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

Roger LeRoy Miller Institute for University Studies

Arlington, Texas

William Eric Hollowell Institute for University Studies

Arlington, Texas

and Member of Florida State Bar

Minnesota State Bar

United States Supreme Court Bar

Business Law T e x T & e x e r c i s e s

N i N T H e d i T i o N

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Business Law TexT & exercises NiNth EditioN Roger LeRoy Miller William Eric Hollowell

Senior Vice President, Higher Ed Product, Content,  and Market Development: Erin Joyner

Product Director: Bryan Gambrel

Senior Product Manager: Vicky True-Baker

Content Developer: Sarah Huber

Product Assistant: Christian Wood

Marketing Manager: Katie Jergens

Senior Content Project Manager: Martha Conway

Production Service: SPi Global

Senior Art Director: Bethany Bourgeois

Intellectual Property Analyst: Jennifer Bowes

Intellectual Property Project Manager: Kathy Kucharek

Text and Cover Designer: Liz Harasymczuk

Cover Images: City buildings: zhangyang13576997233/ Shutterstock.com; handshake: Yanik Chauvin/ Shutterstock.com; credit card and graph: Number1411/Shutterstock.com; rush hour walkers: Rawpixel.com/Shutterstock.com

Design Images: Gavel, Alex Staroseltsev/Shutterstock.com; light bulbs, Belokrylaya/Shutterstock.com; pillars of law and justice, Brandon Bourdages/ Shutterstock.com; business people in office building, Rawpixel.com/Shutterstock.com; puzzle pieces, Sergey Nivens/Shutterstock.com; law icons, PureSolution/Shutterstock.com

Printed in the United States of America

Print Number: 01 Print Year: 2017

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Copyright 2019 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. WCN 02-200-203

iii

U N i T 1

The Law and Our Legal System 1 Chapter 1 Introduction to the Law 2

Chapter 2 Ethics in Business 13

Chapter 3 The Courts and Our Legal System 27

Chapter 4 Constitutional Law 43

Chapter 5 Business Torts 57

Chapter 6 Intellectual Property 69

Chapter 7 Business Crimes 83

U N i T 2

Contracts 97 Chapter 8 Introduction to Contracts 98

Chapter 9 Offer and Acceptance 109

Chapter 10 Consideration 121

Chapter 11 Capacity 131

Chapter 12 The Legality of Agreements 143

Chapter 13 Voluntary Consent 155

Chapter 14 Contracts That Must Be in Writing 165

Chapter 15 Third Party Rights 179

Chapter 16 Termination and Remedies 191

U N i T 3

Sales and Leases 205 Chapter 17 Introduction to Sales

and Lease Contracts 206

Chapter 18 Title and Risk of Loss 219

Chapter 19 Performance and Breach 233

Chapter 20 Warranties and Product Liability 247

Chapter 21 Consumer Protection 261

U N i T 4

Negotiable Instruments 275 Chapter 22 The Essentials of Negotiability 276

Chapter 23 Negotiable Instruments: Transfer and Liability 291

Chapter 24 Banking in the Digital Age 305

U N i T 5

Agency and Employment 321 Chapter 25 Agency Relationships 322

Chapter 26 Employment, Immigration, and Labor Law 337

Chapter 27 Employment Discrimination 351

U N i T 6

Business Organizations 365 Chapter 28 Types of Business Organizations 366

Chapter 29 Formation and Ownership of a Corporation 381

Chapter 30 Management of a Corporation 397

Chapter 31 Combining and Dissolving Corporations 407

U N i T 7

Credit and Risk 417 Chapter 32 Security Interests and Creditors’ Remedies 418

Chapter 33 Mortgages 433

Chapter 34 Bankruptcy 443

Chapter 35 Insurance 455

Contents in Brief

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iv

U N i T 8

Property 467 Chapter 36 Personal Property 468

Chapter 37 Bailments 479

Chapter 38 Real Property 489

Chapter 39 Landlord and Tenant Law 501

Chapter 40 Wills and Trusts 511

U N i T 9

Special Topics 523 Chapter 41 Administrative Law 524

Chapter 42 Antitrust Law 537

Chapter 43 International and Space Law 549

A p p e N d i x

A Answers to the Issue Spotters A–1

Glossary G–1

Table of Cases TC–1

Index I–1

C O N T E N T S I N B R I E F

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v

U N i T 1

The Law and Our Legal System 1

c H A p T e r 1

Introduction to the Law 2 What Is Law? 2 Business Activities and the Legal Environment 2

Highlighting the Point 3 Sources of American Law 3

Real Case 4

Highlighting the Point 6 Civil Law versus Criminal Law 7 National Law around the World 7 International Law 7

Linking Business Law to Your Career: Consulting an Expert for Advice 8

Chapter 1—Work Set 11

c H A p T e r 2

Ethics in Business 13 The Importance of Business Ethics 13 Setting the Right Ethical Tone 14

Real Case 15

Highlighting the Point 15 The Sarbanes-Oxley Act 16 Business Ethics and the Law 16

Highlighting the Point 17 Approaches to Ethical Reasoning 17

Highlighting the Point 19 Business Ethics and Social Media 20

Highlighting the Point 20 Business Ethics on a Global Level 20

Highlighting the Point 21

Linking Business Law to Your Career: Managing a Company’s Reputation 22

Chapter 2—Work Set 25

c H A p T e r 3

The Courts and Our Legal System 27 Jurisdiction 27 The State Court System 28 The Federal Court System 29 The State Court Case Process 31

Highlighting the Point 32

Real Case 34 Alternative Dispute Resolution 36

Chapter 3—Work Set 41

c H A p T e r 4

Constitutional Law 43 The Constitutional Powers of Government 43

Highlighting the Point 45 Business and the Bill of Rights 45

Highlighting the Point 47

Real Case 48 Due Process and Equal Protection 48 Privacy Rights 50

Linking Business Law to Your Career: Pretexting and Marketing 51

Chapter 4—Work Set 55

c H A p T e r 5

Business Torts 57 The Basis of Tort Law 57 Intentional Torts against Persons 57

Real Case 59 Intentional Torts against Property 60

Highlighting the Point 61 Negligence 62

Highlighting the Point 62

Highlighting the Point 63

Highlighting the Point 64 Strict Liability 64

Chapter 5—Work Set 67

Contents

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C O N T E N T Svi

c H A p T e r 6

Intellectual Property 69 Trademarks and Related Property 69

Real Case 70

Highlighting the Point 71

Highlighting the Point 72 Patents 73 Copyrights 73

Highlighting the Point 75

Highlighting the Point 75 Trade Secrets 76 International Protection for Intellectual Property 76

Linking Business Law to Your Career: Trademarks and Service Marks 78

Chapter 6—Work Set 81

c H A p T e r 7

Business Crimes 83 Civil Law and Criminal Law 83 Constitutional Safeguards 85

Highlighting the Point 86 Crimes Affecting Business 86

Highlighting the Point 87

Highlighting the Point 87 Defenses to Criminal Liability 88 Cyber Crime 89

Real Case 90

Linking Business Law to Your Career: Protect Your Company against Hacking 92

Chapter 7—Work Set 95

U N i T 2

Contracts 97

c H A p T e r 8

Introduction to Contracts 98 The Definition of a Contract 98

Real Case 99 Types of Contracts 100

Highlighting the Point 100

Highlighting the Point 101 Interpretation of Contracts 103

Chapter 8—Work Set 107

c H A p T e r 9

Offer and Acceptance 109 Requirements of the Offer 109

Highlighting the Point 110 Termination of the Offer 111

Highlighting the Point 111 Acceptance 112

Real Case 113 E-Contracts—Offer and Acceptance 114

Highlighting the Point 115

Chapter 9—Work Set 119

c H A p T e r 1 0

Consideration 121 Elements of Consideration 121

Highlighting the Point 122

Real Case 122 The Lack of Consideration 123

Highlighting the Point 123 Settlement of Claims 124

Highlighting the Point 125 Promissory Estoppel 125

Chapter 10—Work Set 129

c H A p T e r 1 1

Capacity 131 Minors 131

Highlighting the Point 132

Highlighting the Point 132

Highlighting the Point 133

Highlighting the Point 134 Intoxicated Persons 134 Mentally Incompetent Persons 135

Real Case 135

Highlighting the Point 136

Linking Business Law to Your Career: Contracts with Minors or Intoxicated Persons 137

Chapter 11—Work Set 141

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C O N T E N T S vii

c H A p T e r 1 2

The Legality of Agreements 143 Contracts Contrary to Statute 143

Real Case 144

Highlighting the Point 145 Contracts Contrary to Public Policy 146

Highlighting the Point 146

Highlighting the Point 147 The Effect of Illegality 148

Highlighting the Point 148

Highlighting the Point 149

Chapter 12—Work Set 153

c H A p T e r 1 3

Voluntary Consent 155 Mistakes 155 Fraudulent Misrepresentation 157

Real Case 157

Highlighting the Point 158

Highlighting the Point 159 Undue Influence and Duress 160

Highlighting the Point 160

Chapter 13—Work Set 163

c H A p T e r 1 4

Contracts That Must Be in Writing 165 The Statute of Frauds—

Writing Requirement 165

Highlighting the Point 167

Highlighting the Point 167

Highlighting the Point 169 The Sufficiency of the Writing 169

Real Case 170 The Parol Evidence Rule 170

Highlighting the Point 171

Linking Business Law to Your Career: Enforceable E-Mail Contracts 174

Chapter 14—Work Set 177

c H A p T e r 1 5

Third Party Rights 179 Assignments and Delegations 179

Highlighting the Point 181

Highlighting the Point 181

Highlighting the Point 183 Third Party Beneficiaries 183

Real Case 184

Linking Business Law to Your Career: Assignment and Delegation 186

Chapter 15—Work Set 189

c H A p T e r 1 6

Termination and Remedies 191 Contract Termination 191

Highlighting the Point 192

Highlighting the Point 194

Real Case 195 Contract Remedies 196

Highlighting the Point 197

Highlighting the Point 198

Linking Business Law to Your Career: Performance and Compromise 200

Chapter 16—Work Set 203

U N i T 3

Sales and Leases 205

c H A p T e r 1 7

Introduction to Sales and Lease Contracts 206 Sales and Leases of Goods 206

Highlighting the Point 207

Real Case 207 Sales and Lease Contracts 208

Highlighting the Point 209

Highlighting the Point 210

Highlighting the Point 211

Highlighting the Point 211

Highlighting the Point 212

Chapter 17—Work Set 217

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C O N T E N T Sviii

c H A p T e r 1 8

Title and Risk of Loss 219 Identification 219

Real Case 220 Passage of Title 221

Highlighting the Point 222

Highlighting the Point 223 Risk of Loss 223

Highlighting the Point 224

Highlighting the Point 225 Insurable Interest 227

Highlighting the Point 227

Linking Business Law to Your Career: Risk Management 228

Chapter 18—Work Set 231

c H A p T e r 1 9

Performance and Breach 233 Obligations of the Seller or Lessor 233

Highlighting the Point 234

Highlighting the Point 235

Highlighting the Point 236 Obligations of the Buyer or Lessee 237

Real Case 238 Remedies of the Seller or Lessor 238

Highlighting the Point 239 Remedies of the Buyer or Lessee 240

Highlighting the Point 240

Chapter 19—Work Set 245

c H A p T e r 2 0

Warranties and Product Liability 247 Warranties of Title 247

Highlighting the Point 248 Express Warranties 248

Real Case 249 Implied Warranties 249

Highlighting the Point 250 Warranty Disclaimers and Limitations on Liability 251

Highlighting the Point 252 Product Liability 252

Highlighting the Point 254

Linking Business Law to Your Career: Quality Control Management 256

Chapter 20—Work Set 259

c H A p T e r 2 1

Consumer Protection 261 Deceptive Advertising 261

Highlighting the Point 262

Highlighting the Point 263 Labeling Laws and Consumer Sales 263 Credit Protection 264

Highlighting the Point 266

Real Case 267

Highlighting the Point 268 Protection of Health and Safety 268

Highlighting the Point 269

Chapter 21—Work Set 273

U N i T 4

Negotiable Instruments 275 c H A p T e r 2 2

The Essentials of Negotiability 276 Types of Instruments 276 What Is a Negotiable Instrument? 279

Real Case 280

Highlighting the Point 282 Transfer of Instruments 282

Highlighting the Point 283

Highlighting the Point 284

Linking Business Law to Your Career: Writing and Indorsing Checks 286

Chapter 22—Work Set 289

c H A p T e r 2 3

Negotiable Instruments: Transfer and Liability 291 Requirements for HDC Status 291

Highlighting the Point 292 Signature Liability 293

Real Case 294

Highlighting the Point 296 Warranty Liability 297

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C O N T E N T S ix

Highlighting the Point 297 Defenses 298 Discharge 299

Chapter 23—Work Set 303

c H A p T e r 2 4

Banking in the Digital Age 305 Checks and the Bank-Customer Relationship 305 Honoring Checks 306

Real Case 307

Highlighting the Point 309 Accepting Deposits 310

Highlighting the Point 311 Electronic Fund Transfers 313 E-Money and Online Banking 314

Linking Business Law to Your Career: Banking Risks 315

Chapter 24—Work Set 319

U N i T 5

Agency and Employment 321

c H A p T e r 2 5

Agency Relationships 322 Principal-Agent Relationships 322

Highlighting the Point 323 Agency Formation 323

Highlighting the Point 324 Duties of Agents and Principals 324 Agent’s Authority 326

Highlighting the Point 327

Highlighting the Point 327 Liability in Agency Relationships 328

Real Case 329 Termination of Agency Relationships 329

Highlighting the Point 330

Linking Business Law to Your Career: Independent Contractors 332

Chapter 25—Work Set 335

c H A p T e r 2 6

Employment, Immigration, and Labor Law 337 Employment at Will 337

Highlighting the Point 338 Worker Protections 338

Highlighting the Point 339

Highlighting the Point 340 Retirement Income and Security 341

Highlighting the Point 343 Immigration Law 343 Labor Law 344

Real Case 345

Chapter 26—Work Set 349

c H A p T e r 2 7

Employment Discrimination 351 Title VII of the Civil Rights Act 351

Highlighting the Point 352

Real Case 354 Discrimination Based on Age 355

Highlighting the Point 356 Discrimination Based on Disability 356

Highlighting the Point 357 Defenses to Employment Discrimination 358

Linking Business Law to Your Career: Human Resources Management 359

Chapter 27—Work Set 363

U N i T 6

Business Organizations 365

c H A p T e r 2 8

Types of Business Organizations 366 Sole Proprietorships 366

Real Case 367 Partnerships 367

Highlighting the Point 369

Highlighting the Point 370

Highlighting the Point 370

Highlighting the Point 371

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C O N T E N T Sx

Highlighting the Point 372

Highlighting the Point 373

Highlighting the Point 374 Limited Liability Companies 374

Linking Business Law to Your Career: Business Formation 375

Chapter 28—Work Set 379

c H A p T e r 2 9

Formation and Ownership of a Corporation 381 Formation of a Corporation 381

Highlighting the Point 383 Corporate Classifications,

Powers, and Liability 383 Corporate Financing 385 Sales of Securities 386

Highlighting the Point 387

Real Case 387 Corporate Ownership—Shareholders 388

Highlighting the Point 389

Highlighting the Point 390

Chapter 29—Work Set 395

c H A p T e r 3 0

Management of a Corporation 397 Corporate Management—Directors 397

Highlighting the Point 399

Highlighting the Point 399 Corporate Management—Officers 400 Duties of Directors and Officers 400

Real Case 401 Liability of Directors and Officers 401

Chapter 30–Work Set 405

c H A p T e r 3 1

Combining and Dissolving Corporations 407 Mergers, Consolidations, and Share Exchanges 407

Highlighting the Point 408

Real Case 409 Purchase of Assets 409 Purchase of Stock 410

Termination of a Corporation 411

Highlighting the Point 412

Chapter 31—Work Set 415

U N i T 7

Credit and Risk 417

c H A p T e r 3 2

Security Interests and Creditors’ Remedies 418 Secured Transactions 418

Highlighting the Point 420

Highlighting the Point 421 Laws Assisting Creditors 423

Real Case 423

Highlighting the Point 424

Highlighting the Point 425

Highlighting the Point 427

Chapter 32—Work Set 431

c H A p T e r 3 3

Mortgages 433 Types of Mortgages 433

Highlighting the Point 434 Lender Protections 434

Real Case 435 Borrower Protections 435 Foreclosures 436

Highlighting the Point 437

Chapter 33—Work Set 441

c H A p T e r 3 4

Bankruptcy 443 Types of Bankruptcy Relief 443

Highlighting the Point 445 Chapter 7—Liquidation 445

Real Case 447 Chapter 11—Reorganization 448 Chapter 13—Adjustment 449

Chapter 34—Work Set 453

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C O N T E N T S xi

c H A p T e r 3 5

Insurance 455 Insurance Terminology and Concepts 455 The Insurance Contract 457

Highlighting the Point 458

Highlighting the Point 458

Highlighting the Point 459

Real Case 460

Linking Business Law to Your Career: Risk Management in Cyberspace 461

Chapter 35—Work Set 465

U N i T 8

Property 467

c H A p T e r 3 6

Personal Property 468 The Nature of Personal Property 468 Property Ownership—Rights of Possession 469

Real Case 469 Acquiring Ownership of Personal Property 470 Mislaid, Lost, and Abandoned Property 472

Highlighting the Point 472

Chapter 36—Work Set 477

c H A p T e r 3 7

Bailments 479 The Elements of a Bailment 479

Highlighting the Point 480 The Rights of the Bailee 481

Highlighting the Point 481 The Duties of the Bailee 482

Highlighting the Point 483

Real Case 483 Special Bailments 484

Chapter 37—Work Set 487

c H A p T e r 3 8

Real Property 489 The Nature of Real Property 489 Ownership Interests 491

Highlighting the Point 491

Highlighting the Point 492 Transfer of Ownership 492

Highlighting the Point 493

Real Case 494

Linking Business Law to Your Career: Eminent Domain and Commercial Development 495

Chapter 38—Work Set 499

c H A p T e r 3 9

Landlord and Tenant Law 501 Types of Tenancy 501 The Lease Agreement 502

Real Case 503 Rights and Duties of Landlords and Tenants 503

Highlighting the Point 504 Transferring Rights to Leased Property 505 Terminating the Lease 506

Highlighting the Point 506

Chapter 39—Work Set 509

c H A p T e r 4 0

Wills and Trusts 511 Wills 511

Real Case 513

Highlighting the Point 514 Intestacy Laws 515

Highlighting the Point 515 Trusts 517

Chapter 40—Work Set 521

U N i T 9

Special Topics 523

c H A p T e r 4 1

Administrative Law 524 Agency Creation 524 The Administrative Process 525

Highlighting the Point 526 Controls on Agency Powers 528

Real Case 529 Public Accountability 530

Chapter 41—Work Set 535

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C O N T E N T Sxii

c H A p T e r 4 2

Antitrust Law 537 The Sherman Act 537

Highlighting the Point 538

Highlighting the Point 540

Real Case 540

Highlighting the Point 541 The Clayton Act 541 Enforcement of Antitrust Laws 542 U.S. Antitrust Laws in the Global Context 543

Chapter 42—Work Set 547

c H A p T e r 4 3

International and Space Law 549 International Principles and Doctrines 549

Real Case 550

Doing Business Internationally 551 International Contract Provisions 552

Highlighting the Point 552 Regulation of International Business Activities 553 Space Law 554

Chapter 43—Work Set 559

A p p e N d i x

A Answers to the Issue Spotters A–1

Glossary G–1

Table of Cases TC–1

Index I–1

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C H A P T E R xiii

It is no exaggeration to say that today’s legal world is changing at a pace never before experienced. In many instances, technology is both driving and facilitat-ing this change. In the midst of this evolving environment, however, one thing remains certain: for students entering the business world, an awareness of the legal and regulatory environment of business is critical. Even for those students who do not pursue a business career, legal problems will arise. Thus, a solid background in business law is essential for everyone.

In Business Law: Text and Exercises, Ninth Edition, we present business law in a straightforward, practical manner. The essential aspects of every important topic are covered without overburdening the reader with numerous details and explana- tions of arcane exceptions.

What’s New in the Ninth edition Instructors have come to rely on the coverage, accuracy, and applicability of Busi- ness Law: Text and Exercises. That is why in the Ninth Edition we continue to focus on engaging student interest and providing a basic understanding of busi- ness law. In every chapter, we have incorporated significant new details, timely examples, helpful exhibits, and recent cases.

New Chapter Content To maintain the text’s high-quality, up-to-date content, we have added several new topics and discussions to the Ninth Edition. These content additions include the following: • A new chapter on Mortgages provides a basic explanation of mortgage loans

and the laws and processes that surround them. • The final chapter on International Law now presents a new section on the

emerging area of Space Law. • To reinforce student learning through visual aids, fourteen new Exhibits have

been added to selected chapters. • The chapter discussing employment law now includes new sections on Worker

Protections and Employee Privacy. • The coverage of corporations has been expanded to include new sections on

Sales of Securities, Corporate Ownership, Share Exchanges, and Takeover Attempts.

All-New Pedagogy The Ninth Edition complements its new content coverage with new pedagogical content. To provide students with a variety of study tools for retaining and review- ing chapter materials, we made the following additions and changes: • A new section, titled Straight to the Point, in every chapter features five to

seven questions that focus on important points in the chapter content. These straightforward questions provide pedagogical variety while helping students retain important business law terms and topics.

Preface to the Instructor

xiii

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xiv P R E F A C E T O T H E I N S T R u C T O R

• A new Ethical Question based on a recent court case in every chapter helps emphasize the importance of ethics in business.

• Every chapter presents all-new Real Cases, which are based on 2016 or 2017 cases (formerly titled Real-World Case Examples). Students can quickly read through the Real Cases to see how courts apply legal principles to everyday business scenarios.

• We have added more than forty new Highlighting the Point features. These features help students understand how business law can apply to common situations.

• We have added more than twenty new Conflict Presented/Conflict Resolved features (formerly titled Facing/Answering a Legal Problem). Each chapter opens with a brief legal Conflict Presented scenario and question. At the end of the chapter, the Conflict Resolved feature answers the Conflict Presented question.

• Examples are very helpful for students because they illustrate and clarify legal principles. We have added more than forty new Numbered Examples through- out the text.

• This edition includes forty-three new Real Law case problems (formerly called Real-World Case Problems). Most are based on 2016 cases.

Other Significant Revisions Along with engaging new content and pedagogy, the Ninth Edition also boasts significant revisions and updates. To help students comprehend the more complex concepts of business law, we have removed legalese and reorganized content for better flow and understanding. To accomplish this editorial objective, we have revised some chapters. • For smoother organization and more focused business law coverage, we have

created four new chapters on Business Torts, Business Crimes, Personal Prop- erty, and Bailments by splitting chapters from the previous edition.

• In Unit 6, on Business Organizations, the coverage of Corporations has been expanded to three chapters to simplify coverage and introduce new topics and discussions.

• A complete revision of the chapter on Bankruptcy Law makes the content less confusing and easier to follow. The chapter now focuses on three common types of bankruptcy—Chapter 7, 11, and 13—and emphasizes the bank- ruptcy basics.

• Chapter 32, titled Security Interests and Creditors’ Remedies, combines two chapters from the previous edition. The chapter has been condensed for a clear, layperson-oriented discussion of risk and credit in today’s business world.

Additional practical Learning Tools To help students review chapter materials and prepare for testing, this text provides additional effective, practical features: • Learning Outcomes—Every chapter starts with four to six Learning Outcomes.

This edition includes thirty new Learning Outcomes. Each Learning Outcome is repeated in the margin at the point where it is discussed in the text. Addi- tionally, each Chapter Summary includes that chapter’s Learning Outcomes with a succinct review of the major points students need to remember.

• Linking Business Law to Your Career—Written in an easy-to-understand style, these features emphasize tips, pitfalls, and effective strategies for students

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xvP R E F A C E T O T H E I N S T R u C T O R

to remember once they are working and applying their knowledge of basic business law to real-life workplace scenarios. In selected chapters, these fea- tures often reflect new business developments and examples.

• Work Sets—At the end of every chapter, there is a tear-out sheet called a Work Set, which features true-false and multiple-choice questions, plus an Answering More Legal Problems fill-in-the-blank feature. This in-text study guide helps students review the material covered in the chapter.

• Issue Spotters—The Issue Spotters provide students with two hypothetical sit- uations that end with questions related to the chapter topics. Students answer these questions by reviewing the topic material. They can then compare their answers with those provided in Appendix A at the end of this book.

• Glossary—For students’ convenient reference, each boldfaced key term throughout the text is defined in the Glossary.

supplements Business Law: Text and Exercises, Ninth Edition, provides a comprehensive supple- ments package. The supplements were created with a single goal in mind: to make the tasks of teaching and learning more enjoyable and efficient. The following supplements are available for instructors.

MindTap Business Law for Business Law: Text & Exercises, Ninth Edition MindTap™ is a fully online, highly personalized learning experience built upon authoritative Cengage Learning content. By combining readings, multimedia, activities, and assessments into a singular Learning Path, MindTap guides students through their course with ease and engagement. Instructors personalize the Learn- ing Path by customizing Cengage Learning resources and adding their own content via apps that integrate into the MindTap framework seamlessly with Learning Management Systems.

Business law instructors have told us it is important to help students Prepare for class, Engage with the course concepts to reinforce learning, Apply these concepts in real-world scenarios, and use legal reasoning and critical thinking to Analyze business law content. Accordingly, the Business Law MindTap product provides a four-step Learning Path designed to meet these critical needs while also allowing instructors to measure skills and outcomes with ease. • Prepare—Interactive worksheets are designed to prepare students for class-

room discussion by ensuring that they have read and understood the reading. • Engage—Real-world videos with related questions help engage students by

displaying the relevance of business law in everyday life. • Apply—Brief hypothetical case scenarios help students to practice spotting

issues and applying the law in the context of short factual scenarios. • Analyze—Case-problem analysis promotes deeper critical thinking and legal

reasoning by building on acquired knowledge. These exercises guide students step by step through a case problem and then add in a critical-thinking section based on “What If the Facts Were Different?” Each and every item in the Learning Path is assignable and gradable. This gives

instructors the knowledge of class standings and concepts that may be difficult. Additionally, students gain knowledge about where they stand—both individually and compared to the highest performers in class. MindTap also includes: • Case Collection—Instructors can find more than 1,600 additional cases

included in several previous editions of all Cengage Business Law or Legal

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xvi P R E F A C E T O T H E I N S T R u C T O R

Environment texts. These cases are searchable by name, year, state, and subject matter.

• Adaptive Test Prep—Students can generate their own practice quizzes with questions similar to those found on most exams. To view a demo video and learn more about MindTap, please visit www.cengage

.com/mindtap.

Cengage Learning Testing Powered by Cognero Cengage Learning Testing Powered by Cognero is a flexible, online system that allows instructors to do the following: • Author, edit, and manage Test Bank content from multiple Cengage Learning

solutions. • Create multiple test versions in an instant. • Deliver tests from their Learning Management System (LMS), classroom, or

wherever they want.

Start Right Away! Cengage Learning Testing Powered by Cognero works on any operating system or browser. • No special installs or downloads are needed. • Create tests from school, home, the coffee shop—anywhere with Internet

access.

What Instructors Will Find • Simplicity at every step. A desktop-inspired interface features drop-down

menus and familiar intuitive tools that take instructors through content cre- ation and management with ease.

• Full-featured test generator. Create ideal assessments with a choice of fifteen question types—including true/false, multiple choice, opinion scale/Likert, and essay. Multi-language support, an equation editor, and unlimited metadata help ensure instructor tests are complete and compliant.

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

Instructor’s Companion Website The Instructor’s Companion Website for Business Law: Text and Exercises, Ninth Edition, contains the following supplements: • Instructor’s Manual. The Instructor’s Manual contains all of the answers to

the Issue Spotters, Sraight to the Point questions, Real Law case problems, and Ethical Questions. In addition, it provides the answers to each chapter’s Work Set.

• Test Bank. The comprehensive Test Bank contains multiple-choice, true-false, and short essay questions. More than 30 percent of the material in the Test Bank is either new or has been upgraded.

• PowerPoint Slides. For more details, contact your Cengage Learning sales representative.

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Acknowledgments Business Law: Text and Exercises could never have been written without the extremely helpful criticisms, comments, and suggestions that we received from the following professors on the previous editions:

Helena Armour Southwestern College of Business

David Blumberg LaGuardia Community College–CUNY

Daniel Burnstein Gibbs College

Jeffrey S. Chase Clinton Community College

Jack R. Day Sawyer College

Diamela delCastilla University of Miami

Nancy K. Dempsey Cape Cod Community College

Joseph L. DeTorres Contra Costa College

Lucy Dorum Clover Park Technical College

Greg Drummer Stone Child College

John Elger Georgia State University

Austin Emeagwai Lemoyne Owen College

Linda Ferguson Virginia Wesleyan College

Gary Grau Northeast State Community College

Myrna Gusdorf Linn-Benton Community College

Michael Harford Morehead State University

James P. Hess Ivy Technical State College

Sharon J. Kingrey City College

Doris K. Loes Dakota County Technical College

Margaret A. Lourdes Cleary University–Howell/Ann Arbor

John F. Mastriani El Paso Community College

Arin S. Miller Keiser University

Seymour D. Mintz Queens College

Karen S. Mozengo Pitt Community College

Barb Portzen Mid-State Technical College

Alan Questall Richmond Community College

J. Kent Richards Lake Superior College

Susan Rubisch-Gisler Carlow University

Harold V. Rucker Cuyamaca College

Steve Schneider Lake Superior College

Mary T. Sessom Cuyamaca College

Tom Severance Mira Costa College

Gary T. Shara California State University–Monterey

Bay

Brenda A. Siragusa Corinthian College

Deborah Vinecour SUNY Rockland Community College

Al Walczak Linn-Benton Community College

Ron Weston Contra Costa College

Roger D. Westrup Heald Business College

Frederick D. White Indian River Community College

P R E F A C E T O T H E I N S T R u C T O R xvii

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xviii

Timothy G. Wiedman Thomas Nelson Community College

Tom Wilson Remington College

The staff at Cengage Learning went out of their way to make sure that the Ninth Edition of Business Law: Text and Exercises came out in accurate form. In particu- lar, we wish to thank Bryan Gambrel and Vicky True-Baker for their countless new ideas, many of which have been incorporated into this new edition.

We also extend special thanks to Sarah Huber, our content developer, for her many useful suggestions and for her efforts in coordinating reviews and ensuring the timely and accurate publication of all supplemental materials.

Our senior content project manager, Martha Conway, made sure that we had a visually attractive edition. We will always be in her debt. We are also indebted to project managers Ann Borman and Alison Kuzmickas at SPi Global, our composi- tor. Their ability to generate the pages for this text quickly and accurately made it possible for us to meet our ambitious printing schedule.

The copyediting services of Beverly Peavler and the proofreading services of Jeanne Yost will not go unnoticed. We also thank Vickie Reierson for her proofread- ing and project management assistance. Thank you to Leoni McVey for her detailed and thorough work on the Table of Cases and Index. Finally, our appreciation goes to Roxanna Lee and Suzanne Jasin for their special efforts on the project.

We know we are not perfect. If you find something you don’t like or want us to change, write to us via e-mail, using the text’s website. That is how we can make Business Law: Text and Exercises an even better book in the future.

R.L.M. W.E.H.

P R E F A C E T O T H E I N S T R u C T O R

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DeDication

To Clyde, Whose mastery of all things in publishing continues to live on. Thanks for everything.

—R. L. M.

Para mi esposa, Luisa, y mi hijas, Sandra y Mariel, con mucho amor.

—W. E. H.

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Chapter 1 Introduction to the Law

Chapter 2 Ethics in Business

Chapter 3 The Courts and Our Legal System

Chapter 4 Constitutional Law

Chapter 5 Business Torts

Chapter 6 Intellectual Property

Chapter 7 Business Crimes

Unit Contents

The Law and Our Legal System

UNIT 1

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2

1

2

3

4

1 Introduction to the Law

Persons entering the world of business today will find themselves subject to numerous laws and government regulations. An acquaintance with these laws and regulations is beneficial—if not essential—to anyone contemplating a successful career in business.

In this introductory chapter, we look at the nature of law in general. We also examine the history and sources—both domestic and international—of American law in particular.

1–1 What Is Law? The British jurist William Blackstone (1723–1780) described law as “a rule of civil conduct, . . . commanding what is right, and prohibiting what is wrong.” There are many sets of rules that declare what is right and what is wrong. These may come from religion, philosophy, and other scholarly sources, or arise from peer pressure, customs, and other social conventions.

Only rules enacted by the government apply with equal force to all of the individu- als in a society, however. Of course, these rules are effective only if they are enforced with penalties when they are broken. Thus, the law consists of enforceable rules governing relationships among individuals and between individuals and their society.

1–2 Business Activities and the Legal Environment

To make good business decisions, knowledge of the laws and regulations govern- ing business is essential. Businesspersons must also develop critical thinking and reasoning skills to evaluate how the law might apply in a given situation and deter- mine the best course of action. Businesspersons are also pressured to make ethical decisions. Thus, the study of business law involves an ethical dimension.

LEArNINg OUTcOmEs

The four Learning Outcomes below are designed to help improve your understanding of the chapter. After reading this chapter, you should be able to:

Define law.

List the major sources of law.

Identify the supreme law of the land.

Distinguish different legal systems.

Conflict Presented Max owns photos and other art depicting the Beatles. Max does business through his website, thebeatlesartwork.com. Apple Corps, Ltd., owns trademarks—including “The Beatles”—that it

uses to sell merchandise related to the group. Alleging trademark infringement, Apple Corps files a suit against Max.

Q can Apple corps obtain a court order to stop max’s use of “The Beatles” and recover payment for its lost sales due to that use?

LEArNINg OUTcOmE 1

Define law.

law Enforceable rules governing individuals and their society.

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C H A P T E R 1 Introduction to the Law 3

1–2a Many Different Laws May Affect a Single Business Transaction

As you will see, each chapter in this textbook covers a specific area of the law and shows how the legal rules in that area affect business activities. It is important to remember, however, that many different laws may apply to just one transaction.

Businesspersons should be aware of this and understand enough about the law to know when to hire an expert for advice. See the Linking Business Law to Your Career feature at the end of this chapter for more on this topic.

If a dispute cannot be resolved amicably, then a lawsuit may become necessary. At that point, it is also important to know about the laws and the rules concerning courts and court procedures.

lawsuit A judicial proceeding for the resolution of a dispute.

Highlighting the Point

Mark Zuckerberg starts Facebook when he is a student at Harvard University. Later, oth- ers who attended Harvard at the same time assert that Zuckerberg stole their idea for a social networking website. Meanwhile, Facebook users contend that the company tracks their website visits and scans their messages to mine data to sell to advertisers.

What are some legal issues Zuckerberg and his company could face? The fellow stu- dents may have a claim against Zuckerberg in areas of the law that concern intellec- tual property, contracts, and partnerships. Facebook could also face a class action lawsuit for violating its users’ privacy. Such an action could be brought under tort law, contract law, or constitutional law. Lastly, Facebook could be subject to action for claims by certain federal regulators, which would be based in administrative law.

class action lawsuit A lawsuit in which a number of persons join together.

1–2b The Role of the Law in a Small Business Some of you may end up working in, or owning and operating, a small business. The small-business owner is the most general of managers. When you seek additional financing, you become a finance manager. As you go over the books, you become an accountant. When you direct an advertising campaign, you are the marketing manager.

When you have employees and determine salaries and benefits, you become a human resources manager. Each of these roles has a link to the law. Exhibit 1.1 shows some of the legal issues that can arise in managing a small—or large— business.

1–3 sources of American Law To understand the law, you need to have some understanding of its origins. One major source is the common law tradition that originated in medieval England. Another is constitutional law, which includes the U.S. Constitution and the con- stitutions of the states. Statutes—the laws enacted by Congress and the state legislatures— comprise an additional source of American law. Finally, yet another source of American law is administrative law, which consists of the regulations created by administrative agencies.

1–3a The Common Law In medieval England, the courts established a uniform set of rules from the customs and traditions that had been in force in various regions of the nation. These rules— and the principles behind them—were applied to resolve similar disputes in a consis- tent way. Each application served as a guide for future decisions—a legal precedent.

LEArNINg OUTcOmE 2

List the major sources of law.

precedent A court decision that guides subsequent decisions.

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U n i t 1 The Law and Our Legal System4

Over several centuries, these decisions developed into a body of common law. The English colonists brought this law to America and set up legal systems based on the common-law method of deciding disputes. When the United States was formed, these legal systems were the model for the new nation’s courts.

Today, the common law is still a significant source of legal authority. This body of law—sometimes referred to as case law—includes court interpretations of con- stitutional provisions, statutes enacted by legislatures, and regulations issued by administrative agencies.

common law A body of law developed from court decisions.

case law Rules of law announced in court decisions.

Real Case

Rosa Parks refused to give up her seat on a bus to a white man in violation of a law in Montgomery, Alabama. This event sparked the modern Civil Rights Movement. Her role has been chronicled in books and movies, and featured on mementoes, some of which are offered for sale by Target Corp. The Rosa and Raymond Parks Institute for Self Development is a Michigan firm that owns Parks’s name and likeness. The Institute

Exhibit 1.1 Linking Business Law to the Management of a Small Business

Business Organization What is the most appropriate business organizational form,

and what type of personal liability does it entail?

Taxation How will the small business be taxed, and are there ways to reduce those taxes?

Intellectual Property Does the small business have any patents or other intellectual

property that needs to be protected, and if so, what steps should the �rm take?

Administrative Law What types of government regulations apply to the

business, and what must the �rm do to comply with them?

Employment Does the business need an employment manual,

and does management have to explicitly inform employees of their rights?

Contracts, Sales, and Leases Will the �rm be regularly entering into contracts with others, and if so, should it hire an attorney to review those contracts?

Accounting Do the �nancial statements created by an accountant need to be veri�ed for accuracy?

Finance What are appropriate and legal ways to raise

additional capital so that the business can grow?

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C H A P T E R 1 Introduction to the Law 5

filed a lawsuit against Target, alleging a violation of Michigan’s common law. The court dismissed the suit. The Institute appealed.

Did michigan’s common law protect Target’s sales of merchandise that depicted or discussed rosa Parks and the modern civil rights movement? Yes. In Rosa and Raymond Parks Institute for Self-Development v. Target Corp., the U.S. Court of Appeals for the Eleventh Circuit affirmed the dismissal. Michigan’s common law prohibits the use of a person’s name or likeness without his or her consent. But the state’s common law also includes a “privilege to communicate on matters of public interest. . . . Rosa Parks is a figure of great historical significance and the Civil Rights Movement a matter of . . . the highest public interest.” Target’s sales fell within this privilege.

—812 F.3d 824 (11th Cir.)

The Doctrine of Precedent—Stare Decisis The practice of deciding new cases with reference to previous decisions, or precedents, forms a doctrine called stare decisis (pronounced ster-ay dih-si-ses), which means “to stand on decided cases.” According to this doctrine, a judge is obligated to follow the precedents established within her or his jurisdiction.

This practice is a cornerstone of the U.S. judicial system. The doctrine helps courts to be more efficient, and makes the law more stable and predictable. Some- one bringing an action in a court can expect a result based on how the law has been applied in cases with similar facts.

Departures from Precedent A court may decide that a precedent is incorrect or that a change in society or technology has rendered it inapplicable. In that case, the court may rule contrary to the precedent.

Sometimes, there is no precedent, or there are conflicting precedents. In these situations, a court may base a decision on the principles announced in other court decisions. The court may also consider public policy, social values, or concepts and data from other fields of knowledge.

Equity A person brings a case to a court of law seeking a remedy, or relief from a wrong. Usually, that remedy is damages—the payment of money.

ExamplE 1.1 Elena is injured because of Rowan’s wrongdoing. If Elena files a lawsuit and is successful, a court can order Rowan to compensate Elena for the harm by paying her a certain amount of money (damages). The compensation is Elena’s remedy. j

Money may not always be enough to make a situation right, however. Equity is a branch of the law that seeks to supply a fairer and more adequate remedy in such a case. For instance, a court might issue an injunction to order a party to do specifically what he or she promised. Or a contract might be cancelled and the contracting parties returned to the positions they held before the deal.

Two distinct systems of courts were created to grant the different types of rem- edies. A court of law could award only damages. A court of equity could provide other relief. Today, in most states, the courts of law and equity are merged. A court may now grant either a legal or an equitable remedy, or both, in the same action.

1–3b Constitutional Law The federal government and the states have separate constitutions that set forth the general organization, powers, and limits of their governments. The U.S. Con- stitution is the supreme law of the land. A law in violation of the Constitution, no matter what its source, will not be enforced.

Each state has its own constitution. Unless it conflicts with the U.S. Constitution, a state constitution is supreme within the state’s borders.

stare decisis A doctrine under which judges must follow established precedents.

jurisdiction The authority of a court to decide a specific dispute.

action A court proceeding to enforce or protect a right, or redress or prevent a wrong.

remedy The means to enforce a right or compensate for a wrong.

damages Money sought as a remedy for a harm suffered.

injunction A court order to do or not do a certain act.

LEArNINg OUTcOmE 3

Identify the supreme law of the land.

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U n i t 1 The Law and Our Legal System6

Highlighting the Point

The U.S. Constitution gives Congress the authority to regulate businesses involved in interstate commerce. Under this authority, Congress enacts a law prohibiting busi- nesses from refusing to deal with the members of minority groups. Later, a state leg- islature enacts a law allowing businesses in the state to refuse to deal with members of the groups. Jill, a member of a minority group, brings an action against the state to stop the enforcement of the new state law.

Is the state law valid? No. The law violates the U.S. Constitution because it attempts to regulate an area over which the Constitution gives authority to the federal govern- ment. The law also violates the constitutional rights of the members of any minority group against which it discriminates. The court can order the state to stop its enforce- ment of the law.

statutory law Laws enacted by a legislative body.

1–3c Statutory Law Statutes enacted by Congress and the state legislative bodies make up another source of law, generally referred to as statutory law. Statutory law also includes the ordinances passed by cities and counties. None of these can violate the U.S. Constitution or the relevant state constitution.

Today, legislative bodies and regulatory agencies assume an ever-increasing share of lawmaking. Much of the work of modern courts consists of interpreting what the rulemakers meant when a law was passed and applying the law to a present set of facts.

Uniform Laws State laws differ from state to state. During the 1800s, the differences among state laws made trade and commerce among the states difficult. To counter these problems, a group of legal scholars and lawyers formed the National Conference of Commissioners on Uniform State Laws (NCCUSL). This organization began to draft uniform laws for the states to adopt.

Each state has the option of adopting or rejecting a uniform law. A state legisla- ture may choose to adopt only part of a uniform law or to rewrite the sections that are adopted. Hence, even though many states may adopt a uniform law, the law may not be “uniform” across all these states. Once adopted by a state, a uniform act becomes a part of the statutory law of that state.

The Uniform Commercial Code (UCC) In 1932, the Uniform Commercial Code (UCC) was created through the joint efforts of the NCCUSL and the American Law Institute. The UCC has been adopted in forty-nine states, the District of Columbia, and the Virgin Islands. Louisiana has adopted Articles 1, 3, 4, 5, 7, 8, and 9. The UCC facilitates commerce among the states by providing a uniform, yet flexible, set of rules governing commercial transactions.

1–3d Administrative Law administrative law consists of the rules, orders, and decisions of administra- tive agencies. An administrative agency is a federal, state, or local government body established to perform a specific function. Congress or a state legislature charges these departments, commissions, and boards with carrying out the terms of particular laws.

administrative law The rules, orders, and decisions created by administrative agencies.

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C H A P T E R 1 Introduction to the Law 7

Rules issued by administrative agencies affect almost every aspect of a business’s operations. Regulations govern a business’s capital structure and financing, hiring and firing procedures, relations with employees and unions, and making and sell- ing of products.

1–4 civil Law versus criminal Law The huge body of the law is broken down into several classifications. One impor- tant classification divides law into civil law and criminal law.

Civil law spells out the rights and duties that exist between persons and between citizens and their governments. In a civil case, one party tries to make the other party comply with a duty or pay for the damage caused by a failure to do so. Con- tract law is part of civil law.

ExamplE 1.2 If Craig fails to perform a contract with Mary, she may bring a lawsuit against Craig. The purpose of the lawsuit will be either to compel Craig to perform as promised or, more commonly, to obtain monetary damages for Craig’s failure to perform. j

Criminal law has to do with a wrong committed against the public as a whole. Criminal acts are prohibited by local, state, or federal government statutes. In a criminal case, the government seeks to impose a penalty (a monetary penalty and/or imprisonment) on an allegedly guilty person.

1–5 National Law around the World The common law system practiced in the United States is one of the major legal systems of the world. Other countries that were once colonies of Great Britain—such as Australia, Canada, and India—generally also use common law systems.

Many nations employ a civil law system, however. The basis of the system is codified law—a set of legal principles enacted into law by a legislature. The pri- mary source of law is a statutory code. Precedents do not bind courts, although previous decisions may serve as guidance for judges. Most European nations, along with many countries that were once their colonies, use civil law systems. In the United States, Louisiana has a civil law system, due to the state’s historical ties to France.

1–6 International Law International law can be defined as a body of written and unwritten laws observed by independent nations in their relations with other nations. It governs the acts of individuals as well as governments. International customs and treaties are generally considered to be two of the most important sources of international law.

The key difference between international law and national law (the law of a particular nation) is that national law can be enforced by government authorities. No such authority exists to enforce international law. The only methods to obtain compliance are persuasive tactics, such as sanctions, by other countries or interna- tional organizations.

International law must accommodate two conflicting goals of individual nations. Every nation desires to benefit economically from its dealings with individuals and other nations. At the same time, each nation is motivated

civil law Law that defines and enforces all private and public rights, as opposed to criminal matters.

criminal law Law that defines crimes and subjects criminals to punishment.

LEArNINg OUTcOmE 4

Distinguish different legal systems.

civil law system A legal system based on a statutory code.

international law The law that governs relations among nations.

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U n i t 1 The Law and Our Legal System8

Linking Business Law to Your Career

Consulting an ExpErt for adviCE

Whether you own a business or work for one, you will face many issues that touch on subjects about which you know little. Not every manager is aware of all the information needed to man- age a business. It is therefore necessary for you to know when to ask for advice from experts.

With respect to the law, you may know enough about the law to pre- vent a potential legal dispute simply by taking the appropriate action. In other circumstances, however, the best alter- native will be to seek outside counsel.

Why consult a Legal Expert?

It is not possible to keep up with the variety of statutes, rules, and

regulations that affect the conduct of business in the United States. This problem only gets worse with laws that concern doing business on a global scale. It is possible to break a law without knowing that a law has been broken.

The general standard for compliance with the law is “good faith,” but at any time, an issue may arise that can only be resolved with special expertise. When your business’s reputation and profits are on the line, there is no substitute for the right advice.

How can You Find an Attorney?

To choose an attorney for an issue that affects your employer’s business, first

ask for your employer’s recommenda- tions. There may be an advocate who works for your organization or with whom your employer consults on a reg- ular basis.

To find an attorney for a ques- tion that concerns your own business, obtain the recommendations of your friends, relatives, or business associates. Ask for endorsements from those who have had long-standing relationships with their attorneys.

Other sources of referrals include your local or state bar association and online directories.

Conflict Resolved In the Conflict Presented feature at the beginning of this chapter, Max sells art depicting the Beatles through a website, thebeatlesartwork.com. Apple Corps, Ltd., owns the trademark

“The Beatles,” which Apple Corps uses to sell its own products related to the group. Alleging trademark infringement, Apple Corps files a lawsuit against Max.

a Can apple Corps get a court order to stop max’s use of “The Beatles” and recover payment for lost sales due to that use? Yes. A court can grant both types

of remedies in a single case. Max infringed the “The Beatles” trademark. The court can

issue an injunction to stop him from using “The Beatles” in his business and domain

names. Apple Corps also provides evidence that shows a big decrease in the company’s

revenue during Max’s infringing use. The court can order Max to pay Apple Corps for

its lost sales.

by a need to be the final  authority over its own affairs. International law attempts to balance these national desires and needs. And individual nations agree to be governed by international law in some respects to benefit from international trade.

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C H A P T E R 1 Introduction to the Law 9

1. Under what circumstances might a judge rely on case law to determine the intent and purpose of a statute? (see Sources of American Law.)

2. The First Amendment of the U.S. Constitution pro- tects the free exercise of religion. A state legislature

enacts a law that outlaws all religions that do not derive from the Judeo-Christian tradition. Is this state law valid? Why or why not? (see Sources of American Law.)

issUe sPotteRs Check your answers to the Issue Spotters against the answers provided in Appendix A at the end of this text.

stRaigHt to tHe Point

1. Why is knowledge of business law essential for any busi- nessperson? (see Business Activities and the Legal Environment.)

2. What is the common law? (see Sources of American Law.) 3. When and why does a court apply the decision of

another court to determine the result in a case? (see Sources of American Law.)

4. What are some of the remedies that a party can obtain from a court to make a wrong situation right? (see Sources of American Law.)

5. Which aspects of a business’s operation do the rules, orders, and decisions of administrative agencies affect? (see Sources of American Law.)

LEArNINg OUTcOmE 1: Define law. Law consists of enforceable rules governing relationships among individuals and between individuals and their society.

LEArNINg OUTcOmE 2: List the major sources of law. The common law consists of past judicial decisions. According to the doctrine of stare decisis, these decisions are applied to resolve current disputes.

Constitutional law is the law expressed in the U.S. Constitution and the various state constitutions. Statutory law consists of laws or ordinances created by federal, state, or local legislatures and governing bodies.

LEArNINg OUTcOmE 3: Identify the supreme law of the land. The U.S. Constitution is the supreme law of the land. State constitutions are supreme within state borders to the extent that they do not violate the U.S. Constitution or a federal law. No federal, state, or local statute or ordinance can violate the U.S. Constitution or the relevant state constitution.

LEArNINg OUTcOmE 4: Distinguish different legal systems. The common law system involves the practice of deciding new cases with reference to previous decisions, or precedents. A judge is obligated to follow the precedents established within her or his jurisdiction.

The civil law system is a legal system in which the primary source of law is a statutory code—a set of legal principles enacted into law by a legislature or governing body. Precedents are not binding in a civil law system.

CHaPteR sUmmaRY—intRodUCtion to tHe Law

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U n i t 1 The Law and Our Legal System10

etHiCaL QUestions

1–4. Anticipation of Legal Problems. Should legal problems be anticipated? Why and why not? (see Business Activities and the Legal Environment.)

1–5. The Doctrine of Precedent. Sandra White operated a travel agency. To obtain lower airline fares for her non military clients, she booked military-rate travel by forwarding fake military identification cards to the airlines. The U.S. govern- ment charged White with identity theft, which requires the “use” of another’s identification. As background, the court in the White case had two cases that represented precedents.

In the first case, David Miller obtained a loan to buy land by representing that certain investors had approved the loan when, in fact, they had not. Miller’s conviction for identity

theft was overturned because he had merely said that the investors had done something when they had not. According to the court, this was not the “use” of another’s identification.

In the second case, Kathy Medlock, an ambulance service operator, had transported patients for whom there was no medical necessity to do so. To obtain payment, Medlock had forged a physician’s signature. The court concluded that this was “use” of another person’s identity. Which precedent—the Miller case or the Medlock case—is similar to White’s situa- tion, and why? How would you describe the parties’ ethics in all of these cases? Discuss. [United States of America v. Sandra Maxine White, 846 F.3d 170 (6th Cir. 2017)] (see Sources of American Law.)

ReaL Law

1–1. Stare Decisis. A patent is an exclusive right granted to the creator of an invention. Under U.S. law, a patent owner possesses that right for twenty years. The owner can allow another party to make and market a product based on the invention in exchange for a payment of royalties on the sales. According to the United States Supreme Court in a case known as the Brulotte decision, a contract to pay roy- alties after a patent has expired is unenforceable. Stephen Kimble owned the patent to a toy glove that could shoot foam intended to look like the web of Marvel Comics’ Spider-Man. Kimble agreed to allow Marvel Entertainment, LLC, to sell its version of the toy. Marvel agreed to pay Kimble a royalty of 3 percent on the sales. Their contract did not specify an end date. After the patent expired, Marvel sued to stop the payments. What is the doctrine of stare decisis? What are the arguments for and against applying it in this case? Discuss. [Kimble v. Marvel Entertainment, LLC, 135 S.Ct. 2401, 192 L.Ed.2d 463 (2015)] (see Sources of American Law.)

1–2. role of Law. Otto May, Jr., a pipefitter for Chrysler Group, LLC, was the target of racist, homophobic, and

anti-Semitic remarks. He received death threats, his bike and car tires were punctured, and someone poured sugar into the gas tank of his car. A dead bird was placed at his workstation wrapped in toilet paper to look like a member of the Ku Klux Klan. Chrysler documented and investigated the incidents. Records were checked to determine who was in the building when the incidents occurred, the graffiti handwriting was examined, and employees were reminded that harassment was not acceptable. What role might the law play in these circumstances? Discuss. [May v. Chrys- ler Group, LLC, 716 F.3d 963 (7th Cir. 2013)] (see Business Activities and the Legal Environment.)

1–3. constitutional Law. Under a Massachusetts statute, large wineries could sell their products through wholesalers or to consumers directly, but not both. Small wineries could use both methods. Family Winemakers of California filed a suit against the state, arguing that this restriction gave small wineries a competitive advantage in violation of the U.S. Constitution. Which source of law takes priority, and why? [Family Winemakers of California v. Jenkins, 592 F.3d 1 (1st Cir. 2010)] (see Sources of American Law.)

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11

Chapter 1—work set

1. Law consists of enforceable rules governing relationships among individuals and between individuals and their society.

2. Stare decisis refers to the practice of deciding new cases with reference to previous decisions.

3. The doctrine of stare decisis illustrates how unpredictable the law can be.

4. Common law is a term that normally refers to the body of law consisting of rules of law announced in court decisions.

5. Statutes are a primary source of law.

6. Administrative rules and regulations have virtually no effect on the operation of a business.

7. Each state’s constitution is supreme within that state’s borders even if it conflicts with the U.S. Constitution.

8. The Uniform Commercial Code was enacted by Congress for adoption by the states.

9. In most states, the same courts can grant both legal and equitable remedies.

tRUe-FaLse QUestions

1. The doctrine of stare decisis performs many useful functions, including

a. efficiency. b. uniformity. c. stability. d. all of the above.

2. In addition to case law, when making decisions, courts sometimes consider other sources of law, including

a. the U.S. Constitution. b. state constitutions. c. administrative agency rules and regulations. d. all of the above.

3. Which of the following is a CORRECT statement about the distinction between law and equity?

a. Equity involves remedies different from those available at law. b. Most states maintain separate courts of law and equity. c. Damages may be awarded only in actions in equity. d. None of the above.

4. Under the doctrine of stare decisis, a judge compares the facts in a case with facts in

a. another case. b. a hypothetical case. c. the arguments of the parties involved in the case. d. none of the above.

5. To learn about the coverage of a statute and how the statute is applied, a person must

a. only read the statute. b. only see how courts in his or her jurisdiction have interpreted the statute. c. read the statute and see how courts in his or her jurisdiction have interpreted it. d. none of the above.

mULtiPLe-CHoiCe QUestions

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12

6. Our common law system involves the application of legal principles applied in earlier cases

a. with different facts. b. with similar facts. c. whether or not the facts are similar. d. none of the above.

7. The statutory law of the United States includes

a. the statutes enacted by Congress and state legislatures. b. the rules, orders, and decisions of administrative agencies. c. both the statutes enacted by Congress and state legislatures and the rules, orders, and decisions of administrative

agencies. d. none of the above.

8. The U.S. Constitution takes precedence over

a. a provision in a state constitution or statute only. b. a state supreme court decision only. c. a state constitution, statute, or court decision. d. none of the above.

9. Civil law concerns

a. duties that exist between persons or between citizens and governments. b. wrongs committed against the public as a whole. c. both a and b. d. none of the above.

10. In a civil law system, the primary source of law is

a. case law. b. the decisions of administrative agencies. c. a statutory code. d. none of the above.

1. Dark Brew and Sparkling Ale are competitors in the microbrewing industry. To market their competing wares, they use Facebook, Twitter, and other social media. A dispute arises between these parties over the statements each makes about the other through these sites. Dark Brew files a suit against Sparkling Ale. The parties argue their respective sides of the dispute, each citing earlier cases that appear to favor their conten- tions. Each party asks the court to consider the princi- ples of law established in these cases to make a decision in this case.

What is the term for these former decisions? Which decisions, if any, is the court obligated to follow? The earlier cases are known as _______________. Later cases that involve similar principles or facts are decided with reference to those _______________. Courts are obligated to follow the _______________ established within their _______________. The doctrine attempts

to harmonize the results in cases with _______________ facts. In other words, the objective is to decide similar cases in a similar way.

2. In Dark Brew and Sparkling Ale’s case, the court fol- lows a doctrine that requires it to review the rules of law established by other courts.

What is the term for the doctrine under which a court reviews the principles suggested by the decisions of other courts in earlier cases? What are the advantages of this practice? The practice of deciding new cases by refer- ring to earlier court decisions is known as the doctrine of _______________ _______________. This practice is a _______________ of the U.S. judicial system. The reasoning in the other courts’ opinions can serve as a guide, allowing a court reviewing the cases to be more _______________. When the law on a subject is well settled, the application of this doctrine makes the law more _______________.

answeRing moRe LegaL PRoBLems

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13

Learning OutcOmes

The four Learning Outcomes below are designed to help improve your understanding of the chapter. After reading this chapter, you should be able to:

Discuss how businesses can discourage unethical behavior.

Explain the relationship between law and ethics.

Compare duty-based ethics and utilitarian ethics.

Identify some ethical problems in the global context.

1

2

3

4

2 Ethics in Business

One of the most complex issues that businesspersons and corporations face is eth- ics. Ethics is not as well defined as the law, and yet it can have a tremendous impact on a firm’s finances and reputation. Consider what happened to Wells Fargo Bank when it imposed sales quotas on employees requiring them to unrealistically open at least ten new accounts a day. Bank managers companywide berated and threat- ened employees, who were told to do whatever it took to reach these quotas. As a result, many employees resorted to opening more than 2 million “new” accounts by transferring funds from customers’ existing accounts without their consent. These unauthorized accounts incurred an estimated $2.5 million in bank fees.

Once this systematic unethical practice was uncovered in 2016, Wells Fargo fired thousands of employees and paid $185 million in fines. Despite this fall-out, the scandal will continue to affect Wells Fargo’s reputation and its bottom line for years to come.

Wells Fargo’s conduct has raised several legal questions, but it clearly also raises questions about ethics in business. Business ethics cannot be taken lightly. This chapter examines its definitions, its philosophical bases, and its application to today’s global business situations.

2–1 the importance of Business ethics Ethics can be defined as the study of what constitutes right or wrong behavior. It is the branch of philosophy that focuses on morality and the way in which moral principles are derived or the way in which a given set of moral principles applies to conduct in daily life.

Ethics has to do with questions relating to the fairness, justness, rightness, or wrongness of an action. What is fair? What is just? What is the right thing to do in this situation? These are essentially ethical questions.

ethics A set of moral principles and values applied to social behavior.

Conflict Presented BMI Food Company makes Chuck Wagon, a plastic-wrapped meal, for children. Chuck Wagon meals consist of food such as bologna, chips, candy, and soda. These combinations provide an

unhealthful mix of fat, sugar, and salt. BMI sells Chuck Wagon by sponsoring television shows directed at children.

Q is Bmi’s making and marketing of chuck Wagon unethical?

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U n i t 1 The Law and Our Legal System14

2–1a What Is Business Ethics? Business ethics focuses on what constitutes right or wrong behavior in the business world. It has to do with how moral and ethical principles are applied by businesspersons to situations that arise in their daily activities in the work- place. Business ethics is not a separate kind of ethics. The ethical standards that guide our behavior as students apply equally well to our activities as businesspersons.

2–1b Why Is Business Ethics Important? Making ethical business decisions is vitally important to the long-run viability of a corporation. A thorough knowledge of business ethics is also important to the well- being of the company’s management and employees. Certainly, corporate decisions and activities can also significantly affect such groups as suppliers, the community, and society as a whole.

2–2 setting the right ethical tone Many unethical business decisions are made simply because they can be made. In other words, the decision makers have the opportunity to make such decisions and are not too concerned about being seriously sanctioned for their unethical actions. Perhaps one of the most difficult challenges for business leaders today is to create the right “ethical tone” in their workplaces.

2–2a The Importance of Ethical Leadership Talking about ethical business decision making means nothing if management does not set standards. Moreover, managers must apply those standards to themselves and to the employees of the company.

One of the most important factors in creating and maintaining an ethical work- place is the attitude of top management. Managers who are not totally committed to maintaining an ethical workplace will rarely succeed in creating one. Employees take their cues from management. If a firm’s managers do not violate obvious ethical norms in their business dealings, employees will be likely to follow that example.

In contrast, if managers act unethically, employees will see no reason not to do so themselves. ExamplE 2.1 Janice works at Granite Software. If Janice observes her manager cheating on his expense account, Janice quickly understands that such behavior is acceptable. j

2–2b Ethical Codes of Conduct One of the most effective ways of setting the tone of ethical behavior within an organization is to create an ethical code of conduct. A well-written code of ethics explicitly states a company’s ethical priorities. Its provisions must be clearly com- municated to employees.

Most large companies and organizations have implemented ethics training programs, seminars, and face-to-face meetings to communicate the importance of ethical conduct to employees. Managers find that applying clear codes of ethics can deter unethical behavior in the workplace, as well as other settings, including university campuses.

business ethics A consensus of what constitutes right or wrong behavior in the world of business.

Learning OutcOme 1

Discuss how businesses can discourage unethical behavior.

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C H A P T E R 2 Ethics in Business 15

2–2c Corporate Compliance Programs In large corporations, ethical codes of conduct are usually just one part of a com- prehensive corporate compliance program. Other components of such a program include a corporation’s ethics committee, ethical training programs, and internal audits to monitor compliance with applicable laws and the company’s standards of ethical conduct.

To be effective, especially in large corporations, a compliance program must be integrated throughout the firm. Ethical policies and programs need to be coordi- nated and monitored by a committee that is separate from other corporate depart- ments. Otherwise, unethical behavior in one department could easily escape the attention of those in control of the business.

2–2d Conflicts and Trade-offs Firms have implied ethical (and legal) duties to a number of groups, including shareholders and employees. Because these duties may conflict, management is constantly faced with ethical trade-offs.

Real Case

Case Western Reserve University requires its students to meet a standard of profession- alism, which includes “ethical behavior.” A Committee on Students determines whether a student meets this requirement. Amir Al-Dabagh was a good student academically, but there had been several complaints about his behavior. The complaints included his sexually harassing fellow students, asking instructors not to mark him late, and being convicted of driving while intoxicated. The committee refused to certify Al-Dabagh for graduation and dismissed him from the university. Al-Dabagh filed a lawsuit in a federal district court against Case Western, alleging a breach of good faith and fair dealing. The court ordered the school to issue a diploma. Case Western appealed.

should the court defer to the university’s determination that its student lacked the professionalism required to graduate? Yes. In Al-Dabagh v. Case Western Reserve Univer- sity, the U.S. Court of Appeals for the Sixth Circuit reversed the lower court’s order. The committee’s finding that Al-Dabagh lacked professionalism and its refusal to approve him for graduation were academic judgments. The appellate court would overturn such a decision only if Case Western had substantially departed from accepted academic norms. This did not occur and Case Western did not deal unfairly with Al-Dabagh.

—777 F.3d 355 (6th Cir. Ohio)

Highlighting the Point

Mooseback Outfitters, Inc., a national retailer of outdoor gear and apparel, decides to reduce costs by downsizing and restructuring its business model. While this deci- sion may benefit the company’s stockholders, it will have a direct impact on those employees who are laid off. Mooseback’s president suggests laying off the most senior employees, while other managers recommend making the cuts in jobs with younger employees. It is not illegal to fire senior employees, but ethical issues arise when making such decisions.

(Continues)

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U n i t 1 The Law and Our Legal System16

2–3 the sarbanes-Oxley act Congress enacted the Sarbanes-Oxley Act to help reduce corporate fraud and unethical management decisions. Among other things, the act calls for a greater degree of government oversight of public accounting practices.

2–3a The Public Company Accounting Oversight Board To this end, the act created the Public Company Accounting Oversight Board. Generally, the duties of the board are as follows: 1. To oversee the audit of companies, or issuers, whose securities are sold to public

investors in order to protect the interests of investors and the public. 2. To register public accounting firms that prepare audit reports for issuers. The board also establishes standards relating to the preparation of audit reports for issuers.

2–3b Enforcement and Penalties To enforce compliance, the board can inspect registered public accounting firms, investigate firms that violate the act, and discipline those firms by imposing sanc- tions. Sanctions range from temporary or permanent suspension to civil penalties that can be as high as $15 million for intentional violations.

The Sarbanes-Oxley Act prohibits destroying or falsifying records with the intent to obstruct or influence a federal investigation or in relation to bankruptcy pro- ceedings. Violation of this provision can result in a fine, imprisonment for up to twenty years, or both.

2–4 Business ethics and the Law Today, legal compliance is regarded as a moral minimum—the minimum acceptable standard for ethical business behavior. Simply obeying the law does not fulfill all business ethics obligations, however. In the interests of preserving personal freedom, as well as for practical reasons, the law does not—and cannot—codify all ethical requirements. No law says, for instance, that it is illegal to tell a lie, but it may be unethical to do so.

In contrast, it may seem that answering a question concerning the legality of a given action should be simple. Either something is legal or it is not. In fact, one of the major challenges businesspersons face is that the legality of a particular action is not always clear. In part, this is because there are so many laws regulating busi- ness that it is possible to violate one of them without realizing it.

moral minimum The minimum degree of ethical behavior expected of a firm.

Learning OutcOme 2

Explain the relationship between law and ethics.

Which group of employees should mooseback management downsize first? The answer depends on how management weighs the trade-offs involved. If the company lays off the most senior employees, it can cut costs more quickly because they earn higher salaries. The trade-off in keeping these employees is their loyalty and experience, which could help the company adjust to the downsizing more easily. A negative trade-off is that Mooseback would have to lay off twice as many of the younger employees to make up the dollar difference in salaries because they do not earn as much. By downsizing the younger employees, Mooseback also loses most of its expertise in new product technology and online sales strategies.

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C H A P T E R 2 Ethics in Business 17

2–4a Laws Regulating Business Today’s business firms are subject to extensive government regulation. Nearly every action a firm undertakes—from going into business, to hiring and firing personnel, to selling products in the marketplace—is subject to statutory law as well as regula- tions issued by administrative agencies.

Determining whether a planned action is legal thus requires that decision makers keep abreast of the law. Ignorance of the law will not excuse a business owner or manager from liability for violating a statute or regulation. Normally, large busi- ness firms have attorneys on their staffs to assist them in making key decisions. Small firms must also seek legal advice before making important business decisions because the consequences of just one violation may be costly.

2–4b “Gray Areas” in the Law In many situations, business firms can predict with a fair amount of certainty whether a given action would be legal. In some situations, though, the legality of a particular action may be less clear. These “gray areas” in the law make it difficult to predict with certainty how a court may apply a given law to a particular action.

Uncertainties concerning how particular laws may apply to specific factual situ- ations have been compounded in the cyber age. The widespread use of the Internet has given rise to legal and ethical questions in circumstances that never existed before.

In short, business decision makers need to proceed with caution and evaluate an action and its consequences from an ethical perspective. Generally, if a company can demonstrate that it acted in good faith and responsibly in the circumstances, it has a better chance of successfully defending its action.

2–5 approaches to ethical reasoning Each individual, when faced with an ethical dilemma, engages in ethical reasoning. In this process, the individual links his or her moral convictions or ethical standards to the particular situation at hand. Businesspersons do likewise when making deci- sions with ethical implications.

Ethical reasoning relating to business traditionally has been characterized by two fundamental approaches. One approach defines ethical behavior in terms of duty, which also implies certain rights. The other approach determines what is ethical in terms of the consequences, or outcomes, of any given action.

Learning OutcOme 3

Compare duty-based ethics and utilitarian ethics.

Highlighting the Point

Airway Airlines makes an online forum available to its pilots so that they can exchange ideas and information. Some Airway pilots publish on the forum a series of harassing, gender-based, false messages about Beth Jones, one of Airway’s female pilots.

could airway be liable to Jones for any harm caused by these messages? Yes. An online forum can be considered similar to a company bulletin board, which is part of a workplace. If Airway knows about the messages and does nothing to stop them, the airline can be perceived as sending Jones the statement that the harassment is acceptable. If the airline does not know about the postings or if it does attempt to stop them, however, it can argue that it is acting in good faith.

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U n i t 1 The Law and Our Legal System18

2–5a Duty-Based Ethics Duty-based ethical standards often are derived from revealed truths, such as reli- gious precepts. They can also be derived through philosophical reasoning.

Religion In the Judeo-Christian tradition, which is the dominant religious tradition in the United States, the Ten Commandments of the Old Testament establish fundamental rules for moral action. Other religions have their own sources of revealed truth. Religious rules generally are absolute with respect to the behavior of their adherents.

For instance, the commandment “Thou shalt not steal” is an absolute mandate for a person who believes that the Ten Commandments reflect revealed truth. Even a benevolent motive for stealing (such as Robin Hood’s) cannot justify the act, because the act itself is inherently immoral and thus wrong.

Ethical standards based on religious teachings also involve an element of com- passion. ExamplE 2.2 It might be profitable for Sun Valley Farms to lay off Lee, who is a less productive employee. Lee would find it difficult to get employment elsewhere and his family would suffer as a result, however. This potential suffer- ing would be given substantial weight by decision makers whose ethical standards were based on religion. j Compassionate treatment of others is also mandated by the Golden Rule—Do unto others as you would have done unto you—which has been adopted by most religions.

Philosophy Duty-based ethical standards may also be derived solely from philosophical reasoning. The German philosopher Immanuel Kant (1724–1804), for instance, identified principles for moral behavior based on what he believed to be the fundamental nature of human beings.

Kant held that it is rational to assume that human beings are qualitatively dif- ferent from other physical objects in our world. Persons are endowed with moral integrity and the capacity to reason and conduct their affairs rationally. Therefore, their thoughts and actions should be respected. When human beings are treated merely as a means to an end, they are being regarded as the equivalent of objects and are being denied their basic humanity.

Kant believed that individuals should evaluate their actions in light of the con- sequences that would follow if everyone in society acted in the same way. This categorical imperative can be applied to any action. ExamplE 2.3 Julie is deciding whether to cheat on an examination. If she adopts Kant’s categorical imperative, she will decide not to cheat, because if everyone cheated, the examination would be meaningless. j

The Principle of Rights Another view of duty-based ethics focuses on basic rights. The principle that human beings have fundamental rights, such as the rights to life, freedom, and the pursuit of happiness, is embedded in Western culture.

Those who adhere to this principle of rights believe that a key factor in determining whether a business decision is ethical is how that decision affects the rights of others. These others include the firm’s owners, its employees, its customers, its suppliers, the community in which it does business, and society as a whole.

In general, rights theorists believe that the right with the highest value in a particular circumstance takes precedence. ExamplE 2.4 Murray Chemical has to decide whether to keep its Utah plant open—thereby saving the jobs of one hundred workers—or shut it down. Closing the plant will avoid contaminating a nearby river with pollutants that could endanger the health of tens of thousands of people. A rights theorist could easily choose which group to favor because the value of the right to health and well-being is obviously stronger than the basic right to work. j

categorical imperative An evaluation based on the effect if everyone acted in the same way.

principle of rights The principle that human beings have certain fundamental rights.

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C H A P T E R 2 Ethics in Business 19

2–5b Outcome-Based Ethics: Utilitarianism Utilitarianism is a philosophical theory developed by Jeremy Bentham (1748–1832) and modified by John Stuart Mill (1806–1873)—both British philosophers. In con- trast to duty-based ethics, utilitarianism is outcome oriented. It focuses on the consequences of an action, not on the nature of the action itself or on a set of moral values or religious beliefs.

Those who apply utilitarian ethics believe that an action is morally correct when it produces the greatest amount of good for the greatest number. When an action affects the majority adversely, it is morally wrong. Applying the utilitarian theory requires three steps:

1. A determination of which individuals will be affected by the action in question. 2. A cost-benefit analysis—an assessment of the negative and positive effects of

alternative actions on these individuals.

3. A choice among alternative actions that will produce the greatest positive benefits for the greatest number of individuals.

2–5c Corporate Social Responsibility Groups concerned with employee safety, consumer protection, environmental pres- ervation, and other causes often pressure corporations to behave responsibly with respect to these causes. That corporations have such an obligation is the concept of corporate social responsibility. (See this chapter’s Linking Business Law to Your Career feature for more details on this topic.)

The Stakeholder Approach One view of corporate social responsibility stresses that corporations have a duty not just to shareholders but also to other groups affected by corporate decisions called stakeholders. These groups include employees, customers, creditors, suppliers, and the community. Sometimes, one of these groups may have a greater stake in a company decision than shareholders do.

ExamplE 2.5 To reduce labor costs without laying off its employees, Ellis, Inc., implements four-day workweeks, unpaid vacations and voluntary wage freezes, and flexible work schedules. These options can be in the best interests of many of Ellis’s stakeholders, including its employees and the community in which it does business. j

Corporate Citizenship Another theory of social responsibility argues that corporations should promote goals that society deems worthwhile and take steps toward solving

utilitarianism An evaluation of an action based on its “good” consequences.

cost-benefit analysis Weighing the costs of a given action against the benefits.

corporate social responsibility The idea that corporations should act ethically and be accountable for their actions.

Highlighting the Point

International Foods Corporation (IFC) markets baby formula in developing countries. IFC learns that mothers in those countries often mix the formula with impure water, to make the formula go further. As a result, babies are suffering from malnutrition, diarrhea, and in some instances, even death.

is iFc in violation of the law? No. What is iFc’s ethical responsibility in this situation? If IFC’s decision makers feel that they have an absolute duty not to harm others, then their response will be to withdraw the product from those markets.

If they approach the problem from a utilitarian perspective, they will engage in a cost-benefit analysis. The cost of the action (the suffering and death of babies) will be weighed against its benefit (the availability of the formula to mothers).

Having the formula available frees mothers from the task of breastfeeding and thus allows them to work to help raise their incomes and standards of living. The question in a utilitarian analysis focuses on whether the benefit outweighs the cost.

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U n i t 1 The Law and Our Legal System20

social problems. The idea is that business controls so much of a country’s wealth and power that it should use that wealth and power in socially beneficial ways.

ExamplE 2.6 The Hitachi Group releases an Annual Corporate Social Respon- sibility Report that outlines its environmental strategy (including its attempts to reduce carbon dioxide emissions). The report also discusses its commitment to human rights awareness. j

A Way of Doing Business Corporate social responsibility attains its maximum effectiveness if it is treated as a way of doing business rather than as a special program. The most successful activities are relevant and significant to the corporation’s stakeholders.

ExamplE 2.7 Derek Industries is one of the world’s largest diversified metals and mining companies. As a part of its business decision making, it invested more than $150 million in social projects involving health care, infrastructure, and education around the world. At the same time, it invested more than $300 million in envi- ronmental projects, including the rehabilitation of native species in the Amazon River Valley. j

2–6 Business ethics and social media Today, social media affect many areas of daily life, including the business world. As a result, businesses now face unique ethical issues with respect to all social media platforms. In particular, social media raise ethical questions in business hir- ing decisions.

To gain better insight into a job candidate, managers ask for professional refer- ences from former employers, as well as character references from others who know the candidate. Employers are likely to also conduct Internet searches to discover more about job candidates. Often, an online search can lead managers to several links regarding a candidate. With relative ease, managers can often view the pro- spective candidate’s postings, photos, videos, blogs, and tweets.

In addition, some employers may decide that a candidate with no social media presence is behind the times and is not a good employee choice. Some would con- sider this type of employer behavior to be unethical as well.

2–7 Business ethics on a global Level Frequent conflicts in ethics arise between foreign and U.S. businesspersons. In cer- tain countries, the consumption of alcohol and specific foods is forbidden for reli- gious reasons. Under such circumstances, it would be thoughtless and imprudent for a visiting U.S. businessperson to invite a local business contact out for a drink.

Highlighting the Point

Penny applies for a sales clerk position at Fair City Market, a convenience store in rural Wyoming. Craig, Fair City’s owner, interviews Penny and is seriously considering her for the position. After the interview, Craig does an online search on Penny. The search results reveal that Penny is politically active in an effort to ban off-road vehicles in local wilderness areas. Craig is an off-road enthusiast.

should craig consider Penny’s activism when deciding to hire her? No. Many people believe that judging a job candidate based on what she or he does outside of the workplace is unethical. Penny’s personal opinions and activities should not factor into Craig’s hiring decision.

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C H A P T E R 2 Ethics in Business 21

The role played by women in other countries also may present some difficult ethical problems for firms doing business internationally. Equal employment opportunity is a fundamental public policy in the United States, and Title VII of the Civil Rights Act of 1964 prohibits discrimination against women in the employ- ment context. Some other countries, however, offer little protection for women against gender discrimination in the workplace, including sexual harassment.

2–7a Monitoring the Practices of Foreign Suppliers Many U.S. businesses contract with companies in developing nations to produce goods, because the wage rates are significantly lower than in the United States. Yet what if a foreign company exploits its workers—by hiring women and children at below-minimum-wage? What if the company’s workplace is full of health hazards? What if the company’s supervisors routinely engage in workplace conduct that is offensive to women?

Given today’s global communications network, few companies can assume that their actions in other nations will go unnoticed by “corporate watch” groups that publicize unethical corporate behavior. As a result, U.S. businesses take steps to avoid such adverse publicity. They may refuse to deal with certain suppliers or arrange to monitor their suppliers’ workplaces to make sure that the workers are not being mistreated.

2–7b The Foreign Corrupt Practices Act Another ethical problem in international business dealings has to do with the legiti- macy of certain side payments to government officials. In the United States, most contracts are formed within the private sector. In many foreign countries, however, decisions on major construction and manufacturing contracts are made by govern- ment officials who control local trade and industry.

Side payments (bribes) to government officials in exchange for favorable busi- ness contracts are not unusual in such countries, nor are they considered unethical. U.S. companies, however, are prohibited from making such payments to foreign officials by the Foreign Corrupt Practices Act (FCPA).

Bribery of Foreign Officials The first part of the FCPA applies to all U.S. companies and their directors, officers, shareholders, employees, and agents. This part prohibits payments intended to get a foreign official to act in his or her official capacity to provide business opportunities.

The FCPA does not prohibit payments made to minor officials whose duties are ministerial. (A ministerial action is a routine activity, such as the processing of paperwork with little or no discretion involved in the action.) These payments are often referred to as “grease,” or facilitating payments. They are meant to speed up administrative services that might otherwise be performed at a slow pace. The act also does not prohibit payments to private foreign parties unless the U.S. firm knows that the payments will be passed on in violation of the FCPA.

Learning OutcOme 4

Identify some ethical problems in the global context.

Highlighting the Point

Joan Anderson, who is a representative for American Exports, Inc., makes a payment on American’s behalf to a minor official in Nigeria to speed up an import licensing process.

Has either anderson or her firm violated the Foreign corrupt Practices act? No, if the payment does not violate Nigerian law. Generally, the Foreign Corrupt Practices Act permits “grease” payments to foreign officials if such payments are lawful within the foreign country.

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U n i t 1 The Law and Our Legal System22

Conflict Resolved In the Conflict Presented feature at the beginning of this chapter, BMI Food Company makes Chuck Wagon, a plastic-wrapped meal, for children. Chuck Wagon meals consist of foods that provide an

unhealthful mix of fat, sugar, and salt. BMI sells Chuck Wagon through advertising directed at children.

a Is BmI’s making and marketing of Chuck Wagon unethical? Yes. Consumers generally prefer the taste of fat, sugar, and salt. Consequently, many food products are

processed to contain a tasty, but unhealthful mix of these three. Adults can decide for

themselves what to eat. But children may be especially susceptible to advertising. BMI

has an ethical obligation to its targeted audience—children—to make and market its

products responsibly.

Linking Business Law to Your Career

Managing a CoMpany’s Reputation

Accounting is typically associated with developing balance sheets and profit- and-loss statements, but it can also pro- vide information that helps managers do their jobs. The provision of account- ing information for a company’s internal use, called managerial accounting, helps in planning and decision making.

Managerial accountants also use their skills to manage corporate repu- tations. More than 2,500 multinational companies now release large quantities of accounting information to the public.

internal reports Designed for external scrutiny

Some large companies refer to the man- agerial accounting information that they

release to the public as corporate sustain- ability reports. Dow Chemical Company, for example, issues a sustainability report annually.

Other corporations call their pub- lished documents social responsibility reports. Symantec Corporation issues corporate responsibility reports to dem- onstrate its focus on environmental, social, and governance issues.

Why use managerial accounting to manage reputations?

We live in an age of information. Such sources as cable and online news net- works, social media, and smartphones guarantee that any news, positive or negative, will be known throughout

the world almost immediately after it happens.

Consequently, corporations want to manage their reputations by pre- paring and releasing company news themselves. In a world in which cor- porations are often blamed for any- thing bad that happens, managerial accounting information can be a use- ful counterweight.

To this end, some corporations have combined their social responsibility reports with their traditional financial accounting information. When a cor- poration’s reputation is on the line, its future is at stake.

Accounting Requirements The second part of the FCPA is directed toward accountants, because in the past bribes were often concealed in corporate financial records. All companies must keep detailed records that “accurately and fairly” reflect their financial activities.

In addition, their accounting systems must provide “reasonable assurance” that all transactions entered into by the companies are accounted for and legal. These requirements assist in detecting illegal bribes. The FCPA prohibits any person from making false statements to accountants or false entries in any record or account.

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C H A P T E R 2 Ethics in Business 23

Issue sPotteRs Check your answers to the Issue Spotters against the answers provided in Appendix A at the end of this text.

1. Mac Tools, Inc., markets a product that under some cir- cumstances is capable of seriously injuring consumers. Does Mac have an ethical duty to remove this product from the market, even if the injuries result only from misuse? (see Approaches to Ethical Reasoning.)

2. Acme Corporation decides to respond to what it sees as a moral obligation to correct for past discrimination

by adjusting pay differences among its employees. Does this raise an ethical conflict among Acme’s employees? Between Acme and its employees? Between Acme and its shareholders? (see Approaches to Ethical Reasoning.)

Learning OutcOme 1: Discuss how businesses can discourage unethical behavior. Managers must set and apply ethical standards to which they are committed. Employees will likely follow their example. Components of a comprehensive corporate compliance program include an ethical code of conduct, an ethics committee, training programs, and internal audits to monitor compliance. These components should be integrated throughout the firm. In making ethical trade-offs, a firm’s management must consider which of the firm’s constituent groups has a greater stake in the decision to be made.

Learning OutcOme 2: explain the relationship between law and ethics. The minimum acceptable standard for ethical business behavior is compliance with the law. The law has its limits, though, and some actions may be legal, yet not ethical.

Learning OutcOme 3: compare duty-based ethics and utilitarian ethics. Duty-based ethical standards are based on religious precepts or derived through philosophical reasoning. Duty- based standards imply that human beings have basic rights. A key factor in determining whether a business decision is ethical is how it affects these rights.

Utilitarian ethics are outcome oriented, focusing on the consequences of an action. Under this standard, an action is “right” when it produces the greatest amount of good for the greatest number of people.

Learning OutcOme 4: identify some ethical problems in the global context. Ethical conflicts between foreign and U.S. businesses may arise because of inherent differences between nations. Notable differences relate to workplace conditions and the practice of giving side payments to foreign officials to secure favorable contracts.

CHaPteR summaRY—etHICs In BusIness

stRaIgHt to tHe PoInt

1. Why is the study of business ethics important? (see The Importance of Business Ethics.)

2. How can businesspersons encourage ethical conduct in their workplaces? (see Setting the Right Ethical Tone.)

3. How does the Sarbanes-Oxley Act help to prevent uneth- ical management decisions? (see The Sarbanes-Oxley Act.)

4. How should business decision makers proceed when the legality of a particular action is not clear? (see Business Ethics and the Law.)

5. What are the two fundamental approaches by which ethical business reasoning has traditionally been char- acterized? (see Approaches to Ethical Reasoning.)

6. What is the concept of corporate social responsibility? (see Approaches to Ethical Reasoning.)

7. How might social media raise ethical questions with respect to business hiring decisions? (see Business Ethics and Social Media.)

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U n i t 1 The Law and Our Legal System24

ReaL Law

2–1. Business ethics. Priscilla Dickman worked as a medi- cal technologist at the University of Connecticut Health Center. Dickman’s supervisor received complaints she was getting personal phone calls and was frequently absent from her work area. Based on e-mails and other docu- ments found on her work computer, the state investigated her for violations of state law. She was convicted of con- ducting “personal business for financial gain on state time utilizing state resources.” Separate investigations resulted in convictions for forgery and the filing of an unrelated fraudulent insurance claim. Dickman “retired” from her job and filed a claim with the state of Connecticut against the health center, alleging that her former employer had initiated the investigations to harass her and force her to quit. For lack of “credible evidence or legal support,” Dickman’s claim was dismissed. Were any of Dickman’s actions unethical? If so, identify the actions, and explain why they were unethical. [Dickman v. University of Con- necticut Health Center, 162 Conn.App. 441, 132 A.3d 739 (2016)] (see The Importance of Business Ethics.)

2–2. Business ethics. Stephen Glass made himself infa- mous as a dishonest journalist by fabricating material for more than forty articles for The New Republic and

other publications. At the time, he was a law student at Georgetown University. Once suspicions were aroused, Glass tried to avoid detection. Later, Glass applied for admission to the California bar. The California Supreme Court denied his application, citing “numerous instances of dishonesty” during his “rehabilitation” following the exposure of his misdeeds. How do these circumstances underscore the importance of ethics? [In re Glass, 58 Cal.4th 500, 316 P.3d 1199 (2014)] (see The Importance of Business Ethics.)

2–3. Business ethics. Mark Ramun worked as a manager for Allied Erecting and Dismantling Co., where he had a tense relationship with John Ramun, Allied’s president and Mark’s father. After more than ten years, Mark left Allied, taking 15,000 pages of Allied’s documents (trade secrets) with him. Later, he joined Allied’s competitor, Genesis Equipment & Manufacturing, Inc. Genesis soon developed a piece of equipment that incorporated design elements of Allied equipment. Who violated business eth- ics in these circumstances, and how? [Allied Erecting and Dismantling Co. v. Genesis Equipment & Manufacturing, Inc., 2013 WL 85907 (6th Cir. 2013)] (see The Importance of Business Ethics.)

etHICaL QuestIons

2–4. ethical Workplace. What factors help to create an ethi- cal workplace? (see Setting the Right Ethical Tone.)

2–5. ethical Leadership. Mark Clapp and Albert DiBrito worked for the Public Safety Department (PSD) in St. Joseph, Michigan. Clapp was the director, and DiBrito was the deputy director. One day, Clapp told Tom Vaught, a PSD employee, that the previous city manager had only hired DiBrito because DiBrito had been investigating the city manager for possible wrongdoing. Clapp said that DiBrito

had dropped his investigation in exchange for the deputy director position. Richard Lewis, the current city manager, concluded that Clapp’s remarks were “inappropriate state- ments for a commanding officer to make.” In the meantime, though, DiBrito made his own “inappropriate statements” about Clapp to other PSD employees. How do a manager’s attitudes and actions affect a workplace? What steps do you think Lewis could take to prevent future conflicts? Discuss. [DiBrito v. City of St. Joseph, 2017 WL 129033 (6th Cir. 2017)] (see Setting the Right Ethical Tone.)

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25

Chapter 2—work set

1. Ethics is the study of what constitutes right and wrong behaviors.

2. A background in business ethics is as important as knowledge of specific laws.

3. The minimum acceptable standard for ethical behavior is compliance with the law.

4. According to utilitarianism, it does not matter how many people benefit from an act.

5. The best course for accomplishing legal and ethical behaviors is to act responsibly and in good faith.

6. The ethics of a particular act is always clear.

7. To foster ethical behavior among employees, managers should apply ethical standards to which they are committed.

8. If an act is legal, it is ethical.

9. Bribery of public officials is strictly an ethical issue.

tRue-FaLse QuestIons

1. Beth is a marketing executive for Consumer Goods Company. Compared with Beth’s personal actions, her business actions require the application of ethical standards that are

a. more complex. b. simpler. c. the same. d. none of the above.

2. Pat, an employee of Quality Products, Inc., takes a duty-based approach to ethics. Pat believes that regardless of the consequences, he must

a. avoid unethical behavior. b. conform to society’s standards. c. place his employer’s interests first. d. produce the greatest good for the most people.

3. Joy adopts religious ethical standards. These involve an element of

a. compassion. b. cost-benefit analysis. c. discretion. d. utilitarianism.

4. Eve, an employee of Fine Sales Company, takes an outcome-based approach to ethics. Eve believes that she must

a. avoid unethical behavior. b. conform to society’s standards. c. place her employer’s interests first. d. produce the greatest good for the most people.

5. In a debate, Ed’s best criticism of utilitarianism is that it

a. encourages unethical behavior. b. fosters conformance with society’s standards. c. mandates acting in an employer’s best interests. d. results in human costs many persons find unacceptable.

muLtIPLe-CHoICe QuestIons

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26

answeRIng moRe LegaL PRoBLems

1. Carney & Deb, an accounting firm, performs a variety of tasks for its clients, including completing financial statements and tax returns. To accomplish these tasks, Carney & Deb collects personal and financial informa- tion from the clients.

Does Carney & Deb have an ethical obligation to its clients with respect to this information?  Eth- ics is the study of what constitutes right and wrong _______________, focusing on morality and the way in which _______________ principles are derived or the way in which such principles apply to conduct in daily life. Sometimes, the issues that arise concern fairness, justice, and “the right thing to do.” To answer the ques- tion of the firm’s ethical obligation, you should note that the confidentiality of its clients’ sensitive personal and business information is at stake. The accountants have a(n) _______________ duty to ensure that reason- able security precautions are taken to preserve this con- fidentiality and protect this information.

2. Carney & Deb can store the personal and financial information of its clients on any electronic device, including an iPhone, a flash drive, and a laptop. When Carney & Deb upgrades its storage media, the informa- tion is transferred between devices.

What are the ethical concerns in this situation? Discuss. The _______________ concerns in this situation relate to fairness, justice, “the right thing to do,” per- sonal honesty and integrity, and the duty to maintain the _______________ of the clients’ information. The accountants need to understand where they are putting the information, assess what the risks are of that loca- tion, and consider whether it is appropriate to put the _______________ there. For example, putting sensitive information on an unencrypted flash drive would be a bad idea. When the storage media are upgraded, cli- ent confidentiality needs to be maintained. Any storage device should be sanitized, or wiped clean, of sensitive data before it is discarded.

6. Acme Services, Inc., represents to Best Production Company that certain services can be performed for a stated fee. This representation would be unethical if Acme knew at the time that

a. Acme could not perform the services alone. b. the actual charge would be substantially higher. c. the actual charge would be substantially lower. d. the fee was a competitive bid.

7. Tina, the president of United Sales, Inc., tries to ensure that United’s actions are legal and ethical. To achieve this result, the best course for Tina and United is to act in

a. good faith. b. ignorance of the law. c. regard for the firm’s shareholders only. d. their own self-interest.

8. Alan, an executive with Beta Corporation, follows the “principle of rights” theory. Under this theory, whether an action is ethical depends on how it affects

a. the right determination under a cost-benefit analysis. b. the right of Alan to maintain his dignity. c. the right of Beta to make a profit. d. the rights of others.

9. Gamma, Inc., a U.S. corporation, makes a side payment to the minister of commerce of another country for a favor- able business contract. In the United States, this payment would be considered

a. illegal only. b. unethical only. c. illegal and unethical. d. none of the above.

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27

Learning OutcOmes

The five Learning Outcomes below are designed to help improve your understanding of the chapter. After reading this chapter, you should be able to:

Outline a state court system.

Define federal court jurisdiction.

Discuss trial procedure.

Summarize the steps in a lawsuit.

Identify alternative methods for resolving disputes.

1

2

3

4

5

3 The Courts and Our Legal System

Every society needs to have an established method for resolving disputes. This is particularly true in the business world. Nearly every businessperson will face a lawsuit at some time in his or her career. For this reason, anyone involved in business needs to have an understanding of court systems in the United States, as well as of other methods of dispute resolution that can be pursued outside the courts.

American law has many sources. They include the cases that form the common law, the federal and state constitutions, and the statutes passed by Congress and the state legislatures. With respect to the common law, the role of the courts is to declare judicial precedents. Courts are also called upon to interpret the language of constitutions and statutes. In all cases, it is the duty of the courts to apply the law—whatever its source—to a given set of facts. Thus, the function of the courts is to interpret and apply the law.

Even though there are fifty-two court systems—one for each of the fifty states, one for the District of Columbia, plus a federal system—similarities abound. Keep in mind that the federal courts are not superior to the state courts. They are simply an independent system of courts.

3–1 Jurisdiction Jurisdiction refers either to the geographical area within which a court has the right and power to decide cases or to the right and power of a court to decide matters concerning certain persons, property, or subject matter. Before any court can hear a case, it must have jurisdiction over the person against whom the law- suit is brought or over the property involved in the lawsuit, as well as jurisdiction over the subject matter.

jurisdiction Authority to decide a case.

Conflict Presented Rob slips and falls in Tia’s Restaurant, and as a result, he hurts his back. Rob then files a claim with Tia’s insurer, Secure Insurance Company, to recover damages for this injury. Rob contends that

the injury prevents him from working or engaging in any strenuous activity. Secure denies the claim. Rob files a lawsuit against the insurer. As part of the discovery process before trial, Secure asks Rob to supply all of his Twitter and Facebook postings since the accident. Rob objects to this request.

Q is secure’s request appropriate? Why or why not?

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U n i t 1 The Law and Our Legal System28

3–1a Jurisdiction over Persons or Property Generally, a court’s power is limited to the territorial boundaries of the state in which it is located. Thus, a court can exercise personal jurisdiction (in personam jurisdiction) over residents of the state and anyone else within its boundaries. A court can also exercise jurisdiction over property (in rem jurisdiction) located within its boundaries.

Under a state long arm statute, a court can exercise jurisdiction over out-of-state defendants based on activities that took place within the state. The defendant must have had enough of a connection with the state for the court to conclude that it is fair to exercise its power over the defendant.

Courts apply a minimum-contacts test to determine if they can exercise jurisdic- tion over out-of-state corporations. The test is usually met if a corporation adver- tises or sells its products within the state. The test can also be met if the corporation has an ongoing business relationship with a party within the state, as shown by frequent transactions.

ExamplE 3.1 Allison, a Texas resident, is injured when the PowerFlex exercise machine she is using collapses. Allison files a lawsuit against PowerFlex in a Texas court. PowerFlex, which is headquartered in Chicago, argues that the state court lacks jurisdiction over it. Because PowerFlex sells its exercise products at many retail outlets in Texas, however, there is enough minimum contact within the state for the case to proceed. j

3–1b Jurisdiction in Cyberspace The Internet’s capacity to bypass boundaries undercuts the traditional basis for jurisdiction. Generally, if a defendant’s only connection to a state is through dealings with citizens of the state over the Internet, a “sliding-scale” standard determines when the exercise of jurisdiction is proper.

Jurisdiction is proper when substantial business is done over the Internet. Some interactivity through a website may or may not establish an appropriate basis for jurisdiction. A website with no interactivity—such as passive advertising—does not provide any ground for jurisdiction.

3–2 the state court system The typical state court system is made up of trial courts and appellate courts. Trial courts are courts in which trials are held and testimony is taken. Appellate courts are courts of appeal and review. Exhibit 3.1 shows how state court systems, as well as the federal court system, are structured.

Any person who is a party to a lawsuit typically has the opportunity to plead the case before a trial court and then, if he or she loses, before at least one level of appellate courts. If a federal statute or constitutional issue is involved in the deci- sion of the state supreme court, that decision may be further appealed to the United States Supreme Court.

3–2a Trial Courts The state trial courts have either general or limited jurisdiction. Trial courts that have general jurisdiction as to subject matter may be called county, district, supe- rior, or circuit courts. The jurisdiction of these courts is often determined by the size of the county in which the court sits.

Courts with limited jurisdiction as to subject matter are often called special inferior trial courts or minor judiciary courts. Small claims courts are inferior trial courts that hear only civil cases involving claims of less than a certain

long arm statute A state statute that permits jurisdiction over nonresident defendants.

Learning OutcOme 1

Outline a state court system.

small claims court A trial court for small claims, usually involving $2,500 or less.

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C H A P T E R 3 The Courts and Our Legal System 29

exhibit 3.1 The State and Federal Court Systems

Supreme Court of the United States

U.S. Courts of Appeals

Federal Administrative

Agencies

U.S. District Courts

Specialized U.S. Trial Courts

• Bankruptcy Courts • Court of Federal Claims • Court of International Trade • Tax Court

Highest State Courts

State Courts of Appeals

State Trial Courts of General Jurisdiction

State Trial Courts of Limited Jurisdiction

State Administrative Agencies

amount, usually $2,500. Most small claims are less than $1,000. Suits brought in small claims courts are generally conducted informally, and lawyers are not required.

Other courts of limited jurisdiction are domestic relations courts, local municipal courts, and probate courts. Domestic relations courts handle only divorce actions and child-custody cases. Local municipal courts mainly handle traffic cases, while probate courts handle the administration of wills and estate- settlement problems.

3–2b Appellate, or Reviewing, Courts Every state has at least one appellate, or reviewing, court. About half of the states have intermediate appellate courts. The subject-matter jurisdiction of these courts is substantially limited to hearing appeals.

Appellate courts normally examine the record of a case on appeal and determine whether the trial court committed an error. They look at questions of law and procedure, but usually not at questions of fact. An appellate court will modify a trial court’s finding of fact, however, when the finding is clearly erroneous—that is, when it is contrary to the evidence presented at trial—or when there is no evidence to support the finding.

The highest appellate court in a state is usually called the supreme court but may be called by some other name. For instance, in both New York and Maryland, the highest state court is called the court of appeals. The decisions of each state’s highest court on all questions of state law are final. Only when issues of federal law are involved can a state’s highest court be overruled by the United States Supreme Court.

3–3 the Federal court system The federal court system is similar in many ways to most state court systems. It is a three-level model consisting of trial courts, intermediate courts of appeals, and the United States Supreme Court (see Exhibit 3.1).

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U n i t 1 The Law and Our Legal System30

3–3a U.S. District Courts At the federal level, the United States is divided into thirteen federal judicial “circuits,” and the circuits are subdivided into districts. A federal district court is the equivalent of a state trial court of general jurisdiction. There is at least one federal district court in every state. The number of judicial districts can vary over time, primarily owing to population changes and corresponding caseloads. The law now provides for ninety-four judicial districts.

U.S. district courts have original jurisdiction in federal matters. In other words, federal cases originate in district courts. There are other trial courts with original— although special (or limited)—jurisdiction, such as the U.S. Tax Court, the U.S. Bankruptcy Court, and the U.S. Court of Federal Claims.

3–3b U.S. Courts of Appeals The U.S. courts of appeals for twelve of the thirteen federal judicial circuits hear appeals from the federal district courts located within their respective circuits. The court of appeals for the thirteenth circuit, called the federal circuit, has national jurisdiction over certain types of cases, such as those concerning patent law.

The decisions of the circuit courts of appeals are final in most cases. Appeal to the United States Supreme Court is possible, however. Appeals from federal administrative agencies, such as the Federal Trade Commission, are also made to the U.S. circuit courts of appeals. See Exhibit 3.2 for the geographical boundaries of the U.S. courts of appeals and U.S. district courts.

exhibit 3.2 Boundaries of the U.S. Courts of Appeals and U.S. District Courts

W E

E N

C

S

W

N

E

NW

W E

S

E

S

N

E W

W E

S

N

W

E

C

E

S S

N

S W

W

E

E

N N

MMS

N

S

M

S

E

E

W S

N

MW

N W

M

W N

M

W

W

N

M

E

S

7

1

9

10

5

9

8

9

3 6

4

11

2

1

9

3

Atlanta

Maine

Vermont

Puerto Rico

Virgin Islands

Hawaii

Michigan

Legend Circuit boundaries State boundaries District boundaries Location of U.S. Court of Appeals

Florida

Maryland Delaware

New Jersey Pennsylvania

Connecticut Rhode Island

Massachusetts

New Hampshire

New York

Guam

Northern Mariana Islands

Boston

New York

Philadelphia

District of Columbia Washington, D.C. Richmond

New Orleans

Cincinnati

Chicago

St. Louis

Denver San

Francisco

Texas

Mississippi

Alaska

California

Nevada

Oregon

Washington

Idaho

Montana

Wyoming

Utah

Arizona New

Mexico

Colorado

Kansas

Oklahoma

Nebraska

So. Dakota

No. Dakota Minnesota

Iowa

Missouri

Arkansas

Georgia Alabama

So. Carolina

No. Carolina

Virginia W. Va.

Ohio

Kentucky

Tennessee

Michigan

Indiana Illinois

Wisconsin

Louisiana

D.C. Circuit

Washington, D.C.

12

Federal Circuit

Washington, D.C.

13

Source: Administrative Office of the United States Courts.

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C H A P T E R 3 The Courts and Our Legal System 31

3–3c The United States Supreme Court The highest level of the three-level model of the federal court system is the United States Supreme Court. All other courts in the federal system are consid- ered “inferior.”

The United States Supreme Court has original, or trial court, jurisdiction in a small number of situations. In all other cases, its jurisdiction is appellate. The Court can review any case decided by any of the federal courts of appeals. It also has appellate authority over some cases decided in the state courts. Whether the Court will review a case is entirely within its discretion.

3–3d Federal Court Jurisdiction The Constitution gives Congress the power to control the number and kind of inferior courts in the federal system. Except in those cases in which the Constitu- tion gives the Supreme Court original jurisdiction, Congress can also regulate the jurisdiction of the Supreme Court.

Federal Questions In general, federal courts have jurisdiction over cases involving federal questions. A federal question is an issue of law based, at least in part, on the Constitution, a treaty, or a federal law.

Diversity of Citizenship Federal jurisdiction also extends to cases involving diversity of citizenship. Diversity-of-citizenship cases are those arising between (1) citizens of different states, (2) a foreign country and citizens of a state or of different states, or (3) citizens of a state and citizens or subjects of a foreign country. The amount in controversy in diversity cases must be more than $75,000 before a federal court can take jurisdiction.

Exclusive versus Concurrent Jurisdiction Some cases can be heard in either federal or state courts. This is true of many cases involving federal questions, as well as diversity-of-citizenship cases. When both federal and state courts have the power to hear a case, concurrent jurisdiction exists. When cases can be tried only in federal courts or only in state courts, exclusive jurisdiction exists.

Federal courts have exclusive jurisdiction in cases involving federal crimes, bank- ruptcy, patents, and copyrights, as well as in suits against the United States and in some areas of admiralty law (law governing transportation on the seas). States also have exclusive jurisdiction over certain subject matters, such as divorce and adoption. The concepts of exclusive and concurrent jurisdiction are illustrated in Exhibit 3.3.

3–4 the state court case Process Procedural law establishes the rules and standards for determining disputes in courts. The rules vary from court to court. There is a set of federal rules of proce- dure, and there are various sets of rules for state courts. In addition, procedural rules differ in criminal and civil cases. To clarify some of these procedural rules, we next follow a civil case, in which one party files a lawsuit against another party.

3–4a Standing to Sue Before a person can bring a lawsuit before a court, the party must have standing to sue. To have standing, a party must have a legally protected and tangible interest at stake in the litigation. Additionally, the party must have suffered a harm, or have been threatened by a harm, as a result of the action about which she or he has complained.

Learning OutcOme 2

Define federal court jurisdiction.

federal question An issue based on federal law.

diversity-of-citizenship Situation in which parties to a lawsuit are citizens of different states or countries.

concurrent jurisdiction When two different courts have the power to hear a case.

exclusive jurisdiction When only one court has the power to hear a case.

standing to sue A stake in a controversy sufficient to entitle an individual to bring a lawsuit.

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U n i t 1 The Law and Our Legal System32

3–4b The Pleadings The pleadings inform each party of the claims of the other and specify the issues (disputed questions) involved in the case. Pleadings remove the element of surprise from a case. They allow lawyers to gather the most persuasive evidence and to prepare better arguments, thus increasing the probability that a just and true result will be forthcoming from the trial. The pleadings include the complaint and sum- mons (and a motion to dismiss or an answer.)

Complaint A lawsuit begins when a lawyer files a complaint (sometimes called a petition or a declaration) with the clerk of the trial court with the appropriate jurisdiction. The party who files the complaint is known as the plaintiff. The party against whom a complaint is filed is the defendant.

The complaint contains the following: 1. A statement alleging the facts necessary for the court to take jurisdiction. 2. A short statement of the facts necessary to show that the plaintiff is legally

entitled to a remedy. For instance, a statement of facts should be specific and detailed enough to clearly show the legal basis for the complaint. If important facts are missing or lacking, a court is within its rights to dismiss a complaint.

3. A statement of the remedy the plaintiff is seeking.

pleadings Statements of facts, charges, and defenses in a case.

complaint A pleading alleging wrongdoing on the part of the defendant.

plaintiff A person who initiates a lawsuit.

defendant A person against whom a lawsuit is brought.

Highlighting the Point

Kevin Anderson, driving a Toyota Camry, is in an accident with Lisa Marconi, driving a Ford Focus. The accident occurs at the intersection of Wilshire Boulevard and Rodeo Drive in Beverly Hills, California. Marconi suffers personal injuries, incurring medical and hospital expenses as well as lost wages for four months. Anderson and Marconi are unable to agree on a settlement, and Marconi wants to sue Anderson.

exhibit 3.3 Exclusive and Concurrent Jurisdictions

Exclusive Federal Jurisdiction

Concurrent Jurisdiction

(cases involving federal questions—for example, antitrust, bankruptcy, and patent cases)

(most cases involving federal questions and diversity-of- citizenship cases)

(cases involving all matters not subject to federal jurisdiction—for example, divorce and adoption cases)

Exclusive State Jurisdiction

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C H A P T E R 3 The Courts and Our Legal System 33

Summons After the complaint has been filed, the defendant is served with a summons and a copy of the complaint on the defendant. The summons notifies the defendant that he or she is required to prepare an answer to the complaint and to file a copy of the answer with both the court and the plaintiff’s attorney within a specified time period (usually twenty to thirty days after the summons has been served).

Once the defendant has been served with a copy of the complaint and summons, he or she must respond by filing a motion to dismiss or an answer. If a defendant does not respond, the court may enter a default judgment against him or her, awarding the plaintiff the remedy sought.

Motion to Dismiss A motion to dismiss is an allegation that even if the facts presented in the complaint are true, the defendant is not legally liable. The court may deny the motion to dismiss. If so, the judge is indicating that the plaintiff has stated a recognized cause of action—that is, if the facts are true, the plaintiff has a right to judicial relief.

If the court grants the motion to dismiss, the judge is saying that the plaintiff has failed to state a recognized cause of action. A judgment may then be entered against the plaintiff, who will not be allowed to bring a lawsuit on the matter again.

Answer An answer either admits the allegations in the complaint or denies them and outlines any defenses that the defendant may have. If the defendant admits to the allegations, the court will enter a judgment for the plaintiff. If the allegations are denied, the matter will proceed to trial.

3–4c Pretrial Motions There are numerous procedural avenues for disposing of a case without a trial. Many of them involve one party’s attempts to get the case dismissed through the use of pretrial motions. We have already mentioned the motion to dismiss. Another important pretrial motion is the motion for summary judgment.

Sometimes, one party to a lawsuit believes that the other party does not have a valid case or that there are no important facts in dispute. In this situation, that party will make a motion for summary judgment. In short, the party making the motion claims no trial is necessary because the jury could only rule in its favor.

When the court considers a motion for summary judgment, it can take into account evidence outside the pleadings. The evidence may consist of sworn statements (affidavits) by parties or witnesses, as well as documents, such as a contract.

default judgment A judgment against a defendant who has not appeared in court.

motion to dismiss A pleading that asserts the plaintiff’s claim has no basis in law.

answer A defendant’s response to a complaint.

motion for summary judgment A request by one of the parties asserting that there are no disputed issues of fact that would necessitate a trial.

after obtaining a lawyer, what is marconi’s next step? Marconi’s suit commences with the filing of a complaint against Anderson. The complaint includes the facts that give rise to the suit and allegations concerning the defendant. Marconi’s complaint may state that Marconi was driving her car through a green light at the specified intersection, exercising good driving habits and reasonable care, when Anderson carelessly drove his car through a red light and into the intersection from a cross street, striking Marconi and causing personal injury and property damage. The complaint should state the relief that Marconi seeks—for instance, $10,000 to cover medical bills, $9,000 to cover lost wages, and $6,000 to cover damage to her car.

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U n i t 1 The Law and Our Legal System34

3–4d Discovery Before a trial begins, the parties obtain information and gather evidence about the case. The process of obtaining information from the opposing party or from other witnesses is known as discovery.

Discovery prevents surprises by giving parties access to evidence that might otherwise be hidden. This allows both parties to learn as much as they can about what to expect at a trial before they reach the courtroom. It also serves to narrow the issues so that trial time is spent on the main questions in the case.

Depositions and Interrogatories Discovery can involve the use of depositions, interrogatories, or both. A deposition is sworn testimony by the opposing party or any witness, recorded by an authorized court official. An interrogatory is a series of written questions for which written answers are prepared and then signed under oath.

Other Information A party can serve a written request to the other party for an admission of the truth of matters relating to the trial. An admission in response to such a request is the equivalent of an admission in court.

A party can also gain access to documents and other items not in his or her pos- session in order to inspect and examine them. Likewise, a party can gain “entry upon land” to inspect premises relevant to the case.

When the physical or mental condition of one party is in question, the opposing party can ask the court to order a physical or mental examination. The court will make such an order only when the need for the information outweighs the right to privacy of the person to be examined.

E-Evidence Relevant information stored electronically can be the object of a discovery request. Electronic evidence, or e-evidence, consists of all types of computer-generated or electronically recorded information, such as e-mail, voice mail, tweets, blogs, social media posts, and spreadsheets, as well as documents and other data stored on computers and mobile devices.

discovery Method by which parties obtain information to prepare for trial.

deposition Any evidence verified by oath.

interrogatory Written questions and answers prepared and signed under oath.

e-evidence Evidence consisting of computer- generated or electronically recorded information.

Real Case

Twenty-First Century Bean Processing hired Anthony Lewis, a forty-seven-year-old African American male, for a warehouse position that was subject to a probationary period. At the end of the period, Twenty-First Century fired Lewis. He filed a lawsuit in a federal district court, alleging discrimination on the basis of race and age in violation of federal law. Twenty-First Century filed a motion for summary judgment. The employer provided evidence of Lewis’s poor job performance and claimed that was the reason for his termination. The court granted the motion.

Was the court’s decision to grant the motion for summary judgment proper? Yes. In Lewis v. Twenty-First Century Bean Processing, the U.S. Court of Appeals for the Tenth Circuit affirmed the lower court’s decision. The evidence showed that of the twenty- five workdays in the probationary period, Lewis was absent for four days, found sleeping twice, and seen several times texting and talking on his personal phone. When informed that this use of a personal phone at work was against company policy, Lewis argued with his boss. Lewis’s unsatisfactory job performance was a sufficient and nondiscriminatory reason for his firing.

—638 Fed.Appx. 701 (10th Cir.)

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C H A P T E R 3 The Courts and Our Legal System 35

3–4e The Trial Every trial follows a similar basic procedure. For a jury trial, the first step is to select the jurors and swear them in. If neither party requests a jury, the trial is held before a judge.

Procedures A trial commences with an opening statement by the attorney for each party. (The plaintiff’s attorney goes first.) The plaintiff’s attorney then calls and questions the first witness. This questioning is called direct examination. The defendant’s attorney then questions the witness. This is cross-examination. The plaintiff’s attorney may question the witness again, and the defendant’s attorney may follow again.

After the plaintiff’s attorney has called all of the witnesses and presented all of the evidence for the plaintiff’s side of the case, the defendant’s attorney presents the defendant’s witnesses and evidence. Each side then presents a closing argument (a final statement summarizing its version of the evidence). Finally, the court reaches a verdict.

Motions at the Trial At every stage in a trial, either party can file a motion to dismiss, a motion for summary judgment, and a motion for a directed verdict (known in federal courts as a motion for judgment as a matter of law).

With a motion for a directed verdict, a party asks the judge to direct a verdict in favor of the moving party. The judge will grant the motion if the other party has not produced sufficient evidence to support his or her claim or defense.

Posttrial Motions At the end of the trial, a posttrial motion can be made to set aside the verdict and to hold a new trial. A motion for a new trial will be granted if the judge is convinced, after looking at all the evidence, that the jury was in error but does not feel it is appropriate to grant a judgment for the other side.

3–4f The Appeal Either party can appeal the trial court’s judgment to an appropriate court of appeals. A party who appeals is known as the appellant, or petitioner. His or her attorney files in the reviewing court the record on appeal, which includes trial testimony and the evidence. The party in opposition to the appellant is the appellee, or the respondent. Attorneys for both sides file briefs with the review- ing court. A typical brief has a facts summary, law summary, and argument about how the law applies to the facts. The attorneys may also present oral arguments.

Types of Rulings A court of appeals does not hear any evidence. In general, appellate courts review the record for errors of law. If the reviewing court believes that an error was committed, the judgment will be reversed. Sometimes, the case will be remanded (sent back to the court that originally heard the case) for a new trial. In most cases, the judgment of the lower court is affirmed, resulting in the enforcement of the court’s judgment.

Final Review If the reviewing court is an intermediate appellate court, the losing party normally may appeal to the state supreme court. If this court agrees to hear the case, new briefs must be filed, and there may again be oral arguments. The supreme court may reverse or affirm the appellate court’s decision or remand the case. At this point, unless a federal question is at issue, the case has reached its end.

The events of a typical lawsuit are illustrated in Exhibit 3.4.

Learning OutcOme 3

Discuss trial procedure.

direct examination Examination of a witness by the attorney who calls the witness to testify.

cross-examination Questioning an opposing party’s witness during a trial.

motion for a directed verdict A motion for the judge to direct a verdict on the ground of insufficient evidence.

appellant The party who takes an appeal from one court to another.

appellee The party against whom an appeal is taken.

brief A written summary by a party to explain its case.

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U n i t 1 The Law and Our Legal System36

3–5 alternative Dispute resolution Litigation is an expensive and time-consuming process. For this reason and others, most lawsuits do not go to trial. Instead, many businesses use methods of alternative dispute resolution (aDR) to settle their disputes. Methods of ADR range from informal attempts to work out differences to formal hearings before experts.

Most states require or encourage parties to undertake ADR before a trial. Many federal courts have instituted ADR programs as well. The three traditional ADR methods are negotiation, mediation, and arbitration. A more recent ADR method is online dispute resolution.

3–5a Negotiation The simplest form of ADR is negotiation, a process in which the parties attempt to settle their dispute informally, with or without attorneys to represent them. Attorneys frequently advise their clients to negotiate a settlement voluntarily.

3–5b Mediation In mediation, a neutral third party acts as a communicating agent and works with both sides in the dispute to facilitate a resolution. The mediator talks with the par- ties and emphasizes their points of agreement to help them evaluate their options. The mediator may propose a solution, but he or she does not make a decision resolving the matter.

One of the main advantages of mediation is that it is not as adversarial as litiga- tion. ExamplE 3.2 Trevor and Julie, who are business partners, have a dispute over how the profits of their firm should be distributed. If the dispute is mediated, the mediator will emphasize the common ground shared by Trevor and Julie and help them work toward an agreement. They can then work out the distribution of profits without damaging their continuing business relationship. j

Learning OutcOme 4

Summarize the steps in a lawsuit.

alternative dispute resolution (aDR) The resolution of disputes outside the traditional judicial process.

Learning OutcOme 5

Identify alternative methods for resolving disputes.

negotiation An attempt to settle a dispute without going to court.

mediation The use of a neutral third party to facilitate a settlement.

exhibit 3.4 Stages in a Typical Lawsuit

Pretrial motions may be made and decided.

Discovery and other pretrial work take place.

Trial occurs and judgment is made.

Posttrial motions may be �led.

Appeal may be made.

Injured party goes to an attorney.

Defendant’s attorney �les a motion to dismiss or an answer.

Plainti�’s attorney �les a complaint.

Injury occurs to plainti�.

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C H A P T E R 3 The Courts and Our Legal System 37

3–5c Arbitration A more formal method of ADR is arbitration, in which an arbitrator (a neutral third party or a panel of experts) hears a dispute and imposes a resolution on the parties. Usually, the parties in arbitration agree that the third party’s decision will be legally binding, although they can also agree to nonbinding arbitration. In non- binding arbitration, the parties can go forward with a lawsuit if they do not agree with the arbitrator’s decision.

The arbitrator’s decision is called an award. An award is usually the final word on the matter. A court will set aside an award if the arbitrator’s conduct or “bad faith” substantially prejudiced the rights of one of the parties. In addition, an award may be set aside if it violates an established public policy or the arbitrator arbitrated issues that the parties did not agree to submit to arbitration.

Arbitration is unlike other forms of ADR because the third party hearing the dispute makes a decision for the parties. Exhibit 3.5 outlines the basic differences among the traditional forms of ADR.

3–5d Online Dispute Resolution The settlement of disputes in online forums is known as online dispute resolution (ODR). The disputes resolved in these forums have most commonly involved dis- agreements over the rights to domain names or over the quality of goods sold via the Internet, including goods sold through online auction sites.

ODR may be best for resolving small- to medium-sized business liability claims, which may not be worth the expense of litigation or traditional ADR. Most online forums do not automatically apply the law of a specific jurisdiction. Instead, results are often based on general, universal legal principles. As with most offline methods of dispute resolution, any party may appeal to a court at any time.

arbitration Dispute resolution made by a neutral third party.

online dispute resolution (ODR) The resolution of a dispute via the Internet.

exhibit 3.5 Basic Differences in the Traditional Forms of Alternative Dispute Resolution

type of aDr Description neutral third Party Present Who Decides the resolution

negotiation The parties meet informally with or without their attorneys and attempt to agree on a resolution.

No The parties themselves reach a resolution.

mediation A neutral third party meets with the parties and emphasizes points of agreement to help them resolve their dispute.

Yes The parties decide the resolution, but the mediator may suggest or propose a resolution.

arbitration The parties present their arguments and evidence before an arbitrator at a hearing, and the arbitrator renders a decision resolving the parties’ dispute.

Yes The arbitrator imposes a resolution on the parties that may be either binding or nonbinding.

Conflict Resolved In the Conflict Presented feature at the beginning of this chapter, Rob files a claim with Secure Insurance Company to recover for a back injury. Rob asserts that the injury prevents him from engaging

in work or any strenuous activity. Secure denies the claim. In Rob’s subsequent

(Continues)

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U n i t 1 The Law and Our Legal System38

Learning OutcOme 1: Outline a state court system. A state court system includes trial courts and appellate courts. A trial court is where trials are held and testimony is taken. An appellate court is a court of appeal and review. Every state has at least one appellate court, and many have intermediate appellate courts. Each state has a high court, from which appeal to the United States Supreme Court is possible only if a federal question is involved.

Learning OutcOme 2: Define federal court jurisdiction. Any lawsuit concerning a federal question can originate in a federal court. A federal question is an issue of law based, at least in part, on the Constitution, a treaty, or a federal law. A case involving diversity of citizenship can also be heard in a federal court.

Learning OutcOme 3: Discuss trial procedure. A trial begins with opening statements from both parties’ attorneys. The trial proceeds with each party’s presentation of its side of the case (with the introduction and examination of witnesses and evidence). The trial ends with closing arguments from both sides and the court’s verdict.

Learning OutcOme 4: summarize the steps in a lawsuit. An injury occurs to a party, who then goes to an attorney. The plaintiff’s attorney files a complaint, and a summons is issued. The defendant’s attorney files a motion to dismiss or an answer. Pretrial motions may be made and decided. Discovery and other pretrial work take place. The trial occurs. A judgment is made. Posttrial motions may be filed. An appeal may be made.

Learning OutcOme 5: identify alternative methods for resolving disputes. Alternative methods include negotiation, mediation, and arbitration. In negotiation, the parties attempt to settle their dispute informally without the involvement of a third party. In mediation, the parties attempt to come to an agreement with the assistance of a neutral third party, a mediator, who does not make a decision in the dispute. In arbitration, a neutral third party or a panel of experts hears a dispute and renders a decision.

CHaPteR SummaRy—tHe CouRtS and ouR LegaL SyStem

lawsuit against the insurer, Secure asks him to supply all of his Twitter and Facebook postings since the accident. Rob objects.

a Is Secure’s request appropriate? Why or why not? Yes. If Rob’s Twitter and Facebook posts are public, Secure can review them without Rob’s specific consent. If

the social media profiles are private, the court will likely require Secure to show that its

discovery request is reasonably calculated to lead to relevant and admissible evidence.

Secure would then argue that the social media posts will likely reveal whether or not

Rob suffers from the injury as he claims.

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C H A P T E R 3 The Courts and Our Legal System 39

ISSue SPotteRS Check your answers to the Issue Spotters against the answers provided in Appendix A at the end of this text.

1. Ron wants to sue Art’s Supply Company for Art’s failure to deliver supplies that Ron needed to prepare his work for an appearance at a local artists’ fair. What must Ron establish before a court will hear the suit? (See Jurisdiction and The State Court Case Process.)

2. Carlos, a citizen of California, is injured in an automo- bile accident in Arizona. Alex, the driver of the other car, is a citizen of New Mexico. Carlos wants Alex to pay Carlos’s medical expenses and car repairs, which total $125,000. Can Carlos sue in federal court? Why or why not? (See The Federal Court System.)

StRaIgHt to tHe PoInt

1. Over what must a court have jurisdiction before it can hear a case? (See Jurisdiction.)

2. What is the principal difference between trial and appel- late courts? (See The State Court System.)

3. When do both federal and state courts have the power to hear a case? (See The Federal Court System.)

4. Before a party can bring a lawsuit, what must he or she have? (See The State Court Process.)

5. Before a trial begins, how can the parties obtain infor- mation and collect evidence about the case? (See The State Court Process.)

6. Why do businesses use methods of alternative dispute resolution to settle their disputes? (See Alternative Dispute Resolution.)

ReaL Law

3–1. motion for summary Judgment. Rebecca Nichols drove a truck for Tri-National Logistics, Inc. (TNI). On a deliv- ery trip, Nichols’s fellow driver James Paris made unwel- come sexual advances. Nichols reported this behavior to TNI. Their employer left her with Paris in Pharr, Texas, for another seven days before sending a driver to pick her up. She filed a lawsuit in a federal district court against TNI, alleging discrimination on the basis of sex. Disputed facts included whether Nichols subjectively felt abused by Paris and whether TNI was aware of his conduct and failed to take appropriate action. Could TNI successfully file a motion for summary judgment at this point? Explain. [Nichols v. Tri-National Logistics, Inc., 809 F.3d 981 (8th Cir. 2016)] (See The State Court Case Process.)

3–2. arbitration. Bruce Matthews played football for the Tennessee Titans. As part of his contract, he agreed to sub- mit any dispute to arbitration. He also agreed that Tennes- see law would determine all matters related to workers’

compensation. After Matthews retired, he filed a workers’ compensation claim in California. The arbitrator ruled that Matthews could pursue his claim in California but only under Tennessee law. Should this ruling be set aside? Explain. [National Football League Players Association v. National Football League Management Council, __ F.Supp.2d __ (S.D.Cal. 2011)] (See Alternative Dispute Resolution.)

3–3. Jurisdiction. Independence Plating Corp. (IPC) of New Jersey provides metal-coating services. It does not advertise or otherwise solicit business in North Carolina. Southern Prestige Industries, Inc., a North Carolina firm, contracted with IPC to ship parts from North Carolina to New Jer- sey for processing. After thirty-two transactions, Southern Prestige filed a suit in a North Carolina state court against IPC, alleging breach of contract. Can the court exercise jurisdiction? Explain. [Southern Prestige Industries, Inc. v. Independence Plating Corp., 202 N.C.App. 372, 690 S.E.2d 768 (2010)] (See Jurisdiction.)

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U n i t 1 The Law and Our Legal System40

etHICaL QueStIonS

3–4. to sue or not to sue? What ethical considerations might affect a decision to go to court?

3–5. complaint. John Verble worked as a financial advisor for Morgan Stanley Smith Barney, LLC. After nearly seven years, Verble was fired. He filed a lawsuit in a federal district court against his ex-employer. In his complaint, Verble alleged that he had learned of illegal activity by Morgan Stanley and its clients, he reported that activity

to the Federal Bureau of Investigation, and as a result, he was fired in retaliation. His complaint contained no additional facts surrounding the situation. To avoid a dis- missal of his lawsuit, does Verble have a legal obligation to be more specific with the facts? Does he owe an ethi- cal duty to back up his claims with more facts? Explain your answers. [Verble v. Morgan Stanley Smith Barney LLC, 2017 WL 129040 (6th Cir. 2017)] (See The State Court Case Process.)

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41

Chapter 3—work Set

1. Generally, a court can exercise jurisdiction over the residents of the state in which the court is located.

2. All state trial courts have general jurisdiction.

3. The decisions of a state’s highest court on all questions of state law are final.

4. Federal courts may refuse to enforce a state or federal statute that violates the U.S. Constitution.

5. The United States Supreme Court can hear appeals on federal questions from state and federal courts.

6. Pleadings consist of a complaint, an answer, and a motion to dismiss.

7. If a party does not deny the truth of a complaint, he or she is in default.

8. In mediation, a mediator makes a decision on the matter in dispute.

tRue-FaLSe QueStIonS

1. National Computers, Inc., was incorporated in Nebraska, has its main office in Kansas, and does business in Missouri. National is subject to the jurisdiction of

a. Nebraska, Kansas, and Missouri. b. Nebraska and Kansas, but not Missouri. c. Nebraska and Missouri, but not Kansas. d. Kansas and Missouri, but not Nebraska.

2. Abraham, Inc., sues Ballard, Inc., in a state court. Abraham loses and files an appeal with the state appeals court. The appeals court will

a. not retry the case, because the appropriate place for the retrial of a state case is a federal court. b. not retry the case, because an appeals court examines the record of a case, looking at questions of law and

procedure for errors by the trial court. c. retry the case, because after a case is tried a party has a right to an appeal. d. retry the case, because Abraham and Ballard do not agree on the result of the trial.

3. A lawsuit can be brought in a federal court if it involves

a. a question under the Constitution, a treaty, or a federal law. b. citizens of different states, a foreign country and a U.S. citizen, or a foreign citizen and an American citizen, and

the amount in controversy is more than $75,000. c. either a or b. d. none of the above.

4. Ace Corporation, which is based in Texas, advertises on the Web. A court in Illinois would be most likely to exercise jurisdiction over Ace if Ace

a. conducted substantial business with Illinois residents at its website. b. interacted with any Illinois resident through its website. c. only advertised passively on its website. d. all of the above.

5. Ann sues Carla in a state trial court. Ann loses the suit. If Ann wants to appeal, the most appropriate court in which to file the appeal is

a. the state appellate court. b. the nearest federal district court. c. the nearest federal court of appeals. d. the United States Supreme Court.

muLtIPLe-CHoICe QueStIonS

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42

6. The first step in a lawsuit is the filing of pleadings, and the first pleading filed is the complaint. The complaint contains

a. a statement alleging jurisdictional facts. b. a statement of facts entitling the complainant to relief. c. a statement asking for a specific remedy. d. all of the above.

7. The purposes of discovery include

a. saving time. b. narrowing the issues. c. preventing surprises at trial. d. all of the above.

8. Jim and Bill are involved in an automobile accident. Sue is a passenger in Bill’s car. Jim’s attorney wants to ask Sue, as a witness, some questions concerning the accident. Sue’s answers to the questions are given in

a. a deposition. b. a response to interrogatories. c. a pretrial motion. d. none of the above.

9. After the entry of a judgment, who can appeal?

a. Only the winning party. b. Only the losing party. c. Either the winning party or the losing party. d. None of the above.

10. Cobb and Roberts submit their dispute to binding arbitration. A court can set aside the arbitrator’s award if

a. Cobb is not satisfied with the award. b. Roberts is not satisfied with the award. c. the award involves at least $75,000. d. the award violates public policy.

anSweRIng moRe LegaL PRobLemS

1. Bento Cuisine is a lunch-cart business. It occupies a street corner in Texarkana, a city that straddles the border of Arkansas and Texas. Across the street—and across the state line, which runs down the middle of the street—is Rico’s Tacos. The two businesses compete for customers. Recently, Bento has begun to believe that Rico’s is engaging in competitive behavior that is illegal.

If Bento were to file a lawsuit against Rico’s, in which type of court could Bento initiate the action?  Bento could file a suit against Rico’s in a trial court of _______________ jurisdiction in either the state of Bento’s location or the state of Rico’s location. Because there appears to be diversity of _______________ in this situation, if the amount in controversy could conceiv- ably exceed $75,000, a suit might instead be filed in a _______________ district court, which is the equivalent of a state trial court of general jurisdiction.

2. Bento files a lawsuit against Rico’s. Bento believes that it has both the law and the facts on its side. At the end of the trial, however, the jury decides against Bento, and the judge issues a ruling in favor of Rico’s.

If Bento is unwilling to accept this result, what are its options? Bento’s first option might be to file a motion to set aside the verdict and hold a new _______________. This motion will be granted if the judge is convinced, after examining the evidence, that the jury was in error but does not think it appropriate to issue a judgment for Bento’s side. Bento’s second option would be to appeal the trial court’s judgment, including a denial of the motion for a new trial, to the appropriate court of _______________. An appellate court is most likely to review the case for errors in _______________, not fact. In any case, the appellate court will not hear new _______________.

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43

Learning OutcOmes

The five Learning Outcomes below are designed to help improve your understanding of the chapter. After reading this chapter, you should be able to:

Explain Congress’s power to regulate commerce.

Discuss federal priority over state laws.

Describe the Bill of Rights.

Identify due process protections.

Outline privacy rights.

1

2

3

4

5

4 Constitutional Law

Laws that govern business have their origin in the lawmaking authority granted by the U.S. Constitution, which is the supreme law in this country. Neither Congress nor any state may pass a law that conflicts with the Constitution.

In this chapter, we first look at some basic constitutional concepts and clauses and their significance for business. Then we examine how certain freedoms guar- anteed by the Constitution affect businesspersons.

4–1 the constitutional Powers of government

The United States has a federal form of government in which the national govern- ment and the states share sovereign power. The Constitution sets forth specific powers that can be exercised by the national government. The Constitution also provides that the national government has the implied power to undertake actions necessary to carry out its expressly designated powers. All other powers are “reserved” to the states. The broad language of the Constitution leaves much room for debate over the nature and scope of these powers. Generally, the courts deter- mine where the line between state and national powers lies.

4–1a The Separation of Powers The U.S. Constitution divides these powers among three branches of government. The legislative branch makes the laws, the executive branch enforces the laws, and the judi- cial branch interprets the laws. Each branch performs a separate function. No branch may exercise the authority of another branch.

federal form of government Government in which power is divided between a central government and member states.

Conflict Presented Marvin owns an acre of undeveloped land beside Interstate 8 within the limits of Centre City. On this lot stands a billboard. Marvin rents the billboard to Discount Mart, which is situated across

the highway. A city ordinance prohibits signs that are not on the advertiser’s property if the signs are visible from the highway. The ordinance is intended to make the city more appealing—thereby increasing property values—and to prevent distractions that might cause car accidents. Discount Mart files a lawsuit against the city, claiming that the ordinance violates its First Amendment rights.

Q is centre city’s ordinance valid?

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U n i t 1 The Law and Our Legal System44

A system of checks and balances allows each branch to limit the actions of the other two branches. This prevents any one branch from exercising too much power. For instance, the judicial branch has the power to hold actions of the other two branches unconstitutional.

4–1b The Commerce Clause To prevent states from establishing laws and regulations that would interfere with trade and commerce among the states, the Constitution expressly delegates to the national government the power to regulate interstate commerce. (Interstate commerce crosses state lines and is under federal jurisdiction.)

Article I, Section 8, of the U.S. Constitution expressly permits Congress “[t]o regulate Commerce with foreign Nations, and among the several States.” This clause, referred to as the commerce clause, has had a greater impact on business than any other provision in the Constitution.

National Powers The power over commerce authorizes the national government to regulate every commercial enterprise in the United States. Federal (national) legislation governs nearly every major activity conducted by businesses. It can affect hiring and firing decisions, workplace safety, and how businesses compete and finance their enterprises. The commerce clause may not justify national regulation of noneconomic conduct, however.

The Regulatory Powers of the States State governments have the authority to regulate affairs within their borders. This authority stems in part from the Tenth Amendment to the Constitution, which reserves all powers not delegated to the national government to the states.

State regulatory powers are often referred to as police powers. These powers include the right of state governments to regulate private activities to protect or promote the public order, health, safety, morals, and general welfare. Fire and build- ing codes, antidiscrimination laws, parking regulations, zoning restrictions, licens- ing requirements, and other statutes are based on a state’s police powers. Local governments, including cities, also exercise police powers.

The “Dormant” Commerce Clause The commerce clause gives the national government the exclusive authority to regulate commercial activities that substantially affect trade and commerce among the states. This express grant of authority to the national government implies that the states do not have the authority to regulate interstate commerce. In short, a state regulation that substantially interferes with interstate commerce violates the commerce clause. This aspect of the commerce clause is often referred to as the “dormant” (implied) commerce clause.

The dormant commerce clause comes into play when state regulations affect interstate commerce. In this situation, the courts normally weigh the state’s interest in regulating a certain matter against the burden that the state’s regulation places on interstate commerce.

4–1c The Supremacy Clause Article VI of the Constitution provides that the Constitution, laws, and treaties of the United States are “the supreme Law of the Land.” This article is referred to as the supremacy clause. When there is a direct conflict between a federal law and a state law, the state law is rendered invalid. Because some powers are concurrent (shared by the federal government and the states), however, it is necessary to deter- mine which law governs in a particular circumstance.

Preemption occurs when Congress chooses to act exclusively in a concurrent area. In this circumstance, a valid federal statute or regulation will take precedence over a conflicting state or local law or regulation on the same general subject.

checks and balances Divisions of power among the branches of government.

Learning OutcOme 1

Explain Congress’s power to regulate commerce.

commerce clause Constitutional provision that gives Congress the power to regulate commerce.

police powers Powers possessed by states as part of their inherent sovereignty.

supremacy clause Provision that declares the Constitution “the supreme Law of the Land.”

preemption A doctrine under which federal laws preempt state laws.

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C H A P T E R 4 Constitutional Law 45

4–1d The Taxing and Spending Powers Article I, Section 8, provides that Congress has the “Power to lay and collect Taxes, Duties, Imposts, and Excises.” Section 8 further provides that “all Duties, Imposts and Excises shall be uniform throughout the United States.” The requirement of uniformity refers to uniformity among the states. Thus, Congress may not tax some states while exempting others.

If a tax measure bears some reasonable relationship to revenue production, it is usually within the national taxing power. Also, the commerce clause almost always provides a basis for sustaining a federal tax.

Under Article I, Section 8, Congress has the power “to pay the Debts and provide for the common Defence and general welfare of the United States.” Through the spending power, Congress disposes of the revenues accumulated from the taxing power. Congress can spend revenues to promote any objective it deems worthwhile, so long as it does not violate the Constitution.

4–2 Business and the Bill of rights The Constitution’s first ten amendments, known as the Bill of Rights, embody pro- tections for the individual against types of interference by the federal government. Some constitutional protections apply to business entities. Corporations exist as separate legal entities, or legal persons, and enjoy many of the same rights and privileges as natural persons do. The protections guaranteed by these ten amend- ments are summarized in Exhibit 4.1.

Most of the rights outlined in Exhibit 4.1 also apply to state governments under the Fourteenth Amendment. That amendment provides in part that “[n]o State shall . . . deprive any person of life, liberty, or property, without due process of law.” A law or other governmental action that limits one of the rights or liberties set out in the Constitution may violate the “due process of law.”

4–2a The First Amendment—Freedom of Speech Freedom of speech is a prized freedom protected by the Bill of Rights. Indeed, it forms the basis for our democratic form of government. Democracy could not exist if people could not freely express their political opinions and criticize government actions and policies.

Also protected is symbolic speech—such as gestures, movements, articles of clothing, and other forms of nonverbal expressive conduct. For instance, the burn- ing of the American flag as part of a peaceful protest is a constitutionally protected form of expression. The test is whether a reasonable person would interpret the

Learning OutcOme 3

Describe the Bill of Rights.

Bill of Rights The first ten amendments to the U.S. Constitution.

symbolic speech Nonverbal expressive conduct.

Learning OutcOme 2

Discuss federal priority over state laws.

Highlighting the Point

Congress enacts a law that imposes certain rules for the labeling and packaging of pesticides. Later, a state legislature enacts a law that prescribes different require- ments for pesticide package warnings. Pat, a farmer, uses Quik-Kil, a pesticide that damages her crops. Pat files a lawsuit against Royal Chemical Company, Quik-Kil’s manufacturer, alleging a violation of the state law. Royal argues that the federal packaging rules preempt the state requirements.

is the state law valid? No. Under the supremacy clause, when a state law conflicts with the federal law on the same subject, the federal law takes precedence. A state cannot permit something that the federal law prohibits or ban something that the federal law specifically allows.

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U n i t 1 The Law and Our Legal System46

conduct as conveying some sort of message. ExamPlE 4.1 As a form of expression, Josh has gang signs tattooed on his torso, arms, and neck. If Rebecca reasonably interprets this conduct as conveying a message, then the tattoos might be a pro- tected form of symbolic speech. j

Reasonable Restrictions To protect citizens from those who would abuse the right to free expression, speech is subject to reasonable restrictions. Reasonableness is analyzed on a case-by-case basis.

If a restriction imposed by the government is content neutral, then a court may allow it. To be content neutral, the restriction must be aimed at a societal problem, such as crime, and not be aimed at the expressive conduct of the speech.

ExamPlE 4.2 Roosevelt High School officials confiscate a banner, which reads “Bong Hits 4 Jesus,” from Russell Lende, a high school sophomore. Lende is sus- pended from high school and files a lawsuit, claiming the banner is a protected form of expression. A federal court reasons that the banner could be interpreted as promoting drugs and concludes that the restrictions are justified. j

In addition, speech that violates criminal laws is not constitutionally protected. For instance, if someone’s speech is used to defraud or cheat someone, then the government (through its courts) can restrict that speech.

Corporate Political Speech Political speech by corporations falls within the protection of the First Amendment. In a 2010 landmark case, Citizens United v. Federal Election Committee, the United States Supreme Court struck down a federal law that prohibited corporations from using their funds to advocate the election or defeat of a political candidate. The Court held that this prohibition violated the First Amendment.

Commercial Speech—Advertising Commercial speech consists of communications— primarily advertising—made by business firms involving only their commercial interests. The protection given to commercial speech under the First Amendment

First amendment Guarantees the freedoms of religion, speech, and the press and the rights to assemble peaceably and to petition the government.

Second amendment States that the right of the people to keep and bear arms shall not be infringed.

Third amendment Prohibits, in peacetime, the lodging of soldiers in any house without the owner's consent.

Fourth amendment Prohibits unreasonable searches and seizures of persons or property.

Fifth amendment Guarantees the right to indictment (formal accusation) by a grand jury. Also guarantees all the rights to due process of law and to fair payment when private property is taken for public use. Prohibits compulsory self- incrimination and double jeopardy (trial for the same crime twice).

Sixth amendment Guarantees the accused in a criminal case the right to a speedy and public trial by an impartial jury and with counsel. The accused has the right to cross-examine witnesses against him or her and to solicit testimony from witnesses in his or her favor.

Seventh amendment Guarantees the right to a trial by jury in a civil case involving at least twenty dollars.

Eighth amendment Prohibits excessive bail and fines, as well as cruel and unusual punishment.

Ninth amendment Establishes that the people have rights in addition to those specified in the Constitution.

Tenth amendment Establishes that powers neither delegated to the federal government nor denied to the states are reserved to the states and to the people.

exhibit 4.1 Protections Guaranteed by the Bill of Rights

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C H A P T E R 4 Constitutional Law 47

is not as extensive as that afforded to noncommercial speech. A state may restrict certain kinds of advertising in the interest of protecting consumers from being misled. States also have a legitimate interest in the beautification of roadsides, and this interest allows states to place restraints on billboards.

Generally, a restriction on commercial speech is valid as long as it meets the following three criteria: 1. It must seek to implement a substantial government interest. 2. It must directly advance that interest. 3. It must go no further than necessary to accomplish its objective.

A substantial government interest is a significant connection or concern of the government with respect to a particular matter. The substantial-interest require- ment limits the power of the government to regulate commercial speech.

substantial government interest A significant connection or concern that justifies a government restriction on commercial speech.

Highlighting the Point

California enacts a statute that requires video game makers to attach labels to their games to warn parents of excessive violence. The statute defines a violent video game as one in which “the range of options available to a player include killing, maiming, dismembering, or sexually assaulting an image of a human being.”

Does the california statute violate the First amendment? Yes. Video games are entitled to First Amendment protection, and the statute’s definition of a violent video game is too vague. Many games that are violent are based on popular novels or mov- ies and have complex plots. They should not be treated differently than these novels and movies. The statute is not justified by a substantial government interest, and the law is not narrowly tailored to accomplish any particular objective.

Unprotected Speech Certain types of speech are not given any protection under the First Amendment. Speech that harms the good reputation of another, or defamatory speech, is not protected. Speech that violates criminal laws (such as threatening speech) is not constitutionally protected. Other unprotected speech includes “fighting words,” or words that are likely to incite others to respond violently.

The First Amendment also does not protect obscene speech. Material is obscene if, for instance, the average person finds that it violates contemporary community standards. Or, the work is clearly offensive sexual conduct.

4–2b The First Amendment—Freedom of Religion The First Amendment states that the government may neither establish any religion nor prohibit the free exercise of religious practices. The first part of this constitu- tional provision is referred to as the establishment clause, and the second part is known as the free exercise clause. Government action, both federal and state, must be consistent with this constitutional mandate.

The Establishment Clause The establishment clause prohibits the government from establishing a state-sponsored religion. The clause also prohibits laws that promote religion or that show a preference for one religion over another. The establishment clause does not require a complete separation of church and state, however. On the contrary, it requires the government to accommodate religions.

establishment clause Constitutional provision that prohibits any law “respecting an establishment of religion.”

free exercise clause Constitutional provision that prohibits any law “prohibiting the free exercise” of religion.

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U n i t 1 The Law and Our Legal System48

The establishment clause covers conflicts about the legality of state and local government support for a particular religion or religious organization or school. It also applies to conflicts about such matters as school prayer and the teaching of evolution versus fundamentalist theories of creation in public schools.

For a law or policy to be constitutional, it must not have the primary effect of advancing or inhibiting religions. Generally, federal or state regulation that does not promote religion or place a significant burden on religion is constitutional, even if it has some impact on religion.

The Free Exercise Clause The free exercise clause guarantees that a person can hold any religious belief or no religious belief. When religious practices work against public policy and the public welfare, however, the government can act. For instance, regardless of a child’s or a parent’s religious beliefs, the government can require certain types of medical treatment if the child's life is in danger.

To comply with the free exercise clause, a government action must not place a substantial burden on religious practices. A burden is substantial if it pressures an individual to change his or her behavior and to violate his or her beliefs.

Real Case

Michael Thompson, a Muslim, was an inmate at Waupun Correctional Institution in Wisconsin. A central practice of the Islamic faith is a sunrise-to-sunset fast during the month of Ramadan. The prison accommodates this practice by providing a “meal bag” at sunset to each Muslim inmate. Ten days into Ramadan, the prison withheld Thomp- son’s meal bags for two days. He felt pressure to break his fast by going to the prison cafeteria. But under prison policy he would thereby forfeit meal bags for the rest of the fast. Meanwhile, hunger caused him to miss prayers and undercut his experience of Ramadan. Thompson filed a lawsuit in a federal district court against prison officials, including William Holm, a guard captain. Thompson claimed that his right to exercise his religion freely had been violated. The court issued a summary judgment in the prison’s favor.

Did the withholding of thompson’s meal bags during ramadan constitute a substantial burden on his free exercise right? Yes. In Thompson v. Holm, the U.S. Court of Appeals for the Seventh Circuit vacated (invalidated) the judgment of the lower court and remanded the case for trial. Forcing an inmate to choose between daily nutrition and religious practice is a substantial burden on his or her free exercise rights.

—809 F.3d 376 (7th Cir.)

4–3 Due Process and equal Protection Two other constitutional guarantees of great significance to Americans come from the due process clauses of the Fifth and Fourteenth Amendments and the equal protection clause of the Fourteenth Amendment.

4–3a Due Process Both the Fifth and the Fourteenth Amendments provide that no person shall be deprived “of life, liberty, or property, without due process of law.” The

Learning OutcOme 4

Identify due process protections.

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C H A P T E R 4 Constitutional Law 49

due process clause of each of these amendments has two aspects—procedural and substantive.

Procedural Due Process Procedural due process requires that any government decision to take life, liberty, or property must be made fairly. Fair procedures must be used to determine whether a person will be subject to punishment or have some burden imposed on him or her.

Procedural due process requires that a person have at least an opportunity to object to a proposed action before a fair, neutral decision maker (who need not be a judge). ExamPlE 4.3 Sabrina, a nursing student, takes a selfie with an uncon- scious patient who is a local celebrity. Sabrina is working her shift at the university hospital when she takes the photo. Although she quickly deletes the photo from her smartphone, she first sends it to some fellow nursing students and the photo ends up on Facebook. When the director of nursing sees the photo online, Sabrina is expelled immediately from the university’s nursing program. Sabrina success- fully sues the university, which violated her due process rights by not giving her an opportunity to present her side to school authorities. j

Substantive Due Process Substantive due process focuses on the content, or substance, of legislation. If a law or other governmental action limits a fundamental right, it will be held to violate substantive due process unless it promotes a substantial government interest. Fundamental rights include interstate travel, privacy, voting, and all First Amendment rights.

Substantial government interests include the public’s safety. Thus, laws designat- ing speed limits are valid if they are shown to reduce highway fatalities, because the state has a compelling interest in protecting the lives of its citizens.

In situations not involving fundamental rights, a law or action must rationally relate to a legitimate governmental end. Nearly every business regulation is upheld on this basis against substantive due process challenges. These include insurance regulations, price and wage controls, banking controls, and controls of unfair com- petition and trade practices.

4–3b Equal Protection Under the Fourteenth Amendment, a state may not “deny to any person within its jurisdiction the equal protection of the laws.” This equal protection clause also applies to the federal government. Equal protection means that the government must treat similarly situated individuals in a similar manner.

Equal protection, like substantive due process, relates to the substance of a law or other governmental action. A law or action that limits the liberty of all persons may violate substantive due process, while a law or action that limits the liberty of some persons but not others may violate the equal protection clause.

ExamPlE 4.4 An Urban City law limits all outdoor business signs to a certain size. This raises a substantive due process question. A Metro City ordinance restricts the size of certain businesses’ signs but not those of others. This raises an equal protection issue. j

Under the equal protection clause, when a law or action distinguishes between or among individuals, the basis for the distinction—that is, the classification—is examined. The courts use one of three standards: the “rational basis” test, interme- diate scrutiny, or strict scrutiny.

The “Rational Basis” Test Generally, a law regulating economic or social matters is valid if there is any conceivable “rational basis” on which the classification might relate to any legitimate government interest. It is almost impossible for a law or action to fail the rational basis test.

due process clause Constitutional provision that guarantees due process of law.

equal protection clause Constitutional provision that guarantees equal protection of the laws.

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U n i t 1 The Law and Our Legal System50

Intermediate Scrutiny A higher standard applies to laws involving discrimination based on gender or legitimacy (children born out of wedlock). Laws using these classifications must substantially relate to important government objectives.

ExamPlE 4.5 An Oklahoma statute prohibits the sale of beer to males under twenty-one but allows it to females over eighteen. In a challenge by Peter (a male under twenty-one but over eighteen), the state is not able to show a substantial relationship between the statute and its alleged benefits. Thus, this law violates the equal protection clause. j

Strict Scrutiny The highest standard applies to a law or an action that inhibits some persons’ exercise of a fundamental right or is based on a suspect trait (such as race, national origin, or citizenship status). This will stand only if it is necessary to promote a compelling government interest.

ExamPlE 4.6 A small town in New Jersey begins awarding construction contracts to Wyatt’s Construction and several other minority-owned construction companies. The town is attempting to correct its long history of illegal discrimination against minority-owned construction companies. The preference program goes no further than necessary to correct the problem. Additionally, its guidelines mandate that it stop once there is success in balancing the number of city contracts awarded to Wyatt and other minorities. j

4–4 Privacy rights The U.S. Constitution does not explicitly mention a general right to privacy. The Supreme Court has held that a constitutional right to privacy is implied by the First, Third, Fourth, Fifth, and Ninth Amendments. Privacy rights also receive protection under various state and federal statutes.

Important federal legislation relating to privacy rights is listed and described in Exhibit 4.2. For a discussion of two laws pertaining to the collection of personal information by businesses, see this chapter’s Linking Business Law to Your Career feature.

Learning OutcOme 5

Outline privacy rights.

Freedom of Information act (1966)

Provides that individuals have a right to obtain access to information about them collected in government files.

Privacy act (1974) Protects the privacy of individuals about whom the federal government has information. Regulates agencies’ use and disclosure of data, and gives individuals access to and a means to correct inaccuracies.

Electronic Communications Privacy act (1986)

Prohibits the interception of information communicated by electronic means.

Health Insurance Portability and accountability act (1996)

Requires health-care providers and health-care plans to inform patients of their privacy rights and of how their personal medical information may be used. States that medical records may not be used for purposes unrelated to health care or disclosed without permission.

USa Patriot act (2001) and USa Freedom act (2015)

Increases government authority to monitor Internet activities and to access personal financial and student information. Law enforcement officials can obtain phone data about targeted individuals from private phone companies.

exhibit 4.2 Federal Legislation Relating to Privacy

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C H A P T E R 4 Constitutional Law 51

Conflict Resolved In the Conflict Presented feature at the beginning of this chapter, Marvin owns an acre of land on which a billboard stands. He rents the billboard to Discount Mart. His land is within the limits of Centre

City. A city ordinance prohibits signs that are not on the advertiser’s property if the signs are visible from a nearby interstate highway. The ordinance is intended to make the city more visually appealing and to prevent distractions that might cause car accidents. Discount Mart files a lawsuit against the city, challenging the ordinance as a violation of the First Amendment.

a Is Centre City’s ordinance valid? Yes. A government can regulate commercial speech if the regulation is reasonable. The regulation must implement a substantial

government interest, directly advance that interest, and go no further than necessary

to accomplish its objective.

Here, Centre City restricts billboard advertising to beautify the city and to prevent

accidents. These legitimate government interests are directly advanced by the

ordinance. Lastly, the ordinance’s sign-location restriction prevents it from going further

than necessary to accomplish its objective.

Linking Business Law to Your Career

Pretexting and Marketing

If you work in marketing or sales, gath- ering and obtaining information about your current and target customers will be a significant part of your position. There are many legitimate strategies for gleaning customer and market details, such as purchasing mailing lists, install- ing certain software on the company’s website, and conducting social media and phone surveys.

Because of the rising concern over privacy rights as technology improves, however, you will need to be cautious how you conduct market research and gather personal infor- mation. One problematic research method that you should know about is pretexting.

What is Pretexting?

A pretext is a false motive to hide the real motive. Thus, pretexting is the process of obtaining information by false means. For instance, a pretexter who claims that he is from a certain bank may ask an indi- vidual—via the phone or e-mail—for personal and banking data to assist him in updating that individual’s account with a new security system. Once important details are given, the pretexter can sell the information to a data broker who, in turn, can sell it to another party, such as your company or even an identity thief.

the Law and Pretexting

Congress has passed laws to help deal with the potential problems of

pretexting, such as identity theft and the invasion of privacy. The Gramm- Leach-Bliley Act, for example, made pretexting to obtain financial infor- mation illegal. Another law—the Telephone Records and Privacy Pro- tection Act—prohibits someone from using false representations to obtain another person’s confiden- tial phone records. The act also pro- hibits the buying or selling of such phone records without the owner’s permission.

Despite these two laws, pretexting often skirts the boundary between legal and illegal. Thus, as a marketing professional, be careful not to violate any pretexting laws.

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U n i t 1 The Law and Our Legal System52

Learning OutcOme 1: explain congress’s power to regulate commerce. The commerce clause expressly permits Congress to regulate commerce, authorizing the national government to regulate every commercial enterprise in the United States. A state government may regulate private activities within its borders to protect or promote the public order, health, safety, morals, and general welfare. A state regulation that substantially interferes with interstate commerce violates the commerce clause, however.

Learning OutcOme 2: Discuss federal priority over state laws. The supremacy clause provides that the Constitution, laws, and treaties of the United States are “the supreme Law of the Land.” Whenever a state law directly conflicts with a federal law, the state law is rendered invalid.

Learning OutcOme 3: Describe the Bill of rights. The Bill of Rights consists of the first ten amendments to the U.S. Constitution. These amendments embody a series of protections for individuals against various types of government interference.

Learning OutcOme 4: identify due process protections. Both the Fifth and the Fourteenth Amendments to the U.S. Constitution provide that no person shall be deprived “of life, liberty, or property, without due process of law.” The due process clause of each of these constitutional amendments has two aspects—procedural and substantive.

Learning OutcOme 5: Outline privacy rights. There is no specific guarantee of a right to privacy in the Constitution, but such a right has been derived from guarantees found in the First, Third, Fourth, Fifth, and Ninth Amendments. Federal and state statutes also protect privacy rights.

CHaPteR SummaRY—ConStitutionaL Law

iSSue SPotteRS Check your answers to the Issue Spotters against the answers provided in Appendix A at the end of this text.

1. Can a state, in the interest of energy conservation, ban all advertising by power utilities if conservation could be accomplished by less restrictive means? Why or why not? (See Business and the Bill of Rights.)

2. Suppose that a state taxes out-of-state companies doing business in the state at a rate higher than the rate for

in-state companies. The state’s purpose is to protect local firms from out-of-state competition. Does this tax vio- late the equal protection clause? Explain your answer. (See Due Process and Equal Protection.)

StRaigHt to tHe Point

1. Why is it necessary to determine where the line between state and national powers lies? (See The Constitutional Powers of Government.)

2. Which part of the government has the exclusive author- ity to regulate trade and commerce among the states? (See The Constitutional Powers of Government.)

3. How do protections guaranteed by the Bill of Rights apply to the states? (See Business and the Bill of Rights.)

4. What does due process require? (See Due Process and Equal Protection.)

5. What does “equal protection” mean? (See Due Process and Equal Protection.)

6. Is a constitutional right to privacy express or implied? (See Privacy Rights.)

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C H A P T E R 4 Constitutional Law 53

ReaL Law

4–1. reasonable restrictions on Free speech. Michael May- field, the president of Mendo Mill and Lumber Company in California, received a “notice of a legal claim” from Edward Starski. This “claim” alleged that a stack of lumber fell on a customer as a result of a Mendo employee’s “incompe- tence.” The “notice” presented a settlement offer on the customer’s behalf in exchange for a release of liability for Mendo. In a follow-up phone conversation with Mayfield, Starski said that he was an attorney—which, in fact, he was not. Starski was arrested and charged with violating a state statute that prohibited the unlawful practice of law. He argued that “creating an illusion” that he was an attorney fell within the protection of his First Amendment right to free speech. Is Starski correct? Explain your answer. [The People v. Edward Robert Starski, 7 Cal.App.5th 215, 212 Cal.Rptr.3d 622 (1 Dist. 2017)] (See Business and the Bill of Rights.)

4–2. the commerce clause. Regency Transportation, Inc., operates a freight business throughout the eastern United States. Regency maintains its corporate headquarters and other facilities in Massachusetts. The vehicles in Regency’s fleet were bought in other states. Massachusetts imposes various taxes on all taxpayers subject to its jurisdiction,

including those that, like Regency, do business in interstate commerce. When Massachusetts imposed a tax on the pur- chase price of each vehicle in Regency’s fleet, the trucking firm challenged the assessment as discriminatory under the commerce clause. What is the chief consideration under the commerce clause when a state law affects interstate com- merce? Is Massachusetts’s tax valid? Explain. [Regency Transportation, Inc. v. Commissioner of Revenue, 473 Mass. 459, 42 N.E.3d 1133 (2016)] (See The Constitutional Powers of Government.)

4–3. equal Protection. Abbott Laboratories licensed Smith- Kline Beecham Corp. to sell an Abbott human immunodefi- ciency virus (HIV) drug. Abbott then increased the wholesale price of its drug. This forced SmithKline to increase its price and thereby drove business to Abbott, which continued to sell its product at a lower price. SmithKline filed a suit in a federal district court against Abbott, alleging breach of con- tract. During jury selection, Abbott eliminated the only self- identified gay person among the potential jurors. Could the equal protection clause be applied to prohibit discrimina- tion based on sexual orientation in jury selection? Discuss. [SmithKline Beecham Corp. v. Abbott Laboratories, 740 F.3d 471 (9th Cir. 2014)] (See Business and the Bill of Rights.)

etHiCaL QueStionS

4–4. the establishment clause. Do religious displays on public property violate the establishment clause? Discuss. (See Business and the Bill of Rights.)

4–5. Free speech. Aric Toll owns and manages the Balboa Island Village Inn, a restaurant and bar. Anne Lemen lives across from the inn. Lemen complained to the authorities about the inn’s customers, whom she called “drunks” and

“whores.” Lemen told the inn’s bartender Ewa Cook that Cook “worked for Satan.” She repeated her statements to potential customers, and the inn’s sales dropped more than 20 percent. The inn filed a suit against Lemen. Are her state- ments protected by the U.S. Constitution? Did she act uneth- ically? Explain. [Balboa Island Village Inn, Inc. v. Lemen, 40 Cal.4th 1141, 156 P.3d 339 (2007)] (See The Constitutional Powers of Government.)

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55

Chapter 4—work Set

1. A federal form of government is one in which a central authority holds all power.

2. The president can hold acts of Congress and of the courts unconstitutional.

3. Congress can regulate any activity that substantially affects commerce.

4. A state law that substantially interferes with interstate commerce is unconstitutional.

5. When there is a direct conflict between a federal law and a state law, the federal law is invalid.

6. If a tax is reasonable, it is within the federal taxing power.

7. The Bill of Rights protects individuals against types of interference by the federal government only.

8. Any restriction on commercial speech is unconstitutional.

9. Due process and equal protection are different terms for the same thing.

10. The First Amendment protects individuals from speech that violates state criminal laws.

tRue-FaLSe QueStionS

1. Of the three branches of the federal government provided by the Constitution, the branch that makes the laws is

a. the administrative branch. b. the executive branch. c. the judicial branch. d. the legislative branch.

2. Under the commerce clause, Congress can regulate

a. any commercial activity in the United States. b. any noncommercial activity in the United States. c. both a and b. d. none of the above.

3. A business challenges a state law in court, claiming that it unlawfully interferes with interstate commerce. The court will consider

a. only the state’s interest in regulating the matter. b. only the burden that the law places on interstate commerce. c. the state’s interest in regulating the matter and the burden that the law places on interstate commerce. d. none of the above.

4. A state statute that bans corporations from making political contributions that individuals can legally make is likely to be unconstitutional under

a. the commerce clause. b. the First Amendment. c. the establishment clause. d. the supremacy clause.

muLtiPLe-CHoiCe QueStionS

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56

5. A state statute that bans certain advertising practices for the purpose of preventing consumers from being misled is likely to be unconstitutional under

a. the commerce clause. b. the First Amendment. c. the supremacy clause. d. none of the above.

6. Procedures that are used to decide whether to take life, liberty, or property are the focus of constitutional provisions covering

a. equal protection. b. procedural due process. c. substantive due process. d. the commerce clause.

7. A law that limits the liberty of all persons to engage in a certain activity may violate constitutional provisions covering

a. equal protection. b. procedural due process. c. substantive due process. d. the supremacy clause.

8. A law that restricts most vendors from doing business in a high-traffic area might be upheld under constitutional provisions covering

a. equal protection. b. procedural due process. c. substantive due process. d. the free exercise clause.

9. Congress enacts a law covering airports. If a state enacts a law that directly conflicts with this federal law,

a. both laws are valid. b. neither law is valid. c. the federal law takes precedence. d. the state law takes precedence.

anSweRing moRe LegaL PRoBLemS

1. AgriCorp grows crops on farmland in three states. AgriCorp sells its harvests through USA Distributors, Inc., to Variety Mart and other national grocery chains. Small Potato Farm grows a limited crop on five acres chiefly for the personal use of its owners. The owners sell some of their produce on Saturdays at the Hector County Farmers’ Market.

Which of these growers is subject to federal regula- tion under the commerce clause? Both of these enter- prises are subject to federal regulation under the commerce clause. The U.S. Constitution expressly delegates to the national government the power to regulate _______________ commerce. This power over commerce authorizes the national government to regulate _______________ commercial enterprise in the United States. Federal legislation governs nearly every major activity conducted by businesses. Here, both growers market their products, and their actions have an impact, however great or small, on interstate commerce.

2. Global Enterprises Corporation zealously advocates the election of Courtney Smith as the next president of the United States and the defeat of the incumbent, Herbert Dumpty. The corporation produces and dis- tributes Humpty Dumpty, a film underscoring Presi- dent Dumpty’s shortcomings. The firm buys airtime on satellite and cable networks to broadcast Courtney!, an unabashed tribute to Dumpty’s opponent.

Has global enterprises violated the First amendment?  No. Freedom of _______________ is a highly prized freedom. It forms the basis for our democratic form of government, which could not exist if we could not freely express our _______________ opinions. The _______________ Amendment to the U.S. Constitution guarantees the freedom of speech. Corporations exist as separate legal entities and enjoy many of the same rights as persons. Political speech by corporations falls under the protection of the First Amendment. Like per- sons, corporations can use their funds to advocate the election or defeat of a candidate.

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57

Learning OutcOmes

The four Learning Outcomes below are designed to help improve your understanding of the chapter. After reading this chapter, you should be able to:

Identify the types of intentional torts against persons.

Identify the types of intentional torts against property.

Name the four elements of negligence.

Define strict liability.

1

2

3

4

5 Business Torts

A tort is wrongful conduct—a civil wrong not arising from a breach of contract. Through tort law, society compensates those who have suffered injuries as a result of the wrongful conduct of others. In this chapter, we discuss torts that can occur in any context, but we focus on business torts.

5–1 the Basis of tort Law Tort law recognizes that some acts are wrong because they cause injuries to oth- ers. A tort is not the only type of wrong that exists in the law. Crimes also involve wrongs. A crime is considered a wrong against society as a whole, as well as against the individual victim.

Therefore, the state prosecutes and punishes (through fines, imprisonment, and possibly death) persons who commit criminal acts. A tort action, in contrast, is a civil action in which one person brings a personal lawsuit against another.

Sometimes, the same wrongful act can result in both civil (tort) and criminal actions against the wrongdoer. Exhibit 5.1 illustrates how this might occur.

5–2 intentional torts against Persons An intentional tort requires intent. The tortfeasor (the one committing the tort) must intend to commit an act, the consequences of which interfere with the inter- ests of another in a way not permitted by law. An evil or harmful motive is not required. Intent means only that the actor intended the consequences of his or her act or knew with substantial certainty that particular consequences would result from the act.

Types of intentional torts against persons include assault and battery, false imprisonment, defamation, fraud, and wrongful interference.

tortfeasor One who commits a tort.

intentional tort A wrongful act knowingly committed.

Learning OutcOme 1

Identify the types of intentional torts against persons.

business torts A tort occurring only within the business context.

tort A civil wrong not arising from a breach of contract.

Conflict Presented Jorge works for Google, Inc., and is being considered for a management position. His supervisor, Lydia, writes a memo about his job performance to those evaluating him for the position. This

memo contains some false, negative statements, which Lydia does not believe are true.

Q if the company posts the memo online, can it be the basis for a successful lawsuit by Jorge?

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U n i t 1 The Law and Our Legal System58

5–2a Assault and Battery An intentional, unexcused act that creates in another person a reasonable apprehen- sion or fear of immediate harmful or offensive contact is an assault. Apprehension is not the same as fear. If a contact is such that a reasonable person would want to avoid it, and there is a reasonable basis for believing that the contact will occur, the plaintiff suffers apprehension, whether or not he or she is afraid.

The completion of the act that caused the apprehension, if it results in harm to the plaintiff, is a battery—an unexcused and harmful or offensive physical contact intentionally performed.

ExamplE 5.1 Ivan enters Crown Convenience, a small neighborhood store. Pull- ing out a handgun, he demands the money from the cash register from Jean, the store clerk. Once Jean gives Ivan the money, he shoots her. Ivan’s pointing of the gun at Jean is an assault. The firing of the gun and hitting Jean with a bullet is a battery. j

5–2b False Imprisonment False imprisonment is the intentional confinement or restraint of another person without justification. The confinement can be accomplished through the use of physical barriers, physical restraint, or threats of physical force.

Businesspersons are often confronted with lawsuits for false imprisonment after they have attempted to confine a suspected shoplifter for questioning. The detention must be conducted in a reasonable manner and for only a reasonable length of time. In some states, a merchant can use the defense of probable cause to justify delaying a suspected shoplifter. Probable cause exists when the evidence to support the belief that a person is guilty outweighs the evidence against that belief.

assault Any word or action intended to make another person fearful of immediate physical harm.

battery The intentional touching of another that is harmful or offensive.

exhibit 5.1 Tort Lawsuit and Criminal Prosecution for the Same Act

The assailant commits an assault (an intentional, unexcused act that creates in Joe the reasonable fear

of immediate harmful contact) and a battery (intentional harmful

or o�ensive contact).

PHYSICAL ATTACK AS A TORT

Joe �les a civil suit against the assailant.

A court orders the assailant to pay Joe for his injuries.

The assailant violates a statute that de�nes and prohibits the crime of

assault (attempt to commit a violent injury on another) and battery

(commission of an intentional act resulting in injury to another).

The state prosecutes the assailant.

A court orders the assailant to be �ned or imprisoned.

PHYSICAL ATTACK AS A CRIME

A person suddenly attacks Joe as he is walking down the street.

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C H A P T E R 5 Business Torts 59

5–2c Defamation Defamation involves wrongfully hurting a person’s good name, reputation, or char- acter. Doing so in writing involves the tort of libel. Doing so orally involves the tort of slander. Defamation also occurs when a false statement is made about a person’s product, business, or title to property.

To establish defamation, a plaintiff normally must prove the following: 1. The defendant made a false statement of fact. ExamplE 5.2 Kim’s statement,

“Lane cheats on his taxes,” if false, can lead to liability for defamation. Kim’s statement, “Lane is a jerk,” however, cannot constitute defamation because it is an opinion. j

2. The statement was understood as being about the plaintiff and tended to harm the plaintiff’s reputation.

3. The statement was communicated to at least one person other than the plaintiff. 4. If the plaintiff is a public figure, she or he must prove actual malice.

defamation Anything published or publicly spoken that causes injury to another’s reputation.

libel Defamation in written form.

slander Defamation in oral form.

liability Legal responsibility for a debt or an obligation.

Real Case

Copia Blake hired attorney Ann-Marie Giustibelli to represent her in a divorce. Blake agreed to pay Giustibelli $300 an hour. When Giustibelli sought payment, Blake balked at the amount. Blake posted negative reviews of Giustibelli, stating “the contract she submitted to the courts for her fees were 4 times her original quote.” Giustibelli filed a suit against Blake, alleging libel. Blake argued that her online posts were statements of opinion that fell under her right to free speech. The court ruled in Giustibelli’s favor, and Blake appealed.

Were Blake’s written posts protected statements of opinion? No. In Blake v. Giustibelli, the appellate court affirmed that the right to free speech does not protect defamatory speech. In fact, Blake’s online statements contradicted her testimony at trial, where she admitted that Giustibelli had not charged four times more than what was quoted in the agreement. The evidence showed that Blake had agreed to pay the amount stated in the contract, which is the amount that Giustibelli sought.

—182 So.3d 881 (Fla.App. 4 Dist.)

5–2d Fraud Fraud leads another to believe in a condition that is different from the condition that actually exists. The tort of fraud involves intentional deceit for personal gain. The tort includes several elements: 1. A misrepresentation of facts or conditions with knowledge that they are false

or with reckless disregard for the truth. 2. An intent to induce another to rely on the misrepresentation. 3. A justifiable reliance on the misrepresentation by the deceived party. 4. Injuries suffered as a result of this reliance. 5. A causal connection between the misrepresentation and the injury.

For fraud to occur, more than mere puffery, or seller’s talk, must be involved. Fraud exists only when a person represents as a fact something he or she knows is untrue. ExamplE 5.3 Brandon commits fraud when he claims that a building does not leak when he knows it does. j

fraud Any misrepresentation made with the intention of deceiving another.

puffery A salesperson's opinion about property, products, or services.

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U n i t 1 The Law and Our Legal System60

Facts are objectively ascertainable, whereas seller’s talk is not. ExamplE 5.4 Betty, who is a certified public accountant, says, “I am the best accountant in town.” This is seller’s talk. Betty is not trying to represent something as fact, because the term best is a subjective, not an objective, term. j

5–2e Wrongful Interference Wrongful interference with another’s business rights is generally divided into two categories: wrongful interference with a contractual relationship and wrongful interference with a business relationship.

Wrongful Interference with a Contractual Relationship This business tort requires a valid, enforceable contract (a promise constituting an agreement) between two parties. A third party must know that this contract exists. The third party must intentionally cause either of the two parties to break the contract.

The contract may be between a firm and its employees or a firm and its custom- ers. Sometimes, a firm’s competitor may hire one of the firm’s key employees. If the original employer can show that the competitor induced the former employee to break the contract, damages can be recovered from the competitor.

Wrongful Interference with a Business Relationship Businesspersons cannot interfere unreasonably in another’s business in their attempts to gain a share of the market. ExamplE 5.5 Northgate Shopping Center contains two shoe stores: Johnson’s Athletic Shoes and Lady Foot Locker. One day, Gordon, a Johnson’s employee, stands near the Lady Foot Locker’s entrance and tells incoming customers that his store will beat any Lady Foot Locker price on Nike running shoes. Gordon’s actions constitute the tort of wrongful interference with a business relationship, which is commonly considered to be an unfair trade practice. j

Defenses A person will not be liable for the tort of wrongful interference if the interference results from legitimate competitive behavior. ExamplE 5.6 If Antonio’s Meats advertises so effectively that it induces Alex’s Restaurant to break its contract with Alvarez Meat Company, Alvarez Meat Company will be unable to recover from Antonio’s Meats for wrongful interference, because advertising is legitimate competitive behavior. j

5–3 intentional torts against Property Intentional torts against property include trespass to land, trespass to personal property, conversion, and disparagement of property. Land is real property, which also includes things “permanently” attached to the land. Personal property consists of all other items, which are basically movable. Thus, a house and lot are real property, whereas the furniture inside a house is personal property.

5–3a Trespass to Land A trespass to land occurs when a person, without permission, (1) enters onto, above, or below the surface of land that is owned by another; (2) causes anything to enter onto the land; or (3) remains on the land or permits anything to remain on it. Actual harm to the land is not required.

Common types of trespass to land include walking or driving on the land, shoot- ing a gun over the land, throwing rocks at a building, building a dam and thus causing water to back up on someone else’s land, and placing part of one’s building on an adjoining landowner’s property.

Learning OutcOme 2

Identify the types of intentional torts against property.

trespass to land Entry without the owner’s permission.

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C H A P T E R 5 Business Torts 61

5–3b Trespass to Personal Property When an individual unlawfully harms the personal property of another or other- wise interferes with the owner’s right to exclusive possession and enjoyment of that property, trespass to personal property occurs.

ExamplE 5.7 Kelly takes Ryan’s business law textbook as a practical joke. She hides it so that he cannot find it for several days before a final examination. Kelly has committed trespass to personal property. (She has also committed the tort of conversion, discussed next.) j If it can be shown that trespass to personal property was warranted, however, then a complete defense exists.

5–3c Conversion When personal property is wrongfully taken from its rightful owner or possessor and placed in the service of another, the act of conversion occurs. Conversion is any act depriving an owner of personal property (including electronic data) without that owner’s permission and without just cause.

Conversion is the civil side of crimes related to theft. A store clerk who steals merchandise from the store commits a crime and engages in the tort of conversion at the same time.

trespass to personal property Unlawfully taking or harming another’s personal property.

conversion The wrongful taking, using, or retaining possession of personal property that belongs to another.

Highlighting the Point

Nick works for Welco when he sets up his own company, Turbo Tech. Nick uses a Welco credit card to make unauthorized charges for Turbo Tech. Welco pays the charges through electronic deposits into Nick’s personal account.

is the use of another’s credit card to obtain money conversion? Yes. The tort of con- version can be adapted to different types of property rights. When Nick uses Welco’s credit card, he steals part of Welco’s credit. In this way, Nick made an unauthorized transfer to himself of Welco’s rights to its property (in this case, money).

5–3d Disparagement of Property Disparagement of property occurs when economically injurious falsehoods (lies) are made about another’s product or property. Disparagement of property is a general term for torts that can be more specifically referred to as slander of quality or slander of title.

Slander of Quality Publication of false information about another’s product, alleging that it is not what its seller claims, constitutes the tort of slander of quality. This tort has also been given the name trade libel.

Slander of Title When a publication denies or casts doubt on another’s legal ownership of any property, and when this results in financial loss to that property’s owner, the tort of slander of title may exist. Usually, this is an intentional tort in which someone knowingly publishes an untrue statement about property with the intent of discouraging a third person from dealing with the person slandered.

ExamplE 5.8 Skinner Autos and Lew’s Used Cars are competitors for local auto sales. Larry, the manager at Skinner Autos, posts a notice on his company’s Web site and on social media platforms, claiming that many of Lew’s cars are stolen. As a result, customer traffic at Lew’s dealership decreases drastically. j

disparagement of property Economically injurious falsehoods about another’s product or property.

slander of quality Publication of false information about another’s product.

slander of title The publication of a statement that casts doubt on another’s legal ownership of any property.

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U n i t 1 The Law and Our Legal System62

5–4 negligence The tort of negligence occurs when someone suffers injury because of another’s failure to live up to a required duty of care. It is not required that the tortfeasor intended to bring about the consequences of the act. It is required only that the actor’s conduct created a risk of such consequences. If no risk was created, there is no negligence.

Negligence comprises the following four elements: 1. Duty—Did the defendant owe a duty of care to the plaintiff? 2. Breach—Did the defendant breach that duty? 3. Harm—Did the plaintiff suffer an injury as a result of the defendant’s breach

of the duty of care? 4. Cause—Did the defendant’s breach cause the plaintiff’s injury?

5–4a The Duty of Care and Its Breach People owe each other a duty to act with reasonable care. In determining whether the duty has been breached, the focus is on how a reasonable person would have acted in the same circumstances.

What meets this standard of care varies. Landowners are expected to exer- cise reasonable care to protect persons coming onto their property. For instance, landlords are expected to use reasonable care to ensure that their tenants are not harmed in common areas, such as stairways.

Persons invited to come onto business premises are considered business invitees. Firms are usually charged with a duty to exercise reasonable care to protect busi- ness invitees.

Reasonable care for professionals involves a somewhat different standard. If an individual has knowledge, skill, or intelligence superior to that of an ordinary person, the individual’s conduct must be consistent with that status. Profession- als—including accountants, architects, physicians, and others—have a standard minimum level of special knowledge and ability.

5–4b The Injury Requirement For a tort to have been committed, the plaintiff must have suffered an injury. If no harm or injury results from an action, there is nothing to compensate—and no tort exists. ExamplE 5.9 If Jack carelessly bumps into Lena, who stumbles and falls as

negligence Failure to exercise the standard of care that a reasonable person would exercise.

Learning OutcOme 3

Name the four elements of negligence.

duty of care The duty to exercise a reasonable amount of care in dealings with others.

business invitee A person invited onto business premises by the owner.

Highlighting the Point

Don enters Select Foods, a supermarket. One of the employees has just finished cleaning the floor, but there is no sign warning that the floor is wet. Don slips on the wet floor and sustains injuries as a result.

is select Foods liable for damages? Yes. A court would hold that Select Foods was negligent because the employee failed to exercise reasonable care in protecting the store’s customers against risk that the employee knew or should have known about. That a patron might slip on a wet floor and be injured was a foreseeable risk, and the employee should have taken care to avoid this risk or to warn the customer of it. The store also has a duty to discover and remove any hidden dangers that might injure a customer or other invitee.

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C H A P T E R 5 Business Torts 63

a result, Jack may be liable in tort if Lena is injured in the fall. If she is unharmed, however, there normally could be no suit for damages, because no injury was suf- fered. j

5–4c Causation Another element necessary to a tort is causation. If a person fails in a duty of care and someone suffers injury, the wrongful activity must have caused the harm for a tort to have been committed.

How to Determine Causation In deciding whether a defendant's act caused a plaintiff's injury, there two questions to ask: 1. Is there causation in fact? Did the injury occur because of the defendant’s act?

Causation in fact can usually be determined by use of the but for test. In other words, “but for” the wrongful act, the injury would not have occurred.

2. Was the act the proximate cause of the injury? proximate cause exists when the connection between an act and an injury is strong enough to justify imposing liability.

ExamplE 5.10 Randall carelessly leaves a campfire burning. The fire burns down the forest and sets off an explosion in a nearby chemical plant. The explosion spills chemicals into a river, killing all the fish downstream and ruining the economy of a tourist resort. Is Randall liable to the resort owners? To the tourists whose vaca- tions are ruined? These are questions of proximate cause. j

causation in fact An act without which an event would not have occurred.

proximate cause Connection between an act and an injury strong enough to impose liability.

Highlighting the Point

Jim checks into Travelers Inn. During the night, a fire is started by an arsonist. The inn has no emergency lights or clear exits. Attempting to escape, Jim finds the first- floor doors and windows locked. He forces open a second-floor window and jumps out. To recover for his injuries, he files a suit against Travelers Inn on the ground of negligence.

is the harm caused by a fire set by an arsonist a reasonably foreseeable risk? Yes. The duty to protect others against unreasonable risks of harm extends to risks aris- ing from acts of third persons, even criminals. The inn’s failure to provide adequate lighting and clear exits created a foreseeable risk that a fire, however it started, would harm its guests.

Proximate Cause and Foreseeability Foreseeability is the test for proximate cause. If the victim of the harm or the consequences of the harm are unforeseeable, there is no proximate cause.

5–4d Defenses to Negligence The basic defenses in negligence cases are assumption of risk and comparative negligence.

Assumption of Risk A plaintiff who voluntarily enters into a risky situation, knowing the risk involved, will not be allowed to recover. This is the defense of assumption of risk. The requirements of this defense are (1) knowledge of the risk and (2) voluntary assumption of the risk. For instance, a driver entering a car race knows there is a risk of being injured in a crash. The driver assumes this risk.

assumption of risk Voluntarily assuming the risk of injury from a danger.

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U n i t 1 The Law and Our Legal System64

Comparative Negligence Most states allow recovery based on the doctrine of comparative negligence. Under this doctrine, both the plaintiff’s negligence and the defendant’s negligence are computed and the liability distributed accordingly. Some jurisdictions have a “pure” form of comparative negligence that allows a plaintiff to recover even if the extent of his or her fault is greater than that of the defendant. Many states, however, have a “50 percent” rule by which the plaintiff recovers nothing if he or she was more than 50 percent at fault.

comparative negligence Liability for injuries based on proportionate negligence.

Conflict Resolved In the Conflict Presented feature at the beginning of the chapter, Jorge works for Google, Inc. When he is considered for a management position, his supervisor, Lydia, writes a

memo about his job performance. The memo includes some false, negative statements.

a If the company posts the memo online, can it be the basis for a successful lawsuit by Jorge? Yes. The basis for the suit is defamation—a tort that requires the communication

of false statements harming a person’s reputation. The memo contains such statements—

Jorge’s supervisor, who writes the memo, does not believe the statements to be true.

And the memo is communicated online. If Jorge is denied the position based on the

statements, he can bring an action against his employer for defamation.

Highlighting the Point

Brian is an experienced all-terrain-vehicle (ATV) rider. Without putting on a helmet, Brian takes his ATV for a drive. It flips, and Brian strikes his head, sustaining injuries. He files a suit against the ATV’s manufacturer, American ATV Company. During the trial, it is proved that Brian’s failure to wear a helmet was responsible for essentially all of his injuries. Brian’s state has a “50 percent” rule.

under these circumstances, is the manufacturer liable for any of the damage sus- tained? No. In a 50-percent-rule state, if a plaintiff is found to be at least equally responsible for whatever damage is sustained, he or she can recover nothing. The evidence that Brian’s failure to wear a helmet is responsible for essentially all of the damage means that Brian will lose in court.

5–5 strict Liability Another category of torts is strict liability, or liability without fault. Strict liability for damages proximately caused by an abnormally dangerous activity is one appli- cation of this doctrine. Strict liability applies in such a case because of the extreme risk of the activity. Balancing that risk against the potential for harm, it is fair to ask the person engaged in the activity to pay for any injury caused by it.

ExamplE 5.11 Newman Mining Corp. is using dynamite to create a new nickel mine located in an Idaho wilderness area. Despite the company’s reasonable care in storing the dynamite, a vandal sets fire to its on-site storage facility, and the dynamite explodes. The subsequent explosion damages nearby homes and acres of harvestable timber. Although this damage is not Newman’s fault, the company is still responsible because of the inherent dangerous nature of using dynamite in its operations. j

strict liability Liability regardless of fault.

Learning OutcOme 4

Define strict liability.

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C H A P T E R 5 Business Torts 65

Learning OutcOme 1: identify the types of intentional torts against persons. An intentional tort is an act committed with the intent that its consequences interfere with another’s interests in a way not permitted by law. Intentional torts against persons include assault, battery, fraud, false imprisonment, defamation, and wrongful interference.

Learning OutcOme 2: identify the types of intentional torts against property. Intentional torts against property include trespass to land, trespass to personal property, conversion, and disparagement of property.

Learning OutcOme 3: name the four elements of negligence. The four elements of negligence are (1) the existence of a legal duty of care, (2) a breach of the duty, and (3) an injury, harm, or damage to another (4) caused by the breach.

Learning OutcOme 4: Define strict liability. Strict liability is liability without fault. This doctrine applies when an injury or damage is proximately caused by an abnormally dangerous activity.

CHaPteR SummaRy—BuSineSS toRtS

iSSue SPotteRS Check your answers to the Issue Spotters against the answers provided in Appendix A at the end of this text.

1. A burst water pipe floods a Metal Fabrication Com- pany utility room and trips the circuit breakers on a panel in the room. Metal Fabrication contacts Nel- son, a licensed electrician with five years’ experience, to check the damage and turn the breakers back on. Without testing for short circuits, which Nelson knows that he should do, he switches on a breaker. He is electrocuted, and his wife sues Metal Fabrication for

negligence. What might the firm successfully claim in defense? (See Negligence.)

2. After less than a year in business, Elite Fitness Club surpasses Good Health Club in number of members. Elite’s marketing strategies attract many Good Health members, who then change clubs. Does Good Health have any recourse against Elite? Explain your answer. (See Intentional Torts against Persons.)

StRaigHt to tHe Point

1. What is the difference between a tort and a crime? (See The Basis of Tort Law.)

2. What must a plaintiff normally prove to establish defa- mation? (See Intentional Torts against Persons.)

3. Define fraud. (See Intentional Torts against Persons.) 4. What are the two categories of wrongful interference?

(See Intentional Torts against Persons.)

5. Which tort is the civil side of crimes related to theft? (See Intentional Torts against Property.)

6. State the two questions that determine whether a defen- dant’s act caused a plaintiff’s injury. (See Negligence.)

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U n i t 1 The Law and Our Legal System66

Real law

5–1. negligence. DSC Industrial Supply and Road Rider Supply are located in the North Kitsap Business Park in Seattle, Washington. Paul and Suzanne Marshall, who had outstanding commercial loans from Frontier Bank, owned both firms. Frontier dispatched one of its employ- ees, Suzette Gould, to North Kitsap to “spread Christmas cheer” to the Marshalls as an expression of appreciation for their business. Approaching the entry to Road Rider, Gould tripped over a concrete “wheel stop” and fell, suf- fering a broken arm and a dislocated elbow. The stop was not clearly visible, it had not been painted a contrasting color, and it was not marked with a sign. Gould had not been aware of the stop before she tripped over it. Is North Kitsap liable to Gould for negligence? Explain. [Gould v. North Kitsap Business Park Management, LLC, 192 Wash. App. 1021 (2016)] (See Negligence.)

5–2. negligence. Ronald Rawls and Zabian Bailey were in an auto accident in Bridgeport, Connecticut. Bailey rear- ended Rawls at a stoplight. The evidence showed that Bailey had failed to apply his brakes in time to avoid the collision, failed to turn his vehicle to avoid the collision, failed to keep his vehicle under control, and was inattentive

to his surroundings. Because Bailey’s auto insurance did not cover all of the costs, Rawls filed a suit in a Connecticut state court against his own insurance company, Progressive Northern Insurance Co. Rawls wanted to obtain benefits under an underinsured motorist clause. Rawls claimed that Bailey had been negligent. Could Rawls collect from Pro- gressive because of Bailey’s negligence? Discuss. [Rawls v. Progressive Northern Insurance Co., 310 Conn. 768, 83 A.3d 576 (2014)] (See Negligence.)

5–3. Proximate cause. Galen Stoller was killed at a railroad crossing when a train hit his car. The crossing was marked with a stop sign and a railroad-crossing symbol. The sign was not obstructed by vegetation, but there were no flash- ing lights. Galen’s parents filed a suit against Burlington Northern & Santa Fe Railroad Corp. The plaintiffs accused the defendant of negligence in the design and maintenance of the crossing. The defendant argued that Galen had not stopped at the stop sign. Was the railroad negligent? What was the proximate cause of the accident? Discuss. [Hender- son v. National Railroad Passenger Corp., __ F.3d __ (10th Cir. 2011)] (See Negligence.)

etHiCal QueStionS

5–4. Duty of care. Does a person’s duty of care include a duty to come to the aid of a stranger in peril? (See Negligence.)

5–5. Wrongful interference. Julie Whitchurch was an employee of Vizant Technologies, LLC. After she was fired, she created a website falsely accusing Vizant of fraud and mismanagement to discourage others from doing business with the company. Vizant filed a suit in a federal district court against her, alleging wrongful interference with a busi- ness relationship. The court concluded that Whitchurch’s online criticism of Vizant adversely affected its employees

and operations, forced it to accept reduced compensation to obtain business, and deterred outside investment. The court ordered Whitchurch to stop her online efforts to discour- age others from doing business with Vizant. How does the motivation for Whitchurch’s conduct differ from other cases that involve wrongful interference with a business relation- ship? What does this motivation suggest about the ethics in this situation? Discuss. [Vizant Technologies, LLC v. Julie Whitchurch, 2017 WL 128494 (3d Cir. 2017)] (See Intentional Torts against Persons.)

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67

Chapter 5—work Set

1. To be guilty of an intentional tort, a person must intend the consequences of his or her act or know with substantial certainty that those consequences will result.

2. Immediate harmful or offensive contact is an element of assault.

3. Legitimate competitive behavior does not constitute wrongful interference with a contractual relationship.

4. Slander of title requires publication of false information that denies or casts doubt on another’s legal owner- ship of any property.

5. The tort of defamation does not occur unless a defamatory statement is made in writing.

6. Ed tells customers that he is “the best plumber in town.” This is fraudulent misrepresentation, unless Ed actually believes that he is the best.

7. A person who borrows a friend’s car and fails to return it at the friend’s request is guilty of conversion.

8. All individuals—regardless of their knowledge, skill, or intelligence—must exercise the same duty of care if they wish to avoid liability for negligence.

9. Under the doctrine of strict liability, liability is imposed for reasons other than fault.

tRue-FalSe QueStionS

1. Tom owns Tom’s Computer Store. Tom sees Nan, a customer, pick up software from a shelf and put it in her bag. As Nan is about to leave, Tom tells her that she can’t leave until he checks her bag. If Nan sues Tom for false imprison- ment, Nan will

a. win, because a merchant cannot delay a customer on a mere suspicion. b. win, because Nan did not first commit a tort. c. lose, because a merchant may delay a suspected shoplifter for a reasonable time based on probable cause. d. lose, because Tom did not intend to commit the tort of false imprisonment.

2. Walking in Don’s air-conditioned market on a hot day with her sisters, four-year-old Silvia drops her ice cream on the floor near the dairy case. Two hours later, Jan stops to buy milk, slips on the ice cream puddle, and breaks her arm. Don is

a. liable, because a merchant is always liable for customers’ actions. b. liable, if Don failed to take all reasonable precautions against Jan’s injury. c. not liable, because Jan’s injury was her own fault. d. not liable, because Jan’s injury was Silvia’s fault.

3. Gus sends a letter to José in which he falsely accuses José of embezzling. José’s secretary, Tina, reads the letter. If José sues Gus for defamation, José will

a. win, because Tina’s reading of the letter satisfies the publication element. b. win, because Gus’s writing of the letter satisfies the publication element. c. lose, because the letter is not proof that José is an embezzler. d. lose, because the publication element is not satisfied.

4. Online Services Company (OSC) is an Internet service provider. Ads Unlimited, Inc., sends spam to OSC’s customers, and some of them then cancel OSC’s services. Ads Unlimited is most likely liable for

a. defamation. b. disparagement of property. c. fraud. d. wrongful interference with a business relationship.

multiPle-CHoiCe QueStionS

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68

anSweRing moRe legal PRoBlemS

1. During a professional hockey game, Derek, a player for the Devils, collides with Alexei, a player for the Bruins, and falls, hitting his head hard against the ice. Dazed, Derek tells his coach that he thinks he might have a concussion. The coach orders him to “man up” and get back in the game. Derek suffers a second collision with Alexei and is removed from the game unconscious. He is later diagnosed with a brain injury.

Has a tort been committed? If so, what is it, and who committed it? What is this party’s best defense? The tort that has most likely been committed is _______________. The elements are (1) a duty of care, (2) a breach of the duty, and (3) the breach’s causation of (4) an injury. The coach has a duty to exercise _______________care within the context of the game. Ordering a player with a possible concussion to “man up” is likely not an exercise of reasonable care. This breach leads to further injuries to Derek. The coach’s best defense is _______________ _______ _______________. A party who voluntarily enters into a situation—such as a hockey game—know- ing the risk involved cannot recover if he or she suf- fers an injury as a consequence. The requirements are knowledge of the risk and a voluntary assumption of it. As a player of the game, Derek most likely meets both requirements.

2. Aileen is an assistant to the undergraduate dean at State University. As part of her duties, she helps students qualify for various summer internship programs around the state. The student website publishes an article about the university’s success in placing students in these pro- grams. The article includes a photo of Aileen with the caption that reads “Director of Dirty Little Secrets.” Aileen files a lawsuit against the student website, argu- ing that the insult implies that she does not conduct herself ethically while doing her job.

Which tort is most likely the basis for Aileen’s claim? How does it apply to these facts? The tort most likely to form the basis for Aileen’s complaint is _______________. To establish this tort, a plaintiff must prove that the defendant made a false _______________ of _______________. This must _______________ the plaintiff’s reputation, and it must be _______________. Here, the defendant’s best defense is that the phrase is not _______________. It may be in bad taste, but it can- not be read as stating a _______________. The article otherwise appears to present a positive view of Aileen.

5. Bio Box Company advertises so effectively that Product Packaging, Inc., stops doing business with Styro Cartons, Inc. Bio is

a. liable to Styro for wrongful interference with a contractual relationship. b. liable to Styro for wrongful interference with a business relationship. c. liable to Styro for disparagement of property. d. not liable.

6. Erin borrows Desmond’s iPad. When he asks for his iPad back, Erin says that she gave it to Floyd as a birthday gift. In this situation, Desmond can sue Erin for

a. conversion. b. fraud. c. wrongful interference. d. nothing.

7. Joe buys a warehouse with a defective waste disposal system. He replaces part of the system and puts the property up for sale. His marketing sheet states, “Disposal system totally new—each part totally replaced.” Relying on this representation, Kris buys the warehouse. Joe is most likely liable for

a. conversion. b. disparagement of property. c. fraud. d. nothing.

8. Driving his car negligently, Paul crashes into a light pole. The pole falls, smashing through the roof of a house onto Karl, who is killed. But for Paul’s negligence, Karl would not have died. Regarding Karl’s death, Paul’s crash is the

a. cause in fact. b. proximate cause. c. intervening cause. d. superseding cause.

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69

Learning OutcOmes

The five Learning Outcomes below are designed to help improve your understanding of the chapter. After reading this chapter, you should be able to:

Identify intellectual property.

Discuss legal protection for trademarks.

Describe legal protection for patents.

Summarize legal protection for copyrights.

Define trade secret.

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5

6 Intellectual Property

Intellectual property is any property resulting from intellectual, creative pro- cesses—the products of an individual’s mind. It is familiar to everyone. The infor- mation in books and on computers is intellectual property—as are the apps on your smartphone, the movies you watch, and the music you hear.

The need to protect creative works was first recognized in the U.S. Constitution. Statutory protection of these rights began in the 1940s. Today, businesspersons continue to be concerned with protecting their rights in intellectual property, which can be very valuable. Thus, company trademarks, patents, copyrights, and trade secrets need legal protection.

6–1 trademarks and related Property A trademark is a distinctive word, symbol, sound, or design that identifies the manufacturer as the source of particular goods and distinguishes its products from those made or sold by others. Clearly, if one manufacturer uses the trade- mark of another, consumers can be misled. For instance, an independent athletic clothing manufacturer that uses the trademarked Nike “swoosh” creates confu- sion. Consumers might believe that this manufacturer’s products are Nike brand clothing, even though they are not. The law seeks to avoid this kind of confusion.

Once a trademark is established, the owner has exclusive use of it and has the right to bring a legal action against anyone who infringes on it. Trademark infringe- ment occurs when one who does not own a trademark copies it to a substantial degree or uses it in its entirety.

trademark A word, symbol, sound, or design associated with a good.

Learning OutcOme 1

Identify intellectual property.

Intellectual property Property resulting from intellectual, creative processes.

Conflict Presented Hasbro, Inc., the maker of the children’s board game Candyland, owns the Candyland trademark. A nonaffiliated company—the Internet Entertainment Group (IEG)—uses candyland.com as a

domain name for a sexually explicit Internet site. Any person who performs an online search for “candyland” is directed to this adult website.

Q Has ieg violated Hasbro’s rights in the candyland trademark?

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U n i t 1 The Law and Our Legal System70

6–1a Trademark Protection The Lanham Act of 1946 protects manufacturers from losing business to competi- tors that use confusingly similar trademarks. Other federal laws allow trademark owners to bring a suit in federal court for trademark dilution.

Trademark Dilution Trademark dilution occurs when a trademark is used, without permission, in a way that diminishes the distinctive quality of the mark. Unlike trademark infringement, trademark dilution does not require proof that consumers are likely to be confused by a connection between the unauthorized use and the mark. The products involved do not have to be similar. Dilution does require, however, that a mark be famous when the dilution occurs.

ExamplE 6.1 Samantha opens a small coffee shop in her hometown. She names her business “Sambuck’s Coffeehouse.” Starbucks would have a strong dilution claim against Samantha because the Sambuck’s mark reduces the distinctive qual- ity of Starbucks’ famous mark—even though most consumers would likely not be confused about the coffee products offered by each company. j

In addition, trademark dilution can occur online. ExamplE 6.2 Theft Guard markets its industry-leading home security system under the mark “TheftGuard.” A new Internet startup, Theftwatch.com, begins selling its anti-identity theft app using “theftguard” as part of its online advertising campaign. Theft Guard can stop Theftwatch’s use of “theftguard,” claiming trademark dilution. j

Distinctive Marks Only trademarks that are deemed sufficiently distinctive from all competing trademarks are protected. Fanciful, arbitrary, or suggestive trademarks are generally considered to be the most distinctive (strongest) trademarks.

Fanciful trademarks include invented words. Examples include Xerox for one manufacturer’s copiers and Google for a search engine.

Arbitrary trademarks use common words that would not ordinarily be associ- ated with the product, such as Dutch Boy as a name for paint. Sometimes, a single letter used in a particular style can be deemed an arbitrary trademark.

Learning OutcOme 2

Discuss legal protection for trademarks.

Real Case

Larry Flynt opened The Hustler Club, a bar and nightclub, in Cincinnati, Ohio. He opened Hustler clubs in other Ohio cities as well and later began publishing Hustler, a sexually explicit magazine. He formed LFP IP (LFP) to conduct the enterprises. LFP used “LARRY FLYNT” as a trademark. Larry’s brother, Jimmy, formed his own corporation, Hustler Cincinnati, Inc., and opened his own store called “FLYNT Sexy Gifts.” LFP filed a lawsuit in a federal district court against Hustler Cincinnati, alleging trademark infringement. The court issued an order to limit Jimmy’s use of the name “Flynt” without “Jimmy.” Jimmy appealed.

Did Jimmy commit trademark infringement? Yes. In LFP IP v. Hustler Cincinnati, Inc., the U.S. Court of Appeals for the Sixth Circuit affirmed the lower court’s order. Larry owned the “LARRY FLYNT” mark and used it in commerce before Hustler Cincin- nati in connection with adult entertainment products. Jimmy’s later use of “FLYNT” in the same market was likely to cause confusion. The court’s order balanced the interests of both brothers by allowing Jimmy to use “Flynt” as long as he included “Jimmy.”

—810 F.3d 424 (6th Cir. Ohio)

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C H A P T E R 6 Intellectual Property 71

Suggestive trademarks bring to mind something about a product without describing the product directly. For instance, “Dairy Queen” suggests an associa- tion between its products and milk, but it does not directly describe ice cream.

Descriptive terms, geographical terms, and personal names are not inherently distinctive and do not receive protection under the law until they acquire a second- ary meaning. A secondary meaning may arise when customers begin to associate a specific trademark with the source of the trademarked product. For example, even though it is a personal name, Calvin Klein is a distinctive trademark because con- sumers associate that name with designer clothing and goods marketed by Calvin Klein or licensed distributors of Calvin Klein products.

Trademark Registration The state and federal governments provide for the registration of trademarks. Once a trademark has been registered, a firm is entitled to its exclusive use for marketing purposes.

To register for protection under federal trademark law, a person must file an application with the U.S. Patent and Trademark Office. This registration gives national notice that the trademark belongs exclusively to the registrant.

Infringement Whenever someone else uses a registered trademark in its entirety or copies it to a substantial degree, intentionally or unintentionally, the trademark has been infringed—that is, used without authorization. When a trademark has been infringed, the owner has a cause of action against the infringer.

6–1b Counterfeit Goods Counterfeit goods copy or otherwise imitate trademarked goods. Clearly, the sale of counterfeit goods has negative financial effects on legitimate businesses. In addi- tion, sales of certain counterfeit goods, such as pharmaceuticals and nutritional supplements, can present serious public health risks.

It is a crime to intentionally traffic in counterfeit goods or services or to know- ingly use a counterfeit mark on or in connection with goods or services. It is also a crime to knowingly traffic in counterfeit labels, stickers, packaging, and the like— regardless of whether the item is attached to any goods.

6–1c Service Marks and Trade Names A service mark is similar to a trademark but is used to distinguish the services of one person or company from those of another. For example, each commercial air- line has a particular mark or symbol associated with its name. Titles and character names used in radio and television are frequently registered as service marks. Ser- vice marks are protected in the same way as trademarks.

service mark A mark that distinguishes business services.

Highlighting the Point

Quiksilver, Inc., a maker of surfer clothing, uses a stylized X on its products. Sports entertainment company ESPN, Inc., uses a similarly styled X in connection with its X Games, which are competitions in extreme action sports.

can a single letter, such as an X, that has a particular style be an arbitrary trademark? Yes. The X on Quiksilver’s products is clearly an arbitrary mark. Moreover, the two Xs are similar enough that a consumer might well confuse them. These parties have a basis for trademark infringement claims against each other.

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U n i t 1 The Law and Our Legal System72

The term trade name is used to indicate part or all of a business’s name. Gener- ally, a trade name is directly related to a business and its goodwill. As with trade- marks, words must be unusual or fancifully used if they are to be protected as trade names. For instance, the word Safeway is sufficiently fanciful to obtain protection as a trade name for a grocery store chain.

For more considerations involving trademarks and service marks, see the Link- ing Business Law to Your Career feature at the end of this chapter.

6–1d Domain Names A domain name is an Internet address, such as www.amazon.com. The top-level domain (TLD) is the part of the name to the right of the period. The TLD indicates the type of entity that is using the name. For instance, “com” is an abbreviation for “commercial.” The second-level domain (SLD) often consists of the name of the entity that owns the site, such as Amazon.

No two businesses can use the same domain name. ExamplE 6.3 Acme Truck Rentals in Oklahoma and Acme Plumbing in Maine can own the trademark “Acme,” but only one business can operate on the Internet with the domain name acme.com. j

The unauthorized use of another’s mark in a domain name constitutes trade- mark infringement, if the use would likely cause customer confusion. The Internet Corporation for Assigned Names and Numbers (ICANN) oversees the distribution of domain names and operates an online arbitration system to handle complaints and disputes.

6–1e Cybersquatting Cybersquatting occurs when a person registers a domain name that is the same as, or confusingly similar to, the trademark of another and then offers to sell the domain name back to the trademark owner. Under the Anticybersquatting Con- sumer Protection Act (ACPA), cybersquatting is illegal when the person offering the domain name for sale has a “bad faith intent” to profit from using the trade- mark. The ACPA applies to all domain name registrations of trademarks.

6–1f Meta Tags Search engines compile their results by looking through a website’s key-words coding. meta tags, or key words, are inserted in this coding to increase the frequency with which a site appears in search engine results. Using this technique, one site may appropriate the key words of more popular sites, so that the appropriating site appears in the same search engine results as the other sites. Using another’s trademark in a meta tag without the owner’s permission constitutes trademark infringement.

trade name A name used in commercial activity to designate a business.

domain name An Internet address.

cybersquatting Registering a domain name similar to the trademark of another and then offering to sell that domain name to the trademark owner.

meta tag A key word used in online coding.

Highlighting the Point

Michael and Lisa Tabot are auto brokers—that is, they offer personal car-shopping services. The Tabots offer these services on their website, which includes “lexus” in its key-words coding. Toyota Motor Sales, Inc., is the exclusive distributor of Lexus vehicles and the owner of the Lexus mark.

Does the tabots’ use of the Lexus mark as a meta tag, without toyota’s permission, constitute trademark infringement? Yes. Toyota owns the rights to the Lexus mark, and “lexus” is not a name by which the Tabots’ business is known. The Tabots’ use of the “lexus” mark to attract Internet users to their website creates a likelihood of con- fusion. Thus, the Tabots could be ordered to stop using the mark.

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C H A P T E R 6 Intellectual Property 73

6–2 Patents A patent is a grant from the government that gives an inventor the exclusive right to make, use, and sell an invention for a period of twenty years. Patents for fourteen years are given for designs, as opposed to inventions.

For either a regular patent or a design patent, the applicant must demonstrate to the satisfaction of the U.S. Patent and Trademark Office that the invention, discov- ery, or design is novel, useful, and not obvious in light of current technology. Almost anything is patentable, including artistic methods, certain business processes, and storyline structures and patterns.

The first person to file an application for a patent on the product or process receives patent protection. In addition, after issuance there is a nine-month limit for challenging a patent on any ground. The word Patent or Pat. with a patent number gives notice to the world that the article or design is patented.

6–2a Patent Infringement If a firm makes, uses, or sells another’s patented design, product, or process with- out the patent owner’s permission, patent infringement occurs. This can happen even though not all features or parts of an invention are copied. (With respect to a patented process, however, all steps or their equivalent must be copied for infringe- ment to occur.)

6–2b Licensing To avoid litigation, many patent holders will instead offer to sell a license to the infringer. A license for a patent allows the use of the patented design, product, or process for certain specified purposes. Licensing is one of the best ways to protect patents—as well as trademarks, copyrights, and trade secrets—and avoid costly litigation. Also, a license can limit the use of the patent to the licensee (the person gaining the licensing rights).

ExamplE 6.4 West Coast Beverage Company produces Blast Off, its newly pat- ented sports drink, at its headquarters in California. Garth, one of West Coast’s founding partners, is moving to Vermont and wants to sell and distribute Blast Off there. To expand their product’s territory, the other partners enter into a licensing agreement with Garth, allowing him to use the patented soft drink formula to produce and distribute Blast Off in Vermont. j

6–3 copyrights A copyright is an intangible right granted by statute to the author or originator of certain literary or artistic productions to publish, print, or sell the production. These works are protected by the federal government’s Copyright Act.

Works created after January 1, 1978, are automatically given copyright protec- tion for the life of the author, plus 70 years. For copyrights owned by publishing houses, the copyright expires 95 years from the date of publication or 120 years from the date of creation, whichever is first. For works by one or more authors, the copyright expires 70 years after the death of the last surviving author.

6–3a Copyright Protection Copyrights can be registered with the U.S. Copyright Office. This registration is evidence that the copyright is valid. Registration is not required, though. Protection is automatic. And the copyright owner need not place a © on the work to ensure its protection. Chances are that if somebody created it, somebody owns it.

patent A government grant of the exclusive right to make, use, or sell an invention for a limited time period.

Learning OutcOme 3

Describe legal protection for patents.

license An agreement permitting the use of intellectual property.

copyright The exclusive right to publish, print, or sell an intellectual production.

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U n i t 1 The Law and Our Legal System74

ExamplE 6.5 Rusty Carroll operates an online term paper business, R2C2 Inc., that offers up to 300,000 research papers for sale. Some individuals whose work is posted without their permission sue. The court then prohibits Carroll and R2C2 from selling any term paper without proof that the paper’s author has given his or her permission. j

6–3b What Is Protected Expression? Works that are copyrightable include books, records, films, artworks, architectural plans, menus, music videos, and product packaging. To obtain protection under the Copyright Act, a work must be original. It must also fall into one of the following categories: • Literary works • Musical works • Dramatic works • Pantomimes and choreographic

works

• Pictorial, graphic, and sculptural works • Motion pictures and other audiovi-

sual works • Sound recordings • Computer software

To be protected, a work must be “fixed in a durable medium” from which it can be perceived, reproduced, or communicated.

6–3c Copyright Exclusions The Copyright Act excludes copyright protection for any “idea, procedure, pro- cess, system, method of operation, concept, principle or discovery, regardless of the form in which it is described, explained, illustrated, or embodied.” Note that it is not possible to copyright an idea. The underlying ideas embodied in a work may be freely used by others. What is copyrightable is the way in which an idea is expressed. Whenever an idea and an expression are inseparable, the expression cannot be copyrighted. (A standard calendar, for instance, cannot be copyrighted.)

6–3d Copyright Infringement Whenever the form or expression of an idea is copied without the permission of the copyright owner, an infringement of copyright occurs. The reproduction does not have to be exactly the same as the original. Penalties—including criminal proceed- ings for willful violations or the payment of damages—can be imposed on those who infringe copyrights.

The “Fair Use” Exception An exception to liability for copyright infringement is made under the “fair use” doctrine. A person or organization can reproduce copyrighted material without paying royalties for purposes such as criticism, comment, news reporting, teaching (including multiple copies for classroom use), scholarship, and research.

In determining whether the use of a work in a particular case is a fair use, a court takes several factors into account. The purpose of the use is considered, along with the nature of the copyrighted work and how much of it is copied. The most important factor is the effect of the use on the market for the copyrighted work.

The First Sale Doctrine Once a copyright owner sells or gives away a copy of a work, the copyright owner no longer has the right to control the distribution of that copy. This rule is known as the first sale doctrine. ExamplE 6.6 Lisa buys a copyrighted book, such as The Girl on the Train by Paula Hawkins. Lisa can then legally sell it to another person. j

Learning OutcOme 4

Summarize legal protection for copyrights.

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C H A P T E R 6 Intellectual Property 75

6–3e Copyright Protection for Software In 1980, the Computer Software Copyright Act added computer programs to the list of creative works protected by federal copyright law. This protection extends not only to those parts of a computer program that can be read by humans, such as the source code. It also covers the binary-language object code of the program, which is readable only by the computer. Such elements as the overall structure, sequence, and organization of a program may also be copyrightable.

Highlighting the Point

Oracle America owns many application programming interfaces, or APIs. The com- pany grants licenses to other firms to use the APIs to write apps in Java (a processing language). Without Oracle’s permission, Google, Inc., begins to use some of Oracle’s APIs to run Java on its Android devices.

is this copyright infringement? Yes. A court is likely to conclude that the APIs are source code and entitled to copyright protection.

Copyright protection does not extend to the “look and feel”—meaning the gen- eral appearance, command structure, video images, menus, windows, and other screen displays—of computer programs. Copying the look and feel of another’s product may be a violation of trademark laws, however.

6–3f Copyrights in Digital Information Copyright law is probably the most important form of intellectual property protection on the Internet. This is because much of the material on the Internet (including software and database information) is copyrighted. For that material to be transferred online, it must be “copied.” Generally, whenever a party downloads software or music into a computer’s random access memory, or RAM, without authorization, a copyright is infringed. Technology has vastly increased the potential for copyright infringement.

Highlighting the Point

Bridgeport Music and Westbound Vinyl own the copyright to the song “Rock around the World,” which opens with a three-note solo guitar riff that lasts four seconds. The rap song “Runnin’ Away” contains a two-second sample from that guitar solo, but at a lower pitch. The guitar riff is also looped and extended to sixteen beats in five places in the rap song, with each looped segment lasting about seven seconds.

Does the use of the guitar riff in “runnin’ away” without the permission of Bridgeport and Westbound constitute copyright infringement? Yes. Digitally sampling a copy- righted sound recording of any length is copyright infringement. Even when a small part of a sound recording is sampled, the part taken is something of value.

The Digital Millennium Copyright Act The Digital Millennium Copyright Act (DMCA) gives significant protection to owners of copyrights in digital information. The act established civil and criminal penalties for anyone who circumvents (bypasses) encryption software or other technological antipiracy protection. Also

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U n i t 1 The Law and Our Legal System76

prohibited are the manufacture, import, sale, and distribution of devices or services for circumvention.

The DMCA does not restrict the “fair use” of circumvention methods for educa- tional and other noncommercial purposes. For instance, circumvention is allowed to test computer security and to enable parents to monitor their children’s use of the Internet.

ISP Limited Liability The DMCA limits the liability of Internet service providers (ISps). Under the act, an ISP is not liable for copyright infringement by a subscriber unless the ISP is aware of the subscriber’s violation. An ISP may be held liable only if it fails to take action to shut down the subscriber after learning of the violation. A copyright holder must act promptly, however, by pursuing a claim in court, or the subscriber has the right to be restored to online access.

File-Sharing The DMCA also plays a role in protecting copyrights when file-sharing technology is used. File-sharing technology is especially prevalent in copyright disputes in the music industry.

When file-sharing is used to download others’ stored music files, copyright issues arise. For instance, individuals can make digital downloads or CDs available on distributed networks. Anyone can get the music for free on these networks, result- ing in large revenue losses for recording artists and their labels. Not surprisingly, recording companies have pursued individuals for file-sharing copyrighted works.

File-sharing also creates problems for the motion picture industry, which loses significant amounts of revenue annually as a result of pirated DVDs.

6–4 trade secrets Some business processes and information that are not, or cannot be, patented, copyrighted, or trademarked are nevertheless protected as trade secrets. A trade secret may consist of customer lists, plans, research and development, pricing infor- mation, marketing techniques, or production techniques. Generally, anything that makes an individual company unique and that would have value to a competitor is considered a trade secret.

ExamplE 6.7 Norman is a salesman for Rockford Textiles Company. If he tries to solicit Rockford’s competitors for noncompany business, or if he copies Rock- ford’s unique method of manufacture, he has appropriated a trade secret. Theft of confidential business data by industrial espionage, as when a business taps into a competitor’s computer, is also a theft of trade secrets. The Economic Espionage Act of 1996 made the theft of trade secrets a federal crime. j

6–5 international Protection for intellectual Property

Various international agreements relate to intellectual property rights. One of the first was the Paris Convention of 1883, to which 174 countries are signatories. The Paris Convention allows parties in one country to file for patent and trademark protection in any of the other member countries.

6–5a The Berne Convention The Berne Convention of 1886 is an international copyright agreement. Every member country must recognize the copyrights of authors who are citizens of other member countries. If a citizen of a country that has not signed the agreement first

Internet service provider (ISp) A business that offers users Internet access.

trade secret Information giving a business an advantage over competitors.

Learning OutcOme 5

Define trade secret.

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C H A P T E R 6 Intellectual Property 77

publishes a book in a country that has signed, all other countries that have signed the agreement must recognize that author’s copyright.

6–5b The TRIPS Agreement More than one hundred countries have signed the agreement on Trade-Related Aspects of Intellectual Property Rights (TRIPS). Under this agreement, a member nation cannot give its citizens more favorable treatment, in terms of the administra- tion, regulation, or adjudication of intellectual property rights, than it offers to the citizens of other member countries.

TRIPS specifically provides copyright protection for computer programs by stat- ing that compilations of data, databases, or other materials are “intellectual cre- ations” and that they are to be protected as copyrightable works. Other provisions relate to patents, trademarks, trade secrets, and the rental of computer programs and cinematographic works.

6–5c The Anti-Counterfeiting Trade Agreement Eight countries have signed the Anti-Counterfeiting Trade Agreement (ACTA). This international treaty’s goals are to increase international cooperation, facilitate the best law enforcement practices, and provide a legal framework to combat counter- feiting. ACTA applies to counterfeit physical goods, such as medications, as well as to pirated copyrighted works being distributed online.

Conflict Resolved In the Conflict Presented feature at the beginning of this chapter, the Internet Entertainment Group (IEG) used candyland.com as a domain name for its sexually explicit Internet site without the

permission of Hasbro, Inc., the maker of the children’s game Candyland and owner of the Candyland trademark.

a Has ieg violated Hasbro’s rights in the candyland trademark? Yes. Hasbro’s mark is famous, IEG is using it without permission, and that use arguably diminishes the

quality of the mark. If Hasbro can show that IEG’s use of the mark and the domain name

candyland.com in connection with its site is causing irreparable injury to Hasbro, a court

will likely order IEG to remove all content from the candyland.com site and stop using

the Candyland mark. This would be trademark dilution.

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U n i t 1 The Law and Our Legal System78

Linking Business Law to Your Career

Trademarks and service marks

You might plan on having a career in marketing. As a marketing manager, you might be involved in creating trade- marks or service marks for your firm and protecting the firm’s existing marks.

the Broad range of trademarks and service marks

The courts have held that trademarks and service marks consist of much more than well-known brand names, such as Sony™. Be aware that parts of a brand or other product identification often qualify for trademark protection. Keep the following examples of brand- ing in mind when working in a market- ing department:

• Catchy phrases—Certain brands have established phrases that are associated with them, such as Nike’s “Just Do It!”

• abbreviations—Sometimes, the public abbreviates a well-known trademark. For example, Budweiser™ is also known as Bud.

• Shapes—The shape of a brand name, service mark, or even a con- tainer can take on exclusivity if these shapes clearly aid in product or ser- vice identification, such as the shape of a Coca-Cola bottle.

• Ornamental Colors—Color com- binations can become part of a ser- vice mark or trademark. For instance,

FedEx established its identity with the use of bright orange and purple.

• Ornamental Designs—Symbols and designs associated with a mark normally are protected.

When to Protect Your trademarks and service marks

Once your company has established a trademark or a service mark, if you fail to protect it, your company faces the possibility that it will become generic. Always include the trademark symbols in your advertising—both online and off. You want to take every opportunity to have your trademark on all company documents, too.

Learning OutcOme 1: identify intellectual property. Trademarks, patents, copyrights, and trade secrets are forms of intellectual property.

Learning OutcOme 2: Discuss legal protection for trademarks. To be protected, a registered trademark must be sufficiently distinctive from other trademarks. Trademark infringement occurs when one who does not own a trademark copies it to a substantial degree or uses it in its entirety.

Learning OutcOme 3: Describe legal protection for patents. To be patentable, an invention, discovery, or design must be novel, useful, and not obvious in light of current technology. Patent infringement occurs when one makes, uses, or sells another’s patented design, product, or process without the patent owner’s permission.

Learning OutcOme 4: summarize legal protection for copyrights. Copyright infringement occurs when the form or expression of an idea is copied without the permission of the copyright owner. The copy does not have to be exactly the same as the original to infringe. There is an exception for copying deemed a “fair use.”

Learning OutcOme 5: Define trade secret. Customer lists, plans, research and development, pricing information, and marketing or production techniques are all considered trade secrets.

CHaPteR SummaRY—InteLLeCtuaL PRoPeRtY

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C H A P T E R 6 Intellectual Property 79

ISSue SPotteRS Check your answers to the Issue Spotters against the answers provided in Appendix A at the end of this text.

1. Karl self-publishes a cookbook titled Hole Foods, in which he sets out recipes for donuts, Bundt cakes, tor- tellini, and other foods with holes. To publicize the book, Karl designs the website holefoods.com. Karl appropri- ates the key words of other cooking and cookbook sites with more frequent hits so that holefoods.com will appear in the same search engine results as the more popular sites. Has Karl done anything wrong? Explain your answer. (see Trademarks and Related Property.)

2. Roslyn is a food buyer for Organic Cornucopia Food Company when she decides to go into business for her- self as Roslyn’s Kitchen. She contacts Organic’s suppli- ers, offering to buy their entire harvest for the next year, and Organic’s customers, offering to sell her products for less than her ex-employer’s prices. Has Roslyn violated any of the intellectual property rights discussed in this chapter? Explain. (see Trade Secrets.)

StRaIgHt to tHe PoInt

1. When does trademark infringement occur? (see Trademarks and Related Property.)

2. Which trademarks are protected by the law? (see Trade- marks and Related Property.)

3. How does licensing protect intellectual property? (see Patents.)

4. Which works are copyrightable? (see Copyrights.) 5. What is the federal legislation that significantly protects

copyrights in the digital age? (see Copyrights.) 6. How are trade secrets protected by the law? (see Trade

Secrets.)

ReaL Law

6–1. copyright. Savant Homes, Inc., is a custom home designer and builder. Using what it called the Anders Plan, Savant built a model house in Windsor, Colorado. This was a ranch house with two bedrooms on one side and a master suite on the other, separated by a combined family room, dining room, and kitchen. Ron and Tammie Wagner toured the Savant house. The same month, the Wagners hired builder Douglas Collins and his firm, Douglas Consulting, to build a house for them. After it was built, Savant filed a lawsuit in a federal district court against Collins for copy- right infringement, alleging that the builder had copied the Anders Plan in the design and construction of the Wagner house. Collins showed that the Anders Plan consisted of standard elements and standard arrangements of elements. In these circumstances, has infringement occurred? Explain. [Savant Homes, Inc. v. Collins, 809 F.3d 1133 (10th Cir. 2016)] (see Copyrights.)

6–2. Patents. The U.S. Patent and Trademark Office (PTO) denied Raymond Gianelli’s application for a patent for a “Rowing Machine”—an exercise machine that requires a user to pull on handles to perform a rowing motion against a selected resistance in order to strengthen the back

muscles. The PTO considered the device obvious in light of a previously patented “Chest Press Apparatus for Exer- cising Regions of the Upper Body”—a chest press exercise machine on which a user pushes on handles to overcome a selected resistance. On what ground might this result be reversed on appeal? Discuss. [In re Gianelli, 739 F.3d 1375 (Fed. Cir. 2014)] (see Patents.)

6–3. theft of trade secrets. Hanjuan Jin, a Chinese citizen, worked at Motorola in the United States as a software engineer in a division that created proprietary standards for cellular communications. After a few years, she started corresponding with a company in China about a possible full-time job. During this period, she took several leaves of absence from Motorola to go to China. After one of these leaves, she returned to Motorola and downloaded thou- sands of company documents onto her personal laptop. While Jin was at the airport waiting to board a flight to China, U.S. officials searched her belongings and discovered the Motorola documents. Under which federal law could Jin be prosecuted for theft of trade secrets? What are the penalties under this law? [United States v. Hanjuan Jin, 833 F.Supp.2d 977 (N.D.Ill. 2012)] (see Trade Secrets.)

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U n i t 1 The Law and Our Legal System80

etHICaL QueStIonS

6–4. File-sharing. From an ethical perspective, is it impor- tant to protect copyrighted music from unauthorized file- sharing and other forms of distribution online? Why or why not? (see Copyrights.)

6–5. copyrights in Digital information. Usenet is an online bulletin board network. A user gains access to Usenet posts through a commercial service, such as Giganews, Inc. Giganews deletes or blocks posts that contain child pornography. Otherwise, the service does not monitor content. Perfect 10, Inc., owns the copyrights to tens of

thousands of images—many of which have been ille- gally posted on Usenet through Giganews. When Perfect 10 notified Giganews of posts that contained infringing images, the service took them down. Despite these efforts, however, illegal posting continued. Perfect 10 filed a suit in a federal district court against Giganews, alleging copy- right infringement. Is Giganews liable? Do Internet ser- vice providers have an ethical duty to do more to prevent copyright infringement? Why or why not? [Perfect 10, Inc. v. Giganews, Inc., 847 F.3d 657 (9th Cir. 2017)] (see Copyrights.)

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81

Chapter 6—work Set

1. To obtain a patent, a person must prove to the patent office that his or her invention is novel, useful, and not obvious in light of contemporary technology.

2. To obtain a copyright, an author must prove to the copyright office that a work is novel, useful, and not a copy of another copyrighted work.

3. A personal name can be trademarked if it has acquired a secondary meaning.

4. Using a domain name that is similar but not identical to the trademark of another is legal.

5. Dilution occurs when a trademark is used, without permission, in a way that diminishes the distinctive qual- ity of the mark.

6. Downloading music onto a computer is not copyright infringement, even if it is done without authorization.

7. A formula for a chemical compound is not a trade secret.

8. A copy must be exactly the same as an original work to infringe on its copyright.

9. A license permits the use of another’s intellectual property for certain limited purposes.

tRue-FaLSe QueStIonS

1. Mandy registers a domain name that is confusingly similar to the trademark of Security Services Corporation. She then offers to sell the domain name to Security Services. This is

a. cybersquatting. b. a smart way to do business. c. trademark infringement. d. trademark dilution.

2. Ken invents a light bulb that lasts longer than ordinary bulbs. To prevent others from making, using, or selling the bulb or its design, he should obtain

a. a trademark. b. a copyright. c. a patent. d. none of the above.

3. Standard Products, Inc., obtains a patent on a laser printer. This patent is violated if another firm reproduces the printer

a. in its entirety only. b. either in its entirety or in part. c. in part only. d. none of the above.

4. Bob works for Consolidated Manufacturing Company under a contract in which he agrees not to disclose any process he uses while in Consolidated’s employ. When Bob goes into business for himself, he copies some of Consolidated’s unique production techniques. Bob has committed

a. trademark infringement. b. patent infringement. c. copyright infringement. d. theft of a trade secret.

muLtIPLe-CHoICe QueStIonS

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82

5. To identify its goods, Nationwide Products uses a red, white, and blue symbol that combines the letter N and a map of the United States. This symbol is protected by

a. trademark law. b. copyright law. c. patent law. d. all of the above.

6. The graphics used in “Grave Raiders,” a computer game, are protected by

a. copyright law. b. patent law. c. trademark law. d. trade secrets law.

7. Sales Track, Inc., creates, makes, and sells inventory control software for businesses. Generally, copyright protection extends to

a. no parts of the software. b. the “look and feel” of the software. c. those parts of the software that can be read by humans. d. the brand name of the software.

8. Realty Markets Corporation allows Sam, an independent real estate salesperson, to use Realty’s trademark to adver- tise the properties that Sam represents for sale. This is

a. a license. b. likely to confuse consumers. c. counterfeiting. d. dilution.

9. Ordinarily, you may not reproduce a copyrighted object without the owner’s permission. The exception to this general rule is contained in the

a. Lanham Act. b. appropriation doctrine. c. “fair use” doctrine. d. “fair copy” doctrine.

anSweRIng moRe LegaL PRoBLemS

1. Apple, Inc., obtains design patents on its iPhones and iPads that cover the devices’ graphical user interface, shell, and screen and button design. Other patents cover the way the information is displayed, the way the win- dows pop open, the way the information is scaled and rotated, and other aspects.

What is a patent?  A patent is a grant from the government that gives an inventor the exclusive _______________ to make, use, and sell an invention for a period of twenty years. For designs, patents are given for _______________ years.

How is a patent obtained? To obtain a patent, an applicant must show to the satisfaction of the patent office that the invention, discovery, or design is novel, useful, and not _______________ in light of current technology. The word Patent or Pat. with the patent number gives notice to the world that the article or design is patented.

2. Apple, Inc., files a suit in a federal district court against Samsung Electronics Company, alleging that Samsung’s Galaxy mobile phones and tablets infringe on Apple’s patents. Apple claims that the features of these phones and tablets violate all of Apple’s design patents on the features of its iPhones and iPads.

What is patent infringement?  The tort of patent infringement exists when a firm makes, uses, or sells another’s patented design, product, or process without the patent owner’s _______________.

can patent infringement exist even though not all features of a design or parts of an invention are cop- ied?  _______________. Only with respect to a patented process must all of the steps, or their equivalent, be copied to constitute infringement.

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83

Learning OutcOmes

The five Learning Outcomes below are designed to help improve your understanding of the chapter. After reading this chapter, you should be able to:

Indicate elements of criminal liability.

Outline the rights of criminal suspects.

List the crimes that affect business.

Summarize the defenses to criminal liability.

Know the legal protection for online victims.

1

2

3

4

5

7 Business Crimes

To protect the ability of individuals engaging in business to compete and flourish, our society imposes various sanctions, or punishments. These sanctions include damages for torts and damages for breaches of contract. Other sanctions are imposed under criminal law. As a result, criminal law is an important part of the business world.

In this chapter, we focus on crimes affecting business and the defenses that can be raised to avoid liability for criminal actions. We conclude with an overview of cyber crime.

7–1 civil Law and criminal Law Civil law spells out the duties that exist between persons or between citizens and their governments, excluding the duty not to commit crimes. Contract law, and the whole body of tort law, for instance, are part of civil law. When a civil wrong is committed, the person who suffered the harm can bring a lawsuit for damages.

Criminal law, in contrast, has to do with crime. A crime is a wrong against soci- ety proclaimed in a statute and punishable by society through fines, imprisonment, or, in some cases, death. Because crimes are offenses against society as a whole, they are prosecuted by a public official, such as a district attorney, rather than by the crime victims.

7–1a Key Differences One important difference between civil and criminal law involves the burden of proof required. In a civil case, the plaintiff usually must prove his or her case by a preponderance of the evidence. That is, the plaintiff must convince the court that, based on the evidence, it is more likely than not that the plaintiff’s allegation is true.

crime A wrong against society punishable by fines, imprisonment, or death.

Conflict Presented Capitol Bank customers receive e-mails telling them to click on a “secure” link. On the linked site, they are asked to enter personal information to complete the installation of a new “Online Security

Certificate.” The site is a fraud, however. When unsuspecting customers click on the link, their computers are infected by programs that funnel personal data to a server. The stolen data are then sold.

Q What is this crime called?

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U n i t 1 The Law and Our Legal System84

In a criminal case, in contrast, the state must prove its case beyond a reasonable doubt—a much stricter standard.

In a criminal case, the jury’s verdict normally must be unanimous—that is, every juror must agree in order to convict the defendant. In a civil trial by jury, however, typically only three-fourths of the jurors need to agree.

Another difference is that the sanctions—fines, imprisonment, or death— imposed on criminal wrongdoers are harsher than those in civil cases. The purpose of tort law is to compensate the victims of torts, not to punish the wrongdoers. In contrast, criminal sanctions are designed to punish those who commit crimes and to deter others from committing similar acts in the future.

Exhibit 7.1 presents additional ways in which criminal and civil law differ.

7–1b Classification of Crimes Crimes are classified as felonies or misdemeanors. Felonies are serious crimes pun- ishable by death or by imprisonment in a federal or state penitentiary for more than a year.

Under federal law and in most states, any crime that is not a felony is a misdemeanor. Misdemeanors are crimes punishable by a fine or by confinement for up to a year. If imprisoned, the guilty party goes to a local jail instead of a peni- tentiary. Disorderly conduct and trespass are common examples of misdemeanors.

7–1c What Constitutes Criminal Liability? Two elements must exist for a person to be convicted of a crime: (1) the perfor- mance of a prohibited act and (2) a specified state of mind, or intent, on the part of the actor.

Every criminal statute prohibits certain acts. Most crimes require an act of com- mission—that is, a person must do something to be accused of a crime. An act of omission can be a crime but only when a person has a legal duty to perform the omitted act. Failure to file a tax return is an example of an omission that is a crime.

A wrongful mental state is as necessary as a wrongful act in establishing criminal liability. For theft, the guilty act is the taking of another person’s property, and the mental state involves both the knowledge that the property belongs to another and the intent to deprive the owner of it.

felony A crime that carries the most severe sanctions.

misdemeanor A lesser crime than a felony.

Learning OutcOme 1

Indicate elements of criminal liability.

exhibit 7.1 Key Differences between Civil Law and Criminal Law

Remedy is compensation (damages) or equitable

decree

Typically three-fourths majority of jury

necessary for a verdict

Burden of Proof— Preponderance of

the evidence

Remedy is punishment (imprisonment, �ne, or

death)

A person or entity violates a statute

The government �les the complaint

Verdict nearly always requires unanimous

jury

Burden of Proof— Beyond a reasonable

doubt

CRIMINAL LAW

CIVIL LAW

The person who su�ered the harm sues

A wrongful act causes harm to a

person or property

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C H A P T E R 7 Business Crimes 85

7–2 constitutional safeguards Criminal law brings the force of the state, with all its resources, to bear against the individual. The U.S. Constitution provides safeguards to protect the rights of individuals and to prevent the arbitrary use of power on the part of the government. The United States Supreme Court has ruled that most of these safeguards apply not only in federal but also in state courts. They include the following: 1. The Fourth Amendment protection from unreasonable searches and seizures. 2. The Fourth Amendment requirement that no warrants for a search or an

arrest can be issued without probable cause. 3. The Fifth Amendment requirement that no one can be deprived of “life,

liberty, or property without due process of law.” 4. The Fifth Amendment prohibition against double jeopardy—that is, trying

someone twice for the same criminal offense. 5. The Fifth Amendment requirement that no person can be forced to be a

witness against (incriminate) himself or herself. 6. The Sixth Amendment guarantees of a speedy trial, a trial by jury, a public

trial, the right to confront witnesses, and the right to a lawyer at various stages in some proceedings.

7. The Eighth Amendment prohibitions against excessive bail and fines and against cruel and unusual punishment.

7–2a Searches and Seizures Before searching or seizing private property, a law enforcement officer must obtain a search warrant—an order from a judge or other public official authorizing the search or seizure.

Probable Cause To obtain the warrant, the officer must convince the judge that there is probable cause to believe a search will reveal a specific illegality. Probable cause requires evidence that would convince a reasonable person that the proposed search or seizure is more likely justified than not. The officer must describe what is to be searched or seized.

Businesses as well as individuals are protected against unreasonable searches. For instance, government inspectors do not have a right to search business premises without a warrant. The standard of probable cause is not the same as that required in nonbusiness contexts. The existence of a general and neutral plan of regula- tory enforcement will justify the issuance of a warrant. A warrant normally is not required for a seizure of spoiled or contaminated food. Nor are warrants required for searches of businesses in highly regulated industries, such as those dealing with liquor, guns, and strip mining.

Reasonable Expectation of Privacy The Fourth Amendment only protects against searches that violate a person’s reasonable expectation of privacy. This exists if an individual actually expects privacy and the expectation is one that society, as a whole, thinks is legitimate.

7–2b The Exclusionary Rule Under the exclusionary rule, all evidence obtained in violation of the constitutional rights spelled out in the Fourth, Fifth, and Sixth Amendments usually must be excluded—as well as all evidence derived from the illegally obtained evidence.

Learning OutcOme 2

Outline the rights of criminal suspects.

double jeopardy A situation occurring when a person is tried twice for the same criminal offense.

search warrant An order from a judge authorizing the search or seizure of private property.

probable cause Reasonable grounds for believing a search will reveal a specific illegality.

exclusionary rule Rule preventing the government from using evidence gathered in violation of the U.S. Constitution.

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U n i t 1 The Law and Our Legal System86

Evidence derived from illegally obtained evidence is known as “fruit of the poi- sonous tree.” For instance, if a confession is obtained after an illegal arrest, the arrest is “the poisonous tree.” The confession, if “tainted” by the arrest, is the “fruit.” The purpose of the exclusionary rule is to deter police from misconduct.

7–2c Informing Suspects of Their Rights Individuals who are arrested must be informed of certain constitutional rights— also known as Miranda rights. These include the right to remain silent and the right to legal counsel. If the arresting officer fails to inform a criminal suspect of these rights, any statement the suspect makes normally will not be admissible in court.

7–3 crimes affecting Business Numerous forms of crime occur in a business context. Many of these are referred to as white-collar crimes. The term is used to mean an illegal act or series of acts committed by an individual or business using some nonviolent means to obtain a personal or business advantage. In this section, we focus on white-collar property crimes, as well as violations of the Racketeer Influenced and Corrupt Organizations Act that affect business.

7–3a Forgery The fraudulent making or altering of any writing in a way that changes the legal rights and liabilities of another is forgery. ExamplE 7.1 Without authorization, Severson signs Bennett’s name to the back of a check made out to Bennett. Severson is committing forgery. j Forgery also includes changing trademarks, falsifying pub- lic records, counterfeiting, and altering a legal document.

7–3b Robbery Robbery is forcefully and unlawfully taking personal property of any value from another. The use of force or intimidation is usually necessary for an act of theft to be considered a robbery.

7–3c Larceny The crime of larceny involves the unlawful taking and carrying away of someone else’s personal property with the intent to permanently deprive the owner of pos- session. In short, larceny is stealing or theft. As noted, robbery involves force or fear, but larceny does not. So shoplifting is larceny, not robbery.

Learning OutcOme 3

List the crimes that affect business.

white-collar crime Nonviolent crime committed in the business world.

forgery The fraudulent making or altering of any writing.

robbery The act of forcefully and unlawfully taking personal property from another.

larceny The wrongful taking and carrying away of another person’s personal property.

Highlighting the Point

Deanna works at the local police department collecting traffic fines for the city. She is romantically involved with Travis. When the state charges Deanna with stealing money from the police department (embezzlement), they offer several text messages exchanged between her and Travis as evidence. The state obtained these messages from Travis’s cell phone account. Deanna claims the state cannot use the text mes- sages because doing so violated her Fourth Amendment rights.

Does Deanna have a reasonable expectation of privacy in the text messages she sent to travis? No. Once the messages are both transmitted and received, the expecta- tion of privacy is lost. The state can use the text messages in its case against Deanna.

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C H A P T E R 7 Business Crimes 87

7–3d Embezzlement When a person who is entrusted with another person’s property or money fraudu- lently takes it over, embezzlement occurs. Typically, this involves an employee who steals money. Embezzlement is not larceny, because the wrongdoer does not physi- cally take the property from the possession of another, and it is not robbery, because no force or fear is used.

7–3e Mail and Wire Fraud A potent weapon against white-collar criminals is the federal laws that prohibit mail fraud and wire fraud. Under these acts, it is a federal crime to devise a scheme that uses the U.S. mail, commercial carriers (such as FedEx), or wire (including telegraph, telephone, television, and the Internet) with the intent to defraud the public. These laws are often applied, for instance, when e-mailed ads are sent with the intent to obtain money or personal data by false pretenses. Violators may be fined or imprisoned or both.

7–3f Bribery Basically, three types of bribery are considered crimes: bribery of public officials, commercial bribery, and bribery of foreign officials.

Bribery of Public Officials The attempt to influence a public official to act in a way that serves a private interest is a crime. The bribe can be anything the recipient considers to be valuable. The commission of the crime occurs when the bribe is

embezzlement The fraudulent taking of money or other property by a person to whom it has been entrusted.

Highlighting the Point

While hauling a load of refrigerators from San Diego to New York in a truck owned by National Appliance Company, Fred tries to sell some of the refrigerators. To dis- play them, Fred breaks the truck’s seals, enters the cargo compartment, and opens two refrigerator cartons. No one buys them, and they never leave the truck. Fred is arrested and charged with embezzlement. Fred claims that there are no grounds for the charge, because he never took anything off the truck.

Does the charge of embezzlement apply when property is not physically removed from the owner’s possession? Yes. If a person has control over the property of another and has the intent of converting the goods to his or her own use, then embezzlement occurs. By trying to sell the refrigerators and keep the proceeds, Fred exercised control over the property with the intent to convert it to his own use.

Highlighting the Point

Franklin Systems offers a warranty program to authorized resellers of Franklin parts. George Taylor and Robert Singer devise a scheme to intentionally defraud Franklin by using this reseller program to obtain replacement parts to which they are not enti- tled. The two men send numerous e-mails and Internet service requests to Franklin to convince the company to ship them new parts via commercial carriers.

Does taylor and singer’s use of e-mail and the internet constitute mail and wire fraud? Yes. They sent e-mails with the intent to obtain goods by false pretenses—that is, goods to which they were not entitled. They have committed mail and wire fraud.

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U n i t 1 The Law and Our Legal System88

offered. The recipient does not have to agree to perform whatever action is desired by the person offering the bribe, nor does the recipient have to accept the bribe.

Commercial Bribery Typically, people make commercial bribes to obtain proprietary information, cover up an inferior product, or secure new business. Industrial espionage sometimes involves commercial bribes. ExamplE 7.2 Rosemary works for Telecom. She offers Craig, an employee at QMC Services (a Telecom competitor), a payoff in exchange for QMC trade secrets. j So-called kickbacks, or payoffs for special favors or services, are a form of commercial bribery in some situations.

Bribery of Foreign Officials Bribing foreign officials to obtain favorable business contracts is a crime. The Foreign Corrupt Practices Act was passed to prevent U.S. businesspersons from using bribery to secure foreign contracts.

7–3g Racketeer Influenced and Corrupt Organizations Act

The purpose of the Racketeer Influenced and Corrupt Organizations Act (RICO) was to curb the apparently increasing entry of organized crime into the legitimate business world.

Federal Crimes under RICO Under RICO, it is a federal crime to do the following: • Use income obtained from racketeering activity to purchase any interest in an

enterprise. • Acquire or maintain an interest in an enterprise through racketeering activity. • Conduct or participate in the affairs of an enterprise through racketeering

activity. • Conspire to do any of the preceding acts. RICO incorporates twenty-six separate types of federal crimes and nine types of state felonies. It stipulates that if a person commits two or more of these offenses, he or she is guilty of “racketeering activity.”

Business Crimes under RICO Most of the criminal RICO offenses have little to do with normal business activities. Securities fraud (involving the sale of stocks and bonds) and mail fraud, however, can be criminal violations under RICO. The act has become an effective tool in attacking these white-collar crimes.

7–4 Defenses to criminal Liability The law recognizes several defenses that excuse a defendant’s criminal behavior. Among the most important defenses to criminal liability are mistake, insanity, and entrapment. Also, in some cases, defendants are given immunity and thus relieved, at least in part, of criminal liability for crimes they committed.

7–4a Mistakes Everyone has heard the saying, “Ignorance of the law is no excuse.” Ordinarily, a mistake of law—that is, ignorance of the law or a mistaken idea about what the law requires—is not a valid defense. In contrast, a mistake of fact can often excuse criminal responsibility, if it negates the mental state necessary to commit a crime.

ExamplE 7.3 Wyatt mistakenly walks off with Julie’s briefcase at a popular res- taurant because he thinks it is his. Wyatt has not committed a crime because theft

Learning OutcOme 4

Summarize the defenses to criminal liability.

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C H A P T E R 7 Business Crimes 89

requires knowledge that the property belongs to another. (If Wyatt’s act causes Julie to incur damages, however, she may sue him in a civil action for conversion.) j

7–4b Insanity Someone suffering from a mental illness is sometimes judged incapable of the state of mind required to commit a crime. Different courts use different tests for legal insanity. Almost all federal courts and some state courts hold that a person is not responsible for criminal conduct if, as a result of mental disease or defect, the per- son lacked the capacity to appreciate the wrongfulness of the conduct or to obey the law.

Some states use a test under which a criminal defendant is not responsible if, at the time of the offense, he or she did not know the nature and quality of the act or did not know that the act was wrong. Other states use the irresistible-impulse test. A person operating under an irresistible impulse may know an act is wrong but cannot refrain from doing it.

7–4c Entrapment Entrapment is a defense designed to prevent police officers or other government agents from encouraging crimes in order to apprehend persons wanted for crimi- nal acts.

In the typical entrapment case, an undercover agent suggests that a crime be committed and somehow pressures or induces an individual to commit it. The agent then arrests the individual for the crime. The crucial issue is whether a person who committed a crime was inclined to commit the crime or did so only because the agent induced it.

7–4d Immunity Another form of criminal defense is immunity (or release) from prosecution. Accused persons cannot be forced to give information to the police or other author- ities if it will be used to prosecute them. This privilege against self-incrimination is granted by the Fifth Amendment to the U.S. Constitution.

To obtain information from a person accused of a crime, however, the state can grant that person immunity from prosecution. In addition, the state can agree to prosecute the accused person for a less serious offense in exchange for the information.

7–5 cyber crime Computer crime is any violation of criminal law that involves knowledge of com- puter technology for its perpetration, investigation, or prosecution. Criminal activ- ity occurring online is cyber crime.

7–5a Cyber Fraud Fraud is any misrepresentation knowingly made with the intention of deceiving another and on which a reasonable person would and does rely to her or his detri- ment. Cyber fraud is fraud committed in the virtual community of the Internet.

ExamplE 7.4 Anthony selects two online auction sites and creates fake seller accounts on each. He then creates an auction page on each site for a rare antique clock, complete with a detailed description and photos. His minimum starting bid is $500. The clock sells for more than $500 on each site. Anthony sends one buyer a clock, but it is not the one advertised and is worth only $50. The other buyer receives nothing. j

entrapment An act by which a public official induces someone to commit a crime.

computer crime Crime that involves knowledge of computer technology for its perpetration, investigation, or prosecution.

cyber crime A crime that occurs online.

cyber fraud Any misrepresentation knowingly made online with the intention of deceiving another for gain.

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U n i t 1 The Law and Our Legal System90

7–5b Identity Theft Identity theft occurs when the wrongdoer steals a form of identification—such as a name, date of birth, or Social Security number—and uses the information to access the victim’s financial resources.

identity theft The act of stealing another’s identifying information and using it to access the victim’s financial resources.

Real Case

Mauricio Warner was indicted on charges of obtaining individuals’ identities and using those identities to file more than five thousand false income tax returns. As a result of these filings, millions of dollars in refunds were deposited in bank accounts that Warner controlled. At trial, the evidence included spreadsheets of fraudulently submitted tax returns. Convicted of the charges, Warner appealed.

Was Warner guilty of identity theft? Yes. In United States v. Warner, the U.S. Court of Appeals for the Eleventh Circuit affirmed Warner’s conviction. The evidence showed that Warner stole other people’s identities and used those data to file false income tax returns with the U.S. Internal Revenue Service.

—638 Fed.Appx. 961 (11th Cir.)

phishing is a distinct form of identity theft (and cyber fraud). In a phishing attack, the perpetrators “fish” for financial data and passwords from consumers by posing as legitimate businesses and asking for personal data that help them steal a user’s identity. Phishing scams typically use e-mail but have spread to include text messaging and social networking sites.

7–5c Hacking A person who uses one computer to break into another is referred to as a hacker. Hackers who break into computers and mobile devices without authorization often commit cyber theft. The goals of a hacking operation might include a wholesale theft of data, such as a merchant’s customer files, or the monitoring of a computer to discover a business firm’s plans and transactions.

In particular, retail companies take risks by storing their customers’ debit- and credit-card numbers and personal information online. The electronic warehouses that store these data are attractive targets for cyber thieves and hackers. (See the Linking Business Law to Your Career feature at the end of this chapter.)

ExamplE 7.5 Amy hacks into the website of Urban Mix Boutique, a popular clothing outlet in her community. Customers can purchase items at the retail store or online. After hacking into the site, Amy installs malware that sends her the financial data of every Urban Mix customer. Amy can then sell the stolen data to other cyber thieves or use the information to make fraudulent purchases herself. j

7–5d Cyberterrorism A cyberterrorist is a hacker who exploits computers to create a serious negative impact. For instance, false code entered into the processing control system of a food manufacturer could alter the levels of ingredients so that consumers of the food would become ill. Computer viruses could also cripple communications networks. A prolonged disruption of computer, cable, satellite, or telecommunications systems would have serious effects on business operations—and national security—on a global level.

phishing Sending an electronic message purportedly from a legitimate business to induce the recipient to reveal personal information.

hacker A person who uses one computer to break into another.

malware Malicious software programs designed to disrupt or harm computers.

cyberterrorist A hacker whose purpose is to create a serious negative impact.

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C H A P T E R 7 Business Crimes 91

7–5e Prosecuting Cyber Crime Cyberspace has raised new issues in the investigation of crimes and the prosecution of offenders.

Jurisdiction and Identification Challenges A threshold issue in investigating and prosecuting cyber crime is jurisdiction. For example, a person who commits an act against a business in California, where the act is a cyber crime, might never have set foot in California but might instead reside in New York, where the act may not be a crime.

Identifying the wrongdoer can also be difficult. Cyber criminals do not leave physical traces, such as fingerprints or DNA samples, as evidence of their crimes. Even electronic “footprints” can be hard to find and follow.

The Computer Fraud and Abuse Act At the federal level, the Counterfeit Access Device and Computer Fraud and Abuse Act, which is commonly known as the Computer Fraud and Abuse Act (CFAA), is the most important legislation targeting cyber crime. The CFAA provides that a person who accesses a computer online without authority to obtain classified, restricted, or protected data, or attempts to do so, is subject to criminal prosecution.

The theft is a felony if it is committed for a commercial purpose or for private financial gain, or if the value of the stolen data (or computer time) exceeds $5,000. Penalties include fines and imprisonment for up to twenty years.

Learning OutcOme 5

Know the legal protection for online victims.

Conflict Resolved In the Conflict Presented feature at the beginning of this chapter, a bank’s customers receive e-mails telling them to click on a link. At that site, they are asked to enter personal information to complete

the installation of a new security application. The site is a fraud. Unsuspecting users’ computers are infected, and their personal data are stolen and sold.

a What is this crime called? This is a form of identity theft known as phishing. A perpetrator, posing as a legitimate business, “fishes” for personal data using e-mail.

The e-mail asks recipients to provide vital information. Once the personal information

is obtained, the phisher can use or sell it.

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U n i t 1 The Law and Our Legal System92

Linking Business Law to Your Career

Protect Your comPanY against Hacking

Because millions of dollars are hacked from business accounts every year, you should encourage your company to take action to protect its funds. Unfor- tunately, many businesses do not take steps to reduce the risk of hacking. Their accounts are often in local banks or credit unions, which may have inad- equate security measures and lack the services of cyber security experts.

Know What is “commercially reasonable”

Many small-business owners believe that if their bank accounts are hacked and disappear, their banks will

reimburse them. That is not always the case, however.

Just ask Mark Patterson, the owner of Patco Construction in Maryland. He lost more than $350,000 to hackers. When Patco’s bank would not agree to a settle- ment, Patterson sued, claiming that the bank should have monitored his account. So far, federal judges have agreed with the bank, ruling its protections were “commercially reasonable,” which is the only standard that banks have to follow.

Know Your insurance coverage Policy

Similarly, small-business owners often think that their regular insurance policy

will cover cyber losses at their local banks. In reality, unless there is a spe- cific “rider” to a business’s insurance pol- icy, its bank accounts are not covered.

In other words, your insurance company may reimburse your busi- ness if thieves break in and steal your machines and network servers. But that does not mean you will be covered if hackers break into your bank account.

Learning OutcOme 1: indicate elements of criminal liability. The elements of criminal liability are (1) the performance of a prohibited act and (2) a specified state of mind, or intent.

Learning OutcOme 2: Outline the rights of criminal suspects. The rights of accused persons are protected under the U.S. Constitution, particularly by the Fourth, Fifth, Sixth, and Eighth Amendments. Under the exclusionary rule, evidence obtained in violation of the constitutional rights of the accused will not be admissible in court. Individuals must be informed of their constitutional rights, including their right to counsel and their right to remain silent, when taken into custody.

Learning OutcOme 3: List the crimes that affect business. Crimes affecting business include forgery, robbery, larceny, embezzlement, mail and wire fraud, and bribery. The Racketeer Influenced and Corrupt Organizations Act helps to curb organized crime.

Learning OutcOme 4: summarize the defenses to criminal liability. The most important defenses to criminal liability include mistakes, insanity, and entrapment. In some cases, defendants can be granted immunity from prosecution, or be prosecuted for a less serious offense, in exchange for information.

Learning OutcOme 5: Know the legal protection for online victims. The Counterfeit Access Device and Computer Fraud and Abuse Act prohibits cyber theft, which is accessing, or attempting to access, a computer without authority to obtain classified or protected data. Penalties include fines and imprisonment for up to twenty years.

CHaPteR SummaRY—BuSineSS CRimeS

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C H A P T E R 7 Business Crimes 93

iSSue SPotteRS Check your answers to the Issue Spotters against the answers provided in Appendix A at the end of this text.

1. Without Jim’s permission, Lee signs Jim’s name to several checks that were issued to Jim and then cashes them. Jim reports that the checks were stolen and receives replace- ments. Has Lee committed forgery? Why or why not? (see Crimes Affecting Business.)

2. Carl appears on television talk shows touting a cure for AIDS that he knows is fraudulent. He frequently men- tions that he needs funds to make the cure widely avail- able, and donations pour into local television stations to be forwarded to Carl. Has Carl committed a crime? If so, what? (see Crimes Affecting Business.)

StRaigHt to tHe Point

1. What is the definition of crime? (see Civil Law and Criminal Law.)

2. What must a law enforcement officer obtain before searching or seizing private property? (see Constitutional Safeguards.)

3. What is the definition of white-collar crime? (see Crimes Affecting Business.)

4. When can a person refuse to give information to law enforcement officers? (see Defenses to Criminal Liability.)

5. How is cyber crime distinguished from other crimes? (see Cyber Crime.)

ReaL Law

7–1. criminal Procedures. Federal officers obtained a war- rant to arrest Kateena Norman on charges of credit-card fraud and identity theft. Evidence of the crime included videos, photos, and a fingerprint on a fraudulent check. A previous search of Norman’s house had uncovered credit cards, new merchandise, and identifying informa- tion for other persons. An Internet account registered to the address had been used to apply for fraudulent credit cards and a fraudulently obtained rental car was parked on the property. As the officers arrested Norman outside her house, they saw another woman and a caged pit bull inside. They further believed that Norman’s boyfriend, who had a criminal record and was also suspected of iden- tify theft, could be there. In less than a minute, the officers searched only those areas within the house in which a per- son could hide. Would it be reasonable to admit evidence revealed in this “protective sweep” during Norman’s trial on the arrest charges? Discuss. [United States v. Norman, 638 Fed.Appx. 934 (2016)] (see Constitutional Safeguards.)

7–2. White-collar crime. Matthew Simpson and others cre- ated and operated a series of corporate entities to defraud telecommunications companies, creditors, and credit- reporting agencies, among others. Through these entities, Simpson and the others used routing codes and spoofing services to make long-distance calls appear to be local. They stole other firms’ network capacity and diverted payments to themselves. They leased goods and services without pay- ing for them. To hide their real identities, they assumed false

identities, addresses, and credit histories, and issued false bills, invoices, financial statements, and credit references, to hide their real identities. Did these acts constitute mail and wire fraud? Discuss. [United States v. Simpson, 741 F.3d 539 (5th Cir. 2014)] (see Crimes Affecting Business.)

7–3. criminal Liability. David Green threw bottles and plates from a twenty-sixth-floor hotel balcony overlooking a street in New York City. He suspended his antics when he saw police on the street below and on the roof of the building across the street. He resumed tossing objects off the balcony after the police left, however. Later, he admit- ted that he could recall what he had done, but he claimed to have been intoxicated and that his only purpose had been to amuse himself and his friends. Did Green have the mental state required to establish criminal liability? Dis- cuss. [State of New York v. Green, 104 A.D.3d 126, 958 N.Y.S.2d 138 (1 Dept. 2013)] (see Civil Law and Criminal Law.)

7–4. search. Charles Byrd was in a minimum-security jail awaiting trial. A team of sheriff’s deputies wearing T-shirts and jeans took several inmates into a room for a strip search without any apparent justification. Byrd was ordered to remove all his clothing except his boxer shorts. A female deputy searched Byrd while several male deputies watched. One of the male deputies videotaped the search. Byrd filed a suit against the sheriff’s department. Did the search violate Byrd’s rights? Discuss. [Byrd v. Maricopa County Sheriff’s Department, 629 F.3d. 1135 (9th Cir. 2011)] (see Constitu- tional Safeguards.)

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U n i t 1 The Law and Our Legal System94

etHiCaL QueStionS

7–5. informing suspects of their rights. Should there be any exceptions to the rule that suspects be informed of their rights? Discuss. (see Constitutional Safeguards.)

7–6. identity theft. Heesham Broussard obtained counterfeit money instruments. To distribute them, he used account infor- mation and numbers on compromised FedEx accounts pro- cured from hackers. Text messages from Broussard indicated that he had participated previously in a similar scam and that

he knew the packages would be delivered only if the FedEx accounts were “good.” For his use of the accounts, Broussard was charged with identity theft. In defense, he argued that the government could not prove he knew the misappropriated accounts belonged to real persons or businesses. Does the evi- dence support this assertion? From an ethical perspective, does it matter whether Broussard knew that the accounts belonged to real customers? Why or why not? [United States v. Heesham Broussard, 2017 WL 150495 (5th Cir. 2017)] (see Cyber Crime.)

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95

Chapter 7—work Set

1. A crime is a wrong against society proclaimed in a statute.

2. A person can be convicted simply for intending to commit a crime.

3. If a crime is punishable by death, it must be a felony.

4. Ordinarily, “ignorance of the law” is a valid defense to criminal liability.

5. A person who has been granted immunity from prosecution cannot be compelled to answer any questions.

6. Malware is software designed to protect consumers from identity theft.

7. Immunity is a defense to criminal liability.

8. Fraudulently altering a public document can be forgery.

9. RICO has become an effective law in fighting certain white-collar crime, such as securities fraud.

10. Persons suffering from mental illness are sometimes judged incapable of the state of mind required to com- mit a crime.

tRue-FaLSe QueStionS

1. Which of the following statements is true?

a. Criminal defendants are prosecuted by the state. b. Criminal defendants must prove their innocence. c. Criminal law actions are intended to give the victims financial compensation. d. A crime is never a violation of a statute.

2. Crime requires

a. the performance of a prohibited act. b. the intent to commit a crime. c. both a and b. d. none of the above.

3. Helen, an undercover police officer, pressures Pete to buy stolen goods. When he does so, he is arrested and charged with dealing in stolen goods. Pete will likely be

a. acquitted, because he was entrapped. b. acquitted, because Helen was entrapped. c. acquitted, because both parties were entrapped. d. convicted.

4. Police officer Berry arrests John on suspicion of embezzlement. Berry advises John of his rights. He informs John

a. that John has the right to remain silent. b. that John has the right to consult with an attorney. c. of both a and b. d. of none of the above.

5. In a jewelry store, April takes a diamond ring from the counter and puts it in her pocket. She walks three steps toward the door before the manager stops her. April is arrested and charged with larceny. She will likely be

a. acquitted, because she was entrapped. b. acquitted, because she took only three steps. c. acquitted, because she did not leave the store. d. convicted.

muLtiPLe-CHoiCe QueStionS

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96

6. Kevin takes home the company-owned laptop computer that he uses in his office. He has no intention of returning it. Kevin has committed

a. larceny. b. embezzlement. c. robbery. d. none of the above.

7. Police detective Howard suspects Carol of a crime. Howard may be issued a warrant to search Carol’s premises if he can show

a. probable cause. b. proximate cause. c. causation in fact. d. intent to search the premises.

8. Adam signs Beth’s name, without her consent, to the back of a check payable to Beth. This is

a. burglary. b. embezzlement. c. forgery. d. larceny.

9. Police officer Katy obtains a confession from criminal suspect Bart after an illegal arrest. At Bart’s trial, the confes- sion will likely be

a. admitted as proof of Bart’s guilt. b. admitted as evidence of Bart’s crime. c. admitted as support for Katy’s suspicions. d. excluded.

anSweRing moRe LegaL PRoBLemS

1. Sylvia requires her students, including Ralph, to submit their written assignments to CopyCat Detection Agency. CopyCat compares the work to the universe of material online to expose plagiarism. Ralph obtains another per- son’s password, log-in ID, and credit-card number via the Internet to submit papers to CopyCat, misrepresent- ing himself as a student at a different school.

What is a cyber crime? Has ralph committed such a crime? if so, which one? Criminal activity occur- ring _______________ is referred to as cyber crime. One of the cyber crimes that Ralph has committed is _______________ _______________. This occurs when a wrongdoer steals a form of identification, such as a name, and uses it to access the victim’s financial resources. Here, Ralph obtained another’s password, log-in ID, and credit-card number via the Internet. By using the credit-card number without the other’s _______________, Ralph accessed that person’s financial resources.

2. CopyCat quickly discovers what Ralph has done. The company files a suit against him, alleging that he has gained unauthorized access to its online services in vio- lation of a certain federal statute.

Which statute mentioned in this chapter has ralph most likely violated? The Counterfeit Access Device and Computer _______________ and Abuse Act is one of the statutes that Ralph has violated. Under this act, a per- son who accesses a computer online without authori- zation to obtain classified, restricted, or protected data commits _______________. Here, Ralph used another’s identity to access _______________ data on CopyCat’s website. If the company’s loss, in terms of the cost to verify its security and other expenses, exceeds $5,000, this act is a _______________.

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UNIT 2 Contracts

Chapter 8 Introduction to Contracts

Chapter 9 Offer and Acceptance

Chapter 10 Consideration

Chapter 11 Capacity

Chapter 12 The Legality of Agreements

Chapter 13 Voluntary Consent

Chapter 14 Contracts That Must Be in Writing

Chapter 15 Third Party Rights

Chapter 16 Termination and Remedies

Unit Contents

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98

Introduction to Contracts8 LearNINg OUTcOmes

The four Learning Outcomes below are designed to help improve your understanding of the chapter. After reading this chapter, you should be able to:

List the four requirements of a contract.

Contrast express and implied contracts.

Distinguish valid, voidable, unenforceable, and void contracts.

Understand the plain meaning rule.

1

2

3

4

promisor A person who makes a promise.

promisee A person to whom a promise is made.

promise A declaration that binds the person who makes it to do or not to do a certain act.

Conflict Presented Chandra, who is twenty-five years old, attends a classical concert at the Bijoux Theater. Before she purchases a ticket, a theater staff member reminds her that recording any part of the concert

is prohibited. This restriction is printed on the ticket as well. Chandra agrees. During the concert, theater security personnel clearly see Chandra recording the performance on her smartphone. Chandra is asked to leave the premises because she has breached her contract with the theater by using her phone to record the concert.

Q Did chandra and Bijoux enter into a binding contract?

Contract law deals with, among other things, the formation and keeping of prom- ises. A promise is a declaration that something either will or will not happen now or in the future. The party making the promise is the promisor, and the party to whom the promise is made is the promisee.

Contract law does not govern all promises. Sometimes, promises create moral rather than legal obligations. Failure to perform a moral obligation, such as an agreement to take a friend to lunch, usually does not create legal liability.

Some promises create both moral and legal obligations. ExamplE 8.1 Nolan and Pam are getting a divorce. Nolan’s promise to pay a set amount of child support to Pam every month creates both a moral and a legal duty. j

In addition, many promises are kept because of a sense of duty or because keep- ing them is in the mutual self-interest of the parties involved, not because the parties are conscious of the rules of contract law.

Nevertheless, business agreements depend to a great extent on the rules of contract law. These rules assure the parties that the promises they make will be enforceable and help them to avoid potential problems.

8–1 The Definition of a contract A contract is an agreement that can be enforced in court. It is formed by two or more parties who agree to perform or refrain from performing some act now or in the future. If the contractual promise is not fulfilled, the party who made it is subject to the sanctions of a court. That party may be required to pay monetary damages for failing to perform. In a few instances, the party may be required to perform the promised act.

contract An agreement that can be enforced in court.

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C H A P T E R 8 Introduction to Contracts 99

8–1a The Objective Theory of Contracts The element of intent is of prime importance in determining whether a contract has been formed. In contract law, intent is determined by what is called the objective theory of contracts, not by a party’s personal or subjective intent or belief. That is, a party’s intention to enter into a contract is judged by outward, objective facts as interpreted by a reasonable person, rather than by the party’s own secret, subjective intentions.

What the party said when entering into the contract, for instance, is an objective fact. So is how the party acted or appeared. What circumstances surrounded the transaction is also an objective fact.

8–1b The Basic Requirements of a Contract There are four basic requirements that must be met before a valid contract exists: (1) agreement, (2) consideration, (3) capacity, and (4) legality. If any of these ele- ments is lacking, no contract will have been formed.

Agreement An agreement includes an offer and an acceptance. One party must offer to enter into a legal agreement, and another party must accept the terms of the offer.

Consideration Any promises made by the parties must be supported by legally sufficient and bargained-for consideration. Consideration is something of value received or promised to convince a person to make a deal.

Capacity Both parties entering into the contract must have the legal capacity to do so. The law must recognize them as possessing characteristics that qualify them as competent parties. Such characteristics include being of legal age to enter into contracts (over age twenty-one, in most states) and mentally capable.

Legality The contract’s purpose must be to accomplish some goal that is legal and not against public policy. For instance, you cannot make a contract to rob a bank, which is a crime. Similarly, if a financial adviser contracts with a company to help facilitate hiding part of its sales income, then the contract’s purpose is not legal.

LearNINg OUTcOme 1

List the four requirements of a contract.

objective theory of contracts The view that the intent to contract should be determined by outward, objective facts.

Real Case

Cornell University offered Leslie Weston an associate professorship for a term of five years. The offer stated that it came “with tenure” (meaning permanent status), and it was subject to a review of Weston’s performance. Weston accepted the offer. Later, after the review, Cornell declined to award her tenure. The university, however, extended her appointment for two years “without tenure.” She agreed. At the end of the term, Cornell again denied her tenure and terminated her position altogether. Weston filed a lawsuit in a New York state court against Cornell, alleging breach of contract. The university filed a motion for summary judgment, which the court denied. Cornell appealed.

Did cornell and Weston have an agreement to extend her appointment “without tenure”? Yes. In Weston v. Cornell University, a state intermediate appellate court reversed the lower court’s judgment. Cornell’s offer to extend Weston’s appointment “without tenure” and Weston’s acceptance of this change created a valid contract. This meant that Cornell could fire Weston.

—136 A.D.3d 1094 (N.Y.A.D. 3 Dept.)

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U n i t 2 Contracts100

8–1c Defenses to Enforceability Even if all of these requirements are satisfied, a contract may be unenforceable if the following requirements are not met. These requirements typically are raised as defenses to the enforceability of an otherwise valid contract. 1. Voluntary consent. The apparent consent of both parties must be voluntary. For

instance, if a contract was formed as a result of fraud, undue influence, mistake, or duress, the contract may not be enforceable.

2. Form. The contract must be in whatever form the law requires. Some contracts must be in writing to be enforceable.

8–2 Types of contracts There are many types of contracts, and they are categorized according to differences in formation, enforceability, or performance. The best method of explaining each is to compare one type of contract with another.

8–2a Bilateral versus Unilateral Contracts Every contract involves at least two parties. The offeror is the party making the offer. The offeree is the party to whom the offer is made. The offeror always prom- ises to do or not to do something and thus is also a promisor. Whether the contract is classified as unilateral or bilateral depends on what the offeree must do to accept the offer and to bind the offeror to a contract.

Bilateral Contracts If, to accept the offer, the offeree must only promise to perform, the contract is a bilateral contract. Hence, a bilateral contract is a “promise for a promise.” The contract comes into existence at the moment the promises are exchanged.

ExamplE 8.2 Brian offers to buy Tara’s Android-based smartphone for $250. Brian tells Tara that he will give her the $250 next Friday, when he gets paid. Tara accepts his offer and promises to give him the smartphone when he pays her on Friday. They have formed a bilateral contract. j

Unilateral Contracts If the offer is phrased so that the offeree can accept only by completing the contract performance, the contract is a unilateral contract. Hence, a unilateral contract is a “promise for an act.” In other words, the contract is not formed at the moment when promises are exchanged but rather when the contract is performed.

Contests, lotteries, and other competitions for prizes are examples of offers for unilateral contracts. ExamplE 8.3 Trey buys an Oregon lottery ticket. His ticket has the winning numbers for the jackpot prize. He submits his winning ticket to the state lottery agency before the deadline. By following the rules of the contest, Trey has a unilateral contract. The state must pay him his prize. j

What if the promisor attempts to revoke (cancel) the offer after the promisee has begun performance but before the act has been completed? The offer becomes irre- vocable (irreversible) once performance has begun. Thus, even though the offer has not yet been accepted, the offeror is prohibited from revoking it for a reasonable time.

offeror A person who makes an offer.

offeree A person to whom an offer is made.

bilateral contract A contract that includes the exchange of a promise for a promise.

unilateral contract A contract exchanging a promise for an act.

Highlighting the Point

Margo offers to buy Harry’s sailboat, moored in San Francisco, on delivery of the boat to Margo’s dock in Newport Beach, three hundred miles south of San Francisco. Harry rigs the boat and sets sail. Shortly before his arrival at Newport Beach, Harry receives a radio message from Margo withdrawing her offer.

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C H A P T E R 8 Introduction to Contracts 101

8–2b Express versus Implied Contracts An express contract is one in which the terms of the agreement are fully and explic- itly stated in words, oral or written. For instance, a signed lease for an apartment or a house is an express written contract.

ExamplE 8.4 Katie and her friend Laura are talking to each other using Face- Time. During the online conversation, Katie agrees to buy Laura’s used Macbook Pro computer for $750 on the first day of the following month. They have an express oral contract. j

A contract that is implied from the conduct of the parties is called an implied contract. This contract differs from an express contract in that the conduct of the parties, rather than their words, creates and defines the terms of the contract.

The following three steps normally establish an implied contract: 1. A party furnishes some goods or services. 2. That party expects to be paid for those goods or services. The party to

whom the goods or services were provided knows, or should know, payment is expected (based on the objective theory of contracts test).

3. The party who receives the goods or services that were provided has a chance to reject them but does not.

ExamplE 8.5 Ted visits Rosa, an accountant, about doing his income tax returns. They discuss her fee and services. The next day, Ted brings in his tax information and leaves it with Rosa’s assistant. Ted and Rosa have entered into an implied contract because of their conduct. Rosa expects to be paid for completing the tax return, and by bringing in the records she needs to do the job, Ted has implied an intent to pay her. j

8–2c Quasi Contracts Quasi contracts are wholly different from actual contracts. Express contracts and implied contracts are actual, or true, contracts. Quasi contracts, as their name sug- gests, are not true contracts. They do not arise from any agreement, express or implied, between the parties themselves. Rather, quasi contracts are fictional con- tracts implied by courts and imposed on parties in the interests of fairness and justice. Usually, quasi contracts are imposed to avoid the unjust enrichment of one party at the expense of another.

LearNINg OUTcOme 2

Contrast express and implied contracts.

express contract A contract that is stated in words, oral or written.

implied contract A contract formed from the conduct of the parties.

quasi contract A fictional contract imposed by law to prevent unjust enrichment.

Does margo’s message terminate the offer, or is the offer irrevocable because Harry has begun performing? Margo’s offer is part of a unilateral contract, and only Harry’s delivery of the sailboat at her dock is an acceptance. The offer is irrevocable, because Harry has undertaken performance (and has, in fact, sailed almost three hundred miles). Thus, Harry can deliver the boat and bind Margo to the contract.

Highlighting the Point

Freshwater Services operates a water-distribution system that serves a residential area, including Joe and Carol Green’s home. The Greens do not have an express contract with Freshwater, but the couple pays the firm’s monthly charge for water. When Freshwater increases the monthly price, however, the Greens refuse to pay more. Freshwater files a suit against the Greens to collect the additional charge.

(Continues)

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U n i t 2 Contracts102

voidable contract A contract that can be legally avoided.

There are situations in which the party obtaining the unjust enrichment is not liable. Basically, a quasi contract cannot be invoked by a party who has conferred a benefit on someone else unnecessarily or as a result of misconduct or negligence.

ExamplE 8.6 Rhonda leaves her Camry at the Northgate Toyota dealership for its regular oil and lube service. When she returns to pick up the car, she learns that a Northgate employee mistakenly performed a coolant fluid exchange service in addition to the requested oil and lube service. Rhonda does not have to pay for the additional service that she did not request. j

8–2d Formal versus Informal Contracts Formal contracts require a special form or method of creation (formation) to be enforceable. They include negotiable instruments and letters of credit. Negotiable instruments include checks, notes, drafts, and certificates of deposits. Letters of credit are often used in international sales contracts.

Informal contracts include all contracts other than formal contracts. No special form is required (except for certain types of contracts that must be in writing), because the contracts are usually based on their substance rather than on their form.

ExamplE 8.7 Southwest Grocers Association signs an agreement to lease a ware- house from Commercial Properties for a certain term. In turn, United Trucking Company signs a contract to transport goods to and from the warehouse for South- west for the same period of time. These are informal contracts. j

8–2e Executed versus Executory Contracts Contracts are also classified according to their state of performance. A contract that has been fully performed on both sides is called an executed contract. A con- tract that has not been fully performed on either side is called an executory contract. If one party has fully performed but the other has not, the contract is said to be executed on the one side and executory on the other, but the contract is still classified as executory.

ExamplE 8.8 MTM Incorporated agrees to buy ten tons of coal from Western Coal Company. Western delivers the coal to MTM’s steel mill, where it is now being burned. At this point, the contract is an executory contract—it is executed on the part of Western and executory on MTM’s part. After MTM pays Western for the coal, the contract will be executed on both sides. j

8–2f Valid, Voidable, Unenforceable, and Void Contracts A valid contract has the necessary elements to entitle at least one of the parties to enforce it in court. Those elements consist of an offer and an acceptance that are supported by legally sufficient consideration and are made for a legal purpose by parties who have the legal capacity to enter into the contract. As you can see in Exhibit 8.1, valid contracts may be enforceable, voidable, or unenforceable.

Voidable Contracts A voidable contract is a valid contract that can nevertheless be avoided by one or both of the parties. The party having the option can elect to avoid any duty to perform or can elect to ratify (confirm) the contract. If the

formal contract A contract requiring a specific form to be valid.

informal contract A contract not requiring a specific form to be valid.

executed contract A contract that has been fully performed by both parties.

executory contract A contract that has not yet been fully performed.

valid contract A contract having legal strength or force.

can a quasi contract be imposed for the value of Freshwater’s services? Yes. A quasi contract can be imposed when a person knowingly receives a benefit from another party and it would be unjust for the person not to pay for its value. Here, the Greens enjoy the benefits of Freshwater’s water services and would be unjustly enriched if they did not pay for those services.

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C H A P T E R 8 Introduction to Contracts 103

contract is avoided, both parties are released from it. If it is ratified, both parties must fully perform their respective legal obligations.

As a general rule, but subject to exceptions, contracts made by minors are voidable at the option of the minor. Contracts entered into under fraudulent condi- tions are voidable at the option of the innocent party. In addition, contracts entered into because of mutual mistakes and those entered into under legally defined duress or undue influence are voidable.

Unenforceable Contracts An unenforceable contract is one that cannot be enforced because of certain legal defenses against it. It is not unenforceable because a party failed to satisfy a legal requirement of the contract. Rather, it is a valid contract rendered unenforceable by law. For instance, certain contracts must be in writing. If they are not, they will not be enforceable except under certain exceptional circumstances.

Void Contracts In contrast to a valid contract, a void contract is no contract at all. The terms void and contract are contradictory. A void contract produces no legal obligations on the part of any of the parties.

ExamplE 8.9 Lucy contracts with Brad to shoplift a designer leather jacket for him from a department store. There is no contract because shoplifting is against the law. j

8–2g E-Contracts E-contracts are contracts entered into online. They require the same four basic requirements—agreement, consideration, capacity, and legality—as valid paper contracts.

ExamplE 8.10 Jordan, a graduate student, agrees to rent an apartment from Penny Rentals for $500 a month. The rental agreement is sent to Jordan via e-mail. Jordan electronically signs the contract, agreeing to its terms, and e-mails it back to Penny. This is a valid e-contract. j

8–3 Interpretation of contracts When a contract dispute arises, a court is sometimes asked to interpret contract terms. Whether the court will do so depends on whether the terms are clear or ambiguous (unclear).

LearNINg OUTcOme 3

Distinguish valid, voidable, unenforceable, and void contracts.

unenforceable contract A valid contract that cannot be enforced by a court.

void contract A contract having no legal force.

e-contract A contract entered into online.

exhibit 8.1 Enforceable, Voidable, Unenforceable, and Void Contracts

NO CONTRACT

ENFORCEABLE CONTRACT A valid contract that can be enforced because

there are no legal defenses against it.

VOIDABLE CONTRACT A party has the option of avoiding or enforcing the contractual obligation.

UNENFORCEABLE CONTRACT A contract exists, but it cannot be enforced

because of a legal defense.

VOID CONTRACT No contract exists, or there is a contract

without legal obligations.

VALID CONTRACT A contract that has the necessary contractual

elements: agreement, consideration, legal capacity of the parties, and legal purpose.

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U n i t 2 Contracts104

8–3a The Plain Meaning Rule If what is written in a contract is clear, a court will enforce the contract according to its obvious terms. This is sometimes referred to as the plain meaning rule.

Under this rule, if the words in a contract appear clear, a court cannot consider any evidence not contained in the document itself. The words—and their plain, ordinary meanings—determine the intent of the parties at the time that they entered into the contract. Thus, a court must interpret the contract according to this intent.

8–3b Ambiguity and Outside Evidence If a contract is ambiguous, the court may have to consider outside evidence to determine the parties’ intent. A contract may be ambiguous under the following circumstances: 1. The intent of the parties cannot be determined from the contract’s language. 2. The contract lacks a provision on a disputed issue. 3. A contract term can be interpreted in more than one way. 4. There is uncertainty about a particular provision.

Outside evidence may include oral testimony, additional agreements or com- munications between the parties, and other relevant information. If this evidence fails to make the ambiguous term or provision clear, the court may interpret the ambiguity against the party who was responsible for creating it.

LearNINg OUTcOme 4

Understand the plain meaning rule.

Conflict Resolved In the Conflict Presented feature at the beginning of this chapter, Chandra goes to the Bijoux Theater to attend a concert. Before buying a ticket, she is asked by a theater staff member not to record

any part of the concert. This restriction is also printed on the ticket. She agrees. During the concert, however, she is seen recording part of the concert on her smartphone. She is asked to leave for breaching her contract with the theater.

a Did Chandra and Bijoux have a binding contract? Yes. The theater’s terms for the ticket sale include Chandra’s agreement not to record any part of the concert. The

term appears in writing on the ticket. The consideration is Bijoux’s granting of a ticket

to the concert in exchange for the promise not to record any part of the performance.

As an adult, Chandra presumably has capacity. The agreement’s subject matter is legal.

Chandra’s consent is voluntary. The agreement is valid. Bijoux can ask Chandra to leave

the concert.

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C H A P T E R 8 Introduction to Contracts 105

LearNINg OUTcOme 1: List the four requirements of a contract. The requirements of a contract are (1) agreement, (2) consideration, (3) capacity, and (4) legality.

LearNINg OUTcOme 2: contrast express and implied contracts. The terms of an express contract are fully and explicitly stated in words, oral or written. The terms of an implied contract are based on the conduct of the parties. An implied contract differs from an express contract in that the conduct of the parties, rather than their words, creates and defines the terms.

LearNINg OUTcOme 3: Distinguish valid, voidable, unenforceable, and void contracts. A valid contract has all four basic requirements, which entitles at least one of the parties to enforce it in court. A voidable contract is a valid contract that can be avoided by one or both of the parties. An unenforceable contract is a valid contract rendered unenforceable by law because of certain legal defenses against it. A void contract is no contract at all.

LearNINg OUTcOme 4: Understand the plain meaning rule. The plain meaning rule tells a court that it cannot consider any outside evidence, if the words in a contract appear clear and ambiguous.

CHaPteR sUmmaRy—intRodUCtion to ContRaCts

issUe sPotteRs Check your answers to the Issue Spotters against the answers provided in Appendix A at the end of this text.

1. Molly tells Nick that she will pay him $10,000 to set fire to her store, so that she can collect the money from her fire insurance policy. Nick sets fire to the store, but Molly refuses to pay him. Can Nick recover the $10,000 from Molly? Why or why not? (See Types of Contracts.)

2. Alison receives a notice of property taxes due from the local tax collector. The notice is for tax on Jerry’s prop- erty, but Alison believes that the tax is hers and pays it. Can Alison recover from Jerry the amount that she paid? Why or why not? (See Types of Contracts.)

stRaigHt to tHe Point

1. Define contract. (See The Definition of a Contract.) 2. Identify the element that is of prime importance in

determining whether a contract has been formed. (See The Definition of a Contract.)

3. What determines whether a contract is classified as unilateral or bilateral? (See Types of Contracts.)

4. Which steps normally establish an implied contract? (See Types of Contracts.)

5. What do formal contracts require to be enforceable? (See Types of Contracts.)

6. When is a contract so ambiguous that a court may have to interpret its terms? (See Interpretation of Contracts.)

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U n i t 2 Contracts106

Real law

8–1. Interpretation of contracts. Lehman Brothers, Inc. (LBI), wrote a letter to Mary Ortegón offering her employ- ment. The offer included a salary of $150,000 per year and an annual “minimum bonus” of $350,000. The bonus was not a “signing” bonus—it was clearly tied to her perfor- mance on the job. Ortegón accepted the offer. Before she started work, however, LBI canceled the contract. Later, Ortegón filed a claim with a court to recover the amount of the $350,000 bonus on the ground that LBI had breached its contract with her by not paying it. Can outside evidence be admitted to interpret the meaning of the bonus term? Explain. [Ortegón v. Giddens, 638 Fed.Appx. 47 (2d Cir. 2016)] (See Interpretation of Contracts.)

8–2. Implied contracts. Ralph Ramsey insured his car with Allstate Insurance Co. He also owned a house on which he maintained a homeowner’s insurance policy with Allstate. Bank of America had a mortgage on the house and paid the insurance premiums on the homeowner’s policy from Ralph’s account. After Ralph died, Allstate cancelled the car

insurance. Ralph’s son, Douglas, inherited the house. The bank continued to pay the premiums on the homeowner’s policy, but from Douglas’s account, and Allstate continued to renew the insurance. When a fire destroyed the house, however, Allstate denied coverage, claiming that the policy was still in Ralph’s name. Douglas filed a suit in a federal district court against the insurer. Was Allstate liable under the homeowner’s policy? Explain. [Ramsey v. Allstate Insurance Co., 2013 WL 467327 (6th Cir. 2013)] (See Types of Contracts.)

8–3. Quasi contract. Kim Panenka asked to borrow $4,750 from her sister, Kris, to make a mortgage payment. Kris deposited a check for that amount into Kim’s bank account. Hours later, Kim asked to borrow another $1,100. Kris took a cash advance on her credit card and deposited this amount into Kim’s account. When Kim did not repay her, Kris filed a suit, arguing that she had loaned Kim the money. Can the court impose a contract between the sisters? Explain. [Panenka v. Panenka, 331 Wis.2d 731, 795 N.W.2d 493 (2011)] (See Types of Contracts.)

etHiCal QUestions

8–4. Quasi contract. Should any enrichment always be considered unjust? Discuss. (See Types of Contracts.)

8–5. contract requirements. Mark Carpenter, a certi- fied financial planner, contracted to recruit investors for GetMoni.com, which owned a defunct gold mine in Arizona. Carpenter then contracted with clients to invest their funds, sending more than $2 million to GetMoni.com. Carpenter collected another $1 million, but instead of send- ing it to GetMoni.com, he deposited the money into his

own account. A federal investigation unraveled the scheme. Carpenter was charged with two counts of fraud—one for his deal with GetMoni.com and one for his misrepresen- tations to clients after he stopped dealing with GetMoni .com. Which contract requirements were lacking in these agreements that prevent them from being enforced? Can Carpenter argue successfully that he acted ethically? Dis- cuss. [United States v. Mark J. Carpenter, 2017 WL 129037 (6th Cir. 2017)] (See The Definition of a Contract.)

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107

Chapter 8—work set

tRUe-False QUestions

1. Don contracts with Jan to paint Jan’s townhouse while she’s on vacation. By mistake, Don paints Mick’s town- house. Mick sees Don painting but says nothing. From whom can Don recover?

a. Jan, because she was the party with whom Don contracted. b. Jan, under the theory of quasi contract. c. Mick, because his house was painted. d. Mick, under the theory of quasi contract.

2. Brian offers to sell Ashley his vintage vinyl records collection, forgetting that he does not want to sell some of the records. Unaware of Brian’s forgetfulness, Ashley accepts. Is there a contract including all of Brian’s records?

a. Yes, according to the objective theory of contracts. b. Yes, according to the subjective theory of contracts. c. No, because Brian did not intend to sell his favorite records. d. No, because Ashley had no reason to know of Brian’s forgetfulness.

3. Greg promises to imprint four thousand T-shirts with Rona’s logo. Rona pays in advance. Before Greg delivers the shirts, the contract is classified as

a. executory, because it is executory on Greg’s part. b. executory, because it is executory on Rona’s part. c. executed, because it is executed on Greg’s part. d. none of the above.

4. Without mentioning payment, Mary accepts the services of Lee, a contractor, and is pleased with the work. Is there a contract between them?

a. Yes, there is an express contract. b. Yes, there is an implied contract. c. No, because they made no agreement concerning payment. d. Yes, there is a quasi contract.

mUltiPle-CHoiCe QUestions

1. All contracts involve promises, and every promise is a legal contract.

2. An agreement includes an offer and an acceptance.

3. Consideration, in contract terms, refers to a party’s competency to enter into a contract.

4. A unilateral contract involves performance instead of promises.

5. Formal contracts are contracts between parties who are in formal relationships—employer-employee rela- tionships, for example.

6. An unenforceable contract is a contract in which one or both of the parties have the option of avoiding their legal obligations.

7. A court imposes a quasi contract to avoid one party’s unjust enrichment at another’s expense.

8. An express contract is one in which the terms are fully stated in words.

9. An oral contract is an implied contract.

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108

answeRing moRe legal PRoblems

1. Rocky Mountain Races, Inc., sponsors the Pioneer Trail Ultramarathon, which has an advertised first prize of $10,000. The rules require the competitors to run one hundred miles from the floor of Blackwater Canyon to the top of Pinnacle Mountain. The rules also provide that Rocky reserves the right to change the terms of the race at any time. Monica enters the race and is declared the winner. Rocky offers her a prize of $1,000 instead of $10,000.

Did Rocky and Monica have a contract? Yes. These parties had a contract. Contests, lotteries, and other competitions for prizes are offers for contracts. Here, the _______________ is phrased so that each competitor can accept only by completing the run. At that point, a contract is formed—a _______________ contract—bind- ing its sponsor to perform as promised. By changing the prize, did Rocky breach this contract? No. Rocky did not breach the contract when the prize was changed. Under the rules, Rocky could _______________ the terms at any time.

2. For employment with the Firestorm Smokejumpers— a crew of elite paratroopers who parachute into danger- ous situations to fight fires—applicants must complete a series of tests. The crew chief sends the most qualified applicants a letter stating that they will be admitted to Firestorm’s training sessions if they pass a medical exam. Scott receives one of the letters and passes the exam, but a new crew chief changes the selection pro- cess and rejects him.

Did the letter from Firestorm to Scott constitute a con- tract? Yes. Firestorm and Scott had a contract. The letter was a unilateral offer phrased so that the offeree could accept only by completing the required performance. The contract was formed when the _______________ was complete. This was a _______________ con- tract. Scott accepted the offer by passing the medical exam. Did Firestorm breach this contract? Yes. Fire- storm breached the contract when the new crew chief rejected Scott, who had already received the offer and _______________ it. The appropriate remedy would be to allow Scott to attend Firestorm’s training sessions.

5. The requirements of a contract include

a. agreement only. b. consideration only. c. agreement and consideration only. d. agreement, consideration, and other elements.

6. Sam contracts with Hugo’s Sports Equipment to buy a jet ski and to pay for it in installments. Sam is a minor, and so he can choose to avoid his contractual obligations. The contract between Sam and Hugo is

a. valid. b. void. c. voidable. d. both a and c.

7. A contract consists of promises between two or more parties to

a. refrain from performing some act. b. perform some act in the future. c. perform some act now. d. any of the above.

8. Donny tells Elise that he will pay her $2,000 to hack into the database of Filipe, Donny’s competitor, so that Donny can obtain the names and credit-card numbers of Filipe’s customers, as well as other trade secrets. This deal is

a. an enforceable contract. b. a voidable contract. c. a void contract. d. an executed contract.

9. Rita calls Rick on the phone and agrees to buy his antique rocking chair for $200. This is

a. an express contract. b. an implied contract. c. a quasi contract. d. no contract.

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109

Learning OutcOmes

The four Learning Outcomes below are designed to help improve your understanding of the chapter. After reading this chapter, you should be able to:

Identify the elements of an offer.

Recognize a counteroffer.

Identify the elements of a valid acceptance.

Describe a click-on agreement.

1

2

3

4

9 Offer and Acceptance

Essential to any contract is that the parties agree on the terms of the contract. Agreement exists when an offer made by one party is accepted, or assented to, by the other. Ordinarily, agreement is evidenced by an offer and an acceptance. One party offers a certain bargain to another party, who then accepts that bargain.

9–1 requirements of the Offer An offer is a promise or commitment to perform or refrain from performing some specified act in the future. The party making an offer is called the offeror, and the party to whom the offer is made is called the offeree. Three elements necessary for an offer to be effective are (1) intention, (2) definiteness of terms, and (3) communication.

9–1a Intention The first requirement for an effective offer is a serious intention on the part of the offeror. Furthermore, the offeror’s intention to become bound by the offer must be objectively clear to others.

Serious intent is not determined by the subjective (personal, unspoken) inten- tions, beliefs, or assumptions of the offeror. It is determined by what a reasonable person in the offeree’s position would conclude that the offeror’s words and actions meant. Offers made in obvious anger, jest, or undue excitement do not meet the serious-intent test.

Expressions of Opinion An expression of opinion is not an offer. An expressed opinion does not evidence an intention to enter into a binding agreement.

ExAmplE 9.1 Henry takes his daughter, Miranda, to Dr. Ryan and asks him to operate on her hand, which has been injured in an accident. Ryan says Miranda will be in the hospital three or four days and that the hand will probably heal within a

offer A promise to perform some specified act in the future.

Learning OutcOme 1

Identify the elements of an offer.

agreement When two or more parties consent to a contract’s terms.

Conflict Presented Code Tech Corporation contracts to provide technical services and support for Standing Stone Brewery’s retail website. Later, Code Tech files a lawsuit against Standing Stone, claiming nonpayment

for some of its work. To resolve their dispute, the parties exchange e-mails that outline essential settlement terms.

Q Do the e-mails create a binding settlement agreement?

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U n i t 2 Contracts110

few days. Ryan’s words do not constitute an offer to heal Miranda’s hand in three or four days. Rather, he is expressing an opinion as to when the hand might heal. j

Preliminary Negotiations A request or invitation to negotiate is not an offer. It is only an expression of a willingness to discuss the possibility of entering into a contract. For instance, statements such as “Will you sell your three-bedroom house?” and “I wouldn’t sell my car for less than $8,000” are not offers.

Similarly, when the government and private firms need to have construction work done, contractors are invited to submit bids. The invitation to submit bids is not an offer, and a contractor does not bind the government or private firm by submitting a bid. The bids that the contractors submit are offers, however, and the government or private firm can bind the contractor by accepting the bid.

Advertisements In general, advertisements, catalogues, and circular letters (meant for the general public) are considered invitations to negotiate. They are not considered evidence of an intention to enter into a contract.

Price lists are another form of invitation to negotiate or trade. A seller’s price list is not an offer to sell at that price. It merely invites the buyer to offer to buy at that price. In fact, a seller usually puts “prices subject to change” on a price list. Only in rare circumstances will a price quotation be regarded as an offer.

Auctions In a live auction, a seller “offers” goods for sale through an auctioneer, but this is not an offer to form a contract. Rather, it is an invitation, asking bidders to submit offers. In the context of an auction, a bidder is the offeror, and the auctioneer is the offeree.

Online auctions are the most familiar type of auction today. Online auction sites, such as eBay, provide a forum for buyers and sellers to sell almost anything. Like an advertisement, an “offer” to sell an item on one of these sites is generally treated as an invitation to negotiate.

9–1b Definiteness of Terms The second requirement for an effective offer concerns the definiteness of its terms. An offer must have reasonably definite terms—such as the names of the parties, quantity of items, how work will be performed, and payment details. This definiteness enables a court to determine if a breach has occurred and give an appropriate remedy.

An offer may invite an acceptance to be worded in such specific terms that the contract is made definite. ExAmplE 9.2 Soccer Warehouse e-mails Eastport Athletic Store and offers to sell “from one to twenty-five Kwik Goal heavy-duty anchor bags

Highlighting the Point

An ad on ScienceNOW’s website asks for “news tips.” Erik submits a manuscript in which he claims to have solved a famous mathematical problem. ScienceNOW declines to publish the manuscript. Erik files a lawsuit, alleging breach of contract. He asserts that ScienceNOW’s ad is an offer, which he has accepted.

is the ad on ScienceNOW’s website an offer? No. Most courts would dismiss this suit. Ads are not offers—they invite offers. Responses to ads are not acceptances—they are offers. Thus, Erik’s submission of the manuscript for publication is the offer, which ScienceNOW did not accept.

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C H A P T E R 9 Offer and Acceptance 111

for $200 each. State the number desired in acceptance.” In an e-mail reply, East- port’s general manager agrees to buy one dozen of the bags. Because the quantity is specified in the acceptance, the terms are definite. The contract is enforceable. j

9–1c Communication The third requirement for an effective offer is communication. The offer must be communicated to the offeree, so that he or she will know the offer has been made.

9–2 termination of the Offer The communication of an effective offer to an offeree gives the offeree the power to transform the offer into a binding legal obligation—a contract. This power of acceptance, however, does not continue forever. It can be terminated by action of the parties or by operation of law.

9–2a Termination by Action of the Parties An offer can be terminated by the action of the parties by (1) revocation, (2) rejec- tion, or (3) a counteroffer.

Revocation of the Offer The offeror’s act of withdrawing an offer is called revocation. Unless an offer is irrevocable, the offeror usually can revoke the offer (even if he or she promises to keep the offer open), as long as the revocation is communicated to the offeree before she or he accepts. The offeror can revoke the offer by expressly repudiating it or by performing acts that are inconsistent with the existence of the offer and that are made known to the offeree. For instance, a statement such as “I withdraw my previous offer of October 17” is an express repudiation.

Most states follow the general rule that a revocation becomes effective when the offeree or offeree’s agent actually receives it. Therefore, a revocation sent via FedEx on April 1 and delivered at the offeree’s residence or place of business on April 3 becomes effective on April 3. Similarly, an offer made to the public can be revoked in the same manner in which the offer was originally communicated.

Rejection of the Offer The offer may be rejected by the offeree, which terminates the offer. The offeree can reject the offer by words or by conduct. As with revocation, rejection of an offer is effective only when it is actually received by the offeror or the offeror’s agent.

Simply inquiring about an offer does not constitute rejection. ExAmplE 9.3 Ray- mond offers to buy Jasmine’s iPhone 7 for $250, and Jasmine responds, “Is that

revocation The withdrawal of an offer by an offeror.

Rocky Mountain Adventures sells an exclusive line of mountain bikes at its down- town location. After the store is robbed in an overnight break-in, the owner, Jerry, offers a $5,000 reward for information leading to the arrest and conviction of the bur- glars. He publicizes the offer for four days on the company’s Facebook page and on a flyer posted on the store’s main entrance.

can Jerry revoke his offer of a reward before someone comes forward with information? Yes. Jerry can revoke his reward offer as long as he does so using the same methods for communicating the offer (Facebook and the store flyer) for the same number of days.

Highlighting the Point

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U n i t 2 Contracts112

your best offer?” or “Will you pay me $300 for it?” Jasmine has not rejected the offer but has merely made an inquiry about it. She can still accept and bind Ray- mond to his offered $250 purchase price. j

Counteroffer A counteroffer is a rejection of the original offer and the simultaneous making of a new offer, giving the original offeror (now the offeree) the power of acceptance. ExAmplE 9.4 Jessica offers to sell her home to Bradley for $225,000, and Bradley says, “The price is too high. I’ll pay $200,000.” Bradley’s response is a counteroffer—it terminates the original offer and creates a new offer. j

The mirror image rule requires that the offeree’s acceptance match the offeror’s offer exactly. In other words, the terms of acceptance must “mirror” those of the offer. If the acceptance materially (substantially) changes or adds to the terms of the original offer, it will be considered not an acceptance but a counteroffer.

9–2b Termination by Operation of Law The offeree’s power to transform an offer into a binding obligation can be termi- nated by operation of law in several ways. Lapse of time, destruction or death, or supervening illegality all act to terminate the offer by operation of law.

Lapse of Time An offer terminates automatically when the period of time specified in the offer has passed. For instance, an offer specifying that it will be held open for twenty days will lapse at the end of twenty days.

The time period normally begins to run when the offer is actually received by the offeree, not when it is sent or drawn up. When receipt of the offer is delayed, the period begins to run from the date the offeree would have received the offer, but only if the offeree knows or should know that the offer is delayed.

If no time for acceptance is specified in the offer, the offer terminates at the end of a reasonable period of time. A reasonable period of time is determined by the subject matter of the contract, business and market conditions, and other relevant circumstances.

ExAmplE 9.5 Winston’s offer to sell his farm produce to West Valley Grange ter- minates sooner than his offer to sell West Valley a piece of farm equipment. This is because Winston’s produce is perishable and subject to greater fluctuations in market value. j

Destruction or Death An offer is automatically terminated if the specific subject matter of the offer (such as an iPad or a house) is destroyed before the offer is accepted. An offeree’s power of acceptance is also terminated when the offeror or offeree dies or becomes legally incapacitated, unless the offer is irrevocable.

Supervening Illegality A statute or court decision that makes an offer illegal automatically terminates the offer. ExAmplE 9.6 Lee offers to lend Kim $10,000 at an annual interest rate of 15 percent. Before Kim can accept Lee’s offer, a state law is enacted that prohibits interest rates higher than 12 percent in personal loans. Lee’s offer is automatically terminated. j

9–3 acceptance Acceptance is a voluntary act by the offeree that shows assent, or agreement, to the offer. It may consist of words or conduct. An acceptance has three requirements: 1. An offer must be accepted by the offeree, not by a third party. 2. The acceptance must be unequivocal. 3. In most situations, the acceptance must be communicated to the offeror.

Learning OutcOme 2

Recognize a counteroffer.

counteroffer An offeree’s rejection of the original offer and simultaneous making of a new offer.

mirror image rule A rule requiring that the terms of the offeree’s acceptance exactly match the terms of the offeror’s offer.

Learning OutcOme 3

Identify the elements of a valid acceptance.

acceptance The offeree’s willing consent to the terms of an offer.

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C H A P T E R 9 Offer and Acceptance 113

9–3a Offeree Acceptance Only The identity of the offeree is as much a condition of a bargaining offer as any other term. Thus, except in special circumstances, only the person to whom the offer is made (or that person’s agent) can accept the offer and create a binding contract. ExAmplE 9.7 Lottie makes an offer to Paul. Paul is not interested, but Paul’s friend José says, “I accept the offer.” No contract is formed. j

9–3b Unequivocal Acceptance The offeree must accept without adding or changing any terms. This is the mirror image rule previously discussed. If the acceptance is subject to new conditions, or if the terms of the acceptance materially change the original offer, the acceptance may be deemed a counteroffer.

Ordinarily, silence cannot constitute acceptance. This general rule applies even if the offeror states, “By your silence and inaction, you will be deemed to have accepted this offer.”

9–3c Communication of Acceptance Whether the offeror must be notified of the acceptance depends on the nature of the contract. In a unilateral contract, the full performance of some act is called for. Acceptance is usually evident, and notification is therefore unnecessary (unless the law requires it or the offeror asks for it).

In a bilateral contract, in contrast, communication of acceptance is necessary, because acceptance is in the form of a promise. The bilateral contract is formed when the promise is made rather than when the act is performed. Additionally, acceptance must be timely. The general rule is that acceptance is timely if it is effec- tive before the offer is terminated.

The Mailbox Rule Acceptance takes effect, which completes formation of the contract, at the time the communication is sent via the mode authorized by the offeror. This is called the mailbox rule.

Under this rule, if the authorized mode of communication is via the U.S. mail, then an acceptance becomes valid when the offeror sends it and not when the

mailbox rule A rule providing that an acceptance of an offer becomes effective on dispatch.

Real Case

Melinda Hinkal signed a membership agreement at Gold’s Gym that stated, “The terms on each side of this form are a part of this Agreement.” On the back, a “Waiver of Liability” paragraph provided that a member “voluntarily agrees to assume all risks of personal injury.” While using exercise equipment at the direction of personal trainer Gavin Pardoe, Hinkal injured her neck, requiring surgery. She filed a lawsuit in a Pennsylvania state court against Pardoe to recover damages. The court issued a summary judgment in Pardoe’s favor. Hinkal appealed.

Was Hinkal’s acceptance of the agreement unequivocal and clearly communicated, thus releasing Pardoe from liability for Hinkal’s neck injury? Yes. In Hinkal v. Pardoe, a state intermediate appellate court affirmed that Hinkal had plainly accepted the terms on both sides of the membership agreement by signing it and not making any changes. The appellate court also ruled that the agreement had been clearly communicated. Thus, Hinkal had agreed to the waiver of liability clause and could not sue Pardoe.

—133 A.3d 738 (Pa.Super.)

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U n i t 2 Contracts114

offeror receives it. (This is an exception to the rule that acceptance requires a com- pleted communication in bilateral contracts.)

The mailbox rule does not apply to instantaneous forms of communication, such as face-to-face, phone, and e-mail communication. E-mail is considered sent when it either leaves the control of the sender or is received by the recipient. Either circumstance allows an e-mail acceptance to become effective when sent.

Authorized Means of Acceptance When an offeror specifies how acceptance should be made, such as by overnight delivery, the contract is not formed unless the offeree uses that mode of acceptance. ExAmplE 9.8 Mikelson Wholesale offers to sell one hundred Samsung fifty-five-inch 4K smart TVs to Larson’s Electronics. The offer states that Larson’s must accept the offer via FedEx overnight delivery. The acceptance is effective (and a binding contract is formed) the moment Larson’s gives the overnight envelope containing the acceptance to the FedEx driver. j

If the offeror does not expressly specify a certain mode of acceptance, then acceptance can be made by any reasonable means. Prevailing business practices and other surrounding circumstances determine whether a mode of acceptance is reasonable. Usually, the offeror’s choice of a particular means in making the offer implies that the offeree can use the same or a faster means for acceptance. For instance, if the offer is made via Priority U.S. Mail, it would be reasonable to accept the offer via Priority Mail or a faster method, such as UPS overnight delivery or e-mail.

Substitute Method of Acceptance What if the offeror authorizes a particular method of acceptance, but the offeree accepts by a different means? The acceptance may still be effective if the substituted method serves the same purpose as the authorized means. The use of a substitute method of acceptance is not effective on dispatch, though. No contract will be formed until the acceptance is received by the offeror.

ExAmplE 9.9 Michigan Metals offers to sell Hilton Hardware a truckload of steel roof panels. Its offer specifies FedEx overnight delivery for acceptance. Hil- ton accepts the offer using UPS overnight delivery. The acceptance is effective only when Michigan receives it. j

9–4 e-contracts—Offer and acceptance Today, e-contracts are being used more and more in business interactions. Most often, e-contracts are formed for the sale of goods and services online. Disputes regarding e-contracts tend to center on the terms and whether the parties agreed to them.

9–4a Online Offers To avoid legal disputes, offerors should make sure that online offers are obvious and easy to read. On a website, this requirement can be accomplished with a link to a separate page that contains the contract’s full details. Usually, these details cover specific provisions regarding the acceptance of the terms, payment, disclaimers, the seller’s return policy, remedy limitations, and dispute resolution.

9–4b Online Acceptances As with traditional paper contracts, acceptance of e-contracts must show that the offeree voluntarily assented to the offer’s terms. When ordering online, offerees often

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C H A P T E R 9 Offer and Acceptance 115

indicate their assent through the use of click-on agreements. A click-on agreement may consist of a box that includes the words “I agree.” If the offeree clicks on the box to indicate acceptance, a binding contract is created.

Courts normally have enforced the terms of click-on agreements in the same way as the terms of other contracts. Under the common law of contracts, a binding contract can be created by conduct—including clicking on an online box—that indicates consent to the terms of the agreement.

9–4c The Uniform Electronic Transactions Act The Uniform Electronic Transactions Act (UETA), which has been adopted in most states, applies to many e-contracts. The UETA does not create new rules for e-contracts. Rather, it supports the application of existing contract rules to elec- tronic transactions.

Before the UETA applies, each party to a transaction must agree to conduct it by electronic means. The agreement may be implied by the conduct of the parties and the circumstances. ExAmplE 9.10 Jonas gives out his business card with an e-mail address on it. Jonas has consented to do business electronically. j

click-on agreement An agreement entered into online when a buyer indicates his or her acceptance of an offer by clicking on a button that reads “I agree.”

Learning OutcOme 4

Describe a click-on agreement.

Highlighting the Point

Facebook, Inc., is headquartered in Santa Clara County, California. The “Terms of Use” that govern Facebook users’ accounts include a forum-selection clause stating that all disputes will be resolved in a court in Santa Clara County. Potential Facebook users cannot become actual users unless they click on an acknowledgment that they have agreed to this term.

is the forum-selection clause in Facebook’s user click-on agreement binding? Yes. A binding contract can be created online by clicking on a button that indicates agree- ment to the contract’s terms. Here, a user is informed of the result of his or her click to agree. In short, by clicking on the acknowledgment button and then using Facebook, the user agrees to resolve all disputes according to this term.

Conflict Resolved In the Conflict Presented feature at the beginning of this chapter, Code Tech Corporation agrees to provide technical services and support for Standing Stone Brewery’s website. Claiming

nonpayment, Code Tech later files a lawsuit against Standing Stone. In an effort to resolve their dispute, the parties exchange e-mails outlining essential terms to a settlement contract.

A Do the e-mails create a binding settlement agreement? Yes. The parties’ e-mail exchanges contain the essential terms of the settlement offer and demonstrate voluntary

acceptance by both parties. The messages constitute a complete and unambiguous

statement of the parties’ intent to be bound by the terms. All that remains is for the

contract terms to be performed.

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U n i t 2 Contracts116

Learning OutcOme 1: identify the elements of an offer. The elements of an effective offer are (1) the offeror’s serious intent to be bound by the offer, (2) terms that are reasonably definite, and (3) communication of the offer to the offeree.

Learning OutcOme 2: recognize a counteroffer. A counteroffer is a response to an offer in which an offeree rejects the original offer and at the same time makes a new offer.

Learning OutcOme 3: identify the elements of a valid acceptance. The elements of a valid acceptance are (1) acceptance by the offeree, (2) unequivocal acceptance with no changes in terms, and (3) communication of the acceptance to the offeror.

Learning OutcOme 4: Describe a click-on agreement. A click-on agreement arises when a buyer, completing a transaction online, is required to indicate his or her consent to the terms by clicking on a button or box that says, “I agree.”

CHaPteR SummaRy—OffeR and aCCePtanCe

ISSue SPOtteRS Check your answers to the Issue Spotters against the answers provided in Appendix A at the end of this text.

1. Fidelity Corporation offers to hire Ron to replace Mon- ica, who has given Fidelity a month’s notice of intent to quit. Fidelity gives Ron a week to decide whether to accept. Two days later, Monica signs an employment contract with Fidelity for another year. The next day, Monica tells Ron of the new contract. Ron immediately sends a formal letter of acceptance to Fidelity. Do Fidel- ity and Ron have a contract? Why or why not? (See Ter- mination of the Offer.)

2. While visiting the website of Cyber Investments, Dani encounters a pop-up box that reads, “Our e-mail daily newsletter E-Profit is available by subscription at the rate of one dollar per issue. To subscribe, enter your e-mail address below and click on ‘SUBSCRIBE.’” Dani enters her e-mail address and clicks on “SUBSCRIBE.” Has Dani entered into an enforceable contract? Explain. (See E-Contracts—Offer and Acceptance.)

StRaIgHt tO tHe POInt

1. How can an offeror or offeree terminate an offer? (See Termination of the Offer.)

2. In what ways might the law terminate an offer? (See Ter- mination of the Offer.)

3. What is the mailbox rule? (See Acceptance.)

4. What is the mirror image rule? (See Termination of the Offer.)

5. What must occur for the Uniform Electronic Trans- actions Act (UETA) to apply to a transaction? (See E-Contracts—Offer and Acceptance.)

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C H A P T E R 9 Offer and Acceptance 117

Real law

9–1. acceptance. Lucas Contracting, Inc., is a small con- tractor in Carrollton, Ohio. Altisource Portfolio Solutions, Inc., hired Lucas to work on certain foreclosed properties. When payment for the work was not forthcoming, Lucas filed a suit in an Ohio state court against Altisource. Before the trial, Lucas e-mailed the terms of a settlement. The same day, Altisource e-mailed a response that did not challenge or contradict Lucas’s proposal and indicated agreement to it. Two days later, however, Altisource forwarded a settle- ment document that contained additional terms. Which e-mail proposal most likely satisfies the element of agree- ment to establish a contract? Explain. [Lucas Contracting, Inc. v. Altisource Portfolio Solutions, Inc., 2016 WL 529408 (2016)] (See Acceptance.)

9–2. Offer. While riding her motorcycle, Amy Kemper was seriously injured when Christopher Brown hit her with his vehicle. Kemper wrote to Statewide Claims Services, the administrator for Brown’s insurer, asking for “all the insur- ance money that Mr. Brown had under his insurance policy.” In exchange, Kemper agreed to sign a limited release that

could not contain “any language saying that [she would] have to pay Mr. Brown or his insurance company any of their incurred costs.” Statewide sent a check and a demand that Kemper “place money in an escrow account in regards to any and all liens pending.” Kemper refused the demand. Did Statewide and Kemper have an enforceable agreement? Discuss. [Kemper v. Brown, 325 Ga.App. 806, 754 S.E.2d 141 (2014)] (See Termination of the Offer.)

9–3. acceptance. Kathy Wright and real estate agent Jen- nifer Crilow orally agreed to a contract with a “protection period.” Under this provision, if Wright’s property sold after the contract expired to a party who had been shown the property during the term of the contract, Crilow would still receive a commission. Crilow sent Wright a written copy of the agreement. Wright crossed out the protection-period provision and then signed and returned the copy. Before the contract expired, Crilow showed Wright’s property to Michael Ballway. After the contract expired, Ballway bought the property. Does Wright owe Crilow a commis- sion? Why or why not? [Crilow v. Wright, __ Ohio App.3d __ (2011)] (See Acceptance.)

etHICal QueStIOnS

9–4. intent. Should promises of prizes in ads and circulars always be enforced? Discuss. (See Requirements of the Offer.)

9–5. intention. The Prince Hall Grand Lodge is a fraternal association incorporated in the state of Washington. The Grand Lodge Constitution provides that the Grand Master “shall decide all questions of . . . Masonic law.” Grand Mas- ter Gregory Wraggs suspended the membership of Lonnie Traylor for “unMasonic conduct.” Traylor asked Wraggs to revoke the suspension and prepared a “Memo of

Understanding.” Wraggs agreed to talk but declined to revoke the suspension and did not sign the memo. Traylor filed a suit in a Washington state court against the Grand Lodge and Wraggs, alleging that the Grand Master’s failure to revoke Traylor’s suspension was a breach of contract. On what basis would the court likely hold that there was no contract? Is it unethical of Traylor to assert otherwise? Dis- cuss. [Traylor v. Most Worshipful Prince Hall Grand Lodge, 197 Wash.App. 1026 (Div. 2 2017)] (See Requirements of the Offer.)

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119

Chapter 9—work Set

1. To be effective, an offer must be made with serious intent.

2. A contract providing that Joe is to pay Bill “a fair share of the profits” will be enforced.

3. A simple rejection of an offer will terminate it.

4. Offers that must be kept open for a period of time include advertisements.

5. The mirror image rule is an old rule that no longer applies.

6. If an offeree is silent, he or she can never be considered to have accepted an offer.

7. An offer terminates when the time specified in the offer has passed and the offeror has given one last chance to the offeree to accept.

8. Anyone who is aware of an offer can accept it and create a binding contract.

9. Acceptance is timely if it is made before an offer terminates.

tRue-falSe QueStIOnS

1. Julio offers to sell Christine a used iPad for $400. Which of the following replies would constitute an acceptance?

a. “I accept. Please send a written contract.” b. “I accept, if you send a written contract.” c. “I accept, if I can pay in monthly installments.” d. None of the above.

2. Vern offers to sell his car to Lee, stating that the offer will stay open for thirty days. Vern

a. cannot revoke the offer for thirty days. b. can revoke the offer after any reasonable period of time. c. can revoke the offer any time before Lee accepts. d. can revoke the offer any time within thirty days, even after Lee accepts.

3. Digit Electronics places an ad announcing a sale of its inventory at public auction. At the auction, Digit’s auctioneer points to a seventy-five-inch 4K TV and asks, “What am I bid for this item?” Which of the following is true?

a. The first bid is an acceptance if no other bid is received. b. Each bid is an acceptance if no higher bid is received. c. Each bid is an offer that may be accepted or rejected. d. Each bid is an offer that must be accepted if no higher bid is received.

4. Ed sends to Sax, Inc., a written order for software to be specially designed, offering a certain amount of money. If Sax does not respond, it can be considered to have accepted the offer

a. after a reasonable time has passed. b. if Ed knows that Sax accepts all offers unless it sends notice to the contrary. c. only when Sax begins the work. d. in none of the above situations.

5. Paul makes an offer to Lynn in a written purchase order, saying nothing about how her acceptance should be sent. Lynn indicates her acceptance by signing and returning the purchase order. Lynn’s acceptance is effective

a. when Lynn decides to accept. b. when Lynn sends the signed purchase order. c. when Paul receives the signed purchase order. d. in none of the above situations.

multIPle-CHOICe QueStIOnS

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120

anSweRIng mORe legal PROblemS

1. Nils bargains with the city of Fargo, North Dakota, concerning a contract to design a waste-to-energy incin- erator that is to double as a tourist attraction. Integrated into the structure will be a ski slope with areas for skiers of all skill levels. On January 12, the city sends a written offer that states, “Acceptance of this offer must be made by registered or certified mail and received no later than January 22.” Nils responds with a note accepting the offer via an overnight delivery service. The city receives the note January 23.

Do Nils and Fargo have a contract?  No. Fargo received Nils’s note one day after its deadline had expired. For this reason, his response to the city’s offer is a counteroffer—a new _______________. When an offeror specifies a date for acceptance, an offer auto- matically _______________ on that specified date. This _______________ the offeree’s power to accept the offer. An attempted acceptance after the expiration consti- tutes a new offer.

2. The University of Connecticut offers Jordana an assis- tant coaching position on its women’s basketball team. The offer states that it will expire thirty days from May 1. Jordana rejects the offer on May 12.

Can Jordana change her mind and accept the offer within what remains of the thirty days?  Jordana can change her mind, but she _______________ accept the school’s offer. An offer is terminated when, within its terms, the _______________ rejects it. An attempt to accept an offer after its termination is not an accep- tance, but a new _______________ to enter into a contract.

6. Nintendo of America, Inc. contacts Play 2 Win Games and offers to sell “one to twenty-five new gaming systems for $75 each. State number desired in acceptance.” Play 2 Win agrees to buy twenty systems. This is

a. a counteroffer. b. an enforceable contract. c. an invitation to negotiate. d. a revocable offer.

7. Garfield Company agrees to sell software to Holly from its website. To complete the deal, Holly clicks on a button that, with reference to certain terms, reads, “I agree.” The parties have

a. a binding contract that does not include the terms. b. a binding contract that includes only the terms to which Holly later agrees. c. a binding contract that includes the terms. d. no contract.

8. Icon Properties, Inc., makes an offer to Bob to sell a certain lot for $30,000, with the offer to stay open for thirty days. Bob would prefer to pay $25,000 if Icon would sell at that price. What should Bob reply to Icon to leave room for negotiation without rejecting the offer?

a. “I will not pay $30,000.” b. “Will you take $25,000?” c. “I will pay $25,000.” d. “I will pay $27,500.”

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121

Learning OutcOmes

The four Learning Outcomes below are designed to help improve your understanding of the chapter. After reading this chapter, you should be able to:

List the elements of consideration.

State the preexisting duty rule.

Name two ways to settle a legal claim.

Understand the concept of promissory estoppel.

1

2

3

4

10 Consideration

Just because a party has made a promise does not mean the promise is enforceable. In every legal system, there are promises that will be enforced and promises that will not be enforced. Under the common law, a primary basis for the enforcement of promises is consideration. This term is usually defined as the value (such as money) given in return for a promise (in a bilateral contract) or in return for a performance (in a unilateral contract).

10–1 elements of consideration Often, consideration is broken down into two elements: 1. Something of legally sufficient value must be given in exchange for the promise. 2. There must be a bargained-for exchange.

10–1a Legally Sufficient Value To be legally sufficient, consideration must be something of value in the eyes of the law. The “something of legally sufficient value” may consist of any of the following: 1. A promise to do something that one has no prior legal duty to do (to pay on

receipt of certain goods, for example). 2. The performance of an action that one is otherwise not obligated to

undertake (such as providing accounting services). 3. The refraining from an action that one has a legal right to undertake (called a

forbearance). Legal sufficiency is distinct from adequacy of consideration, which refers to

“how much” consideration is given. Essentially, adequacy of consideration con­ cerns the fairness of the bargain. In general, courts do not question the adequacy of consideration.

forbearance Refraining from an action that one has a legal right to undertake.

Learning OutcOme 1

List the elements of consideration.

consideration The value given in return for a promise or performance.

Conflict Presented Antonio says to his son, “If you will paint the garage, I will buy you a brand new iPhone.” Antonio’s son paints the garage. The act of painting the garage is the consideration that creates the

contractual obligation of Antonio to buy his son a new iPhone.

Q if, instead, antonio had said to his son, “in consideration of the fact that you are not as wealthy as your brothers, i will buy you a new iPhone,” would this promise have

been enforceable?

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U n i t 2 Contracts122

Highlighting the Point

On his sixteenth birthday, Kyle gets his driver’s license. Within six months, he receives three speeding tickets and rear-ends another car at a traffic stop. James, Kyle’s uncle, promises that he will pay Kyle $5,000 if Kyle refrains from driving until he reaches the age of eighteen. Kyle agrees. Six months after his eighteenth birth- day, Kyle e-mails his uncle to let him know that he has not driven a car for the past two years, fulfilling his end of their agreement. They agree that James will invest the $5,000 for Kyle.

When James dies unexpectedly three years later, the executor of James’s estate refuses to pay Kyle the $5,000. The executor contends that the contract is invalid. He argues that there is no consideration because James received nothing of value from Kyle, and Kyle is the only one who benefitted.

Does James and Kyle’s contract have consideration? Yes. On the strength of his uncle’s promise, Kyle stopped his poor driving habits. This performance is the consid- eration that makes the contract. On the faith of the agreement, Kyle refrained from doing something that he was otherwise entitled to do (a forbearance). The contract is enforceable, and the money belongs to Kyle.

10–1b Bargained-for Exchange The second element of consideration is that it must provide the basis for the bargain between the contracting parties. The item of value must be given or promised by the promisor (offeror). In return, the promisee must make a promise or perform.

Real Case

Floyd Case enrolled in an employer-sponsored educational program to become a maintenance technical electrical worker. Case and his employer, USS-POSCO Indus- tries (UPI) agreed that if he quit his job within thirty months of completing the pro- gram, he would reimburse UPI a portion of the program’s cost. Two months after completing the program, Case left UPI. When he refused to reimburse UPI for the cost of his education, the company filed a suit in a California state court against him for breach of contract. Case argued that the reimbursement agreement was unenforce- able, because it lacked consideration. The court granted UPI’s motion for summary judgment. Case appealed.

Did the reimbursement agreement meet the bargained-for exchange element and thus constitute consideration? Yes. In USS-POSCO Industries v. Case, a state intermediate appellate court agreed with the lower court’s judgment. The court reasoned that the bargained-for exchange was clear. Case received wages while furthering his profes- sional education, courtesy of UPI. In return, UPI requested repayment of those costs should Case leave the company before it benefitted from his new training.

—244 Cal.App.4th 197 (1 Dist., Div. 1)

Under the doctrine of freedom of contract, parties are usually free to bargain as they wish. If people could sue merely because they entered into an unwise contract, the courts would be overloaded with frivolous suits.

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C H A P T E R 1 0 Consideration 123

10–2 the Lack of consideration Sometimes, one of the parties (or both parties) to an agreement may think that consideration has been exchanged when, in fact, it has not. Situations in which agreements lack consideration include those involving preexisting duty, past con­ sideration, and illusory promises.

10–2a Preexisting Duty Under most circumstances, a promise to do what one already has a legal duty to do is not legally sufficient consideration, because no legal detriment or benefit has been incurred. This is the preexisting duty rule. The duty may be imposed by law or may arise out of a previous contract.

For instance, a sheriff cannot collect a reward for information leading to the capture of a criminal if the sheriff already has a legal duty to capture the criminal. Thus, if a party is already bound by contract to perform a certain duty, that duty cannot serve as consideration for a second contract.

In the interest of fairness, the courts sometimes allow exceptions to the pre­ existing duty rule. These exceptions include unforeseen difficulties and rescission.

Unforeseen Difficulties A court may decide not to apply the preexisting duty rule when a party to a contract confronts extraordinary difficulties that were totally unforeseen at the time the contract was formed. ExamplE 10.1 Straight Edge Construction contracts with Jacob to build a house. Straight Edge runs into extraordinary difficulties—it finds an underground tank full of hazardous materials. Jacob then agrees to pay extra compensation to cover the cost of the clean­up. A court may enforce the agreement to pay more under these circumstances. j

If the difficulties are the types of risks ordinarily assumed in business, however, the court will likely assert the preexisting duty rule (and not enforce the agreement to pay more).

Rescission and New Contract The law recognizes that two parties can mutually agree to rescind their contract, at least to the extent that it is executory—that is, still to be performed. Rescission is defined as the unmaking of a contract so as to return the parties to the positions they occupied before the contract was made.

Sometimes, parties rescind a contract and make a new contract at the same time. When this occurs, it is often difficult to determine whether there was consid­ eration for the new contract or whether the parties had a preexisting duty under

Learning OutcOme 2

State the preexisting duty rule.

rescission A remedy whereby a contract is terminated and the parties are returned to the positions they had before the contract was made.

Highlighting the Point

Bowman, Inc., begins construction on a seven-story office building. After three months, Bowman demands an extra $75,000 payment on its contract. If the extra $75,000 is not paid, the company will stop working. Richard, the owner of the land, finding no one else to complete construction, agrees to the extra $75,000.

if richard later refuses to pay the extra $75,000, could Bowman successfully sue to enforce the agreement? No. The agreement is not enforceable, because it is not sup- ported by consideration. Bowman had a preexisting duty to complete the building under the original contract with Richard.

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U n i t 2 Contracts124

the previous contract. If a court finds there was a preexisting duty, then the new contract will be invalid because there was no consideration.

10–2b Past Consideration Promises made in return for actions or events that have already taken place are unenforceable. These promises lack consideration because the element of bar­ gained­for exchange is missing. In short, you can bargain for something to take place now or in the future, but not for something that has already taken place. Therefore, past consideration is no consideration.

Sometimes, an employer will ask an employee to sign a noncompete agreement. Under such an agreement, the employee agrees not to compete with the employer for a certain period after the employment relationship ends. When a current employee is required to sign a noncompete agreement, his or her employment is not sufficient consideration for the agreement because the individual is already employed. To be valid, the agreement requires new consideration.

10–2c Illusory Promises If the terms of the contract express such uncertainty of performance that the promi­ sor has not definitely promised to do anything, the promise is illusory. Such a promise is without consideration and unenforceable.

Option­to­cancel clauses in contracts for specified time periods sometimes pres­ ent problems in regard to consideration. ExamplE 10.2 Abe contracts to hire Chris for one year at $5,000 per month, reserving the right to cancel the contract at any time. Abe has not actually agreed to hire Chris, because Abe can cancel Chris’s employment without liability at any time and has not given up the possibility of hiring someone else. This contract is therefore illusory. j

Exhibit 10.1 presents some common situations in which there is a lack of consideration.

10–3 settlement of claims Businesspersons and others often enter into contracts to settle legal claims. An accord and satisfaction is one such agreement. A release is another. It is important to understand the nature of consideration given in these kinds of settlement agree­ ments, or contracts.

past consideration A past act that cannot be consideration for a later promise.

Learning OutcOme 3

Name two ways to settle a legal claim.

exhibit 10.1 Examples of Agreements That Lack Consideration

PAST CONSIDERATION When a person makes a promise in return for actions or events that have already taken place, there is no consideration.

Example: A real estate agent sold a friend’s house without charging a commission, and in return, the friend promises to give the agent $1,000. The friend’s promise is simply an intention to give a gift.

ILLUSORY PROMISES When a person expresses contract terms with such uncertainty that the terms are not de�nite, the promise is illusory.

Example: A storeowner promises a $500 bonus to each employee who works Christmas Day, as long as the owner feels that they did their jobs well. The owner’s promise is just a statement of something she may or may not do in the future.

PREEXISTING DUTY When a person already has a legal duty to perform an action, there is no legally su�cient consideration.

Example: A �re�ghter cannot receive a cash reward from a business owner for putting out a �re in a downtown commercial district. As a city employee, the �re�ghter had a duty to extinguish the �re.

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C H A P T E R 1 0 Consideration 125

10–3a Accord and Satisfaction In an accord and satisfaction, a debtor offers to pay, and a creditor accepts, a lesser amount than the creditor originally claimed was owed. The accord is the agreement. Satisfaction is the performance (usually payment) that takes place after the accord is reached.

A basic rule governing such agreements is that there can be no satisfaction unless there is first an accord. In addition, for accord and satisfaction to occur, the amount of the debt must be in dispute.

10–3b Release A release is an agreement in which one party gives up the right to pursue a legal claim against another party. The release bars any recovery other than that specified in its terms. Releases are generally binding if they are (1) given in good faith, (2) stated in a signed writing, and (3) accompanied by consideration.

accord and satisfaction Settling a claim by the debtor offering to pay less than the creditor claims to be owed.

release An agreement in which one party gives up the right to pursue a legal claim against another party.

Highlighting the Point

Serena is involved in an automobile accident caused by Raoul’s negligence. Raoul offers to give Serena $4,000 if she will release him from further liability resulting from the accident. Serena believes that this amount will cover her damages, so she agrees to the release. Later, Serena discovers that it will cost $5,000 to repair her car.

can serena collect the balance from raoul? The answer is normally no. Serena is lim- ited to the $4,000 specified in the release. Serena and Raoul agreed to the bargain, and sufficient consideration was present. The consideration was the legal detriment Serena suffered—by releasing Raoul from liability, Serena forfeited her right to sue to recover further damages.

10–4 Promissory estoppel Sometimes, individuals rely on promises, and such reliance may form a basis for contract rights and duties. Under the doctrine of promissory estoppel (also called detrimental reliance), a person who has reasonably relied on the promise of another can often obtain some measure of recovery. When this doctrine is applied, the promisor is estopped, or barred, from revoking the promise. For the doctrine of promissory estoppel to be applied, a number of elements are required: 1. There must be a clear and definite promise. 2. The promisee must justifiably rely on the promise. 3. The reliance normally must be of a substantial and definite character. 4. Justice will be better served by the enforcement of the promise.

ExamplE 10.3 Bailey, the owner of a local machine shop, employs six employ­ ees. As part of their employment, Bailey orally promises to pay each of them $2,000 per month for the remainder of their lives after they retire. Hernan­ dez, one of Bailey’s employees, retires. Hernandez receives the $2,000 monthly amount for two years, but after that, Bailey stops paying Hernandez. Under the doctrine of promissory estoppel, Hernandez can sue Bailey in an attempt to enforce Bailey’s promise. j

Learning OutcOme 4

Understand the concept of promissory estoppel.

promissory estoppel A doctrine used to enforce a promise when the promisee justifiably relied on it to his or her detriment.

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U n i t 2 Contracts126

Conflict Resolved In the Conflict Presented feature at the beginning of this chapter, Antonio said to his son, “If you will paint the garage, I will buy you a new iPhone.” Antonio’s son paints the garage. This act is the

consideration that creates Antonio’s obligation to buy the phone.

a If antonio had instead said to his son, “In consideration of the fact that you are not as wealthy as your brothers, I will buy you a new iphone,” would this promise

have been enforceable? No. Antonio’s son would not have given any consideration for

it. Antonio would simply have stated his motive for giving his son a new phone. Using

the word consideration in an agreement does not, alone, create consideration.

Learning OutcOme 1: List the elements of consideration. The two elements of consideration are (1) something of legally sufficient value given in exchange for a promise and (2) a bargained-for exchange.

Learning OutcOme 2: state the preexisting duty rule. A promise to do what already one has a legal duty to do is not legally sufficient consideration. This is because no new legal detriment or benefit has been incurred.

Learning OutcOme 3: name two ways to settle a legal claim. A businessperson can settle a legal claim through (1) an accord or satisfaction or (2) a release.

Learning OutcOme 4: understand the concept of promissory estoppel. Promissory estoppel is a doctrine that applies when (1) there is a clear and definite promise, (2) the promisee justifiably relies on the promise, (3) the reliance is of a substantial and definite character, and (4) justice is better served by enforcing the promise.

CHaPteR SummaRy—ConSideRation

iSSue SPotteRS Check your answers to the Issue Spotters against the answers provided in Appendix A at the end of this text.

1. In September, Sharon agrees to work for Cole Produc­ tions, Inc., at $500 a week for a year beginning January 1. In October, Sharon is offered the same work at $600 a week by Quintero Shows, Ltd. When Sharon tells Cole about the other offer, they tear up their contract and agree that Sharon will be paid $575. Is the new contract binding? Why or why not? (See The Lack of Consideration.)

2. Before Maria starts her first year of college, Fred prom­ ises to give her $5,000 when she graduates. She goes to college, borrowing and spending far more than $5,000. At the beginning of the spring semester of her senior year, she reminds Fred of the promise. Fred sends her a note that says, “I revoke the promise.” Is Fred’s promise binding? Explain. (See Promissory Estoppel.)

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C H A P T E R 1 0 Consideration 127

StRaigHt to tHe Point

1. What is “something of legally sufficient value”? (See Elements of Consideration.)

2. How can something be the basis of a bargain? (See Elements of Consideration.)

3. Identify two situations in which agreements lack consid­ eration. (See The Lack of Consideration.)

4. What is a release? (See Settlement of Claims.) 5. When might reliance form the basis for contract rights

and duties despite a lack of consideration? (See Promissory Estoppel.)

Real law

10–1. Bargained-for exchange. On Brenda Sniezek’s first day of work for the Kansas City Chiefs Football Club, she signed a document that compelled arbitration of any dis­ putes that she might have with the Chiefs. In the document, Sniezek promised that on the arbitrator’s decision, she would release the Chiefs from any related claims. Nowhere in the document did the Chiefs agree to do anything in return for Sniezek’s promise. Was there consideration for the arbitration provision? Explain. [Sniezek v. Kansas City Chiefs Football Club, 402 S.W.3d 580 (Mo.App. W.D. 2013)] (See Elements of Consideration.)

10–2. rescission. Farrokh and Scheherezade Sharabian­ lou agreed to buy a building owned by Berenstein Associ­ ates for $2 million. They deposited $115,000 toward the purchase. Before the deal closed, an environmental assess­ ment of the property indicated the presence of chemicals used in dry cleaning. This substantially reduced the prop­ erty’s value. Do the Sharabianlous have a good argument for the return of their deposit and rescission of the con­ tract? Explain. [Sharabianlou v. Karp, 181 Cal.App.4th 1133, 105 Cal.Rptr.3d 300 (1 Dist. 2010)] (See The Lack of Consideration.)

etHiCal QueStionS

10–3. Legally sufficient Value. Can a moral obligation sat­ isfy the requirements of consideration? Why or why not? (See Elements of Consideration.)

10–4. elements of consideration. Carmen White signed a lease with Sienna Ridge Apartments in San Antonio, Texas. The lease required White to reimburse Sienna Ridge for any damage to the apartment not caused by the land­ lord’s negligence or fault. After moving in, White received a new washer and dryer from her parents. She did not read the instruction manual before overloading the dryer with

bedding, including an unwashed pillow, which started a fire. Sienna Ridge filed a claim for the resulting damage with Philadelphia Indemnity Insurance Company. Philadelphia paid the claim and filed a suit in a Texas state court against White, alleging that she had breached the lease by failing to reimburse Sienna Ridge for the damage. White argued that the lease was unenforceable for lack of consideration. Is White correct? Is it unethical of her to resist payment? Discuss. [Philadelphia Indemnity Insurance Co. v. White, 2017 WL 32899 (Tex.App.—San Antonio 2017)] (See Ele- ments of Consideration.)

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129

Chapter 10—work Set

1. Ordinarily, courts evaluate the adequacy or fairness of consideration even if the consideration is legally sufficient.

2. A promise to do what one already has a legal duty to do is not legally sufficient consideration under most circumstances.

3. Promises made with consideration based on events that have already taken place are fully enforceable.

4. Rescission is the unmaking of a contract so as to return the parties to the positions they occupied before the contract was made.

5. A promise has no legal value as consideration.

6. A release is an agreement in which one party gives up the right to pursue a legal claim against another party.

7. Consideration is the value given in return for a promise.

8. Promissory estoppel may prevent a party from using lack of consideration as a defense.

9. The doctrine of promissory estoppel requires a clear and definite promise.

tRue-FalSe QueStionS

1. Dwight offers to buy a book owned by Lee for $40. Lee accepts and hands the book to Dwight. The transfer and delivery of the book constitute performance. Is this performance consideration for Dwight’s promise?

a. Yes, because performance always constitutes consideration. b. Yes, because Dwight sought it in exchange for his promise, and Lee gave it in exchange for that promise. c. No, because performance never constitutes consideration. d. No, because Lee already had a duty to hand the book to Dwight.

2. Max agrees to supervise a construction project for Al for a certain fee. In midproject, without an excuse, Max removes the plans from the site and refuses to continue. Al promises to increase Max’s fee. Max returns to work. Is going back to work consideration for the promise to increase the fee?

a. Yes, because performance always constitutes consideration. b. Yes, because Al sought it in exchange for his promise. c. No, because performance never constitutes consideration. d. No, because Max already had a duty to supervise the project.

3. Shannon contracts with Dan to build two houses on two lots. After the first house is finished, they decide to build a garage instead of a house on the second lot. Under these circumstances,

a. they must build the second house—a contract must be fully performed. b. they can rescind their contract and make a new contract to build a garage. c. the contract to build two houses is illusory. d. none of the above is true.

4. Ed has a cause to sue Mary in a tort action but agrees not to sue her if she will pay for the damage. If she fails to pay, Ed can bring an action against her for breach of contract. This is an example of

a. promissory estoppel. b. a release. c. a bargained­for exchange. d. an unenforceable contract.

multiPle-CHoiCe QueStionS

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130

5. John’s car is hit by Ben’s truck. A doctor tells John that he will be disabled only temporarily. Ben’s insurance company offers John $5,000 to settle his claim. John accepts and signs a release. Later, John learns that he is permanently disabled. John sues Ben and the insurance company. John will

a. win, because John did not know when he signed the release that the disability was permanent. b. win, because Ben caused the accident. c. lose, because John signed a written release—no fraud was involved, and consideration was given. d. do none of the above.

6. Mike promises that next year he will sell Kim a certain house. Meanwhile, he allows her to live in the house. Kim completely renovates the house, repairs the heating system, and entirely landscapes the property. The next year, Mike tells Kim he’s decided to keep the house. Who is entitled to the house?

a. Kim, under the doctrine of promissory estoppel. b. Kim, because Mike’s decision to keep the house is an unforeseen difficulty. c. Mike, because his promise to sell Kim the house was illusory. d. Mike, because he initially stated only his intention to sell.

7. Deb owes Jim $5,500. In need of the money, Jim threatens to foreclose on the debt. Deb offers to pay $5,000 imme­ diately to settle Jim’s claim. Jim agrees. This is

a. promissory estoppel. b. a release. c. an accord and satisfaction. d. an unenforceable contract.

8. Green Energy Company files a suit against First Bank, claiming that the consideration for a contract between them was inadequate. The court likely will not evaluate the adequacy of consideration unless it is

a. somewhat unbalanced. b. grossly inadequate. c. legally sufficient. d. willfully unfair.

anSweRing moRe legal PRoBlemS

1. RiotGear contracts with Standard Transit, Inc., to dis­ tribute RiotGear’s “Occupy Earth/Global Movement” line of apparel to retail outlets for a certain price. With the goods in transit, RiotGear receives this tweet from Standard: “Price increase of 99 percent or no delivery.” RiotGear agrees and pays, but later sues Standard for the increase over the original price.

Is RiotGear entitled to the difference in price? Yes. Under the _______________ _______________ rule, if a party is already bound by contract to perform a certain duty, that duty cannot serve as _______________ for a second contract. A party to a contract is not bound to a modification of the contract unless there is additional consideration for the change. In this set of facts, there is no new consideration, so RiotGear’s agreement to the change is _______________ _______________.

2. RiotGear promises to donate a share of the proceeds from the sale of the “Occupy Earth/Global Movement”

line to The Cause, a charitable organization dedicated to supporting those who seek social and economic change through protest. In reliance on the expected donation, The Cause contracts for medical and other supplies. When Standard increases the distribution cost, RiotGear tells The Cause that there will be no donation.

Can The Cause enforce RiotGear’s original promise despite the lack of consideration? Yes. Under the doc­ trine of _______________ _______________, a party who makes a promise can be estopped from revoking it. For the doctrine to be applied, (1) there must be a _______________, (2) the promisee must reasonably rely on it, (3) the reliance must be substantial and definite, and (4) justice must be better served by the enforce­ ment of the _______________. It is reasonable to expect that a charitable organization will incur obligations in reliance on a _______________ of a donation. Failing to enforce it would be unjust.

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131

Learning OutcOmes

The four Learning Outcomes below are designed to help improve your understanding of the chapter. After reading this chapter, you should be able to:

Understand a minor’s right to disaffirm a contract.

Identify obligations that minors cannot avoid.

Explain how intoxication can affect a contract.

Discuss how mental incompetence can affect a contract.

1

2

3

4

11 Capacity

The first two requirements for a valid contract are agreement and consideration. The third requirement is contractual capacity—the legal ability to enter into a contractual relationship.

Courts generally presume the existence of contractual capacity. In some situa- tions, however, capacity is lacking or questionable. For instance, a person adjudged by a court to be mentally incompetent cannot form a legally binding contract with another party. In other situations, a party may have the capacity to enter into a valid contract but also have the right to avoid liability under it.

In this chapter, we look at the effects of youth, intoxication, and mental incom- petence on contractual capacity.

11–1 minors Minors—or infants, as they are commonly referred to in the law—usually are not legally bound by contracts. In most states, the age of majority for contractual purposes is eighteen years. Thus, in these states, after someone turns eighteen, he or she is no longer considered a minor. Some states provide for the termination of minority when a minor gets married. Minority status may also be terminated by a minor’s emancipation from his or her parents (discussed shortly).

The general rule is that a minor can enter into any contract an adult can, provided that the contract is not one prohibited by law for minors. ExamplE 11.1 Jamie, who is a freshman in high school, cannot enter into a contract with a local winery to buy a case of white wine. It is against the law for minors to buy alcoholic beverages. j

Subject to certain exceptions, however, the contracts entered into by a minor are voidable (nullified) at the option of that minor. The minor can ratify (accept) the contract and thus make it enforceable. Or a minor can disaffirm (avoid) the contract and set aside all legal obligations.

age of majority The age when a person is no longer a minor.

contractual capacity The legal ability to enter into a contractual relationship.

Conflict Presented Sierra, a sixteen-year-old minor, applies for a job at Fast Burgers. As part of her pre-employment paperwork, her employer requests that she sign an agreement to resolve any future dispute through

arbitration. She signs and begins work. Later, Sierra is injured on the job and quits. Her mother, Marissa, files a lawsuit on Sierra’s behalf against Fast Burgers to recover for the injury. To avoid the lawsuit, Fast Burgers files a motion to compel arbitration.

Q can sierra avoid the agreement to arbitrate?

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U n i t 2 Contracts132

11–1a Disaffirmance Disaffirmance is the legal avoidance, or setting aside, of a contractual obligation. Public policy permits minors to disaffirm, and thereby void, their contracts. It is also a well-settled principle that a court should act to protect a minor’s best inter- ests. This includes financial interests.

For a minor to exercise the option to disaffirm a contract, he or she need only show an intention not to be bound by it. Words or conduct may serve to show this intent.

Disaffirmance within a Reasonable Time A minor can ordinarily disaffirm a contract at any time during minority or for a reasonable time after coming of age. It is important that disaffirmance be timely.

A Minor’s Obligations on Disaffirmance All states’ laws permit minors to disaffirm contracts, including fully executed (performed) contracts. States differ, though, on the extent of a minor’s obligations after disaffirmance. In most states, courts hold that the minor need only return the goods (or other consideration) subject to the contract, provided the goods are in the minor’s possession or control.

disaffirmance The repudiation (avoidance) of a contractual obligation.

Learning OutcOme 1

Understand a minor’s right to disaffirm a contract.

Highlighting the Point

Jared, a minor, is a motocross competitor. At Monster Mountain MX Park, he signs a waiver of liability that releases the park from any loss or injury due to its negligence. While riding on the mountain track, Jared goes over a blind jump and crashes into a tractor, which has been left on the track by a park employee. To recover damages for his injuries, he files a lawsuit against Monster Mountain, alleging negligence for its failure to remove the tractor from the track.

Does the park’s liability waiver bar Jared’s claim to sue for negligence? No. Contracts entered into by minors are voidable at their option. Thus, Jared has the choice of dis- affirming (avoiding) the waiver contract and setting aside all legal obligations arising from it. To disaffirm the waiver contract, Jared need only demonstrate an intention not to be bound by it. Jared’s lawsuit against Monster Mountain clearly shows his intent to disaffirm the waiver.

Highlighting the Point

Darlo’s great-grandmother dies and leaves him a small rental house. As a minor, Darlo is not prepared to manage the property, so he agrees to let his grandmother do so on his behalf. Five years after reaching his majority, Darlo sells the house. His grand- mother asks to be reimbursed for funds she has spent to maintain the property. Darlo refuses.

can Darlo disaffirm the management agreement with his grandmother? No. A minor is bound by his or her contracts unless they are disaffirmed within a reasonable time after the minor reaches majority. What constitutes a reasonable time depends on the circumstances. Here, Darlo’s disaffirmance takes place five years after he reaches majority. It has not occurred within a reasonable time. A court will likely hold that the contract with his grandmother has been ratified.

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C H A P T E R 1 1 Capacity 133

A few states place an additional duty on the minor—the duty of restitution. In these states, courts may hold a minor responsible for damage, ordinary wear and tear, and depreciation of goods that the minor used before disaffirming a contract. This duty of restitution recognizes the legitimate interests of those who enter into agreements with minors. The theory is that the adult party should be returned to the position he or she held before the contract was made with the minor. If a minor disaffirms a contract, he or she must disaffirm the entire contract. The minor cannot decide to keep part of the contracted goods and return the rest.

Certain exceptions apply to a minor’s obligations on disaffirmance. These are discussed next.

Disaffirmance and Misrepresentation of Age Ordinarily, minors can disaffirm contracts even when they have misrepresented their age. ExamplE 11.2 Erica applies for a job at Pacific Jewelry. She tells Kirk, the owner, that she is twenty-one years old. In reality, she is seventeen years old and a senior in high school. Kirk hires her to work evenings. If an employment dispute arises between Kirk and Erica, Erica can disaffirm any legal obligation she has under the contract. j

A growing number of states, however, have enacted laws to prohibit a minor’s disaffirmance in certain situations. In short, the right to disaffirm a contract is to protect minors. If, instead, a minor uses the right to disaffirm for unfair personal gain, then that protection may be dismissed in certain states.

Disaffirmance and Necessaries A minor who enters into a contract for necessaries may disaffirm the contract but remains liable for the reasonable value of the goods. Necessaries include whatever is reasonably needed to maintain the minor’s standard of living. In general, food, clothing, shelter, and medical services are necessaries. What is a necessary for one minor, however, may be a luxury for another, depending on the minors’ customary living standard.

Disaffirmance and Business Contracts In many states, certain business contracts entered into by minors cannot be disaffirmed. In those states, if a minor does business or engages in employment in the manner of an adult, his or her related contracts are fully enforceable.

ExamplE 11.3 Miguel is seventeen years old and a gifted computer science stu- dent. While in high school, he creates a new app called “Taking Care of Business.” The app links personal to-do lists, maps, building directories, and other useful data to connected social media and contact networks. Using attorneys to negotiate a sales agreement, Miguel sells the app to Wilson Tech. Later, another large corpora- tion offers Miguel a better price, but he cannot disaffirm his agreement with Wilson

restitution A remedy that restores a person to the position held before a contract.

necessaries Necessities required for a standard of living, such as food and shelter.

Learning OutcOme 2

Identify obligations that minors cannot avoid.

Highlighting the Point

Jennifer, a minor, contracts to purchase a new car from Haydocy Pontiac. She tells the salesperson that she is twenty-one. Jennifer finances most of the purchase price. Immediately following delivery of the car, she turns it over to her boyfriend and thereafter never has possession. She makes no further payments on the contract and attempts to disaffirm the contract. She makes no offer to return the car. Haydocy sues Jennifer for the balance owed.

can Haydocy recover the balance, given the fact that Jennifer is a minor who mis- represented her age? Yes. If Jennifer lives in a state that prohibits disaffirmance by minors who misrepresent their age for unfair personal gain, Haydocy can attempt to recover the remaining balance of the contract. Jennifer’s misrepresentation of her age in this instance was done to intentionally benefit herself and her boyfriend.

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U n i t 2 Contracts134

Tech. Miguel has done business in the manner of an adult, and in his state, that means his contract cannot be disaffirmed. j

11–1b Ratification In contract law, ratification is the act of accepting and giving legal force to an obliga- tion that previously was not enforceable. A minor who has reached the age of major- ity can ratify a contract expressly or impliedly. Express ratification occurs when the individual, on reaching the age of majority, states orally or in writing that she or he intends to be bound by the contract. Implied ratification takes place when the minor, on reaching the age of majority, indicates an intent to abide by the contract.

11–1c Parents’ Liability As a general rule, parents are not liable for contracts made by their minor children when the children are acting on their own. That is why businesses ordinarily require parents to sign any contract made with a minor. The parents then become person- ally obligated under the contract to perform the conditions of the contract, even if their child avoids liability.

See the Linking Business Law to Your Career feature at the end of this chapter.

11–1d Emancipation The release of a minor by his or her parents is known as emancipation. Emancipa- tion involves completely relinquishing the right to the minor’s control, care, cus- tody, and earnings. It is a repudiation of parental obligations. Emancipation may be express or implied, absolute or conditional, total or partial. A number of juris- dictions permit minors to petition for emancipation themselves.

In addition, a minor may petition a court to be treated as an adult for business purposes. If the court grants the minor’s request, it removes the lack of contractual capacity, and the minor no longer has the right to disaffirm business contracts.

11–2 intoxicated Persons A contract entered into by an intoxicated person can be either voidable or valid. If the person was sufficiently intoxicated to lack mental capacity, the transaction is voidable at the option of the intoxicated person, even if the intoxication was purely voluntary. For the contract to be voidable, it must be proved that the intoxicated

ratification Accepting and giving legal force to an obligation that previously was not enforceable.

emancipation The release of a minor from parental control.

Learning OutcOme 3

Explain how intoxication can affect a contract.

Highlighting the Point

Lindsay posts an ad on Craigslist offering to sell her grandmother’s Yamaha Grand Piano for $6,000. Axel, who is seventeen years old, agrees to purchase the piano by making monthly payments of $200 over the next two and a half years. Axel does not disaffirm the contract, and six months into the agreement, he turns eighteen (the age of majority in his state). When Axel stops by Lindsay’s house to make his seventh pay- ment, he states, “I love the piano and will continue making payments.”

Has axel expressly ratified the contract with Lindsay? Yes. His oral statement to Lindsay to continue making payments on the piano is an express ratification of their contract. He can no longer disaffirm it. If Axel never expressly tells Lindsay he will continue making payments but continues to do so well after reaching the age of majority, he has implied the contract’s ratification.

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C H A P T E R 1 1 Capacity 135

person’s reason and judgment were impaired to the extent that he or she did not comprehend the legal consequences of entering into the contract. If the person was intoxicated but understood these legal consequences, the contract is enforceable. Under any circumstances, an intoxicated person is liable for the reasonable value of any necessaries he or she receives.

Problems often arise in determining whether a party was sufficiently intoxi- cated to avoid legal duties. Many courts prefer looking at factors other than the intoxicated party’s mental state (for example, whether the other party fraudulently induced the person to become intoxicated).

ExamplE 11.4 Bill offers to buy Portside Warehouse, a prime commercial prop- erty, from Nick. Nick refuses to sell. Bill encourages Nick to quickly down a couple of strong alcoholic drinks “to celebrate your resolve.” Bill then persuades Nick to sell the property. If a court finds that Bill fraudulently induced Nick to become intoxicated, and that Nick was sufficiently intoxicated to lack mental capacity, Nick can avoid the sale. j

11–3 mentally incompetent Persons Contracts made by mentally incompetent persons can be void, voidable, or valid.

11–3a When a Contract Is Void If a person has been adjudged mentally incompetent by a court of law and a guard- ian has been appointed, any contract made by the mentally incompetent person is void—no contract exists. Only the guardian can enter into a binding legal duty on the person’s behalf.

ExamplE 11.5 Delilah has a rare form of amnesia as a result of a head injury suf- fered in a car accident ten years ago. Ronald is her legal guardian. When Lisa offers to buy Delilah’s house for a good price, Delilah agrees and signs the sales contract. This contract is void due to Delilah’s amnesia. Lisa, however, could create a valid contract with Ronald to buy Delilah’s house, if Ronald agrees. j

11–3b When a Contract Is Voidable The situation is somewhat different when mentally incompetent persons who have not been adjudged incompetent by a court enter into contracts. Such contracts are voidable if the incompetent persons did not know they were entering into the contracts or they lacked the mental capacity to comprehend the contracts’ subject matter, nature, and consequences. In such situations, the contracts are voidable at the option of the mentally incompetent person but not the other party.

Learning OutcOme 4

Discuss how mental incompetence can affect a contract.

Real Case

Annabelle Duffie was mildly mentally retarded and, at age seventy, had the begin- ning of dementia. For her entire life, she had lived with her brother, Jerome. When Jerome died, he left Annabelle his property, including 180 acres of timberland near Hope, Arkansas, valued at more than $400,000. Less than three months later, Annabelle signed a deed granting her interest in the tract to Charles and Joanne Black. The Blacks agreed to pay Annabelle $150,000 in monthly payments of $1,000. Later, Annabelle’s nephew, Jack, was appointed to be her legal guardian. On her behalf, Jack filed a lawsuit

(Continues)

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U n i t 2 Contracts136

As with minors, voidable contracts made by mentally incompetent persons may be disaffirmed or ratified. Ratification must occur after the person is mentally com- petent or after a guardian is appointed and ratifies the contract. Like intoxicated persons, mentally incompetent persons are liable for the reasonable value of any necessaries they receive.

11–3c When a Contract Is Valid A contract entered into by a mentally incompetent person may also be valid. A person can understand the nature and effect of entering into a certain contract yet simultaneously lack capacity to engage in other activities. In such situations, the contract is valid because the person is not legally mentally incompetent for contractual purposes.

in an Arkansas state court against the Blacks, seeking to void the land deal because of Annabelle’s lack of mental competence. The court ordered the Blacks to return the property to Annabelle. They appealed.

Was the contract between annabelle and the Blacks voidable because of mental incom- petence? Yes. In Black v. Duffie, a state intermediate appellate court cited strong evi- dence that Annabelle had been incompetent her entire life. She lacked the cognitive ability to make the complex financial decisions involved in selling property. She was therefore not capable of entering into a valid, enforceable contract, and the contract was voidable.

—2016 Ark.App. 584

Highlighting the Point

Rhonda is diagnosed with manic depression, but a court has not declared her mentally incompetent. One afternoon, wearing shabby clothes and with her hair uncombed, she arrives at Classic Automotive. After two hours of negotiations, she trades in her Honda Civic and signs a lease for a BMW. She does not test-drive the new car, she has difficulty removing the Civic’s keys from her key ring, and the pay- ments on the BMW are more than she can afford.

can rhonda disaffirm the lease agreement because of mental incompetence? No. A party cannot avoid a contract on the ground of mental incompetence unless at the time of the contract’s execution, the person did not reasonably understand the nature and terms of the contract. In this situation, nothing—including Rhonda’s disheveled appearance, her difficulty with the keys, her failure to test-drive the car, or its price—indicates that she did not understand she was executing an auto lease. After all, she negotiated more than two hours with Classic Automotive.

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C H A P T E R 1 1 Capacity 137

Conflict Resolved In the Conflict Presented feature at the beginning of this chapter, Sierra, a sixteen-year-old minor, is hired by Fast Burgers. At the employer’s request, Sierra signs an agreement to resolve any

dispute through arbitration. Sierra is injured on the job and quits. Her mother files a lawsuit against Fast Burgers on Sierra’s behalf to recover for the injury. The employer files a motion to compel arbitration.

a Can Sierra avoid the agreement to arbitrate? Yes. A minor can disaffirm a contract at his or her option. Sierra opted to disaffirm the agreement to arbitrate by quitting her

job and filing a lawsuit against Fast Burgers.

Linking Business Law to Your Career

ContraCts with Minors or intoxiCated Persons

Some of you have been or will be involved in retail careers at the man- agerial level. Sometimes, sales per- sonnel must deal with minors or intoxicated persons, both of whom have limited contractual capacity. As a sales manager, you should introduce your employees to the law governing contracts with minors and intoxicated persons.

contracts with minors

If your business involves selling consumer durables, such as appli- ances, furniture, or automobiles, your employees must be careful in forming contracts with minors. The employ- ees should heed the adage “When in doubt, check.” Remember that a con- tract signed by a minor (unless it is for

necessaries) normally is voidable by the minor. Employees should demand proof of legal age when they have any doubt about whether a customer is a minor. If the customer is a minor, employees should insist that an adult (such as a parent) be the purchaser or at least the co-signer on any sales contract.

Because the law governing minors’ rights varies from state to state, you should check with an attorney con- cerning the laws governing disaffir- mance in your state. You should know, for instance, what the consequences are if a minor disaffirms a sale or mis- represents his or her age in forming a sales contract. Similarly, you need to find out whether a minor, on disaf- firming a contract, can be required to

pay for damage to goods sold under the contract.

contracts with intoxicated Persons

Little need be said about a salesper- son’s dealings with obviously intoxi- cated persons. If the customer, despite intoxication, understands the legal con- sequences of the contract being signed, the contract is enforceable.

Nonetheless, it may be extremely difficult to establish that the intoxi- cated customer understood the conse- quences of entering into the contract if the customer claims that she or he did not understand it. Therefore, the best advice is “When in doubt, don’t do it.” In other words, if you suspect that a cus- tomer may be intoxicated, do not sign a contract with him or her.

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U n i t 2 Contracts138

Issue sPotteRs Check your answers to the Issue Spotters against the answers provided in Appendix A at the end of this text.

1. Joan, who is sixteen years old, moves out of her parents’ home and signs a one-year lease for an apartment at Kenwood Apartments. Joan’s parents tell her that she can return to live with them at any time. Unable to pay the rent, Joan moves to her parents’ home two months

later. Can Kenwood enforce the lease against Joan? Why or why not? (see Minors.)

2. Cedric, a minor, enters into a contract with Diane. How might Cedric effectively ratify this contract? (see Minors.)

stRaIgHt to tHe PoInt

1. Can a minor enter into any contract that an adult can? (see Minors.)

2. Are minors legally bound to every contract that they enter into? (see Minors.)

3. When a contract has been fully executed, what must a minor do to disaffirm it? (see Minors.)

4. How does ratification affect the right of minors to avoid their contracts? (see Minors.)

5. In what circumstance can an intoxicated person avoid a contract even if the intoxication was purely voluntary? (see Intoxicated Persons.)

6. How does ratification affect the right of mentally incom- petent persons to avoid their contracts? (see Mentally Incompetent Persons.)

Learning OutcOme 1: understand a minor’s right to disaffirm a contract. Contracts with minors are voidable at the option of the minor. Disaffirmance can take place (in most states) at any time during minority and within a reasonable time after the minor has reached the age of majority. If a minor disaffirms a contract, the entire contract must be disaffirmed. When disaffirming an executed contract, the minor has a duty of restitution to return the received goods if they are still in the minor’s control and (in some states) to pay for any damage to the goods.

Learning OutcOme 2: identify obligations that minors cannot avoid. A minor who has misrepresented her or his age will be denied the right to disaffirm by some courts. A minor may disaffirm a contract for necessaries but remains liable for the reasonable value of the goods. In some states, if a minor does business or engages in employment in the manner of an adult, his or her related contracts are fully enforceable.

Learning OutcOme 3: explain how intoxication can affect a contract. A contract entered into by an intoxicated person is voidable at the option of the intoxicated person if the person was sufficiently intoxicated to lack mental capacity, even if the intoxication was voluntary. A contract with an intoxicated person is enforceable if, despite being intoxicated, the person understood the legal consequences of entering into the contract.

Learning OutcOme 4: Discuss how mental incompetence can affect a contract. A contract made by a person adjudged by a court to be mentally incompetent is void. A contract made by a mentally incompetent person not adjudged by a court to be mentally incompetent is voidable at the option of the mentally incompetent person. A contract made by a mentally incompetent person who nevertheless understands the nature and effect of entering into the contract is valid.

CHaPteR summaRY—CaPaCItY

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C H A P T E R 1 1 Capacity 139

ReaL Law

11–1. minors. Bonney McWilliam’s father deeded a house in Norfolk County, Massachusetts, to Bonney and her daugh- ter, Mechelle. Each owned a one-half interest. Described as “an emotionally troubled teenager,” Mechelle had a history of substance abuse and a fractured relationship with her mother. At age sixteen, in the presence of her mother and her mother’s attorney, Mechelle signed a deed transferring her interest in the house to Bonney. Later, still at odds with her mother, Mechelle learned that she did not have a right to enter the house to retrieve her belongings. Bonney claimed sole ownership. Mechelle filed a lawsuit in a Massachusetts state court against her mother to declare the deed void. Could the transfer of Mechelle’s interest be disaffirmed? Explain. [McWilliam v. McWilliam, 46 N.E.3d 598 (Mass. App.Ct. 2016)] (see Minors.)

11–2. mental incompetence. William Zurenda was disabled by post-traumatic stress disorder (PTSD), but had not been adjudged mentally incompetent. During divorce proceed- ings, he agreed to pay his spouse $5,000 within six months.

The settlement was read aloud in court, and the judge asked William if he understood that the settlement was binding. He answered that he did. Later, he argued that he should not have to pay the $5,000, because the stress of the divorce had made his PTSD worse. Is the settlement void on the basis of mental incompetence? Explain. [Zurenda v. Zurenda, 85 A.D.3d 1283, 925 N.Y.S.2d 221 (3 Dept. 2011)] (see Mentally Incompetent Persons.)

11–3. mental incompetence. Dorothy Drury suffered from dementia and chronic confusion. When she became unable to manage her own affairs, including decisions about medi- cal and financial matters, her son arranged for her to move into an assisted-living facility. During admission, she signed a residency agreement, which included an arbitration clause. After she sustained injuries in a fall at the facility, a suit was filed to recover damages. The facility asked the court to compel arbitration. Was Dorothy bound to the residency agreement? Discuss. [Drury v. Assisted Living Concepts, Inc., 245 Or.App. 217, 262 P.3d 1162 (2011)] (see Mentally Incompetent Persons.)

etHICaL QuestIons

11–4. minors. Should the goal of protecting minors from the consequences of unwise contracts ever outweigh the goal of encouraging minors to behave in a responsible man- ner? Discuss. (see Minors.)

11–5. minors. Sky High Sports Nashville Operations, LLC, operated a trampoline park in Nashville, Tennessee. Dur- ing a dodgeball tournament at Sky High, Jacob Blackwell, a minor, suffered a torn tendon and a broken tibia. His mother, Crystal, filed a lawsuit on his behalf in a Tennessee state

court against Sky High. She alleged negligence and sought $500,000 to cover Jacob’s medical and other expenses. Sky High asserted that the claim was barred by a waiver of liabil- ity in a contract between the parties, which the defendant asked the court to enforce. The waiver released Sky High from liability for any “negligent acts or omissions.” What might Sky High argue as a reason for enforcing the waiver? Would it be unethical to allow Jacob to recover? Discuss. [Blackwell v. Sky High Sports Nashville Operations, LLC, __ S.W.3d __, 2017 WL 83182 (Tenn.App. 2017)] (see Minors.)

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141

1. When a person reaches the age of majority, he or she can no longer disaffirm a contract.

2. When a minor disaffirms a contract, whatever the minor transferred as consideration (or its value) normally must be returned.

3. A person who is so intoxicated as to lack mental capacity when he or she enters into a contract must per- form the contract.

4. Emancipation has no effect on a minor’s contractual capacity.

5. If an individual who has not been judged mentally incompetent understands the nature and effect of enter- ing into a certain contract, the contract is normally valid.

6. In many states, certain business contracts entered into by minors cannot be disaffirmed.

7. Some states’ statutes restrict minors from avoiding certain contracts, including for necessaries.

8. Generally, parents are liable for contracts made by their minor children.

9. In most cases, a person, to disaffirm a contract entered into when he or she was intoxicated, must return any consideration received.

tRue-FaLse QuestIons

Chapter 11—work set

1. Troy, a minor, sells his collection of sports memorabilia to Vern for $250. On his eighteenth birthday, Troy learns that the collection may have been worth at least $2,500. Troy

a. can disaffirm, because the contract has not been fully performed. b. can disaffirm, if he does so within a reasonable time after attaining majority. c. cannot disaffirm, because he has already attained majority. d. cannot disaffirm, because the contract has been fully performed.

2. Doug has been drinking heavily. Joe offers to buy Doug’s farm for a fair price. Believing the deal is a joke, Doug writes and signs an agreement to sell and gives it to Joe. Joe believes the deal is serious. The contract is

a. enforceable, if the circumstances indicate that Doug understands what he did. b. enforceable, because Joe believes that the transaction is serious. c. unenforceable, because the intoxication permits Doug to avoid the contract. d. unenforceable, because Doug thinks it is a joke.

3. Ed is adjudged mentally incompetent. Irwin is appointed to act as Ed’s guardian. Irwin signs a contract to sell some of Ed’s property to pay for Ed’s care. On regaining competency, Ed

a. can disaffirm, because he was mentally incompetent. b. can disaffirm, because he is no longer mentally incompetent. c. cannot disaffirm, because Irwin could enter into contracts on his behalf. d. cannot disaffirm, because he may become mentally incompetent again.

4. Adam, a sixteen-year-old minor, enters into a contract for necessaries, which his parents could provide but do not. Adam disaffirms the contract. Adam’s parents

a. must pay the reasonable value of the goods. b. must pay more than the reasonable value of the goods. c. can pay less than the reasonable value of the goods. d. do not have to pay anything for the goods.

muLtIPLe-CHoICe QuestIons

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142

5. First Bank loans money to Patty, a sixteen-year-old minor. Patty must repay the loan

a. if the loan is made for the express purpose of buying necessaries. b. if First Bank makes sure the money is spent on necessaries. c. if both a and b are true. d. in none of the above circumstances.

6. Eve, a fifteen-year-old minor, buys a smartphone app from EZ Spyware. The contract is fully executed. Eve now wants to disaffirm it. In most states, Eve

a. must return only the app to EZ. b. must return the smartphone with the app to EZ. c. must return just the smartphone to EZ. d. need do none of the above.

7. Neal is adjudged mentally incompetent, and a guardian is appointed. Neal later signs an investment contract with Mary. This contract is

a. valid. b. voidable. c. void. d. none of the above.

8. Jeff, a fifteen-year-old minor, contracts with Online, Inc., for Internet access services. Considering that Jeff is a minor, which of the following is true?

a. Online can disaffirm the contract. b. Jeff can disaffirm the contract. c. Both a and b are true. d. None of the above are true.

answeRIng moRe LegaL PRoBLems

1. After sipping half a glass of wine at a meeting with Vineyard Valley Adventures, Esmé buys a discounted tour package. The time of the trip is approaching, and Vineyard’s costs to provide the package have doubled. Vineyard tries to avoid honoring the agreement with Esmé on the ground that she was intoxicated when the agreement was made.

Can Vineyard avoid the contract on the basis of esmé’s lack of capacity? No. A contract entered into by an intoxicated person is _______________ if the person was sufficiently intoxicated to lack mental capacity. But the transaction is _______________ only at the option of the _______________ person. Furthermore, if the person was intoxicated but understood the legal consequences, the contract is enforceable. Vineyard cannot avoid the contract.

2. Lucrezia is diagnosed with chronic, severe schizoaf- fective psychosis. Experiencing hallucinations, she

is hospitalized in a psychiatric ward and placed on medication. On a furlough a month later, she signs an agreement at the insistence of her spouse, Cesare. The agreement states that Cesare has exclusive rights to all of their finances and property, and Lucrezia has the sole duty to pay all of their debts. Cesare files for divorce.

Can Lucrezia avoid this agreement? Yes. When a men- tally incompetent person not previously so adjudged by a court enters into a contract, the contract is _______________ if he or she lacks the capacity to com- prehend its subject matter, nature, and consequences at the time of the _______________. At the time of this agreement, Lucrezia had been diagnosed with schizoaf- fective psychosis. She was experiencing hallucinations, and she was on medication. Based on these facts, she lacked the mental capacity to manage her own affairs and to make decisions in her own best interest.

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143

Learning OutcOmes

The four Learning Outcomes below are designed to help improve your understanding of the chapter. After reading this chapter, you should be able to:

Identify contracts contrary to statute.

Describe an enforceable covenant not to compete.

Identify contracts contrary to public policy.

Explain the consequences of an illegal agreement.

1

2

3

4

12 The Legality of Agreements

Up to this point, we have discussed three of the requirements for a valid contract to exist—agreement (offer and acceptance), consideration, and contractual capacity. Legality is the fourth requirement.

For a contract to be valid and enforceable, it must be formed for a legal purpose. A contract to do something that is prohibited by federal or state statu- tory law is illegal. As such, it is void from the outset and thus unenforceable. Also, a contract that calls for an action contrary to public policy is illegal and unenforceable.

12–1 contracts contrary to statute Statutes often set forth rules affecting the terms of contracts. Statutes may specify clauses that must be included in certain contracts, for instance, or may prohibit certain contracts based on their subject matter.

In this section, we examine several ways in which contracts may be contrary to statute and thus illegal.

12–1a Contracts to Commit a Crime Any contract to commit a crime is contrary to statute and unenforceable. ExamplE 12.1 Lawrence Industrial Works contracts with Dusty’s Transportation to take its industrial waste to a local landfill. The waste is considered hazardous, and federal environmental laws require that it be disposed of at a special facility in another city. This contract’s purpose violates federal law. As a result, the contract is void and unenforceable from the outset. j

Sometimes, the object or performance of a contract is rendered illegal by a stat- ute after the parties have already entered into the contract. When this happens, the contract is discharged (terminated) by law.

Learning OutcOme 1

Identify contracts contrary to statute.

Conflict Presented Each of five co-workers receives a free lottery ticket from a customer. The co-workers orally agree to split the jackpot if one of the tickets turns out to be the winning one. When one of the

tickets is a winner, its holder decides not to share the proceeds. The other co-workers file a suit to collect.

Q is the agreement to split the lottery winnings among the co-workers enforceable?

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U n i t 2 Contracts144

12–1b Usury Almost every state has a statute that sets the maximum rate of interest that can be charged for different types of transactions, including ordinary loans. A lender who makes a loan at an interest rate above the lawful maximum commits usury.

12–1c Gambling Any scheme that involves the distribution of property by chance among persons who have paid valuable consideration for the opportunity to receive the property is gambling. Traditionally, the states considered gambling contracts illegal and thus void.

Today, many states allow (and regulate) certain forms of gambling, such as horse racing, video poker machines, and charity-sponsored bingo. In addition, nearly all states allow state-operated lotteries and gambling on Native American reservations. Even in states that permit certain types of gambling, though, courts often find that gambling contracts are illegal.

12–1d Licensing Statutes All states require members of certain professions—including physicians, lawyers, real estate brokers, architects, electricians, and stockbrokers—to have licenses. Some licenses require extensive schooling and examinations, which indicate to the public that a special skill has been acquired. Others require only that the particular person be of good character and pay a fee.

Generally, licenses provide a means of regulating and taxing certain businesses and protecting the public against actions that could threaten the general wel- fare. ExamplE 12.2 Beth is a stockbroker in New York City. In New York—as in nearly all states—Beth must be licensed and file a bond (a promise obtained from a professional bonding company to pay a certain amount of money if Beth commits theft). The bond is filed with the state to protect the public from Beth’s performing fraudulent stock transactions. j

When a person enters into a contract with an unlicensed individual, the contract may still be enforceable depending on the nature of the licensing statute. If the licensing statute’s purpose is to protect the public from unauthorized practitioners, a contract involving an unlicensed individual is illegal and unenforceable. Some states expressly provide that the lack of a license in certain occupations bars the enforcement of work-related contracts. If a state’s statute does not expressly affirm the barring of a contract’s enforceability, it is then necessary to look to the underly- ing purpose of the licensing requirements for a particular occupation.

usury Charging an illegal rate of interest.

Real Case

Cecil McNatt contracted with Jane Vestal to build Henderson Villa, an assisted-living facility for $1.4 million in Henderson, Tennessee. Three days later, McNatt formed a joint venture with M.S. Burton Construction Company to help build the facility. M.S. Burton was licensed under Tennessee’s Contractors Licensing Act, but McNatt was not. During the construction of Henderson Villa, McNatt remained on-site, select- ing, supervising, and paying the subcontractors. Following the project’s completion, Vestal refused to pay McNatt the balance owed on the contract, claiming a breach of contract because McNatt was unlicensed. McNatt filed a lawsuit in a Tennessee state court against Vestal to collect. The court awarded McNatt nearly $100,000 in damages. Vestal appealed.

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C H A P T E R 1 2 The Legality of Agreements 145

12–1e Contracts in Restraint of Trade Restraint of trade involves interfering with free competition. Contracts in restraint of trade usually adversely affect the public (which favors competition in the econ- omy) and typically violate one or more federal or state statutes.

An exception is recognized when the restraint is reasonable and an integral part of a contract. Many such exceptions involve a type of restraint called a covenant not to compete.

Covenants Not to Compete and the Sale of an Ongoing Business Covenants not to compete are often contained in contracts concerning the sale of an ongoing business. Such agreements enable the seller to sell, and the purchaser to buy, the “goodwill” and “reputation” of an ongoing business.

ExamplE 12.3 For more than twenty years, Ryan has been operating his specialty art supply store, Blue Moon Art Shop, in Ashville. Customers come from other cities to shop at Blue Moon. He decides to sell the business to Barbara, who includes a provision in the sales agreement stating that Ryan will not open an art store within one hundred miles of Ashville. Barbara is protecting her investment in Blue Moon’s goodwill and reputation with its loyal customers. j

Covenants Not to Compete in Employment Contracts Agreements not to compete can also be contained in employment contracts. Often, middle- and upper-level managers agree not to work for competitors or not to start a competing business for a specified period of time after terminating employment. Such agreements generally are legal so long as the specified period of time is not excessive in duration and the geographical restriction is reasonable.

Basically, the restriction on competition must be reasonable—that is, no greater than necessary to protect a legitimate business interest. For instance, for a former employer to claim an irreparable (unfixable) injury under a covenant not to com- pete, it must have occurred or, at a minimum, be imminent.

covenant not to compete A promise to refrain from competing in business with another.

Learning OutcOme 2

Describe an enforceable covenant not to compete.

Did mcnatt’s lack of a contractor’s license violate the state’s contractors Licensing act and thus affect the amount of his $100,000 award? Yes. In McNatt v. Vestal, a state inter- mediate appellate court ruled that McNatt had violated the Contractors Licensing Act. This violation of the state statute limited the amount of his recovery to “actual docu- mented expenses.” As a result, the court lowered the award from $100,000 to $73,000.

—2016 WL 659847 (Tenn.App.)

Highlighting the Point

Brown Insurance Agency hires Tami to provide marketing analysis. Before her first day of work, Tami signs a covenant not to compete. This agreement prohibits Tami from work- ing with a Brown competitor for ten years after she leaves her position with Brown. After six months, Tami leaves Brown for medical reasons. Three years later, she takes a job with The Langley Group, a Brown competitor. Brown sues Tami for breach of contract.

is Brown’s covenant not to compete enforceable? No. Brown’s time requirement of waiting ten years after leaving a job with the company is unreasonable. Tami can work for The Langley Group and is not liable under the Brown covenant not to compete.

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U n i t 2 Contracts146

Covenants Not to Compete and Reformation On occasion, when a covenant not to compete is unreasonable in its essential terms, the court may reform the covenant, converting its terms into reasonable ones. This practice is called contract reformation. In such a situation, the court reasons that the parties intended their contract to contain reasonable terms and changes the contract so that this intent can be enforced. A court usually will reform a contract only when it is necessary to prevent undue burdens or hardships.

12–2 contracts contrary to Public Policy Although contracts involve private parties, some are not enforceable because of the negative impact they would have on society. These contracts are said to be contrary to public policy.

12–2a Unconscionable Contracts or Clauses Ordinarily, a court does not look at the fairness, or equity, of a contract. Persons are assumed to be reasonably intelligent, and the court does not come to their aid just because they have made a foolish bargain.

In certain circumstances, however, bargains are so oppressive that the courts relieve innocent parties of part or all of their duties. Such a bargain may be evi- denced by an unconscionable contract or clause. (Unconscionable means grossly unethical or unfair.) An unconscionable contract is one in which the terms of the agreement are so unfair as to “shock the conscience” of the court.

Court decisions have distinguished between procedural and substantive unconscionability.

Procedural Unconscionability Procedural unconscionability has to do with how a term (a provision or clause) becomes part of a contract. It relates to factors bearing on a party’s lack of knowledge or understanding of the contract.

Procedural unconscionability may involve print that is hard to see or notice or language that is hard to understand (legalese). It may also involve a lack of oppor- tunity to read the contract or to ask questions about its meaning. Finally, it may reflect disparate, or unequal, bargaining power between the parties.

In addition, contracts entered into because of one party’s vastly superior bargain- ing power may be deemed unconscionable. These situations usually involve an adhesion contract. This type of contract is drafted by one party (such as a dishonest retail dealer) and then presented to another (such as an uneducated consumer) on a take-it-or-leave-it basis.

reformation A court-ordered correction of a written contract to reflect the parties’ true intentions.

Learning OutcOme 3

Identify contracts contrary to public policy.

unconscionable contract or clause A contract or clause that is so unfair that it is rendered void.

adhesion contract A contract in which the stronger party dictates the terms.

Highlighting the Point

Gerald, a part-time janitor with a fourth-grade education, agrees to purchase a fifty- five-inch 4K UHD Smart TV from USA Electronics for $2,000. This TV usually sells for $1,000. Gerald signs a two-year contract agreeing to make minimum monthly pay- ments of $100. After ten payments, Gerald refuses to pay more, and USA Electronics sues to collect the remaining balance.

is gerald required to pay the remaining balance owed to usa electronics? No. This contract is considered unconscionable because of Gerald’s lack of education (which may prevent him from fully understanding the terms of the contract) and the obvi- ous disparity of bargaining power between the parties.

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C H A P T E R 1 2 The Legality of Agreements 147

Substantive Unconscionability Substantive unconscionability describes contracts, or portions of contracts, that are oppressive or overly harsh. When determining substantive unconscionability, courts generally focus on provisions that deprive one party of the benefits of the agreement or leave that party without a remedy for nonperformance by the other party.

Procedural and substantive unconscionability are summarized in Exhibit 12.1.

12–2b Exculpatory Clauses Closely related to the concept of unconscionability are exculpatory clauses. These are clauses that release a party from liability in the event of monetary or physical injury, no matter who is at fault. (Exculpatory means tending to avoid blame.) Indeed, some courts refer to such clauses in terms of unconscionability.

Exculpatory clauses are often held to be unenforceable. For instance, exculpatory clauses that relieve a party from liability for harm caused by simple negligence nor- mally are unenforceable when they are asserted by an employer against an employee.

exculpatory clause A contract clause that releases a party from liability for wrongful acts.

exhibit 12.1 Procedural and Substantive Unconscionability

UNCONSCIONABLE CONTRACT OR CLAUSE This is a contract or clause that is void for reasons of public policy.

This occurs if a contract is entered into, or a term becomes part of the contract, because of a party’s lack of knowledge or understanding of the contract or the term.

PROCEDURAL UNCONSCIONABILITY

• Is the contract’s print hard to see or notice? • Is the language too di�cult to understand? • Did one party lack an opportunity to ask questions about the contract? • Was there a disparity of bargaining power between the parties?

Factors That Courts Consider

This exists when a contract, or one of its terms, is oppressive or overly harsh.

SUBSTANTIVE UNCONSCIONABILITY

• Does a provision deprive one party of the bene�ts of the agreement? • Does a provision leave one party without a remedy for nonperformance by the other?

Factors That Courts Consider

Highlighting the Point

Madison Manufacturing Company asks Juan, a new employee, to sign a contract that includes a clause absolving Madison from liability for harm caused “by accidents or injuries in the factory, or which may result from defective machinery or carelessness or misconduct of himself or any other employee in service of the employer.”

if Juan is injured in a factory accident, can madison use the clause to avoid responsibility? Probably not. The provision attempts to remove Madison’s potential liability for injuries occurring to employees, and it would ordinarily be held contrary to public policy.

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U n i t 2 Contracts148

12–3 the effect of illegality In general, an illegal contract is void. If a contract is executory (not yet fulfilled), neither party can enforce it. If it is executed (fully performed), there can be no recovery.

The major justification for this hands-off attitude is that a plaintiff who has bro- ken the law by entering into an illegal bargain should not be able to get help from the courts. Another justification is the hoped-for deterrent effect of this general rule. A plaintiff who suffers a loss because of an illegal bargain should presumably be deterred from entering into similar illegal bargains.

Some persons are excluded from the general rule that neither party to an illegal bargain can sue for breach or recover for performance rendered. These exceptions involve (1) justifiable ignorance of the facts, (2) members of a protected classes, and (3) withdrawal from an illegal agreement.

12–3a Justifiable Ignorance of the Facts Sometimes, one of the parties to a contract has no reason to know that the contract is illegal and thus is relatively innocent. This party can often obtain restitution (recovery of benefits conferred) in a partially executed contract. The courts do not enforce the contract but do allow the parties to return to their original positions. It is also possible for an innocent party who has fully performed under the contract to enforce the contract against the guilty party.

12–3b Members of Protected Classes When a statute protects a certain class of people, a member of that class can enforce a contract in violation of the statute even though the other party cannot. ExamplE 12.4 Dexter, a commercial airline pilot, is prohibited by statute from work- ing more than twenty hours in a two-day period. Dexter works twenty-five hours in two days. As a member of a protected class, he can recover (get paid) for those extra hours of service, despite the illegality of the contract. j

Other examples of statutes designed to protect a particular class of people are blue sky laws. These state laws regulate and supervise investment companies for the protection of the public. Such laws are intended to stop the sale of stock in fly-by-night concerns, such as nonexistent oil wells and gold mines. Investors are protected as a class and can sue to recover the purchase price of stock issued in violation of such laws.

Most states also have statutes regulating the sale of insurance. If an insurance company violates a statute when selling insurance, the purchaser can nevertheless enforce the policy and recover from the insurer.

Learning OutcOme 4

Explain the consequences of an illegal agreement.

blue sky law State law that regulates the offer and sale of securities.

Highlighting the Point

Debbie contracts with Tucker to purchase ten crates of goods that legally cannot be sold or shipped. Tucker hires Silverstone Trucking Company to deliver the shipment to Debbie. Tucker agrees to pay Silverstone the normal shipping fee of $500. He does not, however, tell Silverstone that the goods in the crates are illegal to sell or ship. Silverstone delivers the goods as agreed, but Tucker fails to pay the company.

can silverstone recover the $500 shipping fee from tucker? Yes. Although the law specifies that the shipment and sale of the goods are illegal, Silverstone, being an innocent party, can legally collect the $500 from Tucker.

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C H A P T E R 1 2 The Legality of Agreements 149

12–3c Withdrawal from an Illegal Agreement If the illegal part of a bargain has not yet been performed, the party tendering per- formance can withdraw from the bargain and recover the performance or its value.

Highlighting the Point

Martha and Francisco decide to wager (illegally) on the outcome of a boxing match. Each deposits money with a stakeholder, who agrees to pay the winner of the bet. Before the boxing match is held, Francisco changes his mind about the bet.

can Francisco get his money back? Yes. At this point, each party has performed part of the agreement, but the illegal part of the agreement will not occur until the money is paid to the winner. Before such payment occurs, either party is entitled to withdraw from the agreement by giving notice to the stakeholder.

Conflict Resolved In the Conflict Presented feature at the beginning of this chapter, five co-workers agreed to split the winnings from their individual lottery tickets, but a worker with a winning ticket later refused to

share the proceeds.

a Is the co-workers’ agreement enforceable? No. At first glance, this agreement might seem entirely legal. The contract here, however, is an exchange of promises to

share winnings from the parties’ individually owned lottery tickets in the uncertain

event that one of the tickets wins. Consequently, the agreement is founded on a

gambling consideration and is therefore void.

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U n i t 2 Contracts150

Issue sPotteRs Check your answers to the Issue Spotters against the answers provided in Appendix A at the end of this text.

1. Diane bets Tex $1,000 that the Green Bay Packers will win the Super Bowl. A state law prohibits gambling. Do Diane and Tex have an enforceable contract? Explain. (See Contracts Contrary to Statute.)

2. Potomac Airlines prints on the backs of its tickets that it is not liable for any injury to a passenger caused by

Potomac’s negligence. Ron buys a ticket and boards the plane. On takeoff, the plane crashes, and Ron is injured. If the cause of the accident is found to be Potomac’s negligence, can Potomac use the clause as a defense to liability? Why or why not? (See Contracts Contrary to Public Policy.)

stRaIgHt to tHe PoInt

1. How do statutes affect the terms of contracts? (See Con- tracts Contrary to Statute.)

2. What is the purpose of a business license? (See Contracts Contrary to Statute.)

3. When a person contracts with an unlicensed individual, in what circumstance is the contract enforceable? (See Contracts Contrary to Statute.)

4. When is a contract in restraint of trade enforceable? (See Contracts Contrary to Statute.)

5. What is the definition of unconscionable? (See Contracts Contrary to Public Policy.)

6. In what situation can a party to an illegal contract enforce it against the other party? (See The Effect of Illegality.)

Learning OutcOme 1: identify contracts contrary to statute. Any contract to commit a crime is contrary to statute. It is also illegal to make a loan at an interest rate that exceeds the maximum rate established by state law. Gambling contracts that violate state statutes are illegal. A contract entered into by a person who does not have a license, when one is required by statute, is not enforceable if the underlying purpose of the statute is to protect the public from unlicensed practitioners. Contracts in restraint of trade are generally prohibited by statute, unless the restraint is reasonable.

Learning OutcOme 2: Describe an enforceable covenant not to compete. A covenant not to compete is enforceable if its terms are reasonable as to time and area of restraint. Covenants not to compete are often contained in contracts for the sale of an ongoing business and in certain employment contracts.

Learning OutcOme 3: identify contracts contrary to public policy. Contracts that have a negative impact on society are contrary to public policy. A contract or clause that is so unfair to one party can be deemed unconscionable by a court and will be unenforceable.

Learning OutcOme 4: explain the consequences of an illegal agreement. An illegal contract is void, and the courts will aid neither party when both parties are equally at fault. If the contract is executory, neither party can enforce it. If it is executed, neither party can recover for its breach.

CHaPteR summaRy—tHe LegaLIty of agReements

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C H A P T E R 1 2 The Legality of Agreements 151

ReaL Law

12–1. exculpatory clauses. Sue Ann Apolinar hired a guide through Arkansas Valley Adventures, LLC, for a rafting excursion on the Arkansas River. At the outfitter’s office, Apolinar signed a release that detailed potential hazards and risks, including overturning, unpredict- able currents, obstacles in the water, and drowning. The release clearly stated that her signature discharged Arkansas Valley from liability for all claims arising in connection with the trip. On the river, while attempting to maneuver around a rapid, the raft capsized. The current swept Apolinar into a logjam where, despite efforts to save her, she drowned. Her son, Jesus Espinoza, Jr., filed a lawsuit in a federal district court against the rafting company, alleging negligence. What are the arguments for and against enforcing the release that Apolinar signed? Discuss. [Espinoza v. Arkansas Valley Adventures, LLC, 809 F.3d 1150 (10th Cir. 2016)] (See Contracts Contrary to Public Policy.)

12–2. adhesion contracts. David Desgro hired Paul Pack to inspect a house that Desgro wanted to buy. Pack had Desgro sign a contract that included a twelve-month limit

for claims based on the agreement. Pack reported that the house had no major problems, but after Desgro bought it, he discovered issues with the plumbing, insulation, heat pump, and floor support. Thirteen months after the inspection, Desgro filed a suit in a Tennessee state court against Pack. Was Desgro’s complaint filed too late, or was the contract’s twelve-month limit unenforceable? Discuss. [Desgro v. Pack, 2013 WL 84899 (Tenn.Ct.App. 2013)] (See Contracts Contrary to Public Policy.)

12–3. Licensing statutes. PEMS Co. International, Inc., agreed to find a buyer for Rupp Industries, Inc. Using PEMS’s services, an investment group bought Rupp for $20 million and changed its name to Temp-Air, Inc. PEMS asked Temp-Air to pay a commission on the sale. Temp- Air refused, arguing that PEMS had acted as a broker in the deal without a license. The applicable statute defines a broker as any person who deals with the sale of a business. If this statute was intended to protect the public, can PEMS collect its commission? Explain. [PEMS Co. International, Inc. v. Temp-Air, Inc., __ N.W.2d __ (Minn.App. 2011)] (See Contracts Contrary to Statute.)

etHICaL QuestIons

12–4. gambling. How can states enforce gambling laws in the age of the Internet? (See Contracts Contrary to Statute.)

12–5. covenant not to compete. Surya Challa worked for TransUnion Risk and Alternative Data Solutions, Inc. (TRADS), a data fusion company. Under a covenant not to compete, Challa agreed to not work for any TRADS’s com- petitor for one year after the end of his employment. Challa quit his job at TRADS, and without informing TRADS, he went to work for IDI, Inc., a competitor. TRADS filed a

lawsuit in a federal district against him, alleging breach of their agreement. TRADS argued that Challa’s “presence at IDI created an irreparable injury.” Challa testified that he worked in a different capacity at IDI, relying on publicly available information and skills that he developed before working for TRADS. He was also careful not to reveal TRADS’s propri- etary information. From an ethical perspective, is Challa effec- tively avoiding a conflict of interest? Discuss. [TransUnion Risk and Alternative Data Solutions, Inc. v. Surya Challa, 2017 WL 117128 (11th Cir. 2017)] (See Contracts Contrary to Statute.)

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153

Chapter 12—work set

1. An exculpatory clause may or may not be enforced.

2. An adhesion contract will never be deemed unconscionable.

3. An illegal contract is valid unless it is executory.

4. If the purpose of a licensing statute is to protect the public from unlicensed practitioners, a contract entered into with an unlicensed practitioner is unenforceable.

5. Covenants not to compete are never enforceable.

6. Usury is charging an illegal rate of interest.

7. Even in states that permit certain types of gambling, courts often find that gambling contracts are illegal.

8. All states have statutes that regulate gambling.

tRue-faLse QuestIons

1. At the start of the football season, Bob and Murray make a bet about the results of the next Super Bowl. Adam holds their money. Just as the divisional play-offs are beginning, Bob changes his mind and asks for his money back. Gambling on sports events is illegal in their state. Can Bob be held to the bet?

a. Yes. It would be unconscionable to let Bob back out so late in the season. b. Yes. No party to the contract is innocent, and thus no party can withdraw. c. No. If an illegal agreement is still executory, either party can withdraw. d. No. The only party who can be held to the bet is Murray.

2. Al sells his business to Dan and, as part of the agreement, promises not to engage in a business of the same kind within thirty miles for three years. Competition within thirty miles would hurt Dan’s business. Al’s promise

a. violates public policy, because it is part of the sale of a business. b. violates public policy, because it unreasonably restrains Al from competing. c. does not violate public policy, because it is no broader than necessary. d. does none of the above.

3. Luke practices law without an attorney’s license. The state requires a license to protect the public from unauthorized practitioners. Clark hires Luke to handle a legal matter. Luke cannot enforce their contract because

a. it is illegal. b. Luke has no contractual capacity. c. Luke did not give consideration. d. none of the above.

4. Amy contracts to buy Kim’s business. Kim agrees not to compete with Amy for one year in the same county. Six months later, Kim opens a competing business six blocks away. Amy

a. cannot enforce the contract because it is unconscionable. b. cannot enforce the contract because it is a restraint of trade. c. can enforce the contract because all covenants not to compete are valid. d. can enforce the contract because it is reasonable in scope and duration.

5. Sam signs an employment contract that contains a clause absolving the employer of any liability if Sam is injured on the job. If Sam is injured on the job due to the employer’s negligence, the clause will

a. protect the employer from liability. b. likely not protect the employer from liability. c. likely be held unconscionable. d. do both b and c.

muLtIPLe-CHoICe QuestIons

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154

6. Fred signs a covenant not to compete with his employer, General Sales Corporation. This covenant is enforceable if it

a. is not connected with the sale of an ongoing business. b. is reasonable in terms of geographic area and time. c. is supported by consideration. d. requires both parties to obtain business licenses.

7. Ann contracts with Bob, a financial planner, who is required by the state to have a license. Bob does not have a license. Their contract is enforceable if

a. the purpose of the statute is to protect the public from unlicensed practitioners. b. the purpose of the statute is to raise government revenue. c. Bob does not know that he is required to have a license. d. Ann does not know that Bob is required to have a license.

8. A contract that is full of hard-to-read print and hard-to-understand language and that is presented to someone who is not given an opportunity to read it is

a. always unenforceable. b. always enforceable. c. unenforceable under some circumstances. d. void.

9. In an exculpatory clause, which of the following statements is true?

a. One party agrees that the other party is not mentally incompetent. b. One party releases the other party from liability in the event of monetary or physical injury, no matter who is at

fault. c. One party is able to sue the other party based on the clear fault of the other party. d. Both parties agree to use arbitration, not adjudication, to settle any disputes arising under the contract containing

the clause.

answeRIng moRe LegaL PRobLems

1. To protect professional boxers, California law requires that their managers be licensed by the state. José, who was not licensed by the state, assumed the manage- ment of Marco, a professional boxer. José negotiated a contract for Marco with Everlast Promotions, Inc. José helped Marco resolve three lawsuits and unrelated tax problems so that he could continue boxing. When Marco stopped talking to José, the latter filed a suit in a California court.

Is this management contract enforceable? No. A con- tract with an unlicensed practitioner is not enforceable if the underlying purpose of the state’s licensing statute is to protect the_______________ from unauthorized _______________. Here, the manager of a professional boxer must be licensed by the state. The purpose is to protect boxers. The state did not license José as a box- ing manager, yet he conducted himself as the manager of a professional boxer. Because he acted without a _______________, the alleged contract with Marco is _______________.

2. Roberto, who did not speak or read English, visited Dart Dodge, a car dealership. Aware that Roberto was monolingual, Dart’s staff transacted a deal in Spanish. They explained the English-language contract, except for one clause. This clause limited the buyer’s right to seek damages in court to less than $5,000, but did not limit Dart’s right to ask for damages. Roberto bought a Dodge Ram truck and signed the contract.

Is the damages clause in this contract enforceable? No. The clause is unconscionable. _______________ unconscionability concerns the manner in which a contract is entered into. _______________ unconscio- nability can occur when a contract unfairly limits one party’s remedy for the other’s breach. Having under- taken to explain the contract in Spanish, Dart’s staff was obliged to do so accurately so Roberto would have a meaningful opportunity to bargain. The failure to do so made the contract _______________ uncon- scionable. The unfair limit to the buyer’s damages was _______________ unconscionable.

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155

Learning OutcOmes

The four Learning Outcomes below are designed to help improve your understanding of the chapter. After reading this chapter, you should be able to:

State the difference between mistakes of fact and of value.

List the elements of fraud

Contrast misrepresentations of a material fact and of law.

Recognize the difference between undue influence and duress.

1

2

3

4

13 Voluntary Consent

An otherwise valid contract may still be unenforceable if the parties have not genu- inely agreed to its terms. This lack of voluntary consent can be used as a defense to the contract’s enforceability. Voluntary consent may be lacking if one or more of the parties is mistaken about an important fact concerning the subject matter of the contract. Parties also lack voluntary consent if they have entered into a contract as a result of fraudulent misrepresentation, undue influence, or duress.

13–1 mistakes We all make mistakes, and it is not surprising that mistakes are made when contracts are formed. In certain circumstances, contract law allows a contract to be avoided on the basis of mistake. It is important to distinguish between mistakes of fact and mistakes of value, however. Only a mistake of fact makes a contract voidable.

13–1a Mistakes of Fact Mistakes of fact can occur in two forms—unilateral and bilateral (mutual). These two types of mistakes are illustrated in Exhibit 13.1. In either instance, the mistake must involve a material fact. A material fact is a fact that is important and central to the subject matter of the contract, such as the identity of the parties.

Unilateral Mistakes A unilateral mistake is made by only one of the parties. In general, a unilateral mistake does not give the mistaken party any right to avoid the contract. In other words, the contract normally is enforceable against the mistaken party.

ExamplE 13.1 Elena intends to sell her personal jet ski for $6,500. When she learns that Derek is interested, she sends him a text offering to sell the jet ski to him. When writing the text, she mistakenly keys in the price of $5,600. Derek immediately accepts her offer. Elena has made a unilateral mistake and is bound by the contract to sell the jet ski to Derek for $5,600. j

unilateral mistake A mistake that occurs when one party to a contract is mistaken about a material fact.

Learning OutcOme 1

State the difference between mistakes of fact and of value.

voluntary consent Knowledge of and genuine assent to the terms of a contract.

Conflict Presented Lucinda negotiates with Maurice to buy a closed-down car wash. Maurice tells Lucinda that the property has been winterized, which he guarantees later in an e-mail. After the sale, Lucinda

enters the building and clearly sees that all the equipment is frozen. Lucinda files a lawsuit against Maurice, claiming fraud.

Q Did Lucinda reasonably rely on maurice’s representation that the car wash had been winterized?

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U n i t 2 Contracts156

There are at least two exceptions to this rule. The contract may not be enforce- able if: 1. The other party to the contract knows or should have known that a mistake

was made. 2. The error was due to a substantial mathematical mistake in addition,

subtraction, division, or multiplication and was made accidentally and without intentional carelessness. If, for instance, a contractor’s bid was significantly low because he or she made a mistake when adding up the total estimated costs, any contract resulting from the bid normally may be rescinded.

Of course, in both situations the mistake must still involve some material fact.

Bilateral (Mutual) Mistakes When both parties are mistaken about the same material fact, a bilateral mistake has occurred. In this situation, the contract can be rescinded by either party. Normally, the contract is voidable by the adversely affected party. Again, the mistake must be about a material fact.

One type of bilateral mistake can occur when a word or term in a contract is subject to more than one reasonable interpretation. In that situation, if the par- ties to the contract attach materially different meanings to the term, their mutual misunderstanding may allow the contract to be rescinded.

13–1b Mistakes of Value If a mistake concerns the future market value or quality of the object of the con- tract, the mistake is one of value, and the contract normally is enforceable. Mistakes of value can be bilateral or unilateral. Either way, they do not serve as a basis for avoiding a contract.

ExamplE 13.2 Carlos buys a violin from Beverly for $250. Although the violin is very old, neither party believes that it is valuable. Later, however, an antiques dealer informs Carlos and Beverly that the violin is rare and worth thousands of dollars. A bilateral mistake has been made, but it is a mistake of value rather than a mistake of fact. Therefore, Beverly cannot cancel the contract. j

The reason that mistakes of value or quality have no legal significance is that value is variable. Depending on the time, place, and other factors, the same item may be worth considerably different amounts.

When parties form a contract, their agreement establishes the value of the object of their transaction—for the moment. Each party is considered to have assumed the risk that the value will change in the future or prove to be different from what

bilateral mistake A mistake that occurs when both parties are mistaken about a material fact.

exhibit 13.1 Mistakes of Fact

CONTRACT CAN BE RESCINDED

BY EITHER PARTY

CONTRACT ENFORCEABLE UNLESS—

Other party knew or should have known that mistake was made or

Mistake was due to substantial mathematical error, made inadvertently and without gross negligence

MATERIAL MISTAKE OF FACT

BILATERAL MISTAKE Both parties mistaken

UNILATERAL MISTAKE One party mistaken

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C H A P T E R 1 3 Voluntary Consent 157

he or she thought. Without this rule, almost any party who did not receive what she or he considered a fair bargain could argue mistake.

13–2 Fraudulent misrepresentation Although fraudulent misrepresentation is a tort, the presence of fraud also affects the authenticity of the innocent party’s consent to the contract. When an innocent party consents to a contract with fraudulent terms, the contract usually can be avoided because the innocent party has not voluntarily consented to the terms. Normally, the innocent party can either cancel the contract or enforce it and seek damages.

Typically, fraud has three elements: 1. A misrepresentation of a material fact must occur. 2. There must be an intent to deceive. 3. The innocent party must justifiably rely on the misrepresentation.

To recover damages, the innocent party must also suffer an injury.

13–2a Misrepresentation Has Occurred The first element of proving fraud is to show that misrepresentation of a material fact has occurred. This misrepresentation can occur through words or conduct.

Misrepresentation by Words A misrepresentation of a material fact can be expressly made through a person’s words or writings. ExamplE 13.3 Waylan, an art gallery owner, clearly tells Eva, a wealthy customer, that a painting is a Renoir. Waylan knows that the painting is a forgery, however. Waylan’s statement to Eva regarding the fake Renoir painting is an express misrepresentation. If Eva buys the painting and later discovers the fraud, she can prove misrepresentation of a material fact. j

A statement of opinion cannot be used in a claim of fraud. A fact is objective and verifiable, whereas an opinion usually is subject to debate. ExamplE 13.4 Glenn,

Learning OutcOme 2

List the elements of fraud.

Real Case

Donald Trump formed Trump University (later known as Trump Entrepreneur Initia- tive) to sell courses in real estate investing. A promotional video featured Trump telling prospective students, “We’re going to have professors that are absolutely terrific—terrific people, terrific brains, successful, the best. . . . All people that are handpicked by me.” The New York attorney general, Eric Schneiderman, brought a proceeding against Trump in a New York state court, alleging fraud. Trump University was charged with intentionally misleading more than five thousand students, who paid as much as $35,000 each to participate in its programs. Among other things, according to the attorney general, Trump did not handpick the instructors. The court dismissed the claim on the ground that the state could not bring an action for fraud. The state appealed.

can the state bring an action for fraud? Yes. In Schneiderman v. Trump Entrepreneur Initiative, a state intermediate appellate court reversed the lower court’s dismissal. The lower court had misinterpreted a previous New York Court of Appeals case. In fact, a state statute allowed the state to bring causes of action for fraud.

—145 A.D.3d 533 (1 Dept.)

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U n i t 2 Contracts158

a financial adviser, says to Tanya, “The investment in Silver Ridge Technologies will be worth twice as much next year.” Glenn is only stating an opinion. His statement cannot be verified and is only speculation. j

The distinction between “seller’s talk” and facts allows sellers to tout their prod- ucts and services without being liable for fraud. Contracting parties should recognize this difference and should not rely on any statement of opinion.

Misrepresentation by Conduct A misrepresentation need not be expressly made through the words or writings of another. It can also occur by conduct. ExamplE 13.5 Tom contracts to buy a horse named Zorro from Dolores. By showing Tom health records of another horse and injecting Zorro with pain medication, Dolores leads Tom to believe that Zorro is fit to ride in jumping competitions. In reality, Zorro suffers from a medical condition that makes him unsuitable for competition. Wrongfully concealing Zorro’s condition is a misrepresentation by conduct. j

Misrepresentation by conduct can also involve denial. ExamplE 13.6 Tom asks Dolores whether Zorro has visited a veterinarian recently. Dolores says no. Dolores knows her statement is untrue. Her denial is another misrepresentation by conduct. j

Misrepresentation of Law Misrepresentation of law does not ordinarily entitle the party to avoid a contract. People are assumed to know the law.

Learning OutcOme 3

Contrast misrepresentations of a material fact and of law.

Highlighting the Point

Mercedes has a parcel of property that she is trying to sell to Carlos. Mercedes knows that a local ordinance prohibits building anything higher than three stories on the property. Nonetheless, she tells Carlos, “You can build an office building fifty stories high if you want to.” Carlos buys the land and later discovers that Mercedes’s statement is false.

can carlos avoid the contract? No. Carlos normally cannot avoid the contract. Under the common law, people are assumed to know easily researched state and local laws. Today, these laws are readily available on the Internet.

In general, a person should not rely on a nonlawyer’s statement about a point of law. Exceptions to this rule occur when the misrepresenting party is in a profession known to require greater knowledge of the law than the average citizen possesses.

Misrepresentation by Silence Ordinarily, neither party to a contract has a duty to come forward and disclose facts. Generally, a contract will not be set aside because certain pertinent information is not volunteered. ExamplE 13.7 Norah does not have to tell potential buyers that a car she is selling has been in an accident unless they ask. j

If a seller knows of a serious potential problem that the buyer cannot reasonably be expected to discover, however, the seller may have a duty to speak. ExamplE 13.8 River City is accepting bids for a new sewer system. City officials know that subsoil condi- tions in the area will make it very expensive to construct the system. If River City fails to disclose the conditions to bidders, the city is guilty of fraud. j

13–2b Intent to Deceive The second element of fraud is knowledge on the part of the misrepresenting party that facts have been falsely represented. This element, called scienter (pronounced sy-en-ter) or “guilty knowledge,” signifies that there was an intent to deceive.

scienter A party’s knowledge that material facts have been falsely represented with an intent to deceive.

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C H A P T E R 1 3 Voluntary Consent 159

Scienter clearly exists if a party knows that a fact is not as stated. ExamplE 13.9 Robert applies for a position as a business law professor. He says that he has been a corporate president for several years and has taught business law at another col- lege. Neither claim is true. After he is hired, his probation officer alerts the school to his criminal history. The school immediately fires him. Robert sues for breach of his employment contract. Robert is unlikely to win his suit, because he clearly engaged in an attempt to deceive the college. Furthermore, the college has justifiably relied on his misrepresentations. j

Scienter also exists if a party makes a statement that he or she believes not to be true or makes a statement recklessly, without regard to whether it is true or false. Finally, this element is met if a party says or implies that a statement is made on some basis, such as personal knowledge or personal investigation, when it is not.

13–2c Reliance on the Misrepresentation The third element of fraud is reasonably justifiable reliance on the misrepresenta- tion of fact. The deceived party must have a justifiable reason for relying on the misrepresentation. The misrepresentation must also be an important factor (but not necessarily the sole factor) in inducing the party to enter into the contract.

Reliance is not justified if the innocent party knows the true facts or relies on obviously extravagant statements. If the defects in a piece of property are obvi- ous, the buyer cannot justifiably rely on the seller’s misrepresentations concern- ing those defects. ExamplE 13.10 Dylan, a used-car salesman, tells Shelby, “This old Chevy Trailblazer SUV will get more than sixty miles per gallon.” Shelby cannot justifiably rely on Dylan’s statement, because the statement is obviously not accurate. j

If the defects are latent (hidden), however, the buyer is justified in relying on the seller’s statements.

Highlighting the Point

Michael is the president of North Country Industries. Michael induces Reyna to invest in the company by saying, “We will be launching a new genetically modified corn seed in the spring that will increase our profits substantially.” Michael’s statement is false, however. The company has no modified corn seed in production to help increase its profits. Reyna invests $50,000 in North Country based on Michael’s statement. Later, North Country is forced into bankruptcy, and Reyna loses her investment. To recover her losses, Reyna sues Michael, claiming fraud.

can reyna claim that she justifiably relied on michael’s misrepresentation of north country to make her investment decision? Yes. Reyna, as the innocent party, does not know the status of the corn seed production at the company. In addition, she has no way to discover this information. Reyna may proceed with her claim of fraud against Michael.

13–2d Injury to the Innocent Party For a person to recover damages based on fraud, proof of an injury is required. The measure of damages is ordinarily equal to the property’s value had it been delivered as represented, less the actual price paid for the property.

In actions based on fraud, courts also often award punitive damages. These dam- ages are often used to punish a defendant or set an example for similar wrongdoers.

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U n i t 2 Contracts160

13–3 undue influence and Duress A contract lacks voluntary consent if undue influence or duress is present. If a contract lacks voluntary consent, it is voidable.

13–3a Undue Influence Undue influence arises from relationships in which one party can greatly influence another party, thus overcoming that party’s free will. Minors and elderly people are often under the influence of guardians. Undue influence also can arise from a num- ber of confidential relationships or relationships founded on trust. Examples include attorney-client and doctor-patient relationships.

undue influence Persuasion that induces a person to act according to the will of the dominating party.

Conflict Resolved In the Conflict Presented feature at the beginning of the chapter, Lucinda and Maurice negotiate the sale of a car wash. Maurice tells Lucinda that the car wash has been winterized and guarantees this

fact in an e-mail. After the sale, Lucinda learns that the property has not been properly winterized. She files a lawsuit against Maurice, claiming fraud.

a Did lucinda reasonably rely on maurice’s representation that the car wash had been winterized? Yes. One element of fraud is a person’s reasonably justifiable

reliance on a misrepresentation by another. Here, Lucinda’s reliance on Maurice’s

misrepresentation about the winterizing of the car wash was reasonable. Maurice told

her personally that the car wash was safe from freezing temperatures and later repeated

that guarantee in an e-mail.

Highlighting the Point

Susan has been Ed’s in-home caregiver for several years. Ed is nearly eighty years old and in frail health. One afternoon, Susan convinces Ed to review his will. Together, they rework the will so that Susan will receive a large portion of Ed’s estate. Susan convinces Ed that she deserves the money more than Ed’s two sons. Additionally, Susan implies that she will quit her job if she cannot be a beneficiary of Ed’s will.

are susan’s actions considered undue influence? Yes. Susan has used undue influence to make Ed act in a way that he would not have done ordinarily. Ed’s two sons can claim the revised will agreement is unenforceable because of Susan’s excessive undue influence.

13–3b Duress Consent to the terms of a contract is not voluntary if one of the parties is forced into the agreement. Recognizing this, the courts allow that party to rescind the contract. Forcing a party to enter into a contract under the fear of threats is legally defined as duress. The party on whom the duress is exerted can choose to carry out the contract or to avoid the entire transaction. (The wronged party usually has this choice when consent is not voluntary.)

Learning OutcOme 4

Recognize the difference between undue influence and duress.

duress Threats made to force a party to enter into a contract.

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C H A P T E R 1 3 Voluntary Consent 161

Learning OutcOme 1: state the difference between mistakes of fact and of value. A mistake of fact involves a material fact—one that is important to the subject matter of the contract. Only a mistake of fact can give a party the right to avoid a contract. A mistake of value concerns the future market value or quality of the object of the contract. This type of mistake normally does not serve as a basis for avoiding a contract.

Learning OutcOme 2: List the elements of fraud. The elements of fraud are (1) a misrepresentation of a material fact, (2) an intent to deceive, and (3) an innocent party’s reliance on the misrepresentation. To recover damages, the innocent party must suffer an injury.

Learning OutcOme 3: contrast misrepresentations of a material fact and of law. A material fact is objective and verifiable. A misrepresentation of a material fact can serve as the basis to avoid a contract. A misrepresentation of law usually does not entitle a party to avoid a contract. People are assumed to know the law.

Learning OutcOme 4: recognize the difference between undue influence and duress. Undue influence arises from relationships in which one party can greatly influence another party, thus overcoming that party’s free will. Duress involves forcing a party to enter into a contract under the fear of threats. This pressure causes a party to do what he or she would not do otherwise. A contract entered into under undue influence or duress is voidable due a lack of voluntary consent.

CHaPteR SummaRy—VoluntaRy ConSent

StRaigHt to tHe Point

1. What is the difference between a unilateral mistake and a bilateral mistake? (See Mistakes.)

2. How does the presence of fraud affect an innocent par- ty’s consent to a contract? (See Fraudulent Misrepresentation.)

3. When can a contract be set aside because the seller has not volunteered certain pertinent information? (See Fraud- ulent Misrepresentation.)

4. What is the definition of scienter? (See Fraudulent Misrepresentation.)

5. When is a party’s reliance on another’s misrepresentation not justifiable? (See Fraudulent Misrepresentation.)

iSSue SPotteRS Check your answers to the Issue Spotters against the answers provided in Appendix A at the end of this text.

1. Brad, an accountant, files Dina’s tax returns. When the Internal Revenue Service assesses a large tax against Dina, she retains Brad to contest the assessment. The day before the deadline for replying to the IRS, Brad tells Dina that unless she pays a higher fee, he will with- draw. If Dina agrees to pay, is the contract enforceable? Explain your answer. (See Undue Influence and Duress.)

2. In selling a house, Matt tells Ann that the wiring, fix- tures, and appliances are of a certain quality. Matt knows nothing about the quality, but it is not as speci- fied. Ann buys the house. On learning the true quality, Ann confronts Matt. He says he wasn’t trying to fool her, he was only trying to make a sale. Can she rescind the deal? Why or why not? (See Fraudulent Misrepresentation.)

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U n i t 2 Contracts162

Real law

13–1. Fraudulent misrepresentation. Vianna Stibal owns and operates the ThetaHealing Institute of Knowledge (THIK) in Idaho Falls, Idaho. ThetaHealing is Stibal’s “self-dis- covered” healing method. To induce people to take THIK classes, Stibal claimed that she had been diagnosed with cancer and had cured herself using ThetaHealing. This was false, and Stibal knew it. Her medical records did not confirm a cancer diagnosis. Believing Stibal’s claim, Kara Alexander traveled from New York to Idaho to pay for, and attend, classes in ThetaHealing. Later, Alexander filed a lawsuit in a state court against Stibal, alleging fraud. What are the elements of a cause of action for fraudulent misrepresentation? Do the facts in this situation meet these requirements? Discuss your answer. [Alexander v. Stibal, 368 P.3d 630 (2016)] (See Fraudulent Misrepresentation.)

13–2. Fraudulent misrepresentation. Joy Pervis and Brenda Pauley worked together as talent agents in Georgia. When Pervis “discovered” actress Dakota Fanning, Pervis sent Fanning’s audition tape to Cindy Osbrink, a talent agent in California. Osbrink agreed to represent Fanning in California and to pay 3 percent of Osbrink’s commissions

to Pervis and Pauley, who agreed to split the payments equally. Six years later, Pervis told Pauley that their agree- ment with Osbrink had expired and there would be no more payments. Nevertheless, Pervis continued to receive payments from Osbrink. Each time Pauley asked about commissions, however, Pervis replied that she was not receiving any. Do these facts evidence fraud? Explain. [In re Pervis, 512 Bankr. 348 (N.D.Ga. 2014)] (See Fraudulent Misrepresentation.)

13–3. Bilateral mistake. When Steven Simkin divorced Laura Blank, they agreed to split their assets equally. At the time, they owned an account with Bernard L. Madoff Investment Securities estimated to be worth $5.4 million. Simkin kept the account and paid Blank more than $6.5 million, which included $2.7 million specifically to offset the amount of the funds that they both believed were in the Madoff account. Later, they learned that the account had no funds due to fraud on the part of Madoff. Could their divorce agreement be rescinded on the basis of a mistake? Discuss. [Simkin v. Blank, 80 A.D.3d 401, 915 N.Y.S.2d 47 (1 Dept. 2011)] (See Mistakes.)

etHiCal QueStionS

13–4. Fraudulent misrepresentation. Is honesty an implicit duty of every employee? Discuss. (See Fraudulent Misrepresentation.)

13–5. Fraudulent misrepresentation. Data Consulting Group contracted with Weston Medsurg Center—a health-care facility in North Carolina—to install, maintain, and manage Weston’s computers and software. At about the same time, Ginger Blackwood began to work for Weston as a medical billing and coding specialist. Soon, she was submitting false

time reports and converting Weston documents and data to her own purposes. On her request, Data’s manager, Nasko Dinev, removed evidence of her actions from her work com- puter. What should Weston do when it learns of these activi- ties? With respect to this situation, what is the firm’s primary ethical dilemma? Suppose that despite Dinev’s efforts, Weston is later able to recover the data that was removed from Black- wood’s work computer. How might this affect Weston’s choices? Discuss. [Weston Medsurg Center v. Blackwood, 795 S.E.2d 829 (N.C.App. 2017)] (See Fraudulent Misrepresentation.)

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163

Chapter 13—work Set

1. A contract involving a mistake of fact can sometimes be avoided.

2. When both parties to a contract are mistaken as to the same material fact, the contract cannot be rescinded by either party.

3. To commit fraudulent misrepresentation, one party must intend to mislead another.

4. In an action to rescind a contract for fraudulent misrepresentation, proof of injury is required for damages to be awarded.

5. The essential feature of undue influence is that the party taken advantage of does not exercise free will.

6. If a person makes a statement that he or she believes to be true, he or she cannot be held liable for misrepresentation.

7. A seller has no duty to disclose a defect that is known to the seller but could not reasonably be suspected by the buyer.

8. When both parties make a mistake as to the future market value of the object of their contract, the contract can be rescinded by either party.

9. A contract entered into under duress is voidable.

tRue-FalSe QueStionS

1. Metro Transport asks for bids on a construction project. Metro estimates that the cost will be $200,000. Most bids are about $200,000, but EZ Construction bids $150,000. In adding a column of figures, EZ mistakenly omitted a $50,000 item. Because Metro had reason to know of the mistake

a. Metro can enforce the contract. b. EZ can increase the price and enforce the contract at the higher price. c. EZ can avoid the contract. d. none of the above can be done.

2. To induce Sam to buy a lot in Mel’s development, Mel tells Sam that he intends to add a golf course. The terrain is suitable, and there is enough land, but Mel has no intention of adding a golf course. Sam is induced by the statement to buy a lot. Sam’s reliance on Mel’s statement is justified because

a. Mel is the owner of the development. b. Sam does not know the truth and has no way of finding it out. c. Sam did not buy the golf course. d. the golf course had obviously not been built yet.

3. Bob agrees to sell ten shares of Black Bear Corporation stock to Pam. Neither party knows whether the stock will increase or decrease in value. Pam believes that it will increase in value. If she is mistaken, her mistake will

a. justify voiding the contract. b. not justify voiding the contract. c. justify a refund to her from Bob of the difference. d. justify a payment from her to Bob of the difference.

4. In an e-mail offering to sell amplifiers to Gina for her theater, Dick describes the 120-watt amplifiers as “210 watts per channel.” This is fraudulent misrepresentation if

a. the number of watts is a material fact. b. Dick intends to deceive Gina. c. Gina relies on the description. d. all of the above are true.

multiPle-CHoiCe QueStionS

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164

5. Ken, who is not a real estate broker, sells Global Associates some land. Which of the following statements by Ken, with the accompanying circumstance, would be a fraudulent misrepresentation in that sale?

a. “This acreage offers the most spectacular view of the valley.” From higher up the mountain, more of the valley is visible.

b. “You can build an office building here.” The county requires the property to be exclusively residential, but neither Ken nor Global knows that.

c. “This property includes ninety acres.” Ken knows it includes only eighty acres. d. “The value of this property will triple in five years.” Ken does not know whether the value of the property will

triple in five years.

6. Adam persuades Beth to contract for his company’s services by telling her that his employees are “the best and the brightest.” Adam’s statement is

a. duress. b. fraud. c. opinion. d. undue influence.

7. In selling a warehouse to A&B Enterprises, Ray does not disclose that the foundation was built on unstable pilings. A&B may later avoid the contract on the ground of

a. misrepresentation. b. undue influence. c. duress. d. none of the above.

anSweRing moRe legal PRoblemS

1. Trulov.com is an online dating site. Trulov allows sub- scribers to create profiles, browse other profiles, take a relationship test, use the site’s computerized match- ing system, and exchange messages. Browsing through profiles, Sophia, a subscriber, notices that many use the same phrases and photos. She files a suit against Trulov, alleging that the site created and posted false profiles of nonexistent “potential matches” to attract subscribers.

Has Trulov committed fraudulent misrepresentation? Yes. Fraud requires (1) a _______________ of a mate- rial fact, (2) an intent to deceive, and (3) an innocent party’s justifiable reliance on the _______________. To recover damages, the innocent party must also suffer an injury. Trulov created and posted bogus user profiles to entice new subscribers and retain old ones. This consti- tuted _______________ of material facts with an intent to deceive. Some new subscribers and some renewing subscribers relied on Trulov’s _______________. Dam- ages include the expense of initiating or continuing subscriptions.

2. Lionel, a Trulov subscriber, browses other profiles and contacts some of the subscribers. He discovers that the profiles many of the members created for themselves exaggerate their physical appearance, intelligence, experiences, accomplishments, and occupations. Tru- lov’s policy is to remove a subscriber’s profile when such deception is revealed.

Is Trulov liable for fraud in these circumstances? No. Fraud requires a _______________ of a material fact, as well as an intent to deceive. The intent is knowl- edge on the part of the _______________ party that facts have been falsely represented. There is clearly _______________ in these circumstances. It occurred through the exaggerated profiles created and posted by individual subscribers. Unless Trulov knew that the profiles were false and allowed them to remain despite its stated policy, however, there is no _______________ nor intent to deceive on its part.

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165

Learning OutcOmes

The four Learning Outcomes below are designed to help improve your understanding of the chapter. After reading this chapter, you should be able to:

Identify contracts that must be in writing.

Describe what satisfies the writing requirement.

State the parol evidence rule.

Differentiate between an integrated and a partially integrated contract.

1

2

3

4

14 Contracts That Must Be in Writing

A contract may be unenforceable if it is not in the proper form. Certain types of contracts are required by law to be in writing. If there is no written evidence of the contract, it may not be enforceable.

In this chapter, we examine the kinds of contracts that require a writing under what is called the Statute of Frauds. We conclude the chapter with a discussion of the parol evidence rule.

14–1 the statute of Frauds— Writing requirement

Every state has a statute that specifies what types of contracts must be in writing. Such a statute is referred to as the Statute of Frauds. The Statute of Frauds does not apply to fraud. Rather, it denies enforceability to certain contracts that do not comply with its requirements. The primary purpose of the statute is to prevent harm to innocent parties by requiring written evidence of agreements concerning important transactions.

Essentially, the Statute of Frauds requires certain contracts to be in writing or be evidenced by a written memorandum. A written memorandum can consist of any signed confirmation, invoice, check, sales slip, or e-mail.

The Statute of Frauds varies from state to state, but all states require the follow- ing contracts to be in writing (or evidenced by a written memorandum): 1. Contracts involving interests in land. 2. Contracts that cannot by their terms be performed within one year from the

day after the contract’s formation. 3. Collateral contracts, such as promises to answer for the debt or duty of another. 4. Promises made in consideration of marriage. 5. Under the Uniform Commercial Code, contracts for the sale of goods priced

at $500 or more.

Statute of Frauds A statute under which certain contracts must be in writing to be enforceable.

Learning OutcOme 1

Identify contracts that must be in writing.

form The manner observed in creating a legal agreement, as opposed to the substance of the agreement.

Conflict Presented Regional Community College forms a contract with Yolanda to teach three courses in business law during the next academic year (September 15 through June 15). Janine enters into a contract to

provide security for the college’s student center as long as the college needs the service.

Q Do these two contracts have to be in writing to be enforceable? Why or why not?

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U n i t 2 Contracts166

14–1a Contracts Involving Interests in Land Under the Statute of Frauds, a contract involving an interest in land must be in writing. Land is also called real property. A contract for the sale of land ordinar- ily involves the entire interest in the real property, including buildings, growing crops, vegetation, timber, and fixtures. A fixture is personal property attached to real property in such a way that it is part of that real property. Examples include carpeting, water faucets, and ceiling fans.

A contract calling for the sale of land is not enforceable unless it is in writing or evidenced by a written memorandum. ExamplE 14.1 Lewis is a party to an oral contract with Maria involving a vineyard. Neither Lewis nor Maria can force the other to buy or sell the land that is the subject of their contract. The Statute of Frauds is a defense to the enforcement of this contract. j

14–1b The One-Year Rule A contract that cannot, by its own terms, be performed within one year from the day after the contract is formed must be in writing to be enforceable. The one-year period begins to run the day after the contract is made. The idea behind the one- year rule is that a witness’s memory is not to be trusted for longer than a year.

ExamplE 14.2 Isabella enters into a contract with Diamond Auto Body & Paint in August. She states that she will provide accounting services to Diamond during the firm’s coming fiscal year, which begins October 1 and continues until September 30. Because the contract is formed in August, it must be in writing to be enforceable— because it cannot be performed within one year. j

Exhibit 14.1 graphically illustrates the one-year rule.

If Performance Is Objectively Impossible Note that for a particular contract to fall under the one-year rule, contract performance must be objectively impossible to complete within a year. For instance, a contract to provide five crops of tomatoes to be grown on a specific farm in Illinois would be impossible to perform within a year. It is impossible to grow five crops of tomatoes on the same farmland in a single year in Illinois.

If Performance Is Possible If the contract, by its terms, makes performance within the year possible (even if not probable), the contract does not fall within the Statute of Frauds and need not be in writing. ExamplE 14.3 Jason agrees to provide

exhibit 14.1 The One-Year Rule

If the contract can possibly be performed within a year, the contract does not have

to be in writing to be enforceable.

One Year from the Day after the Date of Contract Formation

Date of Contract Formation

If performance cannot possibly be completed

within a year, the contract must be in writing to be enforceable.

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C H A P T E R 1 4 Contracts That Must Be in Writing 167

office-cleaning services for Omar’s Imports for as long as the company needs his services. This means the contract could be fully performed within a year because Omar’s could go out of business within twelve months. Thus, the contract need not be in writing to be enforceable. j

14–1c Collateral Promises A collateral promise is secondary to a principal transaction or primary contractual relationship. Basically, a collateral promise is made by a third party to assume the debts—that is, the obligations to pay money—of a primary party to a contract if that party does not perform. Any collateral promise of this nature falls under the Statute of Frauds and must be in writing to be enforceable.

Primary versus Secondary Obligations To understand collateral promises, it is important to distinguish between primary and secondary promises and obligations. An unconditional promise to pay another person’s debt is a primary obligation. A promise to pay another person’s debt only if that person fails to pay is a secondary obligation.

collateral promise A secondary promise made by one person to pay the debts of another if that second party fails to perform.

Highlighting the Point

Fiona contracts with Cartwright Manufacturing Company to have some machines made to detailed specifications for her factory. She promises Allrite Supply Company, Cartwright’s supplier, that if Allrite continues to deliver materials to Cartwright, Fiona will guarantee payment.

under the statute of Frauds, does Fiona’s promise need to be in writing to be enforceable? No. Fiona’s promise need not be in writing, because her main purpose is to secure a benefit for herself.

Highlighting the Point

Pablo contracts with Dr. Joanne Leong to have his daughter’s wisdom teeth pulled the following week. Pablo promises to pay for the dental work when he receives the bill from Leong’s dental office. On the same day, Pablo’s daughter borrows $10,000 from the Medford Bank to remodel her kitchen. Pablo promises the bank that he will pay the $10,000 if his daughter does not repay the loan on time.

Which of these promises must be in writing to be enforceable under the statute of Frauds? In contracting for the dental work, Pablo incurs a primary obligation. Under the Statute of Frauds, this contract does not have to be in writing to be enforceable. If Pablo fails to pay Leong and she sues him for payment, Pablo cannot claim that the contract is unenforceable because it was not in writing.

Pablo’s promise to repay his daughter’s debt to Medford Bank, however, is a secondary obligation. This promise must be in writing to be enforceable. Pablo, in this situation, becomes a guarantor of the loan—meaning that he guarantees that he will pay back the loan if his daughter fails to do so.

An Exception—The “Main Purpose” Rule An oral promise to answer for the debt of another need not be in writing if the guarantor’s main purpose in accepting secondary liability is to secure a personal benefit. This exception is known as the “main purpose” rule. The assumption is that a court can infer from the circumstances whether the promisor’s “leading objective” was to secure a personal benefit.

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U n i t 2 Contracts168

Another typical application of the so-called main purpose rule occurs when one creditor guarantees a debtor’s debt to another creditor to prevent litigation. This allows the debtor to remain in business long enough to generate profits sufficient to pay both creditors.

14–1d Promises Made in Consideration of Marriage A unilateral promise to pay a sum of money or to give property in consideration of a promise to marry must be in writing. ExamplE 14.4 Ralph promises to pay Stewart $10,000 if he agrees to marry Ralph’s daughter, Taylor. This promise must be in writing. j

The same rule applies to prenuptial agreements. These agreements are made before marriage and define each partner’s ownership rights in the other partner’s property. Prenuptial arrangements made in consideration of marriage must be in writing to be enforceable.

ExamplE 14.5 Before they marry, Helen and Charlie enter into a prenuptial agreement. Helen, an international supermodel, agrees that if they divorce, she will pay Charlie $100,000 for every year of the marriage, unless he uses drugs. In that event, Charlie will receive nothing from Helen. This agreement must be in writing. j

14–1e Contracts for the Sale of Goods The Uniform Commercial Code (UCC) is a body of law that governs commercial transactions within the United States. Commercial transactions occur in the busi- ness environment between merchants and involve contracts for the sale (and lease) of goods.

Like each state’s Statute of Frauds, the UCC has its own Statute of Frauds provi- sions that require written evidence or an electronic record of a contract. Under these provisions, sales contracts for goods priced at $500 or more must be in writing to be enforceable.

To satisfy the UCC requirement, a writing—including e-mail or another type of electronic record—need only state the quantity term. Other terms need not be stated “accurately” in the writing, as long as they adequately reflect both parties’ intentions. The contract will not be enforceable for any quantity greater than that set forth in the writing. In addition, the writing must have been signed by the person who refuses to perform or the one being sued.

14–1f Exceptions to the Writing Requirement Exceptions to the writing requirement are made in certain situations. These include partial performance, admissions, and promissory estoppel.

Partial Performance An oral contract that should be in writing to be enforceable under the Statute of Frauds may be enforceable if it has been partially performed. When a contract has been partially performed, and the parties cannot be returned to their positions before the contract was made, a court may grant specific performance. Specific performance is an equitable remedy (court-ordered relief that does not usually involve money) that requires performance of the contract according to its precise terms. The parties must prove that an oral contract existed, of course.

In cases involving oral contracts for the transfer of interests in land, for instance, courts usually look at whether justice is better served by enforcing the oral contract when partial performance has taken place.

prenuptial agreements An agreement entered into in contemplation of marriage, specifying the rights and ownership of the parties’ property.

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C H A P T E R 1 4 Contracts That Must Be in Writing 169

Admissions In some states, if a party against whom enforcement of an oral contract is sought “admits” under oath that a contract for sale was made, the contract will be enforceable. If a party admits to a contract subject to the UCC, the contract is enforceable, but only to the extent of the quantity admitted.

ExamplE 14.6 Rachel, the president of Bistro Corporation, admits under oath that an oral agreement was made with Commercial Kitchens, Inc., to buy certain equipment for $10,000. A court will enforce the agreement only to the extent admitted ($10,000), even if Commercial Kitchens claims that the agreement involved $20,000 worth of equipment. j

Promissory Estoppel In some states, an oral contract that would otherwise be unenforceable under the Statute of Frauds may be enforced under the doctrine of promissory estoppel. If a promisor makes a promise on which the promisee justifiably relies to his or her detriment, a court may estop (prevent) the promisor from denying that a contract exists. In these circumstances, an oral promise can be enforceable if two requirements are met: 1. The person making the promise must foresee that the promisee will rely

on it. 2. There must be no way to avoid injustice except to enforce the promise.

14–2 the sufficiency of the Writing Either a written contract or a written memorandum signed by the party against whom enforcement is sought will satisfy the Statute of Frauds.

14–2a Memorandums As mentioned earlier, a written memorandum can consist of any confirmation, invoice, sales slip, check, or e-mail. Any one of these items may constitute a writing that satisfies the Statute of Frauds.

In addition, a written contract need not consist of a single document to consti- tute an enforceable contract. One document may incorporate another document by expressly referring to it. Several documents may form a single contract if they are physically attached by staple, paper clip, or glue, or even if they are only placed in the same envelope.

Highlighting the Point

Liza orally agrees to buy a small piece of vacant land from James for $8,000. Liza gives James a $4,000 down payment and begins making monthly payments on the remaining balance. During this time, she improves the land for a community garden. Liza has several truckloads of fertile soil delivered, and she constructs several raised planting beds on the land. After four months, James claims their agreement is not enforceable and wants his land back.

is the oral contract enforceable because of partial performance? Yes. Liza has paid more than half the purchase price for the land and has made substantial improve- ments. It would be impossible to return James and Liza to their original positions before the oral contract was formed. A court will most likely grant specific per- formance, allowing Liza to finish paying for the land and creating her community garden.

Learning OutcOme 2

Describe what satisfies the writing requirement.

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U n i t 2 Contracts170

14–2b Essential Terms A memorandum evidencing an oral contract must contain the essential terms of the contract. Under the UCC, for a sale of goods the writing need only name the quantity term and be signed by the party being charged. Under most provisions of the Statute of Frauds, the writing must name the parties, subject matter, consider- ation, and quantity.

Contracts for the sale of land must state the essential terms of the contract (such as location and price) and describe the property with sufficient clarity to allow the terms to be determined from the memo, without reference to any outside sources.

Real Case

Russell and Sally Kiker owned a house in Newton County, Arkansas. Mona Sloop agreed to buy it for $850,000. The parties signed a contract that identified the property by its street address and stipulated a $350,000 down payment. The down payment was nonrefundable if closing did not occur by August 31. When the closing did not occur, the Kikers filed a suit in an Arkansas state court against Sloop, seeking a declaration that they were entitled to keep the down payment. Sloop filed a claim for the return of the $350,000. She argued that their contract violated the Statute of Frauds because it lacked a sufficient property description. The court issued a summary judgment in the Kikers’ favor. Sloop appealed.

Did the contract satisfy the statute of Frauds? Yes. In Sloop v. Kiker, a state intermedi- ate appellate court affirmed the judgment of the lower court. The street address of the property in the contract’s terms satisfied the Statute of Frauds.

—484 S.W.3d 696 (Ark.App.)

14–2c Signatures A party’s signature can be anywhere in the writing and does not need to be placed at the end. Also, a signature can even be initials rather than the full name.

E-Signatures An e-signature is “an electronic sound, symbol, or process attached to or logically associated with a record and executed or adopted by a person with the intent to sign the record,” according to the Uniform Electronic Transactions Act (UETA). A party’s name typed at the end of an e-mail note, for instance, meets this signature requirement. An e-signature is as valid as a signature on paper, and an e-document is as enforceable as a paper one. (See the Linking Business Law to Your Career feature at the end of the chapter.)

Enforcement of a Signature Only the party against whom enforcement is sought must have signed the writing. Therefore, a contract may be enforceable by one of its parties but not by the other. ExamplE 14.7 Troy and Wilma make an oral agreement. Troy writes and signs a memo setting out the essential terms of the agreement. Wilma can now hold him to these terms. He cannot enforce the contract against Wilma, however, because she has signed nothing. j

14–3 the Parol evidence rule Sometimes, a written contract does not include—or contradicts—an oral under- standing. When a dispute arises in such situations, the courts look to a common law rule governing the admissibility of oral evidence in court, or parol evidence in

e-signature An electronic sound, symbol, or process used as a signature.

Learning OutcOme 3

State the parol evidence rule.

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C H A P T E R 1 4 Contracts That Must Be in Writing 171

court. Parol evidence is testimony or other evidence of communications between the parties not contained in the written contract.

Under the parol evidence rule, if a court finds that the parties intended their written contract to be a complete and final statement of their agreement, then it will not allow either party to present parol evidence. As a result, evidence of the parties’ prior negotiation or oral agreements cannot be introduced to a court if that evidence contradicts the terms of the written contract.

14–3a Exceptions to the Parol Evidence Rule Because of the rigidity of the parol evidence rule, courts make several exceptions. These exceptions are discussed next.

Contracts Subsequently Modified Evidence of a subsequent modification of a written contract can be introduced into court. Keep in mind that an oral modification may not be enforceable if it comes under the Statute of Frauds. This could occur, for instance, if the oral modification increased the price of the goods in a sales contract to $500 or more. Also, oral modifications will not be enforceable if the original contract provides that any modification must be in writing.

Voidable or Void Contracts Oral evidence can be introduced to show that the contract was voidable or void (for example, induced by mistake or fraudulent misrepresentation). If deception led one of the parties to agree to the terms of a written contract, oral evidence attesting to fraud should not be excluded. Courts frown on bad faith and are quick to allow such evidence when it establishes fraud.

Ambiguous Terms When the terms of a written contract are ambiguous or not clear, evidence is admissible to show the meaning of the terms.

ExamplE 14.8 Pam buys a home from Samuel by taking out a loan with a bank. Pam’s contract with Samuel states that Pam will make payments on the loan until it is paid in full. “The house” will then become Pam’s. The agreement also stipulates that Pam will obtain insurance on “the property.” The house is destroyed in a hur- ricane, and the insurance proceeds pay the balance of Pam’s loan. Samuel claims the land, however, arguing that he sold only the house to Pam. A court finds that the contract’s references to “the house” and “the property” are ambiguous. The court admits parol evidence to show that the parties intended to transfer ownership of both the house and the land. j

Incomplete Contracts Evidence is admissible when the written contract is incomplete in that it lacks one or more of the essential terms. The courts allow evidence to “fill in the gaps.”

parol evidence rule A rule governing the admissibility of oral evidence in court.

Highlighting the Point

Elise, an architect, agrees to design a house for Glenn. Their contract outlines her services and states that Glenn is to pay Elise “a 10 percent fee of the house’s cost.” The contract is silent as to the style of the house and related particulars, including the maximum cost. Elise prepares the design and solicits bids for construction. The lowest bid is $400,000. Glenn rejects it and refuses to proceed, contending that they have agreed the maximum cost would not exceed $250,000. Elise files a lawsuit to recover her $40,000 fee (which is 10 percent of the lowest bid of $400,000).

is the contract incomplete enough to allow the court to admit parol evidence? Yes. At trial, the court finds the written contract to be incomplete and admits parol

(Continues)

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U n i t 2 Contracts172

Customary Practices When buyers and sellers deal with each other over extended periods of time, certain customary practices develop. The parties often overlook these practices when writing a contract. So courts allow the introduction of evidence to show how the parties have acted in the past. Under the UCC, evidence can be introduced to explain or supplement a written contract by showing a prior dealing, course of performance, or usage of trade.

An Orally Agreed-on Condition The parol evidence rule does not apply if the existence of the entire written contract is subject to an orally agreed-on condition. Proof of the condition does not alter or modify the written terms but involves the enforceability of the written contract.

ExamplE 14.9 A lease between the city of Cheddar Bay and Romano, the owner of Monterey Corporate Office Suites, is subject to the approval of the city council. This approval is a condition required for the formation of the lease. If a dispute arises over the lease, the parol evidence rule will not apply. Oral evidence will be admissible to show whether the council has approved the terms and thus whether the lease is enforceable. j

Obvious Errors When an obvious clerical error exists that clearly would not represent the agreement of the parties, parol evidence is admissible to correct the error. For instance, a written lease provides for monthly rent of $300 rather than the $3,000 orally agreed to by the parties. Parol evidence will be admissible to correct the obvious mistake.

14–3b Integrated Contracts In determining whether to allow parol evidence, courts consider whether the writ- ten contract is intended to be a complete and final statement of the terms of the agreement. If it is, the contract is referred to as an integrated contract, and outside evidence is excluded.

To be considered an integrated contract, a contract must be completely inte- grated. That is, it must contain all of the terms of the parties’ agreement. If, instead, the contract contains only some of the agreed-on terms, it is partially integrated. If the contract is only partially integrated, evidence of consistent additional terms is admissible to supplement the written agreement.

Courts allow parol evidence only to add to the terms of a partially integrated contract. For both completely and partially integrated contracts, courts exclude any evidence that contradicts the writing of the contract. Exhibit 14.2 illustrates the relationship between integrated contracts and the parol evidence rule.

integrated contract A written contract that constitutes the final expression of the parties’ agreement.

Learning OutcOme 4

Differentiate between an integrated and a partially integrated contract.

evidence. This parol evidence shows that at the time of contract formation, Glenn told Elise that the cost of the house could not be more than $250,000. The evidence also reveals that Elise replied, “My fee will be $25,000.” The court orders Glenn to pay $25,000, not $40,000, to Elise.

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C H A P T E R 1 4 Contracts That Must Be in Writing 173

exhibit 14.2 The Parol Evidence Rule

COMPLETELY INTEGRATED Intended to be a complete and �nal

embodiment of the terms of the parties’ agreement.

PARTIALLY INTEGRATED Omits an agreed-on term that is

consistent with the parties’ agreement.

Parol Evidence Is Not Allowed. Parol Evidence May Be Allowed.

WRITTEN CONTRACT

Conflict Resolved In the Conflict Presented feature set out at the beginning of this chapter, Regional Community College contracted with Yolanda to teach courses in business law during the next academic year, which

ends June 15, and with Janine to provide security for the student center as long as the college needs it.

a Do these two contracts have to be in writing to be enforceable? Under the Statute of Frauds, a contract that cannot, by its own terms, be performed within one

year from the day after the contract is formed must be in writing to be enforceable.

Thus, if Yolanda’s contract was formed before June 14 of the preceding year, it must be

in writing to be enforceable, because it cannot be performed within one year.

If the contract was formed after June 14, however, it does not need to be in writing,

because it can be performed within one year. Similarly, Janine’s contract does not

need to be in writing, because it could conceivably be performed within one year.

Although the college’s need for her services could continue indefinitely, it could also

run out within twelve months.

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U n i t 2 Contracts174

Linking Business Law to Your Career

EnforcEablE E-Mail contracts

At any point in your business career, you may represent yourself or your company in contract negotiations. These negotia- tions may involve oral and written con- tacts, including communication online.

sufficiency of the Writing

A series of e-mail exchanges can com- prise a writing that constitutes a con- tract. In other words, five e-mail messages between two parties may collectively form a single contract. If the e-mails name the parties, identify the subject matter, and state the con- sideration, a court normally will hold that they satisfy the writing require- ment under the Statute of Frauds.

Precise Language

E-mail is a medium that may increase the possibility for ambiguities. After all, we often compose e-mails quickly and use casual language that may be impre- cise. When e-mailing business contacts, therefore, you should:

1. Include an informative subject line. Specify the subject exactly— such as “Change in Delivery Date for XYZ Portable Generators.”

2. Repeat the subject within the body of the message. That way, if the recipient skips reading the subject line, the message will still be clear.

3. Focus on a limited number of subjects. Send separate e-mails to discuss different topics.

4. Be clear. If you do not phrase your communication carefully to say what you intend, you may create an enforceable contract without intending to do so.

5. proofread your writing. Review- ing your e-mails before you send them may be the most important step in avoiding misinterpretations.

Learning OutcOme 1: identify contracts that must be in writing. Contracts that must be in writing to be enforceable under the Statute of Frauds include the following:

(1) Contracts involving interests in land. (2) Contracts that cannot by their terms be performed within one year from the day after the contract’s formation. (3) Collateral contracts, such as promises to answer for the debt or duty of another. (4) Promises made in consideration of marriage. (5) Contracts for sales of goods priced at $500 or more.

Learning OutcOme 2: Describe what satisfies the writing requirement. To constitute an enforceable contract under the Statute of Frauds, a writing must be signed by the party against whom enforcement is sought and state with reasonable certainty the essential terms of the contract. Generally, it must name the parties, subject matter, consideration, and quantity. A contract for the sale of land must also describe the property. A contract for a sale of goods is not enforceable beyond the quantity of goods stated.

Learning OutcOme 3: state the parol evidence rule. The parol evidence rule prohibits the introduction at trial of oral statements that contradict or change the terms of the contract itself. The written contract is assumed to be the complete and final embodiment of the parties’ agreement.

Learning OutcOme 4: Differentiate between an integrated and a partially integrated contract. An integrated contract is a writing that is intended to be a complete and final embodiment of the terms of an agreement between contracting parties. A partially integrated contract omits an agreed-on term that is consistent with the parties’ agreement.

CHaPteR SummaRY—ContRaCtS tHat muSt Be in WRiting

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C H A P T E R 1 4 Contracts That Must Be in Writing 175

iSSue SPotteRS Check your answers to the Issue Spotters against the answers provided in Appendix A at the end of this text.

1. GamesCo orders $800 worth of game pieces from Mid- state Plastic, Inc. Midstate delivers, and GamesCo pays for $450 worth. GamesCo then says it wants no more pieces from Midstate. GamesCo and Midstate have never dealt with each other before and have nothing in writing. Can Midstate enforce a deal for $350 more? Explain your answer. (see The Statute of Frauds—Writing Requirement.)

2. Paula orally agrees to work with Next Corporation in New York City for two years. Paula moves her family and begins work. Three months later, Paula is fired for no stated cause. She sues for reinstatement or pay. Next Corporation argues that there is no written contract between them. What will the court say? (see The Statute of Frauds—Writing Requirement.)

StRaigHt to tHe Point

1. What is the primary purpose of the Statute of Frauds? (see The Statute of Frauds—Writing Requirement.)

2. When does the one-year period of the one-year rule begin? (see The Statute of Frauds—Writing Requirement.)

3. What is a collateral promise? (see The Statute of Frauds— Writing Requirement.)

4. At what price does a sale of goods require a writing? (see The Statute of Frauds—Writing Requirement.)

5. What are three exceptions to the Statute of Frauds? (see The Statute of Frauds—Writing Requirement.)

6. When the terms of a written contract are ambiguous, how can the meaning of the terms be shown? (see The Parol Evidence Rule.)

ReaL LaW

14–1. statute of Frauds—Writing requirement. Madeline Castellotti was the sole shareholder of Whole Pies, Inc., which owns John’s Pizzeria in New York City. Her other assets included an interest in a real estate partnership, a residence on Staten Island, and bank accounts. When Mad- eline’s son Peter was going through a divorce, Madeline wanted to prevent his wife from obtaining any of Mad- eline’s assets. She removed Peter from her will, leaving her daughter Lisa as the sole beneficiary. Lisa orally agreed to transfer half of the assets to Peter after the divorce. In reli- ance on that promise, Peter agreed to pay the property taxes for the estate. Madeline died and Peter paid the taxes, but Lisa reneged on the deal. Is there a legal theory on which a court might enforce Lisa’s promise? [Castellotti v. Free, 138 A.D.3d 198, 27 N.Y.S.3d 507 (1 Dept. 2016)] (see The Statute of Frauds—Writing Requirement.)

14–2. Promises made in consideration of marriage. After twenty-nine years of marriage, Robert and Mary Lou Tuttle were divorced. They admitted in court that before they were

married, they had signed a prenuptial agreement and had agreed on its general term that each would keep his or her own property and anything derived from that property. But a copy of the prenuptial agreement could not be found. Can the court enforce the agreement without a writing? Why or why not? [In re Marriage of Tuttle, 2013 WL 164035 (5 Dist. 2013)] (see The Statute of Frauds—Writing Requirement.)

14–3. sufficiency of the Writing. Newmark & Co. Real Estate, Inc., contacted 2615 East 17 Street Realty, LLC, to lease certain real property on behalf of a client. Newmark e-mailed the landlord a separate agreement for the pay- ment of Newmark’s commission. The landlord e-mailed it back with a request to pay the commission in installments. Newmark revised the agreement and e-mailed a final copy to the landlord. Does this exchange qualify as a writing under the Statute of Frauds? Explain. [Newmark & Co. Real Estate Inc. v. 2615 East 17 Street Realty, LLC, 80 A.D.3d 476, 914 N.Y.S.2d 162 (1 Dept. 2011)] (see The Sufficiency of the Writing.)

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U n i t 2 Contracts176

etHiCaL QueStionS

14–4. Prenuptial agreements. Should prenuptial agreements be enforced if one party did not have the advice of counsel? Discuss. (see The Statute of Frauds—Writing Requirement.)

14–5. the One-Year rule. Robert and Lynette Knigge owned a B&L Food Store in Redfield, South Dakota. Robert, diagnosed with brain cancer and given five months to live, entered into an oral contract with his brother, David, to manage the store. Robert died five months after the date of the contract. Lynette terminated David’s employment two

months later. David filed a suit in a South Dakota state court against his sister-in-law. He alleged that the oral con- tract with his brother provided for a severance payment if Lynette ended his employment after her husband’s death. Does the one-year rule under the Statute of Frauds apply to these facts? Under what circumstances might Lynette have an ethical duty to honor Robert’s promise to his brother? Is David ethically obligated to honor Lynette’s decision? Explain. [David Knigge v. B&L Food Stores, Inc., 2017 S.D. 4 (2017)] (see The Statute of Frauds—Writing Requirement.)

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177

1. Contracts for transfers, other than sales, of interests in land need not be in writing to be enforceable under the Statute of Frauds.

2. A contract for a sale of goods of over $300 must be in writing to be enforceable under the Statute of Frauds.

3. An oral contract that should be in writing to be enforceable under the Statute of Frauds may be enforceable f it has been partially performed.

4. The only writing sufficient to satisfy the Statute of Frauds is a typewritten form, signed at the bottom by all parties, with the heading “Contract” at the top.

5. Under the parol evidence rule, virtually any evidence is admissible to prove or disprove the terms of a contract.

6. A promise to answer for the debt of another must be in writing to be enforceable, unless the guarantor’s main purpose is to obtain a personal benefit.

7. A contract that makes performance within one year possible need not be in writing to be enforceable.

8. A promise to pay a sum of money in consideration of a promise to marry must be in writing.

9. Under the Statute of Frauds, any contract that is not in writing is void.

tRue-FaLSe QueStionS

Chapter 14—Work Set

1. Walt sells his pickup truck to Bob. When Walt starts to remove its camper shell, Bob says, “Wait. We agreed the camper shell was included.” Walt points to their written contract and says, “No, we didn’t.” The contract says noth- ing about the camper shell. The camper shell is

a. part of the deal under the parol evidence rule. b. not part of the deal under the parol evidence rule. c. part of the deal, because Bob thought it was. d. not part of the deal, because Walt thought it was not.

2. On March 1, the chief engineer for the software design division of Uni Products orally contracts to hire Lee for one year, beginning March 4. Lee works for Uni for five months. When sales decline, Lee is discharged. Lee sues Uni for reinstatement or seven months’ salary. Lee will

a. win, because the contract can be performed within one year. b. win, because employment contracts need not be in writing to be enforceable. c. lose, because the contract cannot be performed within one year. d. lose, because employment contracts must be in writing to be enforceable.

3. National Properties, Inc., orally contracts for a sale of its lot and warehouse to U.S. Merchants, Inc., but later decides not to go through with the sale. The contract is most likely enforceable against

a. both National and U.S. Merchants. b. National only. c. U.S. Merchants only. d. neither National nor U.S. Merchants.

4. Hans owes Bell Credit Company $10,000. Chris orally promises Bell that he will pay Hans’s debt if Hans does not. This promise is

a. not enforceable, because it is not in writing. b. enforceable under the “main purpose rule” exception. c. not enforceable, because the debt is Hans’s. d. enforceable under the partial performance exception.

muLtiPLe-CHoiCe QueStionS

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178

5. Which of the following constitutes a writing that satisfies the Statute of Frauds?

a. A signed sales slip. b. A blank invoice. c. An empty envelope. d. All of the above.

6. Terry signs a letter setting out the essential terms of an oral contract with Adrian. Those terms are most likely enforceable against

a. both Terry and Adrian. b. Terry only. c. Adrian only. d. neither Terry nor Adrian.

7. Jim orally promises to work for Pat, and Pat orally promises to employ Jim at a rate of $500 a week. This contract must be in writing to be enforceable if Jim promises to work for

a. his entire life. b. at least five years. c. five years, but either party may terminate the contract on thirty days’ notice. d. either a or c.

8. Tom orally agrees to be liable for Meg’s debt to Ace Loan Company. If Tom’s purpose for this guaranty is to obtain a personal benefit, the guaranty is

a. enforceable whether or not it is in writing. b. enforceable only if it is in writing. c. unenforceable if it is in writing. d. unenforceable.

anSWeRing moRe LegaL PRoBLemS

1. On June 1, Mel, the owner of Fresco Organico, asks Ray to deliver Fresco’s menu items to customers on State Uni- versity’s campus until June 15, which is the final day of the spring semester. Ray says he’ll do it if Mel agrees to pay him a certain hourly wage or $500 plus tips, which- ever is more. Mel agrees. Nothing is put in writing.

is this oral agreement enforceable? Yes. A contract that is oral when it is required to be in writing will not, as a rule, be enforced by the courts. Mel and Ray’s agreement does not fall into any of the categories listed below and is thus enforceable despite the lack of a writing.

The following types of contracts must be in writing or be evidenced by a written memorandum: (1) con- tracts involving interests in _______________, (2) con- tracts that cannot by their terms be performed within one _______________ from the day after the contract’s formation, (3) _______________ promises, (4) prom- ises made in consideration of _______________, and

(5) contracts for the sale of _______________ priced at $500 or more.

2. Sushi Yo! makes ready-to-eat Asian seafood dishes that are sold in grocery stores. Sushi Yo! and Dragonfly Tea Company comarket their products in Milwaukee. Due to their success, the two firms negotiate a new comar- keting agreement for Chicago. Sushi Yo! e-mails a pro- posed multiyear contract to Dragonfly, but Dragonfly does not sign it or respond.

is this deal enforceable against Dragonfly? No. Under the Statute of Frauds, a contract that cannot, by its own terms, be performed within one _______________ from the day after the contract is formed must be in writing to be enforceable. Because Sushi Yo!’s pro- posed contract could not be performed within a _______________, it was not enforceable without a writing _______________ by Dragonfly. Because Drag- onfly did not _______________ the proposal, it was not enforceable.

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179

Learning OutcOmes

The four Learning Outcomes below are designed to help improve your understanding of the chapter. After reading this chapter, you should be able to:

Describe a contract assignment.

Define a contract delegation.

Identify noncontracting parties with contract rights.

Explain when a third party beneficiary’s rights in a contract vest.

1

2

3

4

15 Third Party Rights

A contract is a private agreement between the parties who have entered into it. So these parties alone should have rights and liabilities under the contract. This is referred to as privity of contract. Privity of contract establishes the basic concept that third parties have no rights in contracts to which they are not parties.

ExamplE 15.1 Jean offers to sell Ben her Superbowl ticket, and he accepts. Later, Jean refuses to deliver the ticket to Ben. Although Ben decides to overlook the breach of contract, his mother, Edith, is outraged by Jean’s behavior and wants to sue. Edith cannot successfully sue Jean for the breach because Edith is not a party to the contract. j

In this chapter, we look at some exceptions to the rule of privity of contract. These exceptions include assignments and delegations, as well as third party beneficiary contracts.

15–1 assignments and Delegations In some situations, third parties acquire rights or assume duties arising from a contract to which they were not parties. The rights are transferred to them by assignment, and the duties are transferred by delegation. Assignment and delegation occur after the original contract is made.

15–1a Assignments The transfer of rights to a third person is known as an assignment. Assignments are important because they are often used in business and mortgage financing. Lending institutions, such as banks, frequently assign the rights to receive payments under their loan contracts to other firms, which pay for those rights.

ExamplE 15.2 Chelsea obtains a loan from Downtown Credit to purchase a car. She may later receive a notice stating that Downtown has transferred (assigned) its rights to receive payments on the loan to another firm and that she should make

assignment Transferring one’s rights under a contract.

privity of contract The relationship that exists between contracting parties.

Learning OutcOme 1

Describe a contract assignment.

Conflict Presented Wayne attends Metro Community College. To pay tuition and meet other expenses, Wayne obtains a loan from the First National Bank. Six months later, Wayne receives a letter stating

that the bank has transferred its rights to receive Wayne’s loan payments to the Educational Loan Collection Agency (ELCA). The letter tells Wayne that when he begins making payments, he should make them directly to the ELCA.

Q What is this transfer called? should Wayne pay the bank or the eLca?

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U n i t 2 Contracts180

her payments to that other firm. j Billions of dollars change hands daily in the business world in the form of assignments of rights in contracts.

Parties to an Assignment In an assignment, the party assigning the rights to a third party is the assignor. The party receiving the assignment rights is the assignee. Other terms used to describe the parties in assignment relationships are obligee (the person to whom a duty, or obligation, is owed) and obligor (the person who is obligated to perform the duty).

Extinguished Rights When rights under a contract are assigned unconditionally, the rights of the assignor are extinguished. The third party (the assignee) has a right to demand performance from the other original party to the contract (the obligor).

ExamplE 15.3 Brent, the obligor, owes Alex, the obligee, $1,000. Later, Alex assigns the right to receive the $1,000 to Carmen. Alex is now the assignor. A valid assignment of a debt exists. Carmen, the assignee, can enforce the contract against Brent, the obligor, if Brent fails to pay the $1,000. j Exhibit 15.1 illustrates this assignment relationship.

Defenses The assignee’s rights are subject to any defenses that the obligor has against the assignor. In other words, the assignee obtains only those rights that the assignor originally had. ExamplE 15.4 Alex leases an apartment from Brent for one year but fails to pay the seventh month’s rent. If Alex then assigns the lease to Carmen, Brent can evict Alex and Carmen, even though Carmen is innocent of the failure to pay the rent. j

Rights That Cannot Be Assigned As a general rule, all rights can be assigned. Exceptions are made, however, under certain circumstances, including the following: 1. The assignment is prohibited by statute. If a statute expressly (clearly)

prohibits assignment, the particular right in question cannot be assigned. 2. The contract is personal in nature. Because personal services are unique

to the person rendering them, the right to receive those services cannot be assigned.

ExamplE 15.5 Brenda signs a contract to tutor Erik’s children. Erik then attempts to assign his right to Brenda’s tutoring services to his friend, Corina, who has three daughters in need of a tutor. Corina, however, cannot enforce the contract against Brenda. Tutoring is a specialized personal service, and only Brenda can decide whom she tutors. j

exhibit 15.1 Assignment Relationships

Original Contract

Assignment of Rights

Brent (obligor)

Carmen (assignee)

Alex (obligee-assignor)

Duties Owed after Assignment

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C H A P T E R 1 5 Third Party Rights 181

3. The assignment materially changes a risk or duty. A right cannot be assigned if that assignment will significantly increase or alter the risks to, or the duties of, the obligor.

ExamplE 15.6 Martin takes out a policy with Coast Insurance to insure his hotel. The policy insures against fire, theft, and floods. Martin then attempts to assign his policy to Camille, who owns a hotel by a river. This assignment is ineffective because it may substantially alter Coast’s duty of performance and its risk. In short, Coast agreed to insure Martin’s hotel, not Camille’s. Camille must apply for her own policy with Coast. j

4. The contract prohibits assignment. If a contract expressly stipulates that the rights cannot be assigned (an anti-assignment clause), then ordinarily they cannot be assigned. Often, how the anti-assignment clause is phrased determines whether it is effective or not. A contract stating that any assignment is void effectively prohibits the assignment of rights.

Notice of Assignment Once a valid assignment of rights has been made to a third party, the third party should notify the original party to the contract (the obligor) of the assignment. This notice is not legally necessary to establish the validity of the assignment, because an assignment is effective immediately. Two major problems arise, however, when notice of the assignment is not given to the obligor. 1. If the assignor assigns the same right to two different persons, the question

arises as to which one has priority—that is, the right to performance by the obligor. The rule most often observed in the United States is that the first assignment in time is the first in right. Some states follow the English rule, however, which basically gives priority to the first assignee who gives notice of assignment.

2. Until the obligor has notice of assignment, the obligor can discharge his or her obligation by performance to the assignor. Performance by the obligor to the assignor constitutes a discharge to the assignee. Once the obligor receives proper notice, only performance to the assignee can discharge the obligor’s obligations.

Highlighting the Point

Shane agrees to build a house for Kenneth. The contract between Shane and Kenneth states, “This contract cannot be assigned by Kenneth without Shane’s consent. Any assignment without such consent renders this contract void, and all rights hereunder will thereupon terminate.” Later, Kenneth assigns his rights to Alana without first obtaining Shane’s consent.

is the anti-assignment clause in shane and Kenneth’s contract enforceable? Yes. The anti-assignment clause is effective. Kenneth cannot assign his rights without Shane’s consent. Alana cannot enforce the contract against Shane.

Highlighting the Point

McKenna owes Hugo $1,000 on a contractual obligation. Hugo assigns this monetary claim to Maria. No notice of assignment is given to McKenna, however. McKenna pays Hugo the $1,000.

(Continues)

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U n i t 2 Contracts182

15–1b Delegations Just as a party can transfer rights through an assignment, a party can transfer duties through a delegation. Normally, a delegation of duties does not relieve the party making the delegation (the delegator) of the obligation to perform in the event that the party to whom the duty has been delegated (the delegatee) fails to perform. No special form is required to create a valid delegation of duties. As long as the delega- tor expresses an intention to make the delegation, it is effective.

Delegation relationships are graphically illustrated in Exhibit 15.2. In the exhibit, Brent delegates his duties under a contract that he made with Alex to a third party, Carmen. Brent thus becomes the delegator and Carmen the delegatee of the con- tractual duties. Carmen now owes performance of the contractual duties to Alex. Note that a delegation of duties normally does not relieve the delegator (Brent) of liability if the delegatee (Carmen) fails to perform the contractual duties.

Duties That Cannot Be Delegated As a general rule, any duty can be delegated. This rule has some exceptions, however. Delegation is prohibited in the following circumstances: 1. When the duties are personal in nature. ExamplE 15.7 Megan is known for

her expertise in finance. She is hired to teach the various aspects of financial underwriting and investment banking. Megan’s duty cannot be delegated. j

2. When performance by a third party will vary materially from that expected by the obligee under the contract. ExamplE 15.8 Jared, a wealthy investor, establishes Heaven Sent, LLC, to provide funds to struggling but potentially successful businesses. Jared contracts with Merilyn, whose judgment Jared trusts to select the recipients. Later, Merilyn delegates this duty to Donald. Jared does not trust Donald’s ability to select worthy recipients. This delegation is not effective because it materially alters Jared’s expectations under the contract with Merilyn. j

Learning OutcOme 2

Define a contract delegation.

delegation The transfer of a contractual duty to a third party.

exhibit 15.2 Delegation Relationships

Original Contract

Performance

Brent (obligor-delegator)

Alex (obligee)

Delegation of Duties

Carmen (delegatee)

is the assignment valid? Does mcKenna’s payment discharge the debt, or does mcKenna also have to pay maria? The assignment is valid. McKenna’s payment to Hugo discharges the debt. Maria’s failure to give notice to McKenna of the assignment causes Maria to lose the right to collect the $1,000 from McKenna. If Maria gives McKenna notice, McKenna's payment to Hugo discharges the debt, and Maria has a legal right to require payment from McKenna.

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C H A P T E R 1 5 Third Party Rights 183

3. When the contract prohibits delegation. ExamplE 15.9 Dakota Company contracts with Bella, a certified public accountant, to perform its audits. Because the contract includes a clause that prohibits delegation, Bella cannot delegate the duty to perform the audits to another accountant. j

Effect of a Delegation If a delegation of duties is enforceable, the obligee must accept performance from the delegatee. The obligee can legally refuse performance from the delegatee only if the duty is one that cannot be delegated. As mentioned, a valid delegation of duties does not relieve the delegator of obligations under the contract. If the delegatee fails to perform, the delegator is still liable to the obligee.

Liability of the Delegatee Can the obligee hold the delegatee liable if the delegatee fails to perform? If the delegatee has made a promise of performance that will directly benefit the obligee, there is an “assumption of duty.” Breach of this duty makes the delegatee liable to the obligee.

Highlighting the Point

Leo contracts with Donna to build a house according to Donna’s blueprint. Leo becomes seriously ill and contracts to have Hal build the house for Donna. Hal fails to build the house.

can Donna sue Leo? can Donna sue Hal? Because the delegatee, Hal, contracted with Leo (the obligor) to build the house for the benefit of Donna (the obligee), Donna can sue Leo, Hal, or both. Although there are many exceptions, the general rule is that the obligee can sue both the delegatee and the obligor.

15–1c Assignment of “All Rights” When a contract provides for an “assignment of all rights,” this wording may also be treated as providing for an “assumption of duties” on the part of the assignee. So if general words are used—such as, “I assign the contract” or “I assign all my rights under the contract”—the contract is interpreted as implying both an assign- ment of rights and a delegation of duties.

(See the Linking Business Law to Your Career feature at the end of this chapter for considerations concerning assignments and delegations.)

15–2 third Party Beneficiaries Another exception to the doctrine of privity of contract arises when the contract is intended to benefit a third party. In this situation, the third party becomes a beneficiary of the contract. The law distinguishes between two types of third party beneficiaries: intended beneficiaries and incidental beneficiaries. Only intended beneficiaries acquire legal rights in a contract.

15–2a Intended Beneficiaries An intended beneficiary can sue the promisor directly for breach of a contract made for the beneficiary’s benefit. Who, however, is the promisor? In a bilateral contract, both parties to the contract make promises that can be enforced, so the court has to determine which party made the promise that benefits the third party. That person is the promisor.

Learning OutcOme 3

Identify noncontracting parties with contract rights.

third party beneficiary One who is not a party to a contract but who benefits from the contract.

intended beneficiary A third party for whose benefit a contract is formed and who can sue the promisor if it is breached.

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U n i t 2 Contracts184

Creditor Beneficiaries One type of intended beneficiary is a creditor beneficiary. A creditor beneficiary benefits from a contract in which one party (the promisor) promises another party (the promisee) to pay a debt that the promisee owes to a third party (the creditor beneficiary). As an intended beneficiary, the creditor beneficiary can sue the promisor directly to enforce the contract.

Donee Beneficiaries Another type of intended beneficiary is a donee beneficiary. When a contract is made for the express purpose of giving a gift to a third party, the third party (the donee beneficiary) can sue the promisor directly to enforce the promise. The most common donee beneficiary contract is a life insurance contract.

ExamplE 15.10 Al (the promisee) pays premiums to Standard Life Insurance Company (the promisor). Standard Life promises to pay $250,000 on Al’s death to Julia, Al’s wife—his donee beneficiary. Under the life insurance policy, Julia, as an intended third party beneficiary, can enforce the promise made by Standard Life to pay her $250,000 after Al dies. j

15–2b Vesting of Intended Beneficiary Rights An intended third party beneficiary cannot enforce a contract against the original parties until the third party rights have vested, or taken effect. Until these rights have vested, the original parties to the contract—the promisor and the promisee— can modify or rescind the contract without the consent of the third party.

When Do Third Party Rights Vest? Generally, the rights of an intended beneficiary vest when one of the following occurs: 1. When the third party demonstrates manifest assent to the contract. A third

party can show manifest assent, for instance, by sending a letter or note consenting to a contract formed for his or her benefit.

vested The condition in which rights have taken effect.

Learning OutcOme 4

Explain when a third party beneficiary’s rights in a contract vest.

Real Case

In the 1980s, Dale Bozzio was the lead singer of the Los Angeles–based band Missing Persons. To receive its royalties, the band formed Missing Persons, Inc. (MPI). Capitol Records (the promisor) entered into a contract with MPI (the promisee) to produce and market the band’s recordings. After the band broke up, MPI lost its official corpo- rate standing in California. Years later, Bozzio filed a lawsuit against Capitol and others. She was seeking royalties on digital downloads, ringtones, and streaming music made using the band’s recordings. Bozzio asserted that she was a third party beneficiary of the contract between Capitol and MPI with a right to sue directly for its enforcement. The court dismissed the complaint on the ground that MPI, as a suspended California corporation, lacked the capacity to sue. Bozzio appealed.

could a third party (Bozzio) sue for breach of contract when the promisee (mPi) lacked the capacity to sue? Yes. In Bozzio v. EMI Group, Ltd., the U.S. Court of Appeals for the Ninth Circuit reversed the dismissal and remanded the case. MPI’s corporate status in California was irrelevant. Bozzio had the right to bring her claim as an intended third party beneficiary of the contract between Capitol and MPI.

—811 F.3d 1144 (9th Cir.)

Allowing a third party to sue the promisor directly in effect circumvents the “middle person” (the promisee) and thus reduces the burden on the courts. Otherwise, the third party would sue the promisee, who would then sue the promisor.

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C H A P T E R 1 5 Third Party Rights 185

2. When the third party materially alters his or her position in detrimental reliance on the contract.

ExamplE 15.11 John and Damien agree that the proceeds of the sale of John’s car will be deposited into Yolanda’s bank account. In anticipation of receiving this sum of money, Yolanda purchases an expensive new copier machine for her small business. Thus, Yolanda has detrimentally relied on the contract between John and Damien. j

3. When the conditions for vesting are satisfied. For instance, the rights of a beneficiary under a life insurance policy vest when the insured person dies.

When Can Vested Third Party Rights Change? If the original parties to the contract expressly reserve the right to cancel or modify the contract, the rights of the third party beneficiary are subject to any changes. In other words, the vesting of the third party’s rights does not terminate the original contracting parties’ rights to alter their legal agreement. In most life insurance contracts, for instance, the policyholder reserves the right to change the designated beneficiary.

15–2c Incidental Beneficiaries The benefit that an incidental beneficiary receives from a contract is unintentional. The incidental beneficiary cannot enforce the contract.

Intended versus Incidental Beneficiaries In determining whether a third party beneficiary is an intended or an incidental beneficiary, the courts generally use the reasonable person test. Basically, this test asks the following question: Would a reasonable person in the position of the third party beneficiary believe that the promisee intended to confer on the beneficiary the right to enforce the contract?

Factors That Indicate an Intended Beneficiary Several other factors must also be examined to determine whether a party is an intended or an incidental beneficiary. The presence of one or more of the following factors strongly indicates an intended (rather than an incidental) benefit to a third party: 1. Performance is rendered directly to the third party. 2. The third party has the right to control the details of performance. 3. The third party is expressly designated as a beneficiary in the contract.

Exhibit 15.3 illustrates the distinction between intended and incidental beneficiaries.

incidental beneficiary A third party who incidentally benefits from a contract but has no rights in it.

exhibit 15.3 Third Party Beneficiaries

To whom performance is rendered directly and/or

Who has the right to control the details of the performance and/or

Who is designated a bene�ciary in the contract

INTENDED BENEFICIARY An intended bene�ciary is a third party–

CONTRACT THAT BENEFITS A THIRD PARTY

Who bene�ts from a contract but whose bene�t was not the reason for the contract and

Who has no rights in the contract

INCIDENTAL BENEFICIARY An incidental bene�ciary is a third party–

Can Sue to Enforce the Contract. Cannot Sue to Enforce the Contract.

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U n i t 2 Contracts186

Conflict Resolved In the Conflict Presented feature at the beginning of this chapter, Wayne obtains a student loan from a bank. Later, Wayne is notified that the bank has transferred its right to receive his payments to

the Educational Loan Collection Agency (ELCA).

a What is this transfer called? Should Wayne pay the bank or the ElCa? The transfer is called an assignment. The ELCA purchased the right to receive Wayne’s

payments and can insist that Wayne make his payments directly to it.

Linking Business Law to Your Career

Assignment And delegAtion

Most sales are based on open accounts. This means that the buyer is obligated to pay, but the seller agrees to accept payment within thirty, sixty, or ninety days, depending on the industry and the parties involved.

During that time, the seller has no cash to show for the sale. To obtain working capital, the seller generally can assign the right to payment to a lender. The assignments of such rights—and the delegations of duties—are common in the business world.

contract rights and Duties

Any contract right or duty can be assigned or delegated unless this is prohibited by the contract, a statute, or another limitation. For example, a man- ufacturer can assign or delegate the production of goods to a third party unless prohibited by a buyer’s contract. Similarly, without a clause specifying

otherwise, a tenant under a lease may assign it to another party.

contract restrictions

In certain situations, businesses may wish to prohibit third parties from acquiring contract rights. For instance, a property owner can prohibit the assign- ment of a lease for the balance of its term without the property owner’s con- sent. Most purchase orders (contracts) have clauses that prohibit the sellers’ assignments or delegations of perfor- mance with respect to the subject of the contract without the buyers’ consent.

contract review

When you are a party to a business con- tract, be aware of the possibility of its assignment or delegation. With this in mind, you should:

1. Read the contract. Review the terms to learn whether you or

the other contracting party can assign or delegate rights or duties under the contract to a third party.

2. permit or prohibit these rights. If you do not want your contract rights or duties to be assigned or delegated, insert a clause that prohibits assign- ment or delegation without your consent.

3. Identify the terms. If you or the other party can assign or delegate the contract rights or performance, then pinpoint the benefits and obligations, such as notice to customers.

4. Follow the requirements. To avoid unwanted liability and other negative consequences, carefully adhere to the requirements for a contract’s assignment or delegation.

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C H A P T E R 1 5 Third Party Rights 187

Issue sPotteRs Check your answers to the Issue Spotters against the answers provided in Appendix A at the end of this text.

1. Brian owes Jeff $100. Ed tells Brian to give him the $100 and he’ll pay Jeff. Brian gives Ed the $100. Ed never pays Jeff. Can Jeff successfully sue Ed for the $100? Why or why not? (see Third Party Beneficiaries.)

2. Fleet Trucking leases a delivery truck to Grocers Express. The lease prohibits Grocers from assigning its rights

without Fleet’s consent. When the truck needs repair, Grocers leaves it with Harland’s Truck Service. Unable to pay for the repair, Grocers assigns its rights to the truck to Harland without obtaining Fleet’s consent. Is the assignment enforceable? Explain your answer. (see Assignments and Delegations.)

stRaIgHt to tHe PoInt

1. When the rights under a contract are assigned, what happens to the rights of the assignor? (see Assignments and Delegations.)

2. What is an anti-assignment clause? (see Assignments and Delegations.)

3. What duties cannot be delegated? (see Assignments and Delegations.)

4. When does a third party have contractual rights? (see Third Party Beneficiaries.)

5. What factors indicate that a third party beneficiary to a contract is an intended beneficiary rather than an inci- dental beneficiary? (see Third Party Beneficiaries.)

Learning OutcOme 1: Describe a contract assignment. An assignment is the transfer of rights under a contract to a third party. The person assigning the rights is the assignor. The party to whom the rights are assigned—the assignee—has a right to demand performance from the other original party to the contract (the obligor). Generally, any right can be assigned, except in a few special circumstances.

Learning OutcOme 2: Define a contract delegation. A delegation is the transfer of duties under a contract to a third party—the delegatee—who assumes the obligation of performing the duties previously held by the one making the delegation—the delegator. With a few exceptions, any duty can be delegated.

Learning OutcOme 3: identify noncontracting parties with contract rights. A third party beneficiary benefits from a contract formed by two other parties. An intended beneficiary is a third party for whose benefit the contract was created. When the promisor—the one making the contractual promise that benefits the third party—fails to perform as promised, the third party can sue the promisor directly.

An incidental beneficiary is a third party who indirectly benefits from a contract but for whose benefit the contract was not specifically intended. Incidental beneficiaries have no rights to the benefits received and cannot sue to have the contract enforced.

Learning OutcOme 4: explain when a third party beneficiary’s rights in a contract vest. An intended third party beneficiary’s rights vest (1) when the third party demonstrates manifest assent to the contract, (2) when the third party materially alters his or her position in detrimental reliance on the contract, or (3) when the conditions for vesting are satisfied.

CHaPteR summaRY—tHIRd PaRtY RIgHts

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U n i t 2 Contracts188

ReaL Law

15–1. third Party Beneficiaries. Randy Jones is an agent for Farmers Insurance Company of Arizona. Through Jones, Robert and Marcia Murray obtained auto insurance with Farmers. On Jones’s advice, the Murrays increased the policy’s limits over the minimums required by the state of Arizona, except for uninsured/underinsured motorist cov- erage, for which Jones made no recommendation. Later, the Murrays’ seventeen-year-old daughter, Jessyka, was in an accident that involved both an uninsured motorist and an underinsured motorist. She sustained a traumatic brain injury that permanently incapacitated her. Does Jessyka, as a third party to her parents’ contract for auto insurance, have standing to bring a claim against Jones and Farmers? Explain. [Lucas Contracting, Inc. v. Altisource Portfolio Solutions, Inc., 2016-Ohio-474 (Ohio App.3d 2016)] (see Third Party Beneficiaries.)

15–2. third Party Beneficiary. David and Sandra Dess con- tracted with Sirva Relocation, LLC, to assist in selling their home. In their contract, the Desses agreed to disclose all information about the property on which Sirva “and

other prospective buyers may rely in deciding whether and on what terms to purchase the Property.” The Kincaids contracted with Sirva to buy the house. After the closing, they discovered dampness in the walls, defective and rotten windows, mold, and other undisclosed problems. Can the Kincaids bring an action against the Desses for breach of their contract with Sirva? Why or why not? [Kincaid v. Dess, 48 Kan.App.2d 640, 298 P.3d 358 (2013)] (see Third Party Beneficiaries.)

15–3. notice of assignment. Arnold Kazery was the owner of a hotel leased to George Wilkinson. The lease included renewal options of ten years each. When Arnold trans- ferred his interest in the property to his son, Sam, no one notified Wilkinson. For the next twenty years, Wilkinson paid the rent to Arnold and renewed the lease by notice to Arnold. When Wilkinson wrote to Arnold that he was exercising another option to renew, Sam filed a suit against him, claiming that the lease was void. Did Wilkinson give proper notice to renew? Discuss. [Kazery v. Wilkinson, 52 So.3d 1270 (Miss.App. 2011)] (see Assignments and Delegations.)

etHICaL QuestIons

15–4. incidental Beneficiaries. Should incidental benefi- ciaries have any legal recourse against parties who do not perform their contracts? Why or why not? (see Third Party Beneficiaries.)

15–5. intended third Party Beneficiaries. The Health Care Providers Self Insurance Trust (the trust) provided workers’ compensation coverage to the employees of its members, including Accredited Aides Plus, Inc. The trust contracted with Program Risk Management, Inc. (PRM), to serve as the program administrator. The contract obligated PRM to

reimburse the trust for “claims, losses, and liabilities . . . aris- ing out of” PRM’s acts or omissions. When the trust became insolvent, the state of New York assessed the trust’s employer- members for some of its debts. These employer-members filed a suit against PRM for breach of contract. Were the trust’s employer-members third party beneficiaries of the trust’s con- tract with PRM? If so, could the employer-members maintain this action against PRM? Did the members have an ethical duty to pursue this claim? Explain. [Accredited Aides Plus, Inc. v. Program Risk Management, Inc., 46 N.Y.S.3d 246 (N.Y.A.D. 3 Dept. 2017)] (see Third Party Beneficiaries.)

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189

Chapter 15—work set

1. Intended beneficiaries have no legal rights under a contract.

2. The party who makes an assignment is the assignee.

3. All rights can be assigned.

4. If a contract contains a clause that prohibits assignment of the contract, then ordinarily the contract cannot be assigned.

5. An assignment is not effective without notice.

6. No special form is required to create a valid delegation of duties.

7. Only intended beneficiaries acquire legal rights in a contract.

8. A transfer of duties is called a delegation.

9. If a delegatee fails to perform, the delegator must do so.

tRue-FaLse QuestIons

1. Gary contracts with Dan to buy Dan a new car manufactured by General Motors Corporation (GMC). GMC is

a. an intended beneficiary. b. an incidental beneficiary. c. not a third party beneficiary. d. both a and b.

2. Bernie has a right to $100 against Holly. Bernie assigns the right to Tom. Tom’s rights against Holly

a. include the right to demand performance from Holly. b. are subject to any defenses Holly has against Bernie. c. do not vest until Holly assents to the assignment. d. include both a and b.

3. Frank owes Jim $1,000. Frank contracts with Ron to pay the $1,000 and notifies Jim of the contract by e-mail. Jim replies by e-mail that he agrees. After Frank receives Jim’s reply, Ron and Frank send Jim an e-mail stating that they have decided to rescind their contract. Jim’s rights under the contract

a. vested when Jim learned of the contract and demonstrated manifest assent to it. b. vested when Frank and Ron formed their contract. c. will not vest, because Ron and Frank rescinded their contract. d. could never vest, because Jim is an incidental beneficiary.

4. Jenny sells her Value Auto Parts store to Burt and makes a valid contract not to compete. Burt wants to sell the store to Discount Auto Centers and assign to Discount the right to Jenny’s promise not to compete. Burt can

a. sell the business and assign the right. b. sell the business but not assign the right. c. assign the right but not sell the business. d. neither assign the right nor sell the business.

muLtIPLe-CHoICe QuestIons

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190

answeRIng moRe LegaL PRoBLems

1. Eli develops and patents the technology behind the VuYu, which allows its users to stream high-definition video from online video services directly to a televi- sion set. Eli assigns the rights to Bright Lights, Inc. In exchange, Bright Lights agrees to make and market the device, and assigns a right to receive a percentage of the gross sales revenue to Eli.

Can these rights be assigned? Yes. As a general rule, all rights can be assigned, except in special circumstances. If a _______________ expressly prohibits the assignment of a certain right, the right cannot be assigned. When a contract is _______________ in nature, the rights in the contract cannot be assigned. A right cannot be assigned if its assignment will significantly _______________ the risks to or the duties of the obligor. If a _______________ provides that certain rights cannot be assigned, then they cannot be assigned. The rights in this contract do not fall into any of these categories.

2. To begin to manufacture the VuYu, Bright Lights buys equipment from Crest Labs, Inc. Because Bright Lights does not have the funds to finance the pur- chase, Crest grants the buyer credit in exchange for monthly payments of the amount owed. Later, the owners of Bright Lights sell the firm to Playback, LLC, which agrees in their contract to make the remaining payments to Crest.

if Playback fails to make the payments, can Crest sue Playback directly? Yes. An _______________ beneficiary can sue the promisor directly for breach of a contract made for the benefit of the _______________. The con- tract between Bright Lights and Playback includes a pro- vision for the continuation of payments to Crest. This provision is clearly for the benefit of _______________. Thus, Crest can sue Playback directly to enforce the contract and obtain payment on the amount owed for the equipment.

5. Dick contracts with Jane to mow Jane’s lawn. Dick delegates performance of the duty to Sally with Jane’s assent. Who owes Jane a duty to cut her grass?

a. Dick, but not Sally. b. Sally, but not Dick. c. Both Dick and Sally. d. Neither Dick nor Sally.

6. Nick contracts with Kathy to paint Nick’s portrait. Nick assigns his right to Kathy’s painting services to Ronaldo. This assignment to Ronaldo

a. cannot be assigned because the contract involves services of a personal nature. b. can be assigned if the duty to paint the portrait is delegated. c. can be assigned if Ronaldo pays in advance. d. can be assigned under any circumstances.

7. Fred unconditionally assigns to Ellen his rights under a contract with Paul. Fred’s rights under the contract

a. continue until the contract is fully executed. b. continue until Paul performs his obligations under the contract. c. continue until Ellen receives Paul’s performance. d. are extinguished.

8. Ann has a right to receive payment under a contract with Bill. Without notice, Ann assigns the right first to Carl and then to Diane. In most states, the party with priority to the right would be

a. Ann. b. Bill. c. Carl. d. Diane.

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191

Learning OutcOmes

The four Learning Outcomes below are designed to help improve your understanding of the chapter. After reading this chapter, you should be able to:

Explain the difference between complete and substantial performance.

Describe discharge by agreement.

Identify different types of damages.

Define the remedy of rescission and restitution.

1

2

3

4

16 Termination and Remedies

Parties to a contract need to know when their contract is terminated. In other words, the parties need to know when their contractual duties are at an end. This chapter deals first with the discharge of a contract. Discharge is normally accom- plished when both parties have performed the acts promised in the contract but can occur in several other ways.

When it is no longer advantageous for a party to fulfill his or her contractual obligations, breach of contract may result. A breach of contract occurs when a party fails to perform part or all of the required duties under a contract. Once this occurs, the other party—the nonbreaching party—can choose one or more of several remedies.

16–1 contract termination The most common way to terminate, or discharge, contractual duties is by performance of those duties. In addition to discharge by performance, a contract can be discharged by failure of a condition, by agreement, and by operation of law.

16–1a Discharge by Failure of a Condition In most contracts, promises of performance are not conditioned. They must be performed, or the party promising the act will be in breach of contract. ExamplE 16.1 Home Farms contracts to sell Bagels & Bytes a truckload of organic produce for $1,000. The promises are unconditional. Bagels & Bytes does not have to pay Home Farms if the produce is not delivered. j

In some situations, however, the duty to perform may be conditioned on the occurrence or nonoccurrence of a certain event. If the condition is not satisfied, the obligations of the parties are discharged. ExamplE 16.2 Restoration Motors

performance The fulfillment of one’s duties arising under a contract.

discharge The termination of one’s obligation under a contract.

breach of contract Failure to perform the obligations of a contract.

Conflict Presented Naomi, a jazz singer, contracts with Primetime, which manages artists and produces recordings. Later, Naomi becomes personally involved with Michael, the president of Primetime. When their

personal relationship falls apart, they agree to have contact only through their lawyers. Later, Naomi seeks to cancel her contract with Primetime, arguing that its performance has become impossible.

Q Does naomi and michael’s agreement to have contact only through their lawyers render the performance of naomi’s Primetime contract impossible?

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U n i t 2 Contracts192

offers to buy Charlie’s 1960 Cadillac limousine only if an expert appraiser esti- mates that it can be restored for less than a certain price. Their obligations are conditioned on the outcome of the appraisal. If the condition is not satisfied— if the appraiser deems the cost to be above that price—their obligations are discharged. j

16–1b Discharge by Performance A contract ends when both parties perform the acts they have promised. Perfor- mance can also be accomplished by tender. Tender is an unconditional offer to perform by a person who is ready, willing, and able to do so.

For instance, a seller who places goods at the disposal of a buyer has tendered delivery and can demand payment. A buyer who offers to pay for goods has ten- dered payment and can demand delivery. ExamplE 16.3 Custom Renovations orders bathroom fixtures from Budget Plumbing. As agreed, Budget places the fixtures on its warehouse loading dock for Custom to pick up on May 1. Budget has tendered delivery and can demand payment from Custom. j

Once performance has been tendered, the party making the tender has done everything possible to carry out the terms of the contract. It is important to distin- guish between complete performance and substantial performance.

Complete Performance When a party performs exactly as agreed, there is no question as to whether the contract has been performed. In this situation, a party’s performance is said to be complete.

Normally, conditions expressly stated in the contract must be fully met for com- plete performance to take place. Any deviation breaches the contract and discharges the other party’s duty to perform.

In most contracts, the parties fully discharge their obligations by complete per- formance. Sometimes, though, a party’s performance is incomplete. The issue then arises as to whether the deviating performance was sufficiently substantial to dis- charge the contractual obligations.

Substantial Performance A party who in good faith performs substantially all of the terms of a contract can enforce the contract against the other party under the doctrine of substantial performance. There are three basic requirements for performance to qualify as substantial performance. 1. The party must have performed in good faith. (Intentional failure to comply

with the contract terms is a breach of the contract.) 2. The performance must not vary greatly from the performance promised in

the contract. (An omission, variance, or defect in performance is considered minor if it can be remedied easily.)

3. The performance must create substantially the same benefits as those promised in the contract.

Courts decide whether performance was substantial on a case-by-case basis, exam- ining all of the facts of the situation.

tender A timely offer to pay a debt or perform an obligation.

Learning OutcOme 1

Explain the difference between complete and substantial performance.

Highlighting the Point

Wilson River Energy Company contracts with O&A Railroad to transport coal to Wilson from mines in Colorado. The contract requires Wilson to notify O&A monthly how many tons of coal it wants to have shipped the next month. The contract states that O&A is to “make good faith reasonable efforts” to meet the schedule.

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C H A P T E R 1 6 Termination and Remedies 193

Material Breach of a Contract If performance is not substantial, there is a material breach—the nonbreaching party is excused from performance and can sue for damages caused by the breach.

ExamplE 16.4 Clay sells an apartment building in San Francisco to Montgomery. The building’s plumbing does not meet the city’s building code. The contract between Clay and Montgomery provides that Clay will have the plumbing fixed within six months. A year later, the repairs have not been made, the city has fined Montgomery for the code violations, and the building’s tenants are moving out. Clay’s failure to fix the plumbing is a material breach. Montgomery is no longer obligated to make payments under the contract. j

Performance to the Satisfaction of Another Contracts often state that completed work must personally satisfy one of the parties or a third person. How this requirement is interpreted depends in part on the subject matter of the contract.

When the subject matter is personal, performance must actually satisfy the party whose satisfaction is required. Contracts for works of art and medical or dental work, for instance, are personal. ExamplE 16.5 Teresa hires Raymond to take a minimum of two hundred photos of her wedding and create an online wedding photo album within two weeks of her wedding day. Teresa’s personal satisfaction with the results of Raymond’s performance is required to successfully complete the contract. j

Most other contracts need only be performed to the satisfaction of a reasonable person unless they expressly state otherwise. When the subject matter of a contract is mechanical—such as installing a heat pump in a house—courts are likely to find that the performing party has performed satisfactorily if a reasonable person would be satisfied with what was done.

Some contracts require performance to the satisfaction of a third party with superior knowledge or training, such as a supervising engineer. Here, the courts are divided. A majority of courts require the work to be satisfactory to a reason- able person, but some courts require the personal satisfaction of the third party designated in the contract.

16–1c Discharge by Agreement Any contract can be discharged by the agreement of the parties. This agreement can be part of the original contract, or the parties can form a new contract for the express purpose of discharging the original contract.

Mutual Rescission Rescission is a process in which the parties cancel the contract and are returned to the positions they occupied before the contract’s formation. For mutual rescission to take place, the parties must make another agreement that also satisfies the legal requirements for a contract—there must be an offer, an acceptance, and consideration.

Ordinarily, if the parties agree to rescind a contract that is executory on both sides, their promises not to perform the acts promised will be the consideration for the second agreement. Contracts that are executed on one side (one party has

Learning OutcOme 2

Describe discharge by agreement.

The contract also requires Wilson to supply the railcars. When Wilson does not supply railcars, O&A uses its own railcars and delivers 85 percent of the requested coal. Wilson sues for breach of contract.

can O&a enforce the contract under the doctrine of substantial performance? Yes. O&A has acted in good faith and has delivered 85 percent of the contracted amount of coal. It has substantially performed and is not in breach of the contract.

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U n i t 2 Contracts194

performed) can be rescinded only if the party who has performed receives consid- eration for agreeing to call off the deal.

Novation The process of novation substitutes a new contract for an old one, terminating the rights under the old contract. A third party takes the place of one of the original parties. The requirements of a novation are as follows: 1. The existence of a previous, valid obligation. 2. Agreement by all the parties to a new contract. 3. The extinguishing of the old obligation (discharge of the prior party). 4. A new, valid contract.

novation The substitution, by agreement, of a new contract for an old one.

Highlighting the Point

Glasso Corporation contracts to sell its pharmaceutical division to Phillip Pharma. Before the transfer is complete, Glasso, Phillip, and a third company, HealthCare Industries, execute a new agreement to transfer Phillip’s contractual rights and duties to HealthCare.

is the original contract discharged and replaced with the new contract? Yes. As long as the new contract is supported by consideration, the novation will discharge the original contract (between Glasso and Phillip) and replace it with the new contract (between Glasso and HealthCare). Phillip prefers a novation instead of an assign- ment because the novation discharges all of the liabilities associated with its contract with Glasso.

Accord and Satisfaction As mentioned in an earlier chapter, an accord and satisfaction occurs when the parties to a contract agree to accept performance that is different from the performance originally promised. An accord is an agreement to perform some act to satisfy an existing contractual duty. A satisfaction is the actual performance of the accord. An accord and its satisfaction discharge the original contractual obligation.

Once the accord has been made, the original obligation is suspended. The obligor can discharge the original obligation by performing the obligation agreed to in the accord. Likewise, if the obligor refuses to perform the accord, the obligee can bring an action on the original obligation.

ExamplE 16.6 Shep obtains a judgment against Marla for $8,000. Later, they agree that the judgment can be satisfied by Marla’s transfer of her automobile to Shep. This agreement to accept the car in lieu of $8,000 is the accord. If Marla transfers her car to Shep, the accord is fully performed, and the $8,000 obligation is discharged. If Marla refuses to transfer her car, the accord is breached. Because the original obligation is merely suspended, Shep can sue to enforce the judgment for $8,000. j

See this chapter’s Linking Business Law to Your Career feature for more on performance and compromise.

16–1d Discharge by Operation of Law Under some circumstances, contractual duties may be discharged by operation of law. These circumstances include the ones discussed next.

Statute of Limitations A statute of limitations limits the time during which a party can sue on a particular cause of action. After the time has passed, a suit based on that cause can no longer be brought. The statutory period for bringing a suit for breach of a written contract is typically four or five years.

statute of limitations A statute limiting the time period a certain action can be brought.

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C H A P T E R 1 6 Termination and Remedies 195

Impossibility of Performance After a contract has been made, performance may become impossible in an objective sense. This situation, known as impossibility of performance, may discharge a contract. Note that objective impossibility (“It cannot be done”) must be distinguished from subjective impossibility (“I’m sorry, I personally cannot do it”).

Certain situations generally qualify under the doctrine of impossibility of per- formance to discharge contractual obligations: 1. When one of the parties to a personal contract dies or becomes incapacitated

before a performance. ExamplE 16.7 Francis, a famous dancer, contracts with Evergreen Dancing Guild to play a leading role in its new ballet. Before the ballet can be performed, Francis dies. His death discharges the contract. j

2. When the specific subject matter of the contract is destroyed. ExamplE 16.8 Ace Farm Equipment agrees to sell Garrett a specific tractor and promises to have it ready for him to pick up on Saturday. On Friday night, the tractor is destroyed beyond repair when a speeding delivery truck crashes into it. The accident renders Ace’s performance impossible. j

3. When a change in the law renders performance illegal.

impossibility of performance A situation in which performance is impossible or totally impracticable in an objective sense.

Commercial Impracticability A party may sometimes be excused from performing a contract under the doctrine of commercial impracticability. Performance becomes commercially impracticable when it turns out to be significantly more difficult or expensive than anticipated. The added burden of performing must be extreme and must not have been foreseeable by the parties at the time the contract was made.

ExamplE 16.9 Sanchez Excavation Company contracts with Energy Fuel to bury a pipeline. Several days into the work, Sanchez encounters unforeseen difficulties in the subsurface that significantly increase its original excavation costs. Both parties agree to discharge the contract on the ground of commercial impracticability. j

commercial impracticability A situation in which the duty to perform becomes too difficult or costly due to unforeseen factors.

Real Case

Scott Harvard worked for Hampton Roads Bankshares (HRB). His employment con- tract included a golden parachute—which is a special financial benefit for departing corporate managers who “bail out” of the company. If he quit, Harvard would receive roughly three times his average annual compensation. Later, Congress enacted new legislation, which included the Troubled Assets Relief Program (TARP). TARP allowed the government to buy “troubled assets” from financial institutions to promote mar- ket stability. TARP barred participating institutions from making golden-parachute payments. HRB participated in TARP. When Harvard quit the firm, HRB refused to make his golden-parachute payment. Harvard filed a suit in a Virginia state court, alleging breach of contract. The court awarded Harvard his golden parachute. HRB appealed.

Did the change in law (tarP) render Harvard and HrB’s contract impossible to perform? Yes. In Hampton Road Bankshares, Inc. v. Harvard, the Virginia Supreme Court reversed the decision of the lower court. Payment of the golden parachute would violate the law. HRB’s obligation to pay Harvard his golden-parachute payment was discharged.

—291 Va. 42

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U n i t 2 Contracts196

Caution should be used in invoking the doctrine of commercial impracticability. The added burden of performing must be extreme and must not have been foresee- able by the parties at the time the contract was made.

Temporary Impossibility An occurrence or event (such as a war) that makes performance temporarily impossible operates to suspend performance temporarily. Once the temporary event ends, the parties must perform the contract as originally planned.

For a visual summary of all the ways in which a contract can be discharged, see Exhibit 16.1.

16–2 contract remedies A remedy is the relief provided for an innocent party when the other party has breached the contract. It is the means employed to enforce a right or to redress an injury. The most common remedies are damages, rescission and restitution, and specific performance.

16–2a Types of Damages When a party breaches a contract, the nonbreaching party can sue for damages (money). Damages are designed to compensate the nonbreaching party for the loss of the bargain. Generally, innocent parties are to be placed in the position they would have occupied had the contract been fully performed. A nonbreaching party can sue for four types of damages: compensatory damages, consequential damages, punitive damages, and liquidated damages.

Compensatory Damages Damages compensating the nonbreaching party for the loss of the bargain are compensatory damages. These damages compensate the injured party only for injuries actually sustained and proved to have arisen directly from the breach of contract.

remedy The relief given to an innocent party to enforce a right or compensate for the violation of a right.

damages Money sought as a remedy for a breach of contract or a wrongful act.

compensatory damages A monetary award equivalent to the actual value of injuries or damages sustained by the aggrieved party.

exhibit 16.1 Contract Discharge

BY AGREEMENT • Mutual rescission • Novation

• Accord and satisfaction

BY PERFORMANCE •  Complete •  Substantial

BY BREACH •  Material breach

BY OPERATION OF LAW •  Statute of limitations

•  Impossibility or impracticability of performance

BY FAILURE OF A CONDITION If performance is

conditional, duty to perform does not

become absolute until that condition

occurs.

CONTRACT DISCHARGE

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C H A P T E R 1 6 Termination and Remedies 197

The amount of compensatory damages is the difference between the value of the breaching party’s promised performance and the value of his or her actual performance. This amount is reduced by any loss that the injured party has avoided. ExamplE 16.10 Mary is hired to perform certain services during August for $3,000. Mary’s employer breaches the contract, and she finds another job that pays only $500. Mary can recover $2,500 as compensatory damages. j

The measurement of compensatory damages varies by type of contract. In a contract for a sale of goods, the usual measure of compensatory damages is the difference between the contract price and the market price at the time and place of delivery.

Consequential Damages Consequential damages are reasonably foreseeable damages that result from a party’s breach of contract. They differ from compensatory damages in that they are caused by special circumstances beyond the contract itself. For a nonbreaching party to recover consequential damages, the breaching party must know (or have reason to know) that special circumstances will cause the nonbreaching party to suffer an additional loss.

Learning OutcOme 3

Identify different types of damages.

consequential damages Special damages to compensate for a loss that goes beyond the contract itself.

Highlighting the Point

Maddox contracts to purchase six hundred cases of a specialty sports drink from Nathan. Nathan knows that Maddox has contracted with Chloe to resell and ship the beverage within hours of its receipt. The beverage will be then sold to fans attending the Super Bowl. Nathan fails to deliver the sports drink in time for Maddox to get the shipment to Chloe.

can maddox recover consequential damages from nathan? Yes. Maddox can recover the consequential damages—the loss of profits from the planned resale to Chloe— caused by Nathan’s nondelivery.

Punitive Damages punitive damages are designed to punish a wrongdoer and set an example to deter similar conduct in the future. Such damages are very seldom awarded in lawsuits for breach of contract. In general, punishment does not play a role in contract law.

Liquidated Damages A liquidated damages provision in a contract specifies a certain amount to be paid in the event of a future default or breach of contract. (Liquidated means determined, settled, or fixed.) Liquidated damages differ from penalties. A penalty specifies a certain amount to be paid in the event of a default or breach of contract and is designed to penalize the breaching party. Liquidated damages provisions normally are enforceable, but penalty provisions are not.

To determine whether a particular provision is for liquidated damages or for a penalty, a court must answer two questions: 1. When the contract was formed, were the potential damages that would be

incurred if the contract was not performed on time difficult to estimate? 2. Was the amount set as damages a reasonable estimate of those potential

damages? If both answers are yes, the provision is for liquidated damages and will be enforced. If either answer is no, the provision is for a penalty and normally will not be enforced.

punitive damages Damages that are awarded to punish the wrongdoer.

liquidated damages A reasonable estimate of the damages that will occur in the event of a breach.

penalty A sum named in a contract as punishment for a default.

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U n i t 2 Contracts198

16–2b Rescission and Restitution Rescission is essentially an action to undo, or cancel, a contract and to return nonbreaching parties to the positions that they occupied before the transaction. When fraud, a mistake, duress, or failure of consideration is present, rescission is available. In addition, the failure of one party to perform entitles the other party to rescind the contract. The rescinding party must give prompt notice to the breach- ing party.

To rescind a contract, the parties must make restitution to each other by return- ing goods, property, or funds previously conveyed. If the property or goods have been consumed, restitution must be an equivalent amount of money. Basically, restitution is a way to avoid the unjust enrichment of one party at the expense of another. In other words, any benefit unfairly obtained must be returned.

Learning OutcOme 4

Define the remedy of rescission and restitution.

restitution The restoration of goods, property, or funds previously conveyed.

Highlighting the Point

Alima pays $10,000 to Milos in return for Milos’s promise to design a house for her. The next day, Milos calls Alima and tells her that he has taken a position with a large architectural firm in another state and cannot design the house. Alima decides to hire another architect that afternoon.

if alima sues milos for restitution, what can alima recover? Alima can obtain restitu- tion of $10,000, because an unjust benefit of $10,000 was conferred on Milos.

16–2c Specific Performance The equitable remedy of specific performance calls for the exact performance of the act promised in the contract. Specific performance is not granted unless the party’s legal remedy (monetary damages) is inadequate.

Readily Available Goods Contracts for the sale of goods, such as wheat or corn, that are readily available rarely qualify for specific performance. Damages ordinarily are adequate in such situations because substantially identical goods can be bought or sold in the market.

Rare or Unique Goods If a contract involves goods that are rare or unique— such as a painting or parcel of land—a court will decree specific performance. In this situation, obtaining substantially identical goods in the market is nearly impossible. ExamplE 16.11 Levy contracts to sell twelve acres to Solano for $65,000. Solano pays for a survey and other costs, and gives Levy $1,000 as a demonstration of good faith. Before the sale closes, Levy dies. His heir, Herschel, refuses to go through with the deal. Solano files a suit against Herschel. Because Solano has substantially fulfilled his duties under the contract and stands ready to perform the rest, a court will issue an order of specific performance in his favor. j

Contracts for Personal Services Personal-service contracts require one party to work personally for another party. Courts normally refuse to grant specific performance of personal-service contracts. Ordering a party to perform personal services against his or her will amounts to involuntary servitude, which is against public policy.

Exhibit 16.2 summarizes the remedies available to a nonbreaching party.

specific performance An equitable remedy requiring exactly the performance that was specified in a contract.

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C H A P T E R 1 6 Termination and Remedies 199

exhibit 16.2 Remedies for Breach of Contract

DAMAGES • Compensatory • Consequential • Punitive (rare) • Liquidated

REMEDIES AVAILABLE TO NONBREACHING PARTY

RESCISSION AND RESTITUTION

SPECIFIC PERFORMANCE

16–2d Mitigation of Damages In most situations, when a breach of contract occurs, the injured party has a duty to mitigate, or reduce, the damages that he or she suffers. Under this doctrine of mitigation of damages, the required action depends on the nature of the situation.

In the majority of states, for instance, a person whose employment has been wrongfully terminated has a duty to mitigate damages by taking a similar job if one is available. If the person fails to do this, the damages received will be equivalent to the person’s former salary less the income he or she would have received in a similar job obtained by reasonable means.

mitigation of damages A rule requiring a plaintiff to reasonably minimize the damages caused by the defendant.

Conflict Resolved In the Conflict Presented feature at the beginning of the chapter, Naomi contracts with Primetime, which manages musical artists and produces their recordings. Later, she becomes personally

involved with Michael, Primetime’s president. When they break up, they agree to have contact only through their lawyers. Later, Naomi seeks to cancel her contract with Primetime.

a Does Naomi and michael’s agreement to have contact only through their lawyers render the performance of Naomi’s primetime contract impossible? Yes.

Performance of the Primetime contract is rendered impossible by the parties’ agreement

prohibiting contact except through counsel. Because of Michael’s position, performance

of the Primetime contract requires his direct input, which is prohibited by his agreement

with Naomi. Additionally, this agreement was not foreseeable, so the Primetime contract

could not have provided for its occurrence.

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U n i t 2 Contracts200

Linking Business Law to Your Career

Performance and comPromise

In any career field, if you become a contractor, you may take on a job that you cannot or do not wish to perform. Simply walking away from the job and hoping for the best normally is not the most effective way to avoid litigation. Instead, you should consider various options that may reduce the likelihood of litigation.

Suppose that you are a building contractor and you sign a contract to build a home for the Andersons. Performance is to begin on June 15. On June 1, Central Enterprises offers you a position that will give you two and a half times the amount of income you could earn as an independent builder. To take this new job, you would have to start on June 15.

consider Your Options When You cannot Perform

What can you do in this situation? One option is to subcontract the work on the Andersons’ home to another builder and oversee the work to make sure it conforms to the contract. Another option is to nego- tiate with the Andersons for a release. You can offer to find another contractor who will build a house of the same quality at the same price. Or you can offer to pay any additional costs if another builder takes the job but is more expensive.

In any event, this additional cost would be one measure of damages that a court would impose on you if the Andersons prevailed in a lawsuit for breach of contract. In addition, you could be liable for any costs the Ander- sons suffered as a result of the breach,

such as costs due to the delay in con- struction. Thus, by making the offer, you might be able to avoid the expense of litigation—if the Andersons accept.

What to consider When You make an Offer

Often, parties are reluctant to pro- pose settlements because they fear that what they say will be used against them in court if litigation ensues. Generally, offers for settlement will not be admitted in court to prove liability for a breach of contract. At times, how- ever, they are admissible to prove that a party breached the duty of good faith. For this reason, the best course might be to work with your attorney in mak- ing an offer unless only an insignificant amount of money is involved.

Learning OutcOme 1: explain the difference between complete and substantial performance. A contract may be discharged by complete performance or by substantial performance. Complete performance takes place when conditions expressly stated in a contract are fully met. Substantial performance does not vary greatly from the performance promised in a contract and must result in substantially the same benefits. A party who in good faith performs substantially all of the terms of a contract can enforce the contract against the other party.

Learning OutcOme 2: Describe discharge by agreement. Any contract can be discharged by an agreement of the parties. This agreement may be part of the original contract, or the parties may form a new contract that expressly discharges the original contract. Parties may also agree to discharge their contract by (1) mutual rescission, (2) novation, or (3) accord and satisfaction.

Learning OutcOme 3: identify different types of damages. Damages are designed to compensate a nonbreaching party for the loss of a bargain on the breach of a contract. Types of damages include (1) compensatory damages, (2) consequential damages, (3) punitive damages, and (4) liquidated damages.

Learning OutcOme 4: Define the remedy of rescission and restitution. Rescission is an action to cancel a contract and return the parties to the positions that they occupied before the transaction. The rescinding party must give prompt notice to the breaching party. When a contract is rescinded, the parties must make restitution—return to each other the goods, property, or money previously conveyed.

CHAPTER SUMMARY—TERMINATION AND REMEDIES

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C H A P T E R 1 6 Termination and Remedies 201

STRAIgHT TO THE POINT

1. What is the most common way to terminate, or discharge, a contract? (see Contract Termination.)

2. What are two ways in which performance of a contract can be accomplished? (see Contract Termination.)

3. How can mutual rescission take place? (see Contract Termination.)

4. What is a statute of limitations? (see Contract Termination.)

5. What are three ways in which performance of a contract may become impossible in an objective sense? (see Contract Termination.)

6. What are the two principal types of damages recoverable on a breach of contract? (see Contract Remedies.)

7. In most situations, when a breach of contract occurs, the injured party has a duty to do what? (see Contract Remedies.)

ISSUE SPOTTERS Check your answers to the Issue Spotters against the answers provided in Appendix A at the end of this text.

1. George contracts to build a storage shed for Ron. Ron pays George in full, but George completes only half the work. Ron pays Paula $500 to finish the shed. If Ron sues George, what will be the measure of recovery? (see Contract Remedies.)

2. Amy contracts to sell her ranch to Mark, who is to take possession on June 1. Amy delays the transfer until

August 1. Mark incurs expenses in providing for cattle that he bought to stock the ranch. When they made the contract, Amy had no reason to know of the cattle. Is Amy liable for Mark’s expenses in providing for the cattle? Explain your answer. (see Contract Remedies.)

REAL LAw

16–1. conditions. H&J Ditching & Excavating, Inc., was hired by JRSF, LLC, to perform excavating and grading work on a residential construction project in Tennessee. Cornerstone Community Bank financed the project with a loan to JRSF. When JRSF defaulted on the loan, Cornerstone took possession of the property. H&J filed a suit in a Tennessee state court against the bank to recover the final payment for the work on its contract. The bank responded that H&J had not received its last payment because it had failed to obtain an engineer’s certificate of completion—a condition under its contract with JRSF. H&J argued that it had completed all the work it had contracted to do. Is H&J entitled to the final payment? Discuss. [H&J Ditching & Excavating, Inc. v. Cornerstone Community Bank, 2016 WL 675554 (Tenn.App. 2016)] (see Contract Termination.)

16–2. specific Performance. Russ Wyant owned Humble Ranch in South Dakota. Edward Humble was Wyant’s uncle and held a two-year option to buy the ranch from Wyant. The option included specific conditions. Once it was exer- cised, for instance, the parties had thirty days to enter into a purchase agreement and the seller could become the buyer’s

lender by matching the terms of the proposed financing. After the option was exercised, Wyant and Humble engaged in lengthy negotiations. Humble, however, did not respond to Wyant’s proposed purchase agreement nor did Humble advise him of available financing terms before the option expired. Six months later, Humble filed a suit against Wyant to enforce the option. Is Humble entitled to specific per- formance? Explain. [Humble v. Wyant, 843 N.W.2d 334 (S.Dak. 2014)] (see Contract Remedies.)

16–3. Damages. Before buying a house, Dean and Donna Testa hired Ground Systems, Inc. (GSI), to inspect the sew- age and water disposal system. GSI reported a split sys- tem with a watertight septic tank, a wastewater tank, a distribution box, and a leach field. The Testas bought the house. Later, Dean discovered that the system was not as GSI described. There was no distribution box or leach field, and there was only one tank, which was not watertight. The Testas arranged for the installation of a new system and sold the house. Assuming that GSI is liable for breach of contract, what is the measure of damages? [Testa v. Ground Systems, Inc., 206 N.J.Super. 330, 20 A.3d 435 (App.Div. 2011)] (see Contract Remedies.)

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U n i t 2 Contracts202

ETHICAL QUESTIONS

16–4. impossibility of Performance. Should the courts allow the defense of impossibility of performance to be be used more often? (see Contract Termination.)

16–5. commercial impracticability. Lisa Goldstein reserved space for a wedding in a building owned by Orensanz Events, LLC, in New York City. The rental agreement provided that on cancellation of the event “for any rea- son beyond” Orensanz’s control, the client’s sole remedy was another date for the event or a refund. Shortly before the wedding, the New York City Department of Buildings found Orensanz’s building to be structurally unstable and

ordered it vacated. Orensanz closed the building and told Goldstein to find another venue. Goldstein filed a lawsuit in a New York state court against Orensanz for breach of contract, arguing that the city’s order had been for a cause within the defendant’s control. Was the commercial building’s structural issue a foreseeable difficulty, thus mak- ing Goldstein’s claim valid? Is the owner of a commercial building ethically obligated to keep it structurally sound? Explain your answers. [Goldstein v. Orensanz Events, LLC, 146 A.D.3d 492, 44 N.Y.S.3d 437 (1 Dept. 2017)] (see Contract Termination.)

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203

Chapter 16—work Set

1. Complete performance occurs when a contract’s conditions are fully satisfied.

2. A material breach of contract does not discharge the other party’s duty to perform.

3. An executory contract cannot be rescinded.

4. Damages compensate a nonbreaching party for the loss of the contract or give a nonbreaching party the benefit of the contract.

5. Punitive damages are usually not awarded for a breach of contract.

6. Liquidated damages are uncertain in amount.

7. Consequential damages are awarded for foreseeable losses caused by special circumstances beyond the contract.

8. Specific performance is available only when damages are also an adequate remedy.

9. Objective impossibility discharges a contract.

TRUE-FALSE QUESTIONS

1. Sam owes Lyle $300. Sam promises, in writing, to give Lyle a PlayStation 4 in lieu of payment of the debt. Lyle agrees, and Sam delivers the gaming console. Substituting and performing one duty for another is

a. a rescission. b. an accord and satisfaction. c. a novation. d. none of the above.

2. C&D Services contracts with Ace Concessions, Inc., to service Ace’s vending machines. Later, C&D wants Dean Vending Services to assume the duties under a new contract. Ace consents. This is

a. a rescission. b. an accord and satisfaction. c. an alteration of contract. d. a novation.

3. Kate contracts with Bob to transport Bob’s goods to his stores. If this contract is discharged as most contracts are, it will be discharged by

a. performance. b. agreement. c. operation of law. d. none of the above.

4. Alan contracts with Pam to build a shopping mall on Pam’s land. Before construction begins, the city enacts a law that makes it illegal to build a mall in Pam’s area. Performance of this contract is

a. not affected. b. temporarily suspended. c. discharged. d. discharged on Pam’s obligations only.

MULTIPLE-CHOICE QUESTIONS

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204

ANSwERINg MORE LEgAL PROBLEMS

1. Russo contracts with Playlist, Inc., to create a website through which users can post and share movies, music, and other forms of digital entertainment. Russo goes to work. Before the site is online, however, Congress passes the No Online Piracy in Entertainment (NOPE) Act. The NOPE act makes it illegal to operate a web- site on which copyrighted works are posted without the copyright owners’ consent.

is russo and Playlist’s contract discharged?  Yes. The contract was discharged by operation of law. After a contract has been made, performance may become impossible in an _______________ sense. This impossibility of performance may discharge a contract. Certain situations qualify under the _______________-impossibility rules to discharge contractual obligations, such as when a change in law renders performance of a contract illegal. Here, the purpose of the contract has been rendered illegal. The contract is discharged for _______________ impossibility on the ground of illegality.

2. Marketshare, Inc., contracts with Ogle, a popular search engine, to use the searches conducted by Ogle’s users to compile data that will accurately pinpoint the users’ interests and provide advertisers with a precisely targeted audience. Marketshare promises that the result will be worth $5 billion, but its data produce incorrect assumptions about Ogle’s users and mistargeted ads. The value of this effort to Ogle is actually $1 billion. Ogle files a suit for breach of contract.

What is the measure of compensatory damages for this breach? The measure of compensatory damages generally is the difference between the value of the breaching party’s promised _______________ and the value of his or her actual _______________. Compensa- tory damages compensate the nonbreaching party for the loss of a _______________. They compensate the injured party only for injuries actually sustained and proved to have arisen directly from the _____________ _____ _____________. The amount of compensatory damages for this breach could be as much as $4 billion.

5. Mix Corporation contracts to sell to Frosty Malts, Inc., eight steel mixers. When Mix refuses to deliver, Frosty buys mixers from MaxCo for 25 percent more than the contract price. Frosty is entitled to damages equal to

a. what Mix’s profits would have been. b. the price Frosty would have had to pay Mix. c. the difference between what Frosty would have had to pay Mix and what Frosty did pay MaxCo. d. what Frosty paid MaxCo.

6. Dave contracts with Paul to buy a delivery truck. Dave tells Paul that if the truck is not delivered on Monday, he will lose $12,000 in business. Paul does not deliver the truck on Monday. Dave is forced to rent a truck on Tuesday. Dave is entitled to

a. compensatory damages. b. actual damages. c. consequential damages. d. all of the above.

7. Jay agrees in writing to sell a warehouse and the land on which it is located to Nora. When Jay refuses to go through with the deal, Nora sues. Jay must transfer the land and warehouse to Nora if she is awarded

a. rescission and restitution. b. specific performance. c. novation. d. none of the above.

8. Jake agrees to hire Teresa. Their contract provides that if Jake fires Teresa, she is to be paid whatever amount would have been payable if she had worked for the full term. This clause is

a. a liquidated damages clause. b. a penalty clause. c. both a and b. d. none of the above.

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UNIT 3 Sales and Leases

Chapter 17 Introduction to Sales and Lease Contracts

Chapter 18 Title and Risk of Loss

Chapter 19 Performance and Breach

Chapter 20 Warranties and Product Liability

Chapter 21 Consumer Protection

Unit Contents

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206

When we turn to contracts for the sale and lease of goods, we move away from common law principles and into the area of statutory law. The state statutory law governing such transactions is based on the Uniform Commercial Code (UCC).

The primary goal of the UCC is to simplify and streamline commercial transac- tions. In short, the UCC allows parties to form sales and lease contracts without observing the same degree of formality used in forming other types of contracts.

17–1 Sales and Leases of Goods Article 2 of the UCC governs sales contracts, or contracts for the sale of goods. Article 2 modifies some of the common law contract requirements discussed in previous chapters. To the extent that it has not been modified by the UCC, however, the common law also applies to sales contracts.

Article 2A of the UCC covers leases of goods. Article 2A is essentially a rep- etition of Article 2, but it varies to reflect the difference between sales and lease transactions.

17–1a What Is a Sale? Under Article 2 of the UCC, a sale is defined as “the passing of title from the seller to the buyer for a price.” Here, title refers to the formal right of ownership of prop- erty. The price may be payable in cash (or its equivalent) or in other goods or services.

sales contract A contract to sell goods.

LearNING OUTcOme 1

State the scope of Article 2 of the UCC.

sale The passing of title to property for a price.

Introduction to Sales and Lease Contracts17

LearNING OUTcOmeS

The four Learning Outcomes below are designed to help improve your understanding of the chapter. After reading this chapter, you should be able to:

State the scope of Article 2 of the UCC.

Identify how the UCC deals with open contract terms.

Explain the UCC’s treatment of additional terms.

Discuss the UCC’s Statute of Frauds.

1

2

3

4

Conflict Presented AirWays Technologies promotes itself as a one-stop shop for electronics design and manufacturing. Barnett Communications hires AirWays to design and make access points—equipment

that enables wireless devices to communicate. Barnett plans to sell the finished products to its customers.

AirWays designs and makes the access points and delivers them to Barnett, but they do not work. When Barnett refuses to pay, AirWays files a lawsuit for breach of contract. The parties dispute whether Barnett’s claim falls under the Uniform Commercial Code (UCC), which applies to sales of goods but not to sales of services.

Q Does the Ucc cover this deal? Why or why not?

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C H A P T E R 1 7 Introduction to Sales and Lease Contracts 207

17–1b What Are Goods? To be characterized as a good, an item of property must be tangible. Tangible property has physical existence—it can be touched or seen and carried from place to place. Intangible property—such as corporate stocks and bonds, patents and copyrights, and ordinary contract rights—has only conceptual existence and thus does not come under Article 2.

In addition, a good must be movable. A movable item can be carried from place to place. Because it is not movable, real estate is excluded from Article 2. Real estate includes land, interests in land, and things permanently attached to the land.

Goods Associated with Real Estate Goods associated with real estate can fall within the scope of Article 2. For instance, a contract for the sale of minerals (including oil and gas) is a contract for a sale of goods if they are to be severed, or detached, from the land by the seller. A sale of growing crops or timber to be cut is a contract for a sale of goods regardless of who severs them. Other “things attached” to real estate but capable of severance without material harm to the real estate (such as a window air conditioner) are considered goods regardless of who severs them from the land.

Goods and Services Combined The majority of courts treat contracts for services as being excluded from Article 2 of the UCC. In cases in which goods and services are combined, however, courts disagree. For instance, is the blood furnished to a patient during an operation a sale of goods or the performance of a medical service? Some courts say it is a good, but others say it is a service.

Because the UCC does not provide the answer, the courts generally use the predominant-factor test to determine whether a contract is primarily for the sale of goods or for the sale of services. If a court decides that a mixed contract is pri- marily a goods contract, any dispute, even a dispute over the services portion, will be decided under the UCC.

predominant-factor test A test to determine whether a contract is primarily for the sale of goods or services.

Highlighting the Point

Oliver buys Grape Street Pub from Allison. Under the sales contract, in addition to the building and fixtures, Oliver agrees to buy the pub’s movable property—such as tables and chairs, wall art, and dishware. Oliver buys the building outright, and he agrees to make monthly payments on the movable property. When a fire destroys much of the pub’s interior, Oliver files an insurance claim to recover for the damage. Allison sues Oliver for part of the insurance proceeds because he has not fully paid for the movable property yet and thus does not have title.

can allison successfully claim that title to the movable property did not pass to Oliver? No. Under Article 2 of the UCC, title to the pub’s movable property passed to Oliver at the time he contracted with Allison for the sale of the business. Oliver is the owner of the goods, even though he has not fully paid for them yet. As the owner, he is entitled to the insurance proceeds to replace them.

tangible property Property that has physical existence.

intangible property Property that exists only conceptually.

Real Case

N111KJ, LLC, contracted to buy a jet from Cessna Aircraft Company. As part of the agree- ment, Cessna promised to manage the jet—that is, rent it out on N111KJ’s behalf—for five years. Three years later, Cessna informed N111KJ that the jet was being dropped from the management program. Because of this decision, N111KJ was forced to sell

(Continues)

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U n i t 3 Sales and Leases208

17–1c Who Is a Merchant? Article 2 applies to sales transactions between all buyers and sellers. In certain situ- ations, however, the UCC imposes special rules on merchants because of their commercial expertise. Under the UCC, a merchant is a person who deals in goods of the kind involved in the sales contract. In addition, a merchant is someone who holds himself or herself out as having knowledge and skill unique to the practices or goods involved in the transaction.

17–1d What Is a Lease? Leases of goods—such as automobiles and industrial equipment—have become increasingly common in today’s business world. In this context, a lease is a transfer of the right to possess and use goods for a period of time in exchange for payment. The UCC’s Article 2A covers these lease agreements.

Article 2A defines a lease agreement as the lessor’s and lessee’s bargain, as found in their language and as implied by other circumstance. A lessor is one who trans- fers the right to the possession and use of goods under a lease. A lessee is one who acquires the right to the possession and use of goods under a lease.

17–2 Sales and Lease contracts As mentioned, sales and lease contracts are not governed exclusively by Articles 2 and 2A of the UCC. They are also governed by general contract law whenever it is relevant and has not been modified by the UCC. Exhibit 17.1 illustrates the relationship between general contract law and statutory law—UCC Articles 2 and 2A—governing contracts for the sale and lease of goods.

The following sections summarize how UCC provisions change the effect of the general law of contracts. It is important to remember, too, that parties to sales and lease contracts are free to establish whatever terms they wish. The UCC comes into play when the parties have left a term out of their contract and that omission later gives rise to a dispute.

17–2a Offer In general contract law, the moment a definite offer is met by an unqualified accep- tance, a binding contract is formed. In commercial sales transactions, the verbal exchanges, the correspondence, and the actions of the parties may not reveal exactly when a binding contract arises. The UCC states that an agreement sufficient to constitute a contract can exist even if the moment of its making is undetermined.

Open Terms According to general contract law, an offer must be definite enough for the parties (and the courts) to understand its essential terms when it is accepted. In

merchant A person engaged in the purchase and sale of goods.

lease An agreement to transfer the right to possess and use goods for a period of time in exchange for payment.

lessor One who transfers the right to the possession and use of goods under a lease.

lessee One who acquires the right to the possession and use of goods under a lease.

LearNING OUTcOme 2

Identify how the UCC deals with open contract terms.

the jet for less than 80 percent of the purchase price. Later, N111KJ filed a suit in a federal district court against Cessna, claiming breach of contract under the UCC. The court dismissed the claim, ruling that the contract was not subject to the UCC because managing a jet was a service. N111KJ appealed.

Did the Ucc govern this contract? Yes. In N111KJ, LLC v. Cessna Aircraft Co., the U.S. Court of Appeals for the Eleventh Circuit reversed the lower court’s dismissal of the suit. The contract involved a sale of goods (the jet) and a sale of services (its management). Under the predominant-factor test, the clear purpose of the agreement was the sale of the jet. Its management was a secondary purpose.

—2017 WL 217982 (11th Cir.)

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C H A P T E R 1 7 Introduction to Sales and Lease Contracts 209

contrast, the UCC states that a sales or lease contract will not fail for indefiniteness even if one or more terms are left open, as long as both of the following factors are true: 1. The parties intended to make a contract. 2. There is a reasonably certain basis for the court to grant an appropriate

remedy. The UCC provides numerous open-term provisions that can be used to fill the

gaps in a contract. Thus, in the case of a dispute, all that is necessary to prove the existence of a contract is an indication (such as a purchase order) that there is a contract. Missing terms can be proved by evidence, or the courts will presume that what the parties intended was whatever is reasonable. The quantity of goods involved must be expressly stated, however. If the quantity term is left open, the courts will have no basis for determining a remedy.

Merchant’s Firm Offer Under regular contract principles, an offer can be revoked at any time before acceptance. The UCC has an exception that applies only to firm offers for the sale or lease of goods made by a merchant (regardless of whether the offeree is a merchant).

A firm offer exists if a merchant gives assurances in a signed writing that the offer will remain open. A firm offer is irrevocable for the stated period or, if no definite period is stated, for a reasonable period (neither to exceed three months).

firm offer An offer (by a merchant) that is irrevocable for a period of time.

exhibit 17.1 Law Governing Contracts

General Contract Law

Relevant Common Law Not Modi�ed by the UCC

Statutory Law (UCC Articles 2 and 2A)

Contracts for the

Sale and Lease of Goods

Nonsales Contracts (including contracts for services

and for real estate)

Controls

Control s

Controls

Highlighting the Point

Chad owns and operates Famous Auto, a used car dealership. Ricardo is interested in buying a used car for his teenaged son. Ricardo meets with Chad at his business, and they discuss various options. A few days later, on January 1, Chad sends Ricardo an e-mail from his Famous Auto account. The e-mail states, “I have a 2017 Toyota RAV4 on the lot that I’ll sell you for $15,000 any time between now and January 31.”

Is chad’s e-mail a firm offer? Yes. This writing creates a firm offer. Chad will be liable for breach if he sells that particular Toyota RAV4 to someone other than Ricardo before January 31.

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U n i t 3 Sales and Leases210

17–2b Acceptance Acceptance of an offer to buy, sell, or lease goods generally may be made in any reasonable manner and by any reasonable means. The UCC permits acceptance of an offer to buy goods by either a promise to ship or the prompt shipment of conforming or nonconforming goods to the buyer. Conforming goods accord with the contract’s terms, whereas nonconforming goods do not.

Shipment of Nonconforming Goods If the seller promptly ships nonconforming goods, this shipment constitutes both an acceptance of an offer (a contract) and a breach. This rule does not apply, however, if the seller notifies the buyer within a reasonable amount of time that the nonconforming shipment is offered only as an accommodation. The notice of accommodation must clearly indicate that the shipment does not constitute an acceptance and that, therefore, no contract has been formed.

Highlighting the Point

McIntosh orders one thousand blue smart fitness watches from Halderson. Halder- son ships one thousand black smart fitness watches to McIntosh. Halderson notifies McIntosh that it has only black watches in stock, and the black watches are being sent as an accommodation.

Is the shipment of black smart fitness watches an acceptance or an offer? The shipment is an offer. A contract will be formed only if McIntosh accepts the black watches. If Halderson ships black watches without notifying McIntosh that the goods are being sent as an accommodation, Halderson’s shipment is both an acceptance of McIntosh’s offer and a breach of the resulting contract. McIntosh may sue Halderson for any appropriate damages.

Notice of Acceptance Recall that a unilateral offer invites acceptance by performance. Under the common law, the offeree need not notify the offeror (a person who makes an offer) of the performance unless the offeror would not otherwise know about it. Under the UCC, however, the offeror must be notified of the offeree’s performance (acceptance) within a reasonable time. Otherwise, the offeror can treat the offer as having lapsed.

Additional Terms Recall that under the common law, the mirror image rule requires that the terms of the acceptance exactly match those of the offer. ExamplE 17.1 Abby e-mails an offer to sell twenty Samsung’s Galaxy 8.5 tablets to Dylan. If Dylan accepts the offer but changes it to require Galaxy 10.5 tablets instead, then there is no contract. j

To avoid these types of voided contracts, the UCC dispenses with the mirror image rule. Under the UCC, a contract is formed if the offeree makes a definite expression of acceptance, such as signing the form in the appropriate location. This is true even if the terms of the acceptance either modify or add to the terms of the original offer. What happens to these new terms? The answer depends on whether the parties are nonmerchants or merchants. 1. When at least one of the parties is a nonmerchant—If one of the parties is a

nonmerchant (or if both are nonmerchants), the contract is formed according to the terms of the original offer and not according to the new terms of the acceptance.

LearNING OUTcOme 3

Explain the UCC’s treatment of additional terms.

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C H A P T E R 1 7 Introduction to Sales and Lease Contracts 211

2. When both parties are merchants—When both parties to the contract are merchants, the additional terms automatically become part of the contract. There are, however, three exceptions to this rule. The terms do not become part of the contract if (a) the original offer expressly required acceptance of its terms, (b) the new terms materially alter the contract, or (c) the offeror rejects the new terms within a reasonable time.

3. Terms subject to the offeror’s consent—Regardless of merchant status, the offeree’s expression is not an acceptance if the new terms are expressly conditioned on the offeror’s consent. ExamplE 17.2 Farmland Harvest offers to sell ninety bales of hay at a certain price to Big Valley Ranch. Doris, the owner of Big Valley, says, “I accept your offer if you agree to include ten more bales.” This is not an acceptance because it includes an additional term (ten more hay bales) that is expressly subject to Farmland’s consent. j

17–2c Consideration The UCC radically changes the common law rule that contract modification must be supported by new consideration. Under the UCC, an agreement modifying a contract needs no consideration to be binding.

Modifications Must Be Made in Good Faith Of course, contract modification must be sought in good faith. Good faith in the case of a merchant means honesty in fact and the observance of reasonable commercial standards of fair dealing in the trade. Modifications extorted from the other party are in bad faith and unenforceable.

Highlighting the Point

Tanya, a public school employee in Idaho, purchases five hundred Ready2Learn easy-grip paintbrushes from Blackwell Education Services, an online retailer based in Michigan. When the paintbrushes arrive, the accompanying invoice includes an addi- tional term stating that any dispute between the parties will be settled in Michigan. When a dispute arises regarding payment, Blackwell files a suit in Michigan.

Is the school district bound by the additional term that was added to the invoice? No. Because the added term was included in an invoice delivered to a nonmerchant buyer (the school district), the Idaho school district is not legally bound to settle the dispute in Michigan.

Highlighting the Point

Jim agrees to manufacture and lease certain goods to Louise for a stated price. Subsequently, a sudden shift in the market makes it difficult for Jim to lease the items to Louise at the agreed-on price without suffering a loss. Jim tells Louise of the situation, and Louise agrees to pay an additional sum for leasing the goods.

can Louise later refuse to pay more than the original lease price? No. A shift in the market is a good faith reason for contract modification. Under the UCC, Louise’s promise to modify the contract needs no consideration to be binding. Thus, Louise is bound to the modified contract.

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U n i t 3 Sales and Leases212

When Modification without Consideration Requires a Writing In some situations, modification without consideration must be written to be enforceable. The contract may prohibit any changes unless they are in a signed writing. Also, any modification that brings a sales contract under the UCC’s Statute of Frauds will require that the modification be written.

17–2d The UCC’s Statute of Frauds The UCC contains a Statute of Frauds provision that applies to contracts for the sale or lease of goods. A contract for the sale of goods priced at $500 or more or the lease of goods involving total payments of $1,000 or more must be in writing to be enforceable. The parties can initially agree orally, so long as the agreement is evidenced by a later writing. ExamplE 17.3 Cosby Renovators enters into an oral contract with Anderson Plumbing Supply for the sale of four cast iron kitchen sinks for $650. For this oral agreement to be enforceable, the parties must put the terms in writing. j

Sufficiency of the Writing A writing, including an e-mail or other electronic record, will be sufficient as long as (1) it indicates that the parties intended to form a contract and (2) it is signed by the party against whom enforcement is sought. The contract will not be enforceable beyond the quantity of goods shown in the writing, but all other terms can be proved in court by oral testimony. For leases, the writing must reasonably identify and describe the goods leased and the lease term.

Written Confirmation between Merchants Merchants can satisfy the requirements of a writing for the Statute of Frauds if, after they have agreed orally, one of the merchants sends a signed written confirmation to the other. If the merchant who receives the confirmation objects to its contents, he or she must give written notice of objection within ten days of receipt. Otherwise, the writing is sufficient against the receiving merchant, even though he or she has not signed anything.

LearNING OUTcOme 4

Discuss the UCC’s Statute of Frauds.

Highlighting the Point

Alfonso is a merchant buyer in Cleveland. He contracts over the telephone to purchase $4,000 worth of goods from Goldstein, a New York City merchant seller. Two days later, Goldstein sends written confirmation detailing the terms of the oral contract, and Alfonso subsequently receives it.

Is alfonso bound to the contract? If Alfonso does not give Goldstein written notice of objection to the contents of the written confirmation within ten days of receipt, Alfonso cannot raise the Statute of Frauds as a defense against the enforcement of the contract. Alfonso will be bound by the contract.

Exceptions to the UCC’s Statute of Frauds There are three exceptions to the UCC’s Statute of Frauds requirement. An oral contract subject to the Statute of Frauds will be enforceable despite the absence of a writing in the following circumstances: 1. Specially manufactured goods—An oral contract is enforceable if (a) it is for goods

that are specially manufactured for a particular buyer or specially manufactured or obtained for a particular lessee, (b) these goods are not suitable for resale or lease to others in the ordinary course of the seller’s or lessor’s business, and (c) the seller or lessor has substantially started to manufacture the goods or has made commitments to manufacture or obtain the goods. In this situation, the buyer or lessee cannot reject the agreement claiming the Statute of Frauds as a defense.

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C H A P T E R 1 7 Introduction to Sales and Lease Contracts 213

2. Admissions—An oral contract is enforceable if the party against whom enforcement is sought admits under oath that a contract was made. The contract will be enforceable even though it was oral, but enforceability will be limited to the quantity of goods admitted.

3. Partial performance—An oral contract is enforceable if payment has been made and accepted or goods have been received and accepted. This is the “partial performance” exception. The oral contract will be enforced at least to the extent of the performance that actually took place.

17–2e The Parol Evidence Rule Often, a contract completely sets forth all the terms and conditions agreed to by the parties that are intended as a final statement of their agreement. Such a contract cannot be contradicted by evidence of any other agreements between the parties. This is the parol evidence rule.

If, however, the writing contains some of the terms the parties agreed on but not others, a court might allow evidence to explain or supplement the terms in the contract. Such evidence may include consistent additional terms or information about course of dealing, usage of trade, or course of performance.

Consistent Additional Terms Sometimes, a court finds an ambiguity in a writing that is supposed to be a complete statement of the agreement between the parties. The court may accept evidence of consistent additional terms to clarify or remove the ambiguity. The court will not, however, accept evidence of contradictory terms.

Course of Dealing and Usage of Trade Under the UCC, the meaning of any agreement, evidenced by the language of the parties and by their actions, must be interpreted in light of commercial practices and other surrounding circumstances. In interpreting an agreement, the court will assume that the course of dealing between the parties and the usage of trade were taken into account when the agreement was phrased.

A course of dealing is a sequence of previous actions and communications between the parties to a transaction that establishes a common basis for their understanding.

A usage of trade is a more generally observed practice or method of dealing. Specifically, it is a practice or method of dealing observed so regularly in a place, vocation, or trade as to justify an expectation that it was observed in the transac- tion in question.

A court will interpret the express terms of an agreement and an applicable course of dealing or usage of trade to be consistent with each other whenever reasonable. When such an interpretation is unreasonable, the express terms in the agreement will prevail.

Course of Performance A course of performance is the conduct that occurs under the terms of a particular agreement. The parties know best what they meant by their words, and the course of performance actually undertaken is the best indication of what they meant.

course of dealing Previous conduct between the parties to a transaction that establishes a common basis for their understanding.

usage of trade A practice or method of dealing observed regularly in a place, vocation, or trade.

course of performance The conduct that occurs under the terms of a particular agreement.

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U n i t 3 Sales and Leases214

Conflict Resolved In the Conflict Presented feature at the beginning of the chapter, Barnett Communications hires AirWays Technologies to design and make access points. Barnett plans to sell the finished products to

its customers. The access points delivered to Barnett do not work, and Barnett refuses to pay. AirWays sues for breach of contract. Part of the dispute is whether the claim falls under the scope of the UCC.

a Does the UCC cover this deal? Why or why not? Yes. The UCC applies to this contract. The UCC covers sales of goods but not sales of services. When a transaction

involves both goods and services, however, a court will apply the predominant-

factor test. This test asks the question: Is the contract primarily for a sale of goods or

a sale of services? The contract between Barnett and Airways requires the design and

manufacture of a product that Barnett can sell to its customers. Thus, the predominant

purpose of the deal is to produce and supply goods.

LearNING OUTcOme 1: State the scope of article 2 of the Ucc. Article 2 of the UCC governs contracts for sales of goods. Under the UCC, a sale is “the passing of title”—the formal right of ownership—“from the seller to the buyer for a price.” To be characterized as a good, an item of property must be tangible and movable.

LearNING OUTcOme 2: Identify how the Ucc deals with open contract terms. Under the UCC, a sales or lease contract will not fail for indefiniteness even if one or more terms are left open as long as (1) the parties intended to make a contract and (2) there is a reasonably certain basis for the court to grant an appropriate remedy. The UCC offers numerous open-term provisions that can be used to fill the gaps in a contract. The quantity of goods must be expressly stated, however.

LearNING OUTcOme 3: explain the Ucc’s treatment of additional terms. A contract is formed if an offeree makes a definite expression of acceptance, even though the terms of the acceptance modify or add to the terms of the original offer. If at least one of the parties is a nonmerchant, the contract is formed according to the terms of the offer and does not include the additional terms of the acceptance.

If both parties are merchants, the additional terms become part of the contract unless:

(1) The original offer expressly required acceptance of its terms. (2) The new terms materially alter the contract. (3) The offeror rejects the new terms within a reasonable time.

Regardless of merchant status, an offeree’s expression is not an acceptance if the new terms are expressly conditioned on the offeror’s consent.

LearNING OUTcOme 4: Discuss the Ucc’s Statute of Frauds. Under the UCC, a contract for a sale of goods priced at $500 or more or a lease of goods involving total payments of $1,000 or more must be in writing to be enforceable. A writing is sufficient if it indicates that the parties intended to form a contract and is signed by the party against whom enforcement is sought. An oral contract may be enforceable despite the absence of a writing if (1) it involves specially manufactured goods, (2) the party against whom enforcement is sought admits under oath that a contract was made, or (3) partial performance has occurred.

CHaPteR sUmmaRy— intRodUCtion to sales and lease ContRaCts

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C H A P T E R 1 7 Introduction to Sales and Lease Contracts 215

issUe sPotteRs Check your answers to the Issue Spotters against the answers provided in Appendix A at the end of this text.

1. Brad orders 150 computer desks. Fred ships 150 printer stands. Is this an acceptance of Brad’s offer or a counteroffer? If it is an acceptance, is it a breach of the contract? What if Fred told Brad that he was send- ing printer stands as an accommodation? (See Sales and Lease Contracts.)

2. Smith & Sons, Inc., sells truck supplies to J&B, which services trucks. Over the phone, J&B and Smith negoti- ate for the sale of eighty-four sets of tires. Smith sends a letter to J&B detailing the terms. Smith ships the tires two weeks later. J&B refuses to pay. Is there an enforce- able contract between them? Explain why or why not. (See Sales and Lease Contracts.)

stRaigHt to tHe Point

1. What are goods? (See Sales and Lease of Goods.) 2. What is a sale? (See Sales and Lease of Goods.) 3. When does the common law govern contracts for sales

and leases of goods? (See Sales and Lease Contracts.) 4. How may the acceptance of an offer to buy, sell, or lease

goods be made? (See Sales and Lease Contracts.) 5. Does the modification of an agreement subject to the

UCC need new consideration to be binding? (See Sales and Lease Contracts.)

6. Under the UCC, in the case of a merchant, what does “good faith” mean? (See Sales and Lease Contracts.)

7. According to the parol evidence rule, can evidence be used to explain or supplement the terms of a contract? (See Sales and Lease Contracts.)

Real law

17–1. acceptance. New England Precision Grinding, Inc. (NEPG), sells parts for medical equipment in Mas- sachusetts. NEPG agreed to supply Kyphon, Inc., with probes and nozzles. NEPG contracted with Simply Surgi- cal, LLC, to obtain the parts required. After half a dozen transactions, NEPG’s payments lagged, and Simply Sur- gical refused to make more deliveries. NEPG filed a suit in a Massachusetts state court against the seller, alleg- ing breach of contract. NEPG claimed that Kyphon had rejected some of the parts supplied by Simply Surgical, which gave NEPG the right not to pay for them. Do the UCC’s rules on acceptance support or undermine NEPG’s position? Discuss. [New England Precision Grinding, Inc. v. Simply Surgical, LLC, 89 Mass.App. 176, 46 N.E.2d 590 (2016)] (See Sales and Lease Contracts.)

17–2. The Statute of Frauds. Kendall Gardner agreed to buy from James Bowen and Richard Cagle—doing business as B&C Shavings—a specially built shaving mill to produce wood shavings for poultry processors. B&C sent an invoice to Gardner reflecting a purchase price of $86,200, with a 30 percent down payment and the “balance due before ship- ment.” Gardner paid the down payment. B&C finished the mill and wrote Gardner a letter, telling him to “pay the

balance due or you will lose the down payment.” By then, Gardner had lost his customers for the wood shavings and could not pay the balance due. He asked for the return of his down payment. Did these parties have an enforceable contract under the Statute of Frauds? Explain. [Bowen v. Gardner, 2013 Ark.App. 52, 425 S.W.3d 875 (2013)] (See Sales and Lease Contracts.)

17–3. additional Terms. B.S. International, Ltd. (BSI), makes costume jewelry. JMAM, LLC, is a wholesaler of costume jewelry. JMAM sent a letter with the terms for its orders to BSI, including the necessary procedure for obtaining credit for items that customers rejected. The letter stated, “By sign- ing below, you agree to the terms.” Steven Baracsi, BSI’s owner, signed the letter and returned it. For six years, BSI made jewelry for JMAM, which resold it. Items rejected by customers were sent back to JMAM, but were never returned to BSI. BSI filed a suit against JMAM, claiming $41,294.21 for the unreturned items. BSI showed the court a copy of JMAM’s terms. Across the bottom had been typed a postscript (P.S.) requiring the return of rejected merchan- dise. Was this “P.S.” part of the contract? Discuss. [B.S. International, Ltd. v. JMAM, LLC, 13 A.3d 1057 (R.I. 2011)] (See Sales and Lease Contracts.)

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U n i t 3 Sales and Leases216

etHiCal QUestions

17–4. Sales of Goods. Should merchants be required to act in good faith? Why or why not? (See Sales and Lease of Goods.)

17–5. Sales and Lease contracts. Camal Terry signed a “Sales Contract” to buy a 1995 BMW 3 Series from Robin Drive Auto, a car dealership in Delaware. Terry agreed to pay $4,995 and Robin Drive agreed to hold the BMW for him in contemplation of a sale within twenty-one days. Also specified were a down payment of $1,200 and the timing of other payments. The payment schedule, however, exceeded

the sale date by three weeks. In addition, the contract pro- vided that the payments were fees for storage and “prep” and were not deductible from the car’s price. Terry paid more than $1,000 before asking Robin Drive to refund it. When the dealership refused, Terry filed a suit in a Del- aware state court against Robin Drive. Testimony about the mismatched contract terms was conflicting. Ethically, what is wrong with this deal, and how could it have been fixed? Discuss. [Terry v. Robin Drive Auto, 2017 WL 65842 (2017)] (See Sales and Lease Contracts.)

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217

Chapter 17—work set

1. If the subject of a sale is goods, Article 2 of the UCC applies.

2. A contract for a sale of goods is subject to the same traditional principles that apply to all contracts.

3. If the subject of a transaction is a service, Article 2 of the UCC applies.

4. The UCC requires that an agreement modifying a contract be supported by new consideration to be binding.

5. Under the UCC’s Statute of Frauds, a writing must include all material terms except quantity.

6. Under certain circumstances, an oral contract for a sale of goods priced at $500 or more can be enforceable despite the absence of a writing.

7. A lease agreement is a bargain between a lessor and a lessee, as shown by their words and conduct.

8. Under the UCC, acceptance can be made by any means of communication reasonable under the circumstances.

9. No oral contract is enforceable under the UCC.

tRUe-False QUestions

1. Adam pays Beta Corporation $1,500 for a laptop. Under the UCC, this is

a. a bailment. b. a consignment. c. a lease. d. a sale.

2. Morro Beverage Company has a surplus of carbon dioxide (which is what puts the bubbles in Morro beverages). Morro agrees to sell the surplus to the Rock Ale Company. Morro is a merchant with respect to

a. carbon dioxide but not Morro beverages. b. Morro beverages but not carbon dioxide. c. both Morro beverages and carbon dioxide. d. neither Morro beverages nor carbon dioxide.

3. Marina Shipyard agrees to build a barge for MaxCo Shipping. The contract includes an option for up to five more barges, but states that the prices of the other barges could be higher. Marina and MaxCo have

a. a binding contract for at least one barge and up to six barges. b. a binding contract for one barge only. c. no contract, because the terms of the option are too indefinite. d. no contract, because both parties are merchants with respect to barges.

4. Mike and Rita orally agree to a sale of one hundred pairs of hiking boots at $50 each. Rita gives Mike a check for $500 as a down payment. Mike takes the check. At this point, the contract is enforceable

a. to the full extent, because it is for specially made goods. b. to the full extent, because it is oral. c. to the extent of $500. d. for none of these reasons.

mUltiPle-CHoiCe QUestions

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218

5. Med Labs sends Kraft Instruments a purchase order for scalpels. The order states that Med will not be bound by any additional terms. Kraft ships the scalpels with an acknowledgment that includes an additional, materially different term. Med is

a. not bound by the term, because the offer expressly states that no other terms will be accepted. b. not bound by the term, because the additional term constitutes a material alteration. c. not bound by the term, for both of the reasons above in a and b. d. bound by the term.

6. Under the parol evidence rule, a contract cannot be contradicted by evidence of any other agreements between the parties except in which of the following circumstances?

a. Consistent terms can be used to clarify or remove an ambiguity in the writing. b. Commercial practices can be used to interpret the contract. c. Both a and b. d. None of the above.

7. Lena, a car dealer, writes to Sam that “I have a Honda Civic that I will sell to you for $4,000. This offer will be kept open for one week.” Six days later, Todd tells Sam that Lena sold the car that morning for $5,000. Who violated the terms of the offer?

a. Lena. b. Sam. c. Todd. d. No one.

8. Stron Cellphones agrees to buy an unspecified quantity of microchips from SmartCorp. The quantity that a court would order Stron to buy under this contract is

a. the amount that Stron would buy during a normal year. b. the amount that SmartCorp would make in a normal year. c. the amount that SmartCorp actually makes this year. d. none of the amounts above.

answeRing moRe legal PRoblems

1. Western Horse, Inc., agreed to buy hay from AgriSales, Inc. They signed a “Purchase Order” for “26 tons (880 bales)” that left other details blank. AgriSales loaded and weighed a trailer and dispatched it. Before delivery, however, Western told AgriSales to cancel the order—it had arranged to buy the hay for a lower price and faster delivery from Orchard Alfalfa Fields.

Can AgriSales recover the cost of attempting to fill Western’s order? Yes. AgriSales will have to show that the parties had an enforceable contract despite the details left “blank.” The UCC states that a sales contract will not fail for indefiniteness even if one or more terms are left open as long as (1) the parties _______________ to make a contract and (2) there is a _______________ certain basis for the court to grant an appropriate remedy. Missing terms can be proved, or it can be presumed that the parties _______________ whatever is _______________, as long as the quantity is not left open.

2. Mountain Stream Trout, Inc., agreed to buy market size trout from trout grower Lake Farms, LLC. Their five- year contract did not define market size. At the time, in the trade market size referred to fish of one-pound live weight. After three years, Mountain Stream began taking fewer, smaller deliveries of larger fish, claiming that market size varied according to whatever its cus- tomers demanded. Lake Farms filed a suit for breach of contract.

Is outside evidence admissible to explain market size? Yes. Under the UCC, in interpreting a commer- cial agreement, a court will assume that the usage of _______________ between the parties was consid- ered when the contract was formed. Also, the con- duct that occurs under an agreement, the course of _______________, is the best indication of what the parties meant. Here, the _______________ usage at the time of the contract indicated that market size referred to fish of one-pound live weight. This was the standard for the course of _______________ between the parties over the first three years of the contract.

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219

Learning OutcOmes

The four Learning Outcomes below are designed to help improve your understanding of the chapter. After reading this chapter, you should be able to:

Explain the concept of identification.

Describe the effects of imperfect title on sales of goods.

Discuss the concept of risk of loss.

Identify insurable interest in goods.

1

2

3

4

18 Title and Risk of Loss

Anything can happen between the time a contract is signed and the time the goods are transferred to the buyer’s or lessee’s possession. For instance, in a sale of oranges to be delivered after the harvest, a natural disaster, such as fire or frost, may destroy the orange groves. Or the oranges may be damaged or lost in transit. Because of these possibilities, it is important to know the rights and liabilities of the parties involved.

Under the Uniform Commercial Code (UCC), rights and liabilities are generally not determined by who has title—the right of ownership. Instead, they depend on the concepts of identification, passage of title, risk of loss, and insurable interest.

18–1 identification Before any interest in goods can pass from the seller or lessor to the buyer or les- see, the goods must exist and be identified as the specific goods in the contract. Identification takes place when specific goods are designated as the subject matter of a sales or lease contract.

Title and risk of loss cannot pass from seller to buyer unless the goods are identi- fied to the contract. (Title to leased goods does not pass to a lessee.) Identification is significant because it gives the buyer or lessee the right to insure the goods and the right to recover from third parties who damage the goods.

The parties can agree in their contract on when identification will take place. If they do not, the UCC determines when identification takes place.

18–1a Existing Goods If the contract calls for the sale or lease of specific goods that are already in existence, identification takes place at the time the contract is made. ExamplE 18.1 Dmitri’s Autoplex contracts to purchase or lease a fleet of five cars designated by their vehicle identification numbers (VINs). Because the cars are identified by their VINs, iden- tification has taken place. j

identification The express designation of the goods provided for in a contract.

Learning OutcOme 1

Explain the concept of identification.

Conflict Presented Tatiana’s Talk & Text is a retail phone and accessories store in Denver, Colorado. One day, Tatiana orders one hundred iPhone 8s from Apple Inc., F.O.B. Denver. Instead of iPhone 8s,

Apple ships iPhone 7s. In addition, some of the smartphones are damaged in transit. Tatiana rejects the shipment.

Q Who suffers the loss?

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U n i t 3 Sales and Leases220

18–1b Future Goods Goods that are not both existing and identified to the contract are called future goods. The UCC has several rules for future goods. 1. If a sale involves unborn animals to be born within twelve months after con-

tracting, identification takes place when the animals are conceived. 2. If a sale involves crops that are to be harvested within twelve months

(or the next harvest season occurring after contracting, whichever is longer), identification takes place when the crops are planted. Otherwise, identification takes place when they begin to grow.

3. For any other future goods, identification occurs when the goods are shipped, marked, or otherwise designated by the seller (or lessor) as the goods to which the contract refers.

18–1c Goods from a Larger Mass Goods that are part of a larger mass are identified when the goods are marked, shipped, or somehow designated by the seller or lessor as the particular goods to pass under the contract. ExamplE 18.2 McKee, the buyer, orders 1,000 cases of beans from a 10,000-case lot. Identification takes place when Adhir, the seller, separates the 1,000 cases of beans from the 10,000-case lot. j

The most common exception to this rule deals with fungible goods. Fungible goods are goods that are alike naturally or by agreement or trade usage. Fungible goods are essentially identical and interchangeable for the purposes of a commer- cial transaction. Examples are wheat and oil that are of the same grade and quality. Owners of fungible goods typically hold title as owners in common, which are owners with an undivided share of the whole. A seller-owner can pass title and risk of loss to the buyer without actually separating the goods. The buyer simply replaces the seller as an owner in common.

fungible goods Goods that are alike by physical nature, by agreement, or by trade usage.

owner in common An owner with an undivided share of the whole.

Real Case

BMW Group, LLC, ordered No. 4 fuel oil from Castle Oil Corporation for delivery to BMW’s building in New York City. BMW paid the retail price for No. 4 fuel oil, but Castle’s delivered product did not conform to the order. Specifically, the fuel oil appeared to have been mixed with waste oil. BMW filed a lawsuit in a New York state court against Castle. BMW alleged that the defendant had delivered goods that did not meet the standard set out in the parties’ contract. The court dismissed BMW’s complaint on the ground that the complaint did not allege that the use of the blended oil had caused an injury. BMW appealed, arguing that the oil did not conform to the contract and that it should be able to recover for that alone.

could BmW sue castle for shipping nonconforming fungible goods? Yes. In BMW Group, LLC v. Castle Oil Corp., a state intermediate appellate court reversed the dismissal of the complaint. Under the UCC, “If the goods that are delivered do not conform to the goods contemplated by the sales contract, the purchaser has a cause of action.”

—139 A.D.3d 78

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C H A P T E R 1 8 Title and Risk of Loss 221

18–2 Passage of title Once goods exist and are identified, title can be determined. Under the UCC, any explicit understanding between the buyer and the seller determines when title passes. If there is no such agreement, title passes to the buyer at the time and the place the seller physically delivers the goods. The delivery arrangements determine when this occurs.

In lease contracts, of course, title to the goods is retained by the lessor-owner of the goods. Hence, the UCC’s provisions relating to passage of title do not apply to leased goods.

18–2a Shipment Contracts In a shipment contract, the seller is required or authorized to ship goods by carrier, such as a trucking company or an air freight company. Under a shipment contract, the seller is required only to deliver the goods into the hands of a carrier. Title passes to the buyer at the time and place of shipment. Generally, all contracts are assumed to be shipment contracts if nothing to the contrary is stated in the contract.

18–2b Destination Contracts In a destination contract, the seller is required to deliver the goods to a particular destination, usually directly to the buyer. Title passes to the buyer when the con- forming goods are tendered at that destination. A tender of delivery occurs when the seller places or holds the goods at the buyer’s disposition (with any reasonably necessary notice) so that the buyer can take delivery.

ExamplE 18.3 Jackson Tools, a seller in New York, agrees to deliver goods to Spencer Hardware’s warehouse in Los Angeles by truck. When the truck arrives in Los Angeles, Jackson calls to tell Spencer that the goods are in the city and to ask that the warehouse be opened so that delivery can take place. j

18–2c Delivery without Movement of the Goods Some sales contracts do not call for the seller to ship or deliver the goods, such as when the buyer is to pick up the goods. The passage of title in this situation depends on whether the seller must deliver a document of title, such as a bill of lading or a warehouse receipt, to the buyer. A bill of lading is a receipt for goods that is signed by a carrier and that serves as a contract for the transportation of the goods. A warehouse receipt is a receipt issued by a warehouser for goods stored in a warehouse.

Required Document of Title When a document of title is required, title passes to the buyer when and where the document is delivered. Thus, if the goods are stored in a warehouse, title passes to the buyer when the appropriate documents are delivered to the buyer. The goods never move.

No Required Document of Title When no documents of title are required, title passes at the time and place the sales contract is made, if the goods have already been identified. If the goods have not been identified, title does not pass until identification occurs.

ExamplE 18.4 Norton Timber Company sells some lumber to Byron. They agree that Byron will pick up the lumber at the company’s sorting yard. If the lumber has been identified—that is, segregated or distinguished from the other lumber—title

shipment contract A contract requiring the seller to deliver the goods to a carrier, at which time title passes to the buyer.

destination contract A contract requiring the seller to tender delivery of the goods at a certain destination, at which time title passes to the buyer.

tender of delivery The seller’s act of giving the buyer reasonable notice that conforming goods are available.

document of title A document that evidences the right to possession of goods.

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U n i t 3 Sales and Leases222

passes to Byron when the contract is signed. If the lumber is still in storage build- ings, however, title does not pass to Byron until the particular pieces of lumber to be sold under this contract are identified. j

18–2d Sales or Leases by Nonowners Problems relating to passage of title occur when persons who acquire goods with imperfect titles attempt to sell or lease the goods. What are the rights of two par- ties who lay claim to the same goods when those goods are sold or leased with imperfect titles? Generally, the buyer acquires at least whatever title the seller has to the goods sold.

Void Title A buyer may unknowingly purchase goods from a seller who is not the owner of the goods. If the seller is a thief, the seller’s title is void—legally, no title exists. Thus, the buyer acquires no title, and the real owner can reclaim the goods from the buyer. Of course, the buyer can then try to recover from the thief! The same result would occur if the goods were leased.

Learning OutcOme 2

Describe the effects of imperfect title on sales of goods.

Highlighting the Point

Jim steals a Nikon digital camera owned by Margaret. He sells the camera to Sandra, who acts in good faith and honestly was not aware that the camera was stolen.

can margaret reclaim the camera from sandra? Yes. Jim had void title to the camera. Margaret can reclaim it from Sandra even though Sandra acted in good faith and hon- estly was not aware that the camera was stolen. Sandra can seek damages from Jim.

Voidable Title A seller has voidable title if the goods that he or she is selling were obtained by fraud, paid for with a check that is later dishonored, purchased from a minor, or purchased on credit when the seller was insolvent. (Under the UCC, a person is insolvent when that person ceases to pay his or her debts, cannot pay the debts as they become due, or is insolvent within the meaning of federal bankruptcy law.)

In contrast to a seller with void title, a seller with voidable title has the power to transfer good title to a good faith purchaser. A good faith purchaser is a buyer who is unaware of circumstances that would make an average person inquire about the validity of the seller’s title to the goods. The real owner cannot recover goods from a good faith purchaser. If the buyer of the goods is not a good faith purchaser, then the owner of the goods can reclaim them. Exhibit 18.1 illustrates these con- cepts. The same rules apply in circumstances involving leases.

The Entrustment Rule Entrusting goods to a merchant who deals in goods of that kind gives the merchant the power to transfer all rights to a buyer in the ordinary course of business. This is the entrustment rule.

Entrusting includes both delivering the goods to the merchant and leaving the goods with the merchant for later delivery or pickup. A buyer in the ordinary course of business is a person who, in good faith and without knowledge that the sale violates the ownership rights of a third party, buys in the normal course of business from a person (other than a pawnbroker) in the business of selling goods of that kind.

The entrustment rule basically allows innocent buyers to obtain legitimate title to goods purchased from merchants even if the merchants do not have good title. The UCC provides a similar rule for leased goods.

insolvent A condition in which a person’s liabilities exceed the value of his or her assets.

good faith purchaser One who buys without notice of invalidity of title.

entrustment rule A rule stating the merchant’s power to transfer entrusted goods to certain buyers.

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C H A P T E R 1 8 Title and Risk of Loss 223

18–3 risk of Loss At the various stages of sales and lease transactions, a question may arise as to who bears the risk of loss. In short, who suffers the financial loss if the goods are damaged, destroyed, or lost in transit?

Under the UCC, the risk of loss does not necessarily pass with title. When the risk of loss passes from a seller or lessor to a buyer or lessee is generally determined by the contract between the parties. When no provision in the contract indicates when risk passes, the UCC provides special rules. (See the Linking Business Law to Your Career feature at the end of this chapter for important considerations concerning the management of risk of loss.)

18–3a Delivery with Movement of the Goods—Carrier Cases

When the contract involves movement of the goods via a common carrier but does not specify when risk of loss passes, the courts look for specific delivery terms in the contract. The terms traditionally used in contracts within the United States are defined in Exhibit 18.2. These terms determine which party will pay the costs of

Learning OutcOme 3

Discuss the concept of risk of loss.

exhibit 18.1 Void and Voidable Titles If goods are transferred from their owner to another by theft, the thief acquires no ownership rights. Because the thief’s title is void, a later buyer can acquire no title, and the owner can recover the goods. If the transfer occurs by fraud, the transferee acquires a voidable title. A later good faith purchaser for value can acquire good title, and the original owner cannot recover the goods.

OWNER

GOODS

FraudTheft

SaleSale

Good faith purchaser for value acquires good title.

Buyer acquires no title.

Owner cannot recover goods.

Transferee has voidable title.Thief has void title.

Owner can recover goods.

Highlighting the Point

Selena steals Jan’s watch and leaves it with a jeweler for repairs. The jeweler sells the watch to Ben, who does not know that the jeweler has no right to sell it.

against whom does Ben get good title? Ben gets good title against Selena, who entrusted the watch to the jeweler, but not against Jan. Jan neither entrusted the watch to Selena nor authorized Selena to entrust it. Therefore, Ben is a buyer in the ordinary course of business as to Selena but not as to Jan. Jan can recover the watch from Ben.

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U n i t 3 Sales and Leases224

delivering the goods and who bears the risk of loss. If the contract does not include these terms, then the courts must decide whether the contract is a shipment contract or a destination contract.

Shipment Contracts and Risk of Loss Recall that in a shipment contract, the seller or lessor is required or authorized to ship goods by carrier. Risk of loss passes to the buyer or lessee when the goods are delivered to the carrier.

Highlighting the Point

Russell Orchards, a seller in Houston, Texas, sells five hundred cases of grapefruit to Grocers Fruit Brokers, a buyer in New York. The contract states that the sale is “F.O.B. Houston” (free on board in Houston—that is, the buyer pays the transportation charges from Houston). The contract authorizes a shipment by carrier. It does not require that the seller tender the grapefruit in New York.

if the goods are damaged in transit, who suffers the loss—the seller or the buyer? The loss is the buyer’s. Risk passes to the buyer when conforming goods are placed in the possession of the carrier.

exhibit 18.2 Contract Terms—Definitions These contract terms help determine which party will bear the costs of delivery and when risk of loss will pass from the seller to the buyer.

Destination Contracts and Risk of Loss In a destination contract, the risk of loss passes to the buyer or lessee when the goods are tendered to the buyer or lessee at that destination. In the preceding Highlighting the Point feature, for instance, if the contract had been F.O.B. New York, risk of loss during transit to New York would have been the seller’s.

18–3b Delivery without Movement of the Goods The UCC also addresses situations in which the seller or lessor is required neither to ship nor to deliver the goods. Frequently, the buyer or lessee is to pick up the goods from the seller or lessor. At other times, the goods are held by bailee. Under

term Definition

F.O.B. (free on board) Indicates that the selling price of goods includes transportation costs to the specific F.O.B. place named in the contract. The seller pays the expenses and carries the risk of loss to the F.O.B. place named. If the named place is the place from which the goods are shipped (for example, the seller’s city or place of business), the contract is a shipment contract. If the named place is the place to which the goods are to be shipped (for example, the buyer’s city or place of business), the contract is a destination contract.

F.a.S. (free alongside ship) Requires that the seller, at his or her own expense and risk, deliver the goods alongside the vessel in the manner usual in that port or on a dock designated and provided by the buyer. An F.A.S. contract is essentially an F.O.B. contract for ships.

C.I.F. or C.&F. (cost, insurance, and freight or just cost and freight)

Requires, among other things, that the seller “put the goods in the possession of a carrier” before risk passes to the buyer. (These are basically pricing terms, and the contracts remain shipment contracts, not destination contracts.)

Delivery ex-ship (delivery from the carrying vessel)

Means that risk of loss does not pass to the buyer until the goods are properly unloaded from the ship or other carrier.

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C H A P T E R 1 8 Title and Risk of Loss 225

the UCC, a bailee is a party who, by a bill of lading, warehouse receipt, or other document of title, acknowledges possession of goods and contracts to deliver them. For instance, a warehousing company or a trucking company that normally issues documents of title for goods it receives is a bailee.

Goods Held by the Seller or Lessor If the goods are held by the seller or lessor, a document of title is usually not used. If the seller or lessor is a merchant, risk of loss to goods held by the seller or lessor passes to the buyer or lessee when he or she takes physical possession of the goods. In other words, the merchant-seller bears the risk of loss between the time the contract is formed and the time the buyer picks up the goods.

bailee One to whom goods are entrusted by a bailor.

Highlighting the Point

Douglas buys a manufactured home from Andy’s Mobile Home and Land Sales. Douglas pays the full price and makes arrangements to have the home moved to his property the next day. The night before it is to be moved, however, fire destroys the home.

Does Douglas suffer the loss? No. The risk of loss passes to the buyer (Douglas) from the merchant-seller (Andy’s) only when the buyer takes actual physical possession of the goods. Even though Douglas is the owner of the home, he has not taken physical possession of the home yet. As the merchant-seller, Andy’s suffers the loss.

If the seller or lessor is not a merchant, the risk of loss passes to the buyer or lessee on tender of delivery. That is, the seller bears the risk of loss until he or she makes the goods available to the buyer and notifies the buyer that the goods are ready to be picked up.

Goods Held by a Bailee When a bailee is holding goods for a seller and the goods are to be delivered without being moved, the goods are usually represented by a document of title. The title document may be written on paper or evidenced by an electronic record. This document may be negotiable or nonnegotiable. Negotiable and nonnegotiable documents transfer different rights to the goods that the documents cover.

With a negotiable document of title, a party can transfer the rights by signing and delivering the document. The rights to the goods—free of any claims against the party that issued the document—pass with the document. ExamplE 18.5 Home Care Appliances signs a negotiable document of title that covers certain goods and delivers it to Town & Country Furniture Stores. As the buyer, Town & Country acquires all rights to the goods (and, by signing and delivering the document, may transfer those rights to someone else). j

With a nonnegotiable document of title, the party who receives it obtains only the rights that the party transferring it had, subject to any prior claims.

When goods are held by a bailee, risk of loss passes to the buyer when one of the following occurs: 1. The buyer receives a negotiable document of title for the goods. 2. The bailee acknowledges the buyer’s right to possess the goods. 3. The buyer receives a nonnegotiable document of title and has had a

reasonable time to present the document to the bailee and demand the goods. In respect to leases, the risk of loss passes to the lessee on acknowledgment by the bailee of the lessee’s right to possession of the goods.

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U n i t 3 Sales and Leases226

18–3c Conditional Sales Buyers and sellers sometimes form sales contracts that are conditioned either on the buyer’s approval of the goods or on the buyer’s resale of the goods. Unless otherwise agreed, if the goods are for the buyer to use, the transaction is a sale on approval. If the goods are for the buyer to resell, the transaction is a sale or return.

Sale on Approval When a seller permits a buyer to take goods on a trial basis, a sale on approval is made. Title and risk of loss (from causes beyond the buyer’s control) remain with the seller until the buyer accepts the offer. Acceptance can be made expressly or by any act inconsistent with the trial purpose or the seller’s ownership—for instance, reselling the goods or failing to return the goods within the trial period. If the buyer does not wish to accept, the buyer must return the goods to the seller. The return is at the seller’s expense and risk. Goods held on approval are not subject to the claims of the buyer’s creditors until acceptance.

ExamplE 18.6 Brad orders a Bowflex TreadClimber online, and the manufacturer allows him to try it risk-free for thirty days. If Brad decides to keep the Tread- Climber, then the sale is complete. If he returns it within thirty days, however, there is no sale, and he is not charged. If Brad files for bankruptcy within the thirty-day period and still has the TreadClimber in his possession, his creditors may not attach (seize) the TreadClimber, because he has not accepted it yet. j

Sale or Return In a sale or return, the sale is completed, but the buyer has an option to return the goods and undo the sale. Sale-or-return contracts often arise when a merchant purchases goods primarily for resale but has the right to return part or all of the goods in lieu of payment if the goods are not resold. ExamplE 18.7 Curtis, Inc., a diamond wholesaler, delivers gems to Shane Company, a jewelry retailer. Their understanding is that Shane can return any unsold gems at the end of six months. This transaction is a sale or return. j

When the buyer receives possession at the time of sale, the title and risk of loss pass to the buyer. Both remain with the buyer until the buyer returns the goods to the seller. If the buyer fails to return the goods within a specified time, the sale is finalized. The return of the goods is at the buyer’s risk and expense. Goods held under a sale-or-return contract are subject to the claims of the buyer’s creditors while they are in the buyer’s possession.

18–3d Risk of Loss When a Contract Is Breached There are many ways to breach a sales or lease contract. The transfer of risk oper- ates differently depending on which party breaches. Generally, the party in breach bears the risk of loss.

When the Seller or Lessor Breaches Sometimes, the seller breaches by supplying goods that are so nonconforming that the buyer has the right to reject them. In this situation, the risk of loss does not pass to the buyer until the defects are cured or until the buyer accepts the goods in spite of their defects. The seller can cure a defect by repairing or replacing the goods or discounting their price. ExamplE 18.8 David orders blue Sony earbuds, but Nikki, the seller, ships red ones. The risk of loss remains with Nikki unless David accepts the earbuds in spite of their color. j

If a buyer accepts a shipment of goods and later discovers a defect, acceptance can be revoked. Revocation allows the buyer to pass the risk of loss back to the seller, at least to the extent that the buyer’s insurance does not cover the loss.

sale on approval Buyer takes goods on a trial basis.

sale or return A conditional sale that can be rescinded by the buyer during a specified time.

cure The right of a party to correct nonconforming performance.

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C H A P T E R 1 8 Title and Risk of Loss 227

There is a similar rule for leases. When a lessee has the right to reject the goods, the risk of loss remains with the lessor until cure or acceptance. When a lessee accepts and then revokes acceptance, the risk passes back to the lessor.

When the Buyer or Lessee Breaches When a buyer or lessee breaches a contract, the general rule is that the risk of loss immediately shifts to the buyer or lessee. There are three important limitations to this rule: 1. The seller or lessor must already have identified the goods under the contract. 2. The buyer or lessee bears the risk for only a commercially reasonable time

after the seller or lessor learns of the breach. 3. The buyer or lessee is liable only to the extent of any deficiency in the seller’s

insurance coverage.

18–4 insurable interest Parties to sales or lease contracts often obtain insurance coverage to protect against damage, loss, or destruction of goods. Any party purchasing insurance, however, must have a “sufficient interest” in the insured item to obtain a valid policy. Insur- ance laws—not the UCC—determine “sufficiency.” The UCC is helpful, however, because it contains certain rules regarding the buyer’s and seller’s insurable interest in goods.

18–4a Insurable Interest of the Buyer or Lessee Buyers and lessees have an insurable interest in identified goods. The moment goods are identified to the contract by the seller or lessor, the buyer or lessee has an interest that allows him or her to obtain insurance coverage for those goods even before the risk of loss passes.

18–4b Insurable Interest of the Seller or Lessor A seller has an insurable interest in goods as long as he or she retains title to the goods. Even after title passes to a buyer, a seller who has a security interest (a right to secure payment) in the goods still has an insurable interest and can insure the goods. Hence, a buyer and a seller can have an insurable interest in identical goods at the same time.

In regard to leases, the lessor retains an insurable interest in leased goods unless the lessee exercises an option to buy. In that event, the risk of loss passes to the lessee.

Learning OutcOme 4

Identify insurable interest in goods.

insurable interest A property interest in goods that permits a party to obtain insurance.

Highlighting the Point

In March, Hillcrest Farms sells a cotton crop that it hopes to harvest in October. After the crop is planted, Simpson Textiles, the buyer, insures it against hail damage. In September, a hailstorm ruins the crop. Simpson files a claim under its insurance pol- icy. The insurer—Liberty Insurance Company—refuses to pay, asserting that Simpson has no insurable interest in the crop.

is Liberty insurance correct? No. Simpson acquired an insurable interest when the crop was planted, because it had a contract to buy it.

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U n i t 3 Sales and Leases228

Conflict Resolved In the Conflict Presented feature at the beginning of the chapter, Tatiana orders smartphones for her retail phone and accessories store in Denver, Colorado. She orders one hundred iPhone 8s from

Apple, Inc., F.O.B. Denver, but Apple ships iPhone 7s. In addition, some of the phones are damaged in transit. Tatiana rejects the shipment.

a Who suffers the loss? The loss falls on Apple. If Apple had shipped iPhone 8s instead of iPhone 7s (nonconforming goods), the loss would have been Tatiana’s.

The goods were sold and shipped “F.O.B. Denver.” The term F.O.B. (free on

board) indicates that the price includes transportation costs to the named

place (Denver). Denver is the buyer’s location, making the transaction a destination

contract.

Under a destination contract, the risk of loss passes to the buyer (Tatiana) when

the goods are tendered at that destination. If, however, the seller (Apple) ships

nonconforming goods, as in this case, the risk does not pass until the defects are cured or

the goods are accepted in spite of their defects. Apple did not cure the nonconforming

goods, nor did Tatiana accept them.

Linking Business Law to Your Career

Risk ManageMent

Issues of liability can arise when an event such as fire or theft damages goods in transit. Before a loss occurs, it is important that a company assess the risk of potential liability and take steps to guard against it.

Liability Provision

Businesses almost always allocate the risk of liability for a loss in their con- tracts. When your company is allocated the risk, the next step is to obtain insur- ance to protect against it.

Delivery terms

If a sales or lease contract does not refer to liability for damaged or lost goods and

the goods are to be shipped or delivered, then the risk is borne by the party having control of the goods. The delivery terms in a contract can serve as a basis for deter- mining control. Thus, under “F.O.B. buy- er’s business”—a destination-delivery term—the risk of loss does not pass to the buyer until there is a tender of deliv- ery at the point of destination. The seller is liable for any damage in transit because the seller has control until tender is made.

Most sellers prefer “F.O.B. seller’s business” as a delivery term. Once the goods are delivered to the carrier, the buyer bears the risk of loss. Thus, if con- forming goods are lost in transit, the buyer suffers the loss.

Breach of contract

If a contract is silent as to risk and either party breaches the contract, the breaching party is liable for any loss. For example, if a buyer orders fifteen cool- ing fans to be installed at a certain loca- tion in a manufacturing facility, and the seller ships the wrong size, the risk of loss does not pass to the buyer until this defect is cured.

Before a loss occurs, you should determine at which point your com- pany will have an insurable interest in the goods and obtain insurance to cover any potential liability for the dam- age, loss, or destruction of the goods.

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C H A P T E R 1 8 Title and Risk of Loss 229

Issue sPotteRs Check your answers to the Issue Spotters against the answers provided in Appendix A at the end of this text.

1. Adams Textiles in Kansas City sells certain fabric to Silk & Satin Stores in Oklahoma City. Adams packs the fabric and ships it by rail to Silk. While the fabric is in transit across Kansas, a tornado derails the train and scatters and shreds the fabric across miles of corn- fields. What are the consequences if Silk bore the risk? If Adams bore the risk? (see Insurable Interest.)

2. Paula boards her horse, Blaze, at Gold Spur Stables. She sells the horse to George and calls Gold Spur to say, “I sold Blaze to George.” Gold Spur says, “Okay.” That night, Blaze is kicked in the head by another horse and dies. Who pays for the loss? (see Risk of Loss.)

Learning OutcOme 1: explain the concept of identification. Before an interest in goods can pass from a seller or lessor to a buyer or lessee, the goods must exist and be identified as the specific goods designated in the contract. Identification occurs when specific goods are designated as the subject matter of a sales or lease contract. Title and risk of loss cannot pass from seller to buyer unless the goods are identified to the contract. Identification gives the buyer or lessee the right to insure the goods and the right to recover from third parties who damage the goods.

Learning OutcOme 2: Describe the effects of imperfect title on sales of goods. When a person who acquires goods with an imperfect title attempts to sell the goods, a buyer acquires at least whatever title the seller has. If the seller is a thief, the seller’s title is void, the buyer acquires no title, and the real owner can reclaim the goods. A seller with voidable title can transfer good title to a good faith purchaser for value, and the real, or original, owner cannot recover the goods. Entrusting goods to a merchant who deals in goods of that kind gives the merchant the power to transfer all rights to a buyer in the ordinary course of business.

Learning OutcOme 3: Discuss the concept of risk of loss. Risk of loss determines who bears the financial loss in a sales or lease contract when goods are damaged, destroyed, or lost. Under the UCC, risk of loss is not necessarily determined by title. When the risk of loss passes from a seller or lessor to a buyer or lessee is generally determined by the contract between the parties. When no provision in the contract indicates when risk passes, the UCC provides special rules. Unless the parties agree otherwise, the risk of loss passes from the seller or lessor to the buyer or lessee at the time and place the seller or lessor physically delivers the goods. Under a shipment contract, this occurs when the seller or lessor delivers the goods into the hands of a carrier. Under a destination contract, the risk passes on the tender of delivery of the goods at the destination specified in the contract.

Learning OutcOme 4: identify insurable interest in goods. A buyer or lessee has an insurable interest in goods that are identified to the contract. A seller or lessor has an insurable interest in goods if he or she has title to them or a security interest in them.

CHaPteR summaRY—tItLe and RIsk of Loss

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U n i t 3 Sales and Leases230

ReaL Law

18–1. Passage of title. James McCoolidge, a Nebraska resident, saw a used Honda Element for sale online. He contacted the seller, Daniel Oyvetsky, who offered to sell the vehicle for $7,500 on behalf of Car and Truck Center, a dealership in Nashville, Tennessee. McCoolidge paid the price and received the car and a certificate of title. Before he registered the certificate with the Nebraska Department of Motor Vehicles, he learned that the state of Tennessee had issued numerous certificates of title to the Element. Based on these documents, title could ultimately be traced to McCoolidge. But McCoolidge chose to file a suit in a Nebraska state court against Oyvetsky, claiming that he had not received “clear” title. What does the UCC provide with respect to the passage of title under a sales contract? How does that rule affect McCoolidge’s claim? Discuss. [McCoolidge v. Oyvetsky, 292 Neb. 955, 874 N.W.2d 892 (2016)] (see Passage of Title.)

18–2. risk of Loss. Ethicon, Inc., entered into an agree- ment with UPS Supply Chain Solutions, Inc., to transport

pharmaceuticals. Under a contract with UPS’s subsidiary, Worldwide Dedicated Services, drivers were provided by International Management Services Co. During the trans- port of a shipment from Ethicon’s facility in Texas to buy- ers “F.O.B. Tennessee,” one of the trucks collided with a concrete barrier, damaging the goods. Who was liable for the loss, and why? [Royal & Sun Alliance Insurance, PLC v. International Management Services Co., 703 F.3d 604 (2d Cir. 2013)] (see Risk of Loss.)

18–3. Delivery without movement of the goods. Aleris International, Inc., signed a contract to buy a John Deere loader from Holt Equipment Co. The agreement provided that “despite physical delivery of the equipment, title shall remain in the seller until” Aleris paid the full price. The next month, Aleris filed for bankruptcy. Holt filed a claim with the court to repossess the loader. Holt asserted that it was the owner. Who is entitled to the loader, and why? [In re Aleris International, Ltd., __ Bankr __ (D.Del. 2011)] (see Identification.)

etHICaL QuestIons

18–4. risk of Loss. If the parties to a contract do not specify when the risk of loss passes, the risk generally rests with the party who has possession of the goods or the right to their possession. Why is this the rule? (see Risk of Loss.)

18–5. Passage of title. Indiana enacted the Vapor Pens and E-Liquid Act to regulate the manufacture and distribution of e-cigarettes. The act was based on the state’s interest in public health and safety. Requirements included childproof packaging and labels designating active ingredients, nicotine content, and expiration dates. The act covered in-state and out-of-state production and sales. Legato Vapors, LLC, an out-of-state maker of e-liquid products, filed a lawsuit in a federal district court against David Cook, head of the Indiana

Alcohol and Tobacco Commission, seeking an injunction. Legato argued that the state’s act violated the U.S. Consti- tution, which prohibits the application of a state statute to commerce that takes places completely outside of the state. Specifically, Legato noted that direct online sales by out- of-state manufacturers to Indiana consumers could not be regulated by the state act. Under the UCC, when does title to goods pass from the seller to the buyer? Does this UCC provision support Legato’s argument for an injunction of the state act? In any event, should Legato follow the act’s require- ments for ethical reasons? Discuss. [Legato Vapors, LLC v. David Cook, 847 F.3d 825 (7th Cir. 2017)] (see Passage of Title.)

stRaIgHt to tHe PoInt

1. If a contract calls for the sale or lease of goods that are already in existence, when does identification take place? (see Identification.)

2. In a transaction for a sale of goods subject to a shipment contract, when does title pass? (see Passage of Title.)

3. What determines who suffers a financial loss if goods are damaged, destroyed, or lost? (see Risk of Loss.)

4. Who bears the risk of loss when a sales or lease contract is breached? (see Risk of Loss.)

5. What can a party to a sales or lease contract obtain to protect against a financial loss if goods are damaged, destroyed, or lost? (see Insurable Interest.)

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231

Chapter 18—work set

1. Identification occurs when goods are shipped by the seller.

2. Unless the parties agree otherwise, title passes at the time and place that the buyer accepts the goods.

3. Unless a contract provides otherwise, it is normally assumed to be a shipment contract.

4. A buyer and a seller cannot both have an insurable interest in the same goods at the same time.

5. In a sale on approval, the risk of loss passes to the buyer as soon as the buyer takes possession.

6. A buyer can acquire valid title to stolen goods if he or she does not know that the goods are stolen.

7. Under a destination contract, title passes at the time and place of shipment.

8. If a seller is a merchant, the risk of loss passes when a buyer takes physical possession of the goods.

tRue-faLse QuestIons

1. Bob contracts to sell to the Marcos University Bookstore 10,000 black USB flash drives. Bob identifies the flash drives by boxing up the order, attaching labels with Marcos’s address to the cartons, and leaving the boxes on the loading dock for shipping. Between Bob and Marcos,

a. the risk of loss has passed with respect to all of the flash drives. b. the risk of loss has passed with respect to half of the flash drives. c. the risk of loss has passed with respect to the flash drives with labels on the boxes. d. none of the above has occurred.

2. Sam obtains his Aunt Claire's laptop computer through fraud. He then sells the computer to Jill. If Jill does not know that the computer was acquired by fraud, what title does she take?

a. Jill takes voidable title, based on Sam’s voidable title. b. Jill takes good title because she was a good faith purchaser. c. Jill takes valid title but may be subject to a tort claim for embezzlement. d. Jill has no title because Sam’s title was void.

3. On Monday, Stan buys a mountain bike from Tom, his neighbor, who says, “Take the bike.” Stan says, “I’ll leave it in your garage until Friday.” On Tuesday, Rosie steals the bike from Tom’s garage. Who bears the risk?

a. Stan. b. Tom. c. Both Stan and Tom. d. Neither Stan or Tom.

4. On Monday, Craft Computers in Seattle delivers five hundred Apple iPads to Pac Transport to take to Portland under a destination contract with Connecting Point Stores. The tablets arrive in Portland on Tuesday, and Pac tells Connecting Point they are at Pac’s warehouse. On Thursday, the warehouse burns down. On Friday, Connecting Point learns of the fire. The risk of loss passes to Connecting Point on

a. Monday. b. Tuesday. c. Friday. d. none of the above days.

muLtIPLe-CHoICe QuestIons

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232

5. Foster Wholesalers agrees to sell one hundred game players to Beta Electronics. Foster identifies the goods by mark- ing the crates with red stripes. Title has not yet passed to Beta. Who has an insurable interest in the goods?

a. Only Foster. b. Only Beta. c. Both Foster and Beta. d. Neither Foster nor Beta.

6. Under a contract with QT Corporation, Gold Medical ships an assortment of medical supplies. When QT opens the crates, it discovers that the supplies are the wrong assortment but agrees to accept them anyway. The risk of loss passes to QT when

a. Gold ships the supplies. b. QT opens the crates. c. QT discovers that the goods are the wrong assortment. d. QT accepts the supplies.

7. Chelsey Bike Makers agrees to sell forty mountain bikes to Orange Mountain Recreation under a shipment contract. Chelsey delivers the goods to Sugar Trucking to take to Orange Mountain. Sugar delivers the goods. Title to the goods passed

a. when Chelsey agrees to sell the goods. b. when Chelsey delivers the goods to Sugar. c. when Sugar delivers the goods to Orange Mountain. d. at none of the above times.

8. Nora leaves her car with OK Auto Sales & Service for repairs. OK sells the car to Pete, who does not know that OK has no right to sell the car. Nora can recover from

a. OK only. b. Pete only. c. OK and Pete. d. neither OK nor Pete

answeRIng moRe LegaL PRoBLems

1. Hank bought a twelve-foot four-by-four beam at Econo Lumber. An Econo employee loaded the beam onto Hank’s truck but did not secure it. A sign at the lumber- yard stated that the store did not secure loads. Hank did not secure the beam, either. As he drove on the highway, the beam fell from the truck. While trying to retrieve it, Hank was struck by a car and injured.

Who held title to the beam at the time of the acci- dent? Hank held the title. Unless the parties agree otherwise, when delivery is made without moving the goods—when the buyer picks them up—title passes at the time and place the _______________ was made, if the goods have been _______________. Here, title to the beam passed when Hank selected it and paid for it at Econo. Who bore the risk of loss when the beam fell from Hank’s truck? Hank bore the risk of loss at the time of the accident. If a buyer is to pick up goods, and the seller is a merchant, the risk of loss to the goods passes to the buyer when he takes _______________ of the goods. The risk of loss passed from Econo to Hank when the beam was loaded onto his truck.

2. Price-Cut Markets ordered strawberries, blueberries, and raspberries from Driscoll County Harvest Distri- bution Cooperative. Driscoll employees designated the berries for Price-Cut, loaded them onto a truck, and dispatched it. En route, the truck overturned, and the berries were damaged.

When could Price-Cut obtain insurance on the ber- ries? Once _______________ of the berries as the subject matter of the contract between Price-Cut and Driscoll occurred, Price-Cut could insure against their loss or damage. When did identification of the berries as the subject matter of the contract take place? Identification occurred when Driscoll employees _______________ the berries for Price-Cut. Unless a buyer and seller agree otherwise, identification takes place when goods are marked, shipped, or somehow _______________ by the seller as the goods to pass under a contract.

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233

Learning OutcOmes

The four Learning Outcomes below are designed to help improve your understanding of the chapter. After reading this chapter, you should be able to:

Explain the seller’s or lessor’s contractual obligations.

Identify the buyer’s or lessee’s contractual duties.

List the seller’s or lessor’s remedies when the buyer is in breach.

State the buyer’s or lessee’s remedies when the seller is in breach.

1

2

3

4

19 Performance and Breach

The performance that is required of the parties under a sales or lease contract con- sists of the duties and obligations each party has under the terms of the contract. The basic obligations of good faith and commercial reasonableness underlie every contract under the Uniform Commercial Code (UCC). These standards are read into every contract. They also provide a framework in which the parties can specify particulars of performance.

In this chapter, we examine the basic performance obligations of the parties under a sales or lease contract. Sometimes, circumstances make it difficult for a person to carry out the promised performance. In this situation, the contract may be breached. When a breach occurs, the aggrieved party looks for remedies.

19–1 Obligations of the seller or Lessor The seller’s or lessor’s major obligation under a sales contract is to tender conforming goods to the buyer or lessee.

19–1a Tender of Delivery Tender of delivery requires that the seller or lessor hold conforming goods at the buyer’s or lessee’s disposal and give the buyer or lessee whatever notification is reasonably necessary to enable the buyer or lessee to take delivery.

Tender must occur at a reasonable hour and in a reasonable manner. Unless the parties have agreed otherwise, the goods must be tendered for delivery at a reason- able hour and kept available for a reasonable period of time to enable the buyer to take possession of them.

conforming goods Goods that conform to contract specifications.

Learning OutcOme 1

Explain the seller’s or lessor’s contractual obligations.

Conflict Presented In San Francisco, Roger contracts to sell Arturo five used trucks, which both parties know are located in a warehouse in Chicago. The parties expect that Arturo will pick up the trucks, but nothing

about a place of delivery is specified in the contract.

Q What is the place for delivery of the trucks? How can roger “deliver” the trucks without moving them?

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U n i t 3 Sales and Leases234

All goods called for by a contract must be tendered in a single delivery unless the parties agree otherwise or one of the parties can rightfully request delivery in lots. ExamplE 19.1 Trend Fashion Stores (the buyer) orders one thousand shirts from Off-the-Rack Clothing (the seller). Both parties understand that the shirts are to be delivered as they are produced in four lots of 250 each, with the price apportioned accordingly. It is commercially reasonable to deliver this order in four lots. In contrast, delivering the order ten shirts at a time would be commercially unreasonable. j

19–1b Place of Delivery The UCC provides for the place of delivery under a contract if the contract does not state or otherwise indicate a place.

Noncarrier Cases If the contract does not designate the place of delivery for the goods, and the buyer is expected to pick them up, the place of delivery is the seller’s place of business. If the seller has no place of business, the place of delivery is the seller’s residence. If the goods are located somewhere other than at the seller’s place of business (such as at a warehouse), then the location of the goods is the place for delivery. In this situation, the goods must have been identified, and the parties must have known their location when they formed the contract.

Carrier Cases In many instances, circumstances or delivery terms in the contract make it apparent that the parties intend that a carrier, such as a trucking company, be used to move the goods. In carrier cases, the seller can fulfill the obligation to deliver the goods through either a shipment contract or a destination contract. 1. Shipment contracts—A shipment contract requires or authorizes the seller to

ship goods by a carrier. The contract does not require that the seller deliver the goods at a particular destination. Unless otherwise agreed, the seller must do the following: • Put the goods into the hands of the carrier. • Make a contract for their transportation that is reasonable according to the

nature of the goods and their value. Certain types of goods, for example, need refrigeration in transit.

• Obtain and promptly deliver or tender to the buyer any documents necessary to enable the buyer to obtain the goods from the carrier.

• Promptly notify the buyer that shipment has been made.

Highlighting the Point

Richard purchases a toolshed kit from Homestead Company. The sales contract requires full payment on tender of delivery of the kit at Richard’s property. The kit is to be delivered on June 30. On the morning of June 30, Homestead tells Richard it no longer provides home delivery. Instead, Richard must come to Homestead’s head- quarters that evening, make his final payment, and provide his own transportation for the kit. Otherwise, the firm will sell the kit to another customer the following day.

is Homestead’s tender of delivery being done in a reasonable manner? No. Waiting until the agreed-on delivery date to inform Richard that he must pick up the kit him- self or lose it to another customer is unreasonable. Richard can sue Homestead for breach of contract.

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C H A P T E R 1 9 Performance and Breach 235

If the seller fails to perform any of these duties and a material loss of the goods or a delay results, the buyer can reject the shipment.

2. Destination contracts—Under a destination contract, the seller agrees to see that conforming goods are tendered to the buyer at a particular destination. The goods must be tendered at a reasonable hour and held at the buyer’s disposal for a reasonable length of time. The seller must also give the buyer appropriate notice. In addition, the seller must provide the buyer with any documents of title necessary to enable the buyer to obtain delivery from the carrier.

19–1c The Perfect Tender Rule and Its Exceptions If the goods or the tender of delivery fail in any respect to conform to the contract, the buyer or lessee can accept the goods, reject the entire shipment, or accept part and reject part. This is known as the perfect tender rule. Because of the rigidity of the perfect tender rule, several exceptions have been created. These exceptions are discussed next.

Agreement of the Parties An exception to the perfect tender rule may be established by agreement of the parties involved in a sales or lease contract. ExamplE 19.2 Bell Lane Nursery contracts with Hanley Growers, Inc., to purchase two hundred tomato plants for the spring growing season. Both parties agree that Bell Lane will not reject defective (dead or diseased) plants if Hanley replaces them within a reasonable time—specifically, no more than five business days. This agreement creates an exception to the perfect tender rule. j

Cure Another exception to the perfect tender rule involves a seller’s or lessor’s right to cure. The term cure refers to the seller’s or lessor’s right to repair, adjust, or replace defective or nonconforming goods. The seller or lessor has a right to attempt to cure when the following are true: 1. A delivery is rejected because the goods were nonconforming. 2. The time for performance has not yet expired. 3. The seller or lessor provides timely notice to the buyer or lessee of the

intention to cure. 4. The cure can be made within the contract time for performance.

Once the time for performance has expired, the seller or lessor can still exercise the right to cure. In this situation, however, the seller or lessor must have had rea- sonable grounds to believe that the nonconforming goods would be acceptable to the buyer or lessee.

perfect tender rule A rule requiring that goods conform exactly to a contract’s terms or the seller is in breach.

Highlighting the Point

In the past, Reddy Electronics frequently allowed the Topps Company to substitute certain electronic supplies when the goods Reddy ordered were not available. Under a new contract for the same type of goods, Reddy rejects the substitute supplies on the last day Topps can perform the contract.

Does topps have the right to cure? Yes. Topps had reasonable grounds to believe Reddy would accept a substitute. Therefore, Topps can cure within a reasonable time, even though conforming delivery will occur after the actual time limit for performance allowed under the contract.

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U n i t 3 Sales and Leases236

The right to cure substantially restricts the right of the buyer or lessee to reject. To reject, the buyer or lessee must inform the seller or lessor of the defect. Other- wise, the seller or lessor does not have the opportunity to cure it. Generally, buyers and lessees must act in good faith and state specific reasons for refusing to accept the goods.

Substitution of Carriers Another exception to the perfect tender rule involves the substitution of carriers. An agreed-on manner of delivery may become impracticable or unavailable through no fault of either party. For instance, the agreed-on carrier may become unavailable. If a commercially reasonable substitute is available, this substitute performance is sufficient.

Installment Contracts An installment contract is a single contract that requires or authorizes delivery in two or more separate lots to be accepted and paid for separately. In an installment contract, a buyer or lessee can reject an installment only if the nonconformity substantially impairs the value of the installment and cannot be cured.

ExamplE 19.3 A seller, Refrigerated Appliances, Inc., is to deliver fifteen freez- ers in lots of five each. In the first lot, four of the freezers have defective cooling units that cannot be repaired. The buyer in these circumstances, Home Furnishings stores, can reject the entire lot. j An entire installment contract is breached only when one or more nonconforming installments substantially impair the value of the whole contract.

Commercial Impracticability Sometimes, unforeseen occurrences can render performance commercially impracticable. When this happens, the perfect tender rule no longer holds. The seller or lessor must, of course, notify the buyer or lessee as soon as possible that there will be a delay.

Commercial impracticability arises only when the parties—at the time the con- tract was made—had no reason to anticipate that the unforeseen event would occur. This exception to the perfect tender rule, however, does not extend to events that could have been foreseen, such as an increase in cost due to inflation.

installment contract A contract in which payments due are made periodically.

Highlighting the Point

Ellis Dairy enters into a contract to supply a local school district with milk for one year. The contract price is the market price of milk in June. By December, however, the price of raw milk has increased by 25 percent due to inflation. Ellis stands to lose $20,000 on the contract. To avoid this loss, Ellis claims that the cost increase makes performance of the contract commercially impracticable.

can ellis use the commercial impracticability exception to cancel its contract with the school district? No. Commercial impracticability arises when an event occurs that is unforeseeable. Inflation and fluctuating prices can be foreseen. They do not render performance commercially impracticable.

Destruction of Identified Goods When identified goods under a contract are completely destroyed through no fault of either party and before risk passes to the buyer or lessee, the parties are excused from performance. If the goods are only partially destroyed, however, the buyer or lessee can inspect them and either treat the contract as void or accept the damaged goods with a reduction of the contract price.

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C H A P T E R 1 9 Performance and Breach 237

Assurance and Cooperation If one party to a contract has “reasonable grounds” to believe that the other party will not perform as contracted, he or she may demand in writing assurance of performance from the other party. Until the assurance is received, he or she may suspend further performance. What constitutes “reasonable grounds” is determined by commercial standards.

Sometimes, the performance of one party depends on the cooperation of the other. When the cooperation does not happen, the first party can proceed to perform the contract in any reasonable manner or suspend his or her own per- formance and hold the uncooperative party in breach.

19–2 Obligations of the Buyer or Lessee Once the seller or lessor has tendered delivery, the buyer or lessee is obligated to accept the goods and pay for them according to the terms of the contract. In the absence of any specific agreements, the buyer or lessee must do the following: 1. Furnish facilities reasonably suited for receipt of the goods. 2. Make payment at the time and place the buyer receives the goods.

19–2a Payment Payment can be made by any means agreed on between the parties—cash or any other method of payment generally acceptable in the commercial world. If a seller demands cash, the seller must give the buyer reasonable time to obtain it. When a sale is made on credit, the buyer must pay according to the specified terms (for example, ninety days). The credit period usually begins on the date of shipment.

19–2b Right of Inspection Unless otherwise agreed, the buyer or lessee has an absolute right to inspect the goods before making payment. This right allows the buyer or lessee to verify, before making payment, that the goods conform to the contract. If the goods are not what the buyer or lessee ordered, he or she has no duty to pay. Unless otherwise agreed, inspection can take place at any reasonable place and time and in any reasonable manner. Generally, what is reasonable is determined by custom of the trade, past practices of the parties, and the like.

19–2c Revocation of Acceptance After a buyer or lessee accepts a lot or a commercial unit, any return of the goods must be by revocation of acceptance. (Revocation means withdrawal.) Acceptance can be revoked if a nonconformity substantially impairs the value of the unit or lot and if one of the following factors is present: 1. Acceptance was based on the reasonable assumption that the nonconformity

would be cured, and it has not been cured within a reasonable time period. 2. The buyer or lessee did not discover the nonconformity until after acceptance.

The failure to discover must have resulted from difficulty in detecting the nonconformity before acceptance or from the seller’s or lessor’s assurance that the goods were conforming.

To effectively revoke acceptance, a buyer must return the goods or at least stop using them, unless the use is necessary to avoid substantial hardship.

Learning OutcOme 2

Identify the buyer’s or lessee’s contractual duties.

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U n i t 3 Sales and Leases238

19–2d Anticipatory Repudiation What if, before the time for performance, one party clearly communicates to the other the intention not to perform? Such an action is a breach of the contract by anticipatory repudiation. Anticipatory repudiation is the refusal to acknowledge the party’s obligations under the contract. When anticipatory repudiation occurs, the aggrieved party can suspend performance and do the following: 1. Await performance by the repudiating party, hoping that he or she will decide

to honor the contract. 2. Resort to any remedy for breach.

19–3 remedies of the seller or Lessor A buyer or lessee may breach a contract by wrongfully rejecting or revoking acceptance of the contract goods, failing to make proper and timely payment, or repudiating all or part of the contract. Numerous remedies are available to a seller or lessor under the UCC when the buyer or lessee is in breach. Several such remedies are discussed next.

19–3a The Right to Withhold Delivery In general, sellers and lessors need not continue to perform when buyers or les- sees are in breach. If the breach occurs when the seller or lessor is still in pos- session of the goods, or when the goods are in transit, the seller or lessor can withhold or stop delivery. If a breach results from the buyer’s or lessee’s inability to pay debts, the seller or lessor can refuse to deliver the goods unless the buyer or lessee pays in cash.

19–3b The Right to Reclaim the Goods If, after delivery, a seller discovers that the buyer has received goods on credit and is insolvent (meaning the buyer’s debts outweigh assets), the seller can demand return of the goods. The demand generally must be made within ten days of the buyer’s receipt of the goods.

Learning OutcOme 3

List the seller’s or lessor’s remedies when the buyer is in breach.

Real Case

Genesis Health Clubs, Inc., contracted with LED Solar & Light Company to furnish replacement lighting for its building. When Genesis experienced problems with the lights, LED Solar offered to fix or replace them or to refund the price. Genesis responded that it wanted a refund and would return all of the lights “in stages so the club would not go dark.” Genesis returned one shipment of the lights but, after disputing how it was credited for the shipment, made no additional returns. In a lawsuit between the parties, a federal district court concluded that Genesis could not recover the purchase price for the lights and issued a judgment in favor of LED Solar. Genesis appealed.

Did genesis effectively revoke acceptance of the lights? No. In Genesis Health Clubs, Inc. v. LED Solar & Light Co., the U.S. Court of Appeals for the Tenth Circuit affirmed the lower court’s judgment. Genesis did not return any of the lights after the first shipment and continued to use them.

—629 Fed.Appx. 550 (10th Cir.)

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C H A P T E R 1 9 Performance and Breach 239

In regard to lease contracts, if the lessee fails to make payments that are due, the lessor may reclaim the leased goods that are in the possession of the lessee.

19–3c The Right to Resell the Goods A seller or lessor still in possession of the goods when the buyer or lessee breaches can resell or dispose of the goods. When the goods contracted for are unfinished at the time of the breach of contract, the seller or lessor can do one of two things: 1. Cease manufacturing the goods and resell them for scrap or salvage value, or 2. Complete the manufacture of the goods and resell or dispose of them.

In any case, the seller or lessor can recover any deficiency between the resale price and the contract price, along with incidental damages (costs to the seller or lessor resulting from the breach).

19–3d The Right to Recover the Purchase Price An unpaid seller or lessor can bring an action to recover the purchase price or payments due under the contract (and incidental damages) under the following circumstances: 1. When the buyer or lessee has accepted the goods and has not revoked

acceptance. 2. When conforming goods have been lost or damaged after the risk of loss has

passed to the buyer or lessee. 3. When the buyer or lessee has breached the contract after the contract goods

have been identified and the seller or lessor is unable to resell the goods. If a seller or lessor sues for the contract price of goods that he or she has been

unable to resell, the goods must be held for the buyer or lessee. The seller or lessor can resell at any time prior to collection of the judgment from the buyer or lessee, but the net proceeds from the sale must be credited to the buyer or lessee.

incidental damages Damages for reasonable expenses incurred because of a contract’s breach.

Highlighting the Point

Dixon Management Consultants contracts with Gem Point to purchase one thousand laser pointers with the company name inscribed on them. Gem Point delivers the laser pointers, but Dixon refuses to accept them.

can gem Point bring an action for the full purchase price? Yes. Gem Point can bring an action for the purchase price because it delivered conforming goods, and Dixon refused to accept or pay for the goods. Gem Point obviously cannot resell the laser pointers to another buyer because Dixon’s business name is inscribed on them.

19–3e The Right to Recover Damages If a buyer or lessee repudiates a contract or wrongfully refuses to accept the goods, a seller or lessor can bring an action to recover the damages that were sustained. Ordi- narily, the amount of damages equals the difference between the contract price and the market price at the time and place of tender of the goods, plus incidental damages.

Sometimes, the difference between the contract price or lease payments and the market price is too small to place the seller or lessor in the position that he or she would have been in if the buyer or lessee had fully performed. In these situations, the proper measure of damages is the seller’s or lessor’s lost profits, including a reasonable allowance for overhead and other incidental expenses.

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U n i t 3 Sales and Leases240

19–4 remedies of the Buyer or Lessee The UCC makes numerous remedies available to the buyer or lessee in the event of a breach of a contract. Of course, the buyer or lessee can recover as much of the price as has been paid. Next, we discuss four additional remedies.

19–4a The Right of Rejection If either the goods or the tender of the goods by the seller or lessor fails to conform to the contract in any respect, the buyer or lessee normally can reject the goods. If some of the goods conform to the contract, the buyer or lessee can keep the con- forming goods and reject the rest.

Timeliness and Reason for Rejection Required The buyer or lessee must reject the goods within a reasonable amount of time and must notify the seller or lessor seasonably (in a timely fashion). Failure to do so bars the buyer or lessee from using those defects to justify rejection or to establish breach when the seller or lessor could have cured the defects if they had been stated seasonably.

Duties of Merchant Buyers and Lessees When Goods Are Rejected If a merchant buyer or lessee rightfully rejects goods, he or she must follow any reasonable instructions received from the seller or lessor with respect to the goods controlled by the buyer or lessee. ExamplE 19.4 Clearwater Pool Supplies enters into a sales contract with North Glen Construction to deliver eight outdoor pool slides to a work site. Clearwater delivers the slides to the site, but North Glen rejects the goods because half of the slides are cracked. Clearwater then asks North Glen to store the defective slides on-site until it can retrieve them the following day. According the UCC, in this situation North Glen is required to store the damaged slides, because the request is reasonable. j

If there are no instructions, the buyer or lessee may store the goods or reship them to the seller or lessor. In any of these situations, the buyer or lessee is entitled to reimbursement for the costs involved.

19–4b The Right to Obtain Specific Performance A buyer or lessee can obtain specific performance—that is, exactly what was con- tracted for—when the goods are unique or when the buyer’s or lessee’s remedy at law (monetary damages) is inadequate. Specific performance may be appropriate, for example, when the contract is for the purchase of a particular work of art, a copyright, or a similarly unique item.

Learning OutcOme 4

State the buyer’s or lessee’s remedies when the seller is in breach.

seasonably Within a specified time period or within a reasonable time.

Highlighting the Point

Sutherlin Vintage Motors contracts to sell a customized classic 1969 Chevrolet Camaro to Fenwick for $40,000. The sales contract states that delivery and payment are due on June 14. Fenwick tenders payment on June 14, but Sutherlin refuses to deliver the Camaro.

if Fenwick sues sutherlin, can Fenwick obtain the car? Yes. Because the 1969 Camaro is unique, Fenwick can probably obtain specific performance of the contract from Sutherlin.

Copyright 2019 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it.

Copyright 2019 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. WCN 02-200-203

C H A P T E R 1 9 Performance and Breach 241

19–4c The Right to Obtain Cover In certain situations, buyers and lessees can protect themselves by obtaining cover—that is, by substituting goods for those that were due under the contract. This option is available to a buyer or lessee who has rightfully rejected goods or revoked acceptance. The option is also available when the seller or lessor repudiates the contract or fails to deliver the goods. After purchasing substitute goods, the buyer or lessee can recover from the seller or lessor the difference between the cost of cover and the contract price, plus incidental and consequen- tial damages, less the expenses (such as delivery costs) that were saved as a result of the breach.

Consequential damages include any loss suffered by the buyer or lessee that the seller or lessor could have foreseen (had reason to know about) at the time of the contract’s formation. ExamplE 19.5 Ridgeline Construction, Inc., tells Quarry Sales Corporation, a heavy equipment manufacturer, that it needs a certain piece of equipment by July 1 to close a $50,000 deal. Quarry can foresee that if the equipment is not delivered by that date, Ridgeline will suffer consequential damages. j

19–4d The Right to Recover Damages If a seller or lessor repudiates the contract or fails to deliver the goods, the buyer or lessee can sue for damages. The measure of recovery is the difference between the contract amount and the current market value at the time the buyer or lessee learned of the breach. The market value is determined at the place where the seller or lessor was supposed to deliver the goods. The buyer or lessee can also recover incidental and consequential damages less expenses that were saved as a result of the seller’s or lessor’s breach.

When the seller or lessor breaches a warranty, the measure of damages equals the difference between the value of the goods as accepted and their value if they had been delivered as warranted. For this and other types of breaches in which the buyer or lessee has accepted the goods, the buyer or lessee is entitled to recover for any loss resulting in the ordinary course of events.

cover A buyer’s purchase of substitute goods on a seller’s breach.

Conflict Resolved In the Conflict Presented feature at the beginning of this chapter, Roger contracts in San Francisco to sell Arturo trucks located in a warehouse in Chicago. Nothing is said about delivery, although the

parties expect Arturo to pick up the trucks.

a What is the place for delivery of the trucks? Chicago. How can Roger “deliver” the trucks without moving them? Arturo will need some type of document to show

the bailee (the warehouser) that Arturo is entitled to the trucks. Roger can tender

delivery without moving the trucks by either giving Arturo a negotiable document of

title or obtaining the bailee’s (warehouser’s) acknowledgment that Arturo is entitled to

possession.

Copyright 2019 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it.

Copyright 2019 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. WCN 02-200-203

U n i t 3 Sales and Leases242

Learning OutcOme 1: explain the seller’s or lessor’s contractual obligations. The seller’s or lessor’s major obligation is to tender conforming goods to the buyer or lessee. Tender must occur at a reasonable hour and in a reasonable manner. If the seller or lessor tenders nonconforming goods and the buyer or lessee rejects them, the seller or lessor may cure—repair or replace the goods—within the contract time for performance. If the agreed-on means of delivery becomes impracticable or unavailable, a commercially reasonable substitute is sufficient.

Learning OutcOme 2: identify the buyer’s or lessee’s contractual duties. On a seller’s or lessor’s tender of conforming goods, a buyer or lessee is obligated to accept them and pay for them according to the contract terms. Unless the parties agree otherwise, a buyer or lessee has a right to inspect the goods before accepting them. The buyer or lessee can revoke acceptance if, among other things, a nonconformity substantially impairs the value of the goods.

Learning OutcOme 3: List the seller’s or lessor’s remedies when the buyer is in breach. When the buyer or lessee is in breach, the seller or lessor may withhold delivery, reclaim the goods, resell the goods, recover the purchase price, or sue for damages.

Learning OutcOme 4: state the buyer’s or lessee’s remedies when the seller is in breach.