited Liability Limited Partnerships\nThe progress toward achieving limited liability continues. A limited liability limited partnership (LLLP, or\ntriple LP) is the latest invention. It is a limited partnership that has invoked the LLLP provisions of its\nstate partnership law by filing with a specified public official the appropriate documentation to become an\nLLLP. This form completely eliminates the automatic personal liability of the general partner for\npartnership obligations and, under most statutes, also eliminates the \xe2\x80\x9ccontrol rule\xe2\x80\x9d liability exposure for\nall limited partners. It is noteworthy that California law does not allow for an LLLP to be formed in\nCalifornia; however, it does recognize LLLPs formed in other states. A \xe2\x80\x9cforeign\xe2\x80\x9d LLLP doing business in\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n790\n\n\x0cCalifornia must register with the secretary of state. As of February 2011, twenty-one states allow the\nformation of LLLPs.\nThe 2001 revision of the Uniform Limited Partnership Act (ULPA) provides this definition of an LLLP:\n\xe2\x80\x9c\xe2\x80\x98Limited liability limited partnership\xe2\x80\x99\xe2\x80\xa6means a limited partnership whose certificate of limited\npartnership states that the limited partnership is a limited liability limited partnership.\xe2\x80\x9d\n\n[4]\n\nSection 404(c)\n\ngets to the point: \xe2\x80\x9cAn obligation of a limited partnership incurred while the limited partnership is a\nlimited liability limited partnership, whether arising in contract, tort, or otherwise, is solely the obligation\nof the limited partnership. A general partner is not personally liable, directly or indirectly, by way of\ncontribution or otherwise, for such an obligation solely by reason of being or acting as a general partner.\nThis subsection applies despite anything inconsistent in the partnership agreement that existed\nimmediately before the consent required to become a limited liability limited partnership[.]\xe2\x80\x9d\n\n[5]\n\nIn the discussion of limited partnerships, we noted that ULPA-2001 eliminates the \xe2\x80\x9ccontrol rule\xe2\x80\x9d so that\nlimited partners who exercise day-to-day control arenot thereby liable as general partners. Now, in the\nsection quoted in the previous paragraph, the general partner\xe2\x80\x99s liability for partnership obligations is\nvaporized too. (Of course, the general partner is liable for its, his, or her own torts.) The preface to ULPA2001 explains, \xe2\x80\x9cIn a limited liability limited partnership (\xe2\x80\x98LLLP\xe2\x80\x99), no partner\xe2\x80\x94whether general or\nlimited\xe2\x80\x94is liable on account of partner status for the limited partnership\xe2\x80\x99s obligations. Both general and\nlimited partners benefit from a full, status-based liability shield that is equivalent to the shield enjoyed by\ncorporate shareholders, LLC members, and partners in an LLP.\xe2\x80\x9d\nPresumably, most existing limited partnerships will switch over to LLLPs. The ULPA-2001 provides that\n\xe2\x80\x9cthe Act makes LLLP status available through a simple statement in the certificate of limited partnership.\xe2\x80\x9d\n\nEthical Concerns\nThere was a reason that partnership law imposed personal liability on the partners: people tend to be\nmore careful when they are personally liable for their own mistakes and bad judgment. Many government\nprograms reflect peoples\xe2\x80\x99 interest in adverting risk: federal deposit insurance, Social Security, and\nbankruptcy, to name three. And of course corporate limited liability has existed for two hundred\nyears.\n\n[6]\n\nWhether the movement to allow almost anybody the right to a business organization that affords\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n791\n\n\x0climited liability will encourage entrepreneurship and business activity or whether it will usher in a new\nera of moral hazard\xe2\x80\x94people being allowed to escape the consequences of their own irresponsibility\xe2\x80\x94is yet\nto be seen.\n\nKEY TAKEAWAY\n\nBusinesspeople always prefer to reduce their risks. The partnership form imposes serious potential risk:\nunlimited personal liability. The corporate form eliminates that risk but imposes some onerous formalities\nand double taxation. Early on, then, the limited partnership form was born, but it still imposed unlimited\nliability on the general partner and on the limited partner if she became too actively involved. Congress\nwas induced in the mid-1950s to allow certain small US corporations the right to single taxation, but the\nsub-S corporation still suffered from various limitations on its structure. In the 1980s, the limited liability\ncompany was invented; it has become the entity of choice for many businesspeople, but its availability for\nprofessionals was limited. In the late 1980s, the limited liability partnership form gained favor, and in the\nearly 2000s, the limited liability limited partnership finished off unlimited liability for limited partnerships.\n\nEXERCISES\n\n1.\n\nThe principal disadvantage of the general partnership is that it imposes unlimited personal liability on the\npartners. What is the disadvantage of the corporate form?\n\n2.\n\nWhy isn\xe2\x80\x99t the limited partnership an entirely satisfactory solution to the liability problem of the\npartnership?\n\n3.\n\nExplain the issue of \xe2\x80\x9cmoral hazard\xe2\x80\x9d and the business organization form.\n4.\n\n[1] \xe2\x80\x9cThe History and Challenges of America\xe2\x80\x99s Dominant Business Structure,\xe2\x80\x9d S Corp: Defending America\xe2\x80\x99s\nSmall and Family-Owned Businesses, http://www.s-corp.org/our-history.\n\n5.\n\n[2] Christine M. Przybysz, \xe2\x80\x9cShielded Beyond State Limits: Examining Conflict-Of-Law Issues In Limited\nLiability Partnerships,\xe2\x80\x9d Case Western Reserve Law Review 54, no. 2 (2003): 605.\n\n6.\n\n[3] Revised Code of Washington (RCW), Section 25.05.130.\n\n7.\n\n[4] \xe2\x80\x9cUniform Limited Partnership Act (2001),\xe2\x80\x9d NCCUSL\nArchives,http://www.law.upenn.edu/bll/archives/ulc/ulpa/final2001.htm; ULPA Section, 102(9).\n\n8.\n\n[5] ULPA Section, 404(c).\n\n9.\n\n[6] See, for example, David A. Moss, \xe2\x80\x9cRisk, Responsibility, and the Role of Government,\xe2\x80\x9dDrake Law\nReview 56, no. 2 (2008): 541.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n792\n\n\x0c22.4 Cases\nLimited Partnerships: Limited Partners\xe2\x80\x99 Liability for Managing Limited\nPartnership\nFrigidaire Sales Corp. v. Union Properties, Inc.\n562 P.2d 244 (Wash. 1977)\nPlaintiff [Frigidaire] entered into a contract with Commercial Investors (Commercial), a limited\npartnership. Defendants, Leonard Mannon and Raleigh Baxter, were limited partners of Commercial.\nDefendants were also officers, directors, and shareholders of Union Properties, Inc., the only general\npartner of Commercial. Defendants controlled Union Properties, and through their control of Union\nProperties they exercised the day-to-day control and management of Commercial. Commercial breached\nthe contract, and Plaintiff brought suit against Union Properties and Defendants. The trial court\nconcluded that Defendants did not incur general liability for Commercial\xe2\x80\x99s obligations by reason of their\ncontrol of Commercial, and the Court of Appeals affirmed.\n[Plaintiff] does not contend that Defendants acted improperly by setting up the limited partnership with a\ncorporation as the sole general partner. Limited partnerships are a statutory form of business\norganization, and parties creating a limited partnership must follow the statutory requirements. In\nWashington, parties may form a limited partnership with a corporation as the sole general partner.\n[Citations]\nPlaintiff\xe2\x80\x99s sole contention is that Defendants should incur general liability for the limited partnership\xe2\x80\x99s\nobligations under RCW 25.08.070, because they exercised the day-to-day control and management of\nCommercial. Defendants, on the other hand, argue that Commercial was controlled by Union Properties, a\nseparate legal entity, and not by Defendants in their individual capacities. [RCW 25.08.070 then read: \xe2\x80\x9cA\nlimited partner shall not become liable as a general partner unless, in addition to the exercise of his rights\nand powers as limited partner, he takes part in the control of the business.\xe2\x80\x9d]\n\xe2\x80\xa6The pattern of operation of Union Properties was to investigate and conceive of real estate investment\nopportunities and, when it found such opportunities, to cause the creation of limited partnerships with\nUnion Properties acting as the general partner. Commercial was only one of several limited partnerships\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n793\n\n\x0cso conceived and created. Defendants did not form Union Properties for the sole purpose of operating\nCommercial. Hence, their acts on behalf of Union Properties were not performed merely for the benefit of\nCommercial.\xe2\x80\xa6\n[P]etitioner was never led to believe that Defendants were acting in any capacity other than in their\ncorporate capacities. The parties stipulated at the trial that Defendants never acted in any direct, personal\ncapacity. When the shareholders of a corporation, who are also the corporation\xe2\x80\x99s officers and directors,\nconscientiously keep the affairs of the corporation separate from their personal affairs, and no fraud or\nmanifest injustice is perpetrated upon third persons who deal with the corporation, the corporation\xe2\x80\x99s\nseparate entity should be respected. [Citations]\nFor us to find that Defendants incurred general liability for the limited partnership\xe2\x80\x99s obligations under\nRCW 25.08.070 would require us to apply a literal interpretation of the statute and totally ignore the\ncorporate entity of Union Properties, when Plaintiff knew it was dealing with that corporate entity. There\ncan be no doubt that Defendants, in fact, controlled the corporation. However, they did so only in their\ncapacities as agents for their principal, the corporate general partner. Although the corporation was a\nseparate entity, it could act only through its board of directors, officers, and agents. [Citations] Plaintiff\nentered into the contract with Commercial. Defendants signed the contract in their capacities as president\nand secretary-treasurer of Union Properties, the general partner of Commercial. In the eyes of the law it\nwas Union Properties, as a separate corporate entity, which entered into the contract with Plaintiff and\ncontrolled the limited partnership.\nFurther, because Defendants scrupulously separated their actions on behalf of the corporation from their\npersonal actions, Plaintiff never mistakenly assumed that Defendants were general partners with general\nliability. [Citations] Plaintiff knew Union Properties was the sole general partner and did not rely on\nDefendants\xe2\x80\x99 control by assuming that they were also general partners. If Plaintiff had not wished to rely\non the solvency of Union Properties as the only general partner, it could have insisted that Defendants\npersonally guarantee contractual performance. Because Plaintiff entered into the contract knowing that\nUnion Properties was the only party with general liability, and because in the eyes of the law it was Union\nProperties, a separate entity, which controlled the limited partnership, there is no reason for us to find\nthat Defendants incurred general liability for their acts done as officers of the corporate general partner.\nThe decision of the Court of Appeals is affirmed.\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n794\n\n\x0cCASE QUESTIONS\n1.\n\nFrigidaire entered into a contract with Commercial Investors, a limited partnership. The general partner in\nthe limited partnership was Union Properties, Inc., a corporation. Who were the limited partners in the\nlimited partnership? Who were the controlling principals of the corporate general partner?\n\n2.\n\nWhy is it common for the general partner in a limited partnership to be a corporation?\n\n3.\n\nWhy does the court reiterate that the plaintiff knew it was dealing with a limited partnership that had a\ncorporate general partner?\n\n4.\n\nWhat could the plaintiff have done in this case to protect itself?\n\n5.\n\nThe court ruled in favor of the defendants, but is this setup kind of a scam? What is the \xe2\x80\x9cmoral hazard\xe2\x80\x9d\nproblem lurking in this case?\n\nLiability Issues in LLCs\nPuleo v. Topel\n856 N.E.2d 1152 (Ill. App. 2006)\nPlaintiffs Philip Puleo [and others]\xe2\x80\xa6appeal the order of the circuit court dismissing their claims against\ndefendant Michael Topel.\nThe record shows that effective May 30, 2002, Thinktank, a limited liability company (LLC) primarily\ninvolved in web design and web marketing, was involuntarily dissolved by the Illinois Secretary of\nState\xe2\x80\xa6due to Thinktank\xe2\x80\x99s failure to file its 2001 annual report as required by the Illinois Limited Liability\nCompany Act (the Act) [Citation].\n[In December 2002], plaintiffs, independent contractors hired by Topel, filed a complaint against Topel\nand Thinktank in which they alleged breach of contract, unjust enrichment, and claims under the account\nstated theory. Those claims stemmed from plaintiffs\xe2\x80\x99 contention that Topel, who plaintiffs alleged was the\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n795\n\n\x0csole manager and owner of Thinktank, knew or should have known of Thinktank\xe2\x80\x99s involuntary\ndissolution, but nonetheless continued to conduct business as Thinktank from May 30, 2002, through the\nend of August 2002. They further contended that on or about August 30, 2002, Topel informed Thinktank\nemployees and independent contractors, including plaintiffs, that the company was ceasing operations\nand that their services were no longer needed. Thinktank then failed to pay plaintiffs for work they had\nperformed.\xe2\x80\xa6\nOn September 2, 2003, the circuit granted plaintiffs\xe2\x80\x99 motion for judgment on the pleadings against\nThinktank. Thereafter, on October 16, 2003, plaintiffs filed a separate motion for summary judgment\nagainst Topel [personally]. Relying on [Citation], plaintiffs contended that Topel, as a principal of\nThinktank, an LLC, had a legal status similar to a shareholder or director of a corporation, who courts\nhave found liable for a dissolved corporation\xe2\x80\x99s debts. Thus, plaintiffs argued that Topel was personally\nliable for Thinktank\xe2\x80\x99s debts.\xe2\x80\xa6\n\xe2\x80\xa6The circuit court denied plaintiffs\xe2\x80\x99 motion for summary judgment against Topel.\xe2\x80\xa6In doing so, the\ncircuit court acknowledged that Topel continued to do business as Thinktank after its dissolution and that\nthe contractual obligations at issue were incurred after the dissolution.\nHowever\xe2\x80\xa6the court entered a final order dismissing all of plaintiffs\xe2\x80\x99 claims against Topel with\nprejudice.\xe2\x80\xa6The court stated in pertinent part:\nBased upon the Court\xe2\x80\x99s\xe2\x80\xa6finding that the Illinois Legislature did not intend to hold a member of a\nLimited Liability Company liable for debts incurred after the Limited Liability Company had\nbeen involuntarily dissolved, the Court finds that all of Plaintiffs\xe2\x80\x99 claims against Defendant Topel\nwithin the Complaint fail as a matter of law, as they are premised upon Defendant Topel\xe2\x80\x99s alleged\npersonal liability for obligations incurred in the name of Thinktank LLC after it had been\ninvoluntarily dissolved by the Illinois Secretary of State.\nPlaintiffs now appeal that order\xe2\x80\xa6[contending] that\xe2\x80\xa6the circuit court erred in dismissing their claims\nagainst Topel. In making that argument, plaintiffs acknowledge that the issue as to whether a member or\nmanager of an LLC may be held personally liable for obligations incurred by an involuntarily dissolved\nLLC appears to be one of first impression under the Act. That said, plaintiffs assert that it has long been\nthe law in Illinois that an officer or director of a dissolved corporation has no authority to exercise\ncorporate powers and thus is personally liable for any debts he incurs on behalf of the corporation after its\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n796\n\n\x0cdissolution. [Citations] Plaintiffs reason that Topel, as managing member of Thinktank, similarly should\nbe held liable for debts the company incurred after its dissolution.\nWe first look to the provisions of the Act as they provided the trial court its basis for its ruling.\xe2\x80\xa6\n(a) Except as otherwise provided in subsection (d) of this Section, the debts, obligations, and\nliabilities of a limited liability company, whether arising in contract, tort, or otherwise, are solely\nthe debts, obligations, and liabilities of the company. A member or manager is not personally\nliable for a debt, obligation, or liability of the company solely by reason of being or acting as a\nmember or manager.\xe2\x80\xa6\n(c) The failure of a limited liability company to observe the usual company formalities or\nrequirements relating to the exercise of its company powers or management of its business is not\na ground for imposing personal liability on the members or managers for liabilities of the\ncompany.\n(d) All or specified members of a limited liability company are liable in their capacity as members\nfor all or specified debts, obligations, or liabilities of the company if:\n(1) a provision to that effect is contained in the articles of organization; and\n(2) a member so liable has consented in writing to the adoption of the provision or to be bound by\nthe provision.\n[Another relevant section provides]:\n(a) A limited liability company is bound by a member or manager\xe2\x80\x99s act after dissolution that:\n(1) is appropriate for winding up the company\xe2\x80\x99s business; or\n(2) would have bound the company before dissolution, if the other party to the transaction did not\nhave notice of the dissolution.\n(b) A member or manager who, with knowledge of the dissolution, subjects a limited liability\ncompany to liability by an act that is not appropriate for winding up the company\xe2\x80\x99s business is\nliable to the company for any damage caused to the company arising from the liability.\n[The statute] clearly indicates that a member or manager of an LLC is not personally liable for debts the\ncompany incurs unless each of the provisions in subsection (d) is met. In this case, plaintiffs cannot\nestablish either of the provisions in subsection (d). They have not provided this court with Thinktank\xe2\x80\x99s\narticles of organization, much less a provision establishing Topel\xe2\x80\x99s personal liability, nor have they\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n797\n\n\x0cprovided this court with Topel\xe2\x80\x99s written adoption of such a provision. As such, under the express language\nof the Act, plaintiffs cannot establish Topel\xe2\x80\x99s personal liability for debts that Thinktank incurred after its\ndissolution.\xe2\x80\xa6\nIn 1998\xe2\x80\xa6the legislature amended [the LLC statute]\xe2\x80\xa6and in doing so removed\xe2\x80\xa6language which explicitly\nprovided that a member or manager of an LLC could be held personally liable for his or her own actions or\nfor the actions of the LLC to the same extent as a shareholder or director of a corporation could be held\npersonally liable [which would include post-dissolution acts undertaken without authority]. As we have\nnot found any legislative commentary regarding that amendment, we presume that by removing the noted\nstatutory language, the legislature meant to shield a member or manager of an LLC from personal\nliability. [Citation] \xe2\x80\x9cWhen a statute is amended, it is presumed that the legislature intended to change the\nlaw as it formerly existed.\xe2\x80\x9d\nNonetheless, plaintiffs ask this court to disregard the 1998 amendment and to imply a provision into the\nAct similar to\xe2\x80\xa6the Business Corporation Act. We cannot do so.\xe2\x80\xa6When the legislature amended section\n[the relevant section] it clearly removed the provision that allowed a member or manager of an LLC to be\nheld personally liable in the same manner as provided in section 3.20 of the Business Corporation Act.\nThus, the Act does not provide for a member or manager\xe2\x80\x99s personal liability to a third party for an LLC\xe2\x80\x99s\ndebts and liabilities, and no rule of construction authorizes this court to declare that the legislature did\nnot mean what the plain language of the statute imports.\nWe, therefore, find that the circuit court did not err in concluding that the Act did not permit it to find\nTopel personally liable to plaintiffs for Thinktank\xe2\x80\x99s debts and liabilities. We agree with plaintiff that the\ncircuit court\xe2\x80\x99s ruling does not provide an equitable result. However, the circuit court, like this court, was\nbound by the statutory language.\nAccordingly, we affirm the judgment of the circuit court of Cook County.\n\nCASE QUESTIONS\n\n1.\n\nIs it possible the defendant did not know his LLC had been involuntarily dissolved because it failed to file\nits required annual report? Should he have known it was dissolved?\n\n2.\n\nIf Topel\xe2\x80\x99s business had been a corporation, he would not have had insulation from liability for\npostdissolution contracts\xe2\x80\x94he would have been liable. Is the result here equitable? Is it fraud?\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n798\n\n\x0c3.\n\nSeven months after the LLC\xe2\x80\x99s existence was terminated by the state, the defendant hired a number of\nemployees, did not pay them, and then avoided liability under the LLC shield. How else could the court\nhave ruled here? It is possible that the legislature\xe2\x80\x99s intent was simply to eliminate compulsory piercing\n(see under corporate law principles and leave the question of LLC piercing to the courts. If so was the\ncourt\xe2\x80\x99s decision was correct? The current LLC act language is similar to the Model Business Corporation\nAct, which surely permits piercing (see ).\n\nDefective Registration as a Limited Liability Partnership\nCampbell v. Lichtenfels\n2007 WL 447919 (Conn. Super. 2007)\nThis case concerns the aftermath of the dissolution of the parties\xe2\x80\x99 law practice. Following a hearing on\nJanuary 2 and 3, 2007, this court issued a memorandum of decision on January 5, 2007 granting the\nplaintiff a prejudgment remedy in the amount of $15,782.01. The plaintiff has now moved for reargument,\ncontending that the court improperly considered as a setoff one-half of a malpractice settlement paid\npersonally by the defendant, which sum the court found to be a debt of a partnership. [The defendant was\nsued for malpractice by a third party; he paid the entire claim personally and when the law firm dissolved,\nthe plaintiff\xe2\x80\x99s share from the liquidated assets was reduced by one-half to account for the amount the\ndefendant had paid.]\nIn support of his motion to reargue, the plaintiff relies on General Statutes Sec. 34-427(c) and, in that\nmotion, italicizes those portions which he believes apply to his request for reargument. That section states\n(with emphasis as supplied in the plaintiff\xe2\x80\x99s motion) that:\na partner in a registered limited liability partnership is not liable directly or indirectly, including\nby way of indemnification, contribution or otherwise, for any debts, obligations and liabilities of\nor chargeable to the partnership or another partner or partners, whether arising in\ncontract, tort, or otherwise, arising in the course of the partnership business while the\npartnership is a registered limited liability partnership. (emphasis in original)\nWhile italicizing the phases that appear to suit his purposes, the plaintiff completely ignores the most\nimportant phrase: \xe2\x80\x9ca partner in a registered limited liability partnership.\xe2\x80\x9d At the hearing, neither party\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n799\n\n\x0cpresented any evidence at the hearing that tended to prove that the nature of the business relationship\nbetween the parties was that of a \xe2\x80\x9cregistered limited liability partnership.\xe2\x80\x9d To the contrary, the testimony\npresented at the hearing revealed that the parties had a general partnership in which they had orally\nagreed to share profits and losses equally and that they never signed a partnership agreement. There was\ncertainly no testimony or tangible evidence to the effect that the partnership had filed \xe2\x80\x9ca certificate of\nlimited liability partnership with the Secretary of the State, stating the name of the partnership, which\nshall conform to the requirements of [the statute]; the address of its principal office;\xe2\x80\xa6a brief statement of\nthe business in which the partnership engages; any other matters the partnership may determine to\ninclude; and that the partnership therefore applies for status as a registered limited liability partnership.\xe2\x80\x9d\n[Citation]\nIt is true that certain of the exhibits, such as copies of checks and letters written on the law firm\nletterhead, refer to the firm as \xe2\x80\x9cCampbell and Lichtenfels, LLP.\xe2\x80\x9d These exhibits, however, were not offered\nfor the purpose of establishing the partnership\xe2\x80\x99s character, and merely putting the initials \xe2\x80\x9cLLP\xe2\x80\x9d on\nchecks and letterhead is not, in and of itself, proof of having met the statutory requirements for\nregistration as a limited liability partnership. The key to establishing entitlement to the protections\noffered by [the limited liability partnership statute] is proof that the partnership has filed \xe2\x80\x9ca certificate of\nlimited liability partnership with the Secretary of the State,\xe2\x80\x9d and the plaintiff presented no such evidence\nto the court.\nBecause the evidence presented at the hearing does not support a claim that the nature of the relationship\nbetween the parties to this case was that of partners in a registered limited liability partnership, the\nprovisions of [the limited liability partnership statute] do not apply. Rather, this partnership is governed\nby the provisions of [the Uniform Partnership Act] which states: \xe2\x80\x9cExcept as otherwise provided\xe2\x80\xa6all\npartners are liable jointly and severally for all obligations of the partnership unless otherwise agreed by\nthe claimant or provided by law.\xe2\x80\x9d Because there has been no evidence that this partnership falls within\n[any exceptions] the court finds Campbell and Lichtenfels to have been a general partnership in which the\nplaintiff shares the liability for the malpractice claim, even if he was not the partner responsible for the\nalleged negligence that led to that claim.\nThe plaintiff correctly points out that reargument is appropriate when the court has \xe2\x80\x9coverlooked\xe2\x80\x9d a\n\xe2\x80\x9c\xe2\x80\xa6principle of law which would have a controlling effect\xe2\x80\xa6\xe2\x80\x9d on the outcome of the case at hand. [Citation]\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n800\n\n\x0cThe principle of law now raised by the plaintiff was \xe2\x80\x9coverlooked\xe2\x80\x9d by the court at the time of the hearing for\ntwo good reasons. First, it was not brought to the court\xe2\x80\x99s attention at the time of the hearing. Second, and\nmore importantly, the plaintiff presented no evidence that would have supported the claim that the\nprinciple of law in question, namely the provisions of [the limited liability partnership] was applicable to\nthe facts of this case. Because the provisions of [that statute] are inapplicable, they are quite obviously not\n\xe2\x80\x9ccontrolling.\xe2\x80\x9d The principle of law which does control this issue is found in [general partnership law] and\nthat principle makes the plaintiff liable for his share of the malpractice settlement, as the court has\npreviously found. The motion for reargument is therefore denied.\n\nCASE QUESTIONS\n\n1.\n\nIf the parties had been operating as a limited liability partnership, how would that have changed the\nresult?\n\n2.\n\nWhy did the court find that there was no limited liability partners
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