Instructor’s Manual

Gregory Cermignano Widener University

Contemporary Business and Online Commerce Law
Sixth Edition

Henry R. Cheeseman

Upper Saddle River, New Jersey 07458

Editor-in-Chief: Eric Svendsen Project Manager, Editorial: Kierra Kashickey Project Manager, Production: Kerri Tomasso Buyer: Michelle Klein

Copyright © 2009 by Pearson Education, Inc., Upper Saddle River, New Jersey, 07458.

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Table of Contents
Chapter 1 Chapter 2 Chapter 3 Chapter 4 Chapter 5 Chapter 6 Chapter 7 Chapter 8 Chapter 9 Chapter 10 Legal Heritage and the Information Age .....................................................1 Constitutional Law for Business and E-Commerce ..................................15 Court Systems and Jurisdiction..................................................................34 Judicial, Administrative, Alternative, and Online Dispute Resolution......46 Torts and Strict Liability............................................................................59 Criminal Law and White Collar Crime......................................................79 Intellectual Property and Piracy.................................................................94 Ethics of Managers and Social Responsibility of Businesses..................116 Nature of Traditional and Online Contracts.............................................127 Agreement and Consideration.................................................................142

Chapter 11 Capacity and Legality ..............................................................................164 Chapter 12 Genuineness of Assent and Statute of Frauds..........................................182 Chapter 13 Third Party Rights and Discharge............................................................203 Chapter 14 Remedies for Breach of Traditional and Online Contracts......................217 Chapter 15 E-Contracts, Internet Law, and Cyber Crimes.........................................232 Chapter 16 Formation of Sales, Lease, and E-Contracts............................................245 Chapter 17 Performance of Sales, Leases, and E-Contracts.......................................257 Chapter 18 Remedies for Breach of Sales, Leases, and E-Contracts………………..272 Chapter 19 Warranties and Product Liability………………………………………..289 Chapter 20 Negotiability and Transferability………………………………………..309 Chapter 21 Holder in Due Course and Liability of Parties…………………………..326 Chapter 22 Checks, Banking System, and E-Money………………………………...339 Chapter 23 Credit and Secured Transactions………………………………………...351 Chapter 24 Bankruptcy and Reorganization…………………………………………370 Chapter 25 Agency Relationships ..............................................................................388 Chapter 26 Sole Proprietorships and General and Limited Partnerships……………406 Chapter 27 Corporate Formation and Financing…………………………………….427 Chapter 28 Corporate Governance and the Sarbanes-Oxley Act……………………441


Chapter 29 Corporate Acquisitions and Multinational Corporations………………..462 Chapter 30 Limited Liability Companies and Limited Liability Partnerships………480 Chapter 31 Franchises and Special Forms of Business……………………………...495 Chapter 32 Investor Protection and Online Securities Transactions………………...514 Chapter 33 Antitrust Law……………………………………………………………534 Chapter 34 Consumer Protection and Environmental Law………………………….558 Chapter 35 Employment, Worker Protection, and Labor Law………………………585 Chapter 36 Equal Opportunity in Employment……………………………………...608 Chapter 37 Personal Property, Bailment, and Insurance…………………………….625 Chapter 38 Real Property and Landlord-Tenant Law………………………………..649 Chapter 39 Family Law, Wills, and Trusts…………………………………………..674 Chapter 40 Accountant’s Liability…………………………………………………...691 Chapter 41 International and World Trade Law……………………………………..703


Legal Heritage and the Information Age 1

Chapter 1 Legal Heritage and the Information Age

What Is The Law And Where Do We Find It?
I. Teacher to Teacher Dialogue One of the most common dilemmas facing instructors of business law is the issue of topic choice. By the very nature of the subjects we teach, the breadth of materials is so wide that choosing what to focus on in the limited classroom time we have with our students can be a most daunting task. This problem is especially exacerbated when the topics we are dealing with are all of deep interest and can stand alone as separate courses. In this chapter, for example, we are asked to introduce students to topics ranging from the definitions and purposes of law to how our system affects business decisions, to some of the most important provisions found in the U.S. Constitution. Any one of these subparts can provide the raw materials for an entire course at the law school level. Our job must start with a self-evident, but sometimes forgotten, point: this is not law school. We are here not to train future lawyers but rather students who need to know enough about these issues to recognize that they are issues. The technical legal problems they may be facing later will ultimately need to be resolved using law and other practitioners. The plus side of this dilemma is that because we have such a diverse menu to select from, we are able to pick and choose our areas of emphasis. For example, if your particular teaching and research interests lie in the area of ethics and the schools of jurisprudential thought from which they are derived, then by all means, run with it! Rather than trying to be all things to all people, it is better to focus your efforts on your strengths. This does not mean that you can shortchange the other material. All key objectives of the chapter should be fully outlined and incorporated in both your lecture and materials outline. But if you have a particular interest and expertise in, for example, the Law and Economics School of jurisprudential thought, then use them as focal points of comparison in the evolutionary process that seeks to distinguish the older schools of jurisprudence from newer approaches to these issues. In any event, remember that philosophical studies of what law is and what its role is in the larger scheme of things have always posed questions virtually impossible to answer. As has been mentioned, this chapter represents attempts by great thinkers to answer the unanswerable. It would be far too presumptuous for us to think that we can teach, in a few hours, what the great philosophers of the world have tried to do over hundreds of years. Perhaps this is an early lesson in what wisdom is really all about: the more we know of history, the more we know of our own limitations. If we can get that point across, the course is off to a good start.

2 Chapter 1

II. Text Materials

*The first chapter objective is an introduction to the historical underpinnings of jurisprudential thought. This would include not only the functions of law listed in the summary, but also an early opportunity to introduce the role of ethics based on the various schools of jurisprudence discussed. Internet & Technology: Students Plug into the Internet and the Law This discusses how the Internet has revolutionized campus life. Over 90 percent of college students own personal computers. Traditional libraries have become obsolete for many students as many students conduct almost all of their research on-line.

Legal Heritage and the Information Age 3

4 Chapter 1

Landmark Law: Brown v. Board of Education This discusses the application of law where the Supreme Court overturned the “separate but equal” doctrine that condoned separate schools for black children and white children.

Legal Heritage and the Information Age 5

History of American Law:

6 Chapter 1

*An historical underpinning can be further reinforced with some discussion of the tie-ins between our own country’s political history with that of the legal traditions of England and other countries. This portion of the chapter material can be used to introduce students to a broad overview of the roles that the world’s major legal systems play in the world economy. For example, the role of the Law Merchant and its influence on international trade is critical to understanding most international rules on import/export laws today. The origins of the Law Merchant, in turn, are traceable in large part to the Roman civil law. In the end, we have ingredients from English common law, Roman civil law, and Judeo-Christian canon law all thoroughly processed into our law. The individual ingredients are all present, but each is no longer independently identifiable.

Legal Heritage and the Information Age 7

Note: The U.S. Constitution is the supreme law of the land. Constitutions establish the legislative (make law), executive (enforce law), and judicial (interpret law) branches of government.

8 Chapter 1

*A key objective of this chapter is to introduce students to the role of the U.S. Constitution and its pivotal role in the ultimate distribution of powers between the federal government and the states vis-à-vis the control of business conduct in the U.S. This aspect of the chapter will introduce students to key terms that they will be using throughout the rest of the course such as substantive and procedural due process and the like.

Internet & Technology: Executive Order Protects Encryption Technology In 1999, after much lobbying by software companies located in the United States, the Clinton administration changed its export policy to allow the export of the most powerful American-made encryption technology. Contemporary Issue: Department of Homeland Security This discusses the Executive Order issued to create the Office of Homeland Security. A discussion of the DHS and terrorism might be appropriate here.

Legal Heritage and the Information Age 9

Contemporary Issue: Regulations and Orders of Administrative Agencies Here, Professor Cheeseman explains the difference among rules, regulations, and orders of administrative agencies.

10 Chapter 1

*Constitutional principles are given living meaning through the critical legal thinking process of using stare decisis on a case-by-case basis. Our system is admired around the world. Yet it is in constant need of updating and definition based on the geopolitical and technological changes taking place in our global environment. Additional Considerations: At this point it might be helpful to point out the various classifications of the law with a brief description: • • • Public vs. Private Civil vs. Criminal Substantive vs. Procedural

she would have received an automatic extra 20 points giving her a score of over 100 and automatic admission. The school used race as one of the factors (“a plus factor”) in the admissions process. Hispanic. as statesupported school. Grutter v.Legal Heritage and the Information Age 11 The Supreme Court speaks on Affirmative Action: Gratz v Bollinger Facts: Gratz. Bollinger Facts: Grutter was denied admission to Michigan’s law school. or Native American. a Caucasian female. This is an appeal from a reversal of a . was denied admission to the University of Michigan. Reason: The analysis failed the strict scrutiny test. This is an appeal from a district court ruling granting summary judgment to the University in a class action suit alleging a 14th Amendment equal protection violation. because she scored too low on a combined evaluative process. Remedy: The Supreme Court reversed and remanded the case for further proceedings. If she had been a Black. Issue: Does the University policy of an automatic extra 20 points to minorities in the admission process violate the 14th Amendment Equal Protection Clause? Decision: Yes.

Ed. The Supreme Court affirmed the decision of the Court of Appeals. but Title VII of the Civil Rights Act of 1964 prohibits any discrimination on the basis of sex in the “terms.e. Reason: Unlike the prior case. the legislature presumably entertained the view that women had special needs.e. It is likely that legislators entertained an unconscious premise that women should not be required to fight a war. a violation of the Equal Protection Clause of the 14th Amendment? Issue: Does the University policy of using race as “a plus factor” in the law school admission’s process violate the 14th Amendment’s Equal Protection Clause? Decision/Remedy: No. Rostker. race is only one individualized factor.e. special needs and presumed weaknesses. i. This speculation might be supported by the fact that the majority of the Supreme Court summoned a technical legal point to justify their ruling. The law has not been progressive in this instance.. Moralists might label this ignorance as excusable in that it is “invincible.2. 1910). modern experience and knowledge require that we question these premises. Wayman. Of course. Most students will react that the statute is unfair as it does not afford women equal status in the workplace. it is a useful exercise to consider arguments for the opposite position in the context of the time period. Answers to Ethics Cases 1. in a class action suit.” W. Ritchie & Co.C. That these premises. 91 N. 101 S. .Ct. In enacting such a statute. Goldberg. 2646.. thereby removing themselves from any further consideration of the substantive issue.1. III. i. 695 (Ill. However. Not only have the items relevant to the test of equal protection broadened under present constitutional interpretations.12 Chapter 1 district court’s ruling in favor of Grutter who alleged. IV. and therefore the demands made on them had to be accommodated in the workplace. Answers to Critical Legal Thinking Cases Flexibility of the Law 1. In light of today’s standards. were subject to certain weaknesses.” i. v. conditions and benefits of employment. an ignorance that cannot be destroyed or offers no moral reason for doing so. might be false does not necessarily preclude one from acting morally.S.. The better case is made by the dissent. The Court held that Congress was the proper party to articulate the public policy that women should not fight at the front. that position is well founded. whether equality was being served as a matter of fairness. 453 U. 57.E.2d 478 (1981). It almost certainly would not be lawful today. 69 L. Director of the Selective Service v.

S. A Baltimore Ordinance prohibited certain outdoor advertising of alcoholic beverages. and Court Anheuser-Busch. B. Anheuser-Busch sued challenging the constitutionality of the Ordinance. Holding Yes. 1. Martin This exercise illustrates the elements of how to brief a case for purposes of developing students’ critical thinking skills. . D. C. Schmoke 63 F. 3d 1304 (1995) U. v. District Court’s judgment was affirmed. Case for briefing: PGA Tour.Legal Heritage and the Information Age 13 Appendix to Chapter 1: Critical Legal Thinking V: Answer to “Briefing the Case” Writing Assignment Professor Cheeseman also introduces the concept of briefing a case and gives a sample case and brief. Inc. The District Court upheld the constitutionality. Inc. Students should be encouraged to use this material as a model for briefing their own cases. Professor Cheeseman’s preferred method for briefing a case is found in the text. Case Name. E.Court of Appeals 2. Issue Is the Baltimore ordinance prohibiting certain outdoor advertising of alcoholic beverages constitutional? 4. Citation. Baltimore did tailor its ban to allow advertising in commercial and industrial areas. Key Facts A. Under age drinking is a major problem. 3. v.

The ordinance directly advances the city’s interest in promoting children’s welfare. . No less restrictive means are available. B. C. Billboards expose viewers (children) involuntarily to messages concerning alcoholic beverages. Court’s Reasoning A. D. Alcohol consumption is high.14 Chapter 1 5.

Text Materials *The key objective of this chapter is to introduce students to the role of the U. Landmark Law: The Constitution of the United States of America The formation of the Constitution and its ability to be amended to address social and economic changes is discussed. 2. dual sovereignty. and the balancing of rights among the often-competing sovereigns of federal and state government. for many legal academics. not only their reason for loving to teach but it also provides the ultimate challenge in illustrating the constant balance of competing but legitimate rights of the individual vis-à-vis the larger society. This underscores the importance of the courts. II. . This aspect of the chapter will introduce students to key terms which they will be using throughout the rest of the course such as substantive and procedural due process and the like.S. Teacher to Teacher Dialogue Constitutional law is.S. The concepts of federalism. Constitution and its pivotal role in the ultimate distribution of powers between the federal government and the states vis-à-vis the control of business conduct in the U. because of the breadth of materials covered. The most impressive fact that surfaces in the study of the Constitution is that it never changes but it always changes. Because of these time limitations.Constitutional Law for Business and E-Commerce 15 Chapter 2 Constitutional Law for Business and E-Commerce Why Can’t We Yell Fire In A Crowded Theater? I. In all likelihood. The only major drawback to this material is the frustration of having the time constraints inherent in a survey course. The enumeration of key individual civil liberties protections listed in the Bill of Rights with an extrapolation of those same theories to business. the lecture/discussion format will work best for purposes of illustrating as much of the material as possible in the time allowed. teaching efforts might best be concentrated on two main objectives: 1. To watch students as they uncover the mysteries found in this document is well worth the effort.

16 Chapter 2 .

Constitutional Law for Business and E-Commerce 17 .

Creates courts and deals with jurisdiction 4. Appoints judges and justices 5. Consents to treaties and approves appointees 3.18 Chapter 2 Executive 5 4 2 1 1 Legislative 3 Judicial 1. Check on constitutionality of actions 2. Veto power .

Secretary of Administration and Finance of MA v. Mille Lacs Band of Chippewa Indians Facts: The federal government entered into a treaty with the Ojibwe Indians in 1937 with the latter selling Minnesota territory property to the Indians.S. Issue: Are the hunting.Constitutional Law for Business and E-Commerce 19 The Supreme Court speaks: Engine Mfgrs. Reason: There is no clear evidence of congressional intent to abrogate the Treaty rights in Minnesota”s enabling act. fishing. a state of California entity. Court of Appeals affirming a U. enacted rules that prohibited the purchase or lease by private and public fleets of vehicles not meeting certain requirements which are more stringent than the Federal Clean Air Act. District Facts: South Coast. Minnesota argues the rights ended in 1858 with their entrance into the Union. The Supreme Court speaks: Crosby. Judgment was vacated and the case was remanded. The material also discusses the Bureau of Indian Affairs and the Indian Health Service. District Court decision. and collect taxes. National Foreign Trade Council Facts: The National Foreign Trade Council filed a lawsuit against MA to have the state law banning MA from purchasing goods and services from companies doing business with Myanmar . U. Reason: What would be the use of having federal standards if any state could change? The Supreme Court speaks: Minnesota V.S. v South Coast Air Quality Mgt.S. Minnesota appeals. regulate. sues claiming preemption of state rules. and other rights guaranteed to the Ojibwe Indians by the 1837 teaty still valid and enforceable? Decision: Yes. The Assoc. Tribal Council’s govern. Assoc. Decision of the U. Court of Appeals was affirmed.S. Court of Appeals upheld the District Court’s decision to uphold the rules. From a ruling in favor of the Ojibwe Indians of the U. Issue: Are South Coast’s Fleet Rules preempted by the federal Clean Air Act? Decision: Yes. In 1990 Mille Lacs Band of the Ojibwe Indians sued seeking enforcement of the rights.

The lower decisions were affirmed. . From rulings in favor of the Council MA appeals.20 Chapter 2 declared unconstitutional. U. the Supreme Court said that the Civil Rights Act of 1964 properly regulates interstate commerce and thus discrimination in the hotel that was readily accessible to U. a) In the stream of commerce b) Substantially affects commerce (Wickard v..S. Filburn and home consumption of wheat) In the landmark case of Heart of Atlanta Motel v. Congress had passed a statute giving the President the power to regulate dealings with Myanmar.S. Congress could not have intended on giving the president power which could be preempted by state statutes like the one from MA. Issue: Did the MA anti-Myanmar statute violate the Supremacy Clause? Decision: Yes. Reason: The MA statute conflicted with the federal law. highways was prohibited.

Constitutional Law for Business and E-Commerce 21 Interstate Commerce Clause (The Dichotomy) Baseball Wickard v. Filburn Today Gun-Free School Zone Act .

addresses telephone numbers. Court of Appeals reversing a U. 2) No anti-federal ban on truck length 3) Permissible local road weight controls. alleging that the federal government exceeded its authority under the Commerce Clause by adopting the DPPA. Congress enacted the Driver’s Privacy Protection Act of 1994. South Carolina sued the United States. They sued the federal government attempting to prohibit the enforcement of the CSA. From a decision of the U. and social security numbers. Reason: The U. District Court’s denial of Raich’s motion for an injunction. Constitution? Decision: Yes. . After receiving thousands of complaints from individuals whose personal information had been sold. The California Compassionate Use Act of 1996(CCUA) allows seriously ill California residents to use marijuana for medical purposes.S.S. There is a fear that unscrupulous people would use the statute for personal gain.S. v.S. Issue: Was the Driver’s Privacy Protection Act properly enacted pursuant to the interstate commerce clause power granted to the federal government by the U. Two such residents are Raich and Manson. Condon Facts: Many state motor vehicle departments register automobiles and issue drivers licenses. Raich Facts: The CSA of 1970 gave the federal government the authority to regulate the manufacture. and use of controlled substances like marijuana. Issue: Does the Commerce Clause of the U. Many states also sold personal information such as names. The Supreme Court Speaks: Reno. Attorney General of the United States v.S. cultivation. distribution. appeals. This statute prohibits a state from selling the personal information of a person unless the person gives affirmative consent. Supreme Court held that Congress had the authority under the Commerce Clause to enact the federal Driver’s Protection Act.S. The lower court’s judgment was vacated and the case was remanded? Reason: The Supreme Court found that the intrastate noncommercial cultivation and possession of marijuana is subject to the CSA. The Supreme Court speaks: Gonzales. the U. This process could have a major impact on the national market of all transactions exempted from federal supervision.22 Chapter 2 No: a) Discrimination b) Undue burden 1) Cannot limit length of passenger trains. Constitution grant the power to the federal government to enact the CSA prohibiting local cultivation and use of marijuana permitted under the CCUA? Decision: Yes. Attorney General of the U. S.

The latter must first sell to Michigan wholesalers who sell to Michigan retailers and then to Michigan consumers. Issue: Does Michigan’s law violate the Commerce Clause? Decision: Yes. Heald Facts: Michigan law permits in-state wineries to sell wine directly to consumers while prohibiting the same of out-of-state wineries. State ban represents a large barrier to expanded e-commerce of wine. Governor of Michigan v. The court of appeal’s ruling was affirmed. From the reversal of a district court ruling in favor of Michigan. This would help to destroy the very purpose of the Commerce Clause. . This law unreasonably discriminates versus outof-state commerce placing an undue burden thereon.Constitutional Law for Business and E-Commerce 23 The Supreme Court speaks: Graham. Reason: Direct sales are very effective especially sales over the internet. Alfred and several other out-of-state wineries sued Michigan alleging an undue burden on interstate commerce. This makes it more costlye and often less profitable than for i-state wineries. the state of Michigan appeals.

action sustained if: (1) Pursuit of important Gov. In addition. COURT TESTS 1 COMPELLING INTEREST TEST (Strict Scrutiny) Gov.S. is pursuing legitimate gov. interest involved & (2) Gov. purpose & (2) Some reasonable basis for the action INTERMEDIATE TEST Gov. objectives USE TEST (1) for fundamental rights & suspect classifications. USE TEST (2) For all others except for classes based on sex or sometimes age → then USE TEST (3). objectives & (2) Significantly related to the attainment of these objectives Fair & substantial relation to important Gov. action constitutional if: (1) Gov. action sustained only if: (1) Overriding or compelling gov.24 Chapter 2 Landmark Law: The Bill of Rights The first 10 amendments to the U. Constitution are known as the Bill of Rights. is using narrowest possible means 2 REASONABLE BASIS TEST Gov. there are 17 other amendments. .

Constitutional Law for Business and E-Commerce 25 Examples Fundamental Rights Religion Speech Association Privacy Marry Vote Non-Fundamental Rights Housing Welfare Education Suspect Clauses Race Religion (Possibly National Origin) Non-Suspect Clauses Poverty a) Commercial speech is subject to time place and manner restrictions. Under the 14th amendment actions of state and local governments are also given constitutional scrutiny. b) Symbolic speech is also protected c) State can define what constitutes obscene speech. .

505 an overly broad restriction on content-based speech that violates free speech rights? Decision: Yes.S. Inc. The district court’s judgment was reversed and the case was remanded for further proceedings. Facts: Many entertainment companies. The district court declared Sec. FTC and FCC Facts: Mainstream and other telemarketers sued the FTC and the FCC alleging violation of free speech rights on the part of the do-not-call-registry which prohibits calss from telemarketers on behalf of sellers of goods and services to numbers on the registry. E-Commerce and Information Technology: Broad Free-Speech Rights Granted in Cyberspace There is discussion of the Computer Decency Act sections which were declared unconstitutional in part because of its chilling effect on adult free speech. Inc. Issue: Is Sec. usually on a pay-per-view basis. including Playboy Entertainment Group. . The U. and the government cannot ban speech if targeted blocking is a feasible and effective means of furthering its compelling interests. v. place and manner” regulation of commercial speech. Reason: The registry has 4 aspects consistent with the 1st amendment: 1) Only core commercial speech(commercial sales calls) is restricted.) Facts: Recipients of junk faxes complained to the government that they tied up fax machines. Playboy Entertainment Group. 3) The registry is an opt-in program with the choice in the hands of the consumers. 505 was an overly broad restriction on free speech. but with today’s analog television sets. produce and distribute sexually explicit adult entertainment features for transmission over cable television stations. 505 unconstitutional. The Supreme Court Speaks: United States v. U. The restrictions do not violate the free speech rights of the telemarketers. Congress enacted the TCPA of 1991 outlawing junk faxes. The Supreme Court speaks: Mainstream Marketing Services. Issue: Are unrestricted telemarketing calls commercial speech that has been constitutionally regulated by the’s commercial speech. 2) Targeted speech invades the privacy of one’s home. Viewers are provided with converter boxes that scramble the usually sexually explicit materials. Reason: The TCPA’s prohibition of junk faxes represents a constitutional “time.registry restrictions? Decision: Yes. Protection from substantial cost shifting and interference is a sustainable government interest needed in a commercial speech case.26 Chapter 2 The Supreme Court Speaks: Fax. costing them money to receive and process.” Congress enacted Sec. USA (Case is discussed in chapter material. Playboy sued the federal government alleging that Sec. there is often “signal for violating the TCPA claiming that restrictions could be placed on Fax. government appealed. 4) Government’s interest of combating abusive telemarketing and preventing the invasion of consumer privacy are furthered by the registry.S. 505 of the Telecommunications Act of 1996. v. Note that businesses can contact consumers in other ways. The district court held for TCPA dismissing the suit. Reason: Targeted blocking is less restrictive than banning. government sued Fax. which requires cable operators not to transmit sexually explicit materials from 6am to 10pm. Issue: Is the federal government’s prohibition against unsolicited commercial advertising faxes a constitutionally permitted regulation of commercial speech? Decision: Yes.

The original text. From a court of appeals ruling affirming a district court’s order re-issuing an injunction. Reason: Government action must have a genuine secular purpose. Issue: Does the display of the Ten Commandments violate the Establishment Clause? Decision: Yes. From a U. which was one of several historical monuments surrounding the state capital. a lawyer who used the law library in the Texas Supreme Court building sued Texas alleging that the monument of the Ten Commandments. ACLU of KY Facts: McCreary and Pulaski(Counties) placed large gold-framed copies of the Ten Commandments in their courthouses. violate the Establishment Clause? Decision: No. This part of a group of displays that have a dual significance (religious and governmental) not violating the Establishment Clause. Counties added other non-religious items to the display after a district court injunction ordering removal.Constitutional Law for Business and E-Commerce 27 The Supreme Court speaks: McCreary County.s. hanging alone. which was one of several historical monuments. viewed in its entirety had an unmistakably religious purpose. ACLU sued alleging violation of the Establishment Clause. violates the Establishment Clause. The monument has a secular purpose. Governor of Texas Facts: VanOrden. Perry. Simply having religious content. They were prominently displayed. The display violate the Establishment Clause. prominently displayed. court of appeals ruling affirming a district court ruling holding no violation of the Establishment Clause. or promoting a message consistent with a religious doctrine does not violate the Establishment Clause. VanOrden appealed. some of which having a religious significance. the Counties appealed. KY v. Reason: There are many historical monuments and items in the courtrooms of America. The Supreme Court speaks: VanOrden v. however. Issue: Does the monument on the Texas Capital grounds. .

. Substantive due process requires a good reason for action.28 Chapter 2 14th Amendment: State cannot deny equal protection of the laws to any person within its jurisdiction.

Constitutional Law for Business and E-Commerce 29 No discrimination with respect to essential activities without a substantial reason. P & I Clause Reasons Acceptable Discrimination Recreational hunting license Higher tuition costs to state universities for non-tax-paying out-of-staters - Unacceptable Discrimination Commercial fishing license extreme difference Right to own property - - .

No. . rather than size of vehicle.S. Supreme Court held that the Washington state statute directly conflicted with a valid federal law and was therefore unconstitutional under the Supremacy Clause of the U. The Supreme Court rejected this argument.2. Iowa’s statute limiting vehicles to 55 feet unduly burdened interstate commerce in violation of the Commerce Clause and was therefore unconstitutional. 343 U. it considered the safety of the vessels and the environment. Iowa argued that it had a right to limit the size of vehicles on highways crossing the state in order to protect the safety of its residents. Also. Under the Supremacy Clause of the U. health.S. The U.Ct. 55 L. 450 U. Commerce and Supremacy Clauses 2.S. 863. 662.S. Answers to Critical Thinking Cases Separation of Powers 2. Constitution reserves the right to enact laws and regulations to protect the safety. The United States Supreme Court held that the Iowa statute created an undue burden on interstate commerce.Ed. However. III. and that all other states permitted the larger 65-foot double trailers. 98 S. The U.Ed. When Congress enacted the Ports and Waterways Safety Act and set the design and length standards for oil tankers.2d 179 (1978.1. Since the federal government had not chosen to regulate the size of vehicles that use the highways (a “naked” Commerce Clause). Governor of Washington v. Youngstown Company v. the Iowa statute that limits the length of vehicles to 55 feet is unconstitutional. The Supreme Court held that because of these reasons. 101 S. Atlantic Richfield Company. The court held that the seizure order could not stand.S. Therefore two smaller trucks crossing Iowa would cause more accidents than one larger truck. Constitution. which states that federal law is the supreme law of the land. Kassel v. 1153 (1952). 1309. finding that traffic accidents are based on the number of miles driven. 435 U. 72 S. ARCO wins. 988. Supreme Court held that the President’s seizure of the steel mills was a violation of separation of powers and unconstitutional.Ct.30 Chapter 2 International Law: Constitution of the People’s Republic of China Selected provisions of Chapter 2.) Undue Burden on Interstate Commerce 2. Constitution. Ed. Supreme Court held that the Washington State statute—which mandated different boat designs and smaller lengths of vessels—directly conflicted with the federal law. 96 L. the Iowa statute must be examined to see if it creates an undue burden on interstate commerce.S. these laws cannot directly conflict with valid federal laws or unduly burden interstate commerce. 67 L.2d 580 (1981). Fundamental Rights and Duties of Citizens are explained in this box. The U. Sawyer. Iowa was “exporting” accidents to other states. The Supreme Court held that the state statute directly conflicted with the federal statute and violated the Supremacy Clause. 579.3. The federal rules were set so that these standards would be uniform across the country and would also comply with international standards.S. the court held that if trucks were diverted around Iowa.S. any state law which directly conflicts with valid federal law fails.S. Consolidated Freightways Corporation. Ray. 151. and welfare of its citizens.Ct. Secretary of Commerce. The U.

Ct. In so holding the court stated that the Constitution “was framed upon the theory that peoples of the several states must sink or swim together. 101 S.2d 397 (1978). City of San Diego.S. the Alaska Hire statute is not constitutional. 102 S.S.2d 362 (1982). Substantive Due Process 2.S. 518. The court reasoned that advertisers had other forms of speech to reach consumers. Constitution provides that “the citizens of each state shall be entitled to all privileges and immunities of citizens in the several states. The Supreme Court held that the village’s licensing ordinance was clear on its face and complied with substantive due process. television and radio commercials. If a statute is overly vague. the City of San Diego’s zoning ordinance which prohibits commercial billboards within the city is lawful. Hoffman Estates. What is involved in this case is commercial speech. The U. place. 453 U. Inc. The Privileges and Immunities Clause of the U. Village of Hoffman Estates v. Flipside. 437 U. 455 U.4. it is unconstitutional as a violation of due process.Ed. Commercial Speech 2. Supreme Court held that the village’s ordinance that required stores that sold drug paraphernalia to be licensed by the village did not violate substantive due process.S. No. The Supreme Court held that the San Diego zoning ordinance was a proper time. Inc. Hicklin v.Ct. and that in the long run prosperity and salvation are in union and not division.S. In this case.6. Metromedia. such as print media. The process requires that laws give a person of ordinary intelligence a reasonable opportunity to know what is prohibited so that he may act accordingly. 2882.Ed. 69 L.” The Supreme Court held that the Alaska Hire statute cannot withstand constitutional scrutiny. Commissioner of the Department of Labor of Alaska. 1186.2d 800 (1981). Yes. this clause prohibits a state from favoring its residents over residents of other states in granting privileges or rights. it is accorded a lesser protection than other constitutionally guaranteed expressions. The U. Supreme Court held that the Alaska Hire statute that required that employers give preference to hiring Alaska residents over residents of other states violated the Privileges and Immunities Clause. The Supreme Court held that commercial speech is subject to proper time.Constitutional Law for Business and E-Commerce 31 Privileges and Immunities Clause 2.Ct.S. v. and manner restrictions. 71 L.S. Orbeck. . 57 L. place and manner restriction on commercial speech and did not violate the First Amendment. the Supreme Court held that the twin goals of the zoning ordinance—traffic safety and aesthetic values—advanced the city’s interests and justified the prohibition on commercial billboards within the city.S. Supreme Court held that although commercial speech such as advertising is protected by the Freedom of Speech Clause of the First Amendment to the U. 98 S.” With few exceptions. The Village of Hoffman Estates wins. Vague laws may trap the innocent by not providing fair warning of what is expected. The court held that the ordinance clearly identified the controlled drugs and that persons of ordinary intelligence could identify drug paraphernalia included in the ordinance. handbills. The U.5. 489. 490.. The Supreme Court held that the village’s ordinance was facially clear. Constitution. 2482. a law is required to be clear enough on its face so that a normal citizen could read and understand it.Ed. Under substantive due process.

V. Oakland Raiders.S. Exercise of eminent domain powers by the city would unduly burden interstate commerce and would subordinate the interest of the NFL in a substantial way. Metropolitan Life Insurance Company (Metropolitan) wins. So the threat of eminent domain proceedings in other cities throughout the nation would affect national commerce in this industry. Not all of them elected to take part.S. Appellees’ prosecution for burning a flag in violation of the Act is inconsistent with the First Amendment. Robert E.2d 287 (1990). 310. some of which own these stadiums. like virulent ethnic and religious epithets. vulgar repudiations of the draft. 689. has been to invite members of the clergy to give invocations and benedictions at middle and high school graduations. Citation. United States v. Answer to “Briefing the Case” Writing Assignment: 1. Eichman. 1676. C. The Supreme Court found that Alabama’s aim was purely and completely discriminatory.I. 1985). 84 L. 470 U. 3d 414.S. By preventing the relocation of the franchise.8. The policy of public schools in Providence. 153 (Cal. 220 Cal. Rabbi Gutterman followed the school’s guidelines for such prayers as set out in “Guidelines for Civic Occasions. Weisman 112 S. The cost of stadium leases would be affected by the shift in bargaining power to the cities. no matter what the cost to foreign corporations also seeking to do business in the state. 174 C. 110 L. B. Metropolitan Life Insurance Company v.Ed. promotion of domestic business by discrimination against nonresident competitors is not a legitimate state purpose.9.7. which is the very kind of parochial meddling that the Commerce Clause was designed to prohibit.Ct. designed only to favor domestic industry within the state. D. principal of Nathan Bishop Middle School in Providence invited Rabbi Leslie Gutterman to deliver prayers at the school’s graduation.Ct.32 Chapter 2 Equal Protection Clause 2. The income derived from TV and radio contracts would also be impaired. 2649 (1992) United States Supreme Court 2. and Court Lee v. Ward. Lee. 496 U. The court stated “the Alabama domestic preference tax gives the 'home team' an advantage by burdening all foreign corporations seeking to do business within the state. Key Facts A.Ed. California v. Case Name. 105 S. While flag desecration. The court found no rational basis for the discriminatory tax. 110 S. the city would affect gate receipts that provide revenue for all the clubs that play with the Raiders. City of Oakland. Rptr.S.” The court held that under the circumstances. Constitution. The Supreme Court held that the Alabama statute that taxed foreign out-of-state insurance companies at a higher rate than domestic insurance companies violated the Equal Protection Clause of the Fourteenth Amendment to the U. 2404. IV. R. These invitations were issued at the discretion of school principals. 2. A. and held it to be an unconstitutional violation of the Equal Protection Clause of the Fourteenth Amendment to the U.2d 751 (1985). the Government may not prohibit the expression of an idea simply because society finds the idea itself offensive or disagreeable. Answers to Ethics Cases 2.” .Ct. Constitution. Commissioner of Insurance of Alabama. App. and scurrilous caricatures is deeply offensive to many.

The practice must avoid excessive government entanglement with religion. a graduating student from Nathan Bishop Middle School. Issue Does the “Establishment Clause” of the U. F. 3. 3. Deborah Weisman. 2. in effect. .Constitutional Law for Business and E-Commerce 33 E. forced unwilling students to participate in a religious exercise. Court’s Reasoning A. The practice must have a primary effect that neither advances nor inhibits religion. The net effect of the Providence prayer policy was to coerce participation in the prayer service as part of the graduation ceremony. The District Court held in favor of Deborah Weisman and issued a permanent injunction. The graduation went forward with the prayer policy. The policy failed to conform to the three-part Establishment Clause test because of the compulsive nature of attendance at the graduation ceremony. The practice must clearly reflect a secular purpose.S. District Court for the District of Rhode Island. The district court denied the motion based on lack of time to consider it. Constitution prohibit the use of prayer policy at Providence schools’ graduation ceremonies? 4.S. H. which. Deborah Weisman attended the graduation and then sought a permanent injunction against the prayer policy at future graduations. objected to prayer policy and sought a temporary restraining order in the U. Holding Yes. B. 5. C. The Supreme Court held that the Establishment Clause calls for a three-part test for a practice to be allowed: 1. G.

The downside is that the media has created many myths on the folklore of law and lawyers. This is not all bad. In many ways. The problem is that a trial rarely resembles the goings on found in the entertainment media. rather that after. These devices have provided the students with a variety of preconceptions. Trials are long. In more modern versions. Rarely do the parties actually want to go through a labyrinth of pleadings.34 Chapter 3 Chapter 3 Court Systems and Jurisdiction How Do The Courts Work? I. It is against this backdrop that we should try to present a more realistic picture of how our system works. no one knows until the end who really did it until a surprise witness shows up to identify the bad guy. Personal experience examples might be helpful in illustrating the growing trends towards ADR. the process is always full of glamour and intrigue. emotionally and financially draining processes for all parties concerned. Among these is the average undergraduate’s notion of how trials are conducted and the role of attorneys in that process. and the like. feeling all the while totally dependent on the sometimes questionable competence of their attorneys. the job of an attorney is to keep his or her client out of court. Unlike the make-believe world of entertainment. Additionally. the fact if at all possible. Current media focus on numerous lawrelated issues has generated a whole new wave of public interest in the workings of our legal system. In the world of pop culture. (This often needs some reinforcement with the student. tedious. a trial represents a failure by the parties to reach some sort of satisfactory solution of the issue beforehand. a fair amount of time should be spent reviewing the growing trend towards alternative dispute resolution (ADR) mechanisms. Teacher to Teacher Dialogue Twenty-first Century technological advances have provided our students with all kinds of instant access to information. . Invariably these perceptions center on popular television series such as Law and Order and Court TV. We can basically start by discussing how few controversies actually get to the trial stage and how even fewer of those are actually reported in the National Reporter System. motions.) The attorney’s professional advice should anticipate and resolve potential legal problems before. To complete the cycle we can then proceed to itemize the key steps used in a court trial. Regardless of the outcome. the attorney first has a business relationship with the client and then proceeds to get him or her acquitted.

. Text Materials with Accompanying PowerPoint Slides *One objective of this chapter is to familiarize students with the court trial sequence of events and the role of the major players in those events.Court Systems and Jurisdiction 35 II.

36 Chapter 3 Highest Appellant Court (Certiorari) Intermediate Appellate Courts (Automatic Right of Appeal) Trial Court Specialty Courts Example: Small Claims .

Court Systems and Jurisdiction 37 .

.38 Chapter 3 Contemporary Issue: Cost-Benefit Analysis of a Lawsuit – Specialized Courts Hear Commercial Disputes This discusses the application of traditional cost benefit environment to a lawsuit.

Court Systems and Jurisdiction 39 .

40 Chapter 3 .

it will issue a writ of certiorari. or dissenting. . plurality(different reasons). If the Court decides to review a case. majority. concurring. Decisions can be unanimous. tie.Court Systems and Jurisdiction 41 Note: To ask the Supreme Court to hear a case a petition for certiorari must be filed.

Supreme Court” This discusses the process necessary to win a review by the U.S.S. Supreme Court.42 Chapter 3 Landmark Law: The Process of Choosing a Supreme Court Justice This shows how presidents can cast their ideologies on the U.S. Contemporary Issue: “I’ll Take You to the U. Supreme Court. .

Court Systems and Jurisdiction 43 Federal Question – case arising under U. (2) Litigation expense is reduced for both parties if they both know where suits can be brought. Inc. Issue: Is the forum selection clause in the contract enforceable? Decision: Reversed.S. The Supreme Court Speaks: Carnival Cruise Lines. Reason: Blackmun. The suit was filed in Washington. The forum clause is fundamentally fair. However. the trial court dismissed the suit on a motion for summary judgment that argued that the contract of the parties specified that defendant could only be sued in Florida courts. Shute Facts: Mrs. Diversity – no plaintiff is a citizen of the same state as that of any defendant. Inc. J. The Washington appellate court reversed the trial court and the defendant appealed to the United States Supreme Court. . treaties or federal statutes and regulations. →Needed to bring a suit →Needed to hear a case: -Subject matter -In Personam →Venue is site of suit within a jurisdiction. Several advantages flow from recognizing the validity of this nonnegotiated forum clause freely entered into by both parties: (1) The cruise line would not risk having to defend actions brought simultaneously in several jurisdictions. Constitution. Shute sued Carnival Cruise Lines. (Carnival) for injuries suffered while she was a passenger aboard one of its ships.. v.

ITE Imperial Corp.” the trial court was correct in dismissing the case. 3d 449. 237 Cal. granted to them by the Constitution and Congress. Jurisdiction 3. Based on the de minimis theory. At present the states vary from limited Internet activity being needed for jurisdiction to outside contracts also being required.S. v. treaties. 1987). Constitution. Several courts have decided cases involving the reach of a state’s long-arm statute to obtain jurisdiction over someone in another state because of his or her Internet activities. Time. 584 (Cal. such as this one brought by Nutrilab. “the law disregards trifles. Since the amount in question was satisfied. the case could be removed to federal court. It. The lawsuit between Allison and ITE involved a citizen of Mississippi and a citizen of Japan. Federal courts have concurrent jurisdiction over cases involving parties with diverse citizenship.44 Chapter 3 (3) Passengers who purchase tickets can expect to benefit from reduced prices due to the savings generated by reasonable and fair clauses. Schweiker. i. This could be citizens of different states. Allison v. Dist Lexis 607 (S. Yes. that involves a federal question must be brought in a federal court. If a case over which the federal courts have concurrent jurisdiction is brought in a state court. and this gave the federal court original jurisdiction to hear the case. Internet & Technology: Obtaining Personal Jurisdiction in Cyberspace Long-arm statutes permit courts located in one state to reach out and make people in another state come to court and defend themselves. and federal statutes and regulations. therefore. III. Federal question cases are cases arising under the U. 729 F. Inc. Miss. . The Zippo case is highlighted.App.3.1. VI. Yes.S.2. Answers to Critical Thinking Cases Federal Question 3. Rptr. Federal courts have limited jurisdiction. The Starch Blockers case was therefore one arising under a federal statute. Te case can be removed to a federal court on the basis of diversity of citizenship. the case can be removed to a federal court. 191 C. the federal courts have the jurisdiction to hear Nutrilab’s case.. The amount in question must be satisfied. Justice King believed that this lawsuit is an absurd waste of the resources of the courts and of the taxpayers’ money. Answers to Ethics Cases 3.45. 1990 U.).e.. Federal courts have original jurisdiction to hear federal question cases. 2d 335 (7th Cir. Part of this limited jurisdiction is to hear cases involving federal questions. Supp. Any lawsuit. App. The courts are already too heavily burdened to be used to punish advertisers who use junk mail. seems better to permit the reasonable inclusion of a forum selection clause whenever its benefits outweigh its dangers. a citizen of a state and a foreign country where the foreign country is the plaintiff. 713 F. 1983). a citizen of a state and a citizen of a foreign country.D. No. Nutrilab was disputing the FDA’s application of a federal statute to stop their distribution of Starch Blockers. Harris v. Nutrilab. A corporation is a citizen of the state of incorporation.

2. Case Name. . Super. One cannot avoid service by refusing to physically accept them. Summary of the Key Facts Plaintiff sued on a promissory note to which the defendants deny liability alleging that the plaintiffs improperly filled in the due date. Defendants also contend that service of process was defective as a matter of law since summons and complaint were left outside the door after the defendant refused to answer the door after she had appeared in the window and the doorbell had been rung.Court Systems and Jurisdiction 45 V. Citation and Court Peoples Trust Co. 236 A. Answer to “Briefing the Case” Writing Assignment 1. 98 NJ Super. 3. Holding Yes. The defendant said the server said he would leave them outside. Kozuck.2d 630. The Issue Can valid service be effected as done in this case? 4. 235.J. of Bergen County v. She found them on the stoop. Summary of the Court’s Reasoning Service must be effected in such a way as to give notice of service. A person has an obligation to accept service and one’s own wrongdoing cannot be a reason for not accepting service. 5. 1967 N. Lexis 389. The jury’s verdict will stand.

In many ways. These devices have provided the students with a variety of preconceptions. We can basically start by discussing how few controversies actually get to the trial stage and how even fewer of those are actually reported in the National Reporter System. Administrative. Additionally. Teacher to Teacher Dialogue Twenty-first Century technological advances have provided our students with all kinds of instant access to information. The problem is that a trial rarely resembles the goings on found in the entertainment media. Unlike the make-believe world of entertainment. This is not all bad. Trials are long. Among these is the average undergraduate’s notion of how trials are conducted and the role of attorneys in that process. To complete the cycle we can then proceed to itemize the key steps used in a court trial. a trial represents a failure by the parties to reach some sort of satisfactory solution of the issue beforehand. no one knows until the end who really did it until a surprise witness shows up to identify the bad guy. Current media focus on numerous lawrelated issues has generated a whole new wave of public interest in the workings of our legal system. It is against this backdrop that we should try to present a more realistic picture of how our system works. Regardless of the outcome. The downside is that the media has created many myths on the folklore of law and lawyers.46 Chapter 4 Chapter 4 Judicial. Alternative and Online Dispute Resolution Is A Trial The Best Approach? I. tedious. Invariably these perceptions center on popular television series such as Law and Order and Court TV. motions.) The attorney’s professional advice should anticipate and resolve potential legal problems before. a fair amount of time should be spent reviewing the growing trend towards alternative dispute resolution (ADR) mechanisms. rather that after. feeling all the while totally dependent on the sometimes questionable competence of their attorneys. emotionally and financially draining processes for all parties concerned. (This often needs some reinforcement with the student. the attorney first has a business relationship with the client and then proceeds to get him or her acquitted. the job of an attorney is to keep his or her client out of court. the fact if at all possible. and the like. Personal experience examples might be helpful in illustrating the growing trends towards ADR. Rarely do the parties actually want to go through a labyrinth of pleadings. In more modern versions. the process is always full of glamour and intrigue. . In the world of pop culture.

Judicial. Administrative. Alternative and Online Dispute Resolution 47 II. Text Materials with Accompanying PowerPoint Slides .

48 Chapter 4 Litigation Procedures Pleading – Complaint and Answer Pre-Trial Conference Discovery Motions Discovery Trial .

The others were held not liable and were granted summary judgment. Olson and Harvey (all of Ohio) went snowmobiling in Michigan.A. Reason: The accident took place in Michigan as did the actions that caused the injury and Michigan law applies. Bertram sued the others for negligence. Issue: Under the federal notice pleadings system. Alternative and Online Dispute Resolution 49 Answer must be filed to avoid default judgment. When A. Kristi suffered from manic-depressive mental illness (now called bipolar disorder). a native of Hungary. her parents filed a wrongful death lawsuit against Upjohn for alleged failure to warn of the unreasonable dangers of taking halcyon.S. A. The district court dismissed and the court of appeals affirmed. The Supreme Court speaks: Swierkiewicz (A. worked for Sonoma. Facts: Bertram.S. A psychiatrist prescribed Halcion and Darvocet-N. it is not appropriate to require a plaintiff to plead facts establishing a prima facie case. Decision was affirmed. Reason: Under a notice pleading system.) v. He sued for age and national origin discrimination. . and Chief Underwriting Officer. Issue: Was the plaintiffs’ action for wrongful death barred by the one-year statute of limitations? Decision: Yes. California. The judgment was reversed and the case remanded for further proceedings. The Court speaks: Bertram v. Norden. Some courts have instituted this procedure. Some of his duties were taken over by a 32-year old.S. Norden hit Bertram’s leg and broke it. Sonoma moved for dismissal. and Upjohn appealed to the Supreme Court of California. et al. Issue: Does Michigan or Ohio law apply to this case? Decision: Michigan.S. In this disease the person cycles between manic episodes to depressive episodes and is often treated with prescription medicines. Sonoma N. Internet & Technology: E-Filings in Court This box discusses the “virtual courthouse” where all filings are done electronically. The Ohio court applied Michigan law under which snowmobilers assumed associated risks. This was done here. was 53 with 26 years of industry experience he was dismissed by Sonoma. Kristi committed suicide by taking an overdose of these drugs. It was repaired in surgery. Ohio law did not have an assumption of risk rule. Bertram appealed. There should simply be a statement that gives the defendant fair notice of what the claim is and the grounds upon which it rests.Judicial. 1991. On October 16. The court of appeals reversed. He was demoted almost 6 years later. Facts: A. exactly six years after Kristi’s death. The Court Speaks: Norgart v. the UpJohn Company Facts: Kristi Norgart McBride lives with her husband in Santa Rosa. The trial court granted Upjohn’s motion for summary judgment based on the fact that the one-year statute of limitations for wrongful death actions had run. After a chain of events involving all four.P. was A.S. Administrative. Norden.’s complaint sufficiently pleaded to permit the case to go to trial? Decision: Yes. He was Senior V. appealed.

Reason: The testimony does not establish. Contemporary Issue: Ford Settles Lawsuit Even though this is a very large verdict. Contemporary Issue: Cost-Benefit Analysis of a Lawsuit The choice of whether to bring or defend a lawsuit should be analyzed like any other business decision. Issue: Should the motion for summary judgment have been granted. it is an example of the hundreds of thousands of civil lawsuits settled out of court every year. Canada Dry and Pathmark Facts: Toote claimed she fell over cases of soda stacked on Pathmark’s floor when she was shopping. She said she did not see the cases and did not know how long they had been there. . prima facie. Pathmark moved for summary judgment which was denied and Pathmark appealed. Contemporary Issue: Phases of a Trial This explains the usual phases of a trial. the lack of notice by Pathmark or that it may not be held liable for an independent contractor’s negligence so the motion must be denied. The Court speaks: Toote v. Decision: No. thus barring the plaintiff’s lawsuit. Motion was denied.50 Chapter 4 Reason: The Upjohn Company was entitled to judgment as a matter of law based on the fact that the one-year statute of limitations for wrongful death actions had run.

Mrs. complete with ears. As described on the product’s package. The costume covered Mr. Susan Ferlito testified that the idea for the costume was hers alone. Marley Company Facts: Weisgram died from carbon monoxide poisoning. Ferlito had constructed a lamb costume for her husband by gluing cotton batting manufactured by defendant Johnson & Johnson Products to a suit of long underwear. be granted? Decision: The trial court granted JJP’s motion for j. Ferlito from his head to his ankles. Ferlito’s body. defendant JJP filed a timely motion for judgment (not withstanding) the verdict. Facts: Plaintiffs Susan and Frank Ferlito. Following a jury verdict entered for plaintiffs.n. Alternative and Online Dispute Resolution 51 The Court Speaks: Ferlito v. vacating the verdict in favor of the Ferlitos. At the party Mr.n. Reason: The evidence in this case clearly demonstrated that neither the use to which plaintiffs put JJP’s product nor the injuries arising from that use were foreseeable. The court of appeals agreed with Marley. Experts were introduced but Marley claimed they were not reliable after a verdict was brought in against Marley.o. Administrative. and the cotton batting on his left sleeve ignited.. applying medications. Ferlito attempted to light his cigarette by using a butane lighter. Inc. Issue: Can an appellate court enter judgment as a matter of law against a jury-verdict winner if it determines on appeal that evidence was erroneously admitted at trial and concludes that the other properly admitted evidence is not sufficient to constitute a submissible case? . except for his face and hands. Johnson & Johnson Products. Ferlito). Issue: Should defendant JJP’s motion for j.v. She had also used defendant’s product to fashion a headpiece. Plaintiffs sued defendant for injuries they suffered from burns that covered approximately one-third of Mr. Plaintiffs’ showing that the product may be used on occasion in classrooms for decorative purposes failed to demonstrate the foreseeability of an adult male encapsulating himself from head to toe in cotton batting and then lighting up a cigarette.o.v. Ferlito) and her little lamb (Mr. its intended uses are for cleansing. The Supreme Court speaks: Weisgram v.Judicial. and infant care. The flame passed close to his left arm. Wrongful death action was brought alleging a defect in a Marley electric baseboard heater that caused the fire causing the death. attended a Halloween party in 1984 dressed as Mary (Mrs. which were blackened with Halloween paint. Weisgram appealed. husband and wife.

Circuit City sought to enjoin the court proceeding and to compel arbitration. Circuit City Stores hired Saint Clair Adams as a sales counselor.S. the court of appeals reversed. Supreme Court granted certiorari. He signed a contract that included an arbitration clause that stated that all claims regarding his application or candidacy for employment would be settled exclusively by final and binding arbitration. Two years later. The district court granted Circuit City’s request. *One objective of this chapter should be introducing students to the growing number of ADR options available to both businesses and private individuals. Inc. Adams filed an employment discrimination lawsuit against Circuit City. and mediation. and the U. Landmark Law: Federal Arbitration Act This explains the Federal Arbitration Act and discusses which types of disputes should be arbitrated. Reason: The Supreme Court held that other employment contracts. It is interesting to note how earlier resistance to arbitration has been overcome with the passage of time combined with a society seemingly all too ready to take every dispute to court. The Supreme Court Speaks: Circuit City Stores. Adams Facts: In October 1995. This would include not only the traditional methods of settlement. arbitration.52 Chapter 4 Decision: Yes. v. Reason: The court of appeals has authority to render the final decision but they should consider the first-instance decision maker’s “feel” for the overall case. . Issue: Are employment contracts subject to arbitration if the parties have entered into a valid arbitration agreement? Decision: Yes. but also newer mechanisms such as the privately conducted mini-trial. including the one between Circuit City and Adams are subject to arbitration if a valid arbitration agreement has been executed.

Contemporary Issue: The Federal Administrative Agencies 10 agencies are discussed. Administrative actions can be reviewed judicially. . An ALJ presides over proceedings. adjudicate. The agency has only the powers delegated to it. They have the powers to make rules.Judicial. Additional material can be found in Chapter 34. and investigate. They may regulate business. The APA sets procedures. Administrative. Administrative Law Administrative agencies are often created by Congress or the Executive Branch to help. Alternative and Online Dispute Resolution 53 Internet & Technology: Online Dispute Resolution Online dispute resolution is discussed.

The U.2d 1271 (Okla. the Oklahoma court gained jurisdiction over Magna Verde through Oklahoma’s long-arm statute. 104 S. 465 U. Thus. Magna Verde Corp. App. A court has the power to order the physical and mental examination of a party to a case. Washington. the Oklahoma state court can use the state’s long-arm statute to gain jurisdiction over Magna Verde. 619 P.Ct. III. However. Calder v. the defendants are subject to suit in California. and that the article would have its greatest impact in California. Magna Verde had also transacted business in Oklahoma. Physical Examination 4. The court will only order Schlagenhauf to be examined by an ophthalmologist. 326 U. Can their system really work here? Or is it only fashionable to complain that we are far too litigious a society? This is a good starting point for a larger comparative debate between your students on the overall role of law and lawyers vis-à-vis a nations’ business culture. Answers to Critical Thinking Cases Long-Arm Statute 4. that the Due Process Clause permits jurisdiction over a defendant in any state in which the defendant has “certain minimum contacts such that the maintenance of the suit does not offend traditional notions of fair play and substantial justice. the minimum contacts rule and the Due Process Clause were not violated. Yes. 79 L. 1980). Minimum Contacts 4. 1482. must “reasonably anticipate being hauled into court” in California to answer for the truth of the statements made in the article.S.Ed.S. The Supreme Court applied the rule of International Shoe Co. v. Brooks v. lived and worked in California. a contract to stage a fight in that state. Because of these contacts with the state.2. who were residents of Florida.3.54 Chapter 4 International Law: Japan’s Legal System This is an interesting comparison on the legal systems of two major economic powers.S. The court in this case stated the rule as requiring that parties making a request for examination must make an affirmative showing that the other party’s “mental or physical condition was in controversy and that there was good cause for the . Supreme Court held that jurisdiction of the California court over the petitioners. promoting the O’Grady prizefight. or who transact other business in the state. as Florida residents. Magna Verde had entered into a contract that would affect Oklahoma. Yes.. this power is limited to situations where the physical or mental condition that is the subject of the examination is at issue in the case. Oklahoma’s long-arm statute gave the Oklahoma court jurisdiction over Magna Verde for several reasons. The Court noted that the magazine has its largest circulation in California. The Supreme Court concluded that the defendants.1. that the defendant knew that plaintiff Shirley Jones. Jones.2d 804 (1984). was proper because of their intentional conduct in Florida that was allegedly calculated to cause injury to plaintiff Shirley Jones in California. The exercise of long-arm jurisdiction is generally permitted over nonresidents who have a contract that affects the state.” The Court applied this rule to the case at hand and found that California was the focal point both of the article that appeared in the National Enquirer and of the distress suffered. 783. 310. A long-arm statute gives a court the ability to gain jurisdiction over an out-of-state business if that business has minimum contacts with the state and the maintenance of the suit does not offend traditional notions of fair play and substantial justice. a professional entertainer and television personality.

all of the other witnesses stated that the traffic light was not operating. 85 S. A Judgment N. Maynard. Cine was required to answer them in a timely and truthful manner.V.O. the court concluded that: Nothing in the pleadings would affect a basis for a belief that Schlagenhauf was suffering from a mental or neurological illness warranting wide-ranging psychiatric or neurological examinations. Yes.O. 602 F. Cine is required to answer the questions submitted by Allied Artists’ attorneys. 4.Ed. 104.O.2d 1 (2nd Cir. 1970). Judgment N. Cine Forty-Second Street Theatre Corp. is “whether the evidence is such that there can be but one conclusion as to the verdict that reasonable men could have reached. Simblest v. In other words. The interrogatories that were served upon Cine sought to discover information about its theater’s box office receipts. the judge is being asked to enter a judgment opposite of what the jury has decided because no reasonable jury could have reached the verdict that this jury has entered. Alternative and Online Dispute Resolution 55 examinations requested.” In this case. 13 L. 234. the judge granted the defendant’s motion for a Judgment N. Nor is there anything stated justifying the broad internal medicine examination. Because interrogatories are an important part of the discovery process. like other forms of discovery. The purpose of interrogatories.V. 1979). Therefore. Holder. Where Simblest claimed to have had a green light in his favor. The standard used by the court in this case in deciding whether to start a Judgment N.V.Ct. Therefore. Interrogatories 4. This information was crucial in determining potential damages in the suit. . v.2d 152 (1964). A party is required by the court to answer the interrogatories in writing within a specified time period. the only examination that the court ordered Schlagenhauf to undergo was one conducted by an ophthalmologist.5. 379 U. These written questions are known as interrogatories.4. that person must be careful to answer them truthfully. Schlagenhauf v. Administrative.S. Interrogatories are usually directed at parties. in direct contradiction with Simblest’s testimony. all of the testimony of the witnesses directly contradicted the statements of Simblest.V.. Allied Artists Pictures Corp. not witnesses.2d 1062 (2nd Cir.Judicial. is a motion that asserts that considering the evidence in a light most favorable to the plaintiff.” In this case the only issue was Schlagnehauf’s eyesight. Four witnesses also testified that they had observed the lights and sirens of the fire engine working. Interrogatories are an important part of the legal process known as discovery.O. 427 F. Because all of the evidence in this case favored the defendant. Because the person answering the interrogatories must sign them under oath. the plaintiff has failed to introduce evidence sufficient for a reasonable jury to have held for the plaintiff. is to obtain facts about the case from the other parties and witnesses before the trial begins.

6. Administrative Procedure 4. Justice Brennan wrote a dissent addressing. Here the FCC did by including broadcasting in its scope which was specifically excluded by the Communications Act. The court gave the following reasons for enforcing the agreement.D. This was beyond the FCC statutory authority. Radio stations are subject to “time. the court held that their dispute had to be submitted for arbitration.. Congress has enacted the Federal Arbitration Act (FAA). citing the language of the legislation that enacted the FAA: Arbitration agreements are purely matters of contract and the effect of the bill is simply to make the contracting party live up to his agreement. Yes the FCC exceeded its statutory authority in adopting its public access rules for cable television operators. The court held that communication broadcasting has the most limited First Amendment protection.7. and enforceable as long as the agreement is not illegal. Rule Making 4. Mallen was not entitled to a presuspension hearing. The comprehensive federal banking laws were meant to protect the public and instill confidence in the banking system.Y. Since theses do have a present and binding effect they are legislative rules. . The FCC inappropriately treated the cable television industry as a common carrier. Brunswick Corp. Because of this fact.8. 1985). Administrative Regulation 4. and manner” restrictions regarding broadcasts. indecent. Yes the FCC regulation and censoring of Pacifica in this case was lawful and constitutional. 456 (E.Supp. irrevocable. Rule Making 4. The act provides that arbitration agreements involving “commerce” are valid. Because AMF and Brunswick had signed an arbitration agreement involving commerce. the court held that the FAA covered the agreement. in part. 621 F.9. AMF Incorporated v. He can no longer refuse to perform his contract when it becomes disadvantageous to him.” George Carlin’s “Filthy Words” monologue fit into this definition.56 Chapter 4 Arbitration 4.N. The Community Nutrition Institute wins. The statute in question specifically forbids the use of any “obscene. An agency cannot go beyond its delegated powers. The arbitration agreement between Brunswick and AMF was clearly one involving commerce. the arbitration agreement between AMF and Brunswick is valid under Federal law. There was no due process violation in this case. To promote the arbitration of disputes.10. or profane language by means of radio communications. The FDA must follow notice-and-comment procedures in adopting its rules. This was done here through an through an immediate suspension. Yes. Yes the statute is constitutional and does not violate the due process clause. the rights of adults. place. The Communication Act’s prohibition against “indecent” broadcasts was justified because broadcast media is pervasive in our lives and is uniquely accessible to children. The question here is whether the “action levels” for contaminants in food constitute a legislative rule or not.

Answers to Ethics Cases 4. the ICC’s grant of licenses to 3 motor carriers and 10 applicants was not overturned on appeal. Mrs.2d 136 (1992) U. Summary of the Key Facts A. Licensing decisions are usually only overturned if the decision was “ arbitrary. 4. Agencies are permitted to act within the scope of the duties delegated to them. In this case. Yes.S. One method of obtaining personal jurisdiction over a defendant is to serve personal service on the defendant when he is within the territorial boundaries of the state. 109 L. Burnham filed a divorce action in California after she and her husband separated and she moved to California from New Jersey. VI.13. There was here. V. a rational connection between the evidence and the decision. The Court held that service of process was good in this case. G. This industry is very dangerous and the need for a warrant may assist in the concealment of such danger. No. naming her husband. Administrative. Ms. A court must have personal jurisdiction over the defendant in a lawsuit. In November 1974. Mr.” Thus the sope of judicial review is a narrow one. The Supreme Court reasoned that the fact that American courts have announced the rule since the latter part of the 19th century provides a defendant voluntarily in a particular state today with clear notice that he is subject to suit in that forum. Searle & Co. he was served the summons and complaint of Mrs. Citation and Court Gnazzo v. Burnham was in California on business. She brought a product liability action against Searle in Federal District Court in May 1990. as the defendant. Therefore. Case Name. 973 F.Judicial. marketed. Alternative and Online Dispute Resolution 57 License 4. Gnazzo purchased and started using an IUD developed. In this case. The assurance of regularity provided by a warrant may not always be necessary although a search pursuant to a warrant is generally reasonable.11. The owner of a mine cannot help but be aware that he will be subject to effective inspection. Court of Appeals for the Second Circuit 2. She then filed a divorce action in California Superior Court. as required. the U. the service of process served on Mr.S. She continued to use it until she had it removed in December 1977 because she was being treated for pelvic inflammatory disease. Burnham’s divorce action. In this case the ICC was within its powers. When there. Burnham.12. Burnham must answer and defend himself in the California divorce action filed by his wife.D.14. capricious. Burnham v.2d 631 (1900). . Burnham is good.Ct. Answer to “Briefing the Case” Writing Assignment 1. who lived in New Jersey. Supreme Court held that jurisdiction might be obtained over a nonresident by personal service in the forum state. 110 S. There were no violations of due process.Ed. or an abuse of discretion. he decided to visit his children who were living with Mrs. 2105. 4. Yes the warrantless searches of the quarries authorized by the Federal Mine and Safety Health Act are constitutional. This was appropriate and although Larkin’s challenge was not unethical it was a waste of time. and sold by Searle. Superior Court of California. When Mr.

Court of Appeals for the Second Circuit affirmed the decision and held in favor of Searle. as a matter of public policy. that she was infertile and that her condition was most likely related to Pelvic Inflammatory Disease—induced adhesions resulting from her use of the Searle IUD. statutes of limitations set maximum time periods during which certain actions can be brought. In May 1989. the action was time-barred by the three-year Connecticut Statute of Limitations. Searle responded by asking for a summary judgment in their favor based on the allegation that the suit was time-barred by the Connecticut Statute of Limitations. when she decided to sue in 1990. C. The lower court agreed with Searle.Gnazzo’s lawsuit? 4. The Court of Appeals believed that her awareness of problems created by this product began in 1981 and that she “discovered or should have discovered through the use of reasonable care” that the Searle product caused such injury. This is an appeal of that judgment. B. no action can be brought regardless of whether any cause of action ever existed. State legislatures have the constitutional authority to decide when claims for injury may be brought. She decided to bring this action after she was notified. Under Connecticut law. Gnazzo completed a questionnaire stating she first suspected that the IUD caused her harm sometime in 1981. Holding The U. 5. Ms. Summary of the Court’s Reasoning A. . Thus.S. a product liability claim must be brought “within three years from the date when the inquiry is first sustained or discovered or in the exercise of reasonable care should have been discovered.58 Chapter 4 B. After the time period stated in the statute has run. in March 1989. The Issue Did the Connecticut Statute of Limitations time-bar Ms. She chose not to pursue the matter at that time because of domestic difficulties. in spite of its sympathy for Ms. Generally. Gnazzo’s condition. The Court of Appeals affirmed the lower district court decision in favor of Searle. 3.

. tort law is really fun to teach because the human condition not only gives us so much incredible raw material to work with but also gives us. Also introduce students to the concept of the big picture where they will be asked to look at the variety of resolution paths available to them rather than just one “right” answer. duties. II. Text Materials The key objectives of this chapter are to itemize the classifications of tort law as used in our system and to help students become familiar with the building block process used to construct each case. but it also introduces them to the underlying logic of “thinking like a lawyer. The other interesting aspect of teaching this material is that it introduces students to the concept of elements or components of a tort or crime or. Encourage them to think in terms of negligence as not the first answer. This process may not only help students make difficult legal doctrines more comprehensible. remind them of the interrelationship between tort law and criminal law and how both may arise from the same act yet create entirely separate legal actions. real positive feedback that it is working in the minds of our students. This is done through the introduction of various classifications of torts with case illustrations for each classification. most legal doctrines. as teachers.Torts and Cyber Torts 59 Chapter 5 Torts and Cyber Torts Why Should They Pay? I. You can start by providing some background on the origins of the word “tort” and where it fits into the legal landscape vis-à-vis crimes and other disturbances of the peace. for that matter. Teacher to Teacher Dialogue: This material provides students with their first real personal opportunity to resolve conflicts placed before them by weighing the respective rights. but rather as the result of a component building block process where negligence is the product of showing the elements are in place. In addition. and obligations that arise from a civil dispute in tort.” All in all.

60 Chapter 5 Contemporary Environment: Wal-Mart Shopper Wins This discusses the shopkeeper’s privilege in a case where a Wal-Mart store falsely accused a shopper of stealing a telephone. .

Torts and Cyber Torts 61 Note: The Doctrine of Transferred Intent Victim can sue .

62 Chapter 5 Truth is an absolute defense. Reckless disregard for the truth .

Lucky Cheng’s sued for defamation and trade libel. Her sister sued Stern. died of an overdose. Issue: Were Zagat’s statements facts or opinions? Decision: Opinion.Torts and Cyber Torts 63 Contemporary Issue: Eminem not Liable for Slander. The Court Speaks: Roach v. This box discusses the case of DeAngelo Bailey versus Eminem for allegedly slanderous song lyrics. LLC Facts: Zagat Survey published consumer guides from surveys of customers. Zagat Survey. and Infinity (the syndicator of the show) to recover damages for intentional infliction of emotional distress. . Their ratings range from 0-30. doing business at Lucky Cheng’s v. Stern Facts: This case involves talk show host Howard Stern. Her sister gave part of her ashes to a friend.Inc.. who brought the box containing the ashes to the Stern show. Reason: The court held that the complaint and the facts of the case as pleaded sufficiently stated a cause of action to recover damages for intentional infliction of emotional distress. Zagat said they were opinions and not actionable. The trial court dismissed the complaint. Deborah Roach. Zagat rated Lucky Cheng’s a 9 for food and 15 for services. and others played with the ashes and made crude comments about the remains on a show that was broadcast to a national cable television audience. Hayden. Eminem won. Lucky Cheng’s appeals. It gave a poor food review with some disparaging remarks. The trial court agreed with Zagat and dismissed the case. Chaunce Hayden. Appellate Court affirmed in favor of Zagat and against defamation or trade libel. The Court Speaks: Themed Restaurants . a perennial guest on the radio show. Issue: Did the plaintiff have a cause of action to recover damages for intentional infliction of emotional distress? Decision: Yes. Reason: Ratings are almost invariably opinions. Stern. Hayden.

Original plaintiff instituted suit and no probable cause .64 Chapter 5 Contemporary Issue: Malicious Prosecution This box discusses malicious prosecution. It discusses what a plaintiff must prove in a malicious prosecution action.

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Carneal. where he shot and killed three students and wounded many others. a 14 year-old brought a pistol and five shotguns to school. ½ from Wilhelm and ½ from Black. . The judgment was for the defendants. In this case. The Court Speaks: James v.000 in damages. He was given a protective suit but not warned of danger by Wilhelm or Black. certain violent interactive video and computer games.591. who killed three children? Decision/Remedy: No. He died as a result of anaphylactic shock reaction. Flores was stung several times after opening the veil on his suit. Flores The Facts: Wilhelm owned beehives. Issue: Did the defendant video and movie producers and distributors owe a duty of care to the plaintiffs by selling and licensing violent video games and movies to Carneal. and after playing regularly. the court said there was no foreseeability even though Carneal was not normal. Jury found $1. The parents sued the producers and distributors of the games and movies for wrongful death.66 Chapter 5 The Court Speaks: Wilhelm v. Reason: Owner of bees owes duty to warn of dangers. Movies are basically too far removed from the classroom. Judgment was affirmed. Inc. The reactions here were not predictable. Issue: Did Wilhelm act negligently by failing to warn Flores of the damages of working with beehives? Decision/Remedy: Yes. Black bought beehives for his honeybee business. Applying a policy analysis. Individuals can assume that third parties will not commit intentional criminal acts. he had the background to know the dangers. Meow Media. Flores worked for Black to help pick up the hives. The Facts: After watching various videos dealing with high school students dreaming of shooting teacher and classmates. Reason: Duty of care depends on a “foreseeability” test.

lost her leg. a lacerated spleen (which was removed).Torts and Cyber Torts 67 The Court Speaks: Clancy v. crossed the center line and collided with Diana Goad’s motorcycle.000/year as a managerial accountant. The trial court judgment was affirmed. Clancy woke up and swerved into the ditch.000 and were expected to continue indefinitely. a fractured left elbow. Issue: Were the damages excessive? Decision: No. Goad Facts: Clancy fell asleep at the wheel of a truck. Clancy appeals claiming damages were excessive. Her leg was severed above her knee and she was thrown into a water-filled ditch. suffered a fractured pelvic bone. She was taken to the hospital by the paramedics. She earned $45. The award was reasonable in this case. Her injuries were severe and her medical expenses totaled more than $368. Reason: Diana was active and athletic. Clancy called 911 and Robert Goad held Diana’s head above the water. . She was in a coma for two weeks. The jury returned a 100% fault verdict against Clancy in a negligence suit and Diana was awarded $10 million in compensatory damages.

Mitchell went 80 mph and went airborne. Business Ethics: Ouch! The Coffee’s Too Hot This box discusses the famous case of a woman who sued McDonald’s when she suffered burns from their hot coffee. spun and slammed broadside into an A&L pole. Facts: Mitchell drove her Honda Accord with Jacobs in the front seat and Messer in the back seat. She lost control and over-steered to the right. Defendant’s guard did not commit a wrong in relation to the plaintiff. The poles were 25 feet from the edge of the right of way. The Court speaks: Carter v. She sideswiped a Bell utility pole. Carter appealed.68 Chapter 5 Plaintiff must show wrong to herself not merely to someone else. Indianapolis’s Power & Light Company(A&L) and Indiana Bell Telephone Company(Bell). where the speed limit was 40 mph. Jacobs’s estate representative sued Bell and P&L for negligent pole placement. Carter. Jacobs suggested they “jump the hills” on Edgewood Ave. Messer escaped.Inc. Summary judgment was granted to Bell and P&L. Issue: Did Bell and P&L breach their duty of care? . The other 2 died. landing in the middle of the two lane road. Railroad was thus not the proximate cause of plaintiffs injuries. and caught fire.

Summary judgment for Bell and P&L affirmed. Issue: Was Motel 6 liable for willful and wanton reckless conduct that supported the award of punitive damages of $186. the accident was the result of the superseding. He sued under negligent infliction of emotional distress. Colbert did not see the drowning or the results “shortly after”. Here Mr. There is nothing to suggest this was negligent. Colbert and his friends jump off and held on at the rear as the boat drove slowly toward shore. Rescuers searched while Mr. Facts: Colbert. after drinking. intentional act of Mitchell. Colbert disappeared. She also had high levels of carbon monoxide and ethanol toxicity from the boat. Colbert under negligent infliction of emotional distress? Decision: No. and Skier’s Choice.000 to each plaintiff? Decision/Remedy: Yes. Inc. 911 was called. Reason: The companies had a duty to exercise reasonable care in placing the poles. Accor… and Motel 6 The Facts: Matthias’s checked into Motel 6 and were given a room labeled “Do not rent. The judgment was affirmed. to solve the original problem.000 in punitive.Torts and Cyber Torts 69 Decision: No. Special Notes Per se violation of statute Res Ipsa Loquitor exclusive control Danger Invites… can sue the person Landowners Invitees and licensees duty of ordinary care Trespassers duty to not willfully or wantonly injurer The Court speaks: Colbert v. up close. He arrived 10-15 minutes after he learned of the accident. the recovery. and he did not witness. Inc. Mr. Colbert died from drowning.” Motel 6 had tried. Colbert and Lynam began swimming. Reason: Negligent infliction of emotional distress is for bystander family members to obtain damages for “foreseeable” intangible injuries caused by viewing a physically injured loved one shortly after a traumatic accident. Issue: Is the defendant liable to Mr. Jury awarded $5. bugs in room. Inc. The Court Speaks: Matthias v. Elements were not met here and dismissal was affirmed. . Instead. Colbert appeals from dismissal of this claim. At about 200 yards out. took out a motorboat. Moomba Sports. Matthias’s were severely bitten and thus sued.000 each in compensatory damages and $186. Colbert looked on. Colbert suffered from severe emotional distress stemming from the incident. The Moomba brand boat had been manufactured by Skier’s Choice. with exterminators. MR.

Liability holds. Upon dismissal by district court and a subsequent ruling by the court of appeals affirming. The summary judgment was affirmed.S. The Supreme Court speaks: Dolan v. or non-delivery. The Court Speaks: Lilya v. They left the mail negligently and she fell. placed on her porch by an employee of the US Postal Service (USPS)and was seriously injured. The Greater Gulf State Fair. Upon denial of claim with USPS. . late delivery. The exception was for claims arising from…” loss. miscarriage.70 Chapter 5 Reason: Failure to control the bedbug infestation constituted willful and wanton reckless conduct warranting the verdict. U. Issue: Does the exception apply? Decision: No. suffering a fractured neck. Inc. USPS claimed an exceptance to the Federal Torts Claim Act (FCTA) applied. He sued. he was thrown. Reason: Negligent transmission should be construed as narrowly as “lost” or “miscarried”. Court said he had assumed the risk. Note: The doctrine of sovereign immunity provides that a government is not liable to anyone hurt by government employees except under the FTCA. Facts: Lilya paid fee to ride a mechanical bull after watching a mechanical bull of defendant throw a rider. Dolan says this does not apply to employees of USPS. she sued in district court. etc. Issue: Was riding a mechanical bull an open and obvious danger that Lilya had voluntarily assumed the risk of when he rode the mechanical bull? Decision/Remedy: Yes. The judgment was reversed and the case was remanded. or negligent transmission of letters or postal matters”. Dolan appeals. These usually mean delivery to a wrong address. Her had signed a release assuming all risks and acknowledging their existence. After boarding the bull for a second time. Postal Services Facts: Dolan fell over packages.

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Reason: The duty of reasonable care to invitee does not include the duty to warn of open and obvious dangers. Lilya had watched and been thrown before he was injured.

The Court speaks: Hurst v. East Coast Hockey League, Inc. and Knoxville Cherokees Hockey, Inc. Facts: Hurst was hit in the face by a hockey puck while standing in the spectator area at the Florence City and County Civic Center. There was some protection by wooden dasher boards and protective Plexiglas up to a certain height. Hurst sued East Coast, Knoxville, the city and the county. Circuit Court ruled that Hurst assumed the risk and the respondents were granted summary judgment. Hurst appeals. Issue: Does applied assumption of risk apply in this case? Decision: Yes. Judgment was affirmed. Reason: The risk of injury from a flying puck is well-known, obvious, and inherent to the game of hockey. Respondent’s duty did not encompass this risk.

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The Court Speaks: Cook v. Whitsell-Sherman The Facts: Cook owned a 100-pound Rottweiler never showing violent tendencies. The dog was left with a neighbor whose 8 year old daughter was holding the dog on a leash when WhitsellSherman was delivering mail. The dog broke free and bit the mail carrier causing injuries. Whitsell-Sherman sued Cook and recovered based on a strict liability statute for pets and postal carriers. The trial court found Cook strictly liable but the court of appeals reversed. Issue: Is the owner of a dog strictly liable for injuries caused by the dog biting a postal carrier? Decision/Remedy: Yes. The damages of $87,000 had to be reconsidered and properly determined. Reason: The Indiana statute changed common law imposing strict liability even though the owner was not there when the incident occurred. International Law: Israeli Tort Law This is an interesting side-by-side comparison to how another country had adopted its assessment of tort damages based on biblical teachings translated into today’s needs.

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III. Answers to Critical Thinking Cases Intentional Tort 5.1. Yes, Ross Grimsley and the Baltimore Baseball Club, Inc. are liable for the injuries suffered by David Manning when a ball thrown by Grimsley struck him. The Court held that the defendants were liable for the intentional tort of battery under the transferred intent doctrine. Under this doctrine, the law transfers the perpetrator’s intent from the target person to the actual victim of the act. In this case, the Court found that Grimsley was an expert pitcher, that on several occasions immediately following the heckling he looked directly at the hecklers, not just into the stands, and that the ball traveled at a right angle to the direction in which he had been pitching and in the direction of the hecklers. The jury could reasonably have inferred that Grimsley intended to throw the ball in the direction of the hecklers, to cause them imminent apprehension of being hit, to respond to conduct presently affecting his ability to warm up and, if the opportunity came, to play in the game itself. Thus, even though Grimsley aimed the ball at a heckler but hit Manning, the Court held Grimsley liable for an intentional tort to Manning under the transferred intent doctrine. The Baltimore Baseball Club, Inc., is liable because Grimsley was an agent of the Club at the time of the incident. Manning v. Grimsley, 643 F.2d 20, 1981 U.S. App. Lexis 19782 (1st Cir. 1981). Merchant Protection Statute 5.2. No, K-Mart Enterprises, Inc. (K-Mart) is not liable to Deborah Johnson for false imprisonment. The Court held that K-Mart was protected from liability because it complied with the Wisconsin merchant protection statute. This statutory “shopkeeper’s privilege” permits merchants to stop, detain, and investigate suspected shoplifters without being held liable for false imprisonment if (1) there are reasonable grounds for the suspicion, (2) the suspect is only detained for a reasonable time, and (3) the investigation is conducted in a reasonable manner. In this case, the Court held that K-Mart had reasonable grounds to suspect Johnson of shoplifting because the price tag remained on the child’s seat and Johnson was hurrying to leave the store. Second, Johnson was detained for a reasonable time, i.e., for not more than 20 minutes. And third, the investigation was conducted in a reasonable manner. The security guard requested Johnson to return to the store, she was questioned in a reasonable manner, and was released as soon as the evidence indicated that she had not shoplifted the child’s seat. The Court held that KMart was protected from liability for false imprisonment by the statute. Johnson v. K-Mart Enterprises, Inc., 297 N.W.2d 74, 1980 Wisc. App. Lexis 3197 (Wis.App. 1980). Trespass 5.3. McKinsey should win. The fact that someone is acting unlawfully while intruding does not justify use of an object intended to injure unless other circumstances are present. [McKinsey v. Wade, 220 S.E.2d (Ga. 1975)] Negligence 5.4. The Automobile Club of Southern California (Auto Club) wins. The Court held that the Auto Club was not negligent to Yanase. The law provides that in order for a defendant to be held liable for negligence, he must owe the plaintiff a duty of care and must breach this duty. In this case, the complaint failed to state sufficient facts to support an action for negligence against the Auto Club. This was because the Court found that the Auto Club did not owe or breach a duty to

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Yanase regarding the safety of the Royal Lodge. The Auto Club’s Tourbook never made a claim that the listing and rating service included a finding that the neighborhood surrounding the motel was safe or that its security measures were adequate. The Tourbook only addressed the motel’s accommodations as to the quality of its lodging, food, and services. The scope of any duty of care owed by Auto Club to its members did not extend to neighborhood safety and security measures. The Court granted Auto Club’s motion on the pleadings. Yanase v. Automobile Club of Southern California, 212 Cal.App.3d 468, 260 Cal.Rptr. 513, 1989 Cal. App. Lexis 746 (Cal.App. 1989). Causation 5.5. Yes, there was causation in fact and proximate cause linking the defendants’ negligence to the fatal accident in which Mr. Davis was killed. A person who commits a negligent act is not liable unless this act was the actual cause and proximate cause of the plaintiff’s injuries. Actual cause is measured by the “but for” test, which may be stated as follows: the defendant’s conduct is not a cause of the event if the event would have occurred without it. In this case, the Court held that if General Motors had not negligently manufactured the alternator, the truck would not have stalled, and there would not have been a stationary vehicle on the freeway for the decedent to hit. Therefore, causation in fact existed. The law establishes a point along the damage chain after which a negligent party is no longer responsible for the consequences of his negligent act. This limitation on liability is referred to as proximate cause or cause in foreseeability. The Court in this case held that General Motors’ negligence was the proximate cause of the decedent’s death. A jury could reasonably find that the malfunction of a piece of automotive equipment would place any person using the highway in danger of bodily injury. The Court held that the defendant’s negligence was the actual and proximate cause of Mr. Davis’ death. General Motors Corporation v. Davis, 233 S.E.2d 825, 1977 Ga. App. Lexis 1961 (Ga.App. 1977). Negligence Per Se 5.6. Julius Ebanks wins. The Court held that he could recover damages from the New York City Transit Authority for the injuries suffered when his foot became caught in the escalator under the doctrine of negligence per se. In a negligence per se action, the plaintiff must prove (1) that a statute existed, (2) the statute was enacted to prevent the type of injury suffered, and (3) the plaintiff was within the class of persons to be protected by the statute. Under the negligence per se doctrine, the injured party does not have to prove the plaintiff breached his duty because the statute establishes that. The Court in this case held that the building code established the requirement that a “gap” between an escalator step and escalator wall not exceed 3/8-inch. Evidence showed that the gap in this case in which Ebanks’ foot became caught was 2 inches, therefore violating the building code. The Court held that the building code was adopted by the city to prevent the type of injury suffered by Ebanks and that he was within the class of persons to be protected by the building code. The Court held that the elements for negligence per se had been established. Ebanks v. New York City Transit Authority, 70 N.Y.2d 621, 518 N.Y.S.2d 776, 1987 N.Y. App. Lexis 17294 (N.Y.App. 1986). Liability of Landowners 5.7. The Wagners win and are not liable for the death of Doehring. The Court held that the Wagners, easement holders, owed the same duty to trespassers as do landowners. Generally, landowners owe a duty of ordinary care to invitees and licensees, but only a duty to not wantonly

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and willfully injure trespassers. In this case, Doehring was riding on a motorcycle and was trespassing on Wagners’ property. No consent had been given by the Wagners or the owners of the land to Doehring to be on the property. Here the Court found that the Wagners had stretched a large metal chain between two poles at the entrance of their right-of-way, and that this was proper for them to do to keep unwanted motorcycles and others off the property. The Court held that the Wagners only owed a duty not to wantonly and willfully injure trespassers such as Doehring. Wagner v. Doehring, 553 A.2d 684, 1989 Md. Lexis 29 (Md.App. 1989).

Liability of Common Carriers 5.8. Carmen and Carla Lopez win. The Court held that the Southern California Rapid Transit District breached its duty of care and failed to protect Carmen and Carla from the violent attack they were victims of while riding an RTD bus. The State of California imposes a duty of utmost care (rather than ordinary care) on public and private carriers. The Court held that this duty includes an obligation to protect passengers from assaults by fellow passengers. Imposing this duty on public carriers is not unreasonable, since they have many methods that may be employed to protect passengers. The Court held that a special relationship exists between the carrier and the passenger because bus passengers are “sealed in a moving steel cocoon,” have no control over who is admitted onto the bus, and are wholly dependent on the bus driver to summon help or provide a means of escape when an occasion arises where such assistance is necessary. Further, the RTD was aware of previous violent attacks that had occurred on its bus routes. Lopez v. Southern California Rapid Transit District, 40 Cal.3d 780, 221 Cal.Rptr. 840, 1985 Cal. Lexis 434 (Cal. 1985). Emotional Distress 5.9. Gregory James wins. The Court held that he may recover for emotional distress he suffered when he saw his sister get killed under the doctrine of negligent infliction of emotional distress. The Nebraska Supreme Court adopted the “foreseeability” test in applying this doctrine. To be successful in a lawsuit for negligent infliction of emotional distress, the plaintiff must prove that (1) a relative was killed or injured by the defendant, (2) the plaintiff suffered severe emotional distress, and (3) the plaintiff’s mental distress resulted from a sensory and contemporaneous observance of the accident. Nebraska does not require that the plaintiff’s mental distress be manifested by some physical injury. In this case, the Court held that all of these elements applied when John Lieb, a driver for Watts trucking service, backed a truck over Demetria James, killing her as her brother Gregory watched. The Court remanded the case for proceedings consistent with its opinion. James v. Watts Trucking Service, Inc., 375 N.W.2d 109, 1985 Neb. Lexis 1209 (Neb. 1985). Defense 5.10. The defendants win. The Court held that the City of New York, who owned Shea Stadium, the Metropolitan Baseball Club, Inc., who leased the stadium, and the other defendants were not liable to Elliot Maddox for the injuries suffered when he slipped and fell in the outfield of Shea Stadium when trying to catch a baseball during a professional baseball game. The defendants alleged that Maddox had assumed the risk of playing on the wet field. The Court agreed, finding that the defendants had proved the two key elements of the defense of assumption of risk: (1) that Maddox had knowledge of the dangerous conditions (wet field) as demonstrated by his comments to the club manager and (2) that Maddox had voluntarily continued to play centerfield without being ordered to do so by any superior even after being fully aware of the danger. The Court

Torts and Cyber Torts 77

granted the defendant’s motion for summary judgment. Maddox v. City of New York, 496 N.Y.S.2d 726, 1985 N.Y. Lexis 17254 (N.Y.App. 1985). VI: Answers to Business Ethics Cases 5.11. RKO is liable. The determination of what duty of care is owed is governed by the principle that all persons are to use ordinary care to prevent others from being harmed by their conduct. Foreseeability is of primary importance in determining one’s duty. Given the nature of the contest and the use of a car that would be moving from one location to another, it was foreseeable that the station’s listeners would attempt to follow the car without regard for highway safety in order to claim prizes. Even though third parties inflicted the harm, the negligent act of RKO instigated the actions of the third parties. Thus, RKO acts were a factor in the incident that resulted in the death of Weirum. Weirum v. RKO General, Inc. 15 Cal. 3d 40, 123 Cal. Rptr. 468, 175 Cal. Lexis 220 (Cal. 1975). 5.12. Portee has a right to sue for negligent infliction of mental distress. This tort requires death or serious physical injury of a person because of the negligence of another, observation by a closely related third party of the deadly or injurious event, and mental distress suffered by the third party. If Portee can prove negligence on the part of the Jaffees, she can recover damages because the other elements are present. Portee v. Jaffee, 417 A.2d 521, 1980 N.J. Lexis 1387 (N.J. 1980).

V. Answer to “Briefing the Case” Writing Assignment 1. Case Name, Citation, and Court Braun v. Soldier of Fortune Magazine, Inc. 968 F.2d 1110 (1992) United States Court of Appeals for the Eleventh Circuit 2. Key Facts A. Michael Savage placed an ad in Soldier of Fortune Magazine where he offered his services as a “professional mercenary,” skilled in the use of guns. B. Savage and an associate, Sean Trevor Doutre were hired by Bruce Gastwirth and John Horton Moore to murder Gatswirth’s business partner, Richard Braun. C. On August 26, 1985, Richard Braun was shot and killed by Doutre in the company of Savage. Braun’s son, Michael, was also shot and wounded. D. Braun and his brother, Ian, brought a wrongful death action against Soldier of Fortune Magazine, Inc. for the death of their father. Michael Braun brought a separate tort action for his own injuries. E. The United States District Court for the Middle District of Alabama considered both actions, and the trial jury found in favor of the Braun brothers on both claims. 3. Issue Under Georgia law, was Soldier of Fortune Magazine, Inc. tortuously liable for negligence by having published Savage’s ad describing himself as a “professional mercenary?” 4. Holding Yes.

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5. Court’s Reasoning The Court of Appeals held that: A. An action for negligence in Georgia must show four elements: 1. A legal duty to conform to a standard of conduct raised by the law for the protection of others against unreasonable risks of harm. 2. A breach of this standard. 3. A showing of a legally attributable causal connection between the conduct and the resulting injury. 4. Loss or damage flowing to the plaintiff’s legally protected interest as a result of the alleged breach of the legal duty. B. All four elements of the Georgia tort statute were met. C. The Court of Appeals affirmed the District Court’s finding that the negligent publication of Mr. Savage’s ad constituted a proximate cause of the Braun’s injuries, and it upheld the jury awards in favor of the Braun’s.

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Chapter 6 Criminal Law and White Collar Crime

What Does “Beyond A Reasonable Doubt” Really Mean?
I. Teacher to Teacher Dialogue: There can be no question that our criminal law system is far from perfect, and anyone who tries to take the position is not grounded in reality. What is important to convey to our students is that, in spite of all these problems, the underlying goal of our system is to balance the rights of the defendant with those the larger society. As a society, we try harder than most to maintain that balance. Try to give students some of the comparative structural differences between our system and some of the worlds’ more totalitarian regimes. Ask them to consider their own personal financial and legal ability to resist the efforts of the state that may have targeted them for prosecution. In that light they start to see that our criminal law system, albeit quite flawed, is all we really have to protect us from the abuses of the sovereign. In the end, recommend to students the following thought: the easier we allow the forces of the criminal law system to be used, the less free we will all be in the end. The measure of a free society is, in many ways, how much we are willing to harness government. Too much freedom in the hands of the sovereign may bring too little freedom to those who deserve it most. Then you might go into the general settings in which crimes against and by business have evolved over the years. Possibly focus on the emerging willingness of states to pursue, and the courts to convict, individual managers for criminal offenses committed in the name of corporate gain. Unfortunately, the daily media is able to provide us with a more than adequate supply of case scenarios to use as illustrative examples of the phenomenon. II. Text Materials The chapter moves from criminal procedure and general classification of crimes to the impact of criminal law on corporate behavior. The chapter then wraps up with an overview of how both individuals and business entities are protected from overzealous governmental intrusions into our lives by way of key safeguards detailed in the U.S. Constitution. It is important to note to students that these protections do not always necessarily apply equally to people and business entities.

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Criminal Law and Whit Collar Crime 81

Note: The same act may be the basis for both a criminal lawsuit and a civil lawsuit.

Ethics Spotlight: Martha Stewart Guilty? This illustrates that anyone can be convicted of a crime. Martha Stewart was convicted of criminal conspiracy, lying to the federal government and obstruction of justice. This case can be used to discuss the ethics and legality of insider trading.

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a) Arrests usually need warrants based on probable cause. b) Felony → grand jury → indictment c) Misdemeanor → magistrate → information d) Pleas: guilty, not guilty, nolo contendere

a) Defendant may appeal b) Government cannot appeal c) Government may retry after a hung jury.

The Supreme Court Speaks: Atwater v. Lago Vista, TX Facts: Texas law requires that front-seat drivers and passengers must wear seat belts, and that a driver must secure any small child riding in front. In March 1997, Gail Atwater was driving her pickup truck in Lago Vista, TX with her three-year-old son and five-year-old daughter in the front seat. None of them was wearing seat belts. A police officer saw the seat-belt violation and pulled Atwater over, hand cuffed her, placed her in his squad car, and drove her to the police station where she was booked. She ultimately pleaded no contest and paid the $50 fine. Atwater sued the city of Lago Vista and the police officer for compensatory and punitive damages, alleging her Fourth Amendment right to be free from unreasonable seizure was violated. The district court and court of appeals ruled against Atwater. Issue: Does the Fourth Amendment permit police to make a warrantless arrest pursuant to a minor criminal offence? Decision: Yes. Reason: The Fourth Amendment permits police officers to make a warrantless arrest pursuant to a minor criminal offense.

Criminal Law and Whit Collar Crime 83

Robbery: Taking of personal property of another by fear or force.

Burglary: Taking of personal property from another’s dwelling. Larceny: Taking of personal property from other than another’s dwelling. Theft: Summary category for previous three. Receiving Stolen Property: Requires knowledge and intent to deprive. Arson: Willful and malicious burning of another’s building. Extortion: Blackmail Forgery: Fraudulent altering or making a written document affecting the legal liability of another. Embezzlement: Fraudulent conversion of property. Bribery: Payoffs or kickbacks Criminal Fraud: Obtaining of title to property through deception or trickery. Murder: Unlawful killing of a human being with malice aforethought. Felony murder rule holds that the intent to commit murder is inferred from the intent to commit another crime if murder is committed during the commission of another crime. Extortion: Obtaining the property of another, with his or her consent, induced by wrongful use of actual or threatened force, violence, or fear. Criminal Conspiracy: Two or more persons enter into an agreement to commit a crime. An overt act is needed.

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Corporations may be held criminally liable for actions of their officers, employees or agents.

The Court speaks: State of Ohio v. Wilson Facts: After arguing with girlfriend Spear earlier in the day, Wilson poured gas from a beer bottle on Spear, ignited it, and walked away as she became engulfed in flames. She had severe burns, underwent much medical treatment, and suffered from depression. She was found dead nine months later. Wilson was convicted of aggravated murder and sentenced to 30 years to life. He appealed. Issue: Was there sufficient causation between Wilson’s act of setting Ms. Spear on fire and Ms. Spear’s death nine months later to warrant a conviction for murder? Decision: Yes. Conviction was affirmed. Reason: Causal connection which is absolutely necessary can be shown from a death that occurs later from the defendant’s act. Here the maladies of Spear were the natural, probable, and foreseeable results of Wilson’s activities.

Florida Penal Code: The Florida Penal Code is highlighted.

Contemporary Issue: A case of an 89-yr. old California man’s guilty verdict for vehicular manslaughter with gross negligence is illustrated.

allow them to be expense deductions and the like.S. International Law: The Foreign Corrupt Practices Act This statute attempts to balance two legitimate concerns. law. . One is to avoid the scandals mentioned in the text where American companies engaged in business practices overseas that were clearly in violation of U. Congress passed the Identity Theft and Assumption Deterrence Act of 1998. Landmark Law: Racketeer Influenced and Corrupt Organizations Act (RICO) The Racketeer Influenced and Corrupt Organization Act (RICO was intended to apply only to organized crime. in turn. Ethics Spotlight: Money Laundering The use of legitimate businesses to “wash” dirty money is discussed.Criminal Law and Whit Collar Crime 85 E-Commerce and Information Technology: Identity Fraud Identity fraud costs businesses over $1 billion per year.S. On the other side of the coin. the act is designed to allow U. but it has been used against nonorganized crime defendants as well. To recognize these payments as legitimate would.S. position in holding such payments illegal within their own jurisdictions. More and more countries are adopting the U. To combat such fraud. based companies to remain competitive in foreign markets where such payments are legal.

.86 Chapter 6 Online Commerce: Information Infrastructure Protection Act This box discusses the IIP Act and computer-related crimes. There can be no unauthorized access or obtaining of information from a protected computer.

Rule usually applies to businesses. Double jeopardy does not usually apply across jurisdictions. Miranda is embedded in routine police practice. business records of corporations and partnerships are generally not protected.Criminal Law and Whit Collar Crime 87 Special Questions for Constitutional Safeguards: 1. 3. Warrantless searches are permitted incident to arrest. spouse-spouse and parentchild privileges are usually recognized under the Fifth Amendment. There is an eighth amendment prohibition of cruel and unusual punishment. Capital punishment is not usually considered “cruel and unusual”. Sixth amendment guarantees the rights to a speedy trial by an impartial jury with a lawyer to confront adverse witnesses. 9. . 8. evidence in “plain view” or possibility of evidence destruction. Evidence form unreasonable search is usually prohibited under the “exclusionary rule”. 5. priest-penitent. Right against self-incrimination applies only to natural persons accused of a crime. The attorney-client. 2. 4. Thus. psychiatrist-patient. 6. 7.

Garcia Facts: Garcia served time in jail for meth offenses. A store video recorded him buying ingredients that could be used to make meth. filed a lawsuit on behalf of themselves and the class of all motorists who had been stopped or were subject to being stopped claiming that the roadblocks violated the Fourth Amendment. including that obtained from the GPS. government agents used thermal imagers from across the street. attorneys who had been stopped at one of the checkpoints. Issue: Is the use of a thermal-imaging device aimed at a private house from a public street to detect heat from within the home a “search” within the meaning of the Fourth Amendment? Decision: Yes. Information could not have otherwise been obtained without physical intrusion. that he brought. and they had abundant grounds for suspecting Garcia. Agents found indoor-growing marijuana plants. the police placed a concealed GPS on the car. A search was conducted with the permission of the owner and equipment and materials used to manufacture meth were discovered.88 Chapter 6 The Supreme Court Speaks: Kyllo v. Indiana began to operate vehicle roadblock checkpoints on Indianapolis roads in an effort to interdict unlawful drugs. The mere tracking on public streets. After finding a car that he was reportedly driving. Garcia appealed claiming an unreasonable search in violation of the 4th amendment. the court of appeals reversed. Based upon the evidence. James Edmond and Joes Palmer. Reason: The Fourth Amendment requires that searches and seizures be reasonable.S. The district court’s judgment that convicted Garcia was upheld. . Garcia was found guilty of crimes related to the manufacture of meth. A search or seizure is ordinarily unreasonable in the absence of individualized suspicion of wrongdoing. v. even by a device. United States Facts: To determine whether marijuana was being grown indoors.A. The Supreme Court Speaks: City of Indianapolis v. Issue: Did the use of the GPS without a warrant constitute a 4th amendment violation as an unreasonable search? Decision: No. is not a search. the warrant-less search of which is very rarely constitutional. Here the police only did GPS tracking when they have a suspect in their sights. The Court speaks: U. The district court found for Indianapolis. Reason: The case involves officers on a public street engaged in more than naked-eye surveillance of a house. with her. The case was remanded for further proceedings. without individualized suspicion. stop vehicles for the primary purpose of discovering and interdicting illegal narcotics. violate the Fourth Amendment? Decision: Yes. There was no warrant. The scanning was used to obtain a search warrant. Upon release a person reported to the police that Garcia used meth. Edmond Facts: In August 1998. Reason: The use of the GPS was not a search. They tracked the car to many visits to a large tract of land. Issue: Do Indianapolis’s highway checkpoint programs whereby police. police of the city of Indianapolis. The Supreme Court reversed an affirmation by the court of appeals of the findings of the trial court. Police were told that he could make it without getting caught.

a constitutionally adequate substitute for a warrant. Contemporary Application: Miranda 2000 Generally. by statute. International Law: Extortion and Bribery This discusses the case of potential terrorist extortion dealing with Chiquita Brands International. information-sharing. Burger moved to suppress the evidence. This box details the Miranda Rights. Plain-clothes officers conducted a surprise inspection and found that Burger had no license to conduct the business and kept no records and concealed. bio-terrorism and money laundering. of regular inspections. This is an appeal from a reversal of a lower court’s decision holing the search to be constitutional. Issue: Does the warrantless search of an automobile junkyard pursuant to a state statute that authorizes such search constitute an unreasonable search and seizure in violation of the 4th amendment? Decision: No. roving wiretaps. Critics argue the act is a violation of constitutional freedoms. after an inspection. This is the case here as is the substantial interest in eradicating automobile theft. Notice has been given. . International Law: Federal Antiterrorism Act of 2001 This discusses the new federal statute as a response to the World Trade Center attacks. therefore. that he was in possession of stolen vehicles and parts. Contemporary Application: Accountant-Client Privilege? About 20 states have enacted special statutes that create an accountant-client privilege. any confession obtained from a suspect prior to being read his or her Miranda Rights can be excluded from evidence. This can be done by controlling the receiver of the stolen property.Criminal Law and Whit Collar Crime 89 NOTE: Certain businesses are subject to warrantless searches with proper statutory procedures. Burger has this type of business in Brooklyn. The Supreme Court speaks: New York v. nationwide search warrants. The act includes provisions dealing with a special intelligence court. Reason: The owner of commercial premises in a closely regulated industry has a reduced expectation of privacy and the warrant and probable cause requirements of the 4th amendment have a lessened application. noncitizen detention. Burger Facts: State of New York enacted a statute authorizing warrantless searches of vehicle dismantlers and automobile junkyards without prior notice. The judgment was reversed and the case remanded. After being arrested and charged. There is.

Accordingly. a corporation can be held criminally liable for the acts of its representatives. Extortion occurs when a person threatens to expose something about another person unless that other person gives money or property. 553 A. In this case. and employees.App. hired. The truth or falsity of the information is immaterial. 711 P. the state must prove beyond a reasonable doubt that the defendant obtained or exercised control over property of another by deception and with the purpose of depriving that person of the property. The crime of extortion would have been committed. 1989).1. it was held that corporations lacked the criminal mind to be held criminally liable. However. or possesses any writing in a fictitious name or in such manner that the writing as made or altered purports to have been made by another person.App. under the common law. Hilton Hotels was held criminally liable for its antitrust violations. The crime of forgery has been committed. State of Georgia. A person is guilty of forgery when.2d 235 (Utah 1985). Roberts.2d 637 (Ga.4. On the other hand. 467 F. Foster v. and their conviction and punishment would be particularly ineffective as a deterrent. State of Utah v.3. because they cannot be put in prison. otherwise known as theft by deception. United States v. his conviction was affirmed. Criminal Fraud 6. with different provisions.2. 1973). and one can be guilty as one who aided and abetted another. alters. theft by deception does not occur when there is only falsity as to matters having no pecuniary significance. On the other hand. or procured another to commit the crime. In order to prove that a defendant committed theft by deception. with intent to defraud. Walton is guilty of criminal fraud. modern courts have held that a corporation can be criminally liable for the acts of its managers. Forgery 6. he knowingly makes. or “puffing” by statements unlikely to deceive ordinary persons. or as one who advised. Deception occurs when a person intentionally promises performance that is likely to affect the judgment of another in the transaction. the lower court convicted the defendant of extortion and the appellate court affirmed the conviction based on the facts presented. Extortion 6. they are usually sanctioned with fines and/or loss of a license or franchise. Answers to Critical Thinking Cases Criminal Liability of Corporations 6.. the court held that the conviction and punishment of the business entity or corporation is likely to be both appropriate and effective.2d 1000 (9th Cir. Moreover.2d 188 (Conn. the court held that Walton’s representations that he would invest Marlowe’s money in gold affected her judgment concerning her investment. Traditionally. In this case. encouraged. State of Connecticut v. . at another time. Knowledge and intent can be inferred from the circumstances of the case. 1989). or by authority of one who did not give such authority. Erhardt. In this case. counseled. 387 S. the court held that the identification of the particular agents responsible for the antitrust law violations is especially difficult. agents. Hilton Hotels Corp. which performance the actor does not intend to perform or knows will not be performed. and that such evidence was sufficient to convict the defendant of theft by deception. In this case the court held that the circumstances were such that a rational trier of fact could have determined beyond a reasonable doubt that Foster had committed forgery with the necessary elements of intent to defraud and knowledge.90 Chapter 6 III. Yes. Accordingly.E.

Criminal Law and Whit Collar Crime 91 Bribery 6. No. Yes.3d 1480. unlike searches of private homes. United States. 216 Cal. In this case. the lower court’s holding that the warrantless search was lawful was affirmed. 1989). One such regulated business is the liquor industry. 1172. Search Warrant 6. and the persons or things to be seized.7. 875 F. . However. Dixon and Hinton v.” The court held. Moreover. require unannounced visits from government agents. 482. the good faith exception is inapplicable when the warrant is so facially overbroad as to preclude reasonable reliance by executing officers. to invoke the good faith exception to the exclusionary rule. the court held that the inspection of the defendant’s premises advances a substantial government interest pursuant to a regulatory scheme of a closely regulated industry. v. the defendants argued that they were executives of a private nonprofit corporation unaffiliated with the federal government. and (3) whether the government was able to describe the items more particularly in light of the information available at the time the warrant was issued.2d 747 (9th Cir. the court concluded that the warrants were overbroad and constitutionally inadequate in that they provided for the almost unrestricted seizure of items that are “evidence of violations of federal criminal law” without describing the specific crimes suspected. only a warrant particularly describing the place to be searched.5. The specificity requirement varies depending on the circumstances of the case and the type of items involved. the government must prove that its agent’s reliance upon the warrant was objectively reasonable. They have committed the crime of bribery by a public official. In this case. however. by their very nature. In this case. 265 Cal. United States. the defendant’s lower court convictions for bribery were affirmed. 579 (Cal. However. Center Art Galleries-Hawaii. 104 S.S. People v. The crime of bribery is defined as the giving or receiving of anything of value in corrupt payment for an “official act” by a public official. legislative schemes authorizing warrantless administrative searches of commercial property do not violate the Fourth Amendment. and as such that they were not “public officials. Generally.2d 458 (1984). is valid. that the defendants were acting “for or on behalf of the United States in an official function” under the authority of HUD.App.6. 79 L. (2) whether the warrant sets out objective standards by which executing officers can differentiate items subject to seizure from those which are not. the warrantless search of the safe was a lawful search. A court will consider such factors as (1) whether probable cause exists to seize all items of a particular type. as well as to private homes. Paulson. Administrative Search 6. The Supreme Court has indicated that such searches are permissible for certain closely regulated industries that. the search warrant is not valid. Accordingly.Rptr. Inc. the Fourth Amendment’s prohibition on unreasonable searches and seizures applies to commercial premises. Accordingly. 465 U.Ct. 1990). In this case.Ed. Generally. the court held that the warrants were so overbroad as to be facially invalid.App.

was both a defense and alleged circumstantial evidence that he never had the specific fraudulent intent to deprive the partnership of its property. however. Embezzlement is not a common law crime. it is not a defense to a prosecution that after the theft was committed. specializing in the area of speech research. the court held that the act of producing the records is protected by the Fifth Amendment’s privilege against self-incrimination. V. TI reported this finding to the Dallas District Attorney’s Office. Rptr. People v. the records do not have to be disclosed. Moreover. Thus. C. After leaving TI. United States v. Citation. 872. App. The court went on to hold. Answer to “Briefing the Case” Writing Assignment: 1. United States v. they joined Voice Control Systems (VCS). another former TI employee. The Fifth Amendment provides that no person shall be compelled in any criminal case to be a witness against himself. No. 12 Cal. Shaw sought to make a showing that his intent to restore funds. D. Schalk and Leonard are both former employees of Texas Instruments (TI). with the theft offense. which filed criminal charges under a code section that makes it a crime to make unauthorized copies of trade secrets. By doing so he hurt the insurance company and its policyholders. Cloud should be found guilty of aiding and abetting a bank fraud. the court found that in this case the act of producing the documents would involve testimonial self-incrimination. 6.Ed. Cloud. Sam Kuzbary.2d 846. Answers to Ethics Cases 6. Texas 823 S. . App. that the act of requiring production of the documents might not be privileged. Key Facts A.10. the court held that the subpoena does not force John Doe to restate. was hired by VCS.92 Chapter 6 Fifth Amendment’s Privilege Against Self-Incrimination 6. 2d 665 (Cal. Cloud realized that the sale would not go through without lying so he lied. complete or partial restitution or offer of restitution was made to the owner of the property. Shaw.W. 1992).Ct.2d 552 (1984). or that the loss was wholly or partly recouped by any other means. This applies to compelled oral testimony. 605.S.8. Case Name. and Court Schalk v. or affirm the truth of the contents of the records. 79 L. E. 104 S. a competitor of TI. IV. Accordingly. He did not consider the effects of his actions on these stakeholders and thus acted unethically. the court held that the records are not privileged under the Fifth Amendment. 10 Cal. Kuzbary suspected that some of the information being used by VCS was proprietary to TI and reported that suspicion to TI.2d 633 (1991) Court of Criminal Appeals of Texas 2.9. F. repeat. It is the result of legislative efforts to provide for an unreasonable gap that appeared in the law of larceny as it developed. 465 U. B. A subpoena compels the holder of the documents to perform an act that may have testimonial aspects and an incriminating effect. 4th 969. coupled with actual restoration. 1237. In this case. John Doe. Generally. TI concluded that Schalk and Leonard downloaded the information before they left TI.

D. affords a competitive advantage and is a protectable secret. each of which. Because the information was found to be a trade secret under the terms of the statute. The search warrant was overly broad.Criminal Law and Whit Collar Crime 93 F. 3. Holding The criteria for the definition of a trade secret were met. Issue What level of protection constitutes statutory criteria for purposes of defining a trade secret? 4. C. There was no evidence presented by Schalk and Leonard to show TI’s permission for them to make copies of this information. by itself. Court’s Reasoning The Court of Criminal Appeals of Texas held that: A. the search warrant sufficiently described the information and made the information admissible in further proceedings against Schalk and Leonard. . Schalk and Leonard claimed that TI did not sufficiently protect the information so as to protect it as a trade secret. G. E. restricted computer access. in a unique operation. 5. TI did take sufficient measures to prevent the information from becoming generally available. but the unified process and operation of which. including premises access security. The statutory definition of trade secret can include a combination of components. and nondisclosure agreements with employees. is in the public domain. The statute in question set no strict standard of what measures are sufficient for the maintenance of a trade secret. B.

trade secrets. creativity. The entire scheme. this is one of the most important legal horizons for business today. in the matter of palming off. copyrights.94 Chapter 7 Chapter 7 Intellectual Property Without The Law. what is the difference between aggressive comparative advertising and the unfair trade practice of disparagement? Or in the area of intellectual property. The benefits of the statutory protection are accorded to those who know how to use the statute on a continuing basis. and the like must be integrated into the entire business cycle of new and emerging companies whose growth is tied to new technologies. . limited period monopolies that would otherwise go against the grain of our free competition laws. With regard to protection provided for intellectual property. The best way for students to approach these areas is to recognize that each of these protections carries a benefit/burden dichotomy. You can talk about the notion of these rights acting as a form of public/private partnership designed to award innovation. In addition. and uniqueness. and trademarks. It might also be worthwhile to review the underlying public policies behind giving these protections in the first place. In the area of business torts. of course. For example. is to provide financial incentives by creating a legally protected property right. Teacher to Teacher Dialogue This chapter is of particular interest to business majors because so many of their areas of study revolve around how to gain a competitive advantage while trying to stay within the bounds of law and professional ethics. it might be helpful to use examples to illustrate the various rules of patents. In many ways. in effect. Some of the more famous examples might be the proverbial Rolex knock-off or purses made look like Chanel bags. and that is why students find it so interesting. I give examples of how the makers of luxury goods are particularly afflicted with this problem. how far can you take the fair use doctrine before you have crossed the line of copyright infringement? Going through the list of various forms of unfair competition and giving some personal observations of cases involving those issues might be helpful. The Internet is changing the way intellectual property laws are interpreted. Who Would Invent? I. Maybe talk about how these protections are. try to show students how the protection of intellectual property rights.

passed in 1952. . is intended to provide an incentive for inventors to invent and make their inventions public and to protect patented inventions from infringement. Text Materials Internet & Technology: The Economic Espionage Act This deals with stealing trade secrets and how that is treated in the Economic Espionage Act of 1996. . Ethics Spotlight: Coca-Cola Worker Convicted of Trying to Sell Trade Secret to Pepsi-Cola This deals with a possible conspiracy issue.Intellectual Property and Piracy 95 II. Landmark Law: Federal Patent Statute This law.

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2) Time begins with patent application .Intellectual Property and Piracy 97 1995 statute made changes: 1) Valid for 20 years.

To obtain utility patent protection. Facts: Pioneer Hi-Bred International.” Congress plainly contemplated that the patent laws would be given wide scope.’ modified by the comprehensive “any. Inc.M. Ag Supply. The Supreme Court affirmed the judgment of the court of appeals. alleging that Farm Advantage infringed its patent and violated the license by creating seed from the hybrid corn products it grew from Pioneer’s patented hybrid seed. In re Hibberd. Supreme Court held that sexually reproducing hybrid plants are patentable subject matter.M.S.S. Inc. Issue: Are sexually reproducing hybrid plants patentable subject matter? Decision: The U. The district court granted summary judgment to pioneer and the court of appeals affirmed.. Farm Advantage filed a counterclaim of patent invalidity. 227 U. purchased patented hybrid seeds from Pioneer in bags bearing this license agreement. Several years after Chakrabarty. mutants.P. a plant breeder must show that the plant he has developed is new. variants. useful. and held that a manmade micro-organism fell within the scope of the statute. The U.” J. 444 (1985).. (BNA) 443. doing business as Farm Advantage.E. Chakrabarty. “In choosing such expansive terms as ‘manufacture’ and ‘composition of matter.” The license strictly prohibits “the use of such seed or progeny thereof for propagation or seed multiplication or for production or development of a hybrid or different variety of seed. at 308 (1980) the language of §101 is extremely broad.S. AG Supply v.98 Chapter 7 The Supreme Court Speaks: J. and modifications of the hybrid. Pioneer sells its patented hybrid seeds under a limited label license that provides: “License is granted solely to produce grain and/or forage. its seeds. 447 U. (Pioneer) has obtained seventeen patents that cover the company’s inbred and hybrid corn and corn seed products. It has been the unbroken practice of the PTO since that time to confer utility patents for plants. the Patent and Trademark Office (PTO) Board of Patent Appeals and Interferences held that plants were within the understood meaning of “manufacture” or “composition of matter” and therefore were within the subject matter of §101. Inc.Q. Inc.S.” The Supreme Court concluded in Chakrabarty that living things were patentable under §101. Supreme Court agreed to hear the appeal. In addition. arguing that Pioneer hybrid plant seed patents are not patentable subject matter.” The license states that it “does not extend to the use of seed from such crop or the progeny thereof for propagation or seed multiplications. and non-obvious.E. A hybrid plant patent protects the plant. Reason: The Supreme Court recognized over 20 years ago in Diamond v. the plant must . Pioneer sued Farm Advantage. Pioneer Hi-bred International.

Chrysler. which require a written description of the plan and a deposit of seed that is publicly accessible.Intellectual Property and Piracy 99 meet the specifications of §112. Contemporary Issue: The Cost of Protecting a Patent Defending a patent is often a long and expensive battle. however. Denying patent protection under §101 simply because such coverage was thought technologically infeasible in 1930. Ethics Spotlight: Inventor Wipes Ford’s and Chrysler’s Windshields Clean This box deals with the case of the person who claims he patented the design for electronic intermittent windshield wipers for cars and other vehicles. Petitioner Farm Advantage essentially asked the Supreme Court to deny utility patent protection for sexually reproduced plants because it was unforeseen in 1930 that such plants could receive protection under §101. . and other auto manufacturers and lost. would be inconsistent with the forward-looking perspective of the utility patent statute. He filed patent infringement suits against Ford. Internet & Technology: Cyber Business Plans are Patentable This discusses how computerized accounting systems can be patented.

Amazon. This box addresses the patent infringement lawsuit between Amazon. Reason: Pfaff could have obtained a patent before he accepted the purchase order. Pfaff’s patent was invalid. Wells Electronics. Inc. The district court said that Pfaff’s patent was valid. Competitor said the one-year “on sale” doctrine invalidated the devised a method that enabled online customers to purchase selected items with a single click of a computer mouse button. On 4/19 of the next year. To address this problem. A competitor made a similar . Pfaff appealed. Pfaff filed a patent application and a patent was issued . He didn’t. he showed a design to TI and received an order on 4/8 without making a prototype. Pfaff sued for infringement. Contemporary Issue: Denied Patent One problem with most e-commerce retailers is that over 50 percent of potential customers who go shopping online abandon their transaction before checkout. Before 3/17. Facts: Pfaff designed a computer chip socket beginning the process in 11/80. The court appeals reversed. Patent was invalid.100 Chapter 7 The Supreme Court speaks: Pfaff v. thus invalidating Pfaff’s patent? Decision: and BarnesandNoble. In July the order was filled. Issue: Was the one-year “on sale” doctrine violated.

Intellectual Property and Piracy 101 Ethics Spotlight: Microsoft Slapped With $1. .52 billion MP3 Verdict The right to the basic technology behind the MP3 format is discussed.

102 Chapter 7 Copyright: 1) Created when author produces work. Copyright Office 3) Berne Convention (an international treaty) eliminated need for symbol © or word. Sonny Bono Copyright Term Extension Act .S. 2) May be registered in U.

Gonzalez said it was law.Intellectual Property and Piracy 103 Computer software and chips can receive copyright protection Recovery: 1) profit 2) damages 3) impoundment & destruction 4) injunction The Court speaks: BMG Music v. . Judgment was affirmed. The district court granted summary judgment for BMG assessing damages and issuing an injunction.370 copyrighted songs using KaZaA. Gonazlez appealed. Issue: Did Gonzalez engage in copyright infringement? Decision: Yes. Gonzalez Facts: Gonzalez downloaded 1. BMG sued for infringement.

90% of the available files are copyrighted. Judgment was vacated and the case was remanded. Reason: Gokster and Steam Cost are not merely passive recipients of information about infringing use. This is not “fair use”. Issue: Is a party who distributes a devise with the object of promoting its use to infringe copyrighted works liable for the resulting acts of infringement by third parties using such devices? Decision: Yes. One infringes contributorily by intentionally inducing or encouraging direct infringement.Ltd. Facts: Grokster and Stream Cost distribute free software allowing sharing of electronics through peer-to-peer networks used primarily to share copyrighted music and movie files without authorization. And Stream Cost Networks. No fee was paid here so the authors received nothing. . The Supreme Court speaks: MGM Studios v. They generated income from selling advertising space which is streamed to users while they are employing the programs.104 Chapter 7 Reason: A downloaded copy is a substitute for a purchased copy that should be paid for. MGM sued alleging secondary liability because of the acts of the down loaders. They took active steps to encourage infringement.Inc. Grokster. The down loaders are liable for copyright infringement.

Issue: Did Passport’s use of the copyrighted materials constitute fair use. or was it copyright infringement? Decision/Remedy: This was not fair use but was copyright infringement. Decision was affirmed enjoining distribution by Passport.Intellectual Property and Piracy 105 Ethics Spotlight: The Court Speaks: Elvis Presley Enterprises v. . Reason: The use was for commercial and not non-profit purposes causing market harm to holders of original copyrights. Passport appeals from a decision in favor of the plaintiff. This was not scholarly research. Passport Video Facts: Passport Video produced a documentary on Elvis using videos of copyrighted music and movie/TV appearances without obtaining permission of copyright holders other than Passport. Passport claimed fair use.

106 Chapter 7 The Court Speaks: Newton v.Inc. It also sold “HD Loader” software that permitted a user to make unauthorized copies of Sony’s Play Station games and to play the unlawful copies on Sony’s consoles. Internet & Technology: The Digital Millennium Copyright Act This act prohibits unauthorized access to copyrighted digital works by circumventing the wrapper or encryption technology that protects the intellectual property. The district court entered Consent Judgment Stipulation liability under the DMCA. Issue: Does the incorporation of a short segment of a copyrighted musical composition into a new musical recording constitute fair use. An expert said thousands of files had been deleted. The Court speaks: Sony Computer Entertainment America. Court agreed. The portion used was relatively small. He signed a Consent Judgment again agreeing to stop the selling and prohibiting destruction or deletion of any document or computer files reflecting the sales. or is it copyright infringement? Decision/Remedy: The court held the “deminimis” sampling was fair use and affirmed. which criminalizes copyright infringement. Beastie Boys claimed fair use. Filipiak Facts: Filipiak sold mod chips that circumvent technological copyright protection measures in Sony’s Play Station and Pay Station 2. He received a cease-and-desist letter from Sony’s lawyers which he signed but circumvented. Sony sued Filipiak who signed a Stipulated Consent Judgment but he continued to ship HD Loader. Sony continued suit and the district court found against Filipiak who filed a motion challenging the award. In a suit for copyright infringement. Issue: Was the award for violating the DMCA supported by the evidence? . Reason: This was not substantial copying but “ deminimis sampling”. Beastie Boys use six seconds of “Choir” in their song “Pass the Mic” without obtaining a license. Internet & Technology : The Net Act: Criminal Copyright Infringement This box discusses the No Electronic Theft Act. Beastie Boys Facts: Newton owns the copyright to the composition “Choir”. v.

Use of the symbol is not mandatory . Reason: He knew what he was doing was illegal and he intended not to abide by it and wilfully violated it. Provides legal protection for names. He has stipulated liability. slogans and logos. Separate statuary damages for each device sold may be awarded.Intellectual Property and Piracy 107 Decision: Yes.

108 Chapter 7 .

and began selling them. Menashe name a line of lingerie “SEXY LITTLE THINGS”. VS had priority. 2002. Petition and case was dismissed. Victoria’s Secret (VS) named a line of lingerie “SEXY LITTLE THINGS”. Inc.Intellectual Property and Piracy 109 The Court speaks: Menashe v. VS applied to register the phrase with the USPTO whey they learned of Menashe’s ITO application. VS sent a cease and desist order stating the phrase was a trademark before the ITV application. Menashe stopped production and filed suit against Menashe seeking a declaratory judgment that there was no trademark infringement and asking for damages. Reason: VS made bona fide trademark use of “SEXY LITTLE THINGS” in commerce before Menashe filed their ITV application. The USPTO suspended act on VS’s application pending disposition of the ITV application. They denied knowledge of VS’s line. Victoria’s Secret Stores. Facts: In Fall. They filed an ITV application with the USPTO. . Issue: Should Menashe be granted a declaratory judgment of trademark non-infringement for using the terms “SEXY LITTLE THING” and “SEXY LITTLE THINGS” for their lingerie? Decision: No. In 2004. Later in 2004.

Later RSI registered <freebies. bright colors.> promoting free offerings of goods and services. Inc. Some forms are protected. FP appealed. The decision was affirmed. v. The Supreme Court Speaks: Two> to operate its printing business.110 Chapter 7 Trade Dress involves the “look and feel” of a product. Two Pesos adopted a similar motif. Issue: Does a restaurant’s design have to have acquired a secondary meaning before it is protected as trade dress under Section 43(a) of the Lanham Trademark Act? Decision/Remedy: No. bright awnings and umbrellas. RSI filed with the district court for an order that their domain name did not infringe FP’s trademark which was generic and should be cancelled. The district court agreed with RSI. The Court speaks: Retail Services. Reason: Distinctive trade dress is protected under the Lanham Trademark Act without proof that it has acquired a secondary meaning. Taco Cabana.Inc. its packaging or a service establishment. Inc. Facts: Taco Cabana had a unique motif in and out of its fast-food restaurant involving a festive eating atmosphere decorated with artifacts. Ethics Spotlight: Apple Computer Sued for Infringing the “iphone” Trademark. paintings and murals and vivid outside colors using top border paint. . International Law: Chinese Courts Uphold Intellectual Property Rights This discusses China and the WTO and the protection of intellectual property rights. They are registered one domain name <freebies. neon strips. This discussed the case between Cisco and Apple over “iphone”. Freebies Publishing Facts: Freebies Publishing (FB) filed an application with the USPTO to register “Freebies” as a trademark which was first denied and subsequently granted. In a suit the court found that Taco’s trade dress was protected and the court of appeals affirmed.

Reason: Sufficient evidence to establish that a word is generic by a preponderance of evidence is required to rebut the presumption of validity flowing from trademark registration. A registration is subject to cancellation at any time if the registered mark becomes the generic name for the goods or services for which it is registered. Judgment in favor of RSI was affirmed. Business Brief: Dilution This involves lessening of the capacity of a famous work to identify and distinguish goods and services. Other websites have “freebie” or ”freebies” in their domain names.Intellectual Property and Piracy 111 Issue: Is the word “freebies” a generic word that does not qualify as a trademark? Decision: Yes. The term “freebie” has had an understood meaning since 1942. A generic word can never function as a trademark. .

Its real value is measured by a country’s willingness to protect it in the international arena of trade and competition. copyrighted.1. Trade secrets do not have to be patented. 478 N. Because the customer list was information that CRA-MAR had developed in the course of business. In the end. and was the type of information that set CRA-MAR apart from its competitors. have adopted the Uniform Trade Secrets Act to give statutory protection to trade secrets. Inc. the court held that it was a trade secret. or other business secrets.. I like to attack this issue from two perspectives: what progress has been made by way of these conventions and what has not. Answers to Critical Thinking Cases Trade Secret 7. CRA-MAR Video Center. I remind students of the constant vigilance owners of intellectual property have to exercise just to stay even in many parts of the world. the court held that CRAMAR’s customer list was a trade secret. 1985). App. Many states. protection of international intellectual property rights begins with the initial registration. compilation of data. a customer list is a trade secret under the Uniform Trade Secret Act. or trademarked to be protected. including Indiana. which has been adopted in the State of Indiana.E. This is especially true in third world countries where the concept of rewarding intellectual achievement is thought of as capitalistic exploitation. Trade secrets are types of information that set one business apart from their competitors.2d 110 (Ind. V. the court enjoined Koach’s from further use of CRA-MAR’s list. Yes.112 Chapter 7 International Law: International Protection of Intellectual Property Rights This reviews the key international treaties on intellectual property to which the United States is a signatory. Based upon its status as a trade secret under the Uniform Trade Secret Act. Trade secrets may be product formulas. pattern designs. Koach’s Sales Corporation v. In this case. and therefore was deserving of protection. .

The Nation argued in defense that its actions were protected under the “fair use doctrine” that permits unauthorized use of another’s copyrighted work if it involves scholarly research. The Supreme Court reversed the appellate court’s decision and upheld the district court’s finding that The Nation had engaged in copyright infringement. and the verbatim use of the words from the work. name. The court could award up to $3. Fair Use Doctrine 7. the court found that the plaintiff. The court found that the unpublished nature of the work. Hughes Tool Co. The Court balanced all of the factors involved in this case and found that the fair use doctrine did not protect The Nation. motto.Intellectual Property and Piracy 113 Patent 7.Ed. held a valid copyright for the song “I love New York. the commercial nature of the work. or device that identifies the goods of a particular business. Yes. a mark must be distinctive or have taken on a “secondary meaning. symbol.” A secondary meaning cannot be trademarked. Harper & Row wins. and quotations in news reports. 623 F. Because the use of copyrighted material in a parody is protected under the fair use doctrine. Where a fair use is found. Harper & Row. Copyright 7. A trademark is a distinctive mark. 2218.. Publishers v.2d 1572. To qualify for protection. use in a parody or satire. and the court of appeals affirmed the decision. word.” Neither NBC nor Saturday Night Live sought Elsmere’s permission before using the “I love New York Song” in their skit. A copyright holder’s rights in a work are not absolute. The United States Supreme Court held that The Nation engaged in copyright infringement in violation of federal copyright law when it published unauthorized verbatim quotes from President Gerald Ford’s soon-to-be published memoirs. The National Broadcasting Company wins the suit based upon the fair use doctrine. A trademark distinguishes the business and its products from those of its competitors. Eismere Music.4.3. 471 U. 85 L. The Supreme Court found that The Nation’s liberal use of the verbatim excerpts posed substantial potential for damage to the marketability of the copyrighted works. 759 F. Nation Enterprises. The Supreme Court rejected this defense.5. Elsmere Music Inc. v. However. The court dismissed the suit. or other fair use. 539. news. Inc.Ct.6 billion or treble damages if action was found to be intentional [Smith Internat’l Inc. 105 S. The court held that the two Clariol slogans had become . The law permits certain limited unauthorized uses of copyrighted materials under the fair use doctrine. the copyright holder cannot recover for copyright infringement. National Broadcasting Company. Examples of uses that are protected under the doctrine are quotations for review or criticism.S. Trademark 7. the court held that the use of the tune was in the form of a parody of New York City’s advertising campaign.. v.2. The Nation obtained a prepublication copy of the memoirs and knowingly published the words verbatim from the memoirs.2d 252 (2nd Cir. Elsmere could not recover from NBC or Saturday Night Live. owned the copyright to the memoirs. Harper & Row. the contract that President Ford had with Harper & Row to publish the memoirs. President Ford and his publisher. 1980). In this case.2d 588 (1985). all worked against The Nation’s claims of fair use. the slogans “Hair Color So Natural Only Her Hair Dresser Knows For Sure” and “Does She or Doesn’t She?” could be validly trademarked.

Because of these reasons. for using the term “Lite” to identify their reduced calorie beer. Through the use of an advertising campaign that cost over $22 million.Pat. Because the slogans had taken on a secondary meaning. Inc. and half of this one percent were lawyers. but the unified process. Prior to this lawsuit by Miller Brewing Company against Falstaff Brewing Corporation. Inc. 1981).2d 1026 (2nd Cir. design. holding that Toyota’s “Lexus” name did not dilute Mead’s “Lexis” name. Miller Brewing Company v.” Mead Data Central. “Lexis” is based on “lex” which is Latin for law and “is” of information systems. affords a competitive advantage and is a protectable secret. The appellate court found that the two marks were not substantially similar in that Mead’s “Lexis” mark applied to computer research and Toyota’s “Lexus” mark applied to automobiles.6. Carson wins.. Toyota wins and can use the name “Lexus” for its line of automobiles. and . (Mead). Further. is in the public domain. Inc. The courts held that the term “lite” was used by consumers to mean all reduced calorie beers no matter from what brewery. The use of a person’s name or likeness is not necessary for such exploitation. which owned the mark “Lexis” which was used as the name for its computerized legal research system. Miller had also sued G. A trade secret can exist in a combination of characteristics and components. by itself. misappropriated ICM’s trade secrets. each of which. Inc. Inc. evidence showed that only one percent of the public associated the name Lexis with computerized legal research. Answers to Ethics Cases 7. in unique combination. Miller could not claim a trademark is a generic term. Inc. finding that Falstaff could use the word “lite” to identify its reduced calorie beer. The term “Lite” to identify reduced calorie beer is a generic name that does not qualify for trademark protection under the Lanham Act. the appellate court held that Toyota’s mark “Lexus” did not infringe or dilute Mead’s “Lexis.S. Inc.114 Chapter 7 distinctive. 655 F. the court granted Clariol a trademark. the court found that the public would not be confused by the use of the two marks in commerce.8. The court in this case relied on the prior holdings in the Heileman and the Schlitz cases and held in favor of Falstaff. and Joseph Schlitz Brewing Co. Further. 875 F. 1989). v. Integrated Cash Management Services. Heileman Brewing Co.2d 823 (Cust. Digital Transactions Inc.. Miller contended that the word lite in the “Miller Lite” name for its reduced calorie beers was subject to trademark protection under the Lanham Act. This interfered with Carson’s interest. and operation of which. A celebrity has a right to protect his pecuniary interest in the commercial exploitation of his identity.2d 5 (1st Cir. The court dismissed Miller’s case against Falstaff. 1970). Therefore. held against Miller and found that the word “lite” was a generic term not subject to trademark protection. The defendant was aware of the association between the phrase and Carson and intended to appropriate for its pecuniary gain. 7.9. Thus. Both slogans had taken on a secondary meaning.A.2d 171 (2nd Cir. the two slogans had become associated with the products of Clariol. 920 F.7. The appellate court reversed the trial court’s decision. Toyota Motor Sales. The court. VI. Generic Name 7. The trial court had held in favor of Mead Data Central.. the court found that the two words had different meanings. Clairol Incorporated. and therefore the words in the slogans were not merely descriptive. v. 1990).App. v. Trademark 7. whereas “Lexus” is an artificial name created by Toyota. 427 F. in both Heileman and Schlitz cases. Roux Laboratories. Falstaff Brewing Corporation. U. Digital Transactions.

Rural sued for copyright infringement. but this list. 1282. Facts alone are not copyrightable because they do not owe their existence to authorship. Case Name. The Supreme Court held that the compilation of Rural’s subscribers list. Inc. Court’s Reasoning A.S.2d 358 (1991) United States Supreme Court 2. 499 U. Holding No. Inc. Ed. Inc. Key Facts A. Facts can be copyrightable if they are creative and original to the author. Answer to “Briefing the Case” Writing Assignment 1. it is a misappropriation. while useful. Here’s Johnny Portable Toilets. 3. Rural refused. 113 L. 5. Feist used Rural’s list without permission.. The lower court ruled in favor of Rural. 1983). Feist asked Rural for permission to use its list as part of Feist’s regional directories.Intellectual Property and Piracy 115 therefore. Issue Was Rural’s list of subscribers qualified as a copyrightable work? 4. failed to show enough creativity to qualify for copyright protection. 340. and Court Feist Publishing. Rural Telephone Service Co. Carson v. B.. D. while useful. Feist Publications publishes regional white and phone directories that are a compilation of several local phone company subscribers’ listings..Ct. claiming that its list was protected by copyright. C. B. E. v. Citation. VIII. 698 F. failed to meet the standard of author-created originality to qualify for copyright protection. 111 S. . Rural is a small local phone company that publishes both white and yellow page directories listing its subscribers.2d 831 (6th Cir.

In spite of this long interaction. this increase in emphasis on law/ethics issues has come none too soon. Professor Cheeseman clearly outlines the key schools of ethical studies and then provides excellent case examples in which to test the various approaches discussed in the text. In this chapter. Text Materials Business Ethics: An Unlicensed Contractor Gets Dunked This box discusses whether parties should sometimes be allowed to enforce their otherwise illegal contracts. Teacher to Teacher Dialogue: The study of ethics and law has been interwoven from the onset. The reasons for this vary.116 Chapter 8 Chapter 8 Ethics of Managers and Social Responsibility of Businesses Why are “Ethics” Left at the Corporate Door? I. . no doubt. using business ethics issues as a freestanding chapter in mainline business law texts is a relatively recent phenomenon. II. the difficulty many traditional law teachers have had in adapting to the language of philosophers and other related social scientists. Both disciplines stress the moral underpinnings of their respective efforts at defining proper human behavior. but one of them is. Given the obvious need for more emphasis on ethics training in all aspects of business education.

a morally based methodology is sought as a guidepost for behavior. then expected. Because so many of our legal and economic activities are conducted in the corporate format. The bottom line in the study of ethics is ultimately personal. The process by which morally based ethical behavior is first desired. respectively. This rationale may be found in outside sources as seen in schools of ethical fundamentalism or in the rule that provides the greatest good to society as illustrated by utilitarianism. That law should be grounded in some sort of morality-based foundation is self-evident. Among the possible issues are the legality of Bayer’s actions. Others such as Kant and Rawls have sought to devise formulas of behavior based on universal rules or social contract. Ethics Spotlight: Wal-Mart Pays Big For Meal Break Violations This group deals with situations where Wal-Mart was accused of denying meal-break violations. If these guideposts are universally accepted. This box discusses the issues surrounding Bayer and its product “Cipro”. In all these systems. Acting ethically involves doing what is right.Ethics and Social Responsibility of Business 117 Ethics is a set of moral principles or values that governs the conduct of an individual or a group. and finally mandated is really the evolution of law. Ethics Spotlight: Government “Gets Relief” from Bayer Aspirin. . juristic (law made) business entities cannot ignore this constant and dynamic tug and pull between ethics and law. and our job as teachers is to help students prepare for these challenges in both their professional and personal ethical lives. the odds are very high that they will no longer be advisory. *The study of ethics revolves around the examination of rules. and character through a morally tinted microscope. but rather required by law. Of note is the ease involved in this type of deception. its ethics in cheating the Medicaid program and whistle blowing. conduct. The goals of all the ethical schools of thought are to identify some sort of morally based rationale for human behavior. The distinction is drawn between the law and ethics.

118 Chapter 8 Note Kant’s categorical imperative “Do unto others as you would have them do unto you. .” This is duty ethics or deontology.

Ethics and Social Responsibility of Business 119 Ethics Deontological Theories Consequentialism Practical Theories Ethical Relativism Egoism Utilitarianism Altruism Consequences Duty Ethics (Reasons) Loot Outside: Ethical Fundamentalism Individual (Reasons) Professional Ethics .

Papa John’s Facts: Pizza Hut filed a lawsuit charging Papa John’s with false advertising violating the Lanham Act. various items of value while Sun-Diamond members had matters of interest pending before the Secretary.120 Chapter 8 The Court Speaks: Bradley v. P&G was attempting to protect its image. Bradley is claiming a violation of the New York Consumer Protection Act. McDonald’s Facts: This is a class action lawsuit by a plaintiff suing for health problems and obesity she claims to have been caused by McDonald’s where she has eaten on an average of twice a day. There was reasonable opportunity to discover the facts. This box discusses the requirement for a code of ethics found in the Sarbanes-Oxley Act. The court of appeals reversed and remanded for entry of judgment for Papa John’s. A typical code is shown. This is an appeal from a reversal of a guilty verdict with a fine of $400. The plaintiff’s case was dismissed. “Better Ingredients. U. The other claims were not material without a showing of potential influence on the purchasing decision of consumers Ethics Spotlight: Proctor and Gamble Wins “Satanism” Lawsuit This discusses Proctor and Gamble’s false advertising lawsuit dealing with rumors of profits going to support the Church of Satan.S. The Suit involved Papa John’s slogan. U. Reason: The slogan was a statement of opinion and not fact. Ethics Spotlight: Sarbanes-Oxely Act Prompts Public Companies to Adopt Code of Ethics. Two matters went in their favor. Sun-Diamond Growers of California Facts: Sun-Diamond gave Epsy.S. Ethics Spotlight: New York City Bans Trans Fats This discusses a New York City law banning nearly all trans fats while many restaurant owners threatened suit. The Supreme Court speaks: United States v. prohibiting deceptive and unfair acts and practices. Reason: There was no objective evidence that a reasonable consumer would have been misled by the defendant’s conduct. Better Pizza” false advertising? Decision: No. Secretary of Agriculture. Issue: Is Papa John’s slogan. 5 days per week for her entire 19 years. The district court found the slogan was just “puffery” but the other claims were misleading and tainted the slogan because of association with these statements. and its claim to have a superior sauce and dough to Pizza Hut. The Court Speaks: Pizza Hut v. There was no proof of causation. She claimed she was mislead by advertising portraying their food as nutritious and part of a healthy lifestyle if consumed on a daily basis.000. Issue: Does a conviction under the federal antibribery and gratuity statute require a showing of a direct nexus between the value conferred on the public official and the official act performed by the public official in favor of the giver? . sued for making illegal gifts in violation of a statute. “Better Ingredients. Issue: Did the plaintiff state a case against McDonald’s for deceptive and unfair acts and practices in violation of the New York Consumer Protection Act? Decision: No. Better Pizza”.

The Supreme Court Speaks: Wal-Mart v. The suit was filed alleging . Reason: To decide otherwise would result in meaningless gifts leading to criminal acts. adherence to socio-cultural objectives. The Slesingers alleged cheating by Disney on the profits by not reporting computer software and video sales royalties. International Law: United Nations Code of Conduct for Transnational Corporations This code includes respect for national sovereignty. respect for human rights and fundamental freedoms. Samara Brothers Facts: Wal-Mart was selling knockoff clothes exactly like those being sold by Samara at a price lower then Samara’s retailers were paying Samara for its clothes. Ethics Spotlight: Disney Loses “Pooh Bear” Lawsuit This discusses a lawsuit over Winnie the Pooh royalties. and abstaining from corrupt practice. The judgment was affirmed since no nexus was proven here. Disney countersued.Ethics and Social Responsibility of Business 121 Decision: Yes.

A settlement was reached with Sallie Mae and a Code of Conduct created by Cuomo was adopted Ethics Spotlight: Media Giant Pays For Bomb Scare This discusses 911 calls that tied up the call system in Boston in 2006.S. The U.000 judgment at trial. As a result. The insurance company lost a $185.6 million in compensatory damages and $145 million in punitive damages by the jury. The district court ruled for Samara without finding a secondary meaning for Samara’s clothes. Issue: Must a product’s design have acquired a secondary meaning before it is protected as trade dress? Decision: Yes. It was part of a guerilla cartoon marketing campaign by Time Warner subsidiaries. Ethics Spotlight: State Farm: Not Such a Good Neighbor After an accident.122 Chapter 8 violation of the Lanham Trademark Act. The judge reduced the award but the Utah Supreme Court reinstated the punitive damages award. The Supreme Court requires showing of a secondary meaning to protect a product’s design. The court of appeals affirmed. The policyholders pursued a bad faith tort action against the company whereby the injured parties would receive 90% of any verdict. Apologies were issued and compensation was arranged. TBS and the Cartoon Network and Adult Swim. They said that few awards exceeding a single-digit ratio between punitive and compensatory damages will satisfy due process. the insurance company for the party causing the accident decided to go to trial after the injured parties and their estates offered to settle for the policy limits. Supreme Court reversed and remanded the case stating that the Due Process Clause prohibits grossly excessive arbitrary punishments on a tort-feasor. leaving the new compensatory damages at $1 million. Reason: The Lanham Act requires a showing of the likeliness of causing confusion with the product for which protection is sought. the policyholder was awarded $2. The Supreme Court reversed the decision of the court of appeals. The bomb scare was fake. . Ethics Spotlight: Student Loan Scandal Comes To Light This discusses arrangements investigated by Cuomo’s office involving alleged deceptive practices benefiting lenders and colleges at the expense of students.

1984).Ethics and Social Responsibility of Business 123 Ethics Spotlight: The Corporate Social Audit Some corporations conduct social audits to prevent unethical conduct by managers.2d 749 (D. 1979). A director could ethically.R.N. The state of science is such that medical positions today will be supplanted by others tomorrow. 8. an ethicist applying the utilitarian approach to the question of bankruptcy might approve of the company’s decision to seek bankruptcy protection. if not all. Warner-Lambert was ordered to include a disclaimer that “Listerine does not kill the germs that cause colds” on its labels for two years.” Warner-Lambert Co. and agents. This is even today a partial truth. Further. in 1879 alcohol. The benefits (the good) from filing in bankruptcy include preserving the assets of the company so that it can ultimately accept responsibility and compensate many more. . Cir. Given the points raised above the company has met its social responsibility. III. The court declined to include prefatory language requested by the FTC. Ethicists would point out that one does not have to have perfect vision and information in order to recommend a product. Identifying and weighing the good and bad in this case would reveal some of the following. who have a valid claim. Answers to Ethics Cases 8.S.C.1. For example. In re JohnsManville Corporation.C.2. 727 (B. it would do the company employees no good for the company assets to be quickly dissipated by payment to those first in line. employees. and practically. The initial order of relief granted by a bankruptcy court freezes all such proceedings pending in other courts. “Contrary to previous claims. This discusses procedures for such an audit including the use of an outside firm with whom the company’s personnel. FTC.Y. The company’s claim is misleading.D. v. Whether or not Listerine acted unethically would depend upon the extent to which it knew the claims it was making were false. 36 B. There are other goods that flow inferentially from those stated above. Listerine’s major ingredient was presumed to kill certain germs. Filing a petition in bankruptcy erects a barrier against those claimants who have already gone to court to demand immediate relief in the form of compensation for their terrible loss. Yes. 562 F. have voted for a filing in bankruptcy for the reasons stated above. and reporting its findings to the Board for review of the results.

might reach a different conclusion regarding the need for a company to withdraw from South Africa. Duties are owed when they are clear answers to problems. Where these speculations have validity. The U. The moral position for affirmative action is based on a restitution theory that.S. The position of these companies was that more bad would come to the region and the affected people than good by their pullout. one can see why a company should donate funds to a local hospital that would ultimately take care of its employees.). 8.. affirmative action programs bear an additional burden. the principle of proportionality requires that the extent to which such holdings contribute to the company would be invoked. Indeed. Following a legal analogy. and benefits of employment. By analogy.S. However. which prohibits discrimination in the terms. If the appropriate ethical component requires only that corporate agents do no harm to the community. While the moral position is generally that man may use the resources of the world as long as it does not injure society or the environment. That such a company should donate to another hospital in a town some distance away is questionable unless the company entertains a corporate citizenship stance. assist in schooling. 8. Weber. Here again one must determine under what standards the business behavior of the corporation are to be judged. 193 (1979). The duty-based examiner must ask the question as to whether investment is a vote for willing evil by the company’s participation in the business of South Africa. according to the Kantian view.5. Despite the plain language of the statute. the level of behavior toward animals is the question. If corporations are merely organizational vehicles to achieve profit for their owners. it is considered improper. Steelworkers v. A company that acts according to the Sullivan Principles is behaving as a Corporate Citizen. and when practiced on a living thing. it embraces company action toward improving the lot of the black in South Africa (e. unfortunately. accordingly. the extent to which they should expend assets for the general benefit of society is limited. albeit an animal. and. is to . Being truly human.g. The question as to whether companies owe a duty of social responsibility to provide an affirmative action program is dependent upon which ethical view a moral judge takes of the corporate purpose. equal protection.. looks for relief from those who did not cause the loss. Its precepts include more than ethical positions within the company (e. The Sullivan Principles propose commitments that fit the Corporate Citizenship model. In this case.4. housing. the consequentialist could argue that the pressure from withdrawal has less worth than the misery unintentionally caused by the withdrawal of business. affirmative action programs are almost like the hypothetical hospital some distance away. etc. the method chosen was agreed to by the union as representative of all workers. a major issue in determining to decide to discontinue stock ownership. the Court reasoned that: this situation was one the statute was intended to remedy.124 Chapter 8 8. and an ethical position. provide equal and fair employment practices). the training program is legal under Title VII. Here. cruelty by itself is immoral. the issue turns on the quality of the behavior toward animals. Constitution demands equality. the number and duration of the minority preference was limited to such time as the percentage of minorities in skilled jobs mirrored the population in the local workforce. a standard somewhat above the ethical duty of business organizations under several approaches.3. this was the strong argument made by those companies who failed to commit to such a plan. To suspend such equality for the purposes of restitution seems fair if the party required to contribute caused the loss. Further.g. The Utilitarian. Not all problems have clear solutions. conditions. 443 U. To the extent that the stock investment manifests a vote for present policies. a divestiture would provide further moral stature to the position regarding apartheid. for example. jobs for the needy. Universities on the other hand could defend their divestment of holdings in companies who failed to withdraw much easier and with less ill effect on the parties they wish to assist.

have a duty to warn in a foreign language? 4.RPTR. A refusal to permit the stockowners an opportunity to express their view about the function of a corporation and the behavior it wished to accept would be ethically wrong under certain approaches. Answer to “Briefing the Case” Writing Assignment: 1. C. IV. In March 1986. through his guardian. whose primary language is Spanish. 12 Cal. The defendant knew that a non-English literate population used its products. and in fact.Ethics and Social Responsibility of Business 125 practice those virtues that elevate man and do not demean or hurt. Ramierz.Supp. 618 F. and Court Ramirez v. 554 (D. The ethical and social significance of plaintiff’s proposal and the fact that it implicates significant levels of sales. a marketer and distributor of St. Ltd. the strongest argument against the corporate practice is having its agents acting inhumanely. Ramierz’s claim was summarily dismissed at the lower court level by summary judgment that said: “There is no duty to ward in a foreign language. Joseph Aspirin for Children (SJAC). contends that he contracted Reye’s syndrome after having ingested SJAC in March 1986. Inc. 1985).C. . The result would be different if plaintiff’s proposal was ethically significant in the abstract but had no meaningful relationship to the business of Iroquois/Delaware as Iroquois/Delaware was not engaged in the business of importing pate de foie gras.. 5. Issue Did the defendant.4th 1110.” 3. supports the likelihood of prevailing on the merits with regard to the issue of whether his proposal is “otherwise significantly related” to Iroquois/Delaware’s business. 15 Cal.2d 423 (1992) Court of Appeals of California 2. B. The burden of placing non-English warnings is not overly burdensome in light of the fact that over 23 million Americans speak a language other than English at home. Iroquois Brands. Plough. voluntary warning labels were placed on SJAC that warned of a possible association between aspirin and Reye’s syndrome. brought suit against Plough. Holding Yes. Inc. In this case. the shareholder wins the right to put the issue on the proxy. Accordingly. C. and there is no causal relationship between plaintiff’s injury and defendant’s activities. Case Name. Citation. B. The court of appeals of California held that a manufacturer of a dangerous or defective product is not immune from liability by English-only warnings when it is expected that non-English literate persons are likely to use the product. the defendant marketed its product directly to this population through various Spanish media outlets. Jorge Ramierz. Lovenheim v. These labels were made mandatory in June 1986. Plough.. App. Court’s Reasoning A. Although public policy generally favors English as an official language. D. Key Facts A. that policy does not provide immunity form liability when an English-only warning does not adequately inform non-English literate persons likely to use the product.

E. To grant summary judgment would give broad immunity to the defendant in this circumstance. The lower court’s grant of summary judgment was overruled. .126 Chapter 8 D. and that decision should be left to the legislature and not the courts.

such as a writing requirement. These are the persons or entities whose rights and obligations we are about to examine and ascertain. There are also certain situations where a contract is created. the first objective is to interject the notion of public policy participation and support of the contracting process. certain persons are given a legally recognized power to avoid a contract after it has been entered into. the agreement is not raised to the status of contract and may be legally void. the other person is the offeree. As is the case with all specialized forms of endeavor. At least two parties are required in all contracts. or can it be done in any manner chosen by the parties (informal) as long as the elements of contract are met? Once the parties have formed an agreement. The key contract terms used tend to be dichotomous. through its courts. If one or more of the essential elements is missing. What elevates a mere agreement between two or more private parties into a legally recognized contract is the willingness of the public. By apparent. to enter the fray and enforce the contract rights and duties. you may have to examine issues of enforceability. a contract has a language all its own. of course. Next. we are talking about the actual participants or signatories to the contract. look at the dichotomy of the promises being used: is it a promise for a promise (bilateral) or is it a promise for an act (unilateral)? Have these promises been expressly made or can they somehow be implied from the circumstances? Does the form that this agreement is taking require certain formalities (such as a negotiable instrument). and . but it will not be enforced. are the performance obligations already fully met (executed). The second objective is to introduce students to some of the working vocabulary of contract law. Take for example. Sometimes. Thus. the contract may be an unenforceable contract. If all the elements are in place. in the end. If a legal defense is found to be in place. and a basic knowledge of some of the key terms used in contracts is essential. The first objective is to introduce the notion of apparent versus hidden “parties” to a contract.Nature of Traditional and Online Contracts 127 Chapter 9 Nature of Traditional and Online Contracts What Is A Contract? I. and you can use that dichotomy as a learning tool. stress the point that a contract is not. the agreement is now considered a valid contract. One of those two parties has to initiate the contract formation process. The person starting the mutual assent process with a promise is the offeror. or are there still remaining performance obligations on the part of one or more of the parties (executory)? In addition. Teacher to Teacher Dialogue: A good way to open the overview of contracts law is by identifying two main teaching objectives from this chapter. the number of parties to a contract. By “hidden” parties. These contracts are voidable. all that private.

128 Chapter 9 examples of this sort of situation can be found in cases involving young people with limited mental capacity. and obligations ascertained. II. Nonparties may have an interest in the outcome but no recognized standing unless they qualify as intended third parties. duties. Stress the notion that being a party is essential to having one’s rights. . Text Materials The first point of coverage should be involved with the notion of who the parties to the contract are.

Nature of Traditional and Online Contracts 129 .

i.. Even though all contracts are agreements. To be a contract the agreement must show: 1. Consideration. Capacity. the agreement fails legally and will not stand. Mutual assent. a table will not only fall if a leg is missing. 2. Legality. 4. Without these legs. . An agreement with all four elements is elevated in the eyes of the law to the status of contract. it is not even really a table. They not only provide support but are also its essence. not all agreements are contracts. 3.e.130 Chapter 9 You can then introduce the concept of elements of contract. Use the analogy of having the elements act as legs of a table.

Nature of Traditional and Online Contracts 131 .

It also allows you to get students thinking early on about the “battle of forms” and how the extensive use of forms has severely limited the real bargaining power of the average lay person. .132 Chapter 9 Contemporary Issue: The Evolution of the Modern Law of Contracts This box fits in nicely with the notions of private versus public participants in the contract process as discussed in the teacher-to-teacher dialogue at the beginning of this chapter.

The safe was part of Sumstad Estate.Nature of Traditional and Online Contracts 133 The Court Speaks: City of Everett Washington v. . and found over $32. The decision was reversed in favor of the Mitchells. The Mitchells appealed. they purchased a used safe and were told by the auctioneer that the inside compartment of the safe was locked and that there was no key for it. The City of Everett commenced an interpleader action against Sumstad Estate and the Mitchells. Mitchell Facts: Al and Rosemary Mitchell owned a small secondhand store. Issue: Was a contract formed between the seller and buyer of the safe? Decision: Yes. The locksmith who opened the safe called the City of Everett Police. The court of appeals affirmed.000 in cash in it. a contract was formed between the seller and buyer of the safe. The trial court entered summary judgment in favor of Sumstad Estate. At an auction. Reason: The state Supreme Court held that under the objective theory of contracts. The Mitchells had the safe opened. who impounded the money.

Online Commerce & Internet Law: Uniform Electronic Commerce Act Adopted This box discusses the Uniform Computer Information Transactions Act (UCITA) and how it establishes uniform legal rules for the formation and enforcement of electronic contracts and licenses. expresses the true intent and meaning of the parties notwithstanding a unilateral misunderstanding or failure to read. Issue: Doe the Receipt and Addendum prohibit Beatrice from selling the original Oscar? Decision: No. Reason: The Academy asserts a unilateral mistake by using the word member which Beatrice was not. the Academy would have a $1. .00 right.134 Chapter 9 The Court speaks: Wells v. The Addendum does not apply to this situation. Beatrice could sell the original.00 right of first refusal. the daughter. The court presumed that a contract. Academy of Motion Picture Arts and Sciences Facts: An Oscar won by Orson Welles eventually passed to Beatrice. When Beatrice found the original she wanted to sell it but the Academy wanted to enforce the $1. She requested a duplicate stating that the original was lost. She signed a receipt and addendum indicating that if the sale by a member is desired. deliberately entered into.

Rinks. created an advertising campaign for Taco bell at their request using their cartoon character “Psycho Chihuahua”. The district court granted summary judgment in favor of Taco Bell. . it would have to pay plaintiffs. No express contract was entered. The judgment was reversed and the case remanded for trial. Wrench suggested that they use a real male dog passing by a female dog to get to Taco Bell. Taco Bell gave Wrench’s material to Chiat/Day who made the same proposal which they say they came up with on their own. through their company Wrench. and Shields state a cause of action for the breach of an implied-in-fact contract? Decision/Remedy: Yes.Nature of Traditional and Online Contracts 135 The Court Speaks: Wrench v. Taco Bell The Facts: Rinks and Shields. Issue: Do the plaintiffs Wrench. Reason: Taco Bell understood if it used the Psycho Chihuahua concept. Taco Bell aired its commercials as suggested by Chiat/Day without paying anything to Wrench who sued for breach of an implied-in-fact contract. LLC. Instead.

paid. This occurred in this case.7 acres of marital property and the other inherited by Susan. Jr. Upon divorce the 2. Sr. . Reason: An implied-in-law contract usually requires recovery for the amount for which the party in question has benefited at the expense of the other party in order to preclude unjust enrichment. Susan was not a party. The Court speaks: Powell v. was entitled to recover from Susan. Sr. whereby Sr. Jr.136 Chapter 9 Ethics Spotlight: “Scrabble” Owner Held Liable on an Implied-in Fact Contract This discusses the question of the existence of an implied-in-fact contract dealing with the use of the Scrabble trademark. borrowed money from Sam. would pay him back. Thompson-Powell Facts: Samuel. Upon default Sam. Jr.7 acre lot was ordered sold and the proceeds to be divided 50-50. orally agreed to pay the mortgage and taxes and Jr. and Susan [husband and wife(H&W)] borrowed money and pledged two pieces of land as collateral – one was 2. but Susan would not. No contract was formed. Issue: Is Susan liable for her half under quasi-contract? Decision: Yes. paid Sr. Sr.

Nature of Traditional and Online Contracts 137 .

and natural law. what is their sense of essential fair play as it relates to the situation at hand? If that sense is being violated.138 Chapter 9 Ethics Spotlight: Equity Saves Contracting Party As students examine cases. equality. Equity is a doctrine that permits judges to make decisions based on fairness. This is a perfect example of where the court did just that. perhaps they may be missing an alternative answer that better takes into account the overriding equities. but even more important. they should be asked not only to review them in the technical sense. . moral rights.

The contract is a bilateral contract. was a bilateral agreement. App. it would impute a “reasonable time” into the agreement. In addition. Lexis 10442 (La. the court held that each of the subsequently executed notes were bilateral contracts. III. I will do all my banking with your bank. The buyer and seller must have their places of business in different countries. Bickham and the bank on January 23. 1974. Here the plaintiff provided services while the defendant provided property.2d 457. The United States. Implied-in-Fact Contract 9. 1987). as well as many other countries. Answers to Critical Thinking Cases Bilateral or Unilateral Contract 9. but failed to do so. The court further held that bilateral contracts can only be altered with the consent of both parties and that the bank acted unilaterally in changing the interest rates on the loans. Therefore. (2) the plaintiff expected to be paid for the property or services. Therefore.” the offer would have been to create a unilateral contract.Nature of Traditional and Online Contracts 139 The CISG applies to contracts for the international sales of goods. Bickham agreed to do his banking in return for the bank’s agreement to make loans at 7 1/2 percent. has ratified the CISG. Bickham v.1. the court held that courts may inquire into the . If Bickham had said “If you promise to loan me money at 7 1/2 percent. and (3) the defendant was given an opportunity to reject the property or services. To hold otherwise would disproportionately enrich one partner at the expense of the other. 515 So. an implied-in-fact contract can result from the conduct of unmarried persons who live together. A contract is bilateral if the offeror’s promise is answered with the offeree’s promise of acceptance. and did not provide the property or services gratuitously.App. The court stated that although the agreement was silent at the time. An implied-in-fact contract arises where (1) the plaintiff provided property or services to the defendant. Washington Bank & Trust Company. The court found that the agreement between Mr. 1987 La. the Appellate Court upheld the trial court’s ruling that the bank had breached its contract. There is no more reason to presume that services are contributed as a gift. Yes.2. It is better to presume that the parties intended to deal fairly with each other.

This doctrine does not apply where there is an enforceable contract between the parties. i. 815. 9. Key Facts A. This would constitute a bilateral agreement. shot a hole-in-one. a court may award monetary damages to a plaintiff for providing work or services to a defendant even though no actual contract existed between the parties. Answers to Ethics Cases 9. Family Health Care. there is no contract until the offeree performs the requested act. 3.140 Chapter 9 conduct of the parties to determine whether that conduct demonstrates an implied-in-fact contract. Marcel Motors. there was a written employment contract between the parties. Holding The contracts are bilateral and could not be cancelled by Rogness during the time provided for in the agreements. Inc. v. Mark argued that these are bilateral contracts (a promise for a promise. The offer cannot be accepted by Chenard promising to get a hole-in-one. that gave Mark and “exclusive right of sale” over certain properties owned by Rogness. for Winkle to be entitled to the profit-sharing bonus the court must find that the written employment contract was altered in writing or by an executed oral contract. . fully performed. Here. the Appellate Court upheld the Superior Court’s ruling that Chenard is entitled to the car. Answer to “Briefing the Case” Writing Assignment: 1.e. V. 1983 Mont. Winkel v. and Court Mark Realty. 557 P. Issue Were the contracts bilateral or unilateral? 4.4. 1983). IV.2d 208. Case Name. the offeree. C. Citation.. Accordingly the appellate court reversed the trial court’s holding that Winkle was entitled to his bonus. The court held that where Chenard.2d 106. 1976). Rogness argued that these contracts were unilateral in nature (a promise in exchange for an act) and that Mark did not provide the act (finding buyers). Marvin. Accordingly. Under the equitable doctrine of quasi-contract. 1978 Me. Winkle does not receive the profit-sharing bonus. Lexis 377 (Cal. P.3. Lexis 911 (Maine 1978). the contract was not executed. Rogness claimed a right to cancel and revoke the contracts. 668 P. Winkle testified that the agreement to receive profit-sharing was an oral agreement. Rptr. 1976 Cal.C. The contract is a unilateral contract. In this case. Thus. No.2d 373 (1982) District Court of Appeals of Florida 2. could not be unilaterally cancelled by Rogness.2d 596. Chenard v. B. A unilateral contract is one in which the offer can only be accepted by the performance of an act by the offeree. Rogness sold the properties during the time period covered by the agreements. The court held that because Winkle had not been paid his salary and bonus.. Rogness entered into four separate agreements with Mark Realty. 387 A. as such. Lexis 785 (Mont. Tilman A. Rogness 418 So. he had accepted the offeror’s offer of a unilateral contract thereby obligating performance of the promise. D. the question becomes whether the oral agreement was executed. 134 Cal. Thus. and. Inc. Marvin v.

B. The realty company promised to provide its best good faith effort to locate a buyer. Since both parties made bilateral promises. . Inc. E. Court’s Reasoning A. The owner promised to pay if a buyer is found during the contract period. Mark Realty. These efforts were evidenced by “an earnest and continued effort to sell. neither party had the power to revoke. Rogness’s sales were in breach of the terms of the contracts. was entitled to the sales commissions from those sales.Nature of Traditional and Online Contracts 141 5. The nature of the contracts is such that both parties made mutual promises. C.” D.

certainty. Once we have a good offer. find a basis upon which it could be measured. And if it brings new terms to the table. it may be deemed a counter offer. does this offer sincerely represent an objective intent to be bound? The second Q stands for quantity of the offer. and a familiarization of those subparts is essential to the study of contract law. The steps leading to mutual assent start with the offer and acceptance process. it may be deemed to be a rejection of the offer. A counter offer is. the first element of contract.142 Chapter 10 Chapter 10 Agreement and Consideration When Do We Have A Deal? I. Remember as long as the acceptance is usually sent by mail (or a similar medium). and communication.. The original offeror is now the new offeree. i. the acceptance must reflect the terms of offer. is the quantity of the offer readily determinable? The C represents communication. In the eyes of the offeree. The first Q represents quality of the offer. Of additional importance is the application of the mailbox rule. a new offer and sets the whole cycle of play into motion again from the reverse angle. that response is dictated in many ways by the terms of the offer. acceptance is usually effective upon dispatch. and implied contracts based on the actions of the parties. . especially as it relates to digital contracts. Remember. in fact. There are many variations on this basic theme as illustrated by the common law rules on advertising. The offer is broken down into three main subcomponents: intent. coupled with a good acceptance. is the agreed upon method or is an answer to a previously mailed offer. These steps can be broken down into subparts. agreement or mutual assent.e. If it fails to do so. the other player must make his or her opening response. Under the traditional common law mirror image rule. If necessary. is arrived at. looking at this offer. auctions. Mutual assent is defined as a reciprocal agreement between all of the parties to a contract. Once a good offer is made. They all have one common denominator: sooner or later some sort of basis for mutual assent must be found before a court will go forward with enforcement of the agreement. As an alternate memorization device. Teacher to Teacher Dialogue: Agreement The first element of contract is finding mutual assent between the contracting parties. students may consider using an anagram called the QQC test. can a court. The offer must be communicated to the offeree in order to be effective.

Spotting consideration. sounds easier than it really is. Thus the concept of looking to bargainedfor value in place of the seal evolved into the modern day law of contracts. contracts between members of the privileged classes did not require consideration because a man’s word was his bond. Another example is found in many state statutes that provide protection to charitable organizations making pledges as enforceable contracts even though the donors may not be getting any consideration in return for their gifts. When consideration is missing.Agreement and Consideration 143 Consideration Consideration is the second of the four elements of contract. but all wanted their contracts to be binding. II. Value means nothing. Detriment represents the value of the contract. In the Middle Ages. The seal was affixed to the contract by way of pressing the signatorius annulus (signet ring) against melted wax onto the contract. It is actually a very practical requirement. The second major category of consideration exceptions from contracts is found in statutory provisions based on public policy. Consideration is usually what is bargained for. will not be allowed to be withdrawn. Text Materials with Accompanying PowerPoint Slides . It is meant to place value on the contract in order to assure evidence of a bond between the parties. Without value being put at issue. Perhaps an historical footnote on the issue may be of value.. the glue that brought the parties to the table in the first place. A noble’s family seal evidenced that bond. Not everyone was a member of nobility. in a contractual setting.e. It is what is given up by one party to induce a similar action by the other. a court looking at the situation may simply say the matter is moot (nothing in controversy). Consideration is that element of a contract that is designed to show the underlying inducement to enter into the contract. the result is not necessarily an absence of contract. Bankruptcy Code allows for court-approved reaffirmation of debts that have already been discharged. the U. i. For example. What if you have examined an agreement for consideration and found it lacking? You may still have a contractual result based on either the equitable doctrine of promissory estoppel or on specific statutory grounds that allow for a consideration waiver or substitute. even though not supported by consideration.S. Detriment is usually divided into two main categories: affirmative detriment where a person promises to do something he or she has no obligation to do but for the contract and negative detriment where a person abstains from doing something he or she has a legal right to do but for the contract. Promissory estoppel literally means that a promise made. because of the harm that would befall the other party. Consideration today is made up of two subcomponents: detriment and bargain theory.

144 Chapter 10 Offer and acceptance Manifestation of willingness to enter into a bargain Effective when received .

The movie grossed over $150 million. This is an appeal of the district court’s dismissal of the claims. Marder was paid $2. “Flashdance” based on the life of Maureen Marder. The coin greatly increased in value. Reason: The Release was very broad and covered “each and every claim. The Court speaks: Marder v. and the Mint notified them that they were unable to fill their order. and the Mesaroses sued for breach of contract. Reason: Generally advertisements are not offers. even those based on any filming or exploitation of the film. The moral? Be careful not to sign your rights away. Ethics Spotlight: “A Contract Is a Contract Is a Contract” The designer of the Mighty Morphin Power Rangers was paid only $250 to transfer his copyright ownership in the logo.Agreement and Consideration 145 Does not include jokes. and the Mesaroses appealed. Marder believed that the video contained scenes from the movies. The lower court decided for the Mint. there was no evidence of uncertain consent. Although it may look like an unfair arrangement. They responded to the advertisement by placing an order for certain coins by the deadline stated in the advertisement.” Marder’s claims reasonably fall within these terms. anger or opinion. The Court Speaks: Mesaros v. United States Facts: The Mesaroses received an advertisement from the United States Mint for certain limited edition coins. She sued for rights as a co-author and co-owner of the movie. Issue: Was the General Release an enforceable contract? Decision: Yes. not an offer.300 and signed a General Release releasing Paramount from any claims. The test is whether a reasonable offeree would reasonably believe the advertisement was an offer or a solicitation. The district court’s dismissal was affirmed. The demand for a certain gold coin exceeded the limited supply. The wording of the . He subsequently sued and lost because he was bound by the agreement he signed. Jennifer Lopez Facts: Jennifer Lopez starred in a video stemming film the movie. Issue: Was the advertisement an offer? Decision: The advertisement was a solicitation of an offer.

.146 Chapter 10 advertisement was such that a reasonable offeree would not reasonably believe it was an offer. Therefore. the decision of the lower court was affirmed.

Agreement and Consideration 147 .

The name had been posted by defendant in its website to be sold to the highest bidder who.TV Corp.148 Chapter 10 Usually involves an offer to form a unilateral contract: Offer for act The Court Speaks: LIM v. Facts: Defendant. THE. . A bid was in response to an auction announcement. The announcement of the auction was an invitation to make an offer. The bid was the offer that was accepted by defendant’s confirmation. at the time. “Golf TV” to plaintiff in what defendant characterized as an auction. Plaintiff claims breach of contract. sold the domain name. After releasing the defendant “from the bid” they offered the name with a much higher beginning bid. as an agent. Claim was reinstated. Reason: Auctions are presumed to be with reserve. was plaintiff. Issue: Did LIM properly state a cause of action for breach of contract against dot TV? Decision/Remedy: Yes. Defendant continued to bid via e-mail. Trial court dismissed the case.

Agreement and Consideration 149 Revocation effective upon direct or indirect receipt unless an option with consideration Rejection effective upon receipt .

Heikkala changed all of the prices and closing dates and added a mineral reservation rights clause and signed the Agreements. Heikkala Facts: Heikkala listed 8 parcels of real property for sale. This is called an option contract. Upon suit by McLaughlin to compel specific performance of the Agreements. McLaughlin did not sign to accept the changes before Heikkala withdrew his offer to sell. McLaughlin appealed.150 Chapter 10 The Court speaks: McLaughlin v. McLaughlin submitted written offers for 3 of the parcels on the Purchase Agreement submitted with checks by McLaughlin. Issue: Did a contract to convey real property exist between Heikkala and McLaughlin? Decision: No. There was no written acceptance of the counteroffer and one is needed. Reason: This was a rejection and a counteroffer because of the mirror image rule. Contemporary Issue: Option Contracts An offeree can prevent the offeror from revoking his or her offer by paying the offeror compensation to keep the offer open for an agreed-upon period of time. . The counteroffers were not accepted in writing and the district court’s decision was affirmed. the district court granted Heikkala’s motion to dismiss.

The Montgomerys made several changes and signed the counteroffer. The Montgomerys appealed from a trial court decision favoring English. English sued for specific performance upon the Montgomerys’ refusal to sell the house. The trial court’s decision was reversed and the case remanded for summary judgment in favor of the Montgomerys. Reason: Since the acceptance was not the mirror image of the offer and the counteroffer was not accepted. English initialed some but not all of the changes.Agreement and Consideration 151 Manifestation of assent to an offer. . Issue: Was an enforceable contract made between English and the Montgomerys? Decision: No. Silence can be acceptance if offeree agrees or prior dealings indicate The Court speaks: Montgomery v .English Facts: English made an offer to purchase the Montgomery’s house and several items of their personal property. no enforceable contract was created.

152 Chapter 10 .

Inc. On 5/13/04 Mustaine e-mailed Ellefson about the termination time and date.Agreement and Consideration 153 TIME LINE Offer Acceptance Revocation Rejection Example: Offer sent on 1/1. On 5/15/04 proposed changes to the offer were exchanged between the attorneys. Facts: Mustaine and Ellefson were original members of the band Megadeath. On 6/02/04 Ellefson received the Agreement sent by mail by Mustaine on 5/20/04. On 5/24/04 Ellefson e-mailed thathe was withdrawing all proposals. Eventually Mustaine gave a 5PM time on 5/14/04 for completion of the settlement. Inc. Megadeath. The offer was received on 4/16/04. Ellefson signed and faxed the signature page to Mustaine. . Ellefsom sued alleging that Mustaine defrauded Ellefson out of his share of the profits. negotiations. Mustaine sent a Proposed Settlement and General Release whereby Mustaine would buy Ellefson’s interest. On 5/15/04 at 4:45PM Mustaine e-mailed Ellefson an execution copy (read only) of the settlement. Megadeath. During. reiterating the deadline and reserving the right to further change Exhibits AS and B the following week. On 5/20/04 Mustaine sent fully executed copies to Ellefson by mail. was formed in 1990 with Mustaine owning an 80% interest and Ellefson 20%. Mustaine answered that a signed agreement had occurred on 5/15/04 by fax. Acceptance sent on 1/8 Revocation sent on 1/6 Contract is valid on 1/8 Effective upon receipt Effective upon receipt except when mailbox rule is appropriate Effective upon receipt if before acceptance unless option says no revocation Effective upon receipt (Mailbox rule in effect) Received on 1/5 Received on 1/12 Received on 1/10 The Court speaks: Ellefson v.

Internet & Technology: Nondisclosure Agreements This discusses the enforceability and importance of a nondisclosure agreement. it was not a valid acceptance but was. Mustaine’s motion to enforces the Agreement was granted. An enforceable contract was formed on 5/20/04. Mustaine’s mailing of the completed contract was an acceptance of the counteroffer valid upon the mailing under the Mailbox Rue. Reason: Because Ellefson’s acceptance o the terms with the deadline did not fully comply with those terms. instead.154 Chapter 10 Issue: Was there an enforceable settlement agreement reached between the parties? Decision: Yes. Both must be inducements for each other. Scale (Each item weighs the same normally) . a counteroffer that signed and faxed and from which Mustaine could reasonably infer an intention by Elleson to be bound. if Mustaine accepted.

Reason: The promise was a promise that was not complete. Issue: Can Cooper recover the gifts or their value? Decision/Remedy: No. which she was to receive in a divorce settlement. Smith Facts: Cooper purchased a number of items for Smith (while they were engaged) without any bargained-for consideration. The judgment was affirmed. Reason: Other than a ring (not in question here). Alden. Presley died before it could be paid. Presley Facts: Elvis Presley agreed to pay off mortgage of fiancée’s mother. he sued for them on their value. gifts exchanged during engagement are irrevocable absent any donor intent to the contrary. His estate refused to pay and recovery on a contract claim was denied to Mrs. After they split-up. The case was dismissed by the magistrate and the dismissal was affirmed by the trial courts. . The court dismissed the case and assessed costs against the plaintiff. The Court Speaks: Cooper v. Issue: Was Presley’s promise to pay the mortgage enforceable? Decision/Remedy: No. There was no bargained-for consideration.Agreement and Consideration 155 The Court Speaks: Alden v.

000 to Drexel University and a scholarship would be created in Wirth’s name. .000. Issue: Was the Pledge Agreement supported by consideration and therefore enforceable against the estate of Wirth? Decision: Yes. Upon suit by Drexel to collect the $150. however. also shows consideration in the language by Drexel’s promising to establish a scholarship fund. the estate refused to pay alleging a lack of consideration. Reason: Under a PA statute an “intent to be legally bound” by a pledge makes a contract enforceable even if lack of consideration is found. This promise. Wirth died before money was paid and the estate refused to honor the pledge. The decision of the surrogate court was reversed and summary judgment was granted in favor of Drexel. Drexel appealed from a surrogate court denial of a motion for summary judgment and to dismiss.156 Chapter 10 Scale 0 or already here The Court speaks: In the Matter of Wirth Facts: Wirth signed a Pledge Agreement stating that in consideration of his education he would pay $150.

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Essential Terms 10. and Best-Effort contracts. There was apparently some discussion as to long-term financing. III. there must be a meeting of the minds as to all terms.2d 759 (Ark. The court found that the total amount of loan proceeds was never decided and that no interest rate or repayment terms were ever agreed upon.App. International Law: China Adopts New Contract Law China officially joined the WTO in late 2001. The UCL was enacted by China to overhaul its contract laws. the court stated that there was no way that it could take the general terms discussed between Hunt and the bank and be asked to enforce the contract without supplying the necessary terms essential to the formation of the contract.158 Chapter 10 Contemporary Issue: When Is Consideration Inadequate Courts usually do not inquire into the ”adequacy of consideration” except in some states where the inadequacy “shocks the conscience of the court.” Contemporary Issue: Special Business Contracts Special types of business contracts allow a greater degree of uncertainty concerning consideration. This seems to be the case here. 616 S. the contract is enforceable.W. however.2. there was not an oral contract for long-term financing. Hunt v. 1981). No. Such terms were left to future determination.1 If a reasonable person would think that the offer was intended and not a joke. Answers to Critical Thinking Cases Objective Theory of Contracts 10. McIlroy Bank and Trust. In addition. They include: output contracts. Accordingly. A court cannot make a contract for the parties. the trial court’s judgment in favor of the Bank was affirmed. In order to make a contract. the parties never agreed on any essential terms. . requirement contracts.

The contract must be interpreted so as to give effect to the mutual intention of the parties at the time of contracting. it could have explicitly done so in the lease. Superior Court. the intention of the parties should be ascertained from the writing alone.. and any subsequent expansion.Agreement and Consideration 159 Implied Terms 10. 1985). conditioned upon the execution of a new lease. A valid acceptance of an offer must be absolute and unqualified. 217 Cal.App. 205 Cal.3. A qualified acceptance that contains terms or conditions materially different from those in the original offer constitutes a counteroffer that terminates the power of the original offeree to accept the offer. No. 171 Cal. if a contract term is missing and a reasonable term can be implied.6. The court held that the lease impliedly incorporated any future development within the designation “Fresno Fashion Fair. 1984) . the court held that the tenant’s qualified acceptance of the settlement offer. The lease at issue here was silent as to any subsequent expansions of the mall.App.App. Implied Terms 10. the court can supply the missing term.4. constituted a counteroffer that terminated its ability to accept the settlement offer. Edmond’s of Fresno v. Reward 10. Furthermore. the Appellate Court affirmed the lower court’s holding that the restrictive covenant applies to all of the Fresno Fashion Fair.5 An offer of a reward is usually considered an enforceable offer if the person answering the request does what is asked. the court held that the process of settlement is best served by allowing the law of contracts to control. and not upon any clause standing alone.” Had MacDonald intended to exclude any future development. The trial court’s denial of the tenant’s motion to compel entry of judgment due to the existence of the settlement was therefore affirmed. Glende Motor Company v. James wins.Rptr. 159 Cal. viewing the contract as a whole. The offer is considered communicated to whomever accepts.3d 389. Counteroffer 10. In the instant case. The courts would indicate a reasonable time when no time is specified. when the contract is reduced to writing. the court applied the rule that in construing a lease any uncertainties will be resolved strictly against the party who drafted the document. Ltd. 682 (Cal. Under the modern view of contracts. Edmond’s of Fresno will be successful in limiting the mall. MacDonald Group. including any subsequent expansions.App. to not more than two jewelry stores. Moreover. there has not been a settlement of the lawsuit. Thus. 375 (Cal.Rptr. Accordingly. Nine months seems excessive in this case but all objective factors should be considered.3d 598.

Postal Service. To be enforceable. the trial court correctly rendered judgment in favor of the tenant. Under the modern law of contracts. The trial court’s judgment in favor of Durick was therefore reversed. the husband and wife mutually agreed to accept division of the shares and to continue to operate the KFC franchise as before.S. that Clyde’s interest in the franchise evolved from his status as a . This was followed by the transfer of jointly owned property to a newly formed corporation. thereby extending the lease for the next five years. the notice exercising the option to renew the lease was effective.App. Jenkins v. 235 Cal.9. 1980). while Clyde suffered a legal detriment when he closed the tire business. including money.3d 1.160 Chapter 10 Implied Terms 10. or the forbearance of a right. It contained no automatic renewal clause and failed to bind the parties in any way after the expiration of the original policy. and the lower court found. and an acceptance by the other. The Mailbox Rule 10. there is a presumption that. 1987). The court found that the prior policy was a separate and independent agreement that came to an end by its own terms. Yes. a contract must be supported by consideration. absent a contract or special agreement to the contrary.2d 249 (Vt. the court held that silence could be considered acceptance where the prior dealings between the parties so indicate or where the recipient retained the benefit of valuable services. services rendered by one spouse in the other’s business are gratuitously performed. The offeror cannot force the offeree to speak or be bound by his silence.7. Andrus. In addition. even if it is lost in transmission. Under this rule. a contract is supported by consideration if either (1) the promisee suffers a legal detriment. Betty argued. the court held that the tenant’s habit and custom regarding mailing practices was sufficient to affirm the trial court’s holding that the tenant’s renewal notice had been properly mailed under the terms of the lease. In addition. property. Acceptance of a bilateral contract occurs at the time the offeree dispatches the acceptance by an authorized means of communication. the provision of services. The court found that the lease notice provision required notice to be sent by “registered or certified United States mail.C. 424 A.Rptr. In this case. None of the communications amounted to an acceptance.8. To constitute a contract there must be a meeting of the minds between the parties. 190 Cal. Betty suffered a legal detriment by giving up half of the shares of the company. The court. Consideration 10. Generally. found that the past dealings of the parties established no course of conduct between the parties and that since the second policy was never in effect. Accordingly. Andrus never retained any benefit. 214 (Cal. J. Generally. thereby extending the lease for the next five years. an offer by one. Tuneup Masters. in the landlord’s unlawful detainer action. Andrus wins and does not have to pay the premiums on the insurance policy. Durick Insurance v. notwithstanding that the notice was not deposited in an officially designated receptacle. Consideration is broadly defined as something of legal value. the acceptance is effective when it is dispatched.” The court went on to state that the risk of loss of the notice of extension had transferred to the addressee once the notice reached the custody of the U. or (2) the promisor receives a legal benefit. The court held that this constituted adequate consideration to support a promise on the part of each of the parties to split the shares in the incorporated business between them. silence is not considered acceptance even if the offeror states that it is.App. the agreement is enforceable. however. Yes.

E. Under both agreements Gough agreed to erect and properly place the same number of trusses. In reversing the lower court’s holding. Waiver of. The Supreme Court of Georgia held that where the only consideration for the 1944 promise was past consideration.C. it is . Lena wins because the contract was supported by valid consideration. In the case at bar. Past Consideration 10. An agreement on the part of one to do what he is already legally bound to do is not sufficient consideration for the promise of another. Gough. Promissory Estoppel 10. The directed verdict in favor of the defendant and denying specific performance was affirmed. S. In this case. 1968).2d 32. Yes. Carter.62 plus interest at a rate of 6 percent. there was no enforceable contract requiring transfer of the property. The Idaho Supreme Court affirmed the District Court’s judgment awarding Lena $19. A. a promise which the promisor should reasonably expect to induce action or forbearance of a definite and substantial character on the part of the promisee and which does induce such action or forbearance is binding if injustice can be avoided only by enforcement of the promise. Penley. the Supreme Court of North Carolina determined that there was sufficient evidence to find a contract or special agreement to the contrary and that such contract or agreement was supported by adequate consideration. Gough is not entitled to any sum not contemplated by the original contract. In this case. the court found that Carter’s promise to pay was supported by Lena’s forbearance from prosecuting an action against him for his interest in her husband’s estate. No. 1980). a right that is not utterly groundless is sufficient consideration to support a contract made in reliance thereon. Whitmire does not receive the property. 1985).2d 6 (Ga. Whitmire v.App.10. the authors of the Restatement have proposed the following modification of Section 90: “A promise which the promisor should reasonably expect to induce action or forbearance on the part of the promisee or a third person and which does induce such action or forbearance is binding if injustice can be avoided only by enforcement of the promise. Reliance is the substitute for a bargained for consideration. Penley v. 159 S.11. plaintiffs win.J. Pursuant to Section 90 of the Restatement of Contracts. Generally. Watkins. had performed the services that he argues constituted his consideration from the period between 1923 until 1944. This doctrine relates only to action or forbearance on the part of a promisee.J. Consideration 10. 332. Gough assumed no obligation or duty that he was not bound to perform under the terms of the original contract. Recognizing that the “morals of the marketplace” periodically change and that today stricter standards of good faith and fair dealings are imposed.E. Gough cannot recover the cost to reerect the thirty-two fallen trusses.12. 437 P.2d 51 (N. No. Robert Chuckrow Construction Company v. Preexisting Duty 10. Frasier v.” If a promise is made to one party for the benefit of another. Lexis 249 (Idaho). past consideration will not support a subsequent promise. Nalley’s argues that the two individuals were only incidental beneficiaries of the contract with Major and thus have no cause of action other than that of a donee or creditor third party beneficiary. 267 So. A.358. or forbearance to exercise. Accordingly.2d 469 (Ga.13. 1968 Ida.Agreement and Consideration 161 husband.

This clause clearly provides that suits must be brought within one year of injury.3d 27.16. 10.14. The Court of Appeals held that the remedy provision of the agreement was illusory and awarded the equitable remedy of specific performance to the buyers. the defendant knew that the individual plaintiffs were leaving their previous employment and investing substantial amounts to enable them to perform under the terms of the agreement. 424 (Cal.2d 437 (Fla. Colangelo. Such contractual provisions. paragraph 13 of the ticket. Answers to Ethics Cases 10.. Norwegian communicated the limitation period to Dempsey.App. The message contained in the box clearly informed the passenger that he or she should read certain pages of the ticket that “affect important legal rights. The physical characteristics of the ticket in this case clearly informed Dempsey that her rights were being limited. This is especially unconscionable in this case in light of the buyer’s deprivation of the use of their money for several years. 972 F. 30 C. The ticket contained the notation “Important Notice” in a bright red box at the bottom right-hand corner of each of the first four pages. Nalley’s.162 Chapter 10 often foreseeable that the beneficiary will rely on the promise. must be reasonable. approved the results. and at the top of this page it is stated in bold letters: “Passengers are advised to read the terms and conditions of the Passenger Ticket Contract set forth below. 1985). 1992). Aronowicz v. Accordingly.2d 998 (9th Cir. Acceptance of this Passenger Ticket Contract by Passenger shall constitute the agreement of Passenger to these Terms and Conditions.Rptr. IV. Norwegian Cruise Line. Norwegian went to great lengths to inform passengers of the various terms and conditions that could affect their rights. Ocean Dune’s obligations are wholly illusory. Dempsey pointed to no factors extrinsic to the ticket that warrant finding that Norwegian did not reasonably communicate this information to Dempsey. 106 Cal. the defendant’s duty under the contract is illusory. the defendant watched such efforts.” The terms and conditions begin on page 6 of the ticket.” The clause at issue is found at page 8. encouraged them. Yes. 10. that is usually the case. and went so far as to commence to secure orders for the products manufactured by the corporate plaintiff and to be distributed by the defendant. In the contract at issue. “Fair Market Value” is more than definite enough to support an action for specific performance if there is an objective way to define market value. Munoz probably did not act ethically in that he was only acting in his own behalf and not for the good of all. The developer. Goodwest should win. With real estate. Where parties enter into a contract in which one or both of the parties can choose not to perform his contractual obligations. on the other hand.A. In this case. Ocean Dunes of Hutchinson Island Development Corporation v. however. Inc. Moreover. Parties to a contract may agree to limit their respective remedies and those remedies need not be the same. the doctrine of promissory estoppel is applicable and supplies the absence of a consideration for the promise. The developer can opt to sell the unit to any new buyer willing to pay a higher price with absolutely no liability to the Colangelos other than a return of their deposit. . was able to choose between retaining the buyer’s deposit and resorting to any other legal or equitable remedy to which he may be entitled. The judgment in favor of the plaintiffs is affirmed. the contract lacks consideration and is unenforceable. 1972).15.App. Enforcement of the promise in such cases rests on the same basis and depends on the same factors as in the cases of reliance by the promisee. 463 So. Dempsey v.

is a supplier of pre-engineered aluminum and glass sliding doors and windows. Traco modified its original bid to come into compliance with the specifications. and actual reliance by Arrow. Traco wanted a contract to supply aluminum and glass sliding doors to Arrow in conjunction with the USAA project. Subsequently. 3. The three basic elements of promissory estoppel were in place: a promise by Traco to supply doors per the original standard at a set price. Court’s Reasoning A. Arrow Glass was a subcontractor engaged in the construction of USAA Towers in San Antonio. Holding Yes. B. not act ethically and the doctrine of promissoryestoppel should apply.000. Inc. Traco. Arrow sued for the difference between its original price with Traco and the higher price it paid to the third party on the basis of promissory estoppel.W. V. there were numerous quality problems with the doors delivered by Traco. Arrow Glass Co. Answer to “Briefing the Case” Writing Assignment: 1. Traco offered to supply a highergrade door at an additional cost of $300. which led them to underbid the cost of the job and have to pay more for the doors to a third party. Its solicitation was rejected because its product did not comply with the original specifications called for by the project. Key Facts A. Citation. B. Red Owl did. 5. E. Arrow sought to have these problems resolved. F. C.2d 186 (1991) Court of Appeals of Texas 2.17. TX. 814 S. . Arrow relied on this revised bid and got the subcontract for the door work. There were several promised on which Hoffman reasonably relied to his detriment. The remedy of promissory estoppel is a “rule of equity” applied to promote the ends of justice.. and Court Traco. D. foreseeable reliance on Arrow’s part in lowering its bid to the USAA general contractor. v. Inc. G. therefore. Issue Does the contract remedy of promissory estoppel apply? 4. Case Name.Agreement and Consideration 163 10. Inc. Arrow refused to purchase the more expensive Traco product and sent the project out for bids.

164 Chapter 11 Chapter 11 Capacity and Legality Did They Know What They Were Doing? I. II. It is the third of the four essential ingredients to a contract. but which have an anticipated outcome that is in violation of public policy (if the buy-sell creates an illegal price-fix). As with the other three elements. Teacher to Teacher Dialogue This chapter embarks upon the third and fourth of the four elements of contract—capacity and legality. . The more difficult aspect in teaching this element surrounds issues of collateral or incidental illegality as well as dealing with contracts which appear legal on their face (such as a buy-sell). full knowledge of all the material circumstances. and a recognized capacity to contract. and should be entered into by persons who are recognizably able to do so. Text Materials The fabric of contract law is thoroughly interwoven with a concern that parties entering into these agreements are doing so with free will. if the capacity element is missing. Capacity is the legal qualification. a contract cannot result from the agreement in question. The need for both capacity and legality is quite self-evident to students. They readily understand that contracts are important. competency. and fitness to enter into contracts. The self-evident and common sense basis of having legality as one of the elements of contract is usually readily understandable.

An important area of concern in the law of contract capacity limitation is found in the public policies that seek to protect certain individuals from sometimes-harsh results of contracts. Inc. Therefore. entered into a contract with Free Flight. All states have established certain minimum age requirements as a threshold which must be crossed before a person is allowed to contract on his or her own (now age 18 in most jurisdictions). these contracts may be enforceable against a minor. Reason: The common law allows a minor to disaffirm a contract until he has ratified the contract.e. In the areas of necessities and certain statutorily recognized areas such as insurance and military enlistment. for his or her own protection. Issue: Has Jones ratified the contract? Decision: Jones has ratified. some reimbursement may be due from the minor. Ten months after reaching majority. The Court Speaks: Jones v. Jones accepted the benefits of the contract for ten months after reaching majority.Capacity and Legality 165 *Capacity to contract is presumed between adults. But as a matter of public policy. attempts to contract by such young persons may have limited success. It is protected legally in the federal and all state constitutions. Jones has ratified the contract. the legal minor. although he had used Free Flight services during the ten-month period. Prior to that threshold age.. Even though protection can sometimes be seen as a euphemism for punishment on the part of the protected party. the simple reality is that sometimes people do need to be protected from themselves and others. Before this legally sanctioned right is limited. If there is misrepresentation by the minor or equity concerns for an adult who dealt with the minor in good faith. This avoidance is not always a free ride. i. The contract can be ratified by action after the minor reaches the age of majority. Free Flight Sport Aviation. to legally avoid the consequences of contractual entanglement. . while a minor. the general rule is that the minor is allowed. Facts: Jones. The first category of persons needing protection is the young. Jones attempted to disaffirm the contract. such limitations must be justified on the basis of sound public policy. A minor ratifies a contract by accepting the benefits of a contract for a reasonable time after reaching majority.

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Fountain’s estate appealed. Issue: Is Fountain’s estate liable to Yale under the doctrine of necessaries? Decision: Yes. a minor.694 of medical service from Yale. The Court speaks: Yale Diagnostic Radiology v. was shot by a playmate. and educational loan agreements. The motion was denied but was granted at the trial court. Yale filed a motion with the probate court for payment from the estate. a secondary implied contract exists between the provider and the minor. . Estate of Fountain Facts: Fountain. sued the playmate and recovered damages place in an estate for Fountain. Yale billed Tucker (Fountain’s mother) who had declared bankruptcy and had Yale’s claim discharged. Tucker. They include in part medical care. duties to pay for the child’s medical expenses. Thus the estate is liable under the doctrine of necessaries. Fountain required and received $17. The supreme court affirmed. The primary contract between a provider and the parent is based on the parents. If the parents do not pay. on behalf of Fountain.168 Chapter 11 Generally necessaries of life or public policy Contemporary Issue: Special Types of Minors’ Contracts There are certain types of contracts that minors may not assert the infancy doctrine against. Reason: A minor may not avoid a contract for goods or services necessary for health care. life insurance.

we do not want documents enforced against persons who had no real ability to comprehend the material elements of those documents. This is not a matter of excusing someone from the binding effects of a contract based on simple ignorance. Be it based on mental limitations. they must prove to a court that at the time they entered into the disputed agreement.Capacity and Legality 169 Note: Parents’ duty to support terminates if a minor becomes emancipated (voluntarily leaves home and lives apart from parents). Attempts to contract with persons legally declared incompetent are void. they lacked the cognitive ability to . Persons who are not legally declared incompetent can seek to avoid contracts based on some sort of lesser capacity. Because contract results can be harmful. The second major area of public policy-based protection from contract capacity is found in the area of persons with varying degrees of limited mental capacity. A person who has been judged incompetent simply has lost the power to contract for himself or herself and needs to have someone else act in his best interest in a fiduciary (trust) role. a lack of a mental ability to protect one’s self-interest is considered fatal to the contract process. What this area of law is concerned about is a real lack of capacity to protect oneself. Just as we do not want very young people signing mortgages. or other affliction. drunkenness. drug use.

emotional weakness. or a predilection for doing stupid things is not sufficient grounds for avoidance of a contract.170 Chapter 11 understand the material elements of the transactions. The burden of proof is on the person raising the issue of limited capacity. As with minors. contracts with persons of limited capacity can be later ratified. . If the contract is disaffirmed. Simple ignorance. and courts will look at those issues on a case-by-case basis. restoration or restitution maybe appropriate depending on the individual circumstances of each case.

. Carr missed the closing. and refused to sell.Capacity and Legality 171 The Court speaks: Campbell v. Issue: Did Carr. A written agreement for that amount was entered into and earnest money was paid by Campbell. returned the money. Campbell sued for specific performance. due to the diseases. The court ordered Carr to specifically perform and Carr appealed. makes it inequitable to order specific performance which is an equitable remedy.000. because of her mental diseases. lack the mental capacity to enter into the contract with Campbell? Decision: Yes. inherited a tract of land. Evidence was introduced valuing the property at $162. Reason: The inadequate consideration combined with Carr’s weakness of mind. who suffered from schizophrenia and depression for which she took prescription medication.000 and that Campbell knew of this. The decision ordering specific performance was reversed. She agreed to sell to Campbell who told Carr that the Tax Assessor assessed the property at $54. Carr Facts: Carr.

172 Chapter 11 The Court speaks: Smith v. Smith appealed from a trial court’s enjoining of the foreclosure. A contracts with B. each legally capable of providing recognized legal value. The trial court’s decision was affirmed. due to alcoholism. Smith loaned Williamson $500 and took back a note and mortgage to secure repayment. She went to an attorney’s (Smith) office after having drunk a pint of 100-proof Vodka and Smith prepared a lawsuit to set aside the sale due to lack of capacity from alcoholism which was won by Williamson. Issue: Was Williamson’s alcoholism a sufficient mental incapacity to avoid the mortgage? Decision: Yes. He did not let Williamson’s son read the mortgage. an alcoholic. Note how the phrase “legal” keeps cropping up through the language of contracts. That is because a contract is . Smith began foreclosure and Williamson filed suit to enjoin the action. was incapable of understanding the nature of the transaction with Smith as she was with the Matthews. Reason: Williamson. The amount she expected to receive was 10 times great than the what she received. The second objective of this chapter is to introduce the element of legality and its role in the formation and enforcement of contracts. Williamson Facts: Williamson. Most people think of a contract as a two party situation. agreed to sell her house to the Matthews while under a threat of foreclosure.

the agreement is void and cannot be raised to the status of a legal contract. or is the problem incidental or collateral to the agreement? The first question is really the easiest to answer. even if they appear legal on their faces. a simple buy-sell agreement looks perfectly legal. can anyone realistically expect courts to use any other ground rules other than their own? The legality element of contract simply refers to those ground rules. If a court finds that the illegality or public policy concern is not at the heart of the contract. Courts look at the reality of these agreements. The second question is much more difficult to answer in that public policy is a moving target. that agreement must be recognized first and foremost as a legal agreement. whose job it is to provide a resolution of the problem between A and B. because the illegality is considered collateral or incidental.Capacity and Legality 173 not only a two party situation. is it a material aspect of this contract. Ethics Spotlight: An Unlicensed Contractor Gets Dunked Should parties sometimes be able to enforce illegal contracts? This sheds light on that subject. In the process of resolving a contract problem. Licensing Statutes: Regulatory Public protection No recovery Revenue-raising Raise revenue Often enforceable . If A and B have a dispute about what the contract terms really provided. If A and B want their agreement honored in a court of law as a valid and binding contract. If this agreement is legal on its face. If there is an element of illegality or violation of public policy. When a court examines an agreement for its legality component. may it have an intent or consequence that is against public policy? 3. a contract for a murder by an underworld figure cannot and will not be enforced by a court of law. To do otherwise would be asking a court to become a party to an agreement that contravenes the basis for its existence. For example. Not all illegalities are fatal to the entire contract. C. where must they ultimately turn to get an answer? Courts are the designated agents of the larger society. it may still enforce the agreement. Is this agreement illegal per se? 2. All contracts have a “hidden” third party which is the larger society represented by the courts. If the agreement calls for an illegal act on its face. Thus. But what if the agreement is designed to act as a restraint of trade by discriminating as to who can sell to whom at fixed prices? Or what if we are looking at a prenuptial agreement that looks fair on its face but gives all the property to the party against whom a divorce action is brought? Is this really just a liquidation of property or an illegal punitive measure against a party who is exercising a legal prerogative? What about an exculpatory clause that goes too far? The third area of concern goes to the issue of enforceability once the problem area is identified. there are three key questions it asks: 1.

purchased a life insurance policy on the life of her husband with herself as the beneficiary. Parents signed a form indemnifying all relevant parties against any claim from participation (or the like) injury. Therefore. . This is called a covenant not to compete. The Court Speaks: Zivich v. Issue: Did the exculpatory agreement signed by Mrs. in the eyes of the law. and the insurance company refused to pay her the proceeds of the policy. Reason: Public policy requires the use of volunteers in these types of organizations without fear of lawsuit for negligent acts. Decision was affirmed. She was convicted of poisoning her husband. Issue: Was the policy contract legal? Decision: The policy is void.174 Chapter 11 Restraints and covenants cannot be unreasonable The Court Speaks: Flood v. Zivich on behalf of her son release the Club from liability for the child’s claims and the parents’ claims? Decision/Remedy: Yes. wrongful act is against public policy. They refunded her premiums. an insurance agent. and she sued to enforce the policy contract. Inc. Inc. Mentor Soccer Club. The trial court granted a summary judgment for Mentor. it is clear that she entered into this contract to use her wrongful act for financial gain. Contemporary Issue: Covenant Not To Compete To protect goodwill after the sale of a business. Reason: To allow the beneficiary of the policy contract to reap the benefits of her own intentional. the policy lacks a legal purpose. Court of appeals affirmed. This action is against public policy. Parents agreed to bear the risk. Fidelity & Guaranty Life Insurance Company Facts: Ellen Flood. Facts: Bryan Zivich played for Mentor Soccer Club. the seller often enters into an agreement with the buyer not to engage in a similar business or occupation within a specified geographical area for a specified period of time after the sale. The lower court decided for Flood. Since the beneficiary has been convicted of the crime. This discusses the enforceability of such covenants. and the company appealed.

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The Court Speaks: Ryno v. Tyra Facts: Ryno discussed selling Tyra a car through his dealership. Instead, they flipped a coin and Tyra won. Ryno gave him the keys and said, “It’s yours.” Issue: Was there an illegal contract? Who owns the car? Decision: Tyra owns the car but not from the coin flip. That was an illegal contract. Reason: The gambling contract was unenforceable and illegal but the car belongs to Tyra because Ryno did deliver it to Tyra and this was a transfer by gift.

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Ethics Spotlight: Unconscionable Contract Mere unbalanced contracts are not necessarily illegal. Those that overreach and are too lopsided can be found unconscionable as in the Supercuts, Inc. case and the arbitration clause in question. III. Answers to Critical Thinking Cases Infancy Doctrine 11.1. Halbman wins. Generally, a minor has an absolute right to disaffirm a contract for the purchase of items that are not necessities and is entitled to recover all consideration given. This rule is designed to protect minors from foolishly squandering their wealth through improvident contracts with crafty adults who would take advantage of them in the marketplace. In return for this protection, the minor is expected to restore as much of the consideration as, at the time of disaffirmance, remains in his possession. This is to assure that a minor who disaffirms a contract will not profit by retaining the property purchased. Here, Lemke seeks restitution of the vehicle’s depreciation in value caused by the damage to the vehicle prior to disaffirmance. Such a recovery would require Halbman to return more than that remaining in his possession. The court held that, absent misrepresentation or a willful

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destruction of property by Halbman, he might recover his purchase price without liability for use, depreciation, damage, or other diminution in value. The Court of Appeals affirmed the lower court’s holding ordering Lemke to pay $1,100 plus interest. Halbman v. Lemke, 298 N.W.2d 562 (Wis. 1980).

Ratification of a Minor’s Contract 11.2. Toyota wins and may enforce the security agreement. It is well settled that the conventional contract of a minor, except those for necessities, are voidable at the election of the minor during minority or within a “reasonable time” after reaching majority. What constitutes a “reasonable time” will be determined on a case-by-case basis. In making this determination, a court will consider affirmative actions as well as silent acquiescence. In the instant case, Smith continued to make monthly payments as required by the note for ten months. The court held that Smith’s extended acceptance of the benefits and continuance of payments under the contract after he reached the age of majority constituted a ratification of the contract, thereby precluding any subsequent disaffirmance. Bobby Floars Toyota, Inc. v. Smith, 269 S.E. 320 (N.C.App. 1980).

Adjudicated Insane 11.3. Yes, Miss Johnson is allowed to void the contract to sell her real estate to Obbie Neal. The law provides that once a person is adjudged insane, any contracts entered into by that person are void. Here, Miss Johnson had been adjudged insane prior to her entering into the contract to sell her real estate to Obbie Neal. Therefore, the court held that the sale contract is void, and Miss Johnson may retain her real property. Beavers v. Weatherby, 299 So.E.2d 730 (Ga. 1983).

Intoxication 11.4. Betty wins and may void the settlement contract. A contract of a person of unsound mind, but not entirely without understanding, made before her incapacity has been determined judicially upon application for the appointment of a guardian, is subject to rescission. Furthermore, where the competency of one of the partners to marriage is a significant element in a suit for divorce, subsequent settlement agreement should be thoroughly scrutinized before the court accepts it. In this case, the record raises many doubts as to Betty’s capacity to contract for an extended period of time prior to and after the settlement agreement. Thus, the court held that Betty may avoid the contract at issue. Galloway v. Galloway, 281 N.W.2d 804 (N.D. 1979).

Licensing or Revenue-Raising Statute 11.5. Wilson wins and may recover his architectural fees from the defendants. Where a licensing statute provides criminal liability but is silent as to civil liability, courts have distinguished between statutes enacted to raise revenue and statutes enacted to protect the public against incompetence and fraud. If the purpose of the statute is for the collection of revenue, the express statutory penalties are held to be exclusive and contracts made without a license are not thereby rendered unenforceable. On the other hand, if the statute is for the protection of the public, it is more likely that the statute’s violator will be denied the enforcement of his bargain.

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In this case, the court held that while the provisions of the statute requiring initial registration are clearly designed to protect the public from unfit and incompetent practitioners of architecture, the provision requiring renewal is purely for the purpose of raising revenue. Renewal involves nothing more than the remittance by the registrant of the annual $15 fee. Reexamination and reinvestigation play no part in the renewal process and there is no relationship between the payment of the annual fee and the competence or character of an architect. Because Wilson simply failed to comply with the renewal provision of the statute, the court concluded that the contract between Wilson and the defendants was enforceable. Wilson v. Kealakekua Ranch, Ltd. and Gentry Hawaii, 551 P.2d 525 (Hawaii 1976).

Covenant Not to Compete 11.6. Yes, the covenant not to compete is valid and enforceable. Although a partial restraint on trade, covenants not to compete that are ancillary to employment contracts or the sale of a business are enforceable where they are reasonably limited as to time and territory. What is reasonable depends on the subject matter of the contract, the kind of business, its location, the purpose to be accomplished by the restriction, and all of the circumstances that show the intention of the parties. Courts distinguish between covenants incidental to employment contracts and those incidental to the sale of a business. In the case of employment contracts, an employee is restricted from using his personal skills and experience, which may substantially impair his ability to earn a living. Thus, courts have interpreted such covenants liberally so as to prevent the seller from recapturing and utilizing the goodwill of the very business that he transferred for value. Such is the case in a small business, operated by an individual who developed a clientele and a reputation in a specialized business. In this case, the covenant does not require Morris to refrain from all business without any limitation as to time and space. The covenant is clearly limited to the kind and character of the business sold for a period of ten years within a 100-mile radius of Tucson. Thus, the court concluded that the scope of the covenant was not unreasonable as broader than necessary to protect the interests of the Ganns. Gann v. Morris, 596 P.2d 43 (Ariz.App. 1979).

Exculpatory Clause 11.7. No, the exculpatory clause in this case is not valid against Alston. Although parties have a right to contract against liability, a party cannot protect himself by contracting against liability for negligence where a public duty is owed or a public interest is involved. The practice of cosmetology and instruction involves the use of hazardous chemicals that may affect the health of the general public. Accordingly, the court held that the Institute and its employees may not contract with their customers in a manner that would absolve themselves from their duty to use reasonable care. Alston v. Monk, 373 S.E.2d 463 (N.C.App. 1988).

Exculpatory Clause 11.8. Yes, the exculpatory clause in this case is effective and valid. Exculpatory agreements, such as the one signed by Koch, have been held not to be against public policy. However, such an agreement may be set aside if there is either fraud in the inducement or fraud in the execution of the agreement. In this case, the record reveals that Koch has been involved in racing for ten years and that he had signed similar agreements in the past. He admitted that he had not read the

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agreement, that he was not prevented from doing so prior to signing it, and that he knew the word “release” meant the racetrack was not liable should an accident occur. Moreover, the document was clearly captioned and the signature lines have a statement regarding reading the release on each line. The court held that these facts should have alerted the plaintiff as to the nature of the document he was signing and that he was not fraudulently induced to execute the release. Thus, the agreement clearly bars any action for negligence against the racetrack or Spaulding. Koch v. Spaulding, 529 N.E.2d 19 (Ill.App.1988).

IV: Answers to Ethics Cases 11.9. The contract was illegal and void. Ordinarily, a contract between an attorney and one not an attorney, providing that the latter shall procure the employment of the former by a third person for the prosecution of suits to be commenced in consideration of a fee to be procured or collected therein, is void as against public policy, independent of statutes prohibiting same. Moreover, courts generally will not enforce illegal contracts. The policy is not to protect or punish either party to the contract, but is for the benefit of the public. On appeal Plumlee attempted to avoid the well-settled law by arguing summary judgment was improper because he was not in pari delicto with appellees; denial of recovery affords appellees unjust enrichment; and denial of recovery is against public policy. However, none of these arguments is valid. It is true there are cases that hold when the parties to an illegal contract are not in pari delicto, the party least culpable may recover. However, such cases depend upon the knowledge of peculiar facts by the defendant, not known by the party seeking to enforce the contract, in other words, a mistake of fact. This case does not involve any mistake of fact. Both parties were aware of the facts surrounding the entering of their contract. It is simply irrelevant that Plumlee maintains ignorance that this type of contract was illegal. Plumlee v. Paddock, Lovless, and Roach, 832 S.W. 2d 757 (Tex. App. 1992). 11.10. The trial court upheld in favor of Zientara. Although lotteries were illegal in Indiana, they were legal in Illinois. The contract called for the purchase of a lottery ticket in Illinois. Such an act is not illegal under Indiana law or against public policy. To not support the contract would allow one who converted the property of another to be rewarded. Therefore, the contract is not illegal, and should be enforced. Kaszuba v. Zientara, 506 N.E. 2d 1 (Ind. 1987).

V. Answer to “Briefing the Case” Writing Assignment 1. Case Name, Citation, and Court Carnival Leisure Industries, Ltd. v. Aubin 938 F2d 624 (1991) United States Court of Appeals for the Fifth Circuit 2. Key Facts A. While on a visit to the Bahamas, George J. Aubin incurred $25,000 in debt evidenced by bank drafts from a Texas bank to the plaintiff, Carnival Leisure Industries, Ltd. (CLI) B. Mr. Aubin issued a stop payment order on the Texas bank draft and CLI sued for enforcement of the debt in Texas. C. The lower court granted CLI’s motion for a summary judgment, and Aubin appealed.

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D. Mr. Aubin’s appeal alleges that Texas public policy bars the collection of debts arising from gambling. 3. Issue Does the public policy of Texas continue to ban the collection of gambling debts in light of the limited forms of gambling made legal in Texas since 1973? 4. Holding Yes, the Texas public policy against the enforcement of gambling debt remains. 5. Court’s Reasoning A. The newer forms of gambling allowed in Texas center around “social gambling,” such as bingo, raffles, and racing. B. These are not considered to be the same as the broad-based forms of casino gambling from which this debt arose. C. Even if there was a shift in the public policy against gambling “per se,” there was no evidence of any shift in the policy against enforcement of debts arising out of gambling activities.

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Chapter 12 Genuineness of Asset and Statute of Frauds

Did I Really Agree To That?

I. Teacher to Teacher Dialogue Genuineness of Assent The first set of defenses to the enforcement of contracts in this chapter revolves around the issue of free will. Where free will is compromised, mutual assent is also compromised, and the agreement may not stand as a contract. What makes this area of law difficult is that courts and juries are asked to exercise 20/20 hindsight when looking back on how the parties were thinking as they were embarking on the road to contract formation. The subjectivity of measuring intent has always been a troublesome puzzle to unravel; yet without it, the objective facts placed before a court may not show the reality of consent. Because of the potential harshness of a bad contract, courts want to be very sure that the assent element of contracts is just that—a free and real consent to the agreement. At on end of the spectrum is an innocent mistake that can be either unilateral or bilateral. In a contract mistake, one or both of the parties is acting under an erroneous belief about the subject matter of the contract. Normally, if only one (unilateral) of the parties is mistaken, there will be no grounds for recission unless that mistake is coupled with some sort of bad faith or abuse on the part of the nonmistaken party. Where the mistake is mutual (bilateral), either party may seek recission if the mistake is considered material (so important that no real meeting of the minds ever occurred). The next issue is found in the area of misrepresentation or concealment. A problem occurs when a person is actively seeking to misrepresent. Here we can see that freedom of assent is even further compromised than in mistake alone. Now the element of scienter (guilty mind) enters the picture, and the grounds for recission are greatly increased. If the misrepresentation is material, known to be so by the maker, made with the intent to deceive, and is justifiably relied upon by an innocent and injured party, then the elements of fraud are in place. With a finding of fraud, the injured party may seek recission and/or civil damages. In addition, the state may choose to prosecute the wrongdoer under the penal code. Contract fraud, unfortunately, not only sits at the other end of the spectrum but can also be found at the top of the charts on the most popular white collar criminal list. As with so many areas of criminal behavior, the consumer pays the ultimate cost of these crimes through passed on costs for insurance, credit, and any number of other services undermined by these kinds of activities.

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Another highly sensitive area of mutual assent is found in the law of undue influence. Undue influence involves taking away a person’s free will through any manner of physical, emotional, or psychological manipulation. It can happen in any relationship, and where it is alleged, the person claiming to be the victim of undue influence has the burden of proof in showing the alleged duress. One important exception to this general rule involves persons who act in a fiduciary role. A person in a fiduciary role is entrusted with acting for the benefit of another. Most professionals in law, accounting, the healing arts, and business find themselves in fiduciary roles to one degree or another. As for the fiduciary, the burden of proof is now reversed. In dealing with their respective clients, patients, or beneficiaries, a contract is presumed to be under undue influence, and the burden of proof is on the fiduciary to show that the transaction is at arm’s length, i.e., is it fairly arrived at.

Writing Requirement As a practical matter, most contracts of any importance should be in writing. Most students already intuitively know this. The more important concern is to recognize how, when and where the writing should be used and when exceptions should be made to the general rule. A three-step logic in the classroom might be helpful: 1. First, be sure to recognize which categories of contracts are covered by the Statute of Frauds, including the major exceptions, such as partial performance or orders for specially made goods under the UCC. 2. Second, have students learn how to use the parol evidence rule. Explain the whys and wherefores of the rule from both the theoretical as well as the practical point of view. 3. Finally, because the bottom line is to make sure that equity is done, explain both the public policy and practical necessity of having exceptions to the parol evidence rule. The second set of defenses to the enforcement of contracts revolves around writing requirements associated with certain contracts. The genesis of the writing requirement for certain contracts is found in two roots: one historical and one practical. The historical root goes back to early English common law as developed under William the Conqueror and his successors. Status in that society was almost entirely measured by how much land one owned or had control over. Being Lord of the Manor meant privilege, power, and rank. Thus contracts involving the transfer of land ownership were of utmost importance because of the bearing they had on social status. Highly ritualized written processes of titled transfers to land evidenced these important contracts. The original title to the land was often traceable to a knights’s fief or fee for services provided to the sovereign. From this phrase, the highest recognized ownership in land today is still called fee simple absolute. The second root of the writing requirement is found on a more mundane level, having less to do with knights in shining armor and more with practicality. A writing is considered the best and most neutral evidence of the parties’ intent at the time the agreement was entered into. The writing does not lose its memory; it does not take sides. Thus when English lawmakers wrote the Statute of Frauds, they decided the statute would serve them with the best of both worlds--impose a writing requirement on the most important contracts to act as the best evidence in a court of law. The English version of the Statute of Frauds has been carried over to our legal system virtually intact for over three hundred years. All U.S. states have adopted their own versions of the statute, and they are virtually uniform in that they require contracts involving interest in land, consideration of marriage, one year plus, third party guarantees, and others to be in writing. The most significant addition to this list came with the adoption of the Uniform Commercial Code. Under the provisions of the UCC, contracts for the sale of goods for more than $500 need to be in writing. Thus, the first question which needs to be answered is: Does the statute cover this contract or not?

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Once you have decided the contract is covered, what are the effects of having failed to use a writing? Several possibilities may occur at this juncture. The parties may proceed to voluntarily perform the contract. But if one or both decide to assert the statute, its teeth are found in it being used as a defense to enforcement, i.e., if the party against whom contract enforcement is sought has not signed, it may not be enforced against him or her. There are equity-based exceptions to this general rule based on partial performance and promissory estoppel. Once the contract is finally reduced to writing, the next element of the Statute of Frauds takes hold: the parol evidence rule and the exceptions to it. The exclusion face of the rule states that the writing is intended to express the final intent of the parties. All prior or contemporaneous statements must ultimately have been reflected in writing and will remain barred from the interpretation of the instrument. This provision is designed to prevent a rewrite of the document after the fact with new evidence to prevent fraud. The converse is found in the exceptions to the parol evidence rule. Long ago, an anonymous legal scholar first said: “The Statute of Frauds should not be used to perpetuate frauds.” The exceptions to the parol evidence rule are designed to let in additional information not shown on the original writing in certain limited circumstances. These special circumstances are grounded in public policy and simple practical necessity. Public policy provides an overriding basis in cases involving fraud, misrepresentation, deceit, bad faith, power to avoid based on age or mental capacity, duress, undue influence, and mistake. All these elements are considered in the best interest of public policy and will be allowed into evidence, notwithstanding the statute, if the facts warrant it. The second area of exception to the parol evidence rule is explaining ambiguities. If the contract, as written, contains ambiguous language, parol evidence is allowable to clear the ambiguity as long as it is consistent with the original terms. The nature of the evidence allowable under this rule can range from oral statements made by the parties on up to entire standards of usage and trade used by a particular industry. This exception is particularly important in contracts covered by the UCC.

II. Text Materials

Genuineness of Assent and Statute of Frauds 185

Look to what non-mistaker thought.

The Court Speaks: Wells Fargo Credit Corp. v. Martin Facts: Wells Fargo Credit Corporation (Wells Fargo) appeals an order denying its motion to set aside a judicial sale and an order denying its motion for relief from judgment. Essentially, both motions sought relief from the judicial sale because an avoidable, unilateral mistake by Wells Fargo’s agent resulted in a grossly inadequate sales price. Wells Fargo obtained a judgment of foreclosure on a house owned by Mr. and Mrs. Clevenger. The total indebtedness stated in the judgment was $207,141. Wells Fargo was represented at this sale by a paralegal employed by its attorney. The paralegal was experienced with public foreclosure sales and had attended more than one thousand similar sales. She brought a form document that had been prepared either by Wells Fargo or its attorneys, containing specific information and instructions for this sale. The instructions informed her to make one bid of $115,500. This was the tax-appraised value of the property after deducting the homestead exemption. Unfortunately, the form was filled in by hand, and the handwriting was not very clear. The first “1” in the number was close to the “$” and slightly separated from the “15,500.” The paralegal misread the bid instruction as $15,500. Mr. Harley Martin also attended this sale. This was the first such foreclosure sale he had ever attended. After the paralegal announced her bid, he bid $20,000. The court clerk checked to make certain Mr. Martin had prepared the required bid information sheet for the clerk’s office. After confirming that Mr. Martin was qualified to bid, the clerk gave ample opportunity for another bid and then announced: “$20,000.00 going once, $20,000.00 going twice, sold to Harley —.” Just after the clerk announced, “Sold,” the paralegal screamed: “Stop, I have another bid,” or “Stop, I’m sorry I made a mistake.” When Mr. Martin indicated that he was content to keep his new home, the clerk took the matter to a circuit court judge. After confirming that the clerk had announced, “sold,” the judge ordered the clerk to issue the certificate of sale. Issue: Could the judicial sale be set aside on the basis of Wells Fargo’s unilateral mistake? Decision: The unilateral mistake did not entitle Wells Fargo to relief from the judicial sale. Reason: Altenbernd, J. The general rule is that, standing alone, mere inadequacy of price is not a ground for setting aside a judicial sale. But where the inadequacy is gross and is shown to result from any mistake, accident, surprise, fraud, misconduct, or irregularity upon the part of

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either the purchaser or other person connected with the sale, with resulting injustice to the complaining party, equity will act to prevent the wrong result. The failure of a party to take the required steps necessary to protect its own interests, cannot, standing alone, be grounds to vacate judicially authorized acts to the detriment of other innocent parties. The law requires certain diligence of those subject to it, and this diligence cannot be lightly excused.

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Ethics Spotlight: Proving Fraud The elements of fraud are discussed.

The Court Speaks: Wilson v. Western National Life Insurance Co. Facts: On October 8, 1985, Gil Cantrell, an agent for Western, met with Doris and Daniel Wilson to take their application for life insurance. Cantrell asked questions of the Wilsons and recorded their responses on a written application form. Both of the Wilsons signed the application. The Wilsons concealed the fact that Daniel Wilson had a heroine overdose in 1985. Daniel Wilson died from a drug overdose on October 10, two days after he and his wife signed the application. Western refused to pay the death benefit, alleging, among other things, a failure to disclose an incident on August 13, 1985, when Daniel fainted from a narcotic overdose and received hospital treatment. Issue: Did concealment of a material fact justify rescission of the life insurance policy? Decision: The concealment of the heroine overdose in 1985 justified rescission of the policy.

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Reason: Stone, J. Concealment, whether intentional or unintentional, entitles the injured party to rescind insurance. If a representation is false in a material point, whether affirmative or promissory, the injured party is entitled to rescind the contract from the time the representation becomes false. The only evidence before the court was that the Wilsons made misrepresentations, and those misrepresentations were material. Western properly rescinded the insurance contract and its obligation to provide coverage terminated as of the date of application.

Void Voidable Voidable Varies Voidable Generally voidable

000 in punitive damages? Decision: Yes. Crane had told the Krysa that the truck would tow their trailer. Here there was also a finding of intent to deceive and also affirmative misrepresentation of the condition of the truck. The truck was not able to tow the trailer after two miles without smoke pouring out of the back of the truck while using a lot of oil. Payne appealed the punitive damages. fraudulent misrepresentation. Krysa could not find a satisfactory substitute.Genuineness of Assent and Statute of Frauds 189 The Court speaks: Krysa v. Upon suit by the Krysas.” A number of things went wrong with the truck in a relatively short time. The potential physical damages here were so great that merely using a ratio of punitive damages to actual damages was not enough and $500. after a test drive. a used car salesman for Payne. recklessly disregarding the Krysas’ and the public’s safety.000 miles. Payne Facts: While shopping for a truck to pull their trailer. . Reason: Payne sold a vehicle that he knew or should have known was unsafe. Evidence showed that the truck was really two halves of different trucks welded together. A CAR FAX report eventually showed 13 prior owners. would make it to 400. Payne told Krysa that he would credit what was paid toward another purchase but would not return the money. The award was justified. Issue: Did Payne engage in fraudulent nondisclosure. the Krysas. and was a “one-owner trade-in.000 in punitive damages.449 in compensatory damages and $500. the jury returned a verdict awarding the Krysas $18. An expert said it was unsafe. and reckless disregard for the safety of the Krysas and the public to support the award of $500.000 (27:1) was justified. The Krysas noticed that a window had been replaced and that there was glass on the floor. purchased one from Crane.

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. Ethics Spotlight: Economic Duress This usually occurs when one party refuses to perform contractual duties unless the other party increases the price and enters into a second contract. Disproportionate gifts made under unusual circumstances can cause undue influence to be inferred. Inc. The Bible Speaks. Inc. v.Genuineness of Assent and Statute of Frauds 191 Ethics Spotlight: Undue Influence Undue influence can be exercised indirectly and in secret ways. See Rich & Whillock. Ashton Development. Some undue influence was found and some not in Dorydenas v.

which Donald Warner testified was. J. the Suttons were required to make all mortgage payments and real estate tax payments. In July 1988. The Molimo Street property. the fair rental value of the property. In addition. and in a second property located in the Russian River area of California. Donald Warner. desire to retain the Russian River property. Donald Warner proposed that the Suttons purchase the residence so that the estate could be settled.000. Arlene Warner inherited a one-third interest in a home at 101 Molimo Street in San Francisco.000. the Warner’s offered. could not support a loan in that amount by itself. they were to have five years to purchase the home after the Warner’s obtained a loan necessary to acquire the two properties. . having a value of approximately $185. The Suttons did not dispute the value of the property.000.000. the value of the property rose to somewhere between $250. the Warner’s were not to have to make any payments on the Molimo Street property. In order to obtain full title to both properties.000 loan.000 and $320. Through 1988. to sell the property to the Suttons for $250. through counsel. She and her husband. In January 1984. but sought to purchase for the previously agreed on $185. the Warners bought out the other heirs. According to the Suttons. The property was transferred out of the estate to Arlene Warner after April 1984. They could not afford the payments on that mortgage and therefore sought assistance from others. which required them to obtain a loan for $170. Donald Warner and Kenneth Sutton were friends. under the terms of this agreement. They did. which they contended was less than its fair market value. Therefore. In sum. had no interest in retaining the Molimo Street property. Reason: Kline.000. Issue: Was this oral contract enforceable under the Statute of Frauds? Decision: The doctrine of part performance applied to not prevent enforcement of this oral contract to sell real estate.000 down payment towards the purchase price of $185. Meanwhile. Warner Facts: In 1983. Warner suggested to Sutton in October of 1983 that the Suttons rent the Molimo Street property. however. The doctrine of part performance by the purchaser is a well-recognized exception to the Statute of Frauds as applied to contracts for the sale or lease of real property. coincidentally. the Suttons continued to pay rent in the amount of the mortgage payments. the Warner’s intended to pledge both properties as collateral for the $170. His proposal included a $15.000.192 Chapter 12 The Court Speaks: Sutton v. The Suttons became tenants and made all rent payments in cash.

the Suttons made a $15. After entering the oral agreement. The actions taken by the Suttons in reliance upon the oral agreement. . when considered together with the Warner’s’ admission that there was an agreement of some duration. Collateral Promises: One person agrees to answer for the debt of another. satisfy both elements of the part performance doctrine—evidence of the existence of the oral contract on the terms found by the court and reliance by the Suttons upon that contract warranting specific performance relief. Must be secondary to require a writing. They reimbursed the Warner’s for property taxes in the sum of $800 every six months. The question here is whether the continued possession of the property by the Suttons and their other actions are sufficiently related to the parol option contract to constitute part performance.Genuineness of Assent and Statute of Frauds 193 Under the doctrine of part performance. If main purpose is pecuniary benefit to guarantor. or makes valuable and substantial improvements on the property.000 loan. Original contract does not fall under this rule. then no writing required.000 down payment and increased their monthly payments to the Warner’s from the original $1. Must be in writing.000 per month rental payment to payments in the precise amount of the variable mortgage payments due under the $170. in reliance on the oral agreement. the oral agreement for the transfer of an interest in real property is enforced when the buyer has taken possession of the property and either makes a full or partial payment of the purchase price.

194 Chapter 12 Ethics Spotlight: An Oral Contract Isn’t Worth the Paper It’s Written On This discusses why businesses should not deal in oral contracts. .

Genuineness of Assent and Statute of Frauds 195 Interpreting Contract Words and Terms There are standards of interpretation where parties have not defined the words and terms in a contract. . See the rules listed in the chapter.

Generally in such cases. In this case.App. Steele v. the estate cannot rescind the contract based on its unilateral mistake. or (3) the mistake is so serious as to make enforcement of the contract unconscionable.196 Chapter 12 Integration clause expressly reiterates the Parole Evidence Rule International Law: Signatures in Foreign Countries This illustrates the broad definition of “signature”. Unilateral Mistake 12. No. The due diligence necessary will not be lightly excused. Generally. Yes.1. 1988). Goettee. the statement about the size of the property was not the essence of the contract and the purchasers committed no fraud or negligent misrepresentation to justify rescission. the contract is voidable by either party if enforcement would be materially more onerous to that party than it would have been had the facts been as the parties .2d 847 (Md. A mutual mistake occurs where both parties to a contract are mistaken as to a fact assumed by them as the basis upon which they agreed. The court held that the rescission based on the defendant’s unilateral mistake was not warranted. the mistaken party will not be permitted to rescind the contract unless (1) the other party knew of the mistake.2 Since Schultz could have checked the zoning ordinances but didn’t. Answers to Critical Thinking Cases Unilateral Mistake 12. The parties agreed to purchase the lot for a lump sum and the contract fully expressed their intentions. Beachcomber can rescind the contract. A unilateral mistake occurs when only one party to a contract is mistaken about a material fact regarding the subject matter of the contract. (2) the mistake is a result of a clerical or mathematical error not the result of gross negligence.3. 542 A. III. this is a case of unilateral mistake and the contract will probably not be rescinded. Mutual Mistake 12.

Deupree had an obligation to disclose his knowledge of those impediments at the time he took their money and such failure amounted to fraud. Deupree v. 182 Cal. Therefore. The Butners win and may recover for fraud against Deupree. McClure.5. the court found ample evidence to support a finding of intentional fraud and justifiable reliance. (2) knowledge that the statement was false. it is undisputed that both parties believed that the coin was genuine.App. Knowing the problematic nature of the business records. v. 522 So. The court awarded compensatory and punitive damages for fraud in the inducement.000 in net income. The price asked and paid was based directly on that assumption. negligent failure of a party to know or to discover the facts to which both parties are mistaken does not preclude rescission. and that Campbell relied upon the warranty in purchasing the business. There was no assumption of the risk that the coin might not be genuine.4. expert testimony established that the business records were misleading. and also granted rescission of the contract. 1988). . and Beachcomber was entitled to rescission of the contract.App. McClure allowed Campbell to believe such representation. and the particular circumstances of each case. McClure signed the escrow instructions which guaranteed the accuracy of his sales brochure while also admitting on the stand that he knew the business did not make as much money as he represented. The court determined that Deupree stood in a special relationship to the Butners. and that they relied upon Deupree.2d 242 (Ala. 227 Cal. Campbell v.3d 806. Butner testified that he would not have closed on the town home contract if Deupree had disclosed the problems he was having getting the boat slips approved.2d 78 (N. Campbell would not have bought the business unless he was assured that the business generated at least $150. the lower court holding was reversed. In this case. Beachcomber Coins. the court held McClure made the warranty to induce Campbell to buy the business by deceiving him as to the size of the profits. Moreover. Boskett. Suppression of a material fact that a party is under an obligation to communicate constitutes fraudulent concealment. 450 (Cal. who had no knowledge of any impediments. Butner. Inc. Accordingly. 1986). 1979). 400 A. the relative knowledge of the parties. The essential elements of fraud are (1) a false statement. with no reasonable basis to conclude it was true. and (4) actual reliance resulting in damage.J. Both parties were laboring under the same misapprehension as to this particular essential fact. Campbell wins and may recover damages from McClure for fraud. Fraud 12. Fraud 12. This obligation depends on the relation of the parties. entitling the Butners to damages. Moreover. the value of the particular fact. Mr.Rptr. Accordingly. In this case.Genuineness of Assent and Statute of Frauds 197 believed them to be. that when he made the warranty McClure knew it was false and had no reasonable grounds to conclude it was true. Here. (3) intent that the statement induced another to act in reliance thereon.

Yost innocently. The court found that Conrad was subject to the influence of Lawrence. Moreover. Schaneman v. There is probably. the innocent party (Rieve) can rescind the contract. The court held this was sufficient to establish a prima facie case of undue influence and that Lawrence had the burden of going forward with the evidence. The Statute of Frauds provides that oral contracts for the sale of land are invalid unless in writing. Pursuant to the Statute of Frauds. not enough to rescind the contract.9.2d 412 (Neb. Duress occurs when one party threatens to do some wrongful act unless the other party enters into a contract. Hoffman v. The threat to hold back her clothes might in a minor way. the court stated that one of the most important elements in determining whether this presumption can be rebutted is whether the grantor received independent counsel. or if and how the note was to be secured. The Sacketts win. 628 P. Yes. Schaneman. that there was a disposition on the part of Lawrence to exercise such undue influence. the contract may . Since this is an innocent misrepresentation. an agreement for the sale of real property is invalid unless the agreement or some note or memorandum thereof be in writing and subscribed by the party to be charged.2d 218 (Idaho 1981). the court affirmed the judgment of the lower court denying specific performance of the oral agreement between the parties. Undue Influence 12. Sun Valley Company. however. so as to render recession inequitable and unjust. however.10. Statute of Frauds 12. made an assertion that was not in accord with the facts.198 Chapter 12 Innocent Misrepresentation 12. Where. the amount of the installment payments.6 Innocent misrepresentation is not fraud. 1980). the party seeking to enforce the conveyance has partially performed the contract. the letter sent by Hoffman was not sufficient to constitute a memorandum. In this case. Hoffman and Frey do not win. who was acting in a confidential relationship. according to the evidence. Moreover. It did not evidence the maturity date of the note. Duress 12. that the opportunity to exercise undue influence existed. Real Property 12.W. Failure to comply with the Statute of Frauds renders an oral agreement unenforceable both in an action at law for damages and in a suit in equity for specific performance.8.7 The threat of a civil lawsuit does not constitute duress. the court found that it was apparent that Conrad was not afforded the opportunity to seek independent advice from any source other than Lawrence. In affirming the lower court’s judgment in favor of the conservator. the conservator of the estate can cancel the deed transferring the farm to Lawrence. 291 N. and that the conveyance appeared to be the effect of such influence. Accordingly. a point of beginning for the installment payments. the lot sale agreement was never signed by Sun Valley.

418 A. 1980) One-Year Contract 12. First Interstate Bank of Idaho. the judgment in favor of the Sacketts was affirmed. Oral contracts that are not capable of being performed within one year are unenforceable unless in writing. Sackett. sought rent. that a guarantee for the debt of another had to be in writing. specific performance will be granted.11. Mr. Under these circumstances. Ohanian’s best efforts to increase sales. Mr. where either party under the contract may rightfully terminate within a year. checked on the condition of the home. For example. resulting in the closing by AVIS of its Northeast operations. 779 F.12. the court agreed with the lower court that there was sufficient evidence of part performance of the oral contract to render it specifically enforceable.Genuineness of Assent and Statute of Frauds 199 be outside of the statute. The court held that the oral agreement for lifetime employment could have been terminated within one year without any breach by Ohanian and is therefore not barred by the Statute of Frauds. West because the bank was in the business of making loans to its customers on a regular basis and knew. The Supreme Court of Idaho. In this case. v. the court held that there was no meeting of the minds between the West’s and the bank. a court will consider the amount of time that has passed before the vendee’s possession was challenged.2d 1053 (Idaho 1984). Avis Rent a Car System. Accordingly. or where other equitable considerations are present. the Wests are not liable on the guaranty contract. during the 14 years the Sacketts inhabited the home on Orchard Drive. This rule is meant to prevent injustice that might result either from a faulty memory or the absence of a witness who might have died or moved. N. This factor is considered because it would be inequitable to aid one who induced another’s detrimental reliance by his failure to promptly pursue his rights. West’s statements and applied the doctrine of equitable estoppel to find that the West’s were liable under the guarantee. or otherwise asserted any interest in the property. held that the bank could not have relied on the oral statements made by Mr. Thus. In this case. No. In this case. . 1985). Among the relevant equitable considerations that may justify specific performance.2d 101 (2nd Cir. however.App. the contract is outside the Statute of Frauds. where it appears that a vendee has taken continuous and exclusive possession under the contract and has made improvements. Robert Briggs never visited. despite Mr. or should have known. Ohanian v. 693 P. the lower court found that the bank reasonably relied on Mr.A. It is well settled that an agreement to guarantee the debt of another must be in writing. Ohanian wins. Briggs v. However.. pursuant to New York law.2d 586 (Pa. Moreover. Ohanian could have been terminated for just cause within a year. adverse market conditions may have motivated a change in business strategy. Guaranty Contract 12. and without such a meeting of the minds. the court held that the bank simply jumped the gun in giving Brown the loan and that the West’s were not liable as guarantors on the loan. Inc. Thus. West. there is no enforceable contract.

App. Accordingly.App. In this case Feiler’s promise was secondary and was not to offer a benefit to himself so it must be in writing and since it was not.. v. It would be inequitable to allow it to do so.15. there is a valid and enforceable contract and Knight is not correct. 1984). Sufficiency of Writing 12.200 Chapter 12 Guaranty Contract 12.13. then rescission can occur. Barber Contracting Co. 2d 717 (Ga. In order to overcome the Statute of Frauds. detrimental change of position in reliance on the contract. The main purpose was not to grant a pecuniary benefit so the main purpose exception does not apply. the court held that Solondz could not claim the Statute of Frauds as a defense to the enforcement of his oral agreement. the doctrine of promissory estoppel prevents the application of the Statute of Frauds in this case. Solondz. Inc.2d 720 (S. IV.17.328 in value. Yes. 320 S. Since the memorandum including all the necessary terms of the deal was initialed or signed. it ordered 300 ounces of silver for which it paid a considerable sum. 1989)..14.E. Feiler does not have to pay. Therefore. As a general rule. Barber wins. Note. and that no remedy except enforcement of the bargain is adequate to restore his former position. Since the lease for a service station must be in writing and there is no such writing.16. The court held that Atlantic suffered a detrimental change in position because. 377 S. When one person agrees to answer for the debt of another if the primarily liable person fails to perform. It is not sufficient to merely show that he lost an expected benefit under the contract. one cannot rescind based on a unilateral mistake. Atlantic lost more than an expected benefit in reliance on Solondz’s word. Because the value of silver declined by $8. substantial. The church had not yet acted upon the bids. Atlantic Wholesale Co. . Barber notified the church immediately upon discovering the error. the guarantor’s liability is secondary and must be in writing under the Statute of Frauds. First Baptist Church of Moultrie v. neither Marks nor Gulf are liable. based on its oral agreement with Solondz. the party asserting estoppel must show that he has suffered a definite. there was no harm to the church.C. a specific type of signature is not required nor is there a specifically required location for the signature on the document. it only lost what it attempted to gain by taking advantage of another’s mistake. but if the mistake was innocent and rescission would have no adverse effect on the mistaken party. Answers to Ethics Cases 12.E. Promissory Estoppel 12. Agent’s Contract 12.

she was promised an exclusive agent. But if there is clear and convincing proof of part performance an exception to the writing requirement makes the oral promise enforceable. . Court of Appeals 2. provided consideration for the father’s promise creating an oral contract. 545 A. the part performance exception applies. 12. With the first two. 1988). wrongful death.” B. Key Facts A. C. Federal Express Corp. Under federal common law. The oral contract is enforceable without a writing. and Court Hampton v. They acted in their own best interests without any regard for Sulzer. Answer to “Briefing the Case” Writing Assignment 1. E. 5. D. so legally Lockheed should win. The samples were never received. They were granted &100 and they appealed.Genuineness of Assent and Statute of Frauds 201 12. Lockheed did not act ethically. Holding Yes. as required. “a common carrier may not exempt itself from liability for negligence but may limit the liability. Because of the son’s performance. Affirmed for the son. Legally. Citation. Since there is no written contract. 3. V. there is no enforceable contract. he used their services and therefore should pay them but has found a loophole.S. The lie was certainly unethical.20. Mozzetti. Case Name. and thus. Issue Can a carrier limit its liability for damages in a contract? 4. B. 917 F. Neither requirement is met by the father’s oral promise. There was a contract with a clear limitation of liability that was not raised. She may not have wanted to deal with others. There was a contract with Federal Express with a $100 limitation of liability which was not raised ever though an opportunity to do so was present. The transplant did not happen and the child died. As to Tiegs.19. and loss of services. Court’s Reasoning A. There was also no indication of a mistake by Sulzer. 12. A child was awaiting a bone marrow transplant and 5 samples were sent by the hospital. Judgment was affirmed. Shepard v. Delaware law requires both an interest in land and a testamentary disposition to be in writing. ABC did not act ethically as to either Blye or Sklar or Tiegs. The Hamptons sued federal Express for personal injury.18 It is obvious that under most theories of ethics. Lockheed did not know for sure why Sulzer’s bid was so low.2d 621 (Del. The evidence clearly shows that the son fully performed his obligation.2d 1119 (1990) U.

202 Chapter 12 C. . Federal Express did not know the package contents and could not reasonably foresee the injury.

canceled. Other examples of third party donee beneficiaries can be found in trusts and contracts to make a will. talking about assignments and the like represents “the wall” to many students. Insurance contracts are good examples of these. or rescinded without his consent. The donee beneficiary contract is probably the one most students will be familiar with and most likely to be a participant in. this relationship may act as the basis for a second contract where the named creditor beneficiary may be protected as an intended . to an often open-ended and obtuse discussion of the minutiae of assignment as opposed to presenting the big picture. Then use a diagram on the board to illustrate some of the key aspects of assignment and novation. such as credit or commodity trading transactions. In this section you can possibly first give an overview of why third parties get involved. And if his rights have vested under the contract. Contracts with third party involvement from the beginning are generically labeled intended beneficiary contracts. All in all. Over and over again. use of examples really helps the students. This difficulty makes it especially important to have a good game plan going into the class session. This chapter has four essential subparts to it: third party involvement ab initio. Not to have one leaves you open. student feedback identifies the materials on after-formation introduction of third parties as the most difficult concept to grasp. In this part of the presentation. the more examples you use to illustrate these points. When there is a preexisting debtor/creditor relationship. Maybe remind students of notice duties between the old and new parties to the contract. Teacher to Teacher Dialogue While it is relatively easy to talk about intended beneficiaries. it might be wise to discuss intended beneficiaries first. Due to the difficulty of this topic. Third parties can become involved in a contract ab initio (from its inception) or after the fact. The insured child becomes a third party intended (donee) contract beneficiary. the role of conditions. the contract cannot be altered. the better. The second category of intended third party beneficiaries is found in the law of creditors rights. Moving on to afterformation third party involvement and a review of performance obligations might work next.Third-Party Rights and Discharge 203 Chapter 13 Third-Party Rights and Discharge Who Else Has Rights In The Contract? I. third party involvement after formation. as an instructor. These contracts are broken down to into two subcategories: donee and creditor. and discharge of performance.

what are the covenants entered into before performance is to be initiated? Were there any conditions that may affect the rights and duties of the parties to contract? Conditions are certain events that have a triggering effect on the obligations of contract. For example. with no standing to sue. Most contracts are completed legally when the parties have lived up to their reciprocal obligations under that contract. during the contract. meaning new. Consider the world of finance. and the like. and postcontract. is not really a category of intended beneficiaries at all. In a novation.204 Chapter 13 beneficiary. derived from the Latin nova. Consider an escrow where a third party is used as a holder of property and is instructed to act vis-à-vis that property only upon satisfaction of mutually dependent acts of third parties. This is a common form of property transfer used in the sale of real estate. In assignment. dealing with incidental beneficiaries. There are certain circumstances that will act to excuse nonperformance. The most common example is found in the assumption of mortgage obligations. In these forms of after-formation involvement of third parties. C. For example: “I will buy this car if my mechanic signs off on the engine inspection. These circumstances are also based in common sense. unless he or she can show that he belongs to a class for whose primary and immediate benefit the government contract was made. Public policy in the law of contracts favors the transferability of contract rights and duties. Compare this with a novation. The third category. The law is very straightforward on this point: if you do not qualify as an intended beneficiary based on donee or creditor grounds. A precondition or condition precedent calls for the event to take place before the contract goes into effect. The rules of performance and breach of contract are rooted in common sense. This party becomes involved by way of assignment or novation.” A concurrent condition calls for two or more events to coincide in time. The escrow holds the deed to the property from the seller until the buyer has delivered the purchase price in a form acceptable to both parties. The timing of conditions can be superimposed upon the contract. the original contract with A and B is ended when a new contract is entered into between one of the original parties and a new party. . Ordinarily. Conversely. If those obligations are not met. but subsequent events have made its enforcement illegal. The evaluation process of contract performance issues is best broken down into time sequence subparts: precontract. The second category of third party involvement in contracts is the introduction of a third party after the contract already was formed. a breach is found when a failure of performance is not somehow excused by law. one of the original parties transfers rights or duties to a new third party participant. breach of contract is the result. the law of assignment is far more important. The second objective of this chapter is to introduce students to the concept of performance obligations and discharge from contracts. A condition subsequent is found where performance may be excused by a certain event after the contract was entered into. commodities. a parolee is allowed to stay out of prison as long as the conditions of the parole release are met. We are expected to live up to our performance obligations and no more. Can it really be reasonable to expect personal service contracts to be enforced after death or disability? Or does it make sense to accept performance after destruction of a unique subject matter of the contract? A third form of excuse is found in subsequent illegality. a taxpayer who objects to these contracts is classified as an incidental beneficiary. even though B has not paid for or been a signatory to the insurance policy between A and his or her insurance company. courts will no longer enforce its performance covenants based upon the new illegality. you are classified as an incidental beneficiary and will not have any legally recognized standing to sue for protection under the contract. and the car is used as collateral for the loan. suppose A borrows money from B to buy a car. For example. All of these commercially critical practices are facilitated by the transfer of contract rights from one person or business entity to another. In precontract issues. If a contract was legal at the time it was formed. B can now be named as a loss-payee (a person named in the policy to be paid in case of loss) up to the amount owed. There is one minor exception to this rule in certain government contracts.

Third-Party Rights and Discharge 205 In addition to excused nonperformance. however. Discharges by acts of the parties are voluntary postcontract formation events such as mutual recission. or performed. excused. In an operation of law discharge. or novation. something has happened where the court steps in and declares that this contract performance obligation can no longer be enforced. In both cases. in effect. the parties have. In all these scenarios. reformation. accord and satisfaction. and the absolute duty to perform has been breached. Examples of such legal impediments to enforcement would include the running of a statute of limitation or bankruptcy. Text Materials Debtor Assignor Assignee Stands in the shoes of assignor . the contract duty has not been discharged. If. a substituted contract. there are a number of possible circumstances that may result in a discharge from any further contractual performance. reentered the bargaining and created a new deal. any further performance under the contract has been legally ended. Third-Parties to Contracts Beneficiaries Donee Creditor Incidental Assignment II. one must examine what remedies are available to the nonbreaching party. These fall into two main categories: discharge by acts of the parties or by operation of law.

206 Chapter 13 .

The U.Third-Party Rights and Discharge 207 Also include antiassignment clauses where valid. AFS brought suit against Prime Retail. . Issue: Does the assignment by a tenant of legal claims against a landlord violate public policy? Is it therefore illegal? Decision/Remedy: Yes.S. District court dismissed the case. Decision was affirmed. Prime Retail Facts: AFS conducted an audit of Prime Retail. The tenant lost the right to not bring suit even if they thought there was no course of action. a landlord. Reason: AFS really became a promoter of litigation. on behalf of tenants that had signed assignment agreements granting AFS the right to file suit on their behalf. The Court Speaks: Accrued Financial v.

Ethics Spotlight: Successive Assignments of the Same Right If an obligee fraudulently or mistakenly makes successive assignments of the same right to a number of assignees. . obligor can continue to deliver performance to the assignor. which assignee has the legal right to the assigned right? This explains the rules that are applied.208 Chapter 13 Assignee must notify obligor. If not.

Delegator remains liable Also include antidelegation clauses .Third-Party Rights and Discharge 209 Note: .

His foul call in the closing minutes of a game eliminated Iowa from the Big Ten championship. The Gillispies. Neither Bain nor the Big Ten intended the Gillispies to be a third-party donee beneficiary. nor was any obligation owed to the Gillispies by either party making the Gillispies a creditor beneficiary. . Reason: The parties to the contract must intend the third party to receive a benefit that is enforceable in court. sued Bain for damages they incurred because of lost revenue due to his alleged negligent foul call.Donee beneficiary can sue promisor agreeing to perform Creditor: (debt) . Gillispie Facts: Bain had a contract with the Big Ten to officiate games. The lower court decided for Bain.No rights The Court Speaks: Bain v. the owners of a novelty shop. Issue: Were the Gillispies intended third-party beneficiaries of Bain’s contract with the Big Ten? Decision: Bain wins. Therefore.Creditor beneficiary can sue debtor or promisor Incidental: . and the Gillispies appealed.210 Chapter 13 Donee: (gift) . the Gillispies are third-party incidental beneficiaries who cannot enforce the contract.

Third-Party Rights and Discharge 211 Tests for Conditions Precedent 1) personal satisfaction: subjective and in good faith 2) reasonable person: objective Also include agreed upon face majeure clauses. Even though he was not progressing. Inc. Arthur Murray. Facts: Parker contracted with Arthur Murray for dance lessons. Discharge by agreement: 1) mutual rescission: both enter into new agreement terminating the first 2) substituted contract: new contract revokes and discharges prior one 3) novation: substitution of a party 4) accord and satisfaction: accepting different consideration The Court Speaks: Parker v. The contracts contained noncancellation and no-refund clauses. Parker was injured in an accident and . he was encouraged to enter into additional contracts that required prepayment.

Reason: Arthur Murray claims that the general rule on impossibility does not apply here because the clauses of the contracts indicated the intent of the parties to waive the rights of excuse because of impossibility. He sued for return of his prepayments. The liability to a third party is also a matter of policy involving the balancing of many factors. and the policy of preventing future harm . intent to benefit a third person must be shown. It is a legal favor. they are construed in favor of Parker. that the damage to the plaintiff was foreseeable. It is not meant to be a back door out for every deal that goes sour. Entrepreneur and the Law: Force Majeure Clauses Parties may agree in their contract that certain events. the court found that the main purpose of the transaction between the defendant and the testator was to provide for the transfer of property to the plaintiff. Inc. However. and one should never rely on it as an initial course of action. III. will excuse nonperformance of the contract. The court concluded that if persons such as the plaintiff were not permitted to recover for such negligence. and the like. not an entitlement. no specific manifestation of such intent is required. It is necessary because there are so many variables in the world of commercial trade. Since the clauses are ambiguous on this point and were drafted by Arthur Murray. I remind students that courts are reluctant to use this doctrine. It is sufficient that the promisor understood that the promisee had such intent.1. The trial court decided for Parker. Thus. Cargill. Such factors included the extent to which the transaction was intended to affect the plaintiff. Contemporary Issue: Commercial Impracticability Modern contract law recognizes that. such as labor strikes. no one would be able to do so. the court stated that nothing indicates that Parker intended to waive the specific right by the general language of the clauses. an economic equity bailout to be used only extreme or unexpected situations.212 Chapter 13 was unable to continue the lessons. sometimes. we see the need for the commercial impossibility doctrine. in effect. Moreover. enforcement by persons who are only incidentally or remotely benefited is not permissible. closeness of the connection between the defendant’s conduct and the injury suffered. and that it was certain that upon the testator’s death the plaintiff would have received the property contemplated. But. Commercial impracticability is a necessary yet difficult concept to teach in contract law.000 from Hamm. These variables make it difficult to write a totally comprehensive instrument that can take all the possible scenarios into account when writing up the contract in the first place. the degree of certainty that plaintiff suffered injury. Generally. the foreseeability of harm to him. absent negligence of the defendant. unforeseen circumstances make the performance of a contract highly impracticable or very expenses and excuses nonperformance in certain circumstances. since they do not specifically provide for waiver of the right of excuse due to impossibility. In this case. The doctrine is. See Alimenta v. contracts made expressly for the benefit of a third person are enforceable. and prevention of future harms. Parker did not waive that right and may enforce it rescinding the contracts. shortages of raw materials. Answers to Critical Thinking Cases Third-Party Beneficiary 13. Lucas wins and may recover the $75. Therefore. Issue: Does impossibility excuse Parker and allow him to rescind the contract? Decision: Parker wins. and Arthur Murray appealed. These are called force majeure clauses.

Munchak Corporation v. Bank of America. Hamm. No. His ability to undertake the construction project was merely incidental to the construction loan agreement between Boussiacos and B of A. 457 F. In this case. the court held that Sofias was only an incidental beneficiary to the agreement between Boussiacos and B of A and could not maintain a suit against B of A.2d 685. The Pillsbury Company wins. .Third-Party Rights and Discharge 213 would be impaired. Sofias cannot sue Bank of America for breach of contract. It is well settled that personal service contracts. the court held that the contract was assignable to the new owners under the facts presented. can recover as a third-party beneficiary. the court found that the rendition of services by Cunningham could not have been affected by the personalities of successive corporate owners. Cunningham. Accordingly.2. including distributorship agreements. Berlinger Foods Corporation v.2d 583. Assignment 13. the court held that the oral contract between Pillsbury and Berlinger was a personal service contract and was therefore not assignable. who loses his testamentary rights because of the failure of an attorney to properly draft that will. The court stated that it would defy common sense to require a manufacturer to leave the distribution of its products to a distributor under the control of a competitor or potential competitor. However. The Pillsbury Company. Sofias was not a party to the contract with B of A and was not an intended beneficiary of the agreement. Yes. Third-Party Beneficiary 13. 633 F. Accordingly.2d 721 (4th Cir.App. Assignment 13. 56 Cal. 1985). However. the court held that the intended beneficiary of a will.4.App. In this case. 626 (Cal. 172 Cal. 218 Cal. 557 (D. Lucas v. a contract made expressly for the benefit of a third party may be enforced by that party. In this case. 1961).3d 583.3.Md. Accordingly. 1986). the third party must show that the contract clearly manifested an intent to benefit that party. 364 P. No benefit flowed directly to Sofias by virtue of the contract. which are silent regarding assignment.Rptr. a personal service contract requiring special skills and based upon the personal relationship between the parties cannot be assigned without the consent of the party rendering the services. where the character of the performance will not be changed. Generally. Sofias v. cannot be assigned without the prior consent of the other party.Supp. Cunningham was not obligated to perform differently for the plaintiffs than he was for the Southern Sports Club. Accordingly. the court held that the Pillsbury Company rightfully terminated the distributor agreement with Berlinger. Cunningham’s contract was validly assigned to the new owners. The policy against assignability of personal service contracts is to prohibit an assignment in which the obligor undertakes to serve only the original obligee. 1972). such contracts are assignable. 15 Cal. Generally.Rptr. 821 (Cal.

A general assignment of the contract will assign the rights and delegate the performance of the duties of the assignor. Condition 13. When a contract prohibits assignment in very specific and unmistakable terms.App. Accordingly. McKinnie v. or impair materially his chance of obtaining return performance. No. In order to properly shift the risk to the subcontractor. In this case. In most subcontract agreements. 627 P. or claims thereof. 531 So.7. the subcontract must unambiguously express such an intention. any assignment will be void. . PEPCo cannot maintain the lawsuit against the City of Vancouver. In this case. Inc.W. In Texas. Accordingly. Generally.6. 1980). City of Vancouver. Pace Construction Corporation v. a party to a contract may perform his duty through a delegate by assigning or transferring the contract to a third party unless the other party has a substantial interest in having his original promisor perform or control the acts required by the contract. Stewart was permitted to delegate his duty of making the horse available to Milford and that McKinnie’s acceptance. contract rights are assignable absent prohibition by statute or contract. 1988). Pace wins the lawsuit and does not have to pay OBS.. In this case. the subcontract clearly states that payment from the owner shall be a condition precedent to the contractor’s obligation to make final payment to the subcontractor. Portland Electric and Plumbing Company v.2d 1350 (Wash.App. 1981). constitutes a promise by McKinnie to perform those duties.5. This promise is enforceable by either the assignor or the other party to the contract. against the City of Vancouver and that PEPCo’s claim was properly dismissed. the court held that Stewart’s promise is enforceable by Milford and that McKinnie must permit the stud services of Hired Chico as provided in the Milford-Stewart agreement. 597 S. Until a condition precedent is satisfied. with full knowledge of the contractual obligations. The primary purpose of a clause prohibiting assignment is to protect the contracting party’s right in selecting the person with whom he deals. if transfer will not change the nature of performance. the other terms of the contract are not enforceable. Moreover. Milford.2d 737 (Fla. and its acceptance by the assignee constitutes a promise by him to perform those duties. and McKinnie must permit the stud services of Hired Chico provided in the Milford-Stewart agreement. Delegation of Duties 13. even though the original buyer remains liable on the contract. the court held that the language in the contract was sufficient to prohibit any effective assignment of monies due. the court held that OBS must bear the risk of nonpayment by the owner. increase materially the burden of risk imposed on him by his contract.214 Chapter 13 Anti-assignment Clause 13. payment by the owner to the contractor is not intended to be a condition precedent to the contractor’s duty to pay the subcontractor. and the assignee becomes liable for the contractual performance of the original buyer. all rights of a buyer can be assigned except where the assignment would materially change the duty of the other party. the court found that because none of the above exceptions apply. Milford wins. OBS Company.2d 953 (Tex.

Inc. 2d 634 (Ill. v. are excused where the other party to the contract prevents performance of the contract. Inc. App. Under American law. 185 Cal. Barrows v. a third party beneficiary to a contract. can enforce its terms. 371. v. 422 N. 419 N. The Commonwealth of Massachusetts entered into two contracts with John J. Estate of Glueck. the construction of a parking lot concerns commercial quality and operative fitness rather than personal aesthetics.10. while they amount to a failure to perform a contract. 1981). C. 1981). Indiana Tri-City Plaza Bowl. 1986).App. IV: Answers to Ethics Cases 13.E. Pabagold. Glueck wins. Under the good faith standard. the court applied the reasonable person standard and held that Tri-City breached the agreement by unreasonably withholding approval. the Commonwealth of Massachusetts entered into an agreement where no further concrete barriers would be used in the project. Inc. This includes subjective satisfaction. or unreasonably. Citation. V: Answer to “Briefing the Case” Writing Assignment 1. operative fitness. v. Key Facts A. Case Name. or mechanical utility that other persons can judge. 603 (1991) Supreme Judicial Court of Massachusetts 2. Under the reasonable person standard. Barrows had sued for a commission on the net profits from a roofing contract. and can enforce the contract. Paonessa Co. capriciously. dissatisfaction cannot be claimed arbitrarily.3d 676.800 linear feet of concrete median barriers to be used in the project. Maco. The reasons for Pabagold’s decision not to pay are not clear and would not be ethically defensible without a very good explanation. John J.Rptr.App. Outdoor Services. Inc. Paonessa entered into a subcontract with Chase Precast Corp. This standard is employed when a contract involves commercial quality. 13. to resurface and improve two stretches of Route 128. Outdoor Services is a creditor beneficiary of an agreement between Pabagold and Mediasmith. Barrows wins. The good faith standard is employed when the contract involves personal aesthetics or fancy. dissatisfied and acts in good faith..9.. Inc. In this case. the recipient of the work performed must be genuinely satisfied. . Inc. to supply 25. such as the work performed was not acceptable.8. other than an incidental beneficiary.2d...E.Third-Party Rights and Discharge 215 Excuse of Condition 13.E. and Court Chase Precast Corp. Satisfaction is received if a reasonable person in exactly the same circumstances would be satisfied. even though unreasonably. To determine whether satisfaction has been received pursuant to a contract that conditions a party’s duty of performance upon his own satisfaction. Paonessa Co. courts will apply either a good faith standard or a reasonable person standard. Delays and nonperformance. The judgment of the arbitrator in Outdoor Services’ favor is affirmed. 409 Mass. Therefore.2d 670 (Ind. 566 N. B. although the mere statement by the recipient that he is dissatisfied is not conclusive. Due of objections by local residents. Most courts will recognize the recipient’s dissatisfaction only when he is honestly. 230 Cal. 73 (Cal.App.

Paonessa cancelled the remainder of its contract with Precast. destroys the object or purpose of the contract. There was no allocation in the contract for any lost profits that may arise out of this cancellation. thus destroying the value of performance. This doctrine excuses the parties from further performance. Court’s Reasoning The Supreme Judicial Court of Massachusetts held that: A. 5. The doctrine of frustration of purpose is used when an event neither party anticipated. Therefore. nor caused. D. half of the original number were already delivered to the site and had been paid for by Paonessa. and the appeals court affirmed that holding. The lower court held against Precast on the basis of impossibility of performance. the doctrine of frustration of purpose applied. E. Precast had experience with prior contracts with the Commonwealth of Massachusetts and was aware of its power to eliminate items or portions of supplies called for in the original contracts. . Holding Yes.216 Chapter 13 Approximately. E. D. the risk of which was not stipulated in the contract. 3. B. but held that the doctrine of frustration of purpose more accurately described the situation. Upon notification from the Commonwealth of its decision not to proceed with any further use of concrete barriers. Issue Does the doctrine of frustration of purpose apply in this case? 4. C. Precast sued Paonessa for its lost profits on the remainder of its original contract. Paonessa bore no responsibility for the Commonwealth’s decision not to order the original number of concrete barriers.

in effect. In addition. If the breach was not material or intentional. and replacement will cost $100. As noted in the prior chapter. the parties have. Putting a time-line on the steps of performance really helps students identify not only when the duty obligations are met. The failure to provide doors may be construed as only partial performance because of lack of security. reentered the bargaining and created a new deal. we are expected to live up to our performance obligations. accord and satisfaction. but also when a breach has taken place. reformation. There are a number of possible circumstances that may result in a discharge from any further performance. The remedy portion of this chapter could be broken down into the traditional law/equity dichotomy. 100 percent of the performance was not involved. In substantial performance. a breach of contract is often the result in the eyes of the law. contract obligations may have been met and breached with less than full performance. Discharge by acts of the parties in voluntary post contract formation might occur in many ways such as mutual rescission. In all of these scenarios. These fall into two main categories: discharge by acts of the parties or by operation of law.Remedies for Breach of Traditional and Online Contracts 217 Chapter 14 Remedies for Breach of Traditional and Online Contracts Why Can’t We Always Find Damages? I. the original contact can still be enforced less the price of the current doorknob. The first objective of this chapter is to introduce students to remedies in contract after a breach has taken place. Seeing how the conditions affect the ultimate rights of the parties also helps students formulate what remedies should be used in case of a breach. The nonbreaching party may then sue for rescission or recover damages. when. if a $100. An overview of the remedies available to the nonbreaching party in . and where the end comes to a contract is what this chapter is about. Teacher to Teacher Dialogue: How. and substituted contract. If these obligations are not met. or novation. Compare this with a house with no doors. For example. the nonbreaching party may sue for damages but not rescission.000 house has the wrong doorknob in it. Examples are usually helpful here.

e. The last category of remedies regards to contract-related torts. punitive damages are not granted for contract breach alone.000 in consequential damages to Mario. quasi-contract. the court might also grant punitive damages. tort damages may be applicable. A common example of rescission is found in return of deposit clauses in purchase contracts or in consumer protection statutes which provide for a three day cooling off period after a contact is signed. but if the bad faith involved shocks the conscience of the court. .218 Chapter 14 contract can be compared to the various directions posted on a map when your car had broken down. These statutes generally allow for a unilateral right of rescission within the three-day period by the buyer.. you must decide which options make the most sense to you.J. Another category of remedies involves going forward with the original terms of the agreement. if Mario had a deal with Zoomo Motors to buy a new car for $20. In this repair process. there is an attempt to provide the innocent party with a financial replacement for the benefits that he or she had under the original contract. For example. The next step is found in compensatory or actual damages.000 and had to buy a comparable model from Zamay Motors for $30. Equitable remedies are often found in modern day versions of specific performance. for $40.000 and Zoomo knew of this second contract. The other two paths available to the nonbreaching party are going backwards or going forward with the contract. One other damage measure possibility lies in the area of liquidation or agreed upon damages set by the parties. or do you need a tow to your original destination? By analogy. Think of monetary damages as an ascending staircase. The underlying theory is that the contract must somehow be enforced as a matter of equity and fair play rather than substituted by money alone. undo the contract. Because your trip has been brought to an abrupt halt. Zoomo may also be liable for an additional $10. Punitive damages are a form of court-imposed civil punishment.000. a court is asked to return the parties to their precontract position by way of rescission or restitution. These damages seek to restore the benefit of the bargain by providing a monetary substitute for what was lost due to the breach. the actual measure of compensatory damages would be $10. Normally. Nominal damages are applicable where there is little real economic consequence arising from the breach. A court will examine these damages to make sure that they are not a disguised penalty. In addition. had Zoomo’s breach been related to a bad faith tort within the contract setting. a court may grant punitive damages. and injunctive relief. or taken forward to their original destination (specific performance).000 due to Zoomo’s breach. the winner wins in principle but not in significant monetary terms. If Mario had a resale contract for the car to A. Do you try to go back where you started? Can the car be fixed where you are. fixed (damages or reformation). Where the contract is related to situations involving intentional interference with contract relations or breach of an implied covenant of good faith and fair dealing. These remedies are classified as equitable remedies because the breach cannot be adequately compensated by normal economic damage measures. contracts can be also brought back (rescission). i. In a nominal damage award. The majority of remedies provided by the courts for contract breach fall into the category of a repair by way of monetary damages. starting at the bottom with token or nominal damages and going all the way to punitive damages. In going backwards.

Text Materials Breach (Unexcused Nonperformance) Remedies Damages Others Equity Compensatory Rescission Restitution Specific Performance Consequential Reformation Liquidated Quasi Contract Nominal Injunction Punitive? .Remedies for Breach of Traditional and Online Contracts 219 II.

220 Chapter 14 .

Issue: Did West Publishing breach the author agreement it had with Chodos? Decision/Remedy: Yes.Remedies for Breach of Traditional and Online Contracts 221 The Court Speaks: Chodos v. In December 1998. 845 UN Limited Partnership Facts: Trump Tower holds luxury condos sold by 845UN which required a 25% nonrefundable down payment which were to be treated as liquidated damages. The Hakans believed this was an unenforceable penalty. West Publishing Facts: Chodos and Bancroft-Whitney (now merged with West Publishing) signed a publishing contract. even though the work was high quality. He spent considerable time away from his practice. or is it an unconscionable and unenforceable penalty? Decision: It was an enforceable liquidated damages clause.S. West assured Chodos of a 1st quarter 1999 publication. The final manuscript was declined in June. 845UN sent default letters and eventually kept the 25%. The trial court granted 845UN partial summary judgment for 10% and 845UN appealed. From July 1995 through June 1998 Chodos spent time writing the manuscript and working with the editors in developing and editing it. Donald Trump was the managing general partner of 845UN. . The decision was reversed and remanded to enter a summary judgment of liability for Chodos. Reason: West’s description of the manuscript as high quality and decision to not publish due to business reasons requires a decision of breach of contract as a matter of law. Chodos received West’s letter saying it would not publish the manuscript because of commercial reasons and business reasons. In February 1999. Cem and Hakan Uzan paid the 25% of their purchase price for 2 condos on the top floor over a 2 year period but after 9/11 feared additional possible terrorist attacks and asked for a rescission. Issue: Is the 25% nonrefundable down payment enforceable liquidated damages. Examples: Compensatory -Sale of goods: market price minus contract price at time of delivery -Construction: can include lost profits -Employment: costs to hire new employee plus increase in salary Consequential -Needs knowledge Liquidated -Cannot be a penalty The Court speaks: Uzan v. 1998. District Court granted summary judgment in favor of West in a suit by Chodos alleging breach of contract. U. Summary judgment was granted to 845UN.

They agreed upon what both thought was a fair figure. Therefore. The ship was delivered in March of 1982. Sun Ship appealed a trial court judgment for California and Hawaiian. Parker rejected the offer and sued to enforce the guaranteed compensation clause. The Court Speaks: Parker v. 1981 during the height of the harvest season. the value is enforceable. Twentieth Century notified Parker that the film would not be made but offered Parker a part in another movie to be made in Australia. and it is now difficult to measure what nonperformance did mean. The Court Speaks: California and Hawaiian Sugar Company v. This is also standard in the industry and the Hakan’s were fully aware of the details. Sun Ship. Fox appealed a judgment for Parker. the court will uphold the parties’ bargain and not substitute its own judgment. Inc. The ship was to be finished by June 30. The contract contained a liquidated damages clause providing that Sun Ship would pay a sum of $1700 a day for each day of nondelivery. Issue: Is this clause an unenforceable penalty clause? Decision: Affirmed for California and Hawaiian. it was critical to California and Hawaiian that the ship be done on time. and at the time of the contract. Twentieth Century-Fox Film Corporation Facts: Parker and Twentieth Century had a contract under which Parker was to star in a film to be made in Los Angeles for certain guaranteed compensation. Reason: Where sophisticated parties with bargain parity have agreed as to what nonperformance would mean.222 Chapter 14 Reason: The 25% was part of an arm’s-length negotiated deal to compensate for the substantial time between signing and closing. they knew what failure of performance might mean. At the time the parties bargained. Reason: The measure of damages for a wrongfully discharged employee is the amount the employee would have earned minus what the employee had earned during the time period and what the employee might have earned at comparable jobs if he had made a reasonable effort to . and California and Hawaiian sued to enforce the clause even though its actual damages had been much less. Issue: Did Parker fail to mitigate damages by rejecting the offer? Decision: Affirmed for Parker. Facts: California and Hawaiian contracted with Sun Ship to build a ship for transport of sugar cane.

subsequently. Patricia agreed to sell to Keith for $500 and she signed legal documents. The trial court found fraud and rescinded the contract but Patricia did not get attorneys’ fees. Joe told her he wanted her to sell her interests in the property to Keith (first cousin and son of Christine) and Sheila. . Parker has not failed to mitigate damages by rejecting the offer. Issue: Should the sales contracts be rescinded because of fraud and should Patricia get attorneys’ fees? Decision: Yes. Patricia. who lived with Christine (Joe’s sister) and her husband. After a call from her dad Joe. Experts valued the property at $279.700. Reason: Consent may be vitiated by fraud which is a misrepresentation or suppression of the truth done intentionally to get an unfair advantage over or to cause loss to another. Ethics Spotlight: Must a Wedding Ring Be Returned if the Engagement Is Broken Off? Contemporary courts generally hold that an engagement ring must be returned to the donor no matter who breaks off the engagement. Failure to do this was fraud. She was 20 years old and had a mental condition. Both sides appealed. Bates Facts: Patricia inherited ½ interests in 2 large Louisiana properties. Note: Writs of attachment and garnishment can be used to enforce remedies. The potential other employment must be comparable or substantially similar to the employment that was lost. Therefore.Remedies for Breach of Traditional and Online Contracts 223 locate other employment. The fraud and rescission judgment was affirmed while the denial of attorneys’ fees was reversed. she went to visit him. The two types of employment for Parker were not comparable. through a friend sued Keith and Sheila to rescind and alleged fraud. The second movie role was entirely different and inferior to the role agreed upon in the contract. The Court speaks: Hickman v. Patricia’s condition as well as her father’s and her trust in her father and cousin led the court to believe Keith had a responsibility to fully inform Patricia and that she understand everything she was doing including the price of the properties.

and both executed a contract for sale. Reason: The Albas showed they were ready. Kaufmann Facts: The Kaufmanns listed property for sale for $350. Mrs. The Albas offered the full price. . The court found such a remedy in this case would not be unreasonably harsh. Issue: Was an order of specific performance of the real estate warranted in this case? Decision: Yes.000. paid a deposit.224 Chapter 14 The Court speaks: Alba v. got title insurance. and able to perform but the Kaufmanns were able but unwilling. The denial of the Albas’ motion was reversed and the motion for summary judgment was granted and specific performance was ordered. willing. Also volitional unwillingness does neither furnish grounds for cancellation nor create a defense against the contract’s specific performance. The motion was denied and the Albas appealed. Also specific performance is routinely the remedy in real estate cases. Prior to the set closing date the Kaufmanns e-mailed a desire to cancel the deed. The Albas e-mailed an intent to go to closing. The Kaufmanns refused to close and the Albas sued for specific performance and move for summary judgment. obtained a mortgage. Kaufmann e-mailed that the thought of the sale was making her ill due to her MS. had a house inspection.

.Remedies for Breach of Traditional and Online Contracts 225 Intentional interference usually involves some inducement to breach a known and enforceable contract.

3 million in punitive damages. The award was reduced by the judge to $5. Kurupt lied to the plaintiffs about a tour he went on promoting Dre’s release of his album. the jury found for O’Neill in the amount of $710.519.000. Issue: Was Gallant liable for a bad faith tort? Decision/Remedy: Yes and judgment was upheld. Knight had been made aware of the exclusive contract. A jury returned a verdict of $731. Kenneth and Lamont (the Brumfields) spent at least $65. inducement to breach and resulting damages. Ethics Spotlight: Brumfield v. they were awarded $14.000 on this venture. They were all introduced to Knight (the owner of Death Row Records) by Dre.000 minimum amount of liability insurance legally permitted with Gallant Insurance Company.5 million in punitive damages. The Court Speaks: O’Neill v. Medical bills were $105. Navvaez assigned her claims against Gallant to O’Neill. The Brumsfields received nothing from the tour. knowledge by defendants.226 Chapter 14 Usually not available for breach of contract but sometimes for tortious non performance. and exclusive publishing agreement with Kenneth’s company and a management agreement with Kenneth for 3 years and an option giving Kurupt 7% royalties.000 leaving Navvaez liable for $711. bad faith lies in an insurer’s failure to give at least equal consideration to the insured’s interest when the insurer .063. Advances had been paid by Dre to Kurupt while still under the original contracts. In a trial for a bad faith act of breaching a covenant of good faith and fair dealing. Dre invited Kurupt to record. A settlement offer of the policy limit was suggested by Gallant’s representatives. The executive VP refused to settle until the evening of the trial but O’Neill refused. Reason: The necessary elements of the tort were present: valid contracts. Gallant Facts: Navvaez carried the $20. Death Row Records Facts: Kurupt signed an exclusive recording agreement with Lamont’s company.000. In a suit by Brumsfield for intentional tortious interference. including $2. Reason: “Where an insurer is pursued for its refusal to settle a claim. Issue: Did defendant engage in tortious intentional interference with the contracts in question? Decision/Remedy: Yes and the award reduction noted was upheld. An album of Kurupt was released by Dre and it sold millions. Navvaez’s car struck O’Neill after a two-year old set the running car in motion after Navvaer had exited the running car.063 in actual damages against Gallant and $2.000 in compensatory and punitive damages.063. Gallant paid $20.343.

Muhammad Ali.2.2d 919 (9th Cir.2d 771 (La.Remedies for Breach of Traditional and Online Contracts 227 arrives at a decision to settle the claim. Haeuser. A contractor who has substantially performed the work is entitled to be paid. less the cost of repairs. i. Microform Data Systems. v.715 for repairs. The court held that the failure to meet the delivery deadline was a material breach and that such inability to meet the contract specifications was a further breach.4. Inc. v. and the amount of money which film stars were making at the time of the trial. 430 F. Anticipatory Repudiation 14. Generally. In this case. the court awarded $750. Microform materially breached its contract with Hawaiian Telephone. it was clearly a stated intention of his refusal to perform under the terms of the contract. Madison Square Garden Boxing.Supp..000 calls per hour with a one-second response time by the mid-February deadline. to put the aggrieved party where she would have been monetarily had the promise been performed. the court concluded that the evidence presented sufficient proof of the necessary defects and that Drennen was entitled to be paid $42.. the other party may treat such repudiation as a breach of contract. Therefore.Ill. when Ali announced his retirement. Wallace C. The court held that such damages were supported by the evidence concerning money which Welch had made from previous film work. Answers to Critical Thinking Cases Performance 14. III. subject to deduction for reasonable costs of repair for any deficiencies proved by the owner or the reasonable diminution in value of the work caused by any partial failure of performance. Hawaiian Telephone Co. Moreover. MSGB could have treated such actions as a breach.324 under the contract. Drennen wins and can recover the full price under the contract. Accordingly. the court awarded $1 million for the loss of professional income. 1977). the purpose of the contract damages is to give the aggrieved party the benefit of her bargain. When a contract provides for a definite time for performance. No.1. Inc.000 for loss of reputation based on evidence of the . Drennen. 1987). Accordingly. Microform was unable to design a system that handled 15.D. the court held that MSGB had the right to sue for that breach before performance was due under the contract. the court upheld the lower court’s judgment awarding breach of contract damages to Hawaiian Telephone. 679 (N. 829 F. There were a number of other minor cases against Gallant. Generally.” Gallant had chosen its own interest above those of Navvaez. Inc.App. less $26. In this case. Yes. MSGB does not have to wait until the date of performance to sue Ali under the contract. where a party’s words or actions make it clear that he is unwilling to perform.e. Damages 14. In this case. expert testimony that Welch would have obtained additional film roles but for the termination of the instant contract. v. 1979). In this case. a failure to meet such deadline results in a material breach of the contract. Damages 14. 402 So. Welch wins and may recover damages for breach of contract.3. absence of film offers subsequent to termination of the instant contract.

Welch v. remote.3d 1289.6. lost profits may be awarded if they are shown with reasonable certainty and are not speculative. Gundersons can recover the lost profits on the remaining two-thirds of the contract to build the golf course. because a nonbreaching party is under a duty to use reasonable means to avoid loss and damage. Metro-Goldwyn-Mayer Film Co. 254 Cal. H.228 Chapter 14 difference between Welch’s premovie reputation as a somewhat difficult but professional actress and her postmovie reputation as a contract breaker who had been fired for cause. The court also held that where the nonbreaching party maintained a long-term lease for equipment used on the project and such equipment was left idle due to the breach.App. the court upheld the limitation of the liability clause. including any incidental or consequential damages caused by the breach. the agreement in question provides for liquidated damages of 20 percent. In this case. consequential damages were awarded for costs incurred in attempting to mitigate damages by seeking substitute golf course construction contracts. consequential damages were appropriate. 678 P. Moreover.5.7. Damages 14. Perlin Company. Moreover. the liquidated damages clause is not enforceable. Accordingly. Moreover.App. and even taking account of lost investment interest and increased administrative costs. Accordingly. A contractor is entitled to recover.App. Generally. 645 (Cal. a liquidated damages provision is enforceable if the harm caused by a breach is difficult or impossible to estimate and if the amount fixed is a reasonable forecast of just compensation for the harm caused.2d 1061 (Colo.App. In this case. the court found that the compensation provided to the alarm company was nominal in relation to the company’s potential liability. 258 Cal. 290 Cal. the court held that a burglar alarm service is a high-risk enterprise and that a limitation on liability clause is acceptable under such circumstances.3d 164. Liquidated Damages 14. 1989). Gundersons may collect for both lost profits and consequential damages. the trial court properly held that the liquidated damages provision was void as a . v. Yes.Rptr. the court concluded that the lost profit damages were shown with reasonable certainty where the president broke down the project into various components and testified as to separate costs to complete each part. The parties must make a good faith attempt to set an amount equivalent to the damages they anticipate. Liquidated Damages 14.Rptr. 207 Cal. Accordingly. they are void as a penalty. Morse Signal Devices of San Diego. 1 (Cal.. 1989). v. 1983). Inc. the court held that the damages represented the parties’ reasonable efforts to determine fair compensation given full knowledge of the circumstances. UMC paid the contribution only four days late. The court held that such a provision was not a good faith attempt to estimate possible damages. Generally. In this case. from a breaching defendant. Yes. Inc. parties to a contract may agree upon a reasonable amount that will be presumed to be the amount of damages in the event of a breach where it would be impracticable or extremely difficult to estimate actual damages. damages sufficient to place it in the position in which it would have been had the breach not occurred. and Morse is only liable for $250. the liquidated damages clause is enforceable. or imaginary. such damages are not a reasonable forecast of just compensation. Gundersons. Finally.App. Ptarmigan Investment Company. Where the damages stipulated are unreasonable.S. No.

No. 260 (Cal.Rptr. she would be deprived of her livelihood and pressured to return to Beverly Glen. all purchase orders placed by Claiborne in accordance with the contract. Inc. v.S. The elements of this tort are: (1) a valid and existing contract. Bear Stearns & Company. Inc. however. (2) defendant’s knowledge of the contract and an intent to induce the breach of that contract.2d 212 (9th Cir. Intentional Interference with Contractual Relations 14. Moreover. distributors. The court held that to do so would have the same effect and intent as enjoining Baker herself. 1988). an injunction adds nothing to Beverly Glen’s recovery other than to coerce Baker to honor her contract.Remedies for Breach of Traditional and Online Contracts 229 penalty.Y. and customers. Idaho Plumbers and Pipefitters Health and Welfare Fund v. 270 Cal. Generally. California courts and the Restatement have concluded that a defendant can be liable for interfering with a contract. Accordingly. (4) caused by the defendant’s wrongful or unjustified conduct.Sup. In this case.App. United Mechanical Contractors. In this case.D. including its distinctive package. Pacific Gas and Electric Company v. Injunction 14. Inc. 1990).App.10. an order of specific performance is an appropriate remedy in this case. 1989).2d 425.3d 1118. the court affirmed the order of the trial court denying injunctive relief. 1986).9. PG&E can sue Bear Stearns for the tort of intentional interference with contractual relations. Specific performance may be decreed where the goods are unique or in other circumstances where money damages do not adequately compensate the plaintiff. Beverly Glen is also seeking to enjoin Warner from employing Baker. Warner Communications. 178 Cal.Rptr. Beverly Glen is prohibited from enjoining Baker from performing the contract with Warner. 224 Cal.App. 530 N. The closing of a much-publicized venture and its failure to supply stores would do nothing to enhance its reputation with suppliers.2d 329 (N.App. To hold otherwise would be a violation of the constitutional right against involuntary servitude. The court held. Accordingly.Y. the court found that money damages would not adequately compensate Claiborne for such intangibles as how the destruction of the Claiborne cosmetic line will affect the other business carried on under the Claiborne name. The court held that PG&E adequately stated a cause of action for intentional interference with contractual relations. 875 F. An unwilling employee cannot be compelled to continue to provide services to his employer by ordering specific performance. the court held that money damages would be inadequate to compensate Claiborne for damages to its reputation and ordered Avon to fill and deliver in a timely and diligent fashion.. Moreover. a contract to render personal services cannot be specifically enforced. and (5) damages.3d 1142. an injunction is not an appropriate remedy in this case. is obvious. Beverly Glen has an adequate remedy by way of damages. (3) breach of the contract by the contracting party.8. 50 Cal. Inc. 141 A. Yes. Bear Stearns contended that the third element is lacking because the contract with PG&E has not been and will not be breached. Beverly Glen Music. 1 (Cal. It contends that it will be inducing the party to legally evade an existing contract. . Therefore. Specific Performance 14. Liz Claiborne. however.. In this case. the court found that the uniqueness of Claiborne’s cosmetics line. v.. retailers. Avon Products. that although a literal reading of the elements might lead one to believe a “breach” is necessary. Inc.

58 Cal. 1989 Tenn.App.B. Security Insurance Company of New Haven.e. Walgreen Co.12. a consideration in good faith of the insured’s interest required the insurer to settle the claim. or future protection. security. Moreover. (3) ordinary contract damages are not adequate. Key Facts A.230 Chapter 14 IV: Answers to Ethics Cases 14. Case Name. and Court E. and (b) they do not make the inferior party whole. App. The facts of this case warranted the equitable remedy of an injunction to protect Walgreen’s interests.2d 425.. (4) one party is especially vulnerable because of the type of harm it may suffer.. to secure peace of mind. Harvey entered into a contract with Prospective Systems to install and monitor a burglary alarm system that complied with Underwriter’s Laboratories for insurance purposes. The judgment of the lower court in favor of Crisci was therefore affirmed.2d 173. Protection Systems.Rptr. the court concluded that it is common knowledge that one of the usual methods by which an insured receives protection under a liability insurance policy is by settlement of claims without litigation.11. 14. i. Harvey & Co. 966 F. 426 P. The insurer must give the interests of the insured at least as much consideration as it gives to its own interest. 66 Cal.B. B. 1967). (2) the motivation for entering the contract must be a nonprofit motive. Accordingly. Connecticut. and fiduciary responsibility. 13 (Cal. In this case. Inc.2d 273 (7th Cir. It maintains an inventory of jewelry valued at approximately $1 million. C. other courts have held that there is a “special relationship” between the insurer and the insured. Inc. (5) the other party is aware of his vulnerability. E. characterized by elements of public interest. the court held that where there is a great risk of recovery beyond the policy limits so that the most reasonable manner of disposing of the claim is settlement that can be made within those limits. . there is an implied covenant of good faith and fair dealing that neither party will do anything that will injure the right of the other to receive the benefits of their agreement. Harvey & Co. and of necessity places trust in the other party to perform.App. because (a) they do not require the party in the superior position to account for its actions.. Injunctions to enforce exclusivity clauses are quite likely to be justifiable by just the considerations present here—damages are difficult to estimate with any accuracy and the injunction is a one-shot remedy requiring no continuing judicial involvement. Answer to “Briefing the Case” Writing Assignment 1. V. Crisci wins based on the insurance company’s breach of covenant of good faith and fair dealing implied in an insurance contract. v. is engaged in the manufacture and wholesale distribution of jewelry. Sara Creek Property Co. and (6) there is a “special relationship” between parties. including policies of insurance. 1992). The elements of this cause are as follows: (1) the contract must be such that the parties are in inherently unequal bargaining positions. The obligation of good faith and fair dealing requires the insurer to settle in an appropriate case although the express terms of the policy do not impose such a duty. v. Crisci v. Citation. Lexis 105 (1989) Court of Appeals of Tennessee 2. The contract between Harvey and protective contained a liquidated damages clause that limited the amount of damages to be paid in case of failure of the alarm system. adhesion. In every contract.

The trial court held in favor of Protective. in part. The alarm system failed. D. Public policy holds that these clauses do not ordinarily protect against fraud or intentional misrepresentation. Harvey sued for the fair $200. 5.000 market value of the loss. The limitations. 1984. as used in this contract. The holding of the lower court was affirmed.Remedies for Breach of Traditional and Online Contracts 231 D. E. due to a telephone system failure and a burglary that took place on July 22. Issue Is the liquidated damages clause of the contract enforceable in this case? 4. have generally been deemed to be reasonable and have been sustained against the providers of burglary and fire alarm systems. and Protective claimed its liability was limited to the liquidated damages set out in the contract. B. Court’s Reasoning The Court of Appeals held that: A. Holding Yes. F. and Harvey appealed. 3. C. There was no showing of fraud or intentional misrepresentation in this case. .

It will take visionary thinking to help steer that technology towards the goals common to all law studies: which is to not only explain what it is but how it can be used as a socially responsible tool for the betterment of both our nation and the larger global community. We must first help our students appreciate that this path has been built and protected by a legal and regulatory environment that is founded on an underlying principle of social order and ethical decision-making. This turn in the road is coupled and driven by incredible technological advancements symbolized by the Internet. The Internet is impacting governmental regulation. It has made planet earth “smaller” than ever through unprecedented connectivity while simultaneously creating an uncharted frontier for all who travel down this exciting path. or social-economic migrations such as our nations conversion from an agrarian to an industrial society. One such major turn that we are now facing is the advent of the Internet.232 Chapter 15 Chapter 15 Internet Law and E-Commerce The Law Was Never Built For The Internet. As teachers of law and ethics. but so too. We must help our students understand and appreciate the roles that both government and business play in attaining the social goods that can come from these new technologies. We are concerned with all aspects of privacy concerns and intellectual property rights. How Can We Fix It? I. A key hallmark of all such events is that the road of history has taken a sharp turn from which there is little possibility of turning back. Future generations will look upon our time as a road land-marked by the information age. can there be great harm. . These landmarks can take place as social upheavals such as civil rights movements. Originally intended only for a select group of military and academic uses. horrible conflagrations such as wars. it is our job to make our fair contribution to the evolution of this new cyberspace highway. of being witness to events that become the landmarks by which future generations will measure history. Our challenge is to interpolate the lessons learned through virtually thousands of years of legal evolution governing every manner of human conduct into the virtual world of the Internet. Teacher to Teacher Dialogue Every generation has the good fortune. How then do we start to teach the laws of e-commerce and the Internet? It has taken the greatest technological minds of our generation to build this highway. it has virtually exploded onto every continent and every country to facilitate a level of communication never imagined before. And most of all. and sometimes misfortune. we must do our part to help them develop both the critical thinking skills and ethical sensitivity to see that not only good can come from the information age. We must also help students recognize the legal issues and risks that will confront them as they travel down this road.

We must take the lessons of history learned in those key areas of business law and remember that they are rooted in an orderly legal system. In the end. the art of teaching the law of e-commerce and the Internet is basically the same as it has been since the beginnings of law.” So it is in the interpolation of the law and the world of the electronic commerce. and as such. For example. when and where do we. Precedent has extraordinary value in charting the new methods of business conducted over the Internet. These new proposals. the newer Uniform Electronic Transactions Act (UETA). but they are still contracts. Technology used in a harmful manner can only magnify the original problem. the basic rules of rights of privacy should not be abrogated simply because it is technologically possible. as a society. As an old proverb says: “the act of faith is jumping off a cliff with the knowledge that you will be ok. and agency laws today. We have to jump because we have no choice: that is where this road is taking us. They seek to expand the economic well being of our nation while still seeking to protect the legitimate concerns of individual rights of privacy and the like. need to be bounded by all the rules of good conscience first evolved in the common law and transferred to the UCC. the corollaries found between the long-standing Uniform Commercial Code (UCC).Internet Law and E-Commerce 233 employment law. How. Text Materials . while surely seen as imperfect by many. We may be involved in transactions measured by milliseconds through cyberspace. business formation. and it takes a certain leap of faith to teach law in an area where our students are very often more technologically “savvy” than we are. We must balance the good that can come from the information age with the lessons learned through centuries of the development of an orderly society. for example. Good legal environments must steer new technologies along the well-precedented path of good faith and good conscience. However. II. we may be looking at unprecedented accumulations of personal information though the use of “cookies” and the like. on the privacy front. It is not easy to do this. But we must have faith in the law’s ability to land safely. consumer protection. Consider. allocate the respective rights and duties of its members? That allocation of rights and duties continues everyday in new ways on the Internet. and the Uniform Computer Information Transactions Act (UCITA). The UCC has long provided us with a tool by which to foster and protect commerce. are evolutionary efforts to do the same for e-commerce.

Issue: Do the indecent transmission and the patently offensive display provisions of the CDA violate the Freedom of Speech Clause of the First Amendment of the U.S. 2) Prohibition of the knowing sending or displaying of patently offensive messages over the Internet in a manner that is available to a person under 18 years of age. The U. The Court Speaks: John Doe v. The district court’s decision was affirmed. GTE The Facts: Tapes were secretly made of the Illinois State football team in their lockers showing undressed players.234 Chapter 15 Internet & Technology: Free Speech and the Internet In this important US Supreme Court case. the court recognized the importance of the Internet and the World Wide Web and issues an opinion guaranteeing the users of the Internet the highest constitutional free-speech protection. The terms here were vague and parents have other means of controlling Internet access of children. known as the Communications Decency Act (CDA) contained the following two provisions: 1) Prohibition of the knowing transmission of obscene or indecent messages over the Internet to a recipient under 18 years of age.S. The statute as written could suppress speech that adults have the right to receive. Reason: The court said the Internet is not as invasive as television or radio and accidental encounters seldom occur. The players sued Franco and GTE. Franco defaulted and was assessed $500 million but they can’t be located. as the Internet Service Provider. The district court preliminarily enjoined enforcement of these provisions. was sued claiming a violation of the First Amendment Right to Freedom of Speech. liable for damages to the plaintiff football players? .youngstuds. ACLU The Facts: Title V of the Telecommunications Act. Issue: Is GTE Corporation. These tapes were displayed at univ. GTE was the ISP who operated the server allowing access to this site. Constitution? Decision/Remedy: operated by Franco Productions. The Supreme Court Speaks: Reno v. The case against GTE was dismissed.

Congress passed the CAN-SPAM Act prohibiting the use of false headers in e-mail messages and requiring proper labeling of sexually oriented e-mail. Internet Law: Anti-Spam Statute As an answer to the junk e-mail or Spam bombardment. Internet Technology: E-Signatures E-signatures have the same force and effect as a pen-inscribed signature on paper. Reason: The CDA provides that “No provider or user of an interactive computer service shall be treated as the publisher or speaker of any information provided by another information content provider.Internet Law and E-Commerce 235 Decision/Remedy: No. Internet & Technology: Electronic Contracts Writing Requirement The E-Sign Act states that electronic contracts generally meet the writing and signature requirements for enforceable contracts. . E-sign is technology neutral.” Web hosts are like the telephone company and the postal service in dealing with liability of this type. The dismissal was affirmed.

They sell domain for names that have been registered. when stored by a router or server. Spider Webs The Facts: “Ernest & Julio Gallo” is a registered trademark of Gallo Winery. Spider Web Ltd. & J. Reason: Bad faith could include not having Spider Web in the domain name and no prior use of the domain name in selling foods and services as well as the fact that Spider was engaging in selling domain names. Look to internic. while in transit. Issue: Did Spider Web Spider Web was ordered to transfer the domain name in question to Gallo.236 Chapter 15 Internet & Technology: Electronic Communication Privacy Act The ECPA makes it a crime to intercept an electronic communication at the point of transmission. and the creators. Gallo sued alleging violation of the ACPA.000 domain names including Decision/Remedy: Yes. registered more than 2. act in bad faith in registering the Internet domain name ernestandjuliogallo. or after receipt by the intended recipient. . Gallo Winery v. The order was upheld. The Court Speaks: E. the Thurmans.

Internet & Technology: Domain Names Sold For Millions Business.Internet Law and E-Commerce 237 Internet & Technology: Armani Outmaneuvered for Domain Name This discusses how a person named Anand Ramnath Mani registered the domain was eventually sold for $7.000.500. Armani. . before the upscale apparel company and was allowed t keep it. Internet & Technology: Domain Name Anticybersquatting Act Congress passed the Anticybersquatting Act that prohibits bad faith registration or use of an Internet domain name that infringes upon a company’s trademark or an individual’s famous name.

UCITA was drafted to answer problems dealing with licensing ↓ Forming contracts over the Internet Enforcing e-commerce contracts Providing consumer protection .238 Chapter 15 Exclusive license grants the licensee exclusive rights to use informational rights for a specified duration Licensing agreement sets forth the express terms of the agreement between the licensor and licensee Internet & Technology: Click-Wrap Licenses Click-wrap licenses are enforceable.

provides that consumers are not always bound by unilateral electronic errors. Usually can be disclaimed . which governs licenses of informational rights. Examples include voice mail and Web page order systems. Internet & Technology: Consumers Saved from Electronic Errors The Uniform Computer Information Transactions Act.Internet Law and E-Commerce 239 Internet & Technology: Counteroffers Ineffectual Against Electronic Agents An electronic agent is any telephonic or computer system that has been established by a seller to accept orders.

240 Chapter 15 .

Mortenson Company. Timberline Software Corporation Facts: Timberline Software Corporation produces software programs that are used by contractors to prepare bids to do work on construction projects. Issue: Was the limitation of remedies clause in the Timberline software contract unconscionable? Decision: No. Timberline defended. c) Internet & Technology: Cyber Identity Fraud – Identity Theft and Assumption Deterrence Act of 1998: This act criminalizes identity fraud. government. There it prohibited Mortenson’s lawsuit to recover consequential damages from Timberline. Mortenson sued to recover consequential damages alleging that the software calculated an inaccurate bid. a customer of Timberline. b) Internet & Technology: EFTA EFTA regulates payment and deposit of funs using electronic funds transfers. a licensor can resort to electronic self-help if a breach occurs. d) Internet & Technology: IIP Act Computer-related crimes are addressed as distinct offenses. and law enforcement. 3) State Criminal Laws . claimed that the software did not work correctly and resulted in a bid that was too low. v. Timberline’s software license agreement contained a limitation of remedies clause. for example. The Court Speaks: M.A.Internet Law and E-Commerce 241 Internet & Technology: Electronic Self-Help Under the UCITA. if the licensee fails to pay a license fee. Mortenson. Inc. Reason: The court of appeals held that the limitation of remedies clause in the software license was conspicuous and not unconscionable. alleging that the limitation of remedies clause in the software license prevented Mortenson’s lawsuit. 2) Cyber Crimes a) Internet & Technology: Counterfeit Access and Device and Computer Fraud and Abuse Act: Criminal Computer Activity is discussed. Online Privacy: 1) ECPA – crime to intercept electronic communications with exception: employer.

2 Under the Uniform Electronic Transactions Act. Classic Coke. License 15. the Anticybersquatting Act has two main sets. Therefore. Therefore. no contract was formed by Tiffany and iSoftware. if one of the parties is not a merchant. License 15. Contract 15. This rejects the offer. and the second is whether the domain name was registered in bad faith. pretty obviously a bad faith gesture. III. West Coast Steel wins under this scenario. Answers to Critical Thinking Cases Domain Name 15. the licensor will not grant any other person rights in the same information. and no contract is formed. it can recover the license payments for three years under its contract in this scenario. His case is discussed.6 Under the Uniform Computer Information Transactions Act. Because Info. Each new counteroffer. This means that for the specified duration of the license.5 The Federal Electronic Signature Act recognizes an electronic signature or esignature. in this scenario. Since the electronic e-mails establishing the contract between Litle Steel and West Coast Steel were signed electronically.4 The Uniform Computer Information Transactions Act recognizes that electronic agents do not have the ability to evaluate and accept counteroffers or make counteroffers. extinguishes the previous offer and becomes a new visible offer. Obviously. Therefore. E-Mail Contract 15.242 Chapter 15 4) Internet & Technology: Computer Hacker Found Guilty of Cyber Crime Kevin Mitnick became the underground icon of computer hackers. varying the terms of an offer by the offeree is a rejection of the offer and constitutes a counteroffer. is a famous name. Under this scenario.1 While this is subject to debate. Inet can recover the license fee against David Abacus.Inc. The first is whether the name is famous. Francis Net loses in this scenario. such as the one Mildred Hayward made. and Francis Net’s objective was to make a fortune selling domain names. Buffet wins. The act gives the e-signature the same force and effect as a pen-inscribed signature on paper.3 Einstein Financial Analysis entered into an exclusive license with William an electronic record satisfies the requirement for writing where the contract is required to be in writing by the Statute of Frauds. did not accept the counteroffer. Electronic Signature 15. .

e. The defendant registered two Internet domain trade names through Website Management for his companies.7 Under the Uniform Computer Information Transactions Act. IV.9 Under the Anticybersquatting Consumer Protection Act.. and Court Toys “R” Us Inc. These trade names were “Toysareus” and “Kidsareus. S. the licensor may sue and recover monetary damages from the licensee depending on the facts of the situation. unless it could prove that General Motors. New York 2. Therefore. Inc. Toys “R” US also sued to collect attorneys’ fees on the basis that defendant’s actions were willful and in bad faith. Citation. Therefore. Metatag wins. i. owns the trademark on a family of businesses which are centered around the use of “R” US language.S. License 15. District Court. The plaintiff. and Exxon Oil win. Answer to “Briefing the Case” Writing Assignment 1.8 Under the Uniform Computer Information Transactions act. 15. under this scenario. He didn’t pay and cancellation is a remedy. He was not ethical because of the theft but neither was Apricot.10 Apricot.Internet Law and E-Commerce 243 License 15. it is defective. Silvia wins. Case Name. Macy’s. D. the non-breaching party may refuse the tender.D. Macy’s.” wins. under this because of the language. Issue Was this a deliberate and bad faith attempt to dilute the Toys “R” US family of trademark names? . Answers to Ethics Cases 15. 3. Key Facts may have had the best of intentions. B. it was acting in bad faith. Abir 1999 WL 61817 (1999) U. and Exxon Oil were guilty of the crimes depicted on their website. Toys “R” Us sued for an injunction to prevent the defendant from using names that it alleged would dilute its well known family of trade names. when a licensee breaches a contract. v. Toys “R” Us. V. While BluePeace. the test of violation of the law is bad faith. and General Motors. if a licensor tenders a Copy that is a material breach of the contract.

5. Holding Yes. The trade names used by the defendant did dilute the Toys “R” US family of protected trade names. The plaintiff’s requests for both injunctive relief and claims for reimbursement of attorneys’ fees were therefore granted. intentional. C. and in bad faith. deliberate.244 Chapter 15 4. B. . This attempted dilution was willful. Court’s Reasoning The District Court for the Southern District of New York held that: A.

First. to the flow of commerce and to discuss the concept of “merchant” from a business sense. rather than an impediment. Of importance to an understanding of the U. Also. modification. and the like are carried over into the UCC by way of the doctrine of conscionability. The UCC is intended to cover a number of areas of contract formerly resolved by common law. appearing to have eclipsed the common law of contracts. maintaining the portions of the common law it needs. it might be worth it to stress the importance of the law as being a facilitator. 3. Teacher to Teacher Dialogue Students for a number of reasons sometimes meet the introduction of materials on the UCC with a degree of resistance. They were designed to have law reflect the needs of commerce. it seems to be somewhat repetitive in that it sounds like "Contracts Verse Two. Providing for more flexibility in the formation." Because of these predispositions to the UCC. . The early faire courts were established by and for merchants. Possibly remind students that the UCC is designed for the “fast track” of commerce by providing for maximum flexibility vis-à-vis formation. Lease And E-Contracts Can the Law Help Business To Be Business? I. and termination of commercial contracts.C. modification. This might include examples of the need for holding merchants to a high standard of imputed knowledge about the usage and trade or norms within their respective areas of commerce. and termination of commercial contracts. Second. but the basic elements for both are the same. Some of the principles that evolve included: 1.Formation of Sales and Lease Contracts 245 Chapter 16 Formation of Sales. Early on. Providing for uniformity of interpretation for commercial contracts. What is vastly different is the implementation of how those elements are arrived at in the light of commercial realities.C is to examine the Code as a specialized body of contract law. Holding merchants to a higher standard. good faith. it appears to be more technically complicated than the common law of contracts or torts. the Law Merchant of England set up special rules for commercial contracts with the realization that the law should be written to foster and encourage commerce rather than encumber it. 2. it might be helpful to remind them of the simple truth that the essential ingredients of common law notions of fair play.

and conscionability in commercial dealings. It was. fair play. in turn. It is updated and revised in order to keep up with changing realities of the marketplace. The authors believed that the law should reflect the realities of commerce that are working rather than impose unnecessary obstacles or impediments to business. at least in part. The UCC is continually being revised to reflect changes in modern commercial practices and technology. Its predecessor. The UCC is the descendent of the Law Merchant. was ultimately adopted by thirty-seven states. eclipsed by the UCC beginning in 1952. in all fifty states. . the 1906 Uniform Sales Act.246 Chapter 16 4. Retaining the common law essential ingredients of equity. good faith. It continues to be one of the single most important legislative enactments in American legal history. II. The UCC has been adopted. Text Materials Note: Article 4A covers Funds Transfers.

in an operation performed at defendant’s medical center received a defective pacemaker.3 in text) .Formation of Sales and Lease Contracts 247 If a sale is part goods and part services (mixed sale) follow the part that is most dominant. Hector. Reason: The primary function of the defendant was to provide medical services and the good was incidental to providing those services. Therefore the contract’s predominant purpose was to provide a service so it is a contract for the sale of a service. Plaintiff sued the defendant claiming this was a sale of goods and that the contract is subject to Article 2 provisions. lessee and supplier (lessor usually buys goods from supplier for the lease. Issue: Does this contract constitute a sale of a good or the sale of a service? Decision: This contract involves the sale of a service. Cedars-Sinai Medical Center Facts: Plaintiff.) (See exhibit 14. The Court Speaks: Hector v. Hector appeals. The trial court granted a motion for a summary judgment and dismissed Hector’s suit. Finance lease is a three-party transaction between lessor.

follow U.C.C. follow common law .C.248 Chapter 16 Contract Law Goods Other than goods U.C. Open offer Firm offer rule Statue of Frauds Modification Remedies If no special provision. Common Law Other Statues or If provision is present.

Formation of Sales and Lease Contracts 249 Relevant Terms: Sale: passing of title from seller to buyer for a price Goods: tangible things that are movable at the time of their identification to a contract Merchant: a person who deals in the kind of goods involved in the transaction or who holds himself or herself out ( because of occupation) as having knowledge or skill peculiar to the goods involved in the transaction Lease: transfer of the right to the possession and use of the named goods for a set term for consideration Lessor: person who transfers the right of possession and use of the goods under the lease Lessee: person who acquires the right to possession n and use of goods under the lease Open Explanation: Price reasonable (market) Payment at delivery Delivery seller’s place Time reasonable Assortment buyer chooses .

if no time is stated. . Contemporary Issue: “Battle of the Forms” There is a contract based on original terms unless the additional terms so materially alter the terms of the original offer that the parties cannot agree on the contract or limitations are in contract or notification of non-acceptance of modification. for a reasonable time (up to three months). Contemporary Issue: UCC Permits Additional Terms in Sales and Lease Contracts This discusses the mirror image rule and counteroffers. Note that an accommodation shipment is a counteroffer.250 Chapter 16 Contemporary Issue: UCC Firm Offer Rule The firm offer rule states that a merchant who offers to buy. or lease goods and gives a written and signed assurance on a separate form that the offer will be held open cannot revoke the offer for the time stated or. sell.

Formation of Sales and Lease Contracts 251 .

C $500 Exceptions for written confirmations between merchants Exception for specially manufactured goods Exception for part performance Parole Evidence Rule and The U.C. Course of performance exception Course of dealing exception Usage of trade exception .C.252 Chapter 16 Statute of Frauds and The U.C.

Because the contract was . The helmet Hemphill had been wearing when he was injured was provided to him as a member of the team. Needs reasonable time and no written objection within 10 days.1. A disparity of bargaining power alone does not itself make a contract unconscionable. See the “Perdue Roasters” case. Further. A transaction is generally a sale. Hemphill v. No. Sometimes a sale involves the provision of service and a good. and (3) the terms of the contract are grossly unfair to the weaker party.Ill.3. No. The UCC defines merchants as persons who deal in goods of the kind involved in the transaction. (2) the dominant party exploits this power. International Law: Use of Letters of Credit in International Trade The irrevocable letter of credit has been developed to manage risks in international sales. The court held that there was no gross disparity of bargaining power between Omni and Wilson. Article 2 applies only to transactions in goods.Formation of Sales and Lease Contracts 253 Contemporary Issue: UCC Written Conformation Rule UCC 2-201(2) stipulates that the confirmation is sufficient when the party to whom it is sent has reason to know its contents. is used by a party to try to back out of an oral sales contract. Although some courts have given a more expansive reading to the UCC. Ethics Spotlight: A Chicken Farmer Gets Plucked Sometimes the Statute of Frauds. Further. 1982). who was experienced in business and in signing contracts. Article 2 does not apply to this transaction. 1975). 552 F. Article 2 of the UCC does not apply to this case. the court held that the contract was primarily one for services. III. 685 (S. Omni gave Wilson an opportunity to read the lease before signing it. 364 A. and even reminded her to read it through the use of the signed statement. Hemphill had asked that Sayers and Schulz be held liable as merchants of football helmets. Bargaining Power 16. This is called a mixed sale. it is not clear if the title to the helmet had passed from the university to Hemphill. Neither Sayers nor Schultz were dealers because they were not involved in the sale of football helmets. Although Omni was a large corporate entity. 16.D. Sayers. the leasing contract was not unconscionable. Stylarama. Gulash was not able to recover against Stylarama by referring to the UCC. The contract also stated that Stylarama was to construct the pool and install a vinyl liner. No. The contract described the transaction as a furnishing of labor and materials. Article 2 applies solely to transactions in goods.Supp. Answers to Critical Thinking Cases Sale by Merchant 16. Because Article 2 of the UCC does not cover service contracts. The helmet was not passed from a buyer to a seller for a price because Hemphill was not required to pay for it.2d 1221 (Conn. Wilson was an adult. The Court held that Sayers and Schulz were not sellers of football helmets. In this situation. A “sale” consists of the passing title from a seller to a buyer for a price. Omni did not attempt to exploit any advantage it may have had. which was designed to prevent fraud. Courts decide whether a given transaction is primarily for goods or services based upon the facts of the case. this court found that Hemphill was not able to use Article 2 to recover for his injuries. A contract will usually be held to be unconscionable if (1) there is a gross disparity in bargaining power between the parties. Gulash v. Article 2 only applies if the provision of the good is the predominant part of the transaction.2.

. 1988). Because the inclusion of this term was a unilateral action by Miller. Both parties behaved as if a contract had been formed.6.Supp. M. Charles Cable TV v. 852 (D. Applying UCC 2-207. The two parties had agreed on the price of the photographs. a valid sales contract existed between St. additional terms do not become part of contracts between merchants if they materially alter the contract.2d 246 (N. E. The formation of a sales contract requires both an offer and an acceptance. Formation 16.A. In this situation. Newsweek. the offer was accepted. Battle of the Forms 16. UCC Section 2-207 applies. The court held that the telephone conversations between St. Miller was not able to collect $1. and they would work a great hardship upon Newsweek. However.5. The court also held that the actions by both St. In this case. World Omni Leasing. The letter gave no assurance that the bid would be held open. 660 F. Inc. and the parties’ conduct recognized the existence of a contract. the clauses in the delivery memo were not part of the contract.500 a piece for the missing photos.2d 713 (Ala. Miller v.Y. 687 F. No. the UCC recognizes an acceptance to the common law rule that allows an offeror to revoke his offer any time prior to its acceptance.e. Therefore. St. and the terms.. The UCC holds that an offer may be accepted by the shipping of conforming or nonconforming goods. Because they had made no such statements. 1966). Charles and Eagle..000 if it accidentally lost the photos. the additional terms materially alter the original contract. Coronis had properly revoked its offer on June 1.4 Yes. 216 A.. Inc. This rule provides as follows: if a merchant offers to buy or sell goods and gives a written and signed assurance on a separate form that the offer will be held open. it only quoted a price. 16. Eagle by shipping goods and accepting returns. even if they were nonconforming. the court held that it materially altered the original contract. the offeror must explicitly state that the offer will be held open. Super. the UCC also holds that conduct by both parties that recognizes the existence of a contract is sufficient to form a contract. The court did not believe that Newsweek would agree to pay over $100. Charles by making payments. .Supp. Newsweek was to pay for each photo used. the court held that a valid contract had been formed between Newsweek and Miller during their phone conversation. 1989). This exception is known as the firm offer rule. Eagle Comptronics. 540 So. If two merchants negotiate a sales contract and then exchange preprinted forms. In order for the firm offer rule to apply.. Wilson was forced to pay off the lease for the destroyed truck.Del. Inc. Because there had been an offer and acceptance. The delivery memo contained terms additional to the original contract. When Eagle shipped the descramblers.J. St. the delivery date. the offeror cannot revoke the offer for the time stated.254 Chapter 16 not unconscionable. Charles and Eagle were such that both parties recognized the existence of a contract. the court found that a valid sales contract existed between the parties. Wilson v. the court held that the firm offer rule did not apply. Charles and Eagle were sufficient to constitute an offer. or if no time is stated. Coronis Associates v.D. i. Gordon Construction Co.N. 1987). 820 (S. Although the letter from Coronis to Gordon may have been a signed form sent between merchants. then for a reasonable time. Coronis wins the lawsuit. The court held that the additional terms materially altered the contract because Newsweek probably would not have agreed to them in the original contract. Because the court found Miller and Newsweek to be merchants in regards to photographs.

Perschke. In this situation. Generally. there was no evidence that Sebasty had ever made a written objection to the contract. Market prices for commodities like potatoes are readily available from government agencies. the court held that the memorandum sent by Perschke’s office manager was a written confirmation. the UCC requires that a contract for the sale of goods for the price of $500. Because the memorandum was sent on the same day Perschke had his phone conversation with Sebasty.00 or more must be in writing. The court did not agree with Schmieding’s claim that the contract was void for indefiniteness. When both parties to an agreement are merchants. V. There was no pressure and they were not grossly unfair presenting no real ethical issues. Both sides were free to read and accept or reject the terms. 16. which may be determined by a market rate. Although this agreement would have been too indefinite under the common law. Schmieding Produce Co. Cagle. The court found that the contract specified the type of potatoes ordered. Yes. Wallach Marine Corp. it was sent within a reasonable time. and (2) there is a reasonably certain basis for giving an appropriate remedy.2d 1200 (Ind. the Statute of Frauds did not bar his claim against Sebasty.Y. courts generally cannot enforce oral sales contracts for over $500. 1987).Supp. not purposely hidden and not unconscionable. 1988). a valid sales contract had been formed.App. Sebasty v. The UCC allows “open terms” to be determined at a later date.8. The contract between Perschke and Sebasty is not unenforceable due to the Statute of Frauds because the statute can be satisfied by a written confirmation. Under the UCC. the quantity in terms of acreage.. The price of the dealership was in excess of $500. The writing must be signed by the party against whom enforcement is sought or by his authorized agent. Perschke wins the suit. The UCC includes a Statute of Frauds provision that applies to sales contracts. Statute of Frauds 16.N.10 The terms in the contract were clear. Under the UCC. the court will imply a reasonable price. the court would not enforce it. The facts clearly showed that no written agreement was ever made between Donzi and Wallach.7. the Statute of Frauds is met if (1) one of the parties to an oral agreement sends a written confirmation of the sale to the other party within a reasonable time and (2) the other party does not give written notice of an objection to the contract within 10 days of receiving the confirmation. the appellate court found it to be a valid contract under the UCC. Because Perschke’s memorandum was a written confirmation of an oral sales contract. and the approximate delivery date. If the contract is not in writing it is not enforceable. Because the oral agreement between Donzi and Wallach violated the Statute of Frauds.E. Donzi Marine Corp. Answers to Ethics Cases 16. One such open term is the price.C.9. Answer to “Briefing the Case” Writing Assignment .D. IV.2d 243 (Ala. Finally. 675 F. the court will not enforce the agreement between Donzi and Wallach. v.Formation of Sales and Lease Contracts 255 Open Terms 16. 404 N. If the market price is not available. 529 So. In this case. 838 (S. 1980). v. No. The court determined that the parties had intended to form a contract. H. a contract does not fail for indefiniteness if (1) the parties intended to form a contract. the court applied the UCC to a contract for the sale of a dealership. and that it was possible to supply any open terms in that contract.

Section 402Aof the Restatement (Second) of Torts grants strict liability for sale of a product in a defective condition unreasonably dangerous with certain stipulations. B. B. He sued claiming strict liability alleging a defect in design unsafe for intended use. and Court Cafazzo v. Provision of medical services is not the sale of a product and case law distinguishes products from services. Central Medical Health Services. C. Court Reasoning A.256 Chapter 16 1. Holding No. A patient goes to a hospital to get treatment not to buy products. 5. Issue Are doctors and hospitals who provide medical services sellers and therefore liable under strict liability? 4. 3. Citation. Case Name. Inc. 668 A. Key Facts A. . Cafazzo underwent surgery for implantation of a mandibular protheses which was defective. and insufficient warning.2d 521(1995) Supreme Court of PA 2.

But make sure to enforce the concept of common sense because it does work here. If the decedent did not act on how his or her estate is to be disposed of. Teacher to Teacher Dialogue The rules of UCC contract performance. The problem here is one of timing. This includes not only the performance obligations listed in this chapter's materials. the state decides for him or her by way of an intestate statute. The second lesson to be learned is an implied message that one has much more control over one's rights in UCC commercial contracts than one thinks. II. but also of fallback expectations imposed on the parties if they fail to anticipate the issue in the initial contract. The same holds true in the law of wills. Other performance issues are addressed later in the text. and the like constitute a set not only of standards of commercial behavior. These performance obligations will be imposed on those who are. Text Materials . use it. Who then bears the risk of loss and/or has the titled passed? Does any of this affect either parties’ obligations? This is the focus of this chapter. It is just that the law is not necessarily coined to protect the legally lazy. If the answer is built into the contract. Otherwise we must look to default rules. but also any contractual modifications entered into by the parties. A third point is that all contract obligations under the UCC come under the umbrella of good faith and conscionability.Performance of Sales and Lease Contracts 257 Chapter 17 Performance of Sales and Lease Contracts Did We Do What We Promised? I. One major issue that must be faced is the possibility that goods are damaged or claimed before they arrive. remedies.

258 Chapter 17 Future goods are not yet in existence. Look to contract first. Existing goods are. .

Performance of Sales and Lease Contracts 259 Transfer of Title Contract Terms Documents of Title Default Title passes when document delivered Time and place of contracting Shipment Contract Title passes at shipment Destination Contract Title passes upon tender of delivery .

260 Chapter 17 Contemporary Issue: Shipping Terms Terms such as free on board point of shipment. insurance and freight are explained. . free alongside. International Law: International Trade Terms The most widely used private trade terms are those published by the International Chamber of Commerce called Incoterms. and cost.

Performance of Sales and Lease Contracts 261 .

Numismatic claims the parties agreed upon the previously used method by implication. Under such a sale. but Numismatic did not receive them. The previous method of shipping was not an implied term of this agreement. and Prewitt was obligated to use it. . Issue: Who had the risk of loss? Decision: Numismatic had the risk of loss. Prewitt shipped them back. There was no such agreement in this case.262 Chapter 17 The Court Speaks: Prewitt v. Numismatic Funding Corporation Facts: Prewitt received coins from Numismatic on an approval basis. Reason: The agreement was a sale on approval. the seller had the risk of loss. Prewitt had previously sent bad coins by another method. the seller had the risk of loss while the goods are in transit back unless the parties agree otherwise. Therefore.

Performance of Sales and Lease Contracts 263 Generally the breaching party bears the risk of loss. .

264 Chapter 17 Contemporary Issue: Insuring Against Loss of Goods A party with an insurable interest in goods may purchase insurance to reimburse him or her from loss. .

Performance of Sales and Lease Contracts 265 .

. after sufficient investigation. The letter constituted the entrustment here and Brant honestly believed. Brant Facts: Lindholm. Lindholm agreed to have “Red Elvis” shown at the Guggenheim as part of an Andy Warhol Exhibition. claiming ownership. has superior rights to the owner. after Brant found no claims or liens in a UCC lien search and search of the relevant Art Loss Registry. sold it to Brant. that Malmberg was the owner. Brant received an invoice from Malmberg. by letter. A good faith purchaser. Malmberg was to make delivery. “Entrusting” includes any delivery and acquiescence regardless of whether the procurement of the entrusting or possessor’s disposition of the goods have been such as to be larcenous under the criminal law. a collector. Lindholm then discovered the fraud and sued in Connecticut to recover “Red Elvis” from Brant who argued was a buyer in the ordinary course of business. under these terms. Lindholm also agreed. Issue: Was Brant a buyer in the ordinary course of business who had a claim of ownership to “Red Elvis” that was superior to that of the owner Lindholm? Decision: Yes. Reason: Brant’s claim as a buyer in the ordinary course was superior to Lindholm’s ownership claim because Lindholm had entrusted “red Elvis” an art dealer who sold the stolen “Red Elvis” to Brant. purchased “Red Elvis” which was created by Andy Warhol. to loan “Red Elvis” to the Louisiana Museum. Instead Malmberg. through an art dealer (Malmberg).266 Chapter 17 The Court speaks: Lindholm v.

Because the parties intended the title of the yacht to pass when the bill of sale was delivered. In this case. title to the goods remains with the seller. 1980. By painting the fire department’s name on the truck. Even though the ship was never moved.1. 1980. . 504 A. 487 A. 506 (Conn. as the seller. Commission of Revenue Services.2d. took place on October 18. In addition to this general rule. The good sold can be specifically named in the contract. Yes. Lowe & Meyer Garage. v. Under UCC 2401. the court held that the sale took place on October 18. Identification means that the goods in the contract have been distinguished from the seller’s other goods. Passage of Title 17. was distinguishing this particular truck from other trucks they owned. Because the specific truck sold had been distinguished from the seller’s other trucks. the fire truck was identified to the sales contract. Identification can occur in different ways. 1986). 1980. This had the effect of separating or designating the specific item sold to the fire department. In the case of a good that is part of a large mass of goods. Hamerly. Until a seller identifies goods to a sales contract. the good is identified when the seller explicitly separates or designates the good sold to the buyer. Passage of title. the UCC provides that the delivery of the document title of the yacht determines when title passes. Answers to Critical Thinking Cases Identification of Goods 17. 1985). where a sales contract does not involve the delivery of goods. (1) title to goods passes from the seller to the buyer in any manner and on any conditions explicitly agreed on by the parties. passage of title occurs when the seller delivers a document of title.Super.Performance of Sales and Lease Contracts 267 III. the court determined that the parties must have agreed to pass title on October 18. New England Yacht Sales v. the court held that the fire truck had been identified to the contract when Hamerly painted the fire department’s name on the cab. and thus the sale of the yacht. The marine bill of sale that New England gave to Pease on that day explicitly passed title of the yacht to him.2.2d 953 (Pa. In this case. Big Knob Volunteer Fire Co. the court held that the goods had been identified to the contract.

he was acting dishonestly with respect to this transaction. Michaels Jewelers. Cherry Creek’s only recourse is against Executive Leasing. The buyer of a good from a seller who has void title to that good cannot obtain valid title against the original owner. In this case.App. Although there was some question as to whether Hyken had paid sufficient money for the car. This meant that Torniero only had void title to the jewels. Torniero had stolen jewelry from Michaels. A good faith purchaser for value can acquire good title..4. Michaels Jewelers.. The UCC provides that: where an owner entrusts the possession of his or her goods to a merchant who deals in goods of that kind. The court in this case found that MMM was a dealer in respect to prefabricated homes. 709 S. Inc.2d 1024 (Wyo. they could not obtain valid title to them. On at least seven occasions MMM had sold Fuqua modular houses to retail customers. the Carters were able to take valid title to the Dodge despite Cherry Creek’s security interest. The Court held that Executive Leasing was a seller of goods of the kind involved here. When Hyken chose to ignore these warning signs.6. Passage of Title 17. Because the Carters acted in good faith in purchasing the Dodge and had no knowledge of Cherry Creek’s interest. 141 (D. The court held that the original owner of the jewelry. The real owner cannot reclaim goods from this buyer. A thief only has void title to the goods he has stolen. A buyer in the ordinary course of business is a person who in good faith and without knowledge that the sale violates security interests of a third party purchases the goods. “Good faith” means honesty in fact in the conduct or transaction concerned. automobiles.2d 509 (Mo.3. had title to the goods and returned the jewelry to them. they were buyers in the ordinary course of business. 1987). and the appellate court gave title of the car back to Coghill. Landshire Food Service. 1985). and in the title document to the car should have put an experienced buyer like Hyken on notice that there was something wrong.Conn. The court found that when Bellman bought Coghill’s Rolls Royce with a forged check. Michaels Jewelers has valid title to the stolen jewelry. Ryan was a buyer in the ordinary course of . The Carters have valid title to the Dodge. “Value” means that the purchaser paid sufficient consideration for the goods. Because of this dishonesty. A buyer in the ordinary course of business who purchases goods from a seller of goods of that kind takes the goods free of any security interests in the goods given by the seller to another party. 1986). Inc. Carter. 733 P. As buyers in the ordinary course of business. It is true that a good faith purchaser for value can obtain valid title to goods from a seller who only has voidable title to them. the merchant has the power to transfer all rights (including title) to the goods to a buyer in the ordinary course of business. Cherry Creek Dodge v. 42 UCC Rep.Serv. a good faith purchaser cannot obtain valid title to goods sold by a seller who has void title to them.5. he received voidable title to the car. A buyer who buys goods with a check that is dishonored receives voidable title to that good. Ryan has a valid title to the house. Coghill.e.W. Hyken was not a good faith purchaser for value. Bellman’s identification. Entrustment Rule 17. United States v.C. However. the trial court’s main concern was with Hyken’s honesty. However. i.268 Chapter 17 Stolen Goods 17. the court also determined that Hyken was not a good faith purchaser for value. Even though G & W was a good faith purchaser of the goods. The irregularities in the ad for the car. Passage of Title 17. The title to the car goes back to Coghill. v.

a merchant-seller bears the risk of loss between the time of contracting and the time the buyer picks up the goods from the seller. 41 N.2d 780 (Ohio App. When the custom furniture was destroyed in a fire while it was within Wycombe’s possession. 477 N.O. Therefore. Silver v. A. A buyer obtains an insurable interest in goods when they are identified to the contract. seller’s plant was used in reference to price. A sales contract that requires the seller to deliver conforming goods to a specific destination is a destination contract. In this case. A contract that specifies the delivery terms F.B. the risk of loss passed from Knitwear to All America.B.2d 14 (N. When Knitwear placed the yarn in the possession of the truck. In other words. Evanston Bldg. point of shipment contract requires that the seller place the goods in the carrier’s possession. Ryan now holds title to the home and Fuqua cannot reclaim it. and All America must pay for the stolen yarn.O.E. Wycombe must return the payment Silver made on the destroyed furniture. Fuqua Homes.9. 1980).Y. Risk of Loss 17. Even though the furniture was to be shipped. The court held that since Mitsubishi bore the risk of loss of the plywood. Mitsubishi International Corporation. An F. Because the yarn was stolen when All America bore the risk of loss. Knitwear wins the case. Mitsubishi must now pay to replace the plywood destroyed during shipping and deliver replacement goods to Crown. The court in this case held that even though the term F. Because Wycombe bore the risk of loss. 1976). v.7. & Loan Co.2d 699 (Ga.App. Inc.S. Because MMM was a merchant of prefabricated homes.Y. The seller retains an . they were able to transfer title to Ryan as a buyer in the ordinary course of business.Y. Georgia Ports Auth. Risk of Loss 17. Risk of Loss 17.B. Both Hayward and Dry Land Marina had an insurable interest in the destroyed yacht. Wycombe bore the risk of loss.. and not picked up by the buyer. In such a contract the seller bears the risk of loss to the goods during their transportation. it bears the risk of loss. 1977). A buyer may obtain an insurable interest before title or risk of loss passes to him.Performance of Sales and Lease Contracts 269 business because he had no knowledge of the security interest Fuqua held in the house that MMM sold to him. Knitwear v. The court held that this was a destination contract because the sales agreement for the plywood specified that Mitsubishi deliver it to Crown’s plant in Atlanta. v. All America.Y. 390 N. it must return the payment Silver had made on the destroyed furniture. Etc. City Civ. Mitsubishi bore the risk of loss.2d 288 (N. this was enough to make the agreement a shipment contract..M. point of shipment is a shipment contract. it could sue the railroad to indemnify itself for that loss. All America must pay for the yarn. the seller is required to replace any goods lost or destroyed in transit. it bore the risk of loss of the plywood during its transport.10.E.2d 832. Meyer & Co.Y.. Insurable Interest 17. and the buyer does not have to pay for any destroyed goods. Ct. 274 S. If a seller is a merchant. risk of loss does not pass to the buyer until the goods are received. 370 N.8. If the goods are destroyed during transportation. When a merchant-seller such as Wycombe holds goods for a buyer. Because Mitsubishi was a seller in a destination contract. the same principles apply. there was no question as to whether Wycombe was a merchant of custom furniture.S.App. the risk of loss falls on the buyer.. 1984). The seller bears the expense and risk of loss until the goods are placed in the carrier’s possession.O. Inc. Wycombe.

Therefore. Court’s Reasoning The Court of Appeals of Ohio held that: . Triangle could pass good title to a good faith purchaser for value that Campus was. Inc.App. Thus.I. 5. A buyer and seller may have an insurable interest in the yacht because it had been identified to the contract. the seller appealed. B. the farmers received good title. Hayward v. Charles had good title and passed good title to Lee. v. E. The seller retained both keys to the mobile home and the shed in order to later remove his contents.270 Chapter 17 insurable interest in goods so long as title or any security interest in the goods remains with the seller. Key Facts A. Purtell 1992 Ohio App. Thus. Answer to “Briefing the Case” Writing Assignment 1. The buyer claimed that the risk of loss had not passed because there was no tender of delivery and wants a refund. This constituted an entrusting. D. Labonte. Affirmed for Charles. The UCC provides that if you entrust your goods to a merchant who deals in the goods of the kind you empower that merchant to pass your title to a purchaser in the ordinary course of business. 715 P. Executive allowed Tri-County to retain possession of the tractors. F.2d 381 (Kan. and Court Burnett v. The yacht became identified to the contract when it was specifically named in the sales agreement. Lee Oldsmobile-Cadillac. On March 3. 74 (R. Affirmed for the farmers. 188 N. Tri-County was empowered to pass Executive’s title to purchasers in the ordinary course of business. Executive Financial Services. 1980).2d 31 (Mich. The court held that both Prewitt and Dry Land held an insurable interest in the yacht at the time it was sold.11.W. 3. The farmers were such purchasers. the mobile home was destroyed by fire through the fault of neither party. The parties entered into a contract for the sale and transfer of a mobile home and shed. V. 30 UCC Rep. Lexis 3467 (1992) Court of Appeals of Ohio 2.12. Potsma. The lower court held in favor of the buyer. the seller transferred to the buyer a certificate of title and one of the keys to the mobile home. IV: Answers to Ethics Cases 17. Dry Land had an insurable interest in the yacht because it retained a security interest in the vessel until Hayward paid off the promissory note. Therefore. Issue Did tender of delivery take place so as to have shifted the risk of loss to the buyer? 4. 1990. C. 1971). Case Name. Citation. v. Charles. Pagel. Campus had good title and passed that title to its buyer. Inc. The next day. Holding No. Triangle had voidable title and under the UCC. 17. 1986).

. B. the risk of loss does not pass until there is a tender of delivery. tender of delivery had not taken place. Under the UCC. C. Where the seller is a non-merchant (as in this case). he had not put the property at the disposition of the buyer. Because the seller retained keys to both the mobile home and the shed and because the seller had not yet removed his contents. the risk of loss passes on the receipt of goods.Performance of Sales and Lease Contracts 271 A. D. Therefore. if the seller is a merchant.

leases were considered to be the domain of real property law. Take. These sections of the code attempt to anticipate and answer problematic situations that arise in the fast pace world of business. the normal performance obligations of the UCC have been satisfied. In both cases. The advent of highly leveraged buyouts and sophisticated techniques has made the use of debt rather than equity a way of life for many. Because Article 2A is designed to reflect existing leasing practices while clarifying the respective rights and duties of the parties to the transaction. The basic rules of common law . In that light.. The basic duties of a buyer are found in the inspection process. One of the most interesting recent trends in the nation is the explosive growth of personal property leasing by both business entities and individuals. the seller makes the opening performance gesture.272 Chapter 18 Chapter 18 Remedies for Breach of Sales. Lease and E-Contracts What Can We Sue For? I. he should not have to wait until he is neck deep before he can yell for legal help. acceptance of the delivery. the UCC says if one of the parties is seeing himself sink into commercial quicksand. it is really no surprise to see widespread leasing replace ownership in may areas of commerce. Article 2A is the UCC’s attempt to keep up with this economic reality. and payment for the goods. Teacher to Teacher Dialogue In UCC sales contracts. the duty shifts to the buyers to live up to their end of the deal. for example. Prior to this trend. changes which seek to mitigate the problems rather than waiting too long and letting too much damage occur. and those goods must conform perfectly to the terms of the contract. The seller’s duties are twofold: he or she must tender delivery of goods. Where both parties have lived up to their respective obligations. These provisions are designed to allow performance modifications that will lessen the ultimate harm done by the breaching party. the doctrines of anticipatory repudiation and adequate assurance. Sometimes. a very high percentage of autos are leased rather than owned. For example. If these obligations have been met. extraordinary situations arise which may modify or excuse these basic performance duties.e. i. The second set of UCC performance obligations reviewed in this chapter center around lease contracts entered into under Article 2A. The interesting and innovative aspect of many of these modifications of basic performance duties is that the UCC seeks to provide anticipatory sorts of changes.

Remedies for Breach of Sales and Lease Contracts 273 contracts. as amended by the UCC. Finally. the UCC allows for excuse from performance in a limited set of circumstances. The writing requirements have been tailored to fit the lease transaction. These circumstances are impossibility and commercial impracticability. and the exceptions to the writing requirement are virtually the same as found in Article 2 of the code as are the performance obligations and remedies. the circumstances need to have been unforeseeable and to enforce performance now would be inequitable in light of the changed situation. II. are carried over into Article 2A. however. The burden of proof on the person claiming excuse is a heavy one. In both cases. One must keep in mind. Text Materials . that these doctrines are not intended to be used as a back door to get out from under binding contract obligations.

C.C.274 Chapter 18 Non-carrier: seller’s or lessor’s place of business Carrier: depends on if shipment or destination contract Cure is the opportunity given by the U. to fix a nonconforming delivery: 1) Time not expired and 2) Notification .

Consolidated Edison Co. and Joc Oil sued. And. of New York. Based upon Joc Oil’s knowledge of the purported quality of the oil tendered and upon Con Ed’s usage pattern at the time. . Inc. v. Joc Oil had a shipment available that would be delivered in one week. Con Ed rejected the offer. After the seller reasonably believes that the buyer will accept the tender. finally. Facts: Joc Oil had a contract to sell oil to Con Ed. Issue: Can Joc Oil cure the nonconformity? Decision: Joc Oil wins. the seller can give reasonable notice of its intent to cure. Joc Oil could reasonably believe Con Ed would accept the delivery. The oil delivered did not meet the contract specifications. and can provide a conforming tender within a reasonable time. Reason: A seller has a right to cure under the UCC. and Con Ed was in breach for rejecting the offer to cure. Second. Joc Oil gave reasonable notice of its intent to cure.Remedies for Breach of Sales and Lease Contracts 275 The Court Speaks: Joc Oil USA Inc. Joc Oil may cure. Therefore. Joc Oil offered to lower the price of the oil and then offered to replace it with conforming oil. since all the criteria were met.

. Lease.276 Chapter 18 Ethics Spotlight: Good Faith and Reasonableness Govern the Performance of Sales. and Web Contracts This box discusses good faith and reasonableness from the UCC point of view.

Remedies for Breach of Sales and Lease Contracts 277 .

278 Chapter 18 .

Remedies for Breach of Sales and Lease Contracts 279 .

280 Chapter 18 Seller or lessor’s right to seek damages is retained. .

At first. it appears that no real harm is done to the seller. What if the goods were custom designed or artistic in nature? Would or should the same apply? .Remedies for Breach of Sales and Lease Contracts 281 Contemporary Issue: Lost Volume Seller This box centers on the issue of how to establish an appropriate measure of damages where the goods in question are sold to a new third party. most students eventually come around to the “lost volume” measure of damages in the commercial setting. Yet.

282 Chapter 18 Cover involves substituted goods Damages now = cost of cover – contract price Replevy involves recovering scarce goods Ethics Spotlight: Sale of Goods with a Design Defect Cost/benefit decisions involving design of safer products can present interesting ethical dilemmas. This box presents a case involving the design of a General Motors truck that had a design defect in the placement of its fuel tank. .

Remedies for Breach of Sales and Lease Contracts 283 Ethics Spotlight: Unconscionable Contract .

If the goods or tender of delivery fails in any way to conform to the contract. 501 N. since Grady had allowed Thompson over two months to repair the car. the buyer may elect to reject the whole shipment. Reasonable time is determined on a case-by-case basis.2d 91 (Ark. The Appellate Court ruled that Hartz’s action was appropriate. v. Thompson had a reasonable time to cure the defect. 612 S. Hartz wins the lawsuit based upon the buyer’s right to reject nonconforming goods.284 Chapter 18 The doctrine of unconscionability says that if a contract is unconscionable. Grady was able to revoke the sales contract. Grady wins the lawsuit. when Thompson was unable to repair the Chevette in this two-month period. III.W. Revocation of Acceptance . In the court’s opinion. because the soybeans failed to conform to the contract. the defective Chevette.E. Inc. Thompson objected to the trial court’s decision that Grady had not given Thompson a reasonable time to cure the nonconforming tender. v. When the buyer rejects a nonconforming tender where the seller had reasonable grounds to believe that it would be accepted by the buyer. General Motors Acceptance Corp. Right to Cure 18. there was an adequate opportunity for Thompson to cure the defect. 1985). based upon the buyer’s right to reject nonconforming goods.. The court held that since Thompson believed that Grady would accept the car. 1981). Coleman. the court may either refuse to enforce the contract of limit the application of the unconscionable clause. The court held that Coleman had violated the perfect tender rule by shipping soybeans with a 65 percent germination level. the seller may have additional “reasonable time” to substitute a conforming tender if he reasonably notifies the buyer. This rule states that the seller is under a duty to deliver conforming goods.1. The Appellate Court affirmed the trial court’s decision that Grady had given Thompson an adequate opportunity to cure the defect. Subsequently.2. Grady. Sales transactions are subject to the perfect tender rule. Thus.2d 68(Ohio App. instead of the contracted 80 percent level. Jacob Hartz Seed Co. Hartz elected to reject the entire shipment. or reject part and accept part. accept the whole shipment. Answers to Critical Thinking Cases Nonconforming Goods 18.

the seller must send the buyer a written notice demanding the return of the goods. The court held that the boxes that International sold to Farrar were nonconforming due to their tendency to collapse. A seller may seek to reclaim sold goods from the possession of the buyer if the seller delivers goods in a credit sale and then discovers that the buyer was insolvent when the goods were received. Farrar. the seller is excused from the breach of contract. The court held that Campbell had not complied with the terms of the sales agreement when he failed to deliver. 9583 bushels of corn out of the 20. When a buyer rightfully revokes the acceptance of goods. Charter International Oil Company. Commercial Impracticability 18.4. and the nonconformity was difficult to discover.Remedies for Breach of Sales and Lease Contracts 285 18. Archer’s written notice to Charter demanding the return of the ethanol was sent within ten days of Charter’s receiving the goods in Houston. 1985).R. . International Paper Co. 1986).2d 463 (Penn. because he had properly revoked the acceptance of nonconforming goods.5. based upon the doctrine of commercial impracticability of the contract.Fla. The court held that Archer learned of Charter’s insolvency after the ethanol had been shipped. Revocation is not effective until the seller is notified.2d 642 (N. 854 (M. 1977). Farrar was no longer obligated to pay for the nonconforming goods.000 contracted for. Once the nonconformity was discovered. if a seller either does not deliver the goods. Farrar wins the case. 60 B. Hostetter Farms.M. Inc.3. When such an unforeseen contingency prevents a seller from delivering goods.D. Campbell’s failure to deliver the 20. v. Campbell v. Seller’s Right to Reclaim Goods 18. the Bankruptcy Court ordered the return of the ethanol to Archer. The seller’s reclamation demand must be made within ten days after the buyer receives the goods. 380 A. This nonconformity both substantially impaired their value. The Appellate Court upheld the lower court’s decision in favor of Farrar. The seller is excused from breach of the contract under the doctrine of commercial impracticability. The rain prevented Campbell from performing his obligations because it stopped him from planting his entire crop and destroyed a portion that was already planted. (2) the nonconformity substantially impairs the value of the goods to the buyer. because the company had properly revoked its acceptance of International’s boxes. In order to exercise the right to reclaim goods from the buyer. and was difficult to discover before the goods were accepted. Revocation of acceptance is permitted if (1) the goods are nonconforming. Campbell wins the lawsuit. the unusually rainy summer was an unforeseen contingency that prevented Campbell from performing the contract.. and (3) the goods are accepted before the nonconformity was discovered. 700 P. Archer has a right to reclaim the ethanol from Charter. Archer Daniels Midland v.000 bushels was excused due to the commercial impracticability of his ability performing the contract. Charter should have honored Archer’s request for the return of the remaining ethanol. Farrar immediately informed International of its revocation. However. the buyer is relieved of any duty to pay. or delays his delivery because an unforeseen contingency prevents the seller from performing his obligations. Because Charter did not honor Archer’s request.

Sedmaks can obtain specific performance of the sales contract for the limited edition Corvette. Because Yazoo was the only potential customer for the bags. Meuser Material & Equipment Co. v. Because of Yazoo’s breach. Specific Performance 18. McMillan v. Meuser still won the lawsuit and the appellate court awarded the company a reduced amount.e.D.286 Chapter 18 Seller’s Right To Resell Goods 18. However. Yazoo is not correct. including reasonable overhead.6.2d 911 (Ark. i. In other words. the seller would have made two sales instead of one if the original buyer had not breached.. the seller may recover both the contract-resale measure of damages.7. Inc. 1976). Meuser had the right to resell it. Under the UCC. the UCC provides that a buyer may obtain . 845 F. Because of this situation. the seller may recover the purchase price if the circumstances reasonably indicate that an effort at resale would be unavailing. However. However. A seller may recover the purchase price. C. and any incidental damages incurred on the resale. Meuser wins the lawsuit. the gasoline Tri-State had originally bought was resold.Supp. Inc. Daniels did not have to attempt a resale. Tri-State’s breach meant that Saber made only one sale instead of two. the court held that Saber was entitled to its lost profits. resold in good faith and in a commercially reasonable manner.. the price agreed to in the contract. Therefore the seller can be awarded its lost profits. this remedy will not put the seller of ordinary items in the same position as if the buyer had performed the sales contract. Yazoo refused to accept and pay for these bags.9. the court held that Daniels was entitled to the purchase price of the grass bags. 1986). on the contract.. the seller may resell the goods if he is still in possession of them. Daniels had the right to recover the purchase price of the goods because there was no use for the bags except in conjunction with Yazoo mowers.R. When a sales contract is for a unique good. Right To Recover Lost Profits 18. 205 (S. Saber was the seller of an ordinary item. Saber would have been able to make this second sale even if its supply of gasoline had not been increased by Tri-State’s breach. 641 F. 1988). the amount that the trial court awarded for contract-resale damages was reduced because the appellate court felt that a resale fourteen months after a breach was not commercially reasonable. and he must pay Daniels for the remaining grass bags. the loss incurred on the sale.2d 575 (5th Cir. i. the seller can be made whole by reselling the goods and then suing the buyer for the difference between the resale and contract price. When a buyer has breached a sales contract for specially manufactured goods. When the goods are ordinary items or of relatively unlimited supply.e.W. Co. Yazoo Mfg. Inc. When the goods are rightfully resold.8. when a buyer breaches or repudiates a sales contract. The grass catcher bags that Daniels was manufacturing had been specially designed to fit a Yazoo model lawn mower. Seller’s Right to Recover the Purchase Price 18. 541 S. Since this occurred when Meuser still had possession of the bulldozer. Saber Energy. gasoline.Miss. The court held that Yazoo had contracted for the purchase of specially manufactured goods. if the buyer rejects specially manufactured goods and the goods cannot be resold. If the buyer contracts to purchase specially manufactured goods and refuses to accept and pay for them. v... When Tri-State breached its contract. Daniels. Tri-State Petroleum Corp.. The appellate court held that Meuser could properly recover the amount spent on the upkeep of the equipment as incidental damages. The Court held that McMillan breached the contract when he stopped payment on his check. Saber has the right to recover its lost profits.

Because the court found that Allsopp had not acted in a commercially reasonable manner. 18. it was commercially reasonable for Lincoln to request the delivery of sand during December. In this case.099 tons of paving material instead of the contracted 20. Lincoln was allowed out of its contractual obligations. the term is defined in reference to the course of dealing between the parties. If the buyer covers the undelivered goods. The UCC does not specifically define what is commercially reasonable. Since Allsopp already had the sand stockpiled. 609 P. it was sufficiently limited in number so that an award of monetary damages would not be a sufficient remedy.12.App. IV: Answers to Business Ethics Cases 18. its refusal of Lincoln’s request was unreasonable.M. . 622 S. Right To Cover 18.W. the plaintiffs’ continuous complaint was due notice that the trailer was defective and they were not satisfied. In this case the court held that the Indy Pace Car Special Edition Corvette was a unique good. Instead. 1988). Therefore. Revocation must be given in a reasonable time and by a reasonable manner. and the contract did mention the availability of delivery by special arrangement. Ybarras win. the requirements of the UCC have been met. Sedmak v.App. 525 N. Four years is a reasonable time under the circumstances. Lincoln’s offer to send an employee to help with the loading also favorably influenced the court’s decision. The court held that C&E had failed to make a delivery when it shipped Nowlin only 2. it was not reasonable for it to charge an extra amount to load during December. 1980). Inc. Nowlin covered in good faith and in reasonable time. In addition. Because Nowlin covered in good faith. the company was entitled to the difference between the original contract price and the price paid to Gallup. 1987).2d 1185 (Ill. A buyer’s cover must be made in good faith and without unreasonable delay. Sales contracts for works of art and antiques are the type of contracts for which courts will order specific performance.. By immediately contracting with another commercial supplier of gravel. Inc.. the usage of trade. Concrete Sales & Equipment Rental Company. and other factors. Inc. Kent Nowlin Construction. If a seller fails to make a delivery of goods. the court held that Lincoln’s request was reasonable. 746 P.Remedies for Breach of Sales and Lease Contracts 287 specific performance because an award of monetary damages is not a sufficient remedy. the buyer may cover by purchasing substitute goods. the Sedmaks were entitled to obtain specific performance. v. the buyer may sue the seller to recover as damages the difference between the cost of cover and the original contract price. This is called the cover minus the contract price measure of damages. When Charlie’s breached the sales contract for the Corvette. Modern Trailer Sales..E.M. Nowlin wins the lawsuit. The court ordered Charlie’s to sell the Indy Pace Car Corvette to the Sedmaks.2d 331 (N. Yes.000 tons. Lincoln’s request was reasonable because it came within the one-year period covered by the contract.11.10.2d 645 (N. Lincoln Sand and Gravel. Inc. Gallop Sand and Gravel Company. Ybarras v. and Allsopp’s refusal of the request was unreasonable. The court awarded Nowlin the cover minus the contract price measure of damages. Allsopp Sand and Gravel v. Charlie’s Chevrolet. C&E’s failure to deliver gave Nowlin the right to cover. 1981). The fact that Charlie’s was attempting to auction the car indicates that the Corvette was unique and was worth more than its sticker price. Therefore.2d 694 (Mo. Even though the car was not one of a kind.

1986. v. Under the terms of the contract.. C. On December 16. E. Thus. and Court LNS Investment Co. 1986. Holding Yes. the plaintiff was to supply as many as possible by December 31. Key Facts A. C. F. Inc. Defendant put the plaintiff on notice that it was entitled to adequate assurance of performance to cure the defects. B. Because plaintiff did not provide commercially adequate assurance of performance. Issue Was the defendant entitled to adequate assurance of performance? 4. 3. the number of bottles to be provided could be as high as 4 million by December 31. B. Case Name. The plaintiff entered into a UCC contract to supply blended. Citation. labeled. defendant did not breach the contract. Because of production problems. Court’s Reasoning The United States District Court held that: A. Answer to “Briefing the Case”Writing Assignment 1. Supp. Defendant claims it was entitled to but did not get a UCC-based adequate assurance of performance. 5. 1484 (1990) United States District Court 2. If the new molds were not up and running. D. . The products supplied by plaintiff were commercially defective. Plaintiff sued alleging a breach of the original contract by the defendant. Phillips 66 Co. 731 F. defendant informed plaintiff that it would not renew any commitments to purchase goods from plaintiff. 1986 if new production molds were online by that date. defendant was entitled under the UCC to terminate the contract. plaintiff was unable to supply enough bottles of satisfactory quality. and packaged quart plastic bottles of motor oil for the defendant.288 Chapter 18 V.

Teacher to Teacher Dialogue The issues covered in these materials go far beyond the question of who pays for what harm. it might be helpful to go over a listing of the arguments on the current state of affairs in the product liability arena. There are five common denominators applicable to all warranties. and most important of all. if there has been a breach of warranty by reason of nonconformity to the promises made. The warranty material can be done as part of the UCC section on Article 2.Warranties and Product Liability 289 Chapter 19 Warranties and Product Liability How Can We Make Sure We Get What We Pay For? I. This time frame may be limited to just the initial sale. or the period of performance may have been extended by way of post sale promises. First. decide if there has been any nonconformance with the terms of the warranty in the time frame covered by the transaction. These matters take students into the realm of how a society chooses to conduct business. After going over the history of the early strict liability cases. A discussion of the concepts of negligence and strict liability seems to be an excellent way to start the chapter. Regardless of the sequence chosen. students should eventually be exposed to the multiple paths available to remedy the victim of a products’ harm. Examine the scope and nature of the promises or assurances made under the alleged warranty. We probably should constantly try to remind students of the wide and varied menu of remedies they have to work with. how much value society places on the balancing process between business latitude and individual rights. The section of this chapter on warranties gives us a timely opportunity to remind students of the multifaceted aspects of the issues covered in this chapter. Third. Teaching the strict liability portion of this chapter right after torts is probably a good way to start. In the end. how it allocates the “costs” of doing that business. the sequence to be used is best selected by each individual instructor. has this breach caused an injury of any sort? . Products liability remains one of the great socioeconomic and legal dilemmas of our day. determine whether any sort of warranty may be in existence either by acts of the parties or by imposition of law. The UCC rules of warranty are a statutory set of buyer protections. Warranty issues invariably raise the possibilities of common law tort remedies as well as the whole gambit of products liability law. Second. The possibilities for debate and open-ended discussion on these matters are endless.

contractual or otherwise. II. ascertain the measure of the alleged injury. consumer protection statutes. Other avenues may include tort law. and equitable remedies. are there any defenses. warranties represent only one path to dealing with the problem. Finally. applicable in this case? Remember also. Text Materials PRODUCT ISSUES (NONCONFORMITY OR DEFECT) Warranty (Contract) Negligence (Tort) Strict Liability (Tort) Express Implied Warranty buyer or lessee’s assurance that the goods meet certain standards .290 Chapter 19 Fourth.

) Transfer of goods - - Transfer of goods by a merchant - Specific language Circumstances by which buyer knows of no title Specific language Circumstances by which buyer knows of no title Not specifically mentioned but probably same as Encumbrance Notes: 1) Must be a basis of the bargain 2) Opinion (puffing) are not warranties .Promise . “with all faults” Examination Course of dealing In writing an conspicuous - Fitness for a particular purpose - Title Sale by anyone if: .Warranties and Product Liability 291 Warranty Summary Sheet Warranty Express: .Seller knows of purpose . etc.Merchantability When Relevant Manner of Disclaimer Anytime given Sale by a merchant N/A Mention merchant If in writing conspicuous “As is”.Buyer relies on seller to select goods Transfer of goods - - Against encumbrance (free from security interest) Against infringement (no conflicting patents.Description .Model Implied: .

s. there was an express warranty.s. Reason: Formal words are not necessary for an express warranty. Issue: Was an express warranty made by Ashe regarding the quality of the diamonds in the bracelet? Decision: Yes.v. One year later and the jeweler indicated that the diamonds were of substantially lower grade than v. .. Ashe Facts: Daughtrey sold a diamond bracelet to Ashe for $15. quality”. The trial court’s decision was reversed and the case was rewarded for appropriate damages. Since he had superior knowledge and was not just offering it as an opinion. Daughtrey filed a specific performance suit for an appropriate replacement or damages.292 Chapter 19 The Court Speaks: Daughtrey v.000 after Ashe completed and signed an appraisal term stating that the diamonds were “H color and v. Here Ashe specifically described the diamonds and their quality. Daughtrey appeal is from a trial court denial verdict.v.

She sued to recover damages for breach of the implied warranty of merchantability. Issue: Did Ford Motor Company breach the implied warranty of merchantability? Decision: Yes. Ford breached the implied warranty of merchantability.Warranties and Product Liability 293 The Court Speaks: Denny v. the Bronco II rolled over and Denny was severely injured. a small SUV that was manufactured by Ford Motor Company. claiming that the Bronco II presented a significantly higher risk of rollover accidents than did ordinary passenger vehicles. Therefore. . Reason: The vehicle was not safe for the “ordinary purpose” of daily driving for which it was marketed and sold. When Denny slammed on her brakes on a paved road to avoid hitting a deer. Ford Motor Company Facts: Nancy Denny purchased a Bronco II.

294 Chapter 19 Must pass the consumer expectation test .

Massey had superb knowledge and expertise and Garnica had inquired and relied on this. Airstream trailer she had on order. Garnica bought the Jeep.Warranties and Product Liability 295 The Court Speaks: Mack Massey Motors. Garnica Facts: Garnica went to Massey to ask about a Jeep Cherokee to tow a 23 ft. She was eventually told to go to another dealer and the driveshaft twisted at 7. Inc. Reason: Massey said the Jeep would work after knowing the requirements. Massey’s sales manager said the Jeep would work. Landmark Law: Magnuson-Moss Warranty Act The Magnuson Moss Warranty Act covers written warranties relating to consumer products. but had it in for repairs for a slipping transmission several times. Garnica sued Massey and Jeep for damages alleging breach of the implied warranty of fitness for a particular purpose. Issue: Did the defendant make and breach an implied warranty of fitness for a particular purpose? Decision: Massey did make and breach the warranty but Eagle did not. Internet & Technology: Warranty Disclaimers in Software Licenses This discusses disclaimer of warranty and limitation of liability clauses that are included in a typical software license. v. . Garnica explained requirements and got the specifications of the trailer from Airstream. Refer to previous sheet. Garnica wins and Massey and Jeep appealed.229 miles.

. That all worked well enough in the preindustrial age populated by small communities with direct dealings between the buyer and seller. The law has stepped in with numerous remedial measures to help alleviate the shortcomings created by caveat emptor.296 Chapter 19 1) Damages: a) Compensatory = warranted value – actual value (at acceptance) b) Consequential c) Incidental Buyer beware! Throughout the history of common law. the law’s expectations of buyer protection started and ended with the buyers themselves. The roles of government and its courts as sources of buyer protection were expected to be minimal. A person entering the marketplace was expected to personally know the seller and to resolve any differences directly with him or her. What are the realistic chances today of an aggrieved buyer working out a problem directly with representatives of many of the major companies? The postindustrial global marketplace has become too complex to expect a buyer to resolve these issues directly with the seller.

Contract law. the protection against defects in products is best provided by the manufacturers of those products. Arguments in favor of restricting the use of product liability doctrines: As persuasive as some of these arguments may be. As a practical matter. Can you as a buyer of an automobile really test the airbag before you buy the car? e. the sanctions imposed by law for defective products should act as a deterrent to further introduction of faulty products into the marketplace. c. Bans on products are enacted only after so many injuries have occurred that the products continued existence in the marketplace can no longer be tolerated. The cost of the present system is simply out of control and is a model of inefficiency. they have the resources to research. The two sides of the public policy debate surrounding this doctrine are set out below. the following points are worth considering: a. and test against harm. . the other side of the coin has its own convincing points. Courts led the way to newer avenues of recourse by way of the doctrine of strict liability. Various legislative enactments at both local and national levels designed to protect consumers tend to be reactive rather than proactive. has also failed to provide adequate assurance to the victims of product harm. Consumers traditionally have had less real bargaining power in the contracting process when it comes to attaching responsibility for harm created by a product. Traditional tort law doctrines based on fault and defenses related thereto have not always adequately served the injured person. Some key arguments raised against the current products liability systems are as follows: a. Compared to the consumer. Arguments in favor of strong product liability laws: In the area of tort law. The second stream of cases arose out of the warranty aspects of UCC sales. On the side of product users. The evolution of strict liability doctrines is a logical consequence of having this deficiency in the law. b. If sellers of goods know this. develop. Finally. they will try harder to make products safer in the first place. d. many argue that traditional negligence doctrines have failed to adequately protect consumers hurt by defective products.Warranties and Product Liability 297 The early cases rising out of strict liability holdings for ultra-hazardous activities lead to the first signs of holding businesses liable for the harms created by their products. both common and UCC.

. 4) Punitive damages can be allowed with intent or seeking disregard for safety. Strict Liability-Specific Considerations 1) All parties in the chain of distribution are strictly liable for the injuries caused by the product. Finally. products based on built-in liability insurance costs makes U. but the pain and suffering losses coupled with potential punitive damages have inspired too many consumers to sue. Conversely.S. Technology never has been and cannot be expected to be one hundred percent precise.S. and to require more is to impose 20/20 retroactive hindsight. the enhanced cost of U. This diminished participation in the worldwide marketplace hurts all of us. The present day procedural rules have allowed a deep pocket mentality to set in.298 Chapter 19 b. The potential harm created by products is dependent on the state of the art at the time. The rules of product liability in the U. employees and the like (possibly bystanders). there is a prevailing "lottery" mentality as a result of large damage awards from product liability costs. d. 3) Sellers and lesser are liable to the ultimate user or consumer including family members. Contemporary Issue: Restatement of Torts Definition of Strict Liability This discusses Section 402A of the Restatement (Second) of Torts) and the Restatement (Third) of Torts). 2) Priority of contract is not required. guests. Rules like joint and several liability of cotortfeasors allow an entity with only a small percentage of responsibility to be liable out of proportion to that level of responsibility based only on their financial resources. c. Many socially beneficial products are kept out of the U. marketplace because of fears raised by our product liability system in the eyes of potential importers.S. compared to those of Japan illustrate this point. products less competitive overseas. The harm one suffers may be minimal.S.

did a defect cause the harm? Decision: The doctrine was adopted and Dolinski wins. Dolinski Facts: Dolinski purchased a bottle of “Squirt” and began to consume it. After drinking a portion of the contents. case authority in most other states is the opposite. Issue: Should the doctrine be adopted. The plaintiff still must prove that his injury was caused by a defect in the product and . the trial adopted it and ruled in favor of Dolinski. Dolinski sued Shoshone under the doctrine of strict liability. and if so. Dolinski suffered physical and mental distress and had an aversion to soft drinks. The Court Speaks: Shoshone Coca-Cola Bottling Company v. part of a decomposed mouse was discovered in the bottle. Shoshone appealed. design. Upon examination. he became ill.Warranties and Product Liability 299 The most common types of defects are defects in manufacture. Reason: Public policy demands that someone who places a bottled beverage in a dangerous condition on the market be strictly liable for harm resulting from usage. and packaging and failure to warn. Although Nevada had not previously recognized the doctrine. Even though Shoshone argues that only the legislature can adopt such a policy.

Senco appealed. Higgins sued Intex based on strict liability. John Lakin was using a Senco SN325 nail gun to build a new home.expectation test requiring a showing of danger greater than an ordinary consumer would expect based on an alternative design. thus supporting the judgment? Decision: Yes. but spun around aiming at 7-year old Potter. Lakin and his wife won. Facts: Senco manufacturers and market a variety of pneumatic nail guns. Evidence showed the lack of a guidance or steering mechanism and that Intex made a Sno-Boggan with bottom ridges that prevented rotation. The Court Speaks: Lakin v. Decision: The two tests for design defect are the risk utility test requiring a showing that the likelihood and seriousness of harm outweighs the burden to the manufacture on a design that could have prevented injury. The judgment was affirmed. Inc. Intex Recreation Corporation Facts: Intex designed and sold the Extreme Tube II to ride down hills with no steering device at a speed as high as 30 mph. Issue: Was the Extreme Sno-Tube II defectively designed. Higgins was awarded 35% of damages after a jury finding of a design defect. Senco Products. The gun fired an unintended second nail that went through his cheekbone and into his brain. Lakin is permanently brain damaged. Higgins got Potter out of the way but was hit and thrown into a spinal cord injury leaving him a quadriplegic. . A reasonable jury could enter an expectation of rotation by a reasonable consumer. Falkner used it the day he bought it . There was sufficient evidence that the plaintiff met his burden of proof. The Court Speaks: Higgins v. Issue: Is Senco liable to Lakin for strict liability based on a design defect in the SN325 that allowed it to double fire? Decision: Yes. The rider could end up going down backwards. Lakin and his wife sued Senco for strict liability based on design defect.300 Chapter 19 such defect existed when the product left the hands of the defendant. and the consumer. Reason: The court of appeals applied the risk-utility analysis and held that the SN325 was defectively designed and affirmed the award of damages to Lakin and his wife.

Summary judgment was granted. He tried a back-flip and accidentally landed on his head and neck resulting in paraplegia. Judgment was affirmed. This was the only seat having only a lap belt. and not the combination lap belt and shoulder harness present in the other seats. An accident occurred where a truck in front of them rear-ended a truck in front of him. In this case. Facts: 16-yr. Jump King. There is no such duty for open and obvious dangers that are common knowledge to the ordinary observer or consumer. The summary judgment order was affirmed.Warranties and Product Liability 301 Ethics Spotlight: Design Defect in Pool Equipment This deals with a punitive damage award against Sta-rite. Johan would have not suffered the extra severe injuries. . The warnings were adequate. There was no adequate warning by Ford of the potential severity of the belt and the better combination seat belt should have been installed. The trial court granted summary judgment to Overhead. The Court Speaks: Glenn v. Ford appealed. The Court Speaks: Crosswhite v.old Gary and another boy were jumping on a trampoline owned by the and manufactured by Jump King. He agreed that the opener should have had a sensor and warnings should have been given about the dangers of a closed door. Jump King moved for summary judgment. Johan sued the truck owner “TCT) and Ford. Issue: Is Jump King liable for strict liability based on either design defect or failure to warn? Decision: No. Additionally there are many warning labels all over the trampoline and there is a manual provided. The garage door and garage door opener was manufactured by Overhead. Reason: Doctors said had the combination belt been worn.old< Johan. the risks were known. Reason: To prove failure to warn one must show that the user was ignorant of the danger. The child died from carbon monoxide poisoning. The Court Speaks: Karlsson v. Gary sues for damages based strictly liability from a design defect and failure to warn. but recovered except for Johan who was left a paraplegic. Reason: No evidence was presented to support defect in design. Issue: Was Overhead liable under the doctrine of strict liability for either design defect or failure to warn? Decision: No. old in a closed garage with the car running. Issue: Was there a design defect in the minivan and did Ford fail to warn of the defect? Decision: Yes. immediately in front and struck the minivan. The child’s father sued Overhead for strict liability based on design defect and failure to warn. Overhead Door Corporation Facts: Glenn left her 3-yr. Inc. The trampoline was and could be used for its design purpose-jumping. was riding in the middle seat. A large steel coil fell off the truck. Ford Motor Company Facts: The Karlsson’s owned a Ford Windstar minivan in which 5-yr. He settled for $10 million with TCT and was awarded $30 million from Ford in a strict liability suit based on design defect and failure to warn. All 6 Karlsson’s were injured. awarded in a personal injury lawsuit.

The case was appealed to the U. Elsroth. and reshelved it at the A&P. could not have been prevented by these steps as so recognized by the FDA. . The judge reduced the $79. however. Reason: Tylenol was marketed in tamper-resistant packaging with a foil seal glued to the mouth of the bottle. Note: In product liability cases.5 million.5 million to $32 million.302 Chapter 19 The Court speaks: Elsroth v. Issue: Was there a defect in packaging that would support an action for strict liability? Decision: No. sued McNeil and the A&P under strict liability for $1 million in compensatory damages and $92 million in punitive damages. The claim of strict liability was not upheld.S. The Oregon Supreme Court denied review. a “shrink seal” around the neck. The jury agreed and awarded $821. They are meant to punish. Supreme Court. The Tylenol was manufactured by McNeil under the name of Johnson & Johnson. Both sides appealed. tampered with it.000 in compensatory damages and $79. and a glued shut sealed box. Johnson & Johnson Facts: Harriet bought Extra-Strength Tylenol from the A&P. The jury was permitted to consider the harm caused to others (not parties to the suit). No packaging can boast of being tamper proof. resealed it carefully. administrator of Diane’s estate.5 million in punitive damages. This is the type of packaging reasonably contemplated by the ultimate consumer and not unreasonably dangerous. The appeals court restores the $79. Whoever did it bought it. a court can award damages if it finds that the defendant’s actions were done with intent or reckless disregard for human life. Williams Facts: Williams died because of his cigarette smoking. Williams’ personal representative sued PM alleging deceit and knowingly misleading that cigarette smoking was safe. She was found dead from a lethal dose of potassium cyanide found in the Tylenol which was tainted after leaving the manufacturer’s control. The Supreme Court speaks: Philip Morris USA v. The expert tampering here. He favored Marlboro which are produced by Philip Morris ISA (PM). Diane took two capsules with water for a headache while visiting Harriet’s house (mother of Diane’s boyfriend).

One cannot deliver title to stolen goods so no title can be delivered to Redmond. Express Warranty 19. Redmond does not win except for return of money. The statements on the tags and in the salesman’s assurances constitute such a warranty. This would only lead to jury speculation. Ethics Spotlight: General Motors Liable For Design Defect This discusses the case of the defective design and placement of the Chevy Malibu fuel tank. Answers to Critical Thinking Cases Warranty of Title 19. A $1 billion punitive award damage award was granted. This is a standardless dimension in the punitive damages equation. Reason: The Due Process Clause forbids use of punitive damages against a defendant if based on injuries to nonparties.2.200 because the sale involved fraud and a void title (or no title). The defendant cannot defend against a charge for nonparties. This can be used to show reprehensibility but not to calculate damages to a nonparty.1. III.Warranties and Product Liability 303 Issue: Did the Oregon court unconstitutionally punish PM by allowing the jury to consider harm to non-party victims when awarding punitive damages? Decision: The wrong standard was permitted. An express warranty is created when a seller makes an affirmation that the goods meet certain standards. Redmond will be able to recover the $6. The case was remanded for use of a correct standard. .

3. Maybank should win.. In determining whether this warranty has been breached. there is a breach of an express warranty. Implied Warranty of Merchantability 19. The disclaimer is set out in large type and the section is clearly labeled “Warranties.” If the disclaimer is in writing. The court held that the UCC applies to contracts for leases. Ansul’s disclaimer is enforceable. in the same way it applies to contracts for the sale of goods. it must be conspicuous. . the warranty for fitness for human consumption has been breached. The consumer expectation test holds that when food contains a substance other than what the consumer might reasonably expect to find in the food. Ingersoll-Rand Company. Because the presence of the clamshell in Keperwes’ soup did not fail the consumer expectation test. Ingersoll-Rand is not liable for the breach of implied warranty of merchantability because it properly disclaimed any such warranty.4. Cole Energy Development Company v.6. Implied Warranty of Fitness For Human Consumption 19.2d 872 (Fla.Ill.304 Chapter 19 Statement of Fact or Opinion 19. requires a car to be fit for normal use (driving). neither Publix Supermarkets nor Doxsee are liable for Keperwes’ injury. the court found in favor of Publix and Doxsee. however. the disclaimer clearly mentions merchantability. Publix Supermarkets. 1988). No. 208 (C. The implied warranty of merchantability. 534 So.D. Disclaimer of Warranty 19. In the agreement between Ingersoll-Rand and Cole Energy. Cole Energy was not able to recover. Thus under this theory Crothers should win. 678 F. Because Ingersoll-Rand had properly disclaimed the implied warranty of merchantability. There is definitely a breach of the implied warranty of merchantability as the bulbs were not fit for normal use. the court found no breach of warranty of fitness for human consumption. Inc. 1988). Because Keperwes’ injuries were not a result of a breach of warranty.7. Disclaimers of the merchantability warranty must specifically mention the term “merchantability. the court followed the consumer expectation test. If the bulb was not safety coated.App.5. Keperwes v.” This passes the UCC test for conspicuousness. No.Supp. Disclaimer of Warranty 19. The disclaimer was in writing and it was clear that any warranty except that stated was not in effect. The issue of being conspicuous might be in question but it was clearly stated on the back of the last page. This implied warranty is incorporated into the implied warranty of merchantability. The statement that the car was a “good runner” may be considered of opinion. The court held that the presence of an occasional piece of clamshell in a bowl of chowder is so well known to a consumer that it can be reasonably anticipated.

Alaska. Jeppesen and Company. The court held Jeppesen strictly liable for damages for the deaths of people killed in the airplane crash. argued that the landing charts it produced for pilots to use were not a product. and be treated as a cost of production against which liability insurance can be obtained. Yes. Emerson Electric Co. Jeppesen.e. the error stemmed from the incorrect data supplied by the Federal Aviation Administration. and that the consumer of such products is entitled to the maximum of protection at the hands of someone. poses a danger to bystanders like Pearce that exceeds the expectations of the ordinary consumer. the defendant. is strictly liable to Pearce. (2) a causally related defect existed in the product at the time it left the manufacturer’s possession and control. with the ordinary knowledge common to the community as to its characteristics. Jeppesen argued that it should not be liable because it is without fault in this case. Under Oklahoma strict liability law. has undertaken and assumes a special responsibility toward any member of the consuming public who may be injured by it.9. that reputable sellers will stand behind their goods. The court awarded . Since there was sufficient evidence to support plaintiff’s version of the accident. and therefore the doctrine of strict liability did not apply. A product is unreasonably dangerous if it is dangerous to an extent beyond that which would be contemplated by the ordinary consumer who purchases it. i. The court held Jeppesen strictly liable for the deaths caused when the airplane crashed into the mountain.2d 1288 (9th Cir.10. The court held that the landing charts were a product. The court held that bystanders like Pearce were protected by the doctrine of strict liability. in the case of products which it needs and for which it is forced to rely upon the seller. The warranty and the disclaimer were in writing and conspicuous. subjecting Jeppesen to the doctrine of strict liability. the court was easily persuaded that the device itself. holding that the concept of fault has been purged from the doctrine of strict liability. 767 F. and the proper person to afford it are those who market the product. the doctrine of strict liability applies to this case. Strict Liability 19. which was not included in Jeppesen’s landing chart for the aircraft at Cold Bay.8. No. Failure to Warn 19. Punitive damages may be assessed against a manufacturer whose conduct reflects reckless disregard for the public safety. a plaintiff must prove three elements to recover on a theory of the manufacturer’s product liability: (1) the product was the cause of the injury. The court rejected this argument. that public policy demands that the burden of accidental injuries caused by the products intended for consumption be placed upon those who market them. The court stated: The justification for strict liability has been said to be that the seller. The doctrine of strict liability applies to products but not the provision of services. Brocklesby v. and that all parties in the chain of distribution of a defective product are liable to the injured party without regard to fault.. 1985). Yes. and (3) the defect made the product unreasonably dangerous to the plaintiff or his property. at an uncontrolled 180 degrees.Warranties and Product Liability 305 Disclaimer of Warranty 19. that the public has the right to and does expect. by marketing his product for use and consumption.

1974). Although a condition may not be the “normal” or intended use of a motor vehicle. Olson Corp. 1972). Here. The court rejected this assertion. Inc. Yes. The defect in design consisted of placing the fuel tank in a vulnerable location in the back of the station wagon and outside of the crossbars of the frame of the vehicle. The court held that there was a defect in the design of the Chevrolet station wagon in which Christine was seated.. Karns v. Where a manufacturer or supplier of a product is or should have been aware that a product is unreasonably dangerous absent a warning and such warning is feasible. Crashworthiness Doctrine 19. 42 C. as an incident of normal operation in the environment in which his product will be used.. the court held that General Motors could have produced a safer alternative design merely by placing the fuel tank underneath the station wagon between the crossbars of the frame. 104 Cal. is strictly liable to Virginia Burkes.306 Chapter 19 Pearce $1 million in compensatory damages and $1 million in punitive damages against Emerson Electric Co. The design and manufacture of products should not be carried out in an industrial vacuum but with recognition of the realities of their everyday use. strict liability in tort will attach if appropriate and conspicuous warning is not given.App. General Motors asserts. E. The court ordered a new trial in this case.A. From this duty it follows that a motor vehicle manufacturer must take into account the possibility of a high-speed collision when it selects a location for the fuel tank in the vehicle. Failure to Warn 19. This location left the fuel tank exposed to the dangers of a collision from another vehicle.Rptr.12. In this case. We agree that strict liability should not be imposed upon a manufacturer when injury results from a use of its product that is not reasonably foreseeable. including high-speed collisions between vehicles. accidents will occur. the likelihood that injury will occur. 116 Cal. Almaden Vineyards. A defect in the design of a product will support an action for strict liability. J. The manufacturer must evaluate the crashworthiness of its product and take such steps as may be reasonable and practicable to forestall particular crash injuries and mitigate the seriousness of other problems. the manufacturer is required to design its vehicle to minimize unreasonable risks of injury and death. stating that this theory had been repudiated in Cronin v. Yes. the courts consider the gravity of the danger posed by the design.. 3d 121. Rptr. The court held that Almaden was aware of the dangerous propensity for plastic corks in its champagne bottles to spontaneously eject from the bottle and . the availability and cost of producing a safer alternative design. Because of this possibility. 575 (Cal. General Motors Corporation. 817 F.11. no evidence was produced to show the station wagon was unsafe for its intended use—operation on the highway. 433 (Cal. vehicle manufacturers must take accidents into consideration as reasonably foreseeable occurrences involving their products. Smith v. 8 C. the Chevrolet station wagon was a defective product. and social utility of the product. General Motors contended that defective design was not properly at issue in the case because a design is defective only if it results in a product that is unsafe for its intended use. The court held that a motor vehicle manufacturer is required to foresee that.2d 1452 (1987). Emerson Electric Co. B. where the Court stated: The argument that the van was built only for “normal” driving is unavailing.3d 1. In evaluating the adequacy of a product’s design.

and was not intended to be used to lift a 1. there was an implied warranty of fitness for a particular purpose that was breached. Keith v. Buchanan. such as using glue or other adhesive. Horn v. 1975). The court held Almaden strictly liable to Burke. unexpected. The law of strict liability provides that the abnormal or unforeseeable misuse of a product by a plaintiff relieves the manufacturer from any liability for any injuries caused by that misuse. Since Swan knew of the specific purpose for the cooker and Troy was to use an expert to build it.Rptr. 1976). 1985). Thus. Keith wins. 17 C. and is not liable in strict liability for an unforeseeable. Almaden Vineyards. The court held that there were safer alternative methods of attaching the horn cap. Horn wins. Burke v. The use of the hook in this manner by Dosier was an unforeseeable and abnormal misuse of the product that relieved Wilcox-Crittendon from strict liability for any injuries suffered by Dosier when the hook broke and crushed his arm. 19.13. 419 (Cal.App.Warranties and Product Liability 307 failed to warn of this danger. and (3) the plaintiff’s undertaking of the risk was unreasonable.Rptr. An affirmative fact that is the basis of the bargain is an express warranty. the failure to warn against this danger constituted a defective product for which strict liability would lie. Misuse 19. A manufacturer or seller of a product is entitled to assume that the product will be put to its intended use. The hook in this case was intended to be used to tie animals to fences. 1978). the defendant must prove that (1) the plaintiff knew and appreciated the risk. etc. unintended. an early ricochet of the cork could produce harm to someone hit by the cork. depending upon bottle temperature. These representations are a basis of the bargain unless the seller can prove that the bargain did not rest on the representations. Inc.3d 13. At such speeds. Wilcox-Crittendon Company.700-pound counterweight into the air. If . an express warranty was created.App.3d 74. 150 Cal.A. 220 Cal. Dosier v. The court held that General Motors was strictly liable to Horn for her injuries.App.Rptr.App. 119 Cal. posts. Defendant Wilcox-Crittendon Company wins. Therefore.14. 45 Cal.. 86 C. For the defense of the assumption of risk to apply. These statements in the brochure are affirmations of fact. This the seller did not do. 173 Cal. Statements in brochures can be affirmations of fact and can be considered part of the bargain. 78 (Cal. The court held that the defense of assumption of the risk did not apply in this case because Horn was unaware of the three hidden prongs underneath the horn cap so therefore could not have knowingly or voluntarily have assumed the risk.3d 768. statements of opinion are not. Assumption of Risk 19. The court held that Almaden was aware of this danger and failed to warn against it. (2) the plaintiff voluntarily assumed the risk.15.App.3d 359. Evidence showed that a plastic cork will eject itself when the wire seal is removed within 3 to 60 seconds at speeds between 37 and 49 miles per hour. 131 Cal. 135 (Cal. The court held that the method used by General Motors to attach the horn cap to the steering wheel of the Chevrolet station was a design defect. with no pressure on or twisting of the cork and agitation of the bottle’s contents.16. or abnormal misuse of the product. 392 (Cal. IV: Answers to Ethics Questions 19. The court next rejected General Motors’ asserted defense that Horn had assumed the risk of being injured by the three sharp prongs underneath the horn cap. General Motors Corporation.Rptr.

The lower court held in favor of plaintiff.308 Chapter 19 Troy truly believed that he had complied. thus compromising the effectiveness of the tool’s safety lock and brakes. Holding Yes. The finding of fact was deemed reasonable by the Court of Appeals. it moved forward and injured plaintiff. C. The plaintiff. Answer to “Briefing the Case” Writing Assignment: 1. Issue Was the product. B. denying liability is not an ethical issue. Citation. D. Key Facts A. unreasonably dangerous so as to allow a determination of product liability? 4. 607 So. Case Name. there is an ethical problem.17. The defendant appeals. The patent defect does not relieve the potential ethical duty to keep the product safe. Johnson. and Court Johnson v. Chicago Pneumatic Tool Co. No. When a 50 gallon drum made contact with the pipe jack.2d 615 (1992) Court of Appeals of Louisiana 2. McDermott had modified a clutch safety device by welding it shut. This accident could have been prevented had the original safety device still been in place. The law is a minimum and ethical conduct might require more. The lower court’s in favor of the plaintiff. 3. was unreasonably dangerous. . One of the tools used by McDermott was a pipe jack device manufactured by the defendant. was upheld. as modified. 19. V. If not. 5. C. as modified. thus entitling him to damages for product liability. D. Plaintiff claims that the product. The product as originally designed had reasonable safety devices.. Inc. E. Court’s Reasoning The Court of Appeals of Louisiana held that: A. B. Johnson. was employed by McDermitt. In the course of implementing this tool. The modifications created an unreasonably dangerous product. as a pipe worker.

There is far more to this than just checks but using the check helps the student relate this material to the one negotiable instrument he or she is most likely to have personal contact with. Another problematic misconception held by first-time students of negotiable instruments is the difference between negotiability and legality. and extension of credit. at the beginning. as a form of payment. it is critical that the elements of negotiability be identified and in place before these documents are passed to third parties. extension of credit. Finally. Remember. is premised on the risks inherent in the use of large amounts of cash for travel. indorsements. Using the check process as the focal illustration throughout the entire set of materials on negotiable instruments seems to help make the material a little easier to understand. the traveler’s check. yet undeniably essential to the conduct of both personal and business affairs. Money simply does not work as well as negotiable instruments for purposes of convenience.Negotiability and Transferability 309 Chapter 20 Negotiability and Transferability How Do You Make A Piece Of Paper Into A Substitute For Money? I. HDC. and so on help make the material more manageable. Out of this process. If students understand. An entire financial services industry. Because this area of the law is so complex. This visualization helps them to spot the point in the process where things may have gone wrong and who may be responsible. Those same concerns apply to the commercial marketplace. and the mechanics of the negotiation process. Teacher to Teacher Dialogue Many first-time students of law find this group of materials on negotiable instruments to be the most difficult part of the course. is not always practical or wise. the study of commercial paper is best begun with an introduction to key terms. then you have gotten them off to the right start. one can readily see that use of cash. In addition. In addition. Negotiable instruments are important money substitutes. checks do remain the single most important form of money substitute. the players who use those terms. recordkeeping. strongly encourage them to diagram the negotiation process for each case. These mini-outlines on the elements of a negotiable instruments. and recordkeeping. that this material is frustrating to all. that special sets of formalized contracts are being used as a substitute for money. Many students proceed to duly memorize the . and as such. safety. encourage students to get into the habit of using key question checklists for each of the major subjects covered in these chapters.

Nor is it necessarily barred from being enforced as a contract. Nonnegotiability does not ipso facto preclude legality.310 Chapter 20 elements of negotiability and learn how to identify them in an instrument. The following flow diagram might help: NEGOTIABLE INSTRUMENTS (IN REVERSE)* Substitute for money None or very few defenses to acceptance as a substitute for money Special holder (HDC) Holder Transfer Elements of negotiability Paper . Even though an instrument may fail to meet the requirements proscribed by the UCC for negotiability. Having done that. they proceed to declare an instrument that lacks a missing critical element of negotiability as legally null and void. that fact does not render it illegal.

Text Materials Important Definitions: 1. 2. The holder is one in possession of paper payable to that person as payee or indorsee or one in possession of bearer paper. 5. The indorser is one who makes an indorsement on an instrument. II. . 8. The maker is one who makes a note.Negotiability and Transferability 311 *Start by asking questions in reverse (per diagram above) and when done reverse order to see what has been done. The bearer is one in possession of bearer paper. Refer students to spot in diagram under study. if at all. The drawer is one who draws a draft. 3. The indorsee is one to whom indorsement is addressed. 7. The drawee is one ordered to pay a draft. 4. draft or check. 6. The payee is one to be paid in either a note.

.312 Chapter 20 Landmark Law: In 1990 Article 3 was replaced with Revised Article 3. This was a comprehensive revision.

Negotiability and Transferability 313 .

acceleration.314 Chapter 20 The inclusion of prepayment. . or extension clauses does not affect negotiability.

Negotiability and Transferability 315 .

BayView became a successor to FMAC with respect to all of these and then assigned its interest to LLMT.316 Chapter 20 The Court speaks: FFP Marketing Company. v. FFP Operating failed to make payments on the notes. Loan and security agreements were also executed. LLMT file suit against FFP Operating and FFP Marketing and also filed a motion for summary judgment. Reason: The notes were not negotiable instruments because they were conditional on obligations contained in other documents. Long Lane Master Trust IV Facts: FFP Operating executed 31 promissory notes in favor of FMAC and FFP Marketing executed guaranties of payment in favor of FMAC for all of the notes. Issue: Are the 31 promissory notes negotiable instruments that can be enforced against FFP Marketing? Decision: No. The decision was reversed and the case was remanded to be tried on the merits using contract law. Inc. The sum certain requirement fails because one cannot determine from the face of each note the extent of the maker’s liability. LLMT gave notice of acceleration and demanded payment but to no avail. FFP Marketing appealed. Summary judgment was entered in favor of LLMT against FFP Marketing. . FFP Operating declared bankruptcy and was nonsuited. The notes incorporated all of the agreements by reference.

International Law: Negotiable Instruments Payable in Foreign Currency Instrument may state it is payable in foreign money. Issue: Is the 1792 document a negotiable instrument? Decision: No and the statute of limitations had run on a contract claim. a USA military officer. Witness the use of the previously mentioned travelers . Contemporary Issue: Variable Interest Rate Loan Revised Article 3 recognizes variable interest rate notes as negotiable instruments and reflects modern commercial and banking practices.Negotiability and Transferability 317 Contemporary Issue: Signature by an Authorized Representative A maker or drawer is liable on a negotiable instrument signed by an authorized agent. USA never made good on its promise. usually satisfied by the equivalent in U. substantial risks inure with its use. indorse it. Because this method is openended. The first path of transfer is by physical possession of the instrument if the document is designated as bearer paper.000.S. dollars. These are loans by lenders where the interest rate on the loan varies throughout a portion or entire period of the loan. It only takes a legal physical transfer. Bearer paper is negotiable by delivery of the document. Think of it as analogous to money. and the Oneida tribe of Native Americans in 1781 whereby blankets were promised in exchange for Revolutionary War assistance. Deeks filed a complaint alleging the document was a negotiable instrument and that Deeks was due an estimated $3. United States Facts: Deeks possesses a 1792 document evidencing an agreement between Willett. The claim was dismissed and Deeks appealed. You do not have to sign it. or in any way change the paper itself to change ownership.000. The Court speaks: Deeks v. Assignee acquires only the rights that the assigner possessed. Reason: The text reveals neither an intent that it be circulated as money nor an unconditional promise to pay a certain sum.

qualification. All indorsements have three elements and should be examined in light of these three subcomponents: name. there are the collateral issues of agency and special situations.318 Chapter 20 checks as testimony for the dangers of using bearer-types of exchange. but also indorsements. Contemporary Issue: Payable to Order or to Bearer ORDER OR BEARER Order Bearer Payable to order of a person To a person or orders (This box further explains order and dearer paper. The second method allowed by Article 3 involves order paper. A document has been made payable to a specific payee or indorsed to a specific indorsee. further negotiable transfer to a third party calls for not only delivery as required for bearer paper. The same dangers apply to bearer negotiable instruments. and restriction. As such. In addition.) or Payable to person in possession .

. See “Types of Indorsements” below. Note: Words of negotiation are not requires for a special indorsement.Negotiability and Transferability 319 Contemporary Issue: Converting Order and Bearer Paper The deciding factor in converting order paper to bearer paper is the type of indorsement placed on the instrument.

320 Chapter 20 An indorsement that purports to prohibit further negotiation does not destroy the negotiability of the instrument. Imposter or Fictitious Payee One who impersonates a payee and induces issuance in payee’s name Contemporary Issue: Multiple Payees or Indorsees Person signing intends no interest for the named payee .

Briggs. because the maker of these instruments is promising to pay the payee himself. Broadway Management Corp. Note 20. 1079 (D.Cal. promised to pay the payees.” The note also states that the promise to pay is made “to the order to CALIFORNIA DREAMSTREET.N. Bailey was a negotiable instrument.D. 332 N. $65. The mere acknowledgment of a debt or an implied promise to pay is not sufficient. v. The language in Dr. 1981).000 because the McGuires promised to personally pay the payees. the note executed by Dr. 1989). by not ordering a third party to pay them. The note in this was an order instrument with an unconditional promise to pay. To be a negotiable instrument.” Although this language is somewhat unusual in that most order instruments are made payable “to the order of. 509 F. Bailey’s note was unambiguous in stating that he “promises to pay. drawer or maker is liable to anyone who. pays the instrument or takes it for value or for collection. Commercial paper.2. The Imposter Rule says the named payee. a writing must contain either an unconditional promise. in good faith. a promise to pay must be an affirmative undertaking. III. Joint needs both.Negotiability and Transferability 321 This box addresses the question of whether one payee or indorsee can negotiate an instrument or whether all signatures are required to negotiate an instrument. Forged indorsements are usually wholly inoperative: The Fictitious Payee and Imposter Rules The fictitious payee rule says that a drawer or maker is liable on a forged or unauthorized indorsement of a fictitious payee.Supp. this promissory note can be described as a promise to pay. Drafts and checks are orders to pay since the drawer orders the drawee to pay the payee. Negotiable instruments must also be payable either to order or to bearer. McGuire. .” the court determined that the note should still be classified as an order instrument. v. 1975).3. Alternative needs one Virgule (slash mark) needs one.2d 131 (Ill. App.A. In this case. P P Inc. the Tursis. Cooperative Centrale Raiffeisen-Boerenleenbank B. or order to pay. Bailey.J. Negotiable Instrument 20. Therefore. Answers to Critical Thinking Cases Type of Negotiable Instrument 20. such as promissory notes. Bailey’s note was both a promise to pay and an order instrument. v. the McGuires. In contrast.E. These are checks. the maker of the note.4. The use of the words “order” or “assigns” usually indicates that a note is an order instrument. can be classified as either orders to pay or promises to pay.1 A check is an unconditional order to pay the payee a sum certain on demand and drawn on a financial institution signed by the drawer. Bearer or Order Instrument 20. Dr. promissory notes and certificates of deposit are promises to pay. Yes. 9 UCC Rep Serv 2d 145 (C. The note signed by McGuire was a promise to pay. An instrument is an order instrument if it is payable to the order or assigns of any person specified with reasonable certainty. A confession of judgment could not be obtained on a note where the holder could not be determined from the face of the instrument because it was an incomplete order instrument and unenforceable until completed. To be negotiable.

despite the letter of authorization. The check that Holsonback used to pay for the Corvette was a negotiable instrument. Yes. Serv. it could not cause the instrument to become negotiable. Thus.2d 1144 (N.M. Progressive Bank & Trust Co. Demand Instrument 20. Holsonback v.6.2d 589 (La. In this case. 1980). and that the language which indicated the note was a demand note was controlling.” Since the monthly installments provided for in the note did not destroy the demand nature of the instrument. . The court in this case held that the note was payable on demand. the promissory note signed by Blanchard was a demand instrument. Any writing that is placed on an object that is small enough to be easily handled qualifies as portable. First State Bank of Gallup v. Yes. Blanchard v. The court also held that the letter that authorized Clark to pledge the note did not make the instrument negotiable. and portable. First State Bank of Albertville. payable at sight. The portability requirement is intended to insure free transfer of the instrument. Among the requirements is that the note contain an unconditional promise or order to pay. The UCC requires that an instrument be payable either on demand or at a definite time. The court held that despite the letter of authorization. The requisite writing is often on a preprinted form. The court reasoned that one must look only to the face of an instrument to determine whether it is negotiable. The note was not negotiable. 1977).322 Chapter 20 Formal Requirements 20. payable upon presentation.5. permanent. 413 So.7. The Court stated: “The notation [about monthly payments] was indicative of a collateral agreement made by the parties to provide for monthly installments but did not destroy the demand nature of the note. Since the authorization letter signed by Horne was not part of the instrument itself. The UCC sets forth a number of requirements in order for an instrument to be classified as negotiable. it met the requirements of the UCC for a negotiable instrument. 222 (Ala. The check was a writing on a paper object. the note was nonnegotiable. Unconditional Promise 20. Most writings on paper meet the permanency requirement. the court held that the promise to pay contained in Horne’s note was not unconditional. Yes. (2) be permanent. an envelope that was standard sized making the check easily portable. 570 P. It found that the note was payable on demand and that the language which referred to monthly payments was an additional agreement. Clark and Horne. since the check was in writing. and those instruments that have no specified payment date. a check printed on an envelope meets the requirements of the UCC for classification as a negotiable instrument. the restriction written on Horne’s promissory note made it nonnegotiable. Demand notes include those instruments that are payable on demand. Three requirements are necessary for a negotiable instrument: (1) the instrument be in writing. the note was a demand instrument. The UCC also states that these requirements appear in writing on the face of the instrument. and (3) be portable.. 1982). because of the restrictive term on the face of the instrument. 30 UCC Rep.App.

the note is not conditional and is negotiable. A specifically indorsed instrument must be indorsed by the one to whom it is payable before it becomes negotiable. A demand instrument is one that is payable on sight or on demand. can be classified as either time instruments or demand instruments. Calcasieu-Marine National Bank of Lake Charles. The purpose stated on the check does not limit its negotiability. Commercial paper.14 Standard wins since it took the note for value by performing the agreed upon consideration. Order or Bearer Paper 20. Reference to Another Document 20. In this case. Mullins wins the case. this special indorsement converted the check back to order paper.15. The check was order paper at the time CM National Bank accepted it.. Subsequently. or one for which no time payment is stated. Since there was no restriction in the indorsement. Reference to Another Document 20. The UCC states that an instrument is payable to the bearer when the only or last indorsement is in blank. 1967).9. It occurs when a holder pays money for a negotiable instrument. the bank could cash them. in itself. Under the UCC. Coltharp v. because the eight notes that the company executed were time instruments. In this case. Inc. set obligations but instead describes the security.2d 568 (La. St.12. Indorsement 20. Since there was room on the instrument and the signature was placed only on the attachments. Thus. such as promissory notes. this special indorsement converted the check back to order paper and the check became payable only upon indorsement of City Savings Bank. This converted the original order paper into bearer paper. when Coltharp specifically indorsed the check making it payable only to the City Savings Bank.8. Mullins had . Taking for Value 20. the court established that St. Coltharp’s intention that the check be converted into order paper was evident by his use of the words “pay to the order of” in his indorsement. Since the obligations are stated in another writing the notes are not negotiable instruments.10. IV: Answer to Ethics Questions 20. [UCC 3-108].11. Mary’s indorsement was in blank. 199 So. Here there was an indorsed check that was cashed.13. Since the mortgage does not. This is a negotiable instrument. Indorsement 20. the check was order paper at the time it was accepted by the CM National Bank. Mary successfully negotiated this bearer instrument when he delivered the check to Coltharp.App. the note was not properly indorsed. Therefore.Negotiability and Transferability 323 Order to Pay 20. The bank is not liable .

Murray clearly intended for his check to be made payable jointly to GE and Johnson. The use of the word “or” effectively creates an instrument payable in the alternative. v. By establishing the dates for payments. C. The lower court held in favor of Galt. The Federal Deposit Insurance Corporation was named the receiver.App. The Appellate Court upheld the trial court’s judgment in favor of Mullins. Inc. That company obtained a loan in the amount of $912. Donald Galt was an officer of the Woodside Construction Company. In this case. Key Facts A. were time instruments. Holding Galt signed in his personal capacity and is personally liable for the loan.324 Chapter 20 executed eight notes to secure loans made by the Corbin Bank. 641 S. 39 UCC Rep Serv 972 (N.16 Mullehnur signed individually and is liable as the note stipulates joint and several liability/ Ethically he used his name to secure financing and refused to pay. Murray indicated this intent on the check by using the word “and. Thus. Marine Midland Bank. the FDIC appeals. Galt alleges that he signed only in his agency capacity and is not personally liable for the note. This was probably just a legal dispute.Y.Sup. 1982). v. As the receiver. the dates and times of installment payments. 3. v.Ct. This is definitely unethical 20. a deed of trust. 20. Corbin Deposit Bank & Trust Co. An instrument which is payable in the alternative is payable if either party indorses it. An instrument can be payable to two or more persons either jointly or alternatively. . The use of the word “and” between two named payees creates an instrument which is payable jointly.2d 172 (1992) United States Court of Appeals for the Ninth Circuit 2. 1982 Ky. these notes were time instruments.17. D. B. then each person’s indorsement is necessary to negotiate the instrument. Issue Did Galt’s signatures on the documents constitute his personal signatures or only his fully disclosed agency capacity? 4. E. Inc. 979 F. Subsequently. Inc. Alaska National Bank merged into Alliance Bank. No. If an instrument is payable jointly. Lexis 264 (Ky.W. and the date of final payment. Case Name. the court ruled against the Bank’s interpretation of the note’s language and found that the eight notes in question. and a contract of guaranty. 1984). Mullins Enterprises. Citation. like most promissory notes. 2d 760. the FDIC now seeks to collect the loan from both Woodside and Galt personally.000 from Alaska Mutual Band that was evidenced by a promissory note. Each of these notes specifically sets out the amount of the debt. Johnson’s signature alone was not sufficient to negotiate the check to Midland. V: Answer to “Briefing the Case” Writing Assignment 1. a loan agreement. Murray Walter.” Johnson’s indorsement alone was not sufficient to negotiate the check to Midland since the check was made payable to two parties jointly. and Court Federal Deposit Insurance Corp. which was closed by the state of Alaska. App. Woodside Construction..

Negotiability and Transferability 325 5. In order for an agent to be not held liable personally for his or her principal’s instrument. Court’s Reasoning The United States Court of Appeals for the Ninth District held that: A. The order and placement of Galt’s signatures did not clearly designate him as signing only inn an agency capacity. he is personally liable for the loan contract. his signatures constituted hiss on personal signature. . B. and as such. thus. that agency capacity must be clearly designated on the instrument.

special forms of transferable contracts. Conversely. therefore.326 Chapter 21 Chapter 21 Holder in Due Course and Liability of Parties Is The Paper Always A Substitute For Money? I. however. duties. Back in contracts. to introduce the student to the unique UCC concept of holder in due course (HDC) and second. If someone hands the student an obviously fake dollar bill. That element is designed to say this: if the law wants instruments to be relied on as money substitutes. So too does the law of negotiable instruments create obligations which are subject to the purview of the courts in case of problems. the law would step in to adjudicate the rights. How. without this reliance factor. The focus of these two objectives. As such. Remind the students that negotiable instruments are. now turns to the third party who becomes involved with a negotiable instrument. *This chapter has two main objectives: first. These obligations are created out of the signatures of the parties and the warranties imposed on them by the UCC. but not total. the rules of transfer are overlaid and interwoven with the laws of contract breach and the like. Where there were problems with performance. The second objective of this chapter revolves around the life cycle of a negotiable instrument and how that cycle comes to an end. Teacher to Teacher Dialogue Because negotiable instruments are meant to be a substitute for money. and when will it not? Because any discussion of negotiable instruments is interwoven with their role as a substitute for money. a comparison with . Try to reach back into the student’s recent exposure to contract law. to illustrate the basic liabilities and defenses which arise out of the use of negotiable instruments. and obligations in light of the changed circumstances. protection for the taker in this second scenario? When put in this light. when. the law must protect innocent takers of those instruments in as many ways as possible. students start to appreciate the practical reliance element of the rule. Should there be a little more. the taker had no realistic way of knowing the history of who had prior ownership and involvement with that instrument before him or herself. should the law protect the taker? What if. and where will the UCC protect that third party. we talked about how most contracts came to an end by way of the parties living up to their respective performance obligations. a comparison to money is useful. the entire system would simply collapse like a house of cards. in reality.

The next objective of this chapter is to review the liability. nonetheless. That course may be just a matter of days in the case of a check. How those respective rights and duties finally fall into place at the point of discharge of a negotiable instrument is the second major objective of this chapter.Holder in Due Course and Liability of Parties 327 money may be useful. The first is found in the rights and duties arising out of the signatures of parties to the instrument. Negotiable instruments are a highly formalized and technically complex set of contracts used primarily as money substitutes. past abuses of HDC principles have led to some statutory overlay on the part of Congress through its delegation of regulatory authority to the Federal Trade Commission (FTC). . If someone hands you a dollar that is clearly a photocopy of currency. or many years as seen in long term notes. The HDC concept allows for a fundamental shift in the law in that. Think of them as duties that arise out of using the road of negotiation: if you go down this road. defense. an assignee steps into the shoes of the assignor. There are two main theories for attaching liability in negotiable instruments. and discharge aspects of negotiable instruments. So too does a negotiable instrument ultimately run its course. In addition. should you accept it in lieu of currency? Or should you be put on notice that there is a problem and act accordingly? The doctrine of holder in due course (HDC) is designed to protect good faith third party takers of money substitutes. but the responsibility to live up to them is there. These elements will be set in the chapter summary. These promises are not always actually expressed by the party against whom the warranties are imposed. In addition. The rules on discharge help make a judge’s job a little easier. Various states have also promulgated similar rules as outlined in the Uniform Consumer Credit Code or by case law. The degrees of protection afforded to third party takers of instruments begin with a comparison between the common law of contract and the UCC. as radical as this shift is from the common law of contract assignment. It may last a long time. The adjudication of the rights and duties of numerous takers of these instruments vis-à-vis each other is of critical importance through the entire spectrum of UCC studies. the taker will be free of all claims and most of the defenses which could otherwise be asserted by other parties having contact with the instrument. Paper money eventually wears out and needs to be taken out of circulation. No contract is forever. Warranties are promises imposed by the statute upon those who want to be players in this game. you want to buy only what you see and not get ambushed by potential lawsuits lurking in the bushes. The law of assignment simply does not cut off enough history and often allows third party takers of documents to be struck with legal entanglements that were not of their making. It is not designed to protect those who think play money is real and do not bother to learn the rules. remember that by their very nature. These rights and duties are essentially derived from contract law as modified by the UCC. the metamorphosis is not complete. The law of contract under this rule subjects the HDC of consumer credit paper to all the defenses and claims of the consumer. Under the common law. the law must provide some form of resolution. negotiable instruments are meant to be handled by many people. It is designed to create justifiable reliance on instruments where the elements of HDC are in place. In the end. you must follow the rules of the road. the FTC has stepped in by preempting the HDC rule. but it will end. Remember. As a buyer of commercial paper. The HDC still takes the instrument subject to a number of defenses called real defenses. The problem with this “what you see is what you get” philosophy is that it may not provide enough protection for third parties who may not be aware of the history behind the document. In the area of consumer credit transactions. Generally. The second source of liability is found in a set of warranties imposed by the UCC. he or she undertakes the assignor’s obligations and benefits from their rights. where its elements are in place.

No Evidence of Forgery. Without Notice of Defect: normally notice of defect is present if the instrument is overdue. does not include executory promise.328 Chapter 21 II. . In Good Faith: honesty in fact. knowledge of suspicious circumstances can be bad faith. Explanation of HDC Requirements Value: similar to consideration but includes past consideration. issued or indorsed to him or his order. a holder who does not qualify as a holder in due course in his or her own right becomes a holder in due course if he or she acquires the instrument through a holder in due course. or in blank. Text Materials Holder is a person who is in possession of a negotiable instrument that is drawn. has been altered. has a claim to it by another person or has a defense against it. contains an unauthorized signature. Defenses Holder Holder in due course Real defenses Real defenses and Personal defenses Under the shelter principle. Alteration or Irregularity: includes being irregular or incomplete enough to call authenticity into question. has been dishonored. case-by-case analysis. or to bearer.

Primary vs.Holder in Due Course and Liability of Parties 329 Signer can be: . Secondary Makers Acceptors Drawers Unqualified indorsers Needs: -Presentment -Dishonor -Timely notice of dishonor -Bank before next banking day midnight Others within 30 days of notice .Accommodation party Note: Signature can be any name. This could include trade names and other assumed names.Drawer . word.Maker .Agent . or mark used in lieu of a written signature.Accepting or certifying drawee .Indorser .

Grand Island sued both. Grand Island appealed. agent is not liable The Court speaks: S. sued the Husein’s. A take-nothing judgment was entered against the Co. Humphrey Facts: The Humphreys signed a line of credit promissory note with Grand Island. Mansuhlal & Company(the Co. The Huseins denied personal liability claiming their signatures were in representative capacities. Issue: Is Mrs. Husein Facts: The Co’ sold goods to Griffen which were delivered. Grand Island complied with the terms and was already committed to Mr. Mrs. The Co. Humphrey on the loan that occurred after her notice. Upon default.) v. Humphrey primarily liable as a comaker? Decision: Grand Island wins. 9 were dishonored for insufficient funds. The trial court did not hold Mrs. Contemporary Issue: Accommodation party signs an instrument lending their name and credit to another party: . Humphrey agreed to be liable on the note according to its tenor at the time she signed it. agent is liable to an HDC b) if payable from principal’s account. The Co. Reason: As a comaker. Humphrey for the new loan before her notice to them of the divorce. principal is bound 2) agent’s liability depends on information disclosed a) if representative capacity is not clear.Guarantee payments primary liability . Mrs. upon the latter facing financial difficulties requested that Griffen issue 10 negotiable instruments in favor of the Co.Guarantee collection secondary liability Agent’s Signatures: 1) if signature is authorized. Therefore. he could borrow more. Afterwards. . he was loaned more money.330 Chapter 21 The Court Speaks: Grand Island Production Credit Association v. Humphrey borrowed up to the limit and was told when he paid back a portion. The former. when Mr. sued but Griffen filed for bankruptcy. Mr. These were signed by Muhammad and Sultan Husein who were officers and directors of Griffen. Humphrey notified Grand Island that the couple was getting a divorce. Humphrey paid down the balance. Subsequently. who appealed. she is fully liable on the note.

The trial court judgment was affirmed. Issue: Ae the Huseib’s personally liable on Griffen. per [signatures of Muhammad Husein and Sultana Husein]. WARRANTIES Transfer Good title Good signatures No material alteration No defenses No knowledge of insolvency Good title No material attention No knowledge of unauthorized signature Presentment . the following appeared at the bottom: “Griffen. as an authorized agent. Inc. Inc. Reason: The form of the signature unambiguously shows that the signature is made on behalf of Griffen. Note: For material on forged indorsement.’s negotiable instruments> Decision: No.Holder in Due Course and Liability of Parties 331 Aside from the normal information on a standard check. see chapter 20 of this manual.

332 Chapter 21 Reasons for not accepting the paper as a substitute for money SELECTED DEFENSE EXPLANATIONS Forgery consider imposter and fictitious payee rules Material Alteration HDC can enforce original unaltered amount .

in spite of all the good reliance factors favoring the creation of the HDC status. Secondly. First. it may be preempted by the exercise of federal authority. Here. . Thus the FTC acted and eliminated HDC status in certain consumer credit transactions. abuses can and did occur in the consumer area. it can be used to remind students that many solid public policy reasons for any statute can be undermined by an abuse of the same.Holder in Due Course and Liability of Parties 333 Landmark Law: FDC Rule Limits HDC Status This serves a number of useful purposes. The old law about the Statute of Frauds being used to perpetrate frauds comes to mind. it can be used as a reminder that the UCC is not a federal but rather a state law and as such.

and the identity of the principal. 649. in good faith having taken a draft for value. Lexis 1926 (Ark. M&I is therefore an HDC and should win.2d 276. signing in his capacity as corporate secretary. which he later gave to Carlisle for payment on a debt. Smith.Supp. 594 S. 1985). Drawer’s Liability 21. the court found that Smith.334 Chapter 21 III. In this case. Lexis 446 (Mo. Southeastern Financial Corporation.2. v. Smith’s signature included the name of the principal and then the word “by. 688 S. Generally. Carriage House is liable on the checks as a principal. The Court of Appeals of Arkansas affirmed the trial court’s finding that Carlisle Distributing Co.S.. Federal. Answers to Critical Thinking Cases Holder in Due Course 21.4. 1975 U. with no notice that it had been dishonored. was a HDC of the draft.D. Dist. an HDC is the holder of a negotiable instrument that was taken for value. The court held that Federal could enforce payment of the note as a HDC. was a holder in due course of an $8200 check given by appellant.2d 748. 1985 Ark. The use of the word “by” to indicate agency status is clear when signing for a corporation because corporations can only sign negotiable instruments through its agents.W. App. Wildman Stores. without notice of defect or other irregularities and in good faith.. Inc. was an authorized agent for Carriage Homes. Inc. Holder in Due Course 21. 397 F. UAW-CIO Local #31 Federal Credit Union v. Federal had no notice of Royal’s stop payment order until the draft was returned. Royal Insurance Co. who properly indicated his agency status. dishonored. v.Ala 1975). in good faith. Federal wins since it can enforce payment of the draft as a holder in due course. In this case. Wildman Stores. 1980 Mo. Since the checks were signed by an authorized agent of Carriage Homes.000 in exchange for the instrument. Lexis 12624 (N. and without notice that it is overdue. 1980).. Federal was the holder of a dishonored draft in the amount of $12. thus taking it for value. Federal took the draft in good faith.000. To qualify as a HDC the transferee must meet the requirements set forth in the UCC. Inc. App. Principal’s Liability 21. . An authorized agent can sign a negotiable instrument on behalf of a principal and bind the principal to the instrument.” The court held that the use of the word “by” indicated Smith’s agency status.1 M&I took the check for value. to William Paladino. The agent is not personally liable on the instrument. Carriage Homes was a principal and solely liable for the checks. or encumbered in any way. a principal is bound to a negotiable instrument if the agent’s signature includes the principal’s name or if the agent’s name appears with an indication of the agency status of the signature.3. Federal had credited Terrell’s account $12.W. when an agent’s signature properly indicates his agency status. A draft is a negotiable instrument. having no reason to believe that the draft would be dishonored. Under the UCC. Carlisle Distributing Co.

Yes. Transfer Warranties 21. the court ordered Lee to make payment on the note to the note’s holder. An accommodation maker is an accommodation party who signs on behalf of a maker. Presentment Warranties 21. she is the object of fraud in the inception. he is still personally liable for the $85.8. and that the instrument has not been materially altered. the First National Bank of Azle breached its presentment warranty of good title. Smith Corporation. is an authorized agent of the corporation. as president of Village homes. 1988 Tex. James Valenti . The holder of an instrument can seek payment directly from the accommodation maker without first seeking payment from the maker. The agent has sole liability even if the other party has knowledge that the signature was made in an agency capacity.App. Matco loses. As an accommodation maker.6 The Banks win.5 Since Mrs.W. Longview Bank & Trust Company v.10. Merchant’s National Bank wins because Lee is personally liable on the note.2d 792. because he failed to indicate his agency status when he signed the note. A presenter of a negotiable instrument for payment warrants three things to the party to whom he presents the instrument.G. App. 1988). v. Thus. Liability of Accommodation Makers 21.W. but does not indicate either the principal’s name.Holder in Due Course and Liability of Parties 335 Maker’s Liability 21. 750 S. In this case. 1983 N.G. The presenter warrants that he has good title to the instrument. the court held that the Bank of Azle had breached the warranty of good title when it presented Waddell’s check for payment to Longview.9. he became solely liable for the note. because E. Paul is primarily liable. the agent has sole liability. This is a real or universal defense against enforcement by even an HDC. the bank breached the presentment of good title because the company still had good title to it when the Bank of Azle presented the check for payment without E.000.” The Bank of Azle did not have better title to the check than the E.D. Lee. First National Bank of Azle. When an authorized agent signs his name to a negotiable instrument.2d 297. Farmer Bank. In this case. As a maker she would have been liable.D. and has primary liability on the instruments he or she signs. since Lee is an authorized agent of Village Homes and signed the promissory note without indicating his agency status. but not in this case. In this case. Lexis 3377 (Tex. Since the indorsement is authorized. Authorized Agent’s Liability 21.D. or the fact that the signature is made in a representative capacity. Smith’s indorsement. Wright was deceived into signing the instrument. Thus. that he has no knowledge that the signatures on the instrument are unauthorized. Smith had not indorsed the check. Lexis 289 (N. Accommodation Party 21. James Valenti is liable as an accommodation maker.G. 333 N.7. Although Lee. 1983). Farmers & Merchants National Bank of Hattan N. A presentment warranty is “an assurance that no one has better title to the check than the warrantor. Pontiac was authorized to accept a check based on the letter sent.

Ct. Since Thompson had signed the promissory note as a result of Bates’ misrepresentation.Sup.Y. Federal Trade Commission Rule 21. may enforce such an instrument since fraud in the inducement is only a personal defense. he was able to assert the defense of fraud in the inducement.C. 465 S. the Court held that Fazzari had fulfilled this duty. 1961). Wade was an employee of Fazzari’s and Fazzari had no reason to suspect that Wade would attempt to defraud him. 1971). 1979 Conn. Imposter Rule 21. Central Motor Company v.12. because he signed on behalf of the maker of a note. Thompson relied on this misrepresentation when he signed the promissory note.13. Firsy National Ban of Boston.Y. The situation in this case is a classic example of fraud in the factum. The exception is the imposter rule where the drawer fails to control the check writing process to allow a check made out to an imposter. In that te case the drawer is liable. Since James was an accommodation maker. 2d 977 (Ma. 1971 Tex. James became an accommodation maker. Valenti. the Mahaffeys can assert the defense of breach of contract because of a rule promulgated by the Federal Trade Commission (FTC). Thompson. A holder in due course. This rule eliminates the HDC status with . The Court found that Thompson had successfully proved the elements of fraud. Ed Bates had knowingly misrepresented that the second note would have an 8 percent interest rate.2d 305. Although a person signing an instrument is under a duty to ascertain what he or she is signing.App.App. Fazzari. v. A negotiable instrument that results from this inducement is not enforceable against the defrauded party by the wrongdoer. Therefore. Knney & Reidy. 2UCC Rep. Fazzari was an immigrant who could not read English. Yes. McCarthy. First National Bank of Odessa v.14. Fraud in the inducement occurs when one person makes a false statement to another in order to induce that person to enter an agreement. 1961 N. James Valenti remained liable on the note as an accommodation maker. P.2d 493. Lexis 857 (N. Thompson wins since he can assert a defense of fraud in the inducement. Wade attempted to exploit Fazzari’s illiteracy by having him sign a promissory note that he represented as being a statement of wages.2d 405. Fraud in the factum occurs when a person is deceived into signing a negotiable instrument thinking that it is something else. when Amoco dropped its suit against John.H. 426 A.336 Chapter 21 signed a promissory note in favor of Amoco as a guarantee that his son would repay Amoco. Fraud in the factum is a real defense against the enforcement of an instrument by an HDC. the law firm is liable. he had primary liability on the note. 223 N.11 Generally a drawer is not liable for forged checks paid against the drawee. 2d 483. American Oil Company v. Therefore. 179 N. in this case.Y. however.W. Lexis 2634 (Tex. this personal defense was effective against their claim. J. Serv. Because Fazzari was the victim of fraud in the factum. 1979). Fraud in the Inducement 21. App. No. the Odessa National Bank cannot enforce payment of the note because Fazzari can assert the real defense of fraud in the factum. Fraud in the Factum 21. Lexis 973 (Conn.Sup. Amoco did not have to seek payment from John before it sought payment from James. 1986).E.S. Because Central was a holder of the instrument and not an HDC. the Odessa National Bank cannot enforce payment of the note.

278 A. Fentress had none of the city or state licenses required to engage in the profession of plumbing.J. App. Courts look to the circumstances of a transaction to determine whether a holder acted in good faith. B.. The plumbing services were not provided. In this case. Citation. 21. that included a promissory note. Plaintiff is engaged in the business of cashing checks for a fee. C. the Rose’s will probably lose. General was also aware that Lustro’s impending insolvency might interfere with their completion of the contract.Holder in Due Course and Liability of Parties 337 regard to negotiable instruments arising out of certain consumer credit transactions. 1971). Lexis 1875 (Nev. and it was discovered that Mr. IV: Answers to Ethics Cases 21. The Mahaffeys claim that Five Star breached this contract. VII. General was not an HDC. 1971 N. General Investment Corp. Defendant had written a $500 check to Fred Fentress as partial payment for future plumbing services.2d 193. . In this case. v.2d 803 (Ill. Because the note was not taken in good faith. Given that General knew that the note did not mature until completion of the work and that there existed a strong possibility that the work would never be completed. Since. “Good faith” means honesty in fact in the conduct of the transaction.J. 1987 Nev.E. The FTC rule eliminated Mortgage Finance’s special status as a holder in due course. v. Investor’s National Security Co. 1987). however. Finally. General knew that Lustro had a poor record of completing installations they had contracted for. Key Facts A. Lexis 263 (N. the holder of a consumer credit instrument may be subject to all of the defenses and claims of the consumer. and therefore was subject to both real and personal defenses to payment of the note. Inc. Angelini.2d 890. Honesty in fact is a subjective test that examines the holder’s actual belief. the Mahaffeys were allowed to assert the defense of breach of contract against payment of the note. Mahaffey v.16 The Bank did not act ethically in failing to make sure that the Rose’s understood what they were signing. 747 F. Answer to “Briefing the Case” Writing Assignment: 1.15. Hodge 601 N. Because the contract sold is one covered by the FTC rule. Angelini wins since General does not qualify as an HDC because it failed to take the Angelinis’ note in good faith. the Mahaffeys had signed a sales contract with the Five Star Co. A holder must take an instrument in good faith to qualify as an HDC. This contract was then sold to Mortgage Finance. The FTC rule applies to all consumer credit transactions where the buyer signs a sales contract that includes a promissory note. they could have read the document but didn’t. Thus. and Court Kedzie & 103rd Currency Exchange Inc. 1992) Appellate Court of Illinois 2. The FTC rule prevents a seller of goods and services from separating the consumer’s duty to pay the credit and the sellers’ duty to perform. General did not take the note in good faith. 1 Dist. the Court found that General knew that the note signed by the Angelinis did not mature until after installation of the siding. Case Name.

The lower court ruling in favor of the defendant stands. B. but they are subject to real defenses. State and local licensing laws are created to protect the public’s health. under the UCC. which. safety. Holders in due course take negotiable instruments free of personal defenses. and the Currency Exchange appeals. D. Contracts entered into in violation of those laws are illegal and have civil and criminal sanctions. The defendant ordered a “stop payment” on the check and claims a real defense of illegality under the UCC. The plaintiff alleges that he is a holder in due course and the defense does not apply. This illegal contract gave rise to a negotiable instrument. Court’s Reasoning The Illinois Court of Appeals held: A. Issue Does the underlying illegality of the contract create a real defense against a holder in due course of this negotiable instrument? 4. C. 5. had a real defense of illegality. The lower court held in favor of Fentress. Holding Yes. . F.338 Chapter 21 D. and welfare. E. 3.

and E-Money 339 Chapter 22 Checks. Wherever possible. . Finally. Banking System. Then determine what public policy based limitations are imposed on the parties by the UCC and the courts. If these activities appear to be involved in money laundering or the like. more efficient than ever. look to see if the transaction falls into the sphere of hi-tech transfers of money substitutes. In addition to the technical aspects of this material. spend a fair amount of time talking about the future direction of technology in the area of money substitutes and some of the practical problems the law is having while trying to keep up with emerging technologies. The rules of rights and duties involving checks are really not all that new to the layperson. This area is particularly ripe for debate when it comes to issues of law enforcement and privacy. The transfer of money substitutes is more complicated than ever because it is. try to illustrate any given rule with examples to help bridge the gap between the theoretical and the practical. and E-Money Why Are Checks Important To Our Society? I. This chapter proceeds to concentrate on that body of UCC rules and the banking system within which these transfers of money substitutes take place. the institution is required to report that to the government. The best way to approach issues involving checks is to first examine the underlying contractual obligations between the respective parties. at least in part.Checks. Financial institutions have many more duties today to report patterns of certain types of “suspicious” activities to the government. But what about the customers’ privacy? As can be readily seen. Money sitting in Tokyo can be transferred to New York City in seconds. The duties imposed on banks can be very strict and difficult to avoid. Banking System. new technology brings with it new legal issues which will ultimately challenge all who use the electronic highway. Teacher to Teacher Dialogue Students relate to materials on the law of checks due to their own involvement with them. Most students have an ongoing contractual relationship with a bank and are already familiar with the basic rules involving negotiable instruments.

Normal relationship involves creditor-debtor Customer │ Creditor Bank │ Debtor Payee can either demand payment or indorse it to another party: Payee Indorser Demand Payment Person to whom indorsed Indorsee Indorse . Text Materials with Accompanying PowerPoint Slides Check is an order by drawer on drawee bank to pay a specified sum of money from drawer’s account to the named payee (or holder).340 Chapter 22 II.

Banking System. and E-Money 341 Internet & Technology: Electronic Fund Transfer Systems The most common electronic fund transfer systems are discussed.Checks. Bank Checks: Certified bank agrees to accept in advance (usually customer’s check) bank is now liable Cashier’s bank guarantees payment after customer pays bank (usually bank’s check) Traveler’s sold by bank and others without named payee (to be filled in by purchaser) .

Can pay after death until notice and time to act (10 day rule) . written good for 6 months Note: If the drawer postdates a check to some future date and gives separate notice to the bank.Oral stops good for 14 days.Can pay a good faith completed incomplete check . . 1) Unsolicited cards permitted if validation is needed 2) $50 liability limit if stolen or lost and reported within 2 days (up to $500 and then over $500 if not reported within 60 days) 3) Written receipt of computer terminal transaction required 4) Periodic statements required Notes: .342 Chapter 22 Internet & Technology: Bank Debit Cards This explains how the Electronic Fund Transfer Act and Regulation E affect debit cards.No obligation to pay stale checks . a bank can be liable for losses if the bank pays before its date. Contemporary Issue: Federal Currency Reporting Law Federal currency reporting laws require financial institutions and other entities to file a Currency Transaction Report with the IRS.

Banking System. Contemporary Issue: Receipt of Bank Statement Same wrongdoer on same account must be reported by customer in 30 days or less from the date of receipt of statement. The Court speaks: Spacemakers of America. SunTrust’s motion for summary judgment was granted and Spacemakers appealed.Checks. Reason: Only the malefactor can be held liable on a forged or counterfeit instrument. Spacemakers sued for negligence and unauthorized payment of forged items. Friendly assigned any causes of action to Triffin who sued to recover on counterfeit forged checks. Pomerantz Staffing Services. v. Jenny was arrested. Jenny basically was in control of the entire accounting cycle. There was a warning about a security measure to confirm authenticity. Eventually SunTrust became suspicious and called Rose. The forged signature is only good against the forger. Failure discharges bank on similar checks. was not discovered. each bearing Pomerantz’s full name and address and a facsimile signature. Inc. If not done within one year bank is relieved of any liability. Because of the failure to investigate. The trial court’s grant of summary judgment to Pomerantz was affirmed.106 but they refused contending Spacemakers’ failure to give timely notice of the forgeries. Dennis Rose had authority to sign checks. . Jenny forged 59 checks ($475. SunTrust Bank Facts: Jenny was hired by Spacemakers as its bookkeeper. Triffin appeals from a granted motion for summary judgment in favor of Pomerantz. Issue: Is Pomerantz liable on the counterfeit forged checks? Decision: No.000) over the first 10 months. Jenny’s criminal background including forging checks of previous employers. Spacemakers demanded that SunTrust credit its account for $523. Friendly cashed the checks which were returned as counterfeit. When he discovered a forged check made out to Jenny’s husband’s company (not a Spacemakers’ vendor). LLC Facts: Friendly was presented within 18 checks purported to be issued by Pomerantz. and E-Money 343 The Court speaks: Triffin v.

Thus with lack of notice and review. the recovery by Spacemakers is barred. No one but Jenny reviewed the bank statements. recovery for forgery is precluded without notice within 30 days of the first forgery. Country Bank = Payor Bank Metro Bank = Depository Bank (collecting bank) City Bank = Intermediary Bank (collecting bank) . Spacemakers was negligent in its hiring of Jenny. Grant of summary judgment was affirmed.344 Chapter 22 Issue: Did Spacemakers’ failure to uncover the forgeries and to give SunTrust timely notice bar its claim? Decision: Yes. Reason: Under the GA commercial code.

Issue: Did the trial court err in imposing the sentence on Heck? Decision: No.Checks. Commercial Wire Transfers: 1) electronic transfers of fund s from a bank to another party 2) two principal systems are the Fedwire and CHIPS 3) speed and low cost are among the benefits 4) commercially reasonable security procedures under UCC 4A Internet & Technology: Article 4A – Fund Transfers This discusses Article 4A of the UCC. The Court speaks: State of Tennessee v. International Law: Hiding Money in Offshore Banks This discusses the confidentiality of the banking laws of the Cayman Islands and other countries. and E-Money 345 Contemporary Issue: Failure to Examine Statements in a Timely Manner This discusses the duty of a bank to provide statements and the duty of the customer to examine them. She was sentenced to 4 years in jail followed by 4 years of probation and she appealed.000). . This applies only to commercial electronic fund transfers. She has more than 100 prior convictions (many of the same offense) and she has previously (3 times) violated probation. The judgment was affirmed. Reason: Incarceration is necessary to protect society or it is suited to the offense or lesser measures have not been effective. She admitted to essentially living her life by stealing money and assuming the identities of others. Heck Facts: TN prosecuted Heck on several counts of criminal check forgery. She pled guilty to 6 counts (5 over $500 and 1 over $1. Banking System.

which has been paid for the check. A cashier’s check is accepted in advance by the act of its issuance and is not subject to a stop payment order. 1982). The check became negotiable upon issue and should not have been subject to a stop payment order. App. The court held that punitive damages are not recoverable in a conversion action simply because CNB intentionally exercised control or dominion over the Goodwin’s account.260 made payable to cash. the Goodwins must show that CNB acted in bad faith or that it deliberately or willfully dishonored the checks. it is not an item payable from a customer’s account. In the present case. the payor bank can either dishonor the check. Neither the purchaser nor the issuer of a cashier’s check can stop payment of the check. Thus. Wood wins. 435 So. the bank debits its own account. Answers to Critical Thinking Cases Cashier’s Check 22. Pulaski. Bank should not have honored Wood’s request. which is drawn on the issuing bank itself. The bank. 1985).2d 1287. in order to receive consequential damages. Wrongful Dishonor 22. drawn against her checking account. because the bank mistakenly confused the . Lexis 3034 (Wis. Kalbe had a checking account with Pulaski State Bank. However. Goodwin and Larry J. Such a rule is necessary to insure the public’s confidence in and reliance upon our banking system.2. The Pulaski State Bank wins because it had the legal right to create the overdraft in Kalbe’s account. Pulaski was relieved of this duty. because the last check was never reported to the bank. Subsequently. Civ. The bank can sue the customer to recover this amount. Pulaski State Bank v. is a debt of the bank.346 Chapter 22 III. 2d 162. Overdraft 22. In general. 1982 Ala. The payor bank can create the overdraft because there is an implied promise between the customer and the bank that the customer will reimburse the bank for paying checks he or she has written. guarantees payment of the check. 1985 Wisc. because of the provisions of UCC 4-401(1). In this case. App. Similarly. Lexis 1362 (Ala. City National Bank of Fort Smith (CNB) wins. Wood had paid the Bank $6. In this case. When there are insufficient funds in a customer’s checking account to pay a check that is presented for payment. App. Central Bank of the South. It is only apparent that CNB mistakenly confused the identity of Larry K. because Wood’s stop payment order should not have been effective. the act of conversion alone will not support an award of punitive damages. When the check is presented for payment. App. when the bank discovered that there were insufficient funds in Kalbe’s account to pay the check.” Because a stop payment order is not effective against a cashier’s check. Such an award would require that CNB had intentionally exercised control or dominion over the Goodwin’s account for the purpose of violating their right to the money or for the purpose of causing damages such as returned checks. whereby CNB accidentally exercised dominion over the wrong Goodwin’s funds. 364 N. As the court stated: “A cashier’s check is the obligation of the bank which issues it. Therefore. when the check was presented for payment.000 to issue a cashier’s check payable to Walker.W. She drafted a check for $7. the Pulaski State Bank had the option to create an overdraft in Kalbe’s account rather than dishonor the check. Goodwin. there was no evidence that CNB converted the Goodwin’s money for the purpose of violating their rights to the money or for the purpose of causing damages. had a duty to honor it.3. A cashier’s check. Kalbe. or honor the check and create an overdraft in the customer’s account.1. if the customer does not subsequently place sufficient funds in the checking account to cover the amount of the overdraft. Wood v. as the payor bank.

Although the bank stated that this request was not valid because Dynamite did not have sufficient funds to pay the check when the request was made. Because the payor bank is subrogated to the rights of the payee. because the New England Bank is subrogated to the rights of the payee. Lexis 3435 (La.000 since the bank had paid a stale check. Charles Ragusa & Son v. the court held a check written against an account with insufficient funds to be irrelevant. Dynamite Enterprises. the New England Bank will have to recredit Siegel’s account for the $20. to afford the bank an opportunity to act on it. Thus. Lexis 1559 (Mass. Stop Payment 22. A postdated check is created when a drawer writes a check and dates it for a time in the future.6. the drawer usually suffers little or no loss when a post-dated check is paid early. Eagle National. The fact that the check was stale should have been sufficient to keep the check from being paid. If a payor bank pays on a postdated check prior to its date. but this was of no importance in relation to the payment of the check.5. Ragusa should not have needed a stop payment order to prevent the Community Bank from paying on a three year old check. Goodwin. 1982 Mass. and may later collect the amount of the check. the court ordered the bank to recredit Ragusa’s account for $5. A check that has been outstanding for more than six months is considered stale. 1990 Ark. A written stop payment is valid for six months.E. and in a reasonable manner. Peter Peters.Checks. Banking System. 1982).000. and E-Money 347 identities of the Goodwins and acted in good faith. However.2d 335. Most states hold a bank liable for paying a stale check without the drawer’s permission. App. A stop payment order is an order by a drawer of a check to the payor bank to not pay or certify a check. . This written request was made before the check had been cashed or deposited. the court held that punitive and consequential damages were not allowable. In this case.2d 218. 1978 La. Dynamite Enterprises was the drawer of a check. A bank is under no obligation to pay a check that is presented for payment more than six months after its date. Stale Check 22. The bank must receive a stop payment order within a reasonable time. 1990). the bank can collect this money from Siegel on the date of the check. 360 So. Postdated Check 22.000.000 because the bank had improperly paid a postdated check. 437 N. In this case. The court stated that “a bank customer has a right to stop payment on an overdrawn check. because Eagle National violated this right. Lexis 49 (Ark.2d 231. 1978).000.4. The court also remanded the case back to the trial court to allow the New England Bank to assert its rights as a subrogor and recover the $20. the bank is liable for any damages incurred by the drawer. The court found that Ragusa’s oral stop payment had expired. In this case. Supp. New England Merchants National Bank. and informed the payor bank of this check. the court ordered the New England Bank to recredit Siegel’s account $20. City Nat. 783 S. App. Ragusa wins because Community Bank is liable for the $5.” Thus. Yes. Bank of Fort Smith v.W. that Dynamite wanted a stop payment order placed on the check. Community State Bank. the Community Bank had paid a check that was over three years old. Siegel v. The drawer can also sue the bank to recredit the account for the improperly paid check. Dynamite Enterprises wins the suit because Eagle National had paid after a valid stop payment order request. the bank was found liable for the amount of the check.

When a checking account customer of a bank borrows money from that bank. The Bank was also relieved of liability because the losses were the result of a series of forgeries by the same wrongdoer. This rule allows banks to fix an afternoon hour of 2:00 p. and Dr. Monday. The failure of Gennone to report a series of forgeries by his wife was an alternative basis to relieve the Peoples Bank of any liability. Crocker National wins. In this case. First. 1979). 1979 Okla.2d 976.7. App. A bank is not “open” for these purposes unless substantially all banking functions are carried on for the public. 517 So. 9 UCC Rep. Peoples Bank is not liable for paying on the 25 forged checks because Gennone failed to promptly examine his bank statements. Oklahoma State Bank wins. or later as a cutoff hour for the purpose of processing items. Pracht tried to argue at trial that the fact that bank employees had continued to work after the check had been left on Friday proved that the check had been received for collection on that day. Oklahoma State Bank had received the check deposited by Dr. Any check received after this cut-off is treated as received on the next banking day. Peoples National Bank & Trust Co. Therefore. Since Gennone simply failed to examine these records for over 3 years. In this case. 1975. Serv. Examining Bank Statements 22. This was not the situation at the Oklahoma State Bank on that Friday. Oklahoma State Bank. States Steamship had borrowed $2 million from Crocker Bank. Lexis 209 (Okla.9.m. did not mean that these were normal banking hours.8.m. wins. as a cutoff time for the purpose of posting checks. Dr. the bank demanded immediate repayment of the loans. the delayed posting rule allowed the bank to establish 2:00 p.348 Chapter 22 Inc. A customer has a duty to examine bank statements and canceled checks and promptly report any forged signatures to the bank. D & C. When a series of forgeries occurs. Lexis 11791 (Fla. 1971 Pa. The customer is liable if the bank suffers a loss because of the customer’s failure to promptly examine bank statements and report forgeries.m. Oklahoma State Bank’s claim is legally correct because of the delayed posting rule. Peoples National Bank & Trust Co. In this case. Banks cannot exercise this right against specialized accounts or collect unpaid credit card debts. This means that the bank has the right to claim any money that is due to it from the customer’s checking account. v. Because States . This right can only be exercised against general accounts. the bank has a common law right of setoff against these accounts. Deferred Posting 22. Second. App. 707. which was payable on demand.m. 1971). Gennone v. Pracht’s check was received for collection on the next banking day. When the bank felt that States had fallen into financial trouble. Right of Setoff 22.. Peoples Bank was relieved of any liability for the forgeries. Pracht after the close of normal business hours on Friday. Crocker’s actions in taking funds from States’ account was legal. and the losses were the result of a series of forgeries. the fact that bank employees were still at the bank after 3:00 p. Pracht’s check was received well past 3:00 p. The bank had two responses to Pracht’s argument. January 20. Eagle National Bank of Miami. 1987 Fla. Pracht v.2d 112. Dr. 592 P. the customer has only fourteen calendar days after receipt of his or her statement to report any such forgeries. 1987). Lexis 160 (Pa. it was proven that Gennone had an opportunity to examine his bank statement because the People’s Bank held them for his personal receipt.

. Firemen’s Fund Insurance Co. Nautilus Leasing Services. Banks allow customers to make use of funds while awaiting final payments. Inc. App. 1983 Cal. 1989 N. Rptr.Y. The Bank of New York. App. a reasonable and trustworthy background investigation constitutes negligence substantially contributing to the making of the unauthorized signatures involved here. Among the assets of IBCA payable to the plaintiff as receiver were $80. who were investors in IBCA. because the union’s negligence substantially contributed to Scotti’s forgery. VII.A. the Bank of New York was not liable for the missing $100. A bank is not liable for paying on a forged signature of the drawer.10. 3. 478. 539 N. E. 195 Cal. Crocker’s actions in exercising its right of setoff was legal. 2d 1387 (Fla.Checks. Lexis 2257 (Cal. 565 So. v. Banking System. App. C. Therefore.2d 339. v. or insisting upon. Rishoi 553 So.Lexis 4172 (N. which were the result of Actors Equity’s own negligence.000. v. 1990) District Court of Appeals of Florida 2. AmSouth Bank. IV: Answers to Ethics Cases 22. Issue . IBCA was shut down by the state of Florida for having operated an illegal pyramid scheme. 1989). Golden Gulf. Lexis 436 (1990). Inc. Even though the bank’s action caused States’ outstanding checks to be returned unpaid. The lower court held that the bank had no right to refuse payment on the checks.” Thus. Crocker National Bank. and Golden Gulf is liable. S. and now owed the bank $2 million.Y.S. Dist. and E-Money 349 maintained a checking account with Crocker. Nothing here indicates any more than a provisional settlement by AmSouth that it was free to retract if the item was not paid. The Bank of New York wins because it is not liable for paying on the forged checks. 22. 1990 Ala. Decision for AmSouth affirmed.000 worth of cashier’s checks issued by the defendant and paid for by Crosbys. Mere availability of the funds does not mean the check has been paid. App. the bank appeals. Sup. 1983). Inc. D. Crocker had the right to claim this amount from States’ account. Answer to “Briefing the Case” Writing Assignment: 1. or on an altered check if the drawer’s negligence “substantially contributed” to the forgery. Citation and Court First American Bank and Trust v. Key Facts A. Case Name.11. (IBCA) B.Div. AmSouth acted properly in creating the overdraft. Scotti’s forging of four checks was the direct result of Actor’s negligence in failing to check Scotti’s background before hiring him as the union’s comptroller.2d 114.Y. The defendant refused to cash the checks based on a claim of underlying illegality. As the court stated: “The fact remains that the conduct of the union in retaining someone to manage many millions of dollars in funds without conducting. N. In this case. Certainly Actor’s Equity cannot avoid the consequences of its own omissions. The plaintiff is a receiver for Clara Lamstein and the business she operated as Interamerican Business Consultants and Associates.

and any defenses to payment must be narrowly limited. The bank must only use its own defenses and not those of a third party. 5. Banks that issue casher’s checks are primarily responsible to a proper holder of the check. Because it could not show any of its own real defenses. . Court’s Reasoning The District Court of Appeals of Florida held that: A. the bank was wrong when it refused to cash its cashier’s check. Cashier’s checks are intended to be the next best thing to cash. The holding of the lower court was affirmed. D. C. B. Holding No.350 Chapter 22 Could the bank use the check payor’s claim of illegality to prevent payment of its own cashier’s check? 4.

and obligations after someone (usually the debtor) has had a problem. The list is virtually endless. duties. Thus it is incumbent upon us. They read these materials and often come to the conclusion that Article 9 and mortgages must be the main ways credit is extended in our economic system. duties. and obligations of the debtor and creditor. Most people who find themselves in credit difficulties feel like they are being compacted by a four-sided vice. this universal perspective allows us to impart another important point—that few credit problems are isolated. Secured credit on sales of personal goods and real estate represent important pieces of a much bigger puzzle.Credit and Secured Transactions 351 Chapter 23 Credit and Secured Transactions How Can I Make Sure The Debt Is Paid? I. credit cards. In addition to creating a sense of relative proportion. When things go wrong. Teacher to Teacher Dialogue Credit One of the difficulties in teaching these materials is trying to steer students clear of a certain statutory myopia. The UCC has sought to interpolate the best elements of all these areas into a . The statutory materials covered in Article 9 of the UCC are extensive. and on and on. this view is far from true. debtor and creditor law. and there is a lot of latitude on how to present them. One involves the rights. as instructors. to put this material in perspective at the outset by reminding students of this larger universe. Obviously. So much of the law of credit really concerns the establishment of an order of priorities between competing creditors. Consider the entire realm of personal credit. corporate bonds. The second side of the coin involves trying to ascertain rights. real property law. Secured Transactions The study of secured transactions allows teachers to focus on two sides of the same coin. Article 9 of the UCC is a particularly good example of the interaction between the old and new. and the law of liens. letters of credit. all sorts of collection actions are likely to occur from both secured and unsecured creditors. The original sources of the law of secured transactions involving personal property can be found in a combination of common law contracts. Raising awareness at this point helps prepare students for the materials that follow on both bankruptcy and other related areas such as real property.

compared to real estate. that same realism attempts to protect the innocent third parties’ good faith reliance on the legitimacy of the marketplace whenever possible. Text Materials *Credit involves risk. This system is premised on the legal realism that merchants doing business with each other are expected to live up to a higher standard of both behavior and knowledge of the law. The ordering of priorities between multiple creditors having claims to the same goods becomes a critical issue. Finally. guaranty. Conversely. distributors. It is no accident that most economic measures of a nation’s growth are tied to the success of its credit-granting financial institutions. II. may have more than one creditor looking to that good as security. it can very quickly become complicated. the role of making sure that the security interest attaches and stays with the goods is of critical importance. Inherent in the nature of our business enterprise system is the principle that risk will be rewarded if well placed and punished if not. but the UCC and the common law rules with regard to liens. such as automobiles and the like. but even more important. The riches of wise credit extension are the stuff of financial and family dynasties. just as there are likely to be multiple creditors. First. surety. to give notice to other creditors that this security-based transaction has taken place. failure to wisely administer and manage these key elements in our society leads to debacles such as the savings and loan crisis. and collection provide some very good rules for both debtor and creditor.352 Chapter 23 cogent and organized structured system of facilitating secured credit transactions for the sale of personal property. With each shift. On the horizontal level. The vertical chain of distribution starts with supplies of raw materials to manufacturers. there lies the probability of having to recognize new duties and obligations with respect to all parties having a legal relationship to those goods. In addition. The law has long reflected this win/lose dichotomy of the credit . These ends are mainly sought through the use of the recording principles long established in real property law transactions. personal property is portable. his or her family. and retailers. there is a strong likelihood that most large personal goods. so are there likely to be multiple users. Second. All in all. in a society based on credit. the users start with the consumer. Several practical factors make the law of secured transactions in personal property particular troublesome. and go on to third party users or acquirers. This reliance on that good may come from either the original acquisition of the good or from subsequent transactions after the good is acquired. These rules are designed to give creditors notice not only of the debtor’s obligation. Being more moveable.

The possibilities for fraud and conspiracy in this area of law have provided both the challenge and the need to seek a balance between the competing rights and duties of creditors. Contemporary Issue: Unsecured Credit versus Secured Credit This discusses why one would always rather be a secured rather than an unsecured creditor. the most apparent problem revolves around resolution of the differences between the debtor and creditor. the long-term interests of the entire economic system are badly served. If the law takes an uneven hand to either side. the main focus of this chapter is on Article 9 of the UCC. but the principles harken back to an earlier age of debtor’s prisons and the like. . That chapter covers the sale of personal property coupled with a security interest in the debtor’s property. remember that most disputes have more than one level of controversy. In an examination of credit relationships. Although there are many sorts of credit relationships. most of the rights and duties of both debtor and creditor are found in statutes. In today’s highly codified scheme of things. A proper examination of any credit case answers both aspects.Credit and Secured Transactions 353 marketplace. On the surface. A second dispute can often be found in competing creditors fighting over priority rights to the debtor’s property. Many of the protections and remedies accorded to creditors have long historical tracings in the common law.

354 Chapter 23 .

including BSPB. Whatley. BSPB was brought into the action. BSPB appealed.Credit and Secured Transactions 355 The Court Speaks: Bank of South Palm Beach (BSPB) v. Stockton. who mistakenly never got a subordination agreement for BSPB.000). The trial court judgment was reversed and BSPB was given priority.000 was used mostly to pay SWD’s initial loan and the deed of trust was modified and recorded. The trial court ruled that SWD had 1st loan priority. The loan was made and all others agreed to subordinate their security interests to SWD. loaned money to Castle and also recorded mortgages.200 to Castle Builders. A mortgage was recorded on 2 parcels of land. BSPB’s loan was for $77. Issue: Did the modification loan from SWD have loan priority over the loans from BSPB? Decision: No. SWD had constructive knowledge of BSPB’s interest prior to the loan modification. . The %150. Davin & Company (SWD) Facts: SWD loaned $448. Reason: BSPB’s priority was based on being recorded before SWD’s loan. Castle fell behind in payments to SWD and asked SWD for more money ($150. Castle defaulted on the SWD loans and SWD began foreclosure.500. Other creditors.

356 Chapter 23 Requires payment in full .

Contemporary Issue: To Obtain a Material Person’s Lien: 1) lien holder must file “notice of lien” 2) notice must have all details 3) follow time requirements 4) notice to owner of real property “Release of lien” is often used after payment. Attachment secured part beats debtor.Credit and Secured Transactions 357 Note: A land sales contract is permitted in most states as a means of transfer and sale of real property. occurs at later of: Value given Rights in collateral Security agreement .

copyrights. Accounts: accounts receivable General Intangibles: patents. etc. warehouse receipts. etc. bonds. . occurs at later of: Attachment Perfecting step Security Agreement creates security interest Description Promise Rights upon default Debtor’s signature Contemporary Environment: Personal Property Subject to a Security Agreement Goods Consumer goods: personal or household Equipment: business use (or default category) Farm products: farming use Inventory: sell or lease Fixtures: affixed to real estate Instruments Checks. stocks.358 Chapter 23 Perfection secured party beats other creditors or people with an interest in collateral. Chattel Paper: note plus security agreement Documents of title: bills of lading. notes. etc.

of Title Chattel Paper Accounts Contract Rights General Intang. PMSI’s a. future advances Floating Lien: lien floats to property not in possession and sale proceeds. after acquired property. Priorities – General Rules 1. Inventory wins with notice and perfection before possession 7. Beat perfected if authorized sale or (BGOCB) or buyer of consumer goods for consumer use with value and without notice 6. Order of filing if filing is perfecting step 3. Beat unperfected if value and no notice – if inventory (BGOCB) win even if knowledge b.Credit and Secured Transactions 359 Perfecting Steps: Collateral/Step Consumer Goods Inventory Farm Products Equipment Instruments Docus. Buyer of goods in ordinary course of business (BGOCB) usually wins 5. Order of perfection 2. Liens over prior unperfected security interest 4. Purchasers of collateral a. Collateral not inventory wins for 10 days and if filed then wins b. Order of attachment if no perfection . Filing A Financing Statement Possession Attachment (PMSI) PMSI Creditor extends credit to buy goods or sells on credit and takes interest in goods.

Therefore. for $1. on June 2. in its capacity as debtor-inpossession. Reason: Derby.Can redeem by payment The Court Speaks: In re Greenbelt Cooperative. need notice of reasonable sale . Raymond’s credit department reported internally that it had no financial information other than sales figures on Scan Furniture. 1989. J.) debts.” Thereafter. and related items. At the request of Werres. Werres has duly assigned the contract to Raymond. 1987. Debtor’s written promotional material identified it as SCAN. is valid against that company. Apparently. and thus it would require individual financials on Scan Furniture or a guarantee from Greenbelt Cooperative. On May 4. Inc. The court has previously granted partial summary judgment for Debtor that this contract was intended as a security agreement for the purchase price. which consisted of forklifts.S. Inc. as trustee of the bankruptcy estate. and it was not a true lease. It engaged in business under the trade name of SCAN.Deficiency is still owed . After filing Debtor and Raymond agreed to sell the equipment at public auction and to hold the proceeds in escrow. 1987. Inc. and there was never an additional filing which in any way identified Greenbelt Cooperative. is responsible for the obligations of Scan Furniture as related to the Raymond Leasing Agreement. Inc. but it was not perfected under Maryland law against third party creditors. Facts: Debtor was a consumer owned cooperative engaged in the retail furniture business with fifteen stores and three warehouses. Inc. On July 5. which it described as the parent company. 544(a) seeking a determination that the recorded financing statement in a trade name was not sufficient to create a perfected lien or security interest in the equipment as against the debtor-inpossession.360 Chapter 23 Default and Remedies: -Take possession Keep notice. a financing statement was filed with the proper office in favor of Werres as secured party and Raymond as assignee. a division of Greenbelt Cooperative. The sale was on February 22. Debtor executed a contract that denominated an equipment lease with defendant Werres Corporation (Werres). avoidance does not constitute a windfall to Debtor without .00. Raymond’s security interest in the equipment under lease to Greenbelt Cooperative. Thereafter. the financing statement was filed listing Scan Furniture as the debtor. Issue: Did Raymond properly identify the debtor on the financing statement? Decision: Raymond failed to identify the actual debtor that voided Raymond’s lien. Raymond and then Werres became concerned about what entity was responsible for the debt. 1987. no written objection. Debtor filed this complaint under 11 U. and it was well known among consumers by the name SCAN. as the debtor. Debtor could purchase the equipment. second. not for 60% paid consumer goods or Sell costs. Debtor confirmed to Werres “that Greenbelt Cooperative. 1989. racking. (etc.C. The Debtor filed this case on November 4. At the conclusion of the lease term. satisfy debt. Sec. Since avoidance of Raymond’s security interest will enhance the likelihood of the debtor’s successful reorganization. the debtor may avoid it. by letter dated June 16. 1988.

and equitable principles do not bar avoidance. Holdren’s did not file a financing statement regarding the computer equipment. Charlene Phillips and her husband filed for Chapter 7 liquidation bankruptcy. which was also a security agreement. Consequently. Inc. Creditway filed a motion with the bankruptcy court to recover the computer and equipment. not consumer goods. Charlene T. Reason: The bankruptcy court held that the secured creditor did not have a perfected purchase money security interest in the collateral because the collateral was equipment. under Maryland law. may on some occasions accept a filing under a variation on a debtor’s legal name which would put a reasonably diligent creditor on inquiry notice of a possible security interest. a filing under SCAN would not be found by those looking for security interests in the assets of Greenbelt Cooperative. Although courts. Contemporary Issue: Artisan’s and Mechanic’s Liens This discusses how these types of liens usually prevail over other interests. As the assets in which Raymond had an unperfected security interest were sold and the proceeds put in escrow. Phillips entered into a retail installment contract to purchase an IBM computer and other equipment from Holdren’s.Credit and Secured Transactions 361 benefit to creditors. Inc. Charlene testified that she told the salesperson at Holden’s that she was purchasing the computer equipment for use in her teaching assignments and for use at her variety store. provided for a total payment of $3.32. The contract. In June 1985. Holdren’s eventually assigned the installment contract to Creditway of America. Issue: Is the computer and other equipment “consumer goods” in which the secured party obtained a perfected purchase money security interest? Decision: No. 1984. The court denied the secured creditor’s motion to recover the collateral. Raymond’s financing statement was not sufficient to perfect its security interest in Debtor’s assets against the claims of others. The Court Speaks: In re Phillips Facts: On December 1.175l68 in equal monthly payments of $132. . the proceeds of the escrow account should be distributed to Debtor. She received a special teacher’s price.

v. GMAC agreed to finance the purchase. GMAC declared the contract in default and brought an action against the Daniels brothers. . In May 1982. his brother. Reason: Because Seymour signed the contract on the line designated “co-buyer. GMAC appealed. Daniels Facts: In June 1981. John Daniels agreed to purchase a used Cadillac from Lindsay Cadillac Co. The lower court decision was reversed. agreed to cosign with him. GMAC was therefore not required to proceed against John first. he was jointly and severally liable for the purchase of the vehicle.362 Chapter 23 The Court Speaks: General Motors Acceptance Corp. The trial court found that Seymour had entered into a guaranty contract and that Seymour was not liable because GMAC had not proceeded against John. Because of his poor credit rating. Seymour. Issue: Was the contract Seymour signed a guaranty or surety contract? Decision: It was a surety contract.

Credit and Secured Transactions 363 .

NA v.364 Chapter 23 Surety Concurrent liability “If he doesn’t” Same instrument No new consideration No demand from debtor vs. execution. Contemporary Issue: “Collection Remedies “ The most common collection remedies are attachment. and garnishment. Pfennig Facts: Pfennig has an MBNA credit card. . Pfennig brought a class action civil suit against MBNA alleging a violation of the TILA. She was able to exceed her limit with a $29 over-limit fee for each month over which she duly charged. and MBNA America Bank. The $29 fee was not on the monthly statement. Guarantor Non-concurrent liability “If he can’t” Different instrument New consideration Needs demand from debtor Rights & duties are basically same Defense of Debtor Discharge Minority of debtor Performance Breach Non-personal Defenses of Surety All non-personal defenses Minority of surety Creditor’s fraud or nondisclosure Modification of debtor’s contract Release of security or debtor Debtor Protection Law 1) Truth-in Lending Act – . The US Court of Appeals’ judgment was reversed. 4) Equal Credit Opportunity Act – no discrimination in the extension of credit 5) Fair Credit Reporting act – sets guidelines for consumer reporting agencies 6) Fair Debt Collection Practices Act – no abusive. a reasonable interpretation of the TILA? Decision: Yes. This fee is expressly not required by Regulation 2 to be part of the required “finance charge’ calculation. Issue: Is Regulation 2. deceptive and unfair practices can be used by debt collectors. The Supreme Court Speaks: Household Credit Services. The US Court of Appeals reversed a district court’s dismissal of Pfennig’s complaint and MBNA appealed. which explicitly excludes over-limit fees from the definition of “finance charge”.Regulations – sets specific disclosures 2) Consumer Leasing Act – extends TILA coverage to leases 3) Fair Credit & Charge card Disclosure Act – requires specific disclosures on credit and charge card solicitations and applications. Inc.

S&D Petroleum Company.5. for malpractice.2 The mortgagor can recover any surplus from a foreclosure sale. One way to create such a security interest is for the creditor to file a financing statement. S&D does not have a security interest in the Mack truck. Atlantic should be paid the surplus in this case. Metropolitan State Bank wins the suit.. To be valid. Clifton Tamsett. Since Illinois requires that they execute a quitclaim deed. had a valid security agreement and financing statement in regards to Metropolitan Protection’s accounts receivable. The court ruled in favor of the Bank because their agreement with Metropolitan Protection specifically mentioned the accounts receivable. Inc. Lantz could have had a material person’s lien but Ivonwood paid Lantz. while World Wide Tracers agreement was too vague to create a perfected security interest. Graco’s claim is against Lantz only. 534 N. The purpose of the financing statement is to notify others who are contemplating extending credit to the debtor that certain property of the debtor is already subject to a security interest. 1988).Sup. S&D did not have a security interest in C&H’s Mack truck because a financing statement regarding the truck had not been filed as required by state law.S 2d 800.Credit and Secured Transactions 365 Reason: The Fed is the primary source for interpretation and application of the TILA. No. App. In this case. World Wide Tracers was .Y. Priority of Security Agreements 23. Tamsett. In order to perfect.Ct.3 The procedure for a foreclosure action and sale are mandated by state statute. However. 1988 N.e. III. A lender can take a security interest in the property of a debtor to serve as collateral when credit is being extended. S&D had no interest in the truck. State Bank or World Wide Tracers. 11258 (N.Y. The issue in this case was which of the two parties. Answers to Critical Legal Thinking Cases Material Person’s Lien 23. Redemption 23. because the security agreement was not perfected. v. such as the Secretary of State. A security interest can be created in various types of personal property. chattel paper. The financing statement must contain such information as the names and addresses of the parties involved in the transaction and the type of collateral secured. Thus. Financing Statement 23. (2) contain a description of the collateral. Foreclosure 23.1 Ivonwood should win.4. and accounts.Y. and (3) reasonably identify the collateral. a written security agreement must (1) be signed by the debtor. it is reasonable to treat this not as a charge for obtaining credit but rather as a penalty for violating the credit agreement.App. or County Clerk. such must be executed before a foreclosure sale. In order for a financing statement to be valid. S&D is able to recover from its attorney. the financing statement must be filed with the proper government entity. Because over-limits fees are imposed only when a limit is exceeded. Div. make valid the security agreement. it must identify the collateral. Tamsett was liable for malpractice for failing to properly file a financial statement securing an interest in the truck as collateral for the loan to C&H. including consumer goods. i.

Yes. Floating Lien 23. pursuant to the floating lien concept. The Court awarded the Bank $10. During the first week of May 1980. In Re Jones. Murphy deposited $97.D. GMAC was able to stop Norstar because of its security interest. N. Thus. A continuation statement may be filed up to six months prior to the expiration of the financing statement’s five-year term. General Motors Acceptance Corporation v.Y. Lexis 753 (Minn. The Bank subsequently filed a valid continuation statement six weeks prior to the expiration of the perfected security interest. 1988 N. 384 N. a perfected security interest is valid for five years. because Metropolitan State Bank’s Agreement was more specific.Y. Inc. because the proceeds were covered by the security agreement. Priority of Security Interests 23. Lexis 595 (N. The Court found that the Bank’s security interest was at all times paramount to Ellerson’s junior lien.R. future advances. the secured party’s interest is satisfied out of the specific property given as collateral for the loan. Misc. Metropolitan Protection. Inc. The Court awarded MP’s accounts receivable to the Bank. the Bank can enforce its security agreement although the collateral was transferred to another party. a secured creditor. v. When the Bank attempted to claim part of this money. Iowa 1987). Columbus Junction State Bank wins the case. 839.7.” Thus. Lexis 1825(Bk. Subsequently. A floating lien attaches to property not originally in the possession of the debtor at the time the security agreement was executed.Ct. the security agreement between Murphy and GMAC called for GMAC to have an interest in all “identifiable proceeds. 1986).075 and Jones’ soybeans. the after acquired property clause in the security agreement covers not only inventory and proceeds of the original debtor company.. The creditor may continue his perfected interest for another five years by filing a continuation statement. GMAC had an interest in the money because it came from the sale of a portion of Murphy’s inventory. This money had been received from the sale of cars. 1986 Minn.2d 685.A.366 Chapter 23 relying on the language “any property of the debtor obtained after July 15. when a creditor has obtained a security interest and the debtor goes bankrupt.” it is characterized as a floating lien. GMAC wins the case. If a security agreement provides for a security interest “in after acquired property. The Court held that a debtor cannot destroy a perfected security interest by merely changing business name or corporate structure.885 in an account at Norstar Bank.Sup.N.Y.. In this case. they are effective for another five years and may be refilled. Columbus Bank. In this case.W. 1987 Bank v. but also that obtained by the newly formed corporation which was bound by the terms of the original agreement. Once filed. The Court prevented the Bank from seizing this money.2d 442. The Bank is a secured creditor of Joseph Jones based upon a properly filed security agreement. 1988). Sale Proceeds 23. 532 N. GMAC had an interest in all proceeds derived from the sale of cars that were bought and sold by Murphy. Columbus Bank was a secured creditor because it had properly purchased a security interest in Jones’ property by filing a financing statement.S. or in proceeds. World Wide Tracers.6. Secured creditors have priority over other creditors. 1980” to claim an interest in Metropolitan Protection’s accounts receivable. The Court also held that the after acquired property clauses contained in the Bank’s security agreement and financing statement covered items which Ellerson had added . Norstar Bank. 79 B.8. had first priority in obtaining the property of the bankrupt Jones. In this case. Once filed.

the model 1066 tractor. A perfected purchase money security interest prevails over a perfected nonpurchase money security interest in after acquired property. McGowen v. IH perfected its security interest in the tractor within ten days of the Prior Brothers accepting the tractor. In this case. Purchase Money Security Interest 23.2d 566. the Bank was first to perfect its security interest by filing a financing statement with the appropriate government office. Lexis 667 (Colo. Nebraska. the first to have perfected that interest generally has priority.2d 772. A creditor with a perfected purchase money security interest has priority over a creditor with a perfected nonpurchase money security interest in after acquired property..Credit and Secured Transactions 367 in his operation of O&E Inc.W. The McGowens filed their financing statement four months later. Once the purchase had been made.2d 522. the purchase money security interest must be perfected within ten days of the debtor receiving the collateral to take priority over a perfected nonpurchase money security interest. Nebraska State Bank perfected its security interest by filing a financing statement with the County Clerk of Dakota County. Although Sandwich State Bank had a perfected interest in all of Klotz’s after acquired property. IH’s interest was a purchase money security interest because IH had extended credit to the Prior Brothers to purchase the collateral. Purchase Money Security Interest 23. 427 N. 1981 Wash. App. American Heritage Bank & Trust Company v. 576 P. If the collateral in question is not inventory. 632 P.. The security interest of the Nebraska State Bank has priority over the security interest of the McGowens. their claim took priority over the Bank’s. Lexis 2507 (Wash. adopted by the state of Nebraska. Inc. when High defaulted on his obligations and a controversy arose as to whose claim had priority. Nebraska State Bank.11. DeKalb’s interest took priority.App. 1978 Colo. the Court awarded the disputed property to the Bank. Yes. In this case.App. UCC 9-312 (5)(a). Since IH had a perfected purchase money security interest. In order for the purchase money security interest to have priority. Priority of Security Interests 23. App. Yes. DeKalb Bank perfected its interest within the ten-day deadline. both creditors had perfected their security interests by filing a financing statement.9. DeKalb Bank’s security interest in the cattle has priority over Sandwich State Bank’s security interest. The Court held that such acceptance acts as the starting point for the ten-day deadline for perfecting the interest in a sale on approval.10. Lexis 290 (Neb. 1988). on December 20. 1981). states that if two or more creditors have perfected security interests in the same collateral.. . This is because IH had a purchase money security interest in the tractor that takes priority over any general security interest in the same property. 1978). it must be perfected within ten days of the debtor taking possession of the collateral. 1980. In the Matter of Prior Brothers. Therefore. Although the McGowens security interest arose first in time. the livestock. & E. International Harvester’s (IH) security interest in the tractor takes priority over the Bank of California’s security interest in the same collateral. In this case. The UCC has established a set of rules to determine which claim will have priority when two or more creditors claim a security interest in the same collateral or property of the debtor. the Court held that DeKalb Bank had a purchase money security interest in the cattle because the Bank had extended credit to Klotz in order for him to make a particular purchase. Inc. 1988 Neb. both parties had an interest in the Prior Brothers’ after acquired property. O.

First National Bank and Trust Company of El Dorado v. Mrs. IV: Answers to Ethics Cases 23. A buyer in the ordinary course of business who purchases goods from a merchant takes the goods free of any security interest of a creditor in the merchant’s inventory. However. a common law lien is a possessory lien. Such a statute would protect the debtor but loans might be more difficult to obtain. by the Forsyth County Hospital. DeKalb Bank was awarded the cattle since the UCC gives priority to perfected purchase money security interests. Heritage Ford. its common law lien terminated. 1986 Ill. Turner. Here. The common law gives artisans and repair people’s liens on personal property of customers to secure payment for labor or services rendered. However. This rule is necessary because buyers would be reluctant to purchase goods from merchants if the merchants’ creditors could recover the goods from the buyer when the merchant defaulted on loans owed to second creditors. Lynch.2d 1256. Ford Motor Credit Corporation (FMCC) wins because its purchase money security interest in the two automobiles has priority over the security interest of First National Bank and Trust Company of El Dorado. Yes. Buyer in the Ordinary Course of Business 23.App. Lexis 280 (Kan. Lexis 4273 (Mo. when Pete & Sons performed the repair services for the Turners. Because there was no common law lien on the truck. Lexis 3357 (Ill. In this case. and were using the financing as a way to raise funds for the dealership.12. The court held that Mrs.13. 1982).App. A guaranty is a promise to answer for the payment of some debt in the case of the failure of the person who is primarily liable to pay the debt. 502 N. a common law lien attached to the truck to secure payment for these services. 1987). Buffalo Federal should win.14 Without an antideficiency statute. 735 S. FMCC’s perfected security interest had priority since the two men were not buyers in the ordinary course of business. The court held that Pete & Sons did not have a common law artisan’s lien on the tractor truck. when Klotz became insolvent. even if that security interest is perfected. Ozark Financial Services v. and the creditor’s cause of action against the guarantor ripens immediately upon the failure of the principal debtor to pay the debt at maturity.e. The court held that when Pete & Sons released the truck to the Turners. App. 1987 Mo. 1982 Kan. Sales is liable as a guarantor for the payment of the medical services provided to her sister. 646 P. 1987). the lien only lasts as long as the lien holder has possession of the goods. Note: If not terminated. both men worked for the merchant offering the goods for sale.368 Chapter 23 Thus. Mrs. it would have taken priority over Ozark’s prior perfected security interest. Klotz. the Court held that the two officers who financed the cars were not buyers in the ordinary course of business. Sales personally guaranteed . Ford Motor Credit Company. A guaranty is a collateral and independent undertaking creating secondary liability.2d 374. Ozark Financial Services wins.E. App. Ozark could foreclose on its perfected security interest in the truck. Artisan’s Lien 23. First National’s security interest would have taken priority if the two officers of Heritage Ford who financed the cars had been buyers in the ordinary course of business..15. 23. i.W. DeKalb Bank v.2d 1057.

Credit and Secured Transactions 369 the payment of Mrs. Lynch to the hospital. and Court Davenport v. Lynch’s medical costs when she signed the form admitting Mrs. Davenport purchased a car from Matthews Motors using financing from CCC.C. Holding No. Case Name. 36 (F. The car was taken from an enclosed garage after a padlock was cut. 3. B.). Key Facts A.2d 212. Eventually they sold it and CCC requested a deficiency payment. They withheld payments and CCC sent a standard delinquency notice after the first payment was 10 days late. Sales is personally liable for the moneys owed by Mrs.C. 1986). 2d 23 (1991) Court of Appeals of TN 2. Mrs. 1986 N. E. 572 F.E. Thus.Pa.App. V. Before driving off the lot the car developed mechanical problems and was returned 7 times for repair before the 1st payment was made. Forsyth County Hospital Authority. C. 346 S.16 Valentine wins since the loan violated the TILA which requires certain disclosures on consumer loans which was present here. C. Influential Savings and Loan Assoc. The trial court held that CCC had a legal right to repossess. Repossession must be accomplished without breach of the peace. When the Davenports did not respond.The Davenports’ dissatisfaction did not allow a unilateral refusal to pay on an installment contract. D. Lexis 2432 (N. CCC held one car for over a year due to the Davenports’ allegations. 5. Issue Can repossession be affected by breach of peace? 4. App. Citation. Supp. Valentine v.D.The Davenports could only recover damages for the manner of repossession. Inc. Court’s Reasoning A.. Answer to “Briefing the Case” Writing Assignment: 1. Repossession was attempted but to no avail at first. Sales. CCC called and told them that they would repossess if no payment was made. What was not correct here was the finance charge and the security interest description. (CCC) 818 S. Lynch to the hospital. v. B. Chrysler Credit Corp.W. 23. .

As with any legal favor. economic downturns. Bankruptcy is built on a cornerstone of good faith. act as a life sentence in keeping that business or its proprietor from reentering the marketplace. financial institution failures. Bankruptcy is really one of the earliest forms of recycling. History shows us that earlier societies in Western Europe held debtors not only in low regard but sought to criminally punish those who could not repay their obligations. The best place to start is with the “preenlightened” era of debtor’s prisons and the like. there are people and business entities that get too greedy when asking for the benefit of the law. both the law . risk takers. Many of those dungeons became so crowded that the New World became a dumping ground for detainees. a recycling of economic opportunity for good faith debtors who deserve a second chance. As fate would have it. Teacher to Teacher Dialogue The bankruptcy material presents an excellent opportunity to illustrate how law works as the end product of social philosophies and value judgments. That failure should not. that migration was most fortuitous for our nation. How many of us can really provide ourselves with a safe haven from financial disasters brought on by bad health. Text Materials Debtor’s prisons were holding cells for economic hostages whose ability to get out was directly proportional to the debtor’s ability to get others to pay his debt for him. II.370 Chapter 24 Chapter 24 Bankruptcy and Reorganization Bankruptcy Is Not The Easy Way Out I. in effect. These views eventually gave way to the more liberal view that allows for a fresh start after proper procedures for debt discharge are used. The basic underlying premise of bankruptcy law is founded on a simple reality: bad things happen to good people. Where debtors’ actions are motivated by bad faith attempts to avoid legitimate obligations. Very often the same people who were in prison for debt were also the innovators. and entrepreneurs who helped build a new economic system less encumbered by class mentalities. and the like? The early bankruptcy laws of England first recognized that businesses can and do fail in spite of the best good faith efforts of their proprietors.

or even worse. This legislation sought to pull in the reins on many of these abuses. Corporations began to use the reorganization provisions of the law as a management wedge to get out from under otherwise binding executory contracts. Federal Bankruptcy Code: 1) Bankruptcy reform Act of 1978 2) Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 . Unfortunately. illustrates Congress’s attempts to deal with the dilemma of trying to make the law more humane while trying to curb abuses.Bankruptcy and Reorganization 371 and the larger societal public policy is subverted.S. Congress responded with the Bankruptcy Amendments and other legislation and subsequent revisions. Graduates of long and expensive professional studies began their lucrative careers with a bankruptcy discharge of school loans. Many consumers loaded up on all sorts of items on credit and kept them debt free after bankruptcy. The history of the law of bankruptcy is riddled with cases of clear abuse and creditor victimization that have created a dilemma for legislators who must draft bankruptcy statutes. The Bankruptcy Act of 1978 provided for sweeping reforms that sought to destigmatize bankruptcy in an economy that had grown too dependent on credit. tort judgments. with this liberalization came a number of abuses of the law. The recent history of federal reforms in the U.

372 Chapter 24 There are no state bankruptcy laws. .

11. larceny. tangible and intangible property unless exempt 3) see list of exempt property in the text The Court speaks: Facts: The Lebovitzs both filed for bankruptcy in TN. Due to co-signing a large loan of Mr.300 unsecured claims 3) submit schedules 4) attorney certification 5) order of relief 6) first creditors meeting – 10 to 20 days 7) creditor files proof of claim 8) trustee is appointed a) mandatory: chapters 7.13 b) may be appointed: chapter 11 9) trustee: a) takes possession of property b) investigates c) distributes 10) automatic stay 11) discharge Exceptions From Discharge: 1) taxes accrued within 3 years prior to filing the petition 2) fines and penalties to the government 3) willful or malicious injury to a person or property 4) fraud. personal.11 (1) fewer than 12 creditors – 1 creditor (2) 12 or more creditors – 3 creditors (3) $12. maintenance . Mr. was because of illness and Mrs.12. and child support 6) unscheduled claims 7) purchase of luxury goods more than $500 from a single creditor within 90 days of the order of relief 8) cash advances over $750 by a consumer-debtor with revolving line of credit or credit cards within 70 days of the order of relief Bankruptcy Estate: 1) created upon commencement of a bankruptcy estate 2) includes all debtors legal and equitable interests in real.13 b) involuntary: chapters 7. or embezzlement while a fiduciary 5) alimony. A number of pieces of jewelry (a gift from husband to wife) .12.Bankruptcy and Reorganization 373 Key Concepts Bankruptcy Procedure: 1) prepetition and post petition counseling 2) filing a petition a) voluntary: chapters 7.

Ethics Spotlight: 2005 Act Limits – The Homestead Exemption The bankruptcy Code’s federal homestead exemption is $18. Ethics Spotlight: Fraudulent Transfers Before Bankruptcy Certain fraudulent transfers are voidable by the bankruptcy court. Jacoway. Issue: Can debtors exempt IRAs from their bankruptcy estate? Decision: The judgment was reversed. Claimed her jewelry fit this exemption and the bankruptcy trustee filed an object to the claim. The Supreme Court speaks: Rousey V. They tried to shield the IRAs as exempt from the bankruptcy estate. Reason: IRAs are similar to plans specified in the statute which provide a substitute for wages and are not mere savings accounts.” The TN legislature has spoken. The IRAs qualify as exempt property.374 Chapter 24 were in the estate. Mrs.450. Several years after establishing such they filed a Chapter 7 bankruptcy petition. the trustee.S. The Rouseys appealed from a judgment of the U. court of appeals affirming the bankruptcy court’s decision. Jacoway Facts: The Rouseys had IRAs. The bankruptcy court agreed with Jacoway. Reason: The items of jewelry are luxury items and not “necessary or proper wearing apparel. The rules are discussed. Issue: Is jewelry “necessary and proper wearing apparel” and thus exempt? Decision: No. The property had to be included in the estate. TN has its own exemptions and does not have one for jewelry but has one for “necessary and proper wearing apparel. 7 amount f) insolvent debtor g) exceptions 2) Fraudulent: a) intent to defraud b) debtor receives less than reasonable value c) insolvent debtor or can’t pay Special Applications: 1) Chapter 7 – new simple abuse rules and means testing to determine if relief should be granted Median Income Test and Means Test: 1) If debtor’s family income (last 6 mos. X 12 /6 is < or = to state’s median income – no presumption of abuse . objected. Preferential and Fraudulent Transfers: 1) Preferential: a) to or with any party on or within 90 days of filing b) to or with any insider between 90 days and one year of filing c) for benefit of creditor d) antecedent debt e) creditor receives more than the Ch. Abusive exemptions are limited.

the value of the assets in his retirement plan was $1. Witwer. The bankruptcy court found this to be the case concerning the retirement plan established by Witwer.D.000 and 9. James J.999 (1) deny relief if total can pay 25% of unsecured debt (2) relief if total can’t pay 25% of unsecured debt 3) If total is > or = to 10. the size of a debtor’s bankruptcy estate is “subject to the vagaries of state exemption law. a California corporation under which he practices medicine.. X (DMI X 60) = Total c) If total < 6. California law exempted retirement plans from a debtor’s bankruptcy estate..s income/6 (certain deductions are available) b) State’s Median Income for 5 yrs. Inc.” .8 million in retirement benefits in bankruptcy while being discharged from debts legitimately owed to creditors seems fundamentally unfair. At the time. several creditors filed objections. Issue: Is Witwer’s retirement plan exempt from the bankruptcy estate? Decision: Witwer’s retirement plan is fully exempt from his bankruptcy estate. which was established in 1970.” The court concluded that under the Bankruptcy Code. Witwer is the sole stockholder. M. Reason: Under California law.000 – abuse is presumed – not eligible for Chapter 7 relief Ethics Spotlight: Attorney Certification A new burden on attorneys under the 2005 act is discussed. Witwer filed a voluntary petition for relief under Chapter 7 (liquidation). 1991.000 – no presumption of abuse d) If total between 6. this court is constrained by the plain meaning of the statutes in the context of this case. and president of James J. On October 21. He is also the sole beneficiary of the corporation’s retirement plan. The court stated: “Regardless of the inequities that may result from a debtor’s use of the California exemption scheme. sole employee. When Witwer claimed that his retirement plan was exempt from the bankruptcy estate. The Court Speaks: In re Witwer Facts: Dr.8 million. the assets of a retirement plan are entirely exempt if the plan was designed and used for retirement purposes. Allowing the debtor to retain over $1.Bankruptcy and Reorganization 375 2) If debtor’s family income > state’s median income – look to mean’s test a) Debtor’s Monthly Income (DMI) = last 6 mo.

and the Kawaahaus appealed to the US Supreme Court. Geiger for a foot injury. The bankruptcy court denied the discharge. is discharable in bankruptcy. etc. 4) Employee benefit claims 5) Farmers and fishermen 6) Deposits 7) Child support. Contemporary Issue: Discharge of Student Loans Students can only discharge student loans if nondischarge would cause an undue hardship on the debtor and his or her dependents—a hardship that is strictly construed. Reason: A medical malpractice judgment based on negligent or reckless conduct. filed for bankruptcy. Geiger prescribed an ineffective drug because he wanted to minimize treatment cost. Issue: Is a debt arising from a medical malpractice judgment that is attributable to negligent or reckless conduct dischargeable in bankruptcy? Decision: Yes. etc. Geiger. . Geiger Facts: Margaret Kawaahau sought treatment from Dr.376 Chapter 24 Unsecured Creditors Priority: 1) Fees and expenses 2) Gap claims 3) Wages. Eventually her condition deteriorated. and not intentional conduct. alimony. the court of appeals reversed. and she had to have her leg amputated at the knee. Kawaahau and her husband sued Geiger for malpractice. who did not have malpractice insurance. 8) Taxes 9) General unsecured 10) Debtor The Supreme Court Speaks: Kawaauhau v.

Bankruptcy and Reorganization 377 .

.378 Chapter 24 Debtor-in-possession is left in place to operate the business during the reorganization proceeding.

Bankruptcy and Reorganization 379 Necessary. . good faith.Plan must be fair to impaired class Contemporary Issue: Discharge of Student Loans Students can only discharge student loans if non-discharge would cause an undue hardship on the debtor and his or her dependents – a hardship is strictly construed. balance of equities favors Under cram-down method: .

And second. the British have favored the accounting profession.S. Ask your students what they think. *One is the relative leniency of U.” Contemporary Issue: Small Business Bankruptcy This discusses the Bankruptcy Code as it helps small businesses take advantage of Chapter 11. I think not. law compared to that of other countries. Contemporary Issue: Prepackaged Bankruptcy Creditor approved tern used in a bankruptcy petition is called a “prepackaged bankruptcy. . But does accounting training per se properly take into “account” (pardon the pun) the intangibles such as due process. This is an example of how a very large corporation used the law to reinvent itself into a growing concern. property rights. International Law: British Bankruptcy Law This provides an opportunity for the instructor to review two interesting aspects of bankruptcy law. what should the role of attorneys be in this process vis-à-vis other professionals? Here.380 Chapter 24 Contemporary Issue: UAL Corporation’s Chapter 11 Bankruptcy UAL Corporation’s case is discussed. such as Great Britain’s reforms illustrated here. and a “taking” in the same way as law training.

It can be up to 3 or 5 years.Bankruptcy and Reorganization 381 Notes: Applies to natural persons -Voluntary filing by debtor only Limitations on Filing: 1) Need unsecured debts < $307.: (DMI X 12) < state’s median income + 525/mo. a) 3 yrs. b) 5 yrs. .: (DMI X 12) > state’s median income + 525/mo.975.675 and secured debts < $922. 3) Plan of payment must be filed no later than 90 days after order of relief. 2) Trustee is appointed.

M.D.Pa. The Bankruptcy Code provides that the Bankruptcy Court shall grant an involuntary petition if the debtor is not paying its debts as they become due. . Answers to Critical Thinking Cases Petition 24. This is a crime. the involuntary petition to place Walnut Street Four. Lexis 1806 (Bk. 56. In re Walnut Street Four.382 Chapter 24 Contemporary Environment This addresses Sect.R. 106 B. The court heard evidence from creditors that the partnership was not paying its debts as they became due. 1989). 802 and the issues of hiding fraud that led to bankruptcies. a general partnership. Based upon this evidence. Yes. the Bankruptcy Court granted an order for relief under Chapter 7 of the Bankruptcy Code. 1989 Bank v. into bankruptcy should be granted. III.1.

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Bankruptcy Estate 24.2. Mrs. Hargis gets to keep the $700,000 life insurance proceeds. The court held that the money became due to Mrs. Hargis more than 120 days after the bankruptcy petition was filed. The Bankruptcy Code provides that any inheritances and life insurance proceeds that become due to the debtor more than 120 days after the bankruptcy petition is filed belong to the debtor and do not become part of the bankruptcy estate. Here, Mr. Hargis died more than 120 days after the bankruptcy petition was filed, and Mrs. Hargis did not become entitled to receive the proceeds of the life insurance policy until that date. In re Hargis, 887 F.2d 77, 1989 U.S. App. Lexis 16246 (5th Cir. 1989).

Stay 24.3. Yes, First Interstate, as the mortgagee, should be granted a release from stay so that it can foreclose on the debtor’s residence. Normally, the filing of a bankruptcy petition stays legal proceedings against the debtor and his property. However, the Bankruptcy Code provides that the court may grant a creditor relief from stay if there is lack of adequate protection of the creditor’s interest in the property or the debtor does not have adequate equity in the property and it is not necessary to an effective reorganization. In this case, the Bankruptcy Court held that the debtor’s equity cushion of 11.5 percent does not constitute adequate protection of the mortgagee’s interest in the property. Further, other evidence showed that the property was deteriorating and the debtor did not have the financial ability to maintain or insure the property, and that the Greybull/Basin area in which the property was located was suffering tough economic times, and the real estate market was declining. Based upon this evidence, the Bankruptcy Court granted First Interstate’s motion for relief from the stay. First Interstate foreclosed on the property and sold it. In re Kost, 102 B.R. 829, 1989 U.S. Dist. Lexis 8316 (D.Wyo. 1989).

Fraudulent Transfer 24.4. The bankruptcy trustee wins, and the debtors’ transfer of their home to their daughters may be set aside as a fraudulent transfer. The court held that the bankruptcy trustee could not employ the one-year fraudulent transfer provision of the Bankruptcy Code because the debtors’ transfer of their residence to their daughters took place approximately 1 1/2 years prior to the filing of their bankruptcy petition. However, the trustee can use the six-year limitation period of the New York fraudulent transfer statute because it was made for no consideration, which raised a presumption of insolvency that the debtors did not overcome. The court held that the transfer could therefore be avoided as a fraudulent transfer and that the residence became part of the bankruptcy estate. In re Tabala, 11 B.R. 405, 1981 Bank v. Lexis 3663 (Bk.S.D. N.Y. 1981). Preferential Payment 24.5. Yes, the payment by the debtor, Air Florida, to its creditor, COPA, within 90 days prior to the commencement of Air Florida’s bankruptcy case was a preferential transfer that can be avoided. A preferential transfer occurs where (1) a debtor transfers property to a creditor within 90 days before the filing of a bankruptcy petition, (2) the transfer is made for an antecedent (preexisting) debt, and (3) the creditor would receive more from the transfer than it would have received had the debtor been liquidated under Chapter 7 of the Bankruptcy Code. In this case, the

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payment was made within 90 days before Air Florida filed its bankruptcy petition, was made for an antecedent debt owed to COPA, and COPA received more from the payment than it would have received if Air Florida was liquidated under Chapter 7 of the Bankruptcy Code. The Bankruptcy Court held that the payment was a preferential payment that could be avoided. In re Jet Florida System, Inc., f/k/a/ Air Florida System Inc., 105 B.R. 137, 1989 Bank v. Lexis 1629 (Bk.S.D. Fla. 1989). Executory Contracts 24.11. Yes, The Record Company may reject the purchase agreement to buy the record stores from Bummbusiness. The Bankruptcy Code permits a debtor in a Chapter 11 case to reject executory contracts. An executory contract is defined as one under which the obligations of both the debtor and the other party are so far unperformed that the failure of either party to complete performance would constitute a material breach. The Bankruptcy Court held that the purchase agreement in the instant case fit this definition. The Record Company still owed Bummbusiness $10,000 and was obligated to keep paying on the $380,000 trade debt. The performance outstanding of Bummbusiness included not competing with the buyer and using its efforts to obtain extensions of the due dates for the trade debt. The court held that the sum total of the performance outstanding by both parties made the purchase agreement an executory contract. As such, the court permitted The Record Company to reject the purchase agreement. In re The Record Company, 8 B.R. 57, 1981 Bank v. Lexis 5157 (Bk.S.D.Ind. 1981). Plan of Reorganization 24.6. No, the debtor’s plan of reorganization cannot be confirmed by the Bankruptcy Court. Under the Bankruptcy Code, a class of creditors is impaired if (1) the plan alters the legal, equitable, and contractual rights of the class of creditor and (2) the class does not vote to accept the plan. In this case, the Bankruptcy Court held that the debtor’s proposed plan of reorganization alters the legal, equitable, and contractual rights of Class 2 because it reduced the class’ claims by 50 percent. Therefore, in order for the plan to be confirmed without use of the cramdown provisions, these creditors must vote for the plan, which they have not. Since Class 2 is impaired and has not accepted the plan, the requirements for confirmation under Section 1129(a) of the Bankruptcy Code have not been met. In addition, the plan cannot be confirmed under the “cramdown” provisions of Section 1129(b). In order for the court to confirm a plan under the cramdown provisions, the Bankruptcy Code requires that at least one class of creditors must vote to accept the plan. Here, the court found that no class of creditors has voted for the plan. Therefore, the court held that the debtor’s proposed plan cannot be crammed down on the impaired Class 2 creditors. The Bankruptcy Court denied confirmation of the debtor’s proposed plan of reorganization. In re Friese, 103 B.R. 90, 1989 Bank v. Lexis 1309 (Bk.S.D.N.Y. 1989). Consumer Debt Adjustment 24.7. No, the debtor’s Chapter 13 plan should not be confirmed because all of the debtor’s “disposable income” is not being made available to make payments to the creditors under the plan. The Bankruptcy Court held that the Blazer was an obvious indulgence, that it was of a recreational variety and was not necessary for the debtor’s work, maintenance, or support, that an adequate new car could be purchased for half of what the debtor paid for the Blazer and that a reliable used car could be purchased for even half of that, and that if the Blazer’s payments were reduced by 1/3, enough funds would be left over to pay unsecured creditors roughly three times the amount that is proposed over the term of the plan.

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The court held that the plan as proposed by the debtor would almost eliminate the unsecured creditors’ claims (90 percent of the amount of their claims would not be paid) while the plan made the secured creditors whole. The court held that the plan was unfair to the unsecured creditors because it did not provide that all the debtor’s “disposable income” would be applied to make payments under the plan. For these reasons, the court refused to confirm the debtor’s proposed Chapter 13 plan. Note: If the debtor files a voluntary petition for Chapter 7 liquidation bankruptcy, the debtor would be able to claim certain exemptions in the secured property. The unsecured creditors may or may not obtain a creditor payment under Chapter 7 bankruptcy. Usually, however, unsecured creditors do not fare any better—and often fare worse—under a Chapter 7 bankruptcy than under the Chapter 13 payment plan. In re Reyes, 106 B.R. 155, 1989 Bank v. Lexis 1731 (Bk.N.D.Ill. 1989). Student Loan 24.8. No, the debtor’s student loan should not be discharged in bankruptcy. Congress, which was concerned about debtors who incurred student loans and then filed bankruptcy after leaving school, enacted Section 523(a)(8)(B) of the Bankruptcy Code to make it more difficult for student loans to be discharged in bankruptcy. This section provides that during the first five years after a student loan becomes due and payable, it is not dischargeable in bankruptcy unless payment would cause “undue hardship” on the debtor and his dependents. After this five-year period has run, student loans are dischargeable in the same manner as other loans. Section 523(a)(8)(B) is strictly construed by the courts, and the debtor bears the burden of proof as to undue hardship. The Bankruptcy Court held that since the debtor’s student loan became due and payable one month before he declared bankruptcy, it falls within the five-year period and is subject to the “undue burden” standard of dischargeability. The court held that the debtor’s two children were reasonably well shielded from the effects of the debtor’s liability for the student loan by virtue of the state court’s order that he pay $300 per month for the support of the children. In addition, the court found that the debtor’s former wife was not dependent on the debtor. Therefore, the only question was whether the liability for the student loan would impose an undue hardship on the debtor. The court, recognizing that this was a “close case,” held that the monthly payment of $50 per month toward paying off the student loan would not cause an undue burden on the debtor. The court held that the debtor’s liability for the student loan was not dischargeable in bankruptcy. In re Doyle, 106 B.R. 272, 1989 Bank v. Lexis 1772 (Bk.N.D.Ala. 1989). Preference Rule 24.9 Payments made on long-term debt may qualify as being made in the ordinary courser of business once-are not voidable as a preferential payment. Payments on long-term debt, as well as those on short-term debt, may qualify for the ordinary course of business exception to the trustee’s power to avoid preferential transfers. Section 547(c)(2) contains no language distinguishing between long- and short-term debts, and, therefore, provides no support for Wolas’ contention that its coverage extends only to short-term debt. Moreover, @ 547’s relevant history in part supports, and is not otherwise inconsistent with, a literal reading of the statute. While @ 547(c)(2), as originally enacted, was limited to payments made within 45 days of the date a debt was incurred, Congress amended the provision in 1984 by deleting the time limitation entirely. That Congress may have intended only to address particular concerns of specific short-term creditors in the amendment or may not have foreseen all of the consequences of its statutory enactment is insufficient reason for refusing to give effect to @ 547(c)(2)’s plain meaning. Also unpersuasive is Wolas’ argument that Congress originally enacted @ 547(c)(2) to codify a judicially crafted “current expense” rule covering

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contemporaneous exchanges for new value, since other @ 547(c) exceptions occupy some (if not all) of the territory previously covered by that rule, and since 547(c)(2). Nor does the fact that the exception’s availability to long-term creditors may not directly further @ 547’s underlying policy of equality of distribution among all creditors support limiting @ 547(c)(2) to short-term debt, for it does further the provision’s other policy of deterring creditors from racing to the courthouse to dismember a debtor and may indirectly further the equal distribution goal as well. Union Bank v. Wolas, 502 U.S. 151, 112 S.Ct.527, 1991 U.S. Lexis 7174 IV: Answers to Ethics Cases 24.10. Yes, the debtor’s petition for Chapter 7 bankruptcy should be dismissed because the debtor acted in bad faith. One of the primary purposes of the Bankruptcy Code is to relieve the honest debtor from the weight of oppressive indebtedness and permit him to start afresh free from his prepetition obligations. However, Congress never intended that bankruptcy be a refuge for the unscrupulous and cunning individual. The Bankruptcy Code provides that a bankruptcy petition may be dismissed if the debtor filed the petition in bad faith. The Bankruptcy Court found that the debtor quit his job rather than attempting to work out a repayment plan with his creditors, did not try his best to pay his debts and made every effort to avoid paying them, and did not adjust his affluent life-style. Based upon this evidence, the Bankruptcy Court held that the debtor acted in bad faith and dismissed his bankruptcy petition. In re Scott Keebler, 106 B.R. 662, 1989 Bank v. Lexis 1919 (Bk.D. Hawaii 1989). 24.11. Yes, The Record Company may reject the purchase agreement to buy the record stores from Bummbusiness. The Bankruptcy Code permits a debtor in a Chapter 11 case to reject executory contracts. An executory contract is defined as one under which the obligations of both the debtor and the other party are so far unperformed that the failure of either party to complete performance would constitute a material breach. The Bankruptcy Court held that the purchase agreement in the instant case fit this definition. The Record Company still owed Bummbusiness $10,000 and was obligated to keep paying on the $380,000 trade debt. The performance outstanding of Bummbusiness included not competing with the buyer and using its efforts to obtain extensions of the due dates for the trade debt. The court held that the sum total of the performance outstanding by both parties made the purchase agreement an executory contract. As such, the court permitted The Record Company to reject the purchase agreement. In re The Record Company, 8 B.R. 57, 1981 Bank v. Lexis 5157 (Bk.S.D.Ind. 1981).

VI. Answer to “Briefing the Case” Writing Assignment 1. Case Name, Citation, and Court Dewsnup v. Timm 116 L. Ed. 2d 903 (1992) United States Supreme Court 2. Key Facts A. On June 1, 1978, Aletha Dewsnup and her husband, T. LaMar Dewsnup borrowed $119,000 from Timm. The loan was secured by a deed of trust lien on two parcels of farmland located in Utah. B. In 1981, the Dewsnups tried to file for Chapter 11 bankruptcy. Subsequently, they filed for Chapter 7 liquidation.

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C. C. Timm sought foreclosure of the lien, and the debtor sought to limit the lien amount to the judicially determined value of the real property. D. The lower court held that the value of the lien stays with the property until such time as the foreclosure and any increase in value during the bankruptcy inured to the creditor. Dewsnups appealed. 3. Issue Does the Bankruptcy Code allow for the increase in value during the proceeding to inure to the creditor? 4. Holding Yes. 5. Court’s Reasoning The U.S. Supreme Court held that: A. Sections 506(a) and 502 of the Bankruptcy Code are not required to be read together thus allowing 502 to operate independently. B. The underlying agreement, signed by both parties allows for this outcome. C. The holding of the lower court for the creditor was affirmed.

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Chapter 25 Agency Relationships

What Can An Agent Do?

I. Teacher to Teacher Dialogue Agency law is very important in a basic undergraduate law course in that it represents a synergy of two otherwise distinctive bodies of law: contracts and torts. It is useful to remind students of the interplay between these two areas of law. For example, go through the creation of the agency relationship (which highlights contract elements), involve a third party (by way of tort), and decide whether any defenses may apply (possibilities from both the law of contracts and torts). Invariably, certain patterns of behavior can be identified that can be used to help students ask key questions about agency-based issues. Agency is defined by Section 1 of the Second Restatement of Agency as: The fiduciary relation which results from the manifestation of consent by one person to another that the other shall act on his behalf and subject to his control, and consent by the other so to act. Agency is a legally recognized relationship that allows an attribution of one person’s behavior to another. This carryover process is two-sided in that both benefit and burden inure to the parties involved in the agency relationship. Under the basic doctrine of agency, the principal is allowed to reap the beneficial harvest of the agent’s actions made on his or her behalf. For example, assume an agent has agreed to be paid a set salary of $100 for selling certain kinds of goods. The principal gets to keep the net profits from that agent’s selling activities, be they $100 or $1,000,000. This net gain is what allows the use of agency theory to maximize one’s efficiency through the actions of others. There, are, however, some limits on the ability to designate others to act on one’s behalf based on uniqueness of personal services or on public policy grounds that forbid use of agents, such as voting or serving a criminal sentence. As a practical matter, business as we know it today simply could not be conducted on any scale beyond sole proprietorship without extensive use of agency relationships. The benefits of agency are not without counterbalancing problems. The Latin maxim respondeat superior may be familiar to your students. In certain instances, a principal is liable to

Agency Relationships 389

third parties for the acts of his or her agent. Just as the benefits of agency can be great, so can the burdens. One of the fastest growing areas of management specialization in today’s business environment is risk management. This area generally concerns business financial responsibility for exposures to specified contingencies or perils. Included in these perils are the acts of the agents for which the principal may be liable. The ironic aspect of all this is that the very same people who help a business grow can lead that same enterprise to financial ruin. *Every agency liability question having an involvement with third parties has three subquestions that must be answered in order to come to a final resolution of the issues at hand. They are: 1. What are the responsibilities of the principal and agent vis-à-vis each other? 2. What are the responsibilities of the agent vis-à-vis the third party? 3. What are the responsibilities of the principal vis-à-vis the third party? Invariably a certain fact pattern emerges. First there is some sort of principal/agent relationship established. This relationship may be based on actual, implied, apparent, or ratified authority. In all events, once that authority line has been drawn, the question of the legal consequences to the principal and agent vis-à-vis each other must be answered. These consequences include their respective rights and duties to each other. Once the first subquestion is resolved, the rights, duties, and obligations of the agent and principal, respectively, must then be examined vis-à-vis the third party. Often there will be some sort of wrongful and unauthorized act committed by the agent. That act will result in probable liability for both the agent and the principal to the third party who was harmed by the act. Think of the three subquestions as a loop that must be closed in order for the whole case to be resolved. An agency issue starts with the establishment of the agency relationship. It goes through the rights and duties of third parties. It terminates where it began, with a determination of the ultimate responsibilities of the principal and agent vis-à-vis each other.

II. Text Materials

usually need contractual capacity to appoint an agent.

390 Chapter 25

Often formed by contract or notification.

The Court Speaks: Bosse v. Brinker Restaurant Corporation,,d.b.a. Chili’s Grill and Bar Facts: Bosse and Griffin and others at a $56 meal at Chili’s. They left without paying . An unidentified patron chased than and called the Chili’s manager who called the police. Bosse’s car hit a wall and Bosse and Grifin were seriously injured. They sued Chili’s for compensatory damages arguing an agency relationship between Chili’s and the patron making him liable under respondeat superior. Chili’s files a motion for summary judgment. Issue: Was the patron an agent of Chili’s? Decision: No. Summary judgment was granted. Reason: To be an agent, there must be consent by Chili’s, retaining of control, and action to benefit Chili’s. Here there was no preliminary communication so any consent is tenuous at best. By using the phone intervention, Chili’s was merely reporting a petty crime that the patron was pursuing. Agency need not exist in this case and it did not.

Agency Relationships 391

Contemporary Issue: Power of Attorney This is an agency agreement often used to give an agent the power to sign legal documents. It can be “general” or “special”.

Note: Implied authority to act on contingencies is called accidental authority.

Ethics Spotlight: Apparent Agency “You can’t have your cake and eat it too.” The benefits of franchising are great and will be covered in more detail in other chapters. One such benefit is the return to the franchisor of a percentage of profit from the operations of the franchisee. Coupled with this return of profit comes a certain amount of control over the activities of the franchisee. But: “There is no free lunch!” Here that control (or lack of it vis-à-vis safety issues) came back to haunt the franchisor.

392 Chapter 25

Agency Relationships 393

Common Breaches of Loyalty: 1) self-dealing 2) usurping an opportunity 3) competing with the principal 4) misuse of confidential information 5) dual agency

394 Chapter 25

The Court Speaks: Collette v. Unique Vacations ,Inc. Facts: The Collette’s booked a Jamaican vacation through Vacations Outlet(VO) with a hurricane guarantee. The brochure identified Unique Vacations (UV) as Sandals’ booking agent but the Collette’s had no contract with UV. During the vacation a hurricane struck and the Collette’s contacted Sandals about the guarantee but got no satisfaction. They sue VO and UV for breech of contract. The VO complaint was dismissed. The trial court found against UV was appealed. Issue: Is UV an agent of Sandals that is liable to the Collette’s based on the hurricane guarantee? Decision” UV was a disclosed agent of Sandals and thus not liable to the Collette’s based on the hurricane guarantee. The judgment was reversed and vacated and a judgment was ordered for UV. Reason: UV was disclosed and not liable and also not a party to the hurricane guarantee. Additionally the Collette’s never dealt with VU.

Agency Relationships 395

Note: A principal is not liable on a contract that exceeds the agent’s authority unless the principal ratifies it. The Court Speaks: Edgewater Motels, Inc. v. Gatzke and The Walgreen Company Facts: Arlen Gatzke was employed by Walgreen Company and was sent to Duluth to supervise the opening of a new store. He also was available to other stores in the territory on a 24-hour basis. At night when he returned to his hotel room after working, he would prepare expense account forms and use the room as an office on occasion. After a fire occurred at the hotel, evidence indicated it was the result of Gatzke’s negligent smoking habit. The motel sued Gatzke and Walgreen. Issue: Was Gatzke’s act of smoking within his “scope of employment” making his principal, Walgreen, vicariously liable for Gatzke’s negligence? Decision: Yes, it was within his scope of employment. Reason: Many cases have held smoking, which is not a major deviation from work, to be within the scope of employment. At the time of the negligent act Gatzke was on call 24 hours a day, he prepared work documents in the room and used it as an office. Smoking in the room, although a matter of personal comfort, did not take Gatzke outside of his employment.

Both usually liable

396 Chapter 25

The Court Speaks: Keating v. Goldrick and Lapp Roofing and Sheet Metal Company, Inc. Facts: Lapp, an Ohio company, sent Goldrick and others to do a roofing job in Wilmington. Company policy prohibits use of company vehicles for personal uses. Goldrick was given a company van for transportation of workers to the site and for necessities while in Wilmington. Goldrick and McNeese (both Lapp employees) went to eat and drink and were ejected. Goldrick drove onto a curb and struck people in various places. He was charged and pleaded guilty to criminal assault. Keating and others injured filed this personal injury suit. Lapp says they were not liable because Goldrick was outside the scope of his employment. Issue : Was Goldrick’s negligence within the scope of his employment at Lapp? Decision: No. Summary judgment was granted. Reason: A reasonable person would not assign liability to a company based on an employee using a company van to drink at night. If the accident occurred after using the van for a necessity, there would probably be a different result. This conduct, however, was completely unrelated to Lapp’s business, outside of working hours and does not benefit Lapp in any way. This was a purely personal activity.

The Court Speaks: Siegenthaler v. Johnson’s Welded Products, Inc. Facts: Spires was employed by Johnson who provided a lunchroom equipped for lunch. While on lunch break, Spires drove his own truck to a friend’s house and collided with and injured Siegenthaler due to Spire’s negligence. Siegenthaler sued Spires and Johnson under respondeat superior. Siegenthaler appeals from summary judgment granted to Johnson. Issue: Was Spires an agent of Johnson acting within the scope of employment when injuring Siegenthaler? Decision: No. Trial court’s grant of summary judgment to Johnson was affirmed. Reason: Spires was not subject to the direction and control of Johnson at the time of the accident while on his way to a friend’s house for lunch. He was thus not within the scope of employment.

The Court Speaks: American National Property and Casualty Company v. Farah Facts: Morgenstern was the owner and sole shareholder of Morning star Chiropractic. He left his office (where he treated patients) for a personal lunch at a restaurant. He went to a grocery store and back to his office for a remedy for an upset stomach. On the way he collided with Farah’s car, injuring Farah who sued Morgenstern and his company for negligence and vicarious liability. ANPAC, Morgenstern’s insurance company object to the vicarious liability claiming he was not within the scope of employment under the “coming and going rule”. Judgment was entered in favor of ANPAC. Farah appealed. Issue: Did the “coming and going rule” protect the company, and therefore, ANPAC from liability? Decision: Yes. Judgment for ANPAC was affirmed. Reason: Morgenstern had a fixed place of employment where he started and ended his substantial employment duties. Even though he was listening to a tape of his lecture notes does not change the fact that he was driving to the office for a personal reason and thus not within the scope of employment.

Morales and Polanco each pleaded guilty to criminal assault. For liability to be imposed on the employer. the manager. Reason: Under the doctrine of respondeat superior. Edwards began verbally harassing her from inside his cab. Issue: Is Desert Cab liable for the intentional tort of its employee? Decision: Desert Cab was liable for the intentional tort of its employee. When Marino approached Edwards to inquire as to the reason for the harassment. Starbucks Corporation Facts: Massey and Rodriguez ordered drinks at Starbucks and paid for them. and Desert Cab was therefore liable to Marino. and appellant James Edwards. As Marino stood alongside her cab conversing with the drive of another taxi. 1986. the intentional tort must be work related.can go outside “. v. The motion for summary judgment was granted. Marino’s cab occupied the first position in the line and Edwards occupied the third. an employer is liable for the intentional torts committed by its employees within the scope of their employment. respondent Maria Marino. Second. the store was closed. Before she could return to work. The Court Speaks: Massey v. The court held that Edwards’ intentional conduct of assault and battery against Marino was work related. After being told the store was closing by Morales. he refunded their money and told them to leave. the assault . The Court Speaks: Desert Cab Inc. Starbucks moved for summary judgment alleging actions outside the scope of employment. Reason: The question to be answered was whether the assault (causing injury) not the dispute was within the scope of employment. parked their cabs at the taxicab stand of the Sundance Hotel and Casino in Las Vegas to await fares. the statement to go outside mentioned it would be after closing. The 3 employees were fired. Marino subsequently filed a wrongful termination suit against her former employer. grabbed Marino by her neck and shoulders. Marino sustained injuries that rendered her unable to work for a time. Polanco ran after Massey and pushed her and a fight ensued. Polanco had told Massey they “…. pulled Edwards off of Marino and escorted her back to her cab. he jumped from his cab. Work-related Test: Principal liable if agent was within work-related time and space. After closing. A bystander intervened. began choking her. a cab driver with Yellow-Checker Cab Company. and threw her onto the front of his taxicab. a cab driver with appellant Desert Cab Company. Yellow-Checker Cab terminated her. After a verbal battle. Marino Facts: On October 6. Polanco. First. They were two separate events. Massey sued Starbucks for her injuries. Third. Morales and Wilson (all employees) held the door open for Massey and Rodriguez. Edwards was convicted of misdemeanor assault and battery for his attack on Marino.Agency Relationships 397 Intentional Tort • • Motivation Test: Principal liable if agent was promoting principal’s business. Issue: Were the employees within the scope of employment during the assault? Decision: No. Marino brought this personal injury action against James Edwards and Desert Cab.

was injured and was rendered a paraplegic. The Reardon’s were not liable to Torres and the summary judgment was affirmed. inherently dangerous activities and negligence in the selection of an independent contractor. Exceptions include nondeligable duties. not hired by day or hour. special risks. The Court Speaks: Torres v. Generally. The job was not part of the Reardon’s business for which he had employees. Torres appealed from a trial court ruling granting the Reardon’s action for summary judgment. While cutting the branch with the help of Boice. . Issue: Was Torres an employee or an independent contractor? Decision: Independent contractor. Vicarious liability only applies where the actions were intended to benefit the employer. who lived next door and was afraid of the branch falling on his house. They had held the door open for them to leave. a principal is not liable for the torts of independent contractors. He was contracted for a job. Torres was thus an independent contractor when he was injured. The Reardon’s claimed an independent contractor relationship. Reason: Torres worked for the Reardon’s out of his independent business with apparently his own equipment. Reardon Facts: Torres was hired to trim a tree in Reardon’s front yard. Ethics Spotlight: Principal Liable for Repo Man’s Tort This discusses liability by a principal for the tortious conduct of an independent contractor amount to breaching the peace. Torres sued Reardon claiming an employment relationship and thus lack of workers’ compensation insurance. This was not the case here. Note: The critical factor in determining an independent contractor is the degree of control. The assault had purely personal motives.398 Chapter 25 happened outside of the store.

Direct notice prior dealings. created for the agent’s benefit. Constructive notice any with knowledge of agency. Termination by Impossibility: 1) loss or destruction of the subject matter of the agency 2) loss of a required qualification 3) change in the law Contemporary Issue: Irrevocable Agency An agency coupled with an interest. is irrevocable.Agency Relationships 399 Notification Required at the Termination of an Agency The principal is under a duty to give certain third parties notification of the termination of an agency. .

Ginn v. the unidentified patron was not an agent of the nightclub. The court found no proof of agency by express agreement or by implication from the circumstances of the case. not under any degree of control from Samuelson. Answers to Critical Thinking Cases Creation of an Agency 25. Renaldo.2d 390. African Adventures (AA) is an independent contractor. No. 1987). The relation of principal and agent arises wherever one person—expressly or by implication—authorizes another to act for him. The appellate court affirmed the trial court’s grant of a directed verdict in favor of defendant nightclub. No. Because there was no agency.E. A review of the record persuaded the court that the unidentified person who caused Ginn’s injuries was merely an individual patron of the nightclub who was acting on his own.400 Chapter 25 Note: principal termination – revocation of authority agent termination – renunciation of authority III. Samuelson is not liable for the torts of an independent contractor.App. App.. the nightclub is not liable for the actions of the patron who injured Ginn.2.1. . Samuelson is not liable. There was no evidence that the nightclub manager requested the patron to assist him in dealing with Ginn or that the manager ratified the patron’s actions. 1987 Ga. Lexis 2023 (Ga. 359 S. Inc. Independent Contractor 25. Samuelson might also be considered an agent for AA and an agent is not liable for the torts of a principal.

731 S.F. Ziobro had apparent authority. had acquired knowledge of the condition of the pipes through his work at the hotel. Pusateri v. Yes.. App. Apparent Agency 25. Fiduciary Duty 25. who was Boulevard’s maintenance supervisor. Universal is the agent for a disclosed principal.000 compensatory damages and $160. The court held that because the manager of E. He was held out as having authority to bind Bank. He did not breach trust or his fiduciary duty and therefore should not be liable to Howard.4.F. 1987). Inc. The appellate court affirmed the trial court’s decision that permitted Iota to rescind the contract. By finding Landmark space in another building it violated its fiduciary duty to Boettcher. Hutton ratified the agent’s tortious acts.F.. Imputed Knowledge 25. Boulevard. App. 1986 Cal. Boulevard Investment Company (Boulevard) is liable to Iota Management Corporation (Iota) for breach of contract. E. 1987 Mo.3.Agency Relationships 401 Contract Liability 25. Lexis 1502 (Cal. The knowledge of an agent of corporate principal regarding matters within the agent’s scope of employment and authority is imputed to the principal. Ratification 25. Yes.000 punitive damages. The court held that this knowledge was imputed to the corporate principal.W. Hutton liable to Pusateri for $120. 225 C.8. Hutton is liable for the fraudulent activities of its employee. E. and is not liable on the contract. The court held that Cecil Lillibridge. He exercised the duty using his best judgment. 526. Power of Attorney 25.2d 399.7. Bolus wins.R. 1986). Secret limitations are ineffective. Octagon. Lexis 4026 (Mo. clearly within the scope of his employment and authority. A principal can be held liable for an agent’s tortious conduct even if such conduct falls outside the scope of the agent’s employment if the principal ratifies such conduct.App.F.App. Johnson. Hutton had knowledge of Johnson’s activities and took no action to prevent this conduct. Hutton & Co. Wilfred acted with a conflict of interests with respect to its duty to Boettcher.F. Boettcher wins.5. Iota Management Corporation v. The court held E. E. . Boulevard Investment Company.6. Punitive damages can be awarded against a principal for an act of an agent if the employer ratifies his tortious activity. King was an agent with a specific duty.

Independent Contractor 25.11. Inc. it will be liable for damages to Pugh’s parents and estate.W.A. 1987). wins. was an agent of the corporation.9. This is a situation of an undisclosed principal. Production Finishing Corporation v.3rd 803. Yes. Sebastian International. An independent contractor is liable for injuries caused by its own negligence.. Sebastian International. by usurping a corporate business opportunity. Both Elvin Grinder personally and G. The general rule is that an agent who signs a contract in his agency capacity and discloses the identity of the principal is not personally liable on the contract..” and the like does not change the character of the person signing. Elvin Grinder Construction. Shields breached his fiduciary duty of loyalty to his principal.402 Chapter 25 Duty of Loyalty 25. A corporate officer or director is an agent of the corporation and under a fiduciary duty not to divert a corporate business opportunity for his own personal gain. Shields.. Pugh v. Inc. 512 So. An agent who makes a contract in his own name without disclosing his agency and the identity of the . Inc. Thus. The Court of Appeals affirmed the trial court’s granting of summary judgment in favor of Production Finishing and remanded the case for a determination of damages. No. 195 C. and that the mere fact that Peck was identified as a “Vice President” did not relieve him of personal liability. Lexis 2237 (Cal. Butler Telephone Company. 405 N. If an agent acquires any pecuniary advantage to himself from third parties by breaching his fiduciary duties. Inc. Butler Telephone Company.R. 1987). Lexis 4468 (Ala. Where a writing is signed by a person and contains apt words to bind him personally. is not liable for Pugh’s death. if it is established that Sandidge was negligent in not shoring up or sloping the walls of the excavation or otherwise violated general safety standards that caused Pugh’s death. The court affirmed a grant of summary judgment in favor of Butler. Production Finishing.” “Vice President. 1987 Mich. and Peck is held personally liable on the lease guarantee. The court held that Shields breached his fiduciary duty of loyalty and honesty to his principal by diverting the Ford contract to him. Here Butler only retained the right to inspect the work for compliance with the terms of the contract.2d 171. There is an exception to this rule where an agent expressly makes himself liable.. The court held that Sandidge was an independent contractor and that Butler was not liable for the negligence of Sandidge. the fact that to his signature is added such words as “President. as president and a member of the board of directors of Production Finishing. 1987). 1987 Ala.. 911. Contract Liability 25. 1987 Cal. Whether a relationship is that of an independent contractor or master/servant depends on whether the entity for which the work is being performed has reserved the right of control over the means by which the work is done. The court found no evidence that Butler exercised any control or retained any right of control over the manner in which Sandidge performed any of its work on the project. The court held that Peck personally obligated himself to the guaranty contract. Shields.10. v. Inc.App. but is considered merely descriptive of him. Inc. Personal Guaranty 25.12. Lexis 2379 (Mich. App. Peck.App.2d 1317. 240 C. App. are liable to Bryans Road Building & Supply Co. he is accountable to his employer for the profit made. The mere fact that a person sustains an agency relation to another does not prevent him from becoming personally liable.

14. Inc. 186 C. is liable to Largey for the injuries caused by its agent. 1981). 1979 U. The court held that Grinder was the agent for an undisclosed principal. Largey v. then the employer will be vicariously liable for any accidents incurred while the employee is driving to or from work. 1982). while an employee is going to or coming from his place of employment. App. Inc.2d 453.3d 660... Therefore. . Washington Steel wins. Generally.App. including acts committed by such agents while acting within the scope of their employment. TW Corporation. Yes. 1982 Cal.. The court held that a creditor who contracts with the agent for an undisclosed principal does not obtain alternative liability. There is an exception to the “coming and going” rule—if it is an implied or express condition of the agent’s employment that he use his vehicle in attending to his duties. Dual Agency 25. Inc. The court enjoined Chemical Bank from in any way financing or participating in the TW’s tender offer. Intrastate Radiotelephone. Since Rogers was basically on the job and the accident occurred during work time.Supp. and intentionally concealed its dual agency status from Washington Steel. The court held that Chemical Bank’s undisclosed dual agency status violated the fiduciary duty of loyalty it owed to Washington Steel. The appellate court affirmed the judgment of the trial court that was entered in favor of Largey against Intrastate. Washington Steel Corporation v. 432 A. 1979). Dist. he is outside the scope of his employment during that period. Pa.Agency Relationships 403 principal is liable on the contract to the other party. The court held that there was sufficient and substantial evidence for the jury to have inferred that Kranhold was acting within the scope of his employment when the accident in question occurred. By accepting TW as a client and agreeing to finance its hostile tender offer on Washington Steel. 465 F. 1981 Md. 520. The court held that Chemical Bank owed a fiduciary duty of loyalty not to act adversely to the interests of its client. Bryans Road Building & Supply Co. Tort Liability 25.A. Grinder v.R. MAC is liable. Lexis 2049 (Cal. Washington Steel and TW had adverse interests to each other because of TW’s planned hostile tender offer for the stock of Washington Steel. and that Bryans is entitled to take judgment against Grinder personally in addition to its unsatisfied judgment against the corporation. Kranhold.D. Chemical Bank became a dual agent. the exception to the coming and going rule applies in this case. 1100. Tort Liability 25.App.15. 136 C.S.13. The principal is liable because the contract was made for his benefit. and also temporarily enjoined TW for a period of 90 days from proceeding with its tender offer for Washington Steel. the principal is liable for the intentional tort of the agent. Ordinarily. Washington Steel. a principal is responsible to third persons for the negligence of its agents. and that he is limited to one satisfaction. Lexis 14391 (W. but that he may proceed to judgment against both. Lexis 246 (Md. Intrastate Radiotelephone. Chemical Bank did not disclose its dual agency status to Washington Steel. did not seek to obtain Washington Steel’s permission to act as a dual agent.

IV: Answers to Ethics Cases 25. 2d 783. 1980 Iowa Sup. 1992) District of Columbia Court of Appeals . Hague. Lexis 882 (Iowa 1980). However. Yes. Where the principal terminates an exclusive agency listing within the term. but for the termination. the court held.W.20. 211 N. 293 N.2d 501 (D. in developing a test for application of the rule the court stated. the Hagues had the power to terminate the exclusive listing agreement with Hilgendorf. the agency agreement was terminated when the Hagues sent the termination letter to Hilgendorf on August 13. 1973 Minn. have sold the property within the unexpired period at the listing price. Lynch was found to have been originally motivated to become argumentative in the furtherance of his employer’s business. Lexis 1106 (Minn 1983). Parana did not act ethically and was not an agent of Krempasky by way of the signed agreement. V.W. 25. App.” Applying this test. The appellate court affirmed the trial court’s award of the commission to Hilgendorf. and are therefore liable for wrongful termination of the agreement.2d 272. Case Name. Bianchi made a deal with an undisclosed principal and thus did not act in good faith in trying to back out of the contract. Howell 607 A. King Realty should be awarded specific performance.C. 25. although the contract is for a period that has not yet expired. except those coupled with an interest. absent some legal ground.19. that the employer is liable where an assault or battery has its origin in an argument concerning the work being done by the employee. and Court District of Columbia v. as a matter of law. National Biscuit Company. The court held an employer is liable for an assault by his employee when the source of the attack is related to the duties of the employer and the assault occurs within work related limits of time and place. Citation. Hilgendorf v.18. Thus. The agent’s authority to bind the principal ceases. However.16. Answer to “Briefing the Case” Writing Assignment: 1.” then liability will be imposed. The Minnesota rule is that where it is shown that “the employee’s acts were motivated by a desire to further the employer’s business. the agent may show that he would. 25. Nabisco is liable for the intentional assault and battery of Lange by its employee Lynch. “the focus should be on the basis of the assault rather than the motivation of the employee. and may subject himself to damages by doing so. a principal has the power to terminate an agency. Since an agency is a consensual relationship. Parana instead became a joint tenant and as such probably acted within the law. and then recover his lost profits as ordinarily measured by the commission he would have earned. The court held that the Hagues had no legal ground for terminating their agency agreement with Hilgendorf.404 Chapter 25 Tort Liability 25. An agent for a partially disclosed principal can act for the principal. Lange v. Under the work-related test the lumber company is liable for the intentional tort of Jackson.17. the principal does not have the right to terminate an unexpired agency contract. 1976.

C. was upheld. Howell. . D. A school principal. The nature of the materials used and the age of the students involved created a special danger. B. B. C. Holding Yes. The chemistry teacher conducted a classroom experiment involving the use of controlled explosions.Agency Relationships 405 2. Thus. Issue Does the exception to the general rule of non-responsibility for the acts of an independent contractor apply in this case? 4. which resulted in harm to Howell. 3. Key Facts A. Court’s Reasoning The District of Columbia Court of Appeals held that: A. The general rule holds that a principal will not be liable for the acts of an independent contractor. The lower court held in favor of the student claiming that this case is an exception to the general rule of non-responsibility for acts of independent contractors because of the dangerous nature of the activities involved. the holding of the lower court in favor of the student plaintiff. working for the District of Columbia school system (DC) hired a chemistry teacher as an independent contractor for a summer program sponsored by the DC school system. 5. a student enrolled in the summer program. An exception to that rule applies where the activities involved includes special dangers and risks. The school system argued it is not responsible for the acts of an independent contractor.

Compare. With each choice comes a list of pros and cons in the eyes of the law. The choices run the gamut from the simplest lemonade stands to a multinational publicly traded corporation. quite extensive. however. The real issue is first finding out what options are legally available and then choosing the best fit. For example. The practice of law for sole proprietorships is akin to the medical family doctor. in fact. in fact. if a person seeks maximum privacy in his or her financial affairs along with the least possible accountability to others. agency. That person may find the corporate form best suited for her needs.406 Chapter 26 Chapter 26 Sole Proprietorship. It is this interdependent equation that makes the practice of business law so difficult yet so interesting. finance. That fit should be tailored by sound advice from a number of quarters including law. the businessperson who wants to leverage the maximum utilization of other people’s money while limiting her personal financial exposure. Every sort of business issue ranging from taxes to zoning may confront this businessperson. a private form of sole proprietorship may be best. few sole proprietors would willingly give up their personal control over their fate. and business management strategy. . With the advent of the information highway and more emphasis on entrepreneurial niche marketing of goods and services. contract. and General and Limited Partnerships How Do I Form My Business? I. and tort law doctrines. Teacher to Teacher Dialogue One of the key roles of attorneys engaged in the practice of modern business law is advising their clients on the selection of the best venue for doing business. Yet in spite of the high risk and sometimes-marginal rewards. this form of business may enjoy a renaissance in the Twenty First Century. accounting. The law of sole proprietorship is. Sole proprietorship is still the most widely used form of business entity even though it may not be the most important in sheer economic terms. derived from a combination of property. The law has something for everyone. The vast majority of the users of Professor Cheeseman’s book will never go to law school. What seems like a relatively limited number of options is. Yet that same majority will be influenced every working day by the legal business entity choices made in whatever business pursuits they chose.

These responsibilities may not always seem fair to the layperson. 4. the best of both worlds. They can provide the flexibility of partnership while affording limited liability exposure to investors. One of the questions students frequently ask is: How is it that multinational business organizations such as large accounting or law firms stay in business as partnerships when they frequently lose partners through death or changes in partnership associations? Technically. Modern contract law. 3. there is no free lunch. Partnerships are much more personal. they remain the same with regard to several key provisions: 1. however. When the partner is gone. Limited partnerships remain. Investment is the key to the original notion of limited partnership. including the use of a certificate of limited partnership. Both statutes generally limit the amount of activity a limited partner may engage in regarding the business as a price of having limited liability protections. so is the partnership. One of the key distinctions between the partnership form of doing business and corporate format is the corporation’s ability to have an indefinite or perpetual existence. “All for one and one for all” was more than just a rallying cry before battle. Under state laws of incorporation. Today’s modern laws of limited partnerships are found in two key statutes: the original 1916 Uniform Limited Partnership Act and its heir apparent. with each of these changes. the dissolution of a partnership. They are the formation of a partnership. the benefit/burden dichotomy illustrated in the law of the agency. and especially agency law all reflect this commonality when it comes to partnerships. A partner is an agent of the partnership and yet is also a principal. As for the dissolution of a partnership. The rules of the legal road must be strictly complied with and failure to do so leads to often severe consequences. the operation of a partnership. and an overview of limited partnerships. the Revised Uniform Limited Partnership Act first promulgated in 1976. but less so visà-vis third parties under the Uniform Partnership Act. Both use the general partnership principles of the Uniform Partnership Act as a fallback position if their respective statutory requirements are not complied with. and a new one is . The phrase connoted an expectation that made your acts the acts of your colleague and vice versa. But as with all deals that seem too good to be true. That gain may be offset by the costs incurred for the agent’s acts. 2. The idea was to create a middle ground between pure partnership and an entity with a totally autonomous existence. chapter is designed to introduce students to four key issues in partnership law. Even though there are substantial differences between the two versions. This is not so with partnerships. We also see that the pendulum can swing both ways in partnership law. Remember. maybe they should think long and hard before partnering with someone legally. Among other things. Remember. tort law. a corporation is allowed to continue its juristic existence in spite of the death of its key players. The principal stands to gain much from the efforts of his or her agent. Both call for two key classes of partners to be in place: at least one general partner with unlimited traditional partner’s liability and a class of limited partners who normally can be held liable only to the extent of their capital contribution. the partnership is ended. Agency law dominates as the foundation of partnership law. Partners are expected to be responsible for each other’s acts in the eyes of the law. both partners have a lot of latitude in contracting rights and duties between themselves. in many ways. A legal oneness came to be recognized between partners and the third parties with whom they dealt. Given the long and sometimes tortuous entanglements that people find themselves in. Persons entering into a partnership arrangement must do so voluntarily and with their legal eyes open to the ramifications of their bonding.Sole Proprietorships and General and Limited Partnerships 407 The operation of a partnership is one of the oldest recognized methods of cooperative business conduct. Many of its antecedents go back to the age of chivalry where the duties of loyalty were paramount. compare its existence with that of a corporation. Both call for statutory creation (as opposed to just contract creation) of limited partnerships. Subsequent evolution of partnership law has carried forth this unity.

Most partnerships are not. A sole proprietorship is owned by the sole proprietor who is the business. specific goal. A well-crafted partnership agreement should have. however that sometimes the best intentions involved in forming a partnership do not always work out in the strain of working with someone else. Where these circumstances are properly planned for. Act (MBCA) Corporation Contracts and Agency Contemporary Issue: “Doing Business As” This discusses the possible use of a fictitious name for a sole proprietorship. Most are created and operated by individuals who have sought to capitalize on their respective economic or talent contributions by acting together in the legal sense. .408 Chapter 26 created. or accounting. an orderly process of succession in case of death or termination. and the life of the new partnership goes on where the old one left off. Law for Business Organizations Types of Organization Partnership Common Law Contract and Agency Statutory Law Uniform Partnership Act (UPA) Model Business Corp. as one of its key components. however. such as erecting a building. Text Materials An Entrepeneur is a person who forms and operates a new business. or extend to a full professional career as a licensed practitioner of law. the transition is seamless. We must keep in mind. medicine. These business ventures could be set for a short term. large and multinational in scale. II.

Sole Proprietorships and General and Limited Partnerships 409 .

Reason: There is generally no continuity of existence because of the death of a sole proprietor. Jerry refused to honor the warranty. the trial court dismissed but the appellate court reinstated. Additionally. Supreme Court of Illinois reversed the decision of the appellant court. a sole proprietorship has no legal identity separate from the owner even if it is doing business under a fictitious name. Upon suit by Vernon for replacement costs. The boiler broke (without possible repair) within the warranty period.410 Chapter 26 The Court Speaks: Vernon v. Schuster The Facts: Vernon hired Diversity to install a new boiler. Jerry inherited the business and ran it as a sole proprietorship. UPA takes over where agreement has gaps. a sole proprietor owner of Diversity died within the 10-year warranty period. Issue: Is Jerry liable for the warranty made by his father? Decision/Remedy: No. Schuster. . which was done along with a 10-year warranty. Jerry’s business was basically a new sole proprietorship May be formed orally or in writing but SHOULD always have a written partnership agreement.

Sweet Facts: Norman E. In 1963. Sweet (Sweet) began as an hourly employee of Vohland’s Nursery. Compensation was paid on an irregular basis to Sweet. No social security or income .Sole Proprietorships and General and Limited Partnerships 411 Partner Rights: 1) participate in management 2) share profits (equally unless stated) 3) not compensation but reasonable reimbursement 4) accounting Partner Duties: 1) loyalty 2) care 3) inform 4) obedience The Court Speaks: Vohland v. Paul Vohland (Vohland) changed Sweet’s status giving him 20 percent of the net profit instead of hourly pay.

and oversaw the performance of customer contracts. The trial court held that Sweet was a partner with a 20 percent interest in the profits and property of the business. Under Indiana Code 23-4-1-7(4). Contemporary Issue: Profits are shared equally unless agreed to otherwise and losses are shared as profits unless otherwise agreed to. Sweet’s tax returns declared that he was a self-employed salesman. It is not crucial that Sweet did not contribute money or property since he did contribute his labor and services. and borrowed money in his own name for business purposes without Sweet’s approval. Sweet contributed no capital or property to the business.412 Chapter 26 taxes were withheld from checks issued to Sweet as compensation. in substance. a share of profits. or was Sweet merely an employee? Decision: Sweet was a partner. Issue: Did Vohland and Sweet enter into a partnership.” Here Vohland and Sweet did in essence share profits. Sweet paid self-employment social security tax. Sweet. Vohland made most of the sales. supervised the care of the nursery stock. Sweet claims Vohland promised to “take him in. Sweet’s compensation was. managed the physical aspects of the nursery. managed the finances of the business. receipt of profits is prima facie evidence of partnership. The evidence viewed most favorably to support the judgment allows an inference of the intention by both to create a partnership. instead. give him a piece of the action. Although they called it a commission. Reason: Indiana code 23-4-1-6(1) defines partnership as “an association of two or more persons to carry on as co-owners a business for profit. Contributions of labor and skill can be as great or greater a contribution than money or property. . Voting is also usually equal unless otherwise agreed to.” Vohland denied these statements.

the partnership is liable. The Supreme Court reversed the decision of the trial courts and held Antenucci jointly liable. Son was born with severe physical problems. Reason: When a partner commits a tort. and the wrong is imputable to all the partners jointly and severally. Issue: Is Antenucci jointly and severally liable for the medical malpractice of his partner? Decision/Remedy: Yes. Antenucci The Facts: Pena and Antenucci were doctors and partners in a medical practice who both treated Zuckerman during her pregnancy. . The plaintiffs filed a post trial motion for judgment against both defendants.Sole Proprietorships and General and Limited Partnerships 413 Usually joint and several liability The Court Speaks: Zuckerman v. the jury found only Pena guilty with a $4 million verdict and a corresponding judgment was entered. In a malpractice suit against both doctors.

000 promissory note to the Foundation as “Cliff W. the “obligor and his immediate obligee” for purposes of R. Each specifically names the partnership. Davis and Dr. 1303. Thus. The trial court found Davis and Mitchell jointly liable. jointly liable on the note? Decision: Both partners were jointly liable. Mitchell formed a general partnership to purchase and operate rental properties for investment purposes. and the note states that it is secured by a mortgage. . and not Mitchell. Partner. William D. The mortgage is executed in the name of the partnership by both Davis and Mitchell. the terms of the instrument may be modified or affected by other writings executed as part of the same transaction. Davis and Mitchell entered into an agreement that provided that only Davis. respectively. The general warranty deed. the Foundation sued the partnership and both partners to recover on the note. Davis signed a $150. Mitchell asserted in defense that the side agreement with Davis relieved him of personal liability. excusing Mitchell from liability. Issue: Are both partners. Kemmler Memorial Foundation (Foundation) on credit. and statement of settlement were all executed and delivered as a part of the same transaction.” Prior to executing the note. The appellate court reversed. When the partnership defaulted on the note. Kemmler Foundation v. Reason: Brown. Davis and Mitchell. The mortgage specifically refers to the promissory note.414 Chapter 26 The Court Speaks: Edward A. however. The partnership and the foundation are. it is apparent that the note was executed in a manner sufficient to bind the partnership. The partnership purchased a parcel of real property from the Edward A. Mitchell Facts: Clifford W.C. Thus. Davis. The Foundation appealed. would be personally liable on the note to the Foundation.18(A). mortgage. J. They did not inform the Foundation of this side agreement.

Sole Proprietorships and General and Limited Partnerships 415 .

By law Notice Actual Prior dealings Constructive All others .By agreement .416 Chapter 26 Dissolution of Partnership: .In breach of contract .

a certificate of limited partnership is needed. they have the right of survivorship.Sole Proprietorships and General and Limited Partnerships 417 Continuation of a Partnership after Dissolution Surviving or remaining partners are given the right to continue the partnership after dissolution. Distribution of Partnership Assets: 1) non-partner creditors 2) partner creditors 3) capital 4) profits Contemporary Issue: Right of Survivorship As a tenant in partnership. . Under RULPA.

. Limited partners cannot participate in management or they will be liable as general partners. including limited partnerships attempt to borrow money from banks to obtain an extension of credit from suppliers. Ethics Spotlight: Limited Partner Liable on Personal Guarantee Many small businesses.418 Chapter 26 Landmark Law: The Revised Uniform Limited Partnership The RULPA was promulgated in 1976. Note: the name of the Limited Partnership may normally not include the surname of a limited partner.

these MLPs can be traded on major stock exchanges in addition to providing protection from double taxation. As seen in the text. .Sole Proprietorships and General and Limited Partnerships 419 Contemporary Issue: Master Limited Partnerships This illustrates a relatively new legal mechanism designed to overcome one of the inherent drawbacks of the limited partnership format—lack of liquidity.

This is also the maximum liability for a limited partner. RULPA says they are shared on the basis of the value of the partner’s capital contribution. Distribution of Assets of an LP: 1) all creditors 2) partners a) unpaid distributions b) capital c) remainder .420 Chapter 26 Note: If there is nothing in the limited partnership agreement about how to share profits.

1988 Tenn.Sole Proprietorships and General and Limited Partnerships 421 International Law: Partnerships Outside the United States These discuss the partnership concept as it applies to other countries. the court enforced this agreement against Morgan on a counterclaim by the other partners. No. Answers to Critical Thinking Cases General Partnership 26. The court dismissed Cox’s lawsuit against Elliot. Smithson v. Lexis 221 (Tenn.App.1. . Ennis. Yes. The court held that Elliot did not create a partnership. and that Smithson would not be required to put any money into the venture. The Uniform Partnership Act defines a partnership as an association of two or more persons to carry on as co-owners of a business for profit. Lexis 2947 (Tex.App.2d 836. The court held that a person cannot be made a partner in a business solely because another person states that he is such a partner. 1976 Tex. Elliot is not liable for the debt owed by Trans Texas to Cox.000 profit made on the sale of the property. Note: Morgan had previously agreed to indemnify the other three partners from any claims by Smithson. Cox Enterprises.W. 1976). and Morgan. The court held that Elliot was not a partner in Trans Texas because he did not own an interest in the firm and did not voluntarily associate himself with the firm. A partnership is defined as a voluntary association of two or more persons carrying on a business as coowners for profit. Inc.App. App. The court held that the preponderance of the evidence showed the existence of a joint venture between Smithson and the four defendants to develop the property on Boyd Mill Pike.2. General Partnership 26. which was one-fifth of the $184. The court entered judgment for Smithson against the four defendants for $36. 538 S. Filip and Elliot. Devrow. It is not necessary that a partnership be designated as such to be created. a partnership was created between Smithson and the four defendants—White. that they would share in the profits equally.800. III. v. White. 1988).

[Thermal Supply of Louisiana. The law firm and the other partners are not liable for McGrath’s tortious conduct in shooting Hayes. the partnership. The court held that a creditor is not obligated to investigate or ask if a partnership is still in operation.3. 198 La. 1984)]. The court held that Edgar Husted was acting within his apparent authority when he took the estate’s check and misappropriated it.5. 749 P. as are the partners of the partnership. The court found that Leonard and Michael had failed to notify Thermal of the dissolution of their partnership. and that Thermal did not receive notice of this fact from any other source. App. Inc. Leonard Sumter. v. is liable to the estate for the conversion by Edgar Husted of the estate’s funds. Where a servant steps aside from the master’s business in order to affect some purpose of his own. Husted v. Sumter.6. Lexis 1244 (Ind. McGrath is liable. 452 So. McGrath. Thatcher. McCloud. A final accounting should be available and Fial apparently breached his duty to the partnership by establishing one new business with former clients without Steeby’s agreement.2d 341. 1982 Ind. either directly or by inference that McGrath was acting in the scope of his employment when he shot Hayes.E. 1988). is liable for the debt owed Thermal Supply by Michael. 8975 (La. a partner is jointly and severally liable for the tortious conduct of another partner committed within the ordinary course of partnership business. Yes.App. 436 N.422 Chapter 26 Tort Liability 26. There was no evidence that McGrath transacted law firm business or engaged in any promotional activities on behalf of the law firm. App. The court found no evidence to indicate. actual notice of the dissolution must be given to third parties who actually dealt with the partnership.App. Notice of Dissolution 26. The court held that Sumters’ failure to give such a notice to Thermal made Leonard liable for Michael’s debts to Thermal. Fiduciary Duty 26. Hayes v. App. Under partnership law. Sr.2d 178 (Wash. Instead. the master is not liable. The court noted that a master is responsible for the servant’s acts under the doctrine of respondeat superior when the servant acts within the scope of his employment and in the furtherance of the master’s business. and its other partners were not liable for McGrath’s tortious conduct. Under the Uniform Partnership Act. the burden is on the partners to notify creditors with whom they have dealt that their partnership has been dissolved. Treadwell & Schoonmaker. Tort Liability 26. The court further held that the passage of one year between purchases at Thermal was not unusual in the plumbing trade because plumbers often use several sources of supplies.4. The partnership is liable for this tortious act. if a partnership is dissolved. The court awarded compensatory and punitive damages to the estate. Torbenson. Husted and Husted. . 1982). Steeby should win.2d 312.

2d 840. he was acting within his authority as a partner and agent of the partnership and thereby bound the other two general partners. Advance Development Corporation. 732 S.7. Dist. as general partners of the limited partnership. he promptly renounces his interest in the profits of the business. Advance.D. However.Supp. 1987 Ark. Partnership law stipulates that only general partners are individually liable for the debts of a limited partnership. the court held that Somers and Robertson. 192. and the general partners are jointly and severally liable for everything chargeable to the partnership. however. the recently added limited partners are not individually liable for the debts of the limited partnership that were allegedly owed to Sloate and Bear Stearns. The court held that Somers and Robertson had charged McGowan and his company. the court held that the newly added partners were not individually liable . that the limited partners may lose their capital contribution that they have made to the limited partnership. none of the limited partners are liable for the debts of the partnership. This exception provides that if a person who has contributed capital to a business conducted by a partnership erroneously believing that he has become a limited partner in a limited partnership. were jointly and severally liable for the partnership debts owed to the unpaid suppliers. there is an exception to this rule. the partnership is a general partnership and the purported limited partners are individually liable as general partners.8. Although Brookwood was defectively formed as a limited partnership because it had failed to amend its certificate of limited partnership to reflect the addition of the new limited partners. National Railroad Passenger Association v. upon ascertaining the mistake. Liability of Limited Partners 26. The partnership assets are subject to the claims of the unpaid suppliers. Generally. partnership law provides that if there is a substantial defect in the formation of a limited partnership. the limited partners of USANL are not individually liable for the alleged breach of contract by the limited partnership. When McGowan acquired labor and materials and then failed to pay for them.9 No. he is not bound by the obligations of the partnership if. McGowan and Advance are liable for their acts. with the responsibility of developing Vermont Place. a partnership is bound by a general partner’s wrongful acts. Liability of Limited Partners 26.Sole Proprietorships and General and Limited Partnerships 423 Liability of General Partners 26. nor had they personally guaranteed the performance of the lease with the NRPA. the court held that these partners were not individually liable because (1) they erroneously believed that they were limited partners in a limited partnership and (2) upon receipt of the arbitration notice from Sloate and Bear Stearns they immediately renounced their interest in the profits of the Brookwood.W. Lexis 22190 (D.S. The partnership agreement provided that the purpose of the partnership was to acquire real estate and construct duplexes for lease or sale. Under limited partnership law. Lexis 2225 (Ark. 643 F. the partners agreed that McGowan and Advance would supervise the construction of the duplexes. In addition. National Lumber Company v. No. In furtherance of this purpose. 1986 U. Note. The court held that in this case the limited partners did not take part in the management or control of the limited partnership. and effectively made McGowan and Advance their agents. 1987).C. Only the limited partnership and its general partners may be held liable to the NRPA. 1986). Therefore. Union Station Associates of New London. Limited partners are not individually liable unless they take part in the management of the partnership or personally guarantee the performance of the partnership. Because of their limited liability.

Limited Partner’s Interest 26.2d 411 (N. Gilroy wins. Here the LP was defectively formed And there was liability also on Molander’s contract..2d 675. Although time alone would not necessarily establish mismanagement when combined with evidence that Moe Hankin.Y. 493 A. Yes. Inc. Although the 70% limit was reached for removal of Aztec (questionable). however. Day 738 S.S. Molander can only recover against the assets of the limited partnership and its corporate general and limited partners. 26.16. App. No. There was a breach of duty and the court should appoint a receiver.No. This was fraud to which a GP was party. Liability of Partners 26. and its general partners could be held liable to Day.2d 103 (Wash App.12.15.2d 87 (Ky. the creditor may recover payment from the limited partner. Removal of a General Partner 26.2d Dept. Molander v. Liability of Limited Partners 26.424 Chapter 26 on the debts allegedly owed by Brookwood to Sloate and Bear Sterns. not against Raugust personally. Lexis 337 (Pa. A personal guarantee of Raugust might have helped. The limited partners of Cosmopolitan are individually liable on the contract between the partnership and Dwinell’s Central Neon. it seems reasonable to find a breach of fiduciary duty on behalf of that partner and to appoint a receiver so as to expedite the liquidation. Bear Stearns & Co.Y.). If a limited partner personally guarantees a loan made by a creditor to the LP and the LP defaults. After six years of management the winding-up partners had failed to liquidate the partnership. If it doesn’t it can’t initiate litigation in KY. 8 Brookwood Fund v. A GP is needed for a limited partnership to exist.W. Because they are corporations. 1985).11. the .A. IV: Answers to Ethics Cases 26.Aztec wins. 722 P. 26.. a unanimous vote is needed to admit a new partner and without this there would be no general partner.) Limited Partnership 26.14.17. the limited partners are not individually liable to Day. the limited partnership. desired to buy certain partnership property at a premium. recovery is only against the shareholders. Virginia Partners Ltd. No other right is affected. Virginia Partners.D. V. Partnership law provides that if a limited partnership “substantially complies” with the legal requirements for organizing a limited partnership. Only an innocent party can recover on th policy. Hankin. one of the winding-up partners.13. Hankin v. the superior court decision was reversed. The trial findings and decision were upheld. Raugust-Mathwig. Not only was Conway unethical but his fiduciary duty was breached. Inc. The limited partners had no liability to Day. 1989). 1985 Pa. Under KY law a foreign(organized outside KY) limited partnership must register in the state.10. 539 N.

and are only liable up to the extent of their capital contribution to the limited partnership. 587 P. The limited partners did not act ethically in denying liability on the contract. of the existence of the limited partnership and the limited liability of the limited partners. the purpose of the filing requirement is to acquaint third persons. The court held that Cosmopolitan had not substantially complied with the legal requirements for the organization of a limited partnership at the time it had entered into the contract with Dwinell’s. and Court Catalina Mortgage Co. and the purported limited partners are individually liable as general partners. Catalina Mortgage Co. However. E. Cox did not act ethically. the court held the purported limited partners individually liable as general partners on the debt due Dwinell’s. Further.2d 574 (1990) Supreme Court of Arizona 2. In 1989. the plaintiff brought a collection action on the note against the defendant and claimed personal liability on the part of the defendant. Therefore. no filing was made at the time Dwinell’s entered into the contract. 3.18. There was certainly a conflict of interest and a breach of the duty of loyalty. Case Name. Inc. In this case. Thus the partnership should be dissolved and damages should be awarded.” not as a limited partnership. under the prevailing view of the Uniform Partnership Act. Key Facts A. Citation. Obviously.App. such as Dwinell’s. if substantial compliance is not met. Defendant argued that. Holding Yes. They lead Dwinell’s to believe they were acting as a partnership causing the transaction to occur. Court’s Reasoning . 800 P. the partnership is a general partnership. and that it was a general partnership at the time the contract was signed with Dwinell’s. Inc. so it had no way of apprising itself of the asserted limited liability. 26. the plaintiff must first go against partnership property before it can go after personal assets. 71. Issue Does Arizona law create an exception to the general common law rule and allow the plaintiff to sue against the partner’s personal assets before the assets of the partnership are exhausted? 4. Defendant was a general partner in an organization called Coronado Industrial Investors Limited Partnership (Coronado). B. This was because the certificate of limited partnership had not been filed with the state until several months after the contract was signed. Cosmopolitan Chinook Hotel.2d 191 (Wash. D. V. in 1986. Answer to “Briefing the Case” Writing Assignment: 1.. C. 5. AZ with plaintiff.Sole Proprietorships and General and Limited Partnerships 425 limited partners are not individually liable for the debts of the partnership. Coronado had refinanced its property located in Tucson. Plaintiff claimed that Arizona law allows for an exception to that general common law rule. the contract only identified Cosmopolitan as a “partnership. Monier 166 Ariz. v. Dwinell’s Central Neon v. The court held that there was a defective formation of Cosmopolitan as a limited partnership. 1978).

Several liability rules the plaintiff go after the partner’s personal assets independently from any other joint and several partnership liability. . Because Arizona law created an exception to the general common law rule.426 Chapter 26 A. B. this action was allowed to go forward against the partner’s personal assets without prior exhaustion of partnership assets.

These advantages are not free. With regard to the state. and agency. Teacher to Teacher Dialogue Corporations can provide many advantages for business including perpetual existence. In addition. and numerous tax and other legal opportunities to massage the system. nor are they always easily obtained. The role of promoter is also tied to the laws of contract. fiduciaries. These funds are generated by two basic methods— debt and equity financing. A promoter of a new corporation is really the catalyst that brings together the diverse elements of law. The charter takes the form of a certificate of incorporation. limited liability. The stakes are simply greater because over eighty-five percent of business done in the U. This chapter has several objectives: to illustrate how the corporate form is established legally and how it is infused with funds. . and technical competence that will eventually drive the fortunes of the new business entity. entrepreneurial talent. The formation of a corporation starts with a contracting process initiated by a person called a promoter. Corporate law has always been more technically intricate and demanding of legal practitioners. The promoter’s main duties are bifurcated towards two main audiences—the state and potential investors. He or she is expected to act for the benefit of the eventual corporation and can be expected to be personally liable for contracts entered into on its behalf in the interim. He or she will be involved in contracts with both of these constituencies. The second critical task of the promoter is to find legal methods for the start up of the corporation so that it may be infused with funds. the process of establishing the basic ground rules for the key players will be examined.Corporate Formation and Financing 427 Chapter 27 Corporate Formation and Financing Is A Corporation A Real Person? I. finance. The corporate form is unparalleled in its ability to be a fund-raiser. This document is the foundation contract between the promoter and the state. This certificate provides the official state-sanctioned ground rules under which the new corporate entity will be allowed to do business. It can also be more unforgiving to its users than sole proprietorships or partnerships if mistakes are made in its formation and financing. uses the corporate format. the revocation of the charter. Violation of these ground rules can lead to an eventual corporate death penalty. the actual creation of the new corporate entity is the outgrowth of a document called the charter.S.

Blacks Law Dictionary defines a close corporation as one where the shares are held by a single or closely knit group of shareholders. The vast majority of for-profit business entities using the corporate form are. The law allows for many distinct advantages to the corporate entity. however. How to protect those corporation-based prerequisites is really what this chapter is all about. Once these rules have been established in the formation process. One of the most important aspects of this entire body of law is to constantly remind students that the use of the corporate form constitutes a favor. and wherefores of control over. closely held. for example G. directors. it might be helpful to present this material in the following order: 1. but what the law gives with one hand. Generally there are no public investors and its shareholders are active in the conduct of the business. The distinctions among these roles are sometimes blurred when it comes to the formation and management of corporations. and managers of the corporation. What is interesting about this two-sided (public vs. 2. This chapter lends itself to the old “black letter” law approach because of the sheer volume of rules. subsequent chapters will proceed to examine the rights. but also with respect to third parties who deal with them. Both entities must comply with the rules. . The world of corporations has. stock ownership is not widely dispersed. shareholders. directors. it can take away with the other. The reality is far different. Only five percent of all corporations are publicly traded. duties. Remember. In terms of financial importance. whys. A listing of responsibilities and liabilities of these parties not only to each other. Yet failure to honor these distinctions can lead to disastrous consequences. are completely different from a small family business. definitions.” they think of the large companies mentioned in the financial news of the day. When most people are asked about the associations they have with the word “corporation. closed) corporate landscape is that. Where they are not. but also to key third parties such as shareholders and parties having a contract or tort nexus with the corporation.428 Chapter 27 Once the proper procedures for the establishment of the corporation have been complied with and adequate financing has been secured. 3. the next step is to see what the basic ground rules will be for key players in this arena. Usually this group of companies will encompass those entities listed in the Fortune 500. or shareholders. most people who get in trouble with corporate law do so not because they are bad managers. and corporate officers are the same on paper for both large and small corporations. In the world of closely held corporations..M. The basic rights. Thus as a matter of teaching technique. Where the rules of the corporate law road are honored. a much less public face—the face of the closely held corporation. or companies publicly traded on the New York or American Stock Exchanges. The hows. and procedures set out in these materials. They get into trouble because they sometimes do not follow the rules of corporate formation and operation. the Dow Jones Industrial. not an entitlement. safe passage and a restful reward are assured. these companies certainly do dominate the corporate landscape. and liabilities of these persons not only vis-à-vis each other. and control is held in virtual perpetuity through proxies and other mechanisms within the “closed” group. in fact. and expectations of shareholders. In all three scenarios try to give case examples that illustrate the rule of law being discussed. The respective rights and duties of the various parties in that line of authority. The leading protagonists will be the board of directors. personal liability looms near. duties. in the eyes of the law. A diagram of the corporate lines of authority. the rules of corporate formation are virtually the same for both. except for some special rules set out in individual state closed corporation statutes. however.

. Text Materials Landmark Law: Revised Model Business Corporation Act The MBCA was revised in 1984. Corporations are fictitious legal entities that are created according to statutory requirements.Corporate Formation and Financing 429 II.

430 Chapter 27 .

Articles of Incorporation Charter Corporate Bylaws Used in Managing .Corporate Formation and Financing 431 Promoter Organizes Negotiates and enters into advance contracts Finds initial investors LIABLE Incorporators Incorporates Ethics Spotlight: Promoters’ Liability Problems with pre-incorporation contracts are discussed. Contemporary Issue: Selecting a State for Incorporating a Corporation A corporation can be incorporated in only one state even though it can do business in all other states in which it qualifies to do business. Contemporary Issue: Selecting a Corporate Name This explains what the organizers should do to ensure that the name selected for a corporation has not already being used by another business. Most corporations choose the state in which the corporation will be doing most of its business as the state for incorporation.

Remember the Anticybersquatting Protection Act. FINANCING THE CORPORATION Note: Shares may be issued in exchange for cash. property.432 Chapter 27 Internet & Technology: Domain Name The process of registering a domain name is discussed. This format does have its advantages but is limited in its utilization for small companies who hope to attract venture capital. (benefit to the corporation) .” this format no longer works. Contemporary Issue: S Corporations This sets out the basic parameters under which the Sub-S rules of the Internal Revenue Code can be used to avoid double taxation by relatively small closely held corporations. etc. When a company decides that it wants to grow by “going public. services. Problems are mentioned. notes.

Liquidation .Dividends .Profits .Conversion .Corporate Formation and Financing 433 Preferences: .Cumulative .

Contemporary Issue: Close Corporation This discusses the Model Statutory Close Corporation Supplement added to the RMBCA. .434 Chapter 27 Contemporary Issue: Stock Options and stock Warrants This explains the difference between stock options and stock warrants. These permit purchase of stock at certain price for a set time. A close corporation may dispense with some of the formalities of operating a corporation.

Corporate Formation and Financing 435 Ultra Vires Act is beyond a corporation’s express or implied powers. .

436 Chapter 27 .

51 N. in effect. Billy was injured in the course of his employment with USM. 626 F. they are prohibited by law from distributing this profit to their members.. 1199. In a publicly held corporation shareholders are normally not responsible for a corporation’s debts. As separate legal entities. No. nonprofit corporation.Y.. 1980 N. Lexis 12767 (E.2d 757.Corporate Formation and Financing 437 III. for profit corporation.4. Deister Corporation can be sued. or scientific purposes. Marine Repair Services. Hutchinson Baseball was incorporated under Kansas’s law as a nonprofit corporation. 530 F. When a corporation is properly incorporated pursuant to the laws of the state of incorporation.2d 152.. Private corporations are formed to conduct privately owned business. corporations are liable for their own contracts. Commissioner of Internal Revenue. Lexis 23179 (10th Cir. Limited Liability of Shareholders 27.3. Hutchinson Baseball Enterprises. Deister Co.S.D. Because of the corporation’s nature. Consolidated Mach. When the corporation became involved in a dispute with Sammak. 1982 U. Most private corporations fall into this category. Inc.E. Tool Corp. 1980).D. directors. this money is never distributed to Hutchinson’s officers or directors. Billy’s widow must look directly to the corporation to satisfy any judgment she may seek in a torts suit against USM. Inc. 1985). Lexis 10456 (S.Y. 1985 U. As such. as artificial persons created by the state that can sue or be sued in their own names. Hutchinson Baseball Enterprises. or contracts. the shareholders of USM cannot be held personally liable for the suit against the corporation. Lexis 2638 (N. Corporations are treated. debts. 696 F.Y. . 1982 U. 1982).S. The purpose of the corporation was to increase the investment made in it by its shareholders. Nonprofit corporations are formed for charitable. Corporation 27. the corporation becomes a separate legal entity for most purposes.1. Since USM is considered a separate legal entity. App. Profit corporations are created to conduct a business for profit and can distribute profits to shareholders in the form of dividends. religious. Inc. Sammak was able to bring suit directly against the Deister Corporation.App.Supp. is a private. claims. torts.Pa. Although nonprofit corporations may make a profit. One of the most important features of a corporation is the limited liability of its shareholders. Blackwood Coal v. Yes.. Billy v.2d 934. USM was a publicly held corporation. Corporation 27. Marine Repair Services was a privately owned corporation.Supp. and torts. Marine Repair Services is a private. 727. Deister was a business properly incorporated under the laws of the state of Pennsylvania. Dist. Marine Repair Services was in the business of repairing shipping containers in order to make a profit. to promote Little League and other amateur baseball teams in Hutchinson. Hutchinson Baseball Enterprises was formed for a charitable purpose. Inc. Although the corporation does generate revenue from ticket sales and concession stands. v. 412 N.N. Marine Repair Services was a for profit corporation.Y. Answers to Critical Thinking Cases Legal Entity 27. 1982). O’Donnel v. Dist. All revenue that the corporation generates is used to fund the corporation’s activities. Corporations are the most dominant form of business organization today. Sammak decided to sue.. or officers. Kansas.2. Private corporations may be further classified as either profit or not-for-profit. Because the law views the corporation as a legal person for most purposes.S. educational.

Ching. since a novation of the contract between the two parties did not occur. A corporation is a domestic corporation in the state in which it is incorporated. negotiate and enter into contracts in advance of its formation. Lake Enterprises. Promoters often enter into contracts on behalf of the corporation prior to its legal incorporation. Handley v. 1987 N. Stern wins. Florida Fashions was illegally taking orders and doing business in Florida because the corporation had never qualified to conduct business in the state. Weldon Electronic can be described as a closely held corporation.7The Allens and Handley should have joint personal liability for the failed project’s contractual obligations. 1981 Haw. Additionally. 1987). when the proposed condominium project failed.2d 38. This meant that Florida Fashions was a foreign corporation in the state of Florida. both friends and former partners. 1976 Fla. Weldon Electric is a closely held corporation. Lexis 14341 (Fla. which included the security of a $69. i. Thus. Jacobson was the promoter who formed a contract for architectural services with Stern. App. The shareholders. relatives. 332 So. Jacobson is incorrect. who are usually involved with the management of the corporation. . the third party. or friends. register. 1981). Lexis 192 (Hawaii. the corporation’s bylaws called for a buy/sell agreement to be reached to prevent outsiders from buying stock in the corporation. Sylvester. sometimes enter into buy/sell agreements that prevent outsiders from becoming shareholders. Therefore. Stern. and the corporation was never formed.8. If the proposed corporation never comes into existence. Lexis 392 (N. Mysels v. to conduct business in states other than their state of incorporation.D.500 loan. Handley and the Allens became liable for these contracts. Florida Fashions was a domestic corporation in the state of Pennsylvania. A novation is a three-party agreement whereby one party (the corporation) agrees to assume the contractual liability of another party (the promoter) with the consent of the original contracting party (the third party). Balvik v. Because of these characteristics. unlawfully doing business due to its failure to register. the promoters have joint personal liability for any contract signed on behalf of the proposed corporation. the two parties signed several contracts on behalf of the proposed corporation. Promoters are the individuals who organize and start a new corporation. App. In this case. App.438 Chapter 27 Corporation 27. When a novation is executed. the promoter is released from liability on the contract. Promoter’s Liability 27.6. Jacobson later formed a corporation. Corporation 27. In addition. 627 P. Weldon Electronics was a corporation with only two shareholders. A closely held corporation is one whose shares are owned by a few shareholders who are often family members.2d 1132. Promoter’s Contracts 27.App. In this case.. The two shareholders were also on the board of directors of the corporation and served as the corporation’s officers. A corporation can become liable on a promoter’s contract by executing a novation. Foreign corporations have to qualify.W. It is a foreign corporation in all other states and jurisdictions.D. never gave his consent for a novation. the Allens and Handley were acting as promoters for a proposed corporation which would build condominiums near Honolulu. Barry. to own and operate the new casino for which Stern was drawing plans.2d 383. 1976). and file the papers necessary to incorporate. 411 N.5. Although the corporation may have adopted this promoter’s contract.e.

and a debenture bond. The Franklin Life Insurance Company v. Lexis 195 (Cal. 602.F.3d 93. IV: Answers to Ethics Cases 27. The terms of the redemption are established when the shares are issued. Goodman v. Neither Knoll nor Cogan owe a fiduciary duty to the debenture holders. Yes. the preferred stock at some future date.Supp. In this case. 1969 Cal. Lexis 522 (Nev. buy back. Upon adoption. unsecured debt instrument. 451 F. were shares of redeemable preferred stock. Stern. Goodman can be held personally liable for the renovation contract with DDS. A debenture bond is a long-term.2d 198. when the market changed. . unless the third party agrees to release him. 1970. adoption. A corporation becomes liable for a contract entered into by a promoter before the corporation was formed if it agrees to be bound by ratification. 1969). 27. H. Therefore. if the corporation becomes insolvent. Jacobson v. 1980). representing an ownership interest. the corporation becomes liable for the contract. 670 P.D. he remained personally liable with the newly formed corporation. $10 a share more than it had to sell the shares for.12. it would have to be by adoption. the corporation is able to protect itself from changing market conditions.S.Rptr. those investing in United Financial received both shares of stock in the company. debenture holders are paid only after the secured creditors claims are met. or novation. Doman & Stafford Associates. The rights of the holder of a debt instrument are spelled out in the documents that accompany the debentures. 1978 U. Ahmanson & Company. Lexis 1776 (Wash. By issuing redeemable preferred stock.9. the corporation borrows money from an investor to whom the debt security is issued. 81 Cal. does not represent an ownership interest in the corporation.2d 648. because the preferred stock was redeemable. 1983 Wash. 605 P.10.Ill. i. which is based on the corporation’s general credit rating. and no novation had occurred place. Redeemable preferred stock (or callable preferred stock) permits the corporation to redeem. Dist. 1 Cal. they did not represent an ownership interest in the company. Since DDS did not agree to release Goodman from liability on the renovation contract. The one million shares of preferred stock issued by Commonwealth Edison on June 24. ratification of the promoter’s contracts was not allowed in the state of Washington. 1978).11. Lexis 17604 (S. Liability for the contract does not automatically transfer because the promoter was acting as the agent of a nonexistent principal when the contract was entered into. investors who bought one of the units offered by United Financial received both debt and equity securities. Jones v. Edison was able to buy back the stock for $110 a share. Therefore. Corporations will usually redeem the shares when the current interest rate falls below the dividend rate of the preferred shares.e. and as such. 592. Preferred Stock 27. while the debenture bonds do not. the promoter remains personally liable on the contract. if the newly formed corporation chose to be bound by the renovation contract. Commonwealth Edison had set the dividend rate of the one million preferred shares higher than it wanted due to market conditions. A debenture bond is a debt security.Corporate Formation and Financing 439 Jacobson remains liable for the contract with Stern. Commonwealth Edison Company. Thus. However. 1983). While the debenture bonds paid a 5 percent interest rate. since a novation cannot occur without the consent of the third party. In this case. Darden. Instead. Debt Security 27. The most important difference between the stock issued by United Financial and the debenture bonds is that the stock represents an equity (ownership) interest in the corporation. 1980 Nev. Therefore.

W. At the time the contract was entered into.. Dodgen 451 N. Dodgen’s counterclaim of unjust enrichment was also rejected. Ch. 5. and did Dodgen assume personal liability for the contract? 4. and the monthly payments were made to two trusts created to collect the payments. . In this case.. Key Facts A. D. In 1982. Issue Did the contract have consideration. V. D. a risk of failure inherent in business contracts. 2d 168 (1990) Supreme Court of Iowa 2. which subsequently was renamed Iowa Growthland Financial Corporation. There was no evidence that the seller intended to rely on payment exclusively from a future non-existent agent. Answer to “Briefing the Case” Writing Assignment: 1. The Iowa Supreme Court reversed the lower court holding by entering a judgment in favor of the seller-trustees for the amounts owned under the contract. G. so there was no agency in place. Citation. Court’s Reasoning A. 3. Lexis 520 (Del. Therefore. Holding The contract had consideration. the sellers died. B. Case Name. Ben P. the bank closed. There is a difference between lack of consideration and failure of consideration. Inc. and they were sold to Joe W. Growthland fell into default and the trusts sued Dodgen for collection. C. 1987 Del. The buyer assigned his contract to a company created after the time of the original agreement. Growthland was not in existence. the promoter was personally liabile. Simons v. Dodgen claims he is not liable based on a lack of consideration in the contract and that he had signed as an agent of Growthland. Dodgen in 1967. The First National Bank of Humbolt. IA failed because of embezzlement.440 Chapter 27 Broad and abstract requirements of a fiduciary character ordinarily can be expected to have little or no role to play in the governance of a negotiated. B. there was lack of consideration. and Dodgen is personally liable under the contract. and Adeline St. and Court Johnson v. commercial relationship. Subsequently. 542 A. John owned the bank’s controlling shares. Humboldt Realty Insurance Co. 1987).2d 785. but Growthland continued to make payments until 1984. C. E. F. Shortly after the sale. Ch. Cogan.

Teacher to Teacher Dialogue This chapter lends itself to the old “black letter” law approach because of the sheer volume of rules. public policy never has allowed the corporate form to act as a total shield from liability to third parties. but what the law gives with one hand. How to protect those corporation-based prerequisites is really what this chapter is all about. personal liability looms near. Text Materials There are two basic theories under which most of the limitations to corporate entity and/or corporate participants’ liability are restricted or eliminated. From the very inception of corporate law. in the eyes of the law. possibly present this material in the following order: 1. Where the rules of the corporate law road are honored. one of the most important aspects of this entire body of law is to constantly remind students that the use of the corporate form constitutes a favor. safe passage and a restful reward are assured. First.Corporate Governance and the Sarbanes-Oxley Act 441 Chapter 28 Corporate Governance and the Sarbanes-Oxley Act Who Are The People In A Corporation? I. but also to key third parties such as shareholders and parties having a contract or tort nexus with the corporation. Thus as a matter of teaching technique. 2. As mentioned in the overview. A listing of responsibilities and liabilities of these parties not only to each other. definitions. and procedures set out in these materials. In all three scenarios try to give case examples that illustrate the rule of law being discussed. Where they are not. tort. 3. The respective rights and duties of the various parties in that line of authority. . Thus in the areas of crimes. A diagram of the corporate lines of authority. it can take away with the other. not an entitlement. II. The law allows for many distinct advantages to the corporate entity. courts and legislators have clung to the back door option of holding someone personally liable where circumstances deemed it appropriate.

In all these cases. The cornerstone of relationships among shareholders. Even though not all aspects of these interdependent relationships could ever realistically be expected to be harmonious. a number of corporate shield-bursting mechanisms have always been in place. some common good is expected to be interwoven into their behavior towards each other. loyalty. the underlying premise is that the corporate form should not allow a person to do something that would otherwise be prohibited by public policy. so too should it not be allowed to be used by various members of corporate organizations to harm each other. Some of the most vociferous business battles are fought within the confines of the corporate boardrooms around the country. directors. These have ranged from piercing the corporate veil to outright revocation of the continued existence of the corporation. Just as the corporate form should not be allowed to defraud creditors and the like. . The second theory is found in the intracorporate workings of the organization itself. and mutual support. and officers is founded in the law of fiduciaries.442 Chapter 28 and generally undesirable behavior.

and time of annual and special meetings is required. Note: Written notice of the place. day. .Corporate Governance and the Sarbanes-Oxley Act 443 Contemporary Issue: Cumulative Voting This explains electing directors by cumulative voting.

444 Chapter 28 .

Corporate Governance and the Sarbanes-Oxley Act 445 .

is primarily state law. Federal law should follow state law if a federal statute is silent. Decision was reversed dismissing Kamen’s suit. The trial court granted Kemper. The Act was silent concerning derivative actions. such that it would be futile. The court of appeals adopted a “universal demand rule”. Inc. . brought a derivative suit against Kemper for breach of fiduciary duty under the Act. Kamen appealed. a shareholder in Fund (which employs Kemper). requiring demand before suit. Facts: Kamen. and affirmed. Issue: Should federal law adopt a universal demand rule for bringing derivative actions? Decision: No.s motion to dismiss. Reason: Corporate law.446 Chapter 28 The Supreme Court speaks: Kamen v. She did not demand that Fund’s Board sue alleging conspiracy. Kemper Financial Services. in dealing with the allocation of governing power. Gaps in federal statutes should be filled with state law.

Corporate Governance and the Sarbanes-Oxley Act 447 Piercing the Corporate Veil Alter Ego Doctrine Thin Capitalization No Separateness .

They invested $2. Issue: Does the doctrine of piercing the corporate veil apply in this case? Decision: Yes. Plaintiff was awarded $3.448 Chapter 28 The Court speaks: Northeast Iowa Ethanol.000. Drizin argued GSI was liable but not him. . Reason: The corporate veil may be pierced in exceptional circumstances.000.000 and North Central invested $500.000. They formed Northeast Iowa to hold the money and develop.000. Drizin formed GSI to raise the financing. commingling of funds. Drizin Facts: Local farmers decided to buld an Ethanol plant.000.800.600. William invested $1. In Iowa this might include undercapitalization. lack of separate books. Northeast argued that the corporate veil should be pierced.000 in compensatory damages and $7. and promotion of fraud. Drizin got investors but commingled funds with his own and orcgestrated a process where all the funds were stolen (mostly worthless investments). LLC v. The corporate veil could be pierced. Internet & Technology: Corporate Codes Recognize Electronic Communications Most states allow electronic communications to shareholders and among directors. Ethics Spotlight: Controlling Shareholder’s Breach of Fiduciary Duty Many courts have held that a controlling shareholder owes a fiduciary duty to minority shareholders. He had $250 capital.000 in punitive damage against Drizin. All money was placed in escrow and financing was needed for another $20.365. Northeast sued Drizin for civil fraud. Here there was undercapitalization and lack of separateness.

Corporate Governance and the Sarbanes-Oxley Act 449 .

450 Chapter 28 Contemporary Issue: Committees of the Board of Directors This sets out the basic board of directors committee structure as currently allowed by the RMBCA. The materials are straightforward in that the duties of the various committees are readily identifiable. the courts look at the acts of the committee as the acts of the whole. Compensation. Audit. Nominating. subject to the rules vis-à-vis directors’ dissent to a majority’s’ actions. Typical committees include Executive. . In the end. there are surprising few cases which go into the problems of committees which may have overstepped their authority. Investment and Litigation committees. The more interesting issues revolve around the so-called “organic” changes which cannot be delegated to a committee such as mergers and the like. In spite of all the recent growth in corporate litigation.

Corporate Governance and the Sarbanes-Oxley Act 451 Business Ethics: Sarbanes Oxley Act of 2002 Regulates Accounting Practices Audit committee Separation Audit Internal Disclosure Some Public company of audit report control of off prohibited sign.requirements balance employment accounting and non oversight audit offs sheet services items board Independent 5 SEC board appointed members members One financial expert 2 CPAs 3 Non CPAs Public accounting firms must register No Conflicts of Interest .

.452 Chapter 28 Contemporary Issue: Indemnification and D&O Insurance Protection This discussed ways in which directs and officers can protect themselves against personal liability.

Corporate Governance and the Sarbanes-Oxley Act 453 Ethics Spotlight: Outside Directors Relieved of Liability for Ordinary Negligence Liability for ordinary negligence in Delaware for an outside discussed. .

.454 Chapter 28 Ethics Spotlight: Disney Board of Directors Did Not Breach Duty of Care This discusses the business judgment rule and Disney.

The Court Speaks: Smith v. and (3) in the honest belief that the action taken was in the best interest of the corporation. Here. Pritzker. and that they not solicit other offers.Corporate Governance and the Sarbanes-Oxley Act 455 Contemporary Issue: State Constituency Statutes These statutes allow directors to consider constituents other than shareholders when making decisions. all of the directors breached their duty of care by not acting on an informed basis. Issue: Did Trans Union’s directors breach their duty of care? Decision: Yes. proposed to his fellow directors that they accept a cash out merger offer by Pritzker. . An ordinary person in the position of a director would have insisted upon a copy of the agreement and time to read it prior to voting. i. acting as chairman of the board. by not reading the merger agreement they have neglected the shareholders’ interest. they voted to accept the Pritzker offer after listening to a twenty-minute presentation by Van Gorkom. Reason: A corporate director is protected by the business judgment rule only if he acted (1) on an informed basis.e. (2) in good faith. Van Gorkom. Van Gorkom Facts: After a meeting with Jay A.. Although none of the directors including Van Gorkom had actually read the merger agreement.

456 Chapter 28 Business Ethics: The Sarbanes Oxley act of 2002 Improves Corporate Governance Enron Tyco WorldCom Major Provisions CEO & CFO Certification Reimbursement of Bonus and Incentive Pay No Personal Loans Crime for Evidence Tampering SEC Prohibition from Acting as an Officer or Director .

The MBCA requires a shareholder to have a proper purpose for such an inspection. Right to Inspect Records 28. Lexis 12741 (E. No. Since Shoenholtz owned over 10 percent of the voting shares of Rye Hospital. or the removal of a director. 677 F. Inc. Ocilla can force the board of directors of Direct Action to hold the shareholders meeting at an earlier date. The MBCA requires shareholders to give written notice to the corporation to exercise their inspection rights. The notice given to Rye’s shareholders was adequate. Supp. 1986. Inc. App. A proxy becomes irrevocable for a longer period if the proxy states that it is irrevocable.W. Ocilla Industries. and investigating corporate mismanagement. Proper purposes include deciding how to vote in a shareholders election.Y. 1984). 1984 N. The purpose of an annual shareholders meeting is to elect directors. . Special meetings may be held to consider important or emergency issues. Lexis 178 (A. Lexis 12900 (Tex. v. 710 S. The court held that the proxy was coupled with an interest in that Smith and Gibbons had given their proxies in exchange for Zollar’s contribution to the corporation. and it is coupled with an interest. Yes. Div. Helmsman’s request should be allowed. unless otherwise stated. Under the MBCA. the purpose of the meeting must also be stated. Rye Psychiatric Hospital Center.2d 155.D. 1291. 1988. App. over 16 months after the previous meeting. and to take other actions.2d 339. v.S. examining the propriety of paying dividends. Smith and Gibbons were attempting to reverse their proxy after only one had passed. and purpose of the meeting. Special Meetings 28. App. or by the holders of at least 20 percent of the voting shares of the corporation. 1987 U. can obtain a court order to compel Direct Action to hold the shareholders meeting at an earlier date.3. and the proxy met the requirements for irrevocability. 1986 Tex. Because the special shareholders meeting was requested by an authorized party and proper notice was given to the shareholders. 476 N. day. and time of annual and special meetings. Ocilla. Shoenholtz wins since the special shareholders meeting was properly called. If the meeting is a special meeting.Corporate Governance and the Sarbanes-Oxley Act 457 III. Because of the importance of shareholders meetings.4.1. the meeting was properly called. the MBCA allows shareholders to force corporations to hold the meetings on an annual basis. Because the proxy agreement was to last for ten years.S. Katz. A normal proxy. the court held that the proxies were still valid. 1986). Dist. Smith and Gibbons cannot reverse their proxy agreement with Zollar. this gave him the right to request a special meeting.D. such as a corporate merger.Y. Smith. The corporation did not plan for another shareholders meeting to be held until January 27. any shareholder may petition the court and obtain an order that such a meeting be held. choose an independent auditor.2. as a shareholder. Shoenholtz. Special shareholder’s meetings may be called by the board of directors.Y. Zollar v. The last annual stockholders meeting held by Direct Action took place on September 19.N. in that it stated the time. Proxy 28. 1987). 2 Dept. is valid for 11 months. Answers to Critical Thinking Cases Shareholders Meeting 28. Shareholders have a right to inspect corporate records. Smith and Gibbons had given Zollar a proxy that specifically stated that it was irrevocable for a period of ten years. Yes. Under the MCBA. The corporation is required to give the shareholders written notice of the place. date.

Because of these two actions.6. As a shareholder. Berk. Inc. 1987). and a majority of the disinterested shareholders approve of the activity. When this action was discovered. Hellenbrand wins since he can obtain an injunction to prevent Berk from leasing the club. Comedy Cottage. Directors and officers cannot use the facilities. for not granting a dividend at their January. Gay v.. personnel.2d 1006. The directors are responsible for determining when. Gaffney and his partners were all officers of Ideal. Chelsea wins and can recover from Gaffney and his partners. internal expansion. This decision was well within the board’s discretion. Ch. This duty requires that officers and directors subordinate their own personal interests to those of the corporation and its shareholders.5. Inc. and the corporation was . 1986). or funds of the corporation for their own benefit. unless full disclosure of the competing activity is made.2d 577. Inc. 495 N. Gay’s Super Markets wins the suit. how. Gaffney and the others set up a competing business without informing the corporation or its shareholders.7. App. Among the purposes for the inspection were to gather information in order to make an informed decision voting in the shareholders election. They also used Ideal’s assets and facilities to build their own business and recruit customers for it. Inc. the court did not interfere with their decision. Duty of Loyalty 28. The corporation can recover any profits made by the nonapproved competition and any other damages caused to the corporation. Helmsman Management Services. Corporations often do not pay dividends. These actions by Gaffney and the other officers constituted a breach of their duty of loyalty to Ideal. Ch. Inc. Duty of Loyalty 28. and how much will be paid in dividends. the court allowed Helmsman to inspect most of A&S’s records. such as expansion. v. 1975 M. Lexis 391 (Maine Sup. Berk was an officer of a corporation. This new club was in direct competition with his old corporation. v. 1987 Del. A&S Consultants.. 1986 Ill. Dividends 28. Helmsman had the right to inspect A&S’s outstanding stock. Berk usurped a corporate opportunity when he arranged for the Comedy Cottage’s lease to be drawn in his own name. Helmsman had the right to inspect A&S’s books. Because Gay’s had usually decided to retain earnings due to increased competition and planned expansion. 343 A. the court held that Berk had breached his duty of loyalty to the Comedy Cottage. 1976). 1972 meeting. Directors and officers of a corporation owe a duty of loyalty to the corporation. The payment of dividends is at the discretion of the board of directors. Berk used his former position to retain the lease and open his own Comedy Club. Part of this duty is to not compete with the corporation. Helmsman wrote to A&S requesting the inspection. where. The duty of loyalty prevents officers and directors from competing with the corporation and usurping corporate opportunities. Directors and officers of corporations owe the corporation a duty of loyalty. and determining why Helmsman had received no dividends on its stock. 525 A.president of Comedy Cottage. and stated several valid purposes for its request. As a shareholder.2d 160. Lexis 2486 (Ill. Because Helmsman was a stockholder making a valid request for inspection. Lexis 397 (Del. and granted Hellenbrand the injunction he sought. Gay’s Super Markets’ board stated valid reasons. Gay’s Super Markets. Courts will only order a corporation to declare a dividend if the directors have abused their discretion in not paying. but retain profits in the corporation to be used for research expense. and a vice.458 Chapter 28 Helmsman held 25 percent of A&S’s outstanding stock. and other anticipated needs.E.App.

.2d 320. Colo. because Wildhorn Ranch. Yes. Piercing the Corporate Veil 28. 1988). App.Supp. Young is entitled to indemnification for the loss he incurred in defending the suit brought against him and Pool Builders. In this case. Inc. he was entitled to mandatory indemnification. (2) the shareholder has made a demand on the directors to pursue this claim. Gaffney. but they had refused. 1988 U. v. Dotlich. officer. or some other person. If someone harms a corporation. Sam had asked the corporation’s board of directors to take action in regards to this matter. Lexis 1413 (Mass. When this occurs. 475 N.. The harm was in the form of retaining property bought by the corporation in his own name. When a shareholder dominates a corporation and does not maintain any separation between himself and the corporation. Because Watters failed to separate himself from the corporation. Derivative Shareholder Lawsuit 28. A director or officer who wins a lawsuit must be indemnified by the corporation for the reasonable costs of litigation.S. 1983). the directors of the corporation have the authority to bring an action on behalf of the corporation to recover damages or gain other relief. Monnie Dotlich. Sam Dotlich can file a shareholders derivative suit on behalf of the corporation. The board’s refusal gave Sam the right to file a shareholders derivative suit. Sup. Sam Dotlich had the right to sue on behalf of Dotlich Brothers. had harmed the corporation. Yes.10. This meant that the corporation had to reimburse Young for all costs he incurred. he was found liable for the corporation’s torts and other debts. Watters paid Wildhorn’s debts with money from his other corporations.2d 1177. Yes. kept no minutes of shareholders meetings. A shareholder may not bring a lawsuit that asserts a claim that belongs to the corporation unless: (1) the corporation has a claim against a director. Inc. Watters dominated the affairs of Wildhorn Ranch. Chelsea Industries. such as holding shareholders meetings. and (3) the directors have refused to pursue the claim. Indemnification 28. Young was a director of Pool Builders and defended a suit brought against him and the corporation. was merely his alter ego. and ran the corporation without observing any of the necessary corporate formalities. Because Young won the suit.2d 331.E. . 486 N. App.E. 449 N. the shareholder may be held personally liable for the corporation’s debts and obligations. A shareholder may be held liable if the corporation fails to follow the necessary formatting required by applicable statutes..E. 1985 Ind. and held the meetings in his living room. Dist. Inc.Corporate Governance and the Sarbanes-Oxley Act 459 able to recover damages from them. Inc. Geringer v. Inc.9. and keeping minutes of these meetings. Lexis 12678 (Ohio App. Corporate directors may be indemnified for certain personal liability and litigation expenses associated with suits against the corporation. Watters can be held personally liable. 1983 Mass. that corporation is merely his alter ego. Lawson v. This is called mandatory indemnification.8. 1985).. Wildhorn Ranch. Young. 1984 Ohio App. Lexis 1570 (D. Dotlich v. 760 F. 1442. Lexis 2233 (Ind. 1954). because another director.

1975). Farms did not have a separate financial existence. Bank. They knew from personal experience his fraudulent character. V: Answer to “Briefing the Case” Writing Assignment: 1. 1985 U.. 1975 Cal. Ray had no other way to pay back the contractual price that they had negotiated with him. The $10. and Court United States v. There were no corporate resolutions authorizing these extraordinary “loans. Case name. a Kentucky corporation.S. D.350 were imposed against WRW. The defendants claim limited liability because of the corporate status of WRW. E. Inc. Observance of corporate formalities is only one aspect of corporateness. F. Plaintiff asked that the corporate veil be pierced and that the owners be held personally liable for the fines. 120 Cal. Lexis 1801 (Cal. Defendants were the sole owners of a coalmine operation doing business as WRW Corporation. The Bank here placed control in a man whose public records are overwhelmingly negative. United States of America v. App. Lexis 21255 (5th Cir. G. 768 F. Jon-T Chemicals. 46 Cal. The lower court held for the plaintiffs. the controlling shareholder has an obligation to conduct a reasonably adequate investigation of the buyer.460 Chapter 28 IV: Answers to Ethics Cases 28. Key Facts A. C. breached its fiduciary duty to the minority shareholders.Rptr.3d 791. The turns of the deal guaranteed that Ray would loot the corporation. All three of the co-owners were found criminally liable and served prison sentences.” Third. The WRW Corporation went out of business in 1985 after having been found in violation of safety standard set out in the Federal Mine Safety and Health Act. long trail of financial failure should have precluded the Bank from dealing with him. WRW Corp. the nature of the loans to Farms from Chemicals reveals that whenever Farms could not pay its debts Chemicals wrote a check for payment.12. 3. regardless of whether the fraudulent papers were signed by Thomas as Farms President or Thomas as Chemical the corporate entity was appropriately disregarded. App. First.11. by itself it does not create a separate existence for an entity. Those violations resulted in the deaths of two miners. 354. Debaun v. Second. Moreover. Citation. 986 F2d 138 (1993) United States Court of Appeals for the Sixth Circuit 2. App. 1985). B. First Western Bank and Trust Company.2d 686. Additional civil penalties in the amount of $90. In selling its control of the corporation. App. as the controlling shareholder of Corporation. 28. they hoped to recover from him a debt owed to them arising out of fraud. The District Court correctly found Farms to be the alter ego of Chemicals. Finally. Issue Should the corporate veil be pierced and the owners of WRW Corporation be held personally liable? . the use of Chemicals’ offices and computers justify the district court’s finding of joint use and ownership of property.000 investment created a thin corporation (diaphanous) that depended upon its parent Chemical for transfusions of working capital. Ray’s long.

Holding Yes. the lower court found that these factors could be used under Kentucky law to pierce the corporate veil. 5. C. Using the factors of under capitalization and failure to follow corporate existence formalities.e.” i. . was upheld. which pierced the corporate veil. Court’s Reasoning A. B. there was a complete merger of ownership and control of WRW with the individual defendants. There was no evidence of an “alter ego.. The lower court’s holding.Corporate Governance and the Sarbanes-Oxley Act 461 4.

should not be encumbered by a labyrinth of law that only imposes artificial barriers to that reality. Several factors have contributed to the frenzy of activity on the street. has always been to preserve freedom without monopoly . This side argues that unrestricted business tends toward monopolies and economic subjugation. This view literally adopts the law of the jungle where only the strong survive. The first is the law level that lays out the basic rules vis-à-vis mergers. not all of it well motivated. and arguments pro and con can be heard from the halls of academia to Wall Street. The proponents for changes first argue mergers. . Given the constant time management choices teachers of undergraduate business law courses have to make.” The world of corporate combinations through mergers and the like has been turned upside down in recent history. Both of these great academic disciplines have had dramatic effects on the formulation of public policy. As Clarence Darrow once said: “The problem in business. it should be swallowed up by more efficient competitors. running on “cruise control. Where a company is poorly managed. The second level involves the much broader socioeconomic debate that gave birth to the Law and Economics Movement. These debates have tended to look like the old cart/horse dilemma. The Law and Economics Movement proponents argue that .” and is not sufficiently lean and mean. But opportunities abound when it comes to corporate combinations.” and as such. reaching this first plateau should suffice. and termination of corporations. and in life. acquisitions. we have solved it as we do most questions by taking both courses at the same time. takeovers.462 Chapter 29 Chapter 29 Corporate Acquisitions and Multinational Corporations How Can Corporations Combine? I. there is no one underlying motive or rhyme or reason to it. The possibilities for stimulating student debate on these issues are virtually endless. Traditional law views an unfettered economic drive as little more civilized than a mere law of the jungle where only the most vicious survive. . As with so many of these sort of fundamental changes to how society orders its affairs. and consolidation are simply market place adjustments that reflect attempts to correct inefficiencies in the marketplace. Teacher to Teacher Dialogue These materials lend themselves to two levels of presentation. Many economists argue that the laws of supply and demand are “natural.

buyouts. The truth probably lies somewhere in between these poles when it comes to business combinations. On the other side of the coin. corporate spin-offs. each and every one of us will ultimately share in the ultimate benefit or burden. the larger society has had to pay for numerous financial scandals because the original players were not really motivated by the long-term good of society. and the like breed a whole new generation of unethical. financial charlatans whose only real self-interest is their personal bank accounts. tax manipulation. our industrial.Corporate Acquisitions and Multinational Corporations 463 the mechanisms of the law should not only allow this natural business evolution to take place. However it all turns out. short-term thinking. Critics of the merger phenomenon point to the endless game-playing going on in this arena. and development of essential business fundamentals have been cast aside in the name of greenmail. II. a number of commentators have argued that runaway activity in the areas of mergers. and golden parachutes. The net result of this sort of short-term thinking is that while the financial market manipulators are playing high stakes poker. but that to stifle it would do harm to society in the end. acquisitions. Out of that gaming mentality. and transportation infrastructure has sunk into a quagmire of noncompetitiveness on the world marketplace. In addition. They argue that what has been created is a big time casino where the chips are bigger than ever. long-term growth. Time will ultimately tell if recent history has reflected a transition cost to stay competitive as a nation. Text Materials Business Combinations Merger A+B=A Consolidation A+B=C Acquisition A+B=A=B Friendly Combinations Hostile Takeovers Defense Strategies . research. or if we are frittering away our industrial base at the gaming table. financial.

Contemporary Issue: SEC Proxy Rules The SEC has adopted certain rules that apply to proxy solicitations and proxy contests. etc. These are discussed.464 Chapter 29 Can be used for voting for mergers. charter amendments. directors. A proxy contest involves a challenge by insurgent shareholders. Under the 1934 Act fraud is prohibited. . Note: Proxy Statements with all information must be filed with the SEC.

Corporate Acquisitions and Multinational Corporations 465 Shareholder Resolutions Submitted to other shareholders for consideration Need 1000 shares < 550 words Business concerns S E C .

466 Chapter 29 Ethics Spotlight: Shareholder Resolution Although an overwhelming majority defeated this shareholder proposal. . some Du Pont shareholders put forth a resolution against alleged child and forced labor by Du Pont in foreign countries.

Corporate Acquisitions and Multinational Corporations 467 Acquisition .

468 Chapter 29 Need for consolidated financial statements Required Approvals For Combination Affirmative Majority Shareholder Vote Board Recommendation Dissenters Appraisal Right .

“In this case. J. Comparative value was an estimate based on a price reflected by prices in similar transactions in the oil and gas industry. 1985. Market value was an estimated price that Shell shares would sell for without the effect of merger speculation. The remaining shares of Shell were held by minority.Corporate Acquisitions and Multinational Corporations 469 The Court Speaks: In the Matter of the Appraisal of Shell Oil Co.6 percent of the stock of Shell Oil Company (Shell). These experts gave the following estimated per share value for Shell’s shares. On June 7. a large natural resource conglomerate. Reason: Walsh.005.001 shares had not accepted the offer and qualified for appraisal rights. Issue: What price should Shell pay its minority shareholders who demanded appraisal rights? Decision: The court determined that the fair value was $71. After the merger was complete. The chancery court gave little or no weight to the valuations reached by the experts because it found that they lacked objectivity. The court stated. each party’s valuation evidence was replete with deficiencies and so susceptible to bias that indiscriminate indorsement of either would have been indefensible. . public shareholders. The parties offered extensive evidence through expert witnesses. Valuation Method Liquidation value Comparative value Market value Shell’s Expert $57 $60 $43-$45 Shareholder’s Expert $100 $106 $92-$143 Liquidation value was the estimated value if Shell was dissolved and its assets sold.” The chancery court reviewed the evidence and used its broad discretion to arrive at a valuation of $71. owned 94.20 per share.20 per share plus 10 percent interest from the date of the merger to date of payment. Facts: Royal Dutch Petroleum Company. The opinions expressed by the expert witnesses significantly reflected the desires of their clients. Royal Dutch effectuated a short-form merger with Shell and offered $60 cash per share for the outstanding shares of Shell it did not own. 1. The Delaware Chancery Court conducted an appraisal hearing.

the IRS. Tender Offer Rules 20 days before closing the offer 10 day extension if increase in # or $ Fair price rule to all Pro rata rule No Fraud Contemporary Issue: Leveraged Buyouts Leveraged buyouts or LBOs remain one of the most dramatic legacies of the so-called “Go Go Eighties. and the Labor Department.” Ethics Spotlight: Golden Parachutes These devices remain popular in spite of the recent reforms enacted by the SEC. Many commentators have argued that it is time for the IRS to step into the golden parachute arena as well.470 Chapter 29 Landmark Law: The Williams Act The Williams Act regulates tender offers. . The problem with these proposals is that they would likely create a turf war between the SEC. It will be interesting to watch them over the coming years to see if they are not plowed into the thinking that has been implemented in the tax code vis-à-vis pension plans and other employee benefit packages. The code has gone a long way towards eliminating discriminatory practices that unduly favored highly compensated executives.

mergers) White Knight Mergers with friendly parties Pac-Man Tender offer on tender offeror Greenmail & Standstill Payment for agreeing to abandon tender offer .g.Corporate Acquisitions and Multinational Corporations 471 Explanation of Defensive Strategies Crown Jewel Sell good assets Poison Pill Built-in contract provisions (e..

Inc.472 Chapter 29 The Court Speaks: Paramount Communications. The Facts: Viacom and Paramount announced a friendly merger in September 1993. a lockup option in favor of Viacom and poison pill strategies. Inc. QVC sued alleging Paramount’s board had breached their fiduciary duties to the corporation and its shareholders.” it must remove all poison pills as to all possible bidders and put itself up for auction to be purchased by the highest bidder. QVC Network. The court agreed with QVC. v. They held that once a Delaware corporation has put itself in plan. Ethics Spotlight: “Just Say No” Defense This deals with a friendly tender offer of Time for Warner to make Time too big for Paramount to take over. Five days later QVC made a $90 hostile bid for Paramount that topped Viacom’s merger offer. Paramount’s board adopted anti takeover strategies including a no-shop provision. Issue: Do the defensive tactics adopted by Paramount’s board of directors violate their fiduciary duties? Decision/Remedy: The court invalidated Paramount’s no-shop provision and lockup option. .

Dynamics challenged the Act in federal court alleging violation of the Williams Act and the Commerce Clause. Multinational Corporations 1) subcontracting with independent firms in host countries 2) wholly-owned foreign branches and subsidiaries 3) international multinational firms International Law: International Branch Office and Subsidiary Corporation These discuss the ways in which a corporation can conduct business in a foreign country. The Williams Act does not preempt the Indiana Act since they are consistent and Congress did not indicate an intention to preempt state law.Corporate Acquisitions and Multinational Corporations 473 The Supreme Court Speaks: CTS Corporation v. carriers by government-subsidized overseas carriers. International Law: The Exon-Florio Law This law is still too new to give us a real track record of its efficacy. when it should have disclosed the tonnage of mineral holdings.5 percent of CTS’s stock. The fear was that it would start a trend of takeovers of weakened U. Sanford E. and to define the rights acquired by purchasing corporate shares. timber holdings in board feet. There is no question. III. Issue: Does the Indiana Control Share Acquisition Chapter conflict with the Williams Act or violate the Commerce Clause by unduly burdening interstate commerce? Decision: No. This would. The Indiana Act protects shareholders from coercive tender offers. Answers to Critical Thinking Cases Proxy Disclosure 29.S. it does not violate the federal laws. a shareholder of Western Maryland Company. One recent example involved a blocked merger of a U.-based air carrier with British Airways. to prescribe their powers. Since the acquisition of over 20 percent of the stock of an Indiana Corporation triggers the Indiana Control Share Acquisition Act and since Dynamics would lose its right to vote its shares. however. Yes. This is an emotional and politically charged debate and makes for good class discussion. lead to a losing of control of our own transportation infrastructure.S. states traditionally have been given the power to create corporations.1. However. in turn. It is an accepted part of the business landscape and does not violate the Commerce Clause. and the actual value of the assets owned by Western. that the intentionally open-ended language of the legislation is designed to give the government a great deal of latitude in deciding these cases on an ad hoc basis. The core of Lockspeiser’s complaint was that Western only disclosed the acreage of its mineral and timber holdings and the book value of these assets. Reason: A basic purpose of the Williams Act was to place investors on an equal footing with the takeover bidders. stated a claim for relief for violation of federal proxy disclosure rules. Lockspeiser. The test for determining the . Dynamics Corporation Facts: Dynamics Corporation of America (Dynamics) announced a tender offer of 1 million shares of CTS that would give it 27. Laws regulating corporate governance necessarily affect certain aspects of interstate commerce.

did not independently evaluate Western’s assets.2d 558. Also. The court held that the corporation could pay both the incumbents’ and insurgents’ costs in waging the proxy contest. 1985).Y. It also directed that Medfield’s new proxy solicitation materials include corrections of all illegal misstatements and omissions. Proxy Contest 29. the incumbent management is reimbursed for the costs of the proxy contest whether they win or lose it. Fairchild Engine and Airplane Corporation wins. 768 F. 426 U. integrity. and (3) the majority of the shareholders ratified the payment of these expenses to the insurgents. The court held that Lockspeiser stated a claim for relief alleging material omission in Western’s proxy materials. 1976).S. Western Maryland Company.2d 291. Fairchild paid for both sides’ costs of the proxy contest.S. Fairchild Engine and Airplane Corporation. The court held that the information about the coal and timber reserves and the actual market value of Western’s assets was significant for a shareholder to make a choice because there was no established market for the company’s stock and First Boston Company. The court held that Medfield had (1) failed to disclose the nature and extent of Medfield’s liabilities. the investment banker hired by Western to give a fairness opinion. App. (2) failed to disclose self-dealing by a director.Y. the court held that the incumbent directors were entitled to have their costs and expenses of the proxy contest to be paid by Fairchild.3. the omitted fact would have assumed actual significance in the deliberations of the reasonable shareholder.2d 1266. upon approval of the majority of the shareholders. If a proxy contest is fought over policy issues and not for personal reasons.App. Based on the fact that the proxy contest in this case was waged over policy issues. Medfield Corporation. The court held that Medfield Corporation’s proxy materials contained multiple instances of material misstatements and material omissions of fact in violation of Section 14(a) of the Securities Exchange Act of 1934 and the applicable proxy disclosure rules adopted by the Securities and Exchange Commission. 2126 (1976): An omitted fact is material if there is a substantial likelihood that a reasonable shareholder would consider it important in deciding how to vote. Lexis 947 (N. the court permitted the insurgents to be reimbursed for the costs of the proxy contest because (1) the contest related to policy issues. Proxy Contest 29. Lockspeiser v. 96 S. 1955 N. Gladwin v. 438.2.474 Chapter 29 materiality of an omission from a proxy statement is set forth in TSC Industries v. App. and (3) unlawfully impugned the character. 128 N. Lexis 20476 (4th Cir. It does not require proof of a substantial likelihood that disclosure of the omitted fact would have caused the reasonable investor to change his vote. Rosenfeld v. 1955). Lexis 6548 (5th Cir. 1985 U. if an insurgent group is successful in unseating incumbent directors in a proxy contest waged over policy issues. the corporation may.E. The Gladwins win. and personal reputation of a rival candidate for office. Northway. and an explanation that the resolicitation was the result of a lawsuit. . 1976 U. What the standard does contemplate is a showing of a substantial likelihood that. Ct. (2) the insurgents were successful in the proxy contest.S.. reimburse the insurgent directors for their costs and expenses of waging the proxy contest. Inc. Thus in this case. In this case. a statement that prior solicitations were in violation of Section 14(a) and SEC proxy rules. The court ordered a new election. under all the circumstances. 540 F.

a chemical substance that was used as a defoliant in Vietnam during the Vietnam conflict.2d 1274. If a shareholder meets the ownership requirements of Section 14(a) (which the Committee met). which was often dropped from airplanes. The court held that the proposed sale of Plant (Quebec) met this definition. 432 F. Napalm. the shareholders are accorded dissenting shareholder appraisal rights. the Medical Committee’s proposed shareholder resolution could be stated in terms to meet the requirements of Section 14(a) to be included in Dow Chemical’s proxy materials. Dissenting Shareholder Appraisal Rights 29. There was substantial public criticism and demonstration against Dow for making napalm. Dow Chemical was manufacturing napalm. where there is a sale of substantially all of the assets of a corporation. under Delaware law.2d 659. Lexis 449 (Del. the Committee could have also asserted that Dow’s manufacture of napalm made it susceptible to product liability lawsuits by those injured by it. Also.Ch. Yes. Delaware state law requires that a sale of all or substantially all of a corporation’s property and assets requires not only the approval of the corporation’s board of directors but also a resolution adopted by a majority of the outstanding stockholders of the corporation.Cir. dissenting shareholders who properly object to the sale and timely require appraisal rights may require the court to appraise the value of their stock. required before the sale of this subsidiary could take place. Yes. Therefore. To obtain appraisal rights. a dissenting shareholder must (1) file a written objection to the merger prior to . 1970). and does not solely relate to a social or religious purpose. Ch. Therefore. the vote of the shareholders of Plant Industries. if a majority of the shareholders vote to approve the sale of the subsidiary. Merely stating that the making of napalm violated the Commission’s credo for the concern for human life would not be sufficient to require the proposal to be included in Dow’s proxy materials. many young people of college age refused to work for Dow because of its manufacture of napalm.6. App. These reasons—the bad publicity and inability to recruit young professionals—were sufficient to support the Committee’s request to include its shareholder proposal in Dow’s proxy materials. In this case. 1981 Del. Merger 29.4. 1970 U. caused damage to humans who were burned by it and those who were exposed to it. Bregman. In addition. John Bershad may not obtain dissenting shareholder appraisal rights. No. and substantially affects the existence and purpose of the corporation. its parent corporation. the shareholders of Plant Industries. Katz v.C. The court issued an injunction preventing the sale of the subsidiary until it was approved by a majority of the outstanding shareholders. Lexis 8284 (D. Each of these are reasons that the Committee could have asserted to support the inclusion of its shareholder proposal in Dow’s proxy materials. must be accorded dissenting shareholder appraisal rights regarding the sale of Plant National (Quebec) Ltd. This is defined as a sale of assets that is quantitatively vital to the operation of the corporation and is out of the ordinary. Inc. sales. Securities and Exchange Commission.5. This was because this subsidiary constituted over 50 percent of the assets. In addition. he has a right to place a proposal in the proxy materials of the corporation if the proposal relates to the corporation’s business. 431 A. 1981).. concerns a policy issue and not the day-to-day operations of the corporation.S. in this case. and net income of Plant Industries. Medical Community for Human Rights v. Whether a sale of assets constitutes a sale of substantial corporate assets is a question of fact. The committee wins.Corporate Acquisitions and Multinational Corporations 475 Shareholder Resolution 29.

The court held that Marathon Oil Company had violated Section 14(e) of the Williams Act. 1981). Note: U. In this case. he tendered his shares for the merger and received payment for his shares. Lexis 14958 (6th Cir. Bershad failed to comply with the statutory requirements. Marathon Oil Company. Steel’s $125 per share offer be kept open for a reasonable time but free of the inhibiting and unlawful impact of these two options. 3. 1987 Del. This can hardly be done when management has agreed not to look for a higher bidder to compete with their own bid for the company. Lexis 1313 (Del. The court ordered that U. Failure to comply with these statutory procedures results in loss of appraisal rights. The “no shop” agreement violated Fruehauf management’s responsibility to shareholders to find the best and highest price for their shares. This stock option violated Section 14(e) because it subsidized U. and (3) make a written demand for payment of his shares.7. He failed to make a written objection to the merger prior to the vote of shareholders. Steel violated Section 14(e) of the Williams Act.8. Mobil Corporation v. Management must not put their personal interests before those of the company’s shareholders. In this case. was given this same right. Fruehauf management’s continued preference for their own bid over that of the Edelman group by giving Merrill Lynch information not given to the Edelman group was a violation of their duty to give all suitors an equal opportunity to bid for the company.S. Second.S. which was currently around $125 per share. 669 F. This was because the fair market value of Marathon’s interest in the Yates Field was worth up to $3. Steel the irrevocable right to purchase Marathon’s interest in Yates Field for $2. App. Steel acquired Marathon Oil through a tender offer and follow-up merger. the stock option was fraudulent in that it gave U. U.476 Chapter 29 the vote of shareholders.2d 366.S.S. Mobil Corporation wins. This is called selling the “crown jewel” because Marathon was selling one of the most important assets that attracted Mobil to make the tender offer for Marathon’s share in the first place. 1987). Steel’s purchase of Marathon. the Yates Field option which gave U. Tender Offer 29. This was really a payment by competing management-led MBO to Merrill Lynch out of the corporate treasury. deceptive. Steel the right to purchase 30 million shares of Marathon common stock for $90 per share. The court held that both the stock option and Yates Field option that Marathon granted to U. First. . The court held that both the stock option and Yates Field option granted by Marathon to U. Tender Offer 29. Curtiss-Wright Corporation. and manipulative practice in violation of Section 14(e).2d 840.S. 535 A. Steel was a fraudulent. deceptive.8 billion if a third party gained control of Marathon violated Section 14(e). the court held that the management and directors of Fruehauf violated the business rule in the following respects: 1.S. 2. The court held that since Bershad did not meet the statutory procedure. The business judgment rule requires management of a company to act in good faith and in the best interests of the corporation’s shareholders.S. (2) not vote in favor of the proposed merger.S. Bershad v. and he failed to make a written demand for payment of his shares.6 billion. Yes. he did not qualify to bring an action to recover dissenting shareholder appraisal rights or any other remedy. No other suitor. and manipulative practices in connection with tender offers. The payment of a breakup fee to Merrill Lynch—which was payable even if the management-led MBO was not misuse of the corporation’s funds. particularly Mobil. the actions of Fruehauf’s management violated the business judgment rule. This was fraudulent because it was below the fair market value of the stock. Section 14(e) prohibits fraudulent.

2d 1346. Further.. Household International.10. violated their fiduciary duty to the shareholders. timing. at the time of the merger. the court held that the proxy contest was for control of Household. Constitution. the court held that such preplanning for the contingency of hostile takeover reduces the risk that.2d 496. Poison Pill Defense 29. The court also held that the Wisconsin act does not unduly burden interstate commerce. i. State Antitakeover Statute 29. Dynamics Corporation of America..S. wins. Their Universal is described as a company ideally situated to profit from both a rejuvenated theatrical market and the . App. prescribe their powers. 1637 (1987). 481 U.. 1986 U. The court held that there was no showing of bad faith on the part of Household’s directors who receive the benefit of the business judgment rule in their adoption of the Rights Plan. Thus.75 per share. Fruehauf Corporation.S. The court held that Wisconsin’s antitakeover statute was lawful and did not conflict with the federal Williams Act or violate the Commerce Clause of the U. Amanda Acquisition Corporation v.36. The court held that all of the actions by Fruehauf’s management was a breach of their fiduciary duties to shareholders and a violation of the business judgment rule. and such. Inc. disclosures. It is an accepted part of the business landscape in this country for states to create corporations.e.S. management will fail to exercise reasonable judgment. the court held that Household demonstrated that the Rights Plan was reasonable in relation to the threat posed.Corporate Acquisitions and Multinational Corporations 477 4. Constitution. The court held that the Wisconsin antitakeover statute did not conflict with the Williams Act or violate the Commerce Clause of the U. Inc. Edelman v. Lexis 27911 (6th Cir. it does not alter any of the procedures governed by federal regulation. The court held that the “flip-over” Rights Plan adopted by the directors of Household did not violate the business judgment rule. App. 500 A. Moran v. Defendant claims that Universal. was a weak wasting asset in a declining industry and calculated the fair value of its shares at that time as $52. 107 S. Lexis 557 (Del. 1985 Del. proration. In addition. None of these provisions are violated by the Wisconsin act.11.9.2d 882. 1989 U. 798 F. Lexis 9024 (7th Cir. That is. The court enjoined Fruehauf management from instituting their actions. 69. under the pressure of a takeover bid. IV: Answers to Ethics Cases 29. and regulate their internal affairs. 877 F. the consequences of the Rights Plan can be avoided if the potential takeover company negotiates with the management of Household regarding the terms of a merger or other form of acquisition. The court also held that the Plan was reasonable because it was not absolute. Supreme Court in upholding a state antitakeover statute in CTS Corporation v.S. Universal Foods. The court in the present case held that the Williams Act regulates the process of tender offers. Ct.S. best price rule. 1989). The dissenting shareholders describe a different view of the corporation. The fair value of minority shareholders’ shares of Universal Pictures Company is $92. Wisconsin has done no more than that in this case. 1985). which would be triggered by their own bid for the company and used as their equity investment to purchase the company. The Court of Appeals reached this decision by applying the reasoning used by the U.S. The court cited the fact that the Plan was adopted to ward off future advances and was not adopted in reaction to a specific threat. Granting such lucrative “golden parachutes” to themselves. 1986). Household International.

The court revised the figure to $92. an Alabama corporation. Universal City Studios. but differed substantially regarding the underlying assumptions related to the valuations. 1991). The court of appeals held that although Section 14(a) gives a normal shareholder the right to sue incumbent management for alleged false and misleading statements in management’s proxy materials. 5. Minority shareholders of ABC were offered a price of $75. in retrospect. However.S. 3. Ch. Ch. D. Citation. B. Holding The valuation preferred by the minority shareholders most closely approximated the fair market value on August 13. Inc. 1985? 4. The court also found no causal nexus between Royal’s alleged injury and Realist’s secret merger negotiations with Ammann. Both sides used appropriate valuation techniques. Issue Under Delaware laws regarding corporate valuation methods. he refused to give the benefit of all inferences as to the specific value factors they maintained and arrived at a value of $91. The defendant (ABC). and “B” without voting rights. Lexis 127 (1990) Court of Chancery of Delaware 2. 1973 Del. which of the two appraisals most fairly represents fair market value on August 13. they would rather not have entered. v. Case Name. Francis I. 8282.60/share. B. Lexis 123 (Del. Lexis 10389 (1st Cir. a Delaware corporation.12. 29. ABC had issued two classes of stock: “A” with voting rights. that is. Ch. 933 F.2d 344. and they claimed that value was too low and sought to assert their appraisal rights under Sec. Answer to “Briefing the Case” Writing Assignment: 1. 1991 U. Both sides presented their respective appraisals. E. Realist is not liable to Royal. No. The court stated that giving a proxy contestant a private right of action for damages would not advance the underlying purpose of Section 14(a). Drummond. a proxy contestant does not have this same right even though the contestant is a shareholder in the target corporation. “The only injury the plaintiffs suffered was caused by their involvement as combatants in an election they won—but one where. 1990 Del. 262 of Title 8 of the Delaware Code. Inc. was engaged in coal mining and related businesses in the 1970s and 1980s.2d 1056.” Royal Business Group.76. v. 312 A. Inc.. 1985. Du Pont & Co. C. The appraiser agreed with the stockholders. Both sides agreed on the use of the discounted future returns model and a net asset model. App.478 Chapter 29 emerging new highly profitable television market in which it has established itself. Realist. Key Facts A. and Court Neal v.75. to protect normal shareholders from fraudulent conduct. The court stated. Court’s Reasoning A. .. made several attempts to acquire and merge with ABC starting in 1977 and culminating with a merger in 1985. Alabama By-Products Corp. 1973). V.

Corporate Acquisitions and Multinational Corporations 479 C. .67/share. Based on the use of the use of the common techniques coupled with the court’s acceptance of certain assumption. the Court of Chancery of Delaware arrived at its own value of $180.

1988-2 C. but also gain the Internal Revenue Service imprimatur for being taxed like a partnership and still provide limited liability to all participants in the entity. et al.S. the possibility for legitimate tax structure avoidance was severely limited to the rules and regulations covering “Sub-S” corporations. They would not only be familiar to overseas investors who were already comfortable with the limited liability company. and its enabling statute is “only” a century old.Rul. As such. jurisprudence from adopting this form of business for so many years? In a word: taxes.R. the specter of double taxation on corporations held back the implementation of limited liability companies.88-76. For example. More specifically. This was the first of many rulings on similar statutes adopted by virtually all states. the I. a number of states decided to create new forms of business entities.S.S.R.C. subsequently adopted the “check-the-box” and the rest is history. Various forms of limited liability companies have been used in other parts of the world for many years. Traditional interpretations of state laws allowing for limited liability focused on corporate laws.360). Germany is considered to be the latest country to add this form of doing business.L.S. The I. then. Teacher to Teacher Dialogue The advent of limited liability companies in our system of jurisprudence reflects a synthesis of both something new and something old. Wyoming was the first to venture forth in heralding the modern era of L. Subchapter S was first added to the Internal Revenue Code in 1958 and has undergone numerous revisions and updates since. which accorded partnership tax treatment to the Wyoming L. that kept U. With increasing pressures to attract more overseas capital and investment into the United States. What is it. Wyoming passed its L. In 1977.B.L. law.480 Chapter 30 Chapter 30 Limited Liability Companies and Limited Liability Partnerships How Can We Get The Best Of Both Worlds? I. . The essence of these provisions has been to allow a corporation to avoid double taxation only under very limited constraints outlined in Internal Revenue Code § 1361.L. laws in the U.C.C. issued its Revenue Ruling (Rev. and in 1978.

However.S. and tax planning. in effect. recent trends have led to the use of the limited liability company format as the best vehicle for providing the “best of both worlds—the singlelayered conduit taxation of proprietorships and partnerships with the limited personal liability accorded to shareholders of a corporation. II. As with any major turn in the process of legal evolution. protection from personal liability. business entity choices are strategic decisions based on a number of factors. This act. Text Materials . seeks to “marry” the best elements of agency. These elements include choosing the best options for potential capital investment and financing growth. The final product is far from complete. and corporate law into a format that allows for uniformity and predictability on these issues throughout the U. As we have seen in earlier chapters. partnership. No one entity format is ideal for all objectives. This chapter focuses on the main element of the Uniform Limited Liability Company Act as promulgated by the National Conference of Commissioners on Uniform State Laws.Limited Liability Companies and Limited Liability Partnerships 481 Because of all the possible permutations that have evolved since this opening foray into limited liability company laws. but it surely has come a long way in a generation. we are witnessing a work in progress. the demand for a uniform statute was not unexpected.

482 Chapter 30 Landmark Laws: .

Nashville Pro Hockey contracted with Creative Resource . v. That use was permitted under Apex’s zoning regulations. NC. claiming the facility would be a nuisance. Facts: Dale C. Local residents sued Roscoe.Limited Liability Companies and Limited Liability Partnerships 483 The Court Speaks: Page v. as a member of the LLC. Reason: Bone. a limited liability company organized in North Carolina. Soskin Facts: Nashville Pro Hockey LLC was a limited liability company in Tennessee that owned and operated the Nashville Nighthawks. was not liable as a matter of law for the acts of the LLC and was therefore improperly named as a defendant in the lawsuit. The residents lost. Bone was a member of Roscoe. Roscoe. Issue: Were the sanctions warranted against the plaintiffs for naming an individual member of a limited liability company in the lawsuit they brought against the LLC? Decision: No. Bone sued to recover the attorney’s fees he spent to defend the lawsuit. Roscoe purchased two acres of land near Apex. LLC. The Court Speaks: Creative Resource Management. to construct and operate a propane gas bulk storage and distributing facility. LLC. Inc. and dropped the lawsuit.

The contract was signed by Barry Soskin. Soskin defended.484 Chapter 30 Management to provide employee leasing services to Nashville Pro Hockey. Issue: Did Soskin’s signature on the contract constitute a personal guarantee for the payment of the debt of Nashville Pro Hockey. alleging that his signature on the contract was in his representative capacity only and not in his individual capacity as a guarantor. CRM sued Nashville Pro Hockey and Barry Soskin.Liability of an LLC o Loss or injury from an act or omission of (within course of business or with authority of LLC) Member Agent Manager Employee o Managers not personally liable for debts of LLC o Tortfeasors (members and managers included) liable for injuries personally caused . . Nashville Pro Hockey failed.Taxation of LLC o Taxed as a partnership unless it elects to be taxed as a corporation o Avoids double taxation Entrepreneur and the Law: Why Operate a Business as a Limited Liability Company? This box discusses the advantages of operating as an LLC over an S corporation. to CRM? Decision: Yes. LLC.000. owing CRM about $30. The trial court agreed. president. . LLC. Reason: Soskin was a guarantor and was liable to repay the money owed to CRM by Nashville Pro Hockey.

Limited Liability Companies and Limited Liability Partnerships 485 .

486 Chapter 30 .

Dreamworks SKG.Limited Liability Companies and Limited Liability Partnerships 487 . Jeffrey Katzenberg. LLC: Script for a Movie Company This discusses a major LLC. .Operating Agreement o Entered into among members o Governs affairs and business of LLC Contemporary Issue: Dreamworks SKG. formed by Steven Spielberg. and David Geffen.

2) Partners are personally liable. 3) Limited partners cannot manage. Contemporary Issue: Why Operate a Business as a Limited Liability Company (LLC)? 1) S Corporations have restrictions. .488 Chapter 30 Note: Terms of Conversion must be approved.

Limited Liability Companies and Limited Liability Partnerships 489 .

490 Chapter 30 .

Limited Liability Companies and Limited Liability Partnerships 491 A nonmanager member of a manager-managed LLC owes no fiduciary duty to the LLC .

Statement of disassociation can give constructive notice if filed LLC can be continued: .Majority vote at will LLC .Unanimous vote prior to expiration .492 Chapter 30 Wrongful disassociation can give rise to damages.

Limited Liability Companies and Limited Liability Partnerships 493 Limited Liability Partnership (LLP) 1) no general partner needed (all are limited partners) 2) often state-restricted 3) “flow through” tax benefits 4) Need articles of partnership 5) Liability insurance often required Contemporary Issue: Accounting Firms Operate as LLPs The LLP was particularly created for accountants. Unlike the typical critical thinking cases in other chapters. and other professionals to offer their services under an umbrella of limited liability. III. it is important for you to check the Web site for this text (http://www. All would make great teaching tools for this chapter. Also. International Law: Limited Liability Companies in Foreign Countries Forms of limited liability companies have been in use in foreign countries for a long time. They cover various issues involving limited liability companies. these cases are all fictional. these cases are all fictional. They are great teaching tools for this chapter. Professor Cheeseman has developed 10 critical thinking case scenarios. lawyers. Unlike the typical ethics cases in other chapters. IV. Answers to Business Ethics Cases In this section. Professor Cheeseman has developed two ethics case as some of these fictional ethics issues become real and are decided by the courts. Also. They cover various issues dealing with limited liability as some of these fictional issues become real and are decided by the courts.prenhall. it is important for you to check the Web site for this text (http://www. Answers to Critical Thinking Cases In this section. .

.494 Chapter 30 V. E. the agents of the L. were Clark and Lanham shielded from personal liability for the debt claimed by Westec? 4.I. Court’s Reasoning The Colorado Supreme Court held that: A. The lower court held in favor of Clark and Lanham.I. Because of this failure of status notification. Waste & Land. 5. which shielded them from personally liability. Case Name.40 to P. managers and members of Preferred Income Investors. F. The lower court’s holding was reversed. Based on an oral contract between Westec and Clark & Landham. Westec appealed. D. The Colorado Supreme Court that Clark and Lanham were personally liable for this debt. C. Westec was not properly notified of the existence of P. in fact. Lanham 955 P. Inc. Key Facts A.L. Clark and Lanham defended on the grounds that they were acting on behalf of an L. B. Issue Under the Colorado Limited Liability Company Act of 1997.183.I. D..’s L. C. B.I.s where proper notice of the existence of the entity status is given. 2d 997 (1998) Supreme Court of Colorado 2. In this case. organized under the laws of Colorado.C.C.L. The Colorado Limited Liability Company Act of 1997 was intended to provide limited liability to members of L. and Court Water.C. 3. Westec was approached by Larry Clark and Donald Landham.C. dba Westec v.C. The services were not paid for and Westec sued Clark and Lanham individually for the amounts due. E. Westec is in the business of providing land development engineering. To allow limited liability here would. LLC. status. Citation. (Clark and Lanham) are therefore personally liable for the contract entered into with Westec. help to perpetrate fraud and misrepresentation against creditors. Holding No. Westec provided services valued at $9. Answer to “Briefing the Case” Writing Assignment: 1.L.

finance. most of all. Under the franchise system. The world of franchising combines concepts of marketing. Like any “business marriage. and technology developed by large multinational enterprises. the franchising concept allows the small businessperson to ride the coattails of the goodwill.” it can lead to the best of all worlds or the worst. a good faith willingness to let each participant do what he or she does best appears to be the key to today’s most successful franchise operations. It is interesting to note that many of the rules promulgated by the Federal Trade Commission are . patent. adhesion contracts. With intelligent planning and quality control. there is ample evidence of the positive effects of good franchise planning. There are some down sides to franchising as well. With sufficient start-up capital and a willingness to provide a lot of personal effort. management. The original basic technology. or other trademarked service or product is allowed to reach many more users or consumers through a franchise system. Many people have lost substantial sums of money trying to invest in pie-in-the-sky sales of bogus franchises. the franchise industry has seen more than its share of pyramid schemes. and. convenience stores.Franchises and Special Forms of Business 495 Chapter 31 Franchises and Special Forms of Business Why Do You Want To Own A Franchise? I. advertising. Another interesting aspect of franchising is its tie to basic capitalism for the little guy. All of these industries rely on the franchise concept to further their businesses. skilled research. shallow capitalizations. process. The “get rich quick” mentality of franchising has led to a number of abuses on the part of would-be franchisors. food product production. and similar behavior in violation of the antitrust laws. In addition. or even professional sports teams. Teacher to Teacher Dialogue Franchises are a way of doing business around the world. Witness the fast food industry. The objective of this chapter involves an introduction to the concept of franchising. and many other diverse skills into a special kind of cooperative venture that is facilitated through the law. Careful planning. all sorts of consumer good retailing systems. the original franchisor of the product or service can see phenomenal growth through the use of equity-sharing participants in that growth.

496 Chapter 31 designed to protect persons about to enter into franchise agreements rather than the ultimate consumer of the franchise’s goods or services. Licensing permits one business to use another business’s intellectual property in selling goods or services. Because a franchisee is an independent contractor. That may sound well and good in legal terms. why not hold a megacorporation responsible rather than just its franchisee? Possibly have the students consider this as they proceed. II. the franchise device has not always served the third party well. Text Materials Joint Ventures allow 2 or more businesses to combine their resources to pursue a single project. but does it always make equitable sense? If the consumer of the goods or services thought he or she was dealing with a megacorporation. In addition. the franchisor is not normally responsible to third parties for torts or contracts that the franchisee has been involved with. .

Starbucks Coffee.Franchises and Special Forms of Business 497 International Law: Starbucks Invades Taiwan This box discusses the very successful franchise. .

498 Chapter 31 .

Projections based on hypothetical .Projections made based on actual figures of an existing franchise .Franchises and Special Forms of Business 499 Special disclosure required if: .

500 Chapter 31 Contemporary Issue: FTC Franchise Notice FTC notice must appear in at least 12-point boldface type on the cover of a franchisor’s required disclosure statement to prospective franchisees. Intellectually Property Issues Registration of trademarks and service marks under Landham Trademark Act Unauthorized use equals trademark infringement Misappropriation of trade secret is unfair competition Can be terminated for cause .

The Court Speaks: Carlock v. they began franchising it. Pillsbury bought the company. Pillsbury’s motion for summary judgment was granted. . Franchise is to buy all ice cream from franchisor at latter’s prices. Pillsbury began selling products in forms other than franchises. Reason: The right to sell in other forms was reserved to the franchisor in the agreement. Franchisees sued claiming breach of agreement. Franchise agreement always grants limited license to operate a single shop at a specific location. including its franchise operations and the franchise agreements were assigned to them. Issue: Did Pillsbury breach the franchise agreement? Decision/Remedy: No. Pillsbury Company The Facts: After Mattus started selling “Häagen-Dazs” ice cream.Franchises and Special Forms of Business 501 Ethics Spotlight: Haagen-Dazs Ice Cream Franchise This looks at a change in the method of distribution after the company was purchased. The right belongs to Pillsbury.

Middletown Donut Corporation Facts: Smothergill entered into 2 franchise and lease agreements with Dunkin Donuts(DD).9% of which was the basic franchise fee and 2% of which was an advertising fee. . DD notified Smothergill of termination due to intentional underreporting of gross sales (4. Inc. The trial court permitted DD to terminate the franchise agreements. Smothergill made no attempt to cure as permitted in the agreement. DD sued. v. Reason: Smothergill was “guilty of unconscionable cheating”. The underreporting of gross sales involves cheating the franchisor and all other franchisees. The decision to terminate was affirmed. Issue: Were the franchise agreements properly terminated “for cause” by DD? Decision: Yes.502 Chapter 31 The Court speaks: Dunkin” Donuts of America. Smothergill appealed.

product liability. The complaint. . Facts: Timothy Cislaw. asked to make a legal determination on uncontradicted facts. The trial court. seeking compensatory and punitive damages. The Cislaws relied solely on the franchise agreement. The Costa Mesa 7-Eleven was franchised to Charles Trujillo and Patricia Colwell-Trujillo. breach of implied and express warranty. Southland owns the 7-Eleven trademark and is the franchisor of California 7-Eleven stores. and infliction of emotional distress. Southland Corp. stated causes of action for negligence. died of respiratory failure on May 10. asserting it could be interpreted to demonstrate an employment or agency relationship. a 17 year old. The Court Speaks: Cislaw v. 1984.Franchises and Special Forms of Business 503 Ethics Spotlight: Franchisee’s Fraud Caught This discusses sales by a franchised licensee of non-franchise products. decided as a matter of law the Trujillos were independent contractors and granted Southland’s motion for summary judgment. His parents filed a wrongful death action alleging Timothy’s death resulted from his use of Djarum Specials clove cigarettes sold at a Costa Mesa 7-Eleven store.

the agreement did not give Southland the right to control the day-to-day operations of its Costa Mesa franchise. a sixwoman teenaged crew was working to clean up and close the restaurant. The franchisor/franchisee arrangement does not create a principal/agent relationship unless the franchisor has the right to exercise substantial control over the operations of the franchisee. it was an independent contractor. Reason: McNulty.504 Chapter 31 Issue: Was the Costa Mesa franchise an agent of Southland? Decision: The Costa Mesa franchise was an independent contractor. McDonald’s had voluntarily assumed a duty to the crew at the Oak Forest franchise by establishing and requiring the franchisee to implement certain security measures. employment. Illinois. and McDonald’s Corporation appealed. The court held that McDonald’s was liable for its own negligence due to the failure of security measures and the failure of its employee. The court found that because the franchisee made all inventory. McDonald’s Corp. and day-to-day operational decisions. The trial court awarded damages to all three victims. Reason: Sonenshire. Therese Dudek. on November 29. and by obligating itself to inspect the restaurant to see that the required security measures were implemented. Therese Dudek. J. to protect its “7-Eleven” trademark from misuse by the franchisee. 1979. The Court Speaks: Martin v. On that evening. Laura Martin. . and Maureen Kincaid were members of that crew. A person later identified as Peter Logan appeared in the back of the restaurant and ordered the crew into the refrigerator and the assistant manager. In the course of moving the crew into the refrigerator. J. Carlson. Issue: Is McDonalds liable for negligence? Decision: McDonald’s was negligent for not making sure that security deficiencies it found at the Oak Forest franchise had been corrected. Facts: This case arose from a murder and robbery that took place after closing hours at the McDonald’s restaurant in Oak Forest. Laura Martin’s parents claimed damages from McDonald’s Corporation for the wrongful death of their daughter. Laura Martin was shot and killed. and Therese Dudek and Maureen Kincaid claimed damages for the negligent infliction of emotional distress. to open the safe and get him money. Although the franchise agreement gave Southland the right to establish the hours of operation of its franchises. and Maureen Kincaid and Therese Dudek were assaulted by Logan. and to set cleanliness and quality control standards at its franchises. to follow up to determine that the security deficiencies at the Oak Forest franchise had been corrected.

The main duty of the guards was to keep the parking lot open for hotel guests. v. The Rodeo Bar. Inc. Mr. Police reports involving 58 offenses.” was located in the hotel. and Shelburne sued the franchisee. Fights occurred all the time in the bar and parking lots. The court also found that Hospitality Venture was the apparent agent of Holiday Inns. and therefore Holiday Inns was vicariously liable for its franchisee’s tortious conduct. a fight erupted. On the night in question. Inc. Ultimately. and the franchisor. for damages. so security guards posted in the Holiday Inn parking lot required Rodeo Bar patrons to park in vacant lots that surrounded the hotel but were not owned by the hotel. and battery and assault charges. and often there were three or four fights a night. including several weapons charges. Issue: Are the franchisor and franchisee liable? . The Holiday Inn and Rodeo Bar did not have sufficient parking. These individuals exchanged remarks as they moved toward the respective vehicles in the vacant parking lots adjacent to the Holiday Inn. Rice died from his injuries. (Holiday Inns). Hospitality Venture. the two groups involved in the altercation did not leave the Rodeo Bar until closing time. Turner. The trial court found Hospitality Venture negligent for not providing sufficient security to prevent the foreseeable incident that took the life of Rice and injured Turner and Shelburne. Holiday Inns. the bar regularly admitted 270 to 300 people with 50 to 75 people waiting outside. and Robert Shelburne. is a franchisor that licenses franchisees to operate hotels using its trademarks and service marks. Shelburne Facts: Holiday Inns. Although the Rodeo Bar had a capacity of 240 people. Carter shot David Rice. Florida. During the course of physical combat. Two unarmed security guards were on duty on the night in question. Holiday Inns licensed Hospitality Venture to operate a franchised hotel in Fort Pierce. Rice’s heirs. which had a reputation as the “hottest bar in town. had been filed during the previous 18 months.Franchises and Special Forms of Business 505 The Court Speaks: Holiday Inns. Scott Turner. Hospitality Venture and Holiday Inns appealed.

A franchisor may be held liable for the tortious conduct of a franchisee that is the “apparent agent” of the franchisor. and not independently owned businesses. the court held that Holiday Inns led the public into believing that its franchisees were part of Holiday Inns’ system. Holiday Inns is vicariously liable for the tortious conduct of its franchisee. Reason: A franchisee is always liable for its own tortious conduct.506 Chapter 31 Decision: The franchisee was negligent. and the franchisee was the apparent agent of the franchisor. This occurs when the franchisor misleads the public into believing that the franchise is really owned and operated by the franchisor even though it is not. . Therefore. Here. The court held that Holiday Inns’ reservation system as well as the signs at the Fort Pierce franchise hotel gave this appearance to the public.

Franchises and Special Forms of Business 507 .

508 Chapter 31 Licensing Party that owns intellectual property Permits another to use In the distribution of goods. and digital information LICENSOR LICENSEE International Law: Pokemon Licensing Licensing was use because Nintendo had doubts about Pokemon and American children and wanted to limit risk. services. Joint Venture Combine to pursue single project or transaction 2 or more business entities JOINT VENTURERS (fiduciary duty of loyalty) equal rights to manage unless otherwise agreed . software.

International Law: International Franchising There is no question that international franchising has become the most visible form of economic cooperation around the world. be considered. Starbucks used joint ventures to enter foreign markets. however. In a joint venture corporation the joint venturers are shareholders of the joint venture corporation. Chinese hurdles as well as examples are also discussed. ..S.Franchises and Special Forms of Business 509 Strategic Alliance Strategic Alliance 2 or more companies / In same industry Agree to ally themselves To accomplish a designated objective Potential Competitors Note: In a joint venture partnership. International Law: Starbucks U. Laws of other countries must. Internet & Technology: Strategic Internet Alliances in China This discusses Internet alliances in the China market. each joint venturer is liable for the debts and obligations of the joint venture partnership.Chinese International Joint Venture Due to government restrictions in some countries and lack of expertise or cultural knowledge.

Lexis 2698 (Ill. Inc. the court held that the covenant not to compete was reasonable in scope (tax preparation). he was still bound by its terms. Inc. it is undisputed that the new franchise is located to the west of that boundary. The court of appeals remanded the case to the trial court for determination of the royalty damages to be awarded to Dowmont. . McDonald’s is not liable for breaching the franchise agreement with Libby-Broadway Drive-In.. Inc. McCart v. The Illinois Franchise Disclosure Act provides for a private cause of action to persons who have been harmed by a franchisor’s noncompliance with the act. The court held that My Pie had violated the Illinois Franchise Disclosure Act when it granted the franchise to Dowmont to operate the restaurant in Glen Ellyn. because My Pie had failed to register with the state of Illinois or to qualify for an exemption from registration. and affirmed the trial court’s grant of summary judgment in favor of McDonald’s. the court determined that although Robert had not signed the franchise agreement. wins on its counterclaim against My Pie International. 470 N. The court held that the covenant not to compete was an enforceable provision of the franchise agreement that had been entered into between the parties. and that customers were attracted to the franchise office because of the company’s name recognition and goodwill.App. Libby-Broadway Drive-In.510 Chapter 31 III. Inc. the franchisee.2d 1. 1984). (Libby).3. The court held that the McCarts had violated the covenant not to compete and issued an injunction enforcing provisions of the covenant. App. Illinois. 1984 Ind. which was heavily advertised nationally. McDonald’s System.E. The court found that the opening of the new office under Robert’s name was a mere subterfuge designed to avoid June’s obligations under the franchise agreement. 1979). The court held that McDonald’s had not breached the franchise agreement. The court held that June and Robert McCart had violated the covenant not to compete that was part of the franchise agreement with H & R Block. 1979 Ill. Franchise Agreement 31. The court held that My Pie’s violations of the act permitted Dowmont to rescind the franchise agreement and recover the royalties it had paid to My Pie during the course of the franchise.E. Dowmont.. the franchise agreement granted Libby an exclusive territory in which the westernmost boundary was simply described as “Turney Road. Block preserved the value of this property right to itself alone after termination of the agreement. the granting of this franchise did not infringe upon the exclusive territory granted to Libby in the franchise agreement. and had failed to provide proper disclosures to Dowmont as required by the act.2d 756. Lexis 3039 (Ind. 391 N.2. Inc. No. time (for two years after termination of the franchise). Therefore. Answers to Critical Thinking Cases Franchise Agreement 31. H&R Block. First.” The court held that even assuming by this description the parties intended that Libby’s exclusive territory should extend to the western edge of Turney Road. App. The court found that H & R Block had a valuable property right in its service mark. Second. When McDonald’s granted a franchise to a third party to operate a franchise restaurant on the west side of Turney Road. H & R Block wins. Franchisor Disclosure 31. The court reasoned that Robert had acted together with June to breach her agreement with Block and that he had knowingly participated in and aided June’s violation of the agreement. v. and place (250 miles from the location of the franchise).1.App. By including the covenant not to compete in its franchise agreements. (My Pie).

The court noted that a franchisor and a franchisee are two separate legal entities.5. or require its franchisee. and design” of the carton in which its product was to be marketed.4. . Lexis 2093 (Ga. 1979). With knowledge of its design. Note: A franchise is always liable for its own tortious acts. plus its specific consent to the use of the carton. Kosters v. McMullan v. the franchisor. v.000 in damages against Seven-Up.. in our view. alleging a violation of the federal law. that it could not be held liable for Koster’s injuries because it did not manufacture. Inc. provide for a private cause of action. A franchisee becomes an agent of the franchisor when the franchisor assumes the right to control the times and manner of executing the franchisee’s work.” The Company also assumed and exercised a degree of control over the “type. It further noted that a franchisor is not liable for the tortious conduct of a franchisee unless a principal/agent relationship has been established between the franchisor and the franchisee. Georgia Girl Fashions. management. as distinguished from the right merely to require results in conformity with the franchise agreement. style. Inc. causing the injury. App. size. and remanded the case for a new trial.2d 748. Georgia Girl Fashions. however. The FTC rules do not. (Georgia Girl). Lexis 16537 (7th Cir.E. 348 S. like a manufacturer or supplier. may be liable to the consumer for its own negligence. 1988). and found that no agency relationship existed between Georgia Girl and its franchisee. holding that a franchisor that retains the right to control the design of the product may be held liable for any injury that product may cause. App. causing blindness in one of Sharon Koster’s eyes. and control of the system for distributing 7-Up. the jury awarded her $150. The trial court jury held the Seven-Up Company liable for the carton breaking and the Seven-Up bottle exploding.2d 919. My Pie International. Tort Liability 31. Inc. No. Dowmont. The law provides that a franchisor.App. 687 F. the court of appeals found that the trial court judge had given the jury an improper instruction regarding the doctrine of “inherently dangerous” products. Inc. is not liable for the conduct of its franchisee who had accused and detained Melanie McMullan as a shoplifter. The court reviewed the franchise agreement and the circumstances of this case. however. the government could have sued My Pie.Franchises and Special Forms of Business 511 Note: If My Pie had violated the disclosure requirement of the Federal Trade Commission Disclosure Rules (FTC Rules). The court of appeals held that the case had been properly submitted to the jury based on the theory of breach of implied warranty. places the franchisor in the position of a supplier of the product for purposes of tort liability. Dowmont could not have sued My Pie to rescind the franchise agreement and recover damages under the FTC Rules. Inc. The court stated: In this case. The franchisor’s sponsorship. 1982). The carton was submitted to Seven-Up for inspection. handle. to use the cartons manufactured by Olinkraft. App. Lexis 15945 (6th Cir. 1986 Ga.S. Brooks. Tort Liability 31. the Seven-Up Company not only floated its franchisee and the bottles of its carbonated soft drink into the so-called “stream of commerce. Seven-Up alleged. Seven-Up Company. However. Therefore. Therefore. Seven-Up consented to the entry in commerce of the carton from which the bottle fell. she could recover tort damages from the franchisee..2d 347. The court rejected this argument. The court of appeals affirmed the trial court’s judgment in favor of Georgia Girl. 595 F. if the court held that the franchise in this case had wrongfully detained and falsely imprisoned McMullan. 1982 U.S. 1979 U.

The court of appeals affirmed the trial court’s judgment which awarded Ramada Inns $47. The franchise agreement granted Gadsden.S.2d 1562. Lexis 1442 (Ill. a license to use the “Ramada Inns” marks during the course of the franchise.2d 457. The only evidence of agency is the fact that the liquor license was issued to “Campbell Valerie Southland #13974. and the contract provided that the relationship was one of independent contractor. The court found that Kawasaki USA had wrongfully terminated the franchise held by Kawasaki Shop of Aurora (Dealer).E.A. and $20. Termination of a Franchise 31.” but this is simply an identification of the licensee as a franchisee of Southland. 1989 Ill.9. Kawasaki Motors Corporation. 1983. Evidence showed. v. the court found that Gadsden had engaged in trademark infringement in violation of the Lanham Act. 1986 U.S. 1977 U. $15. 804 F.7. when Ramada Inns properly terminated the franchise agreement with Gadsden on November 17.165 in trademark infringement damages. Suzuki. App. U. IV. and set their wages. KFC should win. Inc. 549 F. the court held that Kawasaki USA had wrongfully terminated the Dealer and awarded the Dealer $323. The court held that Gadsden Motel Company (Gadsden) had infringed on Ramada Inns’ trademarks and service marks by its unauthorized use of such marks. Trademark 31. App Lexis 34279 (11th Cir. Only Campbell managed the day-to-day activities of the store: she hired and fired employees. Campbell was not an agent of Southland. Thus. Answers to Business Ethics Cases 31. Kawasaki Shop of Aurora. 1989). Based on the evidence. 1986). Here. Diversified Container Corporation. The license was not issued to Campbell and Southland. Ramada Inns. Kawasaki was wrongfully using the site-control provision to violate the multiline dealership provision in the franchise agreement. Therefore. The court held that the site-control provision in the franchise agreement that required the franchisor’s written approval before the franchisee could relocate within its exclusive territory was an unreasonable restriction in violation of the law.6.512 Chapter 31 Trademark 31. v.App. The dealership wins. Inc. The court held that a multiline franchise dealership was expressly permitted by the franchise agreement. 1977). Gadsden Motel Company. However. however. Illinois franchise law provides that a franchise agreement may not impose “unreasonable” restrictions on motor vehicle dealers.8. the factfinder determined that there was no agency relationship and that finding is supported by substantial . The court cited evidence that Kawasaki USA had objected to the move because the dealer was creating a multiline franchise location from which it would sell Honda. $29. The issue of agency is a matter of fact.000 in attorney fees. that Gadsden continued to use the “Ramada Inns” marks for at least six months past that date. Gadsden lost the right to use the Ramada Inn trademarks and service marks. the franchisee. and Yamaha motorcycles as well as Kawasaki motorcycles.S.422 in attorney fees.690 as compensatory damages and $79.2d 368. Diversified infringed upon and tarnished KFC’s trademark Kentucky Fried Chicken Corporation v. App.000 for advertising to restore Ramada Inns’ good reputation. 544 N.. Ramada Inns wins.610 in lost franchise fees for the six-month “hold over” period. Lexis 14128 (5th Cir.

Dist. Supp. V. Here. App. 1985. Rptr. . Lexis 2070 (Cal. C. Citation. The desirability of the franchise depends on the quality of the product being sold. The circuit court reversed. 168 Cal. 455 N. Answer to “Briefing the Case” Writing Assignment: 1. Marion-Kay Company. 1985 Cal. Case Name. Wickham v. 1985 U. B. There was no genuine evidence of fact that an apparent agency existed. 31. The sidewalk was located on the premises of a franchisee that operated a Howard Johnson restaurant. In order to have an illegal tying agreement. 3. Court’s Reasoning The Court of Appeals of Michigan agreed with the original holding of the district court that the defendant was not liable because: A. Key Facts A. Plaintiff was injured in a fall on a sidewalk that she contends was not adequately cleared of ice and snow. the KFC Seasonings are so closely related to the franchise itself. App. 1985). The original ruling of the district court in favor of Howard Johnson was reinstated. Ind. 620 F. and Court Little v. that they cannot be considered two separate products. 1160. KFC’s franchise is a distribution type where the franchisees simply serve as a conduit through which the special chicken is sold. so there can be no tying. the franchisor. 825. KFC did not engage in an illegal tying agreement..W. KFC Corporation v. The trial court found in favor of Howard Johnson.S. 5. Inc. Issue Is Howard Johnson liable for the harm to the plaintiff under either a theory of direct liability and/or agency law? 4. 213 Cal. App. there must be two separate products. because it had no control over the property. The Southland Corporation.D. Howard Johnson had no agency-based liability because it had no actual day-to-day control over the premises in question B. C. 3d 49. Holding No. 2d 390 (1990) Court of Appeals of Michigan 2. Howard Johnson Co. Lexis 14766 (S.10.Franchises and Special Forms of Business 513 evidence.

Those rules are fairly and evenhandedly applied to the players. The rules of the game were fully explained to the players. which has already achieved the dubious distinction of being this country’s most costly financial debacle. With all these suppositions in place. The government does have a proper role and duty to support this financial infrastructure. no set of statutory protections can immunize a stock investor from the basic economic reality of stock investment—risk of loss.514 Chapter 32 Chapter 32 Investor Protection and Online Securities Transactions Why Do We Have To Protect The Market? I. That reality must always be kept in mind from the outset by anyone . This risk was there before the Great Depression. Teacher to Teacher Dialogue One of the most unfortunate aspects of our overly litigious society is the notion that the government must somehow “cover” every loss. c. your team was engaged in a fair contest? In the broadest sense. All the players were well trained. No government. and will be there no matter how many SECs we create. win or lose. Witness the current costs of the so-called S & L bailout. And all the fair rules in the world will not change one essential truth of these or any other contests—there will be winners and there will be losers. Nor can we afford to allow our financial institutions to lose their foundations of reliance and trust. these choices should bring a higher degree of awareness and risk. I do not mean to say that we should allow every innocent depositor to suffer the losses incurred by the managers of these institutions. no agency. But should the rules remain the same for stock investors as opposed to depositors? Many commentators argue that when investment choices are made. An even playing field is used as a site for the contest. Assume a sporting event were to be contested under the following conditions: a. Each participant goes into the game with his or her own self-interest in mind. It is risk that must be fully emphasized at the outset of these materials. can you rest assured your team will win? Or can you hope that. b. d. the buying and selling of securities is similar to an athletic event.

It is most difficult for professionals to master the ins and outs of the financial markets. II. a number of new white-collar crimes have been added to the government’s arsenal for dealing with abuses. Prior to that period. than ever. The great financial stock market crash of 1929 and the ensuing Depression brought on by that calamity brought to the fore the need to create a greater governmental role in securities markets. Manipulative and unscrupulous trading practices coupled with a lot of hopes and prayers all pointed to a need for a better set of ground rules by which this game could be played. Text Materials Purpose of Securities Laws Information Disclosure Prevention of Fraud SEC (Federal) .Investor Protection and Online Securities Transactions 515 seeking to make his or her fortune through the sale or purchase of securities. let alone the casual investor. That substance is public information upon which investment choices can be rationally made. The basic rules of the game go back to the Securities Act of 1933 and the Securities Exchange Act of 1934 that created the Securities and Exchange Commission. it has made the specialized practice of securities law or SEC accounting more difficult. yet more challenging. Over the years. Because of recent scandals in this sector of the economy. Securities law was designed to at least give some substance to those hopes and prayers. the Commission’s role has greatly increased with the advent of new technologies like programmed trading and the need to expand its regulatory framework into the financial services arena. and anyone who fails to appreciate that simple fact should not be there in the first place. All in all. These laws are not designed to assure a win in this high-risk game. but rather to provide a more even playing field. Yet the lure of playing this game is so strong that every year millions of people invest hard-earned money with nothing more than high hopes and a prayer. Risk is inherent in the nature of this activity. the sale of stocks in corporations remained essentially unregulated except for the common law doctrines of fraud and the like.

. The investing public is attracted by representations of investment income for both fixed and variable returns. or an individual. The SEC sued claiming the deal was never registered as a security and securities fraud. Reason: Investments come in many forms and a fixed return does not change its nature. The decision was reversed and the case remanded. Issue: Is the payphone sale-and-lease arrangement that guaranteed a fixed rate of return a security and therefore subject to federal securities laws? Decision/Remedy: Yes. an unincorporated association. The U. a general or limited partnership. To allow a different result would lead to evasion of the securities law by picking a fixed rate of return. a sale-and-lease arrangement and a guarantee that each payphone investor would receive $82 monthly on his or her investment. among other things. The packages included. The payments were never made due to lack of revenues and ETS defaulted and filed for bankruptcy. These were also pitched as low risk.S. Note: The Securities Act of 1933 The Securities Act of 1933 primarily regulates the issuance of securities by a corporation. Edwards The Facts: Edwards was CEO and sole shareholder of ETS which sold payphones via independent distributors. Court of Appeals reversed a district court ruling against Edwards claiming that the fixed rate of return was the issue.516 Chapter 32 The Supreme Court Speaks: SEC v.

Investor Protection and Online Securities Transactions 517 Terms: Issuer Seller Investment banker employed to sell Ethics Spotlight: “Plain English” Disclosure in Securities Offerings The Securities and Exchange Commission has adopted a “plain English” rule for securities offerings. Prospectus disclosure given to prospective purchasers .

Summ. Prospect. . Prospect Tombstone ads May close offers Final prospect Internet & Technology: Going Public over the Internet The SEC permits companies to issue securities over the Internet.518 Chapter 32 Limitations On Activities During The Registration Process Prefiling Period Waiting Period effective statement) (filing until Post Effective Period Issuer may not condition the market Selling campaign No Annual reports Yes Issuer may condition the market Offers Prelim.

.Investor Protection and Online Securities Transactions 519 Contemporary Issue: Small Corporate Offering Registration Form (SCOR) Question-and –answer disclosure form for small businesses is discussed.

520 Chapter 32 Small Offerings < $ 1 million Use SCOR Form .

Investor Protection and Online Securities Transactions 521 Contemporary Issue: .

a private insurance that is funded by annual assessments paid by securities firms. Small Offering Exemption < $1 Million 12 month No registration Contemporary Issue: Securities Investor Protection Corporation (SIPC) If a securities firm fails.522 Chapter 32 Private Placement Exemption Unlimited accredited investors 35 non accredited investors No registration v. the Securities Investor Protection Corporation insures the securities. .

The president and vice-president did not indicate they did not understand the registration statement. BarChris failed and filed for reorganization. There were. . Ethics Spotlight: Sarbanes-Oxley Act Erects a Wall Between Investment Bankers and Securities Analysts This discusses section 501 rules for separating investment banking and advice functions to try to avoid many conflicts of interests. There were enough danger signals to require some further investigation under GAAS that were not done. Issue: Are the defendants liable for violating Section11. The auditors did not establish the defense. The financial statements was audited by Peat. Reason: The CEO of BarChris knew all relevant facts. several material misrepresentations and omissions in the registration statement and prospectus. Marwick. Debentures were sold and a final prospectus was provided. The controller was familiar with the finances and books. or have they proved their due diligence defense? Decision: Due diligence offense was not established. BarChris Construction Corporation Facts: BarChris needed financing and issued debentures to investors. A registration with amendments and a prospectus was filed with the SEC. however.Investor Protection and Online Securities Transactions 523 The Court speaks: Escott v. Escott and others sued alleging violation of Section11 of the 1933 Act. BarChris defaulted on debenture payments. They did not prove due diligence defenses.

524 Chapter 32 .

Investor Protection and Online Securities Transactions 525 Note: Section 10b and Rule 10b5 require reliance by the injured party. .

Coates traded on inside information. 1963. Kline. O’Hagan lost. began purchasing call options for Pillsbury stock. Kline also traded on inside information. The material nonpublic information did not become public until 10:00 am on April 16. April 13. accepted stock options for TGS stock from TGS without informing the Stock Option Committee or the board of directors that he had material nonpublic information. 1964. 1964. in Canada. 1964. Coates had to wait. telephoned his broker with orders to buy TGS stock at midnight on April 15. (TGS) drilled an exploratory hole. On April 15. The SEC brought actions against several defendants for insider trading. in which they disclosed the richness of the Kidd 55 drilling. so Crawford intended to. Facts: On Nov. beat the public by trading on insider information.000 shares at $39 per share. In the meantime. However. No. and did. The district court found one individual liable and dismissed complaints as to the rest. a partner in the law firm of Dorsey & Whitney. . as to TGS. The Supreme Court Speaks: United States v. an employee. On Monday. Reason: (1) The court first held that the Kidd 55 discovery was material information. On Saturday. On April 16.526 Chapter 32 The Court Speaks: Securities and Exchange Commission v. it closed at $29 3/8. 12. 1964. directors. The SEC investigated. (5) The trial court did not determine whether TGS had issued a misleading press release on April 13. as to individuals. By May 15. an employee. and again at 8:30 am on April 16. Grand Metropolitan hired Dorsey and Whitney to represent it in a secret tender offer for stock of Pillsbury. Note: Misappropriation Theory usually involves an outsider misappropriating information in violation of a fiduciary duty. which was after the press conference. The appeals court could not definitely come to that conclusion either. and other employees of TGS bought stock during this period. Issue: Were the individuals guilty of insider trading? Was TGS itself guilty of issuing a misleading press release on April 13. and the Justice Department charged O’Hagan with criminally violating Section 10(b) and Rule 10b-5. two newspapers printed unauthorized reports of the TGS drilling. Assay reports indicated this sample to be remarkably high in certain metals. an employee. those shares went to $60. TGS did not own all the land surrounding Kidd 55. SEC appeals. (2) Crawford. so the issue was remanded back to the trial court to make that determination. Texas Gulf Sulphur Co. at least. (4) On Feb. placed his order to buy TGS stock at 10:20 am on the April 16. 1964. Issue: Can a defendant be criminally convicted of violating Section 10(b) and Rule 10b-5 based on misappropriation theory? Decision: Yes. the press conference was just the first step in the process of publicly disseminating this nonpublic information. TGS held a press conference that lasted for 10 minutes. (3) Coates. 1964. When the tender offer was publicly announced. Several officers. O’Hagan Facts: James O’Hagan. Eventually. 20. TGS stock was trading at $17 3/8. Hagan had purchased 5. Texas Gulf Sulphur Co. in violation of Section 10(b)? Decision: Yes. the stock was selling at $58 1/4. so it kept the results secret while it tried to purchase as much surrounding land as possible. TGS issued a press release that tended to downplay the find. Kidd 55. Each option gave O’Hagan the right to purchase 100 shares. In early November 1963. Thus. rumors of the rich strike surfaced. April 11. until the news could have reasonably been expected to appear on the Dow Jones broad tape. The court held that Kline had a duty to disclose this to the board. at 10:00 am.

Trading blackouts by Nvidia employees were imposed in other e-mail. Bhagat Facts: Nvidia entered into a contract with MICROSOFT FOR A 3-D graphics processor to be used by Microsoft in the “X-Box. Ethics Spotlight: Fair Disclosure to All Regulation FD prohibits companies from leaking important information to securities professionals before the information is disclosed to the public. came in mid-morning of the second day (e-mails on his computer) and within 20 minutes made his largest purchase of Nvidia stock in nearly 3 years. The Court speaks: USA v. There was evidence of an e-mail from Bhagat to Gill one day later with a link to an Internet article discussing Nvidia and the X-Box. Judgment was affirmed. a friend did the same less than 30 minutes later and 10 minutes before Bhagat said he read the e-mails. Bhagat was charged with insider trading and tipping. .Investor Protection and Online Securities Transactions 527 Reason: The misappropriation theory comports with Section 10(b)’s language. a Nvidia engineer. The next morning Nvidia’s VP sent an e-mail to keep the news quiet. The jury was asked to infer Bhagat’s actions 9no direct evidence) from circumstantial evidence. and it was property applied in this case. Reason: Evidence was sufficient to infer guilt from Bhagat’s actions on both counts as noted in the facts above. Gill. Bhagat appealed from a guilty finding. Bhagat.” The Nvidia president and CEO sent e-mails with an announcement of the deal to all employees. Issue: Is Bhagat guilty of insider trading and tipping? Decision: Yes.

528 Chapter 32 .

principal accounting officer. In SEC v.Investor Protection and Online Securities Transactions 529 SEC Section 16 Rules: 1) “Officer” includes president.S. W. principal financial officer. III. Supreme Court defined . Howey Co. (not non-policy deciding officers) 2) No liability for transactions within6 months before becoming an insider. Contemporary Issue: Commodities Regulation Commodities futures contracts. VP of business units or divisions. Yes. CEO. Answers to Critical Thinking Cases Definition of a Security 32. the U.. the Dare sales scheme is a security that should have been registered with the Securities and Exchange Commission (SEC). 3) 6 months rule for insider stays in effect. International Law: Chinese Bank Launches World’s Largest IPO This discusses how ICBC issued shares to the public in the world’s largest initial public offering. etc. commodities exchanges and CEA and CFTC are discussed.J.1.

Note: previous purchasers could sue to rescind the purchase agreement and recover the money they paid. 110 S.e. Securities and Exchange Commission v. 343 F. However. to qualify for the exemption. the notes are securities that are subject to federal securities laws. No. Thus.Ct. Ernst & Young. to be subject to federal securities laws in this case. The company met most of the requirements for an intrastate offering exemption.e. Here. There was obviously an investment of money in a common enterprise. Definition of a Security 32. Ernst & Young. 1972). The Court reasoned that the notes were securities because (1) the Co-Op sold them to raise capital. and others to attend the Adventure Meetings—primarily their profits came from the efforts of others. 343. Inc. the issue of securities by McDonald Investment Company (McDonald) does not qualify for the intrastate offering exemption from registration. 1973). McDonald Investment Company. from the efforts of the Dare people at the meetings to convince the attendees to sign up and pay money for one of the Adventure levels. thus subjecting the Co-Op’s auditor. Glenn W. and (4) there was no risk-reducing factor that would make the application of the Securities Acts unnecessary. Note: Investors who purchased the securities could also rescind their purchase agreement. The court held that the Dare multilevel sales scheme was an “investment contract” and therefore a security that had to be registered with the SEC before it was sold. to a securities lawsuit. Reeves v.S.S. The U.2d 476.2. Because of this fact. the instrument at issue must be found to be a security. 474 F. The court applied the Howey test in the instant case and held that the Dare multilevel sales scheme was an investment contract. Lexis 1051 (1990). (3) the public reasonably perceived from advertisements for the sale of the notes that they were investments.3. and (4) the purchasers of the securities were all residents of the state. Intrastate Offering Exemption 32. (2) its principal place of business was in Minnesota. Lexis 13547 (D.S. The court held that Turner had sold unregistered securities in violation of securities laws and granted an injunction against Turner from selling any more Dare plans. Supreme Court found the note issued by the Co-Op to be a security. i. Dist. such as (1) the company was a resident of Minnesota. the Court held that the transaction did not qualify for an intrastate offering exemption from registration and issued an injunction prohibiting the continued sale of the securities..” In order for the defendant. The only difficult issue was whether the Dare plan derived profits for the investors from the efforts of others. The court held although investors must exert some effort—mainly convincing friends.. (3) it was doing business in Minnesota with over 80 percent of its assets located in the state and over 80 percent of its revenues derived from within the state. The court held that the word “solely” should not be read literally. (2) there was common trading in the notes. . at least 80 percent of the proceeds from the offering must be invested in the state. Turner Enterprises. Lexis 11903 (9th Cir. 1990 U. neighbors. Ernst & Young. 495 U.Minn. The notes issued by the Co-Op are “securities.Supp.S.S. it was incorporated in Minnesota. 945. 1972 U. i. Securities and Exchange Commission v. the entire proceeds from the securities issue were invested in loans on real estate and other assets located outside the state of Minnesota.530 Chapter 32 an “investment contract” as a scheme that involves (1) an investment of money (2) in a common enterprise (3) with the profits to come solely from the efforts of others. 56.. The Supreme Court stated that this definition should be broadly and flexibility construed. The Supreme Court applied a “family resemblance test” in finding the note a security. 1973 U.

S. We hold that a duty to disclose under Section 10(b) does not arise from the mere possession of nonpublic market information. The Supreme Court held that Chiarella did not owe a fiduciary duty to the target companies of whose shares he purchased. The element required making silence fraudulent—a duty to disclose—is absent in this case. 1968 U. The Supreme Court held that this duty only arises if the person owes a fiduciary duty to the company in whose shares he has traded. obviously. The court stated: Not every instance of financial unfairness constitutes fraudulent activity under Section 10(b). Supreme Court reversed the trial court’s judgment that had convicted Chiarella on all counts. He was its largest shareholder. United States v. he was not a fiduciary. holding that a person is not liable for insider trading under Section 10(b) unless he owes a duty to disclose the information.2d 779. 445 U. The court found that the defendants had tried to conceal the sale of the securities by selling them over an 18-month period through many different brokers. The U. The court held that these sales constituted a major “distribution” of Continental securities that should have been registered with the Securities Exchange Commission if the sales did not qualify for an exemption from registration.S. a complete stranger who dealt with the sellers only through impersonal market transactions. The plaintiff investors win and may sue the defendants for the alleged violations of Section 10(b) of the Securities Exchange Act of 1934. and that they had violated Section 5 of the Securities Act of 1933 because they had not registered the securities. Lexis 4342 (2nd Cir.6.” The Court held that an issuer includes any person who directly or indirectly controls the issuer. The court held that the securities sales did not qualify as a sale “not by an issuer” because Wolfson had been found to have been in control of the issuer of the securities— Continental. the sale of the Continental securities by Wolfson and his family and associates does not qualify for an exemption from registration as a sale “not by an issuer. Lexis 88 (1980). 222.4. The defendants had asserted that the common-law defense of in pari delicto (“unclean hands”) prohibited the plaintiffs from suing because they had . in fact. 1980 U.S. 100 S. Chiarella v. He was not their agent. No. The court held that Wolfson and his family and associates should have registered the securities with the SEC. App. Note: On the witness stand.5. underwriter. made the policy decisions for the corporation. 1108. and controlled and directed the company’s officers. 1968). or dealer. the defendants took the position that they operated at a level of corporate finance far above such “details” as securities laws and were too busy with “large affairs” as to bother themselves with such minor matters as securities laws. The U. Supreme Court reversed Chiarella’s conviction. The Court of Appeals affirmed the conviction by holding that anyone— an insider or not—who receives material nonpublic information may not use that information to trade in securities until the information is made public. Wolfson. The U. He was. No duty could arise from Chiarella’s relationship with the sellers of the target company’s securities for Chiarella had no prior dealings with them.Investor Protection and Online Securities Transactions 531 Transaction Exemption 32.S. Wolfson controlled Continental. Section 10(b) 32.S. rejected this defense. and he was not a person in whom the sellers had placed their trust and confidence. The court. 405 F. Insider Trading 32.Ct.S. In this case. No. Supreme Court rejected this rule. Chiarella is not criminally liable for violating Section 10(b) of the Securities Exchange Act of 1934. United States.

Hill Richards. The Supreme Court stated: “We conclude that the public interest will most frequently be advanced if defrauded tippees are permitted to bring suit and to expose illegal practices by corporate insiders and broker dealers to full public view for appropriate sanctions..350 from Hoodes—the difference between the price he sold the original 6. To qualify for a private placement offering. Lexis 95 (1985). 105 S. Hoodes. The court held that the Section 16(b) rule applied whenever the defendant held his position at the time of the initial transaction that gave rise to his liability. v. Insider Trading 32. 299. 672 F. Sullair Corporation v. Inc. was a statutory insider for purposes of Section 16(b).S.Ct. The court held that the corporation could recover $11. and (3) disclosure of material financial and other information must be made to the investors.000 shares for on July 20. (2) there is no limit on the number of accredited investors. may recover the profits made by Hoodes on the sale and purchase of the securities of Sullair securities. under Section 16(b) of the Securities Exchange Act of 1934. 1982 ($27.Supp.000). Berner. . 1982 ($38.S.D. Under the in pari delicto theory.S. 337. but there is a limit of 35 unaccredited investors. In applying these requirements to the instant case. 472 U. (2) the investors were not given material financial and other information about Intertie or its financial difficulties: (3) the investors were not informed that the limited partnerships could not support themselves or that partnership funds were being commingled. the court held that (1) Intertie had not kept track of the qualifications or the number of unaccredited investors. The court found that the two transactions—the sale of securities by Hoodes on July 20 and the purchase of securities on August 20—had occurred within six months of each other and were covered by Section 16(b). the plaintiffs in this case who had participated in the insider-trading scheme with the defendants could sue the defendants for disclosing false inside information to them. Supreme Court held that the in pari delicto theory does not apply to actions brought for alleged violations of securities laws.Ill. The court held that Section 16(b) is a “flat rule” which imposes strict liability for profits earned by any officer or director or 10 percent shareholder who purchases and sells or sells and purchases equity securities of his corporation within a period of less than six months.000 shares he purchased on August 20. i. Dist. if two parties to illegal conduct are mutually or equally at fault. The U. they cannot use the court system to sue the other party to the illegal conduct. each of the limited partnership offerings does not alone qualify for a private placement offering exemption from registration.7. 1987 U. The court held that each limited partnership did not on its own qualify for a private placement exemption because there were too many unaccredited investors and the investors were not provided with adequate disclosure of material information.” The court held that the in pari delicto theory did not apply to suits alleging violations of Section 10(b) and that the plaintiffs could maintain their lawsuit against the defendants. and (4) the investors were not informed that Intertie and the limited partnerships was a pyramid or “Ponzi” scheme whereby the funds raised in later partnership offerings were used to support earlier partnerships. 2622.350) and the fair market value of the 6. who was an officer of Sullair. The court found that Hoodes. the plaintiffs thought they were trading on “inside information” when they purchased the TONM securities. IV: Answers to Ethics Questions 32. Bateman Eichler. The Sullair Corporation (Sullair) wins and. The issue in the instant case is whether the in pari delicto theory should be applied to securities laws.532 Chapter 32 participated in the fraud with the defendants. Thus. 1987).8. No. the following requirements must be met: (1) there is no dollar limit on the amount of securities sold.S. 1985 U. Lexis 10152 (N.e.

Gilbertson 111 S. B. & Petigrow v. Carpenter. They all conspire to violate the securities laws. et al. and Court Lampf. and the proceeds are used for the same purpose. the court integrated all of the thirty limited partnership offerings into one offering. et al. Murphy. 5. The court held that this one integrated offering did not qualify for a private placement exemption from registration because there were too many unaccredited investors and material financial and other information was not disclosed to the investors. 19. 316. Lexis 4815 (1987)]. The 1934 Act calls for a 1-year period after discovery combined with a 3-year period of repose. Securities and Exchange Commission v. Citation. had been advised by Lampf.9. (a law firm) regarding the tax benefits of certain partnerships regarding computer hardware and software. 115 L. D.2d 321 (1991) United States Supreme Court 2. App. 1980).Ct. 2773. Court’s Reasoning A. 626 F. Holding A uniform federal statute of limitations must be applied. 1980 U. Separate securities offerings will be integrated if they are made about the same time. Winans breached a fiduciary duty and acted unethically. [United States v. Based on that interpretation. 484 U.Ed. however. Criminal liability should not be a question. 3. V. involve the same class of securities.Ct. Lipkind. Here. Gilbertson. Pleva. 108 S.Investor Protection and Online Securities Transactions 533 Integration: In addition. C. the action sought by Gilbertson was not filed in a timely manner and dismissal of the original complaint by the district court was correct. 1987 U. The lower court dismissed Gilbertson’s complaint on the grounds that it was not filed in a timely manner. The court issued an injunction against Murphy. Key Facts A. Issue Where there is a difference of opinion about the statute of limitations period for filing of a complaint under the Securities Act of 1934. B. Prupis. are sold for the same consideration. Lexis 15483 (9th Cir. 32. while not acting in a manner popular to his co-conspirators did fulfill his ethical duty even though his motives may be questionable.S. These partnerships filed and the IRS disallowed their claimed tax benefits.S.2d 633. Brant. . 10(b) of the 1934 Securities Exchange Act and Rule 10b-5. can the Supreme Court impose a uniform interpretation? 4. Case Name. Gilsbertson filed a complaint against Lampf alleging that Lampf’s actions violated Sec. Answer to “Briefing the Case” Writing Assignment: 1.S. the court found the existence of sufficient factors to integrate the offerings.

and economic literature that can be plowed into this subject.534 Chapter 33 Chapter 33 Antitrust Law Why Should Competition Be Protected? I. not been consistently used. These objectives are set out in Sections 1 and 2 of the Act.e. For example. in turn. i. By the time the trust was “busted” in 1911. the Sherman Antitrust Act. two main classifications of offenses have evolved. These entities would band together into a form of common trust ownership. The act has two main objectives: (1) To prevent combinations in trust or otherwise. which act in restraint of trade. As seen in other chapters. This entire body of law arose out of a need to stem and reverse some of the abuses of the “Robber Baron” era. there is a wealth of political. however. illegal joining together to restrain trade. today’s use of trusts centers on the need to hold property for the benefit of others. The Per Se Rule is used to strike down restraints that courts deem to be so inherently anticompetitive that they cannot be allowed as a matter of law. over thirty companies were ordered separated from the parent firm. Teacher to Teacher Dialogue Antitrust law lends itself to broad overviews of political and economic history. The federal courts have taken a middle road. In the late 1800s.e. in turn.. Probably the best known of these trusts was Standard Oil. Under their rules of interpretation. and whiskey were all dominated by such trusts. i. Most people do not think of the trust device as a business tool. was able to control the prices and territories of distribution of the product.. and have the time. What is interesting about this Act is that Congress used very broad language to give the Justice Department maximum latitude in seeking enforcement of its provisions. This latitude has. (2) To control markets thought to have a monopoly. cotton. sociological.S. In another era. prior to the enactment of antitrust laws. This sort of monopolization of the marketplace led to the landmark antitrust legislation in 1890. industries like oil. . There appears to have been a constant shift in the enforcement strategies used by various administrations over the years. the business trust was notoriously used as a device to eliminate competition and control markets. sugar. The trustee. illegal domination so strong as to ipso facto restrain trade. In 1890 the Standard Oil Trust controlled over 90 percent of the market for oil products in the U. For those of us who enjoy such exercises. it was common to have key commodities and the industries related to those products controlled by large corporate enterprises.

As compared to the almost philosophical tenor of Sections 1 and 2 of the Sherman Act. So government finds itself in a dilemma. These changes have provided the philosophical underpinnings for the much more tolerant view taken by the government toward mergers. and the like. is the government’s commitment to enforcement combined with some very problematic aspects of the statutes themselves. Many critics of the Act have argued that while provisions like price discrimination look good in theory. The reason these particular measures have failed to live up to their billing is that some price volume cuts. incentives. On the issue of governmental level of commitment to enforcement. In many ways the market factors that were sought to be protected in the early part of the twentieth century are different as we enter the twenty-first century. A free and open market is not measured now on regional or even national scales. combinations. The Sherman Act sets the basic goals and objectives of keeping marketplaces open to competition. Text Materials . there is no question that things have changed in the global scheme of economic competition. it may give noncompetitive parties an unwarranted wedge against more efficient competitors by way of officious intermeddling on the part of government. Yet the basic economic principles of monopolization. and more particularly. and unfair trade practices have not changed. they are difficulty to enforce. On the other hand. and the like are all part of the competitive edge that all players are constantly looking for. speak to much more specific objectives. The Clayton Act and the Federal Trade Commission Act are designed to provide tools of implementation to those basic public policy objectives. To deny the reality of those competitive needs not only frustrates real competition. the Clayton Act. restraint of trade. The second factor involves questions that have been raised about the economic sense of the Clayton Act itself. it has proven to be only a partial remedy. The biggest problem with the Clayton Act. The objectives arose out of discriminatory practices aimed at getting the little guy. and to a lesser extent with the FTC.Antitrust Law 535 regardless of any claimed justifications. the Robinson-Patman Amendment to it. acquisitions. II. It is trying to recognize the need to allow our economy to stay competitive in the worldwide playing field. but rather on worldwide competitive position. As strong and powerful a tool in the fight against monopolization and restraints of trade as the Sherman Act is. yet it must continue to keep the game rules fair. the Rule of Reason has given courts latitude to accept restraints of trade on a case-by-case basis where legitimate concerns are overriding.

536 Chapter 33 .

Antitrust Law 537 1) Price Fixing per se 2) Division of markets per se .

they tried to get the fees increased. The horizontal agreement was a per se violation of Section 1 of the Sherman Act. The order was vacated by the U. Facts: HBJ offered a GA bar review course. No matter how good the motives. They agreed to give BRG the exclusive license to market HBJ materials in GA in exchange for paying HBJ $100 for every student enrolled by BRG in the course. . The price of BRG’s course immediately jumped from $150 to $400. Failing this they refused to new assignments which severely hampered the system. Issue: Did the agreement constitute a division of markets and a per se violation of Section 1 of the Sherman Act? Decision: Yes. HBJ also agreed not to compete with HBJ outside of GA. The district court found no division of markets and this was affirmed by the court of appeals. They are paid according to the CJA fee schedule and many are regulars earning most of their income from these cases.S. Its only major competitor in GA was BRG. Through the SCTLA. Reason: The purpose of the agreement was to raise prices as seen in the revenue-sharing formula and the quick price increase. Palmer and other law school graduates sued alleging violation of Section 1 of the Sherman Act. The judgment was reversed and the case was remanded. Issue: Did the actions of the SCTLA constitute price-fixing? Decision: Yes. Palmer appealed.S. a professional organization. The FTC filed a complaint alleging price-fixing and the finding was against the SCTLA. Superior Court Trial Lawyers Association Facts: In DC. The judgment was reversed and the case was remanded. This constriction of supply is the essence of price-fixing. They basically split the U.538 Chapter 33 The Supreme Court speaks: FTC v. BRG of GA. Inc. the objective is to fix prices and that is “per se” wrong. court of appeals and the FTC appealed. market by agreement. Reason: The agreement was designed to obtain higher prices by refusing to serve the customers. lawyers in private practice are appointed to defend certain indigent defendants. The Supreme Court speaks: Palmer v. This is anticompetitive and unlawful on its face.

Antitrust Law 539 The Supreme Court speaks: NYNEX Corp. This was not a violation. Most group boycotts are per se . Material did this through Discon an independent company. Facts: NYNEX owns NY Telephone (NYT) and Material (purchases services for removing old NYT equipment). the administrators of eight Ivy League schools traded information about applicants seeking scholarships. Material eventually did not renew Discon’s contract and hired AT&T instead. v. Ethics Spotlight: Justice Department Flunks the Ivy League Schools For years. The Justice Department alleged that these schools had conspired and engaged in a horizontal restraint of trade in violation of Section 1 of the Sherman Act. Discon. Discon appealed. Reason: A single buyer’s decision to purchase from a different supplier was not a horizontal agreement among direct competitors necessary for a per se violation. Discon sued alleging an illegal group boycott against Discon. Inc. Issue: Did the defendants’ conduct amount to a horizontal agreement necessary for a per se violation of Section 1 of the Sherman Act? Decision: No. The court of appeals affirmed the district court’s dismissal of the complaint.

combination.540 Chapter 33 Two or more parties on different levels of distribution enter into a contract. or conspiracy to restrain trade .

and may in fact have procompetitive interbrand (i.S. “There is insufficient economic justification for per se invalidation of vertical maximum price fixing. with competing companies) effects that helps rather than harms consumers.e.. alleging that the maximum resale price required by State Oil was a per se violation of Section 1 of the Sherman Act. and then lost the station back to State Oil for falling behind in lease payments.. Issue: Is the establishment of a maximum resale price by a supplier a per se violation of Section 1 of the Sherman Act? Decision: No. Supreme Court held that the setting of a maximum resale price by a supplier is not a per se violation of Section 1 of the Sherman Act. however..” The Supreme Court announced that the Rule of Reason—a balancing of pro.S. but if the price charged was higher than State Oil’s “suggested retail price. The Court acknowledged that this was still a valid decision.S. Khan sued State Oil. The current Supreme Court. Herald Co. 373 (1911)—that the setting of minimum resale prices was a per se violation of Section 1 of the Sherman Act. Reason: The Supreme Court noted that the Court held. Khan and his corporation entered into an agreement with State Oil Company to lease and operate a gas station and convenience store owned by State Oil. v. Khan operated the station under these terms for about one year. In the instant case. The court concluded. in a previous decision—Dr.Antitrust Law 541 The Supreme Court Speaks: State Oil Company v. the Court noted that a previous Supreme Court had previously—in Albrecht v. . The district court entered summary judgment for State Oil. Khan could sell gasoline for less than State Oil’s suggest retail price. 220 U. The agreement provided that Khan would obtain his station’s gasoline supply from State Oil. 145 (1968)—held that the setting of maximum resale prices also was a per se violation of Section 1. Miles Medical Co.” then the excess was to be rebated to State Oil. in the instant case. The court of appeals reversed and held that the maximum resale price set by State Oil was a per se violation of Section 1. Park & Sons Co. Khan Facts: Barkat U. John D. The agreement also provided that Khan could charge any price for the gasoline he sold to the station’s customers. the Supreme Court reversed Albrecht. The U. Supreme Court. decided to reverse the Albrecht decision and held that the setting of maximum resale prices is no longer a per se violation of Section 1. However. 390 U.S. The Court cited substantial criticism of the Albrecht decision by economic and legal scholars who argued that the setting of maximum resale prices by a supplier does not have the same anticompetitive effects as the setting of minimum resale prices. State Oil appealed to the U.and anticompetitive effects—would now be used to examine the lawfulness of maximum vertical price fixing.

ILEC’s and CLECs battled over which network elements the ILECs had to share with the CLECs. ILECs chose not to compete as a CLEC in other ILECs’ territory. however. thus causing inflated charges for local telephone and high speed Internet services and constituting a illegal conspiracy in violation of Section 1 of the Sherman Act. The Supreme Court speaks: Bell Atlantic v. Contemporary Issue: How Trade Association Members Can Avoid Antitrust Liability This suggests activities to avoid if you want to avoid antitrust liability.542 Chapter 33 Minimum resale price fixing would still be per se illegal. Twombly sued (a class action suit) Bell Atlantic and other ILECs alleging parallel conduct that inhibited the growth of new CLECs. CLECs 9local carriers0 developed which purchased wholesale services from ILECs and sold them to competitors of ILEC”s. The complaint was dismissed by . The Supreme Court remanded the current case for trial using the new Rule of Reason standard. Twombly Facts: Bell Atlantic split into regional service monopolies (ILECs) who were ordered by law to share networks and lines with competitors.

. Ethics Spotlight: Trade Association Activities Attendees at trade association meetings should avoid sharing and discussing certain information with each other.Antitrust Law 543 the district court which held that the allegations of conscious parallelism was not a conspiracy. The judgment was reversed and the complaint dismissed with the case remanded. There was no way to infer such an agreement to support illegal conduct. The court of appeals reversed and the defendants appealed. Issue: Can a Sherman Act Section 1 complaint survive a motion to dismiss when it alleges that major telecommunications providers engaged in parallel conduct unfavorable to competition? Decision: No. Reason: Conscious parallelism is not in itself unlawful only if it were part of some type of agreement. Parallel steps are not an agreement.

The verdict was affirmed and this appeal ensued. Issue: Is Weyerhaeuser liable for buy-side predatory bidding that constitutes monopolization in violation of Section 2 of the Sherman Act? Decision: No. Ross-Simmons (RS) began operating a sawmill and between 1998 and 2001 watched prices for the logs go up while lumber prices fell. RS blamed Weyerhaeuser for bidding up costs of the logs and sued alleging predatory bidding amounting to monopolization in violation of Section2 of the Sherman Act. Due to heavy losses.. 2001. they can restrict input purchase reducing the unit price for remaining input purchases with the hope of reaping monopsonistic . By eliminating competition. Ross-Simmons Hardware Lumber Co. From a verdict (26 trebled) of $79 million. Reason: Typically a predatory-pricing scheme involves dropping sales price to below cost helping to drive out competition so that prices can then be raised which will allow profits and initial recouping of the losses. Weyerhaeuser appealed. They buy older sawlogs that are processed at its mills which are state-of-the-art. The judgment vacated and the case remanded. Inc. RS shut down in May. The logs total 75% of their costs. Facts: Weyerhaeuser who had purchased a lumber company and operates 6 mills and purchased 65% of the region’s logs Produces hardwood lumber.544 Chapter 33 The Supreme Court speaks: Weyerhaeuser v.

com/cheeseman .prenhall. Proof must be shown of a high probability of recouping losses incurred to bid up input prices. Check the web site for at www.S. Much of this dealt with its methods to have Explorer used as the web browser by other companies. Internet & Technology: U.Antitrust Law 545 profits. The Court of Appeals upheld an order finding that Microsoft had engaged in monopolization by getting involved in predatory and anticompetitive conduct. There are more developments in this case. Microsoft Corporation This discusses the government case against Microsoft. v. This was not shown by RS.

was the largest merger in history. . at the time.546 Chapter 33 Internet & Technology: AOL Acquires Time Warner in Megamerger This discusses what.

Antitrust Law 547 .

548 Chapter 33 Mergers Horizontal Vertical Market extension Similar field with no overlapping sales Conglomerate Competitors Customersupplier Unrelated businesses Premerger Notification Rule FTC FTC Act No unfair competition and no unfair and deceptive acts and practices .

Antitrust Law 549 .

550 Chapter 33 .

Antitrust Law 551 .

e. engaged in price fixing in violation of Section 1 of the Sherman Act. Answers to Critical Thinking Cases Price Fixing 33. The defendants argued that Section 1 only prohibited the fixing of minimum prices and did not prohibit the fixing of maximum prices. The Supreme Court held that price fixing is a per se violation of Section 1 of the Sherman Act. as set by the doctors in this case. The Supreme Court rejected this argument.S..1. and its members. Foundation. The U. i. The court reaffirmed that all . III. once price fixing is found. holding that the setting of a maximum price is really the setting of a minimum price if all doctors agreed to charge the maximum price. The State of Arizona wins. Supreme Court held that the defendants. the Medical Society. no defenses may be raised to try to justify the price fixing.552 Chapter 33 Examples: Statutory unions. utilities Implied baseball Others non-statutory labor exemption collective bargaining Classic Case: Baseball’s Grand Slam Against Antitrust Laws This discusses the case where baseball’s activities were said not to be in interstate commerce.

S. The U. such as setting published quality control standards that must be met by all manufacturers of Mercedes-Benz replacement parts. 332. The United States wins. 1982 U. they engaged in a geographical division of markets.S. the court held that the tying arrangement in this case was an unreasonable restraint of trade that violated Section 1 of the Sherman Act.S. Union Oil had set the price at which Simpson and other franchised service station dealers could sell Union Oil gasoline and other products. The court held that Mercedes-Benz of North America (MBNA) engaged in an illegal tying arrangement when it required its franchised dealers to purchase their replacement parts for Mercedes-Benz automobiles from MBNA. 828 F. In this case. 1972 U. Applying the rule of reason. The court stated that after considerable experience in examining these types of relationships. it found that division of markets stifled competition.S. Lexis 5 (1982).S. The court held that when the Topco members agreed to divide the country into exclusive geographical markets and not sell Topco products in other members’ territories. United States v. which in this case constituted unreasonable restraint of trade in violation of Section 1 of the Sherman Act.S. the Supreme Court refused to consider evidence of the procompetitive effects alleged by the doctors to justify their price fixing. the court held that the Mercedes-Benz franchise granted by MBNA to dealers was the tying product and the replacement parts it required the dealers to purchase were the tied products.Ct. The court concluded that the anticompetitive aspects outweighed the procompetitive aspects. Mercedes-Benz of North America. Maricopa County Medical Society. The Supreme Court held that the doctors’ price fixing was a per se unreasonable restraint of trade that violated Section 1 of the Sherman Act.. 1987). Resale price maintenance occurs when a manufacturer or distributor sets the price at which retailers may sell products to consumers. whether the setting of minimum or maximum prices. Metrix Warehouse. Inc. Resale Price Maintenance 33. in this case the court did not find the tie to rise to this level of unlawfulness. 596. and not the rule of reason.Antitrust Law 553 price fixing. 1126. App. wins. applies to horizontal division of markets. The U. Supreme Court held that Topco and its members engaged in illegal geographical division of markets which constituted a per se violation of Section 1 of the Sherman Act. The Supreme Court held that the per se rule. 457 U. Simpson. Division of Markets 33. Instead. . Therefore.Ct.S. 405 U. is judged by the per se rule and not the rule of reason. Lexis 67 (1972). In this case. Metrix Warehouse v. the franchised dealer. (Metrix) wins. Although some tying arrangements are considered so anticompetitive as to be per se illegal. Topco Association. A tying arrangement occurs when a seller refuses to sell one product or service (the tying item) unless the customer purchases another product or service (the tied item). Lexis 12341 (4th Cir. The Supreme Court held that the Topco members’ geographical division of markets was an unreasonable restraint of trade and a per se violation of Section 1 of the Sherman Act. 102 S. The court rejected MBNA’s claims that the tie was necessary as a device to regulate quality control.2d 1033. Supreme Court held that Union Oil Company (Union Oil) had engaged in resale price maintenance. the court applied the rule of reason and examined the procompetitive and anticompetitive nature of the tying arrangement. 92 S.3.2.4.. Inc. Union Oil terminated Simpson when he sold gasoline to the public at less than the retail price set by Union Oil. Tying Arrangement 33. 1987 U. 2466. Inc. Arizona v. The court found that there were less anticompetitive methods for assuring quality control.

Although the presumption of illegality is rebuttable. 104 S. The merger of Lipton--the second largest competitor with 32 percent market. Supreme Court in Philadelphia National Bank. it could not abruptly reduce the discounts without causing anticompetitive effects.S. Based upon the alleged deliberate acquisition of monopoly power in the herbal tea market. Greyhound v. their proposed merger would be a horizontal merger. The court rejected IBM’s assertion that the relevant market was the sale and leasing of computers. the court held that Greyhound had suffered antitrust injury because of IBM’s actions.S. Monopolization 33. Merger 33. A horizontal merger occurs when two or more firms in the same line of commerce (product market) serving the same section of the country (geographical market) merge. the court defined the relevant section of the country to be the nation and the relevant product market to be the leasing of computers. Supreme Court held that the resale price maintenance. The court reasoned that although IBM was under no duty to originally offer substantial discounts on its computers. 752. In Monsanto Company v. would only have a 13 percent market share.S.S. Lexis 2378 (1964). Since both firms were in the same line of commerce and served the same section of the country. (Greyhound) wins. the court found that there may be a substantial lessening of competition in that market if the merger were consummated. as well as the Justice Department Merger Guidelines computed by using the Herfindhal index. the court found that IBM. the largest competitor with 52 percent market share. by reducing the discounts at which it sold computers to leasing companies with the stated reason of increasing its market share of the leasing market engaged in an act of monopolization. and Celestial Seasonings. The next largest competitor. plaintiff Bigelow. 1051. the resulting firm would control 84 percent of the national market for herbal teas. possessed the requisite monopoly power in the relevant market.S. The court ordered that the proposed horizontal merger between Lipton and Celestial Seasonings be . The size of the resulting firm and increase in concentration that it would cause would violate the “presumptive illegality” test announced by the U.2d 488. International Business Machines Corporation. The proposed merger between Lipton Tea Co. in this case was coercively applied by Union Oil and constituted a per se violation of Section 1 of the Sherman Act.6. Second. The remaining 3 percent of the market was comprised of “trace” competitors.S. 1977). App.554 Chapter 33 The U. Lexis 11957 (9th Cir. would create a merged firm that would have “monopoly power” over the marketplace. once it did. the U. The court held that IBM had engaged in the act of monopolization that violated Section 2 of the Sherman Act. Third. the court held that it is unlikely to be rebutted in this case because of the market shares controlled by Lipton and Celestial Seasonings and the monopoly power that would result from their proposed merger. 84 S. the court held that IBM had engaged in the willful organization and maintenance of monopoly power in violation of Section 2 of Sherman Act. Note: Not all vertical price fixing constitutes a per se violation of Section 1 of the Sherman Act. Spray-Rite Service Corporation. which controlled approximately 80 percent of the leasing market for computers. The court found that IBM. (Lipton) and Celestial Seasonings would be a horizontal merger. Simpson v. Union Oil Company.Ct. 1464 79 L. First. 465 U. Fourth.S.5. resale price maintenance is to be examined using the rule of reason.Ed. the relevant “section of the country” was the nation. Inc. 1964 U. Supreme Court held that in less egregious and coercive situations.2d 775 (1984). 377 U. If Lipton and Celestial Seasonings were to merge.Ct. or vertical price fixing. 559 F. 1977 U. 13. Greyhound Computer Corporation. The relevant “line of commerce” in this case was the production and distribution of herbal teas nationally.

Pueblo Bowl-O-Mat. Evidence showed that this difference in price was important enough to cause several manufacturers of low-priced candy to move their plants to the Chicago area to avoid having to pay the phantom freight charge. Lexis 2749 (1945). The “phantom freight” paid by nonfavored buyers not located in the favored zone caused them to pay a higher price for glucose than did the favored buyers located in the favored price zone. Corn Products engaged in price discrimination in violation of Section 2(a) of the Robinson. The Supreme Court held that Corn Products had engaged in “indirect” price discrimination in violation of Section 2(a) of the Robinson-Patman Act. This pricing scheme created a favorable zone around Chicago and vicinity. The Supreme Court reversed the judgment of the trial court that had awarded Pueblo Bowl $7 million in damages and $446. Antitrust Injury 33. 477. Federal Trade Commission.S. 65 S. instead. Bigelow. Unilever.S.Ct. 1977 U. constituted indirect price discrimination. were enacted for the protection of competition.S. 726. Lexis 37 (1977). the plaintiff must have suffered an “antitrust injury. not competitors. 690. The Supreme Court stated: At base. The court found that Pueblo Bowl had not suffered antitrust injury from Brunswick’s repossession and operation of bowling centers. the court stated that this is not the type of injury that the antitrust laws were designed to prohibit. Brunswick is not liable to Pueblo Bowl for violating Section 7 of the Clayton Act. 97 S.C. The U.2d 102. Price Discrimination 33.7. Lexis 574 (2nd Cir. 1945 U. App. Supreme Court held that in order for a defendant to be liable under Section 7. 324 U. the court found that Pueblo Bowl had only suffered damages that would have resulted if any party had continued to operate the bowling centers in competition with Pueblo Bowl.Ct. and upheld the trial court’s judgment against Corn Products. It is inimical to the purposes of these laws to award damages for the type of injury claimed here. Brunswick Corporation v. The antitrust laws. Inc. 961. The damages respondent obtained from the judgment of the trial court would have been realized had competition been reduced. 867 F. 429 U.000 in attorneys’ fees. The U.Antitrust Law 555 enjoined. R.8.V. particularly if the newly merged firm enjoys economies of scale from the merger that allows it to sell goods or services at lower prices to its customers.S.S. No.S. whereby every purchaser paid the freight charges from Chicago even if the glucose was shipped from Kansas City. 1989). However.Patman Act. v.S. N. The Supreme Court held that the plaintiff must allege and prove “antitrust injury” in order to prove a violation of Section 7 of the Clayton Act and recover treble damages from the defendant. 1989 U. respondent Pueblo Bowl complains that by acquiring the failing bowling centers. Corn Products Refining Company v..” The Supreme Court noted that any combination of two firms may cause some economic injury to competitors. thereby depriving respondent of the benefits of increased competition. however. Yes. Supreme Court held that the “base-point pricing” system.. Inc. petitioner Brunswick preserved competition. .

v. 1957 U.Ct. At the same time.S. The court generally reviews the meeting the competition defense. 543 (1990) United States Supreme Court 2. but the defendant must prove that this was a reasonable way to do it. Key Facts A. The meeting the competition defense probably protects Falls City from liability for price discrimination. Case Name.S. The court found that automotive finishes and fabrics are distinct enough to comprise a single line of commerce for relevant market purposes.10. 33. The court found that du Pont’s commanding position as a GM supplier was not achieved until after its sizable purchase of GM stock. WA area between 1972 and 1981. Inc. Lexis 1755 (1957). Texaco. Vanco Beverage. Case was remanded for proceedings consistent with this opinion. 460 U. or because of its acquisition of GM stock. at what is known in the industry as retail tank prices. . granted substantial discounts from retail tank prices. It purchased its gasoline directly from Texaco. a major consideration in purchasing that stock was to obtain this market. 428. I. 77 S. Inc. 1983 U. Citation. Lexis 148 (1983). du Pont de Nemours & Co. Hasbrouck dba Rick’s Texaco 496 U. In fact. The defendant must only show that its lower price was made in good faith to meet a competitor’s price.S. “The inference is overwhelming that du Pont’s commanding position was promoted by its stock interest and was not gained solely on competitive merit. The lower price may come about not only from a reduction of price. and Court Texaco v.Ct. D. The issue is whether du Pont’s position as the leading supplier of finishes and fabrics to GM came about because of competition alone. C. Du Pont’s ownership of 23 percent of the stock of GM constitutes a vertical merger that gives du Pont an illegal preference over competitors in the sale of finishes and fabrics to General Motors in violation of the Clayton Act. United States v. E.” Du Pont was later ordered to sell its stock in GM.S.556 Chapter 33 IV: Answers to Ethics Cases 33. 353 U.9. E. but also from an increase lesser than that to other customers. rather than on a customer-by-customer basis. 103 S. Issue Did the discounts granted to the two distributors between 1972 and 1981 constitute a violation of the Act? 4. Inc.. VI. The district court and court of appeals ruled in favor of Hasbrouck 3. Falls City Industries. Answer to “Briefing the Case” Writing Assignment: 1.S. Holding Yes. B. 872. Hasbrouck claimed these discounts were given in violation of the Robinson-Patman Amendment to the Clayton Act. 1282. The price reduction may be made on a territorial basis. Hasbrouck was engaged in the retail sale of Texaco gasoline products in the Spokane. 586. Inc. The court also found that the market affected is substantial.

The same goods and quality were sold to Hasbrouck as to the distributors. There was discrimination in pricing. The sales were made in interstate commerce. The four elements were found within the overall record of the findings by the lower courts. those findings were affirmed. 2. This discrimination had a prohibited effect on competition.Antitrust Law 557 5. 4. In order to find a violation of the Act. four elements must be shown: 1. therefore. . Court’s Reasoning A. B. 3.

you must then look to see if it is acting within that scope vis-à-vis the particular issue at hand. and enabling statutes. The key provisions for control of agency powers are found in the executive branch chain of command and in the overview powers vested in the judiciary. Teacher to Teacher Dialogue Anyone who has dealt with a large governmental bureaucracy can readily appreciate the frustrations of trying to get through a maze with sanity intact. In addition. and judicial can and do often become quickly blurred when examining the breadth and scope of administrative agency activities.558 Chapter 34 Chapter 34 Consumer Protection and Environmental Law Should The Buyer Beware? I. and attention to detail that could not be readily expected of the policy makers. that role has grown tremendously as reflected in these statistics. Remember the basic assumption here is that the executive branch. Once the existence of the agency is settled upon and its scope of authority is established. which delegate certain powers to the agency to act for the executive. This delegation is based on the presumption that the agency can be expected to have certain levels of expertise. legislative. . It is interesting to note at the outset that the “clean functional lines” of executive. or judicial branches of government. scales of economy. and if so. legislative branch. or judicial branch has chosen to designate and delegate a certain portion of its authority to act. legislative. In spite of constant calls to reduce the size of government’s role in the average person’s affairs. These functions are first authorized by what are called organic statutes. and the Administrative Procedure Act to help persons dealing with these agencies to get through the labyrinth. Government’s burgeoning growth of administrative agencies at every level is indeed cause for concern for its constituents. The next step is to see if the power in question was in fact truly delegated. there have been a number of specific information access type statutes such as the Freedom of Information Act. is it being properly exercised by the agency? The mechanisms for control of agency powers are relatively sparse given the scope of agency activity. The basic function undertaken by administrative agencies is to carry out the ministerial functions necessary to the operation of the government. Government in the Sunshine Act. The real functions of government are carried out “in the trenches” by this “fourth branch of government” every day. which create the agency.

As seen in the prior discussions of these areas. Unfortunately. Consider how long it took to take certain dangerous prescription drugs or unsafe toys off the market. They are reactive remedies as opposed to proactive forms of prevention of harm. They want to know more about what our government is doing to protect its citizens from harm. When dealing with subjects like negotiable instruments. students appreciate the necessity of learning the ins and outs of the system. but they often do not like it. tort law generally and products liability specifically are ripe with controversy and a great deal of uncertainty in today’s legal environment. the subject matter is seen as a necessary evil or a cost of getting by in society. and contract. The third side to our picture is found in contract.” On some public safety issues. some consumer comfort may be found in “at least better late than never. torts. The materials in this chapter dealing with environmental law can be quite extensive in that they literally cover the earth! Try to focus on one illustrative issue from each area of air. Possibly explain to the student how pollution is inevitable and clarify the options. These measures can and often do have a chilling effect on many potential harms to the consumer. protect society from further harm. Most students are keenly aware of the environmental issues found in the news every day. Victims of consumer fraud and similar offenses have always been able to seek state-supported sanctions against wrongdoers. they have no assets from which civil judgments can be satisfied. land. and strict liability. Where these laws do provide a measure of safety. Both the common law of contracts and the Uniform Commercial Code have come a long way from the bad old days of: “Let the buyer beware. It has been argued that large civil judgments act as societal signals that are designed to discourage repetition of undesirable behavior. i. at least temporarily. The same goes for topics involving taxation.Consumer and Environmental Protection and Environmental Law 559 This chapter covers the fourth major set of venues within a list of remedies available to a wronged or injured consumer. These remedies can and do provide meaningful substance to civil correction of wrongdoing where the defendant is found to have some financial means. the damage remains at serious levels year in and year out. The second area of consumer protection is found in tort law and the permutations of intentional tort. From the teaching point of view. In both scenarios. Environmental law is different. it is nice for a change to have such a jump start on a teaching assignment. Contract law has the advantage of providing the consumer with the opportunity to anticipate any problems before they befall him or her. .e. there is criminal law. the gap between consumer harm and consumer protection continues to remain unfilled. Move from tort to statute to unsolved problems keeping in mind the purpose.” In spite of all this progress in the areas of crime. most of the individuals convicted of consumer fraud are also judgment proof. Legislators at all levels of government have sought to help fill this void with a number of consumer protections measures.. however. This notion is traditionally found in the doctrine of caveat emptor which courts of another age used with cavalier abandon. First. The major drawback to both the criminal law and tort law methods of consumer protection is that they represent after-the-fact remedies for harm already done. But criminal law does not truly make the victim whole. negligence tort. Some topics are easier to teach than others. another hallmark of many of these measures is that they are the end product of a trail of harm that has reached a crisis or disastrous level. As a matter of fact. This venue may provide some satisfaction for the victim and may even. and water.

Examples of Agencies: FDA enforces Federal Food Drug and Cosmetics Act EPA enforces Federal Environmental Protection laws Administrative Agencies Administrative Procedure Act Delegation Doctrine Powers ALJ’s and Orders Ethics Spotlight: Do-Not-Call Registry The FTC and the FCC and the “Do-Not-Call” Registry involve rules that the courts have said do not violate free speech rights. Text Materials Administrative law deals with the rules and regulations enforced by administrative agencies. .560 Chapter 34 II.

Consumer and Environmental Protection and Environmental Law 561 .

Drug. and sale of foods. the government argues that claims need to be scientifically substantiated before they are allowed on the product labels. Contemporary Issue: A Hidden Source of Protein in Peanut Butter Under federal FDA standards.562 Chapter 34 Landmark Law: Federal Food. peanut better may contain up to 30 insect fragments per 3 ½ ounces and still be safe for human consumption. manufacture.S. and Cosmetic Act This act provides the basis for the regulation of much of the testing. Ethics Spotlight: Food Labeling There have been recent efforts by the FDA to enforce new rules on truth in advertising for food products. The FDA is the agency empowered to enforce this act. drugs. cosmetics. . distribution. In both cases. Even more recent rules have been implemented along the same lines vis-à-vis claims made by nutritional food supplements. and medicinal products and devices in the U.

pay a fine of $2 million and sentenced to a 5-yr. After a USDA inspection discovered the problem to be extensive and potentially causing serious illness.5 million. Reason: Authorized agents or employees knowingly stored products under unsanitary conditions.2 million. The judgment was affirmed except the $2 million fine was reduced to $1. Issue: Did LaGrou violate federal food safety laws? Decision: Yes. president and employees were aware of. the USDA shut the warehouse down. The warehouse had a serious rat problem that the manager. probation. LaGrou appealed. Inc Facts: La Grou operated a cold storage warehouse and distribution center where it stored food for customers. LaGrou was charged with violating federal food safety laws and ordered to pay restitution of $8. . 8 million of the 22 million pounds of food was found to be adulterated and was destroyed. The rest were decontaminated. La Grou Distribution Systems.Consumer and Environmental Protection and Environmental Law 563 The Court Speaks: USA v.

564 Chapter 34 .

(See text for details. There is no valid grant of authority from Congress to the FDA to regulate tobacco products. Judgment was affirmed. Brown & Williamson Tobacco Corporation Facts: The FDA enacted a rule regulating tobacco products.) Tobacco manufacturers and advertises sued claiming FDA did not have authority to regulate tobacco as a drug or nicotine delivery device. . The district court certified the issue to the court of appeals’ finding against the FDA which appealed. Issue: Does the FDCA grant the FDA authority to regulate tobacco products as a drug device? Decision: No. Ethics Spotlight: Safety Warnings About Viagra FDA’s role in necessary warnings about Viagra is discussed.Consumer and Environmental Protection and Environmental Law 565 The Court Speaks: FDA v. Reason: Congress has regulated the area through a number of statutes but chose to exclude tobacco products from the FDA’s jurisdiction as seen in FDCA.

566 Chapter 34 International Law: United Nations Biosafety Protocol for Genetically Altered Foods In January 2000. agreed to the United Nations-sponsored Biosafety Protocol. . a compromise was reached when 138 countries. including the United States.

Consumer and Environmental Protection and Environmental Law 567 Ethics Spotlight: Deceptive = 1) Misinformation or omission likely to mislead reasonable customer or 2) Unsubstantiated claim .

This case is distinguishable from the case where ice cream companies use mashed potatoes instead of ice cream in their commercials. the FTC order to Colgate not to use such methods in advertising any other products in the future is permissible.” In a television commercial promoting Rapid Shave. the sandpaper is being used to give the viewer objective proof of the claims being made. or. This sandpaper was in fact a simulated prop of plexiglass with sand glued on.568 Chapter 34 The Supreme Court Speaks: FTC v. Finally. Here. Ethics Spotlight: Kraft No Longer the “Big Cheese” Kraft’s claims involving the selling of cheese slices are discussed. they could have found another advertisement. The FTC issued a complaint against Colgate for false and deceptive advertising. because the potatoes are not used as additional proof of the claims being made. Issue: Was this commercial false and deceptive advertising in violation of the Federal Trade Commission Act? Decision: Yes. . Colgate-Palmolive Company Facts: Colgate manufactures and sells a shaving cream called “Rapid Shave. a person is shown shaving what was called sandpaper. The fact that some products do not lend themselves to television commercials does not allow the manufacturer to be deceptive. Colgate could have labeled this as a demonstration. Reason: The court found this to be a material deceptive practice.

Consumer and Environmental Protection and Environmental Law 569 .

.570 Chapter 34 Note: Regions that do not meet air quality standards are designated nonattainment areas.

arguing that the EPA must consider the cost caused to trucking firms before issuing the air standards. Contemporary Issue: Indoor Air Pollution This discusses “sick building syndrome. Administrator of Environmental Protection Agency v. sued the EPA. Reason: The EPA has the power to set standards that affect public health regardless of the cost to a particular industry.” The two chief causes are over insulation with sealed windows and hazardous chemicals and construction materials. American Trucking Association Facts: Section 109 of the Federal Clean Air Act requires the administrator of the EPA to set national ambient air quality standards for air pollutants. The American Trucking Assn.Consumer and Environmental Protection and Environmental Law 571 The Supreme Court Speaks: Whitman. won at the district court level. . must the Environmental Protection Agency consider the cost imposed on trucking firms before setting national ambient air quality standards for ozone and particulate emissions from trucks? Decision: No. but lost at the court of appeals level. The Trucking Assn. Issue: Under Section 109 of the Federal Clean Air Act.

000 in penalties under the federal Clean Water Act. Facts: Laidlaw discharged wastes into the river from its hazardous waste facility in South Carolina which exceeded the mercury limits allowed. The district court ordered Laidlaw to pay $405. Inc.800 in civil penalties and ordered a hearing to determine the amount of attorney’s fees to be awarded to FOE. . The FOE appeals the reversal by the court of appeals. (FOE) v. Reason: Injured citizens are awarded redress by civil penalties. Laidlaw argued the above settlement precluded this case. Laidlaw Environmental Services(TOC). The case is remanded. Inc. This saved Laidlaw over $1 million. This is their purpose.572 Chapter 34 The Court Speaks: Friends of the Earth. The DITGC of South Carolina sued but reached a settlement for $100. Issue: Does the settlement with the state make a civil-citizen lawsuit under the federal Act moot? Decision: No.

It issues permits for discharge into navigable waters. USAC would not issue a permit and SWAN sued claiming they were not navigable waters thus denying jurisdiction to USAC. USAC has no jurisdiction. Reason: Isolated ponds. . These ponds were filled by rainwater and melting snow. SWAN was located on real property that had been abandoned and was a proposed site for certain solid waste.Consumer and Environmental Protection and Environmental Law 573 The Supreme Court Speaks: Solid Waste Agency of Northern Cook County. Note: The Federal Oil Pollution Act of 1990 required procedures and plans to readily respond to and clean up oil spills. Illinois (SWAN) v. are not navigable. The court of appeals affirmed a district court ruling for SWAN. Army Corps of Engineers (USAC) Facts: USAC enforces section 404 of the CWA regulating dredge or fill material discharge. The judgment was reversed. There were ponds on the property that served several species of migrating birds. some only seasonal. Issue: Does the gravel and sand pit contain navigable waters? Decision: No. This appeal ensued.

” International Law: European Union Adopts Tough Environmental Law This discusses legislation referred to as REACH.574 Chapter 34 International Law: Kyoto Protocol Reduces Greenhouse Gases This discusses the so-called “greenhouse effect. .

Consumer and Environmental Protection and Environmental Law 575 .

or abandoned. continuous. No remorse whatsoever was shown by Irby. and repetitive discharge of pollutants into the environment. The court stated: “There was absolutely no acceptance of responsibility in this case. thus justifying the imposition of the 33 months of jail time.576 Chapter 34 Ethics Spotlight: Illegal Dumping of Pollutants Irby exercised decision-making authority in directing the employees of the wastewater treatment plant to discharge the untreated sewage into the Reedy River. . The offense resulted in an ongoing.” Was this ethical? Landmark Law: Superfund This statute gave the federal government a mandate to deal with hazardous wastes that have been spilled. prior and current site owners. transporter. Recovery can be from generator. stored.

Landmark Law: The Endangered Species Act This statute was enacted to protect endangered and threatened species of animals.Consumer and Environmental Protection and Environmental Law 577 Ethical Perspective: Disclosing Environmental Liabilities to Shareholders The SEC and EPA share information about corporations’ compliance with environmental laws. .

therefore. Hill Facts: The TVA is a wholly owned public corporation of the U. The district court held in favor of the TVA. The snail darter lived nowhere else in the world. There are no exceptions. the snail darter. it cannot operate. the Secretary of the Interior declared the snail darter an endangered species and its habitat a critical habitat. a new species of perch. Reason: The Endangered Species Act clearly requires that actions of the federal government do not jeopardize an endangered species or its habitat. Congress continued to appropriate funds for construction of this dam. Ethics Spotlight: Smog Swapping This discusses how air pollution credits can be purchased under the 1990amendments to the Clean Air Act. The legislative history of the Act supports this conclusion. began building the Tellico Dam. It was meant to signal all Government agencies that endangered species protection was the first priority. Issue: Would the TVA be in violation of the Endangered Species Act if it operated the Tellico Dam? Decision: Yes. Opening the dam would destroy the habitat and make the snail darter extinct. a group brought this action to obtain a permanent injunction prohibiting the dam from operation.578 Chapter 34 The Supreme Court Speaks: Tennessee Valley Authority v. In 1973. Operating the dam would make the snail darter obsolete. Knowing this. the TVA. In 1976. The court of appeals reversed.S. with appropriations from Congress. was found to live in the river downstream from the dam. In 1976. Also in 1973. .

Atropine Sulfate 1. A new drug application becomes effective if the FDA approves the application. 1988 U. therefore.. and these rodents had caused the spice to become adulterated. 1988). Inc. The FDA wins the case. 1984 U.” or if it is otherwise “unfit for food. or decomposed substance. Answers to Critical Thinking Cases Food Regulation 34.N.” Because Engel and Gel Spice had allowed food to become adulterated. U. Dey should have ceased manufacturing AIS. putrid.. or sale of adulterated food. App. and selling spices that were used as food.S. The presence of rat droppings. the FDCA had the right to seize Dey’s product. and Cosmetics Act. A new drug application must be filed with the FDA. the court found that Engel and his company had violated the FDA. Lexis 21041 (E.0 mg. Engel and Gel Spice violated the section of the Federal Food Drug and Cosmetic Act that concerns adulterated foods. rodent urine.D.” The court found that Gel Spice was in the business of shipping. Lexis 5817 (5th Cir. “unfit for food. The FDA will then hold a hearing and investigate the merits of the application. Drugs.1. 1205. When the FDA informed Dey that the application to market the inhalant would not be approved.S. Gel Spice Co. (Article of Drug). v. Yes. FDA approval must be obtained.2d 860. distributing.S. The FDA prohibits the shipment. 843 F. Regulation of Drugs 34. based upon the Drug Amendment to the Food. distribution. Dist. .2. a food is deemed adulterated if it consists in whole or in part of any “filthy. Gel Spice had allowed rodents to infest their McDonald Avenue warehouse. Dey was violating the Drug Amendment to the FDA. The Court held that Dey had properly applied for permission to market a new drug in the U. Because of this violation.Y 1984). and insects in the spice meant that the spice consisted in part of “filthy and putrid substances” and was. Under the Act.Supp. This amendment gives the FDA broad powers to license new drugs in the United States. To market a new drug in this country. When Dey began to market the inhalant despite the fact that the FDCA had never licensed the drug for use in this country. United States v.Consumer and Environmental Protection and Environmental Law 579 III.S. 601 F.

Inc. occurred. 1989). on-site impact and off-site impact. v.4.N. timber. Zuckerman’s Pharmacy had violated the act when it dispensed the Wahba”s Lomotil Prescription in a regular plastic container. 539 F. and promoting the attractiveness of a person. The Act required that potentially dangerous drugs such as Lomotil be placed in a special “child proof” container. vegetation. this section of the report is divided into two categories. ingesting. Yes. Next.3. Wahba wins since H & N Prescriptions Center and its subsidiary.580 Chapter 34 Cosmetics Regulation 34.20 945. The court held that French Bronze Tablets were cosmetics within the definition of the FDA. In general. economic market of skiing in the winter. Drug Regulation 34. 888 F.” In deciding whether to issue a permit to the ski resort developer. Supp. including prescription drugs. the accidental poisoning of a child. watershed.D. An EIS provides the information required to evaluate the potential of the ski resort.5. and Cosmetic Act of 1938.Y. and visual quality. Because canthaxanthin had never been approved for use as a color additive in cosmetics. The Color Additives Amendment to the FDA requires the approval of the FDA before color additives can be used in cosmetics. The EIS prepared in this case evaluated five alternative levels of development that might be authorized for use of this land. there is a final approval of the master plan for the development.. This ranged from not developing the property at all to creating the ski resort with sixteen ski lifts. Additional factors such as demographic shifts. the Forest Service examines the general environmental and financial feasibility of the project. the exact type of tragedy that Congress was seeking to prevent. The French Bronze Tablets were a substance used both to alter the appearance of and to promote the attractiveness of the consumer. Wahba v. air quality. and operation of the project. Last. range. the study also outlined certain steps that may be used to mitigate any adverse effects on the environment. and the energy requirements necessary to run the development were also considered. Lexis 12327 (E. Lexis 15589 (2nd Cir.S. First. Because the tablets were a cosmetic. the Forest Service has a three-step process. Drug. Dist. 1982 U. wildlife. H & N Prescription Center. 352. The government wins the case and has the right to seize the French Bronze Tablets. as well as land use and transportation. the Federal Drug Administration is empowered to regulate the composition of Cosmetics. the Service selects a developer for the project. In the first stage. Zuckerman’s Pharmacy. construction. the FDA had to approve the use of any color additive in them. soil. When Zuckerman’s failed to comply with the PPPA. Environmental Impact Statement 34. This Act requires manufacturers to provide “child proof” containers and packages for all household products.S. had violated the Poison Prevention Packaging . an environmental impact statement is required. 1989 U. In generating this report. in the final stage of review. Eight Unlabeled Cases of an Article of Cosmetic. The on-site study considered the effect of each level of development on the water resources. the French Bronze Tablets violated the FDA and could be seized and condemned. the Forest Service prepares an Environmental Impact Statement (EIS). U. The Forest Service is authorized by statute to manage the national forests for “outdoor recreation. Off- . Congress enacted the act to prevent children from suffering injury or death by opening household products and inhaling. altering the appearance of. App. or otherwise mishandling dangerous products. Under the Food. Cosmetics include substances and preparations for cleaning. and wildlife and fish purposes.).S.

Methow Valley Citizens Council. Wetlands 34. United States Environmental Protection Agency. and other environmental conditions. App. The court held that the EPA considered the relevant factors in requiring miners to construct settling ponds and recycle the water before discharging it into the streambed. The United States prevails. The Agency measures costs on reasonableness standard. Thus. wildlife. In addition. United States v. 904 F. 1835. the EPA used projections to determine future gold prices and the number of mines that would be forced to close. Inc.N.Supp. The CWA provides that the Secretary of the army may issue permits for the discharge of dredged or fill material into the navigable waters at specified disposal sites. the EPA must consider the “cost” of meeting the technology.S.2d 1276. 1990). pursuant to the Clean air A (CAA). 1990 U.7.D.1989 U.Consumer and Environmental Protection and Environmental Law 581 site considerations included the effect that each alternative may have on community facilities. 1989 U.S. The EPA is further authorized to control plant site runoff. before any discharge or rill is carried out. it is illegal to sell unleaded gasoline that contains a lead concentration in excess of that proscribed by law.6. and maintenance of equipment. Lexis 2160 (1989). Clean Air Act 34. in order to develop the ski resort.. an environmental impact statement was necessary. the court held hat the Army Corps could require Leslie Salt to obtain a permit before draining and filling the land since the property had also acquired some natural “ aquatic characteristics.Y. 332. Furthermore. the court found Pilor liable. In this case. 712F. Leslie salt Co. Dist Lexis 6119 (E. 1990 U. and migratory birds. In this case. as well as for piping fuel. Lexis 1524 (9th Cir. The United States Environmental Protection Agency (EPA) prevails.). 896 F. socioeconomic. 1077. Rule Making 34.Ct. The Army Corps of Engineers (Army Corps) prevails pursuant to the Clean Water act(CWA). In determining the economic achievability of a technology. Pilot Petroleum Associates. Pursuant to the Clean Water Act (CWA). the technological availability of the recirculation process is commonly practiced among placer miners. Rybachek v.” such as fish. United states.S. Since Pilot was engaged in the business of reselling and distributing gasoline to the individual retailers where samples were taken that revealed a violation of the CAA. Lexis 7833 (9th Cir.8. and drainage from raw material storage in order to diminish the amount of toxic pollutants flowing into the waters. sludge or waste disposal. 490 U. a permit must be granted or such discharging or filling is unlawful. In the present case.S. 2d 354. Congress has provided the EPA with broad authority to restore and maintain the chemical and biological integrity of the Nation’s waters. 109 S. App. Robertson v. spillage or leaks. The court held that the best available control technology (BACT) must be both technologically available and economically achievable. installation. ) . v.S. The EPA considered such costs as pumps to recirculate water from the settling ponds.

D.S. . the court properly issued an injunction to protect the red-cockaded woodpecker from extinction in Texas. Placing this burden on those handling hazardous waste materials makes it possible for the EPA to know who is handling hazardous waste. 103 S. monitor their activities. App.2d 1033.9. Nuclear Waste 34. 694 F. 543 F. Since Reserve Mining was in violation of their permit. this action would have jeopardized the survival of the woodpecker. Reserve Mining Co. Lexis 9203 (E. United States v. 1556. The National Environmental Policy Act (NEPA) requires that the Nuclear Regulatory Commission (NRC) evaluate the potential psychological health effects of reopening the nuclear power plant. the Environmental Protection Agency (EPA) determined that the paint drums that were buried were hazardous materials and can only be disposed of at facilities with EPA permits. 766. Thus. and fear.S. In this case. Lyng. tension. The court indicated that the renewed operation may well cause psychological health problems. App. These are not sufficient reasons to prevent the reopening of the nuclear power plant. 1989 U. [United States v. since the Forest Service’s management practices are similar to the monitoring of an endangered species.. v.S.S. the court relied on the evidence that the discharges were causing discoloration of the surface waters outside of the zone of discharge. The United States prevails.460 U. Thus. the court held that the conduct of the Forest Service had a detrimental impact upon the red-cockaded woodpecker in violation of the Endangered Species Act. 880 F. Reserve was fined for each day that the violation occurred. The court stated that those individuals who handle hazardous waste are required to provide information to the EPA in order to secure permits. he was liable for the dumping of hazardous waste. Dist. the court held that the NRC does not need to consider allegations of People against Nuclear Energy (PANE). Metropolitan Edison Co. Tex. The court held that the dumping of approximately 67. 1988 U. In reaching this outcome.000 tons of carcinogenic waste into Lake Superior polluted the public water supplies in violation of its state discharge permit. Although such problems include anxiety. Lexis 6503 (8th 1976)] Hazardous Waste 34.12.582 Chapter 34 Clean Water Act 34.S. and enforce compliance with the statute. Secretary of Agriculture. 1990).1983 U. The Sierra Club is granted the injunction to prevent the Forest Service from leasing these national forests for lumbering.S. 1260. Sierra Club v. Thus. People against Nuclear Energy.). the court held that this harm is simply too remote from the physical environment to justify requiring the NRC to investigate the psychological health damage by the reopening the nuclear plant. Endangered Species 34. since Hoflin failed to inform the EPA of its disposal of the paint. Lexis 10169 (9th Cir. Sup. 1989). Ct. No such permit had been obtained by Hoflin. In the present case. 1976 U.11.Supp.10. Ct.2d 1210.Lexis 21(U. The United States prevails. By allowing the Forest Service to lease several national forests for lumbering in Texas. Hoflin.

Based upon an Environment Impact Statement that indicated that elk would (1) avoid roads even when there is no traffic. District Court 2.W.Pa 1992) U.15.” Deceptive advertising also occurs where a seller makes an objective claim about its product that it cannot substantiate.S. FMC is being ordered to pay for clean-up under CFRCLA. Safety issues may complicate this matter and ethics is definitely in question. If this were bait and switch it would be illegal. The court held that the WMEAC demonstrated the likelihood of the impairment or destruction of the natural resources in the areas. It also is not ethical to take advantage of low income families. Citation. Dept. FMC owned and operated the Facility which was taken over during World War II to produce rayon for war purposed while “hazardous substances” were “disposed of” at the Facility.D.2d 676. Inc. 34. App. Because the appellate court found the name and advertising of rejuvenescence cream to be deceptive.14 FTC wins. West Michigan Environmental Action Council. 1979). The name and advertising of the cream both suggested that the product would restore moisture in the user’s skin and give the skin a healthy. B. Natural Resource Commission. 34. as a result of the proposed drilling of the ten exploratory wells.S. and Court FMC Corp. . Key Facts A. v. A permit is needed. Although virtually all human activities can be found to adversely impact natural resources in some way or another. Deceptive advertising occurs where a seller makes a misrepresentation in an advertisement that is likely to mislead a “reasonable consumer. Section 5 of the FTC Act prohibits the use of deceptive or unfair advertising. The Corps is empowered to adopt regulations dealing with the filling or dredging of wetlands. FTC.16. Case Name. Therefore. Answer to “Briefing the Case” Writing Assignment: 1. 34. The Federal Trade Commission wins the case. and (3) result in further shrinkage of the already diminishing elk population. v. the present case does not justify the destruction of the elk population for the exploration of oil and gas deposits. Charles of the Ritz was making objective claims in its advertising it could not substantiate. U. specifically of the elk.S. The court held that both the name and advertising of rejuvenescence cream were deceptive. v. 1944 U. The FIC was created in 1915 to enforce the Federal Trade Commission Act. The FTC’s experts reported that it was impossible for any cosmetic product to achieve these results. 1979 Mich.Consumer and Environmental Protection and Environmental Law 583 IV. Lexis 347 (Mich. C. Charles of the Ritz Distributing Corp.471 (E. Supp. of Commerce 786 F. 275 N. (2) avoid the impact areas for at least 40 to 50 years. 1944). the appellate court upheld the FTC’s cease and desist order.13. youthful look. Answers to Ethics Cases 34. Lexis 3172 (2nd Cir.2d 538. 143 F. The West Michigan Environmental Action Council (WMEAC) prevails. the court determined that this constitutes an impairment or destruction of a natural resource. FMC seeks indemnification from the Government for some portion of related costs. V.

Court’s Reasoning A. was an owner and is liable. . Issue Is the Government responsible for costs resulting from release of the hazardous substance? 4. Holding Yes. B.584 Chapter 34 3. U. Liability of an owner or operator for removal costs “ is strict and joint and several”. 5.S.

Workers’ Compensation.Employment. and Labor Law 585 Chapter 35 Employment. But in looking out for number one. must do the same. This chapter also discusses the various legal efforts to protect the employment environment. and influence over the past forty years. As with any contract. but also a tragedy. It is a hallmark of advanced industrialized economies that the work force is highly organized and has a strong bargaining power over its affairs. and Labor Law Why Did Labor Need To Be Organized? I. when it came to workers’ safety. The FLSA. Management. Labor must adjust to the situation and make concessions to both the technological and economic realities of trying to compete in a global economy. This chapter describes how the law can help in this process. to workplace and antidiscrimination statutes are traceable to hard fought collective bargaining agreements aimed at solving the problems. In spite of this consider the working conditions that existed before unions. Most modern social legislation. The immediate post-Civil War era of industrialization saw the possibilities for abuse of the work force not only become reality. Labor must realize that it cannot sustain its own survival on the backs of failed companies brought down by union imposed inefficiencies. both parties are expected to enter into the relationship with their own best interests at heart. and Social Security are among the topics discussed. Each side of the labor/management relationship still looks out for itself. Worker Protection. OSHA. Organized labor has suffered from a long and steady decline in membership. both must appreciate their mutual interdependence on each other. in turn. ranging from the minimum wage. Teacher to Teacher Dialogue This chapter is designed to introduce the student to our nation’s sometimes-controversial history with regard to the development of public policies towards organized labor. The basic employer/employee relationship is a contractual one. power. Worker Protection. to child labor laws. however. .

and the Railway Labor Act. the National Labor Relations Act. the LaborManagement Relations Act. Federal Labor Union Statutes (A description) NorrisLaGuardia Act (1932) Employees can organize NLRA (1935) Taft-Hartley Act (1947) Employees can oppose union formation 80 day cooling off LandrumGriffin Act (1959) Internal union after regulation Railway Labor Act (1934) Railroad and airlines carrier employees Employees can join unions Collective bargaining and rights Wagner Act NLRB Federal agency Oversees union election Prevents unfair labor practices Enforces and interprets certain federal labor laws .586 Chapter 35 II. Text Materials Landmark Law: Federal Labor Union Statutes This discusses the Norris-LaGuardia Act. the Labor-Management Reporting and Disclosure Act.

and Labor Law 587 Unfair labor practice to influence joining or not joining a union or to interfere with election Types of Union Elections: 1) contested – needs a simple majority 2) consent – NLRB not always needed 3) decertification – NLRB is needed Ethics Spotlight: Internal Union Affairs The Landrum-Griffin Act is discussed. which is separated from a public highway by a 46-foot-wide grassy strip. In addition. The Supreme Court Speaks: Lechmere. In a campaign to organize Lechmere employees.7 right. After Lechmere denied the organizers access to the lot. Petitioner Lechmere. The Court of Appeals enforced the Board’s order. taking into consideration (3) the availability of reasonably effective alternative means of exercising the Sec. relying on its ruling in Jean Country. nonemployee union organizers placed handbills on the windshields of cars parked in the employees’ part of the parking lot. alleging that Lechmere had violated the NLRA by barring the organizers from its property. Issue: Did Lechmere commit an unfair labor practice by barring nonemployee union organizers from its property? Decision: Lechmere did not commit an unfair labor practice. v. or coerce employees” in the exercise of their Sec. recommending that Lechmere be ordered to cease and desist from barring the organizers from the parking lot.7 right if access is denied. National Labor Relations Board Facts: The National Labor Relations Act (NLRA) guarantees employees “the right to selforganization. join. almost all of which is public property. An administrative law judge ruled in the union’s favor. Inc. owns and operates a retail store located in a shopping plaza in a large metropolitan area.” and makes it an unfair labor practice for an employer “to interfere with. The Board affirmed.Employment. The union filed an unfair labor practice charge with respondent National Labor Relations Board (Board). against (2) the degree of impairment of the private property right if access is granted. Lechmere is also part owner of the plaza’s parking lot. they distributed handbills and picketed from the grassy strip. they were able to contact directly some 20 percent of the employees.7 rights. to form. . or assist labor organizations.. that in all access cases the Board should balance (1) the degree of impairment of the Sec. Inc. Worker Protection. restrain.

The NLRB ordered a new election. The Democrats. Exchange Parts Co. and Helpers advised Exchange Parts that it was going to conduct a campaign to organize workers at the plant. J.7 and private property rights. Issue: Is it an unfair practice for an employer to confer new economic benefits on its employees on the eve of an election? Decision: Yes. Blacksmiths. argued that these sorts of statutes have been uniformly adopted throughout the industrialized nations of the world and that workers needed more lead time to seek other employment or make other adjustments based on the plant closing. In February 1960. By its plain terms. the Board erred in concluding that Lechmere committed an unfair labor practice by barring the nonemployee organizers from its property. is engaged in the business of rebuilding automobile parts in Fort Worth. Facts: Exchange Parts Co. in turn. The facts in this case do not justify application of the inaccessibility exception.” It is only when reasonable access to employees is not feasible that it becomes appropriate to balance Sec.7 simply does not protect nonemployee union organizers except in the rare case where “the inaccessibility of employees makes ineffective the reasonable attempts by nonemployees to communicate with them through the usual channels. an employer cannot be compelled to allow nonemployee organizers onto his property. Exchange Parts held a dinner for its employees and announced new company benefits including an extra holiday.588 Chapter 35 Reason: Thomas. The Supreme Court Speaks: National Labor Relations Board v. Prior to November 1959. increased wages. You might be surprised by their answers. is an unfair labor practice.7. In November 1959. The Union lost the election. the NLRA confers rights only on employees. Nor does the fact that they live in a large metropolitan area render them “inaccessible. as a rule. they are presumptively not “beyond the reach” of the union’s message. . which are designed to affect the outcome of that election. Jean Country is inconsistent with past interpretation of Sec. not on unions or their nonemployee organizers. which was reversed by the court of appeals. Forgers. Sec. the International Brotherhood of Boilermakers. Ethics Spotlight: Plant Closing Act This act was one of the few to survive a presidential veto during the Reagan-Bush era.” Because the union failed to establish the existence of any “unique obstacles” that frustrated access to Lechmere’s employees. a union did not represent its employees. TX. The act really represents a microcosm of the larger employer versus employee rights debate. Reason: An employer’s conferral of benefits on employees on the eve of a union election. The vote on this issue was very much along party lines with the Republicans opposing it as being harmful to business and an unwarranted governmental interference into business decisions. At least as applied to nonemployee union organizers. The NLRB ordered an election date. Iron Shipbuilders. Ask your students where they stand and why. Thus. Because Lechmere’s employees do not reside on its property. WARN was passed in 1988 and deals with plant closing and mass layoffs. and an extended vacation plan.

Worker Protection.Employment. and Labor Law 589 Warn Act Over 100 or more employees 60 day notice for certain closings or layoffs Plant closings Temporary or permanent 50 or more employees 30 days Mass layoffs 33% reduction or 50 or more 30 days employees Exemptions Not reasonably foreseeable business circumstances Good faith effort to stay opened (possibly hampered by notice requirements) .

590 Chapter 35 Compulsory subjects Permissive subjects or illegal Illegal subjects wages. etc. . etc. not compulsory closed shops.

Screen Actors Guild. Marquez appealed.Employment. The collective bargaining agreement included a “union security clause” requiring all Lakeside performers to join SAG. There is a perception that the less a state does to control the activities of business entities within its borders. She sued alleging breech of the clause. Facts: SAG was the exclusive union for Lakeside. the more likely will business choose to move there. . The district court held for Lakeside (SAG) and the court of appeals affirmed. and Labor Law 591 The Supreme Court Speaks: Marquez v. Contemporary Issue: State Right-to-Work Laws This statute represents a test of a state’s loyalty to or opposition to unionization within its borders. Inc. Worker Protection. Marquez won a part in a Lakeside production but did not pay the membership fee and she was not hired. These laws often outlaw union and agency shops. The judgment of the court of appeals was affirmed. Issue: Does the union security clause in question violate federal labor law? Decision: No. Reason: Section 8(a)(3) permits unions and employees to require only that employees pay the fees and dues necessary to support the union’s activities as the employees” exclusive bargaining representative.

Secondary boycott Pressure by picketing suppliers or customers Unlawful if versus neutral employer Lockout by employer .592 Chapter 35 Strike Cessation of Work Union Economic benefits or versus unfair labor practice Picketing No violence. etc.

and Labor Law 593 Wildcat strikes have no proper union authorization. Reason: The section of the NCRA prohibiting secondary boycotts aims to prohibit a union in dispute with one employer from exerting pressure on another neutral employer to force the secondary employer to cease doing business with the primary employer. with whom the Union had a primary labor dispute. This is called a lockout. NLRB v. Union staged a mock funeral in front of the hospital. The Union appealed. The district court agreed and issued an injunction. . The Court Speaks: Kentov Regional Director. The mock funeral could have reasonably been expected to discourage persons from approaching the hospital. There is thus reasonable evidence of an NLRA violation by the Union. Sheet Metal Workers’ International Association Local 15. Worker Protection. In part. Note: An employer may prevent potential strikers from entering. The judgment was affirmed and such activity was banned. Issue: Did the mock funeral possession in question constitute an illegal secondary boycott picketing? Decision: Yes. Kentov (NLRB director) filed for a temporary injunction against Union alleging the mock funeral to be an illegal secondary boycott picketing. the Union wanted to exert pressure on the hospital to cease doing business with non-union contractors. AFL-CIO Facts: Union had a dispute with Massey and WTS who supplied non-union laborers to Massey who was doing word for a hospital.Employment.

594 Chapter 35 Insurance .

Worker Protection. Issue: Was Medrano acting within the scope of employment when the accident occurred? Decision: Yes. Marshall appealed. The Court Speaks: Smith v. and the students were required to submit permission slips to the school. The evaluation of both instructional and noninstructional duties. Smith’s injury employment-related? Decision: Yes. and later died. His family filed for workers’ compensation death benefits. After the training he would have been more valuable by improving the quality of customer services. An ALJ denied claim as not occurring within the course and scope of employment. On the way home one night he was killed by a drunk driver. The Math Club picnic was a school affair. The workers’ compensation judge denied the benefits and the Appeals Board affirmed. Facts: Medrano was a journeyman electrician for Marshall who paid tuition and book fees for him to attend an electrician apprenticeship night class. and he coached the girls’ basketball and baseball teams. Marshall Electrical Contracting. There was evidence that Smith believed that his employer expected his participation at the picnic. Inc. Smith filed a claim for workers’ compensation. permission slips were required of students. Math Club funds paid for the food. The students invited their math teachers. Mrs. which was objected to by the employer. including “the sponsorship or the supervision of out-of-classroom student activities” was made once a year. and Labor Law 595 Employment-Related Injuries Out of and in the course of employment Cafeteria or business lunch included Personal lunch or off-premises not included The Court Speaks: Medrano v. The LIRC reversed. The Math Club paid for the food. When Smith tried it himself. One of the students brought a windsurfer. The students’ Math Club holds an annual picnic.Employment. LIRC’s finding was affirmed. Workers’ Compensation Appeals Board Facts: Ronald Smith was a temporary math instructor. he fell. which the students used. notices for the picnic were . Round-trip was a 75 mile drive. was seriously injured. This was compensable. Issue: Was Mr. Reason: The court fashioned a two-prong test for work relatedness: whether the employee subjectively believed that the employer expected his participation in an activity and whether that belief is objectively reasonable. Reason: The injury suffered occurred while he was acting for the mutual benefit of the employer and employee. His employment contract stated that he “may be required to devote a reasonable amount of time to other duties” in addition to his instructional duties. Driving to and from the class helped foster this mutual benefit.

Smith’s beliefs were objectively reasonable. An ALJ found that Simmons was within the course of employment during the accident and awarded benefits. Simmons files for workers’ compensation.596 Chapter 35 posted on the school bulletin board. Simmons appealed the denial of benefits. and of no benefit to Means and thus outside the course of employment. teachers were encouraged to involve themselves in extracurricular activities. Simmons stopped and picked up whiskey at a liquor store. v. after visiting customers and while driving Mean’s vehicle. he went off the road causing property damage and injuries to himself. On the drive to the customers. he was hit by a car. The Board reversed and awarded workers’ compensation benefits. Means and their insurer denied liability. The police said he was asleep while a doctor said he was intoxicated. The Court Speaks: Simmons v. When the act falls under the “special errand” rule. his windsurfing activities were outside the scope of his employment. Reason: The alcoholic-related frolic was entirely personal. The court held that if there is an incidental or causal connection between the accident and the employment. L&I said the accident did not occur in the course of employment and denied benefits. Issue: Was Mahoney acting within the course of employment when the accident occurred? Decision: Yes. as in this case. He dropped the van off for service and began to drive his bike home. The Commission said he was in an alcohol –related frolic and not in the course of employment. On a day off he drove the van to the office to turn in paperwork. Calling on a retailer would be inappropriate in his condition. The employer argued that even if Smith’s attendance at the picnic was required. the whole trip is within the course of employment. His wife filed for survivor benefits under the act. and died. This trip falls under the “dual purpose” except which applies when the transit served both a business and personal purpose as it did in this case. On the trip home. Bob Means Wholesale Florist Facts: Simmons worked for Means as a sales rep. the accident is within the scope of the employment. Reason: The going and coming rules do not apply if the journey is an inherent part of the service. Mahoney Facts: Mahoney worked as an electrician for Cochran who provided a van to drive to and from job sites. and decedent had been commended for these activities. He left and did not return to the course of his employment. The Court Speaks: Cochran Electric Company. was injured. Issue: Was Simmons acting within the cause of employment when the accident occurred? Decision: No. teachers were evaluated on these extracurricular activities. The judgment was upheld and benefits were awarded. Inc. he stopped and pulled off the highway to drink whiskey for 30 minutes. The denial of benefits was affirmed. . The workers were responsible for getting their vans serviced. The Superior Court affirmed and Cochran appealed. After resuming the trip. One day.

Worker Protection. and Labor Law 597 OSHA Duty Standards: 1) specific duty 2) general duty .Employment.

16-17 non hazardous jobs (unlimited hours) . Child labor: .18 and over no restrictions The Supreme Court Speaks: IBP. The Supreme Court agreed.598 Chapter 35 Ethics Spotlight: Company Violates OSHA’s Safety Rule A specific roofing industry problem dealing with safety nets is discussed. This affirmed by the court of appeals. port. IBP appealed with respect to the walking time. . The district court agreed and awarded damages. They are paid while cutting and bagging and are paid for 4 minutes to change.14 & 15 non hazardous jobs (limited hours) . Issue: Is the time spent by employees walking between lockers and production areas compensable under the FLSA? Decision: Yes. Alvarez Facts: IBP produces beef. They are required to store the equipment and tools in locker rooms where they change before and after work. All workers must wear specific clothing and those using knives must wear additional protective equipment. and related products.Inc. v. A class action suit was filed for compensation for time spent changing and walking between the lockers and the production floors.Under 14 only newspaper delivery . The suit was based on the FLSA.

The EPPA dictates polygraph usage in some cases. and Labor Law 599 Reason: The Department of Labor work day is from “whistle to whistle”. Post-employment testing usually needs a good reason. Contemporary Issue: Drug Testing and Polygraph Tests Pre-employment drug testing is usually acceptable. Walking before and after a shift between lockers and production is integral and indispensable to a principal activity and is thus a principal activity itself. Ethics Spotlight: Microsoft Violates Employment Law This discusses Microsoft’s use of freelancers and temps. . The IRS concluded that these special workers were Microsoft employees rather than independent contractors. Worker Protection.Employment. rather than regular employees.

600 Chapter 35 Unemployment Compensation Federal act requiring employees to pay unemployment taxes Benefits for temporary unemployment Usually must be able and available for work and seeking employment No benefits if bad conduct No benefits if quit without just cause .

Albanese’s Case.” the terms are used in a general sense rather than a specific one. Workers’ Compensation 35. Workers’ Compensation Appeals Board. Wilson wins because the City reasonably expected his participation in the off-duty activity of his employment. The court stated a two-part test to determine whether the activity was “a reasonable expectation of employment:” (1) whether the employee subjectively believes his or her participation in the activity is expected by the employer. Wilson v.2d 83. . Answers to Critical Thinking Cases Workers’ Compensation 35.1. and it would be unrealistic to conclude that offduty running was not expected of any member who wanted to pass the test of running two miles in 17 minutes. entitles Albanese to compensation under the Workers’ Compensation act. the employer is entitled to compensation.719 (Cal. Wilson met the first requirement as indicated by his statements that his superiors told him that off-duty conditioning was required to meet the SERT qualifications. and Labor Law 601 III. 1987). and (2) whether that belief is objectively reasonable.E. These specific stressful episodes which occurred over a relatively short period of time as compared to his twenty years of employment.Rptr.Employment. Wilson also satisfied the second part of the test.1979 Mass.3d 302. 196 Cal. In general. Worker Protection. Although Albanese had been employed by Atlantic Steel Company for approximately twenty years. Furthermore. Wilson benefited his employer by being in the SERT unit. but specific stressful episodes. Albanese wins. combined with the casual nexus between Albanese’s working conditions and his emotional disorder.App. In defining whether an employee has a “mental or emotional disorder. Lexis 795 (Mass). since all members of SERT were made aware that off-duty workouts are necessary. if an employee is incapacitated by a mental or emotional disorder causally related to a series of specific stressful work related incidents.2. App. the court determined that his current condition was not the result of general stress or the wear and tear of working. 239 Cal.” In this case. 389 N.

AFL-CIO v. 698 F. 1333 (N. A fiduciary is required to perform his duties regarding the plan with the “care. the expectation of privacy is minimal.5. The court stated that to violate the Occupational Safety and Health Act. They failed to require evidence of the borrower’s ability to repay the loans. ERISA 35. to charge fair market rates of interest. and diligence under the circumstances then prevailing that a prudent man acting in like capacity and familiar with such matters would use in the conduct of an enterprise of like character and with like aims. the failure to pressure test a pressure vessel before activation was an apparent and obvious hazard that was likely to cause serious injury. 700 F.Supp. the Secretary must prove that (1) the employer failed to render its workplace “free” of a hazard that was (2) recognized. Getty Oil Company v. In this case. Drug Testing 35. . 530 F. 1043. the court found that the trustees had violated their fiduciary duties and required them to resign their positions as trustees of the plan. Thus. The Occupational Safety and Health Review Commission prevails because an employer is required to furnish a safe place of employment for its employees. It is apparent that drug use for air traffic controllers has never been a private matter since they are subject to routine physicals and urinalysis examinations. Tex.).602 Chapter 35 Occupational Safety 35. prudence. Cal. MEBA/NNU.2d 1143 (5th Cir. McLaughlin v. Thus.” The court held that the obligation to act prudently requires the plan fiduciaries to act as a prudent man participating in a similar transactions such as by obtaining a fair return commensurate with prevailing or market rates on planned investments. 1988 U. Lexis 15884 (N.D.3.4. the court stated that it is clear the hazard at issue here was both “recognized” and likely to cause serious harm. and is judged by balancing its intrusions on the individual’s Fourth Amendment interests against its promotion of a legitimate governmental interest. The Secretary of Labor wins because the trustees breached their fiduciary duty in violation of the Employee Retirement Income Security Act (ERISA). Although the court held that urinalysis is a search. Rowley. the trustees failed to act prudently. Occupational Safety and Health Review Commission. In the present case.D.S. it created an extremely high probability of rupture and ensuing harm. 1988). the fundamental command of the Fourth Amendment is that searches and seizures be reasonable. Burnley. This standard of ”reasonableness” depend on the context within which a search takes place. ERISA requires that an administrator or trustee of a pension benefit plan administer the plan as a fiduciary. and (3) causing or likely to cause death or serious physical harm. and to repay the loans when they became due. 1976). In the present case. to enter into a written agreement describing the terms and conditions of the loans. The court held that there was a minimal amount of intrusion of the testing program as compared to the compelling interest in promoting air safety. National Air Traffic Controllers Assn. Furthermore.. Supp. The Secretary of Transportation wins since it was determined that post accident urinalysis of air traffic controllers was not an unreasonable search and seizure in violation of the Fourth Amendment.Dist. as well as preventable by the simple expedient of pressure testing. skill.

). and Labor Law 603 Unemployment Benefits 35. the president of the Sinclair Company violated federal labor law by unlawfully interfering with the union election. Oil. Overstreet v. The court held that the predominant job situs was the controlling factor in determining whether a state’s right-towork law applies.7.8. (Arrow) does not have to bargain with the union regarding its decision to close the Hudson. The U.. Devon Overstreet’s use of cocaine prior to reporting for work constituted a deliberate violation of her employer’s policy and indicated a disregard of the standards of behavior that the employer had the right to inspect. the court reasoned that because most of the employees’ work is done on the high seas and outside the territorial bounds of the state of Texas.S. The court following Sec.E. 602(A) of the Unemployment Insurance Act stated “an individual shall be ineligible for benefits for the week (or time period) in which he has been discharged for misconduct connected with his work. or coercion. 1918. 426 U. The union wins and its agency shop agreement is legal and enforceable. The Supreme Court held that although an employer is free to communicate to his employees his general views about unionism or his specific views about a particular union. and that there is no reason to require every employment situation to be subject to some state’s law with respect to union security agreements. Ct. Unfair Labor Practice 35. Gissel Packing Co. The Supreme Court held that the president of the Sinclair Company interfered with the election and ordered that the election be set aside. 96 S Ct.6. Here. Illinois Department of Employment Security.1976 U. 395 U. hours. The court commented that it is immaterial that Texas may have more contacts than any other state with the workers.S. 89 S. 407.Ct. Chemical & Atomic Workers International Union. Mobile Oil Corporation. No.Ed.” The court defined misconduct as behavior that is willful or a wanton disregard of an employer’s interests. Texas’ right-to-work laws did not apply to these workers. . Massachusetts plant. 2140. AFL-CIO v. Plant Closing Act 35. Worker Protection. Arrow Automotive Industries. Lexis 106 (U. He may make predictions of the effects he believes unionization will have on his company. In this case. 1988).” The court held that the company’s decision to close down the Hudson plant was not a mandatory subject of collective bargaining. Yes.App. his statements may not contain a threat of reprisal.2d 185 (Ill.9.2d 547 (1969). force. 522 N. The court held that the president’s statements were not cast as predictions but rather as threats of retaliatory action if the employees elected a union. Right-to-Work-Law 35. Congress has limited the subjects of mandatory bargaining to “wages.S. Inc.S. Such interests include the intentional and substantial disregard of the employee’s duties and obligations to his employer. Sup. 23 L. The CTA wins.Employment. 575.S. and other terms and conditions of employment. NLRB v. Supreme Court held that Texas’ right-to-work law did not apply to the workers in this case. The court concluded that the intended and understood import of the president’s messages was to threaten to throw the employees out of work if the union won the election.

Making such a decision a mandatory subject of bargaining would give the union a powerful tool for delay. The National Labor Relations Act indicates a preference for collective bargaining. then the workers were illegal strikers who could be discharged without the right to reinstatement. was properly discharged for his conduct.S. In this case. 612. National Woodwork Manufacturers Association v. The court held that although jobs would be eliminated by the decision. 1989). The court held that because this was an illegal wildcat strike.10. Inc.Ed. it must have some assurance as to the identity of that agent and that it can deal with that agent as a responsible spokesperson for the employees of the unit. Bownds. Work Preservation 35. v.2d 357 (1967). Bownds and the employees who engaged in the walkout cannot get their jobs back. 430 F. evidence showed an impasse had been reached in collective bargaining.604 Chapter 35 The court found that the company had justifiable economic reasons for closing the plant.. The object of the union’s action was to preserve work traditionally done by its members. NLRB. 1250. The board of directors of a company should be able to make such significant economic and policy decisions such as closing an unprofitable plant without first having to bargain with the union over the decision. No. the closing of a plant is a permissible subject of collective bargaining. and the company in this case rightfully chose not to bargain over this issue. The Supreme Court held that the preservation of work traditionally done by union members is a proper subject of collective bargaining. and that the decision was not based on antiunion animus. Illegal Strike 35. Note: Under the Plant Closing Act. 853 F.” The court found that the management of a company must be free to make a decision of the magnitude of a plant closing without the constraints imposed by mandatory bargaining. The Supreme Court held that the use of a temporary layoff of employees by the employer in this case solely as a means to bring economic pressure to bear in support of its bargaining position was lawful under the National Labor Relations Act. As the court stated. 18 L. NLRB.Ct. Employer Lockout 35. The Supreme Court upheld the NLRB’s decision to dismiss the charges. The court found that the other employees had engaged in an illegal “wildcat strike” that was not sanctioned by their union. Yes. Arrow Automotive Industries. “the union’s practical purpose in participating will be largely uniform: it will seek to halt or delay the closing. The court held that an employer can . American Ship Building can lawfully lay off the employees in what is called an employer lockout. who was discharged for his actions in cutting the bags of flour. Shop Rite Foods. Federal labor law permits an employer to lockout employees if it reasonably anticipates a strike or has reached an impasse in collective bargaining negotiations and there is a threat of damage to the employer’s property. Yes. Thus. there was a threat of an impending strike by the unions that would shut the shipyard down for the winter months. 1970).12. the Carpenters’ Union’s refusal to hang the prefabricated doors at the job site was a lawful work stoppage and does not violate federal labor law. 386 U.11. Since the employer is required to bargain with the representative of the workers.2d 223 (4th Cir. There cannot be bargaining in any splinter groups. this does not make it a mandatory subject of negotiation.2d 786 (5th Cir. 87 S. today the company would have to give the employees at least 60 days notice if the plant closing resulted in a loss of employment of 50 or more employees. NLRB v. Inc. and therefore the union’s “will not handle” rule that had been bargained for and agreed to by the employer was lawful.

Retail Clerks International Association. 373 U. 2372. and that in this case the lockout was a reasonable response to the threatened strike. 85 S. 13 L. 65 L. If the appeal against the product succeeds. Independent Federation of Flight Attendants. The court held that the union did more than merely follow the struck product. in this case the five local title insurance companies sell only the primary employer’s product. It was negligence and as such the exception did not apply. Ct.Ed. 83 S. it simply induces the neutral retailer to reduce its orders for the product or to drop the item as a poor seller. American Ship Building Company v. Local 1001. the court held that secondary picketing against a struck product is lawful.Ed. NLRB v.14. 1139. This was not an intentional tort. the incidental injury to the neutral employer will be tolerated. The court held that the company unlawfully discriminated between workers in violation of the National Labor Relations Act. 35.2d 855 (1965). Lexis 2492 (U. However. Retail Store Employees Union.15. The Supreme Court held that the superseniority award had the effect of offering individual benefits to certain employees who were induced to abandon the strike and operated to the detriment of those who participated in the strike. The Supreme Court held that the picketing of the neutral employers constituted an illegal secondary boycott in violation of the National Labor Relations Act. 377 U. or restrains a person from buying or using the services of the neutral employer.2d 377 (1980).S. Secondary picketing against consumption of the primary employer’s product leaves responsive consumers no realistic option other than to boycott the five local title companies altogether. IV.S. 447 U.). and Labor Law 605 engage in a lockout and preempt the threatened strike by the unions. Under this circumstance. Ct. The court upheld the NLRB’s finding of an unfair labor practice. 109 S.. 607.S. Ct. Note: Under the Supreme Court’s ruling in Trans World Airlines. No.16.S. 221. 1225 (1989).Ct. Secondary Boycott 35. Although in Tree Fruits. Safer testing could have been provided but he also should have been more careful. without being subject . Inc. Sup. the company’s offer of 20-years’ superseniority for layoff and recall purposes is not lawful and constitutes an unfair labor practice in violation of federal labor law. No. 100 S.Ct. The Supreme Court upheld the NLRB’s decision that ordered the union to cease picketing the five local title insurance companies. The product picketed in Tree Fruits (apples) was but one item among the many that made up the grocery store’s trade. 1063 (1964). NLRB v. the picketing of the five neutral title insurance companies is not lawful. 955.13.S. Worker Protection.S. v. AFL-CIO. 84 S. 58.Ct.S. The Secretary of Labor has promulgated a regulation providing that an employee may choose not to perform his assigned tasks if he has a reasonable apprehension of death or serious injury coupled with a reasonable belief that no less drastic alternative is available. 380 U. 1963 U. coerces. 489 U. Replacement Workers 35. 300. it created a separate dispute with the secondary employers. today the company could offer the crossovers the seniority they had prior to the strike. Erie Resistor Company. the picketing becomes an illegal secondary boycott if the picketing threatens. Answers to Ethics Cases 35. NLRB. Employees can engage in self-help under certain circumstances under OSHA regulations.Employment.

Case Name. 63 L. Whitcraft Houseboat Division. However.17. In response to the unionization efforts. Issue Did the by-law violate the National Labor Relations Act? 4. North American Rockwell Corporation v. 35. This rule was seeking actual employment. Secretary of Labor. The issue here is whether that regulation is valid. Whitcraft’s discharge of the employees was unlawful. B. Answer to “Briefing the Case” Writing Assignment: 1. This legislation is broad in nature. Since an OSHA inspector cannot be present all the time. It would be anomalous to construe this act as to not allowing the employee to withdraw from a dangerous workplace. . E. V. v. 100 S.S. The employer. B. The lower court held in favor of the NLRB. Marshall. and held that they were properly discharged from their employment because of their misconduct.Ct. International Association of Machinists and Aerospace Workers. and Court Wiljef Transportation v. The court found that the conduct of Daniel and Wolfram plainly violated the valid no-solicitation rule. Wiljef.2d 1308 (1991) United States Court of Appeals for the 7th Circuit 2. This would not be lawful. and Wiljef appealed. 195 NLRB 1046 (1972). Whirlpool Corp. 5. If fellow employees are conducting union solicitation. The regulation is valid. D. 3. this regulation allows the employee to get the benefit of a safe workplace in all circumstances. Employers may dismiss employees who violate the rule. an employer may restrict solicitation activities to the employees’ nonworking time and in nonworking areas. 1. AFL-CIO. was involved in a dispute with its employees who were seeking to unionize. The general freedom of expression is recognized in Section 8© of the NLRA. Yes. Section 8© states that if the expression is used as a threat against the employee’s right to associate. Key Facts A.18. Holding Yes. This was not “standing-by”. A labor organization does not engage in an unfair labor practice under 8(b)(6) of the NLRA when it insists on the employment of a local orchestra. The employer contended that this by-law was an expression of free speech as protected by the 1st Amendment. there is an affirmative duty on all employers to provide a safe workplace. NLRB 946 F. The fundamental purpose of OSHA is to prevent occupational deaths and serious injuries. Further. 883. 35. Citation.2d 154 (1980). 445 U. C.606 Chapter 35 to subsequent discrimination. Wiljef amended its bylaws to call for the company’s dissolution if unionization were to take place. Court’s Reasoning The US Court of Appeals for the 7th Circuit held that: A. The NLRB claimed that the by-law violated the National Labor Relations Act. it can be interpreted as an unfair labor practice.Ed.

and Labor Law 607 C. In this case. The lower court’s ruling in favor of the NLRB was upheld. D. Worker Protection.Employment. the lower court found that the by-law was designed to coerce employees to reject the attempted unionization of their ranks. .

we owe it to fair inquiry and academic freedom to put forward opposite views. As we all know. In . Teacher to Teacher Dialogue Today’s students appear far more divided on employment issues than in the past. try to initially clearly define the terms. attempt to have students engage in open debate. Perhaps it is the tight job market or the polarization. The term “discriminate” has within it two distinct and opposite meanings. distinguished. and rewarded in the workplace. try to present both sides of every argument. The U. levels of training. was the first major system of self-governance premised on the assumption that all persons are born equal and should be treated equally in the eyes of the law. *No single American legal issue is inflamed with more controversy than discrimination in the workplace. As a possible way to break the barriers. which comes from crime. that equality has often been a hope rather than a reality for many. and abilities. Teaching these materials is never easy. Employers. and the government founded on it. class. should be allowed and expected to seek utilization of these divergent talents and strengths in their own best interests. The positive aspect of discrimination really says that uniqueness should be discerned. Allowing all sides an opportunity to be heard is a fair approach. After all arguments have been listed.608 Chapter 36 Chapter 36 Equal Opportunity in Employment Why Is Discrimination In Employment Wrong? I. If the class as a whole wants to take only one side. economic disparities.S. On the positive side. We are not all equal in all ways. or caste systems that so often predestined their opportunities for social and economic advancement. and the like. Second. but remains always exciting. discrimination is simply a fact of life. Declaration of Independence. in turn. We have different talents. The genesis of our nation’s heritage is rooted in a diversity of peoples who immigrated to the New World in order to flee the royalist. The same diversity that has been a source of national pride has also been the basis of disparate treatment of persons in the workplace for many years. To discriminate in the positive sense is to reward ability and merit on its face. differentiated. even if we personally do not support those views. strengths. This is especially important in the most controversial areas such as affirmative action.

ability. or national origin without a good job-related reason. Title VII focuses on eliminating job discrimination based on race. . For a society founded on a premise of equality. economic marketplace factors are blind to any other factors but job performance. Until then. that equity will eventually result in a changed culture. For example. The negative side of discrimination is found in wrongful selection processes. None of us can afford to look the other way and say: “It’s not my problem.” Wrongful discrimination against any group is a wrong upon the society at large. sex or national origin. Congress enacted the Civil Rights Act of 1964. is duly rewarded for these talents. justifications. or rationalizations. II. religion. you cannot expect the average man on the street to play golf as well as Tiger Woods. There is basically no good job-related reason for race and color. law and our courts will continue to be the testing grounds for this necessary change in the social order. religion. Almost everyone appreciates that fact intuitively. color.Equal Opportunity in Employment 609 the end. One element that provides hope for positive change is goodwill. Text Materials EEOC is federal agency usually charged with enforcing 1866 Act deals with rights to make and enforce contracts Note: There can be no discrimination in employment based on race. Landmark Law: Title VII of the Civil Rights Act of 1964 After substantial debate. The negative side of discrimination is inequality of treatment based on wrongful motive. in turn. color. sex. Each choice not based on talent. if not intellectually. Where people of goodwill cling to the basic rightness of equity before the law. and merit is a step away from the inherent basis of equality before the law. He. we have certainly had more than our share of unequal treatment in the workplace.

610 Chapter 36 .

there was evidence that approximately 22. allegedly for being Hispanic. 22. Issue: Did Baccarat engage in unlawful national origin discrimination? Decision: Yes. This is an example of a racially neutral policy that has a disparate impact on a protected group.2 percent of the black population proximate to Harrison was qualified for jobs as firefighters or police officers. She filed a charge with the EEOC alleging sex discrimination. Issue: Is Ledbetter’s lawsuit barred by the EEOC 180 day rule? Decision: Yes. Reason: Ledbetter could not shift alleged intent from the first act to the later act. . Rivera sued for violation of Title VII of the Civil Rights Act. it cannot legally be the basis for an adverse employment action. Harrison is a small.1 percent of the private employees in Hudson County were black. The town had virtually no black residents and none of its employees were black. Two raises had been denied to her during this time. (2) the residency requirement was the cause of at least a substantial part of this disparity. in Manhattan. Judgment in favor of Goodyear was affirmed. Russell. and (3) the business reasons for this employment practice could be met in other. Facts: Ledbetter worked for Goodyear for 20 years. The jury returned a verdict for Ledbetter awarding her back pay and damages. and 2 Hispanics were fired while a non-Hispanic was not. River awarded $206. but is closely aligned with the contiguous Essex County and the City of Newark. The Court Speaks: NAACP v. Reason: The court found that: (1) the proportion of blacks hired by Harrison did not fit the racial makeup of the pool of qualified applicants from the four county labor market. Issue: Does the residency requirement violate Title VII of the Civil Rights Act of 1964? Decision: Yes. Employees were being promoted or given raises based on supervisors’ performance evaluation.810.. industrial community in Hudson County. along with another Hispanic sales rep. did not want Hispanic employees. The Goodyear Tire & Rubber Co. The necessary intent would not be present. Inc. requiring that all officers and employees of the town be residents of the town. the CFO. told Rivera 6 months later Negre was terminating her.Equal Opportunity in Employment 611 The Supreme Court speaks: Ledbetter v. On appeal Goodyear claims her claim fell outside the 180 days to file a claim. virtually all of whom came from outside Hudson County. The Court speaks: Rivera v Baccarat. Negre told her that her attitude was bad and she should not speak Spanish on the job. After 8 years she was the top sales representative and was praised as one of the best by Watts. Inc. and later adopted an ordinance. A non-Hispanic salesperson was retained by the store. Negre became the new president and was in charge of personnel. a Hispanic woman. Reason: National origin discrimination can be based on linguistic characteristics. In fact. New Jersey Facts: The town of Harrison had followed a policy. the store manager. The court of appeals agreed with Goodyear and Ledbetter appealed. Town of Harrison. If an accent does not interfere with job performance. Prompt resolution indicates Congress’ strong preference for prompt resolution. nondiscriminatory ways. Further. Here Negre did not like Rivera’s accent. worked for Baccarat. Brigganty. Evidence was introduced that she had been discriminated against. Inc. Facts: Rivera. such as requiring all police and firemen to live within a reasonable response time of Harrison.

The board decided to hold interviews before appointing a new Director. absent the discrimination. and other services to veterans and their dependents. prejudgment interest. The court found that Barbano has established a prima facie case of discrimination under Title VII. The court held that the questions asked of Barbano were unrelated to a bona fide occupational qualification and that Green’s questions were discriminatory and tainted the decision process. “Here are copies of the next resume. information. Appellants provided four reasons why they chose Wagner over Barbano. . and found all of them (including Barbano) to be qualified for the position. Issue: Did Madison County engage in sex discrimination in violation of Title VII? Decision: Defendant was liable for violating Title VII. Greene then asked Barbano her plans on having a family and whether her husband would object to her transporting male veterans. committee member Greene said that he would not consider “some woman” for the position. the court awarded Barbano back pay.” followed by the comment. thus bringing into issue appellant’s purported reasons for not hiring her. The interviews were to be conducted by the Committee. the position of Director of the Agency became vacant. another woman. Barbano said that the questions were irrelevant and discriminatory. Barbano commenced this action in 1982. Following the interview process. Before entering the interview Barbano heard someone say. which would then submit its recommendation to the board. Madison County Facts: The Madison County Veterans Service Agency offers counseling. Barbano applied for the position and was interviewed in February 1980. “Oh. The district court then found that due to Barbano’s education and experience in social services. they still would not have hired Barbano.612 Chapter 36 The Court Speaks: Barbano v.” The interview began. In February 1980. The Committee interviewed several other candidates. Accordingly. which the district court rejected as either unsupported by the record or a pretext for discrimination in light of Barbano’s interview. and attorney’s fees. and after Barbano stated why she thought she was qualified for the job. appellants had failed to prove that. the interviewers ranked the applicants and unanimously agreed to recommend Allan Wagner to the Board. Reason: The court held that the record supported a finding that the committee and Board engaged in sex discrimination against Barbano in making the hiring decision.

must the conduct seriously affect the victim’s psychological well-being? Decision: No.. etc. respondent Forklift System. claiming that the conduct of Forklift’s president toward her constituted “abusive work environment” harassment because of her gender in violation of Title VII of the Civil Rights Act. Reason: To be actionable as “abusive work environment” harassment. conduct need not “seriously affect an employee’s psychological well-being” or lead the plaintiff to suffer injury. Forklift’s president often insulted Harris because of her gender and often made her the target of unwanted sexual innuendos. Forklift Systems. touching.Equal Opportunity in Employment 613 The Supreme Court Speaks: Harris v. Title VII does not require a victim to prove that the challenged conduct seriously affected her psychological well-being. Inc. Facts: Petitioner Harris sued her former employer. Sexual favors often for job advancement Types Quid pro quo Hostile Environment Look to frequency & severity . Sexual Harassment Lewd remarks. Inc. Issue: To be abusive work environment harassment.

Religious Discrimination • • Reasonable accommodation Sometimes permitted in religious groups . Internet & Technology: E-Mails That Cause Sexual Harassment This discusses how e-mail has increased the exposure of businesses to sexual and racial discrimination lawsuits. the abusive conduct was so intolerable that resignation was a fitting response. Contemporary Issue: Employer’s Defense to a Charge of Sexual Harassment This examines the recent case giving rise to certain affirmative defenses: 1) Reasonable care to prevent and commit 2) Plaintiff did not use #1 above Importance of policy is stressed. Suders Facts: Suders was hired by PSP as a police communications operator. an otherwise affirmative defense is not available. Issue: Can an employer be held vicariously liable when the sexual harassment conduct of its employees is so severe that the victim of the harassment resigns? Decision: Yes. there is “constructive discharge”. If. The court yes to the sexual harassment but no to PSP’s vicarious liability and granted PSP’s motion for summary judgment. Reason: The behavior was so severe or pervasive that it created a work environment abusive to employees because of their gender against Title VII’s broad rule of workplace equality. as in this case. She resigned and sued PSP alleging that she was constructively discharged and forced to resign. She contacted PSP’s equal opportunity officer who she found to be insensitive and unhelpful. She subjected to continuous sexual harassment that only ceased when she resigned. The court of appeals reversed and the case was remanded. The case presents a “worst Case” harassment scenario. The case was remanded. PSP appealed.614 Chapter 36 The Supreme Court speaks: PA State Police v. Sine the employer does not seem to have a readily accessible and effective policy for reporting and resolving sexual harassment complaints.

Equal Opportunity in Employment 615 .

claiming that the policy constituted sex discrimination violating Title VII of the Civil Rights Act of 1964. and raise them rather than to the employers who hire those parents or the courts. which classification must be regarded. in the same light as explicit sex discrimination. Fertile women. forbids sexspecific fetal-protection policies. mandates that decisions about the welfare of future children be left to the parents who conceive. Facts: A primary ingredient in Johnson Control’s battery manufacturing process is lead.616 Chapter 36 The Supreme Court Speaks: International Union Etc. Reason: Blackmun. Moreover. the policy explicitly classifies on the basis of potential for pregnancy. occupational exposure to which entails health risks. a group including employees affected by respondent’s fetal-protection policy. respondent’s professed concerns about the welfare of the next generation do not suffice to establish a BFOQ of female sterility. and the Court of Appeals affirmed. Respondent was entitled to summary judgment because its fetal-protection policy is reasonably necessary to further the industrial safety concern that is part of the essence of respondent’s business. protecting women’s unconceived offspring. After eight of its employees became pregnant while maintaining blood lead levels exceeding that were noted by the Occupational Safety and Health Administration (OSHA) as critical for a worker planning to have a family. support. respondent’s policy creates a facial classification based on gender and explicitly discriminates against women on the basis of their sex under Sec. participate in the manufacture of batteries as efficiently as anyone else. Issues: Is Johnson Control’s fetal-protection policy a BFOQ? Decision: Title VII. The latter court held that the proper standard for evaluating the policy was the business necessity inquiry applied by other Circuits and that respondent was entitled to summary judgment because petitioners had failed to satisfy their burden of persuasion as to each of the elements of the business necessity defense. Respondent cannot establish a BFOQ. as amended by the PDA. J. The court granted summary judgment for respondent. v. bear. as amended. from jobs involving actual or potential lead exposure exceeding the OSHA standard. in using the words “capable of bearing children” as the criterion of exclusion. An employer’s tort liability for potential fetal injuries and its increased costs due to fertile women in the workplace do not require a different result. the absence of a malevolent motive does not convert a facially discriminatory policy into a neutral policy with a discriminatory effect. Johnson Controls. Moreover. under the PDA. was ostensibly benign. The incremental cost of employing members of one sex cannot justify a discriminatory refusal to hire members of that gender. The Court of Appeals erred in assuming that the policy was facially neutral because it had only a discriminatory effect on women’s employment opportunities. and because its asserted purpose. By excluding women with childbearing capacity from lead-exposed jobs. respondent announced a policy barring all women. filed a class action in the District Court. Title VII. as far as appears in the record. Inc. 703(a) of Title VII. as amended by the Pregnancy Discrimination Act (PDA). Petitioners. including the risk of harm to any fetus carried by a female employee. despite evidence about the debilitating effect of lead exposure on the male reproductive system. The policy is not neutral because it does not apply to male employees in the same way as it applies to females. . Also. except those whose infertility was medically documented.

Equal Opportunity in Employment 617 Landmark Law: Civil Rights Act of 1866 This statute expressly prohibits racial discrimination. .

Reason: The law has no evidence of wanting to protect younger covered employees versus older covered employees. The decision was reversed. Inc. The opposite could be true but that is not the case here. . Cline who was over 40 but under 50 sued alleging discrimination under the ADEA.618 Chapter 36 The Supreme Court speaks: General Dynamics Land System. v. Cline Facts: GD and UAW entered into a collective bargaining agreement eliminating GD’s obligation to provide health benefits to employees who subsequently retired unless they were at least 50 years old. GD appealed. The case was dismissed the district court whose holding was then reversed by the court of appeals. Issue: Does the ADEA protect a younger covered employee from an employer’s rule that discriminates in favor of older covered employees? Decision: No.

Equal Opportunity in Employment 619 Ethics Spotlight: You’re Overqualified For The Job” Age discrimination and “overqualification” is discussed. Reasonable Accommodations are required. A pre-employment medical exam is forbidden before an offer. An employer cannot ask an applicant about a disability but can ask about the ability to perform a job. Landmark Law: Title I of the ADA This statute prohibits discrimination in regard to a job against qualified individual with disabilities. . Approach Is it a disability? Is there a reasonable accommodation? 1) Physical or mental impairment 2) Record of #1 3) Regarded as having #1 Not covering current illegal drug use or alcoholism Note: A qualified individual can perform the essential functions of the job that they desire or hold.

(UAL) Facts: Twin sisters (Karen Sutton and Kimberly Hinton) applied to UAL. but the PGA Tour denied his request. Sutton and Hinton sued for violation of the ADA. Reason: Disability under the ADA does not include persons with corrected conditions as in this case. The complaint had been properly dismissed. Ethics Spotlight: Obesity Treated As a Disability The court of appeals agreed with the district court that obesity is a protected category under federal disability laws. Inc. When he turned professional. Reason: Golf is a game where it is impossible to guarantee that all competitors will play under exactly the same conditions or that an individual’s ability will be the sole determinant of the outcome. Martin won at the district court and court of appeals levels. a degenerative circulatory disorder that obstructs the flow of blood from his right leg to his heart. by permitting him to use a golf cart while playing in PGA sponsored golf tournaments? Decision: Yes. v. Issue: Are the petitioners disabled within the meaning of the ADA? Decision: No. . UAL had a 20/100 or better visual acuity requirement. Martin sued the PGA in violation of the ADA for not making reasonable accommodations for his disability. There is no substantial limitation of a major life activity with a corrected condition and thus no disability discrimination because there is no limiting impairment. he qualified for the PGA Tour.620 Chapter 36 The Supreme Court Speaks: PGA Tour. The Supreme Court speaks: Sutton v. They are both correctable to 20/20 or better with corrective lenses. He requested to use a golf cart while playing in PGA tournaments. The ADA requires that the PGA Tour accommodate Casey Martin by allowing him to use a golf cart. The district court dismissed and the court of appeals affirmed. a disabled professional golfer. The condition prevents them from doing normal activities without correction. They were not hired because of sever myopias causing visual acuity of 20/200 or worse and 20/400 or worse. Inc. Petitioners appealed. Issue: Does the Americans with Disabilities Act of 1990 require the PGA Tour to accommodate Casey Martin. Martin Facts: Casey Martin is a talented amateur golfer who has Klippel-Trenaunay-Weber Syndrome. United Airlines.

The term “working condition” encompasses only physical surroundings and hazards and not the time of the day worked.Equal Opportunity in Employment 621 Explanation: 1) Narrowly tailored for compelling interest 2) No quotas 3) Reversed discrimination not actionable Contemporary Issue: Affirmative Action and Reverse Discrimination An affirmative action plan must be narrowly tailored and serve a compelling interest.” III.Ct. Corning Glass Works v. It is clear that any individual’s life expectancy is based on a number of factors. Thus. and responsibility. 417 U.2d 1 (1974). Although the Supreme Court acknowledged that as a class women do live longer than men. many women do not live as long as the average man and many men outlive the average woman. Secretary of Labor. Yes. Brennan. 188. it is not true that all individuals of the respective classes will do so. . In order to establish a violation of the Act. of which sex is only one.S. 94 S. 2. and which are performed under similar working conditions. Sex Discrimination 36. it must be shown that an employer pays different wages to employees of opposite sexes “for equal work on jobs the performance of which requires equal skill. the Supreme Court held: 1. the original pay differential between the day (female) shift and the night (male) shift violated the Act.2. 41 L. In fact. Yes. International Law: United Nation Treaty To Protect The Rights Of The Disabled This discusses the “Convention in the Rights of Persons With Disabilities.Ed. Answers to Critical Thinking Cases Equal Pay Act 36. The violation was not cured when Corning began hiring women to work the night shift because the higher “red circle” rate paid to previously hired male night shift workers perpetuated the discrimination. the practice of requiring female employees to make larger contributions to the pension fund than male employees constitutes sex discrimination in violation of Title VII. the wage practices by Corning violated the Equal Pay Act. 2223. effort.” Here.1.

Thus. TWA is not liable for religious discrimination in violation of Title VII. The court held that an employer can be held liable for sexual harassment of its employees under the doctrine of respondeat superior (let the master answer) if the employer either (1) had actual knowledge of the harassment or (2) the harassment was so pervasive that an inference of constructive knowledge arises.D. Federal Bureau of Investigation. In doing so.Ct. TWA did not violate Title VII. As a remedy. the conduct of the male employees and manager of RDC in this case constitutes sexual harassment in violation of Title VII by creating a hostile work environment. Hardison. The court ordered that an independent panel be created to decide these claims.Supp. Texas 1989). the challenged practice was only outlawed in the future. No. The Supreme Court held that TWA had taken all actions necessary to reasonably accommodate Hardison’s religious preference. 435 U.5. Perez v. 845 F. 63. 702. the court ordered that those Hispanic agents who had been discriminated against would be awarded additional seniority to make them whole had such discrimination not occurred. 1414 (W.6.2d 900 (11th Cir. 53 L. 1988). The court did not grant an award of back pay. In this case. 55 L. Religious Discrimination 36.2d 113 (1977). the court cited the potential economic impact that such an award would cause to insurance companies and pension plans. 1370. the FBI is liable for a pattern or practice of discrimination in violation of Title VII. The court reasoned that this would give Hardison an employment benefit that would be based on religion. 98 S. Further. The court held that the FBI’s actions constituted unlawful national origin discrimination against Hispanic agents. Bona Fide Occupational Qualification 36.Ed. In addition. Huddleston v. 432 U.Ct. Yes.Ed. Thus.4. it reversed the District Court’s award of retroactive relief to the entire class of female employees and retirees. Roger Dean Chevrolet. 97 S. City of Los Angeles Department of Water and Power v. 714 F. Huddleston made out a prima facie case against RDC for the sexual harassment attributable to the sales manager of RDC. Hostile Work Environment 36. National Origin Discrimination 36. The court held that the ability to communicate clearly in English was a bona fide occupational qualification (BFOQ) .3. The city and county of Honolulu are not liable for violating Title VII. The court held that TWA could not force other employees to work in place of Hardison without violating the collective bargaining agreement with the union that would be a violation of federal labor law. Inc.S.. Manhart.622 Chapter 36 Note: Although the Supreme Court found a violation of Title VII. which would itself be religious discrimination against the other employees of TWA.2d 657 (1978). the court held that this would cause an undue hardship on TWA by requiring it to hire and train a part-time employee to work Saturdays only or to incur the additional cost of paying overtime wages to a current employee to work overtime on Saturdays.S. Trans World Airlines v. The Supreme Court also held that TWA did not have to meet Hardison’s request to work only a four-day workweek. 2264. the court ordered the FBI to overhaul its system of promoting Hispanic agents and those from other minority groups to eliminate any discriminatory practice. Yes.

it is the safety of the other inmates. There is a basis for expecting that sex offenders who have attacked women before would do so again in prison. and was therefore properly denied the position. 861 F. This is a threat not only to the victim. Department of Public Safety of Alabama v. in this case. IV: Answers to Ethics Cases 36. the ability to speak clear English was one of the most important skills required for the position. The court held that the Association engaged in unlawful age discrimination when it retired Fite. 53 L. City and County of Honolulu. the court found that the CRD had engaged in reverse discrimination against Machakos in violation of Title VII. Also.Equal Opportunity in Employment 623 for the position. but also to the safety of the other inmates. The trial court found that the height rule excluded over 32 percent of women but less than 2 percent of men.9. . 433 U. Dothard argues that height and weight are job related. The court affirmed a jury award of $270. The court found that the CRD’s systematic policy of unlawful minority preference in hiring had adversely impacted the plaintiff.Ed. The court held that Title VII of the Civil Rights Act of 1964 prohibits racial discrimination against all races.Ct. The court found that the Association’s stated reason for retiring Fite—his poor job performance—was a mere pretext for engaging in age discrimination. Fite made a prima facie case of age discrimination against the association. 859 F. including whites.373 attorneys’ fees against the Association. 1989). Fragante v. Fite v. Fite wins the lawsuit.2d 884 (6th Cir. maximum security. At age 57. (NOTE: Generally. because they have a relationship to strength that is required. 36. The weight requirement excluded over 22 percent of women but less than 2. Rawlinson proved a prima facie case of sex discrimination by showing that the racially neutral height and weight restrictions disparately impacted upon women.S. First Tennessee Production Credit Association. In this case. 888 F.C.8. he did not meet the bona fide occupational qualification for the job.000 damages and $71. Fite was protected by the Age Discrimination in Employment Act. A woman’s relative ability to maintain order in a male.) Dothard. Attorney General of the United States.7. 1989). 1988). Cir. Here. these restrictions would exclude over 41 percent of women but less than 1 percent of men. the woman should be able to decide what employment risks she wants to take. 2720. Machakos wins. for which there was no correlation proven. ALSO NOTE: There is no evidence that women guards are more subject to attacks than men guards. heterosexual environment. Rawlinson.5 percent of men.2d 591 (9th Cir. unclassified prison could be directly reduced by her womanhood. it is not her safety that the court is protecting. this was an assumption made by the state. and awarded Machakos back pay retroactive to when she should have been promoted had the CRD not discriminated against her. Age Discrimination 36. Since Fragante’s English oral skills were hampered by his accent and manner of speaking. The court held that a strength test should be given to establish strength.2d 786 (1977). Machakos v. there is a real risk from other prisoners who are deprived of a normal. Director. 321. The essence of a prison guard’s job is to maintain order. Together. Because of the required contact with a sometimes-contentious public. The court found that the inability to communicate well in English was not a cover for unlawful discrimination. ordered that Machakos be promoted. 97 S. the applicant’s womanhood directly undermines her ability to do the job. rather than using height and weight.2d 1487 (D. Thus.

Defendant claims that it is now in compliance with federal anti discrimination rules after it adopted a new sexual harassment policy in April 1987. Plaintiff complained of a number of incidents of unwelcome sexually harassing behavior by co-employees and of a work environment where nude and suggestive photos of women were allowed by management to be displayed in public. Plaintiff brought this complaint against her employer for failure to comply with federal non-discrimination rules regarding sexual harassment and its alleged failure to prevent a hostile work environment. . C. Citation. E. 3. 760 F. B. and as such. D. The current sexual harassment policy failed to comply with federal regulations on sexual harassment. B. 5. which would be in compliance with federal workplace rules regarding sexual harassment prevention. Issue Did the new sexual harassment policy comply with federal anti discrimination rules? 4. Case Name. Jacksonville Shipyards Inc. Defendant was ordered to implement a new policy. Key Facts A. Jacksonville Shipyards is engaged in a number of contracts with the federal government. Supp. Answer to “Briefing the Case” Writing Assignment 1. Court’s Reasoning The United States District Court ruled that: A. and Court Robinson v. 1486 (1991) United States District Court 2. Plaintiff is an employee of defendant and works as one of the few woman welders in the defendant’s ship repair facilities. is bound by federal work rules relating to affirmative action and non-discrimination. The defendant was ordered to cease and desist from the continued maintenance of a work environment that was hostile to women because of their sex. Holding No.624 Chapter 36 V. C.

In addition to the substantive areas of the law of personal property. Bailment. Insurance is defined as a contractual arrangement whereby one undertakes to indemnify another against loss. the need for insurance is rooted in reality.Personal Property. Text Materials The study of personal property revolves around being able to answer three key questions: 1. the role of insurance is more vital than ever. What are the legal consequences of the answers to questions 1 and 2? . wills. Teacher to Teacher Dialogue The laws of contracts. II. and torts all have not only significant roles in business. Even though the law of insurance is derived from contract. How is this property acquired or transferred? 3. How it this property classified? 2. Few activities in today’s overly litigious world are not in one way or another involved with insurance. Bailment. One very real and unfortunate truth of conducting one’s personal and business affairs is that financial safety nets are more necessary than ever. you might want to introduce these materials as part of a body of law (the others being real property. and trusts) that is very much interconnected with their personal planning strategies. Insurance is more important than ever because it appears that new risks never even fathomed by our forefathers emerge every day. insurance. damage. and Insurance 625 Chapter 37 Personal Property. but also play vital roles in how one arranges his or her personal affairs. property. In spite of many problems. or liability. Personal property is one such key area. and Insurance Who Owns The Property? I.

the common law of contracts again controls because the house is treated as real property. get paid. Sales of real property transactions come generally under the purview of the common law of contracts. If the trees have been cut and are being sold to a mill. The type of classification used will have important consequences on how property will be treated in the eyes of the law. that property is classified as real. or inherit. . the UCC will now call the shots. however. or just have it given to you. consider the basic distinction between real and personal property. and that money is exchanged for property. In all these events. If that lumber becomes part of a house. and the common law of contracts controls. however. Sales of goods. and find it.626 Chapter 37 May be owned by more than one person Concurrent Ownership All personal property falls into one classification or another. are generally covered by the UCC. In addition to classification. the acquisition and transfer of rights and duties to property are of key personal and business importance. You work. Most property is transferred by way of contract with some sort of reciprocal exchange of consideration. You may be lucky. For example. If you are selling trees on the land. the acquisition or transfer must be made in compliance with the elements required by law. what are the rights and duties that arise out of that ownership? What if you found it? What if others have claims against it? These issues are of key importance in both business and private lives. Once you have acquired the property.

Personal Property. and Insurance 627 Established procedures for adults to make gifts of money and securities to minors . Bailment.

and is entitled to it. there must exist (1) donative intent. She appealed. Therefore. Michael had never had possession of the painting when Victor died. He made the gift through a letter to Michael. . Since the donor retained a life interest.628 Chapter 37 The Court Speaks: Gruen v. His stepmother refused to give him the painting. it would be impractical to require physical delivery. Michael. and (3) acceptance by the donee. The gift was complete because the law assumes acceptance when something of value is given unless the donee rejects the gift. and he sued. The sending of the letter by the donor served as constructive delivery of the gift and transferred title to the donee. (2) delivery of the gift. The trial court decision in favor of the stepmother was reversed on appeal. The delivery must occur through actual physical delivery or constructive delivery. Victor indicated an intent to transfer such an interest while retaining a life interest. Donative intent requires that the donor intended to make an irrevocable present transfer of ownership. Michael owns the painting. Through his letter. Reason: To make an inter vivos gift. Issue: Did Victor complete an inter vivos gift? Decision: Michael wins. but reserved a life estate. Gruen Facts: Victor Gruen purchased a painting and gave it to his son.

Both Franks and Kazi (hotel owner) sued claiming the money. Franks argued it was lost and should get it as the finder. The trial court agreed with Kazi.Personal Property. He told the manager ho told the police who took custody of the money. Kazi argued it was mislaid and he should get it as the owner of the property where it was found.200 carefully wrapped in a bundle in plain view in a dresser drawer of a hotel in which he was staying. Issue: Was the money mislaid or lost property? Decision: Mislaid property. Kazi Facts: Franks found $14. and Insurance 629 The Court speaks: Franks v. Reason: Mislaid property is intentionally put in a certain place and then forgotten and is presumed to have been left in the custody of the owner who becomes a gratuitous bailee with a duty to deliver to owner. Te finder must return it to the owner. This can often be determined by here it is found as in a drawer as in this case. Bailment. Franks appealed. Judgment was affirmed. .

Reason: Powell did not prove ownership and Michigan’s Estray law had been met by Willsmore. the two of them opened it and found $383. Certainty of title and honesty are considered by the courts as well as the fact that notice was given. Willsmore published the notice and sought a judgment determining ownership of the money in his favor. Issue: Who is the owner of the lost suitcase and its contents? Decision/Remedy: Willsmore and the Township and trial court’s judgment was affirmed. the landowner where the suitcase was found claimed ownership but incorrectly stated the amount of money. The trial court awarded the money to Willsmore and the Township. The statute provides that the finder and the township must share the value if finder published notice and no true claim made within one year. Township of Oceola The Facts: Willsmore found a suitcase while hunting. by statute. Thereafter. The police took custody and. .630 Chapter 37 Ethics Spotlight: The Court Speaks: Willsmore v.840. Powell. deposited it into an interest bearing account. After reporting this to the police.

What is not expected to occur in bailment is any sale. Drop your clothes off at a dry cleaners.” In the legal sense. it too is a bailment. Have your car parked. Bailments are indeed an everyday occurrence. gift. One of the aspects of the study of bailments that surprises first-time students of the law is just how common this sort of transaction is. Bailment. or transfer of title. it is a bailment. That purpose involves some particular use or deposit of the property with the expectation that it be redelivered to the person who originally delivered it or otherwise dealt with it at his or her direction. a bailment is a delivery of personal property with a special purpose. many people find out about the rules of the bailment game after there has been a loss. . Check your bags with an airline. What is not as common knowledge is that things can go wrong in bailments. but the salver is entitled to a very liberal salvage award. and Insurance 631 Contemporary Issue: Treasure Trove on the SS Central America? This deals with the law of salvage that holds that original owners retain ownership interest. The second teaching objective this chapter focuses on is the law of bailments.Personal Property. it is a bailment. The term bailment basically means “to deliver. Just like insurance claims.

Meaux The Facts: Sisters of Charity hospital operate a health and wellness center. Meaux’s locker was robbed while he was swimming. Meaux was awarded damages at the trial. Meaux sued alleging a bailment on the part of the Sisters and subsequent negligence. A lock was provided by Center that kept a key for emergencies. The sign stating nonassurance of safety of valuables was posted at check-in desk. will be protected. Consider the example of common carriers. a member was given the rules. Issue: Was a bailment created between Meaux and the Sisters of Charity? . The public’s expectation has been reflected in the insurancestyled strict liability of carriers for goods in their possession. for a fee. The Court Speaks: Sisters of Charity v. Phil Meaux. Rules say Center is not responsible for lost or stolen items. Here the public wants and expects a high level of reliance in being assured that goods entrusted to a common carrier.632 Chapter 37 Bailments are essentially a special kind of contract. Normal contract rules apply except that a number of special situations have arisen often enough to warrant legislative responses to the problems raised by those situations.

The judgment was reversed. Inc. There was no express or implied agreement in this case since the jewelry was hidden in the trunk and there was no reasonable expectation of its existence on Ziva. . Ziva appealed. the liability that may otherwise have inured to one of the parties by reason of tort. contract limitations should not be allowed to become a false front behind which all sorts of negligent behavior may be somehow hidden or excused. Almost invariably what has happened is that there is an attempt to limit. Judgment was affirmed.Personal Property. but at the last minute someone jumped into the car. Issue: Was a bailment created between Ziva and CWH? Decision: No. another element that often shows up in bailment cases is the interaction between the law of torts and contracts. drove off. v. Car Was Headquarters. There is also no evidence of a bailment agreement. As such. The trial court held no bailment and summary judgment was entered or CWH. He watched the car carefully. Here this was a landlord-tenant relationship in that there was no possession of dominion or control by the Sisters. Inc. by contract. Bailment. In addition. Conversely. and the jewelry was gone. good. On the contract side. Reason: For a bailment we need delivery. Reason: A bailment involves delivery of personal property for a specific purpose with a contract with expectation of a return or accounting for accomplishment of purpose. On a business trip he went to CWH to have the car washed. Custody and possession must be voluntarily assumed by the bailee.s part. clear limitations of extent of liability serve everyone well if they are fairly arrived at between the parties. and Insurance 633 Decision/Remedy: No. The Court speaks: Ziva Jewelry. Courts are then confronted with the age-old problem of choosing between freedom of contract and public policy. Smith padlocked the trunk where he kept the jewelry while traveling for business. Facts: Smith was a traveling salesman for Ziva Jewelry and knew that when he attended trade shows he should be alert for thieves. Ziva sued CWH alleging a bailment and negligence. He had the only padlock key.

634 Chapter 37 .

. Other materials covered in this chapter are part of the bailment story. and liabilities of these special situations are also reviewed. warehouses. If the owner parks his/her own car. and innkeepers are involved in special bailments. Who is liable when a car is parked in a commercial lot or garage depends on whether the parking lot is considered to be a bailee. common carriers. Where the lots assume control. In the commercial setting. This is a good way to bring home the concept of bailment. The various rights. there is a bailment. Bailment. then there is usually a lease. duties. and Insurance 635 Contemporary Issue: Parking Lot’s Liability The issue discussed here could happen to anyone.Personal Property.

636 Chapter 37 .

Personal Property. Bailment. and Insurance 637 .

Note: An insurable interest is necessary to have an enforceable insurance contract. 1) Property Insurance: ownership or monetary loss at time of loss 2) Life Insurance: family relationship or economic benefit from continued life of insured .638 Chapter 37 Insurance is a means for persons and businesses to protect themselves against the risk of loss.

Personal Property. and Insurance 639 Types of Insurance Life Health & Disability Fire & Homeowners Standard Fire Homeowners Personal Articles Renters Automobile Other Whole Term Universal Double Indemnity Annuity Health Disability Dental Collision Comprehensive Liability Medical Payment Uninsured Motorist Credit Title Marine Umbrella . Bailment.

000 life insurance policy from JH. John Hancock Life Insurance Company (JH) Facts: Needleman purchased a $4.640 Chapter 37 The Court speaks: Needleman v. The Needleman family sued JH alleging accidental death induced by antidepression drugs which he was taking which impaired his judgment. . It is irrelevant that he might not be capable of realizing the possible results from his actions or of entertaining an intention to kill himself. Summary judgment was granted to JH. He shot himself in the tub while speaking to someone to whom he said “I waned to do this before you got home.000. Issue: Was this an act of suicide preventing payment of proceeds due to the suicide clause? Decision: Yes.” while he was pointing a gun at his chest and head. Reason: Evidence indicated Needleman’s intent to take his own life. JH refused to pay based on the suicide clause. The policy had a 2 year suicide clause. Within the two years Needleman had personal problems which a psychologist recognized as possible suicide symptoms.

over $. Note: Professional malpractice insurance deals with liability of a professional for negligence in practicing a profession. Valuable items could be covered by a personal articles (effects) floater. and Insurance 641 Note: A personal liability coverage homeowners’ policy provided comprehensive personal liability insurance for the insured and family members. One of the basic arguments for the plan was that prior to the advent of the more cost efficient no-fault plans. Bailment. only a fraction of less than half of the insurance proceeds goes to the intended payee. .e. Contemporary Issue: No-Fault Automobile Insurance As for the no-fault scheme of insurance itself.50 of every insurance dollar was being spent on the cost of transfer. there is no doubt that this is the wave of the future in more and more areas of liability exposure. workmen’s compensation. Terms of Importance Insurable interest Beneficiary No-Fault accident personal interest in insured item or person person or organization who receives benefits at time of death auto insurance where driver’s company pays no matter who caused the Business Insurance key-person life business interruption. Contemporary Trend: Mold Eats Away At Insurers’ Profits The problem of mold for homeowners and the insured is discussed.Personal Property. i. fidelity..

Amex appealed. The trial court denied Amex’s summary judgment motion. a paramedic working for Amex met a man claiming to be Morales and took blood and urine samples.” The blood samples tested HIV negative. As part of the application process.642 Chapter 37 Suicide clause Subrogation Warranty no payment if suicide within a certain time period insurers get rights of insured after payment insured’s representation no contesting claim after a certain time Incontestability The Court Speaks: Amex Life Assurance Company v. Facts: In January 1991. On his application. Reason: Most states. have enacted statutes that require that an incontestability clause be part of a life insurance contract. Morales sold the policy to Slome Capital Corp. Amex issued Morales a life insurance policy on May 1. The facts can best be ascertained and proved early. including California. rather than waiting until the death of the insured. In California. The court ordered Amex to pay the proceeds of Morales’s life insurance policy to Slome. Amex required Morales to have a medical examination. Although he knew he was HIV (human immunodeficiency virus) positive. All premiums were paid. which was part of the life insurance contract between Morales and Amex. The court noted that incontestability clauses are designed to require the insurer to investigate and act with reasonable promptness if it wishes to deny liability on the grounds of false representation or warranty by the insured. Amex refused to pay. Morales listed his height as 5’6” and his weight as 147 pounds. Therefore. Morales’s fraudulent statements on the life insurance application form and his having an imposter take the physical exam for him does not prohibit payment of life insurance benefits because the two-year incontestability clause had run on May 1. When Slome presented Morales’s policy to Amex for payment. the statute requires a two-year incontestability clause. and Morales did not die until six weeks later. Morales died of AIDS-related causes. The examiner registered the man taking the examination as 5’10” and weighing 172 pounds. . The California Supreme Court held that the incontestability clause prevented Amex from denying coverage. The court of appeals held that the incontestability clause prevented Amex from denying coverage. 1993. 1993. On June 11. the policy included a two-year incontestability clause as required by state law. alleging that Morales had engaged in fraud and had an imposter take his physical examination for him. a vertical company that purchased life insurance policies at a discount from AIDS carriers before their death. The court stated that incontestability clauses apply to fraud claims as well as nonfraud claims. Morales lied on the application form and denied having the AIDS (acquired immune deficiency syndrome) virus. Issue: Does the two-year incontestability clause prevent Amex from raising the insured’s fraud as a reason not to pay the life insurance proceeds? Decision: Yes. (Slome). and appearing to be “older than the stated age. Jose Morales applied for a life insurance policy from Amex Life Assurance Company (Amex). In March 1991. Slome Capital Corp. who can no longer give testimony or defend himself or herself. 1991.

App. and Buder must make up for the losses suffered by the children’s accounts because of his investment of their funds in penny stocks. The court also substituted Sartore for Buder as custodian of the children’s money.App.501 to Cori. have no legal claim to the money. the common law rule applies.2. 1989 Colo. 456 So. on behalf of her minor children. Lexis 227 (Colo. a finder of lost property obtains title to the found property against the whole world except the true owner. State of Florida v. Specifically. The court noted that it is true that under common law the finder of abandoned property—unlike the finder of lost or misplaced property—is entitled to claim absolute ownership of the property. 1985 Ala. Sartore. 1984) Bailment . Civ. 774 P. Green and Vogel asserted that they were entitled to the money because it was property that was abandoned on their premises. Lexis 15340 (Fla.2d 1383. Sheriff Purvis.591 in cash was found. Lexis 1280 (Ala. wins. The court held that Fuentes had not abandoned the money at the time he was removed from the apartment and was taken to the hospital suffering from debilitating gunshot wounds in his neck and shoulder.” Under the common law. Buder v. the state acquires title to unclaimed property if it remains unclaimed by the true owner for more than seven years.3.Personal Property. and Insurance 643 III. If he ever did abandon the money. Green. in return. The common law defines abandoned property as that which the owner voluntarily relinquishes all rights and title thereto. and intelligence would exercise in the management of their own affairs under the same circumstances. Therefore. Sartore. The court held that the boat was “lost property. it was later after the money was in the possession of the City of Miami police.” The court ordered that all penny stocks purchased by Buder using the children’s funds be transferred to him and. are awarded the 16-foot fiberglass boat they found lying beside the roadway in Mobile County. as finders. discretion. Lost Property 37.2d 1309. 1989).591 found in Fuentes’ apartment under the theory of abandonment.2d 1131. Note: The court held that under the Florida Disposition of Unclaimed Property Act. Alabama. The Smiths. Answers to Critical Thinking Cases Gift 37. Therefore. Smith v. the custodian is subject to the “prudent-person rule” when investing on behalf of minors subject to the Act. The court held that Buder had breached this duty when he invested the children’s funds in highly speculative “penny stocks. The court also held that Green and Vogel had no claim to the money as lost or misplaced property or as treasure trove. the court awarded the boat to the Smiths. Bailment. Note: If the true owner subsequently appears to claim the boat.App. and the $58. Abandoned Property 37. he pay $32. Alex and Cori. 1985). App. the court held that Green and Vogel were not entitled to $58. The rule states that in acquiring and investing property for the benefit of others. The court held that a custodian of children’s funds subject to the Uniform Gift to Minors Act (UGMA) owes a duty of care when investing the minor’s money. 474 So. the Smiths must transfer the boat to the owner. Green and Vogel. Since Alabama does not have an estray statute that applies in this case.1. 1984 Fla. a fiduciary is required to exercise the judgment and care under which people of prudence. the owners of the apartment building where Fuentes was shot.598 to Alex and $32.

after receiving the evidence. Merritt merely leased a locker.C. i. To create a bailment.. The bailee is legally obligated to return the property as dictated by the bailment contract.6. Lexis 49 (D. or destroyed because of the bailee’s negligence. In a mutual benefit bailment. Nationwide Warehouse Co. The court defined “gross negligence” as that degree of negligence that shows such an indifference to others as to constitute an utter disregard of prudence. (Nationwide).App. damaged. Merritt v. Further. Hamilton. the presumption of liability applied and that the cleaner failed to rebut the presumption. and did not furnish a key to Nationwide. the bailee owes a duty of reasonable care to protect the bailed goods. The law of bailment provides that a gratuitous bailee owes a duty of slight care to protect bailed property. 1983).4. 1983 Va. stolen.. a bailment was not created between Merritt and Nationwide Warehouse Co. it is because of lack of proper care by the bailee. Evidence showed that the bailee’s place of business had been broken into five days before the burglary in which William’s fur coat presumably was lost and that no major steps were taken to upgrade the physical security of the premises before the second burglary. Gratuitous Bailment 37. stolen. he owes a duty not to be grossly negligent in caring for the bailed goods.e. No. Ltd. Williams. The court in this case held that no bailment was created when Merritt stored his personal possessions in a locker leased from Nationwide. Mahallati v.W. the bailee can avoid liability if it introduces evidence to prove that the loss did not occur because of the bailee’s lack of proper care. locked the premises with his own lock and key.2d 300. The court held that a gratuitous bailment was created when Morris took possession of Hamilton’s watch from the kitchen counter. damaged. 479 A. no bailment was created. Lost Goods 37. or destroyed while in the possession of the bailee. This means that the bailee is liable for any goods that are lost. The creation of a bailment requires actual or constructive delivery of personal property to the bailee.C. Such full delivery must be made as to entitle the bailee to exclude the possession of all other persons and put him in sole custody and control of the bailed property. The court held that a mutual benefit bailment had been created when Williams delivered the fur coat to Debonair Cleaners for cleaning and storage. Ltd. .644 Chapter 37 37. The court. concluded as a matter of law that Morris’ conduct did not constitute gross negligence. The court held that because there was no delivery of the goods by Merritt to Nationwide. there must be a delivery of possession of personal property by the bailor to the bailee. Lexis 338 (Tenn. App.App.2d 51. Morris wins and is not liable for the loss of Hamilton’s watch. A bailment is a delivery of personal property by a bailor to a bailee for a particular purpose. i. 605 S. Morris v. 1980). This was because there was no delivery of the goods to Nationwide as a bailor. 1984).2d 250.e. 302 S.E. This is a rebuttable presumption. the law presumes that if bailed property is lost... Lexis 231 (Va. 1980 Tenn. and therefore she was not liable for the loss of Hamilton’s watch.. The court held Debonair Cleaners liable to Williams for the value of the fur coat. App. Williams wins. It must be such a degree of negligence as would shock fair-minded persons. 1984 D. and Nationwide was not given exclusive possession and control over the goods. The court held that because the fur coat was lost or stolen while in the bailee’s possession.5.

the bailee must show how the loss occurred and that it was due to some other cause than his own. destruction.Y. the disclaimer of liability was not enforceable against Conboy. No. which provides coverage for accidents occurring on the insured’s property.Y. this is merely a lease of a parking space. ordinary bailees can limit their liability to bailors by type of risk or dollar amount by including a disclaimer of liability in the bailment contract.W. Misc. 1982).. The court awarded Conboy damages equal to the fair market value of his new coat. Bailment. therefore. Strauder wins. Allright.8. 449 N. the failure of the bailee to deliver them on demand creates a prima facie case of negligence. Generally.2d 391. App. The court held that a mutual benefit bailment was created when Conboy checked his coat with the coatroom attendant at Studio 54. The court held that the disclaimer sign in the coat/check room was not conspicuous. a bailment was created because Strauder left the keys to his car with the parking lot attendant. Lexis 6006 (Tex. few patrons saw the disclaimer. Parking lot cases pose special problems of characterization as a bailment or not. In this case. Although most homeowner’s policies include personal liability insurance. Richard Usher was forced to pay any judgment against him out of his own pocket.Personal Property. No. Graham Coburn was killed when a Chevrolet van that Usher had been loading was accidentally set in motion. The general rules are: (1) if a person self parks and keeps the keys to his car. the bailee. and the coatroom attendant did not call it to his attention. Ct.9. such disclaimer must be conspicuous to be enforced. Most insurance policies contain such exclusions. Inc. In order to rebut the presumption of negligence. Because his homeowner’s policy did not cover this accident. the bailor. Conboy did not see it. The Court held that the exclusionary clause of the policy was clear and unambiguous and. once goods are delivered from the bailor to the bailee. Civ. The court rendered judgment in favor of Strauder. and Insurance 645 Parking Lot’s Liability 37. National American Insurance Co. limiting the liability of the insurer in certain instances. The burden of coming forward. A mutual benefit bailee owes a duty of reasonable care to protect the bailed goods from loss. v.Y. The court held that Allright failed to prove that it was not negligent. Inc. shifted to Studio 54 when Conboy’s coat could not be located. App.S. there was no coverage for this accident under the policy. Therefore. and (2) if the person leaves his keys with a parking lot attendant to park the car.7. or theft. The court held that the disclaimer of liability that Studio 54 had posted in the coat/check room was unenforceable. Under traditional bailment law. Inc. In this case. Lexis 3309 (N. against Allright. The court found that a mutual benefit bailment had been created when Strauder delivered his car into the possession of the Houston Allright parking lot attendant. a mutual benefit bailment is created and the bailee owes a duty of reasonable care to protect the bailed automobile. Conboy v. Disclaimer of Liability 37. 1984). this accident is not covered by the homeowner’s policy issued by National America.2d 81. . Usher’s policy excluded from coverage personal injuries occurring during the loading or unloading of motor vehicles.e. accidents of the type involved in this suit had been specifically excluded from coverage by Usher’s policy. a bailment is not created. A bailor makes a presumptive case of negligence against the bailee by proving the bailment and the failure of the bailee to return the property. The court held that Studio 54 failed to rebut the presumption of negligence. Exclusion 37.1984 Tex. Studio 54. tending to show reasonable care. the disclaimer of liability posted by Studio 54 in its coat/check room is not enforceable. Strauder.. i. 679 S. 1982 N. However.

Yes.Rptr. the insured. On July 29.13. Malpractice Insurance 37. The court held that these items represented intangible personal property and not tangible personal property. Nationwide wins.Y. i. an .. 2d 879.14.Y. Johnson. Coburn. Souders v. 501 So. The notice informed Brecher that the policy would lapse if he did not make the overdue payment by that date. 209 Cal. The policy was in effect when the advice was given and thus Travelers is liable. Inc. the insurance company had not received a payment in over two months. In common law. If the policy had a other-driver coverage clause then Munoz would win. Red Roof Inns. 1986 N. Souders. the insurer may cancel the policy. 591. Automobile Insurance 37. meant the physical contents of his home. In this case liability extends to situations where any person is using the insured’s car. 1989).App. Lexis 6579 (Fla. 1987).15. Therefore. as a party to the insurance contract. Mutual Life Insurance Co. 3d 914. The court held that the word “contents” as used by Dr. is under an obligation to perform a number of duties.. Mutual Life sent Brecher a notice that it had been unable to collect the July premium from his checking account and requested payment before August 28. Edwards’ estate win. Brecher v. 1989 Cal. The court held against Souders and awarded the stocks and passbook and other bank statements to the residual legatees of Dr. Neither of these seem to apply here. Yes. App. is not liable for the alleged value of the jewelry contained in Nova Stylings sample jewelry case.000 claim. 257 Cal. The legatees of the residual portion of Dr. Ronald W. The insured. This is a form of omnibus or other-driver clause which protects the owner when someone else is driving the car with the owners permission. 37. had agreed to pay monthly premiums to Mutual Life totaling $7. Edwards’ estate.Y. 1983. The insured must pay the agreed-upon premiums to the insurer for the insurance coverage he has purchased. Edwards’ condominium. and are entitled to the stock certificates and the passbook and other bank account statements found in Dr.App.2d 745. his widow could not collect from the insurance company.S. App.10. App. which was stolen from the Inn.830 a year. Because Brecher had failed to pay his premiums. Among these duties is the duty to pay premiums.646 Chapter 37 of California v. Mutual Life wins and is not liable for the $100. Insurance 37.000 life insurance policy issued by Mutual Life. App. 56512 (N.12. Lexis 356 (Cal.11. In this case. Div. 1986). If an insured fails to pay the required premiums. IV: Answers to Business Ethics Cases 37. at the time of Brecher’s death on September 18. App. The stepson. No. Automobile Insurance 37. and the like. the tangible personal property such as the furniture. 501 N. such as the stock certificates and passbook and other bank accounts that he stored in his condominium for safekeeping. Edwards did not include intangible personal property. Although Brecher sent Mutual Life a check. 1987 Fla. dishes. Additionally we are not told if this is an uninsured vehicle whereby Munoz could also win. These premiums were to be paid in consideration for a $100. Alex Brecher.e. the bank dishonored the check.

v. Jack Sonneveldt is president of Sonneveldt Inc. Inc. the court held that the Red Roof Inns was not liable to Nova Stylings for the loss of the sample jewelry bag. Sonneveldt parked his motor coach at the hotel’s general parking lot because it would not fit into the hotel’s valet parking area. Holding No. Therefore. Mr. Lexis 469 (Kan. Nova Stylings. N. (1992) United States District Court. claim the policy proceeds. and Michigan Mutual paid Sonneveldt.000. v. and is insured for losses by Michigan Mutual Insurance Co. As subrogee for Sonneveldt. In October 1988. At the direction of Marriott employees. Issue Was a bailment created? 4.D. Great American wins. The United States District Court for the Northern District of Illinois held that no bailment had been created. Mr. The innkeeper has no dollar liability if the guest does not meet these requirements. Inc. The court held that Red Roof Inns had complied with the requirements of the statute. Ruston’s room. The motor coach was stolen. . The evidence showed that Red Roof Inn properly posted the required notice in Ms. Red Roof Inns.Personal Property. Inc. Citation. Most states. The hotel is operated by the Marriott Corporation. Marriott Corporation 1992 WL 82498 N. Michigan Mutual now seeks reimbursement for the loss from Marriott. This was an obvious lie and fraud. E. C. 3. have adopted statutes that abrogate this common law rule and limit an innkeeper’s liability if certain statutory requirements are met.00 for its loss. AMD had fraudulently and unethically represented the condition of the property prior to purchasing the insurance and cannot.2d 107.D. including Kansas. $265.16. and Marriott Incorporated was not responsible for the loss of the coach. For the act to apply. ILL. Kansas Statute Section 36-402(b) limits an innkeeper’s liability to$250 if the guest notifies the innkeeper of the nature of the merchandise and gives the innkeeper an itemized list of the property. the innkeeper is required to post a notice containing the requirements of Section 36-402(b) in the guest’s room. V. 747 P. and Insurance 647 innkeeper was strictly liable for guests’ property that was lost or stolen from the possession of the innkeeper. B. The evidence further showed that Ruston did not notify the hotel clerk that Kulwin’s bag contained sample jewelry or give the clerk an itemized list of the property in the bag. and Court Michigan Mutual Insurance Co. Sonneveldt was a paying guest at the O’Hare Hotel in Chicago. D. Incorporated by claiming that a bailment was created when the coach was parked on its property. Bailment. Answer to “Briefing the Case” Writing Assignment: 1. Key Facts A. Illinois 2. 1987 Kan. Case Name. 37. therefore.. 1987).

B. Court’s Reasoning A. Here. An agreement to take possession of the plaintiff’s property. 2. Therefore. and the complaint by Michigan Mutual failed as a matter of law. because the keys to the coach were at no time controlled by Marriott Incorporated. D. . C. 3. a bailment did not take place. Delivery of the property to the defendant’s exclusive possession and control. no prima facie case is made against Marriott Incorporated. A failure to return the property by the defendant. The defendant motion for a judgment on the pleadings was granted. A prima facie claim for a bailment must show the following elements: 1.648 Chapter 37 5.

air rights. much valuable land has been used for railroads because of the early development of our nation’s transportation infrastructure. Teacher to Teacher Dialogue Real Property This chapter tends to be an eye opener for the students in that. In the mid-1800s. and Chicago Title had guaranteed the railroad’s title. Yet much of that land can and does have additional or alternative uses by way of development of the air rights over the land. The state of Illinois objected. it is critically important to our economic system because of this large dollar outlay. students quickly come to appreciate the importance of real property law in both their business and personal lives. ownership and the rights and duties that arise out of the ownership of real property. office buildings.” It connotes the .Real Property and Landlord-Tenant Law 649 Chapter 38 Real Property and Landlord-Tenant Law What Do You Really Own? I. For many years. As such. This chapter is designed to introduce students to the law of real property from two key perspectives: first. One of the most basic terms used in the law of real estate is “fee simple absolute. the railroad wanted to build a billion dollar development of hotels. the state of Illinois had granted to the Illinois Central Railroad a grant “in fee simple” of land along the lakefront of Chicago to be used for railroad development. and shopping malls by selling the air over its railroad tracks. while they already have a basic grasp of real property as tenants. In the late 1960s. Chicago had long been considered the original hub of the railway universe. Real property represents the largest single outlay most people make in the course of their earning years. they generally do not have much contact with the law of real estate as it relates to issues of minerals. coownership. The Illinois Supreme Court eventually reaffirmed the basic definition of “fee simple absolute” to include air rights (subject to zoning restrictions). it might be useful to describe some of the changes going on in major metropolitan areas. Real estate is not only necessary as a matter of physical survival. To introduce students to the law of air rights. use of real property and the respective rights and duties that can arise out of that use vis-à-vis others. the price of keeping a roof over one’s head will still probably be their biggest expense. Even if they choose to rent. this chapter allows you to broaden their horizons beyond the metes and bounds of what they can immediately see before them. and the like. By using such examples. and second.

business planning. The disturbing aspect of this particular economic and sociological measure is that recent history has witnessed a decline in the number of Americans who can realistically aspire to own their own homes. Between market limitations of supply and the tenant’s lesser economic bargaining position. This chapter also examines some of the main land use statutes used in this country. in turn. will get involved with coownership of property. It is round. Another way to look at real estate as a circular object is in the physical shape of the earth. with no limitation on inheritability. real estate extends theoretically to the center of the earth in minerals below the surface and in development of air rights. Think of fee simple absolute as the whole pie. the laws involving the rights. The basic parameters of that ownership start with the surface rights as defined by the surveyed metes and bounds in the legal description. and obligations of persons involved in nonfreehold estates of all sorts become increasingly important. when. Even if one’s property is entirely his own. More modern attitudes and statutory enactments have given the tenant a more even playing field.S. the law moves away from its first and second tier treatment based on ownership and looks instead more to the common good. The most difficult topic of negotiable instruments is made much easier by illustrating the rules of the UCC as they relate to the student’s own checking account relationship with his or her bank. the percentage of home ownership is very low. finance. and where coownership rights and duties are created is as important as the basic terms of real property law itself. So too can you generate interest and discussion regarding landlord/tenant law by asking students to tell their own war stories of finding housing at college. he or she will need to know the rules of the coownership game for purposes of credit. Most of us. How. duties. This achievement has been one of the foundations of the great middle class dream of Americans and certainly a stabilizing influence in our society. but not real parity. This includes not only a financial return but also a return on the investment. . An interesting comparative measure of the U. With over half of our population now living under someone else’s roof. Landlord-Tenant Relationship One sure way to engage student interest in a topic is to build on their personal experiences outside the classroom. Anyone who shares property interests by gift. and along with them is the notion that an owner can do whatever he or she wants with his property.S. Here. Anyone who is married is a likely coowner. the legitimate claims of both sides must be listened to. Our economy has traditionally boasted of a high percentage of home ownership relative to most any other part of the world. The landlord is entitled to a fair return on his or her investment. Income property should be protected from waste and harm just like any other property. Both these rights are subject to use limitations and the rights of other owners of adjoining properties. the law of leasing needs constant and fair reexamination and updating. The other interesting aspect of this chapter goes into more detail on forms of coownership of property. Land use is simply too important and too interwoven with the rights of others to adapt a laissez-faire attitude. It is infinite.650 Chapter 38 highest form of recognized ownership in real property. may be sliced and diced into all sorts of smaller morsels. In many countries. That pie. and each ownership of land is a unique wedge-shaped slice of that round body. Conversely. inheritance. As the percentage goes down. or earnings is likely to be a coowner. way of life is the percentage of home ownership versus rental. As in any such process. the common law can hardly have been accused of being the tenant’s friend in the past. the bargaining power between landlord and tenant has never been entirely equal. Even in more highly developed parts of the world like Western Europe. sooner or later. the percentage has been much lower than in the U. and does not end upon the happening of any event. and the like. In addition to those rights. The days of wide-open spaces are long gone.

II. safety. But where government sets up measures that are unreasonable and even confiscatory. On the owner’s and user’s side of the equation. Zoning laws have been criticized as an invidious subterfuge to extend governmental control too far into our personal lives. Good zoning controlled growth and other governmental regulations can and do provide enlightened measures towards those goals. environmentally sensitive uses of land. and welfare of its citizenry through the use of its police power on land use. however. a problem is created. quiet. public policy wants free. We must. Text Materials Contemporary Trend: Air Rights: Value in the Heavens This discusses the value of air rights.Real Property and Landlord-Tenant Law 651 Various branches of government must perform the constant balancing act. but also depreciation of the American Dream. The results are not only higher costs of doing business. keep in mind that the government does have the duty to assure the health. .

652 Chapter 38 .

Real Property and Landlord-Tenant Law 653 .

” They occupied the premises until they ended their relationship when Hastings took sole possession.654 Chapter 38 The Court Speaks: Cunningham v. Hastings made the down payment and the property was deeded to them as “joint tenants with the right of survivorship. upon partition and sale. Tenants have an equal right to share in the enjoyment of the land during their lives. The court ordered the sale of the property since it could not be partitioned. Reason: The deed created a joint tenancy in the property. Hastings Facts: Cunningham and Hastings. the court ordered the proceeds be divided between the partners equally after Hastings was paid the amount of his down payment. . Because there are two tenants. who were unmarried. Therefore. Cunningham sought to have the property partitioned. each has a right to one-half of the proceeds. Cunningham appealed. and not as tenants in common. Issue: What interest did Cunningham have in the property? Decision: The court reversed ordering equal division of the proceeds without allowance for the down payment. each owns a one-half interest regardless of whose funds were used to acquire the land. Furthermore. purchased a house together.

Real Property and Landlord-Tenant Law 655 .

Issue: Had the elements for adverse possession been met? Decision/Remedy: Yes. In 1988. Asfaw and Tunus . Reason: The following elements of adverse possession had been met: • Notorious and open occupation • Actual and exclusive • Hostile and adverse • Continuous and peaceful • Far over the statutory period of 10 years. Neither party realized that there was an encroachment.656 Chapter 38 The Court Speaks: Witt v. the Shaughnessey’s sold the 4-acre tract to Miller whose survey showed the Witts’ encroachment. The Court Speaks: Johnson v. Witts built a house and moved in. Miller The Facts: Witt purchased land in 1967 adjacent to a 4-acre tract kept by the Shaughnessey’s after they had purchased and divided adjacent property. Miller sued to quiet title. In 1968 they cleared land extending 40 feet onto the 4-acre tract on which they had made many outward improvements. The court held no adverse possession. The decision was reversed and an order issuing quiet title in favor of the Witts was entered.

in a weeded area. almost landlocked. One year later Johnson developed the adjacent lot to build a house on it. Reason: For adverse possession there must be possession for at least 10 years that is open and notorious. Judgment was affirmed. It is not open and notorious and thus does not constitute actual possession of the land. planning to use the access strip as a driveway. A&T sought title to the strip through adverse possession. This by itself does not advertise their claim on the land. property. Johnson filed for quiet title to the access strip. . and hostile. They planted 6 flowers on the access strip of an adjacent. Issue: Had the elements of adverse possession been met? Decision: No. Ten years later Asfaw and Tunus (A&T) bought the Sauders’ property. actual and uninterrupted. They did nothing else to the strip.Real Property and Landlord-Tenant Law 657 Facts: The Sauders bought a home in Washington. Here there was only a random planting of 6 flowers. Grantor Grantee transferor transferee Note: Grantor must transfer marketable title or good title. A&T appealed. The trial court guaranteed summary judgment quieting the title in Johnson.

Summary judgment was granted. Brunson sold the property to the Ijalba’s and delivered a deed that was property recorded. The Ijalba’s and Chrysler filed motions for summary judgment. Howard brings foreclosure against the property due to Brunson’s default and claimed the property over Ijalba’s deed and Chrysler’s mortgage. Howard’s mortgage from 2 years earlier was then indexed. Reason: Using the index in a title search is reasonable. Brunson Facts: Brunson bought land and had a deed property recorded. The mortgagee has a duty to make sure the mortgage is properly indexed.658 Chapter 38 The Court Speaks: The Howard Savings Bank v. but the records did not list it in its index for recorded documents. He borrowed &50. . The Ijalba’s borrowed money from Chrysler secured by a property recorded and indexed mortgage. Issue: Was Howard’s mortgage property recorded and indexed so as to give notice of its existence to subsequent parties? Decision” No.000 from Howard with a mortgage that was properly recorded.

a tract of land in Sussex County known as “Bluff Point. Bluff Point was sold in fee simple absolute apart from the other holdings. and Walker objected. thereby land locking the parcel. .” The tract is surrounded on three sides by Rehoboth Bay and is landlocked on the fourth side by land owned by Irvin C.Real Property and Landlord-Tenant Law 659 The Court Speaks: Walker v. The trial court granted the easement. Ayres Facts: Elizabeth Ayres and Clara Quillen own. Walker. At one time. The easement was created by necessity because Bluff Point was landlocked and its only access was over Walker’s property. Issue: Should Ayres’ and Quillen’s estate be granted an easement against Walker’s estate? Decision: Yes. Ayres and Quillen sought an easement to use a narrow public road. Reason: An easement appurtenant had been created between two adjacent parcels of property when Bluff Point was separated from the rest of the holdings in 1878. the tracts were held in common. in fee simple absolute. In 1878. the only means of access.

.660 Chapter 38 Note: The rental agreement is called the lease.

Real Property and Landlord-Tenant Law 661 .

662 Chapter 38 Note: If the landlord causes the leased premises to become unfit for intended use. Can: - - Withhold rent Repair and deduct Cancel lease Sue . this is called constructive eviction.

Remedies include withholding rent. Reason: The premises are to be maintained in accordance with the “reasonable expectations” of the tenant.(poor running of water. Landlords owe a duty of reasonable care to tenants and 3rd parties. In this case the higher rents. Feld. Certain amenities fall under this protection. Issue: Did the landlord breech the implied warranty of habitability? Decision: Yes.5 million in punitive damages to each. Predictability and reliability of services is another factor. The Court Speaks: Solew v. Wellner Facts: 80 tenants of a luxury apartment building in Manhattan were the rents were very high engaged in a rent strike putting a long list of deteriorating conditions. and suitable for ordinary residential use. They were both psychologically damaged to a severe state. Reason: Landlord has a duty to protect tenants from the foreseeable criminal actions of 3rd persons. Feld. There were 2 entrances to the grounds and 2 entrances to the garage. Issue: Is Cedarbrook liable for the criminal attack on the Felds? Decision: Yes. The trial court’s judgment was affirmed except for a reduction to $750. $1million to Mr. Note: Premises Liability A tenant owes a duty of reasonable care to persons who enter upon leased premises. Feld.Real Property and Landlord-Tenant Law 663 Note: Many jurisdictions apply the implied warranty of habitability stating that the premises must be fit. The Court Speaks: Feld v. This follows establishing a prima facie case of negligence for inadequate security and notice of criminal activity that he could have helped alleviate and that his failure was proximate cause of the tenant’s injuries. missing public fixtures. cancel. The tenants wanted rent abatement for breech of the implied warranty of habitability. repair and deduct. the building itself. The facility had seen an increasing crime rate. As they walked toward the pedestrian exit.000 in punitive damages to Mr. . The rent was abated by about 70% in total. they were jumped and robbed at gunpoint and Mrs. and the brochure produce certain obvious expectations which include many of the items in question. and $1. safe. Cedarbrook appealed. and broken air conditioners) The landlord sued to recover rent. or sue. The Felds sued and won $2million in compensatory damages to Mrs. stench and mice near the garbage. There was clear evidence of problems in this case. wet mailboxes. Merriam Facts: The Felds drove into the Cedarbrook Complex (owned by Merriam) of which they were tenants and parked in the garage. The landlord was also required to pay the tenants’ attorneys’ fees. Feld was raped.

.664 Chapter 38 Contemporary Issue: Rent Control This discusses rent control ordinances that stipulate the amount of rent a landlord can charge for residential housing.

Real Property and Landlord-Tenant Law 665 .

2 car parking). Board of permits agreed. D/B/A Stratosphere Resort & Casino v. The public protested due to increased traffic and noise.000-square-foot house (5 bedrooms. The court said no and Stratosphere appealed. This would be in a permitted zoning district and needed no variance. Such terms are consistent with this decision. Las Vegas City Council acted lawfully. The Board and Commission may use discretion which is permitted and may thus consider the effect of the proposed project upon the surrounding properties.” Two years later they exercised their review power. The Court speaks: Stratosphere Gaming Corporation. Stratosphere appealed to the district court seeking a declaration allowing it to build within a properly zoned area. The City Council denied the application (6-0 vote). . and welfare. “Edgehill Woods. safety. Building permit application denied.666 Chapter 38 The Court speaks: Guinnane v. Reason: The ordinance was enacted pursuant to the city’s police power to protect its residents’ health. It met the code but the SF Planning Commission said no as “not in character” with the neighborhood. City of Las Vegas. Guinnane appealed. One year later SF designated an area. 5 baths. including Guinnane’s property. Guinnane applied for a permit for a large 6. Ju