You are on page 1of 720

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.

Pearson Prentice Hall. All rights reserved. Printed in the United States of America. This publication is protected by Copyright and permission should be obtained from the publisher prior to any prohibited reproduction, storage in a retrieval system, or transmission in any form or by any means, electronic, mechanical, photocopying, recording, or likewise. For information regarding permission(s), write to: Rights and Permissions Department. This work is protected by United States copyright laws and is provided solely for the use of instructors in teaching their courses and assessing student learning. Dissemination or sale of any part of this work (including on the World Wide Web) will destroy the integrity of the work and is not permitted. The work and materials from it should never be made available to students except by instructors using the accompanying text in their classes. All recipients of this work are expected to abide by these restrictions and to honor the intended pedagogical purposes and the needs of other instructors who rely on these materials. Pearson Prentice HallTM is a trademark of Pearson Education, Inc. 10 9 8 7 6 5 4 3 2 1 ISBN-13: 978-0-13-601502-4 ISBN-10: 0-13-601502-6

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

iii

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

iv

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

Bollinger Facts: Grutter was denied admission to Michigan’s law school. Grutter v. 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. The school used race as one of the factors (“a plus factor”) in the admissions process. Hispanic. was denied admission to the University of Michigan.Legal Heritage and the Information Age 11 The Supreme Court speaks on Affirmative Action: Gratz v Bollinger Facts: Gratz. she would have received an automatic extra 20 points giving her a score of over 100 and automatic admission. Remedy: The Supreme Court reversed and remanded the case for further proceedings. 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. or Native American. If she had been a Black. This is an appeal from a reversal of a . as statesupported school. Reason: The analysis failed the strict scrutiny test. a Caucasian female.

Ed. that position is well founded.e. Reason: Unlike the prior case. That these premises. conditions and benefits of employment. 2646. III. special needs and presumed weaknesses. 57. Director of the Selective Service v. Answers to Ethics Cases 1. 695 (Ill. an ignorance that cannot be destroyed or offers no moral reason for doing so. Moralists might label this ignorance as excusable in that it is “invincible. 453 U. 69 L.” i. It almost certainly would not be lawful today. whether equality was being served as a matter of fairness. v.” W. Of course. 91 N. were subject to certain weaknesses. 1910). in a class action suit. It is likely that legislators entertained an unconscious premise that women should not be required to fight a war. Wayman.C. . Goldberg. but Title VII of the Civil Rights Act of 1964 prohibits any discrimination on the basis of sex in the “terms. Most students will react that the statute is unfair as it does not afford women equal status in the workplace.E. Ritchie & Co. In light of today’s standards. This speculation might be supported by the fact that the majority of the Supreme Court summoned a technical legal point to justify their ruling. 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.2.2d 478 (1981). The Court held that Congress was the proper party to articulate the public policy that women should not fight at the front. IV.. The law has not been progressive in this instance.. the legislature presumably entertained the view that women had special needs.S. i. i. Answers to Critical Legal Thinking Cases Flexibility of the Law 1. race is only one individualized factor.12 Chapter 1 district court’s ruling in favor of Grutter who alleged. Not only have the items relevant to the test of equal protection broadened under present constitutional interpretations.e. thereby removing themselves from any further consideration of the substantive issue. 101 S. However. it is a useful exercise to consider arguments for the opposite position in the context of the time period. modern experience and knowledge require that we question these premises. and therefore the demands made on them had to be accommodated in the workplace.1. In enacting such a statute. Rostker. might be false does not necessarily preclude one from acting morally. The Supreme Court affirmed the decision of the Court of Appeals.Ct.e.. The better case is made by the dissent.

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

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

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. To watch students as they uncover the mysteries found in this document is well worth the effort. and the balancing of rights among the often-competing sovereigns of federal and state government. II. for many legal academics.S. This underscores the importance of the courts. The concepts of federalism. teaching efforts might best be concentrated on two main objectives: 1. The enumeration of key individual civil liberties protections listed in the Bill of Rights with an extrapolation of those same theories to business. because of the breadth of materials covered. The only major drawback to this material is the frustration of having the time constraints inherent in a survey course. Text Materials *The key objective of this chapter is to introduce students to the role of the U. dual sovereignty. 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. The most impressive fact that surfaces in the study of the Constitution is that it never changes but it always changes. Teacher to Teacher Dialogue Constitutional law is. 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. In all likelihood. 2. . 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.S. 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. the lecture/discussion format will work best for purposes of illustrating as much of the material as possible in the time allowed.

16 Chapter 2 .

Constitutional Law for Business and E-Commerce 17 .

Appoints judges and justices 5. Veto power . Check on constitutionality of actions 2. Creates courts and deals with jurisdiction 4.18 Chapter 2 Executive 5 4 2 1 1 Legislative 3 Judicial 1. Consents to treaties and approves appointees 3.

Minnesota argues the rights ended in 1858 with their entrance into the Union. The Supreme Court speaks: Crosby. 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. U. Decision of the U. The material also discusses the Bureau of Indian Affairs and the Indian Health Service. 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.S. regulate. fishing. and collect taxes. Judgment was vacated and the case was remanded. Reason: What would be the use of having federal standards if any state could change? The Supreme Court speaks: Minnesota V. District Facts: South Coast. Issue: Are the hunting. Minnesota appeals. Assoc. Court of Appeals was affirmed. and other rights guaranteed to the Ojibwe Indians by the 1837 teaty still valid and enforceable? Decision: Yes. Issue: Are South Coast’s Fleet Rules preempted by the federal Clean Air Act? Decision: Yes. Reason: There is no clear evidence of congressional intent to abrogate the Treaty rights in Minnesota”s enabling act. In 1990 Mille Lacs Band of the Ojibwe Indians sued seeking enforcement of the rights. Court of Appeals affirming a U.Constitutional Law for Business and E-Commerce 19 The Supreme Court speaks: Engine Mfgrs. sues claiming preemption of state rules. District Court decision.S. From a ruling in favor of the Ojibwe Indians of the U. The Assoc. a state of California entity.S.S. v South Coast Air Quality Mgt. Secretary of Administration and Finance of MA v. Tribal Council’s govern. 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 . Court of Appeals upheld the District Court’s decision to uphold the rules.

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

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

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

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

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

.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. b) Symbolic speech is also protected c) State can define what constitutes obscene speech. Under the 14th amendment actions of state and local governments are also given constitutional scrutiny.

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

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

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

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 - - .

The U. Fundamental Rights and Duties of Citizens are explained in this box.S. III. 450 U.S. Also.S. Ed. Commerce and Supremacy Clauses 2.1. any state law which directly conflicts with valid federal law fails. Under the Supremacy Clause of the U. The federal rules were set so that these standards would be uniform across the country and would also comply with international standards. 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. However. 435 U.Ct.Ct. 579. 98 S. . Youngstown Company v. When Congress enacted the Ports and Waterways Safety Act and set the design and length standards for oil tankers.S.Ct.2d 580 (1981). Kassel v. The Supreme Court held that because of these reasons. and that all other states permitted the larger 65-foot double trailers. Consolidated Freightways Corporation. Supreme Court held that the President’s seizure of the steel mills was a violation of separation of powers and unconstitutional. these laws cannot directly conflict with valid federal laws or unduly burden interstate commerce. Secretary of Commerce. it considered the safety of the vessels and the environment. rather than size of vehicle. 96 L. 988. 1153 (1952). Constitution. 72 S. Constitution. the Iowa statute must be examined to see if it creates an undue burden on interstate commerce. and welfare of its citizens. Iowa’s statute limiting vehicles to 55 feet unduly burdened interstate commerce in violation of the Commerce Clause and was therefore unconstitutional. The court held that the seizure order could not stand. Supreme Court held that the Washington State statute—which mandated different boat designs and smaller lengths of vessels—directly conflicted with the federal law. The U. The U. Atlantic Richfield Company. 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.S. Since the federal government had not chosen to regulate the size of vehicles that use the highways (a “naked” Commerce Clause). which states that federal law is the supreme law of the land. 662. 67 L. The Supreme Court rejected this argument. The Supreme Court held that the state statute directly conflicted with the federal statute and violated the Supremacy Clause.2d 179 (1978. The United States Supreme Court held that the Iowa statute created an undue burden on interstate commerce. 863. 101 S. Answers to Critical Thinking Cases Separation of Powers 2.30 Chapter 2 International Law: Constitution of the People’s Republic of China Selected provisions of Chapter 2. Sawyer. health. 1309. Governor of Washington v. the court held that if trucks were diverted around Iowa. No. finding that traffic accidents are based on the number of miles driven.) Undue Burden on Interstate Commerce 2. Constitution reserves the right to enact laws and regulations to protect the safety. The U.S.S. Ray.3. ARCO wins.Ed. the Iowa statute that limits the length of vehicles to 55 feet is unconstitutional. 151.2. Iowa was “exporting” accidents to other states. Therefore two smaller trucks crossing Iowa would cause more accidents than one larger truck. 55 L.Ed. 343 U.S.S.

such as print media.Constitutional Law for Business and E-Commerce 31 Privileges and Immunities Clause 2. and manner restrictions. 71 L. Under substantive due process. The U. The court reasoned that advertisers had other forms of speech to reach consumers.2d 800 (1981). Inc. The U.S. Yes. What is involved in this case is commercial speech.S.2d 362 (1982). 101 S.S. it is accorded a lesser protection than other constitutionally guaranteed expressions. Inc. Metromedia.S. place and manner restriction on commercial speech and did not violate the First Amendment.4. 518.S. 437 U. 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. Hicklin v. 102 S. 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. 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. 490. No. . 2482. it is unconstitutional as a violation of due process.Ed. In this case.Ed. Commercial Speech 2.Ed. place. 453 U. The Supreme Court held that the village’s ordinance was facially clear.2d 397 (1978). this clause prohibits a state from favoring its residents over residents of other states in granting privileges or rights. The Supreme Court held that the village’s licensing ordinance was clear on its face and complied with substantive due process. Substantive Due Process 2. a law is required to be clear enough on its face so that a normal citizen could read and understand it. 2882. Flipside.Ct. handbills. The Supreme Court held that commercial speech is subject to proper time. City of San Diego. v. Orbeck. 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. 455 U.” The Supreme Court held that the Alaska Hire statute cannot withstand constitutional scrutiny. and that in the long run prosperity and salvation are in union and not division. The Supreme Court held that the San Diego zoning ordinance was a proper time. Village of Hoffman Estates v. 1186. Constitution provides that “the citizens of each state shall be entitled to all privileges and immunities of citizens in the several states. Constitution..5. 489.” With few exceptions.S. 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. 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. the Alaska Hire statute is not constitutional. Hoffman Estates. 98 S. The Village of Hoffman Estates wins.S.Ct.S. 57 L. television and radio commercials. 69 L. Commissioner of the Department of Labor of Alaska.Ct. Vague laws may trap the innocent by not providing fair warning of what is expected. the City of San Diego’s zoning ordinance which prohibits commercial billboards within the city is lawful. The Privileges and Immunities Clause of the U. The U.6. If a statute is overly vague. 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.

32 Chapter 2 Equal Protection Clause 2.Ed. B. Metropolitan Life Insurance Company (Metropolitan) wins. Appellees’ prosecution for burning a flag in violation of the Act is inconsistent with the First Amendment. principal of Nathan Bishop Middle School in Providence invited Rabbi Leslie Gutterman to deliver prayers at the school’s graduation. Metropolitan Life Insurance Company v. City of Oakland. some of which own these stadiums. 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. Key Facts A. By preventing the relocation of the franchise. 153 (Cal. Robert E. The court found no rational basis for the discriminatory tax. no matter what the cost to foreign corporations also seeking to do business in the state.Ed. 2404. Answers to Ethics Cases 2.S. Rptr. V.8. which is the very kind of parochial meddling that the Commerce Clause was designed to prohibit. Lee. Oakland Raiders. 1985). 174 C. promotion of domestic business by discrimination against nonresident competitors is not a legitimate state purpose.” .” The court held that under the circumstances. 220 Cal. Constitution.Ct. Constitution. 310. So the threat of eminent domain proceedings in other cities throughout the nation would affect national commerce in this industry. the Government may not prohibit the expression of an idea simply because society finds the idea itself offensive or disagreeable. Eichman. 1676. 2649 (1992) United States Supreme Court 2. D. Ward. The cost of stadium leases would be affected by the shift in bargaining power to the cities. and scurrilous caricatures is deeply offensive to many.I. C. and held it to be an unconstitutional violation of the Equal Protection Clause of the Fourteenth Amendment to the U. Answer to “Briefing the Case” Writing Assignment: 1. 3d 414. IV. 496 U. The policy of public schools in Providence. R. These invitations were issued at the discretion of school principals. like virulent ethnic and religious epithets. 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. 110 L. United States v. The Supreme Court found that Alabama’s aim was purely and completely discriminatory.2d 287 (1990). Weisman 112 S. 110 S. Case Name. The income derived from TV and radio contracts would also be impaired.S. While flag desecration. Citation. has been to invite members of the clergy to give invocations and benedictions at middle and high school graduations.Ct.9. Rabbi Gutterman followed the school’s guidelines for such prayers as set out in “Guidelines for Civic Occasions.7. 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. A.S. designed only to favor domestic industry within the state. 105 S.Ct. 84 L. vulgar repudiations of the draft. App. 470 U. the city would affect gate receipts that provide revenue for all the clubs that play with the Raiders. Not all of them elected to take part. 2. and Court Lee v. 689. Commissioner of Insurance of Alabama. California v.2d 751 (1985).S.

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

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

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 .

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

.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.S. Supreme Court.S. Supreme Court” This discusses the process necessary to win a review by the U.

→Needed to bring a suit →Needed to hear a case: -Subject matter -In Personam →Venue is site of suit within a jurisdiction. Diversity – no plaintiff is a citizen of the same state as that of any defendant. treaties or federal statutes and regulations. (2) Litigation expense is reduced for both parties if they both know where suits can be brought. The Supreme Court Speaks: Carnival Cruise Lines. v. However.Court Systems and Jurisdiction 43 Federal Question – case arising under U. The suit was filed in Washington. 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.. The Washington appellate court reversed the trial court and the defendant appealed to the United States Supreme Court.S. Inc. Constitution. . Shute Facts: Mrs. J. The forum clause is fundamentally fair. 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. Reason: Blackmun. (Carnival) for injuries suffered while she was a passenger aboard one of its ships. Shute sued Carnival Cruise Lines. Issue: Is the forum selection clause in the contract enforceable? Decision: Reversed. Inc.

Yes. such as this one brought by Nutrilab. the case could be removed to federal court. therefore.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.S.. 237 Cal. Part of this limited jurisdiction is to hear cases involving federal questions. Since the amount in question was satisfied. Federal courts have original jurisdiction to hear federal question cases. Federal courts have concurrent jurisdiction over cases involving parties with diverse citizenship. Justice King believed that this lawsuit is an absurd waste of the resources of the courts and of the taxpayers’ money. Allison v. Te case can be removed to a federal court on the basis of diversity of citizenship. a citizen of a state and a citizen of a foreign country. Miss. and federal statutes and regulations. Dist Lexis 607 (S. granted to them by the Constitution and Congress. Answers to Critical Thinking Cases Federal Question 3. VI. “the law disregards trifles. Yes. App. At present the states vary from limited Internet activity being needed for jurisdiction to outside contracts also being required. ITE Imperial Corp. Rptr. No. If a case over which the federal courts have concurrent jurisdiction is brought in a state court.App. the federal courts have the jurisdiction to hear Nutrilab’s case. 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. 3d 449. i. The amount in question must be satisfied. Constitution. 1990 U. Nutrilab. 1987).S. 191 C.” the trial court was correct in dismissing the case. Inc.2. This could be citizens of different states. Time. 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. 1983). Nutrilab was disputing the FDA’s application of a federal statute to stop their distribution of Starch Blockers. The Starch Blockers case was therefore one arising under a federal statute.D. a citizen of a state and a foreign country where the foreign country is the plaintiff. v. The courts are already too heavily burdened to be used to punish advertisers who use junk mail. 729 F. that involves a federal question must be brought in a federal court. Based on the de minimis theory.). Federal courts have limited jurisdiction.1. Jurisdiction 3. The Zippo case is highlighted. Federal question cases are cases arising under the U. treaties.45. 713 F. Answers to Ethics Cases 3. 2d 335 (7th Cir. Any lawsuit. seems better to permit the reasonable inclusion of a forum selection clause whenever its benefits outweigh its dangers. Harris v.e..3. The lawsuit between Allison and ITE involved a citizen of Mississippi and a citizen of Japan. It. the case can be removed to a federal court. 584 (Cal. A corporation is a citizen of the state of incorporation. and this gave the federal court original jurisdiction to hear the case. . III. Supp. Schweiker.

Answer to “Briefing the Case” Writing Assignment 1. 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.J.Court Systems and Jurisdiction 45 V. 235. 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.2d 630. Holding Yes. 236 A. 2. The defendant said the server said he would leave them outside. 3. A person has an obligation to accept service and one’s own wrongdoing cannot be a reason for not accepting service. 98 NJ Super. Summary of the Court’s Reasoning Service must be effected in such a way as to give notice of service. 5. Lexis 389. The jury’s verdict will stand. She found them on the stoop. . of Bergen County v. 1967 N. Super. Citation and Court Peoples Trust Co. One cannot avoid service by refusing to physically accept them. Kozuck. The Issue Can valid service be effected as done in this case? 4. Case Name.

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

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

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

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

Contemporary Issue: Phases of a Trial This explains the usual phases of a trial. thus barring the plaintiff’s lawsuit. 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. 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. 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. She said she did not see the cases and did not know how long they had been there. . The Court speaks: Toote v. Issue: Should the motion for summary judgment have been granted. prima facie. Pathmark moved for summary judgment which was denied and Pathmark appealed. Reason: The testimony does not establish. Canada Dry and Pathmark Facts: Toote claimed she fell over cases of soda stacked on Pathmark’s floor when she was shopping. Contemporary Issue: Ford Settles Lawsuit Even though this is a very large verdict. Decision: No. it is an example of the hundreds of thousands of civil lawsuits settled out of court every year.

vacating the verdict in favor of the Ferlitos. and infant care. 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. Following a jury verdict entered for plaintiffs.. Issue: Should defendant JJP’s motion for j. The flame passed close to his left arm. Ferlito). Experts were introduced but Marley claimed they were not reliable after a verdict was brought in against Marley.n. Inc. its intended uses are for cleansing. attended a Halloween party in 1984 dressed as Mary (Mrs.v. The costume covered Mr. As described on the product’s package.n. 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? . Alternative and Online Dispute Resolution 51 The Court Speaks: Ferlito v. Susan Ferlito testified that the idea for the costume was hers alone. Ferlito from his head to his ankles.o. 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. Wrongful death action was brought alleging a defect in a Marley electric baseboard heater that caused the fire causing the death. The Supreme Court speaks: Weisgram v. and the cotton batting on his left sleeve ignited. husband and wife. be granted? Decision: The trial court granted JJP’s motion for j. Weisgram appealed. Mrs. 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. Administrative. She had also used defendant’s product to fashion a headpiece. applying medications. The court of appeals agreed with Marley. defendant JJP filed a timely motion for judgment (not withstanding) the verdict. Plaintiffs sued defendant for injuries they suffered from burns that covered approximately one-third of Mr. At the party Mr.Judicial. Marley Company Facts: Weisgram died from carbon monoxide poisoning.v. Ferlito attempted to light his cigarette by using a butane lighter. complete with ears. which were blackened with Halloween paint.o. Facts: Plaintiffs Susan and Frank Ferlito. Ferlito’s body. Johnson & Johnson Products. except for his face and hands. Ferlito) and her little lamb (Mr.

and the U. This would include not only the traditional methods of settlement. Issue: Are employment contracts subject to arbitration if the parties have entered into a valid arbitration agreement? Decision: Yes. Two years later. The district court granted Circuit City’s request. including the one between Circuit City and Adams are subject to arbitration if a valid arbitration agreement has been executed. and mediation. 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. Circuit City Stores hired Saint Clair Adams as a sales counselor. Circuit City sought to enjoin the court proceeding and to compel arbitration. . The Supreme Court Speaks: Circuit City Stores. Reason: The Supreme Court held that other employment contracts. 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. *One objective of this chapter should be introducing students to the growing number of ADR options available to both businesses and private individuals. Inc. arbitration. Adams Facts: In October 1995. 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. Adams filed an employment discrimination lawsuit against Circuit City.S. v. Landmark Law: Federal Arbitration Act This explains the Federal Arbitration Act and discusses which types of disputes should be arbitrated. the court of appeals reversed. but also newer mechanisms such as the privately conducted mini-trial.52 Chapter 4 Decision: Yes. Supreme Court granted certiorari.

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

Washington. The Supreme Court concluded that the defendants. 1980). a professional entertainer and television personality. The court will only order Schlagenhauf to be examined by an ophthalmologist. 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. App. a contract to stage a fight in that state. 1482. Magna Verde Corp. or who transact other business in the state. 326 U. the defendants are subject to suit in California. 783.54 Chapter 4 International Law: Japan’s Legal System This is an interesting comparison on the legal systems of two major economic powers. that the defendant knew that plaintiff Shirley Jones. Yes. the Oklahoma court gained jurisdiction over Magna Verde through Oklahoma’s long-arm statute. the Oklahoma state court can use the state’s long-arm statute to gain jurisdiction over Magna Verde. A court has the power to order the physical and mental examination of a party to a case. The U.Ed. III.2d 1271 (Okla. 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. 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. Magna Verde had entered into a contract that would affect Oklahoma. Supreme Court held that jurisdiction of the California court over the petitioners.S. v. Answers to Critical Thinking Cases Long-Arm Statute 4.2. However.2d 804 (1984). The Supreme Court applied the rule of International Shoe Co. Magna Verde had also transacted business in Oklahoma. 465 U.S. Minimum Contacts 4. The exercise of long-arm jurisdiction is generally permitted over nonresidents who have a contract that affects the state. 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 . as Florida residents. promoting the O’Grady prizefight. Physical Examination 4. and that the article would have its greatest impact in California. Because of these contacts with the state. Yes. the minimum contacts rule and the Due Process Clause were not violated. must “reasonably anticipate being hauled into court” in California to answer for the truth of the statements made in the article.1.” 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. Calder v. was proper because of their intentional conduct in Florida that was allegedly calculated to cause injury to plaintiff Shirley Jones in California.Ct. Oklahoma’s long-arm statute gave the Oklahoma court jurisdiction over Magna Verde for several reasons. 79 L.. who were residents of Florida.3. 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.S. Brooks v. lived and worked in California. Jones. 310. Thus. 619 P. 104 S. The Court noted that the magazine has its largest circulation in California.

Schlagenhauf v. Four witnesses also testified that they had observed the lights and sirens of the fire engine working. 13 L.V. Because interrogatories are an important part of the discovery process.4. The purpose of interrogatories. 85 S.O.” In this case the only issue was Schlagnehauf’s eyesight.O.V. Interrogatories are usually directed at parties. Therefore.O.2d 152 (1964). is to obtain facts about the case from the other parties and witnesses before the trial begins. Administrative. 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. This information was crucial in determining potential damages in the suit. Because the person answering the interrogatories must sign them under oath.S.2d 1 (2nd Cir.V. These written questions are known as interrogatories. Where Simblest claimed to have had a green light in his favor. Therefore. 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. not witnesses. . The interrogatories that were served upon Cine sought to discover information about its theater’s box office receipts.Ed. 602 F. Simblest v. the plaintiff has failed to introduce evidence sufficient for a reasonable jury to have held for the plaintiff. Cine was required to answer them in a timely and truthful manner.Ct. A party is required by the court to answer the interrogatories in writing within a specified time period. that person must be careful to answer them truthfully.Judicial. Holder. is a motion that asserts that considering the evidence in a light most favorable to the plaintiff. the only examination that the court ordered Schlagenhauf to undergo was one conducted by an ophthalmologist. v. Alternative and Online Dispute Resolution 55 examinations requested. The standard used by the court in this case in deciding whether to start a Judgment N. 379 U. 4. 427 F. is “whether the evidence is such that there can be but one conclusion as to the verdict that reasonable men could have reached. all of the other witnesses stated that the traffic light was not operating. Yes.O. Maynard. Because all of the evidence in this case favored the defendant. 234. In other words.V. like other forms of discovery..5. Cine is required to answer the questions submitted by Allied Artists’ attorneys. all of the testimony of the witnesses directly contradicted the statements of Simblest. Cine Forty-Second Street Theatre Corp.” In this case. A Judgment N. Nor is there anything stated justifying the broad internal medicine examination. Interrogatories are an important part of the legal process known as discovery. 1979). Allied Artists Pictures Corp.2d 1062 (2nd Cir. Interrogatories 4. 1970). in direct contradiction with Simblest’s testimony. the judge granted the defendant’s motion for a Judgment N. Judgment N. 104.

in part. or profane language by means of radio communications.” George Carlin’s “Filthy Words” monologue fit into this definition. To promote the arbitration of disputes.7. and enforceable as long as the agreement is not illegal.Supp. The question here is whether the “action levels” for contaminants in food constitute a legislative rule or not. Radio stations are subject to “time. Yes the FCC regulation and censoring of Pacifica in this case was lawful and constitutional. The court gave the following reasons for enforcing the agreement. Here the FCC did by including broadcasting in its scope which was specifically excluded by the Communications Act. 456 (E. the arbitration agreement between AMF and Brunswick is valid under Federal law. the rights of adults.. Yes. 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. Congress has enacted the Federal Arbitration Act (FAA).8. Rule Making 4. The FDA must follow notice-and-comment procedures in adopting its rules. Administrative Regulation 4. Because of this fact. Rule Making 4. 621 F. The court held that communication broadcasting has the most limited First Amendment protection. Mallen was not entitled to a presuspension hearing. There was no due process violation in this case. The FCC inappropriately treated the cable television industry as a common carrier. The statute in question specifically forbids the use of any “obscene. . Since theses do have a present and binding effect they are legislative rules. the court held that their dispute had to be submitted for arbitration. and manner” restrictions regarding broadcasts. The act provides that arbitration agreements involving “commerce” are valid. 1985).Y. This was beyond the FCC statutory authority. Because AMF and Brunswick had signed an arbitration agreement involving commerce. The Community Nutrition Institute wins. AMF Incorporated v. Justice Brennan wrote a dissent addressing.D. This was done here through an through an immediate suspension.9.6. The comprehensive federal banking laws were meant to protect the public and instill confidence in the banking system.56 Chapter 4 Arbitration 4. the court held that the FAA covered the agreement. place. He can no longer refuse to perform his contract when it becomes disadvantageous to him. Administrative Procedure 4.N. The Communication Act’s prohibition against “indecent” broadcasts was justified because broadcast media is pervasive in our lives and is uniquely accessible to children. irrevocable. Brunswick Corp.10. An agency cannot go beyond its delegated powers. Yes the FCC exceeded its statutory authority in adopting its public access rules for cable television operators. The arbitration agreement between Brunswick and AMF was clearly one involving commerce. indecent. Yes the statute is constitutional and does not violate the due process clause.

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

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. The Court of Appeals affirmed the lower district court decision in favor of Searle. Gnazzo’s condition. 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. 5. This is an appeal of that judgment. State legislatures have the constitutional authority to decide when claims for injury may be brought. when she decided to sue in 1990. Court of Appeals for the Second Circuit affirmed the decision and held in favor of Searle. She decided to bring this action after she was notified. In May 1989. Ms. Generally. She chose not to pursue the matter at that time because of domestic difficulties. The lower court agreed with Searle. in spite of its sympathy for Ms. C. no action can be brought regardless of whether any cause of action ever existed. Summary of the Court’s Reasoning A. . Under Connecticut law. in March 1989.Gnazzo’s lawsuit? 4. After the time period stated in the statute has run. as a matter of public policy. Holding The U. B. statutes of limitations set maximum time periods during which certain actions can be brought. Thus. 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. The Issue Did the Connecticut Statute of Limitations time-bar Ms. 3.58 Chapter 4 B.S. the action was time-barred by the three-year Connecticut Statute of Limitations. Gnazzo completed a questionnaire stating she first suspected that the IUD caused her harm sometime in 1981. 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.

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.” All in all. most legal doctrines. This process may not only help students make difficult legal doctrines more comprehensible. as teachers. but rather as the result of a component building block process where negligence is the product of showing the elements are in place. Encourage them to think in terms of negligence as not the first answer. duties. and obligations that arise from a civil dispute in tort. but it also introduces them to the underlying logic of “thinking like a lawyer. 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. 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. 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. for that matter. real positive feedback that it is working in the minds of our students. II. 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. 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. This is done through the introduction of various classifications of torts with case illustrations for each classification. . 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. In addition.Torts and Cyber Torts 59 Chapter 5 Torts and Cyber Torts Why Should They Pay? I.

.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 .

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

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

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

Torts and Cyber Torts 65 .

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

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

landing in the middle of the two lane road. and caught fire. The other 2 died. She sideswiped a Bell utility pole. Issue: Did Bell and P&L breach their duty of care? . 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). Jacobs suggested they “jump the hills” on Edgewood Ave. Facts: Mitchell drove her Honda Accord with Jacobs in the front seat and Messer in the back seat. Defendant’s guard did not commit a wrong in relation to the plaintiff. Messer escaped.Inc. She lost control and over-steered to the right. Carter. spun and slammed broadside into an A&L pole. where the speed limit was 40 mph. Summary judgment was granted to Bell and P&L. 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. Mitchell went 80 mph and went airborne. Jacobs’s estate representative sued Bell and P&L for negligent pole placement. The Court speaks: Carter v. The poles were 25 feet from the edge of the right of way. Railroad was thus not the proximate cause of plaintiffs injuries.

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

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

Torts and Cyber Torts 71

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.

72 Chapter 5

Torts and Cyber Torts 73

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.

74 Chapter 5

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

Torts and Cyber Torts 75

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

76 Chapter 5

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.

78 Chapter 5

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.

Criminal Law and Whit Collar Crime 79

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.

80 Chapter 6

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.

82 Chapter 6

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.

84 Chapter 6

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.

law. the act is designed to allow U. To recognize these payments as legitimate would.Criminal Law and Whit Collar Crime 85 E-Commerce and Information Technology: Identity Fraud Identity fraud costs businesses over $1 billion per year. International Law: The Foreign Corrupt Practices Act This statute attempts to balance two legitimate concerns. 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. but it has been used against nonorganized crime defendants as well.S. allow them to be expense deductions and the like. . On the other side of the coin. To combat such fraud.S. More and more countries are adopting the U. position in holding such payments illegal within their own jurisdictions. 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. based companies to remain competitive in foreign markets where such payments are legal.S. Ethics Spotlight: Money Laundering The use of legitimate businesses to “wash” dirty money is discussed. in turn.

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.

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

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

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

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. Erhardt.E. otherwise known as theft by deception. . the court held that Walton’s representations that he would invest Marlowe’s money in gold affected her judgment concerning her investment. The crime of forgery has been committed. A person is guilty of forgery when. Accordingly. Extortion 6. a corporation can be held criminally liable for the acts of its representatives. with intent to defraud.App. State of Utah v. or procured another to commit the crime. Answers to Critical Thinking Cases Criminal Liability of Corporations 6. because they cannot be put in prison. On the other hand. he knowingly makes. modern courts have held that a corporation can be criminally liable for the acts of its managers. Forgery 6. State of Connecticut v. In this case.. counseled. 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.4. which performance the actor does not intend to perform or knows will not be performed. they are usually sanctioned with fines and/or loss of a license or franchise.2d 235 (Utah 1985). with different provisions. In this case.1. The truth or falsity of the information is immaterial. theft by deception does not occur when there is only falsity as to matters having no pecuniary significance. 1989). 553 A. In this case. hired. the court held that the conviction and punishment of the business entity or corporation is likely to be both appropriate and effective.2d 637 (Ga. and their conviction and punishment would be particularly ineffective as a deterrent. and one can be guilty as one who aided and abetted another. his conviction was affirmed. However. the lower court convicted the defendant of extortion and the appellate court affirmed the conviction based on the facts presented. or “puffing” by statements unlikely to deceive ordinary persons. United States v. Accordingly. 467 F. In order to prove that a defendant committed theft by deception. 387 S.3.90 Chapter 6 III. the court held that the identification of the particular agents responsible for the antitrust law violations is especially difficult. 1973). 1989). On the other hand. Roberts. Walton is guilty of criminal fraud. Traditionally. Extortion occurs when a person threatens to expose something about another person unless that other person gives money or property. 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. Criminal Fraud 6. and that such evidence was sufficient to convict the defendant of theft by deception.2.2d 1000 (9th Cir. encouraged. The crime of extortion would have been committed.2d 188 (Conn. Knowledge and intent can be inferred from the circumstances of the case. and employees. or as one who advised. Foster v. it was held that corporations lacked the criminal mind to be held criminally liable.App. at another time. or by authority of one who did not give such authority. agents. Deception occurs when a person intentionally promises performance that is likely to affect the judgment of another in the transaction. under the common law. Hilton Hotels Corp. Yes. Moreover. alters. 711 P. Hilton Hotels was held criminally liable for its antitrust violations. State of Georgia.

Administrative Search 6. One such regulated business is the liquor industry. 216 Cal. 1172. 482. as well as to private homes. Inc. People v. 1989).App. the good faith exception is inapplicable when the warrant is so facially overbroad as to preclude reasonable reliance by executing officers. In this case. Generally. and as such that they were not “public officials. 265 Cal. 875 F. the lower court’s holding that the warrantless search was lawful was affirmed. 1990).5. 104 S. Accordingly. Dixon and Hinton v.App. However. the search warrant is not valid. Generally. v. United States. Paulson. In this case. In this case. the Fourth Amendment’s prohibition on unreasonable searches and seizures applies to commercial premises. Moreover.2d 747 (9th Cir. Yes. (2) whether the warrant sets out objective standards by which executing officers can differentiate items subject to seizure from those which are not. is valid. require unannounced visits from government agents. United States. The Supreme Court has indicated that such searches are permissible for certain closely regulated industries that.Ct. No. 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. The specificity requirement varies depending on the circumstances of the case and the type of items involved. the court held that the warrants were so overbroad as to be facially invalid. 79 L. 465 U. 579 (Cal. however. the defendants argued that they were executives of a private nonprofit corporation unaffiliated with the federal government. In this case. .Rptr. that the defendants were acting “for or on behalf of the United States in an official function” under the authority of HUD. 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. only a warrant particularly describing the place to be searched. Search Warrant 6.” The court held. They have committed the crime of bribery by a public official. However.7.6. legislative schemes authorizing warrantless administrative searches of commercial property do not violate the Fourth Amendment. unlike searches of private homes. and the persons or things to be seized.2d 458 (1984).S. 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. Accordingly. to invoke the good faith exception to the exclusionary rule. by their very nature. the government must prove that its agent’s reliance upon the warrant was objectively reasonable.Ed.3d 1480. A court will consider such factors as (1) whether probable cause exists to seize all items of a particular type. 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. the defendant’s lower court convictions for bribery were affirmed. Center Art Galleries-Hawaii. the warrantless search of the safe was a lawful search.Criminal Law and Whit Collar Crime 91 Bribery 6.

TI reported this finding to the Dallas District Attorney’s Office. 872. the court held that the subpoena does not force John Doe to restate.9. that the act of requiring production of the documents might not be privileged. D. 1237. 6. the court held that the act of producing the records is protected by the Fifth Amendment’s privilege against self-incrimination. Answer to “Briefing the Case” Writing Assignment: 1. App. Sam Kuzbary. 605. which filed criminal charges under a code section that makes it a crime to make unauthorized copies of trade secrets. Shaw. 465 U. Kuzbary suspected that some of the information being used by VCS was proprietary to TI and reported that suspicion to TI. 12 Cal. Rptr.2d 633 (1991) Court of Criminal Appeals of Texas 2. was hired by VCS. Cloud. 1992). The court went on to hold. United States v. After leaving TI. coupled with actual restoration. they joined Voice Control Systems (VCS). Shaw sought to make a showing that his intent to restore funds. the court found that in this case the act of producing the documents would involve testimonial self-incrimination. In this case. Answers to Ethics Cases 6. or that the loss was wholly or partly recouped by any other means. Embezzlement is not a common law crime.Ed. A subpoena compels the holder of the documents to perform an act that may have testimonial aspects and an incriminating effect.92 Chapter 6 Fifth Amendment’s Privilege Against Self-Incrimination 6.2d 552 (1984).W. the records do not have to be disclosed. The Fifth Amendment provides that no person shall be compelled in any criminal case to be a witness against himself. F. Thus. He did not consider the effects of his actions on these stakeholders and thus acted unethically. Texas 823 S. a competitor of TI. Key Facts A. TI concluded that Schalk and Leonard downloaded the information before they left TI. Generally. 79 L.Ct. People v. United States v. 2d 665 (Cal.10. repeat. C. with the theft offense. Case Name.S. By doing so he hurt the insurance company and its policyholders. Moreover. complete or partial restitution or offer of restitution was made to the owner of the property. IV. 4th 969. the court held that the records are not privileged under the Fifth Amendment. John Doe. and Court Schalk v. It is the result of legislative efforts to provide for an unreasonable gap that appeared in the law of larceny as it developed. App. Cloud should be found guilty of aiding and abetting a bank fraud. it is not a defense to a prosecution that after the theft was committed.2d 846. 104 S. B. No. . E. 10 Cal. V. Citation. was both a defense and alleged circumstantial evidence that he never had the specific fraudulent intent to deprive the partnership of its property. another former TI employee. Cloud realized that the sale would not go through without lying so he lied. however. Schalk and Leonard are both former employees of Texas Instruments (TI).8. or affirm the truth of the contents of the records. specializing in the area of speech research. Accordingly. This applies to compelled oral testimony.

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

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

. Ethics Spotlight: Coca-Cola Worker Convicted of Trying to Sell Trade Secret to Pepsi-Cola This deals with a possible conspiracy issue. 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. . is intended to provide an incentive for inventors to invent and make their inventions public and to protect patented inventions from infringement. Landmark Law: Federal Patent Statute This law.Intellectual Property and Piracy 95 II. passed in 1952.

96 Chapter 7 .

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

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

. 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. would be inconsistent with the forward-looking perspective of the utility patent statute. He filed patent infringement suits against Ford. and other auto manufacturers and lost. Denying patent protection under §101 simply because such coverage was thought technologically infeasible in 1930. Chrysler.Intellectual Property and Piracy 99 meet the specifications of §112. 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. which require a written description of the plan and a deposit of seed that is publicly accessible. however. Contemporary Issue: The Cost of Protecting a Patent Defending a patent is often a long and expensive battle. Internet & Technology: Cyber Business Plans are Patentable This discusses how computerized accounting systems can be patented.

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

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

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

Gonzalez said it was law. Gonazlez appealed. Gonzalez Facts: Gonzalez downloaded 1. The district court granted summary judgment for BMG assessing damages and issuing an injunction. Issue: Did Gonzalez engage in copyright infringement? Decision: Yes. BMG sued for infringement. Judgment was affirmed. .370 copyrighted songs using KaZaA.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.

104 Chapter 7 Reason: A downloaded copy is a substitute for a purchased copy that should be paid for.Inc. No fee was paid here so the authors received nothing. .Ltd. They took active steps to encourage infringement. Judgment was vacated and the case was remanded. The Supreme Court speaks: MGM Studios v. 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. This is not “fair use”. They generated income from selling advertising space which is streamed to users while they are employing the programs. Reason: Gokster and Steam Cost are not merely passive recipients of information about infringing use. And Stream Cost Networks. The down loaders are liable for copyright infringement. One infringes contributorily by intentionally inducing or encouraging direct infringement. Grokster. 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. 90% of the available files are copyrighted. MGM sued alleging secondary liability because of the acts of the down loaders.

Decision was affirmed enjoining distribution by Passport. This was not scholarly research. 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. 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.Intellectual Property and Piracy 105 Ethics Spotlight: The Court Speaks: Elvis Presley Enterprises v. Issue: Did Passport’s use of the copyrighted materials constitute fair use. Passport claimed fair use. or was it copyright infringement? Decision/Remedy: This was not fair use but was copyright infringement. .

Inc. Issue: Was the award for violating the DMCA supported by the evidence? . Beastie Boys use six seconds of “Choir” in their song “Pass the Mic” without obtaining a license. Reason: This was not substantial copying but “ deminimis sampling”. Internet & Technology : The Net Act: Criminal Copyright Infringement This box discusses the No Electronic Theft Act. The Court speaks: Sony Computer Entertainment America. which criminalizes copyright infringement. 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. Court agreed. 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. The district court entered Consent Judgment Stipulation liability under the DMCA. v. In a suit for copyright infringement.106 Chapter 7 The Court Speaks: Newton v. An expert said thousands of files had been deleted. Issue: Does the incorporation of a short segment of a copyrighted musical composition into a new musical recording constitute fair use. Sony sued Filipiak who signed a Stipulated Consent Judgment but he continued to ship HD Loader. He received a cease-and-desist letter from Sony’s lawyers which he signed but circumvented. 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. Beastie Boys Facts: Newton owns the copyright to the composition “Choir”. 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. Sony continued suit and the district court found against Filipiak who filed a motion challenging the award. or is it copyright infringement? Decision/Remedy: The court held the “deminimis” sampling was fair use and affirmed. The portion used was relatively small.

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

108 Chapter 7 .

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

This discussed the case between Cisco and Apple over “iphone”.com> to operate its printing business. Taco Cabana. International Law: Chinese Courts Uphold Intellectual Property Rights This discusses China and the WTO and the protection of intellectual property rights. The Supreme Court Speaks: Two Pesos. The district court agreed with RSI. v. v. The decision was affirmed. Reason: Distinctive trade dress is protected under the Lanham Trademark Act without proof that it has acquired a secondary meaning. Later RSI registered <freebies. FP appealed. Two Pesos adopted a similar motif. The Court speaks: Retail Services. . Some forms are protected. Inc.110 Chapter 7 Trade Dress involves the “look and feel” of a product.Inc. 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.com> promoting free offerings of goods and services. In a suit the court found that Taco’s trade dress was protected and the court of appeals affirmed. 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. bright colors. neon strips. 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. 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. Inc. They are registered one domain name <freebies. its packaging or a service establishment. paintings and murals and vivid outside colors using top border paint.

A generic word can never function as a trademark. Business Brief: Dilution This involves lessening of the capacity of a famous work to identify and distinguish goods and services. The term “freebie” has had an understood meaning since 1942. Other websites have “freebie” or ”freebies” in their domain names. . 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.Intellectual Property and Piracy 111 Issue: Is the word “freebies” a generic word that does not qualify as a trademark? Decision: Yes. Judgment in favor of RSI was affirmed.

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

the court held that the use of the tune was in the form of a parody of New York City’s advertising campaign. A trademark is a distinctive mark. A trademark distinguishes the business and its products from those of its competitors. the contract that President Ford had with Harper & Row to publish the memoirs. Yes. The law permits certain limited unauthorized uses of copyrighted materials under the fair use doctrine.” Neither NBC nor Saturday Night Live sought Elsmere’s permission before using the “I love New York Song” in their skit. and the court of appeals affirmed the decision. In this case. or device that identifies the goods of a particular business. v.Ed. or other fair use.Intellectual Property and Piracy 113 Patent 7. Harper & Row. a mark must be distinctive or have taken on a “secondary meaning. The Supreme Court rejected this defense. all worked against The Nation’s claims of fair use. Where a fair use is found. 539. held a valid copyright for the song “I love New York. motto. the slogans “Hair Color So Natural Only Her Hair Dresser Knows For Sure” and “Does She or Doesn’t She?” could be validly trademarked.” A secondary meaning cannot be trademarked. Elsmere Music Inc. To qualify for protection.2d 588 (1985). owned the copyright to the memoirs. news. The court held that the two Clariol slogans had become . The Supreme Court reversed the appellate court’s decision and upheld the district court’s finding that The Nation had engaged in copyright infringement. Elsmere could not recover from NBC or Saturday Night Live. President Ford and his publisher. symbol. and the verbatim use of the words from the work.S. name. the court found that the plaintiff. 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. 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. National Broadcasting Company.. 2218. Hughes Tool Co. 623 F. Publishers v. 105 S. Trademark 7. word. The Nation obtained a prepublication copy of the memoirs and knowingly published the words verbatim from the memoirs. Because the use of copyrighted material in a parody is protected under the fair use doctrine. Fair Use Doctrine 7. The court dismissed the suit. The National Broadcasting Company wins the suit based upon the fair use doctrine.4. 759 F. the commercial nature of the work. use in a parody or satire.3. v. 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.5.2d 1572.2. The court could award up to $3.2d 252 (2nd Cir. A copyright holder’s rights in a work are not absolute. 1980).. Examples of uses that are protected under the doctrine are quotations for review or criticism. Nation Enterprises. However. and quotations in news reports. Harper & Row. Copyright 7.6 billion or treble damages if action was found to be intentional [Smith Internat’l Inc. The Court balanced all of the factors involved in this case and found that the fair use doctrine did not protect The Nation. 85 L.Ct. Harper & Row wins. Eismere Music. The court found that the unpublished nature of the work. 471 U. Inc. the copyright holder cannot recover for copyright infringement.

in both Heileman and Schlitz cases. VI. Roux Laboratories. Miller could not claim a trademark is a generic term. 1981). Therefore. Clairol Incorporated.2d 5 (1st Cir. The court dismissed Miller’s case against Falstaff. evidence showed that only one percent of the public associated the name Lexis with computerized legal research. and operation of which. the appellate court held that Toyota’s mark “Lexus” did not infringe or dilute Mead’s “Lexis.6. 7. Digital Transactions Inc.8.114 Chapter 7 distinctive. and . Because the slogans had taken on a secondary meaning. Through the use of an advertising campaign that cost over $22 million. by itself. affords a competitive advantage and is a protectable secret. 655 F. 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. v. 427 F. the court found that the two words had different meanings. Thus. for using the term “Lite” to identify their reduced calorie beer. Miller had also sued G. whereas “Lexus” is an artificial name created by Toyota. Carson wins...9. (Mead).7. 875 F. The court in this case relied on the prior holdings in the Heileman and the Schlitz cases and held in favor of Falstaff. 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. 1990). Heileman Brewing Co. v. The term “Lite” to identify reduced calorie beer is a generic name that does not qualify for trademark protection under the Lanham Act. Toyota wins and can use the name “Lexus” for its line of automobiles. Toyota Motor Sales. A celebrity has a right to protect his pecuniary interest in the commercial exploitation of his identity. each of which. Generic Name 7. the two slogans had become associated with the products of Clariol. the court found that the public would not be confused by the use of the two marks in commerce.2d 823 (Cust.App. is in the public domain. and Joseph Schlitz Brewing Co. held against Miller and found that the word “lite” was a generic term not subject to trademark protection. 920 F.2d 171 (2nd Cir. A trade secret can exist in a combination of characteristics and components. Inc. holding that Toyota’s “Lexus” name did not dilute Mead’s “Lexis” name. finding that Falstaff could use the word “lite” to identify its reduced calorie beer. Integrated Cash Management Services. and half of this one percent were lawyers. The use of a person’s name or likeness is not necessary for such exploitation. Inc. Inc. 1970).2d 1026 (2nd Cir. Answers to Ethics Cases 7. 1989). The courts held that the term “lite” was used by consumers to mean all reduced calorie beers no matter from what brewery. Inc.Pat. Inc. which owned the mark “Lexis” which was used as the name for its computerized legal research system. The court.. Falstaff Brewing Corporation. Prior to this lawsuit by Miller Brewing Company against Falstaff Brewing Corporation. and therefore the words in the slogans were not merely descriptive. Further. The defendant was aware of the association between the phrase and Carson and intended to appropriate for its pecuniary gain. U. misappropriated ICM’s trade secrets. Inc. The appellate court reversed the trial court’s decision. the court granted Clariol a trademark.” Mead Data Central. This interfered with Carson’s interest.S. v. The trial court had held in favor of Mead Data Central. design. Further. Inc. Trademark 7.A. in unique combination. “Lexis” is based on “lex” which is Latin for law and “is” of information systems. Digital Transactions. Because of these reasons. Both slogans had taken on a secondary meaning. but the unified process. Miller Brewing Company v.

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

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

The bottom line in the study of ethics is ultimately personal. Acting ethically involves doing what is right. If these guideposts are universally accepted. but rather required by law. Among the possible issues are the legality of Bayer’s actions. This box discusses the issues surrounding Bayer and its product “Cipro”. and our job as teachers is to help students prepare for these challenges in both their professional and personal ethical lives. Ethics Spotlight: Government “Gets Relief” from Bayer Aspirin. *The study of ethics revolves around the examination of rules. That law should be grounded in some sort of morality-based foundation is self-evident. juristic (law made) business entities cannot ignore this constant and dynamic tug and pull between ethics and law. a morally based methodology is sought as a guidepost for behavior.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. The process by which morally based ethical behavior is first desired. The distinction is drawn between the law and ethics. The goals of all the ethical schools of thought are to identify some sort of morally based rationale for human behavior. its ethics in cheating the Medicaid program and whistle blowing. then expected. . Because so many of our legal and economic activities are conducted in the corporate format. and finally mandated is really the evolution of law. conduct. Of note is the ease involved in this type of deception. 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. 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. and character through a morally tinted microscope. In all these systems. the odds are very high that they will no longer be advisory. Others such as Kant and Rawls have sought to devise formulas of behavior based on universal rules or social contract.

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

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 .

There was no proof of causation.120 Chapter 8 The Court Speaks: Bradley v. Better Pizza”. P&G was attempting to protect its image. Issue: Is Papa John’s slogan. 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. 5 days per week for her entire 19 years. This box discusses the requirement for a code of ethics found in the Sarbanes-Oxley Act. Secretary of Agriculture. Bradley is claiming a violation of the New York Consumer Protection Act. The Court Speaks: Pizza Hut v. Two matters went in their favor. The court of appeals reversed and remanded for entry of judgment for Papa John’s. Reason: The slogan was a statement of opinion and not fact. Reason: There was no objective evidence that a reasonable consumer would have been misled by the defendant’s conduct. The Suit involved Papa John’s slogan. Sun-Diamond Growers of California Facts: Sun-Diamond gave Epsy. 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? . and its claim to have a superior sauce and dough to Pizza Hut. various items of value while Sun-Diamond members had matters of interest pending before the Secretary.S.S. sued for making illegal gifts in violation of a statute. She claimed she was mislead by advertising portraying their food as nutritious and part of a healthy lifestyle if consumed on a daily basis. U. prohibiting deceptive and unfair acts and practices. 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. U. There was reasonable opportunity to discover the facts. Better Pizza” false advertising? Decision: No. Papa John’s Facts: Pizza Hut filed a lawsuit charging Papa John’s with false advertising violating the Lanham Act. “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. 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. Ethics Spotlight: Sarbanes-Oxely Act Prompts Public Companies to Adopt Code of Ethics. “Better Ingredients. 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. The Supreme Court speaks: United States v. The plaintiff’s case was dismissed.000. This is an appeal from a reversal of a guilty verdict with a fine of $400. A typical code is shown.

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

TBS and the Cartoon Network and Adult Swim. As a result. The court of appeals affirmed. leaving the new compensatory damages at $1 million. 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. The bomb scare was fake. The insurance company lost a $185. The U. The Supreme Court reversed the decision of the court of appeals. The judge reduced the award but the Utah Supreme Court reinstated the punitive damages award. Ethics Spotlight: State Farm: Not Such a Good Neighbor After an accident. The Supreme Court requires showing of a secondary meaning to protect a product’s design.6 million in compensatory damages and $145 million in punitive damages by the jury. Reason: The Lanham Act requires a showing of the likeliness of causing confusion with the product for which protection is sought. The policyholders pursued a bad faith tort action against the company whereby the injured parties would receive 90% of any verdict. 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. They said that few awards exceeding a single-digit ratio between punitive and compensatory damages will satisfy due process. . Supreme Court reversed and remanded the case stating that the Due Process Clause prohibits grossly excessive arbitrary punishments on a tort-feasor.S. the policyholder was awarded $2. It was part of a guerilla cartoon marketing campaign by Time Warner subsidiaries. The district court ruled for Samara without finding a secondary meaning for Samara’s clothes.122 Chapter 8 violation of the Lanham Trademark Act. 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 2006.000 judgment at trial. Issue: Must a product’s design have acquired a secondary meaning before it is protected as trade dress? Decision: Yes. Apologies were issued and compensation was arranged.

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

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

and Court Ramirez v. 618 F. B. the defendant marketed its product directly to this population through various Spanish media outlets. 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. App. Key Facts A.Ethics and Social Responsibility of Business 125 practice those virtues that elevate man and do not demean or hurt.2d 423 (1992) Court of Appeals of California 2.” 3. Inc. Holding Yes. Plough. 554 (D. C. Joseph Aspirin for Children (SJAC). . Ramierz.. 15 Cal. 1985). 5. These labels were made mandatory in June 1986. Although public policy generally favors English as an official language. Inc. Citation. brought suit against Plough.C. In this case. Court’s Reasoning A. 12 Cal. Plough. D. and in fact. 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. Accordingly. Issue Did the defendant..Supp. Lovenheim v. the strongest argument against the corporate practice is having its agents acting inhumanely. the shareholder wins the right to put the issue on the proxy. voluntary warning labels were placed on SJAC that warned of a possible association between aspirin and Reye’s syndrome. through his guardian. 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. Iroquois Brands. C. 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. B. 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.4th 1110. have a duty to warn in a foreign language? 4. a marketer and distributor of St. Case Name. The ethical and social significance of plaintiff’s proposal and the fact that it implicates significant levels of sales. contends that he contracted Reye’s syndrome after having ingested SJAC in March 1986.RPTR. The defendant knew that a non-English literate population used its products. and there is no causal relationship between plaintiff’s injury and defendant’s activities. Answer to “Briefing the Case” Writing Assignment: 1. Jorge Ramierz. whose primary language is Spanish. 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. Ltd. In March 1986. 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. IV.

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

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

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

Nature of Traditional and Online Contracts 129 .

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

Nature of Traditional and Online Contracts 131 .

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. 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. .

The decision was reversed in favor of the Mitchells.Nature of Traditional and Online Contracts 133 The Court Speaks: City of Everett Washington v. 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. .000 in cash in it. Reason: The state Supreme Court held that under the objective theory of contracts. The Mitchells appealed. Mitchell Facts: Al and Rosemary Mitchell owned a small secondhand store. and found over $32. The locksmith who opened the safe called the City of Everett Police. who impounded the money. The Mitchells had the safe opened. Issue: Was a contract formed between the seller and buyer of the safe? Decision: Yes. The safe was part of Sumstad Estate. a contract was formed between the seller and buyer of the safe. The court of appeals affirmed. The City of Everett commenced an interpleader action against Sumstad Estate and the Mitchells. At an auction. The trial court entered summary judgment in favor of Sumstad Estate.

The Addendum does not apply to this situation. Academy of Motion Picture Arts and Sciences Facts: An Oscar won by Orson Welles eventually passed to Beatrice. Issue: Doe the Receipt and Addendum prohibit Beatrice from selling the original Oscar? Decision: No. When Beatrice found the original she wanted to sell it but the Academy wanted to enforce the $1. Beatrice could sell the original. the daughter. The court presumed that a contract. expresses the true intent and meaning of the parties notwithstanding a unilateral misunderstanding or failure to read.00 right of first refusal. deliberately entered into.00 right. Reason: The Academy asserts a unilateral mistake by using the word member which Beatrice was not.134 Chapter 9 The Court speaks: Wells v. She requested a duplicate stating that the original was lost. . the Academy would have a $1. 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. She signed a receipt and addendum indicating that if the sale by a member is desired.

and Shields state a cause of action for the breach of an implied-in-fact contract? Decision/Remedy: Yes. The district court granted summary judgment in favor of Taco Bell. created an advertising campaign for Taco bell at their request using their cartoon character “Psycho Chihuahua”. it would have to pay plaintiffs. Taco Bell gave Wrench’s material to Chiat/Day who made the same proposal which they say they came up with on their own. Taco Bell The Facts: Rinks and Shields. No express contract was entered. Wrench suggested that they use a real male dog passing by a female dog to get to Taco Bell.Nature of Traditional and Online Contracts 135 The Court Speaks: Wrench v. Issue: Do the plaintiffs Wrench. 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. . through their company Wrench. LLC. The judgment was reversed and the case remanded for trial. Rinks. Reason: Taco Bell understood if it used the Psycho Chihuahua concept. Instead.

and Susan [husband and wife(H&W)] borrowed money and pledged two pieces of land as collateral – one was 2.7 acres of marital property and the other inherited by Susan. Upon default Sam.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. paid Sr. Upon divorce the 2. The Court speaks: Powell v.7 acre lot was ordered sold and the proceeds to be divided 50-50. Jr. but Susan would not. Thompson-Powell Facts: Samuel. No contract was formed. Sr. orally agreed to pay the mortgage and taxes and Jr. was entitled to recover from Susan. Sr. Jr. Susan was not a party. borrowed money from Sam. 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. . whereby Sr. Issue: Is Susan liable for her half under quasi-contract? Decision: Yes. Sr. paid. would pay him back. Jr. This occurred in this case.

Nature of Traditional and Online Contracts 137 .

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

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

2d 373 (1982) District Court of Appeals of Florida 2.4. Thus. shot a hole-in-one. Citation. 668 P.2d 106. 1983). that gave Mark and “exclusive right of sale” over certain properties owned by Rogness. Lexis 911 (Maine 1978). and Court Mark Realty. Mark argued that these are bilateral contracts (a promise for a promise.. and. 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. there was a written employment contract between the parties. 1976 Cal. . V. Marcel Motors. Key Facts A. 557 P. Lexis 377 (Cal. Rogness entered into four separate agreements with Mark Realty. there is no contract until the offeree performs the requested act. as such. the question becomes whether the oral agreement was executed.2d 208. Inc. 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. Rogness 418 So. Lexis 785 (Mont. Family Health Care. Issue Were the contracts bilateral or unilateral? 4. Tilman A. Inc. Thus. D. The court held that because Winkle had not been paid his salary and bonus. Rptr. Chenard v.140 Chapter 9 conduct of the parties to determine whether that conduct demonstrates an implied-in-fact contract. Holding The contracts are bilateral and could not be cancelled by Rogness during the time provided for in the agreements. Accordingly. the contract was not executed. he had accepted the offeror’s offer of a unilateral contract thereby obligating performance of the promise. Under the equitable doctrine of quasi-contract.e. 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). v. the Appellate Court upheld the Superior Court’s ruling that Chenard is entitled to the car. 387 A. This would constitute a bilateral agreement. In this case. Marvin. 1978 Me. 134 Cal. Answers to Ethics Cases 9. fully performed. Rogness sold the properties during the time period covered by the agreements. could not be unilaterally cancelled by Rogness. 3.3. 1976). 9. 815. The court held that where Chenard. Accordingly the appellate court reversed the trial court’s holding that Winkle was entitled to his bonus. Rogness claimed a right to cancel and revoke the contracts. Winkel v. P. This doctrine does not apply where there is an enforceable contract between the parties. Here. Marvin v.2d 596. IV. Winkle testified that the agreement to receive profit-sharing was an oral agreement. 1983 Mont. Case Name. i. C. The offer cannot be accepted by Chenard promising to get a hole-in-one.. Winkle does not receive the profit-sharing bonus. Answer to “Briefing the Case” Writing Assignment: 1. the offeree. B. A unilateral contract is one in which the offer can only be accepted by the performance of an act by the offeree. No.C. The contract is a unilateral contract.

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

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

Bankruptcy Code allows for court-approved reaffirmation of debts that have already been discharged. Consideration is usually what is bargained for.S. It is actually a very practical requirement. the result is not necessarily an absence of contract. Thus the concept of looking to bargainedfor value in place of the seal evolved into the modern day law of contracts. the U. Not everyone was a member of nobility. When consideration is missing. For example. even though not supported by consideration. II. in a contractual setting. Promissory estoppel literally means that a promise made. Spotting consideration. the glue that brought the parties to the table in the first place. Perhaps an historical footnote on the issue may be of value. Consideration today is made up of two subcomponents: detriment and bargain theory. It is what is given up by one party to induce a similar action by the other. 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. sounds easier than it really is. Value means nothing. will not be allowed to be withdrawn.Agreement and Consideration 143 Consideration Consideration is the second of the four elements of contract. 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.. contracts between members of the privileged classes did not require consideration because a man’s word was his bond. Text Materials with Accompanying PowerPoint Slides . a court looking at the situation may simply say the matter is moot (nothing in controversy). It is meant to place value on the contract in order to assure evidence of a bond between the parties. 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.e. i. Without value being put at issue. Detriment represents the value of the contract. but all wanted their contracts to be binding. A noble’s family seal evidenced that bond. 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. because of the harm that would befall the other party. Consideration is that element of a contract that is designed to show the underlying inducement to enter into the contract. The second major category of consideration exceptions from contracts is found in statutory provisions based on public policy.

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

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

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

Agreement and Consideration 147 .

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

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

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

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

152 Chapter 10 .

Inc. Megadeath. Mustaine sent a Proposed Settlement and General Release whereby Mustaine would buy Ellefson’s interest. The offer was received on 4/16/04. was formed in 1990 with Mustaine owning an 80% interest and Ellefson 20%. During. Ellefson signed and faxed the signature page to Mustaine. Eventually Mustaine gave a 5PM time on 5/14/04 for completion of the settlement. negotiations.Agreement and Consideration 153 TIME LINE Offer Acceptance Revocation Rejection Example: Offer sent on 1/1. On 5/20/04 Mustaine sent fully executed copies to Ellefson by mail. 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. On 5/15/04 at 4:45PM Mustaine e-mailed Ellefson an execution copy (read only) of the settlement. reiterating the deadline and reserving the right to further change Exhibits AS and B the following week. On 5/13/04 Mustaine e-mailed Ellefson about the termination time and date. Mustaine answered that a signed agreement had occurred on 5/15/04 by fax. Ellefsom sued alleging that Mustaine defrauded Ellefson out of his share of the profits. On 5/24/04 Ellefson e-mailed thathe was withdrawing all proposals. Inc. 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. . Megadeath. On 5/15/04 proposed changes to the offer were exchanged between the attorneys.

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

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

the estate refused to pay alleging a lack of consideration. 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. Upon suit by Drexel to collect the $150. however. 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.000 to Drexel University and a scholarship would be created in Wirth’s name. also shows consideration in the language by Drexel’s promising to establish a scholarship fund. The decision of the surrogate court was reversed and summary judgment was granted in favor of Drexel. . Wirth died before money was paid and the estate refused to honor the pledge. This promise.000. Issue: Was the Pledge Agreement supported by consideration and therefore enforceable against the estate of Wirth? Decision: Yes.

Agreement and Consideration 157 .

Such terms were left to future determination. International Law: China Adopts New Contract Law China officially joined the WTO in late 2001. there must be a meeting of the minds as to all terms. McIlroy Bank and Trust. The UCL was enacted by China to overhaul its contract laws. and Best-Effort contracts. .” Contemporary Issue: Special Business Contracts Special types of business contracts allow a greater degree of uncertainty concerning consideration. In addition. No. the parties never agreed on any essential terms.2d 759 (Ark. the trial court’s judgment in favor of the Bank was affirmed. III.2.App. 616 S. They include: output contracts. the contract is enforceable. 1981). requirement contracts. This seems to be the case here. 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. Essential Terms 10.158 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. There was apparently some discussion as to long-term financing. In order to make a contract.W. there was not an oral contract for long-term financing.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. A court cannot make a contract for the parties. 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. Hunt v. however. Accordingly.

” Had MacDonald intended to exclude any future development.Rptr.App. Superior Court. the court held that the process of settlement is best served by allowing the law of contracts to control.5 An offer of a reward is usually considered an enforceable offer if the person answering the request does what is asked. James wins. Counteroffer 10.App.App. if a contract term is missing and a reasonable term can be implied. Accordingly. Under the modern view of contracts. constituted a counteroffer that terminated its ability to accept the settlement offer.3d 598.3. In the instant case. The offer is considered communicated to whomever accepts.App. 1984) . the court held that the tenant’s qualified acceptance of the settlement offer. and any subsequent expansion. 682 (Cal. Thus. The courts would indicate a reasonable time when no time is specified. including any subsequent expansions. Glende Motor Company v. there has not been a settlement of the lawsuit. Reward 10. 217 Cal.Agreement and Consideration 159 Implied Terms 10. Edmond’s of Fresno v. the Appellate Court affirmed the lower court’s holding that the restrictive covenant applies to all of the Fresno Fashion Fair. A valid acceptance of an offer must be absolute and unqualified. The contract must be interpreted so as to give effect to the mutual intention of the parties at the time of contracting. 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. 171 Cal. Furthermore. No. 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. 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. 205 Cal. to not more than two jewelry stores. Ltd.3d 389. Nine months seems excessive in this case but all objective factors should be considered. the intention of the parties should be ascertained from the writing alone. The court held that the lease impliedly incorporated any future development within the designation “Fresno Fashion Fair. The lease at issue here was silent as to any subsequent expansions of the mall. Edmond’s of Fresno will be successful in limiting the mall.Rptr.4.. Moreover. 375 (Cal. Implied Terms 10. 1985). it could have explicitly done so in the lease. 159 Cal. MacDonald Group.6. conditioned upon the execution of a new lease. viewing the contract as a whole. the court can supply the missing term. and not upon any clause standing alone.

C. or the forbearance of a right. 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. thereby extending the lease for the next five years. absent a contract or special agreement to the contrary. The offeror cannot force the offeree to speak or be bound by his silence.S. even if it is lost in transmission. Betty argued. property. the trial court correctly rendered judgment in favor of the tenant. including money. To constitute a contract there must be a meeting of the minds between the parties. or (2) the promisor receives a legal benefit. Under the modern law of contracts. 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. that Clyde’s interest in the franchise evolved from his status as a . Postal Service. Jenkins v. Yes. 235 Cal. Yes. the agreement is enforceable. while Clyde suffered a legal detriment when he closed the tire business. Generally. 1987). an offer by one. It contained no automatic renewal clause and failed to bind the parties in any way after the expiration of the original policy. services rendered by one spouse in the other’s business are gratuitously performed. J.App. 424 A. silence is not considered acceptance even if the offeror states that it is. Consideration is broadly defined as something of legal value.3d 1. In addition. 1980). Tuneup Masters. Generally. the provision of services. notwithstanding that the notice was not deposited in an officially designated receptacle. Acceptance of a bilateral contract occurs at the time the offeree dispatches the acceptance by an authorized means of communication. 214 (Cal.160 Chapter 10 Implied Terms 10.” 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. The Mailbox Rule 10. there is a presumption that. None of the communications amounted to an acceptance. Andrus. however. Consideration 10. Betty suffered a legal detriment by giving up half of the shares of the company. 190 Cal.7. In this case. and an acceptance by the other. 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. The court. Andrus wins and does not have to pay the premiums on the insurance policy. The court found that the prior policy was a separate and independent agreement that came to an end by its own terms. In addition. the notice exercising the option to renew the lease was effective.9. thereby extending the lease for the next five years. To be enforceable. a contract is supported by consideration if either (1) the promisee suffers a legal detriment. Under this rule. a contract must be supported by consideration.App. The court found that the lease notice provision required notice to be sent by “registered or certified United States mail. The trial court’s judgment in favor of Durick was therefore reversed. This was followed by the transfer of jointly owned property to a newly formed corporation. Accordingly. the husband and wife mutually agreed to accept division of the shares and to continue to operate the KFC franchise as before. and the lower court found.Rptr. the acceptance is effective when it is dispatched. Andrus never retained any benefit. Durick Insurance v. in the landlord’s unlawful detainer action.8. 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.2d 249 (Vt.

1968 Ida. Lena wins because the contract was supported by valid consideration. Penley.13. 1980). In this case. had performed the services that he argues constituted his consideration from the period between 1923 until 1944. there was no enforceable contract requiring transfer of the property. it is . Gough assumed no obligation or duty that he was not bound to perform under the terms of the original contract. Waiver of. Promissory Estoppel 10. Recognizing that the “morals of the marketplace” periodically change and that today stricter standards of good faith and fair dealings are imposed. The Supreme Court of Georgia held that where the only consideration for the 1944 promise was past consideration. The directed verdict in favor of the defendant and denying specific performance was affirmed.C.358. 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. In the case at bar. Generally. Whitmire v. plaintiffs win. 159 S. Lexis 249 (Idaho).2d 6 (Ga. 332.11. Yes. 1985). Accordingly. Gough.E.2d 32. Past Consideration 10.E.Agreement and Consideration 161 husband. Gough cannot recover the cost to reerect the thirty-two fallen trusses. 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. Watkins. Under both agreements Gough agreed to erect and properly place the same number of trusses. Robert Chuckrow Construction Company v. Pursuant to Section 90 of the Restatement of Contracts.62 plus interest at a rate of 6 percent.” If a promise is made to one party for the benefit of another. S.J. 1968). Carter.2d 469 (Ga.App. Gough is not entitled to any sum not contemplated by the original contract. 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. Reliance is the substitute for a bargained for consideration. a right that is not utterly groundless is sufficient consideration to support a contract made in reliance thereon. No.10. Consideration 10. past consideration will not support a subsequent promise. 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. A.2d 51 (N. 437 P. Whitmire does not receive the property. No. 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. 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. Penley v. A. This doctrine relates only to action or forbearance on the part of a promisee. Preexisting Duty 10.J. 267 So. The Idaho Supreme Court affirmed the District Court’s judgment awarding Lena $19. Frasier v. In this case.12. In reversing the lower court’s holding. or forbearance to exercise.

paragraph 13 of the ticket. 463 So. 106 Cal. The judgment in favor of the plaintiffs is affirmed. Ocean Dunes of Hutchinson Island Development Corporation v.3d 27. Munoz probably did not act ethically in that he was only acting in his own behalf and not for the good of all. Acceptance of this Passenger Ticket Contract by Passenger shall constitute the agreement of Passenger to these Terms and Conditions. With real estate. the doctrine of promissory estoppel is applicable and supplies the absence of a consideration for the promise. 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. Ocean Dune’s obligations are wholly illusory. Goodwest should win. 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. Where parties enter into a contract in which one or both of the parties can choose not to perform his contractual obligations. Such contractual provisions.162 Chapter 10 often foreseeable that the beneficiary will rely on the promise. 10.2d 437 (Fla. This clause clearly provides that suits must be brought within one year of injury..App. 30 C.” The clause at issue is found at page 8. 1992). Inc. . 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. Nalley’s. Norwegian communicated the limitation period to Dempsey. 972 F. on the other hand.Rptr. Yes. Dempsey pointed to no factors extrinsic to the ticket that warrant finding that Norwegian did not reasonably communicate this information to Dempsey. Dempsey v. Colangelo. Moreover. The developer. however. the defendant’s duty under the contract is illusory. 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 ticket contained the notation “Important Notice” in a bright red box at the bottom right-hand corner of each of the first four pages. 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. must be reasonable. the contract lacks consideration and is unenforceable. approved the results. 424 (Cal. This is especially unconscionable in this case in light of the buyer’s deprivation of the use of their money for several years. Accordingly.” The terms and conditions begin on page 6 of the ticket. encouraged them. that is usually the case. In this case. the defendant watched such efforts. Aronowicz v.App. 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. Parties to a contract may agree to limit their respective remedies and those remedies need not be the same. 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. Norwegian Cruise Line. IV. 1985). 1972). The physical characteristics of the ticket in this case clearly informed Dempsey that her rights were being limited. 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.A. “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. Norwegian went to great lengths to inform passengers of the various terms and conditions that could affect their rights.15.14.16.2d 998 (9th Cir. Answers to Ethics Cases 10. 10.

Citation. 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. 814 S. is a supplier of pre-engineered aluminum and glass sliding doors and windows. There were several promised on which Hoffman reasonably relied to his detriment. Traco offered to supply a highergrade door at an additional cost of $300.000. Issue Does the contract remedy of promissory estoppel apply? 4.Agreement and Consideration 163 10. . Key Facts A. Arrow sought to have these problems resolved. Inc. Red Owl did. not act ethically and the doctrine of promissoryestoppel should apply. F. which led them to underbid the cost of the job and have to pay more for the doors to a third party. Arrow refused to purchase the more expensive Traco product and sent the project out for bids. and Court Traco. Arrow Glass Co. v.2d 186 (1991) Court of Appeals of Texas 2. Answer to “Briefing the Case” Writing Assignment: 1. G. Traco wanted a contract to supply aluminum and glass sliding doors to Arrow in conjunction with the USAA project. Arrow Glass was a subcontractor engaged in the construction of USAA Towers in San Antonio. Traco. Its solicitation was rejected because its product did not comply with the original specifications called for by the project. 3.W. there were numerous quality problems with the doors delivered by Traco. V. 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. B. and actual reliance by Arrow. TX. E. Holding Yes. Inc. C.17. Subsequently. 5. Arrow relied on this revised bid and got the subcontract for the door work. Case Name. Inc.. Traco modified its original bid to come into compliance with the specifications. B. Court’s Reasoning A. foreseeable reliance on Arrow’s part in lowering its bid to the USAA general contractor. therefore. D. The remedy of promissory estoppel is a “rule of equity” applied to promote the ends of justice.

and fitness to enter into contracts.164 Chapter 11 Chapter 11 Capacity and Legality Did They Know What They Were Doing? I. Capacity is the legal qualification. and should be entered into by persons who are recognizably able to do so. They readily understand that contracts are important. if the capacity element is missing. The self-evident and common sense basis of having legality as one of the elements of contract is usually readily understandable. It is the third of the four essential ingredients to a contract. As with the other three elements. competency. Teacher to Teacher Dialogue This chapter embarks upon the third and fourth of the four elements of contract—capacity and legality. and a recognized capacity to contract. 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. The need for both capacity and legality is quite self-evident to students. 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). . but which have an anticipated outcome that is in violation of public policy (if the buy-sell creates an illegal price-fix). full knowledge of all the material circumstances. a contract cannot result from the agreement in question. II.

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

166 Chapter 11 .

Capacity and Legality 167 .

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

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

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

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

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

the agreement is void and cannot be raised to the status of a legal contract. C. Licensing Statutes: Regulatory Public protection No recovery Revenue-raising Raise revenue Often enforceable . If there is an element of illegality or violation of public policy. or is the problem incidental or collateral to the agreement? The first question is really the easiest to answer. may it have an intent or consequence that is against public policy? 3. even if they appear legal on their faces. whose job it is to provide a resolution of the problem between A and B. Is this agreement illegal per se? 2. If this agreement is legal on its face. If A and B have a dispute about what the contract terms really provided. All contracts have a “hidden” third party which is the larger society represented by the courts. Not all illegalities are fatal to the entire contract.Capacity and Legality 173 not only a two party situation. If a court finds that the illegality or public policy concern is not at the heart of the contract. 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. When a court examines an agreement for its legality component. The second question is much more difficult to answer in that public policy is a moving target. it may still enforce the agreement. To do otherwise would be asking a court to become a party to an agreement that contravenes the basis for its existence. a contract for a murder by an underworld figure cannot and will not be enforced by a court of law. Thus. there are three key questions it asks: 1. 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. For example. because the illegality is considered collateral or incidental. If A and B want their agreement honored in a court of law as a valid and binding contract. In the process of resolving a contract problem. a simple buy-sell agreement looks perfectly legal. Courts look at the reality of these agreements. 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. where must they ultimately turn to get an answer? Courts are the designated agents of the larger society. that agreement must be recognized first and foremost as a legal agreement. If the agreement calls for an illegal act on its face.

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

Capacity and Legality 175

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.

176 Chapter 11

Capacity and Legality 177

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

178 Chapter 11

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.

Capacity and Legality 179

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

180 Chapter 11

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.

Capacity and Legality 181

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.

182 Chapter 12

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.

Genuineness of Assent and Statute of Frauds 183

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?

184 Chapter 12

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

186 Chapter 12

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.

Genuineness of Assent and Statute of Frauds 187

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.

188 Chapter 12

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

Payne told Krysa that he would credit what was paid toward another purchase but would not return the money. Payne Facts: While shopping for a truck to pull their trailer.000 miles. and was a “one-owner trade-in. Reason: Payne sold a vehicle that he knew or should have known was unsafe.Genuineness of Assent and Statute of Frauds 189 The Court speaks: Krysa v. the Krysas. 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. . Issue: Did Payne engage in fraudulent nondisclosure.” A number of things went wrong with the truck in a relatively short time. Krysa could not find a satisfactory substitute.000 in punitive damages? Decision: Yes. the jury returned a verdict awarding the Krysas $18. recklessly disregarding the Krysas’ and the public’s safety.000 (27:1) was justified. Payne appealed the punitive damages. The potential physical damages here were so great that merely using a ratio of punitive damages to actual damages was not enough and $500. Upon suit by the Krysas. The Krysas noticed that a window had been replaced and that there was glass on the floor. fraudulent misrepresentation. The award was justified.449 in compensatory damages and $500. purchased one from Crane. would make it to 400. A CAR FAX report eventually showed 13 prior owners.000 in punitive damages. and reckless disregard for the safety of the Krysas and the public to support the award of $500. a used car salesman for Payne. An expert said it was unsafe. Evidence showed that the truck was really two halves of different trucks welded together. after a test drive. Crane had told the Krysa that the truck would tow their trailer.

190 Chapter 12 .

Some undue influence was found and some not in Dorydenas v. Disproportionate gifts made under unusual circumstances can cause undue influence to be inferred. .Genuineness of Assent and Statute of Frauds 191 Ethics Spotlight: Undue Influence Undue influence can be exercised indirectly and in secret ways. v. The Bible Speaks. See Rich & Whillock. 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. Inc. Ashton Development. Inc.

could not support a loan in that amount by itself. the Suttons continued to pay rent in the amount of the mortgage payments. His proposal included a $15. Meanwhile. 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. the fair rental value of the property.000. According to the Suttons. Through 1988. Therefore. the Warner’s were not to have to make any payments on the Molimo Street property. In addition. They did. She and her husband. but sought to purchase for the previously agreed on $185. The Suttons became tenants and made all rent payments in cash. The property was transferred out of the estate to Arlene Warner after April 1984. the Warners bought out the other heirs. the Warner’s intended to pledge both properties as collateral for the $170.000. J. In order to obtain full title to both properties.000. The Suttons did not dispute the value of the property. having a value of approximately $185. In January 1984.000. which Donald Warner testified was.000 loan. Reason: Kline. they were to have five years to purchase the home after the Warner’s obtained a loan necessary to acquire the two properties. the Warner’s offered. In sum. Warner suggested to Sutton in October of 1983 that the Suttons rent the Molimo Street property. 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.000. under the terms of this agreement. Donald Warner proposed that the Suttons purchase the residence so that the estate could be settled. The Molimo Street property.000. In July 1988. which they contended was less than its fair market value. however. the Suttons were required to make all mortgage payments and real estate tax payments.000 and $320. 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. had no interest in retaining the Molimo Street property.192 Chapter 12 The Court Speaks: Sutton v.000 down payment towards the purchase price of $185. the value of the property rose to somewhere between $250. Donald Warner and Kenneth Sutton were friends. to sell the property to the Suttons for $250. and in a second property located in the Russian River area of California. through counsel. desire to retain the Russian River property. Arlene Warner inherited a one-third interest in a home at 101 Molimo Street in San Francisco. . Warner Facts: In 1983. coincidentally.

The actions taken by the Suttons in reliance upon 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.Genuineness of Assent and Statute of Frauds 193 Under the doctrine of part performance. Original contract does not fall under this rule. If main purpose is pecuniary benefit to guarantor. then no writing required. Collateral Promises: One person agrees to answer for the debt of another. They reimbursed the Warner’s for property taxes in the sum of $800 every six months.000 per month rental payment to payments in the precise amount of the variable mortgage payments due under the $170.000 down payment and increased their monthly payments to the Warner’s from the original $1. Must be in writing. when considered together with the Warner’s’ admission that there was an agreement of some duration.000 loan. in reliance on the oral agreement. or makes valuable and substantial improvements on the property. 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. After entering the oral agreement. . Must be secondary to require a writing. the Suttons made a $15. 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.

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. .

See the rules listed in the chapter.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. .

Goettee. III. Generally. 542 A. the mistaken party will not be permitted to rescind the contract unless (1) the other party knew of the mistake. or (3) the mistake is so serious as to make enforcement of the contract unconscionable.2 Since Schultz could have checked the zoning ordinances but didn’t. A unilateral mistake occurs when only one party to a contract is mistaken about a material fact regarding the subject matter of the contract. the estate cannot rescind the contract based on its unilateral mistake.196 Chapter 12 Integration clause expressly reiterates the Parole Evidence Rule International Law: Signatures in Foreign Countries This illustrates the broad definition of “signature”. this is a case of unilateral mistake and the contract will probably not be rescinded. The court held that the rescission based on the defendant’s unilateral mistake was not warranted. The due diligence necessary will not be lightly excused. Generally in such cases. 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. 1988). Unilateral Mistake 12. Yes. 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 . Steele v. Beachcomber can rescind the contract. No.App.3. Answers to Critical Thinking Cases Unilateral Mistake 12. (2) the mistake is a result of a clerical or mathematical error not the result of gross negligence. Mutual Mistake 12. In this case.1.2d 847 (Md. The parties agreed to purchase the lot for a lump sum and the contract fully expressed their intentions. 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.

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

Moreover. In this case. Statute of Frauds 12. 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 lot sale agreement was never signed by Sun Valley. 291 N. and that the conveyance appeared to be the effect of such influence. however. 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. however. Pursuant to the Statute of Frauds. the party seeking to enforce the conveyance has partially performed the contract. so as to render recession inequitable and unjust.9. It did not evidence the maturity date of the note.8. Yes. 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. the contract may . Duress occurs when one party threatens to do some wrongful act unless the other party enters into a contract. a point of beginning for the installment payments.2d 218 (Idaho 1981). The threat to hold back her clothes might in a minor way. Yost innocently. the innocent party (Rieve) can rescind the contract. Accordingly. The court found that Conrad was subject to the influence of Lawrence.W. The Sacketts win. Hoffman and Frey do not win. the conservator of the estate can cancel the deed transferring the farm to Lawrence. Hoffman v. according to the evidence. Schaneman.10. 628 P. In affirming the lower court’s judgment in favor of the conservator. the court found that it was apparent that Conrad was not afforded the opportunity to seek independent advice from any source other than Lawrence. Schaneman v. who was acting in a confidential relationship. or if and how the note was to be secured. The Statute of Frauds provides that oral contracts for the sale of land are invalid unless in writing.7 The threat of a civil lawsuit does not constitute duress. the amount of the installment payments. that there was a disposition on the part of Lawrence to exercise such undue influence. the letter sent by Hoffman was not sufficient to constitute a memorandum. made an assertion that was not in accord with the facts. Where. Sun Valley Company. Undue Influence 12.2d 412 (Neb. 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. 1980).6 Innocent misrepresentation is not fraud. Real Property 12. that the opportunity to exercise undue influence existed. Moreover.198 Chapter 12 Innocent Misrepresentation 12. Since this is an innocent misrepresentation. not enough to rescind the contract. There is probably. the court affirmed the judgment of the lower court denying specific performance of the oral agreement between the parties. Duress 12.

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

First Baptist Church of Moultrie v. The main purpose was not to grant a pecuniary benefit so the main purpose exception does not apply. The church had not yet acted upon the bids. Since the memorandum including all the necessary terms of the deal was initialed or signed. the guarantor’s liability is secondary and must be in writing under the Statute of Frauds. there is a valid and enforceable contract and Knight is not correct. Atlantic lost more than an expected benefit in reliance on Solondz’s word.14. Barber wins.17. a specific type of signature is not required nor is there a specifically required location for the signature on the document.2d 720 (S. one cannot rescind based on a unilateral mistake. substantial. v. and that no remedy except enforcement of the bargain is adequate to restore his former position.200 Chapter 12 Guaranty Contract 12. neither Marks nor Gulf are liable. The court held that Atlantic suffered a detrimental change in position because. the court held that Solondz could not claim the Statute of Frauds as a defense to the enforcement of his oral agreement. App. ..E.. based on its oral agreement with Solondz. Accordingly. Feiler does not have to pay. there was no harm to the church.E.C.13. 377 S. IV. As a general rule. It is not sufficient to merely show that he lost an expected benefit under the contract.16. but if the mistake was innocent and rescission would have no adverse effect on the mistaken party. it ordered 300 ounces of silver for which it paid a considerable sum.App. Note. When one person agrees to answer for the debt of another if the primarily liable person fails to perform. 1984). Agent’s Contract 12.15. Inc. detrimental change of position in reliance on the contract. Atlantic Wholesale Co. then rescission can occur. It would be inequitable to allow it to do so. the doctrine of promissory estoppel prevents the application of the Statute of Frauds in this case. the party asserting estoppel must show that he has suffered a definite. Yes. 1989). 2d 717 (Ga. Promissory Estoppel 12. Answers to Ethics Cases 12. In order to overcome the Statute of Frauds. Barber Contracting Co. Solondz. it only lost what it attempted to gain by taking advantage of another’s mistake. Sufficiency of Writing 12. 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. Therefore. 320 S. Because the value of silver declined by $8. Barber notified the church immediately upon discovering the error. Since the lease for a service station must be in writing and there is no such writing.328 in value.

Case Name. V. and loss of services. But if there is clear and convincing proof of part performance an exception to the writing requirement makes the oral promise enforceable. and Court Hampton v. Neither requirement is met by the father’s oral promise. he used their services and therefore should pay them but has found a loophole. 5. As to Tiegs. Issue Can a carrier limit its liability for damages in a contract? 4. She may not have wanted to deal with others. 917 F. They were granted &100 and they appealed. The samples were never received. A child was awaiting a bone marrow transplant and 5 samples were sent by the hospital. 1988).20. Since there is no written contract. she was promised an exclusive agent. 545 A. The oral contract is enforceable without a writing. provided consideration for the father’s promise creating an oral contract. Federal Express Corp. there is no enforceable contract. Court of Appeals 2. There was a contract with a clear limitation of liability that was not raised. B. They acted in their own best interests without any regard for Sulzer. There was also no indication of a mistake by Sulzer. Lockheed did not know for sure why Sulzer’s bid was so low. Affirmed for the son. Shepard v. 12.19. the part performance exception applies. Answer to “Briefing the Case” Writing Assignment 1.” B. wrongful death. The lie was certainly unethical. Under federal common law. and thus. Holding Yes.2d 621 (Del. Legally. Citation. Court’s Reasoning A. “a common carrier may not exempt itself from liability for negligence but may limit the liability.2d 1119 (1990) U. 3. 12.18 It is obvious that under most theories of ethics. Because of the son’s performance. C. 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 Hamptons sued federal Express for personal injury. The transplant did not happen and the child died. Judgment was affirmed. D. Mozzetti.S. ABC did not act ethically as to either Blye or Sklar or Tiegs. E. With the first two. The evidence clearly shows that the son fully performed his obligation. so legally Lockheed should win. as required. .Genuineness of Assent and Statute of Frauds 201 12. Delaware law requires both an interest in land and a testamentary disposition to be in writing. Lockheed did not act ethically. Key Facts A.

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

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

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

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

206 Chapter 13 .

S. Issue: Does the assignment by a tenant of legal claims against a landlord violate public policy? Is it therefore illegal? Decision/Remedy: Yes. The U. . 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. District court dismissed the case. The Court Speaks: Accrued Financial v. Reason: AFS really became a promoter of litigation. Decision was affirmed. a landlord. on behalf of tenants that had signed assignment agreements granting AFS the right to file suit on their behalf.Third-Party Rights and Discharge 207 Also include antiassignment clauses where valid. AFS brought suit against Prime Retail.

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. If not. . which assignee has the legal right to the assigned right? This explains the rules that are applied.208 Chapter 13 Assignee must notify obligor. obligor can continue to deliver performance to the assignor.

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

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

Even though he was not progressing. Arthur Murray. 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. Facts: Parker contracted with Arthur Murray for dance lessons.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. he was encouraged to enter into additional contracts that required prepayment. Parker was injured in an accident and . The contracts contained noncancellation and no-refund clauses. Inc.

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

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

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

Therefore. Under the reasonable person standard. Barrows wins. such as the work performed was not acceptable. Under the good faith standard. although the mere statement by the recipient that he is dissatisfied is not conclusive. 1981). 409 Mass. Inc. Indiana Tri-City Plaza Bowl. while they amount to a failure to perform a contract. and Court Chase Precast Corp. This standard is employed when a contract involves commercial quality. C. 419 N. courts will apply either a good faith standard or a reasonable person standard. v. Barrows v. 13. Key Facts A. Inc. the court applied the reasonable person standard and held that Tri-City breached the agreement by unreasonably withholding approval. v. Paonessa entered into a subcontract with Chase Precast Corp. 2d 634 (Ill.. The reasons for Pabagold’s decision not to pay are not clear and would not be ethically defensible without a very good explanation. the construction of a parking lot concerns commercial quality and operative fitness rather than personal aesthetics. 371.Rptr. John J. Barrows had sued for a commission on the net profits from a roofing contract. App. Glueck wins. Due of objections by local residents.E.2d. B. Outdoor Services. Inc.Third-Party Rights and Discharge 215 Excuse of Condition 13. 422 N. Maco. Inc. or mechanical utility that other persons can judge.2d 670 (Ind. 603 (1991) Supreme Judicial Court of Massachusetts 2.E.App.E. the recipient of the work performed must be genuinely satisfied. a third party beneficiary to a contract.8. 185 Cal. to supply 25.3d 676. Pabagold. The good faith standard is employed when the contract involves personal aesthetics or fancy. IV: Answers to Ethics Cases 13. can enforce its terms.. 1986). Estate of Glueck. Paonessa Co. . other than an incidental beneficiary. the Commonwealth of Massachusetts entered into an agreement where no further concrete barriers would be used in the project. Paonessa Co. The judgment of the arbitrator in Outdoor Services’ favor is affirmed. capriciously. even though unreasonably. 230 Cal. and can enforce the contract. Citation. v. are excused where the other party to the contract prevents performance of the contract. Case Name. Inc. 1981). 566 N. or unreasonably. The Commonwealth of Massachusetts entered into two contracts with John J.App. 73 (Cal. operative fitness. This includes subjective satisfaction..9. In this case. To determine whether satisfaction has been received pursuant to a contract that conditions a party’s duty of performance upon his own satisfaction.10. Outdoor Services is a creditor beneficiary of an agreement between Pabagold and Mediasmith. Delays and nonperformance.800 linear feet of concrete median barriers to be used in the project.App. Under American law. dissatisfaction cannot be claimed arbitrarily. Most courts will recognize the recipient’s dissatisfaction only when he is honestly. Inc. to resurface and improve two stretches of Route 128. Satisfaction is received if a reasonable person in exactly the same circumstances would be satisfied. dissatisfied and acts in good faith. V: Answer to “Briefing the Case” Writing Assignment 1..

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

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

. The other two paths available to the nonbreaching party are going backwards or going forward with the contract. Normally. The last category of remedies regards to contract-related torts. the winner wins in principle but not in significant monetary terms. 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. had Zoomo’s breach been related to a bad faith tort within the contract setting. A court will examine these damages to make sure that they are not a disguised penalty. and injunctive relief. Punitive damages are a form of court-imposed civil punishment. If Mario had a resale contract for the car to A. . 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.000 and Zoomo knew of this second contract. quasi-contract. the actual measure of compensatory damages would be $10. In a nominal damage award. you must decide which options make the most sense to you. i. For example. In addition. Nominal damages are applicable where there is little real economic consequence arising from the breach. for $40. but if the bad faith involved shocks the conscience of the court. The majority of remedies provided by the courts for contract breach fall into the category of a repair by way of monetary damages.000 due to Zoomo’s breach. Do you try to go back where you started? Can the car be fixed where you are. fixed (damages or reformation).e. tort damages may be applicable. the court might also grant punitive damages. undo the contract. a court may grant punitive damages.000. 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. These damages seek to restore the benefit of the bargain by providing a monetary substitute for what was lost due to the breach. Another category of remedies involves going forward with the original terms of the agreement. a court is asked to return the parties to their precontract position by way of rescission or restitution. or taken forward to their original destination (specific performance). Think of monetary damages as an ascending staircase.000 in consequential damages to Mario. The next step is found in compensatory or actual damages.218 Chapter 14 contract can be compared to the various directions posted on a map when your car had broken down.000 and had to buy a comparable model from Zamay Motors for $30. punitive damages are not granted for contract breach alone. or do you need a tow to your original destination? By analogy. In going backwards. starting at the bottom with token or nominal damages and going all the way to punitive damages. One other damage measure possibility lies in the area of liquidation or agreed upon damages set by the parties. These statutes generally allow for a unilateral right of rescission within the three-day period by the buyer. if Mario had a deal with Zoomo Motors to buy a new car for $20.J. These remedies are classified as equitable remedies because the breach cannot be adequately compensated by normal economic damage measures. Zoomo may also be liable for an additional $10. Equitable remedies are often found in modern day versions of specific performance. Because your trip has been brought to an abrupt halt. 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. In this repair process. contracts can be also brought back (rescission).

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

220 Chapter 14 .

Summary judgment was granted to 845UN. 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 decision was reversed and remanded to enter a summary judgment of liability for Chodos. West assured Chodos of a 1st quarter 1999 publication. Issue: Did West Publishing breach the author agreement it had with Chodos? Decision/Remedy: Yes. U.Remedies for Breach of Traditional and Online Contracts 221 The Court Speaks: Chodos v. Donald Trump was the managing general partner of 845UN. 845UN sent default letters and eventually kept the 25%. 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. The trial court granted 845UN partial summary judgment for 10% and 845UN appealed. Chodos received West’s letter saying it would not publish the manuscript because of commercial reasons and business reasons. The Hakans believed this was an unenforceable penalty. even though the work was high quality. Issue: Is the 25% nonrefundable down payment enforceable liquidated damages. . 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.S. West Publishing Facts: Chodos and Bancroft-Whitney (now merged with West Publishing) signed a publishing contract. In December 1998. From July 1995 through June 1998 Chodos spent time writing the manuscript and working with the editors in developing and editing it. He spent considerable time away from his practice. 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. The final manuscript was declined in June. 1998. District Court granted summary judgment in favor of West in a suit by Chodos alleging breach of contract. or is it an unconscionable and unenforceable penalty? Decision: It was an enforceable liquidated damages clause.

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

The second movie role was entirely different and inferior to the role agreed upon in the contract. she went to visit him. The trial court found fraud and rescinded the contract but Patricia did not get attorneys’ fees. The fraud and rescission judgment was affirmed while the denial of attorneys’ fees was reversed. Note: Writs of attachment and garnishment can be used to enforce remedies. Failure to do this was fraud. Issue: Should the sales contracts be rescinded because of fraud and should Patricia get attorneys’ fees? Decision: Yes. who lived with Christine (Joe’s sister) and her husband. Experts valued the property at $279. through a friend sued Keith and Sheila to rescind and alleged fraud. Joe told her he wanted her to sell her interests in the property to Keith (first cousin and son of Christine) and Sheila. The Court speaks: Hickman v. Parker has not failed to mitigate damages by rejecting the offer. Bates Facts: Patricia inherited ½ interests in 2 large Louisiana properties. subsequently. 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.700. 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. Therefore. Patricia. The two types of employment for Parker were not comparable. 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. She was 20 years old and had a mental condition. . After a call from her dad Joe. The potential other employment must be comparable or substantially similar to the employment that was lost. Patricia agreed to sell to Keith for $500 and she signed legal documents. Both sides appealed.Remedies for Breach of Traditional and Online Contracts 223 locate other employment.

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

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.063 in actual damages against Gallant and $2. knowledge by defendants.343. Kurupt lied to the plaintiffs about a tour he went on promoting Dre’s release of his album. A jury returned a verdict of $731. they were awarded $14.000 on this venture.063. The executive VP refused to settle until the evening of the trial but O’Neill refused. Ethics Spotlight: Brumfield v. Gallant paid $20.000.519. In a suit by Brumsfield for intentional tortious interference. Dre invited Kurupt to record. inducement to breach and resulting damages. Issue: Did defendant engage in tortious intentional interference with the contracts in question? Decision/Remedy: Yes and the award reduction noted was upheld. A settlement offer of the policy limit was suggested by Gallant’s representatives. Navvaez’s car struck O’Neill after a two-year old set the running car in motion after Navvaer had exited the running car. Death Row Records Facts: Kurupt signed an exclusive recording agreement with Lamont’s company. and exclusive publishing agreement with Kenneth’s company and a management agreement with Kenneth for 3 years and an option giving Kurupt 7% royalties. The award was reduced by the judge to $5. Kenneth and Lamont (the Brumfields) spent at least $65.000 leaving Navvaez liable for $711. Reason: The necessary elements of the tort were present: valid contracts. bad faith lies in an insurer’s failure to give at least equal consideration to the insured’s interest when the insurer .5 million in punitive damages. In a trial for a bad faith act of breaching a covenant of good faith and fair dealing. the jury found for O’Neill in the amount of $710.000 in compensatory and punitive damages. Medical bills were $105. The Court Speaks: O’Neill v.063.000. Navvaez assigned her claims against Gallant to O’Neill. Advances had been paid by Dre to Kurupt while still under the original contracts. An album of Kurupt was released by Dre and it sold millions. including $2.226 Chapter 14 Usually not available for breach of contract but sometimes for tortious non performance. Issue: Was Gallant liable for a bad faith tort? Decision/Remedy: Yes and judgment was upheld. They were all introduced to Knight (the owner of Death Row Records) by Dre. Gallant Facts: Navvaez carried the $20. Knight had been made aware of the exclusive contract. Reason: “Where an insurer is pursued for its refusal to settle a claim.000 minimum amount of liability insurance legally permitted with Gallant Insurance Company. The Brumsfields received nothing from the tour.

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

6.2d 1061 (Colo.3d 164.App. In this case. 645 (Cal. 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. v. 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. damages sufficient to place it in the position in which it would have been had the breach not occurred. 1 (Cal. and even taking account of lost investment interest and increased administrative costs.Rptr. the liquidated damages clause is not enforceable. the agreement in question provides for liquidated damages of 20 percent. and Morse is only liable for $250. Gundersons.7. 254 Cal. Accordingly. UMC paid the contribution only four days late. Accordingly. the liquidated damages clause is enforceable. Damages 14.5. 207 Cal. the court upheld the limitation of the liability clause. 258 Cal. the trial court properly held that the liquidated damages provision was void as a . Liquidated Damages 14. H. Morse Signal Devices of San Diego. Finally. Yes. Inc. Moreover.3d 1289. consequential damages were appropriate. Moreover.App. Gundersons may collect for both lost profits and consequential damages. A contractor is entitled to recover. 678 P.App. 1989). Generally. Generally. such damages are not a reasonable forecast of just compensation. from a breaching defendant. because a nonbreaching party is under a duty to use reasonable means to avoid loss and damage. consequential damages were awarded for costs incurred in attempting to mitigate damages by seeking substitute golf course construction contracts. Moreover. Welch v. Inc. they are void as a penalty.S. 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.. Gundersons can recover the lost profits on the remaining two-thirds of the contract to build the golf course.App. Liquidated Damages 14. 290 Cal. including any incidental or consequential damages caused by the breach.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 held that a burglar alarm service is a high-risk enterprise and that a limitation on liability clause is acceptable under such circumstances. lost profits may be awarded if they are shown with reasonable certainty and are not speculative. 1989). Yes. Where the damages stipulated are unreasonable. the court found that the compensation provided to the alarm company was nominal in relation to the company’s potential liability. remote. Ptarmigan Investment Company.Rptr. 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. the court held that the damages represented the parties’ reasonable efforts to determine fair compensation given full knowledge of the circumstances. The parties must make a good faith attempt to set an amount equivalent to the damages they anticipate. v. Perlin Company. The court held that such a provision was not a good faith attempt to estimate possible damages. 1983). Accordingly.App. or imaginary. No. Metro-Goldwyn-Mayer Film Co. In this case. In this case.

141 A. Therefore.3d 1142. No. An unwilling employee cannot be compelled to continue to provide services to his employer by ordering specific performance. Warner Communications. The court held that to do so would have the same effect and intent as enjoining Baker herself. In this case. she would be deprived of her livelihood and pressured to return to Beverly Glen.3d 1118. an order of specific performance is an appropriate remedy in this case. Inc. The closing of a much-publicized venture and its failure to supply stores would do nothing to enhance its reputation with suppliers. 1988).App. Beverly Glen is also seeking to enjoin Warner from employing Baker. Avon Products.Remedies for Breach of Traditional and Online Contracts 229 penalty. Specific Performance 14.Y. Inc. Inc. 178 Cal. however. Beverly Glen Music. Accordingly. The elements of this tort are: (1) a valid and existing contract. Generally. however. Intentional Interference with Contractual Relations 14. It contends that it will be inducing the party to legally evade an existing contract. PG&E can sue Bear Stearns for the tort of intentional interference with contractual relations. 1990).. Accordingly. (4) caused by the defendant’s wrongful or unjustified conduct. that although a literal reading of the elements might lead one to believe a “breach” is necessary. Yes.. and (5) damages. 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. distributors.2d 212 (9th Cir. Moreover. United Mechanical Contractors. In this case. the court found that the uniqueness of Claiborne’s cosmetics line. 270 Cal. 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. all purchase orders placed by Claiborne in accordance with the contract. a contract to render personal services cannot be specifically enforced. 1986). 224 Cal.9. (2) defendant’s knowledge of the contract and an intent to induce the breach of that contract.2d 329 (N. 50 Cal.App. and customers. (3) breach of the contract by the contracting party. 1989). Pacific Gas and Electric Company v. California courts and the Restatement have concluded that a defendant can be liable for interfering with a contract. Beverly Glen is prohibited from enjoining Baker from performing the contract with Warner. 1 (Cal.S. . an injunction is not an appropriate remedy in this case. The court held that PG&E adequately stated a cause of action for intentional interference with contractual relations.App.Rptr.10. Bear Stearns contended that the third element is lacking because the contract with PG&E has not been and will not be breached. including its distinctive package.Sup. Liz Claiborne. Inc. Specific performance may be decreed where the goods are unique or in other circumstances where money damages do not adequately compensate the plaintiff.App. The court held. an injunction adds nothing to Beverly Glen’s recovery other than to coerce Baker to honor her contract.Rptr. 530 N. 260 (Cal.Y. To hold otherwise would be a violation of the constitutional right against involuntary servitude. retailers. v.2d 425. Moreover.D. v. the court affirmed the order of the trial court denying injunctive relief. 875 F. is obvious. Inc. In this case. Bear Stearns & Company. Beverly Glen has an adequate remedy by way of damages.. Idaho Plumbers and Pipefitters Health and Welfare Fund v.8. Injunction 14.

In this case. . a consideration in good faith of the insured’s interest required the insurer to settle the claim.11. 13 (Cal. 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. 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. because (a) they do not require the party in the superior position to account for its actions. Case Name. 1992). 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. 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. (3) ordinary contract damages are not adequate. Protection Systems. and of necessity places trust in the other party to perform. 426 P.12. App. The elements of this cause are as follows: (1) the contract must be such that the parties are in inherently unequal bargaining positions. B. Walgreen Co. 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... adhesion. security. V. In every contract.2d 273 (7th Cir.2d 173. Connecticut. Harvey & Co. or future protection. 14. Moreover. Accordingly. 58 Cal. E. v. Inc.2d 425. and (b) they do not make the inferior party whole. 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.. to secure peace of mind. i. 1989 Tenn. C. 966 F.230 Chapter 14 IV: Answers to Ethics Cases 14. Citation. characterized by elements of public interest. Key Facts A. Lexis 105 (1989) Court of Appeals of Tennessee 2. It maintains an inventory of jewelry valued at approximately $1 million. Harvey & Co. other courts have held that there is a “special relationship” between the insurer and the insured. 66 Cal. Inc.App.e. (2) the motivation for entering the contract must be a nonprofit motive. Sara Creek Property Co. Security Insurance Company of New Haven.App.Rptr.B. including policies of insurance. The insurer must give the interests of the insured at least as much consideration as it gives to its own interest. 1967). Crisci v.B. Answer to “Briefing the Case” Writing Assignment 1. and Court E. v. (4) one party is especially vulnerable because of the type of harm it may suffer. and (6) there is a “special relationship” between parties. The judgment of the lower court in favor of Crisci was therefore affirmed. 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. (5) the other party is aware of his vulnerability. is engaged in the manufacture and wholesale distribution of jewelry. Crisci wins based on the insurance company’s breach of covenant of good faith and fair dealing implied in an insurance contract. and fiduciary responsibility. The facts of this case warranted the equitable remedy of an injunction to protect Walgreen’s interests.

D.Remedies for Breach of Traditional and Online Contracts 231 D. Issue Is the liquidated damages clause of the contract enforceable in this case? 4. Holding Yes. The alarm system failed. as used in this contract.000 market value of the loss. due to a telephone system failure and a burglary that took place on July 22. B. 1984. 3. The limitations. and Protective claimed its liability was limited to the liquidated damages set out in the contract. The holding of the lower court was affirmed. Court’s Reasoning The Court of Appeals held that: A. Public policy holds that these clauses do not ordinarily protect against fraud or intentional misrepresentation. have generally been deemed to be reasonable and have been sustained against the providers of burglary and fire alarm systems. and Harvey appealed. The trial court held in favor of Protective. There was no showing of fraud or intentional misrepresentation in this case. in part. Harvey sued for the fair $200. C. . E. F. 5.

. These landmarks can take place as social upheavals such as civil rights movements. 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. it is our job to make our fair contribution to the evolution of this new cyberspace highway. 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. it has virtually exploded onto every continent and every country to facilitate a level of communication never imagined before. 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. 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. but so too. We must also help students recognize the legal issues and risks that will confront them as they travel down this road. Future generations will look upon our time as a road land-marked by the information age. Originally intended only for a select group of military and academic uses. of being witness to events that become the landmarks by which future generations will measure history. As teachers of law and ethics. 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. 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.232 Chapter 15 Chapter 15 Internet Law and E-Commerce The Law Was Never Built For The Internet. 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. 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. This turn in the road is coupled and driven by incredible technological advancements symbolized by the Internet. One such major turn that we are now facing is the advent of the Internet. horrible conflagrations such as wars. How Can We Fix It? I. and sometimes misfortune. And most of all. The Internet is impacting governmental regulation. can there be great harm. Teacher to Teacher Dialogue Every generation has the good fortune. We are concerned with all aspects of privacy concerns and intellectual property rights. or social-economic migrations such as our nations conversion from an agrarian to an industrial society.

In the end. II. consumer protection. But we must have faith in the law’s ability to land safely. 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 UCC has long provided us with a tool by which to foster and protect commerce. Text Materials . and the Uniform Computer Information Transactions Act (UCITA). 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. and agency laws today. Consider. It is not easy to do this. the newer Uniform Electronic Transactions Act (UETA). while surely seen as imperfect by many. 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. For example. when and where do we. are evolutionary efforts to do the same for e-commerce. Good legal environments must steer new technologies along the well-precedented path of good faith and good conscience. We may be involved in transactions measured by milliseconds through cyberspace. How. These new proposals. Technology used in a harmful manner can only magnify the original problem. However. Precedent has extraordinary value in charting the new methods of business conducted over the Internet. 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. on the privacy front. allocate the respective rights and duties of its members? That allocation of rights and duties continues everyday in new ways on the Internet.Internet Law and E-Commerce 233 employment law. 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.” So it is in the interpolation of the law and the world of the electronic commerce. the corollaries found between the long-standing Uniform Commercial Code (UCC). business formation. We have to jump because we have no choice: that is where this road is taking us. the basic rules of rights of privacy should not be abrogated simply because it is technologically possible. As an old proverb says: “the act of faith is jumping off a cliff with the knowledge that you will be ok. we may be looking at unprecedented accumulations of personal information though the use of “cookies” and the like. for example. and as such. as a society. but they are still contracts.

com operated by Franco Productions. 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. Issue: Is GTE Corporation. Franco defaulted and was assessed $500 million but they can’t be located. as the Internet Service Provider.S.S. 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.234 Chapter 15 Internet & Technology: Free Speech and the Internet In this important US Supreme Court case. The players sued Franco and GTE. GTE was the ISP who operated the server allowing access to this site. The district court preliminarily enjoined enforcement of these provisions. The Supreme Court Speaks: Reno v. The case against GTE was dismissed. GTE The Facts: Tapes were secretly made of the Illinois State football team in their lockers showing undressed players. The statute as written could suppress speech that adults have the right to receive. Constitution? Decision/Remedy: Yes. The Court Speaks: John Doe v.youngstuds. ACLU The Facts: Title V of the Telecommunications Act. was sued claiming a violation of the First Amendment Right to Freedom of Speech. 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. These tapes were displayed at univ. Reason: The court said the Internet is not as invasive as television or radio and accidental encounters seldom occur. liable for damages to the plaintiff football players? . 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. The district court’s decision was affirmed. The U. The terms here were vague and parents have other means of controlling Internet access of children.

. The dismissal was affirmed. Internet Technology: E-Signatures E-signatures have the same force and effect as a pen-inscribed signature on paper. Internet & Technology: Electronic Contracts Writing Requirement The E-Sign Act states that electronic contracts generally meet the writing and signature requirements for enforceable contracts.” Web hosts are like the telephone company and the postal service in dealing with liability of this type. Internet Law: Anti-Spam Statute As an answer to the junk e-mail or Spam bombardment. 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. 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 and E-Commerce 235 Decision/Remedy: No. E-sign is technology neutral.

They sell domain names. Gallo sued alleging violation of the ACPA. & J. Gallo Winery v. Spider Web Ltd. when stored by a router or server. .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. registered more than 2. Spider Webs The Facts: “Ernest & Julio Gallo” is a registered trademark of Gallo Winery. act in bad faith in registering the Internet domain name ernestandjuliogallo.com? Decision/Remedy: Yes.000 domain names including ernestandjuliogallow. The Court Speaks: E.com. The order was upheld. 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.net for names that have been registered. Spider Web was ordered to transfer the domain name in question to Gallo. and the creators. Issue: Did Spider Web Ltd. the Thurmans. or after receipt by the intended recipient. while in transit. Look to internic.

before the upscale apparel company and was allowed t keep it.000. Armani.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 name. 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. .com was eventually sold for $7. Internet & Technology: Domain Names Sold For Millions Business.500.

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.

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

such as the one Mildred Hayward made. if one of the parties is not a merchant. did not accept the counteroffer. Francis Net loses in this scenario.6 Under the Uniform Computer Information Transactions Act. Buffet wins. Because Info.3 Einstein Financial Analysis entered into an exclusive license with William Buffet. in this scenario. is a famous name.com. and the second is whether the domain name was registered in bad faith.1 While this is subject to debate. This means that for the specified duration of the license. The act gives the e-signature the same force and effect as a pen-inscribed signature on paper. Therefore. Inet can recover the license fee against David Abacus.4 The Uniform Computer Information Transactions Act recognizes that electronic agents do not have the ability to evaluate and accept counteroffers or make counteroffers. This rejects the offer. Contract 15. E-Mail Contract 15. Answers to Critical Thinking Cases Domain Name 15. Therefore. . Under this scenario. License 15. III. the licensor will not grant any other person rights in the same information. extinguishes the previous offer and becomes a new visible offer. Classic Coke. His case is discussed. Each new counteroffer. Obviously.2 Under the Uniform Electronic Transactions Act. and Francis Net’s objective was to make a fortune selling domain names. The first is whether the name is famous. West Coast Steel wins under this scenario. Electronic Signature 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. an electronic record satisfies the requirement for writing where the contract is required to be in writing by the Statute of Frauds. and no contract is formed. pretty obviously a bad faith gesture. License 15.5 The Federal Electronic Signature Act recognizes an electronic signature or esignature.Inc. it can recover the license payments for three years under its contract in this scenario. the Anticybersquatting Act has two main sets. no contract was formed by Tiffany and iSoftware. Since the electronic e-mails establishing the contract between Litle Steel and West Coast Steel were signed electronically. Therefore.

i. The defendant registered two Internet domain trade names through Website Management for his companies.Internet Law and E-Commerce 243 License 15. The plaintiff.com because of the language. under this scenario. and General Motors. Inc. While BluePeace.. Therefore. License 15. under this scenario.S. Issue Was this a deliberate and bad faith attempt to dilute the Toys “R” US family of trademark names? . He was not ethical because of the theft but neither was Apricot. v. unless it could prove that General Motors. Toys “R” Us. B. S. it is defective. IV. 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. These trade names were “Toysareus” and “Kidsareus.” C. District Court. Citation.D. Metatag wins. Therefore. and Court Toys “R” Us Inc. New York 2. 15. Macy’s. V. 3.com wins.org may have had the best of intentions. Case Name. Answers to Ethics Cases 15.9 Under the Anticybersquatting Consumer Protection Act. Silvia wins. Abir 1999 WL 61817 (1999) U. and Exxon Oil were guilty of the crimes depicted on their website. Toys “R” US also sued to collect attorneys’ fees on the basis that defendant’s actions were willful and in bad faith. D. owns the trademark on a family of businesses which are centered around the use of “R” US language. Key Facts A.10 Apricot. if a licensor tenders a Copy that is a material breach of the contract. Macy’s.e. it was acting in bad faith. Answer to “Briefing the Case” Writing Assignment 1.7 Under the Uniform Computer Information Transactions Act. the test of violation of the law is bad faith.8 Under the Uniform Computer Information Transactions act. He didn’t pay and cancellation is a remedy. and Exxon Oil win. the non-breaching party may refuse the tender. when a licensee breaches a contract. the licensor may sue and recover monetary damages from the licensee depending on the facts of the situation.

intentional. deliberate. 5.244 Chapter 15 4. B. Court’s Reasoning The District Court for the Southern District of New York held that: A. The plaintiff’s requests for both injunctive relief and claims for reimbursement of attorneys’ fees were therefore granted. This attempted dilution was willful. . and in bad faith. Holding Yes. The trade names used by the defendant did dilute the Toys “R” US family of protected trade names. C.

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

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

3 in text) . Hector.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. 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. in an operation performed at defendant’s medical center received a defective pacemaker. Plaintiff sued the defendant claiming this was a sale of goods and that the contract is subject to Article 2 provisions.) (See exhibit 14. 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. lessee and supplier (lessor usually buys goods from supplier for the lease. Hector appeals. The trial court granted a motion for a summary judgment and dismissed Hector’s suit. Cedars-Sinai Medical Center Facts: Plaintiff. Finance lease is a three-party transaction between lessor. The Court Speaks: Hector v.

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

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 .

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. Contemporary Issue: UCC Permits Additional Terms in Sales and Lease Contracts This discusses the mirror image rule and counteroffers.250 Chapter 16 Contemporary Issue: UCC Firm Offer Rule The firm offer rule states that a merchant who offers to buy. . sell. Note that an accommodation shipment is a counteroffer. 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. if no time is stated. for a reasonable time (up to three months).

Formation of Sales and Lease Contracts 251 .

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

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

St..254 Chapter 16 not unconscionable.Supp. 1987).Y. The court did not believe that Newsweek would agree to pay over $100. Coronis wins the lawsuit. M. the court held that it materially altered the original contract. or if no time is stated. Applying UCC 2-207.. Inc.e. and the terms.000 if it accidentally lost the photos. In order for the firm offer rule to apply. additional terms do not become part of contracts between merchants if they materially alter the contract. 1966). it only quoted a price. 540 So. St.. the offer was accepted. Formation 16. When Eagle shipped the descramblers.5. Charles and Eagle were such that both parties recognized the existence of a contract. Gordon Construction Co.4 Yes. Because they had made no such statements. The delivery memo contained terms additional to the original contract. the additional terms materially alter the original contract. Charles by making payments. World Omni Leasing. the court held that the firm offer rule did not apply. the UCC also holds that conduct by both parties that recognizes the existence of a contract is sufficient to form a contract. UCC Section 2-207 applies.J. Both parties behaved as if a contract had been formed. the offeror must explicitly state that the offer will be held open. 1989). Newsweek. Although the letter from Coronis to Gordon may have been a signed form sent between merchants. Wilson was forced to pay off the lease for the destroyed truck. However. . Coronis had properly revoked its offer on June 1. Wilson v. 687 F.. Charles and Eagle were sufficient to constitute an offer. The two parties had agreed on the price of the photographs. Because there had been an offer and acceptance. 16. If two merchants negotiate a sales contract and then exchange preprinted forms.Supp. Because the court found Miller and Newsweek to be merchants in regards to photographs.. 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. Inc. the offeror cannot revoke the offer for the time stated.A. The formation of a sales contract requires both an offer and an acceptance. Because the inclusion of this term was a unilateral action by Miller.2d 246 (N. the delivery date. the UCC recognizes an acceptance to the common law rule that allows an offeror to revoke his offer any time prior to its acceptance.500 a piece for the missing photos. then for a reasonable time. 216 A. Inc. Miller was not able to collect $1. Coronis Associates v. 660 F.N. a valid sales contract existed between St. Battle of the Forms 16. and the parties’ conduct recognized the existence of a contract. even if they were nonconforming. Charles and Eagle. the court found that a valid sales contract existed between the parties.6.D. No. E.2d 713 (Ala. In this case. 1988). the clauses in the delivery memo were not part of the contract. 820 (S.Del. In this situation. Super. the court held that a valid contract had been formed between Newsweek and Miller during their phone conversation. This exception is known as the firm offer rule. Newsweek was to pay for each photo used. Miller v. i. and they would work a great hardship upon Newsweek. The letter gave no assurance that the bid would be held open. The court held that the telephone conversations between St. The UCC holds that an offer may be accepted by the shipping of conforming or nonconforming goods. Eagle by shipping goods and accepting returns. Charles Cable TV v. The court also held that the actions by both St. The court held that the additional terms materially altered the contract because Newsweek probably would not have agreed to them in the original contract. Therefore. Eagle Comptronics. 852 (D.

10 The terms in the contract were clear. it was sent within a reasonable time. and (2) there is a reasonably certain basis for giving an appropriate remedy. 1987). Perschke.00 or more must be in writing. Sebasty v. There was no pressure and they were not grossly unfair presenting no real ethical issues. Finally. 404 N. Yes. Because the oral agreement between Donzi and Wallach violated the Statute of Frauds.9.N..C. Perschke wins the suit.Formation of Sales and Lease Contracts 255 Open Terms 16. the quantity in terms of acreage.8.Y. One such open term is the price.E. Donzi Marine Corp. 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. If the contract is not in writing it is not enforceable. Market prices for commodities like potatoes are readily available from government agencies. the UCC requires that a contract for the sale of goods for the price of $500.2d 243 (Ala. the court will imply a reasonable price. The price of the dealership was in excess of $500. which may be determined by a market rate. the court applied the UCC to a contract for the sale of a dealership.Supp. the court would not enforce it. a contract does not fail for indefiniteness if (1) the parties intended to form a contract. Wallach Marine Corp. the court will not enforce the agreement between Donzi and Wallach. Statute of Frauds 16. The court did not agree with Schmieding’s claim that the contract was void for indefiniteness. 529 So. Answers to Ethics Cases 16.App. Under the UCC. The writing must be signed by the party against whom enforcement is sought or by his authorized agent. In this situation. The facts clearly showed that no written agreement was ever made between Donzi and Wallach.2d 1200 (Ind. 1988). Although this agreement would have been too indefinite under the common law. In this case. If the market price is not available. the court held that the memorandum sent by Perschke’s office manager was a written confirmation. there was no evidence that Sebasty had ever made a written objection to the contract. Because the memorandum was sent on the same day Perschke had his phone conversation with Sebasty. and that it was possible to supply any open terms in that contract. Both sides were free to read and accept or reject the terms. a valid sales contract had been formed. The court determined that the parties had intended to form a contract. 675 F. 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. H. 1980). The UCC allows “open terms” to be determined at a later date. the appellate court found it to be a valid contract under the UCC.D. The court found that the contract specified the type of potatoes ordered. Generally. V. The UCC includes a Statute of Frauds provision that applies to sales contracts. When both parties to an agreement are merchants. 16. not purposely hidden and not unconscionable. the Statute of Frauds did not bar his claim against Sebasty. Because Perschke’s memorandum was a written confirmation of an oral sales contract. Answer to “Briefing the Case” Writing Assignment . Cagle. courts generally cannot enforce oral sales contracts for over $500. v.7. and the approximate delivery date. 838 (S. No. Schmieding Produce Co. Under the UCC. v. IV.

B. Citation. Court Reasoning A. Issue Are doctors and hospitals who provide medical services sellers and therefore liable under strict liability? 4. Central Medical Health Services. 3. He sued claiming strict liability alleging a defect in design unsafe for intended use. Inc.256 Chapter 16 1.2d 521(1995) Supreme Court of PA 2. Case Name. 5. A patient goes to a hospital to get treatment not to buy products. Key Facts A. B. Provision of medical services is not the sale of a product and case law distinguishes products from services. and Court Cafazzo v. . Holding No. C. Cafazzo underwent surgery for implantation of a mandibular protheses which was defective. Section 402Aof the Restatement (Second) of Torts grants strict liability for sale of a product in a defective condition unreasonably dangerous with certain stipulations. and insufficient warning. 668 A.

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

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

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 .

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

Performance of Sales and Lease Contracts 261 .

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

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 .

Brant Facts: Lindholm. “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. has superior rights to the owner. 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. by letter. Malmberg was to make delivery. Lindholm also agreed. after Brant found no claims or liens in a UCC lien search and search of the relevant Art Loss Registry. to loan “Red Elvis” to the Louisiana Museum. through an art dealer (Malmberg). The letter constituted the entrustment here and Brant honestly believed. 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. Brant received an invoice from Malmberg. . after sufficient investigation. A good faith purchaser. purchased “Red Elvis” which was created by Andy Warhol. claiming ownership. under these terms.266 Chapter 17 The Court speaks: Lindholm v. Lindholm agreed to have “Red Elvis” shown at the Guggenheim as part of an Andy Warhol Exhibition. that Malmberg was the owner. 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. sold it to Brant. Instead Malmberg. a collector.

Commission of Revenue Services. Because the specific truck sold had been distinguished from the seller’s other trucks. Yes. 1980. By painting the fire department’s name on the truck. the UCC provides that the delivery of the document title of the yacht determines when title passes. (1) title to goods passes from the seller to the buyer in any manner and on any conditions explicitly agreed on by the parties. Identification can occur in different ways. 1986). Until a seller identifies goods to a sales contract. . Big Knob Volunteer Fire Co. the court held that the fire truck had been identified to the contract when Hamerly painted the fire department’s name on the cab.Performance of Sales and Lease Contracts 267 III.2d 953 (Pa.2. 1980. Because the parties intended the title of the yacht to pass when the bill of sale was delivered. In addition to this general rule. The good sold can be specifically named in the contract.Super. v. Hamerly.2d. 1980. Identification means that the goods in the contract have been distinguished from the seller’s other goods. as the seller. the court determined that the parties must have agreed to pass title on October 18. Passage of Title 17. passage of title occurs when the seller delivers a document of title. Passage of title. Under UCC 2401. took place on October 18. title to the goods remains with the seller. 504 A. the good is identified when the seller explicitly separates or designates the good sold to the buyer. 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. 487 A. the court held that the sale took place on October 18. Even though the ship was never moved. where a sales contract does not involve the delivery of goods. In this case. This had the effect of separating or designating the specific item sold to the fire department. the fire truck was identified to the sales contract. Answers to Critical Thinking Cases Identification of Goods 17.1. New England Yacht Sales v. Lowe & Meyer Garage. 506 (Conn. was distinguishing this particular truck from other trucks they owned. the court held that the goods had been identified to the contract. In this case. In the case of a good that is part of a large mass of goods. 1985).

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. Michaels Jewelers.Conn. Entrustment Rule 17.5. Even though G & W was a good faith purchaser of the goods. Because the Carters acted in good faith in purchasing the Dodge and had no knowledge of Cherry Creek’s interest. Inc. the Carters were able to take valid title to the Dodge despite Cherry Creek’s security interest. Michaels Jewelers has valid title to the stolen jewelry. Coghill. Cherry Creek’s only recourse is against Executive Leasing. This meant that Torniero only had void title to the jewels. However.2d 509 (Mo.2d 1024 (Wyo. Carter. 1985). 1987). The court found that when Bellman bought Coghill’s Rolls Royce with a forged check. automobiles. they were buyers in the ordinary course of business.App. and in the title document to the car should have put an experienced buyer like Hyken on notice that there was something wrong. 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. “Value” means that the purchaser paid sufficient consideration for the goods.. The irregularities in the ad for the car. The court in this case found that MMM was a dealer in respect to prefabricated homes. The court held that the original owner of the jewelry.e. Inc. Passage of Title 17. “Good faith” means honesty in fact in the conduct or transaction concerned. On at least seven occasions MMM had sold Fuqua modular houses to retail customers. Torniero had stolen jewelry from Michaels. The Carters have valid title to the Dodge. Passage of Title 17. he received voidable title to the car. 733 P. When Hyken chose to ignore these warning signs. United States v. In this case. A buyer who buys goods with a check that is dishonored receives voidable title to that good. Although there was some question as to whether Hyken had paid sufficient money for the car. v. Michaels Jewelers. 141 (D. The buyer of a good from a seller who has void title to that good cannot obtain valid title against the original owner. Hyken was not a good faith purchaser for value. The title to the car goes back to Coghill. 1986). a good faith purchaser cannot obtain valid title to goods sold by a seller who has void title to them. they could not obtain valid title to them. 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 trial court’s main concern was with Hyken’s honesty. the court also determined that Hyken was not a good faith purchaser for value. and the appellate court gave title of the car back to Coghill.W.6. The Court held that Executive Leasing was a seller of goods of the kind involved here. Because of this dishonesty. As buyers in the ordinary course of business. i. the merchant has the power to transfer all rights (including title) to the goods to a buyer in the ordinary course of business.268 Chapter 17 Stolen Goods 17. 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. had title to the goods and returned the jewelry to them.. Ryan was a buyer in the ordinary course of . However. Cherry Creek Dodge v. The real owner cannot reclaim goods from this buyer. 709 S. Landshire Food Service. Ryan has a valid title to the house. A good faith purchaser for value can acquire good title.4. Bellman’s identification. 42 UCC Rep. A thief only has void title to the goods he has stolen. he was acting dishonestly with respect to this transaction.Serv.C.3.

S.O. it bore the risk of loss of the plywood during its transport. Inc. 1976). and the buyer does not have to pay for any destroyed goods.App. An F. Because Wycombe bore the risk of loss. 370 N.2d 699 (Ga.2d 14 (N. v. Because Mitsubishi was a seller in a destination contract. Therefore. Silver v. When a merchant-seller such as Wycombe holds goods for a buyer. & Loan Co. Etc. The court in this case held that even though the term F. Because the yarn was stolen when All America bore the risk of loss. Ct.. In this case. this was enough to make the agreement a shipment contract.2d 780 (Ohio App.B. A sales contract that requires the seller to deliver conforming goods to a specific destination is a destination contract. 1980). A contract that specifies the delivery terms F. 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.Y.2d 288 (N.8.9. Because MMM was a merchant of prefabricated homes.O. seller’s plant was used in reference to price. City Civ.Y. A buyer may obtain an insurable interest before title or risk of loss passes to him.App. there was no question as to whether Wycombe was a merchant of custom furniture. When the custom furniture was destroyed in a fire while it was within Wycombe’s possession. 1977). the seller is required to replace any goods lost or destroyed in transit. If a seller is a merchant. A. Mitsubishi International Corporation. the same principles apply. it bears the risk of loss. 390 N. point of shipment is a shipment contract. Knitwear wins the case. When Knitwear placed the yarn in the possession of the truck.O. A buyer obtains an insurable interest in goods when they are identified to the contract. it could sue the railroad to indemnify itself for that loss. 477 N. Mitsubishi must now pay to replace the plywood destroyed during shipping and deliver replacement goods to Crown. The seller bears the expense and risk of loss until the goods are placed in the carrier’s possession.B.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. Risk of Loss 17. 1984).10. Ryan now holds title to the home and Fuqua cannot reclaim it. In other words. and not picked up by the buyer. and All America must pay for the stolen yarn. Insurable Interest 17.E.Y.E. they were able to transfer title to Ryan as a buyer in the ordinary course of business. the risk of loss passed from Knitwear to All America. 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. Mitsubishi bore the risk of loss. If the goods are destroyed during transportation.S.. Meyer & Co. Evanston Bldg. Risk of Loss 17. point of shipment contract requires that the seller place the goods in the carrier’s possession. 41 N. it must return the payment Silver had made on the destroyed furniture. risk of loss does not pass to the buyer until the goods are received. Both Hayward and Dry Land Marina had an insurable interest in the destroyed yacht. All America.B. Wycombe must return the payment Silver made on the destroyed furniture.7.. Even though the furniture was to be shipped. Knitwear v. the risk of loss falls on the buyer.M. v.2d 832. Wycombe bore the risk of loss. In such a contract the seller bears the risk of loss to the goods during their transportation. Risk of Loss 17. Inc.. The seller retains an .Y. Wycombe. Fuqua Homes. All America must pay for the yarn.Y. Georgia Ports Auth. The court held that since Mitsubishi bore the risk of loss of the plywood. 274 S.

B. The farmers were such purchasers. E. On March 3. 3.W. the seller appealed. Tri-County was empowered to pass Executive’s title to purchasers in the ordinary course of business.12. 1980). 1986). 1971). Holding No. The lower court held in favor of the buyer. Executive allowed Tri-County to retain possession of the tractors. Case Name. Therefore. 5.2d 381 (Kan. IV: Answers to Ethics Cases 17. Labonte. 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. Affirmed for Charles. Pagel. Affirmed for the farmers. Lee Oldsmobile-Cadillac. the farmers received good title. 30 UCC Rep. F. 1990. 17. Potsma. Hayward v. Inc. Triangle had voidable title and under the UCC. The court held that both Prewitt and Dry Land held an insurable interest in the yacht at the time it was sold. D. 74 (R. Citation. A buyer and seller may have an insurable interest in the yacht because it had been identified to the contract. the mobile home was destroyed by fire through the fault of neither party. This constituted an entrusting. Issue Did tender of delivery take place so as to have shifted the risk of loss to the buyer? 4. Executive Financial Services. 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.11. and Court Burnett v. v. Charles had good title and passed good title to Lee. The next day. Lexis 3467 (1992) Court of Appeals of Ohio 2. The parties entered into a contract for the sale and transfer of a mobile home and shed. the seller transferred to the buyer a certificate of title and one of the keys to the mobile home. C. Purtell 1992 Ohio App. Therefore. Court’s Reasoning The Court of Appeals of Ohio held that: .2d 31 (Mich. 188 N. V. The yacht became identified to the contract when it was specifically named in the sales agreement. v.I. Thus. Inc.App. Key Facts A. Answer to “Briefing the Case” Writing Assignment 1. Thus.270 Chapter 17 insurable interest in goods so long as title or any security interest in the goods remains with the seller. 715 P. The seller retained both keys to the mobile home and the shed in order to later remove his contents. Campus had good title and passed that title to its buyer. Triangle could pass good title to a good faith purchaser for value that Campus was. The buyer claimed that the risk of loss had not passed because there was no tender of delivery and wants a refund.

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

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

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

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 .

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

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

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. .

What if the goods were custom designed or artistic in nature? Would or should the same apply? . most students eventually come around to the “lost volume” measure of damages in the commercial setting.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. At first. it appears that no real harm is done to the seller. 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 .

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

When such an unforeseen contingency prevents a seller from delivering goods.Fla. Archer Daniels Midland v.5. The court held that Archer learned of Charter’s insolvency after the ethanol had been shipped. The seller’s reclamation demand must be made within ten days after the buyer receives the goods.000 bushels was excused due to the commercial impracticability of his ability performing the contract. the buyer is relieved of any duty to pay. . the unusually rainy summer was an unforeseen contingency that prevented Campbell from performing the contract. and the nonconformity was difficult to discover.D. This nonconformity both substantially impaired their value. Commercial Impracticability 18. Campbell’s failure to deliver the 20. Charter International Oil Company.R. the seller is excused from the breach of contract. Once the nonconformity was discovered. 700 P. 380 A.2d 463 (Penn.4. 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. the Bankruptcy Court ordered the return of the ethanol to Archer. Because Charter did not honor Archer’s request. 1977). if a seller either does not deliver the goods.2d 642 (N. However. v. Farrar immediately informed International of its revocation. Campbell wins the lawsuit. because he had properly revoked the acceptance of nonconforming goods. because the company had properly revoked its acceptance of International’s boxes. Hostetter Farms. and was difficult to discover before the goods were accepted. Revocation is not effective until the seller is notified.Remedies for Breach of Sales and Lease Contracts 285 18..3.M. 1986). Charter should have honored Archer’s request for the return of the remaining ethanol. Campbell v. 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. International Paper Co. and (3) the goods are accepted before the nonconformity was discovered. based upon the doctrine of commercial impracticability of the contract. Inc. 9583 bushels of corn out of the 20. 60 B. 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. Archer has a right to reclaim the ethanol from Charter. or delays his delivery because an unforeseen contingency prevents the seller from performing his obligations. (2) the nonconformity substantially impairs the value of the goods to the buyer. In order to exercise the right to reclaim goods from the buyer. Farrar was no longer obligated to pay for the nonconforming goods. Revocation of acceptance is permitted if (1) the goods are nonconforming. The seller is excused from breach of the contract under the doctrine of commercial impracticability. When a buyer rightfully revokes the acceptance of goods. The court held that the boxes that International sold to Farrar were nonconforming due to their tendency to collapse. Farrar. The Appellate Court upheld the lower court’s decision in favor of Farrar.000 contracted for. The court held that Campbell had not complied with the terms of the sales agreement when he failed to deliver. 1985). Farrar wins the case. the seller must send the buyer a written notice demanding the return of the goods. Seller’s Right to Reclaim Goods 18. 854 (M.

Tri-State’s breach meant that Saber made only one sale instead of two. and he must pay Daniels for the remaining grass bags. In other words.. Seller’s Right to Recover the Purchase Price 18. Meuser still won the lawsuit and the appellate court awarded the company a reduced amount. the UCC provides that a buyer may obtain . Specific Performance 18.. C. 541 S. v.2d 575 (5th Cir. 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. i. Saber was the seller of an ordinary item. Saber Energy.D.6.e. The court held that Yazoo had contracted for the purchase of specially manufactured goods. However. Inc. the gasoline Tri-State had originally bought was resold. If the buyer contracts to purchase specially manufactured goods and refuses to accept and pay for them. Co. Saber has the right to recover its lost profits. if the buyer rejects specially manufactured goods and the goods cannot be resold. 641 F. 1988)..W. and any incidental damages incurred on the resale. the seller may resell the goods if he is still in possession of them. Yazoo Mfg. 1986).Miss. the seller may recover the purchase price if the circumstances reasonably indicate that an effort at resale would be unavailing. 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. Since this occurred when Meuser still had possession of the bulldozer. The appellate court held that Meuser could properly recover the amount spent on the upkeep of the equipment as incidental damages. Meuser wins the lawsuit. on the contract. the seller can be made whole by reselling the goods and then suing the buyer for the difference between the resale and contract price. Right To Recover Lost Profits 18. Because Yazoo was the only potential customer for the bags. 205 (S.e.. Because of Yazoo’s breach. When a buyer has breached a sales contract for specially manufactured goods. i. the court held that Daniels was entitled to the purchase price of the grass bags. this remedy will not put the seller of ordinary items in the same position as if the buyer had performed the sales contract. Daniels did not have to attempt a resale. McMillan v.. The grass catcher bags that Daniels was manufacturing had been specially designed to fit a Yazoo model lawn mower.R. Inc. Meuser had the right to resell it. However. 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.9. Yazoo refused to accept and pay for these bags. when a buyer breaches or repudiates a sales contract. Yazoo is not correct. gasoline. The Court held that McMillan breached the contract when he stopped payment on his check. including reasonable overhead. When Tri-State breached its contract. Daniels. When a sales contract is for a unique good. Inc.7. A seller may recover the purchase price. Tri-State Petroleum Corp. Therefore the seller can be awarded its lost profits. the seller may recover both the contract-resale measure of damages. resold in good faith and in a commercially reasonable manner.286 Chapter 18 Seller’s Right To Resell Goods 18. 845 F. the price agreed to in the contract. Meuser Material & Equipment Co. When the goods are rightfully resold. However.Supp.8. Because of this situation. the court held that Saber was entitled to its lost profits.2d 911 (Ark. the loss incurred on the sale. Sedmaks can obtain specific performance of the sales contract for the limited edition Corvette. Under the UCC. 1976).. v. the seller would have made two sales instead of one if the original buyer had not breached. When the goods are ordinary items or of relatively unlimited supply.

In addition. 18. . v. Because the court found that Allsopp had not acted in a commercially reasonable manner. it was commercially reasonable for Lincoln to request the delivery of sand during December.10. the buyer may cover by purchasing substitute goods. Four years is a reasonable time under the circumstances. the term is defined in reference to the course of dealing between the parties. The court awarded Nowlin the cover minus the contract price measure of damages. the company was entitled to the difference between the original contract price and the price paid to Gallup.2d 331 (N. Since Allsopp already had the sand stockpiled. 1981). Even though the car was not one of a kind. Ybarras win.App. Lincoln’s offer to send an employee to help with the loading also favorably influenced the court’s decision. This is called the cover minus the contract price measure of damages. The court held that C&E had failed to make a delivery when it shipped Nowlin only 2. 1987).11. The court ordered Charlie’s to sell the Indy Pace Car Corvette to the Sedmaks. If a seller fails to make a delivery of goods. In this case. 746 P. Concrete Sales & Equipment Rental Company.000 tons. 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. Right To Cover 18. By immediately contracting with another commercial supplier of gravel. the court held that Lincoln’s request was reasonable. Nowlin covered in good faith and in reasonable time.12. In this case the court held that the Indy Pace Car Special Edition Corvette was a unique good.. Inc. the Sedmaks were entitled to obtain specific performance.2d 694 (Mo. and the contract did mention the availability of delivery by special arrangement. Charlie’s Chevrolet. Lincoln Sand and Gravel. Inc.2d 645 (N. its refusal of Lincoln’s request was unreasonable. IV: Answers to Business Ethics Cases 18.. 622 S. Kent Nowlin Construction. 1988). A buyer’s cover must be made in good faith and without unreasonable delay. 609 P. Lincoln was allowed out of its contractual obligations. Sales contracts for works of art and antiques are the type of contracts for which courts will order specific performance. The UCC does not specifically define what is commercially reasonable. the plaintiffs’ continuous complaint was due notice that the trailer was defective and they were not satisfied.E.. the buyer may sue the seller to recover as damages the difference between the cost of cover and the original contract price.M. it was sufficiently limited in number so that an award of monetary damages would not be a sufficient remedy. Inc. Inc.App. Yes. and Allsopp’s refusal of the request was unreasonable. Gallop Sand and Gravel Company. Because Nowlin covered in good faith. Revocation must be given in a reasonable time and by a reasonable manner. When Charlie’s breached the sales contract for the Corvette. If the buyer covers the undelivered goods.2d 1185 (Ill. 1980). Therefore. 525 N. the usage of trade. Nowlin wins the lawsuit. Allsopp Sand and Gravel v. Sedmak v. the requirements of the UCC have been met. C&E’s failure to deliver gave Nowlin the right to cover.M. Modern Trailer Sales.099 tons of paving material instead of the contracted 20. Lincoln’s request was reasonable because it came within the one-year period covered by the contract.Remedies for Breach of Sales and Lease Contracts 287 specific performance because an award of monetary damages is not a sufficient remedy. Therefore. Ybarras v. it was not reasonable for it to charge an extra amount to load during December.W. Instead. and other factors.

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

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

II. 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 . Other avenues may include tort law. applicable in this case? Remember also. consumer protection statutes. contractual or otherwise. and equitable remedies. Finally. are there any defenses. warranties represent only one path to dealing with the problem. ascertain the measure of the alleged injury.290 Chapter 19 Fourth.

Merchantability When Relevant Manner of Disclaimer Anytime given Sale by a merchant N/A Mention merchant If in writing conspicuous “As is”.Warranties and Product Liability 291 Warranty Summary Sheet Warranty Express: .Promise . “with all faults” Examination Course of dealing In writing an conspicuous - Fitness for a particular purpose - Title Sale by anyone if: .) 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 .Buyer relies on seller to select goods Transfer of goods - - Against encumbrance (free from security interest) Against infringement (no conflicting patents.Seller knows of purpose . etc.Description .Model Implied: .

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

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

294 Chapter 19 Must pass the consumer expectation test .

Airstream trailer she had on order. 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. Garnica sued Massey and Jeep for damages alleging breach of the implied warranty of fitness for a particular purpose. v. Massey had superb knowledge and expertise and Garnica had inquired and relied on this. Reason: Massey said the Jeep would work after knowing the requirements. Garnica explained requirements and got the specifications of the trailer from Airstream. Garnica bought the Jeep. Landmark Law: Magnuson-Moss Warranty Act The Magnuson Moss Warranty Act covers written warranties relating to consumer products. She was eventually told to go to another dealer and the driveshaft twisted at 7. 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.Warranties and Product Liability 295 The Court Speaks: Mack Massey Motors. Refer to previous sheet. but had it in for repairs for a slipping transmission several times. Massey’s sales manager said the Jeep would work. Inc.229 miles. Garnica wins and Massey and Jeep appealed. Garnica Facts: Garnica went to Massey to ask about a Jeep Cherokee to tow a 23 ft. .

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 roles of government and its courts as sources of buyer protection were expected to be minimal. 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. the law’s expectations of buyer protection started and ended with the buyers themselves. A person entering the marketplace was expected to personally know the seller and to resolve any differences directly with him or her. The law has stepped in with numerous remedial measures to help alleviate the shortcomings created by caveat emptor. That all worked well enough in the preindustrial age populated by small communities with direct dealings between the buyer and seller.

On the side of product users. Arguments in favor of strong product liability laws: In the area of tort law. and test against harm. The second stream of cases arose out of the warranty aspects of UCC sales. The two sides of the public policy debate surrounding this doctrine are set out below. the sanctions imposed by law for defective products should act as a deterrent to further introduction of faulty products into the marketplace. many argue that traditional negligence doctrines have failed to adequately protect consumers hurt by defective products. As a practical matter. Compared to the consumer. Traditional tort law doctrines based on fault and defenses related thereto have not always adequately served the injured person.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. b. c. Arguments in favor of restricting the use of product liability doctrines: As persuasive as some of these arguments may be. Courts led the way to newer avenues of recourse by way of the doctrine of strict liability. If sellers of goods know this. The evolution of strict liability doctrines is a logical consequence of having this deficiency in the law. d. Some key arguments raised against the current products liability systems are as follows: a. the following points are worth considering: a. Various legislative enactments at both local and national levels designed to protect consumers tend to be reactive rather than proactive. Can you as a buyer of an automobile really test the airbag before you buy the car? e. both common and UCC. . has also failed to provide adequate assurance to the victims of product harm. they will try harder to make products safer in the first place. the protection against defects in products is best provided by the manufacturers of those products. 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. develop. The cost of the present system is simply out of control and is a model of inefficiency. Contract law. the other side of the coin has its own convincing points. Finally. they have the resources to research. Consumers traditionally have had less real bargaining power in the contracting process when it comes to attaching responsibility for harm created by a product.

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

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

Senco appealed. 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. John Lakin was using a Senco SN325 nail gun to build a new home. Lakin and his wife won. Higgins got Potter out of the way but was hit and thrown into a spinal cord injury leaving him a quadriplegic. thus supporting the judgment? Decision: Yes. Falkner used it the day he bought it . Evidence showed the lack of a guidance or steering mechanism and that Intex made a Sno-Boggan with bottom ridges that prevented rotation. The gun fired an unintended second nail that went through his cheekbone and into his brain. The Court Speaks: Higgins v.expectation test requiring a showing of danger greater than an ordinary consumer would expect based on an alternative design. The rider could end up going down backwards. The Court Speaks: Lakin v. . but spun around aiming at 7-year old Potter. Issue: Was the Extreme Sno-Tube II defectively designed. Higgins sued Intex based on strict liability. There was sufficient evidence that the plaintiff met his burden of proof. Lakin and his wife sued Senco for strict liability based on design defect. 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 judgment was affirmed. Higgins was awarded 35% of damages after a jury finding of a design defect. and the consumer.300 Chapter 19 such defect existed when the product left the hands of the defendant. Facts: Senco manufacturers and market a variety of pneumatic nail guns. 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. A reasonable jury could enter an expectation of rotation by a reasonable consumer. 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. Senco Products. Inc. Lakin is permanently brain damaged.

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

Supreme Court. resealed it carefully. a “shrink seal” around the neck. Reason: Tylenol was marketed in tamper-resistant packaging with a foil seal glued to the mouth of the bottle.302 Chapter 19 The Court speaks: Elsroth v. a court can award damages if it finds that the defendant’s actions were done with intent or reckless disregard for human life. could not have been prevented by these steps as so recognized by the FDA. 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 judge reduced the $79.5 million to $32 million.5 million. Note: In product liability cases. The jury agreed and awarded $821. The case was appealed to the U. . administrator of Diane’s estate. They are meant to punish. The Supreme Court speaks: Philip Morris USA v. Diane took two capsules with water for a headache while visiting Harriet’s house (mother of Diane’s boyfriend). 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 appeals court restores the $79. Williams’ personal representative sued PM alleging deceit and knowingly misleading that cigarette smoking was safe. and a glued shut sealed box. and reshelved it at the A&P. Elsroth. Williams Facts: Williams died because of his cigarette smoking. however. tampered with it. The jury was permitted to consider the harm caused to others (not parties to the suit). The expert tampering here. Both sides appealed.5 million in punitive damages. Johnson & Johnson Facts: Harriet bought Extra-Strength Tylenol from the A&P. No packaging can boast of being tamper proof. The Tylenol was manufactured by McNeil under the name of Johnson & Johnson. Whoever did it bought it.S. He favored Marlboro which are produced by Philip Morris ISA (PM). The Oregon Supreme Court denied review.000 in compensatory damages and $79. The claim of strict liability was not upheld. This is the type of packaging reasonably contemplated by the ultimate consumer and not unreasonably dangerous.

Redmond will be able to recover the $6. . A $1 billion punitive award damage award was granted. The statements on the tags and in the salesman’s assurances constitute such a warranty. An express warranty is created when a seller makes an affirmation that the goods meet certain standards. Redmond does not win except for return of money. Express Warranty 19. Reason: The Due Process Clause forbids use of punitive damages against a defendant if based on injuries to nonparties.200 because the sale involved fraud and a void title (or no title).1. The defendant cannot defend against a charge for nonparties. One cannot deliver title to stolen goods so no title can be delivered to Redmond. The case was remanded for use of a correct standard.2. 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.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. This is a standardless dimension in the punitive damages equation. III. This would only lead to jury speculation. This can be used to show reprehensibility but not to calculate damages to a nonparty.

The disclaimer is set out in large type and the section is clearly labeled “Warranties. the disclaimer clearly mentions merchantability.6.App. Ingersoll-Rand is not liable for the breach of implied warranty of merchantability because it properly disclaimed any such warranty. Inc. The disclaimer was in writing and it was clear that any warranty except that stated was not in effect. in the same way it applies to contracts for the sale of goods.2d 872 (Fla. Disclaimer of Warranty 19. Implied Warranty of Merchantability 19. 1988). Publix Supermarkets. The consumer expectation test holds that when food contains a substance other than what the consumer might reasonably expect to find in the food. Implied Warranty of Fitness For Human Consumption 19. Disclaimer of Warranty 19. 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. Ansul’s disclaimer is enforceable. Disclaimers of the merchantability warranty must specifically mention the term “merchantability. The court held that the UCC applies to contracts for leases. however. 1988). No. neither Publix Supermarkets nor Doxsee are liable for Keperwes’ injury.3.Supp. The issue of being conspicuous might be in question but it was clearly stated on the back of the last page. the court found in favor of Publix and Doxsee.” This passes the UCC test for conspicuousness. The statement that the car was a “good runner” may be considered of opinion. Thus under this theory Crothers should win. the warranty for fitness for human consumption has been breached. Maybank should win. If the bulb was not safety coated. No.D. Because the presence of the clamshell in Keperwes’ soup did not fail the consumer expectation test. The implied warranty of merchantability. 208 (C.7.” If the disclaimer is in writing. 534 So.304 Chapter 19 Statement of Fact or Opinion 19. Ingersoll-Rand Company..Ill. There is definitely a breach of the implied warranty of merchantability as the bulbs were not fit for normal use. . there is a breach of an express warranty. the court followed the consumer expectation test. Because Keperwes’ injuries were not a result of a breach of warranty. In the agreement between Ingersoll-Rand and Cole Energy. This implied warranty is incorporated into the implied warranty of merchantability.4. the court found no breach of warranty of fitness for human consumption. In determining whether this warranty has been breached. Cole Energy Development Company v. requires a car to be fit for normal use (driving). Keperwes v. Because Ingersoll-Rand had properly disclaimed the implied warranty of merchantability. it must be conspicuous. Cole Energy was not able to recover.5. 678 F.

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

including high-speed collisions between vehicles. Inc. E. J. 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.11. 42 C. where the Court stated: The argument that the van was built only for “normal” driving is unavailing. 104 Cal. the manufacturer is required to design its vehicle to minimize unreasonable risks of injury and death. The court held that a motor vehicle manufacturer is required to foresee that. A defect in the design of a product will support an action for strict liability. Failure to Warn 19. Emerson Electric Co. stating that this theory had been repudiated in Cronin v. Rptr. is strictly liable to Virginia Burkes. and social utility of the product. Yes. 817 F. 3d 121. 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. 1974). 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. In this case. the Chevrolet station wagon was a defective product.. Here. as an incident of normal operation in the environment in which his product will be used. Karns v.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. 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. strict liability in tort will attach if appropriate and conspicuous warning is not given. The court held that there was a defect in the design of the Chevrolet station wagon in which Christine was seated. Olson Corp. The court rejected this assertion.12.3d 1. Because of this possibility. 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. Smith v. General Motors asserts. This location left the fuel tank exposed to the dangers of a collision from another vehicle. the likelihood that injury will occur.Rptr.2d 1452 (1987). Yes.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. B. Crashworthiness Doctrine 19. 1972). the availability and cost of producing a safer alternative design. In evaluating the adequacy of a product’s design. The court ordered a new trial in this case.App. General Motors Corporation. the courts consider the gravity of the danger posed by the design. vehicle manufacturers must take accidents into consideration as reasonably foreseeable occurrences involving their products. no evidence was produced to show the station wagon was unsafe for its intended use—operation on the highway. accidents will occur. 116 Cal. 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. 575 (Cal. Almaden Vineyards. 8 C. 433 (Cal. Although a condition may not be the “normal” or intended use of a motor vehicle. 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 ...

Horn v. the defendant must prove that (1) the plaintiff knew and appreciated the risk. General Motors Corporation. 135 (Cal. IV: Answers to Ethics Questions 19.Rptr. The hook in this case was intended to be used to tie animals to fences. 1975).Rptr. or abnormal misuse of the product. the failure to warn against this danger constituted a defective product for which strict liability would lie. Since Swan knew of the specific purpose for the cooker and Troy was to use an expert to build it. Therefore. 392 (Cal. Buchanan. 78 (Cal.. there was an implied warranty of fitness for a particular purpose that was breached. such as using glue or other adhesive. (2) the plaintiff voluntarily assumed the risk. 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. 1985). and was not intended to be used to lift a 1. unintended. Horn wins. Thus. an early ricochet of the cork could produce harm to someone hit by the cork. 86 C. 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.A. Almaden Vineyards. Inc. Dosier v. 173 Cal. An affirmative fact that is the basis of the bargain is an express warranty. 1978). A manufacturer or seller of a product is entitled to assume that the product will be put to its intended use. 19.13. an express warranty was created. statements of opinion are not. 1976). posts. etc. Defendant Wilcox-Crittendon Company wins.App.3d 359.Rptr. Burke v.App. These statements in the brochure are affirmations of fact. The court held that Almaden was aware of this danger and failed to warn against it. These representations are a basis of the bargain unless the seller can prove that the bargain did not rest on the representations. If . 119 Cal. The court held Almaden strictly liable to Burke. with no pressure on or twisting of the cork and agitation of the bottle’s contents. unexpected.App.3d 74. The court held that there were safer alternative methods of attaching the horn cap.Warranties and Product Liability 307 failed to warn of this danger. Misuse 19. 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.700-pound counterweight into the air. 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.App.3d 13. 220 Cal. The court held that General Motors was strictly liable to Horn for her injuries. Wilcox-Crittendon Company. 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. depending upon bottle temperature. 17 C. 45 Cal. 150 Cal.15. and (3) the plaintiff’s undertaking of the risk was unreasonable. 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. At such speeds. This the seller did not do. and is not liable in strict liability for an unforeseeable. Keith v. Statements in brochures can be affirmations of fact and can be considered part of the bargain.14. Assumption of Risk 19. 131 Cal. Keith wins. For the defense of the assumption of risk to apply.App.16. 419 (Cal.Rptr.

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

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

Even though an instrument may fail to meet the requirements proscribed by the UCC for negotiability. that fact does not render it illegal. Nonnegotiability does not ipso facto preclude legality. they proceed to declare an instrument that lacks a missing critical element of negotiability as legally null and void. Having done that.310 Chapter 20 elements of negotiability and learn how to identify them in an instrument. Nor is it necessarily barred from being enforced as a contract. 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 .

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

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 .

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

Think of it as analogous to money. Deeks filed a complaint alleging the document was a negotiable instrument and that Deeks was due an estimated $3.000. and the Oneida tribe of Native Americans in 1781 whereby blankets were promised in exchange for Revolutionary War assistance. Assignee acquires only the rights that the assigner possessed. indorse it. or in any way change the paper itself to change ownership. usually satisfied by the equivalent in U. USA never made good on its promise. Because this method is openended. It only takes a legal physical transfer.S. Contemporary Issue: Variable Interest Rate Loan Revised Article 3 recognizes variable interest rate notes as negotiable instruments and reflects modern commercial and banking practices. dollars. The Court speaks: Deeks v. United States Facts: Deeks possesses a 1792 document evidencing an agreement between Willett. International Law: Negotiable Instruments Payable in Foreign Currency Instrument may state it is payable in foreign money. The claim was dismissed and Deeks appealed.000. Issue: Is the 1792 document a negotiable instrument? Decision: No and the statute of limitations had run on a contract claim. substantial risks inure with its use.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. Witness the use of the previously mentioned travelers . You do not have to sign it. These are loans by lenders where the interest rate on the loan varies throughout a portion or entire period of the loan. Reason: The text reveals neither an intent that it be circulated as money nor an unconditional promise to pay a certain sum. Bearer paper is negotiable by delivery of the document. a USA military officer. The first path of transfer is by physical possession of the instrument if the document is designated as bearer paper.

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

.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. See “Types of Indorsements” below. Note: Words of negotiation are not requires for a special indorsement.

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 .320 Chapter 20 An indorsement that purports to prohibit further negotiation does not destroy the negotiability of the instrument.

N. the maker of the note. 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. To be negotiable.E. or order to pay. Negotiable instruments must also be payable either to order or to bearer. can be classified as either orders to pay or promises to pay. the McGuires. in good faith. Cooperative Centrale Raiffeisen-Boerenleenbank B. Broadway Management Corp.” Although this language is somewhat unusual in that most order instruments are made payable “to the order of.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.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.” the court determined that the note should still be classified as an order instrument. 1989). Bailey was a negotiable instrument. such as promissory notes.” The note also states that the promise to pay is made “to the order to CALIFORNIA DREAMSTREET. Therefore.4. 509 F. v. a promise to pay must be an affirmative undertaking. this promissory note can be described as a promise to pay. Alternative needs one Virgule (slash mark) needs one. An instrument is an order instrument if it is payable to the order or assigns of any person specified with reasonable certainty. To be a negotiable instrument. Bailey. 9 UCC Rep Serv 2d 145 (C.Cal.Supp. Dr. In contrast. P P Inc. The use of the words “order” or “assigns” usually indicates that a note is an order instrument. the Tursis. Bailey’s note was unambiguous in stating that he “promises to pay. by not ordering a third party to pay them. . 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. because the maker of these instruments is promising to pay the payee himself. Negotiable Instrument 20. Yes. 332 N. These are checks. the note executed by Dr. drawer or maker is liable to anyone who. 1079 (D. v. v. 1975). App. Commercial paper. The language in Dr. a writing must contain either an unconditional promise. $65. Note 20.A. promised to pay the payees.J. Briggs. promissory notes and certificates of deposit are promises to pay. Drafts and checks are orders to pay since the drawer orders the drawee to pay the payee. The Imposter Rule says the named payee.000 because the McGuires promised to personally pay the payees. 1981). The note in this was an order instrument with an unconditional promise to pay. In this case. Joint needs both. McGuire.2.3. Bailey’s note was both a promise to pay and an order instrument. The note signed by McGuire was a promise to pay. Bearer or Order Instrument 20. III. Answers to Critical Thinking Cases Type of Negotiable Instrument 20.2d 131 (Ill. pays the instrument or takes it for value or for collection. The mere acknowledgment of a debt or an implied promise to pay is not sufficient.D.

Holsonback v. The court reasoned that one must look only to the face of an instrument to determine whether it is negotiable.5. First State Bank of Albertville. 570 P. Most writings on paper meet the permanency requirement. payable upon presentation. The UCC sets forth a number of requirements in order for an instrument to be classified as negotiable. The portability requirement is intended to insure free transfer of the instrument. 222 (Ala. payable at sight. First State Bank of Gallup v. . Yes. The UCC also states that these requirements appear in writing on the face of the instrument. despite the letter of authorization. In this case. 30 UCC Rep.7. Among the requirements is that the note contain an unconditional promise or order to pay. Demand notes include those instruments that are payable on demand. The UCC requires that an instrument be payable either on demand or at a definite time. Yes. Yes.2d 1144 (N.322 Chapter 20 Formal Requirements 20. 1977). Thus. The court also held that the letter that authorized Clark to pledge the note did not make the instrument negotiable. and those instruments that have no specified payment date. The court held that despite the letter of authorization.” Since the monthly installments provided for in the note did not destroy the demand nature of the instrument. and (3) be portable. 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 check was in writing.M. and that the language which indicated the note was a demand note was controlling. Demand Instrument 20. a check printed on an envelope meets the requirements of the UCC for classification as a negotiable instrument. Any writing that is placed on an object that is small enough to be easily handled qualifies as portable. it could not cause the instrument to become negotiable.6. the promissory note signed by Blanchard was a demand instrument. Progressive Bank & Trust Co. it met the requirements of the UCC for a negotiable instrument. Clark and Horne. The check that Holsonback used to pay for the Corvette was a negotiable instrument. Blanchard v.App. Unconditional Promise 20. The court in this case held that the note was payable on demand.2d 589 (La. the note was a demand instrument. Serv. Since the authorization letter signed by Horne was not part of the instrument itself. and portable. the court held that the promise to pay contained in Horne’s note was not unconditional. 1982). 413 So. Three requirements are necessary for a negotiable instrument: (1) the instrument be in writing. It found that the note was payable on demand and that the language which referred to monthly payments was an additional agreement. 1980). permanent. because of the restrictive term on the face of the instrument. (2) be permanent. The requisite writing is often on a preprinted form. an envelope that was standard sized making the check easily portable. The note was not negotiable. the restriction written on Horne’s promissory note made it nonnegotiable. the note was nonnegotiable. The check was a writing on a paper object..

Since there was no restriction in the indorsement.13.. Coltharp v. 1967). this special indorsement converted the check back to order paper and the check became payable only upon indorsement of City Savings Bank. A specifically indorsed instrument must be indorsed by the one to whom it is payable before it becomes negotiable. 199 So. Indorsement 20. in itself. the check was order paper at the time it was accepted by the CM National Bank. Since there was room on the instrument and the signature was placed only on the attachments. The purpose stated on the check does not limit its negotiability. Thus. the bank could cash them.10. A demand instrument is one that is payable on sight or on demand. 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. Calcasieu-Marine National Bank of Lake Charles. Commercial paper. Mary successfully negotiated this bearer instrument when he delivered the check to Coltharp.9. Since the obligations are stated in another writing the notes are not negotiable instruments. Taking for Value 20. Since the mortgage does not. Reference to Another Document 20. Reference to Another Document 20. the note is not conditional and is negotiable. Order or Bearer Paper 20. In this case. Therefore.App. Here there was an indorsed check that was cashed. Mullins wins the case. Inc.8. [UCC 3-108]. The UCC states that an instrument is payable to the bearer when the only or last indorsement is in blank.2d 568 (La. Under the UCC. It occurs when a holder pays money for a negotiable instrument. The check was order paper at the time CM National Bank accepted it. can be classified as either time instruments or demand instruments. Mullins had . the note was not properly indorsed. this special indorsement converted the check back to order paper. set obligations but instead describes the security. the court established that St.11.14 Standard wins since it took the note for value by performing the agreed upon consideration. St.Negotiability and Transferability 323 Order to Pay 20. The bank is not liable . when Coltharp specifically indorsed the check making it payable only to the City Savings Bank. Mary’s indorsement was in blank. Subsequently.15. because the eight notes that the company executed were time instruments. Indorsement 20.12. This converted the original order paper into bearer paper. such as promissory notes. or one for which no time payment is stated. This is a negotiable instrument. In this case. IV: Answer to Ethics Questions 20.

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

and as such. B. 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.Negotiability and Transferability 325 5. his signatures constituted hiss on personal signature. The order and placement of Galt’s signatures did not clearly designate him as signing only inn an agency capacity. that agency capacity must be clearly designated on the instrument. . thus. he is personally liable for the loan contract.

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

The second source of liability is found in a set of warranties imposed by the UCC. 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). nonetheless. In the area of consumer credit transactions. you must follow the rules of the road. but it will end. The next objective of this chapter is to review the liability. The HDC still takes the instrument subject to a number of defenses called real defenses. the FTC has stepped in by preempting the HDC rule. These elements will be set in the chapter summary. the metamorphosis is not complete. There are two main theories for attaching liability in negotiable instruments. or many years as seen in long term notes. These rights and duties are essentially derived from contract law as modified by the UCC. and discharge aspects of negotiable instruments. you want to buy only what you see and not get ambushed by potential lawsuits lurking in the bushes. an assignee steps into the shoes of the assignor. Generally. Warranties are promises imposed by the statute upon those who want to be players in this game. he or she undertakes the assignor’s obligations and benefits from their rights. 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. 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. 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. Remember. Various states have also promulgated similar rules as outlined in the Uniform Consumer Credit Code or by case law. remember that by their very nature. . In addition. Paper money eventually wears out and needs to be taken out of circulation. 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. If someone hands you a dollar that is clearly a photocopy of currency. That course may be just a matter of days in the case of a check. as radical as this shift is from the common law of contract assignment. It is designed to create justifiable reliance on instruments where the elements of HDC are in place. the law must provide some form of resolution. Negotiable instruments are a highly formalized and technically complex set of contracts used primarily as money substitutes.Holder in Due Course and Liability of Parties 327 money may be useful. The law of contract under this rule subjects the HDC of consumer credit paper to all the defenses and claims of the consumer. As a buyer of commercial paper. It may last a long time. No contract is forever. It is not designed to protect those who think play money is real and do not bother to learn the rules. So too does a negotiable instrument ultimately run its course. These promises are not always actually expressed by the party against whom the warranties are imposed. 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 end. where its elements are in place. The HDC concept allows for a fundamental shift in the law in that. defense. Under the common law. negotiable instruments are meant to be handled by many people. The rules on discharge help make a judge’s job a little easier. In addition. The degrees of protection afforded to third party takers of instruments begin with a comparison between the common law of contract and the UCC. The first is found in the rights and duties arising out of the signatures of parties to the instrument. Think of them as duties that arise out of using the road of negotiation: if you go down this road. but the responsibility to live up to them is there. 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.

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

word. or mark used in lieu of a written signature. 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.Maker .Indorser .Accepting or certifying drawee .Holder in Due Course and Liability of Parties 329 Signer can be: . Primary vs.Drawer .Agent . This could include trade names and other assumed names.

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

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

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 .

it may be preempted by the exercise of federal authority. 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. Thus the FTC acted and eliminated HDC status in certain consumer credit transactions. First. Secondly. abuses can and did occur in the consumer area. .Holder in Due Course and Liability of Parties 333 Landmark Law: FDC Rule Limits HDC Status This serves a number of useful purposes. Here. 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. in spite of all the good reliance factors favoring the creation of the HDC status.

1 M&I took the check for value. 1985). An authorized agent can sign a negotiable instrument on behalf of a principal and bind the principal to the instrument. 1975 U. Smith’s signature included the name of the principal and then the word “by. who properly indicated his agency status. 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.2d 748. Answers to Critical Thinking Cases Holder in Due Course 21. with no notice that it had been dishonored.2. 1980 Mo. Federal had credited Terrell’s account $12. 1980). Since the checks were signed by an authorized agent of Carriage Homes. Federal wins since it can enforce payment of the draft as a holder in due course.2d 276. v. . Carriage House is liable on the checks as a principal. App.” The court held that the use of the word “by” indicated Smith’s agency status. which he later gave to Carlisle for payment on a debt. To qualify as a HDC the transferee must meet the requirements set forth in the UCC. was a HDC of the draft. in good faith having taken a draft for value. 397 F. Inc. Principal’s Liability 21. Federal took the draft in good faith. A draft is a negotiable instrument. or encumbered in any way. was an authorized agent for Carriage Homes. having no reason to believe that the draft would be dishonored. dishonored. 594 S. Holder in Due Course 21. the court found that Smith. 688 S. when an agent’s signature properly indicates his agency status. and without notice that it is overdue. Lexis 446 (Mo.. Royal Insurance Co. v. was a holder in due course of an $8200 check given by appellant. Dist. Southeastern Financial Corporation. an HDC is the holder of a negotiable instrument that was taken for value.D. thus taking it for value. In this case.W. Federal was the holder of a dishonored draft in the amount of $12. The Court of Appeals of Arkansas affirmed the trial court’s finding that Carlisle Distributing Co. Generally. The agent is not personally liable on the instrument.334 Chapter 21 III.000. Under the UCC. Inc.4.Ala 1975).. Wildman Stores. In this case. signing in his capacity as corporate secretary. to William Paladino. Carlisle Distributing Co.000 in exchange for the instrument. The court held that Federal could enforce payment of the note as a HDC. Carriage Homes was a principal and solely liable for the checks.. 649. 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. 1985 Ark. Drawer’s Liability 21. Inc. and the identity of the principal.S. Federal. in good faith. Lexis 12624 (N.Supp. UAW-CIO Local #31 Federal Credit Union v. without notice of defect or other irregularities and in good faith.3. Lexis 1926 (Ark.W. Smith. Wildman Stores. M&I is therefore an HDC and should win. App. Federal had no notice of Royal’s stop payment order until the draft was returned.

333 N.5 Since Mrs. This is a real or universal defense against enforcement by even an HDC.D.Holder in Due Course and Liability of Parties 335 Maker’s Liability 21. 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. since Lee is an authorized agent of Village Homes and signed the promissory note without indicating his agency status. As a maker she would have been liable. In this case. Lexis 289 (N.” The Bank of Azle did not have better title to the check than the E. First National Bank of Azle. A presenter of a negotiable instrument for payment warrants three things to the party to whom he presents the instrument. Presentment Warranties 21. As an accommodation maker. he is still personally liable for the $85. When an authorized agent signs his name to a negotiable instrument. 1988). Yes.9. because E.W.6 The Banks win. 1983 N. Accommodation Party 21. A presentment warranty is “an assurance that no one has better title to the check than the warrantor. Since the indorsement is authorized. and has primary liability on the instruments he or she signs. Matco loses. Smith’s indorsement.G. 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. she is the object of fraud in the inception. In this case.D. An accommodation maker is an accommodation party who signs on behalf of a maker. he became solely liable for the note.W.2d 792. that he has no knowledge that the signatures on the instrument are unauthorized. the court ordered Lee to make payment on the note to the note’s holder. The holder of an instrument can seek payment directly from the accommodation maker without first seeking payment from the maker.10.000. In this case. Thus. App. Thus.G. Smith Corporation. Pontiac was authorized to accept a check based on the letter sent. v. Wright was deceived into signing the instrument. or the fact that the signature is made in a representative capacity. but not in this case. 1988 Tex. The agent has sole liability even if the other party has knowledge that the signature was made in an agency capacity.2d 297. Although Lee. and that the instrument has not been materially altered. Paul is primarily liable. as president of Village homes.D. the agent has sole liability. 750 S. Authorized Agent’s Liability 21.8. Lexis 3377 (Tex. 1983). The presenter warrants that he has good title to the instrument. the First National Bank of Azle breached its presentment warranty of good title. is an authorized agent of the corporation. because he failed to indicate his agency status when he signed the note. Smith had not indorsed the check. Liability of Accommodation Makers 21. James Valenti is liable as an accommodation maker. Longview Bank & Trust Company v.App. Merchant’s National Bank wins because Lee is personally liable on the note. but does not indicate either the principal’s name.7. Farmers & Merchants National Bank of Hattan N. Farmer Bank. James Valenti . Lee.G. Transfer Warranties 21.

Federal Trade Commission Rule 21. the Odessa National Bank cannot enforce payment of the note because Fazzari can assert the real defense of fraud in the factum. the Odessa National Bank cannot enforce payment of the note.Sup. Fraud in the Inducement 21. however.12. 1979 Conn.Y. Lexis 973 (Conn.14. when Amoco dropped its suit against John. Fraud in the inducement occurs when one person makes a false statement to another in order to induce that person to enter an agreement. the law firm is liable. Lexis 857 (N. A negotiable instrument that results from this inducement is not enforceable against the defrauded party by the wrongdoer. Since James was an accommodation maker. 1971). App. Therefore. v. Firsy National Ban of Boston. Therefore. Thompson wins since he can assert a defense of fraud in the inducement. The situation in this case is a classic example of fraud in the factum. Lexis 2634 (Tex. Serv. This rule eliminates the HDC status with . 2UCC Rep.2d 305. 465 S.Y. Imposter Rule 21.E. Because Fazzari was the victim of fraud in the factum. Wade attempted to exploit Fazzari’s illiteracy by having him sign a promissory note that he represented as being a statement of wages. In that te case the drawer is liable.Sup. 179 N. Fazzari. Yes. he had primary liability on the note. the Court held that Fazzari had fulfilled this duty. Thompson. in this case.13.2d 493. J.336 Chapter 21 signed a promissory note in favor of Amoco as a guarantee that his son would repay Amoco.App. 2d 977 (Ma.Y. may enforce such an instrument since fraud in the inducement is only a personal defense. Central Motor Company v. 1961 N. Fraud in the factum is a real defense against the enforcement of an instrument by an HDC. 1986). Fazzari was an immigrant who could not read English.C.App.W. Although a person signing an instrument is under a duty to ascertain what he or she is signing.11 Generally a drawer is not liable for forged checks paid against the drawee. Wade was an employee of Fazzari’s and Fazzari had no reason to suspect that Wade would attempt to defraud him. Fraud in the factum occurs when a person is deceived into signing a negotiable instrument thinking that it is something else. First National Bank of Odessa v. Because Central was a holder of the instrument and not an HDC. this personal defense was effective against their claim.Ct. Valenti. The Court found that Thompson had successfully proved the elements of fraud. P. 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.S. Ed Bates had knowingly misrepresented that the second note would have an 8 percent interest rate. McCarthy. Fraud in the Factum 21. 1979). Since Thompson had signed the promissory note as a result of Bates’ misrepresentation. American Oil Company v. 1971 Tex. Amoco did not have to seek payment from John before it sought payment from James. James Valenti remained liable on the note as an accommodation maker.2d 405. the Mahaffeys can assert the defense of breach of contract because of a rule promulgated by the Federal Trade Commission (FTC). he was able to assert the defense of fraud in the inducement. A holder in due course. James became an accommodation maker. 426 A. No. 223 N. 1961). 2d 483. Thompson relied on this misrepresentation when he signed the promissory note. Knney & Reidy. because he signed on behalf of the maker of a note.H.

Honesty in fact is a subjective test that examines the holder’s actual belief. 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.2d 803 (Ill. 1992) Appellate Court of Illinois 2. Citation. Angelini wins since General does not qualify as an HDC because it failed to take the Angelinis’ note in good faith. the holder of a consumer credit instrument may be subject to all of the defenses and claims of the consumer. Because the contract sold is one covered by the FTC rule. that included a promissory note. General knew that Lustro had a poor record of completing installations they had contracted for. Case Name. Courts look to the circumstances of a transaction to determine whether a holder acted in good faith. Finally. The FTC rule eliminated Mortgage Finance’s special status as a holder in due course.J. B. App. General was also aware that Lustro’s impending insolvency might interfere with their completion of the contract.. v. Mahaffey v. the Court found that General knew that the note signed by the Angelinis did not mature until after installation of the siding. the Mahaffeys had signed a sales contract with the Five Star Co. Answer to “Briefing the Case” Writing Assignment: 1. 747 F. and therefore was subject to both real and personal defenses to payment of the note.E. Lexis 1875 (Nev.16 The Bank did not act ethically in failing to make sure that the Rose’s understood what they were signing. . In this case. VII. Lexis 263 (N. Hodge 601 N. 1987 Nev. the Mahaffeys were allowed to assert the defense of breach of contract against payment of the note.J. The Mahaffeys claim that Five Star breached this contract. “Good faith” means honesty in fact in the conduct of the transaction. The FTC rule applies to all consumer credit transactions where the buyer signs a sales contract that includes a promissory note. Investor’s National Security Co. however. and Court Kedzie & 103rd Currency Exchange Inc. and it was discovered that Mr. General did not take the note in good faith. Inc. Fentress had none of the city or state licenses required to engage in the profession of plumbing. General was not an HDC. 1 Dist. v.2d 193.2d 890. Since. 278 A. In this case. Defendant had written a $500 check to Fred Fentress as partial payment for future plumbing services. IV: Answers to Ethics Cases 21. Angelini.Holder in Due Course and Liability of Parties 337 regard to negotiable instruments arising out of certain consumer credit transactions. the Rose’s will probably lose. This contract was then sold to Mortgage Finance. Because the note was not taken in good faith. 1971). General Investment Corp. The plumbing services were not provided. A holder must take an instrument in good faith to qualify as an HDC. 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. Plaintiff is engaged in the business of cashing checks for a fee. 21. they could have read the document but didn’t.15. 1971 N. 1987). Key Facts A. Thus. C.

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

Then determine what public policy based limitations are imposed on the parties by the UCC and the courts. Most students have an ongoing contractual relationship with a bank and are already familiar with the basic rules involving negotiable instruments. the institution is required to report that to the government. Wherever possible. Finally. 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. But what about the customers’ privacy? As can be readily seen. Banking System. look to see if the transaction falls into the sphere of hi-tech transfers of money substitutes. more efficient than ever. The best way to approach issues involving checks is to first examine the underlying contractual obligations between the respective parties. and E-Money 339 Chapter 22 Checks. The transfer of money substitutes is more complicated than ever because it is. Banking System. 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 duties imposed on banks can be very strict and difficult to avoid. Money sitting in Tokyo can be transferred to New York City in seconds. 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. new technology brings with it new legal issues which will ultimately challenge all who use the electronic highway. at least in part. . In addition to the technical aspects of this material. try to illustrate any given rule with examples to help bridge the gap between the theoretical and the practical.Checks. Teacher to Teacher Dialogue Students relate to materials on the law of checks due to their own involvement with them. Financial institutions have many more duties today to report patterns of certain types of “suspicious” activities to the government. and E-Money Why Are Checks Important To Our Society? I. If these activities appear to be involved in money laundering or the like.

340 Chapter 22 II. 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).

and E-Money 341 Internet & Technology: Electronic Fund Transfer Systems The most common electronic fund transfer systems are discussed. Banking System. 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) .Checks.

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: . a bank can be liable for losses if the bank pays before its date.Oral stops good for 14 days.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.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 . 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.

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

recovery for forgery is precluded without notice within 30 days of the first forgery.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. Spacemakers was negligent in its hiring of Jenny. the recovery by Spacemakers is barred. No one but Jenny reviewed the bank statements. Grant of summary judgment was affirmed. Thus with lack of notice and review. Country Bank = Payor Bank Metro Bank = Depository Bank (collecting bank) City Bank = Intermediary Bank (collecting bank) .

This applies only to commercial electronic fund transfers. Banking System. The Court speaks: State of Tennessee v. . Reason: Incarceration is necessary to protect society or it is suited to the offense or lesser measures have not been effective.Checks. She has more than 100 prior convictions (many of the same offense) and she has previously (3 times) violated probation. She was sentenced to 4 years in jail followed by 4 years of probation and she appealed. She pled guilty to 6 counts (5 over $500 and 1 over $1. The judgment was affirmed.000). International Law: Hiding Money in Offshore Banks This discusses the confidentiality of the banking laws of the Cayman Islands and other countries. Issue: Did the trial court err in imposing the sentence on Heck? Decision: No. 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. 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. 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.

The check became negotiable upon issue and should not have been subject to a stop payment order.346 Chapter 22 III. City National Bank of Fort Smith (CNB) wins. 364 N. 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. Lexis 3034 (Wis. Thus. or honor the check and create an overdraft in the customer’s account. Wrongful Dishonor 22.3. because the last check was never reported to the bank. drawn against her checking account. Answers to Critical Thinking Cases Cashier’s Check 22. Pulaski. Civ.2. Therefore. the act of conversion alone will not support an award of punitive damages. Wood had paid the Bank $6. the Goodwins must show that CNB acted in bad faith or that it deliberately or willfully dishonored the checks. In general. App. because of the provisions of UCC 4-401(1). Goodwin and Larry J. had a duty to honor it. App. She drafted a check for $7.” Because a stop payment order is not effective against a cashier’s check. the bank debits its own account. Lexis 1362 (Ala. the payor bank can either dishonor the check. 1982). 1982 Ala. However. Goodwin. Neither the purchaser nor the issuer of a cashier’s check can stop payment of the check. 1985). Subsequently. because the bank mistakenly confused the . when the bank discovered that there were insufficient funds in Kalbe’s account to pay the check. Wood v.000 to issue a cashier’s check payable to Walker. when the check was presented for payment. As the court stated: “A cashier’s check is the obligation of the bank which issues it. in order to receive consequential damages. It is only apparent that CNB mistakenly confused the identity of Larry K.2d 1287. A cashier’s check. Overdraft 22. 2d 162. When the check is presented for payment. In the present case. Kalbe. whereby CNB accidentally exercised dominion over the wrong Goodwin’s funds. Pulaski was relieved of this duty. Such a rule is necessary to insure the public’s confidence in and reliance upon our banking system. A cashier’s check is accepted in advance by the act of its issuance and is not subject to a stop payment order. is a debt of the bank. 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. The bank can sue the customer to recover this amount. App. Similarly. because Wood’s stop payment order should not have been effective. which is drawn on the issuing bank itself. if the customer does not subsequently place sufficient funds in the checking account to cover the amount of the overdraft. as the payor bank. 435 So. Bank should not have honored Wood’s request. it is not an item payable from a customer’s account. In this case. which has been paid for the check. the Pulaski State Bank had the option to create an overdraft in Kalbe’s account rather than dishonor the check. 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. The bank. 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. In this case. Wood wins.W. App. The Pulaski State Bank wins because it had the legal right to create the overdraft in Kalbe’s account. Central Bank of the South. Pulaski State Bank v. When there are insufficient funds in a customer’s checking account to pay a check that is presented for payment. Kalbe had a checking account with Pulaski State Bank.1. guarantees payment of the check. 1985 Wisc.

the court ordered the bank to recredit Ragusa’s account for $5. However. In this case.E. Supp. In this case. The drawer can also sue the bank to recredit the account for the improperly paid check. Lexis 3435 (La.000.Checks. the bank can collect this money from Siegel on the date of the check. 1990 Ark. A stop payment order is an order by a drawer of a check to the payor bank to not pay or certify a check. Ragusa wins because Community Bank is liable for the $5. In this case. The fact that the check was stale should have been sufficient to keep the check from being paid. Stale Check 22. App. 1982 Mass. but this was of no importance in relation to the payment of the check. A postdated check is created when a drawer writes a check and dates it for a time in the future. the court held a check written against an account with insufficient funds to be irrelevant. 360 So. Thus.2d 231. Community State Bank. Postdated Check 22. Siegel v. the bank was found liable for the amount of the check. Lexis 49 (Ark.000 because the bank had improperly paid a postdated check. and informed the payor bank of this check. 437 N. Banking System. the Community Bank had paid a check that was over three years old. Eagle National. Charles Ragusa & Son v. the bank is liable for any damages incurred by the drawer. that Dynamite wanted a stop payment order placed on the check. Goodwin.” Thus. A check that has been outstanding for more than six months is considered stale.6. Dynamite Enterprises was the drawer of a check. New England Merchants National Bank. because the New England Bank is subrogated to the rights of the payee.5. Stop Payment 22. Dynamite Enterprises wins the suit because Eagle National had paid after a valid stop payment order request. 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. Ragusa should not have needed a stop payment order to prevent the Community Bank from paying on a three year old check.000. and E-Money 347 identities of the Goodwins and acted in good faith. A written stop payment is valid for six months. Peter Peters. 783 S. 1982). App. Bank of Fort Smith v.2d 335. Yes. Most states hold a bank liable for paying a stale check without the drawer’s permission. 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.2d 218. Lexis 1559 (Mass. and in a reasonable manner.W. Because the payor bank is subrogated to the rights of the payee. The court found that Ragusa’s oral stop payment had expired. If a payor bank pays on a postdated check prior to its date. The court stated that “a bank customer has a right to stop payment on an overdrawn check. . 1978). The bank must receive a stop payment order within a reasonable time. 1978 La. Dynamite Enterprises. and may later collect the amount of the check. because Eagle National violated this right. the New England Bank will have to recredit Siegel’s account for the $20. the drawer usually suffers little or no loss when a post-dated check is paid early.4. to afford the bank an opportunity to act on it. A bank is under no obligation to pay a check that is presented for payment more than six months after its date. the court held that punitive and consequential damages were not allowable.000 since the bank had paid a stale check. City Nat. the court ordered the New England Bank to recredit Siegel’s account $20.000. This written request was made before the check had been cashed or deposited. 1990).

v. 1975. it was proven that Gennone had an opportunity to examine his bank statement because the People’s Bank held them for his personal receipt. Because States . A customer has a duty to examine bank statements and canceled checks and promptly report any forged signatures to the bank. Therefore. Pracht v.2d 112. the bank has a common law right of setoff against these accounts. Serv. or later as a cutoff hour for the purpose of processing items. Gennone v.348 Chapter 22 Inc. Lexis 209 (Okla. Second.8. This right can only be exercised against general accounts.7. 1979). When a checking account customer of a bank borrows money from that bank. Oklahoma State Bank’s claim is legally correct because of the delayed posting rule. In this case. Pracht’s check was received for collection on the next banking day. 1971 Pa. App. 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. 1979 Okla. The customer is liable if the bank suffers a loss because of the customer’s failure to promptly examine bank statements and report forgeries. Examining Bank Statements 22. 707. the customer has only fourteen calendar days after receipt of his or her statement to report any such forgeries. Dr. Lexis 11791 (Fla. January 20. Eagle National Bank of Miami. D & C. Dr. 517 So. and the losses were the result of a series of forgeries. This was not the situation at the Oklahoma State Bank on that Friday. Crocker’s actions in taking funds from States’ account was legal. Crocker National wins. wins. 592 P. Right of Setoff 22. as a cutoff time for the purpose of posting checks. Lexis 160 (Pa.m. The bank had two responses to Pracht’s argument.9. Banks cannot exercise this right against specialized accounts or collect unpaid credit card debts. and Dr. Oklahoma State Bank had received the check deposited by Dr. This means that the bank has the right to claim any money that is due to it from the customer’s checking account.. Pracht’s check was received well past 3:00 p. In this case. Oklahoma State Bank. First. 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. Peoples Bank was relieved of any liability for the forgeries. did not mean that these were normal banking hours. Since Gennone simply failed to examine these records for over 3 years. States Steamship had borrowed $2 million from Crocker Bank. 9 UCC Rep. The Bank was also relieved of liability because the losses were the result of a series of forgeries by the same wrongdoer. the bank demanded immediate repayment of the loans. 1987).m. When the bank felt that States had fallen into financial trouble. When a series of forgeries occurs. Peoples National Bank & Trust Co. In this case.2d 976.m. Pracht after the close of normal business hours on Friday. Peoples National Bank & Trust Co. Deferred Posting 22. This rule allows banks to fix an afternoon hour of 2:00 p. the fact that bank employees were still at the bank after 3:00 p. which was payable on demand. Oklahoma State Bank wins. Any check received after this cut-off is treated as received on the next banking day. Monday. A bank is not “open” for these purposes unless substantially all banking functions are carried on for the public.m. the delayed posting rule allowed the bank to establish 2:00 p. 1987 Fla. 1971). Peoples Bank is not liable for paying on the 25 forged checks because Gennone failed to promptly examine his bank statements. App.

1990) District Court of Appeals of Florida 2. 478. which were the result of Actors Equity’s own negligence. 2d 1387 (Fla.A. 1983). E. Lexis 436 (1990). Nautilus Leasing Services. Golden Gulf.2d 114. or on an altered check if the drawer’s negligence “substantially contributed” to the forgery. VII. the bank appeals. A bank is not liable for paying on a forged signature of the drawer. Crocker National Bank. Therefore. In this case. IV: Answers to Ethics Cases 22. Issue . Certainly Actor’s Equity cannot avoid the consequences of its own omissions.11. 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. v. v. The lower court held that the bank had no right to refuse payment on the checks.Y. 3. App. and E-Money 349 maintained a checking account with Crocker.S.Y. C.000. Key Facts A. Lexis 2257 (Cal.” Thus. The defendant refused to cash the checks based on a claim of underlying illegality. because the union’s negligence substantially contributed to Scotti’s forgery. Rptr.Y. The plaintiff is a receiver for Clara Lamstein and the business she operated as Interamerican Business Consultants and Associates. and Golden Gulf is liable. Sup. 1990 Ala. who were investors in IBCA. Crocker’s actions in exercising its right of setoff was legal. Rishoi 553 So. and now owed the bank $2 million. Citation and Court First American Bank and Trust v. Answer to “Briefing the Case” Writing Assignment: 1. or insisting upon. Crocker had the right to claim this amount from States’ account. the Bank of New York was not liable for the missing $100. 1989). App.Div. S. App. Among the assets of IBCA payable to the plaintiff as receiver were $80.. Banking System. 195 Cal. IBCA was shut down by the state of Florida for having operated an illegal pyramid scheme.2d 339. a reasonable and trustworthy background investigation constitutes negligence substantially contributing to the making of the unauthorized signatures involved here. Nothing here indicates any more than a provisional settlement by AmSouth that it was free to retract if the item was not paid. Inc. Decision for AmSouth affirmed.10. N. Dist. Banks allow customers to make use of funds while awaiting final payments. 1989 N. 1983 Cal. The Bank of New York. Inc. AmSouth Bank. 539 N. Case Name. The Bank of New York wins because it is not liable for paying on the forged checks. 565 So. App. AmSouth acted properly in creating the overdraft.Lexis 4172 (N. Inc. 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. D. Mere availability of the funds does not mean the check has been paid.000 worth of cashier’s checks issued by the defendant and paid for by Crosbys. Even though the bank’s action caused States’ outstanding checks to be returned unpaid. (IBCA) B.Checks. 22. Firemen’s Fund Insurance Co. v.

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

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

On the horizontal level. and collection provide some very good rules for both debtor and creditor. Being more moveable. Second. II. These ends are mainly sought through the use of the recording principles long established in real property law transactions.352 Chapter 23 cogent and organized structured system of facilitating secured credit transactions for the sale of personal property. there lies the probability of having to recognize new duties and obligations with respect to all parties having a legal relationship to those goods. guaranty. failure to wisely administer and manage these key elements in our society leads to debacles such as the savings and loan crisis. These rules are designed to give creditors notice not only of the debtor’s obligation. This reliance on that good may come from either the original acquisition of the good or from subsequent transactions after the good is acquired. to give notice to other creditors that this security-based transaction has taken place. Text Materials *Credit involves risk. his or her family. but even more important. surety. Finally. may have more than one creditor looking to that good as security. The ordering of priorities between multiple creditors having claims to the same goods becomes a critical issue. but the UCC and the common law rules with regard to liens. there is a strong likelihood that most large personal goods. it can very quickly become complicated. the users start with the consumer. 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. With each shift. All in all. and go on to third party users or acquirers. First. just as there are likely to be multiple creditors. so are there likely to be multiple users. in a society based on credit. compared to real estate. Several practical factors make the law of secured transactions in personal property particular troublesome. The vertical chain of distribution starts with supplies of raw materials to manufacturers. The riches of wise credit extension are the stuff of financial and family dynasties. In addition. the role of making sure that the security interest attaches and stays with the goods is of critical importance. that same realism attempts to protect the innocent third parties’ good faith reliance on the legitimacy of the marketplace whenever possible. The law has long reflected this win/lose dichotomy of the credit . personal property is portable. Inherent in the nature of our business enterprise system is the principle that risk will be rewarded if well placed and punished if not. such as automobiles and the like. and retailers. 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. Conversely.

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

354 Chapter 23 .

Credit and Secured Transactions 355 The Court Speaks: Bank of South Palm Beach (BSPB) v. including BSPB. Castle fell behind in payments to SWD and asked SWD for more money ($150.200 to Castle Builders. The loan was made and all others agreed to subordinate their security interests to SWD. Issue: Did the modification loan from SWD have loan priority over the loans from BSPB? Decision: No. A mortgage was recorded on 2 parcels of land. BSPB was brought into the action.000).500. Whatley. BSPB’s loan was for $77. .000 was used mostly to pay SWD’s initial loan and the deed of trust was modified and recorded. The %150. Other creditors. SWD had constructive knowledge of BSPB’s interest prior to the loan modification. BSPB appealed. loaned money to Castle and also recorded mortgages. The trial court judgment was reversed and BSPB was given priority. Reason: BSPB’s priority was based on being recorded before SWD’s loan. Castle defaulted on the SWD loans and SWD began foreclosure. The trial court ruled that SWD had 1st loan priority. who mistakenly never got a subordination agreement for BSPB. Davin & Company (SWD) Facts: SWD loaned $448. Stockton.

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. occurs at later of: Value given Rights in collateral Security agreement . 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.

etc. notes. 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.358 Chapter 23 Perfection secured party beats other creditors or people with an interest in collateral. warehouse receipts. . stocks. etc. bonds. copyrights. etc. Accounts: accounts receivable General Intangibles: patents. Chattel Paper: note plus security agreement Documents of title: bills of lading.

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

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

Holdren’s did not file a financing statement regarding the computer equipment. Raymond’s financing statement was not sufficient to perfect its security interest in Debtor’s assets against the claims of others.32. provided for a total payment of $3. Inc. Consequently. 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. Creditway filed a motion with the bankruptcy court to recover the computer and equipment.175l68 in equal monthly payments of $132. and equitable principles do not bar avoidance. Charlene T. a filing under SCAN would not be found by those looking for security interests in the assets of Greenbelt Cooperative. 1984. She received a special teacher’s price. As the assets in which Raymond had an unperfected security interest were sold and the proceeds put in escrow. Contemporary Issue: Artisan’s and Mechanic’s Liens This discusses how these types of liens usually prevail over other interests. not consumer goods. The contract. In June 1985. 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. which was also a security agreement. the proceeds of the escrow account should be distributed to Debtor. under Maryland law. Although courts. . Phillips entered into a retail installment contract to purchase an IBM computer and other equipment from Holdren’s. Issue: Is the computer and other equipment “consumer goods” in which the secured party obtained a perfected purchase money security interest? Decision: No.Credit and Secured Transactions 361 benefit to creditors. The court denied the secured creditor’s motion to recover the collateral. Holdren’s eventually assigned the installment contract to Creditway of America. Inc. The Court Speaks: In re Phillips Facts: On December 1. Charlene Phillips and her husband filed for Chapter 7 liquidation bankruptcy. 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.

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

Credit and Secured Transactions 363 .

deceptive and unfair practices can be used by debt collectors. a reasonable interpretation of the TILA? Decision: Yes. and MBNA America Bank. execution. NA v. Issue: Is Regulation 2. Contemporary Issue: “Collection Remedies “ The most common collection remedies are attachment. The US Court of Appeals’ judgment was reversed. The Supreme Court Speaks: Household Credit Services. Pfennig brought a class action civil suit against MBNA alleging a violation of the TILA. Pfennig Facts: Pfennig has an MBNA credit card. Inc. The US Court of Appeals reversed a district court’s dismissal of Pfennig’s complaint and MBNA appealed. and garnishment. .364 Chapter 23 Surety Concurrent liability “If he doesn’t” Same instrument No new consideration No demand from debtor vs. 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. 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 – . She was able to exceed her limit with a $29 over-limit fee for each month over which she duly charged. This fee is expressly not required by Regulation 2 to be part of the required “finance charge’ calculation.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. The $29 fee was not on the monthly statement. which explicitly excludes over-limit fees from the definition of “finance charge”.

for malpractice.e. In this case. S&D does not have a security interest in the Mack truck. while World Wide Tracers agreement was too vague to create a perfected security interest. The issue in this case was which of the two parties. Thus. it is reasonable to treat this not as a charge for obtaining credit but rather as a penalty for violating the credit agreement. the financing statement must be filed with the proper government entity. had a valid security agreement and financing statement in regards to Metropolitan Protection’s accounts receivable. 1988 N. because the security agreement was not perfected. and (3) reasonably identify the collateral. i. such must be executed before a foreclosure sale. One way to create such a security interest is for the creditor to file a financing statement. Foreclosure 23. Financing Statement 23. 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. v.2 The mortgagor can recover any surplus from a foreclosure sale. Because over-limits fees are imposed only when a limit is exceeded.1 Ivonwood should win. and accounts. S&D had no interest in the truck. Atlantic should be paid the surplus in this case. Redemption 23. such as the Secretary of State. a written security agreement must (1) be signed by the debtor. Clifton Tamsett. In order to perfect. 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. chattel paper. World Wide Tracers was . No. 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.Y. Since Illinois requires that they execute a quitclaim deed.. Lantz could have had a material person’s lien but Ivonwood paid Lantz. make valid the security agreement. S&D Petroleum Company. However. Inc.Credit and Secured Transactions 365 Reason: The Fed is the primary source for interpretation and application of the TILA.Y. A lender can take a security interest in the property of a debtor to serve as collateral when credit is being extended. In order for a financing statement to be valid. Priority of Security Agreements 23. The court ruled in favor of the Bank because their agreement with Metropolitan Protection specifically mentioned the accounts receivable. (2) contain a description of the collateral.S 2d 800. Metropolitan State Bank wins the suit. State Bank or World Wide Tracers. Div.4.5. or County Clerk. it must identify the collateral. S&D is able to recover from its attorney. Answers to Critical Legal Thinking Cases Material Person’s Lien 23. App. 11258 (N.Y.Ct.App. including consumer goods. 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.3 The procedure for a foreclosure action and sale are mandated by state statute. A security interest can be created in various types of personal property. 1988).Sup. Tamsett. Graco’s claim is against Lantz only. To be valid. 534 N. III.

1986). or in proceeds.885 in an account at Norstar Bank. General Motors Acceptance Corporation v. The Bank subsequently filed a valid continuation statement six weeks prior to the expiration of the perfected security interest. When the Bank attempted to claim part of this money.D. Iowa 1987). future advances. a perfected security interest is valid for five years. because the proceeds were covered by the security agreement. The Bank is a secured creditor of Joseph Jones based upon a properly filed security agreement.W.7. GMAC wins the case. The Court prevented the Bank from seizing this money. the secured party’s interest is satisfied out of the specific property given as collateral for the loan. Inc.S. when a creditor has obtained a security interest and the debtor goes bankrupt. pursuant to the floating lien concept. Murphy deposited $97. Yes. Lexis 1825(Bk. but also that obtained by the newly formed corporation which was bound by the terms of the original agreement. GMAC had an interest in the money because it came from the sale of a portion of Murphy’s inventory. In this case. Sale Proceeds 23. GMAC had an interest in all proceeds derived from the sale of cars that were bought and sold by Murphy. a secured creditor. the after acquired property clause in the security agreement covers not only inventory and proceeds of the original debtor company. Metropolitan Protection.” Thus. A continuation statement may be filed up to six months prior to the expiration of the financing statement’s five-year term.Sup. Inc.Y. because Metropolitan State Bank’s Agreement was more specific. The creditor may continue his perfected interest for another five years by filing a continuation statement.6. Once filed. Lexis 753 (Minn. Once filed.A.2d 685. 384 N.Ct.N. 532 N.. 79 B. Misc. In Re Jones. 1980” to claim an interest in Metropolitan Protection’s accounts receivable.2d 442. 1986 Minn. Columbus Bank was a secured creditor because it had properly purchased a security interest in Jones’ property by filing a financing statement.366 Chapter 23 relying on the language “any property of the debtor obtained after July 15. Thus. had first priority in obtaining the property of the bankrupt Jones.075 and Jones’ soybeans. they are effective for another five years and may be refilled. 839. 1988). A floating lien attaches to property not originally in the possession of the debtor at the time the security agreement was executed. In this case. World Wide Tracers. Secured creditors have priority over other creditors. The Court held that a debtor cannot destroy a perfected security interest by merely changing business name or corporate structure.R. Norstar Bank. The Court awarded the Bank $10. The Court found that the Bank’s security interest was at all times paramount to Ellerson’s junior lien. Columbus Junction State Bank wins the case. Columbus Bank.Y. Floating Lien 23. In this case. 1987 Bank v. This money had been received from the sale of cars. the Bank can enforce its security agreement although the collateral was transferred to another party. 1988 N. The Court awarded MP’s accounts receivable to the Bank..8. Priority of Security Interests 23. Subsequently.Y. 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 .” it is characterized as a floating lien. v. N. If a security agreement provides for a security interest “in after acquired property. the security agreement between Murphy and GMAC called for GMAC to have an interest in all “identifiable proceeds. During the first week of May 1980. GMAC was able to stop Norstar because of its security interest. Lexis 595 (N.

the first to have perfected that interest generally has priority.9. 427 N. Purchase Money Security Interest 23. The security interest of the Nebraska State Bank has priority over the security interest of the McGowens. the Court awarded the disputed property to the Bank. 632 P. 1981). 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. Therefore. it must be perfected within ten days of the debtor taking possession of the collateral.App. 1978). adopted by the state of Nebraska..2d 566. . A perfected purchase money security interest prevails over a perfected nonpurchase money security interest in after acquired property.10. Since IH had a perfected purchase money security interest. the Bank was first to perfect its security interest by filing a financing statement with the appropriate government office. when High defaulted on his obligations and a controversy arose as to whose claim had priority. Yes. both creditors had perfected their security interests by filing a financing statement. UCC 9-312 (5)(a). In this case. Priority of Security Interests 23. Nebraska State Bank. The McGowens filed their financing statement four months later. Lexis 2507 (Wash. O.2d 772.2d 522. App. states that if two or more creditors have perfected security interests in the same collateral. 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.App. In this case. on December 20. Yes. 1978 Colo. IH’s interest was a purchase money security interest because IH had extended credit to the Prior Brothers to purchase the collateral. 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. McGowen v. 1980. App. IH perfected its security interest in the tractor within ten days of the Prior Brothers accepting the tractor. 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. the livestock. Lexis 290 (Neb.Credit and Secured Transactions 367 in his operation of O&E Inc. Inc. American Heritage Bank & Trust Company v. Purchase Money Security Interest 23. Once the purchase had been made. their claim took priority over the Bank’s. Lexis 667 (Colo. the model 1066 tractor. DeKalb Bank’s security interest in the cattle has priority over Sandwich State Bank’s security interest. International Harvester’s (IH) security interest in the tractor takes priority over the Bank of California’s security interest in the same collateral. In the Matter of Prior Brothers. 1988).11. 1981 Wash. In order for the purchase money security interest to have priority. If the collateral in question is not inventory.W. both parties had an interest in the Prior Brothers’ after acquired property. DeKalb’s interest took priority. Although Sandwich State Bank had a perfected interest in all of Klotz’s after acquired property. Nebraska State Bank perfected its security interest by filing a financing statement with the County Clerk of Dakota County. Although the McGowens security interest arose first in time. 1988 Neb... 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. Nebraska. 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. Inc. DeKalb Bank perfected its interest within the ten-day deadline. & E. 576 P. In this case.

E. 1982 Kan. First National Bank and Trust Company of El Dorado v.App.2d 374. Artisan’s Lien 23. DeKalb Bank v.15. Heritage Ford. FMCC’s perfected security interest had priority since the two men were not buyers in the ordinary course of business. However. App. 502 N. 1987). Buffalo Federal should win.e. 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. 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.12. 23.W. Buyer in the Ordinary Course of Business 23.14 Without an antideficiency statute. Such a statute would protect the debtor but loans might be more difficult to obtain.13. Mrs.App. Note: If not terminated. DeKalb Bank was awarded the cattle since the UCC gives priority to perfected purchase money security interests. both men worked for the merchant offering the goods for sale.. 1987 Mo. 1987). The court held that when Pete & Sons released the truck to the Turners. A guaranty is a collateral and independent undertaking creating secondary liability. 1982). Ozark Financial Services v. Here. Yes. The court held that Pete & Sons did not have a common law artisan’s lien on the tractor truck. and were using the financing as a way to raise funds for the dealership. Lynch. Ozark Financial Services wins. In this case. 1986 Ill. the Court held that the two officers who financed the cars were not buyers in the ordinary course of business. Ozark could foreclose on its perfected security interest in the truck. IV: Answers to Ethics Cases 23. a common law lien is a possessory lien. it would have taken priority over Ozark’s prior perfected security interest. Turner. by the Forsyth County Hospital. Lexis 3357 (Ill.368 Chapter 23 Thus. Sales personally guaranteed . 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.2d 1256. Klotz. Lexis 280 (Kan. 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. when Pete & Sons performed the repair services for the Turners. The common law gives artisans and repair people’s liens on personal property of customers to secure payment for labor or services rendered. Lexis 4273 (Mo. Because there was no common law lien on the truck. 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. 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. Sales is liable as a guarantor for the payment of the medical services provided to her sister. a common law lien attached to the truck to secure payment for these services. even if that security interest is perfected. when Klotz became insolvent. App. The court held that Mrs. the lien only lasts as long as the lien holder has possession of the goods. However. i. its common law lien terminated. 735 S.2d 1057. Ford Motor Credit Company. 646 P. Mrs.

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

Very often the same people who were in prison for debt were also the innovators. in effect. Bankruptcy is really one of the earliest forms of recycling. 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. financial institution failures. 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. Many of those dungeons became so crowded that the New World became a dumping ground for detainees. As fate would have it. economic downturns. act as a life sentence in keeping that business or its proprietor from reentering the marketplace. 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. a recycling of economic opportunity for good faith debtors who deserve a second chance. and entrepreneurs who helped build a new economic system less encumbered by class mentalities.370 Chapter 24 Chapter 24 Bankruptcy and Reorganization Bankruptcy Is Not The Easy Way Out I. 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 best place to start is with the “preenlightened” era of debtor’s prisons and the like. that migration was most fortuitous for our nation. II. As with any legal favor. That failure should not. 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. risk takers. Where debtors’ actions are motivated by bad faith attempts to avoid legitimate obligations. Bankruptcy is built on a cornerstone of good faith. there are people and business entities that get too greedy when asking for the benefit of the law. The basic underlying premise of bankruptcy law is founded on a simple reality: bad things happen to good people. both the law . How many of us can really provide ourselves with a safe haven from financial disasters brought on by bad health.

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. illustrates Congress’s attempts to deal with the dilemma of trying to make the law more humane while trying to curb abuses. tort judgments. Federal Bankruptcy Code: 1) Bankruptcy reform Act of 1978 2) Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 . Many consumers loaded up on all sorts of items on credit and kept them debt free after bankruptcy. Corporations began to use the reorganization provisions of the law as a management wedge to get out from under otherwise binding executory contracts. This legislation sought to pull in the reins on many of these abuses. 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. with this liberalization came a number of abuses of the law. The Bankruptcy Act of 1978 provided for sweeping reforms that sought to destigmatize bankruptcy in an economy that had grown too dependent on credit.S. The recent history of federal reforms in the U.Bankruptcy and Reorganization 371 and the larger societal public policy is subverted. Unfortunately. or even worse.

372 Chapter 24 There are no state bankruptcy laws. .

13 b) involuntary: chapters 7.12.Bankruptcy and Reorganization 373 Key Concepts Bankruptcy Procedure: 1) prepetition and post petition counseling 2) filing a petition a) voluntary: chapters 7. maintenance .11. or embezzlement while a fiduciary 5) alimony. A number of pieces of jewelry (a gift from husband to wife) . Mr. 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.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.11 (1) fewer than 12 creditors – 1 creditor (2) 12 or more creditors – 3 creditors (3) $12. personal. larceny. Due to co-signing a large loan of Mr. 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. was because of illness and Mrs.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 7.12.

objected. Abusive exemptions are limited. 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. Reason: The items of jewelry are luxury items and not “necessary or proper wearing apparel. The bankruptcy court agreed with Jacoway. Jacoway. They tried to shield the IRAs as exempt from the bankruptcy estate.S. the trustee. court of appeals affirming the bankruptcy court’s decision.374 Chapter 24 were in the estate. The IRAs qualify as exempt property. The Supreme Court speaks: Rousey V. Issue: Is jewelry “necessary and proper wearing apparel” and thus exempt? Decision: No.” The TN legislature has spoken. Reason: IRAs are similar to plans specified in the statute which provide a substitute for wages and are not mere savings accounts. 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. The rules are discussed. Mrs. Jacoway Facts: The Rouseys had IRAs.450. The Rouseys appealed from a judgment of the U. Issue: Can debtors exempt IRAs from their bankruptcy estate? Decision: The judgment was reversed. The property had to be included in the estate. Ethics Spotlight: 2005 Act Limits – The Homestead Exemption The bankruptcy Code’s federal homestead exemption is $18. X 12 /6 is < or = to state’s median income – no presumption of abuse . Claimed her jewelry fit this exemption and the bankruptcy trustee filed an object to the claim. Ethics Spotlight: Fraudulent Transfers Before Bankruptcy Certain fraudulent transfers are voidable by the bankruptcy court. Several years after establishing such they filed a Chapter 7 bankruptcy petition. TN has its own exemptions and does not have one for jewelry but has one for “necessary and proper wearing apparel.

” .000 – no presumption of abuse d) If total between 6. When Witwer claimed that his retirement plan was exempt from the bankruptcy estate.s income/6 (certain deductions are available) b) State’s Median Income for 5 yrs.” The court concluded that under the Bankruptcy Code. Inc. this court is constrained by the plain meaning of the statutes in the context of this case. James J. several creditors filed objections. the assets of a retirement plan are entirely exempt if the plan was designed and used for retirement purposes. California law exempted retirement plans from a debtor’s bankruptcy estate. At the time. the value of the assets in his retirement plan was $1. The court stated: “Regardless of the inequities that may result from a debtor’s use of the California exemption scheme.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. Reason: Under California law. Witwer is the sole stockholder. 1991. and president of James J.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. On October 21. which was established in 1970. the size of a debtor’s bankruptcy estate is “subject to the vagaries of state exemption law. The Court Speaks: In re Witwer Facts: Dr. X (DMI X 60) = Total c) If total < 6. M..8 million. Issue: Is Witwer’s retirement plan exempt from the bankruptcy estate? Decision: Witwer’s retirement plan is fully exempt from his bankruptcy estate. sole employee.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. Allowing the debtor to retain over $1. Witwer.D. Witwer filed a voluntary petition for relief under Chapter 7 (liquidation).8 million in retirement benefits in bankruptcy while being discharged from debts legitimately owed to creditors seems fundamentally unfair.. He is also the sole beneficiary of the corporation’s retirement plan. The bankruptcy court found this to be the case concerning the retirement plan established by Witwer.000 and 9. a California corporation under which he practices medicine.

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

Bankruptcy and Reorganization 377 .

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

. good faith.Bankruptcy and Reorganization 379 Necessary. balance of equities favors Under cram-down method: .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.

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

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

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

Bankruptcy and Reorganization 383

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

384 Chapter 24

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.

Bankruptcy and Reorganization 385

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

386 Chapter 24

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.

Bankruptcy and Reorganization 387

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.

388 Chapter 25

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.

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

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

created for the agent’s benefit. is irrevocable. 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. . Direct notice prior dealings.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.

Lexis 2023 (Ga.App. No. African Adventures (AA) is an independent contractor. the unidentified patron was not an agent of the nightclub.E.2. . Answers to Critical Thinking Cases Creation of an Agency 25.400 Chapter 25 Note: principal termination – revocation of authority agent termination – renunciation of authority III. The appellate court affirmed the trial court’s grant of a directed verdict in favor of defendant nightclub. Samuelson is not liable. Samuelson might also be considered an agent for AA and an agent is not liable for the torts of a principal. Inc. 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. 359 S. the nightclub is not liable for the actions of the patron who injured Ginn. App. 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.2d 390. Samuelson is not liable for the torts of an independent contractor. Because there was no agency. Independent Contractor 25.1. Renaldo.. 1987). The relation of principal and agent arises wherever one person—expressly or by implication—authorizes another to act for him. Ginn v. 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. 1987 Ga. No.

Fiduciary Duty 25.F.2d 399. Apparent Agency 25. and is not liable on the contract. Hutton is liable for the fraudulent activities of its employee. Iota Management Corporation v. The court held that because the manager of E. Wilfred acted with a conflict of interests with respect to its duty to Boettcher. Ziobro had apparent authority.R. Boettcher wins. E. Lexis 1502 (Cal.000 compensatory damages and $160. The appellate court affirmed the trial court’s decision that permitted Iota to rescind the contract. Boulevard Investment Company. clearly within the scope of his employment and authority. The knowledge of an agent of corporate principal regarding matters within the agent’s scope of employment and authority is imputed to the principal. Imputed Knowledge 25. who was Boulevard’s maintenance supervisor. E. He exercised the duty using his best judgment.7.F. 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. App. E. Yes. Power of Attorney 25. Punitive damages can be awarded against a principal for an act of an agent if the employer ratifies his tortious activity. had acquired knowledge of the condition of the pipes through his work at the hotel. 526.000 punitive damages.F. 225 C. He did not breach trust or his fiduciary duty and therefore should not be liable to Howard.4.F. Universal is the agent for a disclosed principal.F.. . Pusateri v.8.W. The court held E. The court held that this knowledge was imputed to the corporate principal. Hutton had knowledge of Johnson’s activities and took no action to prevent this conduct. Inc. Lexis 4026 (Mo.App.5. 731 S.6. King was an agent with a specific duty. 1987). Octagon. Boulevard. Hutton liable to Pusateri for $120. Johnson.Agency Relationships 401 Contract Liability 25. Hutton & Co. App. Yes.3. Hutton ratified the agent’s tortious acts. Secret limitations are ineffective. Bolus wins. He was held out as having authority to bind Bank. 1986 Cal. 1987 Mo. The court held that Cecil Lillibridge.. Ratification 25. Boulevard Investment Company (Boulevard) is liable to Iota Management Corporation (Iota) for breach of contract. 1986). By finding Landmark space in another building it violated its fiduciary duty to Boettcher.

App. Shields. The mere fact that a person sustains an agency relation to another does not prevent him from becoming personally liable. Production Finishing. Personal Guaranty 25. and that the mere fact that Peck was identified as a “Vice President” did not relieve him of personal liability.App. 195 C. The court affirmed a grant of summary judgment in favor of Butler. he is accountable to his employer for the profit made. 911. 1987 Ala. Inc. Where a writing is signed by a person and contains apt words to bind him personally. Both Elvin Grinder personally and G. An independent contractor is liable for injuries caused by its own negligence. Inc. as president and a member of the board of directors of Production Finishing. Inc. 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. and Peck is held personally liable on the lease guarantee. There is an exception to this rule where an agent expressly makes himself liable.10. No. The court held that Sandidge was an independent contractor and that Butler was not liable for the negligence of Sandidge. Here Butler only retained the right to inspect the work for compliance with the terms of the contract. Lexis 4468 (Ala. Yes.” and the like does not change the character of the person signing. Sebastian International. Shields. The court held that Peck personally obligated himself to the guaranty contract. 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.. Pugh v. 405 N. was an agent of the corporation.402 Chapter 25 Duty of Loyalty 25. Elvin Grinder Construction. An agent who makes a contract in his own name without disclosing his agency and the identity of the .2d 171.11.W. App.R.. Lexis 2379 (Mich. Lexis 2237 (Cal. the fact that to his signature is added such words as “President. are liable to Bryans Road Building & Supply Co. by usurping a corporate business opportunity. Peck. Sebastian International.. 1987 Mich.. If an agent acquires any pecuniary advantage to himself from third parties by breaching his fiduciary duties. 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. 240 C. Butler Telephone Company. Contract Liability 25. Inc. Thus. Inc.3rd 803. 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.. Inc. 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. v. 1987).A. Independent Contractor 25.9. This is a situation of an undisclosed principal. 1987). Butler Telephone Company. wins.12.” “Vice President. but is considered merely descriptive of him. Shields breached his fiduciary duty of loyalty to his principal. App. Production Finishing Corporation v. is not liable for Pugh’s death. 1987 Cal. 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. 512 So. The court held that Shields breached his fiduciary duty of loyalty and honesty to his principal by diverting the Ford contract to him. 1987). it will be liable for damages to Pugh’s parents and estate.2d 1317.

D. Generally. 520. Since Rogers was basically on the job and the accident occurred during work time.A. including acts committed by such agents while acting within the scope of their employment.S. 1981 Md. 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. did not seek to obtain Washington Steel’s permission to act as a dual agent. 186 C. the principal is liable for the intentional tort of the agent.2d 453. Washington Steel Corporation v.Agency Relationships 403 principal is liable on the contract to the other party. Grinder v. Washington Steel. Ordinarily. he is outside the scope of his employment during that period. Chemical Bank became a dual agent. Pa..R.Supp. 1982). Intrastate Radiotelephone. The court held that Grinder was the agent for an undisclosed principal. Tort Liability 25. Bryans Road Building & Supply Co.App. By accepting TW as a client and agreeing to finance its hostile tender offer on Washington Steel. The appellate court affirmed the judgment of the trial court that was entered in favor of Largey against Intrastate. and that he is limited to one satisfaction. Dist. 1979). 1981). Lexis 14391 (W..14. Largey v. Inc. Chemical Bank did not disclose its dual agency status to Washington Steel. then the employer will be vicariously liable for any accidents incurred while the employee is driving to or from work. TW Corporation. Washington Steel and TW had adverse interests to each other because of TW’s planned hostile tender offer for the stock of Washington Steel. MAC is liable. Intrastate Radiotelephone. 432 A. . Yes. Washington Steel wins. Tort Liability 25. while an employee is going to or coming from his place of employment. App. The court held that Chemical Bank’s undisclosed dual agency status violated the fiduciary duty of loyalty it owed to Washington Steel. and intentionally concealed its dual agency status from Washington Steel.13. Inc. is liable to Largey for the injuries caused by its agent.3d 660. 1979 U. Lexis 246 (Md.. Therefore. 1100. 136 C. and that Bryans is entitled to take judgment against Grinder personally in addition to its unsatisfied judgment against the corporation. Inc. Dual Agency 25. The principal is liable because the contract was made for his benefit. 1982 Cal. The court held that Chemical Bank owed a fiduciary duty of loyalty not to act adversely to the interests of its client. a principal is responsible to third persons for the negligence of its agents.App. and also temporarily enjoined TW for a period of 90 days from proceeding with its tender offer for Washington Steel. Lexis 2049 (Cal. The court held that a creditor who contracts with the agent for an undisclosed principal does not obtain alternative liability. but that he may proceed to judgment against both. Kranhold. the exception to the coming and going rule applies in this case. The court enjoined Chemical Bank from in any way financing or participating in the TW’s tender offer. 465 F. 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.15.

Citation. the court held. Parana did not act ethically and was not an agent of Krempasky by way of the signed agreement. Parana instead became a joint tenant and as such probably acted within the law. IV: Answers to Ethics Cases 25.19.C. and Court District of Columbia v. and then recover his lost profits as ordinarily measured by the commission he would have earned.17. except those coupled with an interest. Answer to “Briefing the Case” Writing Assignment: 1. Hilgendorf v. absent some legal ground. the Hagues had the power to terminate the exclusive listing agreement with Hilgendorf. Howell 607 A. Case Name. Yes. the agency agreement was terminated when the Hagues sent the termination letter to Hilgendorf on August 13. the principal does not have the right to terminate an unexpired agency contract. and are therefore liable for wrongful termination of the agreement. The agent’s authority to bind the principal ceases.18. “the focus should be on the basis of the assault rather than the motivation of the employee.” then liability will be imposed. 2d 783. Lange v. 211 N. 25. 1973 Minn. have sold the property within the unexpired period at the listing price. 25. King Realty should be awarded specific performance. the agent may show that he would.20. and may subject himself to damages by doing so.W. Hague. App. as a matter of law. Nabisco is liable for the intentional assault and battery of Lange by its employee Lynch. 293 N. 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. although the contract is for a period that has not yet expired. 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.404 Chapter 25 Tort Liability 25. The court held that the Hagues had no legal ground for terminating their agency agreement with Hilgendorf. Lynch was found to have been originally motivated to become argumentative in the furtherance of his employer’s business. However. Lexis 882 (Iowa 1980). Where the principal terminates an exclusive agency listing within the term. 1992) District of Columbia Court of Appeals . a principal has the power to terminate an agency. in developing a test for application of the rule the court stated. but for the termination. 1980 Iowa Sup.2d 272. The appellate court affirmed the trial court’s award of the commission to Hilgendorf. that the employer is liable where an assault or battery has its origin in an argument concerning the work being done by the employee. National Biscuit Company. Under the work-related test the lumber company is liable for the intentional tort of Jackson. 25. However.W.16.” Applying this test. Lexis 1106 (Minn 1983). An agent for a partially disclosed principal can act for the principal. Thus. Since an agency is a consensual relationship. V. 1976. Bianchi made a deal with an undisclosed principal and thus did not act in good faith in trying to back out of the contract.2d 501 (D.

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

and tort law doctrines. finance. Compare. few sole proprietors would willingly give up their personal control over their fate. the businessperson who wants to leverage the maximum utilization of other people’s money while limiting her personal financial exposure. this form of business may enjoy a renaissance in the Twenty First Century. The real issue is first finding out what options are legally available and then choosing the best fit. 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. contract. agency. For example. a private form of sole proprietorship may be best. It is this interdependent equation that makes the practice of business law so difficult yet so interesting. in fact. The vast majority of the users of Professor Cheeseman’s book will never go to law school. That fit should be tailored by sound advice from a number of quarters including law. 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. Every sort of business issue ranging from taxes to zoning may confront this businessperson. The law has something for everyone.406 Chapter 26 Chapter 26 Sole Proprietorship. That person may find the corporate form best suited for her needs. if a person seeks maximum privacy in his or her financial affairs along with the least possible accountability to others. accounting. Yet in spite of the high risk and sometimes-marginal rewards. What seems like a relatively limited number of options is. and business management strategy. Yet that same majority will be influenced every working day by the legal business entity choices made in whatever business pursuits they chose. however. The law of sole proprietorship is. With each choice comes a list of pros and cons in the eyes of the law. and General and Limited Partnerships How Do I Form My Business? I. in fact. The practice of law for sole proprietorships is akin to the medical family doctor. With the advent of the information highway and more emphasis on entrepreneurial niche marketing of goods and services. The choices run the gamut from the simplest lemonade stands to a multinational publicly traded corporation. quite extensive. .

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

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

Sole Proprietorships and General and Limited Partnerships 409 .

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

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. In 1963. No social security or income . Compensation was paid on an irregular basis to Sweet. Sweet (Sweet) began as an hourly employee of Vohland’s Nursery. Paul Vohland (Vohland) changed Sweet’s status giving him 20 percent of the net profit instead of hourly pay. Sweet Facts: Norman E.

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

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

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

Sole Proprietorships and General and Limited Partnerships 415 .

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

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. they have the right of survivorship. Under RULPA. a certificate of limited partnership is needed.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. .

418 Chapter 26 Landmark Law: The Revised Uniform Limited Partnership The RULPA was promulgated in 1976. 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. Note: the name of the Limited Partnership may normally not include the surname of a limited partner. . Limited partners cannot participate in management or they will be liable as general partners.

. 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.

App. Filip and Elliot. and that Smithson would not be required to put any money into the venture. v. III. 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. The court entered judgment for Smithson against the four defendants for $36. A partnership is defined as a voluntary association of two or more persons carrying on a business as coowners for profit. Smithson v. 1988). General Partnership 26. a partnership was created between Smithson and the four defendants—White. Answers to Critical Thinking Cases General Partnership 26.App. 1976 Tex. Elliot is not liable for the debt owed by Trans Texas to Cox. the court enforced this agreement against Morgan on a counterclaim by the other partners. 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.1.App. Lexis 2947 (Tex. 1988 Tenn. App.800. Lexis 221 (Tenn. 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. 538 S.2d 836.000 profit made on the sale of the property.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.W. 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. Inc. Devrow.2. 1976). It is not necessary that a partnership be designated as such to be created. The court held that Elliot did not create a partnership. that they would share in the profits equally. No. which was one-fifth of the $184. Ennis. Cox Enterprises. and Morgan. Yes. Note: Morgan had previously agreed to indemnify the other three partners from any claims by Smithson. . White. The court dismissed Cox’s lawsuit against Elliot.

Instead. 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. App. The law firm and the other partners are not liable for McGrath’s tortious conduct in shooting Hayes. 8975 (La.422 Chapter 26 Tort Liability 26.2d 178 (Wash. either directly or by inference that McGrath was acting in the scope of his employment when he shot Hayes.App. App. is liable to the estate for the conversion by Edgar Husted of the estate’s funds. 1982). 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. 452 So. App.2d 312. Inc. Under partnership law. the burden is on the partners to notify creditors with whom they have dealt that their partnership has been dissolved. Sumter. as are the partners of the partnership. Tort Liability 26. the master is not liable. The court held that Sumters’ failure to give such a notice to Thermal made Leonard liable for Michael’s debts to Thermal. .5. and its other partners were not liable for McGrath’s tortious conduct. Where a servant steps aside from the master’s business in order to affect some purpose of his own. Hayes v. The court found no evidence to indicate. Husted and Husted. Notice of Dissolution 26. v.App. McGrath is liable. Lexis 1244 (Ind. 436 N. The partnership is liable for this tortious act. the partnership. if a partnership is dissolved. Sr.E.3. McCloud. is liable for the debt owed Thermal Supply by Michael. 1988).2d 341. The court held that Edgar Husted was acting within his apparent authority when he took the estate’s check and misappropriated it. actual notice of the dissolution must be given to third parties who actually dealt with the partnership. The court awarded compensatory and punitive damages to the estate. 1984)]. Under the Uniform Partnership Act. Yes. 198 La. The court found that Leonard and Michael had failed to notify Thermal of the dissolution of their partnership. McGrath. and that Thermal did not receive notice of this fact from any other source. Steeby should win. [Thermal Supply of Louisiana. Fiduciary Duty 26. Treadwell & Schoonmaker. a partner is jointly and severally liable for the tortious conduct of another partner committed within the ordinary course of partnership business. Leonard Sumter. 1982 Ind. 749 P. Thatcher. Husted v. 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. Torbenson.6. There was no evidence that McGrath transacted law firm business or engaged in any promotional activities on behalf of the law firm. The court held that a creditor is not obligated to investigate or ask if a partnership is still in operation.

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. National Railroad Passenger Association v. In furtherance of this purpose. the partners agreed that McGowan and Advance would supervise the construction of the duplexes. McGowan and Advance are liable for their acts. Liability of Limited Partners 26.W. upon ascertaining the mistake. none of the limited partners are liable for the debts of the partnership. The partnership assets are subject to the claims of the unpaid suppliers. Advance. National Lumber Company v.D. Note. he was acting within his authority as a partner and agent of the partnership and thereby bound the other two general partners. However. Limited partners are not individually liable unless they take part in the management of the partnership or personally guarantee the performance of the partnership. however.7. were jointly and severally liable for the partnership debts owed to the unpaid suppliers. the court held that Somers and Robertson. the limited partners of USANL are not individually liable for the alleged breach of contract by the limited partnership. 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. partnership law provides that if there is a substantial defect in the formation of a limited partnership. Advance Development Corporation. Union Station Associates of New London. there is an exception to this rule. and the general partners are jointly and severally liable for everything chargeable to the partnership. and effectively made McGowan and Advance their agents. Lexis 22190 (D.9 No. with the responsibility of developing Vermont Place. Therefore. The court held that in this case the limited partners did not take part in the management or control of the limited partnership. No. 732 S.C. 192.Sole Proprietorships and General and Limited Partnerships 423 Liability of General Partners 26. When McGowan acquired labor and materials and then failed to pay for them.Supp. 1987 Ark. the partnership is a general partnership and the purported limited partners are individually liable as general partners. as general partners of the limited partnership. Dist. Partnership law stipulates that only general partners are individually liable for the debts of a limited partnership. Under limited partnership law. 1986). 1986 U. 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. that the limited partners may lose their capital contribution that they have made to the limited partnership.S. he promptly renounces his interest in the profits of the business. a partnership is bound by a general partner’s wrongful acts. 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. Lexis 2225 (Ark. he is not bound by the obligations of the partnership if. Because of their limited liability. nor had they personally guaranteed the performance of the lease with the NRPA. In addition. 643 F. Only the limited partnership and its general partners may be held liable to the NRPA. Liability of Limited Partners 26. The partnership agreement provided that the purpose of the partnership was to acquire real estate and construct duplexes for lease or sale. Generally.8.2d 840. 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 . 1987).

2d 87 (Ky. Inc. Because they are corporations.2d Dept. Molander can only recover against the assets of the limited partnership and its corporate general and limited partners. 1989).) Limited Partnership 26. Not only was Conway unethical but his fiduciary duty was breached. desired to buy certain partnership property at a premium. There was a breach of duty and the court should appoint a receiver. 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. the superior court decision was reversed. No. Although the 70% limit was reached for removal of Aztec (questionable). Removal of a General Partner 26. No other right is affected. 1985). 8 Brookwood Fund v. Inc. A personal guarantee of Raugust might have helped.. Molander v. The trial findings and decision were upheld. If it doesn’t it can’t initiate litigation in KY. recovery is only against the shareholders. 722 P. 539 N. Gilroy wins.Y.W.17. Hankin. The limited partners had no liability to Day.14.No. 1985 Pa. The limited partners of Cosmopolitan are individually liable on the contract between the partnership and Dwinell’s Central Neon.424 Chapter 26 on the debts allegedly owed by Brookwood to Sloate and Bear Sterns. the creditor may recover payment from the limited partner. After six years of management the winding-up partners had failed to liquidate the partnership.2d 103 (Wash App. This was fraud to which a GP was party.).2d 675.Aztec wins.A. the limited partners are not individually liable to Day.D. a unanimous vote is needed to admit a new partner and without this there would be no general partner. 26. Virginia Partners Ltd. and its general partners could be held liable to Day. Bear Stearns & Co. Yes. 26. the .12. one of the winding-up partners. Partnership law provides that if a limited partnership “substantially complies” with the legal requirements for organizing a limited partnership. Liability of Limited Partners 26.15.11. Virginia Partners. however.10. Under KY law a foreign(organized outside KY) limited partnership must register in the state.S.2d 411 (N. V. A GP is needed for a limited partnership to exist. Hankin v. Only an innocent party can recover on th policy.16. If a limited partner personally guarantees a loan made by a creditor to the LP and the LP defaults. Lexis 337 (Pa. IV: Answers to Ethics Cases 26.. not against Raugust personally. Raugust-Mathwig. 493 A. Limited Partner’s Interest 26. Liability of Partners 26. App. Here the LP was defectively formed And there was liability also on Molander’s contract.Y. Although time alone would not necessarily establish mismanagement when combined with evidence that Moe Hankin. Day 738 S.13. the limited partnership.

if substantial compliance is not met. Inc.2d 191 (Wash. Defendant was a general partner in an organization called Coronado Industrial Investors Limited Partnership (Coronado). 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. and that it was a general partnership at the time the contract was signed with Dwinell’s. 26. so it had no way of apprising itself of the asserted limited liability. 587 P. the purpose of the filing requirement is to acquaint third persons. E. C. In 1989. Citation. They lead Dwinell’s to believe they were acting as a partnership causing the transaction to occur. There was certainly a conflict of interest and a breach of the duty of loyalty. such as Dwinell’s. This was because the certificate of limited partnership had not been filed with the state until several months after the contract was signed.Sole Proprietorships and General and Limited Partnerships 425 limited partners are not individually liable for the debts of the partnership. Answer to “Briefing the Case” Writing Assignment: 1. Catalina Mortgage Co. the contract only identified Cosmopolitan as a “partnership. the court held the purported limited partners individually liable as general partners on the debt due Dwinell’s. The limited partners did not act ethically in denying liability on the contract. D. the plaintiff must first go against partnership property before it can go after personal assets. Key Facts A. 5. Further. Dwinell’s Central Neon v. under the prevailing view of the Uniform Partnership Act. 71..18. 3. 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. 1978).2d 574 (1990) Supreme Court of Arizona 2. Holding Yes. The court held that there was a defective formation of Cosmopolitan as a limited partnership. V. AZ with plaintiff. Obviously. in 1986. v. of the existence of the limited partnership and the limited liability of the limited partners. Thus the partnership should be dissolved and damages should be awarded. the partnership is a general partnership.App. Coronado had refinanced its property located in Tucson. B. and are only liable up to the extent of their capital contribution to the limited partnership. Inc. Cosmopolitan Chinook Hotel. the plaintiff brought a collection action on the note against the defendant and claimed personal liability on the part of the defendant.” not as a limited partnership. Therefore. and Court Catalina Mortgage Co. Plaintiff claimed that Arizona law allows for an exception to that general common law rule. Court’s Reasoning . Defendant argued that. 800 P. and the purported limited partners are individually liable as general partners. no filing was made at the time Dwinell’s entered into the contract. Cox did not act ethically. In this case. However. Case Name. Monier 166 Ariz.

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

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

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

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

430 Chapter 27 .

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. Articles of Incorporation Charter Corporate Bylaws Used in Managing . 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.

Problems are mentioned.432 Chapter 27 Internet & Technology: Domain Name The process of registering a domain name is discussed. Remember the Anticybersquatting Protection Act. (benefit to the corporation) . services. etc. FINANCING THE CORPORATION Note: Shares may be issued in exchange for cash. This format does have its advantages but is limited in its utilization for small companies who hope to attract venture capital. notes. property. When a company decides that it wants to grow by “going public. 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.” this format no longer works.

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

Contemporary Issue: Close Corporation This discusses the Model Statutory Close Corporation Supplement added to the RMBCA. . 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.434 Chapter 27 Contemporary Issue: Stock Options and stock Warrants This explains the difference between stock options and stock warrants.

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

436 Chapter 27 .

1980 N. as artificial persons created by the state that can sue or be sued in their own names. educational.2d 934. Inc.Y. torts. USM was a publicly held corporation.S.. Marine Repair Services was in the business of repairing shipping containers in order to make a profit. v. Billy’s widow must look directly to the corporation to satisfy any judgment she may seek in a torts suit against USM. or scientific purposes. Answers to Critical Thinking Cases Legal Entity 27. for profit corporation. is a private.. .Supp.3.Supp. they are prohibited by law from distributing this profit to their members.Pa. Although the corporation does generate revenue from ticket sales and concession stands. Billy v. Lexis 23179 (10th Cir.Y.. Lexis 2638 (N.. When the corporation became involved in a dispute with Sammak. Limited Liability of Shareholders 27. in effect. Lexis 10456 (S. Dist.N. and torts. Yes. Inc.D. religious.4. directors. debts.2d 757. 1980). or officers. to promote Little League and other amateur baseball teams in Hutchinson. One of the most important features of a corporation is the limited liability of its shareholders. Corporation 27. Hutchinson Baseball Enterprises. Although nonprofit corporations may make a profit. Commissioner of Internal Revenue. 1982). Private corporations are formed to conduct privately owned business.1.2d 152. Because of the corporation’s nature. Inc.S. Corporation 27. Most private corporations fall into this category. Marine Repair Services was a for profit corporation. Dist.E. 412 N. Profit corporations are created to conduct a business for profit and can distribute profits to shareholders in the form of dividends. Inc. Hutchinson Baseball Enterprises. Lexis 12767 (E. 1982 U. the corporation becomes a separate legal entity for most purposes. Blackwood Coal v. Corporations are the most dominant form of business organization today. Nonprofit corporations are formed for charitable. Because the law views the corporation as a legal person for most purposes..Y.App. App. Marine Repair Services was a privately owned corporation. or contracts. All revenue that the corporation generates is used to fund the corporation’s activities. As separate legal entities. the shareholders of USM cannot be held personally liable for the suit against the corporation. In a publicly held corporation shareholders are normally not responsible for a corporation’s debts.Corporate Formation and Financing 437 III. 1985 U. Marine Repair Services. this money is never distributed to Hutchinson’s officers or directors. 727. Deister was a business properly incorporated under the laws of the state of Pennsylvania. Private corporations may be further classified as either profit or not-for-profit.S. O’Donnel v. Tool Corp. nonprofit corporation. As such. When a corporation is properly incorporated pursuant to the laws of the state of incorporation. The purpose of the corporation was to increase the investment made in it by its shareholders. Corporations are treated. 1985). Hutchinson Baseball Enterprises was formed for a charitable purpose. 51 N. Marine Repair Services is a private. Kansas. 1982).2. corporations are liable for their own contracts. Deister Co. 1982 U. 530 F. Since USM is considered a separate legal entity.Y. Billy was injured in the course of his employment with USM. Sammak was able to bring suit directly against the Deister Corporation. Sammak decided to sue. Deister Corporation can be sued. 696 F. Hutchinson Baseball was incorporated under Kansas’s law as a nonprofit corporation. 1199. No. claims.D. 626 F. Consolidated Mach.

Florida Fashions was a domestic corporation in the state of Pennsylvania. Stern.2d 383.D. both friends and former partners.5. . 1981 Haw. the two parties signed several contracts on behalf of the proposed corporation. never gave his consent for a novation. and the corporation was never formed. Additionally. App. which included the security of a $69. Because of these characteristics. The shareholders. Balvik v.438 Chapter 27 Corporation 27. A corporation is a domestic corporation in the state in which it is incorporated. Thus. The two shareholders were also on the board of directors of the corporation and served as the corporation’s officers. Weldon Electronic can be described as a closely held corporation. Therefore. If the proposed corporation never comes into existence. the third party. 1987).App.8. unlawfully doing business due to its failure to register. Promoters are the individuals who organize and start a new corporation. the corporation’s bylaws called for a buy/sell agreement to be reached to prevent outsiders from buying stock in the corporation. Sylvester. 1987 N. when the proposed condominium project failed. the Allens and Handley were acting as promoters for a proposed corporation which would build condominiums near Honolulu. App.7The Allens and Handley should have joint personal liability for the failed project’s contractual obligations. Corporation 27. the promoter is released from liability on the contract. Handley and the Allens became liable for these contracts. 1976 Fla. 332 So. In this case. Jacobson later formed a corporation. 1976). 411 N. who are usually involved with the management of the corporation. It is a foreign corporation in all other states and jurisdictions. Mysels v. sometimes enter into buy/sell agreements that prevent outsiders from becoming shareholders. Lexis 392 (N. Promoter’s Contracts 27. Florida Fashions was illegally taking orders and doing business in Florida because the corporation had never qualified to conduct business in the state. Weldon Electronics was a corporation with only two shareholders. Stern wins. 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).500 loan. App. Lake Enterprises. 1981).D. This meant that Florida Fashions was a foreign corporation in the state of Florida. to conduct business in states other than their state of incorporation. i. Jacobson is incorrect. to own and operate the new casino for which Stern was drawing plans.W. Lexis 192 (Hawaii.e. Promoter’s Liability 27. In addition. Lexis 14341 (Fla. 627 P. A corporation can become liable on a promoter’s contract by executing a novation. A closely held corporation is one whose shares are owned by a few shareholders who are often family members. Ching. Promoters often enter into contracts on behalf of the corporation prior to its legal incorporation. In this case. and file the papers necessary to incorporate. since a novation of the contract between the two parties did not occur. Jacobson was the promoter who formed a contract for architectural services with Stern.2d 1132. relatives. Weldon Electric is a closely held corporation.6. the promoters have joint personal liability for any contract signed on behalf of the proposed corporation. or friends. register. When a novation is executed. negotiate and enter into contracts in advance of its formation. Barry..2d 38. Although the corporation may have adopted this promoter’s contract. Foreign corporations have to qualify. Handley v.

Corporations will usually redeem the shares when the current interest rate falls below the dividend rate of the preferred shares.2d 198. 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. Dist. buy back. does not represent an ownership interest in the corporation. 602.Corporate Formation and Financing 439 Jacobson remains liable for the contract with Stern. A debenture bond is a long-term. because the preferred stock was redeemable.2d 648. or novation. Yes. By issuing redeemable preferred stock. Jacobson v. ratification of the promoter’s contracts was not allowed in the state of Washington. 81 Cal. 670 P. unsecured debt instrument.e. Lexis 17604 (S.9.10. unless the third party agrees to release him. Thus. i. Lexis 522 (Nev.Ill. the corporation becomes liable for the contract. IV: Answers to Ethics Cases 27. Darden. the corporation is able to protect itself from changing market conditions. Since DDS did not agree to release Goodman from liability on the renovation contract. Jones v. 1983 Wash. Goodman can be held personally liable for the renovation contract with DDS. the corporation borrows money from an investor to whom the debt security is issued. 27. it would have to be by adoption.12.Rptr. if the newly formed corporation chose to be bound by the renovation contract. the promoter remains personally liable on the contract. Neither Knoll nor Cogan owe a fiduciary duty to the debenture holders. Lexis 1776 (Wash. H. Redeemable preferred stock (or callable preferred stock) permits the corporation to redeem. if the corporation becomes insolvent. 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. $10 a share more than it had to sell the shares for.D. 605 P. were shares of redeemable preferred stock. 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. debenture holders are paid only after the secured creditors claims are met. . 1978 U. Commonwealth Edison Company.3d 93.Supp. 451 F. Goodman v. 1978). While the debenture bonds paid a 5 percent interest rate. while the debenture bonds do not. when the market changed.S. Lexis 195 (Cal. 1980). The rights of the holder of a debt instrument are spelled out in the documents that accompany the debentures. and as such. 1 Cal. In this case. Upon adoption. 1983). Instead.11. representing an ownership interest. he remained personally liable with the newly formed corporation. Preferred Stock 27. adoption. Commonwealth Edison had set the dividend rate of the one million preferred shares higher than it wanted due to market conditions. and a debenture bond. investors who bought one of the units offered by United Financial received both debt and equity securities. Ahmanson & Company. 1969 Cal. Edison was able to buy back the stock for $110 a share. those investing in United Financial received both shares of stock in the company. Stern. Therefore. and no novation had occurred place. Doman & Stafford Associates. A debenture bond is a debt security. 1980 Nev. they did not represent an ownership interest in the company. 1969). which is based on the corporation’s general credit rating. Therefore. The one million shares of preferred stock issued by Commonwealth Edison on June 24. In this case. However.F. The terms of the redemption are established when the shares are issued. 592. the preferred stock at some future date. Debt Security 27. The Franklin Life Insurance Company v. 1970. since a novation cannot occur without the consent of the third party. Therefore.

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

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

and officers is founded in the law of fiduciaries. Just as the corporate form should not be allowed to defraud creditors and the like. the underlying premise is that the corporate form should not allow a person to do something that would otherwise be prohibited by public policy. These have ranged from piercing the corporate veil to outright revocation of the continued existence of the corporation. .442 Chapter 28 and generally undesirable behavior. loyalty. 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. The second theory is found in the intracorporate workings of the organization itself. and mutual support. directors. so too should it not be allowed to be used by various members of corporate organizations to harm each other. In all these cases. Some of the most vociferous business battles are fought within the confines of the corporate boardrooms around the country. The cornerstone of relationships among shareholders.

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

444 Chapter 28 .

Corporate Governance and the Sarbanes-Oxley Act 445 .

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

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

Northeast argued that the corporate veil should be pierced. .000 and North Central invested $500.000 in punitive damage against Drizin.000. LLC v.000.600. Here there was undercapitalization and lack of separateness. Drizin Facts: Local farmers decided to buld an Ethanol plant.365.000 in compensatory damages and $7. lack of separate books. Northeast sued Drizin for civil fraud. They formed Northeast Iowa to hold the money and develop. Drizin argued GSI was liable but not him. He had $250 capital. Ethics Spotlight: Controlling Shareholder’s Breach of Fiduciary Duty Many courts have held that a controlling shareholder owes a fiduciary duty to minority shareholders. Drizin formed GSI to raise the financing. and promotion of fraud. Issue: Does the doctrine of piercing the corporate veil apply in this case? Decision: Yes. The corporate veil could be pierced. Drizin got investors but commingled funds with his own and orcgestrated a process where all the funds were stolen (mostly worthless investments). Reason: The corporate veil may be pierced in exceptional circumstances. Internet & Technology: Corporate Codes Recognize Electronic Communications Most states allow electronic communications to shareholders and among directors.000. Plaintiff was awarded $3.800. They invested $2. In Iowa this might include undercapitalization. All money was placed in escrow and financing was needed for another $20. commingling of funds.000. William invested $1.448 Chapter 28 The Court speaks: Northeast Iowa Ethanol.000.

Corporate Governance and the Sarbanes-Oxley Act 449 .

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

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. .

and (3) in the honest belief that the action taken was in the best interest of the corporation. Reason: A corporate director is protected by the business judgment rule only if he acted (1) on an informed basis. The Court Speaks: Smith v. all of the directors breached their duty of care by not acting on an informed basis. Van Gorkom. acting as chairman of the board. 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. they voted to accept the Pritzker offer after listening to a twenty-minute presentation by Van Gorkom. Van Gorkom Facts: After a meeting with Jay A. Pritzker. by not reading the merger agreement they have neglected the shareholders’ interest.e. Although none of the directors including Van Gorkom had actually read the merger agreement. . proposed to his fellow directors that they accept a cash out merger offer by Pritzker. Issue: Did Trans Union’s directors breach their duty of care? Decision: Yes.. Here. and that they not solicit other offers. i. (2) in good faith.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.

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 purpose of an annual shareholders meeting is to elect directors. Yes. Yes.Y.D. Smith and Gibbons had given Zollar a proxy that specifically stated that it was irrevocable for a period of ten years.2d 155. and it is coupled with an interest.1. the court held that the proxies were still valid. Supp. If the meeting is a special meeting.W. 1986). 1986 Tex. The corporation did not plan for another shareholders meeting to be held until January 27. 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. 476 N. The corporation is required to give the shareholders written notice of the place. and the proxy met the requirements for irrevocability. Because of the importance of shareholders meetings. such as a corporate merger. Zollar v. v.S. Katz. The MBCA requires a shareholder to have a proper purpose for such an inspection. 1291. and to take other actions. v.Y. Shoenholtz. Proper purposes include deciding how to vote in a shareholders election. over 16 months after the previous meeting.Corporate Governance and the Sarbanes-Oxley Act 457 III.S. . Lexis 12741 (E. Answers to Critical Thinking Cases Shareholders Meeting 28. Right to Inspect Records 28.D. Under the MCBA. 1987). Because the proxy agreement was to last for ten years. is valid for 11 months. Lexis 12900 (Tex. any shareholder may petition the court and obtain an order that such a meeting be held. App. A normal proxy. Helmsman’s request should be allowed. Inc. 1984). Special Meetings 28. choose an independent auditor. Ocilla. day. and time of annual and special meetings. The last annual stockholders meeting held by Direct Action took place on September 19. The MBCA requires shareholders to give written notice to the corporation to exercise their inspection rights. Smith and Gibbons were attempting to reverse their proxy after only one had passed. The notice given to Rye’s shareholders was adequate. Smith and Gibbons cannot reverse their proxy agreement with Zollar. Lexis 178 (A. App. as a shareholder. in that it stated the time. and investigating corporate mismanagement. Dist. 2 Dept. Smith. or the removal of a director. Ocilla can force the board of directors of Direct Action to hold the shareholders meeting at an earlier date.2d 339. Shareholders have a right to inspect corporate records. 1986.Y. Under the MBCA. the purpose of the meeting must also be stated. Ocilla Industries. examining the propriety of paying dividends.3. 1988. Special shareholder’s meetings may be called by the board of directors. 1987 U. and purpose of the meeting. Shoenholtz wins since the special shareholders meeting was properly called. App.2. Special meetings may be held to consider important or emergency issues. 710 S. Because the special shareholders meeting was requested by an authorized party and proper notice was given to the shareholders. Div. 1984 N. A proxy becomes irrevocable for a longer period if the proxy states that it is irrevocable. the MBCA allows shareholders to force corporations to hold the meetings on an annual basis.4. date.N. 677 F. No. the meeting was properly called. this gave him the right to request a special meeting. or by the holders of at least 20 percent of the voting shares of the corporation. Since Shoenholtz owned over 10 percent of the voting shares of Rye Hospital. Proxy 28. Rye Psychiatric Hospital Center. can obtain a court order to compel Direct Action to hold the shareholders meeting at an earlier date. unless otherwise stated. Inc.

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

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

1975 Cal. 28. In selling its control of the corporation. The District Court correctly found Farms to be the alter ego of Chemicals. Defendants were the sole owners of a coalmine operation doing business as WRW Corporation. and Court United States v. 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. breached its fiduciary duty to the minority shareholders. Bank. V: Answer to “Briefing the Case” Writing Assignment: 1.2d 686. Additional civil penalties in the amount of $90.. F. they hoped to recover from him a debt owed to them arising out of fraud. Ray had no other way to pay back the contractual price that they had negotiated with him. First Western Bank and Trust Company. D. United States of America v. Inc. Finally. 1985 U. a Kentucky corporation. App.000 investment created a thin corporation (diaphanous) that depended upon its parent Chemical for transfusions of working capital. Jon-T Chemicals. Farms did not have a separate financial existence. First. B.” Third. the use of Chemicals’ offices and computers justify the district court’s finding of joint use and ownership of property. Moreover. 1975). Citation.350 were imposed against WRW. Debaun v.12.460 Chapter 28 IV: Answers to Ethics Cases 28. App. Key Facts A.3d 791. regardless of whether the fraudulent papers were signed by Thomas as Farms President or Thomas as Chemical the corporate entity was appropriately disregarded. Observance of corporate formalities is only one aspect of corporateness. The $10. 768 F. the nature of the loans to Farms from Chemicals reveals that whenever Farms could not pay its debts Chemicals wrote a check for payment. long trail of financial failure should have precluded the Bank from dealing with him. 1985). 46 Cal. All three of the co-owners were found criminally liable and served prison sentences. There were no corporate resolutions authorizing these extraordinary “loans. G.S. WRW Corp. Lexis 21255 (5th Cir. 120 Cal.11. Plaintiff asked that the corporate veil be pierced and that the owners be held personally liable for the fines. C. 354. The defendants claim limited liability because of the corporate status of WRW. the controlling shareholder has an obligation to conduct a reasonably adequate investigation of the buyer.Rptr. 3. Case name. App. Those violations resulted in the deaths of two miners. The turns of the deal guaranteed that Ray would loot the corporation. 986 F2d 138 (1993) United States Court of Appeals for the Sixth Circuit 2. Issue Should the corporate veil be pierced and the owners of WRW Corporation be held personally liable? . They knew from personal experience his fraudulent character. Ray’s long. Lexis 1801 (Cal. as the controlling shareholder of Corporation. Second. App. E. by itself it does not create a separate existence for an entity. The Bank here placed control in a man whose public records are overwhelmingly negative. The lower court held for the plaintiffs.

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

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

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

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

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 .

each party’s valuation evidence was replete with deficiencies and so susceptible to bias that indiscriminate indorsement of either would have been indefensible.6 percent of the stock of Shell Oil Company (Shell). Reason: Walsh. J. 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.” The chancery court reviewed the evidence and used its broad discretion to arrive at a valuation of $71. a large natural resource conglomerate.001 shares had not accepted the offer and qualified for appraisal rights. Facts: Royal Dutch Petroleum Company.20 per share plus 10 percent interest from the date of the merger to date of payment. 1985. The court stated. . The parties offered extensive evidence through expert witnesses.Corporate Acquisitions and Multinational Corporations 469 The Court Speaks: In the Matter of the Appraisal of Shell Oil Co. These experts gave the following estimated per share value for Shell’s shares.005. The chancery court gave little or no weight to the valuations reached by the experts because it found that they lacked objectivity. The Delaware Chancery Court conducted an appraisal hearing. public shareholders. Market value was an estimated price that Shell shares would sell for without the effect of merger speculation. The opinions expressed by the expert witnesses significantly reflected the desires of their clients. 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. “In this case. The remaining shares of Shell were held by minority. Comparative value was an estimate based on a price reflected by prices in similar transactions in the oil and gas industry. After the merger was complete. On June 7. Issue: What price should Shell pay its minority shareholders who demanded appraisal rights? Decision: The court determined that the fair value was $71.20 per share. owned 94. 1.

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.470 Chapter 29 Landmark Law: The Williams Act The Williams Act regulates tender offers.” Ethics Spotlight: Golden Parachutes These devices remain popular in spite of the recent reforms enacted by 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 IRS. Many commentators have argued that it is time for the IRS to step into the golden parachute arena as well. The code has gone a long way towards eliminating discriminatory practices that unduly favored highly compensated executives. The problem with these proposals is that they would likely create a turf war between the SEC. and the Labor Department.

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..

QVC sued alleging Paramount’s board had breached their fiduciary duties to the corporation and its shareholders. a lockup option in favor of Viacom and poison pill strategies. 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. The court agreed with QVC. Inc.472 Chapter 29 The Court Speaks: Paramount Communications. .” it must remove all poison pills as to all possible bidders and put itself up for auction to be purchased by the highest bidder. Paramount’s board adopted anti takeover strategies including a no-shop provision. The Facts: Viacom and Paramount announced a friendly merger in September 1993. Five days later QVC made a $90 hostile bid for Paramount that topped Viacom’s merger offer. QVC Network. 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. They held that once a Delaware corporation has put itself in plan. v. Inc.

The fear was that it would start a trend of takeovers of weakened U. when it should have disclosed the tonnage of mineral holdings. It is an accepted part of the business landscape and does not violate the Commerce Clause. III. Answers to Critical Thinking Cases Proxy Disclosure 29. stated a claim for relief for violation of federal proxy disclosure rules. Laws regulating corporate governance necessarily affect certain aspects of interstate commerce.S. states traditionally have been given the power to create corporations. Lockspeiser. a shareholder of Western Maryland Company. 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. Dynamics challenged the Act in federal court alleging violation of the Williams Act and the Commerce Clause. 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. The Indiana Act protects shareholders from coercive tender offers. The test for determining the . One recent example involved a blocked merger of a U. 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. 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. 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. 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. timber holdings in board feet.1. This would.-based air carrier with British Airways.S. International Law: The Exon-Florio Law This law is still too new to give us a real track record of its efficacy.5 percent of CTS’s stock. it does not violate the federal laws. There is no question. carriers by government-subsidized overseas carriers. Yes. lead to a losing of control of our own transportation infrastructure. and to define the rights acquired by purchasing corporate shares. Sanford E. This is an emotional and politically charged debate and makes for good class discussion. and the actual value of the assets owned by Western. to prescribe their powers. Dynamics Corporation Facts: Dynamics Corporation of America (Dynamics) announced a tender offer of 1 million shares of CTS that would give it 27. However. in turn.

Lexis 6548 (5th Cir. 438. Proxy Contest 29. If a proxy contest is fought over policy issues and not for personal reasons.474 Chapter 29 materiality of an omission from a proxy statement is set forth in TSC Industries v. the court held that the incumbent directors were entitled to have their costs and expenses of the proxy contest to be paid by Fairchild. the incumbent management is reimbursed for the costs of the proxy contest whether they win or lose it. Medfield Corporation. The court ordered a new election. 1976). Lockspeiser v. 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. The Gladwins win. App. 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. Northway.App. the investment banker hired by Western to give a fairness opinion.2d 1266.S. The court held that Lockspeiser stated a claim for relief alleging material omission in Western’s proxy materials. and an explanation that the resolicitation was the result of a lawsuit. 1985 U. It also directed that Medfield’s new proxy solicitation materials include corrections of all illegal misstatements and omissions.. 540 F.3. the court permitted the insurgents to be reimbursed for the costs of the proxy contest because (1) the contest related to policy issues. and personal reputation of a rival candidate for office. Proxy Contest 29. The court held that the corporation could pay both the incumbents’ and insurgents’ costs in waging the proxy contest. Rosenfeld v. (2) failed to disclose self-dealing by a director. 1985). the omitted fact would have assumed actual significance in the deliberations of the reasonable shareholder. upon approval of the majority of the shareholders. and (3) unlawfully impugned the character. Based on the fact that the proxy contest in this case was waged over policy issues. if an insurgent group is successful in unseating incumbent directors in a proxy contest waged over policy issues. What the standard does contemplate is a showing of a substantial likelihood that. App. 1976 U. 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. did not independently evaluate Western’s assets.S. The court held that Medfield had (1) failed to disclose the nature and extent of Medfield’s liabilities. 128 N. the corporation may. 426 U.2.2d 558. Fairchild Engine and Airplane Corporation. Fairchild Engine and Airplane Corporation wins. (2) the insurgents were successful in the proxy contest. 768 F. Inc.Y. reimburse the insurgent directors for their costs and expenses of waging the proxy contest. .E. under all the circumstances. Thus in this case. integrity. 1955 N. Also.S. 1955).Y. Fairchild paid for both sides’ costs of the proxy contest. Gladwin v. 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. Lexis 947 (N. Ct. a statement that prior solicitations were in violation of Section 14(a) and SEC proxy rules. Western Maryland Company. and (3) the majority of the shareholders ratified the payment of these expenses to the insurgents. 96 S.2d 291. In this case.

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. Therefore.2d 659. many young people of college age refused to work for Dow because of its manufacture of napalm. Bregman. 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.Corporate Acquisitions and Multinational Corporations 475 Shareholder Resolution 29. John Bershad may not obtain dissenting shareholder appraisal rights. the Committee could have also asserted that Dow’s manufacture of napalm made it susceptible to product liability lawsuits by those injured by it. The court held that the proposed sale of Plant (Quebec) met this definition. if a majority of the shareholders vote to approve the sale of the subsidiary. If a shareholder meets the ownership requirements of Section 14(a) (which the Committee met). The committee wins. and substantially affects the existence and purpose of the corporation. 431 A. In addition. Medical Community for Human Rights v. the shareholders of Plant Industries. caused damage to humans who were burned by it and those who were exposed to it.Cir.5. No.6. Each of these are reasons that the Committee could have asserted to support the inclusion of its shareholder proposal in Dow’s proxy materials. dissenting shareholders who properly object to the sale and timely require appraisal rights may require the court to appraise the value of their stock. he has a right to place a proposal in the proxy materials of the corporation if the proposal relates to the corporation’s business. Ch.Ch. Inc. a chemical substance that was used as a defoliant in Vietnam during the Vietnam conflict. There was substantial public criticism and demonstration against Dow for making napalm. its parent corporation. To obtain appraisal rights. sales. In addition.4.S. 1981 Del. and does not solely relate to a social or religious purpose. and net income of Plant Industries. 1981). In this case.2d 1274. where there is a sale of substantially all of the assets of a corporation. the vote of the shareholders of Plant Industries.C. a dissenting shareholder must (1) file a written objection to the merger prior to . Katz v. Dow Chemical was manufacturing napalm. 1970 U. under Delaware law. Whether a sale of assets constitutes a sale of substantial corporate assets is a question of fact. the shareholders are accorded dissenting shareholder appraisal rights. in this case. Napalm. Dissenting Shareholder Appraisal Rights 29.. Also. Lexis 8284 (D. The court issued an injunction preventing the sale of the subsidiary until it was approved by a majority of the outstanding shareholders. which was often dropped from airplanes. Securities and Exchange Commission. 432 F. This was because this subsidiary constituted over 50 percent of the assets. must be accorded dissenting shareholder appraisal rights regarding the sale of Plant National (Quebec) Ltd. Merger 29. 1970). App. 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. required before the sale of this subsidiary could take place. Therefore. Yes. Lexis 449 (Del. Yes. 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. concerns a policy issue and not the day-to-day operations of the corporation. This is defined as a sale of assets that is quantitatively vital to the operation of the corporation and is out of the ordinary.

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. 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.S. the actions of Fruehauf’s management violated the business judgment rule. .476 Chapter 29 the vote of shareholders. This was fraudulent because it was below the fair market value of the stock. 1981). 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. 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. Curtiss-Wright Corporation. the stock option was fraudulent in that it gave U. Tender Offer 29.6 billion. he tendered his shares for the merger and received payment for his shares. This was really a payment by competing management-led MBO to Merrill Lynch out of the corporate treasury. Yes. which was currently around $125 per share. and (3) make a written demand for payment of his shares. 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. Steel violated Section 14(e) of the Williams Act.2d 840. and manipulative practices in connection with tender offers. Failure to comply with these statutory procedures results in loss of appraisal rights. Bershad v. No other suitor. Marathon Oil Company. 3. particularly Mobil. The business judgment rule requires management of a company to act in good faith and in the best interests of the corporation’s shareholders. The court held that since Bershad did not meet the statutory procedure. Lexis 14958 (6th Cir. the Yates Field option which gave U. The court held that both the stock option and Yates Field option granted by Marathon to U. 669 F. was given this same right.S.8.S. and he failed to make a written demand for payment of his shares. Steel the irrevocable right to purchase Marathon’s interest in Yates Field for $2. App. The court held that both the stock option and Yates Field option that Marathon granted to U.7. Lexis 1313 (Del. Tender Offer 29. Steel the right to purchase 30 million shares of Marathon common stock for $90 per share. deceptive.S. First. and manipulative practice in violation of Section 14(e). Steel’s purchase of Marathon. The court ordered that U. Second. The “no shop” agreement violated Fruehauf management’s responsibility to shareholders to find the best and highest price for their shares. he did not qualify to bring an action to recover dissenting shareholder appraisal rights or any other remedy. Mobil Corporation wins.2d 366. This stock option violated Section 14(e) because it subsidized U. Note: U. This was because the fair market value of Marathon’s interest in the Yates Field was worth up to $3. U. 1987). Steel was a fraudulent. Section 14(e) prohibits fraudulent.S.S. Management must not put their personal interests before those of the company’s shareholders. 535 A. (2) not vote in favor of the proposed merger. Mobil Corporation v.S. the court held that the management and directors of Fruehauf violated the business rule in the following respects: 1. The court held that Marathon Oil Company had violated Section 14(e) of the Williams Act. deceptive. 2. Bershad failed to comply with the statutory requirements. In this case. In this case. He failed to make a written objection to the merger prior to the vote of shareholders. 1987 Del. Steel acquired Marathon Oil through a tender offer and follow-up merger.S.8 billion if a third party gained control of Marathon violated Section 14(e).

S. at the time of the merger.2d 882. Constitution. The court also held that the Plan was reasonable because it was not absolute. Wisconsin has done no more than that in this case. and regulate their internal affairs. 1637 (1987). under the pressure of a takeover bid. The court in the present case held that the Williams Act regulates the process of tender offers. 500 A. and such. 1986). 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. the court held that the proxy contest was for control of Household. 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. wins.10. violated their fiduciary duty to the shareholders.2d 496. 107 S. 1989 U. App. Lexis 557 (Del. Granting such lucrative “golden parachutes” to themselves. 798 F.S. In addition. The fair value of minority shareholders’ shares of Universal Pictures Company is $92. It is an accepted part of the business landscape in this country for states to create corporations. prescribe their powers. 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. IV: Answers to Ethics Cases 29.. timing. Supreme Court in upholding a state antitakeover statute in CTS Corporation v. Poison Pill Defense 29. Lexis 27911 (6th Cir. Further. the court held that Household demonstrated that the Rights Plan was reasonable in relation to the threat posed. Constitution. Household International. 1989).S.S. The court held that the “flip-over” Rights Plan adopted by the directors of Household did not violate the business judgment rule. 877 F. Their Universal is described as a company ideally situated to profit from both a rejuvenated theatrical market and the . 69. Inc. Fruehauf Corporation. Universal Foods. None of these provisions are violated by the Wisconsin act. Defendant claims that Universal. Household International. 1985). App.9. proration.S.2d 1346.75 per share.36. 481 U. which would be triggered by their own bid for the company and used as their equity investment to purchase the company. was a weak wasting asset in a declining industry and calculated the fair value of its shares at that time as $52. disclosures. The Court of Appeals reached this decision by applying the reasoning used by the U. That is.Corporate Acquisitions and Multinational Corporations 477 4. Ct. The court also held that the Wisconsin act does not unduly burden interstate commerce. Lexis 9024 (7th Cir. Amanda Acquisition Corporation v. The dissenting shareholders describe a different view of the corporation.. The court held that the Wisconsin antitakeover statute did not conflict with the Williams Act or violate the Commerce Clause of the U. 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. Moran v. management will fail to exercise reasonable judgment. 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.. Edelman v. 1986 U. State Antitakeover Statute 29. the court held that such preplanning for the contingency of hostile takeover reduces the risk that.S. Inc. 1985 Del. best price rule. Dynamics Corporation of America.e. i. it does not alter any of the procedures governed by federal regulation.11. The court enjoined Fruehauf management from instituting their actions.

60/share. Francis I. v. Citation. 1973). and “B” without voting rights. Answer to “Briefing the Case” Writing Assignment: 1. but differed substantially regarding the underlying assumptions related to the valuations.. Universal City Studios. Drummond. V. Court’s Reasoning A. E. ABC had issued two classes of stock: “A” with voting rights. Realist is not liable to Royal. Both sides presented their respective appraisals. v. 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. Holding The valuation preferred by the minority shareholders most closely approximated the fair market value on August 13.2d 1056. Minority shareholders of ABC were offered a price of $75. Inc. 29. Inc. B. was engaged in coal mining and related businesses in the 1970s and 1980s. Inc. in retrospect. 5. The defendant (ABC). and Court Neal v.76. 1991 U. Du Pont & Co. Ch. App. Realist.478 Chapter 29 emerging new highly profitable television market in which it has established itself. D. Alabama By-Products Corp. they would rather not have entered. . 1985? 4. 1990 Del. Ch. 8282. Lexis 127 (1990) Court of Chancery of Delaware 2.. made several attempts to acquire and merge with ABC starting in 1977 and culminating with a merger in 1985. an Alabama corporation. The court stated. a Delaware corporation.” Royal Business Group.S. 1991). The court revised the figure to $92. “The only injury the plaintiffs suffered was caused by their involvement as combatants in an election they won—but one where. 312 A. that is. The appraiser agreed with the stockholders. 3. Case Name. Lexis 10389 (1st Cir.2d 344. Key Facts A. which of the two appraisals most fairly represents fair market value on August 13. 262 of Title 8 of the Delaware Code. Ch.12. 933 F. The court also found no causal nexus between Royal’s alleged injury and Realist’s secret merger negotiations with Ammann. C. Issue Under Delaware laws regarding corporate valuation methods.75. Both sides used appropriate valuation techniques. B. Both sides agreed on the use of the discounted future returns model and a net asset model. No. to protect normal shareholders from fraudulent conduct. and they claimed that value was too low and sought to assert their appraisal rights under Sec. he refused to give the benefit of all inferences as to the specific value factors they maintained and arrived at a value of $91. a proxy contestant does not have this same right even though the contestant is a shareholder in the target corporation. 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). 1973 Del. However. 1985. Lexis 123 (Del.

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

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.S. .Rul.S.C. The I. laws in the U. They would not only be familiar to overseas investors who were already comfortable with the limited liability company. subsequently adopted the “check-the-box” and the rest is history. 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.360). As such. law. the specter of double taxation on corporations held back the implementation of limited liability companies. In 1977. For example. Traditional interpretations of state laws allowing for limited liability focused on corporate laws. This was the first of many rulings on similar statutes adopted by virtually all states. jurisprudence from adopting this form of business for so many years? In a word: taxes.R. 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.C. and in 1978.L. then.480 Chapter 30 Chapter 30 Limited Liability Companies and Limited Liability Partnerships How Can We Get The Best Of Both Worlds? I. that kept U. More specifically.88-76. a number of states decided to create new forms of business entities. Various forms of limited liability companies have been used in other parts of the world for many years. et al. 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. Wyoming passed its L. With increasing pressures to attract more overseas capital and investment into the United States. 1988-2 C. issued its Revenue Ruling (Rev.R.L.L. the I. and its enabling statute is “only” a century old.S.S. the possibility for legitimate tax structure avoidance was severely limited to the rules and regulations covering “Sub-S” corporations. Wyoming was the first to venture forth in heralding the modern era of L. Germany is considered to be the latest country to add this form of doing business. What is it.C.B.

in effect. but it surely has come a long way in a generation. As with any major turn in the process of legal evolution. and tax planning. business entity choices are strategic decisions based on a number of factors. As we have seen in earlier chapters. These elements include choosing the best options for potential capital investment and financing growth.S.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. 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. 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. protection from personal liability. the demand for a uniform statute was not unexpected. and corporate law into a format that allows for uniformity and predictability on these issues throughout the U. II. No one entity format is ideal for all objectives. Text Materials . This act. partnership. we are witnessing a work in progress. The final product is far from complete. However. seeks to “marry” the best elements of agency.

482 Chapter 30 Landmark Laws: .

claiming the facility would be a nuisance. to construct and operate a propane gas bulk storage and distributing facility. v. a limited liability company organized in North Carolina. as a member of the LLC. NC. Roscoe purchased two acres of land near Apex. Soskin Facts: Nashville Pro Hockey LLC was a limited liability company in Tennessee that owned and operated the Nashville Nighthawks. LLC. 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. Local residents sued Roscoe. Bone sued to recover the attorney’s fees he spent to defend the lawsuit. Bone was a member of Roscoe. LLC. The residents lost. That use was permitted under Apex’s zoning regulations.Limited Liability Companies and Limited Liability Partnerships 483 The Court Speaks: Page v. and dropped the lawsuit. The Court Speaks: Creative Resource Management. Inc. 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. Nashville Pro Hockey contracted with Creative Resource . Reason: Bone. Roscoe. Facts: Dale C.

Issue: Did Soskin’s signature on the contract constitute a personal guarantee for the payment of the debt of Nashville Pro Hockey.000. Soskin defended. CRM sued Nashville Pro Hockey and Barry Soskin. The contract was signed by Barry Soskin. Reason: Soskin was a guarantor and was liable to repay the money owed to CRM by Nashville Pro Hockey.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 .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. LLC. The trial court agreed. owing CRM about $30. LLC. Nashville Pro Hockey failed. . president.484 Chapter 30 Management to provide employee leasing services to 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. . to CRM? Decision: Yes.

Limited Liability Companies and Limited Liability Partnerships 485 .

486 Chapter 30 .

and David Geffen.Limited Liability Companies and Limited Liability Partnerships 487 . Dreamworks SKG. formed by Steven Spielberg. . 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. Jeffrey Katzenberg.

2) Partners are personally liable. . 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. 3) Limited partners cannot manage.

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: .Unanimous vote prior to expiration .492 Chapter 30 Wrongful disassociation can give rise to damages.Majority vote at will LLC .

They cover various issues involving limited liability companies. Also.com/cheeseman) as some of these fictional ethics issues become real and are decided by the courts. Unlike the typical ethics cases in other chapters. lawyers. All would make great teaching tools for this chapter. They cover various issues dealing with limited liability companies. it is important for you to check the Web site for this text (http://www. They are great teaching tools for this chapter. Answers to Critical Thinking Cases In this section. it is important for you to check the Web site for this text (http://www.prenhall. . IV.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.com/cheeseman) as some of these fictional issues become real and are decided by the courts. International Law: Limited Liability Companies in Foreign Countries Forms of limited liability companies have been in use in foreign countries for a long time. Also. Answers to Business Ethics Cases In this section. Professor Cheeseman has developed 10 critical thinking case scenarios. III. Unlike the typical critical thinking cases in other chapters. these cases are all fictional. and other professionals to offer their services under an umbrella of limited liability.prenhall. Professor Cheeseman has developed two ethics case scenarios. these cases are all fictional.

I. which shielded them from personally liability. Westec appealed. The lower court’s holding was reversed. Because of this failure of status notification.L.C. 3. Westec was approached by Larry Clark and Donald Landham.’s L. dba Westec v. Holding No. F. E. B.. E. Key Facts A.C. help to perpetrate fraud and misrepresentation against creditors. To allow limited liability here would. . Based on an oral contract between Westec and Clark & Landham. Clark and Lanham defended on the grounds that they were acting on behalf of an L. The Colorado Supreme Court that Clark and Lanham were personally liable for this debt. In this case. C. D. were Clark and Lanham shielded from personal liability for the debt claimed by Westec? 4. 2d 997 (1998) Supreme Court of Colorado 2.I. Court’s Reasoning The Colorado Supreme Court held that: A. Issue Under the Colorado Limited Liability Company Act of 1997. C. Inc. D. Waste & Land. Westec provided services valued at $9.L. Lanham 955 P. Westec was not properly notified of the existence of P.494 Chapter 30 V. Answer to “Briefing the Case” Writing Assignment: 1.I. Westec is in the business of providing land development engineering.I. The Colorado Limited Liability Company Act of 1997 was intended to provide limited liability to members of L. B. 5. the agents of the L. The lower court held in favor of Clark and Lanham.183. and Court Water. The services were not paid for and Westec sued Clark and Lanham individually for the amounts due. in fact.C. organized under the laws of Colorado.C. managers and members of Preferred Income Investors.L. Case Name.40 to P.s where proper notice of the existence of the entity status is given. status.C. Citation. (Clark and Lanham) are therefore personally liable for the contract entered into with Westec. LLC.

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

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

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 made based on actual figures of an existing franchise .Projections based on hypothetical .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 .

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

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

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

McDonald’s Corp. . and to set cleanliness and quality control standards at its franchises. 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. The trial court awarded damages to all three victims. and Maureen Kincaid and Therese Dudek were assaulted by Logan. J. on November 29. 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. Reason: Sonenshire. 1979. 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. Laura Martin was shot and killed. The court found that because the franchisee made all inventory. employment. In the course of moving the crew into the refrigerator. and by obligating itself to inspect the restaurant to see that the required security measures were implemented. it was an independent contractor. Carlson. to follow up to determine that the security deficiencies at the Oak Forest franchise had been corrected. Therese Dudek. Therese Dudek. to protect its “7-Eleven” trademark from misuse by the franchisee. the agreement did not give Southland the right to control the day-to-day operations of its Costa Mesa franchise. On that evening. 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. Although the franchise agreement gave Southland the right to establish the hours of operation of its franchises. and Therese Dudek and Maureen Kincaid claimed damages for the negligent infliction of emotional distress. and McDonald’s Corporation appealed. The Court Speaks: Martin v. a sixwoman teenaged crew was working to clean up and close the restaurant. 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. to open the safe and get him money.504 Chapter 31 Issue: Was the Costa Mesa franchise an agent of Southland? Decision: The Costa Mesa franchise was an independent contractor. Laura Martin’s parents claimed damages from McDonald’s Corporation for the wrongful death of their daughter. and day-to-day operational decisions. Laura Martin. Facts: This case arose from a murder and robbery that took place after closing hours at the McDonald’s restaurant in Oak Forest. Reason: McNulty. J. Illinois.

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

Reason: A franchisee is always liable for its own tortious conduct. Holiday Inns is vicariously liable for the tortious conduct of its franchisee. and not independently owned businesses. 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. .506 Chapter 31 Decision: The franchisee was negligent. the court held that Holiday Inns led the public into believing that its franchisees were part of Holiday Inns’ system. A franchisor may be held liable for the tortious conduct of a franchisee that is the “apparent agent” of the franchisor. 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.

Franchises and Special Forms of Business 507 .

software.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. 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 . services.

Laws of other countries must.S.. International Law: Starbucks U. .Chinese International Joint Venture Due to government restrictions in some countries and lack of expertise or cultural knowledge. In a joint venture corporation the joint venturers are shareholders of the joint venture corporation.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. Starbucks used joint ventures to enter foreign markets. be considered. Chinese hurdles as well as examples are also discussed. however. each joint venturer is liable for the debts and obligations of the joint venture partnership. Internet & Technology: Strategic Internet Alliances in China This discusses Internet alliances in the China market. International Law: International Franchising There is no question that international franchising has become the most visible form of economic cooperation around the world.

H & R Block wins. it is undisputed that the new franchise is located to the west of that boundary. 1984 Ind.2. App. . Franchisor Disclosure 31.. Block preserved the value of this property right to itself alone after termination of the agreement. and had failed to provide proper disclosures to Dowmont as required by the act.E.” 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. because My Pie had failed to register with the state of Illinois or to qualify for an exemption from registration. McCart v. v. Second. McDonald’s is not liable for breaching the franchise agreement with Libby-Broadway Drive-In.App. First. Answers to Critical Thinking Cases Franchise Agreement 31.E. Lexis 3039 (Ind. and that customers were attracted to the franchise office because of the company’s name recognition and goodwill. the court held that the covenant not to compete was reasonable in scope (tax preparation). McDonald’s System. time (for two years after termination of the franchise). 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.App. 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. the franchisee.1.. 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 the McCarts had violated the covenant not to compete and issued an injunction enforcing provisions of the covenant. 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. he was still bound by its terms. No. Therefore. wins on its counterclaim against My Pie International. the franchise agreement granted Libby an exclusive territory in which the westernmost boundary was simply described as “Turney Road. Franchise Agreement 31. Illinois. (My Pie). Dowmont. App.3. 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.2d 756. 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. Inc. 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. Inc. which was heavily advertised nationally. The court of appeals remanded the case to the trial court for determination of the royalty damages to be awarded to Dowmont. the court determined that although Robert had not signed the franchise agreement. (Libby). 1984). The court held that McDonald’s had not breached the franchise agreement.510 Chapter 31 III.2d 1. 1979 Ill. the granting of this franchise did not infringe upon the exclusive territory granted to Libby in the franchise agreement. 391 N. Inc. Inc. Inc. By including the covenant not to compete in its franchise agreements. and place (250 miles from the location of the franchise). 470 N. and affirmed the trial court’s grant of summary judgment in favor of McDonald’s. 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. The court found that H & R Block had a valuable property right in its service mark. Libby-Broadway Drive-In. Lexis 2698 (Ill. 1979).

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

165 in trademark infringement damages. Termination of a Franchise 31. Lexis 1442 (Ill. The court held that Gadsden Motel Company (Gadsden) had infringed on Ramada Inns’ trademarks and service marks by its unauthorized use of such marks. Answers to Business Ethics Cases 31. Kawasaki was wrongfully using the site-control provision to violate the multiline dealership provision in the franchise agreement.2d 457. Inc. $15. Gadsden lost the right to use the Ramada Inn trademarks and service marks. The court held that a multiline franchise dealership was expressly permitted by the franchise agreement. The court of appeals affirmed the trial court’s judgment which awarded Ramada Inns $47. and set their wages. The court found that Kawasaki USA had wrongfully terminated the franchise held by Kawasaki Shop of Aurora (Dealer). KFC should win. The issue of agency is a matter of fact. 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. Therefore.512 Chapter 31 Trademark 31. Evidence showed.7. Only Campbell managed the day-to-day activities of the store: she hired and fired employees. the franchisee.” but this is simply an identification of the licensee as a franchisee of Southland.App. IV. 549 F. U.S.6. 1977 U. 544 N. App.E. and $20.8. 1977). that Gadsden continued to use the “Ramada Inns” marks for at least six months past that date. 804 F. Trademark 31.690 as compensatory damages and $79. v. Kawasaki Motors Corporation.2d 368.2d 1562.422 in attorney fees. Ramada Inns. Kawasaki Shop of Aurora. Here. Lexis 14128 (5th Cir. the court held that Kawasaki USA had wrongfully terminated the Dealer and awarded the Dealer $323. and Yamaha motorcycles as well as Kawasaki motorcycles. the court found that Gadsden had engaged in trademark infringement in violation of the Lanham Act.610 in lost franchise fees for the six-month “hold over” period. v. 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. a license to use the “Ramada Inns” marks during the course of the franchise.A. 1989 Ill. Campbell was not an agent of Southland.S. Ramada Inns wins. Suzuki. 1989). Diversified Container Corporation.000 in attorney fees. $29. However.S. Based on the evidence. The franchise agreement granted Gadsden. The only evidence of agency is the fact that the liquor license was issued to “Campbell Valerie Southland #13974.9. and the contract provided that the relationship was one of independent contractor. The dealership wins. The license was not issued to Campbell and Southland. Diversified infringed upon and tarnished KFC’s trademark Kentucky Fried Chicken Corporation v. 1983.. 1986). Illinois franchise law provides that a franchise agreement may not impose “unreasonable” restrictions on motor vehicle dealers.000 for advertising to restore Ramada Inns’ good reputation. however. Thus. Gadsden Motel Company. App. when Ramada Inns properly terminated the franchise agreement with Gadsden on November 17. App Lexis 34279 (11th Cir. Inc. 1986 U.

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

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

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. All in all. the sale of stocks in corporations remained essentially unregulated except for the common law doctrines of fraud and the like. it has made the specialized practice of securities law or SEC accounting more difficult. 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. Because of recent scandals in this sector of the economy. These laws are not designed to assure a win in this high-risk game. and anyone who fails to appreciate that simple fact should not be there in the first place.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. Prior to that period. Text Materials Purpose of Securities Laws Information Disclosure Prevention of Fraud SEC (Federal) . Over the years. 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. Risk is inherent in the nature of this activity. 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. yet more challenging. but rather to provide a more even playing field. II. 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. Securities law was designed to at least give some substance to those hopes and prayers. than ever. It is most difficult for professionals to master the ins and outs of the financial markets. a number of new white-collar crimes have been added to the government’s arsenal for dealing with abuses. That substance is public information upon which investment choices can be rationally made.

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

Prospectus disclosure given to prospective purchasers .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.

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. . Summ.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. the Securities Investor Protection Corporation insures the securities. . 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.

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

524 Chapter 32 .

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

those shares went to $60. 1964. which was after the press conference. 1963.526 Chapter 32 The Court Speaks: Securities and Exchange Commission v. No. . an employee. so it kept the results secret while it tried to purchase as much surrounding land as possible. Coates traded on inside information. The material nonpublic information did not become public until 10:00 am on April 16. two newspapers printed unauthorized reports of the TGS drilling. until the news could have reasonably been expected to appear on the Dow Jones broad tape. Each option gave O’Hagan the right to purchase 100 shares. Kidd 55. Eventually. it closed at $29 3/8.000 shares at $39 per share. O’Hagan lost. On Saturday. Texas Gulf Sulphur Co. and other employees of TGS bought stock during this period. an employee. beat the public by trading on insider information. However. SEC appeals. The Supreme Court Speaks: United States v. Grand Metropolitan hired Dorsey and Whitney to represent it in a secret tender offer for stock of Pillsbury. Issue: Were the individuals guilty of insider trading? Was TGS itself guilty of issuing a misleading press release on April 13. (3) Coates. a partner in the law firm of Dorsey & Whitney. in Canada. On April 15. 1964. (5) The trial court did not determine whether TGS had issued a misleading press release on April 13. Texas Gulf Sulphur Co. at 10:00 am. The court held that Kline had a duty to disclose this to the board. the stock was selling at $58 1/4. TGS stock was trading at $17 3/8. In the meantime. Kline. (2) Crawford. On April 16. as to individuals. and did. (TGS) drilled an exploratory hole. By May 15. at least. The SEC investigated. so Crawford intended to. When the tender offer was publicly announced. O’Hagan Facts: James O’Hagan. 1964. TGS held a press conference that lasted for 10 minutes. 1964. Note: Misappropriation Theory usually involves an outsider misappropriating information in violation of a fiduciary duty. Several officers. the press conference was just the first step in the process of publicly disseminating this nonpublic information. 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. telephoned his broker with orders to buy TGS stock at midnight on April 15. Hagan had purchased 5. Issue: Can a defendant be criminally convicted of violating Section 10(b) and Rule 10b-5 based on misappropriation theory? Decision: Yes. in violation of Section 10(b)? Decision: Yes. On Monday. Facts: On Nov. 12. an employee. began purchasing call options for Pillsbury stock. so the issue was remanded back to the trial court to make that determination. as to TGS. 1964. (4) On Feb. rumors of the rich strike surfaced. 20. The SEC brought actions against several defendants for insider trading. In early November 1963. and again at 8:30 am on April 16. and the Justice Department charged O’Hagan with criminally violating Section 10(b) and Rule 10b-5. placed his order to buy TGS stock at 10:20 am on the April 16. The appeals court could not definitely come to that conclusion either. Kline also traded on inside information. Thus. April 13. 1964. TGS did not own all the land surrounding Kidd 55. The district court found one individual liable and dismissed complaints as to the rest. Assay reports indicated this sample to be remarkably high in certain metals. TGS issued a press release that tended to downplay the find. Reason: (1) The court first held that the Kidd 55 discovery was material information. in which they disclosed the richness of the Kidd 55 drilling. April 11. directors. Coates had to wait.

The next morning Nvidia’s VP sent an e-mail to keep the news quiet. 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. Bhagat.Investor Protection and Online Securities Transactions 527 Reason: The misappropriation theory comports with Section 10(b)’s language. Issue: Is Bhagat guilty of insider trading and tipping? Decision: Yes. Gill. . 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.” The Nvidia president and CEO sent e-mails with an announcement of the deal to all employees. Bhagat was charged with insider trading and tipping. Bhagat appealed from a guilty finding. Reason: Evidence was sufficient to infer guilt from Bhagat’s actions on both counts as noted in the facts above. Judgment was affirmed. 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. Bhagat Facts: Nvidia entered into a contract with MICROSOFT FOR A 3-D graphics processor to be used by Microsoft in the “X-Box. The jury was asked to infer Bhagat’s actions 9no direct evidence) from circumstantial evidence. a friend did the same less than 30 minutes later and 10 minutes before Bhagat said he read the e-mails. and it was property applied in this case. The Court speaks: USA v. a Nvidia engineer. Trading blackouts by Nvidia employees were imposed in other e-mail.

528 Chapter 32 .

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

to qualify for the exemption.S. Because of this fact. Securities and Exchange Commission v.Supp.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. 1973). and (4) there was no risk-reducing factor that would make the application of the Securities Acts unnecessary.” In order for the defendant. The only difficult issue was whether the Dare plan derived profits for the investors from the efforts of others.2. thus subjecting the Co-Op’s auditor. (3) the public reasonably perceived from advertisements for the sale of the notes that they were investments. 343.S. The company met most of the requirements for an intrastate offering exemption. The court held although investors must exert some effort—mainly convincing friends. (2) its principal place of business was in Minnesota. The Supreme Court stated that this definition should be broadly and flexibility construed. 343 F. The court applied the Howey test in the instant case and held that the Dare multilevel sales scheme was an investment contract.3. 1990 U.. Glenn W.e. Ernst & Young. Note: Investors who purchased the securities could also rescind their purchase agreement. Definition of a Security 32. Securities and Exchange Commission v. the notes are securities that are subject to federal securities laws. Inc. 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. There was obviously an investment of money in a common enterprise. 1972). it was incorporated in Minnesota.e. The notes issued by the Co-Op are “securities. i. to be subject to federal securities laws in this case. to a securities lawsuit. 1972 U.Minn. Ernst & Young. The court held that the word “solely” should not be read literally. 110 S. No. i.S. 1973 U. the entire proceeds from the securities issue were invested in loans on real estate and other assets located outside the state of Minnesota. 495 U. However. The Court reasoned that the notes were securities because (1) the Co-Op sold them to raise capital.S. Lexis 11903 (9th Cir.Ct. . (2) there was common trading in the notes. Supreme Court found the note issued by the Co-Op to be a security. at least 80 percent of the proceeds from the offering must be invested in the state. and others to attend the Adventure Meetings—primarily their profits came from the efforts of others. such as (1) the company was a resident of Minnesota.S. Intrastate Offering Exemption 32. Ernst & Young. 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. Here. The U.. Reeves v. Lexis 1051 (1990). (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. McDonald Investment Company. The Supreme Court applied a “family resemblance test” in finding the note a security. 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. 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. neighbors. Note: previous purchasers could sue to rescind the purchase agreement and recover the money they paid. 945.2d 476. the issue of securities by McDonald Investment Company (McDonald) does not qualify for the intrastate offering exemption from registration. Turner Enterprises. 474 F. and (4) the purchasers of the securities were all residents of the state. Lexis 13547 (D.. Thus. Dist. the instrument at issue must be found to be a security.

Chiarella v. 100 S.2d 779. 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. 405 F. obviously. a complete stranger who dealt with the sellers only through impersonal market transactions. 1980 U. United States.5.S. 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. The defendants had asserted that the common-law defense of in pari delicto (“unclean hands”) prohibited the plaintiffs from suing because they had . 1968 U. The court held that Wolfson and his family and associates should have registered the securities with the SEC.” The Court held that an issuer includes any person who directly or indirectly controls the issuer. and he was not a person in whom the sellers had placed their trust and confidence. He was its largest shareholder. underwriter. Wolfson controlled Continental. Supreme Court rejected this rule. and controlled and directed the company’s officers. The U.4. 1968). The Supreme Court held that Chiarella did not owe a fiduciary duty to the target companies of whose shares he purchased. He was not their agent. Wolfson. The court. Chiarella is not criminally liable for violating Section 10(b) of the Securities Exchange Act of 1934. made the policy decisions for the corporation. United States v. Note: On the witness stand. 445 U. 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. No. App.S.S. and that they had violated Section 5 of the Securities Act of 1933 because they had not registered the securities. No. 222. or dealer. he was not a fiduciary. Lexis 88 (1980). The court stated: Not every instance of financial unfairness constitutes fraudulent activity under Section 10(b). The U. in fact. The plaintiff investors win and may sue the defendants for the alleged violations of Section 10(b) of the Securities Exchange Act of 1934.6. Section 10(b) 32. holding that a person is not liable for insider trading under Section 10(b) unless he owes a duty to disclose the information. The U. 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 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. 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. We hold that a duty to disclose under Section 10(b) does not arise from the mere possession of nonpublic market information. 1108. Supreme Court reversed Chiarella’s conviction. In this case. 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. 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. Supreme Court reversed the trial court’s judgment that had convicted Chiarella on all counts.S. He was. rejected this defense. Lexis 4342 (2nd Cir.S. Insider Trading 32.Investor Protection and Online Securities Transactions 531 Transaction Exemption 32.S.Ct. The element required making silence fraudulent—a duty to disclose—is absent in this case.

Insider Trading 32.7. and (3) disclosure of material financial and other information must be made to the investors.Ill. The Sullair Corporation (Sullair) wins and. .350) and the fair market value of the 6. The court held that the corporation could recover $11. To qualify for a private placement offering. Inc. 105 S.S. Berner. Bateman Eichler.350 from Hoodes—the difference between the price he sold the original 6. they cannot use the court system to sue the other party to the illegal conduct. 1982 ($38. (2) there is no limit on the number of accredited investors. if two parties to illegal conduct are mutually or equally at fault. 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. 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. the following requirements must be met: (1) there is no dollar limit on the amount of securities sold. The U. 1982 ($27. 472 U.S. 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).532 Chapter 32 participated in the fraud with the defendants. The court found that Hoodes. 337. 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. Hill Richards. 1985 U. Sullair Corporation v. Lexis 10152 (N. 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. The issue in the instant case is whether the in pari delicto theory should be applied to securities laws. each of the limited partnership offerings does not alone qualify for a private placement offering exemption from registration.8. 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. No.S. under Section 16(b) of the Securities Exchange Act of 1934. IV: Answers to Ethics Questions 32. Under the in pari delicto theory. (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. but there is a limit of 35 unaccredited investors. Lexis 95 (1985). 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.Ct. the plaintiffs thought they were trading on “inside information” when they purchased the TONM securities. Supreme Court held that the in pari delicto theory does not apply to actions brought for alleged violations of securities laws. Thus.S. v. 299. the court held that (1) Intertie had not kept track of the qualifications or the number of unaccredited investors.000). was a statutory insider for purposes of Section 16(b).000 shares for on July 20. 1987 U.D. 672 F. Hoodes. In applying these requirements to the instant case.. may recover the profits made by Hoodes on the sale and purchase of the securities of Sullair securities.e. Dist. who was an officer of Sullair. 2622. i.000 shares he purchased on August 20. 1987).Supp.

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

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

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

536 Chapter 33 .

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

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

Material eventually did not renew Discon’s contract and hired AT&T instead. Facts: NYNEX owns NY Telephone (NYT) and Material (purchases services for removing old NYT equipment). 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. the administrators of eight Ivy League schools traded information about applicants seeking scholarships. Discon appealed. Most group boycotts are per se . 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. Inc.Antitrust Law 539 The Supreme Court speaks: NYNEX Corp. v. Discon. 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. Material did this through Discon an independent company. The court of appeals affirmed the district court’s dismissal of the complaint. This was not a violation. Discon sued alleging an illegal group boycott against Discon. Ethics Spotlight: Justice Department Flunks the Ivy League Schools For years.

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

Herald Co. 220 U.S. the Court noted that a previous Supreme Court had previously—in Albrecht v. 373 (1911)—that the setting of minimum resale prices was a per se violation of Section 1 of the Sherman Act. 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.and anticompetitive effects—would now be used to examine the lawfulness of maximum vertical price fixing. 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. but if the price charged was higher than State Oil’s “suggested retail price. Khan operated the station under these terms for about one year.e. The Court acknowledged that this was still a valid decision..” The Supreme Court announced that the Rule of Reason—a balancing of pro. Reason: The Supreme Court noted that the Court held. . and may in fact have procompetitive interbrand (i. 145 (1968)—held that the setting of maximum resale prices also was a per se violation of Section 1. Park & Sons Co. The agreement provided that Khan would obtain his station’s gasoline supply from State Oil.” then the excess was to be rebated to State Oil.. and then lost the station back to State Oil for falling behind in lease payments. The agreement also provided that Khan could charge any price for the gasoline he sold to the station’s customers.S. 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. the Supreme Court reversed Albrecht. in the instant case. In the instant case. however.Antitrust Law 541 The Supreme Court Speaks: State Oil Company v. Khan Facts: Barkat U. The district court entered summary judgment for State Oil. The U. John D. 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. The current Supreme Court. Miles Medical Co. “There is insufficient economic justification for per se invalidation of vertical maximum price fixing. Khan sued State Oil.S. State Oil appealed to the U. The court of appeals reversed and held that the maximum resale price set by State Oil was a per se violation of Section 1. with competing companies) effects that helps rather than harms consumers. However. Supreme Court. The court concluded. alleging that the maximum resale price required by State Oil was a per se violation of Section 1 of the Sherman Act. 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. in a previous decision—Dr..S. Khan could sell gasoline for less than State Oil’s suggest retail price. v. 390 U.

Contemporary Issue: How Trade Association Members Can Avoid Antitrust Liability This suggests activities to avoid if you want to avoid antitrust liability. ILEC’s and CLECs battled over which network elements the ILECs had to share with the CLECs. The Supreme Court remanded the current case for trial using the new Rule of Reason standard. Twombly sued (a class action suit) Bell Atlantic and other ILECs alleging parallel conduct that inhibited the growth of new CLECs. The complaint was dismissed by . 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.542 Chapter 33 Minimum resale price fixing would still be per se illegal. however. CLECs 9local carriers0 developed which purchased wholesale services from ILECs and sold them to competitors of ILEC”s. ILECs chose not to compete as a CLEC in other ILECs’ territory. 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. There was no way to infer such an agreement to support illegal conduct. Parallel steps are not an agreement. Reason: Conscious parallelism is not in itself unlawful only if it were part of some type of agreement.Antitrust Law 543 the district court which held that the allegations of conscious parallelism was not a conspiracy. The court of appeals reversed and the defendants appealed. . The judgment was reversed and the complaint dismissed with the case remanded. 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.

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

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

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

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 .

the Medical Society..e. The defendants argued that Section 1 only prohibited the fixing of minimum prices and did not prohibit the fixing of maximum prices. III. 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. 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. 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. The U. no defenses may be raised to try to justify the price fixing. i. once price fixing is found.S. Foundation.552 Chapter 33 Examples: Statutory unions. The State of Arizona wins. and its members. The court reaffirmed that all .1. Answers to Critical Thinking Cases Price Fixing 33. Supreme Court held that the defendants. engaged in price fixing in violation of Section 1 of the Sherman Act.

Union Oil terminated Simpson when he sold gasoline to the public at less than the retail price set by Union Oil. The U. is judged by the per se rule and not the rule of reason. 332. 596. 1987). Metrix Warehouse v.S. Simpson. Supreme Court held that Union Oil Company (Union Oil) had engaged in resale price maintenance. Inc. in this case the court did not find the tie to rise to this level of unlawfulness. Union Oil had set the price at which Simpson and other franchised service station dealers could sell Union Oil gasoline and other products. 2466. Mercedes-Benz of North America. .Ct. whether the setting of minimum or maximum prices. Lexis 5 (1982). (Metrix) wins. Lexis 12341 (4th Cir.2d 1033. Resale Price Maintenance 33. which in this case constituted unreasonable restraint of trade in violation of Section 1 of the Sherman Act. Inc.2.S. App. United States v. The Supreme Court held that the per se rule. the franchised dealer. and not the rule of reason. The court concluded that the anticompetitive aspects outweighed the procompetitive aspects.. 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 Topco members’ geographical division of markets was an unreasonable restraint of trade and a per se violation of Section 1 of the Sherman Act. Metrix Warehouse. The court stated that after considerable experience in examining these types of relationships. Maricopa County Medical Society.Antitrust Law 553 price fixing. The court found that there were less anticompetitive methods for assuring quality control. the Supreme Court refused to consider evidence of the procompetitive effects alleged by the doctors to justify their price fixing.3. 1126. The United States wins. wins. 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. 92 S. Therefore. 1982 U.4.S. Applying the rule of reason.S. 405 U. 1987 U. the court held that the tying arrangement in this case was an unreasonable restraint of trade that violated Section 1 of the Sherman Act. applies to horizontal division of markets. The U.. 102 S. such as setting published quality control standards that must be met by all manufacturers of Mercedes-Benz replacement parts. it found that division of markets stifled competition. Tying Arrangement 33. In this case.S. 457 U. 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. Lexis 67 (1972). 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). Arizona v.S. the court applied the rule of reason and examined the procompetitive and anticompetitive nature of the tying arrangement.S. 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. they engaged in a geographical division of markets. 828 F. Instead. The court rejected MBNA’s claims that the tie was necessary as a device to regulate quality control. Although some tying arrangements are considered so anticompetitive as to be per se illegal. Resale price maintenance occurs when a manufacturer or distributor sets the price at which retailers may sell products to consumers. Topco Association. 1972 U. 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. In this case.Ct. Division of Markets 33. Inc.

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

. Price Discrimination 33. respondent Pueblo Bowl complains that by acquiring the failing bowling centers. were enacted for the protection of competition. The U. Bigelow. 726.S. Yes. 97 S. constituted indirect price discrimination.S. However. the plaintiff must have suffered an “antitrust injury. however. 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 37 (1977).S.Ct. Inc. Supreme Court held that in order for a defendant to be liable under Section 7.Patman Act. whereby every purchaser paid the freight charges from Chicago even if the glucose was shipped from Kansas City. 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. Supreme Court held that the “base-point pricing” system. Antitrust Injury 33. Corn Products engaged in price discrimination in violation of Section 2(a) of the Robinson.S. R. thereby depriving respondent of the benefits of increased competition. 429 U. The court found that Pueblo Bowl had not suffered antitrust injury from Brunswick’s repossession and operation of bowling centers.8. Pueblo Bowl-O-Mat.Ct.” The Supreme Court noted that any combination of two firms may cause some economic injury to competitors.. Brunswick is not liable to Pueblo Bowl for violating Section 7 of the Clayton Act. The Supreme Court reversed the judgment of the trial court that had awarded Pueblo Bowl $7 million in damages and $446. 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. The U. Lexis 2749 (1945). 1945 U.000 in attorneys’ fees. the court stated that this is not the type of injury that the antitrust laws were designed to prohibit. v. No. and upheld the trial court’s judgment against Corn Products. 690. This pricing scheme created a favorable zone around Chicago and vicinity. N. The Supreme Court held that Corn Products had engaged in “indirect” price discrimination in violation of Section 2(a) of the Robinson-Patman Act. 1989 U. Inc.2d 102. Corn Products Refining Company v. 477. 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. The damages respondent obtained from the judgment of the trial court would have been realized had competition been reduced. The antitrust laws.S. It is inimical to the purposes of these laws to award damages for the type of injury claimed here.Antitrust Law 555 enjoined. Federal Trade Commission.V. Brunswick Corporation v. not competitors. 324 U. 65 S. 1989). 1977 U. 961. petitioner Brunswick preserved competition. 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. The Supreme Court stated: At base. Unilever.S.S.. instead. 867 F. Lexis 574 (2nd Cir.C. App.7.

Hasbrouck was engaged in the retail sale of Texaco gasoline products in the Spokane. v. I. The court found that du Pont’s commanding position as a GM supplier was not achieved until after its sizable purchase of GM stock. 77 S. and Court Texaco v. 1282. a major consideration in purchasing that stock was to obtain this market. du Pont de Nemours & Co. The district court and court of appeals ruled in favor of Hasbrouck 3. C. granted substantial discounts from retail tank prices. but also from an increase lesser than that to other customers. Key Facts A. E. 33. Inc. rather than on a customer-by-customer basis.9.S. Hasbrouck claimed these discounts were given in violation of the Robinson-Patman Amendment to the Clayton Act.S. E. Inc. 1983 U. The lower price may come about not only from a reduction of price. Answer to “Briefing the Case” Writing Assignment: 1.S. Citation.” Du Pont was later ordered to sell its stock in GM. Holding Yes. or because of its acquisition of GM stock. B. 586. Lexis 148 (1983).Ct. The meeting the competition defense probably protects Falls City from liability for price discrimination. VI.. 460 U. Hasbrouck dba Rick’s Texaco 496 U. Vanco Beverage. “The inference is overwhelming that du Pont’s commanding position was promoted by its stock interest and was not gained solely on competitive merit. Issue Did the discounts granted to the two distributors between 1972 and 1981 constitute a violation of the Act? 4. At the same time. at what is known in the industry as retail tank prices. D. It purchased its gasoline directly from Texaco. The defendant must only show that its lower price was made in good faith to meet a competitor’s price. . 428.S.10. but the defendant must prove that this was a reasonable way to do it. 1957 U. 353 U. Case was remanded for proceedings consistent with this opinion. Texaco. 103 S. The court also found that the market affected is substantial. 543 (1990) United States Supreme Court 2.556 Chapter 33 IV: Answers to Ethics Cases 33. The court found that automotive finishes and fabrics are distinct enough to comprise a single line of commerce for relevant market purposes. Inc. The court generally reviews the meeting the competition defense. Falls City Industries. 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. Inc. Lexis 1755 (1957).Ct. 872. In fact. The price reduction may be made on a territorial basis.S. WA area between 1972 and 1981. United States v. Case Name. The issue is whether du Pont’s position as the leading supplier of finishes and fabrics to GM came about because of competition alone.

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

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

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

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.560 Chapter 34 II. . Text Materials Administrative law deals with the rules and regulations enforced by administrative agencies.

Consumer and Environmental Protection and Environmental Law 561 .

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

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

564 Chapter 34 .

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

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

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

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

Consumer and Environmental Protection and Environmental Law 569 .

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

” The two chief causes are over insulation with sealed windows and hazardous chemicals and construction materials. arguing that the EPA must consider the cost caused to trucking firms before issuing the air standards. 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 Trucking Assn. The American Trucking Assn. sued the EPA. Issue: Under Section 109 of the Federal Clean Air Act. but lost at the court of appeals level. Contemporary Issue: Indoor Air Pollution This discusses “sick building syndrome. . Reason: The EPA has the power to set standards that affect public health regardless of the cost to a particular industry. 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. won at the district court level.Consumer and Environmental Protection and Environmental Law 571 The Supreme Court Speaks: Whitman. Administrator of Environmental Protection Agency v.

800 in civil penalties and ordered a hearing to determine the amount of attorney’s fees to be awarded to FOE. Reason: Injured citizens are awarded redress by civil penalties. The case is remanded. The FOE appeals the reversal by the court of appeals. Facts: Laidlaw discharged wastes into the river from its hazardous waste facility in South Carolina which exceeded the mercury limits allowed. (FOE) v. This saved Laidlaw over $1 million. The DITGC of South Carolina sued but reached a settlement for $100.572 Chapter 34 The Court Speaks: Friends of the Earth.000 in penalties under the federal Clean Water Act. This is their purpose. Laidlaw argued the above settlement precluded this case. Issue: Does the settlement with the state make a civil-citizen lawsuit under the federal Act moot? Decision: No. . Laidlaw Environmental Services(TOC). Inc. Inc. The district court ordered Laidlaw to pay $405.

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

” 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 .

thus justifying the imposition of the 33 months of jail time. continuous. and repetitive discharge of pollutants into the environment. or abandoned. Recovery can be from generator. prior and current site owners.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 court stated: “There was absolutely no acceptance of responsibility in this case. 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. transporter. stored. . No remorse whatsoever was shown by Irby.

.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. Landmark Law: The Endangered Species Act This statute was enacted to protect endangered and threatened species of animals.

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

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

In the first stage. Lexis 15589 (2nd Cir.5.S. Congress enacted the act to prevent children from suffering injury or death by opening household products and inhaling. Lexis 12327 (E. Additional factors such as demographic shifts. and the energy requirements necessary to run the development were also considered. the Forest Service has a three-step process. and visual quality. occurred. the Forest Service prepares an Environmental Impact Statement (EIS).S. Last. range. The EIS prepared in this case evaluated five alternative levels of development that might be authorized for use of this land. construction. wildlife.). the FDA had to approve the use of any color additive in them. Next.N. In generating this report. an environmental impact statement is required. Zuckerman’s Pharmacy had violated the act when it dispensed the Wahba”s Lomotil Prescription in a regular plastic container.” In deciding whether to issue a permit to the ski resort developer.3.20 945. and wildlife and fish purposes. This Act requires manufacturers to provide “child proof” containers and packages for all household products. The on-site study considered the effect of each level of development on the water resources.. The French Bronze Tablets were a substance used both to alter the appearance of and to promote the attractiveness of the consumer. the exact type of tragedy that Congress was seeking to prevent. U. Supp. and Cosmetic Act of 1938. Because the tablets were a cosmetic. 539 F. Wahba wins since H & N Prescriptions Center and its subsidiary. ingesting. the Federal Drug Administration is empowered to regulate the composition of Cosmetics. there is a final approval of the master plan for the development. Cosmetics include substances and preparations for cleaning. When Zuckerman’s failed to comply with the PPPA. App. Drug Regulation 34. Inc. Off- . on-site impact and off-site impact. 888 F. Yes. the French Bronze Tablets violated the FDA and could be seized and condemned. and operation of the project. had violated the Poison Prevention Packaging . Wahba v. the Service selects a developer for the project. altering the appearance of. as well as land use and transportation. H & N Prescription Center. In general. air quality. or otherwise mishandling dangerous products.D. Dist. 1989). Because canthaxanthin had never been approved for use as a color additive in cosmetics. The court held that French Bronze Tablets were cosmetics within the definition of the FDA. The Act required that potentially dangerous drugs such as Lomotil be placed in a special “child proof” container. timber. Zuckerman’s Pharmacy.Y. including prescription drugs. The Forest Service is authorized by statute to manage the national forests for “outdoor recreation. 1989 U. this section of the report is divided into two categories.S.4. First. soil. The Color Additives Amendment to the FDA requires the approval of the FDA before color additives can be used in cosmetics. 352. Eight Unlabeled Cases of an Article of Cosmetic. the study also outlined certain steps that may be used to mitigate any adverse effects on the environment. An EIS provides the information required to evaluate the potential of the ski resort. economic market of skiing in the winter.580 Chapter 34 Cosmetics Regulation 34. and promoting the attractiveness of a person. 1982 U. the Forest Service examines the general environmental and financial feasibility of the project. Environmental Impact Statement 34. Drug. v. Under the Food. This ranged from not developing the property at all to creating the ski resort with sixteen ski lifts. watershed. in the final stage of review. The government wins the case and has the right to seize the French Bronze Tablets. vegetation. the accidental poisoning of a child.

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

.000 tons of carcinogenic waste into Lake Superior polluted the public water supplies in violation of its state discharge permit. The court held that the dumping of approximately 67. Ct.D. These are not sufficient reasons to prevent the reopening of the nuclear power plant. The court indicated that the renewed operation may well cause psychological health problems. Placing this burden on those handling hazardous waste materials makes it possible for the EPA to know who is handling hazardous waste. People against Nuclear Energy.582 Chapter 34 Clean Water Act 34.S. Hoflin. 1989).2d 1210. Sup. The United States prevails. United States v. and enforce compliance with the statute. In this case. The court stated that those individuals who handle hazardous waste are required to provide information to the EPA in order to secure permits. 694 F. Tex. Metropolitan Edison Co. App.S. Endangered Species 34. [United States v. Thus. this action would have jeopardized the survival of the woodpecker. Thus. 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.S. In reaching this outcome. Nuclear Waste 34.Supp..460 U. 1989 U. In the present case. Lexis 6503 (8th 1976)] Hazardous Waste 34. Ct. 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. tension. Dist.11. since Hoflin failed to inform the EPA of its disposal of the paint. Reserve Mining Co.S. By allowing the Forest Service to lease several national forests for lumbering in Texas. Lexis 10169 (9th Cir. he was liable for the dumping of hazardous waste. The Sierra Club is granted the injunction to prevent the Forest Service from leasing these national forests for lumbering. 1988 U. The United States prevails. 766. Although such problems include anxiety. 1260. Since Reserve Mining was in violation of their permit.12. 103 S. No such permit had been obtained by Hoflin. Sierra Club v.Lexis 21(U.S.10. monitor their activities. v.S. and fear. Thus. the court properly issued an injunction to protect the red-cockaded woodpecker from extinction in Texas. Lexis 9203 (E.9. 1990).1983 U. Lyng. the court relied on the evidence that the discharges were causing discoloration of the surface waters outside of the zone of discharge.). Secretary of Agriculture. 1976 U. 1556. the court held that the NRC does not need to consider allegations of People against Nuclear Energy (PANE). since the Forest Service’s management practices are similar to the monitoring of an endangered species. 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. Reserve was fined for each day that the violation occurred. 880 F. 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.2d 1033. 543 F. App.

FMC is being ordered to pay for clean-up under CFRCLA. Charles of the Ritz Distributing Corp. 34. 275 N.” Deceptive advertising also occurs where a seller makes an objective claim about its product that it cannot substantiate. Natural Resource Commission. Answer to “Briefing the Case” Writing Assignment: 1. U. The FTC’s experts reported that it was impossible for any cosmetic product to achieve these results. 34. App. District Court 2. 1979). specifically of the elk. The court held that both the name and advertising of rejuvenescence cream were deceptive. Deceptive advertising occurs where a seller makes a misrepresentation in an advertisement that is likely to mislead a “reasonable consumer. It also is not ethical to take advantage of low income families. 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.16. (2) avoid the impact areas for at least 40 to 50 years. Answers to Ethics Cases 34. The FIC was created in 1915 to enforce the Federal Trade Commission Act.S.13. v. The Corps is empowered to adopt regulations dealing with the filling or dredging of wetlands. Safety issues may complicate this matter and ethics is definitely in question. Although virtually all human activities can be found to adversely impact natural resources in some way or another. Lexis 347 (Mich. C.S.S. and (3) result in further shrinkage of the already diminishing elk population. The Federal Trade Commission wins the case. and Court FMC Corp.W. West Michigan Environmental Action Council. as a result of the proposed drilling of the ten exploratory wells. Case Name. youthful look. the present case does not justify the destruction of the elk population for the exploration of oil and gas deposits.Pa 1992) U. B.471 (E. 34. the court determined that this constitutes an impairment or destruction of a natural resource. Dept.Consumer and Environmental Protection and Environmental Law 583 IV. v. . Lexis 3172 (2nd Cir. Section 5 of the FTC Act prohibits the use of deceptive or unfair advertising.15.2d 676. of Commerce 786 F. If this were bait and switch it would be illegal. 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. v. 1944).14 FTC wins. Inc. Key Facts A. 1979 Mich. 1944 U. Supp. A permit is needed. Therefore. The West Michigan Environmental Action Council (WMEAC) prevails.D. Citation. The court held that the WMEAC demonstrated the likelihood of the impairment or destruction of the natural resources in the areas. Because the appellate court found the name and advertising of rejuvenescence cream to be deceptive. 143 F. FTC.2d 538. FMC seeks indemnification from the Government for some portion of related costs. Charles of the Ritz was making objective claims in its advertising it could not substantiate. V. the appellate court upheld the FTC’s cease and desist order. Based upon an Environment Impact Statement that indicated that elk would (1) avoid roads even when there is no traffic.

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

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

the Labor-Management Reporting and Disclosure Act. Text Materials Landmark Law: Federal Labor Union Statutes This discusses the Norris-LaGuardia Act. the National Labor 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. and the Railway Labor Act. the LaborManagement Relations Act.

Inc. An administrative law judge ruled in the union’s favor. or coerce employees” in the exercise of their Sec. The Court of Appeals enforced the Board’s order.Employment. Lechmere is also part owner of the plaza’s parking lot. alleging that Lechmere had violated the NLRA by barring the organizers from its property. The Supreme Court Speaks: Lechmere. relying on its ruling in Jean Country. In addition. 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. join.7 rights. . or assist labor organizations. restrain. they distributed handbills and picketed from the grassy strip. against (2) the degree of impairment of the private property right if access is granted. The Board affirmed. recommending that Lechmere be ordered to cease and desist from barring the organizers from the parking lot. Worker Protection.. almost all of which is public property. Petitioner Lechmere. to form. which is separated from a public highway by a 46-foot-wide grassy strip. Inc. taking into consideration (3) the availability of reasonably effective alternative means of exercising the Sec. In a campaign to organize Lechmere employees. v. The union filed an unfair labor practice charge with respondent National Labor Relations Board (Board).7 right if access is denied. that in all access cases the Board should balance (1) the degree of impairment of the Sec. After Lechmere denied the organizers access to the lot. 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. 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. they were able to contact directly some 20 percent of the employees. nonemployee union organizers placed handbills on the windshields of cars parked in the employees’ part of the parking lot.7 right. National Labor Relations Board Facts: The National Labor Relations Act (NLRA) guarantees employees “the right to selforganization.

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. increased wages. Because Lechmere’s employees do not reside on its property. . In February 1960. Prior to November 1959.7 and private property rights. Exchange Parts Co. The facts in this case do not justify application of the inaccessibility exception. in turn. Jean Country is inconsistent with past interpretation of Sec. The Democrats. In November 1959. not on unions or their nonemployee organizers.” It is only when reasonable access to employees is not feasible that it becomes appropriate to balance Sec. TX. The act really represents a microcosm of the larger employer versus employee rights debate. as a rule. The Supreme Court Speaks: National Labor Relations Board v. J. Ask your students where they stand and why. Thus. Iron Shipbuilders. is an unfair labor practice. which are designed to affect the outcome of that election. and an extended vacation plan. the Board erred in concluding that Lechmere committed an unfair labor practice by barring the nonemployee organizers from its property. Reason: An employer’s conferral of benefits on employees on the eve of a union election. which was reversed by the court of appeals. Exchange Parts held a dinner for its employees and announced new company benefits including an extra holiday. Facts: Exchange Parts Co. an employer cannot be compelled to allow nonemployee organizers onto his property. a union did not represent its employees. Sec. Nor does the fact that they live in a large metropolitan area render them “inaccessible. WARN was passed in 1988 and deals with plant closing and mass layoffs. Forgers. Ethics Spotlight: Plant Closing Act This act was one of the few to survive a presidential veto during the Reagan-Bush era.588 Chapter 35 Reason: Thomas.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. 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. they are presumptively not “beyond the reach” of the union’s message. You might be surprised by their answers. is engaged in the business of rebuilding automobile parts in Fort Worth. The NLRB ordered a new election. The NLRB ordered an election date.” Because the union failed to establish the existence of any “unique obstacles” that frustrated access to Lechmere’s employees. the NLRA confers rights only on employees. and Helpers advised Exchange Parts that it was going to conduct a campaign to organize workers at the plant. By its plain terms.7. At least as applied to nonemployee union organizers. Blacksmiths. The Union lost the election. the International Brotherhood of Boilermakers. 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.

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) . Worker Protection.

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

. 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. the more likely will business choose to move there. Marquez won a part in a Lakeside production but did not pay the membership fee and she was not hired.Employment. Inc. These laws often outlaw union and agency shops. Issue: Does the union security clause in question violate federal labor law? Decision: No. The collective bargaining agreement included a “union security clause” requiring all Lakeside performers to join SAG. The judgment of the court of appeals was affirmed. 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. Worker Protection. Screen Actors Guild. Facts: SAG was the exclusive union for Lakeside. and Labor Law 591 The Supreme Court Speaks: Marquez v. Marquez appealed. 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. The district court held for Lakeside (SAG) and the court of appeals affirmed.

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

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

594 Chapter 35 Insurance .

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

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

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

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

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

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

Getty Oil Company v. the failure to pressure test a pressure vessel before activation was an apparent and obvious hazard that was likely to cause serious injury. A fiduciary is required to perform his duties regarding the plan with the “care.2d 1143 (5th Cir. the Secretary must prove that (1) the employer failed to render its workplace “free” of a hazard that was (2) recognized. and to repay the loans when they became due. They failed to require evidence of the borrower’s ability to repay the loans. In the present case. . 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. Thus. the fundamental command of the Fourth Amendment is that searches and seizures be reasonable.3. Cal. as well as preventable by the simple expedient of pressure testing. 698 F. Tex. and is judged by balancing its intrusions on the individual’s Fourth Amendment interests against its promotion of a legitimate governmental interest. This standard of ”reasonableness” depend on the context within which a search takes place. Occupational Safety and Health Review Commission. Supp. prudence.Supp. 1988).D. ERISA requires that an administrator or trustee of a pension benefit plan administer the plan as a fiduciary. Rowley.. Drug Testing 35. it created an extremely high probability of rupture and ensuing harm. AFL-CIO v. Burnley. Furthermore.4. and (3) causing or likely to cause death or serious physical harm.Dist. the expectation of privacy is minimal. 1976).” 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. 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. 1988 U. 1043.602 Chapter 35 Occupational Safety 35. the trustees failed to act prudently. In the present case. Thus. to enter into a written agreement describing the terms and conditions of the loans. the court found that the trustees had violated their fiduciary duties and required them to resign their positions as trustees of the plan.5.). Although the court held that urinalysis is a search. the court stated that it is clear the hazard at issue here was both “recognized” and likely to cause serious harm. 700 F. to charge fair market rates of interest. MEBA/NNU. skill. 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. The Secretary of Labor wins because the trustees breached their fiduciary duty in violation of the Employee Retirement Income Security Act (ERISA).S. 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. ERISA 35. Lexis 15884 (N. The court stated that to violate the Occupational Safety and Health Act. National Air Traffic Controllers Assn. 530 F. McLaughlin v. 1333 (N. The Occupational Safety and Health Review Commission prevails because an employer is required to furnish a safe place of employment for its employees.D. In this case.

Illinois Department of Employment Security. Sup.E. 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. 89 S. 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. Gissel Packing Co. 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. and Labor Law 603 Unemployment Benefits 35. 522 N.S.S. or coercion. The Supreme Court held that the president of the Sinclair Company interfered with the election and ordered that the election be set aside.” The court defined misconduct as behavior that is willful or a wanton disregard of an employer’s interests. 407.).7. Oil. Supreme Court held that Texas’ right-to-work law did not apply to the workers in this case.2d 547 (1969). The court following Sec. Chemical & Atomic Workers International Union.S. No. 23 L. 426 U. Such interests include the intentional and substantial disregard of the employee’s duties and obligations to his employer.2d 185 (Ill. 1918. 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.8.S. force. .Ed. his statements may not contain a threat of reprisal. Overstreet v. Yes.S.Ct.” The court held that the company’s decision to close down the Hudson plant was not a mandatory subject of collective bargaining. Inc. hours. 1988). and other terms and conditions of employment. 395 U. 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. (Arrow) does not have to bargain with the union regarding its decision to close the Hudson.Employment. Texas’ right-to-work laws did not apply to these workers. He may make predictions of the effects he believes unionization will have on his company. In this case. The court commented that it is immaterial that Texas may have more contacts than any other state with the workers.9. The U. Right-to-Work-Law 35.. 575. 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. Arrow Automotive Industries. Mobile Oil Corporation. Plant Closing Act 35. Massachusetts plant. 96 S Ct.6. Here. Ct. NLRB v. Congress has limited the subjects of mandatory bargaining to “wages. Worker Protection. the president of the Sinclair Company violated federal labor law by unlawfully interfering with the union election. 2140.App. AFL-CIO v. 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. The union wins and its agency shop agreement is legal and enforceable. Lexis 106 (U. The CTA wins.1976 U. The court held that the predominant job situs was the controlling factor in determining whether a state’s right-towork law applies. Unfair Labor Practice 35.

386 U. 430 F. Yes. Yes. The court found that the other employees had engaged in an illegal “wildcat strike” that was not sanctioned by their union. 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. 1989). Illegal Strike 35. Bownds and the employees who engaged in the walkout cannot get their jobs back. The court held that an employer can . 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. Employer Lockout 35. the closing of a plant is a permissible subject of collective bargaining. then the workers were illegal strikers who could be discharged without the right to reinstatement. and that the decision was not based on antiunion animus. Inc. 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.2d 786 (5th Cir. was properly discharged for his conduct..11. NLRB. 612. Work Preservation 35. Making such a decision a mandatory subject of bargaining would give the union a powerful tool for delay. 18 L. 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. 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.2d 223 (4th Cir. NLRB v. v. The court held that although jobs would be eliminated by the decision. Since the employer is required to bargain with the representative of the workers. Note: Under the Plant Closing Act. 1250. 87 S. As the court stated. evidence showed an impasse had been reached in collective bargaining.12. Shop Rite Foods. and therefore the union’s “will not handle” rule that had been bargained for and agreed to by the employer was lawful. 853 F. The Supreme Court held that the preservation of work traditionally done by union members is a proper subject of collective bargaining.Ed.Ct. NLRB. There cannot be bargaining in any splinter groups.2d 357 (1967). this does not make it a mandatory subject of negotiation. 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. In this case.604 Chapter 35 The court found that the company had justifiable economic reasons for closing the plant.” 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.S. 1970). The Supreme Court upheld the NLRB’s decision to dismiss the charges. No. The National Labor Relations Act indicates a preference for collective 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. Inc. Thus. “the union’s practical purpose in participating will be largely uniform: it will seek to halt or delay the closing. there was a threat of an impending strike by the unions that would shut the shipyard down for the winter months. The object of the union’s action was to preserve work traditionally done by its members. The court held that because this was an illegal wildcat strike. Bownds. National Woodwork Manufacturers Association v.10. Arrow Automotive Industries. and the company in this case rightfully chose not to bargain over this issue.

Worker Protection.16. No.S. the picketing becomes an illegal secondary boycott if the picketing threatens. Retail Clerks International Association. 83 S. Ct. NLRB. 100 S. Answers to Ethics Cases 35. It was negligence and as such the exception did not apply.Ed. Local 1001. Erie Resistor Company. The court upheld the NLRB’s finding of an unfair labor practice. 300. the court held that secondary picketing against a struck product is lawful. The Supreme Court held that the picketing of the neutral employers constituted an illegal secondary boycott in violation of the National Labor Relations Act. Sup.2d 855 (1965). Independent Federation of Flight Attendants.S. 35. 607. it simply induces the neutral retailer to reduce its orders for the product or to drop the item as a poor seller. If the appeal against the product succeeds. without being subject . This was not an intentional tort.13.2d 377 (1980). 373 U. 447 U. the incidental injury to the neutral employer will be tolerated. Inc. 85 S. No. in this case the five local title insurance companies sell only the primary employer’s product. today the company could offer the crossovers the seniority they had prior to the strike. Employees can engage in self-help under certain circumstances under OSHA regulations.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. AFL-CIO. Although in Tree Fruits. 1963 U. v. Under this circumstance. 13 L. or restrains a person from buying or using the services of the neutral employer. NLRB v.S. However. 109 S.14. Ct. 1225 (1989).Ct. The product picketed in Tree Fruits (apples) was but one item among the many that made up the grocery store’s trade.Ct.Employment. 65 L.). 58.Ed. NLRB v. American Ship Building Company v. and that in this case the lockout was a reasonable response to the threatened strike.S. Lexis 2492 (U. Safer testing could have been provided but he also should have been more careful. 377 U.S. Replacement Workers 35. The Supreme Court upheld the NLRB’s decision that ordered the union to cease picketing the five local title insurance companies. the picketing of the five neutral title insurance companies is not lawful. 221. 380 U.S. Retail Store Employees Union.. 2372. coerces. and Labor Law 605 engage in a lockout and preempt the threatened strike by the unions. The court held that the company unlawfully discriminated between workers in violation of the National Labor Relations Act. Secondary Boycott 35. 1063 (1964). 489 U.15. it created a separate dispute with the secondary employers. 84 S. IV. Ct. 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.Ct. 955. 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. 1139. The court held that the union did more than merely follow the struck product. 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. Note: Under the Supreme Court’s ruling in Trans World Airlines.

The employer. This legislation is broad in nature. Section 8© states that if the expression is used as a threat against the employee’s right to associate. 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 court found that the conduct of Daniel and Wolfram plainly violated the valid no-solicitation rule.17.606 Chapter 35 to subsequent discrimination. 63 L. Secretary of Labor.S. and Court Wiljef Transportation v. and Wiljef appealed. This rule was seeking actual employment. Yes. and held that they were properly discharged from their employment because of their misconduct. E. This was not “standing-by”. Wiljef amended its bylaws to call for the company’s dissolution if unionization were to take place. it can be interpreted as an unfair labor practice. 883. there is an affirmative duty on all employers to provide a safe workplace. Since an OSHA inspector cannot be present all the time. Whirlpool Corp. 35. Issue Did the by-law violate the National Labor Relations Act? 4. D. B. The fundamental purpose of OSHA is to prevent occupational deaths and serious injuries. This would not be lawful. . The NLRB claimed that the by-law violated the National Labor Relations Act.2d 154 (1980). Wiljef. this regulation allows the employee to get the benefit of a safe workplace in all circumstances. Employers may dismiss employees who violate the rule. v. If fellow employees are conducting union solicitation. V. 195 NLRB 1046 (1972). The regulation is valid. North American Rockwell Corporation v. Whitcraft Houseboat Division.Ed. International Association of Machinists and Aerospace Workers. 5. Key Facts A. Court’s Reasoning The US Court of Appeals for the 7th Circuit held that: A. Case Name. The general freedom of expression is recognized in Section 8© of the NLRA. 3.Ct. C. The employer contended that this by-law was an expression of free speech as protected by the 1st Amendment. an employer may restrict solicitation activities to the employees’ nonworking time and in nonworking areas. The issue here is whether that regulation is valid. AFL-CIO. NLRB 946 F. 100 S. Answer to “Briefing the Case” Writing Assignment: 1. 1. 445 U.2d 1308 (1991) United States Court of Appeals for the 7th Circuit 2. It would be anomalous to construe this act as to not allowing the employee to withdraw from a dangerous workplace. B. Holding Yes. The lower court held in favor of the NLRB.18. Whitcraft’s discharge of the employees was unlawful. was involved in a dispute with its employees who were seeking to unionize. Further. Marshall. However. In response to the unionization efforts. 35. Citation.

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

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

Until then. sex. we have certainly had more than our share of unequal treatment in the workplace. ability. Congress enacted the Civil Rights Act of 1964. Almost everyone appreciates that fact intuitively. There is basically no good job-related reason for race and color. you cannot expect the average man on the street to play golf as well as Tiger Woods. 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. The negative side of discrimination is inequality of treatment based on wrongful motive. For example. For a society founded on a premise of equality.” Wrongful discrimination against any group is a wrong upon the society at large. religion. II. One element that provides hope for positive change is goodwill. Each choice not based on talent.Equal Opportunity in Employment 609 the end. 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. if not intellectually. color. in turn. He. religion. is duly rewarded for these talents. or national origin without a good job-related reason. Where people of goodwill cling to the basic rightness of equity before the law. law and our courts will continue to be the testing grounds for this necessary change in the social order. Title VII focuses on eliminating job discrimination based on race. that equity will eventually result in a changed culture. justifications. Landmark Law: Title VII of the Civil Rights Act of 1964 After substantial debate. sex or national origin. . color. economic marketplace factors are blind to any other factors but job performance. and merit is a step away from the inherent basis of equality before the law. or rationalizations.

610 Chapter 36 .

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

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

must the conduct seriously affect the victim’s psychological well-being? Decision: No. 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. Issue: To be abusive work environment harassment.Equal Opportunity in Employment 613 The Supreme Court Speaks: Harris v. Inc. touching. 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. Facts: Petitioner Harris sued her former employer. Reason: To be actionable as “abusive work environment” harassment. Sexual Harassment Lewd remarks.. respondent Forklift System. Title VII does not require a victim to prove that the challenged conduct seriously affected her psychological well-being. etc. Inc. Forklift Systems. Sexual favors often for job advancement Types Quid pro quo Hostile Environment Look to frequency & severity .

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.614 Chapter 36 The Supreme Court speaks: PA State Police v. there is “constructive discharge”. The court of appeals reversed and the case was remanded. the abusive conduct was so intolerable that resignation was a fitting response. The case was remanded. Sine the employer does not seem to have a readily accessible and effective policy for reporting and resolving sexual harassment complaints. She contacted PSP’s equal opportunity officer who she found to be insensitive and unhelpful. The case presents a “worst Case” harassment scenario. as in this case. 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. an otherwise affirmative defense is not available. The court yes to the sexual harassment but no to PSP’s vicarious liability and granted PSP’s motion for summary judgment. 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. Suders Facts: Suders was hired by PSP as a police communications operator. Religious Discrimination • • Reasonable accommodation Sometimes permitted in religious groups . She resigned and sued PSP alleging that she was constructively discharged and forced to resign. PSP appealed. If. She subjected to continuous sexual harassment that only ceased when she resigned. 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.

Equal Opportunity in Employment 615 .

occupational exposure to which entails health risks. as amended. despite evidence about the debilitating effect of lead exposure on the male reproductive system. and because its asserted purpose. Reason: Blackmun. under the PDA.616 Chapter 36 The Supreme Court Speaks: International Union Etc. The policy is not neutral because it does not apply to male employees in the same way as it applies to females. Title VII. . The court granted summary judgment for respondent. and the Court of Appeals affirmed. Johnson Controls. support. v. The incremental cost of employing members of one sex cannot justify a discriminatory refusal to hire members of that gender. 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. 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. Petitioners. which classification must be regarded. respondent’s professed concerns about the welfare of the next generation do not suffice to establish a BFOQ of female sterility. Also. and raise them rather than to the employers who hire those parents or the courts. the absence of a malevolent motive does not convert a facially discriminatory policy into a neutral policy with a discriminatory effect. in using the words “capable of bearing children” as the criterion of exclusion. 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. participate in the manufacture of batteries as efficiently as anyone else. including the risk of harm to any fetus carried by a female employee. Facts: A primary ingredient in Johnson Control’s battery manufacturing process is lead. the policy explicitly classifies on the basis of potential for pregnancy. from jobs involving actual or potential lead exposure exceeding the OSHA standard. Moreover. protecting women’s unconceived offspring. a group including employees affected by respondent’s fetal-protection policy. By excluding women with childbearing capacity from lead-exposed jobs. Issues: Is Johnson Control’s fetal-protection policy a BFOQ? Decision: Title VII. 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. 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. forbids sexspecific fetal-protection policies. mandates that decisions about the welfare of future children be left to the parents who conceive. filed a class action in the District Court. except those whose infertility was medically documented. as far as appears in the record. J. Moreover. Fertile women. in the same light as explicit sex discrimination. Inc. as amended by the PDA. claiming that the policy constituted sex discrimination violating Title VII of the Civil Rights Act of 1964. bear. was ostensibly benign. 703(a) of Title VII. as amended by the Pregnancy Discrimination Act (PDA). Respondent cannot establish a BFOQ. respondent announced a policy barring all women. respondent’s policy creates a facial classification based on gender and explicitly discriminates against women on the basis of their sex under Sec.

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

Cline who was over 40 but under 50 sued alleging discrimination under the ADEA. The opposite could be true but that is not the case here. v. Inc. 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. The case was dismissed the district court whose holding was then reversed by the court of appeals. GD appealed. Reason: The law has no evidence of wanting to protect younger covered employees versus older covered employees. Issue: Does the ADEA protect a younger covered employee from an employer’s rule that discriminates in favor of older covered employees? Decision: No.618 Chapter 36 The Supreme Court speaks: General Dynamics Land System. The decision was reversed. .

Landmark Law: Title I of the ADA This statute prohibits discrimination in regard to a job against qualified individual with disabilities. An employer cannot ask an applicant about a disability but can ask about the ability to perform a job. A pre-employment medical exam is forbidden before an offer.Equal Opportunity in Employment 619 Ethics Spotlight: You’re Overqualified For The Job” Age discrimination and “overqualification” is discussed. . 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. Reasonable Accommodations are required.

Issue: Does the Americans with Disabilities Act of 1990 require the PGA Tour to accommodate Casey Martin. United Airlines. They were not hired because of sever myopias causing visual acuity of 20/200 or worse and 20/400 or worse. When he turned professional. Issue: Are the petitioners disabled within the meaning of the ADA? Decision: No. v. The Supreme Court speaks: Sutton v. Reason: Disability under the ADA does not include persons with corrected conditions as in this case. Martin Facts: Casey Martin is a talented amateur golfer who has Klippel-Trenaunay-Weber Syndrome. The condition prevents them from doing normal activities without correction.620 Chapter 36 The Supreme Court Speaks: PGA Tour. 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. Martin won at the district court and court of appeals levels. The ADA requires that the PGA Tour accommodate Casey Martin by allowing him to use a golf cart. Inc. Petitioners appealed. Inc. 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. Sutton and Hinton sued for violation of the ADA. . He requested to use a golf cart while playing in PGA tournaments. he qualified for the PGA Tour. The complaint had been properly dismissed. a degenerative circulatory disorder that obstructs the flow of blood from his right leg to his heart. They are both correctable to 20/20 or better with corrective lenses. but the PGA Tour denied his request. 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. UAL had a 20/100 or better visual acuity requirement. a disabled professional golfer.(UAL) Facts: Twin sisters (Karen Sutton and Kimberly Hinton) applied to UAL. Martin sued the PGA in violation of the ADA for not making reasonable accommodations for his disability. The district court dismissed and the court of appeals affirmed. by permitting him to use a golf cart while playing in PGA sponsored golf tournaments? Decision: Yes.

and which are performed under similar working conditions. Brennan. Corning Glass Works v. it is not true that all individuals of the respective classes will do so.S. 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.Ed. 188. Sex Discrimination 36. International Law: United Nation Treaty To Protect The Rights Of The Disabled This discusses the “Convention in the Rights of Persons With Disabilities. Yes. Although the Supreme Court acknowledged that as a class women do live longer than men. It is clear that any individual’s life expectancy is based on a number of factors.” Here. In fact. Thus. 2223. 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 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 term “working condition” encompasses only physical surroundings and hazards and not the time of the day worked. Secretary of Labor. . the Supreme Court held: 1. 417 U.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.2. 41 L. the original pay differential between the day (female) shift and the night (male) shift violated the Act. of which sex is only one. many women do not live as long as the average man and many men outlive the average woman.” III.Ct.2d 1 (1974). the wage practices by Corning violated the Equal Pay Act. effort. Yes. In order to establish a violation of the Act. 2. 94 S. and responsibility. Answers to Critical Thinking Cases Equal Pay Act 36.1.

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. 1988). Religious Discrimination 36. As a remedy. Further. 98 S. Texas 1989). The court held that the ability to communicate clearly in English was a bona fide occupational qualification (BFOQ) .S. 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.D. Bona Fide Occupational Qualification 36. Yes. City of Los Angeles Department of Water and Power v. 1370. 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.2d 113 (1977). Huddleston v. In addition. 714 F. 2264. Manhart.6.Ed. Perez v.5. The court ordered that an independent panel be created to decide these claims. The Supreme Court held that TWA had taken all actions necessary to reasonably accommodate Hardison’s religious preference. 845 F. 432 U. 435 U. In this case. Thus. Yes.622 Chapter 36 Note: Although the Supreme Court found a violation of Title VII. the court ordered the FBI to overhaul its system of promoting Hispanic agents and those from other minority groups to eliminate any discriminatory practice. 97 S.. 63. 702. which would itself be religious discrimination against the other employees of TWA. Trans World Airlines v. the court cited the potential economic impact that such an award would cause to insurance companies and pension plans. the FBI is liable for a pattern or practice of discrimination in violation of Title VII. 1414 (W. In doing so.3.Ed.Ct. 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. Federal Bureau of Investigation. 55 L.Ct. The court reasoned that this would give Hardison an employment benefit that would be based on religion.S. Inc. Thus. National Origin Discrimination 36. The city and county of Honolulu are not liable for violating Title VII. 53 L. The Supreme Court also held that TWA did not have to meet Hardison’s request to work only a four-day workweek. it reversed the District Court’s award of retroactive relief to the entire class of female employees and retirees.2d 900 (11th Cir. Hardison. 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. Roger Dean Chevrolet.4. TWA did not violate Title VII. The court did not grant an award of back pay. the challenged practice was only outlawed in the future. TWA is not liable for religious discrimination in violation of Title VII.Supp. No.2d 657 (1978). Huddleston made out a prima facie case against RDC for the sexual harassment attributable to the sales manager of RDC. Hostile Work Environment 36. The court held that the FBI’s actions constituted unlawful national origin discrimination against Hispanic agents.

Together. Machakos v. 36. Fite made a prima facie case of age discrimination against the association. and was therefore properly denied the position. 53 L. Also.000 damages and $71. it is the safety of the other inmates. and awarded Machakos back pay retroactive to when she should have been promoted had the CRD not discriminated against her. 888 F. Age Discrimination 36.2d 884 (6th Cir. 1989). 859 F. for which there was no correlation proven. The essence of a prison guard’s job is to maintain order. ordered that Machakos be promoted. First Tennessee Production Credit Association.2d 786 (1977). Fragante v. Rawlinson proved a prima facie case of sex discrimination by showing that the racially neutral height and weight restrictions disparately impacted upon women. Thus.9. Fite v. In this case.5 percent of men.C. it is not her safety that the court is protecting.Ed. . Machakos wins. Dothard argues that height and weight are job related. The trial court found that the height rule excluded ove