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403.BusinessItsLegalEthicalandGlobalEnvironment.pdf

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ElEvEnth Edition

Marianne Moody Jennings Arizona State University

Australia • Brazil • Mexico • Singapore • United Kingdom • United States

its lEgal, Ethical, and global EnvironmEnt

Business

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© 2018, 2015 Cengage Learning®

ALL RIGHTS RESERVED. No part of this work covered by the copyright herein may be reproduced or distributed in any form or by any means, except as permitted by U.S. copyright law, without the prior written permission of the copyright owner.

Library of Congress Control Number: 2016948642

ISBN: 978-1-337-10357-2

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Business: Its Legal, Ethical, and Global Environment , 11e Marianne Moody Jennings

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Part 1 1 Business: Its Legal, Ethical, and Judicial Environment 1

1 Introduction to Law 2

2 Business Ethics and Social Responsibility 24

3 The Judicial System 72

4 Managing Disputes: Alternative Dispute Resolution and Litigation Strategies 102

Part 2 139 Business: Its Regulatory Environment 139

5 Business and the Constitution 140

6 Administrative Law 178

7 International Law 218

8 Business Crime 248

9 Business Torts 294

10 Environmental Regulation and Sustainability 328

Part 3 363 Business Sales, Contracts, and Competition 363

11 Contracts and Sales: Introduction and Formation 366

12 Contracts and Sales: Performance, Remedies, and Collection 410

13 Product Advertising and Liability 448

14 Business Competition: Antitrust 486

15 Business and Intellectual Property Law 520

Part 4 553 Business Management and Governance 553

16 Management of Employee Conduct: Agency 554

17 Governance and Structure: Forms of Doing Business 592

18 Governance and Regulation: Securities Law 634

19 Management of Employee Welfare 680

20 Management: Employment Discrimination 728

Appendices A-1 A The United States Constitution A-1 B The Foreign Corrupt Practices Act (Excerpts) A-12 C The Uniform Commercial Code (Excerpts)* A-15 D Dodd-Frank (Wall Street Reform and Consumer

Financial Protection Act) Key Provisions A-20 E The Securities Act of 1933 and the Securities Exchange

Act of 1934 (Excerpts) A-23 F Sarbanes-Oxley Key Provisions (Excerpts) A-28 G The Copyright Act (as Amended) (Excerpts) A-31 H Title VII and the Civil Rights Act (Employment

Provisions) (Excerpts) A-34 I The Americans with Disabilities Act (Excerpts) A-37

Glossary G-1 Table of Cases T-1 Table of Products, People, and Companies T-11 Index I-1

Brief Contents

iii

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iv

Contents

Preface xv About the Author xxvi Acknowledgments xxviii

1 Introduction to Law 2

1-1 Definition of Law 3

1-2 Classifications of Law 3 1-2a Public versus Private Law 3 1-2b Criminal versus Civil Law 4 1-2c Substantive versus Procedural Law 4 1-2d Common versus Statutory Law 4 1-2e Law versus Equity 5

1-3 Purposes of Law 6 1-3a Keeping Order 6 1-3b Influencing Conduct 6 1-3c Honoring Expectations 6 1-3d Promoting Equality 6 1-3e Law as the Great Compromiser 7

1-4 Characteristics of Law 7 1-4a Flexibility 7 1-4b Consistency 7 1-4c Pervasiveness 7

1-5 The Theory of Law: Jurisprudence 12 1-5a The Theory of Law: Positive Law 12 1-5b The Theory of Law: Natural Law 12 1-5c The Theory of Law: The Protection of

Individuals and Relationships 12 1-5d The Theory of Law: The Social Contract 12

1-6 Sources of Law 13 1-6a Constitutional Law 13

1-6b Statutory Law at the Federal Level 14 1-6c Statutory Law at the State Level 15 1-6d Local Laws of Cities, Counties, and

Townships 16 1-6e Private Laws 16 1-6f Court Decisions 16

1-7 Introduction to International Law 17 1-7a Custom 17 1-7b Treaties 18 1-7c Private Law in International

Transactions 18 1-7d International Organizations 18 1-7e The Doctrines of International Law 18 1-7f Trade Law and Policies 18 1-7g Uniform International Laws 19 1-7h The European Union 19

Summary 20

Questions and Problems 21

2 Business Ethics and Social Responsibility 24

2-1 What Is Ethics? 26 2-1a “It’s Just Not Right!” 26 2-1b Normative Standards: How We Behave to

Keep Order 26 2-1c Line-Cutting and Ethics 27

Part 1 Business: Its Legal, Ethical, and Judicial Environment 1

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Contents v

2-2 What Is Business Ethics? 28 2-2a Ethical Standards: Positive Law and Ethics 29 2-2b Ethical Standards: Natural Law and Ethics 31 2-2c Ethical Standards: Moral Relativism and Ethics 31 2-2d Ethical Standards: Religion and Ethics 31

2-3 What Are the Categories of Ethical Dilemmas? 31 2-3a Taking Things That Don’t Belong to You 31 2-3b Saying Things You Know Are Not True 32 2-3c Giving or Allowing False Impressions 32 2-3d Buying Influence or Engaging in Conflict of

Interest 33 2-3e Hiding or Divulging Information 34 2-3f Taking Unfair Advantage 34 2-3g Committing Acts of Personal Decadence 35 2-3h Perpetrating Interpersonal Abuse 35 2-3i Permitting Organizational Abuse 35 2-3j Violating Rules 36 2-3k Condoning Unethical Actions 36 2-3l Balancing Ethical Dilemmas 36

2-4 Resolution of Business Ethical Dilemmas 37 2-4a Blanchard and Peale 37 2-4b The Front-Page-of-the-Newspaper Test 38 2-4c Laura Nash and Perspective 38 2-4d The Wall Street Journal Model 39 2-4e Other Models 39

2-5 Why We Fail to Reach Good Decisions in Ethical Dilemmas 39 2-5a “Everybody Else Does It” 39 2-5b “If We Don’t Do It, Someone Else Will” 39 2-5c “That’s the Way It Has Always Been Done” 40 2-5d “We’ll Wait until the Lawyers Tell Us It’s

Wrong” 40 2-5e “It Doesn’t Really Hurt Anyone” 41 2-5f “The System Is Unfair” 41 2-5g “I Was Just Following Orders” 41 2-5h “You Think This Is Bad, You Should

Have Seen . . .” 42 2-5i “It’s a Gray Area” 42

2-6 Social Responsibility: Another Layer of Business Ethics 43 2-6a Ethical Postures for Social Responsibility 43

2-7 Why Business Ethics? 45 2-7a Personal Accountability and Comfort: Business

Ethics for Personal Reasons 45

2-8 Importance of Ethics in Business Success and the Costs of Unethical Conduct 51 2-8a Ethics as a Strategy 53 2-8b The Value of a Good Reputation 55 2-8c Leadership’s Role in Ethical Choices 56

2-9 Creation of an Ethical Culture in Business 58 2-9a The Tone at the Top and an Ethical Culture 58 2-9b Dodd-Frank, Sarbanes-Oxley, Sentencing, and

an Ethical Culture 58 2-9c Reporting Lines: An Anonymous Ethics Line

for an Ethical Culture 59 2-9d Developing an Ethics Stance 59 2-9e Being Careful about Pressure and Signals 61

2-10 Ethical Issues in International Business 61

Summary 68

Questions and Problems 69

3 The Judicial System 72

3-1 Types of Courts 73 3-1a Trial Courts 73 3-1b Appellate Courts 73

3-2 How Courts Make Decisions 73 3-2a The Process of Judicial Review 73 3-2b The Doctrine of Stare Decisis 75

3-3 Parties in the Judicial System (Civil Cases) 77 3-3a Plaintiffs 77 3-3b Defendants 77 3-3c Lawyers 77 3-3d Judges 79 3-3e Name Changes on Appeal 79

3-4 The Concept of Jurisdiction 79

3-5 Subject Matter Jurisdiction of Courts: The Authority over Content 80 3-5a The Federal Court System 80 3-5b The State Court Systems 86 3-5c Judicial Opinions 88 3-5d Venue 88

3-6 In Personam Jurisdiction of Courts: The Authority over Persons 90 3-6a Ownership of Property within the State 90 3-6b Volunteer Jurisdiction 90 3-6c Presence in the State 90 3-6d Internet Companies and Long-Arm

Jurisdiction 94

3-7 The International Courts 95 3-7a Jurisdictional Issues in International Law 96 3-7b Conflicts of Law in International Disputes 96

Summary 98

Questions and Problems 99

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vi Contents

4 Managing Disputes: Alternative Dispute Resolution and Litigation Strategies 102

4-1 What Is Alternative Dispute Resolution? 103

4-2 Types of Alternative Dispute Resolution 103 4-2a Arbitration 103 4-2b Arbitration Procedures 106 4-2c Mediation 108 4-2d Medarb 108 4-2e The Minitrial 108 4-2f Rent-a-Judge 109 4-2g Summary Jury Trials 109 4-2h Early Neutral Evaluation 109 4-2i Peer Review 110

4-3 Resolution of International Disputes 110

4-4 Litigation versus ADR: The Issues and Costs 111 4-4a Speed and Cost 111 4-4b Protection of Privacy 111 4-4c Creative Remedies 111 4-4d Judge and Jury Unknowns 112 4-4e Absence of Technicalities 113

4-5 When You Are in Litigation 113 4-5a How Does a Lawsuit Start? 113 4-5b The Complaint (Petition) 115 4-5c The Summons 117 4-5d The Answer 119 4-5e Seeking Timely Resolution of the Case 119 4-5f How a Lawsuit Progresses: Discovery 121 4-5g Resolution of a Lawsuit: The Trial 125

4-6 Issues in International Litigation 131

Summary 134

Questions and Problems 134

5 Business and the Constitution 140

5-1 The U.S. Constitution 141 5-1a An Overview of the U.S. Constitution 141 5-1b Articles I, II, and III—the Framework for

Separation of Powers 141 5-1c Other Articles 142 5-1d The Bill of Rights 143

5-2 The Role of Judicial Review and the Constitution 143

5-3 Constitutional Limitations of Economic Regulations 143 5-3a The Commerce Clause 143 5-3b Constitutional Standards for Taxation of

Business 149

5-4 State versus Federal Regulation of Business— Constitutional Conflicts: Preemption and the Supremacy Clause 152

5-5 Application of the Bill of Rights to Business 156 5-5a Commercial Speech and the First Amendment 156 5-5b First Amendment Protection for Advertising 156 5-5c First Amendment Rights and Profits from

Sensationalism 158 5-5d First Amendment Rights and Corporate Political

Speech 159 5-5e Eminent Domain: The Takings Clause 164 5-5f Procedural Due Process 169 5-5g Substantive Due Process 170 5-5h Equal Protection Rights for Business 171

5-6 The Role of Constitutions in International Law 171

Summary 173

Questions and Problems 173

Part 2 Business: Its Regulatory Environment 139

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Contents vii

6 Administrative Law 178

6-1 What Are Administrative Agencies? 179

6-2 Roles of Administrative Agencies 180 6-2a Specialization 180 6-2b Protection for Small Business 182 6-2c Faster Relief 182 6-2d Due Process 182 6-2e Social Goals 183

6-3 Laws Governing Administrative Agencies 183 6-3a Administrative Procedures Act 183 6-3b Freedom of Information Act 183 6-3c Federal Privacy Act 184 6-3d Government in the Sunshine Act 185 6-3e Federal Register Act 186

6-4 The Functions of Administrative Agencies and Business Interaction 186 6-4a Providing Input When Agencies Are

Promulgating Regulations 186 6-4b Formal Rulemaking 186 6-4c Proactive Business Strategies in Regulation 204 6-4d Informal Rulemaking 204

6-5 Business Rights in Agency Enforcement Action 205 6-5a Licensing and Inspections 205 6-5b Prosecution of Businesses 207 6-5c Beginning Enforcement Steps 207 6-5d Consent Decrees 207 6-5e Hearings 207 6-5f Administrative Law of Appeals 209

6-6 The Role of Administrative Agencies in the International Market 210

Summary 212

Questions and Problems 213

7 International Law 218

7-1 Sources of International Law 219 7-1a International Law Systems 219 7-1b Nonstatutory Sources of International Law 220 7-1c Statutory Sources of International Law 221 7-1d Treaties, Trade Organizations, and Controls

on International Trade 222

7-2 Trust, Corruption, Trade, and Economics 227 7-2a Foreign Corrupt Practices Act (FCPA) 227

7-3 Resolution of International Disputes 232

7-4 Principles of International Law 232 7-4a Act of State Doctrine 232 7-4b Sovereign Immunity 232 7-4c Protections for U.S. Property and Investment

Abroad 235 7-4d Repatriation 237 7-4e Forum Non Conveniens, or “You Have the Wrong

Court” 237 7-4f Conflicts of Law 237

7-5 Protections in International Competition 238 7-5a The International Marketplace and Monetary

Issues: The Disclosure Role of Banks 238 7-5b Antitrust Laws in the International

Marketplace 240 7-5c Protections for Intellectual Property 242 7-5d Criminal Law Protections 242

Summary 244

Questions and Problems 244

8 Business Crime 248

8-1 What Is Business Crime? The Crimes within a Corporation 249 8-1a Financial Fraud: Employees Manipulating

Earnings Numbers 249 8-1b Marketing Missteps: Sales Zeal and

Crimes 250 8-1c Friendly Fire: Employee Theft 250

8-2 What Is Business Crime? The Crimes against a Corporation 252

8-3 Who Is Liable for Business Crime? 253

8-4 Federal Laws Targeting Officers and Directors for Criminal Accountability 254 8-4a White-Collar Crime’s Origins and History 254 8-4b Sarbanes–Oxley (SOX) 255 8-4c Honest Services Fraud 256 8-4d Financial Services Crimes and Reforms 256 8-4e Other Business Crimes and White-Collar

Liability 257

8-5 The Penalties for Business Crime 257 8-5a New Penalties and New Processes 257 8-5b Corporate Integrity Agreements (CIAs) 257

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viii Contents

8-5c Criminal Indictments of Corporations on Common Law Crimes 259

8-5d Shame Punishment 259 8-5e New and Higher Penalties for Corporate

Crime 262 8-5f Corporate Sentencing Guidelines: An Ounce of

Prevention Means a Reduced Sentence 262 8-5g Corporate Board Criminal Responsibility 263

8-6 Elements of Business Crime 265 8-6a Mens Rea, Scienter, or Criminal Intent 265 8-6b Mens Rea, Conscious Avoidance, and Corporate

Officers 267 8-6c Actus Reus 268

8-7 Examples of Business Crimes 268 8-7a Theft and Embezzlement 268 8-7b Obstruction of Justice 268 8-7c Computer Crime 269 8-7d Internet Crime 271 8-7e Criminal Fraud 274 8-7f Commercial Bribery 274 8-7g Racketeer Influenced and Corrupt

Organizations (RICO) Act 275 8-7h Business Crime and the USA Patriot Act 277 8-7i Additional Federal Crimes 279 8-7j State Crimes 279

8-8 Procedural Rights for Business Criminals 279 8-8a Fourth Amendment Rights for Businesses 279 8-8b Exceptions to the Warrant Requirement 281 8-8c Fifth Amendment Rights for Businesses 283

8-9 Business Crime and International Business 287

Summary 289

Questions and Problems 290

9 Business Torts 294

9-1 What Is a Tort? Roots of Law and Commerce 295 9-1a Tort Versus Crime 295 9-1b Types of Torts 295

9-2 The Intentional Torts 296 9-2a Defamation 296 9-2b Contract Interference 304 9-2c False Imprisonment 304 9-2d Intentional Infliction of Emotional Distress 305 9-2e Invasion of Privacy 305

9-3 Negligence 308 9-3a Element One: The Duty 308 9-3b Element Two: Breach of Duty 311 9-3c Element Three: Causation 314 9-3d Element Four: Proximate Cause 315 9-3e Element Five: Damages 319 9-3f Defenses to Negligence 319

9-4 New Verdicts on Tort Reform 321 9-4a Strict Liability 322

Summary 323

Questions and Problems 324

10 Environmental Regulation and Sustainability 328

10-1 Common Law Remedies and the Environment 329 10-1a Nuisances 329 10-1b NIMBYs and Nuisances 329

10-2 Statutory Environmental Laws: Air Pollution Regulation 332 10-2a Early Legislation 333 10-2b 1970 Amendments to the Clean Air Act:

New Standards 333 10-2c 1977 and 1990 Amendments 333 10-2d New Forms of Control: EPA Expansion

Through Administrative Procedures 333 10-2e New Forms of Control: EPA and Climate

Change, Nee Global Warming 334 10-2f New Forms of Control: EPA and Small

Businesses 335 10-2g New Forms of Control: EPA and Economic

Forces 336

10-3 Statutory Environmental Law: Water Pollution Regulation 336 10-3a Early Legislation 336 10-3b Present Legislation 336 10-3c Other Water Legislation 337

10-4 Statutory Environmental Law: Solid Waste Disposal Regulation 338 10-4a Early Regulation 338 10-4b CERCLA and the Superfund 339 10-4c New Developments Under CERCLA 343 10-4d CERCLA and Brownfields 344

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Contents ix

10-5 Statutory Law: Environmental Quality Regulation 345

10-6 Statutory Law: Other Federal Environmental Regulations 347 10-6a Surface Mining 347 10-6b The Fracking Issue 347 10-6c Noise Control 347 10-6d Pesticide Control 347 10-6e OSHA 347 10-6f Asbestos 347 10-6g Endangered Species 348 10-6h State Environmental Laws 351

10-7 Enforcement of Environmental Laws 352 10-7a Parties Responsible for Enforcement 352 10-7b Criminal Sanctions and Penalties for

Violations 352 10-7c Group Suits: The Effect of Environmentalists 356

10-8 International Environmental Issues 356 10-8a The EU and Environmentalism 356 10-8b ISO 14000 356 10-8c LEED Certification 357

Summary 359

Questions and Problems 359

11 Contracts and Sales: Introduction and Formation 366

11-1 What Is a Contract? 367

11-2 Sources of Contract Law 367 11-2a Common Law 368 11-2b The Uniform Commercial Code 368

11-3 Types of Contracts 372 11-3a Bilateral Versus Unilateral Contracts 372 11-3b Express Versus Implied Contracts

(Quasi Contracts) 372 11-3c Void and Voidable Contracts 374 11-3d Unenforceable Contracts 374 11-3e Executed Versus Executory Contracts 374

11-4 Consumer Credit Contracts 375 11-4a Discrimination in Credit Contracts 375 11-4b Subprime or Predatory Lending 376 11-4c Credit Disclosures 377 11-4d Controlling Credit Card Contracts 377

11-5 Formation of Contracts 378 11-5a Offer 378 11-5b Acceptance: The Offeree’s Response 390 11-5c E-Commerce and Contract Formation 391

11-5d Consideration 394 11-5e Contract Form: When a Record Is Required 395 11-5f Writing and E-Commerce: The Uniform

Electronic Transactions Act 398

11-6 Issues in Formation of International Contracts 402 11-6a CISG—UCC for the World 402 11-6b The Payment Issues in International

Contracts 403 11-6c Risk in International Contract Performance:

Force Majeure 405

Summary 406

Questions and Problems 407

12 Contracts and Sales: Performance, Remedies, and Collection 410

12-1 Defenses in Contract Formation 411 12-1a Capacity 411 12-1b Misrepresentation 414 12-1c Fraud or Fraudulent Misrepresentation 415 12-1d Consumer Credit Contracts and Rescission

Rights 417

Part 3 Business Sales, Contracts, and Competition 363

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x Contents

12-1e Subprime Lending Representations and Disclosures 419

12-1f Duress 419 12-1g Undue Influence 419 12-1h Illegality and Public Policy 420

12-2 Contract Performance 426 12-2a When Performance Is Due 426 12-2b Standards for Performance 428 12-2c E-Commerce: Payment Performance Has

Changed 429 12-2d When Performance Is Excused 429 12-2e Finding a Way to End Obligations Under the

Contract 433

12-3 Nonperformance and Nonpayment—The  Collection Remedies 433 12-3a Making Sure the Billing Is Accurate 433 12-3b Collection—Fair Standards for Obtaining

Payment 434 12-3c Suits for Enforcement of Debts 437 12-3d The End of the Line on Enforcement of Debts:

Bankruptcy 437 12-3e Is There a Cost to Breaching a Contract:

Creditor Reports on Nonpaying Debtors 438

12-4 Contract Remedies for Nonperformance 441

12-5 Third-Party Rights in Contracts 442

12-6 International Issues in Contract Performance 443 12-6a Assuring Payment 443 12-6b Assuring Performance: International

Peculiarities 443

Summary 444

Questions and Problems 445

13 Product Advertising and Liability 448

13-1 Development of Product Liability 449

13-2 Advertising as a Contract Basis for Product Liability 449 13-2a Express Warranties 449 13-2b Federal Regulation of Warranties and

Advertising 453

13-2c Content Control and Accuracy 453 13-2d FTC Control of Performance Claims 454 13-2e FTC Control of Celebrity

Endorsements 456 13-2f FTC Control of Bait and Switch 458 13-2g FTC Control of Product Comparisons 458 13-2h FTC Remedies 460 13-2i Ad Regulation by the FDA and Other Federal

Agencies 460 13-2j Professional Ads 460

13-3 Contract Product Liability Theories: Implied Warranties 460 13-3a The Implied Warranty of

Merchantability 461 13-3b The Implied Warranty of Fitness for a

Particular Purpose 464 13-3c Eliminating Warranty Liability by

Disclaimers 464 13-3d Privity Standards for UCC Recovery 466

13-4 Strict Tort Liability: Product Liability Under Section 402A 466 13-4a The Requirement of Unreasonably Dangerous

Defective Condition 467 13-4b Reaching the Buyer in the Same

Condition 471 13-4c The Requirement of a Seller Engaged in a

Business 473 13-4d Negligence: A Second Tort for Product

Liability 473 13-4e Privity Issues in Tort Theories of Product

Liability 473

13-5 Defenses to Product Liability Torts 474 13-5a Misuse or Abnormal Use of a

Product 474 13-5b Contributory Negligence 475 13-5c Assumption of Risk 475

13-6 Product Liability Reform 478

13-7 Federal Standards for Product Liability 478 13-7a Consumer Product Safety

Commission 478

13-8 International Issues in Product Liability 479

Summary 481

Questions and Problems 481

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Contents xi

14 Business Competition: Antitrust 486

14-1 What Interferes with Competition? Covenants Not to Compete 487

14-2 What Interferes with Competition? An Overview of the Federal Statutory Scheme on Restraint of Trade 491 14-2a What Types of Activities Do the Federal Laws

Regulate? 492

14-3 Horizontal Restraints of Trade 493 14-3a Monopolization 493 14-3b Price-Fixing 496 14-3c Divvying Up the Markets 501 14-3d Group Boycotts and Refusals to Deal 502 14-3e Free Speech and Anticompetitive Behavior 502 14-3f Subtle Anticompetitive Behavior: Interlocking

Directorates 503 14-3g Merging Competitors and the Effect on

Competition 503

14-4 Vertical Trade Restraints 503 14-4a Resale Price Maintenance 504 14-4b Monopsony 508 14-4c Sole Outlets and Exclusive Distributorships 508 14-4d Customer and Territorial Restrictions 509 14-4e Tying Arrangements 509 14-4f Price Discrimination 511 14-4g Vertical Mergers 513

14-5 What Are the Penalties and Remedies for Anticompetitive Behavior? 513 14-5a Criminal Penalties 513 14-5b Equitable Remedies 514 14-5c Private Actions for Damages 514

14-6 Antitrust Issues in International Competition 514

Summary 516

Questions and Problems 516

15 Business and Intellectual Property Law 520

15-1 What Can a Business Own? Intangible Property Rights 521

15-2 Patents 521 15-2a The Types and Length of Patents 522 15-2b What You Can Patent: Patentability 522 15-2c The Patent Process 523 15-2d What a Patent Does 523 15-2e The Remedies for Patent Infringement 524

15-3 Copyrights 525 15-3a What Is a Copyright and What Does It

Protect? 525 15-3b The Rights of Copyright Holders Against

Third-Party Infringers 526 15-3c How Long Does a Copyright Run? 528 15-3d Rights of a Copyright Holder 529

15-4 Trademarks 533 15-4a What Are Trademarks? 533 15-4b What Are the Legal Protections for

Trademarks? 534 15-4c Enforcing Trademarks and the Risk of

Going Generic 534 15-4d Trade Names 535 15-4e What Are the Rights When a Trademark or

Trade Name Is Misused? 535 15-4f Trade Dress 538 15-4g Cyber Infringement 538

15-5 Trade Secrets 540 15-5a What are Trade Secrets? 540 15-5b How are Trade Secrets Protected? 541 15-5c Criminal Penalties for Theft of Trade

Secrets 541

15-6 International Intellectual Property Issues 542 15-6a Patent Protection 542 15-6b Trademark Protection 542 15-6c Copyrights in International

Business 543 15-6d Differing International Standards 543

15-7 Enforcing Business Property Rights 544 15-7a Product Disparagement 544 15-7b Palming Off 545 15-7c Misappropriation 545

Summary 548

Questions and Problems 548

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xii Contents

16 Management of Employee Conduct: Agency 554

16-1 Names and Roles: Agency Terminology 555 16-1a Agency 555 16-1b Principals 555 16-1c Agents 556 16-1d Employers and Employees: Master–Servant

Relationships 556 161e Independent Contractors 556 16-1f Agency Law 556

16-2 Creation of the Agency Relationship 557 16-2a Express Authority 557 16-2b The Record 557 16-2c Capacity 557 16-2d Implied Authority 558 16-2e Apparent Authority 559 16-2f Ratification 561

16-3 The Principal–Agent Relationship 562 16-3a The Agent’s Rights and Responsibilities 562 16-3b The Principal’s Rights and

Responsibilities 569

16-4 Liability of Principals for Agents’ Conduct: The Relationship with Third Parties 570

16-4a Contract Liability 570 16-4b Liability of Principals for Agents’ Torts 572

16-5 Termination of the Agency Relationship 577

16-6 Termination of Agents under Employment at Will 577

16-6a The Implied Contract 578 16-6b The Public Policy Exception 580 16-6c Handling Employee Termination

Disputes 584

16-7 Agency Relationships in International Law 585

Summary 588

Questions and Problems 588

17 Governance and Structure: Forms of Doing Business 592

17-1 Sole Proprietorships 593 17-1a Formation 593 17-1b Sources of Funding 593 17-1c Liability 593 17-1d Tax Consequences 594 17-1e Management and Control 594 17-1f Transferability of Interest 594

17-2 Partnerships 594 17-2a Formation 594 17-2b Sources of Funding 599 17-2c Partner Liability 600 17-2d Tax Consequences in Partnerships 601 17-2e Management and Control 601 17-2f Transferability of Interests 603 17-2g Dissolution and Termination of the

Partnership 603

17-3 Limited Partnerships 604 17-3a Formation 604 17-3b Sources of Funding 605 17-3c Liability 605 17-3d Tax Consequences 606 17-3e Management and Control 606 17-3f Transferability of Interests 606 17-3g Dissolution and Termination of a Limited

Partnership 607

17-4 Corporations 607 17-4a Types of Corporations 607 17-4b The Law of Corporations 608 17-4c Formation 608 17-4d Capital and Sources of Corporate Funds 610 17-4e Liability Issues 611 17-4f Corporate Tax Consequences 613 17-4g Corporate Management and Control:

Directors and Officers 614

Part 4 Business Management and Governance 553

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Contents xiii

17-4h Corporate Management and Control: Shareholders 621

17-4i The Dissolution of a Corporation 624

17-5 Limited Liability Companies 625 17-5a Formation 625 17-5b Sources of Funding 625 17-5c Liability 625 17-5d Tax Consequences 627 17-5e Management and Control 627 17-5f Transferability of Interest 627 17-5g Dissolution and Termination 628

17-6 Limited Liability Partnerships 628 17-6a Formation 629 17-6b Sources of Funding 629 17-6c Liability 629 17-6d Tax Consequences 629 17-6e Management and Control 629 17-6f Transferability 629 17-6g Dissolution and Termination 629

17-7 International Issues in Business Structure 629

Summary 630

Questions and Problems 631

18 Governance and Regulation: Securities Law 634

18-1 History of Securities Law 635

18-2 Primary Offering Regulation: The 1933 Securities Act 635 18-2a What Is a Security? 635 18-2b Regulating Primary Offerings:

Registration 636 18-2c Regulating Primary Offerings:

Exemptions 637 18-2d What Must Be Filed: Documents and

Information for Registration 642 18-2e Violations of the 1933 Act 643

18-3 The Securities Exchange Act of 1934 654 18-3a Securities Registration 654 18-3b Emerging Growth Companies (EGCs) and

1934 Act Exemption 654 18-3c Periodic Filing Under the 1934 Act:

Those Alphabet Reports 654 18-3d The 1934 Act Antifraud Provision: 10(b) 655 18-3e Insider Trading and Short-Swing Profits 665 18-3f Regulating Voting Information 666

18-3g Shareholder Rights in Takeovers, Mergers, and Consolidations 668

18-4 State Securities Laws 671

18-5 International Issues in Securities Laws 673

Summary 675

Questions and Problems 676

19 Management of Employee Welfare 680

19-1 Wage and Hours Protection 681 19-1a The Fair Labor Standards Act 681 19-1b The Equal Pay Act of 1963 688

19-2 Workplace Safety 688 19-2a The Occupational Safety and Health Act 688 19-2b OSHA Responsibilities 688 19-2c Employee Impairment and Testing Issues 690

19-3 Employee Pensions, Retirement, and Social Security 690 19-3a Social Security 690 19-3b Private Retirement Plans 692 19-3c Unemployment Compensation 693

19-4 Workers’ Compensation Laws 695 19-4a Employee Injuries 695 19-4b Causation and Worker’s Compensation 696 19-4c Fault Is Immaterial 696 19-4d Employees versus Independent

Contractors 696 19-4e Benefits 696 19-4f Forfeiture of the Right of Suit 697 19-4g Third-Party Suits 697 19-4h Administrative Agency 697 19-4i Insurance 697 19-4j Problems in Workers’ Compensation

Systems 699

19-5 Statutory Protections of Employees Through Labor Unions 700 19-5a The Norris–LaGuardia Act of 1932 700 19-5b The Wagner Act 700 19-5c The Taft–Hartley Act: The Labor-Management

Relations Act of 1947 700 19-5d The Landrum–Griffin Act: The Labor-

Management Reporting and Disclosure Act of 1959 700

19-5e Union Organizing Efforts and Social Media 701

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xiv Contents

19-5f Employers Are Accountable for Employee Electronic Content 701

19-5g Employer Monitoring: What is Legal? 701 19-5h Employers’ Right of Access to

Employee E-Mails 704 19-5I E-Mail and NLRA Issues 705 19-5j The Unionization Process 706 19-5k Union Contract Negotiations 710 19-5l Protected Concerted Activities 711 19-5m Unfair Employee Practices 711 19-5n Employer Rights 712 19-5o Right-to-Work Laws 712 19-5p Economic Weapons of Employers 713

19-6 International Issues in Labor 715 19-6a Immigration Laws 715 19-6b Working Conditions and International Labor

Law 718 19-6c Sample International Standards 718 19-6d The Risks of International Suppliers 719 19-6e New Trends in Managing International Wage

and Safety Standards 720

Summary 722

Questions and Problems 724

20 Management: Employment Discrimination 728

20-1 History of Employment Discrimination Law 729

20-2 Employment Discrimination: Title VII of the Civil Rights Act 731 20-2a Application of Title VII 731 20-2b Employment Procedures Covered 731

20-3 Theories of Discrimination Under Title VII 731 20-3a Disparate Treatment 731 20-3b Disparate Impact 734 20-3c Pattern or Practice of Discrimination 737

20-4 Specific Applications of Title VII 738 20-4a Sex Discrimination 738 20-4b Religious Discrimination 746 20-4c Racial Discrimination 749

20-5 Antidiscrimination Laws and Affirmative Action 749 20-5a What Is Affirmative Action? 750 20-5b Who Is Required to Have Affirmative Action

Programs? 750 20-5c Affirmative Action Backlash: The Theory of

Reverse Discrimination 750

20-6 The Defenses to a Title VII Charge 751 20-6a Bona Fide Occupational Qualification 751 20-6b Seniority or Merit Systems 752 20-6c Aptitude and Other Tests 752 20-6d Misconduct 752

20-7 Enforcement of Title VII 755 20-7a Steps in an EEOC Case 755 20-7b Remedies Available Under Title VII 756

20-8 Other Antidiscrimination Laws 756 20-8a Age Discrimination in Employment Act

of 1967 756 20-8b Equal Pay Act of 1963 758 20-8c Communicable Diseases in the

Workplace 758 20-8d Rehabilitation Act of 1973 759 20-8e Americans with Disabilities Act 759 20-8f The Family and Medical Leave Act 760

20-9 The Global Workforce 761

Summary 764

Questions and Problems 764

Appendices A-1

A The United States Constitution A-1

B The Foreign Corrupt Practices Act (Excerpts) A-12

C The Uniform Commercial Code (Excerpts)* A-15

D Dodd-Frank (Wall Street Reform and Consumer Financial Protection Act) Key Provisions A-20

E The Securities Act of 1933 and the Securities Exchange Act of 1934 (Excerpts) A-23

F Sarbanes-Oxley Key Provisions (Excerpts) A-28

G The Copyright Act (as Amended) (Excerpts) A-31

H Title VII and the Civil Rights Act (Employment Provisions) (Excerpts) A-34

I The Americans with Disabilities Act (Excerpts) A-37

Glossary G-1 Table of Cases T-1 Table of Products, People, and Companies T-11 Index I-1

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xv

Preface

A Different World, but the Same Issues The seventh edition of this book was published amidst the fallout from the legal, ethical, and, too often, financial collapses of Enron, WorldCom, Adelphia, Health- South, Parmalat, Arthur Andersen, Kmart, and others. With Sarbanes–Oxley on the books and new regulatory demands on corporations, we thought perhaps we had turned the corner. But the eighth edition was published as Wall Street and the economy were reeling from the fallout of a subprime mortgage market operating under regulatory radar without a great deal of disclosure on portfolio risk. When the ninth edition was published, the SEC had just settled a civil suit it brought against Goldman Sachs for allegedly selling securities to clients it was betting against as a short-seller in a scheme that saw its profits reach double-digit billions. Goldman paid a fine of $550 million. In late 2009, Goldman’s CEO, Lloyd Blank- fein, uttered the same words that Jeffrey Skilling did in 2000: “We are doing God’s work.” At press time of the tenth edition, there were questions about the fairness of the scrutiny of taxpayers by an administrative agency, the Internal Revenue Service, and the Justice Department’s tapping of phones of news corporations. Book publishers signed antitrust consent decrees for agreeing to fix prices in order to compete with Amazon. A factory in Bangladesh, that produced clothing for U.S. retailers, collapsed, killing over 600 employees, a collapse that was caused by noncompliance with safety and code standards. Now, as this 11th edition is pub- lished the EPA has tightened regulations so much that two major coal companies have gone out of business. The Veterans Administration is trying to recover from a program that was designed to reduce queue times for patients but resulted in patients dying. A pharmaceutical company raised its prices on one prescription drug by 5,000%, and Apple has a monitor because it was found guilty of being the master mind behind publishers fixing prices on their electronic books. The raisin farmers had a major victory in the U.S. Supreme Court that will change forever government price and supplies controls on raisin. And insider trading remains in the news, for both convictions and the reversals of those convictions as courts sort through the question, “When exactly does insider trading occur?”

The patterns of business behavior that push the envelope of law and ethics continue. Two of the leaders in the New York legislature were convicted on cor- ruption charges, companies from Embrauer to GlaxoSmithKline, and even FIFA faced charges and investigations under the Foreign Corrupt Practices Act. Charges against FedEx for alleged shipping of controlled substances were dismissed because there was no proof that anyone knew what was in the packages. Blue Bell ice cream was shut down for four months because of the presence of listeria in its plants. The FCC was deluged with comments on a proposed rule that would have allowed cell phone use on airplanes. In response to the outcry from flight atten- dants, passengers, and pilots, the FCC did not promulgate the rule. The issues of law and ethics are still at the forefront of business, sports, and government. It has become a tall order just to keep up with all the events!

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These companies and organizations and their employees and executives certainly could have benefited from understanding and keeping at the fore- front of their decision processes the basics of law and ethics! The legal and eth- ical environments of business are center stage. Several editions ago, Congress made massive regulatory reform a reality with the passage of the Sarbanes– Oxley legislation on corporate governance, accounting regulation, and crim- inal penalties. But the SEC missed some large market schemes, so Congress passed Dodd-Frank with new directives to the SEC on financial reports, dis- closures, and primary offerings. The continuing reliance on new credit mecha- nisms resulted in a central agency, the Consumer Protection Bureau, handling all forms of consumer credit. Business is even more international, and changes, such as Brexit (Great Britain’s decision to withdraw from the EU), mean more changes in trade, regulation, and tariffs. FCPA cases have expanded and there is increasing cooperation among countries to address money-laundering schemes and the problems of world leaders hiding funds in accounts around the world.

The world and business continue to change and grow, but law and ethics have retained their role and importance. In fact, now more than ever, we need to understand the legal and ethical issues that affect our businesses and our lives. The knowledge base and even the questions in law and ethics remain the same, but the underlying facts have changed. For example, we still debate the social responsibility role of business. Now we raise that issue in the context of whether companies should use inversions, or reverse acquisitions, by foreign companies to reduce their effective tax rates. We continue to delve into the pros and cons of sending production to other countries. We still have the question of when a contract is formed, but now we face that question with “point and click” technology rather than faxes and letters. We continue to be concerned about our privacy as consumers, but now we wonder who really has access to our Facebook page. We still wonder about the extent of copyright law. The file-sharing programs have never quite gone away and the film industry now litigates the downloading of copyrighted films. The world is different, but law and ethics form the constant framework into which we fit the issues of the day. In the materials that follow, you have the chance to understand the marvelous stability of this framework and the ease with which you can apply it to this very different world. Be sure to look for descriptions of the new structure as well as the continuing features in the book, such as the “Consider” tutorials, the ethics issues, and the Business Strategy application exercises.

Building the Bridge: Applying Legal and Ethical Reasoning to Business Analysis I gave my students a midterm exam—a review of Netflix and its various business issues, including the cost of rights, issues in film production, and problems with obtaining subscriptions. These students are in the second year of their master’s degree studies. They have been trained in economics, marketing, management, and finance. But as they completed their analysis of this fast-growing darling of the stock market, they had an epiphany. A company can get the finance issues right, have the right brand appeal and great offerings, and even yield terrific subscription sales. However, it can all fall apart over the legal issues. What if the estimates on subscriptions released with earnings reports are overly optimistic?

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What if something goes wrong in shooting one of their original production films? Does insurance cover them? Who pays the costs of a late finish on those promised films? What about international copyrights? What happens when copyright hold- ers do not want their films licensed internationally? They are very capable busi- ness students. However, they did not realize until this midterm exam how much of business turns on anticipating the legal issues and getting them resolved cor- rectly. And they also realized that all of our discussions of ethics and social respon- sibility had a role in doing business. TANSTAAFL—“there ain’t no such thing as a free lunch” when it comes to international business. There are costs associated with tapping into a seemingly boundless market of subscribers. And those costs come from legal issues, which, if handled poorly, can affect a company’s value and tarnish its brand name.

Why couldn’t these students see the interconnection and critical roles of law and ethics in business until this case for their midterm? It was not for lack of expo- sure to the law. I taught my course “by the book,” so to speak. Students could recite the components of a valid contract, rattle off the requirements for bankruptcy, and recall from memory the antitrust statutes. Yet, I was coming to realize, this rote knowledge was not enough. One of my best former students, who had gone on to medical school, came to me perplexed about her office lease. She said that the complex in which she wanted to open her practice had a “no advertising” policy. In fact, she said that when she toured the premises with a leasing agent, the leasing agent turned to her and said, “You’re not one of those doctors who advertises, are you? Because if you are, we can’t lease to you. We have a policy against it.” One of my best students, who knew the antitrust statutes well, could not apply them to her everyday business. Worse, perhaps, she could not recognize when to apply these statutes: She did not see the antitrust implications of the agent’s statements nor the problems with the physicians in the complex taking such an approach to screening tenants.

I have reached the conclusion that there have always been shortcomings in the standard approach to teaching business students law and ethics. Students were not ignorant of the law; rather, they simply lacked the necessary skills to recognize legal and ethical issues and to apply their knowledge of law and ethics to business decision making. As instructors, we were not integrating legal and ethical reason- ing with business analysis. My conclusion led me to develop my own materials for classroom use and eventually led to the publication of the first edition of this book. Now in its eleventh edition, Business: Its Legal, Ethical, and Global Environment brings to the classroom the most integrated approach to learning law and ethics available in the market today. Throughout every chapter and in every feature, stu- dents and instructors are continually reminded of how various legal and ethical principles apply in business contexts. For all areas of law and ethics, this book answers the question: How does this concept affect a business? This book builds a bridge for the student between knowledge of law and ethics and application of both in business. My 39 years of teaching law and ethics finally brought this realization: Business ethics is not easily grasped nor practiced in business because we depersonalize ethical issues. If we just allow the company or organization to make the decision, our ethics are not in question; the companies’ are. The ethical issues in the book require students to bring ethical issues into their lives, their cir- cumstances, their world. This feature also forces them to answer this question in a wide variety of contexts: “If it were you, and you were faced with the dilemma and required to make a decision, what would you do?”

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Strengthening the Bridge: New Content, Business Applications, and Learning Aids For the eleventh edition, Business: Its Legal, Ethical, and Global Environment has undergone further refinement. New content has been added, outdated content has been removed, new business applications have been integrated into every chapter, and the learning aids have been modified and refocused to help students under- stand and apply legal and ethical concepts.

New Content

The eleventh edition of Business: Its Legal, Ethical, and Global Environment continues to meet its goal of helping students with their understanding of how law and ethics apply to the business world. The organizational structure, based on feedback from those who use the text, has been changed. The four parts remain, but there is a new mix of topics and chapters in those four parts. Part 1 offers the student an overview of the legal, ethical, and judicial environments of business. Part 2 covers the regu- latory environments of business, including environmental regulation and sustain- ability. Part 3 covers all aspects of sales, contracts, and competition. Part 4 covers business management and corporate governance, and this newly restructured sec- tion covers all issues related to employees, boards, agents, and how to keep all of these groups coordinated while taking legal and ethical actions. Cyber law is now integrated into every chapter so that it can be covered in contracts (formation), employment (right of employee privacy in e-mails), and criminal law (everything from industrial espionage to spamming).

Ethics

Business Ethics and Social Responsibility (Chapter 2) offers new examples and insights on the application of ethics to business decision making. Chapter 2 is chock full of the examples the last two years have netted—including GM’s engine switch guilty plea and VW’s use of emissions defeating software. A new biogra- phy focuses on Captain Sullenberger who landed an airplane safely in a river and offers his perspectives on how we know the right thing to do in moments of pres- sure. Ethics coverage is also integrated throughout all chapters.

Business Applications Biography

Each chapter contains a biography. Biographies provide students with business history through the study of individuals and companies involved with the area of law and ethics covered in the chapter. For example, Chapter 1 has a biography on Uber, the company that shook up the world of cab transportation. Chapter 4 has a new biography on a legal battle between a small business and its production of parts for another company’s tabletop game including the tools used in that litigation, and the pro bono work of lawyers in helping a small business in Games Workshop v. Chapterhouse. Chapter 19 provides the story of the death of an orca whale trainer at Sea World and the resulting investigations and backlash that Sea World experienced. Chapter 15 gives a biography of Mattel and its Bratz dolls and its long intellectual property battle over who had the idea for the dolls.

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For the Manager’s Desk

Each chapter also contains at least one “For the Manager’s Desk” feature. These readings provide students the opportunity to see how business interrelates with ethics and law. The readings feature topics tackled by publications such as Wall Street Journal, Harvard Business Review, Corporate Finance Review, and the American Business Law Journal. This feature offers the latest best practices as well as data from academic studies and insights from that research. For example, the Chapter 8 “For the Manager’s Desk” discusses who ends up going to prison for business crimes and how long their sentences last. Chapter 19’s feature deals with the recent series of cases brought by interns for lack of pay and excessive hours as well as the Department of Labor’s proposed responses. Chapter 13 discusses how to manage celebrity tweets when they are your spokesperson, i.e., what can Kim Kardashian tweet about an anti-nausea drug she was using during her pregnancy that will not run afoul of FDA restrictions? Chapter 15’s Manager’s Desk discusses the prob- lems with a trademark or trade name that is offensive.

Learning Aids . . . and the Law

Each chapter contains a popular feature to further integrate law and ethics with the other “silos” of business. The “. . . and the Law” feature puts law and ethics in the context of economics, human resources, public policy, strategy, finance, and other areas to illustrate the ways knowledge of the where and how for the fit of law and eth- ics can help make better managers and better decisions. For example, Chapter 20’s “HR and the Law” discusses the dangers and conflicts office romances produce and how managers can deal with those issues. Chapter 1 includes a discussion of the FIFA corruption scandal how the issues were investigated and the problems involved in an NGO. Chapter 8’s “Strategy and the Law” takes a look at what corporations charged with a crime should do and the options for pleas available with the Justice Department. Chapter 14’s “Social Responsibility and the Law” discusses the possible anticompetitive effects of organizations such as Common Code for the Coffee Community and the Bioplastic Feedstock Alliance. These features apply the principles from business disciplines to understand more fully the depth and breadth of management issues.

Case Headlines

Every court case has a case headline that summarizes what issues are involved in the case. Chapter 7 has a new case on the actions of the Russian tax authorities involving Yukos, an international oil company, and the resulting impact in the mar- ket and has this title, “When Putin Affects the Value of Oil Stock.” In Chapter 8, a new case on criminal intent, whether the owner of a salvage yard was aware of his contamination of water, has this intriguing case title, “Mordechay’s Sump Pump and Mens Rea. In Chapter 6, the case Hornbeck Offshore Services, L.L.C. et al. v Salazar deals with an issue of whether agency action was arbitrary and capricious in issu- ing a moratorium on offshore drilling, and the case title is “Drilling Down to the Facts Supporting a Rule.” The vivid one-line description and colorful facts of the case, a common thread throughout the case choices in the text, help students inter- nalize the rules and lessons about not destroying evidence for a potential lawsuit.

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Chapter Openings and the “Consider. . . “ Feature

Chapters begin with an opening problem, titled “Consider. . .”, which presents a legal dilemma relevant to the chapter’s discussion and similar to those business managers need to handle. These are revisited and answered in the body of the chapter. For example, Chapter 6 has a new chapter opening “Consider. . . “on a proposed regulation on the use of cell phones on airplanes and then walks that issue through the full regulatory process. In addition to this Consider problem opening, each chapter also has quotes, data, humor, or insights to pique reader interest about the chapter topics.

Chapter Summary

Each chapter concludes with a summary that reinforces the major concepts of the chapter. Each summary is constructed around the key questions introduced at the start of the chapter and key terms presented throughout the chapter.

Business Strategy Applications

Each chapter has a business strategy connection designed to help students understand where law and ethics fit in developing effective business strat- egies. For example, in Chapter 13 there is a new business strategy on the problems with highway guard rails and the litigation brought about by a competitor who reported changes in the guard rail design that had not been cleared with the federal government. Chapter 5 has a strategy feature that dis- cusses who gives money in politics, how much, and why. Chapter 8’s strategy feature discusses the components of an effective compliance program. The Chapter 12 strategy deals with how restaurants are coping with no-shows in their reservations and their contract rights when someone makes a reserva- tion but never shows up.

Organization and Features: A Structure to Guide Students to Reasoning and Analysis The classic features have been updated and strengthened. The organization has been retained to continue to meet student needs in the classroom.

Organization

The four parts in the book serve to organize the materials around four basic areas: (1) understanding the legal environment, (2) understanding the regulatory envi- ronment, (3) dealing with sales, contracts and competition, and (4) management and governance. Every chapter integrates international and ethical topics.

Part 1 In four chapters, Part 1 offers an introduction to law, an introduction to business ethics and the judicial system, and a discussion of litigation and alternative dispute resolution. Part 1 provides students with a foundation in law and ethics as well as legal and ethical reasoning, necessary for the areas of law in the chapters that follow. By being brief (four chapters), Part 1 offers instructors an early and logical break for exams.

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Part 2 In six chapters, Part 2 covers the regulatory environment of business, including the following topics: constitutional law, administrative and international law, busi- ness crimes and business torts, and environmental regulation. At the completion of Parts 1 and 2, students have a grasp of the legal system, ethical boundaries, and the laws that affect business operational decisions.

Part 3 The five chapters in Part 3 present students with the legal and ethical issues sur- rounding contracts, sales, and competition. Part 3 includes the following topics: contract formation and performance (including coverage of consumer issues); product liability; intellectual property; trade restraints; and business competition and antitrust. From the negotiation of price to the collection of accounts, this seg- ment of the book covers all aspects of selling business products and services. This section is structured so that the contracts discussion precedes the complexities of property and competition.

Part 4 The five chapters in Part 4 discuss business management and governance. Topics include the management of employees, from agency law to employment regulation to employee rights to issues in discrimination. Part 4 also includes the governance issues of business structure and management, including financing and securities law issues. This section covers the issues of running, managing, and financing a business.

Woven throughout all the chapters are cyber law issues, as marked by margin icons, and featuring discussions of everything from e-mail privacy to the problems of hacking.

Features

Court Cases Edited court language cases provide in-depth points of law, and many cases include dissenting and concurring opinions. Case questions follow to help students under- stand the points of law in the case and think critically about the decision. The courts have been active since the last edition, and many 2015–2016 case decisions are pre- sented throughout the book. Students will be able to study Donald Trump’s claim for defamation when a writer misstated his net worth. Can a company avoid Foreign Cor- rupt Practices Act violations when it has its agent appointed a government official in another country? What happens when a young man saves his Pepsi points to claim a Harrier Jet that he sees in a Pepsi spoof ad for “Pepsi stuff”? Does he get his jet?

Consider . . . “Consider . . .” problems, along with “Ethical Issues” and “Business Planning Tips,” have been a part of every chapter since the first edition. The “Consider . . .” features, often based on real court cases, ask students to evaluate and analyze the legal and ethical issues discussed in the preceding text. Because these issues are integrated into the text, students must address and think critically about these issues as they encounter them. Through interactive problems, students learn to judge case facts and determine the consequences. Moreover, answers to all of these opening “Consider. . .” features are referenced in the text and clearly marked. There are more “Consider. . . “ features throughout each chapter. Chapter 3 has a new “Consider . . . “

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on whether Katy Perry could be sued in Missouri for her alleged infringement of a Missouri songwriter’s song. Chapter 12 has a new consider on whether a mistake on the total square footage in a property is grounds for setting aside a contract for purchase of that property.

“Consider . . . ” brings the most current topics into the book and the classroom.

Thinking, Applying, and Answering: “Consider . . . ” Tutorials—A Guide for Reasoning One “Consider . . . ” per chapter is solved for the students in a methodical walk- through that helps them understand how to apply the legal principles or case prec- edent that they have just studied. The facts of the case or hypothetical are presented and the students are asked to recall what they have just learned. Next, students are walked through applying those principles to the current facts. Finally, they are given the answer and the reason that answer is consistent with their thinking and applying.

Ethical Issues The “Ethical Issues” feature appears in every chapter and presents real-world ethical problems for students to grapple with. “Ethical Issues” help integrate coverage of ethics into every chapter. The ethical issues also include personal and real-life exam- ples that help students relate to the pervasive nature of ethical dilemmas that they do and will continue to face. Chapter 6 includes the U.S. Supreme Court case revers- ing the bribery conviction of former Virginia governor Bob McDonnell and his wife, followed by an ethics issue that asks students to review whether their taking of vaca- tions, a Rolex, clothing, and help with a wedding from a donor crossed ethical lines. Chapter 12 includes an ethical issue that asks students to evaluate students who accept an employment offer and then renege because a better one came along.

Business Planning Tips Students are given sound business and legal advice through “Business Planning Tips.” With these tips, students not only know the law but also know how to antic- ipate issues and ensure compliance. How to make your property safer, how to conduct an interview without violating the Americans with Disabilities Act, and how to train employees to preserve documents and potential evidence if custom- ers make claims.

Cyberlaw Cyberlaw has been integrated throughout the book. Most chapters also include a segment on cyberlaw. These chapter-by-chapter materials, marked by an icon, give students the chance to see how new technology fits into the existing legal framework.

Exhibits Exhibits include charts, figures, and business and legal documents that help highlight or summarize legal and ethical issues from the chapter. With the credit and financial market reforms, securities law reforms on stock offerings, and the changes in criminal penalties, many of the charts are either new or updated.

End-of-Chapter Problems Many end-of-chapter problems have been updated and now focus more on actual cases. There are new chapter problems throughout the book of varied lengths for different instructor needs.

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The Informed Manager: Who Should Use This Book? With its comprehensive treatment of the law, integrated business applications, and full-color design, Business: Its Legal, Ethical, and Global Environment is well suited for both undergraduate and MBA students. The book is used extensively in under- graduate education programs around the country. In addition, this edition has been class-tested with MBA students, and it is appropriate for MBA and executive education programs.

A Note on AACSB Standards

The strong presence of ethics, social responsibility, international law and issues, and the integration of other business disciplines make the book an ideal fit for meeting AACSB standards and curriculum requirements. The AACSB standards emphasize the need for students to have an understanding of ethical and global issues. The eleventh edition continues with its separate chapter on ethics as well as ethical issues and dilemmas for student discussion and resolution in every chapter. The separate chapter on international law continues its expanded cover- age from the last edition, and each chapter has a segment devoted to international law issues. The eleventh edition includes readings on expanded international law enforcement cooperation, the challenges of ethics and law in international busi- ness, the role of lawyers in other countries, and attitudes outside the United States on insider trading and antitrust laws.

This edition presents students with the legal foundation necessary for busi- ness operations and sales but also affords the students the opportunities to analyze critically the social and political environments in which the laws are made and in which businesses must operate. An examination of the lists of companies and individuals covered in the biographies, and of the publications from which the “For the Manager’s Desk” readings are based on, demonstrates the depth of back- ground the eleventh edition offers in those areas noted as critical by the AACSB. The materials provide a balanced look at regulation, free enterprise, and the new global economy.

Supplements Business: Its Legal, Ethical, and Global Environment offers a comprehensive and well- crafted supplements package for both students and instructors.

MindTap

MindTap™ is a fully online, highly personalized learning experience combining readings, multimedia, activities, and assessments into a singular Learning Path. Instructors can personalize the Learning Path by customizing Cengage Learning resources and adding their own content via apps that integrate into the MindTap framework seamlessly with Learning Management Systems.

We have heard that business law instructors want to help students Prepare for class, Engage with the course concepts to reinforce learning, Apply these concepts in real-world scenarios, and use legal reasoning and critical thinking to Analyze business law content. Accordingly, our MindTap product provides a four-step

Preface xxiii

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Learning Path designed to meet these critical needs while also allowing instructors to measure skills and outcomes with ease.

• Prepare: Business Law Ebook and Worksheets – help students prepare for class with interactive guided reading & chapter review questions that can be completed prior to class so that class time can be spent applying the concepts.

• Engage: Video Activities – engage students using real-world scenarios that bring business law to life and help students make connections with real work situations. Includes comprehension questions for practice and assignable gradeable homework.

• Apply: Brief Hypothetical Scenarios – These short fictional scenarios, help students spot the issue and apply the law and concepts that they’ve learned. These are great questions for exam preparation.

• Analyze: Legal Reasoning – Promote deeper critical thinking and legal reasoning by using these case problem questions to help improve critical thinking skills.

Every item in the Learning Path is assignable and gradable. This gives instructors the knowledge of class standings and concepts that students may be finding difficult. Additionally, students gain knowledge about where they stand— both individually and compared to the highest performers in class.

To view a demo video and learn more about MindTap, please visit www.cengage.com/mindtap.

Case Collection

Now, within MindTap, instructors can search Case Collection—a library of cases from previous editions of different Cengage textbooks—by relevant criteria and then incorporate those cases in the learning path for students.

This exciting repository allows instructors to personalize their course and truly engage students, helping them to reach higher levels of critical thinking.

• Easily search by topic, and then refine the search by subtopic, to find case examples of a specific legal concept.

• Search by court or state to bring a local flavor or interest to the classroom. • Enjoy over 1500 cases at your fingertips. All new edition omitted cases will be

added every year, allowing the archive to continually grow.

Mix and match cases from all textbooks, whether you are currently using it in class or not. This allows you to provide longer cases with more information from other resources, which is especially helpful if your text didn’t show the court’s decision.

Weekly Ethics and Law Updates. Available at mariannejennings.com, the weekly updates contributed by the author offer at least 12 current events per month for discussion and analysis. The update features new decisions, new statutes, new reg- ulations, new ethical dilemmas, and a host of examples and cites to current period- icals. The eleventh edition includes references to these updates in the text.

Instructor’s Manual. The Instructor’s Manual, written by the author, provides the following for each chapter: a detailed outline; answers to “Considers . . . ”,

xxiv Preface

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“Ethical Issues,” case problems, and the end-of-chapter Questions and Problems; briefs of all cases; summaries of key features; supplemental readings; and interac- tive/cooperative learning exercises.

PowerPoint® Lecture Review Slides. Developed by the author, these PowerPoint slides consist of lecture outlines and select tables and figures used in the book. The slides are available for use by students as an aid to note taking, and by instructors for enhancing their lectures.

Test Bank. The Test Bank for instructors includes more than 2,000 questions in true/false, multiple-choice, and essay format. The questions vary in levels of diffi- culty, and meet a full range of tagging requirements, including AACSB standards.

Cognero. Cengage Learning Testing Powered by Cognero is a flexible, online system that allows you to: 

• author, edit, and manage Test Bank content from multiple Cengage Learning solutions

• create multiple test versions in an instant • deliver tests from your LMS, your classroom or wherever you want

Start right away! Cengage Learning Testing Powered by Cognero works on any operating system or browser.

• No special installs or downloads needed • Create tests from school, home, the coffee shop—anywhere with Internet

access

What will you find?

• Simplicity at every step. A desktop-inspired interface features drop-down menus and familiar, intuitive tools that take you through content creation and management with ease.

• Full-featured test generator. Create ideal assessments with your choice of 15 question types (including true/false, multiple choice, opinion scale/ likert, and essay). Multi-language support, an equation editor, and unlim- ited metadata help ensure your tests are complete and compliant. 

• Cross-compatible capability. Import and export content into other systems.  

KnowNOW Blog. Included inside MindTap, this is a professor ’s dream—a daily blog on eye-catching legal issues that allow students the opportunity to engage in discussion and really master concepts because of the nature of the subject matter. Insider trading is something that may not grab their attention until you share with them the story of the famous Notre Dame football player, Rudy, who settled pump-and-dump charges by the SEC. And a breached sale of fabric contract sounds like a dull session unless you are able to use the Lululemon problem—the company made thousands of yoga pants with the fab- ric only to discover through customer complaints that the fabric was see-through and those customers wanted their money back. Even antitrust law comes to life when you use the merger of Corona with Bud Light to cover market share and monopoly power.

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xxvi

About the Author

Professor Marianne Jennings is an emeritus professor of legal and ethical studies in business from the W.P. Carey School of Business at Arizona State University. She was named professor of the year in the College of Business in 1981, 1987, 2000, and 2010 and was the recipient of a Burlington Northern teaching excellence award in 1985. She served as director of the Joan and David Lincoln Center for Applied Eth- ics at ASU from 1995–1999. From 2006–2007, she served as the faculty director for the MBA Executive Program. She continues to teach graduate courses in business ethics and ethical culture at ASU and other colleges around the country.

Professor Jennings has authored hundreds of articles in academic, professional and trade journals. She was given best article awards by the institute of Internal Auditors and the Association of Government Accountants in 2001 and 2004. In 2006, her article, “Ethics and Investment Management: True Reform,” was selected by the United Kingdom’s Emerald Management Review from 15,000 articles in 400 journals as one of the top 50 articles in 2005. She was named one of the Top 100 Thought Leaders by Trust Across America in 2010. In 2012 she was named one of the 100 Most Influential People in Business Ethics by Ethisphere magazine. She served on the board of directors for Arizona Public Service (now Pinnacle West Capital Corporation), the owner of the Palo Verde Nuclear Station, from 1987 through 2000. She served on the boards of Zealous Capital Corporation from 1996- 1998 and the Center for Children with Chronic Illness and Disability at the Uni- versity of Minnesota. She served as chair of the Bonneville International Advisory Board for KHTC/KIDR from 1994-199. She was appointed to the board of advi- sors for the Institute of Nuclear Power Operators in 2004. In 2015 she was named an affiliated scholar with the Center for the Study of Economic Liberty at Arizona State University.

Currently she has six textbooks and monographs in circulation. The ninth edi- tion of her textbook, Case Studies in Business Ethics, and the eleventh edition of her textbook, Business: lts Legal, Ethical and Global Environment will be published in January 2017. Her first textbook, Real Estate Law, had its 11th edition published in January 2016. Her text, Anderson’s Business and the Legal Environment had its 23rd edition published in January 2016.

Her book, Business Strategy for the Political Arena, was selected in 1985 by Library Journal as one of its recommended books in business/government rela- tions. A Business Tale: A Story of Ethics, Choices, Success, and a Very Large Rabbit, a fable about business ethics, was chosen by Library Journal in 2004 as its business book of the year. A Business Tale was also a finalist for two other literary awards for 2004. In 2000, her book on corporate governance was published by the New York Times MBA Pocket Series. Professor Jennings’ book on long-term success, Building a Business Through Good Times and Bad: Lessons from Fifteen Companies, Each With a Century of Dividends, was published in October 2002 and has been used by Booz, Allen, Hamilton for its work on business longevity. Her book, The Seven Signs of Ethical Collapse is used by auditors in advance detection of fraud and is a primer on corpo- rate culture, including analysis of board efficacy. Her books have been translated into five languages.

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She is a contributing editor for the Real Estate Law Journal and New Perspectives. She served on the Board of Editors for the Financial Analysts Journal from 2007– 2012. She served as editor-in-chief of the Journal of Legal Studies Education during 2003–2004. During 1984-85, she served as then-Governor Bruce Babbitt’s appoin- tee to the Arizona Corporation Commission. In 1999 she was appointed by then- Governor Jane Dee Hull to the Arizona Commission on Character.

Her columns have been syndicated around the country, and her work has appeared in the Wall Street Journal, the Chicago Tribune, the New York Times, Washington Post, and the Reader’s Digest. A collection of her essays, Nobody Fixes Real Carrot Sticks Anymore, first published in 1994 is still being published. She was given an Arizona Press Club award in 1994 for her work as a feature columnist. She has been a commentator on business issues on All Things Considered for National Public Radio. She served as chair of the Bonneville International Advisory Board for KHTC/KIDR from 1994–1997 and was a weekly commentator on KGLE during 1998. She has appeared on CNBC, CBS This Morning, the Today Show, and CBS Evening News.

Professor Jennings earned her undergraduate degree in finance and her J. D. from Brigham Young University. She has done consulting work for law firms, government agencies, businesses and professional groups including AES, AICPA, Allstate, Amgen, AstraZeneca, Bell Helicopter, Blue Cross Blue Shield, Boeing, Bristol-Myers Squibb, Certified Financial Analysts Institute, CoBank, Coca-Cola, Department of Energy, Department of Interior, Dial Corporation, DuPont, Hy-Vee Foods, IBM, Institute of Internal Auditors, Mattel, Motorola, Southern California Edison, Pfizer, Raytheon, Tenet, Toyota, U.S. Navy, Veterans Administration, and VIAD.

Personal: Married since 1976 to Terry H. Jennings, Maricopa County Attorney’s Office Deputy County Attorney; five children: Sarah, Sam, and John, and the late Claire and Hannah Jennings.

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xxviii

Acknowledgments

By its eleventh edition, a book has evolved to a point of trademark characteristics. This book is known for its hands-on examples and readings for business manag- ers. That trademark evolves because of the efforts of many. They are the reviewers and adopters of the text who provide ideas, cases, and suggestions for improve- ment and inclusion, and I thank them all.

Any edition of a book bears the mark of the editors who work to design, refine, market, and produce it. Seven editions ago, Rob Dewey saw potential for the book and applied his enthusiasm and market insights to mold a somewhat ugly duck- ling into a four-color swan. The book also carries the imprimatur of Steve Silver- stein, who confronted me with a profound question, “Why can’t those in business see these ethical dilemmas when they are in the midst of them?” His question forced me back to the drawing board and resulted in the more personal ethical dilemmas. Vicky True, now in Rob’s role, understands the needs of instructors because of her intense road schedule, holds a keen sense of market direction, and offers the insights of both to help to shape this new edition. Kristen Meere, new as the editor for this edition, came into the work with little lead time and picked up the baton and ran with me as we worked through a tight schedule. Kris Tabor has been with me since the first edition, helping with word processing, IMs, study guides, test banks, and venting. We mark 30 years of a terrific partnership with this edition.

This book also carries the unmistakable liveliness of an author who shares her life with helpful and delightful children and one tolerant husband. Since the first edition of this book, I have added four children to our first, witnessed two grad- uate from college, one from law school, grieved over the loss of two, and seen the others grow up all too quickly in a household in which these words, “Mom, the UPS guy is here with page proofs,” made up their first sentences. They now sim- ply witness me hovering over my computer from dawn’s light until I fall asleep on the keyboard. My children and my husband, collectively my family, are the most charming people I know. They have brought me stories, pop culture, and good sense with their, “Uh-oh, here we go!” when their mother finds outrage in yet another ethical lapse in business. Even from their now–globally dispersed posi- tions, they call and ask, “How’s the writing going?” Their vibrancy is found in the color and charm of these pages. I am grateful for their unanimous and unwavering support for my work. Finally, I am grateful to my parents who taught me through their words and examples of the importance and rewards of ethics and hard work.

Marianne Moody Jennings

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1

Part

1 Business: Its Legal, Ethical, and Judicial Environment

Simply stated, you cannot run a successful business without knowing the law. What is legal? Where can I find the laws I need to know? How do I make decisions about legal conduct that is ethically troublesome

to me? What if I have a disagreement with a customer, employee, or

shareholder? How and where can I resolve our differences?

This portion of the book explains what law is, where it can be found,

how it is applied, and how legal disputes are resolved. But beyond

the legal environment of a business, there are the ethical issues. Just

because what you are doing is legal does not mean it is ethical. And

why should a manager make ethical choices and behave honorably in

business? Law and ethics are inextricably intertwined. A commitment to

both is part of a sustainable business model.

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2

Chapter

Introduction to Law1 Most people understand the law through personal experiences. Some are exposed to law through traffic tickets. Others encounter the law when a problem arises with a landlord or lease. Many wonder about their rights when search engines and other Internet companies gather information about them without their realizing such efforts were ongoing. Facing income reductions in tough economic times, many wonder what their rights are when collectors call or file suit. Their understanding of the law may be limited by the anger they feel about an annoying collection agent, their e-mail being scanned or a traffic tick- et. However, without traffic laws, the roads would be a study in survival of the fittest. The law is your source of assurance that you have rights when it comes to collection agency actions. Each day businesses find and face legal and ethical issues in everything from privacy rights on Facebook to proper documentation of employees’ citizenship.

The types of laws and the penalties for violating them vary from state to state and from city to city, but, however much they vary, laws exist everywhere and at every level of government. Indeed, law is a universal, necessary foundation of an orderly society. Law helps maintain order, imposing on us certain minimum standards of conduct. When we fall short of those standards, we risk penalties. Law is made up of rules that control people’s conduct and their interrelationships. Traffic laws control not only our conduct when we are driving but also our rela- tionships with other drivers using the roads. In some instances, traffic laws give other drivers a right-of-way, and we are liable to them for any injuries we cause by not following those laws.

This chapter offers an introduction to law. How is law defined? What types of laws are there? What are the purposes and characteristics of law? Where are laws found, and who enacts them?

Update For up-to-date legal news, go to mariannejennings.com

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3

1-1 Definition of Law Philosophers and scholars throughout history have offered definitions of law. Aristotle, the early Greek philosopher, wrote that “the law is reason unaffected by desire” and “law is a form of order, and good law must necessarily mean good order.” Oliver Wendell Holmes Jr., a U.S. Supreme Court justice of the early twen- tieth century, said, “[L]aw embodies the story of a nation’s development through many centuries.” Sir William Blackstone, the English philosopher and legal scholar, observed that law was “that rule of action which is prescribed by some superior and which the inferior is bound to obey.” Black’s Law Dictionary defines law as “a body of rules of action or conduct prescribed by the controlling authority, and having legal binding force.”1 Law has been defined at least once by every phi- losopher, statesman, and police officer.

Law is simply the body of rules governing individuals and their relationships. Most of these rules become law through a recognized governmental authority. Laws give us basic freedoms, rights, and protections. Law also offers a model of conduct for members of society in their business and personal lives and gives them certainty of expectation. Plans, businesses, contracts, and property ownership are based on the expectation that the law will provide consistent protection of rights. Without such constancy in legal boundaries, society would be a mass of chaos and confusion.

1-2 Classifications of Law 1-2a public versus private Law

Public law includes those laws enacted by some authorized governmental body. State and federal constitutions and statutes are all examples of public laws, as are the state incorporation and partnership procedures, county taxation statutes, and local zoning laws.

This country’s planted thick with laws from coast to coast . . . and if you cut them down . . . d’you really think you could stand upright in the winds that would blow then? A MAn for All SeASonS, Act I

Consider . . . 1.1 John Yates, a commercial fisherman, caught undersized red grouper in federal waters in the Gulf of Mexico. To prevent federal authorities from confirming that he had harvested undersized fish, Yates ordered a crew member to toss the suspect fish into the sea. Yates was charged with, and convicted of, violating 18 U.S.C. § 1519,

“Whoever knowingly alters, destroys, mutilates, con- ceals, covers up, falsifies, or makes a false entry in any record, document, or tangible object with the intent to impede, obstruct, or influence the investigation . . . or

any case filed . . . or in relation to or contemplation of any such matter or case, shall be fined under this title, imprisoned not more than 20 years, or both.”

Mr. Yates says that the statute applies to financial records and not fish. The statute was passed after Enron collapsed and its financial records and audit papers had been shredded to deter such actions by businesses. Who decides whether the law applies to hurling fish overboard? What should the court decide?

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4 part 1 Business: Its Legal, Ethical, and Judicial Environment

Private law, on the other hand, is developed between two individuals. For exam- ple, landlords usually have regulations for their tenants, and these regulations are private laws. Homeowners’ associations have developed an important body of pri- vate law that regulates everything from the type of landscaping for homes in a sub- division to whether homeowners can erect basketball hoops in their driveways. The terms of a contract are a form of private law for the contracting parties. Although the requirements for forming and the means for enforcing that contract may be a matter of public law, the terms for performance are the private law the parties agree to as the rules for governing their relationships. Employer rules in a corporation are also examples of private law; as long as those rules do not infringe any public rights or violate any statutory or constitutional protections, those rules define a private law relationship between employer and employee. For example, most companies now have Twitter and Facebook policies that limit the type of information and comments employees can post about their employers in social media outlets. Interestingly, both state legislatures and the U.S. Congress have proposed legislation that would con- trol employer restrictions on employees’ posts. Public law is being changed to reflect technological areas that are not yet addressed in employment law.

1-2b Criminal versus Civil Law

A violation of a criminal law is a wrong against society. A violation of a civil law is a wrong against another person or persons. Criminal violations have penalties such as fines and imprisonment. When you run a red light, you have committed a criminal violation and owe society a penalty, such as a fine or imprisonment. Vio- lations of civil laws, on the other hand, require restitution: someone who violates a civil law must compensate the harmed party. If you do run a red light and strike and injure a pedestrian, your criminal case is society’s remedy. The civil wrong in the same action requires you to pay damages to that pedestrian.

If you drive while intoxicated, you are breaking a criminal law and are subject to a fine, jail term, or license suspension. If you have an accident while driving intoxicated, you commit a civil wrong against anyone you injure. People who are injured as a result of your driving while intoxicated can file a civil suit against you to recover for injuries to their persons and property (cars).

Other differences also distinguish civil laws from criminal laws and their enforcement. For example, different rights and procedures are used in the trials of criminal cases (see Chapter 8 for more details).

1-2c Substantive versus procedural Law

Substantive laws are those that give rights and responsibilities. Procedural laws provide the means for enforcing substantive rights. For example, if Zeta Corpo- ration has breached its contract to buy 3,000 microchips from Yerba Corporation, Yerba has the substantive right to expect performance and may be able to collect damages for breach of contract by bringing suit. The laws governing how Yerba’s suit is brought and the trial process are procedural laws. Procedural laws are also used in criminal cases, such as grand jury proceedings or arraignments and pleas (see Chapter 8 for more information).

1-2d Common versus Statutory Law

The term common law has been in existence since 1066, when the Normans con- quered England and William the Conqueror sought one common set of laws for

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Chapter 1 Introduction to Law 5

governing a then-divided England. The various customs of each locality were con- glomerated so that all fiefdoms could operate under a “common” system of law. The common law came about as judges in different areas settled disputes in similar ways by consulting their fellow judges on their previous decisions before making decisions. This principle of following other decisions is referred to as stare decisis, meaning “let the decision stand.” This process of legal reasoning is still followed today. The courts use the judicial decisions of the past in making their judgments in order to provide the consistency and constancy of the law.

As much of an improvement as it was, the common law was still just uncod- ified law. Because of increased trade, population, and complexities, the common law needed to be supplemented. As a result, statutory law, which is passed by some governmental body and written in some form, was created.

Today, in the United States, we have common law and statutory law. Some of our common law still consists of principles from the original English common law. For example, how we own and pass title to real property are areas largely devel- oped from English common law. The body of common law continues to grow, however: the judicial system’s decisions constitute a form of common law that is used in the process of stare decisis. Courts throughout the country look to other courts’ decisions when confronted with similar cases.

Statutory law exists at all levels of government—federal, state, county, city, borough, and town. Our statutory law varies throughout our nation because of the cultural heritages of various regions. For example, the southwestern states have marital property rights statutes—often referred to as community property laws—that were influenced by the Spanish legal system implemented in Mexico. The northeastern states have different marital property laws that were influenced by English laws on property ownership. Louisiana’s contract laws are based on French principles because of the early French settlements there.

1-2e Law versus equity

Equity is a body of law that attempts to do justice when the law does not provide a remedy, when the remedy is inadequate, or when the application of the law is terribly unfair. Equity, which originated in England, came into being because the technicalities of the common law often resulted in unresolved disputes or unfair resolutions. The monarchy allowed its chancellor to hear those cases that could not be resolved in the common law courts; eventually, a separate set of equity courts developed that were not bound by rigid common law rules. These courts could get more easily to the heart of a dispute. Over time, they developed remedies not available under common law. Common law, for example, usually permitted only the recovery of monetary damages. Courts of equity, on the other hand, could issue orders, known as injunctions, prohibiting certain conduct or ordering certain acts. The equitable remedies available in the courts of chancery were gradually com- bined with the legal remedies of the common law courts so that now parties can have their legal and equitable remedies determined by the same court.

Today’s courts award equitable remedies when the legal remedy of money damages would be inadequate. For example, the copyright infringement cases brought by the recording and motion picture industries sought injunctions against the individuals and companies that provided the technological means for making unauthorized individual copies of movies and songs. The record companies, the movie producers, and the artists could never be adequately compensated with

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6 part 1 Business: Its Legal, Ethical, and Judicial Environment

money for these forms of infringement because the continued activity caused the loss of their exclusive copyrights. The remedy that they sought and were given were injunctions that, within certain parameters, ordered a halt to the sites and programs that facilitated the unauthorized downloading of copy- righted materials.

1-3 Purposes of Law 1-3a Keeping Order

Laws carry some form of penalty for their violation. Violations of securities laws carry a fine or imprisonment or both. Violations of civil laws also carry sanctions. If an employer discriminates against you by refusing to give you a raise or promo- tion because of your age, gender, or race, you can seek money damages. A driver who injures another while driving intoxicated can be prosecuted but must also pay for the damages and the costs of the injuries the other person experiences. These civil and criminal penalties for violations of laws prevent feuds and the use of primitive methods for settling disputes, such as force.

During the summer of 2016, a number of U.S. cities experienced protests and riots because of concerns about particular police officers’ conduct. These cities imposed curfews in order to bring quiet to the city streets as well as preventing damages to and looting of businesses. A simple curfew law helped to bring order to those cities.

1-3b Influencing Conduct

Laws also influence conduct in a society. For example, securities laws require com- panies to make certain disclosures about those securities before they can be sold to the public. The antitrust laws passed in the early twentieth century prohibited some methods of competition, such as price fixing, and limited others, such as mergers (see Chapter 14). These types of laws continue to change the way busi- nesses operate. For example, Google recently agreed to stop restricting its advertis- ers from working with other search engines.

1-3c Honoring expectations

Businesses commit resources, people, and time to ventures, expansion, and product development with the expectation that the contracts for those commitments will be honored and enforced according to existing law. Investors buy stock with the knowledge that they will enjoy some protection of that investment through the laws that regulate both the securities themselves and the companies in which they have invested. Laws allow prior planning based on the protections inherent in the law.

1-3d promoting equality

Laws have been used to achieve equality in those aspects of life in which equality is not a reality. For example, the equal-right-to-employment acts (see Chapter 20) were passed to bring greater equality to the job market. The social welfare pro- grams of state and federal governments were created to further the cause of eco- nomic justice. The antitrust laws attempt to level the playing field for the free enterprise system to operate efficiently.

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Chapter 1 Introduction to Law 7

1-3e Law as the Great Compromiser

A final and important purpose of law is to act as the great compromiser. Few people, groups, or businesses agree philosophically on how society, business, or government should be run. Law serves to mesh different views into one united view so that all parties are at least partially satisfied. When disputes occur, the courts apply the law to the parties’ situation in an attempt to strike a compromise between two opposing views. The U.S. Supreme Court has provided compromises for the rights of businesses to be involved in the political process and make dona- tions to candidates (see Chapter 5). In the relationship between freedom of speech and advertising regulation, the law serves as the mediator.

1-4 Characteristics of Law 1-4a Flexibility

As society changes, the law must change with it. When the United States was an agricultural nation, the issues of antitrust, employment discrimination, and secu- rities fraud rarely arose. However, as the United States became an industrialized nation, those areas of law expanded, and they continue to expand today. As the United States further evolves into a technological and information-based society, still more areas of law will be created and developed. Computer fraud and iden- tity theft, for example, were unknown issues 35 years ago; today, both state and federal laws address these issues through criminal statutes (see Chapter 8). The introduction of document attachments and electronic signature programs required the courts to re-examine how offers and acceptances of contracts are made, with electronic signatures now legislatively sanctioned as having the same force and effect as signatures on paper (see Chapter 11).

Circumstances change through technology, sociology, and even biology. The law must address those changes. What are the rights of copyright holders when an Internet company creates a system that allows users to post videos that are copy- righted? With billions of users and millions of videos, how do we protect copy- righted materials?

1-4b Consistency

Although the law must be flexible, it still must be predictable. Law cannot change so suddenly that parties cannot rely on its existence or protection. Being able to predict the outcome of a course of conduct allows a party to rely on a contract or dissuades a party from the commission of a crime. For a contract, a judicial remedy can be ordered for breach or non-performance; for a crime, a prescribed punish- ment is the result.

1-4c pervasiveness

The law must be pervasive and cover all necessary areas, but at the same time, it cannot infringe on individual freedoms or become so complex that it is difficult to enforce. For example, laws cover the formation, operation, and dissolution of corporations. Laws govern corporate management decisions on expanding, devel- oping, and changing the nature of the corporation. Laws also ensure that share- holders’ rights are protected. The corporation has great flexibility in management, as long as it stays within these legal boundaries.

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8 part 1 Business: Its Legal, Ethical, and Judicial Environment

In the following case, the U.S. Supreme Court was a deeply divided court on a statutory interpretation question, a question that touched on many of the pur- poses of law. The majority and dissenting opinions show the struggle courts face as they try to honor the law’s dual purposes of keeping order while preserving rights. Case 1.1 is briefed in Exhibit 1.1. A brief is a tool used by lawyers, law stu- dents, and judges to help them summarize a case and focus on its facts and the key points of the decision by the court. The Yates case answers the questions posed in the “Consider . . .” problem at the beginning of the chapter.

Yates v. U.S. 135 S.Ct. 1074 (2015)

Hurling Fish Overboard the Miss Katie: Obstruction of Justice?

Case 1.1

FaCtS

On August 23, 2007, the Miss Katie, a commercial fish- ing boat, was six days into an expedition in the Gulf of Mexico. Her crew numbered three, including Yates, the captain. Engaged in a routine offshore patrol to inspect both recreational and commercial vessels, Officer John Jones of the Florida Fish and Wildlife Conservation Commission decided to board the Miss Katie to check on the vessel’s compliance with fishing rules. Because he had been deputized as a federal agent by the Nation- al Marine Fisheries Service, Officer Jones had authority to enforce federal, as well as state, fishing laws.

Upon boarding the Miss Katie, Officer Jones noticed three red grouper that appeared to be under- sized hanging from a hook on the deck. At the time, federal conservation regulations required immediate release of red grouper less than 20 inches long. Offi- cer Jones instructed Yates to keep the undersized fish segregated from the rest of the catch until the ship returned to port. After Jones departed, Yates instead told a crew member to throw the undersized fish overboard. For this offense, Yates was charged with destroying, concealing, and covering up undersized fish to impede a federal investigation, in violation of 18 U.S.C. § 1519:

“Whoever knowingly alters, destroys, mutilates, conceals, covers up, falsifies, or makes a false entry in any record, document, or tangible object with the intent to impede, obstruct, or influence the investi- gation or proper administration of any matter with- in the jurisdiction of any department or agency of the United States or any case filed under title 11, or in relation to or contemplation of any such matter

or case, shall be fined under this title, imprisoned not more than 20 years, or both.”

Yates was convicted but moved to dismiss the charges, arguing that §1519’s reference to “tangible object” means objects used to store information, such as computer hard drives, not fish. The District Court denied Yates’s motion, and a jury found him guilty. The Eleventh Circuit affirmed the conviction, concluding that §1519 applies to the destruction or concealment of fish because, as objects having phys- ical form, fish fall within the dictionary definition of “tangible object.” Yates, who was sentenced to 30 days in jail and three years of supervised proba- tion as well as carrying a felony conviction for life, appealed.

JUdICIaL OpINION

GINSBURG, Justice Although dictionary definitions of the words “tangi- ble” and “object” bear consideration in determining the meaning of “tangible object” in §1519, they are not dispositive. Whether a statutory term is unambiguous “is determined [not only] by reference to the language itself, [but also by] the specific context in which that language is used, and the broader context of the statute as a whole.”

Section 1519’s position within Title 18, Chapter 73, further signals that §1519 was not intended to serve as a cross-the-board ban on the destruction of physical evidence. Congress placed §1519 at the end of Chapter 73 following immediately after pre-existing specialized provisions expressly aimed at corporate fraud and financial audits.

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Chapter 1 Introduction to Law 9

The contemporaneous passage of §1512(c)(1), which prohibits a person from “alter[ing], destroy[ing], mutilat[ing], or conceal[ing] a record, document, or other object . . . with the intent to impair the object’s integrity or availability for use in an official proceed- ing,” is also instructive.

Use of traditional tools of statutory interpretation to examine markers of congressional intent within the Sarbanes–Oxley Act and §1519 itself thus call for rejec- tion of an aggressive interpretation of “tangible object.”

Having used traditional tools of statutory inter- pretation to examine markers of congressional intent within the Sarbanes–Oxley Act and §1519 itself, we are persuaded that an aggressive interpretation of “tan- gible object” must be rejected. It is highly improbable that Congress would have buried a general spoliation statute covering objects of any and every kind in a provision targeting fraud in financial record-keeping.

Reversed.

ALITO, Justice, Concurring [T]hough the question is close, traditional tools of statutory construction confirm that John Yates has the better of the argument. Three features of 18 U.S.C. § 1519 stand out to me: the statute’s list of nouns, its list of verbs, and its title. Although perhaps none of these features by itself would tip the case in favor of Yates, the three combined do so. Start with the nouns. Sec- tion 1519 refers to “any record, document, or tangible object.”

[T]he term “tangible object” should refer to some- thing similar to records or documents. A fish does not spring to mind—nor does an antelope, a colonial farm- house, a hydrofoil, or an oil derrick. All are “objects” that are “tangible.” But who wouldn’t raise an eyebrow if a neighbor, when asked to identify something similar to a “record” or “document,” said “crocodile”?

[My] analysis is influenced by §1519’s title: “Destruction, alteration, or falsification of records in Federal investigations and bankruptcy.” (Emphasis added.) This too points toward filekeeping, not fish. Titles can be useful devices to resolve “‘doubt about the meaning of a statute.’” The title is especially valu- able here because it reinforces what the text’s nouns and verbs independently suggest—that no matter how other statutes might be read, this particular one does not cover every noun in the universe with tangible form.

KAGAN, Justice Dissenting with Justices SCALIA, KENNEDY, AND THOMAS

If none of the traditional tools of statutory interpre- tation can produce today’s result, then what accounts

for it? The plurality offers a clue when it emphasizes the disproportionate penalties §1519 imposes if the law is read broadly. Section 1519, the plurality objects, would then “expose[ ] individuals to 20-year prison sentences for tampering with any physical object that might have evidentiary value in any federal investiga- tion into any offense.” That brings to the surface the real issue: overcriminalization and excessive punish- ment in the U.S. Code.

Now as to this statute, I think the plurality some- what—though only somewhat—exaggerates the mat- ter. The plurality omits from its description of §1519 the requirement that a person act “knowingly” and with “the intent to impede, obstruct, or influence” federal law enforcement. And in highlighting §1519’s maxi- mum penalty, the plurality glosses over the absence of any prescribed minimum. (Let’s not forget that Yates’s sentence was not 20 years, but 30 days.) Congress presumably enacts laws with high maximums and no minimums when it thinks the prohibited conduct may run the gamut from major to minor. That is assuredly true of acts obstructing justice. Most district judges, as Congress knows, will recognize differences between such cases and prosecutions like this one, and will try to make the punishment fit the crime. Still and all, I tend to think, for the reasons the plurality gives, that §1519 is a bad law—too broad and undifferentiated, with too-high maximum penalties, which give pros- ecutors too much leverage and sentencers too much discretion. And I’d go further: In those ways, §1519 is unfortunately not an outlier, but an emblem of a deeper pathology in the federal criminal code.

But whatever the wisdom or folly of §1519, this Court does not get to rewrite the law. “Resolution of the pros and cons of whether a statute should sweep broadly or narrowly is for Congress.” If judges dis- agree with Congress’s choice, we are perfectly entitled to say so—in lectures, in law review articles, and even in dicta. But we are not entitled to replace the statute Congress enacted with an alternative of our own design.

I respectfully dissent.

CaSe QUeStIONS

1. Explain what Mr. Yates did and why.

2. Describe the terms used in the statute at issue and the history of the statute.

3. Why does the dissent think the majority made the decision it did?

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10 part 1 Business: Its Legal, Ethical, and Judicial Environment

Exhibit 1.1 Sample Case Brief

Name of case: Yates v. U.S. Court: U.S. Supreme Court Citation: 135 S.Ct. 1074 (2015) Parties and their roles: United States (respondent/prosecutor); John L. Yates (petitioner/defendant) Facts: John Yates, a commercial fisherman, caught undersized red grouper in federal waters in the Gulf of

Mexico. To prevent federal authorities from confirming that he had harvested undersized fish, Yates ordered a crew member to toss the suspect fish into the sea. Yates was charged with obstruction of justice through destruction of the small red-grouper fish.

Issues: Is the release of fish back into the sea obstruction of justice? Lower court decision: Yates was convicted and appealed. His conviction was upheld. He appealed to the U.S. Supreme Court. Decision: A split court held that the fish were not “tangible objects” for purposes of the obstruction of justice

statute. The court held that the statute was passed to cover files and electronic records and not tangible objects such as fish. The conviction was reversed.

Reasoning: The court held that the statute was passed in the wake of financial and ethical collapses in companies and was not intended to have generic application. It was directed at electronic files and documentation, not tangible objects such as fish.

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Ethical Issues

Evaluate the ethics of Mr. Yates in hurling the fish back after the federal agent told him to retain them.

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Consider . . . 1.2 Andrew B. Katakis received a letter from his bank informing him that federal inves- tigators had subpoenaed his bank records. On September 3, 2010, Katakis purchased, downloaded, and installed a program called DriveScrubber on his home computer, a Dell. DriveScrubber places deleted infor- mation into free space on the computer. DriveScrubber actively overwrites all data in the free space of a hard drive. Once a file is

overwritten by DriveScrubber, it is impossi- ble to retrieve it.

Katakis’s business partner, Steve Swanger, kept two computers at their office. Katakis told Swanger that he wanted to install a “scrubber program” on their computers and that there was “nothing wrong with us cleaning our computers.” The Swanger Dell had 4,000 e-mails on it, and Katakis began deleting them. After seeing that it would

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Chapter 1 Introduction to Law 11

take a long time for the e-mails to be delet- ed, Katakis went home. When he returned to the office on Monday, Swanger noticed that almost all of the e-mails on his Dell had been deleted from his e-mail in-box.

The government seized the computers in its investigation of an alleged bid-rigging scheme. When examining Swanger’s Dell, the government discovered ten incriminat- ing e-mails that implicated Katakis. Katakis was either a sender or recipient of all ten e-mails. Swanger was also either the sender or recipient of all ten e-mails. The e-mails were discovered in the deleted items folder in Swanger’s e-mail. Metadata attached to the e-mails showed that Katakis had re- ceived and opened all of them. However, Katakis had deleted the e-mails, and the government expert believed that Katakis had destroyed them using DriveScrubber. However, because the e-mails were part of an Exchange e-mail program, deleted e-mails simply go into a deleted mail folder and are not subject to DriveScrubber over- write. Still, the government never found the e-mails on the Katakis computer. Katakis was charged with obstruction of justice for destroying electronic documents. What should the court do with the case? Based on what you learned in the Yates case, was this obstruction of justice? U.S. v. Katakis, 800 F.3d 1017 (9th Cir. 2015).

THINK: Before answering this prob- lem, review the opinions in the Yates case. Recall the following.

1. According to the majority, the statute applies to the destruction of docu- ments or electronic records. a. The e-mails were electronic records. b. The e-mails were missing.

2. The e-mails were relevant to the bid-rigging investigation and charges.

3. The e-mails were not covered by the DriveScrubber program that Katakis installed.

APPLY: The e-mails are covered by the obstruction statute because the court care- fully outlined what was included in and cov- ered by the statute and electronic records are part of the coverage.

ANSWER: However, what is different about this case from the Yates case is that the proof does not connect Katakis with de- struction of the e-mails. There must be some form of a record, but there must also be destruction, and the experts in the case in- dicated that DriveScrubber would not have automatically destroyed the e-mails because they were in an Exchange folder, not the computer free space over which DriveScrub- ber writes. Circumstantial evidence does not provide the connection between the missing records and Katakis. The case was dismissed.

Re: the Cover-Up vs. the Crime For the Manager’s Desk

One of the important lessons of the Yates case is for those who run businesses to understand that when inspectors or offi- cers find violations in their operations, the worst thing to do is to attempt to conceal the evidence. Concealment or obstruction always reach felony levels. The fines and imprisonment, as with §1519, can be as high as 20 years. Once caught, the best

approach is, in consultation with a lawyer, to determine your rights and options. However, undertaking the destruction of documents, records, or fish only brings greater penalties. If the statutes are excessive or unfair, there is always the appeal of the sentence itself, but the issue will be the fairness of the sen- tence and not a felony conviction for the act of obstruction.

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12 part 1 Business: Its Legal, Ethical, and Judicial Environment

1-5 The Theory of Law: Jurisprudence Law is the compromise of conflicting ideas. Not only do people differ in their thinking on the types of specific laws, they also differ on the theory behind the law or the values a legal system should try to advance or encourage. Many can agree on the definition of law and its purposes but still differ on how those purposes are best accomplished. The incorporation of theories or values into the legal process is, perhaps, what makes each society’s laws different and causes law to change as society changes its values. These different theories or value bases for law are found in an area of legal study called jurisprudence, a Latin term meaning “wis- dom of the law.” In many cases, how the law should work is unclear. Conflicting philosophical views often come together in litigation. Judges and lawmakers must struggle to do the best good for the most members of society.

1-5a the theory of Law: positive Law

There are some who see law as simply written orders that we must keep. Known as the positive law school of thought, those who subscribe to it believe that the crit- ical part of the law is obedience so that we can have an orderly society.

1-5b the theory of Law: Natural Law

Another theory of jurisprudence is that of natural law, a theory that holds that we have certain rights that cannot be taken away by law. The United States of Amer- ica’s form of government was grounded in the natural law theorists’ views that we have certain unalienable rights that cannot be taken away by any law. Any law that purports to take away those rights is invalid and must be challenged, either through the courts or through civil disobedience. An example would be slavery. While slavery was legal in the United States and other countries for many years, it was constantly met with dissent, disobedience, and eventually civil war. Natural law trumped the positive law, and slavery was eliminated because it was a viola- tion of natural law, and laws were changed to make it illegal.

1-5c the theory of Law: the protection of Individuals and Relationships

Justice Oliver Wendell Holmes, in “Natural Law,” his famous essay written in 1918 at the height of World War I, rejected the notion of natural law. His essay began with the famous phrase, “The life of the law has not been logic; it has been expe- rience.” Holmes’s opinion is that our interactions with each other constitute the foundation of law.

If I do live with others they tell me what I must do if I wish to remain alive. If I do live with others they tell me what I must do and abstain from doing various things or they will put the screws to me.2

In other words, the law is what keeps the peace among us, and should we choose to ignore it, those around us will take control and bring us into compliance.

1-5d the theory of Law: the Social Contract

Roscoe Pound, another legal philosopher and dean of Harvard Law School for 20 years, had a different view of jurisprudence from Justice Holmes. His view was that law exists as the result of those who happen to be in power, that there is a type

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Chapter 1 Introduction to Law 13

of social contract that we mutually honor. In 1941, Pound wrote his famous credo, called “My Philosophy of Law.”

I think of law as in one sense a highly specialized form of social control in a developed politically organized society—a social control through the systematic and orderly application of the force of such a society. Moreover, it operates through a judicial process and an administrative process, which also go by the name of law. . . .3

Apply the theories of jurisprudence to the following situations.

1. Major General Antonio M. Taguba led an investigation of the conduct of U.S. soldiers in the Abu Ghraib prison in Iraq. The 54-page report documented brutal treatment of Iraqi prisoners, tor- ture, and humiliation, all in violation of either the Geneva Convention for the treatment of prisoners of war or the standards of the Red Cross. General Taguba referred to the treatment of the prisoners as consisting of “egregious acts and grave violations of interna- tional law.”4 One of the findings of the report is that the soldiers serving as prison guards had little training. General Taguba recommended training for soldiers in when to disobey orders. A fellow officer said of General Taguba, “If you want the truth; he’s going to tell you the truth. He’s a stand-up guy.”5

General Taguba’s father was Staff Sergeant Tomas Taguba, a man who fought in the Battle of Bataan and was taken prisoner by the Japanese. He

escaped from prison there and joined the fighters in Japan who opposed the government.

Based on these brief descriptions of these two men, what philosophy of law do you think they would follow?

2. A supervisor has ordered an employee to inflate the company’s earnings for the quarter so that their unit can meet their goals and attain their bonuses. Must the employee obey?

3. Is a businessperson who believes the tax system to be unconstitutional justified in refusing to pay taxes? How will society react to such a position?

4. Is there any example of a law that is accepted by everyone in society? What about the laws against speed- ing? What happens, according to the philosophers, when there is no common agreement on what the law should be?

5. Refer back to the Yates case. What school of thought on jurisprudence do you think Mr. Yates followed?

Consider . . . 1.3

1-6 Sources of Law Laws exist in different forms at every level of government. As discussed earlier, law exists not only in statutory form but also in its common law form through judi- cial decisions. Statutory law exists at all levels of government. Statutes are written laws enacted by some governmental body with the proper authority—legislatures, city governments, and counties—and published and made available for public use and knowledge. These written statutes are sometimes referred to as codified law, and their sources, as well as constitutions, are covered in the following sections.

1-6a Constitutional Law

The U.S. Constitution and the constitutions of the various states are unique forms of law. Constitutions are not statutes because they cannot be added to, amended,

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14 part 1 Business: Its Legal, Ethical, and Judicial Environment

or repealed with the same ease as can statutes. Constitutions are the law of the peo- ple and are changed only by lengthier and more demanding procedures than those used to repeal statutes.

Constitutions tend to protect general rights, such as speech, religion, and prop- erty (see Chapter 5 for a more complete discussion). They also provide a frame- work for all other forms of laws. The basic rights and protections afforded in them cannot be abridged or denied by the other sources of law. In other words, a stat- ute’s boundaries are formed by constitutionally protected rights. Exhibit 1.2 is an illustration of the sources of law; constitutional law is at the base of the pyramid diagram because of its inviolate status.

1-6b Statutory Law at the Federal Level

Congressional Law Congress is responsible for statutory law at the federal level. The laws passed by Congress become part of the United States Code (U.S.C.). Examples of such laws are the 1933 and 1934 Securities Acts (see Chapter 18), the Sherman Act and other antitrust laws (see Chapter 14), the Equal Employment Opportunity Act (see Chap- ter 20), the National Labor Relations Act (see Chapter 19), the Truth-in-Lending Act (see Chapter 11), the USA Patriot Act (see Chapters 8 and 18), and the Internal Revenue Code (see Chapter 19).

Statutes from the U.S.C. are referenced or cited by a standard form of legal short- hand, often referred to as a cite or citation. The number of the title is put in front of “U.S.C.” to tell which volume of the Code to go to. For example, “15 U.S.C.” refers to Title 15 ``of the U.S. Code (Title 15 happens to cover securities). There may be more than one volume that is numbered “15,” however. To enable you to find the

Exhibit 1.2 Sources of Law

Private Law

City or Borough Ordinances

County Ordinances

State Administrative Regulations

State Legislative Enactments

State Constitutions

Federal Administrative Regulations

Federal Legislative Enactments

C ou

rt D

ec is

io ns

C ourt D

ecisions

Court Decisions

U.S. Constitution

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Chapter 1 Introduction to Law 15

volume you need, the reference or cite has a section (§) number following it. This section number is the particular statute referenced, and you must look for the vol- ume of Title 15 that contains that section. For example, the first volume of Title 15 contains §§ 1–11. A full reference or cite to a United States Code statute looks like this: 15 U.S.C. §77. When a U.S.C. cite is given, the law cited will be a federal law passed by Congress.

executive Orders Executive orders are laws of the executive branch of the federal government and deal with those matters under the direct control of that branch. For example, on his second day in office, President Barack Obama issued an executive order prohibit- ing the use of waterboarding in questioning military combatants who are in U.S. custody. In 2015, President Obama issued an executive order that increased back- ground checks on private gun sales, including those sales at gun shows.

Federal administrative Regulations The federal government has administrative agencies that serve the functions of promulgation of rules (called regulations) for developing specifics such as forms and time requirements for carrying out the legislative enactments of Congress, in addition to enforcing both the laws and regulations (see Chapter 6 for more details). Examples of federal agencies include the Environmental Protection Agency (EPA), the Equal Employment Opportunity Commission (EEOC), and the Securities and Exchange Commission (SEC).

Federal regulations are found in the Code of Federal Regulations (CFR), a set of paperback volumes that is published once each year. A citation from the CFR has a structure similar to that of a U.S.C. cite. For example, 12 C.F.R. §226 is volume 12 of the CFR, and §226 is a section that deals with credit disclosure rights.

1-6c Statutory Law at the State Level

As noted on p. 13–14, each state has its own constitution. State constitutions cannot circumvent or cancel any of the rights afforded under the U.S. Constitution. These state constitutions provide the authority for the state statutory law structure.

Legislative Law and State Codes Each state has its own code containing the laws passed by its legislature. State codes contain the states’ criminal laws, laws for incorporation, laws governing partnerships, and contract laws. Much of the law that affects business is found in these state codes. Some of the laws passed by the states are uniform laws, which are drafted by groups of businesspeople, scholars, and lawyers in an effort to make interstate business less complicated. For example, the Uniform Commercial Code (UCC), which has been adopted in 49 states, governs contracts for the sale of goods, commercial paper, security interests, and other types of commercial transactions. Having this uniform law in the various states gives businesses the opportunity to deal across state lines with some certainty. Other uniform acts passed by many state legislatures include the Uniform Partnership Act (Revised), the Uniform Res- idential Landlord and Tenant Act, the Model Business Corporation Act, and the Uniform Probate Code.

State administrative Law Just as at the federal level, state governments have administrative agencies with the power to pass regulations dealing with the statutes and powers given by the

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16 part 1 Business: Its Legal, Ethical, and Judicial Environment

state legislatures. For example, most states have an agency to handle incorpora- tions and the status of corporations in the state. Most states also have a tax agency to handle income or sales taxes in the state.

1-6d Local Laws of Cities, Counties, and townships

In addition to federal and state statutes, local governments can pass ordinances or statutes within their areas of power or control. For example, cities and counties have the authority to handle zoning issues, and the municipal code outlines the zoning system and whatever means of enforcement and specified penalties apply. These local laws govern lesser issues, such as dog licensing, curfews, and loiter- ing. However, local governments are often responsible for national legal trends. For example, city and county bans on Styrofoam containers have resulted in the transformation of the fast-food industry by the use of new types of containers. City ordinances often affect national companies, and the companies make changes nationwide to comply with local ordinances.

1-6e private Laws

Private laws are a final source of written law and are found, for example, in con- tracts and landlord regulations. These private laws are enforceable provided they are not inconsistent with rights and protections afforded under the other sources of law (see Chapters 3 and 4).

1-6f Court decisions

Looking at Exhibit 1.2, you can see that all of the sources of law just covered are surrounded in the pyramid by the term “Court Decisions.” Often the language in a statute is unclear, or perhaps whether the statute or ordinance applies in a particu- lar situation is unclear. When these ambiguities or omissions occur in the statutory language, courts provide interpretation or clarification of the law when disputing parties bring suit. These court decisions are then read along with the statutory lan- guage in order to give a complete analysis of the scope and intent of the statute. The Yates case is an example of how laws are interpreted and applied as factual twists arise.

Strategy for Small Businesses and Legal Issues

Business Strategy

From the Yates case and the extent of the sources of law, it is easy to see that a small businessman landed in a great deal of legal difficulty. In fact, his court battle began in 2011 and did not end until the 2015 U.S. Supreme Court decision. It also took two years, from the boat inspection in 2009 until 2011, for the criminal charges to be brought against him. How does a small business keep up with legal issues and potential

pitfalls? Small businesses are not always able to have lawyers on call or following all the potential pitfalls they might face. To ensure that they are keeping abreast of the law, changes, and development in their busi- ness areas, many small businesses belong to trade associations. Those associations provide members with information about court decisions, pending legislations, and cautions about business practices. ©

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Chapter 1 Introduction to Law 17

1-7 Introduction to International Law Business is global. Companies headquartered in Japan have factories in the United States, and U.S. firms have manufacturing plants in South America and subcontrac- tors and suppliers in China. Trade and political barriers to economic development no longer exist. Businesses must be adept at trading across country boundaries, and such trade requires an understanding of international law.

International law is not a neat body of law like contract law or the UCC. Rather, it is a combination of the laws of various countries, international trade customs, and international agreements. Article 38(1) of the Statute of the International Court of Justice (a court of the United Nations that countries consent to have resolve dis- putes) is a widely recognized statement of the sources of international law:

(a) international conventions, whether general or particular, establishing rules expressly recognized by the contesting states;

(b) international custom as evidence of a general practice accepted as law;

(c) the general principles of law recognized by civilized nations;

(d) judicial decisions and the teachings of the most highly qualified publicists of the various nations, as subsidiary means for the determination of rules of law.

1-7a Custom

Every country has its boundaries for allowable behavior, and these boundaries are unwritten but recognized laws. The standards of behavior are reflected in state- ments made by businesspeople and government officials. Custom develops over time and through repeated conduct. For example, working conditions in factories around the world have improved over the past 20 years not through changes in laws but through the business custom of inspections, monitors, and transparent disclosure of supply chain resources. Business custom is now one of assuming responsibility for the conditions in factories that supply parts and labor for goods produced around the world.

In addition to operations, businesses must develop a knowledge of and sen- sitivity to individual country customs related to negotiations and relationships. For example, unlike the United States, most countries do not offer a warranty pro- tection on goods and instead follow a philosophy of caveat emptor, “Let the buyer beware.” Other countries also do not recognize the extensive rules of insurance and risk followed here with respect to the shipment of goods. Multinational firms must make provisions for protection of shipments in those countries with differ- ent standards. Differing laws can affect product content and quality. For example, lead-based paint is not permitted for use on children’s toys in the United States, but in China, at one point, lead-based paint was standard in toy production. A toy manufacturer must learn to specify legal standards for suppliers because custom and laws in that country may find the suppliers assuming the same standards they use apply to production for businesses outside their country.

At one time, the customs of China with respect to intellectual property, most particularly computer software, lagged behind those of Europe and the United States. Chinese custom was to separate infringement into two categories: ordinary acts and serious acts. Ordinary infringement was not regarded as a legal issue and requires only that the party apologize, destroy the software, and not engage in infringement again. Courts were rarely involved in ordinary infringement cases.

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18 part 1 Business: Its Legal, Ethical, and Judicial Environment

However, the U.S. government demanded more protection for its copyright hold- ers by imposing trade sanctions, and China eventually agreed to revise its customs and laws to afford protection. In this case, China’s customs had to be changed to provide protection similar to that afforded in other countries.

1-7b treaties

A treaty is an agreement between or among nations on a subject of international law signed by the leaders of the nations and ratified by the nations’ governing bodies. In the United States, treaties are ratified by the Senate and are included in the pyramid (Exhibit 1.2) as federal legislative enactments.

Treaties can be between two nations—bilateral treaties—or multilateral trea- ties—those that are made among several nations. Other treaties, recognized by almost all nations, are called general or universal treaties. Universal treaties are a reflection of widely followed standards of behavior. For example, the Geneva Convention is a universal treaty covering the treatment of prisoners of war. The Vienna Convention is a universal treaty covering diplomatic relations. The Warsaw Convention is a treaty that addresses issues of liability for injuries to passengers and property during inter- national air travel. For more discussion on trade treaties, see Chapter 7.

1-7c private Law in International transactions

Those businesses involved in multinational trade and production rely heavily on private law to ensure performance of contractual obligations. Even though each country has a different set of laws, all of them recognize the autonomy of parties in an international trade transaction and allow the parties to negotiate contract terms that suit their needs, as long as none of the terms is illegal. Party autonomy allows firms to operate uniformly throughout the world if their contracts are recognized as valid in most countries. For example, most international trade contracts have a choice-of-law clause whereby the parties decide which country’s law will apply to their disputes under the contract.

1-7d International Organizations

Some international organizations provide the means for facilitating multinational commercial transactions. For example, the World Trade Organization (WTO) (see Chapter 7 for more details) provides a Dispute Settlement Body (DSB), a forum for resolving trade disputes related to multilateral treaties.

1-7e the doctrines of International Law

There are a number of principles of international law that are widely accepted and honored by most countries. These include the act of state doctrine, a theory that protects governments from reviews of their actions by courts in other coun- tries. In any action in which the government of a country has taken steps to con- demn or confiscate property, the courts of other countries will not interfere (see Chapter 7 for a full discussion of this and other doctrines of international law).

1-7f trade Law and policies

The importance of trade laws, tariffs, and policies has increased directly with the rising numbers of international business transactions. Chapter 7 provides addi- tional details on trade laws, tariffs, restrictions, and trade agreements.

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Chapter 1 Introduction to Law 19

1-7g Uniform International Laws

Because trade barriers have been largely eliminated, contracts have been and are being formed between and among businesses from virtually all nations. How- ever, not all nations have the same approach to contracts. Indeed, some nations have no contract laws or commercial codes. In an attempt to introduce uniformity in international contract law, the United Nations developed its Contracts for the International Sale of Goods (CISG), which has been adopted widely and allows businesses to opt in or out of its application in adopting countries. Similar to the UCC (see Chapter 11), the CISG has provisions on contract formation, perfor- mance, and damages. More information on the CISG can be found in Chapters 7, 11, and 12.

1-7h the european Union

Once referred to as the Common Market and later known as the European Com- munity (EC), the European Union (EU) is a tariff-free group of European coun- tries that have joined together to enjoy the benefits of barrier-free trade. Formed in 1992, the single economic community requires member nations to subscribe to the same monetary standard, the elimination of immigration and customs controls, universal product and job safety standards, uniform licensing of professionals, and unified taxation schedules. The EU has been experiencing tension because of the weaker economies of some of its members and the need for other members to provide economic support for failing government finances. Great Britain’s vote to withdraw (Brexit) from the EU in 2016 signals more tension and change. More details on the governance of the EU can be found in Chapter 7.

Re: When Worldwide Soccer Involves Bribery

For the Manager’s Desk

The scandal erupted around the world as Interpol and law enforcement agents from Europe and the United States descended on the offices of FIFA, the World Cup soccer organization. The agents were there to seize records and computers because of allega- tions of an international bribery scandal in the organization that had existed for years and funneled millions to individual leaders in the organization.

The case was representative of a new approach of cooperation among nations for curbing bribery, money laundering, and securities fraud. Working together,

multinational task forces focus on activ- ities and then together bring charges against individuals in their own countries.

FIFA is an NGO (non-governmental organization) that is still subject to the standards that OECD nations have adopted for curbing bribery. The result of the coop- eration in the investigation is the indict- ment of leaders, their resignations, and the end of the excessive payments that teams and cities vying for the World Cup were paying in exchange for FIFA favors and award of contracts.

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20 part 1 Business: Its Legal, Ethical, and Judicial Environment

Biography

Uber has become the little company that could. In a brilliant recognition of the costs of intra-city transportation, Uber offered customers who had been tied to cabs or public transportation a service of car transportation without the high cost. Staffed by independent contractors who use their own cars, San Francisco–based Uber has expanded worldwide to 300 cities in 60 countries.

However, one lawyer observed, “A lot of these start-ups initially don’t think much about regulation. They do things first, then ask questions.”6 For example, Uber did not understand the power of taxi drivers. In Paris, the company was met with pro- tests by taxi drivers who were lobbying city officials to impose a 15-minute wait time on Uber drivers. That is, they wanted to require Uber to wait 15 minutes before picking up a passenger to give the taxis a chance to pick up the waiting passenger. France has charged two Uber executives with “deceptive commercial practices.”

In the United States, the Depart- ment of Labor has been pushing to have Uber drivers classified as employ- ees, something that would increase Uber’s costs because of benefits and wage taxes. Many cities have been resistant to Uber infiltration and have required cab licensing or restricted Uber to rides within the city and not from the airports.

Uber has learned that it must work with regulators in order to establish a relationship and prevent the types of restrictions it has experienced at the local, state, and federal levels. In Munich, Uber has been working with city officials in order to obtain permission to operate under existing laws there. Uber main- tains that its goal is to provide low-cost transportation in a system in which there are monopolies held by cabs that charge high rates. Filling that niche seems to be working except for the regulatory challenges.

Uber: the Importance of Law in a developing Business

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s u m m a r y How is law defined?

• Law is a form of order. Law is the body of rules of society governing individuals and their relationships.

What types of laws are there?

• Public law—codified law; statutes; law by government body

• Private law—rules created by individuals for their contracts, tenancy, and employment

• Civil law—laws regulating harms and carrying damage remedies

• Criminal law—laws regulating wrongful conduct and carrying sentences and fines

• Statutory law—codified law

• Common law—law developed historically and by judicial precedent

• Substantive laws—laws giving rights and responsibilities

• Procedural laws—laws that provide enforcement rights

What are the purposes of law?

• Keep order; influence conduct; honor expectations; promote equality; offer compromises

What are the characteristics of law?

• Flexibility; consistency; pervasiveness

• Jurisprudence—theory of law

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Chapter 1 Introduction to Law 21

Where are laws found and who enacts them?

• Constitution—document that establishes structure and authority of a government

• Federal statutes—laws passed by Congress: the U.S. Code

• State statutes—laws passed by state legislatures, including uniform laws on contracts and business organizations

• Ordinances—local laws passed by cities, counties, and townships

What are the sources of international law?

• Customs—the standards of conduct and norms in a country

• Treaties—agreements between and among nations regarding their political and commercial relationships

• Private law—party autonomy recognized in all nations

• International doctrines—widely accepted principles of law followed in most countries

• European Union—group of nations working collectively for uniform laws and barrier-free trade

• Uniform laws—Contracts for the International Sale of Goods (CISG)

Q u e s t i o n s a n d P r o b l e m s 1. Bryant Gunderson is a sole proprietor with a successful bungee-jumping business. He is consid- ering incorporating his business. What levels and sources of law would affect and govern the process of incorporation?

2. Jeffrey Stalwart has just been arrested for ticket scalping outside the Great Western Forum in Los Angeles. Jeffrey sold a ticket to a Taylor Swift con- cert to an intense fan for $1,200; the face value of the ticket was $48. Ticket scalping in Los Angeles is a mis- demeanor. Will Jeffrey’s court proceedings be civil or criminal?

3. The U.S. Golf Association put a new rule (effective January 1, 2016) that prohibits players from anchoring their putters to their chests. Tim Clark, a golfer from South Africa, who has won ten championships, anchors his putter to his chest and reacted, “We are not going to roll over and just accept this. We have been put in a position where we have to fight for our livelihoods.”7

Explain what source of law is involved. How can the rule be challenged? Where would the golfers go to court?

4. Define and contrast the following: a. Civil law and criminal law b. Substantive law and procedural law c. Common law and statutory law d. Private law and public law

5. During the 2001 baseball season, Barry Bonds, a player with the San Francisco Giants, hit 73 home runs in one season, a new record that went beyond the 72 set by Mark McGwire in 2000. Mr. Bonds made

his record-breaking home run in San Francisco. When he hit the home run, the ball went into the cheap seats. All agree that Alex Popov had his glove on the home-run ball. However, Patrick Hayashi ended up with the ball.

Mr. Popov filed suit alleging that Mr. Hayashi assaulted Mr. Popov in order to get the ball. A substan- tial amount of videotape shows Mr. Popov’s “glov- ing” of the ball. Mr. Popov says the ball belongs to him because he held that ball in a “Sno-cone position” and others wrested it from his control.

Mark McGwire’s ball from his record-breaking home run sold for $3 million. The battle for the Bonds home-run ball carries high financial stakes. What areas of law will be involved in the judge’s determination of who gets the baseball? (Peter Page, “Ownership of His- toric Baseball Is in Extra Innings,” National Law Journal, November 12, 2001.)

6. They call them “floating bacchanals.” Offshore from Florida and California cities, sunseekers take their rafts and boats and tie them together as they share adult bev- erages, music, swimming, and the sun. However, after a day of floating, many involved in the floating com- munity are so drunk that they cannot get their rafts and boats back to shore. In addition, safety patrols have difficulties gaining access to take action when there are arguments. What level of law could be directed to con- trol these types of activities? Where would those laws be promulgated?

7. Around 5:00 a.m. on January 1, 2004, Matthew Schmucker, who was 18 at the time, was traveling alone in a horse and buggy near the intersection of Indiana

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22 part 1 Business: Its Legal, Ethical, and Judicial Environment

State Road 37 and Notestine Road in Harlan, Indiana. He was intoxicated at the time and failed to stop at an inter- section, thereby colliding with the side of a 2003 Dodge Stratus carrying David Candon and Monica Young, who is now paralyzed from the neck down as a result of the accident. Schmucker was charged with being a minor in possession of alcohol and failing to stop at a through- way. Candon, Young, and their children, who were in the car at the time of the auto/buggy collision, brought suit against Schmucker. Schmucker declared bankruptcy and asked to be discharged from his obligations to Candon and Young. Candon and Young argued that the injury was a “willful and malicious injury by a vessel” under the bankruptcy code and was thus a nondischargeable debt. Schmucker said a horse and buggy is not a vessel. Discuss the role of the court in this case. What would the court look to in making its decision? What is the impact of the court’s decision on the ability of the family to recover for injuries? [Young v Schmucker, 409 B.R. 477 (N.D. Ind. 2008)]

8. Ms. Paris Hilton, a well-known celebrity with a ubiq- uitous presence on television and in People magazine, had her driver’s license suspended by the state of Cal- ifornia because of driving under the influence (DUI) or while intoxicated (DWI). She was then pulled over by officers for DUI while driving with a suspended license. Following a hearing on the second traffic stop, a judge sentenced Ms. Hilton to 45 days in jail for failure to honor the terms of her DUI probation, including driving while intoxicated.

List all the types of laws that apply to Ms. Hilton in her situation and also where the specific California laws would appear on the pyramid of the sources of law. If Ms. Hilton asked for a pardon or commutation of her sentence by the governor of California, would the law allow it?

9. Classify the following subject matters as substantive or procedural laws:

a. Traffic law on speeding b. Small claims court rules c. Evidence d. Labor law e. Securities

10. The New York Attorney General began an investi- gation of Monster Energy Drinks (Monster Beverage), Pepsi’s AMP (PepsiCo), and 5-Hour Energy Drinks (Living Essentials) to determine whether the compa- nies were adequately disclosing the amount of caf- feine in their drinks. The investigation focuses on the fact that there are other ingredients in the drinks, such as black tea extract and guarana, that are disclosed on the labels of the drinks, but the labels don’t disclose that there may be additional caffeine in the additional ingredients.

The Food and Drug Administration (FDA) has already issued a warning about combining these energy drinks with alcohol consumption because of several resulting deaths. In addition, the Department of Health and Human Services (HHS) has issued a report warning about the negative health impact of excessive caffeine consumption. The report documented data from emergency room physicians about young people requiring emergency room treatment because of con- sumption of alcohol and energy drinks. Neither agency has, however, taken any action against the makers of these drinks.

List all of the applicable layers of law involved in this energy drink situation. What statutory interpreta- tions do you think there will have to be as a result of the investigation? (Nelson D. Schwarz, “New York State Is Investigating Energy Drink Makers,” New York Times, August 29, 2012, p. B1.)

Economics, Ethics & the Law The Cost of Corporate Wrongdoing

Read and analyze “Paying the Piper: An Empirical Examination of Longer-Term Financial Consequences of Illegal Corporate Behavior,” 40 Academy of Manage- ment Journal 129 (1997), by Melissa S. Baucus and David A. Baucus. Then answer the following questions.

a. What financial impact does illegal corporate behavior have on a company?

b. How long does a company feel the impact of illegal behavior?

c. How does the market react to illegal corporate behavior?

d. What are the financial costs of violating the law?

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Chapter 1 Introduction to Law 23

n ot e s 1. Reprinted with permission of Thomson Reuters.

2. Oliver Wendell Holmes, “Natural Law,” 32 Harvard Law Review 40 (1918). Copyright © 1918 by The Harvard Law Review Association.

3. From My Philosophy of Law by Roscoe Pound. © 1941 West Publishing Corporation. Reprinted with permission of West Group.

4. Douglas Jehl, “Head of Inquiry on Iraq Abuses Now in Spotlight,” New York Times, May 11, 2004, A1, A12.

5. Id.

6. Mark Scott, “The Bumps in Uber’s Fast Lane,” New York Times, July 8, 2015, p. B1.

7. Steve DiMeglio, “Golf Rule Could Go to Court,” USA Today, May 22, 2013, p. 1C.

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24

Chapter

Business Ethics and Social Responsibility2 If we were to make a list of the headlines of the past 20 years, we would realize that we have been through two stock market and economic collapses, scan- dals with performance-enhancing drugs in sports, car manufacturers falsifying car emissions through software programs, food producers knowingly selling salmonella-contaminated products, and mortgage foreclosures based on robo signatures. We would find fake courses for student-athletes at universities and cheating scandals in high schools, colleges, and on the SAT exams. And then we would recall that bank traders were rigging currency exchange rates even as CEOs were convicted for knowingly violating safety standards. We witnessed the largest Ponzi scheme in the history of the world, one that was masterminded by the former chairman of NASDAQ. World soccer offices were raided one morn- ing because of a multicountry bribery investigation. And a new book explains the rules for young people beginning their business careers with Rule #176 being, Don’t steal more than $3.00 of office supplies per quarter.

What happened to ethics? Is doing business just a matter of lying and getting away with it? Does anybody really care about ethics in business now? Has soci- ety drifted, and is business conduct just a reflection of changing ethical norms? And what does it mean to be ethical in our lives and in business? This chapter dis- cusses these questions and answers several others: What is ethics? How does ethics affect me? What is business ethics? Why is business ethics important? What ethical standards should a business adopt? How do employees recognize ethical dilemmas? How are ethical dilemmas resolved? How does a business create an ethical atmosphere?

Update For up-to-date news on ethical issues, go to mariannejennings.com

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25

The chapter’s opening “Consider . . .” teaches us that often we look at what com- panies and business executives say and do and the fact that the companies are doing well and assume that they must all have high ethical standards. The quotes are ironic because these individuals and/or their companies then crossed the ethi- cal lines they touted as standards.

We look at these individuals’ behaviors and wonder why they thought they could get away with their poor ethical choices or why they believed they were immune from the laws and our ethical standards. We like to think of ourselves as so different from those who cross ethical and/or legal lines. But all of them were col- lege graduates, nearly all with business degrees. All of them were respected by their friends and were active in community projects and institutions. These individuals were “good” people, but they lost sight of personal ethics, business ethics, and the importance of ethics in success. Before they committed their business crimes, the worst that could have been said about many white-collar criminals who are serving six-month to 25-year prison sentences is that they had parking and speeding tickets. Keeping ethics with us, in life and in business, can help us avoid the kinds of mis- takes that so many bright and capable businesspeople have made. But, we wonder, what are ethics? How do we know when we have them? How do we keep them when we face pressures, whether on an important exam or in meeting the quarterly numbers or our sales quota at work? This chapter answers these questions.

Goodness is the only investment that never fails. Henry D. THoreau Walden, “Higher Laws”

Of all the passions, the passion for the Inner Ring is most skillful in making a man who is not yet a very bad man do very bad things. C.S. LewiS “The Inner Ring”

A bad reputation is like a hangover. It takes a while to get rid of, and it makes everything else hurt. JameS PreSTon Former CEO, Avon

There is a big difference between what we have the right to do and what is right. Hon. JuSTiCe PoTTer STewarT Associate Justice, U.S. Supreme Court, 1958–1981

P = f(x) The probability of an ethical outcome is a direct function of the amount of money involved; the more money, the less likely the ethical outcome. CFa inSTiTuTe

Consider . . . 2.1 1. Who said, “I have done absolutely nothing

wrong”?

2. What CEO said, “In today’s regulatory environ- ment, it’s virtually impossible to violate the rules. It’s impossible for a violation to go undetected, certainly not for a considerable period of time”?

3. What CEO said, “We are the good guys. We are on the side of angels”?

4. Who said, “Go after the men who seek out prostitutes”?

5. Who said, “It’ll give me a chance to show my innocence”?

6. What company had a 64-page, award-winning code of ethics?*

*ANSWERS: 1. Former Illinois governor Rod Blagojevich, charged with attempting to fill President Obama’s Senate seat in exchange for favors and perks and convicted of lying to the FBI. 2. Bernie Madoff, former CEO of Bernard L. Madoff Investment Securities LLC, a firm that perpetrated a $50 billion Ponzi scheme. 3. Jeffrey Skilling, former CEO of Enron, and Lloyd Blankfein, CEO of Goldman Sachs. 4. Former New York governor Eliot Spitzer, in 2004, when he was establishing a task force as New York attorney general to halt prostitution in New York. Mr. Spitzer resigned when his long-standing relationship with a call girl was uncovered in a sting operation. 5. John Kinnucan, former owner of Broadband Research LLC, a Wall Street analyst firm, who later entered a guilty plea to all charges of insider trading. 6. Enron.

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26 part 1 Business: Its Legal, Ethical, and Judicial Environment

2-1 What Is Ethics? When we learn that the employees and administrators in the Veterans Administra- tion were falsifying the length of patient queues for medical care in order to ensure their bonuses and good performance evaluations, we label that conduct “uneth- ical.” When we read about underinflated footballs in the NFL, we use the term unethical. When we discover the young CEO of a company has raised the price on a life-saving drug 5,000%, we feel that something is just not right. Uber charges a $10 cancellation fee if you do not cancel within five minutes after the driver accepts. But 15 minutes after you have accepted, the Uber driver is not there, so you take a cab because you do not want to be late. Uber drivers could simply stay in one place or be deliberately late and make money from cancellations. Or the Uber driver cancels, and you have to make a last-minute reservation, something that ups your fare. Again, drivers could game this policy to make money. “This is not fair” is our response.

2-1a “It’s Just Not Right!”

We read about these types of situations in the newspaper each day. From politics to journalism to business to our favorite sports and Hollywood icons, references to ethics run through the stories. But we also face ethical dilemmas ourselves. Two students purchase tickets at a theater to see Star Wars: The Force Awakens, and when they emerge from the theater, they realize they are in an open area with access to other theaters. If they wanted to, they could slip into The Revenant or another movie without paying for another ticket. “Who’s to know?” they might think. “Hollywood makes too much money anyway.” “It doesn’t really hurt anyone.” These thoughts are similar to those that may have run through the minds of the VA administrators, the quarterback and the CEO who did not analyze the risk factors in their conduct. Although we may believe we are different from business execu- tives and others involved in scandals, we all face ethical dilemmas each day. Do I tell the clerk that he gave me too much change? Do I tell the lender on my loan application that my salary was just cut 25%? Do I go back to pay for the laundry detergent that slipped through on the bottom of my cart? Do I do what my boss says when he tells me to write a fake review online for our company’s services? Do I tell a potential buyer of my car about the hairline crack in the engine block? Do I tell my clients that I am selling off the investments I am trying to get them to buy?

The fact pattern changes slightly. The parties’ names and the subject matter vary, but the ethical issues are the same. Some conduct is more harmful, such as those situations in which a criminal statute is violated. Still, regardless of the law, we look at the conduct of VA employees, the quarterback, the students in the the- ater, the company employee writing reviews, and the seller of the car, and we con- clude, “It’s just not right!” We probably agree that they all behaved unethically. We may not be able to zero in on what bothers us about their conduct, but we know an ethics violation, or an ethical breach, when we see one.

2-1b Normative Standards: How We Behave to Keep Order

But what do we mean when we say that someone has acted unethically? Ethical standards are not the standards of the law. In fact, they are a higher standard. Sometimes referred to as normative standards in philosophy, ethical standards are the generally accepted rules of conduct that govern society. Ethical rules are both

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Chapter 2 Business Ethics and Social Responsibility 27

standards and expectations for behavior, and we have developed them for nearly all aspects of life. For example, no statute in any state makes it a crime for someone to cut in line in order to save the waiting time involved by going to the end of the line.1 But we all view those who “take cuts in line” with disdain. We sneer at those cars that sneak along the side of the road to get around a line of traffic as we sit and wait our turn. We resent those who tromp up to the cash register in front of us, ignoring the fact that we were there first and that our time is valuable too.

2-1c Line-Cutting and ethics

If you have ever resented a line-cutter, you understand ethics and have applied ethical standards in life. Waiting your turn in line is a societal expectation. “Wait- ing your turn” is not an ordinance, a statute, or even a federal regulation. “Waiting your turn” is an age-old principle developed because it was fair to proceed with first in time, first to be served. “Waiting your turn” exists because large groups wait for the same road, theater tickets, or fast food at noon in a busy downtown area. We recognize that lines ensure order and that waiting your turn is the just way to allocate the limited space and time allotted for the traffic, the tickets, or the food. “Waiting your turn” is an expected but unwritten behavior that plays a criti- cal role in an orderly society.

So it is with ethics. Ethics consists of those unwritten rules we have developed for our interactions with each other. These unwritten rules govern us when we share resources or honor contracts. “Waiting your turn” is a higher standard than the laws passed to maintain order. Those laws apply when individuals use physi- cal force or threats to push to the front of the line. Assault, battery, and threats are forms of criminal conduct for which the offenders can be prosecuted. But the law does not apply to the stealthy line-cutter who simply sneaks to the front, perhaps using a friend and a conversation as a decoy. No laws are broken, but the notions of fairness and justice are offended by one individual putting him or herself above others and taking advantage of others’ time and position.

Because line-cutters violate the basic procedures and unwritten rules for line formation and order, they commit an ethical breach. We don’t put line-cutters in jail, but we do refer to them as unethical. Other examples of unethical behavior also carry no legal penalty. A married person who commits adultery does not com- mit the type of crime that lands you in jail but does create a breach of trust with his or her spouse. We do label their conduct with adjectives such as unfaithful and even use a lay term to describe adultery: cheating.

Speaking of cheating, looking at someone else’s paper during an exam is not a criminal violation. If you cheat on a test, your professor may sanction you and your college may impose penalties, but the county attorney will not prosecute you for cheating. Your conduct is unethical because you did not earn your standing and grade under the same set of rules applied to the other students. Just like the line-cutter, your conduct is not fair to those who spent their time studying. Your cheating is unjust because you are getting ahead using someone else’s work.

These examples of cutting in line, committing adultery, and cheating on exams bring certain common adjectives to our minds: “That’s not fair!” “That was dishonest!” “That was unjust!” You have just defined ethics for yourself. Ethics is more than com- mon, or normative, standards of behavior. Ethics is honesty, fairness, and justice. The principles of ethics, when honored, ensure that the playing field is level and that we earn our achievements by using our own work and ideas. Being ethical means being honest and fair in our interactions with each other, whether personally or in business.

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28 part 1 Business: Its Legal, Ethical, and Judicial Environment

2-2 What Is Business Ethics? Many have referred to “business ethics” as an oxymoron. The little jibe suggests that it is impossible to be in business and be ethical. Some see the pursuit of profit as being at odds with ethics. However, the term business ethics is actually a complex one with many layers of meaning. The first layer consists of basic values (covered in the following section), such as being honest, keeping promises, and not taking things that do not belong to you. Another layer consists of notions of fairness (also covered in the next section), such as how we treat others, including customers and employees who report to us. Still a third layer consists of issues related to how a business interacts with the community, the environment, and its neighbors.

For the Manager’s Desk

Re: a State of the Union on academic ethics

Ethics is not so difficult to understand, but it is difficult to practice. Data are available on the ethics of everyone from school-age chil- dren to graduate school students. In 1992, the Josephson Institute found that 61% of high school students reported that they had cheated at least once during a school year. By 2008, that number had risen slightly to 64% but then fell to 49% in 2012.2 Accord- ing to the Center for Academic Integrity, about 75% of college students confess that they have cheated in some way in college.3

The rate for graduate students is 50%. They describe taking notes and answers into exams, copying others’ work, downloading and buying term papers from the Internet, and not contributing to team projects but still receiving credit for them. Graduate students at Columbia University extended

the time clock for an online exam. Harvard Business School candidates tapped into the school’s admission database. Thirty-four students at Duke’s Fuqua Business School faced discipline for collaborating on a take- home exam. Several New York high school students faced criminal charges related to a cheating conspiracy on SAT exams. One student took the exam for 20 students, who paid him an average of $2,500 for his efforts at scholastic identity deception. Sixty-four students at Dartmouth were accused of cheating in a course called “Sports, Eth- ics, and Religion.” The students were using handheld clickers for other students to make it seem as if those students were in class doing the work when, in fact, they were absent. Attendance and participation were 15% of the students’ grades in the class.

Why do we worry about ethics in school? What is the point of teaching young peo- ple to be honest? Why do we impose penalties for cheating? How does cheat- ing affect those who do not cheat? What are some of the long-term consequences

if those who cheat are permitted to pass courses, graduate with honors, and pur- sue careers in their fields? What happens when the 75% of those who admit cheat- ing in college reaches 100%?

Consider . . . 2.2

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Chapter 2 Business Ethics and Social Responsibility 29

The three layers of business ethics bring back into the purely quantitative models of business the elements of a fair playing field. Business ethics involve the study of fairness and ethical standards amidst the pressure of earning a profit and providing returns to shareholders and others who have invested in the business.

A business faces the special problem of having to develop ethical standards for a group of people who work together toward the common goal of profit for the firm. Individuals in the group have personal ethical standards, but too often employees find that the ethical standards imposed by managers at the top of a company result in possible harm to those at the bottom or to others outside the firm. An employee may feel compelled to resolve the conflict between loyalty to an employer and the performance of an illegal or unethical act ordered by that employer by simply following the employer’s direction. In other words, in devel- oping standards of business ethics, an employee has personal economic interests in continuing employment that may compromise personal ethical standards. Businesses face the additional challenges of developing business standards that are consistent with individual standards and helping employees understand that their personal standards of honesty and fairness need not be different at work. To accomplish this meshing, business managers should understand the various sources of ethical standards.

2-2a ethical Standards: positive Law and ethics

Ethical standards can be derived from different sources, and ethicists often debate the origins of these standards. One theory is that our ethical standards are the

Ethical Issues

The stories abound. Footballs are baked, microwaved, and placed in the dryer— actions that supposedly make the footballs more pliant, easier to hold, easier to pass, and easier to send farther. The Colorado Rockies place their baseballs in a humidor because if the baseballs dry out, they travel farther, especially when they are playing in the mile-high city of Denver. Phil Jackson and Bill Bradley have confessed to deflating basketballs, and, of course, Tom Brady is suspected of deflating the Patriots’ foot- balls. If you have fake crowd noise in an arena, it can psyche out the opposition.

And the pros are not alone. The Jackie Robinson West Little League team out of Chicago, Illinois, won the national Lit- tle League championship in August 2014. However, after the team won the title, the League discovered that the team had

falsified boundaries in order to get some ringers onto the team and also falsified documents to qualify other players. Jackie Robinson West was stripped of its nation- al title as its leader stated, “For more than 75 years, Little League has been an organization where fair play is valued over the importance of wins and losses.”4 The announcement said that although adults were responsible for the conduct and not the kids, the League was still obligated to preserve the “integrity” of the game: “For more than 75 years, Little League has been an organization where fair play is valued over the importance of wins and losses.”5

Are all of these examples cheating? Are the behaviors ethical? Are all of these ways to gain an advantage in the game? What if the rules do not explicitly prohibit what is being done in each of these cases?

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30 part 1 Business: Its Legal, Ethical, and Judicial Environment

same as actual or positive law and that our ethical decisions are made simply upon the basis of whether an activity is legal. Positive law, or codified law, establishes one standard for ethical behavior. But compliance with positive law is not always ethical. For example, one of the most frequently asked questions about the 2008 financial crisis is, “How come no one has been convicted of any crimes?” The fed- eral government brought several cases against fund managers and analysts in an attempt to attain convictions. However, the juries returned acquittals in the cases. In one of the cases, the jury sent the judge a note along with its acquittal that read, “This verdict should not deter the SEC from continuing to investigate the financial industry, review current regulations and modify existing regulations as necessary.” The jury found that there was no criminal conduct because there was no violation of the law, but they called the conduct “appalling.” The financial crisis acquittals illustrate that ethical and legal standards are not the same. Conduct may be legal but not ethical.

Reprinted with permission of Jim Brown (c) 1991.

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Chapter 2 Business Ethics and Social Responsibility 31

2-2b ethical Standards: Natural Law and ethics

Others believe that our ethical standards are derived from a higher source and that they are universal. Often labeled natural law, this school of ethical thought sup- ports the notion that some standards do not exist because of law (and, indeed, may exist despite laws). For example, as discussed in Chapter 1, at one time the United States permitted slavery. Even though the positive law allowed the activity and the standard of positive law considered slave ownership ethical, natural law dictated that the deprivation of others’ rights was unethical.

2-2c ethical Standards: Moral Relativism and ethics

Moral relativism (also called situational ethics) establishes ethical standards accord- ing to the situation in which the dilemma is faced. Violation of the law, for exam- ple, is permitted if you are stealing to provide food for your starving family. Under moral relativism, adultery is justified when you are caught in an unhappy mar- riage, as is the business situation in which you engage in lying to avoid offending a coworker or a customer. Bribery is illegal in the United States, and most compa- nies even have firm policies against accepting gifts, because doing so may create conflicts of interest, but some companies still use a relativist approach and argue that being competitive in international markets is different. They adhere to a phi- losophy of “When in Rome, do as the Romans do,” following the standards and customs in a given country even though those same behaviors in the United States would be unacceptable and even illegal.

2-2d ethical Standards: Religion and ethics

A final source of moral standards is religious beliefs or divine revelation. The source of standards can be the Bible, the Koran, or any inspired book or writing that is the cornerstone of a religion or faith and believed to have resulted from divine revelation.

2-3 What Are the Categories of Ethical Dilemmas?

Regardless of the root or source of a company’s or individual’s ethical standards, certain categories of conduct involve ethical issues. The following 12 categories were developed and listed in Exchange, the magazine of the Brigham Young Uni- versity School of Business.

2-3a taking things that don’t Belong to You

Everything from the unauthorized use of the Pitney-Bowes postage meter at your office for mailing personal letters to exaggerations on travel expenses to the down- loading of music from the Internet without authorization to not working your required hours at your job but accepting full pay as if you had belongs in this cat- egory of ethical violations. A CFO (chief financial officer) of a large electric util- ity reported that, after taking a cab from LaGuardia International Airport to his midtown Manhattan hotel, he asked for a receipt. The cab driver handed him a full book of blank receipts and drove away. Apparently, the problem of accurately reporting travel expenses involves more than just employees.

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32 part 1 Business: Its Legal, Ethical, and Judicial Environment

2-3b Saying things You Know are Not true

A salesperson who tells a potential customer that a product carries a “money-back guarantee” when the salesperson knows that only an exchange is possible has said something that is not true, committed an ethical breach and possibly a violation of the law, and misled the customer. If a car dealer assures a customer that a car has not been in an accident and it has, an ethical breach has occurred. If a homeowner tells a buyer that a home has not had any water damage when, in fact, the base- ment had been flooded, this false statement is an ethical breach too.

2-3c Giving or allowing False Impressions

An urban legend that has circulated among marketing departments around the country is the story of an infomercial that offered two CDs with the hits of the 1980s on them. The infomercial emphasized over and over again, “All songs by original artists.” Even the CDs carried the line, “All songs by original artists.” When pur- chasers read the label with a closer eye and listened to the CDs, they discovered that all the songs were performed by one group, a group called “The Original Art- ists.” While technically true, the advertising left a false impression with customers who assumed they would be buying songs as performed by the recording artists who made the songs popular.

Ethical Issues

The temptation is remarkable. The run is long. The body screams, “No more!” So, it happened again in the New York City Marathon for 2008. Cheating on this form of a physical final examina- tion became international news when, in 1979, Boston Marathon runner and winner Rosie Ruiz combined her running with a hitch on the train to earn first place. She repeated the ploy in the 1980 Boston Marathon, when her creative approach was discovered.

The New York Road Runners Club, the sponsors and managers of the New York City Marathon, disclosed multiple subway riders in their 2008 race on the eve of the 2009 Marathon with the hope of encourag- ing the 42,000 runners to go the distance, the real distance. For 2008, there were 71 runners disqualified from the race, 46 of them for taking the subway in order to go the distance. The club discovers these free-riders when it investigates what it believes to be extraordinary times for run- ners who have not been able or should not

have been able to achieve their recorded times. In at least two situations, the run- ners who took the subway also took first place in their age categories and deprived the real winners of their Tiffany trophies as well as the thrill of quaffing the elixir of victory on the day of the marathon. The real winners in these age categories from 2008 were not notified of their victories until July 2009 because of the time the investiga- tions take.

A spokesperson from the Road Run- ners Club said that the greatest temptation in the race comes when the runners enter Manhattan via the Queensboro Bridge. That entry to the city is close to Central Park and the finish line, but the race first takes a turn there for another 10 miles into Harlem and the Bronx. Most cheaters simply skip those boroughs and head right into Central Park and the finish line.

Are there any laws that govern this situ- ation with the runners? Discuss the ethical issues of the runners. Is anyone really hurt if runners cheat?

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Chapter 2 Business Ethics and Social Responsibility 33

2-3d Buying Influence or engaging in Conflict of Interest

A company awards a construction contract to a firm owned by the father of the state attorney general while the state attorney general’s office is investigating that company. A county official who has the responsibility for selecting the contractor who will build the county’s new baseball stadium travels around the country at the contractor’s expense to view existing stadium sites. The county official should see as many sites and samples of work as there are bidders on the new stadium, but when the contractors pay, there is an ethical issue. A physician researcher whose work was funded by Coca-Cola concluded that the major influence in childhood obesity was lack of exercise, not enough sleep, and too much television. Other experts believe that soft drinks, such as those produced by Coca-Cola, are a major contributor to childhood obesity. The issue of the $29 million for the research com- ing from Coca-Cola resulted in questions about the study and its conclusions.

Those involved in these conflict situations such as these often protest, “But I would never allow that to influence me.” That they have to insist they are not or would not be influenced is evidence of the conflict. Whether the conflict can or will influence those it touches is not the issue, for neither party can prove conclu- sively that a quid pro quo was not intended. The possibility exists, and it creates suspicion.

Dr. Drew Pinsky, the host of a cable health show, recommended GlaxoSmithKline’s antidepressant Wellbutrin to physicians and patients but did not disclose that he re- ceived $275,000 from Glaxo-SmithKline for “services related to Wellbutrin.” Dr. Drew, as he is known on television, participated in town hall meetings, published writings, and hosted multimedia activities that tout- ed the benefits of Wellbutrin. When asked about his failure to disclose the payments, Dr. Drew said that all of his commentary and writing were consistent with his clinical experience and that, “how does a doctor choose one specific antidepressant medi- cation for a certain patient from the many excellent medications available? The vast majority of doctors attending my lectures stated that they felt I answered this ques- tion and did so in an unbiased and scien- tifically sound manner.” Is there a conflict of interest? Did Dr. Drew manage the con- flict correctly? Is there any significance to Dr. Drew’s statement that doctors felt that he answered their questions in a scientific and unbiased manner?

(Jeanne Whalen, “‘Dr. Drew’ Was Paid by Glaxo,” Wall Street Journal, July 5 2012, B3.)

Steps for Analyzing Ethical Dilemmas and Case Studies in Business

1. Make sure you have a grasp of all the available facts.

2. List any information you would like to have but don’t and what assumptions you would have to make, if any, in resolving the dilemma.

3. Take each person involved in the dilemma and list the concerns they face or might have. Be sure to consider the impact on those not specifically mentioned in the case. For example, product safety issues don’t involve just engineers’ careers and company profits; shareholders, customers, customers’ families, and even communities supported by the business are affected by a business decision on what to do about a prod- uct and its safety issue.

Consider . . . 2.3

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34 part 1 Business: Its Legal, Ethical, and Judicial Environment

4. Develop a list of resolutions for the problem. Apply the various models for reaching this resolution. As you apply the various models to the dilemma, you may find additional insights for questions 1, 2, and 3. If the breach has already occurred, consider the possible remedies and develop sys- temic changes so that such breaches do not occur in the future.

5. Evaluate the resolutions for costs, legalities, and impact. Try to determine how each of the parties will react to and be affected by each of the resolu- tions you have proposed.

6. Make a recommendation for the actions that should be taken.

Some Help for You on the Dr. Drew Case

THINK: To help in your analysis, consid- er the following list of the parties affected by this dilemma.

• GlaxoSmithKline—the company’s credibility is affected by Dr. Drew’s conduct, recommendations, and disclosures.

• The doctors who listened to Dr. Drew’s recommendations without knowing about his compensation.

• The patients who asked for or used the drug Wellbutrin without knowing about Dr. Drew’s conflict.

• Other drug manufacturers whose drugs may have been more appro- priate or worthy of recommendation but were not mentioned because of Dr. Drew’s loyalty to Wellbutrin and GlaxoSmithKline.

APPLY: To further assist you in your analysis, consider the following categories:

• Conflict of interest: Dr. Drew had an obligation to disclose his financial interest in promoting the drug. Those who listened to his analysis, read his recommendations, or used the drug deserved to know before they made their decision that he did have a finan- cial interest.

• Giving or allowing false impressions: Dr. Drew gave the impression of being a detached clinician who had pre- scribed the drug and had patients who benefited, but he did not disclose that he was paid by GlaxoSmithKline for his work in recommending the drug.

ANSWER: Because the conduct has already occurred, your role becomes one of recommendation. You need to provide a recommendation that affords protection to all the parties listed as affected by the con- duct. For example, to protect the credibility of the pharmaceuticals, the companies and their experts need to develop a policy on accepting compensation, as well as one for disclosures of these programs of compen- sation. These policies may require not only disclosure but also prohibitions on certain types of conduct (such as doctors receiving stock ownership in the pharmaceutical com- panies) if the conflict seems too difficult to overcome. Two approaches can be taken in regard to a conflict of interest: (1) don’t do it, or (2) disclose the conflict to those affected. Sometimes disclosure is insufficient and one party must not engage in the conduct. Regulators may force these new standards on physicians and pharmaceutical firms.

2-3e Hiding or divulging Information

Taking your firm’s product development or trade secrets to a new place of employ- ment constitutes an ethical violation: divulging proprietary information. Failing to disclose the results of medical studies that indicate that your firm’s new drug has significant side effects is an ethical violation: hiding information that the product could be harmful to purchasers.

2-3f taking Unfair advantage

One of the areas the Federal Communications Commission continues to investigate and assess fines for is Wi-Fi blocking. When hotels host major company meetings

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Chapter 2 Business Ethics and Social Responsibility 35

or trade associations, suppliers and vendors often pay fees to participate in those meetings. Hotels often scramble or blocks these vendors’ access to their own hot spots or Wi-Fi services so that they are forced to pay for access to the hotel’s Wi-Fi, something that is an extra and expensive fee. The vendors and suppliers are pay- ing for their own Wi-Fi, but the hotel is blocking that access in order to collect fees for something they already have.

Eagle Gate College hired an admission consultant from Stevens-Henager College named Janna Miller. Ms. Miller hired others from Stevens-Henager to join her at Eagle Gate. Those who came along to join Ms. Miller also brought along lists of potential students for recruiting purposes. Those lists of potential students are very valuable to for-profit colleges because of the need for new students. In addition, the information

left behind at Steven-Henager was altered so that the database of potential recruits could not be reached due to incorrect phone numbers and/or e-mails. Stevens-Henager could not contact the potential students from their own data base.

Are there ethical issues in this situa- tion? Or is this just competition? [Stevens-Henager College v Eagle Gate Col- lege, 248 P.3d 1025 (Utah 2011)]

Consider . . . 2.4

2-3g Committing acts of personal decadence

While many argue about the ethical notion of an employee’s right to privacy, it has become increasingly clear that personal conduct outside the job can influence performance and company reputation. During 2012, a number of CEOs and the former head of the CIA, General David Petraeus, had to resign their positions because of affairs with employees or extramarital affairs. The CEOs’ personal con- duct created tension within their companies and resulted in loss of respect from the employees. For General Petraeus, his role as the chief executive for the orga- nization protecting national security was in jeopardy because the affair with a younger woman left him vulnerable to threat and also meant he was not comply- ing with the agency standards that applied to all employees. Personal conduct by those who are in leadership positions affects organizational reputation, morale, and credibility.

2-3h perpetrating Interpersonal abuse

A manager sexually harasses an employee. Another manager is verbally abusive to an employee. Still another manager subjects employees to humiliating correction in the presence of customers. In some cases, laws protect employees. But at the heart of this category is unfair treatment.

2-3i permitting Organizational abuse

Many multinational firms, such as Walmart, Ikea, Apple, and Nike, have faced issues of organizational abuse. The unfair treatment of workers in international operations appears in the form of child labor, demeaning wages, excessive work- ing hours, and factory safety standards. Even though a business cannot change the culture of another country, it can perpetuate—or alleviate—abuse through its operations there.

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36 part 1 Business: Its Legal, Ethical, and Judicial Environment

2-3j Violating Rules

Many rules, particularly those in large organizations that tend toward bureaucracy from a need to maintain internal controls or follow lines of authority, seem burden- some to employees trying to serve customers and other employees. However, those rules do serve a purpose and should be followed so that harms are avoided. For example, Yale University senior Michele Dufault was killed in a lab accident when her hair was caught in a lathe in the machinery lab. The physics and astronomy major did not follow the simple safety rule of tying your hair back before begin- ning work with the heavy equipment. She was also working in the lab at 2:30 a.m., a time when there were no people near the lab, and she violated a basic safety stan- dard of not working alone around the large machines. Sometimes these rules seem superfluous and we feel that we have more expertise and experience and need not follow them. However, there is an ethical issue here in that as a student she had agreed to follow the safety rules of the lab and the university. Not following those rules was a breach of that promise. As a result of Ms. Default’s accident, Yale and other colleges and universities have revamped their rules, enforcement, and train- ing to encourage compliance.

2-3k Condoning Unethical actions

In this breach of ethics, the wrong results from the failure to report the wrong. What if you witnessed a fellow employee embezzling company funds by forging his signature on a check that was supposed to be voided? Would you report that violation? A winking tolerance of others’ unethical behavior is in itself unethical. Suppose that as a product designer, you were aware of a fundamental flaw in your company’s new product—a product predicted to catapult your firm to record earnings. Would you pursue the problem to the point of halting the distribution of the product? Would you disclose what you know to the public if you could not get your company to act? The German auto manufacturer Volkswagen revealed that its engineers had installed emissions test–defeating software, and while many engineers and employees were aware of the illegal conduct, no one spoke up about the problem or objected. One former employee of Lehman Brothers, whose sales efforts and structuring of securities investments “helped lead to the demise of the bank he loved and to an economic unraveling worldwide[,] confessed, ‘I have blood on my hands.’”6 His remorse comes from his failure to speak up and raise his concerns about the ethical issues he saw even as he was rewarded for his work.

2-3l Balancing ethical dilemmas

In some situations, the answers are neither right nor wrong; rather, the situations present dilemmas to be resolved. For example, Google has struggled for years with its decision to do business in the People’s Republic of China because of known human rights violations and censorship by the government there. Its eventual decision was to remain in China despite the government’s censorship of its search engine there. Other companies debated whether to do business in South Africa when that country’s government followed a policy of apartheid. In some respects, the presence of these companies would help by advancing human rights and, cer- tainly, by improving the standard of living or communications for at least some international operations workers. On the other hand, their presence could help such governments sustain themselves by enabling them to point to economic suc- cesses despite human rights violations.

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Chapter 2 Business Ethics and Social Responsibility 37

2-4 Resolution of Business Ethical Dilemmas So far, you know what business ethics is and you have a list of the areas that cover most ethical dilemmas. But if you were faced with an ethical dilemma, how would you resolve it? The resolution of ethical dilemmas in business is often difficult, even in firms with codes of ethics and cultures committed to compliance with ethical models for decision making. Managers need guidelines for making ethical choices. Several prominent scholars in the field of business ethics have developed models for use as guides in difficult situations. This section covers those models.

2-4a Blanchard and peale

The late Dr. Norman Vincent Peale and management expert Kenneth Blanchard offer three questions that managers should ponder in resolving ethical dilemmas: “Is it legal?” “Is it balanced?” “How does it make me feel?” If the answer to the first question, “Is it legal?,” is no, for business ethics purposes, your ethical anal- ysis is done. While there is room for conscientious objection to many laws on an ethical basis, a manager is not given the authority to break the law, and agencies such as the Internal Revenue Service (IRS) and the Securities Exchange Commis- sion (SEC) are not known for helping companies ease their consciences through refusals to pay taxes or file required securities disclosures and reports. The Hewlett-Packard board hired private investigators to determine the source of leaks about its board meetings, activities, and decisions. The investigators hired (actually a subcontractor of a contractor) used a technique known as “pretexting” in the trade. They posed as others in order to obtain access to phone records of directors and reporters to determine who was calling who, an activity prohibited by a California statute.7 Eventually, the investigators as well as some within the company, including HP’s ethics officer, were charged with violations. These man- agers failed to stop when the answer to the question of legality was “no.”

Answering the second question, “Is it balanced?,” requires a manager to step back and view a problem from other perspectives—those of other parties, owners, shareholders, or the community. For example, an M&M/Mars cacao buyer was able to secure a low price on cacao for his company because of pending govern- ment takeovers and political disruption. M&M/Mars officers decided to pay more for the cacao than the negotiated figure. Their reason was that someday their com- pany would not have the upper hand, and then they would want to be treated fairly when the price became the seller’s choice.

Answering “How does it make me feel?” requires a manager to do a self- examination of the comfort level of a decision. Some decisions, though they may be legal and may appear balanced, can still make a manager or employee uncomfort- able. For example, Gil Meche, a pitcher for the Kansas City Royals, was entitled to $12 million in compensation for his final contract year with the Royals. However, his shoulder and arm had significant pain from years of pitching, and he opted not to have surgery for repairs. Under the terms of his contract, all he had to do was report for spring training and the season and go through the motions of rehabili- tation. Mr. Meche retired because he said, “When I signed my contract, my main goal was to earn it. Once I started to realize I wasn’t earning my money, I felt bad. I was making a crazy amount of money for not even pitching. Honestly, I didn’t feel I deserved it. I did not want to have those feelings again.”8 Known as the element of conscience, this test for ethics requires businesspeople to find the source of their discomfort in a particular dilemma or proposed decision.

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38 part 1 Business: Its Legal, Ethical, and Judicial Environment

2-4b the Front-page-of-the-Newspaper test

One simple ethical model requires only that a decision maker envision how a reporter would describe a decision on the front page of a local or national newspa- per. When Salomon Brothers illegally cornered the U.S. government’s bond mar- ket, the BusinessWeek headline read, “How Bad Will It Get?” Nearly two years later, a follow-up story on Salomon’s crisis strategy was headlined “The Bomb Shelter That Salomon Built.” During the aftermath of the bond market scandal, the interim chairman of Salomon, Warren Buffett, told employees, “Contemplating any busi- ness act, an employee should ask himself whether he would be willing to see it immediately described by an informed and critical reporter on the front page of his local paper, there to be read by his spouse, children, and friends. At Salomon we simply want no part of any activities that pass legal tests but that we, as citizens, would find offensive.”9

There are other examples, such as that involving the investigation of the Vet- erans Administration for its falsification of patient queues for treatment: “V.A. Officials Acknowledge Link between Delays and Patient Deaths.”10 You will be productive at work after reading this headline: “Secret Service May Have Turned ‘Lazy,’ Panetta Says.”11

When Wall Street firms were reporting multi-billion-dollar losses due to their highly leveraged portfolios of risky instruments, the headline on the cover of For- tune magazine read, “What Were They Smoking?” (November 26, 2007). The head- line test helps us to put our decisions into a longer-term perspective.

2-4c Laura Nash and perspective

Business ethicist Laura Nash has developed a series of questions that business man- agers should ask themselves as they evaluate their ethical dilemmas. One of the ques- tions is, “How would I view the issue if I stood on the other side of the fence?” For example, in 1993, federal guidelines required meat to be cooked to 140 degrees Fahr- enheit. At that time, however, the state of Washington proposed imposing a higher temperature requirement of 155 degrees. Burger King cooked its hamburgers to 160 degrees, and Wendy’s, Hardee’s, and Taco Bell cooked their meat to 165 degrees.

Health and food industry experts supported a minimum cooking temperature of 155 degrees to be certain E. coli bacteria are eliminated. Jack-in-the-Box followed the legal minimum of 140 degrees. Would you want that information as a consumer? Given the trend toward higher temperatures and the pending regulation, would you want your meat cooked to a higher temperature? Although the cooking temperature was legal, an ethical issue arises in continuing to follow only the law when health experts are concerned about the adequacy of the law. Jack-in-the-Box did, in fact, experience an E. coli outbreak: one child died, and 300 other customers became ill.12

Other questions in the Nash model include these: “Am I able to discuss my decision with my family, friends, and those closest to me?” “What am I trying to accomplish with my decision?” “Will I feel as comfortable about my decision over time as I do today?” The Nash model forces managers to seek additional perspec- tives as decisions are evaluated and implemented. For example, when the late William Aramony served as the CEO of United Way, he enjoyed such perks as an annual salary of close to $400,000, flights on the Concorde, and limousine service. Even though these benefits were about the same as those of other CEOs managing comparable assets, it would still be difficult to justify such benefits to a donor who earns $22,000 a year and has pledged 5% of it to United Way.

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Chapter 2 Business Ethics and Social Responsibility 39

2-4d The Wall Street Journal Model The Wall Street Journal model for resolution of ethical dilemmas consists of compli- ance, contribution, and consequences. Like the Blanchard–Peale model, any pro- posed conduct must first be in compliance with the law. The next step requires an evaluation of a decision’s contributions to the shareholders, the employees, the community, and the customers. For example, furniture manufacturer Herman Miller, in a decision that was prescient in relation to the sustainability initiatives of today, decided both to invest in equipment that would exceed the requirements for compliance with the 1990 Clean Air Act and to refrain from using rain forest woods in producing its signature Eames chair. The decision was costly to the shareholders at first, but ultimately they, the community, and customers enjoyed the benefits.

Finally, managers are asked to envision the consequences of a decision, such as whether headlines that are unfavorable to the firm may result. The initial conse- quence of Miller’s decisions was a reduction in profits because of the costs of the changes. However, the long-term consequences were the respect of environmental regulators, a responsive public committed to rain forest preservation, and Miller’s long-standing recognition as one of America’s top 20 corporate citizens.

2-4e Other Models

Of course, much simpler models for making ethical business decisions are avail- able. One stems from Immanuel Kant’s categorical imperative, loosely similar to the Golden Rule: “Do unto others as you would have them do unto you.” Treating others or others’ money as we would want to be treated is a powerful evaluation technique in ethical dilemmas. (See Exhibit 2.4 and p. 63 for more discussion.)

2-5 Why We Fail to Reach Good Decisions in Ethical Dilemmas

Very often, we look at the harmful conduct of corporate executives and won- der, “Where were their minds, and what were they thinking when they decided to engage in such bad behavior?” Often those involved did not walk through the steps in resolving ethical dilemmas discussed earlier. But they probably also slipped into rationalizations rather than analysis. The following sections provide a list and summary of each of the frequent statements of rationalization that we use to avoid facing ethical dilemmas (see Exhibit 2.1).

2-5a “Everybody Else Does It”

When former Tour de France winner (now stripped of those titles) Lance Arm- strong admitted that he had used performance-enhancing drugs throughout his career, he said, “I looked up the word ‘cheat’ in the dictionary and decided it didn’t apply, given that it meant ‘to gain an advantage on a rival or foe.’ I didn’t view doping that way. I viewed it as a level playing field.”13 “Everybody else does it” is a rationalization, but it is not an analysis of the ethical issues involved in conduct.

2-5b “If We Don’t Do It, Someone Else Will”

The rationalization of competition is one that finds us reasoning that if someone is going to do it and make money, it might as well be us. For example, a friend asks if

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40 part 1 Business: Its Legal, Ethical, and Judicial Environment

he can pay you for the use of your subway pass, a pass that says it is nontransfer- able. You could easily say, “If I don’t do it, he will just get someone else to do it, so I might as well benefit.” The fact that others may engage in unethical conduct does not require you to join them. Think through the consequences if we relied on this notion that they are going to do it anyway, so we might as well participate. There is an impact on the sale of tokens, the ability to trust pass-holders, and the overall revenues of the transportation system if everyone participates in such a sharing program.

2-5c “that’s the Way It Has always Been done”

Corporate or business history and business practices are not always sound. The fact that for years nothing has changed in a firm may indicate the need for change and an atmosphere that invites possible ethical violations. For example, when the New Orleans Saints bounty program was uncovered by the NFL, a program under which some players were able to double their salaries by taking out certain players or inflicting physical injuries on players in exchange for cash bonuses, the players all said that they came into the culture that had always done this kind of thing. They also said that they knew it was a mistake, but because it was accepted behav- ior in their organizations, they did it anyway.

2-5d “We’ll Wait until the Lawyers tell Us It’s Wrong”

Lawyers are trained to provide only the parameters of the law. In many situations, they offer an opinion that is correct in that it does not violate the law. Whether the conduct they have judged as legal is also ethical is a different question. Allowing law and lawyers to control a firm’s destiny ignores the opportunity to make wise and ethical choices. For example, the SEC has given very little guidance to com- panies and lawyers about when they need to disclose health issues of their CEOs. So, when the CEO of United Airlines had a heart attack, the company disclosed the heart attack and the interim plans for who would be running the company. However, the company did not disclose until after the surgery was completed that the CEO had a heart transplant. The airline had come through a rough time with its previous CEO resigning after questions emerged about his close relationships

Exhibit 2.1 the Language of Rationalization

“Everybody else does it.”

“If we don’t do it, someone else will.”

“That’s the way it has always been done.”

“We’ll wait until the lawyers tell us it’s wrong.”

“It doesn’t really hurt anyone.”

“The system is unfair.”

“I was just following orders.”

“You think this is bad, you should have seen . . .”

“It’s a gray area.”

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Chapter 2 Business Ethics and Social Responsibility 41

with New Jersey transit authorities and requests for additional gates at the New- ark airport. In light of an ongoing investigation, a new CEO was appointed, but his heart attack came within weeks of his taking over the helm. Struggling with stock price and transition issues, the information was not as forthcoming. The SEC rules do not mandate disclosure, but the ethical issues in this situation are different. (See Chapter 18 for more information on required disclosures.)

2-5e “It doesn’t Really Hurt anyone”

When we are the sole rubbernecker on the freeway, traffic remains unaffected. But if everyone rubbernecks, we have a traffic jam. If all of us made poor ethical choices, we would cause significant harm. A man interviewed after he was arrested for defrauding insurance companies through staged auto accidents remarked, “It didn’t really hurt anyone. Insurance companies can afford it.” The second part of his statement is accurate. The insurance companies can afford it—but not with- out cost to someone else. Such fraud harms all of us because we must pay higher premiums to allow insurers to absorb the costs of investigating and paying for fraudulent claims.

2-5f “the System Is Unfair”

Often touted by students as a justification for cheating on exams, this rationaliza- tion eases our consciences by telling us we are cheating only to make up for defi- ciencies in the system, yet just one person cheating can send ripples through an entire system. The credibility of grades and the institution come into question as students obtain grades through means beyond the system’s standards. In countries in which corruption is a way of life and government employees award contracts and rights to do business on the basis of payments rather than on the merits of a given company or its proposal, the bribery only results in greater unfairness within and greater costs to those countries. Many economists have noted that a country’s businesses and economy will not progress without some fundamental assurance of trust that comes through a belief that there is a level playing field where the quality of products and services matter.

2-5g “I Was Just Following Orders”

In many criminal trials and disputes over responsibility and liability, managers disclaim their responsibility by stating, “I was just following orders.” Sometimes, individuals should not follow the directions of supervisors because they have been asked to do something illegal or immoral. Judges who preside over the criminal trials of war criminals often remind defendants that an order is not necessarily legal, ethical, or moral. Values require us to question or depart from orders when others will be harmed or wronged. In the days prior to the financial collapse of MF Global, employees were asked to transfer funds from clients’ accounts in order to cover hedging losses, something that is prohibited by law. During the investiga- tion, the employees said that they did what they were ordered to do. However, the result was significant losses for their customers. The same scenario has emerged in the Volkswagen emissions scandal as employees noted that disobedience was not an option in their culture. When the allegations of prisoner abuse in Iraq emerged, along with photos, one of the first defenses raised by lawyers for the soldiers being court-martialed for their role in the abuses was, “I was just following orders.” Sometimes following orders is not the ethical thing to do.

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42 part 1 Business: Its Legal, Ethical, and Judicial Environment

2-5h “You think this Is Bad, You Should Have Seen . . .”

This rationalization finds employees looking back at earlier times and remind- ing others that the company’s safety policies or accounting practices used to be much worse. At one company, when some employees objected to backdating contracts to slip the earnings into the quarter, some employees reassured them by saying, “At least we’re not using the 35-day month we used to use to meet targets.”

2-5i “It’s a Gray area”

The gray area is a comfort level for us when we are in the midst of an ethical dilemma. Once we enter the gray area, we have a fine line that crosses into ille- gality and also an opportunity to explore an issue beyond bare legal require- ments. An attorney for former HP general counsel Ann Baskins says that Ms. Baskins realized after the fact that she should have focused on questioning whether the pretexting was ethical, not just on whether it was legal. “She regrets that she did not do so.”14 Kevin Hunsaker, a deputy general counsel and chief ethics officer, asked internal HP security employees about the legality of the pretexting operations, and one responded, “I think it’s on the edge, but above board.” Hunsaker responded with what have become the infamous words in the investigation: “I shouldn’t have asked.” “On the edge” and “in a gray area” often land us in legal difficulty and controversy. Even though many of the charges were dismissed or reduced, five individuals, including Mr. Hunsaker, were charged with criminal misconduct in the HP pretexting case, and the com- pany paid a $14 million fine to settle the charges.

Ethical Issues

Indy driver Danica Patrick gave an interview to Sports Illustrated writer and radio host Dan Patrick, a transcript of which follows.

Dan: If you could take a perfor- mance-enhancing drug and not get caught, would you do it if it allowed you to win Indy?

Danica: Well then it’s not cheating, is it? If nobody finds out?

Dan: So you would do it?

Danica: Yeah, it would be like finding a grey area. In motorsports we work in the grey areas a lot. You’re trying to find where the holes are in the rule book.

After the interview, in an interview with USA Today, Ms. Patrick indicated that she was just joking. The head of the USADA (U.S. Anti-Doping Agency) called the inter- view “totally irresponsible” and added, “Although joking about the use of danger- ous and unhealthy drugs that cheaters use to rob clean athletes of their dreams is no laughing matter.”

Identify the rationalizations in Ms. Patrick’s statements. Why do you think she answered the questions as she did? Was the joke still an ethical issue?

Sources: Danpatrick.com, http://www.sportsillustrated .cnn.com, accessed June 2, 2009; Eddie Pells, AP wire story, June 2, 2009. ©

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Chapter 2 Business Ethics and Social Responsibility 43

2-6 Social Responsibility: Another Layer of Business Ethics

So far in this chapter we have covered two layers of business ethics: the basic cat- egories and notions of fairness. A third layer of ethics focuses on relationships and conflicts among relationships.

In some ethical dilemmas in business, the interests of the shareholders might be different from the interests of the employees. Lower wages bring higher prof- its and returns, at least temporarily, to shareholders, but is shipping work over- seas to countries where the wages are low or work conditions unhealthy taking unfair advantage? In this third layer of business ethics, we look at the interests of those who are affected by business decisions, often called the stakeholders of the business. For example, suppose the business discovers that its air pollution control equipment is not state-of-the-art technology and that, although no laws are being violated, more pollution is being released than is necessary. To correct the problem, its factory must be shut down for a minimum of three months. The pollution will harm the air and the community, but the shutdown will harm the workers and the shareholders. The business must consider the needs and interests of all its stake- holders in resolving the ethical dilemma it faces. Much discussion and disagree- ment continue to surround this particular issue. In the following interview excerpt, economist Milton Friedman offers a different perspective on this ethical dilemma.

Q: Quite apart from emission standards and effluent taxes, shouldn’t corporate officials take action to stop pollution out of a sense of social responsibility?

Milton Friedman: I wouldn’t buy stock in a company that hired that kind of leadership. A corporate executive’s responsibility is to make as much money for the shareholders as possible, as long as he operates within the rules of the game. When an executive decides to take action for reasons of social responsibility, he is taking money from someone else—from the stockholders, in the form of lower dividends; from the employees, in the form of lower wages; or from the consumer, in the form of higher prices. The responsibility of a corporate executive is to fulfill the terms of his contract. If he can’t do that in good conscience, then he should quit his job and find another way to do good. He has the right to promote what he regards as desirable moral objectives only with his own money. If, on the other hand, the executives of U.S. Steel undertake to reduce pollution in Gary for the purpose of making the town attractive to employees and thus lowering labor costs, then they are doing the stockholders’ bidding. And everyone benefits: The stockholders get higher dividends; the customer gets cheaper steel; the workers get more in return for their labor. That’s the beauty of free enterprise. . . . To the extent that pollution caused by the U.S. Steel plant there is confined to that city and the people there are truly concerned about the problem, it’s to the company’s advantage to do something about it. Why? Because if it doesn’t, workers will prefer to live where there is less pollution, and U.S. Steel will have to pay them more to live in Gary, Indiana.15

2-6a ethical postures for Social Responsibility

Often, decisions in dilemmas that involve stakeholders depend on the overall attitude of a company and its perspective on the role of business in society. The ethical perspective of a business often sets the tone for its operations and employ- ees’ choices. Historically, the philosophical debate over the role of business in society has evolved into four schools of thought on ethical behavior based on the responses to two questions: (1) Whose interest should a corporation serve?

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44 part 1 Business: Its Legal, Ethical, and Judicial Environment

(2) To whom should a corporation be responsive in order to best serve that inter- est? These questions have only two answers—“shareholders only” and “the larger society”—and the combination of those answers defines the school of thought. The following discussion is summarized in Exhibit 2.2.

Inherence According to the inherence school of thought, managers answer only to sharehold- ers and act only with shareholders’ interests in mind. This type of manager would not become involved in any political or social issues unless it was in the sharehold- ers’ best interests to do so, provided the involvement did not backfire and cost the firm sales. Milton Friedman’s philosophy, as previously expressed, is an exam- ple of inherence. To understand how a business following the inherence school of thought would behave, consider the issue of a proposed increase in residen- tial property taxes for school funding. A business that subscribes to the inherence school would support a school tax increase only if the educational issue affected the company’s performance and only if such a position did not offend those who opposed the tax increase.

enlightened Self-Interest According to this school of thought, the manager is responsible to the shareholders but serves them best by being responsive to the larger society. Enlightened self-in- terest is based on the view that, in the long run, business value is enhanced if busi- ness is responsive to the needs of society. In this school, managers are free to speak out on societal issues without the constraint of offending someone, as in inher- ence. Businesses would anticipate social changes and needs and be early advocates for change. For example, many corporations today have instituted job sharing, child-care facilities, and sick-child care in response to the changing structure of the American family and workforce. Others have instituted wellness and fitness pro- grams to improve employees’ health and reduce medical and insurance costs. This responsiveness to the needs of the larger society should also be beneficial to share- holders because it enables the business to retain a quality workforce.

the Invisible Hand The invisible hand school of thought is the opposite of enlightened self-interest. According to this philosophy, business ought to serve the larger society, and it

Exhibit 2.2 Social Responsibility of Corporations

MORaL QUeStION: WHOSe INteReSt SHOULd tHe CORpORatION SeRVe?

pOLICY QUeStION: BeSt WaY tO SeRVe INteReSt IF tHe CORpORatION IS ReSpONSIVe tO:

Inherence Shareholders only Shareholders only

Enlightened self-interest Shareholders only Larger society

Invisible hand Larger society Shareholders only

Social responsibility Larger society Larger society

Source: Adapted with permission of American Business Law Journal, from Daryl Hatano, “Should Corporations Exercise Their Freedom of Speech Rights?” 22 American Bus.L.J. 165 (1984).

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Chapter 2 Business Ethics and Social Responsibility 45

does this best when it serves the shareholders only. Such businesses allow gov- ernment to set the standards and boundaries for appropriate behavior and simply adhere to these governmental constraints as a way of maximizing benefits to their shareholders. They become involved in issues of social responsibility or in polit- ical issues only when society lacks sufficient information on an issue to make a decision. Even then, their involvement is limited to presenting data and does not extend to advocating a particular viewpoint or position. This school of thought holds that it is best for society to guide itself and that businesses work best when they serve shareholders within those constraints.

Social Responsibility In the social responsibility school of thought, the role of business is to serve the larger society by responding to society’s needs as a first priority. A business follow- ing this school of thought would advocate full disclosure of product information to consumers in its advertising and would encourage political activism on the part of its managers and employees on all issues, not just those that affect the corporation. These businesses adhere to the belief that their sense of social responsibility con- tributes to their long-term success.

2-7 Why Business Ethics? Now that you have background on the types of ethical issues businesses face, background on social responsibility, and a framework for analysis of ethical issues, you may still be skeptical: “But why should a business worry about these things beyond just complying with the law? Why not just maximize under the system?” Some compelling reasons promote choosing ethical behavior, as discussed in the following sections.

2-7a personal accountability and Comfort: Business ethics for personal Reasons

Before looking at business data on the value of ethics, it is important to realize that the choices we make in our business lives must still feel personally comfort- able. And it would be misleading to say that every ethical business is a profitable business. First, not all ethical people are good managers or possess the neces- sary skills for making a business a success, but many competent businesspeople have suffered for being ethical, and many others seem to survive despite their lack of ethics. Despite his conviction and jail term related to junk bond sales in the 1980s, Michael Milken decades later earned a $50 million fee for helping Ted Turner negotiate a merger with Time Warner.16 Many whistle-blowers, although highly respected, have been unable to find employment in their industries. If ethi- cal behavior does not guarantee success, then why have ethics? The answer has to do with personal ethics applied in a business context. One investment banker who worked on Drexel Burnham’s trading desk during the Michael Milken days of that firm and who is now chairman of GoldTree Asset Management said, “Just to be able to sit on the desk and see the calls start at 4:15 in the morning, Boesky and Perelman and Diller and Murdoch.”17 But Mr. Wagner said that he took not just the memories of the power of Drexel with him but a powerful lesson as well: “There’s a difference between being very competitive and can-do, and winning at all costs. All costs is costly.”

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46 part 1 Business: Its Legal, Ethical, and Judicial Environment

Business ethics is really nothing more than a standard of personal behavior applied to a group of people working together to make a profit. Some people are ethical because it enables them to sleep better at night. Some people are ethical because of the fear of getting caught. But being personally ethical is a justifica- tion for business ethics—it is simply the correct thing to do. Bowen McCoy’s “The Parable of the Sadhu” focuses on business ethics for personal reasons.

For the Manager’s Desk

Re: the parable of the Sadhu

[In 1982], as the first participant in the new six-month sabbatical program that Morgan Stanley has adopted, I enjoyed a rare oppor- tunity to collect my thoughts as well as do some traveling. I spent the first three months in Nepal, walking 600 miles through 200 villages in the Himalayas and climbing some 1,20,000 vertical feet. On the trip my sole Western companion was an anthropol- ogist who shed light on the cultural patterns of the villages we passed through.

During the Nepal hike, something occurred that has had a powerful impact on my thinking about corporate ethics. Although some might argue that the expe- rience has no relevance to business, it was a situation in which a basic ethical dilemma suddenly intruded into the lives of a group of individuals. How the group responded I think holds a lesson for all organizations no matter how defined.

The Sadhu

The Nepal experience was more rugged and adventuresome than I had anticipated. Most commercial treks last two or three weeks and cover a quarter of the distance we traveled.

My friend Stephen, the anthropologist, and I were halfway through the 60-day Himalayan part of the trip when we reached the high point, an 18,000-foot pass over a crest that we’d have to traverse to reach the village of Mukinath [sic], an ancient holy place for pilgrims.

Six years earlier I had suffered pulmo- nary edema, an acute form of altitude sick- ness, at 16,500 feet in the vicinity of Everest

base camp, so we were understandably concerned about what would happen at 18,000 feet. Moreover, the Himalayas were having their wettest spring in 20 years; hip- deep powder and ice had already driven us off one ridge. If we failed to cross the pass, I feared that the last half of our “once in a lifetime” trip would be ruined.

The night before we would try the pass, we camped at a hut at 14,500 feet. In the photos taken at the camp, my face appears wan. The last village we’d passed through was a sturdy two-day walk below us, and I was tired.

During the late afternoon, four backpack- ers from New Zealand joined us, and we spent most of the night awake, anticipating the climb. Below we could see the fires of two other parties, which turned out to be two Swiss couples and a Japanese hiking club.

To get over the steep part of the climb before the sun melted the steps cut in the ice, we departed at 3:30 a.m. The New Zealanders left first, followed by Stephen and myself, our porters and Sherpas, and then the Swiss. The Japanese lingered in their camp. The sky was clear, and we were confident that no spring storm would erupt that day to close the pass.

At 15,500 feet, it looked to me as if Stephen were shuffling and staggering a bit, which are symptoms of altitude sickness. (The initial stage of altitude sickness brings a headache and nausea. As the condition worsens, a climber may encounter diffi- cult breathing, disorientation, aphasia, and paralysis.) I felt strong, my adrenaline was flowing, but I was very concerned about my ultimate ability to get across. A couple of our

(Continued)

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Chapter 2 Business Ethics and Social Responsibility 47

(Continued)

porters were also suffering from the height, and Pasang, our Sherpa sirdar (leader), was worried.

Just after daybreak, while we rested at 15,500 feet, one of the New Zealanders, who had gone ahead, came staggering down toward us with a body slung across his shoulders. He dumped the almost naked, barefoot body of an Indian holy man—a sadhu—at my feet. He had found the pilgrim lying on the ice, shivering and suffering from hypothermia. I cradled the sadhu’s head and laid him out on the rocks. The New Zealander was angry. He wanted to get across the pass before the bright sun melted the snow. He said, “Look, I’ve done what I can. You have porters and Sherpa guides. You care for him. We’re going on!” He turned and went back up the mountain to join his friends.

I took a carotid pulse and found that the sadhu was still alive. We figured he had probably visited the holy shrines at Muk- inath [sic] and was on his way home. It was fruitless to question why he had chosen this desperately high route instead of the safe, heavily traveled caravan route through the Kali Gandaki gorge. Or why he was almost naked and with no shoes, or how long he had been lying in the pass. The answers were not going to solve our problem.

Stephen and the four Swiss began strip- ping off outer clothing and opening their packs. The sadhu was soon clothed from head to foot. He was not able to walk, but he was very much alive. I looked down the mountain and spotted below the Japanese climbers marching up with a horse.

Without a great deal of thought, I told Stephen and Pasang that I was concerned about withstanding the heights to come and wanted to get over the pass. I took off after several of our porters who had gone ahead.

On the steep part of the ascent where, if the ice steps had given way, I would have slid down about 3,000 feet, I felt vertigo. I stopped for a breather, allowing the Swiss to catch up with me. I inquired about the sadhu and Stephen. They said that the sadhu was fine and that Stephen was just behind. I set off again for the summit.

Stephen arrived at the summit an hour after I did. Still exhilarated by victory, I ran down the snow slope to congratulate him.

He was suffering from altitude sickness, walking fifteen steps, then stopping, walking fifteen steps, then stopping. When I reached them, Stephen glared at me and said: “How do you feel about contributing to the death of a fellow man?”

I did not fully comprehend what he meant.

“Is the sadhu dead?” I inquired. “No,” replied Stephen, “but he surely

will be!” After I had gone, and the Swiss had

departed not long after, Stephen had remained with the sadhu. When the Jap- anese had arrived, Stephen had asked to use their horse to transport the sadhu down to the hut. They had refused. He had then asked Pasang to have a group of our porters carry the sadhu. Pasang had resisted the idea, saying that the porters would have to exert all their energy to get themselves over the pass. He had thought they could not carry a man down 1,000 feet to the hut, reclimb the slope, and get across safely before the snow melted. Pasang had pressed Stephen not to delay any longer.

The Sherpas had carried the sadhu down to a rock in the sun at about 15,000 feet and had pointed out the hut another 500 feet below. The Japanese had given him food and drink. When they had last seen him he was listlessly throwing rocks at the Japa- nese party’s dog, which had frightened him.

We do not know if the sadhu lived or died.

For many of the following days and eve- nings Stephen and I discussed and debated our behavior toward the sadhu. Stephen is a committed Quaker with deep moral vision. He said, “I feel that what happened with the sadhu is a good example of the break- down between the individual ethic and the corporate ethic. No one person was willing to assume ultimate responsibility for the sadhu. Each was willing to do his bit just so long as it was not too inconvenient. When it got to be a bother, everyone just passed the buck to someone else and took off. Jesus was relevant to a more individualist stage of society, and how do we interpret his teaching today in a world filled with large, impersonal organizations and groups?”

I defended the larger group, saying, “Look, we all cared. We all stopped and

(Continued)

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(Continued)

gave aid and comfort. Everyone did his bit. The New Zealander carried him down below the snow line. I took his pulse and suggest- ed we treat him for hypothermia. You and the Swiss gave him clothing and got him warmed up. The Japanese gave him food and water. The Sherpas carried him down to the sun and pointed out the easy trail toward the hut. He was well enough to throw rocks at a dog. What more could we do?”

“You have just described the typical affluent Westerner’s response to a problem. Throwing money—in this case food and sweaters—at it, but not solving the funda- mentals!” Stephen retorted.

“What would satisfy you?” I said. “Here we are, a group of New Zealanders, Swiss, Americans, and Japanese who have never met before and who are at the apex of one of the most powerful experiences of our lives. Some years the pass is so bad no one gets over it. What right does an almost naked pilgrim who chooses the wrong trail have to disrupt our lives? Even the Sherpas had no interest in risking the trip to help him beyond a certain point.”

Stephen calmly rebutted, “I wonder what the Sherpas would have done if the sadhu had been a well-dressed Nepali, or what the Japanese would have done if the sadhu had been a well-dressed Asian, or what you would of done, Buzz, if the sadhu had been a well-dressed Western woman?”

“Where, in your opinion,” I asked instead, “is the limit of our responsibility in a situation like this? We had our own well-be- ing to worry about. Our Sherpa guides were unwilling to jeopardize us or the porters for the sadhu. No one else on the mountain was willing to commit himself beyond cer- tain self-imposed limits.”

Stephen said, “As individual Christians or people with a Western ethical tradition, we can fulfill our obligations in such a situation only if (1) the sadhu dies in our care, (2) the sadhu demonstrates to us that he could undertake the two-day walk down to the vil- lage, or (3) we carry the sadhu for two days down to the village and convince someone there to care for him.”

“Leaving the sadhu in the sun with food and clothing, while he demonstrated hand- eye coordination by throwing a rock at a dog, comes close to fulfilling items one and two,”

I answered. ?“And it wouldn’t have made sense to take him to the village, where the people appeared to be far less caring than the Sherpas, so the third condition is impractical. Are you really saying that, no matter what the implications, we should, at the drop of a hat, have changed our entire plan?”

The Individual versus the Group Ethic

Despite my arguments, I felt and continue to feel guilt about the sadhu. I had literally walked through a classic moral dilemma without fully thinking through the conse- quences. My excuses for my actions include a high adrenaline flow, a superordinate goal, and a once-in-a-lifetime opportunity—factors in the usual corporate situation, especially when one is under stress.

Real moral dilemmas are ambiguous, and many of us hike right through them, unaware that they exist. When, usually after the fact, someone makes an issue of them, we tend to resent his or her bringing it up. Often, when the full import of what we have done (or not done) falls on us, we dig into a defensive position from which it is very dif- ficult to emerge. In rare circumstances we may contemplate what we have done from inside a prison.

Had we mountaineers been free of physical and mental stress caused by the effort and the high altitude, we might have treated the sadhu differently.? Yet isn’t stress the true test of personal and corporate values? The instant decisions executives make under pressure reveal the most about personal and corporate character. Among the many questions that occur to me when pondering my experience are: What are the practical limits of moral  imagination and vision? Is there a collective or institutional ethic beyond the ethics of the individual? At what level of effort or commitment can one discharge one’s ethical responsibilities?

Not every ethical dilemma has a right solution. Reasonable people often disagree; otherwise there would be no dilemma. In a business context, however, it is essential that managers agree on a process for deal- ing with dilemmas.

The sadhu experience offers an inter- esting parallel to business situations. An immediate response was mandatory. Failure

(Continued)

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Chapter 2 Business Ethics and Social Responsibility 49

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to act was a decision in itself. Up on the mountain we could not resign and submit our résumé to a headhunter. In contrast to philosophy, business involves action and implementation—getting things done. Man- agers must come up with answers to prob- lems based on what they see and what they allow to influence their decision-making processes. On the mountain, none of us but Stephen realized the true dimensions of the situation we were facing.

One of our problems was that as a group we had no process for developing a consen- sus. We had no sense of purpose or plan. The difficulties of dealing with the sadhu were so complex that no one person could handle it. Because it did not have a set of preconditions that could guide its action to an acceptable resolution, the group reacted instinctively as individuals. The cross-cultural nature of the group added a further layer of complexity. We had no leader with whom we could identify and in whose purpose we believed. Only Stephen was willing to take charge, but he could not gain adequate sup- port to care for the sadhu.

Some organizations do have a value system that transcends the personal values of the managers. Such values, which go beyond profitability, are usually revealed when the organization is under stress. Peo- ple throughout the organization generally accept its values, which, because they are not presented as a rigid list of command- ments, may be somewhat ambiguous. The stories people tell, rather than printed mate- rials, transmit these conceptions of what is proper behavior.

For twenty years I have been exposed at senior levels to a variety of corporations and organizations. It is amazing how quickly an outsider can sense the tone and style of an organization and the degree of toler- ated openness and freedom to challenge management.

Organizations that do not have a her- itage of mutually accepted, shared val- ues tend to become unhinged during stress, with each individual bailing out for himself. In the great takeover battles we have witnessed during past years, com- panies that had strong cultures drew the wagons around them and fought it out, while other companies saw executives,

supported by their golden parachutes, bail out of the struggles.

Because corporations and their mem- bers are interdependent, for the corporation to be strong the members need to share a preconceived notion of what is correct behavior, a “business ethic,” and think of it as a positive force, not a constraint.

As an investment banker I am continual- ly warned by well-meaning lawyers, clients, and associates to be wary of conflicts of interest. Yet if I were to run away from every difficult situation, I wouldn’t be an effec- tive investment banker. I have to feel my way through conflicts. An effective manager can’t run from risk either; he or she has to confront and deal with risk. To feel “safe” in doing this, managers need the guidelines of an agreed-on process and set of values within the organization.

After my three months in Nepal, I spent three months as an executive-in-residence at both Stanford Business School and the Center for Ethics and Social Policy at the Graduate Theological Union at Berkeley. These six months away from my job gave me time to assimilate twenty years of busi- ness experience. My thoughts turned often to the meaning of the leadership role in any large organization. Students at the seminary thought of themselves as antibusiness. But when I questioned them they agreed they distrusted all large organizations, including the church. They perceived all large orga- nizations as impersonal and opposed to individual values and needs. Yet we all know of organizations where people’s values and beliefs are respected and their expressions encouraged. What makes the difference? Can we identify the difference and, as a result, manage more effectively?

The word “ethics” turns off many and confuses more. Yet the notions of shared values and an agreed-on process for dealing with adversity and change—what many people mean when they talk about corpo- rate culture—seem to be at the heart of the ethical issue. People who are in touch with their own core beliefs and the beliefs of others and are sustained by them can be more comfortable living on the cutting edge.

At times, taking a tough line or a deci- sive stand in a muddle of ambiguity is the only ethical thing to do. If a manager is

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50 part 1 Business: Its Legal, Ethical, and Judicial Environment

indecisive and spends time trying to figure out the “good” thing to do, the enterprise may be lost.

Business ethics, then, has to do with authenticity and integrity of the enterprise. To be ethical is to follow the business as well as the cultural goals of the corporation, its owners, its employees, and its custom- ers. Those who cannot serve the corporate vision are not authentic business people and, therefore, are not ethical in the busi- ness sense.

At this stage of my own business experi- ence I have a strong interest in organization- al behavior. Sociologists are keenly studying what they call corporate stories, legends, and heroes as a way organizations have of transmitting the value system. Corporations such as Arco have even hired consultants to perform an audit of their corporate culture. In a company, the leader is the person who understands, interprets, and manages the corporate value system. Effective managers are then action-oriented people who resolve conflict, are tolerant of ambiguity, stress, and change, and have a strong sense of pur- pose for themselves and their organizations.

If all this is true, I wonder about the role of the professional manager who moves from company to company. How can he or she quickly absorb the values and culture of different organizations? Or is there, indeed, an art of management that is totally trans- portable? Assuming such fungible managers do exist, is it proper for them to manipulate the values of others?

What would have happened had Ste- phen and I carried the sadhu for two days back to the village and become involved with the villagers in his care? In four trips to Nepal my most interesting experiences occurred in 1975 when I lived in a Sher- pa home in the Khumbu for five days recovering from altitude sickness. The high point of Stephen’s trip was an invitation to participate in a family funeral ceremony in Manang. Neither experience had to do with climbing the high passes of the Himalayas. Why were we so reluctant to try the lower path, the ambiguous trail? Perhaps because we did not have a leader who could reveal the greater purpose of the trip to us.

Why didn’t Stephen with his moral vision opt to take the sadhu under his

personal care? The answer is because, in part, Stephen was hard-stressed physically himself, and because, in part, without some support system that involved our involuntary and episodic community on the mountain, it was beyond his individual capacity to do so.

I see the current interest in corporate culture and corporate value systems as a positive response to Stephen’s pessimism about the decline of the role of the individ- ual in large organizations. Individuals who operate from a thoughtful set of personal values provide the foundation of a corporate culture. A corporate tradition that encour- ages freedom of inquiry, supports personal values, and reinforces a focused sense of direction can fulfill the need for individuality along with the prosperity and success of the group. Without such corporate support, the individual is lost.

That is the lesson of the sadhu. In a complex corporate situation, the individual requires and deserves the support of the group. If people cannot find such support from their organization, they don’t know how to act. If such support is forthcoming, a person has a stake in the success of the group, and can add much to the process of establishing and maintaining a corporate cul- ture. It is the management’s challenge to be sensitive to individual needs, to shape them, and to direct and focus them for the benefit of the group as a whole.

For each of us the sadhu lives. Should we stop what we are doing and comfort him; or should we keep trudging up toward the high pass? Should I pause to help the derelict I pass on the street each night as I walk by the Yale Club en route to Grand Central Station? Am I his brother? What is the nature of our responsibility if we consid- er ourselves to be ethical persons? Perhaps it is to change the values of the group so that it can, with all its resources, take the other road.

Discussion Question

Consider the closing questions Mr. McCoy poses. How do they apply to you personally and to businesses?

Source: Reprinted by permission of Harvard Business Review. From “The Parable of the Sadhu,” by Bowen H. McCoy, May–June 1997. Copyright © 1997 by Harvard Business School Publishing Corporation; all rights reserved.

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Chapter 2 Business Ethics and Social Responsibility 51

2-8 Importance of Ethics in Business Success and the Costs of Unethical Conduct

As you learn in other disciplines, from economics to management, business is driven by the bottom line. Profits control whether the firm can obtain loans or gain investors and serve as the sole indicator of the firm’s success—and, in most cases, its employees’ success as well. Indeed, business firms can be defined as groups of people working together to obtain maximum profits. The pursuit of the bottom line, however, can occasionally distort the perspective of even the most conscien- tious among us. The fear of losing business and, consequently, losing profits and capital support can persuade people to engage in conduct that, although not ille- gal, is unethical. But those who pursue only the bottom line fail to recognize that a successful business is more like a marathon than a sprint, requiring that ethical dilemmas be resolved with a long-term perspective in mind. Indeed, those firms that adhere to ethical standards perform better financially over the long run. A 2010 study indicates that if companies are not ever-vigilant in adhering to ethical standards, they slip into illegal activity and destroy their profitability, often to the point of bankruptcy.18

The Tylenol tampering incident of 1982 offers one of the most telling exam- ples of the rewards of being ethical. When Tylenol capsules were discovered to have been tainted with deadly poison, Tylenol’s manufacturer, McNeil Consumer

Ethical Issues

In 2006, David Sharp, 34, from Britain, was not handling a climb to Mt. Everest well. He was a victim of oxygen deprivation and eventually collapsed on the ground. Forty other climbers passed him by, and, unable to move, Mr. Sharp froze to death. Those who passed him by indicated that the con- ditions are rugged and that climbers know going in that they may have to pay the ultimate price.

Lincoln Hall, 50, from Australia, was discovered by an American guide after he had spent a night on the freezing moun- tainside. The MyHeroProject describes Mr. Hall’s condition as follows: “He was sit- ting on the trail with his jacket around his waist, wearing no hat or gloves. The group stopped to investigate and found he was suffering from symptoms of edema, frost- bite and dehydration. He was alone and hallucinating; and generally incoherent in his responses to their offers of help. He

was without any of the proper equipment for survival in such conditions. Apparently, Mr. Hall had collapsed the previous day on his way down from the summit.”

Mr. Dan Mazur and his team aban- doned their climb and stayed with Mr. Hall until rescuer sherpas could come to help. Mr. Hall’s team assumed that he was dead and had called his wife the evening before to tell her.

In the years since 1953, 3,000 climbers have made it to the Everest summit, but 200 climbers have died. A climb with a guide costs about $60,000. What do you think makes the difference in the decision process between those who stop to help and those who continue their climbs?

Source: Adapted from Alan Cowell, “Adventurers Change. Danger Does Not,” New York Times, June 4, 2006, p. WK 5.

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52 part 1 Business: Its Legal, Ethical, and Judicial Environment

Products Company, a subsidiary of Johnson & Johnson, followed its code of ethics, which required it to put the interests of the consumer first. In what many financial analysts and economists considered to be a disastrous decision and a dreadful mis- take, McNeil recalled all Tylenol capsules from the market—31 million bottles with a retail value of about $100 million. A new and safer form of a noncapsule Tylenol caplet was developed, and within a few months Tylenol regained its majority share of the market. The recall had turned out to be neither a poor decision nor a finan- cial disaster. Rather, the company’s actions enhanced its reputation and served to create a bond between Tylenol and its customers that was based largely on trust and respect for the integrity of the company and the product. Johnson & Johnson and McNeil enjoyed decades of goodwill and deferential treatment arising from their recall. The two companies had a near immunity from questions about their products and practices until 2010, when the companies’ conduct differed substan- tially from the 1982 recall. In 2010, the FDA found metal particles in the company’s liquid Infants’ Tylenol. That can happen in production, but the key is to stop pro- duction, issue a recall, and confess. Instead, however, one officer resigned, and the FDA levied penalties against McNeil over its lack of cooperation, mishandling of materials, lax documentation, and failure to follow up on customer complaints.18

An April 2010 FDA site visit to one plant found violations of the agency’s good manufacturing processes. One violation was releasing seven batches of cherry- flavored Infants’ Tylenol after the employees had found the metal from processing pistons in the product. Not only did McNeil not issue a recall, it did not even notify the government about the issue. The result of these decisions has been declining profits, federal monitoring, and a loss of trust by consumers.

Nestlé provides another example of the consequences for poor ethical choices, consequences that can span generations. Nestlé has endured many consumer boy- cotts since the early 1970s as a result of its intense—and what came to be perceived by the public as exploitative and unethical—marketing of infant formula in then–Third World nations, where the lack of sanitation, refrigeration, and education led to serious health problems in infants given the formula. In 1989, nearly 20 years after the infant formula crisis, Nestlé’s new “Good Start” formula was slow in market infiltration and, because of continuing consumer resistance, did not perform as well as its qual- ity and innovativeness would have predicted. Nestlé has never gained the market share or reputation its quality product deserves. As the Nestlé experience illustrates, a firm’s reputation for ethical behavior is the same as an individual’s reputation: it takes a long time to gain, but it can be lost instantly as the result of one bad choice.

BP, the oil and natural gas company, was performing well, with operations in 100 countries, 96,000 employees, and nearly 24,000 retail service stations around the world. As the second-largest oil company in the world and one of the world’s 10 largest corporations, BP had also been a perennial favorite of NGOs and environ- mental groups. For example, Business Ethics named BP the world’s most admired company and one of its top corporate citizens. Green Investors named BP its top company because of BP’s continuing commitment to investment in alternative energy sources. But BP had issues percolating as it gained these recognitions. In 2005, an explosion at one of BP’s refineries, located in Texas City, Texas, resulted in the death of 15 employees and injuries to 170 others. Both an internal investigation and a government report indicated that the accident would have been avoidable if the company had not cut maintenance costs at the expense of safety. The accident followed on the heels of charges that the company’s traders were manipulating the price of propane in the markets by holding back on supplies.

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Chapter 2 Business Ethics and Social Responsibility 53

Also, the company’s oil fields at Prudhoe Bay, Alaska, burst in 2006, resulting in a 267,000-gallon oil spill on pristine Alaskan tundra.20 Industry standards require “smart-pigging” (ultrasonic checking) of pipelines every five years to detect weak- nesses or corrosion. At the time of the March 2006 spill, BP disclosed that it had not done smart-pigging on the Prudhoe Bay line since 1998 and that the pipes had not been cleaned since 1992. The BP field manager at Prudhoe Bay said, follow- ing the spill, “If we had it to do over again, we would have been pigging those lines.”21 The line had to be closed down, and again an internal report revealed that the cost-cutting drive at BP affected the decisions in the oil fields. Following the oil spill, BP’s stock price fell more than 15% in three months.

Oil production dropped 75%, and BP spent $1 billion to fix the Texas refinery. One expert noted at that time that it would take years for BP to recover financially and even longer to restore its credibility with the market and regulators. That pre- scient remark has proved to be even truer after BP’s Deepwater Horizon well in the Gulf of Mexico sprung a “leak” and began gushing oil in April 2010. The evi- dence of compromises on well construction and rig safety was so overwhelming that BP has paid an unprecedented $62 billion in fines and compensation following a guilty plea to environmental and safety violations.

In 2005, a GM employee sent the following e-mail to other employees related to an ignition switch problems that had been previously pointed out by test drivers:

“We have a serious safety problem here. I am thinking big recall. I was driving 45 mph when I hit the pothole and the car shut off, and I had a car behind me that swerved around me. I don’t like to imagine a customer driving their kids in the back seat, on I75, and hitting a pothole in rush hour traffic.”22

GM did not make the information public or issue a recall. Its inaction resulted in the company settling with the federal government to pay a $900 million fine for withholding information from regulators and failure to issue a recall or notify its customers or dealers of the problem. The civil lawsuits by the families of those who were killed in accidents related to the ignition switch are still pending.

The poor ethical choices of the aforementioned firms resulted in tremendous financial setbacks and, in some cases, destruction. The core values of a firm give it long-standing profitability. “The Tony Bennett Factor” offers some insight into longevity, profitability, and values.

2-8a ethics as a Strategy

Ethical behavior not only increases long-term earnings but also enables businesses to anticipate and plan for social needs and cultural changes that require the firm or its product to evolve. One of the benefits of a firm’s ethical behavior and par- ticipation in community concerns is the goodwill that such involvement fosters. Conversely, the absence of that goodwill and consequent loss of trust can mean the destruction of the firm.

Blue Bell ice cream, one of the largest ice cream brands in the United States, issued massive recalls over listeria contamination that resulted in three deaths and at least 10 illnesses. Criminal investigations began because of the presence of liste- ria in its plants. Blue Bell recalled all of its products in 23 states in April 2015 and did not ship products again until August 2015. Just the allegations that Blue Bell did not follow practices recommended by both government regulators and indus- try groups damaged the brand. But reports by Fortune that Blue Bell found listeria at the plant in 2013 but did not take the appropriate steps to correct the problem

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54 part 1 Business: Its Legal, Ethical, and Judicial Environment

For the Manager’s Desk

Re: the tony Bennett Factor

I had blocked out the background noise offered courtesy of MTV and my teenager, but I glanced up and saw Tony Bennett. My parents raised me on Tony Bennett LPs back in the ’50’s. “I Left My Heart in San Francisco” enjoyed hours of play in Tyrone, Pa. And here he was back, “Tony Bennett Unplugged.” Mr. Bennett has not changed. Yet his success has spanned generations. Suddenly my work with a colleague, Prof. Louis Grossman, had new meaning. We had been studying business longevity, trying to determine what makes some businesses survive so successfully for so long.

Prof. Grossman and I began our study when we spotted a 1982 full-page ad in this newspaper placed by Diamond Match Co. The ad touted the company’s 100 years of consistent dividend payments. Today’s standards tell us that quarters of dividend payments would be stellar. What kind of company was this? Were there others?

We discovered seven other industrial firms that could boast of making at least an annual dividend payment for a string of 100 years or more: Scovill, Inc.; Ludlow Corp.; Stanley Works; Singer Co.; Pennwalt, Inc.; Pullman, Inc.; and Corning Glass Works. Pullman, Ludlow and Stanley had unbroken chains of a century of quarterly dividend payments as well.

Mr. Bennett and our eight companies have survival in common. These survivors’ tools make management theories of today seem trite. They had no shifting paradigms. No buzzwords.

Mr. Bennett recognized his strength as a balladeer and stuck with it, through every- thing from the Beatles to Hootie and the Blowfish. Although each of our companies recognized the importance of diversification, they all held fast to a WBAWI—or “what business are we in?”—philosophy. They knew their strengths, developed strong mar- ket presences based on those strengths, and never forgot their roots. Mr. Bennett

never performed without singing “I Wanna Be Around.” Singer never left its sewing machines. Pullman never deserted its train cars. Diamond held on to its matches.

The firms diversified only when their strengths allowed. Scovill began as a brass button manufacturer and backed into brass manufacturing because it knew brass. Scovill bought Hamilton Beach because Hamilton Beach was a major brass pur- chaser. Scovill understood this customer’s business.

Other companies have forgotten the WBAWI lesson and paid the price. Sears abandoned its catalog, insurance and real estate businesses and now struggles to find a retail presence. IBM has suffered for not understanding its business was the work- place, not mainframe computers. Its Lotus takeover shows it may recognize the PC as the workplace.

All Mr. Bennett needs are a microphone and a pianist to make music. All eight of our companies were low-cost producers. All eight were cost conscious. Scovill executive vice presidents with worldwide responsibil- ities shared a secretary. Spartan company headquarters were the rule for these firms. There were barely six-figure salaries for executives. By contrast, IBM’s Louis Gerst- ner hired an executive chef at $120,000 just last month.

Mr. Bennett has used the same musi- cal arranger for nearly 30 years. Our eight companies’ management team histories are in direct contrast to the executive recruiting practices in vogue today. Scovill, found- ed during the Jefferson administration in 1803, had only 12 CEOs during its 100-year dividend run. Three of the companies (Sing- er, Stanley and Diamond) had CEOs who served for more than 40 years. Seven of the companies never had a CEO serve for fewer than 10 years. They were not afraid of home-grown management. Their officers and CEOs came up through the ranks.

(Continued)

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Chapter 2 Business Ethics and Social Responsibility 55

(Continued)Management succession is found in all eight companies.

Perhaps this information demonstrates the importance of continuity and stabili- ty. The executives appreciated the tension between short-term results and long-term performance, but the short term did not control decision making. Donald Davis, chairman and CEO of Stanley Works, put it this way: “The tension is always there. One of the top management’s toughest jobs really is to mediate between the two viewpoints—short-term profit results now versus investment for future development.”

Mr. Bennett did and does spend time on the road in concert, in direct contact with audiences—no mega-tours, just constant gigs. And a full century before we heard of customer service, these firms sent their sales forces and vice presidents alike out on the road to talk directly with customers. They had interesting marketing studies: one- on-one feedback. Sales calls, follow-ups, replacements, and refunds allowed them to remain in the customers’ minds and good graces.

One officer said it best: “Anyone can read the monthly financial reports: What we need to do is to interpret them so we can spot trends. We call on customers, on suppliers, we look at the bottom line of course, but we know how that line reached the bottom.”

Mr. Bennett has never made a bad recording or disappointed during a live

performance. Our eight firms had strong commitments to integrity. Their mantra was: “If there’s integrity, there will be quality and profits.” Their integrity man- ifested itself in more than just quality. Frederick T. Stanley, founder of Stanley Works, spoke of the intricate balance between automation and employees: “Machines are no better than the skill, care, ingenuity and spirit of the men who operate them. We can achieve perfect harmony when shortening of an operation provides mutual advantages to the work- man and the producers.” Ethics before its time. Re-engineering done correctly in the 1800s. Nothing at the expense of the customer or the employee.

Our firms were no less remarkable than Mr. Bennett and his success with Generation X—his third generational con- quest. The sad part of their stories is what happened following the takeover battles of the ’80’s. But that is a story for another time. For now, it is reassuring to realize that cost-consciousness, focus, custom- er service, home-grown management and integrity are keys to longevity. Today’s man- agement fads seem as shallow as Ice T (aka Ice-T) and Madonna. There is a simple Tony Bennett factor in success that makes today’s fads much easier to debunk and infinitely easier to question.

Source: “The Tony Bennett Factor?,” by Marianne M. Jennings, from The Wall Street Journal, June 26, 1995, p. A12.

or make disclosures caused further fallout: “The FDA released inspection reports showing that the company had found the bacteria in its Oklahoma plant, on sur- faces such as floors and catwalks, on 17 occasions beginning in March 2013.”23

The shutdown cost the company $200 million, 1,450 jobs, and the loss of its 6.4% market share.

2-8b the Value of a Good Reputation

A reputation, good or bad, stays with a business or an individual for a long time. Richard Teerlink, the former CEO of Harley-Davidson, has said, “A reputation, good or bad, is tough to shake.” Once a company makes poor ethical choices, it carries the baggage of those choices despite successful and sincere efforts to reform. Salt Lake City struggled to regain its credibility as the trials from the brib- ery allegations surrounding its winning the bid for the 2002 Winter Olympics

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56 part 1 Business: Its Legal, Ethical, and Judicial Environment

progressed and companies withdrew sponsorships. Businesses were, at that time, unsure about the reputations and trustworthiness of those running the Salt Lake City Olympic operations. It took new leadership and a commitment to high ethi- cal standards from Mitt Romney, who went on to become a two-term governor of Massachusetts and presidential candidate in 2008 and 2012, to restore confidence in the Salt Lake City 2002 Winter Olympics.

2-8c Leadership’s Role in ethical Choices

George Fisher, the former CEO of Motorola and Kodak, has defined leadership as the ability to see around corners. In other words, a leader sees a problem before it becomes a legal issue or liability and fixes it, thus saving company time and money. All social, regulatory, and litigation issues progress along a timeline. As the issue is brought to the public’s attention, either by stories or by the sheer mag- nitude of the problem, the momentum for remedies and reforms continues until behavior is changed and regulated. Ethical choices afford firms opportunities to take positions ahead of the curve. Firms can choose to go beyond the law and per- haps avoid regulation that might be costly or litigation that can be devastating. For example, the issues relating to the problems with asbestos dust in the lungs of asbestos workers and installers were clear in the 1930s. More studies needed to be done, but there was sufficient evidence to justify lung protection for workers and the development of alternative forms of insulation. However, the first litiga- tion relating to asbestos and asbestos workers did not arise until 1968. For that 30-year period, those in the business of producing and selling asbestos insulation products had the opportunity to take preventive actions. They chose to wait out the cycle. The results were a ban on asbestos and litigation at levels that forced the largest producer, Johns-Manville (now Manville), into bankruptcy. Leadership choices were available in the 1930s for offering warnings, providing masks, and developing alternative insulators. Johns-Manville chose to continue its posture of controlling information releases and studies. The liability issue progressed to a point of no choice other than bankruptcy and reorganization.

Every business regulation that exists today controls business conduct in an area that was once not subject to control but, rather, provided an opportunity for busi- nesses to self-regulate by making good value choices. Problems resulting from a lack of candor in payday loans and in the so-called subprime loan market have surfaced at all levels of our economy. “We made so much money, you couldn’t believe it. And you didn’t have to do anything. You just had to show up”24 was the comment of Kal Elsayed, a former executive at New Century Financial, a mort- gage brokerage firm based in Irvine, California. With his red Ferrari, Mr. Elsayed enjoyed the benefits of the growth in the subprime mortgage market. However, those risky debtors, whose credit histories spelled trouble, defaulted on their loans. New Century Financial declared bankruptcy under the weight of its portfolio of $39.4 billion in subprime loans. “Subprime mortgage lending was easy until the market changed” is the hindsight comment of mortgage brokers and analysts. And the Wall Street instruments tied to those mortgages carried the defaults throughout the economy. The mortgage lending market is now greatly controlled and limited by state and federal regulations. Wall Street firms not under federal controls are nevertheless subject to increased regulation.25

Ethical choices give businesses the freedom to make choices before regulators mandate them. Breaches of ethics bring about regulation and liability with few

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Chapter 2 Business Ethics and Social Responsibility 57

opportunities to choose and less flexibility. The notions of choices and leadership are diagrammed in Exhibit 2.3, which is explained in the following discussion. Every issue progresses along a cycle that begins with a latency phase, in which the indus- try is aware of a problem. The use of private information about consumers’ buying patterns was well known in the marketing industry, but few consumers were aware of that use. The awareness stage begins when the popular press reports on an issue and raises questions. Once the public has knowledge of a problem, it responds by demanding assurance that the problem either is resolved or is not really an issue— or by calling for reform. The activism stage is one in which members of the public ask for either voluntary or regulatory reform. If voluntary reform is not forthcom- ing, those affected may sue or lobby for reform or both. For example, a group of parents, police officers, and shareholders protested Time Warner’s production of “Cop Killer,” a song by the rap music artist Ice T (a.k.a. Ice-T). The public outcry was strong both in the press and at Time Warner’s shareholder meeting. Congress was considering holding hearings on record labels and record content. Time Warner eventually made a choice to voluntarily withdraw the song, later in the regulatory cycle when public outcry was strong but still in time to avert regulation.

During 2004, the public again became active in demanding changes in the con- tent of entertainment when Janet Jackson and Justin Timberlake’s performance at the halftime show at the Super Bowl resulted in partial nudity on prime-time television. In 2007, CBS Radio and MSNBC pulled the Don Imus show because of questionable comments he made. Entertainment and television executives undertook voluntary controls to prevent government controls. The televised Acad- emy Awards are now on a five-second delay so that any mishaps can be edited out before broadcast. Some artists are not permitted to appear on awards shows because of their past behaviors on similar shows. Voluntary self-control averts government regulation.

Exhibit 2.3 Leadership and ethics: Making Choices before Liability and Regulation

O P T IO

N S

E th ic s

TIME

Latency Awareness Activism

OPTIONS COST

Regulation/Litigation

Source: Adapted from James Frierson, “Public Policy Forecasting: A New Approach,” SAM Advanced Management Journal, Spring 1985, pp. 18–23.

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58 part 1 Business: Its Legal, Ethical, and Judicial Environment

Few people realize one aspect of the Tylenol poisonings case (noted earlier in the chapter), which is that the issue of tamper-proof packaging had been a concern in the industry long before the poisonings involving Tylenol occurred. Those in the industry were concerned that packaging that did not signal unauthorized entry so that a buyer could spot tampering could open the door to the tragedy that even- tually occurred. However, no one in the industry, despite knowledge of this issue, took steps to create tamper-proof packaging. The law did not require such a step, additional costs were associated with the packaging and retooling production, and some were worried that they would be at a competitive disadvantage if their prod- ucts were harder to use than those that did not have the tamper-proof packages. By not solving the problem voluntarily, companies faced unpleasant results: first, the tragedy of the deaths, and, second, additional regulations and costs imposed as the government required tamper-proof packaging.

2-9 Creation of an Ethical Culture in Business 2-9a the tone at the top and an ethical Culture

Employees work under the pressures of meeting quarterly and annual goals and can make poor choices if the company’s priority with respect to values and eth- ics is not made clear. Employees must see that those who evaluate and pay them really do care about ethics. Employees are convinced that ethics is important when they see officers comply with all of the provisions in the company code of ethics. They see the right tone at the top when ethical employees are rewarded and uneth- ical conduct is punished. The tone at the top comes from actions by officers and executives who show they “walk the talk” about ethics.

2-9b dodd-Frank, Sarbanes-Oxley, Sentencing, and an ethical Culture

Following the collapses of Enron, WorldCom, and other companies noted in the chapter’s opening “Consider . . . ,” Congress passed the most extensive reforms of corporate governance and financial reporting since the enactment of the 1933 and 1934 securities laws following the 1929 stock market crash. Following the 2008 financial markets collapse and the bankruptcies of many financial firms, Congress added additional reforms through what is called the Dodd-Frank Act (Wall Street Reform and Consumer Financial Protection Act; see Chapters 17 and 18 for more information on these two statutes). Although both statutory reforms impose many requirements on accountants, lawyers, directors, and officers, they also increased criminal penalties and empowered the Federal Sentencing Commission to exam- ine the types of things companies could do that would improve the ethical culture, thereby reducing the risk of misconduct and earning sentence reductions for com- panies that attempt to create an ethical culture but still have an ethical or legal lapse.

The Federal Sentencing Commission has determined that factors such as the following would be helpful in setting the tone of the company:

• A code of ethics • Training for employees in the code and in ethics • A means for employees to report misconduct anonymously • Follow up on reports employees make on misconduct

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Chapter 2 Business Ethics and Social Responsibility 59

• Action by the board, including follow-up and monitoring, on complaints and reports made by employees

• Self-reporting and investigation of legal and ethical issues • Sanctions and terminations for those within the company who violate the law

and company rules, including officers • A high-ranking officer, with the ability to communicate with the CEO and

board, who is responsible for the code of ethics and ethics training in the company

The guidelines for company practices incorporate the factors most experts agree are critical to setting an ethical culture in a company.

2-9c Reporting Lines: an anonymous ethics Line for an ethical Culture

An anonymous reporting line is a minimum requirement for companies working to achieve and maintain an ethical culture. The reporting line can be received inter- nally, or, in best-practices companies, the report goes out to a third-party contractor who then keeps track of the issue and its progress toward resolu- tion within the company. In addition to encouraging employees to discuss issues with their supervisors, anonymous reporting allows employees to raise issues without the fear and concern that might deter them from reporting to a supervisor. Under the sentencing guidelines, companies that can show they fostered an atmosphere of education and discussion in which employees were encouraged to come forward will fare much better in terms of fines and other punishments if any missteps occur. Many com- panies have developed ethical news bulletins to offer employees examples of and guidelines on ethical dilemmas. DuPont delivers an ethics bulletin to employees through its e-mail system. Blue Cross Blue Shield has given employees Slinky toys for their desks with the hotline reporting number on them so that as employees think and perhaps use the Slinky to relieve pressure and stress, they will be reminded to report any problems. The federal gov- ernment has an ethics encyclopedia online for its employees to use. The encyclopedia is filled with examples of government employees’ misconduct and the sanctions they received.

2-9d developing an ethics Stance

Both individuals and firms should decide up front what types of conduct they would never engage in and be certain that the rules are in writing, that everyone understands the rules, and that the rules will be enforced uniformly. Individuals can vary in their responses to various ethical dilemmas. For example, a woman who had taken $12,000 from her employer was terminated imme- diately upon the company’s discovery of the embezzlement. At the company’s next board meeting, the board members discussed the issue and had varying views. One director felt that taking something that does not belong to you is wrong and that ter- mination was the appropriate action. Another director said that

If an organization wants its code of ethics to be followed, used, understood, and relied upon, the key steps are the following:

1. Develop a code of ethics with input from employees, vendors, suppliers, and others who deal with your organization.

2. Have a ceremony of sorts to roll out the code. For example, in the Arizona State University MBA program, the code of academic integrity is printed on banners, and students come and sign the banners as evidence of their com- mitment. The Facebook posts generate further publicity for the code. The food at the ceremony draws participants to the session.

3. Train everyone on what’s in the code of ethics. Have the code of ethics up on an internal site for easy access and have examples and explanations available there.

4. Integrate the principles of the code into strategy, planning, operations, and community activities.

5. Make sure reporting mechanisms are clear, available, and responsive when employees raise issues and questions.

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60 part 1 Business: Its Legal, Ethical, and Judicial Environment

the ethical CultureBusiness Strategy

A strategic pyramid can help in understand- ing how to implement an ethical culture. At the base of the pyramid are the facial trappings of ethics: codes. Even Enron had a 64-page, award-winning code of ethics. Some companies have progressed beyond annual training seminars to regular ethics scenarios circulated throughout the compa- ny for employees to consider and discuss before the ethics office offers its insights and guidance on the hypothetical or reali- ty-based scenario that has been presented. Some companies regularly report to employ- ees on number of ethics questions/reports, the investigations, and the outcomes (with- in the bounds of privacy constraints). For example: “The ethics office investigated 323 matters and employee disciplinary action was taken in 175 of those matters. The form of discipline included terminations, warnings, loss of bonus [and whatever other sanctions were imposed].” The purpose of this data-based feedback is to let employees know, particularly those who reported anon- ymously and wish to remain anonymous, of

the ethics office activity, the results of inves- tigations, and, perhaps most importantly, the enforcement.

The next layer involves compensation for and recognition of the role of individuals’ moral development and the differing roles employees play in terms of organizational behavior parameters in moving the com- pany toward ethical behavior and an ethical culture.

The final or top layer, and the area con- quered by so few companies, requires lead- ership at the executive level and dramatic shifts in both internal and external policies and behaviors of the company. Exploring these top two layers can provide ethics offi- cers and ethics programs within companies with the next step in the evolution of not just “best practices in ethics programs,” but in the creation of an ethical culture.

Source: Adapted from Marianne M. Jennings, “Taking Ethics Programs to the Next Level: Why CFOs Are Critical,” Corporate Finance Review 10, no. 3 (2005), pp. 38–42. Reprinted by permission of Thomson Reuters.

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Leadership by Example

Company Policies and Compensation Systems

Reward Ethical and Moral Behavior

Ethics Codes Ethics Training: Annual/Scenarios

Investigations/Enforcement/Feedback

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Chapter 2 Business Ethics and Social Responsibility 61

his remedy would be determined by whether the money was taken all at once or over a period of time. Another director said that his remedy would be determined according to why the employee took the money. Still another director noted that perhaps the employee did not understand that this type of action is wrong. The directors varied in their views on ethics. One is pragmatic—it is simply wrong. Another applies a relative approach—why did she take the money?

Knowing where you stand as a company sends clear signals to employees. Knowing where you stand as an individual sends clear signals for the behavior of those around you. Taking a position on a set of values helps a company avoid the either/or conundrum in which tough situations are boiled down to something such as, “Either we release this product now with its flaws and meet the deadline and start getting earnings, or we don’t and the company collapses.” A value-based decision is one that says, “We as a company do not cheat our customers with poorly designed or manufactured products, and we don’t hurt them with defective ones. Because of that value, we retool quickly to correct the problem and get the product out there as soon as possible.” With this value-based decision, the com- pany also makes a good business decision, for it has chosen to avoid the often-de- structive costs of releasing a defective product despite knowledge of that defect. The GM engine switch case discussed earlier represents the destructive costs of deciding not to take action based on values but, rather, taking action based only on immediate costs.

2-9e Being Careful about pressure and Signals

Doing the right and ethical thing often gets lost in the pressures employees felt with respect to goals and number quotas. These types of signals create a pressured environment in which employees fall into ethical lapses that often lead to illegal behavior. Just the disparity between the amount of time devoted to discussion of results versus ethics is a signal. For example, most employees will say that they discuss performance goals every day and then add, “Without fail, we sign off on the ethics policy once each year!” The signal, however unwitting, is that perfor- mance matters most.

In the subprime mortgage meltdown that affected so many Wall Street invest- ment houses, there were clear differences between the firms that collapsed and those that survived. Stan O’Neal at Merrill Lynch, a company that led the pack with over $25 billion in losses and an eventual takeover, was an indefatigable “numbers guy” who took Merrill Lynch from its position of being a safe, trading house to a leveraged player, and O’Neal expected employees to produce results. One Merrill Lynch executive noted the pressure: “It got to the point where you didn’t want to be in the office on Goldman earnings days.” The pressure for goals was so intense that no one really questioned the numbers and how they were get- ting the results. Employees called operations meetings “staged.” The result was Merrill Lynch’s demise, even as employees became concerned but were pressured to just keep going despite the clear consequences.

2-10 Ethical Issues in International Business The global market presents firms with more complex ethical issues than they would experience if operations were limited to one country and one culture. Moral standards vary across cultures. In some cases, cultures change and evolve to allow

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62 part 1 Business: Its Legal, Ethical, and Judicial Environment

conduct that was not previously acceptable. For example, tipping hospital employ- ees is common practice in some countries. In the United States, such behavior could be illegal in the case of government-run hospitals.

In many executive training seminars for international business, executives are taught to honor customs in other countries and to “Do as the Romans do.” Employees are often confused by this direction.

A manager for a U.S. title insurer provides a common example. He com- plained that if he tipped employees in the United States, such as employees at public recording agencies, for their expediting property filings, the manager would not only be violating the company’s code of ethics but could be charged with violations of the Real Estate Settlement Procedures Act and state and federal antibribery provisions. Yet that same type of practice is permitted, recognized, and encouraged in other countries as a cost of doing business. Paying a regula- tory agency in the United States to expedite a licensing process would be bribery of a public official. Yet many businesses maintain that they cannot obtain such authorizations to do business in other countries unless such payments are made. So-called grease or facilitation payments are permitted under the Foreign Corrupt Practices Act (see Chapter 7), but legality does not necessarily make such pay- ments ethical.

An inevitable question arises when custom and culture clash with ethical stan- dards and moral values adopted by a firm. Should the national culture or the com- pany code of ethics prevail? Typical business responses to the question of whether cultural norms or company codes of ethics should control decisions in international business operations are the following: Who am I to question the culture of another country? Who am I to impose U.S. standards on all the other nations of the world? Isn’t legality the equivalent of ethical behavior? The attitude of businesses is one that permits ethical deviations in the name of cultural sensitivity. Many businesses fear that the risk of offending those in other countries is far too high to impose U.S. ethical standards on the conduct of business in other countries.

Part of the misunderstanding about ethics in international business on the part of U.S.-based businesses is that ethical standards in the United States vary significantly from the ethical standards in other countries. Operating under this misconception can create a great deal of ethical confusion among employees. Stra- tegically, businesses and their employees are more comfortable when they oper- ate under uniform standards. What is known as the “Golden Rule” in the United States actually has existed for some time in other religions and cultures and among philosophers. Exhibit 2.4 offers a list of how this simple rule is phrased in different writings. The principle is the same even if the words vary slightly.

The successful operation of commerce depends on the ethical roots of busi- ness. A look at the three major parties in business explains this point. These parties are the risk-takers, the employees, and the customers. Risk-takers—those furnish- ing the capital necessary for production—are willing to take risks on the assump- tion that customers will judge their products as valuable. Employees are willing to offer production input, skills, and ideas in exchange for wages, rewards, and other incentives. Consumers and customers are willing to purchase products and services as long as they receive value in exchange for their furnishing, through payment, costs, and profits to the risk-takers and employees. To the extent that the interdependency of the parties in the system is affected by factors outside of their perceived roles and control, the intended business system does not function on its underlying assumptions.

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Chapter 2 Business Ethics and Social Responsibility 63

Although the roots of business have been described as primarily economic, this economic system cannot survive without recognition of some fundamental values. Some of the inherent—indeed, universal—values built into our capitalis- tic economic system, as described here, are as follows: (1) the consumer is given value in exchange for the funds expended, (2) employees are rewarded accord- ing to their contribution to production, and (3) the risk-takers are rewarded for their investment in the form of a return on that investment. Exhibit 2.5 depicts this relationship. Everyone in the system must be ethical. An economic system is like a four-legged stool. If corruption seeps into one leg, the economic system is off balance. In international business, often the government slips into corrup- tion, with bribes controlling which businesses are permitted to enter the country and who is awarded contracts in that country. In the United States, the wave of reforms at the federal level since 2008 was the result of perceived corruption in the financial markets that resulted in a lack of transparency.

To a large extent, all business is based on trust. The tenets for doing business are dissolved as an economy moves toward a system in which one individual can control the market in order to maximize personal income.

Suppose, for example, that the sale of a firm’s product is determined not by perceived consumer value but, rather, by access to consumers, which is controlled by government officials. That is, your company’s product cannot be sold to con- sumers in a particular country unless and until you are licensed within that coun- try. Suppose further that the licensing procedures are controlled by government officials and that those officials demand personal payment in exchange for your company’s right to even apply for a business license. Payment size may be arbi- trarily determined by officials who withhold portions for themselves. The basic values of the system have been changed. Consumers no longer directly determine the demand.

Beyond just the impact on the basic economic system, ethical breaches involv- ing grease payments introduce an element beyond a now-recognized component

Exhibit 2.4 a possible Uniform Standard for ethical Choices

Categorical imperative: How would you want to be treated?

Would you be comfortable with a world with your standards?

Christian principle: The Golden Rule

And as ye would that men should do to you, do ye also to them likewise. (Luke 6:31)

Thou shalt love . . . thy neighbor as thyself. (Luke 10:27)

Confucius: What you do not want done to yourself, do not do to others.

Aristotle: We should behave to our friends as we wish our friends to behave to us.

Judaism: What you hate, do not do to anyone.

Buddhism: Hurt not others with that which pains thyself.

Islam: No one of you is a believer until he loves for his brother what he loves for himself.

Hinduism: Do nothing to thy neighbor which thou wouldst not have him do to thee.

Sikhism: Treat others as you would be treated yourself.

Plato: May I do to others as I would that they should do unto me.

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64 part 1 Business: Its Legal, Ethical, and Judicial Environment

in economic performance: consumer confidence in long-term economic perfor- mance. Economist Douglas Brown has described the differences between the United States and other countries in explaining why capitalism works here and not in all nations. His theory is that capitalism depends on an interdependent sys- tem of production. For economic growth to proceed, consumers, risk-takers, and employees must all feel confident about the future, about the concept of a level playing field, and about the absence of corruption. To the extent that consumers, risk-takers, and employees feel comfortable about a market driven by these basic assumptions, the investment and commitments necessary for economic growth via capitalism will be made. Significant monetary costs are incurred by business systems based on factors other than customer value, as discussed earlier. In devel- oping countries where “speed” or grease payments are required and corrupt gov- ernment officials are in control, the actual money involved may not be significant in terms of the nation’s culture. Such activities and payments introduce an element of demoralization and cynicism that thwarts entrepreneurial activity when these nations most need risk-takers to step forward.

Bribes and guanxi (gifts) in China given to establish connections with the Chi- nese government are estimated at 3% to 5% of operating costs for companies, totaling an estimated $5 billion of China’s foreign investment. But China incurs costs from the choices government officials make in return for payments. For example, guanxi are often used to persuade government officials to transfer gov- ernment assets to foreign investors for substantially less than their value. Chinese government assets have fallen more than $50 billion in value during the same period of economic growth, primarily because of the large undervaluation by government officials in these transactions with foreign companies. China’s econ- omy was adrift because of this underlying corruption. Economic progress suffers because of graft.

Exhibit 2.5 the Interdependence of trust, Business, and Government

R eg

ul at

io n/

Fa ir

ne ss Fairness A

ssum ptio

n

Return on Investment

Payment

Protection Protection

Reliance

Capital

Reliance

Quality/ Dependency

Investors

Business

Customers

Government

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Chapter 2 Business Ethics and Social Responsibility 65

Perhaps Italy and Brazil provide the best examples of the long-term impact of corruption in foreign business practices. Although the United States, Japan, and Great Britain have had scandals such as the savings and loan failures, political corruption, and insurance regulation, these forms of misconduct do not indicate corruption that pervades entire economic systems. The same cannot be said about Italy. Elaborate connections between government officials, the Mafia, and business executives were unearthed in the 1990s. As a result, half of Italy’s cabinet resigned at one time, and hundreds of business executives were indicted. It has been esti- mated that the interconnections of these three groups cost the Italian government $200 billion, as well as compromising the completion of government projects. Italy is known for its 40-year freeway project. In over 40 years of work, it has not been able to complete a single highway designed to connect the northern and southern parts of the country.

Transparency International publishes an annual index of perceptions of corruption. Business executives are asked to rank

countries on a scale from 1 to 10, with 10 being the least corrupt. The results for 2015 are as follows.

Consider . . . 2.5

Why do you think the index appears as it does? Do you see a correlation between economic development or its absence and corruption?

Source: Reprinted from CORRUPTION PERCEPTION INDEX LIST. Copyright © Transparency International. All Rights Reserved. Used with permission. For more infor- mation, visit http://www.transparency.org.

LeaSt CORRUpt MOSt CORRUpt

• Denmark • Finland • Sweden • New Zealand • Norway • Switzerland • Singapore • Canada • Germany • Luxembourg • United Kingdom • Australia • Iceland • Belgium • Austria • United States • Hong Kong • Ireland • Japan • Uruguay • Qatar

• Somalia • Korea (North) • Afghanistan • Sudan • South Sudan • Angola • Libya • Iraq • Guinea Bissau • Venezuela • Haiti • Yemen • Turkmenistan • Syria • Eritrea • Uzbekistan • Zimbabwe • Cambodia • Burundi • Myanmar

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66 part 1 Business: Its Legal, Ethical, and Judicial Environment

In Brazil, during the 1980s, the level of corruption led to a climate of murder and espionage. Many foreign firms elected not to do business in Brazil because of so much uncertainty and risk—beyond the normal financial risks of international investment. Why send an executive to a country where officials may use force when soliciting huge bribes?

Brazil continues to be saddled with ongoing corruption issues. In 2016, its president as well as many CEOs of major businesses were charged with crimes related to public corruption. But this wave of corruption charges is nothing new for Brazil. The Wall Street Journal offered an example of how Brazil’s corruption has damaged the country’s economy despite growth and opportunity in sur- rounding nations. The governor of the northeastern state of Paraiba in Brazil, Ronaldo Cunha Lima, was angry because his predecessor, Tarcisio Burity, had accused Mr. Lima’s son of corruption. Mr. Lima shot Mr. Burity twice in the chest while Mr. Burity was having lunch at a restaurant. The speaker of Brazil’s Senate praised Mr. Lima for his courage in doing the shooting himself as opposed to sending someone else. Mr. Lima was given a medal by the local city council and granted immunity from prosecution by Paraiba’s state legislature. No one spoke for the victim, and the lack of support reflected a culture controlled by self- interest that benefits those in control. Unfortunately, these self-interests preclude economic development.

Economists in Brazil document hyperinflation and systemic corruption. A São Paulo businessman observed, “The fundamental reason we can’t get our act together is we’re an amoral society.” This businessperson probably understands capitalism. Privatization that has helped the economies of Chile, Argentina, and Mexico cannot take hold in Brazil because government officials enjoy the benefits of generous wages and returns from the businesses they control. The result is that workers are unable to earn enough even to clothe their families, 20% of the Brazilian population lives below the poverty line, and crime has reached the level of nightly firefights. Brazil’s predicament occurred over time, as graft, collusion, and fraud became entrenched in the government-controlled economy.26

Biography

U.S. Air pilot, Captain Chesley “Sully” Sullenberger refers to it as, “That Day.” “That day” was January 15, 2009 when a flock of geese hit one of the engines of his A320 flight taking off from LaGuardia airport in New York City. He felt the lag as his mind raced through the possibil- ities of diverting to Teterboro or turning around to LaGuardia. He made his deci- sion and glided the plane onto the Hudson River. Everyone survived. In recounting “that day” with the Smithsonian’s Air and Space magazine, Sully described his deci- sions and actions:

The way I describe this whole experi- ence—and I haven’t had time to reflect on it sufficiently—is that everything I had done in my career had in some way been a preparation for that moment. There were probably some things that were more important than others or that applied more directly. But I felt like everything I’d done in some way contributed to the outcome.27

Captain Sullenberger’s experience and reflections sum up how it works when we face those life-defining,

Chesley “Sully” Sullenberger: preparation for the Moment When Something Goes Wrong

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Chapter 2 Business Ethics and Social Responsibility 67

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career-defining, and organization-de- fining ethical dilemmas. Everything we do up until those critical decision points is the preparation. Captain Sullenberg- er described his preparation as includ- ing training, handbooks, participation in NTSB investigations, observations, and reading and studying about flights, crash- es, engines, and all things related to air travel. Captain Sullenberger’s preparation translates across to preparing ourselves for those defining ethical moments.

Preparation: The Formal Ethical Infrastructure

Just like airlines have their training and handbooks for pilots, organizations have their have their codes of ethics, hand- books, and training. And organizations lack- ing these formal ethical infrastructures are not giving their employees a critical aspect of preparation. Captain Sullenberger also noted how well trained the crew members were. He said that he could hear the crew members through the cabin door after he made the announcement about the emer- gency landing. In unison they were repeat- ing to the passengers, “Heads down. Stay down.” He said it was comforting for him to know that everyone was on the same page. Everyone knew what to do and what to say. The training kicked in.

When it comes to ethical dilemmas, employees should all be on the same page. Training should give them the methods to raise questions and report issues and the language to use when confronted by a supervisor asking them to cross an ethical line. When everyone has been exposed to the same training, repeated regularly, crisis

situations find them relying on what has been drilled into the culture.

Preparation: Studying the Missteps

Captain Sullenberger indicated that he par- ticipated with NTSB in investigations and studies of crashes in order to learn. So it is with ethics. Unless and until we study the situations in which people make mis- takes, we continue along the cheery path of believing that nothing could possibly go wrong in our organization because we have the formal ethical infrastructure of training and a good code. Sully knew that his first priority was getting the nose of the aircraft down because so many previous crashes resulted from attempted landings with the noses of the aircraft up. That knowledge was critical to the safe water landing.

So it is with ethics. Unless employees understand what it feels and looks like for ethics to go south, they will not make good decisions in averting an ethical crisis. There are common factors that precede ethical crises. For example, in Enron, HealthSouth, Madoff, Finova, Fannie Mae, and other companies, unprecedented performance preceded the ethical collapse. In the recent- ly announced Volkswagen issue of the installation of software to shut off emis- sions controls except during emissions testing, there were questions about how VW was achieving such low emissions. In fact, California regulators raised questions about the phenomenal emissions perfor- mance of the cars two years before VW made its announcement of the deception. Studying what crashes look and feel like helps employees to spot the signs and raise questions or take actions to avert damage.

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68 part 1 Business: Its Legal, Ethical, and Judicial Environment

S u m m a r y What is ethics?

• Behavior beyond the law

• Day-to-day nature of ethics

What is business ethics?

• Ethical standards—normative standards of behavior set by culture

• Ethical standards—standards of behavior set by nat- ural law

• Ethical standards—moral relativism; moral stan- dards by situation

• Ethical standards—religion and ethics

What are the categories of ethical dilemmas in business?

• Taking things that don’t belong to you

• Saying things you know are not true

• Giving or allowing false impressions

• Buying influence or engaging in conflict of interest

• Hiding or divulging information

• Taking unfair advantage

• Committing acts of personal decadence

• Perpetrating interpersonal abuse

• Permitting organizational abuse

• Violating rules

• Condoning unethical actions

• Balancing ethical dilemmas

How do employees resolve ethical dilemmas?

• Blanchard and Peale

• Front-page-of-the-newspaper test

• Wall Street Journal and stakeholders

• Laura Nash and perspective

• Categorical imperative

Why do we fail to reach good ethical decisions?

• “Everybody else does it.”

• “If we don’t do it, someone else will.”

• “That’s the way it has always been done.”

• “We’ll wait until the lawyers tell us it’s wrong.”

• “It doesn’t really hurt anyone.”

• “The system is unfair.”

• “I was just following orders.”

• “You think this is bad, you should have seen . . . ”

• “It’s a gray area.”

What is social responsibility and how does a business exercise it?

• Positive law—codified law

• Inherence—serves shareholders’ interests

• Enlightened self-interest—serves shareholders’ inter- ests by serving larger society

• Invisible hand—serves larger society by serving shareholders’ interests

• Social responsibility—serves largest society best by serving larger society

Why is business ethics important?

• Profit

• Leadership

• Reputation

• Strategy

How does a business create an ethical atmosphere?

• Tone at the top

• Dodd-Frank and corporate sentencing guidelines

• Code of ethics

• Reporting hotlines

• Ethical posture and developing an ethical stance

What are the ethical issues in international business?

• Corruption issues

• Economic systems and ethics

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Chapter 2 Business Ethics and Social Responsibility 69

Q u e S t i o n S a n d P r o b l e m S 1. E. & J. Gallo, the world’s largest winery, announced that it would stop selling its Thunderbird and Night Train Express wines in the Tenderloin, the skid row of San Francisco, for six months. Gallo took the action after meeting with an activist group called Safe and Sober Streets, which has asked grocers to remove the high- alcohol wine from the district, where citizens say drunks create a menace. One retailer in the district said, “If I don’t sell this, I will have to close my doors and go home.”

Discuss the actions of E. & J. Gallo and the dilemma of the retailers in the district. Be sure to discuss the type of philosophy each of them holds with respect to social responsibility and ethical dilemmas.

2. Paul Backman is the head of the purchasing depart- ment for L. A. East, one of the “Baby Bells” that came into existence after the divestiture of AT&T. Mr. Backman and his department purchase everything for the company, from napkins to wires for equipment lines.

S. C. Rydman is an electronics firm and has been a major supplier for L. A. East since 1984. Rydman is also the cosponsor of an exhibit at Wonder World, a theme park in Florida.

Rydman’s vice president and CFO, Gunther Fromme, visited Mr. Backman in his office on April 3, 2004. Rydman had no bids pending at that time, and Mr. Fromme told Mr. Backman that he was there “for goodwill.” Mr. Fromme explained that Rydman had a block of rooms at Wonder World because of its exhibit there and that Mr. Backman and his group could use the rooms at any time, free of charge.

Should Mr. Backman and his employees use the block of rooms? Why or why not?

3. David Tovar served a Walmart’s vice president of communication and had always put on his credentials and résumé that he had received a degree in art from the University of Delaware. He had gone through the gradu- ation ceremonies and assumed that all requirements were met. However, he was notified that he was a “couple of credit hours short.” He did not take the steps to address the shortage and continued to carry the credential. He was under consideration for a promotion, but when Bloomberg News broke the story about problems with his degree, he was terminated. What was the ethical category here? Was termination an appropriate remedy? Discuss the ethical issues.

4. Kenneth Branch was an employee with Lockheed Martin in 1996. At that time Lockheed Martin was com- peting head-to-head with the Boeing Company for a government contract worth $5 billion. Mr. Branch inter- viewed for a job in Boeing’s rocket division in 1996 and began employment at Boeing in January 1997.28

The government awarded the contract to Boeing. An internal investigation by Boeing revealed that Mr. Branch and his supervisor, William Erskine, had thou- sands of pages of proprietary documents from Lockheed Martin, including detailed information about Lockheed Martin’s costs and specifications for the rocket contract. Boeing turned over 11 boxes of documents to Lockheed in 2003, some of which were marked “Proprietary.”

Applying the model on steps for analyzing ethi- cal dilemmas and case studies in business you learned in the “Consider . . .” feature, determine whether there were any ethical breaches in Boeing’s conduct.

The author has performed consulting work for Boeing on changing its ethical culture. Why is this disclosure important in this text? Why is this disclosure important to you?

5. During the 2013 presidential inauguration, a contro- versy arose: Did Beyoncé lip-sync the national anthem? No definitive answer was offered by those involved. What was clear was that the National Marine Band did not play during her performance, that a tape was played, and that those in charge of the event felt a live perfor- mance was too risky because the singer had not had the opportunity to rehearse with the band prior to her perfor- mance. Are there any ethical issues here? Does this action fit into any of the ethical categories? Could you offer any advice to those involved about the ethical issues?

6. Richard M. Scrushy, the former CEO of Health- South and now a convicted felon (bribery), was the subject of a probation hearing. Prosecutors said that Mr. Scrushy was trying to leave the country in February 2007 via his 92-foot yacht, the Chez Soiree. The yacht journey was nixed when bad weather hit the Alabama coast. Mr. Scrushy pro- tested the allegations, testifying that he had permission to travel to South Florida as part of a vacation that had been approved for him and his family (including going to Dis- ney World). He said he did not tell the probation officer about the trip to Miami because her questions were not spe- cific enough: “I can’t answer the question unless she asks me.”29 The federal magistrate said that Mr. Scrushy was being “coy” with his probation officers. Discuss whether Mr. Scrushy breached any ethical standards with his con- duct and interpretation of the terms of his probation.

7. The NCAA sanctioned Syracuse University after releasing a 94-page report that found that the director of basketball operations and other staff members had bas- ketball players’ passwords and used the players’ e-mail accounts to pretend to be the players in communication with the players’ professors. The report also found that players received checks and that the drug policy was lax. After an eight-year investigation, the NCAA took away

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70 part 1 Business: Its Legal, Ethical, and Judicial Environment

12 scholarships, gave the basketball coach a nine-game suspension, and took away 108 victories of the coach, a sanction that takes the coach from the number 2 win- ningest coach in history to number 6. While Syracuse acknowledged the violations, Syracuse Chancellor Kent Syverud responded with the following:

“We believe the NCAA’s investigation of Syracuse University has taken longer than any other investigation in NCAA history. The entire process has taken close to eight years and involved a review of conduct dating back to 2001. By comparison, the investigation into the fixing of the 1919 World Series took two months and the 2007 investigation of steroid use in baseball took 21 months. However, we hope everyone will agree that eight years is too long for an investigation and that a more expeditious and less costly process would be beneficial to student- athletes, public confidence in the NCAA enforcement pro- cess, and major intercollegiate athletics in general.”30

How would you characterize the chancellor ’s response and characterization of the NCAA and the investigation?

8. Gold Peak Tea, a Coca-Cola brand, sponsored its “Take the Year Off” contest. The prize was one year off work and $100,000. Entrants were required to submit a video. Theodore A. Scott, a Decatur, Georgia, attorney, won the grand prize based on votes for his video. His video began with him describing how he had missed out with his family because of his career demands and vowed to spend time with his wife, children, and grand- children if he won the prize. He also said that he would drink, of course, iced tea.

After Gold Peak told Mr. Scott that he had won, the company received a tip (and the company will not iden- tify who gave them the tip) that Mr. Scott had gone to About.com, a site that has information on contests and sweepstakes, and made a pitch to voters there. Mr. Scott asked them to vote for him.

When Gold Peak learned of the post, it disqualified Mr. Peak and gave the prize to the next entrant in line. Rule 6B of the “Take the Year Off” contest provides that

contestants were prohibited from obtaining votes by “offering prizes or other inducements to members of the public, vote farming, or any other activity that artificially inflates such finalists’ votes as determined by sponsor in its sole discretion.”

Mr. Scott has defended his action by saying that the people who voted for him were real people and that he did not use robotics or Facebook accounts. An expert on sweepstakes agrees: “In my opinion, that’s not cheating if those are real people who aren’t being induced.” Is Mr. Scott correct? Did he cheat?

9. Heinz Ketchup holds 54% of the U.S. ketchup market, and nine of every 10 restaurants feature Heinz ketchup. However, Heinz has learned that many restaurant owners simply refill Heinz bottles with cheaper ketchup, thereby capitalizing on the Heinz name without the cost. One restaurant owner explains, “It’s just ketchup. The custom- ers don’t notice.” There are no specific health regulations that apply, and owners are not breaking the law by refill- ing the bottles. Do you think this practice is ethical?

10. Gerald Grinstein, the former CEO of Delta Air Lines, refused to take any bonuses, stock options, or extra compensation for 2006 and instead would take only his base salary of $338,000. Grinstein arranged to have $1 bil- lion distributed to about 39,000 nonunionized employees and 1,000 managers within 12 to 15 months after the air- line emerged from bankruptcy. “I’m the dawning of the old age,” was the comment the 74-year-old CEO made when asked why he was taking such an unprecedented step.31 Grinstein is giving up an estimated $10 million. He also added, “Corporate pay packages have gotten out of control. It has become a salary derby out there.” Grinstein still arranged to have bonuses for top executives if they hit certain profit targets and explained, “You have got to have a program that attracts executives but at the same time you’ve got to take care of the relationships with frontline employees.”32 Apply the various schools of social responsi- bility to Mr. Grinstein and decide which he followed. Think about the regulatory cycle’s application to the issue of CEO pay. What do you think regulators will do?

Economics, Ethics & the Law Self-Interest vs. Selfishness

Adam Smith, in what has been called the seminal work on free-market economics, wrote, “It is not from the benevolence of the butcher, the brewer, or the baker, that we can expect our dinner, but from their regard to their own interest.”33 Self-interest, then, is what Smith believed to be the motivator for eco- nomic engagement and growth. Is there a difference between self-interest and selfishness? Where would social responsibility fit in the Smith view of the rela- tionship between ethics and economics? However,

17 years before writing Wealth of Nations, Smith wrote The Theory of Moral Sentiments and included the follow- ing observation about ethics and business: “How self- ish soever man may be supposed, there are evidently some principles in his nature which interest him in the fortune of others and render their happiness necessary to him though he derives nothing from it except the pleasure of seeing it.”34 What does this quote reveal about Smith’s attitudes toward social responsibility?

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Chapter 2 Business Ethics and Social Responsibility 71

n ot e S 1. There is a misdemeanor statute in Seattle that makes it illegal to cut in line in front of other drivers who are waiting to board a ferry.

2. See http://www.josephsoninstitute.org.

3. Professor Donald McCabe of Rutgers University has conducted surveys on academic integrity for many years. His latest survey involved 4,500 student respondents nationwide. See Center for Academic Integrity at Clemson University, http://www.academicintegrity.org, for more information.

4. Jay Nordlinger, “A Tragic National Pastime,” National Review, March 9, 2015, p. 24.

5. Id.

6. Louise Story and Landon Thomas Jr., “Tales from Lehman’s Crypt,” New York Times, September 12, 2009, p. SB1.

7. Steve Stecklow et al., “Sonsini Defended HP’s Methods in Leak Inquiry,” Wall Street Journal, September 8, 2006, p. A1.

8. Tyler Kepner, “Pitcher Spurns $12 Million, to Keep Self- Respect,” New York Times, January 27, 2011, p. A1.

9. Leah Nathan Spiro, “The Bomb Shelter Salomon Built,” BusinessWeek, September 9, 1991, pp. 78–80.

10. Richard A. Oppell Jr., New York Times, December 18, 2014, p. A17.

11. Susan Page, USA Today, October 6, 2014, p. 4A.

12. Catherine Yang and Amy Barrett, “In a Stew over Tainted Meat,” BusinessWeek, April 12, 1993, p. 36.

13. Jonathan McEvoy, “Career Cheat Still Playing the Game As He Performs Dark Arts for Oprah,” The Daily Mail, January 18, 2013, http://www.dailymail.co.uk/sport/othersports/ article-2264334/Lance-Armstrong-interview-He-glinteye-cocky- smirk-Jonathan-McEvoy.html, last visited October 8, 2013.

14. Sue Reisinger, “Runaway Train Hits H-P’s GC,” National Law Journal, December 18–25, 2006, pp. 8–9.

15. From “Interview: Milton Friedman,” Playboy, February 1973. © 1973 Playboy.

16. Mr. Milken was required by the Securities and Exchange Commission to pay a fine for his involvement in the negotiations (see Chapter 18).

17. Mr. Wagner is referring to Ivan Boesky, another financier who served a prison sentence; Ron Perelman, the chairman of Revlon, Inc.; Barry Diller, former chairman of Paramount and Fox and owner of the Home Shopping Network; Rupert Murdoch, the media mogul who now owns Fox. Jenny Anderson, “The Drexel Diaspora,” New York Times, February 6, 2005, 3-1, Money & Business.

18 Yuri Mishina et al., “Why ‘Good’ Firms Do Bad Things: The Effects of High Aspirations, High Expectations, and Prominence on the Incidence of Corporate Illegality,” 53 Academy of Management Journal 701 (2010).

19 Jonathan D. Rockoff, “J&J Lapses Are Cited in Drugs for Kids,” Wall Street Journal, May 27, 2010, p. B1.

20. For complete information about BP’s presence in Alaska and its contribution to the economic base there, go to http:// alaska.bp.com.

21. Chris Woodward, Paul Davidson, and Brad Heath, “BP Spill Highlights Aging Oil Field’s Increasing Problems,” USA Today, August 14, 2006, pp. 1B, 2B.

22. Jeff Bennett and Siobhan Hughes, “GM Officials Ignored Alert on Car Stalling,” Wall Street Journal, June 19, 2014, p. B1.

23. Peter Elkind, “How the Ice Cream Maker Blue Bell Blew It,” Fortune, September 25, 2015.

24. Julie Creswell and Vikas Bajas, “A Mortgage Crisis Begins to Spiral, and the Casualties Mount,” New York Times, March 5, 2007, pp. C1, C4.

25. For a summary of the state legislation on predatory lending practices, see Therese G. Franzén and Leslie M. Howell, “Predatory Lending Legislation in 2004,” 60 Business Lawyer 677 (2005).

26. Barnaby J. Feder, “An Abrupt Departure Is Seen as a Harbinger,” New York Times, May 1, 2002, pp. C1, C2.

27. Linda Shiner, “Sully’s Tale,” Air and Space, February 18, 2009, http://www.airspacemag.com/as-interview/aamps- interview-sullys-tale-53584029/#xJyMTVCWUvi7pc7e.99.

28. Anne Marie Squeo and Andy Pasztor, “U.S. Probes Whether Boeing Misused a Rival’s Documents,” Wall Street Journal, May 5, 2003, pp. A1, A7.

29. Andrew Backover, “Report Slams Culture at WorldCom,” USA Today, November 5, 2002, p. 1B.

30. http://news.syr.edu/chancellor-syveruds-message- regarding-ncaa-report-72610.

31. Annual report for 1998, posted at http://www.worldcom .com. (Note: Because WorldCom no longer exists, company information can be found only in the Edgar database at http:// www.sec.gov.)

32. Bernard Ebbers’s letter to shareholders in the annual report for 1999, posted at http://www.worldcom.com. (Note: Because WorldCom no longer exists, information about the company can be found only in the Edgar database at http://www.sec. gov.)

33. Adam Smith, An Inquiry into the Nature and Causes of the Wealth of Nations (1776). Book 1, Chapter 2, Paragraph 2, Edited by Edwin Cannan. Chicago: University of Chicago Press, 1976. Accessed online March 5, 2010, at http://www.econlib.org / library/Smith/smWN.html.

34. The Theory of Moral Sentiments (1759). Part 1, Section 1, Chapter 1, Paragraph 1, Edited by D. D. Raphael and A. L. Macfie. Oxford: Clarendon Press; New York: Oxford University Press, 1976. Accessed online March 5, 2010, at http://www. econlib.org/library/Smith/smMS.html.

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72

Chapter

The Judicial System3 Our introduction to law included discussions of statutory law and common law. With so many statutes at so many levels, you perhaps might think that statutory law is a complete source of law. However, sometimes statutes need interpretation. Someone must determine when, how, and to whom statutes apply. Statutory law is not even half of all the law. The bulk of the law is found in judicial decisions. These decisions contain statutory interpretations and common law. This chapter covers the parties involved in these decisions, as well as the courts that make them—what they decide, when they can decide, and how those decisions are made.

Update For up-to-date legal news, go to mariannejennings.com

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73

3-1 Types of Courts All U.S. court systems include two different types or levels of courts: trial courts and appellate courts.

3-1a trial Courts

A trial court is the place in the judicial system where the facts of a case are presented. This court is where the jury sits if the case is a jury trial. Here the evidence and witnesses are presented and the first decision in the case is made, by either judge or jury. The procedures for trials and trial courts are covered in Chapter 4.

3-1b appellate Courts

At least one other court, an appellate court, reviews the conduct during the trial of the judge, the lawyers, the witnesses, and the jury. This process of review helps assure that the lower court applied the law correctly and followed the rules of procedure. Further, this review system provides uniformity. In some appeals, the appellate court issues published opinions, which can then be referred to and used as resources in deciding future cases. However, in many cases the appellate court issues unpublished opinions. Unpublished opinions have become a controversial issue, and although no law prohibits citing such opinions, a cite should always make clear that the opinion is an unpublished one.

3-2 How Courts Make Decisions 3-2a the process of Judicial Review

Appellate courts do not hold trials. Rather, they review what has been done by trial courts to determine whether the trial court, also referred to as the lower court, made an error in applying the substantive or procedural law in the case through the process of judicial review.

The atmosphere in the appellate court is different from that of the trial court. No witnesses, no jury, and no testimony play a role. No new evidence is considered; only the evidence presented at trial is reviewed. The court reviews a transcript of

Hard Candy is a Florida company that sells nail polish and women’s cosmetics throughout the United States. The singer Madonna owns a company called Hard Can- dy Fitness that was created in Delaware and operates out of California. Hard Candy Fitness operates fitness centers throughout the world and sells a line of exercise gear under the company name. Hard Candy filed suit

against Hard Candy Fitness, Madonna, and her holding companies for trademark infringement. Madonna, a California resident, was only in Florida for two concerts and did not sell any of her company’s products while there or mention the centers or their products at her concerts. Can a Florida court force Madonna to defend the suit in Florida?

Consider . . . 3.1

For as thou urgest justice, be assured thou shalt have justice, more than thou desirest. Portia The Merchant of Venice, Act IV, Scene I

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74 part 1 Business: Its Legal, Ethical, and Judicial Environment

the trial along with all the evidence presented at trial to determine whether an error was made.

In addition to the transcript and evidence, each of the parties to a case can pres- ent the appellate court with a brief, which is a summary of the case and the legal issues being challenged on appeal. The appellate brief is each side’s summary of why the trial court decision or procedures were correct or incorrect. The parties make their arguments for their positions in the brief and support them with stat- utes and decisions from other cases. The brief serves as a summary of the major points of error the parties allege occurred during the trial. This type of brief, called an appellate brief, is very detailed. In fact, many refer to “briefs” as a misnomer because they are generally quite lengthy. Note that these briefs differ from the case brief presented in Exhibit 1.1.

Many appellate courts permit the attorneys for the opposing parties to make timed oral arguments in their cases. An oral argument is a summary of the points that have been made in each party’s brief. The judge can also ask questions of the attorneys at that time. At the trial level, one judge makes all decisions. At the appel- late level, more than one judge reviews the actions of the lower court in a case. The typical number is three, but, in the case of state supreme courts and the U.S. Supreme Court, the full bench of judges on the court hears each case. For example, in U.S. Supreme Court decisions, all nine justices review the cases before the Court unless they have recused (disqualified) themselves because of some conflict.

The panel of appellate judges reviews the case and the briefs, hears the oral argument, and then renders a decision. The decision in the case could be unani- mous or could be a split vote, such as 2 to 1. In the case of a split vote, a justice who is not in the majority will frequently draft a dissenting opinion, which is the judge’s explanation for a vote different from that of the majority.

Checking for error A reversible error is one that might have affected the outcome of the case or influ- enced the decision made. Examples of reversible errors include the refusal to allow some evidence to be admitted that should have been admitted, the refusal to allow a particular witness to testify, and misapplication of the law.

When a reversible error has been made, the appellate court reverses the lower court’s decision. However, in some cases, the appellate court will also remand the case, which means the court sends the case back to the trial court for further pro- ceedings. For example, when the court orders a reversal because some evidence should have been admitted that was not, the case is remanded for a new trial with that evidence admitted (i.e., allowed).

If the appellate court does not find a reversible error, it simply affirms the deci- sion of the lower court. The fact that a decision has been affirmed does not mean no mistakes were made at the trial; rather, it means that none of the mistakes was a reversible error. The appellate decision is written by a member of the court who has voted with the majority. The decision explains the facts and the reasons for the court’s reversal, remand, or affirmation.

In some appellate cases, the court will modify the decision of a lower court. The full case is neither reversed nor affirmed; instead, a portion or portions of the case are reversed or modified. For example, a trial court verdict that found a defen- dant negligent might be affirmed, but the appellate court could also hold that the damages awarded were excessive. In this type of decision, the case is remanded for a redetermination of damages at the trial court level.

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Chapter 3 The Judicial System 75

Statutory Interpretation In addition to checking for error, appellate courts render interpretations of statutes. Often, statutes seem perfectly clear until a new factual situation not covered by the statute arises.

3-2b the doctrine of Stare Decisis Judicial review by appellate courts of lower court decisions provides the database for the doctrine of stare decisis, a Latin term meaning “let the decision stand.” The decisions of the appellate courts are written and often published so that they may be analyzed, reviewed, and perhaps applied in the future.

Setting precedent When reviewing the decisions of lower courts, courts examine their own previous decisions, along with decisions of other courts on the same topic. This process of examining other decisions for help in a new case uses case precedent, which is the doctrine of stare decisis. Judges examine all prior cases in the same area of law or related to a statute to determine whether the issue has already been decided and, if so, whether the current case should be decided in the same way. Following case precedent does not mean similar cases will be decided identically; several factors influence the weight given to precedent.

the Quality of precedent Where the case originated is one of the factors that influence the use of precedent in a case. In federal courts, precedent from other federal courts is strongest when the case involves federal issues.

In state courts, prior decisions within a particular state’s own court system are given greater weight than decisions from other states’ courts. One state’s courts are not obliged to follow the precedent of another state’s courts; they are free to examine it and use it, but, as with all precedent, it is not a mandatory requirement to follow another state’s decisions.

the purposes of precedent The purposes of precedent are the same as the purposes of law. Law offers some assurance of consistency and reliability. The judiciary recognizes these obligations in applying precedent. Stability and predictability are necessary in the way law functions. No exact formula applies when deciding a case, but consistency is a key element in the use of precedent.

In addition to consistency, however, judges must remember the law’s need for flexibility. As new twists in facts arise and technology develops, the judiciary must adapt the law to those changes. For example, the courts have issued a number of decisions on copyright infringement in this era of YouTube and segments of mov- ies and TV shows being reproduced and posted there.

the Interpretation of precedent Using precedent involves more than just finding similar cases. Every case decision has two parts. One is the actual rule of law, which technically is the precedential part. However, judges never offer just a rule of law in a case. The rule of law is given at the end of the case decision after a full discussion of reasoning and prece- dent. This discussion is called the dicta of the case, which includes case precedent of benefit to each party. In some instances, the rule of law may benefit one party while the dicta benefit the other party.

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76 part 1 Business: Its Legal, Ethical, and Judicial Environment

A dissenting opinion is dicta and is often quoted in subsequent cases to urge a court to change existing precedent. Application of precedent is not a scientific pro- cess, and it often leaves much room for interpretation and variation.

Then a third-year law student, Andrew Rausa was spending July 4 with some friends on the porch or stoop area of one of the brown- stone homes in Brooklyn, New York. The area in front of the brownstone is enclosed in a fence with a gate entry. Mr. Rausa and his friends were also enjoying several rounds of beer. Two police officers came by, noted the group inside the wrought-iron fence, and cited them all for drinking in public. Mr. Rau- sa looked up the code section on his phone and found that a public place for purposes of the “no drinking in public” code provision was defined as:

[one] to which the public or a substantial group of persons has access, including, but not limited to a park, sidewalk, or beach.

There are exceptions for neighborhood block parties and events covered by per- mits. The group of friends decided to fight the violations because they did not want them to be part of their permanent records. How should the court interpret the code provision? Consider the following questions in interpretation. What if you were drink- ing in your house, but your front door was open? A window?

Consider . . . 3.2

When precedent Is Not Followed Precedent may not be followed for several reasons. Some of those reasons have already been given: the precedent is from another state, or the prece- dent is interpreted differently because of the dicta in that precedent. Precedent is also not followed when the facts of cases can be “distinguished,” which means that the context of the facts in one case is different enough from those in other cases that the precedent cannot be applied. For example, suppose that a court decided that using roadblocks to stop motorists to check for drunk drivers is constitutional. Another court then decides that using roadblocks just to check for drivers’ licenses is not constitutional. The first case can be distinguished because of the purpose of the roadblocks: to prevent a hazard- ous highway condition. The court may not see the same urgency or safety issue in roadblocks used for checking for drivers’ licenses. The precedent can be distinguished.

The theories of law discussed in Chapter 1 may also control whether precedent is applied. Courts struggle with issues of fact and law and with changes in society as they apply precedent and consider modifications.

For example, a court may not follow a precedent because of an ethical reason or because of the need to change the law on the basis of what is moral or what is right. A precedent may also be abandoned on an economic theory; in this case, the court changes the law to do the most good for the most people. For example, a factory may be a nuisance because of the noise and pollution it creates, and ample case law probably supports shutting down the factory as a nuisance. However, the factory may also be the town’s only economic support, and its shutdown will mean unemployment for virtually the whole town. In balancing the economic fac- tors, the nuisance precedent may not be followed or it may be followed in only a modified way.

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Chapter 3 The Judicial System 77

3-3 Parties in the Judicial System (Civil Cases) 3-3a plaintiffs

Plaintiffs are the parties who initiate a lawsuit and are seeking some type of recov- ery. In some types of cases, those who initiate the court action are called petitioners (such as in an action for divorce). Plaintiffs file their suits in the appropriate court, and this filing step begins the litigation process.

3-3b defendants

Plaintiffs seek recovery from defendants, who are named in the suit as having committed some violation of the law or the rights of the plaintiff. Another name for a defendant is respondent.

3-3c Lawyers

In most cases, each of the parties is represented by a lawyer. Lawyers have other functions besides representing clients in a lawsuit. Many lawyers offer “preven- tive” services. Lawyers draft contracts, wills, and other documents to prevent legal problems from arising. One role that lawyers play is advising clients in advance in order to minimize clients’ legal problems and costs.

The attorney–client relationship is a fiduciary one that carries a protected privi- lege. The attorney is expected to act in the best interests of the client and can do so without the fear of having to disclose the client’s thoughts and decisions. The attor- ney–client privilege keeps the relationship confidential and assures that others (even an adversary in a lawsuit) have limited access to lawyer–client conversations. One of the key areas of discussion and debate, under Sarbanes-Oxley (SOX), related to corpo- rate lawyers’ duty to report fraud and other financial misdeeds of their client compa- nies. Lawyers were concerned about the need for client confidentiality, and regulators and investors were concerned that lawyers have remained silent as financial frauds have been ongoing in companies. Under the law, lawyers are not required to blow the whistle on their clients, but they are required to take steps to notify the audit commit- tee and board about misconduct and ultimately resign if the conduct is not changed and rectified. (For more details of the role of general counsel, the privilege, and audi- tors’ responsibilities regarding financial fraud, refer to Chapters 8, 17, and 18.)

Under the American Bar Association’s Model Rules for Professional Responsibil- ity, attorneys are obligated to represent clients with persuasive force. An attorney who agrees to represent a client must represent that client to the best of the lawyer’s ability. Because of the privilege, many lawyers know that their clients actually did commit a crime or breach a contract. However, the client’s confession to an attorney is confi- dential. Even with knowledge of a client’s guilt, an attorney must represent the client in a manner that gives the client all rights and protections under the law. There is a difference between a client’s confession to a crime and the proof required for convic- tion of that crime. A lawyer’s obligation is to see that the other side meets its burdens and responsibilities in proving a case against the client. Lawyers do represent guilty people. Their role is to, as many lawyers phrase it, “keep the system clean.” Protect- ing the rights of the guilty is required in order to ensure that the rights of the inno- cent are also preserved. However, lawyers are not required to remain silent under the privilege if a client is about to commit a crime. A lawyer representing a client accused of murder cannot disclose that the client confessed. However, a lawyer whose client vows to kill someone must make a disclosure in order to prevent a crime.

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78 part 1 Business: Its Legal, Ethical, and Judicial Environment

Lawyers and their titles and roles vary from country to coun- try. Great Britain and most of Canada have solicitors and barristers. Solicitors prepare legal documents, give legal advice, and represent clients in some of the lesser courts. Barristers are the only “lawyers” who can practice before higher courts and administrative agencies. Quebec and France have three types of lawyers: the avocat, who can practice before the higher courts and give legal advice; the notaire, who can handle real property transactions and estates and can pre- pare some legal documents; and the juriste (legal counselor), who can give advice and prepare legal documents. In Germany, a law- yer who litigates is called Rechtsanwalt, and a lawyer who advises clients but does not appear in court is called Rechtsbeistand. Japan has only one class of lawyers, called Bengosh, but does have the Shiho-Soshi, a type of advanced notary with the authority to incor- porate companies, prepare documents, and create wills. In Italy, the two types of lawyers—whose roles are similar to those in the dual British system—are avocati and procuratori.

For the Manager’s Desk

Re: the privilege of Lawyers

To whom does the attorney–client privilege belong? An attorney who is employed as general counsel for a corporation, or a lawyer representing that corporation in a particular matter, owes a duty to the corporation. The cor- poration, in those circumstances, is the client. Employees are not. The privilege, therefore, applies to corporate client communications. Even though officers and employees provide the attorney with the information about what the corporation did, the lawyer does not rep- resent those officers and employees. In most situations, the interests of the officers and employees are the same as those of the cor- poration, and a lawyer can work closely with the officers and employees to represent the corporation. However, in some circumstanc- es the corporation’s interests are different from those of the employees. For example, suppose that a general counsel for a corpo- ration learned that its officers had engaged in price-fixing. (See Chapter 8 for more discus- sion of criminal prosecutions of officers of a corporation and Chapter 14 for discussion of price-fixing and antitrust violations.) The gen- eral counsel would discuss the issue with the board (see Chapters 17 and 18) and perhaps

conclude that it is best to disclose what has happened to the Justice Department. The officers involved might object, but they are not protected by any privilege with the cor- poration’s attorney. The attorney is protecting a client, the company, by disclosing the mis- conduct and perhaps providing assurance that the board was unaware of the price-fixing, which would then reduce any penalties the company might be required to pay.

The issue of client confidentiality also exists when employees discuss information, issues, and possible legal claims with cor- porate counsel. For example, in Schaeffer v Gregory Village Partners, L.P., 78 F. Supp. 3d 1198 (N.D. Cal. 2015), the general counsel talked with a consultant for the company who was handling corporate communications about contamination of neighboring homeowners’ property. The consultant received confidential information about the situation, and in litigation the homeowners tried to force the consultant to testify. The court held that the consultant was the equivalent of an employee and disclo- sure of information did not waive the privilege because employees can discuss issues with corporate counsel without fear of disclosure.

Be careful to protect your lawyer–client privilege. Business letters and memos to lawyers should be marked as privileged and include limitations on access to those letters and memos. If you reveal information to someone other than your lawyer, you may lose your privilege on that information. Holding a conversation or meeting with your lawyer with others present may cost you your privilege, too. Privileged communications should be with your lawyer(s) only.

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Chapter 3 The Judicial System 79

3-3d Judges

Judges control the proceedings in a case and, in some instances, the outcome. Trial judges control the trial of a case, from presiding over the selection of a jury to rul- ing on evidence questions. (See Chapter 4 for more details on trial procedures.) Appellate judges review the work of trial court judges. They do not actually hear evidence. Rather, they review the record of the case to determine whether there has been reversible error.

Judges are selected in various ways throughout the country. Some judges are elected to their offices. Some states have merit appointment systems wherein judges are appointed on the basis of their qualifications. In some states, judges are appointed by elected officials subject to the approval of the legislature. In some states with appointed judges, the judges are put on the ballot every other year (or at some other interval) for retention; voters in these states do not decide whom they want as judges but do decide whether they want to keep them once they are in office. Federal judges are appointed for life by the president with Senate approval.

3-3e Name Changes on appeal

The lawyers and the parties stay in the “game” even after a case is appealed. However, the names of the parties do change on appeal. The party appealing the case is called the appellant. Some courts also call the party appealing a case the petitioner. The other party (the one not appealing) is called the appellee or respondent.

Some states change the name of the case if the party appealing the case is the defendant. For example, suppose that Smith sues Jones for damages in a car acci- dent. The name of the case at trial is Smith v Jones. Smith is the plaintiff, and Jones is the defendant. If Smith wins the case at trial and Jones decides to appeal, Jones is the appellant, and Smith is the appellee. In some courts, the name of the case on appeal becomes Jones v Smith. Other courts leave the case name the same but still label Jones the appellant and Smith the appellee.

3-4 The Concept of Jurisdiction Courts are found at every level of government, and every court handles a different type of case. In order for a court to decide or try a particular case, both parties to the case and the subject matter of the case must be within the established powers of the court. The established powers of a court make up the court’s jurisdiction. Juris means law, and diction means to speak.

Jurisdiction is the authority or power of a court to speak the law. Some courts can handle bankruptcies, whereas others may be limited to traffic vio- lations. Some courts handle violations of criminal laws, whereas others deal only with civil matters. The subject matter of a case controls which court has jurisdiction. For example, a case involving a federal statute belongs in a fed- eral district court by its subject matter; however, federal district courts are found in every state. In personam jurisdiction, or jurisdiction over the person, controls which of the federal district courts will decide the case. Determining which court can be used is a two-step process; subject matter and in personam jurisdiction must fit in the same court.

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80 part 1 Business: Its Legal, Ethical, and Judicial Environment

3-5 Subject Matter Jurisdiction of Courts: The Authority over Content

The two general court systems in the United States are the federal court system (see Exhibit 3.1) and the state court system.

3-5a the Federal Court System

the trial Court of the Federal System The federal district court is the general trial court of the federal system. However, federal district courts are limited in the types of cases they can hear; that is, their subject matter jurisdiction is limited. Federal district courts can hear three types of cases: those in which the United States is a party, those that involve a federal ques- tion, and those that involve diversity of citizenship.

Jurisdiction When the United States Is a party Any time the U.S. government is a party in a lawsuit, it will want to be tried in its own court system—the federal system. The United States is a party when it brings suit or when it is the defendant named in a suit. For example, many busi- nesses have brought suit against the Department of Health and Human Services, a federal agency, regarding the constitutionality of that agency’s rules related to the implementation of Obama Care, the nickname given to national health care reform. Because an agency of the federal government is the defendant in the case, the federal district court has exclusive jurisdiction over the suits.

Federal Jurisdiction for a Federal Question The federal district court also has jurisdiction over cases involving federal ques- tions. For example, if a business is suing for treble damages (a remedy of three times the amount of damages experienced) under the federal antitrust laws

Exhibit 3.1 the Federal Court System

*For example, the Federal Trade Commission (FTC) or the National Labor Relations Bureau (NLRB).

U.S. Supreme Court

U.S. Courts of Appeals

Federal District Courts

Specialty Courts

U.S. Claims Court

Administrative Agencies

(Quasi-Judicial*)

U.S. Court of International

Trade

Bankruptcy Court

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Chapter 3 The Judicial System 81

(see Chapter 14) the case involves a federal question and may be brought in fed- eral district court. A suit charging a violation of the Equal Protection Clause of the U.S. Constitution (see Chapter 5 for more details) also involves a federal question and can be brought in federal district court. Prosecutions for federal crimes also involve federal questions, and the United States will be a party as the prosecutor; these criminal cases are tried in federal district court.

Many federal questions can also be heard by a state court. For example, most state constitutions include the same Fifth Amendment protections included in the U.S. Constitution. A plaintiff often has a choice between federal and state court, and the decision to proceed in one forum as opposed to the other may be a strate- gic one based on the nature of the case, rules of procedure, and other factors related to differences between the two court systems.

Jurisdiction by diversity Most of the civil cases in federal district court are not there because they are federal questions or because the United States is a party. Most civil cases are in federal district court because the plaintiff and defendant are from different states and their case involves damage claims in excess of $75,000. Cases in which the parties are from different states qualify for diversity of citizenship status, and federal district courts have the authority to hear these diversity cases. That authority is not exclu- sive; a state court can also hear diversity cases as long as neither party chooses to exercise the right to a federal district court trial. In diversity cases, state and fed- eral courts have concurrent jurisdiction. Concurrent jurisdiction means that two courts have the authority to hear a case. By contrast, exclusive jurisdiction means that only one court has the authority to hear the case. For example, federal dis- trict courts have exclusive jurisdiction over cases in which the United States has charged an individual or corporation with a federal crime.

Federal courts decide controversies among citizens of different states for rea- sons that go back to fears about state court judges giving preferential or favorable treatment to citizens of their state, as opposed to nonresident parties. If the case is held in one side’s state court, that side might have an unfair advantage or built-in prejudice because of the location of the court.

When corporations are parties to suits, the diversity issue is more complex. The citizenship of a corporation can be its state of incorporation or the state in which its principal office is located. This citizenship test is used for subject matter juris- diction. The citizenship test for in personam jurisdiction has been greatly expanded.

It is important to understand that when a federal court tries a case on the basis of diversity, it is simply trying the case under the same state laws but without the local prejudice that might exist in a state court. In other words, federal courts do not rule under a different set of laws; they simply apply the state law in a different setting.

Limited Jurisdiction: the Special trial Courts of the Federal System Not all cases in which the United States is a party or in which a federal question is involved are decided in federal district courts. The federal system also has spe- cialized trial courts to handle limited matters. For example, the jurisdiction of the Tax Court in the federal system is limited to tax issues. If you challenge the Internal Revenue Service because it would not allow one of your deductions, your case would be heard in Tax Court. The bankruptcy courts make up a well-used lim- ited court system within the federal system and have exclusive jurisdiction over all bankruptcies. No other court can handle a bankruptcy or bankruptcy issues, and bankruptcy courts do not handle any other type of trial or suit.

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82 part 1 Business: Its Legal, Ethical, and Judicial Environment

The U.S. Claims Court is another specialized federal court: it handles disputes that involve government contracts and other claims against the federal govern- ment, such as eminent domain issues. (See Chapter 5 for more discussion of emi- nent domain and “takings.”)

The U.S. Court of International Trade is a specialized court that focuses on international trade transactions regulated by federal agencies in various ways and also on customs issues.

Another court that is often discussed along with the federal system is the Indian Tribal Court. This court, the court of the Native American nations, has exclusive jurisdiction over criminal and civil matters on the reservations. Indian tribal courts are unique because of their limited jurisdiction and their exclusivity, which arises from their sovereign nature.

the Structure of the Federal district Court System Each state has at least one federal judicial district. The number of federal districts in each state is determined by the state’s population and caseload. States such as Wyoming and Nevada have only one federal district each, whereas states such as Illinois and New York have many. The number of courts and judges in each federal district is also determined by the district’s population and caseload. Even in those states with just one district, the district has several judges and multiple courtrooms for federal trials. Ninety-four federal districts serve the 50 states, the District of Columbia, Puerto Rico, Guam, the Virgin Islands, and the Northern Mariana Islands.

the Importance of Federal district Court decisions The subject matter of cases that qualify for federal district court jurisdiction is important. These cases involve the interpretation of federal statutes and often the resolution of constitutional issues. Because of the importance of these decisions, the opinions of federal district judges are published in a reporter series called the Federal Supplement, which reprints most opinions issued by federal district judges in every federal district. (Decisions of the Court of International Trade are also found in the Federal Supplement.) Cases in the Federal Supplement provide excellent precedent for interpretation and application of federal statutes. In addition to the system for citing statutes (see Chapter 1), a specific system is used for citing case opinions. Such a sys- tem is necessary so that precedent can be found easily for use in future cases.

All case cites consist of three elements: an abbreviation for the reporter, the vol- ume number, and the page number. The abbreviation for the Federal Supplement is “F. Supp.” or, for the second series, after volume 999, “F. Supp. 2d,” or, the third series, “F. Supp. 3d.” The volume number always appears in front of the abbre- viation, and the page number appears after it. A formal cite includes in parenthe- ses the federal district in which the case was decided and the year the case was decided. A sample federal district court cite of a case that dealt with an eminent domain question looks like this:

Sansotta v Town of Nags Head, 97 F. Supp. 3d 713 (E.D.N.C. 2014)

This method of uniform citation not only helps ease the burden of research but also provides an automatic way to know where a case came from and how it can be used.

the appellate Level in the Federal System Cases decided in federal district court and the specialized trial courts of the federal system can be appealed. These cases are appealed to the U.S. Courts of Appeals (formerly called the U.S. Circuit Courts of Appeals).

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Chapter 3 The Judicial System 83

Structure. All of the federal district courts are grouped into federal circuits according to their geographic location. Exhibit 3.2 is a map that shows the 13 fed- eral circuits. Note that 11 of the circuits are geographic groupings of states; the twelfth circuit is the District of Columbia, and the thirteenth is a nongeographic circuit created to handle special cases, such as those involving patent disputes and issues and appeals from the Court of Claims and Court of International Trade. Some scholars and members of Congress have proposed creating a fourteenth cir- cuit by dividing the very large Ninth Circuit.

Each circuit has its own court of appeals. The office of the court’s clerk is located in the city named in each of the federal circuits in Exhibit 3.2. The number of judges for each of the federal circuits varies according to caseload. However, most cases are heard by a panel of three of the circuit judges. It is rare for a case to be heard en banc (by the “whole bench,” meaning all the judges in that circuit). One of the more famous cases to be heard en banc following a three-judge panel deci- sion involved a father’s challenge to his child being required to recite the Pledge of Allegiance because the phrase “under God” was in the pledge: Elk Grove Unified School Dist. v Newdow, 292 F.3d 597 (9th Cir. 2002) and 313 F.3d 500 (9th Cir. 2002) with en banc rehearing denied, 328 F.3d 466 (9th Cir. 2003).1

Procedures. The U.S. Courts of Appeals are appellate courts and operate by the same general procedures discussed earlier in the chapter. An appeal consists of a

Exhibit 3.2 the 13 Federal Judicial Circuits

W E

E N

C

S

W

N

E

NW

W

E

S

E

S

N

E W

W E

S

N

W

E

C

E

S

S

N

S W

W

E

E

N N

MMS

N

S

M

S

E

E

W S

N

MW

N W

M

W N

M

W

W

N

M

E

S

7

1

9

10

5

9

8

9

3 6

4

11

2

1

9

3

Atlanta

Maine

Vermont

Puerto Rico

Virgin Islands

D.C. Circuit

Federal Circuit

Hawaii

Michigan

Washington, D.C.

Washington, D.C.

Legend Circuit boundaries

State boundaries

District boundaries

Location of U.S. Court of Appeals

Florida

Maryland Delaware

New Jersey

Pennsylvania

Connecticut Rhode Island Massachusetts

New Hampshire

New York

Guam

Northern Mariana Islands

Boston

New York

Philadelphia

District of Columbia Washington, D.C. Richmond

New Orleans

Cincinnati

Chicago

St. Louis

Denver San

Francisco

Source: Administrative Ofˆce of the United States Courts.

Texas

Mississippi

Alaska

California

Nevada

Oregon

Washington

Idaho

Montana

Wyoming

Utah

Arizona

New Mexico

Colorado

Kansas

Oklahoma

Nebraska

So. Dakota

No. Dakota Minnesota

Iowa

Missouri

Arkansas

Georgia Alabama

So. Carolina

No. Carolina

Virginia W. Va.

Ohio

Kentucky

Tennessee

Michigan

Indiana Illinois

Wisconsin

Louisiana

12

13

Source: A dministrative Office of the U.S. Courts.

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84 part 1 Business: Its Legal, Ethical, and Judicial Environment

record of the trial in the court below (here, the federal district court), briefs, and possible oral argument. The standard for reversal is reversible error. Because the right of appeal is automatic, the appellate courts have tremendous caseloads. A full opinion is not given in every case. In the cases that are affirmed, the opinion may consist of that one word. Other decisions are issued as memorandum opinions for the benefit of the parties but not for publication.

Opinions. The opinions of the U.S. Courts of Appeals are published in the Fed- eral Reporter. The system of citation for these cases is the same as for federal dis- trict court opinions. The abbreviation for the Federal Reporter is “F.” (or sometimes “F.2d” or “F.3d”; the “2d” means the second series, which was started after the first “F” series reached volume 300, and this series is now followed by a third series— “F.3d”). A formal cite includes in parentheses the federal circuit and date of the decision. A sample U.S. court of appeals cite, the appeal of a case challenging the constitutionality of Obama Care mandates on coverage follows:

Little Sisters of the Poor Home for the Aged, Denver, Colo. v Burwell 794 F.3d 1151 (10th Cir. 2015)

the U.S. Supreme Court A decision by a U.S. court of appeals is not necessarily the end of a case. One more appellate court is part of the federal system—the U.S. Supreme Court. However, the Supreme Court’s procedures and jurisdiction are slightly different from those of other appellate courts.

Appellate Jurisdiction and Process. The Supreme Court handles appeals from the U.S. courts of appeals. This appeal process, however, is not an automatic right. The Supreme Court must first decide whether a particular case merits review. That decision is announced when the Court issues a writ of certiorari for those cases it will review in full. The Supreme Court, in its writ, actually makes a preliminary determination about the case and whether it should be decided. Only a small num- ber of cases appealed to the Supreme Court are actually heard. In 1945, 1,460 cases were appealed to the Court. By 1960, that number had grown to 2,313. Now the number averages about 7,000 each year with fiscal year 2012 (the latest year avail- able from the Court), having 7,713 cases. The court grants certiorari in about 100 cases and hears oral arguments and issues written opinions in about 70 to 80 cases. All of the Supreme Court opinions issued in one year total about 5,000 pages, including the majority, concurring, and dissenting opinions.

The court grants writs of certiorari in cases as a matter of discretion. Certiorari may be granted because of a conflict among the circuits about the law, such as the differ- ing decisions among the circuits on the constitutionality of Obama Care, or because the case presents a major constitutional issue, such as with corporate political dona- tions. This writ of certiorari procedure also applies to other sources of appellate cases, such as those coming up through state supreme courts, which can be appealed to the U.S. Supreme Court. For example, in 2015, the U.S. Supreme Court granted certiorari in a case in order to clarify the relationship between state arbitration waiver statutes and the Federal Arbitration Act (DirectTV, Inc. v Imburgia, 136 S.Ct. 463 (2015)). The plaintiff in the case, DirectTV, was granted certiorari because it argued that the Fed- eral Arbitration Act superseded any state law that allowed consumers to opt out of arbitration. The U.S. Supreme Court granted certiorari for purposes of clarifying the federal law and preemption issues on mandatory arbitration clauses.

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Chapter 3 The Judicial System 85

The U.S. Supreme Court also acts as a trial court (called a court of original juris- diction) in certain cases. When one state is suing another state, the U.S. Supreme Court becomes the states’ trial court. For example, the water dispute among Cali- fornia, Arizona, Colorado, and Nevada has been tried over a period of years by the U.S. Supreme Court. The Court also handles the trials (on espionage charges, for example) of ambassadors and foreign consuls.

Structure. The U.S. Supreme Court consists of nine judges, who are nominated as justices to the Court by the president and confirmed by the Senate. The appoint- ment is for life. A president who has the opportunity to appoint a Supreme Court justice is shaping the structure of the Court and the resulting decisions. U.S. Supreme Court justices are often labeled “conservative” or “liberal.” The makeup of the bench controls the philosophy and decisions of the Court.

Opinions. Because the Court is the highest in the land, its opinions are precedent for every other court in the country. The importance of these opinions has resulted in three different volumes of reporters for U.S. Supreme Court opinions. The first is the United States Reports (abbreviated “U.S.”). These reports are put out by the U.S. Government Printing Office and are the official reports of the Court. Because these reports are often slow to be published, two private companies also publish opin- ions in the Supreme Court Reporter (abbreviated “S. Ct.”) and the Lawyer’s Edition

For the Manager’s Desk

The following chart, organized by federal cir- cuits, shows the percentage of lower court

decisions the U.S. Supreme Court reversed in 2014.

CIRCUIt CaSeS takeN CaSeS ReveRSed ReveRSaL Rate

1st 1 0 0%

2nd 1 1 100%

3rd 3 3 100%

4th 6 3 50%

5th 8 6 75%

6th 5 4 80%

7th 3 3 100%

8th 8 7 88%

9th 16 10 63%

10th 4 3 75%

11th 5 5 100%

D.C. Federal Circuit 6 5 83%

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86 part 1 Business: Its Legal, Ethical, and Judicial Environment

(abbreviated “L. Ed.” or “L. Ed. 2d”). The three-part cite for Citizens United v Federal Election Com’n (the Court’s decision on corporate speech during elections) follows:

558 U.S. 310 (2010) 130 S.Ct. 876 (2010) 175 L. Ed. 2d 753 (2010)

3-5b the State Court Systems

Although each state court has a different structure for its court system and the courts may have different names, the basic structure in each state is similar to the federal system. Exhibit 3.3 provides a diagram of a sample state court system.

State trial Courts Each state has its own general trial court. This court is usually called a circuit, dis- trict, county, or superior court. It is the court in which non-diversity civil cases are heard and state criminal cases are tried.

In addition to its general trial court, each state also has its own group of “lesser courts.” They are courts with limited jurisdiction and are comparable to the spe- cialty courts of the federal system. For example, most states have a small claims court in which civil cases with minimal damage claims are tried. In a true small claims court, attorneys are not used. Parties represent themselves before a judge. Such a setting offers parties the chance to have a judge arrive at a solution without the expense of attorneys. The amount recoverable in small claims court is indeed small: $200 to $25,000 is the typical range.

Most states also have a lesser court that allows the participation of lawyers but limits the amount that can be recovered. The idea is to take the burden of lesser cases away from the usually overburdened general trial courts. These courts are called justice of the peace courts or county courts.

Most cities also have their own trial courts, which are limited in their jurisdiction to the trial of lesser crimes, such as violations of city ordinances. Many states call these courts traffic courts because city ordinances involve so many traffic regulations.

Exhibit 3.3 typical State Court System

Trials de novo

City Courts

Probate Courts

Justice of the Peace or

County Courts

Small Claims Courts

General Trial Courts (Circuit, District, County)

State Courts of Appeals

State Supreme Courts

Lesser Courts

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Chapter 3 The Judicial System 87

In addition to these courts, some states have specialized courts to handle mat- ters that are narrow in their application of law but frequent in occurrence. For example, although probating (processing) a will and an estate involves narrow issues of law, the supply of this type of case is constant. Many states have special courts to handle this and related matters, such as guardianships for incompetent persons.

Many of the lesser courts allow appeals to a general state trial court for a new trial (trial de novo) because not all judges in these lesser courts are lawyers, and constitutional protections require a right of de novo appeal in those situations.

State appellate Courts State appellate courts serve the same function as the U.S. courts of appeals. The court system provides an automatic right of review in these courts. Some states have two appellate-level courts to handle the number of cases being appealed. The opinions of these courts are reported in the state’s individual reporter, which contains the state’s name and some indication that an appellate court decided the case. For example, state appellate decisions in Colorado are reported in Colorado Appeals Reports (abbreviated “Colo. App.”). These opinions are also reported in a regional reporter. All states are grouped into regions, and opinions of state appel- late courts are grouped into the reporter for that region. Exhibit 3.4 presents the various regions and state groupings. For example, Nevada is part of the Pacific region, and its appellate reports are found in the Pacific Reporter (abbreviated “P.,”

Exhibit 3.4 National Reporter System Regions

paCIFIC (p. oR p.2d)

NoRthWeSteRN (N.W. oR N.W.2d)

NoRtheaSteRN (N.e. oR N.e.2d)

SoUtheaSteRN (S.e. oR S.e.2d)

Alaska

Arizona

(California)

Colorado

Hawaii

Idaho

Kansas

Montana

Nevada

New Mexico

Oklahoma

Oregon

Utah

Washington

Wyoming

Iowa

Michigan

Minnesota

Nebraska

North Dakota

South Dakota

Wisconsin

Southwestern (S.W. or S.W.2d)

Arkansas

Kentucky

Missouri

Tennessee

Texas

Illinois

Indiana

Massachusetts

(New York)

Ohio

Atlantic (A. or A.2d)

Connecticut

Delaware

District of Columbia

Maine

Maryland

New Hampshire

New Jersey

Pennsylvania

Rhode Island

Vermont

Georgia

North Carolina

South Carolina

Virginia

West Virginia

Southern (So. or So.2d)

Alabama

Florida

Louisiana

Mississippi

Note: California and New York each have their own reporter system. Source: The national reporter system was developed by West Publishing Company. Reprinted with permission of West Publishing Company.

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88 part 1 Business: Its Legal, Ethical, and Judicial Environment

“P.2d,” or “P.3d”). The following is a sample regional reporter cite, a case that deals with UCC warranties:

Wyman v Ayer Properties, 11 N.E.3d 1074 (Mass. 2014).

State Supreme Courts State supreme courts are similar in their function and design to the U.S. Supreme Court. These courts do not hear every case because the right of appeal is not auto- matic. These supreme courts have some discretion in deciding which cases they will hear. State supreme courts also act as trial courts in certain types of cases and so are also courts of original as well as appellate jurisdiction. For example, if two counties within a state have a dispute, the state supreme court would take the trial to ensure fairness. A state supreme court’s decision is not necessarily the end because there is the possibility of an appeal to the U.S. Supreme Court if the case also involves a federal question or an issue of constitutional rights.

The opinions of state supreme courts are significant and are reported in the regional reporters discussed earlier. Many states also have their own reporters for state supreme court opinions. For example, California has the California Reporter. The state supreme court reporters are easily recognized because their abbrevia- tions are the abbreviation of each state’s name. The following is the cite from the California decision on the arbitration clause that the U.S. Supreme Court eventu- ally heard and decided:

DirectTV, Inc. v Imburgia 170 Cal. Rptr. 3d 190 (Cal. 2014)

3-5c Judicial opinions

Although the published opinions of the courts just discussed vary in their places of publication, the format is the same. Exhibit 3.5 shows a sample page from a reporter, with each part of the excerpt identified. Opinions are reported consis- tently in this manner so that precedent can be found and used easily through the research keys highlighted at the beginning.

3-5d venue

The concept of jurisdiction addresses the issue of which court system has the authority to try a case. The concept of venue addresses the issue of the location of the court in the system. For example, a criminal case in which a defendant is charged with a felony can be tried in any of a state’s general trial courts. Heavy media coverage, however, may result in a judge’s changing the venue of a case from the place where the crime was committed to another trial court in an area where there is less publicity about the case and it is easier to obtain an impar- tial jury. However, the bar is a tall one for establishing the need for a change of venue. In Skilling v U.S., 561 U.S. 358 (2010), the U.S. Supreme Court held that the daily and ongoing coverage of Enron’s collapse and the role of former CEO Jef- frey Skilling in that collapse were not enough to require that Mr. Skilling’s trial for criminal fraud be moved from Houston, where the company was headquartered, to another federal court in Texas or outside the state.

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Chapter 3 The Judicial System 89

Exhibit 3.5 Sample page of a Case in a National Reporter

Chapter 3 The Judicial System 93

CASTEEL v STATE Cite as 131 P.3d 1 (Nev. 2006)

Dion Fabion CASTEEL, Appellant, v

The STATE of Nevada, Respondent. No. 42436.

Supreme Court of Nevada. March 30, 2006.

Rehearing Denied May 17, 2006. Reconsideration en banc Denied

June 12, 2006. Background: Defendant was convicted in the Eighth Judicial District Court, Clark County, Joseph T. Bonaventure, J., of 10 counts of sexual assault of a minor and 12 counts of use of a minor under age of 14 in production of pornography. He appealed. Holdings: The Supreme Court, Maupin, J., held that: 1. consent to search of apartment given

by defendant’s live-in girlfriend authorized police ofŽcers to search apartment;

2. girlfriend had authority to consent to ofŽcers’ search of defendant’s gym bag;

3. trial court’s Žndings supported its conclusion that defendant was not in custody for Miranda purposes when he was interrogated by ofŽcer; but

4. defendant could be convicted only of four counts of use of a minor under age of 14 in production of pornography.

AfŽrmed in part, reversed in part, and remanded.

1. Searches and Seizures 177 Consent to search of apartment given

by defendant’s live-in girlfriend autho- rized police ofŽcers to search apartment; girlfriend had equal control over apart- ment, which she shared with defendant. U.S.C.A. Const.Amend. 4.

2. Criminal Law 1139 Appellate court reviews the lawfulness

of a search de novo because such a review requires consideration of both factual circumstances and legal issues. U.S.C.A. Const.Amend. 4.

3. Searches and Seizures 177 A warrantless search is valid if police

ofŽcers acquire consent from a cohabitant who possesses common authority over the property to be searched. U.S.C.A. Const.Amend. 4.

4. Searches and Seizures 186 Defendant’s live-in girlfriend had

authority to consent to police ofŽcers’ search of his gym bag, which was located in closet inside apartment that he shared with girl- friend; girlfriend gave ofŽcers valid consent to search apartment, and defendant appar- ently took no special steps to secure privacy interest in gym bag and did not deny girl- friend all access to apartment, given that both girlfriend and minor victim knew con- tents of gym bag and knew that it could be found in closet. U.S.C.A. Const.Amend. 4.

5. Searches and Seizures 177 A warrantless search is valid based on

the consent of one occupant, despite the physical presence of the nonconsenting occupant. U.S.C.A. Const.Amend. 4.

Philip J. Kohn, Public Defender, and Sharon G. Dickinson and Jordan S. Savage, Deputy Public Defenders, Clark County, for Appellant.

George Chanos, Attorney General, Carson City; David J. Roger, District Attorney, James Tufteland, Chief Deputy District Attorney, and Ross J. Miller, Deputy District Attorney, Clark County, for Respondent.

Before MAUPIN, GIBBONS and HARDESTY, JJ.

MAUPIN, J.

In this appeal, we hold that a warrant- less search of a residence is valid based on the consent of one occupant where the other occupant fails to object. We also resolve questions concerning custody for purposes of Miranda v Arizona.1 Finally, we conclude that only 4 counts of production of child pornography may stand because the State failed to prove production depict- ing separate sexual performances.

case name

decision issue

research tool

docket number

decision of the court

court

case name

case cite

judge deciding case

attorneys for parties

opinion

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90 part 1 Business: Its Legal, Ethical, and Judicial Environment

3-6 In Personam Jurisdiction of Courts: The Authority over Persons

Once the proper court for the subject matter in a case is determined, only half the job is done. For example, a case may involve a million-dollar claim between citizens of different states, in which case a federal district court has subject matter jurisdiction over the parties. So which of the 94 federal district courts will hear the case? The case will be heard by the federal district court with in personam jurisdiction over the parties. Subject matter jurisdiction is one issue; the other jurisdictional issue is power over the parties involved in the case.

The various criteria for determining in personam jurisdiction are examined here and are outlined in Exhibit 3.6.

3-6a ownership of property within the State

A party who owns real property in a state is subject to the jurisdiction of that state’s courts for litigation related to that property. Actually, this type of jurisdiction gives the court authority over the person because the person owns a thing in the state. Technically, this type of jurisdiction through property ownership is called in rem jurisdiction.

3-6b volunteer Jurisdiction

A court has jurisdiction over a person who agrees to be subject to that court. In some contracts, for example, the parties agree that any lawsuits will be brought in the seller’s state. The seller’s state courts then have jurisdiction over that volunteer buyer. Most Internet contracts have a venue clause.

3-6c presence in the State

The third and final way a state court can take jurisdiction is by the “presence” of a party in the state, which is determined by different factors.

Residence Individuals are present in a state if they have a residence in that state. Differ- ent definitions of residency are used for tax and election laws, but the require- ment here is simply that the person live in the state some time during any given year.

Corporations are residents of the states in which they are incorporated. A cor- poration is also a resident, for purposes of judicial jurisdiction, of any state in which it has a business office with employees.

“Minimum Contacts” Both corporations and residents can be subject to a state court’s jurisdiction if they have “minimum contacts” in that state. The standard for minimum contacts is a fairness standard, which was established by the U.S. Supreme Court in Inter- national Shoe v Washington, 326 U.S. 310 (1945). This decision requires states to notify out-of-state defendants of a suit and determine that those defendants have some contact with the state. Such contact can come through the voluntary acts

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Chapter 3 The Judicial System 91

of shipping products or advertising products or services in the state. The courts look at the extent of involvement in the state as a standard for fairness. However, fairness does not require an office or an employee in the state. These standards for in personam jurisdiction are more liberal than the citizenship requirements for diversity actions.

Long-arm Statutes: the tools of Minimum Contacts In order to follow the Supreme Court’s ruling on fairness, all of the states have adopted long-arm statutes. These statutes are appropriately named: they give courts the power to extend their “arms of jurisdiction” into other states. For exam- ple, suppose that Zeta Corporation is incorporated in Ohio and has its manufac- turing plant there. Zeta ships its glass baking dishes to every state in the country, although it has no offices anywhere except in Ohio. Joan Berferd, who lives in Alabama, is injured when one of Zeta’s baking dishes explodes. Can the Ala- bama courts allow Berferd to file suit there and require Zeta to come to Alabama to defend the suit? Yes, because a long-arm statute is fair if it covers businesses shipping products to the state. Zeta entered the Alabama market voluntarily and must be subject to the Alabama courts. Long-arm statutes generally cover busi- nesses with offices in the state, businesses shipping products into the state, and businesses that cause a tort to be committed in that state.

Hard Candy, LLC v Hard Candy Fitness (Case 3.1) deals with a long-arm issue and provides an answer for the chapter’s opening “Consider …”

Exhibit 3.6 personal Jurisdiction

Individuals

Corporations

Residence

Incorporated

Business Of�ce

Minimum Contacts

Standards of Justice and Fair Play

Products in State

Marketing Plan

Long Arm Statute

Ownership of Property within the State

Volunteer Jurisdiction

Presence in the State

Court

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92 part 1 Business: Its Legal, Ethical, and Judicial Environment

Hard Candy, LLC v Hard Candy Fitness 106 F. Supp. 3d 1231 (S.D. Fla. 2015)

A Hard Decision on Madonna’s Hard Candy Fitness Company

Case 3.1

FaCtS

Hard Candy is a Florida limited liability company with its principal place of business in Hollywood, Florida, that began with “Hard Candy” nail polish in 1995. Around that time, Hard Candy filed a U.S. trademark application for the nail polish. Some time later, they filed other applications under the name “Hard Candy” for cosmetics, including lipstick, lip liner, and mascara. Hard Candy’s products are sold in Wal-Mart retail stores and on Wal-Mart’s website. Since 1997, Hard Candy has also operated a website at www.hardcandy. com, on which Hard Candy currently displays its prod- ucts with a link to Wal-Mart’s website.

Hard Candy Fitness (HCF) is a network of luxury fitness clubs operated by Hard Candy Fitness, LLC (“HCF”), a Delaware limited liability company with its principal place of business in California. HCF’s clubs are located worldwide, but there has never been a club in Florida. NEV Hard Candy Fitness, LLC (“NEV-HC”) (a Delaware limited liability company) and MGHCandy (a Delaware limited liability company and owner of HCF) with its principal place of business in California, along with New Evolution Ventures, LLC (“NEV”) (a Delaware limited liability company with its principal place of business in California), are businesses associ- ated with Madonna Louise Ciccone, popularly known as Madonna.

Ciccone (a resident of New York) has Guy Oseary (a resident of California) as MGHCandy’s “senior man- agement representative.” Additionally, Oseary and Sara Zambreno have provided personal management services to Ciccone since around 2005, first as employ- ees of Guyo Entertainment, Inc., and later in affiliation with third-party Live Nation. Although in some cir- cumstances Oseary and Zambreno must consult with Ciccone before making decisions on her behalf, as a general matter both have considerable discretion to manage Ciccone’s affairs without her input.

In November 2008, NEV filed with the U.S. Patent and Trademark Office for use of the mark “Hard Candy Fitness” for “[h]ealth club services.” The “Hard Candy Fitness” mark was used for the first time over two years later. On October 12, 2011, MGHCandy granted HCF a license to use the mark “Hard Candy Fitness” in connection with the operation of fitness clubs, the sale

of related products, and the marketing and promotion of the clubs and products. In May 2014, MGHCandy assigned to HCF its rights in the unregistered mark “Hard Candy” for use on clothing, bags, jewelry, athletic gear, and accessories. All of these companies, Ciccone, Oseary, and Zambreno are the Defendants.

Hard Candy filed suit in Florida for infringement of the Hard Candy Marks by Hard Candy Fitness through the clubs, the apparel, the www.hardcandyfitness.com website, and the Hard Candy Fitness DVD, entitled Addicted to Sweat.

Madonna and her companies (Defendants) filed a motion to dismiss or, in the alternative, to transfer venue to the Northern District of California.

JUdICIaL opINIoN

ALTONAGA, District Judge The Florida long-arm statute recognizes two kinds of per- sonal jurisdiction over a nonresident defendant: specific jurisdiction and general jurisdiction. The statute confers specific jurisdiction over a non-resident defendant if the claim asserted against the defendant arises from the defen- dant’s forum-related contacts (i.e., contacts with Florida). The statute expressly provides a defendant’s contacts may be based not only on the defendant’s personal activities, but also on the actions of the defendant’s agents. Hard Candy relies on this agency theory of jurisdiction.

To establish a defendant is “carrying on business” under the Florida long-arm statute, “the activities of the defendant must be considered collectively and show a general course of business activity in the state for pecuniary benefit. Relevant factors in this analy- sis include “the presence and operation of an office in Florida . . . , the possession and maintenance of a license to do business in Florida . . . , the number of Florida clients served . . . , and the percentage of overall revenue gleaned from Florida clients.”

The Defendants conduct significant business in this District by selling Hard Candy Fitness products and services here, both in stores and via the internet; MGH- Candy “actively participates in all of HCF’s decisions related to the use of the mark ‘Hard Candy,’ and the aesthetics of the mark and the products.” [MGHCandy, Ciccone,] and Oseary approve and control all aspects of the use of the mark “Hard Candy,” including the

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Chapter 3 The Judicial System 93

“artistic content,” aesthetics and images related to the use of the mark. Their approval and control rights spe- cifically include the Addicted to Sweat DVD—from its creation, sale and marketing, to the content and cover— the locations for new fitness centers, and the scope of “Hard Candy Fitness” branded services and products, including apparel, sunglasses, bags, t-shirts and more.

“Generally, a foreign parent corporation is not subject to the jurisdiction of a forum state merely because a subsidiary is doing business there.” A sub- sidiary’s contacts may, however, be imputed to the foreign parent, and therefore potentially subject the parent to personal jurisdiction, “if the subsidiary is merely an agent through which the parent company conducts business in a particular jurisdiction or [the subsidiary’s] separate corporate status is formal only and without any semblance of individual identity.” This agency theory of personal jurisdiction is “not . . . limited to a parent-subsidiary relationship,” but rather may extend to other relationships, such as the relation- ship between members of a limited liability company and the company.

The fact the parent approves major policy decisions of the subsidiary and establishes the subsidiary’s goals and directives is not sufficient to render the subsidiary merely a formality. Similarly, operational control does not exist simply because the parent monitors the sub- sidiary and advises it when necessary.

According to Richard Feldstein, who provides business and accounting services to MGHCandy and Ciccone, MGHCandy was formed for the following purposes: (1) allowing Ciccone and Oseary to hold ownership interests in MGHCandy; (2) fulfilling obli- gations and receiving benefits pursuant to the HCF Operating Agreement; (3) facilitating the transfer of intellectual property rights to HCF; and (4) engaging in other necessary and incidental activities.

The limited purposes for which MGHCandy was formed reflect the limited role MGHCandy plays in HCF.

Ciccone provided input regarding: “(1) the individ- ual names used for the DVDs in the set; (2) the DVD descriptions included on the back of the DVD covers; (3) the wording of the quote attributed to Ciccone on the cover of the DVDs; and (4) the title that should be given to the dancer in the DVD, Nicole Winhoffer.” Ciccone also selected the final DVD cover artwork as well as the final color scheme and layout (including images) for the rest of the DVD artwork. Ciccone also viewed a “sizzle reel” highlighting portions of the DVD’s content, but she never viewed the entire DVD. Ciccone was “only concerned with [her own] image on the cover of the DVD,” and she did not otherwise take part in any approval process regarding how the DVD was advertised, presented, or sold.

When they do discuss HCF-related matters, the issues are “more aesthetic, approving a color of some- thing in a gym, approving flooring.” Indeed, Ciccone approved certain HCF merchandise, including shirts, sunglasses, water bottles, a gym bag, and a pen.

In 2012 and 2013, Live Nation and one of Ciccone’s business entities collaborated to produce a worldwide concert tour. As part of the arrangement, Live Nation— not Ciccone—scheduled and produced the concerts and manufactured and sold merchandise with the “Hard Candy” mark. In late November 2012, Ciccone per- formed two of those concerts in Miami, Florida, but she did not promote HCF or HCF-related goods or services at her concerts, nor did she attend a special event held in Miami around the time of her concerts to promote the ATS DVD. Ciccone has not directly sold concert tickets or merchandise in connection with the concerts she has performed with Live Nation over the past five years.

Strictly construing the Florida long-arm statute, and making all reasonable inferences in favor of Hard Candy, the Court finds the Defendants’ Florida contacts relating to the asserted causes of action are too tenuous to support specific jurisdiction over the Defendants.

The reach of general jurisdiction under the Florida long-arm statute “extends to the limits on personal juris- diction imposed by the Due Process Clause of the Four- teenth Amendment. . . . Corporations are considered “at home” in their place of incorporation and principal place of business. Corporations may be subject to the exercise of general jurisdiction in other places as well, but the Due Process Clause imposes a high standard: “the inquiry . . . is not whether a foreign corporation’s in-forum contacts can be said to be in some sense ‘continuous and system- atic,’ it is whether that corporation’s ‘affiliations with the State are so ‘continuous and systematic’ as to render [it] essentially at home in the forum State.’” Defendants, MGHCandy, LLC, Guy Oseary, and Madonna Louise Ciccone are dismissed from this action. The request to transfer this case to a different venue is granted.

CaSe QUeStIoNS

1. Develop a chart showing the various companies involved along with the people and locations for doing business.

2. Explain when Madonna was in Florida and why her presence was not enough to allow jurisdiction.

3. What kinds of activities would have subjected Madonna and her companies and agents to Florida jurisdiction?

4. Why do you think it is so important for Hard Candy to have Madonna and one of her compa- nies as defendants?

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94 part 1 Business: Its Legal, Ethical, and Judicial Environment

3-6d Internet Companies and Long-arm Jurisdiction

One of the active areas of in personam jurisdiction involves the question of when companies that do business solely over the Internet can be required to travel to a state to defend a lawsuit that is the result of their sales of goods in that state. In making the determination of jurisdiction, courts look at five factors: (1) the nature and quality of the contacts with the state, (2) the quantity of contacts with the state, (3) the relation of the suit to the contacts, (4) the interest of the state in allowing its residents to recover, and (5) the convenience of the parties. These factors are

Ethical Issues

Evaluate the ethics of Hard Candy Fitness in its infiltration of the Florida market using the similar name.

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Strategic Geography on Courts and higher damages

Business Strategy

Not all states have the same laws, not all jurors see issues the same way, and not all courts are as fussy about experts and evidence as others. Businesses must know where to go, court-wise, in order to maxi- mize the results of their litigation.

Companies that purchase patents and file suit against large corporations for infringement have favored the Eastern Dis- trict of Texas (Tyler and Marshall, Texas) for their suits for the past decade because those who live in this area (including lawyers and jurors) believe in patents in the same way they believe in oil and gas rights. If you find it, you own it, and all the rights and royalties that come with that ownership. Most cases filed there are settled because everyone involved understands the area dynamics. If a case does go to trial, the verdicts are Texas-size. Versata Software

recovered $345 million from SAP following a patent infringement trial held in Marshall, Texas. That verdict is the 10th largest in pat- ent infringement history. When Microsoft lost its Eastern District of Texas court case to I4i, it paid $200 million in damages.

There are also geographical differences in how product liability cases are viewed. Philadelphia, Pennsylvania, is a favorite for product liability plaintiffs because the court there is known for its “rocket docket” (fast-moving cases) and because Pennsyl- vania places no limits on damage claims in product liability suits.

Businesses and individuals have learned to choose their courts’ locations very care- fully. As seen in these examples, geography matters in results.

Source: Susan Decker, “A Crackdown on Patently Absurd Lawsuits,” BusinessWeek, May 14–20, 2012, 33. ©

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Chapter 3 The Judicial System 95

applied differently, but Internet immunity seems to be winning the day. For exam- ple, in Sioux Transportation, Inc. v XPO Logistics, LLC, 2015 WL 9412930 (D. Ark. 2015), the court refused to allow personal jurisdiction over an out-of-state com- pany whose employee had posted allegedly defamatory information about the plaintiff company on an industry website.

3-7 The International Courts The decisions of international courts provide precedent for parties involved in international trade. However, one of the restrictions on international court decisions is that the decision binds only the immediate parties to the suit on the basis of their factual situation. International courts do not carry the enforce- ment power or authority of courts in the U.S. federal and state systems. They are consensual courts and are used only when the parties agree to use them.

The International Court of Justice (ICJ) is the most widely known international court. It was first established as the Permanent Court of International Justice (PCIJ) in 1920 by the League of Nations. In 1945, the United Nations (UN) changed the name and structure of the court. The ICJ is made up of judges, no more than two of whom can be from the same nation, who are elected by the General Assembly of the UN. The court has been described as having contentious jurisdiction, which is

Marcus Gray brought suit in Missouri against Kathryn Elizabeth Hudson, aka Katy Perry, for her alleged infringement of his gospel song, “Joyful Noise,” with her song, “Dark Horse.” “Joyful Noise” was written and published five years prior to Ms. Perry’s song.

Ms. Perry is a resident of California and has been to Missouri twice for concerts. “Dark Horse” can be purchased on a web- site established by Ms. Perry’s business- es, and the website has many customers in Missouri. Ms. Perry has challenged the Missouri federal court’s jurisdiction over her for purposes of the suit. What should the court do?

Steps for Analyzing This Case Study

THINK:

1. Determine how much of a presence Ms. Perry had in Missouri.

2. List the contacts she had with Missouri.

3. Determine whether there will be any suit or remedy if the case must be moved to California.

APPLY: Ms. Perry did travel to Missouri for a concert. Ms. Perry and her compa- nies do sell CDs and songs for download- ing through her website to residents of Missouri. However, Ms. Perry does not have a continuing presence in Missouri and does not have offices there. The Hard Candy case from earlier in the chapter pro- vides guidance on this issue. If the case is not heard in Missouri, Mr. Gray will have to pursue the case in California, and he may not have the means to pursue the case there.

ANSWER: The facts of this case do not provide a sufficient basis for granting ju- risdiction over Ms. Perry. She cannot be required to come to Missouri to defend the suit. [Gray v Hudson, 2015 WL 4488143 (E.D. Mo. 2015)]

Consider . . . 3.3

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96 part 1 Business: Its Legal, Ethical, and Judicial Environment

to say that the court’s jurisdiction is consensual: when a dispute occurs, the parties can agree to submit the dispute to the ICJ.

In addition to the ICJ, other international courts include the European Union’s Court of Justice of European Communities and the European Court of Human Rights, as well as the Inter-American Court of Human Rights. Jurisdiction in these courts is also consensual.

The decisions of these courts and decisions from individual countries’ courts dealing with international law issues can be found in International Law Reports.

In recent years, London’s Commercial Court, established more than 100 years ago, has become a popular forum for the resolution of international com- mercial disputes. Over half the cases in this court involve foreign enterprises. Some companies choose London’s Commercial Court as the forum for their dis- putes for several reasons, even though neither they nor their transactions have any connection with England. First, the court has the advantage of being a neu- tral forum. Second, for U.S. firms, the use of the English language in the court is important. Third, the court has a wide range of experience in international dis- putes, from shipping contracts to joint trading ventures. Fourth, the judges on the court were all once commercial litigators themselves and bring their depth of experience to the cases. Fifth, the court is known for its rapid calendar, mov- ing cases along quickly. Major cases are heard within one year from the ser- vice of summons. Finally, the court has used a variety of creative remedies. The Commercial Court has issued pretrial injunctions to freeze assets, and its ties to the English government afford the injunctions international recognition. Per- haps the most famous of the Commercial Court’s cases is its handling of the 20 class actions against Lloyd’s of London.

3-7a Jurisdictional Issues in International Law

The jurisdiction of courts within a particular country over businesses from other countries is a critical issue in international law. A common subject in international disputes is whether courts in the United States, for example, can require foreign companies to defend lawsuits within the United States.

3-7b Conflicts of Law in International disputes

The courts and judicial systems of countries around the globe vary, as do the procedural aspects of litigation. For example, Japan has no discovery process that permits the parties to examine each other ’s documents and witnesses prior to trial (see Chapter 4 for more details on discovery and the Japanese court system), and the United States permits lawyers to collect contingency fees and also permits broader tort recovery than would be available in most other countries.

Because of liberal discovery and recovery rules in the United States, many plaintiffs injured in other countries by products manufactured by U.S.-based firms want to bring suit in the United States to take advantage of our judicial system’s processes and rules. However, the California Supreme Court has ruled in Stangvik v Shiley, Inc., 819 P.2d 14 (Cal. 1991), that if a plaintiff’s home coun- try provides an adequate forum for a dispute, the case cannot be brought in the United States. The suit involved family members of various patients who had died when their heart valves, manufactured by Shiley of Irvine, Califor- nia, failed. The decision of the California Supreme Court required the plaintiffs

With national and international business transactions becoming so frequent, many con- tracts now include “fo- rum selection” claus- es. These portions of a contract stipulate that if litigation is required, a particular court in a particular state or country will have jurisdiction over both parties. For example, a franchisor might have the forum selection clause provide that all litigation by franchi- sees would be in the state and city where the franchisor’s prin- cipal office is located. Checking a contract carefully for these clauses will enable you to decide, before signing, whether you want to agree to travel to another state or country if litigation be- comes necessary.

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Chapter 3 The Judicial System 97

Biographythe Judges and their Words

The judges who handle trials and appeals often find themselves dealing with seri- ous statutory interpretations and legal issues even as they are faced with whim- sical factual patterns. Below are some sample excerpts from judicial opinions that illustrate the tall order judges have in managing their courtrooms and in issuing their wisdom, precedent, and decisions.

That golfers do not always hit their golf balls straight is a matter of common knowledge; it is a fact that needs no supporting evidence, a principle that needs no citation of authority. Geddes v Mill Creek Country Club, Inc., 751 N.E.2d 1150 (Ill. 2001)

A child’s belief in Santa Claus or Spi- derman does not make the child’s testimony about his real-life experi- ences unreliable. Harris v Thompson, 698 F.3d 609 (7th Cir. 2012)

When confronted with a situation involving a juror who appears to have fallen asleep during trial, counsel has a duty to bring the matter to the attention of the trial court and the trial court has a duty to awaken the juror. Mathis v State, S.E.2d 308 (Ga. 2013)

Discharge of sworn juror based on purported misconduct, because other jurors had complained that juror emitted a foul body odor and was flatulent, was improper, where trial court failed to conduct inquiry, especially where defense counsel objected. People v Westbrook, 576 N.Y.S.2d 372 (N.Y. App. Div. 1991)

Juror note sent during delibera- tions, asking for the opportunity to thank all concerned for privilege of serving, mentioning breakup of her marriage and her view that the male lawyer who sat in second chair at the prosecution table was a “Cutie,” and asking to be given that lawyer’s telephone number when trial was over, did not require the juror’s disqualification; trial judge inter- viewed the juror in counsel’s pres- ence, explained to her that the note was inappropriate, and obtained her assurance that nothing, including her favorable impression of a prose- cutor, would prevent her from being fair to both sides. People v Lewie, 953 N.E.2d 760 (N.Y. 2011)

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to return to their home countries, where the recovery would be substantially less. The courts have continued to favor litigation in the home country of the plaintiffs despite hardships. Martinez v E.I. DuPont Nemours and Company, 86 A.3d 1102 (Del. 2014), and Auffret v Capitales Tours, S.A., 2013 WL 1749895 (Cal. App. 2013).

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98 part 1 Business: Its Legal, Ethical, and Judicial Environment

What is the judicial process?

• Judicial review—review of a trial court’s decisions and verdict to determine whether any reversible error was made

• Appellate court—court responsible for review of trial court’s decisions and verdict

• Brief—written summary of basis for appeal of trial court’s decisions and verdict

• Reversible error—mistake by trial court that requires a retrial or modification of a trial court’s decision

• Options for appellate court:

• Reverse—change trial court’s decision

• Remand—return case to trial court for retrial or reexamination of issues

• Affirm—uphold trial court’s decisions and verdict

• Modify—overturn a portion of the trial court’s verdict

• Stare decisis—Latin for “let the decision stand”; doctrine of reviewing, applying, and/or distin- guishing prior case decisions

• Case opinion—written court decision used as precedent; contains dicta or explanation of rea- soning and, often, a minority view or dissenting opinion

Who are the parties in the judicial system?

• Plaintiffs/petitioners—initiators of litigation

• Defendants/respondents—parties named as those from whom plaintiff seeks relief

• Lawyers—officers of the court who speak for plaintiffs and defendants

• Attorney–client privilege—confidential protections for client conversations

• Appellant—party who appeals lower court’s decision

• Appellee—party responding in an appeal

What factors decide jurisdiction?

• The power of the court to hear cases

• Subject matter jurisdiction—authority of court over subject matter

• Jurisdiction over the parties: in personam jurisdiction

• Voluntary

• Through property

• Presence in the state: minimum contacts

• Residence

• Business office

What are the courts and court systems?

• Federal court system

• Federal district court—trial court in federal system; hears cases that involve a federal ques- tion, the United States as a party, or a plaintiff and defendant from different states (diversity of citizenship) and $75,000 or more at issue; opinions reported in Federal Supplement

• Limited jurisdiction courts—bankruptcy courts, court of claims

• U.S. Courts of Appeals—federal appellate courts in each of the circuits; opinions reported in Federal Reporter

• U.S. Supreme Court—highest court in United States; requires writ of certiorari for review; acts as trial court (original jurisdiction) for suits involving states and diplomats

• State court system

• Lesser courts—small claims, traffic courts, justice of the peace courts

• State trial courts—general jurisdiction courts in each state

• State appellate courts—courts that review trial court decisions

• State supreme courts—courts that review appel- late court decisions

• International courts

• Voluntary jurisdiction

• International Court of Justice—UN court; contentious (consensual) jurisdiction; reported in International Law Reports

• London Commercial Court—voluntary court of arbitration

s u m m a r y

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1. The brokerage firm of E. F. Hutton was charged with federal criminal violations of interstate funds transfers. In reviewing the case, the lawyers for the government discovered internal memoranda from and between branch managers in several states that outline a process for check kiting (a literal stringing together of checks and deposits) that enabled E. F. Hutton to earn interest on phantom deposits. Where will the case be tried? Which court system? Which court? Why?

What are the lawyers’ obligations with respect to the documents? What is the company’s obligation? If you were a manager at E. F. Hutton, would you voluntarily disclose the documents to the government?

2. Pharmaceutical manufacturer Merck experienced litigation over its drug Vioxx because of customers who say they had cardiovascular side effects from taking the anti-arthritis pain drug. Merck faced 9,500 lawsuits that a federal judge ruled could not be tried as class actions because of the different health issues among the plain- tiffs who were bringing the suits against Merck. A jury in a federal court in New Orleans cleared Merck of any responsibility for the death of Richard Irvin, a Florida resident who had a fatal heart attack one month after he began to take Vioxx. In 2005, Merck won one state court verdict in New Jersey and lost another state court trial in Texas. Why would some of the cases be tried in state court and some in federal court? Explain the differing decisions.

3. N-the-Water Publishing, Inc. dba Still N the Water Publishing produces hip-hop and rap music through sampling, the process of copying portions of prior mas- ter sound recordings directly onto new sound recordings and then rapping on top of the new sound recording. Bridgeport Music is the owner of the copyright for the music that Still N the Water has used for its rap and hip- hop song productions. Bridgeport is headquartered in Nashville, Tennessee, and Still N the Water is part of a series of record companies based in Florida and Texas. Bridgeport brought suit against Still N the Water in fed- eral district court in Tennessee. Under Tennessee’s long- arm statute, jurisdiction may be asserted on “any basis not inconsistent with the constitution of this state or of the United States.” [Tenn. Code Ann. § 20–2–214(a)(6)] Still N the Water sells CDs in all 50 states, with sales spread equally among the states and marketing plans for each of the states.

Can Still N the Water be required to come to Tennes- see to defend the lawsuit? [Bridgeport Music, Inc. v Still N The Water Pub, 327 F.3d 472 (6th Cir. 2003); cert. denied 540 U.S. 948 (2003)]

4. Troy Francis was driving his 2005 Mitsubishi Lancer automobile—equipped with a Bridgestone Potenza tire— on the Melvin Evans Highway on St. Croix on February 9, 2008. Francis lost control of the vehicle when the tread on the Potenza tire allegedly separated, causing the vehi- cle to leave the road and overturn. As a result, Francis suffered fractures of the neck, ribs, and forearm; a brain injury; lacerations; and disfigurement. Francis filed suit against Bridgestone for strict liability and negligence, alleging that Bridgestone negligently manufactured, engineered, designed, marketed, tested, or failed to test the tire.

Bridgestone Corporation is a Japanese corporation with its principal place of business in Tokyo, Japan. Bridgestone challenged the Court’s personal jurisdiction over it. Bridgestone argued that it does not do business in the Virgin Islands and that it does not have contacts with the Virgin Islands that would allow the Court to exercise personal jurisdiction.

Does the court have jurisdiction? Is there jurisdiction if your products end up in a particular country? How would the tires have ended up on the car? Suppose that Francis was on vacation and driving a rental car but lives in Florida. Could Florida exercise jurisdiction over the case? What would Francis have to show? [Francis v Bridgestone Corporation, 2013 WL 5276365 (D.C.V.I. 2013)]

5. Determine which court(s) would have jurisdiction over the following matters:

a. The sale of securities without first registering them with the Securities and Exchange Commis- sion, as required under 15 U.S.C. § 77 et seq.

b. A suit between a Hawaiian purchaser of sun- screen lotion and its California manufacturer for severe sunburn that resulted $65,000 in medical bills

6. Where will the following cases be tried? a. A will contest that challenges the validity of a will b. A suit by a homeowner against his building con-

tractor for $1.5 million for the failure to provide termite protection on the home the contractor built

c. A suit by a defense contractor against the U.S. Army for nonpayment on drones delivered to Iraq

7. The following rule appears in State University’s cur- rent catalog:

A course in which a grade of C or better has been earned may not be repeated. The second entry will not be counted in earned hours or grade point index for graduation.

Q u e s t i o n s a n d P r o b l e m s

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100 part 1 Business: Its Legal, Ethical, and Judicial Environment

Rod took his business math course and earned a C. Not satisfied with his grade but unaware of the catalog regulation, Rod took the math course again and this time earned a D. The registrar has entered the D grade in Rod’s cumulative average. Rod objects based on the catalog rule, but the registrar says the rule applies only if a higher grade is earned. What should Rod do? Should the grade count?

8. Patricia Baker was a passenger aboard a Royal Carib- bean Cruise Lines ship. She had purchased a ticket to participate in a mock pirate ship excursion tour in the Cayman Islands from E & H Cruises, a Cayman Islands corporation. While boarding the E & H mock pirate ship, Ms. Baker fell and was injured. She brought suit in Flor- ida federal district court against both Royal Caribbean and E & H to recover for her injuries. E & H moved to dismiss the suit because it did not do business in the United States and was not subject to U.S. courts. Ms. Baker argues that she bought the pirate excursion ticket in Florida, so E & H was doing business in the United States. Is she correct? Can E & H be required to come to the United States to defend the suit? [E & H Cruises, Ltd. v Baker, 88 So.3d 291 (Fla. App. 2012)]

9. The words “I’ve fallen and I can’t get up!” were part of a TV commercial for a device whose marketing was directed at the elderly and whose appeal was that the device was hooked to communication links with emer- gency care providers. In fact, the device provided a link,

but not a direct link, to a 911 number; some interlink delay would occur in notifying emergency personnel. The devices, worn around the neck, were in fact a means of effecting communication when the wearer could not get to a phone. However, the device was not directly linked to a 911 number.

Officials in Arizona brought charges against the com- pany for deceptive advertising. Standards in Arizona require proof only that someone could be misled by the commercials; actions against advertisers do not require proof that someone was actually misled. The devices have been a help to many people, bringing assistance to those who would otherwise, because of temporary or permanent mobility impairment, be unable to call for help. Officials in other states did not find the ads mis- leading. Does Arizona have jurisdiction?

If you were an official for the company, would you change all of your ads or modify only those in Arizona? Were the ads unethical?

10. Janice Burns purchased a crockpot from Cooking, Inc. The handles on the crockpot were designed poorly and were too small for lifting. When Janice tried to lift it from the cooking element, the pot slipped, and she was severely burned when the food fell on her legs and feet. Janice has $85,000 in medical bills plus loss of income and pain and suffering. Janice lives in Illinois. Cooking, Inc. is a Delaware corporation based in New Jersey. In which court could Janice file suit? Which state?

Ethics & the Law The Dismissal of a Lawyer

Timothy J. Mayopoulos was the general counsel for Bank of America (B of A) until shortly before its merger/acquisition of Merrill Lynch was approved by B of A shareholders. Mr. Mayopoulos was fired from his position on the day he met with the board, and the board was told that Merrill Lynch had heretofore undisclosed losses that had not been disclosed to B of A shareholders. He was escorted out of the Charlotte, North Carolina, B of A headquarters by security per- sonnel and was not permitted to return to his office and collect his belongings. The merger was approved, and the shareholders brought suit for the bank’s failure to disclose the full scope of the Merrill Lynch losses.

Mr. Mayopoulos gave testimony to New York Attorney General Andrew Cuomo, the official who had been investigating whether information about the

scope of the losses was withheld prior to the share- holder vote on the Merrill Lynch merger/acquisition. Mr. Mayopoulos, however, declined to disclose to Mr. Cuomo’s office the content of the advice he gave to the bank, citing legal ethics rules.

Mr. Cuomo asked B of A to waive “the privilege” because its refusal was hindering his office’s ability to investigate what happened in the days leading up to the merger/acquisition. B of A initially refused to waive its attorney–client privilege. However, when an SEC investigation began, the bank waived the privilege and then settled the SEC case for a $150 million fine. The shareholder litigation was settled for $2.43 billion.

B of A’s then CEO, Kenneth D. Lewis, testified that Mr. Mayopoulos was fired because B of A had more executives than it needed following the merger.

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Chapter 3 The Judicial System 101

Mr. Mayopoulos went on to become general counsel for Fannie Mae and ultimately its CEO, but, in an ironic note, Mr. Mayopoulos who lived in Charlotte, North Caro- lina, continued to live on the same street as Mr. Lewis fol- lowing his termination. The neighborhood block parties during the summer of 2009 must have been tense.

What is the lawyer–client privilege, and when does it apply? Does it apply to general counsel as well as to outside counsel? When is the privilege waived? Why do you think Mr. Mayopoulos stood so firm on his refusal

to answer questions about what happened in the days leading up to the merger and his termination? What do you think really happened in the lead-up to the merger?

For More Information Louise Story, “Bank Firing of Counsel Is Examined,” New York Times, September 9, 2009, p. C1.

Dan Fitzpatrick, “New York Nears Charges on Merrill Deal,” Wall Street Journal, September 9, 2009, p. C1.

n ot e 1. The U.S. Supreme Court ruled that Mr. Newdow lacked standing to challenge the “under God” clause in the pledge of allegiance because he was not the custodial parent of his

daughter. [542 U.S. 1 (2004)] The other cites for this case are 124 S.Ct. 2301(2004) and 159 L.Ed.2d 98(2004).

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102

Chapter

Managing Disputes: Alternative Dispute Resolution and Litigation Strategies4 The study of business regulation to this point has involved an overview of ethics, law,  and the courts responsible for enforcing, interpreting, and applying the law. This chapter focuses on disputes and answers the following questions: How can businesses best resolve disputes? What strategies should a business follow if litigation is inevitable? How do courts proceed with litigation?

Update For up-to-date news on law, ethics, and economics, go to mariannejennings.com

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103

4-1 What Is Alternative Dispute Resolution? Alternative dispute resolution (ADR) offers parties alternative means of resolving their differences outside actual courtroom litigation and the costly preparation for it. ADR ranges from informal options, such as a negotiated settlement between the CEOs of companies, to the formal, written processes of the American Arbitration Associa- tion (AAA). These processes may be used along with litigation or in lieu of litigation.

4-2 Types of Alternative Dispute Resolution 4-2a arbitration

Nature of arbitration Arbitration is the oldest form of ADR and was once the most popular form of ADR, but its increasing costs and time commitment have found businesses and lawyers labeling it “no different from litigation.”1 As of 2012, arbitration cases were down, and motions to set aside arbitration awards or obtain exemptions from mandatory arbitration clauses were up.2 Mandatory arbitration clauses have even been abandoned by the American Institute of Architects (AIA), a pioneer in ADR that had the mandatory clauses in its model contract from 1888 through 2010. The AIA has moved to mandatory mediation. Bank of America has elim- inated mandatory arbitration from its credit card, bank account, and auto loan contracts. The Consumer Financial Protection Bureau has proposed eliminating arbitration in consumer credit contracts. Because of this shift in ADR, arbitration is no longer the preferred method for business dispute resolution.

The one remaining area of growth in arbitration is through state courts, which, in order to encourage ADR, now impose mandatory arbitration in all cases involv- ing amounts below a certain dollar limit, generally $25,000 to $50,000. In Arizona, these mandatory arbitration proceedings are arbitrated by lawyers in the state, who are required to accept such assignments on a rotating basis either for a fee or as part of their pro bono activities. Such mandatory arbitration requirements have reduced the civil caseloads in many states by as much as 50%.

Binding vs. Nonbinding vs. Mandatory arbitration An agreement to submit to arbitration is an enforceable clause in consumer and commercial contracts. The parties may also agree to submit to arbitration after

Pulte Homes was developing a subdivision when its grading of the land resulted in flooding of the proper- ty of adjoining landowners. The landowners brought suit against Pulte. A special master found that Pulte had deleted relevant e-mails and that its lawyers had

removed documents from a stack of documents the landowners’ lawyer had selected to copy while the land- owners’ lawyers went to lunch. What happens when parties do not disclose all evidence? Are there sanctions for destroying evidence?

Consider . . . 4.1

If I were asked where I place the American aristocracy, I should reply without hesitation that it occupies the judicial bench and bar. Alexis de Tocqueville

(1805–1859)

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104 part 1 Business: Its Legal, Ethical, and Judicial Environment

their dispute arises even though they do not have such a clause in their contract. Arbitration can be binding or nonbinding. Binding arbitration means that the decision of the arbitrators is final. Appeals of the decision are limited (see dis- cussion that follows). Nonbinding arbitration is a preliminary step to litigation. If one of the parties is not satisfied with the result in the arbitration, the case may still be litigated.

A contract can also require arbitration, something known as mandatory arbi- tration. Under mandatory arbitration, the parties cannot choose court action first. Mandatory arbitration clauses have been a focus of court challenges. However, the Federal Arbitration Act (FAA) permits mandatory arbitration in consumer contracts and has been upheld by the U.S. Supreme Court. [Green Tree Financial Corp. v Randolph, 531 U.S. 79 (2000)] Arbitration clauses can be set aside if they are included in a contract due to misrepresentation or fraud. Case 4.1, College Park Pentecostal Holiness Church v General Steel Corp., deals with an issue of whether an arbitration clause can be set aside.

College Park Pentecostal Holiness Church v General Steel Corp. 847 F. Supp. 2d 807 (D. Md. 2012)

When a Church Gets Snookered into a Building and Arbitration

Case 4.1

FaCtS

In December 2006, Pastor Jamil Kahn of the College Park Pentecostal Church (plaintiff) discussed by phone with Christopher Davis, an employee of General Steel Corporation (Defendants), the possible construction of a building on the Church’s property in College Park, Maryland. Davis told Pastor Kahn that General Steel would provide a “turnkey” building ready for occupancy and would handle all zoning, design, site planning, and general contracting work. General Steel faxed the contract to Kahn on January 11, 2007.

The cover page of the contract, which was marked “Urgent,” stated that the contract had to be signed that day and directed Kahn to initial the “CONDITIONS” page before faxing the document back to General Steel. The contract outlined the Church’s “STEEL BUILD- ING SPECIFICATIONS,” and farther down the page, in small block print, the contract stated, “. . .  ALL DISPUTES SHALL BE ARBITRATED PURSUANT TO PARAGRAPH 6 OF THE CONDITIONS PAGE.” Para- graph 6 provided:

Any controversy or claim arising out of or relating to this contract, or the breach thereof, shall be resolved by arbitration before the Judicial Arbiter Group, Inc. in Denver, Colorado. Any challenge relating to the entire agreement or any subpart thereto, arbitration of any controversy, and confirmation of any arbitration award

shall be only in Denver, Colorado. Any such challenge that relates to whether claims are arbitrable shall obli- gate the challenging party to pay the attorney’s fees and costs of defense to the non-challenging party. The party initiating arbitration shall advance all costs thereof. This agreement shall be governed by and interpreted in accordance with the laws of the State of Colorado. The Federal Arbitration Act shall govern the interpretation, enforcement, and proceedings pursuant to the arbitra- tion clause in this agreement.

On January 12, Pastor Kahn sent General Steel a check for $45,000 as a deposit. In January 2008, Pastor Kahn signed a “Building Change Order,” which added a mezzanine level to the planned building, and sent General Steel another check for $50,000. Due to the increased price of the mezzanine, however, the parties later executed a second Change Order that restored the original design of the building. General Steel never returned the $50,000.

Following payment of the deposits, General Steel informed the Church that they would provide no assistance with site planning, zoning, or construction and would only supply materials for the building. The Church demanded return of the deposits, claiming it had no intention of entering into a “materials only” contract, but General Steel refused. The Church filed suit for breach of contract.

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continued

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Chapter 4 Managing Disputes: Alternative Dispute Resolution and Litigation Strategies 105

General Steel filed a motion to dismiss the suit and refer the case to arbitration, but the court requested more information in order to determine the validity of the arbitration clause, given the obvious distance, cost, and inconvenience to the Church of having to arbitrate in Colorado.

JUdiCial OpiNiON

MESSITTE, Judge Under Colorado law, an arbitration clause, as with any clause in a contract, may be invalidated if it is deemed unconscionable.

Defendants advance two arguments why the arbi- tration clause in this case should be enforced as writ- ten, neither of which the Court finds persuasive. In its supplemental brief, the Church specifically attacked the “enforceability of the arbitration clause” as “part of a multiple part analysis” that courts use in exam- ining “such issues as venue under the principle of forum non-convenience [sic].” [T]he Church assert- ed the hardship of “litigating and/or arbitrating in Colorado.” The Church’s assets included a savings account totaling $32,736.00 and a checking account, after deducting outstanding liabilities, consisting of $2,319.00. The Church received an income of approxi- mately $24,000.00 per month in donations but incurred approximately per month in $20,000.00 expenses. [T] he Judicial Arbiter Group in Denver, Colorado would charge on average $395.00 per hour for an arbitrator’s services. The Church estimated that an arbitrator would spend between twenty-six to thirty-six hours resolving this case—consisting of two days of hearings and 10 additional hours of work—for an arbitrator’s fee of approximately $14,220.00. Additional costs of arbitration would include the cost of retaining Colora- do counsel and transportation and housing expenses for a minimum of three days for at least two individ- uals representing the Church. To date, the Church’s Maryland counsel has charged only expenses for his legal representation, and has stated that he is unable to devote the time necessary to handle arbitration in Colorado. The Church has contacted several attorneys in Denver, all of whom indicated that it would take some 50 hours to handle the arbitration and draft a post-hearing memorandum. These attorneys reported on average a fee of $325.00 per hour, which would bring their fees to a total of about $17,500.00. As for travel and accommodations expenses for two Church representatives, those may be estimated at $700.00 and $1,275.00, respectively, a total of $1,975.00. Given an approximate total cost of $33,695.00 to arbitrate in

Colorado, arbitrating the dispute would effectively eliminate all of the Church’s remaining assets and likely jeopardize its continued existence. The cost of arbitration that the Church would incur if Defendants’ arbitration clause were fully enforceable can only be described as unconscionable.

Fully cognizant that Colorado public policy “strong- ly favors the resolution of disputes through arbitra- tion,” the Court concludes that some terms of the clause are indeed unconscionable and therefore unenforceable.

It is readily apparent that the arbitration clause was part of a standardized agreement executed by parties of unequal bargaining strength. General Steel sent Pas- tor Kahn the front and back of its [purchase agreement] and pressured him to sign and return it the same day he received it. The terms and conditions of the contract, including the arbitration clause, were not subject to negotiation. According to General Steel’s website, it is a “worldwide leader” in the steel building industry with “years of building design experience.” See General Steel, http://www.gensteel.com. In contrast, from all appearances neither Kahn nor the Church possessed the least business sophistication, including experience with contracts or in the field of construction generally. Additionally, Khan conducted his discussions with Defendants without the benefit of counsel, and signed the Purchase Agreement as the Church’s representative again without the benefit of counsel. This factor weighs heavily against enforceability of the forum selection clause.

It is also clear that the Church had little time to read and familiarize itself with the Purchase Agreement before signing it. Kahn received the contract on Jan- uary 11, 2007 and was obliged to execute the contract and return it on the same day he received it. [T]he same day turn-around hardly gave the Church the opportu- nity to appreciate the significance of its terms, especial- ly the potential onerousness of having to arbitrate in Colorado should it find it necessary to challenge any aspect of Defendants’ performance.

The Court is hard pressed to conclude that it is commercially reasonable to require the representatives of a financially modest church to travel three-quarters of the way across the country to arbitrate its claims, pay Defendants’ attorneys’ fees and costs if it challenges arbitrability (whether the challenge is successful or not), and advance all costs of arbitration.

The Court [must] examine the terms of the arbitra- tion clause and determine whether they are substan- tively unfair. The Court has done so and concludes that most of the provisions are clearly lopsided in favor of Defendants. The Court finds no reason to

continued

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106 part 1 Business: Its Legal, Ethical, and Judicial Environment

challenge the bona fides of the designated arbitrator, the Judicial Arbiter Group, Inc. But the fact remains that General Steel is located in Lakewood, Colorado. The Church is located in College Park, Maryland, over 1,400 miles away. And again, if the Church merely undertakes to challenge enforcement of any aspect of the arbitration clause, it must “pay the attorney’s fees and costs of defense to the non-challenging party,” i.e., Defendants, whether the Church prevails on the point or not.

Perhaps more important, the Church is apparently obliged to “advance all costs thereof.” In other words, even if the Church were to obtain a favorable out- come through arbitration, it would still be obligated to put forward Defendants’ fees and costs and the arbitrator’s fees and costs. Nothing in the contract allows for deferral of payments or shifting fees and costs to the losing party. Courts have expressed concern about fee-splitting provisions in arbitration clauses that require an aggrieved party to pay even one half of an arbitrator’s fees.

Defendants’ argument that hiring new counsel might not be necessary, the implication being that the Church could either appear without counsel, or that current Maryland counsel, presumably out of the goodness of his heart, could offer his services without charge, is altogether fatuous. This case is far too com- plex for the Church members to handle by themselves, and their counsel has already voiced his understand- able unwillingness to handle the arbitration in Colorado pro bono. Defendants’ contention that if Colorado counsel were needed, the Church has overestimated the average hourly rate and ignored the possibility of contingency fee arrangements, is also fatuous. Even $250.00 rather than $325.00 per hour would result in a significant sum over the projected 50 hours of attorney time. Moreover, it is highly unlikely that any Colo- rado counsel worth his or her salt would be willing to sign onto this case on a contingency basis. Finally, Defendants’ suggestion that “telephonic appearances or preservation depositions” might suffice ignores the fact that they would be clearly weak substitutes for live appearances.

The Church alleges, and Defendants have yet to deny, that the latter’s representative told Kahn that

General Steel would provide a “turnkey” building ready for occupancy and would handle all zoning, design, site planning, and general contracting work, a representation the Church maintains was totally false when made.

Finally, it does not pass notice that Defendants’ sales practices have been seriously called into ques- tion in other jurisdictions. The Church asserts that Defendants have yet again engaged in sharp dealings. Perhaps so, perhaps not. What is undisputed, however, is that as a result of signing the contract with General Steel and making the required deposits, the Church has lost $95,000, which Defendants claim is non- refundable, including—incredibly—the $50,000 depos- it the Church made for a change Defendants agree was duly cancelled.

This case involves more than just a disparity of bar- gaining strength and a “‘simple old-fashioned bad bar- gain.’” This is a case where “no decent, fair[-]minded person would view the ensuing result” of enforcement of the arbitration provisions “without being possessed of a profound sense of injustice. . . .”

Accordingly, the Court will excise the uncon- scionable provisions of the arbitration clause. The Court will STRIKE those portions of the arbitration clause (1)  designating “the Judicial Arbiter Group, Inc. in Denver, Colorado,” as the sole arbitrator for any controversy or claim; (2) declaring that “Denver, Colorado” is the only place where any challenge relat- ing to the agreement; (3) compelling the party that challenges arbitrability “to pay the attorney’s fees and costs of defense to the non-challenging party;” and (4) requiring the party “initiating arbitration” to “advance all costs thereof.”

The Court will direct that the arbitration go for- ward, but that it be held in this District, minus the described unconscionable provisions.

CaSe QUeStiONS

1. What does the court find was unconscionable about the contract and negotiations?

2. What is severed from the contract and why?

3. How will the case now proceed?

4-2b arbitration procedures

Once the parties agree to arbitrate, they usually notify the AAA (www.adr.org), which, for a fee, will handle all the steps in the arbitration. The AAA is the largest ADR provider in the country for commercial disputes, and the National Arbitra- tion Forum is the largest for consumer contracts.

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Chapter 4 Managing Disputes: Alternative Dispute Resolution and Litigation Strategies 107

The parties submit names for arbitration, and a mutually agreeable arbitrator or panel is appointed. A hearing date is set at a mutually agreeable time. Between the time the date is set and the actual hearing, the parties have the responsibility of gathering their evidence and necessary witnesses. The parties are, in effect, doing their preparation or discovery (see pp. 120–125). The parties can also request that the other party bring certain documents to the hearing. Some arbitrators are given subpoena power in certain states; that is, they have the power to require the pro- duction of documents or to have a witness testify.

The parties need not have lawyers but have the right to use one under AAA rules. AAA rules require notification to the other parties about the use and iden- tity of counsel. Although the atmosphere is more relaxed, an arbitration hearing parallels a trial. Each of the parties has the opportunity to present evidence and witnesses. Each has the right to cross-examination and a closing statement. Some of the emotion of a trial is missing because, although emotional appeal influences juries, an expert arbitrator is not likely to be swayed by it. After the close of the hearing, the arbitrator has 30 days to make a decision.

In binding arbitration, the arbitrator’s award is final. The award and decision cannot be changed, modified, or reversed. Only the parties can agree to have the case reopened; the arbitrator cannot do so. The courts are strict in their hands-off policy on private arbitration decisions that result from the parties’ contractual agreement to submit to arbitration. The grounds for setting aside an arbitration finding under federal law are (1) the award resulted from corruption, fraud, or undue influence; (2) partiality or corruption occurred among the arbitrators; (3) the arbitrators were guilty of misconduct, which prejudiced the rights of one of the parties; or (4) the arbitrators exceeded their powers.

Re: Understanding the Disillusionment with ADR

For the Manager’s Desk

The issues lawyers raise about arbitration include the following:

• Increasingly, arbitrations are as time-consuming and costly as trials.

• Too many arbitrators are allowing extensive discovery.

• Some arbitrators are requiring $40,000 retainers just for agreeing to begin hearing a case.

• The panel of arbitrators may consist of people who, while knowledgeable in their fields, are beholden to the industry, such as an engineer siding with an engineer defendant.

Some businesses are revisiting their mandatory arbitration clauses because they are looking at some of the arbitration deci- sions and saying, “Maybe the court system isn’t so bad—at least you get due process at some point.”

The concern of many lawyers and court administrators is the loss of common law and statutory interpretation when too many cases opt for the ADR route, which does not include published decisions or rationale.

What are the theoretical benefits of arbi- tration? What are its drawbacks?

Sources: Leigh Jones, “Gotcha Game,” National Law Journal, February 11, 2011, p. 1; Michael Orey, “The Vanishing Trial,” BusinessWeek, April 30, 2007, pp. 38–39.

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108 part 1 Business: Its Legal, Ethical, and Judicial Environment

Nicholas Sharp and Barry and Rhonda Downey own adjacent tracts of land, and for almost eight years, they have been en- gaged in litigation over land and easement rights. One tract of land involved in the dis- pute was landlocked and the other was not, with the main issue being whether there was an easement for the landlocked prop- erty and where that easement would be located. At the end of the eight years, they agreed to submit their issues for binding arbitration.

The arbitrator reached a decision that resulted in the granting of an implied ease- ment to one owner but not to the owner of the landlocked property. The arbitrator found that the landlocked property did not need an implied easement. Further, the arbitrator’s decision on the location of the easement

resulted in an easement that was not actually connected on the land. When one party moved for the court to set aside the decision of the arbitrator as an “arbitrary, irrational decision in manifest disregard of the law,” the court agreed and stated that “While parties to arbitration agree to accept the arbitrator’s interpretation of the law, this does not mean that they agree to per- mit the arbitrator to fabricate the law from whole cloth.” [Sharp v Downey, 13 A.3d 1 (Md. App. 2010)] The case was appealed to the Maryland Supreme Court on the grounds that an arbitration award cannot be set aside when there are factual issues that could have influenced the arbitrator’s deci- sion. What should the Maryland Supreme Court do? [Downey v Sharp, 51 A.3d 573 (Md. 2012)]

Consider . . . 4.2

4-2c Mediation

Other forms of ADR are readily available and relatively inexpensive, especially when compared to arbitration. Mediation is one such alternative. Mediation is a process in which both parties meet with a neutral mediator who listens to each side explain its position. The mediator is trained to get the parties to respond to each other and their concerns. The mediator helps break down impasses and works to have the parties arrive at a mutually agreeable solution. Unlike an arbi- trator, the mediator does not issue a decision; the role of the mediator is to try to get the parties to agree on a solution. Mediation is completely confidential. What is said to the mediator cannot be used later by the parties or their lawyers if litigation becomes necessary. Mediation does not require that the parties be represented by lawyers. Mediation is not binding unless the parties have agreed to be bound by the decision.

4-2d Medarb

Mediation arbitration (medarb) is a recent creation in which the arbitrator begins by attempting to negotiate between the two parties. If the arbitrator is unable to reach a settlement, the case proceeds to arbitration with the same party serving as arbi- trator. One percent of the AAA’s cases each year are decided by a medarb process.

4-2e the Minitrial

In a minitrial, the parties have their lawyers present the strongest aspects of their cases to senior officials from both companies in the presence of a neutral advisor or a judge with experience in the field. At the end of the presentations by both parties, the neutral advisor can provide several forms of input, which are controlled by the parties. The advisor may be asked to provide what his or her judgment would be

Mediation has been a popular form of dis- pute resolution among business-to-business (B2B) e-commerce companies. Amazon. com and eBay have used mediation regu- larly in the resolution of disputes.

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Chapter 4 Managing Disputes: Alternative Dispute Resolution and Litigation Strategies 109

in the case, or the advisor may be asked to prepare a settlement proposal based on the concerns and issues presented by the parties. Minitrials are more adver- sarial than mediation, but they are confidential, and the input from a neutral but respected advisor may help bring the parties together. A minitrial is not binding.

4-2f Rent-a-Judge

Many companies and individuals are discovering that the time that elapses between the filing of a lawsuit and its resolution is too great to afford much relief. As a result, a kind of private court system, known as rent-a-judge, is developing in which parties may have their case heard before someone with judicial experience without waiting for the slower process of public justice. These private courts are like “Judge Judy” without the television cameras. The parties pay filing fees and pay for the judges and courtrooms. These private courts also offer less expensive settlement conferences to afford the parties a chance at mediation prior to their private hearing. This and the other methods of ADR previously discussed offer the opportunity to obtain final dispositions of cases more quickly and at less cost.

4-2g Summary Jury trials

Under this relatively new method of ADR, the parties are given the opportunity to present summaries of their evidence to a judge and jurors. The jurors then give an advisory verdict to start the settlement process. If the parties are unable to agree on a settlement, a formal trial proceeds. This means of resolution gives the parties an idea of a jury’s perception and assists in setting guidelines for settlement. A summary jury trial occurs late in the litigation process, after the costs of discovery have been incurred. It can, however, save the expense of a trial.

4-2h early Neutral evaluation

Early neutral evaluation requires another attorney to meet with the parties, receive an assessment of the case by both sides, and then provide an evaluation of the

Re: Southwest airlines and Creative dispute Resolution

For the Manager’s Desk

In 1991, Dallas-based Southwest Airlines began a marketing campaign using the slogan “Just Plane Smart.” Greenville-based Stevens Aviation had been using the slogan “Plane Smart” to market its airline service business. Following posturing by lawyers, Kurt Herwald, the chairman of Stevens Aviation, called Herb Kelleher, then chair- man of Southwest Airlines, and offered to arm wrestle for the rights to the slogan. Mr. Kelleher rented a wrestling auditorium, sold tickets to the event, and offered the

proceeds to charity. Mr. Kelleher, then 61, lost to Mr. Herwald, then 38, who is also a weightlifter. Mr. Herwald said, “Just to show sympathy for the elderly and that there’s no hard feelings, we’ve decided to allow Southwest Airlines to continue using our slogan.” After the event, a commentator noted, “Not only did the companies save a court battle that would have taken years and cost several hundred thousand dollars, they gained loads of free publicity. They also made donations to charities.”

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110 part 1 Business: Its Legal, Ethical, and Judicial Environment

merits of the case. The attorney, who is either a paid consultant or a volunteer through the state bar association, renders an opinion on the resolution of the case. The idea in this method of resolution is to encourage settlement. Because early neutral evaluation occurs before the discovery phase of the case, it can save time and money if the parties are able to settle.

4-2i peer Review

Peer review has become popular particularly for disputes between employers and employees and is used by Darden Industries (Red Lobster, Olive Garden), TRW Inc., Rockwell International Corp., and Marriott International, Inc. Peer review, which is generally conducted within three weeks of demand, is a review by coworkers of the action taken against an employee (demotion, termination, discipline). These panels of fellow employees (one chosen by management, one chosen by the employee, and one chosen randomly) can take testimony, review documents, and make decisions that can include an award of damages.

Employers say that sometimes their decisions are reversed in peer review, but Darden Industries indicates that peer review has reduced employee litigation and legal fees. Of the 100 disputes handled each year in peer review, only 10 proceed to litigation.

Experiments in the use of peer review for customers, contractors, and physi- cians are ongoing around the country. Many see the perception of fairness as an important quality that has resulted in the growth of the use of peer review.

4-3 Resolution of International Disputes Arbitration has been used in the international business arena since 1922. The Inter- national Chamber of Commerce (ICC) is a private organization that handles arbi- tration cases from parties in 139 countries. In 2014, the Arbitration Court of the ICC handled 791 requests for arbitration and issued 459 arbitration awards. Most requests for ICC arbitration come from 139 countries, and the typical subject mat- ters are trade transactions, contracts, intellectual property, agency, and corporate law. The following statistics were taken from the ICC’s annual report for 2014, the latest data available.

• Arbitrators of 79 different nationalities were appointed or confirmed under the ICC Rules.

• Hearings were held in 57 different countries. • The amount in dispute exceeded $1 million (U.S.) in 77.5% of new cases.

The ICC process is similar to that discussed earlier for the AAA. The award of the ICC is final, and payment must be made at the location of the hearing.

The ICC also provides mediation, referred to as conciliation, services. In con- ciliation, the court assigns an expert to work with the parties to try to achieve a settlement of the case.

In addition to the ICC, the World Bank has established the International Cen- ter for Settlement of Investment Disputes (ICSID). The ICSID is an arbitral organi- zation created specifically to hear disputes between investors and the nations in which they have made investments. This arbitration forum was created because of investors’ fears that the courts of the nation in which they have invested may favor the government of that nation.

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Chapter 4 Managing Disputes: Alternative Dispute Resolution and Litigation Strategies 111

The AAA created the International Centre for Dispute Resolution (ICDR), with offices in New York City, Dublin, and Mexico City, to provide an international AAA service for global U.S.-based companies that face contract and other types of disputes in their international operations. The ICDR has partnering agreements with ADR organizations in 92 countries, including the AAA, and uses those part- nerships to manage disputes that occur primarily in other countries. The United Nations Commission on International Trade Law (UNCITRAL) adopted a Model Law for Arbitration that deals with where arbitration should be held (the parties can decide) and which country’s laws should apply.

4-4 Litigation versus ADR: The Issues and Costs 4-4a Speed and Cost

Speed and cost are two compelling reasons businesses turn to ADR to resolve dis- putes. Costs of ADR have increased substantially over the past five years, and the speed has slowed down considerably.

4-4b protection of privacy

Whatever matter is in dispute can be kept private if referred directly to ADR, which means that no public court documents are available for examination. Even when a suit is filed, the negotiated settlement achieved through alternative means can be kept private to protect the interests of the parties. When Dillard’s, a national department store chain, and Joseph Horne Company, a department store based in Pittsburgh, were litigating over Dillard’s conduct in a Horne’s takeover, the parties’ dispute centered on whether Dillard’s was conducting due diligence in obtaining access to Horne’s facilities and records or whether Dillard’s was actually running the stores in an attempt to drive down the acquisition price. The business press reported on the litigation and the underlying dispute. The information was not flattering to either party. Dillard’s was portrayed as a large firm taking advan- tage of a small chain and engaging in unethical conduct when it was supposed to be obtaining just financial information prior to finalizing the acquisition (a pro- cess called due diligence). Horne’s was portrayed as naive and inept. Dillard’s and Horne’s settled the dispute, and both agreed to keep the terms of the settlement confidential. As a result, the public litigation ended, and the focus on alleged mis- conduct changed because of the settlement and its private nature.

4-4c Creative Remedies

Often, without the constraints of court jurisdiction and the restraints of legal boundaries, a creative remedy can be crafted that helps both sides. For example, Intel, a computer chip manufacturer, experienced ongoing disputes with employ- ees who left the company to begin their own businesses with products and in areas that would compete with Intel. Intel’s concern was whether the departing employ- ees were taking with them technology that had been developed at and belonged to Intel. Using only the courts, Intel would have found itself in lengthy, expensive, and complex litigation over engineering and developmental issues. Such litigation is costly not only in a monetary sense but also to the morale of employees charged with product development. Constant legal battles with former employees are not healthy for a corporate image within a company or from the outside.

Businesses such as Intel have now taken litigation strategy to a prevention stage. Intel and other firms, particularly those in high-tech and product development fields, now offer departing employees a partner- ship if they are leaving to start their own firms. The company provides a sort of incu- bator for the departing employee to get start- ed in business. The company is an investor and will share in the returns the new prod- uct brings. The strategy here: why try to beat them in litigation when you can join them with an investment?

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112 Part 1 Business: Its Legal, Ethical, and Judicial Environment

After filing suit against one group of employees, Intel agreed, along with the former employees, to have an expert oversee the former employees’ work in their business. The expert would have knowledge of Intel’s product development efforts that the employees had been involved with and would agree to notify all sides if the new company was infringing on any of Intel’s patents. The expert agreed to oversee the new company’s work for one year, at which point technology would make obsolete anything developed by the former employees while they were still at Intel. This creative solution permitted the former employees to operate their business, but it also provided Intel officials with the reassurance that their intellec- tual property was not being taken.

4-4d Judge and Jury Unknowns

Even though a good case and preparation are often offered as explanations for vic- tory in a lawsuit, many good cases are lost despite excellent preparation. Various unknowns characterize all forms of litigation and ADR. The unknowns are judges, juries, and arbitrators and their perceptions and abilities. Research shows that 80% of all jurors make up their minds about a case after only the opening statements in a trial have been made. Further research has shown that juries use their predeter- mined ideas in reaching a verdict. Finally, research shows that juries employ hind- sight bias in their deliberation processes; that is, juries view the outcome of a set of facts and conclude that one party should have done more. Knowing that someone was injured often clouds our ability to determine whether that person should have been able to prevent the injury.

They deliberated for 21 days. The jury that was charged with determining whether three lawyers had committed fraud tried to reach a verdict on the 150 counts, but just could not meet minds. The United States, Canada, and some places in Australia are the last great hold-outs on unanimous ver- dicts. The three lawyers were from one of the world’s top law firms, Dewey LeBeouf, and were charged with accounting fraud and other crimes related to inflating the firm’s revenues so as to avoid loans being called and a resulting bankruptcy.

There were four jurors who could not bring themselves to find criminal activity. While the jurors believed that what the law- yers did was wrong, they were not prepared to convict them. Jury research shows that if nine of the 12 jurors are in agreement, they can persuade three hold-outs. However,

with four favoring acquittal, there is strength in the group and a willingness to stand firm. They hung in there for 21 days of delibera- tion, one that ranks as one of the longest in history. However, the juror finally came out and surrendered to the judge—they could not reach a verdict.

The complexity of the case is also part of a recipe for a hung jury. If the case and the alleged counts are confusing, jurors tend to go with defendants because they are unwilling to make a mistake that may be the result of their confusion. As federal district judge, Jed S. Rakoff advis- es, “Keep it simple. A jury that under- stands the basics can reason through to a verdict.”

Source: James B. Stewart, “Deadlock in the Dewey Case Exposes the Jury System’s Flaws,” New York Times. November 6, 2015, p. B1.

For the Manager’s Desk

Re: The Deadlocked Jury and Why

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Chapter 4 Managing Disputes: Alternative Dispute Resolution and Litigation Strategies 113

Exhibit 4.1 Benefits of adR versus litigation

litiGatiON adR

Technical discovery rules

Judicial constraints of precedent

Remedies limited (by law and precedent)

Backlog

Public proceeding

Control by lawyers

Expensive

Strict procedures/timing

Judge/jury unknowns

Those who can afford to stay in win

Judicial enforcement tools

Open lines of communication

Parties can agree to anything

Creative remedies permitted

Parties set timetable

Privacy

Control by parties (or mediator/arbitrator)

Expertise of arbitrator/mediator

More flexibility

Parties select mediator/arbitrator

Positions examined for validity

Enforcement by good faith

Based on information about juries, many businesses opt for a trial in which a judge, not a jury, renders a decision. However, research with judges has demon- strated that even their case judgments are affected by predetermined ideas and hindsight bias, although to a lesser extent than those of jurors. “The Deadlocked Jury and Why” provides background information on the risks that juries pose for businesses in litigation.

4-4e absence of technicalities

Under ADR, the parties have the opportunity to tell their stories. The strict pro- cedural rules and evidentiary exclusions do not apply in these forums, and many companies feel more comfortable because ADR seems to be more of a search for the truth than a battle of processes. A mediator can serve as a communication link between the parties and help them focus on issues and concerns. As one mediator described ADR, “If you’ve done your job . . . everyone goes home with big smiles.”

Exhibit 4.1 provides a list of the benefits of ADR versus litigation.

4-5 When You Are in Litigation At times, a business must face litigation and ADR is not possible. This portion of the chapter explains the language, process, and strategies of civil litigation.

4-5a How does a lawsuit Start?

Lawsuits are based on feelings. Whether rights have actually been violated and what damages were caused as a result are the questions addressed through the trial process. The only restriction on the filing of a suit is that the plaintiff’s claim of right must be based on some statutory law or common law.

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114 part 1 Business: Its Legal, Ethical, and Judicial Environment

Re: a Checklist for When to litigate

Business Strategy

Costs

Every lawsuit costs time and money. Costs of litigation include but by no means end with attorneys’ fees, and other significant costs are often not considered before a business decides to become embroiled in a legal battle.

Legal Costs

The total legal fee must be considered in every case of possible litigation. A lawyer should be required to give an estimate of fees for any suit before the suit begins. The estimate should always include discovery costs. . . .

Time Costs (Hidden Downtime)

Litigation costs time as well as money. Indeed, in many cases, the loss of time can be more devastating to a firm than the financial loss. If a firm takes part in major litigation, chances are that its officers and possibly its directors will be involved in depositions, other forms of pretrial discov- ery and paperwork, and eventually in the trial itself.

Image Costs

If a lawsuit attracts the attention of the media, a firm may incur money and time costs stemming from public relations. Someone must be available to explain the firm’s position to reporters and perhaps initiate an affirmative campaign to minimize negative publicity about the suit.

Capital Costs

Auditors require that pending litigation be listed in the financial reports of the compa- ny. Ongoing litigation that carries the poten- tial for great financial loss to a business can have a negative effect on the firm’s financial rating and the ability to raise capital.

Costs of Alternatives to Litigation

The costs of litigation should be compared with the costs of alternatives to litigation. (See discussion of alternatives.)

Costs of Not Litigating

There are costs for litigating, but there are also costs for not litigating. If the stakes are high enough, litigation may be worth pursu- ing regardless of the expense. For example, if a suit challenges the land records and thus the title to the land on which the business is located, the cost of not responding to the suit may be the loss of the property and the expense of reestablishing the business at another site. In a trademark or trade name suit, the cost may be a product or company name or label. In a patent infringement case, the failure to sue an infringer may undermine a company’s sales and its exclu- sivity in the marketplace.

Public Relations Issues

Litigation is not a private matter. In every city, at least one reporter is assigned to the clerk’s office in the state and federal courts for the purpose of checking on suits filed.

Many an electric bill goes unpaid simply because it is not good public relations for a utility company to appear in the newspapers and on television as the “bad guy” when a retired widow explains that the big power company has just filed suit because she has no money to pay her bill. . . .

Jury Appeal

When considering the effects of publicity on a case, a company should also consider the closely related matter of jury appeal. In some cases, it will not matter how correct a business may be, how much of a remedy the law provides, or how wrong the other side is; the jury will simply side with the “little guy,” and the business will have no chance of succeeding in the courtroom. For example, the Arthur Murray Dance Studios once fully litigated a case in which a man who had been severely injured in a car accident and was unable to complete the lessons in his contract with Arthur Murray (some 2,734 lessons, for which he had paid $24,812.40) sought to recover his pay- ments on the grounds that performance had

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Chapter 4 Managing Disputes: Alternative Dispute Resolution and Litigation Strategies 115

become impossible. It is difficult to build jury appeal into such a case.

Discussion Questions

1. List the factors you should consider as you make a decision to litigate.

2. At the awards show for the Academy of Motion Picture Arts and Sciences (Academy), a character dressed as Snow White appeared in the opening musical number and sang with actor Rob Lowe. Walt Disney, Inc., had not given the Academy permission to use

the Snow White likeness, a trademarked Disney character. If you were the Walt Disney Corporation, would you sue the Academy?

3. List concerns you would have as an employer litigating a sexual harassment case.

Source: Frank Shipper and Marianne Jennings, Avoiding and Surviving Lawsuits: The Executive Guide to Strategic Legal Planning for Business, Jossey- Bass Publishing, Inc., pp. 59–73. Copyright © 1989. Excerpted and reprinted with permission of the authors.

People begin lawsuits. The judicial system does not unilaterally undertake the enforcement of civil rights. Individuals must assume responsibility for protecting their rights. The judicial system determines what and whose rights have been violated.

Although procedures vary from state to state, the following sections offer a general discussion of the procedures involved in a civil lawsuit. Exhibit 4.2 sum- marizes the trial process.

4-5b the Complaint (petition)

The first step in a lawsuit is the filing of a document called a complaint or petition. The plaintiff must file the petition or complaint within certain time limits each state has for filing suit. These time limits are called statutes of limitations. They vary depending on the type of rights involved in a suit. The typical statute of limitations for personal injuries is two years; the typical limitation for contracts is four years.

Exhibit 4.2 the trial process

Pleadings

Discovery

Pretrial Work

Trial

Posttrial Work

Complaint (followed by service of summons), answer, counterclaims, cross-claims

Interrogatories, depositions, requests for production, requests for admission

Motions, pretrial conference

Motions, appeal

(Continued)

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116 part 1 Business: Its Legal, Ethical, and Judicial Environment

Exhibit 4.3 Sample Complaint

) ) ) ) ) ) ) ) ) ) ) ) )

Reed C. Tolman, Esq. (006502) TOLMAN & OSBORNE, PC. 1400 E. Southern, Suite 625 Tempe, Arizona 85282 Attorneys for Plaintiffs

SUPERIOR COURT OF ARIZONA

MARICOPA COUNTY

CRAIG CONNER and KATHY CONNER, husband and wife, individually and on behalf of their minor son, CASEY CONNER,

Plaintiffs,

v.

CARMEN A. CHENAL and THOMAS K. CHENAL, wife and husband,

Defendants.

For their complaint, plaintiffs allege:

1. Plaintiffs and defendants are residents of Maricopa County, Arizona. 2. This Court has jurisdiction over the subject matter under the Arizona Constitution, Art. 6, § 14. 3. Casey Conner is the minor son of Craig and Kathy Conner. 4. Carmen A. Chenal and Thomas K. Chenal are wife and husband. At all times relevant hereto, Carmen A. Chenal was acting for

and on behalf of the marital community of which she is a member. 5. On or about July 20, 1990, defendant Carmen A. Chenal was driving her motor vehicle in the vicinity of Primrose Path and Cave

Creek Road in Carefree, Arizona. At the time, Casey Conner was a passenger in the back seat of defendants’ vehicle, a 1976 Mercedes, ID No.11603312051326.

6. At all times relevant hereto, defendant Carmen A. Chenal had a duty to care properly for the safety of Casey Conner. That duty included the responsibility to place Casey in an appropriate and functioning seat belt.

7. Prior to the accident that resulted in injuries to Casey Conner, Carmen A. Chenal knew that the right rear door of her vehicle was damaged and not functioning properly.

8. Despite the duty Carmen A. Chenal had to care properly for the safety of Casey Conner, and despite her knowledge of a malfunctioning right rear door, Carmen A. Chenal negligently failed to place Casey in an appropriate and functioning seatbelt and negligently and carelessly operated her vehicle in such a way that the right rear door opened and allowed Casey to be ejected from the vehicle while the vehicle was in operation.

9. Carmen A. Chenal’s failure to exercise reasonable care for the safety of Casey and the failure to operate her vehicle in a careful and safe manner proximately caused Casey to suffer personal injuries.

10. As a result of Casey Conner’s injuries, he has experienced physical and psychological suffering, and his parents have incurred medical and other expenses, as well as lost earnings.

WHEREFORE, plaintiffs request judgment against defendants for compensatory damages in an amount to be determined at trial.

CV92–91319

COMPLAINT (Tort—Motor Vehicle)

By:   ________________________________ Reed C. Tolman 1400 E. Southern Suite 625 Tempe, Arizona 85282

DATED: this ——— day of July, 1992. TOLMAN & OSBORNE

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Chapter 4 Managing Disputes: Alternative Dispute Resolution and Litigation Strategies 117

A complaint is a general statement of the plaintiff’s claims. For example, if a plaintiff is suing for a breach of contract, the complaint must describe the con- tract, when it began, and what the defendant did that the plaintiff says is a breach. Exhibit 4.3 shows a sample complaint in a suit over a car accident.

The complaint need not have every detail described in it. The standard for a valid complaint is that it must be definite enough in its description of what hap- pened for the defendant to understand why the suit has been brought.

All complaints must establish the subject matter jurisdiction of the court (see Chapter 3 for a discussion of this concept). For example, for a federal district court action, the complaint would have to allege either diversity of citizenship between the parties and a damage claim of more than $75,000 or that a federal question is involved.

In some cases, the complaint is filed by a group of plaintiffs who have the same cause of action against one defendant. These types of suits, called class action suits, are typically filed in antitrust cases, shareholder actions against corpora- tions, and employment discrimination cases. The class action suit enables a group of plaintiffs to share one lawyer and minimize litigation expenses while at the same time preserving their individual rights. Perhaps the most widely publicized type of class action lawsuit is the suit that results when a large jet airliner crashes and causes multiple deaths and injuries. All the plaintiffs were injured in the same event, and the defendant then litigates once with a group of plaintiffs.

Another form of class action suit is the derivative suit, in which shareholders sue a corporation to recover damages for actions taken by the corporation. (See Chapter 17 for more information.)

The final paragraphs of a complaint list the damages or remedies the plaintiff wants. The damages may be a legal remedy, such as money, in which case a dollar amount is specified. The plaintiff may seek an equitable remedy, such as specific performance in the case of an action for breach of contract. Specific performance is an order of the court requiring a defendant to perform on a contract. In some cases, the plaintiffs just want the defendants to stop violating their rights. In those com- plaints, plaintiffs ask for injunctions, which are court orders requiring the defen- dant to stop doing the act complained of. In an action for nuisance, for example, an injunction orders the defendant to stop engaging in the conduct that causes the nuisance or orders the defendant to comply with a law or a previous decision. As another example, an injunction could order a website to stop infringement of copy- right music or material.

4-5c the Summons

The complaint or petition of the plaintiffs is filed with the clerk of the appropriate court—that is, the court with subject matter jurisdiction, in personam jurisdiction, and venue. The defendant, however, will not know of the suit just because it is filed. The second step in a lawsuit is serving the defendant with a copy of the com- plaint and a summons, which is a legal document that tells the defendant of the suit and explains the defendant’s rights under the law. Those rights include the opportunity to respond and the grant of a limited amount of time for responding. Exhibit 4.4 shows a sample summons.

A summons must be delivered to the defendant. Some states require that the defendant be given the papers personally. Other states allow the papers to be given to some member of the defendant’s household or, in the case of a business, to an agent of that business. (See Chapter 16 for a discussion of an agent’s authority to receive the papers notifying the business of a lawsuit.)

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118 part 1 Business: Its Legal, Ethical, and Judicial Environment

Exhibit 4.4 Sample Summons

YOU ARE HEREBY SUMMONED and required to appear and defend, within the time applicable, in this action in this court. If served within Arizona, you appear and defend within 20 days after the service of the Summons and Complaint upon you, exclusive of the day of service. If served out of the State of Arizona—whether by direct service, by registered or certi†ed mail, or by publication you shall appear and defend within 30 days after the service of the Summons and Complaint upon you is complete, exclusive of the day of service. Where process is served upon the Arizona Director of Insurance as an insurer’s attorney to receive service of legal process against it in this state, the insurer shall not be required to appear, answer or plead until expiration of 40 days after date of such service upon the Director. Service by registered or certi†ed mail without the State of Arizona is complete 30 days after the date of receipt by the party being served. Service by publication is complete 30 days after the date of †rst publication. Direct service is complete when made. Service upon the Arizona Motor Vehicle Superintendent is complete 30 days after †ling the Af†davit of Compliance and return receipt or Of†cer’s Return. RCP 4; ARS §§ 20-222, 28-502, 28-503.

Copies of the pleadings †led herein may be obtained by contacting the Clerk of Superior Court, County, located at Arizona. RCF 4.1 (e).

SUMMONS (Continued on Reverse Side)

YOU ARE HEREBY NOTIFIED that in case of your failure to appear and defend within the time applicable, judgment by default may be rendered against you for the relief demanded in the Complaint.

YOU ARE CAUTIONED that in order to appear and defend, you must †le an Answer or proper response in writing with the Clerk of this Court, accompanied by the necessary †ling fee, within the time required, and you are required to serve a copy of any Answer or response upon the Plaintiffs’ attorney. RCP 10(D); ARS 12-311; RCP5.

The name and address of plaintiffs’ attorney is:

Name: Address: City, State, Zip: Telephone: State Bar Code: Client:

ARlZONA SUPERIOR COURT, County of

ACTION NO:

SUMMONS

THE STATE OF ARIZONA TO THE DEFENDANTS:

1-1 ©LawForms 10-92 1-93

1-1 ©LawForms 11-67, 3-84, 1-93

Method of Service: Private Process Service Sheriff or Marshall Personal Service Registered/Certified Mail (out of State)

SIGNED AND SEALED this date:__________________________

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Clerk

By . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Deputy Clerk

SUMMONS

,

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Chapter 4 Managing Disputes: Alternative Dispute Resolution and Litigation Strategies 119

The summons is delivered by an officer of the court (such as a sheriff or magis- trate) or by private firms licensed as process servers. Once the defendant is served, the server must file an affidavit with the court to indicate when and where the service was made. In rare circumstances, courts allow service of process by mail or by publishing the summons and complaint. These circumstances, however, are limited and are carefully supervised by the courts.

4-5d the answer

The parties’ positions in a case are found in the pleadings. The complaint or peti- tion is a pleading. The defendant’s position is found in the answer, another plead- ing in a case. The defendant must file an answer within the time limits allowed by the court or risk default. The time limits are typically 20 to 30 days for filing an answer to the complaint. A failure to answer, or a default, is like a forfeit in sports: the plaintiff wins because the defendant failed to show up. The plaintiff can then proceed to a judgment to collect damages.

The defendant’s answer can do any or all of several different things. The defen- dant may admit certain facts in the answer. Although it is rare for a defendant to admit the wrong alleged by the plaintiff, the defendant might admit parts of the plaintiff’s complaint, such as those that establish jurisdiction and venue. If the plaintiff already has correct venue, fighting that issue is costly, and admitting juris- diction is a way to move on with the case. If, however, the court lacked in personam jurisdiction over the defendant, the defendant could deny the jurisdiction. (See Chapter 3 for more discussion of in personam jurisdiction.)

A denial is a simple statement in the answer whereby the defendant indicates that the allegation is denied. An answer might also include a statement that the defendant does not know enough to admit or deny the allegations in the complaint and might include a demand for proof of those allegations.

An answer might also include a counterclaim, with which the defendant, in effect, countersues the plaintiff, alleging a violation of rights and damages against the plaintiff. The plaintiff must respond to the counterclaim using the same answer process of admitting or denying the alleged wrong. Exhibit 4.5 shows a sample answer.

The answer must be filed with the clerk of the court and a copy sent to the plaintiff. With the exception of amendments to these documents, the pleadings are now complete.

4-5e Seeking timely Resolution of the Case

The fact that a suit has been filed does not mean that the case will go to trial. A great majority of suits are disposed of before trial because of successful motions to end them. Motions are requests to the court that it take certain action. Motions usually involve filed documents and include citations to precedent that support granting the motion. Often the judge will have the attorneys present oral argu- ments for and against the motion, after which the court then issues a ruling on the motion. For example, in 2012, a federal judge quickly dismissed Lance Arm- strong’s suit against the USADA as it prepared to take disciplinary action against Mr. Armstrong because the complaint had no legal cause of action but was only a “a lengthy and bitter polemic against the named defendants.” Following Mr. Arm- strong’s admissions of the use of performance-enhancing drugs, the judge’s rapid dismissal proved prescient.

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120 part 1 Business: Its Legal, Ethical, and Judicial Environment

Exhibit 4.5 Sample answer

Grand, Canyon & Rafts 12222 W. Camelback Phoenix, Arizona 555-5555 Attorneys for Defendant

SUPERIOR COURT OF ARIZONA

MARICOPA COUNTY

CRAIG CONNER and KATHY CONNER, ) husband and wife, individually ) and on behalf of their minor ) son, CASEY CONNER, )

) Plaintiffs, )

) v. )

) CARMEN A. CHENAL and THOMAS K. CHENAL, wife and husband,

) ) )

Defendants. ) ____________________________________)

For their answer, defendants respond to plaintiffs’ complaint as follows:

1. Admit paragraph one. 2. Admit paragraph two. 3. Have no knowledge to admit or deny paragraph three. 4. Have no knowledge to admit or deny paragraph four. 5. Admit paragraph five. 6. As for paragraphs 6 through 10, inclusive of plaintiffs’

complaint, defendants have no knowledge of the statements alleged and deny all statements made therein.

CV92–91319

ANSWER

Defendents deny any and all parts of plaintiffs’ complaints not specifically mentioned herein.

DATED: this day of August, 1992. Grand, Canyon & Raft

By: ____________________________________________ Robert C. Canyon 12222 W. Camelback Phoenix, Arizona

Motion for Judgment on the pleadings Either in the answer or by separate motion, a defendant can move for judgment based just on the content of the pleadings. The theory behind a motion for judg- ment on the pleadings is that the plaintiff has no cause of action even if everything

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Chapter 4 Managing Disputes: Alternative Dispute Resolution and Litigation Strategies 121

the plaintiff alleges is true. For example, a plaintiff could file suit claiming the defendant is an annoying person, but unless the defendant is annoying to the extent of invading privacy or not honoring contracts, the plaintiff has no right of recov- ery. The defendant in this case could win a motion for judgment on the pleadings because the law (perhaps unfortunately) does not provide a remedy for annoying people. A denial of a motion for judgment on the pleadings does not imply victory for the plaintiff. It simply means that the case will proceed with the next steps.

Motion to dismiss A motion to dismiss can be filed any time during the proceedings but usually is part of the defendant’s answer. Such a motion can be based on the court’s lack of subject matter or in personam jurisdiction. Again, if the case is not dismissed, it does not mean that the plaintiff wins; it just means that the case will proceed to the next steps and possibly trial.

Motion for Summary Judgment A motion for summary judgment has two requirements. Summary judgment is appropriate only when (1) the moving party is entitled to a judgment under the law and (2) no issues of fact remain disputed. Actions brought on the basis of motor vehicle accidents, for example, always involve different witnesses’ testimonies and variations in facts. These types of cases cannot be decided by summary judgment. In other cases, however, the parties do not dispute the facts but differ on the appli- cations of law. Consider, for example, a dispute involving a contract for the repair of a computer, including service and parts. Different laws govern contractual pro- visions for services and provisions for goods. The parties do not dispute the facts: they agree goods and services are covered in the contract. At issue is the question about which law applies, and a summary judgment appropriately will resolve it. A suit may involve other factual disputes about contract performance, but the partial summary judgment will determine which contract law will apply.

4-5f How a lawsuit progresses: discovery

Trials in the United States are not conducted by ambush. Before the trial, the parties engage in a mandatory process of mutual disclosure of all relevant documents and other evidence. This court-supervised process of gathering evidence is called dis- covery. Under procedural rules that govern discovery, the parties must provide to each other lists of witnesses, all relevant documents, tangible evidence, and state- ments related to the case. Under the old discovery rules, the expense and difficulty of discovery techniques often meant that the search for the truth was a cat-and- mouse game won by those with the most funds. Armed with the evidence from a full-disclosure approach, the parties to a case are more prepared—and perhaps more inclined—to negotiate a settlement. Discovery rules provide for sanctions (penalties) for not turning over relevant documents at the start of a case. Sanctions can include fines against the party who withheld the evidence, findings of con- tempt against the lawyers (including fines), and the exclusion of responses to the withheld evidence. The following sections cover the traditional tools of discovery.

Requests for admissions and interrogatories A request for admissions asks the other side to admit a certain fact. Interrogato- ries ask questions about facts. The parties have some incentive to admit the facts requested if they are true because if these facts are denied and then proved at trial, the party who had to prove those true facts can recover the costs of proof. Requests

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122 part 1 Business: Its Legal, Ethical, and Judicial Environment

for admissions request the other party to admit that a document is authentic. For example, the parties might have a dispute about the amount due under a contract but should be willing to admit that they signed the contract and that it is authentic. These requests for admission reduce the length of trials.

depositions Depositions are the oral testimony of parties or witnesses that are taken under oath but outside the courtroom and before the trial. They can be taken long before a trial and help preserve a witness’s or party’s recollection. Depositions are also helpful in determining just how strong a case is. It is far better to discover damag- ing information in a deposition than to have surprises at trial.

Requests for production A request for production requires the other side to produce requested documents. For example, if a business is suing to recover lost profits, the defendant will prob- ably want to request the income statements and perhaps the income tax returns of that business in order to prepare for the presentation of damages issues at trial. A request for production can include medical records as well as tangible evidence. In Kroger Co. v Walters (Case 4.2), the destruction of physical evidence is an issue in a case that provides an answer to the opening “Consider …”

Pulte Home Corporation v Simerly 746 S.E.2d 173 (Ga.App. 2013)

Fooling Around with Documents and E-Mails: Costs and Consequences

Case 4.2

FaCtS

In January 2004, Pulte purchased property to develop sin- gle-family residences for what would become the Notting Hill and Fieldstone subdivisions. The Pulte Development discharged water into Harris Creek and was located upstream of the properties owned by Tim and Adele Simerly and Richard and Susan Trent (Plaintiffs). Pulte had purchased the property from Macauley Properties, which previously hired Lowe Engineering to complete a hydrology and storm-water management study. The Lowe Study was completed in January 2004, and Pulte relied upon the study to design and construct its devel- opment. The Lowe Study recommended that storm water discharges from future developments could be controlled with the construction of a weir on Harris Creek, which consisted of a partial wall across the creek, above Drew Campground Road located within Fieldstone.

Pulte began mass grading and other land-disturbing activities at Fieldstone in March 2004. Shortly thereafter, excessive amounts of storm water, dirt, sediment, and development debris were discharged into Harris Creek and ultimately into the ponds located on the Simerly and Trent properties. Investigations revealed that the discharged sediment and pollutants were caused by

Pulte’s activities upstream and its failure to install and maintain erosion control devices required by law. The Pulte Development also caused a dramatic increase in the rate and flow of storm-water discharge into Harris Creek that caused flooding to the Simerly and Trent properties. During a subsequent study, it was discovered that the weir was inadequate to control the storm-water discharge from the Pulte Development because the Lowe Study, upon which Pulte had relied for storm-water manage- ment, was based upon flawed assumptions and analysis.

The Simerlys and Trents sued Pulte Home Corpo- ration for trespass, nuisance, negligence, negligence per se, riparian rights, unjust enrichment, and eject- ment based on the company’s actions in causing excess storm water and sediment to enter the Simerlys’ and Trents’ properties.

The jury found in favor of the Simerlys, Trents, and Lawsons (collectively, the “Plaintiffs”) and awarded them $2.49 million in damages and attorney fees. The court had found evidence of spoliation by Pulte and excluded certain exculpatory evidence from the trial because of a finding of Pulte’s counsel’s misconduct. The trial court also allowed evidence of Pulte’s conduct during discov- ery in its determination of attorney fees. Pulte appealed.

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Chapter 4 Managing Disputes: Alternative Dispute Resolution and Litigation Strategies 123

JUdiCial OpiNiON

MILLER, Judge During litigation, the trial court found that Pulte had engaged in spoliation by deleting emails relevant to the litigation, and enjoined Pulte from engaging in further destruction of evidence. The trial court had appointed a Special Discovery Master to oversee compliance with the court’s injunction and to resolve other discovery issues, including the attempted recovery of spoliated evidence through a computer forensic investigation. The Special Discovery Master issued a report outlining that the computer forensic investigation revealed that Pulte had engaged in further spoliation of electronic evidence after the trial court’s order and recommended that Pulte be sanctioned for its violations. The trial court adopted the Special Discovery Master’s report and recommendation.

The Special Discovery Master also informed the trial court that the Simerlys’ counsel and Pulte’s counsel had provided conflicting statements relating to Pulte’s removal of discovery documents during a May 2009 document review at Pulte’s offices. At a subsequent hearing before the trial court, Simerlys’ counsel, Michael Carvalho, testi- fied that he and an associate attorney, Christine Westberg, had a scheduled document review at Pulte’s offices in May 2009. Carvalho testified that during the document review, he had stacked a number of documents in a pile that were deemed relevant in order to copy them. Before

taking a break for lunch, Carvalho informed Pulte’s coun- sel that they planned to copy the documents in the stack. When Carvalho returned from lunch, he noticed that the stack of documents was smaller. Carvalho testified that he asked Pulte’s counsel about the missing documents, and she told him that she took the documents because they were privileged. Following the hearing, the trial court found that Pulte’s counsel had taken documents during the document review.

The trial court allowed Carvalho to testify about spoliation during the May 2009 document review, and would [not] allow Pulte to benefit from its discovery violations.

Plaintiffs were forced to undergo unnecessary trou- ble and expense to prosecute their claims in this case, and the evidence [of the spoliation] was properly admit- ted as it related to the issue of attorney fees.

Affirmed.

CaSe QUeStiONS

1. Explain what the Special Master found about Pulte’s behavior in the case.

2. What are the consequences when one side attempts to withhold or destroy evidence?

3. What management lessons should be learned and applied from this case?

The obstruction of justice trial against the accounting firm of Arthur Andersen found the prosecution using the following types of evidence:

• Testimony from partners, employees, and consultants with Andersen

• E-mails among Andersen partners, employees, and consultants; both saved and deleted e-mails were intro- duced into evidence

• A videotape of a partner making a pre- sentation to employees on the pending SEC investigation in which he urged employees to get rid of excess files so that “nosy plaintiffs’ lawyers” wouldn’t be able to find damaging evidence

• The statistics on the e-mail deletions by Andersen employees, including the peak in e-mail deletions following the presen- tation that was shown on video and the instruction to get rid of unnecessary files

• The articles clipped and saved by Andersen employees relating to Enron and SEC investigations

What would the government need to show to establish that Andersen had engaged in spoliation through their e-mail deletions?

THINK: In the Pulte case, the court found that the e-mails were destroyed after the court had ordered the company to stop destruction and that the documents were removed before the plaintiffs’ lawyers could copy them and all this was done during discovery in the case.

APPLY: What is different in this Andersen situation? What is the same?

ANSWER: The evidence shows that the An- dersen employees had been briefed on at least the investigations, a likely source of lit- igation. With the investigations pending, the destruction of e-mails and other documents at that time meets the test for spoliation, even though litigation had not actually begun.

Consider . . . 4.3

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124 part 1 Business: Its Legal, Ethical, and Judicial Environment

limitations on discovery Discovery has the general limitation of relevance. Only things that are evidence or could lead to the discovery of evidence are discoverable. However, discovery also has a specific limitation. Discovery cannot require the production of work product, which consists of the attorney’s legal research, comments or reactions to a witness, thoughts, analysis, and case or trial strategy. Discovery affords the parties the right to know all the evidence (if it asks for it), but it does not give them the right to know how that evidence will be used or what legal precedent supports a party’s position.

Certain evidence in cases is not discoverable. Communications between law- yers and their clients is protected by a privilege and, except in certain limited cir- cumstances, cannot be discovered or used by the opposition. (See Chapter 3 for a complete discussion of privilege.)

Cyberlaw and discovery Businesses are required to preserve their business records. Smartphones create problems because smartphones can be configured in different ways, sometimes with very limited archiving capability. In certain configurations, a message deleted can be lost forever. There are programs that permit hackers to download every- thing from a smartphone in about 30 seconds. There is a risk of everything from corporate espionage to the loss of privilege on documents that become public via hackers or theft.

Companies should develop policies on the use of smartphones by executives, policies that cover the following:

• Configuration of smartphones, access, and archiving. For example, the exec- utive branch of the federal government has configured the smartphones of government officials so that the messages are archived (as required by law for government business) and then stored by a contractor who then manages and indexes the messages so that they are not lost.

• The requirement of a password for access to the phone. • No sharing your passwords with others. • If your smartphone is lost, notify the IT staff immediately so that they can

take protective and preventive action.

Ethical Issues

Evaluate the ethics of the Andersen employees and the lawyers in the Pulte case. Why do you think they followed orders to destroy the e-mails and other documents so willingly? Is “I was just following orders” a defense in criminal and civil cases? Is it a justification for conduct?

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Chapter 4 Managing Disputes: Alternative Dispute Resolution and Litigation Strategies 125

• Topics that should and should not be discussed on social media and smartphones.

• Discussion of risks of social media and smartphone communication. • Deletion of messages on smartphones.

4-5g Resolution of a lawsuit: the trial

If a case is not settled (and many are settled literally on the courthouse steps), the trial begins.

the type of trial—Jury or Nonjury Occasionally, the parties agree not to have a jury trial and instead have a trial to the court. In these cases, the judge acts as both judge and jury—both running the trial and determining its outcome. In highly technical cases, it is sometimes better for both sides to have a knowledgeable judge involved than to try to explain the complexities of the case to a jury of laypersons.

If the parties do not agree on a nonjury trial, then certain types of cases carry a constitutional right to a trial by jury. The Seventh Amendment of the U.S. Constitu- tion covers the jury requirement in civil trials:

In suits at common law, where the value in controversy shall exceed twenty dollars, the right of trial by jury shall be preserved, and no fact tried by a jury shall be otherwise re-examined in any court of the United States other than according to the rules of common law.

Although this right is limited to what existed at common law at the time the U.S. Constitution was adopted, many states have expanded the right under their state constitutions. The absolute right to a jury exists in criminal cases as covered in Article III and the Fifth and Sixth Amendments of the U.S. Constitution.

The size of a jury varies; some states require only six jurors. A jury may have 12 to 18 members, which include alternates, particularly in long trials, to ensure that a panel of 12 participates fully in the trial.

the trial—Jury Selection The pool of potential jurors and the selection of those jurors are resolved before trial. Usually, voting lists, alone or combined with other lists (e.g., rosters of licensed drivers), are used as pools for potential jurors. People on these lists are randomly notified of a period of time during which they should report for jury duty. Many states excuse from jury duty certain individuals, such as doctors and emergency workers, because of the needs they serve in society. Students are often excused if they are summoned for duty during the semester because of their pecu- liar obligations and time limitations on completing classes. Judges also usually have the power to excuse certain individuals who would experience hardship if they were required to serve. For example, a sole proprietor of a service business would have no income during the time of jury service and would probably be excused on a hardship basis.

Many more jurors than are actually needed are summoned to serve. These extra numbers are required because all the parties to a dispute participate in the selection of a jury. Once a pool is available, the court begins the process of voir dire, which determines whether a potential juror is qualified to serve. Most states have jurors complete a questionnaire on general topics so that the selection process can

When in doubt, don’t. That is, if you have any question about litiga- tion or an investigation, do not destroy e-mails, documents, or tangible evidence.

Every company should have a docu- ment retention and file purging policy. Employ- ees should follow the timelines on retention and destruction. Even when the designated time for destruction has arrived, any doubt about pending litiga- tion, investigations, or regulatory issues means the documents should be retained.

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126 part 1 Business: Its Legal, Ethical, and Judicial Environment

move quickly. The questionnaire covers personal information—age, occupation, and so on. The questionnaire might also ask whether the person has ever been a juror, a party to a lawsuit, or a witness.

A juror can be removed from a jury panel for two reasons. First, a juror can be removed for cause, which means the juror is incapable of making an impar- tial decision in the case. If a juror is related to one of the attorneys in the case, for example, the juror would be excused for cause. Some jurors reveal their biases or prejudices, such as racial prejudice, in the questionnaire they are required to complete. Others may express strong feelings of animosity toward the medical profession. Clearly, the removal of such jurors for cause in cases involving civil rights and malpractice suits, respectively, is an important part of trial strategy.

Sometimes a juror cannot be excused for cause but an attorney feels uncom- fortable about the juror or the juror’s attitudes. In these circumstances, the law- yer issues a peremptory challenge, which excuses the juror. The peremptory challenge is the attorney’s private tool. However, the use of peremptory chal- lenges is limited. All states have a statute or court rule limiting the number of peremptory challenges an attorney may use in a trial. The U.S. Supreme Court ruled that the use of peremptory challenges is subject to some limitations. The Court indicated that such a challenge cannot be based on either race or gen- der. If the trial judge suspects that either of these factors may have induced one of the lawyers to seek a peremptory challenge, the lawyer will be required to produce a plausible explanation for the use of the peremptory challenge that is unrelated to race or gender.

Winona Ryder was arrested for shoplift- ing from Saks Fifth Avenue. The charges against her included theft and burglary for taking $5,600 in merchandise from Saks’s Beverly Hills store.

The jury selection process in the trial uncovered the fact that Peter Guber, a Holly- wood executive who was in charge of three films that starred Ms. Ryder (Bram Stoker’s Dracula, The Age of Innocence, Little Wom- en), was among the pool of jurors. When questioned by the judge, Mr. Guber assured

him that he could be impartial in judging the evidence. Mr. Guber was allowed to remain on the jury.

What argument could the prosecution have made against keeping Mr. Guber? What argument could the defense have made against Mr. Guber? What process could each side have used to have him removed from the jury?

Source: Rick Lyman, “For the Ryder Trial, a Holly- wood Script,” New York Times, November 3, 2002, p. SL-1.

Consider . . . 4.4

Jury selection is an art and a science. Jury consulting firms specialize in pro- viding data to attorneys for jury selection. These firms do thorough checks of the potential jurors’ backgrounds (including through their Facebook pages and even the types of bumper stickers on their cars) and offer statistics on the reactions of certain economic and social groups to trials and trial issues. Much about a case at trial is uncontrollable, but jury selection is a part of the process that, with thorough preparation, can increase the likelihood of desired results by ensuring an optimally favorable jury panel.

Jury or trial consultants perform jury profiles, find surrogate juries, and often conduct mock trials. The use of trial consultants has increased dramatically since

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Chapter 4 Managing Disputes: Alternative Dispute Resolution and Litigation Strategies 127

Re: Jury Selection in High-profile Cases

For the Manager’s Desk

Even though the criminal rape charges against him were eventually dismissed, NBA basketball star Kobe Bryant’s trial still had progressed to the point of jury selec- tion. As part of the voir dire questions for the potential Bryant jurors, the 276 jury panelists were asked the following as part of their 82-question background sheet:

• What are your feelings about the sexual assault laws in Colorado?

• Do you think that people who make a lot of money are treated better by our court system than other people?

• Have you ever been afraid of or had any negative experience with an African American individual?

• In your opinion, in general do African Americans in our society experience

(check one): a great deal of racial discrimination; some amount of racial discrimination; or no racial discrimination?

• How do you feel about interracial relationships?

• Do you have particularly strong feel- ings about, or have you or anyone close to you ever been affected by or involved in, a situation of marital infidelity? [At the time of the alleged rape, Mr. Bryant was married and had one child.]

• Which of the following best describes your opinion of profession- al basketball players: very positive; positive; negative; very negative?

the 1970s, and membership in the American Society of Trial Consultants has grown from 19 members in 1982 to 500 members today. Jury consultants are now the norm rather than the exception in trials. In many civil cases, the attitudes about the subject matter of the case can have an impact on the way the jury decides the case. See the “Biography” feature at the end of the chapter for a discussion of the use of consultants in a gaming case.

the trial process

Opening Statements and Burden of Proof. It is often difficult to piece together all the witnesses and evidence in a trial. A lengthy trial may leave the jurors confused. The attorney for each party, therefore, is permitted to make an opening statement that summarizes what that party hopes to prove and how it will be proved. Most attor- neys also mention the issue of burden of proof, which controls who has the respon- sibility for proving what facts. Although the plaintiff has the burden of proving a case, the defendant has the burden of proving the existence of any valid defenses. Various standards are used for meeting the burden of proof. In criminal cases, the standard is proof beyond a reasonable doubt. In civil cases, the standard is proof by a preponderance of the evidence, or more likely than not.

Presentation of the Case and Evidence. Because the plaintiff has the burden of proof, the plaintiff presents his or her case and evidence first. The attorney for the plain- tiff decides the order of the witnesses; questioning of these witnesses under oath is

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128 part 1 Business: Its Legal, Ethical, and Judicial Environment

called direct examination. Although the defense cannot present witnesses during this part of the trial, it can question the plaintiff’s witnesses after their direct examination is completed. The defense questioning of plaintiff witnesses is called cross-examination, after which the plaintiff may again pose questions to clarify under redirect examination.

By the end of the case, the plaintiff must show enough evidence to estab- lish a prima facie case, one in which the plaintiff has offered some evidence on all the elements required to be established for recovery. Although the evidence may be subjected to credibility questions and challenged by defense evidence, some proof is required for each part of the claim. If the plaintiff does not meet this standard, the defendant can and may make a motion for a directed ver- dict. This motion for a directed verdict is made outside the jury’s hearing and argued to the judge. If it is not granted, the trial proceeds with the defendant’s case.

The defendant then has the same opportunity to present witnesses and evi- dence. Throughout the trial, the judge will apply the rules of evidence to deter- mine what can and cannot be used as evidence. All trials have some form of witness testimony. However, tangible evidence is also often presented. In a con- tracts case, for example, a great deal of paper evidence—letters, memos, and cost figures—is likely.

(1) Expert Testimony. One of the evidentiary issues that has been debated and litigated over the past few years is the use of expert testimony in cases. The issue the courts face is determining whether the expert’s testimony reflects scientific knowledge or whether the testimony is contrived for the trial (often called “junk science”). In Daubert v Merrell Dow Pharmaceuticals, Inc., 509 U.S. 579 (1993), the U.S. Supreme Court provided guidance for the standards judges should use in determining whether the studies and testimony of experts and their experiments and analysis should be allowed as evidence in a case.3 One expert, who was testifying in a suit against Merrell Dow (defendant) about birth defects allegedly caused by pregnant women’s use of the anti-nausea drug Bendectin, filed an affidavit in the case stating that the use of Bendec- tin during the first trimester had not been shown to be a risk factor for birth defects. On the other hand, eight experts for the plaintiff parents in the case concluded, based on animal and epidemiological studies, that Bendectin can cause birth defects. The court ruled that the decision to admit the expert’s evi- dence must be based on an examination of the study methodology as well as whether the expert’s work had been subjected to peer review, the means that academics use for testing the validity of new studies and theories. The court noted that studies developed for purposes of the litigation require higher lev- els of scrutiny than studies that existed under the expert’s work prior to the litigation. However, the expert’s work does not require general acceptance and still will be subject to the scrutiny of the opposing parties’ experts as well as the rigor of cross-examination. For example, in U.S. v Parra, 402 F.3d 752 (7th Cir. 2005), a DEA agent could offer testimony about the usual behaviors of drug suspects based on his extensive experience. The agent may not be a PhD psychologist, but the judge can establish through voir dire of the expert the extent and scope of qualifications.

(2) Hearsay Testimony. The forms and types of evidence that can be used at trial are subject to some restrictions. Most people are familiar with the hearsay rule of

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Chapter 4 Managing Disputes: Alternative Dispute Resolution and Litigation Strategies 129

evidence. Hearsay is evidence offered by a witness who does not have personal knowledge of the information being given but just heard it from someone else. For example, suppose that Arkansas Sewing and Fit Fabric are involved in contract litigation. Fit Fabric says there was no contract. Arkansas Sewing has a witness who overheard the president of Fit Fabric talking to someone on a plane saying he had a contract with Arkansas Sewing but had no intention of performing on it. The witness’s testimony of the airplane conversation is hearsay and cannot be used to prove the contract existed. The reason for the hearsay rule is to keep evidence as reliable as possible. The person testifying about the hearsay may not know of the circumstances or background of the conversation and is testifying only to what someone else said.

Closing Arguments and the Jury’s Role. Once the evidence is presented and the parties are finished with their cases, the parties have one final “go” at the jury. The parties are permitted to make closing arguments, which review the presented evidence, highlight the important points for the jurors, and point out the defects in the other side’s case. After the cases and clos- ing arguments are presented, the jurors are given their instructions. These instructions tell the jurors what the law is and how to apply the law to the facts presented. The instructions are developed by the judge and all the attorneys in the case.

Jury deliberations are done privately; they cannot be recorded, and no one can attend the deliberations except the jurors. Jurors can, but are not required to, dis- cuss what happened during the deliberations after they are ended and a decision is returned to the court.

The U.S. Supreme Court has ruled that jury verdicts need not be unanimous. A state can adopt a rule that requires only a simple majority or three-fourths of the jury to agree on a verdict. In those states requiring unanimous verdicts, it is not unusual for juries to be unable to agree on a verdict. The jurors have then reached a deadlock, which is called a hung jury. If a trial results in a hung jury, the case can be retried.

The result of jury deliberations is the verdict. The verdict is given to the judge and is usually read by the judge’s clerk.

Karsten Manufacturing Corporation filed suit against the Professional Golf Associa- tion (PGA) because the PGA had proposed a ban of Karsten’s U-groove Ping brand clubs from professional play. Karsten hired Richard Smith, then an Arizona State Uni- versity finance professor, to develop an eco- nomic model to correlate professional and consumer usage. Professor Smith’s model showed that if pros play with Ping clubs, a proportionate number of duffers will play with them. If the pros cannot use Ping

clubs, Karsten is out of business because amateur golfers will not purchase Karsten products. Professor Smith said he conduct- ed valid regression analysis. The attorney for the PGA, Larry Hammond, called it “junk science” that interferes with the real issues in the case. Should the Smith model be ad- mitted? Does it make a difference that the model was developed only for the case? Does it make a difference that Professor Smith’s consulting firm was paid more than $1 million for the model?

Consider . . . 4.5

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130 part 1 Business: Its Legal, Ethical, and Judicial Environment

post-trial proceedings Even after the verdict, the case is not over. The losing party can make several motions to get around the verdict. One such motion is for a new trial, wherein the attorney argues the need and reason for a new trial to the judge.

For the Manager’s Desk

Re: the Jurors Who Get Online during trial

Social media has become a court man- agement problem. Jurors have gotten online during deliberations to do their own research. Jurors have posted messages on Twitter and Facebook about their expe- riences, issues, questions, and observa- tions during trial. The conduct has become so pervasive that courts now include a discussion of these issues in their jury handbooks that are distributed to every potential juror. The instructions in the book- let and admonitions to jurors need to add one additional caution: jurors should not be communicating by e-mail with the witness- es or lawyers. For example, in Tennessee v Smith, 418 S.W.2d 38 (Tenn. 2013), a juror sent the following note to a doctor who had testified during a criminal trial:

Scott Mitchell: “A-dele!! I thought you did a great job today on the witness stand . . . I was in the jury . . . not sure if you recognized me or not!! You really explained things so great!!”

Adele Maurer Lewis: “I was thinking that was you. There is a risk of a mistrial if that gets out.”

Scott Mitchell: “I know . . . I didn’t say anything about you . . . there are 3 of us on the jury from Vandy and one is a phy- sician (cardiologist) so you may know him as well. It has been an interesting case to say the least.”

Three of the jurors (including Scott Mitchell) worked at the Vanderbilt

University hospital, where Dr. Adele Lewis, the medical examiner for the county and a witness for the prosecution in the case, had done her medical training. None of the jurors had been questioned during voir dire about working at Vanderbilt, but the jurors had been instructed not to speak to any of the parties, attorneys, or witnesses in the case. They were instructed to say nothing if they saw any of these persons in the court facilities until the case was concluded.

The court held that the trial judge should have notified all the parties and then held a hearing to determine the impact of the com- munication, including questioning the juror, Mr. Mitchell, to determine the impact of the interaction on the case and deliberations. The court noted,

Even though technology has made it easier for jurors to communicate with third parties and has made these com- munications more difficult to detect, our pre-internet precedents provide appropriate principles and procedures to address extra-judicial communi- cations, even when they occur on social media websites and applica- tions such as Facebook. Accordingly, we will apply the same principles and procedures.

The technology has facilitated juror com- munication and made it more difficult to see, the standards are the same, and the court must still supervise and question.

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Chapter 4 Managing Disputes: Alternative Dispute Resolution and Litigation Strategies 131

Another motion after the verdict, one that a judge is less likely to grant, is a motion for a judgment NOV. NOV stands for non obstante veredicto, which means “notwithstanding the verdict.” In other words, the moving attorney is asking the trial judge to reverse the decision of the jury. The basis for granting a judg- ment NOV is that the jury’s verdict is clearly against the weight of the evidence. Occasionally, juries are swayed by the emotion of a case and do not apply the law properly. It is, however, a strong show of judicial authority for a judge to issue a judgment NOV, and they are rare.

Even if no motions are granted, the case still may not be over; it can go to an appellate court for review. Such an appeal must be done within a speci- fied time limit in each state. Here the trial has come full circle to the principle of judicial review and stare decisis. Exhibit 4.6 summarizes the steps in civil litigation.

4-6 Issues in International Litigation As noted earlier, international courts have no enforcement powers. They serve as avenues for voluntary mediation. However, courts in each nation in which a firm is doing business would have jurisdiction over that firm in the nation’s court sys- tem. In a recent infringement dispute over Mattel’s “Barbie” and the French doll “Sindy,” the parties litigated in London, where both firms were doing business and the dolls were selling well.

Among the critical questions that arise in international litigation are the following: Which set of laws applies? What court is the appropriate forum for a lawsuit that involves citizens of different countries? For example, many non–U.S. citizens who are injured in their own countries by products made by U.S. firms will generally be able to recover more under the product liability and tort laws of the United States. The U.S. Supreme Court issued a 9–0 deci- sion in a tragic accident case involving a U.S. citizen traveling in Austria. In OBB Personenverkehr A.G. v Sachs, 136 S.Ct. 390 (2015), Carol P. Sachs, of Berke- ley, California, filed suit against an Austrian entity because she was injured in an accident that occurred as she tried to board a moving train in Innsbruck, Austria. As a result of injuries sustained, Ms. Sachs had to have both of her legs amputated. Ms. Sachs filed suit in the United States against OBB Per- sonenverkehr (OBB), which operates a railway that carries nearly 235 million passengers each year on routes within Austria and to and from points outside Austria. OBB—along with 29 other railways throughout Europe—is a member of the Eurail Group. In reversing the Ninth Circuit, 737 F.3d 584 (2013), the court noted that the essence of Ms. Sach’s claims was at the point of her injury, which was in Austria. The sale of the ticket, which was done through a U.S. entity in the United States, was not involved in her injuries. She can pursue her remedies, but only in Austria.

A similar ruling was made with respect to the 2,500 victims of the Union Car- bide gas leak in Bhopal, India. Some of the victims filed suit in the United States because the law and damages provisions here afforded them much greater relief. Their suit was dismissed to India, and the court added that Union Carbide would be required to submit to the jurisdiction of Indian courts and to follow discovery rules of the United States.

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132 part 1 Business: Its Legal, Ethical, and Judicial Environment

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Chapter 4 Managing Disputes: Alternative Dispute Resolution and Litigation Strategies 133

Biography Games Workshop v Chapterhouse

Studios: a tabletop Gamers’ Battle with Jury Selection Help

Benson Green, a jury consultant with Douglas Green and Associates, was perus- ing a tabletop game blog when he came across a post about Games Workshop (GW) filing suit against Chapterhouse, a company of two people who started a business in a garage based on their tabletop gaming hobby. GW is a company based in England and sells science-fiction and fantasy products based on a “dys- topian fictional universe known as ‘War- hammer 40,000.’” Its products include miniature war game figures and parts, books, computer games, and an annual convention.

Chapterhouse, founded in 2008, sold what is known as “bit parts” for the tabletop game such as shoulder pads, shields, weapons, and alternative heads for figures. GW was suing Chapter- house for almost $500,000 for copyright infringement.

After reading about the suit, Mr. Green called Chapterhouse to wish the two “good luck” and learned that the two could not afford an attorney. Mr. Green contacted Lawyers for Creative Arts (LCA), an organization of lawyers who provide pro bono services for artists, actors, authors, and so on. LCA was able to obtain Winston and Strawn to represent Chap- terhouse. The case involved two motions for summary judgment and eventually went to trial. [Games Workshop Limited v Chapterhouse Studios, LLC, 2013 WL 1340559 (N.D. Ill.)] The issues at trial cen- tered on whether there was infringement on specific tabletop figures and icons such

as Blood Ravens, Chaplain, Exorcist, Flesh Tearers, Howling Griffons, Celestial Lions, and Lightning Claw.

Mr. Green and his firm donated over 1,000 hours to the case, including recruiting a mock jury to review the case in advance of the trial. Mr. Green’s firm also provided assistance with jury selection. Following a two-week trial and two days of jury deliberation, Chap- terhouse won on 111 of the 160 infringe- ment claims. Chapterhouse did have to pay damages ($25,000), but the parties reached a settlement on the damages. [Games Workshop Limited v Chapter- house Studios, LLC, 2012 WL 5949105 (N.D. Ill.)] Chapterhouse was permitted to continue its garage-based business, but with fewer products and not using the GW terms.

The case served as a national exam- ple of pro bono work as well as the first experience for the lawyers in the case in using jury consultants. For small business owners, the case is instruc- tive on the complexity of litigation as well as the importance of understand- ing production of a product that corre- sponds to the products of another firm. The case has also served as precedent in circumstances in which one compa- ny is creating parts for the pieces in a tabletop game developed by another company; that is, what is fair use of trademarked items? And licensing the right to make the parts might not have been a bad idea. (See Chapter 15 for more information.)

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134 part 1 Business: Its Legal, Ethical, and Judicial Environment

s u m m a r y How can businesses resolve disputes?

• Alternative dispute resolution (ADR)—means of resolving disputes apart from court litigation

Types of ADR:

• Arbitration—hearing with relaxed rules of evidence

• Mediation—third party acts as go-between

• Conciliation—international term for mediation

• Medarb—combination of mediation and arbitration

• Minitrial—private judge and courtroom; shortened trial

• Rent-a-judge—disputes resolved by hired judge

• Summary jury trial—advisory verdict by jurors in a mock trial

• Early neutral evaluation—third-party evaluation before litigation proceeds

• International Chamber of Commerce (ICC)— voluntary international court that offers arbitration in international disputes

What strategies should businesses follow if litigation is inevitable?

• Evaluate cost, including the unknowns such as jury reaction

• Consider privacy and creative remedies

How do courts proceed with litigation?

• Complaint—plaintiff’s statement of a case

• Summons—document to serve defendant with lawsuit

• Answers—defendant’s response to complaint

• Statute of limitations—time limit for filing suit

• Discovery—advance disclosure of evidence in case

• Production—obtain and produce document

• Deposition—questioning of witnesses under oath

• Interrogatories—information questions to other party

• Admissions—acknowledgment of facts in a case

• Trial—court proceeding for hearing evidence

• Voir dire—jury selection method to screen for bias

• Opening statements—frame by parties’ lawyers of the case

• Plaintiff’s case—facts for proving complaint presented

• Defendant’s case—defenses to allegations presented

• Evidence—testimony and documents presented in the case; no hearsay

Q u e s t i o n s a n d P r o b l e m s 1. Craig Walters slipped and fell on a piece of banana in the meat department of a Kroger store and landed on his left hip and left elbow. Initially, Walters did not expe- rience pain or other symptoms. Peyton Kelley, the store co-manager, came to the scene, and concluded that some- thing “mushy” and smelling like banana caused the fall. Kroger had video cameras that would have filmed both the fall as well as the regularity of cleanup in the aisles of the store. Kelley, however, did not retain the video films and allowed them to be automatically purged after the 17-day automatic preservation period. Walters filed suit and recovered over $1.6 million, partly because the jury was permitted to assume that there would have been negative evidence on the purged videos. Kroger filed an appeal objecting to that assumption about the purged vid- eos. What happens when a business destroys evidence? [Kroger Co. v Walters, 735 S.E.2d 99 (Ga. App. 2012)]

2. In the Johns-Manville asbestos litigation, Samuel Greenstone, an attorney for 11 asbestos workers, settled their claims for $30,000 and a promise that he would not “directly or indirectly participate in the bringing of new actions against the Corporation.” The 1933 case settle- ment was documented in the minutes of Johns-Manville’s board meeting. Could the information in the minutes be used in later litigation against Johns-Manville? How could a plaintiff’s attorney obtain the information? Do you feel Mr. Greenstone made an ethical decision in his agreement? Wasn’t his loyalty to his 11 clients and his obligation to obtain compensation for them? Would you have agreed to the no-further-participation-in-a-law- suit clause? Would you, if you had been an executive at Johns-Manville, have supported the clause?

3. Suppose that your company had received a letter complaint about one of the prescription drugs that it sells.

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Chapter 4 Managing Disputes: Alternative Dispute Resolution and Litigation Strategies 135

The customer and his physician have complained that there were cardiovascular effects from use of the drug over the past 12 months. You know about the complaint, and you also have e-mails from one of your friends in the company, a research scientist who was in your fraternity in college, that indicate he sees some cardiovascular side effects from the same drug. If you deleted the e-mail, would it be spoliation?

What would be required to prove spoliation in this case?

4. After she was found guilty of obstruction of justice and conspiracy (see Chapter 8), lawyers for Martha Stew- art filed a motion for a new trial on the grounds that a juror on the case had possible undisclosed bias. The defense lawyers pointed out that juror Chappel Har- tridge had checked “No” on the juror questionnaire when asked whether he had been accused of, charged with, or convicted of a crime. The lawyers for Ms. Stewart filed an affidavit from a former girlfriend of Mr. Hartridge’s who indicated that he had been arrested and arraigned on charges of assaulting her. Mr. Hartridge’s former girlfriend ultimately dropped the charges against him. What bias do you think Ms. Stewart’s lawyers alleged? Are they right? Should the juror have been eliminated for cause? [U.S. v Stewart, 317 F. Supp. 2d 432 (S.D.N.Y.2004)]

5. A discrimination suit by a former flight attendant against Atlantic East Airlines is going to trial. Jury selec- tion has begun. An executive from Atlantic East notices that a member of the potential juror panel was a flight attendant responsible for pregnancy leave reforms among airline flight attendants during the early 1980s. This potential juror is no longer a flight attendant and is raising two small children at home. The executive informs Atlantic East’s lawyer. Can the lawyer do any- thing to prevent the woman from sitting on the jury?

6. Applegate is in litigation with Magnifium over a con- tract breach. Applegate has been approached by a former janitor for Magnifium who can testify regarding con- versations about the contract between Magnifium exec- utives. The janitor heard them when the executives had stayed late at work and he was cleaning. Can Applegate use the statements at trial?

7. Robert Joiner began work as an electrician in the Water & Light Department of Thomasville, Georgia, in 1973. Mr. Joiner worked with and around electrical transformers that contained a fluid. In 1983, the city of Thomasville discovered that this fluid contained poly- chlorinated biphenyls (PCBs), a substance considered hazardous. Mr. Joiner was diagnosed with lung cancer in 1991 and filed suit against General Electric, the man- ufacturer of the transformers, for negligence and product liability.

Mr. Joiner had been a smoker, his parents were smokers, and his family had a history of lung cancer.

Mr. Joiner offered expert testimony on studies involving the injection of PCB into the stomachs of infant mice and resulting cancer. The experts had no epidemio- logical studies on PCB exposure. Should the expert testi- mony be admitted? [General Electric Co. v Joiner, 522 U.S. 136 (1997)]

8. Dr. John Sutter, a pediatrician, agreed with a number of other physicians to provide medical care for individu- als insured with Oxford Health Plans. Oxford agreed to pay the physicians according to the terms of a contract all the physicians signed. The contract provided for arbitra- tion of any disputes between Oxford and the physicians. Dr. Sutter was not paid in a timely fashion and filed an arbitration claim. However, other physicians wished to join him in the claim for a sort of class action arbitration. Is that possible under arbitration? Who should make that decision about allowing other doctors to join in on the claim of lack of timely payment? [Oxford Health Plans, LLC v Sutter, 133 S.Ct. 2064 (2013)]

9. The SEC investigation of Tyco International for pos- sible securities law violations produced several e-mails. The e-mails focused on two concerns about the company: accounting improprieties and the use of company funds by then-CEO Dennis Kozlowski. The e-mails were writ- ten by outside lawyers from the firm of Wilmer Cutler to former Tyco General Counsel Mark Belnick. The e-mails are as follows.

March 23, 2000: E-mail from a Wilmer Cutler Partner, Lewis Liman, to Mark Belnick

There are payments to a woman whom the folks in finance describe to be Dennis’s girlfriend. I do not know Dennis’s situation, but this is an embarrassing fact.

(Note: The payments were later verified as being made from the Key Employee Loan Account to Karen  Mayo, who subsequently became Karen Kozlowski, who divorced Mr. Kozlowski while he was in prison.)

May 25, 2000: E-mail from a Wilmer Cutler Part- ner, William McLucas, to Mark Belnick

We have found issues that will likely interest the SEC; creativeness is employed in hitting the forecasts.

There is also a bad letter from the Sigma people just before the acquisition confirming that they were asked to hold product shipment just before closing. . . .

(This e-mail also went on to suggest that there was, in regard to Tyco’s financial reports, “something funny which is likely apparent if any decent accountant looks at this.”)

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136 part 1 Business: Its Legal, Ethical, and Judicial Environment

Although Mr. McLucas and Mr. Liman could not comment because of attorney–client privilege, others indicate that they followed up on the e-mails and asked officials at Tyco to correct the concerns and problems raised in the e-mails.

Are the e-mails privileged? How did the SEC gain access to them? Can they be used as evidence? Are they discoverable? (Laurie P. Cohen and Mark Maremont, “E-Mails Show Tyco’s Lawyers Had Concerns,” Wall Street Journal, December 27, 2002, pp. C1, C5)

10. In October 1995, Saint Clair Adams applied for a job at Circuit City Stores, Inc., a now-defunct national retailer of consumer electronics. Mr. Adams signed an employ- ment application that included the following provision.

I agree that I will settle any and all previously unasserted claims, disputes or controversies arising out of or relating to my application or candidacy for employment, employment and/ or cessation of employment with Circuit City, exclusively by final and binding arbitration before a neutral Arbitrator. By way of example only, such

claims include claims under federal, state, and local statutory or common law, such as the Age Discrimination in Employment Act, Title VII of the Civil Rights Act of 1964, as amended, including the amendments of the Civil Rights Act of 1991, the Americans with Disabilities Act, the law of contract and the law of tort.

Mr. Adams was hired as a sales counselor in Circuit City’s store in Santa Rosa, California.

Two years later, Mr. Adams filed an employ- ment discrimination lawsuit against Circuit City in state court, asserting claims under California’s Fair Employment Act. Circuit City filed suit in the U.S. District Court seeking to stop the state court action and to compel arbitration under the FAA. Mr. Adams says the arbitration clause violates his statutory rights for protection against employment discrimination and that he has the right to go to court, not arbitration. Who is correct? Can Mr. Adams be required to submit to arbitration? [Circuit City Stores, Inc. v Adams, 532 U.S. 105 (2001)]

Economics, Public Policy & the Law

Japan’s Changing Legal System Many businesspeople have argued that too many lawyers and lawsuits hurt the United States in the competitive international market. However, Japan is a country that has been moving toward the U.S. model for the role of lawyers in the judicial system even as it preserves some limitations on the standards for civil recovery and the types of recoveries available in those cases.

Lifting Limits on the Number of Lawyers Prior to 2000, in order to become a bengoshi (law- yer) in Japan, an individual had to win a slot at the Legal Training and Research Institute. This government-run school accepted only 2% of the 35,000 annual applicants. As a result, only 400 new bengoshi were added each year to Japan’s bar. How- ever, in 2000, the government allowed the opening of private law schools that are operated in a manner similar to those in the United States. With more slots available for education, there are now 29,000 law- yers in Japan, a more-than-double increase from the 14,336 lawyers there in 1992. There is also increased

competition among lawyers. Japan now permits lawyer advertising. Japanese law firms are also now permitted to merge with other firms to increase the services offered and compete effectively.

Limits on Recovery Japanese courts allow recovery only for actual losses. There is no recovery for mental anguish. Class actions are rare in Japan, and it is very difficult to get a court’s approval to go forward with such a suit. The Toyota recall of so many cars in the sudden-acceleration issues of 2010 resulted in great activity in Japanese courts for class actions and recovery.

Costs to Plaintiffs Plaintiffs are required to pay money to their lawyers up front. The amount required is 8% of the recovery sought plus the nonrefundable filing fee.

Limits on Damage Awards Judges, not juries, determine damages, and even in wrongful death cases, the damages may not include punitive damages.

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Chapter 4 Managing Disputes: Alternative Dispute Resolution and Litigation Strategies 137

Encouragement of Settlement and Cultural Disdain for Confrontation In Japan, a cultural pride exists in being able to resolve disputes outside the courtroom; those who must lit- igate are looked down upon. However, the Japanese culture and judicial system are moving toward the use of litigation as a means of correcting company behav- iors. One financial analyst concluded that litigation is good as he discussed the Toyota issues: “Toyota has been arrogant. It’s good that lawsuits are taking place now so Toyota will go through soul-searching.

diSCUSSiON QUeStiONS

1. Should the United States move more toward some of the rules of the Japanese litigation system as

Japan moves toward ours? Why or why not? Are there benefits to the openness of one and the limit- edness of the other? What are they?

2. In the English court system, the loser pays court costs and the costs of the other party involved in the litigation. Should such a rule be adopted in the United States? For all cases? Would you be less will- ing to pursue a case for yourself or your company if you knew that you would be required to pay if you lost the case?

Sources: Michele Galen et al., “Guilty,” BusinessWeek, April 13, 1992, pp. 60–66; ABA Report on International Lawyers (1990); Yuka Hayashi, “Japanese Culture Shifting on Suits,” Wall Street Journal, February 23, 2010, p. A4. © Ron and Joe/Shutterstock.com

n ot e s 1. Alan Dabdoub and Trey Cox, “Which Costs Less: Arbitration or Litigation?,” Inside Counsel, December 6, 2012, http://www .insidecounsel.com/2012/12/06/which-costs-less-arbitration -or-litigation. In fact, the study concludes that arbitration is higher in costs as well as in attorneys’ fees.

2. Leigh Jones, “Gotcha Game,” National Law Journal, February 4, 2011, p. A1.

3. Michael Gottesman, the attorney who argued the Daubert case in the U.S. Supreme Court on behalf of the plaintiffs,

confirmed that his client’s name is pronounced “dow-burt.” Michael Gottesman, “Admissibility of Expert Testimony after Daubert: The ‘Prestige’ Factor,” 43 Emory Law Journal 867 (1994). During oral argument, the justices of the Supreme Court mispronounced the name as “dough-bear.” Mr. Gottesman chose the wise course of not correcting the justices. You now know something that Supreme Court justices do not.

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139

Part

2 Business: Its Regulatory Environment

A business is regulated by everything from the U.S. Constitution to the rules of the Consumer Product Safety Commission. Managers must know codified law, as well as the law that develops as cases are

litigated and new issues of liability arise. The regulatory environment of

business includes penalties for criminal conduct and punitive damages

for knowingly causing injuries to customers. Part 2 describes the laws

that regulate businesses and business operations, including tort and

environmental law, the sanctions that are imposed for violation of these

laws, and the manner in which businesses can make compliance with

the law a key part of their values.

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140

Chapter

Business and the Constitution5 The U.S. Constitution is a remarkable document. It was drafted by a group of independent states more than 220 years ago in an attempt to unify the states into one national government that could function smoothly and efficiently with- out depriving those independent states of their rights. The fact that it has sur- vived so many years with so few changes indicates the flexibility and foresight built into the document.

This chapter covers the application of the U.S. Constitution to business and answers several questions: What are the constitutional limitations on business regulation? Who has more power to regulate business—the states or the federal government? What individual freedoms granted under the Constitution apply to businesses?

Update For up-to-date legal and ethics news, go to mariannejennings.com

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141

Congress passed the Patient Protection and Afford- able Care Act (also known as Obama Care) in order to increase the number of Americans covered by health insurance and decrease the cost of health care. One key provision in the law is the individual mandate, which requires most Americans to maintain “minimum es- sential” health insurance coverage. Attorneys gener- al and businesses from several states challenged this

requirement (and other provisions of the law) as being unconstitutional under the Commerce Clause. From a series of federal decisions from the courts below, some finding the law constitutional and others not, the affect- ed parties appealed to the U.S. Supreme Court. What does the Commerce Clause have to do with this law? Is the law constitutional?

Consider . . . 5.1

5-1 The U.S. Constitution 5-1a an Overview of the U.S. Constitution

Although virtually all constitutional issues and all court decisions on those issues are complicated and detailed, the U.S. Constitution itself is a simple and short document. Contained within it is the entire structure of the federal government, its powers, the powers of the states, and the rights of all citizens. The exact language of the U.S. Constitution is presented in Appendix A.

5-1b articles I, II, and III—the Framework for Separation of powers

The first three articles of the U.S. Constitution set up the three branches of the federal government. Article I establishes the legislative branch. The two houses of Congress—the House of Representatives and the Senate—are created, their method of electing members is specified, and their powers are listed.

Article II creates the executive branch of the federal government. The office of president along with its qualifications, manner of election, term, and powers are specified.

Article III establishes the judicial branch of the federal government. This arti- cle creates only the U.S. Supreme Court and establishes its jurisdiction. Congress, however, is authorized to establish inferior courts, which it has done in the form of federal district courts, specialized federal courts, and U.S. courts of appeals (see Chapter 3, Exhibit 3.1).

The first three articles establish the nature of the federal government as involv- ing the separation of powers. Each of the branches of government is given unique functions that the other branches cannot perform, but each branch also has curb- ing powers on the other branches through the exercise of its unique powers. For example, the judicial branch cannot pass laws, but it can prevent a law passed by Congress from taking effect by judicially interpreting the law as unconstitutional. The executive branch does not pass legislation but has veto power over legislation

Some men look at constitutions with sanctimonious reverence, and deem them like the ark of the covenant, too sacred to be touched. . . . I am certainly not an advocate for frequent and untried changes in laws and constitutions. . . . But . . . laws and institutions must go hand in hand with the progress of the human mind. Thomas Jefferson

The history of the United States has been written not merely in the halls of Congress, in the Executive offices and on the battlefields, but to a great extent in the chambers of the Supreme Court of the United States. Charles Warren

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142 part 2 Business: Its Regulatory Environment

passed by Congress. The executive branch has responsibility for foreign relations and treaty negotiation. However, those treaties do not take effect until the Senate ratifies them. In 2015, the ratification of the Obama treaty with Iran became a politi- cally charged issue in the Senate. This system of different powers that can be used to curb the other branches’ exercise of power is called a system of checks and balances.

The drafters of the U.S. Constitution designed the federal government this way to avoid the accumulation of too much power in any one branch of government. In Nixon v Administrator of General Services, 433 U.S. 425 (1977), the Supreme Court held that former President Nixon was required to turn over to Congress any records and materials of the executive branch that were relevant to the congressional inquiry into the Watergate scandal (a break-in at the Democratic Party’s national headquarters that was masterminded by members of the Nixon administration). In NLRB v. Noel Canning, 134 S.Ct. 2550 (2014), the Supreme Court declared that President Obama’s interim appointments to the National Labor Relations Board were invalid and would have to be redone with Senate approval. In Clinton v Jones, 520 U.S. 681 (1997), the Supreme Court ruled that even the president is subject to the laws of the land and is accountable for civil wrongs alleged by private citizens. In the case, Paula Corbin Jones alleged that Mr. Clinton had sexually harassed her while he was governor of Arkansas. The Court ruled that, “. . . even the sovereign is subject to God and the law.”

5-1c Other articles

Article IV deals with states’ interrelationships. Article V provides the procedures for constitutional amendments. Article VI is the Supremacy Clause (discussed later in this chapter), and Article VII simply provides the method for state ratifica- tion of the Constitution.

For the Manager’s Desk

Re: the president, Justice alito, Congress, and the Balance of powers

During President Obama’s State of the Union address on January 27, 2009, he made reference to Citizens United v Fed- eral Election Commission, 558 U.S. 310 (2010) (see pp. 162–164). The decision dealt with the constitutionality of portions of the McCain–Feingold campaign and campaign contributions law. The president made the following statements about the decision:

With all due deference to separation of powers, last week the Supreme Court reversed a century of law that, I believe, will open the floodgates for special inter- ests, including foreign corporations, to spend without limit in our elections.

Well I don’t think American elections should be bankrolled by America’s most powerful interests, or worse, by foreign entities. They should be decided by the American people, and that’s why I’m urging Democrats and Republicans to pass a bill that helps to right this wrong.

Following the statement, U.S. Supreme Court Justice Alito could be seen (as he was picked up by the cameras) shaking his head and mouthing what appears to be “not true” or “definitely not true.”

What can be done with regard to the decision? Who was right on what the decision did—Mr. Obama or Justice Alito? (See p. 160.)

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Chapter 5 Business and the Constitution 143

5-1d the Bill of Rights

In addition to the seven articles, the U.S. Constitution 27 has amendments, the first 10 of which are the Bill of Rights. Although these rights originally applied only to federal procedures, the Fourteenth Amendment extended them to apply to the states as well. These amendments establish rights ranging from freedom of speech (First Amendment) to the right to a jury trial (Sixth Amendment) to protection of privacy from unlawful searches (Fourth Amendment) to due process before depri- vation of property (Fifth Amendment). The amendments as they apply to busi- nesses are covered later in this chapter and in Chapter 8.

5-2 The Role of Judicial Review and the Constitution

The Supreme Court and its decisions are often in the news because the cases decided by the Court are generally significant ones that provide interpretations of the U.S. Constitution and also define the extent of the rights we are afforded under it. The role of the U.S. Supreme Court is to decide what rights are provided by the general language of the U.S. Constitution. For example, the Fifth Amendment guarantees that we will not be deprived of our life, liberty, or property without “due process of law.” Due process of law, interpreted by the courts many times now, includes such rights as the right to a hearing before a mortgage foreclosure, or at least the right of notice before property is sold after repossession as a result of nonpayment of the underlying debt.

The First Amendment protects the simple right to freedom of speech, but the Supreme Court has been faced with issues such as whether restrictions on member- ship in student clubs at state universities are an infringement of the First Amend- ment.1 The Fourth Amendment, the “privacy amendment,” protects us from warrantless searches. This general idea has been analyzed in the context of garbage taken from cans waiting for pickup on the street and unannounced inspections of company workplaces by OSHA regulators (see Chapter 19 for more information on OSHA—the Occupational Safety and Health Administration).

The U.S. Supreme Court has the responsibility of determining the extent and scope of the rights and protections afforded by the U.S. Constitution. In addition, the Supreme Court plays the unique role of reviewing the actions of the other branches of government. The Court is a crucial part of the checks-and-balances system set up in our Constitution. As noted in the “For the Manager’s Desk” (see p. 142), the court recently dealt with the issue of the constitutionality of legislation passed by Congress.

5-3 Constitutional Limitations of Economic Regulations

5-3a the Commerce Clause

The Commerce Clause is found in Article I, Section 8, Part 3, of the U.S. Constitu- tion and provides Congress with the power “[t]o regulate Commerce with foreign Nations, and among the several States.” Although the language is short and sim- ple, the phrase “among the several states” has created much controversy. The clause limits Congress to the regulation of interstate commerce. The regulation of local and

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144 part 2 Business: Its Regulatory Environment

intrastate commerce is left to the states. Defining interstate commerce has been the task of the courts. The standards are defined from two perspectives: federal regula- tion of state and local commerce and state and local regulation of interstate commerce.

Standards for Congressional Regulation of State and Local Business activity The issue, as defined by the U.S. Supreme Court, is whether the situation involves sufficient interstate contact or effects for the application of federal standards. The Constitution gives Congress authority to regulate interstate matters and vests all the remaining regulatory authority in the states.

The U.S. Supreme Court initially gave a very narrow interpretation to the scope of the Commerce Clause. In the beginning of the Court’s interstate commerce jurisprudence, federal regulation applied to commercial activity if the commercial activity had a “direct and immediate effect” on interstate commerce. In 1918, the Court ruled that manufacturing was not “commerce” (because it was solely intra- state) and struck down an act of Congress that attempted to regulate goods man- ufactured in plants using child labor. [Hammer v Dagenhart, 247 U.S. 251 (1918)] During the 1930s, Congress and President Roosevelt bumped heads with the Court many times in their attempts to legislate a recovery from the Depression. The Court consistently refused to validate federal legislation dealing with manufactur- ing, operations, and labor. [Schechter Poultry v United States, 295 U.S. 495 (1935); Carter v Carter Coal, 298 U.S. 238 (1936)] Roosevelt refused to accept a judicial road- block to his legislation and initiated his court-packing plan to increase the number of members of the court with Roosevelt appointees.

The Court responded in NLRB v Laughlin Steel, 336 U.S. 460 (1940), by ruling that intrastate activities, even though local in character, may still affect interstate com- merce and thus be subject to federal regulation. The “affectation” doctrine expanded the authority of the federal government in regulating commerce. In the words of the Court, “If it is interstate commerce that feels the pinch, it does not matter how local the squeeze” (336 U.S. at 464). The Commerce Clause has had a critical role in the elimination of discrimination because the Court’s liberal definition of what consti- tutes interstate commerce has permitted the application of federal civil rights laws to local economic activities. However, some recent refinements limit federal authority. For example, in U.S. v Lopez, 514 U.S. 564 (1995), the court held that the Gun-Free School Zones Act of 1990, 18 U.S.C. § 922(q)(1)(A), which made it a federal crime to knowingly possess a firearm in a school zone, exceeded Congress’s authority under the Commerce Clause because Congress was not regulating any form of commerce through the law but imposing criminal sanctions on a local activity. Because there was no commerce or economic activity involved, federal authority to regulate was limited by the Commerce Clause. Congress has the authority to regulate in those areas where what they are regulating substantially affects interstate commerce. Likewise, in U.S. v Morrison, 529 U.S. 598 (2000), the Court struck down the federal Violence Against Women Act because the law, which provided for a federal cause of action for women who had been assaulted, did not deal with any underlying economic activity and the Court held that allowing Congress to regulate the right to file suit for criminal activity would allow Congress to use the Commerce Clause to completely obliterate the Con- stitution’s distinction between national and local authority.

National Federation of Independent Business v Sebelius (Case 5.1) is a landmark case that also limits the scope of federal power under the Commerce Clause but expanded other federal powers, including that of taxation (see discussion of taxa- tion powers on p. 149).

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Chapter 5 Business and the Constitution 145

National Federation of Independent Business v Sebelius 132 S.Ct. 2566 (2012)

Mandating Health Insurance under the Commerce Clause

Case 5.1

FaCtS

Congress passed the Patient Protection and Affordable Care Act (also known as Obama Care) in order to increase the number of Americans covered by health insurance and decrease the cost of health care. One key provision in the law is the individual mandate, which requires most Americans to maintain “minimum essen- tial” health insurance coverage. Attorneys general from several states, along with businesses, challenged this requirement (and other provisions of the law) as being unconstitutional under the Commerce Clause. From a series of federal court decisions below, some finding the law constitutional and others not, the affected par- ties appealed and the Supreme Court granted certiorari. Their cases were consolidated for the court’s review.

JUdICIaL OpInIOn

ROBERTS, Chief Justice The Constitution grants Congress the power to “regu- late Commerce.” (Art. I, § 8, cl. 3.) The power to regulate commerce presupposes the existence of commercial activity to be regulated. If the power to “regulate” something included the power to create it, many of the provisions in the Constitution would be superflu- ous. For example, the Constitution gives Congress the power to “coin Money,” in addition to the power to “regulate the Value thereof.” And it gives Congress the power to “raise and support Armies” and to “provide and maintain a Navy,” in addition to the power to “make Rules for the Government and Regulation of the land and naval Forces.” If the power to regulate the armed forces or the value of money included the power to bring the subject of the regulation into existence, the specific grant of such powers would have been unnecessary. The language of the Constitution reflects the natural understanding that the power to regulate assumes there is already something to be regulated.

Our precedent also reflects this understanding. As expansive as our cases construing the scope of the commerce power have been, they all have one thing in common: They uniformly describe the power as reach- ing “activity.” It is nearly impossible to avoid the word when quoting them.

The individual mandate, however, does not reg- ulate existing commercial activity. It instead compels individuals to become active in commerce by purchas- ing a product, on the ground that their failure to do so affects interstate commerce. Construing the Commerce Clause to permit Congress to regulate individuals precisely because they are doing nothing would open a new and potentially vast domain to congressional authority. Every day individuals do not do an infinite number of things. In some cases they decide not to do something; in others they simply fail to do it. Allowing Congress to justify federal regulation by pointing to the effect of inaction on commerce would bring countless decisions an individual could potentially make within the scope of federal regulation, and—under the Gov- ernment’s theory—empower Congress to make those decisions for him.

Indeed, the Government’s logic would justify a mandatory purchase to solve almost any problem. To consider a different example in the health care market, many Americans do not eat a balanced diet. That group makes up a larger percentage of the total population than those without health insurance. The failure of that group to eat a healthy diet increases health care costs more than the failure of the uninsured to purchase insurance. Those increased costs are borne in part by failure of that group to have a healthy diet increases health care costs, to a greater extent than other Amer- icans who must pay more, just as the uninsured shift costs to the insured. Congress addressed the insurance problem by ordering everyone to buy insurance. Under the Government’s theory, Congress could address the diet problem by ordering everyone to buy vegetables.

People, for reasons of their own, often fail to do things that would be good for them or good for society. Those failures—joined with the similar failures of others— can readily have a substantial effect on interstate com- merce. Under the Government’s logic, that authorizes Congress to use its commerce power to compel citizens to act as the Government would have them act.

That is not the country the Framers of our Consti- tution envisioned. James Madison explained that the Commerce Clause was “an addition which few oppose and from which no apprehensions are entertained.”

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146 part 2 Business: Its Regulatory Environment

The Federalist No. 45, at 293. While Congress’s authori- ty under the Commerce Clause has of course expanded with the growth of the national economy, our cases have “always recognized that the power to regulate commerce, though broad indeed, has limits.” The Government’s theory would erode those limits, per- mitting Congress to reach beyond the natural extent of its authority, “everywhere extending the sphere of its activity and drawing all power into its impetuous vortex.” The Federalist No. 48, at 309 (J. Madison). Congress already enjoys vast power to regulate much of what we do. Accepting the Government’s theory would give Congress the same license to regulate what we do not do, fundamentally changing the relation between the citizen and the Federal Government.

[There were other issues covered in the 106-page opinion. The complicated decision resulted in the lower court decisions being both affirmed and reversed, but the individual mandate was declared unconstitutional under the Commerce Clause but constitutional as a tax.]

CaSe QUeStIOnS

1. What was missing that the Court indicated was needed in order to find that the mandate was constitutional?

2. What was the purpose of the court’s discussion of a healthy diet?

3. What sources does the court rely on for constitu- tional interpretation?

Ollie’s Barbecue is a family-owned restau- rant in Birmingham, Alabama, specializing in barbecued meats and homemade pies, with a seating capacity of 220 customers. It is located on a state highway 11 blocks from an interstate highway and a somewhat greater distance from railroad and bus sta- tions. The restaurant caters to a family and white-collar trade, with a takeout service for “Negroes.” (Note: The court uses this term in the opinion on the case.)

In the 12 months preceding the pas- sage of the Civil Rights Act, the restaurant purchased locally approximately $150,000 worth of food, $69,683 or 46% of which was meat that it bought from a local supplier who had procured it from outside the state.

Ollie’s has refused to serve Negroes in its dining accommodations since its original opening in 1927, and since July 2, 1964, it has been operating in violation of the Civil Rights Act. A lower court concluded that if it were required to serve Negroes, it would lose a substantial amount of business.

The lower court found that the Civil Rights Act did not apply because Ollie’s was not involved in “interstate commerce.” Will the Commerce Clause permit application of the Civil Rights Act to Ollie’s?

THINK: What did the Sebelius case require for the Commerce Clause to allow

Congressional action on intrastate activi- ties? If Congress was to have the authority to regulate seemingly intrastate activities, there had to be some underlying economic activity, and, whatever that economic activity was, it had to have some relation to or an impact on interstate activity.

APPLY: What is different about Ollie’s Barbecue’s activities and the federal health care law?

Ollie’s Barbecue is a commercial enter- prise involved in producing and selling food. This is economic activity, and the Sebelius case discussed that Congress was not au- thorized to regulate inactivity, which is what the mandate did.

Ollie’s has an impact on interstate commerce because it orders goods in in- terstate commerce, and it serves travelers who are moving from state to state. The Civil Rights Act prohibited discrimination in public places, and Congress was regulat- ing economic activity. The activity involved interstate shipment of goods.

ANSWER: Congress had the authority under the Commerce Clause to pass the Civil Rights Act and have it apply to intra- state businesses such as Ollie’s Barbecue.

[Katzenbach v McClung, 379 U.S. 294 (1964)]

Consider . . . 5.2

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Chapter 5 Business and the Constitution 147

Standards for State Regulation of Interstate Commerce The Commerce Clause also deals with issues beyond those of federal power. The interpretation of the clause involves how much commerce the states can regulate without interfering in the congressional domain of interstate commerce. In answer- ing this question, the courts are concerned with two factors: (1) whether federal regulation supersedes state involvement and (2) whether the benefits achieved by the regulation outweigh the burden on interstate commerce. These two factors are meant to prevent states from passing laws that would give local industries and businesses an unfair advantage over interstate businesses. In some circumstances, however, the states can regulate interstate commerce. Those circumstances occur when the state is properly exercising its police power.

What Is the Police Power? The police power is the states’ power to pass laws that promote the public welfare and protect public health and safety. Regulation of these primary concerns is within each state’s domain. It is, however, inevitable that some of the laws dealing with public welfare and health and safety will burden interstate commerce. Many of the statutes that have been challenged constitution- ally have regulated highway use. For example, some cases have tested a state’s power to regulate the length of trucks on state highways. [Raymond Motor Trans- portation v Rice, 434 U.S. 429 (1978)] In Bibb v Navajo Freight Lines, Inc., 359 U.S. 520 (1959), the Supreme Court analyzed an Illinois statute requiring all trucks using Illinois roads to be equipped with contour mudguards. These mudguards were supposed to reduce the amount of mud splattering the windshields of other driv- ers and preventing them from seeing. Both cases revolved around the public safety purpose of the statutes.

The Balancing Test. A statute is not entitled to constitutional protection just because it deals with public health, safety, or welfare. Although the courts try to protect the police power, that protection is not automatic. The police power is upheld only so long as the benefit achieved by the statute does not outweigh the burden imposed on interstate commerce. Each case is decided on its own facts. States present evi- dence of the safety benefits involved, and the interstate commerce interests pres- ent evidence of the costs to and effects on interstate commerce. The question courts must answer in these constitutional cases is whether the state interest in public health, welfare, or safety outweighs the federal interest in preventing interstate commerce from being unduly burdened. In performing this balancing test, the courts of course examine the safety, welfare, and health issues. However, the courts also examine other factors, such as whether the regulation or law provides an unfair advantage to intrastate or local businesses. For example, a prohibition on importing citrus fruits into Florida would give in-state growers an undue advantage.

Courts also examine the degree of the effect on interstate commerce. State stat- utes limiting the length of commercial vehicles would require commercial truck lines to buy different trucks for certain routes or in some cases to stop at a state’s border to remove one of the double trailers being pulled. Such stops can have a substantial effect on interstate travel. On the other hand, a state law that requires travelers to stop at the border for a fruit and plant check is not as burdensome: only a stop is required, and the traveler would not be required to make any further adjustments. Also, the state’s health interest is great; most fruit and plant checks are done to keep harmful insects from entering the state and destroying its crops. In the Bibb case, the courts found that the evidence of increased safety was not per- suasive enough to outweigh the burden on interstate commerce.

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148 part 2 Business: Its Regulatory Environment

Another question courts answer in their analysis is whether the state could accomplish its health, welfare, or safety goal in any other way with less of a bur- den on interstate commerce. Suppose a state has a health concern about having milk properly processed. One way to cover the concern is to require all milk to be processed in state. Such a regulation clearly favors that state’s businesses and imposes a great burden on out-of-state milk producers. The same result, however, could be produced by requiring all milk sellers to be licensed. The licensing pro- cedure would allow the state to check the milk-processing procedures of all firms and accomplish the goal without imposing such a burden on out-of-state firms. In Rowe v New Hampshire Motor Transport Association (Case 5.2), the court dealt with a state’s regulation of tobacco products delivered into the state.

Rowe v New Hampshire Motor Transport Ass’n 552 U.S. 364 (2008)

Minors, Maine, and Motor Transport of Tobacco

Case 5.2

FaCtS

Maine passed a law that prohibited anyone other than a Maine-licensed tobacco retailer from accepting an order for delivery of tobacco. The law required the retailer to arrange for delivery with a special receipt showing that someone over the age of 18 had received and signed for the tobacco products delivered. Out-of- state shippers and tobacco sellers challenged the law as one that favored Maine tobacco retailers.

The state of Maine argued that its law was passed to prevent the public health hazard of minors becom- ing addicted to tobacco. The federal district court granted summary judgment for the shippers, and the court of appeals affirmed. The state of Maine appealed.

JUdICIaL OpInIOn

BREYER, Justice The provision requires the carrier to check each ship- ment for certain markings and to compare it against the Maine attorney general’s list of proscribed shippers. And it thereby directly regulates a significant aspect of the motor carrier’s package pickup and delivery ser- vice. In this way it creates the kind of state-mandated regulation that the federal Act pre-empts.

Maine replies that the regulation will impose no significant additional costs upon carriers. But even were that so (and the carriers deny it), Maine’s reply is off the mark. As with the recipient-verification provi- sion, the “deemed to know” provision would freeze in place and immunize from competition a service-related

system that carriers do not (or in the future might not) wish to provide. To allow Maine to insist that the car- riers provide a special checking system would allow other States to do the same. And to interpret the federal law to permit these, and similar, state requirements could easily lead to a patchwork of state service-deter- mining laws, rules, and regulations.

That state regulatory patchwork is inconsistent with Congress’ major legislative effort to leave such decisions, where federally unregulated, to the compet- itive marketplace. And to allow Maine directly to reg- ulate carrier services would permit other States to do the same. Given the number of States through which carriers travel, the number of products, the variety of potential adverse public health effects, the many differ- ent kinds of regulatory rules potentially available, and the difficulty of finding a legal criterion for separating permissible from impermissible public health- oriented regulations.

In this case, the state law is not general, it does not affect truckers solely in their capacity as members of the general public, the impact is significant, and the connection with trucking is not tenuous, remote, or peripheral. The state statutes aim directly at the car- riage of goods, a commercial field where carriage by commercial motor vehicles plays a major role. The state statutes require motor carrier operators to perform cer- tain services, thereby limiting their ability to provide incompatible alternative services; and they do so sim- ply because the State seeks to enlist the motor carrier operators as allies in its enforcement efforts.

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Chapter 5 Business and the Constitution 149

Congressional Regulation of Foreign Commerce The Commerce Clause also grants Congress the power to regulate foreign com- merce. The case of Gibbons v Ogden, 9 Wheat. 1 (1824), defined foreign commerce as any “commercial intercourse between the United States and foreign nations.” This power to regulate applies regardless of where the activity originates and where it ends. For example, many international trade transactions begin and end in the city of New York. Although the paperwork and delivery of the goods may be solely within one state (here within one city), the foreign commerce power is not restricted by intrastate standards. If the transaction involves foreign commerce, congressional regulation applies (such as customs controls and fees) regardless of the place of transaction.

5-3b Constitutional Standards for taxation of Business

Article I, Section 8, Paragraph 1, of the Constitution gives Congress its powers of taxation: “The Congress shall have Power To lay and collect Taxes, Duties, Imposts and Excises. . . .” In addition, the Sixteenth Amendment to the Constitution gives this power: “The Congress shall have power to lay and collect taxes on incomes, from whatever source derived, without apportionment among the several States, and without regard to any census or enumeration.”

The U.S. Supreme Court has consistently upheld the authority of Congress— and local governments as well—to impose taxes. However, one area in taxation still results in considerable litigation. This area involves state and local taxation of interstate commerce. Interstate businesses are not generally exempt from state and local taxes just because they are interstate businesses. However, the taxes imposed on these businesses must meet certain standards.

First, the tax cannot discriminate against interstate commerce. A tax on milk could not be higher for milk that is shipped in from out of state than for milk pro- duced within the state.

Second, the tax cannot unduly burden interstate commerce. For example, a tax on interstate transportation companies that is based on the weight of their

Maine adds that it possesses legal authority to prevent any tobacco shipments from entering into or moving within the State, and that the broader authority must encompass the narrower authority to regulate the manner of tobacco shipments.

But even assuming purely for argument’s sake that Maine possesses the broader authority, its conclusion does not follow. To accept that conclusion would per- mit Maine to regulate carrier routes, carrier rates, and carrier services, all on the ground that such regulation would not restrict carriage of the goods as seriously as would a total ban on shipments.

And it consequently would severely undermine the effectiveness of Congress’ pre-emptive provi- sion. Indeed, it would create the very exception that we have just rejected, extending that exception to all other products a State might ban. We have explained why we do not believe Congress intended that result.

Finally, Maine says that to set aside its regulations will seriously harm its efforts to prevent cigarettes from falling into the hands of minors. The Solicitor General denies that this is so. He suggests that Maine, like other States, can prohibit all persons from providing tobacco products to minors; that it can ban all non-face-to-face sales of tobacco; that it might pass other laws of general applicability; and that it can, if necessary, seek appro- priate federal regulation.

For these reasons, the judgment of the Court of Appeals is affirmed.

CaSe QUeStIOnS

1. What is the effect of the Maine law, if allowed to stand, on interstate carriers?

2. If this law is constitutional, what would happen to interstate carriers and their activities within particular states?

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150 part 2 Business: Its Regulatory Environment

trucks as measured upon entering and leaving the states would be a burden- some tax.

Third, some connection—“a sufficient nexus”—between the state and the busi- ness being taxed must be established. The business must have some activity in the state, such as offices, sales representatives, catalog purchasers, or distribution systems.

Finally, the tax must be apportioned fairly. Apportionment prevents having businesses taxed in all 50 states for their property. Apportionment also avoids the unjust result of having businesses pay state income tax on all their income in all 50 states. Their income and property taxes must be apportioned according to the amount of business revenues in each state and the amount of property located in that state. General Motors does not pay an inventory tax to all 50 states on all of its inventory, but it does pay an inventory tax on the inventory it holds in each state. A significant decision on tax apportionment is New Mexico Taxation and Revenue Department v BarnesandNoble.com LLC (Case 5.3).

CASE 5.3 New Mexico Taxation and Revenue Department v. BarnesandNoble.com LLC, 283 P.3d 298 (N.M. App. 2012)

dot.com and brick and mortar combo retailers: taxing?

FaCtS

Barnesandnoble.com LLC (bn.com) is a Delaware cor- poration that sells books, movies, and other media over the Internet. In 2006, the New Mexico Taxation and Revenue Department (the Department) assessed gross receipts tax against bn.com on its sales to New Mexico residents during a period from January 1998 through July 2005. Bn.com protested the assessment, and a hearing officer granted summary judgment to bn.com, finding that it lacked a substantial nexus with the State of New Mexico, and therefore it could not constitutionally be required to pay the tax. The Depart- ment appealed, and the Court of Appeals held that bn.com had a substantial nexus with the state. Bn.com appealed.

JUdICIaL OpInIOn

CHÁVEZ, Justice This case presents the question of whether an out-of- state internet retailer (bn.com), which has no physical presence in New Mexico other than through stores owned by a sister corporation, Barnes & Noble Book- sellers, Inc. (Booksellers), is subject to New Mexico gross receipts tax on its sales to New Mexico residents without offending the federal Commerce Clause.

The Commerce Clause has been interpreted not only as an affirmative grant of power to Congress, but also as a limitation on state actions that interfere with interstate commerce. [Quill Corp. v N.D. ex rel. Heit- kamp, 504 U.S. 298 (1992)]

In the absence of specific federal authorization, the Commerce Clause allows a state to tax an actor in inter- state commerce “when the tax is applied to an activity with a substantial nexus with the taxing State, is fairly apportioned, does not discriminate against interstate commerce, and is fairly related to the services provided by the State.” Of these requirements, the only issue in this case is in the substantial nexus. If bn.com’s actual sales have a substantial nexus with New Mexico, New Mexico may constitutionally tax those sales.

A vendor that has a physical presence in the taxing state has a substantial nexus with the state. The key dis- tinction is “between mail-order sellers with [a physical presence in the taxing] State and those . . . who do no more than communicate with customers in the State by mail or common carrier as part of a general interstate business.” The facts in Quill Corp. concern a vendor that did not have a physical presence in the taxing state of North Dakota and Quill Corp. sold its products by mail; it had no offices, employees, or significant proper- ty in North Dakota. Therefore, the U.S. Supreme Court

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CASE 5.3 New Mexico Taxation and Revenue Department v. BarnesandNoble.com LLC, 283 P.3d 298 (N.M. App. 2012)

dot.com and brick and mortar combo retailers: taxing?

Case 5.3

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Chapter 5 Business and the Constitution 151

held that the company lacked a substantial nexus with North Dakota, and North Dakota could not require the company to pay a use tax to the state on its sales. The Court explained that there is a “safe harbor for vendors ‘whose only connection with customers in the [taxing] State is by common carrier or the United States mail.’ . . . In this case, the parties agree that bn.com itself has no employees or property in New Mexico, but that is not the end of our inquiry.

Although bn.com had no property in New Mexico, Booksellers performed activities in New Mexico for bn.com’s benefit. Booksellers operated three stores in New Mexico during the audit period. Bn.com and Booksellers are separate corporations, but they share a parent company, Barnes & Noble, Inc., which owned 100% of Booksellers and between 40% and 100% of bn.com throughout the audit period. During the audit period, Booksellers displayed bn.com’s web address on gift cards (usable at either Booksellers or bn.com) that they sold in stores during part of the audit period, providing bn.com with advertising. Booksellers sold memberships in a loyalty program that also gave customers a discount at bn.com, and Booksellers shared customers’ email addresses with bn.com.

In addition, bn.com and Booksellers both used Barnes & Noble trademarks. A reasonable inference is that consumers would likely have thought of the two corporations as one company. Because of customers’ association of Booksellers with bn.com, bn.com benefitted from brand loyalty established by local branches of Booksellers. Bn.com’s parent company recognized the benefits of such custom- er associations in a filing with the Securities and Exchange Commission during the audit period, in which it wrote that “the Barnes & Noble trade name . . . is a strong motivating factor in attracting customers, especially with regard to the post-early adopter market of consumers who have yet to make an online purchase.”

We therefore hold that Booksellers’ in-state activi- ties assisted bn.com’s efforts to establish and maintain a market in New Mexico.

Even though Booksellers accepted returns of purchases from bn.com on the same basis as returns from its competitors, bn.com advertised its return policy to customers as follows: “You can return your online purchases of most products to us for a full refund or to any Barnes & Noble Store for an in-store credit.” Near its “Easy Returns” link, bn.com also pro- vided a link to a Booksellers store locator. Customers visiting bn.com’s website would likely have seen the ability to return items to Booksellers’ stores as a

benefit of purchasing from bn.com. Nothing on the site suggests that customers could return purchases from Amazon.com or any other bn.com competitor on identical terms, even though that was apparently the case.

We recognize that courts in several states have reached a different conclusion, holding that the pres- ence of affiliated brick-and-mortar stores in a state does not create a nexus that would allow the state to tax catalogue or online sales.

We also recognize that one federal district court considered a case almost identical to this one and found no substantial nexus. [St. Tammany Parish Tax Collector v Barnesandnoble.com, 481 F. Supp. 2d 575, 582 (E.D.La. 2007)] That court seems to have imposed a standard higher than that required by [the U.S. Supreme Court]. The court does not require Booksellers to act as sales agents for bn.com; it requires only that activities performed on bn.com’s behalf be “significantly associated with [bn.com’s] ability to establish and maintain a market” in New Mexico. Booksellers and bn.com presented a single face to the public, so we may infer that Booksellers’ New Mexico locations developed name recognition and loyalty for bn.com. Booksellers sold gift cards that encouraged customers to shop at bn.com, and bn.com advertised its connections to Booksellers by offering a store locator and by promoting its return policy. Bn.com and Booksellers also shared customer data.

We conclude that Booksellers’ presence and activities in New Mexico gave bn.com an advantage over its competitors, which helped bn.com establish and maintain a market in this state. Because Book- sellers’ activities in New Mexico were significantly associated with bn.com’s ability to establish and maintain a market here, bn.com had a substantial nexus with the State of New Mexico. Therefore, New Mexico may collect gross receipts tax on bn.com’s sales in the state without offending the Commerce Clause of the United States Constitution. Affirmed and remanded.

CaSe QUeStIOnS

1. Explain why the Court feels this case is different from other cases in which online retailers have not been taxed.

2. What benefits does an online retailer gain from a physical presence in the state?

3. Were customers of Booksellers and bn.com allowed to interchange their business with the two retailers?

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152 part 2 Business: Its Regulatory Environment

5-4 State versus Federal Regulation of Business—Constitutional Conflicts: Preemption and the Supremacy Clause

Although the Constitution has sections that deal with the authority of the federal government and some that deal with state and local governments, some crossovers between state and federal laws still occur. For example, both state and federal governments regulate the sale of securities and both have laws on the sale of real property. Such crossovers create conflicts and a constitutional issue of who has the power to regulate. These conflicts between state and federal laws are governed by Article VI of the Constitution, sometimes called the Supremacy Clause, which provides, “This Constitution, and the Laws of the United States which shall be made in Pursuance thereof; and all Treaties made, or which shall be made, under the Authority of the United States, shall be the supreme Law of the Land. . . .”

The Supremacy Clause provides that when state and local laws conflict with federal statutes, regulations, executive orders, or treaties, the federal statute, reg- ulation, executive order, or treaty controls the state or local law. However, in a variety of cases, a state law does not directly conflict with the federal law. Some- times, the federal government just has extensive regulations in a particular area. In those areas of extensive federal regulation, the issue of which laws control can be resolved in Congress, which specifies its intent in an act. For example, Congress

Twenty-one states and eight cities have what is commonly called a “jock tax.” These are municipal taxes that were passed pri- marily to obtain revenue from athletes, coaches, trainers, and highly paid entertain- ers when they are present in the city for purposes of earning income. All profession- al sports events and concerts bring revenue from the players and artists in the form of state and municipal income taxes.

Indianapolis Colt player Jeff Saturday challenged the city of Cleveland’s collec- tion of municipal taxes from him. In 2008, the Colts paid Jeff Saturday $3,577,561.11 in compensation and attributed $178,878 (approximately 5% of Mr. Saturday’s total compensation) to a game the Colts played in Cleveland during 2008. The calculation employed the “games played” method of calculation. For example, if the team played 20 games, then 1/20 of the income, or 5%, is allocated to each of the cities involved as the required jock tax. The Colts with- held the allocated Cleveland tax, or $3,594.

However, Mr. Saturday did not travel to the Cleveland game because he stayed in In- dianapolis and participated in rehabilitation for a knee injury, as ordered by the team’s physician.

Mr. and Mrs. Saturday, who filed a joint tax return, applied for a refund from Cleveland. Cleveland refunded $322. The Saturdays appealed to the board of review, which upheld the amount of the payment and the refund. The Saturdays then ap- pealed the refund amount to the Board of Tax Appeals (BTA), and the BTA affirmed the decision of the review board. The Sat- urdays appealed that decision to the Ohio Supreme Court. The city of Cleveland ar- gued that even though Mr. Saturday was not present for the game, there was a part of his salary that was attributable to the playing of the game in Cleveland and was, therefore, taxable. What should the court decide and why? [Saturday v Cleve- land Board of Review, 33 N.E.2d 46 (Ohio 2015)]

Consider . . . 5.3

Know state taxation laws before you decide where to locate a plant, office, or warehouse. For example, Nevada does not have an inven- tory tax, so many man- ufacturers have large warehouse facilities there, including Spiegel and Levi Strauss. Other states have no sales tax but have high property tax rates. Still other states have high sales tax and low income tax rates. Structuring a nationwide business requires an understand- ing of intrastate as well as interstate taxes.

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Chapter 5 Business and the Constitution 153

amazon’s Internet Sales tax Strategy

Amazon.com has been very careful about state sales tax issues. The company has even controlled how often employees can travel to certain states so that it does not reach the level of a physical presence for purposes of being subject to sales tax in those states. However, Amazon, along with other Internet retailers, reached an agreement with the states for a type of uniform sales tax application that simplified what had become a complicated sales tax structure during the height of catalog sales. By 2013, Amazon was supporting feder- al legislation, known as the Marketplace Fairness Act, that would require all online retailers with over $1 million in annual revenue to pay state and local taxes on transactions completed on the Internet by any customers located within those taxing

jurisdictions. The costs of computing those taxes and handling audits by sales tax authorities would give Amazon less com- petition because smaller businesses could not maintain the staff or expertise to handle these complexities.

Amazon also established a division with- in its organization that would provide con- tract services to smaller businesses to help them in collecting their sales taxes on Inter- net sales. Amazon’s approach to the confus- ing constitutional standards was to solve the problem with its own legislative proposals and to find a business niche to operate in helping others to solve the problems of tax collection for Internet sales. Amazon worked strategically with government and empha- sized its business strengths to find a solu- tion to a complex and uncertain legal issue.

Business Strategy

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has provided that many federal workplace safety laws can be circumvented by state law as long as the state law provides as much employee protection as the federal laws. In other words, Congress allows the states to regulate the field in some instances and sets the standards for doing so. Most statutes, however, do not include the congressional intent on preemption. Whether a field has been preempted is a question of fact, of interpretation, and of legislative history. The question of preemption is determined on a case-by-case basis using the following questions:

1. What does the legislative history indicate? Some hearings offer clear state- ments of the effect and scope of a federal law.

2. How detailed is the federal regulation of the area? The more regulation there is, the more likely a court is to find preemption. Volume itself indicates con- gressional intent.

3. What benefits exist from having federal regulation of the area? Some matters are more easily regulated by one central government. Airlines fly across state lines, and if each state had different standards, there would be no guarantee of uniform standards. The regulation of aircraft and their routes is clearly better handled by the federal government.

4. How much does a state law conflict with federal law? Is there any way that the two laws can coexist?

Mutual Pharmaceutical Co., Inc. v Bartlett (Case 5.4) deals with a preemption issue.

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154 part 2 Business: Its Regulatory Environment

Mutual Pharmaceutical Co., Inc. v Bartlett 133 S.Ct. 2466 (2013)

An Anti-Inflammatory Drug and an Inflammatory Decision

Case 5.4

FaCtS

In 1978, the FDA approved an anti-inflammatory pain reliever called “sulindac” under the brand name of “Clinoril.” When the patent expired, the FDA approved several generic versions of sulindac for sale, including one developed by Mutual Pharmaceutical (Petitioner). The warnings for Clinoril included the possibility of developing toxic epidermal necrolysis. Karen Bartlett (respondent) took a generic form of sulindac in Decem- ber 2004 and developed an acute case of toxic epidermal necrolysis. Sixty to 65 percent of Ms. Bartlett’s body deteriorated, was burned off, or turned into an open wound. She spent months in a medically induced coma, underwent 12 eye surgeries, and was tube-fed for a year. She is now severely disfigured, has a number of physical disabilities, and is nearly blind.

At the time Ms. Bartlett got her sulindac prescrip- tion, the label did not refer to toxic epidermal necroly- sis but warned that the drug could cause “severe skin reactions” and “fatalities.” Toxic epidermal necroly- sis was listed as a side effect in the package insert. After Ms. Bartlett was suffering from toxic epidermal necrolysis, the FDA did a comprehensive study and recommended that the product label include more explicit warnings about toxic epidermal necrolysis.

Ms. Bartlett sued Mutual in New Hampshire state court, and Mutual removed the case to federal court. Ms. Bartlett initially asserted both failure-to-warn and design-defect claims, but the District Court dismissed her failure-to-warn claim based on her doctor’s “admi[s- sion] that he had not read the box label or insert.” After a two-week trial on a design-defect claim, a jury found Mutual liable and awarded Ms. Bartlett over $21 million in damages. The Court of Appeals affirmed, and Mutual appealed. The U.S. Supreme Court granted certiorari.

JUdICIaL OpInIOn

ALITO, Justice We must decide whether federal law pre-empts the New Hampshire design-defect claim.

The Supremacy Clause provides that the laws and treaties of the United States “shall be the supreme Law of the Land . . . any Thing in the Constitution or Laws of any State to the Contrary notwithstanding.” “[U]nder

the Supremacy Clause, from which our pre-emption doctrine is derived, any state law, however clearly within a State’s acknowledged power, which interferes with or is contrary to federal law, must yield.”

Federal law prevents generic drug manufacturers from changing their labels. When federal law forbids an action that state law requires, the state law is “without effect.” Because it is impossible for Mutual and other similarly situated manufacturers to comply with both state and federal law, New Hampshire’s warning-based design-defect cause of action is pre-empted with respect to FDA-approved drugs sold in interstate commerce.

The Court of Appeals reasoned that Mutual could escape the impossibility of complying with both its federal- and state-law duties by “choos[ing] not to make [sulindac] at all.” We reject this “stop-selling” rationale as incompatible with our pre-emption jurisprudence. Our pre-emption cases presume that an actor seeking to satisfy both his federal- and state-law obligations is not required to cease acting altogether in order to avoid liability. Indeed, if the option of ceasing to act defeated a claim of impossibility, impossibility pre-emption would be “all but meaningless.”

The dreadful injuries from which products liabil- ities cases arise often engender passionate responses. But sympathy for respondent does not relieve us of the responsibility of following the law.

The dissent accuses us of incorrectly assuming “that federal law gives pharmaceutical companies a right to sell a federally approved drug free from common-law liability.” But we make no such assumption. Rather, we hold that state-law design-defect claims like New Hamp- shire’s that place a duty on manufacturers to render a drug safer by either altering its composition or altering its labeling are in conflict with federal laws that prohibit manufacturers from unilaterally altering drug composi- tion or labeling. The dissent is quite correct that federal law establishes no safe-harbor for drug companies—but it does prevent them from taking certain remedial mea- sures. Where state law imposes a duty to take such reme- dial measures, it “actual[ly] conflict[s] with federal law” by making it “‘impossible for a private party to comply with both state and federal requirements.’“

Finally, the dissent laments that we have ignored “Congress’ explicit efforts to preserve state

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Chapter 5 Business and the Constitution 155

common-law liability.” We have not. Suffice to say, the Court would welcome Congress’ “explicit” resolution of the difficult pre-emption questions that arise in the prescription drug context. That issue has repeatedly vexed the Court—and produced widely divergent views—in recent years.

As the dissent concedes, however, the [federal law’s] treatment of prescription drugs includes nei- ther an express pre-emption clause nor an express non-pre-emption clause. In the absence of that sort of “explicit” expression of congressional intent, we are left to divine Congress’ will from the duties the statute imposes. That federal law forbids Mutual to take actions required of it by state tort law evinces an intent to pre-empt.

Congress [has made the] decision to regulate the manufacture and sale of generic drugs in a way

that reduces their cost to patients but leaves generic drug manufacturers incapable of modifying either the drugs’ compositions or their warnings. Respon- dent’s situation is tragic and evokes deep sympathy, but a straightforward application of pre-emption law requires that the judgment below be reversed.

CaSe QUeStIOnS

1. Explain why the extra labeling could not be placed on the generic version of the drug that Ms. Bartlett purchased.

2. Discuss the relationship between state product liability laws and the duty of manufacturers and federal regulation of generic labels.

3. How does the court address the issue of the tragedy of the case?

Samantha T. Reckis was seven years old in late 2003, when she developed toxic epider- mal necrolysis (TEN), a rare but life-threat- ening skin disorder, after receiving multiple doses of Children’s Motrin. Children’s Mo- trin is an over-the-counter (OTC) medication with ibuprofen as its active ingredient that is manufactured and sold by the McNeil–PPC, Inc., whose parent company is Johnson & Johnson.

Lisa and Richard Reckis, Samantha’s parents, claim that Samantha developed TEN as a result of being exposed to the ibuprofen in the Children’s Motrin. They brought suit alleging that the warning la- bel failed to warn consumers adequately

about the serious risk of developing TEN, a life-threatening disease. After a lengthy jury trial, the trial court found for the Reckis family and awarded $63 million in damages to them. Johnson & Johnson (McNeil) appealed on the grounds that the state suit was preempted because the FDA has exclusive authority over drug labels and the Motrin label complied with the FDA requirements. In fact, the FDA had prohibited McNeil from adding any discussion of possible risk of TEN because it was rare and would confuse consumers. What should the court do? [Reckis v Johnson & Johnson, 28 N.E.3d 445 (Mass. 2015)]

Consider . . . 5.4

Ethical Issues

Evaluate the ethics of a generic drug manufacturer using the same label instead of asking for updates when they are aware of risks and harms from usage of the drug.

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156 part 2 Business: Its Regulatory Environment

5-5 Application of the Bill of Rights to Business Certain of the amendments to the U.S. Constitution have particular significance for business, especially the First Amendment on freedom of speech and the Four- teenth Amendment for its issues of substantive and procedural due process and equal protection. The Fourth, Fifth, and Sixth Amendments on criminal procedures also have significance for business; those issues are covered in Chapter 8.

5-5a Commercial Speech and the First amendment

The area of First Amendment rights and freedom of speech is complicated and full of significant cases. The discussion here is limited to First Amendment rights as they apply to businesses. The speech of business is referred to as commercial speech, which is communication used to further the economic interests of the speaker. Advertising is clearly a form of commercial speech.

5-5b First amendment protection for advertising

Until the early 1970s, the U.S. Supreme Court held that commercial speech was different from the traditional speech afforded protection under the First Amend- ment. The result was that government regulation of commercial speech was virtu- ally unlimited. The Court’s position was refined in the 1970s, however, to a view that commercial speech was entitled to First Amendment protection but not on the same level as noncommercial speech. Commercial speech was not an absolute freedom; rather, the benefits of commercial speech were to be weighed against the benefits achieved by government regulation of that speech. Several factors are examined in performing this balancing test.

1. Is a substantial government interest furthered by restricting the commercial speech?

2. Does the restriction directly accomplish the government interest? 3. Is there any other way to accomplish the government interest? Can it be

accomplished without regulating commercial speech? Are the restrictions no more extensive than necessary to serve that interest?

These standards clearly provide authority for regulation of fraudulent adver- tising and advertising that violates the law. For example, if credit terms are adver- tised, Regulation Z requires full disclosure of all terms (see Chapter 11 for more details). This regulation is acceptable under the standards just listed. Further, restrictions on where and when advertisements are made are permissible. For example, cigarette ads are not permitted on television, and such a restriction is valid.

Exhibit 5.1 illustrates the degrees of protection afforded business speech. The overlapping area represents those cases in which the need to disseminate informa- tion conflicts with regulations on ad content or form.

The overlapping area of the diagram shows a shift during the 1970s when cases were introduced that reformed the commercial speech doctrine by limiting restric- tions on professional advertising. In Virginia State Board of Pharmacy v Virginia Cit- izens Consumer Council, Inc., 425 U.S. 748 (1976), the Supreme Court dealt with the issue of the validity of a Virginia statute that made it a matter of “unprofessional conduct” for a pharmacist to advertise the price or any discount of prescription drugs. In holding the statute unconstitutional, the Court emphasized the need for

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Chapter 5 Business and the Constitution 157

the dissemination of information to the public. In a subsequent case, the Court applied the same reasoning to advertising by lawyers. [Bates v State Bar of Arizona, 433 U.S. 350 (1977)]

An evolving area that is part of the overlapping portion of the two circles is that of corporate speech in defense of corporate decisions and policies—speech by corporations that is neither political speech nor advertising but rather explains and defends corporate policies such as animal testing, outsourcing production

Exhibit 5.1 Commercial Speech: First amendment protections and Restrictions

First Amendment

Full Protection of Commercial

Speech

Political Speech by

Business

Government Regulation of

Commercial Speech

Business Advertising

Speech on Social Issues and Business Operations:

Nike; Professions

The award-winning film Zero Dark Thirty came under federal investigation when then-acting director of the Central Intelli- gence Agency, Michael Morell, was asked by the Senate Intelligence Committee to provide the Committee with “all informa- tion and documents” that the agency had provided to filmmakers, as well as the re- cords that reflected meetings and discus- sions between employees of the agency and the filmmakers. The reason for the request was the Committee’s statement that it found the movie to be “grossly inac- curate.” The alleged inaccuracies centered on whether information obtained through torture (waterboarding) was key in the kill- ing of Osama bin Laden. The Senate Intel- ligence Committee maintains that “such information was not used in tracking down and killing bin Laden and believes that the film allows viewers to draw that conclusion from the way the story is presented.”

The film’s director, Kathryn Bigelow, told TV host Steven Colbert that she can- celed an appearance on his show because she was “spooked” by the investigation. Christopher Dodd, a former U.S. senator who is now the president of the Motion Pic- ture Association of America, has objected to the investigation, saying, “There could, in my view, be a chilling effect if, in the end of all this, you have a screenwriter or a director called before an investigating committee.”

What type of speech is a film? Is it pro- tected under the First Amendment? What could happen if the government were free to investigate those who express differing views and takes on issues, whether through statements or through art and films?

Sources: Alan Ziebel, “‘Zero Dark Thirty’ Writer Slams Probe,” Wall Street Journal, January 28, 2013, p. B4; Michael Cieply, “Hollywood Makes Case for ‘Zero Dark Thirty,’” New York Times, January 19, 2013.

Consider . . . 5.5

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158 part 2 Business: Its Regulatory Environment

to other countries, and environmental policies. The issues the companies are dis- cussing have social and political implications, but they relate directly to the cor- poration’s business and/or operations. Can the government regulate this form of speech? Nike, Inc. v Kasky, 539 U.S. 654 (2003), involved a situation in which Nike responded to charges of mistreating and underpaying workers at its foreign pro- duction facilities in numerous ways, such as by sending out press releases, writing letters to the editors of various newspapers around the country, and mailing letters to university presidents and athletic directors. For example, New York Times colum- nist Bob Herbert wrote two columns that were sharply critical of Nike’s conditions in plants throughout Asia. The columns compared then-CEO Philip Knight’s com- pensation with the $2.20 per day wages of Nike workers in Indonesia. After the columns appeared, CEO Knight wrote a letter to the editor in response to them. In that letter, he wrote, “Nike has paid, on average, double the minimum wage as defined in countries where its products are produced under contract. History shows that the best way out of poverty for such countries is through exports of light manufactured goods that provide the base for more skilled production.”

Marc Kasky sued Nike for unfair and deceptive practices under California’s Unfair Competition Law and False Advertising Law for alleged false statements in those materials and op-eds.

Nike contended that Mr. Kasky’s suit was absolutely barred by the First Amendment. The trial court dismissed the case. Mr. Kasky appealed, and the Cal- ifornia Court of Appeal affirmed, holding that Nike’s statements “form[ed] part of a public dialogue on a matter of public concern within the core area of expression protected by the First Amendment.”

On appeal, the California Supreme Court reversed and remanded for further proceedings. Nike appealed. The Supreme Court granted certiorari but later dis- missed the case with a per curiam opinion (an unsigned opinion that comes from the majority of the court) that indicated only that certiorari was granted improv- idently. The Court said it would need to have the California authorities issue a decision and penalties in the case before it could be heard. Nike settled the case, so there was never a definitive decision. However, it is likely that the Court would have classified Nike’s efforts as fitting into the territory between advertising and political speech, an area that would enjoy great First Amendment protection.

5-5c First amendment Rights and profits from Sensationalism In the past few years, a number of book publishers and movie producers have pur- sued criminal figures for the rights to tell the stories of their crimes in books, tele- vision programs, and movies. Many of the victims of the crimes and their families have opposed such moneymaking ventures as benefits that encourage the commis- sion of crimes. The state of New York, for example, passed a statute requiring that earnings from sales of such stories be used first to compensate victims of the crimes. Statutes such as the one in New York create dilemmas between First Amendment rights and public policy issues concerning criminal activities. In Simon & Schuster, Inc. v Members of the New York State Crime Victims Board, 502 U.S. 105 (1991), the U.S. Supreme Court addressed the constitutionality of New York’s statute. Simon & Schuster had entered into a contract in 1981 with organized crime figure Henry Hill (who was arrested in 1980) and author Nicholas Pileggi for a book about Mr. Hill’s life, Wiseguy, a book full of colorful details and the day-to-day workings of orga- nized crime, primarily in Mr. Hill’s first-person narrative. Throughout Wiseguy, Mr. Hill frankly admits to having participated in an astonishing variety of crimes.

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Chapter 5 Business and the Constitution 159

Ethical Issues

Orenthal James (O.J.) Simpson was charged with murder in June 1994 in the double homicide of his ex-wife, Nicole Brown Simpson, and her friend Ronald Goldman.

Because Mr. Simpson was charged with a capital crime, he was incarcerated upon being charged. California’s version of the Son of Sam law prevents profits from crimes only after there has been a conviction. Mr. Simpson authored a book, I Want to Tell You, while he was incarcerated and his nine-month trial in progress. Mr. Simpson also signed autographs and sports memorabilia and sold them from the Los Angeles County jail. Mr. Simpson’s cottage industry from jail netted him in excess of $3 million. Could a law that passes consti- tutional muster be implemented to prevent crime-related profits like those Mr. Simpson was able to obtain?

Mr. Simpson was acquitted of the mur- ders. Following his acquittal, prosecutors in the case, Christopher Darden, Marcia Clark, and Hank Goldberg, signed multi-mil- lion-dollar book contracts to write about their experiences during the trial. Alan Dershowitz, the late Johnnie Cochran, and Robert Shapiro, members of the Simpson

defense team, signed six-figure contracts to write books about the trial from the defense perspective. Daniel Petrocelli, the lawyer who represented the Goldmans in their civil suit against Mr. Simpson, also wrote a book, Triumph of Justice: The Final Judgment on the Simpson Saga.

In 2007, a book by Mr. Simpson, If I Did It, was released by the Goldman family. The Goldmans had acquired the rights to the Simpson book because of their $33 million judgment against Mr. Simpson fol- lowing the civil case for wrongful death. They were assigned the rights to the book’s royalties as a means of collecting the judgment. Upon its release, the book soared to number 1 on Amazon.com even as Mr. Simpson was arrested in Las Vegas for his alleged role in a robbery of sports paraphernalia.

Is it moral to profit from a crime and a trial? Are these book contracts a form of making money from the deaths of two people? Many publishers refused to pub- lish If I Did It, and networks refused to air interviews with Mr. Simpson about the book. Would you have declined the book for publication or to air an interview that would have brought in ad revenues?

The book was also a commercial success: within 19 months of its publication, more than 1 million copies were in print. A few years later, the book was converted into a film called Goodfellas, which won a host of awards as the best film of 1990.

When the Crime Victims Board requested that Simon & Schuster turn over all monies paid to Mr. Hill and that all future royalties be payable not to Mr. Hill but to the statutorily prescribed escrow account, Simon & Schuster brought suit main- taining that the so-called Son of Sam law violated the First Amendment. The U.S. Supreme Court agreed and held that the statute was overly broad, would have a chilling effect on authors and publications, and required a redrafting of the statute to tailor its scope more narrowly so it could still accomplish the public purpose.

5-5d First amendment Rights and Corporate political Speech

Not all commercial speech is advertising. Some businesses engage in corporate political speech. Corporate political speech generally takes three forms:

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160 part 2 Business: Its Regulatory Environment

1. Through financial support, such as from employee and political action com- mittee (PAC) donations to political candidates

2. Through financial support, such as party donations 3. Through direct communications and ads about issues, ballot propositions,

and funding proposals (such as bond elections)

For more than a century, both legislators and courts have grappled with the balancing of First Amendment rights and the influence of money in election campaigns. “More than a century ago the ‘sober-minded Elihu Root’ advocated legislation that would prohibit political contributions by corporations in order to prevent ‘the great aggregations of wealth from using their corporate funds, directly or indirectly,’ to elect legislators who would ‘vote for their protection and the advancement of their interests as against those of the public.’” [United States v Automobile Workers, 352 U.S. 567, 571 (1957)] (Elihu root was Secretary of War and Secretary of State 1901–1909.)

As a result, Congress, state legislatures, and the U.S. Supreme Court have all addressed corporate speech in all three of these categories. The first legisla- tive prohibition came in 1907 when the Tillman Act completely banned corpo- rate contributions of “money . . . in connection with” any federal election. Since that time corporations have been banned from making direct political donations to political candidates. In 1925, Congress extended the prohibition of contribu- tions “to include ‘anything of value,’ and made acceptance of a corporate con- tribution as well as the giving of such a contribution a crime” (Federal Corrupt Practices Act, 1925, §§ 301, 313, 43 Stat. 1070, 1074). With corporate donations in tow, Congress realized through several election cycles that union contributions were equally plentiful and as powerful as corporate ones. Congress first restricted union contributions in 1940 with the passage of the Hatch Act. Congress later pro- hibited “union contributions in connection with federal elections . . . altogether” (18 U.S.C. § 610). During the passage of these limitations, PACs began. PACs are independent of corporations and labor unions, although they may be formed by those affiliated with both. For example, Coors Brewing has its corporate PAC, known as the Six Pac. Employees of companies and members of labor unions make donations to their PACs. Other PACs include trade association PACs (such as the American Medical Association and the American Association of Trial Law- yers), cooperative PACs, and PACs formed along ideological lines, such as the Right-to-Life PAC or Emily’s List (Early Money Is Like Yeast, a PAC that supports pro-choice candidates beginning in the early primary stages of an election cycle).

As the Supreme Court has noted in its opinions on the topic of donations, “Money is like water and it always finds an outlet,” and the donations and PAC activity became a concern. As a result, in 1972 and 1974, Congress passed and amended the Federal Election Campaign Act (FECA), which limited individual donations, required reporting and public disclosure of contributions and expen- ditures exceeding certain limits, and established the Federal Election Commission (FEC) to administer and enforce the legislation (2 U.S.C. § 431(8)(A)(i)).

The limitations in FECA were challenged and the U.S. Supreme Court ruled on their constitutionality in Buckley v Valeo, 424 U.S. 1 (1976). The Court struck down the expenditure limitations of the federal law but upheld the $1,000 individual dona- tion limitation (now $2,700 per election cycle) as being sufficiently narrowly tailored to address the corruption concerns without infringing on the speech elements of donation. Individuals remained free to spend as much as they wanted on their own campaigns for federal office. FECA does not apply to state and local elections.

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Chapter 5 Business and the Constitution 161

Where the Money Flows

A look at the following list of top corporate and trade PACs (hard dollars, not including soft dollars) indicates that those businesses whose markets or prices are controlled by

the government are the most active political voices. Why do you think these particular PACs are so active?

Business Strategy

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Top 20 PAC Contributors to Candidates, 2013–2014

paC naMe tOtaL aMOUnt deMOCRatIC

peRCent RepUBLICan-

peRCent National Association of Realtors

$3,822,955 40 52

National Beer Wholesalers Association

$3,213,000 44 56

Honeywell International $3,002,603 44 56

National Auto Dealers Association

$2,805,350 29 71

Lockheed Martin $2,629,750 42 58

American Bankers Association $2,537,375 23 76

AT&T Inc. $2,507,250 40 60

Operating Engineers Union $2,488,462 80 20

Credit Union National Association

$2,470,650 49 51

International Brotherhood of Electrical Workers

$2,440,214 97 3

Blue Cross/Blue Shield $2,363,050 39 61

Northrup Grumman $2,350,750 43 57

National Association of Insurance & Financial Advisors

$2,326,750,000 38 62

American Association for Justice

$2,214,450 96 4

Boeing $2,190,000 42 58

National Rural Electric Cooperative

$2,160,522 28 72

Laborers Union $2,146,749 85 15

Comcast Corporation $2,135,750 48 52

Plumbers/Pipefitters Union $2,124,000 93 7

American Crystal Sugar $2,096,499 56 44

Source: FEC, www.fec.gov.

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162 part 2 Business: Its Regulatory Environment

In First National Bank of Boston v Bellotti, 435 U.S. 765 (1978), the U.S. Supreme Court developed what has become known as the Bellotti doctrine, which gives cor- porations the same degree of First Amendment protection for their political speech that individuals enjoy in their political speech. Although commercial speech can be regulated, political speech enjoys full First Amendment rights. That is, when a corporation takes a position on a proposed ballot initiative, its right to participate in public discussion of that issue cannot be restricted.

Under FECA, contributions made with funds that are subject to the act’s dis- closure requirements and source and amount limitations are thus known as “fed- eral dollars” or “hard dollars.” Corporations and unions, as well as individuals who had already made the maximum permissible contributions to federal candi- dates, could still contribute “nonfederal money”—also known as “soft money”— to political parties for activities intended to influence state or local elections. The FEC ruled that political parties could fund mixed-purpose activities—including get-out-the-vote drives and generic party advertising—in part with soft money. In 1995, the FEC concluded that the parties could also use soft money to defray the costs of “legislative advocacy media advertisements,” even if the ads mentioned the name of a federal candidate, as long as they did not expressly advocate the candidate’s election or defeat.

The so-called soft money donations became extensive. As a result, Congress passed the Bipartisan Campaign Reform Act of 2002 (BCRA, 2 U.S.C.A. § 431 et seq.). Often referred to as the McCain–Feingold law, Title I of the BCRA regulates the use of soft money by political parties, officeholders, and candidates. The BCRA was immediately challenged by 11 different parties in different federal courts, and the cases were consolidated and eventually heard by the U.S. Supreme Court in McConnell v Federal Election Comm’n, 540 U.S. 93 (2003). The Supreme Court, in a 175 page opinion (including the dissents), upheld most of the then-new law, but the Court was forced to revisit the constitutionality in Citizens United v FEC (Case 5.5), the decision that the president urged Congress to reverse (see p. 142).

Citizens United v Federal Election Commission 558 U.S. 310 (2010)

Hillary: It’s a Movie! It’s a Campaign! It’s Free Speech!

Case 5.5

FaCtS

Citizens United is a nonprofit corporation with an annual budget of about $12 million, most of which comes from donations by individuals.

In January 2008, Citizens United released a film entitled Hillary: The Movie. It is a 90-minute documen- tary about then-Senator Hillary Clinton, who was a candidate in the Democratic Party’s 2008 presidential primary elections. Hillary mentions Senator Clinton by name and depicts interviews with political com- mentators and other persons, most of them quite

critical of Senator Clinton. Hillary was released in theaters and on DVD, but Citizens United wanted to increase distribution by making it available through video-on-demand.

In December 2007, a cable company offered, for a payment of $1.2 million, to make Hillary available on a video-on-demand channel called “Elections ‘08.” Citizens United was prepared to pay for the video- on-demand, and to promote the film, it produced two ten-second ads and one 30-second ad for Hillary. Each ad includes a short (and, in our view, pejorative) state- ment about Senator Clinton, followed by the name of

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Chapter 5 Business and the Constitution 163

the movie and the movie’s website address. Citizens United desired to promote the video-on-demand offer- ing by running advertisements on broadcast and cable television.

BCRA § 203(§441) prohibits any “electioneering communication.” An electioneering communication is defined as “any broadcast, cable, or satellite com- munication” that “refers to a clearly identified candi- date for Federal office” and is made within 30 days of a primary or 60 days of a general election. The Federal Election Commission’s (FEC’s) regulations further define an electioneering communication as a communication that is “publicly distributed.” “In the case of a candidate for nomination for President . . . pub- licly distributed means” that the communication “[c] an be received by 50,000 or more persons in a State where a primary election . . . is being held within 30 days.” Corporations and unions are barred from using their general treasury funds for express advocacy or electioneering communications. They may establish, however, a “separate segregated fund” (known as a political action committee, or PAC) for these purposes. The moneys received by the segregated fund are lim- ited to donations from stockholders and employees of the corporation or, in the case of unions, members of the union.

Citizens United wanted to make Hillary available through video-on-demand within 30 days of the 2008 primary elections. It feared, however, that both the film and the ads would be covered by § 441b’s ban on corporate-funded independent expenditures, thus sub- jecting the corporation to civil and criminal penalties. In December 2007, Citizens United sought declaratory and injunctive relief against the FEC. It argued that (1) § 441b is unconstitutional as applied to Hillary and that (2) BCRA’s disclaimer and disclosure requirements are unconstitutional as applied to Hillary and to the three ads for the movie.

The District Court denied Citizens United’s motion for a preliminary injunction (per curiam) and then granted the FEC’s motion for summary judgment. The court held that § 441b was facially constitutional and that § 441b was constitutional as applied to Hillary because it was “susceptible of no other interpretation than to inform the electorate that Senator Clinton is unfit for office, that the United States would be a dan- gerous place in a President Hillary Clinton world, and that viewers should vote against her.” The court also rejected Citizens United’s challenge to BCRA’s dis- claimer and disclosure requirements. It noted that “the Supreme Court has written approvingly of disclosure provisions triggered by political speech even though the speech itself was constitutionally protected under the First Amendment.” Citizens United appealed to

the U.S. Supreme Court, where the case was argued twice, once before the retirement of Justice David Souter and again following the addition of Justice Sotomayor.

JUdICIaL OpInIOn

KENNEDY, Justice The narrative [of Hillary] may contain more sugges- tions and arguments than facts, but there is little doubt that the thesis of the film is that she is unfit for the Presidency.

Citizens United argues that Hillary is just “a docu- mentary film that examines certain historical events.” We disagree. The movie’s consistent emphasis is on the relevance of these events to Senator Clinton’s candida- cy for President. The narrator begins by asking “could [Senator Clinton] become the first female President in the history of the United States?” And the narrator reit- erates the movie’s message in his closing line: “Finally, before America decides on our next president, voters should need no reminders of . . . what’s at stake—the well-being and prosperity of our nation.”

Courts, too, are bound by the First Amendment. We must decline to draw, and then redraw, consti- tutional lines based on the particular media or tech- nology used to disseminate political speech from a particular speaker.

The law before us is an outright ban, backed by criminal sanctions. Section 441b makes it a felony for all corporations—including nonprofit advocacy corporations—either to expressly advocate the election or defeat of candidates or to broadcast electioneering communications within 30 days of a primary election and 60 days of a general election. Thus, the following acts would all be felonies under § 441b: The Sierra Club runs an ad, within the crucial phase of 60 days before the general election, that exhorts the public to disapprove of a Congressman who favors logging in national forests; the National Rifle Association pub- lishes a book urging the public to vote for the chal- lenger because the incumbent U.S. Senator supports a handgun ban; and the American Civil Liberties Union creates a Web site telling the public to vote for a Pres- idential candidate in light of that candidate’s defense of free speech. These prohibitions are classic examples of censorship.

Section 441b’s prohibition on corporate indepen- dent expenditures is thus a ban on speech. Were the Court to uphold these restrictions, the Government could repress speech by silencing certain voices at any of the various points in the speech process. If § 441b applied to individuals, no one would believe that it is merely a time, place, or manner restriction on speech.

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164 part 2 Business: Its Regulatory Environment

Its purpose and effect are to silence entities whose voic- es the Government deems to be suspect.

Speech is an essential mechanism of democracy, for it is the means to hold officials accountable to the people.

The First Amendment protects speech and speak- er, and the ideas that flow from each. The Court has recognized that First Amendment protection extends to corporations. This protection has been extended by explicit holdings to the context of political speech. Under the rationale of these precedents, political speech does not lose First Amendment protection “simply because its source is a corporation. . . .” Government lacks the power to ban corporations from speaking.

It is irrelevant for purposes of the First Amendment that corporate funds may “have little or no correlation to the public’s support for the corporation’s political ideas.” All speakers, including individuals and the media, use money amassed from the economic mar- ketplace to fund their speech. The First Amendment protects the resulting speech, even if it was enabled by economic transactions with persons or entities who disagree with the speaker’s ideas.

There is simply no support for the view that the First Amendment, as originally understood, would permit the suppression of political speech by media corporations. The Framers may not have anticipated modern business and media corporations. Yet televi- sion networks and major newspapers owned by media corporations have become the most important means of mass communication in modern times. The First Amendment was certainly not understood to condone the suppression of political speech in society’s most salient media. It was understood as a response to the repression of speech and the press that had existed in England and the heavy taxes on the press that were imposed in the colonies. The great debates between the Federalists and the Anti-Federalists over our founding document were published and expressed in the most important means of mass communication of that era— newspapers owned by individuals.

When Government seeks to use its full power, including the criminal law, to command where a per- son may get his or her information or what distrusted source he or she may not hear, it uses censorship to control thought. This is unlawful. The First Amend- ment confirms the freedom to think for ourselves.

When word concerning the plot of the movie Mr. Smith Goes to Washington reached the circles of Government, some officials sought, by persuasion, to discourage its distribution. [I]t, like Hillary, was speech funded by a corporation that was critical of Members of Congress. Mr. Smith Goes to Washington may be fic- tion and caricature; but fiction and caricature can be a powerful force.

Modern day movies, television comedies, or skits on Youtube.com might portray public officials or public policies in unflattering ways. Yet if a covered transmission during the blackout period creates the background for candidate endorsement or opposi- tion, a felony occurs solely because a corporation, other than an exempt media corporation, has made the “purchase, payment, distribution, loan, advance, deposit, or gift of money or anything of value” in order to engage in political speech. Speech would be suppressed in the realm where its necessity is most evident: in the public dialogue preceding a real elec- tion. Governments are often hostile to speech, but under our law and our tradition it seems stranger than fiction for our Government to make this polit- ical speech a crime. Yet this is the statute’s purpose and design.

“The First Amendment underwrites the freedom to experiment and to create in the realm of thought and speech. Citizens must be free to use new forms, and new forums, for the expression of ideas. The civic dis course belongs to the people, and the Government may not prescribe the means used to conduct it.”

The judgment of the District Court is reversed with respect to the constitutionality of § 441b’s restrictions on corporate independent expenditures.

CaSe QUeStIOnS

1. Why does the Court say it cannot be involved in ongoing monitoring of political ads, documenta- ries, and other forms of communication?

2. Why are independent expenditures by corpo- rations different from corporate donations and funding of candidates?

3. Are time restrictions and unflattering portraits grounds for regulating political speech? Why or why not?

5-5e eminent domain: the takings Clause

The right of a governmental body to take title to property for a public use is called eminent domain. This right is established in the Fifth Amendment to the Constitu- tion and may also be established in various state constitutions. Private individuals cannot require property owners to sell their property, but governmental entities

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Chapter 5 Business and the Constitution 165

can require property owners to transfer title for public projects for the public good. The Fifth Amendment provides that “property shall not be taken for a public use without just compensation.” For a governmental entity to exercise properly the right of eminent domain, three factors must be present: public purpose, taking (as opposed to regulating), and just compensation.

public purpose To exercise eminent domain, the governmental authority must establish that the taking is necessary for the accomplishment of a government or public purpose. When eminent domain is mentioned, we think of the use of property for highways and schools. However, the right of the government to eminent domain extends much further. For example, the following uses have been held to constitute pub- lic purposes: the condemnation of slum housing (for purposes of improving city areas), the limitation of mining and excavation within city limits, the declaration of property as a historic landmark, and the taking of property to provide a firm that is a town’s economic base with a large enough tract for expansion. According to the U.S. Supreme Court, the public purpose requirement for eminent domain is to be interpreted broadly, and “the role of the judiciary in determining whether that power is being exercised for a public purpose is an extremely narrow one.” [United States ex rel. TVA v Welch, 327 U.S. 546 (1946)] The Kelo v City of New London case (Case 5.6) was the U.S. Supreme Court decision that changed the eminent domain landscape, as it were.

Kelo v City of New London 545 U.S. 469 (2005)

Yes, Actually, They Can Take That Away From You

Case 5.6

FaCtS

In 1978, the city of New London, Connecticut, undertook a redevelopment plan for purposes of creating a redeveloped area in and around the existing park at Fort Trumbull. The plan sought to develop the related ambience a state park should have, including the absence of pink cottages and other architecturally eclectic homes. Part of the redevelopment plan was the city’s deal with Pfizer Corporation for the location of its research facility in the area. The preface to the city’s development plan included the following statement of goals and purpose:

To create a development that would complement the facility that Pfizer was planning to build, create jobs, increase tax and other revenues, encourage public access to and use of the city’s waterfront, and eventu- ally “build momentum” for the revitalization of the rest of the city, including its downtown area.

The affected property owners, including Susette Kelo, live in homes and cottages (15 total) located in and around other existing structures that would be permitted to stay in the area designated for the proposed new structures (under the city’s economic development plan) that would be placed there primar- ily by private land developers and corporations. The city was assisted by a private, nonprofit corporation, the New London Development Corporation (NLDC), in the development of the economic plan and pilot- ing it through the various governmental processes, including that of city council approval. The central focus of the plan was getting Pfizer to the Fort Trum- bull area (where the homeowners and their properties were located) with the hope of a resulting economic boost that such a major corporate employer can bring to an area.

Kelo and the other landowners whose homes would be razed to make room for Pfizer and the

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166 part 2 Business: Its Regulatory Environment

accompanying and resulting economic development plan filed suit challenging New London’s legal author- ity to take their homes. The trial court issued an injunc- tion preventing New London from taking certain of the properties but allowing others to be taken. The appel- late court found for New London on all the claims, and the landowners (petitioners) appealed.

JUdICIaL OpInIOn

STEVENS, Justice Two polar propositions are perfectly clear. On the one hand, it has long been accepted that the sovereign may not take the property of A for the sole purpose of trans- ferring it to another private party B, even though A is paid just compensation. On the other hand, it is equally clear that a State may transfer property from one pri- vate party to another if future “use by the public” is the purpose of the taking; the condemnation of land for a railroad with common-carrier duties is a famil- iar example. Neither of these propositions, however, determines the disposition of this case.

The disposition of this case therefore turns on the question whether the City’s development plan serves a “public purpose.” Without exception, our cases have defined that concept broadly, reflecting our long-standing policy of deference to legislative judgments in this field.

In Berman v Parker, 348 U.S. 26, 75 S.Ct. 98, 99 L.Ed. 27 (1954), this Court upheld a redevelopment plan targeting a blighted area of Washington, D.C., in which most of the housing for the area’s 5,000 inhabitants was beyond repair. Under the plan, the area would be con- demned and part of it utilized for the construction of streets, schools, and other public facilities. The remain- der of the land would be leased or sold to private par- ties for the purpose of redevelopment, including the construction of low-cost housing.

The owner of a department store located in the area challenged the condemnation, pointing out that his store was not itself blighted and arguing that the cre- ation of a “better balanced, more attractive communi- ty” was not a valid public use. Writing for a unanimous Court, Justice Douglas refused to evaluate this claim in isolation, deferring instead to the legislative and agency judgment that the area “must be planned as a whole” for the plan to be successful. The Court explained that “community redevelopment programs need not, by force of the Constitution, be on a piecemeal basis—lot by lot, building by building.” “We do not sit to deter- mine whether a particular housing project is or is not desirable. The concept of the public welfare is broad and inclusive. . . . The values it represents are spiritual as well as physical, aesthetic as well as monetary. It is within the power of the legislature to determine that

the community should be beautiful as well as healthy, spacious as well as clean, well-balanced as well as care- fully patrolled. In the present case, the Congress and its authorized agencies have made determinations that take into account a wide variety of values. It is not for us to reappraise them. If those who govern the District of Columbia decide that the Nation’s Capital should be beautiful as well as sanitary, there is nothing in the Fifth Amendment that stands in the way.”

In Hawaii Housing Authority v Midkiff, 467 U.S. 229, 104 S. Ct. 2321, 81 L.Ed.2d 186 (1984), the Court considered a Hawaii statute whereby fee title was taken from lessors and transferred to lessees (for just compensation) in order to reduce the concentration of land ownership. We unanimously upheld the statute and rejected the Ninth Circuit’s view that it was “a naked attempt on the part of the state of Hawaii to take the property of A and transfer it to B solely for B’s private use and benefit.” Reaffirming Berman’s defer- ential approach to legislative judgments in this field, we concluded that the State’s purpose of eliminating the “social and economic evils of a land oligopoly” qualified as a valid public use.

Those who govern the City were not confronted with the need to remove blight in the Fort Trumbull area, but their determination that the area was suf- ficiently distressed to justify a program of economic rejuvenation is entitled to our deference. The City has carefully formulated an economic development plan that it believes will provide appreciable benefits to the community, including—but by no means limited to—new jobs and increased tax revenue. To effectuate this plan, the City has invoked a state statute that specifically authorizes the use of eminent domain to promote economic development. Given the compre- hensive character of the plan, the thorough delibera- tion that preceded its adoption, and the limited scope of our review, it is appropriate for us, as it was in Ber- man, to resolve the challenges of the individual owners, not on a piecemeal basis, but rather in light of the entire plan. Because that plan unquestionably serves a public purpose, the takings challenged here satisfy the public use requirement of the Fifth Amendment.

Petitioners contend that using eminent domain for economic development impermissibly blurs the boundary between public and private takings. Again, our cases foreclose this objection. We cannot say that public ownership is the sole method of promoting the public purposes of community redevelopment projects. It is further argued that without a bright-line rule nothing would stop a city from transferring cit- izen A’s property to citizen B for the sole reason that citizen B will put the property to a more productive

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Chapter 5 Business and the Constitution 167

eminent domain in the post-Kelo World The impact of the Kelo case has been substantial. The decision resulted in back- lash from landowners and paved the way for legislative reforms that restrict eminent domain powers at the state and local levels. Following the Kelo decision and because 80% of the public disapproved of the court’s decision, 45 states have passed some form of limitation on the exercise of eminent domain for economic development either through ballot propositions, constitutional amendments, or legislation.

However, many of those states still allow eminent domain proceedings to eliminate “blight,” with blight carrying a broad definition. Still, Arizona and Florida have placed substantial curbs on the exercise of eminent domain for eco- nomic development purposes. In November 2005, the U.S. House of Represen- tatives passed the Private Property Rights Protection Act of 2005 (also known as House Resolution 4128) by a vote of 376 to 38. The bill died in the Senate. In 2006,

use and thus pay more taxes. Such a one-to-one trans- fer of property, executed outside the confines of an integrated development plan, is not presented in this case. While such an unusual exercise of government power would certainly raise a suspicion that a private purpose was afoot, the hypothetical cases posited by petitioners can be confronted if and when they arise. They do not warrant the crafting of an artificial restric- tion on the concept of public use.

Just as we decline to second-guess the City’s con- sidered judgments about the efficacy of its develop- ment plan, we also decline to second-guess the City’s determinations as to what lands it needs to acquire in order to effectuate the project. “It is not for the courts to over-see the choice of the boundary line nor to sit in review on the size of a particular project area. Once the question of the public purpose has been decided, the amount and character of land to be taken for the proj- ect and the need for a particular tract to complete the integrated plan rests in the discretion of the legislative branch.”

The judgment of the Supreme Court of Connecticut is affirmed.

dISSentInG OpInIOn

O’CONNOR, Justice, joined by Justices SCALIA, THOMAS, and REHNQUIST Under the banner of economic development, all private property is now vulnerable to being taken and trans- ferred to another private owner, so long as it might be upgraded—i.e., given to an owner who will use it in a way that the legislature deems more beneficial to the public—in the process. To reason, as the Court does, that the incidental public benefits resulting from the subsequent ordinary use of private property render economic development takings “for public use” is to

wash out any distinction between private and public use of property—and thereby effectively to delete the words “for public use” from the Takings Clause of the Fifth Amendment. Accordingly I respectfully dissent.

Where is the line between “public” and “private” property use? We give considerable deference to leg- islatures’ determinations about what governmental activities will advantage the public. But were the political branches the sole arbiters of the public-private distinction, the Public Use Clause would amount to little more than hortatory fluff. An external, judicial check on how the public use requirement is interpret- ed, however limited, is necessary if this constraint on government power is to retain any meaning.

Even if there were a practical way to isolate the motives behind a given taking, the gesture toward a purpose test is theoretically flawed. If it is true that incidental public benefits from new private use are enough to ensure the “public purpose” in a taking, why should it matter, as far as the Fifth Amendment is concerned, what inspired the taking in the first place? And whatever the reason for a given condem- nation, the effect is the same from the constitutional perspective— private property is forcibly relinquished to new private ownership.

CaSe QUeStIOnS

1. What is different between this case and a case in which property is taken for constructing a freeway?

2. What is the concern of the dissent about the decision?

3. Why does the majority state that the courts should be reluctant to get involved in local government eminent domain activities?

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168 part 2 Business: Its Regulatory Environment

President George W. Bush signed Executive Order 13406, called “Protecting Prop- erty Rights of the American People,” which prohibited the taking of private prop- erty for purposes of giving economic benefit to another private party.

Ms. Kelo’s home and 15 others were razed. Pfizer merged with Wyeth in 2009 and closed all company operations in New London. The Fort Trumball area has no houses, no research park, and no businesses. However, after Hurricane Irene, in 2010, officials from New London announced that residents could use the Fort Trumball area for dumping their branches and fallen trees. The location that once had Ms. Kelo’s and others’ homes became a landfill and home for feral cats.

In 2015, the mayor of New London announced that the former site of the Kelo home would be turned into a park to “serve as a memorial to all those adversely affected by the city’s use of eminent domain.”2 Justice Richard Palmer of the Con- necticut Supreme Court, who was the swing vote in the Kelo decision, met with Ms. Kelo and explained to her that if he had known then what he knows now, he would have voted differently.

taking or Regulating For a governmental entity to be required to pay a landowner compensation under the doctrine of eminent domain, there must be a taking of the property. Mere reg- ulation of the property does not constitute a taking, as determined by Village of Euclid, Ohio v Ambler Realty Co., 272 U.S. 365 (1926). Rather, a taking must go so far as to deprive the landowner of any use of the property. In the landmark case of Pennsylvania Coal v Mahon, 260 U.S. 393 (1922), the Supreme Court established standards for determining a taking as opposed to mere regulation. At that time Pennsylvania had a statute that prohibited the mining of coal under any land sur- face where the result would be the subsidence of any structure used as a human habitation. The owners of the rights to mine subsurface coal brought suit challeng- ing the regulation as a taking, and the Supreme Court ruled in their favor, holding that the statute was more than regulation and, in fact, was an actual taking of the subsurface property rights.

Because of the vast amount of technology that has developed since that case was decided, many new and subtly different issues affect what constitutes a tak- ing. For example, in some areas, the regulation of cable television companies is an infringement on air rights. Such specialized areas of real estate rights are particu- larly difficult to resolve. In Loretto v Teleprompter Manhattan CATV Corp., 458 U.S. 100 (1982), the U.S. Supreme Court held that the small invasion of property by the placement of cable boxes and wires did constitute a taking, albeit very small, and required compensation of the property owners for this small but permanent occu- pation of their land.

The issue of taking has arisen because of local zoning restrictions on develop- ment. These restrictions focus on beaches, wetlands, and other natural habitats. For example, in Nollan v California Coastal Commission, 483 U.S. 825 (1987), the Nollans sought permission from the California Coastal Commission to construct a home on their coastal lot, where they currently had only a small bungalow. The com- mission refused to grant permission to the Nollans for construction of their home unless they agreed to give a public easement across their lot for beach access. The Supreme Court held that the demand by the commission for an easement was a taking without compensation and, in effect, prevented the Nollans from using their property until they surrendered their exclusive use.3

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Chapter 5 Business and the Constitution 169

Yet another issue that arises in taking occurs when regulations take effect after owners have acquired land but before it is developed. In Lucas v South Carolina Coastal Council, 505 U.S. 1003 (1992), the U.S. Supreme Court declared that ex post facto legislation that prevents development of previously purchased land is a taking. In Lucas, David Lucas purchased for $975,000 two residential lots on the Isle of Palms in Charleston County, South Carolina. In 1988, the South Carolina legislature enacted the Beachfront Management Act, which barred any permanent habitable structures on coastal properties. The Supreme Court held South Carolina was required to compensate Mr. Lucas because his land was ren- dered useless.

Just Compensation The final requirement for the proper exercise by a governmental entity of the right of eminent domain is that the party from whom the property is being taken be given just compensation. The issue of just compensation is difficult to determine and is always a question of fact. Basic to this determination is that the owner is to be compensated for loss and that the compensation is not measured by the gov- ernmental entity’s gain. In United States v Miller, 317 U.S. 369 (1943), the Supreme Court held that in cases where it can be determined, fair market value is the mea- sure of compensation, and in United States ex rel. TVA v Powelson, 319 U.S. 266 (1943), the Supreme Court defined fair market value to be “what a willing buyer would pay in cash to a willing seller.”

Possible problems in applying these relatively simple standards include pecu- liar value to the owner, consequential damages, and greater value of the land because of the proposed governmental project. Basically, the issue of just compen- sation becomes an issue of appraisal, which is affected by all the various factors involved. In determining just compensation, the courts must consider such factors as surrounding property values and the owner’s proposed use.

5-5f procedural due process

Both the Fifth and the Fourteenth Amendments require state and federal govern- ments to provide citizens (businesses included) due process under the law. Proce- dural due process is a right that requires notice and the opportunity to be heard before rights or properties are taken away from an individual or business. Most people are familiar with due process as it exists in the criminal justice system: the right to a lawyer, a trial, and so on (discussed in Chapter 8). However, procedural due process is also an important part of civil law. Before an agency—whether state or federal—can take away a business license, suspend a license, or impose a fine for a violation, it must ensure due process.

Businesses encounter the constitutional protections of due process in their rela- tionships with customers. For example, the eviction of a nonpaying tenant cannot be done unilaterally. The tenant has the right to be heard in the setting of a hearing. The landlord must file an action against the tenant, and the tenant will have the opportunity to present defenses for nonpayment of rent. The Due Process Clause of the U.S. Constitution provides protection for individuals before their property is taken. Property includes land (as in the case of eminent domain, discussed pre- viously), rights of possession (tenants and leases), and even intangible property rights. For example, students cannot be expelled from schools, colleges, or univer- sities without the right to be heard. Students must have some hearing before their property rights with respect to education are taken away.

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In Horne v U.S. Department of Agriculture, 132 S.Ct. 2566 (2015), raisin farmers challenged the taking of their raisin crops by the Department of Agriculture in its efforts to stabilize the raisin market. The farmers’ challenge was based on their lack of a hearing for the taking as well as compensation for the loss of their raisin crops and the imposition of penalties if they sell the raisins prohibited by the Depart- ment of Agriculture. The court held that the Fifth Amendment requires that the government pay just compensation when it takes personal property, just as when it takes real property. The government cannot make raisin growers relinquish their raisins without just compensation.

All proceedings designed to satisfy due process requirements must provide notice and the right to be heard and present evidence (see Chapter 6 for more details). If these rights are not afforded, the constitutional right of due process has been denied, and the action taken is rescinded until due process requirements are met. Suppose that OSHA charges a company with safety violations in its plants. Before a fine or order can be imposed, procedural due process requires that the company have the right to be heard and to present evidence on the violations. In court cases, a matter reduced to a judgment entitles the victorious side to collect on that judgment. However, under due process, even the proceedings for collection allow the losing party or debtor to be notified of the proceedings and to be heard.

5-5g Substantive due process

Procedural rules deal with how things are done. All rules on the adjudication of agency charges are procedural rules. Similarly, all rules for the trial of a civil case— from discovery to jury instructions—are also procedural. These rules exist to make sure the substantive law is upheld. Substantive law consists of rights, obligations, and behavior standards. Criminal laws are substantive laws, and criminal proce- dure rules are procedural laws. Substantive due process is the right to have laws

When the Crafts moved into their residence in October 1972, they noticed two separate gas and electric meters and only one water meter serving the premises. The residence had been used previously as a duplex. The Crafts assumed, based on information from the seller, that the second set of meters was inoperative.

In 1973, the Crafts began receiving two bills: their regular bill and another with an ac- count number in the name of Willie C. Craft, as opposed to Willie S. Craft. In October 1973, after learning from a Memphis Light, Gas & Water (MLG&W) meter reader that both sets of meters were running in their home, the Crafts hired a private plumber and electrical contractor to combine the meters into one gas and one electric meter. Be- cause the contractor did not combine the

meters properly, they continued to receive two bills until January 1974. During this time, the Crafts’ utility service was termi- nated five times for nonpayment.

Mrs. Craft missed work several times to go to MLG&W offices to resolve the “dou- ble billing” problem. She sought explana- tions on each occasion but was never given an answer.

In February 1974, the Crafts and other MLG&W customers filed suit for violation of the Due Process Clause. The district court dismissed the case. The court of ap- peals reversed, and MLG&W appealed.

Have the Crafts been given due process?

[Memphis Light, Gas & Water Div. v Craft, 436 U.S. 1 (1978)]

Consider . . . 5.6

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Chapter 5 Business and the Constitution 171

that do not deprive businesses or citizens of property or other rights without justi- fication and reason. The issue of whether a statute was “void for vagueness” and denied due process was a central one in F.C.C. v Fox Television Stations, Inc., 132 S.Ct. 2307 (2012). In the case, which is discussed in Chapter 6, the Supreme Court held that the Federal Communications Commission (FCC) regulations did not give the television networks enough information to understand the standards for the use of expletives on television as well as the limits on momentary nudity. Justice Kennedy wrote, “A fundamental principle in our legal system is that laws which regulate persons or entities must give fair notice of conduct that is forbidden or required.” This requirement of clarity in regulation is essential to the protections provided by the Due Process Clause of the Fifth Amendment.

5-5h equal protection Rights for Business

The Fourteenth Amendment grants citizens the right to the equal protection of the law. Lawmakers, however, are often required to make certain distinctions in legislating and regulating that result in classes of individuals being treated differently.

Such different or disparate treatment is justified only if some rational basis for it is determined. In other words, a rational connection is necessary between the classifications and the achievement of some governmental objec- tive. Most classifications survive the rational basis test. An example of a clas- sification that would not survive is one requiring the manufacturers of soft drinks to use only unbreakable bottles for their product but allowing juice manufacturers to use glass bottles; this classification is irrational. If a public safety concern is raised about glass bottles, it must apply equally to all bever- age manufacturers.

5-6 The Role of Constitutions in International Law

Although the U.S. Constitution is the basis for all law in the United States, not all countries follow a similar system of governance. The incorporation of other systems (such as a constitution or code) depends on a nation’s history, including its colonization by other countries and those countries’ forms of law. The United States and the United Kingdom (and countries established through British colo- nization) tend to follow a pattern of establishing a general set of principles, as set forth in a constitution, and of reliance on custom, tradition, and precedent for the establishment of law in particular legal areas.

In countries such as France, Germany, and Spain (and nations colonized through their influences), a system of law that is dependent on code law exists. These countries have specific codes of law that attempt to be all-inclusive and cover each circumstance that could arise under a particular provision. These nations do not depend on court decisions, and often the application of the law leads to inconsistent results because of the lack of dependence on judicial precedent.

Approximately 78 countries follow Islamic law in some way. When Islamic law is the dominant force in a country, it governs all aspects of personal and business life. The constitutions in these lands are the tenets of the nation’s religion.

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172 part 2 Business: Its Regulatory Environment

Following a boom in cruise ship construc- tion, ships are now looking for ports at which they can dock in order to begin voyages, most of which start in the Unit- ed States. With so many new ships, the companies are trying to establish con- nections with cities that are not ordinari- ly considered for cruise ship docks. The companies pursue these alternatives because the traditional docking cities of New York, Seattle, Miami, Los Angeles, and Houston have become crowded with cruise ship traffic. The result has been a burden on the facilities and staff at the ports.

Most cruise ship lines are incorporated outside of the United States, do not pay federal income taxes, and are not subject to state income taxes even though the bulk of their passengers come from the United States. (See the section “5-3b Constitution- al Standards for Taxation of Business” earli- er in this chapter.)

Can the ships be taxed to cover the harbor expenses? Can they be required by states and cities to pay docking fees, or are they internationally exempt companies?

Source: Nicole Harris, “Big Cruise Ships Cause Traffic Jams in Ports,” Wall Street Journal, August 20, 2003, pp. B1, B6.

Consider . . . 5.7

Biography

As the saying goes, only in New York City. Times Square has individuals dressed as Mickey Mouse, Minnie Mouse, the Cookie Monster, Elmo, and, well, you name it, who make a living by wander- ing around the famous New York City landmark area and offering photo ops to tourists in exchange for tips. However, perhaps in an effort to offer age-specific photo ops, the so-called topless ladies are now omnipresent in Times Square. The topless ladies, also known as desnudas, earned their name because they are wear- ing little except body paint as they offer photo ops with tourists. Recently, photos and videos of the topless ladies with New York City police officers emerged, but the topless ladies explained that the police officers did not tip them: “We’re working. They are working.”4

The photos with the police were the beginning of public ire. Parents with chil- dren expressed concerns—perhaps the street characters  should be isolated in

one area. As a result, New York City Mayor DeBlasio has proposed having some reg- ulation. However, there are constitutional barriers because the desnudas, as well as Elmo and the Cookie Monster, argue that they are afforded the right to artistic expression under the First Amendment.

Under the U.S. Constitution, the gov- ernment is curbed in its regulation of speech, which includes artistic expression. However, the government can still put time and place limitations. There is precedent for such regulation because, for example, street vendors, such as sketch artists, are restricted on the areas they are permitted to use, restrictions that are based on traf- fic, crowding, and other factors that are tied to the city’s role of general health and welfare of city inhabitants. In statistical tracking, Times Square had more than 120 costume characters and 11 “painted ladies” at one time, a statistic that could support restrictions. In addition, there have also been arguments and confrontations

the Cookie Monster in times Square: Free Speech on parade

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Chapter 5 Business and the Constitution 173

when tourists take pictures with the street performers and fail to tip them. 

The Times Square Alliance, a group of business owners in the area, has been offering help and advice to tourists on how to handle the characters, explaining that payment is not required regardless of how aggressive the street artists become. The Alliance has asked the city to step in and regulate the characters and/or artists. Mayor DeBlasio has noted that the charac- ters and desnudas are not just involved in expression; they are engaged in business

activities, and the city has the authority to regulate all businesses operating within the city, within the parameters of free speech. The businesses can continue to operate but may be subject to licensing, hours restrictions, or even location limitations. Thanks to his constitutional rights, Cookie Monster will go on in Times Square, but the city has imposed area restrictions. The characters are limited to “activity areas,” which are painted turquoise. The characters can pursue their First Amendment rights, but only in the turquoise areas.

s u m m a r y What is the Constitution?

• U.S. Constitution—document detailing authority of U.S. government and rights of its citizens

What are the constitutional limitations on business regulations?

• Commerce Clause—portion of the U.S. Constitution that controls federal regulation of business; limits Congress to regulating interstate and international commerce

• Intrastate commerce—business within state borders

• Interstate commerce—business across state lines

• Foreign commerce—business outside U.S. boundaries

Who has more power to regulate business—the states or the federal government?

• Supremacy Clause—portion of the U.S. Constitution that defines relationship between state and federal laws

• Taxation—authority to tax interstate businesses

What individual freedoms granted under the Constitu- tion apply to businesses?

• Bill of Rights—first 10 amendments to the U.S. Con- stitution, providing individual freedoms and protec- tion of individual rights

• First Amendment—freedom-of-speech protection in U.S. Constitution

• Commercial speech—ads and other speech by businesses

• Corporate political speech—business ads or posi- tions on candidates or referenda

• Due process—constitutional guarantee against the taking of property or other governmental exercise of authority without an opportunity for a hearing

• Equal protection—constitutional protection for U.S. citizens against disparate treatment

• Substantive due process—constitutional protection against taking of rights or property by statute

Q u e s t i o n s a n d P r o b l e m s 1. A group of smokers (Respondents) brought suit against tobacco producer Altria, alleging that they were misled by the Altria and other cigarette producers’ (Peti- tioners) ads and labels on its cigarettes touting “light” and “low-tar.” By covering filter ventilation holes with

their lips or fingers, taking larger or more frequent puffs, and holding the smoke in their lungs for a longer period of time, smokers of “light” cigarettes unknowingly inhale as much tar and nicotine as do smokers of regular ciga- rettes. “Light” cigarettes are in fact more harmful because

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174 part 2 Business: Its Regulatory Environment

the increased ventilation that results from their unique design features produces smoke that is more mutagenic per milligram of tar than the smoke of regular cigarettes. The smokers argued that the tobacco companies violated the Maine Unfair Trade Practices Act (MUTPA) by fraud- ulently concealing that information and by affirmatively representing, through the use of “light” and “lowered tar and nicotine” descriptors, that their cigarettes would pose fewer health risks.

The District Court entered summary judgment in favor of the tobacco companies on the ground that the state-law claim is preempted by the Federal Cigarette Labeling and Advertising Act. The Court of Appeals reversed that judgment, and the U.S. Supreme Court granted certiorari to review its holding that the Labeling Act neither expressly nor impliedly preempts state law. What should the court decide and why? [Altria Group, Inc. v Good, 555 U.S. 70 (2008)]

2. Mrs. Florence Dolan owned a plumbing and electric supply store on Main Street in Portland, Oregon. Fanno Creek flows through the southeastern corner of Mrs. Dolan’s lot, on which her store is located. She applied to the city for a permit to redevelop her lot. Her plans included the addition of a second structure.

The City Planning Commission granted Mrs. Dolan’s permit but included the following requirement:

Where landfill and/or development is allowed within and adjacent to the 100-year floodplain, the city shall require the dedication of sufficient open land area for greenway adjoining and within the floodplain. This area shall include portions at a suitable elevation for the construction of a pedestrian/bicycle pathway within the floodplain in accordance with the adopted pedestrian/bicycle plan.

Mrs. Dolan maintained that the requirements were a taking of her property because she would be required to reserve a portion of her property for the pedestrian/bike path, and her plans would have to be redone to accom- modate the city’s requirements. The city maintains that its requirements are all simply part of a redevelopment plan for the city and a means of working with the flood- plain created by Fanno Creek. Mrs. Dolan says the city has imposed additional expense and forced her to ded- icate a large portion of her lot to public use. Who is cor- rect? Is Portland taking property from Mrs. Dolan? Is the city required to pay compensation to her? [Dolan v City of Tigard, 512 U.S. 374 (1994)]

3. The Heart of Atlanta Motel, which has rooms avail- able to transient guests, is located on Courtland Street, two blocks from downtown Peachtree Street in Atlanta, Georgia. It is readily accessible to interstate highways 75 and 85 and state highways 23 and 41. The motel does advertise outside Georgia through various national

advertising media, including magazines of national cir- culation; it maintains more than 50 billboards and high- way signs within the state, soliciting patronage for the motel; it accepts convention trade from outside Georgia; and approximately 75% of its registered guests are from out of state.

Prior to passage of Title II of the Civil Rights Act, the motel had followed a practice of refusing to rent rooms to Negroes, and it alleged that it intended to continue to do so. The motel filed suit, challenging Congress for passing this act in excess of its power to regulate com- merce under Article I, Section 8, Part 3, of the Constitu- tion of the United States.

Section 201 of Title II provides, “All persons shall be entitled to the full and equal enjoyment of the goods, services, facilities, privileges, advantages, and accom- modations of any place of public accommodation, as defined in this section, without discrimination or segre- gation on the ground of race, color, religion, or national origin.” Section 201(b) covers four classes of business establishments, each of which “serves the public” and “is a place of public accommodation”: any inn, hotel, motel, or other establishment which provides lodging; (2) any restaurant, cafeteria; (3) any motion picture house; and (4) any establishment which is physically located within the premises of any establishment otherwise covered by this subsection.

Is Title II of the Civil Rights Act constitutional? Is this case different from Ollie’s Barbecue? [Heart of Atlanta Motel, Inc. v U.S., 379 U.S. 241 (1964)]

4. Bruce Church, Inc., is a company engaged in extensive commercial farming in Arizona and California. A provi- sion of the Arizona Fruit and Vegetable Standardization Act requires that all cantaloupes grown in Arizona “be packed in regular compact arrangement in closed stan- dard containers approved by the supervisor.” Arizona, through its agent Pike, issued an order prohibiting Bruce Church from transporting uncrated cantaloupes from its ranch in Parker, Arizona, to nearby Blythe, California, for packing and processing.

It would take many months and $200,000 for Bruce Church to construct a processing plant in Parker. Fur- ther, Bruce Church had $700,000 worth of cantaloupes ready for transportation. Bruce Church filed suit in fed- eral district court challenging the constitutionality of the Arizona statutory provision on shipping cantaloupes. The court issued an injunction against the enforcement of the act on the grounds that it was an undue hardship on interstate commerce. Will the regulation withstand Commerce Clause scrutiny? [Pike v Bruce Church, Inc., 397 U.S. 137 (1970)]

5. Diana Levine, a folk singer from Vermont, suffered from migraine headaches. She was being administered

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Chapter 5 Business and the Constitution 175

Wyeth Laboratory’s Phenergan through an IV drip. Either because the IV needle entered Levine’s artery or the drug escaped from the vein into her surrounding tis- sue, Ms. Levine developed gangrene. Doctors amputated her right hand and eventually her forearm. Levine could no longer work as a professional musician. Levine filed suit against both the clinic that administered the drug and Wyeth. She was awarded $7.4 million, and Wyeth appealed on the grounds that the Food and Drug Admin- istration approval of the drug preempted state tort suits by patients. What constitutional provision is involved, and what should the court decide? [Wyeth v Levine, 555 U.S. 555 (2009)]

6. For the past 62 years, Pacific Gas & Electric (PG&E) has distributed a newsletter in its monthly billing enve- lopes. The newsletter, called Progress, reaches more than 3 million customers and contains tips on conservation, util- ity billing information, public interest information, and political editorials.

A group called TURN (Toward Utility Rate Normal- ization) asked the Public Utility Commission (PUC) of California to declare that the envelope space belonged to the ratepayers and that TURN was entitled to use the Progress space four times each year. The PUC ordered TURN’s request, and PG&E appealed the order to the California Supreme Court. When the California Supreme Court denied review, PG&E appealed to the U.S. Supreme Court, alleging a violation of its First Amendment rights. Is PG&E correct? [Pacific Gas & Electric v Public Utility Commission of California, 475 U.S. 1 (1986)]

7. The Minnesota legislature enacted a 1977 statute banning the retail sale of milk in plastic nonreturnable, nonrefillable containers but permitting such sale in other nonrefillable containers, such as paperboard milk car- tons. Clover Leaf Creamery brought suit challenging the constitutionality of the statute under the Equal Protection Clause, alleging that there was no rational basis for the statute. The Minnesota legislature’s purpose in passing the statute was to control solid waste, arguing that plas- tic containers take up more space in solid waste disposal dumps. The Minnesota Supreme Court found evidence to the contrary: the jugs took up less space and required less energy to produce. On appeal to the U.S. Supreme Court, can the statute survive a constitutional challenge? Is there a “rational basis” for the statute? What effect does the evidence to the contrary have on the statute’s constitutionality? [Minnesota v Clover Leaf Creamery, 449 U.S. 456 (1981)]

8. Iowa passed a statute restricting the length of vehi- cles that could use its highways. The length chosen was 55 feet. Semitrailers are generally 55 feet long; double

or twin tracks (one cab pulling two trailers) are 65 feet long. Other states in the Midwest have adopted the 65-foot standard. Consolidated Freightways brought suit, challenging the Iowa statute as an unconstitu- tional burden on interstate commerce. The Iowa statute meant Consolidated could not use its twins in Iowa. The Iowa legislature claims the 65-foot doubles are more dangerous than the 55-foot singles. However, the statute did provide a border exception: Towns and cit- ies along Iowa borders could make an exception to the length requirements to allow trucks to use their city and town roads. Can Iowa’s statute survive a constitutional challenge? Is the statute an impermissible burden on interstate commerce? [Kassel v Consolidated Freightways Corp., 450 U.S. 662 (1981)]

9. In 1989, the city of Cincinnati authorized Discovery Network, Inc., to place on public property freestanding news racks for distributing free magazines that con- sisted primarily of advertising for Discovery Network’s service. In 1990, the city became concerned about the safety and attractive appearance of its streets and side- walks and revoked Discovery Network’s permit on the grounds that the magazines were commercial handbills whose distribution was prohibited on public property by a preexisting ordinance. Discovery Network argues that the prohibition is an excessive regulation of its commer- cial speech and a violation of its rights. The city main- tains the elimination of the news racks decreases litter and increases safety. Is the ban on news racks constitu- tional? [City of Cincinnati v Discovery Network, Inc., 507 U.S. 410 (1993)]

10. Fed up with the warning signals and being outnum- bered on the highways by drivers looking out for one another, police officers and state troopers began issuing tickets to those who send signals and warnings to driv- ers so that they can slow down and avoid being caught going above the speed limit.

On November 17, 2012, a police officer pulled Michael Elli over and issued a citation for “[f]lashing lights on certain vehicles prohibited, warning of RADAR ahead.” Mr. Elli told the judge that he wanted to plead not guilty because he did not believe flashing headlamps violated §375.100 of the Ellisville city code. The judge became agitated and asked Mr. Elli if he had ever heard of “obstruction of justice.”

Mr. Elli then entered a plea of not guilty, and he was ordered to return to court on February 21, 2013. How- ever, Mr. Elli, with the help of the ACLU, filed a civil rights action in federal court. Have Mr. Elli’s rights been violated? Is flashing your headlights a form of speech? What do you think the court decided? [Elli v City of Ellis- ville, 997 F. Supp. 2d 980 (E.D. Mo. 2014)]

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176 part 2 Business: Its Regulatory Environment

Economics & the Law The Perils of Eminent Domain

The bittersweet ending to the Kelo case presents some interesting economic issues. The city spent $87 million razing the homes to make room for the Pfizer project, which failed. Many eminent domain projects for eco- nomic developments do fail as businesses withdraw due to economic factors and other developments.

Consider whether these types of projects are good investments for local governments. Who are the stake- holders in eminent domain cases? Who is affected by the takings? What lessons do we glean about business and government partnerships?

n ot e s 1. Christian Legal Society Chapter of the University of California, Hastings College of the Law v Martinez, 130 S.Ct. 2971 (2010).

2. Ilya Somin, “Lesson from a Little Pink House, 10 Years Later,” Wall Street Journal, June 22, 2015, p. A13.

3. In Koontz v St. Johns River Water Management District, 133 S.Ct. 2586 (2013), the U.S. Supreme Court held that a landowner

could not be required to fund off-site projects in order to obtain land use permits for his property.

4. Patrick McGeehan, “Mayor Says Times Sq.’s Topless Women Should Be Regulated,” New York Times, August 19, 2015, p. A18.

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178

Chapter

Administrative Law6 The regulations of administrative agencies at the federal and state levels affect the day-to-day operations of all businesses. From permits to labor regulations, every business is affected. Agencies are the enforcement arm of governments. Created by one of the branches of government, they affect the way businesses operate. This chapter answers the following questions: What is an administra- tive agency? What does it do? What laws govern the operation of administrative agencies? How do agencies pass rules? How do agencies enforce the law?

Update For up-to-date legal and ethical news, go to mariannejennings.com

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179

6-1 What Are Administrative Agencies? An administrative agency is best defined by what it is not: it is not a legislative or judicial body. An administrative agency is a statutory creation within the executive branch with the power to make, interpret, and enforce laws. Such agencies exist at practically every level of government, and their names vary considerably. Exhibit 6.1 is a list of all the federal administrative agencies.

States also have administrative agencies that are responsible for such things as the licensing of professions and occupations. Architects, contractors, attorneys, accountants, cosmetologists, doctors, dentists, real estate agents, and nurses are all professionals whose occupations are regulated in most states by some adminis- trative agency. Utility and worker compensation regulations are also handled by administrative agencies in each of the states.

All these agencies at every level of government derive their authority from the legislative body responsible for their creation. Congress creates federal agencies, state legislatures create state agencies, and city governments create their cities’ administrative agencies.

The structures of agencies may differ significantly, but most will have an orga- nizational chart to show how different departments operate. Exhibit 6.2 is an organizational chart for the Securities and Exchange Commission (SEC). The SEC consists of five commissioners, six divisions, and 11 regional offices.

Lord’s Prayer 66 words Gettysburg Address 286 words Declaration of Independence 1,322 words Kings James Bible 788,320 Federal regulations on the sale of cabbage 26,911 words Entire Harry Potter series 1,000,000 Internal Revenue Code and Regulation 31,500,000 words (as of 2015 including

statutes and regulations)

THIS TAG NOT TO BE REMOVED EXCEPT BY THE CONSUMER. Modified warning tag (which previously read, “do not reMove under penalty of law”) required on Mattresses The change was made because the agency needed to reduce the number of calls from consumers who were concerned about removing their mattress tags

In December 2013, the Federal Communications Commission (FCC) proposed a rule change that would allow passengers on commercial jet flights to use their cell phones (wireless services) if the airlines agreed to permit their customers to do so. Foreign airlines have already been allowing in-flight use of cell phones. However, flight attendants are concerned about safety issues because passengers will not hear announcements when they are engaged in phone conversations.

Those who fly frequently are concerned about the possibility of being seated next to a “loud” cell phone

users and the resulting agony of a long flight. Flight attendants fear that passengers, agitated by loud cell phone conversations, will experience air rage that will be difficult to manage. On the other hand, cell phone companies are pleased with the possible expansion of usage.

Still, some experts are concerned about high cell phone usage interfering with plane navigation and com- munication systems. What can flight attendants and passengers do to let their concerns be heard? Can the proposed rule be challenged? How do cell phone com- panies offer their support?

Consider . . . 6.1

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180 part 2 Business: Its Regulatory Environment

Exhibit 6.1 Major Federal administrative agencies

eXeCUtIVe OFFICe OF tHe pReSIdeNt

Department of Labor

Department of State

Department of Transportation

Department of the Treasury

Selected Independent Agencies

Commodity Futures Trading Commission (CFTC)

Consumer Product Safety Commission (CPSC)

Environmental Protection Agency (EPA)

Equal Employment Opportunity Commission (EEOC)

Federal Aviation Administration (FAA)

Farm Credit Administration (FCA)

Federal Communications Commission (FCC)

Federal Deposit Insurance Corporation (FDIC)

Federal Election Commission (FEC)

Federal Emergency Management Agency (FEMA)

Federal Maritime Commission (FMC)

Federal Mine Safety and Health Review Commission

Federal Reserve System

Federal Trade Commission (FTC)

General Services Administration (GSA)

Interstate Commerce Commission (ICC)

National Aeronautics and Space Administration (NASA)

National Credit Union Administration (NCUA)

National Highway Traffic Safety Administration (NHTSA)

National Labor Relations Board (NLRB)

National Science Foundation (NSF)

National Transportation Safety Board (NTSB)

Nuclear Regulatory Commission (NRC)

Occupational Safety and Health Administration (OSHA)

Overseas Private Investment Corporation (OPIC)

Patent and Trademark Office

Pension Benefit Guaranty Corporation

Securities and Exchange Commission (SEC)

Selective Service System (SSS)

Small Business Administration (SBA)

Tennessee Valley Authority (TVA)

U.S. Postal Service (USPS)

Veterans Administration (VA)

Executive Departments

Department of Agriculture

Department of Commerce

Department of Defense

Department of the Air Force

Department of the Army

Department of the Navy

Department of Education

Department of Energy

Department of Health and Human Services (HHS)

Department of Homeland Security

Department of Housing and Urban Development (HUD)

Department of the Interior

Department of Justice

Note: Some historical agencies are listed here and in CFR for topical and historical purposes. Current agency structures may include absorption of older agencies.

Legislators begin the creation of an administrative agency with the recogni- tion of a problem and the passage of a law designed to remedy the problem. The enacted law gives the overview—what the legislature wants to accomplish and the penalties for noncompliance with the law. The law may also establish an adminis- trative agency with the power to adopt rules to deal with the problems of enforce- ment of the statute. The law, referred to as an enabling act, gives the agency the power to deal with the issues and problems the act addresses.

6-2 Roles of Administrative Agencies 6-2a Specialization

Administrative agencies are specialists in their particular areas of law, and this type of specialization is needed because of both the complexities of law and the areas of regulation. For example, securities regulation involves both the com- plexity of financial reporting and the underlying technical accounting rules. The SEC has a special division headed by its chief accountant, and that division deals with all current and evolving accounting and financial reporting issues. The peo- ple who work as staff members in these agencies are chosen for their knowledge

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Chapter 6 Administrative Law 181

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182 part 2 Business: Its Regulatory Environment

and experience, which helps them provide protection for the public as well as an understanding of the issues members of the regulated industries face.

6-2b protection for Small Business

An individual or competitor who finds a false advertisement in a newspaper would probably not take the time or effort to bring a private suit to collect dam- ages for the false advertisement. But an agency created to oversee truth in advertis- ing would undertake routine enforcement against such advertisements, affording small business competitors and consumers the protection and rights they might not otherwise have.

6-2c Faster Relief

If enforcement of all government regulations depended on court hearings, courts would be backlogged and the goals of swift action and enforcement defeated. Administrative agencies help expedite investigations and enforcement and pen- alties for violations. In addition, administrative agencies serve as review boards for granting licenses. License and permit applications can be processed far more quickly than they could be handled legislatively.

6-2d due process

Administrative agencies provide the opportunity to be heard, a form of due pro- cess before property, rights, or income is taken. Goldberg v Kelly, 397 U.S. 254 (1970), was the seminal judicial decision responsible for creating administrative agency procedures that provide timely due process. In Goldberg, the Supreme Court ruled that before a benefit (such as aid to dependent children) could be taken away, the agency must present its evidence and allow those who have been receiving the aid an opportunity to respond.

Administrative hearings provide citizens and businesses with a process for see- ing the evidence against them and presenting their side of the story (see Chapter 5 for more insight on due process). For example, the raisin growers had a victory in the U.S. Supreme Court when they successfully challenged the raisin market con- trols of the Department of Agriculture. The Hornes argued that the Fifth Amend- ment requires that the government pay just compensation when it takes personal property, just as when it takes real property. [Horne v Dept. of Agriculture, 135 S.Ct. 2419 (2015)]

The Department of Agriculture had implemented its Marketing Order Regu- lating the Handling of Raisins Produced from Grapes Grown in California. The Marketing Order regulates raisin supply through the oversight of the Raisin Administrative Committee (“RAC”), which sets an annual “reserve tonnage” requirement, a percentage of the overall crop. The remaining raisins are “free ton- nage” and can be sold on the open market. The reserved raisins are diverted from the market to smooth the peaks of the raisin supply curve. Reserved raisins are released when supply is low. The RAC adapts the reserves annually to address changing market conditions. But the growers have their tonnage taken away with- out a hearing or even input on the value of that excess tonnage. The lower courts held that the program was the taking of personal property and that the raisin growers were entitled to due process.

The U.S. Supreme Court agreed, and the Department of Agriculture will have to modify the program to provide compensation as well as the opportunity for

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Chapter 6 Administrative Law 183

growers to be heard regarding any disputes in valuation. Other federal agencies with similar price-support programs will need to re-examine their processes as well because of the decision and its due process implications.

6-2e Social Goals

Some experts see administrative agencies as a means for accomplishing social goals that might otherwise be delayed or debated until no resolution could be reached. For example, the Environmental Protection Agency is assigned the goal of creating a cleaner environment. If Congress had to debate every permit for a factory or rule on discharges, the goal might be lost in the political arena. Further, having judicial review and determination of these issues would result in a delay that might make the goal moot. Administrative agencies can function independently of the judicial and legislative branches. Often, these agencies are created in response to a pressing social issue. For example, the Department of Homeland Security was established to combine several agencies to allow more coordinated responses to terrorism, such as the attacks on the World Trade Center and Washington, D.C., in 2001, as well as natural disasters. The goal was a more centralized means of information distribution and relief.

6-3 Laws Governing Administrative Agencies Apart from their enabling acts, administrative agencies are also subject to some general laws on the functioning of agencies. This section covers those laws.

6-3a administrative procedures act

This act was the first to deal with administrative agency procedures. It was passed in 1946 after some agencies had been in existence long enough for some standard procedures to be established. The Administrative Procedures Act (APA) requires agencies to follow certain uniform procedures in making rules (those procedures are covered later in this chapter). The APA has been amended a number of times by the Freedom of Information Act, the Federal Privacy Act, and the Government in the Sunshine Act, among others.

6-3b Freedom of Information act

The Freedom of Information Act (FOIA) allows access to certain information fed- eral agencies possess and requires that the agencies publicly disclose their pro- cedures and decisions. The types of procedures that must be publicly disclosed relate to agencies’ structures: where the central and regional offices are located and which office or office division will respond to requests for information. Agen- cies must also publish their rules, regulations, procedures, policy statements, and reports.

Some agency information, not published but available to the public, can be obtained by an FOIA request, which must be written and must describe the doc- uments sought. For example, you could request the results of the Federal Trade Commission’s study of coaching programs for college entrance exams. The agency can charge for time and for copying costs in processing the request, although these charges must be published and applied uniformly to all requests. Agencies can waive fees for nonprofit public interest groups.

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184 part 2 Business: Its Regulatory Environment

If an agency wrongfully refuses to supply the information requested, the party requesting it can bring a court action to enforce the request, with all costs paid by the agency.

Some information is exempt from FOIA requests. Those who would be affected by the release of government information can file what are known as “reverse FOIA suits.” These suits seek injunctions to stop the release of government infor- mation on the basis of the FOIA exemptions. The nine categories of exemptions include, for example, requests that would reveal private information about indi- viduals, such as government workers’ personnel records. In some cases, families have an interest in protecting the privacy of loved ones. For example, when Sea World animal trainer Dawn Brancheau was killed by a killer whale during a show at the company’s Florida facility, there were numerous pictures taken by OSHA as part of its investigation into the facility’s compliance with federal safety stan- dards. Ms. Brancheau’s family brought suit to stop the public release of the photos because they were “death-scene materials.” However, there is no such exemption under the FOIA. [Brancheau v Secretary of Labor, 2011 WL 4105047 (M.D.Fla.)]

Businesses often file reverse FOIA suits seeking injunctions. Businesses usually base their reverse FOIA suits on the trade secret exemption. Trade secrets cover a very broad spectrum, including information such as pricing, formulas, and cus- tomer lists. However, the U.S. Supreme Court held in Chrysler Corp. v Brown, 441 U.S. 281 (1979), that the right to stop or grant disclosure rests with the agency and not with the party who supplied the information to the agency.

The exemptions can evolve through legislative additions and clarifications. For example, in 2013, New York passed legislation that prevents government agencies from releasing the names and addresses of gun owners in the state. The effect of the release of that information was that certain police officers’ home addresses became known to criminals who then threatened the officers and also caused thieves to target homes that were revealed by the releases to not have firearms.

6-3c Federal privacy act

In 1974, Congress passed the Federal Privacy Act (FPA) to reduce exchanges of information between agencies about persons (individuals and businesses).

The recordings of 9-1-1 calls have long been subject to FOIA requests by newspapers and television stations. However, the con- tent of those calls often reveals private in- formation or discloses health information about individuals who have not committed a criminal wrong. For example, in 2011, the release of a 9-1-1 call made by friends of actress Demi Moore from her residence as they sought help revealed the actress to be in a disoriented and under-the-influence state, in other words, an unflattering por- trait of a person at an emotional and physi- cal low in her life. However, the recording,

obtained by news outlets, also revealed that agencies involved with the call were slow to respond and confused about jurisdic- tion in the case. Legislation was proposed to ban the public release of these types of calls when there was no criminal behavior. However, opponents of the bill pointed out that the purpose of FOIA requests is of- ten to allow the public to hold government agencies, whether police or administrative agencies, accountable for their conduct and decisions. Discuss whether there should be an exemption or the FOIA should apply to such circumstances.

Consider . . . 6.2

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Chapter 6 Administrative Law 185

The FPA prohibits federal agencies from communicating any records to another agency or person without first obtaining the consent of the person whose record is being communicated. The FPA protects all records about individuals who might be in the possession of the agency, including medical and employment histories.

Because law enforcement agencies would have a difficult time trying to conduct investigations if they had to get permission from the individuals being investigated in order to obtain information, law enforcement agencies are exempt from the FPA. Congress can also obtain information without consent. Routine agency tasks are also exempt from the prior permission requirement. For example, employees of the SEC need constant access to information about stock sales by corporate directors so that the SEC can perform its role of preventing insider trading. Because of ter- rorist attacks, some exchanges of information among federal agencies were broad- ened by the USA Patriot Act.

6-3d Government in the Sunshine act

The Government in the Sunshine Act is often called an open meeting law. Its purpose is to require prior public notice of meetings of those agencies with heads appointed by the president. All the agencies with the word commission in their names have agency heads appointed by the president.

This open meeting law applies only to meetings between or among agency heads. For example, when the commissioners of the FTC meet together, that meet- ing must be public and held only after there has been prior notice. Staff members can hold meetings in private without giving notice. Meetings on law enforcement investigations are also exempt.

Ethical Issues

In 1997, the Internal Revenue Service (IRS) disciplined employees who, out of curiosity, were looking up tax returns of famous people. The employees were not working on the taxpayers’ returns. They were not obtaining information for investigations; they were simply checking to see who made how much income. The IRS fired 23 employees, disciplined 349, and provid- ed counseling for 472. During 1996 and 1997, the IRS investigated 1,515 cases of snooping among its 102,000 employees. By 2007, the number of snooping investiga- tions was increasing by about 400 per year, with employee disciplinary actions taken in about one-half of the cases. About 60 cases per year are referred for criminal prosecu- tion of employees. By 2012, the IRS had

implemented an audit program that tracked employee searches of records to detect access in comparison to the employees’ work assignments and whether the files of individual taxpayers that employees pulled up were related to the audit or review functions that they had been assigned. The report concluded that the tracking was deficient in determining authorization for the employees to access certain files and needed to be improved.

Is this practice so bad? What is wrong with just looking at data accessible at work? The IRS employees said they did not disclose the data and therefore didn’t violate federal privacy laws. Are ethics and laws the same thing?

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186 part 2 Business: Its Regulatory Environment

6-3e Federal Register act

Although the Federal Register Act (FRA) is not a part of the APA, its provisions are necessary for all the acts under the APA to work. The FRA created the Federal Register System, which oversees publication of federal agency information. This system provides the means for Sunshine Act notices and publication of agency rules and procedures.

Three publications make up the Federal Register System. The first is the U.S. Government Manual. This publication is reprinted each year and lists all federal agencies and their regional offices along with addresses. In addition, the Manual contains statistics about the agencies and their sizes.

The second publication of the Federal Register Act is the Code of Federal Regulations. (The U.S. Code is covered in Chapter 1.) The Code of Federal Regu- lations contains all the regulations of all the federal agencies. The volumes are in paperback, and the entire Code is republished each year because of tremendous changes in the regulations.

The third publication under the Federal Register System provides a daily update on changes in the regulations. This publication, called the Federal Register, is published every government working day and contains proposed regulations, notices of meetings (under the Government in the Sunshine Act), notices of hear- ings on proposed regulations, and the final versions of amended or new regula- tions. The Federal Register totals about 83,000 pages a year, or about 320 pages every working day.

6-4 The Functions of Administrative Agencies and Business Interaction

Administrative agencies have three functions: promulgating regulations, enforc- ing rules, and adjudicating rules. Businesses will find themselves interacting with agencies in all three areas of operation.

6-4a providing Input When agencies are promulgating Regulations

The legislative function of administrative agencies has two forms: formal rulemaking and informal rulemaking. Some agencies combine them into a type of rulemaking that is a cross between formal and informal—hybrid rulemaking. This section focuses on formal rulemaking.

6-4b Formal Rulemaking

Exhibit 6.3 diagrams the steps involved in formal rulemaking.

Congressional enabling act Congress is responsible for passing statutes designed to remedy a perceived prob- lem that is within federal jurisdiction. As legislation progresses through Congress, constituents have an opportunity to voice their views and concerns about problem areas.

The chapter-opening “Consider . . .” illustrates an agency carrying out a legis- lative mandate. The Patient Protection and Affordable Care Act (“Affordable Care Act” or “Obama Care”) required the FDA to develop and enforce rules of disclosure

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Chapter 6 Administrative Law 187

on sales of food in restaurants. Its proposed rule on disclosure of theater popcorn was part of the agency’s assignment under the enabling act legislation. Section 4205 of the Patient Protection and Affordable Care Act (PPACA) requires that compa- nies with over 20 restaurants or vending machines must post nutrition content for standard menu items and that vending machines must “provide a sign in close proximity to each article of food or the selection button that includes a clear and conspicuous statement disclosing the number of calories contained in the article.” The law took effect immediately when it was declared constitutional (see Chapter 5 for the case decision), but restaurants and grocery stores needed more guidance in terms of what those labels must include. The result was the FDA’s proposed regula- tions in 2011 regarding content and location of the labels and disclosures, as well as details on exemptions from disclosures. Those proposed rules resulted in extensive push-back from those affected and an 18-month-long rulemaking process, which involved a focus on the theater popcorn regulation proposals.

agency Research of the problem Any regulation passed by an administrative agency must have some purpose and evidence to show that the regulation will accomplish the purpose. Rules passed without some study and evidence supporting their need or effectiveness could be challenged as “arbitrary and capricious” (discussed later in this chapter) by the persons or industries affected by the questioned rules.

Agency staff can perform the study, or the agency can hire outside experts to conduct it. The study will examine issues such as whether the regulation will be cost effective. Some regulations may cost billions of dollars for industries to follow. The food-labeling regulations fell into that category. As the costs of disclosure were explored, the FDA granted more and more exemptions because of the impact on businesses, including the cost of lab analysis for determining

Exhibit 6.3 Stages in Formal Rulemaking by administrative agencies

Agency Study and

Research of Need for

Regulation

Proposed Regulations Published in

Federal Register

Public Comment

Period

Hearings Held

Regionally

1 2 3 4 5

Modi�cation of Proposed Regulation

Public Comment Period on

Modi�cation

Withdrawal of Proposed Regulation

Rule Is Promulgated

Court Challenges

6 7 8 9

Enabling Act by

Congress

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188 part 2 Business: Its Regulatory Environment

label information, costs of printing labels, and the prohibitive costs of devel- oping new products, due to new labeling certification, including the barriers to developing lower-calorie or low-fat versions of food products. The agency study focuses not only on monetary costs but also on the problems the regula- tion is trying to correct and the cost of those problems to the individual and to society.

proposed Regulations Based on the needs and costs shown by the completed study, the agency will pub- lish its proposed rules or rule changes in the Federal Register. To be valid, the notice in the Federal Register must contain certain information. If notice is not given or is given improperly, a court can set aside the action taken by the agency and require the rulemaking process to be repeated with proper notice.

Although not required to do so, some agencies provide background informa- tion in the notice so that some history and the function of the rules are given. In addition to publishing the notice of proposed rules in the Federal Register, an

Exhibit 6.4 example of agency Notice of proposed Rulemaking expanding access to Mobile Wireless Services Onboard aircraft

A Proposed Rule by the Federal Communications Commission

aCtION: Proposed Rules

aGeNCY: Federal Communications Commission

SUMMaRY: In this Notice of Proposed Rulemaking (NPRM), the Commission proposes to revise outdated rules and adopt consistent new rules governing mobile communications services aboard airborne aircraft. These rule changes would give airlines, subject to applicable Federal Aviation Administration (FAA) and Department of Transportation (DoT) rules, the choice of whether to enable mobile communications services using an Airborne Access System and, if so, which specific services to enable. The proposed rules would also replace an existing patchwork of regulatory prohibitions on airborne use of mobile services in some, but not all, of the heavily used mobile wireless bands with a consistent regulatory framework that explicitly forbids airborne use of mobile services in those bands unless they are operating on an aircraft equipped with an Airborne Access System.

Synopsis

I. Introduction and Background

II. Discussion

A. Changes to Current Rules Restricting Airborne Mobile Broadband Use

B. Airborne Access Systems

1. Potential Harmful Interference From Uncontrolled Airborne Mobile Devices

2. Benefits of Airborne Access Systems

3. Technical Requirements

C. Airborne Commercial Mobile Use

D. Other Issues

1. Service Below 3,048 Meters (10,000 Feet)

2. Voice Service Onboard Aircraft

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Chapter 6 Administrative Law 189

agency is required under the Regulatory Flexibility Act to publish a notice in the publications of those trades and industries that will be affected by the rule. For example, the regulation governing food labeling was published in both restaurant and grocery association magazines. Exhibit 6.4 is the original proposed FCC rule on the use of cell phones on airplanes.

the public Comment period One of the purposes for publishing proposed rules is to allow the public an opportunity to review and provide input on the proposed rules. The period during which the agency accepts comments on the rule is called the public com- ment period. Under the APA, the public comment period cannot be fewer than 30 days, but most agencies make the public comment period much longer. The FCC cell phone rules were so controversial that the time from the publication of the proposed rule has lasted two years, with the final rule not yet promulgated. Most experts believe that the FCC will find that cell phone usage is safe but will leave their use for phone conversations while in-flight to airline discretion. The FAA permits PED use of cellphones on flights, but does not permit cellular connections.

Private citizens, government officials, industry representatives, business- people, and corporations can all send in comments. With this opportunity, businesses can provide information and express concerns about proposals. A comment to an agency on a proposed rule need not use a formal format; most just appear in letter form. Exhibits 6.5, 6.6, and 6.7 illustrate the types of com- ments that were submitted by companies and organizations to the FCC about

Exhibit 6.5 Comments in Favor of the proposed Rules

Comments by Consumers in Favor of In-Flight Cell Phone Use (there were only 4)

While I respect the members of the commission and the public who are not excited about the ability of individuals to use cell phones on planes, that lack of support is not a sufficient reason to enforce a pointless ban. May I remind you that just recently many people were upset by the fact that blacks and whites may be forced to endure each other presents [sic] in the same restaurant.

However, those complains [sic] fell on def [sic] ears as the government did its duty. To that end, the duty of the government here is not to decide whether or not customers should be allowed to talk on their phones. The issue here is whether or not it is SAFE for passengers to use their phones.

Dates

Submit comments on or before February 14, 2014. Submit reply comments on or before March 17, 2014.

Paperwork Reduction Act (PRA) comments should be submitted March 17, 2014.

Addresses

You may submit comments, identified by WT Docket No. 13-301 or FCC 13-157, by any of the following methods:

Federal Communications Commission’s Web site: http://fjallfoss.fcc.gov/ecfs2/. Follow the instructions for submitting comments.

Mail: FCC Headquarters, 445 12th St. SW., Washington, DC 20554.

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Exhibit 6.6 Comments that Oppose the proposed Rules

Dear FCC

What better use of my extra Christmas card than to ask you to use any influence you have, during the process of allowing my cellular use on planes, to guide airlines towards allowing data but not voice use on flights. Thank you.

“The ground all dusted white, frosted windows spilling light. . . . Everything says welcome home to Christmas.”

Nooooooooooooooooooooooooooooooooooooooooooooooooooooooooooooooooooooooooooooooooooooooooooooooooooo ooooooooooooooooooooooooooooooooooooooooooooooooooooooooooooooooooooooooooooooooooooooooooooooooooooooo ooooooooooooooooooooooooooooooooooooooooooooooooooooooooooooooooooooooooooooooooooooo!

Flying is already expensive, uncomfortable and full of angst caused by late flights, drunk passengers and badly behaved children. Commercial flights will become hell on earth if this becomes legal.

I beg you to please not allow cell phone conversations on airplanes. I predict hundreds, if not thousands of flights per year forced to divert to a quick landing due to physical confrontations between passengers. The sky marshals will have their hands full breaking up fights, either verbal or physical, between passengers. For the sake of sanity in the air, please do notallow [sic] cell phone conversations in the air. Chaos will reign.

No! God no!! Please God, no!!!

PLEASE, PLEASE, PLEASE, DO NOT ALLOW VOICE CALLS ON FLIGHTS.

Exhibit 6.7 Comments from Various Groups Comment Letters By Groups

From Organized Groups—A Form Comment Letter (Hundreds Submitted)

I oppose the FCC allowing the use of cell phone voice calling on aircraft in flight, except in emergency situations. This isn’t just an issue of comfort or courtesy, it’s one of safety. In cramped airline cabins, passions already run high. Even when people try to talk quietly on mobile phones, they speak more loudly than they expect because of a lack of sidetone and overcompensation for background noise. Loud mobile phone conversations could dramatically increase the prevalence of “air rage,” endangering the lives of passengers and crew.

SMS texting and Internet connectivity are both excellent ways for fliers to stay entertained and in touch with their friends, family and work contacts on the ground. For safety’s sake, the FCC should approve SMS and data use but prohibit voice calls except in emergencies.

From the Association of Flight Attendants

Flight Attendants and passengers are united on this issue—there should be no voice calls in-flight. As first responders in the aircraft cabin, Flight Attendants know that this reckless FCC proposal would have negative effects on aviation safety and security. Repeatedly, studies have shown that a large majority of the American public agrees that voice calls have no place inside the cabin. The FCC should take heed and reverse this nonsensical plan that only stands to benefit a few manufacturers and vendors, and take into consideration the impact it would have on Flight Attendants and the traveling public.

From Members of Congress

Even if the FCC were to find that cell phones on airplanes did not cause any signal interference, airborne cell phone conversations would have other safety implications. It has been demonstrated that people talking on cell phones were much less likely to aid someone in need. Numerous other studies have demonstrated that cell phone conversations are particularly irritating and distracting to people nearby. The combination of these factors could make it much more difficult for crew members to give instructions and count on passenger assistance during an emergency. Altercations between passengers over cell phone use could also result in flight attendants having to act as referees to mitigate “air rage.”

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the proposed cell phone use on aircraft regulations. Comments such as these, along with comments on any other agencies’ proposed regulations, are available through an FOIA request if the agencies have not already made the comments available online.

Other Issues in the Comment Period. Some agencies hold public hearings on pro- posed regulations. The purpose of the hearings is to take input on the proposals and consider additional evidence and factors relevant in promulgating the final version of the rule.

One of the important distinctions between the legislative process and the regulatory rule making process is the nature of the role of those involved. Legislators, such as representatives and senators, can accept campaign contri- butions and meals from lobbyists. However, those who work in administrative agencies fulfill both rulemaking and enforcement roles and cannot accept such gifts. In U.S. v Sun-Diamond Growers of California 526 U.S. 398 (1999), the U.S. Supreme Court held that administrative officials can be prosecuted for criminal bribery if the payments are made in order to persuade agency officials to aban- don or change proposed regulations or actions before the agency. The types of payments that have resulted in bribery convictions of regulatory officials include club memberships [U.S. v Garrido, 713 F.3d 985 (9th Cir. 2013)] or the payment of the regulator’s son’s college tuition [U.S. v McNair, 605 F.3d 1152 (11th Cir. 2010)]. The McDonnell v U.S. case (Case 6.1), deals with the issue of members of executive branch receiving gifts from a constituent who needs agency action.

McDonnell v U.S. 136 S.Ct. 2355 (2016)

The Governor, Supplement Promotion, Some Loans, a Rolex, an Oscar de la Renta Dress, and Ferrari Rides

FaCtS

On November 3, 2009, Robert McDonnell (Defendant/ Appellant), was elected the seventy-first governor of Virginia. When Mr. McDonnell tool office, he was struggling financially. A real estate LLC (Mobo) that he owned with his sister was losing more than $40,000 each year. By 2011, they owed more than $11,000 per month in loan payments. Each year, their loan balance increased, and by 2012, the outstanding balance was nearing $2.5 million. Mr. McDonnell and his wife also had a combined credit card balance exceeding $74,000, which, by September 2010, had grown to $90,000.

Shortly after the election, the McDonnells met Jonnie Williams, the founder and CEO of Virginia- based Star Scientific Inc. Star was close to launching a new product: Anatabloc. For years, Star had been

evaluating the curative potential of anatabine, an alka- loid found in the tobacco plant, focusing on wheth- er it could be used to treat chronic inflammation. Anatabloc was one of the anatabine-based dietary supplements Star developed as a result of these years of evaluation.

The McDonnells had used Williams’s plane during his campaign, and he wanted to thank Williams over dinner in New York. During dinner, Williams ordered a $5,000 bottle of cognac, and the conversation turned to the gown Mrs. McDonnell would wear to the inauguration. Williams mentioned that he knew Oscar de la Renta and offered to purchase Mrs. McDonnell an expensive custom dress. Following this dinner, the McDonnells and Mr. Williams began a relationship depicted in the following chart.

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continued

McDonnell v U.S. 136 S.Ct. 2355 (2016)

The Governor, Supplement Promotion, Some Loans, a Rolex, an The Governor, Supplement Promotion, Some Loans, a Rolex, an Oscar de la Renta Dress, and Ferrari Rides

Case 6.1

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October 2010 McDonnell plane ride with Williams on Williams’s plane from California to Virginia.

Williams asked for help in promoting Anatabloc; both agreed to “independent testing in Virginia.”

McDonnell agrees to introduce Williams to Dr. William Hazel, Virginia’s secretary of health and human services.

April 2011 Williams took Mrs. McDonnell on a shopping spree; they lunched and shopped at Bergdorf Goodman and visited Oscar de la Renta and Louis Vuitton stores on Fifth Avenue. Williams bought Mrs. McDonnell dresses and a white leather coat from Oscar de la Renta; shoes, a purse, and a raincoat from Louis Vuitton; and a dress from Bergdorf Goodman. Williams spent approximately $20,000 on Mrs. McDonnell during this shopping spree.

Williams sits with the McDonnells at a political rally in New York City that evening.

April 29, 2011 Williams joined the McDonnells for a private dinner at the Governor’s Mansion.

The discussion at dinner centered on Anatabloc and the need for independent testing and studies. McDonnell was “intrigued that [Star] was a Virginia company with an idea,” and he wanted to have Anatabloc studies conducted within Virginia.

Two days after this private dinner, Mrs. McDonnell received an e-mail via Williams that included a link to an article titled “Star Scientific Has Home Run Potential,” which discussed Star’s research and stock. Mrs. McDonnell forwarded this e-mail to her husband.

May 2, 2011 Mrs. McDonnell and Williams met at the Governor’s Mansion to discuss Anatabloc.

Mrs. McDonnell began explaining her family’s financial woes— thoughts about filing for bankruptcy, high-interest loans, the decline in the real estate market, and credit card debt. Then, according to Williams, Mrs. McDonnell said, “I have a background in nutritional supplements. and I can be helpful to you with this project, with your company. The governor says it’s okay for me to help you and—but I need you to help me. I need you

Williams called McDonnell to “make sure [he] knew about it” and then cut the checks requested by Mrs. McDonnell.

to help me with this financial situation.” Mrs. McDonnell asked to borrow $50,000. Williams agreed to loan the money to the McDonnells. Mrs. McDonnell also mentioned that she and her husband owed $15,000 for their daughter’s wedding reception. Again, Williams agreed to provide the money.

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May 5, 2011 McDonnell met with Secretary Hazel and Chief of Staff Martin Kent to discuss the strategic plan for the state’s health and human resources office.

McDonnell directed his assistant to forward to Hazel the article about Star that Mrs. McDonnell had earlier brought to his attention.

May 23, 2011 Williams delivers two checks for the amounts discussed on May 2: a $50,000 check made out to Mrs. McDonnell and a $15,000 check that was not made out to anyone but was going to the wedding caterers.

May 28, 2011 Mr. McDonnell expressed his gratitude in a May 28 e-mail to Williams: “Johnnie [sic]. Thanks so much for all your help with my family. Your very generous gift to Cailin was most appreciated as well as the golf round tomorrow for the boys. Maureen is excited about the trip to fla to learn more about the products. . . . Have a restful weekend with your family.”

May 29, 2011 McDonnell, his two sons, and his soon-to-be son-in-law spent the day at Kinloch Golf Club in Manakin– Sabot, Virginia. During this outing, they spent more than seven hours playing golf, eating, and shopping.

June 1, 2011 Mrs. McDonnell traveled to Florida at the start of June to attend a Star- sponsored event at the Roskamp Institute. While there, she addressed the audience, expressing her support for Star and its research. She also invited the audience to the launch for Anatabloc, which would be held at the Governor’s Mansion.

June 1, 2011 Mrs. McDonnell purchased 6,000 shares of Star stock at $5.1799 per share, for a total of $31,079.40.

June 2011 Williams then made a “$100,000 in-kind contributor to the McDonnell campaign and the PAC” and flew the McDonnell children to the resort for a PAC retreat. McDonnell and Williams played golf together during the retreat. A few days later, Williams sent golf bags with brand-new clubs and golf shoes to McDonnell and one of his sons.

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July 2011 McDonnell and his family vacationed at Williams’s multi- million-dollar home at Smith Mountain Lake in Virginia. Williams allowed the McDonnells to stay there free of charge. He also paid $2,268 for the McDonnells to rent a boat. Williams provided transportation for the family: the McDonnell children used Williams’s Range Rover for the trip to the home, and Williams paid more than $600 to have his Ferrari delivered to the home for McDonnell to use.

July 31, 2011 McDonnell drove the Ferrari back to Richmond at the end of the vacation. During the three-hour drive, Mrs. McDonnell snapped several pictures of McDonnell driving with the Ferrari’s top down.

Mrs. McDonnell e-mailed one of the photographs to Williams at 7:47 p.m.

July 31, 2011 At 11:29 p.m., after returning from the Smith Mountain Lake vacation, McDonnell directed Secretary Hazel to have his deputy attend a meeting about Anatabloc with Mrs. McDonnell at the Governor’s Mansion the next day.

August 1, 2011 Hazel sent a staffer, Molly Huffstetler, to the meeting, which Williams also attended.

Williams—with Mrs. McDonnell at his side—told Dr. Clore that clinical testing of Anatabloc in Virginia was important to McDonnell. Williams discussed clinical trials at the University of Virginia (“UVA”) and Virginia Commonwealth University (“VCU”),

After the meeting ended, Mrs. McDonnell noticed the Rolex watch adorning Williams’s wrist. She mentioned that she wanted to get a Rolex for McDonnell. When Williams asked if she wanted him to purchase one for McDonnell, she responded affirmatively.

home of the Medical College of Virginia (“MCV”). Then Williams and Mrs. McDonnell met with Dr. John Clore from VCU, who Williams said was “important, and he could cause studies to happen at VCU’s medical school.”

August 2, 2011 Mrs. McDonnell purchased another 522 shares of Star stock at $3.82 per share, for a total of $1,994.04.

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August 13, 2011 McDonnell and one of his sons returned to Kinloch Golf Club. The bill for this golf outing, which Williams again paid, was $1,309.17.

August 14, 2011 Williams purchased a Rolex from Malibu Jewelers in Malibu, California. The Rolex cost between $6,000 and $7,000 and featured a custom engraving: “Robert F. McDonnell, 71st Governor of Virginia.”

Mrs. McDonnell later took several pictures of McDonnell showing off his new Rolex—pictures that were later sent to Williams via text message.

August 30, 2011 Luncheon at Governor’s Mansion. Invitations bore the Governor’s seal and read, “Governor and Mrs. Robert F. McDonnell Request the Pleasure of your Company at a Luncheon.” Invitees included Dr. Clore and Dr. John Lazo from UVA.

McDonnell thanked the attendees for their presence and “talked about his interest in a Virginia company doing this, and his interest in the product.”

Each place setting featured samples of Anatabloc, and Williams handed out checks for grant applications—each for $25,000—to doctors from various medical institutions.

Fall 2011 Star’s president, Paul L. Perito, began to worry that Star had lost the support of UVA and VCU. In the fall of 2011, Perito was working with those universities to file grant applications. During a particular call with UVA officials, Perito felt the officials were unprepared. According to Perito, when Williams learned about this information, “[h]e was furious and said, ‘I can’t understand it. McDonnell and his wife are so supportive of this and suddenly the administration has no interest.’”

December 2011 Mrs. McDonnell sold all of her 6,522 shares of Star stock for $15,279.45, resulting in a loss of more than $17,000.

This allowed McDonnell to omit disclosure of the stock purchases on a required financial disclosure form known as a Statement of Economic Interest (filed on January 16 2012).

January 7, 2012 McDonnell made another golf visit to Kinloch Golf Club, running up a $1,368.91 bill that Williams again paid.

Outing not disclosed, and other golf outings not disclosed on other 2011 golf trips.

January 20, 2012

Mrs. McDonnell purchased 6,672 shares of Star stock at $2.29 per share, for a total of $15,276.88.

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January 2012 Williams discussed the Mobo properties with Mrs. McDonnell, who wanted additional loans.

Williams agreed to loan more money. Mrs. McDonnell was “furious when [Williams] told her that [they were] bogged down in the administration.” Later, Mrs. McDonnell called Williams to advise him that she had relayed this information to McDonnell, who “want[ed] the contact information of the people that [Star] [was] dealing with at [UVA].”

February 3, 2012 Mrs. McDonnell requested another $50,000 loan.

February 6, 2012 Williams writes a check to Mobo on $50,000.

Mrs. McDonnell received an e-mail, as requested by McDonnell, containing the names of the UVA officials with whom Star had been working. She forwarded this list to McDonnell and his chief counsel, Jacob Jasen Eige, on February 9.

February 10, 2012

While riding with McDonnell, Mrs. McDonnell followed up with Eige:

“Pls call Jonnie today [and] get him to fill u in on where this is at. Gov wants to know why nothing has developed w studies after Jonnie gave $200,000. I’m just trying to talk w Jonnie. Gov wants to get this going w VCU MCV. Pls let us know what u find out after we return. . . .”

February 16, 2012

McDonnell e-mailed Williams to check on the status of certificates and documents relating to loans Williams was providing for Mobo.

Six minutes after McDonnell sent this e-mail, he emailed Eige: “Pls see me about anatabloc issues at VCU and UVA. Thx.”

February 2012 Governor’s Mansion reception for the doctors and Star officials. McDonnell, Mrs. McDonnell, Williams, and two doctors went out for a $1,400 dinner on Williams’s dime.

During dinner, the diners discussed Anatabloc. Mrs. McDonnell talked about her use of Anatabloc, and McDonnell asked one of the doctors—a Star consultant— “How big of a discovery is this?”

Mrs. McDonnell invited the two doctors to stay at the Governor’s Mansion for the evening—an offer the doctors accepted.

May 18, 2012 McDonnell sent Williams a text message concerning yet another loan: “Johnnie. Per voicemail would like to see if you could extend another 20k loan for this year. Call if possible and I’ll ask mike to send instructions. Thx bob.”

Twelve minutes later, Williams responded, “Done, tell me who to make it out to and address. Will FedEx. Jonnie.”

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May 18–26, 2012

McDonnell and his family vacationed at Kiawah Island in South Carolina. The $23,000 vacation was a gift from William H. Goodwin Jr., characterized as a personal friend of the McDonnells.

Not disclosed on McDonnell’s 2012 Statement of Economic Interest.

April–July 2012 McDonnell e-mailed and texted Williams about Star stock on four occasions, each coinciding with a rise in the stock price.

July 3, 2012 Williams texts McDonnell: “Johns Hopkins human clinical trials report on Aug. 8. If you need cash let me know. Let’s go golfing and sailing Chatham Bars inn Chatham mass labor day weekend if you can. Business about to break out strong. Jonnie.”

Labor Day weekend 2012

Williams spent more than $7,300 on this vacation for the McDonnells. Williams paid the McDonnells’ share of a $5,823.79 bill for a private clambake.

Also joining in on the weekend excursion was one of the doctors who attended the February health care leaders reception, whom Williams invited in an attempt “to try to help get the Governor more involved.”

December 12, 2012

McDonnell learns of his wife’s repurchase of Star shares:

“[I]t was her money that she had used for this. But I told her, you know, “Listen. If you have this stock, you know, this is”—“again, triggers a reporting requirement for me. I can do it, but I need”—“I just don’t”—“I really don’t appreciate you doing things that really”—“that affect me without”—“without me knowing about it.”

December 25, 2012

Mrs. McDonnell transferred her Star stock to her children as a gift.

Williams gave the McDonnell’s daughter, Jeanine, a $10,000 wedding gift.

Stock need not be disclosed for the 2012 Statement of Economic Interest.

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Mr. McDonnell was convicted of conspiracy to commit honest-services wire fraud, three counts of honest-services wire fraud, conspiracy to obtain prop- erty under color of official right, and six counts of obtaining property under color of official right.1 He appealed. The Fourth Circuit affirmed and he appealed. The U.S. Supreme Court granted certiorari.

JUdICIaL OpINION

ROBERTS, Chief Justice (for a unanimous court) The parties agreed that they would define honest

services fraud with reference to the federal bribery statute, 18 U.S.C. § 201. That statute makes it a crime for “a public official or person selected to be a public offi- cial, directly or indirectly, corruptly” to demand, seek, receive, accept, or agree “to receive or accept anything of value” in return for being “influenced in the perfor- mance of any official act.” § 201(b)(2). An “official act” is defined as “any decision or action on any question, matter, cause, suit, proceeding or controversy, which may at any time be pending, or which may by law be brought before any public official, in such official’s offi- cial capacity, or in such official’s place of trust or profit.”

[T]he Government was required to prove that Gover- nor McDonnell committed or agreed to commit an “offi- cial act” in exchange for the loans and gifts from Williams.

The issue in this case is the proper interpretation of the term “official act.” The Government concludes that the term “official act” encompasses nearly any activity by a public official. In the Government’s view, “official act” specifically includes arranging a meet- ing, contacting another public official, or hosting an event—without more—concerning any subject, includ- ing a broad policy issue such as Virginia economic development.

Governor McDonnell, in contrast, contends that statutory context compels a more circumscribed read- ing, limiting “official acts” to those acts that “direct [ ] a particular resolution of a specific governmental deci- sion,” or that pressure another official to do so.

The issue here is whether arranging a meeting, contacting another official, or hosting an event—with- out more—can be a “question, matter, cause, suit, pro- ceeding or controversy,” and if not, whether it can be a decision or action on a “question, matter, cause, suit, proceeding or controversy.”

Although it may be difficult to define the precise reach of those terms, it seems clear that a typical meeting, telephone call, or event arranged by a public official does not qualify as a “cause, suit, proceeding or controversy.”

[W]e conclude that a “question” or “matter” must be similar in nature to a “cause, suit, proceeding or controversy.” Because a typical meeting, call, or event arranged by a public official is not of the same stripe

as a lawsuit before a court, a determination before an agency, or a hearing before a committee, it does not qualify as a “question” or “matter.”

The question remains whether—as the Govern- ment argues—merely setting up a meeting, hosting an event, or calling another official qualifies as a decision or action on any of those three questions or matters. Although the word “decision,” and especially the word “action,” could be read expansively to support the Government’s view, our opinion in United States v. Sun–Diamond Growers of Cal., 526 U.S. 398, 119 S.Ct. 1402, 143 L.Ed.2d 576 (1999), rejects that interpretation.

We recognized that “the Secretary of Agriculture always has before him or in prospect matters that affect farmers, just as the President always has before him or in prospect matters that affect college and professional sports, and the Secretary of Education matters that affect high schools.” But we concluded that the existence of such pending matters was not enough to find that any action related to them constituted an “official act.” It was possible to avoid the “absurdities” of convicting individ- uals on corruption charges for engaging in such conduct, we explained, “through the definition of that term,” i.e., by adopting a more limited definition of “official acts.”

Setting up a meeting, hosting an event, or calling an official (or agreeing to do so) merely to talk about a research study or to gather additional information, however, does not qualify as a decision or action on the pending question of whether to initiate the study. Simply expressing support for the research study at a meeting, event, or call—or sending a subordinate to such a meeting, event, or call—similarly does not qualify as a decision or action on the study, as long as the public official does not intend to exert pressure on another official or provide advice, knowing or intend- ing such advice to form the basis for an “official act.”

Of course, this is not to say that setting up a meet- ing, hosting an event, or making a phone call is always an innocent act, or is irrelevant, in cases like this one. If an official sets up a meeting, hosts an event, or makes a phone call on a question or matter that is or could be pending before another official, that could serve as evidence of an agreement to take an official act.

But conscientious public officials arrange meetings for constituents, contact other officials on their behalf, and include them in events all the time. The basic com- pact underlying representative government assumes that public officials will hear from their constituents and act appropriately on their concerns—whether it is the union official worried about a plant closing or the homeowners who wonder why it took five days to restore power to their neighborhood after a storm. The Government’s position could cast a pall of potential prosecution over these relationships if the union had given a campaign contribution in the past or the homeowners invited

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the official to join them on their annual outing to the ballgame. Officials might wonder whether they could respond to even the most commonplace requests for assistance, and citizens with legitimate concerns might shrink from participating in democratic discourse.

This concern is substantial. White House coun- sel who worked in every administration from that of President Reagan to President Obama warn that the Government’s “breathtaking expansion of public- corruption law would likely chill federal officials’ interactions with the people they serve and thus dam- age their ability effectively to perform their duties.”

Because the jury was not correctly instructed on the meaning of “official act,” it may have convicted Governor McDonnell for conduct that is not unlawful.

For that reason, we cannot conclude that the errors in the jury instructions were “harmless beyond a reasonable doubt.” We accordingly vacate Governor McDonnell’s convictions.

Reversed.

CaSe QUeStIONS

1. Give a summary of what was going back and forth between the McDonnells and Mr. Williams.

2. What was Mr. Williams looking to obtain from Governor and Mrs. McDonnell?

3. Why is the term “official act” important on appeal?

deciding What to do with the proposed Regulation After the comment period is over, the agency has three choices about what to do with the proposed rules. The first choice is simply to adopt the rules. The second choice is to modify the proposed rules and go through the process of public com- ment again. If the modification is minor, however, the APA allows the agency to adopt a modified version of the rule without going through the public comment period again. The final choice of the proposing agency is to withdraw the rule. Some rules have so many comments pointing out their impracticability, inflexi- bility, or prematurity that they are withdrawn from the promulgation process. For example, when the EEOC proposed guidelines on religious harassment in the workplace, including regulations on employees wearing necklaces with crosses on them, business comments and concerns about those guidelines resulted in the U.S. Senate passing a resolution urging the EEOC to drop the guidelines. Reli- gious and business groups flooded the EEOC with more than 100,000 letters of protest. EEOC attorneys advised that banning such personal expression, a form of speech, would result in a flood of First Amendment suits. The EEOC with- drew the proposed rules. EEOC spokesman Mike Widomski explained that “the public outcry and the number of comments that were received” triggered the reversal. Public comments and input have an impact in the regulatory process.

Ethical Issues

Despite what the court concluded in McDonnell v U.S., evaluate the ethics of the McDonnells and Williams’s conduct.

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200 part 2 Business: Its Regulatory Environment

Court and Legislative Challenges to proposed Rules Even after the rule is promulgated, those who are affected by the rule can chal- lenge the validity of the rules in court. An administrative rule can be challenged on several different grounds.

The Arbitrary and Capricious Standard for Challenging an Agency Action. The first ground on which to challenge an agency rule is that it is arbitrary, capricious, an abuse of discretion, or in violation of some other law. This standard is generally applied to informal rulemaking and simply requires the agency to show evidence to support the proposed rule. Without such evidence, the rule can be held to be arbitrary and capricious. Hornbeck Offshore Services, L.L.C. et al. v Salazar (Case 6.2) addresses the issue of whether an agency’s action is arbitrary and capricious.

Hornbeck Offshore Services, L.L.C. et al. v Salazar 696 F. Supp. 2d 627 (E.D. La. 2010)

Drilling Down to the Facts Supporting a Rule

Case 6.2

FaCtS

Hornbeck and others (plaintiffs) provide services to sup- port offshore oil and gas drilling, exploration, and pro- duction activities in the Gulf of Mexico. Kenneth Salazar is the secretary of the Department of Interior (DOI), a federal agency that includes the Minerals Management.

Following the BP Deepwater Horizon drilling platform explosion on April 20, 2010, and the resulting devastation and unprecedented disaster, President Obama asked DOI to conduct a study to determine what steps needed to be taken to prevent another problem with oil rigs in the Gulf.

DOI did a 30-day study, consulting respected experts from state and federal governments, academic insti- tutions, and industry and advocacy organizations. On May 27, 2010, DOI issued a report that recommended a six-month moratorium on permits for new wells and an immediate halt to drilling operations on the 33 permitted wells in the Gulf of Mexico. The DOI report also stated that “the recommendations contained in this report have been peer-reviewed by seven experts identified by the National Academy of Engineering.” The experts pointed- ly observed this statement was misleading and called it a “misrepresentation.” Although the experts agreed with the safety recommendations contained in the body of the main Report, five of the National Academy experts and three of the other experts publicly stated that they “do not agree with the six month blanket moratorium” on floating drilling. They envisioned a more limited kind of moratorium, but a blanket moratorium was added after their final review and was never agreed to by them. The plaintiffs moved for a preliminary injunction against the DOI moratorium.

JUdICIaL OpINION

FELDMAN, District Judge The Administrative Procedure Act authorizes judi- cial review of final agency action. The APA cautions that an agency action may only be set aside if it is “arbitrary, capricious, an abuse of discretion, or not otherwise in accordance with law.” The reviewing court must decide whether the agency acted within the scope of its authority, “whether the decision was based on a consideration of the relevant factors and whether there has been a clear error of judgment.”

Normally, an agency rule would be arbitrary and capricious if the agency has relied on factors which Congress has not intended it to consider, entirely failed to consider an important aspect of the problem, offered an explanation for its decision that runs counter to the evidence before the agency, or is so implausible that it could not be ascribed to a difference in view or the product of agency expertise.

After reviewing the Secretary’s Report and the Mor- atorium Memorandum, the Court is unable to divine or fathom a relationship between the findings and the immense scope of the moratorium. The Report describes the offshore oil industry in the Gulf and offers many compelling recommendations to improve safety. But it offers no time line for implementation. The Report patently lacks any analysis of the asserted fear of threat of irreparable injury or safety hazards posed by the 33 permitted rigs also reached by the moratorium. It is incident-specific and driven: Deepwater Horizon and BP only. None others. While the Report notes the increase in deepwater drilling over the past ten years and the increased safety risk associated with deepwater drilling,

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Chapter 6 Administrative Law 201

the parameters of “deepwater” remain confused. And drilling elsewhere simply seems driven by political or social agendas on all sides. The Report seems to define “deepwater” as drilling beyond a depth of 1,000 feet by referencing the increased difficulty of drilling beyond this depth; similarly, the shallowest depth referenced in the maps and facts included in the Report is “less than 1,000 feet.” But while there is no mention of the 500 feet depth anywhere in the Report itself, “deepwater” [is now anything] more than 500 feet.

The Court recognizes that the compliance of the 33 affected rigs with current government regulations may be irrelevant if the regulations are insufficient or if MMS, the government’s own agent, itself is suspected of being corrupt or incompetent. Nonetheless, the Secretary’s determination that a six-month moratorium on issuance of new permits and on drilling by the 33 rigs is neces- sary does not seem to be fact-specific and refuses to take into measure the safety records of those others in the Gulf. There is no evidence presented indicating that the Secretary balanced the concern for environmental safety with the policy of making leases available for develop- ment. There is no suggestion that the Secretary consid- ered any alternatives: for example, an individualized suspension of activities on target rigs until they reached compliance with the new federal regulations said to be recommended for immediate implementation.

The Deepwater Horizon oil spill is an unprece- dented, sad, ugly, and inhuman disaster. What seems clear is that the federal government has been pressed by what happened on the Deepwater Horizon into an

otherwise sweeping confirmation that all Gulf deep- water drilling activities put us all in a universal threat of irreparable harm. While the implementation of reg- ulations and a new culture of safety are supportable by the Report and the documents presented, the blanket moratorium, with no parameters, seems to assume that because one rig failed and although no one yet fully knows why, all companies and rigs drilling new wells over 500 feet also universally present an immi- nent danger.

[T]he Court has found the plaintiffs would likely succeed in showing that the agency’s decision was arbitrary and capricious. An invalid agency decision to suspend drilling of wells in depths of over 500 feet simply cannot justify the immeasurable effect on the plaintiffs, the local economy, the Gulf region, and the critical present-day aspect of the availability of domes- tic energy in this country.

The plaintiffs’ motion for preliminary injunction is granted.

CaSe QUeStIONS

1. Why is the problem with the experts’ objections important in determining whether DOI’s morato- rium was arbitrary and capricious?

2. What is the significance of the difference between the factual information in the report and the terms of the moratorium?

3. What does the court see as alternatives to the moratorium?

The Substantial Evidence Standard for Challenging an Agency Action. A second the- ory for challenging an agency’s regulation is that the regulation is unsupported by substantial evidence. This substantial evidence test is applied in the review of formal and hybrid rulemaking. Where the arbitrary and capricious standard simply requires some proof or basis for the regulation, substantial evidence requires that more convincing evidence exist in support of the regulation than against it.

Failure to Comply with the APA in Challenging an Agency Action. A third ground on which to challenge an agency’s regulation involves the rule that a regulation can be set aside if the agency did not comply with the APA requirements of notice, publication, and public comment or input. The procedures for rulemaking must be followed in order for the regulatory process and resulting rules to be valid. An agency that seeks public comment for the purposes of drafting regulations cannot then turn the proposed regulations into agency rules after the comment period. The promulgated rules must be the result of the proceedings.

The Constitutional Standard for Challenging an Agency’s Action. Another basis for challenging a regulation is that the regulation is unconstitutional. Many challenges based on constitutional grounds deal with regulations that give an agency authority to search records or that impose discriminatory requirements

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202 part 2 Business: Its Regulatory Environment

How Companies Respond to Regulations

When companies take federal agencies to court, they do so as a last resort because the companies remain subject to the agen- cy’s regulation after the litigation ends, even when the companies win. Litigation, such as that in the Hornbeck case, is

undertaken only after careful study and some assurance that the companies can win as well as an examination of what is lost if they do not litigate. In this case, the loss of drilling rights was worth the litigation risk.

Business Strategy

for licensing professionals. For example, a requirement of a minimum residency period before allowing an applicant to become licensed in a particular profes- sion has been challenged successfully. Zoning board regulations that discrim- inate against certain classes or races as to the use of property have also been successfully challenged as unconstitutional. Further, broadcasters often depend on freedom of speech—the First Amendment—to challenge new Federal Com- munication Commission (FCC) regulations. For example, in FCC v Fox Television Stations, Inc., 556 U.S. 502 (2009), the court dealt with a problem on television decency standards. During the 2002 Billboard Music Awards, broadcast by Fox Television, the singer Cher exclaimed during an unscripted acceptance speech, “I’ve also had my critics for the last 40 years saying that I was on my way out every year. Right. So f * * * ’em.” At the 2003 Billboard Music Awards, Nicole Richie made the following unscripted remark while presenting an award: “Have you ever tried to get cow s* * * out of a Prada purse? It’s not so f * * * ing simple.” The third incident involved an episode of NYPD Blue, a regular television show broadcast by ABC Television Network in which there was brief nudity in one episode. The FCC found that the networks had broadcast content that violated decency standards and fined them $1.4 million. The networks appealed, and the U.S. Supreme Court held that the standards were unclear and the fines not related to warnings about issues related to decency standards. The Court held that the FCC could have decency standards but that it needed to make them clear to networks before it could fine them for violations. [FCC v. Fox Television 132 S.Ct. 2307 (2012)]

The Ultra Vires Standard for Challenging an Agency’s Action. Another theory for chal- lenging a regulation in court is ultra vires, a Latin term meaning “beyond its pow- ers.” An ultra vires regulation is one that goes beyond the authority given to the agency in its enabling act. Although most agencies stay clearly within their author- ity, if an agency tries to change the substance and purpose of the enabling act through regulation, the regulations would be ultra vires. For example, the intent of

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Chapter 6 Administrative Law 203

The FDA was challenged by tobacco compa- nies for its new rules that require the tobacco companies to put one of the FDA’s 12 picture labels on its packaging. The tobacco com- panies argued that their First Amendment rights were violated by the rules, forcing them to speak in a certain way using govern- ment-mandated materials. The new labels were promulgated by both the FDA and the Department of Health and Human Ser- vices (HHS) pursuant to authority granted by Congress in 2009 under the Family Smoking Prevention and Tobacco Control Act.

Under the law, the following nine textu- al statements were to be included on ciga- rette labels:

WARNING: Cigarettes are addictive.

WARNING: Tobacco smoke can harm your children.

WARNING: Cigarettes cause fatal lung disease.

WARNING: Cigarettes cause cancer.

WARNING: Cigarettes cause strokes and heart disease.

WARNING: Smoking during pregnancy can harm your baby.

WARNING: Smoking can kill you.

WARNING: Tobacco smoke causes fatal lung diseases in nonsmokers.

WARNING: Quitting smoking now greatly reduces serious risks to your health.

The act required that these warnings and graphic labels take up 50% of the cigarette package label and of all cigarette ads.

After publishing the proposed rule and receiving more than 1,700 comments, the FDA published its final rule in June 2011. Explain how the tobacco companies could challenge the rules. Discuss whether the rules will be set aside.

[In re R.J. Reynolds Tobacco Company, et al. v FDA et al., 696 F.3d 1205 (D.C. Cir. 2012);

see also American Meat Institute v. U.S. Dept. of Agriculture, 760 F.3d 18 (D.D.C. 2014) ]

THINK: The arbitrary and capricious and substantial evidence doctrines require that any agency action, whether a promulgation of a rule or its withdrawal, be supported by evidence and APA processes. That process requires some evidence related to the ac- tion taken or rule promulgated. There must be a full public airing of the issues. Whatever labels and disclosures the agency requires must be supported by evidence.

APPLY: In this case study, the court held initially that the use of pictures and con- clusions is a form of interpretation and not really scientifically grounded statements about the health effects of smoking.

ANSWER: The purpose of the APA require- ments is to curb the emotion of the mo- ment and ensure that agencies do not take action without having followed a process for input and before obtaining evidence that the actions taken are necessary. Ini- tially, the court concluded that the FDA had gone too far in its zeal to warn smokers, stepping beyond the science and into emo- tional appeals, noting:

The graphic images here were neither designed to protect the consumer from confusion or deception, nor to increase consumer awareness of smoking risks; rather, they were crafted to evoke a strong emotional response calculated to provoke the viewer to quit or never start smoking.

However, in the second case cited, the court reversed this stance and overruled itself holding that te requirements could be imposed because there was a gov- ernment interest in correcting decep- tion that allowed a mandate for ad and packaging disclosure of purely factual information.

Consider . . . 6.3

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204 part 2 Business: Its Regulatory Environment

the 1933 Securities Act was to provide full disclosure to investors about a securities sale. The SEC could not, on the basis of its authority, pass a rule that eliminated securities registration in favor of an unregulated securities market. In Massachusetts v EPA, 549 U.S. 497 (2007), the court dealt with greenhouse gases as well as their reg- ulation within the context of challenges to the EPA based on ultra vires, substantial evidence, and the administrative regulation process. Uniquely, the agency’s defense was that the actions groups were demanding were ultra vires. However, the court held that the EPA had the authority to regulate anything that involved air quality.

6-4c proactive Business Strategies in Regulation

Some administrative regulations can be eliminated through the use of legislation. In an enabling act called a sunset law, Congress creates an agency for a limited period of time during which the agency must establish its benefits and other justifi- cation for its continuation. The enabling act may provide for an audit to determine effectiveness after the agency has been in existence for two years. Without renewal by Congress, the “sun sets” on the agency, and it is terminated. Some businesses lobby for the creation of sunset agencies to better control the number of agencies and their effectiveness.

Some agencies’ power is controlled through congressional purse strings. With zero-based budgeting, the agency does not automatically receive a budget amount but rather starts with a zero budget each year and then is required to jus- tify all its needs for funds. This type of control gives Congress some say each year in how the agency is operating. For example, the budget could be renewed only on the condition that the agency not promulgate certain regulations opposed by Congress.

6-4d Informal Rulemaking

The process for informal rulemaking is the same as that for formal rulemaking, with the exception that no public hearings are held on the rule. The only input from the public comes in the form of comments, using the same procedures dis- cussed earlier.

The use of snowmobiles in Yellowstone and Grand Teton National Parks was first permit- ted in 1963, and their use has been a topic of ongoing concern because of their impact on park resources. In 2003, the Department of the Interior (DOI) and various groups, in- cluding snowmobile manufacturers and recreationalists as well as environmental groups, reached a settlement allowing 950 snowmobiles per day in Yellowstone, with similar restrictions in Jackson Hole. The 2003 negotiated rule was challenged and ruled arbitrary and capricious because DOI had not performed the requisite studies for the negotiated rules. [Int’l Snowmobile Mfrs. Ass’n v Norton, 340 F. Supp. 2d 1249, 1266 (D.Wyo. 2004)]

In 2004, NPS promulgated a temporary rule that contained a “sunset clause,” pro- viding its snowmobile authorization would expire at the conclusion of the 2006–2007 winter season. The 2004 temporary rule authorized 720 snowmobiles per day in Yellowstone, 50 per day on the Continen- tal Divide Snowmobile Trail, 50 per day on Grassy Lake Road, and 40 per day on Jack- son Lake. [69 Fed. Reg. 65348 (Nov. 10, 2004)] The 2004 temporary rule triggered litigation by opponents in Washington, D.C., and proponents in Wyoming. The temporary rule survived both challenges. [The Fund for Animals v Norton, 390 F. Supp. 2d 12 (D.D.C.2005)]

Consider . . . 6.4

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Chapter 6 Administrative Law 205

6-5 Business Rights in Agency Enforcement Action

Administrative agencies not only make the rules; they enforce them. In so doing, the agencies are also responsible for adjudicating disputes over the scope or inter- pretation of the rules. Exhibit 6.8 is a chart of the steps involved in agency enforce- ment and adjudication.

6-5a Licensing and Inspections

Much of an administrative agency’s role in enforcement is carried out by requiring the submission of certain types of paperwork. Many agencies issue licenses or per- mits as a way to enforce the law. For example, state administrative agencies may require building contractors to be licensed so that their dues can finance a recov- ery fund for the victims of bankrupt or negligent contractors. The idea behind the licensing and permit method of enforcement is to curtail illegal activity up front and also to have records in case problems arise.

Agencies also have the authority to conduct inspections, such as when an agency responsible for restaurant licenses inspects restaurant facilities to check for health code violations. The Occupational Safety and Health Administra- tion (OSHA) at the federal level has the authority to inspect plants to check for

After the 2004 temporary rule ex- pired under the sunset provision, DOI (with NPS) promulgated what it intended to be a permanent rule in 2007. The 2007 rule allowed 540 snowmobiles per day in Yellowstone, 0 per day on the Continen- tal Divide Snowmobile Trail, 25 per day on Grassy Lake Road, and 40 per day on Jackson Lake. The proponents and oppo- nents again filed simultaneous challenges in Wyoming and Washington, D.C. The Washington, D.C., court ruled first, hold- ing the 2007 rule arbitrary and capricious. [Greater Yellowstone Coal v Kempthorne, 577 F. Supp. 2d 183, 210 (D.D.C. 2008)] Although the Washington, D.C., court be- lieved the 2007 rule allowed too many snowmobiles in the parks, the court did not set forth a maximum number of snowmo- biles that could enter the parks while NPS worked to promulgate a new rule. Thereaf- ter, the Wyoming court issued an order stat- ing its disagreement with the Washington, D.C., court’s ruling but declining to issue a ruling contrary to that of the D.C. court. Because the Wyoming court believed the D.C. court’s ruling did not address what

should happen to snowmobiles in the parks while NPS formulated a new rule, the Wyoming court held that the 2004 rule, as the last valid rule, should be reinstated until NPS could promulgate a new rule. While the litigation regarding the 2007 rule was ongoing, NPS began work on a new rule.

The Wyoming court’s ruling reinstating the 2004 rule became the first decision to reach an appellate court. Before the court could issue a decision, NPS published the 2009 rules. The court ruled the case was moot. [Wyoming v U.S. Dep’t of Interior, 587 F.3d 1245, 1247 (10th Cir. 2009)] How- ever, the 2009 rules ended up in the Wyo- ming court, and the court held that those challenging the rules lacked standing be- cause they had not shown that they had standing through economic harm resulting from the snowmobile restrictions. [Wyo- ming v U.S. Dept. of Interior, 674 F.3d 1220 (10th Cir. 2014)]

What should be the next step for those who are affected by the rule who wish to challenge the rule? Suggest some theories for them to use.

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206 part 2 Business: Its Regulatory Environment

Ethical Issues

In 2010, SeaWorld trainer Dawn Brancheau was killed when she was pulled underwater by Tilikum, a whale at the park. OSHA com- pliance officer Lara Padgett participated in the OSHA investigation of Ms. Brancheau’s death. OSHA issued SeaWorld willful viola- tions after concluding its investigation into Ms. Padgett’s death.

In 2014, SeaWorld delivered a com- plaint to the Department of Labor that accused Ms. Padgett of ethics violations in her investigation. The complaint alleges that Ms. Padgett had improper contacts with animal-rights activists as well as the makers of the film, Blackfish, a 2013 Sun- dance Film Festival entry that has been available on CNN and Netflix. The complaint included photos of Ms. Padgett at the Sun- dance premiere as well as with the film’s makers at other times. The complaint also alleged that Ms. Padgett had transferred confidential investigation documents to one of the film’s producers. Ms. Padgett stayed with the film crew while at Sundance,

something the film’s producer said was due to a “housing shortage.”

SeaWorld’s six-page complaint includ- ed 200 pages of exhibits, including some posts from Ms. Padgett on social media such as, “Wow . . . Take that Sea World [sic]!!!! They’ve got to be getting nervous now.” The post was written in July 2013 after Blackfish opened in Europe.

OSHA pledged to look into the allega- tions. SeaWorld’s complaint alleges that Ms. Padgett “violated the Standards of Ethical Conduct for government employ- ees . . . as well as other requirements of federal law.” OSHA’s Office of the Inspec- tor General had begun an investigation in January 2014 when photos of Ms. Padgett with those associated with the film first emerged. One of the photos showed Ms. Padgett with those from the film in a “Char- lie’s Angels” posing with air guns at the New York City premiere of Blackfish.

Relying on Chapter 2, discuss any eth- ical violations you see in the facts alleged.

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Exhibit 6.8 Steps for administrative agency enforcement and adjudication

Nonprosecuting: 1. Regulation 2. Licensing 3. Inspections

Prosecution

Consent Decrees

Appeal of Agency Action

1 2 3

4 5 6

Hearings

Penalties and Sanctions

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Chapter 6 Administrative Law 207

violations of OSHA standards. This power of inspection at unannounced times is an enforcement tool by itself and provides strong incentive to comply with regula- tions. A business can refuse an inspection, but an agency can obtain a warrant and return for a mandatory inspection.

6-5b prosecution of Businesses

Administrative agencies are also given the authority to prosecute violators. These agency prosecutions, however, are not traditional criminal prosecutions; the sanc- tions imposed for agency violations are not jail terms but rather fines, penalties, and injunctions, which are civil penalties, not criminal ones. For example, in the case of false advertising—a violation of Federal Trade Commission (FTC) rules—the agency could impose restitution as a sanction: the violator would have to reimburse all those individuals who bought the product based on false advertising. In some cases, an agency may merely want a violator to stop certain conduct and promise not to engage in that type of conduct again.

6-5c Beginning enforcement Steps

Regardless of the remedy an agency seeks, all action begins when the agency issues a complaint against the violating party. The complaint describes when and what the company did and why it is a violation.

Once a complaint is filed, an agency can negotiate with a party for an order or proceed to a hearing to obtain an order from an administrative law judge. The rem- edies in an order vary according to the type of violation and whether it is ongoing. The FTC could—and typically does—order companies running deceptive ads to stop using the ads and promise not to use them again in the future. These sanc- tions usually come in the form of an injunction, which is a court order that pro- hibits specifically described conduct. Many statutes are unclear about the extent of authority an agency is given in enforcement proceedings and what types of sanc- tions an agency can impose for violations. The authority to assess civil penalties, for example, varies from agency to agency.

6-5d Consent decrees

Rather than go through a hearing and the expense of the administrative process, some companies agree to penalties proposed by an agency. They do so in a docu- ment called a consent decree, which is comparable to a nolo contendere plea in the criminal system. The party does not admit or deny a violation but simply negotiates a settlement with the administrative agency. The negotiated settlement includes the same types of sanctions the agency would have the power to impose if the case went to a hearing. The agency may be willing to give up a little in exchange for the violator’s willingness to settle and save the agency the time and costs of full prose- cution. The consent decree is a contract between the charged party and the regula- tory agency. Exhibit 6.9 provides an example of an FTC consent decree.

6-5e Hearings

If the parties cannot reach an agreement through a consent decree, the question of violations and penalties will go to an administrative hearing, which is quite different from the litigation procedures described in Chapter 4. This type of hearing does not involve a jury. The plaintiff or prosecutor is the administrative agency, represented

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208 part 2 Business: Its Regulatory Environment

Exhibit 6.9 excerpts from an FtC Consent decree

In the matter of the National Media Group, Inc. et al. Consent Order, etc., in regard to Alleged Violation of The Federal Trade Commission Act

This consent order, among other things, requires a King of Prussia, Pa. firm and a corporate officer engaged in the advertising and sale of “Acne-Statin,” an acne “treatment,” to cease disseminating or causing the dissemination of advertisements that represent that Acne-Statin cures acne, eliminates or reduces the bacteria and fatty acids responsible for acne blemishes, and is superior to all other acne preparations and soap for the antibacterial treatment of acne. . . . Additionally, they are required to establish an independent, irrevocable trust account containing sixty thousand dollars ($60,000) to be used to pay half of all requests for restitution by Acne-Statin purchasers; and obligated to conduct and be totally responsible for the administration of the restitution program.

(The original complaint appeared here.)

Order

It is ordered, That respondents, The National Media Group, Inc. a corporation . . . and the corporate respondent’s officers, agents, representatives, and employees . . . do forthwith cease and desist from:

A. Disseminating or causing the dissemination of any advertisement by means of the United States mails or by any means in or affecting commerce . . . which directly or indirectly:

1. Represents that use of Acne-Statin will cure acne or any skin condition associated with acne.

2. Represents that Acne-Statin will eliminate or reduce the bacteria responsible for pimples, blackheads, whiteheads, or other acne blemishes or any skin condition associated with acne.

3. Represents that Acne-Statin will eliminate or reduce the fatty acids responsible for pimples, blackheads, whiteheads, other acne blemishes or any skin condition associated with acne.

4. Represents that Acne-Statin is superior to prescription or over-the-counter antibacterial acne preparations in the treatment of acne.

5. Represents that Acne-Statin is superior to soap in the antibacterial treatment of acne.

It is further ordered, That:

A. Within thirty (30) days of final acceptance of this consent order by the Federal Trade Commission (hereinafter the ”Commission”), respondent, The National Media Group, Inc., shall establish an interest-bearing trust account containing the sum of sixty thousand dollars ($60,000), for the purpose of paying restitution to Acne-Statin purchasers. . . .

by one of its staff attorneys. The defendant is the person or company accused of vio- lating an administrative regulation. The judge is called an administrative law judge (ALJ) at the federal level and is called a hearing examiner or hearing officer in some state-level agencies. The defendant can be represented by an attorney.

An ALJ has all the powers of a judge. He or she conducts the hearing, rules on evidentiary and procedural questions, and administers oaths. The ALJ also has certain unique powers, such as the ability to hold settlement conferences between the parties. The ALJ also has the responsibility of making the decision in the case. That decision is cast in the form of a written opinion that consists of find- ings of facts, conclusions of law, and an order specifying the remedies and sanctions.

The ALJ also has the ethical responsibilities of a trial judge; that is, the judges are prohibited from having ex parte contacts, which are contacts with one side or one of the parties in the dispute without the knowledge of the others. Staff mem- bers of the agency are prohibited from supplying information to the ALJ except when they are witnesses or attorneys in the hearings.

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Chapter 6 Administrative Law 209

Administrative hearings can have as participants more than just the agency and the party charged with a violation. Other parties with an interest in the case can intervene. These intervenors file motions to intervene and are usually per- mitted to do so at any time before the start of a hearing. Typical intervenors are industry organizations: Should the FCC hold hearings on charges against a tele- vision station on the content of ads on the station, the National Association of Broadcasters would probably want to intervene in the hearing.

The rules of evidence and procedure are somewhat relaxed in administrative hearings. Agencies involved in the hearings can issue subpoenas for documents, but the subpoenas can only be enforced by the courts. All of the investigation and adjudication processes of administrative agencies are subject to the constitutional standards of due process, which include the following rights: right to notification of the charges, right to notification of the hearing day, right to present evidence, right to be represented by an attorney, right to an impartial judge, right to a deci- sion based on the law or regulation, and right to cross-examine the witnesses of the agency or intervenors.

6-5f administrative Law of appeals

Once the ALJ has issued a decision, the decision can be appealed. However, the appel- late process in administrative law is slightly different. The first step in an appeal of an ALJ decision is not to a court but to the agency itself. This step gives the agency a chance to correct a bad decision before the courts become involved.

The appeal is to the next higher level in the agency. For example, in the FTC, an appeal of an ALJ’s decision goes to the five commissioners of the FTC for reconsideration.

In some agencies, the structure is such that appeals may be made to more than one person in the structure. Those appealing an ALJ decision, however, must go through all the required lines of authority in the agency before they can go to court. This process is known as exhausting administrative remedies. An appeal made before administrative remedies are completed will be rejected for the failure to exhaust available administrative processes and remedies.

The exhaustion rule does allow some exceptions. A decision by a zoning board to allow construction of a building project could go directly to court because, if the building is started but the decision to allow construction later overruled, the builder is damaged. Alternatively, if the building is not started, other purchasers of the land and the builder are harmed. In other words, fast action is required to maintain all parties’ positions.

If an agency has gone beyond its enabling act, a party can also go directly to court. This matter is more of a challenge to a regulation than it is to the agency’s decision, and direct appeal is therefore permitted.

Finally, an agency decision can be appealed directly to court if exhaustion of administrative remedies would be futile, as evidenced by public statements of officials of the agency. When the FTC was trying to develop rules on children’s TV advertising, for example, a group of interested parties brought a court action to have then-FTC chairman Michael Pertschuk removed from the rulemaking pro- cess because he had indicated strong feelings in the press about his position. It would have been futile to try administrative remedies because the appeal would have been taken to the party they were trying to remove.

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210 part 2 Business: Its Regulatory Environment

A decision of a federal administrative agency is appealed to one of the U.S. courts of appeals (as indicated in Chapter 3). An appellate court can sim- ply affirm an agency action, find that an agency has exceeded its authority, find that an agency has violated the U.S. Constitution, or rule that an agency has acted arbitrarily or that an agency’s decision or action is not supported by the evidence. The Hornbeck case (see Case 6.2 earlier in the chapter) is an example of a court’s reversal of administrative agency action in the area of rulemaking.

Exhibit 6.10 provides a summary of the roles of administrative agencies.

Exhibit 6.10 the Roles of administrative agencies

aCtIVItY StepS paRtIeS ReSULtS Passing rules Rule proposed Agency New rules

Comments Consumers Modified rules

Modification, withdrawal, or promulgation Business

Congress

Agency

Withdrawn rules

Enforcement Licensing Agency

Business

Inspections Agency

Courts (if warrant is required)

Business

Search and inspection

Complaints Agency Fines

Penalties

Injunctions

Consent decrees

Hearings

6-6 The Role of Administrative Agencies in the International Market

The United States wins the award for having the most administrative agencies and regulations. Some businesses have argued that the amount of regulation hinders them in the international marketplace. For example, the readability level of reg- ulations, as shown in Exhibit 6.11, demands much time and energy as companies attempt to interpret and comply with the laws.

Many regulators, legislators, and businesses have advocated elimination and streamlining of existing regulations, as well as careful consideration before new regulations are promulgated.

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Chapter 6 Administrative Law 211

Exhibit 6.11 Various Reading Levels of documents and populations

dOCUMeNtS aNd pOpULatIONS GRade LeVeL 1. Love Story 7.64

2. Reading level of U.S. population over age 65 9.71

3. Playboy 11.46

4. Reading level of general U.S. population 11.68

5. Sports Illustrated 12.82

6. Your Medicare Handbook 14.94

7. ERISA Summary Plan Description 15.29

8. Wall Street Journal 16.34

9. Social Security Handbook 17.51

10. Reading level of lawyers 19.00

11. Albemarle (U.S. Supreme Court ruling) 20.30

12. Occupational Safety and Health Act 30.79

13. Employment Retirement Income Safety Act 32.10

14. Section 18 of the Social Security Act 41.04

Sources: Warren S. Blumenfeld et al., “Readability of an ERISA Summary Plan Description vis-à-vis Intended Readership: An Empirical Test of Local Legal Compliance with a Federal Regulation,” paper presented at the Western American Institute for Decision Science Meeting, Reno, Nevada, March 1979; Warren S. Blumenfeld et al., “Readability of the Real Estate Settlement Procedures Act,” paper presented at the Southeastern Regional Business Law Association Meeting, Chapel Hill, North Carolina, October 1980.

Ethical Issues

Some businesses are able to take advantage of one government’s regulations. For exam- ple, the Energy Policy Act of 1992 requires that toilets installed after the act took effect (1994) use only 1.6 gallons of water rather than the nearly century-old standard of 3.5 gallons. As of 2000, about one-fourth of the nation’s toilets were the 1.6-gallon types.

As homeowners have remodeled bath- rooms and replaced older toilets, they have learned that the 3.5-gallon toilets are no longer sold in the United States. However, just across the U.S./Canadian border near Detroit, Canadian hardware stores are doing a land-office business selling 3.5-gallon tanks to U.S. citizens.

Those who are remodeling, and even some who are building new homes, gener- ally install a $100 toilet from Home Depot in order to pass inspection. They then purchase a Canadian toilet, which costs in the neighborhood of $500 to $1,000 for a standard fixture because the demand is so high, and install it. Plumbing stores all over Canada report sales are brisk. In a survey conducted in May 2000, owners of Cana- dian plumbing stores said that they sell, on average, one toilet per day to U.S. citizens via either direct sale or shipment.

Do the citizens break any laws by what they do? Is what they do ethical?

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212 part 2 Business: Its Regulatory Environment

s u m m a r y What is an administrative agency?

• Administrative agency—statutory entity with the ability to make, interpret, and enforce laws

What laws govern the operation of administrative agencies?

• Administrative Procedure Act—general federal law governing agency process and operations

• Government in the Sunshine Act—federal law requiring public hearings by agencies (with limited exceptions)

• Federal Privacy Act—federal law protecting transfer of information among agencies unless done for enforcement reasons

• Freedom of Information Act—federal law provid- ing individuals with access to information held by administrative agencies (with some exemptions such as for trade secrets)

What do administrative agencies do?

• Rulemaking—process of turning proposed regula- tions into actual regulations; requires public input

• Federal Register—daily publication that updates agency proposals, rules, hearing notices, and so forth

• Code of Federal Regulations—federal government publication of all agency rules

• Licensing—role in which an agency screens businesses before permitting operation

Earl Devaney served as the inspector general (IG) for the Department of Interior (DOI) from 1999 to 2009. He later became the auditor for funds dispersed under the Recovery Act of 2009. Mr. Devaney’s reports as IG were known for their forth- rightness, insights, and color. When the Denver office of the Minerals Manage- ment Service of the DOI received an anon- ymous complaint from an employee in the Denver office that asked the IG to look into “ethical issues” there, Mr. Devaney responded. He found that agency employ- ees were accepting lodging, gifts, alcohol, and other perks from industry executives in exchange for favorable treatment for the companies. Mr. Devaney also found that agency employees were having affairs with industry executives.2 The agency employees defended these relationships as “arm’s length.” Mr. Devaney’s report concluded, “Sexual relationships cannot, by definition, be arm’s length.”

Mr. Devaney spoke truth to power in a way that resulted in reorganization of

the DOI. As a result of his investigation of lobbyist Jack Abramoff on behalf of Indian tribes, DOI secretary Gale Norton resigned. In testimony before Congress on his reports and recommendations, Devaney testified, “Short of a crime, anything goes at the highest level of the Department of Interior. Ethics failures on the part of senior department officials— taking the form of appearances of impro- priety, favoritism and bias—have been routinely dismissed with a promise of not to do it again.”

Mr. Devaney was appointed by Presi- dent Obama to oversee the use of $787 billion in federal money under the Amer- ican Reinvestment and Recovery Act. Mr. Devaney served in the role until 2013 when he retired from government ser- vice. He now serves as a consultant to Oversight Systems, an analytics systems company where he will be advising the company on audit and detection pro- cesses to detect fraud in corporate and government organizations.

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Biography earl devaney: an auditor Who Kept Federal agencies Clean

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Chapter 6 Administrative Law 213

Q u e s t i o n s a n d P r o b l e m s

1. Florida State University (FSU) was under investi- gation by the NCAA for various types of violations. FSU created a special website where the NCAA and university officials could communicate, send doc- uments, and post transcripts that were part of the investigation. Associated Press (AP) filed a Freedom of Information Act (FOIA) request with FSU for the release of the information on the special website. FSU refused to release the information, maintaining that because the information and documents were posted on a private website, they were not public records and, therefore, not subject to FOIA requests. Applying the principles of law from this chapter as well as what you have learned about precedent and interpretation, decide whether the court granted the FOIA request. [Associated Press v Florida State University Board of Trustees, National Collegiate Athletic Ass’n v Associated Press, 18 So.3d 1201 (Fla. App. 2009)]

2. The Consumer Product Safety Commission is reconsidering a rule it first proposed in 1997 that would require child-resistant caps on household prod- ucts, including cosmetics. When the rule was first pro- posed, it was resisted by the cosmetics industry and abandoned. However, in May 2001, a 16-month-old baby died after drinking baby oil from a bottle with a pull-tab cap.

The proposed rule would cover products such as baby oil and suntan lotion and any products contain- ing hydrocarbons such as cleansers and spot remov- ers. The danger, according to the commission, is simply the inhalation by children, not necessarily the actual ingestion of the products. Five children have died from inhaling such fumes since 1993, and 6,400 children under the age of five were brought into emer- gency rooms and/or hospitalized for treatment after breathing in hydrocarbons. There is no medical treat- ment for the inhalation of hydrocarbons.

Several companies in the suntan oil/lotion industry have supported the new regulations. The head of a con- sumer group has said, “We know these products cause death and injury. That is all we need to know.”3

What process must the CPSC follow to promulgate the rules? What do you think of the consumer group head’s statement? Will that statement alone justify the rulemaking?

3. Because of overcrowded condit ions at the nation’s airports during the late 1960s, the Fed- eral Aviation Administration (FAA) promulgated a regulation to reduce takeoff and landing delays at airports by limiting the number of landing and takeoff slots at five major airports to 60 slots per hour. The airports were Kennedy, LaGuardia, O’Hare, Newark, and National. At National Airport (Washington), 40 of the 60 slots were given to com- mercial planes, and the commercial carriers allocated the slots among themselves until October 1980. In 1980, New York Air, a new airline, requested some of the 40 slots, but the existing airlines refused to give up any. The secretary of transportation, in response and “to avoid chaos in the skies” during the upcom- ing holidays, proposed a rule to allocate the slots at National. The allocation rule was proposed on Octo- ber 16, 1980, and appeared in the Federal Register on October 20, 1980. The comment period was seven days starting from the October 16, 1980, proposal date. The airlines and others submitted a total of 37 comments to the secretary. However, Northwest Airlines filed suit on grounds that the APA required a minimum of 30 days for a public comment period. The secre- tary argued that the 30-day rule was being suspended for good cause (the holiday season). Who is correct? Should an exception be made, or should the FAA be required to follow the 30-day rule? [Northwest Airlines, Inc. v Goldschmidt, 645 F.2d 1309 (8th Cir. 1981)]

• Inspections—administrative agency role of checking businesses and business sites for compliance

How do agencies pass rules?

• Study issue, develop evidence of the need for the rule

• Public comment period—period in rulemaking process when any individual or business can provide input on proposed regulations

• Promulgation—approval of proposed rules by heads of agencies

• Rule must survive challenges based on stan- dards of “arbitrary and capricious,” “substantial evidence,” “ultra vires,” “procedural errors, and constitutionality.”

How do agencies enforce the law?

• Consent decree—settlement (nolo contendere plea) of charges brought by an administrative agency

• Administrative law judge (ALJ)—overseer of hearing on charges brought by administrative agency

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214 part 2 Business: Its Regulatory Environment

4. AAR Airlift Group, Inc., is a civilian contractor that provides services to the Department of Defense (DOD). The United States Transportation Command (USTC) issued a request for proposals (RFP) to pro- cure airlift services for DOD operations in Africa. AAR submitted a proposal and was awarded the contract. USTC received a FOIA request for information about its contracting processes and was going to release the contract terms with AAR. The contract terms included confidential pricing terms and the contract provided that the information in the contract would be con- sidered “confidential and proprietary information.” FOIA Exemption 4 allows the government to with- hold information that is “commercial or financial,” “is obtained from a third party outside the government,” and is “privileged and confidential.” AAR told USTC that all of its contracts with government and private entities are private and confidential and that it does not release its pricing, particularly line-item pricing, because its competitors would gain an unfair advan- tage in the bidding process. AAR filed a reverse FOIA suit asking that the release of its contract and pricing information be stopped by an injunction. What should the court do and why? [AAR Airlift Group, Inc. v United States Transportation Command, 2015 WL 8215522 (D.C. 2015)]

5. Rhonda Kallman founded a company that produces Moonshot 69, a caffeinated beer. Each bottle of beer con- tains about twice as much caffeine as a can of Pepsi. In 2011, Ms. Kallman, along with three other manufactur- ers, was served with a cease-and-desist notice from the FDA to remove the caffeine from her beer or stop sell- ing the product. Ms. Kallman has said that what the FDA is doing is like Prohibition 2010 and that it has no authority to regulate the sale or production of alcohol. She also indicates that Moonshot 69 is not an energy drink like those that are subject to FDA regulation. She says that agencies should regulate and not ban products. What information could you share with Ms. Kallman that would help determine what the FDA is trying to accomplish?

6. San Diego Air Sports Center (SDAS) operates a sports parachuting business in Otay Mesa, California. SDAS offers training to beginning parachutists and facilitates recreational jumping for experienced parachutists. The majority of SDAS jumps occur at altitudes in excess of 5,800 feet.

The jump zone used by SDAS overlaps the San Diego Traffic Control Area (TCA). Although the air- craft carrying the parachutists normally operate out- side the TCA, the parachutists themselves are dropped through it. Each jump must be approved by the air traffic controllers.

In July 1987, an air traffic controller in San Diego filed an Unsatisfactory Condition Report com- plaining of the strain that parachuting was putting on the controllers and raising safety concerns. The report led to a staff study of parachute jumping within the San Diego TCA. In October 1987, representatives of the San Diego Terminal Radar Approach Con- trol (TRACON) facility met with SDAS operators. In December 1987, the San Diego TRACON sent to SDAS a draft letter of agreement outlining agreed-upon procedures and coordination requirements. None- theless, the San Diego TRACON conducted another study between January 14, 1988, and February 11, 1988, and about two months after the draft letter was sent, the San Diego TRACON withdrew it.

SDAS states that the air traffic manager of the San Diego TRACON assured SDAS that it would be invited to attend all meetings on parachuting in the San Diego TCA. However, SDAS was not informed of or invited to any meetings.

In March 1988, the Federal Aviation Administration (FAA) sent a letter to SDAS informing SDAS that “[e]ffec- tive immediately parachute jumping within or into the San Diego TCA in the Otay Reservoir Jump Zone will not be authorized.” The FAA stated that the letter was final and appealable.

SDAS challenged the letter in federal court on grounds that it constituted rulemaking without com- pliance with required APA procedures. Evaluate SDAS’s challenge to the letter by applying administra- tive law and procedure. [San Diego Air Sports Center, Inc. v Federal Aviation Administration, 887 F.2d 966 (9th Cir. 1989)]

7. Hooked on Phonics is a reading program that departs from the current educational reading phi- losophy of “whole-language learning.” The program emphasizes the more traditional reading process of having children sound out letters and combinations of letters. The Federal Trade Commission (FTC) filed a false advertising complaint against Gateway Edu- cational Products, Inc., the owner of the Hooked on Phonics program. The FTC claimed that Gateway’s television claims that those with reading disabil- ities would be helped “quickly and easily” and that Hooked on Phonics could “teach reading in a home setting without additional assistance” were mislead- ing. Gateway does not feel the claims are false, but it does not want to have bad publicity. What advice can you give Gateway on handling the FTC charges?

8. The Thirty Meter Telescope is a project under con- struction in Hawaii under the direction of Cal Tech (2016) and was given a construction permit by the Hawaii Board of Land and Natural Resources. The

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Chapter 6 Administrative Law 215

telescope is being constructed on the state’s tallest mountain, Mauna Kea, and was challenged by a con- servationist group because the mountain is a conser- vation area. The group says that the Board did not follow due process requirements in issuing the permit. The Hawaii Supreme Court revoked the construc- tion permit. Is due process a basis for challenging the actions of an administrative agency? Discuss whether the actions of an agency can be reversed and why. [Mauna Kea Anaina HOU v Board of Land and Natural Resources, 363 P.3d 224 (Haw. 2015)]

9. The Food and Drug Administration (FDA) is con- cerned about laser eye surgery, noting that an indus- try concerned with correcting vision is spawning joint ventures, holding wine-and-cheese seminars to court potential investors, and creating databases of nearsighted consumers. The corrective laser surgery costs $2,000 per eye and is not covered by insurance. Calls to the available 800 numbers have noted some

dissatisfaction among the 700 patients who’ve had the surgery, including complaints of farsightedness. Further, the only regulation the FDA has in the field covers granting laser manufacturers permission to sell their machines to ophthalmologists. The FDA would like to know more and perhaps control some aspects of patients’ care. Describe the steps the FDA must take.

10. Countrywide, the problem mortgage company that was acquired by Bank of America, was once the largest mortgage lender in the country and the big- gest supplier of mortgages to Fannie Mae’s secondary market program. (Fannie Mae has since collapsed.) Countrywide released information that indicated it made additional loans to Fannie Mae officials at favor- able rates. Referred to as the Friends of Angelo group, these officials received favorable rates and expedited service. The following chart shows the officials, their titles at Fannie Mae, and their loan amounts, rates, and terms.

In the last years before the Countrywide problems and Fannie’s collapse, the two firms reached an agree- ment whereby Countrywide would funnel most of its loans to Fannie in exchange for a special rate. At the time they reached the special arrangement, the “Friends of Angelo” program was created. The FOA, as it was known, gave officials an expedited path for processing as well as a one-point reduction in rate. Former Fan- nie Mae vice chair Jamie Gorelick said, “I don’t believe there was any special treatment given.” However, an employee at the time said, “I know 100 percent she went

through the VIP department.” In response, Ms. Gorelick said, “You’d think if somebody was trying to do me a favor, they would tell me they were doing me a favor, and I am unaware of any such treatment. When I did this transaction, I was decidedly a has-been. I had no favor to give.”4

Apply what you know about conflicts of interest to Ms. Gorelick’s responses to the inquiries about her loan. Did former CEO Daniel Mudd have a conflict? What is the relationship of corporate officers to customers? What is the role of regulators? Senators?

NaMe tItLe aMOUNt Rate teRM Franklin Raines Former Chair $982,253 5.125 10 yrs.

Jamie Gorelick Former Vice Chair $960,149 5.000 10 yrs.

Christopher Dodd Chair, Senate Finance Comm. (Oversight for Fannie Mae)

$506,000 4.250 5 yrs.

James Johnson Former CEO $971,650 3.875 5 yrs.

Franklin Raines Former Chair $986,340 4.125 10 yrs.

Daniel Mudd Former CEO $2,965,000 4.250 7 yrs. Source of Data: Real estate records.

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216 part 2 Business: Its Regulatory Environment

Strategy & the Law When Your Product Is Under Regulatory Scrutiny

The Yamaha Rhino is an off-road vehicle that looks like a golf cart with four-wheel drive. Some have called it an all-terrain cycle (ATC) with a front seat and a steering wheel. With the rise in popu- larity over two decades ago of the ATC, increasing numbers of accidents (100 deaths and 100,000 injuries) resulted in extensive federal regulation of the design of ATCs, including the requirement of four wheels (rather than three). The Consumer Product Safety Commission (CPSC) also required extensive training, disclosures, warnings, and prohibitions on children driving ATCs. However, the Rhino is not subject to the ATC regula- tions because it has a steering wheel rather than han- dlebars. The Rhino is also not subject to federal regula- tions for cars because it meets neither the size nor the structure thresholds for autos.

In this regulatory no-man’s-land, the Rhino has emerged as a popular seller. The vehicle weighs 1,100 pounds, costs $11,000, and has been a popular seller since 2003. The 2008 model was the first of the Rhinos to have doors on the side. Owners say the Rhino offers the comfort of a golf cart but the ability to fit on trails as well as on the back of a pickup truck.

However, there have been 30 deaths caused by Rhino accidents, and there are now 200 lawsuits around the country that seek recovery from Yamaha for injuries caused by what the suits claims is the Rhi- no’s defective design. The Rhino is 54.4 inches long but is narrower than any of its competitors (the design’s goal is to allow the Rhino to fit on trails). The cases involve mostly rollover accidents.

Yamaha has always warned its buyers to wear seat belts and helmets when operating the Rhino. In 2006 and 2007, Yamaha sent out stickers to purchas- ers that read, “Abrupt maneuvers or aggressive driv- ing have caused rollovers—even on flat, open areas.” Yamaha also sent out a letter that offered to install doors on doorless Rhinos and extra handholds. The letter also added that drivers should be at least 16 years old.

The death rate for the Rhino (number of deaths in relation to number of vehicles sold per year) is in 10,000.5 However, the actual death rate for 2006, as provided by Yamaha, was 8 in 10,000. Yama- ha said the death rate stat is skewed because you must include the number of hours operated to have the rate mean anything. Yamaha sold 42,000 Rhi- nos in 2007.

Along with other off-road vehicle manufacturers, Yamaha has formed a voluntary trade association group that has the goal of establishing voluntary safety standards. The Recreational Off-Road Vehicle Associa- tion has already proposed changing the generic name of the vehicles to Recreational Off-Highway Vehicle (ROV) from utility terrain vehicle (UTV). Yamaha and other manufacturers say that many accidents are caused by driver error and recklessness.

What are your obligations when you operate in a loophole area of the law? Is Yamaha liable if it com- plied with any regulations and laws that applied? What is the responsibility of a company to report acci- dents related to its product?

n ot e s 1. Mrs. McDonnell was also convicted, but their appeals were handled separately.

2. In 2010, the DOI found similar issues of conflicts in the Minerals Management Office, which was responsible for the Deepwater Horizon well off the coast of Louisiana. The problems emerged after the explosion at that deepwater offshore rig and the resulting oil leak that damaged the coasts of all the Gulf states.

3. Julian E. Barnes, “Safety Caps Are Considered for Cosmetics,” New York Times, October 10, 2001, pp. C1, C8.

4. Glenn R. Simpson, “Countrywide Made Home Loans to Gorelick, Mudd,” Wall Street Journal, September 25, 2008, p. A10.

5. Melanie Trottman and Christopher Conkey, “U.S. Probes Off- Road Vehicles after a String of Accidents,” Wall Street Journal, November 4, 2008, pp. A1, A16.

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218

Chapter

International Law7 Shakespeare was ahead of his time when he wrote that “the world is your oys-ter.” Today’s global business environment is the dream of economists, who have fostered the notion of free trade since the publication of Adam Smith’s The Wealth of Nations 250 years ago. Trade barriers are down, resources are flowing, and even the smallest businesses are involved in international trade. Trade across borders, however, involves additional issues and laws and carries risks that do not exist in transactions within nations. Litigation across borders is expensive and complex, so businesses must understand the legal environment of inter- national trade, including contracts, customs and duties, and anti-bribery provi- sions, in order to minimize their legal risks. This chapter helps with understanding the laws that influence international business. What and whose statutes affect businesses in international trade? What international agreements affect global businesses? How do businesses deal with the complexities of international con- tracts, disputes, and differing cultures and legal systems?

Update For up-to-date legal and ethical news, go to mariannejennings.com

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219

7-1 Sources of International Law “When in Rome, do as the Romans do” is advice that can be modified for business: When in Rome, follow Roman law. In each country where a business has opera- tions, it must comply with the laws of that nation. Just as each U.S. business must comply with all the tax, employment, safety, and environmental laws of each state in which it operates, each international business must comply with the laws of the countries in which it operates.

7-1a International Law Systems

The various systems of laws can be quite different, and businesses are well advised to obtain local legal counsel for advice on the peculiarities of each nation’s laws. Generally, a nation’s laws are based on one of three types of systems. The United States, like England, has a common law system. Our laws are built on tradition and precedent (see Chapter 1). Not every possible situation is codified; we rely on our courts to interpret and apply our more general statutes and, in many cases, to develop principles of law as cases are presented (as with the common law doctrine of negligence; see Chapter 9).

Other countries rely on civil law or code law. This form of law is the foundation of legal systems in France, Germany, Spain, and other European countries. Code law systems do not rely on court decisions but rely instead on statutes or codes that are intended to cover all types of circumstances and attempt to spell out the law, leaving little need for interpretation.

A third system of law is Islamic law, which is the foundation for laws in some form in 27 countries. Islamic legal systems are based on religious tenets and gov- ern all aspects of life, from appropriate dress in public to remedies for contract

If a foreign country can supply us with a commodity cheaper than we ourselves can make it, better buy it of them with some part of our own industry, employed in a way in which we have some advantage. AdAm Smith The Wealth of Nations

“He said that in raising his two children, he would be more upset with one who tattled than one who erred.” Wall Street Journal in reporting on Marcelo Odebrecht’s testimony before a congressional panel in Brazil on whether he was involved in a cartel to control construction bids. Mr. Odebrecht was later arrested on corruption charges in the operation of his multinational, multi-billion-dollar construction firm. Several executives involved in the corruption schemes confessed and tattled.

We didn’t think of the payments as bribes. We thought of them as useful expenditures. ReinhARd SiekAczek Former Siemens employee, after Siemens paid the largest fine in U.S. history for violations of the FCPA

Consider . . . 7.1 Beginning in the fall of 2003, the stock price of Yukos Oil Company, the largest oil company in Russia, dropped precipitously in response to various mea- sures taken by the Russian Federation. In October 2003, the Russian Federation arrested Yukos’s pres- ident, Mikhail Khodorkovsky, and seized his equity holdings in the company. Soon thereafter, the Russian Ministry of Taxation charged Yukos with under- paying the previous years’ taxes by approximately

$27.5 billion and the Russian Federation confiscated Yukos’ primary assets, sending the company into an economic tailspin.

The shareholders brought suit in the United States for the failure of Yukos to disclose its tax strategy as well as the risk of that strategy. Yukos seeks to have the case dismissed because U.S. courts cannot decide issues that involve decisions by the Russian government. What should the court do, and why?

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220 part 2 Business: Its Regulatory Environment

breaches. Many Islamic countries have a combination of civil and Islamic systems that result from the influences of both colonization and Islam.

Before its collapse in the former Soviet Union and Eastern Europe, communism was also classified as a legal system. Now the former communist nations struggle with evolving cultural, market, and governmental systems. Some countries strug- gle with forces trying to restore formerly collapsed entities. For example, Ukraine has experienced the presence of Russian troops as it tries to preserve its indepen- dence from the Putin government and forces.

7-1b Nonstatutory Sources of International Law

Customs and values in a culture often have a controlling effect on negotiations, contracts, and performance in international business. Before doing business in any country, businesses should think through several factors, discussed in the follow- ing sections.

Language Businesspeople should determine which language a particular country prefers for conducting business. Mexico and other Latin American countries are accustomed to doing business in English. In Quebec, Canadian government regulations man- date the use of French in conducting business. English has become the dominant language for contracts, even for contracts among natives of some countries that do not have English as the official language. The trend to English is attributed by some to the Internet. Those in non–English-speaking countries became increas- ingly familiar with English as they interacted on social media and the Internet. One French businessman learned the language so that he could enjoy the English jokes his son e-mailed him. His son was stunned when he visited and found his father so fluent in English following several years of joke exchanges.

environment and technology Technology and business development vary in countries around the world. The process of negotiating and finalizing contracts varies widely in time required for negotiation as well as in how rapidly the parties will be able to verify offers and acceptances (see Chapter 11 on contract formation). Before expanding operations or contracting in any country, a businessperson needs foundational knowledge about the nature of business development and effective communication. For exam- ple, Walmart has experienced significant delays in opening stores in less devel- oped countries because of difficulties with construction authorization and even the availability of transportation routes for delivery of goods and Internet for process- ing sales transactions.

authority Who has negotiating authority is important in a business meeting, and who is sent to a meeting sends a signal about importance in high-context cultures. Lawyers are not considered part of the negotiating team in Japan but are considered critical in the United States. Often, in Asian cultures, the negotiators do not have the author- ity to commit to a deal and must take proposals back to their companies and those who do have authority.

Nonverbal Behavior In the United States, the tendency is to interpret nonverbal behavior differently from the way it is perceived in other cultures. For example, silence during negotiations

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in the United States creates a compulsion for businesspeople to fill the awkward silence or interpret the silence as a rejection. In Asian cultures, such silence is simply a method of contemplating and considering and does not indicate a rejection.

time Concept The United States is a monochronic nation: time is everything, and the goal of businesspeople is to get the deal done. Other monochronic nations include Great Britain, Germany, Canada, New Zealand, Australia, the Netherlands, Norway, and Sweden. Countries that operate with great flexibility regarding time and negotiate within the context of building a relationship as opposed to completing a deal are called polychronic nations. The remainder of the world operates within this flexi- ble form of time culture.

7-1c Statutory Sources of International Law

Contracts for the International Sale of Goods (CISG) Sometimes referred to as the Vienna Convention, the U.N. Convention on Con- tracts for the International Sale of Goods (CISG) began its development in 1964 as an idea that was later discussed and formulated at the 1980 Vienna Convention. The CISG first became effective in 1988 with its adoption in the United States along with a small group of other countries. Today, CISG has been adopted in 60 coun- tries, with ratification processes under way in many other countries. However, its use is voluntary, even in adopting countries. Businesses can opt out of using the CISG to govern their contracts.

The CISG is designed to provide international contracts the convenience and uniformity that the Uniform Commercial Code provides for contracts across state lines in the United States. Although it includes some differences (see details in Chapters 11 and 12), the CISG is a reflection of the Uniform Commercial Code.

tax Law: International Business Structures that Reduce Rates Under a provision in the Internal Revenue Code (Section 482), a multinational, multitiered company has some flexibility in allocating income between the parent corporation and its subsidiaries. U.S. companies have been able to structure their business and subsidiaries in ways that minimize their U.S. income. For example, U.S. company Pfizer earned 65% of its revenue overseas, but it was being taxed at the 35% U.S. corporate tax rate (the highest corporate tax rate in the world). Pfizer attempted to undergo an inversion, an acquisition by Allergan, an Irish company, in order to reduce its tax rate to 17% to 18%, a significant savings for shareholders as well as a way to add share value. However, the U.S. Secretary of the Treasury stepped in to stop the acquisition by an interpretation of the tax law that would not afford the reduction Pfizer hoped to achieve. However, other companies continue to attempt inversion in order to reduce their U.S. taxes.

Apple, Google, Medtronic, Mylan, and Caterpillar are examples of U.S. com- panies that have used international structures to reduce their tax rates. Burger King purchased Canadian company Tim Horton and reincorporated in Canada to reduce its tax rates. These inversions were so popular that the U.S. government began taxing shareholders on the benefit, at a 33% tax rate, in order to make the arrangements less palatable for U.S. companies. This foreign structure loophole is being closed step-by-step. Some proposals would reduce the U.S. corporate tax rate, while others would allow the corporations to bring back foreign profits into the United States for investment purposes at a 5% or lower rate.

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7-1d treaties, trade Organizations, and Controls on International trade

In international trade, a number of treaties, tariffs, and organizations govern and guide international contracts. This section discusses some of the most important ones.

tariffs: Costs of Goods between Countries Whether supported or despised by economists, tariffs and restrictions on trade have existed for as long as trade itself. Duties, quotas, and tariffs have all been used to control the flow of goods over and across national boundaries. Tariffs are fees paid for the import or export of goods. These tariffs add to the cost of the goods and thereby permit individual countries to protect their own industries by import tariffs, which increase the prices for international competitors seeking to enter the country. Export tariffs make it more economical for companies to keep their goods at home. Tariffs are set by individual countries, but treaties between and among countries can result in the elimination of these economic tariffs.

Nontariff Controls over trade Over the past two decades, the United States has used nontariff barriers as a means of enforcing social policies. For example, the United States has a Turtle Tariff, a nontariff barrier that prevents the import of shrimp from countries that do not require turtle excluder devices (TEDs) on their commercial shrimp boats. If the shrimp cannot be verified as being caught using TEDs, then the shrimp cannot come into the United States.

In 2009, Gibson Guitars was raided by federal agents who seized guitars, pallets of wood, and electronic files. The Justice Department had obtained the warrants for seizing evidence that Gibson violated the Lacey Import Act, a federal law that prohibits the importation of “fish or wildlife taken, possessed, transported, or sold in violation of . . . any foreign law.” [16 U.S.C. § 3372(a)(2)(A)] The Justice Depart- ment seized $155,000 in guitars and wood because it alleged that Gibson used wood imported from India that had not been finished by Indian workers. How- ever, Gibson could not use the wood in India because of government regulations there and issues of resulting tariffs for imports from India. Gibson was caught in a loop of noneconomic tariffs. Gibson and the federal government settled the case with Gibson paying a $300,000 fine, making a $50,000 contribution to the National Fish and Wildlife Foundation, and forfeiting wood valued at $261,000 that was seized in the 2009 government raid at Gibson’s Nashville plant. The government

Ethical Issues

When Walgreen’s proposed moving its corporate headquarters outside the Unit- ed States in order to reduce its effective tax rate, under Section 482 of the Internal Revenue Code, the public outcry was so strong that Walgreen’s CEO nixed the plan. A number of U.S. CEOs have asked

Congress as well as the president and the treasury secretary for tax structure reform so that they can afford to compete inter- nationally without having to move facili- ties and operations overseas. Explain the ethical issues in the Section 482 tax-break structure for multinational companies. ©

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Chapter 7 International Law 223

returned some of the wood (valued at $155,000) that it had taken from Gibson. The smallest of businesses have to be concerned with nontariff controls that affect their importation of goods or raw materials.

For most of history, these tariff and nontariff limits on trade have been imposed on a nation-by-nation basis. However, new forms of trade agreements are develop- ing, and nations are organizing in larger groups in an attempt to eliminate many of the individually based barriers to trade. The following sections cover these inter- national trade agreements.

the european Union As discussed in Chapter 1, the European Union (EU) was established with the goal of removing barriers to the free movement across borders of goods, people, ser- vices, and capital. The Treaty on European Union (Maastricht Treaty) established the goals of free trade, a single currency, and uniform laws on commerce and secu- rity. Today, for example, the EU handles antitrust violations by companies in any of the EU’s member nations.

In addition to the European Commission, the EU created other institutions to help it carry out its goal of unified European commercial operations. The European Council, which consists of the heads of state of the various members, is the policy- making body and establishes the broad directives for the operation of the EU. The next step below the council is the European Commission, the body charged with implementation of Council policies. At the third level is the European Parliament, an advisory legislative body with some veto powers. Finally, the European Court of Justice (ECJ) is the judicial body created to handle disputes and any violations of regulations and the EU treaty itself. The EU has in place nearly 300 directives that govern everything from health and safety standards in the workplace to the sale of mutual funds across national boundaries. The recent so-called Brexit vote in Great Britain to leave the EU was, in part, in response to what some believe was heavy- handed EU regulation.

Ethical Issues

When the Taliban was in power in Afghan- istan, it banned watching television. The result of the ban was the creation of a substantial market for smuggling television sets into Afghanistan. For example, a Sony TV set smuggled into Pakistan would cost about $400. The legal cost, paying tariffs, would be $440. The same set smuggled into Afghanistan could bring twice as much. Sony gets the same amount, or $220, for every set sold, regardless of where it is sold and what happens to it in terms of its final destination.

The Taliban decided to impose tariffs and taxes on TV sets even as it held to the ban because the ban resulted in the

smuggling market from which they could extract substantial sums.

Do you think Sony had an ethical obliga- tion to not sell to the Taliban? Does it have an ethical obligation to police what happens to its products? What happens when a company profits from a government mak- ing money from its own ban?

Source: Daniel Pearl and Steve Stecklow, “Taliban Banned TV but Collected Profits on Smuggled Sonys,” Wall Street Journal, January 9, 2002, pp. A1, A8. (Note that the source for this ethical issue was an article co-authored by Daniel Pearl, the U.S. journalist who was kidnapped by terrorists who even- tually killed him and shared graphic coverage of the execution.)©

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the WtO In 1994, the General Agreement on Tariffs and Trade (GATT), a multilateral treaty (treaty among more than two nations) (see Chapter 1), was adopted and established the World Trade Organization (WTO). The WTO lists 159 countries as members, including the United States. The WTO is the body charged with the administra- tion and achievement of the GATT objectives. GATT’s primary objectives are trade without discrimination and protection through tariffs. Trade without discrimina- tion is achieved through GATT’s most-favored-nation (MFN) clause. The issue of China’s membership as a most-favored nation was debated extensively, particu- larly in the political and social context of human rights issues in that country, prior to its admission in 2001. Russia was admitted as a member at the end of 2011 on the condition that it would take steps to ensure that its legal system will enforce contract rights.

For the Manager’s Desk

Re: Fighting and Winning: the International threat of pirates

AARRGGGGGG! Shiver me timbers, and all that other Johnny Depp stuff. We have pirates, savvy? The pirates are from Somalia, and they are wreaking havoc on international commerce off the coast of Africa. NATO has sent ships to patrol the African coasts and rescue ships and hostages. However, there are international law issues regarding what is to be done about—and with—the captured pirates.

In a 1718 trial of pirates, Judge Nich- olas Trott ruled, “It is lawful for any one that takes them, if they cannot bring them under some government to be tried, to put them to death.” More recent due process, human rights, and individual country laws require that the pirates receive a trial. How- ever, the questions still remain: How? By whom? Where?

The conduct of pirates violates inter- national norms of behavior, but what spe- cific laws are broken? Who has jurisdiction when the pirates take ships in international waters? The principles of autonomy apply here: what country has the right to try a citizen of another country for crimes not committed in either country?

Trials for pirates were historically han- dled in military tribunals. However, the backlash today against military tribunals

because of treatment of prisoners of war, as well as court rulings that have trans- ferred the cases to civil courts, means that pirates end up being released. Released pirates are free to pirate another day and, perhaps, another sea.

Countries have come up with differ- ent solutions. The British Royal Navy has instructed its military not to detain pirates because such detention violates the pirates’ human rights. Instructions for the French military are to return the pirates to Somalia. The U.S. policy is to return pirates to their home governments, but only if given assur- ances that the pirates will be detained and prosecuted. The civil and political unrest in Somalia often means that groups are able to secure the freedom of the pirates through the use of force against the government. In the meantime, companies doing interna- tional shipments are vulnerable. There were 300 pirate attacks of shipping vessels in 2009, and by 2012, there were 315, includ- ing 28 hijackings. Since 2013, the number of pirate attacks has decreased almost 90% because of onboard private security, increased naval presence, the addition of onshore security forces in vulnerable areas, and best practices for vessels in handling pirate attacks.

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Under MFN status, subscribing countries treat each other equally in terms of import and export duties and charges. Subscribing countries do not give more favorable treatment to one country as opposed to another. Domestic production is protected by tariffs and not through any other commercial measures.

Some exceptions under GATT for regional trading arrangements are under- taken through other treaties, such as the North American Free Trade Agreement and the European Union.

The WTO also established a Dispute Settlement Body (DSB), which is an interna- tional arbitration body created to bring countries together to resolve trade disputes rather than have those nations resort to trade sanctions. If a WTO panel finds that a country has violated the provisions of GATT, it can impose trade sanctions on that country. The sanctions imposed are generally equal to the amount of economic injury the country caused through its violation of GATT. For example, in 2012, the DSB found that the Philippines was charging differential tax rates on domestic versus imported distilled spirits, and government officials there agreed to stop the practice.

the North american Free trade agreement (NaFta) The North American Free Trade Agreement (NAFTA) is a treaty among Canada, the United States, and Mexico that took effect in 1994 and has achieved its goal of eliminating all tariffs among the three countries over a 15-year period.

Products covered under NAFTA include only those that originate in these countries. All goods traded across the boundaries of these countries must carry a NAFTA certificate of origin, which verifies the original creation of the goods in the country from which they are being exported. NAFTA is unlike the EU in that NAFTA focuses only on free trade and does not create a common labor market, governing body, or currency.

prohibitions on trade: Individual Nation Sanctions In some countries, international tensions have resulted in sanctions being imposed, including trade prohibitions. Countries can impose two types of trade sanctions. With primary trade sanctions, companies based in the United States are prohibited from doing business with certain countries. For example, the United States pro- hibited or regulated trade with Iraq since the time of the 1991 Gulf War and lifted those sanctions only over the past few years as the country’s new government took hold. Currently, the United States is lifting the decades-long sanctions against Iran and Cuba. Primary boycotts can be limited to certain categories of goods. Other category restrictions can include extreme limitations, such as limiting trade to food and medical supplies. In some restrictions, the United States prohibits domestic companies from selling certain types of equipment to certain nations. For example, U.S. firms had severe restrictions on selling certain component parts to Iran prior to the 2016 effective date of the U.S./Iran treaty.

The second form of trade prohibition is the secondary boycott, which is a step beyond the primary boycott in that companies from nations doing business with a sanctioned country will also experience sanctions for such an activity. For exam- ple, in 1996, the United States passed the Iran and Libya Sanctions Act (ILSA) as a secondary boycott against two nations on which the United States already had imposed trade restrictions. This law was passed because of active lobbying by the families of those killed when Pan Am Flight 103 exploded over Lockerbie, Scotland, as a result of bombs planted on the flight by Libyan terrorists. Under the secondary boycott trade prohibition, the United States did not grant licenses to permit its financial institutions to loan money to, award government contracts

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226 part 2 Business: Its Regulatory Environment

to, or allow imports from any company that finances, supplies, or constructs oil procurement in Iran or Libya. Generally, these types of secondary boycotts do not apply retroactively so that companies need not divest themselves of their holdings already invested in these countries. However, no new business is allowed once the act takes effect if the companies wish to continue trading with the United States. With the death of Col. Muammar e-Qaddafi and the fall of his regime in Libya as well as the 2016 treaty with Iran, the United States is lifting the secondary boycotts against these two nations.

the International Monetary Fund (IMF) and the World Bank Created at Bretton Woods, New Hampshire, the International Monetary Fund (IMF) was established following World War II with the goal of expanding inter- national trade through a bank with a lending system designed to bring stability to national currencies. The IMF created the International Bank for Reconstruction and Development (commonly called the World Bank), which allows signing nations to have Special Drawing Rights (SDR) or the ability to draw on a line of credit in order to maintain the stability of their currency.

The idea of the IMF was to enhance and encourage international trade through assurances about monetary stability in various countries. Each time a particular nation, such as Greece or Russia, experiences a difficult economic swing, signifi- cant debate occurs about the use of IMF funds to buoy that nation’s currency so that international trade with that country is not destroyed.

the Hague Convention Although largely thought of as the multilateral treaty that deals with issues of war, the Hague Convention has become increasingly important to businesses because of a 1954 addition that deals with discovery in civil cases across borders. Countries that are signatories to this 1954 treaty agree to cooperate with civil litigation dis- covery requests (see Chapter 4 for more information on discovery), provided that the request is made for documents that are clearly enumerated in the request and that bear a direct connection to the subject matter of the litigation. In other words, a signatory country has the right to refuse to provide the information if the request appears to be part of a fishing expedition to obtain information for reasons other than the litigation itself. As businesses deal with international copyright, patent, and trademark infringement, litigation across borders has become necessary, and cooperation under the Hague Convention Civil Procedure agreement has proven invaluable in obtaining information that can identify the perpetrators who are sell- ing counterfeit and gray-market goods.

the Climate agreements and treaties The Kyoto Protocol, often called the Kyoto Treaty or the global warming treaty, would have required signatory countries to reduce emissions “by at least 5% below 1990 levels.” The United States would have been required to reduce its emissions by at least 7% had it signed the treaty. China, India, and Mexico are excluded from the treaty’s coverage. By the time of the Copenhagen climate summit late in 2009, the Kyoto Treaty was just a bit of history. The nations in attendance were unwilling to commit to its standards. However, in 2015, 200 countries signed on to the Paris Agreement, a multinational compact that includes pledges to reduce carbon emis- sions as well as contribute money to help smaller nations with economic devel- opment. Many provisions are not binding, but the agreement is described as one designed to eliminate the use of fossil fuels.

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the Organization of petroleum exporting Countries (OpeC) The Organization of Petroleum Exporting Countries (OPEC) was a cartel that worked together to control oil supplies and production, prices, and taxes. How- ever, the development of oil and natural gas resources in the United States, Can- ada, and other countries has increased the oil supplies and minimized the pricing controls of OPEC.

7-2 Trust, Corruption, Trade, and Economics Perhaps the greatest activity in multilateral agreements among countries has been in the area of curbing bribes because of their devastating impact on trust and investment, which can stall economic development in a country. In his depar- ture speech as secretary of the U.S. Treasury, Robert Rubin cautioned govern- ment employees to never accept any sort of gift as part of their duties because, he noted, “Corruption and bribery benefit a few at the expense of many.”

7-2a Foreign Corrupt practices act (FCpa)

Perhaps the most widely known criminal statute affecting firms that operate inter- nationally is the Foreign Corrupt Practices Act (FCPA; 15 U.S.C. §§ 78dd-1). The FCPA applies to business concerns that have their principal offices in the United States. It contains anti-bribery provisions as well as accounting controls for these firms and was passed to curb the use of bribery in foreign operations of these companies.

History, purpose, and application of the FCpa First passed in 1977, the FCPA is the result of an investigation by the Securities and Exchange Commission (SEC) that uncovered questionable foreign payments by large stock issuers who were based in the United States. Approximately 435 U.S. corporations made improper or questionable payments totaling $300 million in Japan, the Netherlands, and Korea.

The FCPA prohibits making, authorizing, or promising payments or gifts of money or anything of value to government and NGO officials with the intent to corrupt for the purpose of obtaining or retaining business for or with or directing busi- ness. That one-sentence prohibition has many components, and those components are covered in the following subsections.

What Constitutes a payment under the FCpa? The decisions in cases and Justice Department guidelines have given us the following: cash, country club memberships, excessive comped travel (travel that does not include seminars or presentations and consists of, for example, shop- ping trips to Paris for government officials or their spouses), cash donations to political parties, payment of cell phone or utility bills for government officials, and giving luxury gifts such as sports cars and furs to government officials or their spouses.

In 2012, the Justice Department published its Resource Guide for the Foreign Corrupt Practices Act (FCPA). The 130-page guide, which is available online, includes the kinds of things companies can do that are not prohibited. For exam- ple, the following are not violations of FCPA according to the guide:

1. Small gifts of expressions of gratitude, provided there is transparency in the giving

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228 part 2 Business: Its Regulatory Environment

2. Small gifts to local charities, provided the gift is consistent with the compa- ny’s general philanthropic goals and is not “large”

3. Wedding gift to a government official (if not too large) 4. Hats, t-shirts, pins, and pens that companies offer at trade show booths that

government officials take 5. Payment of the bar tab for drinks for government officials at a group meeting 6. Payment for travel to the United States for training at a company’s

facility (foreign dignitaries can even take in a baseball game at company expense during such training without the company risking an FCPA violation)

Payments to foreign officials for “facilitation,” often referred to as grease payments, are not prohibited under FCPA so long as these payments are made only to get the officials to do jobs that they might not do ordinarily or would do slowly without some payment. These grease payments can be made for obtaining permits, licenses, or other official documents; processing govern- mental papers, such as visas and work orders; providing police protection and mail pickup and delivery; providing phone service, power, and water supply; loading and unloading cargo or protecting perishable products; and sched- uling inspections associated with contract performance or transit of goods across the country.

the Costs of Slipping on the FCpaBusiness Strategy

In China, the use of a particular phar- maceutical’s prescription drugs is deter- mined by doctors within the nationalized health system. GlaxoSmithKline (GSK) began its path to FCPA violations with what could be called culturally acceptable interaction with the doctors. Holding sem- inars to provide the doctors with infor- mation about GSK drugs is not an FCPA violation, but the seminars grew into trips to Hawaii, with travel, dinner, and enter- tainment provided by GSK. Then shopping sprees were added for spouses. Gifts at the seminars were not unusual. Eventu- ally, GSK was using 700 travel agents all around China to book travel for doctors and then funnel gifts, sexual favors, and cash to the doctors in exchange for their willingness to adopt GSK drugs at their medical facilities.

The program was very successful in increasing sales in China, but it was so large that it began to attract attention. Following an investigation, Chinese authorities arrest- ed a GSK officer in China. GSK was found guilty of bribery in China and paid a $489 million fine. Almost 50 GSK employees were arrested, and five entered guilty pleas and were sentenced to two to four years in prison.

GSK is in the process of changing its business model, including dealing with a 30% reduction in its sales in China. There is reluc- tance on the part of doctors and hospitals to do business with GSK because of fears of government prosecution. Without the semi- nars, travel, and favors, GSK has been left to develop better sales representatives and mar- keting techniques different from giving things away in order to sway doctors. ©

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What Is “Obtaining, Retaining, or directing Business”? The types of activities included under “obtaining, retaining, or directing business” are the following: winning contracts, influencing a procurement process, circum- venting rules in order to get products imported, gaining access to non–public bid information, evading taxes or penalties, influencing the outcome of lawsuits or regulatory actions, obtaining exceptions to regulations, avoiding contract termina- tion, asking regulators or officials to exclude your competitors from their country, evading customs duties, and extending drilling contracts.

Who Is Covered under FCpa? The types of officials covered under the FCPA (to whom gifts may not be directed) include foreign officials, political parties, party officials, candidates for office, and any NGO. Using any person who will transmit the gift or money to one of the other types of people also is prohibited. Changes in 1998 added the NGO coverage so that officials such as those with the United Nations, the Olympics, or the IMF are now covered under the act. The bribery involved in awarding the 2002 Olympics held in Salt Lake City resulted in this expansion of the statute’s coverage. The international 2015 FIFA investigation that resulted in FCPA charges, is another example of an NGO (The International Federation of Association Football) being subjected to the anti-bribery laws. Those charged in the case are current and former officials of FIFA who are accused of accepting payments in exchange for awarding contracts to cities and countries for the World Cup and FIFA licensing rights as well as other soccer events. The indictment alleges that companies paid more than $150 million in bribes to FIFA officials for marketing and licensing rights for the World Cup and related soccer activities.

Use of agents and the FCpa When the FCPA was passed initially, many companies tried to find ways around the bribery prohibitions. Companies would hire for- eign agents or consultants to help them gain business in countries and allowed these “third parties” to act independently. However, many of these consultants paid others who then paid bribes to officials. Under the FCPA, even these types of arrangements can constitute a violation if the consulting fees are high, odd payment arrangements occur, or the company has reason to know of a potential or actual violation. Companies must be able to establish that they have performed “due diligence” in investigating those hired as their agents and consultants in foreign countries. For example, if a U.S. company hired a consultant who charged the company $25,000 in fees and $25,000 in expenses, the U.S. com- pany would be, under Justice Department guidelines, on notice for excessive expenses that could signal potential bribes being paid. These types of expenses are known as red flags for U.S. com- panies. The Justice Department uses this information as a means of establishing intent, even when the company may not know pre- cisely what was done with the funds and what was paid to whom.

the FCpa and “Grease” or Facilitation payments Payments to foreign officials for “facilitation,” often referred to as grease payments, are not prohibited under FCPA so long as these payments are made only to get the officials to do jobs that they might not do ordinarily or would do slowly without some

One of the areas of focus for consultants and education programs on FCPA compli- ance is this question: How can we know if we have FCPA violations in our interna- tional operations? Below is a list of tips for staying on top of FCPA issues.

1. Have frequent audits of international offices with tight controls over the dis- bursement of funds. Who? When? How? How much? Why?

2. Screen any agents, advisers, trans- lators, and others hired to help with negotiations.

3. Monitor payments made to individ- uals, foreign entities, and even compa- nies, such as travel agencies, to deter- mine the purpose for those relationships.

4. Listen when employees raise ques- tions. GSK was warned by an employee before the Chinese government acted but had not followed up quickly enough on the allegations.

5. If a foreign office is awarded a large contract, make a visit and trace the path of the contract and how it was won.

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payment. These grease payments can be made for obtaining permits, licenses, or other official documents; processing governmental papers, such as visas and work orders; providing police protection and mail pickup and delivery; providing phone service, power, and water supply; loading and unloading cargo or protecting per- ishable products; and scheduling inspections associated with contract performance or transit of goods across the country.

penalties for Violation of the FCpa For FCPA anti-bribery violations, corporations face a penalty of $2 million per vio- lation. Individuals (including officers, directors, and shareholders) are subject to $250,000 in fines and up to five years in prison. FCPA accounting violations carry a penalty of $25 million for corporations and up to $5 million in fines and 20 years in prison for individuals. Corporations are not permitted to pay the fines of their employees. Also, under the Alternative Fines Act, the Justice Department can seek to obtain two times the benefit the bribe attempted to gain, known as disgorgement. For example, if a company paid a bribe to obtain a $100 million contract for com- puter services for a foreign government, the potential fine could be two times the amount of profit on that contract, not including the statutory fine provisions.

The Justice Department and the SEC continue a steady stream of FCPA charges. During 2010, FCPA charges peaked at 74. In 2011, there were 48 charges and in 2012 only 23. From 2013 to 2016, there were 41 FCPA cases brought against many large companies, including Johnson Controls, Las Vegas Sands, SAP, Bristol-Meyers Squibb, Avon, Hitachi, Mead-Johnson, Goodyear, and Ralph Lauren.

American Ri, Inc. (ARI), a Houston-based company, exports rice to foreign countries, including Haiti. Rice Corporation of Haiti, a wholly owned subsidiary of ARI, was incor- porated in Haiti to represent ARI’s interests and deal with third parties there. Haiti’s customs officials assess duties based on the quantity and value of rice imported into the country. Haiti also requires busi- nesses that deliver rice there to remit an advance deposit against Haitian sales tax- es, based on the value of that rice. The businesses are then given a credit for the deposit when they file their Haitian sales tax returns. David Kay and Douglas Mur- phy, executives of ARI, were charged with violations of the Foreign Corrupt Practic- es Act (FCPA) for allegedly bribing Haitian officials to accept false bills of lading that reflected total rice imports to be about one- third of actual levels so that ARI would owe less in taxes. Is this type of an arrange- ment a bribe? Does it violate the FCPA? [U.S. v Kay, 359 F.3d 738 (5th Cir. 2004)]

THINK: The FCPA criminalizes payments that are intended to (1) influence a foreign

official to act or make a decision in his official capacity, or (2) induce such an of- ficial to perform or refrain from perform- ing some act in violation of his duty, or (3) secure some wrongful advantage to the payor.

APPLY: Securing reduced taxes and duties on imports through bribery enables ARI to reduce its cost of doing business, thereby giving it an “improper advantage” over ac- tual or potential competitors and enabling it to do more business or remain in a market it might otherwise leave.

ANSWER: Bribing foreign officials to low- er taxes and customs duties certainly can provide an unfair advantage over compet- itors and thereby be of assistance to the payor in obtaining or retaining business. The FCPA applies broadly to payments in- tended to assist the payor, either directly or indirectly, in obtaining or retaining busi- ness for some person, and bribes paid to foreign tax officials to secure illegally re- duced customs and tax liability constitute a type of payment that can fall within this broad coverage.

Consider . . . 7.2

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the FCpa and U.S. Competitiveness One of the long-standing concerns about the FCPA is whether it has placed U.S. businesses at a competitive disadvantage in those countries in which bribery is generally accepted as a way to win contracts and government benefits. However, a survey by the U.S. Government Accounting Office of the companies affected by the FCPA found that the ability of companies from other countries to bribe offi- cials did not give them a competitive advantage. The survey found that U.S. trade increased in 51 of 56 foreign countries after the FCPA went into effect. The increase was attributed to the position adopted by U.S. companies with respect to their competitors—if they could not bribe government officials, they would disclose publicly information about bribes made by any of the companies from other nations.

FCpa and the Organization for economic Cooperation and development (OeCd) The Organization for Economic Cooperation and Development (OECD) is now supportive of the U.S. FCPA and its principles. Member countries have enacted legislation for compliance with its international pact against bribery. The OECD’s 38 members1 now work together to investigate companies’ activities across bor- ders.2 However, only the United States, Germany, Norway, and Switzerland actively enforce their anti-bribery statutes. The British version of the FCPA took effect in July 2011 and has required significant changes in companies in terms of compliance and monitoring payments.

When Congress amended the FCPA to implement the OECD Convention on Combating Bribery of Foreign Public Officials in International Business Transactions, the amendments expanded the act’s jurisdiction to cover all U.S. citizens acting out- side the United States and all non-U.S. citizens acting inside the United States. The convention basically adopts the standards of the United States under the FCPA and requires nations signing the agreement to impose criminal penalties, seize profits earned through bribery, and rein in government officials who accept illicit payments by actively prosecuting them along with the companies making the payments.

In 2009, the top aides to Libya’s then leader, the late Col. Muammar e-Qaddafi, held a meeting with 15 executives from global ener- gy companies that had oil operations in Libya. The United States had reopened trade with Libya in 2004 after nearly a decade-long boycott because the Libyan government played a role in the explosion of Pan Am Flight 103 at 34,000 feet over Scotland caused by a bomb onboard the plane.

At the meeting of these executives, the Qaddafi aides asked them to ante up the $1.5 billion Libya was being asked to pay for the compensation of the Pan Am 103 victims’ families. The aides referred to the payments as “signing bonuses” or “consultancy fees” for their companies

being permitted to continue oil operations in Libya.

A State Department 2009 cable con- tained the following warning for U.S. com- panies: “Libya is a kleptocracy in which the regime—either the al-Qadhafi [sic] family itself or its close political allies—has a direct stake in anything worth buying, selling, or owning.” Some of the U.S. companies paid into the $1.5 billion fund; some did not.

Did those who paid violate the FCPA? What strategic issues do you see in the State Department’s warning?

Source: Eric Lichtblau, David Rohde, and James Risen, “Business Payoffs Helped Qaddafis Solidify Control,” New York Times, March 24, 2011, p. A1.

Consider . . . 7.3

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232 part 2 Business: Its Regulatory Environment

7-3 Resolution of International Disputes As discussed in Chapters 1, 3, and 4, there really is no way to enforce international laws. The International Court of Justice established by the United Nations is a court of voluntary jurisdiction for disputes between nations; it is not a court for the resolution of business disputes between nations. More and more companies and individuals favor arbitration to resolve disputes. The most popular forum chosen for such arbitrations and quasi-trials is London’s Commercial Court, which was founded on March 1, 1895, when it heard its first case, a dispute over the quality of cloth a Flemish manufacturer sold to a London agent. The court was perhaps the first to recognize the role of arbitration in deciding international business disputes; such innovation restored the confidence of business in the settlement of disputes by third parties. The London Commercial Court is viewed as a neutral forum with highly experienced judges who are also experienced commercial litigators.

7-4 Principles of International Law The sources of international law simply serve to govern businesses as they oper- ate in a particular country, and the laws may vary from country to country. How- ever, some principles of international law apply to all countries and people in the international marketplace. The principles of international law do affect the deci- sions and operations of businesses, regardless of the availability of court resolution of rights.

7-4a act of State doctrine

The act of state doctrine gives every sovereign state respect from other sovereign states for its laws, actions, decisions, and policies. The act of state doctrine con- firms the independence of sovereign nations and their courts. No country will intervene in the judicial and legislative processes of another country because those actions are inconsistent with that country’s standards. Courts of one country will not undertake the responsibility of providing their citizens with remedies against another country, even when that other country has violated the rights of a citi- zen of the first country. For example, when Union Carbide’s plant in Bhopal had a high-fatality accident, Union Carbide’s CEO was arrested and taken into custody when he went to Bhopal to ensure appropriate relief efforts. Although his impris- onment would have violated his rights in the United States, the U.S. courts did not intervene in India’s criminal processes. Lawyers for the CEO had to work through the courts of India.

7-4b Sovereign Immunity

The concept of sovereign immunity is based on the notion that each country is a sovereign nation. This status means that each country is an equal with other countries; each country has exclusive jurisdiction over its internal operations, laws, and people; and no country is subject to the jurisdiction of another coun- try’s court system unless it so consents. Our court system cannot be used to right injustices in other countries or to subject other countries to penalties. For exam- ple, in Schooner Exchange v McFaddon, 7 Cr. 116 (1812), a group of American citi- zens attempted to seize the vessel Exchange when it came into port at Philadelphia

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Chapter 7 International Law 233

because the citizens believed that the ship had been taken improperly on the high seas by the French emperor Napoleon and that the ship rightfully belonged to them. The U.S. Supreme Court held that the ship could not be seized because sov- ereign immunity applied, and France could not involuntarily be subjected to the jurisdiction of U.S. courts.

The Foreign Sovereign Immunities Act of 1976 clarified the U.S. government’s position on sovereign immunity and incorporated the Schooner Exchange doctrine. Not only are countries immune, but the act also adds a clarification to the concept of sovereign immunity of sovereign nations for illegal acts. For example, in Argen- tine Republic v Amerada Hess Shipping Co., 488 U.S. 428 (1989), the Supreme Court dismissed a suit brought in a U.S. federal court by a Liberian-chartered commercial ship company against the government of Argentina for its unprovoked and illegal attack on a company ship. The ship was in neutral waters when the war between Great Britain and Argentina broke out over the Falkland Islands. The attack by the Argentine Navy was unprovoked and in clear violation of international law. How- ever, the U.S. Supreme Court clarified that under the Sovereign Immunities Act and principles of international law, all sovereign nations are immune from suits in other countries, even for those acts—like that of Argentina—that are clear viola- tions of international law.

There is a distinction, however, under both the Foreign Sovereign Immuni- ties Act and the courts with respect to the commercial transactions of a sovereign nation. For example, the sale of services and goods, loan transactions, and con- tracts for marketing, public relations, and employment services entered into by a country are, in essence, voluntary agreements that subject that country’s govern- ment to civil suits in another nation’s courts according to the terms of the agree- ment or according to the basic tenets of judicial jurisdiction (see Chapter 3).

The In re Yukos Oil Company Securities Litigation case (Case 7.1) deals with the act of state doctrine as well as sovereign immunity and provides answers for the chapter-opening “Consider . . .”

In re Yukos Oil Company Securities Litigation 2006 WL 3026024 (S.D.N.Y.)

When Putin Affects the Value of Oil Stock

Case 7.1

FaCtS

Yukos is a Moscow-based joint-stock company whose shares trade on the Russian stock exchange. Yukos shares also trade indirectly on multiple European exchanges and over-the-counter in the United States.

Allegedly, Khodorkovsky was part of a select group of Russian business leaders known as “oligarchs” who supported former Russian President Boris N. Yeltsin but were politically opposed to current Russian Presi- dent Vladimir V. Putin.

The Tax Code of the Russian Federation prescribed a maximum income tax rate that incorporated two components: a tax payable to the federal budget and a tax payable to the budget of the taxpayer’s local region. For example, in 2004, the statutory maximum rate was 24%, of which up to 6.5% could be collected by the federal government and up to 17.5% by regional governments. The Tax Code also prescribed a mini- mum rate for taxes payable to regional governments. In 2004, that rate was 13.5%. However, the regional

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234 part 2 Business: Its Regulatory Environment

governments could offer tax benefits to reduce or even eliminate the regional budget liability of certain categories of taxpayers. As a result of this regional variance in the effective income tax rate, taxpayers in the metropolitan regions of the Russian Federation, such as Moscow, paid higher taxes than taxpayers in remote regions, or “ZATOs.”

From 2000 through 2003, Yukos allegedly grossly underpaid its taxes to the Russian Federation by ille- gally taking advantage of the ZATOs’ preferential tax treatment. Yukos allegedly booked oil sales at “well below” market prices to 17 trading companies, all of which were registered within ZATOs. Without taking physical possession, the trading companies sold the oil to customers at market prices and claimed the tax ben- efits of their ZATOs. However, the profits were “fun- neled . . . back to Yukos and Yukos paid taxes only on the initial below-market sales while reaping substantial profits from the [actual] market-price sales.”

The regional trading companies may have received the benefits of ZATO registration illegitimately because “[n]o business was actually conducted by the sham companies in the ZATOs.” This Yukos tax strategy pre- sented enormous risk because it violated Russian law and because the Russian Federation had prosecuted other companies that had acted similarly. Nonetheless, the tax risk was not disclosed in any of the Yuko’s fil- ings with the SEC. Also, what was filed with the SEC was not prepared in conformity with U.S. GAAP or other standards of financial reporting.

At a secret meeting with Khodorkovsky and other oligarchs in 2000, Putin promised not to investigate potential wrongdoing at their companies if the oligarchs refrained from opposing Putin. Nearly three years later, at another such meeting, Khodorkovsky was said to have voiced his opinion that high-level officials in Putin’s government should be ousted. According to the shareholders (plaintiffs), Putin reacted negatively and intimated to Khodorkovsky that the Russian Federa- tion might investigate Yukos’ methods of acquiring oil reserves. Despite Putin’s warnings, Khodorkovsky pub- licly criticized Putin and financed opposition parties.

On October 25, 2003, Russian Federation author- ities arrested Khodorkovsky and charged him with fraud, embezzlement and evasion of personal income taxes. Days later, the Russian Government seized con- trol of Khodorkovsky’s 44% interest in Yukos as secu- rity against the approximately $1 billion he owed in taxes. The Tax Ministry then revealed that it had been investigating Yukos’ tax strategies. The Department of Information and Public Relations of the General Prosecutors Office then announced charges that it had accused Khodorkovsky and others of fraudulently

operating an illegal scheme at Yukos to avoid tax lia- bility through shell company transactions.

On December 29, 2003, the Tax Ministry conclud- ed its audit of Yukos for tax year 2000 and issued a report that Yukos had illegally obtained the benefit of the ZATOs’ preferential tax treatment and owed $3.4 billion to the Russian Federation in back taxes, interest, and penalties for tax year 2000.

As a result, Yukos defaulted on a $1 billion loan from private lenders, and the Russian government con- fiscated Yukos’ assets, including its main production facility and billions of dollars from its bank accounts. The price of Yukos securities “plummeted” in response to these events.

Yukos shareholders (plaintiffs) filed consolidated class actions against Khodorkovsky and others (defen- dants) on July 2, 2004. The U.S. plaintiffs had pur- chased Yukos securities between January 22, 2003, and October 25, 2003. They allege that Yukos, its outside auditor, and certain of its executives and controlling shareholders knowingly concealed the risk that the Russian Federation would take action against Yukos by failing to disclose (1) that Yukos had employed an illegal tax evasion scheme since 2000 and (2) that Khodorkovsky’s political activity exposed the compa- ny to retribution from the current Russian government. The plaintiffs based their claims on the fraud provision, Section 10(b), of the Securities Exchange Act.

JUdICIaL OpINION

PAULEY, District Judge Defendants contend that that this Court must abstain under the act of state doctrine.

Firmly entrenched as a principle of jurispru- dence, the act of state doctrine prevents the courts of the United States from “question[ing] the validity of public acts (acts jure imperii) performed by other sovereigns within their own borders.” The doctrine “has its roots, not in the Constitution, but in the notion of comity between independent sovereigns.” It also venerates the separation of powers within the federal Government by precluding the judiciary from deciding matters of foreign policy that are properly the province of the executive and legisla- tive branches.

Defendants urge this Court to abstain under the act of state doctrine because “[t]he adjudication of this dispute inevitably will require this Court to inquire into the actions and motives of the Russian Govern- ment in imposing confiscatory tax levies, penalties and interest on Yukos.” Implicit in their argument and resplendent in other portions of their motion papers is the notion that the Russian Federation targeted Yukos

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Chapter 7 International Law 235

unforeseeably and that the Tax Ministry’s interpreta- tion of the Russian Federation Tax Code was without precedent.

Defendants have not cited any precedent invoking the act of state doctrine to abstain from adjudicating a securities fraud action. Under the arguments advanced by Defendants, the doctrine would mandate absten- tion from any action in which a foreign corporation is alleged to have concealed conduct deemed illegal by its home country upon a defendant’s mere assertion that the sovereign’s determination was in error. Such an application of the act of state doctrine would effec- tively insulate foreign corporations from a large swath of securities fraud claims by United States investors.

The act of state doctrine does not preclude a court from deciding a case that implicates the motives or justifications of a foreign sovereign’s official act but does not seek to invalidate or circumvent that act. Rather, the doctrine applies only “when a court must decide—that is, when the outcome of the case turns upon—the effect of official action by a foreign sovereign.” The act of state doctrine does not compel abstention from “cases and controversies that may embarrass foreign governments, but merely requires that, in the process of deciding, the acts of foreign sovereigns taken within their own jurisdiction shall be deemed valid.”

The Yukos Defendants contend that “any defense by Yukos beyond the pleadings stage necessarily will involve its claims that it was denied due process, and that it never would have suffered the consequences of having its business confiscated, had the Russian government properly applied Russian law.” However, whether Yukos received due process in Russia is irrel- evant. Neither party in this action seeks to enforce or disturb the actions taken by the Russian Federation. Moreover, in this action, the pertinent loss-causation inquiry concerns Defendants’ alleged misstatements or omissions and the losses suffered by Yukos investors— not the propriety of the Russian Federation’s tax

enforcement and penal actions. The central question is whether Defendants acted with fraudulent intent in withholding information from the investing public. Even if Defendants prevail with their arguments that the Russian Federation’s interpretation of Russian law was untenable, the validity of the Russian Federation’s acts would be unaffected.

Under the act-of-state doctrine, the assessment of the validity of a foreign law is limited to its application within the sovereign’s territory; under the revenue rule, United States courts avoid the application of a foreign sovereign’s tax laws in the United States. Both approaches enable courts to avoid entanglement with questions about the underlying validity of a foreign sovereign’s laws.

Because Plaintiffs here are not asking this Court to enforce the Russian tax judgments, this Court need not evaluate the policies behind the Russian Federation’s tax legislation or the regional variance among effective federal income tax rates which Yukos is alleged to have exploited.

In sum, this Court is not being called on to either invalidate or enforce the Russian Federation’s mea- sures, nor will the validity of those sovereign acts have any bearing on Defendants’ motions to dismiss or on questions likely to affect the merits of this litigation. As such, the act of state doctrine does not warrant abstention.

The case was dismissed on grounds other than the act of state doctrine.

CaSe QUeStIONS

1. Describe how Yukos is alleged to have saved sig- nificant amounts in taxes.

2. Explain what act of the Russian Federation is in question.

3. What are the plaintiffs asking the court to decide? Does that decision require revisiting what the Russian Federation did, and why or why not?

7-4c protections for U.S. property and Investment abroad

expropriation The effect of nationalization is that the private property of citizens and businesses operating in that country can be taken by the government, an act referred to as expropriation. While courts do not interfere with a sovereign’s actions, the effect of expropriation, combined with the act of state doctrine and sovereign immu- nity, has a chilling effect on U.S. investments in foreign countries. To discourage expropriation, the Foreign Assistance Act of 1962 contained what has been called the Hickenlooper Amendment, which requires the president to suspend all forms

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236 part 2 Business: Its Regulatory Environment

of assistance to countries that have expropriated the property of U.S. citizens or regulated the property in such a way as to effectively deprive a U.S. citizen of it (through taxation or limits on use).

Minimizing Expropriation. Many trade treaties that have been negotiated or are being negotiated with other countries contain protections against expro- priation. Some treaties provide U.S. companies and investors with the same levels of protection as the citizens of those countries. For example, if a coun- try affords its citizens due process before taking over private property, U.S. citizens and companies must be afforded those same protections prior to expropriation.

Finally, Congress has created a federal insurer for U.S. investments abroad. The Overseas Private Investment Corporation (OPIC) is an insurer for U.S. investment in those countries where the per capita annual income is $250 or less. OPIC will pay damages for expropriation, inability to convert the currency of the country, or losses from war or revolution.

Consumer protections in other countries depend on those countries’ laws. For example, many U.S. citizens have constructed luxury homes along the coast near Ensenada in Baja California. They did so because the land and construction were so much cheaper than in the United States that they could afford large, luxurious homes. However, the land on which many of the homes

Ethical Issues

PricewaterhouseCoopers is one of the “Big 4” accounting firms in the United States. PwC, as it is known, has had a tax practice in Russia since the time that country changed from communist rule. One of PwC’s clients in Russia was Yukos, a major Russian oil company that is now bankrupt.

Russia’s Federal Tax Service, an agency similar to the IRS in the United States, has filed suit against PwC, alleging that it concealed tax evasion by Yukos for the years 2002–2004. The Tax Service also announced a criminal probe of PwC’s con- duct with regard to its tax services for Yukos. Twenty Tax Service agents searched PwC’s offices in Moscow and questioned PwC employees about the Yukos account. Yukos lost its tax case and has paid $9.2 million in charges for the nonpayment of taxes.

The Russian government eventually brought criminal charges against two

PwC partners in Russia but dropped the charges and all proceedings against PwC in exchange for PwC withdrawing its Yukos audits. During the time that PwC was fac- ing off with the Russian government, there were concerns that it would be forced to reveal client information. In addition, the Russian government held the power to revoke PwC’s license to conduct audits in that country. PwC experienced great pres- sure and had to invoke help from the State Department in trying to preserve its rights and the rights of its client, Yukos, in the Russian proceedings against it.

What issues should a company consid- er before doing business in an economically developing country? What are the risks? Did this ethical dilemma begin long before the Russian government’s demands of PwC? What international law, culture, and ethical issues should a company consider before deciding to do business in another country? ©

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Chapter 7 International Law 237

were located was the subject of 14 years of litigation and more than 60 court decisions over disputed ownership rights. With the Mexican Supreme Court’s decision on landownership, most of the current U.S. owners have been told that they must vacate their homes and leave everything behind. Despite due process and property rights in the United States, the homeowners in Ensenada have no hope as long as the Mexican Supreme Court has declared the law for its country and land.

7-4d Repatriation

Repatriation is the process of bringing back to your own country profits earned on investments in another country. Some nations establish limits on repatriation; busi- nesses can remove only a certain amount of the profits earned from the operations of a business within a country. Repatriation limits are considered acts of state and are immune from litigation in the United States.

7-4e Forum Non Conveniens, or “You Have the Wrong Court” The doctrine of forum non conveniens is a principle of U.S. justice under which cases that are brought to the wrong court are dismissed. The doctrine allows judicial discretion whereby such issues as the location of the evidence, the loca- tion of the parties, and the location of the property that will be used to satisfy any judgment are examined. For example, when the Union Carbide disaster occurred at its Bhopal plant in India, victims and families brought suit against Union Carbide in New York City. A U.S. court of appeals dismissed the case and sent it back to India on the grounds of forum non conveniens. [In re Union Carbide Corp. Gas Plant Disaster, 809 F.2d 195 (2nd Cir. 1987); cert. denied, 484 U.S. 871 (1987)]

7-4f Conflicts of Law

No two countries match in terms of the structure of their legal system or their laws. For example, the law in the United States, codified by the widely adopted Uniform Commercial Code (UCC), is that all contracts and contract relationships are subject to a standard of good faith. In Canada, the good faith exists only if the parties place such a provision in their agreement. Under German law, pro- tections are given not on the basis of good faith but, rather, on the basis of who is the weaker party. Just among these three major commercial powers, laws on contracts are significantly different. The rules on conflicts of law in international transactions are as follows: (1) If the parties choose which law applies, that law will apply, and (2) if no provision is made, the law of the country where the con- tract is performed will be used. Agreeing to and understanding the set of laws to be applied in a contract are critical parts of international transactions. The U.S. Supreme Court held in Carnival Cruise Lines v Shute, 499 U.S. 585 (1991), that, even in consumer types of contracts, the parties can agree on how and where their dis- putes will be resolved and which law will apply as long as the place and law selected bear some relationship to the nature of the contract and its place of per- formance. In that case, the court held that Carnival Cruise Lines could require its passengers to come to its place of business, Miami, to bring suit for any breaches of contract or injuries while sailing on a Carnival ship. The Miami location was not only Carnival’s U.S. place of business but also a major port from which many of its cruises departed.

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238 part 2 Business: Its Regulatory Environment

7-5 Protections in International Competition Although trade barriers are coming down and a global marketplace is a reality, international competition is still subject to much regulation found in the forms of antitrust laws, protections for intellectual property, and trade treaties.

7-5a the International Marketplace and Monetary Issues: the disclosure Role of Banks

protections for Banks and International Customers: taxes and Shelters Individuals who place large amounts of cash in banks of other countries have been the subject of increasing numbers of audits because their cash assets are in other countries through tax shelters designed to help them avoid taxation on the money when it is first earned. The U.S. government has been indicting and imposing penalties on foreign banks that held these accounts and then refused to disclose who their customers were when tax officials conducted investigations. Most of the banks have entered into settlements and paid fines. Taxpayers and their advisers have settled their cases and paid significant penalties.

protections for Bank Customers: Information Getting information from banks in other countries continues to be problematic for regulatory agencies as well as for businesses that are seeking help in identifying those engaged in commercial activity that affects their products and or ability to sell those products.

U.S. courts can order foreign banks to make account disclosures as part of dis- covery proceedings under what is known as Hague proceedings discussed earlier in the chapter. Tiffany and Company v Andrew (see Case 7.2) provides a look at this

International Ambassador Programs, Inc., is a Washington-based nonprofit organi- zation that arranges tours and informa- tional visits in foreign countries, including Russia. Archpexpo, once a Soviet state enterprise and now a Russian limited partnership, facilitates and expedites tours such as those sponsored by Am- bassador to Russia and the other former Soviet republics.

Archpexpo and Ambassador entered into several agreements relating to tours. An April 1989 agreement provided that “all disputes and differences without recourse to courts of law shall be referred to the arbitration tribunal with the USSR Trade and Industry Chamber for resolution, such resolution acknowledged as final by the parties.”

A dispute arose between the parties when Archpexpo alleged that it had not been paid certain fees due, and Ambassa- dor claimed it was entitled to an offset of $20,000 for refunds it had to give to travel- ers who were dissatisfied with Archpexpo’s service.

Archpexpo filed for arbitration, and Ambassador brought suit in federal district court in the United States. Does the federal district court have jurisdiction? Must Am- bassador submit to arbitration in Russia? What if Ambassador had more than one contract with Archpexpo and some of the contracts contained the arbitration clause and some did not? Would Ambassador then be required to submit to arbitration? [Inter- national Ambassador Programs, Inc. v Arch- pexpo, 68 F.3d 337 (9th Cir. 1995)]

Consider . . . 7.4

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Chapter 7 International Law 239

bank process and the applicable international standards that apply to bank disclo- sure of information for purposes of identifying those who have harmed U.S. com- panies through infringement or counterfeiting of goods.

Tiffany and Company v Andrew 2012 WL 5451259 (S.D.N.Y.)

Looking for Counterfeiters’ Bank Accounts

Case 7.2

FaCtS

Tiffany (plaintiffs) alleges that Andrew and others (defendants) sold counterfeit Tiffany products through several websites hosted in the United States. Andrew accepted payment in U.S. dollars; used PayPal, Inc., to process customers’ credit card transactions; and then transferred the sales proceeds to accounts held by the Bank of China (“BOC”), Industrial and Commercial Bank of China (“ICBC”), and China Merchants Bank (“CMB”) (“Banks”).

Andrew defaulted on the suit, and Tiffany sought discovery from the Banks by serving subpoenas seek- ing the identities of the holders of the accounts into which the proceeds of the counterfeit sales were transferred and the subsequent disposition of those proceeds. The Banks involved all maintained branch offices in the Southern District of New York, and the subpoenas were served on those branch offices.

The Banks responded to the subpoenas by explain- ing that the information sought was all maintained in China and that the New York branches of the Banks lacked the ability to access the requested information. China’s internal laws prohibited the disclosure of the information except under certain conditions. The Banks proposed that the plaintiffs pursue the request- ed discovery pursuant to the Hague Convention.

The court concluded that Tiffany should pursue discovery through the Hague Convention. Tiffany submitted its Hague Convention application to China’s Central Authority in November 2010, and on August 7, 2011, the Ministry of Justice of the People’s Republic of China (“MOJ”) responded by producing some of the documents requested. For each of the Banks, the MOJ produced account opening documents (including the government identification card of the account holder), written confirmation of certain transfers into the accounts, and a list of transfers out of the accounts. With

respect to CMB, the records indicate that all funds in the account were withdrawn through cash trans- actions either at an ATM or through a teller. BOC and CMB each produced documents concerning a single account; ICBC produced documents for three accounts.

In its cover letter, the MOJ noted that it was not producing all documents requested. Specifically, the letter stated, “Concerning your request for taking of evidence for the Tiffany case, the Chinese competent authority holds that some evidence required lacks direct and close connections with the litigation. As the Chinese government has declared at its accession to the Hague Evidence Convention that for the request issued for the purpose of the pre-trial discovery of documents only the request for obtaining discovery of the docu- ments clearly enumerated in the Letters of Request and of direct and close connection with the subject matter of the litigation will be executed, the Chinese compe- tent authority has partly executed the requests which it deems conform to the provisions of the Convention.”

On the grounds that the MOJ’s production is defi- cient, Tiffany moved to enforce the subpoenas previ- ously served on the New York branches of the Banks. The deficiencies Tiffany claims are (1) whether any of the defendants have any additional accounts at the Banks and (2) detailed wire transfer records concerning the deposits into and withdrawals from the CMB and ICBC accounts.

JUdICIaL OpINION

PITMAN, Magistrate Judge The principal issue to be resolved is whether the

Banks’ production through the MOJ has been so limit- ed that resort to the Hague Convention process can be characterized as futile. Although the Banks’ document production has been more limited than it would have been under the Federal Rules of Civil Procedure, I

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240 part 2 Business: Its Regulatory Environment

cannot conclude that it is so limited that the process has been futile.

The Banks, through the MOJ, have unquestionably produced relevant, responsive documents. In addition, although the MOJ took approximately nine months to respond to the Hague Convention request, this period is not inordinately long given the delays inherent in international discovery proceedings. Although I am not aware of any statistical compilations, based on my experience as a Magistrate Judge, China’s nine-month response time is, at most, only slightly longer than the response time I have seen in other cases involving Hague Convention requests; it is not so long that the process can be described as futile.

Second, the scope of the Banks’ production has not been so narrow that resort to the Convention can fairly be described as futile. The account holders’ identities and addresses have been identified as well as transaction histories. Plaintiffs’ argument that addi- tional documents concerning transfers into and out of the accounts will lead to a fuller understanding of the trademark counterfeiting operation is extremely speculative. While I understand plaintiffs’ desire to identify the source of the counterfeit merchandise, the bank transfer information they are seeking will be at, at most, a small step that may or may not lead to that goal. In an effort to frustrate detection and tracing, many domestic transactions in illegal or contraband merchandise are conducted in cash. The possibility that individuals in China who deal in counterfeit trade- marked jewelry follow a similar practice is a further reason to believe that additional bank transaction doc- uments will not provide fruitful information.

Finally, the fact that the MOJ China takes a narrow- er view concerning the appropriate scope of pretrial dis- covery does not render the Hague Convention process futile. The high cost of discovery in federal litigation is well known, and the fact that another sovereign chooses to take a more restrictive view of the appropriate scope of pretrial discovery is not unreasonable. In addition, as

noted above, China is not unique in reserving its right to limit production in response to a Hague Convention request to documents that it considers to bear a direct and close connection with the litigation; many other countries have made the same reservation.

Absent extraordinary circumstances, it would not comport with considerations of “practicality and wise administration of justice” for the courts of one nation as a matter of course to sit in judgment of the adequacy of due process and the quality of justice rendered in the courts of other sovereigns. There can be no room for arrogance or presumption, or for extravagant rules or practices that may encourage insularity or chauvinism rather than respect for comity. It cannot be the proper province of any one judge in any one country, giving expression to the push of a moment or the pull of the immediate case, to promulgate judgments that impose that court’s rule and will across all sovereign borders so as to reach the rest of humankind.

Concluding that the broad scope of Federal Rules discovery is the only fair manner in which to conduct discovery would be “the essence of sanctimonious chauvinism.”

In summary, resort to the Hague Convention here has not proven futile. Although China, pursuant to its reservation of rights under the Convention, has not produced all the documents that would be required under the Federal Rules of Civil Procedure, its produc- tion is sufficient for plaintiffs to continue their investi- gation concerning the counterfeit goods at issue in their subpoenas against the Banks’ New York branches is, therefore, denied.

CaSe QUeStIONS

1. What information was provided by the Chinese government?

2. What did Tiffany hope for?

3. Why will the court not issue subpoenas to the Chinese government?

7-5b antitrust Laws in the International Marketplace

All U.S. firms are subject to the antitrust laws of the United States, regardless of where their operations and anticompetitive behavior may occur. Firms from other countries operating in the United States or engaging in trade that has a substan- tial impact in the United States are also subject to U.S. antitrust laws. These firms are not covered under the act of state doctrine because they are not governmen- tal entities and are engaging in commercial activity. Likewise, U.S. firms that are operating in other countries are subject to those countries’ antitrust laws. For example, several major U.S. corporations have faced stiff antitrust penalties from the EU. In 2013, Microsoft was required to pay a $732 million penalty to the EU

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Chapter 7 International Law 241

for its failure to comply with an earlier EU order on its anticompetitive behav- ior related to its browser. Citing a technical error, Microsoft took full responsibil- ity for its conduct and apologized for failing to give European consumers their choice of Web browsers on about 15 million copies of the Windows 7 operating system that the company had shipped to them. Although Google was able to set- tle its antitrust suit with the U.S. government, it still has to work through the same allegations with the EU. The distinction between the U.S. case and that in the EU is Google’s higher market share because phones in Europe are more likely to run Google’s Android system, something that gives Google 90% of the market in EU nations.

U.S. firms seeking to merge with competitors must obtain approval from both the U.S. Department of Justice and the EU. Microsoft and GE have been limited in their acquisitions in the EU because of EU antitrust provisions. Generally, if the EU does not approve a merger, the firms drop their plans because it is unlikely they will receive approval from the United States.

The converse is also true. Firms outside the United States may enjoy the pro- tections and benefits of our antitrust laws and bring suit for violations if it can be established that the violations they are alleging had a substantial impact on trade in the United States.

The Export Trading Company Act of 1982 carved an exception to the antitrust laws for U.S. firms that combine to do business in international markets. Large U.S. firms that would otherwise be prohibited from merging for anticompetitive reasons are permitted to form export trading companies (ETCs) for the purpose of participating in international trade. The Justice Department approves applications for ETCs in advance, provided the applicants can demonstrate that the proposed joint venture will not reduce competition in the United States, increase U.S. prices, or cause unfair competition. ETCs such as Mobil and Exxon worked together to explore Siberian oil fields in a combination that would otherwise be prohibited both under the antitrust laws and for ongoing operations. These combinations allow effective negotiation of large foreign contracts. ExxonMobil is now one firm, a result of its joint drilling ventures.

In the United States, the U.S. Customs Service is responsible for developing the tariffs according to a tariff schedule and for enforcing the tariffs on imported goods. The tariff is based on the computed value of the goods coming into the country and is computed at the time of their entry. That computed value depends on how the goods are classified under the schedule. For example, if potato chips are classified as bread, they are tariff- or duty-free. If they are clas- sified as snacks, they carry a tariff. [Sabritas v U.S., 998 F. Supp. 1123 (Ct. Int’l Trade 1998)] The federal government has created a specialized court to handle the many disputes that arise over the application of the tariffs and the underly- ing classification of goods.

Competition may also be controlled by import restrictions, a resulting control on trade balance and prices. By limiting the amounts of certain products or prod- ucts from certain countries, supply and demand (and, through economic princi- ples, price) are affected. These nontariff regulations also control competition and the flow of goods across borders.

As noted earlier, some countries also limit exports, particularly of technologies to certain countries that could use them to harm others through, for example, the development of nuclear technology.

Exhibit 7.1 provides a summary of international law principles and doctrines.

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242 Part 2 Business: Its Regulatory Environment

Exhibit 7.1 The Treaties, Principles, and Statutes of International Law

North Atlantic Treaty North Atlantic Treaty Organization (NATO)

Treaty between U.S. and European nations that establishes a deployment of armed forces and security setup in Europe

Foreign Sovereign Immunities Act of 1976 U.S. statute that clarifies the immunity of foreign countries and officials from prosecution for crimes in the United States

Act of state doctrine (expropriation) Recognition of a foreign government’s actions as valid; U.S. courts may not be used to challenge another country’s actions, even toward U.S. citizens

Foreign Assistance Act of 1962 (Hickenlooper Amendment)

Authorization given to president to cut off aid to countries where U.S. citizens’ property has been taken by the government or regulated so as to deprive owner of use

Overseas Private Investment Corporation (OPIC) Federal insurer for U.S. companies’ investments in countries with low per capita income

Expropriation Act of a sovereign state in taking property from its citizens or businesses operating there

Repatriation Bringing back to your own country money earned on investments in other countries

Export Trading Company Act of 1982 Antitrust combination exemption for companies joining to compete in international markets

Maastricht Treaty Agreement that created European Union

General Agreement on Tariffs and Trade (GATT) Agreement among 150 countries to increase trade by reducing tariffs

North American Free Trade Agreement (NAFTA) Agreement among United States, Canada, and Mexico with the goal of tariff elimination

The Iran Threat Reduction and Syria Human Rights Act of 2012

Paris Agreement of 2015

U.S. law that requires company disclosures about business by them and affiliates in Iran and Syria

Agreement among 200 nations for reduction in the use of fossil fuels

7-5c Protections for Intellectual Property

Protections for intellectual property in the international marketplace are constantly undergoing refinements. Worldwide registration for patents, copyrights, and trade- marks are goals that are within reach as the mechanisms for administration are being put into place. Details on international protections are found in Chapter 15.

7-5d Criminal Law Protections

All persons and businesses present within a country are subject to that nation’s regulatory scheme for business as well as to the constraints of the country’s crimi- nal code. Compliance with the law is a universal principle of international business operations. Expulsion, fines, penalties, and imprisonment are all remedies avail- able to governments when foreign businesses break the law in a particular nation.

Often, the complexities of international operations produce layers of business organizations throughout the world. These layers are often necessary for individual countries and proper business structure under the law. The layers of organizations may provide opportunities for laundering of money, concealment of transactions, and

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other complex transactions that can escape regulatory detection for a time. However, the activities are eventually discovered, and countries are cooperating more to be cer- tain the complexities of international business do not conceal illicit activities.

BiographySiemens: the Company that paid the Largest Fines ever for FCpa Violations

COUNtRY pROdUCt BRIBeS paId date

Russia Medical devices $55 million 2000–2007

Argentina Identity cards project $40 million 1998–2004

China High-voltage transmission lines $25 million 2002–2003

China Metro trains $22 million 2002–2007

Israel Power plants $20 million 2002–2005

Bangladesh Mobile telephone works $5.3 million 2004–2006

Venezuela High-speed trains $16.7 million 2001–2007

Russia Traffic control systems $0.75 million 2004–2006

Vietnam Medical devices $0.5 million 2005

China Medical devices $14.4 million 2003–2007

Nigeria Telecommunications projects €4.2 million 2003

Iraq Power station $1.7 million 2000

Italy Power station €6.0 million 2003

Greece Telecommunications €37 million 2006

Siemens is a German conglomerate that has been in business since 1847. It has three divisions: energy, health care, and industry. Siemens has 428,200 employees and operates in 190 countries. The above chart shows the countries where Siemens paid bribes for contracts in violation of the FCPA. The multination investigation of the company’s bribery activity resulted in Siemens agreeing to pay a fine that was the largest ever paid in the history of the FCPA.

Both the SEC and the U.S. Department of Justice (DOJ) were investigating Siemens. The two agencies concluded that Siemens had paid more than 4,283 bribes totaling $1.4 billion to government officials to secure contracts. The SEC concluded that the bribes resulted in the company obtaining $1.1 billion in profits.

The DOJ and Siemens AG reached an agreement to settle the company’s ongoing

violations. As a result of these violations, Siemens agreed to pay $800 million to the United States, a fine 20 times higher than the largest fine ever collected under the FCPA. Siemens also settled charges with 10 other countries and paid total fines of $5.8 billion. The SEC complaint (www.sec. gov) against Siemens cited the involvement of employees at all levels of the company and a culture that had long been at odds with the FCPA.

The company’s cooperation with the U.S. government since 2006, as well as its efforts to correct the violations, caused government officials to reduce the fine from $2.7 billion to $800 million. Siemens’s efforts to correct its culture included coop- erating with the government, turning over all documents it found, and replacing all but one officer and all board members.

Siemens did follow what is known as “the four-eyes principle” of internal control for the FCPA, meaning all payments required two signatures. How- ever, the company had made so many exceptions to the four- eyes principle that as a practical matter it was not in effect. Rules and processes in com- panies do protect the company. Exceptions should be rare, if ever.

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244 part 2 Business: Its Regulatory Environment

s u m m a r y What laws affect businesses in international trade?

• Foreign Sovereign Immunities Act of 1976

• Foreign Assistance Act of 1962 (Hickenlooper Amendment)

• Overseas Private Investment Corporation (OPIC)

• Export Trading Company Act of 1982

• Contracts for the International Sale of Goods (CISG)

What treaties, agreements, practices, and principles affect international business and trade?

• North Atlantic Treaty

• North Atlantic Treaty Organization (NATO)

• Maastricht Treaty

• General Agreement on Tariffs and Trade (GATT)

• North American Free Trade Agreement (NAFTA)

• International Monetary Fund (IMF)

• Duties, quotas, tariffs—controls on prices and quantities of goods by nations with the goal of balancing imports and exports

• Foreign Corrupt Practices Act (FCPA)—controls on means of accessing governments

• The Iran Threat Reduction and Syria Human Rights Act of 2012

What principles of international law affect business?

• Sovereign immunity—freedom of one country from being subject to orders from another country

• Expropriation; act of state doctrine—recognition by U.S. courts of the actions of other governments as valid despite noncompliance with traditional U.S. rights and procedures

• Repatriation—returning profits earned in other coun- tries to one’s native land

• Conflict of laws—issue as to which country’s law applies in international transactions

• Antitrust issues

• Forum non conveniens—doctrine requiring dismissal of cases that should be heard in another country’s courts

What protections exist in international competition?

• Antitrust laws

• Protections for intellectual property

• Criminal law protections

Q u e s t i o n s a n d P r o b l e m s 1. Tom Welch and Dave Johnson, two officials of the Salt Lake City Olympic Committee, were charged with bribery and racketeering for their alleged role in paying money to and giving rather large gifts to members of the International Olympic Committee (IOC) in order to win the bid for holding the winter Olympics in Salt Lake City in 2002. Salt Lake City did win the bid, but an anonymous letter to the IOC revealed that these types of payments and gifts had been offered. Following an investigation, nine mem- bers of the IOC were removed or resigned and others were sanctioned. The Salt Lake City Olympic Commit- tee removed Mr. Welch and Mr. Johnson and replaced them with Mitt Romney as the head of its committee. Utah declined prosecution under state law, and a fed- eral district court judge dismissed the charges against Mr. Welch and Mr. Johnson. The U.S. Attorney for the case filed an appeal with the tenth circuit federal court of appeals asking that the charges be reinstated. He

noted that the Olympics were an “international” event and mandated federal jurisdiction. He also argued in the brief that the payments, accommodations, and gifts were more than goodwill and amounted to brib- ery in violation of federal law.

Applying the cases and law presented in the dis- cussion on the FCPA, determine whether there was or was not a violation of federal law. What jurisdiction do federal courts have over criminal charges? Describe the appellate process and what an appellate court can do in an appeal such as this. [U.S. v Welch, 327 F.3d 1081, at 1085 (10th Cir. 2003)]

2. Suppose that the government of Brazil took posses- sion of the cacao farms of a chocolate factory owned by a U.S. firm. What rights would the U.S. factory have? What limits exist on those rights?

3. A Philip Morris subsidiary, C. A. Tabacalera National, and a B.A.T Industries subsidiary known

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Chapter 7 International Law 245

as C. A. Cigarrera Bigott entered into a contract with La Fundacion del Nino (the Children’s Foundation) of Caracas, Venezuela. The agreement was signed on behalf of the foundation by the foundation’s presi- dent, who also was the wife of the then–president of Venezuela. Under the terms of the agreement, these two tobacco firms were to make periodic donations to the Children’s Foundation totaling $12.5 million. In exchange, the two firms would receive price con- trols on Venezuelan tobacco, elimination of controls on retail cigarette prices in Venezuela, tax deductions for donations, and assurances that the existing tax rates applicable to tobacco companies would not be increased.

Is the donation to the charity a violation of the FCPA? [Lamb v Philip Morris, Inc., 915 F.2d 1024 (6th Cir. 1990; cert. denied, 498 U.S. 1086 (1995))]

4. In 1973, Chevron and Ecuador signed an agreement allowing Chevron to develop Ecuadorian oil fields in exchange for providing below-market oil to the Ecuador- ian government. The deal was set to expire in 1992, and the parties were unable to agree to an extension. Chevron filed several breach of contract suits against Ecuador. In 1995, Chevron and Ecuador signed a settlement agree- ment conclusively terminating all rights and obligations between the parties. The agreement provided for the con- tinuation of the pending lawsuits.

In 2006, Chevron commenced an international arbitration action before a three-member tribunal based out of The Hague, claiming that Ecuador had violated the contract terms by failing to resolve its lawsuits in a timely fashion. Ecuador objected to the tribunal’s jurisdiction, arguing that it had never agreed to arbitrate with Chevron as well as asserting its sovereign immunity. Who has jurisdiction here? Discuss the sovereign immunity claim. What lessons should companies take away from these types of for- eign contracts? [Chevron v Republic of Ecuador, 795 F.3d 200 (D.C.C. 2015)]

5. James H. Giffen, owner of Mercator Corporation, a New York company, made $78 million in payments to two government officials in Kazakhstan. He was charged with violations of the Foreign Corrupt Prac- tices Act (FCPA). Giffen moved to have the charges dis- missed because he had been named a counselor to the president of Kazakhstan and was immune from pros- ecution under the act of state doctrine. He also asked that the charges be dismissed because any payments he made to the officials were for facilitation and access and were not bribes for contracts with his company. Is he correct? Does the act of state doctrine apply? Did he bribe, or did he facilitate? [U.S. v Giffen, 326 F. Supp. 2d 497 (S.D.N.Y. 2004)]

6. United Arab Shipping Company (UASC) is a corpo- ration formed under the laws of Kuwait. Its capital stock is wholly owned by the governments of Kuwait, Saudi Arabia, the United Arab Emirates, Qatar, Iraq, and Bah- rain. No single government owned more than 19.33% of UASC’s shares, and the corporation was created by a treaty among the owner nations.

Three seamen who were injured while working for UASC brought suit against it in federal district court in the United States. UASC maintains it enjoys sovereign immunity. The seamen claim it is a com- mercial enterprise and not entitled to immunity. Who is correct? [Mangattu v M/V IBN Hayyan, 35 F.3d 205 (5th Cir. 1994)]

7. Smith & Smith, a U.S. computer firm, contracted to install a computer system for Volkswagen in the com- pany’s headquarters in Berlin, Germany. Smith’s con- tract included the following liability limitation: “We are only liable for loss of data which is due to a deliberate action on our part. We are not responsible for lost profits in any event.” The contract had no provisions on choice of law. A crash in the Smith & Smith system caused a loss of 92 days’ worth of financial data. Volkswagen was required to use its auditors to restructure the database at a substantial cost. Smith & Smith says it did nothing deliberate and, therefore, is not liable. Volkswagen cites German law that mandates protection by sellers against such losses and permits recovery of lost profits. U.S. law would honor the Smith & Smith clause. Which law applies? Why?

8. The Western oil firms once were the dominant play- ers in Kazakhstan, a Central Asian country that is rich in oil resources. However, the Justice Department indicted U.S. citizen James Giffen for allegedly making $80 mil- lion in payments to government officials in Kazakhstan on behalf of Mobil and other companies so that the com- panies could obtain drilling rights from the government. Giffen had the touch when it came to getting the oil com- panies access for drilling. Once Giffen was indicted, the Western oil firms’ drilling rights diminished substantially and the presence of Chinese oil firms increased. Many have pointed to this example, with direct causal con- nection between the elimination of U.S. firms and the increased presence of Chinese firms, as evidence that the FCPA puts U.S. firms and the U.S. economy at a distinct disadvantage to those countries that do not take enforce- ment action against bribery. How would you respond to this argument? Discuss the reasons behind the bribery statutes. (Nathan Wardi, “The Bribery Law Bracket,” Forbes, May 24, 2010, p. 70.)

9. The European Union has developed a directive on privacy and e-mail. Nations within the EU are permitted

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246 Part 2 Business: Its Regulatory Environment

to use e-mail for commercial transactions and can exchange information via e-mail. However, businesses from countries outside the EU will not be permitted access to EU business information and EDI systems for contracting purposes unless they can guarantee adequate privacy protections are in place for the data transmitted via e-mail. Most legal experts believe the EU privacy directive applies to all forms of transmissions in business, including commercial contracts and ordering information.

What would happen if a business tapped into an EU business and began entering into transactions without an adequate privacy guarantee? Would there be criminal sanctions? Trade sanctions? How does this directive affect international trade with the EU? The EU has provided that trading privileges can be with- drawn from countries with businesses that violate the privacy standards on e-mail information and data transmission. What happens when trading privileges are withdrawn? Is the EU directive a commercial con- trol of trade?

10. Walid Azab Al-Uneizi was an employee of the Ministry of Defense of Kuwait. Liticia Guzel was an

employee of the Willard Inter-Continental Hotel in Washington, D.C. One of her duties was restocking minibars in guest rooms. Al-Uneizi approached Miss Guzel outside Rooms 610 and 612 and conferred with her about restocking Room 612. After Miss Guzel fin- ished restocking Room 612, Al-Uneizi assaulted and raped her. After the rape, Al-Uneizi gave her a Kuwaiti flag pin. Miss Guzel has brought suit against both Al-Uneizi and the Kuwaiti government, who seek a dis- missal under the act of state doctrine. Should the case be dismissed against both? [Guzel v State of Kuwait, 818 F. Supp. 6 (1993)]

11. When the Barings Bank bankruptcy occurred in 1995, Nick Leeson, the trader responsible for the immense losses the bank experienced after heavy derivative investments, fled to Germany. He was brought back to Hong Kong, the site of his trades, for trial. He is a Brit- ish citizen who was arrested in Germany. Describe all the principles and issues of international law involved in his arrest, return to, and eventual trial in Singapore. (Note: Mr. Leeson has been released from prison and now lives in Ireland.)

Strategy, Ethics, & the Law Why Recovery from Bribery Charges Is So Difficult

The SEC complaint in the Siemens case (see p. 243) notes how many “red flags” the board ignored in the years during which the bribery was occurring. Since 1999, when Germany signed on to the anti-bribery provisions of the OECD, Siemens executives had been concerned about the company’s involvement in bribery around the world. The CEO at the time of the OECD adoption voiced concern to the board about the number of executives who were under investigation by the German government for bribery activities. He asked the board to take protective measures because its members could be held responsible for inaction. Despite his plea, the bribes continued, with support from some board members.

In 2001, the general counsel for the NYSE board notified its board members that in order for the com- pany to meet U.S. standards for its new NYSE listing, it needed to end its practice of having off-the-books accounts for the payment of the bribes. The company

took no steps to investigate or end its practices. The SEC noted there was a stunning lack of internal controls as well as a tone at the top that did not take the FCPA seriously.

What should Siemens have done? Explain the following quote from a Justice Department official: “Crimes of official corruption threaten the integrity of the global marketplace and undermine the rule of law in host countries.”3 What does the quote mean?

Siemens’s new CEO has said that it will take time for the company to recover because it was so depen- dent on such a facile business model. He explains that the company lost the skill sets of negotiating contracts, competing for projects, and submitting effective proposals. What lessons should compa- nies learn from this observation about reliance on bribery?

For more information, the full Siemens complaint can be found at www.sec.gov.

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Chapter 7 International Law 247

n ot e s 1. The OECD member countries include Australia, Austria, Belgium, Canada, the Czech Republic, Denmark, Finland, France, Germany, Greece, Hungary, Iceland, Ireland, Italy, Japan, Korea, Luxembourg, Mexico, the Netherlands, New Zealand, Norway, Poland, Portugal, the Slovak Republic, Spain, Sweden, Switzerland, Turkey, the United Kingdom, and the United States.

2. OECD also has relationships with 70 countries and NGOs.

3. Siri Schubert and T. Christian Miller, “Where Bribery Was Just a Line Item,” New York Times, December 21, 2008, pp. SB1, SB6–7.

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248

Chapter

Business Crime8 The term “white-collar crime” was coined by Edwin Sutherland in a speech he gave to the American Sociological Society in 1939. He defined “white-collar crime” as “[c]rime committed by a person of respectability and high social status in the course of his occupation.” Since that time, the term white-collar crime has evolved to include a wide variety of crimes, but it, along with corporate fraud and public corruption, is among the FBI’s top priorities for their criminal investi- gations and prosecution referrals. Everything from sports memorabilia fraud to adoption scams to Medicare fraud are on the list of the scams, operations, and activities that are tackled at the state and federal levels each year.

Every businessperson is expected to know and understand the types and nature of business crimes. This chapter offers that background by answering the following questions: Why does business crime occur? Who is liable for crimes committed by businesses? What penalties are imposed for business crimes? What are the rights of corporate and individual defendants in the criminal justice system?

Update For up-to-date legal and ethical news, go to mariannejennings.com

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249

8-1 What Is Business Crime? The Crimes within a Corporation

8-1a Financial Fraud: employees Manipulating earnings Numbers

Many business crimes are committed because companies apply pressure to man- agers and employees to produce results. Economic pressure often leads managers to cross ethical and legal lines. Managers feel compelled to meet earnings goals or to reach incentive bonus plan figures, and then they pass along the pressure they feel to employees. The drive to succeed or present a good earnings record can lead many managers and employees into committing crimes on behalf of the corpora- tion. These crimes might not directly line employee pockets. The business bene- fits, and then employees benefit indirectly through profit sharing, salary increases, bonuses, or just being able to keep their jobs.

For example, in January 2004, Andrew Fastow, the former CFO of the collapsed and bankrupt energy company Enron, entered a guilty plea to two counts of con- spiracy to commit securities and wire fraud. His wife, Lea Fastow, pleaded guilty to filing a false joint tax return. Mr. Fastow was the mastermind behind the cre- ation of off-the-books partnerships to which Enron’s substantial debt was trans- ferred. The result was that Enron’s financial reports made the company seem healthy because, under accounting rules that existed at that time, the debt in the entities, which included Mr. and Mrs. Fastow as principals and officers, did not have to be reported on Enron’s financial statements. The Fastows and other offi- cers, including 26 executives who were indicted, have all explained that they were simply trying to meet projected earnings statements so that they could preserve shareholder value and share price on the market. As he testified against his former boss, former Enron CEO Jeffrey Skilling, Mr. Fastow said, “I thought I was being a hero for Enron. At the time, I thought I was helping myself and helping Enron to make its numbers.”

Forensic accounting has been labeled “the most secure job in America” because these individuals are trained to detect fraudulent conduct within companies, whether perpetrated by a management team driven to achieve

I hope no one is taping this. An Amgen mAnAger At A SAleS meeting A fellow employee/whistle-blower was taping it; Amgen paid a $762 million fine for the illegal marketing practices covered in the meeting and later used by the company’s sales force.

Mordechay Sasy owns M & H Used Auto Parts & Cars, Inc. (defendants), a vehicle dismantling business, located in Queens County, New York. Between January 1999 and January 2000, the New York City Police Department conducted an undercover investigation of vehicle dismantling businesses. An undercover detec- tive posed as a scrap metal processor and purchased 166 “junked” vehicles from M & H. The detective discovered that there was oil and other chemicals on

the soil and a sump pump with oil slick was pumping liquids into the street sewers. Mordechay and M  & H were criminally charged for dumping waste into the waterways. Mordechay testified that he did not know that what went into the sewer ended up in any waterways and that he did not intend to violate the environmental laws. Does Mordechay have a defense to the environmental crime of dumping waste into waterways?

Consider . . . 8.1

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250 part 2 Business: Its Regulatory Environment

goals or by individual employees. In 2015, the FBI initiated 84 cases of finan- cial institution fraud, made 69 recommendations for prosecution of individ- uals in those institutions, had 73 indictments of executives and employees, and had 160 individuals sentenced for financial fraud. The average prison time served for financial fraud is 44 months, up from the 2013 average of 32 months.

8-1b Marketing Missteps: Sales Zeal and Crimes

A number of pharmaceutical firms have paid billions in fines for marketing techniques that crossed legal lines. The Food and Drug Administration (FDA) does not permit pharmaceutical firms to market prescription drugs for purposes other than their federally approved use. For example, AstraZeneca paid $520 million to settle federal charges related to its marketing of its antipsychotic drug Seroquel to doctors for prescriptions for children and the elderly when the drug was not approved for use with children or the elderly. In addition, AstraZeneca inter- nal e-mails indicated its awareness that the drug resulted in weight gains and possible development of diabetes, information that was not disclosed to those who were taking Seroquel. Eli Lilly, Bristol-Myers Squibb, Johnson & Johnson, and Pfizer together paid over $6 billion in fines for similar marketing missteps. Salespeople, particularly in the pharmaceutical industry, must be supervised carefully because criminal lines are crossed quite easily in the zeal for more sales.

8-1c Friendly Fire: employee theft

In addition to pressure to meet company goals, some individual employees feel personal financial pressure and resort to embezzlement as a means of remedying their own bleak financial positions. Employee theft is estimated at $50 billion annu- ally. The Association of Certified Fraud Examiners estimates that 37.5% of employ- ees have stolen at least twice from their employers. Walmart loses $3 billion each year to employee theft. In February 2013, Penny Winters, a 63-year-old mainte- nance worker at Walmart, was arrested for felony theft because she was caught on camera eating Oreos and other snacks as she worked her third shift at a Walmart store. She had eaten so much snack food that her charges rose to the felony level of theft. Sarbanes–Oxley imposes requirements (see Chapter 18 for additional infor- mation) for internal control certifications so that companies have adequate systems for detecting embezzlement.

Small businesses have higher employee theft costs because they cannot afford the sophisticated monitoring measures that larger corporations adopt. Most employee theft is systematic. For example, Aramark, a company that specializes in vending machine sales, reported that employees had skimmed millions in revenue by underreporting sales, ever so slightly over a period of time, in its cash/coin business. Employee theft has the hallmark of small amounts taken over a period of time with well-planned and -executed schemes. For example, employees of an air- craft plant filled their pockets with nuts and bolts each day at the end of the shift. Over time, the employees had accumulated enough hardware to fill kegs, which were then sold. Garment workers for apparel manufacturers have gone home with jeans in their purses.

Exhibit 8.1 provides a partial list of the companies and business executives that have had encounters with laws, regulators, and courts.

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Chapter 8 Business Crime 251

Exhibit 8.1 a Roster of Wrongdoing

COMpaNY/peRSON ISSUe StatUS Boeing (2003) Charges of illicit use of competitor’s

proprietary documents; charges of recruiting government official

Loss of 7 government contracts worth $250 million; $615 million fine; guilty plea by official who was wooed; 9-month sentence

Countrywide Mortgage (2009) Insider trading; securities fraud Former CEO Angelo Mozilo charged with insider trading, CFO and COO charged with failure to disclose firm’s relaxed lending standards; settled case for fines

Andrew Fastow, former CFO of Enron (2004)

Multi-million-dollar earnings from serving as principal in SPEs (Special purpose entities) of Enron created to keep debts off the company books

Entered guilty plea to securities and wire fraud; sentenced to 6 years; helped plaintiffs in shareholder suits

Lea Fastow (2004) Filing false income tax return Guilty plea; sentenced to 5 months in prison and 5 months of house arrest

Jeffrey Skilling, former CEO of Enron (2004)

Questions about his role in the Enron fraud; resigned just prior to company’s collapse

Found guilty of securities fraud and sentenced to 24.4 years; U.S. Supreme Court partially reversed his conviction on honest services fraud; sentence reduced to 14 years

Galleon Group (2011) Insider trading charges related to hedge fund’s operations

23 executives, including CEO, convicted or entered guilty pleas; Galleon’s $3.7 billion fund liquidated; CEO (Raj Rajaratnam) sentenced to 11 years; a Goldman Sachs director (Rajat Gupta) also convicted of insider trading and sentenced to 2 years in prison for feeding information to Rajaratnam

HealthSouth (2003) $2.7 billion accounting fraud; overstatement of revenues

16 former executives indicted; 5 guilty pleas

Richard Scrushy, CEO of HealthSouth (2003)

85 federal felony counts, including violations of Sarbanes–Oxley financial certification provisions

Acquitted of financial fraud charges; found guilty of bribery and sentenced to 7 years

Martha Stewart, CEO of Martha Stewart Omnimedia and close friend of Sam Waksal (2003)

Sold 5,000 shares of ImClone one day before public announcement of negative FDA action on Ebritux

Convicted of making false statements and conspiracy; served 5 months in prison, 5 months of home confinement, and 2 years of probation; fine of $30,0000

KMPG (2006) Tax shelter fraud Settled with federal regulators by payment of $456 million penalty

Sotheby’s (2003) Price-fixing Chairman given 1 year and 1 day in prison and a $7.5 million fine; CEO placed under house arrest for 1 year

WorldCom (2003) Accounting issues centered on swaps— selling to other telecommunications companies and hiding expenses, thereby overstating revenue

WorldCom emerged from bankruptcy as MCI; four officers and managers entered guilty pleas; CEO Bernard Ebbers convicted and sentenced to 25 years

(Continued)

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252 part 2 Business: Its Regulatory Environment

COMpaNY/peRSON ISSUe StatUS Bernie Madoff (2009) $50 billion Ponzi scheme Entered guilty plea to all charges; sentenced

to 150 years (was 71 years old at time of sentencing); direct reports convicted

BP (2013) Violation of Clean Air Act; willful failure to correct OSHA violations; manslaughter and obstruction

$50 million fine to EPA; $58 million fine to OSHA (largest in U.S. history) for pre– Deepwater Horizon explosion; $4 billion for crimes related to Deepwater Horizon explosion; $20 billion civil penalty

Stanford Securities (2012) $9 billion Ponzi scheme CEO convicted of mail, wire, and securities fraud and sentenced to 110 years; Laura Pendergest-Holt, the former chief investment officer, entered a guilty plea and was sentenced to 3 years; CFO entered a guilty plea

Massey Coal (2016) Mine collapse resulting in the deaths of 29 miners

3 company officials entered guilty pleas, and one was convicted of charges related to tipping off employees on mine inspections and destroying records to avoid government review; former CEO convicted of violating mine safety rules

Peanut Corporation of America (2016)

Indictments for producing and selling product without cleaning up salmonella issue at plant and falsifying tests that showed the salmonella was gone when it was not

Four company officers, including owner and CEO, convicted of fraud and conspiracy; food broker also indicted for his role in test falsification; CEO sentenced to 28 years, food broker to 20 years

GM (2015) Guilty plea to criminal mishandling of defective ignition switch

$900 million fine

SAC Capital (2014) Insider trading charges; use of advance information from pharmaceutical trials

Settled charges for $600 billion fine; 11 former and current employees convicted of or entered guilty pleas to insider trading

8-2 What Is Business Crime? The Crimes against a Corporation

Interbusiness crime occurs among competitors and results in one business gain- ing a competitive advantage over others. The list of companies and misdeeds in Exhibit 8.1 provides examples of the wide variety of business crimes committed, from kickbacks to antitrust violations to securities fraud to OSHA and EPA viola- tions to obstruction.

Once again, competitive pressure led to these types of crimes. Employees within one company postponed necessary safety fixes so as to correct OSHA viola- tions in order to contain costs and remain competitive. However, as the remainder of the chapter shows, any competitive advantage gained through criminal activity is only temporary.

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Chapter 8 Business Crime 253

8-3 Who Is Liable for Business Crime? One of the major differences between nonbusiness and business crimes is that more people can be convicted of business crimes. For nonbusiness crimes, only those involved in the planning or execution of the crime or assistance after it is committed can be convicted. In other words, those who were in any way involved in the criminal act or aftermath are criminally responsible. For business crimes, on the other hand, those in management positions at firms whose employees actu- ally commit criminal acts can be held liable if they authorized the conduct, knew about the conduct but did nothing, or failed to act reasonably in their supervisory positions. Liability for crimes also extends to employees who participate with the company and its management in illegal acts. For example, employees who help their employers establish fraudulent tax shelters for customers can be held liable along with the company and its officers. The key to establishing criminal liability is showing personal knowledge of wrongdoing.

U.S. v Park (Case 8.1), a landmark case, discusses the liability standards for those who are in charge but may not themselves commit a criminal act.

United States v Park 421 U.S. 658 (1975)

Is Chasing Rats from the Warehouse in My Job Description?

Case 8.1

FaCtS

Acme Markets, Inc., was a national food retail chain headquartered in Philadelphia, Pennsylvania. At the time of the government action, John R. Park (respon- dent) was president of Acme, which employed 36,000 people and operated 16 warehouses.

In 1970, the Food and Drug Administration (FDA) forwarded a letter to Mr. Park describing, in detail, problems with rodent infestation in Acme’s Philadel- phia warehouse facility. In December 1971, the FDA found the same types of conditions in Acme’s Balti- more warehouse facility. In January 1972, the FDA’s chief of compliance for its Baltimore office wrote to Mr. Park about the inspection. The letter included the following language:

We note with much concern that the old and new ware- house areas used for food storage were actively and extensively inhabited by live rodents. Of even more con- cern was the observation that such reprehensible con- ditions obviously existed for a prolonged period of time without any detection, or were completely ignored.

We trust this letter will serve to direct your atten- tion to the seriousness of the problem and formally

advise you of the urgent need to initiate whatever mea- sures are necessary to prevent recurrence and ensure compliance with the law.

After Mr. Park received the letter, he met with the vice president for legal affairs for Acme and was assured that he was “investigating the situation imme- diately and would be taking corrective action.”

When the FDA inspected the Baltimore warehouse in March 1972, there was some improvement in the facility, but there was still rodent infestation. Acme and Mr. Park were both charged with violations of the Federal Food, Drug, and Cosmetic Act. Acme plead- ed guilty. Mr. Park was convicted and fined $500; he appealed based on error in the judge’s instruction, given as follows:

The individual is or could be liable under the statute even if he did not consciously do wrong. However, the fact that the Defendant is president and chief executive officer of the Acme Markets does not require a finding of guilt. Though he need not have personally participated in the situation, he must have had a responsible rela- tionship to the issue. The issue is, in this case, whether the Defendant, John R. Park, by virtue of his position in

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254 part 2 Business: Its Regulatory Environment

the company, had a position of authority and responsi- bility in the situation out of which these charges arose.

The court of appeals reversed Mr. Park’s convic- tion, and the government appealed.

JUdICIal OpINION

BURGER, Chief Justice Central to the Court’s conclusion [in United States v Dotterweich, 320 U.S. 277 (1943)], that individuals other than proprietors are subject to the criminal provisions of the Act was the reality that “the only way in which a corporation can act is through the individuals who act on its behalf.”

At the same time, however, the Court was aware of the concern . . . that literal enforcement “might operate too harshly by sweeping within its condem- nation any person however remotely entangled in the proscribed shipment.” A limiting principle, in the form of “settled doctrines of criminal law” defining those who “are responsible for the commission of a misdemeanor,” was available. In this context, the Court concluded, those doctrines dictated that the offense was committed “by all who have . . . a respon- sible share in the furtherance of the transaction which the statute outlaws.”

The Act does not, as we observed in Dotter- weich, make criminal liability turn on “awareness of some wrongdoing” or “conscious fraud.” The duty imposed by Congress on responsible corporate agents is, we emphasize, one that requires the highest standard of foresight and vigilance, but the Act, in its criminal aspect, does not require that which is objec- tively impossible. The theory upon which responsible corporate agents are held criminally accountable for “causing” violations of the Act permits a claim that a defendant was “powerless” to prevent or correct the violation to “be raised defensively at a trial on the merits.” U.S. v Wiesenfield Warehouse Co., 376 U.S. 86 (1964). If such a claim is made, the defendant has the burden of coming forward with evidence, but this does not alter the Government’s ultimate burden of proving beyond a reasonable doubt the defendant’s guilt, including his power, in light of the

duty imposed by the Act, to prevent or correct the prohibited condition.

Turning to the jury charge in this case, it is of course arguable that isolated parts can be read as intimating that a finding of guilt could be predicated solely on respondent’s corporate position?. . . . Viewed as a whole, the charge did not permit the jury to find guilt solely on the basis of respondent’s position in the corporation; rather, it fairly advised the jury that to find guilt it must find respondent “had a responsible relation to the situation,” and “by virtue of his position . . . had authority and responsibility” to deal with the situation. The situation referred to could only be “food . . . held in unsanitary conditions in a warehouse with the result that it consisted, in part, of filth or . . . may have been contaminated with filth.”

Park testified in his defense that he had employed a system in which he relied upon his subordinates, and that he was ultimately responsible for this system. He testified further that he had found these subordinates to be “dependable” and had “great confidence” in them.

[The rebuttal] evidence was not offered to show that respondent had a propensity to commit criminal acts, that the crime charged had been committed; its purpose was to demonstrate that respondent was on notice that he could not rely on his system of delega- tion to subordinates to prevent or correct unsanitary conditions at Acme’s warehouses, and that he must have been aware of the deficiencies of this system before the Baltimore violations were discovered. The evidence was therefore relevant since it served to rebut Park’s defense that he had justifiably relied upon sub- ordinates to handle sanitation matters.

Reversed.

CaSe QUeStIONS

1. What problems did the FDA find in the Acme warehouses, and over what period?

2. Was Mr. Park warned about the problem? What action did he take?

3. What standard of liability did the instruction given by the judge impose?

8-4 Federal Laws Targeting Officers and Directors for Criminal Accountability

8-4a White-Collar Crime’s Origins and History

With each wave of accounting and fraud scandals, new legislation at the federal level has increased penalties for those who are the masterminds of white-collar

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Chapter 8 Business Crime 255

crimes. In 1988, following the Michael Milken junk-bond era and the Ivan Boesky insider trading scandal, Congress passed additional laws against and sanctions covering insider trading in the Insider Trading and Securities Fraud Enforce- ment Act of 1988 (ITSFEA) (see Chapter 18 for more information). Criminal and civil penalties increased at least 10-fold under the law. In 1990, Congress enacted what has been called the “white-collar kingpin” law. A response to the 1980s and 1990s savings and loan scandals and the 2000 dot-com and 2008 financial mar- ket collapses, the law imposes minimum mandatory sentences (10 years in most instances) for corporate officers who mastermind financial crimes such as bank and securities fraud.

8-4b Sarbanes–Oxley (SOX)

Following the collapses of Enron, WorldCom, Adelphia, and others in the period from 2001 to 2002, Congress passed Sarbanes–Oxley, also known as the White-Collar Criminal Penalty Enhancement Act of 2002. Under SOX, as it is known among businesspeople, penalties for mail and wire fraud, which had a former maximum of five years, have been increased to 20 years in prison. (Refer to Exhibit 8.1 to see the number of wire and fraud charges that have been brought against executives.)

The Drug Enforcement Administration (DEA) issued a suspension order that revoked the controlled medication licenses of two phar- macies because the pharmacies were filling prescriptions for oxycodone (the painkiller) in excess of their monthly allowances for controlled substances. The DEA cited its findings that two pharmacies in a city of only 53,570 residents were alone dispensing over 8 million dosage units over an approximately three-year period. In addition, the DEA is- sued its findings that the pharmacies’ corpo- rate entities failed to conduct on-site inspec- tions and also failed to notice that 42% to 58% of all the sales of the substances were cash sales, a red flag in the sale and distri- bution of controlled substances. Also, the number of prescriptions filled continued to escalate—increasing ninefold in one year to more than 2 million dosages dispensed.

When investigators were present on- site at one of the pharmacies, every third car going through the drive-thru pickup was receiving a prescription for oxycodone. Those using the drive-thru also used “street slang” for requesting certain brands of oxy- codone. Pharmacists at the drugstores, in interviews with the DEA agents, indicat- ed that the customers paying cash for the

oxycodone were “shady” and that they sus- pected that some of the prescriptions were not valid. [Holiday CVS, L.L.C. v Holder, 839 F. Supp. 2d 145 (D.D.C. 2012)]

The shipment of oxycodone to the phar- macies was five times the amount that would have been within normal bounds for the pop- ulation in the area. Many patients living at the same address had the same prescriptions for oxycodone from the same doctor.

The two pharmacies filed suit in federal district court to have the suspension order lifted, but the appellate court upheld the actions of the DEA. [Holiday CVS, L.L.C. v Holder, 493 Fed. Appx. 108 (C.A.D.C. 2012)] Both companies, CVS and Cardinal Health, have indicated in court filings that they have changed their practices and provided train- ing to pharmacy personnel so that they can spot these types of illegal prescriptions and report suspicious activity.

However, the DEA seeks to hold the corporations responsible because of the lack of on-site presence and the failure to follow the numbers for sales and distribu- tion at the pharmacies. Can the corporation be held liable when it was not actual- ly participating in the distribution of the oxycodone?

Consider . . . 8.2

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256 part 2 Business: Its Regulatory Environment

Penalties for violation of the trust, reporting, and fiduciary duties under pen- sion laws increased from one year to 10 years, with fines increasing from $5,000 to $100,000. SOX also provides for the specific crime of false financial statement certification, a crime directed at CEOs and CFOs, who are now required to certify the financial statements issued by their companies. Top officers who certify finan- cial statements that they know contain false information now face being charged with a specific federal crime because of SOX reforms. Richard Scrushy, the former CEO of HealthSouth, became the first CEO charged with a violation of these new provisions. Mr. Scrushy was acquitted of all financial fraud charges but was later convicted of bribery in connection with payments he made to the ad campaign funds of the governor of Alabama. Mr. Scrushy is currently serving a seven-year sentence.

8-4c Honest Services Fraud

Following the Boesky and Milken scandals, part of the 1988 federal reforms included a 28-word addition to the federal mail and wire fraud statutes that provided, “For the purposes of this chapter, the term, scheme or artifice to defraud includes a scheme or artifice to deprive another of the intangible right of honest services.” (18 U.S.C. § 1346) The provision lay fallow for some time until the Enron era of company failures attributable to accounting fraud by officers. Prosecutors began adding so-called honest services fraud charges to mail and wire fraud as a way to obtain harsher sentences for the white-collar criminals. Conviction on this charge requires proof that the activities of the officers deprived the shareholders of the corporation of the honest services to which they were entitled as beneficiaries of the officers’ fiduciary duties. Conrad Black, Richard Scrushy, and Jeffrey Skilling all received longer sentences because they were convicted of honest services fraud. However, the U.S. Supreme Court held in Skilling v U.S., 561 U.S. 358 (2010), that this portion of the mail and wire fraud statute was void for vagueness in the way prosecutors were using it for convictions and pleas (see substantive due process in Chapter 5). The court held that company officers would not know when and how they had violated the law because this portion of the statute was being applied when anything went wrong in the company. In other words, it was difficult to know what conduct deprived shareholders of officers’ “honest services.” The court held that the statute could be applied to the conduct of officers only in those sit- uations in which officers accepted bribes or kickbacks so that they breached their fiduciary duties to shareholders and deprived them of the honest services officers are required to provide. There must be an underlying conflict created by a bribe or a kickback for the statute to apply. This significant decision curbed the govern- ment’s flexibility in prosecuting white-collar crime and resulted in a reduction in sentences for Messrs. Black and Skilling and other white-collar criminals serving their sentences at the time of the decision.

8-4d Financial Services Crimes and Reforms

Following the 2008 collapses and near-collapses of so many investment firms, banks, insurers, and mortgage lenders, Congress passed the Financial Services Reform Act, also known as the Dodd–Frank Wall Street Reform and Consumer Protection Act. The act creates a Bureau of Consumer Financial Services (CFSB) (see Chapter 11 for more information) that can impose civil penalties and also refer cases to the Department of Justice for criminal prosecution for violations of

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Chapter 8 Business Crime 257

disclosure requirements or misrepresentations related to financial transactions. The act covers brokers, insurers, mortgage lenders, investment firms, banks, and any company that provides consumer financial services, including additional dis- closure requirements as well as prohibitions on predatory lending.

8-4e Other Business Crimes and White-Collar liability

There are other federal statutes that impose liability on CEOs and other executives when harm results. For example, Midnight Rider director Randall Miller was sen- tenced to two years in prison based on alleged violations of OSHA rules during the filming of that movie. One crew member lost her life when she was struck by a train while setting up a shoot on a narrow trestle of a railway in Georgia. Criminal liability for those in charge at a company or at a movie shoot can be held criminally liable for the failure to follow OSHA rules, obtain clearance for the location shoot, or not taking proper precautions in setting up a scene. In the Miller case, the alle- gations were that the focus was on the artistic aspects of getting a good shot and not on issues such as safety measures and permissions for use of the trestle. CEOs of mining companies and food processors have been convicted of crimes related to safety issues as well as compliance with various federal standards for production.

8-5 The Penalties for Business Crime Statutes specify penalties for crimes. Some statutes have both business and indi- vidual penalties. Exhibit 8.2 provides a summary of the penalties under the major federal statutes.

8-5a New penalties and New processes

Some regulators and legislators argue that the difficulty with most criminal law penalties is that they were instituted with “natural” persons in mind, as opposed to “artificial” corporate persons. Fines may be significant to individuals, but a $10,000 fine to a corporation with billions in assets and millions in income is sim- ply a cost of doing business.

A recommendation advanced for the reformation of criminal penalties is that the penalties must cost the corporation as much as a bad business decision would cost. For example, if a company develops a bad product line, net earnings could decline 10% to 20%. Penalties expressed in terms of net earnings, as opposed to set dollar amounts, are more likely to have a deterrent effect on business criminal behavior.

8-5b Corporate Integrity agreements (CIas)

Using a corporate integrity agreement (CIA), judges are able to, in effect, place cor- porations on probation. Under CIAs, companies are assigned monitors who are on-site and follow up to be sure the company is not committing any further viola- tions. Most CIAs include requirements that the company create or improve its eth- ics and compliance program, something that can include additional staffing and mandatory training for all employees. A CIA is a form of a deferred prosecution agreement (DPA). If the corporation has no further violations during the time of the CIA, which is generally three to five years, then the CIA is lifted and prosecu- tors do not go forward with a criminal case against the company.

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258 part 2 Business: Its Regulatory Environment

Exhibit 8.2 penalties for Business Crime under Federal law

aCt peNaltIeS

Internal Revenue Code

26 U.S.C. § 7201

$100,000 ($500,000 for corporations) and/or 5 years

For evasion (plus costs of prosecution as well as penalties and assessments: 5–50%)

Sherman Act (antitrust)

15 U.S.C. § 1

$350,000 and/or 3 years; $10,000,000 for corporations

Injunctions

Divestiture

Sarbanes–Oxley

15 U.S.C. § 1341

(document destruction, concealment, alteration, mutilation during pending civil or criminal investigation)

20 years plus fines

(25 years for perjury)

Sarbanes–Oxley

(certification of financial statements)

$1,000,000 and/or 10 years

If willful: $5,000,000 and 20 years; officers who earn bonuses based on falsified financial statements must forfeit them

1933 Securities Act

15 U.S.C. § 77× (as amended by Sarbanes–Oxley)

$100,000 and/or 10 years

Securities and Exchange Act of 1934 $5,000,000 and/or 20 years

15 U.S.C. § 78ff $25,000,000 for corporations

Civil penalties in addition of up to three times profit made or $1,000,000, whichever is greater

Clean Air Act

42 U.S.C. § 7413

$1,000,000 and/or 5 years

Clean Water Act

33 U.S.C. § 1319

For negligent violations: $25,000 per day and/or 1 year

For knowing violations: $50,000 per day and/or 3 years

For second violations: $100,000 per day and/or 6 years

For false statements in reports, plans, or records: $10,000 per day and/or 2 years

Occupational Health Safety Act

29 U.S.C. § 666

Willful violation causing death: $70,000 and/or 1 year; minimum of $5,000 per willful violation

Giving advance notice of inspection: $1,000 and/or 6 months

False statements or representations: $10,000 and/or 6 months

Consumer Product Safety Act

15 U.S.C. § 2070

$50,000 and/or 1 year

Tampering: up to $500,000 and/or 10 years

Monitors One portion of a corporate integrity agreement is generally the assignment of monitors to corporations to follow up on corporate activity. Monitors have offices within the corporation and are permitted to attend meetings, make observations, and provide feedback. The monitors are also there to report back to prosecutors

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Chapter 8 Business Crime 259

any missteps. For example, ConEd was assigned a Natural Resources Defense Council lawyer as a monitor for its asbestos activity. Although their cases were not criminal in nature, both Coca-Cola and Mitsubishi agreed to a panel of monitors as part of their settlements in civil discrimination cases. America Online, Bank of New York, Blue Cross Blue Shield, Boeing, KPMG, and Monsanto are all examples of companies that have had monitors on-site as part of their criminal CIAs.

8-5c Criminal Indictments of Corporations on Common law Crimes

Another recommendation for reforming criminal penalties requires corporations to stand criminally responsible under traditional criminal statutes for corporate wrongs. For example, when Ford Motor Company manufactured the Pinto auto- mobile with a design flaw involving the gas tank location, many civil suits were brought for deaths and injuries caused by the exploding gas tank. However, Ford was also indicted for a criminal charge of homicide. In 1999, the state of Florida charged ValuJet, Inc., with murder and manslaughter for carelessly handling deadly materials for shipment after an investigation showed that company pro- cedural omissions resulted in an airplane crash and the deaths of 110 passengers and the crew. A traditional common law crime was applied to corporations for the wrongful deaths of their customers. The owner of Imperial Foods Company in North Carolina pled guilty to workplace hazards that resulted in the burn deaths of 25 employees at his chicken-processing plant and received a 19-year prison sen- tence. Even though the crimes with which he was charged were violations of busi- ness laws, the sentence was traditional in the sense that an individual within a company was held personally and criminally responsible for the crimes.

8-5d Shame punishment

“Shame punishment” has been on the increase in corporate criminal cases. Shame punishment involves public disclosure of an offense. For example, a Delaware fed- eral judge ordered Bachetti Brothers Market to take out an ad for three weeks con- fessing to its crime of violating federal law by selling meat consisting “in whole or in part of filthy, putrid and contaminated substances.” Another federal judge, Ricardo Urbina, sentenced a former Bristol-Myers Squibb executive to write a book about his criminal misdeeds in reaching an agreement with a competitor to keep its generic drug off the market. The executive had to write, publish, and distrib- ute the book to other pharmaceutical executives at his own expense. The executive was also sentenced to two years of probation and a $5,000 fine. The book was com- pleted, as required, by the end of his probation.

Community Service Courts have begun using community service sentences with corporate execu- tives in the same way they have been using this form of punishment for celebri- ties for a number of years. For example, in United States v Allegheny Bottling Co., 695 F. Supp. 856 (E.D. Va. 1988), cert. denied, 493 U.S. 817 (1989), the court imposed a fine of $1,000,000 on the corporation but also required officers of the corpora- tion to provide community service during the period of the corporate sentence so that nonprofits and community organizations could benefit from the management expertise of executives, expertise that is given free of charge as part of the corpo- ration’s penalty. The corporation had to provide one officer for community/non- profit service for 40 hours per week for three years.

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260 part 2 Business: Its Regulatory Environment

Officer and executive Banishment: the designated Felon One of the rapidly increasing areas of focus when criminal activity is uncovered in a company is that of sanctions, discipline, and punishment for executives and officers of the company. The Park case set the standards for criminal liability of officers, but plea agreements and DPAs often demand that someone within the company be held accountable for the failure to catch, stop, or adequately super- vise those who were directly involved. One of the issues evolving is whether the corporate compliance officer (CCO) can be considered a supervisor for purposes of accountability. For example, the SEC holds CCOs responsible as if they are a supervisor and they become aware of illegal conduct in a corporation and fail to take action to stop that conduct. The SEC has fined compliance officers personally for the failure to report violations of the law. And, as discussed in Chapter 18, those who sign off on financial statements that turn out to be false are personally and criminally liable for that false information.

This punishment practice of fining executives for violations of the law is known as finding a “designated felon.” Executives can also be held criminally liable for withholding information, altering information, or participating in the destruction of documents. A Wells Fargo compliance officer was charged with altering an investi- gation report to make it appear as if there had been a more thorough investigation into insider trading at the bank. The judge dismissed the case because he did not want to send the wrong signal of punishing those who are doing the investigations in companies and trying to navigate that line of being employed by a company that they are expected to blow the whistle on when there are violations of the law.

In the health care field, federal agencies use the “responsible corporate officer” (RCO) doctrine to hold those who head up companies criminally responsible when their hospitals submit false Medicare claims or their drug firms misbrand prescrip- tion drugs. In addition to holding these RCOs criminally responsible, the agen- cies prosecuting the cases often seek to have the RCOs barred from the health care industry for periods that range from one year to life, with the typical time being 12 to 20 years. In some cases, a banishment from the field for eight years or more means that their careers as health care officers are ended.

Other forms of punishment for executives and officers may not be fines or prison. For example, the SEC can bar those who are convicted of securities-related crimes from the securities industry for a period of years or even for life (as in the case of Michael Milken). Henry Blodgett, an equity research analyst at Merrill Lynch, was banned for life from the securities industry when his e-mails showed that his true feelings about certain stocks were very different from the positive views his public reports for Merrill Lynch indicated.

deferred prosecution agreements Deferred Prosecution Agreements (DPAs) are negotiated settlements of criminal charges against a corporate defendant. Under a DPA, the defendant company usu- ally agrees to pay a fine and then go through a period of, generally, one to five years, of monitoring and/or no commission of any additional offenses. In exchange, the company avoids prosecution if the terms of the DPA are met. For example, in U.S. v Fokker Services B.V., 79 F. Supp. 3d 160 (D.D.C. 2015), Fokker was charged with violating U.S. prohibitions on trade with Iran and other countries and an alleged conspiracy to hide the trades from the federal government. Under a consent agree- ment, Fokker was to pay a $10.5 million fine and, for a period of 18 months, to avoid any further violations of the law, implement a new compliance program, and

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cooperate with several U.S. agencies in their investigations of violations of export laws. These DPAs must be approved by a court, just as plea bargains for individu- als require approval by a court. In the Fokker case, the federal district court had to approve the DPA. However, the federal district court judge held that he could not approve the DPA in the form presented because of the following:

Here, Fokker Services is charged with a five-year conspiracy to violate and evade United States export laws for the benefit, largely, of Iran and its military during the post–9/1 1 world when we were engaged in a two-front War against terror in the Middle East. These voluminous violations during that period were knowing and willful, and were orchestrated at the highest levels of the company. The company brought in $21 million in revenue from these illegal transactions of parts that were being excluded from sale to these particular countries for national security and anti-terrorism reasons. Indeed, the majority of Fokker Services’ illegal conduct involved sales of aviation and avionic parts to Iran.

The court denied approval, but the parties appealed, and the appellate court held that the district judge did not have the discretion to deny approval. Fokker had admitted the violations and cooperated with the federal government in its ongoing investigation. For those reasons, the appellate court remanded for approval because the DPA was based on mitigating factors.

Ethical Issues

In 1994, Congress passed a law that per- mitted nonviolent convicts to cut up to 12 months from their sentences if they complete a drug rehab/counseling program. When the program was first created, 3,755 inmates entered the program. In 2008, 18,000 federal prisoners were in the pro- gram, and there was a waiting list of 7,000 inmates.

The program has had some big names. For example, Dr. Sam Waksal, the former CEO of ImClone, served nine fewer months than his original seven-year sentence because he participated in a prison rehab program for inmates who have a problem with substance abuse. When Dr. Waksal was interviewed for the presentencing report, he told the probation officer that he was a “social drinker” and had perhaps five glasses of wine per week. One month after the interview with the probation officer, Waksal’s lawyers informed a federal judge that Waksal had a “dependence on alcohol” and requested approval for Waksal’s entry into a prison rehab program.

The former mayor of Atlanta, Bill Campbell, was admitted into a federal rehab program

and got a nine-month reduction on his 30-month sentence for tax evasion. He was admitted to rehab despite the fact that his lawyers argued at his sentencing hearing that he had no substance abuse problem and that he hated the taste of alcohol and therefore urged the judge to conclude that Campbell’s imprisonment was not necessary.

There are consulting firms that advise white-collar criminals on submit- ting their applications for the program. The firms also advise their clients (for a $5,000 fee) on how to maximize the sentence write-down for completing the rehab program.

The Bureau of Prisons indicates that it is cracking down on admissions to the program, looking more closely at doctors’ letters and past histories of the inmates.

Evaluate the ethics of the inmates who feign addiction. Evaluate the ethics of the consulting firms that help them get into the program.

Source: Kai Falkenberg, “Time Off for Bad Behavior,” Forbes, January 12, 2009, pp. 64–65.©

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8-5e New and Higher penalties for Corporate Crime

Criminal penalties have been increased to allow judges to fine corporations accord- ing to how much a bad decision would cost. For example, if a company develops a faulty product, net earnings could decline 10% to 20%. Criminal penalties can be assessed as a percentage of net income. Rather than using fixed-amount fines for corporations, statutes and courts apply percentage of revenue penalties. For example, a bad decision on a product line would cost a company 10% to 20% of its earnings. A criminal penalty could be imposed in the same percentage fashion with the idea that the company made a bad legal decision that should be reflected in reduced earnings.

8-5f Corporate Sentencing Guidelines: an Ounce of prevention Means a Reduced Sentence

The U.S. Sentencing Commission (USSC), established by Congress in 1984, has developed both federal sentencing guidelines and a carrot-and-stick approach to fighting white-collar crime. Under the commission’s guidelines, companies that take substantial steps to prevent, investigate, and punish wrongdoing and cooper- ate with federal investigators can be treated less harshly in sentencing. The goal of the commission was to ensure that companies would establish internal crime pre- vention programs. The guidelines have been revamped several times since their initial adoption.

The sentencing guidelines are a form of mandatory sentencing. If certain fac- tors are present, the judge must order prison times. Corporate officers who are proven to have masterminded criminal activity must be sentenced to some prison time. However, the U.S. Supreme Court has placed some limits on the authority of judges to mete out sentences. In U.S. v Booker, 543 U.S. 220 (2005), the court held that when judges are determining sentences for defendants under the guidelines, any facts, other than the defendant’s prior conviction, must be established by a jury trial beyond a reasonable doubt. In the case, Booker had been convicted of posses- sion of 50 grams of crack cocaine. The sentencing judge considered additional evi- dence in the sentencing hearing that Booker had 566 additional grams of crack that was not used as evidence at the trial. The result was that Booker was not eligible under the sentencing guidelines for a lesser sentence of 21 years and 10 months, and the judge imposed a sentence of 30 years. The Supreme Court reversed the sentencing portion of the case, remanded the case for resentencing, and held that if the judge was going to consider additional facts that affected the length of sen- tence, such as the additional crack, those additional facts must be proved in the same way as the crime—before a jury and beyond a reasonable doubt. The impact of the Booker case was the reduction of many of the sentences of the business execu- tives convicted and sentenced as a result of the Enron-era scandals.

How the Sentencing Guidelines Work and What Companies Can do to Minimize Sentences The federal sentencing guidelines provide for a score that determines the extent of the sentence of the company and individual officers, managers, and employ- ees. The guidelines use a formula that takes into account the seriousness of the offense, the company’s history of violations, its cooperation in the investigation, the effectiveness of its compliance program, and the role of senior management in the wrongdoing. The formula for the guidelines is actually a mathematical one

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Chapter 8 Business Crime 263

that adds and subtracts to determine a company’s culpability score. Involvement of top officers in criminal conduct also adds to the score. Prior violations increase a company’s score, as do attempts to cover up the conduct (obstruction of justice).

A company’s score is decreased by the presence of effective compliance pro- grams designed to prevent and detect violations. If a company comes forward and reports the violations voluntarily, the score is decreased. Cooperation with investi- gators and acceptance of responsibility also reduce the score.

These multipliers are also used in the computation of fines for a business and its employees and officers. Restitution made by a company before sentencing reduces penalties and fines. For example, a fine of $1 million to $2 million could be reduced to as low as $50,000 for a company with the following: (1) a code of conduct, (2) an ombudsperson (compliance officer), (3) a hotline, and (4) mandatory training for executives.

8-5g Corporate Board Criminal Responsibility

In In re Caremark International, Inc., 698 A.2d 959 (Del. Ch. 1996), a court concluded that corporate boards could be held liable for their failure to institute and monitor adequate internal controls to prevent fraud in the company. This landmark case dealt with a company indicted for its physician referrals fees that were paid in violation of federal laws under the Medicare and Medicaid programs. The court noted that it is the responsibility of the board of directors to ensure that the company’s compliance program is in place and functioning effectively. Since the time of this case, directors have been held personally liable for fraud and resulting shareholder losses committed while they were board members. For example, several board members from World- Com, a company that had an $11 billion overstatement of revenues due to accounting fraud, were required to pay personally in order to settle civil cases brought against them by both the SEC and shareholders. However, the standard for holding directors is high. For example, the suit against the GM directors for their failure to detect the

Much More than Compliance

Businesses should follow these basic princi- ples of the sentencing guidelines.

1. Have a code of ethics in place. 2. Conduct training on the code of ethics. 3. Have a company hotline and compli-

ance officer for employees to use anonymously to report violations. A third-party computer reporting system is also considered a “best practice” for ethics and compliance programs.

4. Protect employees who report violations.

5. Investigate all allegations regardless of their source.

6. Report all violations immediately and voluntarily.

7. Offer restitution to affected parties. 8. Cooperate and negotiate with

regulators. 9. Admit your mistakes and

shortcomings. 10. Be forthright and public with your

code of ethics. Discuss ethics with employees via website examples or illustrations of good ethical choices in the news among companies and employees.

Business Strategy

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264 part 2 Business: Its Regulatory Environment

For the Manager’s Desk

Re: Who Really ends Up Going to Jail for Corporate Crime?

For the most part, those who were sen- tenced in federal court in the pre-Enron era for white-collar crimes tended to come from the middle classes rather than the upper classes. From 1988 to June 30, 1995, the federal gov- ernment, through the Office of the Special Counsel of the Justice Department, was given the charge of investigating the collapse of the country’s savings and loans “to find and prosecute those who looted our financial institutions.” The Office of Special Counsel finished with the following results:

Number of defendants charged: 6,405 Convictions: 5,506 defendants convict-

ed (96.5% conviction rate) Types of persons convicted: Officers,

directors, or CEOs: 29 %; accountants, attorneys, and consultants: 71%

Types of persons charged: Directors and officers: 1,268 (97.5%) convicted; presidents or CEOs: 484 (95.1%) convicted

Prison time: Of the 5,506 defendants convicted: 75.5% sentenced to prison

Criminal violations committed by For- tune 500 corporations over a two-year peri- od in the post-S&L scandal showed that executives were convicted in only 1.5% of the cases. However, managers were more likely than not to be sentenced in such cases. And employees, particularly in secu- rities fraud cases, were more likely to be sentenced to prison than the executives for whom they worked. However, executives are far more likely than both groups to be given civil sanctions.

Since the time these data were gath- ered, there has been a dramatic shift in sentencing for the top executives, as the following list reflects:

Bernie Madoff (CEO Madoff Securities)

150 years

R. Allen Stanford (CEO Stanford Securities)

110 years

Bernie Ebbers (CEO WorldCom)

Stewart Parnell (CEO Peanut Corp. of America)

25 years

28 Years

On the other hand, the employees who were simply following orders were given far lesser sentences:

Peter Madoff, chief operating officer

10 years

21 Madoff employees License suspensions

Standford chief investment officer

3 years

Andrew Fastow (Enron CFO)

6 years

Average sentence of other Enron employees

2.75 years

WorldCom Controller David Myers

1 year and 1 day

WorldCom Accounting Director Buford Yates

1 year and 1 day

WorldCom Director of Management Reporting Betty Vinson

5 months

WorldCom Director of Legal Entity Accounting Troy Normand

3 years probation

Prosecutors now take a bottom-up approach—that is, they work their plea deals with employees in order to build their cases carefully against those at the top. Ponzi scheme criminals remain at the top of the list for the length of their sentences. Fifty-year sentences are not unusual for those involved in these large securities fraud.

Source: Jane Sasseen, “White-Collar Crime: Who Does Time?,” BusinessWeek, February 6, 2006, pp. 60–61.

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Chapter 8 Business Crime 265

problems related to the faulty ignition switches was dismissed. The court held that the shareholders failed to show that the directors’ decision to change the company’s risk management was a cause of the failure to detect the ignition switch issues. [In re General Motors Company Derivative Litigation, 2015 WL 3958724 (Del. 2015)]

8-6 Elements of Business Crime The elements, or requirements for proof, of a business crime vary according to type. Crimes are violations of written laws, such as statutes or ordinances. But all crimes’ specific elements can be classified into two general elements: mens rea (or scienter) and actus reus.

8-6a Mens Rea, Scienter, or Criminal Intent A crime requires calculated or intentional conduct; this mental intent or knowl- edge of wrong (scienter) is the mens rea of a crime. Mens rea is the required state of mind for a crime—the intent to commit the act that is a crime. A criminal wrong is not based on an accident unless a person was forewarned about the accident or the accident arose from criminal conduct. Driving while intoxicated is a crime, and an accident that happens while a driver is intoxicated is also a criminal wrong. Con- cealing income is intentional conduct calculated to avoid paying taxes; it is willful and criminal conduct. An oversight in reporting income is not a crime. People v. M & H Used Auto Parts & Cars, Inc. (Case 8.2) discusses the issue of intent in a case that provides the answer to the opening consider.

People v M & H Used Auto Parts & Cars, Inc. 22 A.D.3d 135, 799 N.Y.S.2d 784 (2005)

Mordechay’s Sump Pump and Mens Rea

Case 8.2

Mordechay Sasy owns M & H Used Auto Parts & Cars, Inc. (defendants), a vehicle dismantling business, located in Queens County, New York. Between Janu- ary 1999 and January 2000, the New York City Police Department conducted an undercover investigation of vehicle dismantling businesses. An undercover detec- tive posed as a scrap metal processor and purchased 166 “junked” vehicles from M & H.

At trial, the detective testified that he observed Sasy dismantle vehicles without first draining the fluids, resulting in a discharge of liquids, such as motor oil, antifreeze, and transmission fluid, onto the ground. He stated that he also observed “Speedy Dry,” a material used to soak up oil spills, on the ground. The detective further testified that he observed Sasy and his employees empty gasoline into five-gallon pails and, in the process, spill gasoline on the ground.

On September 27, 2000, the detective and other government officials executed a search warrant of M & H’s yard and office. They found an eight-by- ten-foot puddle of oily soil at the entrance to the yard and “a lot” of oil and antifreeze covered with Speedy Dry in the yard. In the rear of the yard, located in a pit in the ground was a sump pump that was plugged in with an electrical cord. An uncoiled hose ran from the sump pump into a hole in the rear wall of an adjoining business, through a galvanized pipe mounted along the interior wall of the adjoining business, and out onto 38th Avenue in Queens. The sump pump was not pumping at the time. However, the detective noticed that there was fluid in the hose. The sump pit was about half filled with water that had an oily sheen and smelled like oil, antifreeze, and gasoline, and water appeared to have been pumped

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266 part 2 Business: Its Regulatory Environment

out because the interior of the sump pit was still wet. There were four catch basins at the intersection of 38th Avenue and 126th Street, and when it rained, a “small pond” developed on 38th Avenue and ran from M & H toward 126th Street into the catch basins. A videotape depicting the condition of the yard, including the sump pit, taken on September 27, 2000, was played for the jury.

The supervisor of water and sewer systems for the New York City Department of Environmental Protec- tion in Queens ( DEP) testified that in Queens County, storm sewers carry rainwater via underground pipes out into the nearest waterway. Rainwater enters the storm sewer through catch basins located in the street. In the location of M & H, the storm sewers emptied into Flushing Bay.

A sump pump is a point source, and therefore any- one intending to operate one is required to obtain an State Pollution Discharge Elimination System (SPDES) permit. A search of all SPDES permits issued disclosed that in 1999 and 2000, neither Mordechay nor M & H had been issued an SPDES permit.

Sasy testified that from May 1999 through Janu- ary 2000, he used pans and 55-gallon drums to col- lect the fluids from the vehicles that he dismantled. He also used carpets in case of leaks and Speedy Dry to absorb any occasional spills. He discarded used carpets and used Speedy Dry with the garbage. Sasy claimed that he used a company named Tri- City Waste Oil to collect waste oils every couple of months and a company named Planet Recovery that collected antifreeze and oil. Sasy produced copies of certain receipts that he claimed were given by Tri-City and Planet Recovery. According to Sasy, the original Tri-City receipts were removed from M & H during the execution of the search warrant. Sasy conceded that the inventory list for documents seized from M & H, which was signed by Sasy, did not reflect any receipts.

The State had two witnesses who testified that, during the investigation, Sasy stated that Planet Recov- ery took care of his waste oils and antifreeze disposal and that he never mentioned a company named Tri- City Waste Oil. Further, a search of M & H’s office did not reveal any receipts for the removal of waste oil or antifreeze.

The indictment charged the defendants with seven counts, including knowingly discharging pol- lutants into the waters of the State of New York from an outlet or point source without an SPDES permit, in violation of Environmental Conservation Law. The jury found the defendants guilty. They appealed.

JUdICIal OpINION

RIVERA, Judge Environmental Conservation Law § 17–0701(1)(a) provides:

“1. It shall be unlawful for any person, until a written SPDES permit therefor has been granted by the com- missioner, or by his designated representative, and unless such permit remains in full force and effect, to: “(a) Make or cause to make or use any outlet or point source for the discharge of sewage, industrial waste or other wastes or the effluent therefrom, into the waters of this state.”

Environmental Conservation Law § 71-1933(4)(a)(i) provides that “[a]ny person who knowingly, as defined in section 15.05 of the penal law, violates any provision of title 7 or 8 of article 17 of this chapter . . . shall be guilty of a class E felony.”

According to the defendants, the People were required to prove the culpable mental state—“knowingly”— with respect to every element of the above-mentioned environmental crimes. Specifically, they assert that the People were required to prove that the defendants knew that the outlet or point source, herein the sump pump, contained a pollutant, such as petroleum, and that the defendants knew that any discharge of pollutants from the sump pump would end up in State waters.

[The] evidence established that the defendants knowingly used a point source to discharge a pollut- ant. While there was no direct evidence that Sasy or his employees ever used the sump pump, there was ample circumstantial evidence that the sump pump was oper- able and in use by the defendants. The sump pump was located on M & H property, it was plugged in with an electrical cord, there was liquid in the sump pump, a hose led from the sump pump to the street, and the interior of the hose was wet. Significantly, chemical analysis of a sample of the liquid in the sump revealed that the liquid contained lubricating oil. There was an abundance of evidence regarding the detective’s obser- vations of the practices by Sasy and M & H’s employ- ees regarding the spillage of motor oil, antifreeze, and transmission oil.

Moreover, the People proved that the defen- dants knowingly used the pump for the discharge of industrial waste into the waters of the State. The supervisor of water and sewer systems for the DEP testified that, in Queens County, storm sewers carry rainwater via underground pipes out into the nearest waterway. Rainwater enters the storm sewer through catch basins located in the street. In the location of M & H, the storm sewers emptied into Flushing Bay.

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Chapter 8 Business Crime 267

8-6b Mens Rea, Conscious avoidance, and Corporate Officers The intent element is significant because two intents are actually involved when a corporation is prosecuted for a crime: the intent of the corporation to commit the crime and the intent of those in charge of the corporation, officers, and direc- tors to direct the corporation to commit the wrong. Officers may have intent, but the company may not be aware of these pockets of deceit and malfeasance. How- ever, courts have also developed the doctrine of conscious avoidance as a means of establishing mens rea for officers as well as a pattern of behavior that estab- lished an unwillingness to curb deception. Under this theory, executives cannot

Thus, any petroleum released onto the ground at M & H would eventually be carried out into the waters of the State. There is nothing obscure or uncertain about the People’s proof. The defendants’ argument that they did not know that the waste would even- tually be released into the waters of the State belies common sense.

Accordingly, the judgment should be affirmed.

CaSe QUeStIONS

1. What do you learn about the use of circumstan- tial evidence from this case?

2. Why did the State not have to show direct dis- charge into a body of water?

3. What would be the significance of having receipts in this case?

Skylar Capo, an 11-year-old young lady from Virginia, saved a baby woodpecker from the attack of a domestic cat. Skylar was visiting her dad when the near-death experience of the tiny bird occurred. When Skylar’s mom, Alison, came to pick her up, Skylar asked to take the bird home so that she could nurse it back to health. The two stopped at Lowe’s on the way home and took the woodpecker with them because they were concerned about leaving the tiny creature in a hot car. While they were in the store, a woman who said she was with the U.S. Fish and Wildlife Service confronted the two and told them that it was a crime under the Migratory Bird Act to transport a woodpecker.

Two weeks later, the Fish and Wildlife of- ficer showed up at Alison’s home with a Vir- ginia state trooper. They issued Alison a ticket that required payment of a $535 fine. Neither Alison nor Skylar was aware of the bird trans- port prohibition, so Alison refused to take the ticket from the officer, explaining that they had released the bird. A week later, Alison re- ceived the ticket and notice of fine and crimi- nal penalty of up to one year in jail. Can Alison be issued a criminal ticket and fine?

THINK: From the M & H case, you learned that for someone to be convicted of a crime, they must be aware that they are actually violating the laws on discharge. You learned that being aware of violations is not neces- sarily a requirement of proving a crime. You learned that mens rea can be implied by the nature of the conduct prohibited, that there are some things, such as discharging chem- icals, that indicate the conduct violates the law in some way. You also learned that cir- cumstantial evidence can provide conclu- sive proof of a crime.

APPLY: While Skylar and Alison may not have been aware of the protections afford- ed the woodpecker under federal law, they were perhaps aware of some protections for birds and animals in the wild. However, they were not transporting the woodpecker for profit or even with the intent of keeping it. They were trying to rescue the bird.

ANSWER: The state and federal governments eventually decided that the issuance of the tick- et and fine was not supported by evidence of intent or mens rea. The ticket was expunged, and Alison did not have to pay a fine.

Consider . . . 8.3

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268 part 2 Business: Its Regulatory Environment

“consciously try to avoid knowledge” about the actions and activities of those within the company. For example, under the criminal portions of SOX that apply to CEOs and CFOs for certification of a company’s financial statements, an execu- tive cannot isolate him- or herself from information that the financial reports were inaccurate by not attending meetings or not reading the reports that are disclosed to the public. [U.S. v Ebbers, 549 U.S. 1274 (2007)] The U.S. v Park case has modern application in that these top executives are fully accountable for the information in their companies’ financial statements even when they do not actually prepare those statements. Richard Scrushy’s statement, “I certainly had no knowledge of anything they were doing in terms of moving numbers around in the company,” is not a defense for a CEO.1 Bernie Ebbers, the former CEO of WorldCom, denied knowing that information in the company’s financial statements was false. In fact, he indicated he did not always read the 10-Ks and 10-Qs. However, testimony of witnesses at his trial showed that he attended the “Close the Gap” meetings in which managers discussed how to have actual numbers meet projections. Mr. Ebbers could not avoid criminal culpability by avoiding the final reports when he was aware of trouble brewing.

8-6c Actus Reus All crimes include, in addition to the mental intent, a requirement of some specific action or conduct, which is the actus reus of the crime. For example, in embezzle- ment, the actus reus is the taking of an employer’s money. Various types of crim- inal conduct, or actus reus examples, are found in subsequent sections on specific crimes.

8-7 Examples of Business Crimes 8-7a theft and embezzlement

The action of employees who take their employers’ property is theft or embez- zlement. For theft, the following elements are necessary: (1) intent to take the property, (2) actual taking of the property for permanent use, and (3) no authoriza- tion to take the property. These three elements are the actus reus of the crime. The mens rea is the taking of the property with the intent of permanently depriving the owner of use and possession.

For embezzlement, the elements are the same as for theft, with the addition of one more element: the person commits the crime while in the employ or position of trust of the property owner. In other words, embezzlement is theft from a spe- cific type of person—an employer. Although it is usually limited to funds, embez- zlement can cover such items as inventory and equipment of a business.

8-7b Obstruction of Justice

Because of the cases involving the destruction of documents, SOX amended the federal law on obstruction of justice to make document destruction a specific crime and to increase its penalties. The new obstruction section makes it a felony for any- one, including company employees, auditors, attorneys, and consultants, to alter, destroy, mutilate, conceal, cover up, falsify, or make a false entry with the “intent to impede, obstruct, or influence the investigation or proper administration of any matter within the jurisdiction of any department or agency of the United States.”2 Obstruction can be

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Chapter 8 Business Crime 269

committed by destroying or altering documents that are subject to a subpoena or that are related to a pending investigation, and also by encouraging others to alter or destroy those types of documents. Encouraging or giving false testimony is also a form of obstruction of justice. Martha Stewart was convicted of obstruction of justice for her alteration of phone logs, backdating of an order to her broker, and encouraging a broker’s assistant to lie to support her backdating story.

The SOX provisions on obstruction also cover audit records and require audi- tors to retain their work papers related to a client’s audit for at least five years. Any destruction of these documents prior to the expiration of that period would consti- tute a felony and carries a penalty of up to 10 years.

8-7c Computer Crime

What Is a Computer Crime? The term computer crime is used as though it were a completely separate body of law from criminal law. Although certain crimes can only be committed using a computer, the nature of crime, with both mens rea and actus reus, does not change. Specific statutes addressing the unique means by which property is taken and

Dennis Kozlowski and Mark Swartz, the former CEO and CFO, respectively, of Tyco International, initially had a hung jury in their trial for larceny.

Mr. Kozlowski and Mr. Swartz, who were eventually convicted of embezzle- ment, enjoyed extensive personal benefits from Tyco, an embarrassment of personal acquisition at company expense. Prosecu- tors must show mens rea, criminal intent. The defense that both men raised to counter intent—and apparently successfully enough to flummox some jurors in their first trial— was that none of what they obtained through the various company agreements and pro- grams was done secretly. Both men pro- duced evidence related to board knowledge of their perks and approvals through the es- tablished and proper company procedures for personal loans and the use of company funds for refurbishing and furnishing their homes. Along the lines of a “Why would I be such an idiot?” defense, the two ap- proached their case as one in which the bla- tancy of their conduct would work in their favor in mitigating intent, or mens rea.

None of the loans was made to the men without some form of authorization, however perfunctory. Many in the executive ranks

and perhaps even some board members were aware of the loans, the officer loan policy, and the processes used for booking and forgiving the loans. The issue of board approval on the loans remains a question, but compensation committee minutes from February 21, 2002, show that the commit- tee was given a list of loans to officers and also approved all compensation packages. There was no public disclosure of these developments or the committee’s review.

Do you believe these facts supported the jury’s finding of mens rea in the retri- al of the cases against Mr. Kozlowski and Mr. Swartz? Was their conduct ethical?

Sources: Adapted from Andrew Ross Sorkin, “Judge Ends Trial When Tyco Juror Reports Threat,” New York Times, April 3, 2004, pp. A1, B4; Andrew Ross Sorkin, “After a Mistrial, Choices to Make,” New York Times, April 5, 2004, pp. C1, C6; Jonathan D. Glater, “Prosecutors See More Time in Another Tyco Case,” New York Times, April 8, 2004, p. C4; Mark Maremont, “Kozlowski’s Defense Strategy: Big Spending Was No Secret,” Wall Street Journal, February 9, 2004, pp. A1, A23; Andrew Ross Sorkin and Jonathan D. Glater, “Some Tyco Board Members Knew of Pay Packages, Records Show,” New York Times, September 23, 2002, p. A1; Laurie P. Cohen, “Tyco Ex-Counsel Claims Audi- tors Knew of Loans,” Wall Street Journal, October 22, 2002, p. A6.

Consider . . . 8.4

Do not ever try to withhold a violation or restructure paperwork to cover it up. The truth comes out. Conceal- ment is an additional crime.©

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Ethical Issues

As the financial performance of the infa- mous energy company Enron dipped, its audit firm, Arthur Andersen, worried that Enron’s accounting and financial statements were doubtful. On October 16, 2001, Enron refused to change its earnings release in response to Andersen’s concerns. Ander- sen was preparing a statement about the release. Nancy Temple, legal counsel for Arthur Andersen, e-mailed back and forth with David Duncan, the audit partner for the Enron account in Houston, about the con- tent of the Andersen statement on Enron.

Later that same day, Temple also sent an e-mail to Andersen’s internal team of accounting experts and attached a copy of the company’s document policy. On October 20, the Enron crisis-response team held a conference call during which Temple instructed everyone to “[m]ake sure to follow the [document] policy.” On October 23, 2001, then–Enron CEO Kenneth Lay declined to answer questions during a call with analysts because of “potential law- suits, as well as the SEC inquiry.” After the call, Duncan met with other Andersen part- ners and told them that they should ensure that team members were complying with the company’s document policy. Another meeting for all team members followed, during which Duncan distributed the policy and told everyone to comply. These and other, smaller meetings were followed by considerable shredding and destruction of both paper and electronic documents.

On October 26, 2001, one of Anders- en’s senior partners circulated a New York Times article discussing the SEC’s response to Enron. His e-mail commented, “[T]he problems are just beginning and we will be in the crosshairs. The marketplace is going to keep the pressure on this and is going to force the SEC to be tough.” On October 30, the SEC opened a formal investigation and sent Enron a letter that requested account- ing documents. The document destruction continued despite reservations by some of Andersen’s managers. On November 8, 2001, Enron announced that it would issue a comprehensive restatement of its earn- ings and assets. Also on November 8, the SEC served Enron and Andersen with subpoenas for records. On November 9, Duncan’s secretary sent an e-mail that stated, “Per Dave—No more shredding. . . . We have been officially served for our doc- uments.” Enron filed for bankruptcy less than a month later. Duncan was fired and later pleaded guilty to witness tampering, a plea he later withdrew.3

Applying the Park case, who is criminally liable for the document shredding? The employees who actually did it? The manag- ers who ordered it to begin? The company itself? Were they technically not in violation of the law during the document destruction because there was no  formal notice until November 8? [Arthur Andersen LLP v U.S., 544 U.S. 696 (2005)]

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covering the unique type of property found in computer software and hardware make establishing computer crimes easier than reliance on traditional crimes such as larceny and embezzlement.

Some computer crimes may involve a computer without making direct use of one. Ordinary criminal statutes can apply to these types of crimes. For example, a person who mails flyers that falsely advertise a service as computerized is guilty of committing the federal crime of using the mail to defraud.

For more serious and costly computer-related wrongs that do not fit the ordi- nary definitions of crime, the trend is toward adopting statutes that define specific computer crimes.

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8-7d Internet Crime

We see them almost daily, those fake antivirus message warnings, the stranded traveler plea for money, the fake escrow agent, the online banking phishing scam, and, finally, the notorious Nigerian letter frauds. We are witnesses and, too often, victims of Internet crime. There are a series of older and more recent statutes that make Internet activity criminal.

the Unauthorized access Computer Crimes There are laws at both the state and federal levels that prohibit the unauthorized access of computers and computer files. These types of statutes cover the “hack- ing” crimes, wherein employees tap into the websites of competitors or tap into the Outlook calendar of one of their company executives to see what issues are percolating into meetings, discussions, and documents, or they tap into employee personnel files that are private and confidential. Unauthorized computer access is a crime in all states and at the federal level. For example, a group calling itself The Impact Team released almost 10 gigabytes of data that it had obtained by hacking into the records of Avid Life Media, Inc., the parent company of the website Ash- ley Madison. Because that website is a connection place for marital infidelity, the release of the e-mails, names, and credit card information of users proved embar- rassing to many public figures. The investigation continues as a cooperative effort between Canadian and U.S. authorities.

The Electronic Communications Privacy Act of 1986 (ECPA) prohibits the unauthorized access of “live” communications, as when someone uses a listening device to intercept a telephone conversation. However, e-mail and social media are often stored information, and the question of this act’s application for the various types of Internet activity is often not a clear fit.4

The Stored Communication Act (SCA) prohibits the unauthorized intercep- tion of electronic communications, generally meaning stored communication, not ongoing communication, such as text messaging, tweeting, and instant messaging.

The key to prosecution in unauthorized access computer cases is proof that the access was not authorized. The New Jersey v Riley case (Case 8.3) deals with an issue of whether an employee could be prosecuted for unauthorized access.

New Jersey v Riley 988 A.2d 1252 (N.J. 2009)

Snooping at Work: A Crime?

Case 8.3

FaCtS

Sergeant Kenneth Riley twice viewed digitally stored videotape from his department’s computerized system of the traffic stops of another officer, Sergeant Robert Currier, an officer not in his unit. Sergeant Riley did not like Sergeant Currier. Sergeant Riley then permit- ted police personnel below sergeant’s rank to view the video. The videotapes were used not to train officers

in Riley’s squad but to subject Sergeant Currier to embarrassment and discipline. Under the user terms of the department, an administrative officer or sergeant had a password to the video database that could be used to access the whole database to obtain videos for training purposes. A grand jury returned an indictment against Sergeant Riley for use of computer data with- out authorization and unlawful access and disclosure

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of computer data. Sergeant Riley moved to have the indictment dismissed.

JUdICIal OpINION

OSTRER, Justice It is uncertain what it means, first, to access computer- ized data, and second, what it means to do so “with- out authorization” or “in excess of authorization.” It is also unclear whether unauthorized access may be proved solely with evidence that a defendant, who is an employee or other “insider” with current password access, knowingly violated internal guidelines regard- ing use of computer-based information. A hypothetical can demonstrate the uncertainty.

One can posit a member of the information tech- nology (I.T.) department of a business who possesses all the employees’ passwords in order to maintain the business’s computer system, but internal policy directs him not to read employees’ documents. In one sense, the I.T. professional is authorized to access every employee’s files. If a worker asks the I.T. professional to help retrieve a sensitive trade-secret-related document that the worker accidentally deleted, the I.T. professional can do so, using the passwords already provided to him. In another sense, if the I.T. professional reads the worker’s document, he may be acting in excess of his authorization.

Reference to the plain language of the statute does not clearly indicate which reading is correct. Federal law defines the term, “exceeds authorized access,” to mean “to access a computer with authorization and to use such access to obtain or alter information in the computer that the accesser is not entitled to so obtain or alter.” That also is not unambiguous, as one may pon- der what it means to be “not entitled to obtain or alter” data. Arguably, one is entitled if he has a password or code-based right to obtain or alter the data.

In White v. White, 781 A.2d 85 (Ch. Div. 2001), a wife had retrieved her husband’s stored e-mails to a girlfriend from the family computer. The court held that the wife’s access was not unauthorized because she did not use her husband’s password or code without permission. In other words, unauthorized access meant access by use of another’s password or code-based right of entry.

In considering the potential for arbitrary enforcement of the computer crime law, this court recognizes the ubiquity of computers today in the workplace, in schools, public institutions, and in government, and the prevalence of agreements and policies governing such use. Many of these impose unrealistic rules honored in the breach. It takes no imagination to conjure up a multitude of trivial and not so trivial violations that take place every day in the workplace. Workers use workplace computers for personal use in violation of requirements that they use their computers for business only. Workers violate policies prohibiting access to social network- ing sites. Reportedly, fifty-four percent of compa- nies ban workers from accessing social network- ing sites like Twitter, MySpace and Facebook, yet seventy-seven percent of workers with a Facebook account use it during work hours.

In sum, assuming that a broad range of the popula- tion violates internal workplace computer use policies at one point or another, then deeming such violations a crime would empower the State, unguided by firm definitional standards, to choose to prosecute whom- ever it wishes from that broad cross-section of the population.

The vagueness doctrine is designed to prevent that. In short, the criminal law should not be some pliable material that the State may bend and mold at will to fit an unwarned defendant. Although there is a split among other jurisdictions, there is ample precedent in federal and state courts for adopting the narrow construction of “without or in excess of authorization” found in the New Jersey law.

The indictment is dismissed.

CaSe QUeStIONS

1. Explain why the purpose of Sergeant Riley’s actions became an issue.

2. Discuss how the court uses the I.T. example to illustrate its point.

3. What are the court’s fears about a broad interpre- tation of “unauthorized access”?

Unauthorized Use of Computer Resources In addition to the crimes of unauthorized access, there are the crimes of taking computer resources. Just as it would be theft to steal a computer, it is also theft to steal proprietary computer programs and codes from another, including, for exam- ple, your employer, and then taking those programs or codes to a new employer. The Economic Espionage Act (EEA), which is sometimes called the “verb statute,” makes it a felony to steal, appropriate, or take a trade secret as well as to copy,

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Chapter 8 Business Crime 273

duplicate, sketch, draw, photograph, download, upload, alter, destroy, replicate, transmit, deliver, send, mail, or communicate a trade secret. The penalties for EEA violations are up to $500,000 and 15 years in prison for individuals and $10 mil- lion for organizations. When employees leave one company, their employers are permitted to check that departing employees’ computer e-mails and hard drives to determine whether the employees have engaged in computer espionage by tak- ing proprietary information to their new employers. Many states have laws that prohibit the theft of scientific material from an employer, which could include computer codes. These statutes, as clear as they may seem, have proved to be prob- lematic in prosecution as “the demands of the digital age . . . require further refine- ment of . . . criminal laws.” [People v Aleynikov, 15 N.Y.S.2d 587 (2015)] For example, Sergey Aleynikov, a computer programmer, was prosecuted by both state and fed- eral authorities for allegedly taking source code for high-frequency trading from Goldman Sachs, where he had worked for $400,000 per year, to Teza Technologies, a high-frequency trading firm. In the federal case, he was charged with a violation of the EEA and convicted, but a federal appeals court held that computer source code did not constitute stolen “goods” and that source code was not covered by the EEA. [U.S. v Aleynikov, 676 F.3d 71 (2nd Cir. 2012)] Mr. Aleynikov was then tried by the State of New York for unlawful use of secret scientific material, and after a messy jury verdict, a court held that there was insufficient evidence to establish intent to appropriate material and that he had not taken any tangible material.

Spamming Spamming, the act of sending thousands of e-mails at once to many different computer users, is regulated at the federal level by the Controlling the Assault of Non-Solicited Pornography and Marketing (CAN-SPAM) Act. Under CAN- SPAM, private companies can bring suit against spammers for their unauthorized use of Internet Service Providers (ISPs). Spam attacks can be devastating and have resulted in retaliatory Internet wars. In March 2013, security experts indicated that “the biggest cyberattack in history” was actually a battle over the unalienable right to spam. Spamhaus, a Dutch company that fights spam, added Cyberbunker to its spam blacklist. Spamhaus’s blacklist consists of companies that e-mail provid- ers use as a screen to weed out spam. Cyberbunker is a Web-hosting service that pledges to host any site except “child porn and anything related to terrorism.”5

Cyberbunker lives on spam and Spamhaus wants to prevent spam, so cyberspace wars result. Because of the international nature of these activities, prosecution is difficult and requires law enforcement cooperation across borders.

Using Computers to Commit Fraud The Counterfeit Access Device and Computer Fraud and Abuse Act (CAD- CFA) makes it a federal crime to use or access federal or private computers with- out authorization. The CADCFA also covers additional new technologies, such as scanners, handheld computers, laptops, and smartphones.

the Crime of Cyberbullying In 2008, a federal grand jury indicted Lori Drew in what would become the first of many cases that criminally charged a cyberbully. Ms. Drew had created a MySpace site for Josh Evans, a fictitious teen boy she used as a means of getting information from Megan Meier, a 13-year-old girl with whom Ms. Drew’s daughter had a teen- age rivalry/disagreement. Josh pretended to be interested in Megan but then said that she was “fat” and that the world would be a better place without her. Megan

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274 part 2 Business: Its Regulatory Environment

hanged herself within an hour of receiving those messages from “Josh.” Ms. Drew was later charged and convicted of conspiracy and accessing computers without authorization.6

Since the time of that case, there have been a number of similar incidents in which friends, parents, and others harass individuals using the various sites avail- able from Facebook to Instagram. States now have very specific cyberbullying stat- utes for prosecution. As one expert phrased it, we have to take responsibility for what we post online and the consequences that can stem from hurtful or fearsome comments. There are both civil and criminal statutes that provide curbs for vic- tims. Civil remedies allow for injunctions and criminal penalties are at a level that allows them to serve as a deterrent for the types of postings that began with the Drew case.

Copyright Crimes Online Using the Internet for downloading copyrighted music and movies without autho- rization or payment is both a civil and criminal wrong. The discussion of those issues can be found in Chapter 15.

Crimes Online The Internet often seems to be a place of anonymity, but those who use the Internet for criminal activity can be prosecuted using ordinary criminal statutes. For exam- ple, Ross Ulbricht, the founder and operator of Silk Road, a sort of eBay for drug transactions, operated the encrypted site using the “nom de Internet” of “Dread Pirate Roberts,” accepting only bitcoins as payment. However, following overdose deaths of six people who used the site for purchases, investigators were able to determine his identity. Mr. Ulbricht was convicted of being a drug kingpin and sentenced to life in prison.

The Internet is also a source for child pornography, and those who solicit, post, and view such materials online are subject to federal prosecution. For example, Jared Fogle, the former spokesperson for Subway, was charged and entered a guilty plea to Internet child pornography charges and was sentenced to 15 years and eight months and fined $175,000. Mr. Fogle is also required to pay $1.4 million in restitution to victims.

8-7e Criminal Fraud

Business crimes against individuals usually result from sales transactions. Crimi- nal fraud is an example of this type of crime, the elements of which are the same as those the person defrauded would use to establish a contract defense: a false state- ment was made; the statement was material, that is, it was information that would affect the buying decision; and the person relied on the statement. The only dif- ference between contract fraud and criminal fraud is that criminal fraud requires proof of intent that the seller intended to mislead the buyer for the purpose of effecting the transaction and making money. In the mortgage fraud cases brought against borrowers during 2008–2012, the basis for the fraud is that documents and appraisals were forged or falsified. In many cases, criminal intent was established because the loans had two sets of documents and always the same buyers.

8-7f Commercial Bribery

Most states have provisions that govern both the giving and receiving of gifts or funds in exchange for a contract or favor. A supplier offering a purchasing agent of a company $25,000 in cash as an incentive or reward for choosing that supplier has

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Chapter 8 Business Crime 275

committed commercial bribery. The purchasing agent has betrayed his employer’s interest and compromised his judgment by accepting benefits for himself. This condemnation of bribery in commercial transactions dates back to the first eras of business activity because of concerns that quality and pricing would suffer if cor- ruption were introduced into the bargaining process.

8-7g Racketeer Influenced and Corrupt Organizations (RICO) act

The RICO Act (18 U.S.C. §§ 1961–1968), a complex federal statute, was passed with the intent of curbing organized crime activity. The ease of proof and severity of penalties for RICO violations have made it a popular charge in criminal cases in which organized crime may not actually be involved.

Ethical Issues

Jim G. Locklear was a purchasing agent. His spectacular career as a buyer began in 1977 with Federated Stores in Dallas, Texas. Federated officers described him as a man with an eye for fashion and a keen ability to negotiate. In 1987, Mr. Locklear was offered a position with Jordan Marsh, a retailer in the Boston area, with an annual salary of $96,000.

Citing a desire to return to Dallas, Mr. Locklear left the Jordan Marsh position after only three months. He returned to Dallas as a buyer for JCPenney at an annual salary of $56,000. Mr. Locklear did a phe- nomenal job as the buyer for the JCPenney Home Collection. JCPenney was the first department store to feature coordinated lines of dinnerware, flatware, and glasses. During Mr. Locklear’s tenure as a purchas- ing agent, Penney’s annual sales for his area of its tabletop line went from $25 million to $45 million.

After receiving an anonymous tip, JCPenney hired an investigator to look into Mr. Locklear’s conduct. The investigator found and reported that Mr. Locklear had personal financial difficulties. He had a $500,000 mortgage on his home and child support payments of $900 a month for four children from four previous marriag- es. Mr. Locklear also had a country club membership, luxury vehicles, and large securities accounts, and he was known to take vacations at posh resorts. Despite the

puzzling lifestyle revealed by the investiga- tor, JCPenney took no action.

In 1992, JCPenney received an anony- mous letter disclosing a kickback situation between Mr. Locklear and a manufacturer’s representative. JCPenney investigated a second time, referred the case for criminal prosecution, and filed a civil suit against Mr. Locklear.

The investigation conducted by author- ities found that Mr. Locklear received payments from vendors through several corporations he had established. During the five-year period from 1987 to 1992, Mr. Locklear had received $1.5 million from vendors, manufacturers’ representatives, and others.

Mr. Locklear was charged with com- mercial bribery and entered into a plea agreement. Mr. Locklear also served as a witness for the prosecution at the trials of those who paid him the bribes. A vendor described his payment of a $25,000 fee to Mr. Locklear as follows: “It was either pay it or go out of business.” Mr. Locklear was sentenced to 18 months in federal prison, less than the five-year maximum, due to his cooperation.

Should JCPenney have known of the difficulties earlier? Was Mr. Locklear’s per- sonal life responsible for his poor value choices at work? Is anyone really harmed by Mr. Locklear’s activity? Wasn’t he a good buyer?

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For RICO to apply, a “pattern of racketeering activity” must be established. That pattern is defined as the commission of at least two racketeering acts within a 10-year period. Racketeering acts are defined under the federal statute to include murder; kidnapping; gambling; arson; robbery; bribery; extortion; dealing in por- nography or narcotics; counterfeiting; embezzlement of pension, union, or welfare funds; mail fraud; wire fraud; obstruction of justice or criminal investigation; inter- state transportation of stolen goods; white slavery; fraud in the sale of securities; and other acts relating to the Currency and Foreign Transactions Reporting Act (an act passed to prevent money laundering).

RICO provides for both criminal penalties and civil remedies. In a RICO civil suit, injured parties can recover treble damages, the cost of their suit, and reason- able attorney fees. According to the Journal of Accountancy, 91% of all RICO civil actions have been based on the listed pattern crimes of mail fraud, wire fraud, or fraud in the sale of securities. The statute has been used frequently against cor- porations. For example, Northwestern Bell Telephone Company lobbyists who took public utility commissioners to dinner and hired two of them as consultants after they left their commission jobs were sued under RICO. A lawyer represent- ing phone company customers successfully brought a RICO civil suit based on an alleged pattern of bribing the utility regulators. [H. J., Inc. v Northwestern Bell Tele- phone Co., 492 U.S. 229 (1989)] There are also RICO civil actions brought against government agencies and officials for extortion but also in eminent domain cases and in situations in which government officials have imposed expansive require- ments for regulatory licensing. For example, in Wilkie v Robbins, 551 U.S. 537 (2007), a landowner tried to bring a RICO suit against federal officials for alleged retalia- tory behavior because the landowner refused to grant an easement to the govern- ment for use of the land.

Another portion of the RICO statute permits prosecutors to freeze defendants’ assets to prevent further crimes. When RICO charges are brought against corpora- tions, the seizure of corporate assets can mean the termination of the business. For example, in U.S. v Patel, 949 F. Supp. 2d 642 (W.D. Va. 2013), prosecutors seized over $20 million in cartons of cigarettes alleged to be contraband. The Justice Department has issued guidelines requiring prosecutors to seek a forfeiture of assets in propor- tion to the crime rather than seize all of the business assets. A growing number of states have enacted their own versions of the RICO statute for application at the state level. RICO violations are added charges in many criminal cases. For example, if someone is charged with ongoing bribery of a state or local official, RICO charges can be added because of the pattern of corruption. In Reves v Ernst & Young, 507 U.S. 170 (1993), the accounting firm of Arthur Young (later merged into Ernst & Young) was hired to conduct audits for the Farmer’s Cooperative of Arkansas and Oklahoma. An investment by the co-op in a gasohol plant proved to be a financial disaster, and the farmers who held co-op notes that had served as the organization’s means of financing over the years lost their investment when the co-op filed for bankruptcy. The investors filed suit against Arthur Young for violations of federal securities laws (see Chapter 18) and RICO. However, the Supreme Court exempted the accounting firm from RICO charges because it found that the firm did not par- ticipate in the management of the co-op. The auditor’s participation was not that of directing the co-op’s affairs, only that of offering its opinions on the financial statements of the firm. Over the years, businesses have lobbied heavily for reforms to the broad civil and criminal liabilities created by RICO. Congress has not yielded to changes in a statute that appears to have deterrent mechanisms.

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8-7h Business Crime and the USa patriot act

The Money Laundering Control Act (MLCA), 42 U.S.C. § 5301, prohibited the knowing and willful participation in any type of financial transaction that was set up in order to conceal or disguise the source of funds. Since the attack of 2001, federal investigators have found intricate financial networks in which funding for terrorism activities was concealed. As a result, provisions of the USA Patriot Act, passed fewer than two months after the September 11, 2001 destruction, include substantial expansion of the MLCA as well as the Bank Secrecy Act (BSA).

Regulation of Money laundering Under the current versions of the federal laws, title and escrow companies; broker- age firms; travel agents; check-cashing firms; auto, plane, and boat dealers; loan and finance companies; casinos; currency exchanges; branches of foreign banks located in the United States; and even small businesses are subject to disclosure and reporting requirements for transactions involving cash or transactions of more than $10,000. In addition, the types of accounts covered under the disclosure requirements include not just savings accounts but also money market savings and brokerage accounts. Few financial institutions are exempt from reporting and dis- closure requirements for cash transactions.

Businesses affected by these amendments developed new policies and pro- cedures for preventing and detecting money laundering. Under the Federal Sen- tencing Guidelines, businesses subject to these anti–money-laundering provisions must have a “Know Thy Customer” program that trains employees in how to spot money laundering and suspicious activities by customers.

Funneling Money to terrorist Groups Another portion of the Patriot Act makes it a crime for companies to pay monies to terrorist groups in other countries. For example, a company that pays a mercenary group for protection for its employees or facilities would violate this provision of the act. Under federal law, once an organization is designated by the U.S. govern- ment as a terrorist organization, companies cannot continue to do business with them because the purpose of the law is to curb funding to and money laundering by terrorist groups. The list of terrorist groups is available from a website the gov- ernment provides to businesses via subscription.

Between 1997 and 2004, executives in Chiquita operations in Colombia paid $1.7 million to the United Self-Defense Forces of Colombia (known as AUC, its initials in Spanish). The AUC, according to the U.S. Justice Department, “has been responsible for some of the worst massacres in Colom- bia’s civil conflict and for a sizable percent- age of the country’s cocaine exports. The U.S. government designated the right-wing militia a terrorist organization in September 2001.”7 The payments were made through

a Chiquita wholly owned subsidiary known as Banadex, the company’s most profitable unit by 2003.

The payments began in 1997 follow- ing a meeting between the then–leader of the AUC, Carlos Castaño, and a senior executive of Banadex. No one disputes that during that meeting, Castaño implied that Chiquita’s failure to make the payments could result in physical harm to Banadex employees and property. No one disputes either that the AUC was known for such

Consider . . . 8.5

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violence and had been successful in obtaining payments from other companies, either following Castaño’s meetings with company officials or, when the companies declined, by carrying out the threat of harm as a form of warning. By September 2000, Chiquita’s senior executives were aware that the payments were being made and were also aware that the AUC was a violent paramilitary organization. Chiquita officers, directors, and employees were aware of the Banadex payments to the AUC. Chiq- uita recorded these payments in its finan- cial reports and other records as “security payments” or payments for “security” or “security services.”

Beginning in June 2002, Chiquita began paying the AUC in cash according to new procedures established by senior execu- tives of Chiquita. These new procedures concealed direct cash payments to the AUC. From September 10, 2001, through Febru- ary 4, 2004, Chiquita made payments to the AUC totaling over $825,000, part of the $1.7 million paid from 1997 through 2004.

On February 20, 2003, a Chiquita em- ployee, aware of the payments to the AUC, told a senior Chiquita officer that he had dis- covered that the AUC had been designated by the U.S. government as a foreign terror- ist organization (FTO). The Justice Depart- ment discovered the following sequence of events in response to the employee having raised the issue:

Shortly thereafter, these Chiquita offi- cials spoke with attorneys in the District of Columbia office of a national law firm (“outside counsel”) about Chiq- uita’s ongoing payments to the AUC. Beginning on Feb. 21, 2003, outside counsel emphatically advised Chiquita that the payments were illegal under United States law and that Chiquita should immediately stop paying the AUC directly or indirectly. Outside counsel advised Chiquita:

“Must stop payments.” “Bottom Line: CANNOT MAKE

THE PAYMENT [.]” “Advised NOT TO MAKE

ALTERNATIVE PAYMENT through CONVIVIR [.]”

“General Rule: Cannot do indirectly what you cannot do directly [.]”

Concluded with: “CANNOT MAKE THE PAYMENT [.]”

“You voluntarily put yourself in this position. Duress defense can wear out through repetition. Buz [business] decision to stay in harm’s way. Chiquita should leave Colombia.”

“[T]he company should not contin- ue to make the Santa Marta payments, given the AUC’s designation as a foreign terrorist organization[.]”

“[T]he company should not make the payment.”

On April 3, 2003, a senior Chiquita officer and a member of Chiquita’s Board of Directors first reported to the full Board that Chiquita was making payments to a designated FTO. A Board member object- ed to the payments and recommended that Chiquita consider taking immediate corrective action, including withdrawing from Colombia. The Board did not follow that recommendation, but instead agreed to disclose promptly to the Department of Justice the fact that Chiquita had been making payments to the AUC. Mean- while, Banadex personnel were instructed to continue making the payments.8

On April 24, 2003, Roderick M. Hills, a member of Chiquita’s board and head of its audit committee, Chiquita general counsel Robert Olson, and, some reports indicate, the company’s outside counsel met with members of the Justice Department to dis- close the payments and explain that they had been made under duress. Mr. Hills, a former chairman of the Securities Exchange Commission, and the Chiquita officer were told that the payments were illegal and had to stop. The payments did not stop, and the company’s outside counsel wrote to the board on September 8, 2003, advising that “[Department of Justice] officials have been unwilling to give assurances or guar- antees of non-prosecution; in fact, officials have repeatedly stated that they view the circumstances presented as a technical vio- lation and cannot endorse current or future payments.”9

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Chapter 8 Business Crime 279

8-7i additional Federal Crimes

Many of the statutes on business crimes are found at the federal level. Violations of the Securities Exchange Acts (Chapter 18), the Sherman Act (Chapter 14), the Internal Revenue Act, the Pure Food and Drug Act, the environmental statutes (Chapter 10), the Occupational Safety and Health Act (Chapter 19), and Consumer Product Safety statutes (Chapter 13) carry criminal penalties.

8-7j State Crimes

Similar criminal statutes at the state level cover such areas as criminal fraud and securities. In addition, states have particular regulations and laws for certain indus- tries. The sale of liquor in most states is strictly regulated. The result is an increase in bribes and kickbacks in these highly regulated industries as businesses try to work around the regulatory restrictions. State attorneys general have increasingly taken the lead on prosecutions related to the financial markets, prosecuting such cases as those involving analysts and insurance bid-rigging.

8-8 Procedural Rights for Business Criminals Business criminals are treated procedurally in the same manner as other criminals. They have the same rights under the criminal justice system. The U.S. Constitu- tion guarantees protection of certain rights. The Fourth Amendment protects the individual’s privacy and is the basis for requiring warrants for searches of private property. The Fifth Amendment provides the protection against self-incrimina- tion and is also the “due process” amendment, which guarantees that an accused individual has the right to be heard. The Sixth Amendment is meant to ensure a speedy trial; it is the basis for the requirement that criminal proceedings and trials proceed in a timely fashion. These constitutional rights are discussed in the follow- ing sections.

8-8a Fourth amendment Rights for Businesses

The Fourth Amendment to the U.S. Constitution provides that “the right of the people to be secure in their persons, houses, papers, and effects, against

Nonetheless, the payments continued. From April 24, 2003, through February 4, 2004, Chiquita made payments to the AUC totaling $300,000. On February 4, 2004, Chiquita sold the Banadex operations to a Colombian-owned company.

Chiquita then cooperated with the government by making its records avail- able. In March 2007, Chiquita entered a guilty plea and agreed to pay a $25 million fine. Chiquita was on probation for five years and agreed to create and maintain an effective ethics program. Mr. Hills and

four former Chiquita officers, including Mr. Olson, were given a no-prosecution agree- ment under the terms of the company’s guilty plea. A Justice Department official said of the investigation, “If the only way that a company can conduct business in a particular location is to do so illegally, then the company shouldn’t be doing business there.”10

Is there an actus reus for violation of the Patriot Act? A mens rea? What lessons on ethics in international business should com- panies take from the Chiquita experience?

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280 Part 2 Business: Its Regulatory Environment

unreasonable searches and seizures, shall not be violated.” This amendment pro- tects individual privacy by preventing unreasonable searches and seizures. Before a government agency can seize the property of individuals or businesses, it must obtain a valid search warrant—or have an applicable exception to the warrant requirement—which must be issued by a judge or magistrate and be based on probable cause. In other words, authorities must have good reason to believe that instruments or evidence of a crime are present at the business location to be searched.

A warrant is required only when there is an expectation of privacy in the area being searched. For example, you have an expectation of privacy in the garbage in your garbage can when it is in your house. However, once you move that garbage can onto the public sidewalk for pickup, you no longer have the expectation of privacy because you have left your garbage out in plain view of the public. Many challenges to search warrant involve determining whether there was an expecta- tion of privacy. In Kyllo v United States, 533 U.S. 27 (2001), the court dealt with a Fourth Amendment issue of agents using an Agema Thermovision to scan for heat on Danny Kyllo’s triplex at 3:20 a.m. to determine whether the heat emissions were unusual and therefore consistent with using heat lamps for growing marijuana. In other words, was Mr. Kyllo entitled to privacy from street scanners used on his home?

The scan showed that the roof over the garage and a side wall of Mr. Kyllo’s home were relatively hot compared to the rest of the home and substantially warmer than neighboring homes in the triplex. Based on tips from informants, utility bills, and the thermal imaging, a federal magistrate judge issued a warrant authorizing a search of Mr. Kyllo’s home, and the agents found an indoor growing operation involving more than 100 plants. Mr. Kyllo was indicted on one count of manufacturing marijuana.

The court held that there was a physical intrusion by the agents because they used sense-enhancing technology to obtain evidence that could not otherwise have been obtained without physical “intrusion into a constitutionally protected area”—Mr. Kyllo’s home.

The Fourth Amendment applies equally to individuals and corporations. In an unauthorized search, a corporation’s property is given the same protec- tion. For example, in Dow Chemical Co. v United States, 476 U.S. 1819 (1986),

Carlos Medina was indicted on charges of health care fraud. His terms of bail held him to home confinement, except for medical care treatments, court appearanc- es, and meetings with his lawyer. A feder- al agent interviewed the property manag- er for the landlord of the building where Medina’s company’s offices were located. Upon his request, the property manag- er allowed the agent to view the leased premises. Based on his observations that

patient files were located there, the agent obtained a search warrant. Pursuant to the warrant, the government seizes 19 boxes of records that were then used as evi- dence in the case against Medina. Medina challenged the admission of the records from the file as a violation of his Fourth Amendment rights. What should the court decide about the use of the records? U.S. v. Medina, 158 F. Supp. 3d 1303 (S.D. Fla. 2015)

Consider . . . 8.6

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Chapter 8 Business Crime 281

Dow Chemical challenged the admission of photos of one of its sites taken from low-flying aircraft. However, the U.S. Supreme Court held that a company does not have a right a right of privacy from low-flying planes of its production facil- ities. Pictures taken from the airplanes of plant operations were not a violation of privacy.

If an improper search is conducted , any evidence recovered is inadmissible at trial for the purposes of proving the crime.

8-8b exceptions to the Warrant Requirement

emergencies and Risk of loss of evidence There are exceptions to the warrant requirements, such as when there is evi- dence in a burning building and evidence within the building is being destroyed. The emergency exception requires proof of risk of loss of fruits or evidence of the crime. In Arizona v Gant, 556 U.S. 332 (2009), the U.S. Supreme Court limited the use of evidence that is obtained from a driver’s vehicle when that driver has been handcuffed and locked in the rear of a squad car. Most officers were in the habit of routinely searching the driver’s vehicle on-site at the time of the deten- tion/arrest. In the case of Rodney Gant, who was arrested for driving with a sus- pended license, the officers searched Mr. Gant’s car while he was handcuffed in the backseat of the squad car and found cocaine in the pocket of a jacket lying on the backseat of Gant’s vehicle. Mr. Gant was charged with possession (as well as with driving with a suspended license).

Mr. Gant’s lawyer challenged the search of his client’s vehicle on the grounds that there were no exigent circumstances—that is, locked in and handcuffed as he was, there was no emergency or reason to believe that Mr. Gant would spring into action and hide, destroy, or swallow the cocaine. The Supreme Court held that the officers needed to impound the vehicle and obtain a warrant to search it. Without a warrant, the cocaine was not admissible for purposes of prose- cuting Mr. Gant on the cocaine charges. Without the cocaine evidence, unless Mr. Gant confesses, that charge had to be dropped. Searches require warrants or a valid exception.

the plain View exception Another exception to the warrant requirement is the “plain view” exception. This exception allows police officers to seize evidence that is within their view.

Warrants and technology: texts, e-Mails, and ISps One of the technological areas that is still evolving deals with the rights of anon- ymous posters in chat rooms and the identity of those sending e-mails to others. Must the ISP turn over to law enforcement officials the identity of those who are behind their Internet activities? With a warrant, the answer is clearly yes. And war- rants are relatively easy to obtain because law enforcement agencies simply need to furnish the magistrate or judge with the content the poster or e-mailer posted on the Internet. If those postings involve criminal activities or conspiracies, the court can find probable cause.

One of the questions related to privacy is how much of what we post online and put on our computers at work is a privacy right that would require a war- rant to obtain. If employers have access to the information on your work computer and e-mails and have made that clear as part of your terms of employment, those communications are not private. The U.S. v King (Case 8.4) case deals with such an issue.

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282 part 2 Business: Its Regulatory Environment

U.S. v. King 509 F.3d 1338 (11th Cir. 2007)

When Access Is Shared, Be Scared

Case 8.4

FaCtS

In February 2003, while serving as a civilian contractor, Michael D. King resided in a dormitory at the Prince Sultan Air Base in Saudi Arabia. During his stay in the dormitory, King kept his personal laptop computer in his room and connected it to the base network. All users of the base network signed agreements indicat- ing that they understood that their communications over and use of the base network were subject to monitoring.

An enlisted airman was searching the base net- work for music files when he came across King’s computer on the network. The airman was able to access King’s hard drive because it was a “shared” drive. The airman discovered a pornographic movie and text files “of a pornographic nature.” The airman reported his discovery to a military investigator who in turn referred the matter to a computer specialist. This specialist located King’s computer and hard drive on the base network and verified the presence of pornographic videos and explicit text files on the computer. She also discovered a folder on the hard drive labeled “pedophilia.” Military officials seized King’s computer and also found CDs containing child pornography.

Two years later, the government obtained an indict- ment charging King with possession of child pornog- raphy. After his arrest, the government searched his residence pursuant to a search warrant and found additional CDs and hard drives containing over 30,000 images of child pornography.

King entered a guilty plea and was sentenced to 108 months in prison. King then appealed his con- viction on the grounds that there had been an illegal search and seizure of his computer and files.

JUdICIal OpINION

PER CURIAM King contends that the district court denied his motions to suppress based on the erroneous finding that he did not have a reasonable expectation of privacy in his computer files that were remotely accessed over a mil- itary computer network, because the search of those files by the computer specialist exceeded the scope of her authority to monitor usage of the base network. King asserts that he sought to protect his computer files

through security settings, he never knowingly exposed them to the public, and he was unaware that the files were shared on the network. King further challenges the district court’s alternative finding that the military officials conducted a proper workplace search, argu- ing that this was a criminal investigation into King’s personal computer located in his private dorm room. Finally, King asserts that the subsequent search war- rant was invalid, as it was based on information that was obtained improperly through the remote search of his computer files.

The Fourth Amendment’s prohibition against unreasonable searches and seizures “protects an individual in those places where [he] can demon- strate a reasonable expectation of privacy against government intrusion,” and “only individuals who actually enjoy the reasonable expectation of privacy have standing to challenge the validity of a govern- ment search.”

Accordingly, the threshold issue in this case is whether King had a legitimate expectation of privacy in the contents of his personal laptop computer when it was connected to the base network from his dorm room.

We have held that tenants of a multiunit apart- ment building do not have a reasonable expectation of privacy in the common areas of the building, where the lock on the front door is “undependable” and “inoperable.” We have also held that even though a company has a subjective expectation of privacy in documents that are shredded and disposed of in a garbage bag that is placed within a private dumpster, the company’s “subjective expectation of privacy is not one that society is prepared to accept as objec- tively reasonable” when the company fails to “take sufficient steps to restrict the public’s access to its discarded garbage.”

King has not shown a legitimate expectation of privacy in his computer files. His experience with computer security and the affirmative steps he took to install security settings demonstrate a subjective expectation of privacy in the files, so the ques- tion becomes “whether society is prepared to accept [King’s] subjective expectation of privacy as objective- ly reasonable.”

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Chapter 8 Business Crime 283

privileged documents and the Fourth amendment In many business crimes, the records used to prosecute the defendant are not in the possession of the defendant. The records are, instead, in the hands of a third party, such as an accountant or a bank. Does the Fourth Amendment afford the defendant protection in documents that discuss the defendant or reflect the defendant’s finances and transactions when those documents are in the hands of another? In some cases, a privilege exists between the third party and the defen- dants, and certain documents are protected and need not be turned over. Notes on trial strategy, audit procedures, and other plans and thoughts are not discoverable because such communications are privileged between lawyers and clients. Some states recognize an accountant–client privilege. The priest–parishioner privilege generally exists; however, under certain exceptions, such as in cases of abuse, reporting is required.

8-8c Fifth amendment Rights for Businesses

The Fifth Amendment provides several protections for those facing criminal charges.

Self-Incrimination The statement “I take the Fifth” is used so often that it has made the Fifth Amendment well known for its protection against self-incrimination. For exam- ple, former Major League Baseball (MLB) player Mark McGwire took the Fifth Amendment before a congressional committee investigating MLB’s policies on testing players for steroids and suspensions for their use. Former Turing Phar- maceutical CEO, Martin Shkreli, took the Fifth Amendment when he was called to testify at a congressional hearing on drug prices, including why his company increased the price of one of its drugs by 525% overnight. We cannot be com- pelled to be witnesses against ourselves. However, this protection applies only to natural persons; corporations are not given this privilege. A corporation can- not prevent the required disclosure of corporate books and records on grounds that they are incriminating.

It is undisputed that King’s files were “shared” over the entire base network, and that everyone on the network had access to all of his files and could observe them in exactly the same manner as the com- puter specialist did. As the district court observed, rather than analyzing the military official’s actions as a search of King’s personal computer in his private dorm room, it is more accurate to say that the author- ities conducted a search of the military network, and King’s computer files were a part of that network. King’s files were exposed to thousands of individu- als with network access, and the military authorities encountered the files without employing any special means or intruding into any area which King could reasonably expect would remain private. The con- tents of his computer’s hard drive were akin to items stored in the unsecured common areas of a multiunit

apartment building or put in a dumpster accessible to the public.

Because his expectation of privacy was unreason- able King suffered no violation of his Fourth Amend- ment rights when his computer files were searched through the computer’s connection to the base net- work. It follows that his additional claim that the later search warrant was invalid because it incorporated information obtained from the search of his computer files also lacks merit.

Affirmed.

CaSe QUeStIONS

1. Why does the court draw the comparisons with noncyber searches?

2. What lessons should employees learn from this case?

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284 part 2 Business: Its Regulatory Environment

Corporate officers cannot assert Fifth Amendment protection to prevent com- pulsory production of corporate records. Nor can corporate officers use the Fifth Amendment to prevent the production of corporate records on grounds that those records incriminate them personally. The rules applicable to corporate officers have been extended to apply to those involved in labor unions, close corporations, and even unincorporated associations. The same rule is applicable to sole share- holders of small corporations as well.

Miranda Rights The famous Miranda doctrine resulted from an interpretation of the Fifth Amend- ment by the U.S. Supreme Court in Miranda v Arizona, 384 U.S. 436 (1966). Miranda warnings must be given to all people who are subjected to custodial interrogation. Custody does not necessarily mean “locked in jail,” but it is generally based on an individual’s perceptions of a situation. If a person feels he is without freedom to leave a place by choice, the level of custody at which Miranda rights must be issued has been reached. However, in Missouri v Seibert, 542 U.S. 600 (2004), the U.S. Supreme Court provided further clarification on when Miranda warnings must be given. A law enforcement official cannot coax a confession from an individual and then provide the warnings. If the individual then refuses to answer questions or offer the same information after the warnings are given, the law enforcement offi- cials cannot use the prior confession, given before the warnings, as evidence in court. The warnings tell those in custody of their Fifth Amendment right to say

For the Manager’s Desk

Re: Knowing When to Hold and When to Fold: What to do When Your Company Is in Big trouble

The Wall Street Journal grappled with a question that affects many business pro- fessionals in today’s economy: What do you do when a scandal at your former employer has caused you to lose your job? How do you handle such a situation on your résumé?

Investment advisers from Stanford Financial Group, Madoff Securities, and a host of Wall Street firms such as Lehman Brothers and Bear Stearns find themselves looking for employment because of their defunct employers. Some executive search firms will not consider former employees from scandal-rocked companies, even if the executives worked at subsidiaries or were not involved in the fraud, even remotely. Most agree there is a long path back from such an employment history, but the follow- ing tips might help:

• Leave when the indictments and/or arrests occur—don’t hang on.

• Don’t lie on your résumé.

• Describe your work at the company and others without naming names and wait until the interview to dis- close for whom you worked.

• Don’t badmouth your former employer in your interview—this is often taken as a sign of guilt; rather, explain how difficult it is to be blindsided, something that most managers can identify with because it happens to the best.

Source: JoAnn S. Lublin, “When Scandal Rocks a Résumé,” Wall Street Journal, August 4, 2009, p. D1.

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Chapter 8 Business Crime 285

nothing, as well as their right to an attorney. The failure to give Miranda warnings is not fatal to a case as long as the crime can be proved through evidence other than the statement of the defendant; the prosecution can still proceed based on other evidence.

due process Rights The Fifth Amendment also contains due process language. The same language is found in the Fourteenth Amendment and made applicable to the states. Due process, as Chapters 5 and 6 discuss, means that no one can be convicted of a crime without the opportunity to be heard, to question witnesses, and to present evidence.

Due process in criminal proceedings guarantees certain procedural protections as a case is investigated, charged, and taken to trial. The Sixth Amendment com- plements due process rights by requiring that all these procedures be completed in a timely fashion. The following subsections discuss the basic steps in a criminal proceeding, as diagrammed in Exhibit 8.3.

Warrant and/or Arrest. A criminal proceeding can begin when a crime is witnessed, as when a police officer attempts to apprehend a person who has just robbed a con- venience store. When the convenience store is robbed but the robber escapes, and if the police can establish that a certain individual was probably responsible for the robbery, a warrant can be issued and the individual then arrested. Whether with or without a warrant, the due process steps begin with the arrest.

Initial Appearance. Once an arrest has been made, the defendant must have an opportunity to appear before a judicial figure within a short time period (usually 24 hours) to be informed of his charges, rights, and so on. This proceeding is gen- erally referred to as an initial appearance. Dates for other proceedings are set at this time, and, if the individual can be released, the terms of the release are also established. The individual may be required to post a bond to be released; others are held without release terms (release terms generally depend on the nature of the crime and the defendant). The terms released on his own recognizance and released OR mean the defendant is released without having to post a bond.

Preliminary Hearing or Grand Jury. Up to this step in the criminal proceedings, the defendant’s charges are based on the word of a police officer; no proof has yet been brought forth linking the crime and the defendant. The purpose of a preliminary hearing or grand jury proceeding is to require the prosecution to establish that there is some evidence that the defendant committed the crime.

In a preliminary hearing, the prosecution presents evidence to a judge to indi- cate that the accused committed the crime. The prosecution presents witnesses, and the defendant and the defendant’s attorney are present for cross-examination of those witnesses. The defense does not present its case at this time but might make an offer of proof to show that the defendant could not have committed the crime. If the judge finds sufficient proof, an information is issued. The information is to a criminal proceeding what a complaint is to a civil proceeding: It establishes what the defendant did and when and what crimes were committed.

In some crimes, the evidence of the crime is presented to a grand jury, which is a panel of citizens who serve for a designated period of time (usually six months) and act as the body responsible for the review of evidence of crimes. If the grand jury finds sufficient evidence that a crime was committed, it issues an indictment, which is similar to an information and serves the same function.

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Grand jury proceedings are conducted secretly, whereas preliminary hearings are public. Grand juries also have the authority to conduct investigations to deter- mine whether crimes were committed and who did so. Perhaps one of the most famous grand juries was the San Francisco grand jury investigating steroid use in baseball. The grand jury heard testimony from some of baseball’s biggest stars. However, the content of their testimony remains sealed and secret unless and until it is used at a trial.

Arraignment. An arraignment is the proceeding at which the defendant enters a plea of guilty, not guilty, or no contest (nolo contendere). If a not guilty plea is entered, a date for trial is set. If the defendant enters a guilty or no contest plea, chances are the plea is the result of a plea bargain, which is the term used in crimi- nal proceedings for a settlement. The defendant may plead guilty to a lesser offense in exchange for the prosecution’s promise to support a lesser sentence, such as pro- bation or minimum jail time.

Discovery. If the case is going to trial, the parties then enter a discovery period. Many states have mandatory criminal discovery laws that require each side to turn over certain types of information to the other side, including lists of witnesses they will call and lists of exhibits that will be used at trial. Exhibits include documents, murder weapons, and pictures.

Exhibit 8.3 Steps in Criminal proceedings

Warrant Arrest

Initial Appearance

Preliminary Hearing

Grand Jury

IndictmentInformation

Arraignment

Discovery

Pretrial Conference

Omnibus Hearing

Trial

Appeal

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Chapter 8 Business Crime 287

Omnibus Hearing. In some cases, the defense attorney wishes to challenge the prosecution evidence on grounds that it was obtained in violation of any of the constitutional protections discussed earlier. Some documents, for example, may have been seized without a warrant. The omnibus hearing is the forum wherein all of these challenges can be presented for the judge’s ruling as to the admissibility of evidence. This hearing is held before the trial so the jury is not exposed to evi- dence that should not have been admitted. In the O.J. Simpson double-homicide trial, an omnibus hearing was held on the admissibility of evidence gathered at Mr. Simpson’s estate without a warrant.

Trial. If no plea agreement is reached before trial, the case then proceeds to trial.

8-9 Business Crime and International Business As noted in Chapter 7, businesses are subject to the laws of all countries in which they do business. In many situations, authorities from several countries are work- ing together to bring criminal charges against businesses located in different coun- tries. There is now a cross-border system for criminal prosecutions of businesses. For example, during 2012, British and U.S. authorities uncovered a long-standing scheme at banks in the United Kingdom to fix the London Interbank Offer Rate (LIBOR). The rates were fixed so that the banks could profit from their positions in derivatives tied to that rate. Cooperation among authorities in countries around the world led to the discovery of substantial evidence as well as criminal cases around the world. The banks in Britain faced charges, but so also were the traders in Scotland, Japan, Britain, Canada, and the United States charged with conspiracy and fraud for their participation in the rate-fixing scam, which was reflected in their e-mails that authorities in their own countries discovered and then tied to the British banks.

Biographypeanut Corporation of america: Knowledge Shows Intent

Peanut Corporation of America was a supplier of processed peanuts to some of the largest food production compa- nies in the United States. The compa- ny was founded by Hugh Parnell Sr. when he was selling ice cream vend- ing machines in the 1960s. When he was restocking a machine, he noticed that the peanuts on the Nutty Buddy ice cream cones came from a plant in the North. He decided to begin a company that processed peanuts in the South, where they were grown. The company grew and had plants in

Virginia, Georgia, and Texas. Hugh’s son Stewart Parnell entered the busi- ness in the 1970s after complaining to his father that graduates in his major, oceanography, often ended up working on oil rigs. His father offered him a job, and Stewart left college to begin work in the Virginia facilities.

Major food producers were custom- ers of Peanut Corp. ConAgra, a major peanut butter producer, was a large cus- tomer of Peanut Corp. Peanut Corp.’s peanut product base was used in peanut butter, ice cream, cookies, and crackers.

(Continued)

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Peanut Corporation was known for its cost cutting. When a customer came back with a bid from another peanut product base supplier that was lower, Stewart Parnell, who became the CEO of Peanut Corp., would always cut the price by a few cents in order to win over the potential customer.

E-mails reflect Parnell’s concerns about costs. When a salmonella test at the factory was positive, Peanut Corp. was required to hold off shipment for a retest. Parnell wrote in an e-mail, “We need to discuss this. Beside the cost, this time lapse is costing us $$$$ and causing us obviously a huge lapse from the time when we pick up the peanuts until the time we can invoice.” He also wrote, about products he was informed had tested positive for salmonella, “Turn them loose.” When the FDA made the connection between Peanut Corp. and salmonella poisonings that sickened 700 people in 44 states, which resulted in nine deaths, Mr. Parnell wrote to his man- agers, “Obviously we are not shipping any peanut butter products affected by the recall but desperately at least need to turn the raw peanuts on the floor into money.”

Congress held hearings into Peanut Corp.’s operations. Stewart Parnell took the Fifth Amendment when members of the Commerce Committee in the House of Representatives asked him questions about his company.

The company declared Chapter 7 bankruptcy on February 13, 2009. In early 2013, Mr. Parnell and four others were indicted: Michael Parnell, Stewart’s brother who served as a food broker for the company. along with Samuel Lightsey, Mary Wilkerson, and Daniel Kilgore, all managers and supervisors at Peanut Corporation, were charged with conspiracy, fraud, and falsification

of reports. The information on Mr. Kil- gore and the indictments of Mr. Parnell and the others charged the group with falsifying salmonella reports to indicate that the company’s products were sal- monella free when, in fact, the products contained salmonella. Mr. Parnell, his brother, and Mary Wilkerson were con- victed of obstruction of justice, falsifying food tests, and knowingly shipping con- taminated food.

Experts note that criminal charges in food-poisoning cases are rare because the proof of intent or mens rea is diffi- cult or impossible when there is a one- time problem. However, as the indictment notes, Mr. Parnell was being notified by customers that his company’s product was testing positive, yet he still continued production without cleaning up the plant. The indictment also alleged that the four who were charged misled FDA inspectors in January 2009, conduct that added obstruction of justice to the charges in the indictment. In addition, trial evidence included an e-mail from an employee that indicated the peanut meal containers at the plant (in 2007) were covered with dust and rat feces. Mr. Parnell responded to the employee, “Clean ’em all up and ship them.”

Daniel Kilgore and Samuel Lightsey entered guilty pleas and testified at the Parnell brothers’ trial. They are serving three- and six-year sentences respec- tively. Mary Wilkerson was convicted of obstruction of justice and is serving a five- year term. Mr. Parnell was convicted and sentenced to 28 years, which at his age is, in effect, a life sentence, and his brother was sentenced to 20 years.

Sources: Adapted from “The Ethical Barometer,” mariannejennings.com; Jane Zhang and Julie Jargon, “Peanut Corp. Emails Cast Harsh Light on Executive,” Wall Street Journal, February 12, 2009, p. A3.

(Continued)

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s u m m a r y Who is liable for business crimes?

• Vicarious liability—holding companies accountable for criminal conduct of their officers

• Elements—requirements of proof for crimes

• Mens rea—requisite mental state for committing a crime

• Actus reus—physical act of committing a crime

What penalties exist for business crimes?

• Penalties—punishments for commission of crimes; include fines and imprisonment

• Corporate sentencing guidelines—federal rules used to determine level of penalties for companies and officers; a system that decreases penalties for effort toward prevention of wrongdoing and coop- eration with investigations and increases penalties for lack of effort and other problems in company operations

• Deferred prosecution agreements—negotiated settle- ments of criminal charges that can consist of fines but postpone criminal prosecution for a period of years to determine whether the corporation can return to lawful conduct.

• Corporate integrity agreements—settlements by companies that require changes in ethics programs and,often, a monitor

What is the nature of business crime?

• Obstruction—under Sarbanes–Oxley, prohibits destruction of documents when civil or criminal investigations are pending

• Computer crime—crimes committed while using computer technology

• Criminal fraud—misrepresentation with the intent to take something from another without that person’s knowledge; to mislead to obtain funds or property

• Racketeer Influenced and Corrupt Organizations (RICO) Act—federal law designed to prevent racketeering by intensifying the punishments for engaging in certain criminal activities more than once

• USA Patriot Act—federal law that deals with due process rights as well as substantive issues such as money-laundering prohibitions

and mandatory disclosures by those involved in financial transactions, including banks, escrow and title companies, and other financial institutions

What are the rights of corporate and individual defen- dants in the criminal justice system?

• Fourth Amendment—provision in U.S. Constitution that protects against invasions of privacy; the search warrant amendment

• Fifth Amendment—the self-incrimination protection of the U.S. Constitution

• Sixth Amendment—the right-to-trial protection of the U.S. Constitution

• Search warrant—judicially issued right to examine home, business, and papers in any area in which there is an expectation of privacy

• Miranda warnings—advice required to be given to those taken into custody; details the right to remain silent and the right to have counsel

• Due process—right to trial before conviction

• Warrant—public document authorizing detention of an individual for criminal charges; for searches, a judicial authorization

• Initial appearance—defendant’s first appearance in court to have charges explained, bail set, lawyer appointed, and future dates set

• Preliminary hearing—presentation of abbreviated case by prosecution to establish sufficient basis to bind defendant over for trial

• Information—document issued after preliminary hearing requiring defendant to stand trial

• Grand jury—secret body that hears evidence to determine whether charges should be brought and whether defendant should be held for trial

• Indictment—document issued by grand jury requir- ing defendant to stand trial

• Arraignment—hearing at which trial date is set and plea is entered

• Plea bargain—settlement of criminal charges

• Omnibus hearing—evidentiary hearing outside the presence of the jury

• Trial—presentation of case by each side

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290 part 2 Business: Its Regulatory Environment

Q u e s t i o n s a n d P r o b l e m s 1. Timothy Moher owns 440 acres of land on Sugar Island, Michigan. Sugar Island is located on the St. Mary’s River, which marks the international border between Canada and the United States. Mohr’s land is two miles from Canada. Two United States Cus- toms and Border Protection patrol officers entered Mr. Moher’s land in order to patrol for illegal immi- gration activity. Mr. Moher filed suit for invasion of privacy on the grounds that the officers needed a war- rant to enter his land and did not have one, nor had they obtained Mr. Mohr’s consent. Explain Mr. Mohr’s rights in this situation. [Moher v U.S., 875 F. Supp. 2d 739 (W.D. Mich. 2012)]

2. Rooney Enterprises, Inc., operated a cemetery in Franklin County, Virginia. A state law requires compa- nies that receive advance payments for funeral expenses and burial plots to put those funds into a special trust account. Instead of doing so, Rooney used such funds for operating expenses. It later became insolvent, so all those customers who had prepaid their burial plots and expenses lost both their money and their plots. The Virginia Attorney General brought criminal charges against Patrick Rooney, as president, for his failure to fol- low the requirements for trust fund deposits. Mr. Rooney said he was unaware of the requirement, that the require- ment was not in effect when his company purchased the cemetery, and that only the company could be pros- ecuted for the failure to follow trust-fund requirements. Decide whether Mr. Rooney should be convicted. [Rooney v Com., 500 S.E.2d 830 (Va. App. 1998)]

3. Michael Friedman, Paul Goldenheim, and Howard Udell were executives at Purdue Frederick Company when it misbranded the drug OxyContin. The misbrand- ing dealt with their company’s marketing and promotion of OxyContin as “less addictive, less subject to abuse and diversion, and less likely to cause tolerance and with- drawal than other pain medications”—representations that are false.

The three were convicted of felony charges of mis- branding the drug as responsible corporate officers at a company at the time the misbranding occurred. The three appealed both their convictions as responsible corporate officers as well as their 12-year suspension from participation as an executive in a health care company. Can the three be held criminally responsi- ble for the problems with the drug labels? Explain. Also, discuss the sanction of their banishment from

the health care field. [Friedman v Sebelius, 686 F.2d 813 (C.A.D.C. 2012)]

4. Emma Mary Ellen Holley and David Holley, an inter- racial couple, tried to buy a house in Twenty-Nine Palms, California. A real estate corporation, Triad, Inc., had listed the house for sale. Grove Crank, a Triad salesman, pre- vented the Holleys from obtaining the house for racially discriminatory reasons.

The Holleys brought a lawsuit in federal court against Mr. Crank and Triad. They claimed, among other things, that both were responsible for a fair housing law violation. The Holleys later filed a separate suit against David Meyer, the sole shareholder of Triad and its pres- ident and CEO. They claimed that Mr. Meyer was vicar- iously liable in one or more of these capacities for Mr. Crank’s unlawful actions, which were a violation of the Fair Housing Act. Are the Holleys correct? [Meyer v Hol- ley, 537 U.S. 280 (2003)]

5. The owner of a construction firm in New York City, William Lattarulo, has been charged with manslaugh- ter in the death of one of his workers. Lauro Ortega suffocated when the foundation of a building next to where he was digging at a Lattarulo site collapsed on him. Mr. Ortega’s head was all that was uncovered when the foundation collapsed, but the pressure of the dirt and debris that rendered him immobile con- stricted his chest and made him unable to breathe. He suffocated as his coworkers tried to dig him out from the debris.

Mr. Ortega’s coworkers as well as a safety con- sultant had warned Mr. Lattarulo that the trench was unsafe and needed to have some supports placed in it to prevent a collapse. When he was warned a second time by his workers, Mr. Lattarulo said, “Don’t worry about it.”

Digging operations require that a contractor hire a consultant to oversee site safety. While Mr. Lattarulo listed a company as a consultant for the site safety, he did not actually have or pay a consultant, something that saved him $90,000 on the job. On the day of the col- lapse, a building inspector for the city visited the site following the fatality and said there were “shoddy work conditions.” She also found eight violations of city con- struction codes at the site.

The Lattarulo site involved digging a foundation next to another building, but the Lattarulo building required a deeper dig. The result was that the foundation of the

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building next to the site was weakened and required support until the Lattarulo concrete was poured to pro- vide a substitute for the former ground support. A con- sultant working nearby did warn Mr. Lattarulo about the foundation’s risk of collapse if the digging went deeper.

When the criminal manslaughter charges were brought, contractors had questions about their criminal liability when there are accidents on job sites. How would you advise these contractors? When is an owner crimi- nally liable for actions and work conducted by employees? People v. Lattarulo, 26 Misc.3d 177 (Sup. Ct. 2009)

6. Bernard Saul was a salesperson for A. P. Walter Com- pany, a wholesale auto parts business, assigned to the D&S Auto Parts account. Mr. Saul took inventory at D&S each week and phoned in an order to Walter to cover the needed inventory replacements. Between 1976 and 1982, Mr. Saul ordered parts from Walter and invoiced D&S, but he actually kept a portion of the parts for him- self, sold them to other dealers, and pocketed the money. Through an audit, D&S discovered that it had paid $155,445.20 for parts that were not received. Can Mr. Saul be charged with any crimes? Can Walter be charged with any crimes? [D&S Auto Parts, Inc. v Schwartz, 838 F.2d 965 (7th Cir. 1988)]

7. Odessa Mae French operated the Pines Motel as a house of prostitution for seven years. During that time, Ms. French avoided any local law enforcement action by allowing the sheriff to have free services at the Pines. Eventually, the federal government brought charges against the operation for tax evasion and RICO violations. Would the services to the sheriff constitute a form of bribe that would support a RICO charge? [United States v Tunnell, 667 F.2d 1182 (5th Cir. 1982)]

8. Bobby Unser (three-time Indy winner) and a friend went snowmobiling near Unser ’s ranch in northern New Mexico. While on their short ride, a ground bliz- zard resulted in near zero visibility. The two men got lost trying to find their way back to the truck. One machine crashed when they went into a ravine, and Mr. Unser’s snowmobile eventually stopped working. The two lost men spent the night in a snow cave. The next day, they found a barn and called for help from a phone in that barn. They were treated for frostbite, dehydration, and exhaustion. The snowmobiles were found in a National Forest area. Mr. Unser was charged with unlawful posses- sion and operation of a motor vehicle within a National

Forest Wilderness Area. Mr. Unser says he did not intend to enter the area but was lost in the snow storm. Can he be convicted of a crime? [U.S. v Unser, 165 F.3d 755 (10th Cir. 1999)]

9. Jason Jones, a 19-year-old U.S. Naval Academy mid- shipman, killed John and Carole Hall when he collided with the rear of their car, which was on the shoulder of the road. Mr. Jones was driving 80 to 105 mph and talking on a cell phone when he struck the Halls’ car.

He was prosecuted for manslaughter and negligent driving. Negligent driving is a misdemeanor and car- ries a $500 fine. Manslaughter requires proof that the defendant knew the conduct was likely to cause death or severe bodily harm.

Testimony by experts for the prosecution indicated that cell phone use while driving is an enormous distrac- tion. The increased accident rate during cell phone use while driving is placed at between 34% and 300% by var- ious experts.

It is not illegal in Maryland to use a cell phone while driving. Can someone be convicted for crimes related to conduct that is not illegal? Was mens rea present here?

10. Harlan Nolte and others invested in IFC Leasing Company, a master music recording leasing program. The company was created to acquire and lease master music recordings. Jerry Denby, the executive vice presi- dent of IFC, contacted Stephen Weiss, a partner in the law firm of Rosenbaum, Wise, Lerman, Katz & Weiss, to draft the prospectus for investors. Mr. Weiss drafted four doc- uments used in the recruitment of investors for IFC. The complex structure of the investments, according to the documents, would have substantial tax consequences (to their benefit) for the investors.

After Mr. Nolte and others had made their invest- ments, the IRS issued an opinion that the deductions explained in the prospectus and other documents would not be allowed. Criminal fraud actions were brought against IFC and its officers, as well as Mr. Weiss. The Justice Department also indicted both Mr. Weiss’s law firm and his partners. Mr. Weiss’s partners and the firm, through its management committee, maintain they can- not be held criminally liable for the actions of one part- ner. The Justice Department maintains that the firm and the partners were negligent in their supervision of Mr. Weiss and should, therefore, be held criminally liable. Do you agree with the Justice Department’s position? Why or why not? [Nolte v Pearson, 994 F.2d 1311 (8th Cir. 1993)]

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Strategy, Ethics, & the Law Criminal Charges for Tax Shelters?

In what was called the largest criminal tax fraud case in the history of the United States, 16 former partners and employees of the accounting firm KPMG were charged with criminal tax fraud. The case was so complex that the government alone had produced in discovery, in electronic or paper form, at least 5 million to 6 million pages of documents plus transcripts of 335 depositions and 195 income tax returns.

KPMG, following a dismal performance by its part- ners at a congressional hearing, began negotiations with the Justice Department for the settlement of the case against the firm itself. As a result of those negotiations, KPMG agreed to stop paying the legal fees for the 16 former partners and employees, to waive indictment, to be charged in a one-count information, to admit extensive wrongdoing, to pay a $456 million fine, and to accept restrictions on its practice. In turn, the Justice Department agreed that the information against KPMG would be dismissed if KPMG met all of its obligations under the agreement. Those negotiating on behalf of KPMG had stated to the Justice Department attorneys that their goal was to avoid the fate of Arthur Andersen and save the firm. With KPMG saved, however, the 16 former partners and employees were left without means for paying what had been and would be an expensive defense to the tax shelter fraud accusations.

The 16 argued that the failure of KPMG to pay those fees, as it had done in the past, deprived them of their constitutional rights under the Fifth and Sixth Amendments on self-incrimination as well as the right to a speedy trial. They challenged the agreement in federal court.

The court found that in obtaining the agreement from KPMG, federal prosecutors, acting under Jus- tice Department policy, established in the so-called Thompson memo, indicated to KPMG that the firm’s continuing to pay the legal fees of the 16 would be considered evidence of the firm’s guilt. Federal District Court Judge Lewis Kaplan found that the prosecutors had acted improperly in pressuring KPMG to throw its employees under the bus in order to preserve the firm. Judge Kaplan wrote:

An employer often must reimburse an employee for legal expenses when the employee is sued, or even charged with a crime, as a result of doing his or her job. Indeed, the employer often must advance legal expenses to an employee up front, although the employee sometimes

must pay the employer back if the employee has been guilty of wrongdoing.

This principle is not the stuff of television and movie drama. It does not remotely approach Miranda warnings in popular culture. But it is very much a part of American life. Persons in jobs big and small, private and public, rely on it every day. Bus drivers sued for accidents, cops sued for allegedly wrongful arrests, nurses named in malpractice cases, news reporters sued in libel cases, and corporate chieftains embroiled in securities litigation generally have similar rights to have their employers pay their legal expenses if they are sued as a result of their doing their jobs. This right is as much a part of the bargain between employer and employee as salary or wages.

The Thompson memo, written by U.S. Deputy Attor- ney General Larry D. Thompson, was called Principles of Federal Prosecution of Business Organizations and was written to give prosecutors guidelines and policies on the decision to prosecute or not to prosecute compa- nies. Two of the principles in the memo provided as follows:

(1) [I]n gauging the extent of the corporation’s cooperation, the prosecutor may consider the corporation’s willingness to identify the culprits within the corporation, including senior executives, to make witnesses available, to disclose the complete results of its internal investigation, and to waive attorney-client and work-product privileges. (2) Another factor to be weighed by the prosecutor is whether the corporation appears to be protecting its culpable employees and agents. Thus, while cases will differ depending upon the circumstances, a corporation’s promise of support to culpable employees and agents, either through the advancing of attorneys fees, through retaining the employees without sanction for their misconduct, or through providing information to the employees about the government’s investigation pursuant to a joint defense agreement, may be considered by the prosecutor in weighing the extent and value of a corporation’s cooperation.

Mr. Thompson defended the use of pressure to have companies cut off payment of defense costs for their employees on the ground that “they [the employees] don’t need fancy legal representation” if they do not believe that they acted with criminal intent. (The Thompson Memo was later replaced by the McNulty

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Memo, but its provisions on fee payment remained intact.)

However, Judge Kaplan ruled that the pressure the Justice Department had placed on KPMG was improper, that there were either explicit or implicit agreements to pay the attorneys’ fees for the former partners and employees, and that, as a result, they had been deprived of the constitutional rights to which they were entitled in criminal proceedings. Judge Kaplan found that KPMG had a conflict of interest in repre- senting to the government that it did not have an obligation to pay the attorneys’ fees and that KPMG

was so anxious to “curry favor” with the govern- ment that the government should not have relied on KPMG’s representations about its obligations.

Once Judge Kaplan made the attorneys’ fees ruling, the case developed other issues and problems, and the government dismissed most of the charges against the 16 former partners and employees.

Make a list of the lessons employees and companies can learn from this experience.

Source: U.S. v. KPMG, 316 F. Supp. 2d 30 (D.D.C. 2004) Laurie P. Cohen, “In the Crossfire: Prosecutors’ Tough New Tactics Turn Firms Against Employees,” Wall Street Journal, June 4, 2004, p. A1.

n ot e s 1. Valerie Bauerlin, “Scrushy Denies Role in HealthSouth Fraud,” Wall Street Journal, May 21, 2009, p. B4.

2. 5 U.S.C. § 1512.

3. Mr. Duncan withdrew his plea when the Andersen case was decided by the U.S. Supreme Court in Andersen’s favor. The government has not pursued prosecution against him.

4. “Every circuit court to have considered the matter has held that an ‘intercept’ under the ECPA must occur contemporaneously with transmission.” [Fraser v Nationwide Mut. Ins. Co., 352 F.3d 107, 113 (3rd Cir. 2003)]

5. John Markoff and Nicole Perlroth, “Dispute on Spam Stirs Big Assault on the Internet,” New York Times, March 27, 2013, p. A1.

6. U.S. v Lori Drew, 259 F.R.D. 449 (C.D. Cal. 2009).

7. U.S. Department of Justice, press release #07-161:03, http://www.doj.gov.

8. U.S. Department of Justice, press release #07-161:03, http://www.doj.gov.

9. U.S. Department of Justice, press release #07-161:03, http://www.doj.gov.

10. Neil A. Lewis, “Inquiry Threatens Ex-Leader of Security Agency,” New York Times, August 16, 2007, p. A18.

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294

Chapter

Business Torts9 Criminal wrongs require guilty parties to pay a debt to society through a fine, imprisonment, and/or community service. However, criminal wrongs also have victims who have suffered financial losses, injuries, and, sometimes, per- manent disabilities. Those who are harmed by the conduct of others are the vic- tims of torts. Torts are civil wrongs that provide remedies. This chapter answers these questions: What are the different types of torts? What must you prove to recover for these torts? What are the business and public policy issues in torts?

Update For up-to-date law and ethics news, go to mariannejennings.com

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295

9-1 What Is a Tort? Roots of Law and Commerce

Tort comes from the Latin term tortus, which means “crooked, dubious, twisted.” A tort is some type of interference with someone or with someone’s property that results in injury to persons or property. For example, using someone else’s land without permission is interference with that person’s property rights and is the tort of trespass. If you held a concert on someone else’s land and the concert crowds destroyed the property’s vegetation or left litter that had to be removed, then you committed the tort of trespass. Tort law provides the basis for recovering the costs of restoring the property damaged by the concertgoers.

9-1a tort Versus Crime

A tort is a private wrong. When a tort is committed, the party who was injured is entitled to collect compensation for damages from the wrongdoer for the private wrong. A crime, on the other hand, is a public wrong and requires the wrongdoer to pay a debt to society through a fine or by going to prison. For example, in the shooting death of Michael Brown by a Ferguson, Missouri, police officer, a grand jury found that there was no crime committed by the officer. However, the family of Mr. Brown brought a civil suit against the city of Ferguson and the officer for the shooting death. The criminal justice system found no crime was committed, but the civil justice system can impose liability for the young man’s death. The case was settled.

9-1b types of torts

The three types of tort liability include intentional torts, negligence, and strict tort liability. Intentional torts are those that involve deliberate actions. For example, a battery, or hitting another person, is an intentional tort. Hitting someone in the nose deliberately is the tort of battery. Suppose that you stretch your arms in a crowd and you hit a man in the nose and hurt him. You have not committed the tort of battery, but you may have committed the tort of negligence. You were carelessly

This is the lettuce you eat at Burger King. A cAption on An instAgrAm photo three Burger King employees posted in July 2012; one of them is stAnding, complete with his shoes on, in open Bins of shredded lettuce The photo and caption went viral. Anxious burger eaters tracked down the restaurant to Mayfield Heights, Ohio, through data embedded in the photo. They then used e-mail and other electronic communication to harass the store manager and notify Burger King Corporation. The three employees were fired, yet the picture remains on the Internet.

—Instagram

John Chaney went to a Starbucks café in the Bronx for lunch. Upon entry, he saw that a customer in the seat- ing area had plugged a white electrical charger into an outlet. After buying lunch, Chaney sat down near that patron. When Chaney rose from his chair 20 minutes later, he stepped on the charger, causing him to fall and

injure himself. Six months later, Chaney brought this negligence action against defendant Starbucks Corpora- tion claiming that Starbucks had failed to safely maintain the seating area in its café. Should Chaney be able to recover?

Consider . . . 9.1

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swinging your arms in a crowd of people. Such careless conduct, or actions done without thinking through the consequences, is the tort of negligence. You are still responsible for damages to the nose because when you fail to act cautiously and thoughtfully, you are negligent. Strict tort liability does not turn on state of mind or knowledge of possible harm. For example, when contractors use dynamite to raze a building, they have strict liability because the incendiary devices are so risky and consequences could be so great that we hold them responsible regardless of the precautions they take. Product liability, discussed in Chapter 13, is a form of strict liability. You will see that a company can be held liable for injuries when a customer has misused its product because even the failure to provide enough warnings results in strict liability.

9-2 The Intentional Torts 9-2a defamation

Defamation is an untrue statement made by one party to another about a third party. It consists of either slander or libel; slander is oral or spoken defamation, and libel is written (or, in some cases, broadcast) defamation. The elements of def- amation are the following:

1. A statement about a person’s reputation, honesty, or integrity that is untrue 2. Publication 3. A statement that is directed at a particular person 4. Damages 5. In some cases, proof of malice

publication Defamation requires that whatever is said or written be communicated to a third party. A contractor who untruthfully tells developers that one of his competitors uses workers who are undocumented aliens has met the publication element. So has a supplier who notifies other suppliers that a business is insolvent when it is not. The more folks who hear the statement, the greater will be the defamation damages.

Internet messages and blog postings meet the publication requirement. They provide instantaneous and international communication, so damages can be substantial.

Statement about a particular person To qualify as defamation, the statement made must be about an individual or a small enough group that all in the group are affected. For example, the general statement “All accountants are frauds” is too broad to be defamatory. But the state- ment “All the Andersen audit partners who worked on the Enron accounts were dishonest” is specific enough to meet this requirement.

Product disparagement is defamation of a product. For example, a Consumer Reports evaluation of a product that is not truthful about its qualities or abilities would be product disparagement. In Bose Corporation v Consumers Union of United States, Inc., 466 U.S. 485 (1984), the U.S. Supreme Court dealt with whether prod- uct disparagement of the Bose speaker system actually occurred when Consumer Reports described individual sounds from the speakers, such as those of violins, as

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Chapter 9 Business Torts 297

growing to gigantic proportions. The Supreme Court held that even though Con- sumers Union had not given the Bose speakers a favorable review, it also did not say anything false about them in its negative review. There was, as a result, no dis- paragement (see Chapter 15).

damages The person who is defamed must be able to establish damages, such as lost busi- ness, lost profits, lost advertising, lost reputation, or some economic effect that has resulted from the defamatory statements.

Malice Malice must be proved in defamation cases that involve public figures. Public fig- ures are those voluntarily in the public eye, such as elected officials, recording art- ists, actors, sports figures, and media magnates. An example of someone who was not a voluntary public figure is Abdulrahman Alharbi, a Saudi student who was identified by radio and television commentator Glenn Beck as an active partici- pant in funding the Boston marathon bombing. After federal authorities exoner- ated him in the case, he brought a defamation suit against Mr. Beck and his radio and television networks. The court held that Mr. Alharbi was not an involuntary or limited purpose public figure and that he had alleged sufficient facts to infer that Mr. Beck and his companies were negligent in the truthfulness of their report on Mr. Alharbi’s alleged involvement. [Alharbi v Beck, 62 F. Supp. 3d 202 (D. Mass. 2014)] As a result of these types of cases, when media reports are swirling, media sources and law enforcement officials no longer refer to individuals as “suspects.” The term that allows them to escape defamation liability is person of interest. That label is used until the individual is charged or law enforcement agents clear the individual. In addition, even after charges are brought, media sources phrase their descriptions carefully by stating, for example, “He is alleged to have embezzled $5 million from his employer over three years,” or “He is charged with the crime of embezzlement.”

Malice provides the balance between personal rights and the protections the First Amendment provides for the media. Malice requires proof that the informa- tion was published or broadcast knowing that it was false or with reckless disre- gard for whether it was true or false.

Lavely & Singer has become the law firm that celebrities turn to when they are con- cerned about a pending story in anything from the National Enquirer to the Wall Street Journal. Lavely & Singer represent- ed Britney Spears against US Weekly in a libel suit for its publication of a story it ran on a sexually explicit home video that she and her ex-husband made. A California court dismissed the suit, explaining, basically, that given Ms. Spears’s reputation it was difficult to defame her. The court said that

because Ms. Spears has “put her modern sexuality squarely, and profitably, before the public eye,” the publication of such informa- tion could not be considered harmful to her reputation, thereby meaning that one of the elements of defamation could not be estab- lished. Is the court correct on the Britney Spears decision?

Source: Peter Lattman, “When Celebrities Fear Sting of Publicity, Who Do They Call?,” Wall Street Journal, December 9, 2006, pp. A1, A6.

Consider . . . 9.2

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the defenses to defamation Truth. A statement may be damaging, but, if it is the truth, it is not defamation. For example, you could publicly disclose that your boss took LSD during the late 1960s when he was in college. The remark might hurt your employer’s reputation, but if it is the truth, it is not the tort of defamation despite the harm it may do to him.

Opinion and Analysis. One of the current issues in defamation cases is whether the statements made are protected when they are a columnist’s analysis of a situation. Courts are trying to determine what level of protection is given for viewpoints when someone objects to the conclusions drawn rather than the statements of fact. A fine line is often all that separates statements of fact from expressions of opinion. In business publications, those opinions can be devastating to companies and their stock performance. In Wilkow v Forbes, Inc., 241 F.3d 552 (7th Cir. 2001), the court dealt with an opinion column in Forbes magazine. According to the article, a part- nership led by Marc Wilkow “stiffed” the bank, paying only $55 million on a $93 million loan while retaining ownership of the building.

The bases for Richard Jewell’s suit against NBC were the following sen- tences from a broadcast by Tom Brokaw: “Look, they probably got enough to ar- rest him. They probably have got enough to try him.” Mr. Brokaw finished his on- air commentary by adding, “Everyone,

please understand absolutely he is only the focus of this investigation—he is not even a suspect yet.”

Decide whether Jewell was defamed by the remarks.

Sadly, Mr. Jewell passed away in 2007 at the age of 44 from a heart attack.

Consider . . . 9.3

For the Manager’s Desk

Re: dirty Hotels and defamation

In Grand Resort Hotel v TripAdvisor, LLC, 2012 WL 3637394 (E.D. Tenn. 2012), the Grand Resort filed suit against TripAdvisor for defamation. TripAdvisor is a website that pro- vides customer feedback on hotels so that those considering booking at the hotel can obtain firsthand information about the hotel. Generally, these sites are protected against defamation suits because the information posted there is primarily opinion. However, the Grand Resort, which was included as one of TripAdvisor’s “dirtiest hotels,” argued that such lists were beyond protected opinion

and that the comments posted in determin- ing the list were factual, such as this one about the Grand Resort Hotel, “There was dirt at least ½-inch thick in the bathtub which was filled with lots of dark hair.”

However, the court held that the state- ment was not defamatory because of the nature of the communication and anony- mous feedback. The information on the site was protected as opinion and therefore requires business managers to understand the importance of customer service and satisfaction.

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The court held that if it is plain that the columnist “is expressing a subjective view, an interpretation, a theory, conjecture, or surmise, rather than claiming to be in possession of objectively verifiable facts, the statement is not actionable.” “Stiff- ing,” as the court noted, may “drip of disapproval,” but it is an interpretation of values and is not defamation.

Privileged Speech. Some speech is privileged—that is, strong public interest sup- ports protecting the speech regardless of whether it is true. For example, members of Congress enjoy an absolute privilege when they are speaking on the floor of the Senate or House because of a strong public policy to encourage free debate of issues. The same is true of judicial proceedings; in order to encourage people to come forward with the truth, witnesses enjoy an absolute privilege when testifying about the matters at hand. For example, Roger Clemens sued his former trainer, Brian McNamee, for defamation after McNamee testified before a congressional committee that Clemens had used steroids during his professional baseball career. The defamation suit was dismissed because McNamee had an absolute privilege to testify. [Clemens v McNamee, 608 F. Supp. 2d 811 (S.D. Tex. 2009) 615 F.3d 374 (5th Cir. 2010)1]

There are also some qualified privileges, or privileges that provide limited lia- bility for defamation. In nearly all states, there is a qualified privilege for those who have a moral obligation to speak. These types of privilege statutes provide protection for whistle-blowers (see Chapter 16) in that a controlled (limited) disclo- sure of information made in good faith will not subject a businessperson to liability for defamation. However, verification of the truth of such statements is critical.

Another qualified privilege exists for former employers when discussing for- mer employees, as the following “For the Manager’s Desk” discusses.

Re: those Glowing Letters of Recommendation vs. truth vs.

defamation

For the Manager’s Desk

One area of legal complexity is the inter- section of letters of recommendation, the duty to disclose dangerous conduct by former employees, and defamation. Most employers follow a practice of simply dis- closing for new employers whether a for- mer employee in fact worked at their company and for how long. In order to avoid liability for disclosing negative infor- mation in a defamation action by the former employee, employers are hesitant to offer any additional information beyond these perfunctory facts.

However, such an approach is not with- out risk. In Randi W. v Muroc Joint Unified School District, 929 P.2d 582 (Cal. 1997), a California court grappled with the problems that arose from glowing letters of recommen- dation from a former employer. In the case, Randi W., a 13-year-old minor who attended the Livingston Middle School, was molest- ed and sexually touched on February 1, 1992, by Robert Gadams, who served as vice principal at the school. When her par- ents filed suit against the school district, they uncovered some disturbing facts.

(Continued)

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(Continued) Mr. Gadams had previously been employed at three other school districts:

• Mendota Unified School District (1985–1988). During his time of employment there, Mr. Gadams had been investigated and reprimanded for improper conduct with female junior high students, including giving them back massages, making sexual remarks to them, and being involved in “sexual situations” with them. Gil- bert Rossette, an official with Mendo- ta, provided a letter of recommenda- tion for Mr. Gadams in May 1990. The recommendation was extensive and referred to Mr. Gadams’s “genuine concern” for students, his “outstand- ing rapport” with everyone, and con- cluded, “I wouldn’t hesitate to recom- mend Mr. Gadams for any position.”

• Mr. Gadams had also previously been employed at the Tranquility High School District and Golden Plains Unified District (1987–1990). Richard Cole, an administrator at Golden Plains, also provided a letter of recommendation that listed Mr. Gadams’s “favorable” qualities and concluded that he “would recom- mend him for almost any administra- tive position he wishes to pursue.” At that school, Mr. Gadams had been the subject of various parents’ com- plaints, including that he “led a panty raid, made sexual overtures to stu- dents, sexual remarks to students.” Mr. Cole also knew that Mr. Gad- ams had resigned under pressure because of these sexual misconduct charges. [Mendota Unified School District (1985–1988)] During his time of employment there, Mr. Gadams had been investigated and repri- manded for improper conduct with female junior high students, including giving them back massages, making sexual remarks to them, and being involved in “sexual situations” with them. Gilbert Rossette, an official with Mendota, provided a letter of recommendation for Mr. Gadams in May 1990. The recommendation was extensive and referred to Mr.

Gadams’s “genuine concern” for stu- dents, his “outstanding rapport” with everyone, and concluded, “I wouldn’t hesitate to recommend Mr. Gadams for any position.”

• Mr. Gadams had also previously been employed at the Tranquility High School District and Golden Plains Unified District (1987–1990). Richard Cole, an administrator at Golden Plains, also provided a let- ter of recommendation that listed Mr. Gadams’s “favorable” qualities and concluded that he “would recommend him for almost any administrative position he wishes to pursue.” At that school, Mr. Gadams had been the subject of various par- ents’ complaints, including that he “led a panty raid, made sexual over- tures to students, sexual remarks to students.” Mr. Cole also knew that Mr. Gadams had resigned under pressure because of these sexual misconduct charges.

• Mr. Gadams’s last place of employ- ment (1990–1991) before Livingston was Muroc Unified School District, where disciplinary actions were taken against him for sexual harass- ment. When allegations of “sexual touching” of female students were made, Mr. Gadams was forced to resign from Muroc. Nonetheless, Gary Rice and David Malcolm, offi- cials at Muroc, provided a letter of recommendation for Mr. Gadams that described him as “an upbeat, enthusiastic administrator who relates well to the students” and who was responsible “in large part” for making Boron Junior High School (located in Muroc) “a safe, orderly and clean environment for students and staff.” The letter concluded that they recommended Mr. Gadams “for an assistant principalship or equiva- lent position without reservation.”

The court held the districts liable to Randi W. and her guardians for their glowing letters, which withheld information import- ant for the safety of children at the schools

(Continued)

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Paul Calden, a 33-year-old, low-level manager, was fired from his job at Allstate Insurance Company in St. Petersburg, Florida, for car- rying a gun to his job. His supervisors at Allstate would later describe him as a “total lunatic.”

Mr. Calden applied for a job with Fire- man’s Fund Insurance in Tampa, Florida. Fireman’s Fund contacted the Allstate offices for a reference. Allstate sent a letter signed by a vice president that was neutral in its description of Mr. Calden and did not dis- close the true reasons for his termination. Mr. Calden had threatened litigation, there was some fear among the employees about him, and Allstate had agreed to a four- month severance package despite his hav- ing worked at Allstate for only nine months. Allstate also agreed to draft and send the neutral letter.

After Mr. Calden was terminated by Fireman’s Fund, he shot and killed three executives of the company while they were having lunch at a café. One of the execu- tives’ wives filed suit against Fireman’s Fund and Allstate. The suit against Allstate was based on its failure to disclose Mr. Calden’s bizarre behavior and the risk that he was in the workplace.

Allstate defended its actions on the grounds that the average verdict in a defa- mation suit by a former employee against his former employer for a job reference was $57,000. In one Florida case, a for- mer employee was awarded $25 million in damages. Allstate argued that the cost to businesses would be too high. Is All- state liable? Be sure to discuss the priv- ilege, defamation, and reference issues involved.

Consider . . . 9.4

where Mr. Gadams had worked. The dis- tricts’ issuance of glowing recommenda- tions when there was troubling information resulted in liability.

Nearly all states provide a qualified priv- ilege for letters of recommendation. A sur- vey indicates that without such protection, disclosures about violent tendencies will not be made and the risk to employees at a new firm is high.

Under this privilege, employers are not liable for defamation if the information they disclose about a former employee is provided in “good faith” or “absence of bad faith.” The statutes vary in their language from state to state, but they do provide immunity for factual statements. For example, a letter on Gadams that said, “The man is a child molester,” would not enjoy immunity. However, a letter from a principal that said, “Several parents com- plained about Mr. Gadams’s inappropriate touching of their children,” would enjoy the statutory protection. Also adding to the complexity of the reference issue is a U.S. Supreme Court decision in which the court held that giving a negative reference on a former employee who has sued the

company for discrimination can be consid- ered retaliatory and a violation of Title VII (see Chapter 20). [Robinson v Shell Oil Co., 519 U.S. 337 (1997)]

Most employers do not rely on the immunity and opt to disclose nothing other than the time of employment. Fifty-four percent of all employers indicate they would not disclose violent behavior when asked for reference. However, keep the Gadams case in mind because there can be liability for misleading other employers into hiring those who ultimately cause harm that was predictable based on the facts the previous employer knew. In 2010, Dr. Amy Bishop, a professor at the University of Alabama, was accused of killing three of her colleagues in a dispute over her being denied tenure. As the case was investigated, law enforce- ment agencies discovered a history of que- ries about Dr. Bishop over everything from alleged threats to others at work to ques- tions surrounding what was then called the “accidental” shooting of her brother. None of this sordid past had been disclosed when she applied for the position at the University of Alabama. The risks of nondisclosure are often life-and-death matters.

(Continued)

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Another qualified privilege applies when public figures are involved in the defamation. For public figures, the media also have a qualified privilege. If the news organization prints a retraction of a published statement, it has a defense to defamation. Perhaps one of the most famous libel cases addressing the defense of the media privilege involves Donald Trump and a book that included esti- mates of his wealth. The case decision on this issue follows in Trump v O’Brien (Case 9.1).

Trump v O’Brien 29 A.3d 1090 (N.J. Super. 2011)

Truth Trumps

Case 9.1

FaCtS

Donald Trump (plaintiff) sued Timothy O’Brien, the author of Trump Nation, the Art of Being the Donald, and his publisher (defendants) for defamation by the book’s representations about Mr. Trump’s net worth. To determine Mr. Trump’s net worth, Mr. O’Brien inter- viewed and reinterviewed three anonymous sources who eventually lowered their estimates of Trump’s net worth to be, at that time, between $150 million and $250 million. Their lowered estimates resulted from the decreased value of Trump’s casino holdings at the time O’Brien was writing the book. O’Brien, who also interviewed Trump, wrote:

So I asked around for guidance. Three people with direct knowledge of Donald’s finances, people who had worked closely with him for years, told me that they thought his net worth was somewhere between $150 million and $250 million. By anyone’s standards this still qualified Donald as comfortably wealthy, but none of these people thought he was remotely close to being a billionaire.

That passage was followed by:

Donald dismissed this as naysaying. “You can go ahead and speak to guys who have four-hundred-pound wives at home who are jealous of me, but the guys who really know me know I’m a great builder,” he told me

Trump alleged in his suit that these and other state- ments such as those that referred to Mr. Trump’s “ver- bal billions” and “[T]rump’s ability to float above the wreckage of his financial miscues and magically add zeroes to his bank account ensured that he remained an object of fascination” were false statements that

harmed his reputation. The trial court granted summa- ry judgment for Mr. O’Brien and Mr. Trump appealed.

JUdICIaL OpINION

PAYNE, Appellate Division Judge Because there is no doubt that Trump is a public figure, the alleged defamatory statements by O’Brien must have been uttered or published with “actual malice.” [N.Y. Times Co. v Sullivan, 376 U.S. 254 (1964)] To estab- lish actual malice, Trump was required to demonstrate by clear and convincing evidence, that O’Brien pub- lished his statements “with knowledge that [they were] false or with reckless disregard of whether [they were] false or not.”

In this context, “reckless disregard” refers to “the publishing of defamatory statements with a ‘high degree of awareness of their probable falsity.’” In fact, “the recklessness in publishing material of obviously doubtful veracity must approach the level of publishing a ‘knowing, calculated falsehood.’ Negligent publishing does not satisfy the actual-mal- ice test.”

A determination of the existence of actual mal- ice requires a subjective inquiry focusing on the defendant’s state of mind. “To find actual malice, the factfinder must determine that the defendant in fact entertained serious doubts about the truth of the statement or that defendant had a subjective aware- ness of the story’s probable falsity.” [C]ourts have recognized that an analysis of a defendant’s state of mind in a defamation action “‘does not readily lend itself to summary disposition.’”

O’Brien has certified that he re-interviewed his three confidential sources prior to publishing their

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continued

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Chapter 9 Business Torts 303

net worth estimates, and he has produced notes of his meetings with them both in 2004 and in 2005. The notes are significant, in that they provide remarkably similar estimates of Trump’s net worth, thereby suggesting the accuracy of the information conveyed.

Further, the accounts of the sources contain signif- icant amounts of additional information that O’Brien was able to verify independently.

In the book, O’Brien did not cite the sources’ views as fact, but instead utilized their lower fig- ures as an illustration of the spread in estimates of Trump’s wealth, while suggesting that, in his own view, Trump’s net worth was far less than he claimed it to be. O’Brien’s opinions in this regard were not actionable, because they were absolutely privileged. O’Brien reported Trump’s denial of the accuracy of the low net worth figures, although his statement, touting his abilities as a builder, can be construed as less of a denial than an avoidance of the issue pre- sented. Even if that denial had been absolute, which it certainly was not, publication of a statement in the face of denial, however vehement, does not constitute actual malice.

Trump relied in large measure on a 2004 State- ment of Financial Condition prepared by Weiser L.L.P., Certified Public Accountants, to which O’Brien was allegedly given access on three occa- sions including during the course of the April 21, 2005 meeting. However, a preface to that State- ment demonstrates its limited value as an accurate representation of Trump’s net worth. There, the accountants cautioned that they had “not audited or reviewed the accompanying statement of financial condition and, accordingly, do not express an opin- ion or any other form of assurance on it.” Further,

the accountants noted significant departures from generally accepted accounting principles, and stated “[t]he effects of the departures from generally accepted accounting principles as described above have not been determined.”

Defendants quote a September 9, 2004 article in The Washington Post, which stated:

“Actually, it’s hard to know exactly what percent of Trump’s net worth is tied to the casino business, because most of Trump’s portfolio is in privately held companies that don’t report earnings. He’s described himself as “a billionaire many times over,” but who knows? There are skeptics out there who believe Trump has $300 million, tops. And the guy has a reputation for, let’s say, shading the news in a light that reflects his enthusiasm.”

[W]e find no triable issue as to the existence of actual malice in this matter, and for that reason, affirm summary judgment for O’Brien. Absent actual malice on his part, respondeat superior liability [for the publisher] cannot arise. Thus we find that summary judgment was also properly granted to the publishing defendants.

Affirmed.

CaSe QUeStIONS

1. Explain why the court focuses on the fact-finding efforts of Mr. O’Brien.

2. What is the significance of others raising doubts about Mr. Trump’s net worth?

3. What lessons should writers and reporters learn from this case? Editors? Publishers?

The National Enquirer published a sup- posed interview with actor Clint Eastwood. The interview had never taken place, and Mr. Eastwood said the publication of such an interview in a sensationalist newspaper made it seem as if he was “washed up as a movie star.” Could Mr. Eastwood recover for the publication of the fake interview? What tort has occurred, if any?

THINK: Recall the elements for defama- tion: a false statement that impugns the integrity of a specific person.

APPLY: We don’t have the content of the interview, but it is false that the interview occurred, and Mr. Eastwood argues that just the suggestion that he would be inter- viewed by the National Enquirer harms his career.

ANSWER: Mr. Eastwood took the case to trial and won, precisely because no inter- view ever took place and the content and even the suggestion of him granting an in- terview were false.

Consider . . . 9.5

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9-2b Contract Interference

The tort of contract interference or tortious interference with contracts occurs when parties are not allowed the freedom to contract without interference from third parties.

A basic definition for tortious interference is that someone intentionally per- suades another to break a contract already in existence. Bryan A. Garner, the author of Tortious Interference, offers the following examples: “Say you had a contract with Joe Blow, and I for some reason tried to get you to break that contract. Or say that Pepsi has an exclusive contract with a hotel chain to carry Pepsi products, and Coke tries to get the hotel to carry Coke despite that contract. That’s tortious inter- ference.” For example, Macy’s, JCPenney, and Martha Stewart went through years of litigation based on contract interference. Macy’s had a contract for Ms. Stewart to endorse a line of home products. JCPenney then solicited Ms. Stewart for its line of home products. Ms. Stewart agreed to endorse certain products for JCPenney. Macy’s and Ms. Stewart settled their case, and the stores were left with the bat- tle over whether JCPenney had interfered with Macy’s contractual relationship with Ms. Stewart. A lower court found for Macy’s, holding that there was contrac- tual interference by JCPenney, but held that Macy’s was not entitled to punitive damages. [Macy’s v Martha Stewart Living Omnipedia, Inc., 127 A.D. 3d 48 (Sup. Court N.Y. 2015)]

Contract interference is also often a theory used when employees leave their jobs to start a company of their own that competes with their former employer. The solicitation of other employees to come join the new company can constitute the tort of contractual interference.

9-2c False Imprisonment

False imprisonment is often referred to as “the shopkeeper’s tort” because it gen- erally occurs as a result of a shoplifting accusation in a store. False imprisonment is the detention of a person for any period of time (even a few minutes) against his will. No physical harm need result; the imprisoned party can collect minimal dam- ages simply for being imprisoned without consent. Because shopkeepers need the opportunity to investigate matters when someone is suspected of shoplifting, the tort of false imprisonment does carry the defense of the shopkeeper’s privilege. This privilege allows a shopkeeper to detain a suspected shoplifter for a reason- able period of time while the matter or incident is investigated. In most states, the shopkeeper must have a reasonable basis for keeping the person—that is, the shop- keeper must have reason to suspect the individual even if it turns out later that the individual has an explanation or did not do what the shopkeeper suspected. For example, Timika Pegues entered a Walmart Store in Clinton, Maryland. Pegues’s mother had purchased a bassinet the previous day at the Wal-Mart and was meet- ing Pegues there to return it for a refund. Pegues’s mother gave her the bassinet, a credit card, and a receipt and left after completing her own shopping. However, when Pegues attempted to return the bassinet, she found that she had the wrong receipt and could not return it. She left the Walmart with the bassinet, placed it in her car, and then returned to the store to purchase items that she had placed in her shopping cart before she left.

A Walmart security guard stopped Pegues and arrested, handcuffed, and detained her on suspicion that she had shoplifted the bassinet. The police were called and, once they arrived, issued a citation to Pegues. Pegues filed suit against

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Chapter 9 Business Torts 305

Wal-Mart for false imprisonment. The case turned on whether the security guard had probable cause to detain Pegues. She may not have been guilty of shoplifting, but the shopkeeper’s privi- lege protects Wal-Mart from liability, and the security guard had a reasonable basis for believing there had been a theft and acted reasonably. [Pegues v Wal-Mart Stores, Inc., 63 F. Supp. 3d 539 (D. Md. 2014)]

9-2d Intentional Infliction of emotional distress

This tort imposes liability for conduct that goes beyond all bounds of decency and results in emotional distress in the harmed indi- vidual. One of the difficulties with this tort is that the only dam- age the plaintiff is required to prove is that of emotional distress. Although “pain and suffering” damages have been awarded for some time in negligence actions in which the plaintiff recovers damages for physical and property injuries, the awarding of dam- ages for mental distress alone is a relatively new phenomenon. However, the tort of intentional infliction of emotional distress (IIED) has been used quite often by debtors who are harassed by creditors and collection agencies in their attempts to collect funds.

The actions of bullies may rise to the level of IIED. Bullies who commit the crime of bullying can be prosecuted, but IIED is one of the theories used for civil recovery by the victim or the vic- tim’s family. For example, in some bullying cases, there have been suicides by the victims because of online posts about the victim. The outrageous conduct and posts of the bullies is one basis for family litigation against the bullies.

9-2e Invasion of privacy

The intentional tort of invasion of privacy is actually three different torts.

1. Intrusion into the Plaintiff’s Private Affairs. This tort results in liability when photographers or others stalk individuals, such as in Galella v Onassis, 353 F. Supp. 196 (S.D.N.Y. 1972). In the case, the late Mrs. Jacqueline Kennedy Onassis brought suit against Ron Galella, a photojournalist, for invasion of her privacy. As a result of the case, Mr. Galella was ordered to remain at least 50 yards from Mrs. Onassis and 100 yards from her children.

The Internet and Your Private Affairs

Use of User Information Each time you are online, it is possible that someone is gathering information about you—what you buy, what you are interested in, and even those to whom you are linked. For example, if you use an airline’s website to book your travel arrangements, that website has a profile of your travel habits. The airline knows how frequently you travel and where you travel. Other websites and retailers are willing to pay dearly for that type of targeted customer informa- tion because they know their product is being considered by those most likely to purchase it. If you use Amazon.com to buy books, that website has relevant infor- mation about the types of books you read, your interests, and even some indica- tions about your income level based on your spending habits. Even your e-mails are scanned by certain service providers for information that can be sold for tar- geted marketing. The use of the Internet to gather information about you is so

Invoking the shopkeeper’s privilege involves seven key elements:

1. Stop shoppers discreetly.

2. Don’t use physical force unless it is in response to the shopper’s physical force.

3. Don’t question shoppers publicly or make accusations within earshot of others.

4. Call the police quickly to allow them to take over.

5. If you detain shoppers, be certain the physical conditions are appropriate.

6. Don’t detain shoppers except for waiting for the police or questioning them to the matter.

7. Be especially careful in detaining mi- nors; allow them to call their parents or guardians.

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sophisticated that you could purchase a particular item on a site and find images from that store or similar products pop up as you are using the Internet for other information or purchases.

Even though this issue of privacy may seem new and peculiar to cyberspace, it is, in fact, a rather old issue. It has long been a concern of credit card companies, whose use and sale of information about their customers are restricted. Customers must be given the right to refuse such use of their names and other information for sale as part of lists for target marketing. Some state attorneys general are utilizing these credit card privacy rights to enforce privacy rights against website owners who sell information about their users. The Federal Trade Commission has begun to take positions on all Internet issues that are identical to its stances on other types of commerce issues. For example, if catalog companies are required to provide notice to customers about delays in shipment of goods to customers, Internet com- panies must comply with the same notification rules. 2. Public Disclosure of Private Facts. This tort occurs when a company makes

information about an employee public. The information may be true, but the tort is the invasion of another’s privacy by disclosing facts the public has no reason to know.

The Internet and Private Facts The Internet has resulted in an expansion of the privacy tort. For example, disclosing online the medical records that indicate that a CEO was treated for meth addiction is an invasion of privacy. If a hospital employee takes a picture of a patient’s tattoo and posts it on Facebook, there is also an invasion of privacy. The information disclosed is not defamation because it is true, but it may well be the tort of invasion of privacy.

The Internet, Employees, Employers, and Privacy There are more details on employer monitoring of employee e-mails, Internet use, and servers in Chapters 8 and 19, but there are now some statutory protections that provide employees with spe-

cific privacy rights related to employers’ use of the Internet when doing background checks, particularly with regard to consent of applicants for views of their social media accounts.

The Statutory Protections of Privacy Public disclosure protections are now a statutory issue because of evolving technologies such as e-mail and Internet access. Computer-stored information also carries ease of access. But ease of access does not mean that pri- vacy rights are lost. Statutes now control use of and rights related to computer-stored information. One such statute is the Health Insurance Portability and Accountability Act of 1996 (HIPAA) (42 U.S.C. §§ 1320d-1320d-8). HIPAA controls how medical informa- tion is collected, used, and conveyed. For example, doctors must be careful that computer screens of their office personnel are not visible by other patients. HIPAA has resulted in the complex paperwork we sign when we receive medical care that discloses our rights to access our records. It also led to the marking lines at pharmacies behind which we must stand so that we cannot over- hear the pharmacy worker’s discussions with other customers.

HIPAA has made privacy front and center and introduced some new complexity. One patient services director explained HIPAA’s impact as follows: “In the old days, a social worker could pick up

There has been a recent string of lawsuits in which those applicants who have not been hired have sought recovery from employers who found personal information about them on Facebook, YouTube, and other social networking sites. In some cases, their friends have posted unflattering photos or information about them that resulted in the employers not offering them a job. The courts have held consistently that information posted on the Web is not part of your private affairs and denied recovery. Professor Harold Abelson has explained your rights, privacy, and the Internet as follows: “In today’s online world, what your mother told you is true, only more so: Peo- ple can really judge you by your friends.”2

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the phone and ask Meals on Wheels to deliver lunch to Mrs. Jones five days a week. Under the federal rules, we’ll now have to get a release from Mrs. Jones so we can tell Meals on Wheels that, as a diabetic with cardiac problems, she has special dietary needs.”3

3. Appropriation of Another’s Name, Likeness, or Image for Commercial Advantage. This final form of the privacy tort involves using someone’s name, likeness, or voice for commercial advantage without his or her permis- sion constitutes the tort of unauthorized appropriation. For example, if a gas station used your picture in its window to show you as a satisfied customer, you might not be harmed greatly, but your privacy is invaded because you have the right to decide when, how, and where your name, face, image, or voice will be used. Bullard v MRA Holding, LLC (Case 9.2) deals with an issue of appropriation of a young girl’s image.

Bullard v MRA Holding, LLC, 740 S.E.2d 622 (Ga. 2013)

Overexposed and Commercialized at Age 14

Case 9.2

FaCtS

In the spring of 2000, 14-year-old Lindsay Bullard exposed her breasts to two unknown men in a parking lot in Panama City, Florida. Bullard was aware that the men were videotaping her at the time and raised no objection to being videotaped. The two men and Bull- ard had no discussion about what future use the men might make of the videotape.

MRA Holding LLC obtained the recording and included it in its College Girls Gone Wild video series. MRA also used a still photo of Bullard that was taken from the video clip and placed it in a prominent position on the cover of the video box for the College Girls Gone Wild video that it later marketed and sold nationwide. On that image, MRA blocked out Bullard’s breasts and superimposed an inscription “Get Educated!” in that block. The inscription arguably gave the appearance that Bull- ard was making this statement. MRA did not obtain Bullard’s permission to use the video footage of her in the College Girls Gone Wild video or to use her photo on the video box cover. Television and Inter- net advertisements were aired that incorporated Bullard’s image

Bullard sued MRA for, among other things, appro- priation of her likeness. MRA moved for summary judgment.

JUdICIaL OpINION

MELTON, Justice Here, Bullard is a private citizen whose image was arguably used without her consent to endorse an MRA product for MRA’s own commercial gain. Pre- termitting the question whether Bullard, as a four- teen-year-old, could even legally consent to having her image used to endorse an MRA product for MRA’s commercial gain (and we specifically decline to reach that issue here), the facts as found by the District Court show that it was not possible for Bul- lard to have given MRA consent to use her image to endorse the College Girls Gone Wild video involved here. The men to whom Bullard exposed her breasts never indicated to Bullard that they worked for, had any connection with, or had any intention of giving Bullard’s image to MRA for the purpose of selling College Girls Gone Wild videos. Nor did Bullard have any contact with MRA to give MRA permis- sion to use her image for that purpose. In short, any “consent” that Bullard may have given by exposing herself to the two individuals who videotaped her does not amount to consent for those individuals or an unidentified third party (MRA) to use her image to endorse a product for their own commercial gain. In this regard, as found by the District Court, MRA placed the words “Get Educated!” on the cover of the

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College Girls Gone Wild video in a manner that made it appear as though Bullard may have been making this statement. This could serve as an “endorsement” of the College Girls Gone Wild video by Bullard without her consent, as the viewer of the video cover is ostensibly being invited to “Get Educated!” about the contents of the video (and Bullard’s exposed breasts) by purchas- ing the video at Bullard’s request. Accordingly, Bullard states a claim for MRA’s appropriation of her image without her consent and for its own commercial gain.

Again, here, MRA’s use of Bullard’s image on the cover of the College Girls Gone Wild video with an inscription that arguably indicated that Bullard was encouraging others to “Get Educated!” by purchasing

it would suggest that MRA was using the image “as a part of an advertisement, for the purpose of exploiting [MRA’s] business.” Accordingly, MRA could be subject to liability for its actions.

We find that, under the facts as found by the Dis- trict Court, Bullard states a claim for appropriation of likeness under Georgia law.

CaSe QUeStIONS

1. What was Bullard’s image being used to endorse?

2. Why is her consent to be videotaped not a defense for MRA?

Catherine Balsley (known in the reporting business as “Catherine Bosley”) worked as a television news reporter for WKBN, Channel 27, the CBS television affiliate in Youngstown, Ohio. She worked for WKBN as a news anchor for approximately 10 years, making her a regional celebrity.

In March 2003, while she was on va- cation, Ms. Bosley and her husband went to a Florida nightclub where there was a “wet t-shirt” contest. Ms. Bosley partici- pated with great verve in the contest and removed her clothing. Without either Ms. Bosley’s notice or consent, Dream Girls Inc.

videotaped Ms. Bosley’s actions that night and released them on videos and DVDs. Dream Girls is a video production company for Girls Gone Wild.

Since the incident, images of Ms. Bos- ley have been displayed on the Internet through a series of websites, advertising pictures, and videos of the “naked anchor woman.” Ms. Bosley filed suit against Dream Girls for invasion of privacy. Dream Girls has responded that it filmed Ms. Bos- ley in a public place. What should the court do with the case? [Bosley v Wildwett.com, 310 F. Supp. 2d 914 (N.D. Ohio 2004)]

Consider . . . 9.6

9-3 Negligence The tort of negligence is one that applies in a variety of circumstances, but it is always used when the conduct of one party did not live up to a certain minimal standard of care we are all expected to use in driving, in our work, and in the care of our property. Negligence imposes liability on us when we are careless. The ele- ments of and defenses to negligence are covered next.

9-3a element One: the duty

Each of us has the duty to act like an ordinary and reasonably prudent person in all circumstances. We do not always live up to the standard of the ordinary and reasonably prudent person; when we do not, we are negligent. The standard of the ordinary and reasonably prudent person is not always what everyone else does or what the law provides. For example, suppose you are driving on a curvy highway late at night and it is raining quite heavily. The posted speed limit is

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profiting from amateurs

The NCAA rules are quite simple: A colle- giate athlete loses his or her “amateur” status if (1) the athlete “[u]ses his or her athletics skill (directly or indirectly) for pay in any form in that sport,” or (2) the athlete “[a] ccepts any remuneration or permits the use of his or her name or picture to advertise, recommend or promote directly the sale or use of a commercial product or service of any kind.” In fact, if the student-athlete knows that his or her name or image is being used for commercial purposes, the student-athlete or the school must take steps to stop the use.

However, the NCAA’s use of college ath- letes’ likenesses is quite complex. Through its licensing arm, Collegiate Licensing Co., the NCAA licenses the use of school and team names, uniforms, and all things relat- ed to college sports. Electronic Arts Inc., with permission from and rights payment to Collegiate Licensing, created the NCAA Football video game. In the game, the video quarterback has all the markings of being Rutgers University’s famed quarterback Ryan Hart: same color hair, shirt number, same Scarlet Knights colors, same height, same weight, and even the same helmet visor and wristband on the left wrist. Players even referred to the quarterback as “Hart.” However, no one had ever paid Mr. Ryan for the use of his image or likeness. In fact, no

one had ever asked Mr. Ryan if his image and likeness could be used in the video game. The NCAA simply licensed the rights away to Electronic Arts. Mr. Hart and other former collegiate players whose likenesses had been used filed suit for appropriation of their images. Initially, the suit was dis- missed, but a federal appeals court held that it could go forward because there was appropriation.

The issue centers on the rights of these college athletes when their likenesses con- tinue to be licensed and used after they are no longer student-athletes. For example, Mr. Hart’s image was used in 2004–2006 versions of NCAA Football, and his college football career ran from 2002–2005. The licensing agreement goes on even after his collegiate career is finished and he could collect payments for use of his image.

Strategically, the NCAA will need to reexamine its licensing arrangements to limit them to the time of the student-athletes’ collegiate careers or limit the use of team colors and names and prohibit individual like- nesses in the video games and depictions. The key to avoiding appropriation suits is permission from those whose images are used, not from those authorized to license organizational names and symbols. [Hart v Electronic Arts, Inc., 717 F.3d 141 (3rd Cir. 2013)]

Business Strategy

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45 mph. However, the ordinary and reasonably prudent person will not drive 45 mph because the road and the weather conditions dictate that slower driving is more appropriate. The level of care imposed on us by the ordinary and reasonably prudent person standard is one that requires an examination of all conditions and circumstances surrounding an event that leads to an injury. Many negligence cases struggle with the difficult task of determining whether a duty exists.

Duties, for purposes of negligence actions, can arise because of an underlying statute. Every traffic law carries a criminal penalty (fine and/or imprisonment) for violations of it. However, that law imposes a duty of obedience. A violation of that law is also a breach of duty for purposes of a civil or negligence action. When you run a red light, you have not only committed a crime; you have also breached a duty and are liable for injuries and damages resulting from that breach.

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Professionals such as doctors, lawyers, and dentists have the duty of practic- ing their professions at the level of a reasonable professional. Failure to do so is a breach of duty and a basis for malpractice (negligence by professionals) lawsuits.

Landowners owe duties to people who enter their property. For example, the duty to trespassers, such as thieves, is not to intentionally injure them. Placing mantraps would be a breach of this duty.

There are also the duties we owe one another as fellow journeymen in society. However, those duties that are not defined by statute are becoming more difficult to define and impose. Courts deal with a difficult balance as they define duty, and what constitutes negligence is fulfilling those duties. Only a few states impose a duty to stop and help, but all states provide some form of immunity for those who stop to help but make mistakes in offering their assistance. Van Horn v Wat- son (Case 9.3) deals with these complex issues of duty.

Van Horn v Watson 197 P.3d 164 (Cal. 2008)

Tugging on the Injured while Loaded

Case 9.3

FaCtS

On October 31, 2004, Alexandra Van Horn (plaintiff), Jonelle Freed, and Lisa Torti smoked and inhaled mar- ijuana together at Ms. Torti’s home. They were joined there by Anthony Glen Watson and Dion Ofoegbu, who also joined in on the marijuana. At 10:00 p.m., they all headed to a local bar where they drank until 1:30 a.m. At 1:30 a.m., Ms. Van Horn and Ms. Freed left with Mr. Watson, leaving Ms. Torti to ride with Mr. Ofoegbu. Mr. Watson struck a curb and then a light pole whilst going 45 mph. After Mr. Watson crashed, both Mr. Ofoegbu and Ms. Torti stopped and got out of their car to render aid. Mr. Watson got out of the car by himself, Mr. Ofoegbu helped Ms. Freed out by opening a door for her, and Ms. Torti pulled Ms. Van Horn from the car. Ms. Van Horn said Ms. Torti pulled on her arm and dragged her from the car like a “rag doll.”

Ms. Torti testified that the crashed car was smoking and that she felt she should save Ms. Van Horn before flames ensued. Emergency personnel arrived moments later. Ms. Van Horn had a lacerated liver and damaged vertebrae that rendered her paraplegic. Ms. Van Horn filed suit claiming that Ms. Torti’s pulling her from the wreck contributed to her paralysis. Ms. Van Horn also filed suit against all the other party animals riding in the two vehicles for their negligence. Ms. Torti claimed immunity under California’s Good Samaritan statute.

Ms. Van Horn alleged that Ms. Torti was negligent in pulling her from the car and not waiting for trained

personnel. There were differing accounts on whether the car was smoking and whether there were flames. In other words, the danger to Van Horn was not clear. In fact, given the evening’s activities, not one of them was operating in anything less than a fog at the time of the accident.

The trial court granted summary judgment for Ms. Torti on the grounds that she enjoyed immunity from suit for negligence under the California Good Samari- tan law. The Court of Appeal reversed, holding that the Good Samaritan law applied only to those rendering medical care, and that Torti had not provided medical care. Ms. Torti and the others appealed.

JUdICIaL OpINION

MORENO, Justice Section 1799.102 provides, “No person who in good faith, and not for compensation, renders emergency care at the scene of an emergency shall be liable for any civil damages resulting from any act or omission. The scene of an emergency shall not include emergency departments and other places where medical care is usually offered.” The parties identify two possible con- structions of this provision: Torti urges us to conclude that it broadly applies to both nonmedical and medical care rendered at the scene of any emergency; plaintiff, on the other hand, argues that section 1799.102 applies only to the rendering of emergency medical care at the scene of a medical emergency.

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Although the phrase “emergency care” is not sep- arately defined, section 1797.70’s definition of “emer- gency” certainly supports the conclusion that the Leg- islature intended for “emergency care” to be construed as meaning emergency medical care. After all, if the “scene of an emergency” (§ 1799.102) means a scene where “an individual has a need for immediate med- ical attention” (§ 1797.70), it logically follows that the Legislature intended for the phrase “emergency care” in section 1799.102 to refer to the medical attention given to the individual who needs it.

This construction also comports with the second sentence of section 1799.102, which reads: “The scene of an emergency shall not include emergency depart- ments and other places where medical care is usually offered.” While this sentence does not directly shed light on the intended meaning of the phrase “emergency care” in the previous sentence of section 1799.102, the fact that the Legislature excluded “emergency depart- ments and other places where medical care is usually offered” from section 1799.102’s immunity supports construing “emergency care” as meaning emergency medical care—the exclusion suggests that “emergency departments and other places where medical care is usually offered” are locations where the Legislature did not need (or want) to encourage ordinary citizens to provide emergency medical care because trained medical personnel are available to better render such care.

Torti’s expansive interpretation of section 1799.102 would undermine long-standing common law princi- ples. As we previously noted, the general rule is that “one has no duty to come to the aid of another.” “The origin of the rule lay in the early common law distinc- tion between action and inaction, or ‘misfeasance’ and ‘non-feasance.’” (Rest.2d Torts, § 314, com. c, p. 116.) Courts were more concerned with affirmative acts of misbehavior than they were with an individual “who merely did nothing, even though another might suffer serious harm because of his omission to act.”

While there is no general duty to help, a good Samaritan who nonetheless “undertakes to come to the aid of another . . . is under a duty to exercise due care in performance . . .” “‘[i]t is ancient learning that one who assumes to act, even though gratuitously, may

thereby become subject to a duty of acting carefully, if he acts at all.’”

The broad construction urged by Torti—that sec- tion 1799.102 immunizes any person who provides any emergency care at the scene of any emergency— would largely gut this well-established common law rule. As we recently noted, “‘[w]e do not presume that the Legislature intends, when it enacts a statute, to over- throw long-established principles of law unless such intention is clearly expressed or necessarily implied.’” Torti does not identify anything that would overcome the presumption that the Legislature did not intend to work such a radical departure.

As the Court of Appeal points out, Torti’s sweeping construction of section 1799.102 would render other “Good Samaritan” statutes superfluous. For example, Government Code section 50086 immunizes anyone with first aid training who is asked by authorities to assist in a search and rescue operation and who renders emergency services to a victim. The statute defines “emergency services” to include “first aid and medi- cal services, rescue procedures, and transportation or other related activities.” It is difficult to see what con- duct Government Code section 50086 immunizes that would not already be protected under section 1799.102 as it is interpreted by Torti.

In light of the foregoing reasons, we conclude that the Legislature intended for section 1799.102 to immu- nize from liability for civil damages only those persons who in good faith render emergency medical care at the scene of a medical emergency.

Affirmed.

CaSe QUeStIONS

1. What is the relationship between statutory immu- nity and common law duty here?

2. Would it have been better for Ms. Torti to argue that she was providing medical treatment and have the court deal with the issue of what con- stitutes medical care rather than the issue of immunity?

3. What are the implications of this decision for peo- ple who are trying to offer assistance at the scene of an accident?

9-3b element two: Breach of duty

Once the standard of care and the duty are established under element one, there must be a determination that the defendant fell short of that standard or breached that duty for the plaintiff to recover on the basis of negligence. For example, an accountant owes a duty to his client to perform an audit in a competent and pro- fessional manner and to conform the audit to the standards and rules established

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by the American Institute of Certified Public Accounts (AICPA). Failure to comply with these standards would be a breach of duty and would satisfy this second ele- ment of negligence.

In many cases, courts try to determine whether the duty was breached to deter- mine whether the defendant’s action satisfied the standard of care established in element one.

Chaney v. Starbucks Corporation (Case 9.4) focuses on the issues of safety and the liability of businesses and property owners for injuries that occur on their premises and provides the answer for the chapter’s opening consider.

Chaney v Starbucks Corporation 115 F. Supp. 3d 380 (S.D.N.Y. 2015)

Tripped Up at Starbucks

Case 9.4

FaCtS

On August 9, 2013, John Chaney (plaintiff) went to a Starbucks café in the Bronx for lunch. He worked near- by and visited this particular Starbucks location about two or three times per week. As Chaney entered, he noticed that a customer in the seating area had plugged a white electrical charger into the wall. The charger consisted of a cord attached to a small, white square that lay flat upon the café’s orange tile floor. Chaney did not mention the charger to the customer, nor did he report it to any Starbucks employee.

Chaney walked past the seating area and proceed- ed to the counter, where he ordered lunch (an egg salad sandwich and an Americano beverage). He brought his lunch over to a table to eat, and testified that he did not have to step over the cord in the process of seat- ing himself. The cord remained by the wall, situated about 12 to 14 inches away from his table. After about 20 minutes, Chaney finished eating and got up from his table. As he made his way toward the exit, he stepped on the white square attached to the cord, causing him to lose his balance and fall. At his deposition, Chaney was unable to explain why, having earlier seen the white square, he had not stepped over it or otherwise avoided it. Chaney remained on the floor for about three minutes, after which another customer, Nicole Suozo, asked him if he was “okay.” Chaney responded that he was, and then went to the bathroom to “get [himself] together.”

Upon returning, Chaney approached the counter and told two baristas, including Camille Williams,

about the incident. They offered him a cup of coffee, which he declined. After waiting about five to 10 min- utes, he left. He did not complete any paperwork or tell any Starbucks representative, apart from the two baris- tas, about the incident. Chaney testified that he took a photo of the charger after the incident, that he stored on his computer. However, this photo is not part of the record, and at argument, Chaney’s counsel stated that he does not know whether it still exists.

Chaney then drove to Shire Realty, where he worked as a personal assistant. A coworker took him to the emergency room at the New York–Presbyte- rian Hospital, where he underwent a precautionary MRI exam. He was immediately discharged, but he returned to the emergency room three days later when he experienced more pain. The doctor prescribed him Naproxen, a pain relief medication, but did not recom- mend further treatment.

Six months later, Chaney brought suit against Starbucks, claiming that Starbucks had failed to safely maintain the seating area in its café. Chaney claims that, as a result of the fall, he sustained back, neck, and head injuries, including herniated discs, multiple forms of traumatic brain injury, severe migraines, headaches, dizziness, and neck pain. He claims that he has sought medical attention from the New York– Presbyterian Hospital, Lenox Hill Radiology, and Max- imum Orthopaedics and Sports Medicine and that he was confined to his home for a week after the incident. Chaney seeks special damages of $100,000, including for future medical care.

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Following discovery, Starbucks moved for sum- mary judgment, arguing that the material facts were undisputed, that it had no legal duty to Chaney with respect to the charger because the charger was open and obvious, and that there was nothing inherently dangerous in the plug use.

Starbucks deposed only Chaney. Chaney deposed only Williams, who testified that she did not recall the incident or whether she had worked on the day in question.

JUdICIaL OpINION

ENGELMAYER, Judge To prevail on a negligence claim, the plaintiff must establish “(1) a duty owed by the defendant to the plaintiff, (2) a breach thereof, and (3) injury proximately resulting therefrom.” Only the first element, the exis- tence of a legal duty, is in dispute on this summary judgment motion.

Generally, under New York law, “landowners owe people on their property a duty of reasonable care under the circumstances to maintain their property in a safe condition.” However, “a landowner has no duty to protect or warn against an open and obvious condition which, as a matter of law, is not inherently dangerous.” In such cases, the condition “cannot fairly be attributed to any negligent maintenance of the property” on the landowner’s part. On Starbucks’s motion for summary judgment directed to the existence of a duty, the Court therefore focuses on two questions: Whether the condi- tion that Chaney now complains of was (1) open and obvious, and (2) not inherently dangerous.

As to the first question, “open and obvious is gen- erally fact-specific and thus usually a jury question, [but] a court may determine that a [condition] was open and obvious as a matter of law when the estab- lished facts compel that conclusion, and may do so on the basis of clear and undisputed evidence.”

As to the second question, the “inherently dan- gerous” inquiry is also often a jury question, which “depends on the totality of the specific facts of each case.” However, the landowner may establish a prima facie entitlement to judgment as a matter of law where the evidence shows that the condition was “not inher- ently dangerous.” If, in response, the plaintiff fails to raise “triable issues of fact as to whether the [condition] was inherently dangerous,” the Court may resolve this issue as a matter of law.

In assessing inherent dangerousness, the Court may consider factors including the inherent nature of the condition at issue, evidence of prior accidents, whether there is a statutory violation, the frequency of inspections, photographs depicting the condition, and

expert testimony. Where a landowner fails to establish that the condition was “not inherently dangerous,” summary judgment is to be denied, and the case is to proceed to trial, even if the condition is found open and obvious, because “the open and obvious nature of the condition is relevant [only] to the issue of the plaintiff’s comparative negligence.”

Chaney himself had admitted seeing the charger’s white square upon entering the Starbucks café. Further, at argument, Chaney’s counsel conceded that the white charger was indeed “open and obvious.”

In any event, even putting aside counsel’s conces- sion, the evidence uniformly supports that the relevant condition, the white charger square offset against the store’s orange-colored floor, was “open and obvious.” Virtually any patron in Chaney’s position would have readily noticed the charger by “making reasonable use of his senses,” as there was a stark color contrast between the white charger and the orange tile floor was “open and obvious” based on its “contrast to the color of the pavement to which it was affixed.

The Court therefore finds the condition here to have been open and obvious.

As to the second prong of the duty analysis, a court may determine whether a condition was “inherently dangerous” as a matter of law when the evidence com- pels a single conclusion.

The evidence on which Starbucks, the moving party, relies is undisputed: Indeed, it comes from the testimony of Chaney, the only one of the two witnesses to be deposed who recalled the incident. Chaney testi- fied that the white charger square on which he stepped visibly contrasted with the orange tile floor, that he was aware of it upon entering the property, and that he was able to avoid stepping on it when he entered the seating area. And, although the parties’ minimalist approach to discovery—including declining to gen- erate a record of the floor plan of the store, has left regrettably unrecorded the offending charger’s precise placement in the Johnson Avenue Starbucks, Chaney’s testimony establishes that the charger was not in a walkway, or in front of a service counter, or any other place where a customer might expect the floor to be unobstructed. Rather, Chaney testified, the charger was close to or alongside the wall in the customer seating area, an area where customers, seated at tables, may plug in such devices.

The charger was thus in a position on the floor where a customer would reasonably expect to come across a charger, a point that Chaney himself acknowl- edged. Such chargers today are in fact ubiquitous in public places in this country, including in cafés, eater- ies, and other informal establishments like Starbucks

continued

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duty and Criminal activity Landowners are not liable for harm that comes from criminal activity on their property unless they were on notice of criminal activity, that is, there have been previous incidents of harm or they fail to take reasonable precautions, such as ade- quate lighting, security, or safety precautions.

9-3c element three: Causation

After establishing a duty and breach of duty, the plaintiff in a negligence suit must also establish that the breach of the duty was the cause of the damages. A test often used to determine causation is the “but for” test—“but for the action or

that by design invite customers to sit and work on laptops or handheld devices while they drink, eat, or converse. The Court can fairly take judicial notice of this phenomenon. A customer in the seating area of such an establishment would have every reason to expect charger cords belonging to other customers to be in use, and potentially to rest on the floor. For that matter, such a customer would reasonably expect to find, on the floor of the seating area, any number of small personal items (e.g., purses, knapsacks, shopping bags, briefcases, food wrappers, coffee cups, etc.) that another customer may have carried in or bought at the café itself. And, as Chaney further acknowledged, he was not required to step in the charger’s path to exit the Starbucks location at issue; an alternative path around the charger was available.

To permit a jury to find that the charger was inher- ently dangerous under these spare and unremarkable circumstances—where the charger was conspicuous against the store’s orange floor, and where no evidence of dangerousness has been elicited beyond the fact that the charger rested on a floor where it could potentially be stepped upon—would effectively permit a finding of inherent dangerousness as to virtually any readily visible item of personal property, food, or litter that a

customer may have placed on the floor in the seating area of a café and on which a person could potentially trip. The Court declines to so find.

Finally, at argument, Chaney faulted Starbucks for its anemic efforts to develop the factual record. It is fair to say that neither party here was energetic in discov- ery. The Court would have particularly benefited from a clearer understanding of the layout of the Starbucks café at issue, where precisely Chaney sat, and where the charger was situated immediately before Chaney fell. Either party could have elicited this testimo- ny from Chaney. The Court also was struck by the absence of any discovery as to whether any accidents similar to Chaney’s have ever occurred at the Johnson Avenue site.

For the foregoing reasons, the Court grants Star- bucks’s summary judgment motion.

CaSe QUeStIONS

1. Explain what evidence could have helped the court with its decision.

2. What should managers learn about how to respond to customer accidents based on this case?

3. Why is Starbucks given a summary judgment?

Pearl Glassberg was shopping at a Staples office store in Brooklyn. Another customer was buying a chair that was resting next to the cashier’s counter on a flatbed dol- ly so that the chair could be taken to the customer’s car. There was limited space between the dolly and the cashiers’ areas. The chair customer disputed the price, and the cashier left that station to check on the price. Ms. Glassberg stepped

forward to purchase her items, which took less than one minute. When she turned to leave, she tripped over the flat dolly and broke her elbow. Ms. Glassberg filed suit against Staples for its creation of an unrea- sonably dangerous situation for custom- ers. Explain what the court should do with the case. [Glassberg v Staples the Office Superstore East, Inc., 2010 WL 3924682 (E.D. N.Y. 2010)]

Consider . . . 9.7

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lack of action of the defendant, the plaintiff would not have been injured.” For example, suppose that a guest is enjoying a scenic view of the ocean from a cliff near his hotel. At the edge of the cliff, the hotel had installed a fence, but the hotel does not keep it in good repair. When the guest leans against the fence to take a pic- ture, the fence breaks, and the guest falls over the cliff. The hotel breached its duty to keep its premises in reasonably safe condition, and its failure to do so caused the guest’s injury. The “but for” test is limited by the so-called zone of danger rule, which requires that the plaintiff be in the zone of danger when the injury occurs. The zone of danger includes all those people who could foreseeably be injured if a duty is breached. For example, the hotel would also be liable to those injured by the guest as he fell through the weak fence because they are in the zone of danger.

9-3d element Four: proximate Cause

Some cutoff line must be drawn between the “but for” causation and events that contribute to the injury of the plain- tiff—an element of a negligence case called proximate cause. Suppose that you have a tire replaced at a tire store and the technician fails to tighten the wheel sufficiently. As you drive down the street, the tire comes loose, rolls off, and strikes another car. Did the tire store cause the damage to the other car? Yes. Any accidents caused by that car? Yes. Suppose the tire comes off, rolls onto the sidewalk, and strikes a pedes- trian. Did the tire store cause that injury? Yes. Suppose the pedestrian sees the tire coming and jumps out of the way but, in so doing, injures another pedestrian. Did the tire store cause that injury? Yes. In all of these accidents, the following state- ment can be made: “But for the failure to tighten the wheel, the accident would not have occurred.” Suppose that the tire injures a pedestrian, although not fatally, but a doctor treat- ing the pedestrian, through malpractice, causes the pedestrian’s death. Did the tire store cause the death? No; another’s negligence intervened.

All businesses should help create a safe environment for their customers and discourage criminal acts by providing the following:

1. Good lighting

2. Access to public phones or call boxes

3. Security patrols

4. Locked gates to parking lots; gate or security access

5. Escorts for customers and employ- ees to their vehicles after closing hours

6. Camera security

7. Assigned parking spaces for tenants and employees

8. Warning signs to use caution and be alert

9. Policies for monitoring the premises— when, by whom, and how often.

Many hotels change key access codes with each guest and post security personnel near guest elevators at night in order to limit access to the elevators unless you can show your room key. Some hotels have floors for women who are traveling alone, and extra security is provided on those floors.

Re: Bars and dram Shop Liability For the Manager’s Desk

David Huffman had a blood alcohol level that was three times the legal limit when he slammed the car of Meredith and Mary Eastridge at a speed over 100 mph. The Eas- tridges were critically wounded, and Mrs.

Eastridge lost their unborn son. The two spent over one month in the hospital.

Mr. Huffman, who was killed in the acci- dent, had been served 10 drinks over a two- hour-and 10-minute time frame at Eddie’s

(Continued)

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316 part 2 Business: Its Regulatory Environment

Case 9.5, Palsgraf v Long Island Ry. Co., is a landmark case on the element of proximate cause.

(Continued) Place, a bar and restaurant located in South Charlotte, North Carolina.

The Eastridges filed suit under North Carolina’s dram shop act, a type of law that allows victims of accidents caused by drunk drivers to recover from bars and restaurants that serve alcohol to obviously intoxicated or underage people. The jury awarded the Eastridges $1.7 million. Many states have anti-dram shop laws, laws that prevent recovery from bar owners and other busi- nesses that serve alcoholic beverages to those who later, while driving under the influence, injure third parties. For example, Louisiana’s anti-dram shop act provides:

No person . . . nor any agent, servant, or employee of such person who sells or serves intoxicating beverages . . . to a per- son over the age of the lawful purchase thereof, shall be liable to such person or to any other person . . . for any injury suf- fered off the premises, including wrongful death and property damage, because of the intoxication of the person to whom the intoxicating beverages were sold or served. [La. Rev. Stat. § 9:2800]

Dram shop laws vary by state, but North Carolina’s statute imposes liability when a bar or restaurant serves someone who is obvious- ly intoxicated when they know that the patron

is driving. In this case, employees of Eddie’s arranged for Huffman to get a ride home with another customer who lived in Huffman’s apartment complex. However, it was after he got home that Huffman got into his own car and drove anyway. The Eastridge case pre- sented an interesting legal issue because the lawyers for Eddie’s Place argued that the dram shop law in North Carolina does not impose liability for allowing someone who is legally intoxicated to leave the bar; liability results only when they allow someone to leave who they have reason to believe is going to drive. Given the arrangements for transportation the bar employees made, their lawyer argued that they did everything that they could. Eddie’s Place has been in business for 15 years and never had a problem with any accidents or conduct by its patrons.

The dram shop acts also do not require proof of legal intoxication, the blood-alcohol content used for criminal prosecution for DWI or DUI cases. The dram shop statutes only require proof of visible intoxication.

Other states impose liability even on servers in restaurants who serve the visibly intoxicated. In other states, limits are placed on the extent of the liability of the bars and restaurants.

Source: Larry Copeland, “N.C. Crash Spotlights Dram Shop Laws,” USA Today, November 29, 2012, p. 3A.

Ethical Issues

Is there an ethical obligation on the part of bar owners to prevent intoxicated patrons from leaving their bars? Sup- pose, for example, that the intoxicated patron does not have a car and will not be driving home. Does the bar owner

have any responsibilities regarding this type of patron? What if the bar owner entrusts the non-driving, intoxicated patron to another bar patron? Are there any legal and ethical issues with that approach?

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Chapter 9 Business Torts 317

Palsgraf v Long Island Ry. Co. 162 N.E. 99 (N.Y. 1928)

Fireworks in the Passenger’s Package and Negligence in the Air

Case 9.5

FaCtS

Helen Palsgraf (plaintiff) had purchased a ticket to travel to Rockaway Beach on the Long Island Railway (defendant). While she was standing on a platform at the defendant’s station waiting for the train, another train stopped at the station. Two men ran to catch the train, which began moving as they were running. One of the men made it onto the train without difficulty, but the other man, who was carrying a package, was unsteady as he tried to jump aboard. Employees of the defendant helped pull the man in and push him onto the train car, but in the process the package was dropped. The package contained fireworks, and when dropped, it exploded. The vibrations from the explosion caused some scales (located at the end of the platform on which Ms. Palsgraf was standing) to fall. As they fell, they hit and injured Ms. Palsgraf. She filed suit against the railroad for negligence.

JUdICIaL OpINION

CARDOZO, Chief Justice Negligence is not actionable unless it involves the invasion of a legally protected interest, the violation of a right. “Proof of negligence in the air, so to speak, will not do.” The plaintiff, as she stood upon the plat- form of the station, might claim to be protected against intentional invasion of her bodily security. Such inva- sion is not charged. She might claim to be protected against unintentional invasion by conduct involving in the thought of reasonable men an unreasonable hazard that such invasion would ensue. These, from the point of view of the law, were the bounds of her immunity, with perhaps some rare exceptions, survivals for the most part of ancient forms of liability, where conduct is held to be at the peril of the actor. If no hazard was apparent to the eye of ordinary vigilance, an act inno- cent and harmless, at least to outward seeming, with reference to her, did not take to itself the quality of a tort because it happened to be a wrong, though appar- ently not one involving the risk of bodily insecurity, with reference to someone else.

A different conclusion will involve us, and swiftly too, in a maze of contradictions. A guard stumbles over a package which has been left upon a platform.

It seems to be a bundle of newspapers. It turns out to be a can of dynamite. To the eye of ordinary vigilance, the bundle is abandoned waste, which may be kicked or trod on with impunity. Is a passenger at the other end of the platform protected by the law against the unsuspected hazard concealed beneath the waste? If not, is the result to be any different, so far as the distant passenger is concerned, when the guard stumbles over a valise which a truckman or a porter has left upon the walk? The passenger far away, if the victim of a wrong at all, has a cause of action, not derivative, but original and primary. His claim to be protected against invasion of his bodily security is neither greater nor less because the act resulting in the invasion is a wrong to another far removed. In this case, the rights that are said to have been violated, the interests said to have been invaded, are not even of the same order. The man was not injured in his person or even put in danger. The purpose of the act, as well as its effect, was to make his person safe. If there was a wrong to him at all, which may very well be doubted, it was a wrong to a property interest only, the safety of his package. Out of this wrong to proper- ty, which threatened injury to nothing else, there has passed, we are told, to the plaintiff by derivation or succession a right of action for the invasion of an inter- est of another order, the right to bodily security. The diversity of interests emphasizes the futility of the effort to build the plaintiff’s right upon the basis of a wrong to someone else. The gain is one of emphasis, for a like result would follow if the interests were the same. Even then, the orbit of the danger as disclosed to the eye of reasonable vigilance would be the orbit of the duty. One who jostles one’s neighbor in a crowd does not invade the rights of others standing at the outer fringe when the unintended contact casts a bomb upon the ground. The wrongdoer as to them is the man who carries the bomb, not the one who explodes it without suspicion of the danger. Life will have to be made over, and human nature transformed, before prevision so extravagant can be accepted as the norm of conduct, the customary standard to which behavior must conform.

Here, by concession, there was nothing in the sit- uation to suggest to the most cautious mind that the parcel wrapped in newspaper would spread wreckage through the station. If the guard had thrown it down

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318 part 2 Business: Its Regulatory Environment

knowingly and willfully, he would not have threatened the plaintiff’s safety, so far as appearances could warn him. His conduct would not have involved, even then, an unreasonable probability of invasion of her bodily security. Liability can be no greater where the act is inadvertent.

dISSeNtING OpINION

ANDREWS, Justice Assisting a passenger to board a train, the defendant’s servant negligently knocked a package from his arms. It fell between the platform and the cars. Of its contents the servant knew and could know nothing. A violent explosion followed. The concussion broke some scales standing a considerable distance away. In falling, they injured the plaintiff, an intending passenger.

Upon these facts, may she recover the damages she has suffered in an action brought against the master? The result we shall reach depends upon our theory as to the nature of negligence. Is it a relative concept—the breach of some duty owing to a particular person or to particular persons?

Or, where there is an act which unreasonably threatens the safety of others, is the doer liable for all its proximate consequences, even where they result in injury to one who would generally be thought to be outside the radius of danger? This is not a mere dispute as to words. We might not believe that to the average mind the dropping of the bundle would seem to involve the probability of harm to the plaintiff stand- ing many feet away whatever might be the case as to the owner or to one so near as to be likely to be struck by its fall. If, however, we adopt the second hypothe- sis, we have to inquire only as to the relation between cause and effect. We deal in terms of proximate cause, not of negligence.

Negligence may be defined roughly as an act or omission which unreasonably does or may affect the rights of others, or which unreasonably fails to protect one’s self from the dangers resulting from such acts.

Where there is the unreasonable act, and some right that may be affected there is negligence whether damage does or does not result. That is immaterial. Should we drive down Broadway at a reckless speed, we are negligent whether we strike an approaching car or miss it by an inch. The act itself is wrongful. It is a wrong not only to those who happen to be within the radius of danger, but to all who might have been there—a wrong to the public at large.

Negligence does involve a relationship between man and his fellows, but not merely a relationship between man and those whom he might reasonably expect his act would injure; rather, a relationship between him and those whom he does in fact injure.

If  his act has a tendency to harm someone, it harms him a mile away as surely as it does those on the scene.

The proposition is this: Every one owes to the world at large the duty of refraining from those acts that may unreasonably threaten the safety of others. Such an act occurs. Not only is he wronged to whom harm might reasonably be expected to result, but he also who is in fact injured, even if he be outside what would generally be thought the danger zone.

As we have said, we cannot trace the effect of an act to the end, if end there is. Again, however, we may trace it part of the way. An overturned lantern may burn all Chicago. We may follow the fire from the shed to the last building. We rightly say the fire started by the lantern caused its destruction. A cause, but not the proximate cause. What we do mean by the word “prox- imate” is that, because of convenience, of public policy, of a rough sense of justice, the law arbitrarily declines to trace a series of events beyond a certain point. This is not logic. It is practical politics.

This last suggestion is the factor which must determine the case before us. The act upon which defendant’s liability rests is knocking an apparently harmless package onto the platform. The act was neg- ligent. For its proximate consequences the defendant is liable. If its contents were broken, to the owner; if it fell upon and crushed a passenger’s foot, then to him; if it exploded and injured one in the immediate vicinity, to him. Mrs. Palsgraf was standing some distance away. How far cannot be told from the record—apparently 25 to 30 feet, perhaps less. Except for the explosion, she would not have been injured. . . . The only intervening cause was that, instead of blowing her to the ground, the concussion smashed the weighing machine which in turn fell upon her. There was no remoteness in time, little in space. And surely, given such an explosion as here, it needed no great foresight to predict that the natural result would be to injure one on the platform at no greater distance from its scene than was the plain- tiff. Just how no one might be able to predict. Whether by flying fragments, by broken glass, by wreckage of machines or structures no one could say. But injury in some form was most probable.

Under these circumstances I cannot say as a matter of law that the plaintiff’s injuries were not the proxi- mate result of the negligence.

CaSe QUeStIONS

1. Who was carrying the package?

2. How far away from the incident was Ms. Palsgraf, and why is this significant?

3. What does Justice Cardozo find? Why does the dissent disagree?

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Chapter 9 Business Torts 319

9-3e element Five: damages

The plaintiff in a negligence case must be able to establish damages that resulted from the defendant’s negligence. Such damages could include medical bills, lost wages, and pain and suffering, as well as any property damages. In many of the cases in this chapter, plaintiffs have also recovered punitive damages. Often referred to as “smart money,” punitive damages are similar to civil penalties that are paid to plaintiffs because of the high level of carelessness involved on the defendant’s part.

9-3f defenses to Negligence

Contributory Negligence In some cases, an accident results from the combined negligence of two or more people. A plaintiff who is also negligent gives the defendant the opportunity to raise the defense of contributory negligence. Contributory negligence is simply negligence by the plaintiff that is part of the cause of an accident. For example, suppose that a boat owner is operating his boat late at night on a lake in which the water is choppy and when he is intoxicated. An intoxicated friend is sitting at the bow of the boat trying to put her feet into the water when the owner takes the boat up to high speed. She falls in and is injured. The issue of causation becomes com- plicated here because there were breaches of duties by both parties. Did he cause the accident by driving at high speed late at night on a choppy lake while intoxi- cated? Or did she cause the accident by sitting without protection or restraint on the bow of the boat when the boat was being driven like that? The effect of the defense of contributory negligence is a complete bar to both from recovery.

Comparative Negligence Many states, in order to eliminate the harsh effect of contributory negligence, have adopted a defense of comparative negligence. Under this defense, the jury simply determines the level of fault for both the plaintiff and the defendant and, based on this assessment of fault, determines how much each of the parties will be awarded. Using our boat example, the jury could find that the boat owner was 75% at fault and that the passenger was 25% at fault. Under comparative negligence, the pas- senger could recover for her injuries, but the amount recovered would be 25% less because of her fault in causing the accident.

The defense of comparative negligence was developed largely because of the perceived unfairness of contributory negligence, which was a complete bar to recovery. The concept of comparative negligence has resulted in more litigation and more verdicts for plaintiffs permitted to use the defense.

assumption of Risk The assumption of risk defense requires the defendant to prove that the plaintiff knew of potential risk of injury in the conduct he or she undertook but decided to go forward with it anyway. For example, some dangers are inherent in activi- ties such as skydiving, skiing, and roller-skating. You assume the inherent risks in these activities, but you do not assume the risks caused by the owners of the premises or equipment. For example, when you ski, you assume the natural risks that exist in skiing, but you do not assume the risk of faulty equipment you rent. If the failure of that equipment causes your injuries, the rental company would be responsible for that injury. To assume the risk, you must be completely aware of the risk and you must assume the risk voluntarily. The case of The Landings Assoc. Inc. v Williams (Case 9.6) deals with the issue of assumption of risk.

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320 part 2 Business: Its Regulatory Environment

The Landings Assoc. Inc. v Williams 728 S.E.2d 577 (Ga. 2012)

Snapping at the Homeowner’s Association

Case 9.6

FaCtS

Gwyneth Williams, then 83, was housesitting for her daughter and son-in-law at The Landings, a planned residential development with a golf course located on Skidaway Island off the Georgia coast. Before The Landings was developed, the land within and sur- rounding its boundaries was largely marsh, where indigenous alligators lived and thrived. In order to develop the property, The Landings entities installed a lagoon system that allowed enough drainage to create an area suitable for a residential development. After the project was completed in the 1970s, the indigenous alligators began to move in and out of The Landings through its lagoon systems.

Although alligators inhabited the area, no person had ever been attacked until the night of October 5, 2007, when Mrs. Williams went for a walk near one of the lagoons close to her daughter’s home sometime after 6:00 p.m. The following morning, Mrs. Williams’s body was found floating in the lagoon. Williams’s right foot and both forearms had been bitten off. Later, an eight-foot alligator was caught in the same lagoon, and, after the alligator was killed, parts of Williams’s body were found in its stomach.

Williams’s family filed suit against The Landings for negligence in developing and operating the area. The Landings countered with a defense of contributory negligence—that Mrs. Williams assumed the risk of walking alone among the lagoons at night. The trial court denied a motion for summary judgment in part. The court of appeals reversed in part, and the parties appealed.

JUdICIaL OpINION

MELTON, Justice The record shows that, prior to the attack, Williams was aware that the property was inhabited by alliga- tors. Williams’ son-in-law testified that, on at least one occasion, he was driving with Williams on property in The Landings when he stopped the car to allow Williams to look at an alligator. Williams’ son-in-law also testified that Williams was, in fact, aware that there were alligators in the lagoons at The Landings and that he believed that Williams had a “normal”

respect for wild animals. When asked whether he had ever discussed how to behave around wild alli- gators with Williams, her son-in-law responded: “No. There was never—quite frankly, there was never any reason to. I mean she was an intelligent person. She would—there was no question in my mind that—I guess I have to answer that as it’s not like talking to a five year old child . . . stay away from alligators.” In addition, Williams’ son recalled a similar instance when he stopped the car to allow his mother to look at an alligator. At that time Williams mentioned that she did not like alligators and did not want to go any- where near them.

One who is familiar with the premises cannot rely for recovery upon the negligence of the defendant in failing to correct a patent defect where such party had equal means with the defendant of discovering it or equal knowledge of its existence.

In this case, testimony shows that Williams was aware that wild alligators were present around The Landings and in the lagoons. Therefore, she had knowledge equal to The Landings entities about the presence of alligators in the community. In addition, the record shows that Williams knew that the wild alli- gators were dangerous, saying herself that she would not want to be anywhere near them. Nonetheless, Williams chose to go for a walk at night near a lagoon in a community in which she knew wild alligators were present. This act undisputably shows that Wil- liams either knowingly assumed the risks of walking in areas inhabited by wild alligators or failed to exercise ordinary care by doing so. Under these circumstances, the trial court should have granted the motions for summary judgment brought by the Landings entities regarding Williams’ premises liability claims.

While there is no doubt that Williams’ death was a tragic event, Williams was not incompetent. A rea- sonable adult who is not disabled understands that small alligators have large parents and are capable of moving from one lagoon to another, and such an adult, therefore, assumes the risk of an alligator attack when, knowing that wild alligators are present in a community, walks near a lagoon in that commu- nity after dark.

The motion for summary judgment is granted.

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Chapter 9 Business Torts 321

dISSeNtING OpINION

BENHAM, Justice Notably absent from the majority’s opinion are facts which, if construed in appellees’ favor, require the denial of appellants’ motions for summary judgment. For example, the Landings Association had an adver- tised policy that it removed from the 151 lagoons in the community alligators which were seven feet long or larger and/or alligators which were aggressive toward humans or pets; the appellants did not patrol or inspect the lagoons in order to remove large or aggressive alliga- tors according to its policy, but rather relied on residents and employees to report said animals; and appellants did not post signs near the lagoons warning guests about alligators. One expert opined that the over eight foot long, 130 pound alligator that attacked the decedent had likely been in the lagoon where the decedent’s body was found for some time because such mature alligators tend to be territorial and nest. There was also evidence in the record that the decedent called for help during the attack, but that appellants’ security forces, which were not trained in dealing with alligators, responded to the wrong location and then stopped investigating, assum- ing that the sounds in question were bird calls.

Based on the facts presented at the time of summa- ry judgment in this case, reasonable minds could differ as to the essential elements of appellees’ premises liability claim. Indeed, there are very specific questions in this case that must go to a jury: whether decedent knew that large and aggressive alligators were living on the premises and in the lagoon in which her body was discovered; and whether appellants exercised reasonable care in inspecting and keeping the prem- ises safe from alligators—in particular, alligators that were over seven feet long and alligators that were aggressive toward humans and pets as per appellants’ removal policy. Rather than allowing this evidence to be reviewed by a fact-finder, the majority opinion bars appellees’ premises liability claim simply because the decedent once observed an alligator standing on the roadside.

CaSe QUeStIONS

1. What fact is used to show that Ms. Williams assumed the risk on alligators?

2. Why does the dissent differ with the finding on assumption of risk?

Lisa Winters signed up to take a Latino dance class at the Santa Monica Family YMCA, sort of a dancing-with-the-neigh- bors experience. However, when she ar- rived for class on April 17, 2002, the Lati- no dance instructor was ill, and the jazz instructor had agreed to fill in so that the class would proceed. The jazz instructor, however, taught jazz. No one was wearing the appropriate shoes for jazz dance, the floor was made of wood, and the instructor asked the students to perform a pivoting spin maneuver. After Ms. Winters attempt- ed the maneuver, the jazz instructor asked her to put more effort into the move. Ms.

Winters first performed the maneuver with no difficulty. During her second at- tempt, she performed four leaps (e.g., running-type steps with both feet off the ground). As she attempted to perform the pivoting half-spin maneuver, her left foot stuck to the floor. She fell to the floor and sustained personal injuries. She filed suit against the YMCA for her injuries. The YMCA’s defense is assumption of risk. Will the defense fly (as it were)? Be sure to ex- plain why all of the facts stated are import- ant in reaching your conclusion. [Winter v Santa Monica Family YMCA, 2005 WL 1713936 (Cal. App. 2 Dist.)]

Consider . . . 9.8

9-4 New Verdicts on Tort Reform Although nearly all states have adopted some form of limitations in tort recovery, these reforms are a maze of laws differing from state to state and are in a fluid state of judicial review.

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322 part 2 Business: Its Regulatory Environment

In BMW of North America, Inc. v Gore, 517 U.S. 559 (1996), the U.S. Supreme Court concluded that $4,000,000 in damages was excessive (reduced to $2 million by the judge on a judgment NOV) for the dealer’s failure to disclose to a BMW buyer that his car had been refinished. The actual damages were only $4,000, and the Supreme Court held, “When the ratio [of punitive damages to actual damages] is a breathtaking 500 to 1, however, the award must surely ‘raise a suspicious judi- cial eyebrow.’” The dissent raised the question courts still labor to resolve: how much is too much?

A number of significant decisions have chipped away at answering that ques- tion. In State Farm Mutual Auto Insurance Co. v Campbell, 538 U.S. 408 (2003) (origi- nally a Utah case), the U.S. Supreme Court held that a punitive damage award of $145 million in punitive damages and $1 million in compensatory damages against an insurance company for its wrongful refusal to pay a claim violated the due process clause. Because the highest criminal penalty available for fraud in Utah was $10,000, the Supreme Court could not find a justification for the large punitive damage award. Neither could the Supreme Court find that including out-of-state activities of a company in determining damages for conduct within the state was not proper.

In Exxon Shipping Co. v Baker, 554 U.S. 471 (2008), the U.S. Supreme Court found that the maximum amount for punitive damages in that case (which had peculiar maritime underpinnings) was an amount equal to the compen- satory damages. These types of decisions continue to place limits on punitive damages.

The Mathiases checked into a Motel 6 and were bitten extensively by bedbugs. Upon investigation, they learned that the man- agers and owners of the motel had been warned by guests, employees, and extermi- nators alike that there were bedbugs in the rooms. The exterminator offered to spray the motel each year for $600, but the motel refused. As a result, the bugs remained and propagated. The Mathiases filed suit, seek- ing punitive damages. The trial court award- ed them $5,000 compensatory damages

and $186,000 punitive damages. The motel appealed the punitive damage award as excessive. Is the award excessive? Should the punitive damages award be reversed? Why do you think the hotel wants to have a court decision on this suit? [Mathias v ACCR Economy Lodging, Inc., 347 F.3d 672 (7th Cir. 2003); see also Grogan v Gambler Corporation, 19 Misc. 3d 798 (Sup. Ct. N.Y. 2008), and Mills v Best Western Springdale, 2009 WL 1710765 (C.A. Ohio 2009) (con- tracting scabies at hotel)]

Consider . . . 9.9

9-4a Strict Liability

Strict liability is absolute liability for conduct with few, if any, defenses available. Some activities are so dangerous that engaging in them results in liability. Use of explosives, as in building razing, is a strict liability activity.

For example, an Illinois court discussed that keeping a tiger in your backyard results in strict liability because the danger is so great.

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Chapter 9 Business Torts 323

S u m m a r y What types of civil wrongs create a right of recovery for harm?

• Tort—a civil wrong; action by another that results in damages that are recoverable

• Intentional tort—civilly wrong conduct that is done deliberately

• Negligence—conduct of omission or neglect that results in damages

• Strict tort liability—imposition of liability because harm results

What are the types and elements of torts?

• Defamation—publication of untrue and damaging statements about an individual or company

• Product disparagement—the tort of defamation of products

• Malice—publication of information knowing it is false or with reckless disregard for whether it is false

• Privilege—a defense to defamation that protects cer- tain statements because of a public interest in having

information such as testimony in a trial or media coverage protected from suit

• Interference—the wrong of asking a party to breach a contract with a third party

• False imprisonment—wrongful detention of an indi- vidual; shopkeepers have a privilege to reasonably detain those they have good cause to believe have taken merchandise

• Shopkeeper’s privilege—defense to torts of defama- tion, invasion of privacy, and false imprisonment for merchants who detain shoppers when shopkeepers have reasonable cause to believe merchandise has been taken without payment

• Intentional infliction of emotional distress—bizarre and outrageous conduct that inflicts mental and pos- sible physical harm on another

• Invasion of privacy—disclosing private information, intruding upon another’s affairs, or appropriating someone’s image or likeness

• Appropriation—the use, without permission, of another’s likeness, image, voice, or trademark for commercial gain

BiographyThe Kitty Genovese Story and Duty

Richmond, California, is a suburb of San Francisco and is an industrial area that was ranked the ninth most dangerous city in the United States in 2008. Richmond received national attention and scorn because of the alleged gang rape of a high school student at the homecoming dance at Richmond High School, which occurred as 20 people watched the horrific conduct of the young men.

No one witnessing the brutality noti- fied the police of the ongoing rape until a woman overheard two people discussing it and called 911.

The Richmond witnesses were over- come by what is known as the “bystand- er effect,” the label given to the apart- ment dwellers who witnessed the attack

and eventual murder of Kitty Genovese in Queens, New York, in 1964. As they heard the screams of Miss Genovese while she was being beaten and stabbed, those living in the complex did nothing because of their fear of getting involved, their assumptions that someone else would take care of it, or perhaps callous disregard.

There is no statutory duty in California (yet) to report an ongoing crime and no statutory duty in most states to help another who is in danger. Indeed, many who do help have had liability imposed on them for not helping in a crackerjack fashion (see the Van Horn v Watson case on pp. 310–311). What are our ethical responsibilities to render aid?©

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324 part 2 Business: Its Regulatory Environment

What are the elements and defenses in negligence?

• Reasonable and prudent person—the standard by which the conduct of others is measured; a hypothetical person who behaves with full knowledge and alertness

• Causation—the “but for” reason for an accident

• Proximate cause—the foreseeability requirement of causation

• Contributory negligence—negligence on the part of a plaintiff that was partially responsible for causing injuries

• Comparative negligence—newer negligence defense that assigns liability and damages in accidents on a

percentage basis and thus reduces a plaintiff’s recov- ery by the amount his negligence contributed to the cause of the accident

• Assumption of risk—plaintiff’s voluntary subjection to a risk that caused injuries

What are the public policy and business issues in tort recovery?

• Tort reform—political and legislative process of lim- iting damages and changing methods of recovery for civil wrongs

• Amount of punitive damages

Q u e s t i o n s a n d P r o b l e m s 1. In the May 31, 2004, issue of The Weekly Standard, edi- tor Fred Barnes wrote the following commentary:

A FEW YEARS AGO Michael Moore, who’s now promoting an anti-President Bush movie entitled Fahrenheit 9/11, announced he’d gotten the goods on me, indeed hung me out to dry on my own words. It was in his first bestselling book, Stupid White Men. Moore wrote he’d once been “forced” to listen to my comments on a TV chat show, The McLaughlin Group. I had whined “on and on about the sorry state of American education,” Moore said, and wound up by bellowing: “These kids don’t even know what The Iliad and The Odyssey are!”

Moore’s interest was piqued, so the next day he said he called me. “Fred,” he quoted himself as saying, “tell me what The Iliad and The Odyssey are.” I started “hemming and hawing,” Moore wrote. And then I said, according to Moore: “Well, they’re . . . uh . . . you know . . . uh . . . okay, fine, you got me—I don’t know what they’re about. Happy now?” He’d smoked me out as a fraud, or maybe worse.

The only problem is none of this is true. It never happened. Moore is a liar. He made it up. It’s a fabrication on two levels. One, I’ve never met Moore or even talked to him on the phone. And, two, I read both The Iliad and The Odyssey in my first year at the University of Virginia. Just for the record, I learned what they were about even before college. Like everyone else my age, I got my classical education from the big screen. I saw the Iliad movie called Helen of Troy and while I forget the name of the Odyssey film, I think it starred Kirk Douglas as Odysseus.

So why didn’t I scream bloody murder when the book came out in 2001? I didn’t learn about the phony

anecdote until it was brought to my attention by Alan Wolfe, who was reviewing Moore’s book for the New Republic. He asked, by email, if the story were true. I said no, not a word of it, and Wolfe quoted me as saying that. That was enough, I thought. After all, who would take a shrill, lying lefty like Moore seriously?

Was Mr. Barnes defamed? Could he bring suit now?

2. Douglas Margreiter was severely injured in New Orleans on the night of April 6, 1976. He was the chief of the pharmacy section of the Colorado Department of Social Services and was in New Orleans to attend the annual meeting of the American Pharmaceutical Association.

On Tuesday evening, April 6, Mr. Margreiter had dinner at the Royal Sonesta Hotel with two associates from Colorado who were attending the meeting and were staying in rooms adjacent to Mr. Margreiter’s in the New Hotel Monteleone. Mr. Margreiter returned to his room between 10:30 p.m. and 11:00 p.m.; one of his friends returned to his adjoining room at the same time. Another friend was to come by Mr. Margreiter’s room later to discuss what sessions of the meetings each would attend the next day.

About three hours later, Mr. Margreiter was found severely beaten and unconscious in a parking lot three blocks from the Monteleone. The police who found him said they thought he was highly intoxicated, and they took him to Charity Hospital. His friends later had him moved to the Hotel Dieu.

Mr. Margreiter said two men had unlocked his hotel room door and entered his room. He was beaten about the head and shoulders and had only the recollection of being carried to a dark alley. He required a craniotomy and other medical treatment and suffered permanent effects from the incident.

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Chapter 9 Business Torts 325

Mr. Margreiter sued the hotel on grounds that the hotel was negligent in not controlling access to elevators and hence to the guests’ rooms. The hotel says Mr. Marg- reiter was intoxicated and met his fate outside the hotel. Is the hotel liable? [Margreiter v New Hotel Monteleone, 640 F.2d 508 (5th Cir. 1981)]

3. Rhodes tripped over a hospital cord while visiting a patient in the Detroit Medical Center. She fell and was injured. She filed suit against the hospital for negligence in the condition of its premises. The cord was black and the floor was gray. Should she be able to recover from the hospital? [Rhodes v Detroit Medical Center, 2006 WL 355249 (C.A. Mich. 2006)]

4. The CBS news show 60 Minutes pulled from pro- gramming a scheduled airing of an interview with a Jef- frey S. Wigand, a former tobacco executive, when threats of both libel and tortious interference with contract suits arose. Brown & Williamson lawyers notified CBS News that Wigand had signed a confidentiality agreement and that the company would sue CBS News for interference with that contract if the interview were run. 60 Minutes ran a story on tobacco companies without the interview. CBS correspondents Mike Wallace and Morley Safer protested the decision of CBS News executives. However, the Wall Street Journal ran a story describing CBS News’s unusual arrangements with Wigand, including the payment of a consulting fee of $12,000 and the promise of full indemnifi- cation. Did CBS commit tortious interference of contract?

5. Two disc jockeys at WPYX-FM radio in Albany, New York, were sued for intentional infliction of emotional distress by Annette Esposito-Hilder, who was identified on the air by the two disc jockeys as the “winner” of the “ugliest bride” contest. The two disc jockeys sponsored an ugliest bride contest based on wedding pictures in the daily newspaper. Viewers were invited to call in with their guesses as to which bride had been chosen. Generally, the disc jockeys did not reveal last names of the brides. However, in Ms. Esposito-Hilder’s case, they broke with past practice and revealed her name.

On appeal of the case from an earlier dismissal, the court held that no defamation was involved in their statements because they were “pure, subjective opin- ion.” The court did hold, however, that a suit for inten- tional infliction of emotional distress could go forward. The court held, “Comedic expression does not receive absolute First Amendment protection.”

Is this defamation? Is opinion protected by the First Amendment? Does it make any difference that Ms. Esposito-Hilder was employed by a competing radio sta- tion in the area at the time she “won” the contest? [Esposi- to-Hilder v SFX Broadcasting, Inc., 665 N.Y.S.2d 697 (1997)]

6. Ads on Times Square that feature well-known per- sonalities clad in brand-name items are not unusual.

However, the building-size photo of President Obama in a Weatherproof Garment Company jacket in an ad tout- ing the company’s apparel was out of the ordinary. The ad caught the attention of more than the millions filing through the public square. The office of White House Counsel also took note. “The White House has a long- standing policy disapproving of the use of the president’s name and likeness for commercial purposes.” Mr. Obama had not granted permission for use of his photo.

The photo used in the ad was one taken while the president was at the Great Wall of China in November. Freddie Stollmack, president of Weatherproof Garment Company, spotted the photo in the news and, using a magnifying glass, was able to identify the company’s logo and zipper. The company did pay the licensing fees for use of the photo, one taken by the Associated Press (AP). AP, however, noted that it is the user ’s responsibility to obtain permission and clearances for how the photo is used. The New York Times, the New York Post, and Women’s Wear Daily turned down the presidential ads Weatherproof had tried to place with them.

Weatherproof is known for its publicity-grabbing advertising techniques. In 2008, it issued a press release touting its unique approach of running the shortest ads on the Super Bowl—two seconds. A later press release confirmed that no ad would be run because two-second ads are not available during the Super Bowl. In 2006, Weatherproof photographed company representatives putting a coat on the Naked Cowboy, a well-known street performer in New York City.

The White House legal counsel had its hands full with ads because during the week prior to the jacket hoopla, People for the Ethical Treatment of Animals (PETA) ran an anti-fur ad that featured Michelle Obama on billboards in the Washington, D.C., area. Mrs. Obama had also not given permission. The White House did contact PETA about the ad but did not discuss whether the parties had reached a resolution.

What are the rights of those whose images or like- nesses are used for commercial purposes without their permission? Is there something different about public figures? What about First Amendment issues? Could Weatherproof argue that it was simply revealing what type of coat the president was wearing, just as news- papers reveal which designers the First Lady uses for her wardrobe? Evaluate the ethics of PETA and Weath- erproof in their use of the First Family’s images. (Steph- anie Clifford, “A Coat Endorsed by the President? The White House Says No,” New York Times, January 7, 2009, p. B3.)

7. On the day after Thanksgiving, November 28, 2008, Walmart held a nationwide sale of a limited number of sharply discounted televisions, computers, and video

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game sets. The “blitz sale” had been advertised heavily in newspapers and on television. At the Valley Stream Wal-Mart store in Long Island, New York, 2,000 shoppers lined up hours before the scheduled 6:00 a.m. store open- ing, forming a line at a place marked by a handwritten sign: Blitz Line Starts Here. The crowd became unruly at one point and the store manager called the police. How- ever, the police left after concluding that things were under control. Shortly afterward, at 5:00 a.m., the crowd broke through the glass doors of the store in a stampede. Jdimytai Damour, a Wal-Mart maintenance worker, was trampled by the crowd and died from asphyxiation. OSHA has imposed a $7,000 fine on Wal-Mart for its failure to take appropriate steps to control the crowd. Wal-Mart is fighting the fine because it maintains the stampede and the trampling were not foreseeable simply because Wal-Mart held a post–Thanksgiving day blitz sale. Walmart has argued that OSHA is asking it to pre- dict events and that there were, at that time, no laws or rules on crowd control or so-called blitz sales (sales in which there are a limited number of items at a reduced price). Wal-Mart’s lawyers argued, “If this was a foresee- able event, why did the police feel comfortable in leav- ing the scene?”

Wal-Mart has already entered into an agreement with the Nassau County, New York, district attorney to adopt crowd control policies at its 92 stores in New York, create a $400,000 fund to compensate trampling victims, and donate $1.5 million to various community organi- zations in Nassau County. Wal-Mart also implemented crowd-control policies at its stores nationwide. Evaluate the duty, breach of duty, and foreseeability issues in the Long Island stampede. Be sure to discuss whether Wal- Mart breached any duty to the maintenance worker and why Wal-Mart would push back against the small fine. (Ann Zimmerman, “Walmart Fights Safety Fine, Worried about Precedent,” Wall Street Journal, July 9, 2010, p. B3; Steven Greenhouse, “Wal-Mart Displays Its Legal Might Fighting $7,000 Fine in Trampling Case,” New York Times, July 7, 2010, p. B1.)

8. E*Trade Financial Corporation ran a memorable ad during the 2010 NFL Super Bowl in which a baby boy and a baby girl are chatting online via the use of a web- cam. The dialogue between the two babies, who have the voices of adults, is as follows:

Baby boy: “So, yea, sorry about last night.” Baby girl: “I just don’t understand why you didn’t

call last night.” Baby boy: “I was on E*Trade, you know, diversifying

my portfolio, taking control like a wolf.” Baby girl: “Right.” Baby boy: “That volatility in the market, taken care

of, wolf-style . . . (howls).”

Baby girl: “And that milkaholic Lindsay wasn’t over?”

Baby boy: “Lindsay?” Second baby girl pops in front of the webcam:

“Milkawhat?” Lindsay Lohan, a 23-year-old actress who has

been required to attend drug rehabilitation pro- grams and has served time in jail for various drug charges, has filed a $100 million suit against E*Trade for appropriation of her likeness and image. Ms. Lohan’s lawyers have statements from friends and others who indicate that Ms. Lohan was the first per- son who came to mind when they saw the ad. Is this appropriation?

9. Patricia Holguin went to Sally’s Beauty Supply Store carrying her “eco-friendly canvas shopping tote,” a large bag that is conspicuous when used. Upon entering the store, there were no posted signs stating that shopping totes were not allowed. She picked up a can of mousse that was not exactly what she wanted and started to carry it in her tote toward the front counter to ask the cashier a question about it. As she walked toward the front of the store, the assistant man- ager approached her and asked what was in the bag. She was detained by this manager, who told her that once she put the hair mousse in her tote bag, she was shoplifting. Holguin’s lawsuit for false imprisonment against the store was dismissed with prejudice by the trial court. This court held that once she placed the merchandise in her bag, the store had probable cause to believe she was shoplifting and had a statutory condi- tional privilege to detain her, free from civil liability for false imprisonment, because she “willfully concealed merchandise.” Holguin appealed. What should the court hold? Discuss the shopkeeper’s privilege in this situation. [Holguin v Sally’s Beauty Supply, Inc., 264 P.3d 732 (N. Mex. App. 2011)]

10. Joseph Mosca and 23 others boarded a sportfish- ing boat for a day of fishing off San Clemente Island. David Lichtenwalter, one of the fishermen, was fish- ing off the stern near Mr. Mosca. Mr. Lichtenwalter ’s line became entangled in kelp, and he was unable to get it released. A deckhand approached Mr. Licht- enwalter to help him. Mr. Lichtenwalter backed up and handed the pole to the deckhand just as the line “slingshotted” over the rail toward Mr. Mosca, who was struck in the eye with the sinker, which caused a partial vision loss.

Mr. Mosca filed suit against Mr. Lichtenwalter and others. The trial court, using the defense of assumption of risk, dismissed the case, and Mr. Mosca appealed. Dis- cuss the issues and determine liability. [Mosca v Lichten- walter, 68 Cal. Rptr. 2d 58 (Cal. App. 1997)]

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Chapter 9 Business Torts 327

Management & the Law A Primer on References

If you are assigned the task of developing a new refer- ence policy for your company, remember the following guidelines.

1. Stick with factual disclosures: Use “There was an accusation of embezzlement and he resigned,” not “He is an embezzler.”

2. Stick with easily defined terms: Use “Angers eas- ily,” not “He is a lunatic.”

3. Report what happened, not your view: Use “Other staff members complained about her conduct and work,” not “She was a constant pain in the neck.”

4. Implement an exit interview policy in which you disclose the information you have on file that will be given when references are requested.

5. Verify the protections afforded under your state law, if any.

n ot e s 1. There was an interesting personal jurisdiction issue in the case—whether Brian McNamee could be required to come to Texas to defend against the defamation suit. The court upheld Texas’s jurisdiction over the case. [Clemens v McNamee, 615 F.3d 374 (5th Cir.2010); certiorari denied, Clemens v McNamee, 131 S.Ct. 3091 (2011)] Refer to Chapters 3 and 4 for more information on jurisdiction.

2. “Quotation of the Week,” New York Times, March 21, 2010, p. SB2.

3. Robert Pear, “Health System Warily Prepares for Privacy Rules,” New York Times, April 6, 2003, pp. A1, A19.

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328

Chapter

Environmental Regulation and Sustainability10 Apart from the damage claims and penalties that can result from unlawful pol-lution of the environment, social responsibility emerges again as a business concern. Sustainability, or keeping a clean environment in all aspects of business operations, is a now a long-range goal for companies because both businesses and citizens benefit from efforts to preserve and improve the environment. As the author explained in a conference on the social responsibility of business, “It is not a matter of business profits versus preserving the environment. You can’t keep the first going without taking responsibility for the second. We are all in this together and what each of us does affects the rest.” This chapter answers the following questions: What are the public and private environmental laws? What are the protections and requirements in environmental laws? Who enforces environmental laws? What are the penalties for violations?

Update For up-to-date legal news, go to mariannejennings.com

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329

10-1 Common Law Remedies and the Environment

From earliest times, landowners have enjoyed the protections of the courts and various doctrines to prevent bad smells, noises, and emissions.

10-1a Nuisances

The common law doctrine of nuisance provides relief to adjoining landowners and communities when activities of one landowner interfere with the use and enjoyment of others’ properties. Bad smells, ongoing damage to paint on build- ings, excessive noise, polluted air, and the operation of facilities that present health problems can all be enjoined as nuisances. In many environmental problems, land- owners and members of the communities who are affected do not want money for damages as much as they want the harmful activity halted. The courts have the power to issue injunctions against those who are causing the harm to land, indi- viduals, communities, or the environment. Courts grant injunctions in those cases in which those who request the injunctive relief can establish ongoing harm as a result of the activities. In Spur Industries, Inc. v Del E. Webb Dev. Co. (Case 10.1), the Arizona Supreme Court was faced with issues of property, smells, and the issue of a developer’s new project reaching a preexisting nuisance.

10-1b NIMBYs and Nuisances

Environmental activists who rely on nuisance theories and local zoning laws have emerged as powerful forces in community development. Groups some- times referred to as NIMBYs (Not In My Back Yard) challenge the placement of everything from power plants to refineries to cell phone towers to Walmarts as nuisances, backing their protests with data on traffic, crime, health and safety, and risk. Another group of activists, called the BANANAs (Build Absolutely Nothing

By the shores of Gitche Gumee, By the shining Big-Sea-Water . . . How they built their nests in summer, Where they hid themselves in winter, How the beavers built their lodges, Where the squirrels hid their acorns, How the reindeer ran so swiftly, Why the rabbit was so timid . . . Henry WadsWortH LongfeLLoW “Hiawatha’s Childhood”

Shell Oil sold products to Brown & Bryant, Inc. (B & B), an agricultural chemical distribution business. B & B was what many characterized as a “sloppy” operator. Shell provided guidelines to its distributors, including B & B, for handling its products. Shell also inspected one of B & B’s facilities and requested that the company make op- erational changes. B & B promised to make the changes

but did not follow through. B & B went bankrupt, and state and federal authorities found contaminated soil on B & B’s largest site. Both the EPA and state agencies sought to recover the cost of cleanup for the B & B site from Shell. Shell maintains that it did not spill the chem- icals, could not control the behavior of B & B, and there- fore could not be held liable. Is Shell correct?

Consider . . . 10.1

The groups that protest locations of factories, cell phone towers, plants, and other de- velopment efforts raise political and public relations issues that require businesses to do advance planning and work with local authorities so that pro- posed projects are not derailed. With advance discussions, the proj- ects can perhaps be tailored to address con- cerns of those activists.

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330 part 2 Business: Its Regulatory Environment

Spur Industries, Inc. v Del E. Webb Dev. Co. 494 P.2d 700 (Ariz. 1972)

Cattle and Flies and Retirees, Oh, My!

Case 10.1

FaCts

Spur Industries operated a cattle feedlot near Young- town and Sun City, Arizona (communities 14 to 15 miles west of Phoenix). Spur had been operating the feedlot since 1956, and the area had been agricultural since 1911.

In 1959, Del E. Webb began development of the Sun City area, a retirement community. Webb purchased the 20,000 acres of land for about $750 per acre.

In 1960, Spur began an expansion program in which it grew from an operation of five acres to 115 acres. At the time of the suit, Spur was feeding between 20,000 and 30,000 head of cattle, which produced 35 to 40 pounds of wet manure per head per day, or over 1 million pounds per day, and despite the admittedly good feedlot management and good housekeeping practices by Spur, the resulting odor and flies produced an annoying if not unhealthy situation as far as the senior citizens of southern Sun City were concerned. There is no doubt that some of the citizens of Sun City were unable to enjoy the outdoor living that Del Webb had advertised. Del Webb was faced with sales resis- tance from prospective purchasers as well as strong and persistent complaints from the people who had purchased homes in that area. Nearly 1,300 lots could not be sold. Webb then filed suit alleging Spur’s oper- ation was a nuisance because of flies and odors con- stantly drifting over Sun City. The trial court enjoined Spur’s operations and Spur appealed.

JUdICIal OpINION

CAMERON, Vice Chief Justice It is clear that as to the citizens of Sun City, the opera- tion of Spur’s feedlot was both a public and a private nuisance. They could have successfully maintained an action to abate the nuisance. Del Webb, having shown a special injury in the loss of sales, had standing to bring suit to enjoin the nuisance. The judgment of the trial court permanently enjoining the operation of the feedlot is affirmed.

In addition to protecting the public interest, how- ever, courts of equity are concerned with protecting the operator of a lawfully, albeit noxious, business from the result of a knowing and willful encroachment by others near his business.

In the so-called “coming to the nuisance” cases, the courts have held that the residential landowner may not have relief if he knowingly came into a neighbor- hood reserved for industrial or agricultural endeavors and has been damaged thereby:

“Plaintiffs chose to live in an area uncontrolled by zon- ing laws or restrictive covenants and remote from urban development. In such an area plaintiffs cannot complain that legitimate agricultural pursuits are being carried on in the vicinity, nor can plaintiffs, having chosen to build in an agricultural area, complain that the agricul- tural pursuits carried on in the area depreciate the value of their homes. The area being primarily agricultural, any opinion reflecting the value of such property must take this factor into account. The standards affecting the value of residence property in an urban setting, subject to zoning controls and controlled planning techniques, cannot be the standards by which agricultural proper- ties are judged.”

“People employed in a city who build their homes in suburban areas of the county beyond the limits of a city and zoning regulations do so for a reason. Some do so to avoid the high taxation rate imposed by cit- ies, or to avoid special assessments for street, sewer and water projects. They usually build on improved or hard surface highways, which have been built either at state or county expense and thereby avoid special assessments for these improvements. It may be that they desire to get away from the congestion of traffic, smoke, noise, foul air and the many other annoyances of city life. But with all these advantages in going beyond the area which is zoned and restricted to protect them in their homes, they must be prepared to take the disadvantages.”

“The case affords, perhaps, an example where a business established at a place remote from population is gradually surrounded and becomes part of a populous center, so that a business which formerly was not an interference with the rights of others has become so by the encroachment of the population. . . .”

There was no indication in the instant case at the time Spur and its predecessors located in western Maricopa County that a new city would spring up, full-blown, alongside the feeding operation and that

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Chapter 10 Environmental Regulation and Sustainability 331

the developer of that city would ask the court to order Spur to move because of the new city. Spur is required to move not because of any wrongdoing on the part of Spur, but because of a proper and legitimate regard of the courts for the rights and interests of the public.

Del Webb, on the other hand, is entitled to the relief prayed for (a permanent injunction), not because Webb is blameless, but because of the damage to the people who have been encouraged to purchase homes in Sun City. It does not equitable or legally follow, however, that Webb, being entitled to the injunction, is then free of any liability to Spur if Webb has in fact been the cause of the damage Spur has sustained. It does not seem harsh to require a developer, who has taken advantage of the lesser land values in a rural area as well as the availability of large tracts of land on which to build and develop a new town or city in the area, to indemnify those who are forced to leave as a result.

Having brought people to the nuisance to the foreseeable detriment of Spur, Webb must indemnify Spur for a reasonable amount of the cost of moving or shutting down. It should be noted that this relief to Spur is limited to a case wherein a developer has, with foreseeability, brought into a previously agricultural or

industrial area the population which makes necessary the granting of an injunction against a lawful business and for which the business has no adequate relief.

It is therefore the decision of this court that the matter be remanded to the trial court for a hearing upon the damages sustained by the defendant Spur as a reasonable and direct result of the granting of the permanent injunction. Since the result of the appeal may appear novel and both sides have obtained a measure of relief, it is ordered that each side will bear its own costs.

Affirmed in part, reversed in part, and remanded for further proceedings consistent with this opinion.1

Case QUestIONs

1. What were the factors that made Spur’s activities a nuisance?

2. Should it make any difference that Spur was there first?

3. How does the court balance retirement communi- ties and beef production, two of Arizona’s biggest industries? (Note: The case was settled when Del Webb agreed to pay Spur $11 million.)

data Barns and Nuisances

Data barns are Internet services centers that are generally located in rural areas. They are becoming increasingly important with more and more reliance on cloud storage technology. Google, Facebook, and Amazon are often in a race to build capac- ity as demand increases. Microsoft experi- enced the learning curve for the placement, expansion, and resistance issues in locating,

building, and operating data barns. In 2009, Microsoft bought 75 acres of bean fields in Grant County, Washington, to set up a digital warehouse.2 Although county officials initially were thrilled with the presence of Micro- soft, the issue of nuisance arose because Microsoft installed 40 diesel generators that operate as a backup source of power when there are transmission failures. The

Business Strategy

(Continued)

Anywhere Near Anything), deals with the more generic issues of preventing urban sprawl and encouraging urban redevelopment. Using the legal theory of nui- sance, they attempt to stop development and change, but the courts use a balanc- ing approach in these nuisance cases. Also, businesses and environmental groups are working together to find processes for approval of projects. For example, fed- eral and local laws protect the placement of cell towers so that neighbors cannot impede progress even as accommodations are made on location and design. In Arizona, cell towers are disguised with artificial foliage that gives the towers the appearance of tall palm trees. Aesthetics are protected as technology advances.

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332 part 2 Business: Its Regulatory Environment

10-2 Statutory Environmental Laws: Air Pollution Regulation

At the federal level, most environmental laws can be placed in one of three catego- ries: those regulating air pollution, those regulating water pollution, and those reg- ulating solid waste disposal on land. This section covers regulation of air pollution.

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generators are located next to an elemen- tary school, and the smoke and noise from the generators have affected the learning environment of the school. The emissions from the generators are now classified as a toxic pollutant under Washington state law.

There were also contract disputes with the local Grant County power company. Large data barns, such as the one con- structed by Microsoft, require the electric- ity generation capacity needed for a small town. Power density for these data storage centers is 100 times that of a commer- cial office building and the same as nine Walmart shopping centers. As a result, power companies negotiate contracts with the data barn owners. Those contracts are based on estimates made by the commer- cial users. The utilities use those estimates to determine power purchases and avoid excess and unused capacity. Commercial entities, such as data barns, are penalized under the terms of their contracts for use below and above the estimate figures. For

example, Microsoft had a penalty clause in its utility contract that required it to pay extra when it underestimated its needs. A low estimate means the utility has to buy more expensive, short-term power to sat- isfy the increased demand, and the penalty covers those extra costs. Other customers can be affected by irregularity in commer- cial demand, and the utility faces penalties with its other customers for the failure to provide power.

As data barns have increased in num- bers and size, the Microsoft experience with Grant County allowed technology companies and state and local officials as well as power companies to work through, in advance, all the issues that arise from the presence of data barns. The centers provide revenue, but the costs, both envi- ronmentally and operationally, are high. The centers require disaster plans, generators, and room for expansion because history shows that increased capacity is needed about every 18 months.

Ethical Issues

When you think of companies such as Microsoft and Google, you think of them as “green” companies. What does the data barn scenario teach you about their environmental impact?

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10-2a early legislation

The first legislation dealing with the problem of air pollution, the Air Pollution Control Act, was passed in 1955, but it lacked teeth for enforcement. Federal regu- lation in this area continued to be ineffective in the 1960s. However, under the Air Quality Act of 1967, the federal government was given the authority to oversee the states’ adoption of air quality standards and the implementation of those plans. Still, by 1970, because of little enforcement power, no state had adopted a compre- hensive plan.

10-2b 1970 amendments to the Clean air act: New standards

Because the states did not take action concerning air pollution, Congress passed the 1970 amendments to the original but ineffective 1963 Clean Air Act (42 U.S.C. § 7401); these amendments constituted the first federal legisla- tion with any real authority for enforcement. The act created the Environmental Protection Agency (EPA), a federal agency authorized to establish air quality standards. Once those standards were developed, states were required to adopt implementation plans to achieve the federally developed standards. These state implementation plans (SIPs) had to be approved by the EPA, and adoption and enforcement of the plans were no longer discretionary but mandatory. To obtain EPA approval, the SIPs had to meet deadlines for compliance with the EPA air quality standards, and lack of technology could no longer be used as a defense to air pollution or as a justification for state delays in meeting those standards. The 1970 amendments were the first in a series of federal laws that were known as technology forcing, or statutes that required developments of the means for achieving standards.

10-2c 1977 and 1990 amendments

The 1977 Clean Air Act amendments gave the EPA the authority to regulate busi- ness growth in order to achieve air quality standards. The EPA developed two cat- egories for determining areas for business growth. Nonattainment areas included those areas with existing, significant air quality problems, the so-called dirty areas. The second classification, called prevention of significant deterioration (PSD) areas, provides the EPA with a means for monitoring these areas to stop increased pollution.

10-2d New Forms of Control: epa expansion through administrative procedures

For nonattainment areas, the EPA developed its emissions offset policy, which requires three elements before a new facility can begin operation in an area: (1) the new plant must have the greatest possible emissions controls; (2) the pro- posed plant operator must have all its other operations in compliance with standards; and (3) the new plant’s emissions must be offset by reductions from other facilities in the area.

In evaluating permissions for the new facility, the EPA follows the bub- ble concept, which examines all the air pollutants in the area as if they came from a single source. If a new plant will have no net effect on the air in the area (after offsets from other plants), the EPA allows the new facility to operate.

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334 part 2 Business: Its Regulatory Environment

This bubble concept approach also now applies in PSD areas. PSD regulations give the EPA the right to review proposed plant constructions and modifications before they can be started. Facility operators must establish that air quality will not experience any significant effects and that emissions will be controlled with appropriate devices.

In Environmental Defense v Duke Energy, 549 U.S. 561 (2007), the U.S. Supreme Court supported the EPA’s PSD role in plant modifications, even when those modifications are not major ones. Duke Energy had begun implementing mod- ifications to one of its coal-fired electricity plants without first seeking EPA approval. Duke was relying on past EPA procedures that had required approval for major modifications only. An environmental group brought suit against the company to require EPA approval, and the agency agreed. The Court held that the EPA was acting within the authority granted to it by Congress and that requiring permits for all modifications was not beyond the agency’s authority under the Clean Air Act. The Court also held that the EPA could step up its standard for permit requirements to one that goes beyond best available technology (BAT) to maximum achievable control technology (MACT), a standard not controlled by cost alone.

The cost issue of MACT was addressed by the U.S. Supreme Court when a group of utilities with steam-generating units challenged EPA regulations that placed costly controls on utility emissions. In Michigan v EPA, 135 S.Ct. 2699 (2015), the Court held that the EPA must consider cost in researching and promulgating rules with regard to plant emissions. The Court held that cost is relevant under the statutes that give the EPA its authority. The EPA efforts against primarily coal-fired plants can continue, but the agency will have to examine the costs of, for example, reducing mercury emissions versus the benefits obtained. For example, the case found that the cost of reducing mercury emissions was $9.6 billion per year for the coal plants, but the societal benefits were between 1,600 and 2,400 times smaller, about $4 million to $6 million. The Court did leave the EPA with the authority and discretion to determine what the costs are for implementation of reductions vs. the costs of inaction. The EPA has been able to require MACT in a number of cases. [Nebraska v EPA, 812 F.3d 662 (8th Cir. 2016)]

Since the time of these decisions, the EPA has proposed or promulgated doz- ens of new standards and rules related to all forms of pollution. In 2015, the EPA published a Clean Power Plan, a series of federal regulations that would require coal plants to reduce emissions by 16 percent by 2022.3 Twenty-seven states chal- lenged the plan as ultra vires. While the case was pending, the state attorney gen- eral and others challenging the agency’s authority appealed to the U.S. Supreme Court for a stay on the plan until the issue could be litigated. The Court granted the stay. [West Virginia v EPA, 136 S.Ct. 1000 (2016)] The EPA plan is on hold until the lower courts can do their job in reviewing the case for possible ultra vires prob- lems with the regulations. Both utilities and state attorneys general (in states with significant coal utilities) have joined together for the ultra vires challenge that is now pending.

10-2e New Forms of Control: epa and Climate Change, Nee Global Warming

Massachusetts v EPA, 549 US 497 (2007), was the first of the series of U.S. Supreme Court decisions that held that the Clean Air Act allowed or mandated EPA action on greenhouse gases and global warming. With this decision and the change of

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Re: Upwind and Downwind Liability and Business

Relationships with the EPA

For the Manager’s Desk

The Cross-State Air Pollution Rule (the Trans- port Rule), enacted by the EPA in 2011, was a rule promulgated to address downwind pollution from coal- and gas-fired power plants—that is, pollution that drifts from one state to others. These power plants gener- ate the majority of electricity used in the United States, but they also emit pollutants that affect air quality. The authority for the rule is the Clean Air Act, which authorized the EPA to require the upwind states to reduce omissions that were causing the problems downwind. Upwind states (there are 28) must prevent sources within their borders from emitting pollution that travels across state lines and “contributes signifi- cantly” to a downwind state’s “nonattain- ment” of federal air quality standards. This requirement on downwind responsibility is sometimes called the “good neighbor” pro- vision. The impact of the rule has been the shutdown of many coal-fired utility plants.

Several groups and businesses filed suit against the EPA, challenging the Transport

Rule, Eme Homer City Generation, L.P. v EPA, 134 S.Ct. 1584 (2014), as ultra vires. The court found that under the Transport Rule, upwind states may be required to reduce emissions by more than what they had contributed to a downwind state and that state’s resulting nonattainment of EPA standards. The court held that the Transport Rule was a permissible way for the EPA to construct the good neighbor concept. However, the court’s ruling was limited in that while it did not throw out the Trans- port Rule as ultra vires, it was not holding that all portions of the rule were within the EPA’s authority. The court left it to the states to challenge portions of the rule as ultra vires. Presently, the Transport Rule has been upheld but is subject to state challenges on the specifics of the rule’s content, measurements, and mandates, and those challenges are emerging through the courts.

10-2f New Forms of Control: EPA and Small Businesses

The impact of the 1990 Clean Air Act amendments was more substantial on smaller businesses, such as dry cleaners, paint shops, and bakeries, because the definition of a major source of pollution was changed from those busi- nesses emitting 100 tons or more a year to those emitting 50 tons or more per year. Many dry cleaners impose an environmental surcharge on their custom- ers to cover the cost of emissions compliance. Emissions from dry cleaning operations have been a concern across the environmental statutes. When a dry cleaner has occupied a property, real estate agents recommend soil evaluation before buying that property because of the possibility that the chemicals used in processing have made their way into the soil. (See the discussion of due diligence on p. 343.)

administration in 2009, the EPA has been developing new expansive regulations under the Clean Air Act, the latest, discussed above, dealing with climate change and compliance with the standards set in the Paris Accord of 2015 for worldwide emissions reductions.

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336 part 2 Business: Its Regulatory Environment

10-2g New Forms of Control: epa and economic Forces

The Clean Air Act Amendments of 1990 also resulted in an exchange for the buy- ing and selling of EPA permits for sulfur dioxide emissions. If, for example, a utility has an EPA permit to discharge one ton of sulfur dioxide per year but its equipment permits it to run “cleaner” so that it discharges less than the one ton, the utility can sell the emissions savings portion of its permit to another utility.

10-3 Statutory Environmental Law: Water Pollution Regulation

10-3a early legislation

In 1965, the first federal legislation on water quality standards was passed—the Water Quality Act. The act established a separate enforcement agency—the Fed- eral Water Pollution Control Administration (FWPCA)—and required states to establish quality levels for the waters within their boundaries. Once again, the absence of enforcement procedures resulted in only about one-half of the states developing zones and standards by 1970. None of the states were engaged in active enforcement of those standards with their implementation plans.

The Rivers and Harbors Act of 1899, which prohibits the discharge into nav- igable rivers and harbors of refuse that causes interference with navigation, was used for a time to enforce water standards because state action was minimal. Spe- cifically, the act prohibited the release of “any refuse matter of any kind or descrip- tion” into navigable waters in the United States without a permit from the Army Corps of Engineers.

10-3b present legislation

Not until 1972 was meaningful and enforceable federal legislation enacted. With the passage of the Federal Water Pollution Control Act of 1972 (33 U.S.C. § 1401), Congress set two goals: (1) swimmable and fishable waters by 1983 and (2) zero discharge of pollutants by 1985. The act was amended in 1977 to allow extensions and flexibility in meeting the goals and was renamed the Clean Water Act. This amendment transferred water pollution regulation from local to federal control. The EPA established federal standards for water discharges on an industry-wide basis, and all industries, regardless of state location, are required to comply.

The EPA, with the FWPCA merged into it, establishes ranges of discharge allowed for each industrial group. The ranges for pulp mills, for example, differ from those for textile manufacturers, but all plants in the same industry must com- ply with the same ranges.

The ranges of discharges permitted per industrial group are referred to as efflu- ent guidelines. In addition, the EPA has established within each industrial group a specific amount of discharge for each plant, which is the effluent limitation. Gen- erally, the standards set depend on the type of substance to be released. For setting standards, the EPA has developed three categories for pollutants: conventional, nonconventional, and toxic pollutants.

Finally, for a plant to be able to discharge wastes into waterways, it must obtain a National Pollution Discharge Elimination System (NPDES) permit from the EPA. This type of permit is required only for direct dischargers, or point sources, and is not required of plants that discharge into sewer systems (although these secondary

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Chapter 10 Environmental Regulation and Sustainability 337

dischargers may still be required to pretreat their discharges). Obtaining a permit is a complicated process that requires not only EPA approval but also state approval and public hearings.

The permits also impose requirements on the permit holder. If the plant is going to release a conventional pollutant, the EPA can require the plant to pretreat the substance with the best conventional treatment (BCT). However, the EPA can also require the best available treatment (BAT) standard, which is the highest standard imposed. Until 2009, the standard for requiring BAT was solely the consideration of environmental effects and not the economic effects on the applicant. However, in Entergy Corporation v Riverkeeper, Inc., 556 U.S. 208 (2009), the U.S. Supreme Court held that the EPA can use cost-benefit analysis to allow variances from those standards. In the case, Entergy’s cost of bringing cooling water intake structures to the higher level the EPA requires for new structures would have been nine times the existing costs. The court held that the additional benefit achieved was too small to justify the cost of bringing the cooling water facilities up to current standards.

RC Cape May Holdings operates an oil and gas electric plant in Cape May, New Jersey. The plant applied for the renewal of a discharge permit for the water from its cooling tower. The plant releases water at a higher temperature from the plant than the temperature coming into the plant. Several environment groups objected on the grounds that if the plant constructed a second cooling tower that aquatic organisms (pins fish, crabs) could be better preserved. However, construc- tion of a second tower would require a

feasibility study that would take years, and the elimination of one of the units by the company had already resulted in a 43 percent reduction in the amount of wa- ter the plant needed. The discharge per- mit was renewed, and the environmental groups appealed on the grounds that the plant could do more to protect the organ- isms. Explain what the court should do with the appeal and why. [In re New Jer- sey Pollutant Discharge Elimination Sys- tem permit Number NJ 000544, 2015 WL 3855593 (N.J. Sup. 2015)]

Consider . . . 10.3

Inland Steel Company applied for a permit from the EPA under the Federal Water Pol- lution Control Act of 1972. Although Inland was granted the permit, the EPA made the permit modifiable because new standards for toxic releases and treatment were be- ing developed. Inland filed suit, claiming the

modification restriction on the permit was invalid because the EPA did not have such authority and also because Inland would be subject to every technological change or discovery made during the course of the permit. Was the restriction invalid? [Inland Steel Co. v EPA, 574 F.2d 367 (7th Cir. 1978)]

Consider . . . 10.2

10-3c Other Water legislation

In 1986, Congress passed the Safe Drinking Water Act (42 U.S.C. § 300f), which requires the EPA to establish national standards for contaminant levels in drink- ing water. The states are primarily responsible for enforcement and can have

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338 part 2 Business: Its Regulatory Environment

higher standards than the federal standards, but they must at least enforce the fed- eral standards for their drinking water systems.

In 1990, Congress passed the Oil Pollution Act (OPA; 33 U.S.C. § 1251). The act was passed in response to large oil tanker spills, such as the one resulting from the grounding of the Exxon Valdez in Prince William Sound, Alaska, that resulted in a spill of 11 million gallons of crude oil that coated 1,000 miles of Alaskan coastline. The OPA applies to all navigable waters up to 200 miles offshore and places the federal government in charge of all oil spills. The act also requires that boats be double-hulled. The Oil Spill Liability Trust Fund, established by a five-cent-per- barrel tax, covers cleanup costs when the party responsible is financially unable to do the cleanup.

By the summer of 2010, the Exxon Valdez oil spill seemed to be a relatively small environmental disaster, despite its scope, because of the April 2010 explosion and subsequent 90-day leak from BP’s Deepwater Horizon rig in the Gulf Coast. Over 200 million gallons of oil flowed into the Gulf before the well was capped on August 3, 2010. BP was required to establish a recovery fund of $20 billion for damages to property as well as for payment of lost income to affected businesses and individuals.

The case of Exxon Shipping Co. v Baker, 554 U.S. 471 (2008), went through the courts several times before Exxon’s initial penalty of $4.5 billion was reduced to maritime limitations of $507.5 million. [Exxon Valdez v Exxon Mobil, 568 F.3d 1077 (9th Cir. 2009)] For the 2010 BP Deepwater Horizon rig explosion, BP has paid a total of $43.8 billion in fines and civil and criminal penalties, including $18.7 billion in 2015 to five states and the federal government.

10-4 Statutory Environmental Law: Solid Waste Disposal Regulation

10-4a early Regulation

During the 1970s, two major toxic waste debacles resulted in a new federal regula- tory scheme of toxic waste disposal. In 1978, “Love Canal,” as it came to be called, made national news as 80,000 tons of hazardous waste were found in the ground in an area that was primarily residential and included an elementary school. Epi- demiological studies of cancer and illness rates in the area led to the discovery and eventual cleanup. Also, in Sheppardsville, Kentucky, an area that came to be called “Valley of the Drums,” 17,000 drums of hazardous waste leaked tons of chemicals into the ground and water supply before their removal.

The emotional reaction to these two problem areas and the public outcry resulted in the passage of legislation that provided the federal government with some enforcement power for improper solid waste disposal. The Toxic Substances Control Act (TOSCA; 15 U.S.C. § 601), passed in 1976, authorized the EPA to con- trol the manufacture, use, and disposal of toxic substances. Under the act, the EPA can stop the manufacture of substances that the agency concludes are dangerous.

Congress also passed the Resource Conservation and Recovery Act of 1976 (RCRA; 42 U.S.C. § 6901) in response to the percolating dumping cases. The two goals of the act are to control the disposal of potentially harmful substances and to encourage resource conservation and recovery. A critical part of the act is a permit system that requires manufacturers to obtain a permit for the storage or transfer

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of hazardous wastes so that the location of such wastes can be traced through a federal permit system.

10-4b CeRCla and the superfund

In 1980, Congress passed the Comprehensive Environmental Response, Com- pensation, and Liability Act (CERCLA; 42 U.S.C. § 9601), which authorized the president to issue funds for the cleanup of areas that were once disposal sites for hazardous wastes. CERCLA established a Hazardous Substance Response Trust Fund to provide funding for cleanup. If federal funds are used for cleanup, the company responsible for the disposal of the hazardous wastes can be sued and required to repay the amounts expended from the trust fund. Often called the Superfund, the funds are available for governmental use but cannot be obtained through suit by private citizens affected by the hazardous disposals. Under the Superfund Amendment and Reauthorization Act, the EPA can recover cleanup funds from those responsible for the release of hazardous substances, called poten- tially responsible parties (PRPs). Approximately 700 hazardous substances are now covered. (They are listed at 40 C.F.R. § 302.)

CeRCla lender liability One of the more intriguing issues under CERCLA liability is whether a lender has the responsibility of cleanup because it took back the property and was in posses- sion of the property as the result of a foreclosure sale or a deed in lieu of foreclosure. The Asset Conservation, Lender Liability, and Deposit Insurance Protection Act of 1996 provides a specific exclusion for lenders. This provision has been called the “secured lender exemption” from CERCLA liability. However, these lender amendments also provide that lenders can lose their status if they “actually partic- ipate[s] in the management or operational affairs of a vessel or facility.” A lender can do the following and still not be subject to environmental liability:

• Monitor or enforce terms of the security agreement. • Monitor or inspect the premises or facility. • Mandate that the debtor take action on hazardous materials. • Provide financial advice or counseling. • Restructure or renegotiate the loan terms. • Exercise any remedies available at law. • Foreclose on the property. • Sell the property. • Lease the property.

CeRCla—Four Classes of liability Rules Four classes of parties can be held liable under CERCLA. The present owners and operators of a contaminated piece of property comprise one group. While owner is self-explanatory, operator includes those who lease property and then contaminate it, such as those who lease factories, operate storage facilities, and so forth. The owners and operators at the time the property was contaminated form the second group. This group brings under CERCLA jurisdiction those who were responsible for the property contamination, as opposed to present owners who had the prob- lem deeded to them. For example, many gas stations have been converted to other

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340 part 2 Business: Its Regulatory Environment

businesses. Suppose that one of the underground gas tanks once used by the gas station has been leaking hazardous materials into the surrounding soil. Not only would the present owners be liable, so also would be all those who owned the gas- oline station previously.

The final two groups consist of those who transport hazardous materials and those who arrange for the transportation of hazardous materials. Virtually no lia- bility exemptions are available to those who fit into these four groups. Burlington Northern Railway/Shell Oil Co. v U.S (Case 11.2) deals with a corporation’s CERCLA liability and provides the answer to the chapter-opening “Consider . . .”

Burlington Northern Railway/Shell Oil Co. v U.S. 556 U.S. 599 (2009)

Am I My Customer’s Keeper? I’m Only the Arranger

Case 10.2

FaCts

In 1960, Brown & Bryant, Inc. (B & B), began operating an agricultural chemical distribution business (the Arvin facility). B & B applied its products to customers’ farms. B & B opened its business on a 3.8-acre parcel of former farmland and then expanded operations onto an adjacent 0.9-acre parcel of land owned jointly by the Atchison, Topeka & Santa Fe Railway Company and the Southern Pacific Transportation Company (Rail- roads). Wastewater and chemical runoff from the facility were allowed to seep into the groundwater below it.

B & B purchased chemicals from Shell. Shell would arrange for delivery by common carrier, f.o.b. destina- tion. When the product arrived, it was transferred from tanker trucks to a bulk storage tank located on B & B’s primary parcel. During each of these transfers, leaks and spills could—and often did—occur.

In the late 1970s, Shell took several steps to encour- age the safe handling of its products. Shell provided distributors with detailed safety manuals and instituted a voluntary discount program for distributors that made improvements to their bulk handling and safety facilities. Later, Shell required distributors to obtain an inspection by a qualified engineer and provide self-certification of compliance with applicable laws and regulations. B & B’s Arvin facility was inspected twice, and B & B told Shell that it had made a number of recommended improvements to its facilities. Despite these improvements, B & B remained a “‘[s]loppy’ [o] perator.”

The EPA (referred to in the case as “Governments”) discovered significant contamination of soil and groundwater, and in 1989, B & B’s land was designated

as a Superfund site. However, B & B went bankrupt that year. By 1998, the Governments had spent more than $8 million in cleanup costs.

In 1991, the Governments ordered the Railroads to conduct certain cleanup processes. The Railroads did so, incurring expenses of more than $3 million in the process. The parties ended up in court seeking a determination of their share of cleanup liability. The U.S. District Court held that both the Railroads and Shell were potentially responsible parties (PRPs) under CERCLA: the Railroads because they were owners of a portion of the facility and Shell because it had “arranged for” the disposal of hazardous substances through its sale and delivery of chemicals. The court did not impose joint and several liability on Shell and the Railroads for the entire response cost incurred by the Governments. The court apportioned the Rail- roads’ liability as a percent of the Governments’ total response cost. Based on estimations of chemicals spills of Shell products, the court held Shell liable for 6 per- cent of the total site response cost.

Shell and the Governments appealed. The Ninth Circuit held that Shell had arranged for the disposal of a hazardous substance and held Shell and the Rail- roads jointly and severally liable for the Governments’ cleanup costs.

The Railroads and Shell appealed.

JUdICIal OpINION

STEVENS, Justice . . . [A]n entity could not be held liable as an arranger merely for selling a new and useful product if the purchaser of that product later, and unbeknownst to

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the seller, disposed of the product in a way that led to contamination. Less clear is the liability attaching to the many permutations of “arrangements” that fall between these two extremes—cases in which the seller has some knowledge of the buyers’ planned disposal or whose motives for the “sale” of a hazardous sub- stance are less than clear.

The Governments assert that by including unin- tentional acts such as “spilling” and “leaking” in the definition of disposal, Congress intended to impose liability on entities not only when they directly dis- pose of waste products but also when they engage in legitimate sales of hazardous substances knowing that some disposal may occur as a collateral consequence of the sale itself. The Governments contend that Shell arranged for the disposal by shipping to B & B under conditions it knew would result in spilling by the pur- chaser. Because these spills resulted in waste, a result Shell anticipated, the Governments insist that Shell was properly found to have arranged for the disposal. Shell was aware that minor, accidental spills occurred during transfer. . . .

[t]he evidence does not support an inference that Shell intended such spills to occur. To the contrary, the evidence revealed that Shell took numerous steps to encourage its distributors to reduce the likelihood of such spills, providing them with detailed safety manuals, requiring them to maintain adequate storage facilities, and providing discounts for those that took safety precautions.

Although Shell’s efforts were less than wholly successful, given these facts, Shell’s mere knowledge that spills and leaks continued to occur is insufficient grounds for concluding that Shell “arranged for” the disposal. Accordingly, we conclude that Shell was not liable.

T[he [district] court found that the volume of hazardous-substance-releasing activities on the B & B property was at least 10 times greater than the releas- es that occurred on the Railroad parcel, The District Court’s detailed findings make it abundantly clear that the primary pollution at the Arvin facility was contained in an unlined sump and an unlined pond in the southeastern portion of the facility most dis- tant from the Railroads’ parcel and that the spills of hazardous chemicals that occurred on the Railroad parcel contributed to no more than 10% of the total site contamination, some of which did not require remediation.

The fact that no spills on the Railroad parcel required remediation lends strength to the District Court’s conclusion . . . any miscalculation on that point is harmless.

For the foregoing reasons, we conclude that the Court of Appeals erred by holding Shell liable as an arranger under CERCLA. Furthermore, we conclude that the District Court reasonably apportioned the Rail- roads’ share of the site remediation costs at .

The judgment is reversed.

Case QUestIONs

1. Where do you think the term “arranger” fits in the categories of those who are responsible for cleanup costs under CERCLA?

2. What do you think the practical effect of this deci- sion will be on companies who own Superfund sites? Does the complexity of analysis for liability help companies in cleanup cases?

3. What do you think will happen to government agencies in their efforts to seek reimbursement for their cleanup efforts?

CeRCla and Corporate liability CERCLA liability has also extended to corporate board members and corpo- rate successors and officers in cases where a company is purchased by another firm. Those who merge or buy corporations also buy into CERCLA liability— liability under CERCLA continues after a transfer of ownership. The U.S. Supreme Court ruled in United States v Bestfoods, 528 U.S. 810 (1999), that a parent corporation is not automatically liable under CERCLA for a subsidiary corporation’s conduct, but it may be responsible if the subsidiary is simply a shell. In other words, CERCLA liability of parent corporations for the actions of their subsidiaries is governed by corporate law on piercing the corporate veil. Under the Bestfoods case, liability of the parent corporation for actions of a subsidiary results if

a. the parent corporation operates the facility, is a joint venturer in the opera- tion of the facility, or works side by side with the subsidiary in operations;

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342 part 2 Business: Its Regulatory Environment

b. the parent and subsidiary corporations share officers and directors such that it becomes impossible to separate out the decision-making processes; or

c. an officer of the parent corporation (or other designated or authorized employee) operates the facility of the subsidiary.4

For some 30 years, GE manufactured elec- tric capacitors containing Pyranol at its plants located in New York. GE met its Pyra- nol needs by purchasing “virgin” PCBs that the Monsanto Company marketed. GE then refined the PCBs it purchased from Mon- santo until the PCBs attained the level of purity necessary for use in electric capaci- tors. The end result was Pyranol.

To be of use to GE, the processed Pyra- nol had to meet and retain demanding pu- rity specifications. Pyranol that fell short of these standards was deemed “scrap Pyra- nol” and was stored in 55-gallon drums in designated scrap areas.

Over time, GE accumulated a glut of scrap Pyranol and contacted Frederic H. “Fred” Fletcher, local manufacturer, “chemical scrapper,” and businessman, and through an informal agreement Fletcher purchased scrap Pyranol from GE at bargain prices for his industrial needs.

For approximately ten years ending in 1967, Fletcher regularly purchased 55-gallon drums of scrap Pyranol from GE, about 200,000 gallons, or 3,600 55-gallon drums. By August 1967, when GE notified him by means of a collection letter, Fletcher’s account was delinquent by over $6,000 for failure to pay for 14 shipments of scrap Pyranol. Fletcher responded with a letter informing GE that the quality of the scrap Pyranol he received had markedly declined in recent years. Fletcher’s letter marked the end of his relationship with GE.

In 1987, EPA found hundreds of drums containing scrap Pyranol and other

chemicals at the Fletcher Site. The drums were unmarked and several had leaked. Subsequent testing detected hazardous substances at the site. The EPA filed suit against GE to recoup costs associated with the Fletcher site’s cleanup as an arranger. Explain whether GE is an arranger and whether GE should be held liable for the cost of the Fletcher cleanup. [U.S. v General Elec. Co., 670 F.3d 377 (1st Cir. 2012)]

THINK: In the Burlington case, the court refused to hold Shell liable for the “sloppy” conduct of a customer in receiving goods purchased from Shell because Shell had made legitimate sales to customers and had provided information on the proper transport of its goods. Shell was not involved in the spills, and mere knowledge was not enough to result in its liability under CERCLA.

APPLY: The situation in the GE case is slightly different. This was a situation where GE had contaminated materials and had made arrangements with Fletcher to buy the materials from it. The goods being trans- ferred were the contaminants, and there was a need for disposal. A company cannot isolate itself from responsibility for dispos- al simply by hiring a contractor. There is a requirement to follow through with the reli- ability and responsibility of that contractor.

ANSWER: In this case, GE, in one of the longest-lasting EPA cases in history, was held liable. GE had a duty to follow through on the conduct of the party with whom it had contracted for disposing of its PCB materials.

Consider . . . 10.4

CeRCla and Buying land liability The best safeguard against stepping into CERCLA liability is screening the property carefully before buying it or, in the case of lenders, accepting it as col- lateral. When lenders sell foreclosed property to a third party, the lender is in the position of trying to sell property with a CERCLA problem. The value of

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Chapter 10 Environmental Regulation and Sustainability 343

the collateral is reduced substantially. Lenders and any purchasers of a piece of property should conduct a due diligence review of the property. A due dili- gence review consists of three phases. Phase I consists of a search to determine whether evidence of past or current environmental problems is present on the property. The EPA has established the “all appropriate inquiries” rule for Phase I, which requires the use of experts and documentation. A Phase I search must examine private and public records and include a site inspection. If Phase I reveals some concerns, the parties proceed to Phase II, which consists of chemi- cal analysis of soil, structures, and water from the property. If Phase II finds the presence of contaminants, the report for Phase II estimates the cost of cleanup. Phase III is the actual cleanup plan.

10-4c New developments Under CeRCla

CeRCla Challenges Courts have begun to examine the issue of causation between the contaminants present on a piece of property and its relation to any injury as a means of a cost-benefit analysis. For example, in Licciardi v Murphy Oil U.S.A., Ill F.3d 396 (5th Cir. 1997), one federal circuit court held that some causation must be established between the cleanup and what the owner or operator is alleged to have dumped at the site. However, not all the federal circuit courts have followed that line of rea- soning in their decisions. [Johnson v James Langley Operation Co., Inc., 226 F.3d 957 (8th Cir. 2000)]

Another basis for CERCLA judicial challenges has been one grounded in the basic administrative law principle of an arbitrary and capricious challenge to an EPA demand for cleanup of a site when the demand for cleanup is not linked to any danger. For example, in U.S. v Broderick Investment Co., 200 F.3d 679 (10th Cir. 1999), a company challenged the costly cleanup demands that required the cancer rate in the area to be reduced to 1 in 100,000 a rate higher than in non–Superfund sites. However, because a day care center was planned for the land, the court upheld the cleanup standards as neither arbitrary nor capricious. These types of challenges to CERCLA, including allocation issues, continue their advancement through the judicial system.

Insurers and CeRCla Another judicial issue that continues to evolve is whether property insurance policies include coverage for CERCLA liability. Courts are left with interpreta- tion issues on these policies. Ambiguities in the meaning of the term pollution in a policy are construed against the insurer in favor of coverage for the property owner. In making decisions in these coverage cases, courts focus on determining whether what was spilled is in fact a “pollutant” because the policies exclude coverage for pollutants. [Sulphuric Acid Trading Co., Inc. v Greenwich Ins. Co., 211 S.W.3d 243 (Tenn. App. 2006); Firemen’s Ins. Co. of Washington, D.C. v Kline & Son Cement Repair, Inc., 474 F. Supp. 2d 779 ( E.D. Va. 2007)] CERCLA coverage is available, but it is a policy rider, which requires additional premiums. There are insurers that specialize in offering only CERCLA coverage.

CeRCla and the self-audit The EPA encourages companies to self-identify problem lands and areas in exchange for reduced fines. Companies and the EPA work together to solve the problem and be certain cleanup is done where warranted. These self-audits and

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344 part 2 Business: Its Regulatory Environment

disclosures also help the companies be more accurate in their disclosures to share- holders and analysts.

Under the EPA’s program called Incentives for Self-Policing, Disclosure, Correction, and Prevention of Violations, those companies that come forward voluntarily, having met certain conditions, will have their penalties reduced for any violations uncovered. The conditions for reduced penalties are the following:

1. The violations were uncovered as part of a self-audit or due diligence done on property.

2. The violations were uncovered voluntarily. 3. The violations were reported to the EPA within ten days. 4. The violations were discovered independently and disclosed independently,

not because someone else was reporting or threatening to report. 5. There is correction of the violation within 60 days. 6. There is a written agreement that the conduct will not recur. 7. There can be no repeat violations or patterns of violations. 8. There is no serious harm to anyone as a result of the violation. 9. The company cooperates completely with the EPA.

The EPA will reduce fines and penalties by 75 percent if substantially all the conditions are met. If a company falls into the 75 percent mitigation category, the EPA will not recommend criminal prosecution to the Department of Justice. The documents related to the audit can be protected by the attorney–client priv- ilege, even those that are disclosed to the EPA. The clarification of the privilege has resulted in most companies taking advantage of the EPA’s self-reporting protections.

10-4d CeRCla and Brownfields

CERCLA has been so effective that 69 percent of all cleanups of designated Superfund sites are negotiated by the EPA settlements and orders. There are 1,323 Superfund sites as of October 2015, with 53 new sites to be added in 2016. For every Superfund dollar that is spent, there are eight dollars of private money contributed to cleanups by private responsible parties. Called brown- fields, these sites are defined by the EPA as “real property, the expansion, rede- velopment, or reuse of which may be complicated by the presence or potential presence of a hazardous substance, pollutant, or contaminant.” Brownfields often contribute to urban blight and present barriers to economic development and revitalization.5

The Small Business Liability Relief and Brownfields Revitalization Act was passed to allow 75 federal agencies to work together through the Federal Partner- ship Action Agenda. This agency provides funding for proposals to clean up and use these brownfields (42 U.S.C.A. § 9601). EPA rules promulgated under the act now provide a process for application to become an “innocent landowner,” or someone who seeks to develop the brownfield but wants an exemption from CERCLA expo- sure. That designation then allows the applicant to obtain federal funding for pur- poses of cleaning up and developing the brownfield. These brownfields are being cleaned up at a rate of about 1,300 sites per year, with a total of 24,511 cleanups through 2015 resulting in 56,442 reclaimed acres of land.

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Chapter 10 Environmental Regulation and Sustainability 345

10-5 Statutory Law: Environmental Quality Regulation

As part of its environmental control scheme, Congress also passed an act that regulates what governmental entities can do in the use of their properties. The National Envi- ronmental Policy Act (NEPA) of 1969 (42 U.S.C. § 4321) was passed to require federal agencies to take into account the environmental impact of their proposed actions and to prepare an environmental impact statement (EIS) before taking any proposed action.

An EIS must be prepared and filed with the EPA whenever an agency sends a proposed law to Congress and whenever an agency will take major federal action significantly affecting the quality of the environment. The information required in an EIS is as follows:

1. The proposed action’s environmental impact 2. Adverse environmental effects (if any) 3. Alternative methods 4. Short-term effects versus long-term maintenance, enhancement, and

productivity 5. Irreversible and irretrievable resource use

Examples of federal agency actions that have required the preparation of an EIS include the Alaskan oil pipeline, the extermination of wild horses on federal lands, the construction of government buildings such as post offices, and any high- way construction paid for with federal funds. Even the North American Free Trade Agreement (NAFTA) was challenged on the basis that an EIS was required.

In 2008, the U.S. Supreme Court held there was an exigency exception to the EIS requirements in a case in which Navy training that was necessary for national defense would have been unduly delayed and the resulting harm from the Navy’s use of sonar was not irreparable. [Winter v National Resources Defense Council, 555 U.S. 7 (2008)] The case introduces some cost-benefit analysis into the EIS process.

Sierra Club v United States Dep’t of Transportation (Case 10.3) involves the ques- tion of whether an EIS was needed.

Sierra Club v United States Dep’t of Transportation 753 F.2d 120 (D.C. 1985)

Skiing and Landing at Jackson Hole

Case 10.3

FaCts

In 1983, the Federal Aviation Administration (FAA) issued two orders amending the operations specifica- tions for Frontier Airlines, Inc., and Western Airlines, Inc. These amendments gave the airlines permanent authorizations to operate Boeing 737 jet airplanes (B-737s) out of Jackson Hole Airport, which is located within the Grand Teton National Park in Wyoming.

These two airlines are the only major commercial car- riers that schedule flights to and from Jackson Hole.

Private jets have flown into the airport since 1960, and Western Airlines has been flying into Jackson Hole since 1941. The airport is the only one in the country located in a national park, and Congress has continually funded expansions and improvements of the once-dirt, single-runway airport.

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346 part 2 Business: Its Regulatory Environment

In 1978, Frontier applied for permission to fly B-737s into the Jackson Hole Airport. The FAA released its EIS on the application in 1980, which found that B-737s were comparable with C-580 propeller aircraft (the type then being used by Western and Frontier) for noise intrusion but were substantially quieter than the private jets using the airport. The study also showed that fewer flights would be necessary because the B-737 could carry more passengers and that different flight paths could reduce noise. Based on this EIS, Frontier was given the right to use B-737s for two years. When Frontier applied for permanent approval, the FAA used the 1980 EIS and found that with flight time restrictions, the impact would not harm the environment.

Following FAA orders allowing the runway expan- sion, the Sierra Club (petitioner), a national conserva- tion organization, brought suit for the FAA’s failure to file an EIS for the 1983 amendments and for the use of national park facilities for commercial air traffic with- out considering alternatives. (Because this is an appeal of an administrative agency’s order, the case goes directly to the federal appellate level.)

JUdICIal OpINION

BORK, Circuit Judge We do not think the FAA violated NEPA by failing to prepare an additional EIS. Under NEPA, an EIS must be prepared before approval of any major federal action that will “significantly affect the quality of the human environment.” The purpose of the Act is to require agencies to consider environmental issues before taking any major action. Under the statute, agencies have the initial and primary responsibility to determine the extent of the impact and whether it is significant enough to warrant preparation of an EIS. This is accomplished by preparing an Environmental Assessment (EA). An EA allows the agency to con- sider environmental concerns, while reserving agency resources to prepare full EIS’s for appropriate cases. If a finding of no significant impact is made after analyzing the EA, then preparation of an EIS is unnecessary. An agency has broad discretion in making this determi- nation, and the decision is reviewable only if it was arbitrary, capricious or an abuse of discretion.

This court has established four criteria for review- ing an agency’s decision to forego preparation of an EIS. First, the agency must have accurately identified the relevant environmental concern. Second, once the agency has identified the problem, it must take a “hard look” at the problem in preparing the EA. Third, if a finding of no significant impact is made, the agency must be able to make a convincing case for its finding. Last, if the agency does find an impact of true signifi- cance, preparation of an EIS can be avoided only if the

agency finds that changes or safeguards in the project sufficiently reduce the impact to a minimum.

The first test is not at issue here. Both the FAA and Sierra Club have identified the relevant environmental concern as noise by jet aircraft within Grand Teton National Park. The real issues raised by Sierra Club are whether the FAA took a “hard look” at the problem, and whether the methodology used by the agency in its alleged hard look was proper.

We find that the FAA did take a hard look at the problem. The FAA properly prepared an EA to examine the additional impact on the environment of the plan. The EA went forward from the 1980 EIS. The 1980 EIS, which was based on extensive research by Dr. Hakes of the University of Wyoming, noise testing by the FAA, and data derived from manufacturer information, showed that noise intrusions of B-737 jets over the level caused by C-580 propeller aircraft amounted to only dbl near the Airport and decreased in proportion to the distance from the Airport. The agency, exercising its expertise, has found that an increase this minute is not significant for any environment. In addition, the EIS and Hakes studies were based on a worst-case scenario, and it was determined that if certain precautions were taken the actual noise levels could be diminished greatly.

Petitioner argues that because Jackson Hole Air- port is located within national parkland a different standard—i.e., individual event noise level analysis— is mandated. Both individual event and cumulative data were amassed in preparing the 1980 EIS on which the EAs were based. The fact that the agency in exercis- ing its expertise relied on the cumulative impact levels as being more indicative of the actual environmental disturbance is well within the area of discretion given to the agency. We agree with petitioner that although noise is a problem in any setting, “airplane noise is fundamentally inconsistent with the type of recreational experience Park visitors are seeking” and should be minimized. Here the FAA found that a cumulative noise increase of 1 dbl or less is not significant—even for the pristine environment in which Jackson Hole Airport is located.

Given all of these facts, we think the FAA was not required to prepare yet another EIS before granting permanent authorizations for the use of B-737s.

The orders of the FAA are hereby affirmed.

Case QUestIONs

1. What airport noise is at issue, and who was con- cerned about the issue?

2. What is the basis for the appeal?

3. What has the FAA allowed? Will the authoriza- tions stand?

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Chapter 10 Environmental Regulation and Sustainability 347

10-6 Statutory Law: Other Federal Environmental Regulations

In addition to the previously discussed major environmental laws, many other specific federal statutes protect the environment.

10-6a surface Mining

The Surface Mining and Reclamation Act of 1977 (42 U.S.C. § 6907) requires those mining coal to restore land surfaces to their original conditions and prohibits sur- face coal mining without a permit.

10-6b the Fracking Issue

Currently, several federal agencies, including the EPA, the Department of Energy (DOE), the Bureau of Land Management (BLM), the Centers for Disease Control (CDC), the Department of Agriculture (USDA), and the Securities and Exchange Commission (SEC), have adopted or are working on promulgating regulations related to hydraulic fracturing (fracking). First used in 1947, this process is now employed at 60 percent of oil and gas wells to bring those resources to the sur- face. This technique has become a lightning rod for opposition based on questions about its safety and impact on the environment. For example, the 2010 movie Gas- land resulted in public reaction based on the film’s representation of water contam- ination. The regulations proposed or being promulgated by federal agencies range from required disclosures in shareholder materials about a company’s fracking activity to prohibitions of fracking on federal lands.

10-6c Noise Control

Under the Noise Control Act of 1972 (42 U.S.C. § 4901), the EPA, along with the FAA, can control the amount of noise emissions from low-flying aircraft for the protection of landowners in flight paths.

10-6d pesticide Control

Under the Federal Environmental Pesticide Control Act, the use of pesticides is controlled. All pesticides must be registered with the EPA before they can be sold, shipped, distributed, or received. Also under the act, the EPA administrator is given the authority to classify pesticides according to their effects and dangers.

10-6e Osha

The Occupational Safety and Health Administration (OSHA) is responsible for workers’ environments. OSHA controls the levels of exposure to toxic substances and requires safety precautions for exposure to such dangerous substances as asbestos, benzene, and chloride.

10-6f asbestos

Buildings that contain asbestos materials remain a problem for buyers, sellers, and occupants. The Asbestos Hazard Emergency Response Act (AHERA), passed in 1986, required all public and private schools to arrange for the inspection of their facilities to determine whether their buildings had asbestos-containing materials. Schools are required to develop plans for containment, but other buildings are not

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348 part 2 Business: Its Regulatory Environment

regulated. The Clean Air Act does, however, define airborne asbestos as a toxic pollutant, and liability may result from the release of fibers from this known carcinogen. Further, an amendment to the Superfund Act classified asbestos as a community-right-to-know substance, which means a probable duty exists to disclose the presence of asbestos to buyers, tenants, and employees. Numerous ethical questions arise about the presence of asbestos and the obligations of land- owners to replace the asbestos given that the phaseout of its use did not end until 1997. Questions such as the impact of the release of asbestos from the walls when tenants, employees, and others hang photos and other objects by nailing them into the walls remain. The issues of the degree of harm and the cost of replacement con- tinue to be debated among property owners.

10-6g endangered species

In 1973, Congress passed the Endangered Species Act (ESA), a law that has been a powerful tool for environmentalists in protecting certain species through their advocacy of restrictions on commercial use and development when the habitats of certain species are interfered with. Under the act, the secretary of the interior is responsible for identifying endangered terrestrial species, and the secretary of com- merce identifies endangered marine species. In addition, these cabinet members must designate habitats considered crucial for these species if they are to thrive. In many instances, litigation results over questions about which species should or should not be on the list. Once a species is on the list, its critical habitat cannot be disturbed by development, noise, or destruction. Babbitt v Sweet Home Chapter of Communities for a Great Oregon (Case 10.4) has given federal agencies broad author- ity in protecting endangered species.ity in protecting endangered species.

Babbitt v Sweet Home Chapter of Communities for a Great Oregon 515 U.S. 687 (1995)

Jobs versus Owls: Lumber versus Endangered Species

Case 10.4

FaCts

Two U.S. agencies halted logging in the Pacific North- west because it endangered the habitat of the northern spotted owl and the red-cockaded woodpecker, both endangered species. Sweet Home Chapter (respon- dents) is a group of landowners, logging companies, and families dependent on the forest products indus- tries in the Pacific Northwest. They brought suit, seeking clarification of the authority of the secretary of the interior and the director of the Fish and Wildlife Service (petitioners) to include habitation modification as a harm covered by the ESA.

The federal district court found for the secretary and director and held that they had the authority to protect the northern spotted owl through a halt to log- ging. The court of appeals reversed. Bruce Babbitt, the secretary of the interior, appealed.

JUdICIal OpINION

Stevens, Justice Section 9(a)(1) of the Endangered Species Act pro- vides the following protection for endangered species:

Except as provided in sections 1535(g)(2) and 1539 of this title, with respect to any endangered species of fish or wildlife listed pursuant to section 1533 of this title it is unlawful for any person subject to the jurisdiction of the United States to—(B) take any such species within the United States or the territorial sea of the United States. [16 U.S.C. § 1538(a)(1)]

Section 3(19) of the Act defines the statutory term “take”:

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Chapter 10 Environmental Regulation and Sustainability 349

The term “take” means to harass, harm, pursue, hunt, shoot, wound, kill, trap, capture, or collect, or to attempt to engage in any such conduct. [16 U.S.C. § 1532(19)]

The Act does not further define the terms it uses to define “take.” The Interior Department regulations that implement the statute, however, define the statutory term “harm”:

Harm in the definition of “take” in the Act means an act which actually kills or injures wildlife. Such act may include significant habitat modification or deg- radation where it actually kills or injures wildlife by significantly impairing essential behavioral patterns, including breeding, feeding, or sheltering. [50 CFR § 17.3 (1994)]

We assume respondents have no desire to harm either the red-cockaded woodpecker or the spotted owl; they merely wish to continue logging activities that would be entirely proper if not prohibited by the ESA. On the other hand, we must assume arguendo that those activities will have the effect, even though unintended, of detrimentally changing the natural hab- itat of both listed species and that, as a consequence, members of those species will be killed or injured. Under respondents’ view of the law, the Secretary’s only means of forestalling that grave result—even when the actor knows it is certain to occur—is to use his § 5 authority to purchase the lands on which the survival of the species depends. The Secretary, on the other hand, submits that the § 9 prohibition on takings, which Congress defined to include “harm,” places on respondents a duty to avoid harm that habitat alteration will cause the birds unless respondents first obtain a permit pursuant to § 10.

The text of the Act provides three reasons for concluding that the Secretary’s interpretation is rea- sonable. First, an ordinary understanding of the word “harm” supports it. The dictionary definition of the verb form of “harm” is “to cause hurt or damage to: injure.” Webster’s Third New International Dictionary 1034 (1966). In the context of the ESA, that definition naturally encompasses habitat modification that results in actual injury or death to members of an endangered or threatened species.

Respondents argue that the Secretary should have limited the purview of “harm” to direct applications of force against protected species, but the dictionary defi- nition does not include the word “directly” or suggest in any way that only direct or willful action that leads to injury constitutes “harm.” Moreover, unless the statutory term “harm” encompasses indirect as well as direct injuries, the word has no meaning that does not duplicate the meaning of other words that § 3 uses to

define “take.” A reluctance to treat statutory terms as surplusage supports the reasonableness of the Secre- tary’s interpretation.

Second, the broad purpose of the ESA supports the Secretary’s decision to extend protection against activ- ities that cause the precise harms Congress enacted the statute to avoid. As stated in § 2 of the Act, among its central purposes is “to provide a means whereby the ecosystems upon which endangered species and threatened species depend may be conserved.”

Third, the fact that Congress in 1982 authorized the Secretary to issue permits for takings that § 9(a) (1)(B) would otherwise prohibit, “if such taking is incidental to, and not the purpose of, the carrying out of an otherwise lawful activity,” 16 U.S.C. § 1539(a)(1) (B), strongly suggests that Congress understood § 9(a) (1)(B) to prohibit indirect as well as deliberate takings. The permit process requires the applicant to prepare a “conservation plan” that specifies how he intends to “minimize and mitigate” the “impact” of his activ- ity on endangered and threatened species, 16 U.S.C. § 1539(a)(2)(A), making clear that Congress had in mind foreseeable rather than merely accidental effects on listed species.

The Court of Appeals made three errors in assert- ing that “harm” must refer to a direct application of force because the words around it do. First, the court’s premise was flawed. Several of the words that accom- pany “harm” in the § 3 definition of “take,” especially “harass,” “pursue,” “wound,” and “kill,” refer to actions or effects that do not require direct applications of force. Second, to the extent the court read a require- ment of intent or purpose into the words used to define “take,” it ignored § 9’s express provision that a “know- ing” action is enough to violate the Act. Third, the court employed noscitur a sociis to give “harm” essentially the same function as other words in the definition, thereby denying it independent meaning. The canon, to the contrary, counsels that a word “gathers mean- ing from the words around it.” The statutory context of “harm” suggests that Congress meant that term to serve a particular function in the ESA, consistent with but distinct from the functions of the other verbs used to define “take.” The Secretary’s interpretation of “harm” to include indirectly injuring endangered ani- mals through habitat modification permissibly inter- prets “harm” to have “a character of its own not to be submerged by its association.”

When it enacted the ESA, Congress delegated broad administrative and interpretive power to the Secretary. See 16 U.S.C. §§ 1533, 1540(f). The task of defining and listing endangered and threatened spe- cies requires an expertise and attention to detail that

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350 part 2 Business: Its Regulatory Environment

exceeds the normal province of Congress. Fashioning appropriate standards for issuing permits under § 10 for takings that would otherwise violate § 9 necessarily requires the exercise of broad discretion. The proper interpretation of a term such as “harm” involves a complex policy choice. When Congress has entrusted the Secretary with broad discretion, we are especially reluctant to substitute our views of wise policy for his. In this case, that reluctance accords with our conclu- sion, based on the text, structure, and legislative history of the ESA, that the Secretary reasonably construed the intent of Congress when he defined “harm” to include “significant habitat modification or degradation that actually kills or injures wildlife.”

In the elaboration and enforcement of the ESA, the Secretary and all persons who must comply with the law will confront difficult questions of proximity and degree; for, as all recognize, the Act encompasses a vast

range of economic and social enterprises and endeav- ors. These questions must be addressed in the usual course of the law, through case-by-case resolution and adjudication.

The judgment of the Court of Appeals is reversed.

Case QUestIONs

1. Is habitat modification harming endangered species?

2. Does the Court’s interpretation mean no intent is required to violate ESA?

3. Did Congress intend to give the secretary authority to shut down an industry?

Aftermath: In August 1995, Congress passed, as a rider to a budget-reduction bill, a provision that suspended environmental laws in some national forest areas in Washington and Oregon through 1996.

standing and esa In Bennett v Spear, 520 U.S. 154 (1997), the U.S. Supreme Court held that the ESA also permits lawsuits by landowners affected by the statute’s applica- tion. Landowners have equal rights along with environmental groups to chal- lenge ESA applications and restrictions. However, in a 2009 decision, the U.S. Supreme Court limited somewhat the ability of individuals and groups to bring suit under the ESA. In Summers v Earthland Institute, 555 U.S. 488 (2009), the U.S. Supreme Court held that the claim that the plaintiffs would be using various national parks around the country at some point in the future was not sufficient standing to bring suit to halt the U.S. Forest Service’s policies and regulation on forest clearing. The decision means that those who bring such challenges must have an “active, ongoing dispute” that is specific to

Cooperation as an alternative strategy to litigation

Business Strategy

Since the time of these head-on confronta- tions, the logging and paper industries have adopted a “Sustainable Forestry Initiative.” The Initiative, adopted by 200 members of the American Forest and Paper Association, supports eco-friendly logging. The Nature

Conservancy supports the Initiative, which has had the effect of negotiated solutions to the issue of logging versus environmental prohibi- tions. No further legislation has been needed at the federal level because of the cooperation between and among these groups. ©

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Chapter 10 Environmental Regulation and Sustainability 351

the activity. In addition, the species themselves cannot bring suit. In Cetacean Cmty. v Bush, 386 F.3d 1169 (9th Cir. 2004), the court held that the Cetacean community, consisting of whales, dolphins, and porpoises, lacked standing to sue the federal government under the ESA in claiming that the Navy’s pro- posed deployment of low-frequency active sonar harmed them. The court held that the ESA authorizes only persons to sue and that animals were meant to be protected rather than protectors under the statute.

Arizona Cattle Growers’ Association and Jeff Menges, a rancher seeking a graz- ing permit on the lands at issue (together called “ACGA”), sued the Fish and Wildlife Service and the BLM to challenge Inci- dental Take Statements (ITSs) issued by the Fish and Wildlife Service in a biolog- ical opinion for certain grazing lands. Mr. Menges sought livestock grazing permits for land within the area supervised by the BLM’s Saffold and Tucson, Arizona, field offices, and the Association represented members who claimed to be harmed by the government action. The BLM’s live- stock grazing program for this area affects 288 separate grazing allotments that in total comprise nearly 1.6 million acres of land. The Fish and Wildlife Service’s bio- logical opinion, issued on September 26, 1997, analyzed 20 species of plants and

animals and concluded that the livestock grazing program was not likely to jeopar- dize the continued existence of the spe- cies affected, nor was it likely to result in destruction or adverse modification of the designated or proposed critical habitat. The Fish and Wildlife Service did, however, issue ITSs for various species of fish and wildlife listed or proposed as endangered.

ACGA’s suit challenged both the ITSs and their terms and conditions. The chal- lenge was based on the fact that the razorback sucker and the cactus ferrugi- nous pygmy owl were in abundance and not endangered. The environmental groups challenged ACGA’s right to challenge the conclusions of the agency. Who is correct? [Arizona Cattle Growers’ Ass’n v U.S. Fish and Wildlife, Bureau of Land Management, 273 F.3d 1229 (9th Cir. 2001)]

Consider . . . 10.5

eminent domain and the esa An issue that arose under ESA was whether restrictions on land use that are imposed pursuant to the ESA are an eminent domain taking. Several cases have now held that ESA restrictions are neither takings nor compensable claims. [Seiber v U.S., 364 F.3d 1356 (4th Cir. 2004), cert. denied, 543 U.S. 873 (2004)]

10-6h state environmental laws

In addition to federal enactments, all the states have enacted some form of envi- ronmental law and have established their own environmental policies and agen- cies. Some states may require new industrial businesses to obtain a state permit along with the required federal permits for the operation of their plants. Some states regulate the types of fuels that can be used in vehicles and offer incentives for carpooling.

All states have some form of regulation on hazardous waste, a sort of CERCLA statute at the state level. Some states require sellers of real estate to furnish prop- erty disclosure statements to buyers prior to the closing of a sale. All states have some system of fines for environmental violations.

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10-7 Enforcement of Environmental Laws Federal environmental laws can be enforced through criminal sanctions, penalties, injunctions, and suits by private citizens.

10-7a parties Responsible for enforcement

Although many federal agencies are involved with environmental issues, the EPA is responsible for the promulgation of specific standards and the enforcement of those standards with the use of the remedies discussed in the following subsec- tions. The federal EPA may work in conjunction with state EPAs in the develop- ment and enforcement of state programs.

The Council on Environmental Quality (CEQ) was established in 1966 under the National Environment Act and is part of the executive branch of government. Its role in the environment regulatory scheme is that of policymaker. The CEQ is responsible for formulating national policies on the quality of the environment and then making recommendations to lawmakers regarding its policy statements.

Other federal agencies are involved in enforcement of environmental issues, such as the Department of the Interior, the Forest Service, the BLM, and the Depart- ment of Commerce. Basically, all federal agencies that deal with the use of land, water, and air are involved in compliance with and enforcement of environmental laws.

10-7b Criminal sanctions and penalties for Violations

Nearly all of the federal statutes previously discussed carry some form of sanc- tions, including criminal penalties for violations.

Ethical Issues

Asia Pacific Resources International Hold- ings, Ltd. (called April), signed a landmark agreement with the World Wildlife Fund, an environmental activist group. April agreed to curb timber-cutting areas in Sumatra, Indonesia, to preserve a natural rain forest with great biodiversity. Over the past 20 years, more than half of the forest has been cut down for lumber.

April’s customers, such as Procter & Gamble (makers of Charmin toilet paper and Bounty paper towels), were shunning April as a supplier because of its damage in Indonesia. While April complied with Indo- nesian law (leaving 20 percent of the forest untouched), it left long ribbon strips that could not support the local wildlife. Terms of the deal include the following:

• April will not allow other loggers to use its transportation system (barges and roads).

• April will verify the source of all logs it purchases.

• April will plant tree plantations and was expected to be able to sell only plantation-grown wood by 2009.

Local residents resent these agree- ments with environmental groups because their livelihoods have been blocked when April closes its road and prohibits use by illegal loggers. What advantages do you see in these private contract promises on environmental policy? What disadvantages do you see? What ethical issues prompted April’s voluntary actions?

Source: Steve Stecklow, “Environmentalists, Loggers Near Deal on Asian Rainforest,” Wall Street Journal, February 23, 2006, pp. A1, A14.

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Chapter 10 Environmental Regulation and Sustainability 353

penalties for Clean air act Violations Exhibit 10.1 summarizes the various penalties, which include fines, criminal con- victions, and civil penalties. The fines are assessed on the basis of days or per incident. In exercising its enforcement power, the EPA may require businesses to maintain records or to install equipment necessary for monitoring the amounts of pollutants being released into the air or water.

penalties for Water Violations The Clean Water Act carries criminal penalties of up to $25,000 per day and one year’s imprisonment. For violations that are willful, the penalties increase to $50,000 and/or three years, with repeat violation carrying penalties of $100,000 and/or six years.

Those responsible for oil spills are liable for penalties of $25,000 per day or $1,000 per barrel spilled. If the spill is the result of negligence or willful misconduct, the pen- alties are $3,000 per barrel spilled. Failure to report a spill can bring a $250,000 fine for an individual (sole proprietor or officer, according to agency and criminal liability principles) and up to five years of imprisonment or $1 million for a corporation. Civil penalties run higher and include the full cost of cleanup (up to $50 million) should those responsible not clean up the oil spill. When BP made admissions related to the settlement of the Deepwater Horizon spill, one of the penalties that resulted was that BP was banned from federal contracts for two years. That type of sanction is signifi- cant for an oil company because the ban means not being able to submit bids for drill- ing rights on federal lands, lands that bring the oil for 25 percent of the company’s revenues.

U.S. v Citgo Petroleum Corp. (Case 10.5) deals with the issue of criminal liability for environmental law violations.

U.S. v Citgo Petroleum Corp. 801 F.3d 477 (5th Cir. 2015)

“My Nest Is Best”: The Citgo Refinery Birds

Case 10.5

FaCts

In the 1980s, the Environmental Protection Agency exercised its authority under Section 111 of the Clean Air Act, 42 U.S.C. § 7411, to regulate oil refinery waste- water treatment systems. These systems emit danger- ous levels of volatile organic compounds (“VOCs”), such as xylene, toluene, and benzene. To mitigate the alleged health risks, the EPA sought to reduce the VOCs entering the wastewater system, reduce the surface area of wastewater exposed to the atmo- sphere, and control the venting of VOCs to the extent practicable.

CITGO’s Corpus Christi refinery drains collected wastewater and transports it to two CPI oil–water separators. On average, the CPIs removed about 70 percent of separable oil. The water flowed from the separators into two large equalization tanks, each

measuring 30feet tall and 240 feet in diameter. When unpredictable discharges occurred, oil pooled in the equalization tanks, and CITGO used vacuum trucks and skimmers to remove the excess oil. At the time of the alleged violations, the tanks did not have roofs.

During a surprise inspection in March 2002, gov- ernment officials found 130,000 barrels of oil float- ing atop the uncovered tanks. Texas environmental inspectors cited CITGO for violating the Clean Air Act. Because the equalization tanks contained such a large amount of oil and had no roofs, Texas author- ities concluded that CITGO was violating the Clean Air Act.

Because the government suspected that birds had died in the uncovered tanks, an indictment issued in 2007 also accused CITGO of violating the Clean Air Act and “taking” migratory birds in violation of the

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Migratory Bird Treaty Act (MBTA). CITGO was found guilty. In the nonjury phase of the trial, the district court found CITGO guilty of three counts for “taking” migratory birds. CITGO received $2 million fine for the Clean Air Act counts and $15,000 for each MBTA violation. CITGO appealed.

JUdICIal OpINION

JONES, Circuit Judge A century ago, out of a shared desire to “sav[e] from indiscriminate slaughter and [to] insur[e] the pres- ervation of such migratory birds as are either useful to man or are harmless” the United States and the United Kingdom (on behalf of Canada) agreed to “adopt some uniform system of protection,” and adopted the Migratory Bird Protection Agreement. To implement the new accord, Congress passed the Migratory Bird Treaty Act of 1918. The MBTA makes it “unlawful at any time, by any means or in any manner, to pursue, hunt, take, capture, kill, attempt to take, capture, or kill . . . any migratory bird,” in violation of regulations and permits. The act impos- es strict liability on violators, punishable by a max- imum $15,000 fine and six months imprisonment.

On appeal, the CITGO asserts that illegally “taking” migratory birds involves only “conduct intentionally directed at birds, such as hunting and trapping, not [ ] commercial activity that uninten- tionally and indirectly causes.” [W]e agree with the Eighth and Ninth circuits that a “taking” is limited to deliberate acts done directly and intentionally to migratory birds.

CITGO was indicted for “taking” or “aiding and abetting the taking” of migratory birds, not for “kill- ing” them. We confine analysis to the charging term. The term “take” is “as old as law itself.” Babbitt v Sweet Home Chapter Cmtys. for a Great Or., 515 U.S. 687, 717, 115 S.Ct. 2407, 2422, 132 L.Ed.2d 597 (1995) Justice Scalia’s discussion of “take” as used in the Endangered Species Act is not challenged here by the government, nor was it criticized by the majority in Sweet Home, because Congress gave “take” a broader meaning for that statute. One does not reduce an animal to human control accidentally or by omission; he does so affirmatively.

The government disputes that the common law definition is so limited. Its brief asserts that, at the time Congress passed the act, “take” was not limited to hunting and trapping and that it had a wide vari- ety of contemporaneous meanings. That “take” can or might have had a wide range of meanings is not determinative, because when the MBTA was passed in 1918, “take” was a well-understood term of art

under the common law when applied to wildlife. The government does not explain why Congress implicitly intended to vary from the common law meaning in the MBTA.

A simple comparison with related statutes, both enacted fifty or more years later, shows that Congress well knew how to expand “take” beyond its common law origins to include accidental or indirect harm to animals. The Endangered Species Act (“ESA”) explic- itly defines “take” to mean “harass, harm, pursue, hunt, shoot, wound, kill, trap, capture, or collect, or to attempt to engage in any such conduct.” The inclusion of “harass” and “harm” modified the common law definition. The term “harass,” as interpreted by the ESA’s regulations, includes not just intentional acts, but a “negligent act or omission.” The MBTA adds that the covered activities—pursuit, hunt, taking, captur- ing, killing—are illegal if committed “at any time, by any means, in any manner.” The addition of adverbial phrases connoting “means” and “manner,” however, does not serve to transform the nature of the activities themselves. For instance, the manner and means of hunting may differ from bow hunting to rifles, shot- guns, and air rifles, but hunting is still a deliberately conducted activity. Likewise, rendering all-inclusive the manner and means of “taking” migratory birds does not change what “take” means, it merely modifies the mode of the take.

More fundamentally, we disagree that because mis- demeanor MBTA violations are strict liability crimes, a “take” includes acts (or omissions) that indirectly or accidentally kill migratory birds. These and like decisions confuse the mens rea and the actus reus requirements. Strict liability crimes dispense with the first requirement; the government need not prove the defendant had any criminal intent. But a defendant must still commit the act to be liable. Further, crim- inal law requires that the defendant commit the act voluntarily.

After surveying many circuit and district court cases, the district court adopted the Tenth Circuit’s position and held it “obvious” that “unprotected oil field equipment can take or kill migratory birds.” [T]here are at least two flaws in the district court’s attempt to reconcile its approach with other oil field cases. Most importantly, the MBTA’s text provides no basis, explicitly or implicitly, for criminalizing migratory bird deaths because they result from violations of other state or federal laws. Second, as already discussed, CITGO did not violate the Clean Air Act, the only law which the government accused it of violating. Moreover, although the district court accused CITGO of violating state law, the company

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Chapter 10 Environmental Regulation and Sustainability 355

was never charged or convicted of state law viola- tions. Thus, even under the district court’s errone- ous legal interpretation, the MBTA convictions must be overturned.

We note a final factor that supports our interpre- tation of the MBTA. The scope of liability under the government’s preferred interpretation is hard to over- state. The MBTA protects approximately 836 species of birds. According to the U.S. Fish and Wildlife Service, between 97 and 976 million birds are killed annually by running into windows. Communication towers kill an additional four to five million birds each year, though the government estimates the number may be closer to forty or fifty million. Cars may kill approximately 60 million birds each year. Even domesticated cats are serial violators of the MBTA. In Wisconsin alone, the government estimates that domesticated cats killed 39 million birds. The government refused to speculate on the number of birds that cats kill nationwide, though it would certainly be “much higher.”

If the MBTA prohibits all acts or omissions that “directly” kill birds, where bird deaths are “foresee- able,” then all owners of big windows, communica- tion towers, wind turbines, solar energy farms, cars, cats, and even church steeples may be found guilty of violating the MBTA. This scope of strict criminal liability would enable the government to prosecute

at will and even capriciously (but for the minimal protection of prosecutorial discretion) for harsh penalties: up to a $15,000 fine or six months’ impris- onment (or both) can be imposed for each count of bird “taking” or “killing.” Equally consequential and even more far-reaching would be the societal impact if the government began exercising its muscle to prevent “takings” and “killings” by regulating every activity that proximately causes bird deaths. The absurd results that the government’s interpretation would cause further bolsters our confidence that Congress intended to incorporate the common-law definition of “take” in the MBTA.

Accordingly, we reverse the convictions and remand with instructions to enter a judgment of acquittal.

CASE QUESTIONS

1. Explain why the meaning of “take” is important and what it meant at the time that the MBTA was passed.

2. What does the Court worry would happen if it adopted the government’s definition of “take”?

3. What would you advise CITGO to do in operat- ing its refineries?

Exhibit 10.1 Penalties for Violation of Federal Environmental Laws

ACT PENALTIES PRIVATE SUIT Clean Air Act $25,000 per day, up to one year

imprisonment; 15 years for willful or repeat violations; $10,000 rewards

Citizen suits; authorized EPA suit for injunctive relief

Clean Water Act $25,000 per day, up to one year imprisonment, or both; $50,000/three years for violations with knowledge; $100,000/six years for subsequent violations

Citizen suits; authorized EPA suit for injunctive relief

Resource Conservation and Recovery Act (Solid Waste Disposal Act)

5 years and/or up to $50,000 per day violation

15 years and/or up to $250,000 or $1,000,000 if an organization for intentional

Citizen and negligence suits after EPA refuses to handle

Oil Pollution Act $25,000 per day, or $1,000 per barrel; $3,000 per barrel if willful or negligent; $250,000 and/or 5 years for failure to report

Hazardous Substance/Response Trust Fund for cleanup; EPA suit for injunctive relief and reimbursement of trust funds; private actions in negligence

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356 part 2 Business: Its Regulatory Environment

10-7c Group suits: the effect of environmentalists

In many circumstances, private suits have had the most effect either in terms of obtaining compliance with environmental regulations or in terms of abating existing nuisances affecting environmental quality. The reason for the success of these suits may be the ultimate outcome of the litigation—possible business shutdowns and, at the least, the payment of tremendous amounts of damages and costs.

Private suits have been brought by environmental groups that have both the organizational structure and sufficient funding to initiate and complete such suits. In some cases, environmental groups are formed to protest one specific action, as is the case of Citizens Against the Squaw Peak Parkway; other groups are national organizations that take on environmental issues and litigation in all parts of the country. Examples of these national groups include the Sierra Club; the Envi- ronmental Defense Fund, Inc.; the National Resources Defense Council; and the League of Conservation Voters. Some environmental groups represent business interests in environmental issues, as does the Mountain States Legal Foundation, which becomes involved in presenting business issues when private organizations and individuals bring environmental suits.

These environmental groups have been successful not only in bringing private damage and injunctive relief suits but also in forcing agencies to promulgate regu- lations and to enjoin projects when EISs should have been filed but were not.

10-8 International Environmental Issues 10-8a the eU and environmentalism

The European Union (EU) has passed more than 200 environmental directives that focus on noise restrictions; protection of endangered species; energy efficiency; recycling; and air, land, and water quality. The view of the EU is that environmen- tal planning is to be conducted by member states as part of their economic devel- opment plans and processes. The EU’s European Environment Agency serves as a clearinghouse for environmental information; eventually the agency will operate for members in a manner similar to the EPA.

Many EU directives are designed to eliminate the need for regulation by encour- aging different business choices and educating consumers. One directive requires manufacturers to make 90 percent of all packaging materials recyclable. Another directive awards companies the use of an “eco-audit” sticker on their labels and stationery if they comply with an annual environmental audit of their manufactur- ing, waste management, materials use, and energy choices. An innovative direc- tive of the EU created an EU-wide “eco-label” to be placed on all consumer goods to provide information about the environmental impact of a product’s production, distribution, life, and disposal.

10-8b IsO 14000

The International Organization for Standardization (ISO) has developed its ISO 14000 series of international environmental standards.

Under ISO 14000, companies can become ISO certified, which will permit them to place special insignias on their materials, correspondence, and products to indi- cate their ISO standing. ISO standards emphasize not only compliance but also

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Chapter 10 Environmental Regulation and Sustainability 357

self-audits and self-correction. Genuine dedication to improvement is a key stan- dard for this environmental certification.

10-8c leed Certification

LEED (Leadership in Energy and Environmental Design) is a voluntary interna- tional sustainability program that provides third-party verification of green build- ings. LEED standards deal with the energy sources and uses in buildings and also require that owners think through the full life cycle of a building in making design, energy, and materials decisions. The organization not only offers certification but also issues awards for creativity and design to architects, owners, and builders in meeting LEED standards.

Biographythe story of Bp’s deepwater horizon Well and Oil spill

Before the April 20, 2010, explosion of the BP Deepwater Horizon rig in the Gulf Coast, BP was in the midst of a culture change undertaken in response to three previous incidents that injured employees and damaged the environment. BP’s Prud- hoe Bay pipeline burst in March 2006 and resulted in a spill of 267,000 gallons of oil. Industry standards require smart pigging of pipelines every five years. However, BP had not done smart-pigging on the Prudhoe Bay line since 1998. BP had a request from a board member to look into maintenance issues at Prudhoe Bay; he indicated that he was concerned about serious corrosion issues. A 2004 internal report written by an external consultant warned the company about accelerated corrosion on the Prudhoe pipeline, but BP did not undertake maintenance, nor did it develop a plan for testing the pipeline.

In addition, in 2005, BP had entered into an agreement with OSHA to fix the safety violations at its Texas City Refin- ery. OSHA had found 271 violations at the refinery. The Chemical Safety Board (CSB) report on the refinery concluded that cost cutting played a role in BP’s failure to address the ongoing OSHA vio- lations. BP had commissioned a series of audits and studies in 2002 that revealed serious safety problems at the Texas City refinery, including a lack of necessary preventive maintenance and training, and

although these audits and studies were shared with BP executives in London and were provided to at least one mem- ber of the executive board, few changes were made. Instead, in 2004, BP execu- tives challenged their refineries to cut yet another “25 percent from their budgets for the following year.”6

Tragically, the inattention and cost cutting were a direct contributor to the explosion at BP’s Texas City Refinery that resulted in a loss of 15 lives and injuries to 500 workers. The CSB investigation into the refinery tragedy was headed by James Baker, former U.S. secretary of state, who found “instances of a lack of operating discipline, toleration of serious deviations from safe operating practices and apparent complacency toward seri- ous process safety risks at each refinery.” The OSHA investigation of the refinery found a total of 439 “willful and egre- gious” violations, a finding that resulted in the largest fine in OSHA’s history, $87 million.

The Texas City tragedy and the Prud- hoe Bay spill were so public and resulted in such negative publicity that the BP board made a change in the company’s leader- ship. CEO Lord Browne was removed and Mr. Tony Hayward, a reserved geologist, was expected to help the company turn the corner on its safety and prudence issues. However, Mr.  Hayward was not

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able to make the cultural corrections the board hoped would happen. A 2007 internal report, issued one year into Mr. Hayward’s tenure, concluded that there had been “unprecedented levels of issues and acci- dents at BP and that there was a culture of pervasive unwillingness to stop work when something was clearly wrong.”7

All employees were reminded of Mr. Hayward’s singular message, “Safety is our first priority.”8 But as the safety pro- gram was continued in earnest, there were increasing problems with both the deci- sions about, and the conduct on, BP’s offshore rigs.

Almost two years after Texas City and Prudhoe Bay, and nearly two years before the Deepwater Horizon spill, was the June 5, 2008, 193-barrel oil spill at BP’s Atlantis rig (also in the Gulf of Mexico). The internal report included the following information:

“[Managers] put off repairing the pump in the context of a tight cost budget.”

“Leadership did not clearly question the safety impact of the delay in repair.”

A BP safety officer told company inves- tigators, “You only ever got questioned on why you couldn’t spend less.”?9

During this period of ongoing safety lapses and resulting casualties, BP con- tinued its stellar financial performance. In 2007, BP’s shares were at $77. Its debt/ equity ratio was 0.31, its dividend rate was 15 percent, and it had a 20 percent ROE, with gross margins of 27 percent and net margins of 7.47 percent. EPS growth in 2008 was at 64 percent.

The evidence that has emerged on Deepwater Horizon followed the patterns in place at the refinery and other rigs. A whistle-blower allegation based on e-mails expressed concern about whether cru- cial engineering drawings and paperwork necessary prior to operation of offshore rigs had been completed. The e-mails also reveal that engineers who asked for an additional ten hours in the critical path to address their concerns about the well by installing 21 centralizers instead of just six

were dismissed by the lead engineer with “I do not like this.”10

At hearings before the House of Rep- resentatives, other oil company CEOs tes- tified that BP did not follow appropriate design standards in drilling the well.11 A Wall Street Journal study found that BP used a risky design that was cheaper for one out of three of its deep-water wells. The so-called long-string design is one that uses a single pipe for bringing the oil to the surface. Experts indicate that the result of using one long pipe is that natural gas accumulates around the pipe and can rise unchecked. Most experts recommend its use only in low-pressure wells, not wells such as Deepwater Horizon. They also note that long-string drilling would not be appro- priate when a company does not know the area, something that was true about this well for BP.

The Costs

Following the spill, which is the largest in history, BP lost $30 billion, or 16 percent of its market value.12 Prior to the Deepwater Horizon explosion and spill, BP’s share price was at $62. By July, the share price was $38. BP certainly has displaced Exxon and its Valdez as the bad poster child for oil companies. Retail sales at BP stations dropped 8 to 10 percent after the spill.13

The costs, in terms of cash outlays, continue for BP. From April through July, BP spent $7 million per day trying to contain the spill. BP was given an ultimatum by the Obama administration. Shortly after a White House meeting, BP placed $20 billion in an escrow account for the U.S. government to distribute to those in the Gulf-area states who have been harmed by the spill. BP sold off $7 billion in assets to cover the expenses and the $20 billion. BP took a $32 billion charge in July 2010 for the Gulf oil spill costs.

As noted earlier in the chapter, BP paid fines and civil penalties for the spill and is under a two-year ban from federal con- tracts, which can be lifted if the company is able to demonstrate that ethical standards have been restored at the company.

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Chapter 10 Environmental Regulation and Sustainability 359

s u m m a r y What are the public and private environmental laws? What protections and requirements are present in environmental laws?

• Nuisance—bad smells, noises, or dirt from one prop- erty that interferes with another’s use and enjoyment of their own property

• Nonattainment areas—areas with significant air pol- lution problems

• Emissions offset policy—new plants not built until new emissions are offset by reductions elsewhere

• Bubble concept—EPA policy of maximum air emis- sions in one area

• Clean Air Act—federal law that controls air emissions

• Maximum Achievable Control Technology (MACT)—best means for controlling emissions

• Clean Water Act—federal law that regulates emis- sions in various water sources

• Effluent guidelines—EPA maximum allowances for discharges into water

• Safe Drinking Water Act—federal law establishing standards for contaminants

• Oil Pollution Act (OPA)—federal law imposing civil and criminal liability for oil spills

• Resource Conservation and Recovery Act (RCRA)— federal law controlling disposal of hazardous waste through a permit system

• Superfund—funds available for government to use to clean up toxic waste sites

• Comprehensive Environmental Response, Compen- sation, and Liability Act (CERCLA)—federal law providing funds and authority for hazardous waste site cleanups

• Endangered Species Act (ESA)—powerful federal law that can curb economic activity if it presents harm to endangered species or their habitat

Who enforces environmental laws?

• Environmental Protection Agency (EPA)—federal agency responsible for enforcement of environmental laws at the federal level

• National Environmental Policy Act (NEPA)—federal law that requires federal agencies to assess environ- mental issues before taking actions

• Environmental impact statement (EIS)—report by federal agency on study of proposed action’s effect on the environment

What are the penalties for violations?

• Injunction—judicial order halting an activity

• Fines and criminal penalties

Q u e s t i o n s a n d P r o b l e m s 1. American Rivers, a national river conservation orga- nization, the Environmental Defense Fund, and several national and local environmental organizations brought suit against the U.S. Army Corps of Engineers, the sec- retary of the army, and the secretary of the interior, seek- ing to protect the endangered least tern, the endangered pallid sturgeon, and the threatened Great Plains piping plover, all of which are protected by the ESA.

The groups allege that the manner in which the Corps has operated the extensive dam and reservoir system on the Missouri River has adversely affected the three spe- cies. Do the groups have the right to assert the claim? What response can the government agencies offer? What should the court do? [American Rivers v U.S. Army Corps of Engineers, 271 F. Supp. 2d 230 (D.D.C. 2003)]

2. Under a 2007 mandate from Congress, the Army Corps of Engineers conducted a two-year study, called the Great Lakes and Mississippi River Interbasin Study, of the problem of Asian carp entering the Great Lakes via Chicago’s web of waterways. Asian carp are known as a “nuisance species” that quickly gobbles up the plankton, thereby threatening the food source of the sport fish in the lakes. Conservation groups want the Corps to block the access ways as quickly as possible, but sports fish- ers and commercial shipping companies worry that the impact of blocking the flow of the waterways will have on the lakes. The Corps’ 210-page study estimates the cost of blocking the waterways at $18 billion. Explain what needs to be done under these circumstances and how the Corps should proceed. (Michael Wines, “$18

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360 part 2 Business: Its Regulatory Environment

Billion Price Put on Effort to Block Carp,” New York Times, January 7, 2014, p. A10.)

3. A group of landowners situated near the Sanders Lead Company brought suit to recover for damages to their agricultural property from accumulations of lead particulates and sulfur oxide deposits released in Sand- ers’s production process. The landowners’ property had increased in value because of its commercial potential in being close to the plant. Sanders employs most of the town’s residents in its operations. What common law and statutory rights do the landowners have, and what relief can be obtained? [Borland v Sanders Lead Co., Inc., 369 So.2d 523 (Ala. 1979)]

4. In 1985, Manufacturers National Bank of Detroit issued a letter of credit for Z&Z Leasing, Inc., an indus- trial firm, to enable Z&Z to obtain bond financing from Canton Township, Michigan.

After six years of operation, Z&Z was not doing well and had defaulted on its bond obligations. A consul- tant for the bank found underground storage tanks on Z&Z’s site. The tanks contained a yellowish liquid that was found to be a solvent and a hazardous substance. The bank paid off the Canton township bond obligation and foreclosed on the Z&Z property. By 1993, Z&Z had still not sold the property, and the EPA sought to hold the bank liable as an operator for the costs of cleaning up the tanks.

Can the bank be held liable? [Z&Z Leasing, Inc. v Graying Reel, Inc., 873 F. Supp. 51 (E.D. Mich. 1995)]

5. Holex Company purchased a property in Hollister, California, in 1957. From 1957 through 1980, Holex man- ufactured and tested military munitions under contract with the U.S. government. Whitaker purchased the prop- erty in 1980 and continued the government munitions contract work through 1994.

The California Department of Health Services found that there were elevated levels of TCE in the groundwa- ter beneath the site. Remediation efforts were under- taken, and the parties dispute who is liable for the costs of the remediation of the property. Whittaker purchased a Pollution Legal Liability policy from Chartis Specialty Insurance, and the munitions site is listed as covered under the policy.

The parties and Chartis argue that those who oper- ated the munitions site were doing so under specific direction and specification of the U.S. government. They argue that the U.S. government has liability as a respon- sible party under CERCLA. Explain the requirements for imposing CERCLA liability and discuss whether the U.S. government can be held to be a responsible party. [Char- tis Specialty Insurance Company v. U.S., 2013 WL 3803334 (N.D. Cal. 2013)]

6. Joseph Marcantuone and Robert Gieson owned a shopping center in which one of the spaces was always leased as a dry cleaners. Eventually, the city of East Orange, New Jersey, took the property by eminent domain in order to expand the facilities for a school located next to the shopping center. In performing due diligence, the city learned that solvents from the dry cleaner operations had made their way into the soil beneath the property. The city asked that Messrs. Mar- cantuone and Gieson pay over $200,000 for the cleanup. Can they be held liable for what the dry cleaner tenants did? [New Jersey Schools Development Authority v Marcan- tuone, 54 A.3d 830 (N.J.Super. 2012)]

7. The Natural Resources Defense Council, Inc.; the Humane Society of the United States; the Cetacean Soci- ety International; the League for Coastal Protection; the Ocean Futures Society; and Jean-Michel Cousteau filed suit in federal district court to obtain a preliminary injunction against federal officials to prevent the U.S. Navy’s peacetime use of a low-frequency sonar system for training, testing, and routine operations. This new technology, Low Frequency Active Sonar (LFA), sends out intense sonar pulses at low frequencies that travel hundreds of miles in order to timely detect increasingly quiet enemy submarines. The complaint alleges that the use of LFA is a violation of the Marine Mammal Protec- tion Act, the ESA, the NEPA, and the Administrative Pro- cedures Act. The complaint claims that these violations will cause irreparable injury to sea creatures, many of them rare and endangered, including whales, dolphins, seals, sea turtles, and salmon.

The Navy argues that enjoining the peacetime use of LFA sonar would harm national security, even though the Navy would still be free to use it during wartime or periods of heightened threat because training and test- ing are necessary for military readiness.

Do the groups and Mr. Cousteau have standing to challenge the Navy’s work? Can the Navy’s work be enjoined? What should the court decide and why? [Nat- ural Resources Defense Council, Inc. v Evans, 232 F. Supp. 2d 1003 (N.D. Cal. 2002)]

8. The Sawtooth National Forest established its first travel plan map in 1989. The travel plan map was reprinted in 2002. The maps show visitors to the area the system of roads and trails available for their use as well as how and when they could use them. The National Forest Service decided to revise the current travel plan map to restrict motor vehicle use to designated roads and trails. The revision was initiated in response to the 2005 Travel Management Rule, which mandated certain changes to the management of motor vehicle use on National Forest System lands. Prior to the 2005 Travel Management Rule, motor vehicle use on public

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Chapter 10 Environmental Regulation and Sustainability 361

lands was largely unregulated, resulting in uncontrolled cross-country motor vehicle use, unplanned routes, and damage to the resources. New maps were printed with designated routes, which included some motor vehicle access but limited those routes as compared with pre- vious route use. Any motor vehicle other than desig- nated in the new maps is prohibited under federal law. The Wilderness Society filed suit to stop the new route use plan on the grounds that the Forest Service did not file an EIS. The Forest Service responded that its new plan restricted motor vehicle transport and did not expand it and did not require that an EIS be filed. What should the court decide about the transportation plan? [Wilderness Society v U.S. Forest Service, 850 F. Supp. 2d 1144 (D. Idaho 2012)]

9. CNH owns approximately 100 acres of land near Lake Michigan and operated a foundry and tractor assembly plant there. In July 2004, CNH and Cham- pion entered into a contract that required Champion to remove dismantled equipment, property, materials, and debris from the property and dispose of it legally. Champion was also required to fill all pits, basements, utility tunnels, and other subsurface openings with crushed construction-grade fill concrete. The contract specified that Champion was to comply with all appli- cable laws.

In 2007, a CNH employee saw a Champion truck delivering fill material to fill a large basement area, which had been the tractor assembly portion of the plant. The CNH employee said the fill had a noticeable diesel odor. Although the parties’ contract required that the material used for fill was to be obtained from the site, Champion’s truck came from outside CNH’s Property. Champion’s then–vice president told CNH managers that the fill material came from Racine Steel Castings and that it had delivered 20 to 25 truckloads to CNH property for fill.

CNH had an environmental consulting firm test the fill material, and the lab concluded that the fill material was contaminated with PCBs, gasoline range organics,

and diesel range organics. CNH then notified state and federal authorities of the problem. The government agencies held CNH liable for the cost of cleanup. Discuss whether CNH has any right of recovery from Champion. What happens if Champion is insolvent? What if all of the substances found in the fill were also found on other parts of CNH’s property? [CNH America, LLC v Champion Environmental Services, Inc., 863 F. Supp. 2d 793 (E.D.Wis., 2012)]

10. Larry Dobbs, Frances Dobbs, Wayne Richard, and Lorena Richard live in rural Illinois next to Donald Wiggins. The Dobbses and Richards have lived on their properties for 30 years. Mr. Wiggins purchased his property in 1995 and built a home and dog kennels on that property and began raising, training, and ken- neling dogs.

At first, Wiggins did not have many dogs, and the dogs did not bark much. However, the noise from bark- ing dogs kenneled on Wiggins’s property grew worse over time. Larry planted a row of cedar trees on his property to try and cut down on the barking noise.

However, the Dobbses’ house was approximately 200 to 250 yards from a barn where Wiggins kenneled many of his dogs. The barking was constant, day and night. The dogs might bark for two straight hours, take a break, and start barking again, but there was never any extended period of time in which they com- pletely quit barking. There was rarely a complete hour in which the dogs did not bark. The dogs barked more when they were being fed or when they thought they were going to be taken out of their kennels. In addi- tion, deer and other wildlife running across the prop- erty and coyotes howling at night tended to stir up the dogs.

The Dobbses and Richards filed suit seeking an injunction against the dog kenneling operation, and at that time there were a total of 69 dogs on Wiggins’s property. Based on your study of nuisances in this chap- ter, explain what the court should do. [Dobbs v Wiggins, 929 N.E.2d 30 (Ill. App. 2010)]

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362 part 2 Business: Its Regulatory Environment

Sustainability & the Law Animal Rights and Double Showerheads

Sustainability requires us to think beyond environ- mental law to consequences and impact. Review the following two situations and develop an analysis that addresses consequences and impact.

People for the Ethical Treatment of Animals (PETA) has been a powerful force in demanding changes in corporate behavior. Its latest target has been Burger King for its treatment of chickens—the group wants the company to stop removing the beaks of laying hens and also to enlarge the animals’ cages. Also, PETA would like Burger King to ensure that its animals are stunned before they are slaughtered. PETA has devel- oped a new logo and name for the company, MURDER KING. Burger King is suffering from flat sales and does not welcome the negative publicity. How would you respond to PETA’s concerns? Visit the websites of both PETA and Burger King for more information on these issues: www.peta.org and www.bk.com.

A federal regulation promulgated by the EPA restricts the amount of water than can flow from showerheads to a rate of 2.5 gallons per minute. When the regulation took effect, many hotel chains had com- plaints from their guests about the slow water flow and the difficulty they had in bathing. Westin Hotels and Resorts announced that it would install two shower- heads in the baths and showers of its hotel rooms to accommodate its guests. Each showerhead will meet federal requirements, but if the two are both turned on, the guests will have water at a rate of five gallons per minute. Westin maintains that it is in compliance with the law. A federal employee responded, “But we didn’t anticipate the loophole of two shower heads per shower.”14 Discuss the Westin approach to compliance with the law.

1. The decision in this case does differ from decisions in other states. For example, in Toftoy v Rosenwinkel, 983 N.E.2d 463 (Ill. 2012), the Illinois Supreme Court relied on that state’s Farm Nuisance Act that prohibits neighbors from bringing private nuisance actions against farming operations and concluded that cattle and stable operations that result in flies and smell were not subject to injunctions. Such statutes were passed to protect farms and farming operations that predated the subdivision and development of surrounding land. In other words, some states balance nuisance cases by favoring farming.

2. James Glanz, “Data Barns in a Farm Town, Gobbling Power and Flexing Muscle,” New York Times, September 24, 2012, p. A1.

3. Carbon Pollution Emission Guidelines for Existing Stationary Sources: Electric Utility Generating Units, 80 Fed. Reg. 64662 (October 23, 2015).

4. The work of Professors Cindy A. Schipani and Lynda J. Oswald is an excellent resource for discussions on parent liability for CERCLA violations as well as a history of the development and scope of CERCLA. See, for example, Oswald and Schipani, “CERCLA and the ‘Erosion’ of Traditional Corporate Law Doctrine,” 86 Northwestern Law Review 259 (1990). Their work was referred to in the Bestfoods case.

5. For more information about brownfields, go to http://www .epa.gov/brownfields.

6. Sheila McNulty, “BP Safety Culture under Attack,” Financial Times, March 20, 2007, p. 15. The report recommended that BP comply with 29 C.F.R. 1910.119, Process Safety Management of Highly Hazardous Chemicals, and implement an effective means of process safety management.

7. Guy Chazan, Benoit Faucon, and Ben Casselman, “Safety and Cost Drives Clashed as CEO Hayward Remade BP,” Wall Street Journal, June 30, 2010, p. A1.

8. Sarah Lyall, Clifford Kraus, and Jad Mouawad, “In BP’s Record, a History of Boldness and Blunders,” New York Times, July 13, 2010, p. A1.

9. Guy Chazan, Benoit Faucon, and Ben Casselman, “Safety and Cost Drives Clashed as CEO Hayward Remade BP,” Wall Street Journal, June 30, 2010, p. A1.

10. Neil King Jr. and Russell Gold, “BP Crew Focused on Costs: Congress,” Wall Street Journal, June 15, 2010, pp. A1, A5.

11. Julie Schmit, “Oil Execs: BP Didn’t Meet Standards,” USA Today, June 16, 2010, p. 1B.

12. Peter Coy and Stanley Reed, “Lessons of the Spill,” Bloomberg BusinessWeek, May 10–May 16, 2010, p. 48.

13. Naureen S. Malik, “Protests Target BP but Hit Independents,” Wall Street Journal, June 16, 2010, p. A4.

14. Chris Woodyard, “Dual Shower Heads Land Hotel in Hot Water,” USA Today, May 22, 2001, p. 1B.

n ot e s

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363

Part

3 Business Sales, Contracts, and Competition

This section of the book covers the laws and regulations on what a business sells, how it sells its product, the condition of that product, and how the sales are financed. Do you have the right to sell a product,

or have you appropriated someone else’s idea? What can you say and

write in your advertising? What is fair and legal in competition? When

do you have a contract, and what kinds of terms do you need to have

in it? In this era of electronic commerce, what exactly is a contract, and

when is it formed? When has a contract been performed, and what is

a breach? Can you be compensated if the other side fails to perform?

How are transactions financed, and what disclosures do you need?

What are a seller’s rights for collecting payments due from buyers?

An overarching issue in all sales is whether businesses are competing

on the merits of their products or whether they are colluding on price

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364 Part 3 Business Sales, Contracts, and Competition

or bids. If you build a better mousetrap, you are entitled to the customers

that quality brings. But if you refuse to deal with your bug spray customers

unless they buy your inferior mousetrap, then the antitrust laws apply. The

level playing field is what antitrust laws protect in competition.

This portion of the text covers the issues of contracts, production,

advertising, property ownership and rights, and competition. The materials

walk through the heart of business operations all the way from contract

performance to receivables collection.

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366

11 Contracts allow businesses to count on money, supplies, and services. Contracts are the private law of business; the parties develop their own pri- vate set of laws through their contracts. These private laws can be enforced by the courts in all states. This chapter covers contract basics: What is a con- tract? What laws govern contracts? What are the types of contracts? How are contracts formed? What statutes apply to consumer contract formation and credit extension? What contracts must be in writing?

Chapter

Contracts and Sales: Introduction and Formation

UPdate For up-to-date legal and ethical news, go to mariannejennings.com

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367

11-1 What Is a Contract? Businesses cannot expand and grow without being able to rely on commitments; resources are wasted if promises are not fulfilled. For example, suppose that Aunt Hattie’s Bread Company constructs a new wing and buys new equipment to expand production, but when the wing is ready to operate, its wheat supplier backs out of a supply contract it has with Aunt Hattie’s. Aunt Hattie’s has relied on that promise, spent money counting on delivery on that promise, and now cannot expand because that promise was broken. The failure to honor a promise is more than just a breach of contract; economic ripple effects occur when businesses can- not rely on contractual promises.

“A contract is a promise or set of promises for breach of which the law gives a remedy, or the performance of which the law in some way recognizes as a duty.” This definition comes from the Restatement (Second) of Contracts, a statement of contract law by the American Law Institute (ALI), and means that contract prom- ises not kept require remedies or compensation for the private parties involved. This chapter focuses on the creation, performance, and enforcement of those promises.

11-2 Sources of Contract Law The two general sources of contract law for contracts entered into in the United States are common law and the Uniform Commercial Code (UCC). Some specific federal and state laws, covered later in the chapter, deal with unique issues in e-commerce contracts.

A contract for an employment to continue “until the winter was over” was for a definite time since the winter comprised three months, whether measured astronomically from the winter solstice, about December 22nd, to the vernal equinox, about March 21st, or conventionally as comprising the months of December, January and February.

Saarela v Hoglund, 198 Ill.App. 485, (Ill. App. 1 Dist. 1916)

In the summer of 1996, PepsiCo, Inc., ran a market- ing campaign involving Pepsi Points. The Pepsi Points, obtained by drinking Pepsi, could be redeemed for priz- es. One television ad promoting Pepsi Points shows a Harrier jet outside a schoolyard with the campaign’s slogan beneath it: DRINK PEPSI GET STUFF. The jet pictured in the ad was generated by computer. The ad said the jet could be yours for 7 million Pepsi Points. PepsiCo maintains the ad was a spoof. John Leonard, then a 21-year-old business student, saw the ad and de- livered to Pepsi 15 original Pepsi Points plus a check for

$700,008.50—sufficient for the cost of a Harrier jet, plus shipping and handling.

Pepsi refused to deliver the jet. A Pentagon spokes- man indicated that no Harrier jets were available at that time because the jets must be demilitarized before a member of the public can buy one. Pepsi also said that  because the ad was a joke, it was not an offer. Mr.  Leonard said that the ad induced conduct on his part, as would all Pepsi Points ads, and that Pepsi was required to deliver to him a Harrier jet.

Who was correct? Was the ad an offer?

Consider . . . 11.1

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368 Part 3 Business Sales, Contracts, and Competition

11-2a Common Law

Common law was the first law of contracts. As discussed in Chapter 1, com- mon law today consists of those traditional notions of law along with law devel- oped by judicial decisions dealing with contract issues. Traditional English common law of contracts has been modified by statute in some states. Certain types of contracts have unique and specific content requirements—for exam- ple, listing agreements for real estate agents, insurance policies, and consumer credit contracts (see p. 375 for more information on the statutory requirements in consumer credit contracts). However, the statutory language and statutory requirements do not generally control the basic concepts of formation and enforcement of contracts. Common law applies to contracts that have land or services as their subject matter. Contracts for the construction of a home and employment contracts are governed by common law. A rental agreement for an apartment may be covered by specific landlord– tenant statutes in addition to common law.

A general treatment of the common law for contracts can be found in the Restatement (Second) of Contracts. A group of legal scholars wrote the Restatement, and similar groups work together to consider market changes and dynamics and modify contract law as necessary.

11-2b The Uniform Commercial Code

One of the problems with common law is its lack of uniformity. The states do not follow the same case decisions on contract law, and some states do not fol- low the Restatement; the result is that different rules apply to contracts in different states.

Consequently, businesses experienced great difficulty and expense when they contracted for the sale of goods across state lines because of differ- ences in state contract common law. To address the need for uniformity, the National Conference of Commissioners on Uniform State Laws and the ALI worked to draft a set of commercial laws that would function well with busi- ness (ALI) needs. The result of the efforts of businesspeople, lawyers, and lawmakers working together was the Uniform Commercial Code (UCC). The final draft of the UCC first appeared in the 1940s. With several revisions and much time and effort, the Code was adopted, at least in part, in all the states.

Article 2 of the UCC governs contracts for the sale of goods and has been adopted in all states except Louisiana. Although sections of Article 2 may have various forms throughout the states, the basic requirements for contracts remain consistent. Under Article 2, contracts can be formed more easily, the standards for performance are more readily defined, and the remedies are more easily determined. (Excerpts of Article 2 are reproduced in Appendix C.) Determining which contracts are UCC contracts and which are common law contracts is often difficult. The questions applied in the determination of UCC versus common law include the cost of the goods versus the cost of services in the contract, the parties’ intent, and even some public policy issues. Accessory Overhaul Group, Inc. v Mesa Airlines, Inc. (Case 11.1) deals with a question of goods versus ser- vices contract.

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Chapter 11 Contracts and Sales: Introduction and Formation 369

Accessory Overhaul Group, Inc. v Mesa Airlines, Inc. 994 F. Supp. 2d 1296 (N.D. Ga. 2014)

When the Tire Maintenance Contract Falls Flat

Case 11.1

FaCts

Accessory Overhaul Group, Inc. (AOG) provides commercial aircraft component testing, overhauling and certification services for Mesa Air Group, Inc. (Mesa), and its subsidiary, Mesa Airlines, Inc. AOG submitted a bid to Mesa for work on its planes, which Mesa accepted in the fall of 2007.

AOG began performing work for Mesa in Octo- ber 2007, and the next month the parties executed a memorandum of understanding (MOU). The MOU provides that it “shall remain in effect until the execution of the Contract by the Parties or its ter- mination as described herein.” From 2007 to 2012, AOG serviced and maintained Mesa’s wheels, tires, and brakes.

In January 2010, Mesa filed for bankruptcy protec- tion, and the bankruptcy court deemed AOG a “critical vendor.” Mesa continued its commercial relationship with AOG, and on January 14, 2010, the parties execut- ed a critical trade agreement (CTA). The CTA broadly defined the parties’ relationship during Mesa’s bank- ruptcy case.

Sometime in 2011, after Mesa had emerged from bankruptcy, the parties resumed negotiations of a more detailed contract. AOG’s president, Ron Byrd, worked with Scott Johnson, Mesa’s senior director for main- tenance and engineering technical administration, to draft the contract.

Byrd and Johnson exchanged several drafts of an agreement. On November 21, 2011, Johnson sent Byrd an e-mail, stating that he had updated the pricing per AOG’s request and that he had included with his e-mail “a soft-copy version as well as the PDF.” Johnson then stated, “If you’re good, please sign and return. Then, I’ll route through our contract signature process here at Mesa.” Byrd signed and returned the document that day.

On January 3, 2012, Johnson informed Byrd that the document had “hit a snag” in the finance department. Mesa’s senior vice president of finance had “rejected” a term dealing with late fees, and Byrd agreed to remove that term.

In March 2012, Johnson presented the November 21 document to Mesa’s president, Michael Lotz, for his review. Lotz refused to sign the contract.

On May 9, 2012, AOG met with Mesa to discuss a rate increase. AOG unequivocally told Mesa during the meeting that if the rate did not increase, it would cease work with Mesa right away or “pretty quickly.” Mesa responded by putting out a new call for bids.

AOG bid on the work at its increased rate. By the end of June, Mesa had chosen a different vendor, and on June 30 Mesa removed Mesa’s aircraft from AOG’s servicing.

AOG sent Mesa invoices seeking over $3.4 million. Mesa refused to pay the invoices because it believes that the November 21 document is not a binding contract.

AOG filed suit and Mesa filed a motion for sum- mary judgment.

JUdICIaL OPINION

BATTEN, District Judge Before evaluating the parties’ arguments as to whether the November 21 document was in fact a binding con- tract, the Court first determines whether the Uniform Commercial Code or Georgia common law governs the dispute.

Whether the UCC or common law applies depends on whether the parties’ relationship predominantly involved goods or services. AOG contends that the predominant purpose of its relationship with Mesa was the provision of goods, and therefore the UCC applies. Defendants respond that AOG performed repair services, and while those services may have involved goods, the primary purpose of AOG’s work was to service the wheels, tires and brakes of their aircraft.

Article 2 of the UCC applies “only to transactions in goods and not to service or repair contracts.” Alco Standard Corp. v Westinghouse Elec. Corp., 206 Ga.App. 794, 426 S.E.2d 648, 650 (1992) Difficulty arises when, as here, the contract involves both goods and services. “When the predominant element of a contract is the sale of goods, the contract is viewed as a sales contract and the UCC applies, even though a substantial amount of service is to be rendered in installing the goods.” Heart of Tex. Dodge, Inc. v Star Coach, LLC, 255 Ga.App. 801, 567 S.E.2d 61, 63 (2002)

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370 Part 3 Business Sales, Contracts, and Competition

“When, on the other hand, the predominant element of a contract is the furnishing of services, the contract is viewed as a service contract and the UCC does not apply.”

In repair-contract cases, which typically involve goods and services, courts look to the “fundamental nature of the transaction.” “The primary purpose of a repair transaction is not to sell or purchase parts, but to change or improve the item and return it to the owner. In such cases, the provision of goods is incidental, and the UCC does not apply.”

In Alco, the court held that the UCC did not apply, in part because there was no sale of goods between the parties—only a contract to repair the customer’s auto- transformers. Consequently, the “materials furnished [by the provider] in connection with the repair was merely an incidental part of the services provided.” Similarly, in Heart of Texas Dodge, the primary purpose of the contract was to convert a vehicle and return it to the owner in a modified condition. And the company performing the work was “in the business of perform- ing labor, not selling parts.” Thus, the court held that the work was performed pursuant to a service contract and the UCC did not apply.

Here, the parties’ own words show that the prima- ry purpose of their relationship was for AOG to pro- vide wheel, tire and brake services to Mesa. Beginning with the MOU, the parties characterized their relation- ship as a service-based one. . . . [T]he MOU set forth the “terms and conditions under which AOG will provide such services to Mesa.” Similarly, the CTA continued the parties’ service relationship.

In addition, the November 21 document at issue is entitled “Wheel, Brake and Tire Cost per Landing Services Agreement,” and the second paragraph states that AOG and Mesa “desire to enter into this Agreement with respect to the provision of the Ser- vices applicable to . . . aircraft operated by Mesa during the Term [ ].” Section 2 of the November 21 document also lists the services that AOG will provide.

Finally, in its complaint AOG characterizes itself as a business that “provides parts and repair and maintenance services for commercial aircraft.” AOG also avers that it had to purchase parts from third parties in order to repair and maintain Mesa’s wheels, tires and brakes. AOG’s CEO . . . testified that AOG bought parts from vendors to perform services for Mesa.

Thus, the evidence overwhelmingly shows that AOG is a service provider, not a seller of goods, and that the primary purpose of the parties’ relationship was for AOG to repair and maintain the wheels, tires and brakes on Defendants’ aircraft. Consequently, as in other repair-contract cases, “the provision of goods is incidental, and the UCC does not apply.”

Case QUestIONs

1. List the factors that the court examined to deter- mine UCC versus common law.

2. Why does the court answer the UCC application question first before dealing with the contract dispute?

Paramount, a civil engineering firm and general contractor, submitted a bid to con- struct runway improvements at the Atlanta Hartsfield–Jackson International Airport. Paramount included DPS’s quote for sup- plying the fill dirt for the project in its bid. DPS’s written quote described its work as “furnish[ing] and haul[ing]/deliver[ing] bor- row [ing] dirt from DPS’s location to the job site” and specifically excluded the provi- sion of “traffic control, dust control, secu- rity and escort services” from the scope of work. The quote provides that the dirt would be delivered for a price of “$140/ Truck Load.”

After Paramount was awarded the airport project, it contacted DPS about the amount of dirt and numbers of trucks that it would need for the airport project. DPS believed that the parties had a contract, and it sent a letter to Paramount confirming that it was “holding approximately 45,000 [cubic yards] of borrow dirt ready to be hauled in to your project once we receive [the] 10-day notice from you.” Paramount did not respond.

Over the next two months, DPS sent other letters to Paramount, but Paramount did not respond. After executives from the two companies met, Paramount sent the following:

Consider . . . 11.2

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Chapter 11 Contracts and Sales: Introduction and Formation 371

[Y]ou insisted that we give com- mitment to you for buying the dirt before you will give us price [for other work]. This really was a sur- prise to us. . . . Also please note that we have never committed to buy all the fill materials from you. In the last meeting you were informed that we intend to purchase some materials from you and it may be through other subcontractors. Our decisions will be conveyed to you as soon as possible.

Ultimately, Paramount bought the dirt it needed from another vendor. DPS sued Paramount for breach of contract. What law governs this contract and why? [Paramount Contracting Co. v DPS Industries, Inc., 709 S.E.2d 288 (Ga.App. 2011)]

THINK: The discussion of UCC versus common law has us examine the following:

• The essence of the parties’ agree- ment—what was its purpose? What was to be provided under its terms?

• The general nature of the subject matter of the contract.

• The amount of service provided under the contract.

APPLY: In this case, under the agreement, DPS was obliged to sell dirt for fill at the air- port project. There was delivery of the dirt, but many goods are delivered pursuant to the terms of a contract.

ANSWER: The court held that dirt may be cheap, but that does not change the intent of the parties, which was the purchase and sale of dirt.

Now apply these reasoning skills to de- termine whether the following subject mat- ters would be governed by the UCC or by common law:

• Electricity [Gordonsville Energy, L.P. v Virginia Electric & Power Co., 29 U.C.C. Rep. Serv. 2d 849 (Va. Cir. 1996)]

• Mass-produced software [Simulados Software, Ltd. v Photon Infotech Private, Ltd., 40 F. Supp. 3d 1191(N.D. Cal. 2014)]

• Internet connectivity [In re Sony Gaming Networks and Customer Data Security Breach Litigation, 996 F. Supp. 2d 942 (S.D. Cal. 2014)]

• Weaned pigs [Land O’Lakes Purina Feed LLC v Jaeger, 976 F. Supp. 2d 1073 (S.D. Iowa 2013)]

• Patents and trademarks [MWI Vet- erinary Supply Co. v Wotton, 896 F. Supp. 2d 905 (D. Idaho 2012); 690 F.3d 1139, 78 UCC Rep.Serv.2d 36 (10th Cir. 2012)]

• Golf irrigation systems [Champion Turf, Inc. v Rice, Papuchis Const. Co., 21 U.C.C. Rep. Serv. 2d 519, 853 S.W.2d 323 (Mo. App. 1993)]

• Wheat [Mogan v Cargill, Inc., 21 U.C.C. Rep. Serv. 2d 661, 856 P.2d 973 (1993)]

• Standing timber [Bohle v Thompson, 8 U.C.C. Rep. Serv. 2d 897, 78 Md. App. 614, 554 A.2d 818 (1989)]

• Mobile homes [Aslakson v Home Sav. Ass’n, 6 U.C.C. Rep. Serv. 2d 35, 416 N.W.2d 786 (Minn. App. 1987)]

• High-frequency onboard battery chargers for electric golf carts and the installation and service of the system that charges them [TK Power, Inc. v Textron, Inc., 433 F. Supp. 2d 1058 (N.D. Cal. 2006)]

• Diamonds [Wixon Jewelers, Inc. v Di-Star, Ltd., 218 F.3d 913, 42 U.C.C. Rep. Serv. 2d 94 (8th Cir. 2000)]

• Livestock [Flanagan v Consolidated Nutrition, L.C., 627 N.W.2d 573 (Iowa Ct. App. 2001)]

• Degas painting [Weil v Murray, 161 F. Supp. 2d 250, 44 U.C.C. Rep. Serv. 2d 482 (S.D. N.Y. 2001)]

• Ticket to an amusement park ride [Dantzler v S.P. Parks, Inc., 40 U.C.C. Rep. Serv. 2d 955, 1988 WL 131428 (E.D. Pa. 1988)]

• Concert tickets [State v Cardwell, 38 U.C.C. Rep. Serv. 2d 1158, 718 A.2d 954 (1998)]

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372 Part 3 Business Sales, Contracts, and Competition

Article 2A—Leases The UCC has a section called Article 2A Leases, which applies to leases of goods. Over the past 20 years, many new forms of goods transactions have developed, such as the long-term auto lease, which appears to be more of a sale than a lease. Because of the nature of these agreements, leases did not fit well under common law or traditional Article 2. The Leases section, drafted for these types of contracts, covers such issues as the statute of frauds (leases in which payments exceed $1,000, for example, must be in writing), contract formation, and warranties associated with a lease.

E-Commerce Contract Law: Uniform Computer Information Transactions Act The Uniform Computer Information Transactions Act (UCITA) was promulgated in 1999 and has been adopted in two states (Virginia and Maryland) and proposed in others.1 The UCITA would govern all contracts involving the sale, licensing, maintenance, and support of computer software. Those contracts not involving software that are contracts for the sale of other goods would still be governed by the UCC along with the UETA (see p. 398), if adopted in the state.

11-3 Types of Contracts The following sections cover the various types of contracts and offer an introduc- tion to contract terminology.

11-3a Bilateral Versus Unilateral Contracts

A contract can result from two parties exchanging promises to perform or from one party exchanging a promise for the other party’s actions. A bilateral contract is one in which both parties promise to perform certain things. For example, if you sign a contract to buy a used red Mini Cooper for $2,000, you have entered into a bilateral contract with the seller. The seller has promised not to sell the car to any- one else and will give you the title to the car when you pay the $2,000. You have promised to buy that red Mini Cooper and will turn over the $2,000 to the seller in exchange for the title. The contract consists of two promises: your promise to buy and the seller’s promise to sell.

Some contracts have one party issuing a promise and the other party simply performing. This type of contract is called a unilateral contract. For example, sup- pose that your uncle said, “I will pay you $500 if you will drive my new Mercedes to San Francisco for me within the next five days.” Your uncle has promised to pay, but you have not promised to do anything. Nonetheless, you can hold your uncle to his promise if you drive his car to San Francisco. Your agreement is a promise in exchange for performance. If you drive the car to San Francisco, your uncle’s promise will be enforceable as a unilateral contract.

11-3b Express Versus Implied Contracts (Quasi Contracts) Some contracts are written, signed (even notarized), and very formal in appearance. Others are simply verbal agreements between the parties (see p. 397 for a discussion of the types of contracts that can be oral). Still others are electronic contracts entered into via e-mail and the Internet. A contract that is written or orally agreed to is an express contract. In still other situations, the parties do not discuss the terms of

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Chapter 11 Contracts and Sales: Introduction and Formation 373

the contract but nonetheless understand that they have some form of contractual relationship. A contract that arises from circumstances and not from the express agreement of the parties is called an implied contract, as when you go to a doctor for treatment of an illness. You and the doctor do not sit down and negotiate the terms of treatment, the manner in which the doctor will conduct the examination, or how much you will pay. You understand that the doctor will do whatever examinations are appropriate to determine the cause of your illness and that a fee is associated with the doctor’s work. The payment and treatment terms are implied from general professional customs. You have an implied-in-fact contract.

A second type of implied or enforceable agreement is called an implied-in-law contract or a quasi contract. The term quasi means “as if” and describes the action of a court when it treats parties who do not have a contract “as if” they did. The courts enforce a quasi contract right if one party has conferred a benefit on another, both are aware of the benefit, and the retention of the benefit would be an enrich- ment of one party at the unjust expense of the other.

The theory of quasi contracts is not used to help “the officious meddler.” The officious meddler is someone who performs unrequested work or services and then, based on a quasi contract theory, seeks recovery. For example, you could not be required to compensate a painting contractor who came by and painted your

Re: A Unilateral Tattoo For the Manager’s Desk

In a case bound to leave an imprint in the halls of justice, David Winkleman and Richard Goddard filed suit against the owner of a Davenport, Iowa, radio station (KORB- FM), Cumulus Broadcasting, because they allege that they had “93 Rock” tattooed on their foreheads in response to a disc jock- ey’s promise. According to the permanently tattooed men, they heard disc jockey Ben Stone say on November 29, 2000, that the radio station would pay anyone who got “93 Rock” tattooed on their foreheads $30,000 per year for five years plus concert tickets, backstage passes, and a TV satellite dish.

Mr. Winkleman and Mr. Goddard say that when they called to confirm the offer, someone at the station referred them to a tattoo parlor. The station refused to pay the men, asserting that the statements by Mr. Stone were simply a joke and no one would assume otherwise.

The two men also say that they have been unable to get jobs since the tattoos

and that they have been “publicly scorned and ridiculed for their greed and lack of com- mon good sense.”

The case was dismissed in 2003 because the court found no evidence that such an offer had been made. The audiotapes from the interchange indicated that the disc jockey actually said the men could go ahead and tattoo all they wanted, but that there “wasn’t even a free CD in it for you.” Subsequently, the two tattooed men were involved in dramatic incidents at their trailer park homes, including attempted murder of one by a neighbor wield- ing a ball-peen hammer. Another incident dealt with accusations of arson involving his mobile home because the fire that destroyed the home followed on the heels of his garage sale of all of his personal items that were in the mobile home. For broadcasters, the tapes are always critical. Retain them!

Source: Annie Hsia, “Here’s My Tattoo. Where’s the Cash?,” National Law Journal, June 24–July 1, 2002, p. A4.

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374 Part 3 Business Sales, Contracts, and Competition

house without your permission because the contractor acted both without your knowledge and without your consent. However, if you are aware the painting is going on and you do nothing to stop it, you would be held liable in quasi contract.

11-3c Void and Voidable Contracts

A void contract is an agreement to do something that is illegal or against public policy, or one that lacks legal elements (see Chapter 12). For example, a contract to sell weapons to a country under a weapons ban is a void contract. Neither side can enforce the contract, even if the weapons have already been delivered, because allowing the seller to collect payment would encourage further violations of the law banning the weapons sales.

A contract may be partially void—that is, only a portion of the contract violates a statute or public policy and is therefore unenforceable. For example, in many states, it is illegal to charge excessive rates of interest (known as usury). In a usuri- ous loan contract, the loan repayment would be enforceable, but the interest terms would not be. As another example, suppose that an owner has sold her business and in the contract has agreed never to start another similar business. Although the buyer deserves some protection for the payment of goodwill, the complete elimi- nation of the seller’s right to start a business is an excessive restraint of trade that is against public policy and would not be enforced, even though the actual sale of the business would be enforced.

A voidable contract is a contract that can be unenforceable at the election of one of the parties. For example, a minor who signs a contract can choose to be bound by the agreement or can choose to disaffirm the contract. Voidable contracts give one party the option of disaffirming the contract.

11-3d Unenforceable Contracts

An unenforceable contract is a contract that cannot be honored judicially because of some procedural problem. A contract that should be in writing to comply with the statute of frauds but is not written is unenforceable. Another example of an unenforceable contract is when a party who wishes to enforce a contract does not bring suit within the time limits of the statute of limitations. Filing suit too late means the contract is unenforceable.

11-3e executed Versus executory Contracts

Contracts are executed contracts when the parties have performed according to their promises or required actions (under unilateral agreements). Contracts are executory contracts when the promise to perform is made but the actual per- formance has not been done. If you sign a contract to buy a house but have not obtained a loan or deposited monies in escrow, you have an executory contract. A contract may be wholly executed, wholly executory, or partially executed. For example, when a business files for bankruptcy, some of its contracts are executory and some are partially executed, such as those contracts in which the business has paid for goods but the goods have not been delivered. The bankruptcy trustee has the option of canceling executory contracts but will generally complete or require other parties to complete partially executed contracts. Courts often distinguish between executed and executory contracts in determining both the rights of the parties (particularly with respect to issues of public policy and capacity) and the remedies available to the parties.

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Chapter 11 Contracts and Sales: Introduction and Formation 375

11-4 Consumer Credit Contracts There are certain statutory requirements for the formation of consumer credit con- tracts. The following sections cover these areas of law that control the formation and content of consumer credit contracts.

11-4a discrimination in Credit Contracts

Under the Equal Credit Opportunity Act (ECOA), it is unlawful to discriminate against an applicant for credit on the basis of race, color, religion, national ori- gin, gender, marital status, or age; because all or part of the applicant’s income is obtained from a public assistance program; or because the applicant has in good faith exercised any right under the Consumer Credit Protection Act (CCPA). When a credit application is refused, the lender must provide the applicant with a writ- ten explanation, such as high credit card balances or no credit history on install- ment loans.

Under the ECOA, debtors can recover actual damages for embarrassment and emotional distress and for punitive damages of up to $10,000. If a group of debtors brings a class action against a creditor, they can collect punitive damages of up to the lesser of $500,0000 or 1 percent of the creditor’s net worth. A.B.&S. Auto Service, Inc. v South Shore Bank of Chicago (Case 11.2) involves an ECOA issue.

A.B.&S. Auto Service, Inc. v South Shore Bank of Chicago 962 F. Supp. 1056 (N.D. Ill. 1997)

Do the Crime, Forget the Loan

Case 11.2

FaCts

A.B.&S. Auto Service, Inc. (AB&S) is an automobile repair shop located in Chicago, Illinois. Jerry L. Bonner is AB&S’s president, and he is an African-American. South Shore is a commercial bank that participates in the Small Business Administration’s (SBA) loan guar- antee program.

The SBA requires all applicants for the loan guar- antee program to fill out an SBA Form 912 Statement of Personal History. SBA Form 912 asks applicants if they have ever been charged with or arrested or convicted for any criminal offense other than a minor motor vehicle violation and, if so, asks applicants to provide details. In February 1995, AB&S applied for a $230,000 business loan from the bank. Mr. Bonner submitted Form 912 and in his response to its question about arrests and convictions, Mr. Bonner noted the following:

1. Domestic matters between 1982 and 1984

2. Conviction for aggravated battery and assault (1983) (claims self-defense)

3. Possession of a controlled substance in 1985

4. Disorderly conduct between 1985 and 1990

5. Possession of a controlled substance in 1990

6. Possession of a stolen car in September 1994

Leslie Davis, an African-American vice president at South Shore Bank, recommended approval of Mr. Bon- ner’s application. However, the loan committee agreed that because of Mr. Bonner’s criminal record, the application should be denied. The bank then decided to deny the loan.

During the last 15 years, the South Shore Bank has made at least three business loans to applicants with criminal records. One of these three applicants was an African-American. South Shore evaluates each appli- cation on an individual basis and examines criminal record and other information for purposes of deter- mining character.

Mr. Bonner and his company (plaintiffs) filed suit under the ECOA because the bank’s practice of

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376 Part 3 Business Sales, Contracts, and Competition

11-4b subprime or Predatory Lending

Following the economic crisis of 2008, the federal government made significant reforms in credit contracts. Part of the reforms focused on the subprime lending market. This credit market makes loans to consumers who have bankruptcies, no credit history, low to moderate incomes, or a poor credit history. Because of the higher risk of these types of loans, these credit contracts involve lower loan amounts; higher origination costs, brokers’ fees, and credit insurance fees; higher interest rates; significant collateral pledges; large prepayment penalties (meaning

considering criminal record has an unlawful disparate impact on African-American men. South Shore Bank (defendants) moved for summary judgment as did Mr. Bonner.

JUdICIaL OPINION

WILLIAMS, Anne Claire, District Judge In order to prove discrimination under the disparate impact analysis or “effects” test, an applicant must show how “a policy, procedure, or practice specifically identified by the [applicant] has a significantly great- er discriminatory impact on members of a protected class.”

Plaintiffs traditionally establish this prima facie case by making “a statistical comparison of the repre- sentation of the protected class in the applicant pool with representation in the group actually accepted from the pool. . . . If the statistical disparity is signifi- cant, then plaintiff is deemed to have made out a prima facie case.”

Plaintiffs claim that South Shore Bank’s practice of considering an applicant’s criminal record in making commercial lending decisions has a disparate impact on African-Americans. To make the prima facie case plaintiffs offer the testimony of Dr. Jaslin U. Salmon.

Dr. Salmon testified that any decision that is based on arrest records would militate against people of color. He suggests that, based on his research, there are many cases in which the black applicant is qualified, creditworthy, but was not given the loan for other reasons and among those reasons, arrest records had been taken into consideration. However, the bank disputes this point because Dr. Salmon was unable to identify a single study showing that consideration of arrest records has a disproportionate impact on Afri- can-American applicants for any type of credit, much less any study addressing the impact on business loan applicants.

Both the statistics and Dr. Salmon’s supporting testimony do not answer the following questions: (1) how many African-Americans with convictions or arrests are otherwise qualified for the loan; and (2) how

many African-Americans are deterred from applying because of the bank’s practice . . . [t]he bank has made at least three business loans to applicants with criminal records. One of these three applicants with criminal records is African-American.

South Shore Bank’s practice of inquiring into a credit applicant’s criminal history is legitimately relat- ed to its extension of credit for two reasons. First, the regulations require the SBA, in evaluating a loan guarantee application, to consider “the character, repu- tation, and credit history of the applicant, its associates, and guarantors.”

Secondly, the bank’s inquiry into an applicant’s criminal record provides relevant information about an applicant’s creditworthiness, particularly his judgment and character. Plaintiff Bonner admits that several of the incidents described in his completed SBA Form 912: possession of a controlled substance, domestic abuse, and disorderly conduct, reflected negatively on his judgment and character. Specifically, Bonner admits that these incidents involved an exercise of bad judgment.

Therefore, the court finds that the bank has success- fully demonstrated that its practice of inquiring into a credit applicant’s criminal record is legitimately related to the extension of credit.

For the foregoing reasons, the court grants defen- dant South Shore Bank’s motion for summary judg- ment and denies plaintiff Bonner and AB&S’s motion for summary judgment.

Case QUestIONs

1. What, according to Mr. Bonner’s expert, is the impact of considering criminal records of appli- cants? Did the evidence support the expert’s testimony?

2. Is the use of a criminal record in making a deci- sion to extend credit a violation of the ECOA? Explain.

3. Do you think a criminal record is an indication of character? Explain.

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Chapter 11 Contracts and Sales: Introduction and Formation 377

that the consumer debtor is locked into the high interest rate); and faster repay- ment requirements. Subprime loans have had notoriously difficult-to-read con- tracts. Determining all of the charges and fees from the contract was a tall order. Regulations and laws at the state and federal level have changed and simplified contract disclosures for subprime loans.

Part of the subprime lending market includes lenders who take advantage of less sophisticated consumers or even consumers who are just desperate for funds. For example, title loans (loans made in exchange for title to a car or house if the borrower defaults) have been widely used in subprime markets. These types of loans, sometimes called predatory lending, are now highly regulated by both the states and the federal government. The new wave of consumer protection on sub- prime loans includes limitations on interest rates, ten-day rescission periods, addi- tional contract disclosures requirements, and the requirement of credit counseling before consumers may sign for certain types of subprime loans.

11-4c Credit disclosures

Federal laws require the disclosure of all interest charges, points, and fees for all types of loans and credit contracts. These laws require disclosure of an annual per- centage rate (APR) so that the consumer can see just how much the transaction costs per year and can compare alternatives. The Truth in Lending Act (TILA) pro- vides the requirements for disclosures in credit contracts and consumer rights when full disclosure is not made. When a consumer sale or contract provides for pay- ment in more than four installments, it is subject to the TILA. The application of the TILA is required even when there is no service or finance charge for the installment payments. There are additional obligations of disclosure under the Fair Credit and Charge Card Disclosure Act, the Home Equity Loan Consumer Protection Act, and the Credit Card Accountability, Responsibility and Disclosure (CARD) Act of 2009.

The Dodd-Frank Wall Street Reform and Consumer Protection Act (DFCPA), also known as the Wall Street Reform and Consumer Financial Protection Act or the Consumer Financial Protection Act (CFPA), created the Consumer Financial Protection Bureau (CFPB). Housed within the Federal Reserve, the CFPB now serves the combined roles that the Federal Reserve and the Federal Trade Commis- sion (FTC) played in enforcing consumer credit laws and regulations.

11-4d Controlling Credit Card Contracts Federal regulations prohibit the unsolicited distribution of credit cards to per- sons who have not applied for them. The practice of simply sending credit cards through the mail to consumers is now illegal. The problems with rising identity theft have made this protection especially important to consumers because iden- tity thieves were able to intercept the mail and seize the unsolicited credit cards.

Credit Cards for those Under the age of 21 The CARD Act substantially restricts the solicitation of credit card accounts from those under the age of 21. Credit card companies must have a written application in hand from those under 21 and those applications must carry the signature of a parent, guardian, or someone over the age of 21 who has the means to repay debt. The line of credit on a co-signed card for someone under the age of 21 cannot be increased without the co-signer’s permission.

Colleges and universities are now restricted in their partnering with credit card companies, arrangements that allowed the colleges and universities and their

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378 Part 3 Business Sales, Contracts, and Competition

alumni associations to receive funds from the credit card companies in exchange for access to their students and alumni. The CARD Act limits locations for college student credit card solicitations, requires colleges and universities to disclose their financial relationships with such credit card companies, and also requires colleges and universities to provide debt counseling for their students.

Liability Limitations A cardholder is not liable for more than $50 for the unauthorized use of a credit card. To even recover the $50 amount, the credit card issuer must show that (1) the credit card was an accepted card, (2) the issuer gave the holder adequate notice of possible liability in such a case, (3) the issuer furnished the holder with notifica- tion means in the event of loss or theft of the credit card, (4) the issuer provided a method by which the user of the card could be identified as the person authorized to use it, and (5) unauthorized use of the card had occurred or might occur as a result of loss, theft, or some other event. The burden of proof is on the card issuer to show that the use of the card was authorized or that the holder is liable for its unauthorized use.

Unauthorized Credit Card Use and the Chip As of 2016, merchants who did not require consumers to use a chip credit card would not be entitled to reimbursement from the credit card companies for any fraudulent transactions. Gas stations have until 2017 to convert to chip reader technology before they will be liable for fraud. The goal of the switch is to eliminate thieves’ ability to create credit cards. They can duplicate the card, but they cannot duplicate the chip.

transfer terms Transfers of consumer credit balances to new credit cards were once a lucrative area for banks and credit card companies. However, the CARD Act has changed everything from the maximum fees allowed with these transfers to how quickly credit card companies can change the advertised terms of the transfer. There are mandates about upfront disclosure of transfer fees as well as potential changes in the APR once the transfer has occurred. The CARD Act also places limits on how often companies can change a credit card holder’s interest rate.

11-5 Formation of Contracts A contract is formed when two parties with the correct mental intent, under the correct circumstances, within the boundaries of the law, and with some detriment to each of them agree to do certain acts in exchange for the other’s acts. Forma- tion elements are like ingredients in a recipe: if you leave one ingredient out of the recipe, the final result will be off in some way. So it is with the elements of a contract. Exhibit 11.1 illustrates all elements necessary for the formation of a valid contract.

11-5a Offer

The offer is the first part of a contract. The person who makes the offer is called the offeror, and the person to whom the offer is made is called the offeree. The follow- ing sections cover the requirements for a valid offer.

Intent to Contract versus Negotiation The offeror must have the proper intent (mental state) to contract. Intent is gleaned from the language the offeror uses. This intent requirement distinguishes offers

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Chapter 11 Contracts and Sales: Introduction and Formation 379

from negotiations. For example, a letter from a businessperson may contain the following: “I am interested in investing in a franchise. I have heard about your opportunities. Please send me all necessary information.” The letter expresses an interest in possibly contracting in the future, but it does not express present intent to enter into a contract. But suppose this letter of inquiry was followed by another letter with the following language: “I have decided to invest in one of your fran- chises. Enclosed are the necessary documents, signatures, and a deposit check.” Here the parties have passed the negotiation stage and entered into part one of the contract—an offer.

Courts use an objective standard in determining the intent of the parties, which means that courts look at how a reasonable person would perceive the language, the surrounding circumstances, and the actions of the parties in determining whether a contract was formed. For example, a businessperson who is exasperated with the poor financial performance of her firm may say jokingly to someone over lunch, “I’d sell this company to anyone willing to take it.” If that statement is made in the context of a series of complaints about the firm and the workload, it would not be an offer. That same language used in a luncheon meeting with a prospective buyer would create a different result.

In many situations, one party has simply requested bids or is inviting offers. The frustrated business owner could say, “I am interested in selling my firm. If you run into anyone who is interested, have them call me.” The owner has not made an offer to sell but, rather, has made an invitation for an offer.

Ads are simply invitations for offers. Leonard v PepsiCo (Case 11.3) provides the answer for the chapter’s opening “Consider . . .” because it deals with an issue of the role of an ad in contract formation.

Offer

Acceptance

Consideration

Defenses Void or Voidable

Contract

Writing Required?

Valid Contract

No

No

Yes

Yes

Yes

Capacity?

No

No

Yes Undue

Inuence

Misrepresentation? Fraud? Duress?

Illegality? Mistake?

No Contract

Exhibit 11.1 Overview of Contracts

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380 Part 3 Business Sales, Contracts, and Competition

Leonard v PepsiCo 210 F.3d 88 (2d Cir. 2000)2

Does “Pepsi Stuff” Include a Harrier Jet?

Case 11.3

FaCts

PepsiCo (defendant/appellee) ran a promotion titled “Pepsi Stuff,” which encouraged consumers to collect Pepsi Points from specially marked packages of Pepsi or Diet Pepsi and redeem these points for merchandise fea- turing the Pepsi logo. John Leonard (plaintiff/appellant) saw the Pepsi Stuff commercial featuring the Harrier Jet as an example of “stuff.” The ad shows a teenager in awe of the jet and the subtitles on the screen are descriptions of what the teen sees: “T-SHIRT 75 PEPSI POINTS,” subtitle “LEATHER JACKET 1450 PEPSI POINTS,” and “SHADES 175 PEPSI POINTS.” A voiceover then intones, “Introducing the new Pepsi Stuff catalog,” as the camera focuses on the cover of the catalog.

Following these lesser items, a Harrier jet swings into view and lands by the side of the teen’s school building, next to a bicycle rack. The cockpit opens and the teen, inside the cockpit of the Harrier jet, holding a Pepsi exclaims, “Sure beats the bus!” A military drum- roll sounds as the following words appear: “HARRIER FIGHTER 7,000,000 PEPSI POINTS.” A few seconds later, the following appears in more stylized script: “Drink Pepsi—Get Stuff.”

Inspired by this commercial, Mr. Leonard set out to obtain a Harrier jet. The catalog notes that in the event that a consumer lacks enough Pepsi Points to obtain a desired item, additional Pepsi Points may be pur- chased for ten cents each; however, at least 15 original Pepsi Points must accompany each order.

Mr. Leonard could not collect 7,000,000 Pepsi Points by consuming Pepsi products fast enough, so through acquaintances, Mr. Leonard raised about $700,000. On March 27, 1996, Mr. Leonard submitted an order form, 15 original Pepsi Points, and a check for $700,008.50. At the bottom of the order form, Mr. Leonard wrote in “ Harrier Jet” in the “Item” column and “7,000,000” in the “Total Points” column. In a let- ter accompanying his submission, Mr. Leonard stated that the check was to purchase additional Pepsi Points “expressly for obtaining a new Harrier jet as advertised in your Pepsi Stuff commercial.” On May 7, 1996, Pep- siCo rejected Mr.  Leonard’s submission and returned the check, explaining,

The item that you have requested is not part of the Pepsi Stuff collection. It is not included in the catalogue or on

the order form, and only catalogue merchandise can be redeemed under this program.

The Harrier jet in the Pepsi commercial is fanciful and is simply included to create a humorous and enter- taining ad. We apologize for any misunderstanding or confusion that you may have experienced and are enclosing some free product coupons for your use.

Mr. Leonard responded via his lawyer:

Your letter of May 7, 1996 is totally unacceptable. We have reviewed the video tape of the Pepsi Stuff commercial . . . and it clearly offers the new Harrier jet for 7,000,000 Pepsi Points. Our client followed your rules explicitly . . .

This is a formal demand that you honor your com- mitment and make immediate arrangements to transfer the new Harrier jet to our client. If we do not receive transfer instructions within ten (10) business days of the date of this letter, you will leave us no choice but to file an appropriate action against Pepsi . . .

Mr. Leonard filed suit, and PepsiCo moved for summary judgment. The court granted summary judgment, and Mr. Leonard appealed.

JUdICIaL OPINION

WOOD, District Judge PER CURIAM We affirm for substantially the reasons stated in Judge Wood’s opinion. See 88 F. Supp. 2d 116 (S.D.N.Y.1999). [To help you understand the issues in the case, portions of Judge Wood’s opinion follow.]

The general rule is that an advertisement does not constitute an offer.

An advertisement is not transformed into an enforceable offer merely by a potential offeree’s expres- sion of willingness to accept the offer through, among other means, completion of an order form.

Under these principles, plaintiff’s letter of March 27, 1996, with the Order Form and the appropriate number of Pepsi Points, constituted the offer. There would be no enforceable contract until defendant accepted the Order Form and cashed the check.

The exception to the rule that advertisements do not create any power of acceptance in potential offer- ees is where the advertisement is “clear, definite, and explicit, and leaves nothing open for negotiation,” in

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Chapter 11 Contracts and Sales: Introduction and Formation 381

that circumstance, “it constitutes an offer, acceptance of which will complete the contract.” Lefkowitz v Great Minneapolis Surplus Store, 251 Minn. 188, 86 N.W.2d 689, 691 (1957) In Lefkowitz, defendant had published a newspaper announcement stating: “Saturday 9 am Sharp, 3 Brand New Fur Coats, Worth to $100.00, First Come First Served $1 Each.” Mr. Morris Lefkowitz arrived at the store, dollar in hand, but was informed that under defendant’s “house rules,” the offer was open to ladies, but not gentlemen. The court ruled that because plaintiff had fulfilled all of the terms of the advertisement and the advertisement was specific and left nothing open for negotiation, a contract had been formed.

The present case is distinguishable from Lefkowitz. First, the commercial cannot be regarded in itself as sufficiently definite, because it specifically reserved the details of the offer to a separate writing, the Catalog. The commercial itself made no mention of the steps a potential offeree would be required to take to accept the alleged offer of a Harrier Jet. The advertisement in Lefkowitz, in contrast, “identified the person who could accept.” Second, even if the Catalog had included a Harrier Jet among the items that could be obtained by redemption of Pepsi Points, the advertisement of a Harrier Jet by both television commercial and catalog would still not constitute an offer.

The Court finds, in sum, that the Harrier Jet com- mercial was merely an advertisement.

[P]laintiff largely relies on a different species of unilateral offer, involving public offers of a reward for performance of a specified act. Because these cases gen- erally involve public declarations regarding the effica- cy or trustworthiness of specific products, one court has aptly characterized these authorities as “prove me wrong” cases. The most venerable of these precedents is the case of Carlill v Carbolic Smoke Ball Co., 1 Q.B. 256 (Court of Appeal, 1892), a quote from which heads plaintiff’s memorandum of law: “[I]f a person chooses to make extravagant promises . . . he probably does so because it pays him to make them, and, if he has made them, the extravagance of the promises is no reason in law why he should not be bound by them.”

The case arose during the London influenza epi- demic of the 1890s. Among other advertisements of the time appeared solicitations for the Carbolic Smoke Ball. The specific advertisement that Mrs. Carlill saw, and relied upon, read as follows:

£100 reward will be paid by the Carbolic Smoke Ball Company to any person who contracts the increasing epidemic influenza, colds, or any diseases caused by tak- ing cold, after having used the ball three times daily for two weeks according to the printed directions supplied

with each ball. £1000 is deposited with the Alliance Bank, Regent Street, shewing our sincerity in the matter.

Mrs. Carlill purchased the smoke ball and used it as directed, but contracted influenza nevertheless. The advertisement was construed as offering a reward because it sought to induce performance, unlike an invi- tation to negotiate, which seeks a reciprocal promise. As Lord Justice Lindley explained, “advertisements offering rewards . . . are offers to anybody who performs the con- ditions named in the advertisement, and anybody who does perform the condition accepts the offer.” Because Mrs. Carlill had complied with the terms of the offer, yet contracted influenza, she was entitled to £100.

In the present case, the Harrier Jet commercial did not direct that anyone who appeared at Pepsi headquar- ters with 7,000,000 Pepsi Points on the Fourth of July would receive a Harrier Jet. Instead, the commercial urged consumers to accumulate Pepsi Points and to refer to the Catalog to determine how they could redeem their Pepsi Points. The commercial sought a reciprocal prom- ise, expressed through acceptance of, and compliance with, the terms of the Order Form. As noted previous- ly, the Catalog contains no mention of the Harrier Jet. Plaintiff states that he “noted that the Harrier Jet was not among the items described in the catalog, but this did not affect [his] understanding of the offer.”

In evaluating the commercial, the Court must not consider defendant’s subjective intent in making the commercial, or plaintiff’s subjective view of what the commercial offered, but what an objective, reason- able person would have understood the commercial to convey.

Plaintiff’s insistence that the commercial appears to be a serious offer requires the Court to explain why the commercial is funny. Explaining why a joke is funny is a daunting task; as the essayist E. B. White has remarked, “Humor can be dissected, as a frog can, but the thing dies in the process . . .” The commercial is the embodiment of what defendant appropriately charac- terizes as “zany humor.”

In light of the obvious absurdity of the commercial, the Court rejects plaintiff’s argument that the commer- cial was not clearly in jest.

For the reasons stated above, the Court grants defendant’s motion for summary judgment. Summary judgment granted and affirmed.

Case QUestIONs

1. When does the court think an offer was made?

2. Why is whether the ad is funny an important issue?

3. Will Mr. Leonard get his Harrier jet? Why or why not?

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382 Part 3 Business Sales, Contracts, and Competition

Certain and definite terms One of the ways to determine whether the contract is based on intent is also the second requirement for a valid offer. The offer must contain certain and definite language and cover all the terms necessary for a valid contract, which include the following:

• Parties • Subject matter of the contract • Price • Payment terms • Delivery terms • Performance times

Under the UCC, the requirements for an offer are not as stringent as the require- ments under common law. So long as the offer identifies the parties and the subject matter, the Code sections can cover the details of price, payment, delivery, and per- formance (see § 2-204 in Appendix C).

Also under the UCC, courts give great weight to industry custom and the pre- vious dealings of the parties in determining whether the terms are certain and defi- nite enough to constitute an offer (see § 2-208 in Appendix C). For example, the parties may have done business with each other for ten years and their agreement simply contains a quantity and a price. Whatever payment and delivery terms have been used in their relationship in the past (their course of dealing) will be the terms for their ongoing relationship.

Communication of the Offer An offer must be communicated to the offeree before it is valid. A letter in which an offer is made is not an offer until the letter reaches the offeree. For example, sup- pose OfficeMax had prepared an offer letter to be sent to Renco Rental Equipment and other customers. The letter included an offer for a substantial price discount

Review the following language and deter- mine whether an offer has been made.

TO: Brit Ripley

FROM: Yachts International

RE: Sailing Vessel Infinity

We are prepared to make an offer to purchase the U.S. Coast Guard Doc- umented Vessel Infinity for the price of $600,000 on the following terms and conditions: Price: $600,000 Terms: Cash $300,000 at close of escrow Note: $300,000 (unsecured) due in one year

Interest: 0.5% per month on unpaid balance versus 100,000 shares of stock of a public company

Will guarantee $3.00 per share in one year. Buyer reserves the right to re- purchase shares at $3.00 in one year if guarantee given.

Escrow: ASAP Conditions:

1. All insurance to remain in effect until close.

2. Seller to deliver to Port of San Francis- co in seaworthy and sailable condition.

/s./ J. P. Morgan Yachts International

Consider . . . 11.3

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Chapter 11 Contracts and Sales: Introduction and Formation 383

for computers so that Renco and its regular customers might buy computers at that discount. Before the letter is mailed to Renco, OfficeMax decides that because the computers are in such high demand it will not send the offer and will just sell them at their full retail price. The letter to Renco and other OfficeMax customers is never mailed. Renco, realizing the value of the computers and learning of the unmailed letter, cannot accept the discount computer offer because it was never communi- cated to them.

Ethical Issuesanticipating Morality

When they are at the top of their games, Olympic and professional athletes are able to command multi-million–dollar endorse- ment contracts.

Lance Armstrong, who was recently stripped of his Tour de France wins, was once ranked as the 60th most effective product spokesperson. He was right up there with Brad Pitt. Now, he is ranked 1,410 with rapper Nicki Minaj. The com- panies that have not renewed Mr. Arm- strong’s endorsement agreements or have terminated them include Nike, Radio Shack, Trek Bicycle, Easton-Bell (the makers of the Giro helmets Mr. Armstrong wore in his races), FRS Energy Foods, Anheus- er-Busch, 24 Hour Fitness, and Nissan. Mr. Armstrong earned between $15 million and $17 million per year from the endorsement contracts. Nike withdrew its contract with Mr. Armstrong but agreed to continue to support his LiveStrong Foundation.

In 2013, Chef Paula Deen lost her Food Network contract as well as endorsement contracts with Smithfield Foods, Wal-Mart, Target, and others for her admission that she had use a racial slur.

Celebrity endorsement contracts always have a form of a morals clause, a clause that allows the sponsor to terminate the contract for a variety of reasons such as an arrest. The athletes’ falls from grace are for very different reasons, and those reasons are difficult to anticipate in terms of contract language. However, businesses still place morality clauses in contracts—clauses that cover moral missteps. Defining those mis- steps can be difficult and some contracts resort to nonspecific language such as “conduct that results in a negative response

to the product or company” or “conduct that reduces the credibility of the endorser.”

However, the clauses generally have additional grounds for termination, such as conduct by the celebrity that brings negative publicity or boycotts to the com- pany. The termination rights are basically a judgment call on the part of the company. There is not much wiggle room for the celebrities. In fact, there is a long history of terminations.

Olympian Michael Phelps lost his endorsement contract with Kellogg’s when photos of him smoking a bong at a campus party showed up on the Internet. Model Kate Moss lost her endorsement contracts with Burberry and Chanel when a grainy videotape emerged that showed her using cocaine. Verizon withdrew its sponsorship of the Gwen Stefani tour when a raunchy video of her opening act, Akon, appeared online. The video showed Akon engaged in questionable on-stage behavior with a fan under the age of 18. The video resulted in considerable coverage and outrage from parents and commentators. Uniquely, the Stefani endorsement contract was termi- nated for her association with another artist who had questionable behavior.

Perhaps the best example of discretion in using the morals clauses came when Tiger Woods was in a car crash near his Florida home and the extent of his marital infidelity came to light. Mr. Woods lost endorsement contracts with Accenture, AT&T, Gatorade, and other companies. Are morality clauses appropriate in these con- tracts? Should athletes be role models? Is termination of a contract for personal conduct ethical?©

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384 Part 3 Business Sales, Contracts, and Competition

termination of an Offer by Revocation Because an offer is one-sided, it can be revoked anytime before acceptance by the offeree. Revocation occurs when the offeror notifies the offeree that the offer is no longer good.

Revocation is subject to some limitations. One such limitation has already been mentioned: acceptance by the offeree cuts off the right to revoke. Also, under common law, options cannot be revoked. An option is a contract in which the offeree pays the offeror for the time needed to consider the offer. For exam- ple, suppose that Yolanda’s Yogurt is contemplating opening a new restaurant and that Yolanda has a property location in mind but is uncertain about the market potential.

Yolanda does not want the property to be sold to someone else until she can complete a market study. Yolanda could pay the seller (offeror) a sum of money to hold the offer open for 30 days. During that 30-day period, the offeror can neither revoke the offer nor sell to anyone else.

Under the UCC, one form of an option makes an offer irrevocable, even with- out the offeree’s payment. Under a merchant’s firm offer (see § 2-205 in Appen- dix C), the offer must be made by a merchant, put in some form of record,3 and signed by the merchant. If these requirements are met, the merchant must hold the offer open for a definite time period (but no longer than three months). A merchant is someone who is in the business of selling the goods that are the subject matter of the contract or who holds particular skills or expertise in dealing with the goods. A rain check for sale merchandise from a store is an example of this type of offer. The firm offer cannot be revoked if the requirements are met, and money or consider- ation is not one of those requirements.

termination of an Offer by Rejection An offer carries no legally binding obligation for the offeree, who is free to accept or reject the offer. Once the offeree rejects the offer, the offer is ended and cannot later be accepted unless the offeror renews the offer.

Rejection by Counteroffer under Common Law. An offer also ends when the offeree does not fully reject the offer but rejects some portion of the offer or modifies it before acceptance. These changes and rejections are called counteroffers.

The effect of a counteroffer is that the original offer is no longer valid, and the offeree now becomes the offeror as the counteroffer becomes the new offer. Con- sider the following dialogue as an example:

Alice: I will pay you $500 to paint the trim on my house.

Brad: I will do it for $750.

Alice made the first offer. Brad’s language is a counteroffer and a rejection at the same time. Alice is now free to accept or reject the $750 offer. If Alice declines the $750 counteroffer, Brad cannot then force Alice to contract for the original $500 because the offer ended. “Consider 11.4” deals with an issue of offers and counteroffers.

Rejection by Counteroffer under the UCC. Under the UCC, modification by offer- ees was seen as a necessary part of doing business, and § 2-207 (see Appendix C) allows flexibility for such modifications. Under § 2-207, two separate rules apply for modifications: one governs merchants, and the other governs nonmerchant transactions. Exhibit 11.2 shows a chart of the rules.

The docketing of deadlines is important for businesses. Also, checks or payments received by a compa- ny should be recon- ciled with the purpose of payment to be certain that accidental overpayments (or acceptances do not occur through oversight.©

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Chapter 11 Contracts and Sales: Introduction and Formation 385

For nonmerchants, the addition of terms in the counteroffer does not result in a rejection; there will still be a contract if there is a clear intent to contract, but the additional terms will not be a part of the contract.

For example, consider the following dialogue:

Joe: I will sell you my pinball machine for $250. Jan: I’ll take it. Include $10 in dimes.

Joe and Jan have a contract, but the $10 in dimes is not a part of the contract. If Jan wanted the dimes, she should have negotiated before formally accepting the offer.

For merchants (both parties must be merchants), § 2-207 has more complicated rules and details on additional terms in acceptance. Section 2-207 covers situa- tions, sometimes called the battle of the forms, in which offerors and offerees send

December 30, 1977: John Hancock Insur- ance Company sent a commitment letter to Houston Dairy offering to loan Houston $800,000 at 9.25 percent interest; the let- ter provided that acceptance must be in writing within seven days and must be ac- companied by a $16,000 letter of credit or cashier’s check.

January 17, 1978: The president of Houston Dairy sent a letter of accep- tance to Hancock along with a cashier’s check.

January 23, 1978: Hancock cashed the check, which went through standard com- pany processing.

Hancock claims there is no contract because the acceptance occurred after the offer had expired. Houston Dairy maintains that its letter of acceptance was a new of- fer that was accepted by Hancock with the cashing of the check.

Who is correct? Is there a contract? [Houston Dairy v John Hancock Mutual Life Insurance Co., 643 F.2d 1185 (5th Cir. 1981)]

Consider . . . 11.4

Additional Terms

Objection Offer Is Limited

Material

Contract without

Additional Terms

Contract with

Additional Terms

Nonmerchants Nonmerchant/Merchant

Additional Terms

Merchants

unless

Exhibit 11.2 UCC Rules for additional terms in acceptance under article 2

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386 Part 3 Business Sales, Contracts, and Competition

purchase orders and invoices back and forth with the understanding that they have a contract. Under § 2-207, if the parties reach a basic agreement but the offeree has added terms, there will be an enforceable contract; the added terms are not a rejection under § 2-207. Whether the added terms will become a part of the con- tract depends on the following questions:

1. Are the terms material? 2. Was the offer limited? 3. Does one side object?

If the terms the offeree adds to the original offer terms are material, they do not become a part of the contract. For example, suppose that Alfie sends a purchase order to Bob for 12 dozen red four-inch balloons at four cents each. Bob sends back an invoice that reflects the quantity and price, but Bob’s invoice also has a section that states, “There are no warranties express or implied on these goods.” Do Alfie and Bob have a contract with or without warranties? The waiver of warranties is a material change in what Alfie gets: now a contract without warranties. Because it is material, § 2-207 protects Alfie, and the warranty waiver is not part of the contract.

Terms that can be added but are not considered material are such payment terms as “30 days same as cash.” Shipment terms are generally immaterial unless the method of shipment is unusually costly.

An offeror can avoid the problems of form battles and § 2-207 by simply limit- ing the offer to the terms stated. The following language could be used: “This offer is limited to these terms.” If the offeree attempts to add terms in the acceptance, there will be a contract, but the added terms will not be part of the contract. For example, suppose Alfie’s offer on the balloons was limited and Bob accepted but added that the payment terms were “30 days same as cash.” They would still have a contract but without the additional payment term.

A final portion of § 2-207 allows the parties to take action to eliminate addi- tional terms. They can do so by objecting to any added terms within a reasonable time. For example, if Alfie’s offer was not limited and Bob accepted the pay- ment terms, Alfie could object to the payment terms, and they would then not be a part of the contract. Exhibit 11.2, as already noted, summarizes the UCC’s § 2-207 rules. As noted earlier, the most significant changes under Revised Article 2 deal with § 2-207, and these have resulted in the most resistance to the Arti- cle’s adoption by the states.4

In the following three dialogues, determine whether a contract is formed under UCC § 2-207.

1. A: “I’ll sell you my Peugeot bicycle for $100.”

B: “I’ll take it. Include your tire pump.”

2. A: “I’ll sell you my white 1974 Ford Torino for $358. This offer is limited to these terms.”

B: “I’ll take it. Furnish a history of repairs.”

3. A: “I’ll sell you my antique Coca-Cola sign.”

B: “I’ll take it if you will deliver it.”

Consider . . . 11.5

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Chapter 11 Contracts and Sales: Introduction and Formation 387

C9 Ventures v SVC-West, L.P. 202 Cal. App.4th 1483, 136 Cal. Rptr.3d 550 (Cal. App. 2012)

The Helium Contract That Tanked

Case 11.4

FaCts

SVC–West, L.P., did time-share presentations at hotels and ordered helium tanks quite often for balloons. SVC placed a rush order with C9 Ventures for eight helium-filled tanks used to inflate festive balloons. C9 accepted the order and later that day delivered the tanks.

On the reverse of the invoice was an indemnifica- tion provision requiring SVC to indemnify C9 for any loss arising out of the use or possession of the heli- um-filled tanks. C9’s invoice was on a single piece of paper, on the reverse side of which was an indemnity provision:

“INDEMNITY/HOLD HARMLESS” (boldface omit- ted), which stated in part: “Customer agrees to indem- nify[,] defend and hold harmless C9 . . . from and against any and all liability, claims, judgments, attorneys fees and cost of . . . every[ ] kind and nature, including, but not limited to injuries or death to persons and dam- age to property, arising out of the use, maintenance, instruction, operation, possession, ownership or Rental & Decor of the items rented, however cause[d], except claims or litigation arising through the solo [sic] gross negligence or willful misconduct of C9. . . .”

The reverse side of the invoice also included a section entitled “LEGAL FEES,” which provided, in essence, that in an action to enforce “this Rental & Decor Agreement,” the prevailing party would be enti- tled to recover attorney fees.

C9 had presented the same or similar invoice to SVC 10 times but had received the signature of an SVC employee only six times. SVC never attempted to sub- stitute its own form agreement for C9’s form.

C9 typically delivered the tanks in the morning when no SVC guests were present, but on July 3, C9’s employee, Ernesto Roque, did not arrive at the SVC premises to make the delivery until about 5:00 p.m. Roque asked an SVC employee, Zayra Renteria, where to place the eight helium-filled tanks. Renteria, who was expecting the delivery during her shift, instructed

Roque to bring the tanks up to the mezzanine level of the resort, at which point she would inform him where to place them. Roque wrote the following on the invoice: “[N]obody would sign all running around in lobby nobody knew who. . . . After accident nobody got signatures.”

Roque stacked five to seven tanks against the walls next to the service elevator. He was in the process of bringing up another tank when a young boy, whose parents were attending the time-share presentation, ran up to the tanks and hugged one of them, pulling it over. The tank, which was about five feet tall and weighed 130 pounds, fell on the boy’s hand. He was hospitalized and underwent surgery for his injuries.

SVC and C9 each paid the boy’s family to settle a lawsuit brought to recover for his injuries. C9 filed a cross-complaint against SVC to enforce the indemnifi- cation provision on the back of the unsigned invoice. The trial court found for C9 and SVC appealed.

JUdICIaL OPINION

FYBEL, Judge This case could serve as a question on a law school final examination for a course on the Uniform Commercial Code. As in a law school examination, the facts are undisputed. The question: Is the indemnification pro- vision on the back of the unsigned invoice enforceable against SVC?

The trial court answered the question yes, finding under California Uniform Commercial Code section 2207, the indemnification provision did not materially alter the contract and therefore became an added term.

We answer the question differently and hold the indemnification provision is not binding on SVC. SVC and C9 entered into an oral contract when C9 accepted SVC’s telephone order for eight helium-filled tanks. The oral lease was sufficiently definite, although it left open various terms. Under section 2207, on which the trial court relied, additional terms proposed in an

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C9 Ventures v SVC-West, L.P. (Case 11.4) deals with layers of issues in contract formation, bringing together both common law and UCC principles in formation and determining terms.

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388 Part 3 Business Sales, Contracts, and Competition

acceptance or confirmation may become terms of the contract in certain situations. Section 2207 is part of division 2 of the California Uniform Commercial Code, and division 2 governs transactions in goods. The oral contract between SVC and C9, however, was a lease of personal property (the helium-filled tanks), and personal property leases are governed by division 10, not division 2, of the California Uniform Commercial Code.

Division 10 of the California Uniform Commer- cial Code, which governs the oral contract between SVC and C9, does not have an analog to section 2207. The terms on the back of the unsigned invoice would have become part of the parties’ oral contract only if SVC manifested assent to those terms. SVC did not manifest such assent by course of dealing or course of performance, or under basic contract law. SVC did not sign the invoice or otherwise expressly agree to its terms. An unsigned invoice itself is not a contract, and repeated delivery of a particular form does not make the form part of the parties’ agreement. Payment of the invoice merely constituted SVC’s performance of the obligation under the oral contract to pay for the rental of the helium-filled tanks.

To cover all bases (as one should when answering a law school examination question), we also construe the oral contract between SVC and C9 as if it were a

transaction in goods governed by division 2 of the California Uniform Commercial Code and address whether the indemnification provision would have become an additional term under section 2207, as the trial court found. We conclude it would not. If SVC is not a merchant, the terms of the invoice are considered to be mere proposals for additional terms, which SVC did not accept. If SVC is a merchant, the indemnifi- cation provision would not have become part of the contract if the provision materially altered the contract. Because an indemnification provision is deemed a material alteration to an agreement as a matter of law, the indemnification provision on the back of the invoice would not, under section 2207, become part of the contract between SVC and C9.

We therefore reverse the judgment and remand with directions to enter judgment in SVC’s favor. Because we reverse the judgment on which attorney fees were awarded, we also reverse the order awarding attorney fees.

Case QUestIONs

1. Why is it important to determine whether the contract involved a sale or lease of goods?

2. Is the indemnification clause material?

3. Would it be important to know if SVC is a merchant? Why?

Schulze and Burch Biscuit Company (Schulze) purchased low-moisture 16-mesh dehydrat- ed apple powder from Tree Top, Inc., to use in making strawberry and blueberry “Toast- ettes,” which it sells to Nabisco, Inc.

On April 27, 1984, E. Edward Park, Schul- ze’s director of procurement, telephoned Rudolph Brady, a broker for Tree Top, and ordered 40,000 pounds of Tree Top’s apple powder. Mr. Park told Mr. Brady that the purchase was subject to a Schulze pur- chase order and gave Mr. Brady the number of the purchase order, but Mr. Park did not send the purchase order or a copy of it to Mr. Brady or to Tree Top. On the front of the purchase order was the following clause:

Important: The fulfillment of this order or any part of it obligates the Seller to abide by the terms, conditions and

instructions on both sides of this order. Additional or substitute terms will not become part of this contract unless expressly accepted by Buyer; Seller’s acceptance is limited to the terms of this order, and no contract will be formed except on these terms.

Shortly after the telephone conversa- tion, Mr. Brady sent Schulze a form entitled simply “Confirmation” that listed Mr. Brady as broker, Schulze as buyer, and Tree Top as seller as well as the quantity, price, ship- ping arrangements, and payment terms. It also showed the purchase order number that Mr. Park had given to Mr. Brady. Sev- eral preprinted provisions, including an ar- bitration clause, stood on the lower portion of the form:

Consider . . . 11.6

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Chapter 11 Contracts and Sales: Introduction and Formation 389

termination by Offer expiration An offer can end by expiring and, once expired, can no longer be accepted by the offeree. For example, if an offer states that it will remain open until November 1, it automatically terminates on November 1, and no one has the power to accept the offer after that time. The death of the offeror also ends the offer, unless the offeree holds an option. Even offers without time limits expire after a reasonable time has passed. For example, an offer to buy a home is probably only good for one or two weeks because the offeror needs to know whether to try for another house. The offer- or’s offer terminates naturally if the offeree fails to accept within that time frame.

Re: Checklist for Contract Preliminaries

For the Manager’s Desk

1. Do your contract homework.

a. Do background checks—check ref- erences, complaints at state and private agencies, court dockets.

b. Learn the nature of the business and industry custom—learn to use the language.

2. Negotiate details.

a. Agree on terms that help you accomplish your purpose (“apple powder for bakery equipment,” not just “apple powder”).

b. Make sure your written agreement is complete.

Seller guarantees goods to conform to the national pure food laws. All disputes under this transaction shall be arbitrated in the usual manner. This confirmation shall be subordinate to more formal contract, when and if such contract is executed. In the absence of such contract, this confirmation rep- resents the contract of the parties. If incorrect, please advise immediately.

Mr. Brady had sent a similar confirma- tion form to Schulze in each of at least ten previous transactions between Tree Top and Schulze. Schulze had never objected to any of the preprinted provisions. Schulze had sent Mr. Brady a purchase order in two of those transactions; in each of the other transactions, as in the present case, Schulze simply informed Mr. Brady of the number of the appropriate purchase order.

Subsequently, Schulze brought suit seeking damages for breach of contract, alleging that the dehydrated apple pow- der had been so full of apple stems and wood splinters that it clogged the ma- chinery of Schulze’s Toastette assembly line, causing the line to shut down, with various financial losses. Schulze alleged that the powder thus failed to meet Schul- ze’s specifications, which had governed the previous sales of apple powder. Tree Top alleged that the dispute was subject to arbitration because of the arbitration clause in the confirmation sent by Mr. Brady to Schulze.

Does the arbitration clause apply? Discuss the issues under UCC § 2-207. [Schulze and Burch Biscuit Co. v Tree Top, Inc., 831 F.2d 709 (7th Cir. 1987)]

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390 Part 3 Business Sales, Contracts, and Competition

11-5b acceptance: the Offeree’s Response

An acceptance is the offeree’s positive response to the offeror’s proposed con- tract, and only persons to whom the offer is made have the power of acceptance. That acceptance must be communicated to the offeror using the proper method of communication, which can be controlled by the offeror or left to the offeree. In either case, the method of communication controls the effective time of the acceptance.

acceptance by stipulated Means Some offerors give a required means of acceptance called a specified or stipulated means. If the offeree uses the stipulated means of acceptance, the acceptance is effective sooner than the offeror’s receipt; the acceptance is effective when it is properly sent. For example, if the offeror has required the acceptance to be mailed and the offeree properly mails the letter of acceptance, the acceptance is effective when it is sent. This timing rule for acceptance is called the mailbox rule, and it applies in stipulated means offers so long as the offeree uses the stipulated means to communicate acceptance.

For the Manager’s Desk

Re: Checklist for drafting Contracts

3. Identify both parties clearly. Be certain corporate names are correct. Make sure the parties have the proper authority to enter into the transaction. (Are copies of board resolutions approving the contract available?)

4. Define the terms used in the contract, including industry terms.

a. List all terms: price, subject matter, quantity, delivery, payment terms.

b. Answer “what-if” questions. (What if payment is not made? What if deliveries are late?)

tyPe OF OFFeR MethOd OF aCCePtaNCe aCCePtaNCe eFFeCtIVe? No means given Same or reasonable method of

communication* When properly mailed, dispatched (mailbox rule)

No means given Slower or unreasonable method of communication

When received, if offer still open

Means specified (specified or stipulated means)

Stipulated means used Mailbox rule

Means stipulated (specified or stipulated means)

Stipulated means not used Counteroffer and rejection

*Some states still follow the common low rule that requires the same method of communication in order to have the mailbox rule apply, even in UCC transactions.

Exhibit 11.3 timing Rules for acceptance

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Chapter 11 Contracts and Sales: Introduction and Formation 391

acceptance with No stipulated Means If the offeror does not stipulate a means of acceptance, the offeree is free to use any method for communication of the acceptance. If the offeree uses the same method of communication or a reasonable means, the mailbox rule also applies. If the offeree uses a slower method of acceptance, the acceptance is not effective until it is received. Exhibit 11.3 summarizes the timing of acceptance rules. Kass v Grais (Case 11.5) deals with an issue of timing on offer and acceptance.

Kass v Grais 887 N.Y.S. 2d 578 (N.Y. Div. One 2009)

The FedEx Difference on Delivery and Acceptance

Case 11.5

FaCts

Loryn Kass (plaintiff) made an offer to purchase land from David Grais and others (defendants). Twenty minutes after she revoked her offer, she received a FedEx package that included all the signed documents from Mr. Grais for the sale of the land to Ms. Kass.

Mr. Grais filed suit seeking to enforce their contract on the grounds that the mailbox rule applied and that his acceptance of her offer occurred when he sent the FedEx package, thus making the acceptance effective before her revocation. The trial court granted summary judgment to Ms. Kass, and Mr. Grais appealed.

JUdICIaL OPINION

MAZZARELLI, Presiding Judge Although the mailbox rule has never been extended to encompass the delivery of a contract by Federal Express, defendants propose applying the rule to this purchase contract, notwithstanding the postdating of such contract to the date of delivery. Pursuant to section 25 of the purchase contract, “any notice to

Escrowee shall be deemed given only upon receipt by Escrowee and each Notice delivered in person or by overnight courier shall be deemed given when delivered.” It is undisputed that plaintiff withdrew her offer to purchase defendants’ property before the fully executed contract was delivered. Defendant argues for excluding the executed contract from the ambit of section 25 because that provision uses the word “notice.” To the extent section 25 could be considered ambiguous, which it is not, it is well settled that any ambiguity must be construed in plaintiff’s favor and against defendants, who drafted it.

Affirmed.

Case QUestIONs

1. Is this a stipulated means offer? Explain why or why not.

2. Why does the language change the mailbox rule?

3. Does the court decide the issue of FedEx delivery and the mailbox rule?

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11-5c e-Commerce and Contract Formation

The Internet has provided a means for contracting online. However, the courts have been left to deal with the issue of whether and when a contract has been formed. The new rules that have emerged regarding cyberspace contracts focus on whether the parties knew the terms and whether they voluntarily accepted those terms once aware of them. In other words, the rules on contract formation in cyberspace require that the parties prove that a click was something more than an accidental action and that the click was made after there had been full disclosure of the terms.

A new section of revised Article 2 deals with electronic communication of acceptance, including the timing issues. Section 2-213 provides that “receipt of an electronic communication has a legal effect, it has that effect even though no

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392 Part 3 Business Sales, Contracts, and Competition

individual is aware of its receipt,” and that acknowledgment of the receipt of an electronic communication is receipt but, “in itself, does not establish that the con- tent sent corresponds to the content received.” So, receipt is required for electronic communication and receipt occurs when the e-mail arrives, even if the receiver does not know it has arrived. Also, the parties are left to use other means of proof to establish that all of the message made it from one party to another because acknowledging receipt does not mean that all terms arrived.

Sellers generally accomplish these two goals by establishing on their websites “clickon,” “clickthrough,” or “clickwrap” agreements. The company or offeror simply lists all the terms of the agreement that the visitor/offeree is about to enter into. The visitor/offeree must click on “I agree” or “I agree to these terms,” or he or she cannot proceed to the completion of the contract segments of the site. The terms include cost, payment, warranties, arbitration provisions, and so on, and all applicable terms must be spelled out in advance of the “I agree” click point.

Because this type of contract formation is so new, case law is rare, but Home Basket Co., LLC. v Pampered Chef, Ltd. (Case 12.6) is one example of a contract-formed-on-the-Internet dispute.

Home Basket Co., LLC. v Pampered Chef, Ltd. 55 UCC Rep. Serv. 2d 792 (D. Kan. 2005)

Making a Basket Case

Case 11.6

FaCts

The Greenbrier Basket Company (GBC), a goods dis- tributor (plaintiff) (seller) agreed in October 2003 to sell woven baskets to The Pampered Chef (TPC) (defendant) (buyer). On October 28, 2003, an executive sales agree- ment was drafted but never signed by the parties. GBC had, however, accepted purchase orders from TPC.

Cyndee Pollock (a manager at GBC) received offers to purchase goods via e-mail from TPC and would then tell an employee, Mark Beal, to accept these purchase orders via TPC’s Internet site. GBC denies knowing that there were terms and conditions, including a forum selection clause, on TPC’s Internet acceptance site. TPC sent Mark Beal an e-mail with an attachment showing him how to use TPC’s purchase order management system and included instructions regarding the use of the purchase order management system, including, in section 4, three paragraphs under the title “Accepting and Rejecting Purchase Orders,” the following:

Clicking on the Accept P.O. button will cause the terms and conditions of the purchase order to pop-up. The user should review these terms and conditions and click the Accept P.O. button at the bottom of the pop-up screen. . .  . If the purchase order is not acceptable in it’s [sic]

current form, the user may click on the Reject and Request Changes button. This causes a pop-up window to appear where the user may enter a free-form text describing the reason for rejecting the purchase order and request changes that would make the purchase order acceptable.

Clause 17 of the Terms and Conditions in TPC’s purchase management order system states:

This Purchase Order shall be deemed to have been made in Addison, Illinois USA and shall be governed by and construed in accordance with the laws of State of Illinois [sic]. The sole and exclusive jurisdiction for the purpose of resolving any dispute shall be the United States District Court, Northern District of Illinois, Eastern Division.

When disputes over orders and payments arose, GBC filed suit against TPC in Kansas for breach of contract. TPC moved to dismiss the suit for improp- er venue (wrong geographic court; see Chapter 3) because the terms of its purchase order called for suits in Illinois. GBC maintains it did not agree to that term because it never signed a contract and did not agree to it via their Internet contract.

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Chapter 11 Contracts and Sales: Introduction and Formation 393

JUdICIaL OPINION

BROWN, Senior J. Plaintiff does not dispute that the forum selection clause is valid. Plaintiff instead argues that the forum selection clause was never part of the parties’ contract.

TPC’s e-mails containing purchase order information constituted an offer to buy baskets. The e-mails consist- ed of information about the quantity of baskets to be bought, price, shipment information and delivery dates. None of the e-mails had any forum selection clause; however, they did state a specific manner of acceptance:

1. Upon receipt of order, please acknowledge via Internet at [website]. By acknowledging this P.O. [purchase order], you also acknowledge the terms and conditions of this P.O.

2. To accept this P.O. via Internet, visit [website].

The evidence shows at least nine such e-mail offers. GBC consistently went to the TPC website to accept these offers.

GBC makes several arguments, without supporting case law, that the forum selection clause should not be part of the parties’ contract. None of these arguments dispute when acceptance was made.

Plaintiff first argues that the e-mail offers are ambiguous because it did not alert GBC to the forum selection clause that had to be accepted on the website. The TPC e-mails state that the way to acknowledge (i.e. accept) the purchase order was to go to the website. The e-mail is not ambiguous as it also alerted GBC that there were terms and conditions associated with acknowledging the P.O. on the website.

GBC next argues that it should not be held to the terms and conditions accepted on the website because plaintiff thought that the e-mails’ terms and conditions were all inclusive.

It is a well-established rule of law that contracting parties have a duty to learn the contents of a written contract before signing it, and such duty includes reading the contract and obtaining an explanation of its terms. The negligent failure of a party to read the written contract entered into will estop the contract- ing party from voiding the contract on the ground of ignorance of its contents. Therefore, a party who signs a written contract is bound by its provisions regardless of the failure to read or understand the terms, unless the contract was entered into through fraud, undue influence, or mutual mistake.

In determining intent to form a contract, the test is objective, rather than subjective, meaning that the relevant inquiry is the “manifestation of a party’s intention, rather than the actual or real intention.” Put another way, “the inquiry will focus not on the ques- tion of whether the subjective minds of the parties have

met, but on whether their outward expression of assent is sufficient to form a contract.”

This was a website that required action on the part of GBC. Plaintiff objectively agreed to the forum selection clause by scrolling through the terms and conditions and clicking on the “Accept P.O.” button. Plaintiff’s subjective beliefs that it was the e-mail and not the website terms and conditions that governed the contract are both misplaced and irrelevant. Plaintiff was under a duty to read and understand the terms and conditions prior to clicking the “Accept P.O.” button as this was the formal acceptance required by TPC’s offer to purchase baskets. Failure to read or understand the terms and conditions is not a valid reason to render those provisions nugatory.

Plaintiff next argues that the forum selection clause should not be read into the contract because GBC rejected an Exclusive Sales Agreement containing such a clause. Plaintiff claims that the failure to sign this agreement shows that they did not intend that a forum selection clause be part of the contract. The evidence shows that the Exclusive Sales Agreement was discussed on October 28, 2003. The date of the first e-mail inviting GBC to accept a purchase order was October 7, 2003. Plaintiff’s subjective reasons for refusing to sign the Exclusive Sales Agreement are irrele- vant as GBC consistently agreed, in an objective manner prior to the Exclusive Sales Agreement, to contracts with the terms and conditions on TPC’s website. The Court will not alter the plain terms in the parties’ contract because GBC refused to sign the Exclusive Sales Agreement.

Plaintiff also argues that there was no meeting of the minds regarding the forum selection clause on the website. A meeting of the minds requirement is proved when the evidence shows with reasonable definiteness that the minds of the parties met upon the same mat- ter and agreed upon the terms of the contract. Part of clause 17 states “each shipment received by Buyer from Seller shall be deemed to be only upon the terms and conditions as set forth in this Purchase Order . . .” GBC agreed upon these terms and conditions published on TPC’s website by clicking the “Accept P.O.” button and this satisfied the meeting of the minds standard.

The Court holds that the forum selection clause in the terms and conditions on TPC’s website are a part of the parties’ contract. GBC must file suit in Illinois.

Case QUestIONs

1. Describe the ordering process between the two parties.

2. Does it matter to the court that neither side ever signed a written agreement?

3. What responsibility does the court impose on those who use websites for contracting purposes?

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394 Part 3 Business Sales, Contracts, and Competition

11-5d Consideration

Consideration is what distinguishes gifts from contracts and is what each party—offeror and offeree—gives up under the contract; it is sometimes called bargained-for exchange. If you sign a contract to buy a 1990 Mercedes for $17,000, your consideration is the $17,000 and is given in exchange for the car. The seller’s consideration is giving up the car and is given in exchange for your $17,000. On the other hand, if your grandmother tells you that she will give you her Mercedes, the lack of consideration on your part means your grandmother’s promise (unfortu- nately) is not a contract and is not enforceable.

The courts are not concerned with the amount or nature of consideration as long as it is actually passed from one party to the other. A contract is not unen- forceable because a court feels you paid too little under the contract terms. The amount of consideration is left to the discretion of the parties, but one party cannot demand greater consideration once the contract is finalized.

In 1977, George Lucas granted Kenner Toys the exclusive right to produce Star Wars toys—the action figures and other replicas from the movie—in perpetuity for $100,000 per year. At the time the contract was nego- tiated, no one understood how valuable the contract rights were.

In 1991, Hasbro Toys purchased Ken- ner. By this time, the sales of Princess Leia dolls and R2D2 replicas were nonexistent. Because there was no market for the toys, the toys were no longer produced, and an accountant with Kenner decided to save $100,000 and not send the check to Mr. Lucas.

In 1992, an employee of Mr. Lucas saw a line of Galoob toys at a trade show and asked if Galoob was interested in making the Star Wars toy line. Galoob jumped at the chance and did quite well marketing the toys. Some executives believe that the pop- ularity of the toys motivated Mr. Lucas to rerelease the movies, which turned out to be a moneymaker for Mr. Lucas as well as for the Galoob toy line.

In 1996, Mr. Lucas did grant some rights to Hasbro, but it has lost market share and footing to Galoob. Was the failure to make the payment a failure of consideration? Has Hasbro lost its rights?

Consider . . . 11.7

Unique Consideration Issues The concept of consideration and its requirement for contract formation has pre- sented courts with some unique problems. Often an element of fairness and reli- ance exists in circumstances in which an offer and acceptance are made but no consideration. For example, many nonprofit organizations raise funds through pledges. Such pledges are not supported by consideration, but the nonprofit orga- nizations rely on those pledges. Called charitable subscriptions, these agreements are enforced by courts despite the lack of consideration.

The doctrine of promissory estoppel is also used as a substitute for consid- eration in those cases in which someone acts in reliance on a promise that is not supported by consideration. For example, suppose an employer said, “Move to Denver and I’ll hire you.” There is no detriment on your part until you begin work. The employer has no detriment either. However, if you sold your home in Phoenix and incurred the expense of moving to Denver, it would be unfair to allow the employer to claim the contract did not exist because of no consideration. You

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Chapter 11 Contracts and Sales: Introduction and Formation 395

11-5e Contract Form: When a Record Is Required

Some contracts can exist just on the basis of an oral promise. Others, however, must be evidenced by a record to be enforceable, and these contracts are covered under each state’s statute of frauds.

Common Law statute of Frauds The term statute of frauds originated in 1677 when England passed the first rule dealing with written contracts: the Statute for the Prevention of Frauds and Perjuries.

The purpose of the first statute and the descendant statutes today is to have records of agreements for the types of contracts that might encourage conflicting claims and possible perjury if oral agreements were allowed. The following is a partial list of the types of contracts required to be evidence by a record under most state laws.

1. Contracts for the sale of real property. This requirement includes sales, cer- tain leases, liens, mortgages, and easements.

2. Contracts that cannot be performed within one year. These contracts run for long periods and require the benefit of written terms.

3. Contracts to pay the debt of another. Cosigners’ agreements to pay if a debtor defaults must be in writing. A corporate officer’s personal guarantee of a corporate note must be in writing to be enforceable.

Alan Fulkins, who owns a construction com- pany that specializes in single-family resi- dences, is constructing a small subdivision with 23 homes. Tretorn Plumbing, owned by Jason Tretorn, was awarded the contract for the plumbing work on the homes at a price of $4,300 per home.

Plumbing contractors complete their residential projects in three phases. Phase 1 consists of digging the lines for the plumbing and installing the pipes that are placed in the foundation of the house. Phase 2 involves the placement of pipes within the walls of the home, and phase 3 handles the surface plumbing, such as sinks and tubs. However, industry practice dictates that the plumbing contractor receive one-half of the contract amount after completion of phase 1.

Mr. Tretorn completed the digs of phase 1 for Mr. Fulkins and received payment of $2,150. Mr. Tretorn then went to Mr. Fulk- ins and demanded an additional $600 per

house for completion of the work. Mr. Fulkins said, “But you already have a con- tract for $4,300!” Mr. Tretorn responded, “I know, but the costs are killing me. I need the additional $600.”

Mr. Fulkins explained the hardship of the demand: “Look, I’ve already paid you half. If I hire someone else, I’ll have to pay them two-thirds for the work not done. It’ll cost me $5,000 per house.” Mr. Tretorn re- sponded, “Exactly. I’m a bargain because the additional $600 I want only puts you at $4,900. If you don’t pay it, I’ll just lien the houses and then you’ll be stuck without a way to close the sales. I’ve got the contract all drawn up. Just sign it and everything goes smoothly.”

Should Mr. Fulkins sign the agreement? Does Mr. Tretorn have the right to the addi- tional $600? Was it ethical for Mr. Tretorn to demand the $600? Is there any legal advice you can offer Mr. Fulkins?

Consider . . . 11.8

have acted in reliance on a promise, and that reliance serves as a consideration substitute.

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396 Part 3 Business Sales, Contracts, and Competition

UCC statute of Frauds Under the UCC, a separate statute of frauds applies to contracts covering the sale of goods. Contracts for the sale of goods costing $500 or more must be evidenced by a record to be enforceable. As noted earlier, a record can be in the form of an electronic communication. Under Revised Article 2, the amount was increased from $500 to $5,000. Many states have made this change despite not adopting most of the Revised Article 2 provisions.

Which of the following contracts must be in record form to be enforceable?

1. A contract for the sale of an acre of land for $400

2. A contract for management consulting for six months for $353,000

3. A contract for the sale of a car for $358

4. A contract for a loan cosigned by a corporation’s vice president

5. A contract for the sale of a mobile home for $12,000

Consider . . . 11.9

Sununu v Philippine Airlines, Inc. (Case 11.7) is a case that involves several issues related to contract formation, a record, and terms.

Sununu v Philippine Airlines, Inc. 792 F. Supp. 2d 39 (D. D.C. 2011)

A Turbulent Negotiation Contract with the Airline

and a Contract That Never Took Off

Case 11.7

FaCts

Because of financial setbacks, Philippine Airlines (PAL) wanted to renegotiate its aircraft leases, includ- ing those it had with World Airlines (WA). WA refused to negotiate with PAL. PAL retained John Sununu, the former Governor of New Hampshire and the former Chief of Staff to President George H. W. Bush, and Sununu’s partner, Victor Frank, to try their hands at a renegotiation. Sununu and Frank (plaintiffs) sent a contract proposal to PAL, which included a proposed “success fee” of $600,000 if they persuaded WA to accept a modification of the lease contract. PAL gave Sununu and Frank a verbal go-ahead but did not sign the proposed contract. PAL then sent a contract with terms that were different from what Sununu and Frank had proposed. The PAL terms included a suc- cess fee of 4 percent of savings on the aircraft leases if Sununu and Frank were able to reach a settlement that met two very detailed settlement offers PAL had put into its contract proposal. Because they were so

busy with contract renegotiations, Sununu and Frank did not review the PAL agreement and simply signed the contract.

Sununu and Frank were able to successfully rene- gotiate the lease contract with WA, saving PAL $12.8 million on the lease payments. PAL refused to pay Sununu and Frank their success fee of $520,000 because the actual settlement they had negotiated with WA did not meet the very specific contract terms that WA had put into the unsigned written agreement. Sununu and Frank filed suit against PAL in May 1998, alleging breach of contract, unjust enrichment, and fraud. The litigation went into a nine-year holding pattern while PAL endured financial reorganization proceedings in the Philippines. After reemerging from bankruptcy, PAL moved to dismiss the complaint. This Court grant- ed PAL’s motion on the breach of contract claim but allowed discovery to proceed on unjust enrichment. PAL again moved for summary judgment.

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Chapter 11 Contracts and Sales: Introduction and Formation 397

JUdICIaL OPINION

LAMBERTH, Chief Judge Sununu and Frank first argue that their contract with PAL was invalid because it was rescinded. They note that, under D.C. contract law, rescission can occur “when one party offers the rescission and the other party neither accepts nor rejects the offer.” They claim that they rescinded the contract when they “offered a different deal, to which PAL never responded” after they learned about the severity of the lease termination dispute from WA.

There are several problems with this argument. First, Sununu and Frank present no evidence that their discussions with PAL constituted an offer to rescind the contract and not merely to modify it. (“Mr. Frank and I approached PAL about modifying our remuneration.”) (emphasis added). Under traditional contract law prin- ciples, an unanswered proposal to modify a contract operates as unaccepted offer—leaving the underlying contract unchanged—not as a rescission of the agree- ment. For example, if an employee asks his boss for a raise and the boss doesn’t answer, the employee continues to work at his existing wage. No one would suggest that his employment contract is terminated.

The facts alleged by the plaintiffs make rescission even less plausible here. Sununu and Frank claim they proposed amending the contract with PAL to make it more favorable to PAL by replacing the four-percent success fee with a fixed figure. To return to the example above, this is the equivalent of the employee asking his boss for a pay cut. Even if Sununu and Frank are correct that PAL did not respond to their allegedly generous offer, it makes little sense to conclude that they would opt to rescind a contract they believed dis- proportionately benefited them. Moreover, Sununu’s deposition directly contradicts the allegation that the contract was rescinded. When asked if he had tried to rescind his contract with PAL, he answered, “No, I don’t do that to clients.”

Even if the Court sets aside the argument above and assumes that Sununu and Frank did intend to rescind, D.C. contract law provides that rescission must be total, not partial. Here, however, Sununu and Frank seek to have their contract and rescind it too. They invoiced and accepted payment of the $50,000 fee provided in the contract, yet they claim to have rescinded the other part of the contract and now seek

unjust enrichment on that provision. The law will not allow them to have it both ways.

Similarly, D.C. law provides that affirming a con- tract—continuing to carry it out—negates the opportu- nity to rescind. If a party “affirms the contract through continued performance, that party is precluded from seeking rescission.” Sununu and Frank affirmed the contract by seeking to perform it, invoicing on it, and collecting on it. Finally, even if Sununu and Frank could show that the contract was rescinded and replaced by their modified proposal, they would have a claim for breach of the new contract, not unjust enrichment.

The crux of Sununu and Frank’s theory is that PAL fraudulently concocted contract terms that it knew Sununu and Frank could not meet, thus sending them on the consulting equivalent of Mission Impossible and allowing the Manila airline “to obtain Sununu and Frank’s valuable services, without having to pay [the] Success Fee.”

To grant PAL’s summary judgment motion is not to condone its conduct. The airline can rightly be accused of stinginess for enforcing the formalistic terms of the contract in spite of the plaintiffs’ earnest efforts on its behalf. PAL’s shifting explanations for why it would not pay Sununu and Frank do not reflect well on the airline’s approach to business dealings. But because the airline ultimately had no obligation to pay, the facts surrounding this issue are not material to resolving the case. PAL may have violated Sununu and Frank’s trust, but it did not violate the law.

For their part, Sununu and Frank seem to have done their best to serve their client, but they made a reckless bet by trusting PAL. They were accustomed to handshake deals in which personal relationships count for more than legal documents, so they made little effort to put their understandings with PAL on paper. When they ran into a client who didn’t play by the same rules, they paid the price. The lesson is one that should be taught in law and business schools across America: When in doubt, write it out.

Case QUestIONs

1. What is the significance of the rescission argument?

2. Is there a contract? Explain why or why not.

3. Evaluate PAL’s ethics in this situation.

exceptions to the statute of Frauds Some exceptions to the UCC and common law statute of frauds provisions were created for situations in which the parties have partially or fully performed their unwritten contract. Under both the UCC and common law, if the parties perform

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398 Part 3 Business Sales, Contracts, and Competition

the oral contract, courts will enforce the contract for what has already been done. For example, if Alan agreed to sell land to Bertha under an oral contract and Bertha has paid, has the deed, and has moved in, Alan cannot use the statute of frauds to remove Bertha and get the land back.

What Form of Record Is Required? The form of the record required under the statute of frauds is not formal. Evidence of a written agreement can be pieced together from memos and letters.

11-5f Writing and e-Commerce: the Uniform electronic transactions act

The Uniform Electronic Transactions Act (UETA) has been adopted, as of mid- 2016, in 47 states and the District of Columbia and remains on the agenda of state legislatures in the remaining states. However, state adoptions of the UETA are not nearly as uniform as those of the UCC, and the issues of what constitutes a valid signature and the effect of electronic verification continue to evolve.

The UETA is state recognition of the Electronic Signatures in Global and National Commerce Act of 2000 (ESIGN), 15 U.S.C. § 7001, the federal law that mandates the recognition of electronic signatures for the formation of contracts. Although states may vary in their specifics under the UETA, they cannot deny legal effect to contracts that are entered into electronically and that bear electronic signatures. ESIGN means that faxes, PDFs, and online clicks on a tab that reads “I accept” can all be used to form a valid contract. However, some documents are exempt from this equal treatment, including wills, trusts, checks, letters of credit, court documents, and cancellation of health and life insurance policies. States may require paper documentation for protection of legal rights in these transactions.

Rosenfeld v Basquiat (Case 11.8) deals with the issues of types of writings as well as whether a writing is sufficient to satisfy the statute of frauds requirements.

Rosenfeld v Basquiat 78 F.3d 84 (2d Cir. 1996)

The Artist, the Crayon, and the Contract

Case 11.8

FaCts

Michelle Rosenfeld, an art dealer, alleges she contract- ed with artist Jean-Michel Basquiat to buy three of his paintings. The works that she claims she contracted to buy were entitled Separation of the K, Atlas, and Untitled Head. Ms. Rosenfeld testified that she went to Mr. Bas- quiat’s apartment on October 25, 1982; while she was there, he agreed to sell her three paintings for $4,000 each, and she picked out three. Mr. Basquiat asked for a cash deposit of 10 percent; she left his loft and later returned with $1,000 in cash, which she paid him. When she asked for a receipt, he insisted on drawing up a contract and got down on the floor and wrote it out in crayon on a large piece of paper, remarking that

someday this contract would be worth money. The handwritten document listed the three paintings, bore Ms. Rosenfeld’s signature and Mr. Basquiat’s signature, and stated, “$12,000—$1,000 DEPOSIT—Oct 25 82.” Ms. Rosenfeld later returned to Mr. Basquiat’s loft to discuss delivery, but Mr. Basquiat convinced her to wait for at least two years so that he could show the paintings at exhibitions.

After Mr. Basquiat’s death, the estate argued that there was no contract because the statute of frauds made the agreement unenforceable. The estate con- tended that a written contract for the sale of goods must include the date of delivery. From a judgment in favor of the estate, Ms. Rosenfeld appealed.

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Chapter 11 Contracts and Sales: Introduction and Formation 399

JUdICIaL OPINION

CARDAMONE, J. . . . Because this case involves an alleged contract for the sale of three paintings, any question regarding the Statute of Frauds is governed by the U.C.C. (applica- bility to “transactions in goods”) (contract for $500 or more is unenforceable “unless there is some writing sufficient to indicate that a contract for sale has been made between the parties and signed by the party [charged]”). Under the U.C.C., the only term that must appear in the writing is the quantity.

Beyond that, “[a]ll that is required is that the writ- ing afford a basis for believing that the offered oral evi- dence rests on a real transaction.” The writing supplied by the plaintiff indicated the price, the date, the specific paintings involved, and that Rosenfeld paid a deposit. It also bore the signatures of the buyer and seller. There- fore, the writing satisfied the requirements of § 2-201.

Citing Berman Stores Co. v Hirsh, 240 N.Y. 209 (1925), the estate claims that a specific delivery date, if agreed upon, must be in the writing. Berman Stores was decided before the enactment of the U.C.C. and was based on the principle that “the note or memo- randum . . . should completely evidence the contract which the parties made.” 240 N.Y. at 214 [quoting

Poel v Brunswick-Balke-Collender Co., 216 N.Y. 310, 314 (1915)] The rule that a specific delivery date is “an essential part of the contract and must be embodied in the memorandum,” Berman Stores, 240 N.Y. at 215, was rejected by the legislature—at least for sale-of-goods cases—when it enacted the U.C.C. That rule and the statute upon which it was based were repealed to make way for the U.C.C.

.  .  . Because the writing, allegedly scrawled in crayon by Jean-Michel Basquiat on a large piece of paper, easily satisfied the requirements of § 2-201 of the U.C.C., the estate is not entitled to judgment as a matter of law. It is of no real significance that the jury found Rosenfeld and Basquiat settled on a particular time for delivery and did not commit it to writing. . . . As a consequence . . . the alleged contract is not invalid on Statute of Frauds grounds . . .

Judgment reversed.

Case QUestIONs

1. Why was the contract required to be in writing?

2. Did the contract comply with the statute of frauds?

3. Does a writing that does not comply with the statute of frauds make the alleged contract void?

Under the UCC, merchants can meet the statute of frauds by sending confir- mation memos (see § 2-201 in Appendix C). These merchants’ confirmation mem- oranda summarize the oral agreement and are signed by only one party, but they can be used to satisfy the statute of frauds so long as the memo has been sent to the nonsigning party for review and no objection is raised upon that party’s receipt. The confirmation memoranda could be done via e-mail.

Brooks Peanut Co., Inc. v Great Southern Peanut, LLC (Case 11.9) deals with an issue of the validity of a confirmation memo.

Brooks Peanut Co., Inc. v Great Southern Peanut, LLC 746 S.E.2d 272 (Ga. App. 2013)

A Shell of a Contract For Peanut Supplies

Case 11.9

FaCts

Brooks Peanut is a peanut shelling company oper- ating in Samson, Alabama. Great Southern Peanut, LLC (GSP), is a competing peanut sheller. Pea- nut shellers and other businesses handling peanut products often use brokers to buy and sell peanuts.

Typically, the broker’s fee is paid by the seller. Mazur & Hockman, Inc. (M&H), is a broker used by both Brooks Peanut and GSP.

In mid-September 2010, Barrett Brooks, presi- dent of Brooks Peanut, called Richard Barnhill and Jay Strother, peanut brokers with M&H, and asked ©

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400 Part 3 Business Sales, Contracts, and Competition

them to find peanuts for his company to buy. Brooks requested that Brooks Peanut not be identified as the buyer when M&H contacted potential sellers. M&H solicited offers from several peanut shellers, including GSP, and conveyed them to Brooks. On September 20, Brooks asked Strother to communi- cate a counteroffer to GSP’s manager, Doug Win- gate. Specifically, the counteroffer was an offer to buy 3,168,000 pounds of 2010 crop medium runner shelled peanuts for $.4675 per pound, to be delivered monthly throughout 2011.

Wingate accepted the counteroffer that same day, September 20. After Wingate accepted these terms, Strother revealed that Brooks Peanut was the buyer. According to Strother, Wingate “sighed” upon learn- ing that a competitor was involved in the transac- tion; however, he did not reject the deal. Wingate testified that although he initially accepted the deal, he declined to consummate it when he learned that Brooks Peanut was the buyer.

On the same day, M&H prepared and then faxed to GSP and Brooks Peanut a written confirmation of the sale of peanuts. The confirmation stated, “We confirm a Sale and Purchase Transaction as described below[.]” The confirmation was printed on M&H letterhead and listed the names and addresses of the seller and the buyer, as well as terms covering price, quantity, quality, crop year, delivery schedule, and payment method. The confirmation stated that “[t]his confir- mation is subject to the following condition[ ]: Seller’s contract and Buyer’s purchase order to follow[.]” Next to the term “Quality,” the confirmation noted that the “American Peanut Shellers Association Trading Rules” applied to the transaction. The confirmation was signed by M&H’s Strother.

GSP and Brooks Peanut each received the faxed confirmation from M&H. GSP did not issue a con- tract, and Brooks Peanut did not issue a purchase order. After Strother sent the confirmation to GSP and Brooks Peanut, he continued communicating with the parties to finalize the logistics of the deliveries. For example, on September 21, he told Brooks that GSP had offered to haul the peanut loads. They also discussed increasing the monthly shipments, but Wingate stated that he wanted “to stay at 6 loads a month on the [B]rooks [Peanut] contract for right now[.]”

GSP did not raise any objection to the fax confir- mation until late January 2011, almost four months after M&H sent it. Wingate testified that he “did not see the need” to object to the confirmation. Beginning in January 2011, GSP took the position that, despite the confirmation, GSP and Brooks Peanut had not entered into that particular transaction because Wingate had

rejected the sale when he learned that it involved his company’s competitor, that M&H was not authorized to confirm the sale or to send the confirmation, and that a condition precedent had not occurred because GSP had not issued a written contract.

M&H had routinely brokered thousands of pea- nut sales between other peanut companies, shellers, and manufacturers using the same form of trade con- firmation. GSP had sold peanuts to Brooks Peanut in June 2009 and April 2010 but their agreements were memorialized solely by M&H sending the parties confirmations substantially similar to the one issued this time.

The trial court concluded that GSP had a defense of the statute of frauds as a matter of law. Brooks Peanut appealed.

JUdICIaL OPINION

ELLINGTON, Presiding Judge. Section 2-201(1) is the UCC’s general Statute

of Frauds provision. Section 2-201(2), is sometimes referred to as the “merchant confirmation rule.”

The courts have generally held that the language in § 2-201(1) to the effect that a writing relied upon to satisfy the statute of frauds must be “sufficient to indicate” a contract is equally applicable to § 2-201(2). Similarly, the condition stated in § 2-201(1) to the effect that a contract is not enforceable under the code beyond the quantity stated in the writing used to overcome the statute of frauds has been expressly held applicable to § 2-201(2), as well as by implication.

The record demonstrates that Brooks Peanut and GSP are merchants within the meaning of the UCC and that the transaction at issue is one “between merchants.”

The confirmation in this case indicates that the par- ties entered into a transaction for the sale of a specific quantity of goods for a price exceeding $500.

The required writing need not contain all the mate- rial terms of the contract and such material terms as are stated need not be precisely stated. All that is required is that the writing afford a basis for believing that the offered oral evidence rests on a real transaction. . . . Only three definite and invariable requirements as to the memorandum are made by this subsection. First it must evidence a contract for the sale of goods; sec- ond, it must be “signed,” a word which includes any authentication which identifies the party to be charged; and third, it must specify a quantity.

GSP argues, however, that the confirmation is insufficient to show that the parties had reached a final agreement because it contains a condition that was not fulfilled, that is, that a seller’s contract was

continued

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Chapter 11 Contracts and Sales: Introduction and Formation 401

Exhibit 11.4 provides a summary of provisions for contract formation under UCC and common law.

“to follow.” A formal, written agreement may be a condition precedent to the formation of a binding contract, when the parties so intend. When the par- ties intend to memorialize with a formal document an agreement that they have already reached, on the other hand, the execution of the document is not an act necessary to the creation of an enforceable con- tract. In this case, there is no evidence that the parties intended the execution of the seller’s contract to be a condition precedent, especially since the parties had previously consummated deals using broker confir- mations only.

The record also contains evidence showing that GSP received the written confirmation within a rea- sonable time, given that the record shows that it was sent by fax and received on the same day that the oral agreement was allegedly reached. Further, GSP had reason to know of the confirmation’s contents, given that Wingate had been a party to the negotiations. And it is undisputed that GSP failed to object to the confirmation in writing within days.

GSP argues, however, that the confirmation was not “signed” by GSP or by its authorized agent or broker, and thus fails to satisfy the requirements of 2-201(1). It also argues that the confirmation was not “sufficient against the sender” within the meaning of 2-201(2) because it was not signed by Brooks Peanut or its authorized agent or broker. GSP argues that, because Brooks Peanut had taken the position at the

outset of the litigation that M&H was GSP’s agent, not Brooks Peanut’s, then M&H could not have signed or sent the confirmation on behalf of Brooks Peanut. There is at least a jury issue regarding whether M&H acted as Brooks Peanut’s agent, as GSP’s agent, or as an agent for both in brokering the sale and in signing and sending the confirmation.

An invoice on a printed form that bears the seller’s name and address is “sufficient against the sender” and may constitute a written confirmation of a contract within the meaning of § 2-201(1) provides that the sig- nature on the confirmation may be that of the sender’s authorized agent or broker.

Given these circumstances, the record contains evidence from which the factfinder could infer that the writing was signed by both parties to the transaction through their agent and that the confirmation was signed by the sender’s agent such that it was sufficient against the sender. Consequently, GSP is not entitled to summary judgment based upon its Statute of Frauds defense, and the trial court’s order must be reversed.

Affirmed in part and reversed in part.

Case QUestIONs

1. What does this case teach us about our responsi- bilities when we receive a confirmation memo?

2. Explain the agency question and what works in favor of the memo being valid.

aRea UCC COMMON LaW Application Sales of goods Services, real estate, employment contracts

Offers Need subject matter (quantity); code gives details

Need subject matter, price, terms, full details agreed upon

Options Merchant’s firm offer; no consideration needed Need consideration

Acceptance Can have additional terms; mailbox rule works for reasonable means of acceptance

Mirror image rule followed; must use same method to get mailbox rule*

Consideration Required for contracts but not for modification or firm offers

Always required

Writing requirement Sale of goods for $500 or more Real estate, contracts, not to be performed in one year, paying the debt of another

Defenses Must be free of all defenses for valid contract Must be free of all defenses for valid contract *Some courts have adopted the UCC rule for common low contracts.

Exhibit 11.4 Common Law versus UCC Rules on Formation

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402 Part 3 Business Sales, Contracts, and Competition

the effect of the Written Contract: Parol evidence Once a contract is reduced to its final written form and is complete and unam- biguous, the parties to the contract are not permitted to contradict the contract terms with evidence of their negotiations or verbal agreements at the time the contract was executed. This prohibition on extrinsic evidence for fully inte- grated contracts is called the parol evidence rule and is a means for stopping ongoing contradictions to contracts that have been entered into and finalized. It is a protection for the application of the document to the parties’ rights as well as a reminder of the need to put the true nature of the agreement into the contract.

Some exceptions apply to the parol evidence rule. If a contract is incomplete or the terms are ambiguous, extrinsic evidence can be used to clarify or complete the contract, as in the case of UCC contracts in which price, delivery, and payment terms can be added (see § 2-202 in Appendix C). Also, if one of the parties to the contract is alleging a defense to the contract’s formation, details on the circum- stances creating that defense can be used as evidence. Evidence of lack of capacity or fraud does not violate the parol evidence rule.

11-6 Issues in Formation of International Contracts

International business contracts are similar to domestic contracts. However, the unique aspect of international contracts is that additional risks and questions arise over the choice of currency, the impact of culture on contract interpretation and performance, and the stability of the governments of the parties involved in the contract. In other words, international contracts carry certain risks that are not part of contracts between businesses in the same country. The issues in international contracts are more complex because of risk, differing sources of laws, and difficul- ties in litigation and enforcement.

11-6a CIsG—UCC for the World

The United Nations has developed such a set of laws, called the United Nations Convention on Contracts for the International Sale of Goods (CISG) (see Chapter 7).

The CISG applies to those contracts in which buyer and seller have their businesses in different countries (unless the parties agree otherwise). There are similarities between the CISG and UCC, such as requirements for offers and acceptance, including a merchant’s firm offer provision (without the three- month limitation from the UCC). However, under the CISG, acceptance is effec- tive only upon receipt, and, whenever forms do not match, there is no contract unless the nonmatching terms are immaterial. The CISG also requires an agree- ment on price for an offer to be definite enough to be valid. Merchants’ firm offers exist under the CISG, but their validity is not subject to time limitations, as with the UCC three-month limit. Parties in international trade need to be familiar with the hybrid nature of the CISG in order to protect their contract rights.

Party autonomy is a priority under the CISG. The parties can always choose the applicable law, the nation for the location of courts for resolving disputes,

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Chapter 11 Contracts and Sales: Introduction and Formation 403

and remedies. Those firms and countries not relying on the CISG should be familiar with the nuances of commercial law in the countries in which they are doing business. The tendency of many U.S. businesses is to draft a form contract using the home country legal concepts and carry them over to other countries. As Exhibit 11.5 indicates, such a practice and reliance on form contracts can be dangerous.

11-6b The Payment Issues in International Contracts

One of the content and interpretation issues in international contracts focuses on the method of payment. Is payment to be made in pesos? Japanese yen? Euros? With significant country-by-country economic collapses, the currency to be used for contract payment has become a critical component of contract negotiations.

In addition to the risks of changing currency exchange rates and political instability, international contracts are performed through long distances in transportation and the ever-present difficulties with collection of payments. Most international contracts have built-in performance guarantees. For exam- ple, a seller ships goods with a bill of lading (a document of title that the carrier will have). To be able to pick up the goods from the carrier, the buyer must have a copy of the bill of lading. The seller can have a bank release the bill of lading to the buyer when the buyer has paid or when the buyer’s bank issues a letter of credit (which is the bank’s commitment to pay) to the seller for the amount due for the goods. The effect of these two documents is that the seller or carrier does not release the goods until the payment is made or assured. The flow of goods is controlled across borders through documents that travel with the goods and through banks that issue the payment for them. At the same time, the buyer is assured that the goods are there before payment is made or authorized.

1. Use short, simple contracts. The tendency to place all possibilities in a contract is a U.S. tradition. In Germany, for example, the parties have a one-page agreement that references and incorporates terms and conditions of one of the parties.

2. Watch unconscionability protections. The United States focuses its unfairness protections on consumers, but other countries afford these same protections to commercial transactions.

3. Some disclaimers are void in other countries. For example, the clause, “We are only liable for loss of data which is due to a deliberate act on our part. We are not responsible for lost profits in any event,” would be valid in the United States but void in Germany. In Germany, sellers of software must assume liability for at least gross negligence.

4. One party’s attempt to limit liability would be void in Germany. Any liability limitation must be specifically addressed and negotiated for such a clause to be valid.

5. Unusually long periods for performance are typical in the United States but void in Germany.

6. Price increase limitations are typical in non–U.S. contracts.

7. In other countries, parties can refuse to pay on a current contract if performance on an earlier contract was less than satisfactory and damages are owed.

Exhibit 11.5 Avoiding Legal Pitfalls in International Transactions

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404 Part 3 Business Sales, Contracts, and Competition

Intershoe, Inc. v Bankers Trust 571 N.E.2d 641 (N.Y 1991)

Lira, Shoes, and Exchange Rates

Case 11.10

FaCts

Intershoe, Inc. (plaintiff) is a shoe importer that uses various foreign currencies, including Italian lira, in its business.

On March 3, 1985, Intershoe phoned Bankers Trust (defendant) and entered into several foreign currency transactions, one being a futures transaction involv- ing lira. On March 13, Bankers Trust sent Intershoe a confirmation slip with the following terms: “WE [Bankers] HAVE BOUGHT FROM YOU [Intershoe] ITL 537,750,000” and “WE HAVE SOLD TO YOU USD 250,000.00.”

The confirmation slip specified a rate of 2,151 lira per dollar and called for delivery of the lira approx- imately seven and a half months later, between October 1 and October 31, 1985. Intershoe’s treasurer signed the slip and returned it to Bankers Trust on March 18, 1985.

By letter dated October 11, 1985, Bankers Trust notified Intershoe that it was awaiting instructions as to Intershoe’s delivery of the lira. Intershoe responded in a letter dated October 25, 1985, that the transaction was a mistake and that it would not go through with it. To cover commitments in other currency transactions, Bankers Trust was forced to purchase lira on the open market at a higher price than that on March 13, 1985, resulting in a loss of $55,014.85. Intershoe filed suit claiming that it had purchased, not sold, lira and that it had sustained damages of $59,336.40. Bankers Trust counterclaimed for its damages.

The trial court held that there were issues of fact. Bankers Trust maintained that the case should be decided in its favor by summary judgment because of the parol evidence rule and appealed.

JUdICIaL OPINION

HANCOCK, Jr., Justice We turn to defendant’s argument that UCC § 2-202 bars the parol evidence submitted in opposition to its motion.

There seems to be no question that the UCC applies to foreign currency transactions. Plaintiff does not dispute this point. Instead, plaintiff sim- ply asserts that UCC § 2-202 has no application because defendant has not made a sufficient show- ing that the confirmation slip was “intended by the parties as a final expression of their agreement with respect to such terms as are included therein.” Something more is required, plaintiff says, either language in the confirmation slip indicating that it was intended to be the final expression of the parties’ agreement or uncontroverted evidence that the writing was so intended. Otherwise, accord- ing to plain tiff, there are factual issues as to the effect the parties intended the confirmation slip to have and summary judgment must be denied. We disagree.

Here, the essential terms of the transaction are plainly set forth in the confirmation slip: that plaintiff had sold lira to defendant, the amount of the lira it sold, the exchange rate, the amount of dollars to be paid by defendant for the lira, and the maturity date of the trans action. The signature of plaintiff’s agent who signed and returned the confirmation slip five days later on March 18, 1985, signifies plaintiff’s acceptance of these terms. Noth- ing in the confirmation slip suggests that it was to be a memorandum of some preliminary or tentative understanding with respect to these terms. On the contrary, it is difficult to imagine words which could more clearly demonstrate the final expression of the parties’ agreement than “WE HAVE BOUGHT FROM YOU ITL 537,750,000” and “WE HAVE SOLD TO YOU USD 250,000.00.”

The confirmation is not of some bargain to be made in the future but expresses the parties’ meet- ing of the minds as to a completed bargain’s essen- tial terms—a sale of 537,750 lira at a rate of 2151 for 250,000 dollars— made in a telephone conversation on March 13, 1985. The only evidence plaintiff has

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In Intershoe, Inc. v Bankers Trust (Case 11.9), confusion on payment issues proved expensive for one party.

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Chapter 11 Contracts and Sales: Introduction and Formation 405

11-6c Risk in International Contract Performance: Force Majeure International contracts carry peculiar and additional risks. One of the lessons of the wars in the Middle East, for example, is that international contracts should have provisions for war, interruption of shipping lines, and other political acts. Often referred to as force majeure clauses, these provisions in international contracts allow the parties to agree on what will happen in the event of sudden changes in government or in the global political climate rather than rely on a court to deter- mine after the fact what rights, if any, the parties had. (See Chapter 12 for more details on contract issues.)

tendered does no more than contradict the stated terms of the confirmation slip—the very evidence which UCC § 2-202 precludes. It does not address the critical question of whether the terms in the con- firmation slip were intended to represent the par- ties’ final agreement on those matters. We conclude that where, as here, the form and content of the con- firmation slip suggest nothing other than that it was intended to be the final expression of the parties’ agreement as to the terms set forth and where there is no evidence indicating that this was not so, UCC § 2-202 bars parol evidence of contradictory terms.

We reject plaintiff ’s contentions that UCC §  2-202 requires that there be some express indi- cation in the writing itself or some other evidence that the parties intended it to be the final expres- sion of their agreement. . . . To require that the record include specific extraneous evidence that the writing constitutes the parties’ final agreement as to its stated terms would in many instances impose a virtually insurmountable obstacle for parties seeking to invoke UCC § 2-202, particu- larly in cases involving large commercial banks and other financial institutions, which typically close hundreds of transactions over the telephone during a business day. As a practical matter, a confirmation slip or similar writing is usually the only reliable evidence of such transactions, given the unlikely prospect that one who makes scores of

similar deals each day will remember the details of any one particular agreement. Indeed, this case is illustrative inasmuch as neither of the participants had a specific recollection of the March 13, 1985, telephone conversation.

Plaintiff also argues that UCC § 2-202 does not bar the parol evidence submitted in opposition to defendant’s motion because it is offered to show that there was never a contract between the parties. This argument is unavailing. Plaintiff does not dispute that it entered into a foreign currency transaction with defendant; its only contention is that the transaction called for it to purchase and not sell lira. Hence, the parol evidence is being used to contradict a term of the contract, not to show that there was no contract, and UCC § 2-202 applies.

Reversed.

Case QUestIONs

1. Describe the transaction, the parties, and who sold what to whom.

2. Is the memo a final writing?

3. What dangers would the court introduce if orders such as this were contradicted by oral testimony?

4. Did someone fail to read a document carefully before signing? Does the parol evidence rule allow “failure to read” as a defense?

Terrorist acts have become more frequent over the past few years. Those attacks result in business shutdowns as well as inability to move goods and use transportation systems. What happens when substantial interruption

in a business’s operations occurs because a bombing destroys or damages its leased facilities? Would you add provisions and pro- tections to your lease? What terms would you want if you were the landlord?

Consider . . . 11.10

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406 Part 3 Business Sales, Contracts, and Competition

Biography

Discovery during the litigation by Camer- on and Tyler Winklevoss and Divya Nar- endra against Facebook and Mark Zuck- erberg indicates that Mr. Zuckerberg had a contract to write software for “Harvard Connection,” or ConnectU, a social net- work site conceived by the Winklevosses. Mr. Zuckerberg did not complete the software work and instead developed his social network, Facebook, a site that has attracted 1 in every 14 people in the world. Mr. Narendra provided funding to get Facebook up and running. However, the agreements between and among the parties was oral and the terms were not clear. When Facebook started up, Con- nectU, the Winklevosses, and Narenda filed suit (in 2004) against Mr. Zuckerberg

and Facebook. The result was years of litigation, a settlement by Zuckerberg and Facebook with the Winklevosses for $65 million and with Mr. Zarenda for $18.6 million. The twins’ settlement consisted of $20 million in cash and $45 million in Facebook stock options.

The moral of these stories is to have something more than an oral agreement. Spell out each side’s obligations and be sure to include an anti-compete clause, particularly in your agreement with the fel- low who is going to develop your program and your ideas.

Sources: L. Gordon Crovitz, “The More Exciting Story of Facebook,” Wall Street Journal, October 11, 2010, p. A17; Jon Swartz, “Facebook Lawsuit Settled for Good,” USA Today, April 12, 2011, p. 3B. ©

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s u m m a r y What are contracts?

• Contract—promise or set of promises for breach of which the law gives a remedy, or the performance of which the law in some way recognizes as a duty

What laws govern contracts?

• Common law—traditional notions of law and the body of law developed in judicial decisions

• Restatement (Second) of Contracts—general summary of the common law of contracts

• Uniform Commercial Code (UCC)—set of uniform laws (states) governing commercial transactions

• Federal Consumer Contract Laws—Dodd-Frank Wall Street Reform and Consumer Protection Act (which created the Bureau of Consumer Financial Protec- tion), Credit Card Accountability, Responsibility and Disclosure Act of 2009 (CARD), Truth in Lending Act (TILA), and Equal Credit Opportunity Act (ECOA)

What are the types of contracts?

• Bilateral contract—contract of two promises; one from each party

• Unilateral contract—contract made up of a promise for performance

• Express contract—written or verbally agreed-to contract

• Implied contract—contract that arises from parties’ voluntary conduct

• Quasi contract—theory for enforcing a contract even though there is no formal contract because the par- ties behaved as if there were a contract

• Implied-in-fact contract—contract that arises from factual circumstances, professional circumstances, or custom

• Implied-in-law contract—legally implied contract to prevent unjust enrichment

• Void contract—contract with illegal subject matter or against public policy

• Voidable contract—contract that can be avoided legally by one side

• Unenforceable contract—agreement for which the law affords no remedy

• Executed contract—contract that has been performed

• Executory contract—contract not yet performed

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Chapter 11 Contracts and Sales: Introduction and Formation 407

How are contracts formed?

• Offer—preliminary to contract; first step in formation

• Offeror—person making the offer

• Offeree—recipient of offer

• Course of dealing—UCC provision that examines the way parties have behaved in the past to determine present performance standards

• Revocation—offeror canceling offer

• Options—offers with considerations; promises to keep offer open

• Merchant’s firm offer—written offer signed by a mer- chant that states it will be kept open

• Counteroffer—counterproposal to offer

• Battle of the forms—UCC description of merchants’ tendency to exchange purchase orders, invoices, confirmations, and so on; under Revised UCC, the court determines terms after the fact looking at intent, forms used, and the UCC terms

• Acceptance—offeree’s positive response to offer

• Mailbox rule—timing rule for acceptance

• Consideration—something of value exchanged by the parties that distinguishes gifts from contracts

• Charitable subscriptions—enforceable promises to make gifts

• Promissory estoppel—reliance element used to enforce otherwise unenforceable contracts

When must contracts be in writing?

• Statute of frauds—state statutes governing the types of contracts that must be in writing to be enforceable

• Merchants’ confirmation memorandum—UCC provision that allows one merchant to bind another based on an oral agreement with one signature

• Parol evidence—extrinsic evidence that is not admissible to dispute an integrated unambiguous contract

What issues for contracting exist in international business?

• CISG—Contracts for the International Sale of Goods; a uniform law for international commercial transactions that countries can choose to adopt and contracting parties can choose to use

Q u e s t i o n s a n d P r o b l e m s 1. In September of 1988, Jane Pittsley contracted with Hilton Contract Carpet Co. for the installation of carpet in her home. The total contract price was $4,402. Hilton paid the installers $700 to put the carpet in Ms. Pittsley’s home. Following installation, Ms. Pittsley complained to Hilton that some seams were visible, that gaps appeared, that the carpet did not lie flat in all areas, and that it failed to reach the wall in certain locations. Although Hilton tried several times to fix the installation by stretching the carpet and other methods, Ms. Pittsley was not satisfied with the work. Eventually, Ms. Pittsley refused to allow Hilton to try to fix the carpet. Ms. Pittsley had paid Hilton $3,500, but she refused to pay the remaining balance of $902.

Ms. Pittsley filed suit, seeking rescission of the con- tract, return of her $3,500, and incidental damages. Hilton answered and counterclaimed for the balance remaining on the contract. Hilton also defended on the grounds that the only issue was the installation and that the damages were minimal. Ms. Pittsley argued that the contract was under the UCC and that she was entitled to remedies because the carpet was defective. Hilton disagreed on the application of the UCC. Who is correct? Does the UCC apply to the contract for the carpet sale and installation? Is Ms. Pittsley entitled to the warranty protection of the UCC? [Pittsley v Houser, 875 P.2d 232 (Idaho 1994)]

2. Maria Cantu had a teaching contract with the San Benito Consolidated Independent School District. She hand-delivered to her supervisor a written offer to resign. Three days later, the superintendent of schools mailed her a letter accepting the offer of resignation. Ms. Cantu then changed her mind and the next day hand-delivered a letter withdrawing her resignation. The superintendent refused to recognize the attempted rescission of the resignation. Ms. Cantu appealed to the state district court. It decided against her, and she again appealed. Is there a contract or not? Explain your answer. [Cantu v Central Education Agency, 884 S.W.2d 565 (Tex. App. 1994)]

3. Dr. Cook is a licensed dentist who devotes less than 50 percent of his practice to the work of fitting and mak- ing dentures. Mrs. Downing is a patient of Dr. Cook who was fitted for dentures. Mrs. Downing filed suit against Dr. Cook after she took delivery of her dentures because she said they were ill fitting and produced sore spots in her mouth. Dr. Cook’s expert witness testified that Mrs. Downing’s problems were probably due to candidiasis, an autoimmune reaction, or an allergy to the dental material. No expert testified that her problems were due to ill-fitting dentures.

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408 Part 3 Business Sales, Contracts, and Competition

The trial court awarded damages to Mrs. Downing on the basis of a breach of UCC Article 2, implied warranty of fitness for a particular purpose. Dr. Cook appealed, maintaining that the dentures were not a sale of goods. Explain who is correct about UCC versus common law. [Cook v Downing, 891 P.2d 611 (Ok. Ct. App. 1995)]

4. Consider the following sequences of offers and accep- tances and determine whether in each case there would be a contract.

a. September 1, 2016: A mails an offer to B.

September 2, 2016: B receives the offer.

September 3, 2016: A mails a revocation.

September 4, 2016: B mails an acceptance.

September 5, 2016: B receives the revocation.

September 6, 2016: A receives the acceptance.

RESULT:

b. September 1, 2016: A mails an offer to B.

September 2, 2016: B receives the offer.

September 3, 2016: B wires an acceptance.

September 4, 2016: B wires a rejection.

September 4, 2016 (later): A receives the acceptance.

September 5, 2016: A receives the rejection.

RESULT:

c. September 1, 2016: A mails an offer to B.

September 2, 2016: B receives the offer.

September 3, 2016: A wires a revocation.

September 3, 2016: B wires an acceptance.

September 4, 2016: B receives the revocation.

September 5, 2016: A receives the acceptance.

RESULT:

Would your answers be different under the UCC from those under common law?

5. Mace Industries, Inc., sent a quotation to Pad- dock Pools for water treatment equipment. Paddock responded with a purchase order that had the following written on its reverse side:

“THE SELLER AGREES TO ALL OF THE FOLLOW- ING TERMS AND CONDITIONS.”

The clause was then followed by language stating that acceptance was expressly conditional upon Mace’s acceptance of the terms.

Problems between the parties developed. Paddock says there is no contract because of its conditional acceptance. Mace maintains that § 2-207 applies and

that there was a contract, with the only issues being the additional terms Paddock wrote on its purchase order and whether they are part of the contract. Who is cor- rect? [Mace Industries, Inc. v Paddock Pool Equipment Co., Inc., 339 S.E.2d 527 (S.C. 1986)]

6. On March 23, 1994, Northern Distributing Company made two offers to purchase two brands of beer carried by Keis Distributors, Inc.: 683,136 cases of Genesee beer at $1.75 per case and 95,632 cases of Labatt/Rolling Rock beer at $2 per case. The offer contained a termination date of April 11, 1994 and directed Keis to “accept this offer by signing below.” Keis countersigned as requested and sent the offer back to Northern with a cover letter that stated both sides should retain counsel to work out “the wording of the final details.” A proposed “closing and consulting agreement” was drafted but never signed, and Keis then withdrew from these distribution areas. Northern did purchase some of Keis’s inventory after the distributorship termination, and a dispute arose as to the price due on that inventory. Northern claimed the contract price, and Keis said they had no con- tract, so the price was higher. Who is correct? Read the case and decide. [Keis Distributors, Inc. v Northern Distributing Co., 641 N.Y.S. 2d 417 (App. Div. 1996)]

7. Ronald Semler was a trustee for the Semler Fam- ily Trust. The Trust was presented with an opportunity to participate in a private placement investment in ARI Overland Management LLC. Semler agreed to purchase five $250,000 units in the LLC. ARI was negotiating with GE Capital for financing, and GE refused to agree to the loan to ARI because Semler was a member and he had been convicted of a felony. He was convicted of tax and export violations, sentenced to concurrent sentences of two and three years, and ordered to pay a fine of $40,000. GE’s refusal to lend was challenged as discriminatory. What should the court do and why? [Semler v General Elec- tric Capital Corporation, 196 Cal. App. 4th 1380 (2011)]

8. Procter & Gamble (P&G) began a Pampers catalog pro- motional offer in 1981. A statement on each box of Pampers explained that by saving the teddy bear proof-of-purchase symbols (Teddy Bears points) on packages of Pampers dia- pers, a customer could order various baby items from the Pampers Softouches Baby Catalog at a reduced cost. The catalog would be sent free to consumers upon request. Included in the catalog were pictures of the items for sale and the designated amount of Teddy Bears points and cash necessary for purchase. All sale terms, including the dates during which the offer was in effect, were described in each catalog. The only method for ordering merchandise was the use of the specific order form included in each catalog.

About April 1989, P&G sent out its final catalog. On the front of the catalog was a statement that it was the final cat- alog and that the offer would expire on February 28, 1990.

Ms. Alligood and others had cut out and saved the teddy bear symbols. The diaper purchasers claim that each

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Chapter 11 Contracts and Sales: Introduction and Formation 409

package of Pampers contained an offer to enter into a uni- lateral contract, which they accepted by purchasing Pam- pers and saving the teddy bear proof-of-purchase symbols.

The precise language of the advertisement printed on packages of Pampers states:

Save these Teddy Bears points and use them to save money on toys, clothes, furniture, and lots of other baby things when you shop the Pampers Baby Catalog. For your free copy of the Catalog, send your name, complete address and youngest baby’s date of birth to:

Pampers Baby Catalog

P.O. Box 8634,

Clinton, Iowa 52736.

If P&G refused to redeem the Teddy Bears points, would the purchasers have any contract rights to force P&G to deliver the catalog merchandise? [Alligood v Procter & Gamble Co., 594 N.E.2d 668 (Ohio App. 1991)]

9. Aon Risk Services, Inc. (ARS Arkansas), and Combined Insurance Companies are subsidiaries of Aon Corporation. Aon issued an “Interdependency Memo” in February 2000, which was designed to motivate ARS brokerage offices to place insurance business with Aon- affiliated companies through a bonus pool for revenues generated under the plan. Under the terms of the memo, Aon agreed to pay “30% of an annualized premium on

all life products over 15-year term plus 15% 1st year for all other products.” John Meadors saw the memo in Feb- ruary 2000 and believed it would entitle him to this com- pensation over and above his employment contract.

Meadors put Combined in touch with Dillard’s Depart- ment Stores and on March 24, 2000, Dillard’s and Combined executed a five-year agreement whereby Dillard’s employ- ees could purchase life, disability, and other insurance poli- cies through workplace enrollment. When Meadors did not receive bonus-pool money generated by the transaction, he sued his employer for breach of contract. His employer’s defense was that the memo was not sufficiently definite to constitute an offer. Discuss whether there was a con- tract formed for the bonus compensation system. Are you able to classify the type of contract? [Aon Risk Services Inc. v Meadors, 267 S.W.3d 603 (Ark. App. 2007)]

10. Nation Enterprises, Inc., purchased a large (36 by 3 feet) gas-fired convection oven from Enersyst, Inc., to make its pizza crusts. The oven had problems that the parties were working to resolve, but Nation needed a second oven. It was going to purchase one from someone else, but Ener- syst orally promised to fix the first oven if Nation bought the second oven from it. (Oven 1 was beyond its 60-day warranty.) Nation bought the second oven, but Enersyst did not fix the first one. Nation sued, but Enersyst claims its promise on the first oven is inadmissible under the parol evidence rule. Is this correct? [Nation Enterprises, Inc. v Enersyst, Inc., 749 F. Supp. 1506 (N.D. Ill. 1990)]

Contracts, Ethics, Economics, & the Law Lying to Each Other—An Efficient Way to Conduct Business?

Donald Trump described his contract negotiation methods and pricing as follows: “When I build something for some- body, I always add $50 million or $60 million onto the price. My guys come in, they say it’s going to cost $75 million. I say it’s going to cost $125 million and I build it for $100 million. Basically, I did a lousy job. But they think I did a great job.”

Evaluate this quote, thinking through the econom- ic implications of this pricing. Who is affected by the Trump approach? Is he simply managing expectations? Is he misleading the other party? Is he taking unfair advantage? What happens if pricing does not reflect cost? What would happen if all contractors did this?

n ot e s 1. UCITA was formerly Article 2B of the Uniform Commercial Code. It was separated out because reforms for the UCC on Article 2 were pending and the controversy related to Article 2B (now UCITA) was isolated. UCITA remains controversial. See Americans for Fair Electronic Commerce Transactions at http:// www.ucita.com for a summary of the concerns and issues.

2. The appellate court affirmed the federal district court opinion in a brief affirmation. The bulk of the facts and discussion presented here are taken from the lower court’s decision, 88 F. Supp. 2d 116 (S.D.N.Y. 1999).

3. With the UCC modifications and ESIGN, a writing is no longer required. However, there must be some type

of record, which could come in the form of an electronic submission. 4. Revised UCC § 2-207 is often called the “terms later” provision because it permits parties to go forward with contract performance and decide on terms later or resolve any disputes only if they arise during the course of performance. However, Revised §2-207 has not been adopted by the states. One writer has referred to “terms later” as bad economics because of the inability of parties to rely on definitive laws in making contracts and then performing under them. Roger C. Bern, “‘Terms Later’ Contracting: Bad Economics, Bad Morals, and a Bad Idea for a Uniform Law, Judge Easterbrook Not Withstanding,” 12 Journal of Law and Policy 641 (2004).

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410

Chapter

Contracts and Sales: Performance, Remedies, and Collection12 Once the parties have formed a contract with an offer, acceptance, and con-sideration (as discussed in Chapter 11), it would seem that their troubles are over and that all they need to do is carry through with performance. However, sometimes new information arises and one party challenges the formation as invalid, or perhaps what one party believes is performance is just not enough for the other party or is not what was contemplated when they formed the contract. This chapter focuses on contract problems and answers the following questions: What if the assumptions made in formation turn out to be untrue? Must the parties go through with the contract? If one party does not perform, is the other excused? When is performance required, and when is it sufficient? What are the credit, payment, and collection issues in performance? What remedies exist? What happens if a party to a contract declares bankruptcy? Do third parties have rights in a contract?

Update For up-to-date legal news, go to mariannejennings.com

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411

12-1 Defenses in Contract Formation Even though a contract may have been formed with the three elements of offer, acceptance, and consideration, one of the elements may be flawed. The result is a contract that may be void, voidable, or unenforceable. When one of the required elements of formation is flawed, the contract is subject to a defense. A contract defense is a situation, term, or event that makes an otherwise valid contract invalid. These defenses ensure that the parties enter into contracts voluntarily and on the basis of accurate information. The defenses are displayed in Exhibit 12.1 and are discussed in the following sections.

12-1a Capacity

Both parties to a valid contract must have capacity, which includes both age and mental capacity.

Whether a babysitter’s failure to serve a child one dinner and to serve him a suggested menu of sausage and pancakes for breakfast, and leaving the child with a neighbor during the evening so that she could go out to dinner was a breach of an oral agreement to babysit the child for four days in return for $90 was a jury question. Snider v HopkinS, 334 S.E.2d 776 (N.C. 1985)

Alana K. Durrett took the ACT examination in April, June, and August 2006 before taking the October 2006 exam- ination. In registering for the exams online, Ms. Durrett had to electronically “check” a box certifying that she “read, understand, and hereby agree to abide by all pro- cedures and requirements, including those concerning test score cancellation and binding arbitration.”

One of the terms provided that ACT reserved the right to cancel test scores and any disputes over cancel- lation had to be submitted to arbitration.

Ms. Durrett received a letter from ACT questioning the validity of her scores because her scores were sig- nificantly higher on the fourth attempt than in her three previous test scores and an unusual similarity between her responses and those of an examinee with the same test form who was seated near to Ms. Durrett during the exam. Ms. Durrett did not want to retake the test, as the terms and conditions provided and she filed suit seeking to prevent ACT from canceling the scores. . Is it possible for her scores to be reinstated?

Consider . . . 12.1

Valid Contract

Void

No

Yes Voidable Unenforceable

YesOffer Acceptance Consideration

Defenses Capacity Misrepresentation Fraud Duress Illegality Undue In�uence

Exhibit 12.1 defenses in Contract Formation

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412 part 3 Business Sales, Contracts, and Competition

age Capacity Age capacity requires that both parties be at least the age of majority. In most states, that age is 18. Contracts entered into by minors (sometimes called infants) are voidable. A voidable contract of a minor allows the minor to choose not to honor the contract, in which case the other party to the contract will have no rem- edy. But some exceptions apply to the minors’ contracts rules. Some statutes make certain contracts of minors enforceable; for example, student loan agreements are enforceable against minors, as are agreements to enter the military. Minors’ con- tracts for such necessities as food and clothing are still voidable, but courts do hold minors liable for the reasonable value of those necessities.

Yale Diagnostic Radiology v Estate of Fountain (Case 12.1) deals with an issue of a minor’s liability under a contract.

Yale Diagnostic Radiology v Estate of Fountain 838 A.2d 179 (Conn. 2003)

Shooting for Payment from a Minor

Case 12.1

FaCts

In March 1996, Harun Fountain was shot in the back of the head at point-blank range by a playmate. As a result of his injuries, including the loss of his right eye, Fountain required extensive lifesaving medical services from a variety of medical services providers, including Yale Diagnostic Radiology (plaintiff). The expenses at Yale totaled $17,694. Yale billed Vernetta Turner-Tucker (Tucker), Fountain’s mother, but the bill went unpaid and, in 1999, Yale obtained a judg- ment against her. In January 2001, all of Tucker’s debts were discharged in bankruptcy, including the Yale judgment. There was no reference to Fountain’s father throughout the cases.

Tucker filed suit against the boy who shot Foun- tain. However, Fountain succumbed to his injuries, passing away before the case was settled. The settle- ment on the tort case was placed into probate court as part of Fountain’s estate. Tucker was the administrator of Fountain’s estate. When the settlement was depos- ited, Yale asked the probate court for payment of its $17,694 judgment from the estate. The probate court denied the motion, reasoning that parents are liable for medical services rendered to their minor children and that a parent’s refusal or inability to pay for those ser- vices does not render the minor child liable. The pro- bate court held that Yale could not get payment from the estate. Yale appealed to the trial court, and the trial court held for Yale. Tucker and the estate (defendants) appealed.

JUdiCial OpiniOn

BORDEN, Justice Connecticut has long recognized the common-law rule that a minor child’s contracts are voidable. Under this rule, a minor may, upon reaching majority, choose either to ratify or to avoid contractual obligations entered into during his minority. The traditional reasoning behind this rule is based on the well-estab- lished common-law principles that the law should protect children from the detrimental consequences of their youthful and improvident acts, and that children should be able to emerge into adulthood unencum- bered by financial obligations incurred during the course of their minority. The rule is further supported by a policy of protecting children from unscrupulous individuals seeking to profit from their youth and inexperience.

The rule that a minor’s contracts are voidable, how- ever, is not absolute. An exception to this rule, epony- mously known as the doctrine of necessaries, is that a minor may not avoid a contract for goods or services necessary for his health and sustenance. Such contracts are binding even if entered into during minority, and a minor, upon reaching majority, may not, as a matter of law, disaffirm them.

The parties do not dispute the fact that the medical services rendered to Fountain were necessaries; rather, their dispute centers on whether Connecticut recogniz- es the doctrine of necessaries.

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continued

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Chapter 12 Contracts and Sales: Performance, Remedies, and Collection 413

. . . [W]e conclude that Connecticut recognizes the doctrine of necessaries. We further conclude that, pursuant to the doctrine, the defendants are liable for payment to the plaintiff for the services rendered to Fountain.

Courts in other jurisdictions that have held that minors may be liable pursuant to the doctrine of necessaries for medical services have done so by applying varying legal theories. For example, some courts have held minors liable only if the creditor can show that the minor was not living with or being supported by his or her parents at the time the contract arose or the services were rendered. Still other courts have held minors liable after determining that the goods or services ren- dered were necessaries, and the minor’s parent or guardian was unwilling or unable to pay for them. See Schmidt v Prince George’s Hospital, 366 Md. 535, 555, 784 A.2d 1112 (2001) (minor’s father’s use of insurance proceeds to buy minor car sufficient for finding that father was unwilling to pay minor’s medical expenses). Still other courts have reasoned that the minor’s ever present secondary liability for payment for medical services rendered to him gives rise to an implied-in-law contract.

. . . when a medical service provider renders necessary medical care to an injured minor, two contracts arise: the primary contract between the provider and the minor’s parents; and an implied- in-law contract between the provider and the minor himself. The primary contract between the provider and the parents is based on the parents’ duty to pay for their children’s necessary expenses, under both common law and statute. Such contracts, where not express, may be implied in fact and generally arise both from the parties’ conduct and their reasonable expectations. The primacy of this contract means that the provider of necessaries must make all rea- sonable efforts to collect from the parents before resorting to the secondary, implied-in-law contract with the minor.

The present case illustrates the inequity that would arise if no implied in law contract arose between Fountain and the plaintiff. Fountain was shot in the head at close range and required emer- gency medical care. Under such circumstances, a medical services provider cannot stop to consider how the bills will be paid or by whom. Although the plaintiff undoubtedly presumed that Fountain’s parent would pay for his care and was obligated to make reasonable efforts to collect from Tucker

before seeking payment from Fountain, the direct benefit of the services, nonetheless, was conferred upon Fountain. Having received the benefit of necessary services, Fountain should be liable for payment for those necessaries in the event that his parents do not pay.

Fountain received, through a settlement with the boy who caused his injuries, funds that were calculat- ed, at least in part, on the costs of the medical services provided to him by the plaintiff in the wake of those injuries. This fact further supports a determination of an implied-in-law contract under the circumstances of the case.

Nothing in either the language or the purpose of [Connecticut’s statutes on minors] indicates an intent on the part of the legislature to absolve minors of their secondary common-law liability for necessaries.

To the contrary, the purposes behind the statutory rule that parents are primarily liable and the com- mon-law rule, pursuant to the doctrine of necessaries, that a minor is secondarily liable, when read together, serve to encourage payment on contracts for neces- saries. Those purposes are (1) to reinforce parents’ obligation to support their children, and (2) to provide a mechanism for collection by creditors when, nonethe- less, the parents either refuse or are unable to discharge that obligation.

The undisputed facts show that Tucker had four years to pay the plaintiff’s bill for the services rendered to Fountain. She did not pay that bill even when the plaintiff pursued a collection action against her. These facts are sufficient to show that Tucker was unwilling or unable to pay for Fountain’s necessary medical services.

The fact that Tucker may be supplying other nec- essaries, such as food and shelter, does not undermine the claim that she has not made payment for this nec- essary medical service, which was already provided by the plaintiff to Fountain.

The judgment is affirmed.

Case QUestiOns

1. Describe the series of events that led to Yale requesting that the minor pay for the medical services.

2. What public policy issues and concerns result from this decision?

3. What benefits does the decision provide?

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414 part 3 Business Sales, Contracts, and Competition

Mental Capacity Contracting parties must also have mental capacity, which is the ability to under- stand that contracts are enforceable, that legal documents have significance, and that contracts involve costs and obligations. Contracts of those lacking mental capacity are voidable. Moreover, if a party to a contract has been declared legally incompetent, that person’s contracts are void. A void contract is one the courts will not honor, and neither party is obligated to perform under that agreement.

12-1b Misrepresentation

When one party to a contract is not given full or accurate information by the other party about the contract subject matter, there is misrepresentation. In the case of misrepresentation in the formation of a contract, the law allows a rescission of the contract. Rescission means the contract is set aside. Misrep- resentation occurs when a seller makes inaccurate statements about its prod- uct or fails to disclose pertinent information about its product that would affect someone’s decision to enter into the contract. For example, failure to disclose that a deluxe model car has a standard car engine is misrepresenta- tion. The elements required for innocent misrepresentation are as follows:

1. Misstatement of a material fact (or the failure to disclose a material fact) 2. Reliance by the buyer on that material misstatement or omission 3. Resulting damages to the buyer

To be a basis for rescission, the misrepresentation must have been one regarding a material fact. A material fact is the type of information that would affect some- one’s decision to enter into the contract. For example, if a buyer for your stock in XYZ Corporation failed to disclose that a takeover was pending, it would be con- sidered misrepresentation of a material fact. A takeover affects the price of stock, and the price of stock in the future affects your decision to buy and sell presently.

Misrepresentation cannot be based on sales puffing, which is opinion about the subject matter of a contract. For example, suppose that a real estate agent told you a house you were considering buying was located in the “best area in town.” Such a statement is an opinion and cannot be a basis for misrepresentation.

The buyer must rely on or attach some importance to the statement that was made. A buyer who is buying cars only to take them apart for their used parts does not rely on a misrepresentation that the car has not been in an accident. Whatever information is given must be part of the reason the buyer has agreed to enter into the contract.

Analyze the following statements. Are they opinion, or could they be the basis for a mis- representation claim?

This lightbulb will last 200 hours.

THINK: Misrepresentation requires a statement of fact or a promise of perfor- mance that is a basis for entering into a contract.

APPLY: This statement about the lightbulb is a promise of performance. It is the type of information someone relies on when making a buying decision. ANSWER: The statement is a basis for claiming misrepresentation if it turns out to be false.

These suits are 100% wool.

Consider . . . 12.2

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Chapter 12 Contracts and Sales: Performance, Remedies, and Collection 415

12-1c Fraud or Fraudulent Misrepresentation

Although misrepresentation can result simply because of inaccurate information, fraud is the knowing and intentional disclosure of false information or the knowing failure to dis- close relevant information. Fraud has the same elements of proof as misrepresentation, with the added element of sci- enter, or knowledge that the information given is false. An example of the distinction is a situation in which the seller of a home obtains an exterminator ’s report that says the house is clear of termites and passes the report along to the buyer. If the house actually has termites, it is a case of misrepresenta- tion but not fraud because the seller was simply passing along the information without knowledge of its accuracy. If, how- ever, that same seller received a report from an exterminator that indicated there were termites and then found another exterminator to report there were no termites, and the seller passed only that second report along to the buyer, there would be fraud because there was knowledge of the false report and the intent to defraud the buyer. The failure to disclose mate- rial information about the subject matter of a contract can also constitute fraud. For example, a car dealership that fails to disclose to a customer that the car he is buying was in an accident is engaging in misrepresentation. If the car dealership performed the body work on the car in its own body shop, the failure to disclose the accident and repairs would be fraud.

Reed v King (Case 12.2) includes a discussion of the elements of misrepresenta- tion and of when misrepresentation becomes fraud.

Most states have passed some form of disclosure statutes for real estate trans- actions. In some states, the history of criminal activity on a property must be disclosed. In other states, there are prohibitions on disclosure. Some of these states prohibit disclosure of information, such as whether an occupant of the property

THINK: Misstatement of a material fact that the buyer relies on when making de- cisions can be the basis for a claim of misrepresentation. APPLY: Saying that the suits are 100% wool is a statement of fact about the goods. ANSWER: If the goods are not 100% wool, the statement is a basis for claiming misrepresentation.

Now use this approach to analyze the following statements.

This fabric is the finest money can buy.

This sweater is 50% cashmere.

This toothpaste reduces cavities by 20%.

This car gets 22 miles to the gallon.

This stock has never decreased in value.

This house has no easements running through the backyard.

This car has not been in an accident.

These bicycle locks are theft-proof.

This carpet-cleaning machine will re- move every type of spot on your rugs.

When employees and agents are work- ing for commissions as well as salary (or are on commission alone), they are subject to great temptation to engage in misrepresentation. For example, in the Sears Roebuck & Company contro- versy over the allegations that its auto repair centers overcharged customers, Sears’s then–CEO Edward Brennan issued a statement indicating that the presence of incentives for selling parts and services may have contributed to poor decisions by employees in handling customers. Incentive-based pay systems must also have ethical guidelines.

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416 part 3 Business Sales, Contracts, and Competition

Reed v King 193 Cal. Rptr. 130 (1983)

Buying Property from the Addams Family: How Scary Must It Be?

Case 12.2

FaCts

Dorris Reed (plaintiff) purchased a home from Robert King for $76,000. Mr. King and his real estate agents did not disclose to Mrs. Reed that 10 years earlier, the house had been the site of the murders of a mother and her four children. After Mrs. Reed moved into the home, neighbors disclosed to her the story of the murders and the fact that the house carried a stigma. Because of its history, appraisers evaluated the true worth of the house to be $65,000. Mrs. Reed filed suit on the basis of misrepresentation and sought rescission and damages. Her complaint was dismissed by the trial court, and she appealed.

JUdiCial OpiniOn

BLEASE, Associate Justice In the sale of a house, must the seller disclose it was the site of a multiple murder?

Concealed within this question is the nettlesome problem of the duty of disclosure of blemishes on real property which are not physical defects or legal impair- ments to use.

Reed seeks to state a cause of action sounding in contract, i.e., rescission, or in tort, i.e., deceit. In either event her allegations must reveal a fraud. “The ele- ments of actual fraud, whether as the basis of the rem- edy in contract or tort, may be stated as follows: There must be (1) a false representation or concealment of a material fact (or, in some cases, an opinion) susceptible of knowledge, (2) made with knowledge of its falsity or without sufficient knowledge on the subject to warrant a representation, (3) with the intent to induce the per- son to whom it is made to act upon it; and such person must (4) act in reliance upon the representation (5) to his damage.”

The trial court perceived the defect in Reed’s com- plaint to be a failure to allege concealment of a material fact. “Concealment” and “material” are legal conclu- sions concerning the effect of the issuable facts pled. As appears, the analytic pathways to these conclusions are intertwined.

Reed’s complaint reveals only nondisclosure despite the allegation King asked a neighbor to hold his peace. There is no allegation the attempt at sup- pression was a cause in fact of Reed’s ignorance.

Accordingly, the critical question is: does the seller have duty to disclose here? Resolution of this question depends on the materiality of the fact of the murders.

In general, a seller of real property has a duty to disclose: “where the seller knows of facts materially affecting the value or desirability of the property which are known or accessible only to him and also knows that such facts are not known to, or within the reach of . . . the buyer.”

Materiality “is a question of law, and is part of the concept of right to rely or justifiable reliance.” Accord- ingly, the term is essentially a label affixed to a norma- tive conclusion.

Numerous cases have found nondisclosure of physical defects and legal impediments to use of real property are material. However, to our knowledge, no prior real estate sale case has faced an issue of nondis- closure of the kind presented here. Should this variety of ill repute be required to be disclosed?

The paramount argument against an affirmative conclusion is it permits the camel’s nose of unre- strained irrationality admission to the tent. If such an “irrational” consideration is permitted as a basis of rescission the stability of all conveyances will be seri- ously undermined. Any fact that might disquiet the enjoyment of some segment of the buying public may be seized upon by a disgruntled purchaser to void a bargain. In our view, keeping this genie in the bottle is not as difficult a task as these arguments assume. We do not view a decision allowing Reed to survive a demurrer in these unusual circumstances as endorsing the materiality of facts predicating peripheral, insub- stantial, or fancied harms.

The murder of innocents is highly unusual in its potential for so disturbing buyers they may be unable to reside in a home where it has occurred. This fact may foreseeably deprive a buyer of the intended use of the purchase. Murder is not such a common occurrence that buyers should be charged with anticipating and discovering this disquieting possibility. Accordingly, the fact is not one for which a duty of inquiry and dis- covery can sensibly be imposed upon the buyer.

Reed alleges the fact of the murders has a quan- tifiable effect on the market value of the premises.

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Chapter 12 Contracts and Sales: Performance, Remedies, and Collection 417

Reputation and history can have a significant effect on the value of realty. “George Washington slept here” is worth something, however physically inconsequential that consideration may be. Ill-repute or “bad will” conversely may depress the value of property. Failure to disclose such a negative fact where it will have a foreseeably depressing effect on income expected to be generated by a business is tortious. Some cases have held that unreasonable fears of the potential buying pub- lic that a gas or oil pipeline may rupture may depress the market value of land and entitle the owner to incre- mental compensation in eminent domain.

Whether Reed will be able to prove her allegation, the decade-old multiple murder has a significant effect on market value we cannot determine. If she is able to do so by competent evidence she is entitled to a

favorable ruling on the issues of materiality and duty to disclose. Her demonstration of objective tangible harm would still the concern that permitting her to go forward will open the floodgates to rescission on sub- jective and idiosyncratic grounds.

Case QUestiOns

1. Is the kind of information that was withheld here material? What evidence could be used to show materiality?

2. Is Mrs. Reed’s case dismissed, or will she be per- mitted to go forward with the suit?

3. Should Mr. King and the real estate agents have disclosed the information to Mrs. Reed? Did they have an ethical obligation to do so?

Kelly McClain runs a business known as “A+ Teaching Supplies.” Octagon Plaza LLC was in the process of leasing space in the Valen- cia Shopping Center. Ms. McClain, who was seeking a place in the center, was told by Octagon that the square footage of the unit she wanted to lease was 2,624 square feet because the unit was 23% of the total shop- ping center. Ms. McClain tried to confirm the square footage and was assured by Oc- tagon that the square footage was correct.

After she had entered into a five-year lease, she discovered that in 2005, when

Octagon had applied for earthquake assur- ance that the square footage was deter- mined to be 12,800 square feet rather than 11,835. At a rate of $1.45 per square foot, the base rent for the unit should have been $3,535.10 per month, rather than $3,804, and McClain should have been allocated 19% of the common expenses, rather than the 23% share under the lease. McClain filed suit for misrepresentation. Does the law provide for a remedy in this situation? What should the court do and why? [McClain v Octagon Plaza, LLC, 71 Cal. Rptr.2d 885 (Cal. App. 2008)]

Consider . . . 12.3

12-1d Consumer Credit Contracts and Rescission Rights

There is an extensive set of federal laws that apply to credit contracts, and Exhibit 12.2 provides a summary. For example, certain types of consumer credit contracts1

must include a three-day cooling-off period for the debtor, which is a buyer’s pro- tection for “cold feet,” something that can happen as the full nature of the contract and credit terms become clearer. The buyer has the right to rescind certain types of credit contracts anytime during the 72 hours immediately following execution of a credit contract.

died of AIDS. However, even in states with protections and immunity from disclo- sure, the buyer must be told the truth if the buyer asks specifically about the occu- pants and their health.

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418 part 3 Business Sales, Contracts, and Competition

The types of credit contracts covered by the cooling-off period are those in which the creditor takes a security interest in the debtor’s home. For example, if Alfie is installing a solar hot water system in his home, has purchased it on credit, and is giving the solar company a lien on his house, the three-day period applies; Alfie has three days to change his mind after he signs the contract. The three-day period also applies to home solicitation sales, in which sellers/creditors first approach consumers in the buyers’ homes. The protection here allows buyers to recoup from any sales pressure that might have been used.

Where the three-day rescission period applies, the creditor must include both a description of the rights in the contract and a full explanation of the procedures the debtor should follow to rescind the contract during the three-day period.

Under the Home Equity Loan Consumer Protection Act of 1988 and the Home Ownership and Equity Protection Act of 1994 (HOEPA), additional dis- closures are required for those transactions in which consumers use their homes as security for the credit. The Consumer Financial Protection Act (CFPA) (part of the Dodd–Frank reforms) increases the disclosure requirements and grants the Consumer Financial Protection Bureau (CFPB) broad authority to enforce exten- sive new regulation on mortgage and equity loans, such as mandated explanation about the possibility that consumers could lose their homes for nonpayment of mortgage and home equity loans. The three-day rescission period also applies to home equity credit lines. If notice of this three-day rescission right is not given to the homeowner/debtor, the right of rescission will continue for three years. The disclosures are now personalized enough for the borrower to see how their mort- gage as a percentage of income changes as the mortgage interest rate increases. In addition, CFPA requires the lender to establish its basis for approving the loan, making a determination that the borrower is likely and able to repay the mortgage.

summary of Federal laws on Consumer Credit

CRedit statUte (FedeRal) pURpOse and sCOpe

Dodd–Frank Wall Street Reform and Consumer Financial Protection Act [aka The Consumer Financial Protection Act of 2010 (CFPA)] (amends various sections of 12 U.S.C. and 15 U.S.C)

Creates the Bureau of Consumer Financial Protection to consolidate regulation of consumer credit; includes additional consumer credit protections

Truth in Lending Act [15 U.S.C. § 1601 (1968)] Part of CFPA that governs disclosure of credit terms

Fair Credit Billing Act Timing and content requirements for credit card bills

Home Equity Loan Consumer Protection Act [15 U.S.C. § 1647 (1988)] Disclosure requirements for home equity rescission period

Home Ownership and Equity Protection Act [15 U.S.C. § 1637 (1994)] Disclosure requirements on payment amounts for home equity loans and cancellation rights

Fair Credit Billing Act [15 U.S.C. § 1637 (1974)] Rights of debtors on open-end credit billing disputes

Fair Credit Reporting Act [15 U.S.C. § 1681 (1970)] Right of debtors with respect to reports of their credit histories

Fair Debt Collections Practices Act [15 U.S.C. § 1692 (1977)] Regulation of conduct of third-party bill collectors and attorneys

Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 Requires strict standards for filing for bankruptcy

Exhibit 12.2 Consumer protection statutes

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Chapter 12 Contracts and Sales: Performance, Remedies, and Collection 419

The three-day rescission rights also apply to home mortgage refinancings. How- ever, if the lender failed to make the correct disclosures on the right of rescission, the consumers then have a three-year right of rescission. [However, the consumers must rescind in a timely manner. Jones v Select Portfolio Servicing, Inc., 2016 WL 590248 (W.D. 2016)] There are also monetary penalties for a creditor’s failure to make the required and accurate disclosures, and class-action suits are available for consumers to group together to recover the lesser of $500,000 or 1% of the creditor’s net worth.

12-1e subprime lending Representations and disclosures

Part of the CFPA reforms focused on the subprime lending market. This credit market makes loans to consumers who have bankruptcies, no credit history, low-to-moderate incomes, or a poor credit history. Because of the higher risk of these types of loans, these credit contracts involve lower loan amounts; higher origination costs, brokers’ fees, and credit insurance fees; higher interest rates; sig- nificant collateral pledges; large prepayment penalties (meaning that the consumer debtor is locked into the high interest rate); and faster repayment requirements.

Subprime loans have had notoriously difficult-to-read contracts. Determining all of the charges and fees from the contract was a tall order. Regulations and laws at the state and federal level have changed and simplified contract disclosures for subprime loans. Part of the subprime lending market includes lenders who take advantage of less sophisticated consumers or even consumers who are just desper- ate for funds. These lenders use their superior bargaining positions to obtain credit terms that go well beyond compensating them for their risk. For example, title loans (loans made in exchange for title to a car or house if the borrower defaults) have been widely used in subprime markets.

All of these types of loans, sometimes called predatory lending, are now highly regulated by both the states and the federal government. There are now limits on interest rates as well as expanded rescission periods (such as 10 days), and lists of additional contract disclosures. Some states require credit counseling before the contract can be validly executed. Failure to comply with the requirements allows the debtor a way out of contract performance.

12-1f duress

Duress occurs when a party is physically forced into a contract or deprived of a meaningful choice when deciding whether to enter into a contract. Requiring employees to sell company stock holdings in order to keep their jobs is an example of duress because of a lack of choice. If duress has occurred, the contract is void- able. The party who experienced the duress has the right to rescind the agreement, but rescission is a choice; the law does not make the contract illegal or unenforce- able because duress was present. The choice of enforcement or rescission is left to the party who experienced the duress.

12-1g Undue influence

Undue influence occurs when one party uses a close personal relationship with another party to gain contractual benefits. Before undue influence can be estab- lished, a confidential relationship of trust and reliance must exist between the parties. Attorneys and clients have a confidential relationship. Elderly parents who rely on a child or children for their care have a confidential relationship with those children. To establish undue influence, abuse of this confidential relationship must

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420 part 3 Business Sales, Contracts, and Competition

occur. For example, conditioning an elderly parent’s care upon the signing over of his land to a child is an abuse of the relationship. An attorney who offers advice on property disposition to his benefit is abusing the confidential relationship. Again, contracts subject to undue influence defenses are voidable. They can be honored if the party who experienced the influence desires to honor the contract.

12-1h illegality and public policy

A contract that violates a statute or the general standards of public policy is void and cannot be enforced by either party. To enforce contracts that violate statutes or public conscience would encourage the commission of these illegal acts, so con- tract law is controlled by the statutory prohibitions and public policy concerns of other areas of law. Durrett v ACT, Inc. (Case 12.3) deals with several issues and pro- vides an answer to the chapter-opening “Consider . . .”

Durrett v ACT, Inc. 130 Hawaii 346 (Haw. App. 2011)

I’m a Minor: Do Those ACT Scores Count?

Case 12.3

FaCts

Alana K. Durrett took the ACT examination in April, June, and August 2006 before taking the October 2006 examination. To register for the exam online at the time, student applicants were required to enter a Social Securi- ty number, provide credit card information for payment, agree to ACT’s rules and procedures, and submit the electronic form. To successfully register online, student applicants had to electronically “check” a box certifying that they “read, understand, and hereby agree to abide by all procedures and requirements, including those con- cerning test score cancellation and binding arbitration.”

A student applicant would not be able to complete online registration for the ACT examination without “agree[ing] to the above statement” by electronically checking the box.

ACT’s procedures and requirements concern- ing test score cancellation and binding arbitration appeared in a separate pop-up window that opened when selecting the option to “Click here.” The score cancellation instructions stated that:

ACT reserves the right to cancel test scores when there is reason to believe the scores are invalid. . . . In all instances, the final and exclusive remedy available to examinees who want to appeal or otherwise chal- lenge a decision by ACT to cancel their test scores shall be binding arbitration through written sub- missions to the Dallas, Texas, office of the American Arbitration Association. The issue for arbitration

shall be whether ACT acted reasonably and in good faith in deciding to cancel the scores.

In registering for the exam, Ms. Durrett electroni- cally checked the box stating that she read, understood, and agreed to abide by ACT’s rules and procedures, including those relating to test score cancellation and binding arbitration.

Ms. Durrett received a letter from ACT, dated Jan- uary 29, 2007, questioning the validity of her October scores. ACT noted that Ms. Durrett’s scores were sig- nificantly higher than her three previous test scores and that there was an unusual similarity between her October 2006 responses and those of an examinee with the same test form who was seated near to Ms. Durrett during the exam. Ms. Durrett was given three options: she could retake the exam through private testing that ACT would arrange, cancel her scores, or provide a statement in her own words that could help establish the validity of the scores. In the absence of any election, ACT stated that it may then cancel the scores. Ms. Durrett chose to submit a written statement, along with supporting statements and a transcript.

ACT responded that Ms. Durrett’s statement and documentation were “insufficient to establish the valid- ity of the scores.” Ms. Durrett was given the options of retaking the test, canceling the scores, or challenging ACT’s decision via binding arbitration through written submissions only.

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Chapter 12 Contracts and Sales: Performance, Remedies, and Collection 421

Ms. Durrett filed suit seeking to prevent ACT from canceling the scores. ACT filed its motion to stay because of the arbitration clause, which the Cir- cuit Court granted. Ms. Durrett’s father (appellant) appealed on her behalf.

JUdiCial OpiniOn

MEMORANDUM OPINION

Appellant argues that the arbitration terms were not fully disclosed before registration was completed, and thus there was no meeting of the minds. Specifically, Appellant contends that Ms. Durrett never agreed that (1) the arbitration would be by written submissions only; (2) the arbitration would be submitted to the American Arbitration Association in Dallas, Texas; (3) ACT would select the arbitrator; (4) the decision of the arbitrator would be final and binding; (5) she would abide by the arbitration award; (6) ACT would deter- mine the issue to be arbitrated; and (7) the only issue for arbitration would be whether ACT acted reason- ably and in good faith in canceling Ms. Durrett’s scores.

The record reflects, however, that ACT’s online instructions thoroughly described the process for resolv- ing score disputes and made clear that the final and exclusive remedy for challenging a score dispute was binding arbitration. In addition to certifying her agree- ment upon registering for the exam, Ms. Durrett agreed to abide by ACT’s rules and procedures when she sat for the October 2006 examination. On her test answer folder, Ms. Durrett signed and certified that she agreed to the conditions “set forth in the ACT registration booklet and website instructions for the exam, including the arbitra- tion and dispute remedy provisions.”

As such, Ms. Durrett was conspicuously con- fronted with the fact that she was agreeing to binding arbitration and provided with the opportunity to view those terms immediately before she indicated her agree- ment by electronically checking the box.

Although the public policy underlying Hawai‘i law strongly favors arbitration over litigation, the mere exis- tence of an arbitration agreement does not mean the par- ties must submit to arbitration if the dispute is outside the scope of the arbitration agreement. In this case, there is no ambiguity regarding the subject matter of the dispute. This dispute falls within the language of the contract and arbitration agreement. Consequently, there is a valid arbi- tration agreement between Ms. Durrett and ACT.

As such, cancellation of Durrett’s scores was refer- able to arbitration, and the Circuit Court was, there- fore, not required to hold a trial before granting the Motion to Stay.

Contracts of adhesion are unenforceable if two con- ditions are present: “(1) the contract is the result of

coercive bargaining between parties of unequal bargain- ing strength; and (2) the contract unfairly limits the obli- gations and liabilities of, or otherwise unfairly advantag- es, the stronger party.” ACT did not unfairly limit its own obligations and liabilities or give itself unfair advantages in the arbitration agreement. ACT did not, for example, reserve the right to change the terms of the agreement at its sole discretion. ACT, like Ms. Durrett, will be bound by the arbitrator’s decision if the examinee wishes to challenge ACT’s decision to cancel exam scores. ACT, like Ms. Durrett, can only provide written submissions to the arbitrator for determination of whether it acted reasonably. Finally, there is no discernible advantage to ACT associated with providing written submissions to the Dallas, Texas office of the AAA.

Here, although ACT had superior bargaining strength, neither its obligations nor its liabilities were limited by the arbitration agreement. Therefore, the arbitration agreement in this case is not an unenforce- able adhesion contract.

Hawai‘i has long recognized the common law rule—referred to as “the infancy doctrine” or “the infancy law doctrine”—that contracts entered into by minors are voidable. Under this doctrine, a minor may, upon reaching the age of majority, choose either to rati- fy or avoid contractual obligations entered into during his or her minority.

Appellant does not argue that Ms. Durrett has voided all or part of her arbitration agreement with ACT. Similarly, Ms. Durrett contested only entering into the arbitration agreement, declaring below that she “was not aware that by registering I was agreeing to arbitration and was giving up the right to file a lawsuit”, “did not understand or agree to arbitration”, “never agreed to submit any disputes over the [Scores] to arbitration in Dallas, Texas on written submissions only”, and “did not sign an agreement to arbitrate dis- putes concerning my [Scores]”. Ms. Durrett does not contend that she was disavowing or had disavowed it.

Under the infancy doctrine, the contract is “void- able,” not “void.” As Ms. Durrett did not argue or present any evidence that she voided any agreement under the infancy doctrine, the Circuit Court did not err when it failed to rule on the subject of Ms. Durrett’s infancy or its effects on the case.

Affirmed.

Case QUestiOns

1. What defenses to the ACT agreement are raised in the case?

2. Explain the issue with arbitration.

3. What caused the court to dismiss the issue about a voidable contract?

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422 part 3 Business Sales, Contracts, and Competition

Contracts in Violation of Criminal statutes Contracts that are agreements to commit criminal wrongs are void. For example, the old saying that “there is a contract out on his life” may be descriptive, but it is not accurate in the legal sense. There could never be a valid contract to kill someone because the agreement is one to commit a criminal wrong and is there- fore void. No one is permitted to benefit from contracts to commit illegal acts. For example, a beneficiary for a life insurance policy will not collect the proceeds from the insured’s policy if the beneficiary arranged for the death of the insured (con- tract for murder). The following “Consider . . .” deals with the issue of benefits from an illegal contract.

Janet Peterson signed a contract with Sunrider Corporation in 1976 that provided for her payment arrangements as a partic- ipant in Sunrider’s sales program. Sunrider was a Utah corporation that sold herbs, dietary supplements, skin care products, and beauty aids through a multilevel mar- keting plan. The plan includes several “levels of achievement” through which participants may receive compensation based both on their own sales of company products and on the sales of those whom participants have “sponsored”—that is, those whom participants have brought into the company.

Peterson received commissions from Sunrider Corporation from 1976 through 1994 for sales that were made by Sunrid- er distributors who had been recruited by Peterson. Her payments averaged $3,500 per month. In 1994, after Sunrider had been acquired by another company, the payments ended. The new CEO stopped the payments because he claimed they were illegal. The Utah Pyramid Scheme Act (UPSA) provides that “A person may not organize, establish, promote, or

administer any pyramid scheme.” Part of the UPSA provides:

receiving bonuses in a multi-level marketing business is illegal when the bonuses are based only upon sponsorship of an organization, rather than promoting a product, selling a product, or training and supervising down-line distributors.

Peterson says that her commissions from the lower levels are based on sales of products and not just on her having re- cruited the people and companies to sell Sunrider. The new corporation argues that Peterson still did not make the sales herself and that the payments are illegal. Peterson argues that it would be unfair not to pay the commissions.

What should the court do and why? Be sure to consider the purpose of the antipyra- mid statute. Think also about her reliance on the representations of the previous compa- ny’s officials. Finally, think through the public policy issues in paying or not paying Peterson according to her original contract. [Peterson v The Sunrider Corp., 48 P.3d 918 (Utah 2002)]

Consider . . . 12.4

Contracts in Violation of licensing statutes In some cases, contracts are not contracts to commit illegal acts but are simply con- tracts for a legal act to be done by one not authorized to perform such services. Every state requires some types of professionals and technicians to be licensed before they can perform work for the public. For example, a lawyer must be admit- ted to the bar before representing clients. A lawyer who contracts to represent a client before having been admitted to the practice of law has entered into a void

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Chapter 12 Contracts and Sales: Performance, Remedies, and Collection 423

contract. Even if the lawyer successfully represents the client, no fee could be col- lected because the agreement violated the licensing statute, and to allow the law- yer to collect the fee, even in a quasi contract, would encourage others to violate the licensing requirements.

In some cases, licensing requirements are in place, not for competency reasons but to raise revenues. For example, an architect may be required to pass a competency screening to be initially licensed in a state, and after that the license may be renewed simply by paying an annual fee. Suppose that the architect forgot to pay the annual renewal fee and, after the license had lapsed, entered into a $300,000 contract with a developer. The developer dis- covers the renewal problems after the work is completed and wants to get out of paying the architect. In this case, the issue is not one of competency screening but one of financial oversight, and the architect would be permitted to collect the fee.

Contracts in Violation of Usury laws These contracts are credit or loan contracts that charge interest in excess of the state’s limits for interest or finance charges. These statutes provide various reme- dies including voiding the contracting or some part of it, such as the interest or the interest above the statutory maximum.

Contracts in Violation of public policy Some contracts do not violate any criminal laws or statutory provisions but do violate certain standards of fairness or encourage conduct in violation of public policy. For example, many firms include exculpatory clauses in their contracts that purport to hold the firms completely blameless for any acci- dents occurring on their premises. Most courts consider a firm’s trying to hold itself completely blameless for all accidents, regardless of the degree of care or level of fault, against public policy and will not, therefore, enforce such clauses.

Also grouped into the public policy prohibition are contracts that restrict trade or employment. For example, when a business is sold, part of the purchase price is paid for the business’s goodwill. The benefit of that payment is lost if the seller moves down the street and starts another similar business. Hence, the courts have permitted covenants not to compete to be included in these contracts as long as they are reasonable in time and geographic scope. These covenants and their legal- ity are discussed in detail in Chapter 14.

Some contracts are not actually contracts for criminal or illegal activi- ties, but the terms of the contract are grossly unfair to one party. A contract that gives all the benefits to one side and all the burdens to the other is an unconscionable contract. The standards for determining whether a contract is unconscionable are the public policy standards for fairness that cover all types of contract provisions and negotiations. Many of the predatory lending con- tracts have been held to be unconscionable. The standards for unconscionabil- ity are set on a case-by-case basis. The courts have not given a firm definition of unconscionability. Even the UCC does not specifically define unconsciona- bility, although one section (2-302) prohibits the enforcement of unconsciona- ble contracts. Hawkins v Globe Life Insurance (Case 12.4) deals with an issue of unconscionability.

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424 part 3 Business Sales, Contracts, and Competition

Hawkins v Globe Life Insurance 105 F. Supp. 3d 430 (D. N.J. 2015)

Marijuana Possession, Life Insurance, and Unconscionability

Case 12.4

FaCts

In late August 2011, Natasha Hawkins (plaintiff) applied for a second life insurance policy on her 19-year-old son, Khalil Wallace, from Globe Life Insur- ance Company. After Globe received Ms. Hawkins’s enrollment form and premium payment but before Globe formally approved the policy, Khalil was mur- dered. Globe refused to pay the policy proceeds, and Ms. Hawkins filed suit.

JUdiCial OpiniOn

SCHNEIDER, Magistrate Judge

Globe mailed plaintiff an advertisement for life insur-

ance protection. The materials included these materials:

Pamphlet 1

• First-day coverage

• No waiting period

• Buy direct by mail

• Choose $5,000, $10,000, $20,000, $30,000 or $50,000 coverage

• $1.00 for $50,000

• No medical exam—just answer a few health questions

Pamphlet 2

• Start a Life Insurance Policy for Only $1

Letter

• No Waiting Period (2x)

• Buy Direct by Mail (2x)

• $1.00 Starts Up To $50,000 Life Insurance Coverage

• Globe gives you life insurance coverage that costs only $1.00 to start!

• There’s no medical exam . . . just answer a few Yes/No health questions

• You buy directly through the mail

• Answer A Few Yes/No Health Questions (2x)

Enrollment Form/Application

• No waiting period.

• $1 Buys Up to $50,000

• $1 Buys $50,000—Direct by Mail

• You can choose from $5,000, $10,000, $20,000, $30,000 or even $50,000 life insurance coverage

• There is no medical exam—just a few Yes/No health questions.

Globe’s enrollment form contains Question 2.b. This question asks whether in the past three years Khalil “had or been treated for . . . drug or alcohol abuse.” [P]laintiff was aware her son was previously arrested and charged with multiple drug offenses. [S]ubsequent to one of Khalil’s arrests, plaintiff arranged for Khalil to attend a few counseling sessions with a general therapist. However, plaintiff denied any knowledge of what her son discussed with his therapist. She also denied any knowledge that her son used drugs. Plaintiff testified that despite her son’s troubled past she did not believe he abused drugs. She noted that her son was an athlete and never showed symptoms of drug abuse.

After plaintiff mailed the enrollment form, Khalil was charged on September 2, 2011 with possession of marijuana. Plaintiff learned about this arrest within a few days but did not inform Globe.

[P]laintiff’s application was subject to a “Quality Assurance” (QA) follow-up call. Globe attempted to telephone plaintiff 21 times and sent two letters to ver- ify the truth of the statements on her enrollment form.

On September 20, 2011, plaintiff’s son disappeared into a van with unidentified individuals. On Septem- ber 22, 2011 plaintiff was informed that her son was last seen two days prior and that his cell phone was found in Philadelphia. The same day plaintiff filed a missing persons report with the state police. Despite these events, plaintiff testified she was not concerned for her son’s safety following his disappearance because he would often be away from home for peri- ods of more than two weeks at a time. Additionally, plaintiff testified that when she filed the missing per- sons report the police believed her son had run off to avoid charges from his recent arrest.

On September 28, 2011, plaintiff called Globe to complete the QA. During the call, . . . [t]he Globe

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Chapter 12 Contracts and Sales: Performance, Remedies, and Collection 425

representative asked plaintiff whether the proposed insured had a history of drug or alcohol abuse. Plaintiff again denied any knowledge that her son had a history of drug or alcohol abuse or treatment and affirmed that her answers were true to the best of her knowledge.

Following the QA call, Globe formally approved plaintiff’s policy on October 1, 2011. On October 6, 2011, six days after the policy was issued, Khalil Wallace’s body was found. The cause of death was determined to be multiple gunshot wounds inflicted on September 20, 2011, the day Khalil went missing. Plaintiff called Globe to report her son’s death on October 24, 2011 and submitted her claim for payment on February 6, 2012. On February 21, 2012 Globe advised it was investigating the claim. Following an exchange of letters between Globe and plaintiff, on July 6, 2012, Globe advised that it was voiding its policy because plaintiff misrepresented material facts during the application process.

Plaintiff argues the solicitation materials she received from Globe along with the fact that she answered “No” to all of the health-related questions led her to believe that she received interim coverage when Globe received her application materials on September 9, 2011.

Recognizing that the language of insurance con- tracts is often the result of technical semantic con- structions and unequal bargaining power, New Jersey courts interpret insurance policies to give effect to the reasonable expectations of an objectively reasonable policyholder. As a result, courts resolve ambiguities in insurance contracts against the insurer.

The Court finds Globe’s promotional documents are ambiguous and should be interpreted to meet the reasonable expectations of an objectively reasonable applicant.

Globe’s pamphlet expressly states that Globe is offering “First-day coverage”. [T]he statement is easily read to indicate that interim coverage begins imme- diately. Directly underneath “First-day coverage” are the representations that applicants can “Buy direct by mail” with “No waiting period.” These statements read together indicate that an applicant can submit an appli- cation by mail and receive immediate interim coverage.

The pamphlet further states that if the applicant’s responses to the application show good health, cov- erage begins after the application is approved. Here, plaintiff answered “No” to all of the health-related questions in the application. Thus, it was her reason- able belief that since she answered that the insured was in “good health,” interim coverage applied.

The large and bolded font emphasize that plaintiff was reasonable in expecting interim coverage even before her policy was formally approved. The body of Globe’s letter also states that $1.00 “starts” up

“coverage”. Although the letter later states in non-bold- ed text that the policy will be mailed once the appli- cation is “approved,” Globe still fails to qualify what that entails. Further, even if a reasonable applicant understood that “approval” included an underwriting process, it does not eliminate the impression that inter- im coverage exists while the application is processed.

Globe’s letter also states that “Your FULL protec- tion starts the first day your policy is issued. There is no waiting period.” These sentences create ambiguity because Globe states that full protection starts when the policy is issued, but simultaneously promises no waiting period. Thus, the impression is created that policy issuance and coverage is immediate. Globe would have a better argument if instead of its ambig- uous language it would have stated, “Your coverage starts only IF your policy is approved by Globe after receipt and review of your completed application”, and if it omitted the promise of “first-day coverage” and “no waiting period.”

Globe’s font sizes and text locations further plain- tiff’s impression that she received interim coverage. Representations concerning immediate coverage such as “$1.00 Starts Up to $50,000 Life Insurance Cover- age” and “No waiting period” appear in bold and large font while the “approval” language, which Globe emphasizes in support of its argument, appears in the authorization in much smaller font.

New Jersey courts “depart from the literal text and interpret [a policy] in accordance with the insured’s understanding, even when that understanding con- tradicts the insurer’s intent, if the text appears overly technical or contains hidden pitfalls, cannot be under- stood without employing subtle or legalistic distinc- tions, is obscured by fine print, or requires strenuous study to comprehend.”

Besides the ambiguity in Globe’s solicitation mate- rials there was another good reason for plaintiff to objectively believe she had interim coverage. This belief is supported by considerable New Jersey prec- edent. . . . “[T]he very acceptance of the premium in advance tends naturally towards the understanding of immediate coverage though it be temporary and terminable.”

Globe received plaintiff’s application materials on September 9, 2011 and deposited the premium check on September 12, 2011. For the reasons described above, this initiated interim coverage on Khalil’s life as of Sep- tember 9 or 12, 2011. Accordingly, plaintiff had interim coverage when Khalil died on September 20, 2011.

The law draws a distinction between misrepre- sentations made in response to an insurance compa- ny’s objective and subjective questions. If the ques- tion is objective, even an innocent misrepresentation

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426 part 3 Business Sales, Contracts, and Competition

can warrant rescission and constitutes equitable fraud. Courts are more lenient when the question is subjective.

The application question at issue: “In the past 3 years, has the Proposed Insured had or been treated for . . . drug or alcohol abuse[?]” Plaintiff answered this question “No.” Globe asserts that because plain- tiff was aware that her son was arrested for drug-re- lated crimes and attended general therapy she should have answered the question in the affirmative. The Court disagrees. The problem with Globe’s argument is that it did not ask the right question. Globe did not ask if Khalil was ever arrested. Nor did it ask if Khalil ever possessed or distributed drugs, or was accused of same. Globe’s question only asks if Khalil had or was treated for drug abuse. Globe has failed to point to any evidence that this occurred. [T]he Court finds that Globe has not satisfied its burden of showing that plaintiff misrepresented any answers on her application.

Relatedly, plaintiff did not have a duty to inform Globe about her son’s September 2, 2011 arrest for marijuana possession. Again, Globe never inquired whether the insured had a criminal history on the insurance application. Additionally, that fact that Khalil’s arrest is not material is evidenced by the fact that Globe did not ask plaintiff any questions during the September 28, 2011 QA call which would have required her to inform Globe about the arrest.

Globe’s motion for summary judgment is denied.

Case QUestiOns

1. What were the problems with Globe’s marketing materials?

2. Develop a timeline for the events from the time of the policy mailer. Why are Khalil’s arrest and previous counseling not required to be disclosed?

3. Describe how Globe should have asked its questions.

12-2 Contract Performance Once parties have contracted, they have the obligation of performance. The fol- lowing subsections cover when performance is due, what constitutes performance, and when performance is excused.

12-2a When performance is due

Performance is due according to the times provided in the contract. In some con- tracts, however, prescribed events must occur before performance is required. These events are called conditions. Conditions precedent are events that give rise to performance. Suppose that Zelda has agreed to buy Scott’s house and that their contract provides that Zelda does not have to pay until she is able to obtain a reasonable loan to finance the purchase. This financing clause is a

Ethical Issues

Although Ms. Hawkins was not legally required to make the disclosures about her son, what were her ethical obligations? Why is Globe’s conduct considered unconscionable?

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Chapter 12 Contracts and Sales: Performance, Remedies, and Collection 427

condition precedent to contract performance. If Zelda is denied financing, she is not required to perform under the contract. Another example of a condition precedent is in a contract for construction of jackets out of a material to be fur- nished by the seller. Unless the seller gives the manufacturer the fabric to work with, the manufacturer has no obligation to perform. Conditions concurrent, or conditions contemporaneous, exist in every contract; benefits are exchanged at the same time. One is willing to perform because the other side does.

Restaurant strategies for no-shows

You make a reservation for dinner. The restaurant holds a place for you, and holds, and holds, but then you are a no-show. The restaurant is out the revenue it might have earned because it held, and held, and held an empty table—for you! Because costs are high, restaurants are trying new approaches to reservations, all of which involve legal issues.

The first new strategy finds restaurants tweeting the names of customers who did not show up for their reservations. One restaurant owner claims that what he does by posting their names is no worse than when customers post rants on Twitter and Facebook about his restaurant. The legal issue here is privacy. Years ago, restaurants and stores used to place bounced checks on their walls to disclose publicly those customers who had failed to pay. Such prac- tices are considered a breach of privacy and now rarely done. However, what is posted on Twitter is not account information, just poor etiquette in failing to show and not notifying the restaurant.

A second strategy for online reserva- tions has become popular with restaurants because many hotel concierges make res- ervations 30 days in advance online and just hold them for hotel guests who may want them at the last minute. However, they don’t take the time to cancel if no hotel guest needs those reservations. There is no downside for the concierge because there is no name associated with the res- ervation. As a result, restaurants are using OpenTable.com, a generic booking site that

charges $50 a head for a no-show. The use of the site is the same as the use of a hotel or airline site: the rules are clear, and there are click options that indicate the customer understands the terms of the agreement and when a contract is formed.

A third strategy is one from Chicago. Diners must buy nonrefundable tickets for meals in advance. In effect, the customer pays for the meal in advance, but if they do not show up, they lose the advance payment, just as with nonrefundable airline tickets. The contract law issues here are the same as with the online booking—those who buy the meal tickets in advance must be told of the terms and conditions prior to purchase.

A final strategy is for the restaurant to take a credit card number for a deposit. Just as hotels have done for decades, restau- rants are now asking diners for a credit card to secure a reservation. As they take the credit card number, they are also disclosing that unless you cancel by a certain time (some require 24 hours’ notice and others have a “no later than 4 P.M.” stipulation on the day of the reservation), your card is still charged a deposit for the table. If you show up, the deposit goes toward paying for your meal. As part of this new contractual strategy, the restaurant also discloses that it will hold the table for a limited amount of time—15 to 30 minutes. The contract issues here are letting the customer know the terms of the reservation, including both the costs and the obligation to cancel within time limits.

Business Strategy

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428 part 3 Business Sales, Contracts, and Competition

12-2b standards for performance

The contract details what the parties are required to do for complete performance. In some contracts, performance is easily determined. Performance for a contract between an employment agency and a potential employee to find work for the employee is complete once the work is found.

But in some contracts, performance is complicated, and errors may occur in its execution. For example, construction contracts are long-term, complicated

For the Manager’s Desk

Re: Killer performance Requirements in Retail

It’s called “the Squeeze.” The Squeeze refers to the increasingly onerous logistical demands retailers place on clothing sup- pliers. The logistical demands add tremen- dous costs to suppliers, they are rigid, they are complex (some retailers’ rules run 50 pages), and they carry penalties. Noncom- pliance with logistical requirements allows the retailer to take a “chargeback,” or a deduction from its payment.

Here are some sample logistical requirements:

Shipping and Packing Guidelines from Retailers to Vendors Packing Hanging Garments

You must have written authorization from Federated to ship GOH. All ready-to-wear merchandise should be shipped in convey- able cartons in order to maximize the use of UCC-128 shipping container label. . . .

Lazarus

Routing Instructions

Determine your RPS Zone number on the Zone Chart. . . . Determine your LTL [less than truckload] Zone number from the Zone Chart and follow the LTL Routing for that zone.

Kaufmann’s

Paperwork Documentation

Provide a separate packing list for each store and for each purchase order, detailed as to purchase order #, department #, store # and two letter code, style #, color (when ordered

by color), size (when ordered by size), num- ber of cartons, and total units shipped.

Hecht’s

Charges include $300 for incorrect labels, $500 for incorrect packing materi- als, and a 5% penalty if a shipment arrives late.

Schwab Co., the manufacturer of “Little Me” infant clothes, was charged $400 for late delivery of a $500 shipment.

A buyer for Federated Department Stores says, “. . . [I]t’s not our responsibility to keep vendors afloat. We have a sepa- rate philanthropy program.” Small vendors complain they must hire extra people to handle special boxing and that retailers’ chargebacks are reversed if they offer proof of compliance.

Smaller vendors are taking their prod- ucts to specialty stores and boutiques. Large retailers say, “This is all still negotia- ble.” Some vendors say that retailers are wrong on their charges about 25% to 50% of the time, but “They throw it up to see what will stick.” Vendors note that their cash flow is affected and that, until the disputes are resolved, it often takes a year for them to be paid on their invoices.

(Lazarus, Kaufmann’s, and Hecht’s were regional chains that have been acquired by other national chains.)

Is there a problem with unconscionabili- ty? Is this kind of behavior anticompetitive? Do you feel the guidelines and chargeback fees are truly negotiable? Are the charge- back levels of fees ethical?

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Chapter 12 Contracts and Sales: Performance, Remedies, and Collection 429

agreements. During the construction of a building, it is possible that some mis- takes might be made. Is an owner allowed to not pay a contractor because of a mistake or two? The doctrine of substantial performance applies in construction contracts, and it means that the constructed building is, for practical purposes, just as good as the one contracted for. For example, a builder might have substituted a type of pipe when the brand name specified in the contract was not available. The substitution is a technical breach of contract, but it is a substitute that is just as good. The builder will be paid for the construction, but the owner will be entitled to damages.

12-2c e-Commerce: payment performance Has Changed

One aspect of contract performance is payment. Internet transactions have changed dramatically how we pay for goods and services. Online payment methods are numerous and acceptable means of performance.

12-2d When performance is excused

Sometimes, all conditions of a valid contract are met, but performance of the con- tract is excused. Under common law, the parties are excused from performance if performance has become impossible. Impossibility means that the contract cannot be performed by the parties or anyone else. For example, performance under a contract for the purchase and sale of land that has been washed away into a lake is impossible. Completing a year of dance lessons is impossible for someone who has had a paralyzing accident.

Under the UCC (and under the Restatement), performance can be excused in cases of commercial impracticability. Commercial impracticability (see § 2-615 in Appendix C) excuses performance if the basic assumptions the parties made when they entered into the contract have changed. Although this definition makes it seem that the UCC excuses performance when wars, embargoes, and unusu- ally high price increases occur, courts have been reluctant to apply the excuse of commercial impracticability. The standard of commercial impracticability has been interpreted to mean nothing more or less than the common law standard of impossibility.

Parties can protect themselves from unusual events by putting in their contracts force majeure clauses, which excuse the parties from performance in the event of such problems as wars, economic depression, or embargoes. Following the attack on the World Trade Center in New York City, performance under many contracts was excused for impossibility. For example, because air traffic was halted, all over- night shipping contract performances were excused.

Trans World Airlines (TWA) had a sales/ leaseback arrangement on 10 aircraft with Connecticut National Bank. TWA was ex- periencing difficulty making payments, attributing the difficulties to the Gulf War, which resulted in decreased air travel

because of terrorism and decreased oil flow.

Is this situation an example of commer- cial impracticability?

[Connecticut Nat’l. Bank v Trans World Airlines, Inc., 762 F. Supp. 76 (S.D.N.Y. 1991)]

Consider . . . 12.5

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430 part 3 Business Sales, Contracts, and Competition

Sons of Thunder, Inc. v Borden, Inc. (Case 12.5) deals with the issue of busi- ness needs changing and whether performance can be excused. It is a case that some experts have labeled a landmark one in terms of imposing a duty of good faith in performance. It also contains issues of performance and termination of a contract.

Ethical Issues When Graduates Renege on Jobs

When a student accepts a job offer, there is a contract. However, there is an increasing problem with students accepting employ- ment offers and then backing out at the last minute. Calling it “looking out for their best interests,” students are telling recruiters that they have received better offers and are no longer interested. Students also offering this explanation: “If the company has to downsize, they would cut me loose, so I have the same right if my economic conditions change.” Some students believe that up until the time they report for work that they have only a job offer. The business press is not helpful in dissuading this view. For example, the Wall Street Journal includ- ed this advice in a boxed feature, “How to

Back Out of a Job Offer—Gracefully,” in “‘Thanks, but No Thanks,’ for the Job, Grads Say” (Wall Street Journal, July 15, 2015, p. B1). One does not back out of a job offer— one reneges on a contract. And, technically, there would be damages for the company, such as the costs of trying to recruit a replacement for that position at a late date.

Apart from the legal issues, there are ethical issues. One student said, “I can either make the firm I’m working with a little upset, or pass it up and always won- der, ‘what if?’” That statement shows an analysis model focused internally. List all the stakeholders in a student’s decision to renege. List the possible consequences of reneging. ©

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Sons of Thunder, Inc. v Borden, Inc. 690 A.2d 575 (N.J. 1997)

Ships and Liability Passing in the Night?

Case 12.5

FaCts

Borden, Inc., owned Snow Food Products Division, a leading producer of clam products. Borden had its own four-vessel fleet as well as independent boats for obtaining clams. Boats delivered the clams to Borden’s Cape May plant, where the shell stock was processed into clam meat.

In 1978, Borden hired Donald DeMusz to be the captain of the Arlene Snow, one of Borden’s four boats. Eventually, Mr. DeMusz was hired as an independent contractor to manage Borden’s boats, and Mr. DeMusz formed Sea Labor, Inc., to be the company responsible for the management of those boats. Sea Labor received

five cents per bushel of clams harvested by the four boats.

At about the same time Mr. DeMusz was hired, Borden began its “Shuck-at-Sea” program, which enabled the fishermen to shuck the clams on the boat, thus allowing the boats to bring back larger amounts of clams, thereby reducing costs and eliminating the need for more plants and facilities. However, the existing boats were not large enough for the shucking equipment.

Wayne Booker, a manager for Borden, asked Mr. DeMusz to undertake the Shuck-at-Sea program. Mr. DeMusz submitted a proposal that Mr. Booker and

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Chapter 12 Contracts and Sales: Performance, Remedies, and Collection 431

continued

other executives approved. Along with two partners, Mr. DeMusz formed Sea Works, Inc., and for $750,000 purchased the Jessica Lori, a clam-fishing boat with shucking equipment. Mr. DeMusz financed the pur- chase through a bank loan.

An internal company memo from Mr. Booker included the following paragraph along with a descrip- tion of how Mr. DeMusz’s purchase of a boat would save money:

[W]e still have a significant mutual interest with DeMuse [sic]. His principal business will still be in chartering the Snow fleet and in captaining Arlene. He needs a dependable customer for the clams that he catches, either shell stock or meat. If we terminate our agreement with him, he would have a hard time making the payments on his boat.

Mr. DeMusz drafted a one-page contract, and Mr. Booker approved it with one small change. Mr. DeMusz then formed Sons of Thunder, Inc., with Bill Gifford and Bob Dempsey in order to purchase the second boat. The final contract was entered into on January 15, 1985, and included the following provision:

IT IS understood and Agreed to by the parties hereto that Snow Food Products shall purchase shell stock from Sons of Thunder Corp. for a period of one (1) year, at the market rate that is standardized throughout the industry. The term of this contract shall be for a period of one (1) year, after which this contract shall automat- ically be renewed for a period up to five years. Either party may cancel this contract by giving prior notice of said cancellation in writing Ninety (90) days prior to the effective cancellation date.

Sons of Thunder Corp. will offer for sale all shell stock that is landed to Snow Food.

In March 1985, Sons of Thunder bought a boat, the Sons of Thunder. The cost to rig and purchase the boat was $588,420.26. Sons of Thunder sought financing from First Jersey National Bank but was unable to obtain a loan until Mr. Booker told the bank repre- sentative that Mr. DeMusz had a solid relationship with Borden and that although the contract could be terminated within one year, Borden expected the con- tract to run for five years. Mr. Booker explained to the representative that the five-year term of the contract would be sufficient to pay back the loan. Ultimately, Mr. DeMusz obtained a $515,000 loan, which he, Mr. Gifford, Mr. Dempsey, and their spouses personally guaranteed. Mr. DeMusz used a personal note to cover the remaining balance.

After some preliminary testing, the Sons of Thunder started to operate and to fulfill its contract with Borden. For most weeks, the records show that Borden did not

buy the minimum amount specified in the contract. Problems continued and the relationship between Mr. DeMusz and his companies and Borden began to deteriorate. When Borden discovered that a $500,000 accounting error had actually overstated the benefits of the Shuck-at-Sea program, Borden exercised its ter- mination rights under the contracts and notified Mr. DeMusz of termination.

Mr. DeMusz and his companies experienced sub- stantial losses as a result of the termination of contracts. Mr. DeMusz filed suit. Borden moved for summary judgment on the grounds that it had properly exercised its termination rights. The jury found for Mr. DeMusz, the court of appeals affirmed, and Borden appealed.

JUdiCial OpiniOn

GARIBALDI, Justice The question whether Borden performed its obliga- tions in good faith appears before the Court. . . .

The obligation to perform in good faith exists in every contract, including those contracts that con- tain express and unambiguous provisions permitting either party to terminate the contract without cause. See United Roasters, Inc. v Colgate-Palmolive Co., 649 F.2d 985 (4th Cir.), cert. denied, 454 U.S. 1054, 102 S.Ct. 599, 70 L.Ed.2d 590 (1981). In United Roasters, United Roasters gave Colgate the right to manufacture and distribute Bambeanos, its roasted soybean snack. The contract governing the relationship allowed Colgate to terminate its performance at any time during the test marketing period so long as it gave United Roasters thirty days’ notice. After two years of testing Bambeanos, Colgate announced plans to merge with Riviana Foods, Inc., and in the next five months, it ceased producing Bambeanos, stopped advertising them, sold its entire inventory of raw soybeans and Bambeanos, and transferred its product manager to another project. Eventually, Colgate terminated the contract.

Interpreting North Carolina law in the diversity action, the Fourth Circuit concluded that North Car- olina had not decided whether there was a good faith limitation on an unconditional right to terminate a con- tract. The Fourth Circuit did, however, evaluate United Roasters’ claim that Colgate violated the covenant of good faith and fair dealing. The panel stated

What is wrong with Colgate’s conduct in this case is not its failure to communicate a decision to terminate . . . , but its cessation of performance. Clearly it had an obligation of good faith performance up until its right of termination was actually effective. The contract expressly obliged it to use its best efforts in the pro- motion of Bambeanos. Instead of doing that, it simply

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432 part 3 Business Sales, Contracts, and Competition

ceased performance. . . . Quite simply, it broke its con- tract when it terminated its performance, which was United Roasters’ contractual due.

In Bak-A-Lum Corp., supra, 69 N.J. 123 (1976), this Court reached a similar conclusion even though the contract was oral and the parties had not discussed how the contract could be terminated. In that case, Bak- A-Lum and Alcoa made an oral agreement, which gave Bak-ALum an exclusive distributorship of aluminum siding and related products manufactured by Alcoa. Alcoa eventually terminated the exclusive part of the agreement by appointing four additional distributors. Even though Alcoa planned on terminating the dis- tributorship, it encouraged Bak-A-Lum to expand its warehouse facilities, which substantially increased its operating costs.

Despite acknowledging Alcoa’s unconditional right to terminate the contract, the Court upheld the verdict for Bak-A-Lum because it found that Alcoa had breached the implied covenant of good faith and fair dealing by withholding its plans to terminate the contract while encouraging the plaintiff to expand its facilities. As the Court explained: “While the contrac- tual relation of manufacturer and exclusive territorial distributor continued between the parties an obligation of reciprocal good faith dealing persisted between them.” The Court found that the implied covenant of good faith and fair dealing required the defendant to give the plaintiff reasonable notice of its termination. Ultimately, the Court concluded that “a reasonable period of notice of termination of the distributorship . . . would have been twenty months.”

The case most heavily relied on by Borden and the majority at the Appellate Division, Karl’s Sales & Service, Inc. v Gimbel Brothers Inc., 249 N.J. Super. 487 (App. Div.), cert. denied 127 N.J. 548 (1991), is distin- guishable from this matter. In that case, the Appellate Division stated that where the contractual right to ter- minate is express and unambiguous, the motive of the terminating party is irrelevant. As stated previously, we agree with that view of the law. However, in Karl’s Sales, unlike this case and Bak-A-Lum, there were no allegations of bad faith or dishonesty on the part of the terminating party. Accordingly, Karl’s Sales did not address the issue we are concerned with here.

Borden knew that Sons of Thunder depended on the income from its contract with Borden to pay back the loan. Yet, Borden continuously breached that con- tract by never buying the required amount of clams from the Sons of Thunder. Furthermore, after Gallant took Booker’s place, he told DeMusz that he would not honor the contract with Sons of Thunder. Nicholson

also told DeMusz that he did not plan to honor that contract. Borden’s failure to honor the contract left Sons of Thunder with insufficient revenue to support its financing for the Sons of Thunder.

Borden was also aware that Sons of Thunder was guaranteeing every loan that Sea Work had taken to finance the rerigging and purchasing costs for the [boat]. Thus, Borden knew that the corporations were dependent on each other, and that if one company failed, the other would most likely fail. Borden, how- ever, fulfilled its obligations to Sea Work only for a short time before it began to breach that agreement. Eventually, Borden terminated its contract with Sea Work even though it knew that terminating the con- tract would leave Sea Work with no market to fish the Jessica Lori.

The final issue is whether the jury’s assessment of $412,000, approximately one year’s worth of additional profits, for the breach of the implied covenant of good faith and fair dealing was a reasonable verdict. Specif- ically, can a plaintiff recover lost profits for a breach of the implied covenant of good faith and fair dealing? We agree with Judge Humphreys that the jury’s award of one year’s additional profits “is a reasonable and fair estimate of ‘expectation damages.’” Moreover, we agree with the trial court that lost profits are an appro- priate remedy when a buyer breaches the implied covenant of good faith and fair dealing.

In order to recover for lost profits under [Section 2-708(2)], the plaintiffs must prove the amount of damages with a reasonable degree of certainty, that the wrongful acts of the defendant caused the loss of profit, and that the profits were reasonably within the con- templation of the parties at the time the contract was entered into.

The jury’s award of $412,000, approximately one year’s profit, for the breach of the implied covenant of good faith and fair dealing is reasonable and fair.

Affirmed

Case QUestiOns

1. Were all the DeMusz corporations completely dependent on Borden?

2. What impact does “good faith” have on termina- tion of a contract?

3. What are the damages when there is a lack of good faith in the termination of a contract?

4. What provisions would you suggest be added to a contract such as this in which the relationship is one of contract but also one of dependence?

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Chapter 12 Contracts and Sales: Performance, Remedies, and Collection 433

12-2e Finding a Way to end Obligations Under the Contract

In some cases, the parties substitute someone else for the obligation in an agree- ment called a novation. For example, suppose that before forming a corporation, a business owner had signed a lease for store premises and then incorporates the business. The landlord agrees to substitute the new corporation as the tenant. All three parties (landlord, owner, and corporation) sign a novation. The owner is excused from individual liability and performance, and the corporation is substi- tuted. Note that the landlord must agree; the owner cannot discharge his perfor- mance obligations by unilaterally substituting the corporation.

In other situations, the parties reach an agreement for payment in full on a con- tract; such an agreement is called an accord and satisfaction. The amount they agree to pay may be less than the original contract amount, but disputes over war- ranties, repairs, and other issues change the value of the contract. The accord and satisfaction serves to discharge the performance of both parties.

12-3 Nonperformance and Nonpayment— The Collection Remedies

There are times in contractual relationships where one side has clearly breached— there is no payment for goods or services delivered. How are situations involving nonpayment handled? This section covers the issues related to nonpayment.

12-3a Making sure the Billing is accurate

In consumer credit contracts, the first step a creditor must take in enforcement is to make sure that the bills sent to the nonpaying consumer have complied with all federal laws. The Fair Credit Billing Act affords debtors the opportunity to chal- lenge the figures on credit card monthly statements. Errors on credit card accounts are covered by this act and, to a lesser degree, by Regulation Z. Creditors are required to supply on the monthly statement an address or phone number to write or call in the event a debtor has questions or challenges regarding the bill. The lan- guage must read: “IN CASE OF ERRORS, CALL OR WRITE. . . .”

Under the act, debtors can collect damages if they comply with all the act’s pro- cedural requirements. First, a debtor must notify the creditor of any errors within 60 days of the receipt of the statement. The notification must be in writing for the damage sections to apply. If a creditor supplies a phone number for inquiries, the notice must explain that oral protests do not preserve all Regulation Z rights. The written protest of the debtor must include the debtor’s name, the account number, and a brief explanation of the claimed error.

The creditor has 30 days from the time of receipt of the written protest to acknowledge to the debtor receipt of the protest. The creditor has 90 days from receipt of the protest to take final action, either giving the debtor’s account a credit or reaffirming that the charges are valid.

During the time the creditor is considering the debtor’s protest, the debtor is not required to pay the questioned amount or any finance charges on that amount. If the charges are in fact accurate, the debtor will be charged for the finance charges during this time period. If the creditor fails to comply with any of the requirements or deadlines on bill protests, the debtor can be excused from payment even if the charges disputed were actually accurate.

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434 part 3 Business Sales, Contracts, and Competition

12-3b Collection—Fair standards for Obtaining payment

Enacted to control abuses in the collection process, the Fair Debt Collections Prac- tices Act (FDCPA) controls a great deal of debt collection. Most of the states have also adopted some form of debt collection statute.

When the FdCpa applies The FDCPA applies to consumer debts and debt collectors. Consumer debts are defined here as they are under the TILA: debts for personal, home, or family pur- poses. Debt collectors are third-party collectors. The FDCPA does not apply to orig- inal creditors collecting their own debts; for example, Sears collecting Sears’s debts is not governed by the FDCPA. However, if Sears referred its collection accounts to Central Credit Collection Agency, Central Credit would be under the FDCPA. If Sears created its own collection agency with a name other than Sears, the FDCPA would apply to that agency as well.

The FDCPA does not apply to the collection of commercial accounts or to banks and the Internal Revenue Service. In a rule revision, attorneys collecting debts for clients were made subject to coverage of the FDCPA.

Telecredit Service Corporation’s business is the collection of dishonored checks. Telecredit purchases these checks and then contacts the drawers to collect the funds. Stanley Holmes wrote a $315 check to Union Park Pontiac that was dishonored. Union Park sold the check to Telecredit, and

Telecredit sent letters and made contacts to collect the check. Some contacts would be violations of FDCPA, but Telecredit says it is not covered by FDCPA because it is not col- lecting the debts of another. Is this correct? [Holmes v Telecredit Service Corp., 736 F. Supp. 1289 (D. Del. 1990)]

Consider . . . 12.6

Collector Restrictions under the FdCpa In addition to affirmative disclosure requirements, the FDCPA prohibits certain conduct by collectors, covered in the next sections.

Debtor Contact. One of the most frequent abuses by collectors prior to the FDCPA was constant debtor contact and harassment. The FDCPA curbs the amount of contact: Debtors cannot be contacted before 8:00 a.m. or after 9:00 p.m., and debt- ors who work night shifts cannot be disturbed during their sleeping hours in the daytime. A 2016 proposed rule change will limit contacts to 6 times per week.

The place of contact is also controlled by the FDCPA: collectors must avoid con- tact at inconvenient places. Home contact is permitted, but contact in club, church, or school meetings is prohibited. Collectors can approach debtors at their places of employment unless employers object or have a policy against such contact.

To prevent harassment, the FDCPA gives debtors a chance to “call off” a collec- tor. If a debtor tells the collector that he wants no more contact, the collector must stop and take other steps, such as legal action, to collect the debt. If the debtor is represented by an attorney and gives the name of the attorney to the collector, the collector can contact only the attorney from that point.

Third-Party Contact. The FDCPA also prohibits notifying other parties of the debt- or’s debts and collection problems. However, the debtor’s spouse and parents can

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Chapter 12 Contracts and Sales: Performance, Remedies, and Collection 435

be contacted regarding the debt. Other parties can be contacted for information, but the collector cannot disclose the reason for the contact. Further, the only infor- mation that can be obtained from these third parties is the address, phone number, and place of employment of the debtor.

These third parties cannot be told about the debt, the amount, delinquencies, or any other information about the debtor. The collector must even be careful to use appropriate stationery when writing for information so that the letterhead does not disclose the nature of the collector’s business. Postcard contact with the debtor or third parties is prohibited because of the likelihood that others will see the infor- mation about the debtor.

Prohibited Acts. Collectors have certain other restrictions on their conduct under the FDCPA. The general prohibition in the FDCPA is that collectors cannot “harass, oppress, or abuse” the debtor. Continuing to make calls without identi- fying themselves as collectors is also a FDCPA violation. Using abusive language or physical force is prohibited. Misrepresenting the authority of a collector is also prohibited, as is posing as a law enforcement official or producing false legal doc- uments. Debtors cannot be threatened with prison or other actions not authorized by law.

Litt v Portfolio Recovery Associates LLC (Case 12.6) involves an issue of FDCPA violations.

Litt v Portfolio Recovery Associates LLC 146 F. Supp. 3d 857 (E.D. Mich. 2015)

When Mom and Dad Get 200 Phone Calls from

Their Son’s Collectors

Case 12.6

FaCts

Portfolio Recovery Associates LLC (PRC) was work- ing to collect three debts from Michael Litt (plain- tiff). Tara Privette, employed by PRC, made 213 calls to Marvin and Karol Litt (Michael Litt’s par- ents) (plaintiffs), and five calls were answered. On February 5, 2011, the Litts told Ms. Privette that XXX-XXX-1078 was the “wrong number” to reach Michael.

On February 15, 2011, PRA’s Call Log reflects that it received XXX-XXX-1078 again from TransUnion as a “good” phone number for Plaintiff. PRA began calling Michael Litt’s parents’ phone number again on February 17, 2011, despite the February 5, 2011 nota- tion in the PRA Call Log that the parents’ phone was the “wrong number” at which to reach Michael Litt, and called his parents phone an additional 164 times through February, 2013.

The Litts testified that they told PRA callers that Michael had not lived with them for many years and asked PRA to stop calling them, but PRA callers

continued to call anyway. Both Marvin and Karol Litt testified that the PRA calls upset Karol Litt and made her medical conditions worse and caused her to be sick to her stomach and to have headaches. Both Marvin and Karol testified that Michael Litt was upset and embarrassed over PRA collectors calling his parents’ home and that the PRA harassment strained their rela- tionship with their son.

The Litts, Michael, and PRA moved for summary judgment on several issues.

JUdiCial OpiniOn

BORMAN, District Judge The FDCPA includes a provision specifically regulat- ing third-party communications by debt collectors. 15 U.S.C. § 1692c(b) [covers] third party communications [and] has been described as a “safe harbor” provi- sion, setting forth the limited circumstances under which a debt collector may have contact with third parties, i.e. when seeking to locate the debtor, without

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436 part 3 Business Sales, Contracts, and Competition

violating the FDCPA’s general proscription against such communications.

PRA violated § 1692c(b) by contacting Michael Litt’s parents more than 100 times after learning that Marvin and Karol Litt’s phone number was a “wrong number” for reaching Michael Litt.

PRA argues that it was justified in continuing to call the elder Litts, notwithstanding the notation in its own records that the debtor could not be reached at their number, because it “believed” that it was calling a “good” number for reaching Michael Litt. The FDCPA is a strict liability statute, and “believing” that it was calling a good number to directly reach the debtor is not an exception included within the safe harbor pro- visions of § 1692b.

Courts that have directly considered the ques- tion of whether an unanswered telephone call con- stitutes a “communication” under § 1692c focus the analysis on the information that an unanswered call imparted to the called party based on the facts of the case. In particular, the courts consider whether the telephone number appearing on the called party’s telephone screen, or the information appearing on their caller ID, sufficiently conveyed to that party, in the context of that case, information regarding a debt.

Plaintiffs knew who was calling them from their caller ID system, despite the fact that the phone calls went unanswered and Portfolio never left any voicemails. Additionally, on the facts in this case, it can be reasonably inferred that the reason Plaintiffs retained counsel and had a cease and desist letter sent to Portfolio was because Plaintiffs at some point understood Portfolio to be a debt collector calling about a debt. In this manner, the phone calls that occurred after Plaintiffs retained counsel are properly considered communications because they indirectly conveyed to Plaintiffs “information regarding a debt.”

Section 1692k(c) of the FDCPA provides:

A debt collector may not be held liable in any action brought under this subchapter if the debt collector shows by a preponderance of evidence that the violation was not intentional and resulted from a bona fide error notwithstanding the maintenance of procedures reason- ably adapted to avoid any such error.

This provision entitles a defendant to judgment in their favor if the error was an unintentional bona fide error and the defendant maintained procedures designed specifically to avoid the error that occurred. In this case, PRA collectors continued to place calls to Marvin and Karol Litt’s phone number after learning that this

was a third-party “wrong” number for Michael Litt. PRA claims that its callers are trained not to call third parties more than once and to remove a phone number that a third party states is a wrong number for the debtor.

The fact that PRA may have had policies in place to avoid such an error is only one element of the bona fide error defense. The burden is on PRA to establish each of the elements of the bona fide error defense by a preponderance of the evidence and PRA has failed even to identify the PRA callers who continued to make calls to Marvin and Karol Litt over 160 times after their own records established that it was a wrong number for Michael Litt, let alone establish that the collectors’ “error” in doing so was unintentional under § 1692k(c).

Finally, PRA argues that because Marvin and Karol Litt have already accepted PRA’s Offer of Judgment for full resolution of their claims in this action, Michael Litt cannot seek to recover for damage to him allegedly caused by the same phone calls that underlie his par- ents’ claims.

This Court has concluded that Michael Litt has standing to assert a claim under § 1692c(b) against PRA for the calls made to his parents and that Michael Litt is entitled to summary judgment on that claim. Defendant elected to defend separately the claims of Marvin and Karol Litt on the one hand and the claims of Michael Litt on the other. PRA did not include Michael Litt in its Offer of Judgment and in fact argued in opposition to Plaintiff’s fee petition that Plaintiffs’ counsel’s fee request was “over-in- clusive” because it included “billing for all Plaintiffs rather than only the two additional Plaintiffs who accepted the offer of judgment.” Accordingly, the Magistrate Judge reduced the attorneys fee award by one-half, viewing Marvin and Karol Litt together as pursuing one claim and Michael Litt separately as pursuing another.

Summary judgment [is granted for the Litts for the claims discussed].

Case QUestiOns

1. Explain the good-faith exception to a collec- tor continuing to make phone calls to a phone number.

2. What is the importance of a collector providing training to its employees?

3. Is an unanswered call a form of harassment under the FDCPA?

4. Do Michael and his parents have separate claims against PRA?

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Chapter 12 Contracts and Sales: Performance, Remedies, and Collection 437

penalties for FdCpa Violations Under the CFPA, much of the FDCPA enforcement has been transferred to the CFPB. The CFPB will have the same enforcement authority that the FTC did, in addition to any expanded powers it promulgates under the authority it has been given under the CFPA. Those remedies include cease-and-desist orders to stop col- lectors from violating the FDCPA and penalties for violations. However, the great- est power of enforcement under the FDCPA lies with individual debtors. Debtors who can prove collector violations can collect for actual injuries and mental dis- tress. Debtors can also collect up to $1,000 in addition to actual damages for actions by collectors that are extreme, outrageous, malicious, or repeated. Attorney fees incurred by debtors in bringing their suits are also recoverable.

12-3c suits for enforcement of debts

Occasionally, collection is ineffective and there is no collateral to repossess. The creditor has few options left but to bring suit to enforce collection of the debt. In bringing a successful suit, the creditor will obtain a judgment, which is the court’s official document stating that the debtor owes the money and the collector is entitled to that money. However, in debt cases, the judgment is only the begin- ning. Once the creditor has the judgment, it must be executed to obtain funds.

A judgment is executed by having it attach to various forms of the debtor’s property. For example, a judgment can attach to real property. A judgment can also attach to funds by garnishment, which is the attachment of a judgment to an account, paycheck, or receivables. Once there is attachment, the creditor is entitled to those funds. The third party holding the funds must comply with the terms of the garnishment and release the appropriate amount of funds to the creditor.

Employees are given some protection under the Consumer Credit Protection Act with respect to garnishments. One such protection is the limitation on the employ- er’s ability to fire employees who have their wages garnisheed by a single creditor.

Under the Consumer Credit Protection Act, the amount that consumer credi- tors can garnish on debtor wages is limited to 25% of the net wages. Garnishment for past-due child support is limited to 50% of net wages.

12-3d the end of the line on enforcement of debts: Bankruptcy

Federal laws afford debtors shelter when their obligations cannot be paid. Bank- ruptcy is the legal process of having a debtor—individual, partnership, corporation, LLC (see Chapter 17)—turn over all nonexempt assets in exchange for a release from debts following the distribution of those assets to creditors. The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA) curbed bank- ruptcy being used as a strategic tool by consumers and businesses alike, rather than as a relief mechanism for those who had experienced a loss of income through illness, accident, or loss of employment. Those who wish to declare bankruptcy must qualify under a prescribed statutory formula that they do not have the means for repaying debts. The ability to declare bankruptcy hinges on disposable income, a figure obtained after the court allows for housing, food, and other necessary expenses. If the consumer has disposable income, then a debt adjustment plan, rather than a bankruptcy, is required.

Bankruptcy takes one of three forms. Chapter 7 bankruptcy is the liquidation form, in which the entity is dissolved or the individual’s debts are discharged. Chapter 11 is the reorganization form, in which a business enjoys protection from

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438 part 3 Business Sales, Contracts, and Competition

collection and creditors until a new plan for satisfying the business obligations is approved. Chapter 13 is the consumer debt adjustment plan, under which con- sumers can be given a new repayment plan for their debts. Before consumers can declare Chapter 7 (liquidation) bankruptcy, they must go through Chapter 13. In fact, if consumers who file directly for Chapter 7 bankruptcy do not meet the means test, the courts classify their filing as an abuse of the bankruptcy process and require Chapter 13 proceedings.

Credit repair organizations, counseling and debt service organizations that, for a fee, help consumers work through debt crises, are subject to additional disclosure requirements under the CFPA. These CROs, as they are known, must disclose fully their role, their fees, and that bankruptcy may be a result or recommendation from their efforts on behalf of the consumer debtor. CROs are regulated under the Credit Repair Organizations Act (15 U.S.C. §§ 1679–1679j) and are subject to private suit by consumer debtors for misrepresentations and failures to disclose information about fees, payments, and bankruptcy. In addition, CROs must disclose any affilia- tions with creditors or credit organizations. The CFPB has been given authority to regulate credit counseling organizations.

Individuals and businesses can file a petition for bankruptcy themselves or they can be petitioned into bankruptcy through an involuntary petition. In a vol- untary case, the court now must make the disposable income determination. In an involuntary case, the debtor must have a chance to present evidence against being placed into bankruptcy.

Debtors do have certain property exemptions in bankruptcy—property they do not lose to the bankruptcy estate. Those exemptions have been cut back substan- tially. For example, the homestead exemptions in many states protected all homes, regardless of costs. The reforms limit the amount of equity the debtor can retain following the bankruptcy and how long the protection applies.

Not all debts are discharged in bankruptcy. Alimony, child support, student loans, and taxes are examples of debts that survive bankruptcy.

12-3e is there a Cost to Breaching a Contract: Creditor Reports on nonpaying debtors

The failure to perform on a contract—that is, pay what is due—does have its rep- utational costs, even when the debt is discharged in bankruptcy for a very good reason such as loss of employment, health issues, or, in many cases, the economic hardships that come from the dissolution of a marriage. Creditors are able to report late payments, nonpayments, and contract defaults to credit bureaus that keep a database that future potential creditors can contact to determine the risk associ- ated with entering into a contract with certain debtors. However, the Fair Credit Reporting Act (FCRA) is designed to provide debtors some rights and protections regarding the credit information held by third parties about them. Before the pas- sage of the FCRA, many debtors were denied the right to see their credit reports and were often victims of inaccurate reports. The FCRA brought credit reports out in the open. The enforcement of this law has been assigned to the CFPB.

When the FCRa applies The FCRA applies to consumer reporting agencies, which are third parties (not creditors or debtors) that compile, evaluate, and sell credit information about con- sumer debt and debtors. Commercial credit reporting agencies and commercial debtors are not subject to FCRA standards.

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Chapter 12 Contracts and Sales: Performance, Remedies, and Collection 439

limitations on FCRa disclosures Under the FCRA, consumer reporting agencies can disclose information only to the following:

1. A debtor who asks for his own report 2. A creditor who has the debtor’s signed application for credit 3. A potential employer 4. A court pursuant to a subpoena

When consumers file applications for credit with lenders, they have the right to know where a credit report came from. However, the creditor cannot show the report to the debtor, who must get the report through a credit reporting agency.

Consumer agencies are limited not only as to whom disclosures can be made but also as to what can be disclosed. The following are the general limitations on debtor disclosures:

1. No disclosure of bankruptcies that occurred more than 10 years ago 2. No disclosure of lawsuits concluded more than seven years ago 3. No disclosure of criminal convictions and arrests that were disposed of more

than seven years ago

When a debtor applies for a loan of more than $50,000 or a job that pays more than $20,000, these limitations on disclosures do not apply.

the Right of debtor Correction of information Under the FCRA, debtors have not only the right to see reports but also the right to make corrections of inaccurate information included in those reports. A debtor sim- ply notifies the reporting agency of the alleged error. If the agency acknowledges the error, the debtor’s report must be corrected, and anyone who has received a report on that debtor during the previous two years must be notified.

If the agency still stands by the information challenged by the debtor, the debtor has the right to have included in the credit report a 100-word statement explaining his position on the matter. This statement is then included with the actual credit report in all future reports sent to third parties.

Smith v E-Backgroundcheck.com, Inc. (Case 12.7) deals with a problem of an inac- curate credit report.

Smith v E-Backgroundchecks.com, Inc. 81 F. Supp. 3d 1342 (N.D.Ga. 2015)

Not Doing the Crime Takes Time to Clear Up

Case 12.7

FaCts

On September 11, 2012, Tony Smith (plaintiff) applied for a job as a truck driver with Dart Transit Compa- ny through Dart’s student driver training program. Dart ordered a criminal background check on Smith

from E-Backgroundchecks.com (BGC). Dart ordered a U.S. OneSEARCH, which is an automated computer search of BGC’s nationwide criminal database pro- grammed to return results instantaneously. US One- SEARCH reports are prepared by matching identifying

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440 part 3 Business Sales, Contracts, and Competition

information provided by the end users to identifiers contained within the public criminal records in BGC’s database, and BGC’s practice is to report criminal records that match a consumer’s full name and date of birth.

Dart supplied the name “Tony Willie Smith,” his date of birth, the state within which he works, and his Social Security number, though the Social Security number was not required. BGC’s system identified six criminal records matching plaintiff’s first and last name and date of birth and did not contain any middle name.

BGC returned these records to Dart in a two- step process. First, BGC provided Dart with a summary screen showing basic information about each of the matching records. BGC’s system then required Dart to indicate, based on its review of the summary records, whether any records did not match plaintiff. Dart did not indicate that any of the records supplied by BGC were not a match to plain- tiff, and it therefore continued on to the second step of the process, which entailed BGC providing Dart with a detailed view of the criminal records that carried over from another screen. Dart was then able to review each record individually and was required to indicate whether each record would negatively affect plaintiff’s employment. Following this step, BGC then completed and electronically returned the criminal background report to Dart on September 12, 2012.

Because the report contained public criminal record information, BGC’s system automatically generated a letter to Smith, advising him that BGC had reported public record information to Dart and enclosing a copy of the report, a summary of plaintiff’s rights under the FCRA, and a dispute form. The letter, dated September 12, 2012, was mailed to Smith, which he received at his home some time after BGC transmitted the report to Dart.

Smith contacted BGC on September 17, 2012, and disputed the Dart report. Two days later, on September 19, BGC issued a corrected report remov- ing all of the previously reported criminal records provided on the September 12 report and showing that Smith had no matching criminal records. That same day, BGC e-mailed a notice to Dart, advising Dart that it had updated the criminal background issues. On September 20, 2012, Dart approved Smith to begin the training program, which he began on September 25.

On May 20, 2013, Smith filed suit against BGC for inaccurately reported his criminal history on his consumer report and that he was denied employ- ment with Dart due to the inaccurate information,

which included convictions for possession of a controlled substance by an unregistered person, carrying firearms without a license, and criminal conspiracy. Smith alleged that BGC “continues to publish and disseminate such inaccurate infor- mation to other third parties” in violation of the FCRA.

JUdiCial OpiniOn

VINEYARD, Judge Plaintiff alleges that BGC, by failing to follow rea- sonable procedures to assure maximum possible accuracy when preparing a criminal background check, negligently and willfully violated § 1681e(b) of the FCRA.

The FCRA provides that “[w]henever a [CRA] pre- pares a consumer report[,] it shall follow reasonable procedures to assure maximum possible accuracy of the information concerning the individual about whom the report relates.”

BGC admits that it furnished a report to Dart that inaccurately attributed to plaintiff certain criminal convictions belonging to other individuals with the same first and last name and date of birth. Plaintiff asserts that BGC “had at its disposal the means to determine that the convictions did not belong to [plaintiff], and that [BGC] was able [to] make such a determination within [two days] of being notified of the possible inaccuracy of its initial report.”

BGC furnished to Dart an indisputably inaccu- rate report that did not match plaintiff’s full name and social security number that Dart had provided to BGC. Since BGC had in its possession informa- tion that could have been used to demonstrate the inaccuracy of the report it furnished to Dart, there is a material dispute of fact as to whether BGC’s initial search procedures were in fact reasonable in this instance because “while requiring a [CRA] to go beyond the face of court records to determine whether [those records] correctly report the out- come of the underlying action may be too much to ask, requiring a [CRA] to correctly determine which public records belong to which individual consum- ers is not.”

BGC maintains that its procedures “will only return matching records where there is a first name, last name, and date of birth match, together [with] no middle name mismatch (i.e., the middle name record does not conflict with what the employer supplied).” BGC argues that “[r]eporting records that match complete names and dates of birth is a procedure reasonably designed to assure maxi- mum possible accuracy, and is considered industry

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Chapter 12 Contracts and Sales: Performance, Remedies, and Collection 441

12-4 Contract Remedies for Nonperformance If performance is not excused and there is a valid contract, the nonbreaching party can recover for damages from the nonperforming party. The purpose of such com- pensatory damages is to put the nonbreaching party in the same position he or she would have been in had no breach occurred. The law has formulas to calculate the amount of compensatory damages for breach of every type of contract. For exam- ple, if a seller has agreed to sell a buyer a car for $5,000 and the seller breaches, the buyer could collect the extra $1,000 it would cost to buy a substitute car priced at $6,000.

In addition to compensatory damages, nonbreaching parties are entitled to col- lect the extra damages or incidental damages involved because of the breach. If a seller must run an ad in a newspaper to sell a car a buyer has refused to buy, the costs of the ad are incidental damages.

Some parties agree in their contracts on the amounts they will pay in the case of nonperformance. Damages agreed upon in advance are liquidated damages, and the contractual clauses containing them are enforceable as long as they are not excessive and compensatory damages are not awarded in addition to the liqui- dated damages.

In some cases, the nonbreaching party may be able to collect consequential damages. Consequential damages are damages that result because of the breach and generally involve lost business, lost profit, or late penalties. For example, if a contractor must pay a penalty of $200 for each day a building is late after the completion date stipulated in the contract and the contractor is late because the steel supplier did not meet its deadline, the $200-per-day penalty would be a consequential damage that the steel supplier would be required to pay. Whether a party will be able to collect consequential damages depends on whether the breaching party knew or should have known what the consequences of the breach would be.

best-practice.” However, that is not what BGC did in this case. Dart provided plaintiff’s complete name to BGC, but BGC returned records that only matched plaintiff’s first and last name, a very common name at that, and despite having in its possession plaintiff’s complete name and social security number, BGC took no steps prior to issu- ing its initial report to confirm whether the “Tony Smith” criminal records it provided to Dart were associated with the full name and social security number of plaintiff.

Although BGC has submitted evidence of its procedures and its efforts to match criminal records relating to the individual that is the subject of the background report, plaintiff has submitted evidence that despite BGC’s efforts, the records reported did not relate to plaintiff, and he has also pointed to other matching identifiers that did not match his identifying information, as well as shown that

BGC is capable of utilizing social security numbers during the dispute process to confirm whether the records are in fact a match to the individual. Indeed, [BGC] even admitted that the automated computer program had no way of differentiating between indi- viduals with the same name and date of birth, and that after it compiled its initial matching records, it then placed the burden on the prospective employer to indicate whether any records did not match the individual.

Accordingly, BGC’s motion for summary judgment as to this claim is DENIED.

Case QUestiOns

1. What could and should BGC do differently?

2. What would be Smith’s damages in a case such as this?

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442 part 3 Business Sales, Contracts, and Competition

12-5 Third-Party Rights in Contracts Generally, a contract is a relationship between or among the contracting parties and is not enforceable by others who happen to benefit. For example, suppose a landowner and a commercial developer enter into an agreement for the construc- tion of a shopping mall. Such a project means jobs for the area and additional busi- ness for restaurants, hotels, and transportation companies, but these businesses would not have the right to enforce the contract or collect damages for breach if the developer pulled out of the project. However, certain groups of people do have rights in contracts even though they may not have been parties to the contracts. A good example is a beneficiary of a life insurance policy. The beneficiary does not contract with the insurance company and does not pay the premiums, but the ben- eficiary, called a third-party beneficiary, has contract rights because the purchaser of the policy directed so.

In other types of third-party contract rights, the third parties are not part of the original contract, as is the life insurance beneficiary, but are brought in after the fact. For example, suppose that a homebuilder owes a plumbing contractor $5,000 for work done on homes in the builder’s subdivision. In the sales contracts for the homes, the homebuilder is the seller, and the buyer’s purchase monies will go to the homebuilder. However, the homebuilder could assign payment rights to the plumber as a means of satisfying the debt. This process, called assignment, gives the plumber the right to collect the contract amount from the buyer. The plumber takes the place of the homebuilder in terms of contract rights.

In some cases, the duty or obligation to perform under a contract is transferred to another party. The transfer of contractual duties and obligation is called a dele- gation. Generally, a delegation of duties carries with it an assignment of benefits. For example, suppose that Neptune Fisheries, Inc., has a contract with Tom Tuna, Inc., to sell 30 fresh lobsters each day. Neptune is stopping its lobster line and dele- gates its duties under the Tom Tuna contract to Louie’s Lobsters, Inc. Louie’s takes over Neptune’s obligation to furnish the 30 lobsters and is assigned the right to benefits (payment for the lobsters) under the contract. Both Louie’s and Neptune are liable to Tom Tuna for performance. A delegation, unlike a novation, does not release the original contracting party.

Fingerlakes Aquaculture, LLC, an indoor fish hatchery, entered into a contract for Progas Welding Supply to build and deliver a 13,000-gallon oxygen storage tank. The contract required that the tank be delivered during the week of June 21, 1999, with a $400-per-day liquidated damages provision, denoted a “fine.” Throughout the year, Pro- gas delivered smaller tanks, but was never able to deliver the 13,000-gallon tank. In

June 2001, Fingerlakes Aquaculture bought a tank from another supplier and filed suit seeking the $400-per-day liquidated damag- es. Progas says that because of the other tanks, Fingerlakes Aquaculture had no dam- ages and the total of $292,000 (the $400 per day for the 210 days of delay) was void as a penalty. Who is correct? Why? [Finger- lakes Aquaculture, LLC v Progas Welding Supply, Inc., 825 N.Y.S.2d 559 (2006)]

Consider . . . 12.7

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12-6 International Issues in Contract Performance

12-6a assuring payment

International contract transactions for goods involve extensive shipment requirements. To control access to the goods and payment for them, many sell- ers use a bill of lading for transacting business. The bill of lading is a receipt for shipment issued by the carrier to the seller. It is also a contract for the ship- ment of the goods and provides evidence of who has title to the goods. If a bill of lading is used, the buyer will not gain access to the goods unless and until the seller provides the necessary documents for release of the goods. Once the seller has the bill of lading, the seller can choose to transfer title to the goods by transferring the bill of lading. The seller could also pledge the bill of lading as security for the payment of a debt. A bill of lading can be made directly to the buyer, or it can be a negotiable bill of lading that can be transferred to anyone.

The bill of lading is often used in conjunction with a line of credit in interna- tional transactions because the two together offer the seller assurance of payment and the buyer assurance of arrival of the goods. In international transactions, in which resolution of disputes over great distances can be difficult, this means of controlling access to goods and payment is helpful.

In this type of transaction, the seller delivers goods to a carrier for transporta- tion and receives a bill of lading. The seller then sends the bill of lading through its bank to the buyer’s bank to give the buyer’s bank title to the goods, which will be turned over to the buyer once the funds are deducted from the line of credit estab- lished by the bank for the buyer.

The buyer may also arrange for a letter of credit to be used in conjunction with the bill of lading. The letter of credit is issued by the buyer’s bank and is sent to a corresponding bank where the seller is located. The letter of credit lists the terms and conditions under which the seller can draw on the letter of credit or be paid. For example, turning the bill of lading over to the corresponding bank may be the condition of drawing on the letter of credit; the bill of lading is then used by the corresponding bank and the buyer’s bank to allow the buyer to take possession of the goods. Because banks are involved in these transac- tions through credit assurances, the seller enjoys more of an assurance of pay- ment prior to shipment because a letter of credit is actually a confirmation of payment.

12-6b assuring performance: international peculiarities

International contracts have a particular need for a force majeure clause. Wars, rev- olutions, and coups are often included in international contracts as justification for noncompletion. The force majeure clauses are summaries of potential international events that could hamper production or trade.2

One other risk of international contracts is the stability of various currencies and their possible devaluation. The method and means of payment should be specified in the contract, and a clause covering devaluation may also be included so that full payment is ensured.

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Biography

Charlie Sheen has had a history of drug and alcohol addiction and has been through several rehab programs. During a time when he admits that he was drink- ing, Charlie Sheen was terminated from his hit television show, Two and a Half Men, CBS’s comedy series that was, at the time, the most successful rerun show on cable. The termination came following several public outbursts by Mr. Sheen about executives (including Chuck Lorre, the show’s creator) at his network, as well as some problematic personal conduct related to his ongoing issues with drugs and alcohol.

Mr. Sheen filed suit asking to be paid for the remaining episodes. His contract does provide that, regardless of the reason for termination, he is enti- tled to receive full payment under his contract. Mr. Sheen’s suit also detailed that he was always at rehearsals and

the show’s tapings, despite his rath- er public escapades while under the influence of alcohol and drugs. He also noted in the suit that the network exec- utives had not fired him during his pre- vious absences due to rehab. In short, Mr. Sheen argued that there was no breach of contract.

The network replaced Mr. Sheen with actor Ashton Kutcher. Mr. Sheen tried to reach his fans through an Internet show, but there was little support for his offering. Mr. Sheen continued to falter. The suit was settled for an undisclosed amount, but his contract had a provision of $2,000,000 payment per episode, which signaled a large amount. Mr. Sheen’s career contin- ued to wane along with evolving health and potential liability issues, and Two and a Half Men did not do as well, critically or in the ratings, following Mr. Sheen’s departure.

Charlie sheen: nonperformance or Just a lot of trouble?

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s u m m a r y What if the assumptions made and the information given turn out to be untrue? Must the parties still go forward with the contract?

• Contract defense—situation, term, or event that excuses performance

• Capacity—mental and age thresholds for valid contracts

• Voidable contract—one party can choose not to honor the contract

• Puffing—statements of opinion

• Material fact—basis of the bargain

• Void contract—contract that courts will not honor

• Misrepresentation—incomplete or inaccurate infor- mation prior to contract execution

• Consumer Financial Protection Bureau

• Consumer Financial Protection Act (Dodd–Frank)

• Three-day rescission period

• Home Equity Loan Consumer Protection Act of 1988

• Home Ownership and Equity Protection Act of 1994 (HOEPA)

• Rescission—setting aside of contract as a remedy

• Fraud—intentional misrepresentation

• Scienter—knowledge that information given is false

• Duress—physical or mental force that deprives party of a meaningful choice with respect to a proposed contract

• Undue influence—exerting control over another party for purposes of gain

• Confidential relationship—trust, confidence, reliance in a relationship

• Fair Credit Reporting Act

• Fair Debt Collections Practices Act

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Chapter 12 Contracts and Sales: Performance, Remedies, and Collection 445

• Bankruptcy Abuse Prevention and Consumer Protec- tion Act of 2005 (BAPCPA)

• Public policy—standards of decency

• Exculpatory clauses—attempt to hold oneself harm- less for one’s own conduct

• Unconscionable contract—contract that is grossly unfair

If one party does not perform, is the other side excused? When is performance required, and when is it excused?

• Conditions precedent—advance events that must occur before performance is due, for example, obtaining financing

• Substantial performance—performance that, for practical purposes, is just as good as full-performance

• Commercial impracticability—defense to per- formance of sales contract based on objective impracticability

• Novation—agreement to change contract among all affected, for example, agreement to substitute parties

• Accord and satisfaction—agreement entered into as settlement of a disputed debt

• Obligation of good faith—must perform in a reason- able fashion; performance must meet commercial standards

What remedies exist?

• Compensatory damages—amount required to place party in as good a position as before breach

• Incidental damages—costs of collecting compensa- tory damages

• Liquidated damages—agreement clause in contract that preestablishes and limits damages

• Consequential damages—damages owed to third parties from a breach

What are the contract performance issues in interna- tional business?

• Bill of lading—title document used to control trans- fer of goods

• Letter of credit—pledge by bank of availability of funds for a transaction

• Exchange rate and risk issues in contracts

Q u e s t i o n s a n d P r o b l e m s 1. On December 5, 1997, Michael Dekofsky and Christo- pher Vrakelos sold Brea Range, Inc., an indoor shooting range, to Michael J. and Kimberly A. Hansen for $140,000. The Hansens paid $70,000 cash and assumed two prom- issory notes due and owing from the corporation to Mr. Dekofsky and Mr. Vrakelos. After escrow closed, the Hansens discovered that two patrons committed suicide at Brea Range, in 1995 and March 1997.

The Hansens made interest payments on the prom- issory notes until January 1, 1999; defaulted on the first principal payment; and ceased making payments on June 1, 1999. Mr. Dekofsky and Mr. Vrakelos sued for the balance due. The Hansens defended on the theory that the sellers had unclean hands and breached a duty to disclose material facts. In a cross-complaint, the Han- sens sued for conspiracy, fraud, misrepresentation, and rescission. Do the Hansens have a valid defense to the contract’s formation? Was there misrepresentation? Was there fraud?[Dekofsky v Brea Range, Inc., 2001 WL 1613509 (Cal. App. 2 Dist.) (not printed in Cal. Rptr.—unpub- lished opinion)]

2. Lululemon ordered Luon fabric for its famous black yoga pants from a supplier. The fabric was made into

yoga pants, which were then sold in Lululemon stores. A wave of customer complaints followed because the fab- ric was see-through. Lululemon took the pants back from customers and issued refunds. However, following this glitch in its supply chain, Lululemon began a downward spiral that saw its income and share price drop. Lulu- lemon also struggled to get products back onto the shelf because of difficulty in replacing the Luon fabric. What types of damages could Lululemon recover for this fabric issue?

3. Bernina Sewing Machines imports sewing machines and parts for U.S. distribution. Its contract prices are in francs. Because of the devaluation of the U.S. dollar, Bernina wants to be excused from its contracts. Can it be excused under any contract doctrine? [Bernina Distribu- tors, Inc. v Bernina Sewing Machines, 646 F.2d 434 (10th Cir. 1981)]

4. Leonidas Kavakos, a celebrated and international violinist, purchased a rare and historic French violin bow made by J. Henry in 1850, paying €65,000. Nazaret Mkhsi-Gevorkian owns Gevorkian Nazareth Violins in Burbank, California. Mr. Gevorkian has over 20 years

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446 part 3 Business Sales, Contracts, and Competition

of experience in selling, repairing, and restoring violins. Mr. Kavakos found that his Henry bow was curving and took it to Gevorkian to determine the cause. Gevorkian explained the cause of the curving as not the taut hair of the bow but the wood itself curving. Gevorkian said that he could fix it, but he did not tell Kavakos about the risk that the bow could snap. Mr. Gevorkian did snap the bow while trying to fix it. Mr. Kavakos says that he was not told about the risk that the bow might snap if curvature correction were undertaken. Mr. Kavakos filed suit seek- ing $80,000, interest, and the costs of filing suit. Explain what happened. Is this a breach of contract? What should the damages be? [Kavakos v Nazaret Mkhsi-Gevorkian, 2015 WL 40467 (Cal. Sup. 2015)]

5. Dan O’Connor paid $125 to have the University of Notre Dame’s leprechaun mascot tattooed on his upper arm with the words “Fighting Irish” inscribed above the little gnome. The tattoo parlor inscribed the chosen lepre- chaun and “Fighing Irish.”

Mr. O’Connor’s girlfriend pointed out the spelling error, and Mr. O’Connor filed suit against the Tattoo Shoppe in Carlstadt, New Jersey, seeking unspecified damages.

Mr. O’Connor noted, “I was irate, and for a minute or two after I cooled down I kind of giggled. But I can’t just live with this. You’re not talking about a dented car where you can get another one . . . you’re talking about flesh.”

What damages should Mr. O’Connor receive? Would a refund of $125 be enough? What if the Tattoo Shoppe had a clause in its contract limiting damages to a refund? Would it be valid?

6. Jennifer Cushman has a permanent residence in Pennsylvania but attended college in Vermont. In the summer of 1993, an unknown person, possibly a mem- ber of her household in Philadelphia, applied under Ms. Cushman’s name for credit cards from three credit grantors: American Express (Amex), Citibank Visa, and Chase Manhattan Bank. The person provided the credit grantors with Ms. Cushman’s Social Security number, address, and other identifying information. Credit cards were issued to that person in Ms. Cushman’s name, and that person accumulated balances totaling approximately $2,400 on the cards between June 1993 and April 1994. All this occurred without Ms. Cushman’s knowledge.

In August 1994, an unidentified bill collector informed Ms. Cushman that Trans Union (TUC) was publishing a consumer credit report indicating that she was delinquent on payments to these three credit grant- ors. Ms. Cushman notified TUC that she had not applied for or used the three credit cards in question and sug- gested that a third party had fraudulently applied for and obtained the cards. In response, a TUC clerk called

Amex and Chase to inquire whether the verifying infor- mation (such as Ms. Cushman’s name, Social Security number, and address) in Amex’s and Chase’s records matched the information in the TUC report. The TUC clerk also asked if Ms. Cushman had opened a fraud investigation with the credit grantors. Because the infor- mation matched and because Ms. Cushman had not opened a fraud investigation, the information remained in the TUC report. TUC was unable to contact Citibank, so TUC deleted the Citibank entry from the report. TUC’s investigations are performed by clerks who are paid $7.50 per hour and are expected to perform 10 investigations per hour.

TUC did not obtain records to perform a hand- writing comparison. Ms. Cushman was denied credit because of the report. She filed suit under the FCRA. Did TUC violate the law? [Cushman v Trans Union Corp., 115 F.3d 220 (3rd Cir. 1997)]

7. Robert Hackett became a substitute fireman for the city of New Britain, Connecticut, in 1949. In 1950, he was made a full-time fireman and in 1968 became a lieu- tenant. After earning the highest mark on the captain’s examination, he was promoted to captain in 1974. He then scored the highest score on the deputy chief exam and was promoted to that rank in 1977.

Mr. Hackett had paid an employee in the city department responsible for administering the exams to ensure that he earned the highest grades (which he did). He had, in effect, purchased his last two promotions. When these acts were discovered (after Mr. Hackett had retired), criminal charges were brought against him and the city employee. Both were convicted of felonies.

The pension board of New Britain then met and voted to reduce Mr. Hackett’s pension by $5,483.97 a year because that reduction placed his pension at the level it would have been without the last two promotions. The board said the reduction was necessary because the last two promotions were obtained through illegal conduct. Mr. Hackett filed suit. Is illegality a defense to Hackett’s suit for his full pension? [Hackett v City of New Britain, 477 A.2d 148 (Conn. 1984)]

8. Since 1978, when the first warnings emerged from medical research about using “sun tan lotion,” ads for the products have created some confusion. There were “sun- blocks,” “sunscreens,” and just plain “sun tan lotion.” The descriptive terms were “waterproof,” “water resis- tant,” and “sweatproof.” The lotions also blocked UVB rays, but some blocked only UVA rays. The sun protec- tion factors ranged from SPF 15 factor to SPF 60, and some consumers misunderstood what level was needed.

Consumers were experiencing sunburns despite their use of sunscreens and sun tan lotion. The Federal Trade Commission stepped in during 2012 with disclosure

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rules to clarify what was a material representation and what constituted puffery. Based on your knowledge of the standards for materiality in misrepresentation cases, develop a list of what the FTC rules required the manu- facturers to disclose and what terms they could use.

9. Janet S. Milliken purchased a home from Kathleen and Joseph Jacono through ReMax agents Fran Day and Thomas O’Neil. Neither the sellers nor their agents dis- closed to Ms. Milliken that the prior owners of the house, a husband and wife, had been involved in a murder/ suicide on the property. Ms. Milliken filed suit against the Jaconos as well as their real estate agent to have the sale set aside. Ms. Milliken said that she and her family had experienced paranormal events since moving into the home. Ms. Milliken was aware that the Jaconos had purchased their home from an estate but did not ask any questions about why the home was held by an estate and not by individual owners. The Jacanos and their agents did contact the Pennsylvania Real Estate Commission for an opinion as to whether they had to disclose the murder/ suicide. They received an opinion that it was not material and need not be disclosed. Discuss whether Ms. Milliken can set the sale aside and what legal arguments she could make. [Milliken v Jacono, 60 A.3d 133 (Pa. Super. 2012)]

10. Boeing Company was scheduled to deliver several of its 747-400 jumbo jetliners to Northwest Airlines by December 31, 1988. Northwest set that deadline because it needed the $16 million in investment tax credits the planes would bring. Boeing missed the December dead- line, and Northwest wants to recover compensation from Boeing for the lost tax credits. Could Northwest recover for these lost credits?

11. Several students from a high school in Fairfax County, Virginia, and another in Tucson, Arizona, filed suit against iParadigms for copyright infringement. iPar- adigms is the company that owns and operates Turnitin, a software program that allows educational institutions to check student term papers against previous students’ papers to detect plagiarism. The students wanted their papers removed from Turnitin because no contract was ever formed to allow their papers to be posted to Turni- tin, that there was duress involved when they clicked to submit their papers because they had no choice but to post them in order to turn in their papers, and that they were minors and could not make valid contracts.

Are the students correct? Any other defenses? Or was there a valid contract? [A.V. v iParadigms, 544 F. Supp. 2d 473, 480 (E.D.Va.2008)]

Marketing, Ethics & the Law Graduation and Placement Rates: Good Old-Fashioned Puffery or Fraud

Recruiting students is a tall order in what has become the competitive world of higher education. There is now a federal office assigned the respon- sibility of looking into marketing claims made by educational institutions about their graduation rates, placement figures, and their programs and curriculum. For example, a new law school that makes representations about its accreditation must be careful not to assure potential students that accreditation is a sure thing. Placement rates cannot

mislead. If “90% of our graduates are employed with 90 days of graduation” is the claim, the federal government is requiring additional disclosures about the types of jobs those graduates have. A claim of “90% are place in their fields of study” must mean using the degree, not data entry jobs for those with degrees in computer science. The scruti- ny is now high because the data used in recruiting has been misleading. Marketing is important, but going beyond puffery can be actionable.

n ot e s 1. As noted in Chapter 12, consumer credit contracts are those in which the buyer is purchasing goods, services, or real property for personal and/or home use.

2. International history has played a role in the development of force majeure clauses because wars, trade, and international relations influence contract rights and performance.

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448

Chapter

Product Advertising and Liability13 The first jury verdict over $1 million in a product liability suit occurred in 1962. The top five verdicts in 2014 in the United States totaled $34.5 billion, with the largest product liability verdict being for $23.6 billion.1

Product liability is a unique area of law. It has social roots in that it attempts to lessen the burden of losses by requiring a manufacturer or manufacturer’s in- surer to pay for a defective product. It also has contract roots in that if a product does not do what it is supposed to do, a breach of contract has occurred. Finally, it also has roots in tort law insofar as an injury results from someone else’s care- lessness. In these senses, product liability is a combination of contract law, tort law, and social responsibility.

This chapter answers the following questions: How did product liability law develop? What are the contract theories for recovery? What is required for a tort- based recovery on a defective product? How does advertising create liability for a business? What is strict tort liability for products? What reforms are proposed for cutting back liability? Are international product liability standards different?

Update For up-to-date legal and ethical news, go to mariannejennings.com

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449

13-1 Development of Product Liability For some time, courts followed the principle of caveat emptor—“Let the buyer beware.” This theory meant that sellers were not liable for defects in their products and that it was the buyer’s responsibility to be on the alert for defects and take the appropriate precautions.

Following a series of court decisions in which buyers were allowed recovery and courts questioned the public policy wisdom of caveat emptor, the Restatement (Second) of Torts adopted its now-famous Section 402A on strict tort liability (dis- cussed later in this chapter). With this adoption, the area of product liability had gone full swing from no liability (caveat emptor) to an almost per se standard of lia- bility for defective products.

13-2 Advertising as a Contract Basis for Product Liability

13-2a express Warranties

An express warranty as provided in the Uniform Commercial Code (UCC) is an express promise (oral or written) by the seller as to the quality, abilities, or perfor- mance of a product (UCC § 2-313). The seller need not use the words promise or guar- antee to make an express warranty. A seller makes a warranty by displaying a sample or model or giving a description of the goods. Promises of how the goods will per- form are also express warranties. “These goods are 100% wool,” “This tire cannot be punctured,” and “These jeans will not shrink” are examples of express warranties.

Ads are but one form of express warranties. The negotiation process can find the seller making express warranties to the buyer. For example, if a seller tells the buyer that a dog is a purebred, that a painting is a “painting by Francis Bacon,” or that a horse is “disease-free,” the seller has made an express warranty. Statements made by the seller to the buyer before the sale that are part of the basis of the sale or bargain are express warranties. Information included on the product packaging is an express warranty if that information includes statements of fact or promises of performance.

Advertising may be described as the science of arresting human intelligence long enough to get money out of it. Stephen Leacock

Caution: Cape does not enable user to fly. Instructions on Kenner Products’ Batman costume

Warning: May contain eggs. Warning on a carton of eggs

Caution: Do Not Swallow! Warning on a coat hanger

Remove child before folding. Instructions on a stroller

Do not hold the wrong end of a chainsaw. Warning on the box containing a chainsaw

Amy Rothbaum bought a Samsung 4G phone that shut down randomly (the Random Shut Down De- fect). Rothbaum was given a replacement phone, but it shut down as well. Rothbaum filed a class action

suit against Samsung, along with other purchasers who were experiencing the same difficulties. What theories could she use to recover? And can she recover?

Consider . . . 13.1

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450 part 3 Business Sales, Contracts, and Competition

Opinions, however, are not considered a basis for transactions and are there- fore not express warranties. For example, the statement “This glassware is as good as anyone else’s” is sales puffing and not an express warranty. Exhibit 13.1 gives some examples of statements of fact versus opinion.

Castro v QVC Network, Inc. (Case 13.1) deals with an issue of liability for repre- sentations via ad statements.

StateMeNt FaCt OR OpINION?

This car gets 20 miles per gallon. Fact

This car gets great gas mileage. Opinion

These goods are 100% wool. Fact

This is the finest wool around. Opinion

This truck has never been in an accident. Fact

This truck is solid. Opinion

This mace stops assailants in their tracks. Fact (promise of performance)

This mace is very effective. Opinion

This makeup is hypoallergenic. Fact

This makeup is the future of beauty. Opinion

This ink will not stain clothes. Fact

This ink is safe to use. Opinion

These tulip bulbs are first-grade quality. Fact

These tulip bulbs will make your garden the envy of the neighborhood. Opinion

This watch is waterproof. Fact

This watch is durable. Opinion

Exhibit 13.1 Statements of Fact versus Opinion

Castro v QVC Network, Inc. 139 F.3d 114 (2nd Cir. 1998)

A Turkey of a Pan: Liability on Thanksgiving Day

Case 13.1

FaCtS

In November 1993, QVC Network (appellee), an oper- ator of a cable television home-shopping channel, advertised, as part of a one-day Thanksgiving promo- tion, the “T-Fal Jumbo Resistal Roaster.” The roaster was manufactured by U.S.A. T-Fal Corporation. The QVC ad described the roaster as suitable for roasting a 25-pound turkey. At the time that T-Fal and QVC entered into an agreement for the sale of the roasting

pan, T-Fal did not have a pan in its line large enough to roast a 25-pound turkey. T-Fal asked its parent compa- ny in France to provide a suitable roasting pan as soon as possible. The parent company provided a larger pan to which it added two small handles.

Loyda Castro (appellant) ordered the roasting pan and used it for roasting her turkey on Thanksgiving Day, 1993. Mrs. Castro was injured when she tried to remove the turkey from the oven. Using two large

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Chapter 13 Product Advertising and Liability 451

insulated oven mitts, Mrs. Castro tried to lift the pan from the oven, placing two fingers on each handle. Two fingers were the maximum grip permitted by the small handles. As the turkey tipped toward her, she lost control of the pan, spilling the hot drippings and fat that had accumulated in the pan during the cooking and basting process. Mrs. Castro suffered second- and third-degree burns to her foot and ankle, which have led to scarring, paresthesia, and swelling.

Mrs. Castro filed suit for strict liability and breach of warranty. The warranty charge was dismissed, and the jury returned a verdict for QVC and T-Fal. Mrs. Castro appealed.

JUdICIal OpINION

CALABRESI, Circuit Judge Products liability law has long been bedeviled by

the search for an appropriate definition of “defective” product design. Over the years, both in the cases and in the literature, two approaches have come to pre- dominate. The first is the risk/utility theory, which focuses on whether the benefits of a product outweigh the dangers of its design. The second is the consumer expectations theory, which focuses on what a buyer/ user of a product would properly expect that the prod- uct would be suited for.

Not all states accept both of these approaches. Some define design defect only according to the risk/ utility approach.

One of the first states to accept both approaches was California, which in Barker v Lull Engineering Co., 20 Cal.3d 413, 143 Cal.Rptr. 225, 573 P.2d 443 (1978), held that “a product may be found defective in design, so as to subject a manufacturer to strict liability for resulting injuries, under either of two alternative tests”—consumer expectations and risk/utility. Sev- eral states have followed suit and have adopted both theories.

Prior to the recent case of Denny v Ford Motor Co., 87 N.Y.2d 248, 639 N.Y.S.2d 250, 662 N.E.2d 730 (1995), it was not clear whether New York recognized both tests. In Denny, the plaintiff was injured when her Ford Bronco II sports utility vehicle rolled over when she slammed on the brakes to avoid hitting a deer in the vehicle’s path. The plaintiff asserted claims for strict products liability and for breach of implied warranty, and the district judge—over the objection of defendant Ford—submitted both causes of action to the jury. The jury ruled in favor of Ford on the strict liability claim, but found for the plaintiff on the implied warranty claim. On appeal, Ford argued that the jury’s verdicts on the strict products liability claim and the breach of warranty claim were inconsistent because the causes of action were identical.

This court certified the Denny case to the New York Court of Appeals to answer the following questions: (1) “whether, under New York law, the strict products liability and implied warranty claims are identical”; and (2) “whether, if the claims are different, the strict products liability claim is broader than the implied warranty claim and encompasses the latter.”

In response to the certified questions, the Court of Appeals held that in a products liability case a cause of action for strict liability is not identical to a claim for breach of warranty.

Moreover, the court held that a strict liability claim is not per se broader than a breach of warranty claim such that the former encompasses the latter. Thus, while claims of strict products liability and breach of warranty are often used interchangeably, under New York law the two causes of action are definitive- ly different. The imposition of strict liability for an alleged design “defect” is determined by a risk/utility standard. The notion of “defect” in a U.C.C.-based breach of warranty claim focuses, instead, on consumer expectations.

Since Denny, then, it has been settled that the risk/ utility and consumer expectations theories of design defect can, in New York, be the bases of distinct causes of action: one for strict products liability and one for breach of warranty. This fact, however, does not settle the question of when a jury must be charged separate- ly on each cause of action and when, instead, the two causes are, on the facts of the specific case, sufficiently similar to each other so that one charge to the jury is enough.

While eminent jurists have at times been troubled by this issue, the New York Court of Appeals in Denny was quite clear on when the two causes of action might meld and when, instead, they are to be treated as separate. It did this by adding its own twist to the distinction—namely, what can aptly be called the “dual purpose” requirement. Thus in Denny, the Court of Appeals pointed out that the fact that a product’s over- all benefits might outweigh its overall risks does not preclude the possibility that consumers may have been misled into using the product in a context in which it was dangerously unsafe. And this, the New York court emphasized, could be so even though the benefits in other uses might make the product sufficiently reason- able so that it passed the risk/utility test.

In Denny, the Ford Bronco II was not designed as a conventional passenger automobile. Instead, it was designed as an off-road, dual purpose vehicle. But in its marketing of the Bronco II, Ford stressed its suitability for commuting and for suburban and city driving. Under the circumstances, the Court of Appeals

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452 part 3 Business Sales, Contracts, and Competition

explained that a rational fact-finder could conclude that the Bronco’s utility as an off-road vehicle outweighed the risk of injury resulting from roll-over accidents (thus passing the risk/utility test), but at the same time find that the vehicle was not safe for the “ordinary purpose” of daily driving for which it was also marketed and sold (thus flunking the consumer expectations test).

That is precisely the situation before us. The jury had before it evidence that the product was designed, marketed, and sold as a multiple-use product. The pan was originally manufactured and sold in France as an all-purpose cooking dish without handles. And at trial, the jury saw a videotape of a QVC representative demonstrating to the television audience that the pan, in addition to serving as a suitable roaster for a twen- ty-five pound turkey, could also be used to cook cas- seroles, cutlets, cookies, and other low-volume foods. The court charged the jury that “[a] product is defective if it is not reasonably safe[,] [t]hat is, if the product is so likely to be harmful to persons that a reasonable person who had actual knowledge of its potential for produc- ing injury would conclude that it should not have been marketed in that condition.” And, so instructed, the jury presumably found that the pan, because it had many advantages in a variety of uses, did not fail the risk/utility test.

But it was also the case that the pan was advertised as suitable for a particular use—cooking a twenty-five pound turkey. Indeed, T-Fal added handles to the pan in order to fill QVC’s request for a roasting pan that it

could use in its Thanksgiving promotion. The product was, therefore, sold as appropriately used for roasting a twenty-five pound turkey. And it was in that use that allegedly the product failed and injured the appellant.

In such circumstances, New York law is clear that a general charge on strict products liability based on the risk/utility approach does not suffice. The jury could have found that the roasting pan’s overall utility for cooking low-volume foods outweighed the risk of injury when cooking heavier foods, but that the prod- uct was nonetheless unsafe for the purpose for which it was marketed and sold—roasting a twenty-five pound turkey—and, as such, was defective under the consum- er expectations test. That being so, the appellants were entitled to a separate breach of warranty charge.

In light of the evidence presented by appellants of the multi-purpose nature of the product at issue, the district court, applying New York law, should have granted appellants’ request for a separate jury charge on the breach of warranty claim in addition to the charge on the strict liability claim.

Reversed.

CaSe QUeStIONS

1. Was the pan represented as suitable for roasting a turkey?

2. What is the relationship between tort liability and warranty liability?

3. What is the risk/utility test?

John R. Klages was employed as a night au- ditor at Conley’s Motel on Route 8 in Hamp- ton Township. He worked from 11 p.m. until 7 a.m., five days a week. On March 30, 1968, at approximately 1:30 a.m., two individuals entered the motel and announced, “This is a stickup. Open the safe.” Mr. Klages indi- cated that he was unable to open the safe because he did not know the combination. One of the individuals then pointed a gun at his head and pulled the trigger. Fortunately for Mr. Klages, the gun was a starter pistol, and he was not seriously injured.

The next day, Mr. Klages and a fellow employee, Bob McVay, decided that they needed something to protect themselves

against the possibility of future holdups. Af- ter reading an article concerning the effects of mace, Mr. McVay suggested that they consider using mace for their protection.

After reading and discussing the litera- ture from the Markl Supply Company with their employer, Mr. McVay purchased an MK-II mace weapon, which described the mace as follows.

Rapidly vaporizes on face of assail- ant effecting instantaneous incapac- itation. . . . It will instantly stop and subdue entire groups . . . instantly stops assailants in their tracks.  . . . [A]n attacker is subdued instantly, for a period of 15 to 20 minutes. . . .

Consider . . . 13.2

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Chapter 13 Product Advertising and Liability 453

13-2b Federal Regulation of Warranties and advertising

Advertisements for goods are also express warranties. Accurate advertising is a basis for full information, and full information is a cornerstone for competitive markets. In addition to the UCC protections for buyers, federal and state govern- ments regulate the content of ads.

In 1914, Congress passed the Federal Trade Commission Act, which autho- rized the Federal Trade Commission (FTC) to prevent “unfair and deceptive trade practices.” Congress passed the Wheeler-Lea Act of 1938, which clarified and expanded the FTC’s power by authorizing it to regulate “unfair and decep- tive acts or practices” whenever the public is being deceived, regardless of any effects on competition. The FTC has challenged unsubstantiated or ambiguous advertising claims and has reviewed and eliminated deceptive techniques in tele- vision ads.

13-2c Content Control and accuracy

The FTC has regulated the accuracy of ads in several ways. First, the FTC chal- lenged certain types of price claims. If an ad announces “50% off,” the prices must actually be half the original prices charged for the products or services prior to the sale; that price cannot be inflated to cover the markdown. If an ad quotes a “normal” price, that price must reflect what most sellers in the area are charging.

The FTC has also challenged the accuracy of ads. Claims that goods are “100% wool” are not only the basis for express warranty recovery but also

Time Magazine stated the Chemical Mace is “for police the first, if not the final, answer to a nationwide need—a weapon that disables as effectively as a gun and yet does no permanent injury.” . . . The effectiveness is the result of a unique, incapacitating for- mulation (patent pending), projected in a shotgun-like pattern of heavy liquid droplets that, upon contact with the face, cause extreme tearing, and a stunned, winded condition, often accompanied by dizziness and apathy.

At approximately 1:40 a.m. on Septem- ber 22, 1968, while Mr. Klages was on duty, two unknown individuals entered the motel office, requested a room, and announced a stickup. One of the intruders took out a gun and directed Mr. Klages to open the safe. Using the cash register as a shield, Mr. Klag- es squirted the mace, hitting the intruder “right beside the nose.” Mr. Klages imme- diately ducked below the register, but the intruder followed him down and shot him

in the head. The intruders immediately de- parted, and Mr. Klages called the police. The bullet wound caused complete loss of sight in Mr. Klages’s right eye. He claims a breach of an express warranty. Is he right? [Klages v General Ordnance Equipment Corp., 19 UCC Rep. Serv. (Callaghan) 22 (Pa. 1976)]

THINK: The requirements for an express warranty are a statement of fact or a prom- ise of performance.

APPLY: What statements of fact or promis- es of performance are made in the ad or on the product packaging?

“[I]nstantly stops assailants in their tracks” is a promise of performance; “subdued in- stantly, for a period of 15 to 20 minutes” is also a promise of performance.

ANSWER: The product failed to live up to those promises, so there was a breach of express warranty, and the company is liable for the injury Mr. Klages sustained after us- ing the mace against his attackers.

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454 part 3 Business Sales, Contracts, and Competition

the basis for an FTC challenge. Also, the FTC challenges advertising methods. For example, using “marbles” in soup to make it look thicker as it pours is deceptive. The FTC has used its powers to ensure that ads accurately depict the product as it exists. The regulations also apply to the terms of the con- tract and the time for performance. For example, the FTC, through its Mail or Telephone Order Merchandise Rule, requires that catalog merchants dis- close delays in delivering ordered goods to consumers and that consumers be informed up front about custom product delays, special-order delays, and direct-from-the-manufacturer delays. The ads, pamphlets, catalogs, and mail- ings must disclose delays known up front, and the consumer must be notified after an order is placed if the delay will exceed the maximum amount of time allowed under the rules for delivery. The FTC has enforced those disclosure requirements against Internet merchants as well. In In the Matter of Macys.com, KBkids.com, and CDnow, Inc., the FTC settled charges with these three e-retailers who were alleged to have violated the Mail or Telephone Order Merchandise Rule by failing to provide buyers with adequate notice of shipping delays or had continued to promise specific delivery dates when they were aware that they were unlikely to meet those deadlines.

13-2d FtC Control of performance Claims

Any claims of the ability or efficacy of a product must be supportable. If a sun- burn-relief product claims to “anesthetize nerves,” the advertiser must be able to prove that claim.

Where an advertising claim cannot be substantiated, the FTC has used corrective advertising as a remedy. Corrective advertising requires a seller to correct the unsubstantiated claims made in previous ads. The landmark case Warner-Lambert Co. v FTC (Case 13.2) involves an issue of corrective advertising.

Warner-Lambert Co. v FTC 562 F.2d 749 (D.C. Cir. 1977), cert. den. 435 U.S. 950 (1978)

Does Listerine Prevent Colds?

Case 13.2

FaCtS

Listerine, a product of the Warner-Lambert Company (petitioner), has been on the market since 1879 and has been represented through advertising to be beneficial for colds, cold symptoms, and sore throats. After a 1972 complaint about Warner-Lambert advertising for Listerine, the FTC held four months of hearings on the ad issues and then ordered Warner-Lambert to do the following:

1. Cease and desist representing that Listerine will cure colds or sore throats, that it will prevent

colds or sore throats, or that users of Listerine will have fewer colds than nonusers.

2. Cease and desist representing that Listerine is a treatment for, or will lessen the severity of, colds or sore throats; that it will have any sig- nificant beneficial effect on the symptoms of sore throats or any beneficial effect on symp- toms of colds; or that the ability of Listerine to kill germs is of medical significance in the treatment of colds or sore throats or their symptoms.

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Chapter 13 Product Advertising and Liability 455

3. Cease and desist disseminating any adver- tisement for Listerine unless it is clearly and conspicuously disclosed in each advertisement, in this exact language, that “Contrary to prior advertising, Listerine will not help prevent colds or sore throats or lessen their severity.” This requirement extended only to the next 10 mil- lion Listerine would spend on advertising after the order.

Warner-Lambert appealed the order.

JUdICIal OpINION

WRIGHT, Circuit Judge The first issue on appeal is whether the Commission’s conclusion that Listerine is not beneficial for colds or sore throats is supported by the evidence.

First, the Commission found that the ingredients of Listerine are not present in sufficient quantities to have any therapeutic effect.

Second, the Commission found that in the pro- cess of gargling it is impossible for Listerine to reach critical areas of the body in medically significant concentration.

Third, the Commission found that even if signif- icant quantities of the active ingredients of Listerine were to reach critical sites where cold viruses enter and infect the body, they could not interfere with the activities of the virus because they could not penetrate the tissue cells.

. . . [T]he Commission found that the ability of Listerine to kill germs by millions on contact is of no medical significance in the treatment of colds or sore throats.

. . . [T]he Commission found that Listerine has no significant beneficial effect on the symptoms of sore throat. The Commission recognized that gar- gling with Listerine could provide temporary relief from a sore throat by removing accumulated debris irritating the throat. But this type of relief can also be obtained by gargling with salt water or even warm water.

Petitioner contends that even if its advertising claims in the past were false, the portion of the Commission’s order requiring “corrective advertis- ing” exceeds the Commission’s statutory power. The Commission’s position is that the affirmative disclo- sure that Listerine will not prevent colds or lessen their severity is absolutely necessary to give effect to the prospective cease and desist order; a hun- dred years of false cold claims have built up a large

reservoir of erroneous consumer belief that would persist, unless corrected, long after petitioner ceased making the claims.

If the Commission is to attain the objectives Con- gress envisioned, it cannot be required to confine its road block to the narrow lane the transgressor has traveled; it must be allowed effectively to close all roads to the prohibited goal, so that its order may not be bypassed with impunity.

We turn next to the specific disclosure required: “Contrary to prior advertising, Listerine will not help prevent colds or sore throats or lessen their severity.” Petitioner is ordered to include this statement in every future advertisement for Listerine for a defined peri- od. In printed advertisements it must be displayed in type size at least as large as that in which the principal portion of the text of the advertisement appears and it must be separated from the text so that it can be readily noticed. In television commercials the disclosure must be presented simultaneously in both audio and visual portions. During the audio portion of the disclosure in television and radio advertisements, no other sounds, including music, may occur.

These specifications are well calculated to assure that the disclosure will reach the public. It will neces- sarily attract the notice of readers, viewers and listeners and be plainly conveyed. Given these safeguards, we believe the preamble “Contrary to prior advertising” is not necessary. It can serve only two purposes: either to attract attention that a correction follows or to humiliate the advertiser. The Commission claims only the first purpose for it, and this we think is obviated by other terms of the order. The second purpose, if it were intended, might be called for in an egregious case of deliberate deception, but this is not one. While we do not decide whether petitioner proffered its cold claims in good faith or bad, the record compiled could support a finding of good faith. On these facts, the con- fessional preamble to the disclosure is not warranted.

Accordingly, the order, as modified, is affirmed.

CaSe QUeStIONS

1. What claims does the FTC question in the Lister- ine ads and why?

2. What proposals for corrective advertising are made in the order?

3. What happens to the preamble, “Contrary to prior advertising”?

4. What standard does the case establish for correc- tive ads once the FTC finds a company’s ads have deceived the public?

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456 part 3 Business Sales, Contracts, and Competition

The dietary supplement industry that brings us our ginseng, flax seed oil, and cod liv- er may not have used any ginseng, flax seeds, or cod’s livers in producing those supplements. Although there has been a federal law on the books since 1994 that regulates these supplements, there has been little enforcement. The law requires that the supplements have a label that lists the ingredients in the supplements and the amount contained in the tablets, capsules, or caplets. Studies by the Food and Drug Administration concluded that 70% of the supplement manufacturers did not follow the federal content and labeling law. The supplements often contained fillers such as powdered rice and ground-up weeds.

However, the state of New York, through its attorney general, began its

own investigation. The office of the AG there purchased 78 bottles of supple- ments from 12 Walmart, Target, Wal- greens, and GNC stores in the state. The results of the tests were that there was often no evidence of DNA content from any of the substances claimed to be in the supplements on the labels. For exam- ple, ginseng labels promised “vitality and overall well being” on the label, However, there was no ginseng DNA in the pills. Rather, the lab tests found powdered rice, wheat, pine, and houseplants. [Ana- had O’Connor, “Retailer Adds Stricter Testing of Dietary Pills,” New York Times, March 30, 2015, p. A1]

Explain what the state and federal agen- cies can do (i.e., their authority) based on the findings of false labels and ads.

Consider . . . 13.3

Ethical Issues

Neiman Marcus, DrJays.com, and Revolve were accused of false marketing because they advertised shoes, coats, and other clothing items as having “faux fur.” How- ever, it turns out that the “faux fur” on the items was actually rabbit, raccoon, and, in some cases, mink. Many consumers do not want to be seen wearing real fur, and if they thought they were buying faux fur because of these three retailers’ descriptions, then they were misled.

Neiman Marcus’s website misrepre- sented the fur content and failed to dis- close the animal name and fur country of origin for three products: a Burberry Out- erwear Jacket, a Stuart Weitzman Ballerina Flat shoe, and an Alice + Olivia Kyah Coat. Neiman Marcus also misrepresented the

fur content of the shoe in its catalog, at bergdorfgoodman.com, and in ads mailed to consumers.

DrJays.com featured The Snorkel Jack- et by Crown Holder on its website and described it as including a “faux fur-lined hood.” The NY Subway Bomber jacket fea- tured on the site included the following, “Detachable hood with faux fur lining.” The Snorkel Jacket did include a label on the jacket itself that described the coat as containing “real raccoon fur.” The site also included this description of a vest by Knoles: “faux fur lining.”

Explain what the FTC can do with regard to these ads. Is “faux fur” an express war- ranty? What are the ethical issues in mis- representing real fur as faux fur? ©

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13-2e FtC Control of Celebrity endorsements

During the 1980s, the FTC entered a new aspect of ad content control—namely, the use of celebrity endorsements for products. The regulation of what celebrities say in ads and their qualifications to make the claims remains a focus for the FTC. (See the following “For the Manager’s Desk.”)

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Chapter 13 Product Advertising and Liability 457

Re: Celebrity tweeting For the Manager’s Desk

When celebrities tweet on social media site Twitter, the public responds. Advertisers know that and are willing to pay—sometimes $10,000 per tweet—when celebrities endorse a product. For example, Kim Kardashian boost- ed Old Navy jeans sales with her tweet that the jeans “make your butt look scary good.” She also tweeted during her second preg- nancy that Diclegis, an anti-nausea drug, was relieving her morningsickness: OMG. Have you heard about this? As you guys know my #morningsickness has been pretty bad. I tried changing things about my lifestyle, like my diet, and nothing helped, so I talked to my doctor. He prescribed Diclegis. I felt a lot better and most importantly, it’s been studied and there was no increased risk to the baby. I’m so excited and happy with my results that I’m partnering with Duchesnay USA to raise awareness about treating morning sickness, be [sic] safe and sure to ask your doctor about the pill with the pregnant woman on it and find out more. (http://www.diclegis.com)

Terrell Owens tweeted to his 1 million followers that Comfort Inn was offering a great deal that included free sports tickets, and the chain enjoyed a nice boost in its reservations.

There are companies, such as Izea, Ad.ly, and twtMob, that pair products with celebrities in order to get those tweets out there. The success of this form of adver- tising and its increasing presence brought a new ruling from the FTC. The new ruling relates to a long-standing rule that resulted when former New York Jets quarterback, Joe Namath, endorsed panty hose for women. The purpose of the FTC rule is very simple— to prevent consumers from being deceived about the nature of the endorsement and the product. The rule consists of four parts, as summarized by the FTC:

To thine own self be true. The bedrock principle for celebrity endorsements— and any testimonial—is that they must reflect the honest opinion or experience of the endorser. If the ad suggests that

the celebrity is a satisfied customer, he or she actually must use the product.

Time will tell. You may use a celebrity’s endorsement only as long as you have good reason to believe the opinions in the ad continue to be the views of the celebrity. One way to satisfy your obli- gation is to check periodically that the celebrity’s opinions remain the same.

Don’t bury your head in the sand. A market- ing campaign isn’t the time for ostrich-like behavior. Even if a celebrity is given a script to read, he can’t ignore signs that claims made about the product are false or misleading. For example, suppose an advertiser says its roasting bag can cook chicken in 30 minutes. During the shoot, the celebrity hired to appear in the ad watches five unsuccessful attempts to get the product to work. Each time, the chick- en was raw after 30 minutes and needed a full hour to cook. However, in the com- mercial, the celebrity is shown placing a chicken in the bag, taking out a perfectly roasted chicken, and saying that if you want great chicken every time in only 30 minutes, this is the product you need. The celebrity could be liable for the deceptive statement about the product, and the advertiser could be liable for misrepresen- tations made through the endorsement.

Disclosures about connections. Financial ties between advertisers and celebrities must sometimes be disclosed. If a financial connection is obvious, disclosure is unnec- essary. For example, a tennis star who appears in ads for a line of polo shirts is the type of arrangement most people expect involves payment. However, now suppose she’s a guest on a morning talk show. When asked about her recent victories, she credits them to a laser vision correc- tion procedure at a clinic she names. She doesn’t disclose her contractual deal with the clinic that requires her to speak publicly about her surgery—that’s a problem.

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13-2f FtC Control of Bait and Switch

One of the better-known FTC ad regulations prohibits the use of bait and switch, a sales tactic in which a cheaper product than the one in stock is advertised to get customers into a store. The seller has no intention of selling the product and in some cases might not even have the product in stock, but the ad is used as “bait” to get the customers into the store and then present them with a “better,” more expensive product. Such ad tactics are considered deceptive and subject to FTC remedy.

13-2g FtC Control of product Comparisons

Another aspect of active enforcement by the FTC is in the area of product com- parisons. The FTC permits and even welcomes comparisons of products, but such comparisons must be accurate. Results of surveys must be supportable, and prod- uct preference tests must be done fairly. In the past few years, the FTC has taken a laissez-faire approach in ad regulation. Other agencies, such as the offices of state attorneys general, the Better Business Bureau, and private companies and individ- uals, have undertaken public and private enforcement of deceptive ad claims.

The bulk of litigation over comparative ads is now conducted by and against competitors. The federal trademark law permits competitors to recover from com- panies for ads that include misrepresentations. Litigation over comparative ads is somewhat lucrative because plaintiffs can recover treble damages, the defendant company’s profits, and, in some cases, attorney fees. McNeil-PPC, Inc. v Pfizer Inc. (Case 13.3) involves a competitor’s litigation over misrepresentation.

Always review the language used in ads for products. Deter- mine whether express warranties are being made. Make sure that warranties, statements of fact, and promises of performance are accurate.

McNeil-PPC, Inc. v Pfizer Inc. 351 F. Supp. 2d 226 (S.D.N.Y. 2005)

Stringing Them Along on No Floss

Case 13.3

FaCtS

In June 2004, Pfizer Inc. (“Pfizer”) launched a consum- er advertising campaign for its mouthwash, Listerine Antiseptic Mouthrinse. Print ads and hangtags on the bottles in the stores featured an image of a Listerine bottle balanced on a scale against a white container of dental floss.

The campaign also featured a television commer- cial that announced, “Listerine’s as effective as floss at fighting plaque and gingivitis. Clinical studies prove it.” Although the commercial cautions that “[t]here’s no replacement for flossing,” the commercial repeats two more times the message that Listerine is “as effec- tive as flossing against plaque and gingivitis.” The commercial also shows a narrow stream of blue liquid flowing out of a Cool Mint Listerine bottle, then track- ing a piece of dental floss being pulled from a white floss container, and then swirling around and between teeth—bringing to mind an image of liquid floss.

McNeil-PPC, Inc. (“PPC”) (a division of Johnson & Johnson), the market leader in sales of string dental floss and other interdental cleaning products, brought suit alleging that Pfizer engaged in false advertis- ing and unfair competition in violation of § 43(a) of the Lanham Act, 15 U.S.C. § 1125(a). PPC contends that Pfizer’s advertisements are false and misleading because the ads implicitly claim that Listerine is a replacement for floss—that all the benefits of flossing may be obtained by rinsing with Listerine.

PPC filed a motion for an injunction to stop Pfizer from running the ads.

JUdICIal OpINION

CHIN, District Judge Traditionally, the “most widely recommended”

mechanical device for removing interproximal plaque (the deposits located in the hard-to-reach areas between the teeth) is dental floss. The ADA recommends

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Chapter 13 Product Advertising and Liability 459

“brushing twice a day and cleaning between the teeth with floss or interdental cleaners once each day to remove plaque from all tooth surfaces.” Flossing pro- vides a number of benefits. It removes food debris and plaque interdentally and it also removes plaque sub- gingivally. As part of a regular oral hygiene program, flossing helps reduce and prevent not only gingivitis but also periodontitis and caries.

Some 87% of consumers, however, floss either infrequently or not at all. Although dentists and dental hygienists regularly tell their patients to floss, many consumers do not floss or rarely floss because it is a difficult and time-consuming process.

As a consequence, a large consumer market exists to be tapped. If the 87% of consumers who never or rarely floss can be persuaded to floss more regularly, sales of floss would increase dramatically. PPC has endeavored, with products such as the RADF and the Power Flosser, to reach these consumers by trying to make flossing easier.

In the context of this case, therefore, Pfizer and PPC are competitors.

Pfizer sponsored two clinical studies involving Listerine and floss: the “Sharma Study” and the “Bauroth Study.” These studies purported to compare the efficacy of Listerine against dental floss in controlling plaque and gingivitis in subjects with mild to moderate gingivitis.

The authors of the Sharma Study concluded that the study provided “additional support for the use of the essential oil mouthrinse as an adjunct to mechan- ical oral hygiene regimens.” They cautioned that “[p] rofessional recommendations to floss daily should continue to be reinforced.”

The Bauroth Study authors concluded: “[W]e do not wish to suggest that the mouthrinse should be used instead of dental floss or any other interproximal cleaning device.”

The ADA reported on the Pfizer studies in its own website. The ADA wrote that “[w]hile some study results [referencing the Sharma and Bauroth Studies] indicate the use of a mouth rinse can be as effective as flossing for reducing plaque between the teeth,” it continued to recommend “brushing twice a day and cleaning between the teeth with floss or interdental cleaners once each day.”

A number of individual dentists and hygienists complained directly to Pfizer that consumers would get the wrong message.

From the time Pfizer launched its advertising cam- paign, sales of both the RADF and the Power Flosser have taken a steep decline. Consumers who use the RADF and Power Flosser . . . are predominantly “folks who don’t like to floss,” who “would love to have a replacement for

flossing.” These consumers “would be more susceptible to a message like the Listerine advertising campaign.”

To prevail on a Lanham Act false advertising claim, a plaintiff must demonstrate the falsity of the chal- lenged advertisement, by proving that it is either (1) literally false, as a factual matter; or (2) implicitly false, i.e., although literally true, still likely to mislead or confuse consumers. The false or misleading statement must be material.

The two studies included in their samples included only individuals with mild to moderate gingivitis. They excluded individuals with severe gingivitis or with any degree of periodontitis, and they did not purport to draw any conclusions with respect to these individuals. Hence, the literal claim in Pfizer’s advertisements is overly broad, for the studies did not purport to prove that Listerine is as effective as floss “against plaque and gingivitis,” but only against plaque and gingivitis in individuals with mild to mod- erate gingivitis. Consequently, consumers who suffer from severe gingivitis or periodontitis (including mild periodontitis) may be misled by the ads into believing that Listerine is just as effective as floss in helping them fight plaque and gingivitis, when the studies simply do not stand for that proposition.

Pfizer and its experts argue that the two studies are reliable, notwithstanding the indications that the participants in the flossing group did not floss properly, because these conditions reflect “real-world settings.” But the ads do not say that “in the real world,” where most people floss rarely or not at all, and even those who do floss have difficulty flossing properly, Listerine is “as effective as floss.” Rather, the ads make the blanket assertion that Listerine works just as well as floss, an assertion the two studies simply do not prove. Although it is important to determine how a product works in the real world, it is probably more important to first deter- mine how a product will work when it is used properly.

I find that Pfizer’s false and misleading advertising also poses a public health risk, as the advertisements present a danger of undermining the efforts of dental professionals—and the ADA—to convince consumers to floss on a daily basis.

Injunction granted.

CaSe QUeStIONS

1. What are the limitations of the studies on which Pfizer relied?

2. Why are mouthwash and floss competitors?

3. Evaluate Pfizer’s use of the studies, the ads, and comment on the company’s social responsibility posture. Comment on its competitive strategies.

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460 part 3 Business Sales, Contracts, and Competition

13-2h FtC Remedies

As noted in the previous sections, the FTC has a wide range of remedies available in the event of deceptive advertising, including corrective ads, injunctions to pre- vent deceptive ads from being run, and reimbursement by companies and endors- ers for purchasers who were misled by ads.

More often than not, these remedies come about through a consent decree. A consent decree is a negotiated settlement between the FTC and the advertiser. It is the equivalent of a nolo contendere, or no contest plea. The FTC and the adver- tiser, endorser, and/or agency or website designer agree to remedies, and the case is disposed of through the decree without further action.

The FTC has focused increasingly on companies that, like Pfizer in Case 13.3, are making health claims about their products. For example, Kellogg’s agreed twice in one year to change the packaging of its cereals that made health claims. It agreed to change its boxes for Frosted Mini-Wheats, which claimed to “increase your child’s attentiveness by 20%,” and also agreed to change its Rice Krispies packaging, which claimed, “Now helps support your child’s immunity.”

13-2i ad Regulation by the Fda and Other Federal agencies

Additional federal agencies have become involved in the regulation of product advertising, basing their involvement on health concerns. The Food and Drug Administration (FDA) also has authority over some forms of advertising. Several investigations are pending into energy drinks to determine whether the companies are adequately disclosing the amount of caffeine in their drinks. The investigation focuses on the fact that other ingredients in the drinks such as black tea extract and guarana are disclosed, but labels may not reflect the additional caffeine that those ingredients contain, caffeine levels that are not then disclosed in the drinks’ labels.

The FDA has already issued a warning about combining these energy drinks with alcohol consumption because of several resulting deaths. In addition, the Department of Health and Human Services (HHS) has issued a report warning about the negative health effects of excessive caffeine consumption. There will be regulations on product labels, advertising, and warnings related to these products.

13-2j professional ads

Most states have limitations on the types of ads professionals (such as doctors, law- yers, dentists, and accountants) can use in reaching the public. At one time, states had complete bans on ads by professionals. However, the U.S. Supreme Court held such bans to be too restrictive and violative of First Amendment protections on commercial speech (see Chapter 5). Restrictions may include requirements on fee disclosures or caveats on distinctions in individual cases and needs. The extent and validity of the restrictions continue to be refined through judicial application of First Amendment rights.

13-3 Contract Product Liability Theories: Implied Warranties

The UCC’s Article 2 governs contracts for the sale of goods and includes several provisions for implied warranties. The following sections cover the requirements for each of the implied warranties.

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13-3a the Implied Warranty of Merchantability

The implied warranty of merchantability (UCC § 2-314) is given in every sale of goods by a merchant seller. The warranty is not given by all sellers, only by mer- chant sellers. Briefly defined, merchants are those sellers who are engaged in the business of selling the good(s) that are the subject of the contract. The revisions to the UCC changed the wording of this warranty slightly so that it now provides that goods sold by a merchant “(c) are fit for the ordinary purposes for which goods of that description are used.” The warranty means the goods are of fair or average quality and are fit for ordinary purposes. Under this warranty, basketballs must bounce, book bindings must hold together, and food items must be free of foreign objects. Rothbaum v Samsung Telecommunications America (Case 13.3) deals with an issue of merchantability in cell phones and provides an answer for the chapter’s opening “Consider . . .”

Rothbaum v Samsung Telecommunications America LLC 52 F. Supp. 3d 185 (D.Mass. 2014)

Cell-Phones: Are They Really There?

Case 13.4

FaCtS

Amy Rothbaum (plaintiff) and others brought suit against Samsung Telecommunications (defendant) because they alleged that Samsung knowingly sold its 4G phones with a design defect that causes the phones to shut down randomly (the Random Shut Down Defect). Rothbaum had purchased a Samsung Capti- vate phone from an AT&T Store in Holyoke, Massa- chusetts. “Within months” of her purchase, the phone “began shutting down randomly.” The phone first shut down randomly in mid-December, 2010. During a three-week period in December 2010, her phone shut down at least three times.

Rothbaum went to an AT&T service center in late December 2010 to complain about this problem. The representative performed a factory reset and gave her a phone number to call in case the problems persisted.

Rothbaum’s phone again shut down while “it was powered on and was in sleep mode.” Rothbaum then called AT&T, which sent her a replacement battery, which she received in mid-January. Even after she replaced the battery, the phone “continued to shut down.”

Rothbaum then went to the AT&T store where she had purchased the phone and reported that her prob- lems were persisting. An AT&T representative gave her the Replacement Phone which was same model.

“Within a day or two,” the Replacement Phone shut down randomly while in sleep mode. Rothbaum continued to use the phone for about 18 months, from March 2011 to September 2012, when she gave the Replacement Phone to her attorneys for testing in con- nection with this case.

After negotiating with Rothbaum for the oppor- tunity to test the Replacement Phone, Samsung had it inspected by one of its senior engineers in Korea. Through a variety of tests, the phone did not randomly shut down, either in sleep mode or during active use. The engineer concluded that the phone did not suffer from any shutdown defect and stated that Rothbaum’s reported problems might be attributable to apps she had installed, such as Words with Friends.

In a technical service memo to AT&T, Samsung stated that “[a] small percentage of SGH–I897 hand- sets [the “Captivate” model of Samsung Phone] may exhibit a condition where the handset will power off after going to sleep mode.” The bulletin explained that this problem occurred only in phones within a certain range of IMEI numbers. The service bulletin also explained that phone servicers should remove and replace certain capacitors to remedy the problem.

Overall, Samsung’s internal documents indicate that less than 5% of Samsung Phones produced before November 2010 were returned for any power-related reason and that less than 1.25% of phones produced

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462 part 3 Business Sales, Contracts, and Competition

after the November 2010 remedy were returned for any power-related reason.

Rothbaum alleges that Samsung breached its implied warranty of merchantability on the phone. Samsung moved for summary judgment.

JUdICIal OpINION

WOLF, District Judge Evidently because of the increasing proliferation of smartphones, there is a growing body of cases concerning the application of the implied warranty of merchantability to such devices. As these cases indicate, the problem with Rothbaum’s Replacement Phone caused her an inconvenience, but was not a flaw so great as to deprive her of the phone’s “opera- tive essentials.”

Generally, courts have found that when a plain- tiff has only a minor problem with his or her phone, such an inconvenience is insufficient to prove a breach of the implied warranty of merchantability. For example, in In re Google Phone Litigation, No. 10-CV-01177-EJD, 2012 WL 3155571 (N.D.Cal. Aug. 2, 2012), the plaintiffs alleged that their smartphones’ data connections were inconsistent, leading to dif- ficulty receiving or placing calls. The district court rejected this as a basis for a breach of the implied warranty, explaining that “[p]laintiffs’ allegations that the phone drops or misses calls are insufficient to demonstrate that this alleged defect is more than inconvenience or that the Plaintiffs cannot re-initiate these calls such that the phone is unfit for its ordi- nary purpose.”

Rothbaum claims that Samsung breached the implied warranty of merchantability under Massa- chusetts law by providing a defective phone. In the instant case, the admissible evidence in the record would permit a reasonable factfinder to conclude only that a small percentage of the Samsung Phones

had a random shutdown problem. The evidence, viewed in the light most favorable to Rothbaum, is only sufficient to prove that Samsung knew of a potential defect in some of the Samsung Phones. It is undisputed that, upon learning of the problem, Sam- sung changed the way it manufactured its phones to attempt to remedy the problem and continued to test its devices to determine the remedy’s efficacy. That change reduced the return rate for power-related problems from 5% to 1.25%. This, among other things, strongly indicates that only a small percentage of the Samsung Phones that included Rothbaum’s Replace- ment Phone experienced power related problems. Samsung was not required to disclose this potential problem to Rothbaum.

Here, the evidence in the record indicates that, in view of the undisputed fact that the November 2010 manufacturing change was largely successful, Sam- sung knew only that there was a low likelihood that the Replacement Phone might have a random shut- down problem. The record, therefore, is not sufficient to prove that Samsung had actual knowledge of a material defect in the Replacement Phone. Therefore, the admissible evidence is not sufficient to support a finding that the defendant was engaged in “conduct that would raise an eyebrow of someone inured to the rough and tumble of the world of commerce.” Accordingly, the court is allowing the defendant’s motion for summary judgment on this theory of liability.

CaSe QUeStIONS

1. What does a plaintiff need to establish in order to prove a breach of warranty of merchantability on a smart phone?

2. Does Samsung’s knowledge of the problem result in a breach of warranty?

the Food and drink Merchantability Cases One of the situations in which the warranty of merchantability applies is in the purchase of food, whether in grocery stores or restaurants. For example, in Metty v Shurfine Central Corp., 736 S.W.2d 527 (Mo. 1987), the court found that a breach of the implied warranty of merchantability occurred because part of a grasshopper in a can of green beans was eaten by a pregnant woman who purchased the beans. Shurfine was liable to the woman for resulting compli- cations in her pregnancy. But what happens if there is something naturally present, such as a cherry pit in a cherry pie, that harms someone? Is there still a breach of warranty? Estate of Pinkham v Cargill, Inc. (Case 13.5) deals with an issue of “foreign-natural” and “reasonable expectations” tests in foreign food objects.

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Chapter 13 Product Advertising and Liability 463

Estate of Pinkham v Cargill, Inc. 55 A.3d 1 (Me. 2012)

A Turkey of a Sandwich

Case 13.5

FaCtS

Stanley Pinkham ate a hot turkey sandwich during his break as a line cook at Dysart’s Truck Stop and Restau- rant. Cargill, Inc. manufactured the boneless turkey product in Pinkham’s sandwich, and the kitchen staff at Dysart’s occasionally found pieces of bone in that turkey product. In the middle of eating the sandwich, Mr. Pinkham experienced severe and sudden pain in his upper abdominal area and thought that he might be suffering from a heart attack. He was taken by ambulance to the hospital, where a doctor concluded that Mr. Pinkham’s “esophageal tear or perforation” was caused by bones that were later removed from his esophagus. Mr. Pinkham brought suit against Cargill and Poultry Products of Maine for selling defective and unreasonably dangerous goods. The lower court granted summary judgment for Cargill, and the estate appealed.

JUdICIal OpINION

JABAR, Justice Currently, there are two tests that courts apply when faced with a defective food product claim. The tradi- tional test is called the “foreign-natural” doctrine.

“The ‘foreign-natural’ doctrine provides there is no liability if the food product is natural to the ingredients; whereas, liability exists if the substance is foreign to the ingredients, and the manufacturer can be held liable for injuries.” Newton v Standard Candy Co., 2008 WL 752599 (D.Neb. 2008). “The reasonable expectation test provides that, regardless whether a substance in a food product is natural to an ingredient thereof, liability will lie for injuries caused by the substance where the consumer of the product would not reasonably have expected to find the substance in the product.”

[W]e adopt the “reasonable expectation” test in Maine. We conclude that the Legislature intended to align itself with the Restatement’s objectives, and therefore the Legislature intended the “reasonable expectation” test to be used in applying the language of [the Restatement].

With the proper test for evaluating the Estate’s strict liability claim established, we can now turn our atten- tion to whether the Estate presented enough evidence

to create a genuine issue of material fact, and therefore survive summary judgment and proceed to trial.

The Estate presented evidence that creates a gen- uine issue of material fact as to whether the turkey product caused Pinkham’s injury. Dr. Stern testified that he believed that the injury was a “perforation secondary to a foreign body.” The record demonstrates that the “foreign body” was either a small piece of bone or cartilage, or a larger piece of bone. There is direct evidence of the presence of the smaller pieces of bone or cartilage: Stern actually saw them. There is no direct evidence of a larger piece of bone, but the summary judgment record does contain indirect evidence that a larger piece of bone could have been present in the turkey product Pinkham consumed, but may have passed, undetected, from Pinkham’s throat. The indi- rect evidence is found in the deposition of a Dysart’s employee, who testified that larger pieces of bone had regularly been discovered in Cargill’s “boneless” tur- key product in the past, and in the expert deposition testimony of John F. Erkkinen, M.D., who acknowl- edged that a larger bone piece could have passed through Pinkham’s esophagus and into his stomach.

Whether a consumer would reasonably expect to find a particular item in a food product is normally a question of fact that is left to a jury. The Superior Court noted this, but nonetheless decided that a food bolus containing one-to-two-millimeter bone fragments is not defective as a matter of law. In making this determination, the court erred. The question of whether a consumer would rea- sonably expect to find a turkey bone or a bone fragment large and/or sharp enough to cause an esophageal perfo- ration in a “boneless” turkey product is one best left to the fact-finder. At trial, the jury will have an opportunity to determine whether a foreign body in the turkey product caused Pinkham’s injury, what the foreign body was, and whether Cargill is liable as a result.

Reversed.

CaSe QUeStIONS

1. Explain the differences between the foreign-natu- ral test and the reasonable expectations test.

2. Describe what this court sees as the issues the jury must determine.

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464 part 3 Business Sales, Contracts, and Competition

13-3b the Implied Warranty of Fitness for a particular purpose

The implied warranty of fitness for a particular purpose (UCC § 2-315) arises when the seller promises a buyer that the goods will be suitable for a use the buyer has proposed. For example, the owner of a nursery makes an implied warranty for a particular purpose when telling a buyer that a weed killer will work in the buyer’s rose garden without harming the roses. An exercise enthusiast is given this warranty when the seller recommends a particular shoe as appropriate for aerobics.

The requirements for this warranty are the following:

1. The seller has skill or judgment in use of the goods. 2. The buyer is relying on that skill or judgment. 3. The seller knew or had reason to know of the buyer’s reliance. 4. The seller makes a recommendation for the buyer’s use and purpose.

For example, if you went to a pet store and asked for two male hamsters and one cage, the salesperson who picks out the two hamsters for you is making an implied warranty of fitness for a particular purpose: that the hamsters can cohab- itate without reproducing. Should your hamsters reproduce, the pet store would be responsible for whatever damage you experience, including taking the baby hamsters from the misidentified hamster couple.

13-3c eliminating Warranty liability by disclaimers

Warranties can be eliminated by the use of disclaimers. The proper method for disclaiming a warranty depends on the type of warranty. Express warranties, however, cannot be given and then taken back. Basically, an express warranty can- not be disclaimed. Exhibit 13.2 includes a summary of the means for disclaiming warranties.

John Manley ate at one Wendy’s restaurant during the months of February and March 2007. He ate at no other Wendy’s restau- rants but did eat at other fast-food restau- rants during this period. He always had the same thing: a double-patty hamburger, garnished with cheese, tomatoes, pickles, onions, bacon, mayonnaise, and ketchup; a side of French fries or onion rings; and a soft drink. Mr. Manley always paid in cash and had no receipts from his visits to the Wen- dy’s. When his health began to suffer with

fatigue, coughing, and choking, Mr. Manley sought medical treatment, and tests uncov- ered a piece of plastic from an eating uten- sil that had lodged in his lungs. The utensil fragment that was removed from his lungs was embossed with a portion of the Wen- dy’s logo. Mr. Manley brought suit against Wendy’s for breach of the implied warranty of merchantability.

Discuss the issues you see in this claim. [Manley v Doe, 849 F. Supp. 2d 594 (E.D.N.C. 2012)]

Consider . . . 13.4

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Chapter 13 Product Advertising and Liability 465

The implied warranty of merchantability and the implied warranty of fitness for a particular purpose can be disclaimed by using a phrase such as “WITH ALL FAULTS” or “AS IS.” Either warranty alone can be disclaimed by using the name of the war- ranty: “There is no warranty of merchantability given” or “There is no implied warranty of fitness for a particular purpose.” For those warranty disclaimers required to be in writing, their pres- ence in a record satisfies the writing requirements (see Chapters 11 and 12 for more information).

Even though the UCC is clear on the language to be used for warranty disclaimers and the process seems to be easy, the warranty disclaimers are still subject to the general UCC con- straint of good faith. Unconscionable disclaimers of warran- ties or waiver of warranties when one party has no bargaining power may not be valid. For example, a disclaimer of liability for personal injury resulting from a breach of the warranty of merchantability for a consumer good would be unconsciona- ble. Exhibit 13.2 summarizes the UCC warranty protections and disclaimers.

To disclaim a warranty, follow these guidelines:

1. Use LARGE type.

2. Use a different color for the disclaimer text.

3. Place the disclaimer on the front of the contract.

4. Use proper statutory language.

5. Have buyers initial the disclaimer.

6. On electronic records, get verification of receipt of e-mail or fax with disclaimer.

tYpe CReatION ReStRICtION dISClaIMeR Express Affirmation of fact or promise

of performance (samples, models, descriptions)

Must be part of the basis of the bargain

Cannot make a disclaimer inconsistent with an express

Implied Warranty of Merchantability

Given in every sale of goods by a merchant (“fit for ordinary purposes”)

Only given by merchants (1) Must use disclaimer of quality or use “merchantability” or general disclaimer “as is” or “with all faults”

(2) If written—(record) must be conspicuous

Implied Warranty of Fitness for a Particular Purpose

Seller knows of buyer’s reliance for a particular use (buyer is ignorant)

Seller must have knowledge— buyer must rely

(1) Must be in writing (record)

(2) Must be conspicuous

(3) Must be clear there are no warranties (using specific language) or

(4) Also disclaimed with “as is” or “with all faults”

Title Given in every sale Does not apply in circumstances where apparent warranty is not given

Must state “There is no warranty of title”

Exhibit 13.2 UCC Warranties: Creation, Restrictions, and disclaimers

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466 part 3 Business Sales, Contracts, and Competition

13-3d privity Standards for UCC Recovery

If you have a contract to buy a car and the seller breaches the contract by refusing to deliver, you can bring suit for breach of contract based on the privity between you and the seller. The people in your carpool, however, could not recover from the seller for breach because you no longer have a car to use (even though they are affected). They have no privity of contract with the seller. Traditionally, a recov- ery for a breach of contract requires privity of contract. A breach of warranty is a breach of contract, and until the time of the UCC, privity was required to be able to recover on a breach of warranty theory.

Section 2-318 of the UCC establishes three alternatives that states can adopt, each of which provides warranty protections for more persons than the buyer. For example, Alternative A extends warranty protection to “any natural person who is in the family or household . . . of the remote purchaser or who is a guest in the home [of the remote purchaser].” Alternative B extends coverage to “any natural person who is reasonably expected to use, consume, or be affected by the goods” or who is “injured in person” by the goods. Alternative C extends the warranty protection to “any person that may be reasonably expected to use, consume, or be affected by the goods” and is injured by them or their use. Alternative C also prohibits the dis- claimer of liability for personal injury to those covered by the warranty.

Janet Rosenstern suffered from temporo- mandibular joint syndrome (TMJ), a disorder of the jaw. Allergan is the manufacturer of Botulinum Type A, aka Botox. The FDA has approved Botox for injection to paralyze muscles, but there is a risk in its use in that Botox can migrate outside the muscles with resulting side effects of botulism and auto- immune reactions, including brain damage.

Allergan trained its sales representa- tives to refer to Botox as a “well-tolerated,” “safe,” and “effective” means for treating TMJ. Allergan created and funded several organizations to distribute electronic and printed promotional materials to educate

doctors about this off-label use (a use for which there is no FDA approval) for Botox.

Janet Rosenstern’s physicians recom- mended that she use Botox for her TMJ. She received Botox injections and suffered from autoimmune disorders that affected her brain and resulted in her death. Her husband, Klaus, filed suit for, among other things, breach of the implied warranty of fit- ness for a particular purpose. Allergan sought to have the claim dismissed because it did not make the recommendations directly to Janet. What should the court do with the case and why? [Rosenstern v Allergan, Inc., 987 F. Supp. 2d 795 (N.D. Ill. 2013)]

Consider . . . 13.5

13-4 Strict Tort Liability: Product Liability under Section 402A

The discussion to this point has focused on the statutory and contract theories of product liability. Liability for making false statements about products is addressed under UCC warranty provisions or under federal and state advertising and con- sumer protection statutes. But these theories are grounded in contract relationships and limited statutory authority. A broader focus to product liability is grounded in tort law. Section 402A provides a remedy for those who are harmed by defective products through either a theory of strict liability or one of negligence.

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Chapter 13 Product Advertising and Liability 467

The first tort theory for recovery for defective products is strict liability in tort. This tort was created and defined by Section 402A of the Restatement (Second) of Torts. Restatements of the law are developed by the American Law Institute (ALI), a group of professors and practicing attorneys. Restatements are not the law, even though they are adopted and recognized in many states as the controlling state- ment of law in that state. The adoption of a Restatement generally comes in the form of judicial acceptance of the doctrines provided.

Restatement § 402A: 402A. Special Liability of Seller of Product for Physical Harm to User or Consumer

(1) One who sells any product in a defective condition unreasonably dangerous to the user or consumer or to his property is subject to liability for physical harm thereby caused to the ultimate user or consumer, or to his property if

(a) the seller is engaged in the business of selling such a product, and

(b) it is expected to and does reach the user or consumer without substantial change in the condition in which it is sold.

(2) The rule stated in Subsection (1) applies although

(a) the seller has exercised all possible care in the preparation and sale of his product, and

(b) the user or consumer has not bought the product from or entered into any contractual relations with the seller.2

Part 2 of 402A spells out the distinction between negligence and strict tort liability. Liability results for physical harm even when sellers have exercised all possible care in developing, producing, and selling the product. The fact that the seller is in the business of making and/or selling the product and someone is injured results in the liability. No negligent error or omission is required as an element of proof for recovery. Section 402A applies to defective conditions regardless of the precautions taken by the manufacturer. Manufacturers or food processors that take great precautions in their procedures could overcome a charge of negligence; however, strict liability focuses on the fact that a defect exists, not whether the manufacturer could or could not have prevented the problem. The Restatement (Third) of Product Liability has been proposed and would clarify the definition of defective with regard to knowledge requirements and recovery.

Section 402A has no privity requirements and is not subject to the disclaimers that can eliminate warranty liability. The following sections cover the 402A requirements.

13-4a the Requirement of Unreasonably dangerous defective Condition

The requirement of proof of an unreasonable defective condition can be produced in many different ways. Unreasonable defects can come from everything from the materials used to the manufacturing processes. Every product liability suit finds a different type of defect. A product can be unrea- sonably dangerous because it contains a foreign substance. Most product liability cases relating to food are based on this tenet. Rats in pop bottles, moldy bananas in cereal, parts of a snake in frozen vegetables, and stones in soup are all factual circumstances that have been recognized as Section 402A defective conditions.

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468 part 3 Business Sales, Contracts, and Competition

The most common types of product liability cases are based on the following types of defects:

1. Design defects 2. Dangers of use due to lack of warnings or unclear use instructions 3. Errors in manufacturing, handling, or packaging of the product

design defects A product with a faulty design exposes its users to unnecessary risks. Products must be designed with all foreseeable uses in mind. Cars must be designed in view of the probability of accidents. A design that creates an otherwise unnecessary explosion upon a rear-end collision is a faulty design. A car that suddenly accelerates because of a flaw in the auto’s computer system or accelerator has a design defect.

To make the best possible case in the event of a product liability suit, it is help- ful for the manufacturer to have complied with all federal and state regulations on the product. It is also helpful if the manufacturer has used the latest technol- ogy and designs available within the industry and has met industry standards in designing its product.

Improper Warnings and Instructions Manufacturers have a duty to warn buyers of a foreseeably dangerous use of a product that the buyers are not likely to realize is dangerous. They also have a duty to supplement the warnings. For example, as defects are discovered in autos, the manufacturers send recall notices to buyers. Similarly, manufacturers of air- planes have sent warnings on problems and proper repair procedures to airlines throughout the life of a particular plane design’s use.

Manufacturers must also give adequate instructions to buyers on the proper use of the product. Over-the-counter drugs carry instructions about proper dos- ages and the limitations on dosages. The quotes in the chapter opening give an indication of the levels of warnings required on products. Smith v Coleman Co. (Case 13.6) involves an issue of whether a warning was required and involves an integrated discussion of the various types of warranties in the sale of products.

Ethical Issues

In early 2010, Toyota issued a recall for over 8,000,000 vehicles because there were increasing complaints about a sud- den unintended acceleration (SUA) issue. There had been 24,000 consumer com- plaints about the SUA issue to dealers, to the Consumer Product Safety Com- mission, and via lawsuits filed against the company between 2001 through 2009. Initially, Toyota responded by claiming that the acceleration was caused by faulty floor mats and/or driver error. Causes then shifted to worn pedals, overheated pedals, condensation, and even software

issues. However, the full recall was not made until January 2010 following increas- ingly vocal Toyota owner complaints and a series of fatal accidents.

Discuss the possible product liability theories that would apply. If the floor mats were getting in the way of the brake pedal or pressing on the accelera- tor, would Toyota have liability? Evaluate the ethics of Toyota in holding off on the recalls. What if drivers made a mistake or were just confused and stepped on the wrong pedal? Is there product liability then? ©

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Chapter 13 Product Advertising and Liability 469

Smith v Coleman Co. 71 UCC Rep.Serv.2d 131 (M.D. Ala. 2010)

“Towing” the Line with an Eye on Warnings

Case 13.6

FaCtS

Ginger Smith (plaintiff) was a passenger on Ronald Smith’s boat on West Point Lake, Alabama. Ronald Smith (no relation to Ginger) was operating the boat, which was towing Ms. Smith’s son, Shane McClellan, on an inflatable inner tube behind the boat. Shane McClellan weighed 150 pounds at the time and the tube itself weighed 10 pounds. The inner tube was tied to the boat by a 50-foot Model 51650 polypropylene line that was manufactured by Lehigh Consumer Products, LLC, but carried the label of The Coleman Company (defendants) pursuant to a licensing arrangement, and was purchased at a nearby Walmart store. While Shane McClellan was being towed on the inner tube, the line snapped, and the end connected to the boat flew back toward the boat and hit Ms. Smith in the eye, causing the loss of that eye.

The packaging of the line contained several state- ments. A paper insert identifies it as a “50 ft × 5/16 in UTILITY LINE.” Just below that appears the phrase “Ideal for use on boat or dock.” Still farther down the insert and in an all-caps font smaller than that used in the first statement appears, divided over two lines, “175 LBS WORKING LOAD LIMIT/STAYS AFLOAT.” A longer cautionary message appears at the bottom of the insert. It states:

Avoid using a knot, splicing is preferable. Knots reduce the strength of the rope up to 40%. Do not use this product where personal safety could be endangered. Never stand in line with a rope under tension. Such a rope, particularly nylon rope, may recoil (snap back). Misuse can result in serious injury or death.

There was a warning label printed on the inner tube itself, a portion of which advised boaters to “[u]se a tow rope of at least 1500 lbs average tensile strength for pulling a single person. . . .” The overall size of this warning label is 8 × 9 inches, and its text complies with the warning label recommended by the Water Sports Industry Association for use on inflatable tubes.

Ms. Smith filed suit against Coleman, Walmart, and Ronald Smith. (Walmart and Smith were dismissed from the case). Coleman argued that its package

warned against using the line for towing and moved for summary judgment.

JUdICIal OpINION

WATKINS, District Judge A manufacturer has a duty “to warn users of the dangerous propensities of a product only when such products are dangerous when put to their intended use.” “[A] manufacturer is under no duty to warn a user of every danger which may exist during the use of the product, especially when such danger is open and obvious.” “. . . the warning need only be one that is reasonable under the circumstances and it need not be the best possible warning.”

It is a defense to a negligent failure to warn claim that there is no evidence “that the allegedly inadequate warning would have been read and heeded and would have kept the accident from occurring.” In this case, Defendants point to the deposition testimony of Ron- ald Smith, who purchased the line and attached it to the boat and inner tube. Mr. Smith’s testimony was that he did not recall reading “any other part of the warn- ings on the package other than the poundage.” He specifically answered a question in the negative about whether he had read the warning against tying knots in the line. According to Defendants, Mr. Smith’s use of the line violated three parts of the warnings given on the package insert, which he confessed having not read: (1) the warning against tying knots in the line; (2) the warning against using the line where personal safe- ty could be endangered; and (3) the warning against standing in line “with a rope under tension.”

The court pauses to contemplate an issue not dis- cussed by either party, but which seems so fundamen- tal to the cause of action asserted by Ms. Smith that it is difficult to adequately address the failure-to-warn claim without touching on it. That issue is how a neg- ligent failure-to-warn claim is affected by the plaintiff not having been the purchaser, or even the “user,” of the item at issue. Both parties proceed as if the relevant inquiry is whether Mr. Smith, or perhaps either Mr. or Ms. Smith, read and followed the warnings on the package. It is undisputed that Mr. Smith purchased the rope and is the person who tied it to the boat and

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470 part 3 Business Sales, Contracts, and Competition

inner tube. Given the disposable nature of the package on which the warnings appeared, it is unclear wheth- er Ms. Smith even had the opportunity to read the warnings—and so, in the summary judgment posture, this court must assume that she did not, if that factual question is relevant to the outcome.

Conceding that Mr. Smith did not recall reading the relevant warnings, Plaintiff’s argument seems to be that the phrase “warning” has a particular, technical meaning, such that the statements on the package here were not “warnings” for the purposes of the Alabama case law. The contours of this view are not very well fleshed out, but the argument is perhaps that because the statements on the packaging did not actually contain the word “WARNING,” with accompanying symbols such as an exclamation mark within a trian- gle, they were not actually warnings at all, but merely “safety information.”

The only basis for this distinction is a statement made by one of Defendants’ experts that “warnings can change behavior, but it is difficult to change behavior with safety information.” Perhaps there is a technical distinction, recognized by experts in product labeling or in regulations, between the two concepts, and per- haps, under that distinction, the package insert here is “safety information” rather than a “warning,” although it is far from clear from the deposition excerpts before the court that this is what the expert meant. Regard- less, the argument misses the point that the court must apply the word “warning” as it has been used in the Alabama case law, which governs this diversity case. The cases cited give no indication of limiting the word “warning” to a narrow, technical meaning. Certainly, the common use of the word “warning” does not limit the concept to statements appearing under the word “WARNING,” accompanied by particular symbols, or colored in bright orange. The statements appearing on the utility line’s package are cautionary in nature, designed to warn, in the ordinary sense of the term, users of the product about potential dangers of usage.

Thus, the court concludes that the statements on the package were warnings for purposes of Alabama law. As stated above, it is conceded that Mr. Smith did not read the warnings, except for the weight limitation. The only remaining question is whether failure to heed the warnings caused the accident. The court is reluctant to conclude that the warning against uses “where per- sonal safety could be endangered” can suffice for this purpose; it is so vague as to be essentially meaningless. Any use, no matter how seemingly safe or appropriate, that actually resulted in injury could be said after the fact to have endangered personal safety. The other two warnings, however, are quite specific, and both were violated by Mr. Smith. Mr. Smith tied knots in the rope

in order to attach it to the boat and the inner tube. Both Mr. Smith and Plaintiff were on board the open boat towing the inner tube behind it; in the ordinary use of language, they were both standing “in line with a rope under tension.”

Indeed, it is difficult to conceive how the rope could ever be used for towing someone behind an open boat without both the person being towed and persons on board the boat violating the warning against stand- ing in line with a rope under tension. While Plaintiff’s expert prevaricates somewhat over whether Plaintiff was herself “in line” with the rope at the time it broke, heeding this warning still would have prevented the accident altogether, as there would have been no way to tow Plaintiff’s son on the inner tube without putting him in line with the rope under tension.

Finally, the court does not base its ruling on Defen- dants’ argument that towing a 150-pound child (plus a five to ten pound inner tube) would have produced a dynamic load far in excess of the 175-pound limitation on the rope, so Plaintiff’s argument that there was no way for Mr. Smith or Plaintiff to be aware of the differ- ence between static and dynamic loads is irrelevant. The court also does not base its decision on arguments concerning the warning label on the inner tube itself. Because there is no evidence that the allegedly inad- equate warning was read and heeded, or that, if it had been read and heeded, the accident would have occurred anyway, the motion for summary judgment on the negligent-failure-to-warn claim is due to be granted.

With respect to the express warranty claim, Plain- tiff’s claim is that the statement that the line was “ideal for use on boat or dock” constitutes an express war- ranty. Statements “that are mere sales talk or ‘puffery’ do not give rise to express warranties,” while “repre- sentations of fact” may give rise to such warranties. While the word “ideal” seems closer to the description of an item as “in good shape” that Alabama courts have found to constitute “puffery,” Scoggin v Listerhill Employees Credit Union, 658 So.2d 376, 377 (Ala.1995), arguably the reference to use on a boat or dock could constitute a more specific assurance in some circum- stances. Regardless, the phrase “ideal for use on boat or dock” is not the equivalent of “ideal for towing behind a boat,” especially when, as explained in the previous section, the specific warnings on the package make it essentially impossible to use the utility line for towing in compliance with the packaging. There is no evidence that any express warranty was breached, and summary judgment is due to be granted on this claim.

To the extent that Plaintiff makes a claim for breach of an implied warranty of merchantability, she does

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Chapter 13 Product Advertising and Liability 471

errors in Manufacturing, Handling, or packaging This breach of duty is the most difficult form of negligence to prove. The large num- ber of handlers in the process of manufacturing and packaging a product typically makes it difficult to prove when and how the manufacturer was negligent. One of the issues in drug manufacturing cases is whether the packaging for the materi- als is sufficient. Does it protect against tampering? Is it childproof? These types of dangers are foreseeable and require special duties with regard to packaging drugs.

not explain how that claim fits the requirements of the statute, and the claim fails for essentially the same rea- son as the express warranty claim. A use excluded by warning labels cannot be an “ordinary purpose [ ] for which such goods are used.”

The final warranty claim is for breach of an implied warranty of fitness for a particular purpose. Plaintiff has done no more than assert that Defendants had “reason to know” that the line would be used to tow persons behind a boat; regardless, Plaintiff clearly did not “rely on the seller’s skill or judgment to select or furnish suitable goods.” Rather, Mr. Smith selected and purchased the utility line for himself at a Wal-Mart store. Summary judgment is due to be granted on the warranty claims.

The court need not reach Defendants’ argument that Coleman is entitled to summary judgment because its only role in producing the utility line was to license its name to Lehigh.

Summary judgment for Defendants.

CaSe QUeStIONS

1. What is the law with regard to product users who do not read package warnings?

2. What point does the court make about Ms. Smith not actually being the purchaser of the line?

3. What lessons should Coleman take from its expe- rience of being a defendant along with its licensee for the line?

Classify the following as design, manufac- ture, or warning defects:

• Failure to disclose changes in fuel and operations for a helicopter in hot weather and higher altitudes

• A polio vaccine that produces not im- munity but polio in a child

• Teflon-induced autoimmune system disease caused by Teflon used in the man- ufacture of an implanted TMJ jaw device

• Diamond represented as a grade VVS that is actually a lower grade

• Infant swing that causes infants to fall out backward if they fall asleep and their weight shifts

• Tobacco that causes lung cancer

• Fondue pot tipping over and burning a two-year-old child

• Bleeding of pizza-box ink onto pizza

Consider . . . 13.6

13-4b Reaching the Buyer in the Same Condition

The requirement that a product reach the buyer without “substantial change” is a protection for the seller. A seller will not be liable for a product that has been modi- fied or changed. The reason for this requirement is that once a product is modified or changed, it becomes unclear whether the original product or the modifications caused the unreasonably dangerous condition. Volkswagen would not be held liable for a dune buggy accident just because the builder and owner of the dune buggy happened to use a Volkswagen engine in building the vehicle. Because Volkswagen’s product has been taken apart and modified, its liability has ended.

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472 part 3 Business Sales, Contracts, and Competition

Business Strategy

Trinity Industries is the manufacturer of a product you see every day—the guardrails in the middle of highways, freeways, tollways, and byways around the country. However, Trinity will be paying $525 million to the U.S. Treasury and Joshua Harman, one of his competitors. The story of intrigue, whis- tle-blowing, and a small competitor finishing first began in 2005.

Trinity was the manufacturer of the ET-Plus guardrail system, the preferred sys- tem used by state and local governments in road construction. However, in 2005, Trinity made a change to its guardrail, a change that could cause the system to fail and result in portions of the guardrail piercing cars involved in accidents. The design change to the rails actually resulted in more and greater injuries to drivers and passengers and more vehicle damage. While the rails were designed to prevent crossovers and additional vehicle involvement in accidents, they were wreaking havoc on the roadways. The change did result in a $2 saving for every rail for Trinity.

Enter competitor Joshua Harman, who discovered that the design change was not disclosed to the Federal Highway Adminis- tration, a notification that is required in order to have the rails certified for highway use. Indeed, Trinity had conducted safety tests of the ET-Plus guardrails but never shared those test results with the federal government. The five tests concluded that the ET-5 Plus failed the tests. The federal government does not build the highways (state and local govern- ments do), but these government agencies are not eligible for federal funds if they do not build roads in compliance with federal stan- dards and requirements. And if a company receives federal funds or reimbursement and has not complied with standards or has pro- vided false information, it is liable to the fed- eral government under the False Claims Act.

Mr. Harman reported the change to the federal government as a whistle-blower in 2012. He also filed suit under the False Claims Act, a suit that the federal government was eligible to join but did not. [U.S. ex rel. Har- man v Trinity Industries, Inc., 2014 WL 47258 (E.D. Tex. 2014)] In addition, after Mr. Harman reported that there had been no disclosure of

the design change, Trinity still did not disclose the information about the five failed tests.3

On October 21, 2014, a Texas jury award- ed $175 million to Mr. Harman, an amount that is tripled under the False Claims Act. [U.S. ex rel. Harman v Trinity Industries, Inc., 2015 WL 7587869 (E.D. Tex. 2015)] Under the treble damages provisions of the False Claims Act, that amount is upped to $525 million. The judge also awarded a penalty of $8,250 for each of the false certifications that Trinity made on the guardrails, for an additional $138 million, plus $19 million for Mr. Harman’s attorneys’ fees. The judge noted that Mr. Harman had provided “substantial evidence” that Trinity had “made the decision to modify the ET-Plus, conceal such modifications, and falsely certify that the ET-Plus units had been accepted” by the federal government. As is the case in qui tam whistle-blower actions, Mr. Harman will receive 30% of the award. Generally, qui tam actions involve employees reporting violations to the federal government, but the court held that Mr. Harman qualified despite being a competitor because he report- ed the fraud to the federal government.

This was actually the second trial of the case. The first trial ended in a mistrial when there were allegations that Trinity had tried to intimidate a safety expert.

States have begun demanding the tests results, and a University of Alabama study has concluded that the ET-Plus is three times as likely to cause a fatality as the federally approved standard guardrail. For example, the state of Virginia is demanding to see the safety tests and it has 11,000 of the guardrails. In the meantime, the prod- uct liability suits by crash victims and their families have begun. Trinity’s fine may be only the beginning. There are 14 civil suits pending. Trinity has appealed the judgment.

Explain the False Claims Act and who gets how much when a contractor makes false statements or fraudulent claims for federal monies.

Think about the product liability claim. Can passengers who did not buy the guard- rails recover?

What ethics lessons can a business learn from this case? ©

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Chapter 13 Product Advertising and Liability 473

One issue that arises in airplane crash cases is whether the air carrier followed the manufacturer’s repair procedures. The failure to follow these procedures could eliminate the manufacturer’s liability because the aircraft may have been altered.

13-4c the Requirement of a Seller engaged in a Business

Section 402A requires the seller to be “engaged in the business of selling the prod- uct.” This requirement sounds like the merchant requirement for the UCC war- ranty of merchantability. However, the meaning of “selling the product” is slightly broader under Section 402A than the UCC meaning of merchant. For example, a baseball club is not a merchant of beer, but if the club sells beer at its games, it is a seller for purposes of Section 402A. Section 402A covers manufacturers, whole- salers, retailers, food sellers, and even those who sell products out of their homes.

Some courts have allowed recovery from groups of sellers. For example, in the controversy over diethylstilbestrol (DES, a drug taken by pregnant women), the plaintiffs could show that their harms resulted from DES but could not show exactly who manufactured the drug their mothers took. The courts permitted recovery against the group of manufacturers of DES during that time period. [Sin- dell v Abbott Lab., 607 P.2d 924 (Cal. 1980)]

13-4d Negligence: a Second tort for product liability

A suit for product defects can also be based in negligence. The elements for estab- lishing a negligence case are the same as those for a Section 402A case with one addition: establishing that the product seller or manufacturer either knew of the defect before the product was sold or allowed sales to continue with the knowl- edge that the product had a defect. Establishing this knowledge is difficult in an evidentiary sense in court, but a plaintiff in a product liability suit who shows that the defendant-seller knew of the problem and sold or continued to sell the product can collect punitive damages in addition to damages for personal injury and prop- erty damage. Establishing knowledge in a product liability case usually produces a multi-million-dollar verdict because punitive damages are awarded in addition to compensatory ones.

In Geanacopoulos v Philip Morris, USA Inc., 33 Mass. L. Rptr. 308 (Mass. 2016), the court found that Philip Morris’s actions in marketing and selling its low-tar cigarettes were deceptive and were undertaken for the purpose of selling more cig- arettes by misleading the public about the risk associated with even low-tar ciga- rettes. Knowledge opens the door to punitive damages.

13-4e privity Issues in tort theories of product liability

Privity is not the standard for recovery in tort actions. The standard for recovery in negligence actions is whether the injury that resulted was foreseeable and fore- seeable to that particular party. For example, a manufacturer of toasters can foresee use by children and would have a duty to warn that they should not use the equip- ment unless supervised by adults. A manufacturer of a weed killer could foresee the presence of dogs, cats, and other pets in a yard sprayed with the killer and should either make the product not harmful to them or warn of the need to keep them away from the sprayed area for a certain period of time. Children and pets certainly have no privity with the manufacturers, but they can recover from the manufacturer (or their parents and owners can) on the basis of the foreseeability of the children’s and pets’ presence and the foreseeability of the danger causing their injuries.

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474 part 3 Business Sales, Contracts, and Competition

Likewise, parties other than the product manufacturer may be responsible for defective conditions in the products and can be held liable for their participa- tion. For example, parts manufacturers may be held liable if it can be shown that defects in their parts resulted in a product’s defect and the injury to the plaintiff. Exhibit 13.3 compares product liability theories, and Exhibit 13.4 details the basis for product liability.

13-5 Defenses to Product Liability Torts Three defenses are available to a defendant in a product liability tort:

1. Misuse or abnormal use of a product 2. Contributory negligence 3. Assumption of risk

13-5a Misuse or abnormal Use of a product

Any use of a product that the manufacturer has specifically warned against in its instructions is a misuse. Using a forklift to lift 25,000 pounds when the instructions

tYpe pRIVItY ReQUIRed?

KNOWledGe OF pROBleM ReQUIRed?

WaRRaNtY pROMISe ReQUIRed?

Negligence No Yes No

Section 402A/Strict tort liability No No No

Express warranty Yes No Yes

Implied warranty of merchantability Yes No No

Implied warranty of fitness for a particular purpose Yes No Yes

Exhibit 13.3 Comparison of product liability theories

CONtRaCt tORt

Express warranty 402A—Strict tort liability

Implied warranty of merchantability Elements

Implied warranty of fitness for particular purpose (1) Defective condition unreasonably dangerous: design, manufacturing defect, or inadequate warning

(2) Defendant in business of using, selling, or manufacturing product

(3) Condition of product is the same Negligence elements are the same and add:

(4) Knowledge of defect

Exhibit 13.4 legal Basis for product liability

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Chapter 13 Product Advertising and Liability 475

limit its capacity to 15,000 pounds is a misuse of the product, and any injuries resulting from such misuse will not be the liability of the manufacturer. Product misuse also occurs when a plaintiff has used the product in a manner that the defendant could not anticipate and warn against.

13-5b Contributory Negligence

Contributory negligence is traditionally a complete defense to a product liability suit in negligence. For example, although a front loader might have a design failure of no protective netting around the driver, a driver who is injured while using the front loader for recreational purposes is contributorily negligent. Contributory negligence overlaps greatly with product misuse.

Some states, as discussed in Chapter 9, have adopted a standard of compara- tive negligence, under which the plaintiff’s negligence is not a complete defense: the negligence of the plaintiff merely serves to reduce the amount the plaintiff is entitled to recover. For example, a jury might find that the defendant is 60% at fault and the plaintiff is 40% at fault. The plaintiff recovers, but the amount of that recovery is reduced by 40%.

13-5c assumption of Risk

When a plaintiff is aware of a danger in the product but goes ahead and uses it anyway, assumption of risk occurs. If a car manufacturer recalled your car for repair and you failed to have the repair done, despite full opportunity to do so, you have assumed the risk of driving with that problem.

Thomas v Staples, Inc. (Case 13.7) involves issues of contributory negligence, assumption of risk, and others in product liability that you have studied in this chapter.

Thomas v Staples, Inc. 2 F. Supp. 3d 647 (E.D. Pa. 2014)Case 13.7

FaCtS

Amy Thomas (married to Jason Thomas) purchased the MailMate Paper Shredder online from Staples. com on November 15, 2006, a shredder manufactured, assembled, and distributed by Executive Machines d/b/a Jeam Imports. In choosing the paper shredder, Amy Thomas said that her main considerations were that the shredder be compact and easy to use. The shredder was placed on a countertop in the Thomas’ kitchen, routinely used there for the purpose of keep- ing their “junk mail” under control to prevent identity theft. In using the machine, either Jason or Amy would stand in front of the counter and insert material into the machine to be shredded.

On May 25, 2008, Amy Thomas was shredding mail in the MailMate Paper Shredder when their

19-month-old daughter, Madalyn, started crying and began to pull on Amy’s leg. At this point, while the shredder was still operating, Amy picked up Mada- lyn and placed her on her left hip. Having made no attempt to unplug or turn off the shredder, Amy turned away from Madalyn to get Madalyn some candy; as Amy turned back around to face Madalyn, she saw that Madalyn’s left hand had become stuck in the shredder. Upon realizing that Madalyn’s fingers were stuck in the shredder, Amy unplugged the machine.

Amy does not recall whether there was noise com- ing from the machine when Madalyn’s fingers became stuck, whether Madalyn pulled away from her in order to reach out to the machine, or whether any portion of the envelope she had placed in the machine was still in the process of shredding. Jason was able to extract

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476 part 3 Business Sales, Contracts, and Competition

Madalyn’s hand from the shredder with the use of a crowbar. Subsequently, Madalyn was transported to Wilkes–Barre Hospital for initial examination and then transported to Hershey Medical Center, where surgery was performed. Madalyn’s two partially amputated fingers could not be reattached.

Mr. Thomas, on behalf of Madalyn (plaintiffs), brought suit against the manufacturer of the paper shredder and Staple’s, alleging strict liability, negli- gence, breach of express warranty, breach of implied warranty, and compensatory and punitive damages. Staples and Executive Machines (defendants) moved for summary judgment.

JUdICIal OpINION

TUCKER, Chief Judge Section 402A makes sellers liable for harm caused to consumers by unreasonably dangerous products even if the seller exercised reasonable care.

Defendants have argued the MailMate Paper Shredder was not defective because it received a “UL certificate.” Evidence of compliance with industry standards goes only to the reasonableness of the Defen- dants’ design choices. Evidence of compliance is not, therefore, dispositive of whether or not a product is defective. A reasonable jury could still find Defendants strictly liable even if they complied with UL require- ments or other industry-wide practices.

Likewise, Defendants’ assertion that they complied with the recommendations of the Consumer Product Safety Commission (“CPSC”) is also unavailing. The fact that the CPSC apparently did not require corrective action from Staples after Staples reported an unspeci- fied incident or incidents to it is no basis for granting summary judgment. Further, as Plaintiffs argue, the letter Staples received from the CPSC contains numer- ous deficiencies which undermine its persuasive value.

The Court concludes that Plaintiffs have produced sufficient evidence such that a reasonable jury could conclude that the MailMate Paper Shredder at issue contains certain design defects which render it unrea- sonably dangerous. In his expert report, Plaintiffs’ expert, Dr. Steven Tipton, notes that Staples markets the MailMate Paper Shredder for “Home Office/Small Business” use. Accordingly, he argues, “the presence of children” around the MailMate Paper Shredder is “eminently foreseeable.” Nevertheless, according to Dr. Tipton the MailMate contains no safety features that would protect curious children. In addition, Dr.  Tipton avers that the small size of the shredder (11 inches) makes it easily accessible to small children; Dr. Tipton further notes that the average toddler of Madalyn’s age at the time is 30 to 36 inches. Further, Dr.  Tipton claims that the MailMate has a pull force

nearly twice as strong as other home paper shredders. This feature, coupled with the fact that shredder’s blades are only 1.25 inches below the inlet slot, alleging makes it easy for fingers (especially those of a small child) to become trapped in the slot opening.

Dr. Tipton then goes on to opine on several “inex- pensive” design changes that, in his opinion, would have made the MailMate safer. The first design change Dr. Tipton recommends is narrowing the slot opening at the top of the shredder, which would “eliminate the trap and pull funnel” and “double the distance from the opening to the blades.” In addition to narrow- ing the slot opening, Dr. Tipton further recommends adding “stiffening ribs” to the opening “that could be molded into the top to increase the compliance of the opening if a finger happened to get pinched and pulled into the narrow slot.” Alternatively, Dr. Tipton avers that another inexpensive modification would adding a snap-on cover. This cover would be “placed [over] the opening with a slot either directly above the existing slot . . . or off to the side.” Either type of cover would “narrow the opening at the point of insertion and effec- tively put the fingers further from the cutting blades.” Dr. Tipton further notes that one of these protective covers could have been provided to purchasers of the 2006 MailMate after the fact.

Defendants, however, argue that Plaintiffs are unable to demonstrate that any alleged defect in the shredder was the proximate cause of Madalyn’s inju- ry. Defendants further assert that “there is no expert report on this issue and any such potential report would be based on conjecture as no one witnessed how Madalyn got her fingers into the shredder.”

The Court disagrees. It is true that Amy Thomas testified that, because her head was turned away from Madalyn at the time of the incident, she does not know whether the shredder was still shredding at the time of the incident or whether Madalyn pulled away from her in order to reach out to the machine. Nonetheless, the Court finds that genuine issues of material fact remain as to whether Plaintiffs can establish the causation element. Defendants’ expert, CED Technologies, Inc., concluded in their expert report that “user misuse was a cause and/or contributing factor to the incident.” Specifically, the “misuse” to which the CED Report refers is Amy Thomas “leaving Madalyn within arm’s reach of the operating shredder,” despite the fact that Amy, as she acknowledged at her deposition, had (1) read the shredder’s instruction manual prior to the 2008 incident, which contained warnings regarding keeping children away and not inserting fingers into the shredder opening, and (2) a warning icon on the shredder further advises users to not place fingers into the shredder opening. Dr. Tipton thus reiterates

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Chapter 13 Product Advertising and Liability 477

his position that Madalyn’s fingers were “pinched and pulled” into the opening of the shredder.”

For the foregoing reasons, the Court concludes that Plaintiffs have introduced evidence such that there was a jury question as to whether Defendants were negligent in designing the MailMate Paper Shredder. Defendants’ Motion is DENIED as to Plaintiffs’ negli- gence and strict liability-design defect claims.

CaSe QUeStIONS

1. Explain the theory of the plaintiffs’ expert as to how the paper shredder was defective.

2. What is the impact of the evidence that no one is really sure how Madalyn’s hand got into the shredder?

3. Do you think Amy was negligent in her conduct?

Ethical Issues

In 1994, a group of Chrysler engineers met to review proposals and recommendations for improving their Chrysler Caravan (Car- avan) lines in order to make them more competitive. Paul Sheridan, one of the engi- neers on Chrysler’s Caravan Safety Team, raised the number one issue on the lists of proposals and recommendations: The latches on the Caravan rear doors appeared to be popping open, even in low-speed crashes. The Chrysler Caravan latches did not appear to have the strength of either the Ford Windstar or the Chevy van rear door latches. Mr. Sheridan proposed that Chrysler make the latches stronger and use that strength as a marketing tool.

After Mr. Sheridan made his proposal, and according to testimony in a subsequent product liability suit, a top production engi- neer told Mr. Sheridan, “That ship has sailed. We told you that last time. Next subject.”

In Jimenez v Chrysler Corporation, 269 F.3d 439 (4th Cir. 2001), the jury deliberated only 2.5 hours before returning a verdict for the Jimenez family of $262.5 million, $250 million of which was punitive damages.

Chrysler replaced the latches on 4.3 million Caravans manufactured since 1984. Chrysler spent $115 million for that replace- ment program on everything from notification to installation and estimates that about 61% of the van latches have now been replaced.

The number of deaths from ejection through the rear Caravan doors is 37, which is 11 more than the fatalities from the Ford Pinto exploding gas tank defect but well short of GM’s 168 fatalities in side-saddle gas tank collisions in that company’s pickups.

The following evidence came out in the Jimenez case:

• Chrysler initially used a latch in its vans that the rest of the industry had abandoned.

• When it switched to a better latch, still not meeting federal standards for passenger vehicles, it did not notify the owners of existing vans of the change and safety issues.

• Chrysler destroyed documentation on Caravan crash tests, including films and computer records. (The company says that such destruction was part of its routine document destruction program; however, a juror noted, following the trial, that only the documentation on the col- lisions in which the rear door was affected was destroyed. Chrysler still had the documentation on the vans’ front-end collision tests.)

• Engineers proposed adding a latch strengthener for a cost of about $0.25 per vehicle in 1990, but the plan was vetoed by Chrysler execu- tives because it was believed such an addition would be tantamount to an admission to regulators that the latches were not safe, and Chrysler had been taking the position that the latches were indeed safe.

• Chrysler used political clout to pre- vent a 1994 recall by NHTSA of the vehicles for latch replacement; a let- ter from Chrysler Vice Chairman Tom

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478 part 3 Business Sales, Contracts, and Competition

Denomme to Chairman Robert Eaton and President Robert Lutz read, “If we want to use political pressure to try to quash a recall letter; we need to go now.” Chrysler officials helped staff members for Representative John Dingell of Michigan (the ranking Democrat on the House Commerce Committee, which supervises the NHTSA) draft a letter objecting to the recall. NHTSA postponed the recall. When the recall was made in 1995, there was no acknowledgment that the latches were defective or that there was any safety issue.

Following the verdict, one juror said the evidence painted a picture of corporate indifference and added, “We want people to understand why we made the decision we did. We knew what we were doing. When you speak to a company as big as Chrysler, you’ve got to speak on terms they understand.” Another juror noted that executives answered, “I don’t know. I don’t remember. I can’t recall,” too often to have much credibility.

Chrysler had been the first mover in the van market. Its product filled a niche in the family auto market, and it occupied a unique position in terms of federal reg- ulation in that there were no applicable federal standards for the lifting rear door on the van. Chrysler used latch designs and parts that had been banned in passenger vehicles for years precisely because of the risk of ejection and associated high fatality rates. However, the lack of federal regulations on the vans meant that Chrysler violated no law in using the outmoded sys- tems and parts.

When Chrysler began to receive notice of accidents and began holding design and marketing meetings in 1993, lawyers ordered that no notes be taken at meet- ings, and minutes of meetings were col- lected and destroyed.

Why were punitive damages appropri- ate in this case? Are they too high? What message do the punitive damages send to businesses? What should Chrysler do inter- nally to be certain such a series of events does not happen again? ©

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13-6 Product Liability Reform The ALI has proposed the Restatement (Third) of Torts, which would change the current strict liability standard to a negligence standard for defective design and informational defect cases. In other words, plaintiffs who bring product liability cases based on defective design and instruction would have to establish negligence to recover. The strict liability standard would be eliminated under this new pro- posal. Strict liability would still be the standard for manufacturing defects.

13-7 Federal Standards for Product Liability 13-7a Consumer product Safety Commission

The federal level of government generally is not involved in product liability issues. However, the Consumer Product Safety Commission (CPSC) is a regu- latory agency set up under the Consumer Product Safety Act to regulate safety standards for consumer products. The commission has several responsibilities in carrying out its purposes:

1. To protect the public against unreasonable risks of injury from consumer products— To perform this function, the CPSC has been given the authority to recall products and order their repair or correction. The commission also has the power to ban products completely. This ban can apply only if a product

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Chapter 13 Product Advertising and Liability 479

cannot be made less dangerous. In 1994, the CPSC recalled nearly all types of metal bunk beds. In 2007, the CPSC worked with Mattel on its recall of million toys that had been made in China using lead-based paint, something banned in the United States. In 2008, the CPSC’s authority was expanded by the Consumer Product Safety Improvement Act (CPSIA) to cover secondhand sales because of the lead paint issue that affects so many used toys. Garage sales are now subject to federal product disclosure standards.

2. To develop standards for consumer product safety—These standards take the form of regulations and minimum requirements for certain products.

3. To help consumers become more informed about evaluating safety—Certain regula- tions require disclosure of the limits of performance and hazards associated with using a particular product.

4. To fund research in matters of product safety design and in product-caused injuries and illnesses.

The act carries civil penalties of up to a maximum of $1,500,000. Knowing or willful violations carry a criminal fine of up to $100,000 and/or one year’s impris- onment, and willful repeat violations carry penalties of up to $500,000 and 10 years. In addition, consumers have a right to sue in federal district court for any damages they sustain because of a violation of a regulation or law.

13-8 International Issues in Product Liability The EU directive on product liability limits liability to “producers”; it is not as inclusive as U.S. law, which holds all sellers liable. A 10-year limit on liability and the “state-of-the-art” defense apply to most member countries: If a product upon its release was as good as any available, it is not subject to product liability.

In addition to the council’s guidelines are the International Standards Organization’s 9000 Guidelines for Quality Assurance and Quality Management. These directives require products to carry a stamp of compliance with standards and procedures as a means of limiting product defects.

The CISG (see Chapter 7 for more details) contains similar provisions to the UCC warranty protections for goods sold in international transactions. However, disclaimers are made more easily under the CISG and the notions of consequential damages are limited because the level of damages in product liability cases in the United States far exceeds the levels for any other country in the world. Further, the notion of strict liability for products is unique to the United States, and under EU guidelines, the notion of knowledge is used as a standard for imposing liability.

IKEA learned that one of its meat prod- ucts contained horse meat. The company’s Swedish meatballs were tested in the Czech Republic, and officials found traces of horse meat. IKEA withdrew its Swedish meat- balls from 14 European countries. During early 2013, Nestlé and other large European food producers learned that some suppliers had been selling them meat products that

were not made entirely of beef. Horse meat costs about one-fourth of the cost of beef. IKEA pulled the meatballs from its stores and in-store cafeterias. Food sales account for about 5% of IKEA’s total store revenues.

Discuss IKEA’s liability for the defec- tive meatballs if the company did not pro- duce them. What about the liability of the suppliers?

Consider . . . 13.7

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Ethical Issues

In some cases, products outlawed in the United States are sold outside the United States. In a practice referred to as dumping, the products are sold without mention of the U.S. recall or any litigation pending. What can be done about firms

that sell defective products in Third World countries? For example, the original type of IUD and non–flame-retardant pajamas were dumped after problems developed in the United States. Discuss the ethical issues. ©

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Biography

Buckyballs and Buckycubes were high-powered, small rare earth magnets that were imported into the United States by Maxfield and Oberton Holdings, LLC, from Ningo Prosperous Imports & Exports in Ningbo City, China. The products, which consist of individual magnets packaged as aggregated masses in different size containers of 10, 125, and 216 magnets, became enormously popular with over 3,000,000 of the products sold within the United States. Initially, ads for Buckyballs compared them to the wildly successful Hula-Hoops and Silly Putty of the 1960s. That comparison brought a new customer base for the product, and by 2009, Bucky- balls were being sold as an adult executive toy and/or stress reliever. The price range for Buckyballs was $19.95 to $ 100.00.

Children under the age of 14 (52 of them) ingested the Buckyballs. Their pow- erful magnetic force caused the intestinal walls to pinch or create a trap, a condi- tion that resulted in progressive tissue injury. Some children became septic and removal required endoscopic or surgical procedures, procedures that left children with permanent scarring. The greatest danger was that the symptoms began as simply a stomach upset and treatment was often not pursued, with the result being progressive deterioration of the intestines. Because Buckyballs were such a new and fast-moving phenomenon,

many physicians were not aware of the source of the intestinal problems they were trying to diagnose, something that resulted in further delays in treatment.

The only warning that appeared on Buckyballs was “Warning: Not intended for children. Swallowing of magnets may cause serious injury and require imme- diate medical care. Ages 3+.” The CPSC concluded that the warning was not suffi- cient to reflect the real danger and conse- quences of ingestion. In 2010, Buckyballs had new packaging, new warnings, and new instructions, and the old products with the faulty warning were recalled. Despite these efforts, ingestion among children continued with the most severe cases causing injury to the windpipes and esophaguses of young children.

The CPSC issued a safety alert in 2011, but the ingestion continued because chil- dren thought that Buckyballs looked like candy and older children tried to mimic tongue piercing by placing them on their tongues, thereby resulting in accidental swallowing of the magnets.

At that point, the CPSC ruled that warnings could never be effective because once Buckyballs are removed from their packaging, there is no longer any warning about their use. On July 25, 2012, the CPSC issued a mandatory product recall after fail- ing to reach an agreement for a voluntary recall with the product importing company.4

the Charming and dangerous toy

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Chapter 13 Product Advertising and Liability 481

s u m m a r y How does advertising create liability for a business?

• Express warranty—contractual promise about nature or potential of product that gives right of recovery if product falls short of a promise that was a basis of the bargain

• Bait and switch—using cheaper, unavailable product to lure customers to store with a more expensive one, which is then substituted or offered instead

• Federal Trade Commission (FTC)—federal agency responsible for regulating deceptive ads

• Wheeler-Lea Act—federal law that allows FTC to regulate “unfair and deceptive acts or practices”

• Celebrity endorsements—FTC area of regulation wherein products are touted by easily recognized public figures

• Consent decree—voluntary settlement of FTC complaint

What are the contract theories of product liability?

• Implied warranty of merchantability— warranty of average quality, purity, and adequate packaging given in every sale by a merchant

• Implied warranty of fitness for a particular pur- pose—warranty given in circumstances in which the buyer relies on the seller’s expertise and acts to purchase according to that advice

• Disclaimer—act of negating warranty coverage

• Privity—direct contractual relationship between parties

What is required for tort-based recovery on a defective product? What is strict tort liability for products?

• Strict liability—standard of liability that requires compensation for an injury regardless of fault or prior knowledge

• Restatement (Second) § 402A—American Law Institute’s standards for imposing strict liability for defective products

• Negligence—standard of liability that requires compen- sation for an injury only if the party responsible knew or should have known of its potential to cause such injury

• Punitive damages—damages beyond compensation for knowledge that conduct was wrongful

What defenses exist in product liability?

• Misuse—product liability defense for plaintiff using a product incorrectly

• Contributory negligence—conduct by plaintiff that con- tributed to plaintiff’s injury; serves as a bar to recovery

• Comparative negligence—negligent conduct by plaintiff serves as a partial defense by reducing liability by percentage of fault

• Assumption of risk—defense to negligence available when plaintiff is told of product risk and voluntarily uses the product

What reforms have occurred and are proposed in product liability?

• Consumer Product Safety Commission—federal agency that regulates product safety and has recall power

• Consumer Product Safety Improvement Act of 2008—expands authority to secondhand sales

Q u e s t i o n s a n d P r o b l e m s 1. A 30-minute infomercial for the DeLonghi Amer- ica Caffe Sienna espresso/cappuccino machine included this statement from the host/announcer:

Brew cappuccino just like the pros do right at home. Up until now, the home machines, they just didn’t work.

The FTC ad division approached Jim McCrusker, the president of the U.S. unit of DeLonghi, on the grounds that the ad was misleading. The ad division, reacting to

complaints from competitors, wanted Mr. McCrusker to add language that indicated it wasn’t that other machines didn’t work. The machines worked, but their frothing processes were not good.

Mr. McCrusker brought in other machines and consum- ers to talk with the ad division. The presentation of compet- itors’ machines, along with testimonials from consumers about the problems with other machines, convinced the ad council that the statement “They didn’t work” was indeed accurate for more than just the frothing process.

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482 part 3 Business Sales, Contracts, and Competition

What lessons are learned from Mr. McCrusker ’s experience? Is documentation for ad claims important? Is it appropriate for competitors to complain to a regu- latory body about ad content? [Sunbeam Products, Inc. v DeLonghi America, Inc., Not Reported in F. Supp. 2d, 2007 WL 1321134 (D.N.J.)]

2. While pitching in an American Legion baseball game on July 25, 2003, 18-year-old Brandon Patch was struck in the head by a batted ball that was hit using Hillerich & Bradsby’s (H & B) model CB-13 aluminum bat. Tragically, Brandon died from his injuries.

The Patches brought suit against H & B for the wrongful death of their son on the grounds that the CB-13 aluminum bat was in a defective condition because of the enhanced risks associated with its use: it increased the velocity speed of a batted ball when it left the bat, thus decreasing infielders’ reaction times, and resulted in a greater number of high-energy batted balls in the infield. Some studies note that the average time needed for a pitcher to react to a batted ball is 0.4 seconds. Analysis of the sound recording from the game confirmed that the reaction time available to Brandon to turn away or defend himself was only 0.376 of a second. Is there liability of H & B for what happened? Discuss and apply all theories and defenses you spot in the case. [Patch v Hillerich & Bradsby Co., 257 P.3d 383 (Mont. 2011)]

3. Beck’s Beer originated and was brewed in Germany from 1873 until 2012, when the Anheuser–Busch Compa- nies, LLC, acquired the brand and began brewing Beck’s in St. Louis, Missouri. The fact that Beck’s is brewed in St. Louis only appears on the bottom of the Beck’s Beer car- ton. Consumers who purchased Beck’s filed suit because the font for that disclosure is too small and difficult to read, and its illegibility is further exacerbated by the fact that it is in metallic white print on a metallic silver back- ground and is blocked by the carton design. What are the Beck’s buyers filing suit for and can they recover? [Marty v Anheuser-Busch Companies, LLC, 43 F. Supp. 3d 1333 (S.D. Fla. 2014)]

4. On August 6, 1998, Mr. Ruvolo purchased two chicken gordita sandwiches from Taco Bell. While eating the second sandwich, he felt a sharp pain in his throat and dislodged a chicken bone. The bone caused a scrape in his throat, and, as a result, he was treated at an emer- gency room. The following day, Mr. Ruvolo was diag- nosed with acute tonsillitis, pharyngitis, sinusitis, and gastritis.

Mr. Ruvulo sued Taco Bell and its food distribu- tors, alleging that the infections were due to the chicken bone’s scratching his throat and causing an opening where germs and bacteria could enter. He further alleged that Taco Bell and its food distributors were liable because of their failure to properly inspect the chicken.

Discuss the theories Mr. Ruvulo might use for recovery and who the defendants might be. [Ruvolo v Homovich, 778 N.E.2d 661 (Ohio App. 2002)]

5. Nintendo’s Wii video game system features games with simulation of tennis and boxing. To play the game, the players use a motion-sensitive controller in their hand. When playing the game, some players, in making the motions necessary for the sport, have lost control of their controllers. The controllers have crashed into other objects, including television sets, and injured the play- ers. Players who have been injured brought a class action suit against Nintendo for a defective wrist strap on the controllers, designed to keep the controllers from flying out of control. Could there be remedies for the design of the physical equipment used with computers? [Elvig v Nintendo of America, Inc., 696 F. Supp. 2d 1207 (D. Colo. 2010)]

6. Roy E. Farrar Produce Co. ordered a shipment of boxes from International Paper Company that were to be suitable for the packing and storage of tomatoes. The dimensions of the two sizes of boxes were to be such that either 20 or 30 pounds of tomatoes could be packed without the necessity of weighing each box. Mr. Farrar requested that the boxes be the same type as those sup- plied to Florida packers for shipping tomatoes. Mr. Far- rar told Mr. Wilson, an agent for International, to obtain the correct specifications for the Florida-type box.

International shipped Mr. Farrar 21,500 unassem- bled boxes at a unit price of 64 cents per box. The boxes were not tomato boxes, were not Florida boxes, did not have adequate stacking strength, and would not hold up during shipping. Mr. Farrar had to repack 3.624 boxes (at a cost of $1.92 per box). Substitute boxes were purchased for 10 cents above the International price. The replace- ment boxes were Florida boxes and did not collapse. Mr. Farrar was also forced to pay growers $6 a box for toma- toes damaged during shipping. He could not use 6,100 boxes, and his sales dropped off, resulting in financial deficiencies in his operation. Can Mr. Farrar recover for his damages? Why or why not? [International Paper Co. v Farrar, 700 P.2d 642 (N.M. 1985)]

7. Ms. Hubbs, 80, suffered from arthritis and osteoporo- sis. She purchased the Clapper, a device designed to turn electrical appliances on by responding to sound, namely, the clapping of hands.

Ms. Hubbs did not follow the instructions in the product to adjust its sensitivity. As a result of continual hard clapping, Ms. Hubbs broke her wrists. Ms. Hubbs also did not follow the product instructions to use (buy) a clicker available for the product if clapping is a chore. She sued the Clapper’s manufacturer for breach of the warranty of merchantability. Should she recover? [Hubbs v Joseph Enterprises, 604 N.Y.S.2d 292 (1993)]

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Chapter 13 Product Advertising and Liability 483

8. On February 14, 1999, Garry O. Hickman opened a pack of Big Red gum, which is manufactured by Wrigley. Mr. Hickman purchased the gum at a grocery store on the evening of February 13, 1999. Mr. Hickman unwrapped the package, which was still sealed, and put two pieces of the gum into his mouth. Mr. Hickman provided the following description of the events that occurred after he began to chew the gum:

[A]fter I started chewing the gum I bit down on it, uh, when I bit down on it the tooth exploded in my mouth. I begin to get all of this stuff out of my mouth, tooth fragments all over my mouth and everything. The screw turned up and stuck up in the top of my gum. I had to pull it out which caused me a lot of pain and all and everything and it was very uncomfortable there for a while.

Mr. Hickman sought treatment from Dr. Conly on February 18, 1999. One of Mr. Hickman’s bottom teeth was fragmented. Those fragments chipped his top

front teeth. Dr. Conly recommended that Mr. Hickman have surgery, which would total approximately $905, to remove the fractured tooth. However, Mr. Hickman had been unable to do so because he could not afford the surgery. His gums stayed sore for several weeks.

Mr. Hickman filed suit against Wrigley. Can he recover? What theories might he try? [Hickman v Wm. Wrigley, Jr. Co., Inc., 768 So.2d 812 (La. App. 2000)]

9. New Colt Holding Corporation advertises its Model P single-action revolver as “the gun that won the west.” Competitors have filed suit for false advertising because historical significance is important to gun purchasers and such false claims would draw away customers. Also, its competitors argue that the Winchester 73 rifle is actually the gun that won the west. Is this false advertising? Ana- lyze the statement and determine whether it is an express warranty. Also, determine if the FTC would deem the claim to be false or deceptive advertising. [New Colt Hold- ing Corp. v RJG Holdings of Florida, Inc., 312 F. Supp. 2d 195 (D. Conn. 2004)]

Social Responsibility, Economics, & Food Safety What If Your Product Is Socially Responsible but Risky?

Chipotle became a very popular restaurant chain with its commitment to “fresh, often locally sources, ingre- dients.” The company mantra was “food with integri- ty.” The company eschewed high-tech pesticides and synthetic fertilizers. However, lettuce, tomatoes, and cilantro have dangerous microbes if not properly sani- tized, especially when natural fertilizers are used.

Chipotle experienced problems with E. coli that resulted in the hospitalization of 20 customers, and a total of 52 customers sickened found the chain revis- iting its commitment and processes. After closing 43 stores in the Pacific Northwest, Chipotle took out full- page ads indicating that it was revisiting its processes, including better sanitizing processes for its ingredients. The company’s stock dropped 25% following the E. coli problems.5

Shortly after these issues, Chipotle disclosed in an 8-k, an SEC filing that publicly traded companies must make when there are material business developments (see Chapter 18), that it had received a subpoena from the federal grand jury. The investigation focused on an outbreak of norovirus that occurred among 230 patrons of several of the Chipotle stores in California. There

had been a norovirus issue in Boston that sickened 140 people. The food inspectors for Ventura County found violations in their inspections of the Simi Valley Chipotle restaurant, including storing cooked food at temperatures below the 135-degree requirement, dirty and/or broken utensils, lack of necessary hand wash- ing by employees, and 17 employees who had become sick from eating food at the restaurant. The inspection included failures to address previous violations.

Chipotle, in full-page ads in major newspapers, assured the public that its food is safe and that all its facilities are complying with the law and cooperating with investigators: “It’s prompted us to look at every ingredient we use with an eye to improving our prac- tices.”6 The new procedures require more centralized testing and sampling in the supply chain. Chipotle’s stock price began dropping after the norovirus was discovered and dropped further upon announcement of the criminal investigation.

As many commentators have noted, companies need to be cautious in making decisions about sourc- ing on the basis of social responsibility and consider the economic impacts and risk of using nonconven- tional food sources.

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484 part 3 Business Sales, Contracts, and Competition

n ot e s 1. Margaret Cronin Fisk, “Large Product Liability Awards Made Comeback in 2014,” Insurance Journal, February 19, 2015, http://www.insurancejournal.com/news/ national/2015/02/19/358021.htm.

2. A copy of the order and complaint against the company can be found at the Consumer Product Safety Commission website, http://www.cpsc.gov//PageFiles/131696/maxfield1a.pdf.

3. Aaron M. Kessler and Danielle Ivory, “Guardrail Tests Went Unreported, Court Hears,” New York Times, October 15, 2014, p. B3.

4. The full history of the McDonald’s case is summarized in Pelman v McDonald’s Corp. (Pelman III), 396 F.3d 508, 510 (2nd Cir. 2005), which eventually ended with four iterations and a dismissal in 2010 for the class action, but individual suits continue.

5. Julie Jargon, “New Outbreak Chills Chipotle’s Rebound,” Wall Street Journal, January 28, 2016, p. B1.

6. Chris Arnold, director of public relations for Chipotle, discussing the issues the chain was facing, in the New York Times quotes for January 17, 2016, p. BU2.

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486

Chapter

Business Competition: Antitrust14 Economic power is an inevitable result of the free enterprise system. Building a better mousetrap should result in attracting more customers and developing economic power. But gaining economic power through means other than “supe- rior skill, foresight, and industry” destroys the free enterprise system and often means that buyers don’t get a better mousetrap. They are stuck with a mediocre mousetrap built by a firm with ill-gained economic power and resulting market control.

Antitrust law exists to prevent the growth of economic or market power through means other than superior skill, foresight, and industry. Making sure that the free enterprise system has its necessary fuel of competition is the purpose of antitrust laws. This chapter answers the following questions: What interferes with competition? Or, in other words, what are restraints of trade? What forms do they take? What antitrust laws apply when concerns about competition arise? What penalties can be imposed for violations of these laws?

Update For up-to-date legal news, go to mariannejennings.com

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487

14-1 What Interferes with Competition? Covenants Not to Compete

As early as the sixteenth century, businesspeople developed agreements or cov- enants not to compete. The initial reaction to those agreements was not positive, with the courts issuing a resounding “No!” to those who came seeking to keep others from competing. However, by the seventeenth and eighteenth centuries, the courts began to see that some circumstances required trade restraint if competition was to flourish. As odd as it may sound, covenants not to compete can ensure com- petition. Through careful review of the covenants that resulted in judicial disputes, the courts began to carve out permissible types of restraints, such as protections for the buyer of a business. In these purchase agreements, the seller agreed not to open a competing business. This trade restraint, called a covenant not to compete, was necessary to preserve competition. A buyer purchasing a business meant someone else was entering the market. If the seller dropped down a few doors and opened the same business again, the seller would take customers and put the new buyer out of business.

So, covenants that were part of business purchase agreements are valid as long as they are reasonable in length and scope. For example, in Mitchell v Reynolds, 24 Eng. Rep. 347 (1711), a baker who sold his bakery agreed not to compete in the immediate area for five years, and a court held the covenant valid because it was limited in time and geographic scope.

Contracts and covenants that restrain trade are not illegal per se, meaning prohibited all the time no matter what. Courts continue to examine the scope of covenants and contracts that restrain trade to make sure that they are necessary

People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in some contrivance to raise prices. It is impossible indeed to prevent such meetings, by any law which would be consistent with liberty and justice. But though the law cannot hinder people of the same trade from sometimes assembling together, it ought to do nothing to facilitate such assemblies. AdAm Smith The Wealth of Nations

While the law of competition may be sometimes hard for the individual, it is best for the race, because it ensures the survival of the fittest in every department. Andrew CArnegie

In preparing to launch its iBookstore in 2009, Apple entered into contracts with five of the largest publish- ers to cap their prices for e-books to the iBookstore at $12.99, with Apple taking a 30% commission on the sales, meaning they could make only $8.75 per book. However, the agreements provided that Apple would always get the publisher’s lowest price offered to any other booksellers. The publishers then used the Apple terms to be able to negotiate with Amazon in order to increase their prices there because Amazon held 90%

of the e-book market and they had been held captive to Amazon’s demands for pricing. The presence of the iBookstore gave the publishers leverage, and the uni- form Apple pricing agreements bonded the publishers together with the courage to stand up against Ama- zon. The result was that all the publishers increased their prices to Amazon and, as a result, to consum- ers. Apple no longer needed to worry about Amazon’s pricing dominance. Is this conduct a violation of the antitrust laws?

Consider . . . 14.1

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488 part 3 Business Sales, Contracts, and Competition

for protection and not too broad in scope. For example, a covenant in a contract for the sale of a dry cleaning business that prohibits the seller from opening

another dry cleaning business anywhere in the state is unrea- sonably broad, but a similar covenant limited to the town where the business is located is probably reasonable. The goodwill of the business must be preserved if competition is to take hold. The extent of the protection for the goodwill is determined by the economic base of the area: How many dry cleaners can the area support?

Shopping center owners and anchor tenants may want to con- trol the makeup of the center or even the types of merchandise sold by each retailer. In some instances, the anchor tenant stip- ulates that it must review and approve all potential lessees for a center. For example, in some leases, anchor tenants have clauses that disallow the leasing of space to discount merchants. This type of provision prevents the anchor tenant from being under- sold on certain items.

The issue that arises from these clauses that limit the types of business operations is whether the clauses violate federal or state antitrust laws. At this point, it is difficult to determine which clauses do or do not violate antitrust laws. Because the issues of the type of market, location, and competition vary from city to city, the validity of these clauses also varies. But, for the most part, if the clauses are reasonably necessary for shopping center survival, tenants should insist on them. In the following case, the issue of use restriction is critical. Redner’s Markets, Inc. v Joppatowne G.P. Ltd. Partnership (Case 14.1) deals with the issues in these shopping center restrictions.

When negotiating valid covenants not to compete, follow these guidelines:

1. Be certain the covenant is necessary.

2. Be certain the covenant is reasonable:

a. It covers only the geographic scope necessary. (A five-mile radius for the sale of a dry cleaning business is reasonable; a worldwide prohibition is not.)

b. It covers only the time necessary. (Five years is reasonable; a lifetime prohibition is not.)

3. Make the covenant part of the agree- ment of sale, lease, or employment. Sep- arate agreements arouse suspicions.

4. Be certain both parties initial the non- compete clause or paragraph.

5. Legal representation helps ensure validity by assumed understanding.©

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Redner’s Markets, Inc. v Joppatowne G.P. Ltd. Partnership 918 F. Supp. 2d 428 (D. Md. 2013), affirmed 594 Fed. Appx. 798 (4th Cir. 2014)

The Amish Surge in Stores

Case 14.1

FaCtS

Joppatowne owns and manages the Joppatowne Plaza Shopping Center in Maryland. The departure of a major tenant created a substantial vacancy in the Shop- ping Center. The vacancy attracted the attention of Brian Miller, an entrepreneur who operates a large, suc- cessful flea and farmer’s market. Miller was interested in opening a second flea market and farmer’s market at Joppatowne.

On October 21, 2009, Joppatowne entered into a 10-year lease with, JTF, LLC, Miller’s limited liability corporation. JTF leased approximately 108,000 square feet. This space is divided between the flea market

(roughly 96,000 square feet) and the Amish Farmer’s Market (roughly 12,000 square feet). The two sections are physically separated by a fence that encloses the Amish Farmer’s Market.

Redner’s is a Pennsylvania corporation that oper- ates about 40 grocery stores, with a location at the Joppatowne Plaza Shopping Center. Redner’s stores sell the type of items typically found in a grocery store or supermarket but at lower prices made pos- sible by the company’s no-frills, food warehouse approach.

Joppatowne and Miller recognized that they were running the risk that the Amish Farmer’s Market

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Chapter 14 Business Competition: Antitrust 489

would violate the restrictive covenant in Redner’s lease. To address this risk, Joppatowne, in a letter agreement dated October 15, 2009, agreed that “in the event of legal action based on the issue of a breach of the restrictive covenants in the Redner’s Lease,” it would defend and indemnify JTF.

Although the Amish Farmer’s Market is pro- moted as such, each stall is separately owned and operated. Each has its own trade name and signage. The seven stalls within the enclosure are Dutch Delights, Dutch Pantry Fudge, Kreative Kitchen, Lapp’s Fresh Meat, King’s Cheese & Deli, Beiler’s BBQ, and Beiler’s Baked Goods. The eighth stall, All Fresh Seafood & Produce, is located outside the enclosure.

Redner’s Market filed suit alleging that the lease to JTF (because of the Amish Farmer’s Market) has resulted in a violation of the lease’s restrictive covenant that prohibits competing grocery stores. Joppatowne moved to dismiss the case.

JUdICIaL OpINION

Legg, Senior District Judge The dispute between Redner’s and Joppatowne cen- ters on the meaning of Article XIII of the Lease, headed “Restrictive Covenants.” The Article includes a single section, 13.01, “Landlord’s Restrictive Use Covenant.”

In common parlance, “grocery store” and “food supermarket” have different connotations. Section 13.01(a)(ii)(1) defines the term to include a Super Wal-Mart, a Super Target, or “other big box combo” that includes, as part of its operation, either a “food supermarket or ‘grocery store.’” This definition reflects the fact that large stores, in an effort to be all things to all people, now sell a variety of items that in earlier times would have been found in a specialty store. Big box stores have pharmacies, flower shops, no-appointment medical clinics, and a food section that would dwarf many neighborhood supermarkets.

The Lease reflects the fact that although Redner’s would welcome the power of a big box store to draw people to the shopping center, it wanted to guard itself against a Trojan Horse containing a competitive super- market or grocery store. Neither JTF nor any of the stores or stalls in the Amish Farmer’s Market qualifies as a “big box combo” akin to a Super Wal-Mart or a Super Target.

When applying the Restrictive Covenant, there is logic in viewing the Amish Farmer’s Market as a single retail operation. Physically, the Amish Farmer’s Market is an enclosed area that is fenced off from the Flea Market. Most of the stalls in the Market are run

by members of the Amish community, and the Market seeks to convey an overall Amish theme.

Viewed as a whole, the Amish Farmer’s Market has the appearance of a grocery store. A number of the stalls resemble typical grocery store departments. If the Amish Farmer’s Market were viewed as a single retail operation, subsection (4) would apply because the enclosed Market area comprises more than 30,000 square feet. The Court cannot take such an approach, however, because the Restrictive Covenant bases the definitions of “food supermarket or grocery store” on the term “retail operator.” The term “retail operator” can only apply to the individual stall proprietors. The Amish Farmer’s Market is not a legal entity. Each stall is separately managed by a separate proprietor that operates under a separate business license. Each proprietor has a separate cash register or credit card reader.

aLL FreSh

All Fresh is located outside the Amish Farmer’s Mar- ket enclosure. Without intending to demean these businesses, the Court concludes that they are typical seafood and butcher purveyors of the type found in a typical large supermarket.

All Fresh sells fresh and frozen seafood as well as fresh fruits and vegetables. The Court finds that All Fresh is a “seafood shop” within the intendment of section 13.01(a)(i). A seafood shop is no less a seafood shop merely because it also sells fresh produce. Hence, All Fresh violates the Restrictive Covenant in Redner’s Lease.

Lapp’S FreSh MeatS

Lapp’s Fresh Meats sells fresh and frozen meats. Lapp’s sells pre-packaged meats and meats that are cut to order. A large sign on the wall behind the counter reads, “Lapp’s Fresh Meats, LLC.” Other messages on the sign include: “Steaks Hamburger Pork Chops,” “Frozen Packages!” and “Fresh Cut!” Based on these facts, the Court finds that Lapp’s Fresh Meats is clearly a “butcher shop” within the intendment of section 13.01(a)(i) of the Lease.

Lapp’s is not an “ethnic or specialty food store” and Ruth’s Grill, the small grill at one end of the meat counter, does not turn Lapp’s into a “restaurant.” Accordingly, Lapp’s Fresh Meats is a use that violates the Restrictive Covenant.

dUtCh paNtry FUdge

Dutch Pantry A sells homemade fudge (about 20 dif- ferent types), chocolate, candy apples, caramel apples,

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490 part 3 Business Sales, Contracts, and Competition

fudge apples, chocolate covered pretzels, fudge pret- zels, and chocolate covered bacon and fruit. Dutch Pantry A does not violate the Restrictive Covenant. The store does not meet the definition of “food super- market or grocery store.” Even if it did, Dutch Pantry A would fall within the safe harbor of section 13.01(b) (ii) as both a “candy store” and a “specialty food store.”

The same analysis applies to Dutch Pantry C, which sells only candy. Dutch Pantry B presents a more difficult question, however. Dutch Pantry B [sells] candy, chips, cheese puffs, snacks, and other “junk food” items that one finds in a typical conve- nience store. Dutch Pantry B does not run afoul of the Restrictive Covenant. Dutch Pantry B is [not] a “food supermarket or grocery store.” Redner’s seems to be offended most by Dutch Pantry B’s substantial offering of nuts, trail mix, and other “bulk” items often found in a grocery store like Whole Foods. None of these items, however, are listed. The Court must apply the Restric- tive Covenant as it is written.

KreatIve KItCheN

Kreative Kitchen sells homemade potpies, soups, salads, sandwiches, wraps, and made-to-order subs. The Kreative Kitchen stall is demarked by a sign announcing “Kreative Kitchen: Homemade Pot Pie Soups Salads Subs Deserts.” Kreative Kitchen would fall within the safe harbor applicable to “restaurants of any kind.”

dUtCh deLIghtS

Dutch Delights sells funnel cakes, handrolled pret- zels, and various types of homemade “logs,” which are made from pretzel dough stuffed with various types of meats, including hot dogs, cheesesteaks, chicken, bacon, ham, and ribs. Dutch Delights also offers ice cream cones. Joppatowne and Redner’s agree that Dutch Delights is a “food court style oper- ation.” As such, it does not violate the Restrictive Covenant.

BeILer’S BBQ

Beiler’s BBQ sells various cuts of fresh, raw chicken, and prepared food, including baked beans, string beans, bread, mushrooms, rotisserie potatoes, and barbequed chicken and ribs. Unlike Lapp’s Fresh Meats, Beiler’s BBQ is not a “butcher shop.” While Beiler’s BBQ sells prepared food in substantial quan- tities, it cannot be characterized as a “restaurant of any kind.” The portion of Beiler’s operation dedicat- ed to the sale of fresh, uncooked chicken is simply

too significant to view the stall as a restaurant. The foods that Beiler’s sells do not claim to be foods characteristic of the Amish. Barbequed and fresh chicken are not the type of unique, high quality, specialized foods associated with a specialty store. [Beiler’s BBQ violates the Restrictive Covenant.]

BeILer’S BaKed gOOdS

Beiler’s Baked Goods makes and sells homemade pies, cakes, whoopee pies, sticky buns, and pastries. In addi- tion to baked goods, the stall also sells freshly made coffee. Beiler’s area is demarked by a wall sign that reads, “Beiler’s Baked Goods: Coffee & Donuts.” The analysis of Beiler’s Baked Goods tracks that of Beiler’s BBQ. A bakery is not a prohibited use. Even though Beiler’s Baked Goods sells coffee, and customers may eat their pastries at the Market, the primary character of the stall is a bakery not a “restaurant of any kind.” The “ethnic or specialty food store” exception also does not fit. The baked goods do not claim to be characteris- tic foods of the Amish. Nor are the bakery’s wares the high quality, unique, specialized items of a specialty store. [Beliber’s Baked Goods violates the restrictive covenant.]

KINg’S CheeSe & deLI

King’s Cheese & Deli sells milk and dairy drinks, a variety of cheeses and cheese spreads, pickles, home- made popped rice, eggs, milk and other drinks, cold cuts, deli meats, smoked meats, beef sticks, various canned items and jams. Like Beiler’s Baked Goods and Beiler’s BBQ, King’s does not fit within any of the safe harbors.

Given the wide variety of items it sells, King’s is not an “ethnic or specialty food store.” Nor is King’s a “table service delicatessen,” because it does not “provid[e] at least one-half (1/2) of its leasable floor space, exclusive of office and stock room for tables and chairs.”

The motion to dismiss is denied.

CaSe QUeStIONS

1. Explain why the Amish Farmer’s Market is not a violation of the restrictive covenant against Redner’s.

2. What are the key factors the court uses in evaluat- ing each of the stall stores?

3. What lessons can landlords and tenants learn from this dispute?

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Chapter 14 Business Competition: Antitrust 491

14-2 What Interferes with Competition? An Overview of the Federal Statutory Scheme on Restraint of Trade

During the last half of the nineteenth century, the United States experienced a tre- mendous change in its economy. A primarily agricultural economy changed to an industrial economy. Law on business combinations was largely undeveloped and unsuitable for the types of predatory business practices this new industrial age brought. Using the common law standards discussed in the first section resulted in nonuniform standards for anticompetitive behavior. Congress addressed anticom- petitive behavior with a series of antitrust statutes passed in the late nineteenth and early twentieth centuries. With some amendments and changes, this scheme still exists and applies today. Exhibit 14.1 summarizes the general federal statutory antitrust laws.

StatUte OrIgINaL date JUrISdICtION COverage peNaLtIeS Sherman Act 15 U.S.C. § 1 1890 Commerce clause Monopolies;

attempts to monopolize; boycotts; refusals to deal; price- fixing; resale price maintenance; division of markets

Criminal; $100,000,000 if a corporation, or if individual, $1,000,000, or by imprisonment not exceeding 10 years, $10,000,000, for individuals if intentional; also private suits

Clayton Act 1914 15 U.S.C. § 12

1914 Persons engaged in commerce

Tying; treble damages; mergers; interlocking directorates

Private suits

Federal Trade Commission Act 15 U.S.C. § 41

1914 Commerce clause Unfair methods of FTC competition

Robinson–Patman Act 15 U.S.C. § 13

1936 Persons engaged in commerce and selling

Price discrimination Private suits and criminal penalties for international acts goods across state lines

Celler–Kefauver (part of Clayton Act) 15 U.S.C. § 18

1950 Asset acquisitions

Hart–Scott–Rodino Antitrust Improvements Act 15 U.S.C. § 1311

1976 amended 1980, 1994

Gives greater authority to Justice Department for prosecution; requires premerger notification to Justice Department

Antitrust Modernization Commission

2002 Gave authority to study antitrust laws, and the 2007 report recommended no changes in the laws

Exhibit 14.1 Federal antitrust Statutes

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492 part 3 Business Sales, Contracts, and Competition

Federal antitrust laws apply to business conduct in interstate commerce. Even if an activity is purely intrastate, it is subject to federal laws if the activity has a substantial economic effect on interstate commerce. In only a few instances is interstate commerce not found. In McClain v Real Estate Board of New Orleans, 441 U.S. 942 (1980), for example, an antitrust action against real estate brokers who worked only in the New Orleans area was permitted under the Sherman Act because the U.S. Supreme Court found that the brokers facilitated the loans and insurance for the properties they sold. The loans and insurance were provided by national firms, and funding came from outside the state. This involvement of interstate commerce, even in an indirect fashion, is sufficient for Sherman Act jurisdiction.

The Clayton Act and the Robinson–Patman Act have more stringent require- ments for federal application, such as having sales across state lines or two busi- nesses involved in interstate commerce.

Even if the federal laws do not apply to a particular transaction, states will also have their own laws on anticompetitive behavior, with some states regulating dif- ferent sorts of activities, such as price gouging, which is charging a price that pro- duces a gross or net profit above a certain percentage determined by the statute or regulation. These statutes go into effect in situations such as post-hurricane areas when clean water is not readily available but willing sellers are offering it at prices up to five times higher than normal.

14-2a What types of activities do the Federal Laws regulate?

The federal antitrust laws can be broken down into a chart overview that will help you understand what anticompetitive behavior is and where the federal antitrust laws apply.

Anticompetitive behavior breaks down first into two large chunks: horizontal and vertical. Horizontal behaviors are those between and among competitors, and federal law takes any activities here seriously. In these types of behaviors, the stat- utes and courts find per se illegal behavior, which means that courts do not ana- lyze what the competitors did; their behavior is just plain illegal. Fixing prices and monopolizing are per se illegal. Vertical behaviors are those along the supply chain, between manufacturer and distributor or between manufacturer and retailer. Because other manufacturers and retailers are competing with the parties in the supply chain for the same customers, arrangements that these parties make could actually help competition. Although some vertical behaviors are per se illegal, the courts have been chipping away to make more of the vertical activities subject to a rule of reason standard, which means that the courts examine whether the activi- ties help or hinder competition. Exhibit 14.2 is a diagram of the types of activities and what laws apply.

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Chapter 14 Business Competition: Antitrust 493

14-3 Horizontal Restraints of Trade Horizontal restraints of trade are designed to lessen competition among a firm’s competitors. For example, the collusion on fuel surcharges discovered between Virgin and British Airways was found to be a horizontal restraint. The Sherman Act covers the horizontal restraints of price-fixing, market division, group boy- cotts and refusals to deal, and monopolization. The Clayton Act also covers the problem of anticompetitive horizontal mergers or mergers with competitors.

14-3a Monopolization

Section 2 of the Sherman Act prohibits the act of monopolizing. A Sherman Act monopolization charge requires proof of (1) market power in the relevant market and (2) some intentional or willful abuse of that power.

Market power is the power to control prices or exclude competition in a rele- vant market. Market power is an economic term that means the firm has a relatively inelastic demand curve. An elastic demand curve means that the firm’s products have competition from other firms or from firms with substitute products. For exam- ple, cosmetic firms have an elastic demand; buyers can switch to other products when prices increase in one line, or they can even give up the use of cosmetics. On the other hand, the demand curve for gasoline is less elastic. Although substitute means of transportation are available, those who need to use their cars need gasoline.

The factors that courts examine to determine market power include the firm’s market share. No set percentage figure translates into a final determination of power. However, most monopolization cases were directed at firms with market shares greater than 50%.

Market share is measured after determining the relevant market, including a look at the relevant geographic market. For example, a beer producer may have 50% of all nationwide beer sales, but in a suit involving a local competitor, the producer’s share might be only 20% because of the local beer’s popularity. This local market, or submarket, could be used as the relevant geographic market. A product may have an international market but may have only 10% market share in a particular area.

Each firm also has its own relevant product market, which is determined by con- sumers’ preferences and their willingness to substitute other products for the prod- uct at issue. For example, a market could be defined as plastic wrapping materials. or it could be defined as food storage materials and include wraps such as wax paper,

hOrIzONtaL MarKetS vertICaL MarKetS Monopolization Tying

(Sherman Act) Monopsony (Sherman Act)

Price-fixing Price discrimination

(Sherman Act) (Robinson–Patman Act)

Refusals to deal Resale price maintenance

Group boycotts Exclusive dealing, sole outlets, customer and territory restrictions

Mergers among competitors Mergers along the supply chain

Interlocking directorates Interlocking directorates

(Clayton Act) (Clayton Act)

Exhibit 14.2 a Look at Markets, Competition, and antitrust Laws

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494 part 3 Business Sales, Contracts, and Competition

aluminum foil, and plastic storage bags. A company may have 90% of the plastic wrap market, but if buyers use plastic wrap interchangeably with foil, storage bags, plastic containers, and press-and-seal wraps, that share may only be 20%. The prod- uct market is determined by the cross-elasticity of demand, as explained earlier.

However, the Sherman Act does not prohibit market power or even monopolies—certain types of monopolies are recognized as lawful exceptions. For example, a small town usually has an economic base only large enough to support one newspaper; such an operation is a lawful monopoly. Some businesses are monopolies because they make a product or provide a service that is superior or unique. When a business has obtained a large market share by superior skill, foresight, and industry, it has simply put its product in the market in a superior way and is entitled to its market share.

In order to establish a Sherman Act violation, the government agency or individ- ual bringing suit must show that the firm acquired is maintaining monopoly power by some purposeful or deliberate act that is not “superior skill, foresight, and indus- try” (which, in short, is the ability to build a better mousetrap). Those who bring suit against a company alleging monopolization must have some proof of conspiratorial or nefarious activity and not just market power. In Bell Atlantic v Twombly, 550 U.S. 544 (2007), the U.S. Supreme Court held that companies cannot be required to fig- ure out on their own, as defendants in an antitrust suit, what exactly they did that was monopolistic. Plaintiffs must allege enough facts to give the alleged monopolist notice of what they are defending against. In Bell Atlantic, the plaintiffs alleged that phone companies were engaging in parallel behaviors, or conscious parallelism. However, the fact that companies in the same industry might have similar practices is not enough to put the companies on notice of monopolistic behaviors. Some exam- ples of prohibited purposeful conduct that can be used as a basis for establishing an unlawful monopoly are predatory pricing and exclusionary conduct.

Predatory pricing is pricing below actual cost for a temporary period to drive a potential competitor out of business. Exclusionary conduct is conduct that prevents a potential competitor from entering the market. For example, interfering with the purchase of a factory by a competitor would be improper exclusionary conduct. The landmark case U.S. v Microsoft, 253 F.3d 34 (C.A. D.C. 2001), held that Microsoft was a monopolist because of its 90% market share as well as its refusal to sell its products to customers who also sold Microsoft’s competitors’ products. The Justice Department and Microsoft settled the case. Microsoft did not have to be broken up, but it did agree to pay penalties, including donations of $180 million in software to school districts.

Penny Stafford, the owner of Belvi Cof- fee and Tea Exchange, located in Bel- levue, Washington, brought an antitrust suit against Starbucks. She alleges that through its exclusive leases, Starbucks bans other coffee shops from competing. Starbucks has a 73% market share and $8.4 billion in annual sales in the United States and owns 7,551 of the 21,400 cof- feehouses located in the United States. However, if Dunkin’ Donuts, Krispy Kreme, and Tim Hortons are included in the gour- met coffee market, Starbucks holds only

43% of the coffee market. Starbucks purchased Seattle’s Best Coffee (SBC) in 2003 and Torrefazione Italia the same year. Starbucks then closed one-half of all SBC stores and all of the Torrefazione outlets. Starbucks runs 59 stores within a two- mile radius of downtown Seattle.

Stafford said that Starbucks has exclu- sive leases with landlords so that the land- lords cannot lease space in the same build- ing to another coffee shop. Does such an exclusive lease violate any antitrust laws, or are such clauses permitted under the law?

Consider . . . 14.2

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Chapter 14 Business Competition: Antitrust 495

Steve Jobs’s e-Mails in apple’s antitrust Litigation

For the Manager’s Desk

The most damaging testimony against Apple in its last few antitrust cases has come from the late Steve Jobs—through his e-mails. One antitrust suit has been hang- ing around for 10 years and deals with the issue of the workaround services that had been developed to find a way to get music for the iPods loaded through sources other than Apple’s iTunes. For example, in one e-mail, Mr. Jobs wrote, “We need to make sure that when Music Match launches their download music store they cannot use iPod. Is this going to be an issue?”1 That would be the kind of language someone defending Apple against the antitrust allegations in this iPod case would not want to exist.

During the antitrust litigation over the e-book pricing wars (see p. 492), one of Mr. Jobs’s e-mails to publishers read, “Throw in with Apple and see if we can all make a go of this to create a real mainstream e-books

market at $12.99 and $14.99.” The e-mail provided the kind of evidence the court needed to show the intent of Apple in creating the agreements it did with the pub- lishers—to allow the publishers to increase their prices from Amazon.

E-mail provides what is known as a contemporaneous record of events and has the added bonus that, for whatever psycho- logical reason, those communicating with e-mail tend to be more frank and informal than they would be in a memo. E-mail can also contradict a witness’s testimony and serve to undermine credibility. E-mail is dis- coverable, it is admissible as evidence, and it is definitely not private. Employees should follow the admonition of one executive whose e-mail was used to fuel a million-dol- lar settlement by his company with a former employee: “If you wouldn’t want anyone to read it, don’t send it in e-mail.”

Ethical Issues

W.J. Gore & Associates, Inc., the manufac- turer of Gore-Tex, a waterproof, breathable membrane that is used in everything from tents to clothing for bikers and runners, has an estimated 70% to 90% of the outdoor sports waterproof gear market. Examples of companies that use Gore-Tex include Adidas, Bass Pro, Ecco, L.L.Bean, Nike, Patagonia, Puma, Rockport, The North Face, Timberline, New Balance, Clarks, and Mephisto. However, several of Gore’s com- petitors have alleged that Gore refuses to sell its products to companies that carry other brands, such as the waterproof mem- branes offered by Columbia Sportswear Co.

Columbia alleges that its newer product (Omni-Dry) is superior to the

40-year-old Gore-Tex, but it is unable to get its foot in the door of these com- panies because they have agreed not to carry competitors’ materials. Allega- tions also include information about Gore refusing to place its manufacturing with factories that do work for other manu- facturers that compete with Gore. “This is the worst-kept secret in our indus- try. . . . Gore dictates what waterproof technologies they are allowed to offer consumers.”2

There are pending antitrust investiga- tions in the United States and Europe. Dis- cuss what antitrust issues you see. What are the ethical issues in Gore’s alleged behavior?

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496 Part 3 Business Sales, Contracts, and Competition

14-3b Price-Fixing

Any agreement or collaboration among competitors “for the purpose and with the effect of raising, depressing, fixing, peg- ging, or stabilizing the price of a commodity” is price-fixing, a per se violation of Section 1 of the Sherman Act.

Price-fixing can take many forms, but all of them are illegal. A minimum fee or price schedule discourages compe- tition, puts an artificial restriction on the market, and provides a shield from market forces. Even proof that the minimum price is a reasonable price is irrelevant once there is proof of an agreement. Although establishing maximum prices sounds like an excellent benefit for consumers, the effect is to stabilize prices, which translates into a restriction on free-market forces.

Some competitors have tried to use list prices as a guideline, but such lists are still a violation even though the list prices are not mandatory. Just the exchange of price information has an effect on the market and interferes with competition.

U.S. v Apple (Case 14.2) is a price-fixing case that involves a vertical seller putting pressure on horizontal competitors down the supply chain to agree on prices for retail sales. This case also provides the answer for the chapter’s opening “Consider . . .” problem.

U.S. v Apple, Inc., 791 F.3d 290 (2nd Cir. 2015) settlement affirmed, 649 Fed.Appx. 724 (2nd Cir. 2016); cert. denied 136 S.Ct. 1376 (2016), 496

Apple Slicing Up the E-Book Market

Case 14.2

FACTS

In 2009, Apple, Inc., had plans to release a new tablet computer, the iPad. Executives at the company saw an opportunity to sell e-books on the iPad by creating a vir- tual marketplace, the “iBookstore.” Apple went directly into negotiations with six of the major publishing com- panies in the United States. In two months, it announced that five of those companies—Hachette, HarperCollins, Macmillan, Penguin, and Simon & Schuster (Publisher Defendants)—had agreed to sell e-books on the iPad under arrangements whereby the publishers had the authority to set prices and could set the prices of new releases and New York Times best sellers as high as $19.99 and $14.99, respectively. Each of these agreements resulted in each Publisher Defendant receiving less per e-book sold via Apple as opposed to Amazon, even given the higher consumer prices. Just a few months after the iBookstore opened, however, every one of the

Publisher Defendants had taken control over pricing from Amazon and had raised the prices on many of their e-books, most notably new releases and best sellers.

The Department of Justice and 33 states and territo- ries (plaintiffs) filed suit alleging that Apple, in launching the iBookstore, had conspired with the Publisher Defen- dants to raise prices across the nascent e-book market and that their agreement violated § 1 of the Sherman Antitrust Act. All five Publisher Defendants settled and signed consent decrees, which prohibited them from restricting e-book retailers’ ability to set prices. Apple went to trial, and after a three-week bench trial, the district court concluded that, in order to induce the Pub- lisher Defendants to participate in the iBookstore and to avoid the necessity of itself competing with Amazon over the retail price of e-books, Apple orchestrated a conspira- cy among the Publisher Defendants to raise the price of e-books—particularly new releases and New York Times

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The following tips can help keep trade as- sociations free of anticompetitive behavior:

1. Do not exchange price information, including disclosures about credit terms, shipping fees, and so on.

2. Do not reveal future plans with re- spect to customers (e.g., “I’m not going to deal with that company anymore”).

3. Do not define or reveal territories (e.g., “I’m not interested in the Yuma region anymore”).

4. Do not agree to uniform pricing, com- missions, or refusals to deal.©

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best sellers. [United States v Apple Inc., 952 F. Supp. 2d 638, 647 (S.D.N.Y.2013)] The district court found that the agreement constituted a per se violation of the Sherman Act and, in the alternative, unreasonably restrained trade under the rule of reason. The court issued an injunction that prevents Apple from entering into agreements with the Publisher Defendants that restrict its ability to set, alter, or reduce the price of e-books. Apple appealed.

JUdICIaL OpINION

LIVINGSTON, Circuit Judge Where Amazon departed from the publishers’ tradition- al business model was in the sale of new releases and New York Times bestsellers. Rather than selling more expensive versions of these books upon initial release (as publishers encouraged by producing hardcover books before paperback copies), Amazon set the Kindle price at one, stable figure—$9.99. At this price, Amazon was selling “certain” new releases and bestsellers at a price that “roughly matched,” or was slightly lower than, the wholesale price it paid to the publishers.

The most significant attack that the publishers considered and then undertook, however, was to with- hold new and bestselling books from Amazon until the hardcover version had spent several months in stores, a practice known as “windowing.”

[Apple] devised an alternative to explicitly requiring publishers to switch other retailers to agency [pricing]. This alternative involved the use of a “most-favored nation” clause (“MFN Clause” or “MFN”). In general, an MFN Clause is a contractual provision that requires one party to give the other the best terms that it makes available to any competitor. Put differently, the MFN would require the publisher to offer any ebook in Apple’s iBookstore for no more than what the same ebook was offered elsewhere, such as from Amazon.

The Big Six understood the economic incentives that the MFN Clause created. Suppose a new hardcov- er release sells at a list price of $25, and a wholesale price of $12.50. With Amazon, the publishers had been receiving the wholesale price (or a slightly lower digi- tal wholesale price) for every ebook copy of the volume sold on Kindle, even if Amazon ultimately sold the ebook for less than that wholesale price. Under Apple’s initial agency model—with price caps but no MFN Clause—the publishers already stood to make less money per ebook with Apple. Because Apple capped the ebook price of a $25 hardcover at $12.99 and took 30% of that price, publishers could only expect to make $8.75 per sale. But what the publishers sacrificed in short-term revenue, they hoped to gain in long-term stability by acquiring more control over pricing and, accordingly, the ability to protect their hardcover sales.

This appeal requires us to address the important dis- tinction between “horizontal” agreements to set prices, which involve coordination “between competitors at the

same level of [a] market structure,” and “vertical” agree- ments on pricing, which are created between parties “at different levels of [a] market structure.” Under § 1 of the Sherman Act, the former are, with limited exceptions, per se unlawful, while the latter are unlawful only if an assessment of market effects, known as a rule-of-reason analysis, reveals that they unreasonably restrain trade. See Leegin Creative Leather Prods., Inc. v PSKS, Inc., 551 U.S. 877, 893, 127 S.Ct. 2705, 168 L.Ed.2d 623 (2007).

Although this distinction is sharp in theory, deter- mining the orientation of an agreement can be difficult as a matter of fact and turns on more than simply identifying whether the participants are at the same level of the market structure. For instance, courts have long recognized the existence of “hub-and-spoke” con- spiracies in which an entity at one level of the market structure, the “hub,” coordinates an agreement among competitors at a different level, the “spokes.”

Apple argues that the district court impermissibly inferred its involvement in a horizontal price-fixing conspir- acy from the Contracts themselves. Because (in Apple’s view) the Contracts were vertical, lawful, and in Apple’s independent economic interest, the mere fact that Apple agreed to the same terms with multiple publishers cannot establish that Apple consciously organized a con- spiracy among the Publisher Defendants to raise consum- er-facing ebook prices—even if the effect of its Contracts was to raise those prices. Second, Apple argues that, even if it did orchestrate a horizontal price-fixing conspiracy, its conduct should not be subject to per se condemnation. According to Apple, proper application of the rule of rea- son reveals that its conduct was not unlawful.

The first “crucial question in a Section 1 case is there- fore whether the challenged conduct ‘stem[s] from inde- pendent decision or from an agreement, tacit or express.’” Apple portrays its Contracts with the Publisher Defen- dants as, at worst, “unwittingly facilitat[ing]” their joint conduct. All Apple did, it claims, was attempt to enter the market on profitable terms by offering contractual pro- visions—an agency model, the MFN Clause, and tiered price caps—which ensured the company a small profit on each ebook sale and insulated it from retail price competi- tion. This had the effect of raising prices because it created an incentive for the Publisher Defendants to demand that Amazon adopt an agency model and to seize control over consumer-facing ebook prices industry-wide. But although Apple knew that its contractual terms would entice the Publisher Defendants (who wanted to do away with Amazon’s $9.99 pricing) to seek control over prices from Amazon and other ebook retailers, Apple’s success in capitalizing on the Publisher Defendants’ preexisting incentives, it contends, does not suggest that it joined a conspiracy among the Publisher Defendants to raise prices. In sum, Apple’s basic argument is that because its Contracts with the Publisher Defendants were fully consistent with its independent business interests, those

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agreements provide only “ambiguous” evidence of a § 1 conspiracy, and the district court therefore erred in infer- ring such a conspiracy.

We disagree. Apple offered each Big Six publisher a proposed Contract that would be attractive only if the publishers acted collectively. Under Apple’s proposed agency model, the publishers stood to make less money per sale than under their wholesale agreements with Amazon, but the Publisher Defendants were willing to stomach this loss because the model allowed them to sell new releases and bestsellers for more than $9.99. Because of the MFN Clause, however, each new release and best- seller sold in the iBookstore would cost only $9.99 as long as Amazon continued to sell ebooks at that price. So in order to receive the perceived benefit of Apple’s proposed Contracts, the Publisher Defendants had to switch Amazon to an agency model as well—something no individual publisher had sufficient leverage to do on its own. Thus, each Publisher Defendant would be able to accomplish the shift to agency—and therefore have an incentive to sign Apple’s proposed Contracts—only if it acted in tandem with its competitors.

As a sophisticated negotiator, Apple was fully aware that its proposed Contracts would entice a critical mass of publishers only if these publishers per- ceived an opportunity collectively to shift Amazon to agency. In fact, this was the very purpose of the MFN, which Apple devised as an elegant alternative to a pro- vision that would have explicitly required the publish- ers to adopt an agency model with other retailers. The MFN “force[d] the model” from wholesale to agency. Indeed, the MFN’s capacity for forcing collective action by the publishers was precisely what enabled [Steve] Jobs to predict with confidence that “the price will be the same” on the iBookstore and the Kindle when he announced the launch of the iPad—the same, Jobs said, because the publishers would make Amazon “sign . . . agency contract[s]” by threatening to withhold their ebooks. Apple was also fully aware that once the Pub- lisher Defendants seized control over consumer-facing ebook prices, those prices would rise. It knew from the outset that the publishers hated Amazon’s $9.99 price point, and it put price caps in its agreements because it specifically anticipated that once the publishers gained control over prices, they would push them higher than $9.99, higher than Apple itself deemed “realistic.”

On appeal, Apple nonetheless defends the Contracts that it proposed to the publishers as an “aikido move” that shrewdly leveraged market conditions to its own advantage. “[A]ikido move” or not, the attractiveness of Apple’s offer to the Publisher Defendants hinged on whether it could successfully help organize them to force Amazon to an agency model and then to use their newfound collective control to raise ebook prices. The Supreme Court has defined an agreement for Sherman

Act § 1 purposes as “a conscious commitment to a com- mon scheme designed to achieve an unlawful objective.”

To begin with, it is well established that vertical agree- ments, lawful in the abstract, can in context “be useful evidence for a plaintiff attempting to prove the existence of a horizontal cartel,” particularly where multiple com- petitors sign vertical agreements that would be against their own interests were they acting independently.

Horizontal price-fixing conspiracies traditionally have been, and remain, the “archetypal example” of a per se unlawful restraint on trade. By contrast, the Supreme Court in recent years has clarified that ver- tical restraints—including those that restrict prices— should generally be subject to the rule of reason.

“The true test of legality” under § 1 of the Sherman Act “is whether the restraint imposed is such as merely regulates and perhaps thereby promotes competition or whether it is such as may suppress or even destroy competition.”

Consistent with this principle, the Supreme Court and our Sister Circuits have held all participants in “hub- and-spoke” conspiracies liable when the objective of the conspiracy was a per se unreasonable restraint of trade.

The rule of reason is unquestionably appropriate to analyze an agreement between a manufacturer and its distributors to, for instance, limit the price at which the distributors sell the manufacturer’s goods or the locations at which they sell them. But the relevant “agree- ment in restraint of trade” in this case is not Apple’s vertical Contracts with the Publisher Defendants (which might well, if challenged, have to be evaluated under the rule of reason); it is the horizontal agreement that Apple organized among the Publisher Defendants to raise ebook prices. [H]orizontal agreements with the pur- pose and effect of raising prices are per se unreasonable because they pose a “threat to the central nervous system of the economy”; that threat is just as significant when a vertical market participant organizes the conspiracy.

[P]rice-fixing cartels are condemned per se because the conduct is tempting to businessmen but very dan- gerous to society. Apple and its amici argue that the horizontal agreement among the publishers was not actually a “price-fixing” conspiracy that deserves per se treatment in the first place. But it is well established that per se condemnation is not limited to agreements that literally set or restrict prices. The conspiracy among Apple and the Publisher Defendants comfort- ably qualifies as a horizontal price-fixing conspiracy.

This conspiracy to raise prices also had its intend- ed effect. Immediately after the Publisher Defendants switched Amazon to an agency model, they increased the Kindle prices of 85.7% of their new releases and 96.8% of their New York Times bestsellers to within 1% of the Apple price caps. They also increased the prices of their other ebook offerings. Within two weeks of the

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Chapter 14 Business Competition: Antitrust 499

move to agency, the weighted average price of the Pub- lisher Defendants’ ebooks—which accounted for just under half of all ebook sales in 2010—had increased by 18.6%, while the prices for Random House and other publishers remained relatively stable.

This sudden increase in prices reduced ebook sales by the Publisher Defendants and proved to be durable. One analysis compared two-week periods before and after the Publisher Defendants took control over pricing and found that they sold 12.9% fewer ebooks after the switch. Another expert for Plaintiffs conducted a regres- sion analysis, which showed that, over a six-month peri- od following the switch, the Publisher Defendants sold 14.5% fewer ebooks than they would have had the price increases not occurred. Nonetheless, ebook prices for the Publisher Defendants over those six months, controlling for other factors, remained 16.8% higher than before the switch. And even Apple’s expert produced a chart showing that the Publisher Defendants’ prices for new releases, bestsellers, and other offerings remained elevat- ed a full two years after they took control over pricing.

[N]either Apple nor the dissent has presented any particularly strong reason to think that the conspiracy we have identified should be spared per se condemnation.

Affirmed. JACOBS, Circuit Judge, dissenting:

I respectfully dissent. I have no quarrel with the district court’s conscien-

tious findings of fact; I affirmatively rely on them, and cite them throughout. The 156 pages of findings track communications and interactions that happened over the 48-day course of events, detail by detail.

The district court committed three decisive errors:

• The district court ruled (and the majority affirms) that a vertical enabler of a horizontal price-fixing conspiracy is in per se violation of the antitrust laws. However, the Supreme Court teaches that a vertical agreement designed to facilitate a hor- izontal cartel “would need to be held unlawful under the rule of reason.” Leegin Creative Leather Prods., Inc. v PSKS, Inc., 551 U.S. 877, 893, 127 S.Ct. 2705, 168 L.Ed.2d 623 (2007)

• The district court’s alternative ruling under the rule of reason was predetermined by its (erroneous) per se ruling. Thus the district court assessed impacts on competition without recognizing that Apple’s role as a vertical player differentiated it from the publish- ers. The court should instead have considered Apple as a competitor on the distinct horizontal plane of retailers, where Apple competed with Amazon (and smaller players such as Barnes & Noble).

• Apple’s conduct, assessed under the rule of reason on the horizontal plane of retail competi- tion, was unambiguously and overwhelmingly

pro-competitive. Apple was a major potential competitor in a market dominated by a 90 percent monopoly [Amazon], and was justifiably unwill- ing to enter a market on terms that would assure a loss on sales or exact a toll on its reputation. In that connection, the district court erroneously deemed the monopolist’s $9.99 price as categorically good for competition because it was lower than cost, and because e-book prices rose after the monopoly was broken.

A further and pervasive error (by the district court and by my colleagues on this appeal) is the implicit assumption that competition should be genteel, law- yer-designed, and fair under sporting rules, and that antitrust law is offended by gloves-off competition.

Amazon’s 90 percent market share constituted a monopoly under antitrust law. Amazon’s below-cost pricing was a barrier to entry by Apple in 2009, when it contemplated entry into the e-book retail market via the iPad.

The district court’s principal legal error, from which other errors flow, is its conclusion that Apple violated § 1 under the per se rule. Having found that the publishers’ coordinated strategy was a horizontal price-fixing conspiracy, and that Apple had facilitated that conspiracy in its vertical relationship with the pub- lishers, the district court drew the legal conclusion that these facts established a per se violation of the Sherman Act by Apple. This appeal turns on whether purely vertical participation in and facilitation of a horizontal price-fixing conspiracy gives rise to per se liability.

Section 1 of the Sherman Act “outlaw[s] only unrea- sonable restraints”; so a court weighing an alleged vio- lation “presumptively applies rule of reason analysis, under which antitrust plaintiffs must demonstrate that a particular contract or combination is in fact unreason- able and anticompetitive before it will be found unlaw- ful.” The exception, liability per se, is reserved for those categories of behavior so definitively and universally anti-competitive that a court’s consideration of market forces and reasonableness would be pointless.

Traditionally, restraints that are per se unlawful take the form of horizontal agreements “raising, depressing, fixing, pegging, or stabilizing the price of a commod- ity.” A vertical relationship that facilitates a horizontal price conspiracy does not amount to a per se violation.

CaSe QUeStIONS

1. Explain what Apple did with the publishers and why.

2. What is the “hub and spoke” theory of antitrust violations?

3. What issue does the dissent raise regarding the case?

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500 part 3 Business Sales, Contracts, and Competition

Often price can be controlled through competitors’ actions that affect supply. An agreement among competitors to limit production is an agreement to fix prices because the parties are controlling the supply, which in turn controls the right to demand the resulting price. Likewise, an agreement to limit or eliminate bidding, a form of a group boycott, has an effect on price because the supply is constrained. In National Soc’y of Professional Engineers v United States, 435 U.S. 679 (1978), a pro- fessional society agreed that there should not be bidding on engineering projects because the bidding process encouraged cost cutting and posed possible safety risks in the construction of the projects bid. Although its motives were well inten- tioned, it was still price-fixing and a per se violation of the Sherman Act.

General Electric, through its GES (Gener- al Electric Superabrasives) subsidiary, and DeBeers are both diamond processors and sellers. In 1991, both GES and DeBeers an- nounced a price increase for their diamonds.

Edward Russell was a former GES em- ployee who, in 1986, was promoted to the position of vice president in charge of GES. During this period, Mr. Russell exchanged notes and held meetings with the manag- ing director of a customer who also served as a board member for DeBeers. Following the meetings, both companies announced a 1991 price increase. There was some ev- idence that the customer indicated to GES that DeBeers would be increasing its pric- es. However, the customer who offered the information about the forthcoming price increase was not authorized to nego- tiate contracts or agreements on behalf of DeBeers.

Mr. Russell held his position as vice president of GES until November 11, 1991, when General Electric terminated his employment. In early 1992, Mr. Russell contacted the government, alleging that General Electric employees had commit- ted various acts of wrongdoing, including antitrust violations.

Soon after contacting the government, Mr. Russell filed a civil wrongful termination action against General Electric. He alleged that General Electric fired him because he was a whistle-blower. Mr. Russell settled his wrongful termination suit against General Electric on February 16, 1994, one day before the grand jury handed down an indictment

against General Electric (GE) for price-fixing in violation of the Sherman Act. Mr. Russell was a key witness for the government. His testimony was that there was advance con- tact between GES and DeBeers before the announcement of the price increases. GE and DeBeers do not deny the advance con- tact but assert that there was no agreement to increase prices. [U.S. v General Elec. Co., 869 F. Supp. 1285 (1994)]

THINK: The elements for price-fixing are that competitors act together to keep pric- es at a certain level or agree to charge a certain price. The statute does require an agreement between the parties.

APPLY: There must be evidence of an agreement to fix prices.

ANSWER: The court held that the fact that the managing director of the customer was also the director of a company that manu- factured industrial diamonds did not estab- lish that the managing director was acting on behalf of the competitor and that the industrial diamond manufacturer knew this when the managing director and the manu- facturer exchanged advance list pricing in- formation. The court found that there was no evidence to show that the managing director’s corporate links were used by the director or the competitor to form or facil- itate an agreement with the manufacturer to fix prices.

Any exchange of information took place with both parties aware that the managing director had no authority to act on behalf of the competitor.

Consider . . . 14.3

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Chapter 14 Business Competition: Antitrust 501

Although Apple’s strategy on pricing back- fired with the resulting, successful antitrust suit, there is more to the story. The publish- ing and bookselling field is a brutal one that requires checkmate-like thinking by all par- ticipants. For example, in 2015, as the Apple antitrust case was proceeding, a group of authors asked the Department of Justice to investigate Amazon for its practices. Amazon had just finished a contract dispute with Hachette (one of the five publishers in the Apple case), a battle during which Amazon buyers experienced difficulties in ordering books. The complaint to the Justice Department was based on a position paper called “Cornered: The New Monopoly Cap- italism and the Economics of Destruction.”

The paper alleges that Amazon engages in “destructive” practices such as selling books below cost to drive Borders and other competitors out of business and pressuring publishers for better deals and threatening not to carry those publishers’ books. During the Hachette dispute, Amazon buyers com- plained that some Hachette authors’ works were not available on Amazon or that there were delays in shipping or back orders.

Competing in the rough-and-tumble world of book publishers requires advance thinking as well as a good understanding of the antitrust laws to avoid stepping into a violation and to stop others who may be vio- lating the law in order to restrain or impede competition.

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14-3c divvying Up the Markets

Any agreement between competitors to divide up an available market is a per se violation under the Sherman Act. The result of such an agreement is to give the participants monopolies in their particular area. Such a market division introduces an unnatural force into the competitive market. For example, office product supply companies agreeing to operate only in certain cities throughout a state would be a division of markets and a per se violation.

BRG of Georgia, Inc. (BRG), and Harcourt Brace Jovanovich Legal and Professional Publications (HBJ) are the nation’s two larg- est providers of bar review materials and lectures. HBJ began offering a Georgia bar review course on a limited basis in 1976 and was in direct, often intense competition with BRG from 1977 to 1979. BRG and HBJ were the two main providers of bar review courses in Georgia during this period. In early 1980, they entered into an agreement that gave BRG an exclusive license to mar- ket HBJ’s materials in Georgia and to use its

trade name “BAR/BRI.” The parties agreed that HBJ would not compete with BRG in Georgia and that BRG would not compete with HBJ outside of Georgia.

Under the agreement, HBJ received $100 per student enrolled by BRG and 40% of all revenues over $350. Immediately after the 1980 agreement, the price of BRG’s course was increased from $150 to over $400.

Is this an illegal division of markets? Dis- cuss any perceived economic efficiencies in the arrangement? [Palmer v BRG of Geor- gia, Inc., 498 U.S. 46 (1990)]

Consider . . . 14.4

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14-3d group Boycotts and refusals to deal

A group of competitors that agrees not to deal with buyers unless those buyers agree to standard credit or arbitration clauses has committed a per se violation.

Some group boycotts appear to have the best intentions. Many garment manu- facturers once agreed not to sell to buyers who sold discounted or pirated designer clothing. Certainly their intentions were good, but the result still has the anticom- petitive effect of controlling the marketplace. Competitors cannot enforce the law through boycotts; other avenues of relief are available. The American Medical Association’s rules that prohibited salaried medical practices and prepaid med- ical plans are illegal boycotts in spite of the protection motivations behind the restrictions. In FTC v Superior Court Trial Lawyers Ass’n, 493 U.S. 411 (1990), the U.S. Supreme Court held that the action of a group of well-intentioned defense lawyers who went on strike to get a higher hourly rate for public defenders was noble and perhaps in the interest of justice, but it was still an illegal boycott by horizontal market participants.

The market for teeth whitening began in the 1990s. North Carolina dentists grew a market for the application of concentrations of per- oxide to teeth to create a chemical reaction that results in whiter teeth. In about 2003, non-dentists also started offering teeth-whit- ening services, often at a significantly lower price than dentists. Day spas, chain whiten- ing franchises, and other businesses offered the service. Shortly thereafter, dentists be- gan complaining to the North Carolina State Board of Dental Examiners and sought to have the non-dentist whitening services shut down because allowing such services to be performed by non-dentists created public health, safety, and welfare concerns.

After receiving complaints from den- tists, the Board opened an investigation

into teeth-whitening services performed by non-dentists. As a result of the investiga- tions, the Board issued 47 cease-and-desist letters to 29 non-dentist teeth-whitening providers. The letters were issued on offi- cial letterhead and noted that the compa- nies were subject to misdemeanor charges for the unauthorized practice of dentistry if they did not cease and desist their opera- tions. The result was that non-dentist teeth whiteners were eliminated from North Carolina.

The FTC filed a complaint against the board charging it with unfair competition. The Board moved to dismiss the complaint. Who is correct in this situation? [North Carolina State Bd. of Dental Examiners v F.T.C., 135 S.Ct. 1101 (2015)]

Consider . . . 14.5

14-3e Free Speech and anticompetitive Behavior

Some activities by competitors are protected even though the competitors act as a group and even though the effect may be to reduce competition. One such excep- tion is the Noerr–Pennington doctrine, under which competitors are permitted to work together for the purpose of governmental lobbying and other political action.3 Their activity enjoys the protection of the First Amendment. For example, competitors can make appearances at new licensee hearings and oppose the grant- ing of a license. The resulting reduction in competition enjoys First Amendment protection, which trumps the Sherman Act. In City of Columbia v Omni Outdoor Advertising, 499 U.S. 365 (1991), a company that was controlling the outdoor adver- tising market in one city attempted to use its lobbying First Amendment rights to protect its market control. An objection and suit by a competitor still resulted in the protection of Noerr–Pennington and First Amendment rights.

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14-3f Subtle anticompetitive Behavior: Interlocking directorates

If officers of competing companies serve on each other’s boards of directors, it opens the door to an exchange of information about everything from price to supply chain systems to new products. Certain types of these interlocking directorates are prohib- ited under Section 8 of the Clayton Act. A director of a firm with $10 million or more in capital cannot be a director of a competing company. The risk of anticompetitive results from just the exchange of information is too great. This antitrust concern has percolated in the past several years as directors in high-tech companies have realized their overlapping business conflicts. For example, Eric Schmidt, the CEO of Google, Inc., resigned from Apple’s board. Immediately following Mr. Schmidt’s resignation from Apple, Arthur Levinson, the CEO of Genentech, Inc., who had served on the boards of both Google and Apple, resigned from the Google board. The two compa- nies were increasingly competing with each other because of, among other things, Google’s announcement of its own phone. The two companies were facing increased scrutiny from regulators as a result of their increasingly overlapping business areas. John Doer, a director at both Google and Amazon.com, resigned from the Amazon. com board under pressure from regulators over that interlocking directorship. Google and Amazon had become direct competitors in the electronic book markets.

14-3g Merging Competitors and the effect on Competition

To determine the legality of mergers among horizontal competitors, courts have applied a test of “presumptive illegality”: any merger that produces an undue percentage share of the market or significantly increases market concentration is a violation. Courts examine market share and the relevant markets to determine whether undue concentration is a factor.

Not all horizontal mergers are prohibited. The failing-company doctrine allows the acquisition of a competitor that is teetering on insolvency, shutdown, or bankruptcy if it is an asset or inventory acquisition. Under the small-company doctrine, two small companies are permitted to merge because the hope is that they will be better able to compete with the larger businesses in that market.

The trend in mergers has been to approve larger and larger combinations. In United States v Von’s Grocery Co., 384 U.S. 270 (1966), the Supreme Court held that a merger between Von’s Grocery Company and Shopping Bag Food Stores, which would have given the two companies together a 7.5% share of the retail grocery mar- ket in Los Angeles, was an anticompetitive violation of the Clayton Act. However, by 1988, the Justice Department approved the merger of Von’s and Safeway in southern California. The merger made the new Von’s the largest competitor in terms of market percentage as well as in the number of stores. Justice Department attitudes and guide- lines on mergers have changed, and geographic markets are now defined in light of international trade. The standards for market share have changed, significantly since the grocery-store merger cases, with the federal government showing more leniency in approving mergers that take companies to the 50% or higher level of market share.

14-4 Vertical Trade Restraints Various steps are involved in getting a product from its creation to its ultimate consumer. For example, producing packaged sandwich meats requires the manu- facturer to obtain bulk-butchered meat (originally from a ranch) through a distrib- utor and turn it into packaged sandwich meat that is sold to another distributor.

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This distributor sells to a grocery wholesaler, who sells to grocery stores, where consumers buy the packaged meat. This entire process has different levels of pro- duction and distribution, but it consists of one vertical chain from start to finish.

The types of vertical restraints, discussed in the following subsections, are the following:

• Resale price maintenance • Monopsony • Sole outlets and exclusive distributorships • Customer and territorial restrictions • Tying arrangements • Price discrimination

14-4a resale price Maintenance Resale price maintenance is an attempt by a manufacturer to control the price that retailers charge for the manufacturer’s product. Resale price maintenance is a rule-of-reason violation of Section 1 of the Sherman Act. Resale price maintenance includes either minimum or maximum prices or both. A minimum price encour- ages a retailer to carry a certain product because its profit margin will be higher. One explanation offered to justify minimum prices is that without them, dealers who advertise and offer service may be used by consumers for information only, after which these consumers actually buy at discount houses.

In State Oil Co. v Khan 522 U.S. 3 (1997), the U.S. Supreme Court held that man- ufacturers or producers setting a maximum retail price for products at the retail level is not a per se violation of the antitrust laws. The Supreme Court noted that upholding a maximum benefits consumers and allegations of resale price mainte- nance should be examined for their effects on consumers and not under an abso- lute liability standard.

The “suggested retail price” has been tolerated under the rule of reason stan- dard as long as manufacturers and distributors did not enforce that suggested price through refusals to sell. In fact, a 1975 federal law eliminated state laws that pro- tected these enforcement arrangements, often called fair trade contracts. However, in 2007, the U.S. Supreme Court reversed a long-standing precedent with Leegin Creative Leather Products, Inc. v PSKS, Inc. (Case 14.3), which has changed the nature of distribution agreements by allowing enforcement of the suggested prices. of distribution agreements by allowing enforcement of the suggested prices.

Leegin Creative Leather Products, Inc. v PSKS, Inc. 551 U.S. 877 (2007)

It’s Not in the Bag; It’s in the Service4

Case 14.3

FaCtS

Leegin Creative Leather Products, Inc. (Leegin) (peti- tioner), designs, manufactures, and distributes leather goods and accessories under the brand name “Brigh- ton.” The Brighton brand has now expanded into a full

line of women’s fashion accessories and is sold across the United States in over 5,000 retail stores. PSKS, Inc. (PSKS) (respondent), runs Kay’s Kloset, a Brighton retailer in Lewisville, Texas, that carried about 75 dif- ferent product lines but was known as the place in that

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Chapter 14 Business Competition: Antitrust 505

area to go for Brighton. Kay’s ran Brighton ads and had Brighton days in its store.

Leegin’s president, Jerry Kohl, who also has an interest in about 70 stores that sell Brighton products, believes that small retailers treat customers better, provide customers more services, and make their shopping experience more satisfactory than do larger, often impersonal retailers. In 1997, Kohl released a new strategic refocus for Brighton by explaining: “[W] e want the consumers to get a different experience than they get in Sam’s Club or in Wal-Mart. And you can’t get that kind of experience or support or customer service from a store like Wal-Mart.” As a result, Leegin instituted the “Brighton Retail Pricing and Promotion Policy,” which banished retailers that discounted Brighton goods below suggested prices. The policy had an exception for products not selling well that the retailer did not plan on reordering. The established prices gave its retailers sufficient margins to provide customers with the quality service central to Brighton’s strategy.

In December 2002, Leegin discovered Kay’s Klos- et had been marking down Brighton’s entire line by 20%. Kay’s Kloset said it did so to compete with nearby retailers who also were undercutting Leegin’s suggested prices. Leegin, nonetheless, requested that Kay’s Kloset cease discounting. Its request refused, Leegin stopped selling to the store. The loss of the Brighton brand had a considerable negative impact on the store’s revenue from sales (about 40% to 50% of its profits were from Brighton).

PSKS sued Leegin for violation of the antitrust laws. Leegin asked to introduce expert testimony describing the procompetitive effects of its pricing policy. The District Court excluded the testimony, ruling Leegin’s conduct to be a per se violation of federal antitrust laws. The jury awarded PSKS $1.2 million in damages, and the judge trebled the damages and reimbursed PSKS for its attorney’s fees and costs for a judgment against Leegin of $3,975,000.80. The Court of Appeals affirmed. Leegin appealed. The U.S. Supreme Court granted certiorari.

JUdICIaL OpINION

KENNEDY, Justice In Dr. Miles Medical Co. v John D. Park & Sons Co., 220 U.S. 373, 31 S.Ct. 376, 55 L.Ed. 502 (1911), the Court established the rule that it is per se illegal under § 1 of the Sherman Act, 15 U.S.C. § 1, for a manufacturer to agree with its distributor to set the minimum price the distributor can charge for the manufacturer’s goods. The question presented by the instant case is whether the Court should overrule the per se rule and allow resale price maintenance agreements to

be judged by the rule of reason, the usual standard applied to determine if there is a violation of § 1. The Court has abandoned the rule of per se illegality for other vertical restraints a manufacturer imposes on its distributors. Respected economic analysts, furthermore, conclude that vertical price restraints can have procompetitive effects. We now hold that Dr. Miles should be overruled and that vertical price restraints are to be judged by the rule of reason Sec- tion 1 of the Sherman Act prohibits “[e]very contract, combination in the form of trust or otherwise, or conspiracy, in restraint of trade or commerce among the several States.” The rule of reason is the accepted standard for testing whether a practice restrains trade in violation of § 1. The rule of reason does not govern all restraints. Some types “are deemed unlawful per se.” The per se rule, treating categories of restraints as necessarily illegal, eliminates the need to study the reasonableness of an individual restraint in light of the real market forces at work, and, it must be acknowledged, the per se rule can give clear guidance for certain conduct. Restraints that are per se unlawful include horizontal agreements among competitors to fix prices, or to divide markets.

. . . [T]he per se rule is appropriate only after courts have had considerable experience with the type of restraint at issue, and only if courts can predict with confidence that it would be invalidated in all or almost all instances under the rule of reason.

Dr. Miles treated vertical agreements a manufac- turer makes with its distributors as analogous to a horizontal combination among competing distributors. . . . [I]t is necessary to examine, in the first instance, the economic effects of vertical agreements to fix minimum resale prices, and to determine whether the per se rule is nonetheless appropriate.

Though each side of the debate can find sources to support its position, it suffices to say here that economics literature is replete with procompetitive justifications for a manufacturer’s use of resale price maintenance.

The justifications for vertical price restraints are similar to those for other vertical restraints. Minimum resale price maintenance can stimulate interbrand competition—the competition among manufacturers selling different brands of the same type of product— by reducing intrabrand competition—the competition among retailers selling the same brand. The promotion of interbrand competition is important because “the primary purpose of the antitrust laws is to protect [this type of] competition.” A single manufacturer’s use of vertical price restraints tends to eliminate intrabrand price competition; this in turn encourages retailers to invest in tangible or intangible services or promotional

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506 part 3 Business Sales, Contracts, and Competition

efforts that aid the manufacturer’s position as against rival manufacturers. Resale price maintenance also has the potential to give consumers more options so that they can choose among low-price, low-service brands; high-price, high-service brands; and brands that fall in between.

Absent vertical price restraints, the retail services that enhance interbrand competition might be under- provided. This is because discounting retailers can free ride on retailers who furnish services and then capture some of the increased demand those services gener- ate. Consumers might learn, for example, about the benefits of a manufacturer’s product from a retailer that invests in fine showrooms, offers product demon- strations, or hires and trains knowledgeable employ- ees. Or consumers might decide to buy the product because they see it in a retail establishment that has a reputation for selling high-quality merchandise. If the consumer can then buy the product from a retailer that discounts because it has not spent capital provid- ing services or developing a quality reputation, the high-service retailer will lose sales to the discounter, forcing it to cut back its services to a level lower than consumers would otherwise prefer. Minimum resale price maintenance alleviates the problem because it prevents the discounter from undercutting the service provider. With price competition decreased, the man- ufacturer’s retailers compete among themselves over services.

Resale price maintenance, in addition, can increase interbrand competition by facilitating market entry for new firms and brands. “[N]ew manufacturers and manufacturers entering new markets can use the restrictions in order to induce competent and aggres- sive retailers to make the kind of investment of capital and labor that is often required in the distribution of products unknown to the consumer.”

Resale price maintenance can also increase inter- brand competition by encouraging retailer services that would not be provided even absent free riding. It may be difficult and inefficient for a manufac- turer to make and enforce a contract with a retailer specifying the different services the retailer must perform. Offering the retailer a guaranteed margin and threatening termination if it does not live up to expectations may be the most efficient way to expand the manufacturer’s market share by induc- ing the retailer’s performance and allowing it to use its own initiative and experience in providing valuable services.

While vertical agreements setting minimum resale prices can have procompetitive justifications, they may have anticompetitive effects in other circumstances.

Vertical price restraints also “might be used to orga- nize cartels at the retailer level.” A group of retailers might collude to fix prices to consumers and then compel a manufacturer to aid the unlawful arrange- ment with resale price maintenance. In that instance, the manufacturer does not establish the practice to stimulate services or to promote its brand but to give inefficient retailers higher profits. Retailers with better distribution systems and lower cost structures would be prevented from charging lower prices by the agreement.

Resale price maintenance, furthermore, can be abused by a powerful manufacturer or retailer. A dom- inant retailer, for example, might request resale price maintenance to forestall innovation in distribution that decreases costs. A manufacturer might consider it has little choice but to accommodate the retailer’s demands for vertical price restraints if the manufactur- er believes it needs access to the retailer’s distribution network.

Vertical agreements establishing minimum resale prices can have either procompetitive or anticompet- itive effects, depending upon the circumstances in which they are formed.

Respondent’s argument, furthermore, overlooks that, in general, the interests of manufacturers and consumers are aligned with respect to retailer profit margins. The difference between the price a manufac- turer charges retailers and the price retailers charge consumers represents part of the manufacturer’s cost of distribution, which, like any other cost, the man- ufacturer usually desires to minimize. The retailers, not the manufacturer, gain from higher retail prices. The manufacturer often loses; interbrand competition reduces its competitiveness and market share because consumers will “substitute a different brand of the same product.”

Resale price maintenance, it is true, does have economic dangers. If the rule of reason were to apply to vertical price restraints, courts would have to be diligent in eliminating their anticompetitive uses from the market.

Reversed.

CaSe QUeStIONS

1. What reasons did Leegin give for wanting the minimum price established for its retailers?

2. What points does the Court make about not having minimum prices in terms of reducing competition?

3. What risks are there in allowing minimum price requirements?

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Chapter 14 Business Competition: Antitrust 507

Toys R Us (TRU), a company that sells 20% of all the toys sold in the United States, co- ordinated informal agreements among toy manufacturers including Mattel and Hasbro that they would restrict the distribution of their products to warehouse club stores (such as Sam’s and Costco). The toy market breaks out as follows:

TYPE OF RETAIL OUTLET PRICE MARK-UP

Traditional toy and department stores

40%–50%

Specialized discount toy stores (TRU)

30%

General discount (Wal-Mart/Kmart/Target)

22%

Warehouse/club 9%

To avoid the price competition, the in- formal TRU agreement was that the toy manufacturers would sell their products

to warehouse clubs only if they were part of a more expensive package deal. For ex- ample, a Barbie doll could be purchased in- dividually at Toys R Us for $10.95, but the same Barbie doll could be purchased only as part of a package deal for $15.95 at the warehouse clubs. There were also some restrictions on the toys available to ware- house clubs. For example, Hall of Fame GI Joe was never sold at warehouse clubs. Mattel and Hasbro, fearful of losing Toys R Us as a distribution tool, went along with the arrangement.

The Federal Trade Commission (FTC) filed suit against TRU to end the agree- ments.5 Walk through the antitrust laws and determine whether the conduct of TRU vi- olated any of them. Then think through the ethics of TRU’s actions. What about Mattel and Hasbro agreeing to the informal arrange- ment? Was their conduct in violation of the antitrust laws? Was it ethical? [Toys “R” Us, Inc. v FTC, 221 F.2d 928 (7th Cir. 2000]

Consider . . . 14.6

Ethical Issues

Department 56 is a company that man- ufactures and sells collectible Christmas village houses and other replica items to allow collectors to create the whimsical “Snow Village” town or “Dickens Christ- mas.” Department 56 has only authorized dealers. Sam’s Club, a division of Wal-Mart Stores, Inc., began selling Department 56 pieces from The Heritage Village Collection.

Susan Engel, president and CEO of Department 56, attempted to contact Wal- Mart because it is not an authorized Depart- ment 56 dealer. Wal-Mart did not respond, and Ms. Engel sent by FedEx to National Collector clubs a letter that contained the following language:

Sam’s Club should not have any Department 56 merchandise. In a marketing environment where most companies are fighting to get their merchandise into the Wal-Marts of the world, we are fighting to get our merchandise out. While we recognize there is surely a place for mass market and warehouse stores, Department 56 Villages enjoy a strong heritage of dealer sales and service support. Our products simply do not fit the ware- house-style selling environment of Sam’s Club.

Of strong importance to us—and we hope to you too—is the tradition of

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508 part 3 Business Sales, Contracts, and Competition

14-4b Monopsony A monopsony exists when the buyer, rather than the seller, has the ability to con- trol market prices. In Weyerhaeuser v Ross-Simons, 549 U.S. 312 (2007), the U.S. Supreme Court held that antitrust laws apply to both predatory pricing and pred- atory bidding. In the case, Ross-Simons Hardware Lumber alleged that Weyer- haeuser tried to drive it out of business by bidding up the price of sawlogs to a level that prevented Ross-Simons from being profitable. Although the lower courts found for Ross-Simons, the U.S. Supreme Court held that a plaintiff in a predatory bidding case must be able to show what a plaintiff in a predatory pricing case must show—that the bids were at such a level that below-cost pricing resulted.

In the case, Weyerhaeuser was able to show that its investment in equipment and advanced processes allowed it to process more timber and that its huge demand was driving up the price. Ross-Simons was not able to establish that the price increases were actually sought by Weyerhaeuser. The demand drove up the price, but the demand came through Weyerhaeuser’s superior processing, not through nefarious means.

14-4c Sole Outlets and exclusive distributorships A sole outlet or exclusive distributorship agreement is one in which a manufac- turer appoints a distributor or retailer as the sole or exclusive outlet for the man- ufacturer’s product. This type of arrangement can be a violation of Section 1 but is subject to a rule of reason analysis. In a rule of reason analysis of sole outlets or exclusive distributorships, courts examine a manufacturer’s freedom to pick and choose outlets or distributors. However, the extent of the interbrand competition, which is the competition available for the manufacturer’s product, is critical. For example, in the case of the sandwich-meat manufacturer, as long as other manu- facturers are selling their products in the area, the manufacturer could agree to sell to only one chain of grocery stores. But without interbrand competition, the anti- trust laws require more intrabrand competition. If a manufacturer were the only one distributing sandwich meats in the area, dealing with only one grocery chain might not survive an antitrust challenge under the rule of reason.

selling our villages through an exclu- sive dealer network made up almost entirely of independent retailers. Wal- Mart Stores, Inc., and its subsidiaries are predators on these hard-working individuals. Sales of our products mean virtually nothing to the bottom line of a company the size of Wal-Mart. But to many of our loyal dealers, healthy Department 56 product sales mean survival.

Do you really need to shop at Sam’s Club or Wal-Mart? Let’s refuse to purchase villages or any other products from local Wal-Mart owned stores.

The letter asked collector club mem- bers to write Wal-Mart executives and local store managers. Names, mailing address- es, and telephone and fax numbers were offered.

Has Ms. Engel violated any laws? How does this situation relate to the Leegin case? How do you think Sam’s Club obtained the Department 56 products? Evaluate Ms. Engel’s conduct in sending out the letter. Were her statements about Wal-Mart and calls to action fair? Ethical? Should Wal-Mart respond? How?

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Chapter 14 Business Competition: Antitrust 509

14-4d Customer and Territorial Restrictions

Sole outlets allow manufacturers to decide (within limitations) to whom they will sell goods. However, manufacturers are not given the right to control what the buyer does with goods and how those goods are sold. The restrictions are subject to the rule of reason because interbrand competition may be increased even though intrabrand competition is reduced. For customer and territorial restrictions to be valid, enough interbrand competition must balance out decreased intrabrand competition. Also, the more market power the manufacturer has, the fewer substitute goods consumers have, resulting in less interbrand competition. Vertical restrictions are likely to be reasonable when the manufacturer is new to the market or is having financial or sales difficulties. If the restrictions will help the manufacturer get started or keep going, the positive impact on interbrand competition allows the limit on intrabrand competition.

14-4e Tying Arrangements

Tying sales require buyers to take an additional product in order to buy a needed product. For example, requiring the buyer of a copier machine to buy the seller’s paper when other brands of paper are equally suitable for use in the machine is a tying arrangement. The copier machine is the tying product or the desired product, and the paper is the tied product or the required product. Tying is usually an illegal per se violation of Section 3 of the Clayton Act (for goods contracts) and Section 1 of the Sherman Act (for services, real property, and intangibles). The presence of mar- ket power is the key to whether tying is a violation. For example, requiring the pur- chase of inferior films in order to buy copyrighted quality films is an example of the presence of market power. Because the seller is the only one with the copyrighted films, market power is being used to sell another unnecessary, low-demand prod- uct. However, part of proving that there is an illegal tying arrangement is establish- ing market power in the product used for the tying of the low-demand product.

Two defenses have been recognized in tying cases. The first is the new industry defense. Under this defense, the manufacturer of the tying product is permitted to have a tied product to protect initially the quality control in the start-up of a busi- ness. For example, a cable television antenna manufacturer required purchasers to

If you go to the ophthalmologist or optome- trist (called eye care professionals or ECPs) and have your vision checked you will get a prescription for disposable contact lens- es, you have two choices: (1) you can buy the lenses from your ECP; or (2) you can go to Costco, 1-800 Contacts, Alcon, or some other contact lens discounter. Since 2004, ECPs have been required by federal law to give their patients this choice. Most patients use Costco or other providers be- cause the prices were lower.

Johnson & Johnson Vision Car (JJVC) is the producer for ACUVUE contact lenses

and holds about a 30% share of the dispos- able contact lens market. That market con- sists of 40 million U.S. contact lens wear- ers, a big market.

Costco has filed suit against JJVC for resale price maintenance because unless it follows JJVC’s pricing restrictions, JJVC will no longer sell its products to Costco. Is Costco correct? Is JJVC violated antitrust laws? Costco Wholesale Corporation v. Johnson & Johnson Vision Care, 2015 WL 9987969 (M.D. Fla. 2015)

Consider . . . 14.7

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510 part 3 Business Sales, Contracts, and Competition

take a service contract also. The tying was upheld during the outset of the business so that the system could begin functioning properly and this new cable television industry could catch hold.

A second defense is quality control for the protection of goodwill. This defense is rarely supportable. This defense applies if the specifications for the tied goods were so detailed that they could not possibly be supplied by anyone other than the manufacturer of the tying product.

Illinois Tool Works Inc. v Independent Ink, Inc. (Case 14.4) involves an issue of whether a tying arrangement was valid.

Illinois Tool Works Inc. v Independent Ink, Inc. 547 U.S. 28 (2006)

If You Want Our Cartridges, You Have to Use Our Ink

Case 14.4

FaCtS

Trident, Inc., and its parent, Illinois Tool Works Inc. (petitioners), manufacture and market printing sys- tems that include (1) a patented piezoelectric impulse ink jet printhead; (2) a patented ink container, consist- ing of a bottle and valve cap, which attaches to the printhead; and (3) specially designed but unpatented ink. These products are sold to original equipment manufacturers (OEMs) who are licensed to incorporate the printheads and containers into printers that are in turn sold to companies for use in printing bar codes on cartons and packaging materials. The OEMs agree that they will purchase their ink exclusively from Illinois and that neither they nor their customers will refill the patented containers with ink of any kind.

Independent Ink, Inc. (respondent), has developed an ink with the same chemical composition as the ink sold by petitioners. Independent Ink filed suit alleging that Illinois’s agreements with customers constituted an illegal tying and monopolization in violation of §§ 1 and 2 of the Sherman Act. 15 U.S.C. §§ 1, 2.

The federal district court granted summary judg- ment for Illinois, and Independent appealed. The appellate court reversed the decision, and Illinois appealed.

JUdICIaL OpINION

STEVENS, Justice As we explained in Jefferson Parish, 466 U.S., at 12, 104 S.Ct. 1551, “[o]ur cases have concluded that the essen- tial characteristic of an invalid tying arrangement lies in the seller’s exploitation of its control over the tying product to force the buyer into the purchase of a tied product that the buyer either did not want at all, or

might have preferred to purchase elsewhere on differ- ent terms.”

Over the years, however, this Court’s strong disap- proval of tying arrangements has substantially dimin- ished. Rather than relying on assumptions, in its more recent opinions the Court has required a showing of market power in the tying product. Our early opin- ions consistently assumed that “[t]ying arrangements serve hardly any purpose beyond the suppression of competition.”

In Jefferson Parish, we unanimously reversed a Court of Appeals judgment holding that an alleged tying arrangement constituted a per se violation of § 1 of the Sherman Act. 466 U.S., at 5, 104 S.Ct. 1551. The tying product in Jefferson Parish—hospital ser- vices—was unpatented, and our holding again rested on the conclusion that the plaintiff had failed to prove sufficient power in the tying product market to restrain competition in the market for the tied product— services of anesthesiologists.

In rejecting the application of a per se rule that all tying arrangements constitute antitrust violations, we explained:

“[W]e have condemned tying arrangements when the seller has some special ability—usually called ‘market power’—to force a purchaser to do something that he would not do in a competitive market. . . .”

We conclude that tying arrangements involving patented products should be evaluated under the Jefferson Parish standards rather than under the per se rule. While some such arrangements are still unlawful, such as those that are the product of a true monopoly or a marketwide conspiracy, that conclusion must be

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Chapter 14 Business Competition: Antitrust 511

supported by proof of power in the relevant market rather than by a mere presumption thereof.

Congress, the antitrust enforcement agencies, and most economists have all reached the conclusion that a patent does not necessarily confer market power upon the patentee. Today, we reach the same conclusion, and therefore hold that, in all cases involving a tying arrangement, the plaintiff must prove that the defen- dant has market power in the tying product.

In this case, respondent reasonably relied on our prior opinions in moving for summary judg- ment without offering evidence defining the relevant market or proving that petitioners possess power within it. When the case returns to the District Court, respondent should therefore be given a fair oppor- tunity to develop and introduce evidence on that

issue, as well as any other issues that are relevant to its remaining § 1 claims. The judgment of the Court of Appeals is vacated, and the case is remanded for further proceedings.

CaSe QUeStIONS

1. What is the significance of the court’s requirement that there must be proof of market power before tying an unpatented product to a patented prod- uct as an antitrust violation?

2. What will Independent need to establish once the case is remanded?

3. Explain when and how you could tie a product to one of your other products without running afoul of the federal antitrust laws.

14-4f price discrimination

The Robinson–Patman Act prohibits price discrimination, which is selling goods at prices that have different ratios to the marginal cost of producing them. If two goods have the same marginal cost and are sold to different people at different prices, it is a case of price discrimination. Price discrimination is an example of the use of vertical restraints to lessen horizontal competition. Predatory pricing or pricing below cost is an example of conduct that will injure or destroy competition. Price discrimination has four elements:

1. A seller engaged in commerce 2. Discrimination in price among purchasers 3. Commodities sold that are of like grade or quality 4. A substantial lessening of competition in any line of commerce or a tendency

to create a monopoly; or competition is injured, destroyed, or prevented

If all the elements are established, both the buyer and the seller have violated the Robinson–Patman Act.

Price discrimination can come in the form of the actual price charged but can also come from indirect charges. For example, offering different credit terms to equally qualified buyers can constitute price discrimination. The products sold must be of like grade or quality, which means no physical differences in the

David Ungar holds a Dunkin’ Donuts fran- chise. The terms of his franchise agreement require him to use only those ingredients furnished by Dunkin’ Donuts. He is also required to buy their napkins, cups, and so on with the Dunkin’ Donuts trademark on

them. Is this an illegal tying arrangement? What if Dunkin’ Donuts maintains that it needs these requirements to maintain its quality levels on a nationwide basis? [Ungar v Dunkin’ Donuts of Am., Inc., 531 F.2d 1211 (3rd Cir. 1976)]

Consider . . . 14.8

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512 part 3 Business Sales, Contracts, and Competition

product. Label differences do not make the products different. For example, the sandwich-meat manufacturer that makes a private-label meat cannot discriminate in price for the sale of that meat if the contents are the same as the manufacturer’s advertised-label meat and only the label is different. However, if the private-label meat has lower-quality meat in it, a price difference can be justified because the products are not the same. In Utah Pie Co. v Continental Baking Co., 386 U.S. 685, the U.S. Supreme Court held that a company that prices differently in different markets to eliminate competition, particularly when that pricing is below cost, has engaged in price discrimination. In the case, an out-of-state pie manufacturer priced its pies below cost in Utah so that it could eliminate competition from a local pie manufac- turer. The mark of price discrimination is that once the competition is eliminated, prices return to a much higher level. The larger out-of-state company sustains the losses on the sales until the competitor is driven out of business. The result is less competition.

A&P Grocery Stores decided to sell its own brand of canned milk (referred to as “private-label” milk). A&P asked its long- time supplier, Borden, to submit an offer to produce the private-label milk. Bowman Dairy also submitted a bid, which was lower than Borden’s. A&P’s Chicago buyer then contacted Borden and said, “I have a bid in my pocket. You people are so far out of line it is not even funny. You are not even in the ballpark.” The Borden representative asked for more details but was told only that a $50,000 improvement in Borden’s bid “would not be a drop in the bucket.”

A&P was one of Borden’s largest cus- tomers in the Chicago area. Furthermore,

Borden had just invested more than $5 million in a new dairy facility in Illinois. The loss of the A&P account would result in underutilization of the plant. Borden low- ered its bid by more than $400,000. The Federal Trade Commission has charged Borden with price discrimination, but Borden maintains it was simply meeting the competition. Has Borden violated the Robinson–Patman Act? Does it matter that the milk was private-label milk and not its normal trade-named Borden milk? Are the ethics of the A&P representative trouble- some? [Great A&P Tea Co., Inc. v FTC, 440 U.S. 69 (1979)]

Consider . . . 14.9

defenses to price discrimination Legitimate cost differences in the manufacture or handling of a product mean price discrimination is not the issue. Additional costs of delivery or of adding specifica- tions to a product can increase the price without violating the Robinson–Patman Act. For example, if a sandwich-meat manufacturer produces a special low-fat bologna, the price for that product can be different. If the manufacturer uses dif- ferent shipping companies for its customers, a price differential may be acceptable.

Quantity discounts are permitted as long as the seller can show actual cost savings are realized in the sale of increased quantities and not just an assumption that larger sales are more economical. The law on price discrimination is based on marginal cost differences. Limiting the number of buyers who qualify for quantity discounts is some proof that the actual cost savings are not present.

Prices for products also can change according to market, inflation, material costs, and other variable factors. The seller must simply establish that a price change was initiated in response to one of these factors.

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Chapter 14 Business Competition: Antitrust 513

Another defense to a charge of price discrimination is meeting the competi- tion. This defense must establish that a price change was made in a certain market to meet the competition there. Also, the seller must charge the same as its compet- itors and not a lower price. Finally, the price differences must be limited to an area or individuals. For example, a national firm may have a different price in one state because of more competition within that particular state.

14-4g vertical Mergers

Vertical mergers are between firms that have a buyer-seller relationship. For exam- ple, if a sandwich-meat manufacturer merged with its meat supplier, it would be a vertical merger. In determining whether a vertical merger violates the Clayton Act, the courts determine the relevant geographic and product markets and then deter- mine whether the effect of the merger will be to foreclose or lessen competition.

14-5 What Are the Penalties and Remedies for Anticompetitive Behavior?

The federal antitrust laws have powerful incentives for compliance that include substantial penalties and remedies. The penalties and remedies are summarized in the following text and in Exhibit 14.3.

14-5a Criminal penalties

The Sherman Act carries felony criminal penalties. For individuals, the penalties are fines of up to $10 million and/or up to 10 years in prison. Corporations may be assessed fines of up to $100 million. These criminal penalties require proof that the violator intended the anticompetitive conduct and realized the consequences of the action taken.

The FTC and Clayton Acts do not carry criminal penalties. However, Section 4 of the Robinson–Patman Act makes criminal certain forms of intentional price discrimination. Officers and directors of violating corporations can also be held

SherMaN aCt CLaytON aCt

rOBINSON– patMaN aCt FtC aCt

Criminal $350,000 and/or 3 years in prison for individuals; $10 million for corporations; directors and officers also liable as to intent and knowledge

None Section 4 for intentional price discrimination

None

Civil Treble damages plus costs and attorney fees

Same Same None

Equitable Injunctions, divestitures, asset distributions, sales

Same Same Same

Enforcers Justice Department; U.S. attorney; state attorneys general; private persons

Same Same FTC

Exhibit 14.3 antitrust remedies

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514 part 3 Business Sales, Contracts, and Competition

criminally liable for antitrust violations, depending on their level of knowledge and involvement. For example, in the Archer Daniels Midland price-fixing case, officers were held responsible for the violations because of their direct knowledge of the price-fixing activities. The Antitrust Division of the Department of Justice or the local U.S. attorney’s office is responsible for bringing criminal actions under the antitrust laws.

14-5b equitable remedies

Equitable remedies consist of court orders that restrain or prevent anticompetitive conduct. Equitable remedies are available in both private and government enforce- ment actions. An injunction is a frequent form of antitrust relief; it is a court order prohibiting a violating party from engaging in anticompetitive conduct. For exam- ple, a firm can be ordered to divest itself of an acquired firm, or, in an unlawful asset acquisition, a court order can require that the assets be divided with a com- peting firm. Contracts whose terms violate the antitrust laws can be canceled by court order. Equitable remedies give the courts discretion to fashion remedies that will eliminate the results of anticompetitive behavior.

14-5c private actions for damages

Section 4 of the Clayton Act allows any person whose business or property is injured as a result of an antitrust violation to recover “threefold the damages by him sustained”—commonly referred to as treble damages—along with the costs of the suit and reasonable attorney fees. This section, with its substantial recovery provisions, is a strong incentive for private enforcement of antitrust laws. Consum- ers, businesses, and state attorneys general can all bring private damage actions under Section 4. These treble damages have found plaintiffs looking for ways to tap into the antitrust statutes, but the U.S. Supreme Court has been cautious in extending the remedies. In Credit Suisse Securities (USA) LLC v Billing, 551 U.S. 264 (2007), the Court held that securities investors who were bringing suit for IPO (ini- tial primary offerings; see Chapter 18) pricing and allocation needed to turn to the securities laws for their remedies, not the antitrust laws and their treble damages. The court held that securities regulation is so extensive and investor protections so readily available that the antitrust laws did not apply to the conduct of investment bankers and brokers for purposes of investor relief.

Types of damages include lost profits, increased costs, and decreased value in property. These damage suits have a four-year statute of limitations—that is, suit must be brought within four years of the alleged violation. Those who bring private damage suits enjoy a proof benefit: if the government has brought suit and a violation is found, that judgment can be used in a private suit as prima facie evidence against the violating defendant. A prima facie case allows a plaintiff to survive a directed verdict and entitles the plaintiff to a judgment if the defendant offers no contradictory evidence (see Chapter 4 for more discussion).

14-6 Antitrust Issues in International Competition

As the level of international trade has increased, so also has the number of com- petitors. For example, originally three domestic manufacturers produced cars in

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the United States. However, the availability of international trade markets has resulted in the presence of foreign manufacturers in the United States and impor- tation of cars from Japan, Great Britain, Germany, Sweden, and Yugoslavia. Inter- national competition changes the market perspective because the relevant market is not the United States but the world. In fact, in 2007, Toyota became the number one seller of autos in the United States because of open international competition.

As a result of increased levels of international competition, more joint ventures of competitors and large companies that once would have seemed unthinkable under antitrust protections will be permitted. For example, American Telephone and Telegraph (AT&T) has entered into a joint venture agreement with the Eco- nomic Ministry of Taiwan to improve that nation’s telecommunications systems. General Mills, Inc., was permitted to acquire RJR Nabisco’s cold-cereal business in both the United Kingdom and the United States so that it could compete more effectively in the large North American and European markets.

The EU has developed its own antitrust guidelines and has challenged a num- ber of proposed U.S. firm mergers in the EU. As these large mergers are proposed, the EU and other countries examine closely their anticompetitive effects. The EU has nixed most mergers proposed by U.S. companies, with the exception of the acquisitions undertaken for tax purposes. The U.S. Supreme Court has held that companies from other countries that engage in commerce in the United States will be subject to U.S. antitrust laws. Foreign corporations doing business here are sub- ject to the same rules of competition required of U.S. corporations.

Biographythe auto parts Industry and antitrust Laws

German company and auto parts manu- facturer Bosch entered a guilty plea and agreed to pay a $57.8 million fine for vio- lations of U.S. antitrust laws. Thirty-four other companies and 29 executives in the auto parts industry have entered guilty pleas for price-fixing and bid-rigging. Their fines total $2.5 billion.

The fines and guilty pleas resulted from investigations conducted by the U.S. Department of Justice in cooperation with authorities in countries throughout the world. The companies and executives were charged with price-fixing and bid-rig- ging on the contracts for spark plugs and oxygen sensors sold to DaimlerChrylser, Ford Motor, Volkswagen, and General

Motors. The investigation found that there were antitrust violations in the sales of more than $5 billion in auto parts. The case was put together after the FBI exe- cuted search warrants of parts suppliers in Japan, a search that was orchestrated by the FBI in Detroit. What the investigators found in those records resulted in further investigations into other parts manufactur- ers around the world, including the United States, Europe, Australia, South Korea, Japan, and Canada. The tendency to fix prices and rig bids to automakers seemed to be a part of industry behaviors across the board. Once the FBI found some vio- lations, it was led to other companies and the resulting guilty pleas. ©

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s u m m a r y What restraints of trade are permissible?

• Covenant not to compete—clause in employment or business sale contracts that restricts competition by one of the parties; must be reasonable in scope and time

What antitrust laws exist?

• Sherman Act—first federal antitrust law; prohibits monopolization and horizontal trade restraints such as price-fixing, boycotts, and refusals to deal

• Clayton Act—federal antitrust statute that pro- hibits tying and interlocking directorates; controls mergers

• Federal Trade Commission Act—federal law that allows the FTC to regulate unfair competition

• Robinson–Patman Act—anti–price discrimination federal statute

• Celler–Kefauver Act—regulates asset acquisitions

• Hart–Scott–Rodino Antitrust Improvements Act— antitrust law that broadened Justice Department authority and provided new merger guidelines

What penalties can be imposed for restraints of trade?

• Equitable remedies—nonmonetary remedies such as injunctions

• Treble damages—three times actual damages avail- able in antitrust cases

What are the forms of horizontal trade restraint and defenses?

• Horizontal restraints of trade—anticompetitive behavior among a firm’s competitors

• Price-fixing—controlling price of goods through agreement, limiting supply, controlling credit

• Group boycotts—agreement among competitors to exclude competition

• Joint ventures—temporary combinations that may restrain trade

• Per se violation—violation of antitrust laws that has no defense or justification

• Monopolization—possession of monopoly power in the relevant market by willful acquisition

• Monopsony—control of a market through the control of market supply

• Market power—power to control prices or exclude competition

• Relevant market—geographic and product market used to determine market power

• Predatory pricing—pricing below actual cost to monopolize

• Noerr–Pennington doctrine—protection of First Amendment activities from antitrust laws

What are the forms of vertical trade restraints and defenses?

• Resale price maintenance—requiring prices be set in vertical distribution

• Exclusive distributorship—limited dealership rights; not an antitrust violation as long as horizontal com- petition exists

• Tying—requiring buyers to take an additional prod- uct in order to purchase the product they want

• Price discrimination—selling goods across state lines at prices that have different ratios to marginal costs

Q u e s t i o n s a n d P r o b l e m s 1. Harold Vogel, an experienced gem appraiser, is a member of the American Society of Appraisers. Mr. Vogel’s fee for his work is based on a percentage of the value of the appraised item. The society expelled him under the authority of a bylaw that provides, “It is unprofessional and unethical for the appraiser to do work for a fixed percentage of the amount of value.” Mr. Vogel brought suit under Section 1 of the Sherman Act, alleging that his expulsion was a boycott and that he no longer had referrals from the society. Mr. Vogel also

claims the bylaw is a means of fixing prices. Is he right? [Harold Vogel v American Society of Appraisers, 744 F.2d 598 (7th Cir. 1984)] 2. Booklocker, Inc., is a print-on-demand (POD) book company that specializes in handling the printing of a run of books when there is an online order for those books. Amazon.com facilitated such orders by having customers pay up front for a print run and then placing the order with a POD company. Amazon is the domi- nant channel for those who wish to order books that are

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Chapter 14 Business Competition: Antitrust 517

not available for immediate purchase but must be done through a POD. In April 2005, Amazon acquired Book- Surge, another POD company. BookSurge’s prices are generally higher than those of other POD companies. On February 10, 2008, Amazon began notifying pub- lishers that Amazon would only continue to sell POD books through the Direct Amazon Sales Channel if the publisher agreed to print its books through BookSurge. If publishers and authors wanted to have the POD sales, they had to use Amazon’s printing company. (Brick-and- mortar retailers such as Barnes & Noble do not handle PODs.) Are there any antitrust issues with this require- ment? [BookLocker.com, Inc. v Amazon.com, Inc., 650 F. Supp. 2d (D. Me. 2009)]

3. Amanda Reiss had completed her residency in oph- thalmology in Portland, Oregon, and was moving to Phoenix, Arizona, to start her practice. She began look- ing for office space and met with a leasing agent who showed her several complexes of medical suites. Dr. Reiss was ready to sign for one of them when the leasing agent turned to her and said, “Oh, by the way, you’re not one of those advertising doctors, are you? Because they don’t want that kind in any of my complexes.” Has there been a violation of the antitrust laws?

4. Budget Rent-a-Car and Aloha Airlines have devel- oped a “fly-drive” program. Under their agreement, cus- tomers of Aloha receive a $7 first-day rental rate for car rentals (the usual rate is $14). Robert’s Waikiki U-Drive has brought suit, challenging the agreement as a tying arrangement and unlawful. Is Robert’s correct? [Robert’s Waikiki U-Drive v Budget Rent-a-Car, 732 F.2d 1403 (9th Cir. 1984)]

5. In April 1965, Berkeley Heights Shopping Center leased 11,514 square feet of space to A&P Supermarkets. Under the terms of the lease, Berkeley agreed not to lease any other shopping center space to another grocery store. On April 16, 1977, A&P informed Berkeley that it was ceasing operations and subleasing the premises to Drug Fair, a modern drugstore chain that sells foodstuffs. In 1985, Berkeley sought to lease other space in the center to another grocery store, and Drug Fair objected on the grounds of the covenant not to compete. Berkeley main- tains the covenant only applies when the premises Drug Fair occupies are used as a grocery store operation. Who is correct? [Berkeley Dev. Co. v Great Atlantic & Pacific Tea Co., 518 A.2d 790 (N.J. 1986)]

6. Gardner-Denver, the largest manufacturer of ratchet wrenches and their replacement parts in the United States, has a dual pricing system for wrench parts and components. Its blue list had parts that, if purchased in quantities of five or more, were available for substan- tially less than its white list prices. Has Gardner-Denver

engaged in price discrimination with its two price lists? [D. E. Rogers Assoc., Inc. v Gardner-Denver Co., 718 F.2d 1431 (6th Cir. 1983)]

7. Russell Stover is a candy manufacturer that ships its products to 18,000 retailers nationwide. Stover designates resale prices for its dealers but does not request assur- ances from them that they are honoring the prices. It has, however, refused to sell to those retailers it believes will sell below the prices suggested. Is there an antitrust vio- lation in this conduct? [Russell Stover Candies, Inc. v FTC, 718 F.2d 256 (8th Cir. 1982)]

8. In Arizona, fees for title insurance searches and pol- icies were established by rating bureaus established by the title companies. The bureaus recommended rates to the state, and the state adopted those rates unless some specific objection was made. The result was that title search and insurance fees were the same for all compa- nies within the state. The FTC filed a complaint against the title companies, alleging that they were engaged in price-fixing. The companies responded that government regulation of prices is not price-fixing. Do you agree? [FTC v Ticor Title Ins. Co., 504 U.S. 621 (1992)]

9. Christie’s International and Sotheby’s, international auction houses for art and estate items, are known for their handling of the estates and property of the rich and famous, such as the estate of Jacqueline Kennedy Onas- sis; the gowns of Diana, Princess of Wales; and the effects of Marilyn Monroe. Together, the two firms controlled 95% of the international auction market.

Sotheby’s CEO of more than 20 years, Diana (Dede) Brooks, and Christopher M. Davidge, the CEO of Chris- tie’s, at the direction of their bosses, Sotheby’s chair- man, Sir A. Alfred Taubman, and Christie’s chairman, Sir Anthony Tennant, met to discuss their companies’ charges for commissions. Sir Alfred and Sir Anthony had met and agreed that they were “killing” each other with their competition. Both then directed Brooks and Davidge to reach agreements that ensured their firms’ survivals.

Ms. Brooks and Mr. Davidge then began a series of meetings, many of which were in the backseat of Ms. Brooks’s car as she picked Mr. Davidge up from the airport, in which they discussed the following:

• Their commission rates

• An agreement to publish nonnegotiable commis- sion rates

• An agreement as to who would publish rates first

• Exchange of customer information so that they could monitor each other’s commission rates

• Eliminating interest-free loans to their seller/cus- tomers on consignment arrangements

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518 part 3 Business Sales, Contracts, and Competition

• Eliminating charitable deductions as part of their pricing to sellers

The agreements reached in the town-car meetings worked. In March 1995, Christie’s announced that it was increasing sellers’ fees from a flat commission rate to a sliding scale that ranged from 2% to 20%. In April 1995, Sotheby’s announced the same change. Their rates changed in this pattern until Mr. Davidge was fired in December 1999. Upset about a “paltry” severance pack- age, he turned documents over to the Justice Depart- ment. When Christie’s learned that the documents had been turned over, it announced that it was increasing its buyer’s commission from 15.5% to 18% and charging its sellers less. Seller commissions would drop to between 1% and 5%. Sotheby’s did not follow the change, the first time in the nearly five-year period that there was any difference in the two houses’ commission rates.

The price-fixing charges against the two auction houses involved “conscious parallelism.”

Mr. Taubman denied any involvement in the price-fixing and offered a lie detector test conducted by a former FBI agent to establish that he did not know of the arrangements and communications between Ms. Brooks and Mr. Davidge. The two key questions in the polygraph exam, which Mr. Taubman passed, were the following:

Did you tell Dede Brooks to try and reach an agreement with Davidge regarding amounts to be charged to buyers or sellers?

Did Dede Brooks ever tell you that she had reached an agreement with Davidge about amounts to be charged to buyers and sellers?

Mr. Taubman’s answers of “no” to each of these questions were found to be truthful by the polygraph examiner. The test was conducted without any current law enforcement agents present.

Evaluate whether the actions of “conscious paral- lelism” in pricing violates federal antitrust laws. Also

evaluate whether the executives can be charged with criminal violations of federal antitrust laws. Which fed- eral antitrust statute would apply?

10. Systems and Software, Inc. (SAS), located in Colchester, Vermont, designs, develops, sells, and ser- vices software that allows utility providers to organize their data, including customer information, billing, work management, asset management, and finance and accounting. In August 2002, SAS hired Randy Barnes as an at-will employee to become a regional vice presi- dent of sales. At the time he commenced work for SAS, Barnes signed a noncompetition agreement that, among other things, prohibited him—during his employment and for six months thereafter—from becoming asso- ciated with any business that competes with SAS. In April 2004, Barnes voluntarily left his position with SAS and started a partnership with his wife called Spirit Technologies Consulting Group. Spirit Tech- nologies’ only customer was Utility Solutions, Inc., which, like SAS, services municipalities and utilities nationwide with respect to customer-information-sys- tems software. Shortly after Barnes left SAS, he repre- sented Utility Solutions at a trade fair in a booth near SAS’s booth and identified himself as Utility Solution’s sales director.

SAS filed suit requesting injunctive relief and enforcement of the noncompetition agreement. Barnes says that the effect of enforcement of the clause is to prevent him from working for six months and stopping competition in Vermont. Who is correct on the noncom- petition agreement? Is it valid? Why or why not? [Sys- tems and Software, Inc. v Barnes, 886 A.2d 762, (Vt. 2005)]

11. British Airways and Virgin Atlantic Airlines dis- cussed fuel surcharges at least six times during an 18-month period from 2005 through 2006. As a result, the two companies’ fuel surcharges rose in tandem from 5 pounds (about $10) to 60 pounds (about $120). Would Britain’s Office of Fair Trading be able to establish an antitrust violation?

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Chapter 14 Business Competition: Antitrust 519

Social Responsibility, Collaboration, Strategy, & the Law

Coffee producers have created the Common Code for the Coffee Community (4C), an organization that hopes to improve the economic, social, and environmental conditions of coffee production. The group has a code of conduct that all members must follow, but the members are competitors. If they are to remain in good standing with the group, they must produce, process, and trade coffee according to the Code of Conduct, known as 4C Compliant Coffee. That label on a coffee producer’s packaging has value to consumers. When that label is missing, consumers often decide against purchasing that coffee. Coca-Cola, Pepsi, the World Wildlife Federation, and other organizations joined together to develop plant- based plastics and then agreed to use only those types of plastic bottles, something their competitor might not be able to do. The Bioplastic Feedstock Alliance (BFA) bot- tles carry a label, a label those who do not use the BFA bottles cannot attach.

Legal experts have begun to express concerns about these alliances, undertaken in the name of social responsibility, that give members of the alli- ance a means of competing that those who are not members cannot use.6 In effect, some of the alliances allow horizontal competitors a way to join together to distinguish their products in a way that smaller competitors may not be able to obtain. Because the alli- ances are generally addressing environmental, social, or economic concerns, it becomes a public relations nightmare for smaller firms to oppose the voluntary steps being taken by their large competitors. However, the alliances’ codes often do not permit other compet- itors to join the group or the cost is prohibitive. These alliances may have economic, public relations, or social responsibility motives, but the cooperation does give

them resources for marketing and research that other competitors will not have access to.

One example involved the Fair Factories Clearing- house, an organization of clothing designers and retailers that performs an audit function to be sure their produc- tion facilities meet certain standards. However, those factory audits provided the member competitors with information about costs and, as a result, pricing informa- tion. The sharing of price information is a per se violation for horizontal competitors. Also, the Designated Supplier Program (DSP) , which is part of the Worker Rights Con- sortium, is a group with a board that consists of students from the United Students Against Sweatshops. The DSP was a mandatory list for participating schools; that is, if the clothing companies did not meet DSP standards, then the colleges and universities agreed not to use those suppliers. The DSP standards included a living wage, certain factory conditions, and the right of employees to organize. After the Justice Department began inves- tigating the DPS and would not issue an opinion letter clearing the activities, the DSP program was modified to allow members to make individual choices about carry- ing clothing of manufacturers and retailers listed on the DSP. Group boycotts in the name of social responsibility still present an antitrust problem.

However, the courts’ approach when there are challenges to these collaborations is case by case because they weigh competition, consumer welfare, and efficiency. Even though the cause is good, com- petitors cannot take on self-regulation of markets. The social responsibility alliances are rooted in good intentions and possibly public protection, but the anti- trust laws still apply when competitors collaborate in a good-cause way that lessens competition.

n ot e s 1. Brian X. Chen, “Star Witness in Apple Suit Is Still Jobs,” New York Times, December 1, 2014, p. B1.

2. Thomas Catan, “Gore-Tex Runs into Antitrust Probes,” Wall Street Journal, June 22, 2011, p. B1.

3. The doctrine is named after the two U.S. Supreme Court cases in which it was developed: Eastern R.R. President’s Conference v Noerr Motor Freight, Inc., 365 U.S. 127 (1961), and United Mine Workers v Pennington, 381 U.S. 657 (1965).

4. The author is grateful for the work and insights of Professor Sue Mota, associate dean, College of Business Administration,

Bowling Green State University, Bowling Green, Ohio. More on her work can be found at Sue Mota, “Antitrust Limited: The Supreme Court Reins in Antitrust Enforcement in 2007,” 7 Fla. St. U. Bus. Rev. 1 (2007).

5. Toys “R” Us, Inc. v FTC, (7th Cir. 2000).

6. Inara Scotta, “Antitrust and Socially Responsible Collaboration: A Chilling Combination,” 53 American Business Law Journal 97 (2016).

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520

Chapter

Business and Intellectual Property Law15 The red soles on the bottom of Louboutin designer shoes. That distinctive Burberry plaid. Louis Vuitton. NASCAR. The common thread? They all have lu- crative Iarrangements for their trademarks, images, and symbols. The law affords protection for these images and symbols even though the property right is a bun- dle of images and feelings about a person, business, or logo. This chapter covers the rights of businesses and their intellectual property. Property comes in differ- ent forms, and this chapter focuses on one form of personal property: intellectual property rights. What types of intellectual property does a business own? What are the rights and issues in this property owned by a business? What statutory protections exist for intellectual property? What issues of property protection exist in international business operations? In marketing, we learn the importance of “brand.” This chapter gives the legal backdrop for ensuring a brand’s exclusiv- ity. Protecting the goodwill, symbols, names, and motifs that give a business its identity is an important part of the ongoing success of a business.

Update For up-to-date legal news, go to mariannejennings.com

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521

15-1 What Can a Business Own? Intangible Property Rights

When we see a UPS truck driving along beside us, we understand that UPS owns that truck; it is a part of the UPS fleet and is carried as business equipment on the books of the UPS corporation. If someone took that truck, it would be theft, and UPS would be entitled to compensation if the truck were damaged or destroyed by the theft. UPS would also be entitled to compensation if someone hit the truck in an accident and damaged it. Because the truck is UPS property, it enjoys certain rights of ownership. If someone stole the truck, the business could recover for the damages. However, the business also owns the distinctive brown color and yellow UPS letters that are part of UPS packaging and labels. If someone uses these sym- bols, UPS can recover for the resulting damages.

That distinctive UPS color scheme, name, and writing are also business prop- erty. The recognition and goodwill that come from those brown trucks and yel- low letters are forms of intangible property that enjoy statutory protections. These protections include UPS’s right to prevent others from using its distinctive name and colors, which represent the goodwill and reputation of the company.

Forms of intangible property include patents, copyrights, trademarks, trade names, trade dress, and trade secrets. The protections for these types of property rights come from federal laws, international treaties, and common law rights of action for the damage to or taking of these forms of intangible property.

15-2 Patents Patents are a type of legal monopoly obtained by filing certain information and forms with the U.S. Patent Office. So fundamental is the protection of new prod- ucts and processes that the founding fathers placed protection for inventors in Article 1, Section 8, of the U.S. Constitution.

Happy Birthday to You! Happy Birthday to You! The popular birthday song, which is no longer copyright protected.

We must take care to guard against two extremes equally prejudicial: the one, that men of ability, who have employed their time for the service of the community, may not be deprived of their just merits, and the reward for their ingenuity and labour; the other, that the world may not be deprived of improvements, nor the progress of the arts retarded. Sayre v Moore 102 Eng. Rep. 138, 140 (1785)

Monster Company, the makers of Monster energy drinks, posted a recap video of its “Ruckus in the Rockies” event, a snowboarding competition and after-party. Monster used excerpts of five Beastie Boys songs for the video sound track. Beastie Boys’ music fills all but 32 seconds of the four-minute vid- eo. Monster never obtained permission from the Beastie Boys to use their music or name in the video. Monster posted the video on its website, YouTube

channel, and Facebook page. Counsel for the Beastie Boys sent a letter to Monster pointing out the lack of permission. Monster immediately removed the vid- eo from its YouTube channel, edited out references to the Beastie Boys, replaced the music, and then reposted it. The Beastie Boys sued for damages and a permanent injunction against Monster’s use of the Ruckus video. Are these remedies available to the group?

Consider . . . 15.1

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15-2a the types and Length of patents

There are three forms of patents. Utility or function patents cover machines, pro- cesses, and improvements to existing devices. For example, a computerized method for tracking a dry cleaner’s inventory of clothing is protected by a patent. Prior to 1995, such a patent was valid for 17 years. However, in order to bring the U.S. laws into compliance with GATT provisions (see Chapter 7 for more informa- tion on this treaty), the protection was extended to 20 years. All WTO members follow the 20-year period for protection.

Design patents are those that protect the features of a product. Procter & Gam- ble’s method for putting elasticized legs on its disposable diapers are examples of product designs protected by patent. Some of the litigation between Apple and Samsung was over the shape of the iPhone, a design issue. Design patents are granted for 15 years.

Finally, plant patents are obtained by those who develop new forms of plants and hybrids. Plants patents also carry a 20-year protection.

15-2b What You Can patent: patentability

Because protection is so extensive, an idea is patentable only if it is nonobvi- ous, novel, and useful, and the idea must be reduced to some tangible form. The categories for patent eligibility include processes and machines as well as production of new matter. Whatever the category, the invention or process must be something that is new and nonobvious. New discoveries of existing matter are not patentable, but developing a process to extract that new mat- ter for other use would be. For example, a discovery of a reproductive hor- mone in the male body is not patentable, but a product to stop production of that hormone for birth control purposes can be patented. A microbiologist who developed a bacterium that would break down crude oil, a valuable tool for cleaning up oil spills, was initially denied a patent because he was not manufacturing something but just using something that was living. However, the U.S. Supreme Court has held that developing a method for creating some- thing that exists in nature is protected by the patent laws, such as synthetically generated DNA. [Association for Molecular Pathology v Myriad Genetics, Inc., 133 S.Ct. 2107 (2013)]

Business methods patents have been an area of judicial controversy. For example, patent number 4,022,227, called Method of Concealing Baldness, is a step-by-step process for combing hair so as to create the classic “comb- over” to attempt to conceal baldness. These types of patents, often called junk patents, are distinguishable from those patents that are granted for a business method tied to a machine or step-by-step process for recycling or physical production. The courts have been restricting patents on marketing methods or structuring relationships that do not involve machines and production. In Bilski v Kappos, 561 U.S. 593(2010), the U.S. Supreme Court further restricted the requirements for the patent of a process. In the case, the Supreme Court held that two individuals’ claimed invention for helping buyers and sellers of commodities in the energy market protect, or hedge, against the risk of price changes in the form of a mathematical formula was an “abstract idea” and not a patentable “process.” However, the extent of that decision continues to be refined with, for example, math formulas for correcting code held to be

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Chapter 15 Business and Intellectual Property Law 523

patentable. [California Institute of Technology v Hughes Communications Inc., 59 F. Supp. 3d 974 (C.D. Cal. 2014)]

15-2c the patent process

The America Invents Act (AIA) became effective in 2011. The act is signifi- cant because it changes the effective filing date of a claimed invention as the actual filing date of the patent or application for a patent, which changes us to a “first to invent” system from a “first to file system.” This timing change gives entrepreneurs and inventors greater certainty and also puts the United States on equal footing with other countries that follow this same timing sys- tem. Also, inventors can now apply for an expedited patent process, an option that allows patent application processing within 12 months, reduced from the previous average processing period of three to four years. A special speedy process is also available for inventions that reduce greenhouse emissions or provide energy conservation. Once the patent is issued it is presumed to be valid, but challenges can be made for up to nine months after the date of issue.

15-2d What a patent does

During these exclusive rights periods of 15 and 20 years, the patent holder has the sole rights to profits on sales.

Anyone who sells or uses a patented product or process without the con- sent of the patent holder has committed patent infringement. Infringement entitles the patent holder to a statutory action for damages. The patent holder (the plaintiff) in such a case need only show patent ownership and infringe- ment of that patent. A Patent Office registration for a product or process, how- ever, is not a guarantee of recovery. A court must still agree with the Patent Office determination that the product or process is nonobvious, useful, and novel—that is, an issue in every infringement case is whether the patent was properly granted.

Amazon.com had a battle with Barnes & Noble over the “One-Click” shop- ping method. Amazon.com obtained a patent for its buyers’ shopping method that permits shoppers to place items in a virtual shopping cart and then click just one button when they are ready to purchase. The buyers need not go through the process of filling in shipping, billing, and credit information for each purchase.

Barnes & Noble created a similar “One-Click” shopping experience for its online customers, and Amazon.com sued for patent infringement. On appeal, a court held that Barnes & Noble could continue to use the “One-Click” method while the parties proceeded to trial on the issue of whether the “One-Click” patent was a valid one or simply an obvious convenience for online shoppers. The parties then settled the case. [Amazon.com, Inc. v Barnes & Noble.com, 239 F.3d 1343 (Fed. Cir. 2001)]

On the other hand, the peculiar shading and look of Oakley sunglasses sur- vived judicial review and the court ordered an injunction against Sunglass Hut and others from selling sunglasses that had the same green or blue lens tinting for which Oakley held a patent. [Oakley, Inc. v Sunglass Hut Intern., 2001 WL 1683252, 61 U.S.P.Q.2d 1658 (C.D. Cal., Dec. 7, 2001)]

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15-2e the Remedies for patent Infringement

Two types of remedies are available for patent infringement: monetary damages and injunctions. Injunctions can be temporary, as when the court orders a halt to production or use whilst it determines whether a patent is valid. However, there is also the possibility of a permanent injunction, one that stops the other party from using the process or product for the life of the patent because the injury to the patent holder is so great that money damages are insufficient compensation. One of the patent issues that has emerged in cyberspace is the use of permanent injunctions against competitors to prevent the use of patented processes, even with compensation. In eBay, Inc. v MercExchange (Case 15.1), the U.S. Supreme Court dealt with this important issue.

Procter & Gamble (P&G) was issued patent number 4,455,333 on June 19, 1984, for an invention entitled “Doughs and Cookies Pro- viding Storage-Stable Texture Variety.” The patent covers a method of manufacturing ready-to-serve cookies that remain crispy on the outside and chewy on the inside for an extended shelf life. P&G markets these cookies under the Duncan Hines label.

P&G brought a patent infringement action against Nabisco Brands, Inc., which markets its own lines of dual-textured

cookies called “Almost Home” and “Chewy Chips Ahoy.” P&G also sued Keebler Com- pany for its dual-textured cookie called “Soft Batch” and Frito-Lay, Inc., for its “Grandma’s Rich and Chewy.” Each of the defendants denies infringement. They have moved for dismissal of the case on grounds that the patent is invalid because baking cookies is not patentable. Do you agree? Would you protect P&G’s process?

[Procter & Gamble Co. v Nabisco Brands, Inc., 604 F. Supp. 1485 (D.C. Del. 1985)]

Consider . . . 15.2

dealt with this important issue.

eBay, Inc. v MercExchange, LLC 547 U.S. 388 (2006)

Whether “Buy It Now” Is Halted for 20 Years

Case 15.1

FaCts

eBay and its subsidiary, half.com, operate popular web- sites that allow private sellers to list goods they wish to sell at either an auction or a fixed price (its “Buy it Now” feature). MercExchange, LLC, sought to license its business-method patent to eBay, but the two companies could not reach an agreement. eBay still used the “Buy It Now” process. MercExchange filed suit for patent infringement and a jury found that eBay had infringed a valid patent and awarded MercExchange $29.5 mil- lion in damages. MercExchange requested a permanent injunction against eBay for use of its process, but the trial court denied the motion. The Court of Appeals reversed and the U.S. Supreme Court granted certiorari.

JUdICIaL OpInIOn

THOMAS, Justice According to well-established principles of equity,

a plaintiff seeking a permanent injunction must satisfy a four-factor test before a court may grant such relief. A plaintiff must demonstrate: (1) that it has suffered an irreparable injury; (2) that remedies available at law, such as monetary damages, are inadequate to compensate for that injury; (3) that, considering the balance of hardships between the plaintiff and defendant, a remedy in equity is warranted; and (4) that the public interest would not be disserved by a permanent injunction. . . . The decision to grant or deny permanent injunctive relief is an act of equitable discretion by the district court.

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Chapter 15 Business and Intellectual Property Law 525

The Patent Act . . . declares that “patents shall have the attributes of personal property,” including “the right to exclude others from making, using, offering for sale, or selling the invention.” According to the Court of Appeals, this statutory right to exclude alone justifies its general rule in favor of permanent injunctive relief. But the creation of a right is distinct from the provision of remedies for violations of that right. Indeed, the Patent Act itself indicates that patents shall have the attributes of personal property “[s]ubject to the provisions of this title,” including, presumably, the provision that injunc- tive relief “may” issue only “in accordance with the prin- ciples of equity,” . . . Because we conclude that neither court below correctly applied the traditional four-factor framework that governs the award of injunctive relief, we vacate the judgment of the Court of Appeals, so that the District Court may apply that framework in the first instance. In doing so, we take no position on whether permanent injunctive relief should or should not issue in this particular case, or indeed in any number of other disputes arising under the Patent Act . . .

COnCURRInG OpInIOn

Justice Kennedy, with whom Justice Stevens, Justice Souter, and Justice Breyer join, concurring . . .

To the extent earlier cases establish a pattern of granting an injunction against patent infringers almost as a matter of course, this pattern simply illustrates the result of the four-factor test in the contexts then prev- alent. The lesson of the historical practice, therefore, is most helpful and instructive when the circumstances of a case bear substantial parallels to litigation the courts have confronted before.

In cases now arising trial courts should bear in mind that in many instances the nature of the patent being enforced and the economic function of the pat- ent holder present considerations quite unlike earlier cases. An industry has developed in which firms use patents not as a basis for producing and selling goods but, instead, primarily for obtaining licensing fees.

For these firms, an injunction, and the potentially seri- ous sanctions arising from its violation, can be employed as a bargaining tool to charge exorbitant fees to compa- nies that seek to buy licenses to practice the patent.

When the patented invention is but a small com- ponent of the product the companies seek to produce and the threat of an injunction is employed simply for undue leverage in negotiations, legal damages may well be sufficient to compensate for the infringement and an injunction may not serve the public interest. In addition injunctive relief may have different con- sequences for the burgeoning number of patents over business methods, which were not of much economic and legal significance in earlier times. The potential vagueness and suspect validity of some of these patents may affect the calculus under the four-factor test. . . .

Reversed and Remanded.

Case QUestIOns

1. Why is this type of patent different from the tra- ditional product patents?

2. What are the risks in granting a permanent injunction in cases such as these?

3. Why are the concurring judges raising the issue of undue leverage?

15-3 Copyrights 15-3a What Is a Copyright and What does It protect?

Patents protect inventors. Copyrights protect authors of books, magazine articles, plays, movies, songs, dances, recordings, architectural designs, broadcasts, pho- tographs, computer programs, and so on. Ideas cannot be copyrighted, but the way an idea is expressed can be. Under the Computer Software Copyright Act of 1980, all software can be copyrighted, whether it is written in ordinary language (source code) or machine language (object code). Although software copyrights do not cover methods of operation (such as menus), they do cover the underlying programs.

A copyright gives the holder of the copyright the exclusive right to sell, control, or license the copyrighted work. A copyright exists automatically for works cre- ated after 1989. Although the placement of the traditional C or copyright symbol (©) is not required, it is recommended. Further, the existence of a copyright in the United States is recognized in all nations that have signed the Berne Convention.

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For example, the transmission of NFL games by satellite to Canada is a violation of U.S. copyright laws because Canada is a signatory to the Berne Convention. Under the terms of the Berne Convention and U.S. law, copyright registration is not required, but it is recommended. Registration is a means of preventing some- one violating the copyright from claiming a lack of knowledge about the work’s protection. In order to register a copyright, the creator need only file two copies of the work with the Copyright Office in Washington, D.C. Without copyright regis- tration, the owner cannot bring a suit for copyright infringement.

15-3b the Rights of Copyright Holders against third-party Infringers

Copyright holders also have the right to enforce their copyright against those who are vicariously allowing infringement. Those who develop programs or facilitate infringement can be liable for infringement vicariously, and copyright holders have the right to obtain injunctions to stop their facilitation of infringement by oth- ers. Those who distribute software that facilitates peer-to-peer file sharing can be liable for infringement by the file sharers. Sony BMG Music Entertainment v Tenen- baum (Case 15.2) deals with an issue of a student’s vicarious liability for facilitating infringement.

Sony BMG Music Entertainment v Tenenbaum 660 F.3d 487 (1st. Cir. 2011)

College Entertainment Coordinator and Infringement Facilitator

Case 15.2

FaCts

Joel Tenenbaum was a student at Goucher College who developed file-sharing software that permitted 30 music recordings copyrighted by Sony (plaintiffs) to be down- loaded and distributed without Sony’s authorization. Sony brought suit for damages and a permanent injunc- tion. The district court entered judgment against Tenen- baum as to liability. The jury found that Tenenbaum’s infringement of the copyrights at issue was willful and awarded Sony statutory damages of $22,500 for each infringed recording. Tenenbaum’s request for a reduc- tion in damages (remittitur) from $675,000 was granted by the trial court and the damages were reduced by a factor of 10. Tenenbaum’s request for a dismissal on the grounds that his infringement was not willful was denied. Both Sony and Tenenbaum appealed.

JUdICIaL OpInIOn

LYNCH, Chief Judge Tenenbaum was an early and enthusiastic user of peer-to-peer networks to obtain and distribute copy- righted music recordings. He began downloading and

distributing copyrighted works without authorization in 1999.

Because it enabled copyright infringement, see A & M Records, Inc. v Napster, Inc., 239 F.3d 1004 (9th Cir. 2001), the Napster network was shut down in 2001. This did not stop Tenenbaum from downloading and distributing copyrighted works; he instead began using other peer-to- peer networks for the same illegal purposes. These net- works included AudioGalaxy, iMesh, Morpheus, Kazaa, and Limewire. Tenenbaum shifted to these other net- works after Napster’s termination despite his knowledge that Napster was forced to close on account of a lawsuit brought against it for copyright infringement.

Tenenbaum continued to download and dis- tribute copyrighted materials through at least 2007. During that time span he accessed a panoply of peer-to-peer networks for these illegal purposes from several computers. From 1999 until 2002, he primarily downloaded and distributed copyright- ed works to and from his desktop computer at his family’s home in Providence. He left home to attend Goucher College in Baltimore, Maryland, in 2002, at

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which point he began using a laptop to download and distribute copyrighted works. Following his graduation from Goucher in 2006, he began using a second laptop for these purposes in tandem with his other computers. Over the duration of Tenenbaum’s conduct, he intentionally downloaded thousands of songs to his own computers from other network users. He also purposefully made thousands of songs available to other network users. At one point in time in 2004 alone, Tenenbaum had 1153 songs on his “shared-directory” on the Kazaa network. Most of the networks Tenenbaum used had a “traffic tab” that informed him of the frequency with which other users were downloading his shared files. Tenenbaum regularly looked at the traffic tab, and he admitted it “definitely wasn’t uncommon” for other users to be downloading materials from his computer.

While Tenenbaum was at Goucher College in 2002, his father, Dr. Arthur Tenenbaum, called him to warn him that his use of peer-to-peer networks to obtain and distribute music recordings was unlawful. Dr. Tenen- baum knew that his son was illegally downloading music because, prior to leaving for college, Tenenbaum had showed his father the array of songs that could be downloaded from the Kazaa network. After Dr. Tenen- baum became aware that lawsuits were being brought against individuals who used file-sharing programs to download and distribute music, he instructed Tenen- baum not to continue to engage in such conduct. Dr. Tenenbaum testified that, during their conversation, Tenenbaum did not appear concerned about the con- sequences of his actions. Despite his father’s request, Tenenbaum continued his illegal activity.

Tenenbaum also received direct warnings from Goucher College. Each year Tenenbaum received a Goucher student handbook warning that using the college’s network to download and distribute copy- righted materials was illegal, but he did so anyway. The handbook also warned that illegally downloading and distributing music files could subject the copyright infringer to up to $150,000 of liability per infringement, alerting Tenenbaum to his potential exposure for vio- lating the law. Tenenbaum received handbooks con- taining similar language during each of his four years at Goucher, but was unfazed and continued.

Tenenbaum also knew the college took this serious- ly and had itself acted to stop this illegal activity. By the end of his undergraduate studies at Goucher, the school had implemented so many technological restric- tions on its network—which he knew were designed to prevent illegal downloading of music files—that peer- to-peer programs “wouldn’t work at all.”

The Tenenbaums’ Internet service provider at home in Providence, Cox Communications, also warned

against using the Internet to illegally infringe copyright- ed materials. In a September 2005 letter, plaintiffs them- selves informed Tenenbaum that he had been detected infringing copyrighted materials and notified him that his conduct was illegal. The letter stated: “We are writing in advance of filing suit against you in the event that you have an interest in resolving these claims.” The letter urged Tenenbaum to consult with an attorney immediate- ly, and explained that the recording companies were pre- pared to initiate a legal action against Tenenbaum because of the severe impact of his actions on the industry:

Copyright theft is not a victimless crime. People spend countless hours working hard to create music—not just recording artists and songwriters, but also session players, backup singers, sound engineers and other technicians. In addition, the music industry employ thousands of other people, such as CD-plant workers, warehouse personnel, record store clerks and developers of legitimate online music services. They all depend on sale of recordings to earn a living. So do record compa- nies, which routinely invest millions of dollars to dis- cover and sign promising artists, and then to produce and market their recordings. In addition, piracy eats away at the investment dollars available to fund new music and, in effect, erodes the future of music.

The letter also instructed Tenenbaum to preserve any relevant evidence including “the entire library of recordings that you have made available for distribution as well as any recordings you have downloaded. . . .”

After receiving this letter, Tenenbaum nonetheless took his laptop computer for repairs and had its oper- ating system reinstalled and its hard drive reformatted. At trial, Tenenbaum maintained that he only had work done on the computer because “the thing wouldn’t run,” and that he instructed the computer repairman not to tamper with the music files stored on his computer.

Despite these warnings and his knowledge that he was and had been engaging in illegal activity which could subject him to liability of up to $150,000 per infringement, Tenenbaum continued the illegal downloading and dis- tribution of copyrighted materials until a full two years after receiving the letter from Sony. He stopped his activi- ty only after this lawsuit was filed against him.

Strong evidence established that Tenenbaum lied in the course of these legal proceedings in a number of ways. In his initial responses to Sony’s discovery requests, Tenenbaum represented he “had no knowl- edge or recollection of online media distribution systems used or any dates” of such use. He also denied creating or using the “sublimeguy14@ kazaa” account name that he had used to access various peer-to-peer networks,

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528 part 3 Business Sales, Contracts, and Competition

and he denied any knowledge of whether a peer-to-peer network had been installed on his computer.

At trial, however, Tenenbaum admitted that each of these statements he had made was false. He made numerous admissions in his testimony as to the scope of his conduct from 1999 until 2007.

Before the trial, Tenenbaum also attempted to shift responsibility for his conduct to other individuals by claiming they could have used his computer in order to illegally download and distribute the copyrighted works. These individuals included a foster child living in his family’s home, burglars who had broken into the home, his family’s house guest, and his own sisters. His sisters and others he blamed testified that they had never illegally downloaded music and had no knowledge of who installed the file sharing software on Tenenbaum’s computer.

We affirm the finding of liability against Tenenbaum and in favor of plaintiffs. We affirm the injunctive relief. We vacate the district court’s due process damages ruling and reverse the reduction of the jury’s statutory damages award. We reinstate the jury’s award of damag- es and remand for consideration of defendant’s motion for common law remittitur based on excessiveness.

If, on remand, the court allows any reduction through remittitur, then plaintiffs must be given the choice of a new trial or acceptance of remittitur.

Case QUestIOns

1. What does the court highlight as proof of his intent to infringe the copyright?

2. Explain what will be done with the damages issue.

3. What advice would you give to friends who are downloading music on peer-to-peer programs?

15-3c How Long does a Copyright Run?

Like patents, copyrights are so important that they are found in Article I, Section 8, of the U.S. Constitution, which provides that Congress can secure “for limited times to Authors and Inventors the exclusive Right to their respective Writings and Discoveries.” The initial period of protection for copyrights (established in 1790), one that covered books, maps, and charts, was for 14 years with the right of renewal for another 14 years. In 1831, the protection period increased to 28 years with renewal rights for another 14. In 1909, the time expanded to 28 years with a 28-year renewal. In 1976, the time was increased to 50 years with no renewal. Under the Sonny Bono Copyright Extension Act of 1998, passed as the copyright on Mickey Mouse was about to expire, copyrights were increased to run for the life of the creator plus 70 years. If the work produced was done by an employee of a business, the business then registers the copyright. These types of business copy- rights run for 120 years from the time of creation or 95 years from publication of

Ethical Issues

Evaluate Joel Tenenbaum’s ethics in his long-standing facilitation of file-sharing copyrighted materials. Discuss his misrepresentations prior to trial.

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Be certain your em- ployees understand the copyrighted nature of computer software and the protections afforded to the owners of those programs. Tell them that there are both criminal and civil penal- ties for infringement of software programs.

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Chapter 15 Business and Intellectual Property Law 529

the work, whichever is shorter. The late Representative Sonny Bono led the charge for the increased protection period concerned because copyrights he and many others held were about to expire. Even though the Constitution prohibits granting copyrights in perpetuity, a clear trend in congressional actions favors extending the protection period.

15-3d Rights of a Copyright Holder

A copyright holder has control over the use of the created work. That control includes control over reproduction, distribution, public performances, derivative works, and public displays. Some copyright holders assign or license these rights to others in exchange for royalties. For example, most songwriters assign their rights for public performances of their songs to the American Society of Compos- ers, Authors, and Publishers (ASCAP) and Broadcast Music, Inc. (BMI), who then pay the writers each time their song is used, according to a previously determined schedule of fees. An international fee schedule for payment for tapes, CDs, and records is also in place; it could be a flat fee, a per-minute fee, a per-record fee, or a per-song fee. “Bumper” music played on talk-radio stations is always less than a minute to avoid the significant charges that would result.

Damages for copyright infringement include profits made by the infringer, actual costs, attorney fees, and any other expenses associated with the infringe- ment action. A court can order all illegal copies destroyed and issue an injunction that halts distribution of the illegal copies. In addition to civil recovery for the damages from infringement, federal criminal penalties for copyright infringement can be imposed when the infringement is willful and for “commercial advantage or private financial gain.”

Rights of Copyright Holders and the Internet Technology has created new issues in copyright infringement, particularly in the areas of copyrighted software and music, with the availability of digital technol- ogy. For example, the Tenenbaum case illustrates how colleges can be used to facili- tate file sharing.

As a result, music producers and software developers added protection tech- nology to their copyrighted products and lobbied for a change in copyright law, which came with the Digital Millennium Copyright Act (DMCA) in 1998. This act criminalizes the circumvention of protection technology in order to make cop- ies of copyrighted materials. Assisting others, providing expertise, and manufac- turing products to circumvent protection technology are also criminal activities under the DMCA. Circumvention and facilitating circumvention are now viola- tions of copyright laws. The liability has also been extended to those who facilitate the infringement via downloading programs. Individuals who maneuver around encryption devices and those who hire them to avoid those devices, as in the case of industrial espionage, may face criminal sanctions.

However, thanks largely to the lobbying efforts of colleges and universities, the DMCA has a safe harbor provision. Internet service providers (ISPs) do not have vicarious liability for copyright infringement by their users (such as for download- ing copyright music and films without payment) if the ISPs can establish that they did not know of the infringement, that they are not benefiting from the infringe- ment, that they take action when they know of the infringement, and that they have policies and procedures in place to warn of and prevent infringement. For example, Google’s YouTube has several clips from copyrighted television shows

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and movies. However, Google is not responsible for the posting of the clips; indi- viduals post the clips. In Viacom International, Inc. v YouTube, Inc., 676 F.3d 19 (2nd Cir. 2012) a federal district court held that Google had not violated the DMCA by continuing to allow copyrighted clips to post on its site as long as it had the clips removed upon request by the owner. The key to infringement liability immunity is prompt removal upon request as well as advance warning. When you obtained access to the college or university’s website, you agreed to abide by its standards as well as U.S. copyright laws. In fact, you agreed that your access rights could be terminated if you violated their rules or U.S. law.

Fair Use and Copyrights When the copyright laws were amended in 1976, one change permitted “fair use” of copyrighted materials. Fair use is occasional and spontaneous use of copyrighted materials for limited purposes—for example, a short quote from a copyrighted work. Fair use also allows instructors to reproduce a page or chart from a copyrighted work to use in the classroom. Copies of book pages also can be made for research purposes. The three key questions to ask on fair use are the following:

1. Is the use for commercial or nonprofit/educational use? 2. Is the work large or small or a song, poem, or book? Using a sentence from a

book is different from using a sentence from a poem. 3. What is the effect of the use on the copyrighted work? If you copy a book, the

author and publisher lose sales. If you use a clip from a film, folks may rent or buy the film, and you may actually increase sales.

Photocopying of articles for use in the classroom or workplace is a common practice, but it does not always comply with the protections afforded to the copy- right owners of that article. For example, in American Geophysical Union v Texaco Inc., 60 F.3d 913 (2nd Cir. 1995), the court held that Texaco scientists’ copying of articles from journals for use by fellow scientists at the company was not fair use but infringement because it deprived the journals of subscription revenues or reve- nues from licenses for reproduction of the articles. Likewise, in Princeton University Press v Michigan Document Services, Inc., 99 F.3d 1381 (6th Cir. 1996), the court held that the reproduction of course packs by the University of Michigan for sale to its students was not a fair use by a nonprofit educational institution. The failure to pay royalties to copyright holders not only deprived the holders of their rights but also placed the for-profit copy shops at a competitive disadvantage because

Ethical Issues

Google has been copying and posting por- tions of books and, in some cases, full books for access via the Google search system. Google refers to many of the excerpts as “snippets.” However, authors

have filed a class action suit against Google for infringement. Evaluate the legal issues in the use of snippets. Evaluate the ethical issues in Google’s mass reproduction of the books. ©

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Chapter 15 Business and Intellectual Property Law 531

they were required to pay such royalties. Because of that case, the reproduction of course materials is now outsourced to professional copying services that also han- dle the permissions rights for the materials.

One interesting question that has arisen is the relationship between the notion of fair use and the prohibitions under the DMCA. Can a professor circumvent pro- tection technology for fair use in the classroom? Some feel the professor can do so if he or she has purchased the work. In other words, the professor can use an excerpt from the Beatles’ White Album if the professor owns that album.

Another matter in fair use involves First Amendment issues. For example, satir- ical works use the lyrics and speech of others as a form of social commentary, such as that found in Mad Magazine and Saturday Night Live. The First Amendment pro- tects social commentary, and the copyright laws protect original work. In Camp- bell v Acuff-Rose Music, Inc., 510 U.S. 569 (1994), the U.S. Supreme Court issued its definitive guidelines on satire and copyright. 2 Live Crew, a popular rap musical group, recorded and performed “Pretty Woman,” a rap music version of Roy Orbison’s famed 1964 “Oh, Pretty Woman” rock ballad. The song was written by Mr. Orbison and William Dees, and the rights to the song were assigned to Acuff- Rose Music, Inc. 2 Live Crew’s manager had written to Acuff-Rose to request per- mission to do the parody and offered to pay for rights to do so but was denied permission. 2 Live Crew released the song anyway, and Acuff-Rose filed suit for copyright infringement. The court held that commercial use of copyrighted mate- rial does not render its use presumptively unfair. The court also held that copying excessively is not a bar to fair use when there is parodic purpose in the use of the copyrighted material.

Given that holding, the courts have been inundated with cases in which commercial use in parody form is incorporated into products. For example, in Louis Vuitton Malletier v My Other Bag, Inc. (Case 15.3), the court was faced with a suit involving a product that was a parody of an expensive product.

Louis Vuitton Malletier v My Other Bag, Inc. 2016 WL 70026 (S.D.N.Y. 2016)

Louis: Ridicule in the Bag

Case 15.3

FaCts

My Other Bag, Inc. (“MOB”) (Defendant), sells simple canvas tote bags with the text “My Other Bag . . .” on one side and drawings meant to evoke iconic handbags by luxury designers, such as Louis Vuitton, Chanel, and Fendi, on the other. MOB’s totes—indeed, its very name—are a play on the classic “my other car . . .” novelty bumper stickers, which can be seen on inexpensive, beat-up cars across the country informing passersby—with tongue firmly in cheek—that the driv- er’s “other car” is a Mercedes (or some other luxury car brand). The “my other car” bumper stickers are, of course, a joke—a riff, if you will, on wealth, luxury

brands, and the social expectations of who would be driving luxury and non-luxury cars. MOB’s totes are just as obviously a joke, and one does not necessarily need to be familiar with the “my other car” trope to get the joke or to get the fact that the totes are meant to be taken in jest.

Louis Vuitton Malletier, S.A., the maker of Louis Vuitton bags, is perhaps unfamiliar with the “my other car” trope. Or maybe it just cannot take a joke. In either case, it brings claims against MOB with respect to MOB totes that are concededly meant to evoke iconic Louis Vuitton bags. Louis Vuitton brings claims against MOB, among other things, for copyright infringement.

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MOB moved for summary judgment on all of Louis Vuitton’s claims; Louis Vuitton cross moved for sum- mary judgment on its copyright infringement claim.

JUdICIaL OpInIOn

FURMAN, District Judge While Louis Vuitton sells its handbags for hundreds,

if not thousands, of dollars apiece, MOB’s totes sell at prices between thirty and fifty-five dollars. Its website and other marketing play up the idea that high-priced designer bags cannot be used to carry around, say, dirty gym clothes or messy groceries, while its casual canvas totes can. (“[T]his luncheon worthy designer bag doesn’t fit in at the gym, BUT My Other Bag . . . DOES . . .”).

Louis Vuitton protests that, even if MOB’s totes are a parody of something, they are not a parody of its handbags and, relatedly, that MOB’s argument is a post hoc fabrication for purposes of this litigation. The com- pany notes that MOB’s Chief Executive Officer, Tara Martin, has referred to its bags as “iconic” and stated that she never intended to disparage Louis Vuitton. Thus, Louis Vuitton argues, the “My Other Bag .  .  .” joke mocks only MOB itself or, to the extent it has a broader target, “any humor is merely part of a larger social commentary, not a parody directed towards Louis Vuitton or its products.

Louis Vuitton’s handbags are an integral part of the joke that gives MOB its name and features prominently on every tote bag that MOB sells. In arguing otherwise, Louis Vuitton takes too narrow a view of what can qualify as a parody. The quip “My Other Bag . . . is a Louis Vuitton,” printed on a workhorse canvas bag, derives its humor from a constellation of features— including the features of the canvas bag itself, society’s larger obsession with status symbols, and the meticu- lously promoted image of expensive taste (or showy status) that Louis Vuitton handbags have, to many, come to symbolize. The fact that MOB’s totes convey a message about more than just Louis Vuitton bags is not fatal to a successful parody defense.

Any use by MOB of copyrightable elements of Louis Vuitton’s prints qualifies as a matter of law as “fair use.” “[F]air use of a copyrighted work . . . is not an infringement of copyright.” Parody, like other forms of comment or criticism, “has an obvious claim to trans- formative value” and may therefore be “fair use” under the Copyright Act. Of course, not all parody is protect- ed; instead, parody, “like any other use, has to work its way through the relevant factors, and be judged case by case, in light of the ends of the copyright law.” Thus, in considering whether MOB’s use of any copyrightable material is “fair,” the Court must consider the totality of the circumstances, including the following factors: “(1)

the purpose and character of the use, including whether such use is of a commercial nature or is for nonprofit educational uses; (2) the nature of the copyrighted work; (3) the amount and substantiality of the portion used in relation to the copyrighted work as a whole; and (4) the effect of the use upon the potential market for or value of the copyrighted work.”

[T]he Court concludes that MOB’s tote bags are protected by the fair use doctrine. First, although commercial use “tends to weigh against a finding of fair use,” it is not presumptively unfair. Parody, even when done for commercial gain, can be fair use.. The second factor, the nature of the copyrighted work, does not provide “much help . . . in a parody case, since parodies almost invariably copy publicly known, expressive works.” The third factor requires a court to assess whether “‘the amount and substantiality of the portion used in relation to the copyrighted work as a whole’ . . . are reasonable in relation to the purpose of the copying.” Here, MOB’s use of Louis Vuitton’s patterns is reasonable in relation to the purpose of the use—after all, MOB’s totes must successfully conjure Louis Vuitton’s handbags in order to make sense. Final- ly, although MOB’s totes are, in an abstract sense, in the same market as Louis Vuitton’s handbags, its totes do not “serve[ ] as a market replacement for” Louis Vuitton’s bags in a way that would make “it likely that cognizable market harm to [Louis Vuitton] will occur.” Indeed, any reasonable observer would grasp that the whole point of MOB’s invocation of the “my other car . . .” trope is to communicate that MOB’s totes are not replacements for Louis Vuitton’s designer handbags.

Louis Vuitton is, by its own description, an “active[ ] and aggressive [ ]” enforcer of its trademark rights. In some cases, however, it is better to “accept the implied compliment in [a] parody” and to smile or laugh than it is to sue. This is such a case. MOB’s use of Louis Vuit- ton’s marks in service of what is an obvious attempt at humor is not likely to cause confusion or the blur- ring of the distinctiveness of Louis Vuitton’s marks; if anything, it is likely only to reinforce and enhance the distinctiveness and notoriety of the famous brand. Accordingly, and for the reasons stated above, MOB is entitled to summary judgment on all of Louis Vuitton’s claims; it follows that Louis Vuitton’s own motion for partial summary judgment must be and is denied.

Case QUestIOns

1. Explain the parody that My Other Bag makes.

2. Why does the court find the bags are a parody?

3. What advice does the court offer Louis Vuitton at the end of its opinion?

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15-4 Trademarks 15-4a What are trademarks?

Trademarks are words, names, symbols, designs, or devices that businesses use to identify their products or services. To be protected, a trademark must have some distinctiveness. There are categories for distinctiveness including fanciful (M&Ms or Xerox), descriptive (Sports Illustrated or the Wall Street Journal), arbitrary (such as the use of the word “Apple” for computers), or acquired distinctiveness (such as the Mercedes-Benz triangle coming to represent the car and the company). Generic terms can- not be trademarks, and the failure to enforce the use of a trade- mark can cause it to fall into generic use. Some other examples of trademarks include Owens Corning’s use of the color pink for its insulation (fanciful and distinctive). No other insulation company can have pink insulation, and the use of the Pink Panther reminds us of the company’s unique product. If the symbol is one for a service, such as the symbol for “Martinizing” at the dry cleaners, it is a service mark.

John David California has written a sequel to J. D. Salinger’s The Catcher in the Rye. Salinger and the Salinger Literary Trust brought suit, J.D. Salinger v John Doe, 607 F.3d 68 (2nd Cir. 2010), seeking an injunction to halt the reproduction, publication, adver- tisement, distribution, or other dissemina- tion of the book, which is entitled 60 Years Later: Coming Through the Rye, to be pub- lished by Windupbird and Nicotext. Salinger (and subsequently his estate) alleged in the suit that the book is an unauthorized sequel of the acclaimed copyrighted novel that Sa- linger wrote. Salinger’s estate based its suit for infringement on the use of the character Holden Caulfield of Catcher, who is the nar- rator and the very essence of the novel. At the time of the suit, the sequel was avail- able in Britain and at Amazon.com but had not yet been distributed in bookstores.

Catcher in the Rye is one of the all-time classic American novels, named one of 100 the best novels by both Time maga- zine and The Modern Library, and is taught in schools across the country. It has been described in reviews as “a crucial American

novel . . . ,” an “unusually brilliant novel,” and “a cult book, a rite of passage for the brainy and disaffected” (New York Times).

The sequel begins, as does Catcher, with Holden Caulfield’s departure from an institution (prep school in Catcher, a nurs- ing home in the sequel) and ends with Holden and his sister Phoebe at the car- ousel in Central Park. In between, Holden hangs out aimlessly in New York for a few days, encountering many of the same peo- ple, visiting many of the same settings, and ruminating. The sequel is not a parody, and it does not comment upon or criticize the original.

Mr. Salinger never allowed any deriv- ative works to be made using either The Catcher in the Rye or his Holden Caulfield character. Indeed, in 1980, Salinger stated to the press, “There’s no more to Holden Caulfield. Read the book again. It’s all there. Holden Caulfield is only a frozen moment in time.”1 Is the sequel infringement? Would the court be justified in issuing a temporary and/or permanent injunction against its pub- lication and distribution? Why or why not?

Consider . . . 15.3

To be certain that federal protection for your intangible property rights is maxi- mized, put either the “®” by the trade name or trademark or place the words “Registered in U.S. Patent and Trademark Office” or “Reg. U.S. Pat. & TM. Off.” on the packaging or product. Once you are registered with the U.S. Patent and Trademark Office, obtaining registrations in other countries becomes much easier. Also, a registered product means that U.S. Customs officials exclude products from entry if they infringe a registered property right.

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15-4b What are the Legal protections for trademarks?

The Lanham Act of 1946 is a federal law passed to afford busi- nesses protection of their trademarks. This law is really a protec- tion of a company’s goodwill. A trademark becomes associated with that company and is used as a means of identifying that company’s goods or services. The Lanham Act assures the right to retain that unique identification.

To obtain the federal protection, which lasts in perpetuity as long as the owner enforces the rights, the trademark must be reg- istered with the Patent and Trademark Office (PTO). To be a valid trademark, the mark must serve to distinguish the company’s goods or services from others. The Principal Register at the PTO is the official recording of the trademark rights. From the time of the registration, others have five years to contest the grant of a trademark. If, after five years, there has been no contest, the trademark belongs to the registered owner and is incontestable. Trademarks can also be reserved in advance of beginning a busi-

ness, but the business must be started within 36 months of the time the trademark is reserved.

Trademarks are also protected internationally through the Madrid System of International Registration of Marks, known as the Madrid Protocol. The United States became a signatory to that agreement in 2003. Once a U.S. company has reg- istered its trademark in the United States, it can then do the same in the other 60 countries that have adopted the Madrid Protocol and obtain protection in those countries as well.

15-4c enforcing trademarks and the Risk of Going Generic

Once a trademark is registered, the holder must self-enforce the unique nature of that trademark. The owner must take care so that the trademark does not fall into common use by the public as a descriptive or generic term. For example, there are “Band-Aid brand adhesive strips” instead of “Band-Aids.” There is “Jell-O

Before you pay for a copyright or a trademark, be sure the seller owns the intellectual property and has the authori- ty to sell it. The Lyons Group, owner and developer of Barney, the large, childlike purple dinosaur of PBS fame, purchased the rights to Barney’s “I Love You” theme song from Lee Bernstein. Jean Warren, a music publisher from Everett, Washing- ton, surfaced in 1995 and told the Lyons Group that Ms. Bernstein had sold her the rights in 1983. The result was litiga- tion involving all the parties.

Infringement suit to protect the Brand

Business Strategy

French footwear designer Christian Loubou- tin brought action against designer Yves Saint Laurent (YSL), alleging that YSL violat- ed the Lanham Act by producing “high fash- ion” shoes with Louboutin’s trademarked, signature-lacquered red outsoles. Loubou- tin claimed trademark dilution. YSL coun- terclaimed in the suit for cancellation of designer’s trademark registration, arguing that Louboutin cannot trademark a color. Although the companies tried to settle the

suit, the result was an intellectual property battle over the exclusivity of the colored sole. The federal district court denied Louboutin’s 2011 motion for preliminary injunction, and Louboutin appealed.

What should the court decide? Is it possi- ble that a color allows people to say, “That’s a Louboutin shoe!” Is the colored sole a marketing strategy? [Christian Louboutin v Yves Saint Laurent America Holding, Inc. et al., 696 F.3d 206 (2nd Cir. 2012)] ©

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Chapter 15 Business and Intellectual Property Law 535

brand gelatin dessert” instead of “Jell-O.” There are “Formica brand kitchen coun- tertops” instead of “Formica” ones and “Rollerblade in-line skates” instead of “ Rollerblades.” Parker Brothers lost its “Monopoly” trademark because there is no generic term for its type of board game. Other examples of generics are “aspirin” and “cellophane.”

In Harley-Davidson, Inc. v Grottanelli, 164 F.3d 806 (2nd Cir. 1999), cert. denied, 531 U.S. 1103 (2001), the court held that Harley-Davidson had lost its exclusive rights to call a Harley a “hog” because the term had become generic for describing motorcycles and not just Harley brand motorcycles.

Wordspy.com is a site that specializes in noting newly coined words. The site not- ed that the popularity of the search engine Google has netted a verb, such as when

someone says, “I went in and Googled it.” A lawyer from Google has asked that the new term be deleted from Wordspy’s site. Why does Google want to stop its use as a verb?

Consider . . . 15.4

15-4d trade names

Not all commonly used terms, however, are generic because they may be trade names. In San Francisco Arts & Athletics, Inc. v United States Olympic Committee, 483 U.S. 522 (1987), the Supreme Court held that the term Olympic belongs to the U.S. Olympic Committee and could not be used by San Francisco Arts & Athletics, Inc. (SFAA) in promoting its “Gay Olympic Games.”

The SFAA did not have permission to use the term Olympic. Use of a trade name without the registered owner’s permission is infringement. The owner of the trade name can seek injunctive relief to stop the use of the trade name. The plaintiff owner can also recover all damages and attorney’s fees. If the plaintiff can show a willful infringement, the Lanham Act allows the plaintiff to recover treble damages. Relief by a suit seeking an injunction is also available for using a trademark without authorization in advertising. Recent changes in the law allow a competitor to seek treble damages when its product is used deceptively in a comparative ad.

15-4e What are the Rights When a trademark or trade name Is Misused?

In 1995, Congress passed the Federal Trademark Dilution Act, a statute that per- mits recovery and injunctions for “dilution” of distinctive trademarks. The purpose of the law was to prevent others from capitalizing on the recognition, familiarity, and reputation of a distinctive trademark. This statute protects the trademark owner who can establish confusion—that is, buyers assumed they were purchasing goods or services with the trademark and from the company who owns that trade- mark. The act covers the problem of blurring or creating confusion among con- sumers about the source or association of a product and tarnishing or portraying a product in an unsavory manner. Beastie Boys v Monster Energy Company (Case 15.4) deals with an issue of confusion and association of a musical group with a product as well as copyright infringement and answers the opening “Consider. . . .”

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536 part 3 Business Sales, Contracts, and Competition

Beastie Boys v Monster Energy Company 87 F. Supp. 3d 672 (S.D.N.Y. 2015)

The Monster vs. The Beast (-ie Boys)

Case 15.4

FaCts

Monster organizes and sponsors an annual event called the “Ruckus in the Rockies,” a snowboarding competition and an after-party. Soon after the 2012 Ruckus, Monster employees created a recap video with highlights from the event. The four-minute video features Beastie Boys’ music in all but 32 seconds. The video also contains text that refers to the Beastie Boys.

Monster never obtained or attempted to obtain permission from the Beastie Boys for the video usage. Rather, the Monster employee who produced the video testified that he believed that a third party—a disc jockey who had performed at the 2012 Ruckus and had created a “Megamix” of Beastie Boys music—had the authority and had in fact authorized Monster to use that Megamix, including the underlying Beastie Boys’ songs, in the video.

Monster posted the video on its website, YouTube channel, and Facebook page. The description of the video that Monster posted online and the press releases that Monster and its agents sent to snowboarding mag- azines and websites contained additional references to the Beastie Boys. “Dozens” of websites posted Mon- ster’s press release verbatim, including the reference to the Beastie Boys.

Counsel for the Beastie Boys sent a letter to Mon- ster about its lack of permission. Monster immediately removed the video from its YouTube channel. Monster employees later edited the video—replacing the music and removing the references to the Beastie Boys—and then reposted it.

The Beastie Boys filed suit against Monster. The Complaint alleged copyright infringement and false endorsement in violation of the Lanham Act.

Very shortly before trial, Monster conceded liability on the copyright infringement claims. The trial focused on whether the Copyright Act violations had been willful.

The jury found that Monster’s infringement was willful, which increased the range of available statu- tory damages. The jury also found that Monster had “intended to deceive consumers concerning the Beastie Boys’ endorsement of its products” and that Monster had not proven “that consumers were not, in fact, confused or deceived as to whether the Beastie Boys

endorsed Monster’s products.” The jury awarded a total of $1.7 million in damages.

The Beastie Boys moved for a permanent injunc- tion, seeking to permanently enjoin Monster “(a) from using, distributing, or promoting” the Ruckus video; (b) from using, distributing, or promoting any advertis- ing which includes or uses, without plaintiffs’ consent, any copyrighted musical work or sound recording owned or controlled in whole or part by Beastie Boys or Brooklyn Dust Music; (c) from using the names, voices, and trademarks of [the Beastie Boys] for the purposes of advertising and trade purposes, in any manner; and (d) from suggesting a false endorsement of Monster’s products by the Beastie Boys.

Monster argued that the Beastie Boys have not satisfied the elements required to obtain a permanent injunction or, in the alternative, that the scope of the injunction should be limited to the infringing Ruckus video.

JUdICIaL OpInIOn

ENGELMAYER, District Judge The Copyright Act provides that courts “may” grant injunctive relief “on such terms as it may deem reasonable to prevent or restrain infringement of a copyright.” 17 U.S.C. § 502(a). The Lanham Act simi- larly provides that courts “shall have power to grant injunctions, according to the principles of equity and upon such terms as the court may deem reasonable, to prevent the violation of any right of the registrant of a mark.”

A plaintiff “seeking a permanent injunction still must satisfy the traditional four-factor test before the district court may use its equitable discretion to grant such relief.” Specifically, a plaintiff must demonstrate:

(1) that it will suffer an irreparable injury; (2) that remedies available at law, such as monetary damages, are inadequate to compensate for that injury; (3) that, considering the balance of hardships between the plaintiff and defendant, a remedy in equity is war- ranted; and (4) that the public interest would not be disserved by a permanent injunction.

As to the Ruckus video—which Monster concedes infringed the Beastie Boys’ copyrights, and the jury

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Chapter 15 Business and Intellectual Property Law 537

found infringed their trademarks—the Beastie Boys satisfy the four-factor test.

Here, because the jury found that the Beastie Boys had proven a likelihood of consumer confusion as to the group’s endorsement of Monster’s products, and because the evidence supported that finding, the Court may presume irreparable harm.

Significantly, the two surviving members of the Beastie Boys testified, emphatically, that, “since the beginning,” they have refused to license their music for product advertisements because they view such licenses as “a form of selling out.” The evidence at trial corroborated that claim. The Beastie Boys’ manager testified that, with one arguable exception, the Beastie Boys had never authorized use of their music or names in connection with a product. The Beastie Boys’ extensive licensing history, which was received into evidence at trial, similarly demonstrat- ed that, although the Beastie Boys have licensed their music for use in television programs, motion pictures, movie trailers, and video games, they have never done so for product commercials. Beyond the group’s general policy against licensing their music for product advertisements, the surviving band members testified, credibly, that, had they been asked, they would not have granted permission for Monster to use their music in the Ruckus video because they did not want to associate with Mon- ster’s products and disliked the portrayal of women in Monster’s video.

Monster’s exploitation of the Beastie Boys’ works and persona for its own benefit inflicted an intangible, yet very real, injury on plaintiffs. Against their will, the Beastie Boys were forced to associate publicly with, and advance the cause of, a corporation and marketing campaign for which they had evident disdain.

[T]he monetary damages awarded by the jury did not capture—or attempt to capture—this injury. The Court charged the jury, that the value of actual copy- right damages was set by the market: the price that a willing buyer and a willing seller would have agreed upon for a license to use the Beastie Boys’ music and names in Monster’s video, for the duration of time that video was available. And the award of statutory damages under the Copyright Act was keyed to the willfulness of Monster’s conduct, including “Mon- ster’s state of mind”; “the expenses saved, and profits earned, if any, by Monster in connection with the infringement”; and “the deterrent effect of such an award on Monster and third parties.” None of these awards, as charged, took into account or sought to compensate the Beastie Boys for the injury caused by the forced association with Monster and its products. Nor could this injury be easily measured, “given the

difficulty of protecting a right to exclude through monetary remedies.”

Turning to the third factor, the balance of hard- ships, Monster argues that an injunction would frus- trate its “First Amendment right to express itself,” because “there are many ways in which the mention of the ‘Beastie Boys’ and/or [its members’] names would constitute fair use and/or otherwise be permissible.” As a general proposition, that is surely true, but this generalization gains no traction in the specific context of an injunction not to use the Ruckus video containing the Beastie Boys music and names. Monster long ago conceded that the video infringed the Beastie Boys’ copyrights. And the jury further found that the video violated the Beastie Boys’ trademark rights by falsely implying an endorsement. Monster therefore has no legitimate interest, let alone a First Amendment inter- est, in further dissemination or use of that video. A permanent injunction limited to the infringing Ruckus video would, therefore, protect the Beastie Boys from further injury without imposing any cognizable hard- ship on Monster.

Finally, as to the fourth factor, a permanent injunc- tion limited to the infringing video would not dis- serve the public interest. In light of this analysis, the Beastie Boys are clearly entitled to a permanent injunction that prohibits Monster from any further use of the infringing Ruckus video. The open question is whether such an injunction should sweep any more broadly.

In the Court’s view, the injunction the Beastie Boys propose is highly overbroad. It would sweep well beyond the single video at issue in this lawsuit to expansively ban a host of hypothetical future acts that the Beastie Boys cast as infringement. Given Monster’s marketing strategy, in particular its reliance on social media and sponsored (and somewhat unstructured) events like the Ruckus in the Rockies, almost any refer- ence to the Beastie Boys by Monster or its agents could be construed as having been made “for the purposes of advertising and trade.” The proposed injunction could therefore sweep in instances of nominative fair use, a DJ’s mention of the Beastie Boys during a Mon- ster-sponsored party, or even, conceivably, commen- tary by Monster on this litigation. The Court is unwill- ing to chill Monster’s lawful expression by issuing an overbroad injunction.

[T]he Court is quite unpersuaded that any such a broad injunction is necessary to protect the Beastie Boys’ rights. The evidence showed that Monster’s infringement via the Ruckus video—although blatant and, as found by the jury, intentional—was an oppor- tunistic and, in all likelihood, anomalous occurrence.

continued

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538 part 3 Business Sales, Contracts, and Competition

Although the evidence showed that the Beastie Boys’ fan base overlapped significantly with Monster’s target consumer market, there was no evidence whatsoever that Monster had set out, as a matter of high-level corporate strategy, to obtain and use the Beastie Boys’ music without the necessary permission, or to man- ufacture a false endorsement. Instead, the infringe- ment in the Ruckus video was a product of deficient corporate controls and derelict mid- and site-level employees.

The Beastie Boys have not pointed to any other act of infringement, or evidence outside of the episode involving the Ruckus video, that indicates a propensity by Monster to infringe on others’ intellectual property rights generally or the rights of the Beastie Boys specif- ically. The Court finds that the infringement and false

endorsement here, egregious though they were, were transgressions that are unlikely to recur.

[T]he Court grants the Beastie Boys’ motion for a permanent injunction, limited to the infringing version of Monster’s Ruckus video at issue in this litigation.

Case QUestIOns

1. If Monster conceded infringement, what is the court deciding?

2. Explain what is required for a permanent injunction.

3. Given the court’s findings that Monster engaged in infringement, what advice could you give to companies about events such as the Ruckus in the Rockies and YouTube postings?

15-4f trade dress

A more recent and critical aspect of the Lanham Act is the concept of trade dress. Trade dress consists of the colors, designs, and shapes associated with a product. If someone copies the color schemes and shapes, they are likely to benefit from the goodwill of the owner and developer of the trade dress. The subtle copying of trade dress dilutes the value of the company’s goodwill and reputation. In Two Pesos, Inc. v Taco Cabana, Inc., 505 U.S. 763 (1992), the U.S. Supreme Court resolved issues related to trade dress infringement. In the case, Taco Cabana, Inc., which operated a chain of fast-food restau- rants in Texas that serve Mexican food, had opened in San Antonio and had distinctive trade dress that Two Pesos used as its motif when it opened its restaurants in Houston. With expansion around Texas, the two chains ended up in head-to-head competition in Dallas, and a trade dress infringement suit resulted. The U.S. Supreme Court held that a claim of trade dress infringement requires proof of the same elements as trade- mark infringement—that is, a company must show that its trade dress is distinctive and that consumers are likely to be confused by the similarity.

In Wal-Mart v Samara, 529 U.S. 205 (2000), the U.S. Supreme Court limited its rul- ing in Two Pesos to product packaging and held that no trade dress protection is avail- able for product design absent some form of registration under federal law such as trademark or patent or the product design having achieved some level of distinctive- ness. In the case, Samara designed, produced, and sold a line of seersucker children’s clothes with bold appliqués and large collars. Wal-Mart had introduced its own line of clothing that was similar. Product design trade dress enjoys no inherent protection. Product packaging, which the court noted was involved in Two Pesos, does enjoy pro- tection, as in the shape of a Coca-Cola bottle. However, absent some other statutory protection, product design, with the exception of famous designers such as Tommy Hilfiger, Ralph Lauren, and Izod, requires legislative change for protection.

15-4g Cyber Infringement

What are the rights of search engines such as Google to use the symbols and trade- marks of companies to direct Internet users to sites that are not affiliated with the trademark owners? Playboy Enterprises filed suit against Netscape to stop that search engine’s use of the Playboy Bunny symbol in ads that directed Internet users to sites oriented toward sexual content. Netscape benefits when users click

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Re: When a trademark Is Offensive For the Manager’s Desk

Simon Tam, the front man for the rock band, The Slants, wanted to register the band’s name with the U.S. Patent and Trademark Office. The examiner denied the registration because of a 70-year-old provision in the Lanham Act (15 U.S.C. §1052) that prohibit- ed the registration of names and marks that are disparaging, “immoral,” or “scandolous.” Mr. Tam appealed the denial, and he had some fairly high-powered amici (friends of the court) on his side, including the Wash- ington Redskins, themselves in a battle of survival for their trademark.

Initially, the federal court of appeals for the federal circuit upheld the denial by the U.S. Patent and Trademark office. However, upon rehearing, the court held that the trade name should not have been denied. [In re Tam, 785 F.3d 567 (Fed. Cir. 2015), and In re Tam, 808 F.3d 1321 (Fed. Cir. 2015)]

The argument that Mr. Tam made suc- cessfully was that the Lanham restriction was a violation of the First Amendment. In a 2-to-1 decision, the court held that “the First Amendment forbids government reg- ulators to deny registration because they find the speech likely to offend others.” The court held that the First Amendment pro- tects speech “even when the speech inflicts great pain.” Some examples of the types of registrations cited by the court as painful but protected included the following:

• “Stop the Islamisation of America”

• “Mormon Whiskey”

• “Khoran” as a name for a wine

• “Christian Prostitute”

• “Amoshhomo”

• “Ride Hard Retard”

• “Have you heard that Satan is a Republican?”

• “Democrats shouldn’t breed”

• “Republicans shouldn’t breed”

There are other cases, such as that of the Washington Redskins, pending that have the First Amendment challenge at the heart of their cases. Five Native Americans brought the suit asking for cancelation of the “redskins” name and symbol. [Pro-Football, Inc. v Blackhorse, 112 F. Supp. 3d 439 (E.D. Va. 2015)] The lower court canceled the trademark. The Washington Redskins have appealed. A New York lunch wagon com- pany lost its case against the state of New York for denying it a permit to operate in the state lunch wagon area on the grounds that its company name was offensive. [Wander- ing Dago, Inc. v Destito, 2016 WL 843374 (N.D. N.Y. 2016)] These conflicts in decisions mean that the U.S. Supreme Court will, at some point, need to review one of the cases to determine the constitutionality of the Lanham Act provisions.

onto those sites. However, the use of the Playboy symbol allows Netscape and the sites to capitalize on Playboy’s name, advertising, and goodwill. In Playboy Enter- prise, Inc. v Netscape Communications, 354 F.3d 1020 (9th Cir. 2004), a unanimous Ninth Circuit ruled that such use was an infringement.

Companies also have the right to stop Internet sales that are not by authorized distributors. For example, in Australian Gold, Inc. v Hatfield, 436 F.3d 1228 (10th Cir. 2006), ETS Inc., like most beauty supply companies, sold its tanning products pri- marily through tanning salons. ETS, like most beauty suppliers, has distribution contracts that limit sales to beauty and tanning salons. ETS does not want its prod- ucts to be available in stores because of the need for in-person consultation on their use and application. The Hatfields used a series of fictitious names to purchase ETS products through distributors and then made the products available on the

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Internet through seven different websites. The seven websites used the ETS trade- mark, product pictures, and metatags. ETS recovered $3.7 million for infringement because of the unauthorized use of the trademark and the resulting diversion of Internet traffic and sales to the Hatfields. Use of a trademark on the Internet with- out permission brings the resulting profits back to the owner.

If you have been in a cab in New York City, you have seen the little pine tree cutout hanging from the rearview mirror, spread- ing its aroma throughout the cab. Car-Fresh- ener Corporation manufactures the cabbie air freshener in the shape of a mighty pine. CFC has competition from Exotica Freshen- ers Company, whose shape is a palm tree, including large leaves and coconuts.

The two companies have one particular scent, both calling it “Morning Fresh,” and their respective trees are in the exact same rosy pink color. Car-Freshener has brought suit against Exotica because it maintains that the color is likely to cause trademark confusion. The lawyer for CFC argues that the identical color is no accident but a ploy to create consumer confusion.

This suit is not the first between the two companies. In 1995, Exotica agreed to stop using CFC’s trademark scent names (“Royal Pine” and “Vanillaroma”). In 2011, CFC successfully litigated and stopped Ex- otica from using “Black Ice” and Icy Black,” two scents that appeared after CFC’s intro- duction of it manly “Black Ice” scent.

What should the court do with the cur- rent litigation? [Car-Freshner Corporation v D & J Distributing and Manufacturing, Inc. d/b/a/ Exotica Freshners, 2015 WL 3385683 (S.D.N.Y. 2015)]

THINK: The protections for design require proof that consumers would be confused about the product, that they would likely think the palm tree and the pine tree are one and the same.

APPLY: On the surface, it would seem diffi- cult to confuse a palm tree and a pine tree, but the packaging concept does look simi- lar. The yellow background and the presen- tation of the trees on a yellow card make the two products look very similar. The key element of proof at the trial will be con- sumer confusion. There is some similarity but CFC must show, through data, that a consumer could quickly grab one product thinking it was the other company. Like- wise, D & J cross-claims for trade dress infringement on CFC packaging requires D & J to show the likelihood of consumer confusion.

ANSWER: The court held in a partial dispo- sition of the case that (1) D & J failed to meet its burden of showing confusion be- cause CFC packaging was functional and did not copy D & J’s and that (2) there was little likelihood of confusion because the products are displayed differently and have different color schemes. CFC’s case against D & J will go forward.

Consider . . . 15.5

15-5 Trade Secrets A business often works to develop information that is not known by the public or its competitors. However, the information the business has developed may not fit into any of the federally protected categories covered earlier in the chapter. In fact, sometimes the business does not even want to make the information public in a filing for the federal protections. Therefore, the business protects its rights by keep- ing the information as a trade secret.

15-5a What are trade secrets?

Trade secrets are lists of information, formulas, and even data that businesses com- pile for use in the marketplace, with customers, or in securing contracts. A trade

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Chapter 15 Business and Intellectual Property Law 541

secret is anything that gives the business a competitive edge and that is not known generally or by competitors. For example, products that are in development by employees cannot be taken by those employees to new employers, who might be competitors, for their competitors’ use.

15-5b How are Trade Secrets Protected?

Trade secrets are protected by the business keeping them secret. The information should have controlled access and should be available only to those within the business who have reason to know or need to use the information. Having the documents stamped to reflect their limited use, circulation, and private status is also helpful in establishing the theft or misappropriation of trade secrets because the nature of the information is clear on the face of the document.

Most companies have employees sign nondisclosure agreements so that should they leave their employment they would be subject to suit for breach of contract if they took the information with them. The biography on the nearly decade-long battle between Mattel and MGA (see p. 546), two major toy competitors, illustrates how intense the battle over trade secrets can be.

Forty-five states have adopted the Uniform Trade Secrets Act (UTSA), an act that was drafted and passed to eliminate the common law remedies that relate to the appropriation of trade secrets by current and former employees. The law was intended to make it easier for employers to recover when employees take trade secrets and use them, either while employed or postemployment (by turning them over to another employer or using the information themselves). However, the application of UTSA has proven to be a challenge for employers because of differ- ing interpretations and applications.

If what the employee has done fits within the definition of a trade secret under the UTSA, then all is well—that is, the employer can recover the remedies afforded under UTSA. Trade secrets have been defined to include everything from processes and procedures to customer lists and customer preferences. (The last two items are not protected under common law theories for trade secret appropriation.) For example, the federal government indicted five former employees of GlaxoSmith- Kline for allegedly e-mailing and downloading confidential data about 12 of the company’s products that were in the development stage. The five had planned to use the information in a company they had created in China and to develop and sell the products after leaving GlaxoSmithKline with sufficient information.

However, there are situations in which employees use something that is not considered a trade secret but by doing so they are disloyal to the employer. Some courts have held that UTSA preempts such claims and that there is no recovery unless the actions of the employee fit within the UTSA.

15-5c Criminal Penalties for Theft of Trade Secrets

The Industrial Espionage Act of 1996 makes it a felony to copy, download, upload, fax, or otherwise communicate trade secrets of U.S. companies to benefit anyone other than the owner of that information. Trade secrets are defined under the IEA very similarly to how they are defined under the UTSA. Again, the IEA does not apply unless the information has been treated as a trade secret.

Fines for violations by individuals are up to $500,000, and imprisonment can be for up to 15 years. For corporations that violate the IEA, the fine is the greater of up to $10,000,000 or twice the value of the secret that was communicated.

Exhibit 15.1 provides a summary of intellectual property rights and protections.

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15-6 International Intellectual Property Issues 15-6a patent protection

The period for patent protection varies from country to country. Procedures for obtaining patents also vary significantly from country to country. For exam- ple, many countries hold opposition proceedings as part of the patent process. Much like the federal regulatory promulgation steps (see Chapter 6), the process includes publishing the description of the patent and inviting the public to study the description and possibly oppose the granting of a patent.

Many countries impose working requirements on the patent holder’s use of the patent, which means that the idea or product must be produced commercially within a certain period of time or the patent protection is revoked.

15-6b trademark protection

As noted earlier in the discussion of trademarks, the 1891 Madrid Agreement (updated in 1989) provides for the Madrid Protocol, which is central registration through the International Bureau, which is part of the World Intellectual Property Organization (WIPO) in Geneva, Switzerland. Registrations with the bureau are effective for five years in all member countries unless one of the members objects to the trademark registration, in which case the registration is not effective in that country.

In 1996, the European Union began its one-stop trademark registration, known as Community Trademark (CTM). Under the provisions of this program, U.S.

tYpe OF InteLLeCtUaL pROpeRtY tRadeMaRKs COpYRIGHts patents

tRade seCRets

Protection Words, names, symbols, or devices used to identify a product or service

Original creative works of authorship, such as writings, movies, records, and computer software

Utility, design, and plant patents

Advantageous

formulas, devices, or compilation of information

Applicable standard Identifies and distinguishes a product or service

Original creative works in writing or in another format

New and nonobvious advances

Not readily ascertainable, not disclosed to the public

Where to apply Patent and Trademark Office

Register of Copyrights Patent and Trademark Office

No public registration necessary

Duration Indefinite so long as it continues to be used

Life of author plus 70 years; corporate, 120 years from creation or 95 years from publication of the work

Utility and plant patents, 20 years from date of application; design patents, 15 years

Indefinite so long as secret is not disclosed to public

Source: Adapted from Anderson’s Business Law, © 2016 by David Twomey and Marianne Jennings.

Exhibit 15.1 summary of Intellectual property Rights

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Chapter 15 Business and Intellectual Property Law 543

companies register their trademarks once and enjoy protection in all countries that are part of the European Union. The trademark and backup materials are filed with the Office of Harmonization of the Internal Market (OHIM). The OHIM will then notify the trademark offices in each of the member states of the European Union.

Many countries have permitted the unauthorized use of trademarks in an effort to develop local economies. These countries permit the production of knock-off goods, which are goods that carry the trademark or trade name of a firm’s product but are not actually produced by that firm. A costly problem for trademark holders is the gray market. Manufacturers in foreign countries are authorized to produce a certain amount of goods, but many foreign manufacturers exceed their licensed quota and dump the goods into the market at a much lower price and thereby reduce the trademark owner’s market. Both knock-off and gray-market goods are forms of infringement.

15-6c Copyrights in International Business

The purpose of the Berne Convention, mentioned earlier and called the Conven- tion for the Protection of Literary and Artistic Works, was to establish international uniformity in copyright protection. The convention has been in effect in the United States since 1989. The convention is administered by WIPO and covers member countries. However, the Berne Convention gives backdoor copyright protection to works originating in non–Berne member countries if the work is simultaneously published in a Berne member country.

Ethical Issues

Converse is a 100-year-old American shoe manufacturer known for its Chuck Taylor sneakers—those black shoes with the distinctive white toe tip. Begun in 1917, the Converse model has been iconic for greasers, nonconformists, baby boomers, and now back to teenagers even as baby boomers still wear them. The sneaker has been popularized across generations, but in this era of its existence, Converse is fighting to retain its unique look. Converse

(now owned by Nike) has taken 31 retail- ers and manufacturers, including Wal-Mart, Skechers, Kmart, and others, for producing knock-off Chuck Taylor Converse shoes. The challenge Converse faces is proving that consumers have a clear view of the Converse look and that the presence of the alternate shoes has resulted in confusion. Apart from the legal issues for trademark infringement, discuss the ethical issues in producing knock-offs.

15-6d differing International standards

The protection of intellectual property in other countries is a difficult task, particu- larly when the standards of those countries do not recognize computer software as a property right.

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15-7 Enforcing Business Property Rights 15-7a product disparagement

When an untrue statement is made about a business product or service, the defa- mation is referred to as disparagement and is either trade libel (written) or slan- der of title (oral). These business torts occur when one business makes untrue statements about another business, its product, or its abilities. The elements for disparagement are as follows:

1. False statement about a business product or about its reputation, honesty, or integrity

2. Publication 3. Statement that is directed at a business (in many cases, businesses are con-

sidered public figures, and the statement must be made with malice and the intent to injure that business)

4. Damages

These elements are the same as those discussed in Chapter 9 for the per- sonal tort of defamation. Bose Corporation v Consumers Union of United States, Inc. (Case 15.5) deals with the tort of disparagement.

Bose Corporation v Consumers Union of United States, Inc. 466 U.S. 485 (1984)

Woofers, Tweeters, and Disparagement

Case 15.5

FaCts

Bose Corporation manufactures the Bose 901, a ste- reo loudspeaker. In May 1970, the Consumers Union publication Consumer Reports analyzed and evaluated the middle-range price group of loudspeaker systems, including the Bose 901. It was described in a two-page boxed-off section as “unique and unconventional,” but the description also pointed out that a listener could “pinpoint the location of various instruments much more easily with a standard speaker than with the Bose system.” The following is an excerpt from the boxed description:

Worse, individual instruments heard through the Bose system seemed to grow to gigantic proportions and tended to wander about the room. For instance, a violin

appeared to be ten feet wide and a piano stretched from wall to wall. With orchestral music, such effects seemed inconsequential. But we think they might become annoying when listening to soloists. . . .

We think the Bose system is so unusual that a pro- spective buyer must listen to it and judge it for himself. We would suggest delaying so big an investment until you were sure the system would please you after the novelty value had worn off.

The article was not written by the same people who made the observation of the speakers. The observers described the sound as moving around the room and the article described the sounds as wandering back and forth.

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15-7b palming Off

Palming off, one of the oldest unfair methods of competition, occurs when one company sells its product by leading buyers to believe it is really another compa- ny’s product. For example, many cases of palming off took place during the 1980s, when Cabbage Patch dolls were popular, in demand, and scarce. Many replicas were made and called “Cabbage Patch dolls” even though they were not manufac- tured by Coleco, the original creator.

Establishing that someone is palming off requires proof that consumer confu- sion is likely because of the appearance or name of the competing product. For example, labeling a diamond DeBiers instead of DeBeers is likely to cause confu- sion. Competitors’ packaging with the same colors and design as an original prod- uct creates confusion. Potential buyers are likely to be confused as to who actually made the product and who has what market and quality reputation.

15-7c Misappropriation

The tort of misappropriation is a form of protection for a business whose trade secrets are taken without authorization. Misappropriation is conversion of a trade secret for self-benefit or the benefit of a new employer. For example, an employee who takes proprietary information such as a customer list from her employer and uses it to start a competing business is guilty of misappropriation. Most compa- nies put noncompete clauses that address the issue of taking trade secrets to a new company or forming a competing company in their employment contracts. Those clauses are covered in Chapter 16.

Bose Corporation took exception to many of the statements made and asked Consumer Reports to pub- lish a retraction. Consumer Reports would not retract the statements, and Bose sued for disparagement. The district court found that Bose was a public figure and, as such, was required to prove that the statements were made with knowledge they were false (malice). However, the court did find that some of the remarks constituted disparagement and held for Bose (petition- er). The Court of Appeals reversed on the grounds that the statements were not made with malice and that the article did not accurately reflect what evaluators heard but was written for a mass audience and not with reck- less disregard for the truth. Bose appealed.

JUdICIaL OpInIOn

STEVENS, Justice . . . There are categories of communication and certain special utterances to which the majestic protection of the First Amendment does not extend because they “are no essential part of any exposition of ideas, and are of such slight social value as a step to truth that any benefit that may be derived from them is clearly

outweighed by the social interest in order and moral- ity.” Libelous speech has been held to constitute one such category. . . .

We agree with the Court of Appeals that the dif- ference between hearing violin sounds move around the room and hearing them wander back and forth fits easily within the breathing space that gives life to the First Amendment. We may accept all of the purely factual findings of the District Court and nevertheless hold as a matter of law that the record does not contain clear and convincing evidence that [Consumers Union] prepared the loudspeaker article with knowledge that it contained a false statement, or with reckless disregard for the truth.

The judgment of the Court of Appeals is affirmed.

Case QUestIOns

1. Who prepared the Consumer Reports article?

2. Why is malice an important part of the case?

3. What classes of speech are exceptions to First Amendment protection?

4. Is disparagement a difficult tort to prove?

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Ross Klein and Amar Lalvani, two former employees of Starwood Hotels & Resorts Worldwide, were hired by Hilton Hotels Corporation in the summer of 2008. A suit filed by Starwood alleged that its two former executives took with them more than 100,000 electronic documents that con- tained proprietary information that Hilton then used in creating its new Denizen hotel chain.

In developing a concept for a new chain (Denizen is geared at the high-end market), companies spend years and millions on studying consumer needs and preferences, social trends, lighting, costs, food choices, and even fabrics and designs. The suit alleges that all of Starwood’s W brand was taken by the executives to Hilton and that its concepts made their way into the Den- izen brand. The suit maintains that the two executives sent the documents to Hilton via e-mail and through document shipments.

Starwood uncovered the alleged theft via serendipity. Starwood had begun an arbitration proceeding against Hilton for its recruitment of eight Starwood employees. While Hilton’s in-house legal counsel was preparing for that arbitration, he discovered bundles of Starwood documents in the files

of Mr. Klein and other Hilton employees. Hilton then sent the electronic files and documents back to Starwood. Eight box- es of materials were mailed to Starwood in February 2009. Hilton’s general counsel said in a cover letter that he did not think the information was proprietary or confidential but that he was sending them back as a precaution.

However, Starwood noted that its files included its development plans for its “zen den,” which it was going to put in its upscale “W” hotels. Hilton’s development plans for Denizen referred to it as their “den of zen.”

The Starwood complaint also alleged that the two men took along Starwood’s strategic marketing plans and that Star- wood has heard from existing customers that Hilton has been approaching them using the same tools and marketing tech- niques that Starwood has used with them.

What are the rights of companies on proprietary information? What are the rights of companies in terms of enforcing cove- nants not to compete against employees? Be sure to apply all the enforcement and legal tools that have been covered in this chapter. Evaluate the ethics of Hilton in hir- ing the two men from Starwood.

Consider . . . 15.6

Biography

Mattel, Inc., is the world’s largest manufac- turer and marketer of toys, dolls, games, and stuffed toys and animals. Mattel employed Carter Bryant as a product designer from September 1995 through April 1998 and from January 1999 through October 2000. Upon starting his second term of employ- ment in 1999, Bryant signed an Employ- ee Confidential Information and Inventions Agreement, in which he agreed not to “engage in any employment or business other than for [Mattel], or invest or assist (in any manner) any business competitive with

the business or future business plans of [Mattel].” Also, Bryant assigned to Mattel all rights, title, and interest in the “inventions” he conceived of, or reduced to practice, during his employment.

Bryant also completed Mattel’s Con- flict of Interest Questionnaire and cer- tified that he had not worked for any of Mattel’s competitors in the prior 12 months and had not engaged in any busi- ness dealings creating a conflict of inter- est. Bryant agreed to notify Mattel of any future events raising a conflict of interest.3

Mattel and Its Battle over Bratz dolls2

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A July 18, 2003, Wall Street Jour- nal article suggested Bryant had copied a scrapped Mattel project, known as “Toon Teens,” in creating the Bratz line of dolls. The story reported that MGA said that the Bratz were designed by Carter Bryant, a former member of Mattel’s Barbie team. Bryant didn’t work on the line that Mattel scrapped in 1998. But most Barbie design- ers had seen the prototypes. Although the doll line that was scrapped wasn’t exactly like the Bratz, they were remarkably simi- lar with the Bratz’s oversized heads, their pursed lips, cartoonish eyes, and big feet comparable to the dolls the Barbie team had created. Lily Martinez, a designer who still works at Mattel, came up with the idea for the big doll heads and posted her sketch on her cubicle where anyone could see it.4

By 2003, MGA’s revenues were about $800 million, with 65% of that coming from the Bratz doll line.

After investigating the situation report- ed in the Wall Street Journal, Mattel dis- covered in November 2003 that Bryant had secretly entered into an agreement with MGA Entertainment, Inc., a competitor, during the time that he was employed by Mattel, to receive royalties for “works for hire.” In an agreement signed September 18, 2000, Bryant agreed to provide product design services for MGA’s line of “Bratz” dolls in exchange for $5,500 per month for the first six months and $5,000 per month for the next three months, as well as a 3% royalty on the Bratz he worked on. Mattel filed its copyright registration for the Toon Teens drawings on November 28, 2003— four years after the drawings were created.

Bryant’s last day of employment at Mattel was October 20, 2000. Bryant went through the usual Mattel checkout. The checkout form used for Bryant misquoted Bryant’s Inventions Agreement, which did not expressly assign to Mattel Bryant’s interest in his ideas. This error may have resulted from the fact that prior versions of Mattel’s Inventions Agreement express- ly assigned the contracting employee’s interest in his ideas. Bryant’s agreement identifies “discoveries, improvements, pro- cesses, developments, designs, know-how, data computer programs and formulae,

whether patentable or unpatentable”—lan- guage that was not in prior versions.

Mattel filed suit against Bryant for (1) breach of contract, (2) breach of fiduciary duty, (3) breach of duty of loyalty, (4) unjust enrichment, and (5) conversion.5 MGA Entertainment intervened in that case. Mattel settled with Bryant but amended its complaint against MGA, alleging inten- tional interference with contract, aiding and abetting breach of fiduciary duty, aid- ing and abetting breach of duty of loyalty, conversion, unfair competition, and copy- right infringement.6 However, MGA coun- terclaimed against Mattel for appropriation of trade secrets. MGA’s counterclaim arose out of the activities of Mattel’s “Market Intelligence Group,” a collection of employ- ees dispatched to international toy fairs and directed to gather information from Mattel’s competitors’ private showrooms through the use of false pretenses. Alle- gations in the counterclaim stated that the employees had made copies of identifica- tion credentials in order to gain access to the private showrooms, showrooms that were intended for buyers to be able to see what was available for purchase from MGA in the future.

A jury found for Mattel on all counts, concluding that Bryant conceived the idea for the name Bratz and created the con- cept drawings and sculpt for the Bratz dolls during his second term of employment with Mattel (January 4, 1999, to October 4, 2000). The federal district court placed the Bratz trademarks in a constructive trust and enjoined MGA from continuing to sell dolls. MGA appealed, and the case was remanded for a new trial. Upon remand, both companies moved for summary judg- ment on various issues. The court denied summary judgment on some issues but required a trial for others, including MGA’s counterclaims on Mattel’s market intelli- gence group.7

Following approximately two weeks of deliberations, the jury found that Mat- tel had misappropriated 26 trade secrets owned by MGA and awarded MGA $3.4 million in damages for each act of misap- propriation, reaching a total award of $88.5 million. The jury also found that Mattel’s

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misappropriation had been willful and malicious, thus entitling MGA to exemplary damages under Cal. Civ.Code § 3426.3 for a total verdict of $177.5 million, followed by an award by the court of $2.52 million in attorneys’ fees and costs to MGA.8 However, that decision, including the determination of attorney’s fees, was reversed and is now back in federal district court.9

One expert commented that the litigation “killed” the Bratz line and nearly destroyed MGA as a compet- itor. Others have noted the lessons for all companies on preserving trade secrets, controlling access to trade secrets (such as pictures of developing products being posted in employees’ carrels), and the destructive effects of litigation.

s u m m a r y What are the types of intellectual property businesses own?

• Patents—for products, processes, discoveries

• Copyrights—for books, designs, dramatic works, photographs, films, etc.

• Trademarks—the brand protections for product symbols

• Trade names—the brand protections for product names

• Trade dress—the brand protection for those easily recognizable shapes and colors of a company and its product

• Trade secrets—the knowledge a business develops that provide its competitive edge

What are the legal protections for intellectual property?

• Patents—statutory protection of exclusivity for prod- ucts and processes

• Copyrights—statutory protection of exclusivity for words, thoughts, ideas, music

• Trademarks—statutory protection of exclusivity for product symbols

• Trade names—statutory protection of exclusivity for unique product labels and names

• Trade dress—statutory protection of exclusivity for product colors and motifs

• Trade secrets—criminal sanctions for unauthorized transfer or use and violation of employer nondisclo- sure agreements

What issues of intellectual property protection exist in international operations?

• The Berne Convention—copyright recognition and protection across borders

• OPTH—European Community Trademark registration

• WIPO—World Intellectual Property Organization

What private remedies exist for property protections?

• Product disparagement—false and damaging statements

• Misappropriation—use of another’s ideas or trade secrets

• Palming off—causing deception about the maker or source of a product

Q u e s t i o n s a n d P r o b l e m s 1. The San Diego Chicken, a mascot at professional baseball games, has a portion of his act in which he grabs a purple dinosaur and stomps it, stamps it, pounds it, and pummels it. Lyons Partnership, L.P., produces the Barney the Dinosaur television show, which features a purple dinosaur, and holds all its product licenses. Lyons

filed suit against Ted Giannoulas (the man beneath the San Diego Chicken costume) for copyright infringement.

A Texas court classified the portion of Mr. Giannou- las’s act that involved a purple dinosaur as a form of parody or satire that was thereby protected by the First Amendment. Kenneth Fitzgerald, the lawyer for

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Mr. Giannoulas, said that Mr. Giannoulas will seek to recover his attorney’s fees in the case.

Mr. Fitzgerald noted during the case that Barney has been spoofed by Jay Leno as well as on the television show Saturday Night Live, but Lyons chose only to pur- sue Mr. Giannoulas.

What is wrong with selective enforcement of one’s copyright protections? Is Barney the Dinosaur something that can be copyrighted? [Lyons Partnership v Giannoulas, 179 F.3d 384 (5th Cir. 1999)]

2. Yankee Candle Company, a leading manufacturer of scented candles, sued competitor Bridgewater Candle Company for trade name and trade dress infringement. Yankee alleged that Bridgewater’s labels were the same size, had the same border, and featured similar photo- graphs to depict the scents of the candles. For example, the Bridgewater “French Vanilla” photograph has ice cream cones filled with vanilla ice cream, and the Yan- kee “French Vanilla” only features empty cones with no ice cream. Both the Bridgewater fragrance “Cinnamon Rolls” and the Yankee “Cinnamon” display photographs of cinnamon rolls. However, the Yankee photograph also includes cinnamon sticks, while the Bridgewater rolls highlight the sugary frosting found on a cinnamon roll. Both the Bridgewater “Apple Pie” and the Yankee “Spiced Apple” contain photographs of apple pies. How- ever, the Yankee photograph also features a basket and several apple slices. The Bridgewater photograph con- tains several whole apples. In addition, in the Bridgewa- ter photographs, the darkish filling is oozing out of the pies, while the Yankee pies are lighter in color and not leaking apple filling.

Yankee also c laimed that Bridgewater had infringed its trade dress (1) by copying Yankee’s method of shelving and displaying candles in its stores, called the “Vertical Display System”; (2) by copying the overall “look and feel” of Yankee’s House- warmer line of candles; and (3) by copying the design of Yankee’s merchandise catalog, specifically its one- fragrance-per-page layout.

Is there enough here to support any intellectual property claims by Yankee? Specify what types of and the elements required to establish any possible claims. [Yankee Candle Co., Inc. v Bridgewater Candle Co., LLC, 259 F.3d 25 (1st Cir. 2001)]

3. GM developed an ad for its Terrain utility vehicle that featured a tattooed, shirtless image of Albert Einstein with “his underpants on display.” The body featured in the ad with Dr. Einstein’s head was that of one of People magazine’s “sexiest men alive.” The ad carries the cap- tion “Ideas are sexy too.”

The Hebrew University of Jerusalem has filed suit against GM to enforce the name and intellectual

property rights that Dr. Einstein willed to the univer- sity. GM has responded that it purchased the image of Dr. Einstein for use from a licensing firm. Does the university have a basis for its claim for $75,000? Could it stop the use of Dr. Einstein’s head on another body in an ad? Discuss what intellectual property rights are at issue here.

4. The Hangover Part II has been a hotbed of intellec- tual property issues. Last summer, Warner Brothers settled a lawsuit brought by the tattoo artist who did Mike Tyson’s facial tattoo that was then replicated on a character in the movie. Now, Louis Vuitton has filed suit in federal court for trademark infringement of its famous bags.

The ne’er-do-well character played by Zach Galifi- anakis has coined a pop-culture phrase by warning his fellow imbibers when they touch his Louis Vuitton bag, “Careful, that is a Louis Vuitton.” The lawsuit seeks to have the trademark bag excised from the film as well as a share of the movie’s profits. The company seems most irritated because it alleges that the bag used in the movie is a knock-off. Louis Vuitton is very aggressive in enforc- ing its trademark rights and has brought suit against art- ists who have used the signature handbags and luggage in their paintings.

What is the issue in the use of trademarked products in artistic works? Why is Louis Vuitton so concerned about the use of its products in a film such as The Hang- over Part II?

5. Rich Leivenberg and Jane Wyler, founders of the company Reuseniks, developed a new product called reusable dry cleaning bags. Ms. Wyler met another cou- ple in 2008 and explained to them her plan to develop the reusable dry cleaning bags. The couple was “blown away” by the idea and developed their own, “The Green Garmento.” What are the rights of Reuseniks’ founders? What do you need to know to be able to answer their questions about their rights?

6. LVM has registered trademarks for “LOUIS VUIT- TON” in connection with luggage and ladies’ handbags (the “LOUIS VUITTON mark”) and for a stylized mono- gram of “LV,” used in connection with traveling bags and other goods (the “LV mark”). In 2005, LVM adopted other designs consisting of canvas with repetitions of the LV mark (in multiple colors of red, green, and blue) and smiling cherries on a brown background (the “Cherry design”).

The Multicolor design and the Cherry design attracted immediate and extraordinary media atten- tion and publicity in magazines, such as Vogue, W, Elle, Harper’s Bazaar, Us Weekly, Life and Style, Travel & Leisure, People, In Style, and Jane. The press pub- lished photographs showing celebrities carrying

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550 part 3 Business Sales, Contracts, and Competition

these handbags, including Jennifer Lopez, Madonna, Eve, Elizabeth Hurley, Carmen Electra, and Anna Kournikova, among others. People magazine said that “the wait list is in the thousands.” The handbags retailed in the range of $995 for a medium handbag to $4,500 for a large travel bag.

Haute Diggity Dog, LLC, which is a relatively small and relatively new business located in Nevada, man- ufactures and sells nationally—primarily through pet stores—a line of pet chew toys and beds whose names parody elegant high-end brands of products such as perfume, cars, shoes, sparkling wine, and handbags. These include—in addition to Chewy Vuiton (LOUIS VUITTON)—Chewnel No. 5 (Chanel No. 5), Furcedes (Mercedes), Jimmy Chew (Jimmy Choo), Dog Peri- gnonn (Dom Perignon), Sniffany & Co. (Tiffany & Co.), and Dogior (Dior). The chew toys and pet beds are plush, are made of polyester, and have a shape and design that loosely imitate the signature product of the targeted brand. They are mostly distributed and sold through pet stores, although one or two Macy’s stores carry Haute Diggity Dog’s products. The dog toys are generally sold for less than $20, although larger ver- sions of some of Haute Diggity Dog’s plush dog beds sell for more than $100.

Haute Diggity Dog’s “Chewy Vuiton” dog toys, in particular, loosely resemble miniature handbags and undisputedly evoke LVM handbags of similar shape, design, and color. In lieu of the LOUIS VUITTON mark, the dog toy uses “Chewy Vuiton”; in lieu of the LV mark, it uses “CV”; the other symbols and colors employed are imitations (but not exact ones) of those used in the LVM Multicolor and Cherry designs. LVM brought suit against Haute Diggity alleging trademark infringement, trademark dilution, copyright infringement, and com- mon law violations. Can it recover? Why or why not? And on what basis would LVM argue for its allegations? [Louis Vuitton Malletier S.A. v Haute Diggity Dog, LLC, 507 F.3d 252 (4th Cir. 2007)]

7. ASUS Computer International has brought suit against ExoTablet Ltd. because both companies have developed smartphone/tablet hybrid devices. The devices combine a smartphone with a cradle in a “dumb” tablet such that the “dumb” tablet (1) enlarges and enhances the screen size of the smartphone, (2) provides an enlarged and enhanced user interface (touch screen) for the smartphone, and (3) displays what is displayed on the smartphone. ASUS wants to license its technology, but ExoTablet is already producing the hybrid device. ASUS is worried about losing its first-mover advan- tage on this technology. Explain what protections ASUS could seek that would allow it to preserve its first-mover position. [ASUS Computer Int’l v ExoTablet, Ltd., 2014 WL 3962636 (N.D. Cal. 2014)]

8. In 1997, Sweet Romance Jewelry Manufacturing created a piece of costume jewelry known as the “Lady Caroline Lorgnette” and began manufacturing and selling copies of the necklace in 1999 through various stores and websites. Sometime between 2005 and 2008, Home Shopping Network (HSN) began manufactur- ing and distributing copies of a “virtually identical” necklace.

On March 6, 2008, Sweet Romance submitted an application to the Office for Registration of its copyright in the necklace and received confirmation of receipt of the application on March 12, 2008. On March 27, 2008, Sweet Romance sued HSN for copyright infringement of the necklace. Although the Copyright Office ultimately issued a copyright registration certificate for the necklace, it did not do so before the suit was filed. HSN says that the suit must be dismissed for the failure to register the necklace as a copyrighted product. Is HSN correct? Cosmetic Ideas, Inc. v. IAC/InteractiveCorp., 606 F.3d 612 (9th Cir. 2010)

9. Do the following slogans constitute protectable busi- ness properties?

a. MetLife: “Get Met, It Pays” b. General Electric: “GE Brings Good Things to Life” c. Nike: “Just Do It” d. Toys “R” Us: “R Us”

10. Starbucks, Inc., the international coffeehouse, is an aggressive defender of its name as well as the names for its coffees. It has ongoing litigation for infringement:

• A & D Café of Brooklyn, New York, uses the name “Warbucks” for its coffee, and Starbucks has filed suit against the café for dilution of its trade name.

• Sambuck’s Coffee House of Astoria, Oregon, has been sued by Starbucks for dilution. However, the owner of the café is Samantha Buck-Lundberg, and she explains that the name of the café is a play on her name.

• Black Bear Monster Roastery in New Hamp- shire uses the name “Charbucks Blend” for one of its coffees, and Starbucks has filed suit for disparagement.

• Backwash.com had a link to Starbucks on its web- site. Starbucks filed suit to have the link removed, which Backwash did, citing “unappreciative” reasons.

• Coffee Bean & Tea Leaf Co. of Los Angeles has sued Starbucks for trademark infringement for the company’s use of the term “ice blended,” a term that the LA company claims it coined.10

What protections exist for trade names? For trade- marks? Do you think there is infringement in these cases?

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Chapter 15 Business and Intellectual Property Law 551

Economics, Business Strategy, & the Law Who Owns A Wonderful Life?

In 1946, director Frank Capra produced It’s a Wonder- ful Life, a movie based on a short story by Philip Van Doren Stern called “The Greatest Gift.” The movie, starring Jimmy Stewart, did not perform well at the box office, and, although it received five Academy Award nominations, it won no awards. The movie’s copyright was allowed to lapse. Television stations showed the classic without paying fees because the copyright had lapsed.

However, the U.S. Supreme Court decision in Stew- art v Abend, 495 U.S. 207 (1990), offering an extension of the copyright protection of the underlying story to the movie, affected Jimmy Stewart’s life once again. The original story owner, Mr. Stern, held the rights to the story since the movie rights had lapsed. With

his story copyright in place, royalties for its use in the movie had to be paid once again. The owners of It’s a Wonderful Life began charging fees to cover their fees to Mr. Stern, and the result was costly access. It’s a Won- derful Life was seen on television day and night during the holiday season when the copyright on the movie had lapsed. Now, with the copyright clarification, the movie rights have been reprotected. The story’s con- tinuing protection and the high royalty fees make It’s a Wonderful Life a singular holiday event.

What is the relationship between movie copyrights and the rights to the underlying story? Who owns what between story authors and movie producers? What should businesses negotiating movie rights and royalties be certain about before signing an agreement?

n ot e s 1. From the Salinger complaint filed with the court.

2. By way of full disclosure, the author has done ethics training work for Mattel. All information contained here is from public records.

3. Mattel, Inc. v Bryant, 446 F.3d 1011 (9th Cir. 2006).

4. MaureenTkacik, “Dolled Up: To Lure Older Girls, Mattel Brings in Hip-Hop Crowd; It Sees Stalwart Barbie Lose Market Share, so ‘Flayas’ Will Take on the ‘Bratz,’” Wall Street Journal, July 18, 2003, p. A1.

5. The case has a fascinating history of procedural questions, including an issue of diversity of jurisdiction that resulted in an appellate decision. Mattel, Inc. v Brandt, 446 F.3d 1011 (9th Cir. 2006).

6. Mattel, Inc. v MGA Entertainment, Inc., 782 F. Supp. 2d 911 (C.D. Cal. 2011).

7. Mattel, Inc. v MGA Entertainment, Inc., 2011 WL 3420571 (C.D. Cal.).

8. Mattel, Inc. v MGA Entertainment, Inc., 801 F. Supp. 2d 950 (C.D. Cal. 2011).

9. Mattel, Inc. v MGA Entertainment, Inc., 705 F.3d 1108 (9th Cir. 2013).

10. Emily Lambert, “The Buck Stops Here,” Forbes, January 6, 2003, p. 52.

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553

This portion of the book covers the management of businesses, including the management of employees and the rights and duties of employers and employees as they work together to operate a business. This section of the book also covers the oversight function of boards in the operation of a business. What are the regulations and restrictions related to the hiring, retention, promotion, and firing of employees? How much authority do employees have to make decisions and take actions with respect to their work? What are the safety requirements for business operations? What responsibilities do boards have in selecting and overseeing the managers of the business? How do shareholders have input into board decisions on management and operations? What are the disclosure requirements between companies and their shareholders? How, when, and where is information disclosed to shareholders and markets? All of these questions focus on the operations of a business, making sure that there is responsibility and accountability for what businesses do and how they interact with employees, shareholders, and the capital markets.

Business Management and Governance

Part

4

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16Management of Employee ConductAgency Chapter

All businesses have a common thread: employees. They need them, rely on them, pay them, and give them authority to perform certain business tasks. This chapter focuses on that delegation of authority and these questions: When does an employee act on behalf of an employer? How much authority does an employee have? What duties and obligations do employees owe employers? When is a business liable for an employee’s acts?

Update For up-to-date legal news, go to mariannejennings.com

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555

16-1 Names and Roles: Agency Terminology A principal–agent relationship is one in which one party acts on behalf of another. A clerk who helps you to the dressing room and takes your payment in a department store is an agent. Rory McIlroy, the record-breaking PGA golfer, has an agent who negotiates his endorsement and appearance contracts for him. A power of attorney is a form of agency relationship that grants another author- ity to enter into transactions. A special power of attorney is one limited in time and/or scope, as when a landowner gives another the authority to close a par- ticular land transaction. For example, Rory McIlroy’s agent has general author- ity to negotiate endorsement contracts with the exception of endorsements for alcoholic beverages. Mr. McIlroy will not enter into endorsement contracts with companies whose products are alcoholic beverages and his agent has no author- ity to negotiate such agreements. A general power of attorney is one in which an individual gives another the rights to manage his financial affairs in everything from handling checking accounts to entering into contracts. The common thread in all of these relationships is that one party acts on behalf of another.

16-1a agency

In an agency relationship, one party agrees to act on behalf of another party accord- ing to directions. The principal grants authority to an agent. Agency is a consensual relationship—both sides agree to it—and also a fiduciary relationship with duties and responsibilities on both sides. The general term agency can be used to refer to many different types of relationships. A real estate agent who is hired to help market your house is an agent of yours; talent agents are agents for many actors at the same time.

16-1b principals

In the employer–employee relationship, the employers are referred to as the principals. The term principal is used because some agents are not truly employ- ees. A literary agent, for example, represents many authors who are the agent’s principals, but the principals are not, in the usual sense, “employers” of the agent.

Sarah signed an agreement not to disclose confi- dential information about her employer, Garon, a dis- tributor for peppers it obtains from a supplier that Garon relabels and distributes to cheese manufac- turers to make pepper jack cheese. After working for Garon’s and learning the cheese business, Sarah left

and began to market peppers from Garon’s suppliers directly to Garon’s customers, thus eliminating the middleman costs. Garon’s filed suit to stop Sarah from using what she had learned in her job to com- pete with it. Can Garon’s stop Sarah from marketing her idea?

Consider . . . 16.1

Corporation which operated bar and instructed bartender to maintain order was not liable for injuries to patrons sustained when bartender pulled out gun and shot patron because he was making advances to girl sitting next to him. Howard v Zaney Bar, 85 A.2d 401 (pa. 1952)

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16-1c agents

Agents are those who do a task on behalf of the principal. The agent represents the principal in such a way that if the agent negotiates a contract, the principal, but not the agent, is bound by and a party to the contract. A president of a corporation is an agent of the corporation. When the president negotiates a contract with proper authority, the corporation, not the president, is bound to perform that contract.

All employees are agents of the principal (employer), but not all agents are employees. A corporation might hire an architect to design a new office building and obtain bids for the construction of the building. The architect would be an agent for limited purposes but not an employee of the company.

16-1d employers and employees: Master–Servant Relationships

A master–servant relationship is a relationship in which the principal (master) exercises a great deal of control over the agent (servant).1 An employer–employee relationship for a production line worker is an example of a master–servant rela- tionship. Among the various factors considered are whether an employee works regular hours, is paid a regular wage, and is subject to complete supervision and control by the employer during work hours. The factors used to determine whether a master–servant relationship exists are as follows:

• Level of supervision and control of the agent (most important) • Nature of the agent’s work • Regularity of hours and pay • Length of employment

The presence of a master–servant relationship also determines whether the principal must pay wage taxes such as FICA and FUTA and withhold income taxes. (See Chapter 19 for more details.)

161e Independent Contractors

An independent contractor acts on behalf of another to perform a task but is not under the direct control of the other person. For example, a corporation’s attorney is an agent of the corporation only for purposes of legal representation and court appearances. The attorney is not a corporate employee, and the corporation has no control over the attorney’s office operations. The attorney is an independent con- tractor. A subcontractor hired to perform partial work on a construction site is also an example of an independent contractor.

Principals have less responsibility for independent contractors than for ser- vants because they have little control over a contractor’s conduct. The distinction between master–servant relationships and independent contractor relationships is important because a principal’s liability for an agent’s actions varies depending on the agent’s status as servant or contractor.

The distinction between independent contractor and an employee agent is criti- cal for purposes of wage tax issues (See Chapter 19 for more information).

16-1f agency Law

In general, agency relationships are not governed by statutory law; rather, these relationships are governed by common law. The common law of agency that the majority of states follow is found in a compilation called the Restatement of

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Chapter 16 Management of Employee Conduct: Agency 557

Agency, which is followed by many courts in deciding cases that involve agency law disputes.

Studying agency law actually involves examining three different areas. The first area deals with the creation of the agency relationship. The second area involves the relationship between principals and agents. The final area examines the rela- tionship of the agents and principals to third parties.

16-2 Creation of the Agency Relationship Agency relationships can be created in different ways, and the requirements vary.

16-2a express authority

An employee who is hired by agreement (oral or written) is an agent and has been given express authority to act on behalf of the business. Express authority is limited to what is spoken or written. A driver employee, for example, may only have the authority to deliver packages; a sales employee may have the authority to represent the company but may be required to obtain another employee’s sig- nature to finalize sales contracts. An express contract specifies the limitations of an employee/agent’s authority.

16-2b the Record

An agency relationship is created by agreement, which need not be evidenced by a writing or record, although it is best for both employer and employee if it is. Some form of a record, electronic or written, that specifies the agent’s authority is required only if the agent will enter into contracts required to have a record or if a state statute requires an agent’s authority to be in some record form. For example, most states require that real estate agents’ commission contracts be evidenced by a record. That record could be a written, faxed, or PDF document that is signed by the principal.

16-2c Capacity

Because agents will enter into contracts for their principals, the principals must have the capacity to contract. Capacity here means capacity in the traditional con- tract sense: age and mental capacity (as covered in Chapter 11). In addition, the principal must be in existence for an agent to have authority. If a company has not been incorporated, those who sign for the nonexistent corporation as agents have liability.

One agency capacity issue that comes up frequently in sole proprietorships, general partnerships, and other smaller businesses that are dependent on indi- vidual personalities is the stalemate that results when mental incapacity (through accident or illness frequently) in one of these key individuals becomes a factor. For example, if one of two general partners is injured in an accident and unconscious, the remaining partner has his or her hands tied for certain types of business trans- actions. Under the Uniform Power of Attorney Act (UPAA), formerly the Uniform Durable Power of Attorney Act (UDPAA), these key individuals can execute a type of power of attorney that comes into existence in the event of disability or inca- pacity of the principal.2 This authority then “kicks in” when needed. The UDPAA has also been helpful for children who are trying to manage their parents’ financial

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558 part 4 Business Management and Governance

affairs when their parents become mentally or physically disabled. The durable power of attorney allows the child or children to manage payments, accounts, and assets, depending on the scope of authority given. In many cases, the child or chil- dren need the authority just to be able to manage the medical bills and insurance claims for the parent’s illness.

The contractual capacity of the agent is not an issue in the agency relationship for purposes of the agent’s authority to enter into contracts. However, the capac- ity of the agent to drive, operate equipment, or work with the public is an issue that affects the employer’s liability to third parties. Because of this liability, many employers conduct background checks, polygraph and psychological tests, and drug screening as a precondition to hiring employees. Many firms also have ongo- ing drug-testing programs to ensure that employees are not reporting for work— or working—under the influence of drugs or alcohol.

One of the most controversial issues in agency law concerns the unincorpo- rated association, which is a group that acts as an entity but has no legal exis- tence. Some charitable organizations—churches, for example—have an ongoing existence and have probably built buildings, had fund-raising drives, and entered into many contracts. However, because these organizations are not incorporated and do not have any legal existence, those who sign contracts for these groups are not agents. Moreover, they are liable under these contracts because the orga- nizations are not principals with capacity. For example, suppose that a Little League coach signs a credit contract for the purchase of Little League equipment. The Little League organization is nonprofit and is not incorporated. In the event the league does not raise enough money to pay for the sporting equipment, the signing coach is liable because the league is not a principal with capacity.

The Uniform Unincorporated Nonprofit Association Act (UUNAA) and the Revised Uniform Unincorporated Associations Act (RUUNAA) have been adopted in some form in 12 states. Under RUUNAA, unincorporated nonprofit associations are treated as entities with the ability to hold title to property and to be sued and bring suit in their names. Members of an unincorporated nonprofit association have the same liability protections that officers and other agents of corporations have when acting on behalf of their entities. The RUUNAA does not apply to those organizations that are required under state laws to be incorporated in order to raise charitable funds (such as churches).

16-2d Implied authority

An agent under contract not only has the authority given expressly but also has certain implied authority. Implied authority is the extension of express author- ity by custom. For example, a person who is hired as president of a corporation probably does not have his or her exact duties specified in the contract. However, corporate presidents will likely have the type of authority customarily used by presidents: to sign contracts, to authorize personnel changes, to conduct salary reviews and changes, and to institute operational changes. Customary authority is always given in the agency relationship unless the agent’s contract specifies oth- erwise. This implied authority can be limited by agreement between the parties if they do not want custom and practice to control their relationship.

Together, express and implied authority are called actual authority. The type of authority an agent has determines the liability of the principal to third parties for contracts and torts.

Before you sign on behalf of an organiza- tion, be sure you under- stand your liability. For example, if you sign a contract with a hotel for a group’s meeting, you will have personal liabil- ity if your group is not incorporated and if the hotel is not paid. If your group is incorporated, be sure to sign so that the corporation, not you, is personally liable. You can use the following format:

(Your Group Name) By: (Your Name)

(Your Title)

Here is an example:

Weaving Through the Maze, a nonprofit

corporation By: Marianne M.

Jennings President

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Chapter 16 Management of Employee Conduct: Agency 559

16-2e apparent authority

In many cases, an agency relationship arises not by express or implied contracts but because of the way a principal appears to third parties. This theory of agency law, called apparent authority or agency by estoppel, holds a principal liable if the principal makes others believe there is an agency relationship.

Apparent authority exists by appearance. A third party is led to believe that an agent, although not actually holding express and accompanying implied author- ity, had the proper authority to deal with the third party. The third party is led to believe that certain promises will be fulfilled. For example, a mobile home dealer who has brochures, notepads, and other materials from a mobile home manufac- turer has the appearance of having the authority to sell those homes even no actual authority exists. Thomas v Weatherguard Construction Company (Case 16.1) deals with issues of apparent authority.

On September 20, 1973, a Beech Model 18 aircraft carrying singer Jim Croce and his entourage crashed shortly after takeoff from Natchitoches, Louisiana. All were killed.

At the time of the crash, the plane was being flown by Robert N. Elliott, an em- ployee of Roberts Airways. Roberts had been asked by Mustang Aviation to fly the entourage according to a prepared itinerary. Mustang originally had entered into a con- tract with Lloyd St. Martin of Variety Artists International, a booking agent for popular

singers, to fly the group itself. The agree- ment was entered into on September 18, 1973. Later that same day, Mustang learned that its aircraft was disabled, so Mustang’s director of operations called Roberts and asked it to substitute.

Relatives of Mr. Croce and the others killed in the crash brought suit against Mustang for the crash. What, if any, agency relationships existed in this case? How did they arise? Is Mustang liable for the crash? [Croce v Bromley Corp., 623 F.2d 1084 (5th Cir. 1980)]

Consider . . . 16.2

Thomas v Weatherguard Construction Company, Inc. 42 N.E.3d 21 (Ill. App. 2015)

Weathering the Agency Storm and Being on Guard with Principals

Case 16.1

FaCtS

Raymond Thomas (plaintiff) came across an ad by Weatherguard Construction Company (defendant) on the Career Builder website. The ad contained only Weatherguard’s name. He submitted an online appli- cation, along with his résumé, and received a call “from someone from the office for an interview.” The building at which he interviewed had Weatherguard’s name on it. When Thomas walked into the building, he

saw “several employees that had, like, Weatherguard uniforms and stuff on.”

Thomas was interviewed by Farbaky, who was wearing a Weatherguard uniform. Thomas also spoke to Chad Hagen, who was also wearing a Weatherguard uniform. Thomas received a business card from Hagen at the same time that had Weath- erguard’s name on it. After the interview, Thomas received a call back from Farbaky, inviting him

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560 part 4 Business Management and Governance

back to the office. When he returned to the office, he was invited on a “ride-along” with Farbaky to observe what the job entailed. Farbaky took Thomas to customers’ homes and informed him “about the company.” Thomas had the opportunity to perform a roof inspection with Farbaky, who showed him the process of approaching the customer and inspecting the roof for damage. During the ride-along, Farbaky rang a prospective customer’s doorbell, and Thomas heard him state that “he was from Weatherguard Construction” and that they were in the area inspect- ing roofs for hail damage.

After the ride-along, Thomas called Farbaky and “accepted, you know, the position of coming aboard as far as being a claims specialist for Weatherguard.” Thomas was given a map of the geographic territory, as well as a Weatherguard hat and a Weatherguard jacket. Farbaky also provided a script to read in which Thomas would identify himself as being “from Weatherguard Construction Company.” Farbaky also gave Thomas a business card that had the Weather- guard name on it. Thomas was given business cards with both his and the Weatherguard name on it. Far- baky also applied for a solicitor’s permit on Thomas’s behalf with the City of Naperville and that the permit “allow[ed] Weatherguard employees” to solicit busi- ness in Naperville. Farbaky arranged for Weather- guard logos to be placed on the sides of Thomas’s personal vehicle.

After approximately two weeks of work, Thomas “started kind of feeling like [he had] a kind of like suspicion about the company.” When he received his first paycheck, it was a personal check from Farbaky with the word “draw” written on the memo line. When Thomas asked Farbaky about it, he was told that the term “draw” meant that the check was “[j]ust money being paid up front until Thomas actually got the dol- lar amount that was due [to him] from the jobs that [he] got.” Thomas continued to receive regular personal checks from Farbaky with the word “draw’ written on the memo line. Thomas never received a payroll check from Farbaky and never received any checks from Weatherguard. Thomas received a total of $2,900 in personal checks.

As time passed and Thomas had not received any checks from Weatherguard, he “wasn’t feeling * * * real [sic] good about the company” but continued working for several months. When he was offered a full-time job as a store manager at Lowe’s, he accepted it. He did not receive the commissions he was promised for the jobs he had obtained for Weatherguard. He filed suit to obtain those commissions. Weatherguard said that Farbaky ran a marketing company it had hired but that

it never heard of Thomas until contacted by his lawyer for payment.

The trial court found that Thomas had established apparent agency, that he had secured 31 contracts that benefited Weatherguard, that the gross total on these contracts amounted to $223,932.60, and that he was entitled to 20% of the net amount for these contracts. Weatherguard appealed.

JUdICIaL OpINION

GORDON, Judge Defendant first argues that the trial court erred in finding that defendant had created the appearance that Farbaky had the authority to hire plaintiff on defen- dant’s behalf.

“Defendant allowed [Farbaky] to respond to job applications put into the market by Weatherguard. It allowed its name to be the sole business entity on Far- baky’s and Thomas’ business cards. It allowed use of its offices, address, hats, jackets, car boards, marketing materials, web-site advertising, use of its name exclu- sively in training scripts, use of its secretarial staff and more. Weatherguard had some control over the day to day practices of the claims specialists. It provided the contracts bearing its name. It communicated with home- owners’ insurance adjusters and to arrange days when the adjuster would view the house. It contacted the claims specialists to know the days when the adjuster would be at the house so that the claim specialist could make a point of being present. Further, Weatherguard’s production manager has final say on whether the con- tract will be completed by Weatherguard.”

[S]uch conduct would reasonably lead a person to believe that he was employed by defendant or an agent of defendant, not an employee or agent of an indepen- dent marketing company.

Defendant argues that this conduct demonstrated only that Farbaky was authorized to use defendant’s name in selling its services, not that Farbaky had the authority to hire plaintiff. Plaintiff testified that he responded to an advertisement of defendant, arrived at defendant’s building, observed people with Weath- erguard uniforms, and was given a Weatherguard business card, all of which MacDonald corroborated was permitted by defendant. Plaintiff further testified that Farbaky exclusively used defendant’s name and never mentioned DBar to plaintiff, even when plaintiff was interviewing for employment. We cannot find that it was against the manifest weight of the evidence for the trial court to conclude that a reasonable person would have believed that he was being hired to work for defendant.

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Defendant further argues that plaintiff failed to exercise any diligence in determining whether Farbaky had the authority to hire him to work for defendant. Defendant is correct that one dealing with an agent has to act with reasonable diligence and pru- dence in determining the scope of the agent’s author- ity. However, plaintiff testified that when he received a personal check from Farbaky, he questioned Far- baky about it and was assured that it was merely an advance payment until plaintiff received his entire commission. Accordingly, we cannot find that the trial court’s finding that Farbaky was defendant’s apparent agent was against the manifest weight of the evidence.

The trial court did not “mischaracterize” MacDonald’s testimony in any way. Accordingly,

we cannot find that the trial court erred in awarding plaintiff damages and affirm the trial court’s judg- ment in plaintiff’s favor.

We affirm the trial court’s judgment in plaintiff’s favor. However, we remand the case to the trial court for the limited purpose of determining reasonable attorney fees.

CaSe QUeStIONS

1. List all of the factors that point toward apparent authority.

2. Explain Thomas’s obligations to verify agency relationships.

3. What suggestions would you give to companies that hire third parties to handle their marketing?

16-2f Ratification

On occasion, an agent without proper authority enters into a contract that the prin- cipal later ratifies. Ratification occurs when the principal reviews a contract and voluntarily decides that, even though the agent did not have proper authority, the contract will be honored as if the agent had full authority. Once a contract is rat- ified, it is effective from the time the agent entered into it even though the agent had no authority until after the fact. Ratification is a way for a principal to give an agent authority retroactively.

For example, suppose that an apartment manager does not have the authority to contract for any type of construction work except routine maintenance. Because the fence around the apartment complex is deteriorated, the manager contracts for the construction of a completely new fence at a cost that exceeds by six times any maintenance work he has had done in the past. The contractor begins work on the fence, and the apartment owner drives by, sees the work, and says nothing. By her inaction in allowing the contractor to continue building the fence, the apartment complex owner ratifies the contract.

Suppose that a bar owner has employed a bouncer and the bouncer injures someone while removing him from the premises. Is the employer liable for the conduct of the bouncer? [Byrd v Faber, 57 Ohio St.3d 56, 565 N.E.2d 584, 587 (1991)]

THINK: The Thomas case held that a prin- cipal is liable for the acts of an agent that

a third party would perceive are within the scope of the authority of the agent.

APPLY: When an agent is hired as a bounc- er, battery and assault could be within the agent’s apparent scope of authority.

ANSWER: The bar owner is liable for the bouncer’s conduct.

Consider . . . 16.3

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16-3 The Principal–Agent Relationship To this point, the focus of the discussion has been on the relationship between the agent and the principal on the one hand and third parties on the other. However, it is important to realize that a contractual relationship exists between the agent and the principal, so that each has certain obligations and rights. This section of the chapter covers that relationship.

16-3a the agent’s Rights and Responsibilities

Principals and agents have a fiduciary relationship, which is characterized by loy- alty, trust, care, and obedience. An agent in the role of fiduciary must act in the principal’s best interests.

duty of Loyalty: General An agent is required to act only for the benefit of the principal, and an agent can- not represent both parties in a transaction unless each knows about and consents to the agent’s representation of the other. Further, an agent cannot use the infor- mation gained or the offers available to or by the principal to profit personally. For example, an agent hired to find a buyer for a new invention cannot interfere with the principal’s possible sale by demonstrating his own product. Neither can an agent hired to find a piece of property buy the property and then sell it (secretly of course) to the principal. Lucini Italia Co. v Grappolini (Case 16.2) involves an issue of an agent’s fiduciary duty in a sale transaction.

Benjamin Chavez served as executive di- rector of the National Association for the Advancement of Colored People (NAACP). Mary Stansee, a former employee of the NAACP executive offices, charged Mr. Chavez with sexual harassment, and he settled the claim for $332,400. The NAACP

was financially troubled at the time of the settlement, with a deficit of $2.7 million, and Mr. Chavez did not disclose the settlement to the board until after it was completed.

Did Mr. Chavez have implied authority to make the settlement? Did he have appar- ent authority?

Consider . . . 16.4

Lucini Italia Co. v Grappolini 2003 WL 1989605 (N.D. III. 2003)3

A Slick Deal by the Olive Oil Agent

Case 16.2

FaCtS

Lucini Italia imports and sells premium extra-virgin olive oil of Italy. Lucini was formed by Arthur Frigo, a Chicago entrepreneur and adjunct professor of management and strategy at Northwestern University’s Kellogg Graduate School of Management. Giuseppe Grappolini, from

Loro Ciuffenna, Italy, served as a consultant to Lucini. Under the terms of his consulting contract, Mr. Grap- polini was to develop Lucini Premium Select extra- virgin olive oil as well as other flavored olive oil products. Mr. Frigo had discovered a market niche in the United States for high-end olive oil ($10 to $12 per bottle).

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Mr. Grappolini is also the sole owner of the Grap- polini Company, an Italian limited liability company. The Grappolini Company distributes small volumes of extra-virgin olive oil in Chicago and other markets throughout the United States, but it has much larger sales volume in Europe. Between December 1997 (the date of the Grappolini consulting contract with Lucini) and June 2000, the Grappolini Company was Lucini’s supplier of extra-virgin olive oil. The two companies had signed a supply agreement for this arrangement also in December 1997.

Mr. Frigo instructed Mr. Grappolini to try to nego- tiate an exclusive supply contract for Lucini with Veg- etal, an Italian company with a unique olive oil that Mr. Frigo needed to develop another premium brand of olive oil that would have flavors such as lemon and garlic added (called the LEO project). Vegetal was the only company that could supply the type of olive oil Mr.  Frigo needed for the blending process with the extra flavors. Mr. Grappolini led Mr. Frigo along with promises of a deal with the Vegetal company for nearly a year, through reports of meetings as well as with faxes and memos appearing to detail terms, con- ditions, and dates for delivery. At the same time, Mr. Grappolini was meeting with Mr. Frigo almost daily as they discussed the plans for the new Lucini olive oil. In the meetings, Mr. Frigo discussed the formulas, the marketing, consumer profiles, and marketing strat- egies for the LEO project. Apparently, Mr. Grappolini was impressed by the plans and entered into his own exclusive supply contract with Vegetal. Mr. Grappolini did not tell Mr. Frigo of the contract and continued to work as a consultant. Mr. Grappolini also assured Mr. Frigo that Lucini had a supply contract with Vegetal.

Mr. Frigo proceeded with all the contracts, ads, and plans for the LEO product launch based on assurances from Mr. Grappolini that it had the supply contract with Vegetal. However, when pressed, Mr. Grappolini could not deliver the paperwork. When Mr. Frigo requested a meeting with the CEO of Vegetal, Mr. Grappolini arranged for the meeting but cautioned Mr. Frigo not to mention the supply arrangement because such a discussion in a first-time meeting would be con- sidered rude in the Italian culture.

With the LEO product launch approaching, and no copy of the alleged Vegetal supply contract avail- able, Mr. Frigo had Lucini’s lawyer in Italy contact Vegetal directly for a copy. The lawyer learned that Vegetal had a supply contract but that the contract was with Mr. Grappolini’s company and that it was not transferable to Lucini. Mr. Frigo then confronted the officers of Vegetal, and they acknowledged that they had negotiated with Mr. Grappolini for his company,

not for Lucini, and were not aware of Lucini’s needs or Mr. Grappolini’s representation of Lucini. The officers at Vegetal said that Grappolini had been a “bad boy” in negotiating the contract for himself. Vegetal agreed to supply Lucini with olive oil in the future but could not deliver it in time for the launch of Lucini’s new line. The  soonest it could deliver would be after the next harvest, a time that meant the marketing and sales plans of Lucini for its new product had been wasted.

Mr. Frigo and Lucini filed suit against Mr. Grap- polini and his company (defendants) for breach of fiduciary duty.

JUdICIaL OpINION

DENLOW, Magistrate As agents, Defendants owed Lucini general duties of good faith, loyalty, and trust. In addition, Defendants owed Lucini “full disclosure of all relevant facts relat- ing to the transaction or affecting the subject matter of the agency.”

Defendants were Lucini’s agents and owed Lucini a fiduciary duty to advance Lucini’s interests, not their own. When Defendants obtained an exclusive supply agreement with Vegetal for the Grappolini Company instead of for Lucini, they were disloyal and breached their fiduciary duties. Lucini suffered substantial dam- ages as a result of this breach.

Punitive damages are appropriate where the defendant has intentionally breached a fiduciary duty. Defendants’ breach of their fiduciary duties was fla- grant and intentional. Defendants deliberately usurped a corporate opportunity sought by Lucini, which Lucini had entrusted Defendants to secure on Lucini’s behalf. Although Defendants explicitly accepted this trust and ensured [sic] Lucini that Mr. Grappolini and his company would do as Lucini requested, Defen- dants failed to do so and hid this fact from Lucini.

Defendants misappropriated Lucini’s valuable trade secrets. Defendants acquired Lucini’s trade secrets under circumstances giving rise to a duty to maintain their secrecy. Defendants’ assistant Marco Milandri testified that he understood that Lucini’s Premium Select and LEO product formulations were company secrets. Likewise, Grappolini testified that he understood the secrecy of trade secret information communicated to him. Indeed, his various contracts specified that he would maintain the confidentiality of Lucini’s research conclusions. After Defendants had secretly secured their own exclusive supply contract with Vegetal, they hid this fact from Lucini in order to induce Lucini to continue sharing its trade secret research, strategies, and plans with Grappolini.

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Lucini’s decision to focus its LEO project around essential oils from Vegetal Progress was a closely guarded trade secret. When Mr. Grappolini used this information on behalf of the Grappolini Company to allow it unfettered access to negotiate its own exclusive arrangement with Vegetal, it is necessary to conclude that the Grappolini Company “acquired” the informa- tion with full knowledge that: (i) Lucini had not con- sented to the use of the information by a competitor, and (ii) Mr. Grappolini had no right to transmit or use the information for his own purposes or on behalf of the Grappolini Company.

As a proximate result of Defendants’ breach of their fiduciary duties, Lucini suffered lost profits damages of at least $4.17 million from selling its grocery line of LEO products from 2000 through 2003. The Court will award Lucini its lost profits of $4,170,000, together with its $800,000 of development

costs for LEO project. Defendants engaged in willful and malicious misappropriation as evidenced by their use of the information for directly competitive pur- poses and their efforts to hide the misappropriation and, accordingly, the Court will award $1,000,000 in exemplary damages. Such an award is necessary to discourage Defendants from engaging in such con- duct in the future.

CaSe QUeStIONS

1. Explain how Mr. Grappolini breached his fiduciary duty.

2. What lessons can you learn about contracts, sup- pliers, and product launches from the case?

3. Evaluate the ethics of Mr. Grappolini’s conduct. Why did Vegetal’s officers refer to Mr. Grappolini as a “bad boy”?

duty of Loyalty: postemployment and Noncompete agreements Many companies have their employees sign contracts that include covenants not to compete or covenants not to disclose information about their former employers should the employees leave their jobs or be terminated from their employment.

Downsizings in the high-tech industry have brought back the issue of noncom- pete and confidentiality agreements. When employees are recruited by upstart firms and lured with stock options, it is often difficult for them to imagine a time when the company would need to downsize or would no longer exist. As a result, most of them signed fairly restrictive covenants not to compete.

In dealing with these covenants, courts are striking a balance between the employees’ right to work and an employer’s right to protect the trade secrets, training, and so forth that the former employee has and then transfers to another company or to himself or herself for purposes of starting a business.

Requirements for Noncompete Agreements

1. The Need for Protection

The laws on noncompete agreements vary from state to state, with California and a handful of states being the most protective of employees. However, across all states, courts are clear in their positions that there must first be an underlying need or reason for the noncompete agreement—that is, the employee must have had access to trade secrets or be starting his or her own business in competition with the principal/employer.

2. Reasonableness in Scope

The covenant must also be reasonable in geographic scope and time. These factors depend on the economic base and the nature of the business. For exam- ple, a noncompete in a high-tech employee’s contract could be geographically global but must be shorter in duration because technology changes so rapidly. A noncompete for a collection agency could not be global but might be longer in duration because the nature of that business is one of relationships.

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3. Valid Formation

Noncompete agreements are also subject to the basics of contract law (see Chapters 11 and 12). There must be consideration and there cannot be duress. For example, one dot-com company agreed to give its employees stock options if they would sign a noncompete agreement. Amazon.com offered downsized employees an additional 10 weeks’ pay plus $500, in addition to the normal severance package, if they would sign a three-page “separation agreement and general release” in which they promised not to sue Amazon over the layoff or disparage it in any way. Amazon, as a long-standing prac- tice, has had employees sign a confidentiality agreement at the beginning of their employment that restricts their use of information and systems knowl- edge they gained while working at Amazon.

Some states provide protection for employees who refuse to sign noncompete agreements, punishing employers with punitive damages in wrongful termination cases brought by employees terminated following their refusals to sign.

Other Theories for Noncompete Enforcement Because covenants to compete have been so difficult to enforce, businesses and courts have developed alternative theories to stop agents from competing with their former employers. One theory is called the doctrine of inevitable disclosure, which applies in situations in which the departing employing will be working in a situation in which disclosure of the previous employer’s com- petitive information will necessarily be disclosed. For example, an executive in energy drinks (All Sport) at PepsiCo who left PepsiCo to work for Quaker Oats was not restrained from working for Quaker Oats but had to spend a few years working on something other than its energy drinks (Gatorade) so that Pepsi’s product plans would not be disclosed. [PepsiCo, Inc. v Redmond, 54 F.3d 1262 (7th Cir. 1995)] Another example involved a Thomas English Muffins executive who knew the “Nooks and Crannies” secret to the muffins leaving for another employer. He could work for the bakery but not on English muffins. [Bimbo Bakeries USA, Inc. v Botticella, 613 F.3d 102 (3rd Cir. 2010)]

Some employers have employees sign nonsolicitation clauses. The employ- ees can leave and work for a competitor, but they promise not to recruit other employees from the firm if they leave. These clauses are different from noncom- pete clauses because they do not prohibit work and are more easily enforced.

There are also some statutory protections . For example, most states have trade secrets protections that prevent former employees from disclosing what the employer has identified as a trade secret through limited use by employ- ees and by requiring passwords for access.

Some employers have begun to use the tort of tortious interference with contracts as a means of preventing former employees from working for com- petitors or beginning their own competing businesses. In those states in which noncompete clauses are unenforceable, the tort avenue has been used as a means of enjoining the former employee’s business activities. For example, in TruGreen Companies, LLC v Mower Brothers, Inc., 199 P.3d 929 (Utah 2008), the Utah Supreme Court held that a company whose former employer had gone to work for a competing company and recruited other employees to join him was liable for tortious interference and allowed recovery of lost profits.

Garon Foods, Inc. v Montieth (Case 16.3) provides the answer for the open- ing consider and involves several issues related to former employees com- peting with their former employers.

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Garon Foods, Inc. v Montieth 2013 WL 3338292 (S.D. Ill. 2013)

The Holes in Selling Cheese

Case 16.3

FaCtS

Sarah Montieth was an employee of Garon Foods from November 2011, until she voluntarily resigned in February 2013. Garon sells peppers to cheese manufac- turers for use in making pepper jack cheese. Garon acts as a distributor for peppers it obtains from a supplier and then relabels and distributes to its pepper jack cheese manufacturing customers under Garon’s name. During her time at Garon, she had access to a computer program listing the names of Garon’s customers, and she was assigned to manage the accounts of a small number of customers (around five at any one time).

Prior to starting employment, Sarah signed a “Garon Trade Secrets Confidentiality Agreement” in which she agreed to hold Garon’s trade secrets con- fidential and to refrain from using them for anything other than Garon’s benefit. Under the Agreement, trade secrets included customer lists, customer prod- ucts, customer pricing, data, designs, financial records, formula, packaging, procedures, processes, suppliers, vendors, and other confidential information. Garon further protected some of this information on a com- puter system with individual passwords and by hiding it on its computer server.

At the time of her resignation, Sarah signed another document in which she acknowledged the Agree- ment’s nondisclosure provisions. Garon never asked Sarah to sign a covenant not to compete with Garon.

During Sarah’s employment with Garon, she sent an e-mail with some of the foregoing confidential information to her personal e-mail account. She did this for the purpose of preparing for a meeting to address a customer complaint that had arisen while others at Garon were away on vacation. On one occasion, Sarah also sent a purchase order containing confidential infor- mation to a trucking company to facilitate an urgent transportation request. When Sarah resigned, she was escorted from Garon’s property and took no documents with her. She did retain in her memory the names of purchasing agents of certain Garon customers and gen- eral knowledge of the industry, such as “ballpark” pric- ing arrangements. Any specific pricing details Sarah retained in her memory are likely to be obsolete within a year or less due to the fluctuation of product prices.

After Sarah’s resignation, she began working as an independent contractor for the Supplier of peppers to Garon. This was the Supplier’s first attempt to market its product directly to cheese manufacturers.

No credible evidence shows Sarah gave the Sup- plier any of Garon’s confidential information or trade secrets. Sarah sent mass e-mails to the purchasing agents of the companies on a list of pepper jack cheese manufacturers. She had not obtained the manufacturer list from Garon but derived it on her own through Internet searches. She had remembered some of the purchasing agents’ names from her work at Garon but had obtained others, along with contact information, through telephone calls to the manufacturers. She did not specifically target any of Garon’s customers with her e-mail solicitations, but she did not avoid them either. However, some of the mass e-mails contained references from which the manufacturer could easily conclude that the Supplier was Garon’s source of the products Garon sold under its own name. For example, one mass e-mail offered to sell the Supplier’s product to manufacturers using standard packaging methods (pails, drums, and totes) “at a significant cost savings and with shorter lead times” than the manufacturer could get through a distributor. The e-mail further contained a specification sheet for a product that this customer had purchased from Garon.

Despite receiving a cease-and-desist letter from Garon’s counsel, Sarah continues to solicit business for the Supplier. Sarah has not brought any new customers to the Supplier since her marketing efforts began, but Garon has lost one longtime customer who generated more than $200,000 of business a year. If the Supplier is able to draw customers away from Garon, Garon’s reputation in the industry would suffer, and it would be nearly impossible to get its customers back. Additionally, since Sarah began working for the Supplier, the Supplier has increased the product prices it charges Garon, which Garon has been forced to pass along to its customers.

Garon filed suit alleging Sarah breached the Agree- ment by revealing confidential information and violated the Illinois Trade Secrets Act (“ITSA”) by misappropri- ating Garon’s trade secrets. Garon asked the Court to issue a preliminary injunction.

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JUdICIaL OpINION

GILBERT, District Judge. The first theory under which Garon seeks relief for Sarah’s alleged breach of the Agreement. Sarah argues that she did not breach the Agreement because she did not target Garon’s customers or give any confidential information to the Supplier.

“Confidentiality agreements . . . are restrictive cov- enants and under Illinois law are reviewed with a sus- picious eye.” Specifically, restrictive covenants work in partial restraint of trade and courts must carefully assess their intent to insure they are not used to prevent competition per se.

It is likely that Garon can show Sarah revealed the confidential identity of the Supplier in violation of the Agreement. The identity of the Supplier as Garon’s source of products is confidential information under the Agreement. Garon took pains to protect that information by hiding it from its cheese manufacturer customers. Any communication that identified, either directly or indirectly, the Supplier as Garon’s supplier therefore likely breached the Agreement. For example, Garon was the only manufacturer who sold products in 43-pound pails, 450-pound drums and 1700-pound totes. Thus, the identification of these specific weights associated with the Supplier was sufficient to reveal the Supplier’s identity to Garon’s customers who had purchased products in those packages.

It is likely that Garon can show Sarah used con- fidential information about Garon’s customers’ past product purchases to market to some cheese manu- facturers. For example, she attached to a solicitation e-mail a specification sheet for a product that a Garon customer had purchased from Garon in the past. The customer’s needs and purchasing history, as well as the terms of Garon’s sales to that customer, that Sarah retained in her memory are likely to be Garon’s confidential information under the Agreement, so the Agreement would likely prohibit her from using that information for the Supplier’s benefit.

[I]t is likely that Garon can prove Sarah breached the Agreement by revealing the Supplier’s identity and using past customer purchasing needs and sales terms to solicit customers for the Supplier.

The second theory under which Garon seeks relief is under the ITSA for misappropriation of trade secrets.

Under the ITSA, a “trade secret” includes: Infor- mation, including but not limited to, technical or non-technical data, a formula, pattern, compilation, program, device, method, technique, drawing, process, financial data, or list of actual or potential customers or suppliers, that: (1) is sufficiently secret to derive economic value, actual or potential, from not being

generally known to other persons who can obtain eco- nomic value from its disclosure or use; and (2) is the subject of efforts that are reasonable under the circum- stances to maintain its secrecy or confidentiality.

The Court finds for the reasons discussed above that Garon’s trade secrets include the identity of the Supplier and the past customer purchasing needs and sales terms and that Sarah misappropriated those trade secrets by dis- closing or using them in her solicitations. Garon is unlikely to be able to prove its customer list is a trade secret.

In the absence of a preliminary injunction, Sarah may be able to tempt some of Garon’s customers to patronize the Supplier instead of Garon, although she had not done so as of the date of her testimony. If this happens with respect to more than a minimal number of customers, Garon will suffer irreparable damage to its business which may result in the end of its business and which cannot be remedied by money damages.

If the Court grants the requested injunction, Sarah will be extremely limited in her ability to earn a living soliciting cheese manufacturer customers, and the pub- lic will suffer harm by the loss of competition between pepper suppliers. However, if the Court does not grant an injunction, there is a risk Garon will lose business to the Supplier based on Sarah’s use of some confidential information or trade secrets. In light of these factors, the Court believes it appropriate to grant an injunction limiting Sarah’s solicitation of cheese manufacturers but not prohibiting them, Sarah will still be able to work in her new position without being prevented from attempting to earn a living, but the manner in which she conducts those solicitations must be circumscribed. The limitations described below will protect Garon’s confidential information and trade secrets while still allowing the public the economic benefit of fair and increased competition between Garon and the Supplier.

Sarah is enjoined from soliciting business for the Supplier from any cheese manufacturer whose account she was assigned to manage during the twelve months before she stopped working for Garon. This injunction shall last for eight months following entry of this pre- liminary injunction. This preliminary injunction does not prevent Sarah from servicing any of these cheese manufacturers who independently become customers of the Supplier by means other than her solicitations.

Sarah is enjoined from soliciting business for the Supplier from any cheese manufacturer she knows is or was a Garon customer by mentioning or using any specific information in the solicitation about their past purchasing needs or sales terms. This restriction includes mentioning in the solicitation the specifica- tions of the products she knows from her experience at Garon were sold to that cheese manufacturer by Garon.

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This preliminary injunction does not prevent Sarah from responding to a cheese manufacturer’s request for products that it has purchased from Garon so long as the request for those products is initiated by the cheese manufacturer.

Sarah is enjoined from referring in her solicitations to (1) Garon or (2) any other information from which a cheese manufacturer is likely to draw the conclusion that the Supplier provides Garon with the products Garon sells under its name. This restriction includes, but is not limited to, mentioning in the solicitation the specific weights of products in conjunction with the method of packaging that were sold exclusively by Garon (e.g., 43-pound pails) and inviting the cheese manufacturer to compare the qual- ity audit documentation of Garon and the Supplier.

This preliminary injunction does not prohibit Sarah from responding to a cheese manufacturer’s request for products packaged in the specific weights and meth- ods sold by Garon or for a list of the packaging weights and methods available from the Supplier, so long as the request is initiated by the cheese manufacturer.

CaSe QUeStIONS

1. What kind of information does Sarah have that could harm Garon?

2. What type of business was Sarah attempting to create?

3. What restrictions does the court impose?

Eric Rush (a.k.a. Eric Romero in the dance world) was a dance instructor at a Plano, Texas, Arthur Murray dance studio. Mr. Rush says he was fired, but the attorney for the Arthur Murray studio indicates he resigned. Under the terms of his employment contract, which included a noncompete clause, Mr. Rush was prohibited from teaching dance lessons within a 25-mile radius of the Plano Arthur Murray studio. However, Mr. Rush created a Craigslist notice offering dance lessons and also contacted former students from Arthur Murray to offer dance lessons. He also taught a cha-cha lesson at Tango and Cha-Cha’s Dance Studio in Dallas (to the tune of “I Left My Heart in San Francisco”).

A Texas judge ordered Mr. Rush to take down the Craigslist notices and stop

teaching dance through the end of 2009 within the 25-mile radius. Mr. Rush was also ordered to spend 30 days in jail for contempt of court, which consisted of his ongoing refusals to comply with the court’s orders for his violations of the noncompete clause. The jail sentence represents the latest in a 10-month legal battle between Rush and his former employer. Rush’s lawyer called the sentence excessive and said that the judge was “killing a fly with a bazooka.”

As for Mr. Rush, he is dismayed at his clipped wings, er, silenced taps. He says that the noncompete clause “is like ask- ing a doctor not to practice medicine.”4 He also says that if he did stop dancing “it would be, like, blasphemous.”5 Rush also

Consider . . . 16.5

Ethical Issues

Discuss what ethical issues you see in Sarah’s actions.

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duty of Obedience An agent has the duty to obey reasonable instructions from the principal. The agent is not required to do anything criminally wrong or commit torts, of course; but agents are required to operate according to the principal’s standards and instruc- tions. Failure to do so could mean the agent has gone beyond the authority given and is personally liable for the conduct.

duty of Care Agents have a duty to use as much care and to act as prudently as they would if managing their own affairs. Agents must take the time and effort to perform their principals’ assigned tasks. For example, officers of corporations must base their decisions on information, not guesses, and must ensure that their decisions are car- ried out by employees.

An agent who does not use reasonable care is liable to the principal for any damages resulting from a lack of care. When an agent does not make adequate travel arrangements for a speaker, the agent is liable to the speaker for damages that result from the speaker’s nonappearance at an engagement.

16-3b the principal’s Rights and Responsibilities

Just like the agent on the other side of the agreement, the principal also has certain duties and obligations.

duty of Compensation The first obligation is that of compensation, which can take various forms that range from salary to commission to combinations of both. Some agents work for a fee on a contingency basis. A real estate agent, for example, may have an arrange- ment in which she receives compensation only if a buyer for the property is found. However, compensation is not required for a valid agency if the agent and princi- pal agree that there will be no compensation.

In an agency relationship in which there will be no compensation—a gratu- itous agency—the agent has all the same authority to act for the principal but will not be compensated. For example, some charitable organizations have agents who act in fund-raising capacities but who do not expect compensation.

duty of Indemnification Principals also have an obligation to indemnify agents for expenses the agents incur in carrying out the principal’s orders. Corporate officers, for example, are entitled to travel compensation; sales agents are entitled to compensation for plac- ing ads to sell goods, realty, or services.

adds that dancing is his calling in life and, “I just want to make a living.” Mr. Rush’s lawyer acknowledges that Mr. Rush could teach in cities such as Arlington and Fort Worth and not be in violation of the court order enforcing the covenant. However, Mr. Rush says that with the price of gas and the poor economy, the travel distance is prohibitive.

Mr. Rush says he is teaching dancing to his fellow inmates. From prison, Mr. Rush described dancing: “It means healing. It means grace, serenity, elegance, sex appeal. It means ambition and drive and achievement and confidence.”6

Discuss whether the covenant is en- forceable, whether it is too broad, and how a jail sentence resulted from a contract matter.

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16-4 Liability of Principals for Agents’ Conduct: The Relationship with Third Parties

16-4a Contract Liability

Although the types of authority an agent has and the terms of the agency agree- ment define the authority of the agent, the contract liability of a principal is not determined either by intent or by the limitations agreed to privately by the agent and the principal. In other words, third parties have certain contract enforcement rights depending on the nature of the agent’s work and the authority given by the principal. The liability of the principal for contracts made by an agent is controlled by the perceptions created for and observed by the third party to the contract. Those perceptions vary, so the liability of the principal varies depending on the way in which the agent does business. For example, an officer of a corporation has the authority to bind the corporation, but what if the officer does not disclose that there is a principal corporation? This section deals with those issues.

the disclosed principal In a situation in which a third party is aware a principal is involved and also knows who the principal is, the principal is liable to the third party but the agent is not, regardless of whether the agent has express, implied, or apparent authority. If the agent has no authority, however, then the agent, not the principal, is liable. For example, suppose that Jane Bronte is the vice president of Video Television, Inc., and she signs for a line of credit for the corporation at First Bank. As long as she signed the documents “Video Television, Inc., by Jane Bronte, VP,” Video would be solely responsible for the line of credit. If, however, she signed that same way but had no authority, she would be liable to Video if it had to honor the agreement. As another example, most title insurers and escrow companies require corporations selling or buying real property to have board authorization in the form of a resolu- tion. If Jane signed to buy land and did not have a resolution, she would have no express authority, and without implied or apparent authority, she would be liable for the land contract. (See Chapter 17 for a more thorough discussion of board reso- lutions and officers’ authority.)

the partially disclosed principal In this situation, the third party knows that the agent is acting for someone else, but the identity of the principal is not disclosed. For example, an agent might be used to purchase land for development purposes when the developer does not want to be disclosed because disclosure of a major developer’s involvement might drive up land prices. In this situation, the third-party seller of the land can hold either the principal or the agent liable on the contract. The agent assumes some risk of personal liability by not disclosing the identity of the principal.

the Undisclosed principal In this situation, an agent acts without disclosing either the existence of a principal or the principal’s identity. Again, such an arrangement might be undertaken to avoid speculation, or it could be intended simply to protect someone’s privacy, such as when a famous person purchases a home and does not want any advance disclosure of the purchase or its location. Here, the agent is directly liable to the third party. If the third party discovers the identity of the principal, the third party could hold either the principal or the agent liable. Exhibits 16.1 and 16.2 provide summaries of the lia- bility of agents and principals under the three forms of disclosure of the relationship.

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Exhibit 16.1 Contract Liability of Disclosed Principal

Express Authority

Implied Authority Agent Has Actual Authority

Agent Has Apparent Authority but No Actual Authority

Agent Has No Actual Authority or Apparent Authority

Principal

Third PartyAgent

Principal

Third PartyAgent

Principal

Third PartyAgent

Exhibit 16.2 Contract Liability of Undisclosed or Partially Disclosed Principal

Express Authority

Implied Authority Contract within Actual Authority

Express Authority

Implied Authority Contract outside Actual Authority

Third Party

Third Party

Principal

Principal

Agent

Agent

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16-4b Liability of principals for agents’ torts

The liability of principals for torts committed by agents is controlled by the type of agency relationship—master–servant or independent contractor—and by the type of conduct.

Master–Servant Relationship As discussed earlier in the chapter, the liability of a principal for the acts of a ser- vant differs from that for the acts of an independent contractor. The principal is liable for the torts of the servant—an agent whose work, assignments, and time are controlled by the principal.

Scope of employment Employers (principals) are liable for the conduct of employees (agents/servants) while those employees are acting in the scope of employment. Scope of employ- ment means that an employee is doing work for an employer at the time a tort occurs. Suppose a florist delivery driver, while delivering flowers, has an auto acci- dent that is the delivery driver’s fault. In addition to the driver’s responsibility for the negligence in the accident, the florist is also liable to injured parties under the doctrine of respondent superior.

Scope of employment has been defined broadly by the courts. Negligent torts committed while an employee is driving to a sales call or delivery are clearly within the scope of employment.

An employee who takes the afternoon off is not within the scope of employ- ment, and the principal is not liable if an accident occurs during that time. When an employee begins acting on personal business, the scope of employ- ment ends. An employee who uses the lunch hour to shop is not within the scope of employment. Likewise, an employer who requires an employee to use his lunch hour to run errands for the company has changed personal time into scope-of-employment time.

One of the issues that has emerged in scope of employment involves situations in which employees are fatigued because of extra work shifts or long hours (as with medical interns and residents). They leave work and fall asleep on their way home. While they are no longer in the scope of employment, there are some courts that have held employers liable for their creating situations in which employees are so fatigued that they create hazards and cause accidents that injure others. For example, in Faverty v McDonald’s Restaurants of Oregon, Inc., 892 P.2d 703 (Ct. App. Or. 1995), the court held McDonald’s liable for an accident caused by Matt Theurer, an 18-year-old high school senior with many extracurricular activities, including being a member of the National Guard, who was working at a Port- land, Oregon, McDonald’s restaurant on a part-time basis. Because of long and double shifts, his friends and family were concerned that he was doing too much and getting too little sleep. High school employees frequently complained about being tired, and at least two of McDonald’s employees had accidents while driv- ing home after working the closing shift until midnight.

One week, Mr. Theurer worked until midnight, another shift until 11:30 p.m., two until 9:00 p.m., and another until 11:00 p.m. He then worked his regular shift from 3:30 until 7:30 p.m., followed by a cleanup shift beginning at midnight until 5:00 a.m. Mr. Theurer told his manager that he was tired and asked to be excused from his next regular shift. The manager excused him, and Mr. Theurer began his drive home.

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Chapter 16 Management of Employee Conduct: Agency 573

Mr. Theurer was driving 45 miles per hour on a two-lane road when he became drowsy or fell asleep, crossed the dividing line into oncoming traffic, crashed into the van of Frederic Faverty, and was killed. Mr. Faverty was seriously injured. The court held that McDonald’s was liable for the injuries and death resulting from the accident.

Some courts have declined to follow the McDonald’s decision. In Behrens v Harrah’s Illinois Corp., 852 N.E.2d 553 (Ill. 2006), the court did not allow the family of an employee to recover from the employer when she experienced catastrophic injuries following a rollover accident that occurred when she was driving home from work after being required to work overtime at the casino. A hospital is not liable for injuries caused by a sleep-deprived doctor working extra hours at the hospital. [Brewster v Rush-Presbyterian-St. Luke’s Medical Center, 836 N.E.2d 635 (111. App. 2005)] And Wal-Mart is not liable for the accident caused by an exhausted manager during the holiday season. [Aylward v Wal-Mart Stores, Inc., 2011 WL 2347762 (D. N.J. 2011)] However, other courts have followed the deci- sion for impairment caused by factors other than sleep deprivation. In Bussard v Minimed, Inc., 105 Cal.App.4th 798, 129 Cal.Rptr.2d 675 (2003), an employer was held liable to a third party under a respondeat superior theory where the employee became dizzy and light-headed after being exposed to pesticides at work and, while driving home, struck a car driven by the third party.

Generally, intentional acts not authorized by employers do not result in liabil- ity. However, under the theories of the negligent failure to supervise and negli- gent hiring, an employer may have liability for inaction when it has notice of the violent tendencies of an employee. Lange v National Biscuit Co. (Case 16.4) opened the door for recovery from employers for the intentional acts of employees in cer- tain well-defined circumstances.

Lange v National Biscuit Co. 211 N.W.2d 783 (Minn. 1973)

Shelf Space Is My Life: Flipping Out over Oreos

Case 16.4

FaCtS

Jerome Lange (plaintiff) was the manager of a small grocery store in Minnesota that carried Nabisco (defen- dant) products. Ronnell Lynch had been hired by Nabisco as a cookie salesman–trainee in October 1968. On March 1, 1969, Mr. Lynch was assigned his own territory, which included Mr. Lange’s store.

Between March 1 and May 1, 1969, Nabisco received numerous complaints from grocers about Mr. Lynch being overly aggressive and taking shelf space in the stores reserved for competing cookie companies.

On May 1, 1969, Mr. Lynch came to Mr. Lange’s store to place Nabisco merchandise on the shelves. An argument developed between the two over Mr. Lynch’s

service to the store. Mr. Lynch became very angry and started swearing. Mr. Lange told him to either stop swearing or leave the store because children were present. Mr. Lynch then became uncontrollably angry and said, “I ought to break your neck.” He then went behind the counter and dared Mr. Lange to fight. When Mr. Lange refused, Mr. Lynch viciously assaulted him, after which he threw cookies around the store and left.

Mr. Lange filed suit against Nabisco and was awarded damages based on the jury’s finding that although the acts of Mr. Lynch were outside the scope of employ- ment, Nabisco was negligent in hiring and retaining him. The judge granted Nabisco’s motion for judgment notwithstanding the verdict, and Mr. Lange appealed.

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JUdICIaL OpINION

TODD, Justice There is no dispute with the general principle that in order to impose liability on the employer under the doctrine of respondeat superior it is necessary to show that the employee was acting within the scope of his employment. Unfortunately, there is a wide disparity in the case law in the application of the “scope of employment” test to those factual situations involving intentional torts. The majority rule as set out in Anno- tation, 34 A.L.R.2d 372, 402, includes a twofold test: (a) Whether the assault was motivated by business or personal considerations; or (b) whether the assault was contemplated by the employer or incident to the employment.

Under the present Minnesota rule, liability is imposed where it is shown that the employee’s acts were motivated by a desire to further the employer’s business. Therefore, a master could only be held lia- ble for an employee’s assault in those rare instances where the master actually requested the servant to so perform, or the servant’s duties were such that that motivation was implied in law.

The fallacy of this reasoning was that it made a certain mental condition of the servant the test by which to determine whether he was acting about his master’s business or not. Moreover, with respect of all intentional acts done by a servant in the supposed furtherance of his master’s business, it clothed the master with immunity if the act was right, because it was right, and, if it was wrong, it clothed him with a like immunity, because it was wrong. He thus got the benefit of all his servant’s acts done for him, whether right or wrong, and escaped the burden of all intentional acts done for him which were wrong. Under the operation of such a rule, it would always be more safe and profitable for a man to conduct his business vicariously than in his own person. He would escape liability for the consequences of many acts connected with his business springing from the imperfection of human nature, because done by another, for which he would be responsible if done by himself. Meanwhile, the public, obliged to deal or come in contact with his agents, for intentional injuries done by them, might be left wholly without redress. . .  . A doctrine so fruitful of mischief could not long stand unshaken in an enlightened system of jurisprudence.

In developing a test for the application of respon- dent superior when an employee assaults a third person, we believe that the focus should be on the basis of the assault rather than the motivation of the employee. We reject as the basis for imposing liability the arbitrary determination of when, and at what point, the argument and assault leave the sphere of the employer’s business and become motivated by personal animosity. Rather, we believe the better approach is to view both the argument and assault as an indistinguishable event for purposes of vicarious liability.

We hold that an employer is liable for an assault by his employee when the source of the attack is related to the duties of the employee and the assault occurs within work-related limits of time and place. The assault in this case obviously occurred with- in work-related limits of time and place, since it took place on authorized premises during working hours. The precipitating cause of the initial argument concerned the employee’s conduct of his work. In addition, the employee originally was motivated to become argumentative in furtherance of his employ- er’s business. Consequently, under the facts of this case we hold as a matter of law that the employee was acting within the scope of employment at the time of the aggression and that plaintiff’s post-trial motion for judgment notwithstanding the verdict on that ground should have been granted under the rule we herein adopt. To the extent that our former deci- sions are inconsistent with the rule now adopted, they are overruled.

Plaintiff may recover damages under either the theory of respondeat superior or negligence. Having disposed of the matter on the former issue, we need not undertake the questions raised by defendant’s asserted negligence in the hiring or retention of the employee.

Reversed and remanded.

CaSe QUeStIONS

1. What previous indications did Nabisco have that Mr. Lynch might cause some problems?

2. What test does the court give for determining scope of employment?

3. What is the “motivation test,” and does this court accept or reject it?

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Chapter 16 Management of Employee Conduct: Agency 575

Negligent Hiring and Supervision The Lange case provided the types of circumstances in which employers could be liable for the tort of negligent hiring and/or supervision of employees. Negligent hiring requires proof that the principal/employer hired an agent/employee whose background made him or her ill suited for the position. For example, a school dis- trict that does not check the background of a bus driver or teacher, particularly for past charges or history of child abuse and molestation, has committed the tort of negligent hiring. Negligent supervision liability results when an employer has been put on notice that an employee has engaged in behavior that is harmful to others but leaves the employee in his position. An example is a college or univer- sity leaving a professor in the classroom after having received complaints regard- ing his inappropriate conduct in class and with students. If the professor then harms one of his students, the college or university would be liable to the student for the failure to make a timely termination, suspension, or other action to remove the professor from student contact or at least provide appropriate monitoring of the professor with the students.

The liability of principals for the torts of agents has become a costly part of doing business. Many firms are undertaking various forms of testing to prevent employees who could cause injuries from driving, operating machinery, or oth- erwise working in situations in which human safety is an issue. The courts have upheld the employer’s right to test for the presence of drugs and alcohol when the firms can show a public safety need established by the employee’s contact with the public during the course of employment.

Independent Contractors Principals are not generally liable for the torts of independent contractors, but three exceptions apply to this general no-liability rule. The first exception covers inherently dangerous activities, which are those that cannot be made safe. For example, using dynamite to demolish old buildings is an inherently dangerous activity. Without this liability exception, a principal could hire an independent con- tractor to perform the task and then assume no responsibility for the damages or injuries that might result.

Sean Garrick was an active-duty member of the U.S. Air Force stationed at Buckley Air Force base in Aurora, Colorado. He was given a three-day assignment in Boulder County, at which time he was to work three 12-hours shifts. During these assign- ments, the Air Force provided employees with hotel accommodations, a per diem allowance, and the cost of travel. During his assignment, Mr. Garrick was given a break from 1:00 to 2:30 p.m. When given

breaks such as these, employees usually go back to their hotel and relax. On his way back to the hotel for a nap, Mr. Garrick struck Jason Fowler on his motorcycle and injured him.

Mr. Fowler filed suit against the United States. The United States says that Mr. Garrick was not within the scope of his employment and that it is not liable for Mr. Fowler’s inju- ries. Is the government correct? [Fowler v U.S., 647 F.3d 1232 (10th Cir. 2011)]

Consider . . . 16.6

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The second exception to the no-liability rule occurs when a principal negligently hires an independent contractor. A landlord who hires a security guard, therefore, must check that guard’s background because if a tenant’s property is stolen by a guard with a criminal record, the landlord is responsible. Similarly, if a principal hires independent contractors knowing of their past employment history, the princi- pal is liable for the conduct of those independent contractors. A business that hires a

Jana Waffle Christian was the executive direc- tor of Southwest Oklahoma State University’s Salt Fork Adventure program, a survival and rehabilitation program for minors. Gregory Hyatt was a participant in the program and alleged that Waffle coerced him into a sexual relationship under threat of punishment if he did not comply. Waffle also allegedly provided Hyatt with alcoholic beverages both on and off the grounds of the SWOSU program. Hyatt alleged that on January 31, 2012, Waffle provided him with alcohol in her car while on the grounds of the facility and that, when Hyatt was inebriated, Waffle took Hyatt and another boy to her house in Jett, Oklahoma. At the house, Waffle allegedly

provided more alcohol and marijuana to Hyatt, had sexual relations with him, and took pictures of him naked. As Waffle drove the boys back toward the facility (inebriated and driving at speeds in excess of 110 miles per hour), she was stopped and arrested for driv- ing under the influence. Waffle subsequently pled guilty and was convicted of child endan- germent, contributing to the delinquency of minors, speeding, and transporting an open container of liquor. Hyatt and his mother filed suit against the university for the actions of Waffle. Is the university liable for the conduct of the director in its program? [Hyatt v Board of Regents of Oklahoma Colleges, 2015 WL 52112 (W.D. Okl. 2015)]

Consider . . . 16.7

For the Manager’s Desk

The National Security Agency (NSA) hired Edward Snowden to work in its Internet and phone surveillance area after it received a clear security background check from US Investi- gations Services LLC (USIS). This firm is the largest background check company that does background checks for the federal government.

Edward Snowden left his NSA job abruptly after releasing significant amounts of data as well as disclosures about the surveillance activities of NSA.

After Mr. Snowden leaked the highly sen- sitive information, he left the country, and the federal government began an investigation into USIS. The information that has emerged from

that investigation is that USIS was involved in “flushing,” which is a process of a very fast and shallow look at an individual’s background in order to get an individual’s security clearance and thereby get the money for the work paid.

What would be USIS’s liability if Mr. Snowden’s background check, if done thor- oughly, would have revealed patterns of behavior that would not be a good fit for NSA? In order to avoid negligence hiring liability, companies need to be sure that the firms they hire to do background checks for them need to do their work thoroughly. Shortcomings in background checks translate to liability for employers. ©

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Chapter 16 Management of Employee Conduct: Agency 577

collection agency to collect past-due accounts, knowing that agency’s reputation for violence, is liable for the agency’s torts even though they are independent contractors.

The third exception is the situation in which the principal has provided the specifications for the independent contractor’s procedures or process. Because the independent contractor is required to follow the principal’s directions, the princi- pal will also have liability.

16-5 Termination of the Agency Relationship An agency relationship can end in several different ways. First, the parties can have a definite duration for the agency relationship. A listing agreement for the sale of real property usually ends after 90 days. An agency can also end because the agent quits or the principal fires the agent. When the principal dies or is inca- pacitated, an agency ends automatically because the agent no longer has anyone to contract on behalf of.

Although the agency relationship ends easily when an agent is fired or quits, the authority of the agent does not end so abruptly or easily. An agent can still have lingering apparent authority that exists beyond the termination of the agency in relation to third parties who are unaware of the agency termination. For example, if the purchasing agent for a corporation retires after 25 years, the agency that con- sists of actual authority (express and implied authority) between the agent and corporation has ended. However, departure, retirement, and termination do not end apparent authority. Many customers are used to dealing with the agent and may not be aware of the end of the agency. That purchasing agent could still bind the principal corporation even though the agent’s actual authority has ended.

The principal corporation can end lingering apparent authority by giving public or constructive notice or private or actual notice. Public notice is publica- tion of the resignation. Many trade magazines and business newspapers publish announcements and personal columns about business associate changes and other personnel news. Even though not everyone dealing with the agent may see the notice, these public notices are deemed to serve as constructive notice. However, the principal must also give private notice to those firms that have dealt with the agent or have been creditors in the past. This notice is accomplished by sending a letter to each firm or individual that has dealt with the agent. Without this notice, the agent’s apparent authority lingers with respect to those third parties who have not received notice.

16-6 Termination of Agents under Employment at Will

Most employees do not have written contracts that specify the start and dura- tion of their employment. Rather, most employees work at the discretion of their employers, which is to say that they have employment at will. Recent cases have placed some restrictions on this employer freedom to hire and fire at will because courts have been giving employees/agents the benefit of their reliance. Employees have based their protection rights on several theories, including implied contract and public policy. Exhibit 16.3 summarizes the “do’s” and “don’ts” of disciplining employees.

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16-6a the Implied Contract

Many courts have implied the existence of a contract because of the presence of promises, procedures, and policies in an employee personnel manual. Personnel manuals have been held to constitute, both expressly and impliedly, employee con- tracts or to become part of the employee contracts when they are given to employees at the outset. One of the factors that determines whether a personnel manual and its terms constitute a contract is the reliance of an employee on its procedures and terms.

Because the employee manual represents a potential contract for the employer, its nature and content should be considered carefully. Of the two approaches to employee manuals, one takes a detailed approach in which all rules, rights, and expectations are carefully established. Another approach is the simple one, in which overall general policies and rights are established with details to be filled in as individual issues arise. Dillon v Champion Jogbra, Inc. (Case 16.5) deals with one state’s view on the issue of implied contract.

Exhibit 16.3 the do’s and don’ts of Working with problem employees

DO

Have regular performance evaluations

When disciplining employees, use a standardized procedure and have everything in writing

Make sure your policies and rules are clear

Keep disciplinary processes private

Be honest in stating the reasons for termination

DON’T

Don’t let annual performance reviews slip by

Don’t vary from procedures

Don’t use oral communication in disciplining employees

Don’t add to rules without notice to employees

Don’t forward e-mails regarding discipline to those who have no reason to know; don’t make public examples of terminated employees

Don’t alter the reasons for termination to make things look better

Don’t offer recommendation letters in exchange for the employee’s agreement to leave

Dillon v Champion Jogbra, Inc. 819 A.2d 703 (Vt. 2002)

Letting a Champion Employee Go

Case 16.5

FaCtS

Linda Dillon began working for Jogbra part-time in January 1997. She was hired as a full-time employee in August 1997 in the position of charge-back analyst. In the summer of 1998, the position of sales administrator was going to become vacant. Ms. Dillon was approached by Jogbra management about applying for the position, which started on July 31. She eventually decided to apply and interviewed for the position. In the course of interviewing, Ms. Dillon recalls that she was told that she would receive “extensive training.” The human resources manager told her that she would overlap

with her predecessor, who would train her during those days. However, in the course of Ms.  Dillon’s inter- view with the vice president of sales, who would be her immediate supervisor, he informed her that her predecessor was actually leaving earlier and would be available for only two days of training before Ms. Dillon started the job. He reassured her, though, that the predecessor would be brought back sometime thereafter for more training. Ms. Dillon also recalls that he told her that “it will take you four to six months to feel comfortable with [the] position” and not to be concerned about it. Ms. Dillon accepted the position

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Chapter 16 Management of Employee Conduct: Agency 579

and spent most of her predecessor’s remaining two days with her. Her predecessor then returned in early September for an additional two days of training. Ms. Dillon stated that she felt that, after the supplemental training, she had received sufficient training for the job.

On September 29, Ms. Dillon was called into her supervisor’s office. The human resources manager was also present. They informed Ms. Dillon that things were not working out and that she was going to be reassigned to a temporary position, at the same pay and benefit level, which ended in December. She was told that she should apply for other jobs within the company, but if nothing suitable became available, she would be termi- nated at the end of December. According to Ms. Dillon, her supervisor stated that he had concluded within 10 days of her starting that “it wasn’t going to work out.” Prior to the meeting, Ms. Dillon was never told her job was in jeopardy, nor did Jogbra follow the procedures laid out in its employee manual when terminating her.

Ms. Dillon applied for one job that became avail- able in the ensuing months but was not selected for it. She left Jogbra in December when her temporary posi- tion terminated. Ms. Dillon then brought suit against Jogbra for wrongful termination. She asserted claims for breach of contract and promissory estoppel. Jogbra filed a motion for summary judgment, which the trial court granted. Ms. Dillon appealed.

JUdICIaL OpINION

MORSE, Justice We affirm with respect to Dillon’s claim for promissory estoppel, but reverse and remand on her breach of contract claim.

Jogbra has an employee manual that it distributes to all employees at the time of their employment. The first page of the manual states the following in capital- ized print:

The policies and procedures contained in this manual constitute guidelines only. They do not constitute part of an employment contract, nor are they intended to make any commitment to any employee concerning how indi- vidual employment action can, should, or will be handled.

Champion Jogbra offers no employment contracts nor does it guarantee any minimum length of employment. Champion Jogbra reserves the right to terminate any employee at any time “at will,” with or without cause.

During the period from 1996 to 1997, however, Jogbra developed what it termed a “Corrective Action Procedure.” This procedure established a progressive discipline system for employees and different catego- ries of disciplinary infractions. It states that it applies to all employees and will be carried out in “a fair and

consistent manner.” Much of the language in the sec- tion is mandatory in tone.

. . . [A]n employer may modify an at-will employ- ment agreement unilaterally. When determining whether an employer has done so, we look to both the employer’s written policies and its practices. An employer not only may implicitly bind itself to termi- nating only for cause through its manual and practices, but may also be bound by a commitment to use only certain procedures in doing so.

When the terms of a manual are ambiguous, how- ever, or send mixed messages regarding an employ- ee’s status, the question of whether the presumptive at-will status has been modified is properly left to the jury. This may be the case even if there is a disclaimer stating employment is at-will, as the presence of such a disclaimer is not dispositive in the determination. Furthermore, an employer’s practices can provide context for and help inform the determination. The question of whether a written manual is ambiguous is a determination of law that we review de novo. In this case, we cannot agree with the trial court that the terms of Jogbra’s manual are unambiguous.

Notwithstanding the disclaimer contained on the first page of the manual quoted above, the manual goes on to establish in Policy No. 720 an elaborate system governing employee discipline and discharge. It states as its purpose: “To establish Champion Jogbra policy for all employees.” It states that actions will be carried out “in a fair and consistent manner.” It provides that “[t] he Corrective Action Policy requires management to use training and employee counseling to achieve the desired actions of employees.” It establishes three categories of violations of company policy and corresponding actions to be generally taken in each case. It delineates progres- sive steps to be taken for certain types of cases, including “[u]nsatisfactory quality of work,” and time periods governing things such as how long a reprimand is con- sidered “active.” All of these terms are inconsistent with the disclaimer at the beginning of the manual, in effect sending mixed messages to employees. Furthermore, these terms appear to be inconsistent with an at-will employment relationship, its classic formulation being that an employer can fire an employee “for good cause or for no cause, or even for bad cause.”

With respect to the record before the court on Jog- bra’s employment practices, Dillon herself was aware of at least one employee whose termination was car- ried out pursuant to the terms set forth in the manual. She also testified in her deposition to conversations with the human resources manager, with whom she was friendly, in which the manager had described certain procedures used for firing employees. She

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stated that the manager had told her that Jogbra could not “just get rid of” people, but instead had to follow procedures. The human resources manager herself tes- tified that “she could only recall two instances in which the portion of the manual providing for documentation of progressive action was not followed, one of which resulted in a legal claim against the company and the other of which involved an employee stealing from the company. In fact, the manual specifically provides that stealing “will normally result in discharge on the first offense.” Thus, it is not clear how that discharge devi- ated from the provisions of the manual.

In conclusion, the manual itself is at the very least ambiguous regarding employees’ status, and Jogbra’s employment practices appear from the record to be both consistent with the manual and inconsistent with an at-will employment arrangement. Therefore, sum- mary judgment was not proper on Dillon’s breach of implied contract claim. . . .

We have held that, even if an employee otherwise enjoys only at-will employment status, that employee may still be able to establish a claim for wrongful termination under a theory of promissory estoppel if that employee can demonstrate that the termina- tion was in breach of a specific promise made by the employer that the employer should have reasonably expected to induce detrimental reliance on the part of the employee, and that the employee did in fact detri- mentally rely on the promise. We agree with the trial court in this case, however, that essential elements of promissory estoppel are absent with regard to both statements.

With respect to Jogbra’s promise to Dillon that she would receive training, Dillon specifically conceded that, upon her predecessor’s return in September, she had received adequate training to perform the job. In other words, Jogbra had delivered on its promise. Fur- thermore, even assuming that Jogbra failed to provide the full extent of promised training, Dillon has failed to explain how, as a matter of law, the promise of training modified her at-will status. In other words, it is not clear from Dillon’s brief how the promise of training

foreclosed Jogbra from nevertheless terminating her either on an at-will basis or for cause. . . .

With respect to the assurance that it would take four to six months to become comfortable with the position, the statement cannot reasonably be relied upon as a promise of employment in the sales admin- istrator position for a set period of time. Courts have generally required a promise of a specific and definite nature before holding an employer bound by it.

In sum, the trial court properly granted Jogbra summary judgment on Dillon’s promissory estoppel claim. The grant of summary judgment on Linda Dil- lon’s claim for promissory estoppel is affirmed; the grant of summary judgment on her breach of contract claim is reversed and remanded.

Affirmed in part; reversed in part.

dISSeNtING OpINION

AMESTOY, Chief Justice, dissenting In support of employee’s contention that employer’s practices were at odds with an at-will policy, employee cites to her own deposition, wherein she claimed to have known of other employees who received pro- gressive discipline prior to termination. When pressed, however, employee admitted that, of the three employ- ees with whose discharge she was familiar, she could state with certainty that only one received progressive discipline. Moreover, employee stated that she was unfamiliar with the manner in which the other two employees’ cases were handled prior to their dis- charge. While her own experience is relevant, it does not by itself suggest a definitive company-wide prac- tice. Hearsay statements about what employee “had heard” is insufficient to raise a genuine issue.

CaSe QUeStIONS

1. What is the effect of the disclaimer in the Jogbra employment manual?

2. What changes the application of the employment- at-will doctrine to Dillon?

3. What is the dissenting justice’s concern?

16-6b the public policy exception

In a second group of employment-at-will cases, the courts have afforded pro- tection to those employees called whistle-blowers who report illegal conduct and to those who refuse to participate in conduct that is illegal or that violates public policy.

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There are significant statutory protections for whistle- blowers at the state and federal level. Two generic federal statutes afford protection for federal employees: the Civil Service Reform Act of 1978 and the Whistleblower Protection Act of 1989. The statutes protect federal employees who report wrongdoing and permit them to recover both back pay and their attorney fees in the event they litigate or pro- test a termination for their disclosure of possible violations of the law.

The False Claims Act permits employees of government contractors whose tips and disclosures to federal investiga- tors and agencies result in fines and penalties to collect 30% of those fines and penalties. For example, a health care pro- fessional was so helpful to the government in building a case against a health car provider that the court awarded her the full 33%, which amounted to over $30 million.

Some federal statutes also have specific provisions for certain categories of federal employees. For example, a por- tion of the Energy Reorganization Act provides protection for employees of nuclear facilities who report violations of federal laws and regulations at nuclear plants.

Sarbanes–Oxley (SOX) also provides antiretaliation protections for employees who raise concerns about the financial reports or internal controls of their companies. The protections apply to employees who help with an audit, employees who join in a shareholder suit against the company, employees who report financial issues to a government agency, and employees who use internal reporting systems to raise a financial concern or compliance issue. The SOX protections are unique because they are the first whistle-blower protections that go beyond those for employees who raise public safety concerns. The protections cover not only employees of companies but also analysts who raise concerns about companies they study. The research firms or investment houses the analysts work for cannot take retaliatory action against the ana- lysts for issuing negative reports on companies that might also be clients of the analyst’s employer. Companies that retaliate face criminal penalties or fines as well as imprisonment for those within the company who take action against the whistle-blower. The individual penalties for SOX retaliation are up to 10 years in prison. For the employee, damages for retaliation include back pay, actual damages, and a right to reinstatement.

Protections and rewards for whistle-blowers have been increased through stat- utes and regulations. Under the Dodd-Frank Wall Street Reform and Consumer Protection Act (see Chapters 11 and 18 for more information), a whistle-blower can collect between 10% and 30% of whatever the federal government recovers from a company for violations of the law.

In Hadley v Duke Energy Progress (Case 16.6), a court deals with the issue of an employer firing an employee who has complained about waste on a government project but has other issues at work.

Encourage internal whistleblowing. Employees can benefit from following these suggestions:

1. Work within your system and through its chain of command before going public. Go through the various layers of management, even to the board of directors.

2. Voice/write your concerns; don’t make accusations.

3. Maintain records of your internal contacts and their objections.

4. Find other employees who also know about this potentially volatile situation.

5. Keep a record of your information and carefully document all that you do to raise the issue.

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Hadley v Duke Energy Progress 2016 WL 1071098 (E.D.N.C. 2016)

Off the Grid with Duke

Case 16.6

FaCtS

Timothy S. Hadley worked for Duke Energy Progress (DEP) (defendants) from August 5, 2002 until his termi- nation on December 7, 2010.

On January 31, 2008, Hadley had lunch with Mont- gomery and Hardison. Montgomery and Hardison told Hadley that he would receive a raise in salary that year. Hadley wanted the raise to be effective retroac- tively to May 2006, when he was promoted. According to Hadley, Montgomery and Hardison promised that he would receive four monetary Energy Advantage Awards (“EAAs”) to compensate him appropriately for the time between May 2006 and when the raise would take effect.

Hadley periodically asked Montgomery about the status of the EAAs from 2008 through Septem- ber 2009. In November 2008, Hadley contacted DEP Human Resources’ Sue Bathgate regarding the EAAs. In response, Montgomery called Hadley into a one-on- one meeting and told Hadley that he would be fired if he continued to pursue the EAAs with HR. Hadley alleges that he spoke with Montgomery about the EAAs again during an August 2010 meeting concern- ing Hadley’s 2010 midyear review, and Montgomery repeated his threat. On October 29, 2010, Hadley again mentioned the EAAs to HR.

In 2009, Hadley began to work also on DEP’s Smart Grid Program, an energy efficiency project funded in part by a matching grant awarded under the American Recovery and Reinvestment Act of 2009.

In December 2009, Hadley discovered that DEP had paid IBM over $4 million for work that Hadley consid- ered to be “not worth anywhere near the amount that IBM billed.” In November and December 2009, Hadley criticized the value of IBM’s work to Montgomery and Hardison, telling them that he was concerned that “DEP was submitting costs to U.S. government agen- cies that . . . could not be substantiated.” On December 22, 2009, Hadley received an IBM task order that would pay IBM over $3.5 million for three months’ work but would require “no deliverables.”

On January 5, 2010, Hadley told Montgomery that he “would not initiate the . . . order” because of

IBM’s poor performance, because the task order did not require deliverables from IBM, and because DEP’s own schedulers could “do the same work for approx- imately 10% of the cost.” Throughout December 2009 and January 2010, Hadley complained to DEP person- nel, including Montgomery and others, that the “data on the Smart Grid Program was being inaccurately reported to the Federal Department of Energy” and that there were “major discrepancies with what DEP was proposing to send to the Department of Energy as basis for [an ARRA matching grant].” In October 2010, Hadley also complained about Smart Grid to HR’s Nadine Kloecker-Dunn. Hadley believed DEP’s actions were improper, “constituted a gross mismanagement of an ARRA contract and ARRA funds,” “constituted a gross waste of ARRA funds,” and “constituted an abuse of authority” related to use of ARRA funds. Had- ley thought that the IBM work was “junk,” that “the project was in complete shambles,” and that there was “no rationale or basis behind any of [IBM’s] numbers.” In January 2009, Montgomery told Hadley that “there would be consequences” for his repeated complaints regarding Smart Grid.

In early 2010, Hadley asked to be removed from Smart Grid. Montgomery granted Hadley’s request and assigned Hadley to a project in Sutton, North Carolina. Sutton is a two-and-a-half-hour drive from Hadley’s home in Raleigh. At the time of Hadley’s reassignment, Montgomery did not believe Hadley would be required to be present physically in Sutton on a daily basis. However, around May 2010, DEP enacted a policy change that required Project Controls employees to be physically present at their assigned project locations on a daily basis. Hadley was not the only employee that this change affected. In mid-2010, Montgomery told Hadley that he would need to begin working full-time at Sutton beginning in the third quarter of 2011, approximately 15 months later.

Hadley refused to travel to Sutton. In August 2010, Montgomery told Hadley that if he refused to travel to Sutton, he would no longer have a position. Moreover, Montgomery sent Hadley a memo stating that, in light of his refusal to travel to Sutton, Hadley’s

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continued

employment would end on October 15, 2010, if he did not find another position within DEP. Hadley did not find another position within DEP by October 15, 2010, but he remained employed with DEP until December 7, 2010.

In August or early September 2010, Montgomery noticed that Hadley had a considerable balance of unused vacation time. This fact surprised Montgom- ery because Hadley “typically took a ski vacation each year.” On September 15, 2010, Montgomery instructed Hadley via e-mail to change his time sheet to reflect the correct vacation time. Hadley did not reply to Montgomery’s e-mail but allegedly left a voice mail for Montgomery explaining that he had intentionally miscoded the vacation time to compensate himself for holiday time that had been misrecorded as vacation time in 2009. Hadley did not change his time sheet as Montgomery had requested and acknowledges that miscoding time violates company policy. Nonetheless, Hadley contends that Montgomery approved Hadley’s timekeeping method to compensate for the alleged 2009 vacation error.

DEP investigated whether Hadley violated DEP’s Code of Ethics by falsifying his time sheets. After interviewing Hadley and reviewing Hadley’s building access and business-computer records for 2009 and 2010, investigator Eugene Simmons concluded that Hadley had falsified his time sheets.

On December 7, 2010, DEP terminated Hadley’s employment. DEP’s records reflect that the decision to terminate Hadley’s employment was based on Sim- mons’s conclusion that Hadley had falsified his time sheets.

After his termination, Hadley filed multiple com- plaints with North Carolina state agencies as well as the U.S. Department of Energy. All the agencies denied his complaints.

Hadley then filed suit in federal court. In his amended consolidated complaint, Hadley makes four claims: (1) retaliation in violation of the ARRA, (2) violation of North Carolina’s Retaliatory Employ- ment Discrimination Act (“REDA”), (3) violation of the North Carolina Wage and Hour Act, and (4) wrongful discharge in violation of North Carolina public policy. DPE moved for summary judgment on each claim.7

JUdICIaL OpINION

DEVER, Chief United States District Judge Hadley alleges reprisal against him in violation of the American Recovery and Reinvestment Act of 2009 (ARRA). ARRA provides “whistleblower” protec- tion to any “employee of any non-Federal employer

receiving covered funds.” To recover under ARRA’s whistleblower provision, a plaintiff must prove by a preponderance of the evidence that he (1) made a protected disclosure, (2) suffered a reprisal, and (3) the protected disclosure was a contributing factor in the reprisal. If a plaintiff proves these elements, the employer can rebut the claim with proof “that [the employer] would have taken the action constituting the reprisal in the absence of the disclosure.”

To be actionable, ARRA requires the misuse of funds be severe enough that the employee subjectively believes that it is “gross” and severe enough that a “reasonabl[e]” employee in plaintiff’s position would consider it “gross.”

ARRA does not define “gross mismanagement,” but several courts have interpreted substantially iden- tical language in the Whistleblower Protection Act (“WPA”). Gross mismanagement under the WPA occurs when the “conclusion that [the employer] erred is not debatable among reasonable people.” However, whistleblower protection does not provide a forum to litigate “policy disputes between the employee and [employer].”

Second, a plaintiff must prove that he was “dis- charged, demoted, or otherwise discriminated against.”

Third, a plaintiff must prove that the protected dis- closure was a “contributing factor” in the alleged repri- sal. A plaintiff “need not show that the activities were a primary or even a significant cause of his termination.”

Hadley’s ARRA claim fails. First, Hadley’s opinion of IBM’s work on the Smart Grid project as “a joke,” “junk,” and “garbage” does not constitute “gross mismanagement” under ARRA. Even viewing the evidence in the light most favorable to Hadley, Hadley has failed to show that he made any disclosure that he reasonably believed was protected under. Although Hadley subjectively believed that IBM’s work on Smart Grid constituted a “mismanagement” or “waste” of resources, Hadley’s opinion does not create a genuine issue of material fact.

Alternatively, no reasonable jury could find that Hadley’s alleged protected disclosure concerning Smart Grid was a “contributing factor” in the alleged reprisal.

Hadley’s dispute regarding the alleged unpaid EAA bonuses began years before he worked on Smart Grid. Thus, no rational jury could find that his com- plaints about Smart Grid contributed to Hadley’s fail- ure to receive EAA bonuses.

Second, no reasonable jury could find that any alleged protected statements about Smart Grid contributed to Hadley’s reassignment to the Sutton project. Hadley asked to be removed from Smart

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16-6c Handling employee termination disputes

The number of suits brought by employees for improper discharge has increased tremendously. Many companies, in the interest of maintaining fairness and saving expenses, have adopted a peer review policy. Peer review is a formal grievance procedure for nonunion employees. Employees who feel that they cannot get an adequate response from their supervisors or by following the lines of authority have the opportunity to present their cases to a panel of fellow employees and managers (the general configuration is three employees and two managers). Panel members listen to the presentation, can ask for more information, vote on the issue, and issue a written opinion with an explanation.

Many companies (including Coors and GTE) are avoiding lawsuits through what seems to be a mutually satisfactory resolution of wrongful termination and other grievance cases. Some employers say this process encourages both manag- ers and employees to make better decisions. The peer review process should be in the employee handbook, should be required prior to court action, and should be widely publicized.

Grid. Moreover, when Montgomery removed Had- ley from Smart Grid and transferred Hadley to the Sutton project, Montgomery had no idea that the Sutton Project would require that Hadley be physi- cally on site in Sutton. Thus, no rational jury could find that defendants transferred Hadley to the Sut- ton project as reprisal for Hadley’s alleged protected statements.

Finally, no rational jury could find that Hadley’s alleged protected statements concerning Smart Grid contributed to his termination. Hadley’s protected statements concerning Smart Grid primarily occurred between December 2009 and January 2010, but his termination was on December 7, 2010. The ten-month time period between the bulk of his alleged protected statements about Smart Grid and his termination does not support a causal inference.

Furthermore, even though Hadley made one alleged protected statement in October 2010, that state- ment also is not sufficient in this case. Notably, during 2010, Hadley miscoded his vacation time and refused to correct it. Moreover, Hadley acknowledges that DEP could terminate his employment based on his mis- coded hours. Hadley also admits that his supervisors asked him to correct his timesheets, but he did not do so. That Montgomery could have corrected Hadley’s timesheets himself does not negate Hadley’s miscon- duct or his insubordination. Likewise, the conflicting dates on the internal memorandum summarizing the investigation into Hadley’s timesheets do not under- mine Hardison’s good-faith belief that Hadley violated company policy by falsifying his timesheets and there- fore could be terminated. No rational jury could find that his alleged protected statements concerning Smart Grid contributed to his termination. Thus, the court

grants summary judgment to defendants on Hadley’s ARRA claim.

Finally, Hadley alleges wrongful discharge in vio- lation of North Carolina public policy. According to Hadley, defendants wrongfully discharged him for complaining about unpaid wages and about defen- dants’ alleged mismanagement of ARRA funds.

A wrongful discharge claim is a narrow exception to North Carolina’s general rule of employment at will. To prove a claim of wrongful discharge in violation of North Carolina public policy, a plaintiff must iden- tify and rely upon a specific North Carolina statute or North Carolina constitutional provision as stating North Carolina public policy. A plaintiff asserting wrongful discharge in violation of North Carolina pub- lic policy may not rely on federal law as stating North Carolina public policy.

No rational jury could find that DEP’s termination of Hadley’s employment violated any North Carolina statute or constitutional provision. Thus, Hadley’s wrongful discharge claim fails.

Moreover, and in any event, no rational jury could find that Hadley’s termination violated North Carolina public policy. The court grants summary judgment to defendants on Hadley’s wrongful discharge claim [and all other claims].

CaSe QUeStIONS

1. Give a summary of Hadley’s employment history.

2. What would Hadley have had to say to have an ARRA claim?

3. What advice would you give employees in mak- ing a ARRA complaint? How? When? And what advice regarding work habits and practices?

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the employee Handbook as a Source of Litigation: taking

precautionary Steps The employee handbook continues to be a source of litigation. Every appellate court that has heard a case on the issue of employee handbooks has ruled that an implied contract results from the terms in the employee handbook.

This focus on employee handbooks has been combined with the majority of courts finding the right of an employee to recover for wrongful discharge if the employer has violated its own handbook. Here are the critical components of a good employee handbook:

1. Make sure every employee has a copy. 2. Enforce the rules. Lack of enforcement

results in litigation. 3. Use clear and simple language. 4. Provide training on the handbook and

the rules. 5. Give annual reminders about the rules

and have employees sign off on their annual reminder.

6. Some companies have computer- based training that is required every year for employees to review and demonstrate understanding through questions.

7. Don’t change the handbook without sufficient notice to all employees.

8. Be sure to cover the social media issues in the handbook—what employees can post on Facebook and other sites or whether managers and supervisors are permitted to ask their employees to “friend” them on Facebook.

9. Provide a contact person or depart- ment for employees who have ques- tions about the handbook.

10. Follow the processes and rules in the handbook.

11. Refer to the handbook often when issuing reminders about policies and rules and when disciplining employees.

BUSINESS STRATEGY

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16-7 Agency Relationships in International Law One of the complexities that has developed in law because of global business organizations is the liability of various subsidiaries, officers, and owners of multi- national organizations when the interrelationships and operations may not be clear or even known to them. Perhaps the best example of the pitfalls of global structure is the multinational bank BCCI, a bank that proved elusive as authorities from sev- eral countries investigated it for criminal activity. BCCI was a layered, multinational organization with banks in 70 countries, including the United States (First American Bankshares, headed by the late Clark Clifford and Robert Altman). The banks and businesses in the different countries were staffed by residents of those countries, and the full global network of BCCI was not disclosed to these subsidiaries or to the indi- viduals operating them. Regulations of operations were limited to the entities located in each of the various nations. Jurisdiction over other operations was limited. The layers of the organization made it difficult for anyone, even those in the subsidiaries, to be certain of the roles and activities of the full organization or of other subsidiaries.

BCCI collapsed and surrendered its U.S. assets to U.S. regulators in settlement of various charges. The late Clark Clifford and Robert Altman were indicted for activities involving BCCI, although they were affiliated with U.S. operations only. Mr. Altman was acquitted of the charges, and the court determined that Mr. Clif- ford was too ill to stand trial.

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Following this complex case with its structuring of principal and agent relation- ships to evade the laws of any country, the United Kingdom, the United States, and other countries now work together to share information about tangled and evasive bank structures in order to prevent collapses and also detect the flow of funds by terrorist organizations. The cooperating nations now require filing and full disclo- sure of all principal–agent and parent–subsidiary relationships in all countries in which a bank conducts business.

Another area of agency law caution for companies in international business is the use of foreign agents in other countries for purposes of gaining access to government officials in order to win trade agreements or contracts. Companies are able to use such agents. However, they must know the agent’s background and monitor carefully payments to that agent in order to avoid violations of the For- eign Corrupt Practices Act (FCPA) (see Chapter 7 for more information). Excessive payments to foreign agents is a red flag that requires the company to look into what the agent is doing and, if necessary, self-report any violations. For example, Ralph Lauren reported FCPA violations in its Argentina operations when it uncov- ered that excessive gifts were being transferred to government officials there in order to open up the importation process for its goods there. Ralph Lauren paid a fine and then ended its operations in Argentina.

Biography

Julie Roehm was known throughout the advertising industry for her cutting-edge approach to advertising. When she worked for Chrysler, Ms. Roehm agreed to have Chrysler sponsor an alternative halftime show that would feature scant- ily clad models playing football, which came to be known as the Lingerie Bowl. When consumers and dealers howled, Chrysler dropped its sponsorship. She was the idea person behind the “Grab life by the horns” and “That thang got a hemi?” campaigns for Dodge Ram trucks. She also raised a few advertising eyebrows when she launched a Chrysler campaign for the Durango truck with a television commercial that had two men at a urinal who were also having a double-entendre conversation about size. A Chrysler executive indicated Ms. Roehm was known for going over the marketing edge, but that you don’t know

where the edge is unless you go over it once in a while.

Walmart recruited Ms. Roehm, a fit that many of her friends felt was wrong. Ms. Roehm herself worried about moving her East Coast family to Bentonville, Arkansas. Walmart had to pull one of her first ads, one that was referred to as “sexy.” The ad showed a couple having an intimate discus- sion about red lingerie in front of their extended family at a holiday gathering. Walmart pulled the ad after it aired on Desperate Housewives and Walmart received consumer complaints.

Ms. Roehm’s tenure at Walmart would last only 10 months. She was hired in 2006, and by 2007, Walmart was in litiga- tion with Ms. Roehm, who filed a wrongful termination suit against Walmart.

Walmart counterclaimed against Ms. Roehm’s allegations with its allegations

the avant-Garde ad exec at Walmart in arkansas: Julie Roehm

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Chapter 16 Management of Employee Conduct: Agency 587

that Ms. Roehm had an affair with Sean Womack (both were married with children at that time), her second-in-command at the company. The filing included e-mails allegedly to Mr. Womack from Ms. Roehm that were provided by Mrs. Womack:

“I hate not being able to call you or write you. I think about us together all the time. Little moments like watching your face when you kiss me.”

The filing also accuses the two of seeking employment with Draft FCB. Draft FCB was the company that was awarded the Walmart ad account by Ms. Roehm. Walmart fired Draft FCB after revelations about the conflicts and hired Interpublic Group. Walmart has since reassigned its ad contracts to three different agencies.

The Walmart counterclaim includes the following information about the perks Roehm and Womack enjoyed from Draft FCB:

•  $1,100 dinner •  $700 at LuxBar in Chicago •   $440  at  the  bar  in  the  Peninsula 

Hotel

Draft FCB cooperated with Walmart by providing copies of the e-mail com- munications between its employees and Roehm and Womack. However, Draft FCB also released a statement indicat- ing that the employee communicating with Womack about employment for the two had no authority to negotiate such employment contracts or even had the authority to engage in business development.

Once Walmart counterclaimed, Ms. Roehm fired back with her own allega- tions, ones that basically argued, “What’s sauce for the goose is sauce for the gander,” a timeless legal principle in these

battles of will. She alleged that Lee Scott, Walmart’s then-CEO, enjoyed favorable prices from Irwin Jacobs, a Walmart sup- plier, on everything from jewelry to boats and that Mr. Scott’s son, Eric, worked for Mr. Jacobs for years. Her allegation was that Mr. Scott was not fired for these conflicts and, ergo, she was dismissed wrongfully. WalMart’s code of ethics states that employees are not to have social relationships with suppliers if those relationships create even the appearance of impropriety.

While Walmart and Mr. Jacobs dis- missed the allegations as false and outrageous, Mr. Jacobs and Mr. Scott acknowledged that their families have vacationed together and that Mr. Jacobs attended Mr. Scott’s daughter’s wedding. Mr. Jacobs has also stated that when the two are out together, Mr. Scott always pays and will not allow Mr. Jacobs to pay for even a lunch or other meal. Mr. Jacobs also says, “I swear to God Lee never called me about [putting Eric to work].”

Walmart counterclaimed for its legal fees as well as for the damages (costs) it experienced when it had to re-bid the advertising agency contract Ms. Roehm had awarded. Walmart’s counterclaim alleged that because Ms. Roehm had accepted expensive meals and other gifts from the agency, she violated Walmart’s code of ethics, a strict one when it comes to suppliers, which prohibits employees from accepting anything from those suppliers.

The suit was dismissed and all parties agreed to walk away from the other suits that related to the situation surrounding Ms. Roehm’s termination.

Sources: Louise Story and Michael Barbaro, “WalMart Criticizes 2 in a Filing,” New York Times, March 20, 2007, pp. Cl, C5; Gary McWilliams and James Covert, “Roehm Claims Wal-Mart Brass Defy Ethics Rules,” Wall Street Journal, May 27, 2007, pp. Al, A5.

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When is an employee acting on behalf of an employer?

• Principal—employer; responsible party

• Agent—party hired to act on another’s behalf

• Restatement of Agency—common law view of agent– principal relationship

• Unincorporated association—nonlegal entity; no legal existence as natural or fictitious person

How much authority does an employee hold?

• Express authority—written or stated authority

• Implied authority—authority by custom

• Apparent authority—authority by perceptions of third parties

• Lingering apparent authority—authority left with terminated agent because others are not told of termination

• Actual notice—receipt of notice of termination

• Constructive notice—publication of notice of termination

• Ratification—after-the-fact recognition of agent’s authority by principal

• Disclosed principal—existence and identity of principal are known

• Partially disclosed principal—existence but not iden- tity of principal is known

• Undisclosed principal—neither existence nor identity of principal is known

• Gratuitous agency—agent works without compensation

When is a business liable for an employee’s acts?

• Master–servant relationship—principal–agent relationship in which principal exercises great degree of control over agent

• Independent contractor—principal–agent relation- ship in which principal exercises little day-to-day control over agent

• Scope of employment—time when agent is doing work for the principal

• Inherently dangerous activities—activities for which, even if performed by independent contractor, principal is liable

What duties and obligations do employees owe employers?

• Fiduciary—one who has utmost duty of trust, care, loyalty, and obedience to another

How is an agency relationship terminated?

• Employment at will—right of employer to terminate noncontract employees at any time

• Protections for employees through express contract (manuals), implied contracts, and public policy

• Whistle-blowers protected by antiretaliation statutes

s u m m a r y

Q u e s t i o n s a n d P r o b l e m s 1. AFLAC sells health care insurance policies. Darren Galgano signed an “Associate’s Agreement” with AFLAC, which engaged Galgano to solicit applications for insurance policies offered for sale by AFLAC. The agreement also states that Galgano is an independent contractor, without the authority to bind AFLAC for Gal- gano’s “debts, faults, or actions.” The agreement specifi- cally states that Galgano is prohibited from entering into contracts or incurring debt on behalf of AFLAC.

Galgano became a “District Sales Coordinator ’s Agreement,” which incorporated the terms of the “Asso- ciate’s Agreement” and specifically withheld authority

from Galgano to “rent any office space or telephone, open any bank account, or make any expenditure, obli- gation or commitment for any purpose in the name of AFLAC without specific written authorization from the president, a vice president, or secretary of AFLAC.” When Galgano became a “Regional Sales Coordinator’s Agreement,” he signed a “District Sales Coordinator’s Agreement,” which incorporated the terms from the pre- vious agreements.

Galgano leased retail property located in Crestwood, Illinois, from Cove Management. The first page of the lease listed Cove as the lessor, listed “AFLAC” as the

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Chapter 16 Management of Employee Conduct: Agency 589

tenant, and listed Galgano as the guarantor. The lease provided that the permitted use of the space was “insur- ance services.” On the signature page, Galgano signed his own name under “lessee” and “guarantor.” He did not indicate on the signature page that he was signing on behalf of AFLAC.

After Cove was not paid rent and the property in Crestwood was abandoned, Cove filed suit for breach of the lease agreement against both AFLAC and Galgano. Can AFLAC be held liable? [Cove Management v AFLAC, Inc., 986 N.E.2d 1206 (Ill. App. 2013)]

2. On September 29, 1984, Wilton Whitlow was taken to Good Samaritan Hospital’s emergency room in Mont- gomery County, Ohio, because he had suffered a seizure and a blackout. He was examined by Dr. Dennis Aumen- tado, who prescribed the antiepileptic medication Dilan- tin. Mr. Whitlow experienced no further seizures and was monitored as an outpatient at Good Samaritan over the next few weeks.

Mr. Whitlow complained to Dr. Aumentado of warm and dry eyes, and his Dilantin dose was reduced. On October 20, 1984, he was again admitted to the emer- gency room with symptoms that were eventually determined to be from Stevens–Johnson syndrome, a condition believed to be caused by a variety of medi- cations. Mr. Whitlow sued Dr. Aumentado and Good Samaritan for malpractice and Parke-Davis, the manu- facturer of Dilantin, for breach of warranty.

The hospital maintains it is not liable because Dr. Aumentado was an independent contractor. Is the hospital correct? [Whitlow v Good Samaritan Hosp., 536 N.E.2d 659 (Ohio 1987)]

3. On March 29, 1983, Barry Mapp was observed in the JCPenney department store in Upper Darby, Penn- sylvania, by security personnel, who suspected that he might be a shoplifter. Michael DiDomenico, a secu- rity guard employed by JCPenney, followed Mr. Mapp when he left the store and proceeded to Gimbels department store. There, Mr. DiDomenico notified Rosemary Federchok, a Gimbels security guard, about his suspicions. Even though his assistance was not requested, Mr. DiDomenico decided to remain to assist in case Ms. Federchok, a short woman of slight build, required help in dealing with Mr. Mapp if he commit- ted an offense in Gimbels.

Mr. Mapp was observed taking items from the men’s department of Gimbels; when he attempted to escape, he was pursued. Although Ms. Federchok was unable to keep up, Mr. DiDomenico continued to pur- sue Mr. Mapp and ultimately apprehended him in the lower level of the Gimbels parking lot. When Ms. Feder- chok arrived with Upper Darby police, merchandise that had been taken from Gimbels was recovered. Mr. Mapp,

who had been injured when he jumped from one level of the parking lot to another, was taken to the Delaware County Memorial Hospital, where he was treated for a broken ankle.

Mr. Mapp filed suit against Gimbels for injuries sustained while being chased and apprehended by Mr. DiDomenico. He alleged in his complaint that Mr. DiDo- menico, while acting as an agent of Gimbels, had chased him, had struck him with a nightstick, and had beaten him with his fists. Gimbels says it is not liable because Mr. DiDomenico was not its agent. Is Gimbels correct? [Mapp v Gimbels Dep’t Store, 540 A.2d 941 (Pa. 1988)]

4. John Coon purchased a piece of commercial property in Washington, D.C., through real estate broker Edward Wood. Mr. Coon later decided to purchase other property in West Virginia by selling the D.C. property. Mr. Coon asked Mr. Wood about structuring the sale of the D.C. property as a “Starker Exchange,” an investment prop- erty exchange that allows the property owner to avoid capital gains taxes in selling one investment property if there is an immediate investment in another property. Mr. Wood offered advice on the exchange, but the sale went through on the D.C. property without the exchange being set up. When Mr. Coon had his taxes done at H&R Block, he discovered that he owed $75,000 in capital gains taxes for sale of the D.C. property. Did Mr. Wood breach any duty as Mr. Coon’s agent? [Coon v Wood, 68 F. Supp. 2d 77 (D.D.C. 2014)]

5. Nineteen-year-old Lee J. Norris was employed by Burger Chef Systems as an assistant manager of one of its restaurants. On a day when he was in charge and change was needed, Mr. Norris left to get change but also decided to get Kentucky Fried Chicken at a nearby store for his lunch to take back to Burger Chef. The bank where Mr. Norris usually got change is 1.6 miles from Burger Chef, and the Kentucky Fried Chicken outlet is 2.5 miles from Burger Chef. After Mr. Norris left the bank and was on his way to the Kentucky Fried Chicken restaurant, he negligently injured Lee J. Govro in an accident. Is Burger Chef liable for the accident? [Burger Chef Systems v Govro, 407 F.2d 921 (8th Cir. 1969)]

6. Kevin Gardner is a driver with Loomis Armored, Inc., which is a company that supplies armored truck deliv- ery services to banks, businesses, and others requiring secure transport of funds and other valuables. Because of the safety and liability issues surrounding armored truck deliveries, Loomis has adopted a policy for all drivers that their trucks cannot be left unattended. The policy is provided in the employee handbook and the penalty for violation of the rule is stated as follows:

Violations of this rule will be grounds for termination.

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590 part 4 Business Management and Governance

While Mr. Gardner was making a scheduled stop at a bank for a pickup of funds, he noticed a woman being threatened with a knife by an obviously agitated man. Mr. Gardner left his truck unattended as he went to the aid of the woman. The woman was saved and her assail- ant apprehended, and Mr. Gardner was then fired by Loomis for violating the company policy of not leaving the truck unattended. Mr. Gardner filed suit for wrong- ful termination in violation of public policy. Discuss whether he can recover. [Gardner v Loomis Armored, Inc., 913 P.2d 377 (Wash. 1996)]

7. Reverend John Fisher is the pastor of St. James Episco- pal Church in Ohio. Catherine Davis served there as parish secretary from 1978 until six months after Reverend Fisher arrived at St. James in January 1988. Reverend Fisher fired her after she went to the bishop of the diocese to complain about sexual harassment by Reverend Fisher. The bishop promised an investigation, which was not conducted because Reverend Fisher denied the allegations. Ms. Davis then brought suit against the Episcopal Diocese. The diocese denied liability, claiming it was not in control of Reverend Fisher’s actions because he was an independent contractor. Do you agree? [Davis v Black, 591 N.E.2d 11 (Ohio 1991)]

8. John Guz, 49, first hired in 1971, had worked for Bech- tel Corporation for 33 years. In 1986, he was assigned to BNI, a division specializing in engineering, construction, and environmental remediation that focuses on federal government programs, principally for the Departments of Energy and Defense (BNI-MI). Mr. Guz worked his way up through Bechtel and BNI both, going from administra- tive assistant, beginning at a salary of $750 per month, to financial reports supervisor, earning $70,000 year. During his time with Bechtel and BNI, Mr. Guz had been given generally favorable performance evaluations, steady pay increases, and a continuing series of promotions.

During this time, Bechtel maintained Personnel Pol- icy 1101, dated June 1991, on the subject of termination of employment (Policy 1101). Policy stated that “Bechtel employees have no employment agreements guarantee- ing continuous service and may resign at their option or be terminated at the option of Bechtel.”

Between 1986 and 1991, BNI-MI’s size was reduced from 13 to 6, and its costs were reduced from $748,000 in 1986 to $400,000 in 1991. Bechtel eventually eliminated Mr. Guz’s division. Mr. Guz was discharged, as were all the employees in the division. Mr. Guz brought suit against Bechtel alleging that he had an “implied-in-fact contract” with Bechtel that prevented the company from terminating him as long as the company was performing well financially.

The trial court granted Bechtel’s motion for sum- mary judgment and dismissed the action. In a split deci- sion, the Court of Appeal reversed. Bechtel appealed.

Who should prevail on appeal? [Guz v Bechtel, 8 P.3d 1089 (Cal. 2000)]

9. Bernice Bisbee is a real estate broker employed by Midkiff Realty, Inc. In September 1972, she obtained from Richard and Marian Silva an exclusive listing agreement for the sale of their property in Kaleheo, Kauai. The land, which fronted on the Kaumualii Highway, consisted of 34,392 square feet, one two-bedroom house, and one four-bedroom house. The Silvas told Ms. Bisbee that they wanted $100,000 for the property.

Sometime later, Ms. Bisbee obtained an offer for the property from David Larsen. The down payment was set at $35,000, with payments of $2,000 a month at 8% a year, but Mr. Larsen backed out before closing. After that, a joint venture of six members formed the Pacific Equity Associates to buy the property. Ms. Bisbee was to man- age the joint venture and would receive 10% of the profits for her services. One of the joint venture members, Toshio Morikawa, appeared as the buyer at the July 1973 closing of the property sale. Ms. Bisbee did not tell the Silvas of the venture nor of her pecuniary interest in it.

In August 1973, Ms. Bisbee prepared for the venture a financial statement that listed the market value of the Silva property at $149,424. Several times, the venture was late making payments, which Ms. Bisbee covered. Mr. Silva and his wife were emotionally distressed about the late payments and told Ms. Bisbee. Eventually, because of defaults on the payments, the Silvas brought suit to cancel the contract and for damages for fraud by Ms. Bisbee, naming Midkiff Realty in the suit as well.

The jury returned a verdict for $29,000 in general dam- ages for the Silvas and $50,000 in punitive damages. Ms. Bis- bee and Midkiff appealed. Was there a breach of fiduciary duty? Should the damage award stand because of Ms. Bis- bee’s actions? [Silva v Bisbee, 628 P.2d 214 (Haw. App. 1981)]

10. Recovery Express and Interstate Demolition (IDEC) are two Boston-based companies with the same business address. Albert Arillotta, who claimed to be a partner at IDEC, sent an e-mail to Leo Whitehead of CSX Trans- portation about purchasing rail cars for scrap purposes. The e-mail came from [email protected]. The two reached an agreement, and Arillotta went to the CSX yard and disassembled rail cars and hauled them away. Mr. Whitehead sent invoices to IDEC for $115,757.36 because he believed Arillotta to be an agent for IDEC and Recovery Express. IDEC has no assets and CSX seeks to recover the amount due from Recovery Express. Recov- ery Express’s CEO said he just allowed IDEC, a new company, to share office space and the e-mail server. Mr. Whitehead says that he assumed from the e-mail and the same address that Arillotta was an agent for Recovery as well. Who is liable? [CSX Transportation, Inc. v Recovery Express, Inc., 415 F. Supp. 2d 6 (D. Mass. 2006)]

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Chapter 16 Management of Employee Conduct: Agency 591

Organizational Behavior & the Law Penn State: Oversight, Omissions, and Organizational Liability

Gerald A. Sandusky (Jerry) was a Penn State University alum who was hired in 1969 as an assistant football coach and assistant professor of physical education, a position he held until his retirement in 1999. During that time, Mr. Sandusky engaged in various acts of sex- ual assault with young boys who accompanied him to the campus as part of a program he had begun to help young boys who did not have father figures in their homes.

Between May 4 and May 30, 1998, there were notes and e-mails among and between Penn State University President Graham Spanier, Gary Schultz, the senior vice president for finance and business at Penn State, and Tim Curley, the Penn State athletic director regarding possible courses of action in dealing with Mr. San- dusky’s actions with young boys on the campus. It is not clear how Mr. Schultz first learned of the May 4, 1998, events involving Mr. Sandusky on the campus, but his notes reflect that he knew almost immediately and instructed University Police Department Chief Thomas Harmon, to let him know everything as the investigation into Mr. Sandusky’s conduct proceeded. His notes concluded that Mr. Sandusky’s behavior was “at best—inappropriate @ worst sexual improprieties.”8 After he received more information about a second boy’s experience and the hotline report, his notes ask, “Is this opening of pandora’s box? Other children?”9

The correspondence and notes also indicate that Mr. Curley had notified Mr. Schultz and football coach

Joe Paterno, and both had asked to be kept informed about the investigation. Other documents indicate that Mr. Spanier was also notified, but he denied being aware of the issue and noted that he received many e-mails each day that keep him informed about an array of evolving concerns.

Mr. Sandusky was indicted (and eventually convicted) for child molestation and other charges. When the charges were announced publicly, there were also charges against Mr. Curley and Mr. Schultz for perjury, conspiracy, and endangering child welfare. Mr. Spanier was later indicted for similar charges, and all three entered not guilty pleas. Most charges were dropped, but a trial is pending.

The trustees for Penn State fired all three men as well as Coach Paterno. There was great alumni and public backlash for the termination of the coach. The National Collegiate Athletic Association (NCAA) imposed sanctions on the university’s football program—sanctions that the university accepted without protest or a hearing but that were eventually lifted. When the NCAA sanctions were accepted, the university removed the statue of Coach Paterno from in front of the stadium during the wee hours of the morning. Some sanctions were lifted.

Write a memo explaining why the trustees took the action they did. Be sure to include discussion of the principles of agency law, potential liability, and the rights of all of the terminated Penn State employees.

n ot e s 1. The terminology of master and servant has its roots in the historical nature of the employment relationship of indentured servants and slaves. For more information, see the Instructor’s Manual. 2 One of these two acts has been adopted in some version in all of the states. 3. Note: This opinion was not authorized for publication. However, the fact pattern in the case is an excellent one for analysis of fiduciary duty in agency relationships. 4. Eric Aasen, “Dancer’s Misstep Lands Him in Collin County Jail,” Dallas Morning News, October 18, 2008.

5. “Dancing Fool,” National Law Journal, October 27, 2008, p. 16. 6. Id. 7. Due to space constraints, the excerpted opinion includes only the ARRA and public policy claims, the two claims related to this chapter’s materials. 8. Freeh Report, at p. 47. 9. Id.

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592

Chapter

Governance and Structure Forms of Doing Business17 Creating a sole proprietorship is a popular way to do business, but the most popular forms of business organizations, and the ones producing the most revenues, are those formed by more than one person. Partnerships, limited partnerships, limited liability companies, and corporations are all multi-individual forms of doing business. This chapter answers the following questions: How are various business entities formed? What are the advantages and disadvantages of various entities? What are the rights, responsibilities, and liabilities of the indi- viduals involved?

Each form of doing business is examined by reviewing its formation, sources of funding, the personal liability of owners, tax consequences, management and control, and the ease of transferring interests.

Update For up-to-date legal news, go to mariannejennings.com

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593

17-1 Sole Proprietorships 17-1a Formation

A sole proprietorship is not a true business entity because it consists of only one individual operating a business. According to the U.S. Small Business Associa- tion, most small businesses operate as sole proprietorships, with 50% operating as home-based businesses. Often, a sole proprietorship is evidenced by the fol- lowing language: “Homer Lane d/b/a Green Grower’s Grocery”; “d/b/a” is an acronym for “doing business as.” Because a sole proprietorship is not a separate organization, it has no formal requirements for formation. The individual simply begins doing business. In some states, “d/b/a” businesspeople are required to file their name(s) with a designated state agency and then publish the fictitious names under which they will be doing business.

17-1b Sources of Funding

Most sole proprietorships have small business capital needs initially. Their financ- ing usually comes from loans, either direct loans from banks or loans through gov- ernment agencies such as the Small Business Administration.

Some sole proprietorships are started with financial backing from other people, usually in the form of personal loans. In such cases, the sole propri- etor may have the skills or clients for a successful business but not the funds necessary to begin.

17-1c Liability

Because financing for a sole proprietorship is based on the sole proprietor’s credit rating and assets the proprietor is personally liable for the business loan, and his or her assets are subject to attachment should a default occur. To get financing, a sole proprietor takes personal financial risk.

Please accept my resignation. I don’t want to belong to any organization that will accept me as a member. Groucho Marx

Although our form is corporate, our attitude is partnership. We do not view the company itself as the ultimate owner of our business assets but instead view the company as a conduit through which our shareholders own the assets. Warren Buffett Chairman, Berkshire Hathaway

Roberta Blumberg and Michael Ambrose worked togeth- er to create and market a for-profit Web-based electronic medical records program called “CampDoc” that would allow camps to input and access the medical records of their campers. Blumberg participated in both the design and the development of the CampDoc system, includ- ing its prototype, and Ambrose wrote the code for the

CampDoc software. Ambrose told Blumberg that he was going to make her “a millionaire” through a share of the profits and ownership of the business. The two worked together to build the program and the markets for it. Ambrose created an LLC with himself as the sole owner. Blumberg realized she had been cut out of the company ownership. Does she have any rights?

Consider . . . 17.1

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594 part 4 Business Management and Governance

17-1d tax Consequences

The positive side of a sole proprietor’s unlimited personal liability is the right to claim all tax losses associated with the business. The income of the business is the income of the sole proprietor and is reported on the individual’s income tax return. The IRS does not require a separate filing for the business itself; the sole proprietor files a Schedule C form with the usual 1040 form. Moreover, although sole proprietors owe all the taxes, they also get the benefit of all business deductions.

17-1e Management and Control

The proprietor is the manager of the business. In many businesses, the sole propri- etor is both manager and employee. The proprietor makes all decisions. This form of business operation is truly centralized management.

17-1f transferability of Interest

Because the business is in many ways the owner, the business can be trans- ferred only if the owner allows it. When a sole proprietor’s business is trans- ferred, the transfer consists of the property, inventory, and goodwill of the business. The sole proprietor is generally required to sign a noncompetition agreement so that the goodwill that has been paid for is preserved (see Chapter 16 for more details). In addition, upon the owner’s death, the heirs or devisees of the owner inherit the property involved in the business. They may choose to operate the business, but the business usually ends upon the death of the sole proprietor.

17-2 Partnerships Partnerships are governed by some version of the Uniform Partnership Act (UPA), which has been adopted in 49 states. There is the original UPA and also the Revised Uniform Partnership Act (RUPA). The states have adopted one or a combination of the UPA and RUPA. The RUPA defines a partnership as “the association of two or more persons to carry on as co-owners of a business for profit forms a partnership, whether or not the persons intend to form a part- nership.” “Persons” can include corporations, known as “artificial” persons, and natural persons.

17-2a Formation

A partnership can be formed voluntarily by direct action of the parties, such as through a partnership agreement or articles of partnership, or its formation can be implied by the ongoing conduct of the parties. (See Exhibit 17.1 for a sum- mary of the types of business entities and Exhibit 17.2 for content of a partnership agreement.)

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Chapter 17 Governance and Structure: Forms of Doing Business 595

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596 part 4 Business Management and Governance

Conduct that Forms partnerships by Implication A partnership can arise even though no express agreement is made and the parties do not call themselves partners. In certain circumstances, courts infer that a partnership exists even if the persons involved say they are not partners.

Simply owning property together does not result in a partnership by implica- tion. A cousin to apparent authority (see Chapter 16), a partnership by implication arises because the behaviors of the principals lead others to believe there is a part- nership. Courts examine a number of factors in determining whether a partnership exists by implication. Section 7 of the RUPA provides that if two or more parties share the profits of a business, it is prima facie evidence that a partnership exists. (Prima facie evidence means the presumption that a partnership exists.) However, the presumption of partnership by profit sharing can be overcome if someone received profits for any of the following reasons:

1. Profits paid to repay debts 2. Profits paid as wages or rent 3. Profits paid to a widow or estate representative 4. Profits paid for the sale of business goodwill

Many shopping center leases, for example, provide for the payment of both a fixed amount of rent and a percentage of net profits. The owners of the shopping center profit as the stores do, but they profit as landlords, not as partners with the shopping center businesses.

Blumberg v Ambrose (Case 17.1) addresses the question of whether a partnership is implied by the conduct of two principals and provides the answer to the chap- ter’s opening “Consider . . .” problem.

Exhibit 17.2 Information Included in articles of partnership

MInIMUM reQUIreMentS SUggeSted proVISIonS

1. Names of the partners 1. Disability issues

2. Name of the partnership 2. Insurance coverage

3. Nature of the partnership’s business 3. Sale of interest

4. The time frame of operation 4. Divorce of one of the partners

5. Amount of each partner’s capital contribution 5. Indemnity agreements

6. Managerial powers of partners 6. Noncompetition agreements

7. Rights and duties of partners 7. Leaves of absence

8. Accounting procedures for partnership books and records

9. Methods for sharing profits and losses

10. Salaries (if any) of the partners

11. Causes and methods of dissolution

12. Distribution of property if the partnership is terminated

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Chapter 17 Governance and Structure: Forms of Doing Business 597

Blumberg v. Ambrose 2015 WL 5604474 (E.D. Mich. 2015)

CampDoc and Its Missing Docs

Case 17.1

FaCtS

During the summer of 2004, Roberta Blumberg (plain- tiff) and Michael Ambrose (with LLC referred to as defendants) worked together at the health clinic of Tamarack Camps. Blumberg was a registered nurse and the director of health and safety at Tamarack, while Ambrose was an undergraduate student and a clinical assistant. Blumberg and Ambrose collaborated to cre- ate and market a for-profit Web-based electronic med- ical records program called “CampDoc” that would allow camps to input and access the medical records of their campers. This program was expanded to allow parents the ability to fill out health forms and medical histories online as well as electronically submit infor- mation regarding allergies and medications. Blumberg participated in both the design and the development of the CampDoc system, including its prototype, and Ambrose wrote the code for the CampDoc software.

In the summer of 2009, Blumberg and Ambrose were able to pilot the software program at Tamarack. With the success of the pilot program, the two decided to market and sell the CampDoc program to other camps across the county.

In October 2009, Ambrose filed articles of incor- poration for CampDoc as a Michigan limited liability company and, unbeknownst to Blumberg, included himself as the sole member. As part of organizing the company, Ambrose told Blumberg that she needed to sign several documents, including an employment agreement, which she did in May 2010. However, Blumberg did not believe that these documents altered her relationship as a partner with Ambrose. Ambrose also had conversations with Blumberg in 2011 about her interest in the profits of CampDoc, and he told her that “she would receive some percentage of the profits from the business.”

From 2010 to March 2012, Blumberg attended conferences for CampDoc. Blumberg “brought sev- eral dozen camps on board in 2011,” but she was not paid for that work. In 2012, Blumberg quit her job “as a registered nurse to devote [her] attention to CampDoc.” Blumberg never received compensation for her services in 2009. Blumberg was paid $100 in

2010, $1,000 in 2011, $6,250.02 in 2012, and $18,750.06 in 2013. Ambrose believed that Blumberg’s services in 2010 and 2011 were worth more than what she actually received, and it was his intention to make Blumberg “a millionaire.”

In September 2012, Ambrose provided Blumberg with four more documents to sign—a consulting agree- ment, a participation plan agreement, a noncompete/ nondisclosure agreement, and a confidentiality agree- ment. Although Blumberg claims that Ambrose con- sidered her a “co-founder” and called her “the heart and face of the company,” Ambrose’s lawyers advised him that she should not be listed as an owner of Camp- Doc. Rather, Ambrose suggested that Blumberg own a “phantom” interest in the company, which would be “the equivalent of real equity.”

After reviewing the documents, Blumberg informed Ambrose that she intended to seek legal advice. Ambrose then terminated Blumberg’s “employment” with CampDoc the following day.

Blumberg filed suit seeking to have the association between herself and Ambrose declared a partnership under Michigan’s Uniform Partnership Act.

JUdICIaL opInIon

GOLDSMITH, District Judge Michigan’s Uniform Partnership Act defines a “part- nership” as being a voluntary “association of 2 or more persons . . . to carry on as co-owners a business for profit.” Whether a partnership exists is typically a question of fact. The parties need not possess the sub- jective intent to form a partnership in order for one to exist. Rather, the proper focus of the Court’s inquiry “is on whether the parties intended, and in fact did, carry on as co-owners a business for profit.” Byker v. Mannes, 641 N.W.2d 210, 218 (Mich.2002).

Defendants raise several arguments in support of their contention that a partnership did not exist in this case. First, Defendants argue that the only written agreements that existed between the parties were an employment agreement, a confidentiality agreement, and a non-compete/non-solicitation/confidentiality agreement, all of which Blumberg signed in May 2010.

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According to Defendants, these agreements defeat Blumberg’s claim that a partnership existed because they suggest that the only relationship between the parties was an employer-employee relationship.

Second, Defendants contend that Blumberg received occasional commissions or bonuses from Jan- uary 2010 through September 2012, pursuant to those agreements. Defendants further state that Blumberg received a monthly salary as an independent con- tractor from October 2012 through September 2013. Blumberg also received a Form 1099 for the 2011–2013 tax years, which Defendants contend further supports their position that Blumberg was receiving wages as a mere employee or independent contractor, not as a partner. Defendants argue that, even if there was an agreement between the parties with respect to employ- ee profit sharing, the payment of profits as wages of an employee or independent contractor would not consti- tute indicia of a partnership.

Third, Defendants argue that Blumberg’s deposi- tion testimony illustrates “her complete lack of knowl- edge and control over the very basic operations of CampDoc,” which, according to Defendants, strongly militates “against any right of co-ownership, mutual agency or right to management.” Defendants contend that Blumberg has not met her burden of establishing a partnership, given her “complete ignorance regarding the development, financing, operations, decision mak- ing, management[,] and structure of CampDoc.”

Blumberg argues that there are genuine issues of fact regarding the existence of a partnership. For instance, Blumberg states that she and Ambrose “worked together to create, market and monetize CampDoc,” for which many hours of work went uncompensated. Blumberg also claims that Ambrose told her that she was going to be a millionaire, and that he referred to her as a “co-founder” of CampDoc. Blumberg further states that she and Ambrose had dis- cussed percentages of equity ownership in CampDoc. Although the two were unable to reach an agreement on this issue, Blumberg argues that the default pro- visions of the partnership act provide that she and Ambrose share the partnership’s profits equally.

According to Blumberg, she and Ambrose began working on CampDoc years prior to her signing any agreements, and when she did sign the agreements in May 2010, she did not believe that they modified her relationship as a partner. While acknowledging that she received some financial compensation for her work on CampDoc, Blumberg claims that she was not paid in 2009, she was only paid $100 in 2010, and her services were worth more than the $1,000 she received in 2011.

Regarding her lack of knowledge about Camp- Doc’s daily operations, Blumberg contends that such

evidence does not counsel against her claims of a partnership, because she and Ambrose had agreed that he would handle administrative matters. By doing so, Blumberg states that she focused her efforts on the research, development, testing, and marketing of the program.

In this case, there was no express agreement among the parties concerning the formation of a partnership. Thus, the Court must determine whether the par- ties’ conduct demonstrates their intention to carry on CampDoc for profit as co-owners.

Various actions by Ambrose support the conclusion that a partnership existed between himself and Blum- berg. For instance, Ambrose told Blumberg that she was going to “make millions,” which the Court finds would be a rather hefty wage for a mere employee. Ambrose also told Blumberg that he considered her a “cofounder,” as well as the “heart and face” of Camp- Doc. And it was not until late in the relevant timeframe that Ambrose ever protested that Blumberg was not a partner. Moreover, when negotiating a more formal arrangement in the fall of 2012, Ambrose proposed a “phantom” equity ownership that would functionally recognize Blumberg as an equity owner. Lastly, while some of Blumberg’s time was compensated under an employee agreement, much of it wasn’t, and, for sig- nificant periods of time, Blumberg was paid little or nothing for her efforts. [T]he Court finds that there is a genuine issue of material fact concerning the existence of a partnership between the parties.

Although Defendants argue that Blumberg lacked awareness of the CampDoc’s daily administrative operations, this does not necessarily weigh against her ability to participate and control the administration of the business, nor does it establish that there was no mutual agency among the parties.

Defendants also point out that, during her depo- sition, Blumberg testified that she did not know if she ever invested any financial capital in CampDoc. Nor does she allege a common interest in the capital that was employed for either the creation of CampDoc or the pro- totype software. However, investment of capital is not fatal to Blumberg’s claim for a partnership. The invest- ment of time, labor, and skill is evidence of a partnership.

Blumberg states that she brought several dozen camps on board in early 2011, and she was involved in designing CampDoc’s marketing materials, as well as participating in the design and development the pro- gram. Blumberg further claims that she communicated with CampDoc employees and customers regularly, attended conferences to market CampDoc, and was the person responsible for signing up many of CampDoc’s customers. Blumberg’s contributions of labor, skill, and expertise evidence the existence of a partnership.

continued

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Chapter 17 Governance and Structure: Forms of Doing Business 599

It is true that the parties did not file a certificate of partnership as required under Michigan law. However, the failure to file the certificate is not dispositive; it is only one factor in determining whether a partnership has been formed.

The Court concludes that the above facts, when viewed as a whole and in the light most favorable to Blumberg, sufficiently demonstrate a factual basis for Blumberg’s contention that the parties acted in asso- ciation to carry on for profit a business as co-owners.

CaSe QUeStIonS

1. If an LLC was created, how is this case about the formation of a partnership?

2. What are the indications that there was a partner- ship created?

3. What list of lessons could you develop for two people who are starting a business based on what happened in this case?

Conduct that Forms a partnership by estoppel At times, someone can be held to be a partner because he or she acted like a part- ner. Some court decisions have held that those who help a new business obtain a loan are holding themselves out as partners. Section 16 of the UPA provides as follows:

When a person by words spoken or written or by conduct, represents himself, or consents to another representing him to anyone as a partner in an existing partnership or with one or more persons not actual partners, he is liable to any party to whom such representation has been made.

In other words, if the conduct of two or more parties leads others to believe a partnership exists, that partnership may be found to exist legally under the notion of partnership by estoppel. Partnerships by estoppel arise when others are led to believe there is a partnership. Partnership by estoppel is a cousin to agency by estoppel, another ostensible relationship.

17-2b Sources of Funding

Funding for a partnership comes from the partners who initially contribute prop- erty, cash, or services to the partnership accounts. These contributions are the capital of the partnership. Not only are these contributions put at the risk of the business, but so are each of the partners’ personal assets: partners are personally liable for the full amount of the partnership’s obligations. Partners can also make loans to the partnership.

Richard Chaiken entered into agreements with both Mr. Strazella and Mr. Spitzer to operate a barbershop. Mr. Chaiken was to provide barber chairs, supplies, and licenses. Mr. Strazella and Mr.  Spitzer were to bring their tools, and the agree- ments included work hours and holidays for them. The Delaware Employment

Security Commission determined that Mr. Strazella and Mr. Spitzer are employees, not partners, and seeks to collect unemploy- ment compensation for the two barbers. Mr. Chaiken maintains that they are part- ners and not employees. Who is correct? [Chaiken v. Employment Security Comm’n, 274 A.2d 707 (Del. 1971)]

Consider . . . 17.2

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600 part 4 Business Management and Governance

17-2c partner Liability

Each partner is both a principal and an agent to the other partners and is liable both for the acts of others and to the others for individual acts. The discussion of the liability of agents to third parties for contracts and torts in Chapter 16 applies to partners’ acts on behalf of the partnership. If one partner enters into a contract for partnership business supplies, all the partners are liable. Similarly, if partners have a motor vehicle accident while out doing partnership deliveries, the individ- ual partners are liable for their own negligence, but because they were acting in the scope of partnership business, the partnership itself is also liable.

Partners are jointly and severally liable for all obligations. If partnership assets are exhausted, each partner is individually liable. Creditors can satisfy their claims by looking to the assets of the individual partners after the partnership assets are exhausted.

Vrabel v Acri (Case 17.2) deals with an issue of partnership liability.

Triangle Chemical Company supplied $671.10 worth of fertilizer and chemicals to France Mathis to produce a cabbage crop. When Mr. Mathis first asked for credit, he was denied. He then told Triangle that he had a new partner, Emory Pope. The com- pany president called Mr. Pope, who said he was backing Mr. Mathis. Mr. Pope had loaned Mr. Mathis money to produce the crop, and Mr. Mathis said Mr. Pope would

pay the bills. Mr. Pope said, “We’re grow- ing the crop together and I am more or less handling the money.” When Mr. Mathis could not pay, Triangle wanted to hold Mr. Pope personally liable. Mr. Pope said his promise to pay another’s debt would have to have been in writing. Triangle claimed Mr. Pope was a partner and personally lia- ble. Is he? [Pope v. Triangle Chemical Co., 277 S.E.2d 758 (Ga. 1981)]

Consider . . . 17.3

Vrabel v. Acri 103 N.E.2d 564 (Ohio 1952)

Shot Down in a Ma & Pa Café: Is Ma Liable When Pa Goes to Jail?

Case 17.2

FaCtS

On February 17, 1947, Stephen Vrabel and a companion went into the Acri Café in Youngstown, Ohio, to buy alcoholic drinks. While Mr. Vrabel and his companion were sitting at the bar drinking, Michael Acri, without provocation, drew a .38-caliber gun, shot and killed Mr. Vrabel’s companion, and shot and seriously injured Mr. Vrabel. Mr. Acri was convicted of murder and sen- tenced to a life term in the state prison.

Florence and Michael Acri, as partners, had owned and operated the Acri Café since 1933. From the time of his marriage to Mrs. Acri in 1931 until 1946, Mr. Acri had been in and out of hospitals, clinics, and sanitariums for the treatment of mental disorders and nervousness. Although he beat Mrs. Acri when they had marital difficulties, he had not attacked, abused, or mistreated anyone else. The Acris separated in Septem- ber 1946, and Mrs. Acri sued her husband for divorce

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Chapter 17 Governance and Structure: Forms of Doing Business 601

soon afterward. Before their separation, Mrs. Acri had operated and managed the café primarily only when Mr. Acri was ill. Following the marital separation and until the time he shot Mr. Vrabel, Mr. Acri was in exclu- sive control of the management of the café.

Mr. Vrabel brought suit against Mrs. Acri to recover damages for his injuries on the grounds that, as Mr. Acri’s partner, she was liable for his tort. The trial court ordered her to pay Mr. Vrabel damages of $7,500. Mrs. Acri appealed.

JUdICIaL opInIon

ZIMMERMAN, Judge The authorities are in agreement that whether a tort is committed by a partner or a joint adventurer, the principles of law governing the situation are the same. So, where a partnership or a joint enterprise is shown to exist, each member of such project acts both as prin- cipal and agent of the others as to those things done within the apparent scope of the business of the project and for its benefit.

Section 13 of the Uniform Partnership Act pro- vides: “Where, by any wrongful act or omission of any partner acting in the ordinary course of business of the partnership or with the authority of his copartners, loss or injury is caused to any person, not being a partner in the partnership, or any penalty is incurred, the partner- ship is liable therefore to the same extent as the partner so acting or omitting to act.”

However, it is equally true that where one member of a partnership or joint enterprise commits a wrongful and malicious tort not within the actual or apparent scope of the agency, or the common business of the particular venture, to which the other members have

not assented, and which has not been concurred in or ratified by them, they are not liable for the harm thereby caused.

Because at the time of Vrabel’s injuries and for a long time prior thereto Florence had been excluded from the Acri Cafe and had no voice or control in its management, and because Florence did not know or have good reason to know that Michael was a danger- ous individual prone to assault cafe patrons, the theory of negligence urged by Vrabel is hardly tenable.

We cannot escape the conclusion, therefore, that the above rules, relating to the nonliability of a partner or joint adventurer for wrongful and malicious torts com- mitted by an associate outside the purposes and scope of the business, must be applied in the instant case. The willful and malicious attack by Michael Acri upon Vrabel in the Acri Cafe cannot reasonably be said to have come within the scope of the business of operating the cafe, so as to have rendered the absent Florence accountable.

Since the liability of a partner for the acts of his associates is founded upon the principles of agency, the statement is in point that an intentional and willful attack committed by an agent or employee, to vent his own spleen or malevolence against the injured person, is a clear departure from his employment and his prin- cipal or employer is not responsible therefore.

Judgment reversed.

CaSe QUeStIonS

1. What was the nature of the business?

2. Why was Mr. Acri not a defendant?

3. Explain why Mrs. Acri is or is not liable for the injuries.

17-2d tax Consequences in partnerships

A partnership does not pay taxes. It simply files an informational return. The partners, however, must report their shares of partnership income (or losses) and deductions on their individual tax returns on Schedule C, and must pay taxes on the reported share.

17-2e Management and Control

partnership authority Unless agreed otherwise, each partner has a duty to contribute time to manage the partnership. Each partner has an equal management say, and each has a right to use partnership property for partnership purposes. No one partner controls the property, funds, or management of the firm (unless the partners so agree).

The partners may agree to delegate day-to-day management responsibilities to one or more of the partners. However, the agency rules of express, implied,

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602 part 4 Business Management and Governance

and apparent authority (see Chapter 16) apply to partnerships. Each partner is an agent of the other partners, and each has express authority given by the UPA and any partnership agreement, implied authority relating to those pow- ers, and apparent authority as is customary in their business. Some manage- ment matters are simply a matter of a vote; a majority of the partners makes the decision. The unanimous consent of the partners is required for some deci- sions, however, such as confessing a judgment (settling a lawsuit), transferring all the partnership’s assets, or selling its goodwill. Basically, unusual transac- tions in which no apparent authority could be claimed require all the partners’ approval.

The partners are not entitled to compensation for their management of the partnership’s business, unless so specified in the partnership agreement. Under the UPA, a partner who winds up a dissolved partnership’s business can be compensated.

partner Fiduciary duties Because each partner is an agent for the partnership and the other partners as well, each owes the partnership and the other partners the same fiduciary duties an agent owes a principal. Partners’ obligations as fiduciaries are the same as agents’ duties to principals.

partnership property Partnership property is defined as property contributed to the firm as a capi- tal contribution or purchased with partnership funds. Partners are co-owners of partnership property in a form of ownership called tenancy in partnership. Tenants in partnership have equal rights in the use and possession of the prop- erty for partnership purposes. On the death of one of the partners, rights in the property are transferred to the surviving partner or partners. The partnership interest in the property remains, and the property or a share of the property is not transferred to the estate of the deceased partner. The estate of the deceased partner simply receives the value of the partner’s interest, not the property.

Timothy Bums formed ESG Capital Partners II, LP, and raised money from investors for purposes of having the partnership purchase shares of stock of Facebook, Inc., before that company’s then-anticipated initial public offer- ing (IPO). Once Facebook had completed a successful IPO, the partnership would dis- tribute to its investors either the Facebook shares themselves or their cash value. After that, the partnership would dissolve.

Forty-four investors purchased units, and the partnership used their capital to buy Facebook shares. But rather than making a distribution in compliance with the partner- ship agreement, Bums made preferential

transfers to certain limited partners. The favored limited partners received one Face- book share for each of their units, without regard to their actual percentage interests. Other limited partners either did not receive any Facebook shares or received less than one Facebook share for each of their units, again without regard to their actual percent- age ownership interests.

The nonpreferred investors filed suit against the partnership. What theory would allow the investors who received no distribu- tion to recover? [ESG Capital Partners II LP v. Passport Special Opportunities Master Fund LP, 2015 WL 9060982 (Ct. Chancery 2015)]

Consider . . . 17.4

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Chapter 17 Governance and Structure: Forms of Doing Business 603

partner Interests Partners’ interests in the partnership are different from partnership property. A partner’s interest is a personal property interest that belongs to the partner. It can be sold (transferred) or pledged as collateral to a creditor. Creditors (personal) can attach a partner’s interests to collect a debt.

A transfer of a partner’s interest affects the partnership interests in several ways. The transfer does not result in the transferee becoming a new partner because no person can become a partner without the consent of all the existing partners. Fur- ther, the transfer does not relieve the transferring partner of personal liability. A transfer of interest will not eliminate individual liability to existing creditors.

Some partnership agreements place restrictions on transfer. For example, a pro- vision may allow the partnership the right to buy out a partner before the partner has the authority to transfer interest.

17-2f transferability of Interests

A partner cannot transfer his or her partnership status without the unanimous consent of the other partners. However, if that transfer is approved, the departing or outgoing partner and the incoming partner should be aware of their liability. Absent an agreement from creditors, the outgoing partner remains personally lia- ble for all partnership debts up to the time of departure. If the departing partner gives public notice of disassociation, no further personal liability results from con- tracts and obligations entered into after departure. The incoming partner is liable for all contracts after the date of entry into the firm. Incoming partners are liable for existing debts only to the extent of their capital contribution.

Partnership liabilities do not end when the partners no longer do business together. The debts remain and must be satisfied, even from partners no longer involved in running the business.

17-2g dissolution and termination of the partnership

Dissolution is not necessarily termination. The UPA defines dissolution as one partner’s ceasing to be associated with carrying on the business. The RUPA refers to “dissociation” of partners, which may or may not lead to dissolution. When a partner leaves, retires, or dies, the partnership is dissolved though not terminated. Dissolution is basically a change in the structure of the partnership. Dissolution may have no effect on the business: the partnership may be reorganized and con- tinue business without the partner who is leaving.

Dissolution can lead, however, to termination of the partnership. Termination means all business stops, the assets of the firm are liquidated, and the proceeds are distributed to creditors and partners to repay capital contributions and distribute profits (if any). The following events are grounds for dissolution.

dissolution by agreement The partnership agreement itself may limit the partnership’s time of existence. Once that time expires, the partnership is dissolved. If the agreement does not specify the time or there is no partnership agreement, the partners can (by unani- mous consent) agree to dissolve the partnership.

dissolution by operation of Law Another way a partnership is dissolved is by operation of law when certain events require the dissolution of the partnership. When one partner dies, the partnership

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604 part 4 Business Management and Governance

is automatically dissolved. The business could go on, but the partnership as it once existed ends, and the deceased partner’s estate must be paid for his or her interest. Also, if the partnership or an individual partner becomes bankrupt, the partner- ship is dissolved by law.

dissolution by Court order The third method for dissolution of a partnership is by court order. Sometimes partners just cannot work together any longer. In such circumstances, they can petition a court for dissolution in the interest of preserving their investments.

17-3 Limited Partnerships A limited partnership is a partnership with a slight variation in the liability of those involved. The types of partners in a limited partnership include at least one general partner and one limited partner. General partners have the same obliga- tions as partners in general partnerships—full liability and full responsibility for the management of the business. Limited partners have liability limited to the amount of their contribution to the partnership, and they cannot be involved in the management of the firm. General partners run the limited partnership, and the limited partners are the investors.

The Uniform Limited Partnership Act (ULPA) was drafted in 1916. At that time, few limited partnerships existed and most of them were quite small. The limited partnership, however, has become a favored type of business structure, particularly for oil exploration and real estate development because of the tax advantages available through limited partnerships. The attractiveness of limited liability combined with tax advantages have resulted in an increase in the numbers and sizes of limited partnerships.

In 1976, the National Conference of Commissioners on Uniform State Laws developed the Revised Uniform Limited Partnership Act (RULPA). The act was designed to update limited partnership law to address the ways limited partner- ships were doing business. The RULPA was revised in 1985 and has been adopted in nearly every state.

17-3a Formation

A limited partnership is a statutory creature and requires compliance with certain procedures in order to exist. If these procedures are not followed, it is possible that the limited partners could lose their limited liability protection.

The RULPA requires a formal filing at the appropriate government agency in order for valid formation. That form must include certain contact information for the partnership and name a statutory agent (the individual who is authorized to receive summons for litigation against the firm and government notices). Limited partners need not be listed in the certificate, nor are they all required to sign the certificate. The size of many limited partnerships makes such a listing impossible.

The formal filing is the public notice of this structure for the business, a struc- ture that limits liability. If there are any errors in filing and formation, the limited partnership could be deemed a general partnership, and the limited partners could lose the protection of their limited liability. However, limited partners can make fil- ings to correct any formation problems or they could withdraw from the improp- erly formed partnership. A limited partner would still be liable to any third parties

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for liabilities incurred by what was really a general partnership (because of the errors in filing).

The certificate of limited partnership is simply public disclosure of the for- mation and existence of the limited partnership; it does not deal with the many more rights and obligations that the partners may agree on among themselves. Those issues are generally addressed in a much longer document called a limited partnership agreement or the articles of limited partnership.

17-3b Sources of Funding

Capital contributions supply the initial funding for a limited partnership. Both the general and the limited partners make contributions upon entering the partner- ship. Under the RULPA, the contribution can be in the form of cash, property, ser- vices already performed, or a promissory note or other obligation to pay money or property. The RULPA requires that limited partners’ promises to contribute must be in writing to be enforceable. The limited partners are always personally liable for the difference between what has actually been contributed and the amount promised to be contributed.

Some partners make advances or loans to the partnership. The partnership can also borrow money from third parties. However, only the general partner has any personal liability for repayment of the loan to the third party.

17-3c Liability

The principal advantage of a limited partnership is the limited personal liability. To ensure personal limited liability, several requirements must be met. First, as already discussed, there must be proper formation with all required public filings. Second, at least one general partner is required. The general partner can be a cor- poration. Third, the limited partners cannot be involved in the management of the business because such involvement would give the appearance of general partner status. Finally, limited partners cannot use their names in the name of the part- nership, which would give the wrong impression to outside parties and create an estoppel type of relationship.

Under the RULPA, a limited partner who participates in the management of the firm in the same way as does the general partner is liable only to those persons who are led to believe by the limited partner’s conduct that the limited partner is a general partner. The RULPA also provides a list of activities that limited partners can engage in without losing their limited liability status, such as the following:

1. Being employed by the general partnership as an employee or a contractor 2. Consulting with or advising the general partner 3. Acting as a surety or guarantor for the limited partnership 4. Voting on amendments, dissolution, sale of property, or assumption of debt

If limited partners comply with the rules for limited liability, their liability is limited to the amount of their capital contribution. If they have pledged to pay a certain amount as capital over a period of time, they are liable for the full amount. For example, some real estate syndications that are limited partnerships allow the limited partners to make their investment in installment payments over two to four years. Limited partners in these arrangements are liable for the full amount pledged whenever an obligation to a creditor is not paid.

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17-3d tax Consequences

Limited partnerships are taxed the same way as general partnerships. The general and limited partners report the income and losses on their individual returns and pay the appropriate taxes. A limited partnership files an information return but does not pay any taxes as an entity.

One of the benefits of limited partnership status is the combination of lim- ited liability with direct tax benefits. In this sense, a limited partnership is the best of both worlds. Because of this ideal situation, limited partnership interests are closely scrutinized by the IRS to determine whether they are, in reality, cor- porations as opposed to true limited partnerships. Some of the factors examined in determining whether an organization is a corporation or a limited partnership are (1) the transferability of the interests, (2) the assets of the general partners, and (3) the net worth of the general partners. The IRS looks beyond the formal filing for creation to other factors to determine whether the organization is truly a limited partnership for tax purposes.

17-3e Management and Control

profits and distributions The general partner in a limited partnership has absolute authority to decide not only when distributions are made but also whether they will be made; for exam- ple, the general partner might decide not to distribute funds but to put them back into the business.

Profits and losses are allocated on the basis of capital contributions. Under the RULPA, the agreement for sharing of profits and losses must be in writing.

partner authority The authority of the general partner in a limited partnership is the same as the authority of the partners in a general partnership. These powers can be restricted by agreement. However, the general partner cannot perform some general activi- ties without the consent of the limited partners, including the following:

1. Admitting a new general partner (also requires consent of other general partners)

2. Admitting a new limited partner unless the partnership agreement allows it

3. Extraordinary transactions, such as selling all the partnership assets

Limited partners can monitor the general partner’s activity with the same rights provided to partners in general partnerships: the right to inspect the books and records and the right to an accounting.

17-3f transferability of Interests

Although the assignment of limited partnership interests is not prohibited by the RULPA, a limited partnership agreement may provide for significant restraints on assignment. Transfer restrictions can be placed on limited partners’ interests for two reasons. First, limited partnership interests may have been sold without regis- tration as exemptions to the federal securities law (see Chapter 18 for more details on securities registrations). If those exempt interests are readily transferable, the

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Chapter 17 Governance and Structure: Forms of Doing Business 607

exemption could be lost. Second, for the limited partners to enjoy the tax benefits of limited partner status, ease of transferability is a critical issue. The more eas- ily an interest can be transferred, the more likely the limited partnership will be treated (for tax purposes) as a corporation.

The assignment of a partnership interest does not terminate a limited partner- ship. The assignee is entitled to receive only the distributions and profits to which the partner is entitled. The assignee does not become a partner without the consent of the other partners. Under the RULPA, a limited partnership can agree that the assigning limited partner will have the authority to make the assignee a limited partner. The effect of the RULPA provision is to simplify transfers and allow lim- ited partners to decide whether they want to transfer their interest or their limited partner status.

17-3g dissolution and termination of a Limited partnership

A limited partnership can be dissolved in one of the following ways:

1. Expiration of the time period designated in the agreement or the occurrence of an event causing dissolution, as specified in the agreement

2. Unanimous written consent of all partners 3. Withdrawal of a general partner 4. Court order after application by one of the partners

Upon dissolution, a partnership can continue (assuming a general partner remains), but the partnership can also be terminated after dissolution. If termina- tion occurs, all assets of the partnership are liquidated. The RULPA specifies that the money from the sale of the assets be used to pay partnership obligations in the following order of priority:

1. Creditors (including partners, but not with respect to distributions) 2. Partners and former partners, for distributions owed to them 3. Return of capital contributions 4. Remainder split according to distribution agreement

17-4 Corporations Corporations have the following characteristics: unlimited duration, free transferability of interest, limited liability for shareholders/owners, con- tinuity, and centralized management. Corporations are legal entities in and of themselves. Because they are treated as persons under the law, they can hold title to property, they can sue or be sued in the corporate name, and they are taxed separately.

17-4a types of Corporations

Each of the diverse types of corporations can be described by one or more adjec- tives. For example, corporations are either profit corporations (those seeking to earn a return for investors) or nonprofit corporations. In addition, they are either domestic corporations or foreign corporations. A corporation is a

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domestic corporation in the state in which it is incorporated and a foreign cor- poration in every other state. Further, corporations organized by government agencies that exist to achieve a social goal are called government corporations. Professional corporations are corporations organized by physicians, dentists, attorneys, and accountants; they exist by statute in most states. Professional cor- poration shareholders have no personal liability for any corporate debts, as in any other corporation, except for professional malpractice claims. The corporate veil or shield (explained later) will not give individuals personal immunity for professional negligence despite their general liability limitation through incor- poration. Close corporations are the opposite of publicly held corporations— that is, the former are corporations with few shareholders. Close corporations and publicly held corporations are created in the same way, but most states then have a separate statute governing the operation of close corporations. Close corporation owners are generally given more discretion in their internal oper- ations, and the degree of formality required for publicly held corporations is not required.

The S corporation (sometimes called Subchapter S or Sub S corporation) is formed no differently from any other corporation, but it must meet the IRS requirements for an S corporation and must file a special election form with the IRS indicating it wants to be treated as an S corporation. The benefit of an S corporation is that shareholders’ income and losses are treated like those of partners, but the shareholders enjoy the protection of limited liability behind a corporate veil. The income earned and losses incurred by an S corporation are reported on the shareholders’ individual returns, but the shareholders’ per- sonal assets are protected from creditors of the business. For tax purposes, the S corporation is like a partnership in the sense of the flow-through of profits and losses, and the shareholders avoid the double taxation of having the corporation pay tax on its earnings and the shareholders pay tax on the dividends distrib- uted to them.

17-4b The Law of Corporations

The Model Business Corporation Act (MBCA), as drafted and revised by the Cor- porate, Banking, and Business Section of the American Bar Association, is the uni- form law on corporations. The provisions of the MBCA are quite liberal and give management great latitude in operations. The MBCA tends to follow the principles of corporate law long established in Delaware, a state where many of the country’s major companies are incorporated. Delaware boasts a rich body of case law on cor- porate governance that offers the stability companies want as they incorporate. Despite the ability to draw on the Delaware case law and experience, the MBCA is not adopted as widely as the UPA or the Uniform Commercial Code (UCC). Even those states that have adopted the MBCA have made significant changes in their adopted versions. As a result, each state’s law on corporations is quite different. The following sections cover the revised MBCA rules, but each state may have its own variations.

17-4c Formation

A corporation is a statutory entity. Formal public filing is required to form a corpo- ration. The following procedures for corporate formation are those of the MBCA. Without the filing, the corporation does not exist and liability is as if there is a

Under the Internal Revenue Code, Subchapter S corporations must meet the following requirements:

•   Domestic corporations

•   No more than 100 shareholders

•   Limited types of shareholders

•   No nonresi- dent aliens as shareholders

•  One class of stock

•  Some restrictions on the types of corporations (by line of business) that qualify

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general partnership. One of the complicated issues under the MBCA is what hap- pens when there is a flaw in the corporate documents that have been filed but the corporation operates as a corporation. In some states, the courts recognize a de facto existence and allow for a corporate existence and liability of that corporation. Other states simply conclude that either there is a valid corporation or there is not, and if there is not (because of flawed filings or paperwork), then there is liability on the part of the individuals involved.

Where to Incorporate The following factors should be considered when determining in which state to incorporate:

1. The status of the state’s corporation laws (See the preceding discussion about Delaware; also, some states’ laws and judicial decisions are oriented more toward management than toward shareholders.)

2. State tax laws 3. The ability to attract employees to the state 4. The incentives that states offer to attract the business (new freeways, office

space, urban renewal)

the Formation document All states require articles of incorporation to be filed in order to create a corpo- ration. These articles give the structure and basic information about the corpora- tion. Under the MBCA, the articles of incorporation must include the following information:

1. The name of the corporation 2. The names and addresses of all incorporators (In addition, each incorporator

must sign the articles of incorporation.) 3. The share structure of the corporation: (a) the common and preferred

classes; (b) which shares vote; and (c) the rights of shareholders, or preemptive rights

4. The statutory agent (the party who will be served with any lawsuits against the corporation)

Who Is Incorporating The incorporators (required to be listed in the articles of incorporation) are the par- ties forming the corporation. Under the MBCA, only one incorporator is required and that person may be a natural person, a corporation, a partnership, a limited partnership, or an association.

Incorporators are personally liable for any contracts entered into or actions taken during the pre-incorporation stage. Until the corporation exists, incorpora- tors are acting as individuals. After incorporation, the corporation could agree to assume liability through a novation of the incorporators’ acts.

For example, if an incorporator of a lumberyard entered into a contract for the purchase of lumber and the corporate board (after formation) agreed that the con- tract was a good one, the corporation could ratify it or enter into a novation to assume liability. In novation, the lumberyard agrees to substitute the corporation as the contracting party. In a ratification, the corporation assumes primary liabil- ity for payment, but the incorporator still remains liable. Incorporators generally

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are paid for their efforts in shares of the corporation’s stock. They may also be the contributors of initial corporate assets and may be paid in shares for their contributions.

postformation After the paperwork of incorporating is complete, a corporation must begin its day-to-day operations with an initial meeting. At this meeting, the officers of the corporation are elected and bylaws are adopted to govern corporate procedures. The bylaws define the authority of each of the officers, prescribe procedures for announcing and conducting meetings (i.e., quorum numbers and voting num- bers), and set the terms of officers and directors and who is eligible to serve in such offices. Articles of incorporation give an overview of a corporate entity; the bylaws constitute the operational rules.

17-4d Capital and Sources of Corporate Funds

A corporation has a variety of sources of funds. It may use short-term financing, which consists of loans from banks or credit lines. The problems with short-term financing are higher interest rates and shorter payback periods. The other forms of financing used most frequently by corporations are debt and equity.

debt Financing: the Bond Market Long-term debt financing is available to corporations when they issue bonds. Bonds are, in effect, long-term promissory notes from a corporation to the bond buyers. The corporation pays the holders interest on the bonds until the maturity date, which is when the bonds are due or must be paid. The interest is fixed and is a fixed payment responsibility regardless of the corporation’s profitability. The benefits of debt financing include the tax deductibility of interest as an expense. Further, bondholders have the benefit of first rights in corporate assets in the event of insolvency. However, a corporation cannot maintain a sound financial policy or rating with debt financing only.

equity Financing: Shareholders Equity financing comes through the sale of stock in a corporation. It provides a means of raising capital up front with the exchange of proportionate cor- porate ownership and the promise of proportionate profits. Shareholders are given shares of stock in exchange for their money. To avoid personal liability, the shareholders must pay at least par value for their shares and must honor the terms of their subscription agreement (share purchase agreement). A share- holder who has not paid at least par value is said to hold watered shares and is liable to creditors for the amount not paid. For example, if a shareholder paid $500 for shares with a par value of $1,000, the shareholder would be personally liable for the $500 difference. Along with those shares of stock come certain promises of future performance from the corporation. The rights of sharehold- ers depend on the type of stock purchased. A discussion of the various types of stock follows.

equity Financing: Common Stock Common stock is the typical stock in a corporation and is usually the most voluminous in terms of the number of shares. Common stock generally car- ries voting rights so that common shareholders have a voice in the election of

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Chapter 17 Governance and Structure: Forms of Doing Business 611

directors, the amendment of articles and bylaws, and other major corporate matters. Common stock generally does not have a fixed dividend rate and does not carry with it any right to have a dividend declared. Common stock dividends depend on both profitability and decisions of the board of directors. If a corporation is dissolved, the common shareholders have a right to a pro- portionate share of the assets (after creditors and preferred stockholders have been paid).

equity Financing: preferred Stock Preferred stock is appropriately named because its owners enjoy preferred status over holders of a corporation’s common stock. For example, preferred stock- holders have priority in the payment of dividends. Some preferred dividends are even at a fixed rate, and cumulative preferred stock guarantees the payment of a dividend so that if a dividend is not paid one year, the holder’s right to be paid carries over until funds are available. Preferred shareholders also have pri- ority over common shareholders in the event the corporation is dissolved and the assets distributed.

17-4e Liability Issues

Limited liability for shareholders is one of the advantages of corporate organi- zation. Sometimes, however, individuals—such as shareholders, directors, and officers—can be personally liable for corporate obligations.

Shareholder Liability Shareholders’ personal liability is limited to the amount of their investment in the corporation. The personal assets of shareholders are not subject to the claims of cor- porate creditors. In some circumstances, however, a shareholder is liable for more than the amount of investment. For example, if a shareholder has not paid for his shares or has paid for them with overvalued property, creditors could turn to the shareholder’s personal assets for satisfaction of his debt but only to the extent of the amount due on the shares.

In other, more serious circumstances, shareholders can be held liable for the full amount of corporate debts. A creditor who successfully pierces the corporate veil overcomes the shield of limited liability protecting shareholders from having to accept personal liability for corporate debts. The corporate veil can be pierced for several reasons. One is inadequate capitalization. The owners of a corporation are required to place as much capital at risk in the corporation as is necessary to cover reasonably anticipated expenses of the business. The purpose of this requirement is to ensure that someone does not use the corporation to avoid liability without actually transferring to the corporation some assets for the payment of corporate liabilities.

Another theory a court can use to pierce the corporate veil is the alter ego theory, which means that the owners and managers of the corporation have not treated the corporation as a separate entity but have used the structure more as a personal resource. Personal and corporate assets and debts are mixed, no formality is observed with regard to operations and meetings, and transfers of property are made without explanation or authorization.

U.S. v. Bestfoods (Case 17.3) deals with an issue of piercing the corporate veil in a situation involving CERCLA liability (see Chapter 10).

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U.S. v. Bestfoods, Inc. 524 U.S. 51 (1998)

Lifting the Veil Is Best for Cleanup but Not for Shareholders

Case 17.3

FaCtS

In 1957, Ott Chemical Co. manufactured chemicals at its plant near Muskegon, Michigan, and both inten- tionally and unintentionally dumped hazardous sub- stances in the soil and groundwater near the plant. Ott sold the plant to CPC International, Inc.

In 1965, CPC incorporated a wholly owned subsid- iary (Ott II) to buy Ott’s assets. Ott II then continued both the chemical production and dumping. Ott II’s officers and directors had positions and duties at both CPC and Ott.

In 1972, CPC (now Bestfoods) sold Ott II to Story Chemical, which operated the plant until its bank- ruptcy in 1977. Aerojet-General Corp. bought the plant from the bankruptcy trustee and manufactured chemi- cals there until 1986.

In 1989, the EPA filed suit to recover the costs of cleanup on the plant site and named CPC, Aerojet, and the officers of the now defunct Ott and Ott II.

The District Court held both CPC and Aerojet lia- ble. After a divided panel of the Court of Appeals for the Sixth Circuit reversed in part, the court granted rehearing en banc and vacated the panel decision. This time, seven judges to six, the court again reversed the District Court in part. Bestfoods appealed (Ott settled prior to the appeal).

JUdICIaL opInIon

SOUTER, Justice The issue before us, under the Comprehensive Envi- ronmental Response, Compensation, and Liability Act of 1980 (CERCLA), is whether a parent corporation that actively participated in, and exercised control over, the operations of a subsidiary may, without more, be held liable as an operator of a polluting facility owned or operated by the subsidiary. We answer no, unless the corporate veil may be pierced. But a corporate parent that actively participated in, and exercised control over, the operations of the facility itself may be held directly liable in its own right as an operator of the facility.

The District Court said that operator liability may attach to a parent corporation both directly, when the parent itself operates the facility, and indirectly, when the corporate veil can be pierced under state law. The court explained that, while CERCLA imposes direct

liability in situations in which the corporate veil cannot be pierced under traditional concepts of corporate law, “the statute and its legislative history do not suggest that CERCLA rejects entirely the crucial limits to liabil- ity that are inherent to corporate law.”

Applying that test to the facts of this case, the court found it particularly telling that CPC selected Ott II’s board of directors and populated its executive ranks with CPC officials, and that a CPC official, G.R.D. Williams, played a significant role in shaping Ott II’s environmental compliance policy.

[W]here a parent corporation is sought to be held liable as an operator pursuant to 42 U.S.C. § 9607(a)(2) based upon the extent of its control of its subsidiary which owns the facility, the parent will be liable only when the requirements necessary to pierce the corporate veil [under state law] are met. In other words . . . whether the parent will be liable as an operator depends upon whether the degree to which it controls its subsidiary and the extent and manner of its involvement with the facility, amount to the abuse of the corporate form that will warrant pierc- ing the corporate veil and disregarding the separate cor- porate entities of the parent and subsidiary.

It is a general principle of corporate law deeply “ingrained in our economic and legal systems” that a parent corporation (so-called because of control through ownership of another corporation’s stock) is not liable for the acts of its subsidiary. . . .

But there is an equally fundamental principle of corporate law, applicable to the parent-subsidiary relationship as well as generally, that the corporate veil may be pierced and the shareholder held liable for the corporation’s conduct when, inter alia, the corporate form would otherwise be misused to accomplish cer- tain wrongful purposes, most notably fraud, on the shareholder’s behalf.

Nothing in CERCLA purports to rewrite this well-settled rule, either. If a subsidiary that operates, but does not own, a facility is so pervasively controlled by its parent for a sufficiently improper purpose to warrant veil piercing, the parent may be held deriv- atively liable for the subsidiary’s acts as an operator.

The fact that a corporate subsidiary happens to own a polluting facility operated by its parent does nothing,

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Chapter 17 Governance and Structure: Forms of Doing Business 613

then, to displace the rule that the parent “corporation is [itself] responsible for the wrongs committed by its agents in the course of its business.” It is this direct lia- bility that is properly seen as being at issue here.

We are satisfied that the Court of Appeals correctly rejected the District Court’s analysis of direct liability. But we also think that the appeals court erred in limit- ing direct liability under the statute to a parent’s sole or joint venture operation, so as to eliminate any possible finding that CPC is liable as an operator on the facts of this case.

In imposing direct liability on these grounds, the District Court failed to recognize that “it is entirely appropriate for directors of a parent corporation to serve as directors of its subsidiary, and that fact alone may not serve to expose the parent corporation to lia- bility for its subsidiary’s acts.”

The Government would have to show that, despite the general presumption to the contrary, the officers and directors were acting in their capacities as CPC officers and directors, and not as Ott II officers and directors, when they committed those acts. The District Court made no such enquiry here, however, disregard- ing entirely this time-honored common-law rule. . . .

In sum, the District Court’s focus on the rela- tionship between parent and subsidiary (rather than parent and facility), combined with its automatic attribution of the actions of dual officers and directors to the corporate parent, erroneously, even if unin- tentionally, treated CERCLA as though it displaced or fundamentally altered common-law standards of limited liability. . . .

There is, in fact, some evidence that CPC engaged in just this type and degree of activity at the Muskegon plant. The District Court’s opinion speaks of an agent of CPC alone who played a conspicuous part in dealing

with the toxic risks emanating from the operation of the plant. G.R.D. Williams worked only for CPC; he was not an employee, officer, or director of Ott, and thus, his actions were of necessity taken only on behalf of CPC. The District Court found that “CPC became directly involved in environmental and regulatory matters through the work of . . . Williams, CPC’s gov- ernmental and environmental affairs director. Williams . . . became heavily involved in environmental issues at Ott II.” He “actively participated in and exerted control over a variety of Ott II environmental matters,” and he “issued directives regarding Ott II’s responses to regulatory inquiries.”

We think that these findings are enough to raise an issue of CPC’s operation of the facility through Williams’s actions, though we would draw no ultimate conclusion from these findings at this point. Prudence thus counsels us to remand, on the theory of direct operation set out here, for reevaluation of Williams’s role, and of the role of any other CPC agent who might be said to have had a part in operating the Muskegon facility.

The judgment of the Court of Appeals for the Sixth Circuit is vacated, and the case is remanded.

Case Questions

1. Describe the corporate ownership history that surrounds the Muskegon facility.

2. What must be shown to hold a parent liable for the actions of the subsidiary? Is CERCLA liability determined under the same corporate veil stan- dards as other issues?

3. Are joint directors of parent and corporate subsidiaries evidence of a need to pierce the corporate veil?

17-4f Corporate tax Consequences

the Double-taxation Cost of Limited Liability Although corporations have the benefit of limited liability, they have the detriment of double taxation. Not only does the corporation pay taxes on its earnings, but shareholders must also report their dividend income on their separate returns and pay individual taxes on their dividend income. However, these shareholders pay taxes only if the dividends are paid. Unlike partnerships in which the partners pay taxes on earnings whether they are distributed or not, shareholders pay taxes on corporate earnings only when they are distributed to them.

statutory solutions to Double taxation One way to resolve the problem of the cost of double taxation is the S corporation (see p. 608). Another solution to high corporate tax rates and double taxation that has become quite popular since 2009 is the corporate inversion. In an inversion a

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corporation from another country acquires a U.S. company. The effect of having ownership transferred outside the United States is the reduction of the corporation’s effective tax rate. For example, Pfizer proposed acquisition by British Allergan. With a corporate domicile in Great Britain, Pfizer’s taxes would have been substantially reduced. However, Medtronic’s inversion with an Irish company resulted in these inversions becoming politically charged. With additional treasury regulations that placed restrictions on inversions, Pfizer withdrew its proposed inversion.

17-4g Corporate Management and Control: directors and officers

election of directors A corporation might be owned by a million shareholders, but its operation will be controlled by the hands of a few, the board of directors. The shareholders elect these directors, who serve as the corporate policy makers. The directors also have responsibility for management of the corporation. To that end, the directors usu- ally set up an executive committee composed of about three board members to handle the more routine matters of running the corporation so that board meetings are not required as frequently.

role of directors Directors are the strategic planning and policy makers for the corporation. They are also the outside perspective for the company. They can provide insight on current management practices. They also serve a watchdog role, as with the now mandatory audit committees required of all stock exchange companies. Audit committees, made up of independent outside directors and at least one financial expert under Sarbanes–Oxley, none of whom have any contracts or former salary ties with the company, are responsible for assuring that the financial reports the management issues are accurate.

Institutional investors and other groups have been placing increasing pres- sure on boards for accountability. Some have developed standards for service on boards such as required stock ownership in the company, nominating committees to assure sufficient business background and knowledge, and term limits so that members do not become complacent. Some companies have procedures for the board to evaluate itself and its performance.

One area of director responsibility that receives ongoing attention is that of offi- cers’ compensation. Directors not only elect the officers of the corporation but also decide the salaries for these officers and themselves. Some possible reforms are on the horizon. The issue of officer compensation has long been a contentious one for lawmakers and regulators. During the Clinton administration, Congress limited the deductibility of officer compensation to $1 million annually. Under the Dodd– Frank Wall Street Reform and Consumer Financial Protection Act, shareholders will have a “say on pay.” At least once every three years, shareholders must have the right to cast votes (nonbinding) on executive compensation as well as golden parachutes. In addition, Dodd–Frank requires companies to have “claw-back” provisions giving them the right to take back executive compensation if it was paid as a result of inflated financial reports. In addition to the Dodd–Frank rights, shareholders can continue to make proposals to limit executive compensation (see Chapter 18 for more information on additional regulation of pay as well as share- holder proposals) and exercise their rights of director removal if the board is not responsive to their concerns about compensation.

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Chapter 17 Governance and Structure: Forms of Doing Business 615

re: Ceo Compensation For the Manager’s Desk

The highest-paid CEOs in 2015 are summa- rized in the following table. The nature of the companies has shifted dramatically since pre-2008 when the financial firm CEOs dominated the list. This list has the Internet, pharmaceutical, and communications and

media firms dominating. Noticeably miss- ing are also the long-standing Fortune 100 companies.

For more information, go to the com- panies’ 10-K forms at www.sec.gov/edgar. shtml.

Ceo CoMpany CoMpenSatIon ($)

David M. Zaslav Discovery Communications $156,077,912

Michael T. Fries Liberty Global $111,914,319

Mario J. Gabelli GAMCO Investors $88,518,411

Satya Nadelli Microsoft $84,308,755

Nicholas Goodman GoPro $77,427,175

Gregory Maffei Liberty Media $73,750,882

Lawrence J. Ellison Oracle $67,261,251

Steven M. Mollenkopf Qualcomm $60,740,592

David T. Hamamoto NorthStar Realty Finance $60,334,396

Les Moonves CBS $54,403,721

Phillipe P. Dauman Viacom $44,288,992

Robert A. Iger Disney $43,701,750

Joseph W. Brown Jr. MBIA $43,602,334

Marissa A. Mayer Yahoo $42,083,508

Richard S. Schleifer Regeneron Pharmaceuticals $41,965,424

Joshua W. Sapan AMC Networks $40,313,856

Marc Benioff salesforce.com $39,907,534

Jeffrey M. Leiden Vertex Pharmaceuticals $36,635,468

Herve Hoppenot Incyt $32,691,026

Jeffrey L. Bewkes TimeWarner $32,657,579

director Liability Officers and directors are fiduciaries of the corporation, which means they are to act in the best interests of the corporation and not profit at the corporation’s expense. They are subject to the business judgment rule, a standard of corporate behavior under which it is understood that officers and directors can make mis- takes, but they are required to show that their decisions were made after careful

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study and discussion. In those decisions, they may consult experts, such as attor- neys, accountants, and financial analysts; but again, they need to show that these experts were well-chosen and reliable individuals.

Brehm v Eisner (Case 17.4) deals with the business judgment rule.

Brehm v. Eisner 746 A.2d 244 (Del. 2000)

Kind of a Mickey-Mouse Judgment Call

Case 17.4

FaCtS

On October 1, 1995, Michael Eisner, the then CEO and chairman of Disney, hired Michael Ovitz as Disney’s president. Mr. Ovitz was a longtime friend of Mr. Eis- ner. Mr. Ovitz was also an important talent broker in Hollywood. Although he lacked experience managing a diversified public company, other companies with entertainment operations had been interested in hiring him for high-level executive positions. Mr. Ovitz’s employment agreement was unilaterally negotiated by Eisner and approved by the board. Since the hiring, there had been shareholder uprisings and director battles that resulted in a shift in the board structure. Eisner had recommended an extraordinarily lucrative contract for Ovitz, with a base salary of $1 million per year, a discretionary bonus, and two sets of stock options (the “A” options and the “B” options) that collectively would enable Ovitz to purchase 5 million shares of Disney common stock.

Disney needed a strong second in command because Mr. Eisner’s health, due to major heart sur- gery, was in question, and there really was no succes- sion plan. Mr. Eisner also had a rugged history when it came to working with important or well-known subordinate executives who wanted to position them- selves to succeed him. Over the previous five years, Disney executives Jeffrey Katzenberg, Richard Frank, and Stephen Bollenbach had all left after short tenures under Eisner.

Following a tumultuous year that enjoyed intense media coverage about legendary battles between the two, Mr. Ovitz and Mr. Eisner negotiated Mr. Ovitz’s departure on December 11, 1996. Mr. Ovitz was given a “Non-Fault Termination” that carried $38,888,230.77 as well as the option to purchase 3 million Disney shares under the terms of his employment agreement.

The shareholders (plaintiffs) filed suit against the directors for their failure to adequately consider the

Ovitz contract initially, for not considering the issues surrounding that hiring as well as the employment package itself, and for committing waste in giving Ovitz what amounted to a $140 million severance package (when the value of the options were included). The Court of Chancery dismissed the suit and the shareholders appealed.

JUdICIaL opInIon

VEASEY, Chief Justice This is potentially a very troubling case on the merits. On the one hand, it appears from the Complaint that: (a) the compensation and termination payout for Ovitz were exceedingly lucrative, if not luxurious, compared to Ovitz’ value to the Company; and (b) the processes of the boards of directors in dealing with the approval and ter- mination of the Ovitz Employment [this is a close case].

This is a case about whether there should be personal liability of the directors of a Delaware cor- poration to the corporation for lack of due care in the decision-making process and for waste of corporate assets. This case is not about the failure of the directors to establish and carry out ideal corporate governance practices. All good corporate governance practices include compliance with statutory law and case law establishing fiduciary duties. But the law of corporate fiduciary duties and remedies for violation of those duties are distinct from the aspirational goals of ideal corporate governance practices. Aspirational ideals of good corporate governance practices for boards of directors that go beyond the minimal legal require- ments of the corporation law are highly desirable, often tend to benefit stockholders, sometimes reduce litigation and can usually help directors avoid liability. But they are not required by the corporation law and do not define standards of liability.

The facts in the Complaint (disregarding conclu- sory allegations) show that Ovitz’ performance as

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Chapter 17 Governance and Structure: Forms of Doing Business 617

president was disappointing at best, that Eisner admit- ted it had been a mistake to hire him, that Ovitz lacked commitment to the Company, that he performed ser- vices for his old company, and that he negotiated for other jobs (some very lucrative) while being required under the contract to devote his full time and energy to Disney.

All this shows is that the Board had arguable grounds to fire Ovitz for cause. But what is alleged is only an argument—perhaps a good one—that Ovitz’ conduct constituted gross negligence or malfeasance.

The Complaint contends that the Board committed waste by agreeing to the very lucrative payout to Ovitz under the non-fault termination provision because it had no obligation to him, thus taking the Board’s deci- sion outside the protection of the business judgment rule. Construed most favorably to plaintiffs, the Com- plaint contends that, by reason of the Board’s available arguments of resignation and good cause, it had the leverage to negotiate Ovitz down to a more reason- able payout than that guaranteed by his Employment Agreement. But the Complaint fails on its face to meet the waste test because it does not allege with particu- larity facts tending to show that no reasonable business person would have made the decision that the Board made under these circumstances.

The Board made a business decision to grant Ovitz a Non-Fault Termination. Plaintiffs may disagree with the Board’s judgment as to how this matter should have been handled. But where, as here, there is no reasonable doubt as to the disinterest of or absence of

fraud by the Board, mere disagreement cannot serve as grounds for imposing liability based on alleged breaches of fiduciary duty and waste. There is no alle- gation that the Board did not consider the pertinent issues surrounding Ovitz’s termination. Plaintiffs’ sole argument appears to be that they do not agree with the course of action taken by the Board regarding Ovitz’s separation from Disney. This will not suffice to create a reasonable doubt that the Board’s decision to grant Ovitz a Non-Fault Termination was the product of an exercise of business judgment.

One can understand why Disney stockholders would be upset with such an extraordinarily lucra- tive compensation agreement and termination payout awarded a company president who served for only a little over a year and who underperformed to the extent alleged. That said, there is a very large—though not insurmountable—burden on stockholders who believe they should pursue the remedy of a derivative suit instead of selling their stock or seeking to reform or oust these directors from office.

Affirmed.

CaSe QUeStIonS

1. What must the shareholders prove to recover?

2. What does the court say is the relationship between good corporate governance, liability, and business judgment?

3. What alternatives to litigation do shareholders have?

William Shlensky was a minority shareholder of Chicago National League Ball Club, Inc. (the Cubs). In 1966, he brought suit against the directors of the Cubs for violation of the busi- ness judgment rule because at the time of the suit the Cubs did not play night games at Wrigley Field, their home field. All of the other 19 teams in the major leagues had some night games, with substantially all of their weekday and nonholiday games scheduled under the lights. Between 1961 and 1965, the Cubs had sustained operating losses. Mr. Shlensky filed a derivative suit (a suit on behalf of shareholders) against the Cubs’ di- rectors for negligence and mismanagement.

Mr. Shlensky’s suit maintained that the Cubs would continue to lose money unless night games were played. The directors’ re- sponse was that baseball was a “daytime” sport and that holding night games would have a “deteriorating effect upon the sur- rounding neighborhood.”

Why does Mr. Shlensky believe the directors did not use good judgment? Is there a difference between negligence and differing business opinions? Does the busi- ness judgment rule allow directors to make mistakes? [Shlensky v. Wrigley, 237 N.E. 2d 776 (Ill. 1968)]

Consider . . . 17.5

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Officers and directors are also required to follow the corporate opportunity doctrine, under which officers and directors may not take an opportunity for them- selves that the corporation might be interested in taking. For example, a director of a lumber company who discovers a deal on timberland would be required to present that opportunity to the corporation before she could take it. If the director does not first present the idea to the corporation, a constructive trust is put on the profits the director makes, and the corporation is the beneficiary of that trust. If, however, the director presents the opportunity and the corporation is unable or unwilling to take it, the director may go ahead with the opportunity without the problem of a constructive trust.

officer Liability Recent prosecutions have demonstrated an increased effort to hold corporate offi- cers criminally responsible for the acts of the corporation. In environmental law, changes in the law and aggressive prosecutions have brought about convictions of officers, particularly concerning the disposal of hazardous waste. The issues of officer liability are covered in Chapters 8, 10, 16, and 18.

Shareholder Litigation against Boards and officers: derivative Suits Although boards and officers can be held liable to shareholders when they make missteps without following the business judgment rule, there is a preliminary step that, ironically, requires the shareholders to obtain the go-ahead for filing suit to recoup losses from the company’s management. These suits by shareholders are called derivative suits because the shareholders have their right to sue derived from their ownership and their recovery belongs to the corporation. There are times, however, when the issue of permission to proceed becomes litigious. One of the longest-running and most contentious shareholder derivative suits is that involving AIG and Hank Greenberg. In AIG, Inc. v. Greenberg, 965 A.2d 763 (Del. Ch. 2009), the Delaware Chancery court dealt with an issue of shareholders’ rights to proceed with a derivative suit against AIG’s directors and officers for its inflation of loss reserves through fictional reinsurance transactions. A special litigation com- mittee of the board approved a shareholder suit to recover the losses from the rein- surance scam and even joined with the shareholders in their litigation. The board filed suit demanding that the shareholders obtain approval from the full board. The court held that the shareholders had followed the approval process required under AIG’s bylaws and had the right to go forward with their suit and recovery.

THINK: Under the principles of liability for directors and the protection of the business judgment rule, a director and board can make mistakes. They can make decisions that ultimately prove to be big mistakes, even in judgment. However, courts do not step in and, with hindsight, second-guess the directors. So long as the directors have given their time, thought, and effort to the decision and obtained independent advice, their judgment is protected from liability to

shareholders, even if they are proven com- pletely wrong. APPLY: While the parties disagree over whether to hold day games or night games, the Cubs organization has articulated its reasons, rightly or wrongly. ANSWER: The reasons show that the Cubs directors have devoted the time, energy, and thought necessary to make the deci- sion and thus enjoy protection from liability under the business judgment rule.

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Chapter 17 Governance and Structure: Forms of Doing Business 619

officers, Boards, Sarbanes–oxley, and dodd–Frank Sarbanes–Oxley, the legislation passed following the collapse of companies such as Enron and WorldCom, imposed detailed requirements on boards and officers of publicly traded companies. These reforms imposed new duties beyond any statu- tory requirements imposed by state corporation laws such as the MBCA. In addi- tion, the passage of the Dodd–Frank Wall Street Reform and Consumer Financial Protection Act has resulted in more regulation of board structure and directors’ duties and responsibilities to shareholders.

Prohibitions on Loans to Officers. Corporations can no longer make loans to offi- cers and directors. This provision is the result of revelations that companies such as WorldCom, Adelphia, and others had made hundreds of millions of dollars in loans to their CEOs and other executives because they had pledged their shares in the company for their personal investments. When those investments did not per- form well, their shares had to be sold to satisfy the loans. A sell-off of their major holdings would have sent the company’s stock into a dive. The result was a vicious circle in which more loans were made in order to prevent the sale of shares, with ever-increasing pressure to keep the share price up in order to satisfy the loans the shares secured.

Codes of Ethics for Financial Reporting. Companies must now have codes of ethics in place for the financial officers of their companies. Even though 97% of publicly held companies now have codes of ethics, this provision requires specific con- tent about the standards for financial reporting and accounting in the company. These financial officers are also subject to greater federal penalties for certifying false financial statements (see Chapter 8 for more information on their criminal liability).

Role of Legal Counsel to the Company. In many of the collapsed companies, two of the questions that arose were “Where were the auditors?” and “Where were the lawyers?”1 As Congress and the SEC grappled with these questions, they imposed extensive disclosure obligations on auditors and accountants (see Chapter 18 for those requirements), but they also imposed reporting requirements on legal coun- sel for corporations. Under the new requirements, lawyers have several progres- sive steps in their duties and disclosure requirements:2

• A lawyer who suspects material violations must instigate an investigation to determine whether such violations have occurred.

• The lawyer must inform the CEO of the investigation. • The lawyer must report material violations of the law to the CEO. • If no action is taken, the lawyer must go “up the ladder” and report the

material violations to the audit committee or a group of independent board members.

• Companies must create a legal compliance committee based on the idea of strength in numbers, in that the committee will be told of investigations and findings and can take the matter “up the ladder.”

• Because of concerns and objections from the American Bar Association, the SEC did not adopt the so-called noisy withdrawal rule, a process that would have required a lawyer who has found a material violation that the company will not remedy to resign from the company and report the violation to the SEC.

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620 part 4 Business Management and Governance

Ethical Issues

General David Petraeus, a graduate of West Point, a military scholar, and a respected gen- eral who is credited with the success of the “surge” operation in Iraq, resigned abruptly as CIA director following an FBI investigation that uncovered an extramarital affair between the general and his biographer, Paula Broadwell. Both Ms. Broadwell and General Petraeus were married. The FBI investigation began when Jill Kelley, a social liaison at MacDill Air Force Base, began receiving threatening e-mails. When Mrs.  Kelley reported the e-mails to the FBI, the agency’s investigation linked them to Ms.  Broadwell. Upon inter- viewing Ms. Broadwell and General Petraeus in late October 2012, the FBI uncovered the affair, which both admitted. General Petraeus then resigned as director of the CIA because of the fears regarding national security and, as the general explained, his “extremely poor judgment.”

What has unfolded is what would be called in business “a mess.” Revelations of affairs by CEOs can cause significant damage for companies both because of market and shareholder concerns about judgment and stability (which then affects the stock price) and because the CEOs generally must resign because their leadership ability is questioned by employees who are skeptical about lead- ers who do not set a good example. Compa- nies that have suffered significant setbacks, including drops in their share prices, because of affairs or alleged harassment that involved their CEOs include Boeing, Best Buy, Stryker Corporation, and Hewlett-Packard.

Prevention is the key, and companies now follow certain best practices that might have helped General Petraeus avoid the trap of personal decadence:

•  CEOs should never meet alone with outside vendors. Inappropriate advances and physical contact do not occur when a third party is present. This pol- icy carries additional benefits in that there is always a witness to potential claims about deals and promises.

•  CEOs should follow company policies on employee relationships. Most

companies have policies that prohibit employees who are in a reporting-line relationship from dating. The compa- nies offer transfers or other accom- modations, but they are strict when it comes to disregarding Cupid’s arrow if one employee in the relation- ship reports to the other employee, directly or indirectly. The potential for perceptions of favoritism or resulting harassment are too great.

•  CEOs need to understand their vul- nerability. An affair leaves the CEO subject to potential blackmailing because the other party has informa- tion that the CEO would not want to be disclosed. Ethical compromises or revelations of company inside information often result when a CEO tries to keep relationships and affairs secret. There is also the risk of the so-called bunny boiler, where the per- son with whom the CEO has an affair begins harassing the CEO or other employees or friends and relatives.

•  Companies understand that there is a fine line between wanted romance and advances and harassment and tend to be strict about policies for employees, including executives and the CEO.

•  Companies audit expense reports of CEOs and executives frequently because unexplained expenses in travel and entertainment often lead to revelations about affairs that can then be investigated and ended before company information is compromised.

•  Companies monitor e-mails. What you put in an e-mail is discoverable, can be reviewed, and is not private. General Petraeus would have done well to understand this principle of cyberspace.

What effect does a CEO’s affair have on the company? Why does an affair leave a com- pany vulnerable? What is the relationship between harassment and office romance?

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Chapter 17 Governance and Structure: Forms of Doing Business 621

Role of the Chairman and CEO. Under Dodd–Frank, companies are required to inform shareholders when the offices of CEO and chairman of the board are combined or separated and provide an explanation for the decision on the role of the two offices or their combination. Some studies indicate that the separa- tion of these two roles resulted in better governance as well as better financial performance. The 2013 shareholder meeting for JPMorgan Chase resulted in a significant battle among shareholders for separating the dual CEO/chairman role of Jamie Dimon. Mr. Dimon retained both roles.

Role of the Compensation Committee. Also under Dodd–Frank, board compensation committees must be composed of independent directors, meaning directors who do not have affiliations or contractual relationships with the company. (See p. 613 for more information on the definition of “independent directors.”) Board com- pensation committees that hire consultants (and most publicly traded companies do) must hire those consultants independently of management input, and the con- sultants must have a direct line of reporting to the compensation committee, not management.

Board Membership. Under Sarbanes–Oxley, boards must consist of a majority of members who are independent. Independent is defined as someone who has not been an officer, employee, or manager of the company during any of the past three years; who is not related to anyone who works for the company; who is not under any type of consulting or remuneration arrangement with the company; and who is not a principal or owner of a company that does business with the board or the company. This independence requirement caused some shake-ups in boards. For example, Kenneth Chenault, the CEO of American Express, was no longer an independent member of IBM’s board because IBM does business with American Express. Dodd–Frank expanded independence requirements to compensation committees. Audit committee members must all be independent directors, and at least one member of the audit committee must meet standards for certification as a financial expert.

17-4h Corporate Management and Control: shareholders

shareholder Rights: annual Meetings Shareholders have the opportunity to express their views at the annual meeting by electing directors who represent their interests. Annual meetings also give share- holders the opportunity to vote on critical corporate issues. Under the MBCA, the failure to hold an annual meeting does not result in dissolution or revocation of corporate status.

shareholder Rights: Voting At annual and special meetings, shareholders have the right to vote. Shareholders may vote their own shares or delegate their votes in a variety of ways.

The Proxy. The most common method of delegating voting authority is the proxy, with which shareholders can transfer their right to vote to someone else. This type of vote assignment is temporary. Under the MBCA, a proxy is good only for 11 months, which allows a shareholder to decide to give a different proxy before the next annual meeting. Many shareholder groups solicit proxies to obtain control. Those solicitations are subject to the federal securities laws, and certain disclosures are required (see Chapter 18).

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622 part 4 Business Management and Governance

Pooling Agreements. A method of grouping shareholder votes is the pooling agreement, which is a contract among shareholders to vote their shares a certain way or for a certain director. One of the problems with pooling agreements is enforceability: if the agreements are breached, it is really too late to do anything about the breach because the corporation will take the action authorized by the votes or a particular director will take a seat.

Voting Trust. Another form of shareholder cooperation is the voting trust. In this form of group voting, shareholders actually turn their shares over to a trustee and are then issued a trust certificate. The shareholders still have the right to dividends and may sell or pledge the certificate. However, the shares remain in the hands of the trustee, and the trustee votes those shares according to the terms of the trust agreement. The shareholders get their shares back only when the trust ends. Most states have specific requirements for the voting trust: A copy must be filed with the corporate offices, and some states have a maximum duration (such as 10 years) for such trusts. Hershey’s has a voting trust that has nixed acquisition attempts.

Shareholder rights in Combinations Because shareholders’ interests are involved, corporations are not free to combine at will or to merge or consolidate without shareholder input. All states have proce- dures for obtaining shareholder approval for business combinations.

The Procedure. All mergers, consolidations, and sales of assets (other than in the ordinary course of business) must have shareholder approval. Further, that approval must be obtained in a manner prescribed by the MBCA:

• Board resolution. The process of obtaining shareholder approval begins with the board of directors. They must adopt and approve a resolution favoring the merger, consolidation, or asset sale.

governing Corporate governanceBusiness Strategy

In addition to incorporating the statutory requirements under Sarbanes–Oxley and Dodd-Frank, many companies are adopting new policies and procedures for corporate governance. Some of those changes, poli- cies, and processes are mentioned here as possible strategies for effective governance:

•  Ethics and compliance officers are now part of executive management teams for purposes of vetting pro- posed strategies as well as human resource actions and the release of financial information.

•  Compliance and ethics officers as well as directors of internal audit now gen- erally have direct reporting lines to the chairs of board audit committees so

that the internal monitors have access to a quasi-external source for purposes of conducting investigations and dis- cussing issues.

•  Board meetings are more likely to be held in person and take longer so that board processes can be more delibera- tive than rubber stamp.

•  Directors have orientation programs before they begin their board service so that they understand processes as well as the nature and business of the corporation.

•  Board members interact more frequently with employees and shareholders in order to obtain different perspectives on issues.

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Chapter 17 Governance and Structure: Forms of Doing Business 623

• Notice to shareholders. Once the resolution is adopted, it must be sent to the shareholders along with a notice of a meeting for the purpose of taking action on the resolution. A notice is sent to all shareholders regardless of whether they are entitled to vote under the corporation’s articles.

• Shareholder approval. The shareholders must then vote to approve the reso- lution at the announced meeting. In the cases of mergers and consolidations, all shareholders are entitled to vote whether they own voting or nonvoting shares because their interests are affected by the results. The number of votes needed to approve a merger under the MBCA is a majority. However, the articles of incorporation or the bylaws may require more, known as a supermajority.

Shareholder approval is not required for a short-form merger, which is one between a subsidiary and a parent that owns at least 90% of the stock of the sub- sidiary. In the absence of these narrow requirements, the long-form merger provi- sions of resolution and voting must be followed.

Shareholder rights: the dissenting Shareholder Not all shareholders vote in favor of a merger or a consolidation. Under the MBCA and most state statutes, these dissenting shareholders are entitled to their appraisal rights. Appraisal rights allow shareholders to demand the value of their shares. Under the MBCA, a dissenting shareholder must file a written objection to the merger or consolidation before the meeting to vote on either is held.

If the merger or consolidation is approved, the corporation must notify dissent- ing shareholders and offer them the fair value of the shares. Fair value is deter- mined as of the day before the action is taken on the merger or consolidation because the action taken will affect the value of the shares. If the dissenting shareholders do not believe the corporation’s offer is fair, they can bring suit against the corpora- tion for establishing fair value. However, if the value the corporation offered is

re: the Battles for Silicon Valley Control

For the Manager’s Desk

Pooling and trust agreements are often used when shareholders are trying to work together to gain control of a company. When Silicon Valley first began, the techie entrepre- neurs were willing to sign over majority inter- ests in their companies to venture capitalists because they needed funding. Now, however, many investors are willing to simply buy an interest in the company with the founding entrepreneurs retaining majority control. For example, Mark Zuckerberg holds 57% of Facebook’s voting shares. The remaining

investors become increasingly nervous because young and untested entrepreneurs are running these companies and control the board. The arrangements have been working well because of the profitability. However, if the earnings or strategic picture changes, the investors have little recourse if they are unable to control the controlling CEO. Shareholders and board members have to work together to keep the company moving forward in a positive way so that battles for control do not hamper progress.

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624 part 4 Business Management and Governance

found to be fair and the dissenting shareholders’ rejection arbitrary, they will be required to pay the corporation’s costs of the lawsuit.

Shareholders also enjoy some protections during merger activity that are offered under federal securities laws in terms of notice and disclosure (see Chapter 18).

Some corporations have experienced a freeze-out, which is a merger under- taken to get rid of the minority shareholders in a corporation. Although these minority shareholders have their dissenting rights, it is expensive to pursue a court action for a determination of fair value. The majority shareholders are able to buy out, at a low price, the minority shareholders, who are left without a remedy and usually with a loss. For this reason, many courts now impose on majority stock- holders a fiduciary duty to the minority stockholders and will prevent a merger without a business purpose from freezing out minority shareholders. Courts and some state laws (corporate constituency statutes) also require a showing that a merger or consolidation is fair to the minority shareholders. These general terms of “business purpose” and “fairness” are defined on a case-by-case basis.

Shareholder rights: Inspection of Books and records The MBCA gives shareholders the absolute right to examine shareholder lists. For other records (minutes, accounting), shareholders must give notice of their request. In addition to this mechanical requirement, some courts also require a proper pur- pose, which means a shareholder has a legitimate interest in reviewing corporate progress, financial status, and fiduciary responsibilities. Improper purposes are those related to use of corporate records to advance the shareholders’ moral, reli- gious, or political ideas.

Shareholder rights: transfer of Shares Stock shares can have transfer restrictions, which are valid as long as the follow- ing requirements are met:

1. The restrictions must be necessary. Valid circumstances include family-owned corporations, employee-owned corporations, and corporations that need restrictions to comply with SEC registration exemptions (see Chapter 18).

2. The restrictions must be reasonable. Requiring that the shares first be offered to the board before they can be sold is reasonable; requiring that the shares be offered to all the other shareholders first may be unreasonable if there are more than 5 to 10 shareholders.

3. The restrictions and/or their existence must be conspicuously noted on the stock shares.

17-4i the dissolution of a Corporation

A corporation can continue indefinitely unless its articles of incorporation limit its duration. Long before perpetuity, however, a corporation can be dissolved volun- tarily or involuntarily.

Voluntary dissolution Voluntary dissolution occurs when the shareholders agree to dissolve the corpora- tion. This type of dissolution occurs in smaller corporations when the shareholders no longer get along, the business does not do well, or one of the shareholders is ill or dies.

A voluntary dissolution begins with a resolution by the board of directors, which is then put before the shareholders at a special meeting called for that

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Chapter 17 Governance and Structure: Forms of Doing Business 625

purpose. Under the MBCA, all shareholders (voting and nonvoting alike) vote on the issue of dissolution because all of them will be affected by it. Once the share- holders pass the resolution (a majority or two-thirds vote in most states), the assets of the corporation are liquidated, and debts and shareholders are paid in the order of their priorities. Each state also has filing and publication requirements for dissolution.

Involuntary dissolution An involuntary dissolution is forced by some state agency, usually the state attor- ney’s office. A dissolution can be forced because of fraud or failure to follow state law regarding reporting requirements for corporations.

17-5 Limited Liability Companies The limited liability company (LLC), first created in 1977, is the newest form of business structure and is now available in 48 states and the District of Columbia. The LLC has been in existence for many years in Europe (known as a GMBH) and South America (limitada). The LLC is more of an aggregate form of business organi- zation than an entity such as a corporation. Owners of an LLC are called members. An LLC provides limited liability (members lose only up to their capital contribu- tions) and flow-through tax treatment similar to a partnership in that tax liability is assessed only at the member’s level of income and not at the business level. An LLC is not a corporation or a partnership. It can be taxed as a partnership, with limited liability for all its owners, and, unlike a limited partnership, all personal owners can participate in management without risking liability.

It has been said that the LLC combines the best of all of the business structures: limited liability for the owners, flexibility in management in that all the owners can participate in management, and flow-through of the income directly to personal profits and losses and resulting tax liability. However, this ideal creation, in order to enjoy the flow-through characteristics necessary for the tax break, must be dis- tinguished from a corporation. The result is that LLCs are limited in duration, with most statutes allowing them to run for periods of 30 to 40 years. The point at which LLCs dissolve by statutory limitations has not yet arrived because LLCs did not exist until 1977. However, when those dissolutions come, the restructuring and re- creation should create interesting issues among and between the owners of the LLCs.

17-5a Formation

An LLC is formed through the filing of a document called the articles of organi- zation, which is filed with a centralized state agency. The name of the business formed must contain either “limited liability company,” “L.L.C.,” or “LLC.”

17-5b Sources of Funding

Members of an LLC make capital contributions in much the same way as partners make capital contributions.

17-5c Liability

Members of an LLC have limited liability; the most they can lose is their capital contributions. Debts belong to the LLC, and creditors’ rights lie with the LLC’s assets, not the personal assets of the members. However, many states require that

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the nature of the business organization appear on the business cards and statio- nery of the company so that members of the public are not misled about the nature of the business as well as the nature of the limited liability of the owners.

However, some states have applied the concept of piercing the corporate veil to LLCs. In Martin v Freeman (Case 17.5), a court applies the doctrine of piercing the corporate veil to an LLC.

Martin v. Freeman 272 P.3d 1182 (Colo. App. 2012)

Leaving the Creditor Hanging on the Hangar

Case 17.5

FaCtS

Dean C. B. Freeman managed Tradewinds as a sin- gle member LLC. Tradewinds contracted to have Robert C. Martin construct an airplane hangar. In 2006, Tradewinds sued Martin for breaching the construction agreement. In 2007, while the litigation against Martin was pending, Tradewinds sold its only meaningful asset, an airplane, for $300,000, and the proceeds of that sale were diverted to Freeman, who paid Tradewinds’ litigation expenses. The trial court declared Martin the prevailing party and awarded him $36,645.40 in costs.

Because the proceeds of the sale of Tradewinds’ only significant asset, the airplane, went directly to Freeman, the LLC was without any assets. Martin filed suit to pierce the LLC veil. The trial court pierced the LLC veil and found Freeman personally liable for the cost award entered against Tradewinds. Tradewinds and Freeman (defendants) appeal.

JUdICIaL opInIon

NAY, Judge To pierce the LLC veil, the court must conclude (1) the corporate entity is an alter ego or mere instrumentality; (2) the corporate form was used to perpetrate a fraud or defeat a rightful claim; and (3) an equitable result would be achieved by disregarding the corporate form.

Courts consider a variety of factors in determining alter ego status, including whether (1) the entity is operated as a distinct business entity; (2) funds and assets are commingled; (3) adequate corporate records are maintained; (4) the nature and form of the enti- ty’s ownership and control facilitate insider misuse; (5) the business is thinly capitalized; (6) the entity is used as a mere shell; (7) legal formalities are dis- regarded; and (8) entity funds or assets are used for non-entity purposes.

Tradewinds’ assets were commingled with Free- man’s personal assets and the assets of one of his other entities, Aircraft Storage LLC;

• Tradewinds maintained negligible corporate records;

• the records concerning Tradewinds’ substantive transactions were inadequate;

• the fact that a single individual served as the enti- ty’s sole member and manager facilitated misuse;

• the entity was thinly capitalized; • undocumented infusions of cash were required

to pay all of Tradewinds’ operating expenses, including its litigation expenses;

• Tradewinds was never operated as an active business;

• legal formalities were disregarded; • Freeman paid Tradewinds’ debts without charac-

terizing the transactions; • Tradewinds’ assets, including the airplane, were

used for nonentity purposes in that the plane was used by Aircraft Storage LLC, without agreement or compensation;

• Tradewinds was operated as a mere assetless shell, and the proceeds of the sale of its only signi²cant asset, the airplane, were diverted from the entity to Freeman’s personal account.

Defendants further argue that the court erred in not recognizing that (1) limited liability companies have fewer restrictions than corporations concerning main- taining formal corporate records, (2) member-owners are permitted to fund LLCs, (3) thin capitalization is not a reason to disregard the corporate form, and (4) third-party payment of attorney fees is proper. However, the court considered the appropriate factors and its findings support a conclusion that Tradewinds was Freeman’s alter ego.

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Chapter 17 Governance and Structure: Forms of Doing Business 627

17-5d tax Consequences

The LLC enjoys the so-called flow-through treatment: the LLC does not pay taxes; income and losses are passed through to the members to be reported on their individual returns. LLC agreements must be drafted carefully to enjoy flow-through status.

17-5e Management and Control

Members of an LLC adopt an operating agreement that specifies the vot- ing rights, withdrawal rights and issues, responsibilities of members, and how the LLC is to be managed. The members can agree to manage collectively, delegate authority to one member, or hire an outsider to manage the business.

17-5f transferability of Interest

A member’s LLC interest is personal property and is transferable. How- ever, the transferee does not become a member without approval by the majority of members. Members do not hold title to LLC property; the LLC owns the property, and each member has an interest in the LLC that reflects the property’s value. Further, the owners of the LLC should struc- ture their LLC and its operation in order to address their tax status issues.

The second prong of the veil-piercing test is whether justice requires recognizing the substance of the rela- tionship between the corporation and the person or entity sought to be held liable over the form because the corporate fiction was “used to perpetrate a fraud or defeat a rightful claim.” Defendants have not cited any Colorado case, and we are aware of none, estab- lishing that a party seeking to pierce the corporate veil must show wrongful intent. We conclude that showing that the corporate form was used to defeat a creditor’s rightful claim is sufficient and further proof of wrong- ful intent or bad faith is not required.

Here, in finding that the corporate form was used to defeat a rightful claim, the court relied on Tradewinds’ sale of its only asset, the airplane, and diversion of the proceeds to Freeman during the litigation with Martin. Defendants argue that the airplane’s sale in 2007 does not support the second prong because Martin did not have a rightful claim until the cost award in his favor was entered in 2009. We conclude that defeating a potential creditor’s claim is sufficient to support the second prong. We further conclude, as a matter of first impression, that wrongful intent or bad faith need not be shown to pierce the LLC veil.

Freeman drained Tradewinds of all assets during litigation, even though it was exposed to potential lia- bility because it had sued Martin. Leaving Tradewinds without any assets would have, without a finding that veil piercing was appropriate, defeated any of Martin’s

potential valid claims. We conclude that transferring all of the LLC’s assets to defeat a rightful creditor’s poten- tial claim is sufficient to support piercing the corporate veil.

The judgment is affirmed.

dISSentIng opInIon

JONES, Judge Tradewinds’ sale of its airplane, and the distribution of the proceeds of that sale to Mr. Freeman, . . . occurred more than two years earlier and bore no relationship to the debt which later arose. Were that transaction some- how wrongful, such a result might be justified. But the district court did not find that the transaction was wrongful, and its factual findings, which are uncontest- ed on appeal, permit no such inference. Therefore, the district court’s decision was, in my view, contrary to the controlling Colorado authority, which requires the party seeking to pierce the corporate veil to prove, at a minimum, wrongful conduct in the use of the corpo- rate form. Accordingly, I respectfully dissent.

CaSe QUeStIonS

1. Give the list of reasons the court finds that pierc- ing the LLC is necessary.

2. Why does the dissent disagree with the decision?

3. What advice would you give to someone who is the sole owner of an LLC based on this case?

Getting LLC Tax Status If an LLC is not created accord- ing to both state law and IRS guidelines, the tax benefits can be lost. The IRS has issued guidelines on the four charac- teristics of an LLC entitled to pass-through or flow-through status. An LLC must not have more than two of the following: limited liability for members, continuity, free transferability of interests, and no centralized management.

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17-5g dissolution and termination

Most LLC statutes provide that the LLC dissolves upon the withdrawal, death, or expulsion of a member. Some states permit judicial dissolution, and all states permit voluntary dissolution upon unanimous (usually written) consent of the owners.

LLC agreements can dictate terms, timing, and results of dissolution, as well as the rights of withdrawing partners.

17-6 Limited Liability Partnerships A limited liability partnership (LLP) is a partnership with unique statutory pro- tection for all its members.

For The Manager’s Desk

re: Stephen Baldwin and His LLC with Kevin Costner

Stephen Baldwin and his friend, Spyridon Contogouris, along with Kevin Costner were investors in Ocean Therapy Solutions, LLC, a company that had developed oil-separating centrifuges. These devices “eat up” the oil from spills and do so quickly enough to halt damage.

Following the April 2010 explosion at the BP Deepwater Horizon rig, BP officials met with Mr. Costner and other Ocean Therapy representatives to determine whether the centrifuges would work on the Gulf spill. As a result of the meeting, BP contracted with Ocean Therapy to spend $52 million on the devices. BP made a deposit of $18 million upon signing the contract.

At about the same time that Ocean Ther- apy and Mr. Costner were negotiating with BP, Mr. Baldwin and Mr. Contogouris were negotiating to sell their interests in Ocean Therapy Solutions. The two sold their inter- ests for about $2 million ($1.4 million for Mr. Baldwin and $500,000 for Mr. Contogouris). However, they were unaware of the negoti- ations with BP. After they learned of the BP contract, Mr. Baldwin and Mr. Contogouris filed suit against Mr. Costner seeking an additional $21 million for the value of their interests.

The case went to trial in New Orleans, and the jury deliberated for two hours before returning a verdict in favor of Mr. Costner. The jury concluded that Mr. Costner was not aware that Mr. Baldwin and Mr. Conto- gouris were seeking a buyout. Mr. Costner did use funds from the BP deposit to buy out the two. However, Mr. Baldwin and Mr. Contogouris had put very little cash into the company, and the $2 million represented a substantial return on their investment.

Limited liability companies can place man- agement responsibilities in the hands of one owner, as Ocean Therapy Solutions did with Mr. Costner. There is a fiduciary duty between the owners of the LLC and also between the managing owner and the “silent” owners, but daily disclosures of ongoing negotiations and contracts are not required. The jury concluded that Mr. Costner was not aware of what Mr. Baldwin and Mr. Contogouris knew and could have assumed that they thought the buyout was fair, given their initial investment, even with the BP contract.

The lessons learned from the Costner experience are the importance of regular reporting of financials and transactions to owners as well as careful disclosures at the time of any buyouts of owners.

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Chapter 17 Governance and Structure: Forms of Doing Business 629

17-6a Formation

Not all states have LLP statutes, but those with such statutes have strict formal requirements for the creation of an LLP. The failure to comply with these require- ments results in a general partnership with full personal liability for all the part- ners. The general requirements for LLP registration are filing (1) the name of the LLP (which must include LLP or Reg LLP), (2) the name of the registered agent, (3) the address, (4) the number of partners, and (5) a description of the business.

17-6b Sources of Funding

As in partnerships and limited partnerships, LLP partners make capital contributions.

17-6c Liability

In most of the states with LLP statutes, partners are shielded from liability for the negligence, wrongful acts, or misconduct of their partners. Other states provide more extensive protection, such as limited liability even for debts entered into by other partners. In order to attain this liability limitation, some states require, upon registration, evidence of adequate liability insurance. In some states, professional negligence by partners is not covered by the shield from liability.

17-6d tax Consequences

All LLP income is a flow-through or pass-through to partners.

17-6e Management and Control

Partners can manage without risking personal liability exposure because the LLP is identified as such and registered with the state.

17-6f transferability

For tax and security regulation reasons, the transferability must be restricted and is generally governed by the same principles of transfer for limited partnerships.

17-6g dissolution and termination

Causes similar to those for the dissolution of limited partnerships and notification to the state are required.

17-7 International Issues in Business Structure Global trade has resulted in global business structures, with many companies dis- covering the benefits of joint ventures. A joint venture is a partnership of existing businesses for a limited time or a limited purpose. The existing businesses are then partners for that limited transaction or line of business. The Justice Department has relaxed antitrust merger rules to permit joint ventures so that U.S. firms can compete more effectively internationally. For example, Mobil and Exxon formed a joint venture for oil exploration in Russia. The joint venture allows the combi- nation of their experience and financing so that Russian negotiators can be per- suaded to contract for the exploration rights.

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In an attempt to break into the Japanese toy market, Toys R Us, Inc., entered into a joint venture with McDonald’s Co., Ltd., a Japanese toy company with 20% of the market. Nestlé and Coca-Cola formed a joint venture to market ready- to-drink coffees and teas; Nestlé’s expertise is in dry goods (instant coffee), and Coca-Cola is a beverage company, so each plans to take advantage of the other’s established reputation.

Business structures vary in other countries. In Germany, for example, a pub- lic company has both a board of directors and a shareholder advisory committee, which elects the board of directors. It is quite likely, however, that the shareholder advisory committee is composed of shareholders that are large institutional inves- tors (such as banks) or representatives from labor unions.

Biography

Martin Shkreli, 32, was the CEO of Tur- ing Pharmaceuticals. In September 2015, over the objections of the corporation’s legal counsel, Mr. Shkreli raised the price of the company’s drug, Daraprim, from $13.50 per pill to $750 per pill, an increase of over 5,000%. Daraprim is used to fight infections in cancer patients and patients with HIV.

Public outrage was great, congres- sional hearings were scheduled, and the corporation was left paralyzed because Mr. Shkreli was a controlling shareholder. When presidential candidate Hillary Clin- ton asked that he lower prices on drugs, he tweeted, “lol.” Presidential candidate Bernie Sanders returned Mr. Shkreli’s

$2,700 campaign contribution. At a panel discussion on the pharma industry, Mr. Shkreli explained his duty to his investors to maximize profits.

However, on December 16, 2015, Mr. Shkreli was arrested at 6:30 a.m. in his New York City apartment on securities fraud charges. He entered a not guilty plea to charges that he was running a Ponzi scheme at his former company (Retrophin) and was released on a $5 million bond. He was forced to resign as CEO of Turing.

Explain Mr. Shkreli’s business model and approach to returns for investors.

What powers would a board have over such a CEO? The shareholders?

the Ceo Who raised the price of His Company’s drug by 5,000%

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s u m m a r y What are the various forms of business organization?

• Sole proprietorship—individual ownership and operation of a business

• Partnership—voluntary association of two or more persons as co-owners in a business for profit

• Corporation—an entity formed by statute that has the rights of a legal person along with limited liability for its shareholder owners

• Limited liability company—newer form of business organization in which liability is limited except for conduct that is illegal

• Limited liability partnership—newest form of busi- ness organization, in which partners’ liability is limited

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Chapter 17 Governance and Structure: Forms of Doing Business 631

How is a partnership formed and operated?

• Uniform Partnership Act (UPA)—law on partner- ships adopted in 49 states

• Revised Uniform Partnership Act (RUPA)—update of partnership law

• Partnership by implication—creation of a partner- ship by parties’ conduct

• Partnership by estoppel—partnership that arises by perception of third parties of its existence

• Dissolution—when partner ceases to be associated with the partnership

• Limited partnership—partnership with two types of partners: general and limited

• General partner—full and personal liability partner

• Limited partner—partner whose personal liability is limited to capital contributions

• Uniform Limited Partnership Act (ULPA)—uniform law adopted in nearly every state

• Revised Uniform Limited Partnership Act (RULPA)—update of limited partnership law

• Advances—partners’ loans to partnership

How is a corporation formed and operated?

• Corporation—business organization that is a separate entity with limited liability and full transferability

• Domestic corporation—a corporation is domestic in the state in which its incorporation is filed

• Foreign corporation—category or label for corporation in all states except in state in which it is incorporated

• Professional corporation—entity with limited liabil- ity except for malpractice/negligence by its owners

• S corporation—IRS category of corporation with flow-through characteristics

• Model Business Corporation Act (MBCA)—uniform law adopted in approximately one-third of the states

• Articles of incorporation—document filed to orga- nize a corporation

• Common stock—generally most voluminous type of corporate shares and usually allows shareholders to vote

• Preferred stock—ownership interest with priority over common stock

• Corporate veil—liability shield for corporate owners

• Watered shares—failure to pay par value for shares

• Business judgment rule—standard of liability for directors

• Corporate opportunity doctrine—fiduciary responsi- bility of directors with respect to investments

• Board of directors—policy-setting body of corporations

• Derivative suits—right of shareholder to recoup losses from those who made decisions not guided by proper process

• Proxy—right to vote for another

• Pooling agreement—shareholder contract to vote a certain way

• Voting trust—separation of legal and equitable title in shares to ensure voting of shares in one way

• Dissenting shareholder—shareholder who objects to merger

• Appraisal rights—value of shares immediately before merger that is paid to dissenting shareholder

How is a limited liability company formed?

• Articles of organization

• Flow-through of income

How is a limited liability partnership formed?

• Register with state

• Flow-through of income

• May need proof of liability insurance

Q u e s t i o n s a n d P r o b l e m s 1. Gailey, Inc., incorporated in 1980, removed asbestos and mechanical insulation on contract jobs that required union labor. Richard Gailey had been the president, con- trolling shareholder, and director of Gailey, Inc., from its inception.

Universal Labs, Inc., was incorporated by Mr. Gai- ley in March 1984 to analyze asbestos samples and air samples and to perform general laboratory work. Mr. Gailey was the sole shareholder of Universal Labs.

As president and director of Gailey, Inc., Mr. Gailey directed Gailey to pay certain debts of Universal Labs.

Subsequent to that, Gailey, Inc., provided $14,500 to Universal Labs to pay for the latter’s start-up expenses and costs.

Gailey, Inc., filed a voluntary petition pursuant to Chapter 11 of the Bankruptcy Code and the case was later converted to a Chapter 7.

The trustee in bankruptcy filed suit alleging that Mr. Gailey usurped a corporate business opportunity belonging to Gailey, Inc., when he incorporated Univer- sal Labs. Is the trustee correct? [In re Gailey, Inc., 119 B.R. 504 (Bankr. W.D. Pa. 1990)]

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2. Former Governor J. Fife Symington of Arizona was, during the 1980s, a director of Southwest Savings & Loan, a federal thrift headquartered in Phoenix. Mr. Symington was also a developer who constructed two major commer- cial projects in Phoenix, with Southwest Savings & Loan providing the loans for development. Southwest was a victim of the 1980s downturn and was taken over by the Resolution Trust Corporation (RTC). The RTC brought suit against Mr. Symington, alleging that he took advantage of his board position to obtain the loans. Mr. Symington said he was required to present the projects to the Southwest Board as part of the corporate opportunity doctrine and Southwest took the investment. Who is correct?

3. Marc and Brenda Bertorelli and their company, Marc Bertorelli Builders, joined together to purchase a condo- minium. Their goal was to purchase properties and then turn around and sell them for a profit. The condomini- ums (lofts) were part of what had once been an aban- doned factory. The factory had been contaminated with trichloroethylene, and, in the process of converting it into condominiums, a vapor barrier was installed, but the site was never properly decontaminated.

The Bertorellis and their company sold the condo- minium they had purchased to the Alfieris. The Alfieris were led to believe by Marc and newspapers clippings that he produced that the condominium had been decontami- nated. The site later turned out to be seriously contaminated.

The Alfieris brought suit against Marc, Brenda, and their company for silent fraud and negligent misrepre- sentations. Brenda and the building company argued that they were not liable because they had not made the representations about the decontamination. The Alfi- eris have argued that the Bertorellis were operating as a partnership and all of them were, therefore, liable. The Bertorellis say that they have no partnership agreement. Discuss the issues and liability of the parties in this case. [Alfieri v. Bertorelli, 813 N.W.2d 772 (Mich. App. 2012)]

4. The Community Youth Center (CYC) corporation failed to pay its annual registration fee in 2000 and was automatically dissolved by the State Corporation Com- mission. CYC continued to operate as a corporation. In fact, in 2005, it obtained a loan from the First Commu- nity Bank to finance a swimming pool at its facility. The loan was signed by officers of the corporation and was secured by property owned by CYC.

CYC defaulted on the loan and First Community Bank foreclosed on the CYC property that was subject to the mort- gage. First Community purchased the property at a foreclo- sure sale. CYC challenged the foreclosure on the grounds that the president, vice president, and treasurer of CYC had no authority to enter into the 2005 loan agreement because CYC’s corporate status had been terminated and it no longer existed as a corporation. The bank responded that CYC had continued to hold itself out as a corporation and that it relied on that existence in making the loan. What should the court

hold in this case and why? [First Community Bank, N.A. v. Community Youth Center, 2010 WL 8696179 (Va. Cir. Ct. 2010)]

5. Allan Jones sold a ski shop franchise to Edward Ham- ilton. Although Mr. Jones did not contribute equity to the business or share in the profits, he did give Mr. Hamilton advice and share his experience to help him get started. Most of Mr. Hamilton’s capital came in the form of a loan from Union Bank. When Mr. Hamilton failed to pay, Union Bank sued Mr. Jones for payment under the theory that Mr. Jones was a partner by implication or estoppel. Was he? [Union Bank v. Jones, 411 A.2d 1338 (Vt. 1980)]

6. Heritage Hills (a land development firm) was orga- nized on July 2, 1975, as a limited partnership, but the partnership agreement was never properly filed. Her- itage Hills went bankrupt, and the bankruptcy trustee has sought to recover the debts owed by the partnership from the limited partners. Can he? [Heritage Hills v. Zion’s First Nat’l Bank, 601 F.2d 1023 (9th Cir. 1979)]

7. The Orleans Parish School Board hired Johnson & Higgins (J & H) to provide consulting services. J & H pro- vided those services over the next few years but was then acquired by Marsh & McLennan, a larger insurance firm. Marsh continued the work that J & H had been doing and submitted an invoice to the Orleans Parish School Board for reimbursement. The Board said that it had no contractual arrangement with Marsh and, as such, was not liable for the services. Is the Board correct? Describe what happened in the relationships and apply the principles of corporate law to determine whether Marsh can be paid. [Marsh Advantage America v. Orleans School Board, 995 So. 2d (La. App. 2008)]

8. The Trapp Family Lodge, Inc. (TFL), was incorporated in 1962 as a holding company for certain assets of the Von Trapp family, including the Trapp Family Lodge, a resort hotel in Stowe, Vermont, and other assets, including certain royalty rights related to the family’s story as portrayed in a Broadway musical and movie, The Sound of Music.

A majority of TFL shareholders approved a merger with a new corporation in 1994, and the merger took place on January 28, 1995. The dissenting shareholders, holding of the corporation’s outstanding shares, were paid $33.84 per share as fair value by the TFL board of directors. The dis- senting shareholders brought suit seeking a higher price as fair value. After the trial court set the fair value of $63.44, TFL appealed. What are the rights of dissenting sharehold- ers who object to a merger? [In re 75,629 Shares of Common Stock of Trapp Family Lodge, 725 A.2d 927 (Vt. 1999)]

9. A. W. Ham Jr. served on the board of directors for Golden Nugget, Inc., a Nevada corporation. In 1969, while Mr. Ham was a director and legal counsel for Golden Nugget, he obtained a leasehold interest with an option to purchase in the California Club. The California Club is at 101 Fremont Street, Las Vegas, Nevada, and is located next to a series of properties on which Golden Nugget operates its casinos. Mr. Ham leased the property

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Chapter 17 Governance and Structure: Forms of Doing Business 633

from his former wife. Golden Nugget was looking for property to expand and had, in fact, been expanding onto other lots in the area. Was there a breach of a corporate opportunity? What if Mr. Ham offers to lease the prop- erty to Golden Nugget? [Ham v. Golden Nugget, Inc., 589 P.2d 173 (Nev. 1979)]

10. McNeil, a division of Johnson & Johnson, had sig- nificant problems with quality control on its products, including infant Tylenol and Motrin. Worn equipment

in plants resulted in metal flakes in some of the compa- ny’s products. The result was federal sanctions and a series of lawsuits by users of the products. The sharehold- ers brought suit against the directors for their failure to supervise the company’s activities and facilities. Can the shareholders sue the directors for these reasons? Who recovers if they can sue? What theories would the share- holders use? [Monk v. Johnson & Johnson, 2011 WL 6339824 (D. N.J. 2011)]

1. The questions were actually a resurrection of questions asked by Judge Stanley Sporkin when he was dealing with all of the fraud cases from the savings and loan collapses in the early 1990s. [Lincoln Savings & Loan Ass’n v Wall, 743 F. Supp. 901, at 920 (D.D.C. 1990)]

2. The final rules can be found at 17 C.F.R. § 205 (2013).

3. Del Jones, “CEOs Openly Pull against Say-on-Pay,” USA Today, July 16, 2009, p. 1B.

n ot e s

HR & the Law Who Says What the CEO Makes?

The so-called say-on-pay legislation has been kicking around Congress for a number of sessions and now, with the passage of the Dodd–Frank Wall Street Reform and Consumer Financial Protection Act, shareholders will have an advisory vote on executive compensation. Steve Hafner, the CEO of Kayak (a travel search engine), explained, “I wonder if the congressmen backing this legislation would propose similar laws governing their own compensation. I’d love to vote on congressional pay and perks.”3

There are concerns on both sides about CEO pay. From the investors’ perspective, the concerns are the following:

• Increases in pay and bonuses despite poor perfor- mance of the company and its stock.

• Failure of the board to provide independent over- sight on compensation.

• The say-on-pay is not binding; directors can take the advice of shareholders or go against it (but they are elected by the same shareholders).

• Say-on-pay takes away shareholder frustration with the process.

• In companies that are already allowing shareholders a say on pay, the shareholders appear to be fairly rea- sonable. For example, at Aµac, 93% of the sharehold- ers voted in 2008 in favor of the multi-million-dollar pay package for CEO Dan Amos. His pay approval package rate rose to 97% of the shareholders in 2009

after Amos turned down the $2.8 million bonus he was entitled to under the 2008 approval.

The CEO’s perspective on say-on-pay follows:

• There are concerns about shareholders microman- aging the company.

• There are concerns that some shareholders are fairly sophisticated and may, through the say-on- pay approval process, force CEOs into making decisions that carry a very short-term focus for the company that can prove harmful in the long run.

• This type of micro-regulation could result in a talent pool drain in what is now an international marketplace; it would allow CEOs to go to compa- nies not subject to U.S. regulation.

• The say-on-pay rule would be another impetus for companies to go private, where there would be less transparency on true market performance.

• Say-on-pay does not promote a dialogue between management and shareholders that could bring about more meaningful self-reform on pay packages.

How will the advisory vote work? Could companies go further and ask for shareholder ratification as a required step for compensation packages? How would this work from a governance perspective? Are the roles of shareholders and managers blending together? Do you believe the advisory vote that is now law will evolve into something more?

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634

Chapter

Governance and Regulation Securities Law18 One method for raising the capital needed for a corporation or partnership is to sell interests in it. Corporations sell shares, and partnerships sell limited partnership interests. Investors provide the capital these businesses need to operate. They give the businesses their money to work with and in return are given an interest in the business. The investors’ hope is that the business will give them a profit on their investment (dividends on stock and interest income on bonds and other forms of securities) and that the value of their investment will grow as the business in which they have invested increases in value (which provides them with capital gains). The investment arrangement in theory is mutually beneficial. However, because people are so eager to have their money grow and because businesses need money for growth, the interests of business and investors are often at odds. Because of this inherent conflict of interest in the investment relationship, laws regulate investments at both state and federal levels. These laws, called securities laws, govern everything from the sale of securities to soliciting proxies from owners of securities. Within these laws are mandatory governance standards. This chapter answers these questions: Why do we have securities laws, and what is their history? What requirements affect primary offerings of securities? How do securities laws reg- ulate the secondary market? How do those laws protect shareholders in share and company acquisitions?

Update For up-to-date legal news, go to mariannejennings.com

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635

18-1 History of Securities Law Although most people think of the market crash of 1929 as the beginning of secu- rities regulation, regulation actually began nearly 20 years earlier at the state level. In 1911, Kansas passed the first securities law, which regulated the initial sale of securities to members of the public. Some states followed the lead of Kansas, but until 1929 the field of securities was relatively free of regulation.

At that time, investors were engaging in a great deal of speculation in stocks. Investors traded “on margin,” which means they borrowed money to invest in a stock, and when the stock went up in value, they sold it, paid off the loan, and still made money. On a Friday in 1929, however, stock prices dropped on all the exchanges and continued to drop. Investors defaulted on the margin loans, lenders foreclosed on their properties, and the entire country was thrown into a depression.

Because of the 1929 market crash, Congress perceived a problem with the investment market. As a result, the Securities Act of 1933 and the Securities Exchange Act of 1934 were passed, the former to regulate initial sales of stock by businesses and the latter to regulate the secondary trading of stock on the markets. These statutes, as amended, and their accompanying regulations still govern the sale of securities today.

18-2 Primary Offering Regulation: The 1933 Securities Act

A primary offering—an offering by an issuer, which could be its first, known as an initial public offering (IPO)—is a sale of securities by the business itself. The 1933 act regulates these initial sales of securities.

18-2a What Is a Security?

The 1933 act applies only to the sale of securities. The language of the act itself is broad in the definition of securities, and approximately 20 items are considered securities, including notes; stock; bonds; debentures; warrants; subscriptions; voting trust certificates; rights to oil, gas, and minerals; and limited partnership

October. This is one of the peculiarly dangerous months to speculate stocks in. The others are July, January, September, April, November, May, March, June, December, August, and February. Mark Twain Pudd’nhead Wilson

We are doing God’s work.1 Jeffrey Skilling former Enron CEO, circa 2000

lloyd Blankfein Goldman Sachs CEO, November 2009

Maher Kara, who worked at Citigroup’s health care in- vestment group, passed along information to his older brother Michael about upcoming mergers and acquisi- tions being handled by Citigroup. Michael then passed the information along to their sister’s fiancé, Bassam Salman. Mr. Salman, through his sister’s husband’s

account, made trades on the advance information from 2004 to 2007, making $1.7 million on the information. The SEC has brought charges of insider trading against Mr. Salman. He says he did nothing wrong because he did not get the information from the companies or their employees. Is he correct?

Consider . . . 18.1

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636 part 4 Business Management and Governance

interests. Every investment contract that gives the owner evidence of indebtedness or business participation is a security.

In interpreting the application of the 1933 act, the courts have been liberal. The landmark case on the definition of a security is SEC v W. J. Howey Co., 328 U.S. 293 (1946). In holding that the sale of interests in Florida citrus groves constituted the sale of securities, the U.S. Supreme Court defined a security as “a contract, trans- action, or scheme whereby a person invests his money in a common enterprise and is led to expect profits solely from the efforts of a promoter or a third party.” With this even broader definition than the actual 1933 act language, known as the Howey test, courts have been reluctant to impose restrictions on the definition of a security. In recent years, the only type of arrangement the U.S. Supreme Court has excluded from this definition is an employer pension plan in which employees are not required to make contributions. The exclusion of these plans from securities laws is probably based on the fact that employees are afforded other statutory pro- tections (see Chapter 19 and the discussion of the Employment Retirement Income Security Act and the Pension Protection Act of 2006).

Determine whether general partnership in- terests would be considered securities for purposes of the 1933 Securities Act.

THINK: The Howey definition is that secu- rities are investments in a common enter- prise with profits to come from the efforts of others.

APPLY: Even though partnerships are in- vestments in a common enterprise, we learned in Chapter 17 that each partner is required to contribute work and effort to the partnership. General partners, unless otherwise specified, are not paid salaries for their work and effort in making the part- nership work. Because of this obligation to work and the full liability exposure, the results from investing in a partnership do

not come primarily from the efforts of oth- ers but through the partnership itself.

ANSWER: A general partnership interest is not a security for purposes of the 1933 act.

Now determine whether the following are securities under the 1933 Securities Act:

• Limited partnership interests

• Limited liability company interests

• Limited liability partnership interests

• Oil and gas leases

• Limited partnership in an oil field

• An interest in a real estate investment trust

• Options to buy tickets for the World Series if your team makes it to that point

Consider . . . 18.2

18-2b Regulating primary Offerings: Registration

The Securities and Exchange Commission (SEC) is the administrative agency responsible for regulating the sale of securities under both the 1933 and 1934 acts. The SEC is subject to all of the administrative rules covered in Chapter 6 because it was the administrative agency created by Congress in its enabling legislation, the 1934 Securities Exchange Act. The SEC can issue injunctions, institute criminal proceedings, bring civil suits, enter into consent decrees, handle enforcement, and promulgate rules.

The rules promulgated by the SEC provide the requirements for the registra- tion of securities, financial reporting, and stock exchange operations. The SEC has

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Chapter 18 Governance and Regulation: Securities Law 637

a complete staff of lawyers, accountants, financial analysts, and other experts to assist in both the review of informational filings and the enforcement of the secu- rities laws.

18-2c Regulating primary Offerings: exemptions

Unless an exemption applies, anyone selling securities must complete certain fil- ing requirements before the securities can be sold legally. The two types of exemp- tions are exempt securities and exempt transactions. These exemptions work only for the 1933 act.

exempt Securities Certain investments, called exempt securities, have been excluded specifically from coverage of the 1933 act. The following is a list of some of the exemptions:

1. Securities (bonds etc.) issued by federal, state, county, or municipal govern- ments for public purposes

2. Commercial paper (includes notes, checks, and drafts with a maturity date under nine months)

3. Banks, savings and loans, and religious and charitable organizations 4. Insurance policies 5. Annuities 6. Securities of common carriers (those regulated by the Interstate Commerce

Commission) 7. Stock dividends and stock splits 8. Charitable bonds

exempt transactions Exempt transactions are more complicated than exempt securities; more details are required to comply with the exempt transaction standards. The following subsections discuss these transaction exemptions, which are summarized in Exhibit 18.1.

The Intrastate Offering Exemption. This exemption exists because the Commerce Clause prohibits the federal government from regulating purely intrastate mat- ters (see Chapter 5 for a full discussion of Commerce Clause issues). Under 2016 changes to this exemption, the SEC has expanded the ability of issuers to qualify for the intrastate exemption. The strict constraints of former Rule 147 were lifted as part of the JOBS Act mandate to the SEC to simplify the process for businesses to raise funds. The requirements for a Rule 147 exemption are:

1. All sales of securities must be made to residents of the state where the issuer is a resident and is operating its principal place of business, defined as the location from which partners, officers, or managers direct or control the business.

2. Offers are not limited to in-state residents. This provision allows Rule 147 issuers to do general solicitations and advertising without running the risk of losing the exemption.

3. The issuer need not be incorporated in the state in which it is making sales as long as the issuer is a resident of that state. The requirement now is that the state be the principal place of business for the issuer and have one other

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638 part 4 Business Management and Governance E

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Chapter 18 Governance and Regulation: Securities Law 639

connection to that state, such as incorporation there or registration as an out- of-state entity in that state.

4. The issuer must register the securities in the state in which it is selling those securities and comply with any state registration requirements or qualify for an exemption

5. There is a $5 million limitation of the amount of the issue (in any 12-month period).

6. The issuer must meet any one of the following 80% requirements: • Eighty percent of its assets must be located in the state. • Eighty percent of its income must be earned from operations within the

state. • Eighty percent of the proceeds from the sale must be used on operations

within the state. • OR the issuer has the majority of its employees located in the state

Under the SEC’s Rule 147, some restrictions apply to the transfer of exempt intrastate offerings, including a nine-month transfer restriction to state residents only.

Small-Offering Exemption: Regulation A. Although it is not a true exemption, Regulation A is a shortcut method of registration. The lengthy, complicated pro- cesses of full registration are simplified in that only a short-form registration state- ment is filed, a sort of fill-in-the-blanks application. Regulation A applies to issues of $5 million or less during any 12-month period. Under the Jump Start Our Busi- ness Startups Act (JOBS), the amount can go up to $50,000,000 if the offering com- pany has audited financial statements. There are Tier 1 Regulation A offerings (up to $20,000,000) and Tier 2 Regulation A offerings (up to $50,000,000). Tier 2 offerings include investment limitations for non-accredited investors, audited financial statements, and the filing of financial reports after the offering. Tier 1 offerings must be registered with the states, but Tier 2 offerings need not. However, Tier 2 offerings are still subject to state fees and fraud enforcement laws and processes. Both Tier 1 and Tier 2 offerings have restrictions on the individuals running the companies offering the shares, the so-called “bad-actor provisions.” Those seeking Regulation A registration cannot have been involved in previous securities fraud cases.

Regulation A securities are not subject to transfer restrictions and can be offered publicly even with general advertising. In fact, Regulation A allows offerors to “test the waters” prior to filing with the SEC to see if there will be a market for the shares, something that can be done without a regulatory filing.

The SEC groups or “integrates” registration. An offerer cannot qualify for this exemption if three smaller issues less than the maximum amount are issued within one 12-month period. They would qualify, however, if three smaller amounts were issued over three years. JOBS preempts state blue sky laws for Regulation A offer- ings if the securities offered are listed on a national exchange or are sold only to “qualified investors,” something the SEC defines as “accredited investor.” (See the discussion below.)

Small-Offering Exemption: Regulation D. Regulation D creates a three-tiered exemp- tion structure that consists of Rules 504, 505, and 506, which permit sales without registration. Sellers are, however, required to file a Form D informational statement

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640 part 4 Business Management and Governance

about the sale. Rule 501 of Regulation D lists the definitions of various terms used in the three exemptions. One of the key definitions under Regulation D is that of an accredited investor, a term that was changed significantly by the Dodd–Frank Wall Street Reform and Consumer Financial Protection Act because so many small investors lost their investments in the 2008 subprime derivative markets.2 Under these changes, an accredited investor is any investor who at the time of the sale falls into any of the following categories:

• Banks, insurance companies, registered investment companies, business development companies, or small business investment companies

• Trusts with assets in excess of $5,000,000 • Any entity in which all investors are accredited investors • ERISA (see Chapter 19) employee benefit plan if the plan has a bank, insur-

ance company, or registered investment adviser making investment decisions or if the plan has total assets greater than $5 million

• Charitable organizations, corporations, or partnerships with greater than $5 million in assets

• Directors, executive officers, or general partners of the company selling the securities

• Individuals with net worth, or joint net worth with spouse, that exceeds $1 million at the time of the purchase, excluding the value of the primary residence of such person

• A natural person with income exceeding $200,000 in each of the two most recent years or joint income with a spouse exceeding $300,000 for those years and a reasonable expectation of the same income level in the current year

• Under JOBS, certain types of offerings under Regulation D provide accredited status for investors with net worth or income of $100,000 to invest up to 5% (maximum $2,000) and those worth or earning more than $100,000 to invest up to 10% (maximum of $100,000)

• A trust with assets in excess of $5 million, not formed to acquire the securities offered, whose purchases a sophisticated person makes

Rule 502 originally placed a number of limitations on the means an issuer could use in offering securities. JOBS allows general advertising and the use of Internet funding pools, if those pools are registered. This general access and the expansion of qualified investors has allowed what has been called “crowd funding,” which is intended to allow small businesses easier and less expensive access to all types of investors. All of the securities sold through Regulation D exemptions are still subject to restrictions on resale in order to prevent the immediate rollover of the securities involved in these exempt transactions.

The three tiers of Regulation D exemptions are as follows:

• The Rule 504 exemption applies to offerings of $1 million or less (within any 12-month period). Sales of stock to directors, officers, and employees are not counted in the $1 million limitation. The Rule 504 exemption applies in offer- ings of up to $2 million, provided the offering is registered under a state blue- sky law. Under JOBS, audits for offerings over $500,000 and financial reviews for offerings between $100,000 and $500,000 are required.

• The Rule 505 exemption covers sales of up to $5 million, provided no more than 35 nonaccredited investors are involved, with JOBS expanding the definition of

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Chapter 18 Governance and Regulation: Securities Law 641

an accredited investor. Again, with state registration, it is possible to take a Rule 505 exemption up to $7.5 million. Also, if the issue is sold to both accredited and nonaccredited investors, the issuer must give all buyers a prospectus.

• The Rule 506 exemption has no dollar limitation, but the number and type of investors are limited. Any number of accredited investors is allowed, but the number of nonaccredited investors is limited to 35, and these investors must meet the standards as discussed under the JOBS changes. Under a Rule 506 exemption, the resale of the shares is also subject to some restrictions.

Under Dodd–Frank, the private placement market under Regulation D pre- vents so-called bad actors from making private placement offerings. Bad actors are those who have a history of failed offerings and investor litigation. These types of offerors would be required to go through the supervised registration process.3

Crowdfunding under JOBS. The crowd-funding exemption was also a part of the JOBS Act that was created to allow entrepreneurs and small businesses to use the Internet to raise capital. Under this exemption, the offeror can raise up to $1,000,000 in any 12-month period if the following requirements are met:

• All investors must purchase through a funding portal that is registered with the SEC and FINRA (a private regulatory body—Financial Industry Regula- tory Authority)

• All investors must be given general information on the risk of investments generally and investments in start-ups

• The funding portal or broker must do background checks (due diligence) on the offeror’s owners, directors, and 20% shareholders

• There must be an escrow arrangement for receiving the money • Investors are limited in total amount of their investment to the greater of 5%

of their annual income or net worth if either of these is $100,000 or less • Investors are limited in total amount of their investment to the greater of 10%

of their annual income or net worth if either of these is $100,000 or more • Disclosure requirements as follows:

o Tax return if the offeror is raising $100,000 or less o Review of —nancial statements by an accountant if the offering is between

$100,000 and $500,000 o Audited —nancials if the offering is between $500,000 and $1,000,000

State securities laws are preempted by the federal crowd-funding exemp- tion. In other words, states cannot stop the sales of securities qualified under this exemption because the nature of the Internet makes this exemption a subject of interstate controls. However, 29 states have passed some form of intrastate crowd-funding regulation that would allow issu- ers to raise smaller amounts of money without full state registration.

Under the federal rules, there are some drawbacks to crowdfunding. For example, there is a slight restriction on the way crowdfunding solic- itation is done. Issuers cannot compensate others for providing personal information about potential investors. Also, exemption under the 1933 act is not exemption under the 1934. Once a company reaches a certain size, it will still be required to do 1934 act filings (that registration is discussed below).

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642 part 4 Business Management and Governance

Corporate Reorganizations. If a firm is issuing new shares of stock under a Chapter 11 bankruptcy reorganization supervised by a bankruptcy court, registration is not necessary, provided court approval is obtained for the issue.

18-2d What must Be filed: documents and Information for Registration

If none of the exemptions applies, the offeror of the securities must go through the registration process. (There is more information on the Facebook IPO under the 1934 act registration requirements discussion.) The offeror (issuer) must file a registration statement (S-1) and sample prospectus with the SEC. A prospectus here means the formal document the SEC requires all shareholders to have. However, for purposes of disclosure and misrepresen- tation issues, a prospectus is any ad or written materials the offeror provides or places.

A filing fee is based on the aggregate offering price of the sale. The SEC has 20 business days to act on the filing, after which the registration statement auto- matically becomes effective. The SEC takes some form of action within that time period. The SEC need not actually approve or disapprove the offering within that time limit as long as a comment letter or deficiency letter is issued. A new regis- tration, for a first-time offeror, generally takes about six months to get through the

Ethical Issues

When investment banking firm Goldman Sachs’s representatives appeared before Congress to testify about their failure to disclose to investors that the firm was shorting securities it was selling to its clients (betting that the securities would drop in value), members of the com- mittee asked whether Goldman had an obligation to disclose its position to those investors. All witnesses testified with an unequivocal “No!” because of Rule 506. Rule 506 is a sale to accredited (sophis- ticated) investors, investors who under- stand how markets work, can afford to invest, and/or can afford to have advisers regarding their investments. Goldman maintains that its clients were “qualified accredited” and/or “sophisticated” inves- tors to whom the firm was not required to provide the detailed information that

is mandated for general public offerings. Goldman’s position is that the clients who purchased the instruments had enough knowledge of markets to understand and process the risk and realize that all invest- ment bankers are positioned in the mar- ket according to their theories on risk.

Did Goldman have a fiduciary duty to its investing clients under the regulations? Evaluate Goldman’s position from an ethical perspective—that is, you know Goldman met its legal requirements for disclosure— and now determine whether its conduct in nondisclosure was ethical. Discuss what role Goldman’s conduct may have had in the Dodd–Frank changes to accredited investor definitions and the private place- ment securities market. Be sure to think back on the regulatory cycle from Chapter 2 as you provide your answer. ©

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Chapter 18 Governance and Regulation: Securities Law 643

SEC. The SEC’s guide in reviewing the registration materials is the full-disclosure standard. The SEC does not pass on the merits of the offering or the soundness of the investment; rather, it simply requires that certain information be supplied. The SEC does not verify the accuracy of the information, only that it is on file. The following information is required in the registration statement:

1. A description of what is being offered, why it is offered, how the securities will fit into the business’s existing capital structure, and how the proceeds will be used

2. An audited financial statement 3. A list of corporate assets 4. The nature of the issuer’s business 5. A list of those in management and their shares of ownership in the firm 6. Other relevant and material information, such as pending lawsuits

Before and after the registration statement is filed, the issuer is very much restricted in what can be done to sell the securities. After the registration state- ment is filed, the issuer can run a tombstone ad, as shown in Exhibit 18.2, which simply announces that securities will be sold and who will have information— but clearly indicates that the ad is not an offer. Also, after filing, but before the registration statement becomes effective, the issuer can send out a red-herring prospectus, which has printed in red at the top that the registration is not yet effective. These red herrings are a way to get out information while waiting for SEC approval.

During this interval between filing and the effective date, no sales and no gen- eral advertising are allowed. Activity is limited until the date the registration gets SEC approval and becomes effective. Exhibit 18.3 is a diagram of federal securities registration and exemptions.

The SEC permits firms to complete shelf registrations. Under this process, a firm completes all the registration requirements and is then free to issue the securities any time within a two-year period, generally when market conditions are most favorable. The company’s quarterly and annual filings serve to update the shelf registration. This means of filing was permitted to help corporations raise capital.

18-2e Violations of the 1933 act

Section 11 Violations Section 11 of the 1933 act imposes civil and criminal liability on those who do not comply with the act’s requirements regarding the submission of a registration statement. Section 11 is used when full disclosure has not been made in the regis- tration statement or if any of the information in that registration statement is false. Section 11 is a statutory fraud section that applies to security registrations. The Facebook public offering in 2012 went down in value after material information surfaced that had not been disclosed in the offering materials to all investors. For example, Facebook did not disclose that it had recently adjusted its revenue projec- tions downward. Problems with this offering had a chilling effect on pending and future IPOs in the tech industry.

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Exhibit 18.2 Sample of a tombstone ad

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Chapter 18 Governance and Regulation: Securities Law 645

What Is Required for a Violation? For an investor to recover civilly under Section 11, the following elements must be proved:

1. The investor purchased a security that was required to have a registration statement.

2. The registration statement contained a material misstatement or omission. 3. The investor need not show reliance unless the purchase was made over a

year after the effective date. 4. The investor experienced a loss.

Exhibit 18.3 federal Securities Registration and exemptions

Security

Yes No

Yes No

Exemption Registration

Regulation A Short Form

$5 Million Limit

Corporate Reorganization (Chapter 11 Bankruptcy)

Small Issue Exemptions

Intrastate

Judicial Hearing Regulation D Offerees and Purchaser All Residents

Rule 504 $1 Million

Crowdfunding Issuer Is Resident

Rule 505 $5 Million

No More than 35, Excluding Accredited Purchasers ( JOBS)

Triple 80 (one of) 80% Revenue 80% Assets 80% Use

Rule 506 Unlimited Accredited and 35 Nonaccredited

(Sophisticated) Investors

Role 147 Resale Restrictions

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646 Part 4 Business Management and Governance

Who Is Liable? Liability under Section 11 attaches to all individuals who signed the registra- tion statement—each director and officer of the issuing corporation and every accountant, engineer, appraiser, attorney, geologist, or other expert whose input was used in the preparation of the statement. Underwriters are also included as potential defendants. Experts (such as accountants, engineers, appraisers, and lawyers) are liable only for the information they provided. Directors and officers are jointly and severally liable under Section 11. Under the Dodd–Frank changes, the SEC will be studying whether to expand Section 11 liability to “aiders and abettors”—those who help offerors continue to hold out a deceptive appearance of financial solvency. (See the full discussion of this issue on p. 662.)

Defenses for Section 11 Violations Several defenses are available to defendants. The burden of proof for these defenses rests with Section 11 defendants.

1. Immateriality. Because proving that a material misstatement or omission was made is part of the investor’s case, proving that the statement or omission was immaterial is a valid defense. The standards for what is or is not material are basically the same standards used in contract misrepre- sentation cases.

2. Investor knowledge. If the investor knew of the misstatement or omission and purchased the stock anyway, there is no Section 11 liability. Section 11 defendants can offer proof of knowledge of the investor to establish a defense.

3. Due diligence. The due diligence defense is one that allows defendants (non-issuers) to show that they were acting reasonably in preparing and signing the registration statement. The experts are required to show that they acted within the standards of their profession in preparing their portions of the registration statement. Officers and directors are required to show that they had no reason to suspect or had no knowledge of an omission or misstatement. Their certification of the financial statements included in the registration is required and certification of false financial statements is a crime in and of itself under SOX.

Escott v BarChris Constr. Corp. (Case 18.1) is the leading case on Section 11 lia- bility. It involves a variety of defendants, including an accounting firm and audit partners, and discusses the defense of due diligence. Ironically, although the case is from 1968, it remains the classic example of the type of financial overstatement of a company’s performance that SOX was passed to address.

Penalties for Violations of Section 11 Violations of Section 11 carry maximum penalties of $10,000 and/or five years’ imprisonment. In addition, the SEC has the authority to bring suit seeking an injunction to stop sales based on false or omitted information in the registra- tion statement. Civil penalties for Section 11 violations range from $5,000 to $500,000. Purchasers harmed by the false or omitted statements have a right of civil suit in federal district court for recovery of their losses and other damages.

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Chapter 18 Governance and Regulation: Securities Law 647

Escott v. BarChris Constr. Corp. 283 F. Supp. 643 (S.D.N.Y. 1968)

Bowling for Fraud: Right Up Our Alley

Case 18.1

faCtS

BarChris was a bowling alley company established in 1946. The bowling industry grew rapidly when auto- matic pin resetters went on the market in the mid-1950s. BarChris began a program of rapid expansion and in 1960 was responsible for the construction of over 3% of all bowling alleys in the United States. BarChris used two methods of financing the construction of these alleys, both of which substantially drained the company’s cash flow.

In 1959, BarChris sold approximately one-half mil- lion shares of common stock. By 1960, its cash flow pic- ture was still troublesome, and it sold debentures. The debenture issue was registered with the SEC, approved, and sold. In spite of the cash boost from the sale, BarChris was still experiencing financial difficulties and declared bankruptcy in October 1962. The debenture holders were not paid their interest; BarChris defaulted.

The purchasers of the BarChris debentures brought suit under Section 11 of the 1933 act. They claimed that the registration statement filed by BarChris contained false information and failed to disclose certain material information. Their suit, which centered on the audited financial statements prepared by a CPA firm, claimed that the statements were inaccurate and full of omissions. The following chart summarizes the problems with the finan- cial statements submitted with the registration statements. 1. 1960 Earnings (a) Sales Per prospectus $9,165,320 Correct ¦gure 8,511,420 Overstatement $ 653,900 (b) Net Operating Income Per prospectus $ 1,742,801 Correct ¦gure 1,496,196 Overstatement $ 246,605 (c) Earnings per Share Per prospectus $ 0.75 Correct ¦gure 0.65 Overstatement $ 0.10 2. 1960 Balance Sheet Current Assets Per prospectus $ 4,524,021 Correct ¦gure 3,914,332 Overstatement $ 609,689

3. Contingent Liabilities as of December 31, 1960, on Alternative Method of Financing

Per prospectus $ 750,000 Correct ¦gure 1,125,795 Understatement $ 375,795 Capitol Lanes should have been shown as a direct liability $ 325,000 4. Contingent Liabilities as of April 30, 1961 Per prospectus $ 825,000 Correct ¦gure 1,443,853 Understatement $ 618,853 Capitol Lanes should have been shown as a direct liability $ 314,166 5. Earnings Figures for Quarter Ending March 31,

1961 (a) Sales Per prospectus $ 2,138,455 Correct ¦gure 1,618,645 Overstatement $ 519,810 (b) Gross Pro‰t Per prospectus $ 483,121 Correct ¦gure 252,366 Overstatement $ 230,755 6. Backlog as of March 31, 1961 Per prospectus $ 6,905,000 Correct ¦gure 2,415,000 Overstatement $ 4,490,000 7. Failure to Disclose Of‰cers’ Loans Outstanding and

Unpaid on May 16, 1961 $ 386,615 8. Failure to Disclose Use of Proceeds in Manner Not

Revealed in Prospectus: Approx $ 1,160,000 9. Failure to Disclose Customers’ Delinquencies in May

1961 and BarChris’s Potential Liability with Respect Thereto:

Over $ 1,350,000 10. Failure to Disclose the Fact That BarChris Was

Already Engaged and Was About to Be More Heavily Engaged in the Operation of Bowling Alleys

The federal district court reviewed all of the exhib- its and statements included in the prospectus and dealt with each defendant individually in issuing its decisions. The defendants consisted of those officers

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continued

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648 part 4 Business Management and Governance

and directors who signed the registration statement, the underwriters of the debenture offering, the audi- tors (Peat, Marwick, Mitchell & Co.4), and BarChris’s attorneys and directors.

JUdICIaL OpINION

McLEAN, District Judge Russo. Russo was, to all intents and purposes, the chief executive officer of BarChris. He was a member of the executive committee. He was familiar with all aspects of the business. He was personally in charge of dealings with the factors. He acted on BarChris’s behalf in mak- ing the financing agreement with Talcott and he handled the negotiations with Talcott in the spring of 1961. He talked with customers about their delinquencies.

Russo prepared the list of jobs which went into the backlog figure. He knew the status of those jobs.

It was Russo who arranged for the temporary increase in BarChris’s cash in banks on December 31, 1960, a transaction which borders on the fraudulent. He was thoroughly aware of BarChris’s stringent financial condition in May 1961. He had personally advanced large sums to BarChris of which $175,000 remained unpaid as of May 16.

In short, Russo knew all the relevant facts. He could not have believed that there were no untrue statements or material omissions in the prospectus. Russo has no due diligence defenses.

Vitolo and Pugliese. They were the founders of the business who stuck with it to the end. Vitolo was pres- ident and Pugliese was vice president. Despite their titles, their field of responsibility in the administration of BarChris’s affairs during the period in question seems to have been less all-embracing than Russo’s. Pugliese in particular appears to have limited his activ- ities to supervising the actual construction work. Vitolo and Pugliese are each men of limited education. It is not hard to believe that for them the prospectus was difficult reading, if indeed they read it at all.

But whether it was or not is irrelevant. The liability of a director who signs a registration statement does not depend upon whether or not he read it or, if he did, whether or not he understood what he was reading.

And in any case, Vitolo and Pugliese were not as naive as they claim to be. They were members of BarChris’s executive committee. At meetings of that committee BarChris’s affairs were discussed at length. They must have known what was going on. Certainly they knew of the inadequacy of cash in 1961. They knew of their own large advances to the company which remained unpaid. They knew that they had agreed not to deposit their checks until the financing proceeds were received. They knew and intended that part of the pro- ceeds were to be used to pay their own loans.

All in all, the position of Vitolo and Pugliese is not significantly different, for present purposes, from Russo’s. They could not have believed that the regis- tration statement was wholly true and that no material facts had been omitted. And in any case, there is nothing to show that they made any investigation of anything which they may not have known about or understood. They have not proved their due diligence defenses.

Kircher. Kircher was treasurer of BarChris and its chief financial officer. He is a certified public accountant and an intelligent man. He was thoroughly familiar with BarChris’s financial affairs. He knew the terms of BarChris’s agreements with Talcott. He knew of the cus- tomers’ delinquency problems. He participated actively with Russo in May 1961 in the successful effort to hold Talcott off until the financing proceeds came in. He knew how the financing proceeds were to be applied and he saw to it that they were so applied. He arranged the officers’ loans and he knew all the facts concerning them.

Moreover, as a member of the executive committee, Kircher was kept informed as to those branches of the business of which he did not have direct charge. He knew about the operation of alleys, present and pro- spective. In brief, Kircher knew all the relevant facts.

Knowing the facts, Kircher had reason to believe that the expertised portion of the prospectus, i.e., the 1960 figures, was in part incorrect. He could not shut his eyes to the facts and rely on Peat, Marwick for that portion.

As to the rest of the prospectus, knowing the facts, he did not have a reasonable ground to believe it to be true. On the contrary, he must have known that in part it was untrue. Under these circumstances, he was not entitled to sit back and place the blame on the lawyers for not advising him about it. Kircher has not proved his due diligence defenses.

Trilling. Trilling’s position is somewhat different from Kircher’s. He was BarChris’s controller. He signed the registration statement in that capacity, although he was not a director.

Trilling entered BarChris’s employ in October 1960. He was Kircher’s subordinate. When Kircher asked him for information, he furnished it. On at least one occasion he got it wrong.

Trilling may well have been unaware of several of the inaccuracies in the prospectus. But he must have known of some of them. As a financial officer, he was familiar with BarChris’s finances and with its books of account. He knew that part of the cash on deposit on December 31, 1960, had been procured temporarily by Russo for window dressing purposes. He should have known, although perhaps through carelessness he did not know at the time, that BarChris’s contingent liability was greater than the prospectus stated. In the

continued

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Chapter 18 Governance and Regulation: Securities Law 649

light of these facts, I cannot find that Trilling believed the entire prospectus to be true.

But even if he did, he still did not establish his due diligence defenses. He did not prove that as to the parts of the prospectus expertised by Peat, Marwick he had no rea- sonable ground to believe that it was untrue. He also failed to prove, as to the parts of the prospectus not expertised by Peat, Marwick, that he made a reasonable investigation which afforded him a reasonable ground to believe that it was true. As far as appears, he made no investigation. As a signer, he could not avoid responsibility by leaving it up to others to make it accurate. Trilling did not sustain the burden of proving his due diligence defenses.

Birnbaum. Birnbaum was a young lawyer, admitted to the bar in 1957, who, after brief periods of employ- ment by two different law firms and an equally brief period of practicing in his own firm, was employed by BarChris as house counsel and assistant secretary in October 1960. Unfortunately for him, he became sec- retary and director of BarChris on April 17, 1961, after the first version of the registration statement had been filed with the Securities and Exchange Commission. He signed the later amendments, thereby becoming respon- sible for the accuracy of the prospectus in its final form.

It seems probable that Birnbaum did not know of many of the inaccuracies in the prospectus. He must, however, have appreciated some of them. In any case, he made no investigation and relied on the others to get it right. Unlike Trilling, he was entitled to rely upon Peat, Marwick for the 1960 figures, for as far as appears, he had no personal knowledge of the company’s books of account or financial transactions. As a lawyer, he should have known his obligations under the statute. He should have known that he was required to make a reasonable investigation of the truth of all the statements in the unexpertised portion of the document which he signed. Having failed to make such an investigation, he did not have reasonable ground to believe that all these state- ments were true. Birnbaum has not established his due diligence defenses except as to the audited 1960 exhibits.

Auslander. Auslander was an “outside” director, i.e., one who was not an officer of BarChris. He was chairman of the board of Valley Stream National Bank in Valley Stream, Long Island. In February 1961 Vitolo asked him to become a director of BarChris. As an inducement, Vitolo said that when BarChris received the proceeds of a forthcoming issue of securities, it would deposit $1 million in Auslander’s bank.

Auslander was elected a director on April 17, 1961. The registration statement in its original form had already been filed, of course without his signature. On May 10, 1961, he signed a signature page for the first amendment to the registration statement which was filed on May 11, 1961. This was a separate sheet without any

document attached. Auslander did not know that it was a signature page for a registration statement. He vaguely understood that it was something “for the SEC.”

Auslander attended a meeting of BarChris’s direc- tors on May 15, 1961. At that meeting he, along with the other directors, signed the signature sheet for the second amendment which constituted the registration statement in its final form. Again, this was only a sepa- rate sheet without any document attached.

Auslander never saw a copy of the registration state- ment in its final form. It is true that Auslander became a director on the eve of the financing. He had little oppor- tunity to familiarize himself with the company’s affairs.

Section 11 imposes liability in the first instance upon a director, no matter how new he is.

Peat, Marwick. Peat, Marwick’s work was in general charge of a member of the firm, Cummings, and more immediately in charge of Peat, Marwick’s manager, Logan. Most of the actual work was performed by a senior accountant, Berardi, who had junior assistants, one of whom was Kennedy.

Berardi was then about thirty years old. He was not yet a CPA. He had had no previous experience with the bowling industry. This was his first job as a senior accountant. He could hardly have been given a more difficult assignment.

After obtaining a little background information on BarChris by talking to Logan and reviewing Peat, Marwick’s work papers on its 1959 audit, Berardi exam- ined the results of test checks of BarChris’s accounting procedures which one of the junior accountants had made, and he prepared an “internal control question- naire” and an “audit program.” Thereafter, for a few days subsequent to December 30, 1960, he inspected BarChris’s inventories and examined certain alley construction. Finally, on January 13, 1961, he began his auditing work which he carried on substantially con- tinuously until it was completed on February 24, 1961. Toward the close of the work, Logan reviewed it and made various comments and suggestions to Berardi.

It is unnecessary to recount everything that Berardi did in the course of the audit. We are concerned only with the evidence relating to what Berardi did or did not do with respect to those items found to have been incor- rectly reported in the 1960 figures in the prospectus.

Accountants should not be held to a standard higher than that recognized in their profession. I do not do so here. Berardi’s review did not come up to that standard. He did not take some of the steps which Peat, Marwick’s written program prescribed. He did not spend an adequate amount of time on a task of this magnitude. Most important of all, he was too easily satisfied with glib answers to his inquiries.

continued

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650 part 4 Business Management and Governance

This is not to say that he should have made a com- plete audit. But there were enough danger signals in the materials which he did examine to require some further investigation on his part. Generally accepted accounting standards required such further investiga- tion under these circumstances. It is not always suffi- cient merely to ask questions.

CaSe QUeStIONS

1. How much time transpired between the sale of the debentures and BarChris’s bankruptcy?

2. Give a summary of the types of items that were materially misstated.

3. Who was sued under Section 11? Who was held liable?

The Private Securities Litigation Reform Act of 1995 (PSLRA) limits attorneys’ fees to a reasonable percentage of the amount recovered or the agreed-upon set- tlement amount. The problem of “professional plaintiffs” was also addressed through a section in the PSLRA that prevents a plaintiff from being named in more than five class action securities lawsuits in a three-year period.

One final portion of PSLRA is the so-called safe-harbor protection. With certain precautions and qualifications, companies can make forward-looking predictions for company performance in materials given to investors. The company is not held to these statements about its future as long as it makes the required SEC disclo- sures on forward-looking statements.

Section 12 Violations Section 12 carries the same criminal penalties as Section 11 and covers the follow- ing offenses:

1. Selling securities without registration and without an exemption 2. Selling securities before the effective date of the registration statement 3. Selling securities using false information in the prospectus (In this case,

“prospectus” includes not only the formal document but also all ads, circulars, and so on used in the sale of securities.)

The SEC also has injunctive remedies here, and buyers also have the right of civil suit. The same defenses that apply to Section 11 apply to Section 12.

For The Manager’s Desk

Re: a primer on Sarbanes–Oxley and dodd–frank

SOX and Dodd–Frank made fundamental changes in accounting, auditing, financial reporting, and corporate governance. The new portions of the law appear at 15 U.S.C. § 7201. However, because many of the provi- sions amend the Securities Exchange Act of 1934, which begins at 78 U.S.C. § 1 et seq., many of the provisions can be found there.

Part I: The Creation of the Public Company Accounting Oversight Board

This section of SOX established a quasi gov- ernment entity called the Public Company Accounting Oversight Board (PCAOB, but called “Peek-a-Boo”) under the direction of the SEC to (1) oversee the audit of public com- panies covered by the federal securities laws

(Continued)

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Chapter 18 Governance and Regulation: Securities Law 651

(the 1933 and 1934 acts), (2) establish audit report standards and rules, and (3) investi- gate, inspect, and enforce compliance through both the registration and regulation of public accounting firms.

Under this section of SOX, companies that conduct audits of companies covered under federal securities laws must register with PCAOB. With this registration control, PCAOB is given the power to discipline public accounting firms, including the ability to impose sanctions such as prohibitions on conducting future audits. PCAOB’s powers related to intentional conduct or repeated negligent conduct by audit firms when they are doing company audits and financial certifications. PCAOB’s power to regulate was upheld in Free Enterprise Fund v. Public Company Accounting Oversight Board, 561 U.S. 477 (2010). Under the Dodd–Frank changes, PCAOB will also have authority to regulate the auditors of broker/dealer firms. From 2005 to 2016, PCAOB has settled 135 disciplinary actions and adjudicated 15 against audit firms for problems in their audits of their clients

The SEC is now responsible for deter- mining what are or are not “generally accepted” accounting principles for purpos- es of complying with securities laws.

Part II: Auditor Independence

This portion of SOX is a bit of a statutory code of ethics for public accounting firms. Accounting firms that audit publicly traded companies cannot also perform the follow- ing consulting services for the companies for which they conduct audits:

1. Bookkeeping and other services related to the accounting records or financial statements of the audit client

2. Design and implementation of financial information systems

3. Appraisal and valuation services, fair- ness opinions, and contribution-in-kind reports

4. Actuarial services

5. Internal audit outsourcing services

6. Management functions and human resources

7. Broker or dealer, investment adviser, and investment banking services

8. Legal services and expert services unrelated to the audit

Another conflicts prohibition is that the audit firm cannot audit, for one year, a com- pany that has one of its former employees as a member of senior management. For example, if a partner from PwC is hired by Xena Corporation as its controller or CFO, PwC cannot be the auditor (for SEC purpos- es) for Xena for one year. At least one year must elapse between the hire date of the former partner and the start of the audit if PwC is to conduct the audit.

Procedural requirements in this section include rotating the audit partner for the accounting firm every five years. Also, the auditor must report directly to the audit committee of the company.

Part III: Corporate Responsibility

This section of SOX deals with the audit committees of publicly traded companies and makes these committees responsible for the hiring, compensation, and oversight of the public accounting firm responsible for conducting the company’s audits and certify- ing its financial statements. All members of the audit committee must be members of the company’s board of directors, and must be independent. Independent is defined by the SEC to require that the director be an outside board member (not an officer), not have been an officer for a period of time (if retired from the company), not have close relatives working in management in the com- pany, and not have contractual or consulting ties to the company. The SEC and companies have developed complex checklists to help directors determine whether they meet the standards for independence for purposes of qualifying for audit committee membership.

In addition to these structural changes in audit committees, this portion of SOX is also the officer certification section (more related to the 1934 Securities Exchange Act covered on p. 646). The company’s CEO and CFO are required to certify the financial statements the company files with the SEC as being fair in their representation of the compa- ny’s financial condition and accurate “in all

(Continued)

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652 part 4 Business Management and Governance

(Continued) material respects.” CFOs and CEOs forfeit any bonuses and compensation that were received based on financial reports that sub- sequently had to be restated because they were not materially accurate or fair in their disclosures.

The SEC is given the authority to ban those who violate securities laws from serving as an officer or director of a publicly traded company if the SEC can prove that they are unfit to serve. The standard under the statute is “substantial unfitness.” For example, Al Dunlap, the former CEO of Sun- beam, settled SEC charges that he oversaw an accounting fraud on its barbecue sales program by a fine and agreeing to never serve as an officer or director of a publicly traded company.

One final section in Part III regulates the stock sales of officers at publicly traded companies.

During the so-called blackout periods on pension plans, those times when owners of the plans cannot trade in the company stock, officers of the company are also subject to the blackout periods. The pen- alty for violating this prohibition on stock dealing is that the officers must return any profits from blackout period trading to the company. This requirement to return the profits exists even when the trading was not intentional.

Part IV: Enhanced Financial Disclosures

This section of SOX is the accounting sec- tion. Congress directed the SEC to do something about accounting practices for off–balance sheet transactions, including special purpose entities and relationships that while immaterial in amount may have a material effect upon the financial status of the company. For example, a spin-off com- pany that concealed $2 million in company debt is not a material amount. But if the spin-off company is involved in leveraged transactions and the company has agreed to serve as a guarantor to investors in the spin-off for those leveraged amounts, then the spin-off can have a material effect. The SEC changed the rules for off–balance sheet transactions quite substantially to require companies to show the economics of such off–balance sheet transactions in a

transparent fashion. Lehman Brothers’ 2008 bankruptcy revealed another debt spin-off strategy that company used to hide its obli- gations, and those types of spin-offs now must also be disclosed.

A second portion of Part IV gets right to the heart of pro forma and EBITDA. Compa- nies must use Generally Accepted Account- ing Principles (GAAP) and non-GAAP, side by side.

A third segment of Part IV deals again with officers. Corporations can no longer make personal loans to corporate exec- utives. The only exception is when the company is in the business of making loans—that is, GE executives are permitted to use GE Capital as long as they have the same types of loans that are available to the general public.

Another officer requirement shortens the time for them to disclose transactions in the company’s shares. Prior to SOX, exec- utives simply had to disclose transactions within 10 days from the end of the month in which the transactions occurred. The disclo- sure period now is within two business days of the transaction.

As a result of the activities that led to these statutory revisions, SOX also requires companies to develop a separate code of ethics for senior financial officers, one that applies to the principal financial offi- cer, comptroller, and/or principal accounting officer. These codes of ethics deal with the specifics of financial reporting.

Internal Controls Certification: SOX 404

Referred to fondly now as just “404,” a final portion of SOX requires companies to include an internal control report and assessment as part of the 10-K annual reports. A public accounting firm that issues the audit report must also certify and report on the state of the company’s internal controls.

Although the audit committee provisions are covered in a different section, Part IV does mandate that every audit committee have at least one member who is a financial expert. The SEC established rules for who qualifies as a financial expert and compa- nies’ annual reports identify the financial expert and give the background.

(Continued)

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Chapter 18 Governance and Regulation: Securities Law 653

Under JOBS, certain types of companies (the EGCs discussed later in the chapter) were given an additional three years for phas- ing in 404 requirements (SOX gives compa- nies two years from their IPOs), which gives them a total of five years following their IPOs to meet SOX standards.

Title V: Analyst Conflicts of Interest

Analysts and their conflicts contributed to the problems of the turn-of-the-century dot-com and other company unforeseen collapses as well as the evaporation of the mortgage and mortgage securities market in 2008. The SEC now regulates the following:

1. Prepublication clearance or approval of research reports by investment bankers

2. Supervision, compensation, and eval- uation of securities analysts by invest- ment bankers

3. Retaliation against a securities analyst by an investment banker because of an unfavorable research report that may adversely affect an investment banker’s relationship or a broker’s or dealer’s relationship with the company that is discussed in the report

4. Separating securities analysts from pressure or oversight by investment bankers in a way that might potentially create bias

5. Developing rules on disclosure by securities analysts and broker/dealers of specified conflicts of interest

Under Dodd–Frank, the SEC continues to study analysts’ relationships and roles in financial markets and is working still on rules related to fiduciary duties of investment advisers and brokers, especially with regard to their own analysts’ research and reports and the obligation to disclose their knowl- edge and information to clients.

Title VIII: Corporate and Criminal Fraud Accountability

This section of SOX expanded and clarified the criminal law portions of securities law

by creating new crimes, increasing penalties on existing crimes, and elaborating on the elements required to prove already existing crimes. Also known as the Corporate and Criminal Fraud Accountability Act of 2002, most of this SOX section was covered in Chapter 8.

This section amended federal bankruptcy law to make fines, profits, and penalties that result from violation of federal securities laws a nondischargeable debt in bankruptcy. Also, if common law fraud is involved in the sale of securities, any judgment owed as a result of the fraud is also a nondischargeable bankruptcy debt.

This section also extended the time for bringing a civil law suit for securities fraud to not later than the earlier of (1) five years after the date of the alleged violation or (2) two years after its discovery.

Finally, this section prohibits retaliation against employees in publicly traded com- panies who assist in an investigation of pos- sible federal violations or file or participate in a shareholder suit for fraud against the company (see Chapter 17). The protections for whistle-blowers are expanded under Dodd–Frank to provide for their recovery of 10% to 30% of any fines the company must pay.

Title IX: White-Collar Criminal Penalty Enhancements

Most of this section was covered in Chap- ter 8, but it also contains some remarkable grants of authority to the SEC. For example, this section gives the SEC the authority to freeze bonus, incentive, and other payoffs to corporate officers during an ongoing inves- tigation. The SEC has the authority to ban- ish violating officers and directors from the securities markets as well as from working at a publicly traded company in the future. Auditors must keep their work papers for five years, and the penalties for destruction of documents were increased.

Source: Adapted and updated from Marianne Jennings, Business Ethics: Case Studies and Selected Readings, 8th ed., 2014.

(Continued)

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18-3 The Securities Exchange Act of 1934 The Securities Exchange Act of 1934 regulates securities and their issuers once they are on the market. Securities sales, brokers, dealers, and exchanges are all regulated under the 1934 act. In addition, the act requires public disclosure of financial infor- mation for certain corporations. In effect, the 1934 act is responsible for the regulation of the securities marketplace. The SEC accomplishes its goal of regulating undesir- able market practices in several ways, which are discussed in the following sections.

18-3a Securities Registration

Under the 1934 act, all securities traded on a national stock exchange must be registered. Originally, any issuer with over $10 million in assets and 500 or more shareholders was required to register its equity stock (not bonds) if those shares are traded in interstate commerce. However, the Facebook experience changed this requirement. Facebook was approaching the limit of having 500 sharehold- ers because so many of its employees were shareholders. While the company was not ready to do an IPO, it went ahead with one because of the shareholder lim- itation. Under the Private Company Flexibility and Growth Act, the shareholder maximum was raised to 2,000 shareholders in total, or 500 persons who are not accredited investors. Those who are investors through employee compensation systems or investors who purchased through crowd-funding offerings are also not included in the count. This 1934 act information registration is in addition to all the filing requirements for issuing securities that were discussed under the 1933 act.

18-3b emerging Growth Companies (eGCs) and 1934 act exemption

The JOBS Act has given companies, called emerging growth companies (ECGs), that have just finished their IPOs to have a grace period before the 1934 act reporting requirements apply. To qualify for this delay in the reporting require- ments, an EGC is defined under JOBS as follows:

• Less than $1 billion in annual gross revenues • Publicly traded for less than five years • A public offering of $700 million or less • Have not issued $1 billion in debt in the immediate past three years

If the company qualifies as an EGC, then the reporting requirements are post- poned until the five-year anniversary of its IPO or until it loses any of the ECG requirements (whichever comes first).

AN EGC has another benefit that precedes its IPO. An EGC has a right to a confidential review by the SEC of its IPO materials. The purpose of this part of the legislation was to prevent the stalled IPOs that resulted when the filing was dis- closed and the companies, trying to raise funds, were stigmatized by an SEC delay. A delay may not be indicative of the financial success or stability of the company, but the delay had the psychological impact of affecting the IPO.

18-3c periodic filing Under the 1934 act: those alphabet Reports

In addition to the one-time registration required under the 1934 act, those same companies (national stock exchange companies that meet the 500/2,000

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shareholder requirements and $10 million in assets) must comply with the periodic reporting requirements imposed by the SEC. Each quarter, these firms must file a 10-Q form, which is basically a quarterly financial report. An annual report, the 10-K form, must be filed by the company at the end of its fiscal year. Any unusual events—bankruptcies, spin-offs, takeovers, and other changes in company control—must be reported on the 8-K form. The 10-Qs and 10-Ks are the reports the CEO and CFO must certify under SOX. The certification means the CEO and CFO offer the following assurances:

• They have reviewed the report. • Based on their knowledge, the report contains no untrue statements, has no

omissions of fact, and includes nothing misleading. • Based on their knowledge, the financial statements included with the peri-

odic reports fairly present all material aspects of the company’s financial performance.

• They are responsible for establishing, maintaining, and certifying internal controls for the financial operations and reporting of the company.

The increased penalties for the certifying officers run up to 20 years and $10 million.

18-3d the 1934 act antifraud provision: 10(b)

In addition to regulating the reporting of information, the 1934 act regulates the propriety of sales in the marketplace. Section 10(b) and Rule 10b-5 (the SEC reg- ulation on 10(b)) are the antifraud provisions of the 1934 act. These sections are statutory versions of common law fraud. If the free market is to work, all buyers and sellers must have access to the same information. To withhold information is to commit fraud and is a violation of Section 10(b).

application of Section 10(b) Of all the provisions of the 1934 act, Section 10(b) has the broadest application. It applies to all sales of securities: exempt, stock-exchange-listed, over-the-counter, public, private, small, and large. The only prerequisite for 10(b) application is that interstate commerce be involved in the sales transaction. As Chapter 5 indicates, it is not difficult to find an interstate commerce connection; for example, if mail or phones were used in the transaction, 10(b) applies. The practical effect is that 10(b) applies to all sales of securities.

proof of Section 10(b) Violation: Corporations Running afoul The corporate dissemination violation of 10(b) means that a corporation has not been forthcoming with material information, whether positive or negative, about the company, its performance, and its future. In 2000, the SEC promulgated the “fair-disclosure rule” (Regulation FD); now, material information about the com- pany must be made available to everyone at the same time. The Dodd–Frank legis- lation requires the SEC to perform several additional studies to examine the issues in disclosure, analysts’ reports, and conflicts between and among underwriters and offerors.

The application and enforcement of Section 10(b) have become two of the most significant issues affecting Wall Street. Under SOX, as noted in the Primer, sales of shares by officers now require immediate reporting on 8-K forms. The previous standard of reporting by the close of the month in which the transactions occur has been changed to a two-day period.

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Corporations have an obligation to disclose material information. To determine whether an item is material, the question to be answered is, “Is this the type of information that would affect the buying or selling decision?” Examples of items that have been held to be material are the following:

1. Pending takeovers 2. Drops in quarterly earnings 3. Pending declaration of a large dividend 4. Possible lawsuit on product line

Siracusano v Matrixx Initiatives, Inc. (Case 18.2) deals with an issue of the failure of a corporation to make a material disclosure in a timely manner.

Siracusano v. Matrixx Initiatives, Inc. 563 U.S. 27 (2011)

Missing Disclosures by a Nose

Case 18.2

faCtS

Matrixx Initiatives, Inc., is a pharmaceutical company that sells Zicam through its wholly owned subsidiary, Zicam, LLC. One of its products, responsible for 70% of its sales, is Zicam Cold Remedy, a homeopathic product marketed as stopping or minimizing cold symptoms.

In December 1999, Matrixx began to receive ques- tions from physicians whose patients were developing anosmia (loss of the sense of smell). Researchers at medical facilities contacted Matrixx in 2002 to offer access to studies showing that zinc sulfate (present in Zicam) was linked to anosmia.

During this time, Matrixx’s public disclosures did not discuss these inquiries and studies. In fact, on Octo- ber 22, 2003, Matrixx issued an optimistic press release announcing that its net sales for the third quarter of 2003 had increased by 163% over the third quarter of 2002.

On an October 23, 2003, earnings conference call, executives for Matrixx expressed their “enthusiasm for the most recently completed quarter” and “opti- mis[m] about the future.” At one point during the call, Zicam executives were asked to “make any comment on the litigation MTXX or its officers are involved in, or whether or not there is any SEC [Securities and Exchange Commission] investigation.” They replied that “[t]he officers of this company are not involved in any litigation,” and that they were not aware of any

SEC investigation. In fact, a lawsuit alleging that Zicam caused anosmia had already been filed at this time.

By January 30, 2004, the FDA was “looking into complaints that an over-the-counter common-cold medicine manufactured by a unit of Matrixx Initiatives Inc. may be causing some users to lose their sense of smell.” Matrixx’s stock declined after this report, “fall- ing from $13.55 per share on January 30, 2004, to $11.97 per share on February 2, 2004.”

NECA-IBEW Pension Fund and James Siracusa- no (plaintiffs/appellants) brought a class action suit against Matrixx and three Matrixx executives (appel- lees) alleging a violation of the Securities Exchange Act of 1934 by their failure to disclose material information regarding problems with Zicam. The district court granted Matrixx’s motion to dismiss the complaint. The court of appeals reversed. The shareholders appealed.

JUdICIaL OpINION

Sotomayor, Justice To prevail on a § 10(b) claim, a plaintiff must show

that the defendant made a statement that was “mis- leading as to a material fact.”

Matrixx urges us to adopt a bright-line rule that reports of adverse events associated with a pharma- ceutical company’s products cannot be material absent a sufficient number of such reports to establish a statis- tically significant risk that the product is in fact caus- ing the events. Absent statistical significance, Matrixx

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argues, adverse event reports provide only “anecdotal” evidence that “the user of a drug experienced an adverse event at some point during or following the use of that drug.” Accordingly, it contends, reasonable investors would not consider such reports relevant unless they are statistically significant because only then do they “reflect a scientifically reliable basis for inferring a potential causal link between product use and the adverse event.”

A lack of statistically significant data does not mean that medical experts have no reliable basis for inferring a causal link between a drug and adverse events. As Matrixx itself concedes, medical experts rely on other evidence to establish an inference of causation.

The FDA similarly does not limit the evidence it considers for purposes of assessing causation and taking regulatory action to statistically significant data. For example, the FDA requires manufacturers of over- the-counter drugs to revise their labeling “to include a warning as soon as there is reasonable evidence of an association of a serious hazard with a drug; a causal relationship need not have been proved.”

This case proves the point. In 2009, the FDA issued a warning letter to Matrixx stating that “[a] significant and growing body of evidence substantiates that the Zicam Cold Remedy intranasal products may pose a serious risk to consumers who use them.” The letter cited as evidence 130 reports of anosmia the FDA had received, the fact that the FDA had received few reports of anosmia associated with other intranasal cold remedies, and “evidence in the published scien- tific literature that various salts of zinc can damage olfactory function in animals and humans.” It did not cite statistically significant data. Given that medical professionals and regulators act on the basis of evi- dence of causation that is not statistically significant, it stands to reason that in certain cases reasonable investors would as well.

The information provided to Matrixx by medi- cal experts revealed a plausible causal relationship between Zicam Cold Remedy and anosmia. Consum- ers likely would have viewed the risk associated with Zicam (possible loss of smell) as substantially out- weighing the benefit of using the product (alleviating cold symptoms), particularly in light of the existence of many alternative products on the market. Viewing the allegations of the complaint as a whole, the com- plaint alleges facts suggesting a significant risk to the commercial viability of Matrixx’s leading product. It is substantially likely that a reasonable investor would have viewed this information “‘as having sig- nificantly altered the “total mix” of information made available.’”

Matrixx elected not to disclose the reports of adverse events not because it believed they were mean- ingless but because it understood their likely effect on the market. “[A] reasonable person” would deem the inference that Matrixx acted with deliberate reckless- ness (or even intent). We conclude, in agreement with the Court of Appeals, that respondents have adequately pleaded [materiality and] scienter.

Affirmed.

CaSe QUeStIONS

1. Based on this decision, if you had been the exec- utives at Matrixx, what would you have dis- closed and when would you have disclosed it?

2. Why is it relevant that consumers would be affect- ed by the studies, whether significant or not?

3. By 2009, the FDA required that Zicam be removed from stores and warned consumers about the risk of losing their sense of smell. What happens to the company as a result? What will be the impact on Matrixx investors? What will their damages be?

Running afoul of 10(b): How Soon Can you trade after Corporate disclosures? One of the questions asked most frequently about 10(b) cases is when trading can take place. One of the most famous corporate (and individual) 10(b) cases is SEC v Texas Gulf Sulphur Co., 401 F.2d 833 (2nd Cir. 1968), a case that provides answers to that question. Texas Gulf Sulphur was involved in test-drilling operations in Canada. Early tests indicated that the company would make a substantial strike. Press releases did not indicate the richness of the strike. Corporate officers, geol- ogists, and relatives bought stock before the richness of the find was finally disclosed, and the price of the stock soared. The court found that the overly pessi- mistic press release was misleading under 10(b). The company and the individual purchasers both ran afoul of 10(b).

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proof of a Violation: How Individuals Run afoul of 10(b) In simplest form, an individual’s 10(b) violation occurs when one side to a secu- rities transaction has information not generally available to the public and the transaction proceeds without disclosure. For example, the factual backdrop in the Galleon Hedge Fund insider trading investigation provides examples of what the SEC believes is inside information. Mr. Raj Rajaratnam, founder and CEO of Galleon, had information furnished to him by a number of individuals who were, in some way, insiders in corporations. For example, Rajat Gupta, a former McKinsey partner, served on the boards of Goldman Sachs and Procter & Gam- ble. Mr. Gupta had a Goldman board conference call for purposes of approving Warren Buffett’s investment in the firm in exchange for Goldman stock, a move that would restore investor confidence in Goldman and increase the price of Gold- man stock. That call ended at 3:55 p.m. Within 35 seconds, Mr. Gupta’s secretary connected him with Mr. Rajaratnam’s direct line. The two spoke for seconds, and Mr. Rajaratnam would then purchase $43 million in Goldman stock. The next day, when Goldman made the Buffett announcement, the value of Goldman shares increased 18% in one day. Simply put, Mr. Gupta was an insider who passed along nonpublic information to a tippee—Mr. Rajaratnam. Neither man knew that their phones had been tapped. Both were charged with insider trading. Mr. Rajaratnam and Mr. Gupta were both convicted of securities fraud.

Ethical Issues

“In my own mind, the line between permi- ssible ‘detective work’ and impermissible insider trading was not always clear, especially with regard to companies broadly covered by the news media as to which there was a wealth of publicly available information, including frequent leaks, rumors and specu- lation about corporate transactions and other important developments.”5

This quote was from Raja Rajaratnam when he was about to be sentenced for his convictions for insider trading.

Is he correct about the use of public information?

Was the information he received from Mr. Gupta public information?

Is the line clear, or is Mr. Rajaratnam correct that he was confused by a gray area?

Prosecutors responded to the statement by saying that the quote reflected a “serious disregard for the law.” Are the prosecutors correct?

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Who Runs afoul: the extent of Section 10(b) Liability Anyone who has access to information not readily available to the public is covered under 10(b). Officers, directors, and large shareholders are included in this group. However, 10(b) also applies to people who get information from these corporate insiders. These people are called tippees. For example, relatives of officers and directors would be considered tippees if they were given nonpublic information.

Who is covered under Section 10(b) has been a critical question during the past few years. In U.S. v. Salman (Case 18.3), a federal court clarified who is a tippee for purposes of insider trading and provides the answer for the opening Consider.

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U.S. v. Salman 792 F.3d 1087 (9th Cir. 2015) cert. granted, 136 S.Ct. 899 (2016).

My Brother—The Keeper of Inside Information

Case 18.3

FACTS

In 2002, Maher Kara joined Citigroup’s health care investment banking group. Over the next few years, Maher began to discuss aspects of his job with his older brother, Mounir (“Michael”) Kara. Maher began to suspect that Michael was trading on the information they discussed, although Michael initially denied it. As time wore on, Michael became more brazen and more persistent in his requests for inside information, and Maher knowingly obliged. From late 2004 through early 2007, Maher regularly disclosed to Michael infor- mation about upcoming mergers and acquisitions of and by Citigroup clients.

In 2003, Maher Kara became engaged to Salman’s sister, Saswan (“Suzie”) Salman. Salman and Michael Kara became fast friends. In the fall of 2004, Michael began to share with Salman the inside information that he had learned from Maher, encouraging Salman to “mirror-imag[e]” his trading activity. Rather than trade through his own brokerage account, however, Salman arranged to deposit money, via a series of transfers through other accounts, into a brokerage account held jointly in the name of his wife’s sister and her hus- band, Karim Bayyouk. Salman then shared the inside information with Bayyouk, and the two split the profits from Bayyouk’s trading. From 2004 to 2007, Bayyouk and Michael Kara executed nearly identical trades in securities issued by Citigroup clients shortly before the announcement of major transactions. As a result of these trades, Salman and Bayyouk’s account grew from $396,000 to approximately $2.1 million.

The government presented evidence that Salman knew full well that Maher Kara was the source of the information. Michael Kara (who pled guilty and testified for the government) testified that, early in the scheme, Salman asked where the information was coming from, and Michael told him, directly, that it came from Maher. Michael further testified about an incident that occurred around the time of Maher and Suzie’s wedding in 2005. According to Michael Kara, on that visit, Michael noticed that there were many papers relating to their stock trading strewn about Sal- man’s office. Michael became angry and admonished Salman that he had to be careful with the information

because it was coming from Maher. Michael testified that Salman agreed that they had to “protect” Maher and promised to shred all of the papers.

Maher and Michael Kara enjoyed a close and mutually beneficial relationship. Michael helped pay for Maher’s college. Maher, for his part, testified that he “love[d] [his] brother very much” and that he gave Michael the inside information in order to “benefit him” and to “fulfill [ ] whatever needs he had.” For example, Maher testified that on one occa- sion, he received a call from Michael asking for a “favor,” requesting “information,” and explaining that he “owe[d] somebody.” After Michael turned down Maher’s offer of money, Maher gave him a tip about an upcoming acquisition instead.

Michael gave a toast at Maher’s wedding, which Salman attended, in which Michael described how he spoke to his younger brother nearly every day and described Maher as his “mentor,” his “private coun- sel,” and “one of the most generous human beings he knows.” Maher, overcome with emotion, began to weep.

The jury found Salman guilty on all five counts of insider trading. Salman appealed.

JUDICIAL OPINION

RAKOFF, Senior District Judge Salman urges us to adopt U.S. v. Newman, 773 F.3d438 (2nd Cir. 2014), cert. denied, 136 S.Ct. 242 (2015) as the law of this Circuit, and contends that, under Newman, the evidence was insufficient to find either that Maher Kara disclosed the information to Michael Kara in exchange for a personal benefit, or, if he did, that Sal- man knew of such benefit.

The “personal benefit” requirement for tippee liability derives from the Supreme Court’s opinion in Dirks v. S.E.C., 463 U.S. 646, 103 S.Ct. 3255, 77 L.Ed.2d 911 (1983). Dirks presented an unusual fact pattern. Ronald Secrist, a whistleblower at a company called Equity Funding, had contacted Raymond Dirks, a well-known securities analyst, after Secrist’s prior dis- closures to the Securities and Exchange Commission (“SEC”) had gone for naught. Secrist, for no other purpose than exposing the Equity Funding fraud,

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disclosed inside information about the company to Dirks, who in turn launched his own investigation that eventually led to public exposure of a massive fraud. However, in the process of his investigation, Dirks openly discussed the information provided by Secrist with various clients and investors, some of whom then sold their Equity Funding stock on the basis of that information. Upon learning this, the SEC charged Dirks with securities fraud, and this position was upheld by an SEC Administrative Law Judge and affirmed by the District of Columbia Circuit, after which certiorari was granted.

When the case came to the Supreme Court, the Court, began by noting that, whistleblowing quite aside, corporate insiders, in the many conversations they typically have with stock analysts, often acciden- tally or mistakenly disclose material information that is not immediately available to the public. Thus, “[i] mposing a duty to disclose or abstain solely because a person knowingly receives material nonpublic infor- mation from an insider and trades on it could have an inhibiting influence on the role of market analysts, which the SEC itself recognizes is necessary to the preservation of a healthy market.” At the same time, the Court continued, “[t]he need for a ban on some tippee trading is clear. Not only are insiders forbidden by their fiduciary relationship from personally using undisclosed corporate information to their advantage, but they may not give such information to an outsider for the same improper purpose of exploiting the infor- mation for their personal gain.”

“Thus, the test is whether the insider personally will benefit, directly or indirectly, from his disclosure,” for in that case the insider is breaching his fiduciary duty to the company’s shareholders not to exploit com- pany information for his personal benefit. And a tippee is equally liable if “the tippee knows or should know that there has been [such] a breach,” i.e., knows of the personal benefit.

The last-quoted holding of Dirks governs this case. Maher’s disclosure of confidential information to Michael, knowing that he intended to trade on it, was precisely the “gift of confidential information to a trading relative” that Dirks envisioned. Indeed, Maher himself testified that, by providing Michael with inside information, he intended to “benefit” his brother and to “fulfill[ ] whatever needs he had.” As to Salman’s knowledge, Michael Kara . . . testified that he directly told Salman that it was Michael’s brother Maher who was, repeatedly, leaking the inside information that Michael then conveyed to Salman. Given the Kara brothers’ close relationship, Salman could readily have inferred Maher’s intent to benefit Michael. Thus, there

can be no question that, under Dirks, the evidence was sufficient for the jury to find that Maher disclosed the information in breach of his fiduciary duties and that Salman knew as much.

Salman argues that the Second Circuit in Newman interpreted Dirks to require more than this. Of course, Newman is not binding on us. . . . But we would not lightly ignore the most recent ruling of our sister circuit in an area of law that it has frequently encountered.

The defendants in Newman, Todd Newman and Anthony Chiasson, both portfolio managers, were charged with trading on material non-public infor- mation regarding two companies, Dell and NVIDIA, obtained by a group of analysts at various hedge funds and investment firms. The information came to them via two distinct tipping chains. The Dell tipping chain originated with Rob Ray, a member of Dell’s investor relations department. Ray tipped information regarding Dell’s earnings numbers to Sandy Goyal, an analyst. Goyal, in turn, relayed the information to Jesse Tortora, another analyst, who relayed it to his manager, Newman, as well as to other analysts includ- ing Spyridon Adondakis, who passed it to Chiasson. Id. The NVIDIA tipping chain began with Chris Choi, of NVIDIA’s finance unit, who tipped inside informa- tion to his acquaintance Hyung Lim, who passed it to Danny Kuo, an analyst, who circulated it to his analyst friends, including Tortora and Adondakis, who in turn gave it to Newman and Chiasson. Having received this information, Newman and Chiasson executed trades in both Dell and NVIDIA stock, generating lavish profits for their respective funds.

The Second Circuit held that this evidence was insufficient to establish that either Ray or Choi received a personal benefit in exchange for the tip. It noted that, although the “personal benefit” standard is “permis- sive,” it “does not suggest that the Government may prove the receipt of a personal benefit by the mere fact of a friendship, particularly of a casual or social nature.” Instead, to the extent that “a personal benefit may be inferred from a personal relationship between the tipper and tippee, . . . such an inference is imper- missible in the absence of proof of a meaningfully close personal relationship that generates an exchange that is objective, consequential, and represents at least a potential gain of a pecuniary or similarly valuable nature.”

Salman reads Newman to hold that evidence of a friendship or familial relationship between tipper and tippee, standing alone, is insufficient to demonstrate that the tipper received a benefit. In particular, he focuses on the language indicating that the exchange of information must include “at least a potential gain

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of a pecuniary or similarly valuable nature,” which he reads as referring to the benefit received by the tipper. Salman argues that because there is no evidence that Maher received any such tangible benefit in exchange for the inside information, or that Salman knew of any such benefit, the Government failed to carry its burden.

To the extent Newman can be read to go so far, we decline to follow it. Doing so would require us to depart from the clear holding of Dirks that the element of breach of fiduciary duty is met where an “insider makes a gift of confidential information to a trading relative or friend.”

In our case, the Government presented direct evidence that the disclosure was intended as a gift of market-sensitive information. Specifically, Maher Kara testified that he disclosed the material nonpublic infor- mation for the purpose of benefitting and providing for his brother Michael. Thus, the evidence that Maher Kara breached his fiduciary duties could not have been more clear, and the fact that the disclosed informa- tion was market-sensitive—and therefore within the reach of the securities laws. If Salman’s theory were accepted and this evidence found to be insufficient,

then a corporate insider or other person in possession of confidential and proprietary information would be free to disclose that information to her relatives, and they would be free to trade on it, provided only that she asked for no tangible compensation in return. Proof that the insider disclosed material nonpublic infor- mation with the intent to benefit a trading relative or friend is sufficient to establish the breach of fiduciary duty element of insider trading.

[W]e find that the evidence was more than suf- ficient for a rational jury to find both that the inside information was disclosed in breach of a fiduciary duty, and that Salman knew of that breach at the time he traded on it.

Affirmed.

CaSe QUeStIONS

1. Explain the differences between and among the Dirks, Newman, and Salman cases.

2. List the elements the court requires for proof of insider trading.

3. What should those who have inside information learn from this decision?

Huddles with analysts or Strategists: does It matter?

The SEC prohibits an analyst from issuing reports on securities that run contra to the analyst’s personal beliefs about the securi- ties. The SEC also requires an investment firm to engage in “fair dealing with its cus- tomers.”6 Whether those two requirements were met at the investment firms continues to be the subject of debate. For example, Goldman Sachs held what were known as “trading huddles.” The huddle found ana- lysts and traders meeting to determine short and long investments on particular shares. The conclusions of the huddle were then shared with Goldman’s traders and a selected few of Goldman’s thousands of clients; those conclusions were often differ- ent from the Goldman analysts’ reports and

recommendations that were issued publicly. Other firms such as Morgan Stanley also have huddles in addition to their published research recommendations, but their con- clusions from the weekly meetings are then sent out in an e-mail blast to all clients.

One distinction between Goldman’s hud- dles and those of other investment firms was that Goldman’s huddles did not involve equity research analysts, the analysts who are sub- ject to the SEC rules. Rather, those who par- ticipated in the huddle were from Goldman’s “Fundamental Strategies Group,” a group that would be exempt from the SEC rules.7

Was this change of name a good business strategy? Are there risks in this strategy?

Business Strategy

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Running afoul Using the Net: e-Commerce and Insider trading One trend that has emerged in stock trading is the practice of “pump and dump.” This practice uses the rapid communication of the Internet to disperse information about a company so that the market price is affected. Those who have pumped the stock then sell, or dump, their shares when their efforts on the Internet have caused a sufficient jump in the price.

For example, Mark S. Jakob was dealing in call options in Emulex stock. His prediction that Emulex stock would take a dive was wrong, and the stock in fact increased in value. He had a loss of $100,000. In order to cover his losses, the 23-year-old sent an e-mail press release to an Internet wire service. The fake press release indicated that the CEO of Emulex would resign due to the fact that earnings had been overstated. The news release was then distributed to various websites. The overall loss to shareholders in reaction to the negative news was $2.5 billion as the share price plummeted. However, Mr. Jakob made $240,000 on his trades in the stock.

Mr. Jakob was arrested for securities fraud and wire fraud.8 However, his use of the Internet resulted in significant damage to the company’s stock value. The rapid dissemination of information via the Internet and the resulting damage has resulted in significant enforcement efforts against fraud committed online.

Running afoul of 10(b): aiders and abettors One area of 10(b) liability that remained unclear for almost two decades was whether those who participated with a company in disseminating false information—that is, those who aided and abetted—could be held liable under 10(b). The U.S. Supreme Court’s decision in Stonebridge Investment Partners, LLC v. Scientific-American, Inc., 552 U.S.148 (2008), limited the civil liability of third- party aiders and abettors to accounting manipulation and fraud. However, Dodd–Frank will expand the liability of those who participate in helping a com- pany to overstate or understate items in financial reports that result in a rosier picture such as inflating inventory levels and valuations of accounts receivable.

In the Stonebridge case, the conduct of third parties helped a company appear to be in better financial condition than it really was. Scientific-Atlanta and Motorola supplied Charter Communications with the digital cable converter boxes that Charter furnished to its customers. Charter arranged to overpay these two suppli- ers $20 for each set top box it purchased until the end of the year, with the under- standing that Scientific-Atlanta and Motorola would return the overpayment by purchasing advertising from Charter. The transactions had no economic substance; but, because Charter would then record the advertising purchases as revenue and capitalize its purchase of the boxes, in violation of generally accepted accounting principles, the transactions would enable Charter to fool its auditor into approv- ing a financial statement that showed Charter had met projected revenue and operating cash flow numbers. So that Arthur Andersen would continue auditing in the dark and not discover or understand the link between Charter’s increased payments for the boxes and the advertising purchases by Motorola and Scientific- Atlanta, the companies drafted documents to make it appear the transactions were unrelated and were just business as usual between and among friends, suppliers, and customers (although it was not entirely clear to an outsider that the two roles were being played with the same cash). Charter asked Scientific-Atlanta to send documents to Charter stating that it had increased production costs. It raised the price for boxes for the rest of 2000 by $20 per box. Charter, under a written agree- ment, would then purchase from Motorola a specific number of boxes and pay

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Chapter 18 Governance and Regulation: Securities Law 663

liquidated damages of $20 for each unit it did not take. The whole idea of the con- tract was to set up Charter’s failure to purchase all the units and then have Charter ship the cash back by paying Motorola the liquidated damages.

To cloud the transactions for the auditor further, the new box agreements were backdated to have a different start date from the advertising agreements. The back- dating was important to convey the impression that the negotiations were uncon- nected; this is a point auditors get testy about.

The case resulted in outrage from the investors who lost their investments because two companies participated in obfuscation that duped the auditor and resulted in a clean audit opinion that offered investors ongoing reassurance of an

Re: What’s ethical in Insider trading?

For The Manager’s Desk

Insider trading is a tough area. Consider a few examples to test how well you under- stand the law:

1. You are employed by Marsh, a large insurance underwriter. Marsh has been charged with antitrust violations, and the price of the company’s shares has taken a beating. As you and your coworkers worry about your future, you decide to have a happy hour session at a local bar. During the discussion, a coworker says, “The stock is down now, but there’s still value in the company. I am buying a bunch of shares now, while the market is down on us. I can make a killing when it all comes back, and it will.” You take his words to heart and on Monday buy a large block of your company’s shares. Did you violate 10b?

__Yes __No __Maybe __Ethical __Unethical

2. Mark Cuban, the wealthy Internet entrepreneur and owner of the Dallas Mavericks, purchased a 6.3% interest in Mamma.com, Inc., a Canadian-based company. In June 2004, Mamma.com, Inc., executives invited Cuban to par- ticipate in a private equity placement (private investment in public equity [PIPE]) for Mamma.com. Cuban was told that the offering would be made

at a discount and that it would result in dilution for existing shareholders. At the end of the call, Cuban told the CEO, “Well, now I’m screwed. I can’t sell.”

The CEO called Cuban again and offered to let him speak with the invest- ment adviser (Merriman) handling the pri- vate equity placement. Cuban did so and the investment adviser has described Cuban as angry. Within one minute of this conversation and within hours of his conversation with Mamma.com’s CEO, Cuban called his broker and instructed him to sell Cuban’s entire position in the company. Cuban instructed his broker, “Sell what you can tonight and just get me out the next day.” On June 29, 2004, Cuban sold his remaining 590,000 Mamma.com shares during regular trading at an average cost per share of $13.2937. The SEC charged Cuban with insider trading. When the offering was publicly announced, Mamma.com’s stock price opened at $11.89, down $1.215 or 9.3% from the prior day’s closing price of $13.105. According to the complaint, Cuban avoided losses in excess of $750,000 by selling his stock prior to the public announcement of the offering. Was this insider trading?

__Yes __No __Maybe __Ethical __Unethical

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investment that was actually going south very quickly. The court held, correctly as the law existed at that time, that the two companies could not be held liable because they did not assist in preparing Charter’s financial statements. Aiders and abettors who help create the atmosphere for deceptive financial statements but do not prepare them can now be held liable under the changes Dodd–Frank provides for that expanded liability.

Standing to Sue Under Section 10(b) To be able to recover under Section 10(b), a party suing must have standing. Stand- ing in these cases has been defined by the U.S. Supreme Court as the actual sale or purchase of stock in reliance on the information or lack of information given. For example, persons who would have purchased stock had they known the truth could not recover for damages under 10(b). Likewise, they cannot recover dam- ages because they would have sold their stock had they known the truth. An actual sale or purchase must have occurred for a plaintiff to satisfy the standing require- ments of 10(b). In Blue Chip Stamp v. Manor Drug Store, 421 U.S. 723 (1975), the U.S. Supreme Court held that a pessimistic statement of income and potential was not a 10(b) violation because a potentially interested buyer who did not buy because of the pessimism did not have actual damages and, hence, no standing.

the Requirement of Scienter Under Section 10(b) A conviction under 10(b) cannot be based on negligence—that is, the failure to dis- cover financial information. Because 10(b) is a criminal statute, violators must have some intent to defraud or knowledge of wrongdoing, or scienter. Convictions are only for knowing the financial information but failing to disclose it.

In Ernst & Ernst v. Hochfelder, 425 U.S. 185 (1978), the Supreme Court held that an accounting firm that had negligently performed an audit of a business based on a fraud could not be held liable under 10(b) because, although the accounting firm made a mistake, it had no intent to defraud.

penalties for Running afoul of Section 10(b) Each time a major scandal breaks, the penalties for insider trading increase. Fol- lowing Boesky’s insider schemes on Wall Street, the Insider Trading and Secu- rities Fraud Enforcement Act of 1988, an amendment to the 1934 act, increased substantially the penalties for violations of Section 10(b). SOX changes have more than doubled the penalties of those earlier reforms. Violations of 10(b) carry prison terms of up to 25 years plus penalties. Corporate financial officers also face the increased penalties and the claw-back of bonuses and other compensation earned through false financial statements. In addition to these criminal penalties, the SEC is authorized to bring civil actions against the companies and its officers and col- lect civil penalties for financial reporting violations, insider trading, and other activities related to 10(b) violations.

To increase the likelihood of corporate employees coming forward with infor- mation on fraudulent financial reporting, the SEC can pay bounties in the form of a percentage of the amount recovered to informants who report violations. Sarbanes–Oxley includes protections for company whistle-blowers who report violations to the SEC. These protections are similar to many antiretaliation statutes at the federal and state levels and provide the employees with a shield against termination for reporting violations. Dodd–Frank allows the SEC to increase the bounties paid to whistle-blowers to up to 30% and also provides employees who are retaliated against for reporting information to the SEC a right of private action

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against their employers. Officers and legal counsel are also protected under this provision. The American Bar Association (ABA) amended its Model Code of Eth- ics to allow lawyers, without being considered in violation of their duty of client confidentiality, to report the conduct of clients who are using the lawyer’s advice to commit a fraud. As noted in Chapter 17, lawyers are also required to report con- duct of company officers “up the ladder” in the corporation to the board and audit committee, and the ABA changed its Model Code of Ethics to allow such reporting.

Scott London was a senior partner at KPMG for 29 years. What began as a friendship and a case of braggadocio ended with over $100,000 in cash and gifts exchanged and criminal charges for both Mr. London and Bryan Shaw, Mr. London’s golfing friend. The two met at a Los Angeles golf course and in their initial contacts made conversation about business. Mr. London let slip the names of companies KPMG was auditing and some information about those companies. Mr. Shaw used the information to position him- self to profit from the advance tips on the companies’ fates. For example, if the infor- mation was negative, Mr. Shaw positioned himself short. If the information was positive, Mr. Shaw simply purchased the stock ahead of the release of the positive news.

There were phone calls between the two men, some during which Mr. London read the company press releases prior to their public disclosure. Mr. Shaw was able to net $1.2 million from the stock trades

based on the London tips. And after each profitable sale of stock, Mr. Shaw would meet Mr. London in a parking lot and pay him $10,000 in cash. For example, KPMG was doing the audits on Skechers and Herb- alife, and Mr. Shaw, possessing negative information on those companies, was able to position himself short and profit once the questions about earnings were pub- licly disclosed (in the case of Herbalife, its accounting methods for pyramid sales were revealed). The FBI and the SEC have photos of those exchanges and records of those telephone calls because Mr. Shaw began cooperating with federal authorities on February 8, 2013. He wore a wire, tipped the FBI on the cash pay-off sites, and allowed his phone to be tapped.

Mr. London was charged with securities fraud—Section 10(b) of the 1934 Securities Exchange Act. Did he violate 10(b) if he did not work for the companies directly? Even if he did not work on the course directly?

Consider . . . 18.3

18-3e Insider trading and Short-Swing profits

In addition to the application of Section 10(b) and Rule 10b-5 to trading on inside information, the 1934 act also has a form of a strict liability statute for insider trading. Officers, directors, and 10% or more shareholders have greater access to inside information. They are involved in setting a corporation’s policy and directions in dividend decisions, in product decisions, and in expansion deci- sions. They will always have access to information that is not yet available to the public. Section 16 of the 1934 act is a per se liability section designed to deal with stock trading by corporate insiders, who are defined as officers, directors, and 10% shareholders of those companies and are required to be registered under the 1934 act.

Under 16(a), officers, directors, and 10% shareholders (10% of any class of stock) are required to file reports declaring their holdings. In addition, they must

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file updated reports after any change in ownership (purchase, sale, or transfer). Any changes in ownership must be reported within two days.

Under 16(b), officers, directors, and 10% shareholders are required to give to the corporation any short-swing profits—that is, profits earned on the sale and purchase or purchase and sale of stock during any six-month period. For example, suppose Director Cadigan of a listed New York Stock Exchange company engaged in the following transactions:

April 11, 2017—Ms. Cadigan bought 200 shares of her corporation’s stock at $50 each. April 30, 2017—Ms. Cadigan sold 200 shares at $30 each. May 15, 2017—Ms. Cadigan bought 200 shares at $20 each.

The SEC will match the highest sale with the lowest purchase. Ms. Cadigan has a profit of $10 per share even though she has a net loss. This profit must be returned to the corporation. It is irrelevant whether the officer, director, or 10% shareholder actually used inside information: The presumption under 16(b) for short-swing trades is that the officer, director, or 10% shareholder had access to inside information.

These rules also apply to stock options. However, the issue of stock options and compensation has become a sensitive one following their role in the collapse of so many companies. To minimize or eliminate the incentives for making the financial picture brighter for purposes of increasing the value of stock options, some companies, such as GE and Coca-Cola, have changed their compensation plans to eliminate options and offer employees special classes of stock that have predetermined values or that are awarded only after a period of years following the release of earnings.

18-3f Regulating Voting Information

At one time, shareholders could give their proxies to the company just by endors- ing the backs of their dividend checks; proxies then were obtained easily and with- out much disclosure. The 1934 act changed the way proxies were solicited. With the same philosophy used for registration, the SEC required full disclosure to be the goal of all proxy solicitations. To achieve that goal, the SEC now requires prior filing and adequate representation of shareholder interests.

the proxy Statement Under Section 14 of the 1934 act, all companies required to register under the act must file their proxy materials with the SEC at least 10 days before those materials are to be sent. Proxy materials include the proxy statement and all other solicita- tion materials that will be sent to shareholders. The proxy statement required by the SEC must contain the following details:

1. Who is soliciting the proxy 2. How the materials will be sent 3. Who is paying for the costs of soliciting 4. How much has been spent to date on the solicitation 5. How much is expected to be spent on the solicitation 6. Why the proxy is being solicited—annual meeting elections, special meeting

on a merger, and so on

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Shareholder proposals Because the purpose of Section 14 is full disclosure, the representation of views other than those of corporate management is important in proxy solicitations. Shareholders , who have continuously held at least $2,000 in market value, or 1%, of the company’s securities can submit proposals to be included in proxy solic- itation materials. If the company does not oppose what is being proposed, the proposition is included as part of the proxy materials. If management is opposed, the proposing shareholder has the right to include a 500-word statement on the proposal in the materials. These proposals are not permitted along with their 500- word statements unless they propose conduct that is legal and related to business operations, as opposed to social, moral, religious, and political views. Many com- panies receive shareholder proposals related to climate change issues as well as the disclosure of political donations. However, as shown in Exhibit 18.4, attention has shifted back to corporate governance proposals.

Under Dodd–Frank, the SEC must issue rules permitting shareholders to use proxy solicitation materials supplied by the company in order to distribute their proposals, something that eliminates a barrier shareholders faced in getting pro- posals to go forward. With this access, shareholders will be able to nominate indi- viduals for board membership.

The Dodd–Frank say-on-pay provision requires shareholders to vote on execu- tive compensation every two years. While the vote is advisory only, this statutory requirement has emboldened shareholders, and some companies now are required, through shareholder votes, to obtain their consent for compensation packages.

The focus of shareholder proposals shows a distinct shift from social and envi- ronmental issues to procedural and governance issues. Directors and management have also changed their approaches with shareholders, often meeting with the activists and agreeing to make changes without the need for a vote. With almost half of shareholder proposals approaching 50% approval, this new strategy seems to be an inevitable one. GE, Hewlett-Packard, and Verizon Communications now allow groups of shareholders to put forth their own nominees for corporate boards, a voluntary decision that allows those who own at least 3% of the shares to have a voice in the board composition.

Remedies for Violations of Section 14 If proxies are solicited without following the Section 14 guidelines, the proxies are invalid. They must then be resolicited, and if the meeting has been held in which the invalid proxies were used, the action taken at the meeting can be set aside. Also, if the information in proxy materials is false or misleading, the action taken could be set aside until full and accurate information is furnished to holders of the voting shares.

Exhibit 18.4 the top topic areas for Shareholder proposals

tHe tOp SHaReHOLdeR pROpOSaLS dURING tHe 2015 aNNUaL meetING SeaSON

Political and lobbying activities Declassification of board directors Independent chairman of the board Take action on climate change Executive compensation approval End supermajority vote requirement

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18-3g Shareholder Rights in takeovers, mergers, and Consolidations

definitions Mergers. A merger is a combination of two or more corporations, after which only one corporation continues to exist. For example, when US Airways merged with American Airlines, the newly merged company became American Airlines. American Airlines owned all of US Airways’s assets and assumed all of US Air- ways’s liabilities. The three types of mergers are horizontal, vertical, conglomerate, and inversion. The airline merger is horizontal because two competitors merged. Budweiser’s acquisition of Corona was a horizontal merger. A vertical merger would occur if American Airlines acquired the food servicer for airlines, the acqui- sition of a vendor. A vertical merger would result if Budweiser began purchasing restaurants that sell Corona or beer distributors. A conglomerate merger is what Yahoo! accomplished by its acquisition of Tumblr, Right Media, Zimbra, and seven other companies. An inversion merger, as discussed in Chapter 7, is one generally done for tax purposes and occurs when a small foreign company acquires a U.S. company for purposes of reducing the income tax rate of the U.S. company.

Consolidations. In a consolidation, two or more companies combine into one new company and none of the old companies continues to exist. For example, if US Airways and American had become Worldwide Airlines, then both corporations would have given all of their rights and liabilities to the new company, which

Ethical Issues

The Trinity Wall Street Church is a Wal-Mart shareholder. Pursuant to Section 14 of the Securities Exchange Act of 1934, the church submitted a shareholder proposal for inclu- sion on the Wal-Mart. The proposal related to “whether or not the company should sell guns equipped with magazines holding more than ten rounds of ammunition (‘high capacity magazines’) and to balancing the benefits of selling such guns against the risks that these sales pose to the public and to the Company’s reputation and brand value.” In simple language, the proposal was to have Wal-Mart stop selling assault rifles.

Wal-Mart responded to the Securities Exchange Commission (SEC) indicating that it would not be including the proposal in its proxy materials because the proposal dealt

with the company’s ordinary business oper- ations. Under 17 CFR §240.14a-8, a com- pany can refuse to include a shareholder proposal for a number of reasons that it can provide to the SEC including personal griev- ances, management functions (ordinary business operations), or that the proposal is not related to the corporation’s business.

Wal-Mart sells firearms in less than half of its 4,500 stores and has maintained it does so because it has hunters and sports- men as customers in those stores. Wal- Mart has argued that allowing such propos- als would mean that shareholder proposals could interfere with issues such as product mix, brands, etc. What should the court do? [Trinity Street v. Wal-Mart Stores, Inc., 2015 WL 1905766 (3rd Cir. 2015)] ©

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Chapter 18 Governance and Regulation: Securities Law 669

would have held all assets of the consolidating companies and assumed all their liabilities.

Tender Offers. A tender offer is not a business combination; it is a method for achieving a business combination. An offer that is publicly advertised to share- holders for the purchase of their stock is a tender offer. The offering price for the stock is usually higher than the market price of the shares, which makes the tender offer attractive to the shareholders.

Originally, the tender offer was used as a means for a corporation to reacquire its shares. However, it has become a tool of business combinations of every sort, sometimes friendly and sometimes hostile.

Takeovers. Takeovers are accomplished through the use of tender offers and can be either friendly or hostile. A friendly takeover is one the management of a firm favors, whereas a hostile takeover is one the management of a firm opposes. Dol- lar General made a takeover offer to Family Dollar, one of its major competitors. Family Dollar advised shareholders to reject the offer, but Dollar General kept increasing the offer. Dollar General eventually reached a figure for acquisition, which was $8.5 billion. The hostile takeover resulted in a horizontal merger of two competitors. Restrictions on the use of tender offers and procedures for accom- plishing a takeover are discussed later in the chapter.

Acquisitions. The acquisition of another firm’s assets is either a means of expand- ing or a way to eliminate a creditor; asset acquisition, however, is different from the other business combinations. Because the corporate structure does not change, shareholder approval is not required for an asset acquisition. However, asset acqui- sitions are subject to the constraints of the Clayton Act.

1934 act Regulation of takeovers In all of these business combinations (except asset acquisitions), someone is buy- ing enough stock to own a company. That much buying and selling has long had the attention of the SEC. The Williams Act amendment to the Securities Exchange Act of 1934 regulates these offers to buy stock or tender offers. The Williams Act was passed in 1968 to apply to all offers to buy more than 5% of a corporation’s securities.

Filing Requirements under the Williams Act. Any offeror subject to the Williams Act is required to file a tender offer statement with both the SEC and the target company. The offeror must also send or publish for shareholders of the target company all the information and details about the offer. If the target company is opposing the takeover (i.e., if it is hostile), the target must also file its materials with the SEC.

A registration statement for a tender offer must include the name of the offeror, its source of funding for the offer, its plans for the company if its attempted take- over is successful, and the number of shares now owned.

Shareholders have seven days after a tender offer to withdraw their shares. This seven-day period is to prevent shareholders from being forced into a “now- or-never” transaction. The actual purchase of the shares cannot take place until at least 15 days after the tender offer began. If the offeror changes the tender offer terms, shareholders must be notified, and if a better price is offered, all sharehold- ers must be given 10 days to tender their shares at that price (even those who have already tendered their shares at the lower price).

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Williams Act Penalties for Violations. The Williams amendments provide for both civil and criminal penalties for violations of the act’s procedures. The penalties are based on the same type of language used for 10(b) violations. Criminal and civil penalties are imposed for “fraudulent, deceptive or manipulative” practices used in making a tender offer. Penalties may also be assessed for omissions or misstate- ments of material facts in the tender offer materials.

Special Protections for the Hostile Takeover. In a noncontested takeover, the target company must declare to its shareholders one of the following within 10 days after the date the tender offer commenced:

1. That it recommends acceptance or rejection of the offer 2. That it has no opinion and remains neutral 3. That it is unable to take a position

The target company must also justify its position. For example, in 2015, Perrigo was able to thwart a takeover by Mylan when Perrigo’s board recommended that share- holders not accept the price Mylan was offering because of the risks and downside of a takeover. The shareholders followed that advice and Mylan’s takeover failed.

In those cases in which the target company does not want to be taken over, both the target company and the offeror develop strategies for stopping the other. Some of the tactics used by a target company to fight takeovers are the following:

1. Persuading shareholders that the tender offer is not in their best interests 2. Filing legal suits or complaints on the grounds that the takeover violates pro-

visions of the antitrust laws 3. Matching the buyout with a target company offer 4. Soliciting a “white knight” merger or a merger from a friendly party

State Laws affecting tender Offers The U.S. Supreme Court has held that state statutes that change the regulatory pro- cess for takeovers are violations of the Supremacy Clause (see Chapter 5). Congress has preempted the field by establishing a full regulatory scheme for takeovers under the Williams Act. [Edgar v MITE Corp., 457 U.S. 624 (1982)] However, follow- ing the MITE case, the states passed a new type of antitakeover statute that permits shareholders to have some say in whether a corporation should be taken over.

Current shareholder proposal activity focuses on having their companies opt out of these state takeover requirements as a matter of governance so that manag- ers can deal with takeover offers more efficiently.

proxy Regulations and tender Offers Once some shares are acquired, a firm poised for a takeover wages a proxy battle, which means it solicits proxies in order to be able to command the number of votes needed to gain control of the board. Even though these proxy solicitations origi- nate outside the company, the proxy statement and solicitation materials must be filed with the SEC.

Failure to file these materials makes the proxies invalid, and any action taken at a meeting using the proxies can be set aside. Mergers voted on with invalid proxies can be “unwound.” The SEC or the shareholders can bring an action to prevent the use or undo the use of invalid proxies. If a shareholder successfully brings an action seeking a remedy for a violation of the SEC proxy solicitation rules outlined

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Chapter 18 Governance and Regulation: Securities Law 671

in Section 14, the offeror must fully reimburse the shareholder for all costs of the court action.

Proxies obtained by using misleading information or by not disclosing mate- rial information are also invalid. Again, either the SEC or individual sharehold- ers can bring suit to stop the use of these proxies or to set aside action taken with them.

Proxy contests are expensive. Who pays for their costs? If management wins, they can be reimbursed for reasonable costs. However, some courts limit this reimbursement right to battles waged over corporate policy and not over personality conflicts. If the new group wins, they can vote to reimburse for reasonable expenses, but many states require shareholders to ratify such reimbursement.

18-4 State Securities Laws Today all states have their own securities laws. In addition to federal laws, all issuers are required to follow state blue-sky laws in all states in which their secu- rities are sold. Two types of state securities laws govern registration: those that follow the SEC standards for full disclosure and those that follow a merit review standard. Under SEC standards, a filing is required, and as long as all the required information is there, the offering will be approved for public sale. Under a merit review standard, the regulatory agency responsible for securities enforcement can actually examine a filed offering for its merits as to adequate capitalization, excessive stock ownership by the promoters, and penny-stock problems. These agencies apply a general standard that the offering must be “fair, just, and equi- table.” This general standard gives them great latitude in deciding which issues will be approved. The SEC and state regulators have been working together since the passage of JOBS, as noted in the discussion of crowd funding, in order to make securities offerings less of a burden in terms of filings and costs for new and smaller companies.

Ethical Issues

Joseph Horne Company, a department store in Pennsylvania, entered into an agreement to have Dillard’s (a national retail chain) take it over. Dillard’s performed its due diligence—the process of getting internal access to computers and records to verify financial statements. During due diligence, Dillard’s assumed responsibility for ordering and shipping merchandise. Employees in Horne’s management were told that they would no longer have jobs, and nearly 500 employees left Horne. Horne’s Christmas

merchandise was delayed and was often wrong, and the merger fell through. Horne says that Dillard’s went too far. Dillard’s says that due diligence is part of a takeover, that Horne’s financial statements were inaccurate, and that Horne could have stopped the ordering and shipping at any time. One of the officers at Horne’s bank says a Dillard’s official told him that Dillard’s would just wait until the company was in Chapter 11 bankruptcy and pick it up cheaply. Evaluate the ethics of both parties.

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Many companies do not register their offerings in states that conduct merit review. They sell in the other states to avoid the problems of being denied registration.

As on the federal level, all states have their own exemptions from registration. Most SEC exemptions also work at the state level, the only requirement being that the issuer file a notice of sale with the state agency.

In addition to regulating securities offerings, these state agencies also control the licensing of brokers and agents of securities within the state. The licensing pro- cess consists of an application and a background check conducted by the agency to identify possible criminal problems.

Exhibit 18.5 provides a summary of securities regulation under state and federal law.

Exhibit 18.5 State and federal Securities Law

1933 aCt 1934 aCt BLUe SKy

S1—Registration statement

Financial information

Officers/directors

Prospectus 20-day effective date, deficiency letter

Section 11—Filing false registration statement

Liability: anyone named in prospectus or offering expert materials for it

Material: false statement; privity not required unless longer than one year

Defenses: due diligence; buyer’s knowledge

Section 12—Failure to file; selling

before effective date; false prospectus

Material: false statement; privity required

Defenses: due diligence; buyer’s knowledge

Penalties

$100,000 and/or five years (criminal/ civil suit)

Application

500 or more unaccredited shareholders (or more than 2,000 total shareholders) with $10 million or more in assets or listed on national exchange

Sec. 10b—insider trading/fraud 10K

10K

Annual reports

10Q

Quarterly report

Foreign Corrupt Practices Act

Financial reports

Internal controls

Applies to 1933 and 1934 act registrants

Section 14

Proxy registration

Compensation disclosure

Section 16A

Officers, directors, 10% shareholders

Sales registration

Section 16B—short-swing profits

Tender offer regulations (Williams Act)

Penalties—up to 25 years

Separate financial certification penalties under Sarbanes–Oxley

State securities registration

Merit versus disclosure standards

blue sky registration is preempted if shares are registered at the federal level; cannot block crowdfunding

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18-5 International Issues in Securities Laws The following policy statement from the State Department summarizes the nature of international capital markets today: “The United States Government is committed to an international system which provides for a high degree of freedom in the movement of trade and investment flows.” That commitment has resulted in interconnectivity of stock markets. When the Chinese stock mar- ket goes down, the U.S. stock market follows the next day with a corresponding decline.

In addition to the cooperation on the free flow of capital across borders, countries now cooperate on investigations related to the conduct of traders in the exchanges as well as insider trading. For example, the SEC spearheaded an investigation into insider trading in Switzerland in advance of the acquisition of H.J. Heinz Company by Berkshire Hathaway and 3G Capital. In that case, the SEC did not even know the identity of the Swiss traders, but it was able to get the account in a Swiss bank frozen from which the funds were generated and the gains deposited. U.S. authorities could get the account frozen because U.S. firm Goldman Sachs owned the Swiss bank as a subsidiary. [S.E.C. v. Cer- tain Unknown Traders in Securities of H.J. Heinz Co., 2013 WL 1174139 (S.D.N.Y.)] The interconnection of business has made international law enforcement eas- ier. As businesses cross borders in doing business, regulators gain access to their resources and activities in other countries.

Biography Bernie madoff: the Largest and Longest ponzi Scheme in History ($50 Billion and

18 years)

It is a remarkable story, that of Mad- off (pronounced MADE-off) Securities. An entrepreneur from his early years, Bernie Madoff, the founder of Mad- off Investments, Inc., worked his way through college as a part-time lifeguard who also ran his own lawn sprinkler sys- tem company. He installed and repaired lawn sprinkler systems in the mornings and went to class in the afternoons. He graduated from Hofstra University and then went on to Brooklyn Law School, again running his business in the morn- ing and going to classes in the afternoon. Because he was not really interested in practicing law, he left law school after the first year and, using $5,000 he had saved from his business, bought a trader position on Wall Street. He had grown

up familiar with stocks, bonds, and trad- ing because his mother had operated a small securities trading firm when Bernie was younger. She had even been investigated by the SEC, but when she withdrew her registration as a trader, the SEC withdrew its investigation.

From the time he began his Wall Street career until his arrest, Bernie was on an upward swing. Over decades, he delivered 12% to 18% returns to his investors. He was the investment firm for the rich and famous. Kevin Bacon, Kyra Sedgwick, Steven Spielberg, and others from the wealthiest sets in New York City and Palm Beach were clients of Madoff Securities. He was one of the founders of NASDAQ and served as chairman of its board in its early years. ©

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He spent a great deal of time in Wash- ington, D.C., testifying at congressional hearings and meeting with regulators on markets, regulations, and trading issues.

Madoff and his wife were kind to employees, generous to charities, and active with colleges and universities, donating money to Hofstra, Brooklyn University, and Yeshiva University. They were also known for their wealth and spending.

Some have said the scheme began in the 1980s, but Madoff said in court that he believes it began in the 1990s. Mr. Madoff put clients’ money in a Chase Manhattan bank account and then used the money to pay individual investors, trust funds, charitable organizations and others as they requested withdrawals from their accounts. He said he did not promise a specific rate of return, but his clients expected that he would outperform the market, so he concocted a bogus invest- ment strategy that he then used to recruit new clients. Mr. Madoff was adamant in insisting that his other businesses, including a stock trading company with offices in New York and London, which were run by his sons and his brother, were not connected to his Ponzi scheme, “The other businesses my firm engaged in, proprietary trading and market-making, were legitimate, profitable, and success- ful in all respects. Those businesses were managed by my brother and two sons.”9

In order to keep the funds flowing, he was dependent upon the classic Ponzi scheme model: getting more investors in with additional money, which is criti- cal to keeping the earlier investors sat- isfied. However, there comes a point when there are not enough new recruits to satisfy the existing participants and the fund collapses under even just the daily demands for payouts, let alone the

draw-downs that can come from fears in a bull market.

The scheme was uncovered by fed- eral investigators in December 2008, and Mr. Madoff entered a guilty plea to crimi- nal charges of securities fraud, wire fraud, conspiracy, and other crimes and was sentenced to 150 years in prison. When he entered his guilty plea, Mr. Madoff told the packed courtroom,

“I am actually grateful for this oppor- tunity to publicly speak about my crimes, for which I am so deeply sorry and ashamed. I knew what I was doing was wrong, indeed, crimi- nal. When I began the Ponzi scheme, I believed it would end shortly and I would be able to extricate myself and my clients. [Finding an exit] proved difficult and ultimately impossible. As the years went by I realized this day, and my arrest, would inevitably come.

I am painfully aware that I have deeply hurt many, many people, including members of my family, my closest friends, business associates and the thousands of clients who gave me their money. I cannot ade- quately express how sorry I am for what I have done.”10

The psychology of Madoff, like that of all diabolical Ponzi schemers, is fas- cinating. One of his best friends, for whom Mr. Madoff served as best man, was asked to explain why Bernie would engage in such behavior and not under- stand the consequences of the huge fraud, “There is no way to. I can’t make it add up. It doesn’t make sense. I cannot take the Bernie I knew and turn him into the Bernie we’re hearing about 24/7. It doesn’t compute.”11 ©

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Chapter 18 Governance and Regulation: Securities Law 675

What requirements affect primary offerings?

• Primary offering—sale of securities by the business in which interests are offered

• Security—investment in a common enterprise with profits to come from efforts of others

Why do we have securities laws, and what is their history?

• Securities Act of 1933—federal law regulating initial sales of securities

• Securities Act of 1934—federal law regulating securi- ties and companies in the secondary market

• Amendments include SOX, PSLRA, and JOBS

How do securities laws regulate the primary market?

• Blue-sky laws—state securities registration regulations

• Merit review—regulation of merits of an offering as opposed to disclosure

• Howey test—Supreme Court definition of security

• SEC—federal agency responsible for enforcing fed- eral securities laws

• Exemption—security not required to be registered

• Exempt transaction—offering not required to be registered

• Regulation D—small offering exemption rules

• Accredited investor—investor who meets threshold standards for assets and income

• Rules 504, 505, 506—portion of Regulation D afford- ing exemptions for variously structured offerings

• Crowdfunding

• Registration statement—disclosure statement filed by the offeror with the SEC

• Prospectus—formal document explaining offering or any ad or written materials describing offering

• Comment letter—request by SEC for more information

• Deficiency letter—request by SEC for more information

• Full-disclosure standard—review for information, not a review on the merits

• Tombstone ad—ad announcing offering that can be run prior to effective date of registration statement

• Red herring prospectus—redlined prospectus that can be given to potential purchasers prior to effective date of registration statement

• Shelf registrations—SEC approval process that allows approval and then waiting period for market conditions

• Material misstatement—false information that would affect the decision to buy or sell

• Section 11—portion of 1933 act that provides for lia- bility for false statements or omissions in registration statements

• Due diligence—defense of good faith and full effort to Section 11 charges

• Section 12—portion of 1933 act that provides for liability for selling without registration or exemption before effective date or with a false prospectus

• SOX and Dodd-Frank require investor protections through certifications and disclosures

How do securities laws regulate the secondary market?

• 10-Q—periodic reporting forms required of 1934 act companies

• SOX and certification of financial reports by CEO and CFO

• 10-K—periodic reporting forms required of 1934 act companies

• 8-K—periodic reporting forms required of 1934 act companies

• Emerging growth companies (ECGs)

• Section 10(b)—antifraud provision of Securities Exchange Act

• Rule 10b-5—SEC regulation on antifraud provision of Securities Exchange Act

• Insider—person with access to nonpublic informa- tion about a company

• Tippee—person who gains nonpublic information from an insider

• Fair Disclosure Rule—SEC regulation on disclosure to analysts

• Insider Trading and Securities Fraud Enforcement Act of 1988—federal law increasing penalties for insider trading violations

• Section 16—portion of 1934 act regulating short-swing profits by officers, directors, or 10% shareholders

• Short-swing profits—gain on sale and purchase or pur- chase and sale of securities within a six-month period

• Proxy solicitations—formal paperwork requesting authority to vote on behalf of another

How do securities laws protect shareholders in share and company acquisitions?

• Mergers, consolidations, tender offers, and asset acquisitions are regulated

• Williams Act regulates tender offers

• States have antitakeover statutes

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1. The Farmer ’s Cooperative of Arkansas (Co-Op) was an agricultural cooperative that had approximately 23,000 members. In order to raise money to support its general business operations, the Co-Op sold promissory notes payable on demand by the holder. The notes were uncollateralized and uninsured and paid a variable rate of interest that was adjusted to make it higher than the rate paid by local financial institutions. The notes were offered to members and nonmembers and were mar- keted as an “investment program.” Advertisements for the notes, which appeared in the Co-Op newsletter, read in part: “YOUR CO-OP has more than $11,000,000 in assets to stand behind your investments. The Investment is not Federal [sic] insured but it is . . . Safe.”

Despite the assurance, the Co-Op filed for bank- ruptcy in 1984. At the time of the bankruptcy filing, over 1,600 people held notes worth a total of $10 million.

After the bankruptcy filing, a class of note hold- ers filed suit against Arthur Young & Co., alleging that Young had failed to follow generally accepted account- ing principles in its audit, specifically with respect to the valuation of the Co-Op’s major asset, a gasohol plant. The note holders claimed that if Young had properly treated the plant in its audited financials, they would not have purchased the notes. The petitioners were awarded $6.1 million in damages by the federal district court. Are the notes securities? [Reves v. Ernst & Young, 494 U.S. 56 (1990)]

2. In August 1994, Mervyn Cooper, a psychotherapist, was providing marriage counseling to a Lockheed exec- utive. The executive had been assigned to conduct the due diligence (review of the accuracy of the books and records) of Martin Marietta, a company with which Lock- heed was going to merge.

At his August 22, 1994, session with Mr. Cooper, the executive revealed to him the pending, but nonpublic, merger. Following his session with the executive, Mr. Cooper contacted a friend, Kenneth Rottenberg, and told him about the pending merger. They agreed that Mr. Rottenberg would open a brokerage account so they could buy Lockheed call options and common stocks and then share in the profits.

When Mr. Rottenberg went to some brokerage offices to set up an account, he was warned by a broker about the risks of call options. Mr. Rottenberg told the broker that Lockheed would announce a major busi- ness combination shortly and that he would not lose his money.

Did Mr. Rottenberg and Mr. Cooper violate Section 10(b)? What about the broker? [SEC v. Mervyn Cooper and Kenneth E. Rottenberg, No. 95-8535 (C.D. Cal. 1995)]

3. Reed Hastings, the CEO of Netflix, announced on his personal Facebook page that Netflix had reached a new benchmark, that of streaming 1 billion hours of its con- tent in a one-month period. Later, the company made an official announcement about the 1 billion hours of streaming. The SEC opened an investigation into the dis- closure. Why? What do you think the SEC did in the situ- ation? Would it always be a problem to disclose company information on Facebook? [Release No. 69279, Investiga- tion Pursuant to Section 21(a) of the Securities Exchange Act of 1934: Netflix, Inc., and Reed Hastings, https:// www.sec.gov/litigation/investreport/34-69279.pdf]

4. James Herman O’Hagan was a partner in the law firm of Dorsey & Whitney in Minneapolis, Minnesota. In July 1988, Grand Metropolitan PLC, a company based in London, retained Dorsey & Whitney as local counsel to represent it regarding a potential tender offer for com- mon stock of Pillsbury Company (based in Minneapolis).

Mr. O’Hagan did no work on the Grand Met mat- ter, so on August 18, 1988, he began purchasing call options for Pillsbury stock. Each option gave him the right to purchase 100 shares of Pillsbury stock. By the end of September, Mr. O’Hagan owned more than 2,500 Pillsbury options. Also in September, Mr. O’Hagan pur- chased 5,000 shares of Pillsbury stock at $39 per share.

Grand Met announced its tender offer in October, and Pillsbury stock rose to $60 per share. Mr. O’Hagan sold his call options and made a profit of $4.3 million.

The SEC indicted Mr. O’Hagan on 57 counts of ille- gal trading on inside information, including mail fraud, securities fraud, fraudulent trading, and money launder- ing. Is what Mr. O’Hagan did insider trading? [United States v. O’Hagan, 521 U.S. 657 (1997)]

5. Steve Hindi is an animal rights activist who owns in $5,000 Pepsi stock. He discovered that Pepsi advertises in bullrings in Spain and Mexico, and he has attended annual shareholder meetings and put forward share- holder proposals to have the company halt the practice. His proposal did not pass, but he did not give up easily and started a website to increase pressure on the com- pany. (See http://www.sharkonline.org for an article containing more details regarding this issue.)

Pepsi has withdrawn bullfighting ads in Mexico but continues with them in Spain. Mr. Hindi continues his quest. Should the proposal have been approved? Does Mr. Hindi run any risk with his website activism?

6. Iroquois Brands, Ltd., is a food company that imports French foie gras, a pâté made from the enlarged livers of force-fed geese. The French method for raising the geese is to funnel corn down the geese’s throats and gag

Q u e s t i o n s a n d P r o b l e m s

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Chapter 18 Governance and Regulation: Securities Law 677

them with rubber bands to keep them from regurgitat- ing. A shareholder wishes to include in the proxy mate- rials a proposal that the company study this method of force-feeding as an unethical business practice (cruelty to animals). Should the proposal be included? Does Section require that it be included? [Lovenheim v. Iroquois Brands, Ltd., 618 F. Supp. 554 (D.C. 1985)]

7. Following the collapse of the World Trade Center (WTC) in New York City on September 11, 2001, the stock markets were closed for several days. When the stock markets reopened on Monday, September 17, 2001, there was unusual activity in stocks that were hit the hardest by the attacks and subsequent shutdown of the U.S. air- line industry: airlines and insurance. Investors based in Europe had purchased puts in airline and insurance com- panies with the expectation of earning returns based on the fall in these companies’ share prices.

Puts work as follows: A company sells 1,000,000 put options on its stock (trading at $100 per share) exercis- able at $100 within a month or two months or one year. Investors buy the puts at $10 a share. The company pockets $10,000,000 in cash.

When the put date arrives: If the stock price is $100 or more, the puts expire worthless. Company A has made $10,000,000. If the stock price drops to $50, the investor can buy shares at $50 and exercise the puts. Company A must buy back the shares at $100. The company loses $50 million less its $10 million for a net loss of $40 million.

In the case of the WTC disaster, someone with advance knowledge of the attacks, by buying puts, bet that the stocks of these companies would go down. They were correct, and the SEC placed a hold on the payments to the put holders as investigators looked into trading on inside information and tracing the links of those who bought the puts. Would advance knowledge of the attacks be a form of inside information? Would buying with that advance knowledge be a violation of 10(b)? What about the fact that they were foreign investors?

8. Vincent Chiarella was employed as a printer in a financial printing firm that handled the printing for takeover bids. Although the firm names were left out of the financial materials and inserted at the last moment, Mr. Chiarella was able to deduce who was being taken over and by whom from other information in the reports being printed. Using this information, Mr. Chiarella was able to dabble in the stock market over a 14-month period for a net gain of $30,000. After an SEC investigation, he signed a consent decree that required him to return all of his profits to the sellers from which he purchased during that 14-month period. He was then indicted for violation of 10(b) of the 1934 act and the SEC’s Rule 10b-5. Did

Mr. Chiarella violate 10b-5? [Chiarella v. United States, 445 U.S. 222 (1980)]

9. Jeff Charleston is a retired executive of Clarkson, Inc. He retired in 2016. He has been asked to join the board and serve on the audit committee. Clarkson is a publicly traded 1934 Act reporting company. Can he serve on the board? On the audit committee?

10. William H. Sullivan, Jr. gained control of the New England Patriots Football Club (Patriots) by forming a separate corporation (New Patriots) and merging it with the old one. Plaintiffs are a class of stockholders who voted to accept New Patriots’ offer of $15 a share for their common stock in the Patriots’ corporation. They now claim that they were induced to accept this offer by a misleading proxy statement drafted under the direc- tion of Mr. Sullivan, who owned a controlling share in the voting stock of the Patriots at the time of the merger. The proxy statement, plaintiffs claim, contained various misrepresentations designed to paint a gloomy picture of the financial position and prospects of the Patriots, so that the shareholders undervalued their stock. They seek to rescind the merger or to receive a higher price per share for the stock they sold. Does the court have the authority to rescind under Section 14? [Pavlidis v. New England Patriots Football Club, 737 F.2d 1227 (1st Cir. 1984)]

11. Charles Edwards was the chairman, chief executive officer, and sole shareholder of ETS Payphones, Inc. ETS sold payphones packaged with a site lease, a five- year leaseback and management agreement, and a buy- back agreement. The purchase price for the payphone packages was approximately $7,000. Under the lease- back and management agreement, purchasers received $82 per month, a 14% annual return. Purchasers were not involved in the day-to-day operation of the pay- phones they owned. ETS selected the site for the phones, installed the equipment, arranged for connection and long-distance service, collected coin revenues, and main- tained and repaired the phones. The payphones did not generate enough revenue for ETS to make the pay- ments required by the leaseback agreements, so the com- pany depended on funds from new investors to meet its obligations.

In September 2000, ETS filed for bankruptcy. The SEC brought suit against Edwards and ETS for fail- ure to register securities prior to sale. The district court concluded the arrangement was an “investment contract” subject to the securities laws. The Court of Appeals reversed the lower court. Which court is correct? Did the sale of securities take place? [SEC v. Edwards, 540 U.S. 389 (2004)]

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678 part 4 Business Management and Governance

Ethics, Public Policy & the Law Goldman Sachs: The Gold (?) Standard of Wall Street

Goldman Sachs was founded in 1869 as an originator and a clearinghouse for commercial paper. Marcus Goldman, a German immigrant, founded the compa- ny along with his son-in-law, Samuel Sachs. But the stodgy negotiable instruments market proved insuf- ficient as the firm drifted from its founders’ influence and its basic roots in tangible one-on-one business loans to more complex and sophisticated financial instruments.

In 1999, the same year Goldman itself went pub- lic, Goldman underwrote 47 companies. The 1990s investors did not know that the standard underwrit- ing practice of requiring that a company show three years of profitability before being taken public was no longer enforced. That profitability standard had been slowly eased back to one year and then to one quarter. In fact, some Internet IPOs that Goldman underwrote had not yet seen any profits and their business plans indicated that profits were not on the immediate horizon.

In addition, Goldman engaged in laddering in the 1990s. Goldman and its best clients arranged for the allocation of a certain portion of an IPO at a pre-established price. However, those clients also had to agree to purchase a certain number of shares later during the IPO rollout at $10 to $15 higher. Laddering is a trick, a sort of insider scam by the underwriter and its favored clients. The underwriter locks pre- committed buyers into a price above the initial price and the shares of the IPO are guaranteed to rise. Goldman knows the fixed hand, but those in the mar- ket who are evaluating the IPO do not know that the increase in price is not due to legitimate demand for the company’s shares.

For example, in 2000, Goldman was the under- writer for eToys, whose stock was priced for the IPO at $20. Goldman had laddered the shares and the price climbed to $75 per share by the end of the first day. By March 2001, eToys was in bankruptcy. Then–Gold- man Chairman Hank Paulson condemned the practice when the firm received its SEC Wells notice for ladder- ing, but denied any charges of securities fraud. Gold- man settled the SEC charges of laddering by agreeing to pay a $40 million fine.12

In the 2000s, Goldman was a big player in mort- gage-backed securities such as collateralized debt obligations (CDOs). Goldman made recommenda- tions to clients to purchase CDOs as it was pushing to have the instruments rated high even as it was

positioning itself short on the instruments. Posi- tioning short means that Goldman stood to make money when the value of the CDOs declined. Inter- nal e-mails at Goldman found the investment bank- er referring to CDO securities as “junk,” “s___,” or “crappy.”13 When Goldman executives were asked at a congressional hearing about their internal neg- ative characterizations of securities the firm was touting and selling to its clients, Goldman executive David Viniar responded, “I think that’s very unfor- tunate to have on e-mail.” When his response elicit- ed laughter in the hearing room, Mr. Viniar changed his answer to, “It’s very unfortunate to have said that in any form.”14

When the real estate market declined rapidly, the value of the CDOs plummeted to junk levels. Gold- man received $10 billion from the U.S. government as a bailout. In addition, the government had to bail out AIG, the insurer Goldman had used for its hedges against the CDO market.

Goldman’s 2009 annual revenues topped $13 bil- lion, with first-quarter earnings for 2010 of $3.2 billion showing it on track for a repeat. The company has 32,000 employees worldwide and takes no new clients unless they have a minimum of $10 million to invest. The company has several management mantras. One is “long-term greedy,” which Goldman executives translate to mean “don’t kill the marketplace,”15 and the other is “filthy rich by 40,” a motivator for young people.

The SEC filed a civil action against Goldman for its conduct in ABACUS, a CDO deal. According to the complaint, 31-year-old Goldman employee Fabrice Tourre put together a deal of CDOs with the mortgage pool handpicked by John Paulson, a finan- cial wizard who planned to position himself short on the securities Goldman would sell to its clients. The SEC complaint shows that Paulson chose mort- gage pools that were dogs—that is, “crappy.” Those mortgages were chosen because these securities “tanking” was important to Goldman and Paulson due to their positions on the mortgage instrument markets.

Goldman’s position is that the clients who pur- chased the instruments were “qualified” or “sophisti- cated” investors and had a sufficient level of knowl- edge of markets to understand and process the risk and realize that all investment bankers are positioned in the market according to their theories on risk.

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Goldman’s activities have been described as “Heads Goldman wins, tails you lose.”16 And “Every game has a sucker, and in this case, the sucker was not so much AIG as it was the U.S. government and the taxpayer.”17 Goldman CEO Lloyd Blankfein defended his firm’s conduct in November 2009 in an interview with the London Times by stating that he was just a banker “doing God’s work.”18

dISCUSSION QUeStIONS

1. What are the results when companies create a busi- ness model based on loopholes and interpretations of the law?

2. Evaluate Goldman’s ethics on the role it believed it played with its clients. Mr. Tourre was charged and found guilty of civil fraud. Goldman paid a fine. What lessons should employees learn from this result?

n ot e s 1. John Arlidge, “I’m Doing ‘God’s Work.’ Meet Mr. Goldman Sachs,” London Times interview, The Sunday Times, November 8, 2009, p. 1.

2. Dodd–Frank requires the SEC to review the definition of an “accredited investor” at least once every four years to be certain that the exemption is not including those who need further disclosures and protections from securities sales not subject to full registration. The Government Accounting Office (GAO) must conduct a study every three years to determine whether the private investment thresholds are appropriate for necessary protections.

3. The SEC proposed a bad-actor rule one year after Dodd– Frank was passed. However, the proposed rule has been a proposed rule for two years. The SEC has not finalized or promulgated the proposed rule.

4. Peat, Marwick, Mitchell was one of the Big 8 accounting firms that existed during the 1960s and 1970s. These firms did all the audits on publicly traded companies. During the 1990s, the firms merged down to the Big 5. With the demise of Andersen following Enron, the Big 4 accounting firms remain.

5. David Glovin, “Galleon’s Rajaratnam May Face Stiffer Jail Sentence after Questioning Law,” Bloomberg News, September 12, 2011.

6. Susanne Craig, “Goldman’s Trading Trips Reward Its Biggest Clients,” Wall Street Journal, August 24, 2009, p. A1.

7. Andrew Ross Sorkin, “At Goldman, E-Mail Message Lays Bare Conflicts in Trading,” New York Times, January 13, 2010, p. B1.

8. Alex Berenson, “Man Charged in Stock Fraud Based on Fake News,” New York Times, September 1, 2000, pp. C1, C2.

9. Joanna Chung and Brooke Masters, “Madoff Says He Acted Alone,” Financial Times, March 13, 2009, pp. 1, 7.

10. http://www.justice.gov/usao/nys/madoff/ madoffhearing031209.pdf.

11. Julie Creswell and Landon Thomas Sr., “The Talented Mr. Madoff,” New York Times, January 25, 2009, p. SB1.

12. SEC v Goldman Sachs, January 25, 2005, http://www.sec. gov/litigation/complaints/comp19051.pdf. Settlement at http://www.sec.gov/litigation/litreleases/lr19051.htm.

13. Michael M. Phillips, “Senators Seek, Fail to Get an ‘I’m Sorry,’” Wall Street Journal, April 28, 2010, pp. A3, A5.

14. Michael M. Phillips, “Senators Seek, Fail to Get an ‘I’m Sorry,’” Wall Street Journal, April 28, 2010, p. A5.

15. Michael M. Phillips, “Senators Seek, Fail to Get an ‘I’m Sorry,’” Wall Street Journal, April 28, 2010, p. A6.

16. Robert Farzad and Paula Dwyer, “Not Guilty, Not One Little Bit,” BusinessWeek, April 12, 2010, p. 31.

17. Robert Farzad and Paula Dwyer, “Not Guilty, Not One Little Bit,” BusinessWeek, April 12, 2010, p. 32.

18. John Arlidge, “I’m Doing ‘God’s Work.’ Meet Mr. Goldman Sachs,” London Times interview, The Sunday Times, November 8, 2009, p. 1.

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680

Chapter

Management of Employee Welfare19 The employer–employee relationship has evolved from one of a paternal nature in the 1600s and 1700s to one of a contractual nature.1 In those earlier periods, employers often assumed responsibility for the well-being of their em- ployees through personal relationships that were possible because of the less complex nature of business at the time. With the Industrial Revolution, however, more employees were needed, and personal relationships were no longer possi- ble. The employer–employee relationship became thoroughly contractual.

One effect of the change in the relationship to one of contract was that both parties behaved as parties in contracts and negotiation do: They wanted to max- imize their own economic benefits. Employers wanted the most work for the least amount of money. Employees wanted maximum pay, safe working condi- tions, and some type of insurance for retirement, unemployment, and disability. Because employers had the upper hand—they controlled the jobs—their bar- gaining positions were stronger than those of employees. To balance the scales of power a bit, workers organized to give themselves more bargaining power through unionization, and the federal government enacted worker protection leg- islation to provide workers with some of their needs.

This chapter discusses the work and safety standards covered in federal leg- islation and answers the following questions: What wage and work hour pro- tections exist for employees? Are there restrictions on children’s work? What protections exist for safety in the workplace? What happens when an employee is injured in the workplace? Are workers entitled to pensions, and are they reg- ulated? What is the Social Security system, and what benefits does it provide? What rights do unemployed workers have? How are labor unions formed, and what is their relationship with employees?

Update For up-to-date legal news, go to mariannejennings.com

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681

19-1 Wage and Hours Protection Exhibit 19.1 summarizes the series of laws affecting employee rights over the past 50 years, which are discussed in this chapter.

19-1a the Fair Labor Standards act

The Fair Labor Standards Act (FLSA) is commonly called by workers the “minimum wage law” or the wage and hour law. This act does establish a minimum wage, but it also includes provisions regulating child labor, overtime pay requirements, and equal pay provisions. The FLSA was originally introduced in the Senate by Hugo L. Black when he was a senator from Alabama. His 1937 appointment to the U.S. Supreme Court may have helped it pass the high court’s scrutiny. Amended several times, the FLSA is an enabling statute that sets up various administrative agencies to handle the regulations and necessary enforcement.

Coverage of FLSa The FLSA applies to all businesses that affect interstate commerce. As discussed in Chapter 5, “affecting” interstate commerce is a broad standard.

Fatal Occupational Injuries in 2014: 4,679

Causes Transportation: 40% Falls: 17% Equipment: 15% Homicides 9% Animal injuries 7% Exposure to harmful substances 8% Fires and explosions 3%

Highest number of deaths: Drivers/sale force/truck drivers Farmers, ranchers, and agricultural managers Construction Aircraft pilots and flight engineers Roofers Loggers Refuse and recycling Electric power workers Fishers

U.S. Department of Labor StatiSticS, october 2015

Total OSHA federal inspections 2014: 35,820

Top five violations 1. Fall protection 2. Scaffolding 3. Hazard communication

(warning signs) 4. Tagouts 5. Ladders

occUpationaL Safety anD HeaLtH aDminiStration

www.osha.gov

Brock Hopkins worked at the Great Bear Adventures near West Glacier, Montana. He did maintenance and fed the bears. Some workers at Great Bear, including Hopkins, have been known to smoke marijuana on the premises.

On November 2, 2007, Hopkins smoked marijuana on his way into work. When he arrived, he mixed food for the bears, entered the bears’ pen, and began to place food out. At some point, the largest bear, Red, attacked him. The bear knocked Hopkins to the ground, sat on him, and bit his leg, knee, and rear end. While this was occurring, another bear, Brodie, came up from behind, and bit Red. In response, Red moved off

Hopkins momentarily, and Hopkins escaped by crawl- ing under one of the electrified wires surrounding the pen. Kilpatrick eventually found Hopkins, and he was transported to the hospital by helicopter. He suffered severe injuries.

Kilpatrick did not carry workers’ compensation in- surance. Hopkins petitioned for workers’ compensation benefits from the Uninsured Employers’ Fund. The Un- insured Employers’ Fund opposed Hopkins’ petition on the grounds of his marijuana use and the nature of the accident. Is this workplace injury covered under Workers' Compensation?

Consider . . . 19.1

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682 Part 4 Business Management and Governance

FLSA Minimum Wage and Overtime Regulations Under FLSA, all covered employees must be paid a minimum wage. The mini- mum wage is established by Congress and is increased through legislation. How- ever, states are free to have a minimum wage higher than the federal minimum. For example, Seattle had adopted a $15 per hour minimum wage and California has legislation pending to increase the minimum wage to $15 per hour state wide. Domestic service workers, including full-time babysitters, cooks, home health care workers, and housekeepers must be paid a minimum wage. The minimum wage is determined after the employer deducts any expenses for housing and food.

The FLSA also includes an hours protection for covered employees in the form of time-and-one-half pay for hours worked above 40 hours per week. Regardless of the pay period for covered employees (monthly, weekly, or biweekly), overtime is computed on the basis of 40 hours per week. For example, if a covered employee worked 38, 42, 35, and 47 hours in four consecutive weeks and is paid on a monthly basis, that employee is entitled to nine hours of overtime pay.

The definition of covered employees is provided in the FLSA. Some catego- ries of employees are covered for purposes of minimum wage protections but not for overtime pay. There is ongoing litigation as to whether interns are covered employees. (See The Manager’s Desk feature on p. 683) Executives, professionals, and others who exercise discretion and judgment in their positions may be covered for purposes of minimum wage protections but not for purposes of overtime pro- tections. The reason for this exemption is that these employees, often referred to as “white-collar” workers, possess sufficient training, knowledge, and experience to

Exhibit 19.1 Statutory Scheme for Employee Welfare

STATUTE DATE PROVISIONS

Worker’s Compensation (state laws)

1900 Absolute liability of employers for employee injury; no common law tort suits by employees against employers

Social Security Act 42 U.S.C. § 301

1935 FICA contributions; unemployment compensation; retirement benefits

Fair Labor Standards Act 29 U.S.C. § 201

1938 Minimum wages; child labor restrictions; overtime pay

Equal Pay Act 29 U.S.C. § 206

1963 Amendment to FLSA; equal pay for equal work

Occupational Safety and Health Act 29 U.S.C. § 651

1970 Safety in the workplace; employee rights; employer reporting; inspections

Employment Retirement Income Security Act 29 U.S.C. § 441

1974 Disclosure of contributions, investments, loans; employee vesting; employee statements

Family and Medical Leave Act 29 U.S.C. § 2601

1993 Protection of job after family leave (for pregnancy, child care, adult illness, elderly care)

Pension Protection Act 29 U.S.C. §§ 302 et. seq.

2006 Amends ERISA to require higher funding levels as well as limits on officer stock sales during blackout periods

Patient Protection & Affordable Care Act 42 U.S.C. §§ 18001 et seq.

2010 Imposes responsibility on employers for health care coverage for employees

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Chapter 19 Management of Employee Welfare 683

counter employer unfairness. The FLSA, under rules promulgated by the Depart- ment of Labor, has specific salary and job requirements for employees to be cov- ered under the overtime exemption. The trend has been one of expanding the list of employees who are protected by overtime pay requirements.

One issue that has resulted from the impact of downsizing is whether employ- ees can be required to work overtime hours. The FLSA simply provides the right to time-and-one-half pay for overtime worked; it does not include limitations on hours (except in child labor regulations for children under the age of 18), nor does it provide a statutory right to refuse to work overtime. Union collective bargain- ing agreements can impose restraints, and many employers seek volunteers for overtime.

Re: How Uber, Lyft, Home Health Care, and New Business Models are Changing employment Law

For The Manager’s Desk

Who works for whom? The traditional work- place has changed and is continuing to change. The U.S. Department of Labor has been struggling to keep up with how the rules on wages, hours, and employment taxes apply when we have so many in the workforce who work their own hours or drive their own cars. From Uber rides to pizza delivery to staffing agencies, we no longer have the structure of employees reporting to work at one place and working at one desk and being paid by one company.

On January 20, 2016, the Department of Labor issued an administrative ruling (Administrator’s Interpretation No. 2016-1) that provides some guidance on who is an employee and who is an independent contractor. Employers are now sharing employees, using third-party management companies, or hiring independent contrac- tors. The multiple-employer model is prev- alent in construction, janitorial, warehouse and logistics, staffing, and hospitality indus- tries. The purpose of the ruling is to provide guidance on employee rights and employer responsibilities in these situations. While the ruling is not binding, it could provide courts with guidance in situations in which multiple- employer employees seek to enforce their

rights under FLSA. Here are the key ele- ments of the ruling:

• The FLSA applies to joint (hori- zontal and vertical) employment relationships.

• In horizontal employment arrange- ments (where employees work for two different companies, part-time), both jobs count for the 40-hour overtime clock. If the employees work for more than 40 hours at the two restaurants owned by the same person or company, they are owed overtime because there is one owner. This part of the ruling gives the following example:

Casey, a registered nurse, works at Springfield Nursing Home for 25 hours in one week and at River­ side Nursing Home for 25 hours during that same week. If Spring­ field and Riverside are joint employ­ ers, Casey’s hours for the week are added together, and the employers are jointly and severally liable for paying Casey for 40 hours at her regular rate and for 10 hours at the overtime rate. Casey should receive

(Continued)

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684 Part 4 Business Management and Governance

(Continued) 10 hours of overtime compensa- tion in total (not 10 hours from each employer).

• Shared functions between employees also mean the overtime rules apply.

An employee is employed at two locations of the same restaurant brand. The two locations are oper- ated by separate legal entit ies (Employers A and B). The same indi- vidual is the majority owner of both Employer A and Employer B. The managers at each restaurant share the employee between the locations and jointly coordinate the schedul- ing of the employee’s hours. The two employers use the same pay- roll processor to pay the employee, and they share supervisory author- ity over the employee. This is joint employment.

In contrast, an employee works at one restaurant (Employer A) in the mornings and at a different restaurant (Employer B) in the afternoons. The owners and managers of each restau- rant know that the employee works at both establishments. The establish- ments do not have an arrangement to share employees or operations, and do not otherwise have any common

management or ownership. This is not joint employment.

• For vertical employment (such as those who work for subs who always work for the same contrac- tor or builder), the factors for joint employment are the following:

o Whether the general contractor controls or supervises the work

o Whether the general contractor controls employment conditions (rate or method of pay)

o The length of the relationship

o Joint handling of payroll, insurance, and facilities by vertical companies

The old business model of a builder hiring carpenters no longer exists. The new model inserts a company that provides car- penters, thus escaping all the payroll costs. Sometimes the builder started the carpenter company. But, this ruling means that builders cannot set up shell companies to hire car- penters to escape protections of the FLSA for those carpenters. Overtime protections, insurance coverage, workers’ compensation, and the right to organize are now applica- ble to situations in which companies are structured to avoid traditional employment relationships that are there through the cor- porate veils of shell companies.

FLSA and Child Labor Provisions The child labor provisions of the FLSA keep children in school for a mini- mum number of years. The provisions of the act govern particular ages and restrict the types of jobs those age-groups can hold. For example, those over the age of 18 can work in any type of job. Those who are ages 14 and 15 can work only in nonhazardous, nonmanufacturing, and nonmining jobs and only during nonschool hours.

Among the exemptions to the laws are those for young actors and actresses, for example. However, the Screen Actors Guild rules place strin- gent limits on “set time” for children. But in the film industry, states may require approval of minors’ contracts and also require that some of the earn- ings be put in trust for use by the child actor when he or she becomes an adult. Other exemptions apply to work-study programs and farmwork. (For information on child labor in international business, see p. 719.)

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Chapter 19 Management of Employee Welfare 685

Managing and paying Interns For The Manager’s Desk

NBC Universal, Condé Nast, the Hearst Cor- poration, Fox Searchlight, and even Charlie Rose have been or are defendants in class action lawsuits brought against them by unpaid interns who served internships at these companies or for individuals. The suits seek to have back wages paid to those who have served as interns.

Traditionally, an unpaid internship was an opportunity for those who lack experi- ence to break into a particular field and gain contacts and experiences by working in that field. The arrangement was viewed as a win-win opportunity. Young people had the opportunity to get a foot in the door for a job, make contacts for future employment, and gain experience. The companies who had the unpaid interns had the opportu- nity to see their work habits, abilities, and fit within the organization. The companies also held their help—and all without paying wages.

However, the U.S. Department of Labor has held that an internship can be unpaid only if the intern is part of an educational training program. If the employer uses the intern in lieu of hiring additional employees or using existing staff, then they are not interns and must be paid compensation according to the terms of the FLSA. The U.S. Supreme Court has ruled on this standard in Walling v. Port­ land Terminal Co., 330 U.S. 148 (1947).

Examples of students involved in the intern litigation include the following:

• Matthew Lieb served as an intern at the New Yorker (owned by Condé Nast) in 2009 and 2010. During his time there, he proofed and edited articles, did research for articles, and maintained an online cartoon database. He worked three days per week from 10:00 a.m. until 5:30 p.m. and was paid less than $1 per hour.

• Lauren Ballinger served as an intern at W magazine in 2009 and was paid $12 per day to run errands for edi- tors and deliver items to vendors.

A court has already found that Fox Search- light Pictures violated the FLSA when it used unpaid interns in its making of the film Black Swan. The film grossed $300 million, and the class group that brought the suit had worked for very little or nothing on the film. [Glaat, et al. v. Fox Searchlight Pictures, Inc., 2 F.R.D. 516 (S.D.N.Y. 2013)] However, other cases have held that the Department of Labor test for paying interns is too rigid. [Solis v. Laurelbrook Sanitarium and School, Inc., 642 F.3d 518 (6th Cir. 2011)] But see Winfield v. Babylon Beauty School of Smithtown Inc., 89 F. Supp. 3d 556 (E.D.N.Y. 2015).

Charlie Rose faced a lawsuit from 190 unpaid interns who worked for him from 2006 through 2012 and settled the case for $110,000. The interns will receive $110 for each week that they worked, for a maximum of 10 weeks.

The litigation is likely to continue because a 2013 survey by the National Association of Colleges and Employers (NACE) found that one-half of college students report that their internships were unpaid. The survey was conducted in 2013 and involved 30,000 students. The survey also found that stu- dents who held paid internships were more likely to obtain a job with that employer and that their salaries were higher: 60% of students with paid internships got jobs with their employers at a $51,930 starting salary, whereas 37% of students with unpaid internships got jobs with their employers at a starting salary of $35,721.

Discuss the ethical issues in long-hour internships. What about internships for no pay? Are there benefits? Do both sides ben- efit from the internship programs?

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686 part 4 Business Management and Governance

enforcement of FLSa Enforcement of the FLSA requirements comes about in different ways. Employees can initiate the process by filing a complaint with the U.S. Department of Labor. In some cases, employers make the laws self-enforcing by requesting interpretations from the Labor Department that are then published in the Code of Federal Regulations.

In a final type of case, the Labor Department initiates its own investigation of a firm for possible violations. For example, after the Labor Department reviewed car dealership programs that had high school–age vocational students working in service departments, it halted several common practices in that industry. Although teens could train by doing mechanical work, using under-18 students as car jock- eys to bring the customers’ cars around to them following service work was a vio- lation of the age restrictions on types of work under FLSA.

penalties for FLSa Violation The FLSA carries both civil and criminal penalties for violations. Employees have the right to sue civilly to recover from an employer any wages that were not paid or any overtime compensation that was denied, plus reasonable attorney fees required to bring the action to recover. In addition to the employees’ rights, the U.S. Department of Labor’s Wage and Hour Division has enforcement power for violations. A willful violation of FLSA carries a maximum $10,000 fine and possible imprisonment of up to six months.

To help employees pursue their rights, the FLSA makes it a violation for any employer to fire an employee for filing an FLSA complaint or for participating in any FLSA proceeding.

Liability for FLSa Violation Officers of a corporation can be held individually liable for the corporation’s viola- tions. The FLSA imposes fines on both corporations and officers involved in man- aging employees. These personal penalties are particularly likely in cases in which the company has not kept accurate records of the wages and hours worked of its employees, a requirement of the FLSA. Chao v. Hotel Oasis, Inc. (Case 19.1) reflects the enforcement standards and policies of the Department of Labor.

Chao v. Hotel Oasis, Inc. 493 F.3d 26 (1st Cir. 2007)

Two Sets of Books, One Big Penalty

Case 19.1

FaCtS

Hotel Oasis, Inc., operates a hotel and restaurant in southwestern Puerto Rico. Dr. Lionel Lugo-Rodríguez (defendant-appellant) (Lugo) is the president of the corporation, runs the hotel, and manages its employ- ees. Oasis’s records show that between October 3, 1990, and June 30, 1993, employees were paid less than minimum wage, were not paid for training time or meetings held during nonworking hours, were paid in cash “off the books,” and were not paid correctly

for overtime. Oasis also maintained two sets of payroll records for the same employees, covering the same time periods, one showing fewer hours at a higher rate and the other showing more hours at a subminimum wage rate. Lugo maintains that the two sets of books were necessary, one for temporary employees and one for permanent employees.

On April 5, 1994, the Secretary of Labor (the “Sec- retary”) filed a complaint in the United States District Court for the District of Puerto Rico against Oasis and

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continued

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Chapter 19 Management of Employee Welfare 687

Lugo (“Defendants”), alleging violations of the mini- mum wage, overtime, and record-keeping provisions of the Fair Labor Standards Act (“FLSA”). The Secre- tary also sought liquidated damages.

After years of litigation, the district court ordered Oasis to pay $141,270.64 in back wages and an equal amount in liquidated damages to 282 current and for- mer employees. The court also found Lugo personally liable for the back wages and penalties. Lugo and Oasis appealed.

JUdICIaL OpINION

TORRUELLA, Circuit Judge “[T]he overwhelming weight of authority is that a corporate officer with operational control of a corpora- tion’s covered enterprise is an employer along with the corporation, jointly and severally liable under the FLSA for unpaid wages.” Although we found it “difficult to accept . . . that Congress intended that any corporate officer or other employee with ultimate operational control over payroll matters be personally liable,” we narrowly determined that the FLSA did not preclude personal liability for “corporate officers with a signif- icant ownership interest who had operational control of significant aspects of the corporation’s day to day functions, including compensation of employees, and who personally made decisions to continue operations despite financial adversity during the period of non- payment.”. . .

. . . [Because] not every corporate employee who exercised supervisory control should be held per- sonally liable, we identified several factors that were important to the personal liability analysis, including the individual’s ownership interest, degree of control over the corporation’s financial affairs and compensa- tion practices, and role in “caus[ing] the corporation to compensate (or not to compensate) employees in accordance with the FLSA.”

Based on the above considerations, we affirm the district court’s judgment holding Lugo personally liable for Oasis’s compensation decisions. Lugo was not just any employee with some supervisory control over other employees. He was the president of the corporation, and he had ultimate control over the business’s day- to-day operations. In particular, it is undisputed that Lugo was the corporate officer principally in charge of directing employment practices, such as hiring and fir- ing employees, requiring employees to attend meetings unpaid, and setting employees’ wages and schedules. He was thus instrumental in “causing” the corporation to violate the FLSA. The FLSA contemplates, at least in certain circumstances, holding officers with such per- sonal responsibility for statutory compliance jointly and severally liable along with the corporation.

Finally, Defendants argue that the district court erred in awarding liquidated damages based on a finding of willfulness. The FLSA authorizes the Secretary of Labor to recover on behalf of employees unpaid wages and over- time compensation plus an equal amount in liquidated damages. The only way an employer can escape liquidated damages is to “show[] to the satisfaction of the court” that it acted in good faith and had reasonable grounds for believing that its acts did not violate the FLSA.

Here, the district court found that Defendants failed to show good faith or objective reasonableness, referring back to its findings on willfulness with respect to the applicable statute of limitations. Defen- dants “intentionally and consistently failed to keep accurate records of the time worked by its employees[,] . . . disguised minimum wage, as well as overtime pay violations, . . . did not record the amounts of cash tips . . . [and] most salient. . .[to] a finding of willfulness . . . [paid] employees ‘off the books.’”

Oasis’s failure to keep adequate payroll records and its intentional manipulation of the records it did keep are sufficient grounds for concluding that Oasis did not act in good faith or with a reasonable belief that it was in compliance with the FLSA. “[T]he fact that an employer knowingly under-reported its employee’s work hours could suggest to a [fact finder] that the employer was attempting to conceal its failure to pay overtime from regulators, or was acting to eliminate evidence that might later be used against it in a suit by one of its employees.”

Defendants’ primary argument on appeal is that the court had indicated at trial that the willfulness issue was “close” and that the Secretary had offered no evidence that Oasis acted in reckless disregard of its statutory obligations. These arguments are unpersua- sive. First, the district court noted its “initial inclination against a determination of willfulness,” but explained that it ultimately relied on the employees’ testimony and Defendants’ own documentary evidence to reach its conclusion regarding willfulness. We have already determined that the willfulness finding is not clearly erroneous. Furthermore, it is the employer’s burden to show good faith and objective reasonableness, and therefore the Secretary’s alleged failure to offer evi- dence of willfulness is not an impediment to the court’s decision to refrain from awarding liquidated damages.

Affirmed.

CaSe QUeStIONS

1. What shows willfulness of a violation?

2. What are the standards for holding an officer lia- ble for FLSA violations?

3. Explain what liquidated damages are and when they are available for recovery.

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688 part 4 Business Management and Governance

19-1b the equal pay act of 1963

The Equal Pay Act of 1963 is an amendment to the FLSA that makes it illegal to pay different wages based on gender to men and women who are doing substan- tially the same work. If the jobs involve equal responsibility, training, or skill, men and women must have equal pay. Merit systems and seniority systems instituted in good faith do not violate the Equal Pay Act even though they may result in dif- ferent pay rates for the same jobs. As long as the disparate pay is based on length of employment or a merit-raise system, the disparity is within the act.

The Equal Pay Act is not an act that requires the application of compara- ble worth. Comparable worth requires that men and women be paid on the same scale, not just for the same jobs but when they are doing different jobs that require equal skill, effort, and responsibility. This issue came to light in 1983 when Louise Peterson, a licensed practical nurse at Western State Hospital in Tacoma, Washington, brought suit when she discovered that her salary of $1,462 per month for her supervision of the daily care of 60 men convicted of sex crimes was $192 less per month than that of the hospital groundskeeper and $700 less per month than men doing similar jobs at Washington’s state prisons. A federal court found no violation of the Equal Pay Act.

19-2 Workplace Safety 19-2a the Occupational Safety and Health act

One of the worker welfare concerns of Congress has been safety in the work- place. In the past, the economic concerns of employers often overshadowed their concern for proper safety precautions. To ensure worker safety, Congress passed the Occupational Safety and Health Act of 1970. Its application was broad, pro- tecting virtually every employee in the country. It was an enabling statute that created three agencies responsible for worker safety standards: the Occupational Safety and Health Administration (OSHA), the Occupational Safety and Health Review Commission (OSHRC), and the National Institute for Occupational Safety and Health (NIOSH). OSHA is the agency responsible for the promul- gation and enforcement of workplace safety standards. OSHA’s enforcement powers include investigations, record-keeping requirements, and research. The stated purpose of the act is to “assure so far as possible every working man and woman in the nation safe and healthful working conditions and to preserve our human resources.”

OSHa Coverage and duties OSHA coverage is broad: Every employer that is in a business affecting commerce and has at least one employee is covered by OSHA. Several other federal acts reg- ulate safety for particular industries, including the Coal Mine and Safety Act and the Railway Safety Act.

19-2b OSHa Responsibilities

promulgating Rules and Safety Standards OSHA is responsible for promulgating rules and regulations for safety standards and procedures. The rules are adopted by the standard administrative process of notice in the Federal Register, public input, and final decision (see Chapter 6).

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Chapter 19 Management of Employee Welfare 689

Inspections OSHA inspections are an enforcement tool. Inspectors can enter the workplace “without delay and at a reasonable time” to inspect. They can check the workplace and the records and can question employees. OSHA’s inspection power is limited by numbers, however. Because of OSHA’s limited staff, the regulations provide for an order of priority on inspections. For example, OSHA places priorities on investi- gations of fatal accident sites as well as employee complaints.

OSHA must follow certain inspection procedures. An OSHA inspector who appears at a workplace must show identification and ask the employer’s per- mission to conduct an inspection. If the employer allows the inspection, the employer or an agent of the employer can accompany the OSHA inspector. After the inspection, the inspector and employer meet to discuss violations, and the problems are often worked out on the spot and the violations remedied immediately.

Employee Rights, Inspections, and OSHA. If an inspection is the result of an employee complaint, the employer cannot take any retaliatory action against that employee. Because of OSHA’s limited staff, the agency relies on those in the workplace to bring violations to its attention. If workers fear retaliation, the violations will remain unreported. An employee who is fired, demoted, or discriminated against for registering an OSHA complaint can file a complaint, and the Department of Labor can pursue the employee’s rights in federal district court. In Whirlpool Cor- poration v Marshall, 445 U.S. 1 (1980), the U.S. Supreme Court held that employees could not be sent home from work or docked on their pay if they refused to work because of an unsafe condition or employer practice.

OSHa Search Warrant Requirements Although most businesses voluntarily permit OSHA inspections, employers do have the right to refuse access. In Marshall v Barlows, Inc., 436 U.S. 307 (1978), the U.S. Supreme Court ruled that OSHA inspectors must obtain warrants if employ- ers refuse access.

OSHa penalties In 2015, OSHA modified its penalty structure for the first time since 1990. There is now a sliding scale for gravity of violations for first-time violators. However, there are also additional penalties beyond the maximums for repeat violators. Exhibit 19.2 is a summary of current OSHA penalties.

Exhibit 19.2 OSHa penalties

tYpe OF OFFeNSe deSCRIptION peNaLtY

Willful/Repeat Employer aware of danger or a repeat violator (violations within the prior 5 years)

Up to 10% above the maximum fine of $126,000 and/or six months’ imprisonment

Gravity-based Sliding scale of $3,000 to $12,600

De minimis Failure to post rights Up to $12,600 per violation

Failure to correct Citation not followed $12,600 per day

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690 part 4 Business Management and Governance

State OSHa programs Most federal regulatory laws preempt state laws, but state laws addressing occu- pational safety are not generally preempted, and the states share responsibility for workplace safety with the federal government. Some states do go beyond the fed- eral standards. For example, some states have “right to know” laws for employees— laws that require employers to post the presence of hazardous substances at the office, plant, and so forth. Also, state criminal laws may be used to prosecute offi- cers and companies already sanctioned by OSHA.

For a state to assume responsibility for an OSHA program, the agency must be assured that the state plan will be as effective as federal OSHA would be. Also, OSHA is in charge of the Complaints against State Program Administration, which permits those affected and interested in safety to file complaints with OSHA regarding state performance. OSHA can then investigate and, if necessary, revoke state approval.

19-2c employee Impairment and testing Issues

One safety problem in the workplace is the presence of impaired coworkers. An employee operating equipment, whether a drill press or a delivery van, while under the influence of drugs or alcohol presents a substantial safety concern for any business. Current estimates are that between 14% and 20% of the U.S. work- force is impaired on the job. Employees who use drugs are almost four times more likely to be involved in workplace accidents. Further, the annual cost in reduced productivity attributable to impaired workers is $100 billion. As a result, drug test- ing of employees by their employers is not only permitted but also essential for workplace safety.

19-3 Employee Pensions, Retirement, and Social Security

One of the concerns of workers is what happens to them when they retire: will they have an income? Other concerns are whether they will have a source of income in the event of disability or whether their survivors will have income in the event of their death. Finally, what if no work is available? What income will they have until they find another job? These issues are the social issues of employment law— providing for those who, because of age, disability, or unemployment, are unable to provide for themselves.

19-3a Social Security

The Social Security Act of 1935 was a key component of the massive reforms in federal government during Franklin Roosevelt’s presidency.

The idea of the Social Security system was to have those who could work shoul- der the social burden of providing for those who could not. Every employer and employee is required to contribute to the Social Security programs under the Fed- eral Insurance Contributions Act (FICA). The amount employees contribute is based on their annual wage. Changes under the Patient Protection and Affordable Care Act (Obama Care) now make interest and dividend income as well as capital gains subject to FICA contributions at a rate of nearly 4%. FICA contributions are paid one-half by employers and one-half by employees. Independent contractors

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Chapter 19 Management of Employee Welfare 691

pay their own FICA contributions. Social Security includes provision of death bene- fits for spouses and children as well as disability and retirement benefits.

The benefits paid to retired and disabled people are based on formulas. The amount depends on how long an individual worked and within what salary range. Surviving spouse and children’s benefits are likewise tied to the employee’s work and salary history.

Re: the Gig economy Start-Ups: pumping the Brakes on

Independent Contractors and Moving to employees

For The Manager’s Desk

Uber, Lyft, and service start-up companies such as Luxe, Shyp, and Instacart have built their companies on the independent contrac- tor model. That is, they staff their companies with individuals who are not paid a salary, who work their own hours, and who allow a reduc- tion in labor costs of 20% to 40% because of the savings on wage taxes (FICA, FUTA). These on-demand companies were created with the idea of flexibility—that someone would be there to drive, move, or park when needed. The nature of their businesses demands an on-call staff, not a full-time labor force.

However, because of litigation from their workers as well as the need for some sched- uling and training, some of the companies are switching from independent contractor models to employee models. For example, Homejoy, Inc. (a company that offers house cleaning), is shutting down, following four lawsuits involving wages and hours. With all the pending litigation, Homejoy was not able to raise the additional capital it needed for expansion.

Known as the gig economy or the shar- ing economy, these start-ups are based on a model of connecting those in need of certain services with those who can provide such service on demand. The estimate is that, currently, 34% to 40% of the workers in the United States are freelancers.

The litigation by freelancers began as part of a so-called democracy movement. The founders of these service-on-demand

start-ups became very wealthy very quickly when the companies went public. However, the freelancers or independent contractors working for them were limited in compen- sation, stability, and benefits.

There is a difference between a free- lancer (independent contractor) and an employee. Those differences, and something that controls whether the company must pay wage taxes or the freelancers can simply be “1099ed,” or required to report his or her own income include the following:

• Control over the schedules of the freelancers, including factors such as regularity of hours and the ability of the freelancer to not work certain hours, days, or weeks

• Degree of control exercised over the freelancers

• Whether freelancers pay their own expenses or the company pays those for them

Unfortunately, as demand for the compa- ny’s services increases, so do demands on freelancers. The flexibility they experienced in the growth mode is often no longer available as the company needs all hands on deck. Once the company begins controlling sched- ules, it crosses the line into employee territory.

There is another aspect of the switch to an employee model. Some of the com- panies worry that quality suffers as they

(Continued)

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(Continued) take on more independent contractors and customers experience a lack of uniformity in quality or training among the service pro- viders. For example, Luxe Valet is switching to an employee model to allow for better training and quality control.

However, these start-ups of the gig economy operate on razor-thin margins, and most will not be able to make the switch to the employee model. In fact, public offerings for these companies are put on hold if they follow a 1099 model for employees and there is any litigation. If the litigation is successful,

those working for the start-ups will have unemployment benefits and the matching FICA contributions, but they will also earn less. As Handy Technologies noted, if forced to move to an employee model, those who work for them would go from $17 per hour to something more like a minimum wage.

Sources: Greg Bensinger, “Startups Scramble to Define ‘Employee,’” Wall Street Journal, July 30, 2015, p. B1; Nithin Coca, “The First Domino Falls in the Gig Economy: HomeJoy Shuts Down,” Triple Pundit, August 3, 2015, http://www.triplepundit.com/2015/08/first-domi- no-falls-gig-economy-homejoy-shuts.

19-3b private Retirement plans

For many, Social Security retirement benefits do not provide enough security, and at present there is no assurance that those employed today will be able to collect their Social Security benefits upon retirement. For these reasons, many employees have invested in their own private retirement plans.

Many retirement and pension plans are set up by employers, who enjoy tax benefits from some plans. However, when evidence revealed that employees’ funds in plans were being misused, not invested wisely, and in some cases embez- zled, Congress enacted the Employee Retirement Income Security Act of 1974 (ERISA), which was amended in 2006 by the Pension Protection Act of 2006.

Coverage of eRISa ERISA applies to any employer engaged in or affecting interstate commerce and to any organization (such as a union) representing employees in interstate commerce. ERISA covers any medical, retirement, or deferral-of-income plan.

Requirements of eRISa plans ERISA does not require employers to have pension plans, but if an employer chooses to have a pension plan, the employer is subject to funding, accounting, and disclo- sure requirements imposed by federal law, including changes under the Pension Protection Act, enacted because of company and pension funding failures. As part of its 2006 Chapter 11 bankruptcy, United Airlines was relieved of its pension liabilities. However, in the GM and Chrysler bankruptcies, the pension plans were preserved. Because many former Enron employees lost their pensions when Enron declared bankruptcy because it was funded with Enron stock, there are now new regulations on disclosures to employees about stock investments in their companies for their pri- vate retirement funds as well as additional restrictions on management stock trades.

The wide disparity in the security of pension plans continues to attract congres- sional attention. One discovery following the United bankruptcy was that loop- holes in the accounting processes for pension fund reporting had permitted United (and many others) to report pension numbers that made the health of the fund look better than it actually was. The loopholes were Enronesque in nature, allow- ing obligations to be spun off the books so that the existing levels of obligations of the plan looked small and the assets rich.

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Under the Pension Protection Act of 2006, Congress closed these financial reporting accounting loopholes. Companies must now fund their pension plans according to the numbers reported to the SEC in their financials. Companies reported their pension obligations and funding accurately to the SEC, but for ERISA purposes, those numbers were inflated. For example, if United had funded its plans when its SEC numbers indicated it needed to (i.e., 1998), United would have had a sufficiently funded plan at the time of its bankruptcy. However, under ERISA guidelines, United was not required to kick in funds until 2002, by which time the fund was so grossly underfunded that the company was unable to salvage the fund or provide the cash for increased levels of funding.

By 2012, another type of pension plan resulted in more bankruptcies. States, cities, counties, and towns were underfunded in pensions for government work- ers. The result was bankruptcies (as with Detroit and Stockton and San Bernardino, California) as well as significant pension and contract reforms, as done in Wiscon- sin through a bitter political battle.

eRISa employee Rights Under ERISA, employees are entitled to receive an annual statement showing both their total benefits in any of the covered plans and the amount that is vested or that is nonforfeitable should they leave their jobs. In addition, ERISA sets min- imum vesting requirements for employees before they will have rights in their retirement, pension, or annuity plans. To avoid the Enron problem of manage- ment sell-offs pending bad news announcements, the Pension Protection Act of 2006 added another protection for employees that prohibits officers of the com- pany from selling their shares when employees are subject to blackout periods on their pension funds. That is, when employees cannot make changes in their pen- sion fund allocations or deposits, officers likewise cannot trade in the company’s stock. This provision was passed to prevent what happened at Enron. Enron offi- cers sold off large blocks of stock even as the employees’ pension plan was frozen by a blackout period. All the employees could do was sit and watch the values of their plans decline. They were unable to allocate pension funds to other sources.

One final protection for employees resulted from a 2008 U.S. Supreme Court decision. Employees may now bring suit against their employers for failure to honor their fiduciary duties in managing employee pension accounts. [LaRue v. DeWolff, Boberg & Associates, Inc., 552 U.S. 248 (2008)]

19-3c Unemployment Compensation

Benefits provided Unemployment compensation programs were created under the Federal Unem- ployment Tax Act (FUTA). The federal government collects the FUTA tax and established the minimum standards for such programs, such as the period of time that unemployment coverage lasts. The amount is tied to the average amount earned by an individual during the months preceding employment termination. The benefits are usually paid on a weekly or biweekly basis. The federal gov- ernment has increased the maximum time period for unemployment benefits to nearly two years.

Qualifying for Benefits Each state has its own standards for payment of benefits. Generally, eligibility requirements demand that an individual be (1) involuntarily terminated from

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a job, (2) able and available for work, and (3) involved in seeking employment. Termination cannot be the result of voluntary action by an employee, such as quitting, or such as engaging in behavior that the employee has been warned about in the past. Willful disregard of employer rules is voluntary termination.

The payment of unemployment benefits raises many social issues regarding its effects. Many opponents of such benefits maintain that awarding them, par- ticularly for the nearly two years now available, encourages unemployment. In addition, unemployment compensation has created some conflicts in federal labor legislation. In Wimberly v. Labor and Industrial Relations Comm’n of Missouri, 479 U.S. 511 (1987), the U.S. Supreme Court held that leaving the workforce voluntarily because of pregnancy is still a voluntary departure from a job and does not entitle the mother to collect unemployment benefits.

Ashok K. Gupta, a native of India, was em- ployed at Lightbridge, Inc., as a credit analyst from November 10, 1999, until his discharge on August 20, 2001. Lightbridge operates a telephone call center where sellers of cel- lular telephones obtain credit checks on prospective customers. Gupta’s responsi- bilities included answering calls and running credit checks. Lightbridge’s customer ser- vice procedures explicitly state that “[a]ny incidences, i.e. disconnecting calls, not answering calls, unprofessional conduct while on the phone . . . or anything that causes an adverse business impact on Lightbridge, Inc. (complaint from client or agent, financial loss or client loss, etc.) may result in correc- tive action.”

Gupta had been the subject of two com- plaints from callers. The first incident oc- curred after a dealer asked Gupta to repeat himself. Gupta replied, “What do you mean I’m speaking to you in English,” and discon- nected the call after ignoring the dealer’s request to speak with a supervisor. Gupta received a verbal warning and an “Employee Corrective Action Form” admonishing that he would be subject to disciplinary action for “[a]ny further infractions of this or any other company policy.”

The second warning came after a dif- ferent dealer called Lightbridge crying and reporting that Gupta had been rude and uncooperative. Gupta was again spoken to and received another corrective action form, which noted that “[a]ny further violations of this company policy or any other company policies will result in additional disciplinary action up to and including termination.” Gupta had signed both disciplinary forms.

On August 17, 2001, a caller referred to Gupta as “[y]ou stupid Indian.” Gupta replied, “Hold on you idiot.” He then placed the caller on hold and attempted to locate a supervi- sor. Unable to find a supervisor, he returned to the call, but it had been disconnected. A short time later, the same dealer called again, but upon hearing Gupta’s voice, the dealer said, “Jesus,” and hung up. Light- bridge lost a customer as a result. Gupta was terminated, and he applied for unemploy- ment. The state denied his benefits because he had willfully disobeyed workplace rules.

Gupta filed suit to collect his unemploy- ment benefits. Is he entitled to them? Explain why the state decided as it did and what the appeals court should do. [Gupta v. Deputy Director of Div. of Employment & Training, 818 N.E.2d 217 (Mass. App. Ct. 2004)]

Consider . . . 19.2

Who pays for Unemployment Benefits? Although the idea and mandate for unemployment compensation came from the federal government, the states actually administer their own programs. Employ- ers in each state are taxed based on the number of workers they employ and their

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wages. Those taxes are collected by the states on a quarterly basis. These funds are deposited with the federal government, which maintains an unemployment insurance program with the funds. Each state has an account in the federal fund on which it can draw. Employers effectively pay the costs of the unemployment compensation system.

19-4 Workers’ Compensation Laws The purpose of workers’ compensation laws is to provide wage benefits and med- ical care to victims of work-related injuries. Although each state has its own system of workers’ compensation, several general principles remain consistent through- out the states:

1. An employee who is injured in the scope of employment is automatically entitled to certain benefits (a discussion of work-related injuries and the scope of employment follows).

2. Fault is immaterial. Employees’ contributory negligence does not lessen their right to compensation. Employers’ care and precaution do not lessen their responsibility.

3. Coverage is limited to employees and does not extend to independent contractors.

4. Benefits include partial wages, hospital and medical expenses, and death benefits.

5. In exchange for these benefits, employees, their families, and dependents give up their common law right to sue an employer for damages.

6. If third parties (e.g., equipment manufacturers) are responsible for an accident, recovery from the third party goes first to the employer for reimbursement.

7. Each state has some administrative agency responsible for administration of workers’ compensation.

8. Every employer who is subject to workers’ compensation regulation is required to provide some security for liability (such as insurance).

19-4a employee Injuries

As they originated, workers’ compensation systems were created to provide ben- efits for accidental workplace injuries. Over the years, however, the term accident has been interpreted broadly. Most injuries are those that result suddenly, such as broken arms, injured backs caused by falls, burns, and lacerations. But work- ers’ compensation has been extended to cover injuries that develop over time. For example, workers involved in lifting heavy objects might eventually develop back problems. Even such medical problems as high blood pressure, heart attacks, and nervous breakdowns have in some cases been classified as work related and compensable.

The standard for recovery under the workers’ compensation system is that the injury must originate in the workplace, be caused by the workplace, or develop over time in the workplace. Issues that arise include whether the injury occurred during work hours, whether the employee caused the injury, and scope of employment.

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19-4b Causation and Worker’s Compensation

One of the most litigated areas in worker’s comp involves issues about injuries that may not be exclusive to work. For example, stress can have personal and work- related causation, but when it is shown to be caused or originated by employment, is a compensable injury. The employee must tie the onset or increase in stress to job functions. Workers’ compensation issues have become more complex, and many of the hearings involve the issue of determining whether a disability originated on the job or would have existed independently of the job. For example, the family of an employee of an oilfield storage facility who contracted psittacosis after he was exposed to pigeons roosting in the facility and died was not entitled to death ben- efits under workers’ compensation. There was no evidence that pigeons or psit- tacosis were incidental to the character of the oilfield supply business or that the nature of his work there was the proximate cause of his disease. However, blood pressure and alcoholism, if tied to the nature of the employee’s work, are compen- sable under workers’ compensation systems if there is a tie between these diseases and workplace stress. [Castillo v. Caprock Pipe & Supply, Inc., 285 P.3d 1072 (N.M. App. 2012)]

19-4c Fault Is Immaterial

The fact that an injury occurs in the workplace is enough for recovery. Employee negligence, employer precautions, contributory negligence, and assumption of risk are generally not issues in workers’ compensation cases.

19-4d employees versus Independent Contractors

Workers’ compensation applies to employees but not to independent contractors. Employees are those who are present at the workplace on a regular basis, paid a wage, and supervised. Independent contractors are those who work on a job basis, work irregular hours, and are not supervised by the employer. A backhoe operator working daily from 5:00 a.m.to 1:00 p.m. for a plumbing company and paid a weekly wage is an employee. A backhoe operator hired and paid on a per- job basis is an independent contractor. A more complete discussion of employee status can be found in Chapter 16.

19-4e Benefits

Workers’ benefits can be grouped into three different categories: medical, disabil- ity, and death. Medical benefits include typical insurance-covered costs such as hospital costs, physician and nursing fees, therapy fees, and rental costs for equip- ment needed for recovery.

Disability benefits are payments made to compensate employees for wages lost because of a disability injury. The amount of benefits is based on state statutory figures. Most states base disability benefits on an employee’s average monthly wage, and they also specify a maximum amount. State statutes also generally have a list of scheduled injuries, which will carry a percentage disability figure. For example, loss of a body part is a typical injury. In Arizona, the disability amount for a lost thumb is 55% of the average monthly wage for 15 months (Ariz. Rev. Stat. § 23–1044). For a lost foot, the amount is 55% of the average monthly wage for 50 months. Total disability is also defined by statute. Workers who have total

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disability are generally entitled to two-thirds of their average monthly salary for the period of the disability. Total disability usually includes the loss of both eyes or both hands or complete paralysis.

Some injuries suffered by workers are not listed in statutes. Those not specifi- cally described in statutes are called unscheduled injuries. The amount allowed for unscheduled injuries is discretionary and an area of frequent litigation.

Death benefits are paid to the family of a deceased employee and generally include burial expenses. In addition, survivors who were economically dependent on an employee are also paid benefits. The amount of death benefits is generally some percentage of the average monthly salary; for example, a surviving spouse might be entitled to a 35% benefit.

19-4f Forfeiture of the Right of Suit

The majority of states require employees to forfeit all other lawsuit rights in exchange for workers’ compensation benefits. Employees receive automatic ben- efits but lose the right to sue their employers for covered incidents. Some states even prohibit employees from suing their coworkers under most conditions. In addition, some states allow family members to sue employers for direct injury to themselves. In those states, a spouse could bring a lawsuit against an employer for loss of consortium (marital companionship).

19-4g third-party Suits

If an employee is injured by a machine malfunction while on the job, the employee is covered by workers’ compensation. However, product liability may also be at issue in the accident. If suit is brought against the machine’s manufacturer for product liability, any recovery goes first to the employer to compensate for the cost of the employee’s benefits. In other words, third-party recovery is first used to reimburse the employer.

19-4h administrative agency

Every state has some administrative agency responsible for the administration of claims, hearings, and benefits. In most states, this agency holds hearings for claims, and its decision is appealable in the same manner as any other agency decision.

The procedure for compensation requires employees to file claims with the agency along with medical documentation for the claim. Most claims are paid without contest, but if a challenge is made to a decision, a hearing with evidence and testimony is held.

19-4i Insurance

All states with workers’ compensation systems require employers to be financially responsible for benefits under their systems. Employers can show financial respon- sibility by (1) maintaining an insurance policy, (2) obtaining a policy through the state agency, or (3) offering evidence of sufficient assets and resources to cover potential claims and benefits.

Hopkins v. Uninsured Employers’ Fund (Case 19.2) deals with various issues in a worker’s compensation claim and provides the answer to the chapter opening “Consider” . . . .

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Hopkins v. Uninsured Employers’ Fund 251 P.3d 118 (Mont. 2011)

A Bear of a Worker’s Compensation Case

Case 19.2

FaCtS

Great Bear Adventures is located near West Glacier, Montana. Visitors to the Park enjoy a drive-through expe- rience of bears in their natural habitat. Russell Kilpatrick owns the Park and lives on adjacent property. Brock Hop- kins began working there in 2002, doing various tasks, including maintenance and feeding the bears. In the past, some workers have been known to smoke marijuana on the premises. Although Kilpatrick professed to not con- done marijuana use by workers, testimony established that he had smoked marijuana at the Park in the past, and on occasion had done so with Hopkins.

On November 2, 2007, Hopkins smoked marijuana on his way into work. When he arrived, Kilpatrick told Hopkins to raise the boards on the Park’s front gates so they would not freeze to the ground. Hopkins asked Kil- patrick if he should feed the bears as well. The Workers’ Compensation Commission (WCC) ultimately found that Kilpatrick never told Hopkins not to feed the bears.

After completing work on the gates, Hopkins returned to Kilpatrick’s house. Kilpatrick was asleep inside. Hopkins mixed food for the bears and used Kilpatrick’s truck to drive into the Park. He entered the bears’ pen and began to place food out. At some point, the largest bear, Red, attacked him. The bear knocked Hopkins to the ground, sat on him, and bit his leg, knee, and rear end. While this was occurring, another bear, Brodie, came up from behind, and bit Red. In response, Red moved off Hopkins momentarily, and Hopkins escaped by crawling under one of the electri- fied wires surrounding the pen. Kilpatrick eventually found Hopkins, and he was transported to the hospital by helicopter. He suffered severe injuries.

Kilpatrick did not carry workers’ compensation insurance. Hopkins petitioned the WCC for workers’ compensation benefits from the Uninsured Employ- ers’ Fund. Both the Uninsured Employers’ Fund and Kilpatrick opposed Hopkins’ petition. The WCC found for Hopkins. Kilpatrick appealed.

JUdICIaL OpINION

MCGRATH, Chief Justice The WCC correctly concluded that Kilpatrick, “unques- tionably controlled the details of Hopkins’ work at

the bear park.” Hopkins had worked at the Park since 2002, received regular payments from Kilpatrick, and engaged in tasks at Kilpatrick’s command. Furthermore, Kilpatrick’s assertion that Hopkins was a volunteer is without support. As the WCC succinctly stated, “[t]here is a term of art used to describe the regular exchange of money for favors—it is called ‘employment.’”

Factors considered in a “course and scope” analysis include (1) whether the activity was undertaken at the employer’s request, (2) whether the employer, directly or indirectly, compelled the employee’s attendance at the activity, (3) whether the employer controlled or par- ticipated in the activity, and (4) whether the employer and the employee mutually benefited from the activity. On November 2, 2007, Kilpatrick compelled Hopkins to work at the Park. Even though there was conflicting testimony as to whether Kilpatrick agreed that Hopkins should feed the bears on that day, an employee’s injuries are compensable unless the employee is not “attending to employment-related matters” and has abandoned the course and scope of his employment. Feeding the bears was one of Hopkins’ regular employment duties. Hopkins testified he was engaged in the “same routine” he had done for two or three years and would not have fed the bears had Kilpatrick expressly so instructed him. Feeding the bears was not a personal activity “severed” from the continuity of Hopkins’ employment-related duties at the Park. Additionally, the WCC found that “Kilpatrick benefitted from the care and feeding of the bears that Hopkins provided since presumably custom- ers are unwilling to pay cash to see dead and emaciated bears.” The WCC did not err when it concluded that Hopkins was acting in the course and scope of his employment at the time of his injuries.

Non-prescription drug consumption will preclude an injured employee’s benefits if consumption was the leading cause contributing to the result, when compared to all others. No evidence was presented regarding Hopkins’ level of impairment. The WCC aptly noted, “Hopkins’ use of marijuana to kick off a day of working around grizzly bears was ill-advised to say the least and mind-bogglingly stupid to say the most.” However, the WCC further noted that grizzlies are “equal opportunity maulers,” without regard to marijuana consumption. Without evidence of Hopkins’

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level of impairment, the WCC correctly concluded that marijuana was not the major contributing cause of Hopkins’ injuries.

Subject to exceptions that are inapplicable here, employment of a person performing services in exchange for aid or sustenance only is not covered by the Workers’ Compensation Act. The Workers’ Com- pensation Act defines aid or sustenance as a “subsidy made to provide a means of support, maintenance, or subsistence for the recipient.” Kilpatrick testified that he gave money to Hopkins, not as wages, but rather “out of his heart.” The WCC found this testimony to be with- out credibility, and the trier of fact is in the best position

to weigh the respective credibility of witnesses. The WCC did not err when it concluded that Hopkins’ ser- vices were not in exchange for aid or sustenance only.

Affirmed.

CaSe QUeStIONS

1. Why was the question of actual employment an issue?

2. What does the court mean when it says that “bears are equal opportunity maulers”?

3. Of what significance is the confusion about the duty to feed the bears?

19-4j problems in Workers’ Compensation Systems

Increasingly, states and employers are experimenting with reforms to workers’ compensation systems. Concerns focus on fraud that stems from incentives in the system. For example, medical benefits in workers’ compensation are better than most medical plans. Because nearly all disability payments are tax-free, employ- ees may be living on close to 90% of what they lived on (after taxes) before their disability.

Some doubts exist about the legitimacy of many complaints. For example, in one state, a janitor moonlighting for HGO, Inc., hurt his little finger while on the job. He collected $16,800 in disability payments over the next three years, even though he was able to continue his regular day job as a police officer.

Suggested reforms have included imposing a maximum number of years for disability payouts. Other states have hired more investigators to detect fraud. Companies are also attempting to cut costs by using staff doctors or by returning employees to other jobs that can be done despite an injury.

Workers’ compensation systems were established during the Industrial Revolu- tion, when the injuries sustained were primarily the types of factory and machinery accidents we traditionally associate with workers’ compensation claims. How- ever, the majority of jobs in the United States are now in service industries, and the nature of work-related injuries has changed from sudden-accident types to ongoing, progressive problems that are more expensive to treat and correct. For example, the repetitive hand-and-arm motions of computer keyboard operators can injure word processors, journalists, reservationists, and cashiers. This injury, often called carpal tunnel syndrome, can require expensive surgery and results in many lost workdays, if not new job assignments. Such repetitive stress injuries are the basis of many worker injuries.

The office environment itself is presenting new and difficult-to-control health-related problems for workers. Ergonomics is a rapidly growing field that examines the design of work areas and office equipment to minimize such worker injuries as repetitive motion syndromes and back problems. Archi- tects and engineers are working together to design buildings that eliminate the so-called sick-building syndrome, in which poor air quality or the lack of fresh air circulation increases the incidence of illness and causes other symptoms in office workers.

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A final issue in workers’ compensation is the relationship between the state systems and the Americans with Disabilities Act (see Chapter 20), which prohibits discrimination against employees with disabilities and requires accommodation of employer facilities to permit disabled persons to work. Traditionally, when an acci- dent caused disability, an employee collected payment in lieu of being rehired. An issue that arises as the systems of laws interact is whether an employer is required to rehire a disabled employee.

19-5 Statutory Protections of Employees Through Labor Unions

19-5a the Norris–LaGuardia act of 1932

The Norris–LaGuardia Act prohibits the use of injunctions as a remedy in labor disputes. Violent strikes can still be enjoined, provided evidence shows that vio- lence did or would have occurred and that public officers could not control the violence and any resulting damage. Injunctions cannot be issued without first holding a hearing.

19-5b the Wagner act

The Wagner Act, also known as the National Labor Relations Act of 1935 (NLRA), gave employees the right to organize and choose representatives to bargain collec- tively with their employers. Further, it established the National Labor Relations Board (NLRB), which had two functions: to conduct union elections and to inves- tigate and remedy unfair labor practices.

19-5c the taft–Hartley act: the Labor-Management Relations act of 1947

Over President Truman’s veto, Congress passed the Taft–Hartley Act, which was a response to the public’s concern about too many strikes, secondary boycotts, and the unrestrained power of union officials. Strikes to force employers to discharge nonunion employees, secondary boycotts, and strikes over work assignments are prohibited as unfair labor practices. Employees were also given the right to remove a union they no longer wanted as their representative. The act also contains provi- sions that allow the president to invoke a cooling-off period of bargaining before a strike that threatens to imperil the public health and safety can begin. This power has been used by presidents in transportation and coal strikes.

19-5d the Landrum–Griffin act: the Labor-Management Reporting and disclosure act of 1959

The Landrum–Griffin Act provides employee protection within union organiza- tions. The act gave union members a bill of rights, required certain procedures for election of officers, prescribed financial reporting requirements for union funds, and established criminal and civil penalties for union misconduct.

In the 1950s, about one-third of U.S. workers were unionized. By the 1980s, about one-fifth of U.S. workers were unionized. As of 2015, 11.1% of U.S. workers were represented by unions, with membership being strongest in government unions.

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19-5e Union Organizing efforts and Social Media

Employees have the right to communication to organize themselves. Today, that organization effort may depend on the use of social media. That form of communication should be controlled by employer policies that comply with federal standards. The following sections cover this increasingly important area of employment law.

19-5f employers are accountable for employee electronic Content

Employers are held responsible for the content of employee e-mails, and employ- ers must have access and control rights over employee information that is released publicly through various electronic means. For example, e-mails that contain off-color jokes or suggestive comments create an atmosphere of harassment.2

(See Chapter 20 for more information on sexual harassment.) Employers are also responsible when employees use e-mail or the Internet at work to violate intellec- tual property rights. Employers are accountable when employees use e-mails and blogs to defame fellow employees or competitors, vendors, or even customers.

Employee e-mail is spontaneous, candid, and discoverable. As a result, the content of employees’ e-mail is often fertile territory for prosecutors who can find evidence of intent in employee e-mails and blogs. For example, in 2008, investi- gators uncovered e-mails of employees at Standard & Poor’s, the investment rating agency, that indicated that while the employee/analysts were rating debt instruments as AAA, they were also having doubts about them. One employee wrote, “These deals could have been structured by cows and we would still rate them.”3 Another e-mail read, “Rating agencies continue to create [an] even bigger monster—the CDO market. Let’s hope we are all wealthy and retired by the time this house of cards falters.” These candid e-mails were a foundation for settlements paid by the analysts’ firms and resulted in general reforms of the analyst industry.

E-mails provide a contemporaneous record of events that often defy our recol- lections. And e-mails on a company’s computers and servers are always subject to employer review and use for purposes of disciplining employees. For example, in 2011, the indictment of former Penn State assistant football coach Jerry Sandusky for child sexual abuse resulted in questions about whether university officials had failed to report past incidents of Mr. Sandusky’s inappropriate involvement with children. The late and then–head football coach Joe Paterno denied any knowledge of a 1998 incident in the football program showers with a young boy. However, a subsequent investigation uncovered e-mails that contradicted Coach Paterno’s recollection. On May 13, 1998, Tim Curley, the university’s athletic director, sent an e-mail to Gary Schultz, a university vice president of finance and operations, with the caption “Jerry” and this message: “Anything new in this department? Coach is anxious to know where it stands.”4 Mr. Curley also requested updates on May 18 and May 30, 1998. As a result, Mr. Curley and Mr. Schultz were charged with perjury regarding their testimony of not knowing about previous incidents. The e-mail era means our own words often determine our consequences.

19-5g employer Monitoring: What is Legal?

Because they are held accountable for what employees do in cyberspace, employ- ers use various methods for monitoring employees, including random reviews of e-mails, investigations that utilize e-mail content, and even keystroking software that allows the employer to see messages that employees typed but did not send.

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Employers also limit or control employee Web access by using blocking software that limits sites that employees can visit, monitoring blogs for content, and exam- ining items posted on Facebook, Twitter, and YouTube.

In the early days of cyberspace, some efforts were made to apply the Electronic Communications Privacy Act of 1986 (ECPA), which prohibits the unauthorized access of “live” communications, as when someone uses a listening device to intercept a telephone conversation. However, e-mail and social media are stored information, and the question of this act’s application for resolving the privacy issue is doubtful.5 ECPA also has an exception for consensual intercep- tion, as when an employee consents to being monitored as a term and condition of employment.

The Stored Communication Act (SCA) prohibits the unauthorized intercep- tion of electronic communications, generally meaning stored communication, not ongoing communication such as text messaging, tweeting, and instant mes- saging. However, the courts have held consistently that employees give consent to such monitoring, and there are no statutory violations when employers do live listening, interception, or recovery of sent communication that is stored and avail- able electronically. When employers have informal policies or policies that allow employees to reimburse their employers for private use of text services, the courts have held that monitoring and disclosure of those messages is a violation of the law. City of Ontario v. Quon (Case 19.3) deals with this issue between employees and employers and their text, e-mail, and privacy policies.

City of Ontario. v Quon 560 U.S. 746 (2010)

Employees Exceeding Their Text Characters and Employers Exceeding Their Right to See the Texts

Case 19.3

FaCtS

Jeff Quon, a sergeant and member of the city of Ontar- io’s SWAT team, sent personal and sometimes racy text messages to Sergeant Steve Trujillo, dispatcher April Florio, and his wife Jerilyn Quon (respondents) using Arch Wireless text-messaging services that were pro- vided for Quon through the city.

Ontario Police Department (the city) (OPD) (peti- tioners) had no official policy directly addressing the use of text messaging. However, the city did have a general “Computer Usage, Internet, and E-mail Policy” applicable to all employees. The policy provided that all software, programs, networks, Internet, e-mail, and other systems were to be used only for city of Ontar- io-related business. The policy also said, “Users should have no expectation of privacy or confidentiality when

using these resources,” and indicated that usages were monitored and recorded. Quon attended a meeting during which SWAT team members and others were told that text messages would fall under the city’s policy as public information, and be therefore eligible for auditing.

Under the city’s contract with Arch Wireless, each pager was allotted 25,000 characters, after which the city was required to pay overage charges. Quon’s supervisor told him that he was over by more than 15,000 characters and that he should reimburse the city for the overage charges so that he (the supervi- sor) would not have to audit the transmission and see how many messages were non–work related. Quon refused to pay and was told to cut down on his transmissions.

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When Quon and another officer again exceeded the 25,000-character limit, his supervisor told the officers that he was “tired of being a bill collector with guys going over the allotted amount of characters on their text pagers.” Ontario’s chief of police, Chief Scharf, then requested an audit of the text messages.

Because city officials were not able to access the text messages themselves, they requested and obtained the messages from Arch Wireless. The audit of the messages revealed abuse of on-the-clock time through sheer num- bers of personal texts and their sexually explicit content. The officers were disciplined, and they subsequently challenged the discipline by claiming violation of their Fourth Amendment rights. The trial court found that there was a Fourth Amendment violation but granted Arch Wireless a summary judgment on Quon’s claims of invasion of privacy. The Ninth Circuit held that the search was unreasonable and the city appealed.

JUdICIaL OpINION

KENNEDY, Justice The City’s Computer Policy stated that “[u]sers should have no expectation of privacy or confidentiality when using” City computers. Chief Scharf’s memo and Duke’s statements made clear that this official policy extended to text messaging. The disagreement is over whether Duke’s later statements over-rode the official policy. Respondents contend that because Duke told Quon that an audit would be unnecessary if Quon paid for the overage, Quon reasonably could expect that the contents of his messages would remain private.

Cell phone and text message communications are so pervasive that some persons may consider them to be essential means or necessary instruments for self-expression, even self-identification. That might strengthen the case for an expectation of privacy. On the other hand, the ubiquity of those devices has made them generally affordable, so one could counter that employees who need cell phones or similar devices for personal matters can purchase and pay for their own.

Even if Quon had a reasonable expectation of privacy in his text messages, petitioners did not nec- essarily violate the Fourth Amendment by obtaining and reviewing the transcripts. Although as a general matter, warrantless searches “are per se unreasonable under the Fourth Amendment,” there are “a few spe- cifically established and well-delineated exceptions” to that general rule. The Court has held that the “‘special needs’” of the workplace justify one such exception.

The search here was reasonable under that approach. The search was justified at its inception because there were “reasonable grounds for suspecting

that the search [was] necessary for a noninvestigatory work-related purpose.” Chief Scharf ordered the search in order to determine whether the character limit on the City’s contract with Arch Wireless was sufficient to meet the City’s needs. This was, as the Ninth Circuit noted, a “legitimate work-related rationale.”

The City and OPD had a legitimate interest in ensuring that employees were not being forced to pay out of their own pockets for work-related expenses, or on the other hand that the City was not paying for extensive personal communications.

As for the scope of the search, OPD requested tran- scripts for only the months of August and September 2002. While it may have been reasonable as well for OPD to review transcripts of all the months in which Quon exceeded his allowance, it was certainly reason- able for OPD to review messages for just two months in order to obtain a large enough sample to decide whether the character limits were efficacious. And it is worth noting that during his internal affairs investiga- tion, McMahon redacted all messages Quon sent while off duty, a measure which reduced the intrusiveness of any further review of the transcripts.

Even if he could assume some level of privacy would inhere in his messages, it would not have been reasonable for Quon to conclude that his messages were in all circumstances immune from scrutiny. Quon was told that his messages were subject to auditing. As a law enforcement officer, he would or should have known that his actions were likely to come under legal scrutiny, and that this might entail an analysis of his on-the-job communications. Under the circumstances, a reasonable employee would be aware that sound management principles might require the audit of messages to determine whether the pager was being appropriately used. Given that the City issued the pagers to Quon and other SWAT Team members in order to help them more quickly respond to crises— and given that Quon had received no assurances of privacy—Quon could have anticipated that it might be necessary for the City to audit pager messages to assess the SWAT Team’s performance in particular emergency situations.

OPD’s audit of messages on Quon’s employer-pro- vided pager was not nearly as intrusive as a search of his personal e-mail account or pager, or a wiretap on his home phone line, would have been. That the search did reveal intimate details of Quon’s life does not make it unreasonable, for under the circumstances a reason- able employer would not expect that such a review would intrude on such matters.

This Court has “repeatedly refused to declare that only the ‘least intrusive’ search practicable can be

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reasonable under the Fourth Amendment.” That ratio- nale “could raise insuperable barriers to the exercise of virtually all search-and-seizure powers,” because “judges engaged in post hoc evaluations of govern- ment conduct can almost always imagine some alterna- tive means by which the objectives of the government might have been accomplished.” Even assuming there were ways that OPD could have performed the search that would have been less intrusive, it does not follow that the search as conducted was unreasonable.

Finally, the Court must consider whether the search violated the Fourth Amendment rights of Jerilyn Quon, Florio, and Trujillo, the respondents who sent text messages to Jeff Quon. Petitioners and respondents disagree whether a sender of a text message can have a reasonable expectation of privacy in a message he knowingly sends to someone’s employer-provided pager. It is not necessary to resolve this question in order to dispose of the case, however. Respondents argue that because “the search was unreasonable as to

Sergeant Quon, it was also unreasonable as to his corre- spondents.” They make no corollary argument that the search, if reasonable as to Quon, could nonetheless be unreasonable as to Quon’s correspondents. In light of this litigating position and the Court’s conclusion that the search was reasonable as to Jeff Quon, it necessarily follows that these other respondents cannot prevail.

The judgment of the Court of Appeals for the Ninth Circuit is reversed.

CaSe QUeStIONS

1. What general advice could you give a business about its access to employees’ text messages based on the decision in this case?

2. Why are alternative methods for searching the text messages not relevant?

3. How does the court deal with the issue of expec- tation of privacy on the part of the officer’s family and friends?

What Employers Should Know and Remember about Social Media Policies

1. What your employees post on the Internet can hurt you— and it can also result in liability.

2. Let your employees know that you are watching them on the Internet. Put your policies in writing. Train employees on those policies. Explain why the policies are important.

3. Use caution on drawing from the In- ternet for applicant screening—develop a policy on this issue and follow it.

4. Do monitor the blogs, websites, and other social media to which the public has access in order to detect problems as they evolve.

5. Follow state laws on requesting Facebook access.

6. Enforce your policy often and consistently.

The bottom line is, as always, be care- ful what you post. It may be personal, but it is not private.

19-5h employers’ Right of access to employee e-Mails

Employers generally require employees to sign a document in which they acknowledge that by working at the company and using the company’s e-mail and server that they have waived their right to privacy. Former Sun Microsoft Systems CEO Scott McNealy summed up employee rights to privacy when it comes to Internet use: “You have zero privacy. Get over it.”6 Despite this wide latitude, employers do not have the right to publish, release, or forward information in employee e-mails when that informa- tion is private.

The scope of employer monitoring of e-mails includes mon- itoring electronic communications from employees that are marked as private, e-mails that are sent from home and from private computers that use the company server, e-mails that do not involve company business, text messages sent using com- pany phones (as in the Quon case), and tweets sent over com- pany iPhones, BlackBerries, and other phone communication systems.

Employees should be careful when using their work lap- tops for private communications. Courts have reached differ- ent conclusions, for example, on whether employees waive their attorney–client privilege when using their work comput- ers or employer-issued cell phones to communicate with their employers. Communicating with your lawyer over the com- pany e-mail system is risky when it comes to protecting the privilege.7

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19-5I e-Mail and NLRa Issues

Employee e-mails and employer control over and responsibility for the content of those e-mails has raised some interesting NLRA issues. The NLRB released a memo explaining when employees are protected in their use of social media.8

For example, Lydia Cruz, who was a domestic violence advocate working for Hispanics United of Buffalo (HUB), frequently communicated with her coworker, Mariana Cole-Rivera. Their communications were often very critical of the job performance of other employees in HUB’s housing department. For roughly six months, Cruz complained to multiple employees and management that the employees in the housing department were not doing enough for cli- ents. Cole-Rivera, upset with Cruz’s constant criticism of coworkers, planned to meet with the executive director to discuss Cruz’s criticism. In preparation for the meeting, Cole-Rivera posted this public message on her Facebook page from home during off-work hours:

[Cole-Rivera:] Lydia Cruz, a coworker feels that we don’t help our clients enough at HUB I about had it! My fellow coworkers how do u [sic] feel?9

Four employees of HUB responded to Cole-Rivera’s posting on Facebook, and the next workday, HUB’s executive director fired Cole-Rivera and the other four employees who responded to Cole-Rivera’s initial solicitation on Facebook. The NLRB held that the employee communication from home was protected and the administrative law judge affirmed that decision, so that the employer’s actions constituted an unfair labor practice under the NLRA.10 The key to their protec- tion is that they were expressly communicating about organization—“What do you think?”

The decisions on employee e-mail communications related to union organi- zation are not consistent and continue to evolve. For example, in Paulsen v CSC Holdings, LLC, ____ F. Supp. 3d _____, 2016 WL 951535 (E.D.N.Y. 2016), the court dealt with the termination of an employee who had sent the following e-mail to her CEO:

It has been three years since I last wrote you. For a few years after your address to the TSG department and the concerns over unionization, it appeared that the unfair management and supervision practices of the department relaxed in favor of the employees. Now it appears that TSG is again reverting back to the tactics it used to dismiss employees on a regular basis.

Our customers appreciate the time and need the attention which is why Optimum always scores high marks with J.D. Powers. To begin coaching on handle time will cause many techs to once agin [sic] rush customers off the phone leading to many more repeat calls and dissatisfaction with our technical support team. For your information, the low whispers of unionization have begun in the department because the staff is feeling less secure in their positions.

The employee’s termination, following the e-mail, was for poor perfor- mance (which had been documented) as well as falsification of information on her employment application. The secretary of labor issued a complaint against CSC for an unfair labor practice in interfering with the right of employees to organize. In denying the employee’s interim reinstatement as the labor case proceeded, the court held that the activity had not yet ripened into organizing activities and that termination for documented cause was not interference with organizing activities.

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19-5j the Unionization process

Employees have the right to make the decision as to whether a union will repre- sent them and, if so, which will serve as their representative. This process is called selecting a bargaining representative, and the NLRB has strict procedures for such selection. The NLRB carefully chooses how employees will be grouped together so that they share common interests.

the Collective Bargaining Unit The first step in union organization is the establishment of a collective bargaining unit. The collective bargaining unit is a group of employees recognized by the NLRB as appropriate for exclusive representation of all employees in that group. Collective bargaining units are determined by the NLRB.

Some bargaining units consist of entire plants of workers, whereas others are specialized units within a plant, such as the maintenance staff or the line work- ers in an assembly plant. For some national companies, the bargaining unit is all employees, whereas for other national firms the bargaining unit is one particular plant or store.

the petition, Cards, and Vote Once the collective bargaining unit is set, the union, employees, or employers can file a petition for exclusive representation of employees within a unit. An employer can voluntarily recognize the union. However, if a majority of employees in the bargaining unit do not support the union, the employer can insist on a formal election.

The NLRB monitors closely the conduct of both employer and union as the election approaches. Employers can prohibit oral campaigning during work hours and can restrict literature distribution both during and, to a degree, before and after work hours. Employers cannot make threats about relocation or make speeches to captive audiences (employees on their shifts) in the 24 hours before an election. United Food v NLRB (Case 19.4) deals with the issue of appropriate conduct by employers.

United Food and Commercial Workers Union Local 24 v. NLRB 506 F.3d 1078 (D.C. Cir. 2007)

Veiled Threat or Economic Prediction?

Case 19.4

FaCtS

In March 1999, United Food and Commercial Workers’ Union (UFCW) attempted to organize a Smithfield Foods meatpacking plant in Wilson, North Carolina. After a three-month campaign, the union lost the elec- tion. The union filed a series of unfair labor practice

charges against Smithfield, alleging that the compa- ny’s antiunion campaign had tainted the election. An administrative law judge (ALJ) found that Smithfield executives violated NLRA section 8(a)(1) by threat- ening to close the company’s Wilson plant if workers unionized.

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On review, the NLRB found for Smithfield on the issues of threatened plant closure. The union appealed the NLRB’s dismissal of the unfair labor practice charges.

JUdICIaL OpINION

TATEL, Circuit Judge NLRA guarantees employees “the right to self- organization, to form, join, or assist labor organiza- tions, . . . for the purpose of collective bargaining or other mutual aid or protection.” Section 8(c), however, protects employers’ First Amendment rights to convey their views on unionization to employees so long as such expression “contains no threat of reprisal or force or promise of benefit.”

In a case like this, which deals only with predic- tions of adverse economic consequences, a two-part inquiry [is required] to distinguish “permissible predictions” from “forbidden threats.” First, did the employer predict “adverse economic consequences” as a result of unionization? If not, the inquiry ends. But if the employer made such predictions, then we proceed to the second question: did those predic- tions rest on objective facts outside the employer’s control?

Guided by these questions, we turn to the union’s claim that communications by high-level Smithfield managers during the unionization campaign consti- tuted unlawful threats of plant closure. In a series of speeches and letters designed to combat the UFCW’s unionization campaign, Plant Manager Phil Price and Smithfield President and Chief Operating Offi- cer Lewis Little repeatedly told employees that three other companies had previously operated the Wilson plant, that the UFCW had unionized the plant under each of those companies, and that each company ultimately shut down the plant. Both managers, how- ever, carefully avoided linking the previous closures directly to the union. For example, in one speech Price mentioned the three previous plant closures but made clear he had no idea whether the UFCW had caused them:

In none of these three cases did a union contract pro- vide long-term job security for employees. Maybe it was just the opposite. Maybe the union forced inflex- ible rules on these companies so that they could not compete in today’s environment. Maybe this union made it so these companies couldn’t satisfy their cus- tomers’ demands. It really doesn’t matter. Whether this union caused these other three plants to close is

not for me to say. I don’t know what happened. I do know that Smithfield wants this plant to be a success. . . .

Later in the unionization campaign, Price sent a let- ter to all Smithfield employees that again emphasized the Wilson plant’s repeated failures under previous management. Offering no prediction about the com- pany’s intentions, he stated, “I can’t predict the future, especially if the union were to get in,” and he again disclaimed any direct link between the union and the previous plant closures. Price said:

Did the UFCW cause these three companies to close the plant here on Wilco Boulevard? I don’t know the answer to that. Maybe they did, maybe not. But I can spot a bad trend. . . . The UFCW is obviously a jinx for this plant. They have struck out for Wilson employees three times. It’s time for another approach.

Finally, in an election-eve speech to employees, Smithfield President Lewis Little explained that he was “committed to the success of this plant.” Echoing Price, however, Little made no predictions: “I cannot stand here and tell you what will happen.” He concluded by urging employees not to “hang the UFCW around this plant’s neck for a fourth time.”

Based on full circumstances, the ALJ ruled that Price and Little unlawfully threatened employees by repeatedly mentioning the three previous plant clo- sures without providing a sufficient objective explana- tion for the closures.

The Board disagreed. Reviewing all the evidence “in context,” the Board, over one member’s dissent, found no threat or coercion in Price’s and Little’s statements and concluded that they merely contained “relevant, factual information about the union’s history at the facility.” The Board emphasized that the two managers “never mentioned closure” and “expressly disclaimed any certainty about the connection between the previous closures at the Wilson facility and the union.”

The union argues that an employer can violate the Act by merely suggesting that it may close a plant as a result of unionization; it need not defini- tively assert that it will do so. Placing the statements recounted above in the context of the company’s overall antiunion campaign, the union contends that the unmistakable effect of Price’s and Little’s remarks was to threaten workers with the specter of a plant shutdown.

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The Board reads the record differently. It argues that neither Price nor Little ever raised the possibility that Smithfield might shut the plant. As the Board sees it, Price and Little simply related indisputable historical facts without ever explicitly linking previ- ous plant closures to the UFCW. Under this interpre- tation of the record, case law requiring an employer to provide objective justification for a predicted plant closure—the second of the two questions established in our case law—has no applicability to this appeal because here the managers never made such a prediction.

[W]e conclude that substantial evidence sup- ports the Board’s finding that neither Price nor Little threatened to close the Wilson plant in the event of unionization. As the Board found, neither executive predicted that the company would take any partic- ular course of action, nor did either ever suggest closing the plant.

The record also reveals that when asked whether Price ever said that “the plant would close if the union got in,” one employee responded, “No, he just asked what would—what do we think would hap- pen.” Finally, in a pre-election speech to employees, Little mentioned that Smithfield had dealt with the UFCW at other plants, and told employees that in the event of a strike Smithfield would “operate the plant without” the striking workers.

In upholding the Board’s decision, we acknowl- edge that the record could be read differently. Per- haps the Board could have interpreted the managers’ statements as the union does, namely as “thinly veiled prediction[s] that electing the union a fourth time would result in closure.” Nevertheless, as the union acknowledges, it is the Board’s duty, not ours, to “focus on the question: ‘What did the speaker intend and the listener understand?’” Here, the Board determined that threats were neither intended

nor understood. Had the Board reached the opposite conclusion, we likely would have deferred to that determination as well. For, as we have previously noted, “the very existence of competing views reinforces the need for reliance on the Board’s experience.”

The union argues that the Board departed from its own precedent, specifically Eldorado Tool, Divi- sion of Quamco, Inc., 325 N.L.R.B. 222 (1997). There, the employer had displayed a poster depicting a row of tombstones bearing names of plants that had previously closed after unionization. The last tomb- stone bore the employing plant’s own name with a question mark beneath it. Although the Board con- cluded that the employer’s actions violated the Act, the case is both distinguishable and irrelevant. It’s distinguishable because there the Board found that “no member of the [employer’s] management ever sought to clarify the message, or to assure employ- ees that it was not predicting that the same fate awaited [them] as had befallen other plants,” while here the Board found exactly the opposite. [This is] nothing more than an example of the Board prop- erly exercising its judgment to interpret arguably ambiguous statements made in the employment context.

For the reasons given above, we deny the union’s petition for review.

CaSe QUeStIONS

1. What does the court find is critical in the state- ments by the managers about the future of the plant in the event of unionization?

2. Why was the Eldorado Tool decision a different outcome from this case?

3. What advice would you give plant managers when faced with a unionization effort?

Jimenez was a vocal and visible supporter of a union seeking to organize employees at the Woodcrest Health Care Center. Both the NLRB and Woodcrest filed complaints about unfair labor practices used during the election. Two weeks after the successful

election, Jimenez’s supervisor approached him while he was caring for patients. The supervisor told him that the Director of Nursing wanted to see him in her office. He obliged and went to her office, but only James Monica, an attorney for Woodcrest

Consider . . . 19.3

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Chapter 19 Management of Employee Welfare 709

Certification If a majority of employees vote for the union in a secret ballot process administered by the NLRB, the union has completed its certification. An employer who refuses to deal with the certified union can be forced to by an injunction obtained by the NLRB.

After a union has been certified, an election for a new union cannot be held for 12 months from the time of certification. If the union signs a collective bar- gaining agreement, no union certification election can be held until the collective bargaining agreement expires. These limitations on elections and certifications pre- vent chaos in the workplace that would result from constant changeovers in union representation.

Nonunion Members in the Certified Workplace Although the NLRA gave unions the right to exist, it also gave workers the right to a choice. Workers are not required to join unions and cannot be coerced into supporting union action. Attempts by a union to force its members to participate in strikes and other union activities are considered unfair labor practices. In Pat- tern Makers’ League of North America, AFL-CIO v. NLRB, 473 U.S. 95 (1985), the U.S. Supreme Court held that a union member could not be fined for his failure to participate in a strike. However, nonunion members can be required to pay dues

who said he was investigating whether any supervisors engaged in objectionable conduct in favor of the Union, was there. He handed Jimenez a form document, which Jimenez signed. The form docu- ment included the following language: “[t]he only purpose I have in interviewing you is to investigate whether any objec- tionable conduct occurred in connection with the election held here at Woodcrest on March 9, 2012 and the events leading to that election during the previous weeks and months”; “[w]e are not interested in determining whether you are for or against the Union or if, or how, you voted in the election”; and “[w]e positively assure you that you have the right to join or not to join any labor organization without fear of reprisals.”

Monica asked Jimenez whether any supervisors had been involved with the Union, had passed out cards for the Union, or had influenced him in any way to change his vote. He asked if any representative for the Union had gone to Jimenez’s house

and if Jimenez “knew any employees who were involved in a union or passing out cards.” He also asked Jimenez if he had signed a card for the Union. Jimenez refused to identify the employees who had supported the Union. Jimenez left the room but then returned, clearly upset, tore up the signed form document, and threw it in the garbage.

Five days later, Jimenez’s supervisor approached him, again while he was car- ing for patients, and informed him that Monica wished to see him in a conference room. When Jimenez arrived, Monica told Jimenez that she did not believe his an- swers during their first meeting and wanted to give him a second chance to be truthful. Monica repeated many of the same ques- tions but also asked why Jimenez wanted to form a union. Jimenez answered Moni- ca’s questions, and the interrogation ended without further incident. Any unfair labor practices here? [800 River Road Operating Co., LLC v. National Labor Relations Board, 784 F.3d 902 (3rd Cir. 2015)]

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for concerted, nonpolitical activities of the certified union in their workplaces. In Friedrichs v California Teachers Association, 136 S.Ct. 1083 (2016) because of a split court decision (4 to 4 due to the death of Justice Scalia), the lower court’s decision that nonmembers could be required to pay their “fair share” of fees for the union’s work that benefits them under their contracts but not for political activities.

19-5k Union Contract Negotiations

Once a union is certified as the employees’ representative, one of its major roles is to obtain a contract or collective bargaining agreement between employer and employees. Both sides must engage in good-faith bargaining, which the NLRB defines as a mutual obligation of employer and union to meet at reasonable times, confer in good faith on employment issues, and execute a written agreement reflecting their oral agreement. Both parties must bargain with an open mind and the sincere intent of reaching an agreement.

Two types of subject matters can be discussed during bargaining: (1) manda- tory or compulsory subject matter and (2) permissive subject matter. As to the former, the NLRA describes mandatory bargaining terms as those dealing with “wages, hours, and other terms and conditions of employment.” Obviously, the amount to be paid as wages is included but so also are related issues, such as merit pay, vacations, overtime, work hours, leaves, and paydays. Exhibit 19.3 lists the usual topics covered in a collective bargaining agreement.

Permissive subject matters, in contrast to compulsory subject matters, would be those the parties are required to negotiate but on which they need not reach an agreement. A strike vote of employees before a strike starts is an example of a permissive subject. Any topic that does not directly concern employer–employee relations is a permissive subject. A refusal to bargain on a permissive subject is not, however, an unfair labor practice; a refusal to bargain on mandatory subject matter is an unfair labor practice.

Some subjects are “unbargainable.” Employers and employees cannot bargain to give away statutory rights—for example, the procedures for certifying a union. Nor can they bargain about having a closed shop, which requires employees to be union members before they can be hired. Such shops are illegal under the Taft– Hartley Act.

Exhibit 19.3 Usual topics for a Collective Bargaining agreement

Union recognition

Wages

Work hours

Vacations

Sick leave

Seniority

Insurance

Pension/retirement plans

Employee grievances

Length of agreement/ expiration date

Incentive plans

Union announcements (bulletin board rights)

Definition of terms

Leaves of absence

Drug testing

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Failure to bargain on mandatory subject matter is an unfair labor practice, which is conduct prohibited by statute or NLRB decision. When an employer or union fails to bargain on a mandatory topic, a charge can be brought and the NLRB can proceed with a complaint.

Are insurance plans a mandatory, permis- sive, or nonbargainable topic?

THINK: The law says that the terms and conditions of employment are mandatory collective bargaining topics.

APPLY: Insurance is a term and condition of employment—it determines the level of employee benefits.

ANSWER: Insurance plans are a mandatory topic.

Now determine whether the following subjects are mandatory, permissive, or nonbargainable:

• Maternity leaves

• Plant rules

• Subcontracting procedures

• Strikes

• Layoffs

• Union bookkeeping procedures

• Meal periods

Consider . . . 19.4

19-5l protected Concerted activities

Some union activities are protected under the NLRA. Ads and handbills that explain the union’s issues and position are permitted and can be an effective tool for obtaining boycotts. Employees’ handbills and ads can encourage customers not to deal with their employer until the strike is settled. A union currently recognized as a certified collective bargaining agent can engage in picketing an employer, but picketing for recognition of a union is not permitted. The strike is the best-known and most widely used economic weapon of unions. A strike is a work stoppage because employees no longer report to work.

In recent years, unions have developed a new economic tool—contacting insti- tutional shareholders and board members to put public pressure on corporate officers to work with unions. These public-attention tactics have been effective.

19-5m Unfair employee practices

Employees are also prohibited from engaging in some activities that are classi- fied as unfair labor practices. A slowdown is an economic tool that interrupts the employer’s business but falls short of a stoppage or strike. Slowdowns usually occur when employees refuse to perform work or use certain equipment that is in violation of their collective bargaining agreement with the employer. For example, American Airlines pilots staged a slowdown by calling in sick, known as a sickout. After more than 1,000 flights per day were canceled, a federal court ordered the pilots to halt their slowdown.

Featherbedding is payment for work not actually performed. It is an unfair labor practice for a union to negotiate an agreement that requires an

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employer to pay for work that was not actually performed. For example, some bricklayers’ unions at one time required payment for a minimum num- ber of bricks even though the work might not have actually involved that many bricks.

19-5n employer Rights

Employers have the right to give information to employees about unions and the results of union organization. The speech of employers cannot be controlled by the NLRB unless the speech is accompanied by some unlawful conduct, such as a threat of physical force or a promise of benefit. For example, an employer who threatens the loss of jobs if employees join the union is not protected by the free speech rule. An employer who tells employees that it will not negotiate with a union is also not protected by the free speech rule.

Exhibit 19.4 is a summary of management do’s and don’ts when faced with an upcoming union election.

19-5o Right-to-Work Laws

Section 14(b) of the Taft–Hartley Act is in some ways a protection for employers as well as for employees. This section outlaws the closed shop, which, as discussed earlier, is a business that requires union membership before an employee can be hired. Based on this section of Taft–Hartley, states can pass right-to-work laws that give people the right to work without having to join a union. About half the states have right-to-work statutes.

Exhibit 19.4 Management do’s and don’ts in the Unionization process

dO dON’t

Tell employees about current wages and benefits and how they compare to other firms.

Promise employees pay increases or promotions if they vote against the union.

Tell employees you will use all legal means to oppose unionization.

Threaten employees with termination or discriminate when disciplining employees.

Tell employees the disadvantages of having a union (especially cost of dues, assessments, and requirements of membership).

Threaten to close down or move the company if a union is voted in.

Spy or have someone spy on union meetings.

Show employees articles about unions and negative experiences others have had elsewhere.

Make a speech to employees or groups at work within 24 hours of the election (before that, it is allowed).

Explain the unionization process to your employees accurately.

Ask employees how they plan to vote or if they have signed authorization cards.

Forbid distribution of union literature during work hours in work areas.

Urge local employees to persuade others to vote against the union (such a vote must be initiated solely by the employee).

Enforce in a consistent and fair manner disciplinary policies and rules.

Source: R. L. Mathis and J. H. Jackson, Human Resource Management, 8th ed., p. 533. © 1997. Reprinted with permission of South-Western, a part of Cengage Learning.

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Chapter 19 Management of Employee Welfare 713

Ethical Issues

Many employers are ranking employees, or “placing them in buckets” as it is commonly called, as part of their annual performance evaluations. For example, Ford Motor Com- pany, when it used this system, had 18,000 managers who were grouped into sets of 30 to 50. Of each group, 10% must be assigned an “A” grade, 80% must be assigned a “B” grade, and 10% must be given a “C” grade. Those with the bottom grades are then eased out of the company. Those with a “C” grade cannot be given a pay raise, and those with a “C” grade for two years in a row are demoted or terminated. No exceptions are made for any of the groups, but Ford did cut back on the “C” requirement to 5% in 2001 and changed the system in 2003.

Other companies with grading systems include Intel and Sun Microsystems.

Cisco Systems has established a goal of getting rid of 1 of every 20 employees, with the purpose of terminating employees who are given substandard performance evaluations.

GE had a 20–70–10 plan for ranking em- ployees. GE followed a carrot approach in that it rewarded the top 20% so well that few ever left the company. GE used the 10% group to terminate employees, and it termi- nated about 8,000 management and profes- sional employees each year. Former GE CEO Jack Welch noted that employees in the 10% bottom group would end up leaving the com- pany anyway because they were unhappy in not performing, and GE just maked the inevit- able decision for them early.

Workers’ rights groups call the systems inhumane. Some say that instead of moti- vating employees to do better, the result is that they are demoralized and do worse or leave the company.

Do these systems violate any laws? Are they a mandatory collective bargaining is- sue? Are you comfortable with them from the perspective of business ethics?

Source: Del Jones, “More Firms Cut Workers Ranked at the Bottom to Make Way for Talent,” USA Today, May 30, 2001, pp. 1B, 2B.

19-5p economic Weapons of employers

Employers have economic weapons that can be used in response to employee eco- nomic weapons. In response to union certifications and strikes, some employers have opted to close the affected plants. In some cases, employers have abandoned the business altogether. It is clear that these shutdowns and closures are strong economic weapons, and their legality under the federal labor law scheme has some restrictions. In Textile Workers Union v Darlington Manufacturing Co., 380 U.S. 263 (1965), the Supreme Court ruled that employers have the right to terminate their entire business for any reason. Even if the reason for the closing is vindictiveness toward the union, neither the NLRB nor the courts can require an employer to stay in business.

Employers cannot use a temporary closing with a promise of reopening after a union is defeated in an election. Further, employers cannot stage a runaway shop, which is when work is transferred to another plant or a new plant is opened to carry the workload of the old plant.

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The concern of the NLRB in the closing of one plant is that employees in other plants, fearful that their plants will be closed, will fail to exercise their rights to unionize. For a plant closure to be an unfair labor practice, the evidence must show that the closure was done with the intent of curbing unionization in that and other plants owned by the employer.

Federal plant-closing legislation is called the Worker Adjustment and Retraining Notification Act of 1988 (WARN). Under this act, employers with 100 or more workers are required to give workers 60 days’ advance notice of plant shutdowns that would affect at least 50 workers and of layoffs that would last more than six months and affect one-third of the workers at the site. There are some exceptions to the 60-day notice requirement, such as unforeseeable cir- cumstances and seasonal, agricultural, and construction businesses. Penalties for violations include back pay and benefits for employees for each day of vio- lation and up to $500 per day for each day notice was not given. The closing of Arthur Andersen following Enron resulted in WARN litigation, but the court held the closing was not foreseeable. [Roquet v. Arthur Andersen LLP, 398 F.3d 585 (7th Cir. 2005)]

One result of the increased globalization of business is the availability of lower-cost labor pools outside the United States. When union demands increase business costs beyond what managers feel will allow a firm to remain com- petitive, plants are closed and work is transferred to plants outside the United States. The global marketplace provides management with a bargaining tool that becomes difficult for unions to address. Demands for wage increases, more benefits, and better working conditions are often met with a plant closing in the United States and a plant opening in another country where the labor pool is large and the wages low.

A lockout is an employer ’s economic weapon in which the employer refuses to allow employees to work. Lockouts have been recognized by the U.S. Supreme Court as a legitimate measure to help an employer avoid a strike at an economically damaging time. The reason for an employer’s lockout must be economic. A lockout to discourage union membership, therefore, is an unfair labor practice.

Employers can use benefits as economic weapons; the only restriction is the timing of those benefits. Offering them too close to an election can be an unfair labor practice. Conferring benefits on a temporary basis to gain an advantage (pre- cluding the union) is also an unfair labor practice.

Bankruptcy has become a solution for many business problems, labor prob- lems among them. When strikes extend for long periods of time, the financial well- being of the firms affected can deteriorate, often to the degree that some firms declare bankruptcy. The type of bankruptcy proceedings initiated will deter- mine the fate of labor contracts. In a reorganization, the contracts remain in force. In a straight bankruptcy, the workers stand in line (although with some priority) to collect any wages due and any contributions made to the firm’s retirement plan. Bankruptcy can be an escape for a firm, but the bankruptcy laws themselves limit the availability of this economic weapon. The firm must still meet the tests for declaring bankruptcy, so the weapon is not entirely optional.

Exhibit 19.5 provides a summary of labor weapons, rights, and unfair practices.

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19-6 International Issues in Labor Today’s labor market is considerably different from the market that existed at the time of the enactment of federal labor legislation. Both operations within the United States and operations in other countries are affected by a new international labor force. Domestic operations must be certain that all employees from other countries are documented workers. International operations present numerous ethical and public policy issues in the conditions and operations of plants in other countries with different labor standards.

19-6a Immigration Laws

The fluidity of commerce across borders has found companies in the United States with employees from around the world. Employers are responsible for ensuring that their employees are properly in the United States. This section deals with immigration laws, documentation for alien employees, and the penalties for employer violations of the compliance requirements.

The Immigration and Naturalization Act (INA), the Immigration Reform and Control Act of 1986 (IRCA), and the Immigration Act of 1990 (8 U.S.C. § 11101 et seq.) are the federal laws that apply to immigrants in the United States and impose requirements on employers in the United States that employ immigrants. The Immigration Act of 1990, or IMMACT 90, increased legal immigration by 35%, enabled more family-sponsored immigration, and increased employment-based immigration while providing a “diversity” program to increase the number of

Exhibit 19.5 Union disputes: economic Weapons and Rights of employers and employees

eCONOMIC WeapONS RIGHtS UNFaIR LaBOR pRaCtICeS

eMpLOYeR Business closing

Plant closings

Lockouts

Right to confer benefits (timing)

eMpLOYee Strike

Ads

Picketing

Boycotts

Shareholders

Freedom of speech

Demand election

Freedom of speech

Right to union representation upon investigation

Right to join union

Right of members to adequate representation

Right to union office

Refusal to bargain in good faith

Refusal to bargain on a mandatory issue

Violation of collective bargaining agreement

Interference with joining union

Timing of benefits

Observation of union activities

Domination of labor union

Discrimination in promotion of union members

Blacklisting

Violation of collective bargaining agreement

Secondary boycotts

Payment for union cards

Coercion or discrimination in union membership

Causing an employer to pay excessive amounts or for work not done

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716 part 4 Business Management and Governance

immigrants from countries traditionally underrepresented in the U.S. immigrant mix (e.g., Ireland and some African countries). This program is also known as the “green card visa lottery.”

Two federal statutes cover the issues of immigration, deportation, and pen- alties for hiring illegal immigrants: the Illegal Immigration Reform and Immi- grant Responsibility Act of 1996 and the Antiterrorism and Effective Death Penalty Act (18 U.S.C. § 1). The statutes served to increase the types and numbers of crimes that rendered illegal immigrants deportable from the United States and denied them entry from other countries. The statutes also decreased the defenses to deportation as well as the procedural protections for opposing deportation. The enforcement of the immigration laws is now under a cabinet-level agency known as the U.S. Department of Homeland Security (DHS). DHS has Immigration and Customs Enforcement (ICE) as one of its reporting agencies. The Immigration and Naturalization Service (INS), originally housed within the U.S. Department of Jus- tice, was abolished, and INS’s responsibilities have been divided among separate bureaus within DHS. This reorganization and the creation and elevation of DHS to a cabinet-level position was the result of the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act (USA Patriot Act; 18 U.S.C. § 1).

With the passage of Homeland Security Act of 2002, the nature of immigration enforcement issues changed. The USA Patriot Act toughened security clearances and background checks for nonimmigrant and immigrant admittance into the United States, tightened coordination between immigration-related government agencies, and increased the U.S. government’s ability to track foreign nationals in the United States.

Before hiring a new employee, employers must verify that the employee is either a U.S. citizen or is permitted to work in the United States. All non–U.S. citizens must have an I-9 form on file with the employer. Form I-9 provides com- plete information about noncitizens and requires the employer to verify the infor- mation provided through an Alien Registration Card, commonly called a “green card.” Verification of U.S. citizenship can be provided by a driver’s license from a state in the United States, a Social Security card, or a U.S. passport. If someone with a foreign accent can provide evidence of U.S. citizenship, the employer is not permitted to question further or require additional documentation, for such questioning on the basis of the accent would be an act of discrimination under the immigration laws.

Because of lobbying from the high-tech industries, Congress has passed a series of laws that address immigration exemptions, the latest of which is the Ameri- can Competitiveness in the Twenty-First Century Act of 2000. Under this statute, employers cannot lay off American employees within the 90 days following their submission of an application for entrance and employment of one of these highly skilled workers. Referred to as H-1B professionals, their pay scale is also controlled by the act so that their pay is equivalent to what an equally skilled U.S. worker would earn in the same position. This constraint on wages eliminates the incentive for companies to hire all foreign H-1B professionals at much lower salaries. Work- ers who have H-1 visa classification have “distinguished merit and ability” and are permitted to work in the United States on a temporary basis. These types of aliens include architects, engineers, lawyers, physicians, and teachers. H-1B visas

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are limited to 65,000 per annum. L-1 visas allow companies to make intracompany transfers of employees who work in other countries on temporary assignment and seek permission from the government through their visas.

Re: the High Cost of the Failure to Comply with U.S.

Immigration Laws

For The Manager’s Desk

The tale of Agriprocessors, Inc., has nearly come to an end. However, the story of the company’s demise is a lesson in the impor- tance of following labor and employment laws. The company had received more than 12 letters in 2005 and 2006 that indicated the Social Security numbers that the company was using for its workers did not match

the information that the federal agency had in its files. The 3,000 discrepancies the agency found affected 78% of the plant’s workers. The company did not respond and the Social Security Administration stopped sending letters after 2007. The following chart shows the discrepancies the SSA found:

date SS# dISCRepaNCIeS tax YeaR

May 9, 2002 22 2001

May 19, 2005 500 2004

May 19, 2005 500 2003

May 19, 2005 500 2002

May 19, 2005 500 2001

May 19, 2005 461 2000

March 24, 2006 52 2004

March 24, 2006 42 2003

March 24, 2006 37 2002

March 24, 2006 24 2000

April 21, 2006 68 2005

May 5, 2006 500 2005

Elizabeth Billmeyer was the director of HR at the Agriprocessors, Inc., plant in Postville, Iowa, a company that has been called the largest kosher slaughterhouse in the coun- try. Federal authorities conducted a raid at

the plant in April 2008 and arrested 900 undocumented workers there.

Ms. Billmeyer was charged with conspir- acy to harbor undocumented aliens for profit and knowingly accepting false resident alien

(Continued)

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(Continued) cards. Ms. Billmeyer entered two guilty pleas to two counts, one on each charge.

In September 2008, the Iowa attorney general charged the food processor with over 9,000 violations of child labor laws. The charges focused on 32 minors who were working at the company and had been assigned work tasks or worked in areas not permitted for minors under Iowa law. The charges alleged that children under the age of 18 were exposed to poisonous chemicals and that children under 16 were employed in the operation or tending of power-driven machinery, including but not limited to con- veyor belts, meat grinders, circular saws, power washers, and power shears.

Sholom Mordechai Rubashkin was the CEO of the plant that was owned by his father, Aaron. The Rubashkins were also charged with fraud and money laundering schemes, and Sholom was convicted of 86 of the 91 charges. The media coverage of the company and the raid and arrests was so extensive that the trial had to be moved

to South Dakota. Following his conviction on the fraud charges, a federal judge dismissed the immigration charges against Sholom. He was sentenced to 27 years in prison.

The charges against Aaron Rubashkin were eventually dismissed. Five supervisors and managers entered guilty pleas to vari- ous federal charges.

Agriprocessors filed for bankruptcy in 2008, was purchased by a Canadian company, and is now known as AgriStar.

Using your textbook, go through this summary of events and list how many chap- ter topics you can find that are covered in this scenario. When you are finished, reach some conclusions about what the executives and managers could have done to avoid the com- pany’s demise and their criminal prosecution.

Sources: “H.R. Chief Pleads Guilty after Immigration Raid,” National Law Journal, April 20, 2009, p. B5; Lynda Waddington, “Agriprocessors Ignored Government Warnings for Years,” The Iowa Independent, May 24, 2008, http://www.iowaindependent.com; U.S. v Agriprocessors, 2009 WL 2255729 (N.D. Iowa).

19-6b Working Conditions and International Labor Law

Many countries do not have comparable Department of Labor or OSHA organi- zations or the experience and regulatory structures to enforce any existing laws. As a result, production is often done quite cheaply in other countries because of reduced wages and the lower costs that come from sub-par construction, ventila- tion, and hygiene. The result is that companies can only be urged to meet certain standards because, legally, they are not violating the law when these low-cost pro- duction facilities continue to produce cheaper goods.

19-6c Sample International Standards

The United Nations Commission on Human Rights has developed the Interna- tional Covenant on Economic, Social, and Cultural Rights. This covenant includes the right to work, join trade unions, enjoy leisure, earn a decent living, and receive education, medical care, and Social Security. Although this international cove- nant would carry with it the protections outlined in this chapter for U.S. workers, enforcement of the covenant is difficult. Its real strength comes through documen- tation and disclosure of its violation.

One of the most successful organs of the United Nations is the International Labour Organization (ILO). This commission, founded in 1920, continues to work to develop such principles as the right to work, to join trade unions, and to have a safe work environment. Member nations submit reports on their nation’s status and compliance with the standards of the ILO agreement.

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The National Labor Committee (NLC), an activist group, periodically releases information on conditions in foreign factories and the companies utilizing those factories.

19-6d the Risks of International Suppliers

U.S. companies’ investments in foreign manufacturing in major developing nations such as China, Indonesia, and Mexico have tripled in the past 15 years. However, new issues about the use of foreign labor and factories are emerging.

Quality of Goods produced Mattel, a company that has the majority of its inventory produced by factories in China, had to recall 70% of its inventory in 2007 because Chinese contractors had used paint on the toys that contained lead at levels prohibited in the United States. The recall of pet food because of another toxic material used in production in Chi- nese factories has required U.S. companies to rethink the foreign outsourcing pro- cess because of the damage to their brands when these massive recalls are forced on them through substandard conditions and lesser standards in other countries.

Safety Issues in production plants In a practice that is widely accepted in other countries, children ages 10 to 14 labor in factories for 50 or more hours per week. Their wages enable their families to survive. School is a luxury, and children attend only until they are able to work in a factory. For example, Foxconn, a supplier for Apple and other U.S. technology firms, made international news for its use of child labor, suicides at its plants, and the long working hours demanded of employees.

Plant safety issues in production outsourced to other countries have become a subject of intense media coverage and a focus of protests in the United States. The April 2013 collapse of a clothing factory in Bangladesh resulted in 617 deaths. The tragedy was close on the heels of a November 2012 Bangladesh fac- tory collapse that resulted in the loss of 117 lives of workers there. The site of the 2013 collapse was a building that was approved for five floors of construction, but eight floors were built. The building had never been approved for indus- trial use, but five different factories were operating in the building. Numerous inspections by government authorities found fire safety and ventilation issues, but no action was taken by either the factory owners or the government to address the industrial safety issues. On the day of the collapse, cracks in the building indicated unsafe stress and the police ordered the building closed. The banks and other offices located on the first floor of the building shut down their operations, but the factory workers were ordered to report for work. The result was a collapse that killed hundreds and found hundreds more trapped—some for up to 11 days.

These factories were the production locations for Walmart, Benetton, and NTD Apparel (a Canadian company). Inspections by monitors who provide information about production facilities to U.S. companies in May 2011 warned that the condi- tions in the Bangladesh factory required attention. After the fire in 2012, there was significant pressure from international rights groups for the companies to examine standards at their factories in Bangladesh. Benetton, despite stiff competition from Zara and other retailers on cost, has decided to pull out of Bangladesh because the country’s officials cannot seem to get their arms around conditions at the factories and the enforcement of standards.

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Wage Issues in production plants Nike is perhaps the poster child company for wage issues at factories in countries outside the United States. The effective campaign that placed its $150 shoes next to the pennies-per-hour wages of its foreign production workers resulted in boycotts of its goods as well as cancellation of its contracts with colleges and universities because of the protests of students. The reports on Nike’s factories issued by Viet- nam Labor Watch included the following: women required to run laps around the factory for wearing nonregulation shoes to work; payment of subminimum wages; physical beatings, including with shoes, by factory supervisors; and employment mostly of women between the ages of 15 and 28.

19-6e New trends in Managing International Wage and Safety Standards

The backlash against Nike as well as companies such as Apple resulted in the formation and activism of the American Apparel Manufacturers Association (AAMA), which counts 70% of all U.S. garment makers in its membership. AAMA maintains a database for its members to check labor compliance by con- tractors. In addition, the National Retail Federation has established the follow- ing statement of Principles on Supplier Legal Compliance (now signed by 250 retailers):

1. We are committed to legal compliance and ethical business practices in all of our operations.

2. We choose suppliers that we believe share that commitment. 3. In our purchase contracts, we require our suppliers to comply with all

applicable laws and regulations. 4. If it is found that a factory used by a supplier for the production of our

merchandise has committed legal violations, we will take appropriate action, which may include canceling the affected purchase contracts, terminating our relationship with the supplier, commencing legal actions against the supplier, or other actions as warranted.

5. We support law enforcement and cooperate with law enforcement authorities in the proper execution of their responsibilities.

6. We support educational efforts designed to enhance legal compliance on the part of the U.S. apparel manufacturing industry.

Some companies, including Walmart, have decided to depart from reliance on group data and have undertaken a new independent approach to confirming that their suppliers meet certain safety and wage standards. The U.S. Department of Labor has recommended that U.S. apparel importers should do more to monitor subcontractors and homeworkers (the areas where child labor violations occur) and take a more active and direct role in the monitoring and implementation of codes of conduct that the production factories sign.

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Biography Killer Whales, Workplace Safety, and Unending Litigation

On February 24, 2010, SeaWorld trainer, Dawn Brancheau, was killed by an orca whale named Tilikum during a performance. Tilikum pulled Ms. Brancheau off a platform into the pool. OSHA imposed a penalty of $70,000 on Sea World for “willful viola- tions” for its failure to recognize and train employees for the dangers of working with the whales. SeaWorld appealed the penalty, but it was upheld by an appellate court. [SeaWorld of Florida, LLC v, Perez, 748 F.3d 1202 (D.C. Cir. 2014)]

Following Ms. Brancheau’s death, the sheriff’s office, which conducted its inves- tigation of the death, found a tape that in- cluded portions of the fatal attack. The DOL obtained the tape for use in its investigation and a Freedom of Information Act (FOIA) request to make the tapes available for the public was opposed by Ms. Brancheau’s family as well as by SeaWorld. [Brancheau v. Secretary of Labor, 2012 WL 1072227 (M.D. Fla. 2012)] SeaWorld intervened to have the tape declared private commercial property that could not be revealed under FOIA. The court found that there was no private right of action for such copyright claims and that because DOL had not released the tape, the court could not take jurisdiction under a copyright claim. With regard to the family, the court found that the death scene materials were not pro- tected under any FOIA statutes and were not “records” for purposes of applying the Privacy Act to prevent release. [Brancheau v. Secretary of Labor, 2011 WL 4105047 (M.D. Fla. 2011)]

There was also ongoing litigation that involved SeaWorld and the rights of pro- testors outside their Florida facilities. The protestors were animal rights activists de- manding that SeaWorld stop the breeding and raising of orca whales in captivity. The death of Ms. Brancheau intensified both the protests and the litigation.

The death of Ms. Brancheau also intensified the so-called marketing litigation

against SeaWorld. There were several class actions that focused on SeaWorld’s failure to fully disclose information about the condition and treatments of whales, information that would have caused them to not purchase SeaWorld tickets. [Wirth v. Mars, 2016 WL 471234 (C.D. Cal.)], Ander­ son v. SeaWorld Parks and Entertainment, Inc., 2016 WL 125510 (N.D. Cal. 2016)], and Nguyen v. Lopez, 2015 WL 9308285 (S.D. Cal. 2015)]

The documentary “Blackfish,” about whales in captivity, was featured at the Sundance Film Festival in 2013 and went on to theaters and then CNN and Netflix. The film’s message is that killer whales should not be used for entertainment purposes, and the film heightened protests and emo- tions about the whales at SeaWorld.

The film resulted in SeaWorld filing a complaint with the Department of Labor (DOL) because it discovered that the DOL employee in charge of the 2010 Bran- cheau investigation, Laura A. Padgett, was allegedly leaking confidential doc- uments to the film makers and having close relationships with animal rights activists. The complaint contains copies of posts Ms. Padgett made on social me- dia cheering on the activists and the film. For example, one post on her Facebook site linked to a story, “‘Blackfish’ on the move in Europe,” and added her com- ment, “Wow—take that Sea World!!!! They’ve got to be nervous now.” The complaint contains photos of Ms. Pafgett with the film’s producers at Sundance and other film events and also notes that Ms. Padgett attended both the debut of the film at Sundance and its New York premiere when it went to the box office. The complaint cites the provisions of the department’s ethical code that prohibits employees from using their position to benefit those with whom they are pri- vately affiliated or to imply an endorsement for a particular work, activity, or event.

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The film’s producers indicate that Ms. Padgett’s attendance was simply to see how her agency was depicted in the film.

The Department of Labor will review the current complaint, and, depending on its findings, SeaWorld will have the right of appeal to the federal circuit court for D.C., its third run to the courts in the case.

In March 2016, SeaWorld’s CEO, Joel Manby, read a statement during an earn- ings phone call that acknowledged that several SeaWorld employees had gone undercover to infiltrate PETA’s ranks. The activities of the SeaWorld employees were not known to the board, and the board put a halt to this program.

In the week before the earnings call, the CEO had announced the departure of Sea- World’s chief zoologist as well as its chief of parks operations. During 2015, SeaWor- ld’s stock dropped 30%, attendance at their parks declined significantly, and the March 2016 disclosures caused an additional 11% drop in the stock price.

SeaWorld has not terminated the individual who authorized the infiltration of PETA, but it has hired the firm of former FBI director Louis Freeh to investigate its security practices. PETA discovered that the mailbox used as the address for the Sea World employee in joining PETA was a mailbox registered to Sea World’s director of security in San Diego.

The employee who infiltrated PETA is on paid administrative leave. The employ- ment law aspects of the case present interesting questions. PETA is demanding

the employee’s termination, but if the employee was acting at the direction of a Sea World manager, then the termination cannot be classified as one for cause. Sea World is left with a delicate situation in trying to honor the employee’s rights while at the same time facing the public relations problems the employee’s actions have created.

The actions of the employee could be classified as industrial espionage, but the employee was not trying to gain trade secrets, just information as well as promote activities for PETA with regard to Sea World. There are series of tweets and messages that indicate the Sea World employee may have been inciting PETA to take action against Sea World; for example, in one message, the Sea World employee wrote, “Who wants to come with me in 2018 to drain the new tanks at #seaworld before they put the whales in them. if [sic] you build them I can drain them.” The Sea World employee had also urged protestors to “burn it [Sea World] to the ground.”

On March 17, 2016, SeaWorld seemed to surrender. It announced that it would no longer breed orca whales. When its final orca in the current SeaWorld herd dies, the orca shows end. With the estimate that it will take decades for the end of the last whale comes another prediction: SeaWorld may have all of its litigation finished by then as well.

Sources: Michael Cieply, “SeaWorld Questions Ethics of ‘Blackfish’ Investigator,” New York Times, February 28, 2014, p. B1; “SeaWorld Flips Stance on Orcas,” Wall Street Journal, March 18, 2016, p. B1.

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s u m m a r y What wage and hour protections exist for employees?

• Fair Labor Standards Act (FSLA)—federal law that regulates minimum wage and overtime pay

• Minimum wage—federal hourly rate of pay

• Overtime pay—rate of 1½ times the hourly rate for hours over 40 per week worked

• Equal Pay Act—equal wages for equal work regard- less of gender

• Child labor standards—restrictions on hours and types of work for children under the age of 18

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What protections exist for safety in the workplace?

• Occupational Safety and Health Act—federal law setting and enforcing workplace safety standards

• Occupational Safety and Health Administration (OSHA)—federal agency responsible for safety in the workplace

• Drug testing—screening of employees for impairment

What happens when a worker is injured in the workplace?

• Workers’ compensation—state-by-state system of employer strict liability for injuries of workers on the job; the few exceptions to recovery include self-in- flicted injuries

What is the Social Security system, and what benefits does it provide?

• Social Security Act—federal law establishing disabil- ity, beneficiary, and retirement benefits

• Federal Insurance Contributions Act (FICA)—statute establishing system for withholding contributions for Social Security benefits

Are workers entitled to pensions, and are they regulated?

• Employment Retirement Income Security Act (ERISA)—federal law regulating employer- sponsored pension plans

• Pension Protection Plan of 2006

What rights do unemployed workers have?

• Unemployment compensation—federal program handled by states to provide temporary support for displaced workers

• Workers’ compensation—system of no-fault liability for employees injured on the job

How are labor unions formed, and what is their relationship with employees?

• Norris–LaGuardia Act—federal law prohibiting injunctions to halt strikes

• National Labor Relations Act (Wagner Act)–federal law authorizing employee unionization

• Labor Management Relations Act (Taft–Hartley Act)—federal law limiting union economic- weapons

• Labor-Management Reporting and Disclosure Act (Landrum–Griffin Act)—federal law regulating union membership and organizations

• National Labor Relations Board (NLRB)—federal agency responsible for enforcing labor laws

• Collective bargaining unit—group of employees recognized as exclusive bargaining agent

• Certification—recognition of union as exclusive bargaining agent

• Collective bargaining agreement—exclusive rights agreement between employer and employee

• Good-faith bargaining—requirement that parties negotiate terms in earnest

• Unfair labor practice—conduct by labor or manage- ment prohibited by statute

• Concerted activities—union-sponsored activities

• Picketing—public appearance of striking union members

• Boycotts—refusal to work for or to buy from or han- dle products of an employer

• Slowdown—workers report to job but do not operate at full speed

• Right-to-work laws—right to work at a company without being required to join a union

• Worker Adjustment and Retraining Notification Act (WARN)—federal law requiring employers to give 60 days’ notice of plant shutdowns

• Lockout—employer closure of plant or business so workers cannot work

What are the laws and procedures related to immigrants and employment?

• Immigration and Naturalization Act (INA)

• Immigration Reform and Control Act of 1986 (IRCA)

• Immigration Act of 1990

• Illegal Immigration Reform and Immigrant Respon- sibility Act of 1996

• Antiterrorism and Effective Death Penalty Act

• Uniting and Strengthening America by Prov- ing Appropriate Tools Required to Intercept and Obstruct Terrorism Act (USA Patriot Act)

• The Homeland Security Act

• American Competitiveness in the Twenty-First Century Act of 2000

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1. Whirlpool, a manufacturer of household appliances, uses a system of overhead conveyor belts to send a con- stant stream of parts to employees on the line throughout the plant. Beneath the conveyor belt is a netting or mesh screen to catch any parts or other objects that might fall from the conveyor belt.

Some items did fall to the mesh screen, located some 20 feet above the plant floor. Maintenance employees had the responsibility for removing the parts and other debris from the screen. They usually stood on the iron frames of the mesh screen, but occasionally they found it necessary to go onto the screen itself. While one main- tenance employee was standing on the mesh, it broke, and he fell the 20 feet to his death on the floor below. After this fatal accident, maintenance employees were prohibited from standing on the mesh screen or the iron frames. A mobile platform and long hooks were used to remove objects.

Two maintenance employees, Virgil Deemer and Thomas Cornwell, complained about the screen and its safety problems. When the plant foreman refused to make corrections, Mr. Deemer and Mr. Cornwell asked for the name of an OSHA inspector, and Mr. Deemer contacted an OSHA official on July 7, 1974.

On July 8, 1974, Mr. Deemer and Mr. Cornwell reported for work and were told to do their mainte- nance work on the screen in the usual manner. Both refused on safety grounds, so the plant foreman sent them to the personnel office. They were then forced to punch out and were not paid for the six hours left on their shift.

Explain Mr. Deemer and Mr. Cornwall’s rights under OSHA. [Whirlpool Corporation v Marshall, 445 U.S. 1 (1980)]

2. Supervisors at Walmart asked employees to work off the clock, erase hours from their time cards, and not take lunch and other breaks. Determine whether there would be any FLSA violations if the employees voluntarily agreed to do what the supervisors requested.

3. Joe Ortiz was discharged from Magma Copper Co. for absenteeism. He missed the last shift of work before he was fired because he was temporarily in custody fol- lowing an arrest for a criminal offense. He filed for unem- ployment but was denied. Mr. Ortiz said he notified Magma that he was missing because of being detained in jail. The unemployment compensation agency says Mr. Ortiz is disqualified for benefits because he was fired for misconduct. Who is right? [Magma Copper v Department of Employment Security, 625 P.2d 935 (Ariz. 1981)]

4. Casimer Gacioch began working for Stroh Brewery on February 24, 1947. When he began his work for Stroh, he was predisposed to alcoholism, but he had not yet become an uncontrolled alcoholic.

Beer was provided free at the brewery and was avail- able to all employees on the job. This availability had been negotiated through a collective bargaining agree- ment. Employees could drink beer during their breaks and at lunch with no limit on the amount.

Mr. Gacioch did not drink at home during the week but drank three or four bottles of beer on the weekend. At work, he drank 12 bottles a day. He was not a test taster; he ran a machine that fed cases of beer to a soaker.

He became an alcoholic, was intoxicated on the job, and could not perform his work. He was fired on August 30, 1974.

Mr. Gacioch pursued a workers’ compensation claim against Stroh because the free-beer policy accelerated his problem. Explain whether he is entitled to worker’s compensation. [Gacioch v Stroh Brewery Co., 396 N.W.2d 1 (Mich. 1990)]

5. Janice W. Craig was employed by Drenberg and Associates, an insurance agency. About the time she started to work, Drenberg began a year of explosive growth. Under normal conditions, an agency with 400,000 accounts could expect to acquire approximately 40,000 new accounts in the period of a year. Drenberg grew from 400,000 to 1,200,000 in just over one year. Craig and the agency’s employees worked many over- time hours.

Mrs. Craig was a conscientious perfectionist. She also took over a part of the commercial desk, handling correspondence, renewals, and changes. She was under constant pressure.

In April 1975, Drenberg purchased another agency, thereby acquiring 500 new accounts and an additional employee. Mrs. Craig was given responsibility for super- vising the new employee and merging the books of the two agencies. The additional responsibility and mount- ing pressure began to affect her. She began to feel frus- trated and ineffective. She experienced difficulty relating to her coworkers and on occasions had heated exchanges with customers. On September 25, 1975, she engaged in a particularly emotional telephone conversation with one of the agency’s customers, after which she eventu- ally left the office in tears.

In addition to Mrs. Craig’s difficulties at the office, she was experiencing domestic disharmony. She and her husband argued frequently concerning his drinking

Q u e s t i o n s a n d P r o b l e m s

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Chapter 19 Management of Employee Welfare 725

habits. She encountered difficulties in relating to her daughters, and her mother’s death caused additional internal pressures. On the evening of September 25, 1975, the Craigs again argued, following which she took an overdose of medication.

The following day she sought help at the Tri- City Mental Hospital and was subsequently admit- ted to Camelback Hospital, where her condition was diagnosed as neurotic depression, or a mental breakdown.

Mrs. Craig filed a claim for worker ’s compensa- tion. Explain whether Mrs. Craig should receive work- ers’ compensation. [Fireman’s Fund Ins. Co. v Industrial Comm’n, 579 P.2d 555 (Ariz. 1979)]

6. Felix Santos, Carlos Garcia, and Jose A. Valdes Prieto were stock persons for Cuba Tropical, Inc., a supermarket supplier. They regularly worked over 40 hours per week, but they were not paid overtime. They brought suit to recover their overtime pay against Cuba Tropical as well as Jose L. Rodriguez, a co-owner of Cuba Tropical. Mr. Rodriguez has no control over the hiring and firing of employers, does not establish their working hours, and did not visit the warehouse where the three employees worked. He hired managers for the business and had them handle the day-to-day operations. He was required to sign certain documents for the corporation, but he did not sign any checks personally. Can Mr. Rodriguez be held personally liable for the overtime wages that are due to the three men? [Santos v Cuba Tropical, Inc., 829 F. Supp. 2d 1304 (S.D. Fla. 2011)]

7. An employee of Walmart worked at the store on the night restocking crew. For security reasons, the manager of the store implemented a policy of locking all doors leading into and out of the store at the close of the business day. Only management personnel had keys to the store and no one in management worked on the night crew. Consequently, employees on the night crew were locked in the store without a key to exit the building until it opened the following day.

While working one night, the employee suffered a stroke and collapsed, unconscious. When the emergency medical personnel arrived, approximately six minutes later, they were unable to enter the store because no one on the night crew had a key to the door. By the time the emergency crew was able to assist the employee, they were unable to revive her. The deceased employee was taken to the hospital where she was declared brain dead, and after 15 hours, the life support systems to which she was connected were discontinued. Subsequently, the executor of her estate and guardian for her child filed suit against Wal-Mart for unlawful false imprisonment. The trial court granted Wal-Mart’s motion for summary

judgment, and the executor/guardian appealed. How should the appellate court decide the case and why? [Bryant v Wal-Mart Stores, Inc., 417 S.E.2d 688 (Ga. App. 1992)]

8. Boeing Company has long built many of its planes in the Puget Sound region in Washington, using a unionized workforce. In October 2009, Boeing CEO Jim McNerney announced that Boeing would be diversifying its labor force by moving production for its new 787 Dreamliner Jumbo Jet to a new plant in South Carolina due to “strikes happening every three to four years in Puget Sound.” South Carolina is a right-to-work state. Mr. McNerney added that Boeing needed stability in production for its new jet in order to meet order demands, and the move to South Carolina would reduce Boeing’s “vulnerability to delivery disruptions caused by work stoppages.”

In April 2011, just two months prior to the ribbon-cutting ceremony for the South Carolina facility, the National Labor Relations Board (NLRB) issued a complaint against Boeing. The complaint charged Boeing with unfair labor practices because its decision to build the plant and move the 787 Dreamliner work to South Carolina interfered with the rights of employees guaranteed under the National Labor Relations Act (NLRA). Is the transfer of work from a unionized plant because of strikes an unfair labor practice? May an employer consider costs in making its decision to transfer work from a unionized plant? Would the transfer of work from a plant have a chilling effect on employee rights to unionize? To strike? What would happen if employers could not transfer work from plants for cost reasons?

9. A group of exotic dancers at several clubs in the San Fernando Valley of California brought a class action suit against their employers, the club owners, for the follow- ing violations of labor law:

• Failure to provide meal breaks

• Failure to provide rest breaks

• Club managers taking 50% of the dancers’ tips, which resulted in some dancers earning less than the minimum wage for hours worked

• Failure to reimburse dancers for the costs of their uniforms

The club owners acknowledge that the dancers worked over 40 hours each week but that they were pro- fessionals and not subject to the provisions of the FLSA. The club owners also claim that the dancers work on a type of commission basis and so are not covered by the minimum wage law. Are labor law violations going on at the clubs? Are you able to respond to the defenses that the club owners raised?

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10. Dawnmarie Souza was fired from American Med- ical Response (AMR) after using vulgarities to ridicule her supervisor in a Facebook posting. Souza also wrote, using the company’s terminology for a psychiatric patient: “Love how the company allows a 17 to become

a supervisor.” (17 is the company’s code for a psychiatric patient.) Ms. Souza filed a complaint with the NLRB for AMR’s retaliatory conduct and interference with her right to organize fellow employees. What can employees post about their employers in social media and on the Internet?

Economics & the Law The Cost of the Cheap Shirt

Economists warn about quick fixes for wages and the imposition of U.S. safety standards on foreign factories. They offer the following figures to illustrate that the issue of labor conditions in other countries is complex.

In Bangladesh, clothing factories get about $6.75 per shirt. These are the factory costs:11

$4.75 for the fabric and thread

$1.00 for the shirt’s labels

$0.38 wage costs for each shirt (workers earn $70 to $80 a month)

$0.15 per shirt for laundering

That leaves $0.47 per shirt for facilities, shipment, marketing, and perhaps the interest on loans. The cost of living in Bangladesh is $40 per month for rent, and food per adult is $13 per month. Milk for a child

is $5 per month. Those who work in the factories are generally the main wage earners in their families because no other jobs pay as well.

Given this analysis, where do you see some fixes for the safety and wage issues? What needs to be done besides instituting codes of ethics and factory and labor standards?

n ot e s 1. For more information on the history of employment law, see the Instructor’s Manual.

2. See Garrity v. John Hancock Mut. Life Ins. Co., 2002 WL 974676 (D. Mass. 2002) (memorandum opinion), in which an employer ‘s termination of an employee for sending an e-mail entitled “The Top Ten Reasons Cookie Dough Is Better Than Men” was upheld on grounds that such content created an atmosphere of harassment. An employer was held liable for its failure to take action against an employee who used a company computer to post nude photographs of his daughter. [Doe v. XYC Corp., 887 A.2d 1156 (N.J. Super.Ct. 2005)]

3. Summary Report of Issues Identified in the Commission’s Examination of Select Credit Rating Agencies, July 8, 2008.

4. Freeh Sporkin Sullivan, LLP, Report of the Special Investigative Counsel Regarding the Actions of the Pennsylvania State University Related to the Child Sexual Abuse Committed by Gerald A. Sandusky (2012), at p. 4.

5. “Every circuit court to have considered the matter has held that an ‘intercept’ under the ECPA must occur contemporaneously with transmission.” [Fraser. v Nationwide Mut. Ins. Co., 352 F.3d 107, 113 (3rd Cir. 2003)]

6. A. Michael Froomkin, “The Death of Privacy,” 52 Stanford Law Review, 1461, 1462 (2000). Presented at the Cyberspace and Privacy: A New Legal Paradigm? Symposium, Stanford, CA, 2000.

7. Scott v. Beth Israel Med. Ctr., 847 N.Y.S.2d 436 (2007).

8. NLRB, Office of Gen. Counsel, Div. of Operations-Mgmt., OM 11-74, Report of the Acting Gen. Counsel Concerning Social Media Cases (Aug. 18, 2011).

9. Hispanics United, 2011 WL 3894520, slip op. at 6.

10. Hispanics United of Buffalo, Inc., No. 3-CA-27872, 2011 WL 3894520 (N.L.R.B. Div. of Judges Sept. 2, 2011).

11. Thanks to Rubana Huk, “The Economics of a $6.75 Shirt,” Wall Street Journal, May 17, 2013, p. A15, for his cost figures.

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Chapter

Management Employment Discrimination20 Few employers have remained unaffected by the impact of antidiscrimination laws and cases.

This chapter answers the following questions: What laws governing employ- ment discrimination exist? What types of discrimination exist? Are there any defenses to discrimination? What penalties or damages can be imposed for violations?

Update For up-to-date legal news, go to mariannejennings.com

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20-1 History of Employment Discrimination Law Protections against employment discrimination are strictly statutory. Common law afforded employees no protection against discrimination. Indeed, common law viewed the entire employment relationship as a private contractual matter that should be free from judicial interference.1

Notwithstanding the Civil Rights Acts of 1866 and 1870, the first effective anti- discrimination employment statute was a long time in coming. The first federal leg- islation to deal directly with the issue of discrimination was the Equal Pay Act of 1963 (see Chapter 19 for more details). The statutory right to equality was expanded beyond the issue of pay less than a year later by Title VII of the Civil Rights Act of 1964. Title VII is the basis for discrimination law and judicial decisions in such mat- ters. Although it has been amended many times, its basic purpose is to prohibit dis- crimination in employment on the basis of race, color, religion, sex, or national origin.

Title VII was first amended by the Equal Employment Opportunity Act of 1972. This amendment gave the act’s enforcer, the Equal Employment Opportu- nity Commission (EEOC), greater powers—for example, the right to file suits in federal district court. In 1975, Title VII was again amended, with the Pregnancy Discrimination Act, which defined “sex” discrimination to include discrimination on the basis of pregnancy and childbirth.

Laws have also been enacted to protect against discrimination because of age or handicap. Discrimination on the basis of age was prohibited by the Age Discrimination in Employment Act of 1967 (discussed later in this chapter). Under

I have a dream that one day this nation will rise up and live out the true meaning of its creed: “We hold these truths to be self-evident; that all men are created equal.” I have a dream . . . I have a dream that my four little children will one day live in a nation where they will not be judged by the color of their skin but by the content of their character. I have a dream. . . . Dr. Martin Luther King Jr.

Nature of Complaint

Number of Complaints

Total 88,778 Race 31,073 Sex 26,027 Disabilities 25,369 Age 20,588 National origin 9,579 Religion 3,549 Equal pay 938 eeOC 2014 Data On eMpLOyMent DisCriMinatiOn Cases

Lydia Gonzalez, 58, worked as a reporter at El Nuevo Dia, a Puerto Rican newspaper. Her supervisor, Maria Luisa Ferre, often said that Ms. Gonzalez’s demeanor and cou- ture were “[o]ut of style” and “colorless” and that her coiffure was “like Phyllis Diller.” Ms. Ferre also said that Ms. Gonzalez was old-fashioned (i.e., “manias de vieja,” or “old person’s ways”) and that she should have retired and gone to live with her grandchildren in Florida long ago.

Ms. Gonzalez asked to cover fashion shows, and when Ms. Ferre balked at the idea, Ms. Gonzalez responded, “You want me to look like a Vogue model?” Ms. Ferre simply stared and assigned younger reporters to cover the fashion shows.

Ms. Gonzalez was terminated shortly after. Follow- ing her termination, Ms. Gonzalez filed suit for age dis- crimination. Can she recover?

Consider . . . 20.1

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the Rehabilitation Act of 1973, federal contractors are prohibited from discriminat- ing against certain employees in performing their contracts. With the Americans with Disabilities Act (ADA), passed in 1990, employers of 15 or more employees are prohibited from discriminating against employees with disabilities and are required to make reasonable accommodations for qualified employees with disabil- ities. Although the substance of the existing antidiscrimination laws remains, the Civil Rights Act of 1991 made significant changes in procedural aspects of Title VII litigation. There has been a series of federal laws that address specific problems in discrimination at a more detailed level and they are described in Exhibit 20.1, which provides a summary of federal legislation to date.

Exhibit 20.1 employment discrimination Statutory Scheme

StatUte date pROVISIONS

Civil Rights Acts of 1866 and 1870 42 U.S.C. § 1981

1866 1870

Prohibited intentional discrimination based on race, color, national origin, or ethnicity; permit lawsuits

Equal Pay Act 29 U.S.C. § 206

1963 Prohibits paying workers of one sex different wages from the other when the jobs involve substantially similar skill, effort, and responsibility; Wage and Hour Division of Department of Labor enforces; private lawsuits permitted; double damage recovery for up to three years’ wages plus attorney fees

Civil Rights Act of 1964 42 U.S.C. § 1981

1964 Outlaws all employment discrimination on the basis of race, color, religion, sex, or national origin; applies to hiring, pay, work conditions, promotions, discipline, and discharge; EEOC enforces; private lawsuits permitted; costs and attorney fees recoverable

Age Discrimination in Employment Act 42 U.S.C. § 6101

1967 Prohibits employment discrimination because of age against employees over 40 and mandatory retirement restrictions; EEOC enforces; private lawsuits permitted; attorney fees and costs recoverable

Equal Employment Opportunity Act 42 U.S.C. § 2000

1972 Expanded enforcement power of EEOC

Rehabilitation Act 29 U.S.C. § 701

1973 Prohibits employment discrimination on the basis of handicaps

Pregnancy Discrimination Act 42 U.S.C. § 2000e

1975 Prohibits discrimination on the basis of pregnancy and childbirth

Americans with Disabilities Act 42 U.S.C. § 12101

1990 Prohibits discrimination against those with covered disabilities (plus 2008 amendments)

Civil Rights Act of 1991 42 U.S.C. § 1981

1991 Clarifies disparate impact suit requirements; clarifies the meaning of “business necessity” and “job related”; changes some Supreme Court decisions (Wards Cove); punitive damage recovery

Glass Ceiling Act 42 U.S.C. § 2000e

1991 Creates commission to study barriers to women entering management and decision-making positions

Family and Medical Leave Act 29 U.S.C. § 26

1993 Establishes 12 weeks of unpaid leave for medical or family reasons

Title II of the Genetic Information Nondiscrimination Act of 2008 42 U.S.C. § 2000ff

2008 Prohibits employment discrimination based on genetic information about an applicant, employee, or former employee

Lilly Ledbetter Fair Pay Act (2009) 42 USC § 2000a

2009 Changes the recovery period for back wages to the EEOC standard that existed prior to the decision in Ledbetter v Goodyear Tire & Rubber Co., Inc., 550 U.S. 618 (2007); each paycheck triggers a new 180-day filing period regardless of when the discrimination began

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In addition to this legislation, several executive orders that apply to admin- istrative agencies (see Chapter 6) have been issued. These orders require federal government contractors to institute, among other things, affirmative action pro- grams in their labor forces.

20-2 Employment Discrimination: Title VII of the Civil Rights Act

Title VII of the Civil Rights Act of 1964—also known as the Fair Employment Practices Act—as amended in 1991, prohibits discrimination in all areas of employment on the basis of race, color, religion, national origin, and sex (including pregnancy, childbirth, or abortion). Other acts prohibit discrimination based on physical disability or age.

20-2a application of title VII

Groups Covered Title VII does not apply to all employers but is limited to the following groups:

1. Employers with at least 15 workers during each working day in each of 20 or more calendar weeks in the current or preceding year (state antidiscrimina- tion statutes may apply to employers with fewer than employees).

2. Labor unions that have members at companies that meet the employer standard or operate a hiring hall that refers workers to covered employers.

3. Employment agencies that procure workers for an employer who is covered by the law.

4. Any labor union or employment agency, provided it has 15 or more employees. Companies should note, however, that even if they do not meet the minimum size requirements for federal laws, state antidiscrimination laws most likely do apply to their operations and employment practices.

20-2b employment procedures Covered

Every step in the employment process is covered by Title VII. Hiring, compensa- tion, training programs, promotion, demotion, transfer, fringe benefits, employer rules, working conditions, and dismissals are all covered. In the case of an employ- ment agency, the system for the agency’s job referrals is also covered.

20-3 Theories of Discrimination Under Title VII Three basic but not mutually exclusive theories of discrimination under Title VII include disparate treatment, disparate impact, and pattern or practice of discrimination.

20-3a disparate treatment

The most common form of discrimination at the time Title VII was passed was treating employees of one race or sex differently from employees of another race or sex. This different, or disparate, treatment results in unlawful discrimination when an individual is treated less favorably than other employees because of race, color, religion, national origin, or sex. The U.S. Supreme Court established the elements required to be shown to establish disparate treatment under Title VII in McDonnell

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Douglas Corp. v. Green, 411 U.S. 792 (1973). The case involved the rights of a black mechanic who had been laid off during a general workforce reduction and then not rehired. McDonnell claimed Mr. Green was not rehired because of his partici- pation in a lock-in at the plant to protest racial inequality. Mr. Green brought suit for a Title VII violation, and the Supreme Court established the following elements as a prima facie case for discrimination:

1. The plaintiff belongs to a racial minority. 2. The plaintiff applied for and was qualified for a job with the employee. 3. The plaintiff, despite job qualifications, was rejected. 4. After the plaintiff’s rejection, the job remained open and the employer

continued to seek applicants.

These same elements can be applied to other forms of discrimination by just substi- tuting, for example, “The plaintiff belongs to a protected age group” or “The plaintiff has a disability.” The employer has the burden of proof to show that the employment decision was made for a nondiscriminatory reason. That burden arises when the employee-plaintiff establishes the four elements set out in Green. For example, a com- pany may have retained a male supervisor when it terminated a female supervisor, but if the company can show that, because of reductions in force, it needed managers with broader experience and the male supervisor had that experience, the decision is not discriminatory. Chescheir v. Liberty Mutual Ins. Co. (Case 20.1) deals with an issue of disparate treatment and proof of discrimination in an employment decision.

Chescheir v. Liberty Mutual Ins. Co. 713 F.2d 1142 (5th Cir. 1983)

Why Can He Go to Law School but I Can’t? The Case of the Law Student Claims Adjuster

Case 20.1

FaCtS

Liberty Mutual Insurance Company has a rule prohibiting its adjusters and first-year supervisors from attending law school. This “law school rule” was proposed and implemented on a national basis by Edmund Carr, a vice president and general claims manager, in November 1972.

Joan Chescheir (plaintiff) was hired by Liberty Mutu- al’s Dallas office in March 1973 as a claims adjuster. In January 1975, she voluntarily resigned but in June of that year was hired in Liberty’s Houston office as a claims adjuster.

In August 1976, Wyatt Trainer, the claims manager at the Houston office, received an anonymous letter informing him that Ms. Chescheir was attending law school. After consulting with his assistants and supe- rior, Mr. Trainer fired her after she admitted she was attending law school.

Charity O’Connell also worked in the Houston office as a claims adjuster during the same period Ms. Chescheir did. During a coffee break with a

new employee, Timothy Schwirtz (also an adjuster), Ms. O’Connell relayed the story of Ms. Chescheir’s fir- ing. Mr. Schwirtz then said, “Oh, that’s strange, because when I was hired, when Wells [Southwest Division claims manager] interviewed me, he told me that I could go to law school and in fact if I came down to the Houston office, there were law schools in Houston.” Ms. O’Connell then went to her supervisor and told him she also was attending law school. She refused to quit law school and was fired.

William McCarthy, Liberty’s house counsel in its Houston office, attended law school while working as an adjuster and was retained as house counsel upon his graduation. The trial court found that Mr. McCarthy’s supervisors were aware of his contemporaneous law school career. Alvin Dwayne White was employed as an adjuster in Liberty’s Fort Worth office and asked for a transfer to Houston so he could attend law school. He was given the transfer and attended law school in Houston. James Ballard worked as an adjuster in Houston, attended

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Chapter 20 Management: Employment Discrimination 733

law school, and was promoted to supervisor while in law school. Supervisors and employees were aware of his law school attendance, but the law school rule was not enforced against him. In short, none of the male employ- ees known to have been attending law school was fired.

Ms. Chescheir and Ms. O’Connell both filed com- plaints with the EEOC, were given right of suit letters, and filed suit in federal district court. After a lengthy trial, the court found that Liberty Mutual had violated Title VII. Both women were given back pay. Liberty Mutual appealed.

JUdICIal OpINION

GOLDBERG, Circuit Judge Title VII applies . . . not only to the more blatant forms of discrimination, but also to subtler forms, such as discriminatory enforcement of work rules.

The four-part test for demonstrating a prima facie case for discriminatory discharge due to unequal impo- sition of discipline [is]:

1. That plaintiff was a member of a protected group;

2. That there was a company policy or practice concerning the activity for which he or she was discharged;

3. That nonminority employees either were given the benefit of a lenient company practice or were not held to compliance with a strict company policy; and

4. That the minority employee was disciplined either without the application of a lenient policy, or in conformity with the strict one.

Of course, if an employer is unaware that a non- minority employee is in violation of company policy, the absence of discipline does not demonstrate a more lenient policy. It follows from this that if an employer applies a rule differently to people it believes are differ- ently situated, no discriminatory intent has been shown.

It is clear that the plaintiffs are members of a protected group and that there was a company policy or practice concerning the activity for which the plaintiffs were dis- charged; thus the first two elements of the test are met. It is also clear that minority employees were disciplined with- out the application of a lenient policy, and in conformity with a strict policy. All women known to violate the law school rule were immediately discharged. Furthermore, even potential violations of the rule by women were inves- tigated promptly. An anonymous letter was sufficient to trigger an investigation of Chescheir, and the fact that Chescheir was attending law school moved the company to interrogate another woman.

The only remaining element of the prima facie case is a finding that male employees either were given the

benefit of a lenient company practice or were not held to compliance with a strict company policy. This is the element upon which Liberty Mutual focuses its attack. Recasting Liberty Mutual’s argument slightly, it claims that other males were strictly disciplined in accord with the law school rule, and that Liberty Mutual never knew that McCarthy, White, and Ballard were attending law school. Thus, claims Liberty Mutual, the third element was not met.

We are not persuaded. First, our review of the record does not disclose any males in the Southwest Division who were discharged because of the law school rule. Second, even were we to accept Liberty Mutual’s conten- tion that it did not actually know McCarthy, White, and Ballard were attending law school, we would still affirm the judgment. The operative question is merely whether Liberty Mutual applied a more liberal standard to male employees. The district court found that there were wide- spread rumors that McCarthy and Ballard were attending law school. Also, the EEOC notified Liberty Mutual that a male adjuster was attending law school (Ballard) and requested an explanation. Key managerial employees, at a minimum, suspected McCarthy was attending law school but preferred not to ask and confirm their suspi- cions. One male adjuster was told when he was hired that he could attend law school. In contrast to Liberty Mutu- al’s energetic investigation of women it believed might be attending law school, Liberty Mutual never investigated any of these allegations, suspicions, or rumors about male adjusters. The case of Mr. White is even more dramatic. After he expressed a desire to transfer to Houston in order to attend law school, that transfer was granted and he was never told he could not attend law school.

The preceding facts are more than enough to sup- port the third leg [of the test]. Males at Liberty Mutual were subject to lenient enforcement of the law school rule. The district court’s ultimate finding of fact that Liberty Mutual applied its law school rule discrimina- torily finds firm support in the record; all four elements of the prima facie case are present.

Once Chescheir and O’Connell established a prima facie case of discrimination, the burden shifted to Liberty Mutual to present a justification. The district court found that Liberty Mutual offered no justification. Accordingly, the judgment of the district court is affirmed.

CaSe QUeStIONS

1. Had any male employees ever been fired under the rule?

2. Were there examples of disparate use of the rule?

3. Give an example of some facts that would have supported a defense theory that there were non- discriminatory reasons for the terminations.

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20-3b disparate Impact

Many employment hiring, promoting, and firing practices are not intentionally discriminatory. In fact, the basis for such decisions may be quite rational. Even so, the effect or impact of many employment standards is to discriminate against par- ticular races or on the basis of sex.

In one case, the Alabama prison system had a minimum height requirement of 5 feet 2 inches and a minimum weight requirement of 120 pounds for all of its “correctional counselors” (prison guards). The impact of the rule was to exclude many females and very few males. [Dothard v. Rawlinson, 433 U.S. 321 (1977)] Although the rule had a purpose other than one of discrimination, namely, making sure guards were large enough to perform their jobs, the effect of the rule was to exclude women from the job position.

Disparate impact cases do not require the four steps of proof outlined in the Green case. Rather, the proof required in disparate impact cases is a statistical showing of the impact of an employment practice.

The 1991 amendments to the Civil Rights Act require a plaintiff to establish that a practice or practices have a disparate impact on a protected class. The bur- den then shifts to the employer to show “business necessity” for the practice. The employer must show that the practice is “job related for the position in question and consistent with business necessity.” However, disparate impact cases cannot be based on an analysis of only the demographics of the labor market; the proper comparison is between the skilled labor force (as defined by the position in ques- tion) and those actually holding the position.

In November, 1980, Kathryn Davis Matthews was hired by A-1, Inc., a mobile home sales company, as a sales associate. She was the only female sales associate in the Lubbock, Texas, office. She was fired on July 11, 1981, for (1) violating company policy prohibiting “moonlighting” and (2) tardiness and absen- teeism. Her “moonlighting” activity was selling Mary Kay cosmetics. A-1’s manager, Wayne Swinney, listed three examples of Ms. Matthew’s absenteeism: (1) when her mother was ill, (2) when she went to the hair- dresser, and (3) when she had car trouble.

Male associates in the office with tar- diness and absenteeism problems were counseled and, in some instances, had documentation placed in their files. Male associates were permitted to leave on per- sonal errands and to go to the barbershop. Two of the office’s male associates engaged in some “moonlighting” activity, even on company time. They were both given an exemp tion from the company rule. No male employees were terminated for tardiness and

absenteeism unless there also was a problem with their productivity. Ms. Matthews had no problems with productivity given in her dis- charge notice. Ms. Matthews filed suit for discrimination. Does she have the elements of a sex discrimination case? [Matthews v. A-1, Inc., 748 F.2d 975 (5th Cir. 1984)]

THINK: The rulings in Green and Chescheir are that employers cannot treat those who are members of different groups or pro- tected classes (race, gender, religion) using different standards or rules, with the result being that the members of the nonprotect- ed group are hired or retained, while those in the protected class are not.

APPLY: A-1 did not apply the same stan- dard to all employees. Male employees were given more latitude on absences and A-1 was inconsistent in the application of its moonlighting policy.

ANSWER: The treatment was disparate and constituted discrimination.

Consider . . . 20.2

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Chapter 20 Management: Employment Discrimination 735

Ricci v DeStefano (Case 20.2) is a landmark U.S. Supreme Court decision on the issue of testing and disparate impact. The case focuses on an area of active litiga- tion in employment discrimination—the validity of employer skill and knowledge tests for hiring and promoting.

Ricci v. DeStefano 557 U.S. 557 (2009)

Fighting Fire with Stats

Case 20.2

FaCtS

In 2003, 118 firefighters in the city of New Haven, Con- necticut, took examinations to qualify for promotion to the rank of lieutenant or captain. Promotion exam- inations in New Haven (City) were infrequent, so the stakes were high. Exam results determined which fire- fighters would be considered for promotions during the next two years, and their order for consideration. Many firefighters, including Frank Ricci, studied for months, at considerable personal and financial cost.

The examination results showed that white can- didates had outperformed minority candidates. Seventy-seven candidates completed the lieutenant examination—43 whites, 19 blacks, and 15 Hispan- ics. Of those, 34 candidates passed—25 whites, six blacks, and three Hispanics. Eight lieutenant posi- tions were vacant at the time of the examination, which meant that the top 10 candidates were eligible for an immediate promotion to lieutenant. All 10 were white. Subsequent vacancies would have allowed at least three black candidates to be considered for promotion to lieutenant.

Forty-one candidates completed the captain examination—25 whites, eight blacks, and eight His- panics. Of those, 22 candidates passed—16 whites, three blacks, and three Hispanics. Seven captain posi- tions were vacant at the time of the examination. Nine candidates were eligible for an immediate promotion to captain—seven whites and two Hispanics.

Following a briefing on the exam results, the mayor and other local politicians opened a public debate on the results that turned rancorous. The firefight- ers argued that the test results should be discarded because the results were discriminatory. Some firefight- ers threatened a discrimination lawsuit if the city made the promotions on the basis of the tests. Other fire- fighters said the exams were neutral and fair, and they, in turn, threatened a discrimination lawsuit if the city, relying on the statistical racial disparity, ignored the test results and denied promotions to the candidates

who had performed well. In the end, the city took the side of those who protested the test results. It threw out the examination results. Mr. Ricci and others filed suit.

The federal district court found that there was dis- crimination against the white and Hispanic firefighters, and the city (respondents) appealed. The appellate court reversed the district court’s decision.2 The firefighters (petitioners) appealed to the U.S. Supreme Court.

JUdICIal OpINION

KENNEDY, Justice The City’s actions would violate the disparate- treat- ment prohibition of Title VII absent some valid defense. All the evidence demonstrates that the City chose not to certify the examination results because of the statistical disparity based on race—i.e., how minority candidates had performed when compared to white candidates. As the District Court put it, the City rejected the test results because “too many whites and not enough minorities would be promoted were the lists to be certified.” With- out some other justification, this express, race-based decision making violates Title VII’s command that employers cannot take adverse employment actions because of an individual’s race.

Whatever the City’s ultimate aim—however well intentioned or benevolent it might have seemed—the City made its employment decision because of race. The City rejected the test results solely because the higher scoring candidates were white. The question is not whether that conduct was discriminatory but whether the City had a lawful justification for its race-based action.

Allowing employers to violate the disparate-treat- ment prohibition based on a mere good-faith fear of disparate-impact liability would encourage race-based action at the slightest hint of disparate impact. A min- imal standard could cause employers to discard the results of lawful and beneficial promotional exam- inations even where there is little if any evidence of disparate-impact discrimination. That would amount

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to a de facto quota system, in which a “focus on sta- tistics  . . . could put undue pressure on employers to adopt inappropriate prophylactic measures.”

Congress has imposed liability on employers for unintentional discrimination in order to rid the work- place of “practices that are fair in form, but discrimina- tory in operation.” But it has also prohibited employers from taking adverse employment actions “because of” race. Applying the strong-basis-in-evidence standard to Title VII gives effect to both the disparate-treatment and disparate-impact provisions, allowing violations of one in the name of compliance with the other only in certain, narrow circumstances. The standard leaves ample room for employers’ voluntary compliance efforts, which are essential to the statutory scheme and to Congress’s efforts to eradicate workplace discrim- ination. And the standard appropriately constrains employers’ discretion in making race-based decisions: It limits that discretion to cases in which there is a strong basis in evidence of disparate-impact liability, but it is not so restrictive that it allows employers to act only when there is a provable, actual violation.

Examinations like those administered by the City create legitimate expectations on the part of those who took the tests. As is the case with any promotion exam, some of the firefighters here invested substantial time, money, and personal commitment in preparing for the tests. Employment tests can be an important part of a neutral selection system that safeguards against the very racial animosities Title VII was intended to prevent. Here, however, the firefighters saw their efforts invalidated by the City in sole reliance upon race-based statistics.

If an employer cannot rescore a test based on the candidates’ race, then it follows a fortiori that it may not take the greater step of discarding the test altogeth- er to achieve a more desirable racial distribution of promotion-eligible candidates—absent a strong basis in evidence that the test was deficient and that dis- carding the results is necessary to avoid violating the disparate-impact provision. Restricting an employer’s ability to discard test results (and thereby discriminate against qualified candidates on the basis of their race) also is in keeping with Title VII’s express protection of bona fide promotional examinations.

For the foregoing reasons, we adopt the strong- basis-in-evidence standard as a matter of statutory construction to resolve any conflict between the disparate-treatment and disparate-impact provisions of Title VII.

The City argues that, even under the strong-basis- in-evidence standard, its decision to discard the exam- ination results was permissible under Title VII. That is incorrect. Even if respondents were motivated as a subjective matter by a desire to avoid committing dis- parate-impact discrimination, the record makes clear there is no support for the conclusion that respondents had an objective, strong basis in evidence to find the tests inadequate, with some consequent disparate- impact liability in violation of Title VII.

On the record before us, there is no genuine dis- pute that the City lacked a strong basis in evidence to believe it would face disparate-impact liability if it certified the examination results. In other words, there is no evidence—let alone the required strong basis in evidence—that the tests were flawed because they were not job-related or because other, equally valid and less discriminatory tests were available to the City. Fear of litigation alone cannot justify an employer’s reliance on race to the detriment of individuals who passed the examinations and qualified for promotions. The City’s discarding the test results was impermissible under Title VII, and summary judgment is appropriate for petitioners on their disparate-treatment claim.

Our statutory holding does not address the con- stitutionality of the measures taken here in purported compliance with Title VII. We also do not hold that meeting the strong-basis-in-evidence standard would satisfy the Equal Protection Clause in a future case.

Reversed.

CaSe QUeStIONS

1. Explain what happened on the exam and why the city decided to toss the exam results.

2. What does the court establish as the law applica- ble to “tossing” exam results?

3. What is the court trying to balance in interpreting the law?

disparate Impact and Class action Suits One of the realities of discrimination litigation is that those who allege discrimina- tion must find the resources to pursue their claims. In other areas of law, the class action suit has been a way for a large group of plaintiffs to establish their claims with little or no individual costs for litigation. In Dukes v. Wal-Mart Stores, 603 F.3d 571 (9th Cir. 2010), the female employees of Wal-Mart filed suit under Title VII of the 1964 Civil Rights Act alleging that women employed in Wal-Mart stores (1) are

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Chapter 20 Management: Employment Discrimination 737

paid less than men in comparable positions, despite having higher performance ratings and greater seniority, and (2) receive fewer promotions to in-store manage- ment positions than do men, and those who are promoted must wait longer than their male counterparts to advance.

The statistical evidence cited was the approximate percentages of women in specific hourly and salaried management positions as follows:

Salaried Positions

• Store manager—14% • Co-manager (only in larger stores)—23% • Assistant manager—36%

Hourly Positions

• Management trainee—42% • Support manager—50% • Department manager—78% • Customer service manager—85% to 90% • Other hourly positions—70%

Wal-Mart challenged the case (brought on behalf of 1.5 million women employed at Wal-Mart, the largest employment class action suit ever filed) on the grounds that mere statistics do not establish a Title VII violation. The U.S. Supreme Court held that class actions are not appropriate for these statistics-based cases suits when the claims are monetary because the individual plaintiffs’ claims are quite different depending upon their job circumstances and individual employment histories. [Wal-Mart Stores, Inc. v. Dukes, 564 U.S. 338 (2011)] However, a lower court has cer- tified a class action for female employees claiming disparate treatment in pay and promotion solely on the basis of general numbers. [Dukes v. Wal-Mart Stores, Inc., 222 F.R.D. 137 (N.D. Cal. 2014)] The Dukes case continues its saga with the most recent partial summary judgment granted for Wal-Mart but still allowing several disparate impact claims. The judge noted, “This case, fourteen years and counting, lives to fight another day.” [Dukes v. Wal-Mart Stores, Inc., 2015 WL 3623481 (N.D. Cal. 2015)] Resolution of class actions and disparate impact cases will require an additional U.S. Supreme Court decision(s).

20-3c pattern or practice of discrimination

The “pattern or practice” theory involves discrimination not against one person but, rather, against a group or class of persons (e.g., women or African-Americans).

The standards for establishing a pattern or practice of discrimination are affected by the 1991 amendments to the Civil Rights Act; the burdens of proof are those discussed under disparate impact, with a “reasonable justification” defense for employers. The plaintiff must show causation between the practice of the employer and the disparate impact. In pattern or practice cases, the initial burden of proof of discrimination is on the plaintiff or the EEOC. For example, in one case that immediately preceded the 1991 amendments, the Seventh Circuit found that a company was not discriminating because the plaintiff’s established low percentage of African-Americans in its workforce was due to its location in a Hispanic neighborhood and not because of its practice of hiring by word

Tests have become tricky for employers. Those who allege discrimination do not need to prove that there is anything dis- criminatory about the test. They need only allege that the employer did not choose a test with the least impact on protected classes. Employers that use testing will need to re- view the results of the tests and use caution in their use of those results as well as in the continuing use of the test for screening.

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of mouth. [EEOC v. Chicago Miniature Lamp Works, 947 F.2d 292 (7th Cir. 1991)] Commuting distance is one factor that can be used to explain the structure of an employer’s work force. [Bolden v. Walsh Group, 2012 WL 1079898 (N.D. Ill. 2012)]

FAPS, Inc., is a company located in Port Newark, New Jersey. FAPS operates an auto processing facility, work that involves storing autos and then transporting them to dealerships. FAPS relied on word of mouth to obtain employees. Many of its appli- cants came from current employees who saw the postings for available jobs near the time clock at the company’s dock fa- cilities. FAPS did place ads on Craigslist, at technical schools, and through the Newark OneStop Program. All applicants for FAPS

positions must have a waterfront card, which requires a screening process and the payment of a fee. FAPS cannot accept an application from anyone who does not have a waterfront card. From 2003 to 2008, FAPS hired 12 African-Americans and 263 non–African-Americans. The EEOC filed a complaint against FAPS for discrimination. Discuss the possible basis for the com- plaint, what the EEOC must establish, and what FAPS needs to prove. [EEOC v.. FAPS, Inc., 2014 WL 4798802 (D.N.J.)]

Consider . . . 20.3

20-4 Specific Applications of Title VII The various theories of Title VII discrimination apply to specific types of discrim- ination. The following sections cover these types of discrimination and Title VII’s application to them.

20-4a Sex discrimination

Although Title VII included sex discrimination in its prohibitions, its presence and effects were not as obviously in existence as the more blatant racial discrimination. Many of the initial discrimination suits were brought in response to “protective legislation,” which consisted of state statutes that prohibited women from work- ing in certain fields and occupations for safety reasons. The reasons for such pro- hibitions were that the jobs were too strenuous, too dangerous, or too stressful. Because the effect of the statutes was to keep women from certain higher-paying occupations and men from certain female-dominated jobs, the EEOC issued guide- lines providing that employers guilty of discrimination could not use these statu- tory cloaks. The Dothard v. Rawlinson case [433 U.S. 321 (1977)] discussed earlier is an example of a sex discrimination case.

A prima facie case of sex discrimination by an employer requires proof of the same elements established in the Green case. The only difference is that the issue of rejection, firing, or demotion is based on sex rather than race.

Other, more subtle hints of discrimination have slowly been eliminated from every area of employment. Even job listings in classified ads cannot carry any sex- ual preference. For example, an employer cannot advertise for just a “waitress”; the ad must be for a “waiter/waitress.” Further, state laws and company policies that prohibit women from working during certain hours if they have school-age children are violations of Title VII.

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Chapter 20 Management: Employment Discrimination 739

Sexual Harassment Sexual harassment is a violation of Title VII of the Civil Rights Act. Company pol- icies on this issue should attempt to make it clear that an environment of harass- ment is not appropriate for any employee. Companies should also enforce policies uniformly.

Sexual harassment cases take two forms. In quid pro quo cases, an employee is required to submit to sexual advances in order to remain employed, secure a pro- motion, or obtain a raise. In the other—atmosphere of harassment cases—the invita- tions, language, pictures, or suggestions become so pervasive as to create a hostile work environment.

Quid Pro Quo Harassment. This form of harassment occurs when someone in a position of authority in the workplace has made sexual advances to an employee that carry the threat of employer sanctions if the employee does not accept the advances. While a supervisor may be the individual who initiates the quid pro quo advance, the company or employer of the supervisor may also be liable for the supervisor’s conduct in certain circumstances. Burlington Industries, Inc. v. Ellerth (Case 20.3) deals with the issue of when an employer is vicariously liable for the sexual harassment of one of its employees by another employee.

Burlington Industries, Inc. v Ellerth 524 U.S. 742 (1998)

The Boorish Supervisor Meets Vicarious Liability

Case 20.3

FaCtS

Kimberly Ellerth (respondent) worked as a salesperson in one of Burlington’s divisions from March 1993 to May 1994. During her employment, she reported to a midlevel manager, Ted Slowik. Ms. Ellerth worked in a two-person office in Chicago and was one of Burling- ton’s 22,000 employees. Mr. Slowik was based in New York but was responsible for Ms. Ellerth’s office. The following incidents of boorish and offensive behavior occurred during Ms. Ellerth’s employment.

Summer 1993

While on a business trip, Ms. Ellerth accepted Mr. Slowik’s invitation to the hotel lounge. Mr. Slowik made remarks about Ms. Ellerth’s breasts, told her to “loosen up,” and said, “You know, Kim, I could make your life very hard or very easy at Burlington.”

March 1994 Ms. Ellerth was being considered for a promotion, and Mr. Slowik expressed concern during the interview that she was not “loose enough.” Mr. Slowik then reached out and rubbed her knee.

March 1994 Mr. Slowik called Ms. Ellerth to give her the promotion and said, “You’re gonna be out there with men who work in factories, and they certainly like women with pretty butts/legs.”

May 1994 Ms. Ellerth called Mr. Slowik for permission to insert a logo into a fabric sample. Mr. Slowik said, “I don’t have time for you right now, Kim—unless you want to tell me what you’re wearing.” Ms. Ellerth ended the call.

May 1994 Ms. Ellerth called again for permission, and Mr. Slowik said, “Are you wearing shorter skirts yet, Kim, because it would make your job a whole heck of a lot easier.”

In May 1994, the supervisor in the Chicago office cautioned Ms. Ellerth about returning phone calls. Ms.  Ellerth quit and faxed a letter giving reasons for her decision unrelated to the alleged sexual harass- ment. Three weeks later, however, she sent another letter complaining of Mr. Slowik’s behavior.

During her employment at Burlington, Ms. Ellerth did not tell anyone about Mr. Slowik’s behavior. She

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chose not to tell her supervisor in the Chicago office because, “It would be his duty as my supervisor to report any incidents of sexual harassment.”

Ms. Ellerth filed suit against Burlington for viola- tion of Title VII in that the sexual harassment forced her constructive discharge.

The District Court found Mr. Slowik’s behavior created a hostile work environment but found that Burlington neither knew nor should have known about the conduct. The Court of Appeals reversed, with eight separate opinions imposing vicarious liability on Burl- ington. Burlington appealed.

JUdICIal OpINION

KENNEDY, Justice The terms quid pro quo and hostile work environment are helpful, perhaps, in making a rough demarcation between cases in which threats are carried out and those where they are not or are absent altogether, but beyond this are of limited utility.

We do not suggest the terms quid pro quo and hostile work environment are irrelevant to Title VII litigation. When a plaintiff proves that a tangible employment action resulted from a refusal to submit to a supervi- sor’s sexual demands, he or she establishes that the employment decision itself constitutes a change in the terms and conditions of employment that is actionable under Title VII. Because Ellerth’s claim involves only unfulfilled threats, it should be categorized as a hostile work environment claim which requires a showing of severe or pervasive conduct.

We must decide, then, whether an employer has vicarious liability when a supervisor creates a hostile work environment by making explicit threats to alter a subordinate’s terms or conditions of employment, based on sex, but does not fulfill the threat. We turn to principles of agency law, for the term “employer” is defined under Title VII to include “agents.” We rely “on the general common law of agency, rather than on the law of any particular State, to give meaning to these terms.”. . .

The general rule is that sexual harassment by a super- visor is not conduct within the scope of employment.

Scope of employment does not define the only basis for employer liability under agency principles. In limited circumstances, agency principles impose liabil- ity on employers even where employees commit torts outside the scope of employment.

In a sense, most workplace tortfeasors are aided in accomplishing their tortious objective by the existence of the agency relation: Proximity and regular contact may afford a captive pool of potential victims.

Tangible employment actions are the means by which the supervisor brings the official power of the enterprise to bear on subordinates.

For these reasons, a tangible employment action taken by the supervisor becomes for Title VII purposes the act of the employer. An employer is subject to vicarious lia- bility to a victimized employee for an actionable hostile environment created by a supervisor with immediate (or successively higher) authority over the employee. When no tangible employment action is taken, a defending employer may raise an affirmative defense to liability or damages, subject to proof by a preponderance of the evidence. The defense comprises two necessary elements: (a) that the employer exercised reasonable care to prevent and correct promptly any sexually harassing behavior, and (b) that the plaintiff employee unreasonably failed to take advantage of any preventive or corrective opportu- nities provided by the employer or to avoid harm other- wise. While proof that an employer had promulgated an anti-harassment policy with complaint procedure is not necessary in every instance as a matter of law, the need for a stated policy suitable to the employment circumstances may appropriately be addressed in any case when litigat- ing the first element of the defense. And while proof that an employee failed to fulfill the corresponding obligation of reasonable care to avoid harm is not limited to showing any unreasonable failure to use any complaint procedure provided by the employer, a demonstration of such failure will normally suffice to satisfy the employer’s burden under the second element of the defense. No affirmative defense is available, however, when the supervisor’s harassment culminates in a tangible employment action, such as discharge, demotion, or undesirable reassignment.

Affirmed.

dISSeNtING OpINION

Justice THOMAS, with whom Justice SCALIA joins, dissenting

The Court today manufactures a rule that employ- ers are vicariously liable if supervisors create a sexually hostile work environment, subject to an affirmative defense that the Court barely attempts to define. . . .

Sexual harassment is simply not something that employers can wholly prevent without taking extraordi- nary measures—constant video and audio surveillance, for example—that would revolutionize the workplace in a manner incompatible with a free society. Indeed, such measures could not even detect incidents of harassment such as the comments Slowik allegedly made to respon- dent in a hotel bar. The most that employers can be charged with, therefore, is a duty to act reasonably under the circumstances.

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The Court’s holding does guarantee one result: There will be more and more litigation to clarify appli- cable legal rules in an area in which both practitioners and the courts have long been begging for guidance. . . .

Popular misconceptions notwithstanding, sexual harassment is not a freestanding federal tort, but a form of employment discrimination. As such, it should be treated no differently (and certainly no better) than the other forms of harassment that are illegal under Title VII. I would restore parallel treatment of employer liability for racial and sexual harassment and hold an employer

liable for a hostile work environment only if the employ- er is truly at fault. I therefore respectfully dissent.

Case Questions

1. When will an employer be held liable (i.e., vicari- ously liable) for sexual harassment despite a lack of actual knowledge?

2. What is the liability of a company for harassment of an employee by an immediate supervisor?

3. What major issues does the dissenting opinion raise?

Atmosphere of Harassment. Unwanted advances are one type of sexual harassment. However, sexual harassment can also exist when the atmosphere of the workplace becomes one of sexual tone or suggestion. Derogatory, suggestive, and offensive e-mails and electronic bulletin boards on servers sponsored by an employer can be the basis for a hostile environment sexual harassment suit. Employers not only have the responsibility to prohibit employees from posting such materials; they also have a responsibility to supervise such bulletin boards and e-mails to be cer- tain that no atmosphere of harassment results from the contents. Under Oncale v. Sundowner Offshore Services, Inc., both opposite-sex and same-sex sexual harass- ment is actionable under Title VII. [523 U.S. 75 (1998)]

Further, in litigation over such materials, plaintiffs may rely on printed copies of the materials and messages in establishing their cases even though the materials may have already been deleted from the company system.

Determine whether the following would constitute sexual harassment (either quid pro quo or atmosphere of harassment) un- der Title VII:

1. A manager who referred to female cus- tomers as “bitchy” or “dumb” flirted with an employee’s female relatives and told of spending a weekend at a nudist camp [Gleason v. Mesirow Financial, Inc., 118 R.3d 1134 (7th Cir. 1997)]

2. A manager who told a single, pregnant female employee that he disapproved of premarital sex [Brill v. Lante, 119 R.3d 1266 (7th Cir. 1997)]

3. A manager commenting to an employee that he liked his suits and touching the suits and instructing the employee to appear in a body fat contest at a sales meeting in St. Kitt’s. During the

body fat contest, the manager told the employee that he looked good in a Speedo and attempted to touch his buttocks. [McElroy v. American Family Insurance Co., 51 F. Supp. 3d 1093 (D. Utah 2015)]

4. A coworker making comments about sexual orientation and offering invi- tations to “drag shows.” [Fugett v. Security Transport Services, Inc., 147 F. Supp. 3d 1216 (D. Kan. 2015)]

5. A supervisor who referred to the archi- tecture of a shopping mall as looking like “two hooters” and a “bra bazaar” while having dinner with an employee on a business trip [Penry v. Federal Home Loan Bank of Topeka, 970 F. Supp. 833 (D. Kan. 1997)]

Consider . . . 20.4

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For The Manager’s Desk

Re: Romance at Work

A great many married couples met at work. From Barack and Michele Obama to Bill and Melinda Gates to Brad Pitt and Angelina Jolie, romance befalls many at work, wheth- er they are working at a software company, a law firm, or making a movie together. Romance is even more prevalent among the less famous. The data indicate that 39% of us have dated a coworker. There is one question to ask as a follow-up: “Were your employers aware of the dating?”

Employers cannot control when and where Cupid’s arrow may strike, but they do need to have rules and policies in place to deal with the potential issues that can arise from workplace romances.

Some rules can help both employers and their employees. The goal for employers is to prevent issues of favoritism and sexual harassment. Along the way, the employers’ rules may save an employee from a broken heart. A few sample rules that companies use for purposes of avoiding the pitfalls of office romance follow:

1. Some companies simply prohibit employees who work together from having a relationship. Such a rule can be problematic because employees have the relationship anyway and simply hide it from the employer as other employees gossip. Often, companies accompany this policy with a policy on finding one member of the couple a different position outside the division or office where both met and are currently working.

2. Some companies prohibit relationships between employees when one reports to the other. For example, when Barack worked as a summer intern at the same law firm as Michele, she

was his supervisor. Many companies would require a transfer or that one leave the firm.

3. Some companies follow this rule: dis- close to your supervisor that you are having a romantic relationship with a coworker. The purpose of such disclo- sure is for the supervisor to determine whether there are any issues with conflicts or if an adjustment needs to be made because of reporting lines—that is, two employees who are dating should not be in a direct report relationship. Some companies do not permit even indirect reportees to date supervisors. These companies work to find one of the employees a different position in the company outside the direct or indirect reporting lines.

4. Most companies remind employees that a consensual relationship that goes south can very often turn into allegations of sexual harassment. Employees are cautioned to proceed within company rules for their own protection. Some companies have what is called a “love contract” that the two employees sign upon disclo- sure of their relationship so that there is a written record that there is a con- sensual relationship—a protection for both the employer and the employees against sexual harassment charges.

5. Although most companies do not address the issue directly, an adulter- ous relationship between two employ- ees is generally a career killer, at least within the company. During the past year, two CEOs of major firms have had to depart following disclosures of their affairs with employees.

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Chapter 20 Management: Employment Discrimination 743

Sex discrimination and pensions Another area of sex discrimination in employment involves the statistical fact that women live longer than men. It costs more for a female employee to have a pen- sion than a male employee because she will likely live longer after retirement. In City of Los Angeles Department of Water v. Manhart, 435 U.S. 702 (1978), the Supreme Court held that employers could not require female employees to contribute more to their pension plans than males. The additional contributions for the female employees were required by the employer because the pension planner had statis- tical evidence that longevity of female employees exceeded that of male employ- ees. If the Supreme Court had sanctioned the disparity in pension plan payments, the higher cost of having female employees could have been cited by employers as the reason for their hiring practices.

the pregnancy discrimination act This act, which revolutionized maternity issues in the employment world, prohib- its an employer from forcing someone to resign because of a pregnancy, refusing to allow a mother to return to work after her pregnancy is completed, providing dif- ferent benefits for sick leaves than for pregnancy, and refusing to hire or promote someone because of pregnancy or family plans.

The landmark case International Union v. Johnson Controls, Inc. (Case 20.4) focuses on some nuances in sex discrimination issues.

International Union v. Johnson Controls, Inc. 499 U.S. 187 (1991)

The Acid Test for Women: The Right to Choose High-Risk Jobs

Case 20.4

FaCtS

Johnson Controls, Inc. (respondent), manufactures bat- teries. In the manufacturing process, the element lead is a primary ingredient. Occupational exposure to lead entails health risks, including the risk of harm to any fetus carried by a female employee.

Before the Civil Rights Act of 1964 became law, Johnson Controls did not employ any woman in a battery-manufacturing job. In June 1977, however, it announced its first official policy concerning its employment of women in jobs with lead exposure risk:

[P]rotection of the health of the unborn child is the immediate and direct responsibility of the prospective parents. While the medical profession and the company can support them in the exercise of this responsibility, it cannot assume it for them without simultaneously infringing their rights as persons. . . .

Since not all women who can become mothers wish to become mothers (or will become mothers), it would appear to be illegal discrimination to treat all who are capable of pregnancy as though they will become pregnant.

Consistent with that view, Johnson Controls “stopped short of excluding women capable of bear- ing children from lead exposure” but emphasized that a woman who expected to have a child should not choose a job in which she would have such exposure. The company also required a woman who wished to be considered for employment to sign a statement indicating that she had been advised of the risk of having a child while she was exposed to lead. The statement informed the woman that although there was evidence “that women exposed to lead have a higher rate of abortion,” this evidence

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was “not as clear . . . as the relationship between cigarette smoking and cancer,” but that it was, “med- ically speaking, just good sense not to run that risk if you want children and do not want to expose the unborn child to risk, however small. . . .”

In 1982, Johnson Controls shifted from a policy of warning to a policy of exclusion. Between 1979 and 1983, eight employees became pregnant while main- taining lead levels in excess of 30 micrograms per deca- liter of blood. The company responded by announcing a broad exclusion of women from jobs that exposed them to lead:

[I]t is [Johnson Controls’] policy that women who are pregnant or who are capable of bearing children will not be placed into jobs involving lead exposure or which could expose them to lead through the exer- cise of job bidding, bumping, transfer or promotion rights.

The policy defined “women . . . capable of bearing children” as “[a]ll women except those whose inability to bear children is medically documented.”

Several employees (petitioners) and their unions filed suit alleging that Johnson Controls’ fetal protec- tion policy violated Title VII of the Civil Rights Act. Included in the group were the following:

• Mary Craig—sterilized to avoid losing her job

• Elsie Nason—50-year-old divorcee who lost compensation when transferred out of lead exposure job

• Donald Penney—denied request for leave of absence to lower his lead level before becoming a father

The district court entered summary judgment for Johnson Controls. The court of appeals affirmed, and the employees appealed.

JUdICIal OpINION

BLACKMUN, Justice The bias in Johnson Controls’ policy is obvious. Fertile men, but not fertile women, are given a choice as to whether they wish to risk their reproductive health for a particular job. Section 703(a) of the Civil Rights Act of 1964, 78 Stat. 255, as amended, 42 U.S.C. § 2000e- 2(a), prohibits sex-based classifications in terms and conditions of employment, in hiring and discharging decisions, and in other employment decisions that adversely affect an employee’s status. Respondent’s fetal-protection policy explicitly discriminates against

women on the basis of their sex. The policy excludes women with childbearing capacity from lead-exposed jobs and so creates a facial classification based on gen- der. Respondent assumes as much in its brief before this Court.

Nevertheless, the Court of Appeals assumed, as did the two appellate courts who already had con- fronted this issue, that sex specific fetal- protection policies do not involve facial discrimination. These courts analyzed the policies as though they were facially neutral, and had only a discriminatory effect upon the employment opportunities of women. Consequently, the courts looked to see if each employer in question had established that its policy was justified as a business necessity. The business necessity standard is more lenient for the employer than the statutory BFOQ [bona fide occupational qualification] defense. The court assumed that because the asserted reason for the sex-based exclu- sion (protecting women’s unconceived offspring) was ostensibly benign, the policy was not sex- based discrimination. That assumption, however, was incorrect.

First, Johnson Controls’ policy classifies on the basis of gender and childbearing capacity, rather than fertility alone. Respondent does not seek to pro- tect the unconceived children of all its employees. Despite evidence in the record about the debilitating effect of lead exposure on the male reproductive system, Johnson Controls is concerned only with the harms that may befall the unborn offspring of its female employees. . . .

The Pregnancy Discrimination Act has now made clear that, for all Title VII purposes, discrimi- nation based on a woman’s pregnancy is, on its face, discrimination because of her sex. In its use of the words “capable of bearing children” in the 1982 pol- icy statement as the criterion for exclusion, Johnson Controls explicitly classifies on the basis of potential for pregnancy. Under the PDA, such a classification must be regarded, for Title VII purposes, in the same light as explicit sex discrimination. Respondent has chosen to treat all its female employees as poten- tially pregnant; that choice evinces discrimination on the basis of sex.

We concluded above that Johnson Controls’ policy is not neutral because it does not apply to the reproduc- tive capacity of the company’s male employees in the same way as it applies to that of the females. Moreover, the absence of a malevolent motive does not convert a facially discriminatory policy into a neutral policy with a discriminatory effect. Whether an employment

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Chapter 20 Management: Employment Discrimination 745

practice involves disparate treatment through explic- it facial discrimination does not depend on why the employer discriminates but rather on the explicit terms of the discrimination.

In sum, Johnson Controls’ policy “does not pass the simple test of whether the evidence shows ‘treatment of a person in a manner which but for that person’s sex would be different.’”

We therefore turn to the question whether Johnson Controls’ fetal-protection policy is one of those “certain instances” that come within the BFOQ exception.

Johnson Controls argues that its fetal-protection policy falls within the so-called safety exception to the BFOQ. Our cases have stressed that discrimina- tion on the basis of sex because of safety concerns is allowed only in narrow circumstances. In Dothard v. Rawlinson, 433 U.S. 321 (1977), this Court indicated that the danger to a woman herself does not justify discrimination. We there allowed the employer to hire only male guards in contact areas of maxi- mum-security male penitentiaries only because more was at stake than the “individual woman’s decision to weigh and accept the risks of employment.” We found sex to be a BFOQ inasmuch as the employment of a female guard would create real risks of safety to others if violence broke out because the guard was a woman. Sex discrimination was tolerated because sex was related to the guard’s ability to do the job— maintaining prison security. We also required in Dothard a high correlation between sex and ability to perform job functions and refused to allow employ- ers to use sex as a proxy for strength although it might be a fairly accurate one.

Similarly, some courts have approved airlines’ layoffs of pregnant flight attendants at different points during the first five months of pregnancy on the ground that the employer’s policy was necessary to ensure the safety of passengers.

The unconceived fetuses of Johnson Controls’ female employees, however, are neither customers nor third parties whose safety is essential to the busi- ness of battery manufacturing. No one can disregard the possibility of injury to future children; the BFOQ, however, is not so broad that it transforms this deep social concern into an essential aspect of battery making. . . .

A word about tort liability and the increased cost of fertile women in the workplace is perhaps necessary. It is correct to say that Title VII does not prevent the employer from having a conscience. The

statute, however, does prevent sex-specific fetal- protection policies. These two aspects of Title VII do not conflict.

More than 40 states currently recognize a right to recover for a prenatal injury based either on negligence or on wrongful death. According to Johnson Controls, however, the company complies with the lead standard developed by OSHA and warns its female employees about the damaging effects of lead. It is worth noting that OSHA gave the problem of lead lengthy consider- ation and concluded that “there is no basis whatsoever for the claim that women of childbearing age should be excluded from the workplace in order to protect the fetus or the course of pregnancy.” Instead, OSHA established a series of mandatory protections which, taken together, “should effectively minimize any risk to the fetus and newborn child.” Without negligence, it would be difficult for a court to find liability on the part of the employer. If, under general tort principles, Title VII bans sex-specific fetal-protection policies, the employer fully informs the woman of the risk, and the  employer has not acted negligently, the basis for holding an employer liable seems remote at best.

Although the issue is not before us, the concurrence observes that “it is far from clear that compliance with Title VII will preempt state tort liability.”

Our holding today that Title VII, as so amended, forbids sex-specific fetal-protection policies is neither remarkable nor unprecedented. Concern for a woman’s existing or potential offspring historically has been the excuse for denying women equal employment opportunities.

It is no more appropriate for the courts than it is for individual employers to decide whether a woman’s reproductive role is more important to herself and her family than her economic role. Congress has left this choice to the woman as hers to make.

The judgment of the Court of Appeals is reversed and the case is remanded for further proceedings con- sistent with this opinion.

CaSe QUeStIONS

1. Describe Johnson Controls’ evolving policy on lead exposure.

2. Are there circumstances when sex is a BFOQ?

3. What problem is presented by the exclusion of men from the policy?

4. What is the court’s position on tort liability of the company with respect to the fetus?

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20-4b Religious discrimination

Employers are required to make reasonable efforts to accommodate an employee’s religious practices, holidays, and observances. Not all religious or church activi- ties, however, are protected; for example, the observance of a religion’s Sabbath is a protected activity, but taking time to prepare for a church bake sale or pageant is an unprotected activity. The 1972 amendments to Title VII defined religion to include “all aspects of religious observance and practice, as well as belief.” The accommodation of religion thus defined is required unless an employer is able to establish that allowing the employee such an accommodation would result in “undue hardship on the conduct of the employer’s business.”

In Trans World Airlines, Inc. v. Hardison, 432 U.S. 63 (1977), the Supreme Court confirmed the clear language of the 1972 act that requires an employer to demon- strate an ability to accommodate an employee’s religious needs. As a member of a church that worshiped on Saturdays, Larry G. Hardison expressed a desire not to work that day. TWA worked through several alternatives to afford Mr. Hardison the opportunity for Saturdays off, including asking the union to waive a seniority rule that limited substitutes for him and looking for an alternative job that would not require Saturday work. The union would not waive its rule, and no managers were available to take the shift. When Mr. Hardison refused to work on Saturdays, he was dismissed and filed suit, but the Supreme Court found for TWA because of its extensive efforts and the constraints that prevented shifting of workers without substantial interference in TWA’s operations.

Title VII requires only reasonable accommodation. Employees are not neces- sarily entitled to the accommodation they desire. For example, in American Postal Workers Union v. Postmaster General, 781 F.2d 772 (9th Cir. 1986), several postal employees refused to work at a window in the post office where draft registra- tion forms were handled. They asked to be able to direct draft registrants to the

dangerous exposureBusiness Strategy

The Johnson Controls decision has allowed many women to work in jobs that expose them to toxins. The U.S. Supreme Court did acknowledge in its holding that tort liability might result from its decision but that such liability was often used as a guise or cover for gender discrimination. However, nearly 20 years after the decision, women who were protected by Title VII in their right to high-risk jobs are now suing their employ- ers for the birth defects in their children. For example, IBM has several suits from employees and their children against it for

defects allegedly tied to production-line tox- ins. The position of many of the employers is that even if there were evidence linking the toxins to birth defects, the women took the jobs with knowledge about the risk and agreed to that risk. How can employers, leg- islators, and public policy specialists recon- cile antidiscrimination laws and these risks of exposure?

Source: Stephanie Armour, “Workers Take Employers to Court over Birth Defects,” USA Today, February 26, 2002, pp. 1A, 2A. For more information, visit http:// www.cdc.gov/niosh. ©

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Chapter 20 Management: Employment Discrimination 747

windows of employees who did not have religious objections to the draft. The Postal Service transferred the employees to nonwindow jobs, which was sup- ported by the court as a reasonable accommodation.

EEOC v. Abercrombie & Fitch (Case 20.5) deals with the actions of an employer in making a decision to hire based on a religious issue.

EEOC v. Abercrombie & Fitch Stores, Inc. 135 S.Ct. 2028 (2015)

The Scarf, the Look, and Religious Discrimination

Case 20.5

Abercrombie & Fitch Stores, Inc. (Respondent), operates several lines of clothing stores, each with its own “style.” Consistent with the image Abercrombie seeks to project for each store, the company imposes a Look Policy that governs its employees’ dress. The Look Policy prohibits “caps”—a term the Policy does not define—as too infor- mal for Abercrombie’s desired image.

Samantha Elauf is a practicing Muslim who, consis- tent with her understanding of her religion’s require- ments, wears a headscarf. She applied for a position in an Abercrombie store and was interviewed by Heather Cooke, the store’s assistant manager. Using Abercrom- bie’s ordinary system for evaluating applicants, Cooke gave Elauf a rating that qualified her to be hired; Cooke was concerned, however, that Elauf’s headscarf would conflict with the store’s Look Policy.

Cooke sought the store manager’s guidance to clarify whether the headscarf was a forbidden “cap.” When this yielded no answer, Cooke turned to Randall Johnson, the district manager. Cooke informed Johnson that she believed Elauf wore her headscarf because of her faith. Johnson told Cooke that Elauf’s headscarf would violate the Look Policy, as would all other head- wear, religious or otherwise, and directed Cooke not to hire Elauf.

The EEOC sued Abercrombie on Elauf’s behalf, claiming that its refusal to hire Elauf violated Title VII. The District Court granted the EEOC summary judgment on the issue of liability [798 F. Supp. 2d 1272 (N.D. Okla. 2011)], held a trial on damages, and awarded $20,000. The Tenth Circuit reversed and awarded Aber- crombie summary judgment. [731 F.3d 1106 (2013)] It concluded that ordinarily an employer cannot be liable under Title VII for failing to accommodate a religious practice until the applicant (or employee) pro- vides the employer with actual knowledge of his need

for an accommodation. The Supreme Court granted certiorari.

JUdICIal OpINON

SCALIA, Justice Title VII of the Civil Rights Act of 1964 prohibits two categories of employment practices.

These two proscriptions, often referred to as the “disparate treatment” (or “intentional discrimina- tion”) provision and the “disparate impact” provision, are the only causes of action under Title VII. The word “religion” is defined to “includ[e] all aspects of religious observance and practice, as well as belief, unless an employer demonstrates that he is unable to reasonably accommodate to” a “religious observance or practice without undue hardship on the conduct of the employer’s business.”

Abercrombie’s primary argument is that an applicant cannot show disparate treatment without first showing that an employer has “actual knowledge” of the appli- cant’s need for an accommodation. We disagree. Instead, an applicant need only show that his need for an accom- modation was a motivating factor in the employer’s decision.

The disparate-treatment provision forbids employ- ers to: (1) “fail . . . to hire” an applicant (2) “because of” (3) “such individual’s . . . religion” (which includes his religious practice). Here, of course, Abercrombie (1) failed to hire Elauf. The parties concede that (if Elauf sincerely believes that her religion so requires) Elauf’s wearing of a headscarf is (3) a “religious practice.” All that remains is whether she was not hired (2) “because of” her religious practice.

The term “because of” appears frequently in anti- discrimination laws. It typically imports, at a minimum,

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the traditional standard of but-for causation Title VII relaxes this standard, however, to prohibit even mak- ing a protected characteristic a “motivating factor” in an employment decision. “Because of” in § 2000e-2(a) (1) links the forbidden consideration to each of the verbs preceding it; an individual’s actual religious practice may not be a motivating factor in failing to hire, in refusing to hire, and so on.

It is significant that § 2000e-2(a)(1) does not impose a knowledge requirement. As Abercrombie acknowledges, some antidiscrimination statutes do. For example, the Americans with Disabilities Act of 1990 defines discrimination to include an employer’s failure to make “reasonable accommodations to the known physical or mental limitations” of an applicant. Title VII contains no such limitation.

Instead, the intentional discrimination provision prohibits certain motives, regardless of the state of the actor’s knowledge. Motive and knowledge are sepa- rate concepts. An employer who has actual knowledge of the need for an accommodation does not violate Title VII by refusing to hire an applicant if avoiding that accommodation is not his motive. Conversely, an employer who acts with the motive of avoiding accom- modation may violate Title VII even if he has no more than an unsubstantiated suspicion that accommoda- tion would be needed.

Thus, the rule for disparate-treatment claims based on a failure to accommodate a religious practice is straightforward: An employer may not make an appli- cant’s religious practice, confirmed or otherwise, a factor in employment decisions. For example, suppose that an employer thinks (though he does not know for certain) that a job applicant may be an orthodox Jew who will observe the Sabbath, and thus be unable to work on Saturdays. If the applicant actually requires an accommodation of that religious practice, and the employer’s desire to avoid the prospective accom- modation is a motivating factor in his decision, the employer violates Title VII.

Abercrombie urges this Court to adopt the Tenth Circuit’s rule “allocat[ing] the burden of raising a religious conflict.” This would require the employer to have actual knowledge of a conflict between an appli- cant’s religious practice and a work rule. The problem with this approach is the one that inheres in most incor- rect interpretations of statutes: It asks us to add words to the law to produce what is thought to be a desir- able result. That is Congress’s province. We construe Title VII’s silence as exactly that: silence. Its disparate- treatment provision prohibits actions taken with the motive of avoiding the need for accommodating a

religious practice. A request for accommodation, or the employer’s certainty that the practice exists, may make it easier to infer motive, but is not a necessary condition of liability.

Abercrombie argues in the alternative that a claim based on a failure to accommodate an applicant’s religious practice must be raised as a disparate-impact claim, not a disparate-treatment claim. We think not. That might have been true if Congress had limited the meaning of “religion” in Title VII to religious belief— so that discriminating against a particular religious practice would not be disparate treatment though it might have disparate impact. In fact, however, Congress defined “religion,” for Title VII’s purposes, as “includ[ing] all aspects of religious observance and practice, as well as belief.” Thus, religious prac- tice is one of the protected characteristics that can- not be accorded disparate treatment and must be accommodated.

Nor does the statute limit disparate-treatment claims to only those employer policies that treat religious practices less favorably than similar secu- lar practices. Abercrombie’s argument that a neutral policy cannot constitute “intentional discrimination” may make sense in other contexts. But Title VII does not demand mere neutrality with regard to religious practices—that they be treated no worse than other practices. Rather, it gives them favored treatment, affirmatively obligating employers not “to fail or refuse to hire or discharge any individual . . . because of such individual’s” “religious observance and prac- tice.” An employer is surely entitled to have, for example, a no-headwear policy as an ordinary matter. But when an applicant requires an accommodation as an “aspec[t] of religious . . . practice,” it is no response that the subsequent “fail[ure] . . . to hire” was due to an otherwise-neutral policy. Title VII requires otherwise- neutral policies to give way to the need for an accommodation.

The Tenth Circuit misinterpreted Title VII’s require- ments in granting summary judgment. We reverse its judgment and remand the case for further consider- ation consistent with this opinion.

CaSe QUeStIONS

1. Explain the sequence of events that led to Aber- crombie’s failure to hire Elauf.

2. What is the requirement for knowledge about religion of applicants to establish discrimination under Title VII?

3. List the lessons for employers from this case.

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Chapter 20 Management: Employment Discrimination 749

20-4c Racial discrimination

When Title VII was first enacted, its clear intent was to prevent discrimination against the minority workforce. After Title VII had been in effect for several years, an unanticipated problem arose: Does Title VII’s protection extend to all races? Are white employees entitled to the same protection Title VII affords other races?

In 1976, the Supreme Court provided the answer in McDonald v. Santa Fe Trail Transportation Co., 427 U.S. 273 (1976). Here, some black employees had been rein- stated after committing the same offense as a group of white employees who were not reinstated. The Court held that Title VII prohibited such racial discrimination.

20-5 Antidiscrimination Laws and Affirmative Action

Some employers, either voluntarily or through the EEOC, have instituted affirma- tive action programs. Nothing prohibits such programs under Title VII, and the Supreme Court has sanctioned them as methods for remedying all the past years of discrimination. Although Title VII does not mandate such programs, employers may legally institute them.

Kimberly Cloutier was a member of the Church of Body Modification. In 1997, during her job interview for a position at Costco, Ms. Cloutier sported four tattoos and multi- ple earrings, but she had no facial piercings. She was hired and given a copy of the Cost- co dress code, which was modified several times between 1997 and 2001. One of the modifications prohibited employees from having facial piercings. As the policy was modified, Ms. Cloutier increased the num- ber of body piercings she had, including an eyebrow ring. Ms. Cloutier maintained that they were part of her adherence to her faith, the Church of Body Modification (CBM), but she did not join the CBM until 2001. The CBM, which anyone can join via electronic application, had approximately 1,000 members at that time. The members participate in piercing, tattooing, branding, cutting, and body manipulation. Among the goals espoused in the CBM’s mission statement are for its members to “grow as individuals through body modification and its teachings,” to “promote growth in mind,

body and spirit,” and to be “confident role models in learning, teaching, and displaying body modification.” However, the tenets of the faith do not require that body modifica- tions be on display at all times.

Ms. Cloutier did not object to the dress code or any of the modifications on religious grounds until, in 2001, her supervisors asked her to either remove the eyebrow ring while she was working or cover it with some form of Band-Aid adhesive bandage. Costco also proposed having her wear a clear plastic ring in the eyebrow piercing while she was working so that her body modification could still be seen but would not be conspicuous. Ms. Cloutier refused the proposed accommodations and filed a complaint with the EEOC. The EEOC con- cluded that Costco had discriminated on the basis of Ms. Cloutier’s religion, and she then filed suit against Costco for reli- gious discrimination in violation of Title VII. Discuss whether there has been religious discrimination. [Cloutier v. Costco, 390 F.3d 126 (1st Cir. 2004)]

Consider . . . 20.5

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20-5a What Is affirmative action?

Affirmative action is a remedial step taken to ensure that those who have been victims of discrimination in the past are given the opportunity to work in positions they would have attained had there not been discrimination.

Affirmative action programs are used to improve job opportunities for those in the so-called protected classes, including African-Americans, Hispanics, Native Americans, Asians, women, persons with disabilities, and Vietnam veterans.

20-5b Who Is Required to Have affirmative action programs?

Some federal funding laws, such as those for education and state and local govern- ments, mandate affirmative action programs.

Some employers have an obligation to take steps to equalize the representa- tion of minorities and women in their labor forces. This equalization of represen- tation in the labor force is the process of affirmative action. The following types of employers are obligated to undertake affirmative action programs:

1. Employers who, pursuant to consent decree or court order, must implement plans to compensate for past wrongs

2. State and local agencies, colleges, and universities that receive federal funds 3. Federal agencies under congressional mandates [see e.g., Shea v. Kerry, 796

F.3d 42 (D.D.C. 2015)] 4. Government contractors 5. Businesses that work on federal projects (10% of their subcontract work must

employ minority businesses)

Affirmative action plans cannot simply be quotas. (A quota program is an unlawful infringement of the rights of a majority group of employees.) Rather, affirmative action programs set goals—for example, a certain number of minorities employed by a certain date. If the goal is not met, a business has not violated the law so long as it has made a good-faith effort to recruit and hire minorities. That good-faith effort can be established by a showing of internal and external advertis- ing, monitoring of the program’s progress, and changes and improvements in the program’s development.

20-5c affirmative action Backlash: the theory of Reverse discrimination

Currently, some legislative movements and grassroots referenda mandate the elimination of affirmative action programs. The University of California system eliminated affirmative action programs in 1995, but the programs were reinstated by a court after the elimination was challenged. A state referendum then passed, eliminating racial preferences by any state agency, including its colleges and universities.

In Adarand Constructors, Inc. v. Vena, 515 U.S. 200 (1995), the U.S. Supreme Court was faced with the issue of affirmative action programs in a case brought by a contractor that challenged the federal government’s program granting socially and economically disadvantaged contractors and subcontractors preferences in the awarding of government contracts. The case was remanded for trial after a ruling by the Court that such programs were subject to a standard of review known as strict scrutiny. The Court held that the government’s set-aside program offering

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Chapter 20 Management: Employment Discrimination 751

preferences to minority-owned businesses was a racial classification. To survive the strict scrutiny test, which is derived from the Equal Protection Clause of the U.S. Constitution (see Chapter 5), the federal government must be able to show, when a case goes to trial, that the contractor preferences serve a compelling gov- ernment interest. Adarand II, heard by the U.S. Supreme Court in 2001, was upheld without opinion.3

In Taxman v. Board of Education of Piscataway [91 F.3d 1547 (3rd Cir. 1996); cert. granted, 521 U.S. 1117 (1997); cert. dismissed, 522 U.S. 1010 (1997)], a school district, when facing the need to reduce the size of its teaching staff, decided to retain an African-American schoolteacher, Debra Williams. Sharon Taxman, a white school- teacher, challenged the decision as discriminatory, and the school board defended on the grounds of its affirmative action program. On appeal, the circuit court held that the decision was unconstitutional because the school board’s program was adopted to promote diversity and not to remedy any past wrongs the school dis- trict had committed. The U.S. Supreme Court granted certiorari to review the case, but the school board agreed to a settlement, paying Ms. Taxman $433,500, of which $308,500 was paid by national civil rights organizations. The civil rights organiza- tions indicated that they agreed to pay the bulk of the settlement because they were fearful that the court might outlaw affirmative action programs. A few years later, and on the same day, the U.S. Supreme Court issued two landmark decisions on affirmative action in admissions programs: Gratz v. Bollinger, 539 U.S. 244 (2003), and Grutter v Bollinger, 539 U.S. 306 (2003). In one case, the law school two-track admissions system was upheld, but the undergraduate two-track admission system was held to be unconstitutional. In another case, involving the admissions program at the University of Texas, the U.S. Supreme Court reexamined the issue of pre- ferred admissions programs. [Fisher v. University of Texas at Austin, 133 S.Ct. 2411 (2013)] The U.S. Supreme Court sent the case back for retrial because the court had not applied the strict scrutiny test that the U.S. Constitution demands when race is used as a basis for making determinations in, as in this case, admission to a pub- lic university. Although the case was remanded, the court failed to apply the strict scrutiny standard (771 F.3d 274 (5th Cir. 2014)), and the U.S. Supreme Court got the case back again. In Fisher v. University of Texas, 136 S.Ct. 2198 (2016), the court upheld the right of the university to have an affirmative action admissions program.

20-6 The Defenses to a Title VII Charge Title VII is not a strict liability statute. The act provides some defenses that employ- ers can use to defend against a charge of discrimination.

20-6a Bona Fide occupational Qualification

A bona fide occupational qualification (BFOQ) is a job qualification based on sex, religion, or national origin that is necessary for the operation of business. A partic- ular religious belief is a BFOQ for a pastor of a church. Similarly, an actor, to qual- ify for a role, may need to be a certain sex for purposes of realism and thus sex is a BFOQ for such employment.

The BFOQ exception has been applied narrowly, however. For a discrimina- tory qualification for employment to fall within the BFOQ exception, the employer must be able to establish that the job qualification is carefully formulated to respond to public safety, privacy, or other public needs, and the formulation of

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the policy must not be broader than is reasonably necessary to preserve the safety or privacy of individuals involved. For example, a restriction on hiring male employees for work in a nursing home occupied by women is excessive if male employees can work in jobs not involved with the personal care of the residents. Nor is personal preference a justification for a BFOQ; for example, many airlines have argued that there is a customer preference for female as opposed to male flight attendants. But customer preference is not a basis for a BFOQ; it is not a business necessity.

20-6b Seniority or Merit Systems

The goals and objectives of Title VII are often inconsistent with labor union rules of operation. Although matters of discrimination and union supervision are both covered by federal law, the two statutory schemes conflict on some points. Which controls the other: the remedial effect of Title VII or the long-standing history of seniority and other union rules?

The following criteria are used to determine whether a seniority or merit sys- tem is valid:

1. The system must apply to all employees. 2. Whatever divisions or units used for the system must follow the industry

custom or pattern—that is, the divisions cannot be set up so as to discrimi- nate against particular races or groups.

3. The origins of the system cannot lie in racial discrimination. 4. The system must be maintained for seniority and merit purposes and not to

perpetuate racial discrimination.

20-6c aptitude and Other tests

Any employer charged with Title VII discrimination because of employee aptitude testing must be able to show that the tests used are valid. Validity means that the tests are related to successful job performance and that a test does not have the effect of eliminating certain races from the employment market.

An employer can validate a test in any of several different ways. Test scores of applicants can later be compared with the applicants’ eventual job performance to validate the test. An employer can also give the test to current employees and use the correlation between their scores and job performance as a means for validat- ing the test. Some tests can be validated by their content. For example, requiring potential police officers to complete a driving course, a physical fitness test, and a marksmanship test is valid because the tests are based on the things police officers actually do. (Refer to p. 714 and the discussion of disparate impact for more infor- mation on validation of tests.)

20-6d Misconduct

For many years, an absolute defense to discrimination was employee miscon- duct. If an employee violated company rules, the case did not involve discrim- ination. The defense was so broad that even evidence the employer acquired after the termination and charge of discrimination could be used as a defense. In McKennon v. Nashville Banner Publishing Co. (Case 20.6), the Supreme Court limited this defense.

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Chapter 20 Management: Employment Discrimination 753

McKennon v Nashville Banner Publishing Co. 524 U.S. 742 (1995)

Lying Is Not a Defense for Discrimination

Case 20.6

FaCtS

For 30 years, Christine McKennon (petitioner) worked for Nashville Banner Publishing Company (respon- dent) (Banner), but she was terminated as part of a work reduction plan. She was 62 years old at the time of her termination. Ms. McKennon filed suit, alleging her termination was a violation of the Age Discrimina- tion in Employment Act (ADEA).

During Ms. McKennon’s deposition, she testified that during her final year of employment, she had copied several confidential documents bearing upon the company’s financial condition. She had access to these records as secretary to Banner’s comptroller. Ms.  McKennon took the copies home and showed them to her husband. Her motivation, she averred, was apprehension that she was about to be fired because of her age. When she became concerned about her job, she removed and copied the documents for “insurance” and “protection.” A few days after these deposition disclosures, Banner sent Ms. McKennon a letter declaring that removal and copying of the records was in violation of her job responsibilities and advised her (again) that she was terminated. Banner’s letter also recited that had it known of Ms. McKennon’s misconduct, it would have discharged her at once for that reason.

Banner conceded its discrimination in district court, which granted summary judgment for Banner on grounds that Ms. McKennon’s misconduct was a defense. The court of appeals affirmed, and Ms. McK- ennon appealed.

JUdICIal OpINION

KENNEDY, Justice We shall assume that the sole reason for McKennon’s initial discharge was her age, a discharge violative of the ADEA. Our further premise is that the misconduct revealed by the deposition was so grave that McK- ennon’s immediate discharge would have followed its disclosure in any event. We do question the legal conclusion reached by those courts that after-acquired evidence of wrongdoing which would have resulted in discharge bars employees from any relief under the ADEA. That ruling is incorrect.

The ADEA and Title VII share common substantive features and also a common purpose: “the elimina- tion of discrimination in the workplace.” Congress designed the remedial measures in these statutes to serve as a “spur or catalyst” to cause employers “to self-examine and to self-evaluate their employment practices and to endeavor to eliminate, so far as possi- ble, the last vestiges” of discrimination. The ADEA, in keeping with these purposes, contains a vital element found in both Title VII and the Fair Labor Standards Act: it grants an injured employee a right of action to obtain the authorized relief.

The objectives of the ADEA are furthered when even a single employee establishes that an employer has discriminated against him or her. The disclosure through litigation of incidents or practices which vio- late national policies respecting nondiscrimination in the work force is itself important, for the occurrence of violations may disclose patterns of noncompliance resulting from a misappreciation of the Act’s opera- tion or entrenched resistance to its commands, either of which can be of industry-wide significance. The efficacy of its enforcement mechanisms becomes one measure of the success of the Act.

As we have said, the case comes to us on the express assumption that an unlawful motive was the sole basis for the firing. McKennon’s misconduct was not dis- covered until after she had been fired. The employer could not have been motivated by knowledge it did not have and it cannot now claim that the employee was fired for the nondiscriminatory reason. Mixed motive cases are inapposite here, except to the important extent they underscore the necessity of determining the employer’s motives in ordering the discharge, an essential element in determining whether the employer violated the federal antidiscrimination law. As we have observed, “proving that the same decision would have been justified . . . is not the same as proving that the same decision would have been made.”

The ADEA, like Title VII, is not a general regula- tion of the workplace but a law which prohibits dis- crimination. The statute does not constrain employers from exercising significant other prerogatives and discretions in the course of the hiring, promoting, and discharging of their employees. In determining

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appropriate remedial action, the employee’s wrongdo- ing becomes relevant not to punish the employee, or out of concern “for the relative moral worth of the par- ties,” but to take due account of the lawful prerogatives of the employer in the usual course of its business and the corresponding equities that it has arising from the employee’s wrongdoing.

The proper boundaries of remedial relief in the general class of cases where, after termination, it is dis- covered that the employee has engaged in wrongdoing must be addressed by the judicial system in the ordinary course of further decisions, for the factual permutations and the equitable considerations they raise will vary from case to case. We do conclude that here, and as a general rule in cases of this type, neither reinstatement nor front pay is an appropriate remedy. It would be both inequitable and pointless to order the reinstatement of someone the employer would have terminated, and will terminate, in any event and upon lawful grounds.

Where an employer seeks to rely upon after-ac- quired evidence of wrongdoing, it must first establish

that the wrongdoing was of such severity that the employee in fact would have been terminated on those grounds alone if the employer had known of it at the time of the discharge. The concern that employers might as a routine matter undertake extensive discov- ery into an employee’s background or performance on the job to resist claims under the Act is not an insub- stantial one, but we think the authority of the courts to award attorney’s fees, mandated under the statute, 29 U.S.C. §§ 216(b), 626(b), and in appropriate cases to invoke the provisions of Rule 11 of the Federal Rules of Civil Procedure will deter most abuses.

The judgment is reversed.

CaSe QUeStIONS

1. Why is the timing of the misconduct disclosure important?

2. Does Banner deny discriminatory intent?

3. Why are “mixed motive” cases not relevant in this analysis?

Ethical Issues

Consider the following circumstances and decide whether there has been a violation of Title VII. Consider the ethical implica- tions of the conduct along with the legal ones:

1. An employee must be dismissed. Two women, one white and the other black, have been with the company for the same amount of time and have the same rate of absenteeism. Their performance evaluations are about the same. Can the black employee be dis- missed without violating Title VII?

2. Company B has had a significant problem with absenteeism, tardiness,

and failure to follow through on job assignments among the employees who are of a certain race. The person- nel director is concerned about compa- ny productivity, the costs of training, and the costs of constant turnover. The personnel director is also aware of the constraints of Title VII. The director instructs those staffing the front office to tell members of that particular race who apply for a job that the compa- ny is not accepting applications. The director’s theory is that his applicant pool will be prescreened and he will not have to make discriminatory hir- ing decisions. Is the director correct?

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Chapter 20 Management: Employment Discrimination 755

20-7 Enforcement of Title VII Title VII is an enabling act that created the Equal Employment Opportunity Commission for the purpose of administration and enforcement. The EEOC is a five-member commission whose members are appointed by the president with the approval of the Senate. As with all other federal commissions, no more than three members can belong to the same political party.

The EEOC was given broad powers under Title VII. In addition to its rulemak- ing and charging powers, the EEOC has broad investigatory authority, including the authority to subpoena documents and testimony.

20-7a Steps in an eeOC Case

the Complaint An EEOC complaint can be filed by an employee or by the EEOC. An employee has 180 days (in some cases, up to 300 days) from the time of the alleged violation to file a complaint. In Ledbetter v. Goodyear, 550 U.S. 618 (2007), the U.S. Supreme Court clarified the 180-day rule for individual suits. Lilly Ledbetter filed suit against Goodyear after her retirement in 1999, following 19 years of employment at the company’s plant in Gadsden, Alabama. While she filed suit within 180 days after receiving her last paycheck, the court held that she must have brought her pay discrimination suit within 180 days from when the alleged discrimination in pay occurred. The suit was dismissed, with the high court noting that employers must have current enough allegations so that they can defend the suit with their records, which may not be available after 19 years. The decision required employ- ees to bring suit within 180 days from the time of the discriminatory conduct. The Lilly Ledbetter Fair Pay Act, which provides that each paycheck triggers a new 180-day filing period regardless of when the discriminatory practices that led to pay disparity began.

The complaint may be filed with either the EEOC or the state administrative agency set up for employment discrimination issues. For the state agency to con- tinue handling the complaint, it must be an EEOC-approved program. If it is not, the EEOC handles the complaint. The EEOC has special forms that can be filled out by any employee wishing to file such a complaint.

Notification of the employer Once a complaint has been filed, the EEOC has 10 days to notify the employer of the charges. Employers are prohibited from the time of notification from taking any retaliatory action against the charging employee.

eeOC action After the complaint is filed, the EEOC has 180 days from that time to take action in the case before the complaining party can file suit on the matter. During this time, the EEOC can use its investigatory powers to explore the merits of the charges. In the case of University of Pennsylvania v. EEOC, 493 U.S. 182 (1990), the Supreme Court ruled that the EEOC could have access to all information in an employee’s file—even evaluation letters in which evaluators were promised confidentiality. During this conciliation period, the EEOC may also try to work out a settlement between the employer and the employee.

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the Right-to-Sue letter If the EEOC has not settled its complaint within 180 days from the time of its filing, the employee has the right to demand a right-to-sue letter from the EEOC, which is a certification that the employee has exhausted available administrative reme- dies. If a state agency is involved, the time for its settlement of the matter must also expire before the employee can take the matter to court.

The employee has the right to this letter regardless of the EEOC’s findings. Even if the EEOC has investigated and determined the charges have no merit, the employee can still pursue the case in court. Under EEOC v. Waffle House, 534 U.S. 279 (2002), the U.S. Supreme Court held that the EEOC, as an agency, has the right to proceed with its remedies even if the private remedies are dismissed or not available to the affected employee.

20-7b Remedies available Under title VII

Remedies available under Title VII include injunctions, back pay, punitive dam- ages, and attorneys’ fees. If a court finds a violation, it may order that corrective or affirmative action be taken to compensate for past wrongs. An injunction usually requires the employer to stop the illegal discrimination and then institute a plan to hire or promote minorities. Back-pay awards are limited to two years under Title VII. Section 706(b) of the act permits successful parties to recover “reasonable attorneys’ fees.”

An employer cannot take retaliatory action against employees who file charges or who are successful in a suit; Title VII makes such action unlawful.

Title VII originally allowed damages for back pay for all forms of discrim- ination. Punitive and compensatory damages are now permitted in racial and ethnic discrimination cases. The 1991 amendments extend the recovery of punitive and compensatory damages to cases involving sex, religion, or disability.

20-8 Other Antidiscrimination Laws 20-8a age discrimination in employment act of 1967

Title VII does not cover the real problem of age discrimination, which generally involves companies’ hiring preference for younger people. To correct this loophole, the Age Discrimination in Employment Act (ADEA) was passed in 1967, and the EEOC was given responsibility for its enforcement. The act covers all employers with 20 or more employees and prohibits age discrimination in the hiring, firing, and compensation of employees. All employment agencies are covered. The act protects workforce members above age 40.

The elements in an age discrimination case are similar to those in other discrim- ination cases—simply substitute that the terminated employee was replaced with a younger employee. The replacement need not be below the age of 40. [O’Connor v Consolidated Coin Caterers Corp., 517 U.S. 308 (1996)] Gonzalez v. El Dia, Inc. (Case 20.7) deals with an issue of age discrimination and provides the answer for the chapter’s opening “Consider . . .”

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Chapter 20 Management: Employment Discrimination 757

Gonzalez v El Dia, Inc. 304 F.3d 63 (1st Cir. 2002)

¿La Empleada con Manias de Vieja y El Empresario con Responsabilidad?

Case 20.7

FaCtS

Lydia Gonzalez, 58 (plaintiff), worked as a reporter at El Nuevo Dia, a Puerto Rican newspaper. Her supervi- sor, Maria Luisa Ferre, often said that Ms. Gonzalez’s demeanor and couture were “[o]ut of style” and “col- orless” and that her coiffure was “like Phyllis Diller.” Ms.  Ferre also said that Ms. Gonzalez was old-fash- ioned (i.e., “manias de vieja,” or “old person’s ways”) and that she should have retired and gone to live with her grandchildren in Florida long ago. Ms. Ferre also taunted Ms. Gonzalez by saying that she would not live long enough to see her grandson play major league baseball.

Ms. Gonzalez asked Ms. Ferre if she could be assigned to cover fashion shows, but Ms. Ferre balked at the idea. Ms. Gonzalez then asked, “You want me to look like a Vogue model?” Ms. Ferre simply stared at her and then assigned younger reporters to the fash- ion shows, telling Ms. Gonzalez, “Dona Lydia, I don’t know what I’m going to do with you.”

Jorge Mercado, the director of the human resources department at the newspaper, frequently stated that Ms. Gonzalez had “manias de vieja.” Mr. Mercado would often accost Ms. Gonzalez when he visited the department in which Gonzalez worked by calling her “Mom” and making comments such as, “Are you still here?” or “I thought you had been discharged or termi- nated a long time ago.”

Following a serious work-related injury in April 1997, Ms. Gonzalez took medical leave while receiving treatment and rehabilitative therapy. During Ms. Gon- zalez’s medical leave, Ms. Ferre contacted the El Dia human resources department regarding retirement packages that might be offered to Gonzalez.

During one discussion during her leave, Ms. Ferre asked Ms. Gonzalez whether she would like to retire, adding, “Look, you are already 63 years old and your health is not good.” Ms. Gonzalez offered to return to work immediately, but Ms. Ferre rejected her offer and advised Gonzalez to take a vacation and return to work on July 1. Ms. Gonzalez had no remaining paid vacation time and was in difficult financial straits. Ms. Ferre arranged for a $6,000 advance on salary for Ms. Gonzalez, what Ms. Ferre believed was part of a voluntary retirement package the two had agreed to.

Four days later, Ms. Gonzalez was presented with a resignation, release, and compensation agreement. Ms. Gonzalez refused to retire and returned to work three days later, when she signed a note agreeing to repay the $6,000. Ms. Gonzalez then took work from a competing newspaper in order to meet her repayment obligations on the note. Working for a competing newspaper was a violation of the conflict-of-interest clause in her contract.

She was then terminated and filed suit for viola- tions of the ADEA. The district court granted summary judgment to El Dia.

JUdICal OpINION

CYR, Senior Circuit Judge Under the ADEA, an employer may not “discharge . . . or otherwise discriminate against any individual with respect to [her] compensation, terms, conditions, or privileges of employment, because of [her] age.” El Dia acknowledges that Gonzalez established a prima facie case under the ADEA.

[T]he burden of proof [then] shifts to the defendant employer to articulate a legitimate, nondiscriminatory basis for its adverse employment action. The plaintiff employee may meet her burden of proof by showing that the employer’s proffered reason for the challenged employment action was pretextual.

El Dia met its burden by identifying a nondis- criminatory basis for the Gonzalez discharge: i.e., her acceptance of employment as a reporter for a competing newspaper, in direct violation of the conflict-of-interest provision in the employee collective bargaining agree- ment (CBA) . . . the burden then shifted back to Gonza- lez to prove that the nondiscriminatory basis assertedly relied upon by El Dia was merely a pretext, and that age animus was the real reason for her termination. “[Fed- eral courts] do ‘not sit as a super-personnel department that reexamines an entity’s business decisions.’ ‘No matter how medieval a firm’s practices, no matter how high-handed its decisional process, no matter how mistaken the firm’s managers, [the ADEA does] not interfere.’” Accordingly, in order to establish that an age-based animus nonetheless constituted a motivating factor in the decision to terminate her employment, Gonzalez relies upon varieties of evidence.

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tHe aGeISt ReMaRkS

“[S]tray workplace remarks,” as well as statements made either by nondecision makers or by decision makers not involved in the decisional process, normal- ly are insufficient, standing alone, to establish either pretext or the requisite discriminatory animus.

Secondly, it is far from clear that the alleged remarks bespeak any age-based animus at all. Some statements, such as those made by Mr. Mercado, merely displayed a measure of surprise that Gonzalez was still employed at El Dia, without either assert- ing or implying that she was too old to be working. Moreover, Mr. Mercado’s alleged use of the salutation “Mom”—though no doubt insensitive, perhaps even rude—hardly constituted a self-sufficient foundation for an ADEA claim, especially since these particular attributions—motherhood and advanced age—plainly are not synonymous.

[T]he Spanish phrase “manias de vieja” (“old ways”) did not unambiguously connote that Gonzalez was old, let alone too old, but rather that she acted in ways which did not appear in keeping with a person her age. [S]uch terms “apply more to a person’s state of mind than to a person’s age.”

tHe FaSHION SHOW COVeRaGe

Given her acknowledged penchant for old-fashioned clothing and hairstyles, it seems much more plausible to attribute El Dia’s decision to the fact that Gonzalez was insufficiently attuned to current fashions; and, therefore, that her representation of El Dia at fashion shows could very well reflect adversely upon its busi- ness image in such circles.

tHe ReMaRkS Made By MS. FeRRe [IN tHe leaVe dISCUSSION]

On June 12, Ms. Ferre adverted to Gonzalez’ age while the two were discussing Gonzalez’ vacation plans and the retirement offer which had been made to her. Of course the mere tender of a retirement proposal does not evince the requisite discriminatory animus.

Moreover, even viewed in the light most favorable to Gonzalez, Ms. Ferre’s statement plainly conveyed the rational concern that retirement might prove the more prudent course, especially since Gonzalez had been experiencing serious health problems, as well as financial difficulties.

Gonzalez ignores the fact that, arguably at least, she engaged in a series of infractions. She defaulted on a promissory note which she had insisted that Mr. Mer- cado draw up, and thereafter deliberately went to work for a competing newspaper in direct contravention of the CBA (collective bargaining agreement). Thus, no rational jury reasonably could conclude that El  Dia lacked “just cause” to terminate Gonzalez.

Affirmed.

CaSe QUeStIONS

1. Describe how the burden of proof works in dis- crimination suits.

2. What workplace rules would you put in place to avoid these types of lawsuits?

3. Explain how the human resources manager and the supervisor could have handled the issues with Ms. Gonzalez in a way that would have avoided the litigation.

20-8b equal pay act of 1963

The Equal Pay Act of 1963 is an amendment to the Fair Labor Standards Act. (The details of its coverage are outlined in Chapter 20.)

20-8c Communicable diseases in the Workplace

Whether employees can be fired because they may carry a communicable disease has recently become a crucial issue. Court decisions on the treatment of infected employees have varied, but the Supreme Court decision School Board of Nassau County v. Arline, 480 U.S. 273 (1987), has been touted as a protectionist measure as a result of its finding that a school board could not discriminate against a teacher because she had tuberculosis (a contagious disease). The Americans with Disabilities Act will provide new issues and remedies with regard to communi- cable diseases (see the following discussion).

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20-8d Rehabilitation act of 1973

Congress enacted the Rehabilitation Act to prohibit discrimination in employment against handicapped persons by persons and organizations that receive federal contracts or assistance. The Labor Department is responsible for enforcing the act.

The Rehabilitation Act laid the groundwork for the Americans with Disabili- ties Act, but is limited in application to employers who have federal contracts and requires the same reasonable accommodation standards now required under ADA.

20-8e americans with disabilities act

The intent of the Americans with Disabilities Act (ADA) was to eliminate discrimi- nation against individuals with disabilities. The ADA has been called the “Emanci- pation Proclamation” for disabled U.S. citizens.

Portions of the ADA apply to employment discrimination issues, while other sections ensure that those with disabilities have access to public streets, walkways, buildings, and transportation.

Under the ADA, employers of 15 or more employees cannot discriminate in hiring, promotion, and selection criteria against a “qualified individual with a dis- ability.” A disability is defined by the ADA and its 2008 amendments as a physi- cal or mental impairment that substantially limits one or more major life activities such as seeing, hearing, speaking, walking, breathing, learning, or self-care. Pur- suant to a U.S. Supreme Court case [Bragdon v Abbott, 524 U.S. 624 (1998)], human immunodeficiency virus (HIV) is considered a physical impairment for purposes of the ADA. In that case, a dentist’s refusal to treat an HIV-positive patient who needed a cavity filled violated the ADA public accommodation provisions.

Employers must make “reasonable accommodations” for disabled individuals to enable them to perform essential functions. Included in reasonable accommo- dations are providing employee facilities that are readily accessible to and usable by disabled individuals, job restructuring, allowing part-time or modified work schedules, reassigning disabled individuals to vacant positions, acquiring or mod- ifying equipment, and providing qualified readers or interpreters. Perhaps the accommodation best known to the public is the right golfer Casey Martin won in PGA Tour, Inc. v. Martin, 531 U.S. 1049 (2001). Martin wanted to use a cart in PGA tournaments because of his circulatory ailment. Martin has been afflicted since birth with Klippel-Trenaunay-Weber syndrome, a degenerative circulatory disor- der. Walking aggravates the condition, but the PGA refused to allow him to use a cart. He filed suit claiming an ADA violation, and the U.S. Supreme Court agreed.

Preemployment medical examinations are prohibited under the ADA, as are specific questions about a protected individual’s disabilities. However, an employer may inquire about the ability of the applicant to perform job-related functions. “Can you carry 50 pounds of mail?” is an appropriate question; “Do you have the use of both arms?” is not.

Employers can refuse employment if an ADA-protected individual cannot per- form necessary job functions. Also, employers can refuse to hire individuals who pose a direct threat to the health and safety of others in the workplace (assuming the risk cannot be minimized through accommodation).

The ADA is enforced through the EEOC and carries the same rights and reme- dies provided under Title VII. Exhibit 20.2 provides a list of items to help employ- ers comply with ADA. Exhibit 20.3 examines proper and improper questions for job interviews under ADA.

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Exhibit 20.2 Compliance tips for ada

MINIMIZING aN eMplOyeR’S ada RISkS

1. Post notices describing the provisions of the ADA in your workplace.

2. Review job requirements to ensure that they bear a direct relationship to the ability to perform the essential functions of the job in question.

3. Identify, in writing, the “essential functions” of a job before advertising for or interviewing potential candidates.

4. Before rejecting an otherwise qualified applicant or terminating an employee on the basis of a disability, first determine that (a) the individual cannot perform the essential duties of the position, or (b) the individual cannot perform the essential duties of the position without imminent and substantial risk of injury to self or others, and (c) the employer cannot reasonably accommodate the disability.

5. Articulate factors, other than an individual’s disability, that are the basis of an adverse employment decision. Document your findings and the tangible evidence on which a decision to reject or terminate was based; make notes of accommodations considered.

6. Ask the disabled individual for advice on accommodations. This shows the employer’s good faith and a willingness to consider such proposals.

7. Institute programs of benefits and consultation to assist disabled employees in effectively managing health, leave, and other benefits.

8. Check with your insurance carrier regarding coverage of disabled employees and attempt (within economic reason) to maintain provided coverage or arrange for separate coverage.

9. Keep disabled individuals in mind when making structural alterations or purchasing office furniture and equipment.

10. Document all adverse employment actions, including reasons for the employment action with respect to disabled employees; focus on the employee’s inability to do the job effectively rather than any relation to the employee’s disability.

Source: EEOC Enforcement Guidance, http://www.eeoc.gov.

leGal IlleGal 1. Do you have 20/20 corrected vision? What is your corrected vision?

2. How well can you handle stress? Does stress ever affect your ability to be productive?

3. Can you perform this function with or without reasonable accommodation?

Would you need reasonable accommodation in this job?

4. How many days were you absent from work last year? How many days were you sick last year?

5. Are you currently illegally using drugs? What medications are you currently taking?

6. Do you regularly eat three meals per day? Do you need to eat a number of small snacks at regular intervals throughout the day in order to maintain your energy level?

7. Do you drink alcohol? How much alcohol do you drink per week?

Source: EEOC’s “Enforcement Guidance on Pre-Employment Disability-Related Inquiries,” May 12, 1994.

Exhibit 20.3 legal and Illegal Versions of Similar Job Interview Questions

20-8f the Family and Medical leave act

The Family and Medical Leave Act (FMLA) requires companies with 50 or more employees to provide 12 weeks’ leave each year for medical or family reasons, including the birth or adoption of a child or the serious health condition or illness

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of a spouse, parent, or child. Although pay is not required during the leave, med- ical benefits of the employee must continue, and the same or an equivalent job must be available for the employee upon return.

20-9 The Global Workforce Currently 2,000 U.S. companies have 21,000 subsidiary operations in countries throughout the world. With the free trade agreements (see Chapter 7), those num- bers will increase, as will the sizes of global operations.

One of the many employment issues that arises with respect to employees in subsidiary operations is whether the protections of Title VII apply to workers in these foreign operations. In EEOC v. Arabian American Oil Co., 499 U.S. 244 (1991), the U.S. Supreme Court was faced with the issue of whether U.S. companies could engage in employment discrimination against U.S. citizens when they are working in countries outside the United States. The Supreme Court held that the companies are governed by the employment laws of the country of operations and not the provisions of U.S. legislation.

Congress responded to the Supreme Court’s ruling in Arabian American Oil by adding a section to the Civil Rights Act of 1991 addressing the issue of foreign operations. The statutory provision on foreign operations and civil rights protec- tions is neither universal nor automatic. The amendment provides basically that in a case of conflict between U.S. employment discrimination laws and those of a host country, a company should follow the laws of the host country. An example is a law in the host country that prohibits the employment of women in management. The company would be required to follow that prohibition for operations located in the host country. If the host country has no laws on employment discrimination, the company is then required to follow all U.S. antidiscrimination laws.

Several multilateral treaties govern the rights of workers. In 1948, the United Nations adopted its Universal Declaration of Human Rights. The declaration sup- ports, among other things, equality of pay and nondiscriminatory employment policies. Also, the Helsinki Final Act of 1973 supports nondiscriminatory employ- ment policies. In 1977, the International Labor Office issued its Tripartite Declara- tion of Principles Concerning Multinational Enterprises, which supports equal pay and nondiscriminatory payment policies. The EU has adopted all of these treaties and policies for their implementation.

Biographyann Hopkins, a Shunned partner

Ann Hopkins was a senior manager in the Management Advisory Services division of the Price Waterhouse Office of Govern- ment Services (OGS) in Washington, D.C. After earning undergraduate and gradu- ate degrees in mathematics, she taught mathematics at her alma mater, Hollins College, and worked for IBM, NASA, Touche Ross, and American Management

Systems before beginning her career with Price Waterhouse in 1977. She became the firm’s specialist in large-scale comput- er system design and operations for the federal government. While salaries in the accounting profession are not published, estimates put her salary as a senior man- ager at about $65,000. Estimates of the increase in salary were that she would

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earn almost double that, or $125,000 annually, on average (1980 figures).

At that time, Price Waterhouse was known as one of the “Big 8,” or one of the top public accounting firms in the United States. A senior manager became a candidate for partnership when the part- ners in her office submitted her name for partnership status. In August 1982, the partners in Hopkins’s office proposed her as a candidate for partnership for the 1983 class of partners. Of the 88 candidates who were submitted for consideration, Hopkins was the only woman. Hopkins was responsible for bringing to Price Waterhouse a two-year, $25 million con- tract with the Department of State, the largest contract ever obtained by the firm. At that time, Price Waterhouse had 662 partners, 7 of whom were women. All of the firm’s partners were invited to submit written comments regarding each candi- date, but not every partner did so. Of the 32 partners who submitted comments on Hopkins, one stated that “none of the other partnership candidates at Price Waterhouse that year [has] a comparable record the partnership.”

Her billable hours were 2,442 in 1982 and 2,507 in 1981, amounts that none of the other partnership candidates’ billable hours even approached.

There were no limits on the number of persons to whom partnership could be awarded and no guidelines for evaluating comments about candidates. Price Water- house offered 47 partnerships to the 88 candidates in the 1983 round; another 27 were denied partnerships, and 20, includ- ing Ms. Hopkins, were put on hold. Ms. Hopkins had received more “no” votes than any other candidate for partnership, with most of those votes coming from members of the partnership committee outside the firm’s government services unit.

Thirteen of the 32 partners who sub- mitted comments on Hopkins supported her, three recommended putting her on hold, eight said they did not have enough information, and eight recommended denial.

The partners in Hopkins’s office praised her character as well as her accomplishments, describing her in their joint statement as “an outstanding profes- sional” who had a “deft touch,” a “strong character, independence, and integrity.” Clients appear to have agreed with these assessments. One official from the State Department described her as “extreme- ly competent, intelligent,” “strong and forthright, very productive, energetic, and creative.” She “was generally viewed as a highly competent project leader who worked long hours, pushed vigorously to meet deadlines, and demanded much from the multidisciplinary staffs with which she worked.”

On too many occasions, however, Hopkins’s aggressiveness apparently spilled over into abrasiveness. Staff mem- bers seem to have borne the brunt of Hopkins’s brusqueness. Long before her bid for partnership, partners evaluating her work had counseled her to improve her relations with staff members. Although later evaluations indicate an improvement, Hopkins’s perceived shortcomings in this important area eventually doomed her bid for partnership. Virtually all of the partners’ negative remarks about Hopkins—even those of partners who supported her— concerned her “interpersonal skills.” Both “[s]upporters and opponents of her can- didacy indicated that she was sometimes overly aggressive, unduly harsh, difficult to work with, and impatient with staff.”

Another partner testified at trial that he had questioned her billing records and was left with concerns because he found her answers unsatisfying.

One partner’s evaluation described her as “macho,” while another suggested that she “overcompensated for being a woman”; a third advised her to take “a course at charm school.” One partner wrote that Hopkins was “universally dis- liked.” Several partners criticized her use of profanity. In response, one partner suggested that those partners object- ed to her swearing only “because it[‘] s a lady using foul language.” Another supporter explained that Hopkins “ha[d]

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matured from a tough-talking, somewhat masculine, hardnosed manager to an authoritative, formidable, but much more appealing lady partner candidate.” In order for Hopkins to improve her chances for partnership, Thomas Beyer, a partner who supervised Hopkins at OGS, suggested that she “walk more femininely, talk more femininely, dress more femininely, wear make-up, have her hair styled, and wear jewelry.” Ms. Hopkins said she could not apply makeup because that would require removing her trifocals and she would not be able to see. Also, her allergy to cosmetics made it difficult for her to find appropriate makeup. Mr. Beyer also sug- gested that she should not carry a brief- case, should stop smoking, and should not drink beer at luncheon meetings.

Dr. Susan Fiske, a social psychologist and associate professor of psychology at Carnegie-Mellon University who would testify for Hopkins in her suit against Price Waterhouse, reviewed the Price Waterhouse selection process and con- cluded that it was likely influenced by sex stereotyping. Dr. Fiske indicated that some of the partners’ comments were gender-biased, while others that were gender-neutral were intensely critical and made by partners who barely knew Hop- kins. Dr. Fiske concluded that the subjec- tivity of the evaluations and their sharply critical nature were probably the result of sex stereotyping.

Although Hopkins and 19 others were put on hold for the following year, her future looked dim. Later, two partners withdrew their support for Hopkins, and she was informed that she would not be reconsidered the following year. Hopkins, who maintains that she was told after the second nomination cycle that she would never be a partner, then resigned and filed a discrimination complaint with the EEOC.

At that time, the law was not clear and the assumption was that Title VII did not apply to partnership decisions in com- panies. With the EEOC refusing to take action, Hopkins filed suit against Price

Waterhouse. She has stated she filed the suit to find out why Price Waterhouse made “such a bad business decision.” The U.S. Supreme Court found that Ms. Hopkins did indeed have a cause of action for discrimination in the partnership deci- sion. The Hopkins case was an important employment discrimination case because the Supreme Court recognized stereo- typing as a way of establishing discrimi- nation. However, the case is also known for its clarification of the law on situations in which employers take action against employees for both lawful and unlaw- ful reasons. Known as “mixed-motive” cases, this form of discrimination case shifts the burden of proof to the employer to establish that it would have made the same decision if using only the lawful con- siderations and in spite of unlawful con- siderations that entered into the process. The “same-decision” defense requires employers to establish sufficient grounds for termination or other actions taken against employees that are independent of the unlawful considerations.

In 1990, on remand, Ms. Hopkins was awarded her partnership and damages. She was awarded back pay plus interest, and while the exact amount of the award is unclear, Hopkins later verified that she paid $300,000 in taxes on her award that year and also paid her attorneys the $500,000 due and owing them. Ms. Hopkins rejoined Price Waterhouse as a partner in 1991.

Ms. Hopkins retired from Pricewa- terhouseCoopers in 2002, and she has written a book about her experience as a litigant. She also gardens, does carpentry work, and enjoys spending time with her grandchildren. She experienced years’ long litigation over the death of her young- est son, who was struck by a drunk driver.

Sources: Adapted from Marianne M. Jennings, Business Ethics: Cases and Selected Readings, 7th ed., 2011; Ann Hopkins, “Price Waterhouse v Hopkins: A Personal Account of a Sexual Discri- mination Plaintiff,” 22 Hofstra Lab. & Emp. L.J. 357 (2005).

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s u m m a r y What laws govern employment discrimination?

• Civil Rights Acts of 1866, 1964, 1991—federal statutes prohibiting discrimination in various aspects of life (employment, voting)

• Equal Pay Act—equal pay for the same work regard- less of gender

• Equal Employment Opportunity Act— antidiscrimi- nation employment amendment to Civil Rights Act

• Pregnancy Discrimination Act—prohibits refusing to hire, refusing to promote, or firing because of pregnancy

• Age Discrimination in Employment Act (ADEA)— prohibits hiring, firing, promotion, benefits, raises based on age

• Rehabilitation Act of 1973—federal statute prohib- iting discrimination on basis of disability by federal agencies and contractors

• Americans with Disabilities Act (ADA)—federal law prohibiting discrimination on basis of disability by certain employees

• Family and Medical Leave Act (FMLA)—federal law providing for 12 weeks of leave for childbirth, adop- tion, or family illness

• Lilly Ledbetter Fair Pay Act—federal law that expands the time for filing claims for violations of Title VII for compensation

What types of discrimination exist?

• Disparate treatment—form of discrimination in which members of different races/sexes are treated differently

• Disparate impact—test or screening device that affects one group more than another

• Pattern or practice of discrimination—theory for establishing discrimination that compares popula- tion percentages with workplace percentages

• Sexual harassment—form of discrimination that involves a quid pro quo related to sexual favors or an atmosphere of harassment

What are the defenses to discrimination?

• Bona fide occupational qualification (BFOQ)—job qualification of sex, religion, or national origin that is necessary for the operation of a business, such as religious affiliation for the pastor of a church

• Affirmative action—programs created to remedy past wrongs that permit choices on the basis of race, sex, or national origin

Q u e s t i o n s a n d P r o b l e m s 1. Patrick Brady, 19, who has cerebral palsy, had worked for two years as a pharmacy assistant at a local pharmacy. He had no incidents at work there and was given a good recommendation from his employer. He then applied at Wal-Mart for a pharmacy aide position and went right to work in the Wal-Mart pharmacy. After a few days as a pharmacy aide, he was transferred to the job of collecting shopping carts and garbage in the parking lot. His super- visor, Ms. Yem Hung Chin, said Brady was “absolutely awful,” and she “wanted [him] away from [her] prescrip- tions.” Although Wal-Mart had an institutional “coaching policy,” she never approached Brady about participating in it, because “I really didn’t think it kind of applied. I didn’t know how to teach him to find names better. . . .” Brady testified that he never handed out the wrong pre- scription, was never unable to find a prescription in the bin, and never required assistance from Ms. Chin or any other coworker to perform his job.

Brady was never given the 90-day probationary period given to other employees, nor was he given any training. When he met with the store manager about his parking lot job, he was transferred to the bakery with no training and no uniform. When he asked to return to the pharmacy, he was given a work schedule that con- flicted with his community college class schedule, some- thing he had noted on his application for employment in describing his availability. Frustrated, Brady quit and filed suit. Explain his rights under the Americans with Disabilities Act. Discuss Ms. Chin’s statements and any- thing else Wal-Mart did that might be used as proof of discrimination. [Brady v Wal-Mart Stores, Inc., 531 F.3d 127 (2nd Cir. 2008)]

2. Calvin Rhodes began as a salesman with Dresser Industries in 1955. In 1986, the oil industry experi- enced a severe economic downturn, and Mr. Rhodes

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was laid off. His severance report said he was dis- charged as part of a reduction in force. Within two months, Dresser had hired a 42-year-old replacement. Mr. Rhodes sued for violation of ADEA. Will he win? [Rhodes v Guiberson Oil Tools (subsidiary of Dresser), 75 F.3d 989 (5th Cir. 1996)]

3. Vivian Martyszenko was working as a cashier at a Safeway grocery store in Ogallala, Nebraska, when she received a call from the police informing her that her two children might have been molested. Ms. Martyszenko’s supervisor gave her two weeks’ vacation leave to care for her children.

The psychiatrist’s exam of the children was inconclu- sive, and Ms. Martyszenko was told it would take time for their recovery. She asked for leave under the FMLA, which Safeway denied. She then filed suit, alleging Safe- way had violated FMLA. Was the boys’ condition a seri- ous health condition covered under FMLA? [Martyszenko v Safeway, Inc., 120 F.3d 120 (8th Cir. 1997)]

4. On August 11, 1980, Shelby Memorial Hospital hired Sylvia Hayes, a certified X-ray technician, to work the 3:00 11:00 p.m. shift in the hospital’s radiol- ogy department. Two months later, she was fired after she informed her supervisor that she was pregnant. The supervisor fired Ms. Hayes because Dr. Cecil Eiland, the hospital’s radiology director and director of radia- tion safety, recommended that Ms. Hayes be removed from all areas using ionizing radiation, and the hospital could not find alternative work for her. After her dis- missal, Ms. Hayes filed suit for violation of the Preg- nancy Discrimination Act and Title VII. Should she recover? [Hayes v Shelby Memorial Hosp., 726 F.2d 1543 (11th Cir. 1984)]

5. The Masonic nursing home has mostly female occu- pants and hires fewer male attendants than female ones. Home administrators maintain that the female occupants (for privacy reasons) would not consent to intimate per- sonal care by males and would, in fact, leave the home. A substantial portion of the women at the home are “total care” patients who require assistance in performing vir- tually all activities, including bathing, dressing, and using toilets, catheters, and bedpans. In a suit brought by a male nurse’s aide who was denied employment, who would win? [Fessel v Masonic Home, 17 FEP Cases 330 (Del. 1978)]

6. Between 1985 and 1990, while attending college, Beth Ann Faragher worked part-time and during the summers as an ocean lifeguard for the Parks and Rec- reation Department of the City of Boca Raton. Ms. Fara- gher worked for three immediate supervisors during this period: Bill Terry, David Silverman, and Robert Gordon.

Ms. Faragher resigned in June 1990 and brought a Title VII sexual harassment suit against the City in 1992. She alleged a sexually hostile atmosphere because of “unin- vited and offensive touching,” lewd remarks, and Mr. Silverman’s comment, “Date me or clean the toilets for a year.”

Ms. Faragher had not complained to higher manage- ment, and the lifeguards had no significant contact with higher city officials. Two months before Ms. Faragher’s resignation, a former lifeguard, Nancy E. Wanchew, wrote to the City’s personnel director complaining about Mr. Terry and Mr. Silverman’s harassment of female lifeguards. Should the City be held liable? Does it mat- ter that Ms. Faragher asked only for nominal damages, attorney’s fees, and costs? [Faragher v. City of Boca Raton, 524 U.S. 775 (1998)]

7. Wendy Komac was hired by Gordon Food Service as a salesperson. During the course of her employment, Gordon held sales contests such as the “Winner’s Circle” competition, which rewarded the salesperson who gen- erated the most new customers. Ms. Komac’s supervisor received an unsigned letter that accused Ms. Komac of falsely representing new sales customers in her report. When confronted, she denied the allegations but was eliminated from the sale competition when she stated that “other employees routinely violated the rules.” Her supervisor gave a speech at the next sales meeting explaining that violations of the rules during sales com- petition would be grounds for termination.

During a subsequent Tyson product competition, allegations again emerged about Ms. Komac’s conduct. When confronted, Ms. Komac admitted that she had reported products normally purchased by one of her long-term customers as being purchased by two other customers.

Following the second contest problem, Ms. Komac was fired. Ms. Komac filed suit alleging discrimi- nation by Gordon. She gave examples of statements made to her over the course of her employment such as her pay being less because male employees “have a wife and three kids at home.” She also alleged that no male employees were terminated for violating contest rules. However, there was no evidence that any male employees had been caught cheating in contests after the supervisor’s speech. Explain whether Ms. Komac has established a prima facie case of gender discrimi- nation. [Komac v. Gordon Food Service, 3 F. Supp. 2d 850 (N.D. Ohio 1998)]

8. Would the following actions constitute sexual harassment?

a. Making sexual comments or innuendoes; telling sexual jokes or stories

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b. Asking questions about social or sexual life c. Telling lies or spreading rumors about a person’s

personal sex life d. Making sexual comments about a person’s body e. Turning work discussions to sexual topics f. Looking a person up and down g. Staring repeatedly at someone h. Blocking a person’s path or hindering them i. Giving unwanted gifts of a sexual nature j. Invading a person’s body space k. Making sexual gestures or kissing sounds or

offering massages l. Displaying sexual posters, cartoons, or handouts

9. American Airlines passed a grooming rule that pro- hibited “cornrow” hairstyles on all employees. Renee

Rogers, a black woman, brought a Title VII suit alleging that the denial of her right to wear the hairstyle intruded upon her rights and discriminated against her. What will be the result? [Rogers v. American Airlines, Inc., 527 F. Supp. 229 (S.D.N.Y. 1981)]

10. American Airlines has a policy of not hiring flight officers over the age of 40. The reason for their policy is that it takes 10 to 15 years for a flight officer to become a copilot and then another 10 to 15 years for a copilot to become a captain. Because the FAA requires retirement at age 60, service would be limited. Edward L. Murnane, age 43, was denied employment on the basis of age and filed an age discrimination suit. Is age a BFOQ for the job? [Murnane v. American Airlines, Inc., 667 F.2d 98 (D.C. 1981)]

Ethics, Organizational Behavior, & the Law English Only in Emergencies?

English-only policies in the workplace have become the fastest-growing area of EEOC challenges as well as litigation under Title VII. In 1996, the EEOC had 30 discrimination complaints related to English-only policies of employers. Since 1996, the EEOC has had a 500% increase in those complaints.4 Employers that have implemented English-only policies include the Salvation Army, All-Island Transportation (a Long Island taxi company), a geriatric center in New York, and Oglethorpe University in Atlanta.

One lawyer noted that employers seem more willing to make the policies and risk the legal battles because they think such policies are appropriate and necessary in order to provide adequate customer service or, in the case of health operations such as the geriatric center, correct medical care. Employers are, however, warned by their lawyers that they will have “a target on their backs” if they implement the policies.

However, the case law is clear: employers must be acting in the best interests of their companies. For example, in Reyes v Pharma Chemie, Inc., 890 F. Supp. 2d 1147 (D. Neb. 2012), the court upheld the termination of an employee for not speaking English because the employer was able to show that the ability to speak English was critical for the production lines in their facility. Lawyers offer the

following guidelines for enforceable English-only policies:

1. Such policies are permitted if they are needed to promote safe or efficient operations.

2. Such policies are permitted where communication with customers, coworkers, or supervisors who speak only English is also important.

3. Such policies are permitted where there are fre- quent emergency encounters in which speaking a common language is necessary for purposes of managing such situations.

4. Such policies are necessary in situations in which cooperation and close working relationships demand a common language and some workers speak only English.

dISCUSSION QUeStIONS

1. Is there a common thread among the companies mentioned that have English-only policies?

2. Do these language policies create a hostile environment?

3. Give a list of the types of employers you believe could qualify for an English-only policy under the EEOC guidelines.

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n ot e s 1. See the Instructor’s Manual for additional background on the history of employment discrimination law.

2. Justice Sonia Sotomayor’s confirmation to the high court was pending at the time of this decision. She was one of the appellate judges who reversed the lower court decision.

3. For updates on affirmative action and other issues in employment discrimination law, be sure to visit the course website.

4. U.S. Equal Employment Opportunity Commission (EEOC), “Litigation Statistics,” http://www.eeoc.gov. At the EEOC home page, search “Litigation Statistics.” Or click on “About the EEOC,” go to “Statistics,” and then click on “EEOC Enforcement and Litigation Statistics” or go to http://www. eeoc.gov/eeoc/statistics/enforcement/litigation.cfm.

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A-1

We the People of the United States, in Order to form a more perfect Union, establish Justice, insure domestic Tranquility, provide for the common defence, promote the general Welfare, and secure the Blessings of Liberty to ourselves and our Pos- terity, do ordain and establish this Constitution for the United States of America.

ARTICLE I Section 1 All legislative Powers herein granted shall be vested in a Congress of the United States, which shall con- sist of a Senate and House of Representatives.

Section 2 The House of Representatives shall be composed of Members chosen every second Year by the People of the several States, and the Electors in each State shall have the Qualifications requisite for Electors of the most numerous Branch of the State Legislature.

No Person shall be a Representative who shall not have attained to the Age of twenty five Years, and been seven Years a Citizen of the United States, and who shall not, when elected, be an Inhabitant of that State in which he shall be chosen.

Representatives and direct Taxes shall be apportioned among the several States which may be included within this Union, according to their respective Numbers, which shall be determined by adding to the whole Number of free Persons, includ- ing those bound to Service for a Term of Years, and excluding Indians not taxed, three fifths of all other Persons. The actual Enumeration shall be made within three Years after the first Meeting of the Con- gress of the United States, and within every subse- quent Term of ten Years, in which Manner as they shall by Law direct. The Number of Representatives shall not exceed one for every thirty Thousand, but each State shall have at Least one Representative; and until such enumeration shall be made, the State of New Hampshire shall be entitled to choose three, Massachusetts eight, Rhode Island and Providence

Plantations one, Connecticut five, New York six, New Jersey four, Pennsylvania eight, Delaware one, Maryland six, Virginia ten, North Carolina five, South Carolina five, and Georgia three.

When vacancies happen in the Representation from any State, the Executive Authority thereof shall issue Writs of Election to fill such Vacancies.

The House of Representatives shall chuse their Speaker and other Officers; and shall have the sole Power of Impeachment.

Section 3 The Senate of the United States shall be composed of two Senators from each State, chosen by the Leg- islature thereof, for six Years; and each Senator shall have one Vote.

Immediately after they shall be assembled in Consequence of the first Election, they shall be divided as equally as may be into three Classes. The Seats of the Senators of the first Class shall be vacated at the Expiration of the second Year, of the second Class at the Expiration of the fourth Year, and of the third Class at the Expiration of the sixth Year, so that one third may be chosen every second Year; and if Vacancies happen by Resignation, or otherwise, during the Recess of the Legislature of any State, the Executive thereof may make tempo- rary Appointments until the next Meeting of the Legislature, which shall then fill such Vacancies.

No Person shall be a Senator who shall not have attained to the Age of thirty Years, and been nine Years a Citizen of the United States, and who shall not, when elected, be an Inhabitant of that State for which he shall be chosen.

The Vice President of the United States shall be President of the Senate, but shall have no Vote, unless they be equally divided.

The Senate shall chuse their other Officers, and also a President pro tempore, in the Absence of the Vice President, or when he shall exercise the Office of President of the United States.

The Senate shall have the sole Power to try all Impeachments. When sitting for that Purpose, they

Appendix AThe United States Constitution

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A-2 Appendix A The United States Constitution

shall be on Oath or Affirmation. When the Presi- dent of the United States is tried the Chief Justice shall preside: And no Person shall be convicted without the Concurrence of two thirds of the Mem- bers present.

Judgment in Cases of Impeachment shall not extend further than to removal from Office, and disqualification to hold and enjoy any Office of honor, Trust or Profit under the United States: but the Party convicted shall nevertheless be liable and subject to Indictment, Trial, Judgment and Punish- ment, according to Law.

Section 4 The Times, Places and Manner of holding Elections for Senators and Representatives, shall be pre- scribed in each State by the Legislature thereof; but the Congress may at any time by Law make or alter such Regulations, except as to the Places of chusing Senators.

The Congress shall assemble at Least once in every Year, and such Meeting shall be on the first Monday in December, unless they shall by Law appoint a different Day.

Section 5 Each House shall be the Judge of the Elections, Returns and Qualifications of its own Members, and a Majority of each shall constitute a Quorum to do Business; but a smaller Number may adjourn from day to day, and may be authorized to compel the Attendance of absent Members, in such Man- ner, and under such Penalties as each House may provide.

Each House may determine the Rules in its Proceedings, punish its Members for disorderly Behaviour, and, with the Concurrence of two thirds, expel a Member.

Each House shall keep a Journal of its Pro- ceedings, and from time to time publish the same, excepting such Parts as may in their Judgment require Secrecy; and the Yeas and Nays of the Mem- bers of either House on any question shall, at the Desire of one fifth of those Present, be entered on the Journal.

Neither House, during the Session of Congress, shall, without the Consent of the other, adjourn for more than three days, nor to any other Place than that in which the two Houses shall be sitting.

Section 6 The Senators and Representatives shall receive a Compensation for their Services, to be ascertained by Law, and paid out of the Treasury of the United States. They shall in all Cases, except Treason, Felony and Breach of the Peace, be privileged from Arrest during their Attendance at the Session of their respec- tive Houses, and in going to and returning from the same; and for any Speech or Debate in either House, they shall not be questioned in any other Place.

No Senator or Representative shall, during the Time for which he was elected, be appointed to any civil Office under the Authority of the United States, which shall have been created, or the Emol- uments whereof shall have been encreased during such time; and no Person holding any Office under the United States, shall be a Member of either House during his Continuance in Office.

Section 7 All Bills for raising Revenue shall originate in the House of Representatives; but the Senate may pro- pose or concur with amendments as on other Bills.

Every Bill which shall have passed the House of Representatives and the Senate, shall, before it become a Law, be presented to the President of the United States; If he approve he shall sign it, but if not he shall return it, with his Objections to that House in which it shall have originated, who shall enter the Objections at large on their Journal, and pro- ceed to reconsider it. If after such Reconsideration two thirds of that House shall agree to pass the Bill, it shall be sent, together with the Objections, to the other House, by which it shall like wise be reconsid- ered, and if approved by two thirds of that House, it shall become a Law. But in all such Cases the Votes of both Houses shall be determined by Yeas and Nays, and the names of the Persons voting for and against the Bill shall be entered on the Journal of each House respectively. If any Bill shall not be returned by the President within ten Days (Sundays excepted) after it shall have been presented to him, the Same shall be a Law, in like Manner as if he had signed it, unless the Congress by their Adjournment prevent its Return, in which Case it shall not be a Law.

Every Order, Resolution, or Vote to which the Con- currence of the Senate and House of Representatives may be necessary (except on a question of Adjourn- ment) shall be presented to the President of the United States; and before the Same shall take Effect,

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Appendix A The United States Constitution A-3

shall be approved by him, or being disapproved by him, shall be repassed by two thirds of the Senate and House of Representatives, according to the Rules and Limitations prescribed in the Case of a Bill.

Section 8 The Congress shall have Power To lay and collect Taxes, Duties, Imposts and Excises, to pay the Debts and provide for the common Defense and general Welfare of the United States; but all Duties, Imposts and Excises shall be uniform throughout the United States;

To borrow Money on the credit of the United States;

To regulate Commerce with foreign Nations, and among the several States, and with the Indian Tribes;

To establish an uniform Rule of Naturalization, and uniform Laws on the subject of Bankruptcies throughout the United States;

To coin Money, regulate the Value thereof, and of foreign Coin, and fix the Standard of Weights and Measures;

To provide for the Punishment of counterfeit- ing the Securities and current Coin of the United States;

To establish Post Offices and post Roads; To promote the Progress of Science and useful

Arts, by securing for limited Times to Authors and Inventors the exclusive Right to their respective Writings and Discoveries;

To constitute Tribunals inferior to the supreme Court;

To define and punish Piracies and Felonies com- mitted on the high Seas, and Offenses against the Law of Nations;

To declare War, grant Letters of Marque and Reprisal, and make Rules concerning Captures on Land and Water;

To raise and support Armies, but no Appropria- tion of Money to that Use shall be for a longer Term than two Years;

To provide and maintain a Navy; To make Rules for the Government and Regula-

tion of the land and naval Forces; To provide for calling forth the Militia to exe-

cute the Laws of the Union, suppress Insurrections and repel Invasions;

To provide for organizing, arming, and disci- plining, the Militia, and for governing such Part

of them as may be employed in the Service of the United States, reserving to the States respectively, the Appointment of the Officers, and the Authority of training the Militia according to the discipline prescribed by Congress;

To exercise exclusive Legislation in all Cases whatsoever, over such District (not exceeding ten Miles square) as may, by Cession of particular States, and the Acceptance of Congress, become the Seat of the Government of the United States, and to exercise like Authority over all Places purchased by the Consent of the Legislature of the State in which the Same shall be, for the Erection of Forts, Mag- azines, Arsenals, dock-Yards, and other needful Buildings;—And

To make all Laws which shall be necessary and proper for carrying into Execution the foregoing Powers, and all other Powers vested by this Consti- tution in the Government of the United States, or in any Department or Officer thereof.

Section 9 The Migration or Importation of such Persons as any of the States now existing shall think proper to admit, shall not be prohibited by the Congress prior to the Year one thousand eight hundred and eight, but a Tax or duty may be imposed on such Importa- tion, not exceeding ten dollars for each Person.

The Privilege of the Writ of Habeas Corpus shall not be suspended, unless when in Cases of Rebel- lion or Invasion the public Safety may require it.

No Bill of Attainder or ex post facto Law shall be passed.

No Capitation, or other direct, Tax shall be laid, unless in Proportion to the Census or Enumeration herein before directed to be taken.

No Tax or Duty shall be laid on Articles exported from any State.

No Preference shall be given to any Regulation of Commerce or Revenue to the Ports of one State over those of another; nor shall Vessels bound to, or from, one State, be obliged to enter, clear or pay Duties in another.

No Money shall be drawn from the Treasury, but in Consequence of Appropriations made by Law; and a regular Statement and Account of the Receipts and Expenditures of all public Money shall be published from time to time.

No Title of Nobility shall be granted by the United States: And no Person holding any Office of

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A-4 Appendix A The United States Constitution

Profit or Trust under them, shall, without the Con- sent of the Congress, accept of any present, Emol- ument, Office, or Title, of any kind whatever, from any King, Prince or foreign State.

Section 10 No State shall enter into any Treaty, Alliance, or Confederation; grant Letters of Marque and Repri- sal; coin Money; emit Bills of Credit; make any Thing but gold and silver Coin a Tender in Pay- ment of Debts; pass any Bill of Attainder, ex post facto Law or law impairing the Obligation of Con- tracts, or grant any Title of Nobility.

No State shall, without the Consent of the Con- gress, lay any Imposts or Duties on Imports or Exports, except what may be absolutely necessary for executing its inspection Laws: and the net Pro- duce of all Duties and Imposts, laid by any State on Imports or Exports, shall be for the Use of the Treasury of the United States; and all such Laws shall be subject to the Revision and Control of the Congress.

No State shall, without the Consent of Congress, lay any Duty on Tonnage, keep Troops, or Ships of War in time of Peace, enter into any Agreement or Compact with another State, or with a foreign Power, or engage in War, unless actually invaded, or in such imminent Danger as will not admit of delay.

ARTICLE II Section 1 The executive Power shall be vested in a President of the United States of America. He shall hold his Office during the Term of four Years, and, together with the Vice President, chosen for the same Term, be elected, as follows:

Each State shall appoint, in such Manner as the Legislature thereof may direct, a Number of Elec- tors, equal to the whole Number of Senators and Representatives to which the State may be entitled in the Congress: but no Senator or Representative, or Person holding an Office of Trust or Profit under the United States, shall be appointed an Elector.

The Electors shall meet in their respective States, and vote by Ballot for two Persons, of whom one at least shall not be an Inhabitant of the same State with themselves. And they shall make a List of all the Persons voted for, and of the Number of

Votes for each; which List they shall sign and cer- tify, and transmit sealed to the Seat of the Govern- ment of the United States, directed to the President of the Senate. The President of the Senate shall, in the Presence of the Senate and House of Repre- sentatives, open all the Certificates, and the Votes shall then be counted. The Person having the great- est Number of Votes shall be the President, if such Number be a Majority of the whole Number of Electors appointed; and if there be more than one who have such Majority, and have an equal Num- ber of Votes, then the House of Representatives shall immediately chuse by Ballot one of them for President; and if no Person have a Majority, then from the five highest on the List the said House shall in like Manner chuse the President. But in chusing the President, the Votes shall be taken by States, the Representation from each State having one Vote; a quorum for this Purpose shall consist of a Member or Members from two thirds of the States, and a Majority of all the States shall be nec- essary to a Choice. In every Case, after the Choice of the President, the Person having the greatest Number of Votes of the Electors shall be the Vice President. But if there should remain two or more who have equal Votes, the Senate shall chuse from them by Ballot the Vice President.

The Congress may determine the Time of chus- ing the Electors, and the Day on which they shall give their Votes; which Day shall be the same throughout the United States.

No Person except a natural born Citizen, or a Citizen of the United States, at the time of the Adoption of this Constitution, shall be eligible to the Office of President; neither shall any Person be eligible to that Office who shall not have attained to the Age of thirty-five Years, and been fourteen years a Resident within the United States.

In Case of the Removal of the President from Office, or of his Death, Resignation, or Inability to discharge the Powers and Duties of the said Office, the Same shall devolve on the Vice President, and the Congress may by Law provide for the Case of Removal, Death, Resignation, or Inability, both of the President and Vice President, declaring what Officer shall then act as President, and such Offi- cer shall act accordingly, until the Disability be removed, or a President shall be elected.

The President shall, at stated Times, receive for his Services, a Compensation, which shall neither

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Appendix A The United States Constitution A-5

be encreased nor diminished during the Period for which he shall have been elected, and he shall not receive within that Period any other Emolument from the United States, or any of them.

Before he enter on the Execution of his Office, he shall take the following Oath or Affirma- tion:—“I do solemnly swear (or affirm) that I will faithfully execute the Office of President of the United States, and will to the best of my Ability, preserve, protect, and defend the Constitution of the United States.”

Section 2 The President shall be Commander in Chief of the Army and Navy of the United States, and of the Militia of the several States, when called into the actual Service of the United States; he may require the Opinion, in writing, of the principal Officer in each of the executive Departments, upon any Subject relating to the Duties of their respective Offices, and he shall have Power to grant Reprieves and Pardons for Offenses against the United States, except in Cases of Impeachment.

He shall have Power, by and with the Advice and Consent of the Senate, to make Treaties, pro- vided two thirds of the Senators present concur; and he shall nominate, and by and with the Advice and Consent of the Senate, shall appoint Ambassa- dors, other public Ministers and Consuls, Judges of the supreme Court, and all other Officers of the United States, whose Appointments are not herein otherwise provided for, and which shall be estab- lished by Law: but the Congress may by Law vest the Appointment of such inferior Officers, as they think proper, in the President alone, in the Courts of Law, or in the Heads of Departments.

The President shall have Power to fill up all Vacancies that may happen during the Recess of the Senate, by granting Commissions which shall expire at the End of their next Session.

Section 3 He shall from time to time give to the Congress Information of the State of the Union, and recom- mend to their Consideration such Measures as he shall judge necessary and expedient; he may, on extraordinary Occasions, convene both Houses, or either of them, and in Case of Disagreement between them, with Respect to the Time of Adjourn- ment, he may adjourn them to such Time as he shall think proper; he shall receive Ambassadors and

other public Ministers; he shall take Care that the Laws be faithfully executed, and shall Commission all the Officers of the United States.

Section 4 The President, Vice President and all Civil Officers of the United States, shall be removed from Office on Impeachment for, and Conviction of, Treason, Bribery, or other high Crimes and Misdemeanors.

ARTICLE III Section 1 The judicial Power of the United States, shall be vested in one supreme Court, and in such inferior Courts as the Congress may from time to time ordain and establish. The Judges, both of the supreme and inferior Courts, shall hold their Offices during good Behaviour, and shall, at stated Times, receive for their Services, a Compensation, which shall not be dimin- ished during their Continuance in Office.

Section 2 The judicial Power shall extend to all Cases, in Law and Equity, arising under this Constitution, the Laws of the United States, and Treaties made, or which shall be made, under their Authority;—to all Cases affecting Ambassadors, other public Min- isters and Consuls;—to all Cases of admiralty and maritime Jurisdiction;—to Controversies to which the United States shall be a Party;—to Controver- sies between two or more States;—between a State and Citizens of another State;—between Citizens of different States,—between Citizens of the same State claiming Lands under Grants of different States, and between a State, or the Citizens thereof, and foreign States, Citizens or Subjects.

In all Cases affecting Ambassadors, other pub- lic Ministers and Consuls, and those in which a State shall be Party, the Supreme Court shall have original Jurisdiction. In all the other Cases before mentioned, the supreme Court shall have appel- late Jurisdiction, both as to Law and Fact, with such Exceptions, and under such Regulations as the Congress shall make.

The Trial of all Crimes, except in Cases of Impeachment, shall be by Jury; and such Trial shall be held in the State where the said Crimes shall have been committed; but when not committed within any State, the Trial shall be at such Place or Places as the Congress may by Law have directed.

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Section 3 Treason against the United States, shall consist only in levying War against them, or in adhering to their Enemies, giving them Aid and Comfort. No Person shall be convicted of Treason unless on the Testi- mony of two Witnesses to the same overt Act, or on Confession in open Court.

The Congress shall have Power to declare the Punishment of Treason, but no Attainder of Trea- son shall work Corruption of Blood, or Forfeiture except during the Life of the Person attainted.

ARTICLE IV Section 1 Full Faith and Credit shall be given in each State to the public Arts, Records, and judicial Proceedings of every other State. And the Congress may by gen- eral Laws prescribe the Manner in which such Acts, Records and Proceedings shall be proved, and the Effect thereof.

Section 2 The Citizens of each State shall be entitled to all Privileges and Immunities of Citizens in the several States.

A Person charged in any State with Treason, Fel- ony, or other Crime, who shall flee from Justice, and be found in another State, shall on Demand of the executive Authority of the State from which he fled, be delivered up, to be removed to the State having Jurisdiction of the Crime.

No Person held to Service or Labour in one State, under the Laws thereof, escaping into another, shall, in Consequence of any Law or Reg- ulation therein, be discharged from such Service or Labour, but shall be delivered up on Claim of the Party to whom such Service or Labour may be due.

Section 3 New States may be admitted by the Congress into this Union; but no new State shall be formed or erected within the Jurisdiction of any other State; nor any State be formed by the Junction of two or more States, or Parts of States, without the Consent of the Legislatures of the States concerned as well as of the Congress.

The Congress shall have Power to dispose of and make all needful Rules and Regulations respect- ing the Territory or other Property belonging to

the United States; and nothing in this Constitution shall be so construed as to Prejudice any Claims of the United States, or of any particular State.

Section 4 The United States shall guarantee to every State in this Union a Republican Form of Government, and shall protect each of them against Invasion; and on Application of the Legislature, or of the Executive (when the Legislature cannot be convened) against domestic Violence.

ARTICLE V The Congress, whenever two thirds of both Houses shall deem it necessary, shall propose Amendments to this Constitution, or, on the Application of the Legislatures of two thirds of the several States, shall call a Convention for proposing Amendments, which, in either Case, shall be valid to all Intents and Purposes, as Part of this Constitution, when ratified by the Legislatures of three fourths of the several States, or by Conventions in three fourths thereof, as the one or the other Mode of Ratification may be proposed by the Congress; Provided that no Amendment which may be made prior to the Year One thousand eight hundred and eight shall in any Manner affect the first and fourth Clauses in the Ninth Section of the first Article; and that no State, without its Consent, shall be deprived of its equal Suffrage in the Senate.

ARTICLE VI All Debts contracted and Engagements entered into, before the Adoption of this Constitution, shall be as valid against the United States under this Constitution, as under the Confederation.

This Constitution, and the Laws of the United States which shall be made in Pursuance thereof; and all Treaties made, or which shall be made, under the Authority of the United States, shall be the supreme Law of the Land; and the judges in every State shall be bound thereby, any Thing in the Constitution or Laws of any State to the Contrary notwithstanding.

The Senators and Representatives before men- tioned, and the Members of the several State Leg- islatures, and all executive and judicial Officers, both of the United States and of the several States,

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shall be bound by Oath or Affirmation, to support this Constitution; but no religious Test shall ever be required as a Qualification to any Office or public Trust under the United States.

ARTICLE VII The Ratification of the Conventions of nine States, shall be sufficient for the Establishment of this Con- stitution between the States so ratifying the Same.

AMENDMENT I (1791) Congress shall make no law respecting an estab- lishment of religion, or prohibiting the free exer- cise thereof; or abridging the freedom of speech, or of the press; or the right of the people peaceably to assemble, and to petition the Government for a redress of grievances.

AMENDMENT II (1791) A well regulated Militia, being necessary to the security of a free State, the right of the people to keep and bear Arms, shall not be infringed.

AMENDMENT III (1791) No Soldier shall, in time of peace be quartered in any house, without the consent of the Owner, nor in time of war, but in a manner to be prescribed by law.

AMENDMENT IV (1791) The right of the people to be secure in their persons, houses, papers, and effects, against unreasonable searches and seizures, shall not be violated, and no Warrants shall issue, but upon probable cause, supported by Oath or affirmation, and particularly describing the place to be searched, and the persons or things to be seized.

AMENDMENT V (1791) No person shall be held to answer for a capital or otherwise infamous crime, unless on a present- ment or indictment of a Grand Jury, except in cases arising in the land or naval forces, or in the Militia,

when in actual service in time of War or public dan- ger; nor shall any person be subject for the same offense to be twice put in jeopardy of life or limb; nor shall be compelled in any criminal case to be a witness against himself, nor be deprived of life, liberty, or property, without due process of law; nor shall private property be taken for public use, with- out just compensation.

AMENDMENT VI (1791) In all criminal prosecutions, the accused shall enjoy the right to a speedy and public trial, by an impar- tial jury of the State and district wherein the crime shall have been committed, which district shall have been previously ascertained by law, and to be informed of the nature and cause of the accusation; to be confronted with the witnesses against him; to have compulsory process for obtaining Witnesses in his favor, and to have the Assistance of Counsel for his defense.

AMENDMENT VII (1791) In Suits at common law, where the value in contro- versy shall exceed twenty dollars, the right of trial by jury shall be preserved, and no fact tried by a jury, shall be otherwise reexamined in any Court of the United States, than according to the rules of the common law.

AMENDMENT VIII (1791) Excessive bail shall not be required nor excessive fines imposed, nor cruel and unusual punishments inflicted.

AMENDMENT IX (1791) The enumeration in the Constitution, of certain rights, shall not be construed to deny or disparage others retained by the people.

AMENDMENT X (1791) The powers not delegated to the United States by the Constitution, nor prohibited by it to the States, are reserved to the States respectively, or to the people.

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A-8 Appendix A The United States Constitution

AMENDMENT XI (1798) The Judicial power of the United States shall not be construed to extend to any suit in law or equity, commenced or prosecuted against one of the United States by Citizens of another State, or by Citizens or Subjects of any Foreign State.

AMENDMENT XII (1804) The Electors shall meet in their respective states and vote by ballot for President and Vice Presi- dent, one of whom, at least, shall not be an inhab- itant of the same state with themselves; they shall name in their ballots the person voted for as Pres- ident, and in distinct ballots the person voted for as Vice-President, and they shall make distinct lists of all persons voted for as President, and of all persons voted for as Vice-President, and of the number of votes for each, which lists they shall sign and certify, and transmit sealed to the seat of the government of the United States, directed to the President of the Senate;—The President of the Senate shall, in the presence of the Senate and House of Representatives, open all the certificates and the votes shall then be counted;—The person having the greatest number of votes for President, shall be the President, if such number be a majority of the whole number of Electors appointed; and if no person have such majority, then from the per- sons having the highest numbers not exceeding three on the list of those voted for as President, the House of Representatives shall choose immedi- ately, by ballot, the President. But in choosing the President, the votes shall be taken by states, the representation from each state having one vote; a quorum for this purpose shall consist of a mem- ber or members from two-thirds of the states, and a majority of all the states shall be necessary to a choice. And if the House of Representatives shall not choose a President whenever the right of choice shall devolve upon them, before the fourth day of March next following, then the Vice-President shall act as President, as in the case of the death or other constitutional disability of the President— The person having the greatest number of votes as Vice-President, shall be the Vice-President, if such number be a majority of the whole number of Elec- tors appointed, and if no person have a majority, then from the two highest numbers on the list, the

Senate shall choose the Vice-President; a quorum for the purpose shall consist of two-thirds of the whole numbers of Senators, and a majority of the whole number shall be necessary to a choice. But no person constitutionally ineligible to the office of President shall be eligible to that of Vice President of the United States.

AMENDMENT XIII (1865) Section 1 Neither slavery nor involuntary servitude, except as a punishment for crime whereof the party shall have been duly convicted, shall exist within the United States, or any place subject to their jurisdiction.

Section 2 Congress shall have power to enforce this article by appropriate legislation.

AMENDMENT XIV (1868) Section 1 All persons born or naturalized in the United States and subject to the jurisdiction thereof, are citizens of the United States and of the State wherein they reside. No State shall make or enforce any law which shall abridge the privileges or immunities of citizens of the United States; nor shall any State deprive any person of life, liberty, or property, with- out due process of law; nor deny to any person within its jurisdiction the equal protection of the laws.

Section 2 Representatives shall be apportioned among the several States according to their respective num- bers, counting the whole number of persons in each State, excluding Indians not taxed. But when the right to vote at any election for the choice of elec- tors for President and Vice President of the United States, Representatives in Congress, the Executive and Judicial officers of a State, or the members of the Legislature thereof, is denied to any of the male inhabitants of such State, being twenty-one years of age, and citizens of the United States, or in any way abridged, except for participation in rebellion, or other crime, the basis of representation therein shall be reduced in the proportion which the number of

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Appendix A The United States Constitution A-9

such male citizens shall bear to the whole number of male citizens twenty-one years of age in such State.

Section 3 No person shall be a Senator or Representative in Congress, or elector of President and Vice President, or hold any office, civil or military, under the United States, or under any State, who, having previously taken an oath, as a member of Congress, or as an officer of the United States, or as a member of any State legislature, or as an executive or judicial offi- cer of any State, to support the Constitution of the United States, shall have engaged in insurrection or rebellion against the same, or given aid or comfort to the enemies thereof. But Congress may by a vote of two-thirds of each House, remove such disability.

Section 4 The validity of the public debt of the United States, authorized by law, including debts incurred for payment of pensions and bounties for services in suppressing insurrection or rebellion, shall not be questioned. But neither the United States nor any State shall assume or pay any debt or obligation incurred in aid of insurrection or rebellion against the United States, or any claim for the loss or eman- cipation of any slave; but all such debts, obligations and claims shall be held illegal and void.

Section 5 The Congress shall have power to enforce, by appro- priate legislation, the provisions of this article.

AMENDMENT XV (1870)

Section 1 The right of citizens of the United States to vote shall not be denied or abridged by the United States or by any State on account of race, color, or previ- ous condition of servitude.

Section 2 The Congress shall have power to enforce this arti- cle by appropriate legislation.

AMENDMENT XVI (1913) The Congress shall have power to lay and collect taxes on incomes, from whatever source derived, without apportionment among the several States, and without regard to any census or enumeration.

AMENDMENT XVII (1913) The Senate of the United States shall be composed of two Senators from each State, elected by the peo- ple thereof, for six years; and each Senator shall have one vote. The electors in each State shall have the qualifications requisite for electors of the most numerous branch of the State legislatures.

When vacancies happen in the representation of any State in the Senate, the executive author- ity of such State shall issue writs of election to fill such vacancies: Provided, That the legislature of any State may empower the executive thereof to make temporary appointments until the people fill the vacancies by election as the legislature may direct.

This amendment shall not be so construed as to affect the election or term of any Senator chosen before it becomes valid as part of the Constitution.

AMENDMENT XVIII (1919) Section 1 After one year from the ratification of this article the manufacture, sale, or transportation of intoxi- cating liquors within, the importation thereof into, or the exportation thereof from the United States and all territory subject to the jurisdiction thereof for beverage purposes is hereby prohibited.

Section 2 The Congress and the several States shall have con- current power to enforce this article by appropriate legislation.

Section 3 This article shall be inoperative unless it shall have been ratified as an amendment to the Constitution by the legislatures of the several States, as provided in the Constitution, within seven years from the date of the submission hereof to the States by the Congress.

AMENDMENT XIX (1920) The right of citizens of the United States to vote shall not be denied or abridged by the United States or by any State on account of sex.

Congress shall have power to enforce this article by appropriate legislation.

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A-10 Appendix A The United States Constitution

AMENDMENT XX (1933) Section 1 The terms of the President and Vice President shall end at noon on the 20th day of January, and the terms of Senators and Representatives at noon on the 3d day of January, of the years in which such terms would have ended if this article had not been ratified; and the terms of their successors shall then begin.

Section 2 The Congress shall assemble at least once in every year, and such meeting shall begin at noon on the 3d day of January, unless they shall by law appoint a different day.

Section 3 If, at the time fixed for the beginning of the term of the President, the President elect shall have died, the Vice President elect shall become President. If a President shall not have been chosen before the time fixed for the beginning of his term, or if the President elect shall have failed to qualify, then the Vice President elect shall act as President until a President shall have qualified; and the Congress may by law provide for the case wherein neither a President elect nor a Vice President elect shall have qualified, declaring who shall then act as President, or the manner in which one who is to act shall be selected, and such person shall act accordingly until a President or Vice President shall have qualified.

Section 4 The Congress may by law provide for the case of the death of any of the persons from whom the House of Representatives may choose a President whenever the right of choice shall have devolved upon them, and for the case of the death of any of the persons from whom the Senate may choose a Vice President whenever the right of choice shall have devolved upon them.

Section 5 Sections 1 and 2 shall take effect on the 15th day of October following the ratification of this article.

Section 6 This article shall be inoperative unless it shall have been ratified as an amendment to the Constitu- tion by the legislatures of three fourths of the sev- eral States within seven years from the date of its submission.

AMENDMENT XXI (1933) Section 1 The eighteenth article of amendment to the Consti- tution of the United States is hereby repealed.

Section 2 The transportation or importation into any State, Territory, or possession of the United States for delivery or use therein of intoxicating liquors, in violation of the laws thereof, is hereby prohibited.

Section 3 This article shall be inoperative unless it shall have been ratified as an amendment to the Constitution by conventions in the several States, as provided in the Constitution, within seven years from the date of the submission hereof to the States by the Congress.

AMENDMENT XXII (1951) Section 1 No person shall be elected to the office of the Presi- dent more than twice, and no person, who has held the office of President, or acted as President, for more than two years of a term to which some other person was elected President shall be elected to the Office of the President more than once. But this Article shall not apply to any person holding the office of Presi- dent when this Article was proposed by the Con- gress, and shall not prevent any person who may be holding the office of President, or acting as President, during the term within which this Article becomes operative from holding the Office of President or act- ing as President during the remainder of such term.

Section 2 This article shall be inoperative unless it shall have been ratified as an amendment to the Constitution by the legislatures of three fourths of the several States within seven years from the date of its sub- mission to the States by the Congress.

AMENDMENT XXIII (1961) Section 1 The District constituting the seat of Government of the United States shall appoint in such manner as the Congress may direct:

A number of electors of President and Vice Pres- ident equal to the whole number of Senators and

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Appendix A The United States Constitution A-11

Representatives in Congress to which the District would be entitled if it were a State, but in no event more than the least populous State; they shall be in addition to those appointed by the States, but they shall be considered, for the purposes of the elec- tion of President and Vice President, to be electors appointed by a State; and they shall meet in the District and perform such duties as provided by the twelfth article of amendment.

Section 2 The Congress shall have power to enforce this arti- cle by appropriate legislation.

AMENDMENT XXIV (1964) Section 1 The right of citizens of the United States to vote in any primary or other election for President or Vice Pres- ident, for electors for President or Vice President, or for Senator or Representative in Congress, shall not be denied or abridged by the United States or any State by reason of failure to pay any poll tax or other tax.

Section 2 The Congress shall have power to enforce this arti- cle by appropriate legislation.

AMENDMENT XXV (1967) Section 1 In case of the removal of the President from office or of his death or resignation, the Vice President shall become President.

Section 2 Whenever there is a vacancy in the office of the Vice President, the President shall nominate a Vice Pres- ident who shall take office upon confirmation by a majority vote of both Houses of Congress.

Section 3 Whenever the President transmits to the President pro tempore of the Senate and the Speaker of the House of Representatives his written declaration that he is unable to discharge the powers and duties of his office, and until he transmits to them a written decla- ration to the contrary, such powers and duties shall be discharged by the Vice President as Acting President.

Section 4 Whenever the Vice President and a majority of either the principal officers of the executive

departments or of such other body as Congress may by law provide, transmit to the President pro tempore of the Senate and the Speaker of the House of Representatives their written declaration that the President is unable to discharge the powers and duties of his office, the Vice President shall immedi- ately assume the powers and duties of the office as Acting President.

Thereafter, when the President transmits to the President pro tempore of the Senate and the Speaker of the House of Representatives his writ- ten declaration that no inability exists, he shall resume the powers and duties of his Office unless the Vice President and a majority of either the principal officers of the executive department or of such other body as Congress may by law pro- vide, transmit within four days to the President pro tempore of the Senate and the Speaker of the House of Representatives their written declara- tion that the President is unable to discharge the powers and duties of his office. Thereupon Con- gress shall decide the issue, assembling within forty-eight hours for that purpose if not in ses- sion. If the Congress, within twenty-one days after receipt of the latter written declaration, or, if Congress is not in session, within twenty-one days after Congress is required to assemble, deter- mines by two-thirds vote of both Houses that the President is unable to discharge the powers and duties of his office, the Vice President shall con- tinue to discharge the same as Acting President; otherwise, the President shall resume the powers and duties of his office.

AMENDMENT XXVI (1971) Section 1 The right of citizens of the United States, who are eighteen years of age or older, to vote shall not be denied or abridged by the United States or by any State on account of age.

Section 2 The Congress shall have power to enforce this arti- cle by appropriate legislation.

AMENDMENT XXVII (1992) No law varying the compensation for services of the Senators and Representatives shall take effect until an election of representatives shall have intervened.

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A-12

Appendix B The Foreign Corrupt Practices Act (Excerpts)

15 U.S.C. § 78dd-1 § 78dd-1. Prohibited foreign trade practices by issuers (15 U.S.C. § 78dd-2) (a) Prohibition

It shall be unlawful for any issuer which has a class of securities registered pursuant to section 78l of this title or which is required to file reports under section 78o(d) of this title, or for any officer, director, employee, or agent of such issuer or any stockholder thereof acting on behalf of such issuer, to make use of the mails or any means or instru- mentality of interstate commerce corruptly in fur- therance of an offer, payment, promise to pay, or authorization of the payment of any money, or offer, gift, promise to give, or authorization of the giving of anything of value to—

(1) any foreign official for purposes of— (A)(i) influencing any act or decision of such

foreign official in his official capacity, (ii) inducing such foreign official to do or omit to do any act in violation of the lawful duty of such official, or (iii) securing any improper advantage; or

(B) inducing such foreign official to use his influence with a foreign government or instru- mentality thereof to affect or influence any act or decision of such government or instrumentality, in order to assist such issuer in obtaining or retaining business for or with, or directing business to, any person;

(2) any foreign political party or official thereof or any candidate for foreign political office for pur- poses of—

(A)(i) influencing any act or decision of such party, official, or candidate in its or his official capacity, (ii) inducing such party, official, or candi- date to do or omit to do an act in violation of the lawful duty of such party, official, or candidate, or (iii) securing any improper advantage; or

(B) inducing such party, official, or candi- date to use its or his influence with a foreign gov- ernment or instrumentality thereof to affect or influence any act or decision of such government

or instrumentality, in order to assist such issuer in obtaining or retaining business for or with, or directing business to, any person; or

(3) any person, while knowing that all or a por- tion of such money or thing of value will be offered, given, or promised, directly or indirectly, to any foreign official, to any foreign political party or offi- cial thereof, or to any candidate for foreign political office, for purposes of—

(A)(i) influencing any act or decision of such foreign official, political party, party official, or can- didate in his or its official capacity, (ii) inducing such foreign official, political party, party official, or candidate to do or omit to do any act in violation of the lawful duty of such foreign official, political party, party official, or candidate, or (iii) securing any improper advantage; or

(B) inducing such foreign official, political party, party official, or candidate to use his or its influence with a foreign government or instrumen- tality thereof to affect or influence any act or deci- sion of such government or instrumentality, in order to assist such issuer in obtaining or retaining busi- ness for or with, or directing business to, any person. (b) Exception for routine governmental action

Subsections (a) and (g) of this section shall not apply to any facilitating or expediting payment to a foreign official, political party, or party official the purpose of which is to expedite or to secure the per- formance of a routine governmental action by a for- eign official, political party, or party official. (c) Affirmative defenses

It shall be an affirmative defense to actions under subsection (a) or (g) of this section that—

(1) the payment, gift, offer, or promise of any- thing of value that was made, was lawful under the written laws and regulations of the foreign official’s, political party’s, party official’s, or candi- date’s country; or

(2) the payment, gift, offer, or promise of any- thing of value that was made, was a reasonable and bona fide expenditure, such as travel and lodg- ing expenses, incurred by or on behalf of a foreign

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Appendix B The Foreign Corrupt Practices Act (Excerpts) A-13

official, party, party official, or candidate and was directly related to—

(A) the promotion, demonstration, or expla- nation of products or services; or

(B) the execution or performance of a con- tract with a foreign government or agency thereof.

15 U.S.C. § 78dd-2 (g) Penalties

(1)(A) Any domestic concern that is not a nat- ural person and that violates subsection (a) or (i) of this section shall be fined not more than $2,000,000.

(B) Any domestic concern that is not a natu- ral person and that violates subsection (a) or (i) of this section shall be subject to a civil penalty of not more than $10,000 imposed in an action brought by the Attorney General.

(2)(A) Any natural person that is an officer, director, employee, or agent of a domestic concern, or stockholder acting on behalf of such domestic concern, who willfully violates subsection (a) or (i) of this section shall be fined not more than $100,000 or imprisoned not more than 5 years, or both.

(B) Any natural person that is an officer, director, employee, or agent of a domestic concern, or stockholder acting on behalf of such domestic concern, who violates subsection (a) or (i) of this section shall be subject to a civil penalty of not more than $10,000 imposed in an action brought by the Attorney General.

(3) Whenever a fine is imposed under para- graph (2) upon any officer, director, employee, agent, or stockholder of a domestic concern, such fine may not be paid, directly or indirectly, by such domestic concern. (h) Definitions

For purposes of this section: (1) The term “domestic concern” means—

(A) any individual who is a citizen, national, or resident of the United States; and

(B) any corporation, partnership, associa- tion, joint-stock company, business trust, unincor- porated organization, or sole proprietorship which has its principal place of business in the United States, or which is organized under the laws of a

State of the United States or a territory, possession, or commonwealth of the United States.

(2)(A) The term “foreign official” means any officer or employee of a foreign government or any department, agency, or instrumentality thereof, or of a public international organization, or any per- son acting in an official capacity for or on behalf of any such government or department, agency, or instrumentality, or for or on behalf of any such pub- lic international organization.

(B) For purposes of subparagraph (A), the term “public international organization” means—

(i) an organization that is designated by Executive order pursuant to section 1 of the Inter- national Organizations Immunities Act (22 U.S.C. 288); or

(ii) any other international organization that is designated by the President by Executive order for the purposes of this section, effective as of the date of publication of such order in the Federal Register.

(3)(A) A person’s state of mind is “know- ing” with respect to conduct, a circumstance, or a result if—

(i) such person is aware that such person is engaging in such conduct, that such circumstance exists, or that such result is substantially certain to occur; or

(ii) such person has a firm belief that such circumstance exists or that such result is sub- stantially certain to occur.

(B) When knowledge of the existence of a particular circumstance is required for an offense, such knowledge is established if a person is aware of a high probability of the existence of such cir- cumstance, unless the person actually believes that such circumstance does not exist.

(4)(A) The term “routine governmental action” means only an action which is ordinarily and com- monly performed by a foreign official in—

(i) obtaining permits, licenses, or other official documents to qualify a person to do busi- ness in a foreign country;

(ii) processing governmental papers, such as visas and work orders;

(iii) providing police protection, mail pick-up and delivery, or scheduling inspections associated with contract performance or inspec- tions related to transit of goods across country;

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A-14 Appendix B The Foreign Corrupt Practices Act (Excerpts)

(iv) providing phone service, power and water supply, loading and unloading cargo, or pro- tecting perishable products or commodities from deterioration; or

(v) actions of a similar nature. (B) The term “routine governmental action”

does not include any decision by a foreign official

whether, or on what terms, to award new business to or to continue business with a particular party, or any action taken by a foreign official involved in the decision-making process to encourage a deci- sion to award new business to or continue business with a particular party.

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A-15

Appendix C The Uniform Commercial Code (Excerpts)*

PART 1. SHORT TITLE, GENERAL CONSTRUCTION AND SUBJECT MATTER § 2–106. Definitions: “Contract”; “Agreement”; “Contract for Sale”; “Sale”; “Present Sale” (1) In this Article unless the context otherwise requires “contract” and “agreement” are limited to those relating to the present or future sale of goods. “Contract for sale” includes both a present sale of goods and a contract to sell goods at a future time. A “sale” consists in the passing of title from the seller to the buyer for a price (Section 2-401). A “present sale” means a sale which is accom- plished by the making of the contract. [Note: Some notations appear regarding the Revised UCC Article 2. Because Revised UCC Article 2 has enjoyed limited adoption, it is not included here.]

PART 2. FORM, FORMATION AND READJUSTMENT OF CONTRACT § 2–201. Formal Requirements; Statute of Frauds (1) Except as otherwise provided in this section a contract for the sale of goods for the price of $500 or more is not enforceable by way of action or defense unless there is some writing sufficient to indicate that a contract for sale has been made between the parties and signed by the party against whom enforcement is sought or by his authorized agent or broker. A writing is not insufficient because it omits or incorrectly states a term agreed upon but the contract is not enforceable under this para- graph beyond the quantity of goods shown in such writing.

(2) Between merchants if within a reasonable time a writing in confirmation of the contract and sufficient against the sender is received and the party receiving it has reason to know its contents, it satisfies the requirements of subsection (1) against such party unless written notice of objection to its contents is given within 10 days after it is received.

(3) A contract which does not satisfy the require- ments of subsection (1) but which is valid in other respects is enforceable

(a) if the goods are to be specially manufac- tured for the buyer and are not suitable for sale to others in the ordinary course of the seller’s busi- ness and the seller, before notice of repudiation is received and under circumstances which reason- ably indicate that the goods are for the buyer, has made either a substantial beginning of their man- ufacture or commitments for their procurement; or

(b) if the party against whom enforcement is sought admits in his pleading, testimony or other- wise in court that a contract for sale was made, but the contract is not enforceable under this provision beyond the quantity of goods admitted; or

(c) with respect to goods for which payment has been made and accepted or which have been received and accepted (Sec. 2-606).

§ 2–202. Final Written Expression: Parol or Extrinsic Evidence Terms with respect to which the confirmatory memoranda of the parties agree or which are oth- erwise set forth in a writing intended by the parties as a final expression of their agreement with respect to such terms as are included therein may not be contradicted by evidence of any prior agreement or of a contemporaneous oral agreement but may be explained or supplemented

(a) by course of performance, course of dealing, or usage of trade (Section 1-303); and

(b) by evidence of consistent additional terms unless the court finds the writing to have been

*Copyright 2012 by the American Law Institute and the National Conference of Commissioners on Uniform State Laws. Reproduced with the permission of the Permanent Editorial Board for the Uniform Commercial Code. All rights reserved.

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A-16 Appendix C The Uniform Commercial Code (Excerpts)

intended also as a complete and exclusive state- ment of the terms of the agreement.

§ 2–204. Formation in General (1) A contract for sale of goods may be made in any manner sufficient to show agreement, including conduct by both parties which recognizes the exis- tence of such a contract.

(2) An agreement sufficient to constitute a contract for sale may be found even though the moment of its making is undetermined.

(3) Even though one or more terms are left open a contract for sale does not fail for indefiniteness if the parties have intended to make a contract and there is a reasonably certain basis for giving an appropriate remedy.

§ 2–205. Firm Offers An offer by a merchant to buy or sell goods in a signed writing which by its terms gives assurance that it will be held open is not revocable, for lack of consideration, during the time stated or if no time is stated for a reasonable time, but in no event may such period of irrevocability exceed three months; but any such term of assurance on a form supplied by the offeree must be separately signed by the offeror.

§ 2–207. Additional Terms in Acceptance or Confirmation (1) A definite and seasonable expression of accep- tance or a written confirmation which is sent within a reasonable time operates as an acceptance even though it states terms additional to or different from those offered or agreed upon, unless accep- tance is expressly made conditional on assent to the additional or different terms.

(2) The additional terms are to be construed as proposals for addition to the contract. Between merchants such terms become part of the contract unless:

(a) the offer expressly limits acceptance to the terms of the offer;

(b) they materially alter it; or (c) notification of objection to them has

already been given or is given within a reasonable time after notice of them is received.

(3) Conduct by both parties which recognizes the existence of a contract is sufficient to establish a contract for sale although the writings of the parties do not otherwise establish a contract. In

such case the terms of the particular contract con- sist of those terms on which the writings of the parties agree, together with any supplementary terms incorporated under any other provisions of this Act.

§ 2–209. Modification, Rescission and Waiver (1) An agreement modifying a contract within this Article needs no consideration to be binding.

(2) A signed agreement which excludes modifi- cation or rescission except by a signed writing can- not be otherwise modified or rescinded, but except as between merchants such a requirement on a form supplied by the merchant must be separately signed by the other party.

(3) The requirements of the statute of frauds section of this Article (Section 2-201) must be satisfied if the contract as modified is within its provisions.

§ 2–211. Legal Recognition of Electronic Contracts, Records and Signatures (Revised UCC) (Completely new section) (Some states have adopted some version of this electronic signature section) (1) A record or signature may not be denied legal effect or enforceability solely because it is in elec- tronic form.

(2) A contract may not be denied legal effect or enforceability solely because an electronic record was used in its formation.

(3) This article does not require a record or sig- nature to be created, generated, sent, communi- cated, received, stored, or otherwise processed by electronic means or in electronic form.

(4) A contract formed by the interaction of an individual and an electronic agent under Sec- tion 2–204(4)(b) does not include terms provided by the individual if the individual had reason to know that the agent could not react to the terms as provided.

§ 2–213. Electronic Communication (Revised UCC) (Completely new section) (1) If the receipt of an electronic communication has a legal effect, it has that effect even though no indi- vidual is aware of its receipt.

(2) Receipt of an electronic acknowledgment of an electronic communication establishes that the

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Appendix C The Uniform Commercial Code (Excerpts) A-17

communication was received but, in itself, does not establish that the content sent corresponds to the content received.

PART 3 GENERAL OBLIGATION AND CONSTRUCTION OF CONTRACT § 2–302. Unconscionable Contract or Term (1) If the court as a matter of law finds the contract or any clause of the contract to have been unconsciona- ble at the time it was made the court may refuse to enforce the contract, or it may enforce the remainder of the contract without the unconscionable clause, or it may so limit the application of any unconscionable clause as to avoid any unconscionable result.

(2) When it is claimed or appears to the court that the contract or any clause thereof may be unconscionable the parties shall be afforded a rea- sonable opportunity to present evidence as to its commercial setting, purpose and effect to aid the court in making the determination.

§ 2–312. Warranty of Title and Against Infringement; Buyer’s Obligation Against Infringement (1) Subject to subsection (2) there is in a contract for sale a warranty by the seller that

(a) the title conveyed shall be good, and its transfer rightful; and

(b) the goods shall be delivered free from any security interest or other lien or encumbrance of which the buyer at the time of contracting has no knowledge.

(2) A warranty under subsection (1) will be excluded or modified only by specific language or by circumstances which give the buyer reason to know that the person selling does not claim title in himself or that he is purporting to sell only such right or title as he or a third person may have.

(3) Unless otherwise agreed a seller who is a merchant regularly dealing in goods of the kind warrants that the goods shall be delivered free of the rightful claim of any third person by way of infringement or the like but a buyer who furnishes specifications to the seller must hold the seller harmless against any such claim which arises out of compliance with the specifications.

§ 2–313. Express Warranties by Affirmation, Promise, Description (1) Express warranties by the seller are created as follows:

(a) Any affirmation of fact or promise made by the seller to the buyer which relates to the goods and becomes part of the basis of the bargain creates an express warranty that the goods shall conform to the affirmation or promise.

(b) Any description of the goods which is made part of the basis of the bargain creates an express warranty that the goods shall conform to the description.

(c) Any sample or model which is made part of the basis of the bargain creates an express war- ranty that the whole of the goods shall conform to the sample or model.

(2) It is not necessary to the creation of an express warranty that the seller use formal words such as “warrant” or “guarantee” or that he have a specific intention to make a warranty, but an affir- mation merely of the value of the goods or a state- ment purporting to be merely the seller’s opinion or commendation of the goods does not create a warranty.

§ 2–314. Implied Warranty: Merchantability; Usage of Trade (1) Unless excluded or modified (Section 2-316), a war- ranty that the goods shall be merchantable is implied in a contract for their sale if the seller is a merchant with respect to goods of that kind. Under this section the serving for value of food or drink to be consumed either on the premises or elsewhere is a sale.

(2) Goods to be merchantable must be at least such as

(a) pass without objection in the trade under the contract description; and

(b) in the case of fungible goods, are of fair average quality within the description; and

(c) are fit for the ordinary purposes for which such goods are used; and

(d) run, within the variations permit- ted by the agreement, of even kind, quality and quantity within each unit and among all units involved; and

(e) are adequately contained, packaged, and labeled as the agreement may require; and

(f) conform to the promise or affirmations of fact made on the container or label if any.

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A-18 Appendix C The Uniform Commercial Code (Excerpts)

(3) Unless excluded or modified (Section 2-316) other implied warranties may arise from course of dealing or usage of trade.

§ 2–315. Implied Warranty: Fitness for Particular Purpose Where the seller at the time of contracting has rea- son to know any particular purpose for which the goods are required and that the buyer is relying on the seller’s skill or judgment to select or furnish suitable goods, there is unless excluded or modified under the next section an implied warranty that the goods shall be fit for such purpose.

§ 2–316. Exclusion or Modification of Warranties (1) Words or conduct relevant to the creation of an express warranty and words or conduct tending to negate or limit warranty shall be construed wher- ever reasonable as consistent with each other; but subject to the provisions of this Article on parol or extrinsic evidence (Section 2-202) negation or lim- itation is inoperative to the extent that such con- struction is unreasonable.

(2) Subject to subsection (3), to exclude or mod- ify the implied warranty of merchantability or any part of it the language must mention merchantabi- lity and in case of a writing must be conspicuous, and to exclude or modify any implied warranty of fitness the exclusion must be by a writing and con- spicuous. Language to exclude all implied warran- ties of fitness is sufficient if it states, for example, that “There are no warranties which extend beyond the description on the face hereof.”

(3) Notwithstanding subsection (2) (a) unless the circumstances indicate other-

wise, all implied warranties are excluded by expres- sions like “as is”, “with all faults” or other language which in common understanding calls the buyer’s attention to the exclusion of warranties and makes plain that there is no implied warranty; and

(b) when the buyer before entering into the contract has examined the goods or the sample or model as fully as he desired or has refused to exam- ine the goods there is no implied warranty with regard to defects which an examination ought in the circumstances to have revealed to him; and

(c) an implied warranty can also be excluded or modified by course of dealing or course of per- formance or usage of trade.

(4) Remedies for breach of warranty can be lim- ited in accordance with the provisions of this Arti- cle on liquidation or limitation of damages and on contractual modification of remedy (Sections 2-718 and 2-719).

§ 2–318. Third Party Beneficiaries of Warranties Express or Implied

Alternative A A seller ’s warranty whether express or implied extends to any natural person who is in the family or household of his buyer or who is a guest in his home if it is reasonable to expect that such person may use, consume or be affected by the goods and who is injured in person by breach of the warranty. A seller may not exclude or limit the operation of this section.

Alternative B A seller ’s warranty whether express or implied extends to any natural person who may reasonably be expected to use, consume or be affected by the goods and who is injured in person by breach of the warranty. A seller may not exclude or limit the operation of this section.

Alternative C A seller ’s warranty whether express or implied extends to any person who may reasonably be expected to use, consume or be affected by the goods and who is injured by breach of the war- ranty. A seller may not exclude or limit the oper- ation of this section with respect to injury to the person of an individual to whom the warranty extends.

§ 2–615. Excuse By Failure of Presupposed Conditions Except so far as a seller may have assumed a greater obligation and subject to the preceding section on substituted performance:

(a) Delay in delivery or non-delivery in whole or in part by a seller who complies with paragraphs (b) and (c) is not a breach of his duty under a con- tract for sale if performance as agreed has been made impracticable by the occurrence of a con- tingency the non-occurrence of which was a basic assumption on which the contract was made or by compliance in good faith with any applicable for- eign or domestic governmental regulation or order whether or not it later proves to be invalid.

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Appendix C The Uniform Commercial Code (Excerpts) A-19

(b) Where the causes mentioned in paragraph (a) affect only a part of the seller ’s capacity to perform, he must allocate production and deliv- eries among his customers but may at his option include regular customers not then under con- tract as well as his own requirements for further

manufacture. He may so allocate in any manner which is fair and reasonable.

(c) The seller must notify the buyer seasonably that there will be delay or non-delivery and, when allocation is required under paragraph (b), of the estimated quota thus made available for the buyer.

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A-20

Appendix D Dodd-Frank (Wall Street Reform and Consumer Financial Protection Act) Key Provisions

Corporate governance (15 U.S.C. § 78n-2) Not later than 180 days after July 21, 2010, the Com- mission shall issue rules that require an issuer to disclose in the annual proxy sent to investors the reasons why the issuer has chosen—

(1) the same person to serve as chairman of the board of directors and chief executive officer (or in equivalent positions); or

(2) different individuals to serve as chairman of the board of directors and chief executive officer (or in equivalent positions of the issuer).

WHISTLEBLOWER PROTECTION (15 U.S.C. § 78u-7) § 78u-7. Implementation and transition provisions for whistleblower protection (a) Implementing rules

The Commission shall issue final regulations implementing the provisions of section 78u-6 of this title, not later than 270 days after July 21, 2010. (Note: As of September 2013, the Commission (SEC) had implemented only 47 percent of the rules required for Dodd-Frank.) (b) Original information

Information provided to the Commission in writing by a whistleblower shall not lose the status of original information (as defined in section 78u- 6(a)(3) of this title) solely because the whistleblower provided the information prior to the effective date of the regulations, if the information is provided by the whistleblower after July 21, 2010. (c) Awards

A whistleblower may receive an award pur- suant to section 78u-6 of this title, regardless of whether any violation of a provision of the securi- ties laws, or a rule or regulation thereunder, under- lying the judicial or administrative action upon which the award is based, occurred prior to July 21, 2010.

Securities whistleblower incentives and protection (15 U.S.C § 78u-6) In any covered judicial or administrative action, or related action, the Commission, under regula- tions prescribed by the Commission and subject to subsection (c), shall pay an award or awards to 1 or more whistleblowers who voluntarily provided original information to the Commission that led to the successful enforcement of the covered judicial or administrative action, or related action, in an aggregate amount equal to—

(A) not less than 10 percent, in total, of what has been collected of the monetary sanctions imposed in the action or related actions; and

(B) not more than 30 percent, in total, of what has been collected of the monetary sanctions imposed in the action or related actions.

Recovery of Erroneously Awarded Compensation Policy (15 U.S.C. § 78j-4) The Commission shall, by rule, direct the national securities exchanges and national securities associ- ations to prohibit the listing of any security of an issuer that does not comply with the requirements of this section. (b) Recovery of funds

The rules of the Commission under subsection (a) shall require each issuer to develop and imple- ment a policy providing—

(1) for disclosure of the policy of the issuer on incentive-based compensation that is based on financial information required to be reported under the securities laws; and

(2) that, in the event that the issuer is required to prepare an accounting restatement due to the material noncompliance of the issuer with any financial reporting requirement under the secu- rities laws, the issuer will recover from any cur- rent or former executive officer of the issuer who received incentive-based compensation (including stock options awarded as compensation) during

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Appendix D Dodd-Frank (Wall Street Reform and Consumer Financial Protection Act) Key Provisions A-21

the 3-year period preceding the date on which the issuer is required to prepare an accounting restate- ment, based on the erroneous data, in excess of what would have been paid to the executive officer under the accounting restatement.

SEC. 917. Study Regarding Financial Literacy Among Investors (a) IN GENERAL.—The Commission shall conduct a study to identify—

(1) the existing level of financial literacy among retail investors, including subgroups of investors identified by the Commission;

(2) methods to improve the timing, content, and format of disclosures to investors with respect to financial intermediaries, investment products, and investment services;

(3) the most useful and understandable relevant information that retail investors need to make informed financial decisions before engaging a financial intermediary or purchasing an investment product or service that is typically sold to retail investors, including shares of open-end companies, as that term is defined in section 5 of the Invest- ment Company Act of 1940 (15 U.S.C. 80a–5) that are registered under section 8 of that Act;

(4) methods to increase the transparency of expenses  and conflicts of interests in transac- tions involving investment services and products, including shares of open-end companies described in paragraph (3);

(5) the most effective existing private and public efforts to educate investors; and

(6) in consultation with the Financial Literacy and Education Commission, a strategy (including, to the extent practicable, measurable goals and objectives) to increase the financial literacy of inves- tors in order to bring about a positive change in investor behavior.

SECTION 929X. Short Sale Reforms (15 U.S.C. § 78m(f)) (d) TRANSACTIONS RELATING TO SHORT SALES OF SECURITIES.—

It shall be unlawful for any person, directly or indirectly, by the use of the mails or any means or instrumentality of interstate commerce, or of any

facility of any national securities exchange, or for any member of a national securities exchange to effect, alone or with one or more other persons, a manipulative short sale of any security. The Com- mission shall issue such other rules as are neces- sary or appropriate to ensure that the appropriate enforcement options and remedies are available for violations of this subsection in the public interest or for the protection of investors.

SEC. 1403. Prohibition on Steering Incentives Section 129B of the Truth in Lending Act (as added by section 1402(a)) is amended by inserting after subsection (b) the following new subsection: (c) PROHIBITION ON STEERING INCENTIVES.—

(1) IN GENERAL.—For any residential mort- gage loan, no mortgage originator shall receive from any person and no person shall pay to a mort- gage originator, directly or indirectly, compensation that varies based on the terms of the loan (other than the amount of the principal).

(2) RESTRUCTURING OF FINANCING ORIGINATION FEE.—

(A) IN GENERAL.—For any mortgage loan, a mortgage originator may not receive from any person other than the consumer and no per- son, other than the consumer, who knows or has reason to know that a consumer has directly com- pensated or will directly compensate a mortgage originator may pay a mortgage originator any origination fee or charge except bona fide third party charges not retained by the creditor, mort- gage originator, or an affiliate of the creditor or mortgage originator.

SUBTITLE B—MINIMUM STANDARDS FOR MORTGAGES SEC. 1411. Ability to Repay (a) IN GENERAL.—

(1) RULE OF CONSTRUCTION.—No regu- lation, order, or guidance issued by the Bureau under this title shall be construed as requiring a depository institution to apply mortgage under- writing standards that do not meet the minimum

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A-22 Appendix D Dodd-Frank (Wall Street Reform and Consumer Financial Protection Act) Key Provisions

underwriting standards required by the appro- priate prudential regulator of the depository institution.

(2) AMENDMENT TO TRUTH IN LENDING ACT.—Chapter 2 of the Truth in Lending Act (15 U.S.C. 1631 et seq.) is amended by inserting after section 129B (as added by section 1402(a)) the following new section:

§ 129C. Minimum standards for residential mortgage loans (a) ABILITY TO REPAY.—

(1) IN GENERAL.—In accordance with regu- lations prescribed by the Board, no creditor may make a residential mortgage loan unless the cred- itor makes a reasonable and good faith determina- tion based on verified and documented information that, at the time the loan is consummated, the con- sumer has a reasonable ability to repay the loan, according to its terms, and all applicable taxes, insurance (including mortgage guarantee insur- ance), and assessments.

(2) MULTIPLE LOANS.—If the creditor knows, or has reason to know, that 1 or more residential mortgage loans secured H. R. 4173—768 by the same dwelling will be made to the same consumer, the creditor shall make a reasonable and good faith determination, based on verified and documented information, that the consumer has a reasonable ability to repay the combined payments of all loans on the same dwelling according to the terms of those loans and all applicable taxes, insurance (including mortgage guarantee insurance), and assessments.

(3) BASIS FOR DETERMINATION.—A determi- nation under this subsection of a consumer’s ability to repay a residential mortgage loan shall include consideration of the consumer’s credit history, cur- rent income, expected income the consumer is rea- sonably assured of receiving, current obligations, debt to-income ratio or the residual income the con- sumer will have after paying non-mortgage debt and mortgage-related obligations, employment status, and other financial resources other than the consumer’s equity in the dwelling or real prop- erty that secures repayment of the loan. A creditor shall determine the ability of the consumer to repay using a payment schedule that fully amortizes the loan over the term of the loan.

(4) INCOME VERIFICATION.—A creditor making a residential mortgage loan shall verify amounts of income or assets that such creditor relies on to determine repayment ability, includ- ing expected income or assets, by reviewing the consumer’s Internal Revenue Service Form W–2, tax returns, payroll receipts, financial institution records, or other third-party documents that pro- vide reasonably reliable evidence of the consum- er’s income or assets. In order to safeguard against fraudulent reporting, any consideration of a con- sumer’s income history in making a determination under this subsection shall include the verification of such income by the use of—

(A) Internal Revenue Service transcripts of tax returns; or

(B) a method that quickly and effectively verifies income documentation by a third party subject to rules prescribed by the Board.

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A-23

Appendix E The Securities Act of 1933 and the Securities Exchange Act of 1934 (Excerpts)

SECURITIES ACT OF 1933 Civil Liabilities on Account of False Registration Statement (15 U.S.C. § 77k) SECTION 11. (a) In case any part of the registration statement, when such part became effective, contained an untrue statement of a material fact or omitted to state a material fact required to be stated therein or necessary to make the statements therein not mis- leading, any person acquiring such security (unless it is proved that at the time of such acquisition he knew of such untruth or omission) may, either at law or in equity, in any court of competent jurisdic- tion, sue—

(1) every person who signed the registration statement;

(2) every person who was a director of (or per- son performing similar functions) or partner in, the issuer at the time of the filing of the part of the reg- istration statement with respect to which his liabil- ity is asserted;

(3) every person who, with his consent, is named in the registration statement as being or about to become a director, person performing sim- ilar functions, or partner;

(4) every accountant, engineer, or appraiser, or any person whose profession gives authority to a statement made by him, who has with his consent been named as having prepared or certified any part of the registration statement, or as having pre- pared or certified any report or valuation which is used in connection with the registration statement, with respect to the statement in such registration statement, report, or valuation, which purports to have been prepared or certified by him;

(5) every underwriter with respect to such security.

If such person acquired the security after the issuer has made generally available to its security holders an earning statement covering a period of at least twelve months beginning after the effective date of the registration statement, then the right of

recovery under this subsection shall be conditioned on proof that such person acquired the security rely- ing upon such untrue statement in the registration statement or relying upon the registration statement and not knowing of such omission, but such reliance may be established without proof of the reading of the registration statement by such person. (b) Persons exempt from liability upon proof of issues

Notwithstanding the provisions of subsection (a) no person, other than the issuer, shall be liable as provided therein who shall sustain the burden of proof—

(1) that before the effective date of the part of the registration statement with respect to which his liability is asserted (A) he had resigned from or had taken such steps as are permitted by law to resign from, or ceased or refused to act in, every office, capacity, or relationship in which he was described in the registration statement as acting or agreeing to act, and (B) he had advised the Commission and the issuer in writing that he had taken such action and that he would not be responsible for such part of the registration statement; or

(2) that if such part of the registration state- ment became effective without his knowledge, upon becoming aware of such fact he forthwith acted and advised the Commission, in accordance with paragraph (1), and, in addition, gave reason- able public notice that such part of the registration statement had become effective without his knowl- edge; or

(3) that (A) as regards any part of the registration statement not purporting to be made on the author- ity of an expert, and not purporting to be a copy of or extract from a report or valuation of an expert, and not purporting to be made on the authority of a public or official document or statement, he had, after reasonable investigation, reasonable ground to believe and did believe, at the time such part of the registration statement became effective, that the statements therein were true and that there was no omission to state a material fact required to be

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A-24 Appendix E The Securities Act of 1933 and the Securities Exchange Act of 1934 (Excerpts)

stated therein or necessary to make the statements therein not misleading; and (B) as regards any part of the registration statement purporting to be made upon his authority as an expert or purporting to be a copy of or extract from a report or valuation of himself as an expert, (i) he had, after reasonable investigation, reasonable ground to believe and did believe, at the time such part of the registra- tion statement became effective, that the statements therein were true and that there was no omission to state a material fact required to be stated therein or necessary to make the statements therein not mis- leading, or (ii) such part of the registration state- ment did not fairly represent his statement as an expert or was not a fair copy of or extract from his report or valuation as an expert; and (C) as regards any part of the registration statement purporting to be made on the authority of an expert (other than himself) or purporting to be a copy of or extract from a report or valuation of an expert (other than himself), he had no reasonable ground to believe and did not believe, at the time such part of the registration statement became effective, that the statements therein were untrue or that there was an omission to state a material fact required to be stated therein or necessary to make the statements therein not misleading, or that such part of the registration statement did not fairly represent the statement of the expert or was not a fair copy of or extract from the report or valuation of the expert; and (D) as regards any part of the registration state- ment purporting to be a statement made by an offi- cial person or purporting to be a copy of or extract from a public official document, he had no reason- able ground to believe and did not believe, at the time such part of the registration statement became effective, that the statements therein were untrue, or that there was an omission to state a material fact required to be stated therein or necessary to make the statements therein not misleading, or that such part of the registration statement did not fairly rep- resent the statement made by the official person or was not a fair copy of or extract from the public official document. (c) Standard of reasonableness

In determining, for the purpose of paragraph (3) of subsection (b) of this section, what constitutes reasonable investigation and reasonable ground for belief, the standard of reasonableness shall be that required of a prudent man in the management of his own property.

Civil Liabilities Arising in Connection with Prospectuses and Communications (15 U.S.C. § 77l) SECTION 12. (a) In general

Any person who—(1) offers or sells a security in violation of section 77e or

(2) offers or sells a security (whether or not exempted by the provisions of section 77c other than paragraph (2) of subsection (a) of said section), by the use of any means or instruments of transpor- tation or communication in interstate commerce or of the mails, by means of a prospectus or oral com- munication, which includes an untrue statement of a material fact or omits to state a material fact nec- essary in order to make the statements, in the light of the circumstances under which they were made, not misleading (the purchaser not knowing of such untruth or omission), and who shall not sustain the burden of proof that he did not know, and in the exercise of reasonable care could not have known, of such untruth or omission, shall be liable to the person purchasing such security from him, who may sue either at law or in equity in any court of competent jurisdiction, to recover the consideration paid for such security with interest thereon, less the amount of any income received thereon, upon the tender of such security, or for damages if he no lon- ger owns the security.

Penalties (15 U.S.C. § 77x) SECTION 24. Any person who willfully violates any of the provisions of this subchapter, or the rules and regulations promulgated by the Commission under authority thereof, or any person who will- fully, in a registration statement filed under this subchapter, makes any untrue statement of a mate- rial fact or omits to state any material fact required to be stated therein or necessary to make the state- ments therein not misleading, shall upon convic- tion be fined not more than $10,000 or imprisoned not more than five years, or both.

SECURITIES EXCHANGE ACT OF 1934 Manipulative and Deceptive Devices (15 U.S.C. § 78j) SECTION 10. It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce or of the

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Appendix E The Securities Act of 1933 and the Securities Exchange Act of 1934 (Excerpts) A-25

mails, or of any facility of any national securities exchange—

(a) (1) To effect a short sale, or to use or employ any stop-loss order in connection with the purchase or sale, of any security registered on a national securities exchange, in contravention of such rules and regulations as the Commission may prescribe as necessary or appropriate in the public interest or for the protection of investors.

* * * * * (b) To use or employ, in connection with the

purchase or sale of any security registered on a national securities exchange or any security not so registered, any manipulative or deceptive device or contrivance in contravention of such rules and reg- ulations as the Commission may prescribe as neces- sary or appropriate in the public interest or for the protection of investors.

Audit requirements (15 U.S.C. § 78j-1) (a) In general

Each audit required pursuant to this chapter of the financial statements of an issuer by a registered public accounting firm shall include, in accordance with generally accepted auditing standards, as may be modified or supplemented from time to time by the Commission—

(1) procedures designed to provide reasonable assurance of detecting illegal acts that would have a direct and material effect on the determination of financial statement amounts;

(2) procedures designed to identify related party transactions that are material to the financial state- ments or otherwise require disclosure therein; and

(3) an evaluation of whether there is substantial doubt about the ability of the issuer to continue as a going concern during the ensuing fiscal year. (b) Required response to audit discoveries

(1) Investigation and report to management If, in the course of conducting an audit pur-

suant to this chapter to which subsection (a) of this section applies, the registered public accounting firm detects or otherwise becomes aware of infor- mation indicating that an illegal act (whether or not perceived to have a material effect on the financial statements of the issuer) has or may have occurred, the firm shall, in accordance with generally accepted auditing standards, as may be modified or supple- mented from time to time by the Commission—

(A) (i) determine whether it is likely that an illegal act has occurred; and

(ii) if so, determine and consider the possi- ble effect of the illegal act on the financial statements of the issuer, including any contingent monetary effects, such as fines, penalties, and damages; and

(B) as soon as practicable, inform the appro- priate level of the management of the issuer and assure that the audit committee of the issuer, or the board of directors of the issuer in the absence of such a committee, is adequately informed with respect to illegal acts that have been detected or have otherwise come to the attention of such firm in the course of the audit, unless the illegal act is clearly inconsequential.

(2) Response to failure to take remedial action If, after determining that the audit commit-

tee of the board of directors of the issuer, or the board of directors of the issuer in the absence of an audit committee, is adequately informed with respect to illegal acts that have been detected or have otherwise come to the attention of the firm in the course of the audit of such firm, the registered public accounting firm concludes that—

(A) the illegal act has a material effect on the financial statements of the issuer;

(B) the senior management has not taken, and the board of directors has not caused senior management to take, timely and appropriate reme- dial actions with respect to the illegal act; and

(C) the failure to take remedial action is rea- sonably expected to warrant departure from a stan- dard report of the auditor, when made, or warrant resignation from the audit engagement; the regis- tered public accounting firm shall, as soon as prac- ticable, directly report its conclusions to the board of directors.

(3) Notice to Commission; response to failure to notify

An issuer whose board of directors receives a report under paragraph (2) shall inform the Com- mission by notice not later than 1 business day after the receipt of such report and shall furnish the reg- istered public accounting firm making such report with a copy of the notice furnished to the Commis- sion. If the registered public accounting firm fails to receive a copy of the notice before the expiration of the required 1-business-day period, the registered public accounting firm shall—

(A) resign from the engagement; or (B) furnish to the Commission a copy of its

report (or the documentation of any oral report given) not later than 1 business day following such failure to receive notice.

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A-26 Appendix E The Securities Act of 1933 and the Securities Exchange Act of 1934 (Excerpts)

(4) Report after resignation If a registered public accounting firm resigns

from an engagement under paragraph (3)(A), the firm shall, not later than 1 business day following the failure by the issuer to notify the Commission under paragraph (3), furnish to the Commission a copy of the report of the firm (or the documentation of any oral report given). (c) Auditor liability limitation

No registered public accounting firm shall be liable in a private action for any finding, conclu- sion, or statement expressed in a report made pur- suant to paragraph (3) or (4) of subsection (b) of this section, including any rule promulgated pursuant thereto. (d) Civil penalties in cease-and-desist proceedings

If the Commission finds, after notice and oppor- tunity for hearing in a proceeding instituted pur- suant to section 78u-3 of this title, that a registered public accounting firm has willfully violated para- graph (3) or (4) of subsection (b) of this section, the Commission may, in addition to entering an order under section 78u-3 of this title, impose a civil pen- alty against the registered public accounting firm and any other person that the Commission finds was a cause of such violation.

Proxies (15 U.S.C. § 78n) SECTION 14. (a) It shall be unlawful for any person, by the use of the mails or by any means or instrumentality of interstate commerce or of any facility of a national securities exchange or otherwise, in contravention of such rules and regulations as the Commission may prescribe as necessary or appropriate in the public interest or for the protection of investors, to solicit or to permit the use of his name to solicit any proxy or consent or authorization in respect of any security (other than an exempted security) regis- tered pursuant to section 78(l) this title.

Directors, Officers, and Principal Stockholders (15 U.S.C. § 78p)

SEC. 16. DIRECTORS, OFFICERS, AND PRINCIPAL STOCKHOLDERS (a) DISCLOSURES REQUIRED.—

(1) DIRECTORS, OFFICERS, AND PRINCIPAL STOCKHOLDERS REQUIRED TO FILE.—Every person who is directly or indirectly the beneficial owner of more than 10% of any class of any equity

security (other than an exempted security) which is registered pursuant to section 78, or who is a direc- tor or an officer of the issuer of such security, shall file the statements required by this subsection with the Commission.

(2) TIME OF FILING.—The statements required by this subsection shall be filed—

(a) at the time of the registration of such security on a national securities exchange or by the effective date of a registration statement filed pur- suant to section 78(g) of this title;

(b) within 10 days after he or she becomes such beneficial owner, director, or officer or within such shorter time as the Commission may establish by rule; (b) Profits from purchase and sale of security within six months

For the purpose of preventing the unfair use of information which may have been obtained by such beneficial owner, director, or officer by rea- son of his relationship to the issuer, any profit real- ized by him from any purchase and sale, or any sale and purchase, of any equity security of such issuer (other than an exempted security) within any period of less than six months, unless such secu- rity was acquired in good faith in connection with a debt previously contracted, shall inure to and be recoverable by the issuer, irrespective of any inten- tion on the part of such beneficial owner, director, or officer in entering into such transaction of hold- ing the security purchased or of not repurchasing the security sold for a period exceeding six months. Suit to recover such profit may be instituted at law or in equity in any court of competent jurisdiction by the issuer, or by the owner of any security of the issuer in the name and in behalf of the issuer if the issuer …

Liability for Misleading Statements (15 U.S.C. § 78r) SECTION 18. (a) Any person who shall make or cause to be made any statement in any application, report, or document filed pursuant to this title or any rule or regulation thereunder or any undertaking con- tained in a registration statement as provided in subsection (d) of section 78o of this title, which statement was at the time and in the light of the circumstances under which it was made false or misleading with respect to any material fact, shall

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Appendix E The Securities Act of 1933 and the Securities Exchange Act of 1934 (Excerpts) A-27

be liable to any person (not knowing that such statement was false or misleading) who, in reli- ance upon such statement, shall have purchased or sold a security at a price which was affected by such statement, for damages caused by such reli- ance, unless the person sued shall prove that he acted in good faith and had no knowledge that such statement was false or misleading. A person seeking to enforce such liability may sue at law or in equity in any court of competent jurisdiction. In any such suit the court may, in its discretion, require an undertaking for the payment of the costs of such suit, and assess reasonable costs, including reasonable attorneys’ fees, against either party litigant.

(b) Every person who becomes liable to make payment under this section may recover contribu- tion as in cases of contract from any person who, if joined in the original suit, would have been liable to make the same payment.

(c) No action shall be maintained to enforce any liability created under this section unless brought within one year after the discovery of the facts con- stituting the cause of action and within three years after such cause of action accrued.

§ 78n-1. Shareholder approval of executive compensation (a) Separate resolution required

(1) In general Not less frequently than once every 3 years,

a proxy or consent or authorization for an annual or other meeting of the shareholders for which the proxy solicitation rules of the Commission require compensation disclosure shall include a separate resolution subject to shareholder vote to approve the compensation of executives, as disclosed pur- suant to section 229.402 of title 17, Code of Federal Regulations, or any successor thereto.

§ 78n-2. Corporate governance Not later than 180 days after July 21, 2010, the Com- mission shall issue rules that require an issuer to disclose in the annual proxy sent to investors the reasons why the issuer has chosen—

(1) the same person to serve as chairman of the board of directors and chief executive officer (or in equivalent positions); or

(2) different individuals to serve as chairman of the board of directors and chief executive officer (or in equivalent positions of the issuer).

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Appendix F Sarbanes-Oxley Key Provisions (Excerpts)

SEE 15 § U.S.C. 78j-1 (B) IN APPENDIX E FOR DETAILS ON AUDIT REQUIREMENTS

SEC. 201. SERVICES OUTSIDE THE SCOPE OF PRACTICE OF AUDITORS (g) Prohibited activities 15 § U.S.C. 78j-1

Except as provided in subsection (h), it shall be unlawful for a registered public accounting firm (and any associated person of that firm, to the extent determined appropriate by the Com- mission) that performs for any issuer any audit required by this title or the rules of the Commis- sion under this title or, beginning 180 days after the date of commencement of the operations of the Public Company Accounting Oversight Board established under section 101 of the Sarbanes-Ox- ley Act of 2002 (in this section referred to as the “Board”), the rules of the Board, to provide to that issuer, contemporaneously with the audit, any non-audit service, including—

(1) bookkeeping or other services related to the accounting records or financial statements of the audit client;

(2) financial information systems design and implementation;

(3) appraisal or valuation services, fairness opinions, or contribution-in-kind reports;

(4) actuarial services; (5) internal audit outsourcing services; (6) management functions or human

resources; (7) broker or dealer, investment adviser, or

investment banking services; (8) legal services and expert services unre-

lated to the audit; and (9) any other service that the Board deter-

mines, by regulation, is impermissible. (h) Preapproval required for non-audit services

A registered public accounting firm may engage in any non-audit service, including tax services, that is not described in any of paragraphs (1) through (9) of subsection (g) for an audit client, only if the activity is approved in advance by the audit com- mittee of the issuer, in accordance with subsection (i) of this section.

SEC. 203. AUDIT PARTNER ROTATION (15 U.S.C. § 78j-1(j)) (j) Audit partner rotation

It shall be unlawful for a registered public accounting firm to provide audit services to an issuer if the lead (or coordinating) audit partner (having primary responsibility for the audit), or the audit partner responsible for reviewing the audit, has performed audit services for that issuer in each of the 5 previous fiscal years of that issuer.

AUDIT COMMITTEE INDEPENDENCE (15 U.S.C. § 78j-1(m)(3)) (3) Independence

(A) In general Each member of the audit committee of the

issuer shall be a member of the board of directors of the issuer, and shall otherwise be independent.

(B) Criteria In order to be considered to be independent

for purposes of this paragraph, a member of an audit committee of an issuer may not, other than in his or her capacity as a member of the audit com- mittee, the board of directors, or any other board committee—

(i) accept any consulting, advisory, or other compensatory fee from the issuer; or

(ii) be an affiliated person of the issuer or any subsidiary thereof.

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Appendix F Sarbanes-Oxley Key Provisions (Excerpts) A-29

SEC. 302. CORPORATE RESPONSIBILITY FOR FINANCIAL REPORTS Failure of Corporate Officers to Certify Financial Reports 18 U.S.C. § 1350

§ 1350. Failure of corporate officers to certify financial reports (a) Certification of periodic financial reports

Each periodic report containing financial state- ments filed by an issuer with the Securities Exchange Commission pursuant to section 13(a) or 15(d) of the Securities Exchange Act of 1934 (15 U.S.C. 78m(a) or 78o(d)) shall be accompanied by a written statement by the chief executive officer and chief financial offi- cer (or equivalent thereof) of the issuer (b) Content

The statement required under subsection (a) shall certify that the periodic report containing the financial statements fully complies with the requirements of section 13(a) or 15(d) of the Securi- ties Exchange Act of 1934 (15 U.S.C. 78m or 78o(d)) and that information contained in the periodic report fairly presents, in all material respects, the financial condition and results of operations of the issuer. (c) Criminal penalties

Whoever— (1) certifies any statement as set forth in sub-

sections (a) and (b) of this section knowing that the periodic report accompanying the statement does not comport with all the requirements set forth in this section shall be fined not more than $1,000,000 or imprisoned not more than 10 years, or both; or

(2) willfully certifies any statement as set forth in subsections (a) and (b) of this section knowing that the periodic report accompanying the statement does not comport with all the requirements set forth in this section shall be fined not more than $5,000,000, or imprisoned not more than 20 years, or both.

SEC. 404. MANAGEMENT ASSESSMENT OF INTERNAL CONTROLS (15 U.S.C. § 78m (2)) (2) Every issuer which has a class of securities reg- istered pursuant to section 78l of this title and every issuer which is required to file reports pursuant to section 78o(d) of this title shall—

(A) make and keep books, records, and accounts, which, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the issuer;

(B) devise and maintain a system of internal accounting controls sufficient to provide reasonable assurances that—

(i) transactions are executed in accor- dance with management’s general or specific authorization;

(ii) transactions are recorded as necessary (I) to permit preparation of financial statements in conformity with generally accepted accounting principles or any other criteria applicable to such statements, and (II) to maintain accountability for assets;

(iii) access to assets is permitted only in accordance with management’s general or specific authorization; and

(iv) the recorded accountability for assets is compared with the existing assets at reason- able intervals and appropriate action is taken with respect to any differences; and

(C) notwithstanding any other provision of law, pay the allocable share of such issuer of a reason- able annual accounting support fee or fees, deter- mined in accordance with section 7219 of this title.

SEC. 406. CODE OF ETHICS FOR SENIOR FINANCIAL OFFICERS (a) Code of ethics disclosure

The Commission shall issue rules to require each issuer, together with periodic reports required pursuant to section 13(a) or 15(d) of the Securities Exchange Act of 1934, to disclose whether or not, and if not, the reason therefor, such issuer has adopted a code of ethics for senior financial offi- cers, applicable to its principal financial officer and comptroller or principal accounting officer, or per- sons performing similar functions.

SEC. 802. CRIMINAL PENALTIES FOR ALTERING DOCUMENTS (18 U.S.C. § 1519) § 1519. Destruction, alteration, or falsification of records in Federal investigations and bankruptcy

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A-30 Appendix F Sarbanes-Oxley Key Provisions (Excerpts)

Whoever knowingly alters, destroys, mutilates, conceals, covers up, falsifies, or makes a false entry in any record, document, or tangible object with the intent to impede, obstruct, or influence the inves- tigation or proper administration of any matter within the jurisdiction of any department or agency of the United States or any case filed under title 11, or in relation to or contemplation of any such mat- ter or case, shall be fined under this title, impris- oned not more than 20 years, or both. § 1520. Destruction of corporate audit records (a)(1) Any accountant who conducts an audit of an issuer of securities to which section 10A(a) of the Securities Exchange Act of 1934 (15 U.S.C. 78j- 1(a)) applies, shall maintain all audit or review workpapers for a period of 5 years from the end of the fiscal period in which the audit or review was concluded.

(2) The Securities and Exchange Commission shall promulgate, within 180 days, after adequate notice and an opportunity for comment, such rules and regulations, as are reasonably neces- sary, relating to the retention of relevant records such as workpapers, documents that form the basis of an audit or review, memoranda, corre- spondence, communications, other documents, and records (including electronic records) which are created, sent, or received in connection with an audit or review and contain conclusions, opin- ions, analyses, or financial data relating to such an audit or review, which is conducted by any

accountant who conducts an audit of an issuer of securities to which section 10A(a) of the Secu- rities Exchange Act of 1934 (15 U.S.C. 78j-1(a)) applies. The Commission may, from time to time, amend or supplement the rules and regulations that it is required to promulgate under this sec- tion, after adequate notice and an opportunity for comment, in order to ensure that such rules and regulations adequately comport with the pur- poses of this section. (b) Whoever knowingly and willfully violates sub- section (a)(1), or any rule or regulation promul- gated by the Securities and Exchange Commission under subsection (a)(2), shall be fined under this title, imprisoned not more than 10 years, or both.

SEC. 1102. TAMPERING WITH A RECORD OR OTHERWISE IMPEDING AN OFFICIAL PROCEEDING (18 U.S.C. § 1512) (c) Whoever corruptly—

(1) alters, destroys, mutilates, or conceals a record, document, or other object, or attempts to do so, with the intent to impair the object’s integrity or availability for use in an official proceeding; or

(2) otherwise obstructs, influences, or impedes any official proceeding, or attempts to do so, shall be fined under this title or imprisoned not more than 20 years, or both.

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A-31

Appendix G The Copyright Act (as Amended) (Excerpts)

SECTION 102. SUBJECT MATTER OF COPYRIGHT: IN GENERAL (15 U.S.C. § 102) (a) Copyright protection subsists, in accordance with this title, in original works of authorship fixed in any tangible medium of expression, now known or later developed, from which they can be perceived, reproduced, or otherwise communi- cated, either directly or with the aid of a machine or device. Works of authorship include the following categories:

(1) literary works; (2) musical works, including any accompanying

words; (3) dramatic works, including any accompany-

ing music; (4) pantomimes and choreographic works; (5) pictorial, graphic, and sculptural works; (6) motion pictures and other audiovisual

works; (7) sound recordings; and (8) architectural works.

(b) In no case does copyright protection for an original work of authorship extend to any idea, procedure, process, system, method of operation, concept, principle, or discovery, regardless of the form in which it is described, explained, illustrated, or embodied in such work.

SECTION 106. EXCLUSIVE RIGHTS IN COPYRIGHTED WORKS (15 U.S.C. § 106) Subject to sections 107 through 120, the owner of copyright under this title has the exclusive rights to do and to authorize any of the following:

(1) to reproduce the copyrighted work in copies or phonorecords;

(2) to prepare derivative works based upon the copyrighted work;

(3) to distribute copies or phonorecords of the copyrighted work to the public by sale or other transfer of ownership, or by rental, lease, or lending;

(4) in the case of literary, musical, dramatic, and choreographic works, pantomimes, and motion pictures and other audiovisual works, to perform the copyrighted work publicly; and

(5) in the case of literary, musical, dramatic, and choreographic works, pantomimes, and pictorial, graphic, or sculptural works, including the indi- vidual images of a motion picture or other audio- visual work, to display the copyrighted work publicly; and

(6) in the case of sound recordings, to perform the copyrighted work publicly by means of a digi- tal audio transmission.

SECTION 107. LIMITATIONS ON EXCLUSIVE RIGHTS: FAIR USE (17 U.S.C. § 107) Notwithstanding the provisions of sections 106 and 106A, the fair use of a copyrighted work, includ- ing such use by reproduction in copies or phon- orecords or by any other means specified by that section, for purposes such as criticism, comment, news reporting, teaching (including multiple cop- ies for classroom use), scholarship, or research, is not an infringement of copyright. In determining whether the use made of a work in any particular case is a fair use the factors to be considered shall include—

(1) the purpose and character of the use, includ- ing whether such use is of a commercial nature or is for nonprofit educational purposes;

(2) the nature of the copyrighted work; (3) the amount and substantiality of the portion

used in relation to the copyrighted work as a whole; and

(4) the effect of the use upon the potential market for or value of the copyrighted work.

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A-32 Appendix G The Copyright Act (as Amended) (Excerpts)

The fact that a work is unpublished shall not itself bar a finding of fair use if such finding is made upon consideration of all above factors.

SECTION 408. COPYRIGHT REGISTRATION IN GENERAL (17 U.S.C. § 408) (a) Registration permissive

At any time during the subsistence of copyright in any published or unpublished work in which the copyright was secured before January 1, 1978, and during the subsistence of any copyright secured on or after that date, the owner of copyright or of any exclusive right in the work may obtain regis- tration of the copyright claim by delivering to the Copyright Office the deposit specified by this sec- tion, together with the application and fee specified by sections 409 and 708. Such registration is not a condition of copyright protection.

SECTION 591. INFRINGEMENT OF COPYRIGHT (17 U.S.C. § 501) (a) Anyone who violates any of the exclusive rights of the copyright owner as provided by sections 106 through 118 or of the author as pro- vided in section 106A(a), or who imports copies or phonorecords into the United States in violation of section 602, is an infringer of the copyright or right of the author, as the case may be. For pur- poses of this chapter (other than section 506), any reference to copyright shall be deemed to include the rights conferred by section 106 (a). As used in this subsection the term “anyone” includes any State, any instrumentality of a State, and any offi- cer or employee of a State or instrumentality of a State acting in his or her official capacity. Any State, and any such instrumentality, officer, or employee, shall be subject to the provisions of this title in the same manner and to the same extent as any nongovernmental entity.

(b) The legal or beneficial owner of an exclusive right under a copyright is entitled, subject to the requirements of section 411, to institute an action for any infringement of that particular right com- mitted while he or she is the owner of it. The court may require such owner to serve written notice of the action with a copy of the complaint upon any person shown, by the records of the Copyright

Office or otherwise, to have or claim an interest in the copyright, and shall require that such notice be served upon any person whose interest is likely to be affected by a decision in the case. The court may require the joinder, and shall permit the interven- tion, of any person having or claiming an interest in the copyright.

REMEDIES FOR INFRINGEMENT: DAMAGES AND PROFITS (17 U.S.C. § 504) Section 504. (a) In general. Except as otherwise provided by this title, an infringer of copyright is liable for either—

1. the copyright owner’s actual damages and any additional profits of the infringer, as provided by subsection (b); or

2. statutory damages, as provided by subsection (c). (b) Actual damages and profits

The copyright owner is entitled to recover the actual damages suffered by him or her as a result of the infringement, and any profits of the infringer that are attributable to the infringement and are not taken into account in computing the actual damages. In establishing the infringer’s profits, the copyright owner is required to present proof only of the infringer’s gross revenue, and the infringer is required to prove his or her deductible expenses and the elements of profit attributable to factors other than the copyrighted work. (c) Statutory damages

(1) Except as provided by clause (2) of this subsection, the copyright owner may elect, at any time before final judgment is rendered, to recover, instead of actual damages and profits, an award of statutory damages for all infringements involved in the action, with respect to any one work, for which any one infringer is liable individually, or for which any two or more infringers are liable jointly and severally, in a sum of not less than $750 or more than $30,000 as the court considers just. For the pur- poses of this subsection, all the parts of a compila- tion or derivative work constitute one work.

(2) In a case where the copyright owner sustains the burden of proving, and the court finds, that infringement was committed willfully, the court in its discretion may increase the award of statu- tory damages to a sum of not more than $150,000. In a case where the infringer sustains the burden

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Appendix G The Copyright Act (as Amended) (Excerpts) A-33

of proving, and the court finds, that such infringer was not aware and had no reason to believe that his or her acts constituted an infringement of copy- right, the court in its discretion may reduce the award of statutory damages to a sum of not less than $200. The court shall remit statutory damages in any case where an infringer believed and had reasonable grounds for believing that his or her use of the copyrighted work was a fair use under section 107, if the infringer was: (i) an employee or agent of a nonprofit educational institution, library, or archives acting within the scope of his or her employment who, or such institution, library, or archives itself, which infringed by reproducing the work in copies or phonorecords; or (ii) a pub- lic broadcasting entity which or a person who, as a regular part of the nonprofit activities of a public broadcasting entity (as defined in subsection (g) of section 118) infringed by performing a published nondramatic literary work or by reproducing a transmission program embodying a performance of such a work.

SECTION 506. CRIMINAL OFFENSES (15 U.S.C. § 506) (a) Criminal infringement

(1) In general—Any person who infringes a copyright willfully and for purposes of commercial advantage or private financial gain shall be pun- ished as provided in section 2319 of title 18, if the infringement was committed—

(A) for purposes of commercial advantage or private financial gain;

(B) by the reproduction or distribution, including by electronic means, during any 180-day period, of 1 or more copies or phonorecords of 1 or more copyrighted works, which have a total retail value of more than $1,000; or

(C) by the distribution of a work being prepared for commercial distribution, by mak- ing it available on a computer network accessible to members of the public, if such person knew or should have known that the work was intended for commercial distribution.

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A-34

Appendix H Title VII and the Civil Rights Act (Employment Provisions) (Excerpts)

§ 1981. EQUAL RIGHTS UNDER THE LAW (a) All persons within the jurisdiction of the United States shall have the same right in every State and Territory to make and enforce contracts, to sue, be parties, give evidence, and to the full and equal benefit of all laws and proceedings for the security of persons and property as is enjoyed by white citi- zens, and shall be subject to like punishment, pains, penalties, taxes, licenses, and exactions of every kind, and to no other.

(b) For purposes of this section, the term “make and enforce contracts” includes the making, perfor- mance, modification, and termination of contracts, and the enjoyment of all benefits, privileges, terms, and conditions of the contractual relationship.

(c) The rights protected by this section are pro- tected against impairment by nongovernmental discrimination and impairment under color of State law.

§ 1981A. DAMAGES IN CASES OF INTENTIONAL DISCRIMINATION IN EMPLOYMENT (a) Right of recovery

(1) Civil rights. In an action brought by a com- plaining party under section 706 or 717 of the Civil Rights Act of 1964 (42 U.S.C. § 2000e-5 [or 2000e- 16]) against a respondent who engaged in unlaw- ful intentional discrimination (not an employment practice that is unlawful because of its disparate impact) prohibited under section 703, 704, or 717 of the Act (42 U.S.C. § 2000e-2 or 2000e-3 [or 2000e- 16]), and provided that the complaining party cannot recover under section 1977 of the Revised Statutes (42 U.S.C. § 1981), the complaining party may recover compensatory and punitive dam- ages as allowed in subsection (b), in addition to any relief authorized by section 706(g) of the Civil

Rights Act of 1964 [42 USCS § 2000e-5(g)], from the respondent.

SECTION 703. UNLAWFUL EMPLOYMENT PRACTICES Employer Practices (a) It shall be an unlawful employment practice for an employer—

(1) to fail or refuse to hire or to discharge any individual, or otherwise to discriminate against any individual with respect to his compensation, terms, conditions, or privileges of employment, because of such individual’s race, color, religion, sex, or national origin; or

(2) to limit, segregate, or classify his employees or applicants for employment in any way which would deprive or tend to deprive any individual of employment opportunities or otherwise adversely affect his status as an employee, because of such individual’s race, color, religion, sex, or national origin.

Employment Agency Practices (b) It shall be an unlawful employment practice for an employment agency to fail or refuse to refer for employment, or otherwise to discriminate against, any individual because of his race, color, religion, sex, or national origin, or to classify or refer for employment any individual on the basis of his race, color, religion, sex, or national origin.

Labor Organization Practices (c) It shall be an unlawful employment practice for a labor organization—

(1) to exclude or to expel from its membership, or otherwise to discriminate against, any individual because of his race, color, religion, sex, or national origin;

(2) to limit, segregate, or classify its membership or applicants for membership, or to classify or fail or refuse to refer to employment any individual, in any way which would deprive or tend to deprive

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Appendix H Title VII and the Civil Rights Act (Employment Provisions) (Excerpts) A-35

any individual of employment opportunities, or would limit such employment opportunities or oth- erwise adversely affect his status as an employee or as an applicant for employment, because of such individual’s race, color, religion, sex, or national origin; or

(3) to cause or attempt to cause an employer to discriminate against an individual in violation of this section.

Training Programs (d) It shall be an unlawful employment prac- tice for any employer, labor organization, or joint labor-management committee, controlling appren- ticeship or other training or retraining, includ- ing on-the-job training programs to discriminate against any individual because of his race, color, religion, sex, or national origin in admission to, or employment in, any program established to pro- vide apprenticeship or other training.

Businesses or Enterprises with Personnel Qualified on Basis of Religion, Sex, or National Origin; Educational Institutions with Personnel of Particular Religion (e) Notwithstanding any other provision of this subchapter, (1) it shall not be an unlawful employ- ment practice for an employer to hire and employ employees, for an employment agency to classify or refer for employment any individual, for a labor organization to classify its membership or to clas- sify or refer for employment any individual, or for an employer, labor organization, or joint labor-man- agement committee controlling apprenticeship or other training or retraining programs to admit or employ any individual in any such program, on the basis of his religion, sex, or national origin in those certain instances where religion, sex, or national origin is a bona fide occupational qualification rea- sonably necessary to the normal operation of that particular business or enterprise, and (2) it shall not be an unlawful employment practice for a school, college, university, or other educational institu- tion or institution of learning to hire and employ employees of a particular religion if such school, college, university, or other educational institution or institution of learning is, in whole or in substan- tial part, owned, supported, controlled, or managed

by a particular religion or by a particular religious corporation, association, or society, or if the curric- ulum of such school, college, university, or other educational institution or institution of learning is directed toward the propagation of a particular religion.

Seniority or Merit System; Quantity or Quality of Production, Ability Tests; Compensation Based on Sex and Authorized by Minimum Wage Provisions (h) Notwithstanding any other provisions of this subchapter, it shall not be an unlawful employ- ment practice for an employer to apply different standards of compensation, or different terms, con- ditions, or privileges of employment pursuant to a bona fide seniority or merit system, or a system which measures earnings by quantity or quality of production or to employees who work in different locations, provided that such differences are not the result of an intention to discriminate because of race, color, religion, sex, or national origin, nor shall it be an unlawful employment practice for an employer to give and to act upon the results of any professionally developed ability test provided that such test, its administration or action upon the results is not designed, intended or used to discrim- inate because of race, color, religion, sex, or national origin. It shall not be an unlawful employment practice under this subchapter for any employer to differentiate upon the basis of sex in determining the amount of the wages or compensation paid or to be paid to employees of such employer if such differentiation is authorized by the provisions of section 206(d) of Title 29.

SECTION 704. OTHER UNLAWFUL EMPLOYMENT PRACTICES Discrimination for Making Charges, Testifying, Assisting, or Participating in Enforcement Proceedings (a) It shall be an unlawful employment practice for an employer to discriminate against any of his employees or applicants for employment, for an employment agency, or joint labor-management

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A-36 Appendix H Title VII and the Civil Rights Act (Employment Provisions) (Excerpts)

committee controlling apprenticeship or other training or retraining, including on-the-job training programs to discriminate against any individual, or for a labor organization to discriminate against any member thereof or applicant for membership, because he has opposed any practice, made an unlawful employment practice by this subchapter, or because he has made a charge, testified, assisted, or participated in any manner in an investigation, proceeding, or hearing under this subchapter.

Printing or Publication of Notices or Advertisements Indicating Prohibited Preference, Limitation, Specification, or Discrimination; Occupational Qualification Exception (b) It shall be an unlawful employment practice for an employer, labor organization, employment agency, or joint labor-management committee

controlling apprenticeship or other training or retraining, including on-the-job training programs, to print or publish or cause to be printed or pub- lished any notice or advertisement relating to employment by such an employer or membership in or any classification or referral for employment by such a labor organization, or relating to any clas- sification or referral for employment by such an employment agency, or relating to admission to, or employment in, any program established to pro- vide apprenticeship or other training by such a joint labor-management committee, indicating any pref- erence, limitation, specification, or discrimination, based on race, color, religion, sex, or national origin, except that such a notice or advertisement may indi- cate a preference, limitation, specification, or dis- crimination based on religion, sex, or national origin when religion, sex, or national origin is a bona fide occupational qualification for employment.

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A-37

Appendix I The Americans with Disabilities Act (Excerpts)

TITLE I—EMPLOYMENT (42 U.S.C. § 12102) Sec. 101. Definitions. As used in this chapter:

(1) Disability The term “disability” means, with respect to an

individual— (A) a physical or mental impairment that sub-

stantially limits one or more major life activities of such individual;

(B) a record of such an impairment; or (C) being regarded as having such an impair-

ment (as described in paragraph (3)).

(2) Major life activities (A) In general For purposes of paragraph (1), major life activ-

ities include, but are not limited to, caring for one- self, performing manual tasks, seeing, hearing, eating, sleeping, walking, standing, lifting, bend- ing, speaking, breathing, learning, reading, concen- trating, thinking, communicating, and working.

(B) Major bodily functions For purposes of paragraph (1), a major life activ-

ity also includes the operation of a major bodily function, including but not limited to, functions of the immune system, normal cell growth, digestive, bowel, bladder, neurological, brain, respiratory, cir- culatory, endocrine, and reproductive functions.

(3) Regarded as having such an impairment For purposes of paragraph (1)(C): (A) An individual meets the requirement of

“being regarded as having such an impairment” if the individual establishes that he or she has been subjected to an action prohibited under this chapter because of an actual or perceived physical or men- tal impairment whether or not the impairment lim- its or is perceived to limit a major life activity.

(B) Paragraph (1)(C) shall not apply to impair- ments that are transitory and minor. A transitory

impairment is an impairment with an actual or expected duration of 6 months or less.

(4) Rules of construction regarding the definition of disability The definition of “disability” in paragraph (1) shall be construed in accordance with the following:

(A) The definition of disability in this chapter shall be construed in favor of broad coverage of individuals under this chapter, to the maximum extent permitted by the terms of this chapter.

(B) The term “substantially limits” shall be inter- preted consistently with the findings and purposes of the ADA Amendments Act of 2008.

(C) An impairment that substantially limits one major life activity need not limit other major life activities in order to be considered a disability.

(D) An impairment that is episodic or in remis- sion is a disability if it would substantially limit a major life activity when active.

(E) (i) The determination of whether an impair- ment substantially limits a major life activity shall be made without regard to the ameliorative effects of mitigating measures such as—

(I) medication, medical supplies, equip- ment, or appliances, low-vision devices (which do not include ordinary eyeglasses or contact lenses), prosthetics including limbs and devices, hearing aids and cochlear implants or other implantable hearing devices, mobility devices, or oxygen ther- apy equipment and supplies;

(II) use of assistive technology; (III) reasonable accommodations or auxil-

iary aids or services; or (IV) learned behavioral or adaptive neu-

rological modifications. (ii) The ameliorative effects of the mitigat-

ing measures of ordinary eyeglasses or contact lenses shall be considered in determining whether an impairment substantially limits a major life activity.

(iii) As used in this subparagraph—

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A-38 Appendix I The Americans with Disabilities Act (Excerpts)

(I) the term “ordinary eyeglasses or contact lenses” means lenses that are intended to fully correct visual acuity or eliminate refractive error; and

(II) the term “low-vision devices” means devices that magnify, enhance, or otherwise aug- ment a visual image.

Definitions. 42 U.S.C. § 12111 (9) Reasonable accommodation

The term “reasonable accommodation” may include—

(A) making existing facilities used by employ- ees readily accessible to and usable by individuals with disabilities; and

(B) job restructuring, part-time or modified work schedules, reassignment to a vacant posi- tion, acquisition or modification of equipment or devices, appropriate adjustment or modifications of examinations, training materials or policies, the provision of qualified readers or interpreters, and other similar accommodations for individuals with disabilities.

(10) Undue hardship

(A) In general The term “undue hardship” means an action

requiring significant difficulty or expense, when considered in light of the factors set forth in sub- paragraph (B).

(B) Factors to be considered In determining whether an accommodation

would impose an undue hardship on a covered entity, factors to be considered include—

(i) the nature and cost of accommodation needed under this chapter;

(ii) the overall financial resources of the facility or facilities involved in the provision of the reasonable accommodation; the number of persons employed at such facility; the effect on expenses and resources, or the impact otherwise of such accommodation upon the operation of the facility;

(iii) the overall financial resources of the covered entity; the overall size of the business of a covered entity with respect to the number of its employees; the number, type, and location of its facilities; and

(iv) the type of operation or operations of the covered entity, including the composition,

structure, and functions of the workforce of such entity; the geographic separateness, administrative, or fiscal relationship of the facility or facilities in question to the covered entity.

Sec. 102. Discrimination. 42 U.S.C. § 12112 (a) General rule

No covered entity shall discriminate against a qualified individual with a disability because of the disability of such individual in regard to job appli- cation procedures, the hiring, advancement, or dis- charge of employees, employee compensation, job training, and other terms, conditions, and privi- leges of employment.

(b) Construction As used in subsection (a), the term “discrimi-

nate” includes— (1) limiting, segregating, or classifying a job

applicant or employee in a way that adversely affects the opportunities or status of such applicant or employee because of the disability of such appli- cant or employee;

(2) participating in a contractual or other arrangement or relationship that has the effect of subjecting a covered entity’s qualified applicant or employee with a disability to the discrimination prohibited by this title (such relationship includes a relationship with an employment or referral agency, labor union, an organization providing fringe benefits to an employee of the covered entity, or an organization providing training and appren- ticeship programs);

(3) utilizing standards, criteria, or methods of administration—

(A) that have the effect of discrimination on the basis of disability; or

(B) that perpetuate the discrimination of others who are subject to common administrative control;

(4) excluding or otherwise denying equal jobs or benefits to a qualified individual because of the known disability of an individual with whom the qualified individual is known to have a relation- ship or association;

(5) (A) not making reasonable accommodations to the known physical or mental limitations of an otherwise qualified individual with a disabil- ity who is an applicant or employee, unless such

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Appendix I The Americans with Disabilities Act (Excerpts) A-39

covered entity can demonstrate that the accommo- dation would impose an undue hardship on the operation of the business of such covered entity; or

(B) denying employment opportunities to a job applicant or employee who is an otherwise qualified individual with a disability, if such denial is based on the need of such covered entity to make reasonable accommodation to the physical or men- tal impairments of the employee or applicant;

(6) using qualification standards, employment tests or other selection criteria that screen out or tend to screen out an individual with a disability or a class of individuals with disabilities unless the standard, test or other selection criteria, as used by the covered entity, is shown to be job-related for the position in question and is consistent with business necessity; and

(7) failing to select and administer tests con- cerning employment in the most effective manner to ensure that, when such test is administered to a job applicant or employee who has a disability that impairs sensory, manual, or speaking skills, such test results accurately reflect the skills, apti- tude, or whatever other factor of such applicant or employee that such test purports to measure, rather than reflecting the impaired sensory, manual, or speaking skills of such employee or applicant (except where such skills are the factors that the test purports to measure).…

Sec. 104. Illegal Use of Drugs and Alcohol.… 42 U.S.C. § 12114 (a) Qualified individual with a disability

For purposes of this subchapter, “a qualified individual with a disability shall” shall not include any employee or applicant who is currently engag- ing in the illegal use of drugs, when the covered entity acts on the basis of such use.

(b) Rules of construction Nothing in subsection (a) shall be construed to

exclude as a qualified individual with a disability an individual who—

(1) has successfully completed a supervised drug rehabilitation program and is no longer engaging in the illegal use of drugs, or has other- wise been rehabilitated successfully and is no lon- ger engaging in such use;

(2) is participating in a supervised rehabilitation program and is no longer engaging in such use; or

(3) is erroneously regarded as engaging in such use, but is not engaging in such use; except that it shall not be a violation of this Act for a covered entity to adopt or administer reasonable policies or procedures, including but not limited to drug test- ing, designed to ensure that an individual described in paragraph (1) or (2) is no longer engaging in the illegal use of drugs. …

(c) Authority of covered entity A covered entity— (1) may prohibit the illegal use of drugs and the

use of alcohol at the workplace by all employees; (2) may require that employees shall not be

under the influence of alcohol or be engaging in the illegal use of drugs at the workplace;

(3) may require that employees behave in con- formance with the requirements established under the chapter 81 of Title 41;

(4) may hold an employee who engages in the illegal use of drugs or who is an alcoholic to the same qualification standards for employment or job performance and behavior that such entity holds other employees, even if any unsatisfactory perfor- mance or behavior is related to the drug use or alco- holism of such employee; and

(5) may, with respect to Federal regulations regarding alcohol and the illegal use of drugs, require that—

(A) employees comply with the standards established in such regulations of the Department of Defense, if the employees of the covered entity are employed in an industry subject to such regulations, including complying with regulations (if any) that apply to employment in sensitive positions in such an industry, in the case of employees of the covered entity who are employed in such positions (as defined in the regulations of the Department of Defense);

(B) employees comply with the standards established in such regulations of the Nuclear Reg- ulatory Commission, if the employees of the cov- ered entity are employed in an industry subject to such regulations, including complying with reg- ulations (if any) that apply to employment in sen- sitive positions in such an industry, in the case of employees of the covered entity who are employed in such positions (as defined in the regulations of the Nuclear Regulatory Commission); and

(C) employees comply with the standards established in such regulations of the Department of Transportation, if the employees of the covered

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A-40 Appendix I The Americans with Disabilities Act (Excerpts)

entity are employed in a transportation indus- try subject to such regulations, including com- plying with such regulations (if any) that apply to employment in sensitive positions in such an industry, in the case of employees of the covered entity who are employed in such positions (as defined in the regulations of the Department of Transportation).

(d) Drug testing (1) In general For purposes of this subchapter, a test to deter-

mine the illegal use of drugs shall not be considered a medical examination.

(2) Construction Nothing in this subchapter shall be construed

to encourage, prohibit, or authorize the conducting of drug testing for the illegal use of drugs by job

applicants or employees or making employment decisions based on such test results.

(e) Transportation employees Nothing in this subchapter shall be construed

to encourage, prohibit, restrict, or authorize the otherwise lawful exercise by entities subject to the jurisdiction of the Department of Transportation of authority to—

(1) test employees of such entities in, and appli- cants for, positions involving safety-sensitive duties for the illegal use of drugs and for on-duty impair- ment by alcohol; and

(2) remove such persons who test positive for illegal use of drugs and on-duty impairment by alcohol pursuant to paragraph (1) from safety- sensitive duties in implementing subsection (c) of this section.

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G-1

10-K form an annual report filed by the company at the end of its fiscal year

10-Q form the quarterly financial report of a firm 8-K form a report that is triggered with the occurrence of unusual events such as bankruptcies, spin-offs, takeovers, and other changes in company control

A absolute privilege a defense to defamation, enjoyed in certain contexts or venues

acceptance the offeree’s positive response to the offeror’s proposed contract

accord and satisfaction an agreement entered into as set- tlement of a disputed debt

accredited investor an investor who meets the threshold standards for assets and income

act of state doctrine the principle that protects a govern- ment’s act done within its own territory, from reviews of their actions by courts in other countries

actual authority express and implied authority. actus reus it refers to the physical act of committing a crime.

administrative agency a statutory creation within the executive branch with the power to make, interpret, and enforce laws

administrative law judge (ALJ) the judge of a feder- al-level administrative hearing

Administrative Procedures Act (APA) a law that requires agencies to follow certain uniform procedures in making rules

advance loan by a partner to the partnership affirms if the appellate court does not find a reversible error, it sustains the decision of the lower court

Age Discrimination in Employment Act of 1967 an act that prohibits hiring, firing, promotion, benefits, and raises based on age; it prevents employment discrimination against employees over the age of 40 and mandatory retire- ment restrictions

agency by estoppel a principal-agency relationship that arises not by express or implied contracts but by percep- tions of third parties

agents those who do a task on behalf of the principal alter ego theory a doctrine used by the court to lift the corporate veil; it deems that the owners of the corporation have used it as a personal resource rather than treating it as a separate entity

America Invents Act (AIA) an act that changed the U.S.A’s rights to a patent, from a “first to file” system, to a “first to invent” system

American Competitiveness in the Twenty-First Century Act provides that employers cannot lay off American employees within 90 days following their submission of an application for entrance and employment of one of these highly skilled workers

Americans with Disabilities Act (ADA) an act that prohibits discrimination by the employer against individuals with disabilities

answer the formal statement that explain the defendant’s position in a case

Antiterrorism and Effective Death Penalty Act a reform to the Habeas Corpus writ; in addition to other provisions, it includes provisions to prevent terrorism, to provide justice to victims, and to provide for an effective death penalty to criminals

apparent authority an authority that exists by appearance or the perceptions of third parties

appellant the party who seeks a higher court to reverse a lower court’s decision

appellate brief a summary of the major points of error the parties allege occurred during the trial

appellate court that reviews the conduct of trial courts (also known as lower courts) to determine whether they apply the law correctly and follow the rules of procedure

appellee or respondent the party who has won the trial and against whom an appeal is filed by the petitioner

appraisal rights the value of shares immediately before the merger that is paid to the dissenting shareholders

appropriation a privacy tort that involves the use of a person’s likeness, image, voice, or trademark for commer- cial gain, without the permission of that person

arbitrary and capricious an illogical and unreliable agency rule that abuses discretion and violates laws

arraignment the hearing at that trial date is set and plea is entered by the defendant

articles of incorporation the document that is filed to organize a corporation; contains the structure and basic information about the corporation

Asbestos Hazard Emergency Response Act (AHERA) a law that requires inspection of all public and private schools to determine if their buildings have asbestos-containing materials

Glossary

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G-2 Glossary

asset acquisition a strategy where the assets of a company are purchased, rather than its stock

Asset Conservation, Lender Liability, and Deposit Insurance Protection Act of 1996 the law that pro- vides a specific exclusion for lenders, from the CERCLA liability

assignment a type of third-party contract rights in that the third parties are not part of the original contract, but are brought in at a later stage

assumption of risk the plaintiff’s voluntary subjection to a risk that caused injuries

attorney–client privilege a legal concept that prevents the disclosure of confidential communications between the clients and their lawyers

audit committees the independent bodies that assure the accuracy of the financial reports issued by the management of the corporation

B bait and switch a sales tactic in that a cheaper product than the one in stock is advertised (used as “bait”) to get customers into a store and then present them with a “bet- ter,” more expensive product (a switch)

Bankruptcy Abuse Prevention and Consumer Protec- tion Act of 2005 (BAPCPA) an act that lists strict stan- dards for filing for bankruptcy

bargained-for exchange something of value exchanged by the offeror and offeree that distinguishes gifts from contracts

best available treatment (BAT) the highest standard imposed by the EPA with regards to treating a pollutant

best conventional treatment (BCT) the pretreatment of a conventional pollution by a plant, before its release into the environment

bilateral contract a contract in that both parties promise to perform certain things

bilateral treaties or multilateral treaties agreements between two or more states that encompass obligations and exceptions

bill of lading it is a receipt for shipment issued by the car- rier to the seller; it also serves as a contract for the shipment of the goods and provides evidence of who has title to the goods

Bill of Rights the first 10 amendments to the U.S. Con- stitution, providing individual freedom and protection of individual rights

binding arbitration it indicates that the decision of the arbitrators is final

blue-sky law a set of laws containing state securities regis- tration regulations

board of directors the policy-setting body of the corporations

bona fide occupational qualification (BFOQ) a job qualification based on sex, religion, or national origin that is necessary for the operation of business

brief a tool used to summarize a case, focus on its facts, and on the key points of the decision by the court

brief a summary of the case and the legal issues being challenged on appeal

bubble concept an evaluating concept that examines all the air pollutants in the area as if they came from a single source, to check whether a new plant has a net effect on the air in the area

burden of proof the responsibility for proving the fact of a case

business judgment rule a standard of corporate pre- sumption under which it is understood that business decisions were made by officers and directors after careful study and discussion

“but for” test a test that is used to determine causation; it is formed on the basis that the injury could have been prevented by the action or the lack of action of the defendant

bylaws the rules and regulations that are adopted by a corporation to govern its procedures

C capacity the capacity of the principal (age and mental capacity) to make contracts

causation the “but for” reason for an accident caveat emptor a theory that states that the sellers are not liable for defects in their products; it is the buyer’s respon- sibility to be on the alert for defects and take appropriate precautions

celebrity endorsements product advertisements by easily recognized public figures

certification the recognition of a union as an exclusive bargaining agent

charitable subscriptions pledges or enforceable promises to make gifts

cite or citation statutes from the U.S.C. referenced by a standard form of legal shorthand

civil law a set of laws regulating ordinary legal disputes distinct from criminal, political, and military issues

Civil Rights Act of 1964 an act that outlaws all employ- ment discrimination on the basis of race, color, religion, sex, or national origin; it applies to hiring, pay, work conditions, promotions, discipline, and discharge

Civil Rights Act of 1991 an amendment of the Civil Rights Act that requires an employer to justify a pattern or practice, executed as a business necessity or for job related purposes

Civil Rights Acts of 1866 and 1870 the first effective antidiscrimination employment statute that prohibits inten- tional discrimination based on race, color, national origin, or ethnicity

class action suit complaint filed by a group of plain- tiffs who have the same cause of action against one defendant

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Glossary G-3

Clayton Act a federal antitrust statute that controls merg- ers and prohibits tying and interlocking directorates

Clean Air Act the federal law that controls air pollution

Clean Water Act a federal law that regulates emissions in various water sources

close corporations a type of smaller corporation that operates in a simplified and flexible manner without strict formalities; its owners are generally given more discretion in their internal operations

closed shop it refers to a business that requires union membership before an employee can be hired

closing arguments the statements presented by the parties to review the evidence, highlight the important points for the jurors, and point out the defects in the other side’s case

Code of Federal Regulations the second publication of the Federal Register System that contains all the regulations of all the federal agencies

collective bargaining agreement an exclusive rights agreement between employer and employee

collective bargaining unit a group of employees recognized by the National Labor Relations Board (NLRB) as appropriate for exclusive representation of all employees in that group

comment letter or deficiency letter it is a request made by SEC for more information from the registrants of the offering

Commerce Clause the part of the U.S. Constitution that controls federal regulation of business; limits Congress to regulating interstate and international commerce

commercial impracticability the defense to perfor- mance of sales contract based on objective impractica- bility; it excuses performance if the basic assumptions the parties made when they entered into the contract have changed

commercial speech the speech of business where different forms of communications, such as advertising, are used to further the economic interests of the speaker

common law a set of laws developed historically and by judicial precedent

common stock the typical stock in a corporation; usually the most voluminous in terms of the number of shares; allows the common shareholders to vote

community-right-to-know substance the substances such as asbestos, when used in the construction of build- ings, impose a probable duty on the building owner to dis- close their presence to buyers, tenants, and employees

comparative negligence negligent conduct by plaintiff that serves as a partial defense by reducing liability by per- centage of the plaintiff’s fault

comparative negligence a negligence defense that assigns liability and damages in accidents on a percentage basis; it calculates the contribution of both the defendant and the plaintiff towards the accident, thus reducing a plaintiff’s recovery by the amount his/her negligence contributed to the cause of the accident

compensatory damages the amount required to place a party in as good a position as before the breach

complaint or petition the first legal document that is filed in a lawsuit and outlines the plaintiff’s claim of rights

Comprehensive Environmental Response, Compensation, and Liability Act(CERCLA) a federal law providing funds and authority for hazardous waste site cleanups

computer crime the crimes committed while using com- puter technology

Computer Software Copyright Act of 1980 an act under which all software can be copyrighted, whether it is written in ordinary language (source code) or machine language (object code)

concurrent jurisdiction the authority of courts from dif- ferent systems (such as state and federal courts) to hear a specific case

conditions the prescribed events that must occur before performance is required

condition concurrent or condition contemporaneous a contract scenario where one party is willing to perform because the other party does

conditions precedent the events that give rise to performance

confidential relationship the trust, confidence, and reli- ance in a relationship

conscious avoidance a doctrine under which executives cannot “consciously try to avoid knowledge” about the actions and activities of those within the company, that may help in curbing deception

conscious parallelism the undiscussed pricing strat- egies that occur among competitors in a market with limited competition (for example, when a business rais- es the price of its products, the competitors follow the same)

consent decree the settlement (nolo contendere plea) of charges brought by an administrative agency

consequential damages the damages owed to third par- ties as a result of the breach of contract

consideration something of value exchanged by the par- ties that distinguishes gifts from contracts; it is sometimes called bargained-for exchange

consolidation the merger or combination of two or more companies into a single new company, eliminating the exis- tence of the former companies

Constitution a set of fundamental principles and laws that are used to govern a state or an organization

constructive notice or actual notice the publication of the resignation or termination

Consumer Financial Protection Act (CFPA) an act that increases the disclosure requirements and grants the Consumer Financial Protection Bureau (CFPB) broad authority to enforce extensive new regulation on mortgage and equity loans

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G-4 Glossary

Consumer Product Safety Commission (CPSC) a reg- ulatory agency set up under the Consumer Product Safety Act to regulate safety standards for consumer products

Consumer Product Safety Improvement Act (CPSIA) an act that expands CPSC’s authority to cover secondhand sales

contentious jurisdiction the jurisdiction of a court to hear cases that deal with controversial matters between parties

contract a set of agreements between parties that enforces duties and responsibilities, the breach of which require rem- edies or compensation

contract defense it refers to a situation, term, or event that makes an otherwise valid contract invalid

contract interference or tortious interference with contracts a tort where parties are not allowed the freedom to contract without interference from third parties

contributory negligence the negligence on the part of a plaintiff that was partially responsible for causing injuries

contributory negligence the negligence on the part of a plaintiff that was partially responsible for causing injuries

Controlling the Assault of Non-Solicited Pornography and Marketing (CAN-SPAM) Act an act under which private companies can bring suit against spammers for their unauthorized use of Internet Service Providers (ISPs)

conventional type of that can be eliminated or reduced in a treatment plant

cooling-off period the time allowed to the parties of a contract to reconsider or relieve themselves from any duties of the contract, without penalty

copyright an exclusive right to sell, control, or license, words, thoughts, ideas, and music

corporate opportunity doctrine a legal principle that prohibits officers and directors to exploit a business oppor- tunity that could benefit the corporation

corporate political speech speech in business ads or posi- tions on candidates or referenda

corporate veil a liability shield for corporate owners corporations a business organization that is a separate entity with limited liability and full transferability

corrective advertising requires a seller to correct the unsubstantiated claims made in the previous advertisements

Council on Environmental Quality (CEQ) a division of the executive branch of government that is responsible for formulating national policies with regards to the quality of the environment

counterclaim an answer in which the defendant, in effect, countersues the plaintiff, alleging a violation of rights and damages against the plaintiff

counteroffer a modification or rejection of a portion of the original offer, resulting in a new counterproposal

Court of Justice of European Communities the Europe- an Union’s judicial system that includes the Court of Justice, the Court of First Instance, and the Civil Service Tribunal

court of chancery a court that applies the principles of equity to cases presented to it

covenant not to compete a clause under which the employee agrees that he or she will not enter a trade in competition against the employer

crime an act or an omission that violates the law and results in punishment

criminal fraud misrepresentation of information or iden- tity, with the intent to take something (funds or property) from another without that person’s knowledge

criminal law a body of laws regulating wrongful conduct and penalizing individuals who commit crimes

cross-elasticity a measurement of the change in the quan- tity demand of one product when a price change occurs in another product

cross-examination the defense’s questioning of plaintiff witnesses

cumulative preferred stock stock with guaranteed payment of a dividend so that if a dividend is not paid one year, the holder’s right to be paid carries over until funds are available

customer and territorial restriction a vertical trade restraint in which manufacturers are not given the right to control what the buyer does with goods and how those goods are sold

D defamation an untrue or damaging statement made by one party to another about a third party – comprises either slander or libel

default a failure to answer a call for legal proceeding; the plaintiff wins because the defendant failed to show up

defendants the parties or respondents from whom plain- tiff seeks relief

Deferred Prosecution Agreements (DPAs) the negotiated settlements of criminal charges against a corpo- rate defendant

delegation the transfer of contractual duties and obliga- tions from one party to another contracting party

derivative suit a form of class action suit in which share- holders sue a corporation to recover damages for actions taken by the corporation

derivative suits right of the shareholder to recover losses from those who made decisions not guided by proper processes

Digital Millennium Copyright Act (DMCA) an act passed in 1998 that criminalizes the bypassing of protec- tion technology in order to make copies of copyrighted materials

direct examination process of questioning the witnesses under oath, to help a case

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Glossary G-5

directed verdict a verdict by a jury based on the directions provided by the judge, when one of the parties of the case do not offer sufficient proof for the claim

disclaimer a statement that restricts the scope of a warran- ty or a promise

discovery a fact-finding pre-trial procedure in which the parties involved obtain evidence from each other using legal methods

disparagement an untrue statement made about a busi- ness product or service; it is divided into two types - trade libel (written) or slander of title (oral)

disparate impact test or screening practices used in employment, which affects one group more than another

disparate treatment to certain distinctions made by law- makers in legislating and regulating, which result in classes of individuals being treated differently

dissenting opinion in the case of a split vote, the explana- tion of a justice who is not in the majority for a vote differ- ent from that of the majority

dissenting shareholders a shareholder who does not vote in favor of a merger or a consolidation

dissolution it is an act of officially ending an association with the partnership, by a partner

diversity of citizenship means by which a federal court to hear a lawsuit, in which the opposing parties are citizens of different states

Dodd–Frank Wall Street Reform and Consumer Financial Protection Act a set of federal regulations that promote financial stability by improving accountability and transparency; and protect the consumer from incorrect financial practices

domestic corporations a corporation is in the state in which its incorporation is filed

due diligence a defense of Section 11 violation that allows defendants (non-issuers) to show that they were acting reasonably in preparing and signing the registra- tion statement

due process the right to trial before conviction or some review or procedure prior to loss of rights

duress when a party is physically forced into a contract or deprived of a meaningful choice when deciding whether to enter into a contract

E Economic Espionage Act (EEA) an act that makes it a felony to steal, copy, alter, or transmit a trade secret

effluent guidelines the ranges of discharges into water, permitted per industrial group by the EPA

Electronic Communications Privacy Act of 1986 (ECPA) a federal law which prohibits the unautho- rized access of “live” communications such as when someone uses a listening device to intercept a telephone conversation

Electronic Communications Privacy Act of 1986 (ECPA) an act which prohibits the unauthorized access of “live” communications such as when someone uses a listen- ing device to intercept a telephone conversation

Electronic Signatures in Global and National Commerce Act of 2000 (ESIGN) the federal law that mandates the rec- ognition of electronic signatures for the formation of contracts

elements the requirements of proof for crimes

emerging growth companies (ECGs) companies that have less than $1 billion in annual gross revenues; that publicly traded for less than five years; that have a public offering of $700 million or less; and have not issued $1 billion in debt in the immediate past three years

eminent domain it is the right of a governmental body to take ownership of a private property for a public use

emissions offset policy a policy which requires a new plant to have the greatest possible emissions controls; to have its operations in compliance with standards; and whose emissions must be offset by reductions from other facilities in the area

employees the individuals who perform work for an employer, in exchange for an agreed sum of money

employment at will the right of an employer to hire or terminate noncontract employees at any time

enabling act an act which empowers a person or an orga- nization to deal with certain issues and problems

Endangered Species Act (ESA) a powerful federal law that can curb an economic activity, if it presents harm to endangered species or their habitat

environmental impact statement (EIS) a report prepared by the federal agency on the study of the proposed action’s effect on the environment

Environmental Protection Agency (EPA) the federal agency responsible for enforcement of environmen- tal laws; thereby, curbing pollution and protecting the environment

Equal Employment Opportunity Act of 1972 an anti- discrimination employment amendment to Civil Rights Act which expands the enforcement power of EEOC

Equal Employment Opportunity Commission (EEOC) an agency of the U.S government responsible for enforcing the anti-discrimination laws at workplace

Equal Pay Act of 1963 an amendment to the FLSA that makes it illegal to pay different wages based on gender to men and women who are doing substantially the same work

Equal Pay Act of 1963 an act which makes it illegal to pay different wages based on gender, to men and women who are doing substantially the same work

equal protection the constitutional protection offered to U.S. citizens, against disparate treatment

Equitable remedies court orders that restrain or prevent anti-competitive conduct; these are non-monetary remedies such as injunctions

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G-6 Glossary

equitable remedy a type of remedy that decrees specific actions not covered by legal remedies

equity remedies and procedures that provide relief when legal laws are inadequate

ethical standards a set of accepted rules of conduct that governs society

European Court of Human Rights a regional human rights judicial body that hears applications alleging breach of one or more human rights by a contracting state

ex parte contacts contacts with one of the parties in a dispute without the knowledge of the others

exclusionary conduct conduct that prevents a potential competitor from entering the market

exclusive jurisdiction the power of a court to serve as the sole forum to adjudicate a case

exculpatory clause clause to hold oneself harmless for one’s own conduct

executed contract a contract where the parties have performed according to their promises or required actions

executive committee a group of three or more board members who handle the routine responsibilities of running the corporation

executive orders laws of the executive branch of the feder- al government that deal with issues under the direct control of that branch

executory contracts the contracts where the promise to per- form is made but the actual performance has not been done

exempt securities refer to the securities that need not be registered with the SEC

exempt transactions refer to minor transactions that need not be filed with the SEC

exemption a privilege which provides freedom from the law’s application

exhausting administrative remedies the process in which those appealing an administrative law judge’s (ALJ) decision must go through all the required lines of authority in the agency before they can go to court

express authority a written or stated agreement authoriz- ing an agent to act on behalf of another person or business

express contract a written or an orally agreed to contract express contract a spoken or written agreement that spec- ifies the terms and limitations of an employee or an agent’s authority

express warranty a contractual promise about the nature or the potential of the product that gives the right of recov- ery if the product falls short of a promise that was a basis of the bargain

F failing-company doctrine a doctrine that allows the asset or inventory acquisition of a competitor that is teetering on insolvency, shutdown, or bankruptcy

Fair Credit Billing Act an act that covers timing and con- tent requirements for credit card bills; it affords debtors the opportunity to challenge the figures on credit card monthly statements

Fair Credit Reporting Act (FCRA) an act that covers the rights of debtors with respect to reports of their credit histories held by third parties

Fair Debt Collections Practices Act (FDCPA) an act that regulates the conduct of third-party bill collectors and attor- neys; enacted to control abuses in the collection process

“fair-disclosure rule” (Regulation FD) the SEC prom- ulgation that mandates that material information about the company must be made available to everyone at the same time

Fair Employment Practices Act an act that outlaws all employment discrimination on the basis of race, color, reli- gion, sex, or national origin

Fair Labor Standards Act (FLSA) an act that establishes a minimum wage and includes provisions regulating child labor, overtime pay requirements, and equal pay provisions

fair trade contract an agreement between a manufacturer and a retailer to sell the trademark commodities of the man- ufacturer, at or above a specified price

fair use an occasional and spontaneous use of copyrighted materials for limited purposes

false imprisonment the wrongful detention of a person for any period of time against his or her will; this shop- keeper’s tort occurs as a result of a shoplifting accusation

Family and Medical Leave Act (FMLA) a federal law which requires companies with 50 or more employees to provide 12 weeks leave each year for medical or family reasons

Featherbedding an unfair labor practice that involves payment for work not actually performed

federal circuit the grouping of federal district courts according to their geographic location

Federal Environmental Pesticide Control Act a law which controls the use of pesticides

Federal Insurance Contributions Act (FICA) an act under which every employer and employee is required to contribute to the Social Security programs

Federal Privacy Act (FPA) a federal law that reduces exchange of information between agencies about indi- viduals and businesses, unless done for enforcement reasons

Federal Register the third publication of the Federal Regis- ter System which provides a daily update on changes in the regulations

Federal Register Act (FRA) an act that requires the use of Federal Register for publishing information related to agency rules and regulations, notice of meetings, and presi- dential documents, that have general applicability

Federal Register System that which oversees publication of federal agency information

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Glossary G-7

Federal Trade Commission (FTC) a federal agency responsible for regulating deceptive advertisements

Federal Trade Commission Act an act passed in 1914, which authorized the Federal Trade Commission (FTC) to prevent unfair and deceptive trade practices

Federal Trademark Dilution Act statute that permits recovery and injunctions for “dilution” of distinctive trademarks; it protects the trademark owner and pre- vents others from capitalizing on the popularity of the trademark

Federal Water Pollution Control Act of 1972 a federal law that regulated emissions in various water sources and implemented pollution control programs

Federal Water Pollution Control Administration (FWPCA) a separate enforcement agency that sets the water quality standards on behalf of the states

fiduciaries the officers and directors of the corporation who act in the best interests of the corporation and not prof- it at the corporation’s expense

Fifth Amendment an amendment to the U.S. Consti- tution that provides protection against self-accusation; it also guarantees that an accused individual has the right to be heard

FOIA request a request to obtain agency information that is not published but available to the public

force majeure potential international events that could hamper production or trade (such as wars, economic depression, or embargoes)

foreign corporation corporation in all states except the state in which it is incorporated

Foreign Corrupt Practices Act a criminal statute that pro- hibits making, authorizing, or promising payments or gifts of money or anything of value to government and NGO officials with the intent to corrupt for the purpose of obtain- ing or retaining business for or with or directing business

formal rulemaking the creation or modification of admin- istrative rules, which requires presenting evidence along with a hearing on the record

Fourteenth Amendment grants citizens the right to the equal protection of the law

Fourth Amendment a provision in U.S. Constitution that protects against invasions of privacy; it forms the basis for requiring warrants for searches of private property

fraud it is the knowing and intentional disclosure of false information or the knowing failure to disclose relevant information

Freedom of Information Act (FOIA) a law that allows access to certain information possessed by federal agencies; it also requires that the agencies publicly disclose their pro- cedures and decisions

freeze-out a merger undertaken to remove the minority shareholders in a corporation

friendly takeover the acquisition of a target company that is approved by its management

full-disclosure standard the SEC’s guide in reviewing the registration materials; requires that certain informa- tion be supplied; it is not a review on the merits of the offering

G garnishment the attachment of a judgment to an account, paycheck, or receivables

general partner a type of partner in a limited partnership who takes full liability and responsibility for the manage- ment of the business

geographic market the area or region in which the com- panies supply their products and services

good-faith bargaining a requirement that the parties negotiate terms in earnest

Government in the Sunshine Act an open meeting law that requires prior public notice of meetings of those agen- cies with heads appointed by the president

grand jury a secret panel of citizens who serve for a des- ignated period of time (usually six months) and act as the body responsible for the review of evidence of crimes; it determines whether charges should be brought and wheth- er the defendant should be held for trial

gratuitous agency a principal-agent relationship in which the agent has the authority to act for the principal but will not be compensated

gray market a parallel market in which the cost and the quality of goods is less, when compared to the trademark owner’s market

grease payments a facilitating payment, relatively small in amount, paid to officials to expedite the performance of a duty

group boycotts a group of competitors that agrees not to deal with buyers unless those buyers agree to certain conditions

H Hazardous Substance Response Trust Fund provides funding for clean-up of sites containing hazardous wastes

hearing examiner or hearing officer the judge of a state-level administrative hearing

Home Equity Loan Consumer Protection Act of 1988 an act that covers the disclosure and advertisement requirements for home equity loans

Home Ownership and Equity Protection Act of 1994 (HOEPA) an act that covers disclosure requirements on payment amounts for home equity loans and cancellation rights

home solicitation sales that in which sellers and creditors first approach consumers in the buyers’ homes

horizontal restraints of trade the restraints that are designed to lessen competition among a firm’s competitors

hostile takeover an unfriendly acquisition of a target company, despite resistance from its management

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G-8 Glossary

Howey test the Supreme Court’s definition of security or investment contracts

hung jury a jury in which the jurors reach a deadlock, unable to unanimously agree on a verdict

hybrid rulemaking a type of rulemaking that is a cross between formal and informal rulemaking

I Illegal Immigration Reform and Immigrant Respon- sibility Act of 1996 a law which improves border control and prevents illegal immigration by denying legal entry into the U.S, unless a pardon is obtained

Immigration Act of 1990 the federal laws that increased legal immigration by 35%, enabled more family-sponsored immigration, and increased employment-based immigra- tion; it is also known as the “green card visa lottery.”

Immigration and Naturalization Act (INA) an act which enforces restrictions on the laws governing immigra- tion and naturalization in the U.S

Immigration Reform and Control Act of 1986 (IRCA) a law which prevents illegal immigration into the U.S

implied authority an extension of express authority by custom

implied contract a contract that arises from the parties’ voluntary conduct and not from express agreements

implied warranty of fitness for a particular purpose the warranty given in circumstances in which the buyer relies on the seller’s expertise and acts, and makes a pur- chase according to that advice

implied warranty of merchantability the warranty of average quality, purity, and adequate packaging given in every sale by a merchant

implied-in-fact contract a contract that arises from factual circumstances, professional circumstances, or custom

implied-in-law contract a legally implied contract to prevent unjust enrichment; it is also known as a quasi-contract

Impossibility a scenario where the contract cannot be per- formed by the parties or anyone else

in rem jurisdiction a type of jurisdiction through property ownership

In personam jurisdiction a type of jurisdiction through physical presence

incidental damages the costs of collecting compensatory damages

incorporators the parties responsible for setting up the corporation

independent contractor those who act on behalf of anoth- er to perform a task but are not under the direct control of the other person

indictment a document issued by the grand jury requiring the defendant to stand trial

infants a person who is a minor (below the age of 18)

informal rulemaking the creation or modification of administrative rules without public hearings

information a document issued after the preliminary hear- ing requiring the defendant to stand trial

inherently dangerous activities the activities for which the principal is liable, even if the activities are performed by an independent contractor

initial appearance the defendant’s first appearance in court to be informed of his or her charges and rights; to set bail and future dates and appoint a lawyer

initial meeting the first meeting after incorporation, where the officers of the corporation are elected and bylaws are adopted

injunction judicial orders that prohibit certain conduct or order certain acts

Insider Trading and Securities Fraud Enforcement Act of 1988 a federal law which increases penalties for insider trading violations

insiders the directors, officers, and the shareholders of a company who own more than 10% of its shares

instructions the guidelines developed by the judge and all the attorneys in the case, to inform the jurors what the law is and how to apply the law to the facts presented

intentional infliction of emotional distress a bizarre and outrageous conduct that goes beyond all bounds of decency, and inflicts mental and possible physical harm on another

intentional torts a private wrong that involves deliberate actions that results in injury to a person or a property

Inter-American Court of Human Rights an autonomous judicial institution dedicated to the protection of human rights in America

interbrand competition the competition available for the manufacturer’s product from a similar rival product

interlocking directorates competing companies in which the officers of those companies serve on each other’s boards of directors

International Chamber of Commerce a voluntary international court that offers arbitration in international disputes

International Court of Justice a judicial branch of the UN with contentious (consensual) jurisdiction; reported in International Law Reports

interrogatories a set of questions presented by a litigator and answered by an adversary to clarify certain facts of a case

intervenors parties with an interest in the case between the agency and the party charged with a violation

intrabrand competition the competition among the retail- ers and distributors of the same brand of products

J joint ventures a partnership between existing businesses for a limited time or a limited purpose

judges individuals who control or review the proceedings and outcome in a case

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Glossary G-9

judgment the court’s official document regarding the rights and responsibilities of the parties involved in a legal proceeding

judgment NOV judgment notwithstanding the verdict or non obstante veredicto. The moving attorney asks the trial judge to reverse the decision of the jury in cases where the jury’s verdict is clearly against the weight of the evidence.

judicial review a review of a trial court’s decisions and verdict to determine whether any reversible error was made in the proceedings

Jurisdiction the authority or power of a court to make legal judgments and decisions

jurisprudence an area of legal study encompassing the different theories or values that forms the basis for creating laws

just compensation compensation provided by the gov- ernment to a property owner, in order to take that private property for public use or for use in a governmental project

justice of the peace courts or county courts lesser courts that allow the participation of lawyers but limits the amount that can be recovered

K knock-off goods goods that carry the trademark or trade name of a firm’s product but are not actually produced by that firm

L Landrum–Griffin Act an act that provides employee protection within union organizations; it is also known as The Labor-Management Reporting and Disclosure Act of 1959

Lanham Act of 1946 a federal law passed to afford businesses, protection of their trademarks

lawyer a person who practices law and represents each of the parties in a case

legal remedy the means by which a court imposes a pen- alty upon the wrong doer and provides monetary compen- sation for the plaintiff

legislative branch a branch of the federal government containing the two houses of Congress—the House of Representatives and the Senate

letter of credit a pledge by bank stating the availability of funds for a transaction

libel a written defamation made by one party to another about a third party; it includes images, broadcasts, and other media

like grade or quality products containing no physical differences

Lilly Ledbetter Fair Pay Act a federal law that extends the time for filing claims for discriminatory practices that led to pay disparity

limited jurisdiction a court’s power to hear only certain types of cases such as bankruptcy and family issues

limited liability company (LLC) a newer form of business organization in which liability is limited except for conduct that is illegal

limited liability partnership (LLP) the newest form of business organization in which the partners’ liability is limited; it offers unique statutory protection for all its members

limited partner a type of partner in a limited partnership whose personal liability is limited to capital contributions

limited partnership a partnership with two types of partners - general and limited

limited partnership agreement or articles of limited partnership a document that contains the rights and obli- gations of the partners in a limited partnership

lingering apparent authority the authority that exists with a terminated agent because other parties are not aware of the termination

liquidated damages an agreement clause in a contract that pre-establishes and limits the damages

lockout an employer’s economic weapon in which the employer refuses to allow employees to work

long-arm statutes the power given to courts to extend their jurisdiction into other states

M Madrid Agreement it enables universal registering and managing of trademarks

mailbox rule the timing rule for acceptance that is applied in stipulated means offers so long as the offeree uses the stipulated means to communicate acceptance

malice the publication of information with a reckless disregard for whether it is false or true

mandatory bargaining terms the agreements that deal with “wages, hours, and other terms and conditions of employment.”

market power it is the power to control prices or exclude competition in a relevant market

master–servant relationship a principal–agent relation- ship in which the principal (master) exercises a great degree of control over the agent (servant)

material fact the type of information that would affect someone’s decision to enter into the contract

material misstatement false information present in the financial statements that would affect the decision to buy or sell

mediation a process in which both parties meet with a neutral mediator who listens to each side explain its position

meeting the competition a defense to a charge of price discrimination in which the defense must establish that a price change was made in a certain market to meet the competition there

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Copyright 2018 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. WCN 02-200-203

G-10 Glossary

mens rea the mental intent (state of mind) or knowledge of wrong required for committing a crime

merchant’s firm offer a written offer signed by a mer- chant that makes an offer irrevocable, even without the offeree’s payment

merchants’ confirmation memoranda memos that sum- marize oral agreements and are signed by only one party, but they can be used to satisfy the statute of frauds so long as the memos have been sent to the non-signing party for review and no objection is raised upon that party’s receipt

merger a combination of two or more corporations, after which only one corporation continues to exist

merit review a standard under which the regulatory agency responsible for securities enforcement can examine a filed offering for its merits

minimum contacts a list of requirements satisfied by cor- porations and non-residents of a state that subjects them to that state court’s jurisdiction

minimum wage the federal hourly rate of pay minitrial an alternative dispute resolution procedure where the parties have their lawyers present the strongest aspects of their cases to senior officials from both compa- nies in the presence of a neutral advisor or a judge with experience in the field

minors a person who has not attained the age of 18 Miranda warnings the advice required to be given to those taken into custody, such as a description of the right to remain silent and the right to have counsel

misappropriation the use of another’s ideas or trade secrets, for self-benefit or the benefit of a new employer

misrepresentation incomplete or inaccurate informa- tion provided by one party to another prior to contract execution

misuse a product liability defense for plaintiff using the product in a manner that the manufacturer has specifically warned against; or in a way the defendant could not antici- pate and warn against

Model Business Corporation Act (MBCA) the uniform law on corporations that is drafted and revised by the Corporate, Banking, and Business Section of the American Bar Association; adopted in approximately one-third of the states

modify in some appellate cases, a portion or portions of the case are reversed or modified by the court

monopolizing the exclusive possession of power in the relevant market by willful acquisition

monopsony a type of vertical restraint that exists when the buyer, rather than the seller, has the ability to control market prices

moral relativism a system that establishes ethical stan- dards according to the situation in which the dilemma is faced. It is also known as situational ethics

motion for judgment on the pleadings a defendant’s request to the court to move for judgment based just on the content of the pleadings

motion for summary judgment a request for judgment that is applicable only when the moving party is entitled to a judgment under the law and when no issues of fact remain disputed

motion to dismiss a defendant’s formal request to a court to dismiss a case

motions procedures that involve requests to the court to take certain actions

multilateral treaty an agreement among more than two nations

N National Environmental Policy Act (NEPA) a federal law that requires federal agencies to assess environmental issues before taking actions

National Labor Relations Act of 1935 (NLRA) the federal law authorizing employee unionization; it is also known as the Wagner Act

National Labor Relations Board (NLRB) the federal agency responsible for enforcing labor laws; it has 2 func- tions - to conduct union elections, and to investigate and remedy unfair labor practices

natural law a system of moral standards that forms the basis for all human conduct

negligence a conduct of omission or neglect that results in damages

negligence the conduct of omission or carelessness that results in damages

negligent failure to supervise a failure on the part of an employer to investigate or supervise the violent tendencies of an employee

negligent hiring the act of a principal or employer, hiring an agent or employee, whose background made him or her ill-suited for the position

nexus a link between people, places, and things (such as a connection between the state and the business being taxed)

Noerr–Pennington doctrine a doctrine under which com- petitors are permitted to work together for the purpose of governmental lobbying and other political action

Noise Control Act of 1972 a law which protects land- owners in flight paths, by authorizing the EPA and the FAA (Federal Aviation Administration) to control the amount of noise emissions from low-flying aircraft

nolo contendere a plea of no contest where the defendant accepts conviction but does not admit guilt

nonattainment areas the areas with existing, significant air quality problems

nonbinding arbitration preliminary step to litigation if one of the parties is not satisfied with the result in the arbitration

nonconventional pollutants that are neither conventional nor toxic (for example, chlorine and ammonia)

nonprofit corporations a type of corporation that does not seeks to earn a return for the investors; it primarily

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Glossary G-11

involves in social, educational, religious, and charitable endeavours

Norris–LaGuardia Act an act which prohibits the use of injunctions as a remedy in labor disputes

novation an agreement to change contract among all affected (for example, an agreement to substitute parties)

novation an official agreement where a new party substi- tutes another and assumes primary liability for payment

nuisances the activities of one party that interferes with the use and enjoyment of others’ properties (such as bad smells and excessive noise)

O Occupational Safety and Health Act of 1970 the federal law setting and enforcing workplace safety standards; includes 3 agencies - the Occupational Safety and Health Administration (OSHA), the Occupational Safety and Health Review Commission (OSHRC), and the National Institute for Occupational Safety and Health (NIOSH)

Occupational Safety and Health Administration (OSHA) the agency responsible for the promulgation and enforcement of workplace safety standards

Occupational Safety and Health Administration (OSHA) the agency responsible for the promulgation and enforcement of workplace safety standards

offer the first step in the formation of a contract offeree the recipient of an offer offeror the person making an offer Oil Pollution Act a federal law that imposes civil and criminal liabilities for oil spills

omnibus hearing the forum wherein all the evidentiary challenges can be presented for the judge’s ruling as to the admissibility of the evidence

open meeting law a law that requires prior public notice of meetings of those agencies with heads appointed by the president

opening statement the summaries made by the attorneys of each party, outlining what that party hopes to prove and how it will be proved

opposition proceedings a process which includes pub- lishing the description of a patent and inviting the public to study the description and possibly oppose the granting of the patent

options a contract in which the offeree pays the offeror for the time needed to consider the offer

oral argument a summary of the points that have been made in each party’s brief

ordinances laws passed by local governments to settle minor issues within their areas of control

ordinary and reasonably prudent person a person exercising a level of care that requires an examination of all conditions and circumstances surrounding an event that leads to an injury

original jurisdiction the authority of a court to hear a case for the first time

overtime pay the rate of 1½ times the hourly rate for hours over 40 per week worked

P palming off an unfair method of competition that involves causing deception about the maker or source of a product

parol evidence extrinsic evidence that is not admissible to dispute an integrated unambiguous contract

partnership by estoppel a presumption of partnership that arises by the perception of the third parties of its existence

partnership by implication the creation of a partnership by the parties’ conduct; it arises because the behaviours of the parties lead others to believe that there is a partnership

partnership association of two or more persons to carry on as co-owners of a business for profit

party autonomy a guiding principle that allows firms to operate uniformly across borders if their contracts are rec- ognized as valid in most countries

patents a type of legal monopoly over inventions, prod- ucts, and processes; it is obtained by filing certain informa- tion and forms with the U.S. Patent Office

pattern or practice of discrimination a theory based on discrimination against a group or class of persons, and not against an individual

peer review a formal grievance procedure for non-union employees in which they have the opportunity to present their cases to a panel of fellow employees and managers

per curiam it is an an unsigned opinion that comes from the majority of the court

per se in its own nature without needing any proof per se illegal behavior that is just plain illegal (such as fixing prices and monopolizing)

peremptory challenge the attorney’s private tool that excuses the juror from hearing a case

petitioner the party who appeals the lower court’s decision

picketing the public appearance of striking union members

plaintiffs the parties or petitioners who initiate a lawsuit and are seeking some type of recovery

plea bargain term used in criminal proceedings to denote settlement of criminal charges

pleadings formal statements that feature the parties’ posi- tions in a case and include the plaintiff’s complaint and the defendant’s answer

police power it is the states’ power to pass laws that pro- mote the public welfare and protect public health and safety

pooling agreement a contract among shareholders to vote their shares a certain way or for a certain director

positive law codified laws that establish the standards for ethical behaviour

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G-12 Glossary

power of attorney a form of agency relationship that grants a person authority to enter into transactions, on behalf of another

precedent the process of examining other court’s decisions for help in a new case

predatory bidding a pricing strategy where a company pays more for a product; thereby, increasing its price and preventing other competitors from acquiring enough sup- plies of the same product

predatory lending the fraudulent practices of a lender that subjects the borrower to unfair or deceptive loan terms

predatory pricing it is the pricing of products, below the actual cost, for a temporary period to drive a potential com- petitor out of business

preemption in cases where the state and local laws conflict with federal laws, the latter displaces the former

preferred stock the type of stock whose owners enjoy preferred status over holders of a corporation’s common stock

Pregnancy Discrimination Act an act which prohibits refusal to hire, promote, or fire on the basis of pregnancy and childbirth

preliminary hearing a proceeding that requires the prosecution to establish that there is some evidence that the defendant committed the crime

prevention of significant deterioration (PSD) areas the areas with existing air quality problems that are monitored to stop increased pollution

price discrimination a practice in which two goods hav- ing the same marginal cost are sold to different people at different prices

price-fixing the act of controlling the price and supply of goods, through an agreement

prima facie case the presentation of adequate evidence by the plaintiff to support a complaint or a claim and enable a verdict to be made

primary offering the sale of securities by the business in which interests are offered

principals it refers to an employer in an employer– employee relationship

private law rules and regulations developed between two individuals

privity the direct contractual relationship between parties

procedural due process it is a right that requires notice and the opportunity to be heard before rights or properties are taken away from an individual or business

procedural laws rules and regulations that must be followed to enforce substantive laws

process servers the private firms that are licensed to deliver summons

product disparagement the tort of defamation of products product market the marketplace in which consumers can purchase finished goods and services

professional corporations an entity with limited liability except for malpractice or negligence by its owners

profit corporations a type of corporation that seeks to earn a return for the investors

promissory estoppels the reliance element used to enforce otherwise unenforceable contracts

proper purpose a statement explaining the shareholder’s legitimate interest in reviewing corporate progress, financial status, and fiduciary responsibilities

prospectus a formal document explaining the offering, or any advertisement or written materials describing offering; it is required by and filed with the SEC

proximate cause the foreseeability requirement of causation proxy a common method of delegating voting authority with which the shareholders can transfer their right to vote, to another person

proxy solicitations the formal paperwork that requests an authority to vote on behalf of another

public comment period the period during which the agency accepts public comments on the proposed rules; it cannot be fewer than 30 days, as per the Administrative Procedures Act (APA)

public law a set of laws enacted by an authorized governmental body

publicly held corporations a public company whose ownership is sold to the public in several shares of stock that are freely traded in over the counter markets or on stock exchanges

puffing an opinion about the subject matter of a contract

Q qualified privileges the privileges that provide limited liability for defamation

quasi contract a theory for enforcing a contract, even though there is no formal contract, because the parties behaved as if there were a contract

quotas a system or a program which causes unlawful infringement of the rights of a majority group of employees

R ratification a voluntary recognition of an agent’s authority by the principal, after the said agent without proper author- ity, enters into a contract

ratification an official agreement which states that the corporation assumes primary liability for payment, but the incorporator still remains liable

red-herring prospectus a document submitted by a com- pany, containing a red print at the top stating that the regis- tration is not yet effective

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Glossary G-13

redirect examination after cross-examination, the plaintiff may again question the witnesses, to clarify certain statements

regional reporter the reports that contain judicial opinions from cases decided by courts

registration statement (S-1) a disclosure statement filed by the offeror with the SEC

Regulation A a shortcut method of registration for small offerings

Regulation D a set of small offering exemption rules (Rules 504, 505, and 506) which permit sales without registration

Regulatory Flexibility Act a law that requires govern- ment agencies to review regulation in order to prevent unequal economic burden on small business owners and entities

Rehabilitation Act of 1973 an act which prohibits federal contractors from discriminating against certain employ- ees (such as handicapped persons) in performing their contracts

relevant market the geographic and product market that is used to determine market power

remand if an appellate court determines the occurrence of reversible error, it sends the case back to the trial court for further proceedings

rent-a-judge a private court system in which parties may have their case heard before someone with judicial experience without waiting for the slower process of public justice

repatriation the process of converting foreign capital (earned on investments in another country) to domestic currency

request for admissions a set of statements sent by the litigator asking the adversary to admit or deny certain facts or allegations

request for production a legal request made by one party that requires the other party to produce documents and other information specified in the request

resale price maintenance manufacturer control of the price that retailers charge for the manufacturer’s product

rescission setting aside of a contract as a remedy Resource Conservation and Recovery Act of 1976 a law which controls the disposal of potentially harmful substances, and encourages resource conservation and recovery

respondent the parties or defendants who are named in the lawsuit as having committed some violation of the law or the rights of the plaintiff

respondent superior a legal doctrine which holds an employer liable for the negligent or wrongful actions of an employee acting within the scope of employment

Restatement (Second) of Contracts the general summary of the common law of contracts

Restatement of Agency a compilation of the common law of agency followed by the majority of states, in regard to the agent–principal relationship

reverses when a reversible error has been made, the appel- late court reverses the lower court’s judgement and may order a new trial

reversible error decisions that might have affected the outcome of the case or influenced the verdict passed

Revised Uniform Limited Partnership Act (RULPA) an update of the Uniform Limited Partnership act that is designed to improve the flexibility and stability of limited partnerships

Revised Uniform Partnership Act (RUPA) an update of the partnership law which defines a part- nership as “the association of two or more persons to carry on as co-owners of a business for profit forms a partnership, whether or not the persons intend to form a partnership.”

Revised Uniform Unincorporated Associations Act (RUUNAA) an act that treats unincorporated non-profit associations as entities with the ability to hold title to prop- erty and to be sued and bring suit in their names

revocation the offeror cancels offer and notifies the offeree of the termination

right-to-sue letter a certification issued by the Equal Employment Opportunity Commission (EEOC) in cases where the EEOC has not settled a complaint within 180 days from the time of its filing

right-to-work laws the federal laws that give people the right to work without having to join a union

Rivers and Harbors Act of 1899 a law which prohibits the discharge of refuse that causes interference with navigation, into rivers and harbors

Robinson–Patman Act the anti–price discrimination federal statute

Rule 10b-5 the SEC regulation on antifraud provision of the Securities Exchange Act

Rule 504 a part of Regulation D; excludes the company from the registration requirements of the federal securi- ties laws; applies to offerings of $1 million or less (within any 12-month period); applies in offerings of up to $2 million, provided the offering is registered under a state blue-sky law

Rule 505 a part of Regulation D; excludes the company from the registration requirements of the federal securities laws; covers sales of up to $5 million, provided no more than 35 non-accredited investors are involved

Rule 506 a part of Regulation D; excludes the company from the registration requirements of the federal securities laws; does not have dollar limitation, but the number and type of investors are limited

rule of reason the courts examination of vertical activ- ities to determine whether the activities help or hinder competition

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G-14 Glossary

runaway shop an act by an employer where work is relo- cated to another plant or a new plant is opened to carry the workload of the old plant; it is done with the intent of eluding state laws and union regulations

S S corporation an IRS category for corporations with flow- through characteristics in which the shareholders’ income and losses are treated like those of the partners, but the shareholders enjoy the protection of limited liability behind a corporate veil; sometimes called Subchapter S or Sub S Corporation

Safe Drinking Water Act a federal law which required the EPA to establish national standards for contaminant levels in drinking water

scheduled injuries the list of injuries suffered by workers that are described in statutes; it usually carries a percentage disability figure

scienter the knowledge that the information given is false scope of employment the time period in which the agent is doing work for the principal

search warrant a judicially issued order to examine home, business, and papers in any area in which there is an expec- tation of privacy

Section 10(b) it is one of the antifraud provisions of the 1934 act

Section 16 a portion of the 1934 act, regulating short- swing profits by officers, directors, and 10% shareholders

securities an investment in a common enterprise with profits to come from efforts of others

Securities Act of 1933 a set of federal laws regulating the initial sale of stock by businesses

Securities and Exchange Commission (SEC) the admin- istrative agency responsible for regulating the sale of securi- ties under both the 1933 and 1934 acts

Securities Exchange Act of 1934 an act which regulates securities and their issuers once they are on the market

sexual harassment a form of discrimination that involves a quid pro quo related to sexual favors or an atmosphere of harassment that creates a hostile work environment

Sherman Act the first federal antitrust law; prohibits monopolization and horizontal trade restraints such as price-fixing, boycotts, and refusals to deal

shopkeeper’s privilege a defense to torts of defamation, invasion of privacy, and false imprisonment for merchants; it allows a shopkeeper to detain a suspected shoplifter for a reasonable period of time while the matter or incident is investigated

short-swing profits the profits earned on the sale and purchase, or the purchase and sale of securities, within any six-month period

Sixth Amendment the right-to-trial protection of the U.S. Constitution; ensures that the criminal proceedings and tri- als advance in a timely fashion

slander an oral or spoken defamation made by one party to another about a third party

slander of title an untrue statement (spoken defamation) made about a business product or service

slowdown an economic tool that interrupts the employ- er’s business but falls short of a stoppage or strike

small claims court a court with limited jurisdiction where civil cases with minimal damage claims are tried

small-company doctrine a doctrine under which two small companies are permitted to merge to effectively com- pete with the larger businesses in that market

Social Security Act of 1935 the federal law establishing disability, beneficiary, and retirement benefits

sole outlet or exclusive distributorship a distributor or retailer who acts as the sole or exclusive outlet for the man- ufacturer’s product

sole proprietorship it consists of an individual who oper- ates a business

sovereign immunity a judicial doctrine that ensures the freedom of one country from being subject to orders from another country

specific performance an order of the court requiring a defendant to act as per the terms stated in a contract

standing the actual sale or purchase of a stock, based on the information provided or the lack of it

stare decisis the principle of consulting judicial decisions of the past, to pass judgments in future cases with similar facts, to ensure consistency of the law

State codes a code pertaining to each state and comprising laws passed by its legislature

state implementation plans (SIPs) the plans adopted by the states to achieve the federally developed standards for air quality and environmental standards

statutes of limitations the time limits unique to each state for filing the petition or complaint

statutory law a set of formally written laws, enacted by a legislative body

stipulated means a required means of acceptance given by the offerors

Stored Communication Act (SCA) an act that prohibits the unauthorized interception of stored electronic communi- cations such as text messages, tweets, and instant messages

strict liability an absolute liability for engaging in dan- gerous activities with risky consequences, regardless of the precautions taken

strict liability the standard of liability that requires compensation for an injury regardless of fault or prior knowledge

strict tort liability imposition of liability because of harm- ful results, regardless of the precautions taken, and from failure to provide enough warnings

strike stoppage of work because employees no longer report to work; the best-known and most widely used economic weapon of unions

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Glossary G-15

submarket the specialized geographic or economic subdi- vision of a market within a larger market

substantial evidence test a test that requires more con- vincing evidence in support of an agency’s regulation

substantial performance a performance that, for prac- tical purposes, is accepted to be nearly equivalent to a full-performance

substantive due process it is the right to have laws that do not deprive businesses or citizens of property or other rights without justification and reason

substantive law a system of laws that describes rights and responsibilities

summary jury trial a mock trial where jurors give adviso- ry verdict after hearing the summaries of evidence present- ed by the parties involved

summons a legal document issued to the defendant, by a judicial or an administrative body, to explain a lawsuit

sunset law a law which governs the continuation or termi- nation of an agency

Superfund the funds available for government use to clean up toxic waste sites

Superfund Amendment and Reauthorization Act a law which authorizes the EPA to recover clean-up funds from the parties responsible for the release of hazard- ous substances [called as potentially responsible parties (PRPs)]

superior skill, foresight, and industry the ability to build a better product or service

Supremacy Clause states that, when state and local laws conflict with federal statutes, regulations, executive orders, or treaties, the federal statute, regulation, executive order, or treaty controls the state or local law

Surface Mining and Reclamation Act of 1977 a law which requires coal companies to restore land surfaces to their original conditions; it also prohibits surface coal min- ing without a permit

T Taft–Hartley Act the federal law limiting union econom- ic-weapons; it is also known as the Labor-Management Relations Act of 1947

tender offer an offer that is publicly advertised to share- holders for the purchase of their stock

theft or embezzlement the action of an employee that expresses the intent to take the property of the employer or the actual taking of the property for permanent use without authorization from the employer

three-day cooling-off period the 72 hours immediately following execution of certain types of credit contracts during which the buyer has the right to rescind the contract

tippees the people who get non-public information from corporate insiders

Title VII a federal law which prohibits discrimination in all areas of employment, on the basis of race, color, religion, sex, or national origin

tombstone ad an ad announcing offering that can be run prior after the registration statement is filed

tort a wrongful acts that leads to legal liability toxic pollutants the toxins such as lead, mercury, and arsenic which, when released into the environment, cause adverse effects on health

Toxic Substances Control Act a federal law which autho- rizes the EPA to control or stop the manufacture, use, and disposal of toxic substances

trade dress the colors, designs, and shapes associated with a product

trade libel an untrue statement made about a business product or service in written form such as in images, print- ed words, and in other media

trade name an official name under which a company functions; it also includes unique product labels and names

trade secret the knowledge a business develops that pro- vide it a competitive edge; it is not known generally or by competitors

trademarks it includes words, names, symbols, designs, or devices that businesses use to identify their products or services

traffic courts lesser courts that are limited in their juris- diction to the trial of lesser crimes, such as violations of city ordinances

transfer restriction an agreement which restricts the part- ners or shareholders from selling their shares

treaty an agreement between or among nations on a sub- ject of international law signed by the leaders of the nations and ratified by the nations’ governing bodies

treble damages thrice the actual damages available in antitrust cases

trial court a place in the judicial system where the facts of a case are presented

trial de novo an appeal to a different tribunal for a new trial

Truth in Lending Act (TILA) a law which provides the requirements for disclosures in credit contracts and con- sumer rights when full disclosure is not made

tying sales a type of sale that requires the buyer to take an additional product in order to buy a needed product

U U.S. Constitution the supreme law of America which con- tains the entire structure of the federal government, its powers, the powers of the states, and the rights of all citizens

U.S. Department of Homeland Security (DHS) a cabinet- level agency that enforces immigration laws

U.S. Government Manual the first publication of the Federal Register System which lists all federal agencies;

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G-16 Glossary

their regional offices along with addresses; and statistics about the agencies and their sizes

U.S. Supreme Court highest court in the United States of America; requires writ of certiorari for review; acts as trial court (original jurisdiction) for suits involving states and diplomats

ultra vires a regulation that goes beyond the authority given to the agency in its enabling act

unconscionable a doctrine that describes highly unjust terms of a contract, which are in favor of a party with a greater bargaining power

unconscionable a doctrine that describes highly unjust terms of a contract, which are in favor of a party with a greater bargaining power

undue influence it occurs when one party uses a close personal relationship with another party to gain contractual benefits

unemployment compensation the federal program han- dled by states to provide temporary support for displaced workers

unenforceable contract an agreement for which the law affords no remedy

unfair labor practice a conduct by the labor or the man- agement which is prohibited by statute

Uniform Commercial Code the set of uniform laws (pertaining to states) that govern commercial transactions

Uniform Commercial Code (UCC) the set of uni- form laws (pertaining to states) that govern commercial transactions

Uniform Computer Information Transactions Act (UCITA) a law which governs all contracts involving the sale, licensing, maintenance, and support of computer software

Uniform Durable Power of Attorney Act (UDPAA) the Uniform Power of Attorney Act that enables key indi- viduals to execute a type of power of attorney that comes into existence in the event of disability or incapacity of the principal

Uniform Electronic Transactions Act (UETA) the state recognition of the Electronic Signatures in Global and National Commerce Act of 2000 (ESIGN)

uniform laws a system of laws that simplify interstate business

Uniform Limited Partnership Act (ULPA) an act designed to provide flexibility and stability to the ways lim- ited partnerships were doing business

Uniform Partnership Act (UPA) it is the law on partner- ships that is adopted in 49 states; defines a “partnership” as being a voluntary “association of 2 or more persons . . . to carry on as co-owners a business for profit.”

unilateral contract a contract in which one party issues a promise and the other party simply performs

unincorporated association it refers to a group that acts as an entity but has no legal existence as a natural or ficti- tious person

United Nations Convention on Contracts for the International Sale of Goods (CISG) a convention that is designed to provide international contracts the convenience and uniformity that the Uniform Commercial Code provides for contracts across state lines in the United States

United States Code an official compilation of the general and permanent laws of the United States of America

Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act an antiterrorism law that strengthens domestic security and increases the powers of law- enforcing government agencies, to enable the identification and prevention of terrorism; it is also known as the USA Patriot Act

universal treaties a set of widely followed standards of behaviour recognized by almost all nations

unscheduled injuries the list of injuries suffered by work- ers that are not described in statutes

USA Patriot Act an antiterrorism law that strengthens domestic security and increases the powers of law- enforcing government agencies, to enable the identification and prevention of terrorism

V venue a concept that addresses the issue of the location of the court in the system

verdict a decision that is usually made by a jury, after care- ful consideration of the facts of a case

Vertical mergers an integration of operations between firms that have a buyer-seller relationship

void contract an agreement to do something that is illegal or against public policy

void contract a contract that the courts will not honor, and neither party is obligated to perform under that agreement

voidable contract contract in which one party can choose not to honor (rejects) the contract

voidable contract contract in which one party can choose not to honor (rejects) the contract

voting trust a form of shareholder cooperation that involves the separation of legal and equitable title in shares to ensure voting of shares in one way

W Wagner Act a federal law which gives employees the right to organize and choose representatives to bargain collective- ly with their employers [also known as the National Labor Relations Act of 1935 (NLRA)]

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Glossary G-17

warrant a judicial document authorizing detention of an individual for criminal charges and for searches when there is an expectation of privacy

Water Quality Act a law which requires states to establish quality levels for the waters within their boundaries

watered shares the shares that are held by a shareholder who has not paid the par value for the shares

Wheeler-Lea Act of 1938 an act passed by the Congress, which clarified and expanded the FTC’s power by autho- rizing it to regulate “unfair and deceptive acts or practices” whenever the public is being deceived, regardless of any effects on the competition

whistle-blowers employees who report illegal conduct white-collar crime a crime committed by a person in a high position of authority (such as business and govern- ment professionals) during their tenure

Williams Act an act that regulates tender offers work product the attorney’s legal research, comments or reactions to a witness, thoughts, analysis, and case or trial strategy

Worker Adjustment and Retraining Notification Act of 1988 (WARN) the federal law requiring employers to give 60 days’ notice of plant shutdowns and layoffs

workers’ compensation the laws which provide wage benefits and medical care to victims of work-related injuries

Z zero-based budgeting a budgeting method in which the agency starts with a zero budget each year and then is required to justify all its needs for funds

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T-1

Table of Cases

800 River Road Operating Co., LLC v. National Labor Relations Board, 784 F.3d 902 (3rd Cir. 2015), 709

A A & M Records, Inc. v Napster, Inc., 239 F.3d 1004 (9th Cir. 2001), 526 A.B.&S. Auto Service, Inc. v South Shore Bank of Chicago, 962 F. Supp. 1056 (N.D. Ill. 1997), 375 AAR Airlift Group, Inc. v United States Transportation Command, 2015 WL 8215522 (D.C. 2015), 214 Accessory Overhaul Group, Inc. v Mesa Airlines, Inc., 994 F. Supp. 2d 1296 (N.D. Ga. 2014), 369 Adarand Constructors, Inc. v. Vena, 515 U.S. 200 (1995), 750 AIG, Inc. v. Greenberg, 965 A.2d 763 (Del. Ch. 2009), 618 Alco Standard Corp. v Westinghouse Elec. Corp., 206 Ga.App. 794, 426 S.E.2d 648, 650 (1992), 369 Alfieri v. Bertorelli, 813 N.W.2d 772 (Mich. App. 2012), 632 Alharbi v Beck, 62 F. Supp. 3d 202 (D. Mass. 2014), 297 Alligood v Procter & Gamble Co., 594 N.E.2d 668 (Ohio App. 1991), 409 Altria Group, Inc. v Good, 555 U.S. 70 (2008), 174 Amazon.com, Inc. v Barnes & Noble.com, 239 F.3d 1343 (Fed. Cir. 2001), 523 American Geophysical Union v Texaco Inc., 60 F.3d 913 (2nd Cir. 1995), 530 American Meat Institute v. U.S. Dept. of Agriculture, 760 F.3d 18 (D.D.C. 2014), 203 American Postal Workers Union v. Postmaster General, 781 F.2d 772 (9th Cir. 1986), 746 American Rivers v U.S. Army Corps of Engineers, 271 F. Supp. 2d 230 (D.D.C. 2003), 359 Anderson v. SeaWorld Parks and Entertainment, Inc., 2016 WL 125510 (N.D. Cal. 2016), 721 Aon Risk Services Inc. v Meadors, 267 S.W.3d 603 (Ark. App. 2007), 409 Argentine Republic v Amerada Hess Shipping Co., 488 U.S. 428 (1989), 233 Arizona Cattle Growers’ Ass’n v U.S. Fish and Wildlife, Bureau of Land Management, 273 F.3d 1229 (9th Cir. 2001), 351 Arizona v Gant, 556 U.S. 332 (2009), 281 Arthur Andersen LLP v U.S., 544 U.S. 696 (2005), 270 Aslakson v Home Sav. Ass’n, 6 U.C.C. Rep. Serv. 2d 35, 416 N.W.2d 786 (Minn. App. 1987), 371

Associated Press v Florida State University Board of Trustees, National Collegiate Athletic Ass’n v Associated Press, 18 So.3d 1201 (Fla. App. 2009), 213 Association for Molecular Pathology v Myriad Genetics, Inc., 133 S.Ct. 2107 (2013), 522 ASUS Computer Int’l v ExoTablet, Ltd., 2014 WL 3962636 (N.D. Cal. 2014), 550 Auffret v Capitales Tours, S.A., 2013 WL 1749895 (Cal. App. 2013), 97 Australian Gold, Inc. v Hatfield, 436 F.3d 1228 (10th Cir. 2006), 539 Aylward v Wal-Mart Stores, Inc., 2011 WL 2347762 (D. N.J. 2011), 573

B Babbitt v Sweet Home Chapter of Communities for a Great Oregon, 515 U.S. 687 (1995), 348 Bak-A-Lum Corp., 69 N.J. 123 (1976), 432 Barker v Lull Engineering Co., 20 Cal.3d 413, 143 Cal.Rptr. 225, 573 P.2d 443 (1978), 451 Bates v State Bar of Arizona, 433 U.S. 350 (1977), 157 Beastie Boys v Monster Energy Company, 87 F. Supp. 3d 672 (S.D.N.Y. 2015), 536 Behrens v Harrah’s Illinois Corp., 852 N.E.2d 553 (Ill. 2006), 573 Bell Atlantic v Twombly, 550 U.S. 544 (2007), 494 Bennett v Spear, 520 U.S. 154 (1997), 350 Berkeley Dev. Co. v Great Atlantic & Pacific Tea Co., 518 A.2d 790 (N.J. 1986), 517 Berman Stores Co. v Hirsh, 240 N.Y. 209 (1925), 399 Berman v Parker, 348 U.S. 26 (1954), 166 Bernina Distributors, Inc. v Bernina Sewing Machines, 646 F.2d 434 (10th Cir. 1981), 445 Bibb v Navajo Freight Lines, Inc., 359 U.S. 520 (1959), 147 Bilski v Kappos, 561 U.S. 593 (2010), 522 Bimbo Bakeries USA, Inc. v Botticella, 613 F.3d 102 (3rd Cir. 2010), 565 Blue Chip Stamp v Manor Drug Store, 421 U.S. 723 (1975), 664 Blumberg v. Ambrose, 2015 WL 5604474 (E.D. Mich. 2015), 597 BMW of North America, Inc. v Gore, 517 U.S. 559 (1996), 322 Bohle v Thompson, 8 U.C.C. Rep. Serv. 2d 897, 78 Md. App. 614, 554 A.2d 818 (1989), 371

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T-2 Table of Cases

Bolden v. Walsh Group, 2012 WL 1079898 (N.D. Ill. 2012), 738 BookLocker.com, Inc. v Amazon.com, Inc., 650 F. Supp. 2d (D. Me. 2009), 517 Borland v Sanders Lead Co., Inc., 369 So.2d 523 (Ala. 1979), 360 Bose Corporation v Consumers Union of United States, Inc., 466 U.S. 485 (1984), 544 Bosley v Wildwett.com, 310 F. Supp. 2d 914 (N.D. Ohio 2004), 308 Brady v Wal-Mart Stores, Inc., 531 F.3d 127 (2nd Cir. 2008), 764 Bragdon v Abbott, 524 U.S. 624 (1998), 759 Brancheau v. Secretary of Labor, 2011 WL 4105047 (M.D. Fla. 2011), 721 Brancheau v. Secretary of Labor, 2012 WL 1072227 (M.D. Fla. 2012), 721 Brancheau v Secretary of Labor, 2011 WL 4105047 (M.D.Fla.), 184 Brehm v. Eisner, 746 A.2d 244 (Del. 2000), 616 Brewster v Rush-Presbyterian-St. Luke’s Medical Center, 836 N.E.2d 635 (Ill. App. 2005), 573 Bridgeport Music, Inc. v Still N The Water Pub, 327 F.3d 472 (6th Cir. 2003); cert. denied 540 U.S. 948 (2003), 99 Brill v. Lante, 119 R.3d 1266 (7th Cir. 1997), 741 Brooks Peanut Co., Inc. v Great Southern Peanut, LLC, 746 S.E.2d 272 (Ga. App. 2013), 399 Bryant v Wal-Mart Stores, Inc., 417 S.E.2d 688 (Ga. App. 1992), 725 Buckley v Valeo, 424 U.S. 1 (1976), 160 Bullard v MRA Holding, LLC, 740 S.E.2d 622 (Ga. 2013), 307 Burger Chef Systems v Govro, 407 F.2d 921 (8th Cir. 1969), 589 Burlington Industries, Inc. v Ellerth, 524 U.S. 742 (1998), 739 Burlington Northern Railway/Shell Oil Co. v U.S., 556 U.S. 599 (2009), 340 Bussard v Minimed, Inc., 105 Cal.App.4th 798, 129 Cal. Rptr.2d 675 (2003), 573 Byker v. Mannes, 641 N.W.2d 210, 218 (Mich.2002), 597 Byrd v Faber, 57 Ohio St.3d 56, 565 N.E.2d 584, 587 (1991), 561

C C9 Ventures v SVC-West, L.P., 202 Cal. App.4th 1483, 136 Cal. Rptr.3d 550 (Cal. App. 2012), 387 California Institute of Technology v Hughes Communications Inc., 59 F. Supp. 3d 974 (C.D. Cal. 2014), 523 Campbell v Acuff-Rose Music, Inc., 510 U.S. 569 (1994), 531 Cantu v Central Education Agency, 884 S.W.2d 565 (Tex. App. 1994), 407 Car-Freshner Corporation v D & J Distributing and Manu- facturing, Inc. d/b/a/ Exotica Freshners, 2015 WL 3385683 (S.D.N.Y. 2015), 540

Carlill v Carbolic Smoke Ball Co., 1 Q.B. 256 (Court of Appeal, 1892), 381 Carnival Cruise Lines v Shute, 499 U.S. 585 (1991), 237 Carter v Carter Coal, 298 U.S. 238 (1936), 144 Castillo v. Caprock Pipe & Supply, Inc., 285 P.3d 1072 (N.M. App. 2012), 696 Castro v QVC Network, Inc., 139 F.3d 114 (2nd Cir. 1998), 450 Cetacean Cmty. v Bush, 386 F.3d 1169 (9th Cir. 2004), 351 Chaiken v. Employment Security Comm’n, 274 A.2d 707 (Del. 1971), 599 Champion Turf, Inc. v Rice, Papuchis Const. Co., 21 U.C.C. Rep. Serv. 2d 519, 853 S.W.2d 323 (Mo. App. 1993), 371 Chaney v Starbucks Corporation, 115 F. Supp. 3d 360 (S.D.N.Y. 2015), 312 Chao v. Hotel Oasis, Inc., 493 F.3d 26 (1st Cir. 2007), 686 Chartis Specialty Insurance Company v. U.S., 2013 WL 3803334 (N.D. Cal. 2013), 360 Chescheir v. Liberty Mutual Ins. Co., 713 F.2d 1142 (5th Cir. 1983), 732 Chevron v Republic of Ecuador, 795 F.3d 200 (D.C.C. 2015), 245 Chiarella v. United States, 445 U.S. 222 (1980), 677 Christian Legal Society Chapter of the University of California, Hastings College of the Law v Martinez, 130 S.Ct. 2971 (2010), 176 Christian Louboutin v Yves Saint Laurent America Holding, Inc. et al., 696 F.3d 206 (2nd Cir. 2012), 534 Chrysler Corp. v Brown, 441 U.S. 281 (1979), 184 Circuit City Stores, Inc. v Adams, 532 U.S. 105 (2001), 136 Citizens United v Federal Election Com’n, 558 U.S. 310 (2010), 86 Citizens United v Federal Election Commission, 558 U.S. 310 (2010), 162 City of Cincinnati v Discovery Network, Inc., 507 U.S. 410 (1993), 175 City of Columbia v Omni Outdoor Advertising, 499 U.S. 365 (1991), 502 City of Los Angeles Department of Water v. Manhart, 435 U.S. 702 (1978), 743 City of Ontario. v Quon, 560 U.S. 746 (2010), 702 Clemens v McNamee, 608 F. Supp. 2d 811 (S.D. Tex. 2009), 615 F.3d 374 (5th Cir. 2010), 564 U.S. 1052 (2011), 299 Clinton v Jones, 520 U.S. 681 (1997), 142 Cloutier v. Costco, 390 F.3d 126 (1st Cir. 2004), 749 CNH America, LLC v Champion Environmental Services, Inc., 863 F. Supp. 2d 793 (E.D.Wis., 2012), 361 College Park Pentecostal Holiness Church v General Steel Corp., 847 F. Supp. 2d 807 (D. Md. 2012), 104 Connecticut Nat’l. Bank v Trans World Airlines, Inc., 762 F. Supp. 76 (S.D.N.Y. 1991), 429 Cook v Downing, 891 P.2d 611 (Ok. Ct. App. 1995), 408 Coon v Wood, 68 F. Supp. 3d 77 (D.D.C. 2014), 589

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Table of Cases T-3

Costco Wholesale Corporation v. Johnson & Johnson Vision Care, 2015 WL 9987969 (M.D. Fla. 2015), 509 Cove Management v AFLAC, Inc., 986 N.E.2d 1206 (Ill. App. 2013), 589 Credit Suisse Securities (USA) LLC v Billing, 551 U.S. 264 (2007), 514 Croce v Bromley Corp., 623 F.2d 1084 (5th Cir. 1980), 559 CSX Transportation, Inc. v Recovery Express, Inc., 415 F. Supp. 2d 6 (D. Mass. 2006), 590 Cushman v Trans Union Corp., 115 F.3d 220 (3rd Cir. 1997), 446

D D&S Auto Parts, Inc. v Schwartz, 838 F.2d 965 (7th Cir. 1988), 291 D. E. Rogers Assoc., Inc. v Gardner-Denver Co., 718 F.2d 1431 (6th Cir. 1983), 517 Dantzler v S.P. Parks, Inc., 40 U.C.C. Rep. Serv. 2d 955, 1988 WL 131428 (E.D. Pa. 1988), 371 Daubert v Merrell Dow Pharmaceuticals, Inc., 509 U.S. 579 (1993), 128 Davis v Black, 591 N.E.2d 11 (Ohio 1991), 590 Dekofsky v Brea Range, Inc., 2001 WL 1613509 (Cal. App. 2 Dist.), 445 Denny v Ford Motor Co., 87 N.Y.2d 248, 639 N.Y.S.2d 250, 662 N.E.2d 730 (1995), 451 Dillon v Champion Jogbra, Inc., 819 A.2d 703 (Vt. 2002), 578 DirectTV, Inc. v Imburgia, 136 S.Ct. 463 [2015], 84 DirectTV, Inc. v Imburgia, 170 Cal. Rptr. 3d 190 (2014), 88 Dirks v. S.E.C., 463 U.S. 646, 103 S.Ct. 3255, 77 L.Ed.2d 911 (1983), 659 Dobbs v Wiggins, 929 N.E.2d 30 (Ill. App. 2010), 361 Dolan v City of Tigard, 512 U.S. 374 (1994), 174 Dothard v. Rawlinson case 433 U.S. 321 (1977), 738 Dow Chemical Co. v United States, 476 U.S. 1819 (1986), 280 Downey v Sharp, 51 A.3d 573 (Md. 2012), 108 Dr. Miles Medical Co. v John D. Park & Sons Co., 220 U.S. 373, 31 S.Ct. 376, 55 L.Ed. 502 (1911), 505 Dukes v. Wal-Mart Stores, 603 F.3d 571 (9th Cir. 2010), 736 Dukes v. Wal-Mart Stores, Inc., 2015 WL 3623481 (N.D. Cal. 2015), 737 Dukes v. Wal-Mart Stores, Inc., 222 F.R.D. 137 (N.D. Cal. 2014), 737 Durrett v ACT, Inc., 130 Hawaii 346 (Haw. App. 2011), 420

E E & H Cruises, Ltd. v Baker, 88 So.3d 291 (Fla. App. 2012), 100 eBay, Inc. v MercExchange, LLC, 547 U.S. 388 (2006), 524 Edgar v MITE Corp., 457 U.S. 624 (1982), 670

EEOC v. Abercrombie & Fitch Stores, Inc., 135 S.Ct. 2028 (2015), 747 EEOC v. Arabian American Oil Co., 499 U.S. 244 (1991), 761 EEOC v. Chicago Miniature Lamp Works, 947 F.2d 292 (7th Cir. 1991), 738 EEOC v. Waffle House, 534 U.S. 279 (2002), 756 EEOC v.. FAPS, Inc., 2014 WL 4798802 (D.N.J.), 738 Eldorado Tool, Division of Quamco, Inc., 325 N.L.R.B. 222 (1997), 708 Elk Grove Unified School Dist. v Newdow, 292 F.3d 597 (9th Cir. 2002) and 313 F.3d 500 (9th Cir. 2002) with en banc rehearing denied, 328 F.3d 466 (9th Cir. 2003), 83 Elli v City of Ellisville, 997 F. Supp. 2d 980 (E.D. Mo. 2014), 175 Elvig v Nintendo of America, Inc., 696 F. Supp. 2d 1207 (D. Colo. 2010), 482 Eme Homer City Generation, L.P. v EPA, 134 S.Ct. 1584 (2014), 335 Entergy Corporation v Riverkeeper, Inc., 556 U.S. 208 (2009), 337 Environmental Defense v Duke Energy, 549 U.S. 561 (2007), 334 Ernst & Ernst v. Hochfelder, 425 U.S. 185 (1978), 664 Escott v. BarChris Constr. Corp., 283 F. Supp. 643 (S.D.N.Y. 1968), 647 ESG Capital Partners II LP v. Passport Special Opportunities Master Fund LP, 2015 WL 9060982 (Ct. Chancery 2015), 602 Esposito-Hilder v SFX Broadcasting, Inc., 665 N.Y.S.2d 697 (1997), 325 Estate of Pinkham v Cargill, Inc., 55 A. 3d 1 (Me. 2012), 463 Exxon Shipping Co. v Baker, 554 U.S. 471 (2008), 322, 338, 659 Exxon Valdez v Exxon Mobil, 568 F.3d 1077 (9th Cir. 2009), 338

F F.C.C. v Fox Television Stations, Inc., 132 S.Ct. 2307 (2012), 171 Faragher v. City of Boca Raton, 524 U.S. 775 (1998), 765 Faverty v McDonald’s Restaurants of Oregon, Inc., 892 P.2d 703 (Ct. App. Or. 1995), 572 FCC v Fox Television Stations, Inc., 556 U.S. 502 (2009), 202 Fessel v Masonic Home, 17 FEP Cases 330 (Del. 1978), 765 Fingerlakes Aquaculture, LLC v Progas Welding Supply, Inc., 825 N.Y.S.2d 559 (2006), 442 Fireman’s Fund Ins. Co. v Industrial Comm’n, 579 P.2d 555 (Ariz. 1979), 725 Firemen’s Ins. Co. of Washington, D.C. v Kline & Son Cement Repair, Inc., 474 F. Supp. 2d 779 ( E.D. Va. 2007), 343 First Community Bank, N.A. v. Community Youth Center, 2010 WL 8696179 (Va. Cir. Ct. 2010), 632 First National Bank of Boston v Bellotti, 435 U.S. 765 (1978), 162

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T-4 Table of Cases

Fisher v. University of Texas at Austin, 133 S.Ct. 2411 (2013), 751 Fisher v. University of Texas at Austin, 136 S.Ct. 198 (2016) Flanagan v Consolidated Nutrition, L.C., 627 N.W.2d 573 (Iowa Ct. App. 2001), 371 Fowler v U.S., 647 F.3d 1232 (10th Cir. 2011), 575 Francis v Bridgestone Corporation, 2013 WL 5276365 (D.C. V.I. 2013), 99 Fraser v Nationwide Mut. Ins. Co., 352 F.3d 107 (3rd Cir. 2003), 293 Free Enterprise Fund v. Public Company Accounting Over- sight Board, 561 U.S. 477 (2010), 651 Friedman v Sebelius, 686 F.2d 813 (C.A.D.C. 2012), 290 Friedrichs v California Teachers Association, 136 S.Ct. 1083 (2016), 710 FTC v Superior Court Trial Lawyers Ass’n, 493 U.S. 411 (1990), 502 FTC v Ticor Title Ins. Co., 504 U.S. 621 (1992), 517 Fugett v. Security Transport Services, Inc., 147 F. Supp. 3d 1216 (D. Kan. 2015), 741

G Gacioch v Stroh Brewery Co., 396 N.W.2d 1 (Mich. 1990), 724 Galella v Onassis, 353 F. Supp. 196 (S.D.N.Y. 1972), 305 Games Workshop Limited v Chapterhouse Studios, LLC, 2012 WL 5949105 (N.D. Ill.), 133 Games Workshop Limited v Chapterhouse Studios, LLC, 2013 WL 1340559 (N.D. Ill.), 133 Gardner v Loomis Armored, Inc., 913 P.2d 377 (Wash. 1996), 590 Garon Foods, Inc. v Montieth, 2013 WL 3338292 (S.D. Ill. 2013), 566 Geddes v Mill Creek Country Club, Inc., 751 N.E.2d 1150 (Ill. 2001), 97 General Electric Co. v Joiner, 522 U.S. 136 (1997), 135 Gibbons v Ogden, 9 Wheat. 1 (1824), 149 Glaat, et al. v. Fox Searchlight Pictures, Inc., 2 F.R.D. 516 (S.D.N.Y. 2013), 685 Glassberg v Staples the Office Superstore East, Inc., 2010 WL 3924682 (E.D. N.Y. 2010), 314 Gleason v. Mesirow Financial, Inc., 118 R.3d 1134 (7th Cir. 1997), 741 Goldberg v Kelly, 397 U.S. 254 (1970), 182 Gonzalez v El Dia, Inc., 304 F.3d 63 (1st Cir. 2002), 757 Gordonsville Energy, L.P. v Virginia Electric & Power Co., 29 U.C.C. Rep. Serv. 2d 849 (Va. Cir. 1996), 371 Grand Resort Hotel v TripAdvisor, LLC, 2012 WL 3637394 (E.D. Tenn. 2012), 298 Gratz v. Bollinger, 539 U.S. 244 (2003), 751

Gray v Hudson, 2015 WL 4488143 (E.D. Mo. 2015), 95 Great A&P Tea Co., Inc. v FTC, 440 U.S. 69 (1979), 512 Green Tree Financial Corp. v Randolph, 531 U.S. 79 (2000), 104 Grogan v Gambler Corporation, 19 Misc. 3d 798 (Sup. Ct. N.Y. 2008), 322 Grutter v Bollinger, 539 U.S. 306 (2003), 751 Gupta v. Deputy Director of Div. of Employment & Training, 818 N.E.2d 217 (Mass. App. Ct. 2004), 694 Guz v Bechtel, 8 P.3d 1089 (Cal. 2000), 590 Guzel v State of Kuwait, 818 F. Supp. 6 (1993), 246

H H. J., Inc. v Northwestern Bell Telephone Co., 492 U.S. 229 (1989), 276 Hackett v City of New Britain, 477 A.2d 148 (Conn. 1984), 446 Hadley v Duke Energy Progress, 2016 WL 1071098 (E.D. N.C. 2016), 582 Ham v. Golden Nugget, Inc., 589 P.2d 173 (Nev. 1979), 633 Hammer v Dagenhart, 247 U.S. 251 (1918) Hard Candy, LLC v Hard Candy Fitness, 106 F. Supp. 3d 1231 (S.D. Fla. 2015), 92 Harley-Davidson, Inc. v Grottanelli, 164 F.3d 806 (2nd Cir. 1999), cert. denied, 531 U.S. 1103 (2001), 535 Harold Vogel v American Society of Appraisers, 744 F.2d 598 (7th Cir. 1984), 516 Harris v Thompson, 698 F.3d 609 (7th Cir. 2012), 97 Hart v Electronic Arts, Inc., 717 F.3d 141 (3rd Cir. 2013), 309 Hawaii Housing Authority v Midkiff, 467 U.S. 229, 104 S. Ct. 2321, 81 L.Ed.2d 186 (1984), 166 Hawkins v Globe Life Insurance, 105 F.Supp.3d 430 (D. N.J. 2015), 424 Hayes v Shelby Memorial Hosp., 726 F.2d 1543 (11th Cir. 1984), 765 Heart of Atlanta Motel, Inc. v U.S., 379 U.S. 241 (1964), 174 Heart of Tex. Dodge, Inc. v Star Coach, LLC, 255 Ga.App. 801, 567 S.E.2d 61, 63 (2002), 369 Heritage Hills v. Zion’s First Nat’l Bank, 601 F.2d 1023 (9th Cir. 1979), 632 Hickman v Wm. Wrigley, Jr. Co., Inc., 768 So.2d 812 (La. App. 2000), 483 Holguin v Sally’s Beauty Supply, Inc., 264 P.3d 732 (N. Mex. App. 2011), 326 Holiday CVS, L.L.C. v Holder, 493 Fed. Appx. 108 (C.A.D.C. 2012), 255 Holiday CVS, L.L.C. v Holder, 839 F. Supp. 2d 145 (D.D.C. 2012), 255 Holmes v Telecredit Service Corp., 736 F. Supp. 1289 (D. Del. 1990), 434

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Table of Cases T-5

Home Basket Co., LLC. v Pampered Chef, Ltd., 55 UCC Rep. Serv. 2d 792 (D. Kan. 2005), 392 Hopkins v. Uninsured Employers’ Fund, 251 P.3d 118 (Mont. 2011), 698 Hornbeck Offshore Services, L.L.C. et al. v Salazar, 696 F. Supp. 2d 627 (E.D. La. 2010), 200 Horne v Dept. of Agriculture, 135 S.Ct. 2419 (2015), 182 Horne v U.S. Department of Agriculture, 132 S.Ct. 2566 (2015), 170 Houston Dairy v John Hancock Mutual Life Insurance Co., 643 F.2d 1185 (5th Cir. 1981), 385 Howard v Zaney Bar, 85 A.2d 401 (Pa. 1952), 555 Hubbs v Joseph Enterprises, 604 N.Y.S.2d 292 (1993), 482 Hyatt v Regents of Board of Regents of Oklahoma Colleges, 2015 WL 52112 (W.D. Okl. 2015), 576

I Illinois Tool Works Inc. v Independent Ink, Inc., 547 U.S. 28 (2006), 510 In re 75,629 Shares of Common Stock of Trapp Family Lodge, 725 A.2d 927 (Vt. 1999), 632 In re Caremark International, Inc., 698 A.2d 959 (Del. Ch. 1996), 263 In re Gailey, Inc., 119 B.R. 504 (Bankr. W.D. Pa. 1990), 631 In re General Motors Company Derivative Litigation, 2015 WL 3958724 (Del. 2015), 265 In re New Jersey Pollutant Discharge Elimination System permit Number NJ 000544, 2015 WL 3855593 (N.J. Sup. 2015), 337 In re Sony Gaming Networks and Customer Data Security Breach Litigation, 996 F. Supp. 2d 942 (S.D. Cal. 2014), 371 In re Union Carbide Corp. Gas Plant Disaster, 809 F.2d 195 (2nd Cir. 1987); cert. denied, 484 U.S. 871 (1987), 237 Inland Steel Co. v EPA, 574 F.2d 367 (7th Cir. 1978), 337 International Ambassador Programs, Inc. v Archpexpo, 68 F.3d 337 (9th Cir. 1995), 238 International Paper Co. v Farrar, 700 P.2d 642 (N.M. 1985), 482 International Shoe v Washington, 326 U.S. 310 (1945), 90 International Union v. Johnson Controls, Inc., 499 U.S. 187 (1991), 743 Intershoe, Inc. v Bankers Trust, 571 N.E.2d 641 (N.Y 1991), 404

J J.D. Salinger v John Doe, 607 F.3d 68 (2nd Cir. 2010), 533 Jimenez v Chrysler Corporation, 269 F.3d 439 (4th Cir. 2001), 477 Johnson v James Langley Operation Co., Inc., 226 F.3d 957 (8th Cir. 2000), 343 Jones v Select Portfolio Servicing, Inc., 2016 WL 590248 (W.D. 2016), 419

K Karl’s Sales & Service, Inc. v Gimbel Brothers Inc., 249 N.J. Super. 487 (App. Div.), cert. denied 127 N.J. 548 (1991), 432 Kass v Grais, 887 N.Y.S. 2d 578 (N.Y. Div. One 2009), 391 Kassel v Consolidated Freightways Corp., 450 U.S. 662 (1981), 175 Katzenbach v McClung, 379 U.S. 294 (1964), 146 Kavakos v Nazaret Mkhsi-Gevorkian, 2015 WL 40467 (Cal. Sup. 2015), 446 Keis Distributors, Inc. v Northern Distributing Co., 641 N.Y.S. 2d 417 (App. Div. 1996), 408 Kelo v City of New London, 545 U.S. 469 (2005), 165 Klages v General Ordnance Equipment Corp., 19 UCC Rep. Serv. (Callaghan) 22 (Pa. 1976), 453 Komac v. Gordon Food Service, 3 F. Supp. 2d 850 (N.D. Ohio 1998), 765 Koontz v St. Johns River Water Management District, 133 S.Ct. 2586 (2013), 176 Kroger Co. v Walters, 735 S.E.2d 99 (Ga. App. 2012), 134 Kyllo v United States, 533 U.S. 27 (2001), 280

L Lamb v Philip Morris, Inc., 915 F.2d 1024 (6th Cir. 1990; cert. denied, 498 U.S. 1086 (1995)), 245 Land O’Lakes Purina Feed LLC v Jaeger, 976 F. Supp. 2d 1073 (S.D. Iowa 2013), 371 Lange v National Biscuit Co., 211 N.W.2d 783 (Minn. 1973), 573 LaRue v. DeWolff, Boberg & Associates, Inc., 552 U.S. 248 (2008), 693 Ledbetter v Goodyear Tire & Rubber Co., Inc., 550 U.S. 618 (2007), 730 Leegin Creative Leather Prods., Inc. v PSKS, Inc., 551 U.S. 877, 893, 127 S.Ct. 2705, 168 L.Ed.2d 623 (2007), 497 Leegin Creative Leather Products, Inc. v PSKS, Inc., 551 U.S. 877 (2007), 504 Lefkowitz v Great Minneapolis Surplus Store, 251 Minn. 188, 86 N.W.2d 689, 691 (1957), 381 Leonard v PepsiCo, 210 F.3d 88 (2d Cir. 2000), 380 Licciardi v Murphy Oil U.S.A., Ill F.3d 396 (5th Cir. 1997), 343 Litt v Portfolio Recovery Associates LLC, 146 F. Supp. 3d 857 (E.D. Mich. 2015), 435 Little Sisters of the Poor Home for the Aged, Denver, Colo. v Burwell, 794 F.3d 1151 (10th Cir. 2015), 84 Loretto v Teleprompter Manhattan CATV Corp., 458 U.S. 100 (1982), 168 Louis Vuitton Malletier S.A. v Haute Diggity Dog, LLC, 507 F.3d 252 (4th Cir. 2007), 550 Louis Vuitton Malletier v My Other Bag, Inc., 2016 WL 70026 (S.D.N.Y. 2016), 531

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T-6 Table of Cases

Lovenheim v. Iroquois Brands, Ltd., 618 F. Supp. 554 (D.C. 1985), 677 Lucas v South Carolina Coastal Council, 505 U.S. 1003 (1992), 169 Lucini Italia Co. v Grappolini, 2003 WL 1989605 (N.D. III. 2003), 562 Lyons Partnership v Giannoulas, 179 F.3d 384 (5th Cir. 1999), 549

M Mace Industries, Inc. v Paddock Pool Equipment Co., Inc., 339 S.E.2d 527 (S.C. 1986), 408 Macy’s v Martha Stewart Living Omnipedia, Inc., 127 A.D. 3d 48 (Sup. Court N.Y. 2015), 304 Magma Copper v Department of Employment Security, 625 P.2d 935 (Ariz. 1981), 724 Mangattu v M/V IBN Hayyan, 35 F.3d 205 (5th Cir. 1994), 245 Manley v Doe, 849 F. Supp. 2d 594 (E.D.N.C. 2012), 464 Mapp v Gimbels Dep’t Store, 540 A.2d 941 (Pa. 1988), 589 Margreiter v New Hotel Monteleone, 640 F.2d 508 (5th Cir. 1981), 325 Marsh Advantage America v. Orleans School Board, 995 So. 2d (La. App. 2008), 632 Marshall v Barlows, Inc., 436 U.S. 307 (1978), 689 Martin v. Freeman, 272 P.3d 1182 (Colo. App. 2012), 626 Martinez v E.I. DuPont Nemours and Company, 86 A.3d 1102 (Del. 2014), 97 Marty v Anheuser-Busch Companies, LLC, 43 F. Supp. 3d 1333 (S.D. Fla. 2014), 482 Martyszenko v Safeway, Inc., 120 F.3d 120 (8th Cir. 1997), 765 Massachusetts v EPA, 549 U.S. 497 (2007), 204 Massachusetts v EPA, 549 US 497 (2007), 334 Mathias v ACCR Economy Lodging, Inc., 347 F.3d 672 (7th Cir. 2003), 322 Mathis v State, S.E.2d 308 (Ga. 2013), 97 Matthews v. A-1, Inc., 748 F.2d 975 (5th Cir. 1984), 734 Mauna Kea Anaina HOU v Board of Land and Natural Resources, 2015 WL 7760324 (Haw. 2015), 215 McClain v Octagon Plaza, LLC, 71 Cal. Rptr.2d 885 (Cal. App. 2008), 417 McClain v Real Estate Board of New Orleans, 441 U.S. 942 (1980), 492 McConnell v Federal Election Comm’n, 540 U.S. 93 (2003), 162 McDonald v. Santa Fe Trail Transportation Co., 427 U.S. 273 (1976), 749 McDonnell Douglas Corp. v. Green, 411 U.S. 792 (1973), 731–732 McElroy .v. American Family Insurance Co., 51 F. Supp. 3d 1093 (D. Utah 2015), 741

McKennon v Nashville Banner Publishing Co., 524 U.S. 742 (1995), 753 McNeil-PPC, Inc. v Pfizer Inc., 351 F. Supp. 2d 226 (S.D.N.Y. 2005), 458 Memphis Light, Gas & Water Div. v Craft, 436 U.S. 1 (1978), 170 Metty v Shurfine Central Corp., 736 S.W.2d 527 (Mo. 1987), 462 Meyer v Holley, 537 U.S. 280 (2003), 290 Michigan v EPA, 135 S.Ct. 2699 (2015), 334 Milliken v Jacono, 60 A.3d 133 (Pa. Super. 2012), 447 Mills v Best Western Springdale, 2009 WL 1710765 (C.A. Ohio 2009), 322 Minnesota v Clover Leaf Creamery, 449 U.S. 456 (1981), 175 Miranda v Arizona, 384 U.S. 436 (1966), 284 Missouri v Seibert, 542 U.S. 600 (2004), 284 Mitchell v Reynolds, 24 Eng. Rep. 347 (1711), 487 Mogan v Cargill, Inc., 21 U.C.C. Rep. Serv. 2d 661 P.2d 973 (1993), 371 Moher v U.S., 875 F. Supp. 2d 739 (W.D. Mich. 2012), 290 Monk v. Johnson & Johnson, 2011 WL 6339824 (D. N.J. 2011), 633 Mosca v Lichtenwalter, 68 Cal. Rptr. 2d 58 (Cal. App. 1997), 326 Murnane v. American Airlines, Inc., 667 F.2d 98 (D.C. 1981), 766 Mutual Pharmaceutical Co., Inc. v Bartlett, 133 S.Ct. 2466 (2013), 154 MWI Veterinary Supply Co. v Wotton, 896 F. Supp. 2d 905 (D. Idaho 2012); 690 F.3d 1139, 78 UCC Rep.Serv.2d 36 (10th Cir. 2012), 371

N N.Y. Times Co. v Sullivan, 376 U.S. 254 (1964), 302 Nation Enterprises, Inc. v Enersyst, Inc., 749 F. Supp. 1506 (N.D. Ill. 1990), 409 National Federation of Independent Business v Sebelius, 132 S.Ct. 2566 (2012), 145 National Soc’y of Professional Engineers v United States, 435 U.S. 679 (1978), 500 Natural Resources Defense Council, Inc. v Evans, 232 F. Supp. 2d 1003 (N.D. Cal. 2002), 360 New Colt Holding Corp. v RJG Holdings of Florida, Inc., 312 F. Supp. 2d 195 (D. Conn. 2004), 483 New Jersey Schools Development Authority v Marcantuone, 54 A.3d 830 (N.J.Super. 2012), 360 New Jersey v Riley, 988 A.2d 1252 (N.J. 2009), 271 Newton v Standard Candy Co., 2008 WL 752599 (D.Neb. 2008), 463 Nguyen v. Lopez, 2015 WL 9308285 (S.D. Cal. 2015), 721 Nike, Inc. v Kasky, 539 U.S. 654 (2003), 158

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Table of Cases T-7

Nixon v Administrator of General Services, 433 U.S. 425 (1977), 142 NLRB v Laughlin Steel, 336 U.S. 460 (1940), 144 NLRB v. Noel Canning, 134 S.Ct. 2550 (2014), 142 Nollan v California Coastal Commission, 483 U.S. 825 (1987), 168 Nolte v Pearson, 994 F.2d 1311 (8th Cir. 1993), 291 North Carolina State Bd. of Dental Examiners v F.T.C., 135 S.Ct. 1101 (2015), 502 Northwest Airlines, Inc. v Goldschmidt, 645 F.2d 1309 (8th Cir. 1981), 213

O O’Connor v Consolidated Coin Caterers Corp., 517 U.S. 308 (1996), 756 Oakley, Inc. v Sunglass Hut Intern., 2001 WL 1683252, 61 U.S.P.Q.2d 1658 (C.D. Cal., Dec. 7, 2001), 523 OBB Personenverkehr A.G. v Sachs, 136 S.Ct. 390 (2015), 131 Oxford Health Plans, LLC v Sutter, 133 S.Ct. 2064 (2013), 135

P Pacific Gas & Electric v Public Utility Commission of Califor- nia, 475 U.S. 1 (1986), 175 Palmer v BRG of Georgia, Inc., 498 U.S. 46 (1990), 501 Palsgraf v Long Island Ry. Co., 162 N.E. 99 (N.Y. 1928), 317 Paramount Contracting Co. v DPS Industries, Inc., 709 S.E.2d 288 (Ga.App. 2011), 371 Patch v Hillerich & Bradsby Co., 257 P.3d 383 (Mont. 2011), 482 Pattern Makers’ League of North America, AFL-CIO v. NLRB, 473 U.S. 95 (1985), 709 Paulsen v CSC Holdings, LLC, ____ F. Supp. 3d ____, 2016 WL 951535 (E.D.N.Y. 2016), 705 Pavlidis v. New England Patriots Football Club, 737 F.2d 1227 (1st Cir. 1984), 677 Pegues v Wal-Mart Stores, Inc., 63 F. Supp. 3d 539 (D. Md. 2014), 305 Pennsylvania Coal v Mahon, 260 U.S. 393 (1922), 168 Penry v. Federal Home Loan Bank of Topeka, 970 F. Supp. 833 (D. Kan. 1997), 741 People v Aleynikov, 15 N.Y.S.2d 587 (2015), 273 People v Lewie, 953 N.E.2d 760 (N.Y. 2011), 97 People v M & H Used Auto Parts & Cars, Inc., 22 A.D.3d 135, 799 N.Y.S.2d 784 (2005), 265 People v Westbrook, 576 N.Y.S.2d 372 (N.Y. App. Div. 1991), 97 PepsiCo, Inc. v Redmond, 54 F.3d 1262 (7th Cir. 1995), 565 Peterson v The Sunrider Corp., 48 P.3d 918 (Utah 2002), 422 PGA Tour, Inc. v. Martin, 531 U.S. 1049 (2001), 759 Pike v Bruce Church, Inc., 397 U.S. 137 (1970), 174 Pittsley v Houser, 875 P.2d 232 (Idaho 1994), 407

Playboy Enterprise, Inc. v Netscape Communications, 354 F.3d 1020 (9th Cir. 2004), 539 Poel v Brunswick-Balke-Collender Co., 216 N.Y. 310, 314 (1915), 399 Pope v. Triangle Chemical Co., 277 S.E.2d 758 (Ga. 1981), 600 Princeton University Press v Michigan Document Services, Inc., 99 F.3d 1381 (6th Cir. 1996), 530 Procter & Gamble Co. v Nabisco Brands, Inc., 604 F. Supp. 1485 (D.C. Del. 1985), 524 Pro-Football, Inc. v Blackhorse, 112 F. Supp. 3d 439 (E.D. Va. 2015), 539 Pulte Home Corporation v Simerly, 746 S.E.2d 173 (Ga. App. 2013), 122

Q Quill Corp. v N.D. ex rel. Heitkamp, 504 U.S. 298 (1992), 150

R R.J. Reynolds Tobacco Company, et al. v FDA et al., 696 F.3d 1205 (D.C. Cir. 2012), 203 Randi W. v Muroc Joint Unified School District, 929 P.2d 582 (Cal. 1997), 299 Raymond Motor Transportation v Rice, 434 U.S. 429 (1978), 147 Reckis v Johnson & Johnson, 28 N.E.3d 445 (Mass. 2015), 155 Redner’s Markets, Inc. v Joppatowne G.P. Ltd. Partnership, 918 F.Supp. 2d 428 (D. Md. 2013), affirmed 594 Fed. Appx. 798 (4th Cir. 2014), 488 Reed v King, 193 Cal. Rptr. 130 (1983), 416 Reves v Ernst & Young, 507 U.S. 170 (1993), 276 Reves v. Ernst & Young, 494 U.S. 56 (1990), 676 Reyes v Pharma Chemie, Inc., 890 F. Supp. 2d 1147 (D. Neb. 2012), 766 Rhodes v Detroit Medical Center, 2006 WL 355249 (C.A. Mich. 2006), 325 Rhodes v Guiberson Oil Tools (subsidiary of Dresser), 75 F.3d 989 (5th Cir. 1996), 765 Ricci v. DeStefano, 557 U.S. 557 (2009), 735 Robert’s Waikiki U-Drive v Budget Rent-a-Car, 732 F.2d 1403 (9th Cir. 1984), 517 Robinson v Shell Oil Co., 519 U.S. 337 (1997), 301 Rogers v. American Airlines, Inc., 527 F. Supp. 229 (S.D.N.Y. 1981), 766 Rooney v Com., 500 S.E.2d 830 (Va. App. 1998), 290 Roquet v. Arthur Andersen LLP, 398 F.3d 585 (7th Cir. 2005), 714 Rosenfeld v Basquiat, 78 F.3d 84 (2d Cir. 1996), 398 Rosenstern v Allergan, Inc., 987 F. Supp. 2d 795 (N.D. Ill. 2013)], 466 Rothbaum v Samsung Telecommunications America LLC, 52 F. Supp. 3d 185 (D.Mass. 2014), 461

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T-8 Table of Cases

Rowe v New Hampshire Motor Transport, Ass’n 552 U.S. 364 (2008), 148 Russell Stover Candies, Inc. v FTC, 718 F.2d 256 (8th Cir. 1982), 517 Ruvolo v Homovich, 778 N.E.2d 661 (Ohio App. 2002), 482

S S.E.C. v. Certain Unknown Traders in Securities of H.J. Heinz Co., 2013 WL 1174139 (S.D.N.Y.), 673 Saarela v Hoglund, 198 Ill.App. 485 (Ill. App. 1 Dist. 1916), 367 Sabritas v U.S., 998 F. Supp. 1123 (Ct. Int’l Trade 1998), 241 San Diego Air Sports Center, Inc. v Federal Aviation Admin- istration, 887 F.2d 966 (9th Cir. 1989), 214 San Francisco Arts & Athletics, Inc. v United States Olympic Committee, 483 U.S. 522 (1987), 535 Sansotta v Town of Nags Head, 97 F. Supp. 3d 713 (E.D. N.C. 2014), 82 Santos v Cuba Tropical, Inc., 829 F. Supp. 2d 1304 (S.D. Fla. 2011), 725 Saturday v Cleveland Board of Review, 33 N.E.2d 46 (Ohio 2015), 152 Sayre v Moore, 102 Eng. Rep. 138, 140 (1785), 521 Schaeffer v Gregory Village Partners, L.P., 78 F. Supp. 3d 1198 (N.D. Cal. 2015), 78 Schechter Poultry v United States, 295 U.S. 495 (1935), 144 Schmidt v Prince George’s Hospital, 366 Md. 535, 784 A.2d 1112 (2001), 413 School Board of Nassau County v. Arline, 480 U.S. 273 (1987), 758 Schooner Exchange v McFaddon, 7 Cr. 116 (1812), 232 Schulze and Burch Biscuit Co. v Tree Top, Inc., 831 F.2d 709 (7th Cir. 1987), 389 Scoggin v Listerhill Employees Credit Union, 658 So.2d 376, 377 (Ala.1995), 470 SeaWorld of Florida, LLC v, Perez, 748 F.3d 1202 (D.C. Cir. 2014), 721 SEC v Texas Gulf Sulphur Co., 401 F.2d 833 (2nd Cir. 1968), 657 SEC v W. J. Howey Co., 328 U.S. 293 (1946), 636 SEC v. Edwards, 540 U.S. 389 (2004) SEC v. Mervyn Cooper and Kenneth E. Rottenberg, No. 95-8535 (C.D. Cal. 1995), 676 Seiber v U.S., 364 F.3d 1356 (4th Cir. 2004), cert. denied, 543 U.S. 873 (2004), 351 Semler v General Electric Capital Corporation, 196 Cal. App. 4th 1380 (2011), 408 Sharp v Downey, 13 A.3d 1 (Md. App. 2010), 108 Shea v. Kerry, 796 F.3d 42 (D.D.C. 2015), 750 Shlensky v. Wrigley, 237 N.E. 2d 776 (Ill. 1968), 617 Sierra Club v United States Dep’t of Transportation, 753 F.2d 120 (D.C. 1985), 345 Silva v Bisbee, 628 P.2d 214 (Haw. App. 1981), 590

Simon & Schuster, Inc. v Members of the New York State Crime Victims Board, 502 U.S. 105 (1991), 158 Simulados Software, Ltd. v Photon Infotech Private, Ltd., 40 F. Supp. 3d 1191(N.D. Cal. 2014), 371 Sindell v Abbott Lab., 607 P.2d 924 (Cal. 1980), 473 Sioux Transportation, Inc. v XPO Logistics, LLC, 2015 WL 9412930 (D. Ark. 2015), 95 Siracusano v. Matrixx Initiatives, Inc., 563 U.S. 27 (2011), 656 Skilling v U.S., 561 U.S. 358 (2010), 88 Smith v Coleman Co., 71 UCC Rep.Serv.2d 131 (M.D. Ala. 2010), 469 Smith v E-Backgroundchecks.com, Inc., 81 F. Supp. 3d 1342 (N.D.Ga. 2015), 439 Snider v Hopkins, 334 S.E.2d 776 (N.C. 1985), 411 Solis v. Laurelbrook Sanitarium and School, Inc., 642 F.3d 518 (6th Cir. 2011), 685 Sons of Thunder, Inc. v Borden, Inc., 690 A.2d 575 (N.J. 1997), 430 Sony BMG Music Entertainment v Tenenbaum, 660 F.3d 487 (1st. Cir. 2011), 526 Spur Industries, Inc. v Del E. Webb Dev. Co., 494 P.2d 700 (Ariz. 1972), 330 St. Tammany Parish Tax Collector v Barnesandnoble.com, 481 F. Supp. 2d 575, 582 (E.D.La. 2007), 151 Stangvik v Shiley, Inc., 819 P.2d 14 (Cal. 1991), 96 State Farm Mutual Auto Insurance Co. v Campbell, 538 U.S. 408 (2003), 322 State Oil Co. v Khan 522 U.S. 3 (1997), 504 State v Cardwell, 38 U.C.C. Rep. Serv. 2d 1158, 718 A.2d 954 (1998), 371 Stevens-Henager College v Eagle Gate College, 248 P.3d 1025 (Utah 2011), 35 Stewart v Abend, 495 U.S. 207 (1990), 551 Stonebridge Investment Partners, LLC v. Scientific-American, Inc., 552 U.S.148 (2008), 662 Sulphuric Acid Trading Co., Inc. v Greenwich Ins. Co., 211 S.W.3d 243 (Tenn. App. 2006), 343 Summers v Earthland Institute, 555 U.S. 488 (2009), 350 Sunbeam Products, Inc. v DeLonghi America, Inc., Not Reported in F. Supp. 2d, 2007 WL 1321134 (D.N.J.), 482 Sununu v Philippine Airlines, Inc., 792 F. Supp. 2d 39 (D. D.C. 2011), 396 Systems and Software, Inc. v Barnes, 886 A.2d 762, (Vt. 2005), 518

T In re Tam, 808 F.3d 1321 (Fed. Cir. 2015), 539 Taxman v. Board of Education of Piscataway [91 F.3d 1547 (3rd Cir. 1996); cert. granted, 521 U.S. 1117 (1997); cert. dismissed, 522 U.S. 1010 (1997)], 751

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Table of Cases T-9

Tennessee v Smith, 418 S.W.2d 38 (Tenn. 2013), 130 Textile Workers Union v Darlington Manufacturing Co., 380 U.S. 263 (1965), 713 The Landings Assoc. Inc. v Williams, 728 S.E.2d 577 (Ga. 2012), 320 Thomas v Staples, Inc., 2 F. Supp. 3d 647 (E.D. Pa. 2014), 475 Thomas v Weatherguard Construction Company, Inc., 42 N.E.3d 21 (Ill. App. 2015), 559 Tiffany and Company v Andrew, 2012 WL 5451259 (S.D.N.Y.), 239 TK Power, Inc. v Textron, Inc., 433 F. Supp. 2d 1058 (N.D. Cal. 2006), 371 Toftoy v Rosenwinkel, 983 N.E.2d 463 (Ill. 2012), 362 Toys “R” Us, Inc. v FTC, 221 F.2d 928 (7th Cir. 2000), 507 Trans World Airlines, Inc. v. Hardison, 432 U.S. 63 (1977), 746 Trinity Street v. Wal-Mart Stores, Inc., 2015 WL 1905766 (3rd Cir. 2015), 668 TruGreen Companies, LLC v Mower Brothers, Inc., 199 P.3d 929 (Utah 2008), 565 Trump v O’Brien, 29 A.3d 1090 (N.J. Super. 2011), 302 Two Pesos, Inc. v Taco Cabana, Inc., 505 U.S. 763 (1992), 538

U U.S. ex rel. Harman v Trinity Industries, Inc., 2014 WL 47258 (E.D. Tex. 2014), 472 U.S. ex rel. Harman v Trinity Industries, Inc., 2015 WL 7587869 (E.D. Tex. 2015), 472 U.S. v Aleynikov, 676 F.3d 71 (2nd Cir. 2012), 273 U.S. v Apple, Inc., 791 F.3d 290 (2nd Cir. 2015) settlement affirmed, 649 Fed.Appx. 724 (2nd Cir. 2016); cert. denied 136 S.Ct. 1376 (2016), 496 U.S. v Booker, 543 U.S. 220 (2005), 262 U.S. v Broderick Investment Co., 200 F.3d 679 (10th Cir. 1999), 343 U.S. v Citgo Petroleum Corp.801 F.3d 477 (5th Cir. 2015), 353 U.S. v Ebbers, 549 U.S. 1274 (2007), 268 U.S. v Fokker Services B.V., 79 F. Supp. 2d 160 (D.D.C. 2015), 260 U.S. v Garrido, 713 F.3d 985 (9th Cir. 2013), 191 U.S. v General Elec. Co., 670 F.3d 377 (1st Cir. 2012), 342 U.S. v General Elec. Co., 869 F. Supp. 1285 (1994), 500 U.S. v Giffen, 326 F. Supp. 2d 497 (S.D.N.Y. 2004), 245 U.S. v Kay, 359 F.3d 738 (5th Cir. 2004), 230 U.S. v Lopez, 514 U.S. 564 (1995), 144 U.S. v Lori Drew, 259 F.R.D. 449 (C.D. Cal. 2009), 293 U.S. v McNair, 605 F.3d 1152 (11th Cir. 2010), 191 U.S. v Microsoft, 253 F.3d 34 (C.A.D.C. 2001), 494 U.S. v Morrison, 529 U.S. 598 (2000), 144 U.S. v Parra, 402 F.3d 752 (7th Cir. 2005), 128 U.S. v Patel, 949 F. Supp. 2d 642 (W.D. Va. 2013), 276

U.S. v Sun-Diamond Growers of California 526 U.S. 398 (1999), 191 U.S. v Unser, 165 F.3d 755 (10th Cir. 1999), 291 U.S. v Welch, 327 F.3d 1081 (10th Cir. 2003), 244 U.S. v Wiesenfield Warehouse Co., 376 U.S. 86 (1964), 254 U.S. v. Bestfoods, Inc., 524 U.S. 51 (1998), 612 U.S. v. Katakis, 800 F.3d 1017 (9th Cir. 2015), 11 U.S. v. King, 509 F.3d 1338 (11th Cir. 2007), 282 U.S. v. Medina, 158 F. Supp. 3d 1303 (S.D. Fla. 2015), 280 U.S. v. Newman, 773 F.3d438 (2nd Cir. 2014), cert. denied, 136 S. Ct. 242 (2015), 659 U.S. v. Salman, 792 F.3d 1087 (9th Cir. 2015), 659 U.S. v Stewart, 317 F. Supp. 2d 432 (S.D.N.Y.2004), 135 Ungar v Dunkin’ Donuts of Am., Inc., 531 F.2d 1211 (3rd Cir. 1976), 511 Union Bank v. Jones, 411 A.2d 1338 (Vt. 1980), 632 United Food and Commercial Workers Union Local 24 .v NLRB, 506 F.3d 1078 (D.C. Cir. 2007), 706 United Roasters, Inc. v Colgate-Palmolive Co., 649 F.2d 985 (4th Cir.), cert. denied, 454 U.S. 1054, 102 S.Ct. 599, 70 L.Ed.2d 590 (1981), 431 United States ex rel. TVA v Powelson, 319 U.S. 266 (1943), 169 United States ex rel. TVA v Welch, 327 U.S. 546 (1946), 165 United States v Allegheny Bottling Co., 695 F.Supp.856 (E.D. Va. 1988), cert. denied, 493 U.S. 817 (1989), 259 United States v Apple Inc., 952 F. Supp. 2d 638, 647 (S.D.N.Y.2013), 497 United States v Automobile Workers, 352 U.S. 567 (1957), 160 United States v Bestfoods, 528 U.S. 810 (1999), 341 United States v Dotterweich, 320 U.S. 277 (1943), 254 United States v Miller, 317 U.S. 369 (1943), 169 United States v Park, 421 U.S. 658 (1975), 253 United States v Tunnell, 667 F.2d 1182 (5th Cir. 1982), 291 United States v Von’s Grocery Co., 384 U.S. 270 (1966), 503 United States v. O’Hagan, 521 U.S. 657 (1997), 676 University of Pennsylvania v. EEOC, 493 U.S. 182 (1990), 755

V Van Horn v Watson, 197 P.3d 164 (Cal. 2008), 310 Viacom International, Inc. v YouTube, Inc., 676 F.3d 19 (2nd Cir. 2012), 530 Village of Euclid, Ohio v Ambler Realty Co., 272 U.S. 365 (1926), 168 Virginia State Board of Pharmacy v Virginia Citizens Con- sumer Council, Inc., 425 U.S. 748 (1976), 156 Vrabel v. Acri, 103 N.E.2d 564 (Ohio 1952), 600

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T-10 Table of Cases

W Walling v. Portland Terminal Co., 330 U.S. 148 (1947), 685 Wal-Mart Stores, Inc. v. Dukes, 564 U.S. 338 (2011), 737 Wal-Mart v Samara, 529 U.S. 205 (2000), 538 Wandering Dago, Inc. v Destito, 2016 WL 843374 (N.D. N.Y. 2016), 539 Warner-Lambert Co. v FTC, 562 F.2d 749 (D.C. Cir. 1977), cert. den. 435 U.S. 950 (1978), 454 Weil v Murray, 161 F. Supp. 2d 250, 44 U.C.C. Rep. Serv. 2d 482 (S.D. N.Y. 2001), 371 Weyerhaeuser v Ross-Simons, 549 U.S. 312 (2007), 508 Whirlpool Corporation v Marshall, 445 U.S. 1 (1980), 689 White v. White, 781 A.2d 85 (Ch. Div. 2001), 272 Whitlow v Good Samaritan Hosp., 536 N.E.2d 659 (Ohio 1987), 589 Wilderness Society v U.S. Forest Service, 850 F. Supp. 2d 1144 (D. Idaho 2012), 361 Wilkie v Robbins, 551 U.S. 537 (2007), 276 Wilkow v Forbes, Inc., 241 F.3d 552 (7th Cir. 2001), 298 Wimberly v. Labor and Industrial Relations Comm’n of Missouri, 479 U.S. 511 (1987), 694 Winfield v. Babylon Beauty School of Smithtown Inc., 89 F. Supp. 3d 556 (E.D.N.Y. 2015), 685 Winter v National Resources Defense Council, 555 U.S. 7 (2008), 345

Winter v Santa Monica Family YMCA, 2005 WL 1713936 (Cal. App. 2 Dist.), 321 Wirth v. Mars, 2016 WL 471234 (C.D. Cal.), 721 Wixon Jewelers, Inc. v Di-Star, Ltd., 218 F.3d 913, 42 U.C.C. Rep. Serv. 2d 94 (8th Cir. 2000), 371 Wyeth v Levine, 555 U.S. 555 (2009), 175 Wyman v Ayer Properties, 11 N.E.3d 1074 (Mass. 2014), 88 Wyoming v U.S. Dept. of Interior, 674 F.3d 1220 (10th Cir. 2014), 205

Y Yale Diagnostic Radiology v Estate of Fountain, 838 A.2d 179 (Conn. 2003), 412 Yankee Candle Co., Inc. v Bridgewater Candle Co., LLC, 259 F.3d 25 (1st Cir. 2001), 549 Yates v. U.S. 135 S.Ct. 1074 (2015), 8 Young v Schmucker, 409 B.R. 477 (N.D. Ind. 2008), 22 In re Yukos Oil Company Securities Litigation, 2006 WL 3026024 (S.D.N.Y.), 233

Z Z&Z Leasing, Inc. v Graying Reel, Inc., 873 F. Supp. 51 (E.D. Mich. 1995), 360

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T-11

Table of Products, People, and Companies

A A-1, Inc., 734 AAR Airlift Group, Inc., 214 Abbott Lab., 473 Abercrombie & Fitch Stores, Inc.,

747–748 Abramoff, Jack, 212 A.B.&S. Auto Service, Inc. (AB&S),

375–376 Accessory Overhaul Group, Inc. (AOG),

369–370 Acme Markets, Inc., 253–254 Acne-Statin, 208 ACT, Inc., 420–421 Acuff-Rose Music, Inc., 531 Adarand Constructors, Inc., 750 A & D Café, 550 Adelphia, 255 Adidas, 495 Ad.ly, 457 Aerojet-General Corp., 612 AFLAC, 588–589 Agema Thermovision, 280 Agriprocessors, Inc., 717–718 AgriStar, 718 AIG, Inc., 618 Alcoa, 432 Alcon, 509 Alco Standard Corp., 369 Alito, Samuel, 142, 154–155 Allegheny Bottling Co., 259 Allergan, Inc., 466 All Fresh, 489 Alliance Bank, 381 Allstate Insurance Company, 301 Aloha Airlines, 517 Altman, Robert, 585 Altria Group, Inc., 174 Amazon.com, 108, 151, 153, 159, 305,

331, 487, 497–499, 501, 503, 516–517, 523, 565

AMC Networks, 615 Amerada Hess Shipping Co., 233 American Airlines, 668, 766 American Express (Amex), 446, 621 American Family Insurance Co., 741 American Forest and Paper

Association, 350 American Geophysical Union, 530 American Law Institute (ALI), 467 American Management Systems, 761 American Postal Workers Union, 746 American Ri, Inc. (ARI), 230 American Rivers, 359 American Society of Appraisers, 516

American Telephone and Telegraph (AT&T), 515

America Online, 259 Amish Farmer’s Market, 488–490 Andersen, Arthur, 662 Anheuser–Busch Companies,

LLC, 482 Aon Corporation, 409 Aon Risk Services, Inc. (ARS

Arkansas), 409 A&P, 512, 517 Apple, Inc., 35, 221, 487, 495, 496–499,

501, 503, 522, 533, 719, 720 Applegate, 135 Aramony, William, 38 Archer Daniels Midland, 514 Archpexpo, 238 Arco, 50 ARI Overland Management LLC., 408 Aristotle, 3 Arizona, 632 Arizona Cattle Growers’ Association

(ACGA), 351 Arkansas Sewing, 129 Armstrong, Lance, 39, 383 Arthur Andersen, 123, 270 Arthur Murray Dance Studios, 114,

568–569 Arthur Young & Co., 276 Asia Pacific Resources International

Holdings, Ltd. (April), 352 Associated Press (AP), 213, 325 Association for Molecular

Pathology, 522 AstraZeneca, 250 ASUS Computer Int’l, 550 Atchison, Topeka & Santa Fe railway

Company, 340 Atlanta Hartsfield–Jackson International

Airport, 370 Atlantic East Airlines, 135 AT&T, 69, 161, 461 Australian Gold, Inc., 539 Avon, 25, 230

B Babbitt, Bruce, 348–350 Babylon Beauty School of Smithtown

Inc., 685 Bachetti Brothers Market, 259 Backman, Paul, 69 Backwash.com, 550 Bacon, Kevin, 673 Bak-A-Lum Corp., 432 Baker, James, 357

Baker, Patricia, 100 Baldwin, Stephen, 628 Balsley, Catherine, 308 Banadex, 277–279 Bankers Trust, 404–405 Bank of China (“BOC”), 239 Bank of New York, 259 BarChris Constr. Corp., 647–650 Barings Bank, 246 Barlows, Inc., 689 Barnes, Fred, 324 Barnesandnoble.com LLC, 150–151 Barnes & Noble, 517, 523 Bartlett, Karen, 154–155 Baskins, Ann, 42 Basquiat, Jean-Michel, 398–399 Bass Pro, 495 B.A.T Industries, 244 BCCI, 585 Beal, Mark, 392 Bear Stearns, 284 Beastie Boys, 536–538 Beatles, 54 Bechtel Corporation, 590 Beck, Glenn, 297 Beiler’s Baked Goods, 490 Beiler’s BBQ, 490 Bell Atlantic, 494 Belnick, Mark, 135 Belvi Coffee and Tea Exchange, 494 Benetton, 719 Bennett, Tony, 54–55 Berkeley Dev. Co., 517 Berman Stores Co., 399 Bernina Sewing Machines, 445 Best Buy, 620 Bestfoods, Inc., 341, 612–613 Bigelow, Kathryn, 157 Bimbo Bakeries USA, Inc., 565 Bisbee, Bernice, 590 Bishop, Amy, 301 Black, Conrad, 256 Black Bear Monster Roastery, 550 Blackstone, Sir William, 3 Blagojevich, Rod, 25 Blanchard, Kenneth, 37 Blankfein, Lloyd, 635 Blodgett, Henry, 260 Blue Chip Stamp, 664 Blue Cross Blue Shield, 59, 259 BMW of North America, Inc., 322 Board of Education of Piscataway, 751 Boeing, 69, 259, 447, 620, 725 Boesky, Ivan, 45, 255, 664 Bollenbach, Stephen, 616 Bonds, Barry, 21

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T-12 Table of Products, People, and Companies

Bono, Sonny, 529 Booker, Wayne, 430 Booklocker, Inc., 516 BookLocker.com, Inc., 517 BookSurge, 517 Borden, Inc., 430–432 Bose Corporation, 296, 544–545 Boston Marathon, 32 BP, 52–53, 200, 338, 357–358, 628 Bradley, Bill, 29 Brancheau, Dawn, 184, 206, 721–723 Brea Range, Inc., 445 Brennan, Edward, 415 Breyer, Stephen, 148–149 BRG of Georgia, Inc. (BRG), 501 Bridgeport Music, 99 Bridgestone Corporation, 99 Bridgewater Candle Company, 549 Bristol-Myers Squibb, 230, 259 British Airways, 518 British Royal Navy, 224 Broadcast Music, Inc. (BMI), 529 Broderick Investment Co., 343 Brokaw, Tom, 298 Bronte, Jane, 570 Brooks Peanut Co., Inc., 399–401 Brown, Michael, 295 Brown & Bryant, Inc. (B & B), 329, 340 Browne, Lord, 357 Bruce Church, Inc., 174 Brunswick-Balke-Collender Co., 399 Bryant, Kobe, 127 Budget Rent-a-Car, 517 Buffett, Warren, 38 Bullard, Lindsay, 307–308 Bums, Timothy, 602 Burger, Warren Earl, 254 Burger Chef Systems, 589 Burger King, 38, 221, 295, 362 Burity, Tarcisio, 66 Burlington Industries, Inc., 739–741 Burlington Northern Railway/Shell Oil

Co., 340–341 Bush, George H. W., 396 Bush, George W., 324

C C9 Ventures, 387–388 C. A. Cigarrera Bigott, 245 California Institute of Technology, 523 California Teachers Association, 710 Cal Tech, 214 Capra, Frank, 550 Caprock Pipe & Supply, Inc., 696 Carbolic Smoke Ball Co., 381 Car-Freshener Corporation, 540 Cargill, Inc., 462, 463 Carnegie, Andrew, 487 Caterpillar, 221 CBS, 57, 325, 444, 615 CDnow, Inc., 454 Central Credit Collection Agency, 434 Central Education Agency, 407 Cetacean Society International, 360

CFA Institute, 25 Champion Jogbra, Inc., 578–580 Chaney, John, 295, 312–314 Chanos, George, 89 Chapterhouse, 133 Chartis Specialty Insurance

Company, 360 Chase Manhattan Bank, 446 Chavez, Benjamin, 562 Chenault, Kenneth, 621 Chevron, 245 Chiarella, Vincent, 677 Chiasson, Anthony, 661 Chicago Miniature Lamp Works, 738 Chicago National League Ball Club, Inc.,

617–618 Children’s Foundation of Caracas,

Venezuela, 245 China Merchants Bank (“CMB”)

(“Banks”), 239 Chipotle, 483 Chiquita, 277–279 Christian Louboutin, 534 Christie’s International, 517–518 Chrysler Corporation, 184, 477–478,

586–587, 692 Church of Body Modification, 749 Circuit City Stores, Inc., 136 Cisco Systems, 713 Citgo Petroleum Corp., 353–355 Citibank Visa, 446 Citigroup, 635

health care, 659 Citizens United, 162–164 City of Boca Raton, 765 City of Columbia, 502 City of Los Angeles Department of

Water, 743 City of Ontario, 702–704 Clapper’s manufacturer, 482 Clark, Marcia, 159 Clarks, 495 Clarkson, Inc., 677 Clemens, Roger, 299 Clifford, Clark, 585 Clinton, Hillary, 162–163 Clinton, William J. “Bill,”, 142 Clover Leaf Creamery, 175 CNH, 361 CNN, 206 Coca-Cola, 33, 259, 630, 666 Cochran, Johnnie, 159 Coffee Bean & Tea Leaf Co., 550 Cohen, Laurie P., 136 Coleman Co., 469–471 Cole-Rivera, Mariana, 705 Colgate-Palmolive Co., 431 College Park Pentecostal Holiness

Church, 104–106 Columbia Sportswear Co., 495 Community Youth Center (CYC)

corporation, 632 ConAgra, 287 Condé Nast, 685 ConEd, 259

Connecticut National Bank, 429 Consolidated Coin Caterers Corp., 756 Consumers Union of United States, Inc.,

296, 544–545 Continental Baking Co., 512 Contogouris, Spyridon, 628 Converse, 543 Cookie Monster, 172–173 Cooking, Inc., 100 Coors Brewing Company, 160 Corning Glass Works, 54 Cosmetic Ideas, Inc., 550 Costco, 509 Costner, Kevin, 628 Countrywide, 215 Cousteau, Jean-Michael, 360 Cove Management, 588–589 CPC International, Inc., 612–613 Credit Suisse Securities (USA)

LLC, 514 Croce, Jim, 559 Cruz, Lydia, 705 CSX Transportation, Inc., 590 Cuban, Mark, 663 Cuba Tropical, Inc., 725 Cumulus Broadcasting, 373 Cuomo, Andrew, 100 Curley, Tim, 591, 701 Cyberbunker, 273

D Dago, Inc., 539 Dallas Mavericks, 663 Darden, Christopher, 159 Darden Industries, 110 Darlington Manufacturing Co., 713 Dart Transit Company, 439–440 Data barns, 331–332 DeBeers, 500, 545 Deemer, Virgil, 724 Deepwater Horizon, 353 Del E. Webb Dev. Co., 330–331 Dell, 660 DeLonghi America, Inc., 482 Delta Air Lines, 70 Denizen, 546 Denomme, Tom, 478 Department 56, 507–508 Depp, Johnny, 224 Deputy Director of Div. of Employment &

Training, 694 D. E. Rogers Assoc., Inc., 517 Dershowitz, Alan, 159 de Tocqueville, Alexis, 103 Detroit Medical Center, 325 Devaney, Earl, 212 Dewey LeBeouf, 112 DeWolff, Boberg & Associates, Inc., 693 Diamond Match Co., 54 DiDomenico, Michael, 589 Dillard’s, 111 Dillard’s Department Stores, 409 Diller, Barry, 45 Dillon, Linda, 578–580

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Table of Products, People, and Companies T-13

Dimon, Jamie, 621 Dingell, John, 478 Dirks, Raymond, 659–660 Discovery Communications, 615 Discovery Network, Inc., 175 Disney, 615, 616–617 Disney World, 69 D & J Distributing and Manufacturing,

Inc., 540 Dodd, Christopher, 215 Dolan, Florence, 174 Dollar General, 669 Dorsey & Whitney, 676 Douglas, William O., 166 Dow Chemical Co., 280 DPS Industries, Inc., 370–371 Dream Girls Inc., 308 Drenberg and Associates, 724–725 Dresser Industries, 764–765 Drexel Burnham, 45 DrJays.com, 456 Dr. Miles Medical Co., 505 Drug Fair, 517 D&S Auto Parts Inc., 291 Duke Energy Progress, 582–584 Dunkin’ Donuts, 494, 511 Dunlap, Al, 652 DuPont, 59 Dutch Delights, 490 Dutch Pantry, 489–490 Dysart’s Truck Stop and Restaurant, 463

E Eagle Gate College, 35 Eastridge, Mary, 315–316 Eastwood, Clint, 301 E-Backgroundchecks.com, Inc., 439–441 eBay, 108, 274, 524–525 Ebbers, Bernard “Bernie,”, 268 Ecco, 495 Economic Ministry of Taiwan, 515 Ecuador, 245 E. F. Hutton, 99 E & H Cruises, Ltd., 100 800 River Road Operating Co., LLC, 709 Eisner, Michael, 616–617 E. & J. Gallo, 69 El Dia, Inc., 757–758 Eldorado Tool, Division of Quamco, Inc., 708 Electronic Arts Inc., 309 Ellerth, Kimberly, 739–741 Ellison, Lawrence J., 615 El Nuevo Dia, 729 el-Qaddafi, Muammar, 231 Eme Homer City Generation, L.P., 335 Emily’s List, 160 Employment Security Comm’n, 599 Emulex stock, 662 Enersyst, Inc., 409 Enron, 58, 60, 67, 88, 249, 255, 270, 296,

635, 692 Entergy Corporation, 337 Environmental Defense Fund, Inc.,

356, 359

Ernst & Ernst, 664 Erskine, William, 69 Escott, 647–650 ESG Capital Partners II, LP, 602 Esposito-Hilder, Annette, 325 ET-Plus guardrail system, 472 E*Trade Financial Corporation, 326 ETS Inc., 539 ETS Payphones, Inc., 677 European Environment Agency, 356 ExoTablet, Ltd., 550 Exotica Fresheners Company, 540 ExxonMobil, 241, 338, 629 Exxon Shipping Co., 322, 338 Exxon Valdez, 338

F Facebook, 2, 4, 126, 130, 272, 274, 306,

331, 406, 427, 521, 536, 585, 602, 623, 642, 643, 654, 676, 702, 705, 721, 726

Family Dollar, 669 Fannie Mae, 67, 101, 215 FAPS, Inc., 738 Faragher, Beth Ann, 765 Farmer’s Cooperative of Arkansas,

276, 676 Fastow, Andrew, 249 Federal Home Loan Bank of

Topeka, 741 Federal Trade Commission, 446 Federated Department Stores, 428 FedEx, 507 Feingold, Russell, 142 Ferrari, 56 Fingerlakes Aquaculture, LLC, 442 Finova, 67 Firemen’s Ins. Co. of Washington,

D.C., 343 First Community Bank, N.A., 632 First Jersey National Bank, 431 Fisher, George, 56 Fit Fabric, 129 Fitzgerald, Kenneth, 548 Fogle, Jared, 274 Fokker Services, 260 Forbes magazine, 298 Ford Motor Co., 451 Ford Motor Company, 259, 713 Foxconn, 719 Fox Searchlight, 685 Fox Television Stations, Inc., 171, 202 Free Enterprise Fund, 651 Freeman, Dean C. B., 626–627 Friedman, Milton, 43–44 Friends of Angelo group, 215 Frito-Lay, Inc., 524 Fromme, Gunther, 69

G Gailey, Inc., 631 Galella, Ron, 305 Galleon Hedge Fund, 658

Galoob toys, 394 GAMCO Investors, 615 Games Workshop (GW), 133 Gardner-Denver Co., 517 Garner, Bryan A., 304 Garon Foods, Inc., 566–568 Gates, Bill, 742 Gates, Melinda, 742 GE, 342, 666, 667, 713 Genentech, Inc., 503 General Electric, 135, 500, 550 General Mills, Inc., 515 General Motors (GM), 53, 150 General Steel Corp., 104–106 Genovese, Kitty, 323 Gerstner, Louis, 54 Gevorkian Nazareth Violins,

445–446 Giannoulas, Ted, 548–549 Gibson Guitars, 222 Gimbel Brothers Inc., 432 Gimbels Dep’t Store, 589 GlaxoSmithKline, 33, 34, 541 Globe Life Insurance Company,

424–426 GM, 549, 692 Golden Nugget, Inc., 632–633 Goldman, Ronald, 159 Goldman Sachs, 25, 273, 635, 642, 658,

661, 673, 678 Gold Peak Tea, 70 GoldTree Asset Management, 45 Goodman, Nicholas, 615 Good Samaritan Hosp., 589 Goodyear, 230 Google, 6, 36, 221, 331, 332, 503, 529, 530,

535, 538 GoPro, 615 Gordon Food Service, 765 Gordonsville Energy, L.P., 371 Gorelick, Jamie, 215 Grand, Canyon & Rafts, 120 Grand Metropolitan PLC, 676 Grand Resort, 298 Grant County power company, 332 Grappolini, Giuseppe, 562–564 Grappolini Company, 562–564 Graying Reel, Inc., 360 Great Atlantic & Pacific Tea Co., 517 Great Bear Adventures, 681,

698–699 Great Southern Peanut, LLC,

399–401 Greenberg, Hank, 618 Greenbrier Basket Company (GBC),

392–393 Green Investors, 52 Greenstone, Samuel, 134 Green Tree Financial Corp.,

104–106

H Hamilton Beach, 54 Handy Technologies, 692

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T-14 Table of Products, People, and Companies

Harcourt Brace Jovanovich Legal and Professional Publications (HBJ), 501

Hard Candy Fitness, 73 Hardee’s, 38 Harley-Davidson, Inc., 55, 535 HarperCollins, 496 Harrah’s Illinois Corp., 573 Harrier Jet, 380–381 Hasbro, 507 Hasbro Toys, 394 Hastings, Reed, 676 Hathaway, Berkshire, 673 Haute Diggity Dog, LLC, 550 Hawaii Housing Authority, 166 Hawkins, Natasha, 424–426 Hayward, Tony, 357 HealthSouth, 67, 256 Health- South, 69 Hearst Corporation, 685 Heart of Tex. Dodge, Inc., 369 Heinz Ketchup, 70 Heritage Hills, 632 Herman Miller, 39 Hershey Medical Center, 476 Hewlett-Packard (HP), 37, 42,

620, 667 HGO, Inc., 699 Hillerich & Bradsby Co., 482 Hills, Roderick M., 278 Hilton, Paris, 22 Hilton Contract Carpet Co., 407 Hilton Hotels Corporation, 546 Hitachi, 230 H. J., Inc., 276 H.J. Heinz Company, 673 Holguin, Patricia, 326 Holiday CVS, L.L.C., 255 Holmes, Oliver Wendell, Jr., 3, 12 Home Basket Co., LLC., 392–393 Home Depot, 211 Home Shopping Network

(HSN), 550 Honeywell International, 161 Hooked on Phonics, 214 Hootie and the Blowfish, 54 Hopkins, Ann, 761–763 Hornbeck Offshore Services, L.L.C.,

200–201 Hotel Dieu, 324 Hotel Oasis, Inc., 686–687 Hughes Communications Inc., 523 Humane Society of the United

States, 360

I IAC/InteractiveCorp., 550 IBM, 54, 582–583, 621, 746, 761 iBookstore, 487, 498 Ice T, 55, 57 IFC Leasing Company, 291 Iger, Robert A., 615 IKEA, 479 Ikea, 35

Illinois Tool Works Inc., 510–511 ImClone, 261 Imperial Foods Company, 259 Imus, Don, 57 Incyt, 615 Independent Ink, Inc., 510–511 Industrial and Commercial Bank of

China (“ICBC”), 239 Inland Steel Company, 337 In re Caremark International,

Inc., 263 Instacart, 691 Intel Corporation, 111–112 International Ambassador Programs,

Inc., 238 International Paper Company, 482 International Union, 743–745 Intershoe, Inc., 404–405 iParadigms, 447 Iroquois Brands, Ltd., 676–677

J Jack-in-the-Box, 38 Jackson, Janet, 57 Jackson, Phil, 29 Jacono, Joseph, 447 Jakob, Mark S., 662 James Langley Operation Co.,

Inc., 343 JCPenney, 275, 304, 589 J.D. Powers, 705 Jefferson, Thomas, 141 Jennings, Marianne M., 558 Jobs, Steve, 495 John D. Park & Sons Co., 505 John Hancock Insurance

Company, 385 Johns-Manville, 56, 134 Johnson Controls, 230, 743–745, 746 Johnson & Higgins (J & H), 632 Johnson & Johnson, 52, 633 Johnson & Johnson Vision Car

(JJVC), 509 Joiner, Robert, 135 Jolie, Angelina, 742 Jones, Allan, 632 Jones, Jason, 291 Jones, John, 8 Jones, Paula Corbin, 142 Joppatowne G.P. Ltd. Partnership,

488–490 Jordan Marsh, 275 Joseph Horne Company, 111, 671 Josephson Institute, 28 J.P. Morgan, 382 JPMorgan Chase, 621

K Kant, Immanuel, 39 Kaplan, Lewis, 292–293 Kara, Maher, 635, 659 Kardashian, Kim, 457 Karl’s Sales & Service, Inc., 432

Karsten Manufacturing Corporation, 129

Katzenberg, Jeffrey, 616 Kavakos, Leonidas, 445 Kayak, 633 Kazaa, 527 KBkids.com, 454 Keebler Company, 524 Keis Distributors, Inc., 408 Kellogg’s, 460 Kelo, Susette, 165–168, 176 Kennedy, Anthony M., 163–164, 171 Kenner Toys, 394 Kentucky Fried Chicken, 589 King, Martin Luther, Jr., 729 King, Michael D., 282–283 King, Robert, 416–417 King’s Cheese & Deli, 490 Kline & Son Cement Repair,

Inc., 343 Kodak, 56 KORB FM, 373 Kozlowski, Dennis, 135, 269 KPMG, 259, 292–293, 665 Kreative Kitchen, 490 Krispy Kreme, 494 Kroger Co., 134 Kutcher, Ashton, 444 Kyllo, Danny, 280

L Labor and Industrial Relations Comm’n

of Missouri, 694 L. A. East, 69 The Landings Assoc. Inc., 320–321 Lange, Jerome, 573–574 Lapp’s Fresh Meats, 489 Las Vegas Sands, 230 Laurelbrook Sanitarium and

School, Inc., 685 Lauren, Ralph, 586 Lavely & Singer, 297 Lawyers for Creative Arts (LCA), 133 Lay, Kenneth, 270 Leacock, Stephen, 449 League for Coastal Protection, 360 League of Conservation Voters, 356 Leegin Creative Leather Products, Inc.,

497–498, 504–506 Leeson, Nick, 246 Lehigh Consumer Products, LLC, 469 Lehman Brothers, 36, 284, 652 Lenox Hill Radiology, 312 Levinson, Arthur, 503 Levi Strauss, 152 Lewis, C.S., 25 Lewis, Kenneth D., 100 Liberty Global, 615 Liberty Media, 615 Liberty Mutual Ins. Co., 732–733 Lightbridge, Inc., 694 Lindley, Lord Justice, 381 Listerhill Employees Credit Union, 470 Listerine, 454–455, 458–459

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Table of Products, People, and Companies T-15

Little League, 558 L.L.Bean, 495 Lloyd’s of London, 96 Lockheed Martin, 69, 676 Locklear, Jim G., 275 Lohan, Lindsay, 326 London, Scott, 665 Longfellow, Henry Wadsworth, 329 Long Island Ry. Co., 317–318 Loomis Armored, Inc., 589–590 Louie’s Lobsters, Inc., 442 Louis Vuitton, 520, 549 Louis Vuitton Malletier, 531–532,

549–550 Lowe, Rob, 115 Lowe Engineering, 122 Lucas, George, 394 Lucini Italia Co., 562–564 Ludlow Corp., 54 Lululemon stores, 445 Luon fabric, 445 Luxe Valet, 691–692 Lyft, 691–692 Lyons Group, 534 Lyons Partnership, L.P., 548

M Macauley Properties, 122 Mace Industries, Inc., 408 Macmillan, 496 Macy’s, 304 Macys.com, 454 Madison, James, 145 Madoff, Bernie, 25, 67, 673 Madoff Investments, Inc., 673–674 Madoff Securities, 264, 284 Madonna, 55, 73 Magma Copper Co., 724 Magnifium, 135 Major League Baseball (MLB), 283 Mamma.com, Inc., 663 Manor Drug Store, 664 Manville, 56 Marc Bertorelli Builders, 632 Maremont, Mark, 136 Markl Supply Company, 452 Marriott International, Inc., 110 Marsh Advantage America, 632 Marsh & McLennan, 632 Martha Stewart Living Omnipedia,

Inc., 304 Martin, Casey, 759 Martin Marietta, 676 Martyszenko, Vivian, 765 Masonic nursing home, 765 Matrixx Initiatives, Inc., 656–657 Mattel, Inc., 479, 507, 541, 546–548 Mauna Kea Anaina HOU, 214–215 Maxfield and Oberton Holdings,

LLC, 480 Mayer, Marissa A., 615 Mayo, Karen, 135 Mayopoulos, Timothy J., 100–101 Mazur & Hockman, Inc. (M&H), 399–401

MBIA, 615 McCain, John, 142 McCoy, Bowen, 46–50 McDonald’s, 630, 749 McDonald’s Restaurants of Oregon,

Inc., 572 McDonnell Douglas Corp., 731–732 McGwire, Mark, 21, 283 McIlroy, Rory, 555 McKennon, Christine, 753–754 McKinsey, 658 McLaughlin Group, 324 McNamee, Brian, 299, 327 McNealy, Scott, 704 McNeil, 633 McNeil Consumer Products Company, 52 McNeil-PPC, Inc., 458–459 McNerney, Jim, 725 Mead-Johnson, 230 Meadors, John, 409 Meche, Gil, 37 Medtronic, 221 Memphis Light, Gas & Water

(MLG&W), 170 Mendota Unified School District, 299–301 Mephisto, 495 Mercator Corporation, 245 Mercedes-Benz, 394, 533 MercExchange, LLC, 524–525 Merck, 99 Merrell Dow Pharmaceuticals, Inc., 128 Merrill Lynch, 61, 100, 260 Mesa Airlines, Inc., 369–370 Mesirow Financial, Inc., 741 MetLife, 550 MF Global, 41 MGA Entertainment, Inc., 541 M & H Used Auto Parts & Cars, 249,

265–267 Michigan Document Services, Inc., 530 Microsoft, 331–332, 615 Microsoft Corporation, 240 Midkiff Realty, Inc., 590 Milken, Michael, 45, 255 Milliken, Janet S., 447 Mini Cooper, 372 Minimed, Inc., 573 MITE Corp., 670 Mitsubishi, 259 Mkhsi-Gevorkian, Nazaret, 445–446 M&M/Mars, 37 Mobil, 241, 245, 629 Monsanto, 259 Monster Beverage, 22 Monster Company, 521 Monster Energy Company, 536–538 Moonves, Les, 615 Moore, Demi, 184 Moore, Michael, 324 Morgan Stanley, 46, 661 Motorola, 56, 662, 663 Mower Brothers, Inc., 565 MRA Holding, LLC, 307–308 MSNBC, 57 Mudd, Daniel, 215

Muffins, Thomas English, 565 Murdoch, Rupert, 45 Murphy, Douglas, 230 Murphy Oil U.S.A., 343 Mutual Pharmaceutical Co., Inc.,

154–155 MyHeroProject, 51 Mylan, 221 My Other Bag, Inc. (“MOB”), 531–532 Myriad Genetics, Inc., 522 MySpace, 273

N Nabisco, Inc., 573 Nabisco Brands, Inc., 524 Namath, Joe, 457 NASA, 761 Nash, Laura, 38 Nashville Banner Publishing Co.,

753–754 National Arbitration Forum, 106 National Biscuit Co., 573–574 National Labor Relations Board

(NLRB), 709 National Media Group, Inc., 208 National Resources Defense

Council, 356 National Soc’y of Professional

Engineers, 500 Nation Enterprises, Inc., 409 Natural Resources Defense Council,

Inc., 360 NBA, 127 NBC, 298, 685 NCAA, 69–70 Neiman Marcus, 456 Neptune Fisheries, Inc., 442 Nestlé, 52, 479, 630 Netflix, Inc., 206, 676 Netscape Communications, 538–539 Nevada corporation, 632 New Balance, 495 New Century Financial, 56 New Colt Holding Corporation, 483 New England Patriots Football

Club, 677 New Hampshire Motor Transport

Association, 148–149 New Hotel Monteleone, 324 New London Development Corporation

(NLDC), 165 Newman, Todd, 661 New York Air, 213 New York–Presbyterian Hospital, 312 New York Road Runners Club, 32 New York Stock Exchange

company, 666 Night Train Express wines, 69 Nike, 35, 158, 495, 550, 720 Nixon, Richard, 142 Normand, Troy, 264 North Carolina State Bd. of Dental

Examiners, 502 Northern Distributing Company, 408

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T-16 Table of Products, People, and Companies

North Face, 495 NorthStar Realty Finance, 615 Northwest Airlines, Inc., 213, 447 Northwestern Bell Telephone Co., 276 Norton, Gale, 212 NTD Apparel, 719 N-the-Water Publishing, Inc., 99 NTSB, 67 NYSE, 246

O Oakley, Inc., 523 Obama, Barack, 12, 142, 212, 325,

358, 742 Obama, Michelle, 325, 742 OBB Personenverkehr A.G., 131 Ocean Futures Society, 360 Ocean Therapy Solutions, LLC, 628 O’Connor, Sandra Day, 167 Octagon Plaza LLC, 417 OfficeMax, 382 O’Hagan, James Herman, 676 Olive Garden, 110 Ollie’s Barbecue, 146, 174 Olympics, 229, 244 Omni Outdoor Advertising, 502 Onassis, Jacqueline Kennedy, 305 O’Neal, Stan, 61 1-800 Contacts, 509 Oracle, 615 Orleans School Board, 632 Ortiz, Joe, 724 Ott Chemical Co., 612 Ovitz, Michael, 616 Oxford Health Plans, 135 OxyContin, 290

P Pacific Gas & Electric (PG&E), 175 Paddock Pool Equipment Co., 408 Palsgraf, Helen, 317–318 Pampered Chef, Ltd., 392–393 Pampers, 408–409 Pan Am, 225 Paramount Contracting Co., 370–371 Parker Brothers, 535 Parnell, Hugh, Sr., 287 Parnell, Stewart, 287 Passport Special Opportunities Master

Fund LP, 602 Patagonia, 495 Paterno, Joe, 591, 701 Patrick, Dan, 42 Patrick, Danica, 42 Pattern Makers’ League of North

America, AFL-CIO, 709 Paulson, Hank, 678 PayPal, Inc., 239 Peale, Norman Vincent, 37 Peanut Corporation of America,

287–288 Pegues, Timika, 304 Penguin, 496

Pennsylvania Coal, 168 Pennwalt, Inc., 54 Pension Benefit Guaranty

Corporation, 180 Pepsi, 304, 676 PepsiCo, Inc., 22, 367, 380–381, 565 Perelman, Ron, 45 Pertschuk, Michael, 209 Petraeus, David, 35, 620 Petrocelli, Daniel, 159 Pfizer Inc., 165, 168, 176, 221,

458–459, 614 PGA Tour, Inc., 759 Pharma Chemie, Inc., 766 Philip Morris International, 244, 473 Philippine Airlines, Inc., 396–397 Photon Infotech Private, Ltd., 371 Pillsbury Company, 676 Pines Motel, 291 Pinsky, Drew, 33–34 Pitt, Brad, 742 Playboy Enterprise, Inc., 538 Portfolio Recovery Associates LLC

(PRC), 435–436 Portland Terminal Co., 685 Postmaster General, 746 Pound, Roscoe, 12 PricewaterhouseCoopers (PwC), 236, 651,

761–763 Prince George’s Hospital, 413 Princeton University Press, 530 Procter & Gamble (P&G), 352, 408, 522,

524, 658 Professional Golf Association

(PGA), 129 Pro-Football, Inc., 539 Progas Welding Supply, Inc., 442 PSKS, Inc., 497–498, 504–506 Public Company Accounting Oversight

Board, 650–653 Pudd’nhead Wilson, 635 Pullman, Inc., 54 Pulte Home Corporation, 103, 122–123 Puma, 495 Purdue Frederick Company, 290

Q Quaker Oats, 565 Qualcomm, 615 Quill Corporation, 150 QVC Network, Inc., 450–452

R Raines, Franklin, 215 Ralph Lauren, 230 RC Cape May Holdings, 337 Real Estate Board of New

Orleans, 492 Recovery Express, Inc., 590 Red Lobster, 110 Redner’s, 488 Redner’s Markets, Inc., 488–490 Regeneron Pharmaceuticals, 615

ReMax, 447 Renco Rental Equipment, 382 Ricci, Frank, 735–736 Rice, Gary, 300 Rice Corporation of Haiti, 230 Richie, Nicole, 202 Right Media, 668 Riverkeeper, Inc., 337 Roberts, John Glover, 145–146 Roberts Airways, 559 Robert’s Waikiki U-Drive, 517 Rockport, 495 Rockwell International Corp., 110 Roehm, Julie, 586–587 Romney, Mitt, 56, 244 Rooney, Patrick, 290 Rooney Enterprises, Inc., 290 Roosevelt, Franklin D., 144 Rose, Charlie, 685 Rosenbaum, Wise, Lerman, Katz &

Weiss, 291 Ross-Simons Hardware Lumber, 508 Rothbaum, Amy, 449, 461–462 Rottenberg, Kenneth, 676 Royal Sonesta Hotel, 324 Roy E. Farrar Produce Co., 482 Rubin, Robert, 227 Rush, Eric (a.k.a. Eric Romero),

568–569 Rush-Presbyterian-St. Luke’s Medical

Center, 573 Russell Stover Candies, Inc., 517 Ryder, Winona, 126

S Sabritas, 241 Sachs, Carol P., 131 Safe and Sober Streets, 69 Safer, Morley, 325 Safeway, Inc., 765 Safeway grocery store, 765 Saks Fifth Avenue, 126 Salazar, Kenneth, 200–201 salesforce.com, 615 Salinger, J.D., 533 Sally’s Beauty Supply, Inc., 326 Salman, Saswan (“Suzie”), 659–661 Salomon Brothers, 38 Sambuck’s Coffee House, 550 Sam’s Club, 507 Samsung, 461–462 Samsung 4G phone, 449 Samsung Telecommunications America

LLC, 461–462 Sanders Lead Company, 360 San Diego Air Sports Center

(SDAS), 214 San Diego Chicken, 548–549 Sandusky, Gerald A., 591 San Francisco Arts & Athletics,

Inc., 535 Santa Fe Trail Transportation Co., 749 Santa Monica Family YMCA, 321 Santos, Felix, 725

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Copyright 2018 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. WCN 02-200-203

Table of Products, People, and Companies T-17

SAP, 230 Saul, Bernard, 291 Schechter Poultry, 144 School Board of Nassau County, 758 Schultz, Gary, 591 Schulze and Burch Biscuit Company

(Schulze), 388–389 Schwab Co., 428 Schwirtz, Timothy, 732 Scientific-American, Inc., 662 Scientific-Atlanta, 662 Scovill, Inc., 54 Scrushy, Richard, 256 Scrushy, Richard M., 69, 268 Sea Labor, Inc., 430–431 Sears, 54, 434 Sears Roebuck & Company, 415 Seattle’s Best Coffee (SBC), 494 Sea Works, Inc., 431 SeaWorld of Florida, LLC, 721–723 Security Transport Services, Inc., 741 Sedgwick, Kyra, 673 Select Portfolio Servicing, Inc., 419 SFX Broadcasting, Inc., 325 Shakespeare, William, 218 Shapiro, Robert, 159 Sheen, Charlie, 444 Shelby Memorial Hosp., 765 Shell Oil Co., 329, 340–341 Sheridan, Paul, 477 Shiley, Inc., 96 Shiley of Irvine, 96 Shkreli, Martin, 283, 630 Shlensky, William, 617–618 Shopping Bag Food Stores, 503 Shurfine Central Corp., 462 Shyp, 691 Siekaczek, Reinhard, 219 Siemens, 219, 243, 246 Sierra Club, 163, 345–346, 356 Sigma, 135 Simon & Schuster, Inc, 159, 496 Simpson, Nicole Brown, 159 Simpson, Orenthal James “O.J.”,

159, 287 Simulados Software, Ltd., 371 Singer Co., 54 Six Pac, 160 Skilling, Jeffrey, 25, 88, 249, 256, 635 Slinky, 59 Smith, Adam, 70, 218, 219, 487 Smithfield Foods, 707 Smith & Smith, 245 Snowden, Edward, 576 Snow Food Products Division, 430 Sons of Thunder, Inc., 430–432 Sony, 223 Sony BMG Music Entertainment,

526–528 Sotheby’s, 517–518 Sotomayor, Sonia, 163 Souter, David, 163 Southern Pacific Transportation

Company, 340 South Shore Bank of Chicago, 375–376

Southwest Savings & Loan, 632 Spamhaus, 273 Spanier, Graham, 591 Spears, Britney, 297 Spiegel, 152 Spielberg, Steven, 673 Spirit Technologies Consulting

Group, 518 Spitzer, Eliot, 25 Spur Industries, Inc., 330–331 Standard Candy Co., 463 Standard & Poor’s, 701 Stanford Financial Group, 284 Stanley, Frederick T., 55 Stanley Works, 54, 55 Staples, Inc., 314, 475–477 Starbucks, 295, 312–314, 494 Star Coach, LLC, 369 Starwood Hotels & Resorts

Worldwide, 546 State Farm Mutual Auto Insurance

Co., 322 State Oil Co., 504 Stevens, John P., 166–167 Stevens-Henager College, 35 Stewart, Martha, 135, 269 Stewart, Potter, 25 Still N the Water Publishing, 99 Stonebridge Investment Partners,

LLC, 662 Story Chemical, 612 Stroh Brewery, 724 Stryker Corporation, 620 Sullenberger, Chesley “Sully,” 66–67 Sulphuric Acid Trading Co.,

Inc., 343 Sunbeam Products, Inc., 482, 652 Sun-Diamond Growers of

California, 191 Sundowner Offshore Services, Inc., 741 Sunglass Hut Intern., 523 Sun Microsoft Systems, 704 Sun Microsystems, 713 Sunrider Corporation, 422 Sununu, John, 396–397 Super Bowl, 57 Superior Court Trial Lawyers

Ass’n, 502 SVC-West, L.P., 387–388 Swanger, Steve, 10–11 Swartz, Mark, 269 Sweet Home Chapter of Communities

for a Great Oregon, 348–350 Sweet Romance Jewelry

Manufacturing, 550 Swinney, Wayne, 734 Swiss bank, 673 Symington, J. Fife, 632 Systems and Software, Inc. (SAS), 518 Syverud, Kent, 69

T Taco Bell, 38, 482 Taco Cabana, Inc., 538

Taguba, Antonio M., 13 Taubman, A. Alfred, 517–518 Teerlink, Richard, 55 Teflon, 471 Telecredit Service Corporation, 434 Teleprompter Manhattan CATV

Corp., 168 Temple, Nancy, 270 Tenenbaum, Joel, 526–528 Tennant, Anthony, 517 Texaco Inc., 530 Texas Gulf Sulphur Co., 657 Textile Workers Union, 713 T-Fal Corporation, 450 Thirty Meter Telescope, 214–215 Thoreau, Henry D., 25 Ticor Title Ins. Co., 517 Tiffany and Company, 239–240 Timberlake, Justin, 57 Timberline, 495 Time Warner, 45, 57, 615 Tim Hortons, 221, 494 Tolman, Reed C., 116 Tolman & Osborne, PC., 116 Tom Tuna, Inc., 442 Touche Ross, 761 Toyota, 136–137, 468, 515 Toys R Us, Inc., 507, 550, 630 Tradewinds, 626–627 Transparency International, 65 Trans Union Corp., 446 Trans World Airlines (TWA), 429, 746 Trapp Family Lodge, Inc. (TFL), 632 Tretorn Plumbing, 395 Triangle Chemical Company, 600 Trinity Industries, 472 Trinity Wall Street Church, 668 TruGreen Companies, LLC, 565 Trump, Donald, 302–303, 409 TRW Inc., 110 Tufteland, James, 89 Tumblr, 668 Turing Pharmaceuticals, 283, 630 Turner, Ted, 45 Twain, Mark, 635 Twitter, 130, 457, 702 Two Pesos, Inc., 538 twtMob, 457 Tyco International, 135–136, 269 Tylenol, 52, 58 Tyson, 765

U Uber, 20, 26, 683–684, 691–692 Udell, Howard, 290 U-groove Ping clubs, 129 Ulbricht, Ross, 274 Uninsured Employers’ Fund,

698–699 Union Bank, 632 Union Carbide, 131, 232 United Airlines, 692 United Arab Shipping Company

(UASC), 245

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T-18 Table of Products, People, and Companies

United Food and Commercial Workers Union Local 24, 706–708

United Roasters, Inc., 431 United Way, 38 Universal Labs, Inc., 631 University of Pennsylvania, 755 University of Texas at Austin, 751 Unser, Bobby, 291 Urbina, Ricardo, 259 USA Inc., 473 US Airways, 668 U.S. Army Corps of Engineers, 359 U.S. Steel, 43 Utah Pie Co., 512

V ValuJet, Inc., 259 Van Horn, Alexandra, 310–311 Verizon Communications, 667 Vertex Pharmaceuticals, 615 Viacom, 530, 615 Video Television, Inc., 570 Vinson, Betty, 264 Vioxx, 99 Virgin Atlantic Airlines, 518 Virginia Electric & Power Co., 371 Vogel, Harold, 516 Volkswagen, 36, 67, 245, 471 Von’s Grocery Co., 503

W Waffle House, 756 Wagner, Leon, 45 Waksal, Sam, 261 Walgreen’s, 221

Wallace, Khalil, 424–426 Wallace, Mike, 325 Wal-Mart, 35, 69, 304–305, 325–326, 469,

489, 505, 507–508, 538, 573, 586–587, 668, 719, 724, 725, 736–737, 764

Walt Disney Company, 115 Walters, Craig, 134 Warner-Lambert Company,

454–455 Water & Light Department, 135 Water Sports Industry Association, 469 Watson, Anthony Glen, 310–311 Weatherguard Construction Company,

Inc., 559–561 Weatherproof Garment

Company, 325 Welch, Jack, 713 Wellbutrin, 34 Wendy’s, 38, 464 Westinghouse Elec. Corp., 369 Westin Hotels and Resorts, 362 Whirlpool Corporation, 689, 724 White, Alvin Dwayne, 732 Wiesenfield Warehouse Co., 254 Wigand, Jeffrey S., 325 Wiggins, Donald, 361 Wilderness Society, 361 Wilkes–Barre Hospital, 476 Willard Inter-Continental

Hotel, 246 Wilmer Cutler, 135 Winkleman, David, 373 Winklevoss, Tyler, 406 W.J. Gore & Associates, Inc., 495 W. J. Howey Co., 636 WKBN, 308 Wm. Wrigley, Jr. Co., Inc., 483

Wood, Edward, 589 Woodcrest Health Care Center,

708–709 Wordspy.com, 535 WorldCom, 58, 255, 263, 268 Worldwide Airlines, 668 World Wildlife Fund, 352 WPYX-FM radio, 325 Wyler, Jane, 549

X Xena Corporation, 651 XYZ Corporation, 414

Y Yachts International, 382 Yahoo!, 615, 668 Yale Diagnostic Radiology, 412–413 Yamaha Rhino, 216 Yankee Candle Company, 549 Yates, Buford, 264 Yolanda’s Yogurt, 384 YouTube, 164, 306, 529–530,

536, 702 Yukos Oil Company, 219

Z Zara, 719 Zeta Corporation, 91 Zicam, LLC, 656–657 Zimbra, 668 Zion’s First Nat’l Bank, 632 Zuckerberg, Mark, 406, 623 Z&Z Leasing, Inc., 360

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I-1

Index

A AAA. see American Arbitration

Association AAMA. see American Apparel

Manufacturers Association ABA. see American Bar Association Abnormal use of product, 474–475 Absolute privilege, 299 Acceptance of offer, 390–391 Accord and satisfaction, 433 Accredited investors, 641, 654 Accuracy of advertising, 453–454 Acquisition, defined, 669 Activism stage, issue cycle, 57 Act of state doctrine, 18, 232–235 Actual authority, 558 Actual (private) notice, 577 Actus reus of crime, 265, 268 ADA. see Americans with

Disabilities Act ADEA. see Age Discrimination in

Employment Act Administrative agencies

business rights, 205–210 defined, 179 federal administrative regulation, 15 in federal court system hierarchy, 80 functions of, 186–205 in international market, 210–211 laws governing, 183–186 major federal, 180 roles of, 180–183, 210 state administrative law, 15–16 steps for enforcement and

adjudication, 206 workers’ compensation laws, 681

Administrative law judge (ALJ), 208 Administrative law of appeals, 209–210 Administrative Procedures Act (APA),

183, 186, 189, 201 Administrative regulation, proactive

business strategies in, 204 ADR. see Alternative dispute resolution Adultery, 27, 31 Advertising, 586–587

as contract basis for product liability, 449–460

corrective, 454

federal regulation of, 453 First Amendment and, 156–158

Affirmative action, 749–751 Affirming decisions, 74 Afghanistan, 223 Age capacity, 412 Age Discrimination in Employment Act

(ADEA), 729, 730, 756 Agency, 554–587

agent’s rights and responsibilities, 562–569

defined, 555 international law, 585–586 liability of principals for agents’

conduct, 570–577 power of attorney, 555 principal’s rights and

responsibilities, 569 termination of agents under

employment at will, 577–585 terminology, 555–557

Agency by estoppel (apparent authority), 559

Agency relationships, 556 creation of, 557–561 international law, 585–586 termination of, 577

Agents defined, 556 duty of care, 569 duty of loyalty, 562–569 duty of obedience, 569 Foreign Corrupt Practices Act

and, 229 liability of principals for conduct of,

570–571 liability of principals for torts,

572–577 rights and responsibilities of,

562–569 termination of, 577–585

AHERA. see Asbestos Hazard Emergency Response Act

AIA. see America Invents Act; American Institute of Architects

AICPA. see American Institute of Certified Public Accounts

Air Pollution Control Act, 333 Air pollution regulation, 332–336

Air Quality Act, 333 ALI. see American Law Institute ALJ. see Administrative law judge Alter ego theory, 611 Alternative dispute resolution (ADR),

103–113 Alternative Fines Act, 230 AMC. see Antitrust Modernization

Commission America Invents Act (AIA), 523 American Apparel Manufacturers

Association (AAMA), 720 American Arbitration Association (AAA),

103, 106–107, 110–111 American Bar Association (ABA), 608,

619, 665 American Competitiveness in the

Twenty-First Century Act, 716 American Institute of Architects

(AIA), 103 American Institute of Certified Public

Accounts (AICPA), 312 American Law Institute (ALI),

367, 467 American Society of Composers,

Authors, and Publishers (ASCAP), 529

American Society of Trial Consultants, 127

Americans with Disabilities Act (ADA), 700, 730, 758, 759–760

Annual percentage rate (APR), 377 Answers, 119, 120 Anticompetitive behavior, 491, 492

free speech and, 502 interlocking directorates, 503 penalties and remedies for,

513–514 Antidiscrimination laws, 749–751,

see also Title VII of Civil Rights Act of 1964 (Fair Employment Practices Act)

affirmative action, 749–751 Age Discrimination in Employment

Act, 729, 756–758 Americans with Disabilities Act, 730,

759–760 communicable diseases in

workplace, 758

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I-2 Index

Antidiscrimination laws (Continued) Equal Pay Act, 688, 729, 758 Family and Medical Leave Act

(FMLA), 682, 760–761 Rehabilitation Act, 730, 759

Antiterrorism and Effective Death Penalty Act, 716

Antitrust, 486–515 AMC, 615 covenants not to compete, 487–490 federal laws, 491–493 horizontal restraints of trade,

493–503 influencing conduct, 6 international issues, 514–515 laws in international marketplace,

240–242 penalties and remedies for, 513–514 tying arrangements, 509–511 vertical trade restraints, 503–513

Antitrust Modernization Commission (AMC), 491

APA. see Administrative Procedures Act Apparent authority, 559 Appellants (petitioners), 79 Appellate briefs, 74 Appellate court, 73, 210 Appellate judges, 79 Appellee (respondent), 79 Appraisal rights, 623 Aptitude tests, 752 Arbitrary and capricious standard,

200, 201 Arbitration, 103–104, 105 Arbitration procedures, 106–107 Argentina, 66, 233, 586 Arraignment, 286 Article 2A Leases, 372 Articles of incorporation, 609 Articles of limited partnership (limited

partnership agreement), 605 Articles of organization, for LLCs, 625 Articles of partnership, 596 Asbestos, 347–348 Asbestos Hazard Emergency Response

Act (AHERA), 347 ASCAP. see American Society of

Composers, Authors, and Publishers

Asset acquisition, 669 Asset Conservation, Lender Liability, and

Deposit Insurance Protection Act of 1996, 339

Assignment, defined, 442 Association of Certified Fraud

Examiners, 250

Assumption of risk, 319, 475 Atmosphere of harassment, 739, 741 Attorney–client privilege, defined, 77 AUC, 277–279 Audit committees, 614 Authority, as source of international

law, 220 Avocat, 78 Avocati, 78 Awareness stage, issue cycle, 57

B Bad actors, 641 Bait and switch, 458 Balancing test, 147–148 BANANA. see Build Absolutely Nothing

Anywhere Near Anything Bankruptcy, 437–438

courts, 80–81 Bankruptcy Abuse Prevention and

Consumer Protection Act of 2005 (BAPCPA), 437

Bargained-for exchange, 394 Barristers, 78 BAT. see Best available treatment B2B companies. see Business-to-business

companies BCFP. see Bureau of Consumer Financial

Protection BCT. see Best conventional treatment Beachfront Management Act, 169 Bengosh, 78 Bengoshi, 136 Berne Convention (Convention for the

Protection of Literary and Artistic Works), 525–526, 543

Best available treatment (BAT), 337 Best conventional treatment

(BCT), 337 BFOQ. see Bona fide occupational

qualification Bilateral contracts

defined, 372 vs. unilateral contracts, 372

Bilateral treaties, 18 Bill of lading, 403, 443 Bill of Rights, 143, 156–171 Binding arbitration, 104, 107 Bipartisan Campaign Reform Act (BCRA;

McCain-Feingold law), 162 Blue-sky laws, 671 Board resolution, 622 Boards of directors, 618 Bona fide occupational qualification

(BFOQ), 751–752

Bond market, 38, 610 Brazil, 65–66 Brexit, 19, 223 Bribery, 19, 31, 41, 62, 191, 227, 229, 231,

274–275 Briefs, 8, 74 Bright-line rule, 166 Brownfields, 344 Bubble concept, 333–334 Build Absolutely Nothing Anywhere

Near Anything (BANANA), 329 Burden of proof, 127 Bureau of Consumer Financial Protection

(BCFP), 418, see also Consumer Financial Protection Bureau

Business criminals, procedural rights for,

279–287 custom, 17–18 equal protection rights for, 171 state vs. federal regulation of,

152–153 Business competition, 486–515

AMC, 615 covenants not to compete,

487–490 federal laws, 491–493 horizontal restraints of trade,

493–503 international issues, 514–515 penalties and remedies, 513–514 tying arrangements, 509–511 vertical trade restraints, 503–513

Business crime, 248–288 crimes against a corporation, 252 crimes within a corporation,

249–252 defining, 249–252 elements of, 265–268 examples of, 268–279 federal laws targeting criminal

accountability, 254–257 and international business, 287 liability for, 253 penalties for, 257 –265 procedural rights for business

criminals, 279–287 Business entities, 592–630

corporations, 607–625 international issues, 629–630 limited liability companies, 625–628 limited liability partnerships,

628–629 limited partnerships, 604–607 partnerships, 594–604 sole proprietorships, 593–594

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Index I-3

Business ethics. see also Ethics business ethical dilemmas, 37–39 business success and, 51–58 creation of ethical culture, 58–61 defined as, 28–31, 45–46 international business, 61–67 reasons for, 45–46 social responsibility, 43–45

Business judgment rule, 615 Business-to-business (B2B)

companies, 108 Business torts, 294–327

vs. crime, 295 defining, 295 intentional torts, 296–308 negligence, 308–321 new verdicts on tort reform,

321–322 strict liability, 322 types of, 295–296

“But for” test, 314 Buyers, 416 Buying influence, 33 Buying land liability, 342–343 Bylaws, corporation, 610 “Bystander effect,” 323

C California’s Unfair Competition

Law, 158 Canada, 78, 221, 225, 227, 287 CAN-SPAM. see Controlling the Assault

of Non-Solicited Pornography and Marketing

Capacity, 411, 557–558 Capital costs, 114 Capitalism, 64, 66 Care, duty of, 569 Case

citations (cites), 14 opinion, 84

Catalog merchandise, 153 Causation, 314–315

and worker’s compensation, 696 Caveat emptor principle, 17, 449 C corporations, 608 CCPA. see Consumer Credit

Protection Act CDOs. see Collateralized debt

obligations Celebrity endorsements, 456 Celler–Kefauver Act, 491 CEOs. see Chief executive officers CEQ. see Council on Environmental

Quality

CERCLA. see Comprehensive Environmental Response, Compensation, and Liability Act

Certain and definite terms, 382 Certification, union, 709 CFAA. see Computer Fraud and

Abuse Act CFPA. see Consumer Financial Protection

Act CFR. see Code of Federal Regulations CFSB. see Bureau of Consumer Financial

Services or Consumer Financial Services Bureau

CFTC. see Commodities Futures Trading Commission

Chairman, role of, 621 Charitable subscriptions, 394 Cheating, 27, 41 Checks and balances, 142, 143 Chief executive officers (CEOs),

615, 621 Child labor provisions, 684 China

bribery, 64 customs, 17–18 most-favored-nation status, 224

CIAs. see Corporate integrity agreements

Circuit judges, 83 CISG. see Contracts for the International

Sale of Goods Citation, 14 Cites, case, 14 City

courts, 86 ordinances, 16

Civil cases, 77–79, 81 Civil law, 4, 219

criminal law vs., 4 Civil litigation process, 131, 132 Civil Rights Acts, 729–730, 731, 734,

737, 739 Civil Service Reform Act, 581 Class action suits, 117, 736–737 Clayton Act, 491–492, 493, 503, 513 Clean Air Act, 39, 252, 258, 333, 334–335,

353, 355 Clean Water Act, 258, 336, 353, 355 Clickwrap (clickon; clickthrough)

contracts, 392 Close corporations, 608 Closed shop, 710 Closing arguments, 129 Code law (civil law), 219 Code of Federal Regulations (CFR), 15,

186, 686

Codes of ethics, 619 Codified law (positive law), 5, 13, 30 Collateralized debt obligations

(CDOs), 678 Collective bargaining unit, 706 Comment letters (deficiency letters),

190, 642 Commerce Clause, 143–149 Commercial bribery, 274–275 Commercial impracticability, 429 Commercial speech, 156

and the First Amendment, 156, 157

Commodities Futures Trading Commission (CFTC), 180

Common law, 4 contracts, 368 criminal indictments of corporations

on, 259 defined, 219, 368 environmental regulation,

329–331 nuisances, 329–331 rejection by counteroffer

under, 384 rules on contract formation, 401 statute of frauds, 395 statutory law vs., 4–5

Common Market. see European Union Common stock, 610–611 Communicable diseases in

workplace, 758 Communication of offer, 382–383 Communism, 220 Community property laws, 5 Community-right-to-know

substances, 348 Community Trademark

(CTM), 542 Comparative negligence, 319, 475 Compensation committee, 621 Compensation

of CEOs, 615 duty of, 569 just, 169 unemployment, 693–695

Compensatory damages, 441 Competition

business. see Business competition interbrand, 508 intrabrand, 508 interference with, 487–488,

491–493 merging competitors and the effect

on, 503 Complaints, 115–117, 210

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I-4 Index

Comprehensive Environmental Response, Compensation, and Liability Act (CERCLA), 339–343

and Brownfields, 344 and buying land liability, 342–343 challenges, 343 four classes of liability rules,

339–340 and corporate liability, 341–342 insurers and, 343 lender liability, 339 and the self-audit, 343–344 and the superfund, 339–343

Compromise, 7 Computer crime, 269–270 Computer Fraud and Abuse Act

(CFAA), 273 Computers

access for unauthorized advertising, 271

committed EEA, 272–273 using to commit fraud, 273

Computer resources, unauthorized use of, 272–273

Computer Software Copyright Act, 525

Concurrent jurisdiction, 81 Conditions concurrent (conditions

contemporaneous), 427 Conditions contemporaneous, 427 Conditions, defined, 426 Conditions precedent, 426 Condoning unethical actions, 36 Conduct. see Employee conduct

management Confidential relationship, 419 Conflict of interest, 33 Conflict of law, 96–97, 237 Congress

enabling acts, 186–187 regulation of foreign commerce, 149 regulation of state and local business

activity, 144 Congressional law, 14–15 Congressional regulation

of foreign commerce, 149 standards for, 144

Conscious avoidance, 267–268 Conscious parallelism, 494 Consent decrees, 206, 207 Consequential damages, 441 Consideration, 394

unique issues, 394–395 Consistency, as characteristic of law, 7 Consolidations, 668–669

Constitutional conflicts, 152–153 Constitutional law, 13–14 Constitutional limitations of economic

regulations Commerce Clause, 143–149 constitutional standards for taxation

of business, 149–150 Constitutions

defined, 13–14 in international law, 171

Constitution, U.S., 141–173 Article I, 141–142, 528 Article II, 141–142 Article III, 141–142 Article VI, 142, 152 Bill of Rights, 143, 156–158 Commerce Clause, 143–149 Fourteenth Amendment, 143,

169–170 judicial review and, 143 limitations of economic regulations,

143–152 overview of, 141 regulation of business-constitutional

conflicts, 152–155 role of judicial review and, 143

Constructive (public) notice, 577 Consumer credit contracts, 368,

375–378 Consumer Credit Protection Act (CCPA),

375, 437 Consumer Financial Protection Act

(CFPA), 377, 418, 614, 619, 640 Consumer Product Safety Act,

258, 478 Consumer Product Safety Commission

(CPSC), 478–479 Consumer Product Safety Improvement

Act (CPSIA), 479 Consumer Protection Act, 256, 581 Consumer Protection Statutes, 418 Contentious jurisdiction, 95 Content of advertising, 453 Contract defenses, 411–426 Contract interference, 304 Contracts, 366–409

checklist for, 390–391 consumer credit, 375–378 cost to breaching, 438–441 debtor, 434 defined, 367 electronic, 372 formation of. see Formation of

contracts form of writing, 398 “forum selection” clauses, 96

international, 402–406, 443–444 issues, cyberspace, 391 labor union, 710–711 liability, 570–571 overview, 379 parol evidence, 402 performance, 426–433 remedies, 433–441, 441 sources of law, 367–372 statute of frauds, 395–396 third-party, 434–435 third-party rights in, 442 types of, 372–374

Contracts for the International Sale of Goods (CISG), 19, 221, 402

Contributory negligence, 319, 475 Controlling the Assault of Non-Solicited

Pornography and Marketing (CAN-SPAM), 273

Conventional pollutants, 337 Convention for the Protection of

Literary and Artistic Works (Berne Convention), 525–526, 543

Cooling-off period, 700 Copyrights, 525–533

crimes online, 274 fair use and, 530–531 holders, rights of, 529–533 intellectual property, 525–540 in international business, 543

Corporate board criminal responsibility, 263–265

Corporate crime, new and higher penalties for, 262

Corporate integrity agreements (CIAs), 257–259

Corporate liability, 341–342 Corporate opportunity doctrine, 618 Corporate reorganizations, 642 Corporate veil, 608 Corporations, 44, 81, 90, 91, 259,

607–625 Corrective advertising, 454 Corruption perceptions index, 65 Costs, 114, 222, 377

slipping on FCPA, 228 speed and, 111 of unethical conduct, 51–58

Council on Environmental Quality (CEQ), 352

Counterclaims, 115 Counteroffers, 384–385 County courts, 86 County laws, 14 Court of Justice of European

Communities, 96

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Index I-5

Courts. see also Judicial system; Specific courts by name

federal system, 80–86 international, 95–97 state systems, 86–88 types of, 73

Courts of chancery, 5 Covenants not to compete, 423,

487–490 CPSC. see Consumer Product Safety

Commission CPSIA. see Consumer Product Safety

Improvement Act Credit Card Accountability,

Responsibility and Disclosure (CARD) Act of 2009, 377

Credit contracts consumer, 375–378 controlling, 377–378 disclosures in, 377 discrimination in, 375–376 subprime or predatory lending,

376–377 Creditor reports on nonpaying debtors,

438–441 Credit repair organizations (CROs), 438 Crime

business, 248–293 torts vs., 295

Crime Victims Board, 159 Criminal fraud, 274 Criminal intent, 265–267 Criminal law, 4

vs. civil law, 4 protections, 242–243

Criminal penalties, 262 for anticompetitive behavior, 513–514 for corporate crime, 262 for theft of trade secrets, 541–542 for violations, 352–355

Criminal proceedings, 286 Criminal sanctions, 352–355 Cross-elasticity of demand, 494 Cross-examination, 128 Cross-State Air Pollution Rule, 335 CTM. see Community Trademark Cultural differences, 62 Cumulative preferred stock, 611 Currency and Foreign Transactions

Reporting Act, 276 Customer and territorial

restrictions, 509 Customs, international, 17–18 Cyberbullying, 273–274 Cyber infringement, 538–540 Cyberlaw, and discovery, 124–125

D Damages, 113, 297 DEA. see Drug Enforcement

Administration Debts

end of line on enforcement of, 437–438

suits for enforcement of, 437 Decisions, 14, 73–76, 82 Defamation, 296–303 Default, defined, 119 Defendants (respondents), 77 Defenses

of defamation, 298–303 employment discrimination,

751–754 in formation of contracts, 411–426 negligence, 319–321 new industry, 509 to price discrimination, 512–513 product liability torts, 474–478 quality control for protection of

goodwill, 510 Deferred prosecution agreement (DPA),

257, 260 Deficiency letters (comment letters), 642 Degrees of protection, 156 Delegation, defined, 442 Deliberations, jury, 129 Department of Health and Human

Services (HHS), 80, 460 Department of Homeland Security

(DHS), 183, 716 Department of Labor, 683, 686,

689, 718 Department of the Interior (DOI), 180,

204, 352 Depositions, 122 Derivative suits, 117, 618 Design defects, 468 Design patents, 522 DFCFPA. see Dodd–Frank Wall Street

Reform and Consumer Protection Act

DHS. see Department of Homeland Security

Dicta, 75–76 Difficult-to-read contracts, 377, 419 Digital Millennium Copyright Act

(DMCA), 529, 530, 531 Directed verdict, 128 Direct examination, 128 Directors, 614–621 Disclaimers, 464–465 Disclosed principal, 570-571

Disclosure, 277, 455, 656–657 in credit contracts, 377 limitations on FCRA, 439 role of banks, 238–240 subprime lending representations

and, 419 Discovery, 109, 121–125, 286

cyberlaw and, 124–125 limitations on, 124

Discrimination in credit contracts, 375–376 employment. see Employment

discrimination pattern or practice of, 737–738 price. see Price discrimination racial, 749 religious, 746–748 sex, 738–745

Disgorgement, 230 Disparagement, product,

296–297, 544 Disparate impact, 731, 734–735 Disparate treatment, 171, 731–734 Dispute resolution, 102–113, 232 Dispute Settlement Body (DSB),

18, 225 Dissenting opinions, 84 Dissenting shareholders, 623–624 Dissolution

by agreement, 603 of corporations, 624–625 by court order, 604 involuntary, 625 of limited liability companies, 628 of limited liability partnerships, 629 of limited partnerships, 607 by operation of law, 603–604 of partnerships, 603–604 and termination, 628, 629

Diversity of citizenship, 81 Divulging information, 34 Divvying up markets, 501 DMCA. see Digital Millennium

Copyright Act Dodd-Frank Act, 58 Dodd–Frank Wall Street Reform and

Consumer Protection Act (DFCPA), 256, 377, 418, 581, 614, 619

DOI. see Department of the Interior Domestic corporations, 607–608 Double taxation, 613 DPA. see Deferred prosecution

agreement Drug Enforcement Administration

(DEA), 255 DSB. see Dispute Settlement Body

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I-6 Index

Due diligence, 111, 229 defense, 646 review, 343

Due process, 143, 169–171, 182–183, 279 procedural, 169–170 rights, 285–287 substantive, 170–171

Duress, 419 Duty, 308–311

breach of, 311–314 of care, 569 of compensation, 569 and criminal activity, 314 of indemnification, 569 of loyalty, 562–569 of obedience, 569

E Early neutral evaluation, 109–110 ECJ. see European Court of Justice ECOA. see Equal Credit Opportunity

Act E-commerce

and contract formation, 391–393 contract law, 372 contract performance, 429 Section 10(b), Securities Exchange

Act, 662 writing and, 398–402

Economic Espionage Act (EEA), 272 Economic pressure, 249 EDI. see Electronic digital interchange EEA. see Economic Espionage Act EEOC. see Equal Employment

Opportunity Commission Effluent guidelines, 336 8-K form, 655 EIS. see Environmental impact statement Electioneering communication, 164 Electronic communication, 391–393 Electronic Communications Privacy Act

of 1986 (ECPA), 271, 702 Electronic contracts, 372 Electronic payment, 429 Electronic Signatures in Global and

National Commerce Act, 398 E-mails, 281–283

employee, 704 and NlRA issues, 705

Embezzlement, 250, 268, 269–270 Eminent domain

and ESA, 351 just compensation, 169 perils of, 176 in the post-Kelo world, 167–168

public purpose, 165–167 taking/regulating, 168–169

Emissions offset policy, 333 Emotional distress, intentional infliction

of, 305 Employee conduct management, 554–587

agent’s rights and responsibilities, 562–569

committing acts of personal decadence, 35

creation of agency relationship, 557–562

international law, 585–587 liability of principals for agents’

conduct, 570–577 principal’s rights and responsibilities,

569 termination of agency relationship, 577 termination of agents under

employment at will, 577–585 terminology, 555–557

Employee Retirement Income Security Act (ERISA), 692

coverage of, 692 employee rights, 693 requirements of, 692–693

Employees economic weapons of, 713–715 handbooks, 585 independent contractors vs., 696 injuries, 695 labor unions, 685–694 master–servant relationships, 556 pensions, 690–693 ranking, 713 rights, ERISA, 693, 712 termination disputes, 584 theft, 250

Employee welfare management, 680–722

international issues, 715–722 labor unions, 700–715 pensions and retirement, 690–695 unemployment compensation,

693–695 wage and hours protection, 681–688 worker’s compensation laws,

695–700 workplace safety, 688–690

Employment at will, 577–585 Employment discrimination, 728–763

affirmative action, 749–751 Age Discrimination in Employment

Act, 729, 756–758 Americans with Disabilities Act,

759–760

communicable disease in workplace, 758

defenses, 751–754 enforcement, 755–756 Equal Pay Act, 688, 729, 758 Family and Medical Leave Act

(FMLA), 760–761 global workforce, 761–763 history of law, 729–731 international issues, 720 Rehabilitation Act, 730, 759 specific applications, 738–749 theories of discrimination, 731–738 Title VII of Civil Rights Act, 731

Employment impairment and testing issues, 690

Enabling acts, 180, 186–187 Endangered species, 348–350 Endangered Species Act (ESA),

348–350 Endorsement contracts, 383, 555 Energy Policy Act, 211 Energy Reorganization Act, 581 Enforcement

of debts, suits for, 437 of environmental laws, 352–356

English-only policies, 766 Enlightened self-interest, 44 Enron era, 256 Environment

common law remedies and, 329–332 regulatory scheme, 352 as source of international law, 220

Environmental impact statement (EIS), 345

Environmentalists, effect of, 356 Environmental Protection Agency (EPA),

15, 180, 183, 333, 353 Environmental quality regulation,

345–346 Environmental regulation, 328–358

common law remedies, 329–332 enforcement of, 352–356 federal, 347–352 international issues, 356 state, 351–352

EPA. see Environmental Protection Agency

Equal Credit Opportunity Act (ECOA), 375

Equal Employment Opportunity Act, 14, 729

Equal Employment Opportunity Commission (EEOC), 15, 180, 729, 755

Equality, promoting through law, 6

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Index I-7

Equalization of representation, 750 Equal Pay Act, 688, 729, 758 Equal protection, 171 Equal Protection Clause, violation, 81 Equal-right-to-employment acts, 6 Equitable remedies, 117, 514 Equity vs. law, 5–6 ERISA. see Employee Retirement Income

Security Act ESA. see Endangered Species Act ETCs. see Export trading companies Ethical postures for social responsibility,

43–45 Ethical standards

moral relativism, 31 natural law and ethics, 31 positive law and ethics, 29–30 religion, 31

Ethics, 24–71 business, 28–31, 45–50 categories of ethical dilemmas, 31–36 creation of ethical culture in business,

58–61 defined as, 26–27 description, 26–27 importance of values, 51–58 in international business, 61–66 rationalization, 39–42 reasons for, 45–46 resolution of business ethical

dilemmas, 37–39 social responsibility, 43–45 stance development, 59–61 as strategy, 53

EU. see European Union European Commission, 223 European Community. see European

Union European Council, 223 European Court of Human Rights, 96 European Court of Justice (ECJ), 223 European Parliament, 223 European Union (EU)

antitrust guidelines, 515 environmental regulation, 356 Great Britain leaving (Brexit), 19, 223 international law, 19 international trade, 223 trademark registration, 542

Evidentiary issues, 128 Exchange rates, 404–405 Exclusionary conduct, 494 Exclusive distributorship, 508 Exclusive jurisdiction, 81 Exculpatory clauses, 423 Executed contracts, 374

Executive branch of federal government, 141–142

Executive committee, 614 Executive orders, 15 Executory contracts, 374 Exempt securities, 637 Exempt transactions, 637–642 Exhausting administrative

remedies, 209 Ex parte contacts, 208 Expectations, honoring through law, 6 Expert testimony, 128 Expiration, termination by offer, 389 Export trading companies (ETCs), 241 Export Trading Company Act, 241, 242 Express authority, 557 Express contracts, 557

defined, 372 vs. implied contracts, 372–374

Express warranties, 449–452, 464 Expropriation, 235–237, 242

F Facilitation payments, 62, 229–230 Fact, vs. opinion, 450 Failing-company doctrine, 503 Fair Credit and Charge Card Disclosure

Act, 377 Fair Credit Billing Act, 433 Fair Credit Reporting Act (FCRA), 438

application, 438 disclosures, limitations on, 439 right of debtor correction of

information, 439–441 Fair Debt Collections Practices Act

(FDCPA), 434 application, 434 collector restrictions under, 434–436 violations, penalties for, 437

Fair-disclosure rule (Regulation FD), 655

Fair Employment Practices Act, 731 Fair Labor Standards Act (FLSA),

681–687 and child labor provisions, 684 coverage of, 681 enforcement of, 686 liability for violation, 686 minimum wage and overtime

regulations, 682–683 violation, penalties for, 686–687

Fair trade contracts, 504 Fair use, 530–532 Falkland Islands, 233 False Advertising Law, California, 158

False Claims Act, 472, 581 False impressions, 32 False imprisonment, 304–305 False representation, 416 Family and Medical Leave Act (FMLA),

760–761 Family Smoking Prevention and Tobacco

Control Act, 203 FCCA. see Florida-Caribbean Cruise

Association FCC regulations. see Federal

Communication Commission regulations

FCPA. see Foreign Corrupt Practices Act FCRA. see Fair Credit Reporting Act FDA. see Food and Drug Administration FDCPA. see Fair Debt Collections

Practices Act Featherbedding, 711–712 FEC. see Federal Election Commission FECA. see Federal Election Campaign

Act Federal administrative regulations, 15 Federal circuits, 83 Federal Communication Commission

(FCC) regulations, 202 Federal court system, 80–86 Federal crimes, 279 Federal district courts, 80–84 Federal dollars (hard dollars), 162 Federal Election Campaign Act

(FECA), 160 Federal Election Commission (FEC), 160,

162, 163 Federal environmental laws, penalties for

violation of, 355 Federal Environmental Pesticide Control

Act, 347 Federal environmental regulations,

347–351 Federal Insurance Contributions Act

(FICA), 690 Federal judges, selection of, 79 Federal law, 15, 418, 433

congressional law, 14–15 executive orders, 15 federal administrative regulations, 15 penalties for business crime,

257, 258 regulation of business-constitutional

conflicts, 152–153 restraint of trade, 491–492

Federal Privacy Act (FPA), 184–185 Federal Register, 186, 188 Federal Register Act (FRA), 186 Federal Register System, 186

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I-8 Index

Federal Reporter, 84 Federal Sentencing Commission, 58 Federal sentencing guidelines, 262 Federal Supplement, 82 Federal Tax Service, Russia, 236 Federal Trade Commission (FTC), 183,

207, 306, 377, 453–460 Federal Trade Commission (FTC) Act,

208, 453, 513 Federal Trademark Dilution Act, 535 Federal trademark law, 458 Federal Unemployment Tax Act

(FUTA), 693 Federal Water Pollution Control Act of

1972, 336 Federal Water Pollution Control

Administration (FWPCA), 336 FICA. see Federal Insurance

Contributions Act Fiduciaries, corporate, 615 Fifth Amendment, 81, 143, 164–165, 279

rights for businesses, 283–287 Financial fraud, 249–250 Financial Services Reform Act, 256 First Amendment

commercial speech and, 156 protection for advertising, 156–158 rights and corporate political speech,

159–164 rights and profits from sensationalism,

158–159 Flexibility, as characteristic of law, 7 FLSA. see Fair Labor Standards Act FMLA. see Family and Medical

Leave Act FOIA. see Freedom of Information Act Food and Drug Administration (FDA),

52, 55, 154, 186–187, 250, 253, 460 Food labeling rules, proposed FDA rule

on, 187 Force majeure clauses, 405, 429, 443 Foreign

business corruption, 65 commerce, congressional regulation

of, 144 Foreign Assistance Act, 235, 242 Foreign corporations, 607–608 Foreign Corrupt Practices Act (FCPA), 62,

227–231, 243, 377, 586 Foreign Sovereign Immunities Act,

233, 242 Forensic accounting, 249 Formal rulemaking

agency research of problem, 187–188 congressional enabling act, 186–187 proposed regulations, 188–189, 199

proposed rules, court and legislative challenges to, 200–204

public comment period, 189–199 Formation of contracts

acceptance, 390–391 consideration, 394–395 e-commerce and, 391–393, 398–402 issues in, 402–405 offer, 378–390 requirement of records, 395–398 writing, 398–402

Forum non conveniens doctrine, 237 “Forum selection” clauses, 96 Fourth Amendment rights for businesses,

279–281 FPA. see Federal Privacy Act FRA. see Federal Register Act France, 78 Fraud, 249–250, 415–417 Fraudulent misrepresentation, 415–417 Freedom of Information Act (FOIA),

183–184 Free speech, 502 Freeze-out, corporate, 624 Friendly takeover, 669 Front-page-of-the-newspaper test, 38 FTC. see Federal Trade Commission FTC Act. see Federal Trade Commission

Act Full-disclosure standard, 643 Function (utility) patents, 522 FUTA. see Federal Unemployment Tax

Act FWPCA. see Federal Water Pollution

Control Administration

G Garnishment, 437 General Agreement on Tariffs and Trade

(GATT), 224, 242 General partners, 604 Generics, 534–535 Genetic Information Nondiscrimination

Act (GINA), 730 Geneva Convention, 13, 18 Geographic market, 493 Germany, 78, 231, 630 GINA. see Genetic Information

Nondiscrimination Act Glass Ceiling Act, 730 Global warming, 334–335 Global warming treaty (Kyoto

Protocol), 226 “Golden Rule,” 39, 62 Good-faith bargaining, 710

Good reputation, value of, 55–56 Government corporations, 608 Government in the Sunshine Act, 185 Grand juries, 286 Gratuitous agency, 569 Gray market, 543 Grease payments, 63–64, 229–230 Great Britain, 78, 221

leaving European Union, 19, 223 Greenhouse gas emissions, 204 Group boycotts, 493, 502 Group suits, 356 GSA. see Government Services

Administration Guanxi, 64 Gun-Free School Zones Act of

1990, 144

H Hague Convention, 226 Hague proceedings, 238–239 Haiti, 230 Handling errors, 471 Hard dollars (federal dollars),

161, 162 Hart–Scott–Rodino Antitrust

Improvements Act, 491 Hazardous Substance Response Trust

Fund, 339 Health Insurance Portability and

Accountability Act (HIPAA), 306 Hearing examiners, 208 Hearing officer, 208 Hearings, administrative agency,

207–209 Hearsay, 128–129 HHS. see Department of Health and

Human Services Hickenlooper Amendment, Foreign

Assistance Act, 235, 242 High-context cultures, 220 HIPAA. see Health Insurance Portability

and Accountability Act Home Equity Loan Consumer Protection

Act of 1988, 377, 418 Homeland Security Act, 716 Homeowners’ associations, 4 Home Ownership and Equity Protection

Act of 1994 (HOEPA), 418 Home solicitation sales, 418 Honest services fraud, 256 Horizontal restraints of trade, 493–503

anticompetitive behavior, 502 divvying up markets, 501 free speech, 502

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Index I-9

group boycotts, 502 interlocking directorates, 503 merging competitors and effect on

competition, 503 monopolization, 493–494 price fixing, 496–500 refusals to deal, 502

Hostile takeovers, 669, 670 Howey test, 636 Hung juries, 129 Hybrid rulemaking, 186

I ICC. see International Chamber of

Commerce ICDR. see International Centre for

Dispute Resolution ICJ. see International Court of Justice ICSID. see International Center for

Settlement of Investment Disputes Illegal Immigration Reform and

Immigrant Responsibility Act, 716 Illegality, 420–426 ILO. see International Labour

Organization ILSA. see Iran and Libya Sanctions Act Image costs, 114 IMF. see International Monetary Fund Immigration Act of 1990 (IMMACT

90), 715 Immigration and Naturalization Act

(INA), 715 Immigration laws, 715–717 Immigration Reform and Control Act

(IRCA), 715 Implied authority, 558 Implied contracts, 373, 578–580 Implied-in-fact contract, 373 Implied-in-law contract (quasi contract),

373 Implied warranty of fitness for a

particular purpose, 464 Implied warranty of merchantability,

461–465 Impossibility, defined, 429 Improper warnings and instructions,

468–471 INA. see Immigration and Naturalization

Act Incentives for Self-Policing, Disclosure,

Correction, and Prevention of Violations program, 344

Incidental damages, 441 Incorporators, 609 Indemnification, duty of, 569

Independence requirement, board membership, 621

Independent contractors, 575–577 defined, 556 employees vs., 696 worker’s compensation laws,

695–700 Indian Tribal Court, 82 Indictment, 259 Industrial Espionage Act, 541 Infants (minors), 412–413 Influencing conduct, through law, 6 Informal rulemaking, 204–205 Information

criminal proceedings, 285–287 right of debtor correction of, 439

Inherence, 44 Inherently dangerous activities, 575 Initial appearance, 285 Initial meeting, corporations, 610 Injunctions, 207

common law remedies, 329 defined, 5, 117, 207, 514

Innocent misrepresentation, 414 In personam jurisdiction, 79, 81,

90–95, 119 In rem jurisdiction, 90 Insiders

corporate, 658 trading, 658, 660, 665

Insider Trading and Securities Fraud Enforcement Act (ITSFEA), 255, 664

Inspections, 689 administrative agencies, 205–207 of books and records by

shareholders, 624 Instructions, juror, 129 Insurance, worker’s compensation,

697–699 Intangible property, 521 Intellectual property, 520–548

copyrights, 525–533 enforcing rights, 544–548 intangible property rights, 521 international issues, 543–544 patents, 521–525 protections for, 242 trademarks, 533–540 trade secrets, 540–542

Intentional torts, 296–308 contract interference, 304 defamation, 296–303 emotional distress, intentional

infliction of, 305 false imprisonment, 304–305

intentional infliction of emotional distress, 305

invasion of privacy, 305–308 Intent to contract, 378–381 Inter-American Court of Human

Rights, 96 Interbrand competition, 505–506,

508, 509 Interbusiness crime, 252 Interlocking directorates, 503 Internal Revenue Code, 14, 221, 258 Internal Revenue Service (IRS), 37,

185, 434 International Bank for Reconstruction

and Development, 226 International business, 287–288 International Center for Settlement

of Investment Disputes (ICSID), 110

International Centre for Dispute Resolution (ICDR), 111

International Chamber of Commerce (ICC), 110

International contracts, issues in formation of, 402–405

CISG and UCC, 402–403 payment issues in, 403 risk in performance, 405

International Court of Justice (ICJ), 95, 232

International courts, 95–97 International Covenant on Economic,

Social, and Cultural Rights, 718 International disputes, resolution of,

110–111 International environmental issues,

356–357 International Labour Organization

(ILO), 718 International law, 17–20, 217–243

agency relationships, 585–587 alternative dispute resolution,

110–111 antitrust, 514–515 Brexit, 19, 223 congressional regulation of foreign

commerce, 149 constitutions in, 171–173 contract performance, 405 contracts, 402–406 custom, 17–18 doctrines of, 18 employee welfare management,

715–720 employment discrimination, 761–763 EU, 19

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I-10 Index

International law (Continued) forms of doing business, 629–630 intellectual property, 542–543 international organizations, 18 jurisdiction issues in, 96 litigation, 131 principles of, 232–237 private law, 16 product liability, 477 protections in international

competition, 238–243 securities law, 673–674 sources of, 219–227 trade law and policies, 18 treaties, 18, 242 trust, corruption, trade, and economics,

227–231 uniform, 19

International Law Reports, 96 International market, administrative

agencies in, 210–211 International marketplace

antitrust laws in, 240–241 criminal law protections, 242–243 monetary issues and, 238–240 protections for intellectual property

in, 242 International Monetary Fund

(IMF), 226 International Olympic Committee

(IOC), 244 International Organization for

Standardization (ISO) 14000, 356–357

International organizations, 18 International standards, 543 International transactions, avoiding legal

pitfalls in, 403 Internet, 306

companies, 94–95 copyright infringement, 529–530 crimes, 271–274 sales tax, 153

Internet service providers (ISPs), 273, 529

Interpersonal abuse, 35 Interrogatories, 121 Interstate commerce, 143–144, 147–148 Intervenors, 209 Interview questions, 760 Intrabrand competition, 508, 509 Intrastate offering exemption, Securities

Act, 637, 639 Intrusion into Plaintiff’s Private Affairs

tort, 305 Invasion of privacy, 305–308

Invisible hand school of thought, 44–45

Involuntary dissolution, 625 IOC. see International Olympic

Committee Iran, 225 Iran and Libya Sanctions Act (ILSA), 225 Iran Threat Reduction, 242 Iraq, 41, 225 IRCA. see Immigration Reform and

Control Act IRS. see Internal Revenue Service Islamic law, 171, 219 ISPs. see Internet service providers Italy, 65, 78 ITFA. see Internet Tax Freedom Act ITSFEA. see Insider Trading and

Securities Fraud Enforcement Act

J Japan

Foreign Corrupt Practices Act, 227 lack of discovery process, 96 lawyers, 78 legal system, 136–137, 220

Joint ventures, 629 Judges, 96

alternative dispute resolution vs. litigation, 112–113

appellate court, 74, 79 circuit, 83 civil cases, 79 defined, 79 rent-a-judge, 109 selection of, 79 Supreme Court, 85

Judgment, 437 Judgment NOV (non obstante veredicto),

131 Judicial branch of federal

government, 141 Judicial review, 73–75, 143 Judicial system, 72–99

decision-making, 73–76 international courts, 95–97 jurisdiction, 79 parties in civil cases, 77–79 in personam jurisdiction, 90–95 subject matter jurisdiction, 80–89 types of courts, 73

Junk patents, 522 “Junk science,” 128 Juries

alternative dispute resolution vs. litigation, 112–113

business litigation and, 113 consultants, 126–127 deliberations, 129 grand, 285–286 hung, 129 instructions to, 129 jury appeal, 114 jury consultants, 126–127 nonjury trials vs., 125 summary jury trials, 109 trial—jury selection, 125–127

Jurisdiction, 117 concept of, 79 defined, 79 by diversity, 81 for federal questions, 80–81 issues in international law, 95 limited, 81–82, 86 long-arm, 93 in personam, 79, 90–95 by presence in state, 90–93 in rem, 90 subject matter, 80–88 when United States is party, 80

Jurisprudence, 12–13 Juriste, 78 Just compensation, 169 Justice of the peace courts, 86 Justice, relationship to law, 10

K Knock-off goods, 543 Korea, 227 Kyoto Protocol (Kyoto Treaty; global

warming treaty), 226

L Labeling Act, 174 Labor

FLSA and, 684 immigration laws, 715–717 international standards,

718–719 international wage and safety

standards, 720–722 risks of international suppliers,

719–720 working conditions and international

labor law, 718 Labor-Management Relations Act

(Taft–Hartley Act), 700 Labor unions, statutory protections

through, 700–714 Laissez-faire approach, 458

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Index I-11

Landlords, 4 Landrum–Griffin Act (Labor-

Management Reporting and Disclosure Act), 700

Language, as source of international law, 220

Lanham Act, 534–535 Latency phase, issue cycle, 57 Law, 2–22, see also specific laws

by name characteristics of, 7–8 classifications of, 3–6 definition of, 3 international, 17–20 jurisprudence, 12–13 purposes of, 6–7 sources of, 13–16

Lawsuits danger in using as business

strategy, 16 forfeiture of right of, 697 Section 10(b), Securities Exchange

Act, 655 worker’s compensation, 696

Lawyers attorney–client privilege, 77–78 civil cases, 77–79 defined, 77 dismissal of, 100–101

Lawyer’s Edition, 85–86 Leadership in Energy and Environmental

Design (LEED), 357 Lease covenants, 487–490 LEED. see Leadership in Energy and

Environmental Design Legal costs, 114 Legal remedy, defined, 117 Legislative law, 15 Letter of credit, 443 Letter of recommendation, 300 LHDs. see Local health departments Liability limitations, cardholder, 378 Libel, 296 LIBOR. see London Interbank

Offer Rate Libya, 225–226 Licensing, 205–207, 422–423 Like grade or quality, 511–512 Lilly Ledbetter Fair Pay Act,

730, 755 Limited jurisdiction, 81–82, 86 Limited liability companies (LLCs), 595,

625–628 Limited liability partnerships (LLPs), 595,

628–629 Limited partners, 604

Limited partnership agreement (articles of limited partnership), 605

Limited partnerships, 595, 604-607 Line-cutting, 27 Line on enforcement of debts,

437–438 Lingering apparent authority, 577 Liquidated damages, 441 Litigation

alternative dispute resolution vs., 111–113

answers, 119, 120 complaints, 115–117 costs, 111 danger in using as business

strategy, 15 discovery, 121–125 international, 131–133 Japan, 136–137 post-trial proceedings, 130–131 resolution, 125–131 seeking timely resolution, 119, 121 start of lawsuits, 113–115 summons, 117–119

LLCs. see Limited liability companies LLPs. see Limited liability partnerships Lockout, 714 London Commercial Court, 232 London Interbank Offer Rate

(LIBOR), 287 Long-arm jurisdiction, 94–95 Long-arm statutes, 91–93 Long-term debt financing, 610 Loss of evidence, risk and emergencies

of, 281 Lower courts. see Trial courts Loyalty, duty of, 562–564

M Maastricht Treaty (Treaty on European

Union), 223, 242 MACT. see Maximum achievable control

technology Madrid Agreement, 542 Madrid System of International

Registration of Marks (Madrid Protocol), 534, 542

Mafia, 65 Mailbox rule, 390 Mail/Telephone Order Merchandise

Rule, 454 Maine Unfair Trade Practices Act

(MUTPA), 174 Malice, 297 Mandatory arbitration, 103–104

Mandatory bargaining terms, 710 Manufacturing errors, 471 Market power, 493 Master–servant relationships,

556, 572 Material facts, 414 Material misstatement defense, 646 Maximum achievable control technology

(MACT), 334 MBCA. see Model Business Corporation

Act McCain-Feingold law (Bipartisan

Campaign Reform Act (BCRA)), 162

Mediation, 108 Mediation arbitration (medarb), 108 Meeting the competition, 513 Mens rea, 265–267 Mental capacity, 414 Merchants’ confirmation

memoranda, 399 Merchant’s firm offer, 384 Mergers, 668 Merging competitors, 503 Merit review standard, 671 Merit systems, 752 MFN status. see Most-favored-nation

status Minimum contacts, 90–91 Minitrials, 108–109 Minors (infants), 412–413 Miranda rights, 284–285 Misappropriation, 545 Misconduct, 752–754 Misrepresentation, 414–417

in cyberspace, 306 fraud or fraudulent, 415–417

Misuse of product, 474–475 MLCA. see Money Laundering Control

Act Model Business Corporation Act

(MBCA), 15, 608 Model Law for Arbitration, 111 Modifying decisions, 74 Money laundering, 277 Money Laundering Control Act

(MLCA), 277 Monitors, 258–259 Monochronic nations, 221 Monopolization, 493–495 Monopsony, 508 Morality clauses, 383 Moral relativism (situational

ethics), 31 Most-favored-nation (MFN)

status, 224

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I-12 Index

Motion for judgment on the pleadings, 120–121

Motion for summary judgment, 121 Motions, 119 Motion to dismiss, 121 Multilateral treaty, 224, 226 MUTPA. see Maine Unfair Trade Practices

Act

N NACCHO. see National Association of

County and City Health Officials NAFTA. see North American Free Trade

Agreement NAMA. see National Automatic

Merchandising Association National Arbitration Forum, 106 National Collegiate Athletic Association

(NCAA), 591 National Environmental Policy Act

(NEPA), 345 National Labor Committee (NLC), 719 National Labor Relations Act (NLRA;

Wagner Act), 700, 725 National Labor Relations Board (NLRB),

142, 700, 725 National Pollution Discharge Elimination

System (NPDES) permits, 336 National reporters, 87, 89 National Security Administration

(NSA), 576 NATO. see North Atlantic Treaty

Organization Natural law, 12, 31 NCAA. see National Collegiate Athletic

Association Negligence, 295, 308–321, 475 Negligent failure to supervise, 573 Negligent hiring, 573, 575 Negotiation, 378–381, 710–711 NEPA. see National Environmental Policy

Act Netherlands, 221, 227 New industry defense, 509 New London Development Corporation

(NLDC), 165 New York Road Runners Club, 32 Nexus, 150 NGO, 227, 229 NIMBYs. see Not In My Back Yard

groups NLC. see National Labor Committee NLDC. see New London Development

Corporation NLRA. see National Labor Relations Act

NLRB. see National Labor Relations Board

Noerr–Pennington doctrine, 502 Noise control, 347 Noise Control Act of 1972, 347 Nolo contendere, 207 Nonattainment areas, 333 Nonbinding arbitration, 104 Noncompete agreements, 564–565 Nonconventional pollutants, 336 Nonfederal money (soft money

donations), 162 Non obstante veredicto (NOV), 131 Nonpaying debtors, creditor reports on,

438–441 Nonpayment, 433–441 Nonperformance, 433–441 Nonprofit corporations, 607 Nonverbal behavior, as source of

international law, 220–221 Normative standards, 26–27 Norris–LaGuardia Act, 700 North American Free Trade Agreement

(NAFTA), 225, 242, 345 North Atlantic Treaty, 242 North Atlantic Treaty Organization

(NATO), 242 Notaire, 78 Notices to shareholders, 623 Not In My Back Yard groups

(NIMBYs), 329 NOV. see Non obstante veredicto Novations, 433, 609 NPAs. see Non-prosecution agreements NPDES permits. see National Pollution

Discharge Elimination System permits

Nuisances, 331–332

O Obedience, duty of, 569 Obstruction of justice, 268–269 Occupational Safety and Health

Act, 279, 688 Occupational Safety and Health

Administration (OSHA), 205–206, 347, 688

coverage and duties, 688 inspections, 689 penalties, 689 promulgating rules and safety

standards, 688 regulators, 143 search warrant requirements, 689 state programs, 690

violations, 252, 257 OCILLA. see Online Copyright

Infringement Liability Limitation Act

OECD. see Organization for Economic Cooperation and Development

Offer, contract, 378–390 Offeree, contract, 378, 390–391 Offeror, contract, 378 Office of Harmonization of the Internal

Market (OHIM), 543 Officers, corporate, 267–268 Officious meddler, 373 OHIM. see Office of Harmonization of

the Internal Market Oil Pollution Act, 338, 355 Oil Spill Liability Trust Fund, 338 Omnibus hearings, 287 Online sales tax, 153 OPEC. see Organization of Petroleum

Exporting Countries Opening statements, 127 Open meeting law, 185 OPIC. see Overseas Private Investment

Corporation Opinion, vs. fact, 450 Opposition proceedings, 542 Options, defined, 384 Oral arguments, 74 Order

keeping, through law, 6 normative standards, 26–27

Ordinances, 16 Ordinary and reasonably prudent person

standard, 308–309 Organizational abuse, 35 Organization for Economic

Cooperation and Development (OECD), 231

Organization of Petroleum Exporting Countries (OPEC), 227

Original jurisdiction, 85 OSHA. see Occupational Safety and

Health Administration Overseas Private Investment Corporation

(OPIC), 236, 242 Over-the-counter drugs, 468 Overtime pay, 682

P Pacific Reporter, 87 Packaging errors, 471 PACs. see Political action committees Palming off, 545 Parable of the Sadhu, 46–50

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Index I-13

Parody of copyrighted material, 531–532

Parol evidence, 402 Partially disclosed principal, 570, 571 Parties responsible for enforcement, 352 Partnership by estoppel, 599 Partnership by implication, 596 Partnerships, 594–597

dissolution and termination of, 603–604

formation of, 594–599 liability, 600–601 limited, 604–607 limited liability, 628–629 management and control of,

601–603 sources of funding, 599–600 tax consequences in, 601 transferability of interest, 603

Party autonomy, 18 Patents, 521–525

infringement, remedies for, 524–525

process, 523 protection, 542 types and length of, 522

Patient Protection and Affordable Care Act (PPACA), 145, 186–187, 690

Pattern or practice of discrimination, 731, 737–738

Payment assuring, 443 electronic, 429 fair standards for obtaining,

434–437 issues in international contracts,

403–405 method and means of, 443

PCIJ. see Permanent Court of International Justice

Peer review, 110, 584 Pension Protection Act, 692 Pensions, 690–691 People for the Ethical Treatment of

Animals (PETA), 362 Per curiam opinion, 158 Peremptory challenge, 126 Performance

assuring, 443 claims, 454–456 contract, 426–433, 443–444 standards for, 428–429

Permanent Court of International Justice (PCIJ), 95

Per se illegal behavior, 487, 492, 496, 497, 498, 499, 502, 504, 505

Personal accountability and comfort, 45–46

Pervasiveness, as characteristic of law, 7–8

Pesticide control, 347 PETA. see People for the Ethical

Treatment of Animals Petitioners, 79 Petitions, 115–117 Picketing, 711 Pirates, 224 Plaintiffs, 77 “Plain view” exception, 281 Plant patents, 522 Plea bargains, 286 Pleadings, 119 Police power, 147 Political action committees (PACs),

160–161 Polychronic nations, 221 Ponzi schemes, 673–674 Pooling agreements, 622 Positioning short, 678 Positive law, 12, 29–30 Postemployment, 564–565 Power of attorney, 555 PPACA. see Patient Protection and

Affordable Care Act Precedents, 75–76 Predatory bidding, 508 Predatory lending, 419

credit contracts, 376–377 Predatory pricing, 494 Preemployment medical

examinations, 759 Preemption, 152–153 Preferred stock, 611 Pregnancy Discrimination

Act, 729 Preliminary hearings, 285–286 Presence in the state, 90–93 Pretexting, 37, 42 Prevention of significant deterioration

(PSD) areas, 333 Price discrimination, 511–512

defenses to, 512–513 Price fixing, 493, 496–500, 515 Prima facie case, 128, 514, 596, 732,

733, 738 Primary trade sanctions (primary

boycotts), 225–226 Principal–agent relationship, 551, see also

Agency relationships Principals, 555, 562–569 Principles of Federal Prosecution of Business

Organizations, 292

Privacy alternative dispute resolution vs.

litigation, 111 invasion of, 305–308

Private actions for damages, 514 Private law, 4, 18

in international transactions, 18 Private (actual) notice, 577 Private retirement plans, 692–693 Private Securities Litigation Reform Act

(PSLRA), 650 Privatization, 66 Privileged speech, 299–302 Privity, 466, 473–474 Probate courts, 86 Procedural due process, 169–170 Procedural laws, 4 Procedural rights for business criminals,

279–287 Process servers, 119 Procuratori, 78 Product comparisons, FTC control of,

458–459 Product disparagement, 296,

544–545 Product liability, 448–485

advertising as contract basis for, 449–460

defenses to product liability torts, 474–478

development of, 449 federal standards for, 478–479 implied warranties, 460–466 international issues in, 479 legal basis for, 474 product liability reform, 478 strict tort liability, 466–474 theories, comparison of, 474

Product market, 493 Professional ads, 460 Professional corporations, 608 Profit corporations, 607 Promissory estoppel, 394 Proper purpose, 624 Proposed labeling rules, 188, 189 Prospectus, 642 Proxies, 666, 667, 670–671 Proximate cause, 315–318 PSD areas. see Prevention of significant

deterioration areas PSLRA. see Private Securities Litigation

Reform Act Publication, 296 Public comment period, 189–191 Public Disclosure of Private Facts tort,

306–307

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I-14 Index

Public law, 4 Publicly held corporations, 608 Public (constructive) notice, 577 Public policy, 420–426, 580–584 Public Use Clause, 167 Puffing, 414 Punitive damages, 322, 375, 473, 756

Q Qualified privileges, 299, 302 Quality control for protection of goodwill

defense, 510 Quasi contract. see Implied-in-law

contract Quebec, 78 Quota program, 750

R Racial discrimination, 749 Racketeer Influenced and Corrupt

Organizations (RICO) Act, 275–276

Racketeering acts, 276 Ranking employees, 713 Ratification, 561, 609 Rationalization, 39–42 RCO doctrine. see Responsible corporate

officer doctrine Reaching buyer in same condition,

471–473 Readability level of regulation, 211 Rechtsanwalt, 78 Red-herring prospectus, 643 Redirect examination, 128 Refusals to deal, 502 Regional reporters, 87, 88 Registration, 636–637 Registration statement (S-1),

642–643 Regulation A, Securities Act, 639 Regulation D, Securities Act,

693–641 Regulation FD (“fair-disclosure rule”),

655 Regulatory Flexibility Act, 189 Rehabilitation Act, 730, 759 Rejection, termination of an offer by,

384–388 Relativism, 61 Released on own recognizance, 285 Relevant market, 493 Religion

discrimination, 746–748 ethics and, 31

Remanding cases, 74 Rent-a-judge, 109 Repatriation, 237, 242 Reporting lines, 59 Request for admissions, 121–122 Request for production, 122–123 Resale price maintenance, 504–508 Rescission

of contracts, 414 rights, 417–419

Residency, 90 Resource Conservation and Recovery Act

of 1976, 338, 355 Respondents

appellee, 79 defendants, 77

Respondent superior doctrine, 572, 574

Responsible corporate officer (RCO) doctrine, 260

Restatement of Agency, 556–557 Restatement (Second) of Contracts,

367, 368 Restatement (Second) of Torts, 449,

466–474 Reverse, 74

FOIA suits, 184 Reversible errors, 74 Revised Uniform Limited Partnership

Act (RULPA), 604 Revised Uniform Partnership Act

(RUPA), 594 Revocation, termination of offer

by, 384 RICO Act. see Racketeer Influenced and

Corrupt Organizations Act Right of debtor correction, 439–441 Right-to-sue letter, 756 Right-to-work laws, 712–713 Risk-takers, 63–64 Rivers and Harbors Act of 1899, 336 Robinson–Patman Act, 492, 511,

512–513 Routine agency tasks, 185 Rule 504 exemption, Regulation

D, 640 Rule 505 exemption, Regulation D,

640–641 Rule 506 exemption, Regulation D, 641 Rule of reason standard, 492 RULPA. see Revised Uniform Limited

Partnership Act Runaway shop, 713 RUPA. see Revised Uniform Partnership

Act Russia, 219, 220, 224, 226, 233–234

S S-1 (registration statement), 642 Sadhu, Parable of, 46–50 Safe Drinking Water Act, 337 Sanctions, 121, , 207, 225–226,

352–355 Sarbanes–Oxley (SOX), 58–59, 77, 250,

255–256, 258, 268, 269 581, 619–621, 646, 650–653, 655, 664

SCA. see Stored Communication Act Scheduled injuries, 696–697 Scienter, 265–267, 415, 664 Scope of employment, 572–574 S corporations, 608, 613 SDR. see Special Drawing Rights Search warrants, 280, 689 SEC. see Securities and Exchange

Commission Secondary boycotts, 225–226, 700 Section 14, Securities Act, 666, 667,

668, 671 Section 16, Securities Act, 665 Section 10(b) (antifraud provision),

Securities Exchange Act, 655–665 Section 11 violations, Securities Act, 643,

646–650 Section 12 violations, Securities

Act, 650 Secured lender exemption, 339 Securities Act, 204, 635–653 Securities and Exchange Act of

1934, 258 Securities and Exchange Commission

(SEC), 15, 30, 37, 40–41, 179, 180–182, 227, 260, 270, 619, 636–637, 639, 641, 642–679, 693

organizational chart, 181 Securities Exchange Act, 635, 654–671 Securities law, 634–679

Foreign Corrupt Practices Act, 672 history of, 635 influencing conduct, 6 international issues, 673–674 Securities Act, 635–653 Securities Exchange Act, 654–671 state securities laws, 671–672

Self-incrimination, 283–284 Self-interest, 70 Selfishness, 70 Seller engaged in business, 473 Seniority systems, 688, 752 Sensationalism, profits from,

158–159 Sentencing guidelines, 59, 262–263 Separation of powers, 141–142

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Index I-15

Settled doctrines of criminal law, 254 Sex discrimination, 738–745 Sexual harassment, 35, 739–742 Shame punishment, 259–261 Shareholders, 7, 39, 43–45, 117, 611–613,

621–624, 668–671 Shelf registrations, 643 Sherman Act, 14, 258, 279, 491, 492, 493,

496–502, 504, 509, 513 Shiho-Soshi, 78 Shopkeeper’s privilege, 304, 305 Short-swing profits, 665–666 SIPs. see State implementation plans Situational ethics, 31 Sixth Amendment, 279, 285 Slander, 296 Slander of title, 544 Slowdown, 711 Small Business Liability relief and

Brownfields revitalization Act, 344 Small claims courts, 86 Small-company doctrine, 503 Small-offering exemption, Securities Act,

639–641 Smartphones, 124–125 Smart-pigging (ultrasonic checking), 53 Social contract, 12–13 Social media

celebrity tweeting, 457 as court management problem, 130 ECPA and, 271, 702 NLRB and, 705 non–English-speaking countries

and, 220 union organizing efforts and, 701

Social responsibility, 43–45 Social security, 690–691 Social Security Act, 690 Social welfare programs of state and

federal governments, 6 Soft money donations (nonfederal

money), 162 Sole outlet, 508, 509 Sole proprietorships, 593–594 Solicitors, defined, 78 Solid waste disposal regulation,

338–344 Somalia, 224 Sonny Bono Copyright Extension

Act, 528 Son of Sam law, 159 Sovereign immunity, 232–235 SOX. see Sarbanes–Oxley Special Drawing Rights (SDR), 226 Specialty courts, 80, 86 Specific performance, 117

Specified means. see Stipulated means Speed and cost, 111 Stakeholders, 43 Standards for performance, 428–429 Stare decisis doctrine, 5, 75–76 State administrative law, 15–16 State appellate courts, 87–88 State codes, 15 State courts of appeals, 86 State court systems, 86–88 State crimes, 279 State environmental laws, 351 State implementation plans

(SIPs), 333 State laws

administrative law, 15–16 environmental regulation, 351 Occupational Safety and Health

Administration, 688–690 regulation of business-constitutional

conflicts, 152–155 regulation of interstate commerce,

147–149 securities law, 671–672 tender offers, 669

State reporters, 87 State supreme courts, 86, 88 State trial courts, 86–87 Statute of frauds, 395–398 Statutes of limitations, 115 Statutory environmental laws,

332–352 air pollution regulation, 332–336 environmental quality regulation,

345–346 federal environmental regulations,

347–351 solid waste disposal regulation,

338–344 water legislation, 336–338 water pollution regulation,

336–338 Statutory interpretations, 75 Statutory law, 5, 13

at federal level, 14–15 environment quality regulation,

345–356 at state level, 15–16

Stipulated means, 390–391 Stored Communication Act (SCA),

271, 702 Strict liability, 322, 467 Strict tort liability, 296, 466–474 Strikes, 700 SUA. see Sudden unintended

acceleration

Subject matter jurisdiction, 80–89 Submarket, 493 Subprime lending, 376–377, 419 Substantial evidence standard, 201 Substantial evidence test, 201 Substantial performance, 429 Substantive due process, 170–171 Substantive laws, 4, 170 Sudden unintended acceleration

(SUA), 468 Suggested retail price, 504 Summary jury trials, 109 Summons, 117–119 Sunset law, 204 Superfund, 339, 344, 348 Superfund Amendment and

Reauthorization Act, 339 Superior skill, foresight, and

industry, 494 Supremacy Clause, 142, 152–155 Supreme Court Reporter, 85 Supreme courts, 7, 8–10, 74, 80,

84–86, 88 Surface mining, 347 Surface Mining and Reclamation Act of

1977, 347 Sustainability, 328, 362 Sustainable Forestry Initiative, 350 Syria Human Rights Act, 242

T Taft–Hartley Act (Labor-Management

Relations Act), 700, 710, 712 Takeovers, 668–671 Takings Clause, 164–169 Tangible evidence, 122, 128 Tariffs, 222, 223 Taxation of business, constitutional

standards for, 149–151 Tax Court, 81 Taxes

constitutional standards for, 149–151

corporations, 613–614 limited liability companies,

625–626 limited liability partnerships, 629 limited partnerships, 606 partnerships, 601 sole proprietorships, 594

Technology forcing, 333 as source of international law, 220

Tenancy in partnership, 602 Tender offers, 669–671

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I-16 Index

10-K form, 655 10-Q form, 655 Termination

of agency relationship, 577 of agents under employment at will,

577–585 disputes, employees, 584 of limited liability companies, 628 of limited liability partnerships, 629 of limited partnerships, 607 of offer by expiration, 389 of offer by rejection, 384–389 of offer by revocation, 384 of partnerships, 603–604

Terrorist groups, 277 Text messages, 281–283 Theft

defined, 268 employee, 250

Third-parties contact, 434–435 copyright infringement, 526–528 liability of principals for agents’

conduct, 570–577 worker’s compensation lawsuits, 697

Thompson memo, 292–293 Three-day cooling-off period, 417 Three-day rescission rights, 418–419 TILA. see Truth in Lending Act Tillman Act, 160 Time concept, as source of international

law, 221 Time costs (hidden downtime), 114 Timing rules for acceptance, 390 Tippees, 658 Title II of Genetic Information

Nondiscrimination Act (GINA), 730

Title VII of the Civil Rights Act of 1964 (Fair Employment Practices Act), 729

application of, 731 defenses to, 751–754 employment procedures

covered, 731 enforcement, 755–756 specific applications of, 738–749 theories of discrimination under,

731–738 Title warranties, 465 Tombstone ads, 643, 644 Tony Bennett factor, 54–55 Tortious interference with contracts,

304, 565 Torts, 91, 277

business. see Business torts

definitions and types, 91 liability of principals for agents,

572–577 TOSCA. see Toxic Substances

Control Act Township laws, 16 Toxic pollutants, 336 Toxic Substances Control Act

(TOSCA), 338 Trade

controls, 222–227 federal laws, 491–493 horizontal restraints of. see Horizontal

restraints of trade law and policies, 18 organizations, 222–227 vertical restraints. see Vertical trade

restraints Trade dress, 538 Trade libel, 544 Trademarks, 533–540

cyber infringement, 538–540 defined, 533 enforcing, 534–535 legal protections for, 534 misuse, rights for, 535–538 protection, 542–543 trade dress, 538

Trade names, 535 Trade secrets, 184, 540–542

criminal penalties for, 541 defined, 540–541 protection, 541

Trading huddles, 661 Traffic courts, 86 Traffic laws, 2, 309 Transfer restrictions, stock

share, 624 Transfers of consumer credit

balances, 378 Transport Rule, 335 Treaties, 18, 222–227, 236, 242, 761 Treaty on European Union (Maastricht

Treaty), 223 Treble damages, 80, 514, 535 Trial consultants, 126–127 Trial courts

defined, 73 federal district courts, 80, 81–82 special, 81–82 state, 86–87

Trial de novo, 87 Trial judges, 79. see also Judges Trial—jury selection, 125–127 Trial process, 113, 115, 127–130 Truth in Lending Act (TILA), 377

Tying arrangements, 509–513 price discrimination, 511–513 vertical mergers, 513

Tying sales, 509

U UCC. see Uniform Commercial Code UCITA. see Uniform Computer

Information Transaction Act UDPAA. see Uniform Durable Power of

Attorney Act UETA. see Uniform Electronic

Transactions Act ULPA. see Uniform Limited

Partnership Act Ultrasonic checking, 53 Ultra vires standard, 202, 204,

334, 335 UN. see United Nations Unauthorized appropriation

tort, 307 UNCITRAL. see United Nations

Commission on International Trade Law

Unconscionable contracts, 423 Unconscionable disclaimers, 465 Undisclosed principal, 570, 571 Undue influence, 419–420 Unemployment compensation

benefits provided, 693 employers, 694–695 qualifying for benefits, 693–694

Unenforceable contract, 374, 394 Unfair advantage, 34–35 Unfair employee practices,

711–712 Unfair labor practice, 711 Unfair treatment, 35 Uniform Commercial Code (UCC),

15, 237 additional terms of acceptance, 386 Article 2A Leases, 372 CISG and, 402–403 contracts, 368–372 defined, 368 eliminating warranty by disclaimers,

464–465 express warranty, 449 privity standards, 466 rejection by counteroffer under,

384–389 rules on contract formation, 402 statute of frauds, 396–398

Uniform Computer Information Transaction Act (UCITA), 372

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Index I-17

Uniform Durable Power of Attorney Act (UDPAA), 557–558

Uniform Electronic Transactions Act (UETA), 372, 398–402

Uniform international laws, 19 Uniform laws, 15 Uniform Limited Partnership Act

(ULPA), 604 Uniform Partnership Act (UPA),

15, 594 Uniform Probate Code, 15 Uniform Residential Landlord and

Tenant Act, 15 Uniform Trade Secrets Act

(UTSA), 541 Uniform Unincorporated Nonprofit

Association Act (UUNAA), 558 Unilateral contracts, 372

bilateral contracts vs., 372 Unincorporated associations, 558 Union Carbide, 131, 232, 237 Unionization process

certification, 709 collective bargaining unit, 706 nonunion members in certified

workplace, 709-710 petition, cards, and vote, 706–709

Unions, 700–715 United Nations (UN)

Contracts for the International Sale of Goods, 19, 221

International Court of Justice, 17, 95–96, 232

international standards, 534 United Nations Commission on

International Trade Law (UNCITRAL), 111

United Nations Convention on Contracts for the International Sale of Goods (CISG), 19, 221, 402–403, 479

United States Code (U.S.C.), 14, 15 United States Reports, 85 Uniting and Strengthening America

by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act (USA Patriot Act), 14, 185, 277–279, 716

Universal treaties, 18 Unpublished opinions, 73 Unreasonably dangerous defective

condition, 467–471 Unscheduled injuries, 697 UPA. see Uniform Partnership Act U.S. Anti-Doping Agency (USADA), 42 USA Patriot Act. see Uniting and

Strengthening America by Providing

Appropriate Tools Required to Intercept and Obstruct Terrorism Act

U.S.C. see United States Code U.S. Claims Court, 80, 82 U.S. Competitiveness, 231 U.S. Court of International Trade, 80,

82, 83 U.S. (circuit) courts of appeals, 80, 82,

83–84, 87, 210 U.S. Customs Service, 241 U.S. Department of Homeland Security

(DHS), 183, 716 U.S. Department of Labor, 20, 683, 686,

689, 720 U.S. Government Manual, 186 U.S. Sentencing Commission

(USSC), 262 U.S. Supreme Court, 7, 8–10, 74, 80,

84–86 Usury laws, 423 Utility (function) patents, 522 UTSA. see Uniform Trade

Secrets Act UUNAA. see Uniform Unincorporated

Nonprofit Association Act

V VAWA. see Violence Against

Women Act Venue, concept of, 88 Verbal abuse, 35 Verdicts, defined, 129 Vertical behaviors, 492 Vertical mergers, 513, 668 Vertical trade restraints, 503–513

customer and territorial restrictions, 509

exclusive distributorship, 508 monopsony, 508 price discrimination,

511–513 resale price maintenance,

504–508 sole outlet, 508 tying arrangements, 509–511 types of, 504

Vienna Convention, 18, 221 Violating rules, 36 Violations, penalties for, 352–355 Violence Against Women Act

(VAWA), 144 Voidable contracts, 412, 419

defined, 374 void contracts and, 374

Void contracts, 414 defined, 374 and voidable contracts, 374

Voir dire, 125, 128 Voluntary dissolution, 624–625 Voluntary self-control, 57 Volunteer jurisdiction, 90 Voting trust, 622

W Wage and hours protection,

681–688 Equal Pay Act, 688, 758 Fair Labor Standards Act, 681–687

Wagner Act (National Labor Relations Act (NLRA)), 700

“Waiting your turn” principle, 27 Wall Street Journal model, 39 Wall Street Reform and Consumer

Financial Protection Act, 58, 377, 418, 614, 619, 640

Wall Street Reform and Consumer Protection Act, 256–257, 377, 581

WARN Act of 1988. see Worker Adjustment and Retraining Notification Act of 1988

Warranties express, 449–453 federal regulation of, 453 implied, 460–466

Warrants, 280, 281–283, 285, 689 Warsaw Convention, 18 Watered shares, 610 Watergate scandal, 142 Water legislation, 336–338 Water pollution regulation,

336–338 Water Quality Act, 336 Water violations, penalties for,

353–355 Wheeler-Lea Act of 1938, 453 Whistleblower Protection Act,

581, 583 Whistle-blowers, 45, 580–581, 664 White-collar crime, 248, 254,

255, 256 White-collar liability, 257 White-Collar Criminal Penalty

Enhancement Act, 244, 644 White-collar kingpin law, 255 Williams Act amendment, Securities

Exchange Act, 669–670 WIPO. see World Intellectual Property

Organization

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I-18 Index

Witness testimony, 128 Worker Adjustment and Retraining

Notification Act of 1988 (WARN), 714

Worker’s compensation laws, 695–700 administrative agency, 697 benefits, 696–697 causation and worker’s

compensation, 696 employee injuries, 695 employees vs. independent

contractors, 696

fault is immaterial, 696 insurance, 697 problems, 699–700 rights of suit, 697 third-party suits, 697

Workplace safety, 688–690 employee impairment and testing

issues, 690 Occupational Safety and Health Act, 688 OSHA responsibilities, 688–690

Work product, defined, 124 World Bank, 110, 226

World Intellectual Property Organization (WIPO), 542, 543

World Trade Organization (WTO), 18, 224–225, 522

Writ of certiorari, 84 Written contracts, 395, 577

effect of, 402 WTO. see World Trade Organization

Z Zero-based budgeting, 204

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  • Cover
  • Brief Contents
  • Contents
  • Preface
  • About the Author
  • Acknowledgments
  • Part 1: Business: Its Legal, Ethical, and Judicial Environment
    • Ch 1: Introduction to Law
      • 1-1 Definition of Law����������������������������
      • 1-2 Classifications of Law���������������������������������
      • 1-3 Purposes of Law��������������������������
      • 1-4 Characteristics of Law���������������������������������
      • 1-5 The Theory of Law: Jurisprudence�������������������������������������������
      • 1-6 Sources of Law�������������������������
      • 1-7 Introduction to International Law��������������������������������������������
      • Summary��������������
      • Questions and Problems�����������������������������
    • Ch 2: Business Ethics and Social Responsibility
      • 2-1 What Is Ethics?
      • 2-2 What Is Business Ethics?
      • 2-3 What Are the Categories of Ethical Dilemmas?
      • 2-4 Resolution of Business Ethical Dilemmas��������������������������������������������������
      • 2-5 Why We Fail to Reach Good Decisions in Ethical Dilemmas�������������������������������������������������������������������
      • 2-6 Social Responsibility: Another Layer of Business Ethics�������������������������������������������������������������������
      • 2-7 Why Business Ethics?
      • 2-8 Importance of Ethics in Business Success and the Costs of Unethical Conduct
      • 2-9 Creation of an Ethical Culture in Business�����������������������������������������������������
      • 2-10 Ethical Issues in International Business����������������������������������������������������
      • Summary��������������
      • Questions and Problems�����������������������������
    • Ch 3: The Judicial System
      • 3-1 Types of Courts��������������������������
      • 3-2 How Courts Make Decisions������������������������������������
      • 3-3 Parties in the Judicial System (Civil Cases)
      • 3-4 The Concept of Jurisdiction��������������������������������������
      • 3-5 Subject Matter Jurisdiction of Courts: The Authority over Content
      • 3-6 In Personam Jurisdiction of Courts: The Authority over Persons
      • 3-7 The International Courts�����������������������������������
      • Summary��������������
      • Questions and Problems�����������������������������
    • Ch 4: Managing Disputes: Alternative Dispute Resolution and Litigation Strategies
      • 4-1 What Is Alternative Dispute Resolution?
      • 4-2 Types of Alternative Dispute Resolution
      • 4-3 Resolution of International Disputes�����������������������������������������������
      • 4-4 Litigation versus ADR: The Issues and Costs
      • 4-5 When You Are in Litigation�������������������������������������
      • 4-6 Issues in International Litigation���������������������������������������������
      • Summary��������������
      • Questions and Problems�����������������������������
  • Part 2: Business: Its Regulatory Environment
    • Ch 5: Business and the Constitution
      • 5-1 The U.S. Constitution��������������������������������
      • 5-2 The Role of Judicial Review and the Constitution������������������������������������������������������������
      • 5-3 Constitutional Limitations of Economic Regulations��������������������������������������������������������������
      • 5-4 State versus Federal Regulation of Business-Constitutional Conflicts: Preemption and the Supremacy Clause
      • 5-5 Application of the Bill of Rights to Business��������������������������������������������������������
      • 5-6 The Role of Constitutions in International Law���������������������������������������������������������
      • Summary��������������
      • Questions and Problems�����������������������������
    • Ch 6: Administrative Law
      • 6-1 What Are Administrative Agencies?
      • 6-2 Roles of Administrative Agencies�������������������������������������������
      • 6-3 Laws Governing Administrative Agencies�������������������������������������������������
      • 6-4 The Functions of Administrative Agencies and Business Interaction�����������������������������������������������������������������������������
      • 6-5 Business Rights in Agency Enforcement Action��������������������������������������������������������
      • 6-6 The Role of Administrative Agencies in the International Market
      • Summary��������������
      • Questions and Problems�����������������������������
    • Ch 7: International Law
      • 7-1 Sources of International Law���������������������������������������
      • 7-2 Trust, Corruption, Trade, and Economics��������������������������������������������������
      • 7-3 Resolution of International Disputes�����������������������������������������������
      • 7-4 Principles of International Law������������������������������������������
      • 7-5 Protections in International Competition���������������������������������������������������
      • Summary��������������
      • Questions and Problems�����������������������������
    • Ch 8: Business Crime
      • 8-1 What Is Business Crime? The Crimes within a Corporation
      • 8-2 What Is Business Crime? The Crimes against a Corporation
      • 8-3 Who Is Liable for Business Crime?
      • 8-4 Federal Laws Targeting Officers and Directors for Criminal Accountability
      • 8-5 The Penalties for Business Crime�������������������������������������������
      • 8-6 Elements of Business Crime�������������������������������������
      • 8-7 Examples of Business Crimes��������������������������������������
      • 8-8 Procedural Rights for Business Criminals���������������������������������������������������
      • 8-9 Business Crime and International Business����������������������������������������������������
      • Summary��������������
      • Questions and Problems�����������������������������
    • Ch 9: Business Torts
      • 9-1 What Is a Tort? Roots of Law and Commerce
      • 9-2 The Intentional Torts��������������������������������
      • 9-3 Negligence���������������������
      • 9-4 New Verdicts on Tort Reform��������������������������������������
      • Summary��������������
      • Questions and Problems�����������������������������
    • Ch 10: Environmental Regulation and Sustainability
      • 10-1 Common Law Remedies and the Environment
      • 10-2 Statutory Environmental Laws: Air Pollution Regulation
      • 10-3 Statutory Environmental Law: Water Pollution Regulation
      • 10-4 Statutory Environmental Law: Solid Waste Disposal Regulation�������������������������������������������������������������������������
      • 10-5 Statutory Law: Environmental Quality Regulation������������������������������������������������������������
      • 10-6 Statutory Law: Other Federal Environmental Regulations
      • 10-7 Enforcement of Environmental Laws���������������������������������������������
      • 10-8 International Environmental Issues����������������������������������������������
      • Summary��������������
      • Questions and Problems�����������������������������
  • Part 3: Business Sales, Contracts, and Competition
    • Ch 11: Contracts and Sales: Introduction and Formation
      • 11-1 What Is a Contract?
      • 11-2 Sources of Contract Law�����������������������������������
      • 11-3 Types of Contracts������������������������������
      • 11-4 Consumer Credit Contracts�������������������������������������
      • 11-5 Formation of Contracts����������������������������������
      • 11-6 Issues in Formation of International Contracts�����������������������������������������������������������
      • Summary��������������
      • Questions and Problems�����������������������������
    • Ch 12: Contracts and Sales: Performance, Remedies, and Collection
      • 12-1 Defenses in Contract Formation������������������������������������������
      • 12-2 Contract Performance��������������������������������
      • 12-3 Nonperformance and Nonpayment-The Collection Remedies
      • 12-4 Contract Remedies for Nonperformance������������������������������������������������
      • 12-5 Third-Party Rights in Contracts�������������������������������������������
      • 12-6 International Issues in Contract Performance���������������������������������������������������������
      • Summary��������������
      • Questions and Problems�����������������������������
    • Ch 13: Product Advertising and Liability
      • 13-1 Development of Product Liability��������������������������������������������
      • 13-2 Advertising as a Contract Basis for Product Liability
      • 13-3 Contract Product Liability Theories: Implied Warranties��������������������������������������������������������������������
      • 13-4 Strict Tort Liability: Product Liability under Section 402A
      • 13-5 Defenses to Product Liability Torts�����������������������������������������������
      • 13-6 Product Liability Reform������������������������������������
      • 13-7 Federal Standards for Product Liability
      • 13-8 International Issues in Product Liability
      • Summary��������������
      • Questions and Problems�����������������������������
    • Ch 14: Business Competition: Antitrust
      • 14-1 What Interferes with Competition? Covenants Not to Compete
      • 14-2 What Interferes with Competition? An Overview of the Federal Statutory Scheme on Restraint of Trade
      • 14-3 Horizontal Restraints of Trade������������������������������������������
      • 14-4 Vertical Trade Restraints�������������������������������������
      • 14-5 What Are the Penalties and Remedies for Anticompetitive Behavior�����������������������������������������������������������������������������
      • 14-6 Antitrust Issues in International Competition���������������������������������������������������������
      • Summary��������������
      • Questions and Problems�����������������������������
    • Ch 15: Business and Intellectual Property Law
      • 15-1 What Can a Business Own? Intangible Property Rights����������������������������������������������������������������
      • 15-2 Patents�������������������
      • 15-3 Copyrights����������������������
      • 15-4 Trademarks����������������������
      • 15-5 Trade Secrets�������������������������
      • 15-6 International Intellectual Property Issues
      • 15-7 Enforcing Business Property Rights����������������������������������������������
      • Summary��������������
      • Questions and Problems�����������������������������
  • Part 4: Business Management and Governance
    • Ch 16: Management of Employee Conduct: Agency
      • 16-1 Names and Roles: Agency Terminology�����������������������������������������������
      • 16-2 Creation of the Agency Relationship�����������������������������������������������
      • 16-3 The Principal-Agent Relationship
      • 16-4 Liability of Principals for Agents' Conduct: The Relationship with Third Parties
      • 16-5 Termination of the Agency Relationship��������������������������������������������������
      • 16-6 Termination of Agents under Employment at Will
      • 16-7 Agency Relationships in International Law�����������������������������������������������������
      • Summary��������������
      • Questions and Problems�����������������������������
    • Ch 17: Governance and Structure: Forms of Doing Business
      • 17-1 Sole Proprietorships��������������������������������
      • 17-2 Partnerships������������������������
      • 17-3 Limited Partnerships��������������������������������
      • 17-4 Corporations������������������������
      • 17-5 Limited Liability Companies���������������������������������������
      • 17-6 Limited Liability Partnerships������������������������������������������
      • 17-7 International Issues in Business Structure������������������������������������������������������
      • Summary��������������
      • Questions and Problems�����������������������������
    • Ch 18: Governance and Regulation: Securities Law
      • 18-1 History of Securities Law�������������������������������������
      • 18-2 Primary Offering Regulation: The 1933 Securities Act
      • 18-3 The Securities Exchange Act of 1934�����������������������������������������������
      • 18-4 State Securities Laws���������������������������������
      • 18-5 International Issues in Securities Laws���������������������������������������������������
      • Summary��������������
      • Questions and Problems�����������������������������
    • Ch 19: Management of Employee Welfare
      • 19-1 Wage and Hours Protection�������������������������������������
      • 19-2 Workplace Safety����������������������������
      • 19-3 Employee Pensions, Retirement, and Social Security
      • 19-4 Workers' Compensation Laws
      • 19-5 Statutory Protections of Employees through Labor Unions
      • 19-6 International Issues in Labor�����������������������������������������
      • Summary��������������
      • Questions and Problems�����������������������������
    • Ch 20: Management: Employment Discrimination
      • 20-1 History of Employment Discrimination Law����������������������������������������������������
      • 20-2 Employment Discrimination: Title VII of the Civil Rights Act�������������������������������������������������������������������������
      • 20-3 Theories of Discrimination under Title VII
      • 20-4 Specific Applications of Title VII����������������������������������������������
      • 20-5 Antidiscrimination Laws and Affirmative Action�����������������������������������������������������������
      • 20-6 The Defenses to a Title VII Charge����������������������������������������������
      • 20-7 Enforcement of Title VII������������������������������������
      • 20-8 Other Antidiscrimination Laws�����������������������������������������
      • 20-9 The Global Workforce��������������������������������
      • Summary��������������
      • Questions and Problems�����������������������������
  • Appendices
    • Appendix A: The United States Constitution
    • Appendix B: The Foreign Corrupt Practices Act (Excerpts)
    • Appendix C: The Uniform Commercial Code (Excerpts)
    • Appendix D: Dodd-Frank (Wall Street Reform and Consumer Financial Protection Act) Key Provisions
    • Appendix E: The Securities Act of 1933 and the Securities Exchange Act of 1934 (Excerpts)
    • Appendix F: Sarbanes-Oxley Key Provisions (Excerpts)
    • Appendix G: The Copyright Act (as Amended) (Excerpts)
    • Appendix H: Title VII and the Civil Rights Act (Employment Provisions) (Excerpts)
    • Appendix I: The Americans with Disabilities Act (Excerpts)
  • Glossary
  • Table of Cases
  • Table of Products, People, and Companies
  • Index
    1. 2016-12-23T02:38:04+0000
    2. Preflight Ticket Signature