Business Law: The Ethical, Global, and Digital Environment [18 ed.] 126073689X, 9781260736892

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Table of contents :
Cover
Business Law: The Ethical, Global, and Digital Environment
The Authors
Preface
Acknowledgments
A Guided Tour
Instructor Supplements
Brief Contents
Contents
List of Cases
Part 1: Foundations of American Law
1: The Nature of Law
Types and Classifications of Law
The Types of Law
Priority Rules
Classifications of Law
Jurisprudence
Legal Positivism
Natural Law
American Legal Realism
Sociological Jurisprudence
Other Schools of Jurisprudence
The Functions of Law
Legal Reasoning
Case Law Reasoning
Statutory Interpretation
Limits on the Power of Courts
Appendix A: AReading and Briefing Cases
2: The Resolution of Private Disputes
State Courts and Their Jurisdiction
Courts of Limited Jurisdiction
Trial Courts
Appellate Courts
Jurisdiction and Venue
Federal Courts and Their Jurisdiction
Federal District Courts
Specialized Federal Courts
Federal Courts of Appeals
The U.S. Supreme Court
Civil Procedure
Service of the Summons
The Pleadings
Motion to Dismiss
Discovery
Summary Judgment
The Pretrial Conference
The Trial
Appeal
Enforcing a Judgment
Class Actions
Alternative Dispute Resolution
Common Forms of ADR
Other ADR Devices
3: Business and the Constitution
An Overview of the U.S. Constitution
The Evolution of the Constitution and the Role of the Supreme Court
The Coverage and Structure of This Chapter
State and Federal Power to Regulate
State Regulatory Power
Federal Regulatory Power
Burden on, or Discrimination against, Interstate Commerce
Independent Checks on the Federal Government and the States
Incorporation
Government Action
Means-Ends Tests
Business and the First Amendment
Due Process
Equal Protection
Independent Checks Applying Only to the States
The Contract Clause
Federal Preemption
The Takings Clause
4: Business Ethics, Corporate Social Responsibility, Corporate Governance, and Critical Thinking
Why Study Business Ethics?
The Corporate Social Responsibility Debate
Ethical Theories
Rights Theory
Justice Theory
Utilitarianism
Shareholder Theory
Virtue Theory
Improving Corporate Governance and Corporate Social Responsibility
Independent Boards of Directors
The Law
Guidelines for Ethical Decision Making
What Facts Impact My Decision?
What Are the Alternatives?
Who Are the Stakeholders?
How Do the Alternatives Impact Society as a Whole?
How Do the Alternatives Impact My Business Firm?
How Do the Alternatives Impact Me, the Decision Maker?
What Are the Ethics of Each Alternative?
What Are the Practical Constraints of Each Alternative?
What Course of Action Should Be Taken and How Do We Implement It?
Knowing When to Use the Guidelines
Thinking Critically
Non Sequiturs
Appeals to Pity
False Analogies
Begging the Question
Argumentum ad Populum
Bandwagon Fallacy
Argumentum ad Baculum
Argumentum ad Hominem
Argument from Authority
False Cause
The Gambler’s Fallacy
Reductio ad Absurdum
Appeals to Tradition
The Lure of the New
Sunk Cost Fallacy
Common Characteristics of Poor Decision Making
Failing to Remember Goals
Overconfidence
Complexity of the Issues
Resisting Requests to Act Unethically
Recognizing Unethical Requests and Bosses
Buying Time
Find a Mentor and a Peer Support Group
Find Win–Win Solutions
Work within the Firm to Stop the Unethical Act
Prepare to Lose Your Job
Leading Ethically
Be Ethical
Communicate the Firm’s Core Ethical Values
Connect Ethical Behavior with the Firm’s and Workers’ Best Interests
Reinforce Ethical Behavior
Part 2: Crimes and Torts
5: Criminal Law and Procedure
Role of the Criminal Law
Nature of Crimes
Purpose of the Criminal Sanction
Essentials of Crime
Constitutional Limitations on Power to Criminalize Behavior
Criminal Procedure
Criminal Prosecutions: An Overview
Role of Constitutional Safeguards
The Fourth Amendment
Key Fourth Amendment Questions
Warrantless Searches and the Fourth Amendment
The Fifth Amendment
The Sixth Amendment
White-Collar Crimes and the Dilemmas of Corporate Control
Introduction
Evolution of Corporate Criminal Liability
Corporate Criminal Liability Today
Individual Liability for Corporate Crime
New Directions
Important White-Collar Crimes
Regulatory Offenses
Fraudulent Acts
The Sarbanes–Oxley Act
Bribery and Giving of Illegal Gratuities
Computer Crime
6: Intentional Torts
Interference with Personal Rights
Battery
Assault
Intentional Infliction of Emotional Distress
False Imprisonment
Defamation
Invasion of Privacy
Misuse of Legal Proceedings
Deceit (Fraud)
Interference with Property Rights
Trespass to Land
Private Nuisance
Conversion
Other Examples of Intentional Tort Liability
7: Negligence and Strict Liability
Negligence
Duty and Breach of Duty
Causation of Injury
Res Ipsa Loquitur
Negligence Defenses
Strict Liability
Abnormally Dangerous Activities
Statutory Strict Liability
Tort Reform
8: Intellectual Property and Unfair Competition
Protection of Intellectual Property
Patents
Copyrights
Trademarks
Trade Secrets
Definition of a Trade Secret
Ownership and Transfer of Trade Secrets
Misappropriation of Trade Secrets
Commercial Torts
Injurious Falsehood
Interference with Contractual Relations
Interference with Prospective Advantage
Lanham Act § 43(a)
Part 3: Contracts
9: Introduction to Contracts
The Nature of Contracts
The Functions of Contracts
The Evolution of Contract Law
The Methods of Contracting
Basic Elements of a Contract
Basic Contract Concepts and Types
Bilateral and Unilateral Contracts
Valid, Unenforceable, Voidable, and Void Contracts
Express and Implied Contracts
Executed and Executory Contracts
Sources of Law Governing Contracts
The Uniform Commercial Code: Origin and Purposes
Application of Article 2
Application of the Common Law of Contracts
Law Governing “Hybrid” Contracts
Relationship of the UCC and the Common Law of Contracts
Basic Differences in the Nature of Article 2 and the Common Law of Contracts
Influence of Restatement (Second) of Contracts
“Noncontract” Obligations
Quasi-Contract
Promissory Estoppel
10: The Agreement: Offer
Requirements for an Offer
Intent to Contract
Definiteness of Terms
Communication to Offeree
Special Offer Problem Areas
Advertisements
Rewards
Auctions
Bids
Which Terms Are Included in the Offer?
Termination of Offers
Terms of the Offer
Lapse of Time
Revocation
Rejection
Death or Mental Incapacity of Either Party
Destruction of Subject Matter
Intervening Illegality
11: The Agreement: Acceptance
What Is an Acceptance?
Intention to Accept
Intent and Acceptance on the Offeror’s Terms
Communication of Acceptance
When Is Acceptance Communicated?
Acceptances by Instantaneous Forms of Communication
Acceptances by Noninstantaneous Forms of Communication
Stipulated Means of Communication
Special Acceptance Problem Areas
Acceptance in Unilateral Contracts
Acceptance in Bilateral Contracts
Silence as Acceptance
Acceptance When a Writing Is Anticipated
Acceptance of Ambiguous Offers
Who Can Accept an Offer?
12: Consideration
Elements of Consideration
Legal Value
Bargained-For Exchange
Exchanges That Fail to Meet Consideration Requirements
Illusory Promises
Preexisting Duties
Past Consideration
Exceptions to the Consideration Requirement
Promissory Estoppel
Promises to Pay Debts Barred by Statutes of Limitations
Promises to Pay Debts Barred by Bankruptcy Discharge
Charitable Subscriptions
13: Reality of Consent
Effect of Doctrines Discussed in This Chapter
Necessity for Prompt and Unequivocal Rescission
Misrepresentation and Fraud
Relationship between Misrepresentation and Fraud
Requirements for Rescission on the Ground of Misrepresentation
Mistake
Nature of Mistake
Requirements for Mutual Mistake
Requirements for Unilateral Mistake
Duress
Nature of Duress
Requirements for Duress
Economic Duress
Undue Influence
Nature of Undue Influence
Determining Undue Influence
14: Capacity to Contract
What Is Capacity?
Effect of Lack of Capacity
Capacity of Minors
Minors’ Right to Disaffirm
Period of Minority
Emancipation
Time of Disaffirmance
Ratification
Duties upon Disaffirmance
Effect of Misrepresentation of Age
Capacity of Mentally Impaired Persons
Theory of Incapacity
Test for Mental Incapacity
The Effect of Incapacity Caused by Mental Impairment
Contracts of Intoxicated Persons
Intoxication and Capacity
15: Illegality
Meaning of Illegality
Determining Whether an Agreement Is Illegal
Agreements in Violation of Statute
Agreements Declared Illegal by Statute
Agreements That Violate the Public Policy of a Statute
Agreements That May Be in Violation of Public Policy Articulated by Courts
Agreements in Restraint of Competition
Exculpatory Clauses
Family Relationships and Public Policy
Unfairness in Agreements: Contracts of Adhesion and Unconscionable Contracts
Unconscionability
Contracts of Adhesion
Effect of Illegality
General Rule: No Remedy for Breach of Illegal Agreements
Exceptions
16: Writing
The Significance of Writing in Contract Law
Purposes of Writing
Writing and Contract Enforcement
Overview of the Statute of Frauds
History and Purposes
Effect of Violating the Statute of Frauds
Contracts Covered by the Statute of Frauds
Collateral Contracts
Interest in Land
Contracts That Cannot Be Performed within One Year
Promise of Executor or Administrator to Pay a Decedent’s Debt Personally
Contract in Which Marriage Is the Consideration
Meeting the Requirements of the Statute of Frauds
Nature of the Writing Required
UCC: Alternative Means of Satisfying the Statute of Frauds in Sale of Goods Contracts
Promissory Estoppel and the Statute of Frauds
The Parol Evidence Rule
Explanation of the Rule
Scope of the Parol Evidence Rule
Admissible Parol Evidence
Interpretation of Contracts
17: Rights of Third Parties
Assignment of Contracts
Nature of Assignment of Rights
Creating an Assignment
Assignability of Rights
Nature of Assignee’s Rights
Subsequent Assignments
Successive Assignments
Assignor’s Warranty Liability to Assignee
Delegation of Duties
Nature of Delegation
Delegable Duties
Language Creating a Delegation
Assumption of Duties by Delegatee
Discharge of Delegator by Novation
Third-Party Beneficiaries
Intended Beneficiaries versus Incidental Beneficiaries
Vesting of Beneficiary’s Rights
18: Performance and Remedies
Conditions
Nature of Conditions
Types of Conditions
Creation of Express Conditions
Excuse of Conditions
Performance of Contracts
Level of Performance Expected of the Promisor
Good-Faith Performance
Breach of Contract
Effect of Material Breach
Determining the Materiality of the Breach
Anticipatory Repudiation
Recovery by a Party Who Has Committed Material Breach
Excuses for Nonperformance
Impossibility
Commercial Impracticability
Other Grounds for Discharge
Discharge by Mutual Agreement
Discharge by Accord and Satisfaction
Discharge by Waiver
Discharge by Alteration
Discharge by Statute of Limitations
Discharge by Decree of Bankruptcy
Remedies for Breach of Contract
Types of Contract Remedies
Interests Protected by Contract Remedies
Legal Remedies (Damages)
Equitable Remedies
Restitution
Part 4: Sales
19: Formation and Terms of Sales Contracts
Sale of Goods
Leases
Higher Standards for Merchants
UCC Requirements
Terms of Sales Contracts
Gap Fillers
Price Terms
Quantity Terms
Output and Needs Contracts
Exclusive Dealing Contracts
Time for Performance
Delivery Terms
Title
UCC Changes
General Title Rule
Title and Third Parties
Obtaining Good Title
Transfers of Voidable Title
Buyers in the Ordinary Course of Business
Entrusting of Goods
Risk of Loss
Terms of the Agreement
Shipment Contracts
Destination Contracts
Goods in the Possession of Third Parties
Risk Generally
Effect of Breach on Risk of Loss
Insurable Interest
Sales on Trial
Sale or Return
Sale on Approval
20: Product Liability
The Evolution of Product Liability Law
The 19th Century
The 20th and 21st Centuries
The Current Debate over Product Liability Law
Theories of Product Liability Recovery
Express Warranty
Implied Warranty of Merchantability
Implied Warranty of Fitness
Negligence
Strict Liability
The Restatement (Third)
Other Theories of Recovery
Time Limitations
Damages in Product Liability Cases
The No-Privity Defense
Tort Cases
Warranty Cases
Disclaimers and Remedy Limitations
Implied Warranty Disclaimers
Express Warranty Disclaimers
Disclaimers of Tort Liability
Limitation of Remedies
Defenses
The Traditional Defenses
Comparative Principles
Preemption and Regulatory Compliance
21: Performance of Sales Contracts
General Rules
Good Faith
Course of Dealing
Usage of Trade
Modification
Waiver
Assignment
Delivery
Basic Obligation
Place of Delivery
Seller’s Duty of Delivery
Inspection and Payment
Buyer’s Right of Inspection
Payment
Acceptance, Revocation, and Rejection
Acceptance
Effect of Acceptance
Revocation of Acceptance
Buyer’s Rights on Improper Delivery
Rejection
Right to Cure
Buyer’s Duties after Rejection
Assurance, Repudiation, and Excuse
Assurance
Anticipatory Repudiation
Excuse
22: Remedies for Breach of Sales Contracts
Agreements as to Remedies
Statute of Limitations
Seller’s Remedies
Remedies Available to an Injured Seller
Cancellation and Withholding of Delivery
Resale of Goods
Recovery of the Purchase Price
Damages for Rejection or Repudiation
Seller’s Remedies Where Buyer Is Insolvent
Seller’s Right to Stop Delivery
Liquidated Damages
Buyer’s Remedies
Buyer’s Remedies in General
Buyer’s Right to Damages
Buyer’s Right to Cover
Incidental Damages
Consequential Damages
Damages for Nondelivery
Damages for Defective Goods
Buyer’s Right to Specific Performance
Buyer and Seller Agreements as to Remedies
Part 5: Property
23: Personal Property and Bailments
Nature of Property
Classifications of Property
Personal Property versus Real Property
Tangible versus Intangible Personal Property
Public and Private Property
Acquiring Ownership of Personal Property
Production or Purchase
Possession of Unowned Property
Rights of Finders of Lost, Mislaid, and Abandoned Property
Legal Responsibilities of Finders
Leasing
Gifts
Conditional Gifts
Uniform Transfers to Minors Act
Will or Inheritance
Confusion
Accession
Bailments
Nature of Bailments
Elements of a Bailment
Creation of a Bailment
Types of Bailments
Special Bailments
Duties of the Bailee
Duty of Bailee to Take Care of Property
Bailee’s Duty to Return the Property
Bailee’s Liability for Misdelivery
Limits on Liability
Right to Compensation
Bailor’s Liability for Defects in the Bailed Property
Special Bailments
Common Carriers
Hotelkeepers
Safe-Deposit Boxes
Involuntary Bailments
Documents of Title
Warehouse Receipts
Bills of Lading
Duty of Care
Negotiation of Document of Title
Rights Acquired by Negotiation
Warranties of Transferor of Document of Title
24: Real Property
Scope of Real Property
Fixtures
Rights and Interests in Real Property
Estates in Land
Co-ownership of Real Property
Interests in Real Property Owned by Others
Easements
Creation of Easements
Profits
Licenses
Restrictive Covenants
Acquisition of Real Property
Acquisition by Purchase
Acquisition by Gift
Acquisition by Will or Inheritance
Acquisition by Tax Sale
Acquisition by Adverse Possession
Transfer by Sale
Steps in a Sale
Contracting with a Real Estate Broker
Contract of Sale
Fair Housing Act
Deeds
Form and Execution of Deed
Recording Deeds
Methods of Assuring Title
Seller’s Responsibilities Regarding the Quality of Residential Property
Implied Warranty of Habitability
Duty to Disclose Hidden Defects
Other Property Condition–Related Obligations of Real Property Owners and Possessors
Expansion of Premises Liability
Americans with Disabilities Act
Land Use Control
Nuisance Law
Eminent Domain
Zoning and Subdivision Laws
Land Use Regulation and Taking
25: Landlord and Tenant
Leases and Tenancies
Nature of Leases
Types of Tenancies
Execution of a Lease
Rights, Duties, and Liabilities of the Landlord
Landlord’s Rights
Landlord’s Duties
Landlord’s Responsibility for Condition of Leased Property
Landlord’s Tort Liability
Rights, Duties, and Liabilities of the Tenant
Rights of the Tenant
Duty to Pay Rent
Duty Not to Commit Waste
Assignment and Subleasing
Tenant’s Liability for Injuries to Third Persons
Termination of the Leasehold
Eviction
Agreement to Surrender
Abandonment
26: Estates and Trusts
The Law of Estates and Trusts
Estate Planning
Wills
Right of Disposition by Will
Nature of a Will
Common Will Terminology
Testamentary Capacity
Execution of a Will
Incorporation by Reference
Informal Wills
Joint and Mutual Wills
Construction of Wills
Limitations on Disposition by Will
Revocation of Wills
Codicils
Advance Directives: Planning for Incapacity
Durable Power of Attorney
Living Wills
Durable Power of Attorney for Health Care
Federal Law and Advance Directives
Intestacy
Characteristics of Intestacy Statutes
Special Rules
Simultaneous Death
Administration of Estates
The Probate Estate
Determining the Existence of a Will
Selecting a Personal Representative
Responsibilities of the Personal Representative
Trusts
Nature of a Trust
Trust Terminology
Why People Create Trusts
Creation of Express Trusts
Charitable Trusts
Totten Trusts
Powers and Duties of the Trustee
Liability of Trustee
Spendthrift Trusts
Termination and Modification of a Trust
Implied and Constructive Trusts
27: Insurance Law
Nature and Benefits of Insurance Relationships
Insurance Policies as Contracts
Interested Parties
Offer, Acceptance, and Consideration
Effect of Insured’s Misrepresentation
Legality
Form and Content of Insurance Contracts
Performance and Breach by Insurer
Property Insurance
The Insurable Interest Requirement
Covered and Excluded Perils
Nature and Extent of Insurer’s Payment Obligation
Right of Subrogation
Duration and Cancellation of Policy
Liability Insurance
Types of Liability Insurance Policies
Liabilities Insured Against
Insurer’s Obligations
Is There a Liability Insurance Crisis?
Bad-Faith Breach of Insurance Contract
Part 6: Credit
28: Introduction to Credit and Secured Transactions
Credit
Unsecured Credit
Secured Credit
Development of Security
Security Interests in Personal Property
Security Interests in Real Property
Suretyship and Guaranty
Sureties and Guarantors
Creation of Principal and Surety Relation
Defenses of a Surety
Creditor’s Duties to Surety
Subrogation, Reimbursement, and Contribution
Liens on Personal Property
Security Interests in Personal Property and Fixtures under the Uniform Commercial Code
Common Law Liens
Statutory Liens
Characteristics of Liens
Foreclosure of Lien
Security Interests in Real Property
Historical Developments of Mortgages
Form, Execution, and Recording
Rights and Liabilities
Foreclosure
Right of Redemption
Recent Development Concerning Foreclosures
Deed of Trust
Land Contracts
Mechanic’s and Materialman’s Liens
Rights of Subcontractors and Materialmen
Basis for Mechanic’s or Materialman’s Lien
Requirements for Obtaining a Lien
Priorities and Foreclosure
Waiver of Lien
29: Security Interests in Personal Property
Article 9
Security Interests under the Code
Security Interests
Types of Collateral
Obtaining a Security Interest
Attachment of the Security Interest
Attachment
The Security Agreement
Purchase Money Security Interests
Future Advances
After-Acquired Property
Proceeds
Perfecting the Security Interest
Perfection
Perfection by Public Filing
Possession by Secured Party as Public Notice
Control
Perfection by Attachment/Automatic Perfection
Exceptions to Perfection by Attachment: Consumer Goods
Motor Vehicles
Fixtures
Priority Rules
Importance of Determining Priority
General Priority Rules
Purchase Money Security Interest in Inventory
Purchase Money Security Interest in Noninventory Collateral
Rationale for Protecting Purchase Money Security Interests
Buyers in the Ordinary Course of Business
Artisan’s and Mechanic’s Liens
Liens on Consumer Goods Perfected Only by Attachment/Automatic Perfection
Fixtures
Default and Foreclosure
Default
Right to Possession
Sale of the Collateral
Consumer Goods
Distribution of Proceeds
Liability of Creditor
30: Bankruptcy
The Bankruptcy Code
Bankruptcy Proceedings
Liquidations
Reorganizations
Family Farms
Consumer Debt Adjustments
The Bankruptcy Courts
Chapter 7: Liquidation Proceedings
Petitions
Involuntary Petitions
Automatic Stay Provisions
Order of Relief
Meeting of Creditors and Election of Trustee
Duties of the Trustee
The Bankruptcy Estate
Exemptions
Avoidance of Liens
Redemptions
Preferences (Preferential Payments or Liens)
Preferential Liens
Transactions in the Ordinary Course of Business
Fraudulent Transfers
Claims
Allowable Claims
Secured Claims
Priority Claims
Distribution of the Debtor’s Estate
Discharge in Bankruptcy
Discharge
Objections to Discharge
Acts That Bar Discharge
Nondischargeable Debts
Reaffirmation Agreements
Dismissal for Substantial Abuse
Chapter 11: Reorganizations
Reorganization Proceeding
Use of Chapter 11
Chapter 12: Family Farmers and Fishermen
Relief for Family Farmers and Fishermen
Chapter 13: Consumer Debt Adjustments
Relief for Individuals
Procedure
Discharge
Advantages of Chapter 13
Part 7: Commercial Paper
31: Negotiable Instruments
Nature of Negotiable Instruments
Uniform Commercial Code
Negotiable Instruments
Negotiability
Kinds of Negotiable Instruments
Promissory Notes
Certificates of Deposit
Drafts
Checks
Benefits of Negotiable Instruments
Rights of an Assignee of a Contract
Rights of a Holder of a Negotiable Instrument
Formal Requirements for Negotiability
Basic Requirements
Importance of Form
In Writing
Signed
Unconditional Promise or Order
Requirement of a Promise or Order
Promise or Order Must Be Unconditional
Fixed Amount of Money
Fixed Amount
Payable in Money
Payable on Demand or at a Definite Time
Payable on Demand
Payable at a Definite Time
Payable to Order or Bearer
Special Terms
Additional Terms
Ambiguous Terms
32: Negotiation and Holder in Due Course
Negotiation
Nature of Negotiation
Formal Requirements for Negotiation
Nature of Indorsement
Wrong or Misspelled Name
Checks Deposited without Indorsement
Transfer of Order Instrument
Indorsements
Effects of an Indorsement
Kinds of Indorsements
Rescission of Indorsement
Holder in Due Course
General Requirements
Holder
Value
Good Faith
Overdue or Dishonored
Notice of Unauthorized Signature or Alteration
Notice of Claims
Irregular and Incomplete Instruments
Shelter Rule
Rights of a Holder in Due Course
Claims and Defenses Generally
Importance of Being a Holder in Due Course
Real Defenses
Personal Defenses
Claims to the Instrument
Claims in Recoupment
Changes in the Holder in Due Course Rule for Consumer Credit Transactions
Consumer Disadvantages
State Consumer Protection Legislation
Federal Trade Commission Regulation
33: Liability of Parties
Liability in General
Contractual Liability
Primary and Secondary Liability
Obligation of a Maker
Obligation of a Drawee or an Acceptor
Obligation of a Drawer
Obligation of an Indorser
Obligation of an Accommodation Party
Signing an Instrument
Signature by an Authorized Agent
Unauthorized Signature
Contractual Liability in Operation
Presentment of a Note
Presentment of a Check or a Draft
Time of Presentment
Warranty Liability
Transfer Warranties
Presentment Warranties
Payment or Acceptance by Mistake
Operation of Warranties
Other Liability Rules
Negligence
Impostor Rule
Fictitious Payee Rule
Comparative Negligence Rule Concerning Impostors and Fictitious Payees
Fraudulent Indorsements by Employees
Conversion
Discharge of Contractual Liability on Negotiable Instruments
Discharge of Contractual Liability
Discharge by Payment
Discharge by Cancellation
Altered Instruments: Discharge by Alteration
Discharge of Indorsers and Accommodation Parties
34: Checks and Electronic Transfers
The Drawer–Drawee Relationship
Bank’s Duty to Pay
Bank’s Right to Charge to Customer’s Account
Stop-Payment Order
Bank’s Liability for Payment after Stop-Payment Order
Certified Check
Cashier’s Check
Death or Incompetence of Customer
Forged and Altered Checks
Bank’s Right to Charge Account
Customer’s Duty to Report Forgeries and Alterations
Check Collection and Funds Availability
Check Collection
Funds Availability
Check 21
Electronic Transfers
Electronic Fund Transfer Act
Wire Transfers
Part 8: Agency Law
35: The Agency Relationship
Creation of an Agency
Formation
Capacity
Nondelegable Obligations
Agency Concepts, Definitions, and Types
Authority
General and Special Agents
Gratuitous Agents
Subagents
Employees and Nonemployee Agents
Duties of Agent to Principal
Agent’s Duty of Loyalty
Agent’s Duty to Obey Instructions
Agent’s Duty to Act with Care and Skill
Agent’s Duty to Provide Information
Agent’s Duties of Segregation, Record-Keeping, and Accounting
Duty Not to Receive a Material Benefit
Duty of Good Conduct
Duties of Principal to Agent
Duty to Compensate Agent
Duties of Reimbursement and Indemnity
Termination of an Agency
Termination by Act of the Parties
Termination by Operation of Law
Termination of Agency Powers Given as Security
Effect of Termination on Agent’s Authority
36: Third-Party Relations of the Principal and the Agent
Contract Liability of the Principal
Actual Authority
Apparent Authority
Agent’s Notification and Knowledge
Ratification
Estoppel
Contracts Made by Subagents
Contract Liability of the Agent
The Nature of the Principal
Liability of Agent by Agreement
Implied Warranty of Authority
Tort Liability of the Principal
Respondeat Superior Liability
Direct Liability
Liability for Torts of Nonemployee Agents
Liability for Agent’s Misrepresentations
Tort Liability of the Agent
Tort Suits against Principal and Agent
Part 9: Partnerships
37: Introduction to Forms of Business and Formation of Partnerships
Types of Business Entities
Sole Proprietorship
Partnership
Limited Liability Partnership
Limited Partnership
Corporation
Professional Corporation
Limited Liability Company
Benefit Corporations
Partnerships
Creation of Partnership
RUPA Definition of Partnership
Creation of Joint Ventures
Creation of Mining Partnerships
Creation of Limited Liability Partnerships
Purported Partners
Purporting to Be a Partner
Reliance Resulting in a Transaction with the Partnership
Effect of Purported Partnership
Partnership Capital
Partnership Property
Examples
Need for Partnership Agreement
Partner’s Partnership Interest
Partner’s Transferable Interest
Effect of Partnership Agreement
38: Operation of Partnerships and Related Forms
Duties of Partners to the Partnership and Each Other
Having Interest Adverse to Partnership
Competing against the Partnership
Duty to Serve
Duty of Care
Duty to Act within Actual Authority
Duty to Account
Other Duties
Joint Ventures and Mining Partnerships
Compensation of Partners
Profits and Losses
Management Powers of Partners
Individual Authority of Partners
Special Transactions
Disagreement among Partners: Ordinary Course of Business
When Unanimous Partners’ Agreement Is Required
Joint Ventures and Mining Partnerships
Effect of Partnership Agreement
Liability for Torts and Crimes
Torts
Tort Liability and Limited Liability Partnerships
Crimes
Lawsuits by and against Partnerships and Partners
Limited Liability Partnerships
39: Partners’ Dissociation and Partnerships’ Dissolution and Winding Up
Dissociation
Nonwrongful Dissociation
Wrongful Dissociation
Acts Not Causing Dissociation
Effect of Partnership Agreement
Dissolution and Winding Up the Partnership Business
Events Causing Dissolution and Winding Up
Joint Ventures and Mining Partnerships
Performing Winding Up
Partner’s Authority during Winding Up
Distribution of Dissolved Partnership’s Assets
Asset Distributions in a Limited Liability Partnership
Termination
When the Business Is Continued
Successor’s Liability for Predecessor’s Obligations
Dissociated Partner’s Liability for Obligations Incurred while a Partner
Dissociated Partner’s Liability for Obligations Incurred after Leaving the Partnership
Effect of LLP Status
Buyout of Dissociated Partners
Partners Joining an Existing Partnership
Liability of New Partners
40: Limited Liability Companies and Limited Partnerships
Limited Liability Companies
Tax Treatment of LLCs
Formation of LLCs
Members’ Rights and Responsibilities
Members’ Dissociations and LLC Dissolution
Limited Partnerships
The Uniform Limited Partnership Acts
Use of Limited Partnerships
Creation of Limited Partnerships
Defective Compliance with Limited Partnership Statute
Rights and Liabilities of Partners in Limited Partnerships
Rights and Liabilities Shared by General and Limited Partners
Other Rights of General Partners
Other Liabilities of General Partners
Other Rights of Limited Partners
Other Liabilities of Limited Partners
Partners’ Dissociations and Limited Partnership Dissolution
Partners’ Dissociations
Limited Partnership Dissolutions
Mergers and Conversions
Part 10: Corporations
41: History and Nature of Corporations
History of Corporations
American Corporation Law
Classifications of Corporations
Regulation of For-Profit Corporations
State Incorporation Statutes
State Common Law of Corporations
Regulation of Nonprofit Corporations
Regulation of Foreign and Alien Corporations
Due Process Clause
Commerce Clause
Subjecting Foreign Corporations to Suit
Taxation
Qualifying to Do Business
Regulation of a Corporation’s Internal Affairs
Regulation of Foreign Nonprofit Corporations
Piercing the Corporate Veil
Nonprofit Corporations
42: Organization and Financial Structure of Corporations
Promoters and Preincorporation Transactions
Corporation’s Liability on Preincorporation Contracts
Promoter’s Liability on Preincorporation Contracts
Obtaining a Binding Preincorporation Contract
Preincorporation Share Subscriptions
Relation of Promoter and Prospective Corporation
Liability of Corporation to Promoter
Incorporation
Steps in Incorporation
Close Corporation Elections
Defective Attempts to Incorporate
De Jure Corporation
De Facto Corporation
Corporation by Estoppel
Defective Incorporation
Modern Approaches to the Defective Incorporation Problem
Incorporation of Nonprofit Corporations
Liability for Preincorporation Transactions
Financing For-Profit Corporations
Equity Securities
Authorized, Issued, and Outstanding Shares
Options, Warrants, and Rights
Debt Securities
Consideration for Shares
Quality of Consideration for Shares
Quantity of Consideration for Shares
Share Subscriptions
Issuance of Shares
Transfer of Shares
Restrictions on Transferability of Shares
Financing Nonprofit Corporations
43: Management of Corporations
Corporate Objectives
Corporate Powers
Purpose Clauses in Articles of Incorporation
Powers of Nonprofit Corporations
The Board of Directors
Board Authority under Corporation Statutes
Committees of the Board
Who Is an Independent Director?
Powers, Rights, and Liabilities of Directors as Individuals
Election of Directors
Directors’ Meetings
Officers of the Corporation
Managing Close Corporations
Managing Nonprofit Corporations
Directors’ and Officers’ Duties to the Corporation
Acting within Authority
Duty of Care
Board Opposition to Acquisition of Control of a Corporation
Oversight of Legal Compliance
Duties of Loyalty
Conflicting Interest Transactions
Usurpation of a Corporate Opportunity
Oppression of Minority Shareholders
Trading on Inside Information
Duties of Directors and Officers of Nonprofit Corporations
Corporate and Management Liability for Torts and Crimes
Liability of the Corporation
Directors’ and Officers’ Liability for Torts and Crimes
Insurance and Indemnification
Mandatory Indemnification of Directors
Permissible Indemnification of Directors
Insurance
Nonprofit Corporations
44: Shareholders’ Rights and Liabilities
Shareholders’ Meetings
Notice of Meetings
Conduct of Meetings
Shareholder Action without a Meeting
Shareholders’ Election of Directors
Straight Voting
Cumulative Voting
Classes of Shares
Shareholder Control Devices
Fundamental Corporate Changes
Procedures Required
Dissenters’ Rights
Shareholders’ Inspection and Information Rights
Preemptive Right
Distributions to Shareholders
Dividends
Share Repurchases
Ensuring a Shareholder’s Return on Investment
Shareholders’ Lawsuits
Shareholders’ Individual Lawsuits
Shareholder Class Action Suits
Shareholders’ Derivative Actions
Defense of Corporation by Shareholder
Shareholder Liability
Shareholder Liability for Illegal Distributions
Shareholder Liability for Corporate Debts
Sale of a Control Block of Shares
Shareholders as Fiduciaries
Members’ Rights and Duties in Nonprofit Corporations
Members’ Meeting and Voting Rights
Member Inspection and Information Rights
Distributions of Assets
Resignation and Expulsion of Members
Derivative Suits
Dissolution and Termination of Corporations
Winding Up and Termination
Dissolution of Nonprofit Corporations
45: Securities Regulation
Purposes of Securities Regulation
Securities and Exchange Commission
SEC Actions
What Is a Security?
Securities Act of 1933
Registration of Securities under the 1933 Act
Mechanics of a Registered Offering
Registration Statement and Prospectus
Section 5: Timing, Manner, and Content of Offers and Sales
Exemptions from the Registration Requirements of the 1933 Act
Securities Exemptions
Transaction Exemptions
Intrastate Offering Exemption
Private Offering Exemption
Small Offering Exemptions
The JOBS Act and Regulation Crowdfunding
Transaction Exemptions for Nonissuers
Sale of Restricted Securities
Consequence of Obtaining a Securities or Transaction Exemption
Liability Provisions of the 1933 Act
Liability for Defective Registration Statements
Other Liability Provisions
Criminal Liability
Securities Exchange Act of 1934
Registration of Securities under the 1934 Act
Holdings and Trading by Insiders
Proxy Solicitation Regulation
Liability Provisions of the 1934 Act
Liability for False Statements in Filed Documents
Section 10(b) and Rule 10b–5
Elements of a Rule 10b–5 Violation
Regulation FD
Criminal Liability
Tender Offer Regulation
Private Acquisitions of Shares
State Regulation of Tender Offers
State Securities Law
Registration of Securities
46: Legal and Professional Responsibilities of Auditors, Consultants, and Securities Professionals
General Standard of Performance
Professionals’ Liability to Clients
Contractual Liability
Tort Liability
In Pari Delicto
Breach of Trust
Securities Law
Professionals’ Liability to Third Persons: Common Law
Negligence and Negligent Misrepresentation
Fraud
Professional’s Liability to Third Parties: Securities Law
Securities Act of 1933
Securities Exchange Act of 1934
State Securities Law
Securities Analysts’ Conflicts of Interest
Dodd–Frank Act and Broker-Dealers
Regulation Best Interest and Broker-Dealers
Qualified Opinions, Disclaimers of Opinion, Adverse Opinions, and Unaudited Statements
Criminal, Injunctive, and Administrative Proceedings
Criminal Liability under the Securities Laws
Other Criminal Law Violations
Injunctions
Administrative Proceedings
Securities Exchange Act Audit Requirements
SOX Section 404
Cooperation with PCAOB Investigations
Ownership of Working Papers
Professional–Client Privilege
Part 11: Regulation of Business
47: Administrative Law
Origins of Administrative Agencies
Agency Creation
Enabling Legislation
Administrative Agencies and the Constitution
Agency Types and Organization
Agency Types
Agency Organization
Agency Powers and Procedures
Nature, Types, and Source of Powers
Investigative Power
Rulemaking Power
Adjudicatory Power
Controlling Administrative Agencies
Presidential Controls
Congressional Controls
Judicial Review
Information Controls
Freedom of Information Act
Privacy Act of 1974
Government in the Sunshine Act
Issues in Regulation
“Old” Regulation versus “New” Regulation
“Captive” Agencies and Agencies’ “Shadows”
Is the Agency Doing Its Job?
Deregulation versus Reregulation
48: The Federal Trade Commission Act and Consumer Protection Laws
The Federal Trade Commission
The FTC’s Powers
FTC Enforcement Procedures
Actions in Court
Anticompetitive Behavior
Deception and Unfairness
Deception
Unfairness
Remedies
Consumer Protection Laws
Telemarketing and Consumer Fraud and Abuse Prevention Act
Do-Not-Call Registry
Do Not Track
Magnuson–Moss Warranty Act
Truth in Lending Act
Fair Credit Reporting Act
FACT Act and the Identity Theft Problem
Equal Credit Opportunity Act
Fair Credit Billing Act
The Dodd–Frank Act
Fair Debt Collection Practices Act
Product Safety Regulation
49: Antitrust: The Sherman Act
The Antitrust Policy Debate
Chicago School Theories
Traditional Antitrust Theories
Impact of Chicago School
Jurisdiction, Types of Cases, and Standing
Jurisdiction
Types of Cases and the Role of Pretrial Settlements
Criminal Prosecutions
Civil Litigation
Standing
Section 1—Restraints of Trade
Concerted Action
Per Se versus Rule of Reason Analysis
Horizontal Price-Fixing
Vertical Price-Fixing
Horizontal Divisions of Markets
Vertical Restraints on Distribution
Group Boycotts and Concerted Refusals to Deal
Tying Agreements
Reciprocal Dealing Agreements
Exclusive Dealing Agreements
Joint Ventures by Competitors
Section 2—Monopolization
Monopolization
Attempted Monopolization
Conspiracy to Monopolize
50: The Clayton Act, the Robinson–Patman Act, and Antitrust Exemptions and Immunities
Clayton Act Section 3
Tying Agreements
Exclusive Dealing Agreements
Clayton Act Section 7
Introduction
Federal Filing Requirements for Mergers
Relevant Market Determination
Horizontal Mergers
Vertical Mergers
Conglomerate Mergers
Clayton Act Section 8
The Robinson–Patman Act
Jurisdiction
Section 2(a)
Defenses to Section 2(a) Liability
Indirect Price Discrimination
Buyer Inducement of Discrimination
Antitrust Exceptions and Exemptions
Statutory Exemptions
State Action Exemption
The Noerr–Pennington Doctrine
Patent Licensing
Foreign Commerce
51: Employment Law
Legislation Protecting Employee Health, Safety, and Well-Being
Workers’ Compensation
The Occupational Safety and Health Act
The Family and Medical Leave Act
Legislation Protecting Wages, Pensions, and Benefits
Social Security
Unemployment Compensation
ERISA
The Fair Labor Standards Act
Collective Bargaining and Union Activity
Equal Opportunity Legislation
The Equal Pay Act
Title VII
Section 1981
The Age Discrimination in Employment Act
The Americans with Disabilities Act
Genetic Information Nondiscrimination Act
Immigration Reform and Control Act
Uniformed Services Employment and Reemployment Rights Act
Executive Order 11246
State Antidiscrimination Laws
Retaliation
Employee Privacy
Polygraph Testing
Drug and Alcohol Testing
Employer Searches
Records and References
Employer Monitoring
Job Security
The Doctrine of Employment at Will
The Common Law Exceptions
52: Environmental Regulation
Historical Perspective
The Environmental Protection Agency
The National Environmental Policy Act
Air Pollution
Background
Clean Air Act
Ambient Air Control Standards
Acid Rain Controls
Control of Hazardous Air Pollutants
New Source Controls
Permits
Enforcement
Automobile Pollution
International Air Problems
Water Pollution
Background
Early Federal Legislation
Clean Water Act
Discharge Permits
Water Quality Standards
Enforcement
Wetlands
Waters of the United States
Ocean Dumping
Liability for Oil Spills
Drinking Water
Waste Disposal
Background
The Resource Conservation and Recovery Act
Underground Storage Tanks
State Responsibilities
Enforcement
Solid Waste
Superfund
Community Right to Know and Emergency Cleanup
Regulation of Chemicals
Background
Regulation of Agricultural Chemicals
Toxic Substances Control Act
International Developments Concerning Regulation of Toxic Substances
Biotechnology
Glossary
Appendix A: The Constitution of the United States of America
Appendix B: Uniform Commercial Code
Index
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Business Law

The Ethical, Global, and Digital Environment

18e

E I G H TE E N TH E DI TI O N

Jamie Darin Prenkert A. James Barnes Joshua E. Perry Todd Haugh Abbey R. Stemler all of Indiana University

Pixtal/AGE Fotostock

Final PDF to printer

BUSINESS LAW

Published by McGraw Hill LLC, 1325 Avenue of the Americas, New York, NY 10121. Copyright © 2022 by McGraw Hill LLC. All rights reserved. Printed in the United States of America. No part of this publication may be reproduced or distributed in any form or by any means, or stored in a database or retrieval system, without the prior written consent of McGraw Hill LLC, including, but not limited to, in any network or other electronic  storage or transmission, or broadcast for distance learning. Some ancillaries, including electronic and print components, may not be available to customers outside the United States. This book is printed on acid-free paper. 1 2 3 4 5 6 7 8 9 LWI 24 23 22 21 ISBN 978-1-265-40639-4 MHID 1-265-40639-1

Cover Image: bonetta/Getty Images

All credits appearing on page or at the end of the book are considered to be an extension of the copyright page.

The Internet addresses listed in the text were accurate at the time of publication. The inclusion of a website does not indicate an endorsement by the authors or McGraw Hill LLC, and McGraw Hill LLC does not guarantee the accuracy of the information presented at these sites.

mheducation.com/highered

pre06391_fm_ISE.indd ii

12/12/20 02:55 PM

The Authors The Authors Jamie Darin Prenkert, Professor of Business Law and

the Charles M. Hewitt Professor, joined the faculty of Indiana University’s Kelley School of Business in 2002. He is the Associate Dean of Academics for the Kelley School. He served as chair of the Department of Business Law and Ethics from 2014 to 2016 and from 2019 to 2020, having served as an Associate Vice Provost for Faculty and Academic Affairs for the Indiana University–Bloomington campus from 2016 to 2019. Professor Prenkert is a former editor in chief of the American Business Law Journal and is a member of the executive committee of the Academy of Legal Studies in Business. His research focuses on issues of employment discrimination and the human rights obligations of transnational corporations. He has published articles in the American Business Law Journal, the North Carolina Law Review, the Berkeley Journal of Employment and Labor Law, and the University of Pennsylvania Journal of International Law, among others. He also coedited a volume titled Law, Business and Human Rights: Bridging the Gap. Professor Prenkert has taught undergraduate and graduate courses, both in-residence and online, focusing on the legal environment of business, employment law, law for entrepreneurs, business and human rights, and critical thinking. He is a recipient of the Harry C. Sauvain Undergraduate Teaching Award and the Kelley Innovative Teaching Award. Professor Prenkert earned a B.A. (summa cum laude) from Anderson University and a J.D. (magna cum laude) from Harvard Law School. Prior to joining the faculty of the Kelley School, he was a senior trial attorney for the U.S. Equal Employment Opportunity Commission.

A. James Barnes, Professor of Public and Environ-

mental Affairs and Professor of Law at Indiana University– Bloomington (IU), previously served as Dean of IU’s School of Public and Environmental Affairs and has taught business law at IU and Georgetown University. His teaching interests include commercial law, environmental law, alternative dispute resolution, law and public policy, and ethics and the public official. He is the co-author of several leading books on business law. From 1985 to 1988, Professor Barnes served as the deputy administrator of the U.S. Environmental Protection Agency (EPA). From 1983 to 1985, he was the EPA general counsel and in the early 1970s served as chief of staff to the first administrator of EPA. Professor Barnes also served as a trial attorney in the U.S. Department of Justice and as general counsel of the U.S. Department of Agriculture. From 1975 to 1981, he had a commercial and environmental law practice with the firm of Beveridge and Diamond in Washington, D.C. Professor Barnes is a Fellow of the National Academy of Public Administration, and a Fellow in the American College of Environmental Lawyers. He served as chair of the Environmental Protection Agency’s Environmental Finance Advisory Board and as a member of the U.S. Department of Energy’s Environmental Management Advisory Board. From 1992 to 1998,

he was a member of the Board of Directors of the Long Island Lighting Company (LILCO). Professor Barnes received his B.A. from Michigan State University and a J.D. (cum laude) from Harvard Law School.

Joshua E. Perry, Graf Family Professor and Associate

Professor of Business Law and Ethics, joined the faculty of Indiana University’s Kelley School of Business in 2009. He currently serves as chair of the Department of Business Law and Ethics, an appointment he has held since 2020. He was formerly the Faculty Chair for the Kelley School’s Undergraduate Program. A three-time winner of the IU Trustees’ Teaching Award and two-time winner of the Kelley Innovative Teaching Award, he teaches graduate and undergraduate courses on business ethics, critical thinking, and the legal environment of business. Professor Perry earned a B.A. (summa cum laude) from Lipscomb University, a Masters of Theological Studies from the Vanderbilt University Divinity School, and a J.D. from the Vanderbilt University Law School, where he was Senior Articles Editor on the Law Review. Prior to joining Kelley, he was on faculty at the Center for Biomedical Ethics and Society at Vanderbilt University Medical Center. In that role, he taught medical ethics in the School of Medicine and professional responsibility in the Law School, and served as a clinical ethicist in both the adult and children’s hospitals at Vanderbilt. Before entering academe, he practiced law in Nashville, Tennessee, at a boutique litigation firm, where he specialized in dispute resolution and risk mitigation for clients in the health care, intellectual property, and entertainment industries.   Professor Perry’s award-winning scholarship explores legal, ethical, and public policy issues in the life science, medical device, and health care industries, as well as in the business of medicine. He is the author of over 30 articles and essays that have appeared in a variety of journals, including the American Business Law Journal; the Georgia Law Review; the Notre Dame Journal of Law, Ethics, and Public Policy; the Journal of Law, Medicine and Ethics; and the University of Pennsylvania Journal of Law and Social Change, among others. His expertise has been featured in The New York Times, USA Today, Wired, Fast Company, Huffington Post, and Salon. Since 2015, he also has served on the editorial board for the Journal of Business Ethics as section editor for law, public policy, and ethics.

Todd Haugh, Associate Professor of Business Law and

Ethics and Weimer Faculty Fellow at Indiana University’s  Kelley School of Business. His scholarship focuses on whitecollar and corporate crime, business and behavioral ethics, and federal sentencing policy. His work has appeared in top law and business journals, including the Northwestern University Law Review, Notre Dame Law Review, Vanderbilt Law Review, and the MIT-Sloan Management Review. Prof. Haugh’s expertise relating to the burgeoning field of behavioral compliance has led to frequent speaking and consulting engagements with major U.S.

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The Authors

companies and ethics organizations. He is also regularly quoted in national news publications such as The New York Times, The Wall Street Journal, Forbes, Bloomberg News, and USA Today. A graduate of the University of Illinois College of Law and Brown University, Professor Haugh has extensive professional experience as a white-collar criminal defense attorney, a federal law clerk, and a member of the general counsel’s office of the U.S. Sentencing Commission. In 2011, he was chosen as one of four Supreme Court Fellows of the Supreme Court of the United States to study the administrative machinery of the federal judiciary. Prior to joining the Kelley School, where he teaches courses on business ethics, white-collar crime, and critical thinking, Professor Haugh taught at DePaul University College of Law and Chicago-Kent College of Law. He is a recipient of numerous teaching and scholarly awards, including a Trustees Teaching Award and multiple Innovative Teaching Awards, and a Jesse Fine Fellowship from the Poynter Center for the Study of Ethics and American Institutions, to which he now serves as a board member. In 2019 he was awarded the Distinguished Early Career Achievement Award by the Academy of Legal Studies in Business.

Abbey R. Stemler, Assistant Professor of Business Law and Ethics at Indiana University’s Kelley School of Business.

She is a leading scholar on the sharing economy, and her scholarship and teaching have garnered many university and national awards. She is frequently sought out for her expertise on platform-based technology companies, such as Facebook, Uber, and Google. Professor Stemler has published multiple articles in leading law journals such as the Iowa Law Review, Emory Law Journal, Maryland Law Review, Georgia Law Review, and Harvard Journal on Legislation. Her research explores the interesting spaces where law has yet to catch up with technology. In particular, her aim is to expose the evolving realities of Internet-based innovations and platforms and to find ways to effectively regulate them without hindering their beneficial uses. As she sees it, many modern firms inhabit a world that operates under alien physics—where free is often costly and “smart” is not always wise. She employs tools and insights from economics, behavioral science, regulatory theory, and rhetoric to understand how we, as a society, can better protect consumers, privacy, and democracy. Professor Stemler is also a faculty associate at the Berkman Klein Center for Internet & Society at Harvard University, practicing attorney, entrepreneur, and consultant for governments and multinational organizations such as the World Bank Group.

Preface Preface This is the 18th Edition (and the 24th overall edition) of a ­business law text that first appeared in 1935. Throughout its more than 80 years of existence, this book has been a leader and an innovator in the fields of business law and the legal ­environment of business. One reason for the book’s success is its clear and comprehensive treatment of the standard topics that form the traditional business law curriculum. Another reason is its responsiveness to changes in these traditional subjects and to new views about that curriculum. In 1976, this textbook was the first to inject regulatory materials into a business law textbook, defining the “legal environment” approach to business law. Over the years, this textbook has also pioneered by introducing ­materials on business ethics, corporate social responsibility, global legal issues, and the law of an increasingly digital world. The 18th Edition continues to emphasize change by integrating these four areas into its pedagogy.

Appendix B: The Uniform Commercial Code The Uniform Commercial Code, or UCC, was developed by the American Law Institute (ALI) and the National Conference of Commissioners on Uniform State Laws (NCCUSL) as a body of rules intended to make the application of law to commercial transactions consistent across fifty states. The UCC has been adopted in whole by all but one state legislature, Louisiana, which adopted only certain sections. Such widespread use of the UCC, even with the minor deviations some jurisdictions make from the official code, makes possible more efficient and more confident transactions across state lines. The UCC can be accessed here: www.law.cornell.edu/ucc.

Continuing Strengths The 18th Edition continues the basic features that have made its predecessors successful. They include: • Comprehensive coverage. We believe that the text continues to excel in both the number of topics it addresses and the depth of coverage within each topic. This is true not only of the basic business law subjects that form the core of the book, but also of the regulatory and other subjects that are said to constitute the “legal environment” curriculum. • Style and presentation. This text is written in a style that is direct, lucid, and organized, yet also relatively relaxed and conversational. For this reason, the text lends itself to the flipped classroom, allowing coverage of certain topics by assigning them as reading without lecturing on them. As always, key points and terms are emphasized; examples, charts, figures, and concept summaries are used liberally; and elements of a claim and lists of defenses are stated in numbered paragraphs. • Case selection. We try very hard to find cases that clearly illustrate important points made in the text, that should interest

students, and that are fun to teach. Except when older decisions are landmarks or continue to provide the best illustrations of particular concepts, we also try to select recent cases. Our collective in-class teaching experience with recent editions has helped us determine which of those cases best meet these criteria.

Important Changes in This Edition For this edition, we welcome Todd Haugh and Abbey Stemler, our Indiana University colleagues, to the author team. They bring new teaching, research, and legal practice experiences to our team that have helped shape our approach to the 18th Edition and will allow us to continue to deliver excellent coverage of the ever-changing legal environment of business. Our longtime co-author Arlen Langvardt decided to retire from authoring the textbook along with retiring from his faculty position at Indiana University. The author team wishes to express our gratitude for his leadership on the textbook for the past couple of editions and to thank him for the profound impact he has made on this text. In his place, Jamie Prenkert has moved into the lead author role. Co-author Jim Barnes remains our connection to the long and vital history of this textbook. With this edition, Jim will have been a co-author of this text for more than 50 years! In this edition, the combination of new and longstanding authors has led to a number of innovations, while maintaining the thorough yet accessible approach for which the book is well known. Along with a more explicit focus on compliance in addition to ethics (see Ethics and Compliance in Action features), the 18th Edition includes new cases, tracks recent developments in various substantive areas of law, and offers revisions to various textual material in our ongoing commitment to clarity and completeness. The book continues to include both hypothetical examples and real-life cases so that instructors can elucidate important concepts for students while also maintaining student interest and engagement. Key additions and revisions for the 18th Edition include the following: Chapter 1 • New problem case dealing with a spectator injured by a foul ball at a professional baseball game. The problem case can be used to enrich class discussion around case law reasoning, as illustrated in the Coomer case in the main text. • Introduction of the new Ethics and Compliance in Action feature, which is present throughout the book. Chapter 2 • New discussion of the Forced Arbitration Injustice Repeal Act (Fair Act). Chapter 3 • Incorporation in the text of several recent Supreme Court cases, including Trump v. Vance (separation of powers and v

vi

Preface

Supremacy Clause), Burwell v. Hobby Lobby Stores and Masterpiece Cakeshop, Ltd. v. Colorado Civil Rights Commission (First Amendment religion clause, as well as the federal Religious Freedom Restoration Act). • Reorganization of the Commerce Clause discussion and the addition of 2018 Supreme Court decision South Dakota v. ­Wayfair, Inc., which illustrates the standard for excessive burden on interstate commerce. • New figure describing the Food and Drug Administration’s tobacco regulations pursuant to the Family Smoking Prevention and Tobacco Control Act and related court challenges, with specific focus on First Amendment speech issues. • New discussion of the claims against Harvard College and the University of North Carolina related to their admissions practices.

Chapter 12 • New case, Mid-American Salt, LLC v. Morris County Cooperative Pricing Council, which illustrates that requirements contracts, though recognized under the UCC, must create some obligation in order to avoid being illusory. • Revision of the discussion of forbearance as a form of consideration for added clarity.

Chapter 4 • New discussion of the Business Roundtable’s 2019 statement regarding stakeholder theory.

Chapter 18 • New case, Macomb Mechanical, Inc. v. Lasalle Group Inc., which illustrates the operation of a “pay if paid” clause as a condition precedent.

Chapter 5 • New discussion of Fourth Amendment searches and the thirdparty doctrine. • New case note that highlights the importance of New York Central & Hudson River Railroad v. United States, which established the concept of corporate criminal liability. • Revision of discussion of criminal racketeering offenses. • New problem regarding whether a health care company and its senior executives had standing to challenge a warrant in a tax fraud case based on Fourth Amendment grounds. • New problem case on the Sixth Amendment’s reach in the context of corporate criminal fines based on the Apprendi line of Supreme Court cases. Chapter 7 • New case that provides a clear illustration of negligence elements in the context of an easily understood fact pattern. Chapter 8 • New case, ZUP, LLC v. Nash Manufacturing, Inc., which provides a relatable example of the patent requirement of nonobviousness. Chapter 9 • New case, Grimes v. Young Life, Inc., which deals with a hybrid contract and the application of the predominant factor test. • New case, PWS Environmental, Inc. v. All Clear Restoration and Remediation, LLC, which provides a straightforward application of quasi-contract. Chapter 10 • New Cyberlaw in Action feature dealing with Twitter and offer terms. • Replacement of the term “insanity” with the more modern concept of “mental incapacity.” Chapter 11 • General update of examples to ensure that concepts and technology references remain relevant.

Chapter 16 • Discussion of the 21st Century Integrated Digital Experience Act (IDEA). Chapter 17 • New Ethics and Compliance in Action feature, which explores the ethics of obligating a donee beneficiary to an arbitration clause.

Chapter 19 • New case, National Music Museum: America’s Shrine to Music v. Johnson, which deals with a contract for the sale of a guitar once owned by Elvis Presley and illustrates the rules concerning the passage of title. Chapter 20 • New introduction problem, which explores products liability and ethical issues involving JUUL e-cigarettes. • New Cyberlaw in Action feature that explores the question of whether Amazon, when it sells a defective product via a third-party seller, can be held liable. The box references and discusses recent litigation including Allstate New Jersey Insurance Co. v. Amazon.com; Eberhart v. Amazon.com; Oberdorf v. Amazon.com, Inc.; and Papataros v. Amazon.com. • Revision of discussion of punitive damages to include recent verdicts against Johnson & Johnson and Monsanto. Chapter 21 • New case, Hillerich & Bradsby v. Charles Products, which addresses whether a buyer timely notified the seller that products delivered to the buyer for sale to children in buyer’s Louisville Slugger Museum Store were defective (i.e., contained lead content in excess of limits prescribed under the Consumer Products Safety Improvement Act of 2008). Chapter 22 • New case, Beau Townsend Ford Lincoln v. Don Hinds Ford, which illustrates the principle that a buyer is liable for the purchase price of goods that have been received and accepted and that the buyer is not relieved of that obligation when deceived into making payment to someone other than the seller to whom the buyer is contractually obligated to pay. Chapter 23 • New problem case.

Preface

Chapter 24 • Revision to Francini v. Goodspeed Airport, LLC to note that the Connecticut Supreme Court upheld the Connecticut Appellate Court’s decision (included in the text) in 2018. Chapter 25 • Revisions to text to clarify state and local variations in the law that have developed in recent years. • Revision and update to the discussion of a landlord’s duty to mitigate damages. Chapter 26 • Revision to the explanation of the formalities of a will for greater clarity. Chapter 27 • New Cyberlaw in Action feature discussing the burgeoning cyber insurance market. • Updates to the status of health care insurance under the Affordable Care Act. Chapter 28 • New case, Trump Endeavor 12 LLC v. Fernich, Inc. d/b/a The Paint Spot, involving a contractor who sued to enforce a lien on property on which it had provided materials but had not been paid by the owner of the property. Chapter 29 • New case, Hyman v. Capital One Auto Finance, where the court held that a debtor had stated a case for conversion and breach of the peace in the course of an attempted repossession of her automobile where the “repo man” involved the state police without judicial authorization. Chapter 30 • Revision of discussion of preferential liens. • New case, Rosenberg v. N.Y State Higher Education Services Corp., in which a bankruptcy court granted a discharge of student loans on the grounds their repayment would constitute an undue hardship. The court criticized previous bankruptcy court decisions that produced harsh results for students on the grounds that the courts did not properly apply prior case authority. • New text concerning the Small Business Organization Act of 2019 that provides a modified procedure to facilitate reorganization under Chapter 11 of small businesses in financial difficulty. Chapter 32 • New case, Triffin v. Sinha, which illustrates the operation of the shelter rule: The assignee of a check was held to be entitled to holder-in-due-course status because the entity that assigned the check to him was a holder in due course. Chapter 33 • Revision of the text for clarity and to reflect recent changes in the law. Chapter 34 • New case, Grodner & Associates v. Regions Bank, which involves a bookkeeper who defrauded the law firm for which she worked over a period of 15 months by writing checks utilizing

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facsimile signatures and initiating ACH transactions, which she was not authorized to perform. The bank refused to recredit the account on the grounds the law firm had not notified the bank of the fraud within a year after receiving a statement containing an unauthorized payment and the law firm was unable to show any deviation from the bank’s own procedures or local banking standards or from the terms of the parties’ deposit agreement. • Revision of discussion of Check 21, the electronic processing of checks, and Federal Reserve Board Regulations concerning wire transfers. Chapter 35 • New case, Krakauer v. Dish Network LLC, which illustrates the objective standard of manifested assent for agency formation. • New Cyberlaw in Action feature, which discusses California’s judicial and legislative responses to misclassification of gig workers as nonemployee agents in a variety of industries, specifically focusing on sharing-economy platform businesses like Uber and Lyft. Chapter 36 • New case, Synergies3 Tec Services, LLC v. Corvo, in which the court analyzes whether employees’ intentional tort was committed in the scope of their employment. Chapter 37 • Introduction of one of the newest business forms: the benefit corporation. Chapter 38 • New problem case, which deals with the possible creation of a partnership amid a pandemic. Chapter 39 • New case, Gelman v. Buehler, which demonstrates to students the importance of partnership agreements. Chapter 40 • New introduction problem, which examines the appropriateness for and tax implications of forming a limited liability company. • New in-depth discussion of the tax advantages of limited liability companies. • Removal of discussion of the now-outdated business form: the limited liability limited partnership. Chapter 41 • New text, which discusses benefit corporations and their growing importance, including a new chart comparing benefit corporations and certified “B corps.” • New case about scholarly critique of benefit corporations suggesting they may actually hurt socially conscious companies that are more traditionally organized. Chapter 42 • Revision of Ethics and Compliance in Action feature concerning offshore tax havens used by major U.S. companies.

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• New problem cases about the policy arguments for holding promoters liable for preincorporation contracts and the equity stakes taken in entrepreneurial ventures on the popular show Shark Tank. Chapter 43 • New text related to CEO compensation, including that of Tesla’s Elon Musk and Disney’s Bob Iger. • New text that highlights the duty-of-care obligations related to the oversight of legal compliance. • New case, In re Caremark Int’l Inc. Derivative Litig., which established the fiduciary obligation of board oversight of compliance and effectively created modern corporate compliance regimes. • Revised discussion of the foundations of corporate criminal liability and the costs of white-collar crime. • New problem case about a shareholder suit against Allergan, the company that makes Botox, and the theory of legal liability underlying fiduciary duty claims. Chapter 44 • New Ethics and Compliance in Action feature about the ethicality of share dissolution at Facebook. • New problem case regarding dividend distribution under the Model Business Corporation Act. Chapter 45 • New discussion of the Security and Exchange Commission’s powers, including implications of recent Supreme Court opinions Lucia v. SEC and Kokesh v. SEC. • New and revised text about Section 5 of the Securities Act of 1933, including Rules 163A, 135, 169, and the Jumpstart Our Business Startups (JOBS) Act. • Revision of the Concept Review concerning the communications issuers may provide to the public. • New text on “gun jumping” violations levied against Google and Salesforce. • Revisions to text on offering exemptions, including new text concerning Regulation A, Regulation Crowdfunding, and Rule 506, and deletion of text referring to the withdrawn Rule 595. • Revision of Ethics and Compliance in Action feature related to the trade-offs and criticisms of the JOBS Act. • Revision of the Concept Review regarding issuers’ exemptions from registration requirements. • New discussion of scienter and the Private Litigation Securities Reform Act. • Revision of text concerning insider trading, including a new discussion of classical and misappropriation theories, as well as tippee liability under Dirks v. SEC. • New case, SEC v. Dorozhko, which considered computer hacking as insider trading under the misappropriation theory. • New case note comparing United States v. Newman and United States v. Salman, which address the personal benefit test of tippee liability. • New problem case on whether Elon Musk violated securities laws based on his tweets.

• New problem case about insider trading prosecution of Mathew Martoma and SAC Capital Advisors. Chapter 46 • New discussion of Regulation Best Interest, including a summary chart of obligations of broker-dealers. • New case, United States v. Goyal, which concerned the evidence used to convict a former CFO for securities fraud violations under Section 10(b) of the 1934 Act. • New problem case about whether the suit against a seller of high-performance liquid chromatography systems met the pleading standards for scienter and materiality under the securities laws. Chapter 47 • Revision to discussion of Federal Communications Commission action about network neutrality regulation. Chapter 48 • Revision to discussion of the recent actions taken by the FTC to regulate deceptive practices. • Revision to discussion of the Truth in Lending Act. • New discussion of the Economic Growth, Regulatory Relief, and Consumer Protection Act (Economic Growth Act) and its impact on the Fair Credit Reporting Act. Chapter 49 • New case box about United States v. Apple, Inc., in which Apple was held responsible for violating the Sherman Act when it conspired among major book publishers to raise the retail prices of ebooks. • New Ethics and Compliance in Action feature that discusses how antitrust laws may hinder socially responsible business practices. Chapter 50 • New Ethics and Compliance in Action feature about consolidation among big tech firms such as Facebook and Instagram. Chapter 51 • New case concerning workers’ compensation, American Greetings Corp. v. Bunch, in which an employee is injured during a work-related event but not while performing day-to-day work responsibilities. • Added discussion of emergency medical and family leave provisions of the Families First Coronavirus Response Act. • Revised discussion of collective bargaining and unionization to reflect recent Supreme Court cases, including Janus v. AFSCME and Epic Systems Corp. v. Lewis. • New discussion of the Equal Pay Act that includes consideration of the U.S. Women’s National Soccer Team’s pay discrimination claim against U.S. Soccer. • New case, Bostock v. Clayton County, in which the U.S. Supreme Court held that Title VII of the 1964 Civil Rights Act prohibition against discrimination in employment because of sex includes discrimination on the basis of sexual orientation and gender identity.

Preface

Chapter 52 • Revision of text to incorporate retrenchment by Trump administration of Environmental Protection Agency regulations to control greenhouse gasses associated with global climate change, including the Clean Power Plan and the automobile fuel economy standards adopted during the Obama administration.

Acknowledgments We would like to thank the many reviewers who have contributed their ideas and time to the development of this text. We express our sincere appreciation to the following: Wade Chumney, California State University–Northridge Amanda Foss, Modesto Junior College Richard Guertin, Orange County Community College Gwenda Bennett Hawk, Johnson County Community College Joseph Pugh, Immaculata University Kurt Saunders, California State University–Northridge Henry Lowenstein, Coastal Carolina University

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Dennis Wallace, University of New Mexico Melanie Stallings Williams, California State University–Northridge We also acknowledge the assistance and substantive c­ ontributions of Professor Sarah Jane Hughes of Indiana ­University’s Maurer School of Law and Professors Angela ­Aneiros (Chapter 25), Victor Bongard (Chapter 24), Shawna Eikenberry (Chapter 18), Goldburn Maynard (Chapter 26), and April Sellers (Chapters 3 and 51) of Indiana University’s Kelley School of Business. We further acknowledge the technical contributions of Elise Borouvka and the research assistance of Lin Ye, a student at the Maurer School. Jamie Darin Prenkert A. James Barnes Joshua E. Perry Todd Haugh Abbey R. Stemler

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A Guided Tour

A New Kind of Business Law The 18th Edition of Business Law continues to focus on global, ethical, and digital issues  affecting legal aspects of business. The new edition contains a number of new features as well as a revised supplements package. Please take a few moments to page through some of the highlights of this new edition.

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OPENING VIGNETTES Each chapter begins with an opening vignette that presents students with a mix of real-life and hypothetical situations and discussion questions. These stories provide a preview of issues addressed in the chapter and help to stimulate students’ interest in the chapter content.

CHAPTER 2

The Resolution of Private Disputes

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llnewsPublishingInc.,afirmwhoseprincipalofficesarelocatedinOrlando,Florida,ownsandpublishes 33 newspapers. These newspapers are published in 21 different states of the United States. Among the AllnewsnewspapersistheSnakebite Rattler,thelonenewspaperinthecityofSnakebite,NewMexico.The RattlerissoldinprintformonlyinNewMexico.However,manyofthearticlesinthenewspapercanbeviewedby anyonewithInternetaccess,regardlessofhisorhergeographiclocation,bygoingtotheAllnewswebsite. InarecentRattler edition,anarticleappearedbeneaththisheadline:“LocalBusinessExecutiveSuedforSexual Harassment.”Theaccompanyingarticle,writtenbyaRattlerreporter(anAllnewsemployee),statedthataperson namedPhilAndersonwasthedefendantinthesexualharassmentcase.Besidesbeingmarried,AndersonwasawellknownbusinesspersonintheSnakebitearea.HewasactiveinhischurchandincommunityaffairsinbothSnakebite (hiscityofprimaryhome)andPetoskey,Michigan(whereheandhiswifehaveasummerhome).Astockphotoof Anderson,whichhadbeenusedinconnectionwithpreviousRattlerstoriesmentioninghim,appearedalongsidethe storyaboutthesexualharassmentcase.Anderson,however,wasnotthedefendantinthatcase.Hewasnamedin theRattler storybecauseofanerrorbytheRattler reporter.Theactualdefendantinthesexualharassmentcasewas alocalbusinessexecutivewithasimilarname:PhilAnderer. AndersonplanstofileadefamationlawsuitagainstAllnewsbecauseoftheabove-describedfalsehoodintheRattler story.Heexpectstoseek$500,000indamagesforharmtohisreputationandforotherrelatedharms.InChapter6, youwilllearnaboutthesubstantivelegalissuesthatwillariseinAnderson’sdefamationcase.For now, however, the focus is on important legal matters of a procedural nature. ConsiderthefollowingquestionsregardingAnderson’scaseasyoureadthischapter: •Where,inageographicsense,mayAndersonproperlyfileandpursuehislawsuitagainstAllnews? •MustAndersonpursuehiscaseinastatecourt,ordoeshehavetheoptionoflitigatingitinfederalcourt? •AssumingthatAndersonfileshiscaseinastatecourt,whatstrategicoptionmayAllnewsexerciseifitacts promptly? •Intherun-uptoapossibletrialinthecase,whatlegalmechanismsmayAndersonutilizeinordertofindout,on apretrialbasis,whattheRattlerreporterandotherAllnewsemployeeswouldsayinpossibletestimonyattrial? IsAllnewsentitledtodothesamewithregardtoAnderson? •IfAnderson’scasegoestotrial,whattypesoftrialsarepossible? •Throughwhatlegalmechanismsmightacourtdecidethecasewithoutatrial? •Today,manylegaldisputesaredecidedthrougharbitrationratherthanthroughproceedingsincourt.Giventhe prevalenceofarbitrationthesedays,whyisn’tAnderson’scaseacandidateforarbitration?

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2-2

LO

Part One Foundations of American Law

pre3689X_ch02_001_032 2-1

LEARNING OBJECTIVES After studying this chapter, you should be able to: 2-1

Describethebasicstructuresofstatecourt systemsandthefederalcourtsystem. 2-2 Explainthedifferencebetweensubject-matter jurisdictionandinpersonamjurisdiction. 2-3 Identifythemajorlegalissuescourtsmust resolvewhendecidingwhetherinpersonam jurisdictionexistswithregardtoadefendantina civilcase. 2-4 Explainwhatisnecessaryinorderforafederal courttohavesubject-matterjurisdictionovera civilcase.

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BUSINESS LAW COURSES examine many substantive legal rules that tell us how to behave in business and in society.Examplesincludetheprinciplesofcontract,tort, andagencylaw,aswellasthoseofmanyotherlegalareas addressedlaterinthistext.Mostoftheseprinciplesareappliedbycourtsastheydecidecivilcasesinvolvingprivate parties.Thischapterlaysafoundationforthetext’sdiscussionofsubstantivelegalrulesbyexaminingthecourtsystemsoftheUnitedStatesandbyoutlininghowcivilcases proceedfrombeginningtoend.Thechapteralsoexplores

2-5 Identifythemajorstepsinacivillawsuit’s progressionfrombeginningtoend. 2-6 Describethedifferentformsofdiscovery availabletopartiesincivilcases. 2-7 Explainthedifferencesamongthemajorforms ofalternativedisputeresolution.

these courts, procedures may be informal, and parties oftenarguetheirowncaseswithoutrepresentationbyattorneys.Courtsoflimitedjurisdictionoftenarenotcourts ofrecord—meaningthattheymaynotkeepatranscriptof theproceedingsconducted.Appealsfromtheirdecisions therefore require a new trial (a trial de novo) in a trial court.

Trial Courts Courts of limited jurisdiction find the relevantfacts,identifytheappropriaterule(s)oflaw,and

LEARNING OBJECTIVES 09/11/2009:15PM

Active Learning Objectives open each chapter. LOs inform you of specific outcomes you should have after finishing the chapter. Icons reference each LO’s reference within the chapter.

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A Guided Tour 2-16

Part One Foundations of American Law

CYBERLAW IN ACTION In recent years, the widespread uses of e-mail and information presented and stored in electronic form have raised questions about whether, in civil litigation, an opposing party’s e-mails and electronic information are discoverable to the same extent as conventional written or printed documents. With the Federal Rules of Civil Procedure and comparable discovery rules applicable in state courts having been devised prior to the explosion in e-mail use and online activities, the rules’ references to “documents” contemplated traditional on-paper items. Courts, however, frequently interpreted “documents” broadly, so as to include e-mails and certain electronic communications within the scope of discoverable items. Even so, greater clarity regarding discoverability seemed warranted—especially as to electronic material that might be less readily classifiable than e-mails as “documents.” Various states responded by updating their discovery rules to include electronic communications within the list of discoverable items. So did the Federal Judicial Conference. In Federal Rules of Civil Procedure amendments proposed by the Judicial Conference and ratified by Congress in 2006, “electronically stored information” became a separate category of discoverable material. The electronically stored information (ESI) category is broad enough to include e-mails and similar communications as well as electronic business records, web pages, dynamic databases, and a host of other material existing in electronic form. So-called e-discovery has become a standard feature of civil litigation because of the obvious value of having access to the opposing party’s e-mails and other electronic communications. Discovery regarding ESI occurs in largely the same manner as discovery regarding conventional documents. The party seeking discovery of ESI serves a specific request for production on the other. The served party must provide the requested ESI if it is relevant, is not protected by a legal privilege (e.g., the attorney–client privilege), and is reasonably accessible. Court involvement becomes necessary only if the party from whom discovery is sought fails to comply or objects on lack of relevance, privilege, or burdensomeness grounds. The Federal Rules allow the party seeking discovery of ESI to specify the form in which the requested copies should appear (e.g., hard copies, electronic files, searchable CD, direct access to database, etc.). The party from whom discovery is sought may object to the specified form, in which event the court may have to resolve the dispute. If the requesting party does not specify a form, the other party must provide the requested electronic material in a form that is reasonably usable. The Federal Rules provide that if the requested electronic material is “not reasonably accessible because of undue burden or cost,” the party from whom discovery is sought need not provide it. When an objection along those lines is filed, the court decides whether the

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objection is valid in light of the particular facts and circumstances. For instance, if requested e-mails appear only on backup tapes and searching those tapes would require the expenditures of significant time, money, and effort, are the requested e-mails “not reasonably accessible because of undue burden or costs”? Perhaps, but perhaps not. The court will rule, based on the relevant situation. The court may deny the discovery request, uphold it, or condition the upholding of it on the requesting party’s covering part or all of the costs incurred by the other party in retrieving the ESI and making it available. When a party fails or refuses to comply with a legitimate discovery request and the party seeking discovery of ESI has to secure a court order compelling the release of it, the court may order the noncompliant party to pay the attorney fees incurred by the requesting party in seeking the court order. If a recalcitrant party disregards a court order compelling discovery, the court may assess attorney fees against that party and/or impose evidentiary or procedural sanctions such as barring that party from using certain evidence or from raising certain claims or defenses at trial. The discussion suggests that discovery requests regarding ESI may be extensive and broad-ranging, with logistical issues often attending those requests. In recognition of these realities, the Federal Rules seek to head off disputes by requiring the parties to civil litigation to meet, at least through their attorneys, soon after the case is filed. The meeting’s goal is development of a discovery plan that outlines the parties’ intentions regarding ESI discovery and sets forth an agreement on such matters as the form in which the requested ESI will be provided. If the parties cannot agree on certain ESI discovery issues, the court will become involved to resolve the Confirming Pages disputes. The discoverability of ESI makes it incumbent upon businesses to retain and preserve such material not only when litigation to which the material may be related has already been instituted, but also when potential litigation might reasonably be anticipated. Failure to preserve the electronic communications could give rise to allegations 2-18 Part One Foundations of American Law of evidence destruction and, potentially, sanctions imposed by a court. (For further discussion of related legal and ethical issues, see this chapter’s Ethics and Compliance in Action box.) Finally, given the now-standard requests of plaintiffs and defendants that the opposing party provide access to relevant Thebroadscopeofdiscoveryrightsinacivilcase to impose appropriate sanctionson thedocument-destroying e-mails, one should not forget this important piece of advice: Do willoftenentitleapartytoseekandobtaincopies party.Thesesanctionsmayincludesuchremediesascourtorof e-mails, records, memos, and other documents ders prohibiting the document-destroyer from raising certain not say anything in an e-mail that you would not say in a formal andelectronicallystoredinformationfromtheopposingpar- claims or defenses in the lawsuit, instructions to the jury rewritten memo or in a conversation with someone. There is a tooty’sfiles.Inmanycases,someofthemostfavorableevidence gardingthewrongfuldestructionofthedocuments,andcourt frequent tendency to think that because e-mails often tend to be fortheplaintiffwillhavecomefromthedefendant’sfiles,and ordersthatthedocument-destroyerpaycertainattorneyfeesto informal in nature, one is somehow free to say things in an e-mail vice versa. If your firm is, or is likely to be, a party to civil theopposingparty. that he or she would not say in another setting. Many individuals litigationandyouknowthatthefirm’sfilescontainmaterials Whataboutthetemptationtorefusetocooperateregardand companies have learned the hard way that comments made thatmaybedamagingtothefirminthelitigation,youmaybe inganopposingparty’slawfulrequestfordiscoveryregarding in their e-mails or those of their employees proved to be damning faced with the temptation to alter or destroy the potentially material in one’s possession? Although a refusal to cooperevidence against them in litigation and thus helped the opposing damagingitems.Thistemptationposesseriousethicaldilem- ate seems less blameworthy than destruction or alteration parties win the cases. mas.Isitmorallydefensibletochangethecontentofrecords ofdocuments,extremeinstancesofrecalcitranceduringthe

In keeping with today’s technological world, these boxes describe and discuss actual instances of how the Internet is affecting business law today.

ETHICS AND COMPLIANCE IN ACTION BOXES

Ethics and Compliance in Action

These boxes appear throughout the chapters and offer critical thinking questions and situations that relate to ethical/public policy concerns.

ordocumentsonanafter-the-factbasis,inordertolessenthe adverseeffectonyourfirminpendingorprobablelitigation? Isdocumentdestructionore-maildeletionethicallyjustifiable whenyouseektoprotectyourfirm’sinterestsinalawsuit? If the ethical concerns are not sufficient by themselves to make you leery of involvement in document alteration or destruction, consider the potential legal consequences for yourConfirming Pages selfandyourfirm.Themuch-publicizedcollapseoftheEnron Corporationin2001ledtoconsiderablescrutinyoftheactions oftheArthurAndersenfirm,whichhadprovidedauditingand consultingservicestoEnron.AnAndersenpartner,DavidDuncan,pleadedguiltytoacriminalobstructionofjusticecharge pre3689X_ch02_001_032 2-16 09/11/2009:15PM thataccusedhimofhavingdestroyed,orhavinginstructedAndersenemployeestodestroy,certainEnron-relatedrecordsin 1-28 Part One Foundations of American Law ordertothwartaSecuritiesandExchangeCommission(SEC) investigation of Andersen. The U.S. Justice Department also between real parties with tangible opposing interests in eventhoughtheircontroversyhasnotadvancedtothelaunchedanobstructionofjusticeprosecutionagainstAnderthe lawsuit. Courts generally do not issue advisory opinpointwhereharmhasoccurredandlegalreliefmaybesen on the theory that the firm altered or destroyed records ions on abstract legal questions unrelated to a genuine necessary. This enables them to determine their legalpertaining to Enron in order to impede the SEC investigation. A jury found Andersen guilty of obstruction of justice. dispute,anddonotdecidefeigned controversiesthatparposition without taking action that could expose themAlthoughtheAndersenconvictionwaslateroverturnedbythe ties concoct to seek answers to such questions. Courts toliability.Forexample,ifDarlenebelievesthatsome- U.S.SupremeCourtbecausethetrialjudge’sinstructionstothe mayalsorefusetodecidecasesthatareinsufficientlyripe thingsheplanstodowouldnotviolateEarl’scopyrightjuryonrelevantprinciplesoflawhadbeenimpermissiblyvague to have matured into a genuine controversy, or that are onaworkofauthorshipbutsherecognizesthathemayregardingthecriticalissueofcriminalintent,adevastatingefmoot because there no longer is a real dispute between take a contrary view, she may seek a declaratory judg- fectonthefirmhadalreadytakenplace. the parties. Reflecting similar policies is the doctrine of ment on the question rather than risk Earl’s lawsuit Ofcourse,notallinstancesofdocumentalterationordestanding to sue,whichnormallyrequiresthattheplaintiff by proceeding to do what she had planned. Usually, astructionwillleadtocriminalprosecutionforobstructionof have some direct, tangible, and substantial stake in the declaratoryjudgmentisawardedonlywhentheparties’justice. Other consequences of a noncriminal but clearly severe nature may result, however, from document destruction outcomeofthelitigation. disputeissufficientlyadvancedtoconstitutearealcase thatinterfereswithlegitimatediscoveryrequestsinacivilcase. Stateandfederaldeclaratory judgmentstatutes,howorcontroversy. In such instances, courts have broad discretionary authority

ever, allow parties to determine their rights and duties

THE GLOBAL BUSINESS ENVIRONMENT BOXES

witnesses or to certain evidence that has been offered for admission.Thetrialjudgeutilizesthelegalrulesofevidence todeterminewhethertosustaintheobjection(meaningthat Just as statutes may require judicial interpreta- distress,whereuponhiswifeandadoctorwhowasonboardtheobjected-toquestioncannotbeansweredbythewitness tion when a dispute arises, so may treaties. The gave him shots of epinephrine from an emergency kit thatorthattheofferedevidencewillbedisallowed)or,instead,

The Global Business Environment

techniques that courts use in interpreting treaties correspond closely to the statutory interpretation techniques discussedinthischapter.Olympic Airways v. Husain,540U.S. 644(2004),furnishesausefulexample. In Olympic Airways, the U.S. Supreme Court was faced withaninterpretationquestionregardingatreaty,theWarsaw Convention,whichdealswithairlines’liabilityforpassenger deathsorinjuriesoninternationalflights.Numerousnations (including the United States) subscribe to the Warsaw Convention, a key provision of which provides that in regard to international flights, the airline “shall be liable for damages sustainedintheeventofthedeathorwoundingofapassengeroranyotherbodilyinjurysufferedbyapassenger,ifthe accidentwhichcausedthedamagesosustainedtookplaceon board the aircraft or in the course of any of the operations ofembarkingordisembarking.”Aseparateprovisionimposes limitsontheamountofmoneydamagestowhichaliableairlinemaybesubjected. The Olympic Airways case centered around the death of Dr. Abid Hanson, a severe asthmatic, on an international flight operated by Olympic. Smoking was permitted on the flight. Hanson was given a seat in the nonsmoking section, buthisseatwasonlythreerowsinfrontofthesmokingsection.BecauseHansonwasextremelysensitivetosecondhand smoke, he and his wife, Rubina Husain, requested various timesthathebeallowed,forhealthreasons,tomovetoaseat fartherawayfromthesmokingsection.Eachtime,therequest was denied by an Olympic flight attendant. When smoke from the smoking section began to give Hanson difficulty, he used a new inhaler and walked toward the front of the planetogetsomefresherair.Hansonwentintorespiratory

discovery process may cause a party to experience adverse consequences similar to those imposed on parties who destroy or alter documents. Litigation involving Ronald Perelman and the Morgan Stanley firm provides an illustration. Perelman had sued Morgan Stanley on the theory that the investmentbankparticipatedwithSunbeamCorp.inafraudulent scheme that supposedly induced him to sell Sunbeam hisstakeinanotherfirminreturnforSunbeamshareswhose value plummeted when Sunbeam collapsed. During the discovery phase of the case, Perelman had sought certain potentiallyrelevante-mailsfromMorganStanley’sfiles.Morgan Stanley repeatedly failed and refused to provide this discoverable material and, in the process, ignored court orders to providethee-mails. Eventually, a fed-up trial judge decided to impose sanctions for Morgan Stanley’s wrongful conduct during the discoveryprocess.ThejudgeorderedthatPerelman’scontentionswouldbepresumedtobecorrectandthattheburden of proof would be shifted to Morgan Stanley so that Morgan Stanley would have to disprove Perelman’s allegations. Inaddition,thetrialjudgeprohibitedMorganStanleyfrom contesting certain allegations made by Perelman. The jury laterreturnedaverdictinfavorofPerelmanandagainstMorganStanleyfor$604millionincompensatorydamagesand $850millioninpunitivedamages.ThecourtorderssanctioningMorganStanleyforitsdiscoverymisconductundoubtedly playedakeyroleinPerelman’svictory,effectivelyturninga case that was not a sure-fire winner for Perelman into just that.Thecaseillustratesthatapartytolitigationmaybeplayingwithfireifhe,she,oritinsistsonrefusingtocomplywith legitimatediscoveryrequests.

Hansoncarried.AlthoughthedoctoradministeredCPRand oxygen when Hanson collapsed, Hanson died. Husain, acting as personal representative of her late husband’s estate, suedOlympicinfederalcourtonthetheorythattheWarsaw Convention made Olympic liable for Hanson’s death. The federaldistrictcourtandthecourtofappealsruledinfavor ofHusain. InconsideringOlympic’sappeal,theU.S.SupremeCourt pre3689X_ch02_001_032 2-18 noted that the key issue was one of treaty interpretation: whethertheflightattendant’srefusalstoreseatHansonconstituted an “accident which caused” the death of Hanson. NotingthattheWarsawConventionitselfdidnotdefine“accident” and that different dictionary definitions of “accident” exist,theCourtlookedtoaprecedentcase,Air France v. Saks, 470 U.S. 392 (1985), for guidance. In the Air France case, theCourtheldthattheterm“accident”intheWarsawConventionmeans“anunexpectedorunusualeventorhappening thatisexternaltothepassenger.”Applyingthatdefinitionto the facts at hand, the Court concluded in Olympic Airways thattherepeatedrefusalstoreseatHansondespitehishealth concernsamountedtounexpectedandunusualbehaviorfora flightattendant.Althoughtherefusalswerenotthesolereason why Hanson died (the smoke itself being a key factor), therefusalswerenonethelessasignificantlinkinthecausation chain that led to Hanson’s death. Given the definition of “accident” in the Court’s earlier precedent, the phrasing, the Warsaw Convention, and the underlying public policies supportingit,theCourtconcludedthattherefusalstoreseat Hanson constituted an “accident” covered by the Warsaw Convention.Therefore,theCourtaffirmedthedecisionofthe lowercourts.

overruleit(meaningthatthequestionmaybeansweredor thattheofferedevidencewillbeallowed). Thewitnessesthatplaintiffsanddefendantscalltotestifyattrialmayincludethosewhocantestifyastorelevant factsofwhichtheyhavepersonalknowledge(oftencalled

Because global issues affect people in many different aspects of business, this material appears throughout the text instead of in a separate chapter on international issues. This feature brings to life global issues that are affecting business law. 09/11/2009:15PM

AccordingtothelegalrealistsdiscussedinChapter1,written “book law” is less important than what public decisionmakersactually do.Usingthisapproach,wediscover a Constitution that differs from the written Constitution xii A Guided Tour justdescribed.Theactualpowersoftoday’spresidency,for instance,exceedanythingonewouldexpectfromreading LOG ON BOXES ArticleII.Asyouwillsee,moreover,someconstitutional provisions have acquired a meaning different from their These appear throughout the chapters and direct students, meaningwhenfirstenacted.Americanconstitutionallaw where appropriate, tohasevolvedratherthanbeingstatic. relevant websites that will give them more information aboutManyofthesechangesresultfromthewayonepublic each featured topic. Many of these decision nine-member U.S. Supreme Court— are key legal sites that may bemaker—the used repeatedly by business law has interpreted the Constitution over time. Formal constudents and business professionals alike. stitutional change can be accomplished only through the amendmentprocess.Becausethisprocessisdifficulttoemploy,however,amendmentstotheConstitutionhavebeen relatively infrequent. As a practical matter, the Supreme Court has become the Constitution’s main “amender” through its many interpretations of constitutional First Pages provisions. Various factors help explain the Supreme Court’s ability and willingness to play this role. Because of their vagueness, some key constitutional provisions invite di3-22 Part One Foundations of American Law verseinterpretations.“Dueprocessoflaw”and“equalprotectionofthelaws”areexamples.Inaddition,thehistory CONCEPT REVIEW surrounding the enactment of constitutional provisions The First Amendment sometimesissketchy,confused,orcontradictory. Under the power of judicial review, courts can deLevelofFirstAmendment ConsequencesWhenGovernmentRegulates TypeofSpeech Protection ContentofSpeech clare the actions of other government bodies unconstiNoncommercial Full tutional. HowGovernmentactionisconstitutionalonlyifactionisnecessaryto courts exercise this power depends on fulfillmentofcompellinggovernmentpurpose.Otherwise,governmentactionviolatesFirstAmendment. how they choose to read the Constitution. Courts thus Commercial(nonmisleading Intermediate have politicalGovernmentactionisconstitutionalifgovernmenthassubstanpower—a conclusion especially applicable and about lawful activity) tialunderlyinginterest,actiondirectlyadvancesthatinterest,and actionisnomoreextensivethannecessarytofulfillmentofthat totheSupremeCourt.Indeed,theSupremeCourt’sjusinterest(i.e.,actionisnarrowlytailored). ticesare,toaconsiderableextent,publicpolicymakers. Commercial(misleading None Governmentactionisconstitutional. or about unlawful activity) Theirbeliefsareimportantinthedeterminationofhow the United States is governed. This is why the justices’ to enhance First Amendment protection for commercial speech),ithadnotmadeformaldoctrinalchangesasofthe timethisbookwenttopress. Matal v. Tam, which appears later in the chapter, addresses the four-part test utilized in determining the constitutionalityofcommercialspeechrestrictions,and illustrates the rigor with which the Supreme Court has applied the third and fourth parts of the test in recent years.

Court,reasoned,thegovernmentspeechdoctrineapplied and shielded the program against a First Amendment– basedchallengebyanassociationthatdidnotwanttoparticipateinthegovernment-createdprogram.Morerecently, in Walker v. Texas Division, Sons of Confederate Veterans, Inc., 576 U.S. 200 (2015), the Supreme Court held that theFirstAmendmentwasnotviolated—andthatthegovFigure 2.1 The Thirteen ernmentspeechdoctrineapplied—whentheStateofTexas rejectedagroup’srequestforaspecialtylicenseplateconFirst Circuit (Boston, sistingofanimageoftheConfederatebattleflag.IndecidMass.) Maine, pre3689X_ch03_001-044.indd 3-3 The Government Speech Doctrine Previous discusingthatthegovernmentspeechdoctrineapplied,theCourt Massachusetts, New Hampshire, Puerto Rico, sionhasrevealedthatwhenthegovernmentrestrictsthe stressedthegovernment’shistoricuseoflicenseplatesto Rhode Island contentofprivateparties’speech,aFirstAmendmentvioconvey messages and the supervisory control maintained lationislikelytohaveoccurred.Butwhenthegovernment by the government in running the specialty license plate itself speaks, it is free to convey its preferred viewpoints program. Figure 3.3, which appears later in the chapter, Fifth Circuit (New and to reject contrary views that private parties wish to exploresrecentrequirementstoincludegraphicwarnings Orleans, La.) Louisiana, express.Suchisthepremiseoftherecentlydeveloped,and ontobaccoproducts. Mississippi, TexasCourt stillnotpreciselydefined,government speech doctrine.  In Matal v. Tam, which follows, the Supreme Whether government speech is present depends struckdown,onFirstAmendmentgrounds,aprovisionin largely upon the extent to which the government crafted federallawthatallowedthegovernmenttorefusetoregisConfirming Pages the conveyed messages or supervised, through heavy teratrademarkthatisdisparagingtoindividualsorgroups. involvement, the communication of the messages. In (TrademarkregistrationisaddressedinChapter8.DiscusNinth Circuit (San Francisco, Johanns v. Livestock Marketing Association, 544 U.S. 550 sion of Tam also appears there.) In so ruling, Court Calif.) Alaska,the Arizona, (2005),forinstance,theSupremeCourtupheldafederal rejected the government’s attemptCalifornia, to invoke Guam, the governHawaii, Idaho, Montana, Nevada, statute that set up a program of paid advertisements dementspeechdoctrineandremindedreadersthattheFirst Northern Mariana Islands, signedtopromotetheimageandsaleofbeefproducts.The Amendmentprotectsagreatdealofspeechthatisoffen2-4 Part One Foundations of American Law Oregon, Washington Court emphasized that the U.S. Department of Agriculsiveinnature.Tamalsoexploresanissuenotedearlierin turedesignedtheprogram,establisheditscontours,andexthechapter:theproblematicnature,forFirstAmendment ercisedclosesupervisoryauthorityoverthemessagesthat purposes,oflawsthatdiscriminateamongspeakersonthe Abdouch v. Lopez   829 N.W.2d 662 (Neb. 2013) werecommunicatedintheadvertisements.Therefore,the basisoftheviewpointstheyexpress.

FIGURES

The figures appear occasionally in certain chapters. These features typically furnish further detail on special issues introduced more generally elsewhere in the text.

Helen Abdouch, an Omaha, Nebraska, resident, served as executive secretary of the Nebraska presidential campaign of John F. Kennedy in 1960. Ken Lopez, a Massachusetts resident, and his Massachusetts-based company, Ken Lopez Bookseller (KLB), are engaged in the rare book business. In 1963, Abdouch received a copy of a book titled RevolutionaryRoad. Its author, Richard Yates, inscribed the copy with a note to Abdouch. The inscribed copy was later stolen from Abdouch. In 2009, Lopez and KLB bought the inscribed copy from a seller in Georgia. They sold it that same year to a customer from a state other than Nebraska. In 2011, Abdouch learned that Lopez had used the inscription and references to her in an advertisement on KLB’s website. The advertisement, which appeared on the pre3689X_ch03_001-044.indd 3-22 10/27/2004:25PM website for more than three years after Lopez and KLB sold the inscribed copy, contained a picture of the inscription, the word “SOLD,” and this statement:

putpoliticalconstraintsonjudgesbecausecourtsdepend on the other branches of government—and ultimately on publicbeliefinjudges’fidelitytotheruleoflaw—tomake theirdecisionseffective.Therefore,judgessometimesmay be reluctant to declare statutes unconstitutional because theyarewaryofpowerstruggleswithamorerepresentativebodysuchasCongress.

LOG ON For a great deal of information about the U.S. Supreme Court and access to the Court’s opinions in recent cases, see the Court’s website at http://www.supremecourtus.gov.

The Coverage and Structure of This Chapter Thischapterexaminescertainconstitutionalprovisionsthat areimportanttobusiness;itdoesnotdiscussconstitutional lawinitsentirety.Theseprovisionshelpdefinefederaland statepowertoregulatetheeconomy.TheU.S.Constitution limits government regulatory power in two general ways. First, it restricts federal legislative authority by listing the CONCEPT REVIEWS powersCongresscanexercise.TheseareknownastheenuThese boxes visually represent important concepts merated powers.Federallegislationcannotbeconstitutional presented in the text to help summarize key ideas at ifitisnotbasedonapowerspecificallystatedintheConstiatution.Second,theU.S.Constitutionlimitsbothstate glance and simplify students’ conceptualization ofand federalpowerbyplacingcertainindependent checksinthe complicated issues. path of each. In effect, the independent checks establish thatevenifCongresshasanenumeratedpowertolegislate onaparticularmatterorastateconstitutionauthorizesa statetotakecertainactions,therestillarecertainprotected spheresintowhichneitherthefederalgovernmentnorthe Confirming Pages stategovernmentmayreach.

Chapter Two The Resolution of Private Disputes

Federal Judicial Circuits Second Circuit (New York, N.Y.) Connecticut, New York, Vermont

Third Circuit (Philadelphia, Pa.) Delaware, New Jersey, Pennsylvania, Virgin Islands

Fourth Circuit (Richmond, Va.) Maryland, North 10/27/2004:25PM Carolina, South Carolina, Virginia, West Virginia

Sixth Circuit (Cincinnati, Ohio) Kentucky, Michigan, Ohio, Tennessee

Seventh Circuit (Chicago, Ill.) Illinois, Indiana, Wisconsin

Eighth Circuit (St. Louis, Mo.) Arkansas, Iowa, Minnesota, Missouri, Nebraska, North Dakota, South Dakota

Tenth Circuit (Denver, Colo.) Colorado, Kansas, New Mexico, Oklahoma, Utah, Wyoming

Eleventh Circuit (Atlanta, Ga.) Alabama, Florida, Georgia

District of Columbia Circuit (Washington, D.C.)

CASES

Federal Circuit (Washington, D.C.)

The cases in each chapter help to provide concrete examples of the rules stated in the text. A list of cases appears at the front of the text.

controversies between the United States and a state; and

This copy is inscribed by Yates: ‘For Helen Abdouch—with admiration and best wishes. Dick Yates. 8/19/63.’ Yates had worked as a casesinwhichastateproceedsagainstcitizensofanother speech writer for Robert Kennedy when Kennedy served as Attorney General; Abdouch was the executivestateoragainstaliens. secretary of the Nebraska (John F.) Kennedy organization when Robert Kennedy was campaign manager. . . . A scarce book, and it is extremely uncommon to find this advance issue of it signed. Given the date of the inscription—that is, during JFK’s Presidency—and the connection between writer and recipient, it’s reasonable to suppose this was an author’s copy, presented to Abdouch by Yates.

Civil Procedure

Because Lopez and KLB did not obtain her permission before mentioning her and using the inscription in the advertisement, AbIdentify the major douch filed an invasion-of-privacy lawsuit against Lopez and KLB in a Nebraska state district court. Contending that the Nebraska court steps in a civil lawsuit’s progression LO2-5 lacked in personam jurisdiction, Lopez and KLB filed a motion to dismiss the case. The state district court grantedfrom the motion. Abdouch beginning to end. then appealed to the Supreme Court of Nebraska. (Further facts bearing upon the in personam jurisdiction issue appear in the following edited version of the Supreme Court’s opinion.)

McCormack, Judge Abdoucharguesthatthedistrictcourterredinfindingthatthe Statelackedinpersonamjurisdiction[,oftenreferredtohereas personal jurisdiction,]overLopezandKLB.Abdoucharguesthat [thedefendants’]activewebsitedeliberatelytargetedherwithtortiousconduct.Sheallegesthesecontactsaresufficienttocreate thenecessaryminimumcontactsforspecificjurisdiction. Personaljurisdictionisthepowerofatribunaltosubjectand

2-13

Civil procedure is the set of legal rules establishing how a civil lawsuit proceeds from beginning to end.5 Because

minimumcontactswiththeforumstatesoasnottooffendtracivil procedure sometimes varies with the jurisdiction in ditional notions of fair play and substantial justice. [See Interquestion,6thefollowingpresentationsummarizesthemost national Shoe Co. v. Washington,326U.S.310,316(1945).]The benchmark...iswhetherthedefendant’sminimumcontactswith widelyacceptedrulesgoverningcivilcasesinstateandfedthe forum state are such that theeralcourts.Knowledgeofthesebasicproceduralmatters defendant should reasonably anticipate being haled into court there. Whether a forum state willbeusefulifyoubecomeinvolvedinacivillawsuitand court has personal jurisdiction over a nonresident defendant willhelpyouunderstandthecasesinthistext. depends on whether the defendant’s actions created substantial

positionsbeforeajudgeandpossiblyajury.Towinacivil case,theplaintiffmustproveeachelementofhis,her,orits claimbyapreponderance of the evidence.7Thisstandardof proofrequirestheplaintifftoshowthatthegreaterweight oftheevidence—bycredibility,notquantity—supportsthe existence of each element. In other words, the plaintiff must convince the fact-finder that the existence of each element is more probable than its nonexistence. The attorneyforeachpartypresentshisorherclient’sversion ofthefacts,triestoconvincethejudgeorjurythatthis versionistrue,andattemptstorebutconflictingfactual allegations by the other party. Each attorney also seeks topersuadethecourtthathisorherreadingofthelaw iscorrect.

Service of the Summons A summons notifies the defendant that he, she, or it is being sued. The summons typically names the plaintiff and states the time

Confirming Pages



PROBLEMS AND PROBLEM CASES Problem cases appear at the end of each chapter for student review and discussion.

KEY TERMS Key terms are in color and bolded throughout the important terminology.

A Guided Tour

xiii Chapter Two The Resolution of Private Disputes

2-29

Problems and Problem Cases

residentsAnneandJimCornelsen.WhenAnneCornelson telephoned the Bomblisses and said she was readytoselltwolittersofTibetanmastiffpuppies,Ron Bomblissexpressedinterestinpurchasingtwofemales ofbreedingquality.TheCornelsenshadawebsitethat allowedcommunicationsregardingdogsavailablefor purchasebutdidnotpermitactualsalesviathewebsite.TheBomblissestraveledtoOklahomatoseethe Cornelsens’puppiesandendeduppurchasingtwoof them. The Cornelsens provided a guarantee that the puppies were suitable for breeding purposes. Followingthesale,theCornelsensmailed,totheBomblisses’ home in Illinois, American Kennel Club registration papersforthepuppies.Aroundthissametime,Anne CornelsenpostedcommentsinanInternetchatroom frequented by persons interested in Tibetan mastiffs. Thesecommentssuggestedthatthemotherofcertain Tibetanmastiffpuppies(includingonetheBomblisses hadpurchased)mayhavehadageneticdisorder.The comments were made in the context of an apparent dispute between the Cornelsens and Richard Eich2. Alex Ferrer, a former judge who appeared as “Judge horn,whoownedthemothermastiffandhadmadeit Alex” on a television program, entered into a conavailabletotheCornelsensforbreedingpurposes.The tractwithArnoldPreston,aCaliforniaattorneywho Bomblisses believed that the comments would have renderedservicestopersonsintheentertainmentinbeen seen by other persons in Illinois and elsewhere dustry.Seekingfeesallegedlydueunderthecontract, andwouldhaveimpairedtheBomblisses’abilitytosell Preston invoked the clause setting forth the parties’ theirpuppieseventhough,whentested,theirpuppies agreementtoarbitrate“anydispute... relatingtothe werehealthy.TheBomblissesthereforesuedtheCorterms of [the contract] or the breach, validity, or lenelsensinanIllinoiscourtonvariouslegaltheories. galitythereof... inaccordancewiththerules[ofthe TheCornelsensaskedtheIllinoiscourttodismissthe AmericanArbitrationAssociation].”Ferrercountered caseonthegroundthatthecourtlackedinpersonam Preston’s demand for arbitration by filing, with the jurisdiction over them. Did the Illinois court lack in CaliforniaLaborCommissioner,apetitioninwhichhe personamjurisdiction? contendedthatthecontractwasunenforceableunder the California Talent Agencies Act (CTAA) because 4. HallStreetAssociateswasthelandlordandMattelInc. Preston supposedly acted as a talent agent without wasthetenantundervariousleasesforpropertythat thelicenserequiredbytheCTAA.Inaddition,Ferrer Mattel used as a manufacturing site for many years. suedPrestoninaCaliforniacourt,seekingadeclaraTheleasesprovidedthatthetenantwouldindemnify tionthatthedisputebetweenthepartiesregardingthe thelandlordforanycostsresultingfromthetenant’s contractanditsvaliditywasnotsubjecttoarbitration. failure to follow environmental laws while using the Ferrer also sought an injunction restraining Preston premises. Tests of the property’s well water in 1998 fromproceedingbeforethearbitratorunlessanduntil showedhighlevelsoftrichloroethylene(TCE),theaptheLaborCommissionerconcludedthatshedidnot parentresidueofmanufacturingdischargesconnected haveauthoritytoruleontheparties’dispute.Preston withMattel’soperationsonthesitebetween1951and respondedbymovingtocompelarbitration,inreliance 1980. After the Oregon Department of Environmentext ontheFederalArbitrationAct.TheCaliforniacourt and defined in the Glossary at the end oftalthe text(DEQ) for discovered better comprehension Quality even more pollutants, of deniedPreston’smotiontocompelarbitrationandisMattel signed a consent order with the DEQ providsued the injunction sought by Ferrer. Was the court ing for cleanup of the site. After Mattel gave notice correctindoingso? of intent to terminate the lease in 2001, Hall Street sued, contesting Mattel’s right to vacate on the date 3. Dog-breedersRonandCatherineBomblisslivedinIlitgaveandclaimingthattheleasesobligedMattelto linois. They bred Tibetan mastiffs, as did Oklahoma 1. VictoriaWilson,aresidentofIllinois,wishestobring an invasion of privacy lawsuit against XYZ Co. because XYZ used a photograph of her, without her consent, in an advertisement for one of the company’s products. Wilson will seek money damages of $150,000 from XYZ, whose principal offices are locatedinNewJersey.ANewJerseynewspaperwas the only print media outlet in which the advertisement was published. However, XYZ also placed the advertisementonthefirm’swebsite.Thiswebsitemay beviewedbyanyonewithInternetaccess,regardless oftheviewer’sgeographiclocation.Where,inageographic sense, may Wilson properly file and pursue her lawsuit against XYZ? Must Wilson pursue her caseinastatecourt,ordoesshehavetheoptionof litigatinginfederalcourt?AssumingthatWilsonfiles hercaseinstatecourt,whatstrategicoptionmayXYZ exerciseifitactspromptly?

pre3689X_ch02_001_032 2-29

09/11/2009:15PM

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BUSINESS LAW APPLICATIONBASED ACTIVITIES (ABAS) Application-based activities for business law provide students valuable practice using problem-solving skills to apply their knowledge to realistic scenarios. Students progress from understanding basic concepts to using their knowledge to analyze complex scenarios and solve problems. Applicationbased activities have been developed for the topics most often taught (as ranked by instructors) in the business law course. These unique activities are assignable and auto-gradable in Connect.

REMOTE PROCTORING & BROWSER-LOCKING CAPABILITIES

New remote proctoring and browser-locking capabilities, hosted by Proctorio within Connect, provide control of the assessment environment by enabling security options and verifying the identity of the student. Seamlessly integrated within Connect, these services allow instructors to control students’ assessment experience by restricting browser activity, recording students’ activity, and verifying students are doing their own work. xiv

Instant and detailed reporting gives instructors an at-a-glance view of potential academic integrity concerns, thereby avoiding personal bias and supporting evidence-based claims.

TEST BUILDER Available within Connect, Test Builder is a cloud-based tool that enables instructors to format tests that can be printed or administered within an LMS. Test Builder offers a modern, streamlined interface for easy content configuration that matches course needs, without requiring a download. Test Builder allows you to: • Access all test bank content from a particular title. • Easily pinpoint the most relevant content through robust filtering options. • Manipulate the order of questions or scramble questions and/ or answers. • Pin questions to a specific location within a test. • Determine your preferred treatment of algorithmic questions. • Choose the layout and spacing. • Add instructions and configure default settings. Test Builder provides a secure interface for better protection of content and allows for just-in-time updates to flow directly into assessments.

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Features

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TEST BANK AND QUIZZES The test bank consists of true-false, multiple-choice, and short essay questions in each chapter. Questions adapted from previous CPA exams are also included and highlighted to help Accounting students review for the exam. Instructors can test students using the quiz questions divided by chapter.

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BUSINESS LAW CASE REPOSITORY Available in Connect, the Case Repository is a collection of cases from current and previous editions. 

INTERACTIVE APPLICATIONS Assignable in Connect, interactive applications offer a variety of automatically graded exercises that require students to apply key concepts. These applications provide instant feedback and progress tracking for students and detailed results for the instructor.

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INSTRUCTOR’S MANUAL A package of supplementary materials is included in the instructor’s manual.

Assurance of Learning Many educational institutions today are focused on the notion of assurance of learning, an important element of some

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Brief Contents Brief Contents

Preface v

Part 1 Foundations of American Law The Nature of Law 1-3 The Resolution of Private Disputes 2-1 Business and the Constitution 3-1 Business Ethics, Corporate Social Responsibility, Corporate Governance, and Critical Thinking 4-1

1 2 3 4

Part 2 Crimes and Torts Criminal Law and Procedure 5-3 Intentional Torts 6-1 Negligence and Strict Liability 7-1 Intellectual Property and Unfair Competition 8-1

5 6 7 8

Part 3 Contracts 9 10 11 12 13 14 15 16 17 18

Introduction to Contracts 9-3 The Agreement: Offer 10-1 The Agreement: Acceptance 11-1 Consideration 12-1 Reality of Consent 13-1 Capacity to Contract 14-1 Illegality 15-1 Writing 16-1 Rights of Third Parties 17-1 Performance and Remedies 18-1

Part 4 Sales 19 20 21 22

Formation and Terms of Sales Contracts 19-3 Product Liability 20-1 Performance of Sales Contracts 21-1 Remedies for Breach of Sales Contracts 22-1

Part 5 Property 23 24 25 26 27

Personal Property and Bailments 23-3 Real Property 24-1 Landlord and Tenant 25-1 Estates and Trusts 26-1 Insurance Law 27-1

Part 6 Credit 28 Introduction to Credit and Secured Transactions 28-3 29 Security Interests in Personal Property 29-1 30 Bankruptcy 30-1

Part 7 Commercial Paper 31 Negotiable Instruments 31-3 xx

32 Negotiation and Holder in Due Course 32-1 33 Liability of Parties 33-1 34 Checks and Electronic Transfers 34-1

Part 8 Agency Law 35 The Agency Relationship 35-3 36 Third-Party Relations of the Principal and the Agent 36-1

Part 9 Partnerships 37 Introduction to Forms of Business and Formation of Partnerships 37-3 38 Operation of Partnerships and Related Forms 38-1 39 Partners’ Dissociation and Partnerships’ Dissolution and Winding Up 39-1 40 Limited Liability Companies and Limited Partnerships 40-1

Part 10 Corporations 41 History and Nature of Corporations 41-3 42 Organization and Financial Structure of Corporations 42-1 43 Management of Corporations 43-1 44 Shareholders’ Rights and Liabilities 44-1 45 Securities Regulation 45-1 46 Legal and Professional Responsibilities of  Auditors, Consultants, and Securities Professionals 46-1

Part 11 Regulation of Business 47 Administrative Law 47-3 48 The Federal Trade Commission Act and Consumer Protection Laws 48-1 49 Antitrust: The Sherman Act 49-1 50 The Clayton Act, the Robinson–Patman Act, and Antitrust Exemptions and Immunities 50-1 51 Employment Law 51-1 52 Environmental Regulation 52-1 Glossary G-1 Appendix A The Constitution of the United States of America A-1 Appendix B Uniform Commercial Code B-1 Index I-1

Contents Contents

1

Alternative Dispute Resolution 2-24 Common Forms of ADR 2-24 Other ADR Devices 2-28

Preface v

Part 1 Foundations of American Law 1

The Nature of Law 1-3

3

An Overview of the U.S. Constitution 3-2 The Evolution of the Constitution and the Role of the Supreme Court 3-3 The Coverage and Structure of This Chapter 3-3 State and Federal Power to Regulate 3-4 State Regulatory Power 3-4 Federal Regulatory Power 3-4 Burden on, or Discrimination against, Interstate Commerce 3-13 Independent Checks on the Federal Government and the States 3-13 Incorporation 3-13 Government Action 3-14 Means-Ends Tests 3-14 Business and the First Amendment 3-15 Due Process 3-27 Equal Protection 3-28 Independent Checks Applying Only to the States 3-37 The Contract Clause 3-37 Federal Preemption 3-38 The Takings Clause 3-39

Types and Classifications of Law 1-4 The Types of Law 1-4 Priority Rules 1-8 Classifications of Law 1-10 Jurisprudence 1-10 Legal Positivism 1-11 Natural Law 1-11 American Legal Realism 1-11 Sociological Jurisprudence 1-12 Other Schools of Jurisprudence 1-12 The Functions of Law  1-13 Legal Reasoning 1-13 Case Law Reasoning 1-14 Statutory Interpretation 1-18 Limits on the Power of Courts 1-27 APPENDIX  Reading and Briefing Cases 1-29

2

The Resolution of Private Disputes 2-1 State Courts and Their Jurisdiction 2-2 Courts of Limited Jurisdiction 2-2 Trial Courts 2-2 Appellate Courts 2-3 Jurisdiction and Venue 2-3 Federal Courts and Their Jurisdiction 2-9 Federal District Courts 2-9 Specialized Federal Courts 2-12 Federal Courts of Appeals 2-12 The U.S. Supreme Court 2-12 Civil Procedure 2-13 Service of the Summons 2-13 The Pleadings 2-14 Motion to Dismiss 2-14 Discovery 2-15 Summary Judgment 2-17 The Pretrial Conference 2-17 The Trial 2-17 Appeal 2-20 Enforcing a Judgment 2-20 Class Actions 2-20

Business and the Constitution 3-1

4

Business Ethics, Corporate Social Responsibility, Corporate Governance, and Critical Thinking 4-1 Why Study Business Ethics? 4-2 The Corporate Social Responsibility Debate 4-3 Ethical Theories 4-3 Rights Theory 4-5 Justice Theory 4-7 Utilitarianism 4-7 Shareholder Theory 4-8 Virtue Theory 4-11 Improving Corporate Governance and Corporate Social Responsibility 4-12 Independent Boards of Directors 4-13 The Law 4-15 Guidelines for Ethical Decision Making 4-16

xxi

xxii

Contents

What Facts Impact My Decision? 4-16 What Are the Alternatives? 4-17 Who Are the Stakeholders? 4-17 How Do the Alternatives Impact Society as a Whole? 4-17 How Do the Alternatives Impact My Business Firm? 4-18 How Do the Alternatives Impact Me, the Decision Maker? 4-18 What Are the Ethics of Each Alternative? 4-19 What Are the Practical Constraints of Each Alternative? 4-20 What Course of Action Should Be Taken and How Do We Implement It? 4-20 Knowing When to Use the Guidelines 4-21 Thinking Critically 4-21 Non Sequiturs 4-22 Appeals to Pity 4-22 False Analogies 4-22 Begging the Question 4-22 Argumentum ad Populum 4-23 Bandwagon Fallacy 4-23 Argumentum ad Baculum 4-23 Argumentum ad Hominem 4-23 Argument from Authority 4-24 False Cause 4-24 The Gambler’s Fallacy 4-24 Reductio ad Absurdum 4-25 Appeals to Tradition 4-25 The Lure of the New 4-25 Sunk Cost Fallacy 4-25 Common Characteristics of Poor Decision Making 4-26 Failing to Remember Goals 4-26 Overconfidence 4-26 Complexity of the Issues 4-27 Resisting Requests to Act Unethically 4-27 Recognizing Unethical Requests and Bosses 4-27 Buying Time 4-28 Find a Mentor and a Peer Support Group 4-28 Find Win–Win Solutions 4-28 Work within the Firm to Stop the Unethical Act 4-29 Prepare to Lose Your Job 4-30 Leading Ethically 4-30 Be Ethical 4-30 Communicate the Firm’s Core Ethical Values 4-30

Connect Ethical Behavior with the Firm’s and Workers’ Best Interests 4-31 Reinforce Ethical Behavior 4-31

2

Part 2 Crimes and Torts 5

Criminal Law and Procedure 5-3 Role of the Criminal Law 5-5 Nature of Crimes 5-5 Purpose of the Criminal Sanction 5-6 Essentials of Crime 5-8 Constitutional Limitations on Power to Criminalize Behavior 5-10 Criminal Procedure 5-15 Criminal Prosecutions: An Overview 5-15 Role of Constitutional Safeguards 5-15 The Fourth Amendment 5-16 Key Fourth Amendment Questions 5-16 Warrantless Searches and the Fourth Amendment 5-19 The Fifth Amendment 5-24 The Sixth Amendment 5-29 White-Collar Crimes and the Dilemmas of Corporate Control 5-29 Introduction 5-29 Evolution of Corporate Criminal Liability 5-30 Corporate Criminal Liability Today 5-31 Individual Liability for Corporate Crime 5-32 New Directions 5-33 Important White-Collar Crimes  5-34 Regulatory Offenses 5-34 Fraudulent Acts 5-34 The Sarbanes–Oxley Act 5-37 Bribery and Giving of Illegal Gratuities 5-37 Computer Crime 5-38

6

Intentional Torts 6-1 Interference with Personal Rights 6-5 Battery 6-5 Assault 6-8 Intentional Infliction of Emotional Distress 6-8 False Imprisonment 6-11 Defamation 6-13 Invasion of Privacy 6-27 Misuse of Legal Proceedings 6-33 Deceit (Fraud) 6-34



Contents

Interference with Property Rights 6-34 Trespass to Land 6-34 Private Nuisance 6-35 Conversion 6-37 Other Examples of Intentional Tort Liability 6-38

7

Negligence and Strict Liability 7-1 Negligence 7-2 Duty and Breach of Duty 7-3 Causation of Injury 7-16 Res Ipsa Loquitur 7-27 Negligence Defenses 7-28 Strict Liability 7-29 Abnormally Dangerous Activities 7-29 Statutory Strict Liability 7-33 Tort Reform 7-33

8

Intellectual Property and Unfair Competition 8-1 Protection of Intellectual Property 8-2 Patents 8-2 Copyrights 8-11 Trademarks 8-25 Trade Secrets 8-35 Definition of a Trade Secret 8-37 Ownership and Transfer of Trade Secrets 8-38 Misappropriation of Trade Secrets 8-38 Commercial Torts 8-40 Injurious Falsehood 8-40 Interference with Contractual Relations 8-41 Interference with Prospective Advantage 8-42 Lanham Act § 43(a) 8-45

3

Part 3 Contracts 9

Introduction to Contracts 9-3 The Nature of Contracts 9-3 The Functions of Contracts 9-4 The Evolution of Contract Law 9-4 The Methods of Contracting 9-4 Basic Elements of a Contract 9-5 Basic Contract Concepts and Types 9-7 Bilateral and Unilateral Contracts 9-7 Valid, Unenforceable, Voidable, and Void Contracts 9-8 Express and Implied Contracts 9-8 Executed and Executory Contracts 9-8

xxiii

Sources of Law Governing Contracts 9-9 The Uniform Commercial Code: Origin and Purposes 9-9 Application of Article 2 9-9 Application of the Common Law of Contracts 9-9 Law Governing “Hybrid” Contracts 9-9 Relationship of the UCC and the Common Law of Contracts 9-9 Basic Differences in the Nature of Article 2 and the Common Law of Contracts 9-11 Influence of Restatement (Second) of  Contracts 9-12 “Noncontract” Obligations 9-12 Quasi-Contract 9-13 Promissory Estoppel 9-13

10 The Agreement: Offer 10-1 Requirements for an Offer 10-2 Intent to Contract 10-2 Definiteness of Terms 10-2 Communication to Offeree 10-7 Special Offer Problem Areas 10-7 Advertisements 10-7 Rewards 10-8 Auctions 10-10 Bids 10-11 Which Terms Are Included in the Offer? 10-11 Termination of Offers 10-13 Terms of the Offer 10-13 Lapse of Time 10-13 Revocation 10-13 Rejection 10-15 Death or Mental Incapacity of Either Party 10-18 Destruction of Subject Matter 10-18 Intervening Illegality 10-18

11 The Agreement: Acceptance 11-1 What Is an Acceptance? 11-1 Intention to Accept 11-2 Intent and Acceptance on the Offeror’s Terms 11-5 Communication of Acceptance 11-9 When Is Acceptance Communicated? 11-9 Acceptances by Instantaneous Forms of Communication 11-9 Acceptances by Noninstantaneous Forms of Communication 11-9 Stipulated Means of Communication 11-13 Special Acceptance Problem Areas 11-13

xxiv

Contents

Acceptance in Unilateral Contracts 11-13 Acceptance in Bilateral Contracts 11-13 Silence as Acceptance 11-14 Acceptance When a Writing Is Anticipated 11-16 Acceptance of Ambiguous Offers 11-18 Who Can Accept an Offer? 11-19

12 Consideration 12-1 Elements of Consideration 12-2 Legal Value 12-2 Bargained-For Exchange 12-3 Exchanges That Fail to Meet Consideration Requirements 12-5 Illusory Promises 12-5 Preexisting Duties 12-8 Past Consideration 12-12 Exceptions to the Consideration Requirement 12-13 Promissory Estoppel 12-14 Promises to Pay Debts Barred by Statutes of Limitations 12-17 Promises to Pay Debts Barred by Bankruptcy Discharge 12-17 Charitable Subscriptions 12-18

13 Reality of Consent 13-1 Effect of Doctrines Discussed in This Chapter 13-1 Necessity for Prompt and Unequivocal Rescission 13-2 Misrepresentation and Fraud 13-2 Relationship between Misrepresentation and Fraud 13-2 Requirements for Rescission on the Ground of Misrepresentation 13-2 Mistake 13-8 Nature of Mistake 13-8 Requirements for Mutual Mistake 13-9 Requirements for Unilateral Mistake 13-11 Duress 13-13 Nature of Duress 13-13 Requirements for Duress 13-14 Economic Duress 13-17 Undue Influence 13-17 Nature of Undue Influence 13-17 Determining Undue Influence 13-17

14 Capacity to Contract 14-1 What Is Capacity? 14-1 Effect of Lack of Capacity 14-2 Capacity of Minors 14-2 Minors’ Right to Disaffirm 14-2 Period of Minority 14-5 Emancipation 14-5 Time of Disaffirmance 14-5 Ratification 14-5 Duties upon Disaffirmance 14-6 Effect of Misrepresentation of Age 14-8 Capacity of Mentally Impaired Persons 14-8 Theory of Incapacity 14-8 Test for Mental Incapacity 14-9 The Effect of Incapacity Caused by Mental Impairment 14-9 Contracts of Intoxicated Persons 14-11 Intoxication and Capacity 14-11

15 Illegality 15-1 Meaning of Illegality 15-1 Determining Whether an Agreement Is Illegal 15-2 Agreements in Violation of Statute 15-4 Agreements Declared Illegal by Statute 15-4 Agreements That Violate the Public Policy of a Statute 15-4 Agreements That May Be in Violation of Public Policy Articulated by Courts 15-5 Agreements in Restraint of Competition 15-5 Exculpatory Clauses 15-9 Family Relationships and Public Policy 15-12 Unfairness in Agreements: Contracts of Adhesion and Unconscionable Contracts 15-13 Unconscionability 15-13 Contracts of Adhesion 15-16 Effect of Illegality 15-17 General Rule: No Remedy for Breach of Illegal Agreements 15-17 Exceptions 15-17

16 Writing 16-1 The Significance of Writing in Contract Law 16-1 Purposes of Writing 16-1 Writing and Contract Enforcement 16-2 Overview of the Statute of Frauds 16-2



Contents

History and Purposes 16-2 Effect of Violating the Statute of Frauds 16-2 Contracts Covered by the Statute of Frauds 16-2 Collateral Contracts 16-3 Interest in Land 16-3 Contracts That Cannot Be Performed within One Year 16-6 Promise of Executor or Administrator to Pay a Decedent’s Debt Personally 16-9 Contract in Which Marriage Is the Consideration 16-10 Meeting the Requirements of the Statute of Frauds 16-11 Nature of the Writing Required 16-11 UCC: Alternative Means of Satisfying the Statute of Frauds in Sale of Goods Contracts 16-12 Promissory Estoppel and the Statute of Frauds 16-15 The Parol Evidence Rule 16-16 Explanation of the Rule 16-16 Scope of the Parol Evidence Rule 16-16 Admissible Parol Evidence 16-17 Interpretation of Contracts 16-19

17 Rights of Third Parties 17-1 Assignment of Contracts 17-1 Nature of Assignment of Rights 17-2 Creating an Assignment 17-3 Assignability of Rights 17-3 Nature of Assignee’s Rights 17-6 Subsequent Assignments 17-7 Successive Assignments 17-7 Assignor’s Warranty Liability to Assignee 17-7 Delegation of Duties 17-8 Nature of Delegation 17-8 Delegable Duties 17-8 Language Creating a Delegation 17-10 Assumption of Duties by Delegatee 17-11 Discharge of Delegator by Novation 17-11 Third-Party Beneficiaries 17-13 Intended Beneficiaries versus Incidental Beneficiaries 17-13 Vesting of Beneficiary’s Rights 17-17

18 Performance and Remedies 18-1 Conditions 18-2 Nature of Conditions 18-2 Types of Conditions 18-2

xxv

Creation of Express Conditions 18-7 Excuse of Conditions 18-7 Performance of Contracts 18-8 Level of Performance Expected of the Promisor 18-8 Good-Faith Performance 18-8 Breach of Contract 18-9 Effect of Material Breach 18-9 Determining the Materiality of the Breach 18-10 Anticipatory Repudiation 18-12 Recovery by a Party Who Has Committed Material Breach 18-13 Excuses for Nonperformance 18-14 Impossibility 18-14 Commercial Impracticability 18-17 Other Grounds for Discharge 18-17 Discharge by Mutual Agreement 18-17 Discharge by Accord and Satisfaction 18-17 Discharge by Waiver 18-17 Discharge by Alteration 18-17 Discharge by Statute of Limitations 18-18 Discharge by Decree of Bankruptcy 18-18 Remedies for Breach of Contract 18-18 Types of Contract Remedies 18-18 Interests Protected by Contract Remedies 18-18 Legal Remedies (Damages) 18-19 Equitable Remedies 18-24 Restitution 18-26

4

Part 4 Sales 19 Formation and Terms of Sales Contracts 19-3 Sale of Goods 19-4 Leases 19-6 Higher Standards for Merchants 19-6 UCC Requirements 19-6 Terms of Sales Contracts 19-6 Gap Fillers 19-6 Price Terms 19-7 Quantity Terms 19-8 Output and Needs Contracts 19-8 Exclusive Dealing Contracts 19-8 Time for Performance 19-10 Delivery Terms 19-11 Title 19-11

xxvi

Contents

UCC Changes 19-11 General Title Rule 19-11 Title and Third Parties 19-13 Obtaining Good Title 19-13 Transfers of Voidable Title 19-13 Buyers in the Ordinary Course of Business 19-14 Entrusting of Goods 19-14 Risk of Loss 19-16 Terms of the Agreement 19-16 Shipment Contracts 19-17 Destination Contracts 19-17 Goods in the Possession of Third Parties 19-17 Risk Generally 19-17 Effect of Breach on Risk of Loss 19-19 Insurable Interest 19-19 Sales on Trial 19-19 Sale or Return 19-19 Sale on Approval 19-19

20 Product Liability 20-1 The Evolution of Product Liability Law 20-3 The 19th Century 20-3 The 20th and 21st Centuries 20-3 The Current Debate over Product Liability Law 20-3 Theories of Product Liability Recovery 20-3 Express Warranty 20-4 Implied Warranty of Merchantability 20-5 Implied Warranty of Fitness 20-5 Negligence 20-10 Strict Liability 20-14 The Restatement (Third) 20-16 Other Theories of Recovery 20-20 Time Limitations 20-20 Damages in Product Liability Cases 20-22 The No-Privity Defense 20-23 Tort Cases 20-23 Warranty Cases 20-23 Disclaimers and Remedy Limitations 20-24 Implied Warranty Disclaimers 20-24 Express Warranty Disclaimers 20-29 Disclaimers of Tort Liability 20-29 Limitation of Remedies 20-29 Defenses 20-29 The Traditional Defenses 20-29 Comparative Principles 20-33 Preemption and Regulatory Compliance 20-35

21 Performance of Sales Contracts 21-1 General Rules 21-2 Good Faith 21-2 Course of Dealing 21-2 Usage of Trade 21-2 Modification 21-4 Waiver 21-4 Assignment 21-5 Delivery 21-5 Basic Obligation 21-5 Place of Delivery 21-5 Seller’s Duty of Delivery 21-5 Inspection and Payment 21-6 Buyer’s Right of Inspection 21-6 Payment 21-6 Acceptance, Revocation, and Rejection 21-6 Acceptance 21-6 Effect of Acceptance 21-9 Revocation of Acceptance 21-9 Buyer’s Rights on Improper Delivery 21-12 Rejection 21-12 Right to Cure 21-15 Buyer’s Duties after Rejection 21-15 Assurance, Repudiation, and Excuse 21-16 Assurance 21-16 Anticipatory Repudiation 21-16 Excuse 21-16

22 Remedies for Breach of Sales Contracts 22-1 Agreements as to Remedies 22-2 Statute of Limitations 22-4 Seller’s Remedies 22-5 Remedies Available to an Injured Seller 22-5 Cancellation and Withholding of Delivery 22-5 Resale of Goods 22-5 Recovery of the Purchase Price 22-6 Damages for Rejection or Repudiation 22-8 Seller’s Remedies Where Buyer Is Insolvent 22-9 Seller’s Right to Stop Delivery 22-10 Liquidated Damages 22-10 Buyer’s Remedies 22-10 Buyer’s Remedies in General 22-10 Buyer’s Right to Damages 22-11 Buyer’s Right to Cover 22-12 Incidental Damages 22-12 Consequential Damages 22-13



Contents

Damages for Nondelivery 22-13 Damages for Defective Goods 22-15 Buyer’s Right to Specific Performance 22-18 Buyer and Seller Agreements as to Remedies 22-18

5

Part 5 Property 23 Personal Property and Bailments 23-3 Nature of Property 23-4 Classifications of Property 23-4 Personal Property versus Real Property 23-4 Tangible versus Intangible Personal Property 23-4 Public and Private Property 23-4 Acquiring Ownership of Personal Property 23-5 Production or Purchase 23-5 Possession of Unowned Property 23-5 Rights of Finders of Lost, Mislaid, and Abandoned Property 23-5 Legal Responsibilities of Finders 23-6 Leasing 23-8 Gifts 23-9 Conditional Gifts 23-9 Uniform Transfers to Minors Act 23-9 Will or Inheritance 23-11 Confusion 23-11 Accession 23-11 Bailments 23-12 Nature of Bailments 23-12 Elements of a Bailment 23-12 Creation of a Bailment 23-12 Types of Bailments 23-12 Special Bailments 23-13 Duties of the Bailee 23-13 Duty of Bailee to Take Care of Property 23-13 Bailee’s Duty to Return the Property 23-14 Bailee’s Liability for Misdelivery 23-14 Limits on Liability 23-14 Right to Compensation 23-16 Bailor’s Liability for Defects in the Bailed Property 23-16 Special Bailments 23-17 Common Carriers 23-17 Hotelkeepers 23-17 Safe-Deposit Boxes 23-17 Involuntary Bailments 23-18 Documents of Title 23-18

xxvii

Warehouse Receipts 23-18 Bills of Lading 23-19 Duty of Care 23-20 Negotiation of Document of Title 23-21 Rights Acquired by Negotiation 23-21 Warranties of Transferor of Document of Title 23-21

24 Real Property 24-1 Scope of Real Property 24-2 Fixtures 24-2 Rights and Interests in Real Property 24-5 Estates in Land 24-5 Co-ownership of Real Property 24-6 Interests in Real Property Owned by Others 24-9 Easements 24-9 Creation of Easements 24-10 Profits 24-12 Licenses 24-12 Restrictive Covenants 24-12 Acquisition of Real Property 24-18 Acquisition by Purchase 24-18 Acquisition by Gift 24-18 Acquisition by Will or Inheritance 24-18 Acquisition by Tax Sale 24-18 Acquisition by Adverse Possession 24-18 Transfer by Sale 24-20 Steps in a Sale 24-20 Contracting with a Real Estate Broker 24-21 Contract of Sale 24-21 Fair Housing Act 24-21 Deeds 24-22 Form and Execution of Deed 24-23 Recording Deeds 24-23 Methods of Assuring Title 24-24 Seller’s Responsibilities Regarding the Quality of Residential Property 24-24 Implied Warranty of Habitability 24-25 Duty to Disclose Hidden Defects 24-25 Other Property Condition–Related Obligations of Real Property Owners and Possessors 24-25 Expansion of Premises Liability 24-26 Americans with Disabilities Act 24-26 Land Use Control 24-27 Nuisance Law 24-27 Eminent Domain 24-28

xxviii

Contents

Zoning and Subdivision Laws 24-31 Land Use Regulation and Taking 24-32

25 Landlord and Tenant 25-1 Leases and Tenancies 25-2 Nature of Leases 25-2 Types of Tenancies 25-2 Execution of a Lease 25-3 Rights, Duties, and Liabilities of the Landlord 25-4 Landlord’s Rights 25-4 Landlord’s Duties 25-4 Landlord’s Responsibility for Condition of Leased Property 25-5 Landlord’s Tort Liability 25-9 Rights, Duties, and Liabilities of the Tenant 25-15 Rights of the Tenant 25-15 Duty to Pay Rent 25-15 Duty Not to Commit Waste 25-15 Assignment and Subleasing 25-15 Tenant’s Liability for Injuries to Third Persons 25-16 Termination of the Leasehold 25-16 Eviction 25-16 Agreement to Surrender 25-16 Abandonment 25-16

26 Estates and Trusts 26-1 The Law of Estates and Trusts 26-2 Estate Planning 26-2 Wills 26-2 Right of Disposition by Will 26-2 Nature of a Will 26-2 Common Will Terminology 26-2 Testamentary Capacity 26-3 Execution of a Will 26-6 Incorporation by Reference 26-8 Informal Wills 26-8 Joint and Mutual Wills 26-8 Construction of Wills 26-8 Limitations on Disposition by Will 26-8 Revocation of Wills 26-9 Codicils 26-10 Advance Directives: Planning for Incapacity 26-10 Durable Power of Attorney 26-10 Living Wills 26-10

Durable Power of Attorney for Health Care 26-10 Federal Law and Advance Directives 26-11 Intestacy 26-12 Characteristics of Intestacy Statutes 26-12 Special Rules 26-12 Simultaneous Death 26-15 Administration of Estates 26-16 The Probate Estate 26-16 Determining the Existence of a Will 26-16 Selecting a Personal Representative 26-16 Responsibilities of the Personal Representative 26-16 Trusts 26-17 Nature of a Trust 26-17 Trust Terminology 26-17 Why People Create Trusts 26-18 Creation of Express Trusts 26-18 Charitable Trusts 26-18 Totten Trusts 26-20 Powers and Duties of the Trustee 26-20 Liability of Trustee 26-21 Spendthrift Trusts 26-21 Termination and Modification of a Trust 26-21 Implied and Constructive Trusts 26-21

27 Insurance Law 27-1 Nature and Benefits of Insurance Relationships 27-2 Insurance Policies as Contracts 27-3 Interested Parties 27-3 Offer, Acceptance, and Consideration 27-3 Effect of Insured’s Misrepresentation 27-6 Legality 27-6 Form and Content of Insurance Contracts 27-6 Performance and Breach by Insurer 27-8 Property Insurance 27-8 The Insurable Interest Requirement 27-9 Covered and Excluded Perils 27-9 Nature and Extent of Insurer’s Payment Obligation 27-13 Right of Subrogation 27-15 Duration and Cancellation of Policy 27-15 Liability Insurance 27-17 Types of Liability Insurance Policies 27-17 Liabilities Insured Against 27-17



Contents

Insurer’s Obligations 27-21 Is There a Liability Insurance Crisis? 27-25 Bad-Faith Breach of Insurance Contract 27-25

6

Part 6 Credit 28 Introduction to Credit and Secured

Transactions 28-3 Credit 28-4 Unsecured Credit 28-4 Secured Credit 28-4 Development of Security 28-5 Security Interests in Personal Property 28-5 Security Interests in Real Property 28-5 Suretyship and Guaranty 28-6 Sureties and Guarantors 28-6 Creation of Principal and Surety Relation 28-8 Defenses of a Surety 28-8 Creditor’s Duties to Surety 28-9 Subrogation, Reimbursement, and Contribution 28-9 Liens on Personal Property 28-10 Security Interests in Personal Property and Fixtures under the Uniform Commercial Code 28-10 Common Law Liens 28-10 Statutory Liens 28-10 Characteristics of Liens 28-10 Foreclosure of Lien 28-13 Security Interests in Real Property 28-13 Historical Developments of Mortgages 28-13 Form, Execution, and Recording 28-13 Rights and Liabilities 28-13 Foreclosure 28-14 Right of Redemption 28-14 Recent Development Concerning Foreclosures 28-15 Deed of Trust 28-16 Land Contracts 28-17 Mechanic’s and Materialman’s Liens 28-18 Rights of Subcontractors and Materialmen 28-18 Basis for Mechanic’s or Materialman’s Lien 28-18 Requirements for Obtaining a Lien 28-19 Priorities and Foreclosure 28-19 Waiver of Lien 28-19

29 Security Interests in Personal Property 29-1 Article 9 29-2 Security Interests under the Code 29-2

xxix

Security Interests 29-2 Types of Collateral 29-2 Obtaining a Security Interest 29-3 Attachment of the Security Interest 29-3 Attachment 29-3 The Security Agreement 29-3 Purchase Money Security Interests 29-3 Future Advances 29-5 After-Acquired Property 29-5 Proceeds 29-5 Perfecting the Security Interest 29-6 Perfection 29-6 Perfection by Public Filing 29-6 Possession by Secured Party as Public Notice 29-9 Control 29-9 Perfection by Attachment/Automatic Perfection 29-9 Exceptions to Perfection by Attachment: Consumer Goods 29-10 Motor Vehicles 29-11 Fixtures 29-12 Priority Rules 29-12 Importance of Determining Priority 29-12 General Priority Rules 29-12 Purchase Money Security Interest in Inventory 29-12 Purchase Money Security Interest in Noninventory Collateral 29-14 Rationale for Protecting Purchase Money Security Interests 29-15 Buyers in the Ordinary Course of Business 29-15 Artisan’s and Mechanic’s Liens 29-15 Liens on Consumer Goods Perfected Only by Attachment/ Automatic Perfection 29-18 Fixtures 29-18 Default and Foreclosure 29-20 Default 29-20 Right to Possession 29-20 Sale of the Collateral 29-20 Consumer Goods 29-20 Distribution of Proceeds 29-20 Liability of Creditor 29-21

30 Bankruptcy 30-1 The Bankruptcy Code 30-2 Bankruptcy Proceedings 30-2 Liquidations 30-2 Reorganizations 30-3 Family Farms 30-3

xxx

Contents

Consumer Debt Adjustments 30-3 The Bankruptcy Courts 30-3 Chapter 7: Liquidation Proceedings 30-3 Petitions 30-3 Involuntary Petitions 30-3 Automatic Stay Provisions 30-4 Order of Relief 30-5 Meeting of Creditors and Election of Trustee 30-5 Duties of the Trustee 30-5 The Bankruptcy Estate 30-6 Exemptions 30-6 Avoidance of Liens 30-9 Redemptions 30-9 Preferences (Preferential Payments or Liens) 30-9 Preferential Liens 30-10 Transactions in the Ordinary Course of Business 30-10 Fraudulent Transfers 30-10 Claims 30-13 Allowable Claims 30-13 Secured Claims 30-13 Priority Claims 30-13 Distribution of the Debtor’s Estate 30-14 Discharge in Bankruptcy 30-14 Discharge 30-14 Objections to Discharge 30-14 Acts That Bar Discharge 30-16 Nondischargeable Debts 30-16 Reaffirmation Agreements 30-18 Dismissal for Substantial Abuse 30-18 Chapter 11: Reorganizations 30-22 Reorganization Proceeding 30-22 Use of Chapter 11 30-25 Chapter 12: Family Farmers and Fishermen 30-28 Relief for Family Farmers and Fishermen 30-28 Chapter 13: Consumer Debt Adjustments 30-29 Relief for Individuals 30-29 Procedure 30-29 Discharge 30-33 Advantages of Chapter 13 30-33

7

Part 7 Commercial Paper 31 Negotiable Instruments 31-3 Nature of Negotiable Instruments 31-4 Uniform Commercial Code 31-4 Negotiable Instruments 31-4

Negotiability 31-4 Kinds of Negotiable Instruments 31-5 Promissory Notes 31-5 Certificates of Deposit 31-5 Drafts 31-6 Checks 31-7 Benefits of Negotiable Instruments 31-8 Rights of an Assignee of a Contract 31-8 Rights of a Holder of a Negotiable Instrument 31-9 Formal Requirements for Negotiability 31-9 Basic Requirements 31-9 Importance of Form 31-10 In Writing 31-10 Signed 31-10 Unconditional Promise or Order 31-10 Requirement of a Promise or Order 31-10 Promise or Order Must Be Unconditional 31-10 Fixed Amount of Money 31-12 Fixed Amount 31-12 Payable in Money 31-13 Payable on Demand or at a Definite Time 31-13 Payable on Demand 31-13 Payable at a Definite Time 31-13 Payable to Order or Bearer 31-14 Special Terms 31-16 Additional Terms 31-16 Ambiguous Terms 31-17

32 Negotiation and Holder in Due Course 32-1 Negotiation 32-2 Nature of Negotiation 32-2 Formal Requirements for Negotiation 32-2 Nature of Indorsement 32-2 Wrong or Misspelled Name 32-3 Checks Deposited without Indorsement  32-3 Transfer of Order Instrument 32-3 Indorsements 32-5 Effects of an Indorsement 32-5 Kinds of Indorsements 32-5 Rescission of Indorsement 32-7 Holder in Due Course 32-8 General Requirements 32-9 Holder 32-9 Value 32-11 Good Faith 32-11 Overdue or Dishonored 32-12 Notice of Unauthorized Signature or Alteration 32-13



Contents

Notice of Claims 32-13 Irregular and Incomplete Instruments 32-15 Shelter Rule 32-15 Rights of a Holder in Due Course 32-16 Claims and Defenses Generally 32-16 Importance of Being a Holder in Due Course 32-16 Real Defenses 32-17 Personal Defenses 32-18 Claims to the Instrument 32-20 Claims in Recoupment 32-20 Changes in the Holder in Due Course Rule for Consumer Credit Transactions 32-21 Consumer Disadvantages 32-21 State Consumer Protection Legislation 32-22 Federal Trade Commission Regulation 32-22

33 Liability of Parties 33-1 Liability in General 33-2 Contractual Liability 33-2 Primary and Secondary Liability 33-2 Obligation of a Maker 33-2 Obligation of a Drawee or an Acceptor 33-3 Obligation of a Drawer 33-3 Obligation of an Indorser 33-3 Obligation of an Accommodation Party 33-4 Signing an Instrument 33-6 Signature by an Authorized Agent 33-6 Unauthorized Signature 33-7 Contractual Liability in Operation 33-8 Presentment of a Note 33-8 Presentment of a Check or a Draft 33-8 Time of Presentment 33-10 Warranty Liability 33-10 Transfer Warranties 33-10 Presentment Warranties 33-12 Payment or Acceptance by Mistake 33-13 Operation of Warranties 33-13 Other Liability Rules 33-15 Negligence 33-15 Impostor Rule 33-15 Fictitious Payee Rule 33-15 Comparative Negligence Rule Concerning Impostors and Fictitious Payees 33-16 Fraudulent Indorsements by Employees 33-16 Conversion 33-19 Discharge of Contractual Liability on Negotiable Instruments 33-20

xxxi

Discharge of Contractual Liability 33-20 Discharge by Payment 33-21 Discharge by Cancellation 33-21 Altered Instruments: Discharge by Alteration 33-21 Discharge of Indorsers and Accommodation Parties 33-22

34 Checks and Electronic Transfers 34-1 The Drawer–Drawee Relationship 34-2 Bank’s Duty to Pay 34-2 Bank’s Right to Charge to Customer’s Account 34-2 Stop-Payment Order 34-5 Bank’s Liability for Payment after Stop-Payment Order 34-8 Certified Check 34-9 Cashier’s Check 34-9 Death or Incompetence of Customer 34-10 Forged and Altered Checks 34-10 Bank’s Right to Charge Account 34-10 Customer’s Duty to Report Forgeries and Alterations 34-12 Check Collection and Funds Availability 34-14 Check Collection 34-14 Funds Availability 34-18 Check 21 34-19 Electronic Transfers 34-20 Electronic Fund Transfer Act 34-20 Wire Transfers 34-22

8

Part 8 Agency Law 35 The Agency Relationship 35-3 Creation of an Agency 35-4 Formation 35-4 Capacity 35-5 Nondelegable Obligations 35-5 Agency Concepts, Definitions, and Types 35-5 Authority 35-6 General and Special Agents 35-6 Gratuitous Agents 35-6 Subagents 35-6 Employees and Nonemployee Agents 35-7 Duties of Agent to Principal 35-9 Agent’s Duty of Loyalty 35-10 Agent’s Duty to Obey Instructions 35-12 Agent’s Duty to Act with Care and Skill 35-12

xxxii

Contents

Agent’s Duty to Provide Information 35-12 Agent’s Duties of Segregation, Record-Keeping, and Accounting 35-12 Duty Not to Receive a Material Benefit 35-12 Duty of Good Conduct 35-12 Duties of Principal to Agent 35-12 Duty to Compensate Agent 35-13 Duties of Reimbursement and Indemnity  35-13 Termination of an Agency 35-14 Termination by Act of the Parties 35-14 Termination by Operation of Law 35-14 Termination of Agency Powers Given as Security 35-15 Effect of Termination on Agent’s Authority 35-16

36 Third-Party Relations of the Principal and the

Agent 36-1 Contract Liability of the Principal 36-2 Actual Authority 36-2 Apparent Authority 36-3 Agent’s Notification and Knowledge 36-3 Ratification 36-3 Estoppel 36-4 Contracts Made by Subagents 36-6 Contract Liability of the Agent 36-6 The Nature of the Principal 36-6 Liability of Agent by Agreement 36-8 Implied Warranty of Authority 36-8 Tort Liability of the Principal 36-10 Respondeat Superior Liability 36-10 Direct Liability 36-13 Liability for Torts of Nonemployee Agents 36-13 Liability for Agent’s Misrepresentations 36-13 Tort Liability of the Agent 36-14 Tort Suits against Principal and Agent 36-15

9

Part 9 Partnerships 37 Introduction to Forms of Business and Formation

of Partnerships 37-3 Types of Business Entities 37-4 Sole Proprietorship 37-4 Partnership 37-4 Limited Liability Partnership 37-5 Limited Partnership 37-5 Corporation 37-6 Professional Corporation 37-6

Limited Liability Company 37-6 Benefit Corporations 37-7 Partnerships 37-9 Creation of Partnership 37-9 RUPA Definition of Partnership 37-10 Creation of Joint Ventures 37-12 Creation of Mining Partnerships 37-13 Creation of Limited Liability Partnerships 37-13 Purported Partners 37-14 Purporting to Be a Partner 37-14 Reliance Resulting in a Transaction with the Partnership 37-14 Effect of Purported Partnership 37-14 Partnership Capital 37-16 Partnership Property 37-17 Examples 37-17 Need for Partnership Agreement 37-17 Partner’s Partnership Interest 37-19 Partner’s Transferable Interest 37-19 Effect of Partnership Agreement 37-20

38 Operation of Partnerships and Related

Forms 38-1 Duties of Partners to the Partnership and Each Other 38-2 Having Interest Adverse to Partnership 38-2 Competing against the Partnership 38-2 Duty to Serve 38-4 Duty of Care 38-4 Duty to Act within Actual Authority 38-4 Duty to Account 38-4 Other Duties 38-4 Joint Ventures and Mining Partnerships 38-5 Compensation of Partners 38-5 Profits and Losses 38-5 Management Powers of Partners 38-8 Individual Authority of Partners 38-8 Special Transactions 38-9 Disagreement among Partners: Ordinary Course of Business 38-10 When Unanimous Partners’ Agreement Is Required 38-11 Joint Ventures and Mining Partnerships 38-11 Effect of Partnership Agreement 38-11 Liability for Torts and Crimes 38-13 Torts 38-13 Tort Liability and Limited Liability Partnerships 38-14 Crimes 38-14



Contents

Lawsuits by and against Partnerships and Partners 38-14 Limited Liability Partnerships 38-14

39 Partners’ Dissociation and Partnerships’

Dissolution and Winding Up 39-1 Dissociation 39-2 Nonwrongful Dissociation 39-2 Wrongful Dissociation 39-3 Acts Not Causing Dissociation 39-3 Effect of Partnership Agreement 39-3 Dissolution and Winding Up the Partnership Business 39-3 Events Causing Dissolution and Winding Up 39-5 Joint Ventures and Mining Partnerships 39-7 Performing Winding Up 39-7 Partner’s Authority during Winding Up 39-9 Distribution of Dissolved Partnership’s Assets 39-11 Asset Distributions in a Limited Liability Partnership 39-12 Termination 39-12 When the Business Is Continued 39-12 Successor’s Liability for Predecessor’s Obligations 39-12 Dissociated Partner’s Liability for Obligations Incurred while a Partner 39-12 Dissociated Partner’s Liability for Obligations Incurred after Leaving the Partnership 39-13 Effect of LLP Status 39-14 Buyout of Dissociated Partners 39-14 Partners Joining an Existing Partnership 39-16 Liability of New Partners 39-16

40 Limited Liability Companies and Limited

Partnerships 40-1 Limited Liability Companies 40-1 Tax Treatment of LLCs 40-2 Formation of LLCs 40-2 Members’ Rights and Responsibilities 40-2 Members’ Dissociations and LLC Dissolution 40-5 Limited Partnerships 40-9 The Uniform Limited Partnership Acts 40-9 Use of Limited Partnerships 40-9 Creation of Limited Partnerships 40-10

xxxiii

Defective Compliance with Limited Partnership Statute 40-11 Rights and Liabilities of Partners in Limited Partnerships 40-12 Rights and Liabilities Shared by General and Limited Partners 40-12 Other Rights of General Partners 40-13 Other Liabilities of General Partners 40-13 Other Rights of Limited Partners 40-14 Other Liabilities of Limited Partners 40-14 Partners’ Dissociations and Limited Partnership Dissolution 40-14 Partners’ Dissociations 40-14 Limited Partnership Dissolutions 40-16 Mergers and Conversions 40-17

10

Part 10 Corporations 41 History and Nature of Corporations 41-3 History of Corporations 41-4 American Corporation Law 41-4 Classifications of Corporations 41-4 Regulation of For-Profit Corporations 41-6 State Incorporation Statutes 41-6 State Common Law of Corporations 41-7 Regulation of Nonprofit Corporations 41-7 Regulation of Foreign and Alien Corporations 41-7 Due Process Clause 41-8 Commerce Clause 41-8 Subjecting Foreign Corporations to Suit 41-8 Taxation 41-9 Qualifying to Do Business 41-9 Regulation of a Corporation’s Internal Affairs 41-12 Regulation of Foreign Nonprofit Corporations 41-12 Piercing the Corporate Veil 41-12 Nonprofit Corporations 41-14

42 Organization and Financial Structure of

Corporations 42-1 Promoters and Preincorporation Transactions 42-1 Corporation’s Liability on Preincorporation Contracts 42-2 Promoter’s Liability on Preincorporation Contracts 42-2 Obtaining a Binding Preincorporation Contract 42-2

xxxiv

Preincorporation Share Subscriptions 42-3 Relation of Promoter and Prospective Corporation 42-4 Liability of Corporation to Promoter 42-4 Incorporation 42-4 Steps in Incorporation 42-4 Close Corporation Elections 42-7 Defective Attempts to Incorporate 42-7 De Jure Corporation 42-7 De Facto Corporation 42-8 Corporation by Estoppel 42-8 Defective Incorporation 42-8 Modern Approaches to the Defective Incorporation Problem 42-8 Incorporation of Nonprofit Corporations 42-10 Liability for Preincorporation Transactions 42-11 Financing For-Profit Corporations 42-11 Equity Securities 42-11 Authorized, Issued, and Outstanding Shares 42-12 Options, Warrants, and Rights 42-12 Debt Securities 42-13 Consideration for Shares 42-13 Quality of Consideration for Shares 42-13 Quantity of Consideration for Shares 42-13 Share Subscriptions 42-16 Issuance of Shares 42-16 Transfer of Shares 42-17 Restrictions on Transferability of Shares 42-17 Financing Nonprofit Corporations 42-20

43 Management of Corporations 43-1 Corporate Objectives 43-2 Corporate Powers 43-3 Purpose Clauses in Articles of Incorporation 43-3 Powers of Nonprofit Corporations 43-3 The Board of Directors 43-3 Board Authority under Corporation Statutes 43-4 Committees of the Board 43-4 Who Is an Independent Director? 43-5 Powers, Rights, and Liabilities of Directors as Individuals 43-5 Election of Directors 43-5 Directors’ Meetings 43-8 Officers of the Corporation 43-9 Managing Close Corporations 43-9 Managing Nonprofit Corporations 43-10

Contents

Directors’ and Officers’ Duties to the Corporation 43-11 Acting within Authority 43-11 Duty of Care 43-11 Board Opposition to Acquisition of Control of a Corporation 43-16 Oversight of Legal Compliance 43-20 Duties of Loyalty 43-22 Conflicting Interest Transactions 43-22 Usurpation of a Corporate Opportunity 43-23 Oppression of Minority Shareholders 43-25 Trading on Inside Information 43-27 Duties of Directors and Officers of Nonprofit Corporations 43-27 Corporate and Management Liability for Torts and Crimes 43-28 Liability of the Corporation 43-28 Directors’ and Officers’ Liability for Torts and Crimes 43-29 Insurance and Indemnification 43-32 Mandatory Indemnification of Directors 43-32 Permissible Indemnification of Directors 43-32 Insurance 43-32 Nonprofit Corporations 43-32

44 Shareholders’ Rights and Liabilities 44-1 Shareholders’ Meetings 44-2 Notice of Meetings 44-2 Conduct of Meetings 44-2 Shareholder Action without a Meeting 44-2 Shareholders’ Election of Directors 44-2 Straight Voting 44-2 Cumulative Voting 44-3 Classes of Shares 44-3 Shareholder Control Devices 44-3 Fundamental Corporate Changes 44-6 Procedures Required 44-7 Dissenters’ Rights 44-7 Shareholders’ Inspection and Information Rights 44-13 Preemptive Right 44-15 Distributions to Shareholders 44-16 Dividends 44-16 Share Repurchases 44-18 Ensuring a Shareholder’s Return on Investment 44-19 Shareholders’ Lawsuits 44-19



Contents

Shareholders’ Individual Lawsuits 44-19 Shareholder Class Action Suits 44-19 Shareholders’ Derivative Actions 44-19 Defense of Corporation by Shareholder 44-22 Shareholder Liability 44-22 Shareholder Liability for Illegal Distributions 44-22 Shareholder Liability for Corporate Debts 44-22 Sale of a Control Block of Shares 44-22 Shareholders as Fiduciaries 44-23 Members’ Rights and Duties in Nonprofit Corporations 44-25 Members’ Meeting and Voting Rights 44-26 Member Inspection and Information Rights 44-26 Distributions of Assets 44-27 Resignation and Expulsion of Members 44-27 Derivative Suits 44-27 Dissolution and Termination of Corporations 44-27 Winding Up and Termination 44-29 Dissolution of Nonprofit Corporations 44-29

45 Securities Regulation 45-1 Purposes of Securities Regulation 45-2 Securities and Exchange Commission 45-3 SEC Actions 45-3 What Is a Security? 45-4 Securities Act of 1933 45-7 Registration of Securities under the 1933 Act 45-7 Mechanics of a Registered Offering 45-7 Registration Statement and Prospectus 45-7 Section 5: Timing, Manner, and Content of Offers and Sales 45-8 Exemptions from the Registration Requirements of the 1933 Act 45-12 Securities Exemptions 45-12 Transaction Exemptions 45-13 Intrastate Offering Exemption 45-13 Private Offering Exemption 45-13 Small Offering Exemptions 45-15 The JOBS Act and Regulation Crowdfunding 45-16 Transaction Exemptions for Nonissuers 45-16 Sale of Restricted Securities 45-17 Consequence of Obtaining a Securities or Transaction Exemption 45-20 Liability Provisions of the 1933 Act 45-20 Liability for Defective Registration Statements 45-21 Other Liability Provisions 45-26

xxxv

Criminal Liability 45-26 Securities Exchange Act of 1934 45-26 Registration of Securities under the 1934 Act 45-27 Holdings and Trading by Insiders 45-28 Proxy Solicitation Regulation 45-28 Liability Provisions of the 1934 Act 45-30 Liability for False Statements in Filed Documents 45-30 Section 10(b) and Rule 10b–5 45-31 Elements of a Rule 10b–5 Violation 45-31 Regulation FD 45-43 Criminal Liability 45-44 Tender Offer Regulation 45-44 Private Acquisitions of Shares 45-46 State Regulation of Tender Offers 45-46 State Securities Law 45-46 Registration of Securities 45-46

46 Legal and Professional Responsibilities

of Auditors, Consultants, and Securities Professionals 46-1 General Standard of Performance 46-3 Professionals’ Liability to Clients 46-3 Contractual Liability 46-3 Tort Liability 46-4 In Pari Delicto 46-7 Breach of Trust 46-7 Securities Law 46-8 Professionals’ Liability to Third Persons: Common Law 46-8 Negligence and Negligent Misrepresentation 46-8 Fraud 46-13 Professional’s Liability to Third Parties: Securities Law 46-13 Securities Act of 1933 46-14 Securities Exchange Act of 1934 46-15 State Securities Law 46-18 Securities Analysts’ Conflicts of Interest 46-18 Dodd–Frank Act and Broker-Dealers 46-20 Regulation Best Interest and Broker-Dealers 46-20 Qualified Opinions, Disclaimers of Opinion, Adverse Opinions, and Unaudited Statements 46-22 Criminal, Injunctive, and Administrative Proceedings 46-23 Criminal Liability under the Securities Laws 46-24

xxxvi

Other Criminal Law Violations 46-25 Injunctions 46-26 Administrative Proceedings 46-26 Securities Exchange Act Audit Requirements 46-27 SOX Section 404 46-27 Cooperation with PCAOB Investigations 46-27 Ownership of Working Papers 46-28 Professional–Client Privilege 46-28

11

Part 11 Regulation of Business 47 Administrative Law 47-3 Origins of Administrative Agencies 47-5 Agency Creation 47-6 Enabling Legislation 47-6 Administrative Agencies and the Constitution 47-7 Agency Types and Organization 47-11 Agency Types 47-11 Agency Organization 47-12 Agency Powers and Procedures 47-12 Nature, Types, and Source of Powers 47-12 Investigative Power 47-12 Rulemaking Power 47-14 Adjudicatory Power 47-16 Controlling Administrative Agencies 47-17 Presidential Controls 47-17 Congressional Controls 47-17 Judicial Review 47-18 Information Controls 47-27 Freedom of Information Act 47-27 Privacy Act of 1974 47-31 Government in the Sunshine Act 47-31 Issues in Regulation 47-31 “Old” Regulation versus “New” Regulation 47-31 “Captive” Agencies and Agencies’ “Shadows” 47-31 Is the Agency Doing Its Job? 47-31 Deregulation versus Reregulation 47-32

48 The Federal Trade Commission Act

and Consumer Protection Laws 48-1 The Federal Trade Commission 48-2 The FTC’s Powers 48-2

Contents

FTC Enforcement Procedures 48-2 Actions in Court 48-3 Anticompetitive Behavior 48-6 Deception and Unfairness 48-6 Deception 48-6 Unfairness 48-15 Remedies 48-15 Consumer Protection Laws 48-15 Telemarketing and Consumer Fraud and Abuse Prevention Act 48-15 Do-Not-Call Registry 48-16 Do Not Track 48-17 Magnuson–Moss Warranty Act 48-17 Truth in Lending Act 48-18 Fair Credit Reporting Act 48-19 FACT Act and the Identity Theft Problem 48-23 Equal Credit Opportunity Act 48-24 Fair Credit Billing Act 48-24 The Dodd–Frank Act 48-24 Fair Debt Collection Practices Act 48-25 Product Safety Regulation 48-30

49 Antitrust: The Sherman Act 49-1 The Antitrust Policy Debate 49-2 Chicago School Theories 49-3 Traditional Antitrust Theories 49-3 Impact of Chicago School 49-3 Jurisdiction, Types of Cases, and Standing 49-3 Jurisdiction 49-3 Types of Cases and the Role of Pretrial Settlements 49-4 Criminal Prosecutions 49-4 Civil Litigation 49-4 Standing 49-5 Section 1—Restraints of Trade 49-5 Concerted Action 49-5 Per Se versus Rule of Reason Analysis 49-9 Horizontal Price-Fixing 49-9 Vertical Price-Fixing 49-13 Horizontal Divisions of Markets 49-17 Vertical Restraints on Distribution 49-18 Group Boycotts and Concerted Refusals to Deal 49-18 Tying Agreements 49-19



Contents

Reciprocal Dealing Agreements 49-25 Exclusive Dealing Agreements 49-25 Joint Ventures by Competitors 49-25 Section 2—Monopolization 49-26 Monopolization 49-27 Attempted Monopolization 49-34 Conspiracy to Monopolize 49-35

50 The Clayton Act, the Robinson–Patman Act,

and Antitrust Exemptions and Immunities 50-1 Clayton Act Section 3 50-2 Tying Agreements 50-3 Exclusive Dealing Agreements 50-3 Clayton Act Section 7 50-3 Introduction 50-3 Federal Filing Requirements for Mergers 50-4 Relevant Market Determination 50-4 Horizontal Mergers 50-5 Vertical Mergers 50-13 Conglomerate Mergers 50-14 Clayton Act Section 8 50-15 The Robinson–Patman Act 50-16 Jurisdiction 50-16 Section 2(a) 50-17 Defenses to Section 2(a) Liability 50-22 Indirect Price Discrimination 50-23 Buyer Inducement of Discrimination 50-24 Antitrust Exceptions and Exemptions 50-24 Statutory Exemptions 50-24 State Action Exemption 50-25 The Noerr–Pennington Doctrine 50-25 Patent Licensing 50-29 Foreign Commerce 50-29

51 Employment Law 51-1 Legislation Protecting Employee Health, Safety, and Well-Being 51-2 Workers’ Compensation 51-2 The Occupational Safety and Health Act 51-6 The Family and Medical Leave Act 51-6 Legislation Protecting Wages, Pensions, and Benefits 51-7 Social Security 51-7 Unemployment Compensation 51-7 ERISA 51-8 The Fair Labor Standards Act 51-8

xxxvii

Collective Bargaining and Union Activity 51-8 Equal Opportunity Legislation 51-10 The Equal Pay Act 51-10 Title VII 51-11 Section 1981 51-27 The Age Discrimination in Employment Act 51-27 The Americans with Disabilities Act 51-28 Genetic Information Nondiscrimination Act 51-32 Immigration Reform and Control Act 51-32 Uniformed Services Employment and Reemployment Rights Act 51-32 Executive Order 11246 51-33 State Antidiscrimination Laws 51-33 Retaliation 51-33 Employee Privacy 51-34 Polygraph Testing 51-34 Drug and Alcohol Testing 51-35 Employer Searches 51-36 Records and References 51-36 Employer Monitoring 51-36 Job Security 51-36 The Doctrine of Employment at Will 51-36 The Common Law Exceptions 51-37

52 Environmental Regulation 52-1 Historical Perspective 52-2 The Environmental Protection Agency 52-2 The National Environmental Policy Act 52-3 Air Pollution 52-3 Background 52-3 Clean Air Act 52-3 Ambient Air Control Standards 52-3 Acid Rain Controls 52-4 Control of Hazardous Air Pollutants 52-4 New Source Controls 52-4 Permits 52-7 Enforcement 52-7 Automobile Pollution 52-8 International Air Problems  52-9 Water Pollution 52-12 Background 52-12 Early Federal Legislation 52-12 Clean Water Act 52-12 Discharge Permits 52-12 Water Quality Standards 52-13 Enforcement 52-13

xxxviii

Contents

Wetlands 52-16 Waters of the United States 52-16 Ocean Dumping 52-16 Liability for Oil Spills 52-17 Drinking Water 52-19 Waste Disposal 52-19 Background 52-19 The Resource Conservation and Recovery Act 52-20 Underground Storage Tanks 52-20 State Responsibilities 52-20 Enforcement 52-20 Solid Waste 52-23 Superfund 52-23 Community Right to Know and Emergency Cleanup 52-26 Regulation of Chemicals 52-26 Background 52-26

Regulation of Agricultural Chemicals 52-26 Toxic Substances Control Act 52-27 International Developments Concerning Regulation of Toxic Substances 52-27 Biotechnology 52-29

Glossary G-1 Appendix A The Constitution of the United States of America A-1 Appendix B Uniform Commercial Code B-1 Index I-1

List of Cases Abdouch v. Lopez . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2-4

Cordas v. Uber Technologies, Inc.. . . . . . . . . . . . . . . . . . . . 10-12

Advance Dental Care, Inc. v. SunTrust Bank. . . . . . . . . . . . . . 1-9

Coyle v. Schwartz. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 42-19

Aliaga Medical Center v. Harris Bank. . . . . . . . . . . . . . . . . . . 34-6

Currie v. Chevron U.S.A., Inc.. . . . . . . . . . . . . . . . . . . . . . . . . . 7-7

Alice Corporation Ltd. v. CLS Bank International . . . . . . . . . 8-4

D’Agostino v. Federal Insurance Company . . . . . . . . . . . . . 10-16

Allstate Lien & Recovery Corporation v. Stansbury . . . . . . 28-11

Day v. Fortune Hi-Tech Marketing, Inc.. . . . . . . . . . . . . . . . . 12-5

American Greetings Corp. v. Bunch. . . . . . . . . . . . . . . . . . . . 51-4

DePetris & Bachrach, LLP v. Srour . . . . . . . . . . . . . . . . . . . . 36-9

American Needle, Inc. v. National Football League . . . . . . . 49-6

Dixon v. Crawford, McGilliard, Peterson & Yelish. . . . . . . 39-14

A Note on United States v. Apple. . . . . . . . . . . . . . . . . . . . . . 49-13

Dodge v. Ford Motor Co.. . . . . . . . . . . . . . . . . . . . . . . . . . . 44-16

Arthur Andersen LLP v. United States. . . . . . . . . . . . . . . . . 46-29

Doe v. Roman Catholic Archdiocese of Indianapolis . . . . . 12-13

AT&T Mobility LLC v. Concepcion. . . . . . . . . . . . . . . . . . . . 2-25

Domingo v. Mitchell . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10-3

Ballard v. Dornic . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24-7

Drake Manufacturing Company, Inc. v. Polyflow, Inc.. . . . 41-10

Bank of America, N.A. v. Inda . . . . . . . . . . . . . . . . . . . . . . . 32-10

Durham v. McDonald’s Restaurants of Oklahoma, Inc.. . . . . 6-9

Banks v. Lockhart. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6-6

Duro Textiles, LLC v. Sunbelt Corporation. . . . . . . . . . . . . . 11-8

Bauer v. Qwest Communications Company, LLC. . . . . . . . 11-14

Dynegy, Inc. v. Yates. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16-4

Beau Townsend Ford Lincoln v. Don Hinds Ford. . . . . . . . . 22-6

EEOC v. Kohl’s Dep’t Stores, Inc. . . . . . . . . . . . . . . . . . . . . 51-30

Beer v. Bennett. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22-11

E & G Food Corp. v. Cumberland Farms. . . . . . . . . . . . . . . 32-18

Berghuis v. Thompkins. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5-25

Escott v. BarChris Construction Corp.. . . . . . . . . . . . . . . . . 45-22

Bertrand v. Mullin . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6-20

Evory v. RJM Acquisitions Funding, L.L.C.. . . . . . . . . . . . . 48-26

Bissinger v. New Country Buffet. . . . . . . . . . . . . . . . . . . . . . . 20-6

Exxon Shipping Co. v. Baker. . . . . . . . . . . . . . . . . . . . . . . . . 52-17

Black v. William Insulation Co.. . . . . . . . . . . . . . . . . . . . . . . . 7-22

Farrell v. Macy’s Retail Holdings, Inc.. . . . . . . . . . . . . . . . . . 6-11

Bostock v. Clayton County, Georgia. . . . . . . . . . . . . . . . . . . 51-18

Federal Trade Commission v. Ross. . . . . . . . . . . . . . . . . . . . . 48-4

Bouchat v. Baltimore Ravens Limited Partnership. . . . . . . . . 8-21

Federal Trade Commission v. Staples, Inc.. . . . . . . . . . . . . . 50-10

Branham v. Ford Motor Co. . . . . . . . . . . . . . . . . . . . . . . . . . 20-17

Ferris, Baker Watts, Inc. v. Ernst & Young, LLP . . . . . . . . 46-16

Brehm v. Eisner . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 43-13

Filer, Inc. v. Staples, Inc.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17-5

Brooke Group Ltd. v. Brown & Williamson Tobacco Corp. .50-18

Finch v. Raymer. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 37-18

Brooks v. Lewin Realty III, Inc.. . . . . . . . . . . . . . . . . . . . . . . . 25-6

Fish v. Tex. Legislative Serv., P’ship. . . . . . . . . . . . . . . . . . . . 38-6

Browning v. Poirier. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .16-7

Fitzgerald v. Racing Association of Central Iowa . . . . . . . . . 3-28

Cabot Oil & Gas Corporation v. Daugherty Petroleum, Inc. .11-16

Forcht Bank v. Gribbins. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 34-4

Cahaba Disaster Recovery v. Rogers. . . . . . . . . . . . . . . . . . . 22-15

Francini v. Goodspeed Airport, LLC. . . . . . . . . . . . . . . . . . 24-11

Capshaw v. Hickman. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19-18

Frontier Leasing Corp. v. Links Engineering, LLC. . . . . . . . 36-5

CBS Corp. v. FCC. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35-7

Gamboa v. Alvarado. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .15-18

Cincinnati Insurance Company v. Wachovia  Bank National Association . . . . . . . . . . . . . . . . . . . . . . . . . . 34-10

Garden Ridge, L.P. v. Advance International, Inc.. . . . . . . . 18-22

Citizens National Bank of Paris v. Kids Hope United, Inc.. 26-19

Gelman v. Buehler. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 39-6

Citizens United v. Federal Election Commission . . . . . . . . . 3-17

General Credit Corp. v. New York Linen Co.. . . . . . . . . . . 32-19

Clark’s Sales and Service, Inc. v. Smith . . . . . . . . . . . . . . . . . 15-7

George v. Al Hoyt & Sons, Inc.. . . . . . . . . . . . . . . . . . . . . . . 18-20

Coggins v. New England Patriots Football Club, Inc.. . . . . 43-26

Gniadek v. Camp Sunshine at Sebago Lake, Inc.. . . . . . . . . 35-16

Coleman v. Retina Consultants, P.C. . . . . . . . . . . . . . . . . . . . 8-39 Columbia Realty Ventures v. Dang. . . . . . . . . . . . . . . . . . . . . 28-6

Gold v. Deloitte & Touche, LLP (In re NM Holdings  Co., LLC). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 46-5

Coma Corporation v. Kansas Department of Labor . . . . . . . 15-2

Grace Label, Inc. v. Kliff. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21-3

Coomer v. Kansas City Royals Baseball Corp.. . . . . . . . . . . . 1-15

Grande v. Jennings. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23-7

Gaskell v. University of Kentucky. . . . . . . . . . . . . . . . . . . . . 51-13

xxxix

xl

List of Cases

Green v. Ford Motor Co.. . . . . . . . . . . . . . . . . . . . . . . . . . . . 20-33

Kirtsaeng v. John Wiley & Sons, Inc.. . . . . . . . . . . . . . . . . . . 8-16

Green Garden Packaging Co. v. Schoenmann Produce Co..16-14

Kolodziej v. Mason . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10-8

Green Wood Industrial Company v.  Forceman International Development Group . . . . . . . . . . . 22-13

Kraft, Inc. v. Federal Trade Commission. . . . . . . . . . . . . . . . 48-7

Grimes v. Young Life, Inc.. . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-10

Krupinski v. Deyesso. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 42-9

Grodner & Associates v. Regions Bank . . . . . . . . . . . . . . . . 34-13

Kruser v. Bank of America NT & SA. . . . . . . . . . . . . . . . . . 34-21

Guth v. Loft, Inc.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 43-24

Lach v. Man O’War, LLC. . . . . . . . . . . . . . . . . . . . . . . . . . . 40-17

Gyamfoah v. EG&G Dynatrend (now EG&G  Technical Services) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23-20

Leegin Creative Leather Products v. PSKS, Inc. . . . . . . . . . 49-14

Harrison v. Family Home Builders, LLC . . . . . . . . . . . . . . . 18-10

Lewis-Gale Medical Center, LLC v. Alldredge. . . . . . . . . . . . 8-42

Hecht v. Andover Assoc. Mgmt. Co.. . . . . . . . . . . . . . . . . . . . 40-4

Lincoln Composites, Inc. v. Firetrace USA, LLC . . . . . . . . 20-30

Helena Chemical Co. v. Williamson. . . . . . . . . . . . . . . . . . . . 22-2

Lindh v. Surman. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23-10

Heritage Bank v. Bruha . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31-12

Long v. Provide Commerce, Inc.. . . . . . . . . . . . . . . . . . . . . . . 11-2

Hertz Corp. v. Friend. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2-10

Lord v. D & J Enterprises, Inc.. . . . . . . . . . . . . . . . . . . . . . . . 7-11

Hicks v. Sparks. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13-10

Macomb Mechanical, Inc. v. LaSalle Group, Inc. . . . . . . . . . 18-5

Hill v. Nakai (In re Estate of Hannifin) . . . . . . . . . . . . . . . . 26-13

Magri v. Jazz Casino Co., LLC. . . . . . . . . . . . . . . . . . . . . . . . . 7-3

Hillerich & Bradsby Co. v. Charles Products. . . . . . . . . . . . 21-13

Marion T v. Northwest Metals Processors. . . . . . . . . . . . . . . 33-6

Holiday Motor Corp. v. Walters . . . . . . . . . . . . . . . . . . . . . . 20-12

Mark v. FSC Securities Corp.. . . . . . . . . . . . . . . . . . . . . . . . 45-14

Houseman v. Dare. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18-25

Massachusetts v. Environmental Protection Agency. . . . . . 52-10

Huntington National Bank v. Guishard, Wilburn & Shorts. 33-11

Matal v. Tam. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3-23

Hutchison v. Kaforey. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26-3

Mathias v. Accor Economy Lodging, Inc.. . . . . . . . . . . . . . . . . 6-3

Hyman v. Capital One Auto Finance . . . . . . . . . . . . . . . . . . 29-21

Mayo Foundation for Medical Education v. United States. . . .47-23

In re Bernard L. Madoff Investment Securities . . . . . . . . . . 30-11

McDonough v. McDonough. . . . . . . . . . . . . . . . . . . . . . . . . . 40-7

In re Borden. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29-15

McLellan v. Charly. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12-15

In re Burt . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30-30

McMillian v. McMillian. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 38-2

In re Caremark Int’l Inc. Derivative Litig. . . . . . . . . . . . . . . 43-20

Medmarc Casualty Insurance Co. v. Avent America, Inc.. . 27-21

In re Foreclosure Cases. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28-15

Meyer v. Christie . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 39-4

In re Lance. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29-10

Michigan Battery Equipment, Inc. v. Emcasco  Insurance Co.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27-11

In re Made In Detroit. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30-24 In re Rogers (Wallace v. Rogers). . . . . . . . . . . . . . . . . . . . . . .30-7

Krakauer v. Dish Network, L.L.C. . . . . . . . . . . . . . . . . . . . . . 35-4

Lehigh Presbytery v. Merchants Bancorp. . . . . . . . . . . . . . . . 32-6

In re Siegenberg. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30-19

Mid-American Salt, LLC v. Morris County Cooperative  Pricing Council. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12-7

James v. City of Costa Mesa. . . . . . . . . . . . . . . . . . . . . . . . . . 1-24

Miller v. Burnett. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25-17

Janke v. Brooks. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19-5

Milner v. Department of the Navy . . . . . . . . . . . . . . . . . . . . 47-28

J.D. Fields & Company, Inc. v. United States  Steel International, Inc. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10-5

Mitchell Partners, L.P. v. Irex Corp.. . . . . . . . . . . . . . . . . . . 44-24

Johnson v. Bank of America, N.A. . . . . . . . . . . . . . . . . . . . . . 17-9

Montgomery Cellular Holding Co., Inc. v. Dobler. . . . . . . . . 44-8

Johnson v. Fluor Corporation. . . . . . . . . . . . . . . . . . . . . . . . 51-25

Mortgage Grader, Inc. v. Ward & Olivo, L.L.P . . . . . . . . . . 38-15

Johnson v. J. Walter Thompson U.S.A., LLC . . . . . . . . . . . 51-23

Moser v. Moser. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 40-11

Jones v. Wells Fargo Bank, N.A.. . . . . . . . . . . . . . . . . . . . . . 33-19

Moss v. Batesville Casket Co.. . . . . . . . . . . . . . . . . . . . . . . . . 20-9

Jordan v. Jewel Food Stores, Inc. . . . . . . . . . . . . . . . . . . . . . . 6-29

MP Nexlevel of Cal., Inc. v. CVIN. . . . . . . . . . . . . . . . . . . . 37-15

J.T. ex rel. Thode v. Monster Mountain, LLC . . . . . . . . . . . . 14-2

Music Acceptance Corp. v. Lofing. . . . . . . . . . . . . . . . . . . . 32-22

Kelo v. City of New London. . . . . . . . . . . . . . . . . . . . . . . . . 24-29

National College Loan Trust 2004-1 v. Irizarry . . . . . . . . . . . 33-4

Kibler v. Hall . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8-31

National Federation of Independent  Business v. Sebelius . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3-9

*

Killian v. Ricchetti. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18-3

Mogilevsky v. Rubicon Technology, Inc.. . . . . . . . . . . . . . . . 24-4



List of Cases

xli

National Music Museum: America’s Shrine to  Music v. Johnson. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19-12

SmithStearn Yachts, Inc. v. Gyrographic  Communications, Inc.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 42-3

NBN Broadcasting, Inc. v. Sheridan Broadcasting  Networks, Inc.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 38-12

Sogeti USA LLC v. Scariano. . . . . . . . . . . . . . . . . . . . . . . . . . 17-3

Neumann v. Liles. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6-14

SRM Global Fund L.P. v. Countrywide Financial Corp.. . . 45-32

Noble Roman’s v. Pizza Boxes . . . . . . . . . . . . . . . . . . . . . . . . 19-9

Stahlecker v. Ford Motor Co.. . . . . . . . . . . . . . . . . . . . . . . . . 7-24

North Atlantic Instruments, Inc. v. Haber . . . . . . . . . . . . . . 35-10

Star Athletica, LLC v. Varsity Brands, Inc.. . . . . . . . . . . . . . . 8-12

North Carolina State Board of Dental  Examiners v. Federal Trade Commission . . . . . . . . . . . . . . 50-26

Steinberg v. United States . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12-3

Nye Capital Appreciation Partners, L.L.C. v. Nemchik. . . . . 45-5

Stratford v. Long . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24-19

Obergefell v. Hodges . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3-30

Stuart v. Pittman. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27-3

Obsidian Finance Group, LLC v. Cox . . . . . . . . . . . . . . . . . . 6-24

Supply Chain Assocs., LLC v. ACT Electronics, Inc.. . . . . 41-14

O’Connor v. Oakhurst Dairy. . . . . . . . . . . . . . . . . . . . . . . . . . 1-19

Suture Express, Inc. v. Owens & Minor Distribution, Inc.. . 49-20

Olmsted v. Saint Paul Public Schools. . . . . . . . . . . . . . . . . . 13-15

Synergies3 Tec Services, LLC v. Corvo . . . . . . . . . . . . . . . . 36-11

Omnicare, Inc. v. NCS Healthcare, Inc.. . . . . . . . . . . . . . . . . 43-7

Tan v. Arnel Management Company . . . . . . . . . . . . . . . . . . 25-13

Paciaroni v. Crane . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 39-10

Tedeton v. Tedeton. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .42-14

Palmatier v. Wells Fargo Financial National Bank. . . . . . . . . 29-4 Paramount Communications, Inc. v. Time, Inc.. . . . . . . . . . 43-18

The Industrial Development Board of the City of  Montgomery v. Russell. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17-11

Patterson v. CitiMortgage, Inc.. . . . . . . . . . . . . . . . . . . . . . . 13-12

Thomas v. Archer. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-15

Pearson v. Shalala. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .47-7

Timothy v. Keetch . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13-7

Pelican National Bank v. Provident Bank of Maryland . . . . 31-14

Toms v. Calvary Assembly of God, Inc.. . . . . . . . . . . . . . . . . 7-30

Pena v. Fox. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11-5

Town of Freeport v. Ring. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 32-3

Peterson v. AT&T Mobility Services, LLC. . . . . . . . . . . . . . 51-38 Philibert v. Kluser. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7-17

Toyo Tire North America  Manufacturing, Inc. v. Davis. . . . . . . . . . . . . . . . . . . . . . . . . . 6-35

Pittman v. Henry Moncure Motors. . . . . . . . . . . . . . . . . . . . 21-10

Trapani Construction Co. v. Elliot Group, Inc.. . . . . . . . . . . . 9-6

POM Wonderful LLC v. Coca-Cola Co.. . . . . . . . . . . . . . . . . 8-45

Treadwell v. J.D. Construction Co.. . . . . . . . . . . . . . . . . . . . . 36-7

POM Wonderful, LLC v.  Federal Trade Commission . . . . . 48-9

Tricontinental Industries, Ltd. v.  PricewaterhouseCoopers, LLP . . . . . . . . . . . . . . . . . . . . . . . 46-10

Price v. High Pointe Oil Company, Inc.. . . . . . . . . . . . . . . . . . 1-5 ProMedica Health System, Inc. v. Federal Trade  Commission. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 50-6 PWS Environmental, Inc. v. All Clear Restoration  and Remediation, LLC . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-14

South Dakota v. Wayfair, Inc.. . . . . . . . . . . . . . . . . . . . . . . . . . 3-5

Stephen A. Wheat Trust v. Sparks. . . . . . . . . . . . . . . . . . . . . . 13-4

Triffin v. Sinha. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 32-15 Trump Endeavor 12 LLC v. Fernich, Inc. d/b/a The  Paint Spot. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28-19 Tyson Foods, Inc. v. Bouaphakeo. . . . . . . . . . . . . . . . . . . . . . 2-21

Rasmussen v. Jackson . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 37-12

United States v. Anderson. . . . . . . . . . . . . . . . . . . . . . . . . . . . 5-35

Reynolds Health Care Services, Inc. v. HMNH, Inc.. . . . . . . 44-4

United States v. Domenic Lombardi Realty. . . . . . . . . . . . . 52-24

Riegel v. Medtronic, Inc.. . . . . . . . . . . . . . . . . . . . . . . . . . . . 20-37

United States v. Goyal. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 46-24

Rochester Gas and Electric Corporation. v. Delta Star. . . . 21-17

United States v. Hopkins. . . . . . . . . . . . . . . . . . . . . . . . . . . . 52-13

Rogers v. Household Life Insurance Co.. . . . . . . . . . . . . . . . .14-9

United States v. Hsiung. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 49-10

Rosenberg v. N.Y. State Higher Education Services Corp.. 30-16

United States v. Jensen . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 43-29

RR Maloan Investment v. New HGE. . . . . . . . . . . . . . . . . . 32-11

United States v. Jones . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5-17

Safeco Insurance Co. of America v. Burr. . . . . . . . . . . . . . . 48-20

United States v. Microsoft Corp.. . . . . . . . . . . . . . . . . . . . . . 49-28

SEC v. Dorozhko. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 45-37

United States v. Newman. . . . . . . . . . . . . . . . . . . . . . . . . . . . 45-40

Sekhar v. United States . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5-8

United States v. Ohio Edison Company. . . . . . . . . . . . . . . . . 52-5

Shaw v. United States. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5-13

United States v. Salman. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 45-41

Singh v. Uber Technologies Inc.. . . . . . . . . . . . . . . . . . . . . . 15-14

United States v. Southern Union Co. . . . . . . . . . . . . . . . . . . 52-20

xlii

List of Cases

United States Life Insurance Company in the City  of New York v. Wilson . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11-10

Wendzel v. Feldstein . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25-10

United Techs. Corp. v. Treppel. . . . . . . . . . . . . . . . . . . . . . . 44-14

Wilke v. Woodhouse Ford, Inc.. . . . . . . . . . . . . . . . . . . . . . . 20-25

Urbain v. Beierling. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 39-8

Winger v. CM Holdings, L.L.C.. . . . . . . . . . . . . . . . . . . . . . . 7-14

Utility Air Regulatory Group v. Environmental  Protection Agency. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 47-19

World Harvest Church v. Grange Mutual Casualty Co.. . . . 27-18

Valley Bank of Ronan v. Hughes. . . . . . . . . . . . . . . . . . . . . . 34-16

Woven Treasures v. Hudson Capital . . . . . . . . . . . . . . . . . . 29-13

Victory Clothing Co. v. Wachovia Bank, N.A.. . . . . . . . . . . 33-16

Wykeham Rise, LLC v. Federer . . . . . . . . . . . . . . . . . . . . . . 24-13

Volvo Trucks North America, Inc. v.  Reeder-Simco GMC, Inc. . . . . . . . . . . . . . . . . . . . . . . . . . . . 50-20

Yung-Kai Lu v. University of Utah . . . . . . . . . . . . . . . . . . . . 16-18

Wallis v. Brainerd Baptist Church. . . . . . . . . . . . . . . . . . . . . 17-14

Zaretsky v. William Goldberg Diamond Corp.. . . . . . . . . . . 19-14

Walters v. YMCA. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15-10

Zelnick v. Adams. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14-7

Weil v. Murray. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21-8

Zimmerman v. Allen . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26-6

Weissman v. City of New York. . . . . . . . . . . . . . . . . . . . . . . 23-15

ZUP, LLC v. Nash Manufacturing, Inc.. . . . . . . . . . . . . . . . . . 8-7

Welsh v. Lithia Vaudm, Inc. . . . . . . . . . . . . . . . . . . . . . . . . . . 12-9

Whitman v. American Trucking Associations . . . . . . . . . . . 47-10

World of Boxing LLC v. King. . . . . . . . . . . . . . . . . . . . . . . . 18-15

Zapata Corp. v. Maldonado. . . . . . . . . . . . . . . . . . . . . . . . . . 44-21

t One Part One Part One Part One Part One Part One Part One Part One Part One Part One Part One Part One t One Part One Part One Part One Part One Part One Part One Part One Part One Part One Part One Part One t One Part One Part One Part One Part One Part One Part One Part One Part One Part One Part One Part One t One Part One Part One Part One Part One Part One Part One Part One Part One Part One Part One Part One t One Part One Part One Part One Part One Part One Part One Part One Part One Part One Part One Part One t One Part One Part One Part One Part One One Part One Part One Part One Part One Part One Part One Part One t One Part One Part One Part One One Part One Part One Part One Part One Part One Part One Part One Part One t One Part One Part One One Part One Part One Part One Part One Part One Part One Part One Part One Part One

Part One

Chapter 1

The Nature of Law

Chapter 2

Foundations of American Law

The Resolution of Private Disputes

Chapter 3

Business and the Constitution

Chapter 4

Business Ethics, Corporate Social Responsibility, Corporate Governance, and Critical Thinking

Pixtal/AGE Fotostock

CHAPTER 1

The Nature of Law

A

ssume that you have taken on a management position at MKT Corp. If MKT is to make sound business decisions, you and your management colleagues must be aware of a broad array of legal considerations. These may range, to use a nonexhaustive list, from issues in contract, agency, and employment law to considerations suggested by tort, intellectual property, securities, and constitutional law. Sometimes, legal principles may constrain MKT’s business decisions; at other times, the law may prove a valuable ally of MKT in the successful operation of the firm’s business. Of course, you and other members of the MKT management group will rely on the advice of in-house counsel (an attorney who is an MKT employee) or of outside attorneys who are in private practice. The approach of simply “leaving the law to the lawyers,” however, is likely to be counterproductive. It will often be up to nonlawyers such as you to identify a potential legal issue or pitfall about which MKT needs professional guidance. If you fail to spot the issue in a timely manner and legal problems are allowed to develop and fester, even the most skilled attorneys may have difficulty rescuing you and the firm from the resulting predicament. If, on the other hand, your failure to identify a legal consideration means that you do not seek advice in time to obtain an advantage that applicable law would have provided MKT, the corporation may lose out on a beneficial opportunity. Either way—that is, whether the relevant legal issue operates as a constraint or offers a potential advantage—you and the firm cannot afford to be unfamiliar with the legal environment in which MKT operates. This may sound intimidating, but it need not be. The process of acquiring a working understanding of the legal environment of business begins simply enough with these basic questions: • What major types of law apply to the business activities and help shape the business decisions of firms such as MKT? • What ways of examining and evaluating law may serve as useful perspectives from which to view the legal environment in which MKT and other businesses operate? • What role do courts play in making or interpreting law that applies to businesses such as MKT and to employees of those firms, and what methods of legal reasoning do courts utilize? • What is the relationship between legal standards of behavior and notions of ethical conduct?

LO

LEARNING OBJECTIVES After studying this chapter, you should be able to: 1-1

Identify the respective makers of the different types of law (constitutions, statutes, common law, and administrative regulations and decisions). 1-2 Identify the type of law that takes precedence when two types of law conflict.

1-3 Explain the basic differences between the criminal law and civil law classifications. 1-4 Describe key ways in which the major schools of jurisprudence differ from each other.

1-4

Part One Foundations of American Law

1-5 Describe the respective roles of adhering to precedent (stare decisis) and distinguishing precedent in case law reasoning.

Types and Classifications of Law The Types of Law Identify the respective makers of the different types of law

LO1-1 (constitutions, statutes, common law, and administrative

regulations and decisions).

Constitutions Constitutions, which exist at the state and federal levels, have two general functions.1 First, they set up the structure of government for the political unit they control (a state or the federal government). This involves creating the branches and subdivisions of the government and stating the powers given and denied to each. Through its separation of powers, the U.S. Constitution establishes the Congress and gives it power to make law in certain areas, provides for a chief executive (the president) whose function is to execute or enforce the laws, and helps create a federal judiciary to interpret the laws. The U.S. Constitution also structures the relationship between the federal government and the states. In the process, it respects the principle of federalism by recognizing the states’ power to make law in certain areas. The second function of constitutions is to prevent the government from taking certain actions or passing certain laws, sometimes even if those actions or laws would otherwise appear to fall within the authority granted to the government under the first function. Constitutions do so mainly by prohibiting government action that restricts certain individual rights. The Bill of Rights to the U.S. Constitution is an example. You could see the interaction of those two functions, for instance, where Congress is empowered to regulate interstate commerce but cannot do so in a way that would abridge the First Amendment’s free speech guarantee. Statutes Statutes are laws created by elected representatives in Congress or a state legislature. They are stated in an authoritative form in statute books or codes. As you will see, however, their interpretation and application are often difficult. Chapter 3 discusses constitutional law as it applies to government regulation of business. 1

1-6 Identify what courts focus on when applying the major statutory interpretation techniques (plain meaning, legislative purpose, legislative history, and general public purpose).

Throughout this text, you will encounter state statutes that were originally drafted as uniform acts. Uniform acts are model statutes drafted by private bodies of lawyers and scholars. They do not become law until a legislature enacts them. Their aim is to produce state-by-state uniformity on the subjects they address. Examples include the Uniform Commercial Code (which deals with a wide range of commercial law subjects), the Revised Uniform Partnership Act, and the Revised Model Business Corporation Act. Common Law The common law (also called judge-made law or case law) is law made and applied by judges as they decide cases not governed by statutes or other types of law. Although, as a general matter, common law exists only at the state level, both state courts and federal courts become involved in applying it. The common law originated in medieval England and developed from the decisions of judges in settling disputes. Over time, judges began to follow the decisions of other judges in similar cases, called precedents. This practice became formalized in the doctrine of stare decisis (let the decision stand). As you will see later in the chapter, stare decisis is not completely rigid in its requirement of adherence to precedent. It is flexible enough to allow the common law to evolve to meet changing social conditions. The common law rules in force today, therefore, often differ considerably from the common law rules of earlier times. The common law came to America with the first English settlers, was applied by courts during the colonial period, and continued to be applied after the Revolution and the adoption of the Constitution. It still governs many cases today. For example, the rules of tort, contract, and agency discussed in this text are mainly common law rules. In some instances, states have codified (enacted into statute) some parts of the common law. States and the federal government have also passed statutes superseding the common law in certain situations. As discussed in Chapter 9, for example, the states have established special rules for contract cases involving the sale of goods by enacting Article 2 of the Uniform Commercial Code.



Chapter One The Nature of Law

This text’s torts, contracts, and agency chapters often refer to the Restatement—or Restatement (Second) or (Third)—rule on a particular subject. The Restatements are collections of common law (and occasionally statutory) rules covering various areas of the law. Because they are written by the American Law Institute rather than by courts, the Restatements are not law and do not bind courts. However, state courts often find Restatement rules persuasive and adopt them as common law rules within their states. The Restatement rules usually are the rules followed by a majority of the states. Occasionally, however, the Restatements stimulate changes in the common law by suggesting new rules that the courts later decide to follow.

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Because the judge-made rules of common law apply only when there is no applicable statute or other type of law, common law fills in gaps left by other legal rules if sound social and public policy reasons call for those gaps to be filled. As a result, with regard to the common law, judges sometimes serve in the unexpected role of crafting legal rules in addition to interpreting the law. In Price v. High Pointe Oil Company, Inc., which follows shortly, the court surveys the relevant legal landscape and concludes that a longstanding common law rule should remain in effect. A later section in the chapter will focus on the process of case law reasoning, in which courts engage when they make and apply common law rules. That process is exemplified by the first half of the Price opinion.

Price v. High Pointe Oil Company, Inc.   828 N.W.2d 660 (Mich. 2013) In 2006, Beckie Price replaced the oil furnace in her house with a propane furnace. The oil furnace was removed, but the pipe that had been used to fill the furnace with oil remained in place. At the time the furnace was replaced, Price canceled her contract for oil refills with the predecessor of High Pointe Oil Company, the defendant. Somehow, though, in November 2007, High Pointe mistakenly placed Price’s address back on its “keep full list.” Subsequently, a High Pointe truck driver pumped around 400 gallons of fuel oil into Price’s basement through the oil-fill pipe before realizing the mistake. Price’s house and her belongings were destroyed. The house was eventually torn down, the site was remediated, and a new house was built on a different part of Price’s property. Price’s personal property was all cleaned or replaced. All of her costs related to her temporary homelessness were reimbursed to her, as well. Thus, she was fully compensated for all of her economic losses resulting from High Pointe’s error. Nevertheless, Price sued High Pointe alleging a number of claims. The only of her claims to survive to trial was one focused on her noneconomic losses—for example, pain and suffering, humiliation, embarrassment, and emotional distress. A jury found in Price’s favor and awarded her $100,000 in damages. High Pointe filed an appeal to the intermediate appellate court but lost. High Pointe then appealed to the Michigan Supreme Court, excerpts of whose opinion is below. Markman, J. III. Analysis The question in this case is whether noneconomic damages are recoverable for the negligent destruction of real property. Absent any relevant statute, the answer to that question is a matter of common law.  A. Common Law As this Court explained in [a prior case], the common law “is but the accumulated expressions of the various judicial tribunals in their efforts to ascertain what is right and just between individuals in respect to private disputes[.]” The common law, however, is not static. By its nature, it adapts to changing circumstances. . . . The common law is always a work in progress and typically develops incrementally, i.e., gradually evolving as individual disputes are decided and existing common-law rules are considered and sometimes adapted to current needs in light of changing times and circumstances.

The common-law rule with respect to the damages recoverable in an action alleging the negligent destruction of property was set forth in [a 1933 case]: If injury to property caused by negligence is permanent or irreparable, the measure of damages is the difference in its market value before and after said injury, but if the injury is reparable, and the expense of making repairs is less than the value of the property, the measure of damages is the cost of making repairs. Michigan common law has continually followed [that] rule. . . . Accordingly, the long-held common-law rule in Michigan is that the measure of damages for the negligent destruction of property is the cost of replacement or repair. Because replacement and repair costs reflect economic damages, the logical implication of this rule is that the measure of damages excludes noneconomic damages. Lending additional support to this conclusion is the simple fact that, before the Court of Appeals’ opinion below, no case ever in the history of the Michigan common law has approvingly discussed the recovery of noneconomic damages for the negligent

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destruction of property. Indeed, no case has even broached this issue except through the negative implication arising from limiting damages for the negligent destruction or damage of property to replacement and repair costs. . . . Moreover, the Court of Appeals has decided two relatively recent cases concerning injury to personal property in which noneconomic damages were disallowed. In Koester v. VCA Animal Hospital, the plaintiff dog owner sought noneconomic damages . . . against his veterinarian following the death of his dog . . . . The trial court [ruled in favor of the veterinarian], holding that “emotional damages for the loss of a dog do not exist.” On appeal, the Court of Appeals affirmed, noting that pets are personal property under Michigan law and explaining that there “is no Michigan precedent that permits the recovery of damages for emotional injuries allegedly suffered as a consequence of property damage.” Later, in Bernhardt v. Ingham Regional Medical Center, the plaintiff [accidentally left] her grandmother’s 1897 wedding ring (which was also her wedding ring) and a watch purchased in 1980 around the time of her brother’s murder . . . in the [hospital’s] washbasin and left the hospital. Upon realizing her mistake, the plaintiff contacted the defendant and was advised that she could retrieve the jewelry from hospital security. However, when she tried to retrieve the jewelry, it could not be located. The plaintiff sued, and the defendant . . . argu[ed] that the plaintiff’s damages did not exceed the $25,000 [minimum amount for a valid case in the] trial court. The plaintiff countered that her damages exceeded that limit because the jewelry possessed great sentimental value. The trial court granted the defendant’s motion. On appeal, the Court of Appeals affirmed, citing Koester for the proposition that there “is no Michigan precedent that permits the recovery of damages for emotional injuries allegedly suffered as a consequence of property damage”. . . . In support of its conclusion, Bernhardt quoted the following language from the Restatement Second of Torts: If the subject matter cannot be replaced, however, as in the case of a destroyed or lost family portrait, the owner will be compensated for its special value to him, as evidenced by the original cost, and the quality and condition at the time of the loss. . . . In these cases, however, damages cannot be based on sentimental value. Compensatory damages are not given for emotional distress caused merely by the loss of the things, except that in unusual circumstances damages may be awarded for humiliation caused by deprivation, as when one is deprived of essential elements of clothing. While Koester and Bernhardt both involved negligent injury to personal property, they speak of property generally. Although the Court of Appeals in the instant case seeks to draw distinctions between personal and real property, neither that Court nor plaintiff has explained how any of those distinctions, even if they had some pertinent foundation in the law, are relevant with regard to

the propriety of awarding noneconomic damages. In short, while it is doubtlessly true that many people are highly emotionally attached to their houses, many people are also highly emotionally attached to their pets, their heirlooms, their collections, and any number of other things. But there is no legally relevant basis that would logically justify prohibiting the recovery of noneconomic damages for the negligent killing of a pet or the negligent loss of a family heirloom but allow such a recovery for the negligent destruction of a house. Accordingly, Koester and Bernhardt underscore [the long-standing] exclusion of noneconomic damages for negligent injury to real and personal property. Finally, we would be remiss if we did not address Sutter v. Biggs, which the Court of Appeals cited as providing the “general rule” for the recovery of damages in tort actions. Sutter stated: The general rule, expressed in terms of damages, and long followed in this State, is that in a tort action, the [party that committed the tort] is liable for all injuries resulting directly from his wrongful act, whether foreseeable or not, provided the damages are the legal and natural consequences of the wrongful act, and are such as, according to common experience and the usual course of events, might reasonably have been anticipated. Remote contingent, or speculative damages are not considered in conformity to the general rule. Although Sutter articulates a “general rule,” it is a “general rule” that has never been applied to allow the recovery of noneconomic damages in a case involving only property damage, and it is a “general rule” that must be read in light of the more narrow and specific “general rule” [that Michigan has always followed with regard to the noneconomic damages exclusion in cases involving property damage]. The development of the common law frequently yields “general rules” from which branch more specific “general rules” that apply in limited circumstances. Where tension exists between those rules, the more specific rule controls. . . . With respect to this case, although Sutter articulated a general rule, [the rule excluding noneconomic damages for property damages is] a more specific “general rule”. . . . Accordingly, because this case involves only property damage, the [latter] rule . . . controls. B. Altering the Common Law Because the Court of Appeals determined that the “general rule” is that “in a tort action, the [party who committed the tort] is liable for all injuries,” the Court of Appeals contended that it was not altering the common law but, rather, “declin[ing] to extend” to real property the personal property “exception” set forth in Koester and Bernhardt. However, as previously mentioned, the Court of Appeals’ opinion constitutes the first and only Michigan case to support the recovery of noneconomic damages for the negligent destruction of property. Accordingly, contrary to the Court of Appeals’ own characterization and for the reasons



Chapter One The Nature of Law

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discussed [above], the Court of Appeals’ holding represents an alteration of the common law. With that understanding, we address whether the common law should be altered. “This Court is the principal steward of Michigan’s common law,” . . . and it is “axiomatic that our courts have the constitutional authority to change the common law in the proper case. . . .” However, this Court has also explained that alteration of the common law should be approached cautiously with the fullest consideration of public policy and should not occur through sudden departure from longstanding legal rules. . . . Among them has been our attempt to “avoid capricious departures from bedrock legal rules as such tectonic shifts might produce unforeseen and undesirable consequences.” . . . As this emphasis on incrementalism suggests, when it comes to alteration of the common law, the traditional rule must prevail absent compelling reasons for change. This approach ensures continuity and stability in the law. With the foregoing principles in mind, we respectfully decline to alter the common-law rule that the appropriate measure of damages for negligently damaged property is the cost of replacement or repair. We are not oblivious to the reality that destruction of property or property damage will often engender considerable mental distress, and we are quite prepared to believe that the particular circumstances of the instant case were sufficient to have caused exactly such distress. However, we are persuaded that the present rule is a rational one and justifiable as a matter of reasonable public policy. We recognize that might also be true of alternative rules that could be constructed by this Court. In the final analysis, however, the venerability of the present rule and the lack of any compelling argument that would suggest its objectionableness in light of changing social and economic circumstances weigh, in our judgment, in favor of its retention. Because we believe the rule to be sound, if change is going to come, it must come by legislative alteration. A number of factors persuade us that the longstanding character of the present rule is not simply a function of serendipity or of judicial inertia, but is reflective of the fact that the rule serves legitimate purposes and values within our legal system. First, one of the most fundamental principles of our economic system is that the market sets the price of property. This is so even though every individual values property differently as a function of his or her own particular preferences. . . . Second, economic damages, unlike noneconomic damages, are easily

verifiable, quantifiable, and measurable. Thus, when measured only in terms of economic damages, the value of property is easily ascertainable. . . . Third, limiting damages to the economic value of the damaged or destroyed property limits disparities in damage awards from case to case. Disparities in recovery are inherent in legal matters in which the value of what is in dispute is neither tangible nor objectively determined, but rather intangible and subjectively determined. . . . Fourth, the present rule affords some reasonable level of certainty to businesses regarding the potential scope of their liability for accidents caused to property resulting from their negligent conduct. [U]nder the Court of Appeals’ rule, those businesses that come into regular contact with real ­property—contractors, repairmen, and fuel suppliers, for example—would be exposed to the uncertainty of not knowing whether their exposure to tort liability will be defined by a plaintiff who has an unusual emotional attachment to the property or by a jury that has an unusually sympathetic opinion toward those emotional attachments. Once again, it is not our view that the common-law rule in Michigan cannot be improved, or that it represents the best of all possible rules, only that the rule is a reasonable one and has survived for as long as it has because there is some reasonable basis for the rule and that no compelling reasons for replacing it have been set forth by either the Court of Appeals or plaintiff. We therefore leave it to the Legislature, if it chooses to do so at some future time, to more carefully balance the benefits of the current rule with what that body might come to view as its shortcomings.

Equity The body of law called equity historically concerned itself with accomplishing “rough justice” when common law rules would produce unfair results. In medieval England, common law rules were technical and rigid and the remedies available in common law courts were too few. This meant that some deserving parties could not obtain adequate relief. As

a result, separate equity courts began hearing cases that the common law courts could not resolve fairly. In these equity courts, procedures were flexible, and rigid rules of law were deemphasized in favor of general moral maxims. Equity courts also provided several remedies not available in the common law courts (which generally awarded

IV. Conclusion The issue in this case is whether noneconomic damages are recoverable for the negligent destruction of real property. No Michigan case has ever allowed a plaintiff to recover noneconomic damages resulting solely from the negligent destruction of property, either real or personal. Rather, the common law of this state has long provided that the appropriate measure of damages in cases involving the negligent destruction of property is simply the cost of replacement or repair of the negligently destroyed property. We continue today to adhere to this rule and decline to alter it. Accordingly, we reverse the judgment of the Court of Appeals and remand this case to the trial court for entry of summary disposition in defendant’s favor.

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Part One Foundations of American Law

only money damages or the recovery of property). The most important of these equitable remedies was—and continues to be—the injunction, a court order forbidding a party to do some act or commanding him to perform some act. Others include the contract remedies of specific performance (whereby a party is ordered to perform according to the terms of her contract), reformation (in which the court rewrites the contract’s terms to reflect the parties’ real intentions), and rescission (a cancellation of a contract and a return of the parties to their precontractual position). As was the common law, equity principles were brought to the American colonies and continued to be used after the Revolution and the adoption of the Constitution. Over time, however, the once-sharp line between law and equity has become blurred. Nearly all states have abolished separate equity courts and have enabled courts to grant whatever relief is appropriate, whether it be the legal remedy of money damages or one of the equitable remedies discussed earlier. Equitable principles have been blended together with common law rules, and some traditional equity doctrines have been restated as common law or statutory rules. An example is the doctrine of unconscionability discussed in Chapter 15. Administrative Regulations and Decisions As Chapter 47 reveals, the administrative agencies established by Congress and the state legislatures have acquired considerable power, importance, and influence over business. A major reason for the rise of administrative agencies was the collection of social and economic problems created by the industrialization of the United States that began late in the 19th century. Because legislatures generally lacked the time and expertise to deal with these problems on a continuing basis, the creation of specialized, expert agencies was almost inevitable. Administrative agencies obtain the ability to make law through a delegation (or grant) of power from the legislature. Agencies normally are created by a statute that specifies the areas in which the agency can make law and the scope of its power in each area. Often, these statutory delegations are worded so broadly that the legislature has, in effect, merely pointed to a problem and given the agency wide-ranging powers to deal with it. The two types of law made by administrative agencies are administrative regulations and agency decisions. As do statutes, administrative regulations appear in a precise form in one authoritative source. They differ from statutes, however, because the body enacting regulations is not an elected body. Many agencies have an internal courtlike structure that enables them to hear

cases arising under the statutes and regulations they enforce. The resulting agency decisions are legally binding, though appeals to the judicial system are sometimes allowed. Treaties According to the U.S. Constitution, ­treaties made by the president with foreign governments and approved by two-thirds of the U.S. Senate become “the supreme Law of the Land.” As will be seen, treaties invalidate inconsistent state (and sometimes federal) laws. Ordinances State governments have subordinate units that exercise certain functions. Some of these units, such as school districts, have limited powers. Others, such as counties, municipalities, and townships, exercise various governmental functions. The enactments of counties and municipalities are called ordinances; zoning ordinances are an example. Ordinances resemble statutes, and the techniques of statutory interpretation described later in this chapter typically are used to interpret ambiguous language in ordinances. Executive Orders In theory, the president or a state’s governor is a chief executive who enforces the laws but has no law-making powers. However, these officials sometimes have limited power to issue laws called executive orders. This power normally results from a legislative delegation.

Priority Rules LO1-2

Identify the type of law that takes precedence when two types of law conflict.

Because the different types of law may, from time to time, conflict, rules for determining which type takes priority are necessary. Here, we briefly describe the most important such rules. 1. According to the principle of federal supremacy, the U.S. Constitution, federal laws enacted pursuant to it, and treaties are the supreme law of the land. This means that federal law defeats conflicting state law. 2. Constitutions defeat other types of law within their domain. Thus, a state constitution defeats all other state laws inconsistent with it. The U.S. Constitution, however, defeats inconsistent laws of whatever type. 3. When a treaty conflicts with a federal statute over a purely domestic matter, the measure that is later in time usually prevails. 4. Within either the state or the federal domain, statutes defeat conflicting laws that depend on a legislative



Chapter One The Nature of Law

delegation for their validity. For example, a state statute defeats an inconsistent state administrative regulation. 5. Statutes and any laws derived from them by delegation defeat inconsistent common law rules. Accordingly, either a statute or an administrative regulation defeats a conflicting common law rule. Courts are careful to avoid finding a conflict between the different types of law unless the conflict is clear. In fact, one maxim of statutory interpretation (described later in this chapter) instructs courts to choose an interpretation that avoids unnecessary conflicts with other types of law, particularly constitutions that would preempt the statute. Statutes will sometimes explicitly state

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the enacting legislature’s intent to displace a common law rule. In the absence of that, though, courts will look for significant overlap and inconsistency between a statute and a common law rule to determine that there is a conflict for which the statute must take priority. The following Advance Dental Care, Inc. v. SunTrust Bank case illustrates this. Notice how the court first looks to the statutory language for explicit instruction regarding displacement of the common law rule. Then it considers whether the statute and common law rule overlap, particularly whether the statute offers a sufficient remedy to replace the common law rule. Finally, the court notes an important inconsistency between the statute and the common law rule.

Advance Dental Care, Inc. v. SunTrust Bank    816 F. Supp. 2d 268 (D. Md. 2011)

Michelle Rampersad was an employee of Advance Dental at its dental office in Prince George’s County, Maryland. During a period of more than three years ending in fall 2007, Rampersad took approximately 185 insurance reimbursement checks that were written to Advance Dental and endorsed them to herself. She then took the checks to SunTrust Bank and deposited them into her personal accounts. The checks totaled $400,954.04. Advance Dental filed a lawsuit against SunTrust after it discovered Rampersad’s unauthorized endorsement and deposit of the checks. The lawsuit claimed SunTrust violated two provisions of the Maryland version of the Uniform Commercial Code (UCC) dealing with negligence and conversion. It also stated a claim of negligence pursuant to the common law of Maryland. The court had previously dismissed the UCC negligence claim for reasons not relevant here. In the opinion that follows, the court considers whether Advance Dental’s common-law negligence claim has been displaced by the statutory UCC conversion claim. Alexander Williams, Jr., U.S. District Court Judge III. Legal Analysis In this case of first impression, the Court must determine whether section 3-420 of the Maryland U.C.C. [(the U.C.C. conversion provision)] displaces common-law negligence when a payee seeks to recover from a depositary bank that accepted unauthorized and fraudulently endorsed checks. A. Availability of an Adequate U.C.C. Remedy [C]ourts have held that common-law negligence claims can proceed only in the absence of an adequate U.C.C. remedy. In the present case, it is indisputable that Advance Dental has an adequate U.C.C. remedy—conversion—for which Advance Dental has already filed a claim. Therefore, in light of the overwhelming case law, . . . [the U.C.C. conversion provision] displaces common-law negligence because Advance Dental has an adequate U.C.C. remedy. B. Indistinct Causes of Action with Conflicting Defenses Statutory authority also emphasizes the necessity of displacing common-law negligence in this case. Section 1-103(b) of

the Maryland U.C.C. establishes the U.C.C.’s position regarding the survival of common-law actions alongside the U.C.C.: “[u]nless displaced by the particular provisions of Titles 1-10 of this article, the principles of law and equity . . . shall supplement its provisions. . . .” Since the U.C.C. has no express “displacement” provision, the Court must determine whether [the U.C.C. conversion provision] is a “particular provision” that displaces the common law. The Court finds significant overlap between [the U.C.C. conversion provision] and common-law negligence. [The U.C.C. conversion provision] defines conversion as “payment with respect to [an] instrument for a person not entitled to enforce the instrument or receive payment.” Here, Advance Dental alleges that SunTrust is liable in negligence for allowing Rampersad to fraudulently endorse and deposit checks made payable to Advance Dental into her personal account. Therefore, . . . both negligence and conversion require a consideration of whether there was payment over a wrongful endorsement. The duplicative nature of these two theories suggests the U.C.C.’s intention to create a comprehensive regulation of payment over unauthorized or fraudulent endorsements. . . . In the presence

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Part One Foundations of American Law

of such intent, courts have preempted common-law claims. To do otherwise would destroy the U.C.C.’s attempt to establish reliability, uniformity, and certainty in commercial transactions. Here, Advance Dental’s common-law negligence action has no independent significance apart from [the U.C.C. conversion provision]. In fact, when discussing common-law negligence, Advance Dental simply refers to the same conduct alleged in Count I (conversion) to argue that SunTrust has breached its duty of reasonable and ordinary care. . . . In other words, [the U.C.C. conversion provision] has effectively subsumed common-law negligence claims. Not only is common-law negligence insufficiently distinct from [the U.C.C. conversion provision], but the conflicting

defenses available for each cause of action are also problematic. The U.C.C. is based on the principle of comparative negligence. In contrast, contributory negligence remains a defense for common-law negligence.[2] Displacement is thus required since Maryland courts “hesitate to adopt or perpetuate a common law rule that would be plainly inconsistent with the legislature’s intent. . . .”

Classifications of Law Three common classifi-

of substantive law. A statute making murder a crime, for example, is a rule of substantive law. The rules describing the proper conduct of a trial, however, are procedural. This text focuses on substantive law, although Chapters 2 and 5 examine some of the procedural rules governing civil and criminal cases.

cations of law cut across the different types of law. These classifications involve distinctions between (1) criminal law and civil law; (2) substantive law and procedural law; and (3) public law and private law. One type of law might be classified in each of these ways. For example, a burglary statute would be criminal, substantive, and public; a rule of contract law would be civil, substantive, and private. LO1-3

Explain the basic differences between the criminal law and civil law classifications.

Criminal and Civil Law Criminal law is the law under which the government prosecutes someone for committing a crime. It creates duties that are owed to the public as a whole. Civil law mainly concerns obligations that private parties owe to each other. It is the law applied when one private party sues another. The government, however, may also be a party to a civil case. For example, a city may sue, or be sued by, a construction contractor. Criminal penalties (e.g., imprisonment or fines) differ from civil remedies (e.g., money damages or equitable relief). Although most of the legal rules in this text are civil law rules, Chapter 5 deals specifically with the criminal law. Even though the civil law and the criminal law are distinct bodies of law, the same behavior will sometimes violate both. For instance, if A commits an intentional act of physical violence on B, A may face both a criminal prosecution by the state and B’s civil suit for damages. Substantive Law and Procedural Law Substantive law sets the rights and duties of people as they act in society. Procedural law controls the behavior of government bodies (mainly courts) as they establish and enforce rules

IV. Conclusion For the foregoing reasons [and reasons not included in this edited version of the opinion], the Court GRANTS Defendant’s Renewed Motion to Dismiss Count III of Plaintiff’s Complaint.

Public and Private Law Public law concerns the powers of government and the relations between government and private parties. Examples include constitutional law, administrative law, and criminal law. Private law establishes a framework of legal rules that enables parties to set the rights and duties they owe each other. Examples include the rules of contract, property, and agency.

Jurisprudence LO1-4

Describe key ways in which the major schools of jurisprudence differ from each other.

The various types of law sometimes are called positive law. Positive law comprises the rules that have been laid down by a recognized political authority. Knowing the types of positive law is essential to an understanding of the American legal system and the topics discussed in this text.

The comparative and contributory negligence defenses are discussed in detail in Chapter 7. They address in different manners whether and to what extent a plaintiff’s own negligence in the actions upon which a claim is based ought to excuse the defendant from liability. Here the defenses would be relevant in that SunTrust might argue that Advance Dental was at fault for failing to discover and to prevent Rampersad’s fraudulent activities on its own. 2



Chapter One The Nature of Law

Yet defining law by listing these different kinds of positive law is no more complete or accurate than defining “automobile” by describing all the vehicles going by that name. To define law properly, some say, we need a general description that captures its essence. The field known as jurisprudence seeks to provide such a description. Over time, different schools of jurisprudence have emerged, each with its own distinctive view of the essence of the law.

Legal Positivism One feature common to all types

of law is their enactment by a governmental authority such as a legislature or an administrative agency. This feature underlies the definition of law that characterizes the school of jurisprudence known as legal positivism. Legal positivists define law as the command of a recognized political authority. As the British political philosopher Thomas Hobbes observed, “Law properly, is the word of him, that by right hath command over others.” The commands of recognized political authorities may be good, bad, or indifferent in moral terms. To legal positivists, such commands are valid law regardless of their “good” or “bad” content. In other words, positivists see legal validity and moral validity as entirely separate questions. Some (but not all) positivists say that every properly enacted positive law should be enforced and obeyed, whether just or unjust. Similarly, a judge who views the law through a positivist lens would typically try to enforce the law as written, excluding her own moral views from the process. Note, however, that this does not mean that a positivist is bound to accept the law as static or unchangeable. Rather, a positivist who was unhappy with the law as written would point to established political processes as the appropriate mechanism for the law to evolve (e.g., by lobbying a legislature to amend or repeal a statute).

Natural Law At first glance, legal positivism’s “law is

law, just or not” approach may seem to be perfect common sense. It presents a problem, however, for it could mean that any positive law—no matter how unjust—is valid law and should be enforced and obeyed so long as some recognized political authority enacted it. The school of jurisprudence known as natural law rejects the positivist separation of law and morality. Natural law adherents usually contend that some higher law or set of universal moral rules binds all human beings in all times and places. The Roman statesman Marcus Cicero described natural law as “the highest reason, implanted in nature, which commands what ought to be done and forbids the opposite.” Because this higher law

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determines what is ultimately good and ultimately bad, it serves as a criterion for evaluating positive law. To Saint Thomas Aquinas, for example, “every human law has just so much of the nature of law, as it is derived from the law of nature.” To be genuine law, in other words, positive law must resemble the law of nature by being “good”—or at least by not being “bad.” Unjust positive laws, then, are not valid law under the natural law view. As Cicero put it: “What of the many deadly, the many pestilential statutes which are imposed on peoples? These no more deserve to be called laws than the rules a band of robbers might pass in their assembly.” An “unjust” law’s supposed invalidity does not translate into a natural law defense that is recognized in court, however. Nonetheless, judges may sometimes take natural law-oriented views into account when interpreting the law. As compared with positivist judges, judges influenced by natural law ideas may be more likely to read constitutional provisions broadly in order to strike down positive laws they regard as unjust. They also may be more likely to let morality influence their interpretation of the law. Of course, neither judges nor natural law thinkers always agree about what is moral and immoral—a major difficulty for the natural law position. This difficulty allows legal positivists to claim that only by keeping legal and moral questions separate can we obtain stability and predictability in the law.

American Legal Realism To some, the debate

between natural law and legal positivism may seem disconnected from reality. Not only is natural law unworkable, such people might say, but sometimes positive law does not mean much either. For example, juries sometimes pay little attention to the legal rules that are supposed to guide their decisions, and prosecutors have discretion concerning whether to enforce criminal statutes. In some legal proceedings, moreover, the background, biases, and values of the judge—and not the positive law—drive the result. An old joke reminds us that justice sometimes is what the judge ate for breakfast. Remarks such as these typify the school of jurisprudence known as American legal realism. Legal realists regard the law in the books as less important than the law in action—the conduct of those who enforce and interpret the positive law. American legal realism defines law as the behavior of public officials (mainly judges) as they deal with matters before the legal system. Because the actions of such decision makers—and not the rules in the books—really affect people’s lives, the realists say, this behavior is what deserves to be called law.

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It is doubtful whether the legal realists have ever developed a common position on the relation between law and morality or on the duty to obey positive law. They have been quick, however, to tell judges how to behave. Many realists feel that the modern judge should be a social engineer who weighs all relevant values and considers social science findings when deciding a case. Such a judge would make the positive law only one factor in her decision. Because judges inevitably base their decisions on personal considerations, the realists assert, they should at least do this honestly and intelligently. To promote this kind of decision making, the realists have sometimes favored fuzzy, discretionary standards that allow judges to decide each case according to its unique facts.

Sociological

Jurisprudence  Sociological jurisprudence is a general label uniting several different approaches that examine law within its social context. The following quotation from Justice Oliver Wendell Holmes is consistent with such approaches: The life of the law has not been logic: it has been experience. The felt necessities of the time, the prevalent moral and political theories, intuitions of public policy, avowed or unconscious, even the prejudices which judges share with their fellow-men, have had a good deal more to do than the syllogism in determining the rules by which men should be governed. The law embodies the story of a nation’s development through many centuries, and it cannot be dealt with as if it contained only the axioms and corollaries of a book of mathematics.3

Despite these approaches’ common outlook, there is no distinctive sociological definition of law. If one were attempted, it might go as follows: Law is a process of social ordering reflecting society’s dominant interests and values. Different Sociological Approaches By examining examples of sociological legal thinking, we can add substance to the definition just offered. The “dominant interests” portion of the definition is exemplified by the writings of Roscoe Pound, an influential 20th-century American legal philosopher. Pound developed a detailed and changing catalog of the social interests that press on government and the legal system and thus shape positive law. An example of the definition’s “dominant values” component is the historical school of jurisprudence identified with the 19th-century German legal philosopher Friedrich Karl von Savigny. Savigny saw law as an unplanned, almost unconscious, reflection of the collective spirit of a particular society. In his view,

Oliver Wendell Holmes, The Common Law (1881).

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legal change could only be explained historically, as a slow response to social change. By emphasizing the influence of dominant social interests and values, Pound and Savigny undermine the legal positivist view that law is nothing more than the command of some political authority. The early 20th-century Austrian legal philosopher Eugen Ehrlich went even further in rejecting positivism. He did so by identifying two different “processes of social ordering” contained within our definition of sociological jurisprudence. The first of these is positive law. The second is the “living law,” informal social controls such as customs, family ties, and business practices. By regarding both as law, Ehrlich sought to demonstrate that positive law is only one element within a spectrum of social controls. The Implications of Sociological Jurisprudence  Because its definition of law includes social values, sociological jurisprudence seems to resemble natural law. Most sociological thinkers, however, are concerned only with the fact that moral values influence the law, and not with the goodness or badness of those values. Thus, it might seem that sociological jurisprudence gives no practical advice to those who must enforce and obey positive law. Sociological jurisprudence has at least one practical implication, however: a tendency to urge that the law must change to meet changing social conditions and values. In other words, the law should keep up with the times. Some might stick to this view even when society’s values are changing for the worse. To Holmes, for example, “[t]he first requirement of a sound body of law is, that it should correspond with the actual feelings and demands of the community, whether right or wrong.”

Other Schools of Jurisprudence During the past half century, legal scholars have fashioned additional ways of viewing law, explaining why legal rules are as they are and exploring supposed needs for changes in legal doctrines. For example, the law and economics movement examines legal rules through the lens provided by economic theory and analysis. This movement’s influence has extended beyond academic literature, with law and economics-oriented considerations, factors, and tests sometimes appearing in judicial opinions dealing with such matters as contract, tort, or antitrust law. The critical legal studies (CLS) movement regards law as inevitably the product of political calculation (mostly of the right-wing variety) and longstanding class biases on the part of lawmakers, including judges. Articles published by CLS adherents provide controversial assessments and critiques of legal rules. Given the thrust of CLS and the view it takes of



Chapter One The Nature of Law

lawmakers, however, one would be hard-pressed to find CLS adherents in the legislature or the judiciary. Other schools of jurisprudence that have acquired notoriety in recent years examine law and the legal system from the vantage points of particular groups of persons or sets of ideas. Examples include feminist and queer legal theory and critical disability theory. As you read the excerpts of judicial opinions throughout this text, consider whether one or more of these jurisprudential approaches appear to have influenced the judges’ thinking when interpreting or applying the law. Certainly judges seldom, if ever, explicitly reference those influences, but you may find them lurking significantly between the lines of some of the opinions.

The Functions of Law In societies of the past, people often viewed law as unchanging rules that deserved obedience because they were part of the natural order of things. Most lawmakers today, however, treat law as a flexible tool or instrument for the accomplishment of chosen purposes. For example, the law of negotiable instruments discussed later in this text is designed to stimulate commercial activity by promoting the free movement of money substitutes such as promissory notes, checks, and drafts. Throughout the text, moreover, you see courts manipulating existing legal rules to achieve desired results. One strength of this instrumentalist attitude is its willingness to adapt the law to further the social good. A weakness, however, is the legal instability and uncertainty those adaptations often produce. Just as individual legal rules advance specific purposes, law as a whole serves many general social functions. Among the most important of those functions are: 1. Peacekeeping. The criminal law rules discussed in Chapter 5 further this basic function of any legal system. Also, as Chapter 2 suggests, the resolution of private disputes serves as a major function of the civil law. 2. Checking government power and promoting personal freedom. Obvious examples are the constitutional restrictions examined in Chapter 3. 3. Facilitating planning and the realization of reasonable expectations. The rules of contract law discussed in Chapters 9, 10, 11, 12, 13, 14, 15, 16, 17, and 18 help fulfill this function of law. 4. Promoting economic growth through free competition. The antitrust laws discussed in Chapters 48, 49, and 50 are among the many legal rules that help perform this function.

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5. Promoting social justice. Throughout this century, government has intervened in private social and economic affairs to correct perceived injustices and give all citizens equal access to life’s basic goods. Examples include some of the employment laws addressed in Chapter 51. 6. Protecting the environment. The most important federal environmental statutes are discussed in Chapter 52. Obviously, the law’s various functions can conflict. The familiar clash between economic growth and environmental protection is an example. Chapter 5’s cases dealing with the constitutional aspects of criminal cases illustrate the equally familiar conflict between effective law enforcement and the preservation of personal rights. Only rarely does the law achieve one end without sacrificing others. In law, as in life, there generally is no such thing as a free lunch. Where the law’s objectives conflict, lawmakers may try to strike the best possible balance among those goals. This suggests limits on the law’s usefulness as a device for promoting particular social goals.

Legal Reasoning This text seeks to describe important legal rules affecting business. As texts generally do, it states those rules in what lawyers call “black letter” form, using sentences saying that certain legal consequences will occur if certain events happen. Although it provides a clear statement of the law’s commands, this black letter approach can be misleading. It suggests definiteness, certainty, permanence, and ­predictability—attributes the law frequently lacks. To illustrate, and to give you some idea how lawyers and judges think, we now discuss the two most important kinds of legal reasoning: case law reasoning and statutory interpretation.4 However, we first must examine legal reasoning in general. Legal reasoning is basically deductive, or syllogistic. The legal rule is the major premise, the facts are the minor premise, and the result is the product of combining the two. Suppose a state statute says that a driver operating an automobile between 55 and 70 miles per hour must pay a $50 fine (the rule or major premise) and that Jim Smith drives his car at 65 miles per hour (the facts or minor premise). If Jim is arrested, and if the necessary facts can be proved, he will be required to pay the $50 fine. As you will

The reasoning courts employ in constitutional cases resembles that used in common law cases, but often is somewhat looser. See Chapter 3. 4

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Ethics and Compliance in Action Some schools of jurisprudence discussed in this chapter concern themselves with the relationship between law and notions of morality. These schools of jurisprudence involve considerations related to key aspects of ethical theories, which address ethical issues arising in business contexts, corporate governance, and compliance. Chapter 4 defines major ethical theories. Chapter 44 discusses corporate governance issues in more detail. And compliance, which refers to the processes by which an organization polices its own behavior to ensure that it conforms to applicable laws, is addressed throughout this text. In this Ethics and Compliance in Action feature, we will focus on those parallel considerations between two schools of jurisprudence and several ethical theories.

now see, however, legal reasoning often is more difficult than this example would suggest.

Case Law Reasoning Describe the respective roles of adhering to precedent

LO1-5 (stare decisis) and distinguishing precedent in case law

reasoning.

In cases governed by the common law, courts find the appropriate legal rules in prior cases called precedents. The standard for choosing and applying prior cases to decide present cases is the doctrine of stare decisis, which states that like cases should be decided alike. That is, the present case should be decided in the same way as past cases presenting the same facts and the same legal issues. If no applicable precedent exists, the court is free to develop a new common law rule to govern the case, assuming the court believes that sound public policy reasons call for the development of a new rule. When an earlier case may seem similar enough to the present case to constitute a precedent, but the court deciding the present case nevertheless identifies a meaningful difference between the cases, the court distinguishes the earlier decision. Because every present case differs from the precedents in some respect, it is always possible to spot a factual distinction. For example, one could attempt to distinguish a prior case dealing with a defense to a claim of breach of contract because both parties in that case had black hair, whereas one party in the present case dealing with that same defense has brown hair. Of course, such a distinction would be ridiculous because the difference it identifies is insignificant in moral, social policy, or legal terms. A valid distinction involves a

Natural law’s focus on rights thought to be independent of positive law has parallels in ethical theories that are classified under the rights theory heading. In its concern over unjust laws, natural law finds common ground with the ethical theory known as justice theory. When subscribers to sociological jurisprudence focus on the many influences that shape law and the trade-offs involved in a dynamic legal system, they may explore considerations that relate not only to rights theory or justice theory but also to the theory of utilitarianism and considerations central to shareholder theory. As you study Chapter 4 and later chapters, keep the schools of jurisprudence in mind. Think of them as you consider the extent to which a behavior’s probable legal treatment and the possible ethical assessments of it may correspond or, instead, diverge.

widely accepted ethical or policy reason for treating the present case differently from its predecessor. Because people disagree about moral ideas, public policies, and the degree to which they are accepted, and because all these factors change over time, judges may differ on the wisdom of distinguishing a prior case. This is a source of uncertainty in the common law, but it gives the common law the flexibility to adapt to changing social conditions.5 When a precedent has been properly distinguished, the common law rule it stated does not control the present case. The court deciding the present case may then fashion a new common law rule to govern the case. Consider, for instance, an example involving the employment-at-will rule, the prevailing common law rule regarding employees in the United States. Under this rule, an employee may be fired at any time—and without any reason, let alone a good one— unless a contract between the employer and the employee guaranteed a certain duration of employment or established that the employee could be fired only for certain recognized legal causes. Most employees are not parties to a contract containing such provisions. Therefore, they are employees-at-will. Assume that in a precedent case, an employee who had been doing good work challenged his firing and that the court hearing the case ruled against him on the basis of the employment-at-will rule. Also assume that in a later case, a fired employee has challenged her dismissal. Although the fired employee would appear to be subject to the ­employment-at-will rule applied in the seemingly similar precedent case, the court deciding the later case nevertheless identifies an important difference: that in the later case, Also, though they exercise the power infrequently, courts sometimes completely overrule their own prior decisions. 5



Chapter One The Nature of Law

the employee was fired in retaliation for having reported to law enforcement authorities that her employer was engaging in seriously unlawful business-related conduct. A firing under such ­circumstances appears to offend public policy notwithstanding the general acceptance of the employmentat-will rule. Having properly distinguished the precedent, the court deciding the later case would not be bound by the employment-at-will rule set forth in the precedent and would be free to develop a public policy–based exception under which the retaliatory firing would be deemed wrongful. (Chapter 51 will reveal that courts in a number of states have adopted such an exception to the employment-at-will rule.) The Coomer case, which follows, provides a further illustration of the process of case law reasoning. In Coomer, the Missouri Supreme Court scrutinizes various precedents as it attempts to determine whether Missouri’s courts should extend the so-called baseball rule, under which injuries

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suffered as a result of certain risks that are inherent to an activity—like being struck by a foul ball at a baseball game — are not legally considered to be the fault of the baseball team or stadium, even though it was theoretically possible for the team or stadium to have done more to protect the injured person from the risk. (Negligence law, upon which Coomer’s claim is based, is discussed in depth in Chapter 7.) Ultimately, the court decides not to expand the baseball rule to the facts of Coomer’s case, finding his injury did not result from a risk inherent to attending the baseball game.6

Though mastery of the nuances of the rules of baseball is not necessary to understand the court’s reasoning in the Coomer case, readers who are unfamiliar with baseball may find an explanation of the basics of  the game helpful. One such explanation can be found at www .howbaseballworks.com/FieldofPlay.htm. 6

Coomer v. Kansas City Royals Baseball Corp.   437 S.W.3d 184 (Mo. 2014) On September 8, 2009, John Coomer and his father attended a Major League Baseball game between the Kansas City Royals and the Detroit Tigers. The game, which took place in Kansas City at Kauffman Stadium, was less well attended than normal because it rained most of the day leading up to the first pitch. Early in the game, Coomer and his father moved from their assigned seats to better, empty seats six rows behind the visitor’s dugout. Shortly after Coomer moved to the better seats, Sluggerrr, the mascot for the Royals, mounted the dugout to begin the “Hotdog Launch,” which had been a feature of every Royals home game since 2000. The Launch happened between innings, when Sluggerrr used an air gun to shoot hotdogs from the roof of the visitor’s dugout to fans seated beyond hand-tossing range. When his assistants were reloading the air gun, Sluggerrr tossed hotdogs by hand to the fans seated nearby. Sluggerrr usually tossed the hotdogs underhand while facing the fans, but sometimes he threw them overhand, behind his back, or side-armed. At the game in question, Sluggerrr began to toss hotdogs by hand to fans seated near Coomer, while Sluggerrr’s assistants were reloading the hotdog-shaped air gun. Coomer testified that he saw Sluggerrr turn away from the crowd as if to prepare for a behind-the-back throw, but because Coomer chose that moment to turn and look at the scoreboard, he admits he never saw Sluggerrr throw the hotdog that he claims injured him. Coomer testified only that a “split second later . . . something hit me in the face,” and he described the blow as “pretty forceful.” A couple of days later, Coomer reported that he was “seeing differently” and something “wasn’t right” with his left eye. The problem progressed until, approximately eight days after the incident. Coomer saw a doctor and was diagnosed with a detached retina. Coomer underwent surgeries to repair the retina and to remove a “traumatic cataract” in the same eye. Coomer sued the Kansas City Royals Corp. for, among other things, negligence (i.e., that Sluggerrr’s careless acts, which were the responsibility of the Royals to oversee and control, caused his injury). The Royals did not deny responsibility for Sluggerrr’s acts but instead argued that Sluggerrr did not act negligently and, in any event, that Coomer had accepted the risk posed by Sluggerrr’s hotdog toss by buying a ticket and attending the game. The latter is a theory known as implied primary assumption of risk.7 Among the instructions the trial judge gave to the jury was one asking the jury to decide whether the risk of being injured by Sluggerrr’s hotdog toss is one of the inherent risks of watching a Royals home game, which Coomer assumed merely by attending the game. The jury found in favor of the Royals, and Coomer appealed. Paul C. Wilson, Judge In the past, this Court has held that spectators cannot sue a baseball team for injuries caused when a ball or bat enters the Chapter 7 includes a detailed discussion of the negligence defense of assumption of risk. 7

stands. Such risks are an unavoidable—even desirable—part of the joy that comes with being close enough to the Great American Pastime to smell the new-mown grass, to hear the crack of 42 inches of solid ash meeting a 95-mph fastball, or to watch a diving third baseman turn a heart-rending triple into a soul-soaring double-play. The risk of being injured by Sluggerrr’s hotdog toss,

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on the other hand, is not an unavoidable part of watching the Royals play baseball. That risk is no more inherent in watching a game of baseball than it is inherent in watching a rock concert, a monster truck rally, or any other assemblage where free food or T-shirts are tossed into the crowd to increase excitement and boost attendance. *** II. Implied Primary Assumption of the Risk and the “Baseball Rule” Long before the Kansas City Athletics moved to Oakland and the fledging [sic] Royals joined the Junior Circuit, an overwhelming majority of courts recognized that spectators at sporting events are exposed to certain risks that are inherent merely in watching the contest. Accordingly, under [the] implied primary assumption of the risk, these courts held that the home team was not liable to a spectator injured as a result of such risks. The archetypal example of this application of implied primary assumption of the risk is when a baseball park owner fails to protect each and every spectator from the risk of being injured by a ball or bat flying into the stands. Just as Missouri teams have led (and continue to lead) professional baseball on the field, Missouri courts helped lead the nation in defining this area of the law off the field. More than 50 years ago, this Court was one of the first to articulate the so-called “Baseball Rule”: [W]here a baseball game is being conducted under the customary and usual conditions prevailing in baseball parks, it is not negligence to fail to protect all seats in the park by wire netting, and that the special circumstances and specific negligence pleaded did not aid plaintiff or impose upon the defendant a duty to warn him against hazards which are necessarily incident to baseball and are perfectly obvious to a person in possession of his faculties. Anderson v. Kansas City Baseball Club, 231 S.W.2d 170, 172 (Mo. 1950) (emphasis added). Anderson was based on this Court’s earlier decision in Hudson v. Kansas City Baseball Club, 164 S.W.2d 318, 320 (Mo. 1942), which used the “no duty” language of implied primary assumption of the risk to explain its holding: The basis of the proprietor’s liability is his superior knowledge and if his invitee knows of the condition or hazard there is no duty on the part of the proprietor to warn him and there is no liability for resulting injury because the invitee has as much knowledge as the proprietor does and then by voluntarily acting, in view of his knowledge, assumes the risks and dangers incident to the known condition. Hudson, 164 S.W.2d at 323 (emphasis added) (applying Restatement (Second) of Torts, § 343). Hudson involved a spectator

with personal knowledge of the inherent risk of being injured by a foul ball while watching a baseball game. But, when the Court returned to this same issue eight years later in Anderson, it continued to rely on section 343 of the Restatement (Second) of Torts (i.e., the “open and obvious dangers” doctrine under the rules of premises liability) to extend Missouri’s noduty rule to cases involving baseball spectators with no prior knowledge of baseball or the risks inherent in watching it. All of the cases cited here and many others which are cited in Hudson v. Kansas City Baseball Club . . . emphasize that when due care has been exercised to provide a reasonable number of screened seats, there remains a hazard that spectators in unscreened seats may be struck and injured by balls which are fouled or otherwise driven into the stands. This risk is a necessary and inherent part of the game and remains after ordinary care has been exercised to provide the spectators with seats which are reasonably safe. It is a risk which is assumed by the spectators because it remains after due care has been exercised and is not the result of negligence on the part of the baseball club. It is clearly not an unreasonable risk to spectators which imposes a duty to warn [or protect]. Anderson, 231 S.W.2d at 173 (emphasis added). Anderson and Hudson are just two of the many dozens of cases around the country holding that, as long as some seats directly behind home plate are protected, the team owes “no duty” to spectators outside that area who are injured by a ball or bat while watching a baseball game. Despite being decided by such different courts across so many decades, all of these cases reflect certain shared principles. First, it is not possible for baseball players to play the game without occasionally sending balls or bats (or parts of bats) into the stands, sometimes at unsafe speeds. Second, it is not possible for the home team to protect each and every spectator from such risks without fundamentally altering the game or the spectators’ experience of watching it through such means as: (a) substituting foam rubber balls and bats that will not injure anyone (or be very fun to watch); (b) erecting a screen or other barrier around the entire field protecting all spectators while obstructing their view and making them feel more removed from the action; or (c) moving all spectators at least 600 feet away from home plate in all directions. Third, ordinary negligence principles do not produce reliably acceptable results in these circumstances because the risk of injury (and the extent of the harm) to spectators is substantial, yet the justification for not protecting spectators from that risk can be expressed only in terms of the amusement or entertainment value of watching the sport that brought the spectators to the stadium in the first place. Against this background, Anderson and Hudson (and dozens of Baseball Rule cases around the country) represent a



Chapter One The Nature of Law

conscious decision to favor the collective interests of all spectators by rejecting as a matter of law the individual claims of injured spectators. [T]he rationale [is] now identified as implied primary assumption of the risk, [and] these decisions protect the home team from liability for risks that are inherent in watching a baseball game based on the team’s failure to take steps that could defeat the reason spectators are there at all, i.e., to get as close as they can to the action without interfering with the game they came to watch. But the rationale for this rule—and, therefore, the rule itself— extends only to those risks that the home team is powerless to alleviate without fundamentally altering the game or spectator’s enjoyment of it. As a result, the solid wall of authority in support of the Baseball Rule is badly cracked in cases where a spectator is injured by a ball when the game is not underway or where fans ordinarily do expect to have to keep a careful lookout for balls or bats leaving the field. This Court has not had to address such a question and does not do so now. Moreover, even though the “no duty” rationale of the Baseball Rule applies to risks inherent in watching a baseball game, the home team still owes a duty of reasonable care not to alter or increase such inherent risks. One example, useful both for its facts and its analysis, is Lowe v. California League of Prof. Baseball, 56 Cal. App. 4th 112 (1997). In Lowe, even though the plaintiff was struck by a foul ball, he claimed that his injuries were not caused by that inherent risk. Instead, the plaintiff claimed he was prevented from watching for foul balls because he was repeatedly jostled and distracted by the team’s dinosaur mascot. The court agreed that the Baseball Rule did not bar such a claim: [T]he key inquiry here is whether the risk which led to plaintiff’s injury involved some feature or aspect of the game which is inevitable or unavoidable in the actual playing of the game. . . . Can [this] be said about the antics of the mascot? We think not. Actually, the . . . person who dressed up as Tremor, recounted that there were occasional games played when he was not there. In view of this testimony, as a matter of law, we hold that the antics of the mascot are not an essential or integral part of the playing of a baseball game. In short, the game can be played in the absence of such antics. Id. (emphasis added). Accordingly, even though implied primary assumption of the risk precludes recovery for injuries caused by the inherent risk of being hit by a foul ball while watching a baseball game, Lowe holds that the jury can hold the team liable for such injuries if the negligence of its mascot altered or increased that otherwise inherent risk and this negligence causes the plaintiff’s injuries. Accordingly, the proper application of implied primary assumption of the risk in this case . . . is this: if Coomer was

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injured by a risk that is an inherent part of watching the Royals play baseball, the team had no duty to protect him and cannot be liable for his injuries. But, if Coomer’s injury resulted from a risk that is not an inherent part of watching baseball in person—or if the negligence of the Royals altered or increased one of these inherent risks and caused Coomer’s injury—the jury is entitled to hold the Royals liable for such negligence. . . . *** IV. Being Injured by Sluggerrr’s Hotdog Toss Is Not a Risk Inherent in Watching Royals Baseball According to the Royals, the risk to a spectator of being injured by Sluggerrr’s hotdog toss shares the same essential characteristics as the other risks that this Court (and many others) determined long ago were inherent in watching a baseball game in person, i.e., risks that a spectator will be injured by a flying ball or bat. The Court disagrees. The rationale for barring recovery for injuries from risks that are inherent in watching a particular sport under implied primary assumption of the risk is that the defendant team owner cannot remove such risks without materially altering either the sport that the spectators come to see or the spectator’s enjoyment of it. No such argument applies to Sluggerrr’s hotdog toss. Millions of fans have watched the Royals (and its forebears in professional baseball) play the National Pastime for the better part of a century before Sluggerrr began tossing hotdogs, and millions more people watch professional baseball every year in stadiums all across this country without the benefit of such antics. Some fans may find Sluggerrr’s hotdog toss fun to watch between innings, and some fans may even have come to expect it, but this does not make the risk of injury from Sluggerrr’s hotdog toss an “inherent risk” of watching a Royals game. “[I]nherent” means “structural or involved in the constitution or essential character of something: belonging by nature or settled habit,” Webster’s Third New International Dictionary (1966), at 1163 (emphasis added). There is nothing about the risk of injury from Sluggerrr’s hotdog toss that is “structural” or involves the “constitution or essential character” of watching a Royals game at Kauffman Stadium. The Royals concede that Sluggerrr’s hotdog toss has nothing to do with watching the game of baseball but contend that the Hotdog Launch is a well-established (even customary) part of the overall stadium “experience.” In support, the Royals cite cases that have applied the Baseball Rule to risks that were not created directly from the game. These cases do not support the Royals’ argument. In Loughran v. The Phillies, 888 A.2d 872, 876–77 (Pa. Super. 2005), because a plaintiff was injured when a fielder tossed the ball into the stands after catching the last out of

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the inning, the court held that implied primary assumption of the risk barred the plaintiff’s claims. In rejecting the plaintiff’s claim that the Baseball Rule should not apply because the throw was not part of the game itself, Loughran holds that—even though the “‘no duty’ rule applies only to ‘common, expected, and frequent’ risks of the game”—the link between the game and the risk of being hit with a ball tossed into the stands by a player is undeniable. Id. at 876. Baseball is the reason centerfielder Marlon Byrd was there, just as it was the reason the fans were in the stands (including the many who were yelling for Byrd to toss the ball to them). Here, on the other hand, there is no link between the game and the risk of being hit by Sluggerrr’s hotdog toss. The Hotdog Launch is not an inherent part of the game; it is what the Royals do to entertain baseball fans when there is no game for them to watch. Sluggerrr may make breaks in the game more fun, but Coomer and his 12,000 rain-soaked fellow spectators were not there to watch Sluggerrr toss hotdogs; they were there to watch the Royals play baseball. Somewhat closer to the mark—but still inapposite—is the Royals’ reliance on Cohen v. Sterling Mets, L.P., 840 N.Y.S.2d 527 (N.Y. Sup. Ct. 2007), aff’d 58 A.D.3d (N.Y. App. Div. 2009). A vendor sued the team for injuries caused by a fan who hit the vendor while diving for a souvenir T-shirt that had been tossed into the crowd. The court dismissed these claims, stating: “When a ball is tossed into the stands by a player many spectators rush toward the ball in hopes of getting a souvenir, just as what allegedly occurred here during the t-shirt launch.” Id.

The Royals’ reliance on Cohen highlights one of the basic flaws in its effort to use implied primary assumption to bar Coomer’s claims, and it shows the importance of correctly identifying the risks and activity in each case. [W]hat makes a risk “inherent” for purposes of this doctrine . . . is that the risks are so intertwined (i.e., so “structural” or involved in the “constitution or essential character”) with the underlying activity that the team cannot control or limit the risk without abandoning the activity. In Cohen, because the Mets could not control how fans reacted to the T-shirt launch, that reaction was an inherent risk—not of watching a baseball game but—of taking part in the T-shirt launch (which the plaintiff’s work required him to do). Here, on the other hand, not only is being injured by Sluggerrr’s hotdog toss not an inherent risk of watching a Royals game, it is not an inherent risk of the Hotdog Launch. . . . Accordingly, the Court holds as a matter of law that the risk of injury from Sluggerrr’s hotdog toss is not one of the risks inherent in watching the Royals play baseball that Coomer assumed merely by attending a game at Kauffman Stadium. This risk can be increased, decreased or eliminated altogether with no impact on the game or the spectators’ enjoyment of it. As a result, Sluggerrr (and, therefore, the Royals) owe the fans a duty to use reasonable care in conducting the Hotdog Launch and can be held liable for damages caused by a breach of that duty.

Statutory Interpretation Because statutes are

deliberate ambiguity include the need for legislative compromise and legislators’ desire to avoid taking controversial positions. Ambiguity in statutory language can also arise from the vagaries of grammar, either as a result of sloppiness or because rules of grammar are contested. The following O’Connor case, for instance, illustrates just how much can ride on a “missing” comma, namely millions of dollars in unpaid overtime wages. As you read the case, consider what strategies the judges use to resolve the ambiguity. Those strategies correspond to the techniques of statutory interpretation that are described in the text following the case.

written in one authoritative form, their interpretation might seem easier than case law reasoning. However, this is not so. The natural ambiguity of language serves as one reason courts face difficulties when interpreting statutes. The problems become especially difficult when statutory words are applied to situations the legislature did not foresee. In some instances, legislators may deliberately use ambiguous language when they are unwilling or unable to deal specifically with each situation the statute was enacted to regulate. When this happens, the legislature expects courts and/or administrative agencies to fill in the details on a case-by-case basis. Other reasons for

Conclusion For the reasons set forth above, this Court vacates the judgment and remands the case.



Chapter One The Nature of Law

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O’Connor v. Oakhurst Dairy   851 F.3d 69 (1st Cir. 2017) A group of delivery drivers for Oakhurst Dairy sued the dairy and its parent company for unpaid overtime wages. Oakhurst Dairy processes, bottles, stores, markets, and distributes milk and other dairy products from facilities in Portland, Waterville, Bangor, and Presque Isle, Maine. Oakhurst designated the plaintiff drivers as “route salesmen” on their official job descriptions. The drivers, however, claimed they solely engaged in deliveries of Oakhurst’s products. State and federal wage and hour laws generally require employers to pay their employees a premium wage for any hours the employees work in excess of 40 hours in a given week, unless the employees are exempted from overtime rules by the relevant statutory language. The drivers argued that they were not exempted from the overtime wage requirement in the Maine wage and hour statute, while Oakhurst argued that they were exempt under a provision focused on workers who deal with perishable food products. The district court considered the question and agreed with Oakhurst. The drivers appealed.

BARRON, Circuit Judge For want of a comma, we have this case. It arises from a dispute between a Maine dairy company and its delivery drivers, and it concerns the scope of an exemption from Maine’s overtime law. Specifically, if that exemption used a serial comma to mark off the last of the activities that it lists, then the exemption would clearly encompass an activity that the drivers perform. And, in that event, the drivers would plainly fall within the exemption and thus outside the overtime law’s protection. But, as it happens, there is no serial comma to be found in the exemption’s list of activities, thus leading to this dispute over whether the drivers fall within the exemption from the overtime law or not. The District Court concluded that, despite the absent comma, the Maine legislature unambiguously intended for the last term in the exemption’s list of activities to identify an exempt activity in its own right. But, we conclude that the exemption’s scope is actually not so clear in this regard. And because, under Maine law, ambiguities in the state’s wage and hour laws must be construed liberally in order to accomplish their remedial purpose, we adopt the drivers’ narrower reading of the exemption. I. The Maine overtime law is part of the state’s wage and hour law. The overtime law provides that “[a]n employer may not require an employee to work more than 40 hours in any one week unless 1 1/2 times the regular hourly rate is paid for all hours actually worked in excess of 40 hours in that week.” [S]ome workers who fall within the statutory definition of “employee” nonetheless fall outside the protection of the overtime law due to a series of express exemptions from that law. The exemption to the overtime law that is in dispute here is ­Exemption F.

Exemption F covers employees whose work involves the ­ andling—in one way or another—of certain, expressly enumerh ated food products. Specifically, Exemption F states that the protection of the overtime law does not apply to: “The canning, processing, preserving, freezing, drying, marketing, storing, packing for shipment or distribution of: (1) Agricultural produce; (2) Meat and fish products; and (3) Perishable foods.” The parties’ dispute concerns the meaning of the words “packing for shipment or distribution.” The delivery drivers contend that, in combination, these words refer to the single activity of “packing,” whether the “packing” is for “shipment” or for “distribution.” The drivers further contend that, although they do handle perishable foods, they do not engage in “packing” them. As a result, the drivers argue that, as employees who fall outside Exemption F, the Maine overtime law protects them. Oakhurst responds that the disputed words actually refer to two distinct exempt activities, with the first being “packing for shipment” and the second being “distribution.” And because the delivery drivers do—quite obviously—engage in the “distribution” of dairy products, which are “perishable foods,” Oakhurst contends that the drivers fall within Exemption F and thus outside the overtime law’s protection. * * *    III. Each party recognizes that, by its bare terms, Exemption F raises questions as to its scope, largely due to the fact that no comma precedes the words “or distribution.” But each side also contends that the exemption’s text has a latent clarity, at least after one applies various interpretive aids. Each side then goes on to argue

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Part One Foundations of American Law

that the overtime law’s evident purpose and legislative history confirms its preferred reading. We conclude, however, that Exemption F is ambiguous, even after we take account of the relevant interpretive aids and the law’s purpose and legislative history. For that reason, we conclude that, under Maine law, we must construe the exemption in the narrow manner that the drivers favor, as doing so furthers the overtime law’s remedial purposes. Before explaining our reasons for reaching this conclusion, though, we first need to work our way through the parties’ arguments as to why, despite the absent comma, Exemption F is clearer than it looks. A. First, the text. In considering it, we do not simply look at the particular word “distribution” in isolation from the exemption as a whole. We instead must take account of certain linguistic conventions—canons, as they are often called—that can help us make sense of a word in the context in which it appears. Oakhurst argues that, when we account for these canons here, it is clear that the exemption identifies “distribution” as a stand-alone, exempt activity rather than as an activity that merely modifies the standalone, exempt activity of “packing.” Oakhurst relies for its reading in significant part on the rule against surplusage, which instructs that we must give independent meaning to each word in a statute and treat none as unnecessary. To make this case, Oakhurst explains that “shipment” and “distribution” are synonyms. For that reason, Oakhurst contends, “distribution” cannot describe a type of “packing,” as the word “distribution” would then redundantly perform the role that “­shipment”—as its synonym—already performs, which is to describe the type of “packing” that is exempt. By contrast, Oakhurst explains, under its reading, the words “shipment” and “distribution” are not redundant. The first word, “shipment,” describes the exempt activity of “packing,” while the second, “distribution,” describes an exempt activity in its own right. Oakhurst also relies on another established linguistic convention in pressing its case—the convention of using a conjunction to mark off the last item on a list. Oakhurst notes, rightly, that there is no conjunction before “packing,” but that there is one after “shipment” and thus before “distribution.” Oakhurst also observes that Maine overtime law contains two other lists in addition to the one at issue here and that each places a conjunction before the last item. Oakhurst acknowledges that its reading would be beyond dispute if a comma preceded the word “distribution” and that no comma is there. But, Oakhurst contends, that comma is missing for good reason. Oakhurst points out that the Maine Legislative Drafting Manual expressly instructs that: “when drafting Maine law or rules, don’t use a comma between the penultimate and the last item of a

series.” In fact, Oakhurst notes, Maine statutes invariably omit the serial comma from lists. B. If no more could be gleaned from the text, we might be inclined to read Exemption F as Oakhurst does. But, the delivery drivers point out, there is more to consider. And while these other features of the text do not compel the drivers’ reading, they do make the exemption’s scope unclear, at least as a matter of text alone. The drivers contend, first, that the inclusion of both “shipment” and “distribution” to describe “packing” results in no redundancy. Those activities, the drivers argue, are each distinct. They contend that “shipment” refers to the outsourcing of the delivery of goods to a third-party carrier for transportation, while “distribution” refers to a seller’s in-house transportation of products directly to recipients. And the drivers note that this distinction is, in one form or another, adhered to in [the New Oxford English American Dictionary and Webster’s Third New International Dictionary] definitions. Consistent with the drivers’ contention, Exemption F does use two different words (“shipment” and “distribution”) when it is hard to see why, on Oakhurst’s reading, the legislature did not simply use just one of them twice. After all, if “distribution” and “shipment” really do mean the same thing, as Oakhurst contends, then it is odd that the legislature chose to use one of them (“shipment”) to describe the activity for which “packing” is done but the other (“distribution”) to describe the activity itself. The drivers’ argument that the legislature did not view the words to be interchangeable draws additional support from another Maine statute. That statute clearly lists both “distribution” and “shipment” as if each represents a separate activity in its own right. And because Maine law elsewhere treats “shipment” and “distribution” as if they are separate activities in a list, we do not see why we must assume that the Maine legislature did not treat them that way here as well. After all, the use of these two words to describe “packing” need not be understood to be wasteful. Such usage could simply reflect the legislature’s intention to make clear that “packing” is exempt whether done for “shipment” or for “distribution” and not simply when done for just one of those activities.[a] Next, the drivers point to the exemption’s grammar. The ­drivers note that each of the terms in Exemption F that indisputably names an exempt activity—“canning, processing, preserving,” and so forth on through “packing”—is a gerund. By, contrast, We also note that there is some reason to think that the distinction between “shipment” and “distribution” is not merely one that only a lawyer could love. Oakhurst’s own internal organization chart seems to treat the two as if they are separate activities. [a]



Chapter One The Nature of Law

“distribution” is not. And neither is “shipment.” In fact, those are the only non-gerund nouns in the exemption, other than the ones that name various foods. Thus, the drivers argue, in accord with what is known as the parallel usage convention, that “distribution” and “shipment” must be playing the same grammatical role—and one distinct from the role that the gerunds play. In accord with that convention, the drivers read “shipment” and “distribution” each to be objects of the preposition “for” that describes the exempt activity of “packing.” And the drivers read the gerunds each to be referring to stand-alone, exempt activities—“canning, preserving. . . .” By contrast, in violation of the convention, Oakhurst’s reading treats one of the two non-gerunds (“distribution”) as if it is performing a distinct grammatical function from the other (“shipment”), as the latter functions as an object of a preposition while the former does not. And Oakhurst’s reading also contravenes the parallel usage convention in another way: it treats a non-gerund (again, “distribution”) as if it is performing a role in the list—­ naming an exempt activity in its own right—that gerunds otherwise exclusively perform. Finally, the delivery drivers circle back to that missing comma. They acknowledge that the drafting manual advises drafters not to use serial commas to set off the final item in a list—despite the clarity that the inclusion of serial commas would often seem to bring. But the drivers point out that the drafting manual is not dogmatic on that point. The manual also contains a proviso—“Be careful if an item in the series is modified”—and then sets out several examples of how lists with modified or otherwise complex terms should be written to avoid the ambiguity that a missing serial comma would otherwise create. Thus, the drafting manual’s seeming—and, from a judge’s point of view, entirely welcome—distaste for ambiguous lists does suggest a reason to doubt Oakhurst’s insistence that the missing comma casts no doubt on its preferred reading. For, as the drivers explain, the drafting manual cannot be read to instruct that the comma should have been omitted here if “distribution” was intended to be the last item in the list. In that event, the serial comma’s omission would give rise to just the sort of ambiguity that the manual warns drafters not to create. Still, the drivers’ textual points do not account for what seems to us to be Oakhurst’s strongest textual rejoinder: no conjunction precedes “packing.” Rather, the only conjunction in the exemption—“or”—appears before “distribution.” And so, on the drivers’ reading, the list is strangely stingy when it comes to conjunctions, as it fails to use one to mark off the last listed activity. To address this anomaly, the drivers cite to Antonin Scalia & Bryan Garner, Reading Law: The Interpretation of Legal Texts

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(2012), in which the authors observe that “[s]ometimes drafters will omit conjunctions altogether between the enumerated items [in a list],” in a technique called “asyndeton,” id. at 119. But those same authors point out that most legislative drafters avoid asyndeton. And, the delivery drivers do not provide any examples of Maine statutes that use this unusual grammatical device. Thus, the drivers’ reading of the text is hardly fully satisfying.[b] IV. The text has, to be candid, not gotten us very far. We are reluctant to conclude from the text alone that the legislature clearly chose to deploy the nonstandard grammatical device of asyndeton. But we are also reluctant to overlook the seemingly anomalous violation of the parallel usage canon that Oakhurst’s reading of the text produces. And so—there being no comma in place to break the tie—the text turns out to be no clearer on close inspection than it first appeared. As a result, we turn to the parties’ arguments about the exemption’s purpose and the legislative history.  A. Oakhurst contends that the evident purpose of the exemption strongly favors its reading. The whole point of the exemption, Oakhurst asserts (albeit without reference to any directly supportive text or legislative history), is to protect against the distorting effects that the overtime law otherwise might have on employer decisions about how best to ensure perishable foods will not spoil. And, Oakhurst argues, the risk of spoilage posed by the distribution of perishable food is no less serious than is the risk of spoilage posed by the other activities regarding the handling of such foods to which the exemption clearly does apply.  B. We are not so sure. Any analysis of Exemption F that depends upon an assertion about its clear purpose is necessarily somewhat

The drivers do also contend that their reading draws support from the noscitur a sociis canon, which “dictates that words grouped in a list should be given related meaning.” In particular, the drivers contend that distribution is a different sort of activity than the others, nearly all of which entail transforming perishable products to less perishable forms—“canning,” “processing,” “preserving,” “freezing,” “drying,” and “storing.” However, the list of activities also includes “marketing,” which Oakhurst argues undercuts the drivers’ noscitur a sociis argument. And even if “marketing” does not mean promoting goods or services, as in the case of advertising, and means only “to deal in a market,” . . . it is a word that would have at least some potential commonalities with the disputed word, “distribution.” For that reason, this canon adds little insight beyond that offered by the parallel usage convention. [b]

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Part One Foundations of American Law

speculative. Nothing in the overtime law’s text or legislative history purports to define a clear purpose for the exemption. Moreover, even if we were to share in Oakhurst’s speculation that the legislature included the exemption solely to protect against the possible spoilage of perishable foods rather than for some distinct reason related, perhaps, to the particular dynamics of certain labor markets, we still could not say that it would be arbitrary for the legislature to exempt “packing” but not “distributing” perishable goods. The reason to include “packing” in the exemption is easy enough to conjure. If perishable goods are not packed in a timely fashion, it stands to reason that they may well spoil. Thus, one can imagine the reason to ensure that the overtime law creates no incentives for employers to delay the packing of such goods. The same logic, however, does not so easily apply to explain the need to exempt the activity of distributing those same goods. Drivers delivering perishable food must often inevitably spend long periods of time on the road to get the goods to their destination. It is thus not at all clear that a legal requirement for employers to pay overtime would affect whether drivers would get the goods to their destination before they spoiled. No matter what delivery drivers are paid for the journey, the trip cannot be made to be shorter than it is. Of course, this speculation about the effect that a legal requirement to pay overtime may or may not have on increasing the risk of food spoilage is just that. But such speculation does make us cautious about relying on what is only a presumed legislative purpose to generate a firm conclusion about what the legislature must have intended in drafting the exemption. ***

Identify what courts focus on when applying the major LO1-6 statutory interpretation techniques (plain meaning, legislative purpose, legislative history, and general public purpose).

To deal with the problems of ambiguity that arise from drafting errors, unclear language, or the application of clear language to unanticipated circumstances, courts use various techniques of statutory interpretation. As you saw in the O’Connor case, different techniques may dictate different results in a particular case. Sometimes judges employ the techniques in an instrumentalist or result-oriented fashion, emphasizing the technique that will produce the result they want and downplaying the others. It is, therefore, unclear which technique should control when different techniques yield different results. Judges have considerable latitude in this regard.

C. To be clear, none of this evidence is decisive either way. It does highlight, however, the hazards of simply assuming—on the basis of no more than supposition about what would make sense—that the legislature could not have intended to craft Exemption F as the drivers contend that the legislature crafted it. Thus, we do not find either the purpose or the legislative history fully clarifying. And so we are back to where we began. V. We are not, however, without a means of moving forward. The default rule of construction under Maine law for ambiguous provisions in the state’s wage and hour laws is that they “should be liberally construed to further the beneficent purposes for which they are enacted.” Dir. of Bureau of Labor Standards v. Cormier, 527 A.2d 1297, 1300 (Me. 1987). The opening of the subchapter of Maine law containing the overtime statute and exemption at issue here declares a clear legislative purpose: “It is the declared public policy of the State of Maine that workers employed in any occupation should receive wages sufficient to provide adequate maintenance and to protect their health, and to be fairly commensurate with the value of the services rendered.” Thus, in accord with Cormier, we must interpret the ambiguity in Exemption F in light of the remedial purpose of Maine’s overtime statute. And, when we do, the ambiguity clearly favors the drivers’ narrower reading of the exemption. *** VI. Accordingly, the District Court’s grant of partial summary judgment to Oakhurst is reversed.

A conceptually helpful metaphor here might be to think of a judge approaching a question of statutory interpretation as a repairperson. The various techniques of statutory interpretation described here are the tools he or she might use for a repair job. Sometimes a particular tool is more suited to a particular job, but a repairperson uses his or her judgment in determining which tools to use to accomplish the goal of making the repair. Likewise, a judge retains the freedom to reach in the “statutory interpretation toolbox” for any of the tools described here, but professional norms and experience often guide a judge’s choice, just as it would a repairperson’s. Plain Meaning Courts routinely begin their interpretation of a statute with its actual language. If the statute’s words have a clear, common, accepted meaning, courts often employ the plain meaning rule. This approach calls for the court to apply the statute according to the usual meaning



Chapter One The Nature of Law

of its words, without concerning itself with anything else. At times, this approach is clear and settles the matter. Often, though, judges find the application of plain meaning unhelpful. It may lead to absurd or patently unjust results, or it might simply fail to resolve the ambiguity at issue. In James v. City of Costa Mesa, which follows the description of these statutory interpretation techniques, both the majority and the dissenting judges agree that the plain meaning of the statutory text at issue is ambiguous, even as they disagree as to what that meaning is. Legislative History and Legislative Purpose Courts sometimes refuse to follow a statute’s plain meaning when its legislative history suggests a different result. Almost all courts resort to legislative history when the statute’s language is ambiguous. A statute’s legislative history includes the following sources: reports of investigative committees or law revision commissions that led to the legislation, transcripts or summaries of hearings of legislative committees that originally considered the legislation, reports issued by such committees, records of legislative debates, reports of conference committees reconciling the chambers’ conflicting versions of the law in a bicameral legislature, amendments or defeated amendments to the legislation, other bills not passed by the legislature but proposing similar legislation, and discrepancies between a bill passed by one chamber of a bicameral legislature and the final version of the statute. Sometimes a statute’s legislative history provides no information or conflicting information about its meaning, scope, or purposes. Some sources prove to be more authoritative than others. The worth of debates, for instance, may depend on which legislator (e.g., the sponsor of the bill or an uninformed blowhard) is quoted. Some sources are useful only in particular situations; prior unpassed bills and amendments or defeated amendments are examples. Consider, for instance, whether mopeds are covered by an air pollution statute applying to “automobiles, trucks, buses, and other motorized passenger or cargo vehicles.” If the statute’s original version included mopeds, but this reference was removed by amendment, it is unlikely that the legislature wanted mopeds to be covered. The same might be true if six similar unpassed bills had included mopeds, but the bill that was eventually passed did not, or if one house had passed a bill including mopeds, but mopeds did not appear in the final version of the legislation. Courts use legislative history in two overlapping but distinguishable ways. They may use it to determine what the legislature thought about the specific meaning of statutory language. They may also use it to determine the overall aim, end, or goal of the legislation. In this second case, they then ask whether a particular interpretation of the statute is consistent with this

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legislative purpose. To illustrate the difference between these two uses of legislative history, suppose that a court is considering whether our pollution statute’s “other motorized passenger or cargo vehicles” language includes battery-powered vehicles. The court might scan the legislative history for specific references to battery-powered vehicles or other indications of what the legislature thought about their inclusion. The court might also use the same history to determine the overall aims of the statute and then ask whether including battery-powered vehicles is consistent with those aims. Because the history probably would reveal that the statute’s purpose was to reduce air pollution from internal combustion engines, the court might well conclude that covering battery-powered vehicles would be inconsistent with the legislative purpose and, therefore, decline to include them within the coverage of the statute. General Public Purpose Occasionally, courts construe statutory language in the light of various general public purposes. These purposes are not the purposes underlying the statute in question; rather, they are widely accepted general notions of public policy. For example, the Supreme Court once used the general public policy against racial discrimination in education as an argument for denying tax-exempt status to a private university that discriminated on the basis of race. Prior Interpretations Courts sometimes follow prior cases and administrative decisions interpreting a statute, regardless of the statute’s plain meaning or legislative history. The main argument for following these prior interpretations is to promote stability and certainty by preventing each successive court that considers a statute from adopting its own interpretation. The courts’ willingness to follow a prior interpretation depends on such factors as the number of past courts adopting the interpretation, the authoritativeness of those courts, and the number of years that the interpretation has been followed.8 Maxims Maxims are general rules of thumb employed in statutory interpretation. There are many maxims, which courts tend to use or ignore at their discretion. The O’Connor court used several maxims to interpret the Maine overtime law exemption in the case at the beginning of this section. Note here that this technique is related to, but distinct from, a court’s obligation to follow binding precedent. If a prior interpretation of a statute was handed down by a higher court whose rulings are binding on a lower court, then the lower court must follow that interpretation. As such, the application of binding precedent is not truly considered statutory interpretation. The technique of statutory interpretation that follows prior interpretations of a statute arises when courts look to nonprecedential decisions of other courts for guidance. 8

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Part One Foundations of American Law

The court there referred to the maxims as “canons” of statutory interpretation.   For our purposes, maxim and canon are synonyms. The judge in O’Connor explained the maxim of noscitur a sociis in the second footnote of the opinion. Another example of a maxim is the ejusdem generis rule, which says that when general words follow words of a specific, limited meaning, the general language should be limited to things of the same class as those specifically stated. Suppose that the pollution statute quoted earlier listed 12 types of gas-powered vehicles and ended with the words “and other motorized passenger or cargo vehicles.” In that instance, ejusdem generis probably would dictate that ­battery-powered vehicles not be included. The following James v. City of Costa Mesa case reports the decision of a three-judge panel of the U.S. Court of

Appeals for the Ninth Circuit. Two of the three judges agreed with one interpretation of the statutory language at issue; the third disagreed with that interpretation. The decision of the two judges who agreed is presented as the majority opinion of the court, while the disagreeing judge’s argument is in the dissenting opinion. Notice how each opinion uses plain meaning and legislative history and purpose (with a maxim or two peppered in for good measure) to interpret the language to different conclusions. This illustrates how, regardless of these consistent techniques described here, there is still substantial room for contested judgment in statutory interpretation. Likewise, you should compare and contrast the James court’s application of those techniques with the earlier O’Connor opinion.

James v. City of Costa Mesa   700 F.3d 394 (9th Cir. 2012) Marla James, Wayne Washington, James Armantrout, and Charles Daniel Dejong (collectively referred to here either as “the plaintiffs” or “James,” the name of the lead plaintiff) suffer from serious medical conditions. To alleviate pain associated with their impairments, they each use marijuana, as recommended and monitored by their doctors. In California, where the plaintiffs live, the medical use of marijuana is permissible according to state law. Marijuana, however, remains a controlled substance under the federal Controlled Substances Act (CSA). As a result, it is generally a federal crime to possess and distribute marijuana, even for medical purposes. The plaintiffs filed a lawsuit against the cities of Costa Mesa and Lake Forest, California, for taking steps to close down or otherwise prohibit the operation of marijuana-dispensing facilities within their boundaries. The plaintiffs claimed that the cities’ actions violated Title II of the Americans with Disabilities Act (ADA), which prohibits discrimination on the basis of disability in the provision of public services. The lawsuit asked the court to enjoin the cities’ actions (i.e., issue a decision ordering the cities to stop their efforts to close the marijuana-dispensing facilities). A judge in the U.S. District Court for the Central District of California declined to issue an injunction on the ground that the ADA does not protect against discrimination on the basis of plaintiffs’ marijuana use, even medical marijuana use supervised by a doctor in accordance with state law. The judge based his decision on a determination that the plaintiffs are not entitled to the protection of the ADA in this instance because only a “qualified individual with a disability” is protected from being denied the benefit of public services. The ADA states that “the term ‘individual with a disability’ does not include an individual who is currently engaging in the illegal use of drugs, when the covered entity acts on the basis of such use.” The plaintiffs appealed the District Court’s ruling to the U.S. Court of Appeals for the Ninth Circuit.

Raymond C. Fisher, Circuit Judge This case turns on whether the plaintiffs’ medical marijuana use constitutes “illegal use of drugs[.]” [The ADA] defines “illegal use of drugs” as the use of drugs, the possession or distribution of which is unlawful under the Controlled Substances Act. Such term does not include the use of a drug taken under supervision by a licensed health care professional, or other uses authorized by the Controlled Substances Act or other provisions of Federal law. The parties agree that the possession and distribution of marijuana, even for medical purposes, is generally unlawful under the

CSA, and thus that medical marijuana use falls within the exclusion set forth in [the above definition’s] first sentence. They dispute, however, whether medical marijuana use is covered by one of the exceptions in the second sentence. The plaintiffs contend their medical marijuana use falls within the exception for drug use supervised by a licensed health care professional. There are two reasonable interpretations of the [ADA]’s language excepting from the illegal drug exclusion “use of a drug taken under supervision by a licensed health care professional, or other uses authorized by the Controlled Substances Act or other provisions of Federal law.” The first interpretation—urged by the plaintiffs—is that this language creates two exceptions to



Chapter One The Nature of Law

the illegal drug exclusion: (1) an exception for professionally supervised drug use carried out under any legal authority, and (2) an independent exception for drug use authorized by the CSA or other provisions of federal law. The second interpretation— offered by the cities and adopted by the district court—is that the provision contains a single exception covering all uses authorized by the CSA or other provisions of federal law, including both CSAauthorized uses that involve professional supervision (such as use of controlled substances by prescription . . . and uses of controlled substances in connection with research and experimentation), and other CSA-authorized uses. Under the plaintiffs’ interpretation, their state-sanctioned, doctor-recommended marijuana use is covered under the supervised use exception. Under the cities’ interpretation, the plaintiffs’ state-authorized medical marijuana use is not covered by any exception because it is not authorized by the CSA or another provision of federal law. Although [the definition of “illegal use of drugs”] lacks a plain meaning and its legislative history is not conclusive, we hold, in light of the text and legislative history of the ADA, as well as the relationship between the ADA and the CSA, that the cities’ interpretation is correct. The meaning of [“illegal use of drugs”] cannot be discerned from the text alone. Both interpretations of the provision are somewhat problematic. The cities’ reading of the statute renders the first clause in [the definition]’s second sentence superfluous; if Congress had intended that the exception cover only uses authorized by the CSA and other provisions of federal law, it could have omitted the “taken under supervision” language altogether. But the plaintiffs’ interpretation also fails to give effect to each word of [the statute], for if Congress had really intended that the language excepting “other uses authorized by the Controlled Substances Act or other provisions of Federal law” be entirely independent of the preceding supervised use language, it could have omitted the word “other,” thus excepting “use of a drug taken under supervision by a licensed health care professional, or uses authorized by the Controlled Substances Act.” Moreover, unless the word “other” is omitted, the plaintiffs’ interpretation renders the statutory language outright awkward. One would not naturally describe “the use of a drug taken under supervision by a licensed health care professional, or other uses authorized by the Controlled Substances Act or other provisions of Federal law” unless the supervised uses were a subset of the uses authorized by the CSA and other provisions of federal law. The plaintiffs’ reading thus results not only in surplusage, but also in semantic dissonance. The cities’ interpretation also makes the most sense of the contested language when it is viewed in context. . . . Here, the context reveals Congress’ intent to define “illegal use of drugs” by reference to federal, rather than state, law. [The definition] mentions the CSA by name twice, and [a subsequent provision of the ADA] provides that “[t]he term ‘drug’ means a

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controlled substance, as defined in . . . the Controlled Substances Act.” We therefore conclude that the cities’ interpretation of the statutory text is the more persuasive, though we agree with the dissent that the text is ultimately inconclusive. We therefore look to legislative history, including related congressional activity. The legislative history of this provision, like its text, is indeterminate. It is true, as the plaintiffs point out, that Congress rejected an early draft of the “taken under supervision” exception in favor of a broader version. [The early version excepted drugs taken pursuant to a valid prescription, rather than the use of a drug taken under supervision by a licensed health care professional.] We are not persuaded, however, that this history compels the plaintiffs’ interpretation. Although the expansion of the supervised use exception suggests Congress wanted to cover more than just CSAauthorized prescription-based use, it does not demonstrate that the exception was meant to extend beyond the set of uses authorized by the CSA and other provisions of federal law. The CSA does authorize some professionally supervised drug use that is not prescription-based, and Congress could have intended simply to expand the supervised use exception to encompass all such uses. One House Committee Report does include a brief passage that arguably supports the notion that [the] supervised use language and [the] authorized use language are independent, stating “The term ‘illegal use of drugs’ does not include the use of controlled substances, including experimental drugs, taken under the supervision of a licensed health care professional. It also does not include uses authorized by the Controlled Substances Act or other provisions of federal law.” This discussion is of limited persuasive value, however, because it may rest on the unstated assumption—quite plausible at the time—that professionally supervised use of illegal drugs would always be consistent with the CSA. There is no reason to think that the 1990 Congress that passed the ADA would have anticipated later changes in state law facilitating professional supervision of drug use that federal law does not permit. The first such change came six years later, when California voters passed Proposition 215, now codified as the Compassionate Use Act of 1996. [D]uring and after adoption of the ADA there has been a strong and longstanding federal policy against medical marijuana use outside the limits established by federal law itself. . . . Under the plaintiffs’ view, the ADA worked a substantial departure from this accepted federal policy by extending federal protections to federally prohibited, but state-authorized, medical use of marijuana. That would have been an extraordinary departure from policy, and one that we would have expected Congress to take explicitly. It is unlikely that Congress would have wished to legitimize state-authorized, federally proscribed medical marijuana use without debate, in an ambiguously worded ADA provision. ***

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Affirmed.

2. Legislative History

DISSENT BY: Marsha S. Berzon, Circuit Judge

James’ reading of the statute also accords much better with the overall thrust of the legislative history. That history, while not entirely without ambiguity, strongly supports James’s interpretation.

The statutory interpretation issue at the core of this case is an unusually tough one, as the majority opinion recognizes. Looking at the language of [the definition of “illegal use of drugs”] alone, I would come out where the majority does—concluding that the statute is ambiguous. But unlike the majority, I would not declare a near-draw. Instead, looking at the words alone, I would conclude that the plaintiffs have much the better reading, but not by enough to be comfortable that their interpretation is surely correct. Turning then to the legislative history, I would again declare the plaintiffs the winner, this time sufficiently, when combined with the language considerations, to adopt their interpretation, absent some very good reason otherwise. 1. Statutory Text Although [the definition] is not entirely clear, James has very much the better reading of the statutory language. In James’s view, the phrases “use of a drug taken under supervision by a licensed health care professional” and “other uses authorized by the [CSA]” create two different exceptions, so that the ADA protects use of drugs under supervision of a doctor even when that use is not authorized by the CSA. If Congress intended to carve out only drug use authorized by the CSA, after all, the entire first clause—“the use of a drug under supervision by a licensed health care professional”—would have been unnecessary. a. The use of “other” [T]he word “other” is not necessarily redundant at all. It could be read to indicate that use under supervision of a doctor is meant to be a category of uses entirely subsumed by the larger category of uses authorized by the CSA, but this is not the only possible interpretation. Put another way, omitting the word “other” entirely would certainly have compelled the reading James advances, but its presence does not invalidate her interpretation. There is, after all, a middle ground between these two readings. . . . [T]he two clauses could . . . be seen as partially overlapping, with the group of uses supervised by a doctor partially included within the set of uses authorized by the CSA but also partially independent, encompassing in addition a set of uses not authorized by the CSA. This reading strikes me as the most sensible. Under this interpretation, “other” is not redundant. Instead, it accurately reflects the overlap. Were the “other” not there, the exception would have divided the relevant universe into two nonoverlapping sets. Yet, in fact the CSA authorizes some (but not all) uses of “drugs taken under supervision of a licensed health care professional.” The “other” serves to signal that there is no strict dichotomy between the two phrases, as the bulk of the CSA-­authorized uses are within the broader set covered by the first phrase. ***

a. Evolution of the exception As the majority observes, Congress replaced a draft of the exception that required that use of drugs be “pursuant to a valid ­prescription,” . . . with the broader language eventually enacted. Critically, the House Committee Report restates the exception, once amended, in precisely the cumulative manner I have suggested most accords with the statutory language: “The term ‘illegal use of drugs’ does not include the use of controlled substances, including experimental drugs, taken under the supervision of a licensed health care professional. It also does not include uses authorized by the [CSA] or other provisions of Federal law.” This summary is in no way ambiguous, and indicates at least that members of the House familiar with the statutory language understood it in the manner that, for reasons I have explained, most accords with ordinary principles of grammar and syntax. b. Congressional awareness of medical marijuana The majority discounts any significance in the way the current language is described in the relevant Committee report, observing that California voters did not pass Prop. 215 until 1996 and that there were no state laws in 1990 allowing for professionally supervised use of drugs in a manner inconsistent with the CSA. Congress would not have carefully drafted the exception to include non-CSA authorized medically supervised uses, the majority posits, as no such uses were legal under state law at the time. That explanation for dismissing the best reading of the statute and the only coherent reading of the Committee’s explanation of the statute won’t wash, for several reasons. First, while California in 1996 became the first of the sixteen states that currently legalize medical marijuana, the history of medical marijuana goes back much further, so that use for medical purposes was not unthinkable in 1990. At one time, “almost all States . . . had exceptions making lawful, under specified conditions, possession of marihuana by . . . persons for whom the drug had been prescribed or to whom it had been given by an authorized medical person.” What’s more, the Federal government itself conducted an experimental medical marijuana program from 1978 to 1992, and it continues to provide marijuana to the surviving participants. The existence of these programs indicates that medical marijuana was not a concept utterly foreign to Congress before 1996. *** The upshot is that the statutory language and history, taken together, fit much better with James’s version of what Congress meant than the Cities’.



Chapter One The Nature of Law

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CYBERLAW IN ACTION Section 230 of the Communications Decency Act (CDA), a federal statute, provides that “[n]o provider or user of an interactive computer service shall be treated as the publisher or speaker of any information provided by another information content provider.” Although § 230 appears in a statute otherwise designed to protect minors against online exposure to indecent material, the broad language of § 230 has caused courts to apply it in contexts having nothing to do with indecent expression. For instance, various courts have held that § 230 protects providers of an interactive computer service (ICS) against liability for defamation when a user of the service creates and posts false, reputation-harming statements about someone else. (ICS is defined in the statute as “any information service, system, or access software provider that provides or enables computer access by multiple users to a computer server.”) With courts so holding, § 230 has the effect of superseding a common law rule of defamation that anyone treated as a publisher or speaker of defamatory material is liable to the same extent as the original speaker or writer of that material. Absent § 230, ICS providers could sometimes face defamation liability under the theory that they are publishers of statements made by someone else. (You will learn more about defamation in Chapter 6.) This application of § 230 illustrates two concepts noted earlier in the chapter: first, that federal law overrides state law when the two conflict, and second, that an applicable statute supersedes a common law rule. Cases in other contexts have required courts to utilize statutory interpretation techniques discussed in this chapter as they determine whether § 230’s shield against liability applies. For example, two cases presented the question whether § 230 protects website operators against liability for alleged Fair Housing Act (FHA) violations based on material that appears on their sites. The FHA states that it is unlawful to “make, print or publish” or to “cause” the making, printing, or publishing of, notices, statements, or advertisements that “with respect to the sale or rental of a dwelling[,] . . . indicate[s] any preference, limitation, or discrimination based on race, color,

Limits on the Power of Courts By now, you

may think that anything goes when courts decide common law cases or interpret statutes. Many factors, however, discourage courts from adopting a freewheeling approach. Their legal training and mental makeup cause judges to be likely to respect established precedents and the will of the legislature. Many courts issue written opinions, which expose judges to academic and professional criticism if the opinions are poorly reasoned. Lower court judges may be

religion, sex, handicap, familial status, or national origin, or an intention to make any such preference, limitation, or discrimination.” A civil rights organization sued Craigslist Inc., which operated a wellknown electronic forum for those who sought to buy, sell, or rent housing and miscellaneous goods and services. The plaintiff alleged that Craigslist users posted housing-related statements such as “No minorities” and “No children” and that those statements constituted FHA violations on the part of Craigslist. In Chicago Lawyers Committee for Civil Rights Under Law, Inc. v. Craigslist, Inc., 519 F.3d 666 (7th Cir. 2008), the U.S. Court of Appeals for the Seventh Circuit affirmed the district court’s dismissal of the plaintiff’s complaint. The Seventh Circuit held that a “natural reading” of § 230 of the CDA protected Craigslist against liability. The statements that allegedly violated the FHA were those of users of the electronic forum—meaning that Craigslist would be liable only if it were treated as a publisher or speaker of the users’ statements. The plain language of § 230, however, prohibited classifying Craigslist as a publisher or speaker of the content posted by the users. Neither did Craigslist “cause” users to make statements of the sort prohibited by the FHA. Using a commonsense interpretation of the word “cause,” the court concluded that merely furnishing the electronic forum was not enough to implicate Craigslist in having “cause[d]” the users’ statements. There were no facts indicating that Craigslist suggested or encouraged statements potentially running afoul of the FHA. Very shortly after the Craigslist decision, a different federal court of appeals decided Fair Housing Council v. Roommates. com, LLC. That case presented the question whether § 230 of the CDA protected Roommates.com against FHA liability for allegedly discriminatory housing-related statements posted by users of Roommates.com’s electronic forum. The case’s basic facts appear in problem case 10 at the end of this chapter. Review those facts and compare them to the facts of the Craigslist case. Then determine whether § 230 protected Roommates.com against liability (as it protected Craigslist) or whether the facts of the Roommates.com case warranted a different outcome.

discouraged from innovation by the fear of being overruled by a higher court. Finally, political factors inhibit judges. For example, some judges are elected, and even judges with lifetime tenure can sometimes be removed. An even more fundamental limit on the power of courts is that they cannot make or interpret law until parties present them with a case to decide. In addition, any such case must be a real dispute. That is, courts generally limit themselves to genuine, existing “cases or controversies”

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Part One Foundations of American Law

between real parties with tangible opposing interests in the lawsuit. Courts generally do not issue advisory opinions on abstract legal questions unrelated to a genuine dispute, and do not decide feigned controversies that parties concoct to seek answers to such questions. Courts may also refuse to decide cases that are insufficiently ripe to have matured into a genuine controversy, or that are moot because there no longer is a real dispute between the parties. Reflecting similar policies is the doctrine of standing to sue, which normally requires that the plaintiff have some direct, tangible, and substantial stake in the outcome of the litigation. State and federal declaratory judgment statutes, however, allow parties to determine their rights and duties

even though their controversy has not advanced to the point where harm has occurred and legal relief may be necessary. This enables them to determine their legal position without taking action that could expose them to liability. For example, if Darlene believes that something she plans to do would not violate Earl’s copyright on a work of authorship but she recognizes that he may take a contrary view, she may seek a declaratory judgment on the question rather than risk Earl’s lawsuit by proceeding to do what she had planned. Usually, a declaratory judgment is awarded only when the parties’ dispute is sufficiently advanced to constitute a real case or controversy.

The Global Business Environment Just as statutes may require judicial interpretation when a dispute arises, so may treaties. The techniques that courts use in interpreting treaties correspond closely to the statutory interpretation techniques discussed in this chapter. Olympic Airways v. Husain, 540 U.S. 644 (2004), furnishes a useful example. In Olympic Airways, the U.S. Supreme Court was faced with an interpretation question regarding a treaty, the Warsaw Convention, which deals with airlines’ liability for passenger deaths or injuries on international flights. Numerous nations (including the United States) subscribe to the Warsaw Convention, a key provision of which provides that in regard to international flights, the airline “shall be liable for damages sustained in the event of the death or wounding of a passenger or any other bodily injury suffered by a passenger, if the accident which caused the damage so sustained took place on board the aircraft or in the course of any of the operations of embarking or disembarking.” A separate provision imposes limits on the amount of money damages to which a liable airline may be subjected. The Olympic Airways case centered around the death of Dr. Abid Hanson, a severe asthmatic, on an international flight operated by Olympic. Smoking was permitted on the flight. Hanson was given a seat in the nonsmoking section, but his seat was only three rows in front of the smoking section. Because Hanson was extremely sensitive to secondhand smoke, he and his wife, Rubina Husain, requested various times that he be allowed, for health reasons, to move to a seat farther away from the smoking section. Each time, the request was denied by an Olympic flight attendant. When smoke from the smoking section began to give Hanson difficulty, he used a new inhaler and walked toward the front of the plane to get some fresher air. Hanson went into respiratory

distress, whereupon his wife and a doctor who was on board gave him shots of epinephrine from an emergency kit that Hanson carried. Although the doctor administered CPR and oxygen when Hanson collapsed, Hanson died. Husain, acting as personal representative of her late husband’s estate, sued Olympic in federal court on the theory that the Warsaw Convention made Olympic liable for Hanson’s death. The federal district court and the court of appeals ruled in favor of Husain. In considering Olympic’s appeal, the U.S. Supreme Court noted that the key issue was one of treaty interpretation: whether the flight attendant’s refusals to reseat Hanson constituted an “accident which caused” the death of Hanson. Noting that the Warsaw Convention itself did not define “accident” and that different dictionary definitions of “accident” exist, the Court looked to a precedent case, Air France v. Saks, 470 U.S. 392 (1985), for guidance. In the Air France case, the Court held that the term “accident” in the Warsaw Convention means “an unexpected or unusual event or happening that is external to the passenger.” Applying that definition to the facts at hand, the Court concluded in Olympic Airways that the repeated refusals to reseat Hanson despite his health concerns amounted to unexpected and unusual behavior for a flight attendant. Although the refusals were not the sole reason why Hanson died (the smoke itself being a key factor), the refusals were nonetheless a significant link in the causation chain that led to Hanson’s death. Given the definition of “accident” in the Court’s earlier precedent, the phrasing, the Warsaw Convention, and the underlying public policies supporting it, the Court concluded that the refusals to reseat Hanson constituted an “accident” covered by the Warsaw Convention. Therefore, the Court affirmed the decision of the lower courts.



Chapter One The Nature of Law

APPENDIX

Reading and Briefing Cases Throughout

this text, you will encounter cases—the judicial opinions accompanying court decisions. These cases are highly edited versions of their much longer originals. What follows are explanations and pointers to assist you in studying cases. 1. Each case has a case name that includes at least some of the parties to the case. Because the order of the parties may change when a case is appealed, do not assume that the first party listed is the plaintiff (the party suing) and the second the defendant (the party being sued). Also, because some cases have many plaintiffs and/or many defendants, the parties discussed in the court’s opinion sometimes differ from those found in the case name. 2. Each case also has a citation, which includes the volume and page number of the legal reporter in which the full case appears, plus the year the case was decided. James v. City of Costa Mesa, for instance, begins on page 394 of volume 700 of the third edition of the Federal Reporter (the official reporter that compiles the published opinions of the U.S. Circuit Courts of Appeal) and was decided in 2012. (Each of the many different legal reporters has its own abbreviation. The list is too long to include here.) In parentheses accompanying the date, we also give you some information about the court that decided the case. For example, “1st Cir.” is the U.S. Court of Appeals for the First Circuit, “D. Md.” is the U.S. District Court for the District of Maryland, “Mich.” is the Supreme Court of Michigan, and “Minn. Ct. App.” is the Minnesota Court of Appeals (a Minnesota intermediate appellate court). Chapter 2 describes the various kinds of courts. 3. At the beginning of each case, there is a statement of facts containing the most important facts that gave rise to the case. These appear in italics and are largely written by the authors of this text, though some of the language may be that of the court. 4. As part of the statement of facts, we give you the case’s procedural history. This history tells you what courts previously handled the case you are reading, and how they dealt with it. 5. Next comes your major concern: the body of the court’s opinion. Here, the court determines the applicable law and applies it to the facts to reach a conclusion. The court’s discussion of the relevant law may be elaborate; it may include prior cases, legislative history,

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applicable public policies, and more. The court’s application of the law to the facts usually occurs after it has arrived at the applicable legal rule(s), but also may be intertwined with its legal discussion. 6. At the very end of the case, we complete the procedural history by stating the court’s decision. For example, “Judgment reversed in favor of Smith” says that a lower court judgment against Smith was reversed on appeal. This means that Smith’s appeal was successful and Smith wins. 7. The cases’ main function is to provide concrete examples of rules stated in the text. (Frequently, the text tells you what point the case illustrates.) In studying law, it is easy to conclude that your task is finished once you have memorized a black letter rule. Real-life legal problems, however, seldom present themselves as abstract questions of law; instead, they are hidden in particular situations one encounters or particular actions one takes. Without some sense of a legal rule’s real-life application, your knowledge of that rule is incomplete. The cases help provide this sense. 8. You may find it helpful to brief the cases. There is no one correct way to brief a case, but most good briefs contain the following elements: (1) a short statement of the relevant facts, (2) the case’s prior history, (3) the question(s) or issue(s) the court had to decide, (4) the answer(s) to those question(s), (5) the reasoning the court used to justify its decision, and (6) the final result. A brief of Price v. High Pointe Oil Company, Inc. (a case included earlier) might look this way: Price v. High Pointe Oil Company, Inc. Facts Beckie Price’s house and all of her personal belongings were destroyed when High Pointe erroneously filled her basement with 400 gallons of oil through an oil fill pipe that formerly led to an oil furnace in the basement. Price had replaced the oil furnace with a propane furnace a year earlier and canceled her fill order with High Pointe. Somehow, though, her address was mistakenly included on a “keep full list.” Despite the fact that Price’s house was eventually rebuilt, her land was remediated, her personal belongings cleaned or replaced, and her expenses while she was displaced from her home covered, she sued High Pointe for negligence, including claims for noneconomic damages. History A Michigan jury found for Price on the claim they heard and awarded her $100,000. The Michigan appellate court affirmed. High Pointe appealed to the Michigan Supreme Court. Issues Should the Michigan common law include the recognition of noneconomic damages for the negligent destruction of real property?

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Part One Foundations of American Law

Holdings Michigan common law has never allowed the recovery of noneconomic damages for the negligent destruction of real or personal property and the court will not adopt a new common law rule doing so in this case. Reasoning The longstanding rule in Michigan is that the remedy for the negligent destruction of property is the market value of the property if it is destroyed or the repair cost of the property if it is only damaged. No cases have ever held differently. Two recent cases applied the exclusion of noneconomic damages to claims regarding personal property, and the Court found that the current case was not distinguishable from those cases. Consistent with the proper caution courts should exercise when considering changing the common law, the Court further declined to modify that longstanding rule for a number of reasons. The rule is rational and can be

Problems and Problem Cases 1. In August 2002, Dayle Trentadue, as the daughter and representative of the estate of Margarette Eby, sued various parties for their part in Eby’s 1986 murder at the home she rented in Flint, Michigan. The murder had been unsolved from 1986 until 2002, when DNA evidence established that Jeffrey Gorton had committed the crime. Gorton worked for his parents’ corporation, which serviced the sprinkler system on the grounds surrounding the rental home where Eby lived. In addition to Gorton, Trentadue sued Gorton’s parents, their corporation, the estate of the rentalhome owner, the property management company that managed the rental home, and two employees of the rental-home owner. The claims against the parties other than Gorton were negligence-based wrongful death theories. Those parties asked the court to dismiss Trentadue’s lawsuit against them, claiming the action was barred by Michigan’s three-year statute of limitations for wrongful death actions. Statutes of limitations require that a plaintiff who wishes to make a legal claim must file her lawsuit within a designated length of time after her claim accrues. Normally a claim accrues at the time the legal wrong was committed. If the plaintiff does not file her lawsuit within the time specified by the applicable statute of limitations, her claim cannot lawfully be pursued. The defendants other than Gorton argued that Trentadue’s case should be dismissed because her

justified by important considerations of public policy, including: 1. A reliance on the market for valuation of property; 2. Easy verifiability, quantifiability, and measurability of economic damages (and concomitant difficulty of those in noneconomic damages); 3. Avoidance of disparity among the valuation of the same property in different cases; and 4. Certainty for businesses that have frequent contact with property and might damage it through negligence. The Legislature is the appropriate entity to change the rule if it sees fit. Result The Supreme Court of Michigan reversed the judgment of the Court of Appeals and remanded the case to the trial court to enter judgment in favor of High Pointe.

claim accrued when Eby was killed in 1986—­meaning that the 2002 filing of the lawsuit occurred long after the three-year period had expired. Trentadue responded that a common law rule known as the “discovery rule” should be applied so as to suspend the running of the limitations period until 2002, when she learned the identity of Eby’s killer. Under the discovery rule, the 2002 filing of the lawsuit would have been timely because the limitations period would have been tolled, or suspended, until the 2002 discovery that Gorton was the murderer. The Michigan Compiled Laws (MCL)—the statute that includes the relevant three-year statute of limitations for wrongful death claims—does not include a tolling provision similar to the common law discovery rule for wrongful death claims, even though it does in other areas. Nonetheless, the statute likewise does not explicitly reject the discovery rule. How should the court determine whether the common law discovery rule applies to Trentadue’s claims or whether it has been displaced by the MCL’s statute of limitations? 2. Which of the following types of law will have priority in the event that they present an unresolvable and unavoidable conflict? • A federal administrative regulation and a state statute. • A federal statute and the U.S. Constitution. • A federal statute and a federal administrative regulation.



Chapter One The Nature of Law

• A state constitution and a treaty that has been ratified by Congress. 3. The Freedom of Access to Clinic Entrances Act (FACE), a federal statute, provides for penalties against anyone who “by force or threat of force or by physical obstruction . . . intentionally injures, intimidates, or interferes . . . with any person . . . in order to intimidate such person . . . from obtaining or providing reproductive health services.” Two persons, Lynch and Moscinski, blocked access to a clinic that offered such services. The federal government sought an injunction barring Lynch and Moscinski from impeding access to, or coming within 15 feet of, the clinic. In defense, the defendants argued that FACE protects the taking of innocent human life, that FACE is therefore contrary to natural law, and that, accordingly, FACE should be declared null and void. A federal district court issued the injunction after finding that Lynch and Moscinski had violated FACE by making entrance to the clinic unreasonably difficult. On appeal, the defendants maintained that the district court erred in not recognizing their natural law argument as a defense. Were the defendants correct? 4. Many states and localities used to have so-called Sunday Closing laws—statutes or ordinances forbidding certain business from being conducted on Sunday. A few may still have such laws. Often, these laws have not been obeyed or enforced. What would an extreme legal positivist tend to think about the duty to enforce and obey such laws? What would a natural law exponent who strongly believes in economic freedom tend to think about this question? What about a natural law adherent who is a Christian religious traditionalist? What observation would almost any legal realist make about Sunday Closing laws? With these laws looked at from a sociological perspective, finally, what social factors help explain their original passage, their relative lack of enforcement today, and their continued presence on the books despite their lack of enforcement? 5. Keith Rawlins and his daughter, Jenna, attended the July 20, 2012, baseball game between the Cleveland Indians and the Baltimore Orioles. That night, following the game, the Indians were hosting a post-game fireworks display. As a result, the Cleveland Fire Department ordered that certain sections of spectator seating had to be vacated prior to the display. The Rawlinses’ seats were in one of those sections. Rawlins and his daughter claimed that ushers indicated that they had to vacate their seats prior to the end of the game. Though they

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did not want to leave, they complied, and as they proceeded up the steps to leave the stadium, Rawlins was struck in the head with a foul ball. Rawlins was seriously injured as a result, and Jenna suffered emotional trauma from seeing her father injured in this way. They sued the Indians. Based on the discussion of the common law “baseball rule” in the Coomer case in this chapter and the precedents that applied and declined to apply it, if you were the judge in this case, would you apply the baseball rule to shield the Cleveland Indians from liability or would you distinguish this case from those where the baseball rule applies? Why? 6. Linda Hagan and her sister Barbara Parker drank from a bottle of Coke that they both agreed tasted flat. Hagan then held the bottle up to a light and observed what she and Parker thought was a used condom with “oozy stringy stuff coming out of the top.” Both women were distressed that they had consumed some foreign material, and Hagan immediately became nauseated. The bottle was later delivered to Coca-Cola for testing. Concerned about what they had drunk, the women went to a health care facility the next day and were given shots. The medical personnel at the clinic told them that they should be tested for HIV. Hagan and Parker were then tested and informed that the results were negative. Six months later, both women were again tested for HIV, and the results were again negative. Hagan and Parker brought a negligence action against Coca-Cola. Coca-Cola’s beverage analyst testified at trial that he had initially thought, as Hagan and Parker had, that the object in the bottle was a condom; however, upon closer examination, he concluded that the object was a mold and that, to a “scientific certainty,” the item floating in the Coke bottle was not a condom.  There is case law that lays out the so-called impact rule in negligence claims. The rule requires that before a plaintiff may recover damages for emotional distress, she must demonstrate that the emotional stress suffered flowed from injuries sustained in an impact. Nonetheless, there are a number of exceptions to the impact rule, in which a lack of physical impact would not preclude an otherwise viable claim for emotional distress. Those exceptions include bystander cases, wrongful birth cases, negligent stillbirth cases, and bad-faith claims against insurance carriers. Other courts had found that ingestion of a contaminated product could serve in the place of the traditionally required impact. Given that Hagan and Parker’s claim is in common law, how should the court go about determining whether the impact rule applies to their case?

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Part One Foundations of American Law

7. The federal Age Discrimination in Employment Act (ADEA) makes it unlawful for employers “to fail or refuse to hire or to discharge any individual or otherwise discriminate against any individual with respect to his compensation, terms, conditions, or privileges of employment, because of such individual’s age.” The ADEA also provides that the statute’s protection against discrimination applies only when the affected individual is at least 40 years of age. A pre-1997 collective bargaining agreement between the United Auto Workers (UAW) and General Dynamics Land Systems, Inc. (GDLS) called for GDLS to furnish health benefits to retired employees who had worked for the company for a qualifying number of years. In 1997, however, the UAW and GDLS entered into a new collective bargaining agreement that eliminated the obligation of GDLS to provide health benefits to employees who retired after the effective date of the new agreement, except for then-current workers who were at least 50 years old at the time of the agreement. Employees in that 50-and-over category would still receive health benefits when they retired. Dennis Cline and certain other GDLS employees objected to the new collective bargaining agreement because they were under 50 years of age when the agreement was adopted, and thus would not receive health benefits when they retired. Cline and the other objecting employees were all at least 40 years of age. In a proceeding before the Equal Employment Opportunity Commission (EEOC), Cline and the similarly situated employees asserted that the 1997 agreement violated the ADEA because they were within the ADEA’s protected class of persons (those at least 40 years of age) and because the agreement discriminated against them “with respect to . . . compensation, terms, conditions, or privileges of employment, because of [their] age” (quoting the ADEA). They contended that age discrimination occurred when their under-50 age served as the basis for denying them the more favorable treatment to be received by persons 50 years of age or older. After no settlement occurred despite the EEOC’s encouragement, Cline and the similarly situated employees sued GDLS for a supposed violation of the ADEA. In asserting that they had been discriminated against in favor of older workers, did Cline and the other plaintiffs state a valid claim under the ADEA? 8. A federal statute known as the Freedom of Information Act (FOIA) establishes a general rule that federal agencies must make records and documents publicly

available upon submission of a proper request. However, if those records or documents fall within certain exemptions set forth in FOIA, they can be withheld from public disclosure. After the Federal Communications Commission (FCC) conducted an investigation of AT&T regarding AT&T’s possible overbilling of the government under an FCC-administered program, the FCC and AT&T entered into an agreement to settle any allegations of wrongdoing. The agreement included a payment from AT&T to the government of $500,000, though AT&T admitted no wrongdoing. Subsequently, a trade association and some of AT&T’s competitors submitted a FOIA request to the FCC for records related to the investigation. The FCC withheld certain documents that contained AT&T trade secrets, pursuant to a specific FOIA exemption. But the FCC determined that other documents not containing trade secrets had to be disclosed despite AT&T’s contention that they should not be disclosed under Exemption 7(C), which exempts “records or information compiled for law enforcement purposes” if the records “could reasonably be expected to constitute unwarranted invasion of personal privacy.” The FCC determined that Exemption 7(C) did not apply because corporations like AT&T, unlike humans, do not possess “personal privacy” interests. This dispute ultimately ended up in court, requiring judges to determine the meaning of “personal privacy” in Exemption 7(C). How might a judge go about determining whether Exemption 7(C) applies to AT&T’s interests? 9. Law enforcement officers arrived at a Minnesota residence in order to execute arrest warrants for Andrew Hyatt. During the officers’ attempt to make the arrest, Hyatt yelled something such as, “Go ahead, just shoot me, shoot me,” and struck one of the officers. Another officer then called for assistance from City of Anoka, Minnesota, police officer Mark Yates, who was elsewhere in the residence with his leashed police dog, Chips. Yates entered the room where Hyatt was, saw the injured officer’s bloodied face, and observed Hyatt standing behind his wife (Lena Hyatt). One of the officers acquired the impression that Lena may have been serving as a shield for her husband. When Andrew again yelled, “Shoot me, shoot me” and ran toward the back of the room, Yates released Chips from the leash. Instead of pursuing Andrew, Chips apprehended Lena, taking her to the ground and performing a “bite and hold” on her leg and arm. Yates then pursued Andrew, who had fled through a window. When Yates



Chapter One The Nature of Law

later reentered the room, he released Chips from Lena and instructed another officer to arrest her on suspicion of obstruction of legal process. Lena was taken by ambulance to a hospital and treated for lacerations on her elbow and knee. She later sued the City of Anoka, seeking compensation for medical expenses and pain and suffering. Her complaint alleged liability on the basis of Minnesota’s dog bite statute, which read as follows: If a dog, without provocation, attacks or injures any person who is acting peaceably in any place where the person may lawfully be, the owner of the dog is liable in damages to the person so attacked or injured to the full amount of the injury sustained. The term “owner” includes any person harboring or keeping a dog but the owner shall be primarily liable. The term “dog” includes both male and female of the canine species. In defense, the city argued that the dog bite statute does not apply to police dogs and municipalities that own them. Was the city correct? 10. Roommates.com, LLC (“Roommates”) operated a widely used website designed to match people renting out spare rooms with people looking for a place to live. Before subscribers to Roommates could search listings or post housing opportunities on the website, they had to create profiles by answering a series of questions. Besides requesting basic information such as name, location, and e-mail address, Roommates required each subscriber to disclose his or her sex and sexual orientation and whether he or she would bring children to a household. Each subscriber was further required to describe his or her roommate preferences with respect to the same

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three criteria (sex, sexual orientation, and whether children would be brought to the household). Roommates also encouraged subscribers to provide “Additional Comments” describing themselves and their desired roommate in an open-ended essay. After a new subscriber completed the application, Roommates would assemble his or her answers into a profile page. Subscribers to Roommates were entitled to view their own profile pages and those of others, send personal e-mail messages through the site, and receive notices from Roommates regarding available housing opportunities matching their preferences. The Fair Housing Councils of the San Fernando Valley and San Diego (“Councils”) sued Roommates, alleging that its activities violated the federal Fair Housing Act (“FHA”). The FHA prohibits discrimination in the sale or rental of housing on the basis of “race, color, religion, sex, familial status, or national origin.” The FHA also bars mak[ing], print[ing], or publish[ing], or caus[ing] to be made, printed, or published, any notice, statement, or advertisement, with respect to the sale or rental of a dwelling that indicates any preference, limitation, or discrimination based on race, color, religion, sex, handicap, familial status, or national origin, or an intention to make any such preference, limitation, or discrimination. Roommates argued, however, that it was immune from liability under § 230 of the federal Communications Decency Act, which provides that “[n]o provider . . . of an interactive computer service shall be treated as the publisher or speaker of any information provided by another information content provider.” Did § 230 protect Roommates against liability?

CHAPTER 2

The Resolution of Private Disputes

A

llnews Publishing Inc., a firm whose principal offices are located in Orlando, Florida, owns and publishes 33 newspapers. These newspapers are published in 21 different states of the United States. Among the Allnews newspapers is the Snakebite Rattler, the lone newspaper in the city of Snakebite, New Mexico. The Rattler is sold in print form only in New Mexico. However, many of the articles in the newspaper can be viewed by anyone with Internet access, regardless of his or her geographic location, by going to the Allnews website. In a recent Rattler edition, an article appeared beneath this headline: “Local Business Executive Sued for Sexual Harassment.” The accompanying article, written by a Rattler reporter (an Allnews employee), stated that a person named Phil Anderson was the defendant in the sexual harassment case. Besides being married, Anderson was a wellknown businessperson in the Snakebite area. He was active in his church and in community affairs in both Snakebite (his city of primary home) and Petoskey, Michigan (where he and his wife have a summer home). A stock photo of Anderson, which had been used in connection with previous Rattler stories mentioning him, appeared alongside the story about the sexual harassment case. Anderson, however, was not the defendant in that case. He was named in the Rattler story because of an error by the Rattler reporter. The actual defendant in the sexual harassment case was a local business executive with a similar name: Phil Anderer. Anderson plans to file a defamation lawsuit against Allnews because of the above-described falsehood in the Rattler story. He expects to seek $500,000 in damages for harm to his reputation and for other related harms. In Chapter 6, you will learn about the substantive legal issues that will arise in Anderson’s defamation case. For now, however, the focus is on important legal matters of a procedural nature. Consider the following questions regarding Anderson’s case as you read this chapter: • Where, in a geographic sense, may Anderson properly file and pursue his lawsuit against Allnews? • Must Anderson pursue his case in a state court, or does he have the option of litigating it in federal court? • Assuming that Anderson files his case in a state court, what strategic option may Allnews exercise if it acts promptly? • In the run-up to a possible trial in the case, what legal mechanisms may Anderson utilize in order to find out, on a pretrial basis, what the Rattler reporter and other Allnews employees would say in possible testimony at trial? Is Allnews entitled to do the same with regard to Anderson? • If Anderson’s case goes to trial, what types of trials are possible? • Through what legal mechanisms might a court decide the case without a trial? • Today, many legal disputes are decided through arbitration rather than through proceedings in court. Given the prevalence of arbitration these days, why isn’t Anderson’s case a candidate for arbitration?

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Part One Foundations of American Law

LEARNING OBJECTIVES

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After studying this chapter, you should be able to: 2-1 Describe the basic structures of state court systems and the federal court system. 2-2 Explain the difference between subject-matter jurisdiction and in personam jurisdiction. 2-3 Identify the major legal issues courts must resolve when deciding whether in personam jurisdiction exists with regard to a defendant in a civil case. 2-4 Explain what is necessary in order for a federal court to have subject-matter jurisdiction over a civil case. BUSINESS LAW COURSES examine many substantive legal rules that tell us how to behave in business and in society. Examples include the principles of contract, tort, and agency law, as well as those of many other legal areas addressed later in this text. Most of these principles are applied by courts as they decide civil cases involving private parties. This chapter lays a foundation for the text’s discussion of substantive legal rules by examining the court systems of the United States and by outlining how civil cases proceed from beginning to end. The chapter also explores related subjects, including alternative dispute resolution,  a collection of processes for resolving private disputes outside the court systems.

State Courts and Their Jurisdiction LO2-1

Describe the basic structures of state court systems and the federal court system.

The United States has 52 court systems—a federal system plus a system for each state and the District of Columbia. This section describes the various types of state courts. It also considers the important subject of jurisdiction, something a court must have if its decision in a case is to be binding on the parties.

Courts of Limited Jurisdiction Minor criminal cases and civil disputes involving small amounts of money or specialized matters frequently are decided in courts of limited jurisdiction. Examples include traffic courts, probate courts, and small claims courts. Such courts often handle a large number of cases. In some of

2-5 Identify the major steps in a civil lawsuit’s progression from beginning to end. 2-6 Describe the different forms of discovery available to parties in civil cases. 2-7 Explain the differences among the major forms of alternative dispute resolution.

these courts, procedures may be informal, and parties often argue their own cases without representation by attorneys. Courts of limited jurisdiction often are not courts of record—meaning that they may not keep a transcript of the proceedings conducted. Appeals from their decisions therefore require a new trial (a trial de novo) in a trial court.

Trial Courts Courts of limited jurisdiction find the

relevant facts, identify the appropriate rule(s) of law, and combine the facts and the law to reach a decision. State trial courts do the same but differ from inferior courts in two key ways. First, they are not governed by the subject-matter restrictions or the limits on civil damages or criminal penalties that govern courts of limited jurisdiction. Cases involving significant dollar amounts or major criminal penalties usually begin, therefore, at the trial court level. Second, trial courts are courts of record that keep detailed records of hearings, trials, and other proceedings. These records become important if a trial court decision is appealed. The trial court’s fact-finding function may be handled by the judge or by a jury. Determination of the applicable law, however, is always the judge’s responsibility. In cases pending in trial courts, the parties nearly always are represented by attorneys. States usually have at least one trial court for each county. It may be called a circuit, superior, district, county, chancery, or common pleas court. Most state trial courts can hear a wide range of civil and criminal cases, with little or no subject-matter restriction. They may, however, have civil and criminal divisions. If no court of limited jurisdiction deals with these matters, state trial courts may also contain other divisions such as domestic relations courts or probate courts.



Chapter Two The Resolution of Private Disputes

Appellate Courts State

appeals (or appellate) courts generally decide only legal questions. Instead of receiving new evidence or otherwise retrying the case, appellate courts review the record of the trial court proceedings. Although appellate courts correct legal errors made by the trial judge, they usually accept the trial court’s findings of fact. Appellate courts may also hear appeals from state administrative agency decisions. Some states have only one appeals court (usually called the Supreme Court), but most also have an intermediate appellate court. The U.S. Supreme Court sometimes hears appeals from decisions of the state’s highest court.

Jurisdiction and Venue LO2-2

Explain the difference between subject-matter jurisdiction and in personam jurisdiction.

The party who sues in a civil case (the plaintiff) cannot sue the defendant (the party being sued) in whatever court the plaintiff happens to prefer. Instead, the chosen court—whether a state court or a federal court—must have jurisdiction over the case. Jurisdiction is a court’s power to hear a case and to issue a decision binding on the parties. In order to render a binding decision in a civil case, a court must have not only subject-matter jurisdiction but also in personam jurisdiction or in rem jurisdiction. Even if a court has jurisdiction, applicable venue requirements must also be satisfied in order for the case to proceed in that court. Subject-Matter Jurisdiction Subject-matter jurisdiction is a court’s power to decide the type of dispute involved in the case. Criminal courts, for example, cannot hear civil matters. Similarly, a $500,000 claim for breach of contract cannot be pursued in a small claims court. In Personam Jurisdiction Identify the major legal issues courts must resolve when

LO2-3 deciding whether in personam jurisdiction exists with

regard to a defendant in a civil case.

Even a court with subject-matter jurisdiction cannot decide a civil case unless it also has either in personam jurisdiction or in rem jurisdiction. In personam jurisdiction is based on the residence, location, or activities of the defendant. A state court has in personam jurisdiction over defendants who are citizens or residents of the state (even if situated out-of-state), who are within the state’s borders when

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process is served on them (even if nonresidents),1 or who consent to the court’s authority (for instance, by entering the state to defend against the plaintiff’s claim).2 The same principle governs federal courts’ in personam jurisdiction over defendants. In addition, most states have enacted “long-arm” statutes that are designed to give their courts in personam jurisdiction over out-of-state defendants in certain instances. Under these statutes, nonresident individuals and businesses may become subject to the jurisdiction of the state’s courts by, for example, doing business within the state, contracting to supply goods or services within the state, committing a tort (a civil wrong) within the state, or committing a tort outside the state if it produces harm within the state. (Some long-arm statutes are phrased with even broader application in mind, so that in personam jurisdiction may extend as far as the U.S. Constitution’s Due Process clauses permit.) Federal law, moreover, permits federal courts to rely on state long-arm statutes as a basis for obtaining in personam jurisdiction over nonresident defendants. Even if a long-arm statute applies, however, a state or federal court’s assertion of in personam jurisdiction over a nonresident defendant must also meet due process standards. In International Shoe Co. v. Washington (1945), the U.S. Supreme Court held that in order for due process requirements to be satisfied when a state or federal court asserts in personam jurisdiction over a nonresident defendant, the defendant must be shown to have had the requisite “minimum contacts” with the forum state or federal district. These contacts must be significant enough that it would not offend “traditional notions of fair play and substantial justice” to require the nonresident defendant to defend the case in the forum state or federal district. After International Shoe, in personam jurisdiction cases involving nonresident defendants became divided into two categories: general jurisdiction and specific jurisdiction. In Abdouch v. Lopez, which follows, the Supreme Court of Nebraska explains each of these types of in personam jurisdiction and goes on to address the specific jurisdiction arguments made in the case. In Daimler AG v. Bauman, which serves as a basis of the Global Business Environment box that appears later in the chapter, the U.S. Supreme Court decides whether general jurisdiction exists regarding a German firm sued in the United States over actions that occurred outside the United States. Service of process is discussed later in the chapter. In many states, however, out-of-state defendants may make a special appearance to challenge the court’s jurisdiction without consenting to the court’s authority. 1 2

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Part One Foundations of American Law

Abdouch v. Lopez   829 N.W.2d 662 (Neb. 2013) Helen Abdouch, an Omaha, Nebraska, resident, served as executive secretary of the Nebraska presidential campaign of John F. ­Kennedy in 1960. Ken Lopez, a Massachusetts resident, and his Massachusetts-based company, Ken Lopez Bookseller (KLB), are engaged in the rare book business. In 1963, Abdouch received a copy of a book titled Revolutionary Road. Its author, Richard Yates, inscribed the copy with a note to Abdouch. The inscribed copy was later stolen from Abdouch. In 2009, Lopez and KLB bought the inscribed copy from a seller in Georgia. They sold it that same year to a customer from a state other than Nebraska. In 2011, Abdouch learned that Lopez had used the inscription and references to her in an advertisement on KLB’s website. The advertisement, which appeared on the website for more than three years after Lopez and KLB sold the inscribed copy, contained a picture of the inscription, the word “SOLD,” and this statement: This copy is inscribed by Yates: ‘For Helen Abdouch—with admiration and best wishes. Dick Yates. 8/19/63.’ Yates had worked as a speech writer for Robert Kennedy when Kennedy served as Attorney General; Abdouch was the executive secretary of the Nebraska (John F.) Kennedy organization when Robert Kennedy was campaign manager. . . . A scarce book, and it is extremely uncommon to find this advance issue of it signed. Given the date of the inscription—that is, during JFK’s Presidency—and the connection between writer and recipient, it’s reasonable to suppose this was an author’s copy, presented to Abdouch by Yates. Because Lopez and KLB did not obtain her permission before mentioning her and using the inscription in the advertisement, Abdouch filed an invasion-of-privacy lawsuit against Lopez and KLB in a Nebraska state district court. Contending that the Nebraska court lacked in personam jurisdiction, Lopez and KLB filed a motion to dismiss the case. The state district court granted the motion. Abdouch then appealed to the Supreme Court of Nebraska. (Further facts bearing upon the in personam jurisdiction issue appear in the following edited version of the Supreme Court’s opinion.)

McCormack, Judge Abdouch argues that the district court erred in finding that the State lacked in personam jurisdiction [, often referred to here as personal jurisdiction,] over Lopez and KLB. Abdouch argues that [the defendants’] active website deliberately targeted her with tortious conduct. She alleges these contacts are sufficient to create the necessary minimum contacts for specific jurisdiction. Personal jurisdiction is the power of a tribunal to subject and bind a particular entity to its decisions. Before a court can exercise personal jurisdiction over a nonresident defendant, the court must determine whether the long-arm statute is satisfied and, if the long-arm statute is satisfied, whether minimum contacts exist between the defendant and the forum state [for due process purposes]. Nebraska’s long-arm statute provides: “A court may exercise personal jurisdiction over a person . . . [w]ho has any other contact with or maintains any other relation to this state to afford a basis for the exercise of personal jurisdiction consistent with the Constitution of the United States.” Nebraska’s long-arm statute, therefore, extends Nebraska’s jurisdiction over nonresidents having any contact with or maintaining any relation to this state as far as the U.S. Constitution permits. [T]he issue is whether Lopez and KLB had sufficient contacts with Nebraska so that the exercise of personal jurisdiction would not offend federal principles of due process. To subject an out-of-state defendant to personal jurisdiction in a forum court, due process requires that the defendant have

minimum contacts with the forum state so as not to offend traditional notions of fair play and substantial justice. [See International Shoe Co. v. Washington, 326 U.S. 310, 316 (1945).] The benchmark . . . is whether the defendant’s minimum contacts with the forum state are such that the defendant should reasonably anticipate being haled into court there. Whether a forum state court has personal jurisdiction over a nonresident defendant depends on whether the defendant’s actions created substantial connections with the forum state, resulting in the defendant’s purposeful availment of the forum state’s benefits and protections. In analyzing personal jurisdiction, we consider the quality and type of the defendant’s activities in deciding whether the defendant has the necessary minimum contacts with the forum state. A court exercises two types of personal jurisdiction depending upon the facts and circumstances of the case: general personal jurisdiction or specific personal jurisdiction. In the exercise of general personal jurisdiction, the plaintiff’s claim does not have to arise directly out of the defendant’s contacts with the forum state if the defendant has engaged in continuous and systematic general business contacts with the forum state. But if the defendant’s contacts are neither substantial nor continuous and systematic, as Abdouch concedes is the case here, and instead the cause of action arises out of or is related to the defendant’s contacts with the forum, a court may assert specific jurisdiction over the defendant, depending upon the nature and quality of such contact.



Chapter Two The Resolution of Private Disputes

The Internet and its interaction with personal jurisdiction over a nonresident is an issue of first impression for this court. [However,] we take note that technological advances do not render impotent our longstanding principles. With this in mind, [most federal courts of appeal have] adopted the analytical framework set forth in Zippo Manufacturing Co. v. Zippo Dot Com, Inc., 952 F. Supp. 1119 (W.D. Pa. 1997), for Internet jurisdiction cases. In that case, Zippo Manufacturing filed a complaint in Pennsylvania against nonresident Zippo Dot Com, Inc., alleging causes of action under the federal Trademark Act of 1946. Zippo Dot Com’s contact with Pennsylvania consisted of over 3,000 Pennsylvania residents subscribing to its website. The court in Zippo Manufacturing famously created a “sliding scale” test that considers a website’s interactivity and the nature of the commercial activities conducted over the Internet to determine whether the courts have personal jurisdiction over nonresident defendants. The court explained the sliding scale as follows: At one end of the spectrum are situations where a defendant clearly does business over the Internet. If the defendant enters into contracts with residents of a foreign jurisdiction that involve the knowing and repeated transmission of computer files over the Internet, personal jurisdiction is proper. . . . At the opposite end are situations where a defendant has simply posted information on an Internet website which is accessible to users in foreign jurisdictions. A passive website that does little more than make information available to those who are interested in it is not grounds for the exercise [of] personal jurisdiction.  .  .  .  The middle ground is occupied by interactive websites where a user can exchange information with the host computer. In these cases, the exercise of jurisdiction is determined by examining the level of interactivity and commercial nature of the exchange of information that occurs on the website. The court in Zippo Manufacturing held that Pennsylvania had personal jurisdiction over Zippo Dot Com. In doing so, the court . . . found that the Zippo Dot Com website was a highly interactive commercial site [and] that the trademark infringement causes of action were related to the business contacts with customers in Pennsylvania. [Although Zippo Manufacturing’s test] is widely recognized and accepted, most circuits use it only as a starting point. As the Second Circuit noted, “it does not amount to a separate framework for analyzing Internet-based jurisdiction”; instead, “traditional statutory and constitutional principles remain the touchstone of the inquiry.” [Case citation omitted.] The Seventh Circuit has noted that “[c]ourts should be careful in resolving questions about personal jurisdiction involving online contacts to ensure that a defendant is not haled into court simply because the defendant owns or operates a website that is accessible in the forum state, even if that site is interactive.”

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[Citation omitted.] Many courts have held that even if the defendant operates a highly interactive website which is accessible from, but does not target, the forum state, then the defendant may not be haled into court in that state without offending the Constitution. Our precedent states that for there to be specific personal jurisdiction, the cause of action must arise out of or be related to the defendant’s contacts with the forum state. This is consistent with the U.S. Supreme Court’s precedent which has stated “mere purchases, even if occurring at regular intervals, are not enough to warrant a State’s assertion of in personam jurisdiction over a nonresident corporation in a cause of action not related to those purchase transactions.” Helicopteros Nacionales de Colombia v. Hall, 466 U.S. 408 (1984). In the case at hand, it is evident that the KLB website is interactive under the Zippo Manufacturing test. In his affidavit, Lopez admits that customers can browse and purchase books from the online inventory. Lopez admits that he has two customers in Nebraska who are on the mailing list for KLB’s catalogs. He admits that from 2009 through 2011, . . . $614.87 in sales from the website was made to Nebraska residents out of an estimated $3.9 million in total sales. But, beyond the minimal website sales to Nebraska residents and mailing catalogs to two Nebraska residents [who requested them], Lopez’s and KLB’s contacts with Nebraska are nonexistent. Lopez and KLB do not own, lease, or rent land in Nebraska. They have never advertised directly in Nebraska, participated in bookfairs in Nebraska [despite having participated in many bookfairs in other states], or attended meetings in Nebraska, and neither has paid sales tax in Nebraska. Furthermore, the Seventh Circuit has recently stated that when “the plaintiff’s claims are for intentional torts, the inquiry focuses on whether the conduct underlying the claims was purposely directed at the forum state.” [Citation omitted.] The reason for requiring purposeful direction is to “ensure that an out-of-state defendant is not bound to appear to account for merely ‘random, fortuitous, or attenuated contacts’ with the forum state.” Burger King Corp. v. Rudzewicz, 471 U.S. 462 (1985). Here, Abdouch’s cause of action is an intentional tort based on Nebraska’s privacy statute. There is no evidence that Lopez and KLB purposefully directed the advertisement at Nebraska. Further, there is no evidence that Lopez and KLB intended to invade Abdouch’s privacy in Nebraska. Rather, the limited Internet sales appear to be random, fortuitous, and attenuated contacts with Nebraska. Therefore, although KLB’s website is highly interactive, all of the contacts created by the site with Nebraska are unrelated to Abdouch’s cause of action. Abdouch argues that the effects test formulated by the U.S. Supreme Court in Calder v. Jones, 465 U.S. 783 (1984), creates personal jurisdiction over Lopez and KLB. In Calder, two Florida residents participated in the publication of [a National Enquirer]

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Part One Foundations of American Law

article about a California resident who brought a libel action in California against the Florida residents. Both defendants asserted that as Florida residents, they were not subject to the jurisdiction of the California court. The Supreme Court rejected the defendants’ argument and noted that the defendants [committed] intentional, and allegedly tortious, actions [that] were expressly aimed at California. [They] wrote and . . . edited an article that they knew would have a potentially devastating impact upon [the plaintiff]. And they knew that the brunt of that injury would be felt by [her] in the State in which she lives and works and in which the National Enquirer has its largest circulation. Under the circumstances, [the defendants] must reasonably anticipate being haled into court there to answer for the truth of the statements made in their article. [Calder, 465 U.S. at 789–90.] In coming to its holding, the U.S. Supreme Court created a test, now known as the Calder effects test, which has been explained by the Eighth Circuit: “[A] defendant’s tortious acts can serve as a source of personal jurisdiction only where the plaintiff makes a prima facie showing that the defendant’s acts (1) were intentional, (2) were uniquely or expressly aimed at the forum state, and (3) caused harm, the brunt of which was suffered—and which the defendant knew was likely to be suffered—[in the forum state].” Johnson v. Arden, 614 F.3d 785 (8th Cir. 2010). In the context of Internet intentional tort cases, the federal circuit courts have rejected the argument that [merely] posting defamatory or invasive material to the World Wide Web [is enough to satisfy the Calder effects test and give rise to in personam jurisdiction].

[Here,] Lopez’s and KLB’s placement of the advertisement online was directed at the entire world, without expressly aiming the posting at Nebraska. Abdouch pleaded in her complaint that the advertisement was “broadcast or sent out over the World Wide Web,” but Abdouch failed to plead facts that demonstrate that Nebraska residents were targeted with the advertisement. Although the advertisement does mention that “Abdouch was the executive secretary of the Nebraska (John F.) Kennedy organization,” the advertisement does not expressly direct its offer of sale to Nebraska. The mention of Nebraska here is incidental and was not included for the purposes of having the consequences felt in Nebraska. Lopez did not know that Abdouch was a resident of Nebraska [until he learned that fact in 2011]. He [initially] assumed that she had passed away and thus had no way of knowing that the brunt of harm would be suffered in Nebraska. We conclude that Abdouch’s complaint fails to plead facts to demonstrate that Lopez and KLB have sufficient minimum contacts with Nebraska. Although the website used to post the advertisement is interactive, the contacts created by the website are unrelated to Abdouch’s cause of action. Furthermore, . . . the pleadings fail to establish that Lopez and KLB expressly aimed their tortious conduct at Nebraska. For these reasons, Lopez and KLB could not have anticipated being haled into a Nebraska court for their online advertisement. Dismissal for lack of in personam jurisdiction affirmed.

The Global Business Environment Daimler AG v. Bauman  134 S. Ct. 746 (2014) In 2004, 22 residents of Argentina filed suit in the U.S. District Court for the Northern District of California against Daimler, a German company that manufactures Mercedes-Benz vehicles in Germany. The plaintiffs contended that during Argentina’s 1976–1983 “Dirty War,” Daimler’s subsidiary, Mercedes-Benz Argentina (MB Argentina), collaborated with state security forces to kidnap, detain, torture, and kill certain MB Argentina workers. These workers included the plaintiffs and deceased persons closely related to the plaintiffs. No part of MB Argentina’s alleged collaboration with Argentinian authorities took place in California or anywhere else in the United States. The plaintiffs maintained that Daimler should be held vicariously liable for MB Argentina’s actions. They brought claims under U.S. law as well as claims for wrongful death

and intentional infliction of emotional distress under the laws of California and Argentina. Relying on a California long-arm statute that applies to the full extent of what constitutional notions of due process will permit, the plaintiffs contended that in personam jurisdiction over Daimler should be predicated on the California contacts of Mercedes-Benz USA, LLC (MBUSA), another Daimler subsidiary. MBUSA, which is incorporated in Delaware and has its principal place of business in New Jersey, distributes Daimler-manufactured vehicles to dealerships in ­California and throughout the United States. MBUSA has multiple California-based facilities and is the largest supplier of luxury vehicles to the California market. Daimler sought dismissal of the case on the ground that the court lacked in personam jurisdiction over it. A federal district court granted Daimler’s request. The U.S. Court of Appeals for



Chapter Two The Resolution of Private Disputes

the Ninth Circuit reversed, concluding that in personam jurisdiction (personal jurisdiction) existed. The U.S. Supreme Court granted Daimler’s petition for a writ of certiorari. Writing for the Supreme Court in Daimler AG v. Bauman, Justice Ginsburg noted the landmark decision in International Shoe Co. v. Washington, 326 U.S. 310 (1945). That decision’s “minimum contacts” doctrine and “fair play and substantial justice” test continue to guide the due process inquiry when in personam jurisdiction over a nonresident defendant is at issue. (See the discussion of International Shoe earlier in the chapter.) Justice Ginsburg’s Daimler majority opinion also outlined the differences between general jurisdiction and specific jurisdiction. (For an explanation of these two types of in personam jurisdiction, see Abdouch v. Lopez, a case included earlier in the chapter.) The following excerpts from Daimler focus on the question of whether general jurisdiction existed. Ginsburg, Justice This case concerns the authority of a court in the United States to entertain a claim brought by foreign plaintiffs against a foreign defendant based on events occurring entirely outside the United States. The question presented is whether the Due Process Clause of the Fourteenth Amendment precludes the district court from exercising jurisdiction over Daimler, given the absence of any California connection to the atrocities, perpetrators, or victims described in the complaint. Plaintiffs invoked the court’s general or all-purpose jurisdiction. California, they urge, is a place where Daimler may be sued on any and all claims against it, wherever in the world the claims may arise. For example, as plaintiffs’ counsel affirmed, under the proffered jurisdictional theory, if a Daimler-­ manufactured vehicle overturned in Poland, injuring a Polish driver and passenger, the injured parties could maintain a design defect suit in California. [We must decide whether such] exercises of personal jurisdiction . . . are [permitted or, instead,] barred by due process constraints on the assertion of adjudicatory authority. In Goodyear Dunlop Tires Operations, S. A. v. Brown, 131 S. Ct. 2846 (2011), we addressed the distinction between general or all-purpose jurisdiction, and specific or conduct-linked jurisdiction. As to the former, we held that a court may assert jurisdiction over a foreign corporation “to hear any and all claims against [it]” only when the corporation’s affiliations with the State in which suit is brought are so constant and pervasive “as to render [it] essentially at home in the forum State.” Id. at 2851. Since [the 1945 decision in] International Shoe, “specific jurisdiction has become the centerpiece of modern jurisdiction theory, while general jurisdiction [has played] a reduced role.” Goodyear, 131 S. Ct. at 2854. Our post-International Shoe opinions on general jurisdiction  .  .  .  are few. [In] Perkins v. Benguet Consolidated Mining Co., 342 U.S. 437 (1952), an Ohio resident sued Benguet [in an Ohio court] on a claim that neither arose in Ohio nor related to the corporation’s activities

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in that State. [Benguet] was a company incorporated under the laws of the Philippines, where it operated gold and silver mines. [However,] Benguet ceased its mining operations during the Japanese occupation of the Philippines in World War II; its president moved to Ohio, where he kept an office, maintained the company’s files, and oversaw the company’s activities. We held that [because Ohio was the corporation’s principal, if temporary, place of business,] the Ohio courts could exercise general jurisdiction over Benguet without offending due process. Id. at 448. The next case on point, Helicopteros Nacionales de Colombia, S.A. v. Hall, 466 U.S. 408 (1984), arose from a helicopter crash in Peru. Four U.S. citizens perished in that accident; their survivors and representatives brought suit in Texas state court against the helicopter’s owner and operator, a Colombian corporation. That company’s contacts with Texas were confined to “sending its chief executive officer to Houston for a contract-negotiation session; accepting into its New York bank account checks drawn on a Houston bank; purchasing helicopters, equipment, and training services from a Texas-based helicopter company for substantial sums; and sending personnel to Texas for training.” Id. at 416. Notably, those contacts bore no apparent relationship to the accident that gave rise to the suit. We held that the company’s Texas connections did not resemble the “continuous and systematic general business contacts . . . found to exist in Perkins.” Id. “[M]ere purchases, even if occurring at regular intervals,” we clarified, “are not enough to warrant a State’s assertion of in personam jurisdiction over a nonresident corporation in a cause of action not related to those purchase transactions.” Id. at 418. Most recently, in Goodyear, we answered this question: “Are foreign subsidiaries of a United States parent corporation amenable to suit in state court on claims unrelated to any activity of the subsidiaries in the forum State?” 131 S. Ct. at 2850. That case arose from a bus accident outside Paris that killed two boys from North Carolina. The boys’ parents brought a wrongful-death suit in North Carolina state court alleging that the bus’s tire was defectively manufactured. The complaint named as defendants not only Goodyear, an Ohio corporation, but also Goodyear’s Turkish, French, and Luxembourgian subsidiaries. Those foreign subsidiaries, which manufactured tires for sale in Europe and Asia, lacked any affiliation with North Carolina. A small percentage of tires manufactured by the foreign subsidiaries were distributed in North Carolina, however, and on that ground, the North Carolina Court of Appeals held the subsidiaries amenable to the general jurisdiction of North Carolina courts. We reversed, observing that the North Carolina court’s analysis “elided the essential difference between case-specific and all-purpose (general) jurisdiction.” Id. at 2846. Although the placement of a product into the stream of commerce “may bolster an affiliation germane to specific jurisdiction,” we explained, such contacts “do not warrant a determination that, based on

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Part One Foundations of American Law

those ties, the forum has general jurisdiction over a defendant.” Id. As International Shoe itself teaches, a corporation’s “continuous activity of some sorts within a state is not enough to support the demand that the corporation be amenable to suits unrelated to that activity.” 326 U.S. at 318. Because Goodyear’s foreign subsidiaries were “in no sense at home in North Carolina,” we held, those subsidiaries could not be required to submit to the general jurisdiction of that State’s courts. 131 S. Ct. at 2854. With this background, we turn directly to the question whether Daimler’s affiliations with California are sufficient to subject it to the general (all-purpose) personal jurisdiction of that State’s courts. In sustaining the exercise of general jurisdiction over Daimler, the Ninth Circuit relied on an agency theory, determining that MBUSA acted as Daimler’s agent for jurisdictional purposes and then attributing MBUSA’s California contacts to Daimler. This Court has not yet addressed whether a foreign corporation may be subjected to a court’s general jurisdiction based on the contacts of its in-state subsidiary. But we need not pass judgment on invocation of an agency theory in the context of general jurisdiction, for in no event can the appeals court’s analysis be sustained. The Ninth Circuit’s agency finding rested primarily on its observation that MBUSA’s services were important to Daimler, as gauged by Daimler’s hypothetical readiness to perform those services itself if MBUSA did not exist. Formulated this way, the inquiry into importance stacks the deck, for it will always yield a pro-jurisdiction answer: “Anything a corporation does through an independent contractor, subsidiary, or distributor is presumably something that the corporation would do by other means if the independent contractor, subsidiary, or distributor did not exist.” [Citation omitted.] The Ninth Circuit’s agency theory thus appears to subject foreign corporations to general jurisdiction whenever they have an in-state subsidiary or affiliate, an outcome that would sweep beyond even the sprawling view of general jurisdiction we rejected in Goodyear. Goodyear made clear that only a limited set of affiliations with a forum will render a defendant amenable to all-purpose jurisdiction there. With respect to a corporation, the place of incorporation and principal place of business are paradigm

bases for general jurisdiction. Those affiliations have the virtue of being unique—that is, each ordinarily indicates only one place—as well as easily ascertainable. Cf. Hertz Corp. v. Friend, 559 U.S. 77 (2010). These bases afford plaintiffs recourse to at least one clear and certain forum in which a corporate defendant may be sued on any and all claims. Goodyear did not hold that a corporation may be subject to general jurisdiction only in a forum where it is incorporated or has its principal place of business; it simply typed those places paradigm all-purpose forums. Plaintiffs would have us look beyond the exemplar bases Goodyear identified, and approve the exercise of general jurisdiction in every State in which a corporation “engages in a substantial, continuous, and systematic course of business” [quoting the plaintiffs’ brief]. That formulation, we hold, is unacceptably grasping. [The relevant] inquiry under [International Shoe and] Goodyear is not whether a foreign corporation’s in-forum contacts can be said to be in some sense “continuous and systematic,” it is whether that corporation’s “affiliations with the State are so continuous and systematic as to render [it] essentially at home in the forum State.” Goodyear, 131 S. Ct. at 2851. Here, neither Daimler nor MBUSA is incorporated in California, nor does either entity have its principal place of business there. If Daimler’s California activities sufficed to allow adjudication of this Argentina-rooted case in California, the same global reach would presumably be available in every other State in which MBUSA’s sales are sizable. Such exorbitant exercises of all-­purpose jurisdiction would scarcely permit out-of-state defendants “to structure their primary conduct with some minimum assurance as to where that conduct will and will not render them liable to suit.” [Citation omitted.] It was therefore error for the Ninth Circuit to conclude that Daimler, even with MBUSA’s contacts attributed to it, was at home in California, and hence subject to suit there on claims by foreign plaintiffs having nothing to do with anything that occurred or had its principal impact in California. Ninth Circuit decision reversed; Daimler held not subject to court’s in personam jurisdiction.

In Rem Jurisdiction In rem jurisdiction is based on the presence of property within the state. It empowers state courts to determine rights in that property even if the persons whose rights are affected are outside the state’s in personam jurisdiction. For example, a state court’s decision regarding title to land within the state is said to bind the world.3

Venue Even if a court has jurisdiction, it may be unable to decide the case because venue requirements have not been met. Venue questions arise only after jurisdiction is established or assumed. In general, a court has venue if it is a territorially fair and convenient forum in which to hear the case. Venue requirements applicable to state

Another form of jurisdiction, quasi in rem jurisdiction or attachment jurisdiction, also is based on the presence of property within the state. Unlike cases based on in rem jurisdiction, cases based on quasi in rem jurisdiction do not necessarily determine rights in the property itself. Instead, the property is regarded as an extension of the out-of-state defendant—an extension

that sometimes enables the court to decide claims unrelated to the property. For example, a plaintiff might attach the defendant’s bank account in the state where the bank is located, sue the defendant on a tort or contract claim unrelated to the bank account, and recover the amount of the judgment from the account if the suit is successful.

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Chapter Two The Resolution of Private Disputes

courts typically are set by state statutes, which normally determine the county in which a case must be brought. For instance, the statute might say that a case concerning land must be filed in the county where the land is located, and that other suits must be brought in the county where the defendant resides or is doing business. If justice so requires, the defendant may be able to obtain a change of venue. This can occur when, for example, a fair trial would be impossible within a particular county. Role of Forum Selection Clauses Contracts sometimes contain a clause reciting that disputes between the parties regarding matters connected with the contract must be litigated in the courts of a particular state. Such a provision is known as a forum selection clause. Depending on its wording, a forum selection clause may have the effect of addressing both jurisdiction and venue issues. Although forum selection clauses may appear in agreements whose terms have been hammered out by the parties after extensive negotiation, they fairly often are found in form agreements whose terms were not the product of actual discussion or give-and-take. For example, an Internet access provider (IAP) may include a forum selection clause in a so-called clickwrap document that sets forth the terms of its Internet-related services—terms to which the IAP’s subscribers are deemed to have agreed by virtue of utilizing the IAP’s services. Forum selection clauses, whether expressly bargained for or included in a clickwrap agreement, are generally enforced by courts unless they are shown to be unreasonable in a given set of circumstances. Assume, for instance, that the IAP’s terms of service document calls for the courts of Virginia to have “exclusive jurisdiction” over its subscribers’ disputes with the company, but that a subscriber sues the IAP in a Pennsylvania court. Unless the subscriber performs the difficult task of demonstrating that application of the clickwrap agreement’s forum selection clause would be unreasonable, the Pennsylvania court will be likely to dismiss the case and to hold that if the subscriber wishes to litigate the claim, he or she must sue in an appropriate Virginia court.

Federal Courts and Their Jurisdiction Federal District Courts LO2-1

Describe the basic structures of state court systems and the federal court system.

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In the federal system, lawsuits usually begin in the federal district courts. As do state trial courts, the federal district courts determine both the facts and the law. The fact-­ finding function may be entrusted to either the judge or a jury, but determining the applicable law is the judge’s responsibility. Each state is designated as a separate district for purposes of the federal court system. Each district has at least one district court, and each district court has at least one judge. District Court Jurisdiction LO2-4

Explain what is necessary in order for a federal court to have subject-matter jurisdiction over a civil case.

There are various bases of federal district court civil jurisdiction. The two most important are diversity jurisdiction and federal question jurisdiction. One traditional justification for diversity jurisdiction is that it may help protect out-of-state defendants from potentially biased state courts. Diversity jurisdiction exists when (1) the case is between citizens of different states and (2) the amount in controversy exceeds $75,000. Diversity jurisdiction also exists in certain cases between citizens of a state and citizens or governments of foreign nations, if the amount in controversy exceeds $75,000. Under diversity jurisdiction, a corporation is a citizen of both the state where it has been incorporated and the state where it has its principal place of business. For an example of diversity jurisdiction and an explanation of how a corporation’s principal place of business is to be determined for diversity jurisdiction purposes, see the U.S. Supreme Court’s Hertz decision, which follows shortly. Federal question jurisdiction exists when the case arises under the Constitution, laws, or treaties of the United States. The “arises under” requirement normally is met when a right created by federal law is a basic part of the plaintiff’s case. There is no amount-in-controversy requirement for federal question jurisdiction. Diversity jurisdiction and federal question jurisdiction are forms of subject-matter jurisdiction. Even if one of the two forms exists, a federal district court must also have in personam jurisdiction in order to render a decision that is binding on the parties. As indicated earlier in the chapter, the analysis of in personam jurisdiction issues in the federal court system is essentially the same as in the state court systems. Further limiting the plaintiff’s choice of federal district courts are the federal system’s complex venue requirements, which are beyond the scope of this text.

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Concurrent Jurisdiction and Removal The federal district courts have exclusive jurisdiction over some matters. Patent cases, for example, must be litigated in the federal system. Often, however, federal district courts have concurrent jurisdiction with state courts—meaning that both state and federal courts have jurisdiction over the case. For example, a plaintiff might assert state court in personam jurisdiction over an out-of-state defendant or might sue in a federal district court under that court’s diversity

jurisdiction. A state court, moreover, may sometimes decide cases involving federal questions. Where concurrent jurisdiction exists and the plaintiff opts for a state court, the defendant has the option to remove the case to an appropriate federal district court, assuming the defendant acts promptly. The Hertz decision, which follows, provides an example of a defendant’s ability to have a case removed from state court to federal court in an instance of concurrent jurisdiction.

Hertz Corp. v. Friend   559 U.S. 77 (2010) Alleging violations of California’s wage and hour laws, California citizens Melinda Friend and John Nhieu sued Hertz Corporation in a California state court. Hertz filed a notice seeking removal of the case to a federal court on the basis of diversity-of-citizenship jurisdiction. The relevant federal statute provides that a federal court possesses diversity jurisdiction if the plaintiff and defendant are citizens of different states and the amount in controversy exceeds $75,000. The statute further provides that “a corporation shall be deemed to be a citizen of any State by which it has been incorporated and of the State where it has its principal place of business.” In seeking removal, Hertz argued that diversity jurisdiction was appropriate because the plaintiffs and the defendant were citizens of different states and more than $75,000 was in controversy. The plaintiffs contended, however, that Hertz was a California citizen (just as they were) and that the case should therefore remain in state court. Hertz submitted a declaration meant to demonstrate that its “principal place of business” was in New Jersey rather than in California. Besides stressing that Hertz was a national operation with car rental locations in 44 states, the declaration recited a series of statistics indicating that California accounted for approximately 20 percent of Hertz’s rental locations, full-time employees, annual revenue, and annual car rental transactions. The declaration also listed Park Ridge, New Jersey, as the location of Hertz’s corporate headquarters and stated that Hertz’s core executive and administrative functions are conducted there. In deciding whether Hertz was a California citizen for purposes of the diversity jurisdiction statute, the U.S. District Court for the Northern District of California applied Ninth Circuit Court of Appeals precedent instructing courts to identify a corporation’s principal place of business by first determining the amount of a corporation’s business activity state by state. Then, if the amount of activity was significantly larger or substantially predominated in one state, that state would be considered the corporation’s principal place of business. Applying the Ninth Circuit’s test to the relevant facts, the federal district court reasoned that the extent of Hertz’s business activities in California, as compared with its activities in other states, made California Hertz’s principal place of business. Because it concluded that Hertz was a California citizen and that diversity jurisdiction did not exist, the district court ordered that the case be remanded to state court. Hertz appealed this order to the Ninth Circuit Court of Appeals, which affirmed. The U.S. Supreme Court agreed to decide the case at Hertz’s request. Breyer, Justice The federal diversity jurisdiction statute provides that “a corporation shall be deemed to be a citizen of any State by which it has been incorporated and of the State where it has its principal place of business.” We seek here to resolve different interpretations that the [federal courts of appeal] have given this phrase. In doing so, we place primary weight upon the need for judicial administration of a jurisdictional statute to remain as simple as possible. The phrase “principal place of business” has proved . . . difficult to apply. [C]ourts were . . . uncertain as to where to look to determine a corporation’s “principal place of business” for diversity purposes. If a corporation’s headquarters and executive

offices were in the same state in which it did most of its business, the test seemed straightforward. The “principal place of business” was located in that state. But suppose those corporate headquarters, including executive offices, are in one state, while the corporation’s plants or other centers of business activity are located in other states? In 1959 a distinguished federal district judge, Edward Weinfeld, answer[ed] this question in part: Where a corporation is engaged in far-flung and varied activities which are carried on in different states, its principal place of business is the nerve center from which it radiates out to its constituent parts and from which its officers direct, control and coordinate all activities without regard to locale, in the furtherance of the corporate objective. The test . . . is



Chapter Two The Resolution of Private Disputes

that place where the corporation has an office from which its business was directed and controlled—the place where all of its business was under the supreme direction and control of its officers. Scot Typewriter Co. v. Underwood Corp., 170 F. Supp. 862, 865 (S.D.N.Y. 1959). Numerous [circuit courts of appeal] have since followed this rule, applying the “nerve center” test for corporations with “farflung” business activities. Scot’s analysis, however, did not go far enough. For it did not answer what courts should do when the operations of the corporation are not “far-flung” but rather limited to only a few states. When faced with this question, various courts have focused more heavily on where a corporation’s actual business activities are located. Perhaps because corporations come in many different forms, involve many different kinds of business activities, and locate offices and plants for different reasons in different ways in different regions, a general “business activities” approach has proved unusually difficult to apply. Courts must decide which factors are more important than others: for example, plant location, sales or servicing centers, transactions, payrolls, or revenue generation. The number of factors grew as courts explicitly combined aspects of the “nerve center” and “business activity” tests to look to a corporation’s “total activities,” sometimes to try to determine what treatises have described as the corporation’s “center of gravity.” Not surprisingly, different circuit courts of appeal (and sometimes different courts within a single circuit) have applied these highly general multifactor tests in different ways. This complexity . . . is at war with administrative simplicity. And it has failed to achieve a nationally uniform interpretation of federal law, an unfortunate consequence in a federal legal system. In an effort to find a single, more uniform interpretation of the statutory phrase, we have reviewed the courts of appeals’ divergent and increasingly complex interpretations. [W]e now return to, and expand, Judge Weinfeld’s approach [in Scot]. We conclude that “principal place of business” is best read as referring to the place where a corporation’s officers direct, control, and coordinate the corporation’s activities. It is the place that courts of appeals have called the corporation’s “nerve center.” And in practice it should normally be the place where the corporation maintains its headquarters—provided that the headquarters is the actual center of direction, control, and coordination, i.e., the “nerve center,” and not simply an office where the corporation holds its board meetings (for example, attended by directors and officers who have traveled there for the occasion). [Important considerations] convince us that this approach, while imperfect, is superior to other possibilities. First, the statute’s language supports the approach. The statute’s text deems a corporation a citizen of the “State where it has its principal place of business.” The word “place” is in the singular, not the plural.

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The word “principal” requires us to pick out the “main, prominent” or “leading” place. And the fact that the word “place” follows the words “State where” means that the “place” is a place within a state. It is not the state itself. A corporation’s “nerve center,” usually its main headquarters, is a single place. The public often (though not always) considers it the corporation’s main place of business. By contrast, the application of a more general business activities test has led some courts, as in the present case, to look, not at a particular place within a state, but incorrectly at the state itself, measuring the total amount of business activities that the corporation conducts there and determining whether they are significantly larger than in the next-ranking state. This approach invites greater litigation and can lead to strange results, as the Ninth Circuit has since recognized. Namely, if a “corporation may be deemed a citizen of California on th[e] basis” of “activities [that] roughly reflect California’s larger population . . . nearly every national retailer— no matter how far flung its operations—will be deemed a citizen of California for diversity purposes.” [Case citation omitted.] But why award or decline diversity jurisdiction on the basis of a state’s population, whether measured directly, indirectly (say proportionately), or with modifications? Second, administrative simplicity is a major virtue in a jurisdictional statute. Complex jurisdictional tests complicate a case, eating up time and money as the parties litigate, not the merits of their claims, but which court is the right court to decide those claims. [Moreover,] courts benefit from straightforward rules under which they can readily assure themselves of their power to hear a case. Simple jurisdictional rules also promote greater predictability. Predictability is valuable to corporations making business and investment decisions. Predictability also benefits plaintiffs deciding whether to file suit in a state or federal court. A “nerve center” approach, which ordinarily equates that “center” with a corporation’s headquarters, is simple to apply comparatively speaking. The metaphor of a corporate “brain,” while not precise, suggests a single location. By contrast, a corporation’s general business activities more often lack a single principal place where they take place. That is to say, the corporation may have several plants, many sales locations, and employees located in many different places. If so, it will not be as easy to determine which of these different business locales is the “principal” or most important “place.” We recognize that there may be no perfect test that satisfies all administrative and purposive criteria. We recognize as well that, under the “nerve center” test we adopt today, there will be hard cases. For example, in this era of telecommuting, some corporations may divide their command and coordinating functions among officers who work at several different locations, perhaps communicating over the Internet. That said, our test nonetheless

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points courts in a single direction, towards the center of overall direction, control, and coordination. Courts do not have to try to weigh corporate functions, assets, or revenues different in kind, one from the other. We also recognize that the use of a “nerve center” test may in some cases produce results that seem to cut against the basic rationale for [diversity jurisdiction]. For example, if the bulk of a company’s business activities visible to the public take place in New Jersey, while its top officers direct those activities just across the river in New York, the “principal place of business” is New York. One could argue that members of the public in New Jersey would be less likely to be prejudiced against the corporation than persons in New York—yet the corporation will still be entitled to remove a New Jersey state case to federal court. And note too that the same corporation would be unable to remove a

New York state case to federal court, despite the New York public’s presumed prejudice against the corporation. We understand that such seeming anomalies will arise. However, in view of the necessity of having a clearer rule, we must accept them. Accepting occasionally counterintuitive results is the price the legal system must pay to avoid overly complex jurisdictional administration while producing the benefits that accompany a more uniform legal system. [In this case, Hertz’s] unchallenged declaration suggests that Hertz’s center of direction, control, and coordination, its “nerve center,” and its corporate headquarters are one and the same, and they are located in New Jersey, not in California.

Specialized Federal Courts The federal court

The U.S. Supreme Court The United States Su-

system also includes certain specialized federal courts, including the Court of Federal Claims (which hears claims against the United States), the Court of International Trade (which is concerned with tariff, customs, import, and other trade matters), the bankruptcy courts (which operate as adjuncts of the district courts), and the Tax Court (which reviews certain IRS determinations). Usually, the decisions of these courts can be appealed to a federal court of appeals.

Federal Courts of Appeals The U.S. courts of

appeals do not engage in fact-finding. Instead, they review only the legal conclusions reached by lower federal courts. As Figure 2.1 shows, there are 13 circuit courts of appeals: 11 numbered circuits covering several states each; a District of Columbia circuit; and a separate federal circuit. Except for the Court of Appeals for the Federal Circuit, the most important function of the U.S. courts of appeals is to hear appeals from decisions of the federal district courts. Appeals from a district court ordinarily proceed to the court of appeals for that district court’s region. Appeals from the District Court for the Southern District of New York, for example, go to the Second Circuit Court of Appeals. The courts of appeals also hear appeals from the Tax Court, from many administrative agency decisions, and from some bankruptcy court decisions. The Court of Appeals for the Federal Circuit hears a wide variety of specialized appeals, including some patent and trademark matters, Court of Federal Claims decisions, and decisions by the Court of International Trade.

Ninth Circuit’s decision vacated, and case remanded for further proceedings in federal district court.

preme Court, the highest court in the land, is mainly an appellate court. It therefore considers only questions of law when it decides appeals from the federal courts of appeals and the highest state courts.4 Today, most appealable decisions from these courts fall within the Supreme Court’s certiorari jurisdiction, under which the Court has discretion whether to hear the appeal. The Court hears only a small percentage of the many appeals it is asked to decide under its certiorari jurisdiction. Nearly all appeals from the federal courts of appeals are within the Court’s certiorari jurisdiction. Appeals from the highest state courts are within the certiorari jurisdiction when (1) the validity of any treaty or federal statute has been questioned; (2) any state statute is challenged as repugnant to federal law; or (3) any title, right, privilege, or immunity is claimed under federal law. The Supreme Court usually defers to the states’ highest courts on questions of state law and does not hear appeals from those courts if the case involves only such questions. In certain rare situations, the U.S. Supreme Court has original jurisdiction, which means that it acts as a trial court. The Supreme Court has original and exclusive jurisdiction over all controversies between two or more states. It has original, but not exclusive, jurisdiction over cases involving foreign ambassadors, ministers, and like parties;

In special situations that do not often arise, the Supreme Court will hear appeals directly from the federal district courts. 4



Chapter Two The Resolution of Private Disputes

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Figure 2.1 The Thirteen Federal Judicial Circuits First Circuit (Boston, Mass.) Maine, Massachusetts, New Hampshire, Puerto Rico, Rhode Island

Second Circuit (New York, N.Y.) Connecticut, New York, Vermont

Third Circuit (Philadelphia, Pa.) Delaware, New Jersey, Pennsylvania, Virgin Islands

Fourth Circuit (Richmond, Va.) Maryland, North Carolina, South Carolina, Virginia, West Virginia

Fifth Circuit (New Orleans, La.) Louisiana, Mississippi, Texas

Sixth Circuit (Cincinnati, Ohio) Kentucky, Michigan, Ohio, Tennessee

Seventh Circuit (Chicago, Ill.) Illinois, Indiana, Wisconsin

Eighth Circuit (St. Louis, Mo.) Arkansas, Iowa, Minnesota, Missouri, Nebraska, North Dakota, South Dakota

Ninth Circuit (San Francisco, Calif.) Alaska, Arizona, California, Guam, Hawaii, Idaho, Montana, Nevada, Northern Mariana Islands, Oregon, Washington

Tenth Circuit (Denver, Colo.) Colorado, Kansas, New Mexico, Oklahoma, Utah, Wyoming

Eleventh Circuit (Atlanta, Ga.) Alabama, Florida, Georgia

District of Columbia Circuit (Washington, D.C.)

Federal Circuit (Washington, D.C.)

controversies between the United States and a state; and cases in which a state proceeds against citizens of another state or against aliens.

Civil Procedure LO2-5

Identify the major steps in a civil lawsuit’s progression from beginning to end.

Civil procedure is the set of legal rules establishing how a civil lawsuit proceeds from beginning to end.5 Because civil procedure sometimes varies with the jurisdiction in question,6 the following presentation summarizes the most widely accepted rules governing civil cases in state and federal courts. Knowledge of these basic procedural matters will be useful if you become involved in a civil lawsuit and will help you understand the cases in this text. In any civil case, the adversary system is at work. Through their attorneys, the litigants take contrary Criminal procedure is discussed in Chapter 5. In the following discussion, the term jurisdiction refers to one of the 50 states, the District of Columbia, or the federal government. 5 6

positions before a judge and possibly a jury. To win a civil case, the plaintiff must prove each element of his, her, or its claim by a preponderance of the evidence.7 This standard of proof requires the plaintiff to show that the greater weight of the evidence—by credibility, not quantity—­supports the existence of each element. In other words, the plaintiff must convince the fact-finder that the existence of each element is more probable than its nonexistence. The attorney for each party presents his or her client’s version of the facts, tries to convince the judge or jury that this version is true, and attempts to rebut conflicting factual allegations by the other party. Each attorney also seeks to persuade the court that his or her reading of the law is correct.

Service of the Summons A summons notifies

the defendant that he, she, or it is being sued. The summons typically names the plaintiff and states the time within which the defendant must enter an appearance in court (usually through an attorney). In most jurisdictions, In a criminal case, however, the government must prove the elements of the alleged crime beyond a reasonable doubt. This standard of proof is discussed in Chapter 5. 7

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Part One Foundations of American Law

it is accompanied by a copy of the plaintiff’s complaint (which is described later). The summons is usually served on the defendant by an appropriate public official after the plaintiff has filed her case. To ensure that the defendant is properly notified, statutes, court rules, and constitutional due process guarantees set standards for proper service of the summons. For example, personal delivery to the defendant almost always meets these standards. Many jurisdictions also permit the summons to be left at the defendant’s home or place of business. Service to corporations often may be accomplished by delivery of the summons to the firm’s managing agent. Many state long-arm statutes permit out-of-state defendants to be served by registered mail. Although inadequate service of process may sometimes defeat the plaintiff’s claim, the defendant who participates in the case without making a prompt objection to the manner of service will be deemed to have waived the objection.

The Pleadings The pleadings are the documents the

parties file with the court when they first state their respective claims and defenses. They include the complaint, the answer, and, in some jurisdictions, the reply. Traditionally, the pleadings’ main function was to define and limit the issues to be decided by the court. Only those issues raised in the pleadings were considered part of the case, amendments to the pleadings were seldom permitted, and litigants were firmly bound by allegations or admissions contained in the pleadings. Although many jurisdictions retain some of these rules, most have relaxed them significantly. The main reason is the modern view of the purpose of pleading rules: that their aim is less to define the issues for trial than to give the parties general notice of each other’s claims and defenses. The Complaint The complaint states the plaintiff’s claim in separate, numbered paragraphs. It must allege sufficient facts to show that the plaintiff would be entitled to legal relief and to give the defendant reasonable notice of the nature of the plaintiff’s claim. The complaint also must state the remedy requested. The Answer Unless the defendant makes a successful motion to dismiss (described later), he must file an answer to the plaintiff’s complaint within a designated time after service of the complaint. The amount of time is set by applicable law, with 30 to 45 days being typical. The answer responds to the complaint paragraph by paragraph, with an admission or denial of each of the plaintiff’s allegations. An answer may also include an affirmative defense to the claim asserted in the complaint. A successful

affirmative defense enables the defendant to win the case even if all the allegations in the complaint are true and, by themselves, would have entitled the plaintiff to recover. For example, suppose that the plaintiff bases her lawsuit on a contract that she alleges the defendant has breached. The defendant’s answer may admit or deny the existence of the contract or the assertion that the defendant breached it. In addition, the answer may make assertions that, if proven, would provide the defendant an affirmative defense on the basis of fraud committed by the plaintiff during the contract negotiation phase. Furthermore, the answer may contain a counterclaim.8 A counterclaim is a new claim by the defendant arising from the matters stated in the complaint. Unlike an affirmative defense, it is not merely an attack on the plaintiff’s claim, but is the defendant’s attempt to obtain legal relief. In addition to using fraud as an affirmative defense to a plaintiff’s contract claim, for example, a defendant might counterclaim for damages caused by that fraud. The Reply In some jurisdictions, the plaintiff is allowed or required to respond to an affirmative defense or a counterclaim by making a reply. The reply is the plaintiff’s point-by-point response to the allegations in the answer or counterclaim. In jurisdictions that do not allow a reply to an answer, the defendant’s new allegations are automatically denied. Usually, however, a plaintiff who wishes to contest a counterclaim must file a reply to it.

Motion to Dismiss Sometimes it is evident from

the complaint or the pleadings that the plaintiff does not have a valid claim. In such a situation, it would be wasteful for the litigation to proceed further. The procedural device for ending the case at this early stage is commonly called the motion to dismiss. This motion often is made after the plaintiff has filed her complaint. A similar motion allowed by some jurisdictions, the motion for judgment on the pleadings, normally occurs after the pleadings have been completed. A successful motion to dismiss means that the defendant wins the case. If the motion fails, the case proceeds. The motion to dismiss may be made on various grounds—for example, inadequate service of process or lack of jurisdiction. The most important type of motion to dismiss, however, is the motion to dismiss for failure to state a claim upon which relief can be granted, sometimes In appropriate instances, a defendant also may file a cross claim against another defendant in the plaintiff’s suit, or a third-party complaint against a party who was not named as a defendant in the plaintiff’s complaint. 8



Chapter Two The Resolution of Private Disputes

called the demurrer. This motion basically says “So what?” to the factual allegations in the complaint. It asserts that the plaintiff cannot recover even if all of his allegations are true because no rule of law entitles him to win on those facts. Suppose that Potter sues Davis on the theory that Davis’s bad breath is a form of “olfactory pollution” entitling Potter to recover damages. Potter’s complaint describes Davis’s breath and the distress it causes Potter in great detail. Even if all of Potter’s factual allegations are true, Davis’s motion to dismiss almost certainly will succeed. There is no rule of law allowing the “victim” of another person’s bad breath to recover damages from that person.

Discovery LO2-6

Describe the different forms of discovery available to parties in civil cases.

When a civil case begins, litigants do not always possess all of the facts they need to prove their claims or establish their defenses. To help litigants obtain the facts and to narrow and clarify the issues for trial, the state and federal court systems permit each party to a civil case to exercise discovery rights. The discovery phase of a lawsuit normally begins when the pleadings have been completed. Each party is entitled to request information from the other party by utilizing the forms of discovery described in this section. Moreover, for civil cases pending in federal court, the Federal Rules of Civil Procedure require each party to provide the other party certain relevant information at an early point in the case without a formal discovery request by the other party. Discovery is available for information that is not subject to a recognized legal privilege and is relevant to the case or likely to lead to other information that may be relevant. Information may be subject to discovery even if it would not ultimately be admissible at trial under the legal rules of evidence. The scope of permissible discovery is thus extremely broad. The broad scope of discovery stems from a policy decision to minimize the surprise element in litigation and to give each party the opportunity to become fully informed regarding facts known by the opposing party. Each party may then formulate trial strategies on the basis of that knowledge. The deposition is one of the most frequently employed forms of discovery. In a deposition, one party’s attorney conducts an oral examination of the other party or of a likely witness (usually one identified with the other party). The questions asked by the examining attorney and the answers given by the deponent—the person being ­examined— are taken down by a court reporter. The deponent is under

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oath, just as he or she would be if testifying at trial, even though the deposition occurs on a pretrial basis and is likely to take place at an attorney’s office or at some location other than a courtroom. Some depositions are recorded in audiovisual form. Interrogatories and requests for admissions are among the other commonly utilized forms of discovery. Interrogatories are written questions directed by the plaintiff to the defendant, or vice versa. The litigant on whom interrogatories are served must provide written answers, under oath, within a time period prescribed by applicable law (30 days being typical). Requests for admissions are one party’s written demand that the other party admit or deny, in writing, certain statements of supposed fact or of the application of law to fact, within a time period prescribed by law (30 days again being typical). The other party’s failure to respond with an admission or denial during the legal time period is deemed an admission of the statements’ truth or accuracy. Requests for production of documents or other physical items (e.g., videos, photographs, and the like) are a discovery form employed by the parties in many civil cases. What about e-mail and other electronically stored information? For a discussion of the discoverability of such items, see the Cyberlaw in Action box that appears later in the chapter. When the issues in a case make the opposing litigant’s physical or mental condition relevant, a party may seek discovery in yet another way by filing a motion for a court order requiring that the opponent undergo a physical or mental examination. With the exception of the discovery form mentioned in the previous sentence, discovery generally takes place without a need for court orders or other judicial supervision. Courts become involved, however, if a party objects to a discovery request on the basis of privilege or other recognized legal ground, desires an order compelling a noncomplying litigant to respond to a discovery request, or seeks sanctions on a party who refused to comply with a legitimate discovery request or abusively invoked the discovery process. Documents and similar items obtained through the discovery process may be used at trial if they fall within the legal rules governing admissible evidence. The same is true of discovery material such as answers to interrogatories and responses to requests for admissions. If a party or other witness who testifies at trial offers testimony that differs from her statements during a deposition, the deposition may be used to impeach her—that is, to cast doubt on her trial testimony. A litigant may offer as evidence the deposition of a witness who died prior to trial or meets the legal standard of unavailability to testify in person.

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Part One Foundations of American Law

CYBERLAW IN ACTION In recent years, the widespread uses of e-mail and information presented and stored in electronic form have raised questions about whether, in civil litigation, an opposing party’s e-mails and electronic information are discoverable to the same extent as conventional written or printed documents. With the Federal Rules of Civil Procedure and comparable discovery rules applicable in state courts having been devised prior to the explosion in e-mail use and online activities, the rules’ references to “documents” contemplated traditional on-paper items. Courts, however, frequently interpreted “documents” broadly, so as to include e-mails and certain electronic communications within the scope of discoverable items. Even so, greater clarity regarding discoverability seemed warranted—especially as to electronic material that might be less readily classifiable than e-mails as “documents.” Various states responded by updating their discovery rules to include electronic communications within the list of discoverable items. So did the Federal Judicial Conference. In Federal Rules of Civil Procedure amendments proposed by the Judicial Conference and ratified by Congress in 2006, “electronically stored information” became a separate category of discoverable material. The electronically stored information (ESI) category is broad enough to include e-mails and similar communications as well as electronic business records, web pages, dynamic databases, and a host of other material existing in electronic form. So-called e-discovery has become a standard feature of civil litigation because of the obvious value of having access to the opposing party’s e-mails and other electronic communications. Discovery regarding ESI occurs in largely the same manner as discovery regarding conventional documents. The party seeking discovery of ESI serves a specific request for production on the other. The served party must provide the requested ESI if it is relevant, is not protected by a legal privilege (e.g., the attorney–client privilege), and is reasonably accessible. Court involvement becomes necessary only if the party from whom discovery is sought fails to comply or objects on lack of relevance, privilege, or burdensomeness grounds. The Federal Rules allow the party seeking discovery of ESI to specify the form in which the requested copies should appear (e.g., hard copies, electronic files, searchable CD, direct access to database, etc.). The party from whom discovery is sought may object to the specified form, in which event the court may have to resolve the dispute. If the requesting party does not specify a form, the other party must provide the requested electronic material in a form that is reasonably usable. The Federal Rules provide that if the requested electronic material is “not reasonably accessible because of undue burden or cost,” the party from whom discovery is sought need not provide it. When an objection along those lines is filed, the court decides whether the

objection is valid in light of the particular facts and circumstances. For instance, if requested e-mails appear only on backup tapes and searching those tapes would require the expenditures of significant time, money, and effort, are the requested e-mails “not reasonably accessible because of undue burden or costs”? Perhaps, but perhaps not. The court will rule, based on the relevant situation. The court may deny the discovery request, uphold it, or condition the upholding of it on the requesting party’s covering part or all of the costs incurred by the other party in retrieving the ESI and making it available. When a party fails or refuses to comply with a legitimate discovery request and the party seeking discovery of ESI has to secure a court order compelling the release of it, the court may order the noncompliant party to pay the attorney fees incurred by the requesting party in seeking the court order. If a recalcitrant party disregards a court order compelling discovery, the court may assess attorney fees against that party and/or impose evidentiary or procedural sanctions such as barring that party from using certain evidence or from raising certain claims or defenses at trial. The discussion suggests that discovery requests regarding ESI may be extensive and broad-ranging, with logistical issues often attending those requests. In recognition of these realities, the Federal Rules seek to head off disputes by requiring the parties to civil litigation to meet, at least through their attorneys, soon after the case is filed. The meeting’s goal is development of a discovery plan that outlines the parties’ intentions regarding ESI discovery and sets forth an agreement on such matters as the form in which the requested ESI will be provided. If the parties cannot agree on certain ESI discovery issues, the court will become involved to resolve the disputes. The discoverability of ESI makes it incumbent upon businesses to retain and preserve such material not only when litigation to which the material may be related has already been instituted, but also when potential litigation might reasonably be anticipated. Failure to preserve the electronic communications could give rise to allegations of evidence destruction and, potentially, sanctions imposed by a court. (For further discussion of related legal and ethical issues, see this chapter’s Ethics and Compliance in Action box.) Finally, given the now-standard requests of plaintiffs and defendants that the opposing party provide access to relevant e-mails, one should not forget this important piece of advice: Do not say anything in an e-mail that you would not say in a formal written memo or in a conversation with someone. There is a toofrequent tendency to think that because e-mails often tend to be informal in nature, one is somehow free to say things in an e-mail that he or she would not say in another setting. Many individuals and companies have learned the hard way that comments made in their e-mails or those of their employees proved to be damning evidence against them in litigation and thus helped the opposing parties win the cases.



Chapter Two The Resolution of Private Disputes

In addition, selected parts or all of the deposition of the opposing party or of certain persons affiliated with the opposing party may be used as evidence at trial, regardless of whether such a deponent is available to testify “live.” Participation in the discovery process may require significant expenditures of time and effort, not only by the attorneys but also by the parties and their employees. Parties who see themselves as too busy to comply with discovery requests may need to think seriously about whether they should remain a party to pending litigation. The discovery process may also trigger significant ethical issues, such as those associated with uses of discovery requests simply to harass or cause expense to the other party, or the issues faced by one who does not wish to hand over legitimately sought material that may prove to be damaging to him or to his employer.

Summary Judgment Summary judgment is a de-

vice for disposing of relatively clear cases without a trial. It differs from a demurrer because it involves factual determinations. To prevail, the party moving for a summary judgment must show that (1) there is no genuine issue of material (legally significant) fact and (2) she is entitled to judgment as a matter of law. A moving party satisfies the first element of the test by using the pleadings, relevant discovery information, and affidavits (signed and sworn statements regarding matters of fact) to show that there is no real question about any significant fact. She satisfies the second element by showing that, given the established facts, the applicable law clearly mandates that she win. Either or both parties may move for a summary judgment. If the court rules in favor of either party, that party wins the case. (The losing party may appeal, however.) If the parties’ summary judgment motions are denied, the case proceeds to trial. The judge may also grant a partial summary judgment, which settles some issues in the case but leaves others to be decided at trial.

The Pretrial Conference Depending

on the jurisdiction, a pretrial conference is either mandatory or held at the discretion of the trial judge. At this conference, the judge meets informally with the attorneys for both litigants. He or she may try to get the attorneys to stipulate, or agree to, the resolution of certain issues in order to simplify the trial. The judge may also urge them to convince their clients to settle the case by coming to an agreement that eliminates the need for a trial. If the case is not settled, the judge enters a pretrial order that includes the attorneys’ stipulations and any other agreements. Ordinarily, this order binds the parties for the remainder of the case.

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The Trial Once the case has been through discovery

and has survived any pretrial motions, it is set for trial. The trial may be before a judge alone (i.e., a bench trial), in which case the judge makes findings of fact and reaches conclusions of law before issuing the court’s judgment. If the right to a jury trial exists and either party demands one, the jury finds the facts. The judge, however, continues to determine legal questions.9 During a pretrial jury screening process known as voir dire, biased potential jurors may be removed for cause. In addition, the attorney for each party is allowed a limited number of peremptory challenges, which allow him to remove potential jurors without having to show bias or other cause. Trial Procedure At either a bench trial or a jury trial, the attorneys for each party make opening statements that outline what they expect to prove. The plaintiff’s attorney then presents her client’s case-in-chief by calling witnesses and introducing documentary evidence (relevant documents and written records, e-mails, videos, and other evidence having a physical form). The plaintiff’s attorney asks questions of her client’s witnesses in a process known as direct examination. If the plaintiff is an individual person rather than a corporation, he is very likely to testify. The plaintiff’s attorney may choose to call the defendant to testify. In this respect, civil cases differ from criminal cases, in which the Fifth Amendment’s privilege against self-incrimination bars the government from compelling the defendant to testify. After the plaintiff’s attorney completes direct examination of a witness, the defendant’s lawyer cross-examines the witness. This may be followed by redirect examination by the plaintiff’s attorney and recross examination by the defendant’s lawyer. Once the plaintiff’s attorney has completed the presentation of her client’s case, defense counsel presents his client’s case-in-chief by offering documentary evidence and the testimony of witnesses. The same process of direct, cross-, redirect, and recross-examination is followed, except that the examination roles of the respective lawyers are reversed. After the plaintiff and defendant have presented their casesin-chief, each party is allowed to present evidence rebutting the showing made by the other party. Throughout each side’s presentations of evidence, the opposing attorney may object, on specified legal grounds, to certain questions asked of The rules governing availability of a jury trial are largely beyond the scope of this text. The U.S. Constitution guarantees a jury trial in federal court cases “at common law” whose amount exceeds $20. Most states have similar constitutional provisions, often with a higher dollar amount. Also, Congress and the state legislatures have chosen to allow jury trials in various other cases. 9

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Part One Foundations of American Law

Ethics and Compliance in Action The broad scope of discovery rights in a civil case will often entitle a party to seek and obtain copies of e-mails, records, memos, and other documents and electronically stored information from the opposing party’s files. In many cases, some of the most favorable evidence for the plaintiff will have come from the defendant’s files, and vice versa. If your firm is, or is likely to be, a party to civil litigation and you know that the firm’s files contain materials that may be damaging to the firm in the litigation, you may be faced with the temptation to alter or destroy the potentially damaging items. This temptation poses serious ethical dilemmas. Is it morally defensible to change the content of records or documents on an after-the-fact basis, in order to lessen the adverse effect on your firm in pending or probable litigation? Is document destruction or e-mail deletion ethically justifiable when you seek to protect your firm’s interests in a lawsuit? If the ethical concerns are not sufficient by themselves to make you leery of involvement in document alteration or destruction, consider the potential legal consequences for yourself and your firm. The much-publicized collapse of the Enron Corporation in 2001 led to considerable scrutiny of the actions of the Arthur Andersen firm, which had provided auditing and consulting services to Enron. An Andersen partner, David Duncan, pleaded guilty to a criminal obstruction of justice charge that accused him of having destroyed, or having instructed Andersen employees to destroy, certain Enron-related records in order to thwart a Securities and Exchange Commission (SEC) investigation of Andersen. The U.S. Justice Department also launched an obstruction of justice prosecution against Andersen on the theory that the firm altered or destroyed records pertaining to Enron in order to impede the SEC investigation. A jury found Andersen guilty of obstruction of justice. Although the Andersen conviction was later overturned by the U.S. ­Supreme Court because the trial judge’s instructions to the jury on relevant principles of law had been impermissibly vague regarding the critical issue of criminal intent, a devastating effect on the firm had already taken place. Of course, not all instances of document alteration or destruction will lead to criminal prosecution for obstruction of justice. Other consequences of a noncriminal but clearly severe nature may result, however, from document destruction that interferes with legitimate discovery requests in a civil case. In such instances, courts have broad discretionary authority

witnesses or to certain evidence that has been offered for admission. The trial judge utilizes the legal rules of evidence to determine whether to sustain the objection (meaning that the objected-to question cannot be answered by the witness or that the offered evidence will be disallowed) or, instead,

to impose appropriate sanctions on the document-destroying party. These sanctions may include such remedies as court orders prohibiting the document-destroyer from raising certain claims or defenses in the lawsuit, instructions to the jury regarding the wrongful destruction of the documents, and court orders that the document-destroyer pay certain attorney fees to the opposing party. What about the temptation to refuse to cooperate regarding an opposing party’s lawful request for discovery regarding material in one’s possession? Although a refusal to cooperate seems less blameworthy than destruction or alteration of documents, extreme instances of recalcitrance during the discovery process may cause a party to experience adverse consequences similar to those imposed on parties who destroy or alter documents. Litigation involving Ronald Perelman and the Morgan Stanley firm provides an illustration. Perelman had sued Morgan Stanley on the theory that the investment bank participated with Sunbeam Corp. in a fraudulent scheme that supposedly induced him to sell Sunbeam his stake in another firm in return for Sunbeam shares whose value plummeted when Sunbeam collapsed. During the discovery phase of the case, Perelman had sought certain potentially relevant e-mails from Morgan Stanley’s files. Morgan Stanley repeatedly failed and refused to provide this discoverable material and, in the process, ignored court orders to provide the e-mails. Eventually, a fed-up trial judge decided to impose sanctions for Morgan Stanley’s wrongful conduct during the discovery process. The judge ordered that Perelman’s contentions would be presumed to be correct and that the burden of proof would be shifted to Morgan Stanley so that Morgan Stanley would have to disprove Perelman’s allegations. In addition, the trial judge prohibited Morgan Stanley from contesting certain allegations made by Perelman. The jury later returned a verdict in favor of Perelman and against Morgan Stanley for $604 million in compensatory damages and $850 million in punitive damages. The court orders sanctioning Morgan Stanley for its discovery misconduct undoubtedly played a key role in Perelman’s victory, effectively turning a case that was not a sure-fire winner for Perelman into just that. The case illustrates that a party to litigation may be playing with fire if he, she, or it insists on refusing to comply with legitimate discovery requests.

overrule it (meaning that the question may be answered or that the offered evidence will be allowed). The witnesses that plaintiffs and defendants call to testify at trial may include those who can testify as to relevant facts of which they have personal knowledge (often called



Chapter Two The Resolution of Private Disputes

lay witnesses) and, sometimes, so-called expert witnesses. If the court agrees that someone a plaintiff or defendant wishes to use as an expert witness possesses relevant scientific, technical, or other specialized knowledge, skill, experience, or educational background and could provide testimony potentially useful to the judge or jury, the court may permit the expert witness to provide opinion testimony or other insights regarding matters of importance in the case. (Lay witnesses, on the other hand, normally are not permitted to offer opinions in their testimony.) Before allowing such opinion testimony, however, the court must be satisfied not only that the witness qualifies as an expert by virtue of knowledge, skill, experience, or background, but also that his or her opinion testimony would be based on sufficient facts and would result from reasoned application of principles and methods considered reliable in the relevant field. In a significant number of cases, there may be “dueling experts” on a given matter—one expert witness called by the plaintiff and another by the defendant. After all of the evidence has been presented by the parties, each party’s attorney makes a closing argument summarizing his or her client’s position. In bench trials, the judge then usually takes the case under advisement rather than issuing a decision immediately. The judge later makes findings of fact and reaches conclusions of law, renders judgment, and, if the plaintiff is the winning party, states the relief to which the plaintiff is entitled. Jury Trials At the close of a jury trial, the judge ordinarily submits the case to the jury after issuing instructions that set forth the legal rules applicable to the case. The jury then deliberates, makes the necessary determinations of the facts, applies the applicable legal rules to the facts, and arrives at a verdict on which the court’s judgment will be based. The verdict form used the majority of the time is the general verdict, which requires only that the jury declare which party wins and, if the plaintiff wins, the money damages awarded. The jury neither states its findings of fact nor explains its application of the law to the facts. Although the nature of the general verdict may permit a jury, if it is so inclined, to render a decision that is based on bias, sympathy, or some basis other than the probable facts and the law, one’s belief regarding the extent to which juries engage in so-called jury nullification  of the facts and law is likely to be heavily influenced by one’s attitude toward the jury system. Most proponents of the jury system may be inclined to believe that “renegade” juries, though regrettable, are an aberration, and that the vast majority of juries make a good-faith effort to decide cases on the basis of

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the facts and controlling legal principles. Some jury system proponents, however, take a different view, asserting that juries should engage in jury nullification when they believe it is necessary to accomplish “rough justice.” Those who take a dim view of the jury system perceive it as fundamentally flawed and as offering juries too much opportunity to make decisions that stray from a reasonable view of the evidence and the law. Critics of the jury system have little hope of abolishing it, however. Doing so would require amendments to the U.S. Constitution and many state constitutions, as well as the repeal of numerous federal and state statutes. Another verdict form known as the special verdict may serve to minimize concerns that some observers have about jury decisions. When a special verdict is employed, the jury makes specific, written findings of fact in response to questions posed by the trial judge. The judge then applies the law to those findings. Whether a special verdict is utilized is a matter largely within the discretion of the trial judge. The special verdict is not as frequently employed, however, as the general verdict. Directed Verdict Although the general verdict gives the jury considerable power, the American legal system also has devices for limiting that power. One device, the directed verdict, takes the case away from the jury and provides a judgment to one party before the jury gets a chance to decide the case. The motion for a directed verdict may be made by either party; it usually occurs after the other (nonmoving) party has presented her evidence. The moving party asserts that the evidence, even when viewed favorably to the other party, leads to only one result and need not be considered by the jury. Courts differ on the test governing a motion for a directed verdict. Some deny the motion if there is any evidence favoring the nonmoving party, whereas others deny the motion only if there is substantial evidence favoring the nonmoving party. More often than not, trial judges deny motions for a directed verdict. Judgment Notwithstanding the Verdict On occasion, one party wins a judgment even after the jury has reached a verdict against that party. The device for doing so is the judgment notwithstanding the verdict (also known as the judgment non obstante veredicto or judgment n.o.v.). Some jurisdictions provide that a motion for judgment n.o.v. cannot be made unless the moving party previously moved for a directed verdict. In any event, the standard used to decide the motion for judgment n.o.v. usually is the same standard used to decide the motion for a directed verdict.

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Part One Foundations of American Law

Motion for a New Trial In a wide range of situations that vary among jurisdictions, the losing party can successfully move for a new trial. Acceptable reasons for granting a new trial include legal errors by the judge during the trial, jury or attorney misconduct, the discovery of new evidence, or an award of excessive damages to the plaintiff. Most motions for a new trial are unsuccessful, however.

Appeal A

final judgment generally prevents the parties from relitigating the same claim. One or more parties still may appeal the trial court’s decision, however. Normally, appellate courts consider only alleged errors of law made by the trial court. The matters ordinarily considered “legal” and thus appealable include the trial judge’s decisions on motions to dismiss, for summary judgment, for directed verdict or judgment notwithstanding the verdict, and for a new trial. Other matters typically considered appealable include trial court rulings on service of process and admission of evidence at trial, as well as the court’s legal conclusions in a nonjury trial, instructions to the jury in a jury case, and decision regarding damages or other relief. Appellate courts may affirm the trial court’s decision, reverse it, or affirm parts of the decision and reverse other parts. One of three things ordinarily results from an appellate court’s disposition of an appeal: (1) the plaintiff wins the case, (2) the defendant wins the case, or (3) the case is remanded (returned) to the trial court for further proceedings if the trial court’s decision is reversed in whole or in part. For example, if the plaintiff appeals a trial court decision granting the defendant’s motion to dismiss and the appellate courts affirm that decision, the plaintiff loses. On the other hand, if an appellate court reverses a trial court judgment in the plaintiff’s favor, the defendant could win outright, or the case might be returned to the trial court for further proceedings consistent with the appellate decision.

Enforcing a Judgment In this text, you may oc-

casionally see cases in which someone was not sued even though he probably would have been liable to the plaintiff, who sued another party instead. One explanation is that the first party was “judgment-proof”—so lacking in assets as to make a civil lawsuit for damages a waste of time and money. The defendant’s financial condition also affects a winning plaintiff’s ability to collect whatever damages she has been awarded. When the defendant fails to pay as required after losing a civil case, the winning plaintiff must enforce the judgment. Ordinarily, the plaintiff will obtain a writ of execution enabling the sheriff or federal marshal to seize designated property of the defendant and sell it at a judicial

sale to help satisfy the judgment. A judgment winner may also use a procedure known as garnishment to seize property, money, and wages that belong to the defendant but are in the hands of a third party such as a bank or employer. Legal limits exist, however, concerning the portion of wages that may be garnished. If the property needed to satisfy the judgment is located in another state, the plaintiff must use that state’s execution or garnishment procedures. Under the U.S. Constitution, the second state must give “full faith and credit” to the judgment of the state in which the plaintiff originally sued. Finally, when the court has awarded an equitable remedy such as an injunction, the defendant may be found in contempt of court and subjected to a fine or a jail term if he fails to obey the court’s order.

Class Actions So far, our civil procedure discussion

has proceeded as if the plaintiff and the defendant were single parties. Various plaintiffs and defendants, however, may be parties to one lawsuit. In addition, each jurisdiction has procedural rules stating when other parties can be joined to a suit that begins without them. One special type of multiparty case, the class action, allows one or more persons to sue on behalf of themselves and all others who have suffered similar harm from substantially the same wrong. Class action suits by consumers, environmentalists, and other groups now are reasonably common events. The usual justifications for the class action are that (1) it allows legal wrongs causing losses to a large number of widely dispersed parties to be fully compensated and (2) it promotes economy of judicial effort by combining many similar claims into one suit. The requirements for a class action vary among jurisdictions. The issues addressed by state and federal class action rules include the following: whether there are questions of law and fact common to all members of the alleged class; whether those common questions predominate over other questions; whether the class is small enough to allow all of its members to join the case as parties, rather than use a class action; and whether the plaintiff(s) and their attorney(s) can adequately represent the class without conflicts of interest or other forms of unfairness. To protect the individual class members’ right to be heard, some jurisdictions have required that unnamed or absent class members be given notice of the case if this is reasonably possible. The damages awarded in a successful class action usually are apportioned among the entire class. Establishing the total recovery and distributing it to the class, however, pose problems when the class is large, the class members’ injuries are indefinite, or some members cannot be identified.



Chapter Two The Resolution of Private Disputes

In 2005, Congress moved to restrict the filing of class actions in state courts by enacting a statute giving the federal district courts original jurisdiction over class actions in which the amount in controversy exceeds $5 million and any member of the plaintiff class resides in a state different from the state of any defendant. Proponents of the measure describe it as being designed to curtail “forum shopping” by multistate plaintiffs for “friendly” state courts that might be especially likely to favor the claims of the plaintiffs. Critics assert that the 2005 enactment is too protective of corporate defendants and likely to curtail the bringing of legitimate civil rights, consumer-protection, and environmental-harm claims. Those criticisms have been countered by assertions from other quarters that the 2005 law did not go far enough in restricting class actions. These critics contend that some proposed classes are simply “too big”—meaning that a corporate defendant could face ruinous financial consequences if the court allowed the case to proceed as a class action and liability was established. In such instances, the argument goes, the court should refuse to certify the case as a class action and thereby force individual plaintiffs to sue on a case-bycase basis. Over the last decade, the Supreme Court has issued important decisions dealing with class action certification issues. In Wal-Mart Stores, Inc. v. Dukes, 564 U.S. 338 (2011), the Court rejected class status for a group of 1.5 million females employed, or formerly employed, by Walmart. All 1.5 million claimed to have been the victims of sex discrimination during their Walmart employment as a result of a company practice that allowed local store managers very broad discretion in making salary and promotion decisions regarding store employees. The plaintiffs who sought class recognition alleged that in exercising this discretion, store managers made salary and promotion decisions that discriminated against them on the basis of their sex. In ruling that the case could not go forward as a class action, the Court concluded that even though the plaintiffs all

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claimed to have experienced sex discrimination as a result of a supposed corporate practice, this surface similarity in the discrimination allegations was not enough to satisfy a key class action certification requirement: the need for the plaintiffs’ claims to reflect common questions of law and fact. According to the Court, this “commonality” requirement called for the plaintiffs to show that they “suffered the same injury” in a specific sense. The Court reasoned that they could not do so, given the large number of store managers who exercised discretion in making decisions regarding individual employees and given the variability in the particular harms—and extent of harms—experienced by the employees. Although the Court did not invoke the “too big” argument referred to in an earlier paragraph, it seems possible that such a concern may have lurked in the background. Of course, the decision in Wal-Mart did not mean that the plaintiffs were automatically deprived of legal recourse for the alleged wrongs they claimed. They could still pursue their cases individually. As might be expected, however, only a small percentage of the employees and former employees opted to pursue their own individual cases once the Court denied them the opportunity to band together as a class. Wal-Mart appeared to suggest that courts should closely scrutinize class action requests and that class action certification would likely become more difficult for plaintiffs to obtain. A 2016 Supreme Court decision, however, reveals that class actions are not necessarily a dying breed after Wal-Mart. In Tyson Foods, Inc. v. Bouaphakeo, which follows, the Court affirms the lower court’s grant of class action certification. Besides concluding that the commonality element held lacking in WalMart was present in Bouaphakeo, the Court focuses on the related yet separate question of whether the common questions in the dispute predominate over the individual ones. In addition, the Court addresses an important evidentiary question. 

Tyson Foods, Inc. v. Bouaphakeo   136 S. Ct. 1036 (2016) A federal law, the Fair Labor Standards Act (FLSA), requires that if employees covered by the statute work more than 40 hours during a week, their employers must pay them overtime compensation. For those excess hours, employees are to be paid one and one-half times their regular hourly rate. The FLSA also requires employers to pay employees for activities that are integral and indispensable to their regular work, even if those activities do not occur at the employees’ workstations. In addition, the FLSA requires employers to keep records of employees’ wages, hours worked, and employment conditions. Peg Bouaphakeo and numerous other employees of Tyson Foods Inc. were covered by the FLSA. They worked in the kill, cut, and re-trim departments of a Tyson pork processing plant. Safety considerations associated with the nature of their work necessitated that these employees wear protective gear. The exact composition of the gear depended on the tasks they were assigned to perform on a given

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Part One Foundations of American Law

day. Tyson compensated some of the employees for the time spent in donning and doffing the protective gear. These employees were paid for an extra four minutes each day because Tyson estimated that four minutes was the time necessary to put on and take off the protective gear. For certain other employees, Tyson estimated that eight minutes was the relevant amount of time. Tyson, therefore, paid those employees for an extra eight minutes per day. Still other Tyson employees, though required to wear protective gear, were not paid for the donning-and-doffing time. Although Tyson recorded the amount of time each employee spent at his or her actual workstation, it did not record the time each employee spent in putting on and taking off the required protective gear. The employees took the position that this time significantly exceeded the four- and eight-minute estimates Tyson used. Bouaphakeo and the other employees sued Tyson in a federal district court, alleging that in either not including or not accurately including the donning-and-doffing time in hours the employees worked, Tyson had denied the employees overtime compensation required by the FLSA. The employees contended that wearing the protective gear was integral and indispensable to their work and that if their time spent putting on and taking off the required protective gear had been included in hours worked, they would have exceeded the 40-hours-per-week threshold for overtime pay. The employees sought to have their claims against Tyson certified as a class action under a collective action provision in the FLSA. Tyson argued that because of the variance in protective gear the respective employees wore, the employees’ claims were not sufficiently similar to be resolved in a class action. The district court concluded, however, that class action certification was warranted because common questions, such as whether putting on and taking off required protective gear was compensable under the FLSA, were present even if not all of the workers wore the same gear. Because Tyson did not keep records of the donning-and-doffing time, the employees relied on evidence stemming from a study by an industrial relations expert. The expert conducted more than 700 videotaped observations of how long various donning-and-doffing activities took and then averaged the time taken. This process yielded an estimate of 18 minutes per day for the cut and re-trim departments and 21.25 minutes per day for the kill department. These estimates were then added to the timesheets of each employee to ascertain which class members worked more than 40 hours in a week and to shed light on a possible class-wide recovery. The jury awarded the class approximately $2.9 million in unpaid wages. Before that amount was paid by Tyson and distributed to class members, Tyson appealed to the U.S. Court of Appeals for the Eighth Circuit. Tyson argued that the district court erred in certifying the case as a class action. After the Eighth Circuit affirmed the lower court’s decision, the U.S. Supreme Court agreed to decide the case.

Kennedy, Justice Tyson challenges the certification of the FLSA collective action. The parties do not dispute that the standard for certifying a collective action under the FLSA is no more stringent than the standard for certifying a class under the Federal Rules of Civil Procedure. This opinion assumes, without deciding, that this is correct. For purposes of this case, then, if certification of respondents’ class action under the Federal Rules was proper, certification of the collective action was proper as well. Federal Rule of Civil Procedure 23(b)(3) requires that, before a class is certified under that subsection, a district court must find that “questions of law or fact common to class members predominate over any questions affecting only individual members.” The “predominance inquiry tests whether proposed classes are sufficiently cohesive to warrant adjudication by representation.” Amchem Products, Inc. v. Windsor, 521 U.S. 591, 623 (1997). This calls upon courts to give careful scrutiny to the relation between common and individual questions in a case. An individual question is one where “members of a proposed class will need to present evidence that varies from member to member,” while a common question is one where “the same evidence will suffice for each member to make a prima facie showing [or] the issue is

susceptible to generalized, class-wide proof.” [Citation omitted.] The predominance inquiry “asks whether the common, aggregation-enabling, issues in the case are more prevalent or important than the non-common, aggregation-defeating, individual issues.” [Citation omitted.] When “one or more of the central issues in the action are common to the class and can be said to predominate, the action may be considered proper under Rule 23(b)(3) even though other important matters will have to be tried separately, such as damages or some affirmative defenses peculiar to some individual class members.” [Citation omitted.] Here, the parties do not dispute that there are important questions common to all class members, the most significant of which is whether time spent donning and doffing the required protective gear is compensable work under the FLSA. To be entitled to recovery, however, each employee must prove that the amount of time spent donning and doffing, when added to his or her regular hours, amounted to more than 40 hours in a given week. Tyson argues that these necessarily person-specific inquiries into individual work time predominate over the common questions raised by the employees’ claims, making class certification improper. The employees counter that these individual inquiries are unnecessary because it can be assumed each employee donned and



Chapter Two The Resolution of Private Disputes

doffed for the same average time observed [by the industrial relations expert in his review of videotapes of employees putting on protective gear]. Whether this inference is permissible becomes the central dispute in this case. Tyson contends that [the expert’s] study manufactures predominance by assuming away the very differences that make the case inappropriate for classwide resolution. Reliance on a representative sample, Tyson argues, absolves each employee of the responsibility to prove personal injury, and thus deprives petitioner of any ability to litigate its defenses to individual claims. Calling this unfair, Tyson maintains that the Court should announce a broad rule against the use in class actions of what the parties call representative evidence. A categorical exclusion of that sort, however, would make little sense. A representative or statistical sample, like all evidence, is a means to establish or defend against liability. Its permissibility turns not on the form a proceeding takes—be it a class or individual action—but on the degree to which the evidence is reliable in proving or disproving the elements of the relevant cause of action. It follows that the Court would reach too far were it to establish general rules governing the use of statistical evidence, or so-called representative evidence, in all class-action cases. Evidence of this type is used in various substantive realms of the law. Whether and when statistical evidence can be used to establish classwide liability will depend on the purpose for which the evidence is being introduced and on the elements of the underlying cause of action. In many cases, a representative sample is the only practicable means to collect and present relevant data establishing a defendant’s liability. In a case where representative evidence is relevant in proving a plaintiff’s individual claim, that evidence cannot be deemed improper  merely because the claim is brought on behalf of a class. One way for the employees to show, then, that the sample relied upon here is a permissible method of proving classwide liability is by showing that each class member could have relied on that sample to establish liability if he or she had brought an individual action. If the sample could have sustained a reasonable jury finding as to hours worked in each employee’s individual action, that sample is a permissible means of establishing the employees’ hours worked in a class action. In this suit, the employees sought to introduce a representative sample to fill an evidentiary gap created by the employer’s failure to keep adequate records. If the employees had proceeded with 3,344 individual lawsuits, each employee likely would have had to introduce [the expert’s] study to prove the hours he or she worked. Rather than absolving the employees from proving individual injury, the representative evidence here was a permissible means of making that very showing. Reliance on [the expert’s] study did not deprive Tyson of its ability to litigate individual

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defenses. Since there were no alternative means for the employees to establish their hours worked, Tyson’s primary defense was to show that [the expert’s] study was unrepresentative or inaccurate. That defense is itself common to the claims made by all class members. Tyson’s reliance on Wal-Mart Stores, Inc. v. Dukes, 564 U.S. 338 (2011), is misplaced. Wal-Mart does not stand for the broad proposition that a representative sample is an impermissible means of establishing classwide liability. Wal-Mart involved a nationwide Title VII class of over 1½ million employees. In reversing class certification, this Court did not reach Rule 23(b)(3)’s predominance prong, holding instead that the class failed to meet even Rule 23(a)’s more basic requirement that class members share a common question of fact or law. The plaintiffs in Wal-Mart did not provide significant proof of a common policy of discrimination to which each employee was subject. “The only corporate policy that the plaintiffs’ evidence convincingly establishe[d was] Wal-Mart’s ‘policy’ of allowing discretion by local supervisors over employment matters”; and even then, the plaintiffs could not identify “a common mode of exercising discretion that pervade[d] the entire company.”   Id. at 355–56. The plaintiffs in Wal-Mart proposed to use representative evidence as a means of overcoming this absence of a common policy. Under their proposed methodology, a “sample set of the class members would be selected, as to whom liability for sex discrimination and the backpay owing as a result would be determined in depositions supervised by a master.” Id. at 367. The aggregate damages award was to be derived by taking the percentage of claims determined to be valid from this sample and applying it to the rest of the class, and then multiplying the number of presumptively valid claims by the average backpay award in the sample set. The Court held that this “Trial By Formula” was [improper] because it enlarged the class members’ substantive right[s] and deprived defendants of their right to litigate statutory defenses to individual claims. The Court’s holding in the instant case is in accord with WalMart. The underlying question in Wal-Mart, as here, was whether the sample at issue could have been used to establish liability in an individual action. Since the Court held that the employees were not similarly situated, none of them could have prevailed in an individual suit by relying on depositions detailing the ways in which other employees were discriminated against by their particular store managers. By extension, if the employees had brought 1½ million individual suits, there would be little or no role for representative evidence. Permitting the use of that sample in a class action, therefore, would have [been inappropriate because it would have given] plaintiffs and defendants different rights in a class proceeding than they could have asserted in an individual action.

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Part One Foundations of American Law

In contrast, the study here could have been sufficient to sustain a jury finding as to hours worked if it were introduced in each employee’s individual action. While the experiences of the employees in Wal-Mart bore little relationship to one another, in this case each employee worked in the same facility, did similar work, and was paid under the same policy. [U]nder these circumstances the experiences of a subset of employees can be probative as to the experiences of all of them. This is not to say that all inferences drawn from representative evidence in an FLSA case are just and reasonable. Representative evidence that is statistically inadequate or based on implausible assumptions  could not lead to a fair or accurate estimate of the uncompensated hours an employee has worked. Tyson, however, did not raise a challenge to the methodology [used by the employees’ expert]. As a result, there is

no basis in the record to conclude it was legal error to admit that evidence. Once a district court finds evidence to be admissible, its persuasiveness is, in general, a matter for the jury. Reasonable minds may differ as to whether the average time [the expert] calculated is probative as to the time actually worked by each employee. Resolving that question, however, is the near-exclusive province of the jury. The district court could have denied class certification on this ground only if it concluded that no reasonable juror could have believed that the employees spent roughly equal time donning and doffing. The district court made no such finding, and the record here provides no basis for this Court to second-guess that conclusion.

Alternative Dispute Resolution

parties. Most cases settle at some stage in the proceedings described previously. The usual settlement agreement is a contract whereby the defendant, without admitting liability, agrees to pay the plaintiff a sum of money in exchange for the plaintiff’s promise to drop the claim against the defendant. Such agreements must satisfy the requirements of contract law discussed later in this text. In some cases, moreover, the court must approve the settlement in order for it to be enforceable. Examples include class actions and litigation involving minors.

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Explain the differences among the major forms of alternative dispute resolution.

Lawsuits are not the only devices for resolving civil disputes. Nor are they always the best means of doing so. Settling private disputes through the courts can be a cumbersome, lengthy, and expensive process for litigants. With the advent of a litigious society and the increasing caseloads it has produced, handling disputes in this fashion also imposes ever-greater social costs. For these reasons and others, various forms of alternative dispute resolution (ADR) have assumed increasing importance in recent years. Proponents of ADR cite many considerations in its favor. These include ADR’s (1) quicker resolution of disputes; (2) lower costs in time, money, and aggravation for the parties; (3) lessening of the strain on an overloaded court system; (4) use of decision makers with specialized expertise; and (5) potential for compromise decisions that promote and reflect consensus between the parties. As will be seen in later discussion, however, there are ADR skeptics.

Common Forms of ADR Settlement The settlement of a civil lawsuit is not everyone’s idea of an alternative dispute resolution mechanism. It is an important means, however, of avoiding protracted litigation—one that often is a sensible compromise for the

Judgment of Eighth Circuit Court of Appeals affirmed.

Arbitration Arbitration is the submission of a dispute to a neutral, nonjudicial third party (the arbitrator) who issues a binding decision resolving the dispute. Arbitration usually results from the parties’ agreement. That agreement normally is made before the dispute arises (most often through an arbitration clause in a contract). As noted in the Concepcion case, which follows shortly, the Federal Arbitration Act requires judicial enforcement of a wide range of agreements to arbitrate claims. This means that if a contract contains a clause requiring arbitration of certain claims but one of the parties attempts to litigate such a claim in court, the court is very likely to dismiss the case and compel arbitration of the dispute. Arbitration may also be compelled by other statutes. One example is the compulsory arbitration many states require as part of the collective bargaining process for certain public employees. Finally, parties who have not agreed in advance to submit future disputes to arbitration may agree upon arbitration after the dispute arises.



Chapter Two The Resolution of Private Disputes

Arbitration usually is less formal than regular court proceedings. The arbitrator may or may not be an attorney. Often, she is a professional with expertise in the subject matter of the dispute. Although arbitration hearings often resemble civil trials, the applicable procedures, the rules for admission of evidence, and the record-keeping requirements typically are not as rigorous as those governing courts. Arbitrators sometimes have freedom to ignore rules of substantive law that would bind a court. The arbitrator’s decision, called an award, is filed with a court, which will enforce it if necessary. The losing party may object to the arbitrator’s award, but judicial review of arbitration proceedings is limited. According to the Federal Arbitration Act (FAA), grounds for overturning an arbitration award include (1) a party’s use of fraud, (2) the arbitrator’s partiality or corruption, and (3) other misconduct by the arbitrator. The previously noted advantages of arbitration and the enforceability of arbitration clauses in contracts have combined in recent years to make such clauses common features in various types of contracts. Skeptics of arbitration, however, worry about this development, particularly when the relevant contract is one drafted entirely or almost entirely by the party with greater economic power and business sophistication. These critics point to arbitration’s potential for unfairness to ordinary consumers or employees of, say, a large corporation when they find that their dispute with the corporation cannot be resolved in court but must instead be submitted to arbitration because of an arbitration clause in the parties’ contract. In such situations, the contract’s terms probably would have been dictated by the corporation rather than having been arrived at through a genuine bargaining process. Although most arbitrators almost certainly strive to be fair, critics cite the supposed danger that some arbitrators may tend to favor parties with greater economic clout because, as the old saying goes, “they know which side their bread is buttered on.” These arguments about the potential for second-class justice, whether accurate or overblown, have led to calls in

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some quarters for legislative action in which Congress would tinker with the FAA by denying or restricting the ability of business organizations to include binding arbitration clauses in their contracts with ordinary consumers or employees (as opposed to contracts with other business entities). In 2019 the U.S. House of Representatives passed the Forced Arbitration Injustice Repeal Act (FAIR Act), which prohibits a forced arbitration agreement from being enforced if it requires forced arbitration of an employment, consumer, or civil rights claim against a corporation. As this book went to press, passage in the Senate and enactment of this legislation was uncertain. During recent years, this further question about arbitration has arisen: If state law permits the creation of a classwide arbitration that combines individual arbitrations presenting the same issues, is an arbitration clause enforceable under the FAA if it not only requires individual arbitration but also bans classwide arbitration? The two Supreme Court decisions discussed below address that question. AT&T Mobility LLC v. Concepcion, which follows shortly, addresses the FAA’s purposes and emphasizes that the FAA’s provision requiring enforcement of agreements to arbitrate controls over nearly all state laws that would stand in the way of enforcement of such an agreement. The Supreme Court goes on to hold that contract provisions requiring arbitration of claims on an individual basis—and prohibiting joinder of those claims with others in a class action–type arbitration—are both permissible and enforceable under the FAA, notwithstanding any state law to the contrary. In American Express Co. v. Italian Colors Restaurant, 133 S. Ct. 2304 (2013), the Supreme Court followed the lead of Concepcion and held that a court must respect a contractual waiver of class arbitration even if plaintiffs seeking to bring a class action in court contend that the plaintiffs’ costs of individually arbitrating claims for an alleged violation of federal law would exceed the potential recovery. Taken together, the two decisions probably will make class arbitration an increasingly rare species, as corporations seem likely to draft arbitration clauses so that they not only

AT&T Mobility LLC v. Concepcion   563 U.S. 333 (2011) Vincent and Liza Concepcion entered into a contract for the sale and servicing of cellular phones with AT&T Mobility LLC (AT&T). AT&T used the same contract in its dealings with other customers. The agreement called for arbitration of all disputes between the parties but required that claims be brought in the parties’ “individual capacity, and not as a plaintiff or class member in any purported class or representative proceeding.” AT&T advertised the service that the Concepcions purchased as including the provision of free phones. Although the Concepcions were not charged for the phones, they were charged $30.22 in sales tax based on the phones’ retail value. The Concepcions later sued AT&T in the U.S. District Court for the Southern District of California. Their complaint was consolidated with a class action case alleging, among other things, that AT&T had engaged in false advertising and fraud by charging sales tax on phones it advertised as free.

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Part One Foundations of American Law

AT&T filed a motion asking the court to compel arbitration under the terms of its contract with the Concepcions. The Concepcions opposed the motion, contending that the arbitration agreement was unconscionable and otherwise objectionable under California law because it disallowed classwide procedures. Finding the arbitration provision unconscionable because AT&T had not shown that arbitration of individual disputes adequately substituted for the deterrent effects of class actions, the district court denied AT&T’s motion. In so ruling, the court relied on the California Supreme Court’s decision in Discover Bank v. Superior Court, 113 P.3d 1100 (Cal. 2005). The U.S. Court of Appeals for the Ninth Circuit affirmed on the same ground. The Ninth Circuit also held that the Federal Arbitration Act (FAA) did not preempt the California rule stemming from Discover Bank. The U.S. Supreme Court granted AT&T’s request that it decide the case. Scalia, Justice Section 2 of the FAA makes agreements to arbitrate “valid, irrevocable, and enforceable, save upon such grounds as exist at law or in equity for the revocation of any contract.” We consider whether the FAA prohibits states from conditioning the enforceability of certain arbitration agreements on the availability of classwide arbitration procedures. The FAA was enacted in 1925 in response to widespread judicial hostility to arbitration agreements. We have described [§ 2 of the FAA] as reflecting both a “liberal federal policy favoring arbitration” and the “fundamental principle that arbitration is a matter of contract.” [Case citations omitted.] In line with these principles, courts must place arbitration agreements on an equal footing with other contracts, and enforce them according to their terms. The final phrase of § 2, however, permits arbitration agreements to be declared unenforceable “upon such grounds as exist at law or in equity for the revocation of any contract.” This saving clause permits agreements to arbitrate to be invalidated by “generally applicable contract defenses, such as fraud, duress, or unconscionability,” but not by defenses that apply only to arbitration or that derive their meaning from the fact that an agreement to arbitrate is at issue. [Case citations omitted.] The question in this case is whether § 2 preempts California’s rule classifying most collective-arbitration waivers in consumer contracts as unconscionable. We refer to this rule as the Discover Bank rule. Under California law, courts may refuse to enforce any contract found “to have been unconscionable at the time it was made,” or may “limit the application of any unconscionable clause.” [Statutory citation omitted.] A finding of unconscionability requires “a ‘procedural’ and a ‘substantive’ element, the former focusing on ‘oppression’ or ‘surprise’ due to unequal bargaining power, the latter on ‘overly harsh’ or ‘one-sided’ results.” [Case citation omitted.] In Discover Bank, the California Supreme Court applied this framework to class-action waivers in arbitration agreements and held as follows: [W]hen the waiver is found in a consumer contract of adhesion in a setting in which disputes between the contracting parties predictably involve small amounts of damages, and when it is alleged that the party with the superior bargaining power has carried out a scheme to deliberately cheat

large numbers of consumers out of individually small sums of money, then . . . the waiver becomes in practice the exemption of the party from responsibility for [its] own fraud, or willful injury to the person or property of another. Under these circumstances, such waivers are unconscionable under California law and should not be enforced. California courts have frequently applied this rule to find arbitration agreements unconscionable. The Concepcions argue that the Discover Bank rule, given its origins in California’s unconscionability doctrine and California’s policy against exculpat[ory] [agreements] is a ground that “exist[s] at law or in equity for the revocation of any contract” under FAA § 2. Moreover, they argue that even if we construe the Discover Bank rule as a prohibition on collective-action waivers rather than simply an application of unconscionability, the rule would still be applicable to all dispute-resolution contracts, since California prohibits waivers of class litigation as well. When state law prohibits outright the arbitration of a particular type of claim, the analysis is straightforward: The conflicting rule is displaced by the FAA. Preston v. Ferrer, 552 U.S. 346, 353 (2008). But the inquiry becomes more complex when a doctrine normally thought to be generally applicable, such as duress or, as relevant here, unconscionability, is alleged to have been applied in a fashion that disfavors arbitration. In Perry v. Thomas, 482 U.S. 483 (1987), for example, we noted that the FAA’s preemptive effect might extend even to grounds traditionally thought to exist “‘at law or in equity for the revocation of any contract.’” We said that a court may not “rely on the uniqueness of an agreement to arbitrate as a basis for a state-law holding that enforcement would be unconscionable, for this would enable the court to effect what . . . the state legislature cannot.” An obvious illustration of this point would be a case finding unconscionable or unenforceable as against public policy consumer arbitration agreements that fail to provide for judicially monitored discovery. The rationalizations for such a holding are neither difficult to imagine nor different in kind from those articulated in Discover Bank. A court might reason that no consumer would knowingly waive his right to full discovery, as this would enable companies to hide their wrongdoing [and possibly evade legal responsibility]. And, the reasoning would continue, because such a rule applies the general principle of



Chapter Two The Resolution of Private Disputes

unconscionability or public-policy disapproval of exculpatory agreements, it is applicable to “any” contract and thus preserved by § 2 of the FAA. In practice, of course, the rule would have a disproportionate impact on arbitration agreements, but it would presumably apply to contracts purporting to restrict discovery in litigation as well. Although § 2’s saving clause preserves generally applicable contract defenses, nothing in it suggests an intent to preserve state-law rules that stand as an obstacle to the accomplishment of the FAA’s objectives. The “principal purpose” of the FAA is to “ensur[e] that private arbitration agreements are enforced according to their terms.” [Case citation omitted.] [Accordingly,] we have held that parties may agree to limit the issues subject to arbitration, to arbitrate according to specific rules, and to limit with whom a party will arbitrate its disputes. [Case citations omitted.] The point of affording parties discretion in designing arbitration processes is to allow for efficient, streamlined procedures tailored to the type of dispute. It can be specified, for example, that the decision-maker be a specialist in the relevant field, or that proceedings be kept confidential to protect trade secrets. And the informality of arbitral proceedings is itself desirable, reducing the cost and increasing the speed of dispute resolution. [O]ur cases  .  .  .  have repeatedly described the FAA as “embod[ying] [a] national policy favoring arbitration,” and “a liberal federal policy favoring arbitration agreements, notwithstanding any state substantive or procedural policies to the contrary.” [Case citations omitted.] Thus, in Preston v. Ferrer, holding preempted a state-law rule requiring exhaustion of administrative remedies before arbitration, we said: “A prime objective of an agreement to arbitrate is to achieve ‘streamlined proceedings and expeditious results,’” which objective would be “frustrated” by requiring a dispute to be heard by an agency first. That rule, we said, would “at the least, hinder speedy resolution of the controversy.” California’s Discover Bank rule similarly interferes with arbitration. Although the rule does not require classwide arbitration, it allows any party to a consumer contract to demand it ex post. The rule also requires that damages be predictably small, and that the consumer allege a scheme to cheat consumers. The former requirement, however, is toothless and malleable, and the latter has no limiting effect, as all that is required is an allegation. Consumers remain free to bring and resolve their disputes on a bilateral basis under Discover Bank, and some may well do so; but there is little incentive for lawyers to arbitrate on behalf of individuals when they may do so for a class and reap far higher fees in the process. And faced with inevitable class arbitration, companies would have less incentive to continue resolving potentially duplicative claims on an individual basis. Although we have had little occasion to examine classwide arbitration, our decision in Stolt-Nielsen S.A. v. Animal Feeds Int’l

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Corp., 130 S. Ct. 1758 (2010), is instructive. In that case we held that an arbitration panel exceeded its power under . . . the FAA by imposing class procedures based on policy judgments rather than the arbitration agreement itself or some background principle of contract law that would affect its interpretation. We then held that the agreement at issue, which was silent on the question of class procedures, could not be interpreted to allow them because the “changes brought about by the shift from bilateral arbitration to class-action arbitration” are “fundamental.” Classwide arbitration includes absent parties, necessitating additional and different procedures and involving higher stakes. Confidentiality becomes more difficult. And while it is theoretically possible to select an arbitrator with some expertise relevant to the classcertification question, arbitrators are not generally knowledgeable in the often-dominant procedural aspects of certification, such as the protection of absent parties. The conclusion follows that class arbitration, to the extent it is manufactured by Discover Bank rather than consensual, [interferes with fundamental attributions of arbitration and] is inconsistent with the FAA. First, the switch from bilateral to class arbitration sacrifices the principal advantage of arbitration—its informality—and makes the process slower, more costly, and more likely to generate procedural morass than final judgment. [B]efore an arbitrator may decide the merits of a claim in classwide procedures, he must first decide, for example, whether the class itself may be certified, whether the named parties are sufficiently representative and typical, and how discovery for the class should be conducted. A cursory comparison of bilateral and class arbitration illustrates the difference. According to the American Arbitration Association (AAA), the average consumer arbitration between January and August 2007 resulted in a disposition on the merits in six months. As of September 2009, the AAA had opened 283 class arbitrations. Of those, 121 remained active, and 162 had been settled, withdrawn, or dismissed. Not a single one, however, had resulted in a final award on the merits. For those cases that were no longer active, the [mean] time from filing to settlement, withdrawal, or dismissal—not judgment on the merits—was . . . 630 days. Second, class arbitration requires procedural formality. The AAA’s rules governing class arbitrations mimic the Federal Rules of Civil Procedure for class litigation. And while parties can alter those procedures by contract, an alternative is not obvious. If procedures are too informal, absent class members would not be bound by the arbitration. For a class-action money judgment to bind absentees in litigation, class representatives must at all times adequately represent absent class members, and absent members must be afforded notice, an opportunity to be heard, and a right to opt out of the class. At least this amount of process would presumably be required for absent parties to be bound by the results of arbitration. We find it unlikely that in passing the FAA, Congress meant to leave the disposition of

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Part One Foundations of American Law

these procedural requirements to an arbitrator. Indeed, class arbitration was not even envisioned by Congress when it passed the FAA in 1925. Third, class arbitration greatly increases risks to defendants. Informal procedures do of course have a cost: The absence of multilayered review makes it more likely that errors will go uncorrected. Defendants are willing to accept the costs of these errors in arbitration, since their impact is limited to the size of individual disputes, and presumably outweighed by savings from avoiding the courts. But when damages allegedly owed to tens of thousands of potential claimants are aggregated and decided at once, the risk of an error will often become unacceptable.

Faced with even a small chance of a devastating loss, defendants will be pressured into settling questionable claims. The dissent claims that class proceedings are necessary to prosecute small-dollar claims that might otherwise slip through the legal system. But states cannot require a procedure that is inconsistent with the FAA, even if it is desirable for unrelated reasons. Because it “stands as an obstacle to the accomplishment and execution of the full purposes and objectives of Congress,” [case citation omitted,] California’s Discover Bank rule is preempted by the FAA.

mandate arbitration but require it to be of the individual claim variety.

mock jury trial that does not bind the parties. If the parties do not settle after completion of the summary jury trial, they still are entitled to a regular court trial. There is some disagreement over whether courts can compel the parties to take part in a summary jury trial.

Court-Annexed Arbitration In this form of ADR, certain civil lawsuits are diverted into arbitration. One example might be cases in which less than a specified dollar amount is at issue. Most often, court-annexed arbitration is mandatory and is ordered by the judge, but some jurisdictions merely offer litigants the option of arbitration. The losing party in a court-annexed arbitration still has the right to a regular trial. Mediation In mediation, a neutral third party called a mediator helps the parties reach a cooperative resolution of their dispute by facilitating communication between them, clarifying their areas of agreement and disagreement, helping them see each other’s viewpoints, and suggesting settlement options. Mediators, unlike arbitrators, cannot make decisions that bind the parties. Instead, a successful mediation process results in a mediation agreement. Such agreements normally are enforced under regular contract law principles. Mediation is used in a wide range of situations, including labor, commercial, family, and environmental disputes. It may occur by agreement of the parties after a dispute has arisen. It may also result from a previous contractual agreement by the parties. Increasingly, court-annexed mediation is either compelled or made available by courts in certain cases. Summary Jury Trial Sometimes settlement of civil litigation is impeded because the litigants have vastly different perceptions about the merits of their cases. In such cases, the summary jury trial may give the parties a needed dose of reality. The summary jury trial is an abbreviated, nonpublic

Decision of Ninth Circuit Court of Appeals reversed, and case remanded for further proceedings.

Minitrial A minitrial is an informal, abbreviated private “trial” whose aim is to promote settlement of disputes. Normally, it arises out of a private agreement that also describes the procedures to be followed. In the typical minitrial, counsel for the parties present their cases to a panel composed of senior management from each side. Sometimes a neutral advisor such as an attorney or  a retired judge presides. This advisor may also offer an  opinion about the case’s likely outcome in court. After the presentations, the managers attempt to negotiate a settlement.

Other ADR Devices Other ADR devices include

(1) med/arb (a hybrid of mediation and arbitration in which a third party first acts as a mediator, and then as an arbitrator), (2) the use of magistrates and special masters to perform various tasks during complex litigation in the federal courts, (3) early neutral evaluation (ENE) (a courtannexed procedure involving early, objective evaluation of the case by a neutral private attorney with experience in its subject matter), (4) private judging (in which litigants hire a private referee to issue a decision that may be binding but that usually does not preclude recourse to the courts), and (5) private panels instituted by an industry or an organization to handle claims of certain kinds (e.g., the Better Business Bureau). In addition, some formal legal processes are sometimes called ADR devices. Examples include small claims courts and the administrative procedures used to handle claims for veterans’ benefits or Social Security benefits.



Chapter Two The Resolution of Private Disputes

Problems and Problem Cases 1. Victoria Wilson, a resident of Illinois, wishes to bring an invasion of privacy lawsuit against XYZ Co. because XYZ used a photograph of her, without her consent, in an advertisement for one of the company’s products. Wilson will seek money damages of $150,000 from XYZ, whose principal offices are located in New Jersey. A New Jersey newspaper was the only print media outlet in which the advertisement was published. However, XYZ also placed the advertisement on the firm’s website. This website may be viewed by anyone with Internet access, regardless of the viewer’s geographic location. Where, in a geographic sense, may Wilson properly file and pursue her lawsuit against XYZ? Must Wilson pursue her case in a state court, or does she have the option of litigating in federal court? Assuming that Wilson files her case in state court, what strategic option may XYZ exercise if it acts promptly? 2. Alex Ferrer, a former judge who appeared as “Judge Alex” on a television program, entered into a contract with Arnold Preston, a California attorney who rendered services to persons in the entertainment industry. Seeking fees allegedly due under the contract, Preston invoked the clause setting forth the parties’ agreement to arbitrate “any dispute . . .  relating to the terms of [the contract] or the breach, validity, or legality thereof . . .  in accordance with the rules [of the American Arbitration Association].” Ferrer countered Preston’s demand for arbitration by filing, with the California Labor Commissioner, a petition in which he contended that the contract was unenforceable under the California Talent Agencies Act (CTAA) because Preston supposedly acted as a talent agent without the license required by the CTAA. In addition, Ferrer sued Preston in a California court, seeking a declaration that the dispute between the parties regarding the contract and its validity was not subject to arbitration. Ferrer also sought an injunction restraining Preston from proceeding before the arbitrator unless and until the Labor Commissioner concluded that she did not have authority to rule on the parties’ dispute. Preston responded by moving to compel arbitration, in reliance on the Federal Arbitration Act. The California court denied Preston’s motion to compel arbitration and issued the injunction sought by Ferrer. Was the court correct in doing so? 3. Dog-breeders Ron and Catherine Bombliss lived in Illinois. They bred Tibetan mastiffs, as did Oklahoma

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residents Anne and Jim Cornelsen. When Anne Cornelson telephoned the Bomblisses and said she was ready to sell two litters of Tibetan mastiff puppies, Ron Bombliss expressed interest in purchasing two females of breeding quality. The Cornelsens had a website that allowed communications regarding dogs available for purchase but did not permit actual sales via the website. The Bomblisses traveled to Oklahoma to see the Cornelsens’ puppies and ended up purchasing two of them. The Cornelsens provided a guarantee that the puppies were suitable for breeding purposes. Following the sale, the Cornelsens mailed, to the Bomblisses’ home in Illinois, American Kennel Club registration papers for the puppies. Around this same time, Anne Cornelsen posted comments in an Internet chat room frequented by persons interested in Tibetan mastiffs. These comments suggested that the mother of certain Tibetan mastiff puppies (including one the Bomblisses had purchased) may have had a genetic disorder. The comments were made in the context of an apparent dispute between the Cornelsens and Richard Eichhorn, who owned the mother mastiff and had made it available to the Cornelsens for breeding purposes. The Bomblisses believed that the comments would have been seen by other persons in Illinois and elsewhere and would have impaired the Bomblisses’ ability to sell their puppies even though, when tested, their puppies were healthy. The Bomblisses therefore sued the Cornelsens in an Illinois court on various legal theories. The Cornelsens asked the Illinois court to dismiss the case on the ground that the court lacked in personam jurisdiction over them. Did the Illinois court lack in personam jurisdiction? 4. Hall Street Associates was the landlord and Mattel Inc. was the tenant under various leases for property that Mattel used as a manufacturing site for many years. The leases provided that the tenant would indemnify the landlord for any costs resulting from the tenant’s failure to follow environmental laws while using the premises. Tests of the property’s well water in 1998 showed high levels of trichloroethylene (TCE), the apparent residue of manufacturing discharges connected with Mattel’s operations on the site between 1951 and 1980. After the Oregon Department of Environmental Quality (DEQ) discovered even more pollutants, Mattel signed a consent order with the DEQ providing for cleanup of the site. After Mattel gave notice of intent to terminate the lease in 2001, Hall Street sued, contesting Mattel’s right to vacate on the date it gave and claiming that the leases obliged Mattel to

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Part One Foundations of American Law

indemnify Hall Street for the costs of cleaning up the TCE. A federal district court ruled in Mattel’s favor on the termination issue. The parties then proposed that they be permitted to submit the indemnification issue to arbitration rather than having the court rule on it. The court was amenable. The parties drew up an arbitration agreement, which the court approved and entered as an order. One paragraph of the agreement provided that [t]he United States District Court for the District of Oregon may enter judgment upon any [arbitration] award, either by confirming the award or by vacating, modifying or correcting the award. The court shall vacate, modify or correct any award: (i) where the arbitrator’s findings of facts are not supported by substantial evidence, or (ii) where the  arbitrator’s conclusions of law are erroneous.

The arbitrator initially decided in Mattel’s favor on the indemnification question, but the federal district court vacated the arbitrator’s decision on the ground of legal error (the basis set forth in the parties’ arbitration agreement). On remand, the arbitrator ruled in favor of Hall Street. The district court upheld this ruling. Mattel then appealed to the U.S. Court of Appeals for the Ninth Circuit, arguing that the arbitrator’s initial decision in Mattel’s favor should be reinstated. In particular, Mattel argued that the agreement calling for the district court to vacate the arbitrator’s decision in the event of legal error amounted to an unenforceable attempt to expand the legally permitted grounds for setting aside an arbitrator’s decision (as set forth in the Federal Arbitration Act). How did the Ninth Circuit rule? 5. WWP Inc. (WWP) is a charitable organization that furnishes assistance to injured military veterans and their families. WWP conducts its operations under the name “Wounded Warrior Project.” After WWP had been in existence for approximately a year, a separate, unaffiliated charitable organization, Wounded Warriors Family Support Inc. (WWFS), began providing assistance to injured veterans and their families. WWFS operated outside the United States as of 2002 but later became active within the United States. WWFS also launched a website whose domain name, “wounded warriors.org,” was similar to a domain name used by WWP. In addition, WWFS’s website included content referring to a “Wounded Warriors Hospital Fund.” Through use of this website, WWFS received large amounts of donated funds. WWP sued WWFS in the U.S. District Court for the District of

Nebraska. Relying on various legal theories, WWP alleged that WWFS created confusion through its website as to whether WWP and WWFS were affiliated and that WWFS had been unjustly enriched through receipt and retention of donations actually meant for WWP. After a jury trial, the district court awarded WWP approximately $1.7 million in damages and issued an injunction meant to curb further instances of confusion. WWFS appealed to the U.S. Court of Appeals for the Eighth Circuit. In its appeal, WWFS argued (among other things) that the district court had erred in denying WWFS’s motion to compel WWP to produce “[a]ll documents relating to or evidencing any donations received by [WWP] from January 1, 2002 to the present” after WWP refused to provide the documents. WWFS also argued on appeal that the district court erred in allowing a forensic accountant to testify as an expert witness who offered an opinion regarding the amount of damages allegedly sustained by WWP. WWFS argued that the forensic accountant should not have been permitted to testify as an expert because he utilized what WWFS regarded as simple mathematical calculations and because his opinion on damages was insufficiently connected with the facts of the case. Did the district court err in denying the motion to compel production of the requested documents? Did the district court err in permitting the forensic accountant to offer an expert opinion? 6. Jerrie Gray worked at a Tyson Foods plant where she was exposed to comments, gestures, and physical contact that, she alleged, constituted sexual harassment. Tyson disputed the allegation, arguing that the behavior was not unwelcome; that the complained-about conduct was not based on sex; that the conduct did not affect a term, condition, or privilege of employment; and that proper remedial action was taken in response to any complaint by Gray of sexual harassment. During the trial in federal court, a witness for Gray repeatedly volunteered inadmissible testimony that the judge had to tell the jury to disregard. At one point, upon an objection from the defendant’s counsel, the witness asked, “May I say something here?” The judge told her she could not. Finally, after the jury left the courtroom, the witness had an angry outburst that continued into the hallway, in view of some of the jurors. The jury awarded Gray $185,000 in compensatory and $800,000 in punitive damages. Tyson believed that it should not have been liable, that the awards of damages were excessive and unsupported by evidence, and



Chapter Two The Resolution of Private Disputes

that the inadmissible evidence and improper conduct had tainted the proceedings. What courses of action may Tyson pursue? 7. Oklahoma resident Samantha Guffey purchased a used 2009 Volvo XC90 (Volvo) from Odil Ostonakulov and Motorcars of Nashville Inc. (MNI). Ostonakulov resides in Tennessee. MNI is a Tennessee corporation with its principal place of business in Nashville, Tennessee. Ostonakulov and MNI operate a used car lot in Nashville. The sale occurred after Guffey was the winning bidder for the car in an auction by MNI on eBay. After receiving the Volvo, Guffey determined that it was not in the condition advertised. She later sued Ostonakulov and MNI in an Oklahoma state trial court for alleged fraud and alleged violations of an Oklahoma consumer protection law. The defendants moved to dismiss for lack of in personam jurisdiction. In an affidavit Guffey provided for the court as it considered the defendants’ jurisdiction objection, Guffey stated that she bid on the Volvo listed on eBay based, in part, on the representation of a 30-day limited warranty on the car. The affidavit also stated that after she submitted her bid, but several days before the closing date of the auction, she received an e-mail solicitation from Ostonakulov suggesting that she contact him by phone and negotiate a “buy-it-now” price for the vehicle. She chose not to do so, but only after calling and speaking with him personally about the matter. After Gulley learned that she had won the auction with the highest bid, she had her father call and speak to Ostonakulov about final details and payment instructions. Ostonakulov mailed a purchase agreement to Gulley’s father’s office in Oklahoma City. Gulley signed the agreement and returned it to Tennessee. Ostonakulov also helped arrange shipping of the vehicle to Oklahoma, where Guffey took delivery. According to Guffey’s affidavit, the eBay sale to her was not an isolated transaction for the defendants and that they have between 12 and 35 cars listed for sale every day on eBay. The affidavit also asserted that the defendants had sold at least three cars in Oklahoma and that they have sold more than 30 cars to Oklahoma residents. Oklahoma has a long-arm statute that applies to the full extent permitted by due process principles. The Oklahoma trial court dismissed the case after concluding that it did not have in personam jurisdiction over the defendants. Guffey appealed to the Supreme Court of Oklahoma. How did that court rule on the jurisdiction question?

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8. Abbott Laboratories manufactured and sold the Life Care PCA, a pump that delivers medication into a person intravenously at specific time intervals. Beverly Lewis sued Abbott in a Mississippi state court, alleging that a defective Life Care PCA had injured her by delivering an excessive quantity of morphine. Abbott served Lewis with a request for admission calling for her to admit that her damages did not exceed $75,000. Lewis did not answer the request for admission. Abbott removed the case to the U.S. District Court for the Southern District of Mississippi, predicating the court’s subject-matter jurisdiction on diversity of citizenship and an amount in controversy exceeding $75,000. Contending that her silence had amounted to an admission that her damages were less than $75,000, Lewis filed a motion asking that the federal court remand the case to the state court. Did the federal court have subject-matter jurisdiction? How did the federal court rule on Lewis’s motion to send the case back to the state court? 9. The state of New Jersey says it is sovereign over certain landfilled portions of Ellis Island. The state of New York disagrees, asserting that it is sovereign over the whole of the island. New Jersey brings an action in the U.S. District Court for the Southern District of New York. Should the court hear the case? 10. Florian Hinrichs, a citizen of Germany and a member of the German military, had been assigned to Fort Rucker for flight training. Fort Rucker is located in Alabama. Hinrichs and Daniel Vinson were in the same training program. On June 24, 2007 (during the time of his assignment to Fort Rucker), Hinrichs was riding in the front passenger seat of Vinson’s 2004 GMC Sierra 1500 pickup truck (the Sierra). Vinson was driving the Sierra. As the vehicle proceeded down an Alabama roadway, it was struck by a vehicle whose intoxicated driver (Kenneth Earl Smith) caused it to run a stop sign. The Sierra rolled over twice, and Hinrichs suffered a spinal-cord injury that left him paralyzed. In the litigation referred to below, Hinrichs alleged that his injuries were caused by the defective design of the Sierra’s roof. This design, Hinrichs contended, allowed the roof over the passenger compartment to collapse during the rollover. Hinrichs also alleged that Sierra’s seatbelt, which he was wearing at the time of the accident, was defectively designed because it failed to restrain him. General Motors Corp. designed the Sierra. General Motors of Canada Ltd. (GM Canada), whose principal place of business is in Ontario, Canada, is a separate legal entity from

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Part One Foundations of American Law

GM. GM Canada was incorporated under Canadian law and has its principal place of business in Ontario, Canada. It does not do business directly in the United States. GM Canada manufactured certain parts of the Sierra eventually purchased by Vinson, assembled the vehicle in Canada, and sold it to GM. The transfer of title to the vehicle (i.e., from GM Canada to GM) occurred in Canada. GM then distributed the Sierra for sale in the United States through a dealer located in Pennsylvania. Vinson purchased the Sierra from the Pennsylvania dealer in 2003. He drove it to Alabama in 2006 when he was assigned to Fort Rucker. Besides suing Smith (the intoxicated driver) for negligence, Hinrichs brought product liability claims

against both GM and GM Canada in an Alabama trial court. Arguing that the Alabama court lacked in personam jurisdiction over it, GM Canada moved for dismissal. In opposition to the motion, Hinrichs stressed that even if GM Canada does not do business directly in the United States, it anticipates that almost all of the vehicles it assembles in Canada will end up in the stream of commerce in the United States and that Alabama is among the states in which the vehicles will be sold or driven. The Alabama trial court dismissed the claim against GM Canada on the ground that in personam jurisdiction was lacking. Hinrichs appealed the dismissal. Was the trial court’s ruling correct?

CHAPTER 3

Business and the Constitution

A

federal statute and related regulations prohibited producers of beer from listing, on a product label, the alcohol content of the beer in the container on which the label appeared. The regulation existed because the U.S.  government believed that if alcohol content could be disclosed on labels, certain producers of beer might begin marketing their brand as having a higher alcohol content than competing beers. The government was concerned that “strength wars” among producers could then develop, that consumers would seek out beers with higher alcohol content, and that adverse public health consequences would follow. Because it wished to include alcohol content information on container labels for its beers, Coors Brewing Co. filed suit against the U.S. government and asked the court to rule that the statute and regulations violated Coors’s constitutional right to freedom of speech. Consider the following questions as you read Chapter 3: ••On which provision in the U.S. Constitution was Coors relying in its challenge of the statute and regulations? ••Does a corporation such as Coors possess the same constitutional right to freedom of speech possessed by an individual human being, or does the government have greater latitude to restrict the content of a corporation’s speech? ••The alcohol content disclosures that Coors wished to make with regard to its product would be classified as commercial speech. Does commercial speech receive the same degree of constitutional protection that political or other noncommercial speech receives? ••Which party—Coors or the federal government—won the case, and why? • Do producers and other sellers of alcoholic beverages have, in connection with the sale of their products, special ethical obligations that sellers of other products might not have? If so, what are those obligations and why do they exist?

LO

LEARNING OBJECTIVES After studying this chapter, you should be able to: 3-1 Describe the role of courts in interpreting constitutions and in determining whether statutes or other government actions are constitutional. 3-2 Explain the key role of the U.S. Constitution’s Commerce Clause in authorizing action by Congress. 3-3 Explain the burden-on-commerce doctrine’s role in making certain state government actions unconstitutional.

3-4 Describe the incorporation doctrine’s role in making most guarantees of the Bill of Rights operate to protect persons not only against certain federal government actions, but also against certain state and local government actions. 3-5 Explain the differences among the means-ends tests used by courts when the constitutionality of government action is being determined (strict scrutiny, intermediate scrutiny, and rational basis).

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Part One Foundations of American Law

3-6 Describe the differences between noncommercial speech and commercial speech and the respective levels of First Amendment protection they receive. 3-7 Explain the difference between procedural due process and substantive due process. 3-8 Identify the instances when an Equal Protection Clause–based challenge to government action

CONSTITUTIONS SERVE TWO general functions. First, they set up the structure of government, allocating power among its various branches and subdivisions. Second, they prevent government from taking certain actions— especially actions that restrict individual or, as suggested by the Coors scenario that opened this chapter, corporate rights. This chapter examines the U.S. Constitution’s performance of these functions and considers how that performance affects government regulation of business.

An Overview of the U.S. Constitution The U.S. Constitution exhibits the principle of separation of powers by giving distinct powers to Congress, the president, and the federal courts. Article I of the Constitution establishes a Congress composed of a Senate and a House of Representatives, gives it sole power to legislate at the federal level, and sets out rules for the enactment of legislation. Article I, § 8 also defines when Congress can make law by stating its legislative powers. Three of those powers— the commerce, tax, and spending powers—are discussed later in the chapter. Article II gives the president the executive power—the power to execute or enforce the laws passed by Congress. Section 2 of that article lists other presidential powers, including the powers to command the nation’s armed forces and to make treaties. Article III gives the judicial power of the United States to the Supreme Court and the other federal courts later established by Congress. Article III also determines the types of cases the federal courts may decide. Besides creating a separation of powers, Articles I, II, and III set up a system of checks and balances among Congress, the president, and the courts. For example, Article I gives the president the power to veto legislation passed by Congress, but allows Congress to override such a veto by a two-thirds vote of each House. Articles I and II provide that the president, the vice president, and other federal officials may be removed from office if, following an impeachment trial in the Senate, two-thirds of

triggers more rigorous scrutiny than the rational basis test. 3-9 Identify the major circumstances in which federal law will preempt state law. 3-10 Explain the power granted to the government by the Takings Clause, as well as the limits on that power.

the Senate concludes that the impeached office-holder committed “Treason, Bribery, or other high Crimes and Misdemeanors.” Article II states that treaties agreed to by the president must be approved by a two-thirds vote of the Senate. Article III gives Congress some control over the Supreme Court’s appellate jurisdiction. The Constitution recognizes the principle of federalism in the way it structures power relations between the federal government and the states. After listing the powers Congress holds, Article I lists certain powers that Congress cannot exercise. The Tenth Amendment provides that those powers the Constitution neither gives to the federal government nor denies to the states are reserved to the states or the people. Article VI, however, makes the Constitution, laws, and treaties of the United States supreme over state law. As will be seen, this principle of federal supremacy may cause federal statutes to preempt inconsistent state laws. The Constitution also puts limits on the states’ lawmaking powers. One example is Article I’s command that states shall not pass laws impairing the obligation of contracts. Of course, there is sometimes disagreement (between state and federal officials, for example) about whether a particular branch of government has overreached. For example, in 2020, President Trump challenged a subpoena (issued as part of a state criminal investigation) for financial records related to his personal and business financial records. The president argued that a sitting president is absolutely immune from such a process; among other things, he argued that the criminal subpoenas would divert him from his duties and impose an intolerable burden on a president’s ability to perform his Article II functions. The Supreme Court found that distraction was not sufficient to confer absolute immunity and held that Article II and the Supremacy Clause do not preclude or require a heightened standard for the issuance of a state criminal subpoena to a sitting president. Trump v. Vance, 140 S. Ct. 2412 (2020). Article V sets forth the procedures for amending the Constitution. The Constitution has been amended 27 times. The first 10 of these amendments comprise the Bill of Rights. Although the rights guaranteed in the first



Chapter Three Business and the Constitution

10  amendments once restricted only federal government action, most of them now limit state government action as well. As you will learn, this results from their incorporation within the Due Process Clause of the Fourteenth Amendment.

The Evolution of the Constitution and the Role of the Supreme Court Describe the role of courts in interpreting constitutions

LO3-1 and in determining whether statutes or other government

actions are constitutional.

According to the legal realists discussed in Chapter 1, written “book law” is less important than what public decision makers actually do. Using this approach, we discover a Constitution that differs from the written Constitution just described. The actual powers of today’s presidency, for instance, exceed anything one would expect from reading Article II. As you will see, moreover, some constitutional provisions have acquired a meaning different from their meaning when first enacted. American constitutional law has evolved rather than being static. Many of these changes result from the way one public decision maker—the nine-member U.S. Supreme Court— has interpreted the Constitution over time. Formal constitutional change can be accomplished only through the amendment process. Because this process is difficult to employ, however, amendments to the Constitution have been relatively infrequent. As a practical matter, the Supreme Court has become the Constitution’s main “amender” through its many interpretations of constitutional provisions. Various factors help explain the Supreme Court’s ability and willingness to play this role. Because of their vagueness, some key constitutional provisions invite diverse interpretations. “Due process of law” and “equal protection of the laws” are examples. In addition, the history surrounding the enactment of constitutional provisions sometimes is sketchy, confused, or contradictory. Under the power of judicial review, courts can declare the actions of other government bodies unconstitutional. How courts exercise this power depends on how they choose to read the Constitution. Courts thus have political power—a conclusion especially applicable to the Supreme Court. Indeed, the Supreme Court’s justices are, to a considerable extent, public policy makers. Their beliefs are important in the determination of how the United States is governed. This is why the justices’

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nomination and confirmation often involve so much political controversy. Yet even though the Constitution frequently is what the courts say it is, judicial power to shape the Constitution has limits. Certain limits spring from the Constitution’s language, which sometimes is quite clear. Others result from the judges’ adherence to the stare decisis doctrine discussed in Chapter 1. Perhaps the most significant limits on judges’ power, however, stem from the tension between modern judicial review and democracy. Legislators are chosen by the people, whereas judges—especially appellate level judges—often are appointed, not elected. Today, judges exercise political power by declaring the actions of legislatures unconstitutional under standards largely of the judiciary’s own devising. This sometimes leads to charges that courts are undemocratic, elitist institutions. Such charges put political constraints on judges because courts depend on the other branches of government—and ultimately on public belief in judges’ fidelity to the rule of law—to make their decisions effective. Therefore, judges sometimes may be reluctant to declare statutes unconstitutional because they are wary of power struggles with a more representative body such as Congress.

LOG ON For a great deal of information about the U.S. Supreme Court and access to the Court’s opinions in recent cases, see the Court’s website at http://www.supremecourtus.gov.

The Coverage and Structure of This Chapter This chapter examines certain constitutional provisions that are important to business; it does not discuss constitutional law in its entirety. These provisions help define federal and state power to regulate the economy. The U.S. Constitution limits government regulatory power in two general ways. First, it restricts federal legislative authority by listing the powers Congress can exercise. These are known as the enumerated powers. Federal legislation cannot be constitutional if it is not based on a power specifically stated in the Constitution. Second, the U.S. Constitution limits both state and federal power by placing certain independent checks in the path of each. In effect, the independent checks establish that even if Congress has an enumerated power to legislate on a particular matter or a state constitution authorizes a state to take certain actions, there still are certain protected spheres into which neither the federal government nor the state government may reach.

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Part One Foundations of American Law

Accordingly, a federal law must meet two general tests in order to be constitutional: (1) it must be based on an enumerated power of Congress and (2) it must not collide with any of the independent checks. For example, Congress has the power to regulate commerce among the states. This power might seem to allow Congress to pass legislation forbidding women from crossing state lines to buy or sell goods. Yet such a law, though arguably based on an enumerated power, surely would be unconstitutional because it conflicts with an independent check—the equal protection guarantee discussed later in the chapter. Today, the independent checks are the main limitations on congressional power. The most important reason for the decline of the enumerated powers limitation is the perceived need for active federal regulation of economic and social life. Recently, however, the enumerated powers limitation has begun to assume somewhat more importance, as will be seen. After discussion of the most important state and federal powers to regulate economic matters, the chapter explores certain independent checks that apply to the federal government and the states. The chapter then examines some independent checks that affect the states alone. It concludes by discussing a provision—the Takings Clause of the Fifth Amendment—that both recognizes a governmental power and limits its exercise.

State and Federal Power to Regulate State Regulatory Power Although

state constitutions may do so, the U.S. Constitution does not list the powers state legislatures can exercise. The U.S. Constitution does place certain independent checks in the path of state lawmaking, however. It also declares that certain powers (e.g., creating currency and taxing imports) can be exercised only by Congress. In many other areas, though, Congress and the state legislatures have concurrent powers. Both can make law within those areas unless Congress preempts state regulation under the Supremacy Clause. A very important state legislative power that operates concurrently with many congressional powers is the police power, a broad state power to regulate for the public health, safety, morals, and welfare.

Federal Regulatory Power Article

I, § 8 of the U.S. Constitution specifies a number of ways in which Congress may legislate concerning business and commercial matters. For example, it empowers Congress to coin and borrow money, regulate interstate commerce, establish uniform laws regarding bankruptcies, create post offices,

and enact copyright and patent laws. The most important congressional powers contained in Article I, § 8, however, are the powers to regulate commerce among the states, to lay and collect taxes, and to spend for the general welfare. Because they now are read broadly, these three powers are the main constitutional bases for the extensive federal social and economic regulation that exists today. The Commerce Power LO3-2

Explain the key role of the U.S. Constitution’s Commerce Clause in authorizing action by Congress.

Article I, § 8 states that “The Congress shall have Power . . . . To regulate Commerce . . . among the several States.” The original reason for giving Congress this power to regulate interstate commerce (that is, commerce between or among multiple states) was to nationalize economic matters by blocking the protectionist state restrictions on interstate trade that were common after the Revolution. As discussed later in the chapter, the Commerce Clause serves as an independent check on state regulation that unduly restricts interstate commerce. Our present concern, however, is the Commerce Clause’s role as a source of congressional regulatory power. The literal language of the Commerce Clause simply empowers Congress to regulate commerce that occurs among the states. Supreme Court decisions interpreting the Commerce Clause have held, however, that it sets up three categories of actions in which Congress may engage: first, regulating the channels of interstate commerce; second, regulating and protecting the instrumentalities of interstate commerce, as well as persons or things in interstate commerce; and third, regulating activities that substantially affect interstate commerce. Largely because of judicial decisions regarding congressional action falling within the third category, the Commerce Clause has become a federal power with an extensive regulatory reach. How has this transformation occurred? The most important step in the transformation was the Supreme Court’s conclusion that the power to regulate interstate commerce includes the power to regulate intrastate (that is, commerce within a state) activities that affect interstate commerce. For example, in a 1914 decision, the Supreme Court upheld the Interstate Commerce Commission’s regulation of railroad rates within Texas (an intrastate matter outside the language of the Commerce Clause) because those rates affected rail traffic between Texas and Louisiana (an interstate matter within the clause’s language). This “affecting commerce” doctrine eventually was used to justify federal police power measures with significant intrastate reach. For instance, the Supreme Court



Chapter Three Business and the Constitution

upheld the application of the 1964 Civil Rights Act’s “public accommodations” section to a family-owned restaurant in Birmingham, Alabama. It did so because the restaurant’s racial discrimination affected interstate commerce by reducing the restaurant’s business and limiting its purchases of out-of-state meat and by restricting the ability of Blacks to travel among the states. By the early 1990s, broad judicial interpretations of the Commerce Clause led many observers to conclude that the clause established a federal power with almost unlimited reach. Then two Supreme Court decisions, United States v. Lopez, 514 U.S. 549 (1995), and United States v. ­Morrison, 529 U.S. 598 (2000), offered clear reminders that the power to regulate interstate commerce is not without limits. Those cases struck down laws that made possessing a

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gun in a school zone a federal crime (Lopez) and addressed gender-motivated violent crimes (Morrison). In both cases, the Court held that Congress had exceeded its power. One area that has tested Congress’s Commerce Clause power is the federal ban on marijuana. Though many states and cities have made it legal as a matter of state law, it remains (at least at the time of this writing) illegal under federal law. The Supreme Court has found that Congress has the power to prohibit its use under federal law, finding that there exists an interstate market for the drug and that such a law regulates economic activity. Gonzales v. Raich, 545 U.S. 1 (2005). In the case below, the Court considered whether a state law was an unconstitutional burden on interstate commerce.

South Dakota v. Wayfair, Inc.   138 S. Ct. 2080 (2018) The State of South Dakota (like most states) requires companies to collect a sales tax on goods and services sold in the state and remit the money to the state. That practice is fairly straightforward for businesses that sell their products through physical locations in the state (brick-and-mortar stores, for example), when a customer pays at the point of sale. But online retailers with no physical location in the state had argued that states could not force them to collect the tax. The U.S. Supreme Court had ruled in the past, most recently in a case called Quill Corp. v. North Dakota (504 U.S. 298 (1992)), that states could not require a business to collect the state’s sales tax if that business had no physical presence in the state. That ruling was based on the Commerce Clause: Without a strong connection between the business and the state (such as a physical presence), the tax collection requirement imposed an undue burden on the free flow of interstate commerce. South Dakota sued Wayfair and other online retailers, seeking to require them to collect its sales tax from online sales to customers in South Dakota. It argued that the “physical presence” rule was depriving them of needed tax dollars and should be overturned. Because of binding precedent from the U.S. Supreme Court (i.e., the Quill case and a case before it called Bellas Hess), the retailers won on their motions for summary judgment in the trial court and the South Dakota Supreme Court. The U.S. Supreme Court granted certiorari to hear South Dakota’s appeal. Kennedy, Justice All concede that taxing the sales in question here is lawful. The question is whether the out-of-state seller can be held responsible for its payment, and this turns on a proper interpretation of the Commerce Clause, U.S. Const., Art. I, § 8, cl. 3. Under this Court’s decisions in Bellas Hess and Quill, South Dakota may not require a business to collect its sales tax if the business lacks a physical presence in the State. Without that physical presence, South Dakota instead must rely on its residents to pay the use tax owed on their purchases from out-of-state sellers. “[T]he impracticability of [this] collection from the multitude of individual purchasers is obvious.” National Geographic Soc. v. California Bd. of Equalization, 430 U.S. 551, 555 (1977). And consumer compliance rates are notoriously low. . . . It is estimated that Bellas Hess and Quill cause the States to lose between $8 and $33 billion every year.  .  .  . In South Dakota alone, the Department of Revenue estimates revenue loss at $48 to $58 million

annually. Particularly because South Dakota has no state income tax, it must put substantial reliance on its sales and use taxes for the revenue necessary to fund essential services. Those taxes account for over 60 percent of its general fund. In 2016, South Dakota confronted the serious inequity Quill imposes by enacting S. 106—“An Act to provide for the collection of sales taxes from certain remote sellers, to establish certain Legislative findings, and to declare an emergency.” The legislature found that the inability to collect sales tax from remote sellers was “seriously eroding the sales tax base” and “causing revenue losses and imminent harm . . . through the loss of critical funding for state and local services.” § 8(1). . . . The Act applies only to sellers that, on an annual basis, deliver more than $100,000 of goods or services into the State or engage in 200 or more separate transactions for the delivery of goods or services into the State. Respondents Wayfair, Inc., Overstock.com, Inc., and Newegg, Inc., are merchants with no employees or real estate in South

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Dakota. . . . Each easily meets the minimum sales or transactions requirement of the Act, but none collects South Dakota sales tax. II. The Constitution grants Congress the power “[t]o regulate Commerce . . . among the several States.” Art. I, § 8, cl. 3. . . . Although the Commerce Clause is written as an affirmative grant of authority to Congress, this Court has long held that in some instances it imposes limitations on the States absent congressional action. Modern precedents rest upon two primary principles that mark the boundaries of a State’s authority to regulate interstate commerce. First, state regulations may not discriminate against interstate commerce; and second, States may not impose undue burdens on interstate commerce. [A] State “may tax exclusively interstate commerce so long as the tax does not create any effect forbidden by the Commerce Clause.” [Complete Auto Transit, Inc. v. Brady, 430 U.S. 274, 285 (1977)]. After all, “interstate commerce may be required to pay its fair share of state taxes.” D. H. Holmes Co. v. McNamara, 486 U.S. 24, 31 (1988). In National Bellas Hess, Inc. v. Department of Revenue of Ill., 386 U.S. 753, 754–55 (1967),] . . . [t]he Court held that . . . [unless a] retailer maintained a physical presence such as “retail outlets, solicitors, or property within a State,” the State lacked the power to require that retailer to collect a local use tax. Ibid. In 1992, the Court reexamined the physical presence rule in Quill. III The physical presence rule has “been the target of criticism over many years from many quarters.” Direct Marketing Assn. v. Brohl, 814 F.3d 1129, 1148, 1150–1151 (10th Cir. 2016) (Gorsuch, J., concurring). . . . Quill created an inefficient “online sales tax loophole” that gives out-of-state businesses an advantage. And “while nexus rules are clearly necessary,” the Court “should focus on rules that are appropriate to the twenty-first century, not the nineteenth.” Hellerstein, Deconstructing the Debate Over State Taxation of Electronic Commerce, 13 Harv. J. L. & Tech. 549, 553 (2000). Each year, the physical presence rule becomes further removed from economic reality and results in significant revenue losses to the States. These critiques underscore that the physical presence rule, both as first formulated and as applied today, is an incorrect interpretation of the Commerce Clause. All agree that South Dakota has the authority to tax these transactions.  .  .  . The central dispute is whether South Dakota may require remote sellers to collect and remit the tax without some additional connection to the State. . . . There just must be “a substantial nexus with the taxing State.” Physical presence is not necessary to create a substantial nexus. The Quill majority expressed concern that without the

physical presence rule “a state tax might unduly burden interstate commerce” by subjecting retailers to tax collection obligations in thousands of different taxing jurisdictions. But the administrative costs of compliance, especially in the modern economy with its Internet technology, are largely unrelated to whether a company happens to have a physical presence in a State. For example, a business with one salesperson in each State must collect sales taxes in every jurisdiction in which goods are delivered; but a business with 500 salespersons in one central location and a website accessible in every State need not collect sales taxes on otherwise identical nationwide sales. Quill puts both local businesses and many interstate businesses with physical presence at a competitive disadvantage relative to remote sellers. Remote sellers can avoid the regulatory burdens of tax collection and can offer de facto lower prices caused by the widespread failure of consumers to pay the tax on their own. . . . In effect, Quill has come to serve as a judicially created tax shelter for businesses that decide to limit their physical presence and still sell their goods and services to a State’s consumers—something that has become easier and more prevalent as technology has advanced. Worse still, the rule produces an incentive to avoid physical presence in multiple States. . . . Rejecting the physical presence rule is necessary to ensure that artificial competitive advantages are not created by this Court’s precedents. Modern e-commerce does not align analytically with a test that relies on the sort of physical presence defined in Quill. Between targeted advertising and instant access to most consumers via any internet-enabled device, “a business may be present in a State in a meaningful way without” that presence “being physical in the traditional sense of the term.” Quill’s physical presence rule intrudes on States’ reasonable choices in enacting their tax systems. And that it allows remote sellers to escape an obligation to remit a lawful state tax is unfair and unjust. It is unfair and unjust to those competitors, both local and out of State, who must remit the tax; to the consumers who pay the tax; and to the States that seek fair enforcement of the sales tax, a tax many States for many years have considered an indispensable source for raising revenue. In essence, respondents ask this Court to retain a rule that allows their customers to escape payment of sales taxes—taxes that are essential to create and secure the active market they supply with goods and services. An example may suffice. Wayfair offers to sell a vast selection of furnishings. Its advertising seeks to create an image of beautiful, peaceful homes, but it also says that “[o]ne of the best things about buying through Wayfair is that we do not have to charge sales tax.” Brief for Petitioner 55. What Wayfair ignores in its subtle offer to assist in tax evasion is that creating a dream home assumes solvent state and local governments. State taxes fund the police and fire departments that protect the homes containing their customers’ furniture and



Chapter Three Business and the Constitution

ensure goods are safely delivered; maintain the public roads and municipal services that allow communication with and access to customers; support the “sound local banking institutions to support credit transactions [and] courts to ensure collection of the purchase price,” Quill, 504 U.S., at 328 (opinion of White, J.); and help create the “climate of consumer confidence” that facilitates sales. IV *** Though Quill was wrong on its own terms when it was decided in 1992, since then the Internet revolution has made its earlier error all the more egregious and harmful. . . . In 1992, less than 2 percent of Americans had Internet access. Today that number is about 89 percent. When it decided Quill, the Court could not have envisioned a world in which the world’s largest retailer would be a remote seller. The Internet’s prevalence and power have changed the dynamics of the national economy. In 1992, mail-order sales in the United States totaled $180 billion. Last year, e-commerce retail sales alone were estimated at $453.5 billion. This expansion has also increased the revenue shortfall faced by States seeking to collect their sales and use taxes. In 1992, it was estimated that the States were losing between $694 million and $3 billion per year in sales tax revenues as a result of the physical presence rule. Now estimates range from $8 to $33 billion. Here, the tax distortion created by Quill exists in large part because consumers regularly fail to comply with lawful use taxes. Some remote retailers go so far as to advertise sales as tax free.

The Taxing Power Article I, § 8 of the Constitution states that “The Congress shall have Power To lay and collect Taxes, Duties, Imposts and Excises.” The main purpose of this taxing power is to provide a means of raising revenue for the federal government. The taxing power, however, may also serve as a regulatory device. Congress may choose to regulate a disfavored activity by taxing it heavily or may opt to encourage a favored activity by lowering or eliminating a tax on it. Today, the reach of the taxing power is seen as very broad, as evidenced by National Federation of Independent Business v. Sebelius, which follows shortly. The Spending Power If taxing-power regulation uses a federal club, congressional spending-power regulation employs a federal carrot. Article I, § 8 also gives Congress a broad ability to spend for the general welfare. By basing the receipt of federal money on the performance of certain

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For these reasons, the Court concludes that the physical presence rule of Quill is unsound and incorrect. The Court’s decisions in Quill Corp. v. North Dakota, 504 U.S. 298 (1992), and National Bellas Hess, Inc. v. Department of Revenue of Ill., 386 U.S. 753 (1967), should be, and now are, overruled. V In the absence of Quill and Bellas Hess, the first prong of the Complete Auto test simply asks whether the tax applies to an activity with a substantial nexus with the taxing State. “[S]uch a nexus is established when the taxpayer [or collector] ‘avails itself of the substantial privilege of carrying on business’ in that jurisdiction.” Polar Tankers, Inc. v. City of Valdez, 557 U.S. 1, 11 (2009). Here, the nexus is clearly sufficient based on both the economic and virtual contacts respondents have with the State. The Act applies only to sellers that deliver more than $100,000 of goods or services into South Dakota or engage in 200 or more separate transactions for the delivery of goods and services into the State on an annual basis. This quantity of business could not have occurred unless the seller availed itself of the substantial privilege of carrying on business in South Dakota. And respondents are large, national companies that undoubtedly maintain an extensive virtual presence. Thus, the substantial nexus requirement of Complete Auto is satisfied in this case. The judgment of the Supreme Court of South Dakota is vacated, and the case is remanded for further proceedings not inconsistent with this opinion.

conditions, Congress can use the spending power to encourage states to take certain actions and thereby advance specific regulatory ends. Conditional federal grants to the states, for instance, are common today. Over the past several decades, congressional spending-power regulation routinely has been upheld. There are limits, however, on its use. First, an exercise of the spending power must serve general public purposes rather than particular interests. Second, when Congress conditions the receipt of federal money on certain conditions, it must do so clearly. Third, the condition must be reasonably related to the purpose underlying the federal expenditure. This means, for instance, that Congress probably could not condition a state’s receipt of federal highway money on the state’s adoption of a one-house legislature. Fourth, though Congress may use conditional grants of funding to states to encourage them to

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take certain regulatory actions, Congress can neither compel states to enact a desired regulatory program nor otherwise coerce them into doing so. For an example of issues arising under this last limit on Congress’s spending power, see the National Federation case, which follows shortly. The Necessary and Proper Clause After listing the commerce power, the taxing and spending powers, and

various other powers extended to Congress, Article I, § 8 concludes with a provision granting Congress the further power to “make all Laws which shall be necessary and proper for carrying into Execution the foregoing Powers. . . .” The Necessary and Proper Clause is dependent upon Article I, § 8’s previously listed powers but augments them by permitting Congress to enact laws that are useful or conducive to the exercise of those enumerated powers.

Figure 3.1 A Note on the Affordable Care Act Decision Congress enacted the Patient Protection and Affordable Care Act (hereinafter, Affordable Care Act or ACA) in 2010. Several cases filed shortly thereafter in federal courts presented constitutional challenges to two provisions in the statute: (1) the requirement, applicable to most Americans, that they have health insurance in force by a certain date specified in the law or, instead, pay what the statute termed a “[s]hared responsibility payment” (a provision that has come to be known as the individual mandate and will be referred to by that designation here) and (2) the requirement that states participate in an expansion of Medicaid, the long-standing federally created program under which the federal government and the states act together to fund health care for low-income persons and others with special needs. After the lower courts issued conflicting decisions, the Supreme Court agreed to decide the constitutionality of the challenged provisions. National Federation of Independent Business v. Sebelius (hereinafter, NFIB) proved to be not only an important Commerce Clause case, but also a major decision regarding two other enumerated powers, the taxing power and the spending power. This note focuses on NFIB’s treatment of the Commerce Clause issue triggered by the individual mandate referred to above. An edited version of NFIB appears in the chapter. It focuses on the 2012 decision’s taxing-power and spending-power analyses, which dealt, respectively, with the individual mandate and the Medicaid expansion provision. When Congress enacted the Affordable Care Act, it relied chiefly on the Commerce Clause as the source of power to enact the law. The federal government, accordingly, placed primary emphasis on the Commerce Clause when it sought to defend the individual mandate in the courts. The government invoked its taxing power as an alternative justification. Although there was no true majority opinion for the Supreme Court on the commerce-power question in NFIB, five justices concluded that the individual mandate exceeded the regulatory authority Congress possesses under the Commerce Clause. Chief Justice Roberts, who wrote for a majority of the Court on the taxing-power question, garnered no official votes for the portion of his opinion dealing with the commerce power. However, the four dissenting justices—Scalia, Kennedy, Thomas, and Alito—joined in an opinion adopting a commerce-power analysis that closely resembled the Chief Justice’s analysis. (The dissenters’ extreme dissatisfaction with the Chief Justice’s treatment of the taxing-power issue probably kept them from joining any part of the Roberts opinion despite their apparent agreement with his Commerce Clause analysis.) Chief Justice Roberts and the four dissenters separately acknowledged that the Court’s precedents contemplated expansive authority for Congress under the Commerce Clause. They concluded, however, that the individual mandate went beyond what those precedents would authorize. The Chief Justice stressed that in giving Congress the power to “regulate” commerce, the Commerce Clause presupposes the existence of relevant activity to be regulated. The individual mandate, he observed, sought to compel persons not otherwise inclined to engage in commercial activity to do so by purchasing insurance. Noting the seemingly unprecedented nature of a congressional requirement that persons make a purchase from a private party, the Chief Justice asserted that the Court’s precedents dealing with activities substantially affecting interstate commerce could not be stretched far enough to let Congress reach the absence of commercial activity and regulate it by requiring such activity. The four dissenters took a similar tack, emphasizing that the individual mandate amounted to an impermissible attempt to regulate inactivity rather than the activity necessary, in their view, to make the Commerce Clause a potential source of regulatory authority. (The other four justices—Ginsburg, Breyer, Sotomayor, and Kagan—regarded the Court’s “affecting commerce” precedents as leading logically to the conclusion that the individual mandate should be seen as authorized under the Commerce Clause, given the inevitability that everyone will need health care at some point and the notion that the insurance requirement was largely a payment mechanism designed to help control health care costs. Their Commerce Clause arguments failed, however.) With five justices concluding that the Commerce Clause did not authorize the individual mandate, it became necessary for the Court to determine whether a separate enumerated power—the taxing power—would provide the necessary constitutional foundation for the provision (which, as noted earlier, required that an individual make a “[s]hared responsibility payment” if



Chapter Three Business and the Constitution

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he or she did not obtain health insurance). Although the taxing-power argument was its backup argument, the government succeeded with it. Chief Justice Roberts, joined by Justices Ginsburg, Breyer, Sotomayor, and Kagan, determined that the congressional power to tax justified the provision. (See the later edited version of NFIB, which focuses on the taxing-power issue as well as the spending-power issue raised by the Affordable Care Act’s Medicaid expansion provision.) Critics of the Affordable Care Act and of the notion that the Commerce Clause permits expansive federal power likely were heartened by the government’s failure to succeed with its commerce-power argument in NFIB. But if critics won the Commerce Clause battle, they lost the constitutional war. The government’s success with the taxing-power argument meant that the individual mandate—often described as the centerpiece of the Affordable Care Act—was every bit as constitutional as it would have been if the government had succeeded with the Commerce Clause argument. At the time of this writing, the Supreme Court was preparing to consider another challenge to the ACA. In cases brought by a group of states, some plaintiffs claim the entire law should be struck down because of changes that Congress had made to the law. Specifically, Congress changed the penalty for not buying health insurance, making the penalty zero. A legal question the cases present is whether the change to the law means that the entire ACA is now unconstitutional.

National Federation of Independent Business v. Sebelius    567 U.S. 519 (2012) Congress enacted the Patient Protection and Affordable Care Act in 2010 (hereinafter, ACA) in an effort to increase the number of Americans covered by health insurance and decrease the cost of health care. As noted in Figure 3.1, one key ACA provision has come to be known as the individual mandate. That provision requires most Americans to maintain “minimum essential” health insurance coverage. For persons who are not exempt, and who do not receive health insurance through an employer or government program, the means of satisfying the requirement is to purchase insurance from a private company. The ACA further requires that those who do not comply with the mandate to have insurance in force must make a “[s]hared responsibility payment” to the federal government. That payment, which the ACA describes as a “penalty,” is calculated as a percentage of household income, subject to a floor based on a specified dollar amount and a ceiling based on the average annual premium the individual would have to pay for qualifying private health insurance. The ACA states that this “penalty” will be paid to the Internal Revenue Service (IRS) with an individual’s taxes, and “shall be assessed and collected in the same manner” as tax penalties. Some individuals who are subject to the insurance mandate are nonetheless exempt from the shared responsibility payment if their income is below a certain threshold. As noted in Figure 3.1, the ACA also features a provision calling for an expansion of the Medicaid program, which offers federal funding to states to assist low-income families, children, pregnant women, the blind, the elderly, and the disabled in obtaining medical care. The ACA provision at issue expands Medicaid’s scope and increases the number of individuals the states must cover. For example, the ACA calls for state programs to provide Medicaid coverage to adults with incomes up to 133 percent of the federal poverty level, whereas many states historically have covered adults with children only if their income is considerably lower and have not covered childless adults at all. The ACA’s Medicaid provision increases federal funding to cover all of the states’ costs in expanding Medicaid coverage in early years of the expansion and most of those costs in succeeding years. However, the ACA also provides that if a state does not comply with the new Medicaid coverage requirements, the state could lose not merely the federal funding for those requirements, but potentially all of its federal Medicaid funds. In various federal court cases, plaintiffs challenged the above-referred-to ACA provisions on constitutional grounds. The cases yielded conflicting results. Included among the cases was one filed by 26 states, several individuals, and the National Federation of Independent Business. In that case, the U.S. Court of Appeals for the Eleventh Circuit concluded that Congress lacked constitutional authority to enact the individual mandate. However, the Eleventh Circuit upheld the Medicaid expansion as a valid exercise of Congress’s spending power. The U.S. Supreme Court agreed to decide the case. As explained in Figure 3.1, five justices concluded in National Federation of Independent Business v. Sebelius that the Commerce Clause could not be interpreted as authorizing the individual mandate. The following edited version of the opinion authored by Chief Justice Roberts focuses on whether Congress’s taxing power authorizes the individual mandate and on whether Congress’s spending

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power justifies the Medicaid expansion. Justices Ginsburg, Breyer, Sotomayor, and Kagan joined the Chief Justice to form a majority on the taxing-power question. On the spending-power question, Justices Breyer and Kagan subscribed to the Chief Justice’s analysis. Justices Ginsburg and Sotomayor provided the fourth and fifth votes for the outcome reached by the Chief Justice’s opinion on the Medicaid expansion, though they otherwise disagreed with his analysis.  Roberts, Chief Justice Today we resolve constitutional challenges to two provisions of the ACA: the individual mandate, which requires individuals to purchase a health insurance policy providing a minimum level of coverage [or, instead, make a “[s]hared responsibility payment”]; and the Medicaid expansion, which gives funds to the states on the condition that they provide specified health care to all citizens whose income falls below a certain threshold. [R]ather than granting general authority to perform all the conceivable functions of government, the Constitution lists, or enumerates, the federal government’s powers. The same does not apply to the states, because the Constitution is not the source of their power. The Constitution may restrict state governments—as it does, for example, by forbidding them to deny any person the equal protection of the laws. But where such prohibitions do not apply, state governments do not need constitutional authorization to act. The states thus can and do perform many of the vital functions of modern government—punishing street crime, running public schools, and zoning property for development, to name but a few. Our cases refer to this general power, possessed by the states but not by the federal government, as the police power. This case concerns . . . powers that the Constitution does grant the federal government, but which must be read carefully to avoid creating a general federal authority akin to the police power. The Constitution authorizes Congress to “regulate Commerce with foreign Nations, and among the several States, and with the Indian Tribes.” Art. I, § 8, cl. 3. Congress may also “lay and collect Taxes, Duties, Imposts and Excises, to pay the Debts and provide for the common Defence and general Welfare of the United States.” Art. I, § 8, cl. 1. Put simply, Congress may tax and spend. This grant gives the federal government considerable influence even in areas where it cannot directly regulate. The federal government may enact a tax on an activity that it cannot authorize, forbid, or otherwise control. And in exercising its spending power, Congress may offer funds to the states, and may condition those offers on compliance with specified conditions. These offers may well induce the states to adopt policies that the federal government itself could not impose. The reach of the federal government’s enumerated powers is broader still because the Constitution authorizes Congress to “make all Laws which shall be necessary and proper for carrying into Execution the foregoing Powers.” Art. I, § 8, cl. 18. We have long read this provision to give Congress great latitude

in exercising its powers. Our respect for Congress’s policy judgments [, however,] can never extend so far as to disavow restraints on federal power that the Constitution carefully constructed.  The Individual Mandate and the Taxing Power The government advances two theories for the proposition that Congress had constitutional authority to enact the ACA’s individual mandate. First, the government argues that Congress had the power to enact the mandate under the Commerce Clause. [Alternatively], the government argues that if the commerce power does not support the mandate, we should nonetheless uphold it as an exercise of Congress’s power to tax. [Authors’ note: As explained earlier, the government failed to succeed with its Commerce Clause argument. For discussion of the Court’s Commerce Clause analysis, see Figure 3.1.] Because the Commerce Clause does not support the individual mandate, it is necessary to turn to the government’s second argument: that the mandate may be upheld as within Congress’s enumerated power to “lay and collect Taxes.” Under the mandate, if an individual does not maintain health insurance, the only consequence is that he must make an additional payment to the IRS when he pays his taxes. That, according to the government, means the mandate can be regarded as establishing a condition—not owning health insurance—that triggers a tax—the required payment to the IRS. Under that theory, the mandate is not a legal command to buy insurance. Rather, it makes going without insurance just another thing the government taxes, like buying gasoline or earning income. And if the mandate is in effect just a tax hike on . . . taxpayers who do not have health insurance, it may be within Congress’s constitutional power to tax. Granting the ACA the full measure of deference owed to federal statutes, it can be so read. The exaction the Affordable Care Act imposes on those without health insurance looks like a tax in many respects. The “[s]hared responsibility payment,” as the statute entitles it, is paid into the Treasury by “taxpayer[s]” when they file their tax returns. It does not apply to individuals who do not pay federal income taxes because their household income is less than the filing threshold in the Internal Revenue Code. For taxpayers who do owe the payment, its amount is determined by such familiar factors as taxable income, number of dependents, and joint filing status. The requirement to pay is found in the Internal Revenue Code and enforced by the IRS, which . . . must assess and collect it “in the same manner as taxes.” This process yields the essential feature of any tax: it produces at least some revenue for



Chapter Three Business and the Constitution

the government. Indeed, the payment is expected to raise about $4 billion per year by 2017. It is of course true that the Act describes the payment as a “penalty,” not a “tax.” But . . . that label . . . does not determine whether the payment may be viewed as an exercise of Congress’s taxing power. [We have decided cases in which something labeled as a “penalty” was nevertheless a tax, and other cases in which something labeled a “tax” was nevertheless a penalty.] The [use of a functional analysis that is not tied to labels] suggests that the shared responsibility payment may for constitutional purposes be considered a tax, not a penalty. First, for most Americans the amount due will be far less than the price of insurance, and, by statute, it can never be more. In 2016, for example, individuals making $35,000 a year are expected to owe the IRS about $60 for any month in which they do not have health insurance. Someone with an annual income of $100,000 a year would likely owe about $200. The price of a qualifying insurance policy is projected to be around $400 per month. It may often be a reasonable financial decision to make the payment rather than purchase insurance, unlike [a situation in which there would be a large] financial punishment. Second, the individual mandate contains no . . . requirement [of knowing wrongdoing or other corrupt intent]. Third, the payment is collected solely by the IRS through the normal means of taxation—except that the IRS is not allowed to use those means most suggestive of a punitive sanction, such as criminal prosecution. The [types of] reasons the Court [has used in previous cases for concluding that] what was called a “tax” . . . was a penalty support the conclusion that what is called a “penalty” here may be viewed as a tax. None of this is to say that the payment is not intended to affect individual conduct. Although the payment will raise considerable revenue, it is plainly designed to expand health insurance coverage. But taxes that seek to influence conduct are nothing new. Some of our earliest federal taxes sought to deter the purchase of imported manufactured goods in order to foster the growth of domestic industry. Today, federal and state taxes can compose more than half the retail price of cigarettes, not just to raise more money, but to encourage people to quit smoking. And we have upheld such obviously regulatory measures as taxes on selling marijuana and sawed-off shotguns.  Indeed, “[e]very tax is in some measure regulatory. To some extent it interposes an economic impediment to the activity taxed as compared with others not taxed.” [Citation omitted.] That [the challenged ACA provision] seeks to shape decisions about whether to buy health insurance does not mean that it cannot be a valid exercise of the taxing power. Because the Constitution permits such a tax, it is not our role to forbid it, or to pass upon its wisdom or fairness.

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The Medicaid Expansion and the Spending Power The states also contend that the Medicaid expansion exceeds Congress’s authority under [its spending power]. They claim that Congress is coercing the states to adopt the changes it wants by threatening to withhold all of a state’s Medicaid grants, unless the state accepts the new expanded funding and complies with the conditions that come with it. This, they argue, violates the basic principle that the “federal government may not compel the states to enact or administer a federal regulatory program.” New York v. United States, 505 U.S. 144, 188 (1992). There is no doubt that the ACA [calls for] dramatic[] increases [in] state obligations under Medicaid. The current Medicaid program requires states to cover only certain discrete categories of needy individuals—pregnant women, children, needy families, the blind, the elderly, and the disabled. There is no mandatory coverage for most childless adults, and the states typically do not offer any such coverage. The states also enjoy considerable flexibility with respect to the coverage levels for parents of needy families. On average states cover only those unemployed parents who make less than 37 percent of the federal poverty level, and only those employed parents who make less than 63 percent of the poverty line. The Medicaid provisions of the ACA, in contrast, require states to expand their Medicaid programs by 2014 to cover all individuals under the age of 65 with incomes below 133 ­percent of the federal poverty line. The ACA provides that the federal government will pay 100 percent of the costs of covering these newly eligible individuals through 2016. In the following years, the federal payment level gradually decreases, to a minimum of 90 percent. In light of the expansion in coverage mandated by the ACA, the federal government estimates that its Medicaid spending will increase by approximately $100 billion per year. The [Constitution’s] Spending Clause grants Congress the power “to pay the Debts and provide for the . . . general Welfare of the United States.” Art. I, § 8, cl. 1. We have long recognized that Congress may use this power to grant federal funds to the states, and may condition such a grant upon the states’ “taking certain actions that Congress could not require them to take.” [Citation omitted.] Such measures “encourage a state to regulate in a particular way, [and] influenc[e] a state’s policy choices.” [Citation omitted.]  At the same time, our cases have recognized limits on Congress’s power under the Spending Clause to secure state compliance with federal objectives. We have repeatedly characterized . . . Spending Clause legislation as “much in the nature of a contract.” [Citations omitted.] The legitimacy of Congress’s exercise of the spending power “thus rests on whether the State voluntarily and knowingly accepts the terms of the contract.”

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[Citation omitted.] Respecting this limitation is critical to ensuring that Spending Clause legislation does not undermine the status of the states as independent sovereigns in our federal system. That insight has led this Court to strike down federal legislation that commandeers a state’s legislative or administrative apparatus for federal purposes. It has also led us to scrutinize Spending Clause legislation to ensure that Congress is not using financial inducements to exert a “power akin to undue influence.” [Citation omitted.] Congress may use its spending power to create incentives for states to act in accordance with federal policies. But when pressure turns into compulsion, the legislation runs contrary to our system of federalism. Spending Clause programs do not pose this danger when a state has a legitimate choice whether to accept the federal conditions in exchange for federal funds. In such a situation, state officials can fairly be held politically accountable for choosing to accept or refuse the federal offer. But when the state has no choice, the federal government can achieve its objectives without accountability. Congress may attach appropriate conditions to federal taxing and spending programs to preserve its control over the use of federal funds. In the typical case we look to the states to defend their prerogatives by adopting “the simple expedient of not yielding” to federal blandishments when they do not want to embrace the federal policies as their own. [Citation omitted.] The states, however, argue that the Medicaid expansion is far from the typical case. They object that [instead] of simply refusing to grant the new funds to states that will not accept the new conditions, Congress has also threatened to withhold those states’ existing Medicaid funds. The states claim that this threat serves no purpose other than to force unwilling states to sign up for the dramatic expansion in health care coverage effected by the ACA. Given the nature of the threat and the programs at issue here, we must agree. In South Dakota v. Dole, 483 U.S. 203 (1987), we considered a challenge to a federal law that threatened to withhold five percent of a State’s federal highway funds if the State did not raise its drinking age to 21. The Court found that the condition was “directly related to one of the main purposes for which highway funds are expended—safe interstate travel.” [Id.] at 208. At the same time, the condition was not a restriction on how the highway funds—set aside for specific highway improvement and maintenance efforts—were to be used. We accordingly asked whether “the financial inducement offered by Congress” was “so coercive as to pass the point at which pressure turns into compulsion.” Id. at 211. By “financial inducement” the Court meant the threat of losing 5 percent of highway funds; no new money was offered to the states to raise their drinking ages. We found that the inducement was not impermissibly

coercive, because Congress was offering only “relatively mild encouragement to the States.” Id. We observed that “all South Dakota would lose if she adheres to her chosen course as to a suitable minimum drinking age is 5 percent” of her highway funds. Id. In fact, the federal funds at stake constituted less than half of one percent of South Dakota’s budget at the time. In consequence, “we conclude[d] that [the] encouragement to state action [was] a valid use of the spending power.” Id. at 212. Whether to accept the drinking age change “remain[ed] the prerogative of the states not merely in theory but in fact.” Id. at 211–212. In this case, the financial “inducement” Congress has chosen is much more than “relatively mild encouragement”—it is a gun to the head. A state that opts out of the ACA’s expansion in health care coverage . . . stands to lose not merely “a relatively small percentage” of its existing Medicaid funding, but all of it. Medicaid spending accounts for over 20 percent of the average state’s total budget, with federal funds covering 50 to 83 percent of those costs. It is easy to see how the Dole Court could conclude that the threatened loss of less than half of one percent of South Dakota’s budget left that state a “prerogative” to reject Congress’s desired policy, “not merely in theory but in fact.” The threatened loss of over 10 percent of a state’s overall budget, in contrast, is economic dragooning that leaves the states with no real option but to acquiesce in the Medicaid expansion. Nothing in our opinion precludes Congress from offering funds under the ACA to expand the availability of health care, and requiring that states [agreeing to accept] such funds comply with the conditions on their use. What Congress is not free to do is to penalize states that choose not to participate in that new program by taking away their existing Medicaid funding. In light of the Court’s holding, the [federal government] cannot . . . withdraw existing Medicaid funds [from states] for failure to comply with the requirements set out in the [ACA’s Medicaid] expansion. The Court today limits the financial pressure the [federal government] may apply to induce states to accept the terms of the Medicaid expansion. As a practical matter, that means states may now choose to reject the expansion. Some states may indeed decline to participate. Other states, however, may voluntarily sign up, finding the idea of expanding Medicaid coverage attractive, particularly given the level of federal funding the ACA offers at the outset.  Judgment of Eleventh Circuit affirmed insofar as it held that individual mandate exceeded commerce power, reversed insofar as it held that individual mandate was not authorized by taxing power, and reversed insofar as it held that Medicaid expansion was justified under spending power.



Chapter Three Business and the Constitution

Burden on, or Discrimination against, Interstate Commerce LO3-3

Explain the burden-on-commerce doctrine’s role in making certain state government actions unconstitutional.

In addition to empowering Congress to regulate interstate commerce, the Commerce Clause limits the states’ ability to burden or discriminate against such commerce. This limitation is not expressly stated in the Constitution. Instead, it arises by implication from the Commerce Clause and reflects that clause’s original purpose of blocking state protectionism and ensuring free interstate trade. (Because this limitation arises by implication, it is often referred to as the “dormant” Commerce Clause.) The burden-on-commerce limitation and the nondiscrimination principle operate independently of congressional legislation under the commerce power or other federal powers. If appropriate federal regulation is present, the preemption questions discussed in the next section may also arise. Many different state laws can raise burden-on-commerce problems. For example, state regulation of transportation (e.g., limits on train or truck lengths) has been a prolific source of litigation. The same is true of state restrictions on the importation of goods or resources, such as laws forbidding the sale of out-of-state food products unless they meet certain standards. Such restrictions sometimes benefit local economic interests and reflect their political influence. Burden-on-commerce issues also arise if states try to aid their own residents by blocking the export of scarce or valuable products, thus denying out-of-state buyers access to those products. In part because of the variety of state regulations it has had to consider, the Supreme Court has not adhered to one consistent test for determining when such regulations impermissibly burden interstate commerce. In a 1994 case, the Court said that if a state law discriminates against interstate commerce, the strictest scrutiny will be applied in the determination of the law’s constitutionality. Discrimination is express when state laws treat local and interstate commerce unequally on their face. State laws might also discriminate even though on their face, they seem neutral regarding interstate commerce. This occurs when their effect is to burden or hinder such commerce. In one case, for example, the Supreme Court considered a North Carolina statute that required all closed containers of apples sold within the state to bear only the applicable U.S. grade or standard. The State of Washington, the nation’s largest apple producer, had its own inspection and grading system for Washington apples. This system generally was regarded

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as superior to the federal system. The Court struck down the North Carolina statute because it benefited local apple producers by forcing Washington sellers to regrade apples sold in North Carolina (thus raising their costs of doing business) and by undermining the competitive advantage provided by Washington’s superior grading system. On the other hand, state laws that regulate evenhandedly and have only incidental effects on interstate commerce are constitutional if they serve legitimate state interests and their local benefits exceed the burden they place on interstate commerce. There is no sharp line between such regulations and those that are almost always unconstitutional under the tests discussed above. In a 1981 Supreme Court case, a state truck-length limitation that differed from the limitations imposed by neighboring states failed to satisfy the tests for constitutionality. The Court concluded that the measure did not further the state’s legitimate interest in highway safety because the trucks banned by the state generally were as safe as those it allowed. In addition, whatever marginal safety advantage the law provided was outweighed by the numerous problems it posed for interstate trucking companies. Laws may also unconstitutionally burden interstate commerce when they directly regulate that commerce. This can occur, for example, when state price regulations require firms to post the prices at which they will sell within the state and to promise that they will not sell below those prices in other states. Because they affect prices in other states, such regulations directly regulate interstate commerce and usually are unconstitutional.

Independent Checks on the Federal Government and the States Even if a regulation is within Congress’s enumerated powers or a state’s police power, it still is unconstitutional if it collides with one of the Constitution’s independent checks. This section discusses three checks that limit federal and state regulation of the economy: freedom of speech, due process, and equal protection. Before discussing these guarantees, however, we must consider three foundational matters.

Incorporation Describe the incorporation doctrine’s role in making most guarantees of the Bill of Rights operate to protect persons LO3-4 not only against certain federal government actions, but also against certain state and local government actions.

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The Fifth Amendment prevents the federal government from depriving “any person . . . of life, liberty, or property, without due process of law.” The Fourteenth Amendment creates the same prohibition with regard to the states. The literal language of the First Amendment, however, restricts only federal government action. Moreover, the Fourteenth Amendment says that no state shall “deny to any person . . . the equal protection of the laws.” Thus, although the due process guarantees clearly apply to both the federal government and the states, the First Amendment seems to apply only to the federal government and the Equal Protection Clause only to the states. The First Amendment’s free speech guarantee, however, has been included within the “liberty” protected by Fourteenth Amendment due process as a result of Supreme Court decisions. The free speech guarantee, therefore, restricts state governments as well as the federal government. This is an example of the process of incorporation, by which almost all Bill of Rights provisions now apply to the states. The criminal procedure–related provisions in the Fourth, Fifth, and Sixth Amendments (examined in Chapter 5 of this text) are further examples of Bill of Rights protections that the federal government must honor but that state and local governments must respect as well because of the incorporation doctrine. The Fourteenth Amendment’s equal protection guarantee, on the other hand, has been made applicable to federal government action through incorporation of it within the Fifth Amendment’s Due Process Clause.

Government Action People

often talk as if the Constitution protects them against anyone who might threaten their rights. However, most of the Constitution’s individual rights provisions block only the actions of government bodies, federal, state, and local.1 Private behavior that denies individual rights, while perhaps forbidden by statute, is very seldom a constitutional matter. This government action or state action requirement forces courts to distinguish between governmental behavior and private behavior. Judicial approaches to this problem have varied over time. Before World War II, only formal arms of government such as legislatures, administrative agencies, municipalities, courts, prosecutors, and state universities were deemed state actors. After the war, however, the scope of government action increased considerably, with various sorts of traditionally private behavior being subjected to individual rights limitations. The Supreme Court, in Marsh However, the Thirteenth Amendment, which bans slavery and involuntary servitude throughout the United States, does not have a government action requirement. Some state constitutions, moreover, have individual rights provisions that lack a state action requirement. 1

v. Alabama, 326 U.S. 501 (1946), treated a privately owned company town’s restriction of free expression as government action under the public function theory because the town was nearly identical to a regular municipality in most respects. In Shelley v. Kraemer, 334 U.S. 1 (1948), the Court held that when state courts enforced certain white homeowners’ private agreements not to sell their homes to Blacks, there was state action that violated the Equal Protection Clause. Later, in Burton v. Wilmington Parking Authority, 365 U.S. 715 (1961), the Court concluded that racial discrimination by a privately owned restaurant located in a state-owned and state-operated parking garage was unconstitutional state action, in part because the garage and the restaurant were intertwined in a mutually beneficial “symbiotic” relationship. Among the other factors leading courts to find state action during the 1960s and 1970s were extensive government regulation of private activity and government financial aid to a private actor. The Court, however, severely restricted the reach of state action during the 1970s and 1980s. Since then, private behavior generally has not been held to constitute state action unless a regular unit of government is directly responsible for the challenged private behavior because it has coerced or encouraged such behavior. The public function doctrine, moreover, has been limited to situations in which a private entity exercises powers that have traditionally been exclusively reserved to the state; private police protection is a possible example. In addition, government regulation and government funding have become somewhat less important factors in state action determinations.

Means-Ends Tests Explain the differences among the means-ends tests used LO3-5 by courts when the constitutionality of government action is being determined (strict scrutiny, intermediate scrutiny, and rational basis).

Throughout this chapter, you will see tests of constitutionality that may seem strange at first glance. One example is the test for determining whether laws that discriminate on the basis of sex violate equal protection. This test says that to be constitutional, such laws must be substantially related to the achievement of an important government purpose. The Equal Protection Clause does not contain such language. It simply says that “No State shall . . . deny to any person . . . the equal protection of the laws.” What is going on here? The sex discrimination test just stated is a means-ends test developed by the Supreme Court. Such tests are judicially created because no constitutional right is absolute and because judges, therefore, must weigh individual rights against the



Chapter Three Business and the Constitution

social purposes served by laws that restrict those rights. In other words, means-ends tests determine how courts strike the balance between individual rights and the social needs that may justify their suppression. The “ends” component of a means-ends test specifies how significant a social purpose must be in order to justify the restriction of a right. The “means” component states how effectively the challenged law must promote that purpose in order to be constitutional. In the sex discrimination test, for example, the challenged law must serve an “important” government purpose (the significance of the end) and must be “substantially” related to the achievement of that purpose (the effectiveness of the means). Some constitutional rights are deemed more important than others. Accordingly, courts use tougher tests of constitutionality in certain cases and more lenient tests in other situations. Sometimes these tests are lengthy and complicated. Throughout the chapter, therefore, we will simplify by referring to three general kinds of means-ends tests: 1. The rational basis test. This is a very relaxed test of constitutionality that challenged laws usually pass with ease. A typical formulation of the rational basis test might say that government action need only have a reasonable relation to the achievement of a legitimate government purpose to be constitutional. 2. Intermediate scrutiny. This comes in many forms; the sex discrimination test discussed above is an example. 3. Full strict scrutiny. Here, the court might say that the challenged law must be necessary to the fulfillment of a compelling government purpose. (Sometimes a court might choose different phrasing, such as by saying that the challenged law must be narrowly tailored to fulfillment of the government’s compelling purpose. Despite the different phrasing, the test is substantively the same.) Government action that is subjected to this rigorous test of constitutionality is usually struck down.

Business and the First Amendment Describe the differences between noncommercial speech

LO3-6 and commercial speech and the respective levels of the

First Amendment protection they receive.

The First Amendment provides that “Congress shall make no law . . . abridging the freedom of speech.” Despite its absolute language (“no law”), the First Amendment does not prohibit every law that restricts speech. Although the First Amendment’s free speech guarantee is not absolute, government action restricting the content of speech usually receives close scrutiny from the courts. One justification

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for this high level of protection is the “marketplace” rationale, under which the free competition of ideas is seen as the surest means of attaining truth. The marketplace of ideas operates most effectively, according to this rationale, when restrictions on speech are kept to a minimum and all viewpoints can be considered. During recent decades, the First Amendment has been applied to a wide variety of government restrictions on the expression of individuals and organizations, including corporations. This chapter does not attempt a comprehensive discussion of the many applications of the freedom of speech guarantee. Instead, it explores basic First Amendment concepts before turning to an examination of the free speech rights of corporations.  The religion portions of the First Amendment are mostly beyond the scope of this text. Two issues related to business, though, bear mention here. First, in 2017, a company called Hobby Lobby argued that its religious beliefs should exempt it from having to comply with certain Affordable Care Act regulations that it found objectionable—specifically, a rule requiring it to cover the cost of contraceptives for its employees. The Court did not consider the First Amendment implications but instead ruled in Hobby Lobby’s favor on the ground that the company had religious beliefs under a statute called the Religious Freedom Restoration Act. Burwell v. Hobby Lobby Stores, 573 U.S. 682 (2014). Second, in one well-publicized case, a baker in Colorado declined to bake a cake for a same-sex wedding, claiming that it violated his religious beliefs. He argued that the cakes he baked, though for a business, were expressive activity protected by the First Amendment. The U.S. Supreme Court ruled in his favor but not on First Amendment grounds (instead, it found that the state administrative agency had acted improperly when considering his claim). It seems inevitable that the Court will address the First Amendment arguments in some similar case in the future, eventually deciding whether a business has such a right. See Masterpiece Cakeshop, Ltd. v. Colorado Civil Rights Commission, 138 S. Ct. 1719 (2018). Restrictions on Content of Speech For constitutional purposes, there is a fundamental distinction between conduct and speech (or, to use a frequently employed alternative term, expression). Because conduct usually does not receive constitutional protection, the government typically has considerable latitude to regulate it. Speech, on the other hand, enjoys First Amendment protection. The line between unprotected conduct and potentially protected speech may seem distinct, but that is not always the case in actual practice. Consider the cases involving so-called expressive conduct—conduct so inherently expressive that it is treated for First Amendment

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Part One Foundations of American Law

purposes the same as speech uttered verbally or communicated in writing. As the Supreme Court has held, flag-burning is an example of expressive conduct. Most conduct is not considered to be inherently expressive, however, and thus does not receive First Amendment protection. In a recent Supreme Court decision, Expressions Hair Design v. Schneiderman, 137 S. Ct. 1144 (2017), the conductversus-speech issue came to the forefront. A New York statute barred merchants from imposing, on customers who paid by credit card, a surcharge in addition to the price charged to cash-paying customers. Expressions Hair Design (EHD) wished to post notices that announced a price for cash-paying customers and that an added fee would be tacked on for creditcard-paying customers. Because it feared that posting such notices could leave it vulnerable to legal proceedings for alleged violations of the statute, EHD challenged the statute on First Amendment grounds. The State of New York argued that the statute merely regulated price and was therefore a conduct regulation undeserving of the First Amendment. The Supreme Court disagreed, classifying the statute as a speech restriction— and hence potentially a violation of the First Amendment— because it had the effect of prohibiting the communication of the price information that EHD wished to convey. If speech stands to be affected by a law or other government action speech, the next key question is whether the government action restricts the content of speech, as opposed to operating in a content-neutral way by regulating such matters as time, place, or manner of speech. Whereas content-neutral restrictions are evaluated under a looser test for First Amendment purposes, content restrictions strike at the heart of the freedom of speech guarantee and are reviewed with strict scrutiny. An example comes from Reed v. Town of Gilbert, 576 U.S. 155 (2015), which pertained to an Arizona town’s sign code that prohibited the display of outdoor signs without a permit but set forth various exemptions from the prohibition. One exemption was for “Ideological Signs,” another was for “Political Signs,” and another was for “Temporary Directional Signs.” Signs in the first two categories could be much larger than those in the Temporary Directional Signs category, and either had no placement or time-of-display restrictions (Ideological Signs) or could be displayed during a time period of significant length (Political Signs, which could be displayed during an election season). Temporary Directional Signs, however, had to be much smaller. Moreover, they could only be displayed not more than 12 hours before a qualifying event and not more than one hour afterward. A church that was cited for violating the Temporary Directional Signs time restrictions challenged the town code provisions as a violation of the First Amendment. Rejecting the town’s argument that the code’s sign provisions were content-neutral because they

did not single out particular viewpoints for adverse treatment, the Supreme Court emphasized that the provisions still were content restrictions because their application depended completely on the communicative content of the signs. The Court concluded that the code provisions could not withstand strict scrutiny because even if it were assumed that the town possessed compelling interests in aesthetics and public safety, there were content-neutral ways of furthering those objectives (such as by consistently regulating such matters as sign size, materials, lighting, and portability). Therefore, the sign provisions violated the First Amendment. The Court also noted in Reed that viewpointdiscrimination, though not present in the case and not necessary for a content restriction to be identified, is a particularly egregious type of content restriction. Matal v. Tam, which appears later in the chapter, provides an example of viewpoint discrimination and the role it plays in First Amendment analysis. Political and Other Noncommercial Speech Political speech—expression that deals in some fashion with government, government issues or policies, public officials, or political candidates—is often described as being at the “core” of the First Amendment. Various Supreme Court decisions have held, however, that the freedom of speech guarantee applies not only to political speech, but also to noncommercial expression that does not have a political content or flavor. According to these decisions, the First Amendment protects speech of a literary or artistic nature; speech dealing with scientific, economic, educational, and ethical issues; and expression on many other matters of public interest or concern. Government attempts to restrict the content of political or other noncommercial speech normally receive full strict scrutiny when challenged in court. Unless the government is able to meet the exceedingly difficult burden of proving that the speech restriction is necessary to the fulfillment of a compelling government purpose, a First Amendment violation will be found. Because government restrictions on political or other noncommercial speech trigger the full strict scrutiny test, such speech is referred to as carrying “full” First Amendment protection. Do corporations, however, have the same First Amendment rights that individual human beings possess? The Supreme Court has consistently provided a “yes” answer to this question. Therefore, if a corporation engages in political or other noncommercial expression, it is entitled to full First Amendment protection, just as an individual would be if he or she engaged in such speech. In the much-publicized Citizens United case, which follows shortly, the Supreme Court ruled on a First Amendment–based challenge to a federal statute that restricted uses of corporate funds for “electioneering



Chapter Three Business and the Constitution

communications” close to the time of an election and for advertisements amounting to express advocacy for or against a candidate who was seeking office. Treating the funding restrictions as speech restrictions, a five-justice majority of the Court held that they violated the First Amendment because they could not withstand strict scrutiny. Figure 3.2, which follows the case, describes some observed impacts of the Citizens United decision on subsequent election cycles. Although corporate speakers have First Amendment rights, not all speech of a corporation is fully protected. Some corporate speech is classified as commercial speech, a category of expression examined later in the chapter. As

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will be seen, commercial speech receives First Amendment protection but not the full variety extended to political or noncommercial speech. The mere fact, however, that a profit motive underlies speech does not make the speech commercial in nature. Books, movies, television programs, musical works, works of visual art, and newspaper, magazine, and journal articles are normally classified as noncommercial speech—and are thus fully protected—despite the typical existence of an underlying profit motive. Their informational, educational, artistic, or entertainment components are thought to outweigh, for First Amendment purposes, the profit motive.

Citizens United v. Federal Election Commission    558 U.S. 310 (2010) Citizens United, a nonprofit corporation with a $12 million annual budget, receives most of its funds in the form of donations by individuals. A small portion comes from for-profit corporations. In January 2008, Citizens United released a film titled Hillary: The Movie (hereinafter Hillary). It is a 90-minute documentary about then-senator Hillary Clinton, a candidate in the Democratic Party’s 2008 presidential primary elections. Hillary depicts interviews with political commentators and other persons, most of them quite critical of Senator Clinton. Hillary was released in theaters and on DVD, but Citizens United wanted to increase distribution by making it available through video-on-demand. Although video-on-demand services often require viewers to pay a small fee to view a selected program, Citizens United planned to pay for the service and to make Hillary available to viewers free of charge. To promote the film, Citizens United produced two 10-second advertisements and one 30-second ad for airing on broadcast and cable television. Each ad included a pejorative statement about Senator Clinton, followed by the name of the movie and the address of a website for the movie. Before the Bipartisan Campaign Reform Act of 2002 (BCRA), federal law prohibited corporations and unions from using general treasury funds for direct contributions to candidates or as independent expenditures expressly advocating, through any form of media, the election or defeat of a candidate in certain qualified federal elections. 2 U.S.C. § 441b. The BCRA amended § 441b to include any “electioneering communication” as well. The statute defined “electioneering communication” as “any broadcast, cable, or satellite communication” that “refers to a clearly identified candidate for Federal office” and is made within 30 days of a primary election or 60 days of a general election. When combined, the federal law that preexisted the BCRA and the amendments added by the BCRA barred corporations and unions from using their general treasury funds for express advocacy or electioneering communications. However, they were permitted to establish a “separate segregated fund” (known as a political action committee, or PAC) for these purposes. The funds to be received by the PAC were limited to donations from the corporation’s stockholders and employees or from the union’s members. Citizens United wanted to make Hillary available through video-on-demand within 30 days of the 2008 primary elections. It feared, however, that both the film and the ads promoting it would be covered by § 441b’s ban on corporate-funded independent expenditures and could thus subject the corporation to civil and criminal penalties. Citizens United therefore sought declaratory and injunctive relief against the FEC, arguing that § 441b was unconstitutional on its face and as applied to Hillary and that the BCRA’s disclaimer and disclosure requirements were unconstitutional as applied to Hillary and to the three ads for the movie. A federal district court granted the FEC’s motion for summary judgment. The court held that § 441b was constitutional under previous Supreme Court precedents, as were the statute’s disclaimer and disclosure requirements. Citizens United sought review by the Supreme Court (rather than a circuit court of appeals) under a review provision in the challenged law.

Kennedy, Justice Federal law prohibits corporations and unions from using their general treasury funds to make independent expenditures for speech defined as an “electioneering communication” or for speech expressly

advocating the election or defeat of a candidate. 2 U.S.C. § 441b. Limits on electioneering communications were upheld in ­McConnell v. Federal Election Comm’n, 540 U.S. 93 (2003). The holding of McConnell rested to a large extent on an earlier case, Austin v. ­Michigan Chamber of Commerce, 494 U.S. 652 (1990). In this case we are asked to reconsider Austin and, in effect, McConnell.

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Part One Foundations of American Law

The law before us is an outright ban [on speech], backed by criminal sanctions. Section 441b makes it a felony for all corporations—including nonprofit advocacy corporations—either to expressly advocate the election or defeat of candidates or to broadcast electioneering communications within 30 days of a primary election and 60 days of a general election. These prohibitions are classic examples of censorship. Section 441b is a ban on corporate speech notwithstanding the fact that a PAC created by a corporation can still speak. A PAC is a separate association from the corporation. So the PAC exemption from § 441b’s expenditure ban does not allow corporations to speak. Even if a PAC could somehow allow a corporation to speak—and it does not—the option to form PACs does not alleviate the First Amendment problems with § 441b. PACs are burdensome alternatives; they are expensive to administer and subject to extensive regulations. [Also,] PACs must file detailed monthly reports with the FEC. PACs have to comply with these regulations just to speak. This might explain why fewer than 2,000 of the millions of corporations in this country have PACs.  [P]olitical speech must prevail against laws that would suppress it, whether by design or inadvertence. Laws that burden political speech are subject to strict scrutiny, which requires the Government to prove that the restriction furthers a compelling interest and is narrowly tailored to achieve that interest. Premised on mistrust of governmental power, the First Amendment stands against attempts to disfavor certain subjects or viewpoints. Prohibited, too, are restrictions distinguishing among different speakers, allowing speech by some but not others. The Court has recognized [in various cases] that First Amendment protection extends to corporations. [E.g.,] First National Bank of Boston v. Bellotti, 435 U.S. 765 (1978). This protection has been extended by explicit holdings to the context of political speech.  At least since the latter part of the 19th century, the laws of some states and of the United States imposed a ban on corporate direct contributions to candidates. Yet not until 1947 did Congress first prohibit independent expenditures by corporations and labor unions. For almost three decades thereafter, the Court did not reach the question whether restrictions on corporate and union expenditures are constitutional. In Buckley v. Valeo, 424 U.S. 1 (1976), the Court addressed various challenges to the Federal Election Campaign Act of 1971 (FECA), as amended in 1974. [FECA limited direct contributions to candidates, established] an independent expenditure ban . . . that applied to individuals as well as corporations and labor unions, [and included a separate ban on corporate and union independent expenditures.] [Buckley considered only the direct contributions provision and the broader independent expenditure ban that applied to individuals as well as corporations and unions.] Before addressing the constitutionality of [the broader] independent expenditure ban, Buckley first upheld . . . FECA’s limits on direct

contributions to candidates. The Buckley Court recognized a “sufficiently important” governmental interest in “the prevention of corruption and the appearance of corruption.” This followed from the Court’s concern that large contributions could be given “to secure a political quid pro quo.” The Buckley Court explained that the potential for quid pro quo corruption distinguished direct contributions to candidates from independent expenditures. The Court emphasized that “the independent expenditure ceiling . . . fails to serve any substantial governmental interest in stemming the reality or appearance of corruption in the electoral process,” because “[t]he absence of prearrangement and coordination . . . alleviates the danger that expenditures will be given as a quid pro quo for improper commitments from the candidate.” Buckley invalidated [FECA’s broader] restriction on independent expenditures. Buckley did not consider [FECA’s] separate ban [that specifically applied to] corporate and union independent expenditures. Had [that specific ban] been challenged in the wake of Buckley, however, it could not have been squared with the reasoning and analysis of that precedent. [Nevertheless], Congress recodified [the] corporate and union expenditure ban at 2 U.S.C. § 441b four months after Buckley was decided. Section 441b is the independent expenditure restriction challenged here. Less than two years after Buckley, Bellotti reaffirmed the First Amendment principle that the government cannot restrict political speech based on the speaker’s corporate identity. Bellotti could not have been clearer when it struck down a state-law prohibition on corporate independent expenditures related to referenda issues. Bellotti did not address the constitutionality of the state’s ban on corporate independent expenditures to support candidates. In our view, however, that restriction would have been unconstitutional under Bellotti’s central principle: that the First Amendment does not allow political speech restrictions based on a speaker’s corporate identity. Thus the law stood until Austin, [which] “uph[eld] a direct restriction on the independent expenditure of funds for political speech for the first time in [this Court’s] history.” (Kennedy, J., dissenting in Austin.) [In Austin], the Michigan Chamber of Commerce sought to use general treasury funds to run a newspaper ad supporting a specific candidate. Michigan law, however, prohibited corporate independent expenditures that supported or opposed any candidate for state office. The Austin Court sustained the speech prohibition. To bypass Buckley and Bellotti, the Court identified a new governmental interest in limiting political speech: an anti-distortion interest. Austin found a compelling governmental interest in preventing “the corrosive and distorting effects of immense aggregations of wealth that are accumulated with the help of the corporate form and that have little or no correlation to the public’s support for the corporation’s political ideas.” The Court is thus confronted with conflicting lines of precedent: a pre-Austin line that forbids restrictions on political speech



Chapter Three Business and the Constitution

based on the speaker’s corporate identity and a post-Austin line that permits them. No case before Austin had held that Congress could prohibit independent expenditures for political speech based on the speaker’s corporate identity. In its defense of the corporate-speech restrictions in § 441b, the government notes the anti-distortion rationale on which Austin and its progeny rest in part, yet . . . the government does little to defend it. And with good reason, for the rationale cannot support § 441b. If the First Amendment has any force, it prohibits Congress from fining or jailing citizens, or associations of citizens, for simply engaging in political speech. If the anti-distortion rationale were to be accepted, however, it would permit government to ban political speech simply because the speaker is an association that has taken on the corporate form.   If Austin were correct, the government could prohibit a corporation from expressing political views in media beyond those presented here, such as by printing books. The government responds “that the FEC has never applied this statute to a book,” and if it did, “there would be quite [a] good as-applied [constitutional] challenge.” This troubling assertion of brooding governmental power cannot be reconciled with the confidence and stability in civic discourse that the First Amendment must secure. [As noted in Bellotti,] [p]olitical speech is “indispensable to decisionmaking in a democracy, and this is no less true because the speech comes from a corporation rather than an individual.” This protection for speech is inconsistent with Austin’s anti-distortion rationale. Austin sought to defend the anti-distortion rationale as a means to prevent corporations from obtaining “an unfair advantage in the political marketplace” by using “resources amassed in the economic marketplace.” But Buckley rejected the premise that the government has an interest “in equalizing the relative ability of individuals and groups to influence the outcome of elections.” Buckley was specific in stating that “the skyrocketing cost of political campaigns” could not sustain the governmental prohibition. The censorship we now confront is vast in its reach. The government has “muffle[d] the voices that best represent the most significant segments of the economy” (opinion of Scalia, J., in McConnell).  The purpose and effect of this law is to prevent corporations, including small and nonprofit corporations, from presenting both facts and opinions to the public. This makes Austin’s anti-distortion rationale all the more an aberration. When government seeks to use its full power, including the criminal law, to command where a person may get his or her information or what distrusted source he or she may not hear, it uses censorship to control thought. This is unlawful. The First Amendment confirms the freedom to think for ourselves. What we have said also shows the invalidity of [another argument] made by the government. For the most part relinquishing the anti-distortion rationale, the government falls back on the argument that corporate political speech can be banned in order to prevent

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corruption or its appearance. The Buckley Court . . . sustained limits on direct contributions in order to ensure against the reality or appearance of corruption. That case did not extend this rationale to independent expenditures, and the Court does not do so here. [The Court stated in Buckley that] “[t]he absence of prearrangement and coordination of an expenditure with the candidate or his agent not only undermines the value of the expenditure to the candidate, but also alleviates the danger that expenditures will be given as a quid pro quo for improper commitments from the candidate.” Limits on independent expenditures, such as § 441b, have a chilling effect extending well beyond the government’s interest in preventing quid pro quo corruption. The anti-corruption interest is not sufficient to displace the speech here in question. For the reasons above, it must be concluded that Austin was not well reasoned. Austin is [also] undermined by experience since its announcement. Political speech is so ingrained in our culture that speakers find ways to circumvent campaign finance laws. Our nation’s speech dynamic is changing, and informative voices should not have to circumvent onerous restrictions to exercise their First Amendment rights.  Rapid changes in technology—and the creative dynamic inherent in the concept of free expression—counsel against upholding a law that restricts political speech in certain media or by certain speakers. Today, 30-second television ads may be the most effective way to convey a political message. Soon, however, it may be that Internet sources, such as blogs and social networking websites, will provide citizens with significant information about political candidates and issues. Yet, § 441b would seem to ban a blog post expressly advocating the election or defeat of a candidate if that blog were created with corporate funds. The First Amendment does not permit Congress to make these categorical distinctions based on the corporate identity of the speaker and the content of the political speech. Due consideration leads to this conclusion: Austin should be and now is overruled. We return to the principle established in Buckley and Bellotti that the government may not suppress political speech on the basis of the speaker’s corporate identity. No sufficient governmental interest justifies limits on the political speech of nonprofit or for-profit corporations. Austin is overruled, so it provides no basis for allowing the government to limit corporate independent expenditures. As the government appears to concede [in its brief], overruling Austin “effectively invalidate[s] not only [the BCRA’s amendments to § 441(b)] but also § 441b’s prohibition on the use of corporate treasury funds for express advocacy.” Section 441b’s restrictions on corporate independent expenditures are therefore invalid and cannot be applied to Hillary. Given our conclusion, we are further required to overrule the part of McConnell that upheld [the BCRA’s] extension of § 441b’s restrictions on corporate independent expenditures. 

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Part One Foundations of American Law

District court’s judgment reversed as to constitutionality of restrictions on corporate independent expenditures. Stevens, Justice (joined by Ginsburg, Breyer, and Sotomayor, Justices), concurring in part and dissenting in part Although I concur in the Court’s decision to sustain the BCRA’s disclaimer and disclosure provisions, I emphatically dissent from its principal holding. Citizens United is a wealthy nonprofit corporation that runs a PAC with millions of dollars in assets. Under the BCRA, it could have used those assets to televise and promote Hillary wherever and whenever it wanted to. It also could have spent unrestricted sums to broadcast Hillary at any time other than the 30 days before the last primary election. Neither Citizens United’s nor any other corporation’s speech has been “banned.” All that the parties dispute is whether Citizens United had a right to use the funds in its general treasury to pay for broadcasts during the 30-day period. The notion that the First Amendment dictates an affirmative answer to that question is, in my judgment, profoundly misguided. The Court today rejects a century of history when it treats the distinction between corporate and individual campaign spending as an invidious novelty born of Austin. Relying largely on individual dissenting opinions, the majority blazes through our precedents, overruling or disavowing a [large] body of case law. The only thing preventing the majority from affirming the district court, or adopting a narrower ground that would retain Austin, is its disdain for

Austin. The laws upheld in Austin and McConnell leave open many additional avenues for corporations’ political speech. Roaming far afield from the case at hand, the majority worries that the government will use [the statute at issue] to ban books, pamphlets, and blogs. Yet by its plain terms, [the statute] does not apply to printed material. And . . . we highly doubt that [§ 441b] could be interpreted to apply to a website or book that happens to be transmitted at some stage over airwaves or cable lines, or that the FEC would ever try to do so. So let us be clear: Neither Austin nor McConnell held or implied that corporations may be silenced; the FEC is not a “censor”; and in the years since these cases were decided, corporations have continued to play a major role in the national dialogue. Laws such as [§ 441b] target a class of communications that is especially likely to corrupt the political process. Such laws burden political speech, and that is always a serious matter, demanding careful scrutiny. But the majority’s incessant talk of a “ban” aims at a straw man. In [our] democratic society, the longstanding consensus on the need to limit corporate campaign spending [reflects] the common sense of the American people, who have . . . fought against the distinctive corrupting potential of corporate electioneering since the days of Theodore Roosevelt. It is a strange time to repudiate that common sense. While American democracy is imperfect, few outside the majority of this Court would have thought its flaws included a dearth of corporate money in politics.

Figure 3.2 A Note on Post–Citizens United Developments After Citizens United, not-for-profit and for-profit corporations were free to spend unlimited sums from their general treasury funds for express advocacy purposes or for other electioneering communications regarding candidates for federal election, as long as the spending took place independently from the campaigns of favored candidates. Corporations could fund such advertisements directly, without being bound by the invalidated requirement of using a PAC to which only employees and shareholders could contribute. Further, they could engage in such independent expenditures by providing unlimited funds to so-called Super PACs—organizations that were not formally affiliated with candidates for office but accepted money from any individual or organization for the purpose of producing advertisements favoring or disfavoring candidates. In the run-up to the 2012 elections, some corporations donated significant amounts to Super PACs and other not-for-profit organizations in order to help fund such advertisements. So did many individual persons. This tendency became especially pronounced after a federal court of appeals reasoned that given the conclusions drawn in Citizens United and the Supreme Court’s long-standing position that the First Amendment rights of individuals and corporations are coextensive, individuals should be free to engage in unlimited spending for express advocacy purposes. In the 2012 elections, certain very wealthy individuals proved to be even bigger spenders in this regard than corporate entities were. The total dollars spent in connection with the 2012 elections easily surpassed the spending levels in previous elections. Similar patterns could be observed in the 2014 and 2016 elections.



Chapter Three Business and the Constitution

Commercial Speech The exact boundaries of the commercial speech category are not certain, though the Supreme Court has usually defined commercial speech as speech that proposes a commercial transaction. As a result, most cases on the subject involve advertisements for the sale of products or services or for the promotion of a business. In 1942, the Supreme Court held that commercial speech fell outside the First Amendment’s protective umbrella. The Court reversed its position, however, during the 1970s. It reasoned that informed consumer choice would be furthered by the removal of barriers to the flow of commercial information in which consumers would find an interest. Since the mid-1970s, commercial speech has received an intermediate level of First Amendment protection if it deals with a lawful activity and is nonmisleading. Commercial speech receives no protection, however, if it misleads or seeks to promote an illegal activity. As a result, there is no First Amendment obstacle to federal or state regulation of deceptive commercial advertising. (Political or other noncommercial speech, on the other hand, generally receives—with very few exceptions—full First Amendment protection even if it misleads or deals with unlawful matters.) Because nonmisleading commercial speech about a lawful activity receives intermediate protection, the government has greater ability to regulate such speech without violating the First Amendment than when the government seeks to regulate fully protected political or other noncommercial speech. Nearly four decades ago, the Supreme Court developed a still-controlling test that amounts to intermediate scrutiny. Under this test, a government restriction on protected commercial speech does not violate the First Amendment if the government proves each of these elements: that a substantial government interest underlies the restriction, that the restriction directly advances the underlying interest, and that the restriction is no more extensive than necessary to further the interest (i.e., that the restriction is narrowly tailored). It usually is not difficult for the government to prove that a substantial interest supports the commercial speech restriction. Almost any asserted interest connected with the promotion of public health, safety, or welfare will suffice. The government is likely to encounter more difficulty, however, in proving that the restriction at issue directly advances the underlying interest without being more extensive than necessary—the elements that address the “fit” between the restriction and the underlying interest. If the government fails to prove any element of the test, the restriction violates the First Amendment. Although the same test has been used in evaluating commercial speech restrictions for nearly four decades, the Supreme Court has varied the intensity with which

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it has applied the test. From the mid-1980s until 1995, the Court sometimes applied the test loosely and in a manner favorable to the government. The Court has applied the test—especially the “fit” elements—more strictly since 1995, however. For instance, in Coors v. Rubin, 514 U.S. 476 (1995), the Court struck down federal restrictions that kept beer producers from listing the alcohol content of their beer on product labels. (The Coors case was the subject of the introductory problem that began this chapter.) In 44 Liquormart v. Rhode Island, 517 U.S. 484 (1996), the Court held that Rhode Island’s prohibition on price disclosures in alcoholic beverage advertisements violated the First Amendment. A 1999 decision, Greater New Orleans Broadcasting Association v. United States, 527 U.S. 173 (1999), established that a federal law barring broadcast advertisements for a variety of gambling activities could not constitutionally be applied to radio and television stations located in the same state as the gambling casino whose lawful activities were being advertised. Sorrell v. IMS Health, Inc., 564 U.S. 552 (2011), involved a challenge to a Vermont law that barred pharmacies from releasing data about physicians’ prescribing practices and tendencies if the release would be to parties wishing to use the information for marketing purposes. The law, however, allowed pharmacies to disclose such information if it would be used for various other purposes. Continuing to display its inclination to afford significant protection to commercial speech, the Court held that in singling out marketing-related uses for adverse treatment while otherwise allowing the disclosure of the information, the statute violated the First Amendment. In its commercial speech decisions during the past twoplus decades, the Court has tended to emphasize that the government restrictions at issue suffered from a “fit” problem. Sometimes the defective fit consisted of too tenuous a relationship between the restriction and the government interest underlying it. More frequently the restriction prohibited more speech than was necessary because the government failed to adopt alternative measures that would have furthered the underlying public health, safety, or welfare interest just as well, if not better. Two key conclusions may be drawn from the Court’s commercial speech decisions since 1995: (1) the government has found it more difficult to justify restrictions on commercial speech and (2) the gap between the intermediate protection for commercial speech and the full protection for political and other noncommercial speech has effectively become smaller than it was roughly 25 years ago. Although the Court has hinted that it might consider formal changes in the commercial speech doctrine (so as

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Part One Foundations of American Law

CONCEPT REVIEW The First Amendment

Type of Speech

Level of First Amendment Consequences When Government Regulates  Protection Content of Speech

Noncommercial

Full

Government action is constitutional only if action is necessary to fulfillment of compelling government purpose. Otherwise, government action violates First Amendment.

Commercial (nonmisleading and about lawful activity)

Intermediate

Government action is constitutional if government has substantial underlying interest, action directly advances that interest, and action is no more extensive than necessary to fulfillment of that interest (i.e., action is narrowly tailored).

Commercial (misleading or about unlawful activity)

None

Government action is constitutional.

to enhance First Amendment protection for commercial speech), it had not made formal doctrinal changes as of the time this book went to press. Matal v. Tam, which appears later in the chapter, addresses the four-part test utilized in determining the constitutionality of commercial speech restrictions, and illustrates the rigor with which the Supreme Court has applied the third and fourth parts of the test in recent years. The Government Speech Doctrine Previous discussion has revealed that when the government restricts the content of private parties’ speech, a First Amendment violation is likely to have occurred. But when the government itself speaks, it is free to convey its preferred viewpoints and to reject contrary views that private parties wish to express. Such is the premise of the recently developed, and still not precisely defined, government speech doctrine. Whether government speech is present depends largely upon the extent to which the government crafted the conveyed messages or supervised, through heavy involvement, the communication of the messages. In Johanns v. Livestock Marketing Association, 544 U.S. 550 (2005), for instance, the Supreme Court upheld a federal statute that set up a program of paid advertisements designed to promote the image and sale of beef products. The Court emphasized that the U.S. Department of Agriculture designed the program, established its contours, and exercised close supervisory authority over the messages that were communicated in the advertisements. Therefore, the

Court, reasoned, the government speech doctrine applied and shielded the program against a First Amendment– based challenge by an association that did not want to participate in the government-created program. More recently, in Walker v. Texas Division, Sons of Confederate Veterans, Inc., 576 U.S. 200 (2015), the Supreme Court held that the First Amendment was not violated—and that the government speech doctrine applied—when the State of Texas rejected a group’s request for a specialty license plate consisting of an image of the Confederate battle flag. In deciding that the government speech doctrine applied, the Court stressed the government’s historic use of license plates to convey messages and the supervisory control maintained by the government in running the specialty license plate program. Figure 3.3, which appears later in the chapter, explores recent requirements to include graphic warnings on tobacco products. In Matal v. Tam, which follows, the Supreme Court struck down, on First Amendment grounds, a provision in federal law that allowed the government to refuse to register a trademark that is disparaging to individuals or groups. (Trademark registration is addressed in Chapter 8. Discussion of Tam also appears there.) In so ruling, the Court rejected the government’s attempt to invoke the government speech doctrine and reminded readers that the First Amendment protects a great deal of speech that is offensive in nature. Tam also explores an issue noted earlier in the chapter: the problematic nature, for First Amendment purposes, of laws that discriminate among speakers on the basis of the viewpoints they express.



Chapter Three Business and the Constitution

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Matal v. Tam   137 S. Ct. 1744 (2017) Simon Tam is the lead singer of a musical group known as “The Slants.” Members of the band are Asian Americans. Although “Slants” has been used as a derogatory term for persons of Asian descent, Tam and the other band members believe that by taking the term as the name of their group, they will help to “reclaim” the term and drain its denigrating force. Tam sought to have THE SLANTS registered as a trademark on the federal principal register. An examining attorney at the U.S. Patent and Trademark Office (PTO) denied Tam’s application, invoking a Lanham Act provision (referred to here as the disparagement clause). That provision bars the registration of trademarks that may “disparage . . . or bring . . . into contemp[t] or disrepute” any “persons, living or dead.” In the examining attorney’s judgment, THE SLANTS was disparaging with regard to persons of Asian descent. Tam unsuccessfully appealed the examining attorney’s denial of registration to the PTO’s Trademark Trial and Appeal Board. He then appealed to the U.S. Court of Appeals for the Federal Circuit, which held the disparagement clause unconstitutional under the First Amendment. The PTO filed a petition for certiorari, which the U.S. Supreme Court granted in order to decide whether the disparagement clause violates the First Amendment. Alito, Justice “The principle underlying trademark protection is that distinctive marks—words, names, symbols, and the like—can help distinguish a particular artisan’s goods from those of others.” B&B Hardware, Inc. v. Hargis Industries, Inc., 135 S. Ct. 1293 (2015). A trademark . . . helps consumers identify goods and services that they wish to purchase, as well as those they want to avoid. Trademarks . . . were protected at common law and in equity at the time of the founding of our country. Eventually, Congress stepped in to provide a degree of national uniformity [through] the Lanham Act, enacted in 1946. By that time, trademark had expanded far beyond phrases that do no more than identify a good or service. Then, as now, trademarks often consisted of catchy phrases that convey a message. Under the Lanham Act, trademarks that are used in commerce may be placed on the [federal] principal register. This system of federal registration helps to ensure that trademarks are fully protected and supports the free flow of commerce. Without federal registration, a valid trademark may still be used in commerce [and] can be enforced against would-be infringers. Federal registration, however, confers important legal rights and benefits on trademark owners who register their marks. [Authors’ note: Those rights and benefits are summarized in Chapter 8 of the text and will not be discussed here.] The Lanham Act contains provisions that bar certain trademarks from the principal register. At issue in this case is one such provision, which we will call “the disparagement clause.” This provision prohibits the registration of a trademark “which may disparage . . . persons, living or dead, institutions, beliefs, or national symbols, or bring them into contempt, or disrepute.”  When deciding whether a trademark is disparaging, an examiner at the PTO generally applies a two-part test [set forth in the Trademark Manual of Examining Procedure]. The examiner first considers “the likely meaning of the matter in question, taking into account not only dictionary definitions, but

also . . . the manner in which the mark is used in the marketplace in connection with the goods or services.” If that meaning refers to “identifiable persons, institutions, beliefs or national symbols,” the examiner moves to the second step, asking “whether that meaning may be disparaging to a substantial [component] of the referenced group.”  If the examiner finds that a “substantial [component], although not necessarily a majority, of the referenced group would find the proposed mark . . . to be disparaging in the context of contemporary attitudes,” a prima facie case of disparagement is made out, and the burden shifts to the applicant to prove that the trademark is not disparaging. What is more, the PTO has specified that “[t]he fact that an applicant may be a member of that group or has good intentions underlying its use of a term does not obviate the fact that a substantial composite of the referenced group would find the term objectionable.” [The examiner in this case applied the two-part test in concluding that THE SLANTS was a disparaging term.] [W]e must decide whether the disparagement clause violates the Free Speech Clause of the  First Amendment. And at the outset, we must consider [an argument] that would eliminate any  First Amendment  protection. Specifically,  the Government contends that trademarks are government speech, not private speech. The First Amendment prohibits Congress and other government entities and actors from “abridging the freedom of speech”; the First Amendment does not say that Congress and other government entities must abridge their own ability to speak freely. And our cases recognize that “[t]he Free Speech Clause . . . does not regulate government speech.” Pleasant Grove City v. Summum, 555 U.S. 460, 467 (2009). See Johanns v. Livestock Marketing Association, 544 U.S. 550, 553 (2005) (“[T]he Government’s own speech . . . is exempt from First Amendment scrutiny”). As we have said, “it is not easy to imagine how government could function” if it were subject to the restrictions that the First

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Part One Foundations of American Law

Amendment  imposes on private speech.  Summum,  555 U.S. at 468. See Walker  v.  Texas Division, Sons of Confederate Veterans, Inc., 135 S. Ct. 2239 (2015). [Although] “the  First Amendment  forbids the government to regulate speech in ways that favor some viewpoints or ideas at the expense of others,” [citation omitted,] . . . imposing a requirement of viewpoint-neutrality on government speech would be paralyzing. When a government entity embarks on a course of action, it necessarily takes a particular viewpoint and rejects others. The Free Speech Clause does not require government  to maintain viewpoint neutrality when its officers and employees speak about that venture. Here is a simple example. During the Second World War, the Federal Government produced and distributed millions of posters to promote the war effort. There were posters urging enlistment, the purchase of war bonds, and the conservation of scarce resources.  These posters expressed a viewpoint, but the  First Amendment did not demand that the Government balance the message of these posters by producing and distributing posters encouraging Americans to refrain from engaging in these activities. But while the government-speech doctrine is important— indeed, essential—it is a doctrine that is susceptible to dangerous misuse. If private speech could be passed off as government speech by simply affixing a government seal of approval, government could silence or muffle the expression of disfavored viewpoints. For this reason, we must exercise great caution before extending our government-speech precedents. At issue here is the content of trademarks that are registered by the PTO, an arm of the Federal Government. The Federal Government does not dream up these marks, and it does not edit marks submitted for registration. Except as required by the statute involved here, an examiner may not reject a mark based on the viewpoint that it appears to express. Thus, unless that section is thought to apply, an examiner does not inquire whether any viewpoint conveyed by a mark is consistent with Government policy or whether any such viewpoint is consistent with that expressed by other marks already on the principal register. Instead, if the mark meets the Lanham Act’s viewpoint-neutral requirements, registration is mandatory.  In light of all this, it is far-fetched to suggest that the  content of a registered mark is government speech. If the federal registration of a trademark makes the mark government speech, the Federal Government is babbling prodigiously and incoherently. It is saying many unseemly things. It is expressing contradictory views. (Compare, [for instance, these two registered marks:] “Abolish Abortion” [and] “I Stand With Planned Parenthood.”) It is unashamedly endorsing a vast array of commercial products and services. And it is providing Delphic advice to the consuming public. For example, if trademarks represent government speech, what does the Government have in mind when it advises Americans

to “make.believe” (Sony), “Think different” (Apple), “Just do it” (Nike), or “Have it your way” (Burger King)? Was the Government warning about a coming disaster when it registered the mark “EndTime Ministries”? None of our government speech cases even remotely supports the idea that registered trademarks are government speech. In Johanns, we considered advertisements promoting the sale of beef products. A federal statute called for the creation of a program of paid advertising “to advance the image and desirability of beef and beef products.”  544 U.S. at 561. Congress and the Secretary of Agriculture provided guidelines for the content of the ads, Department of Agriculture officials attended the meetings at which the content of specific ads was discussed, and the Secretary could edit or reject any proposed ad. Noting that “[t]he message set out in the beef promotions [was] from beginning to end the message established by the Federal Government,” we held that the ads were government speech. Id. at 560. The Government’s involvement in the creation of these beef ads bears no resemblance to anything that occurs when a trademark is registered. [Moreover, trademarks] have not traditionally been used to convey a Government message. With the exception of the enforcement of [the statute at issue here], the viewpoint expressed by a mark has not played a role in the decision whether to place it on the principal register. And there is no evidence that the public associates the contents of trademarks  with the Federal Government. This brings us to the case on which the Government relies most heavily,  Walker, which likely marks the outer bounds of the government-speech doctrine. Holding that the messages on Texas specialty license plates are government speech [and that the State of Texas therefore did not violate the First Amendment when it rejected a request for a specialty license consisting of a representation of the Confederate battle flag], the Walker Court cited three factors. First, license plates have long been used by the States to convey state messages. Second, license plates “are often closely identified in the public mind” with the State, since they are manufactured and owned by the State, generally designed by the State, and serve as a form of “government ID.” Third, Texas “maintain[ed] direct control over the messages conveyed on its specialty plates.” As explained above, none of these factors is present in this case. In sum, the federal registration of trademarks is vastly different from the beef ads in Johanns [and] the specialty license plates in Walker. Holding that the registration of a trademark converts the mark into government speech would constitute a huge and dangerous extension of the government-speech doctrine. For if the registration of trademarks constituted government speech, other systems of government registration could easily be characterized in the same way.



Chapter Three Business and the Constitution

Perhaps the most worrisome implication of the Government’s argument concerns the system of copyright registration. If federal registration makes a trademark government speech and thus eliminates all  First Amendment  protection, would the registration of the copyright for a book produce a similar transformation? The Government attempts to distinguish copyright on the ground that it is “the engine of free expression,” Brief for Petitioner (quoting  Eldred  v.  Ashcroft, 537 U.S. 186, 219 (2003)), but as this case illustrates, trademarks often have an expressive content. Companies spend huge amounts to create and ­publicize trademarks that convey a message. It is true that the necessary brevity of trademarks limits what they can say. But powerful messages can sometimes be conveyed in just a few words. Trademarks are private, not government, speech. Having concluded that the disparagement clause cannot be sustained under our government-speech [cases, we note the existence of] a dispute between the parties on the question whether trademarks are commercial speech and are thus subject to the relaxed scrutiny outlined in  Central Hudson Gas & Electric Corp. v. Public Service Commission, 447 U.S. 557 (1980). The Government and  amici  supporting its position argue that all trademarks are commercial speech. They note that the central purposes of trademarks are commercial and that federal law regulates trademarks to promote fair and orderly interstate commerce. Tam and his amici, on the other hand, contend that many, if not all, trademarks have an expressive component. In other words, these trademarks do not simply identify the source of a product or service but go on to say something more, either about the product or service or some broader issue. The trademark in this case illustrates this point. The name “The Slants” not only identifies the band but expresses a view about social issues. We need not resolve this debate between the parties because the disparagement clause cannot withstand even  Central Hudson  review. Under  Central Hudson, a restriction of speech must serve “a substantial interest,” and it must be “narrowly drawn.”  Id. at 564–565. This means, among other things, that “[t]he regulatory technique may extend only as far as the interest it serves.” Id. at 565. The disparagement clause fails this requirement. It is claimed that the disparagement clause serves two interests. The first is phrased in a variety of ways in the briefs. The Government asserts [in its brief] an interest in preventing “underrepresented groups” from being “bombarded with demeaning messages in commercial advertising.” An amicus supporting the Government refers [in its brief] to “encouraging racial tolerance  and protecting the privacy and welfare of individuals.” But no matter how the point is phrased, its unmistakable thrust is this: The Government has an interest in preventing speech

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expressing ideas that offend. And that idea strikes at the heart of the  First Amendment. Speech that demeans on the basis of race, ethnicity, gender, religion, age, disability, or any other similar ground is hateful; but the proudest boast of our free speech jurisprudence is that we protect the freedom to express “the thought that we hate.” United States v. Schwimmer, 279 U.S. 644, 655 (1929) (Holmes, J., dissenting). The second interest asserted is protecting the orderly flow of commerce. Commerce, we are told, is disrupted by trademarks that “involv[e] disparagement of race, gender, ethnicity, national origin, religion, sexual orientation, and similar demographic classification”  [quoting the Federal Circuit’s decision in this case]. Such trademarks are analogized to discriminatory conduct, which has been recognized to have an adverse effect on commerce. A simple answer to this argument is that the disparagement clause is not narrowly drawn to drive out trademarks that support invidious discrimination. The clause reaches any trademark that disparages  any person, group, or institution. It applies to trademarks [such as] the following: “Down with racists,” “Down with sexists,” “Down with homophobes.” It is not an anti-discrimination clause; it is a happy-talk clause. In this way, it goes much further than is necessary to serve the interest asserted. There is also a deeper problem with the argument that commercial speech may be cleansed of any expression likely to cause offense. The commercial market is well stocked with merchandise that disparages prominent figures and groups, and the line between commercial and non-commercial speech is not always clear, as this case illustrates. If affixing the commercial label permits the suppression of any speech that may lead to political or social “volatility,” free speech would be endangered. For these reasons, we hold that [regardless of whether trademarks are or are not commercial speech,] the disparagement clause violates the Free Speech Clause of the First Amendment. [The disparagement clause] offends a bedrock  First Amendment principle: Speech may not be banned on the ground that it expresses ideas that offend. Justice Kennedy, with whom Justices Ginsburg, Sotomayor, and Kagan join, concurring in part and concurring in the judgment As the Court is correct to hold, [the disparagement clause] constitutes viewpoint discrimination—a form of speech suppression so potent that it must be subject to rigorous constitutional scrutiny. The Government’s action and the statute on which it is based cannot survive this scrutiny. The Court is correct in its judgment, and I join [most] of its opinion.  This separate writing explains in greater detail why the First Amendment’s protections against viewpoint discrimination apply to the trademark here. It submits further that the viewpoint discrimination rationale renders

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Part One Foundations of American Law

unnecessary any extended treatment of other questions raised by the parties. Those few categories of speech that the government can regulate or punish—for instance, fraud, defamation, or incitement—are well established within our constitutional tradition. Aside from these and a few other narrow exceptions, it is a fundamental principle of the First Amendment that the government may not punish or suppress speech based on disapproval of the ideas or perspectives the speech conveys. A law found to discriminate based on viewpoint is an “egregious form of content discrimination,” which is “presumptively unconstitutional.” [Citation omitted.] At its most basic, the test for viewpoint discrimination is whether . . . the government has singled out a subset of messages for disfavor based on the views expressed. In the instant case, the disparagement clause the Government now seeks to implement and enforce identifies the relevant subject as “persons, living or dead, institutions, beliefs, or national symbols.” Within that category, an applicant may register a positive or benign mark but not a derogatory one. The law thus reflects the Government’s disapproval of a subset of messages it finds offensive. This is the essence of viewpoint discrimination.

The parties dispute whether trademarks are commercial speech. [This] issue may turn on whether certain commercial concerns for the protection of trademarks might, as a general matter, be the basis for regulation. However that issue is resolved, the viewpoint based discrimination at issue here [causes the disparagement clause to violate the First Amendment]. Justice Thomas, concurring in part and concurring in the judgment I join [much of] the opinion of Justice Alito. I also write separately because “I continue to believe that when the government seeks to restrict truthful speech in order to suppress the ideas it conveys, strict scrutiny is appropriate, whether or not the speech in question may be characterized as ‘commercial.’”  Lorillard Tobacco Co. v. Reilly, 533 U.S. 525, 572 (2001) (Thomas, J., concurring in part and concurring in judgment). I nonetheless join . . . Justice Alito’s opinion [insofar as it] concludes that the disparagement clause is unconstitutional even under the less stringent test announced in Central Hudson Gas & Electric Corp. v. Public Service Commission. Judgment of Federal Circuit affirmed.

Figure 3.3 A Note on Tobacco Regulations What about rules that require tobacco companies to print warnings about their products; do those infringe on the companies’ First Amendment rights? Congress has passed and amended several laws regulating the labeling and advertising of tobacco products. In 2009, it passed a law known as the Family Smoking Prevention and Tobacco Control Act (TCA). The TCA requires a federal agency, the Food and Drug Administration (FDA), to issue regulations that require color graphics depicting the health risks of smoking. Here are some examples of the required graphic images the FDA has proposed (see www.fda.gov/tobacco-products/ labeling-and-warning-statements-tobacco-products/cigarette-health-warnings#sample):



Chapter Three Business and the Constitution

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Companies that produce these products have challenged both the FDA’s rules and the TCA. The U.S. Court of Appeals for the D.C. Circuit struck down one set of regulations in 2012, holding that the required images proposed by the FDA violated the First Amendment and that the FDA did not provide substantial evidence that graphic warnings on cigarette advertising would directly advance its interest in reducing smoking rates to a material degree. R.J. Reynolds Tobacco Co. v. Food & Drug Admin., 696 F.3d 1205 (D.C. Cir. 2012). In a separate ruling also in 2012, the U.S. Court of Appeals for the Sixth Circuit upheld the TCA’s graphic warning requirement, finding the provision did not violate the First Amendment and the graphic warning requirement was reasonably related to the government’s interest in preventing consumer deception. Discount Tobacco City & Lottery, Inc. v. United States, 674 F.3d 509 (6th Cir. 2012). Several public health and medical organizations sued in 2016 to force the FDA to issue final regulations on graphic labels, as required by the TCA. The U.S. District Court for the District of Massachusetts ruled in favor of the plaintiffs and ordered the FDA to issue a final rule requiring graphic health warnings by March 15, 2020. American Academy of Pediatrics v. FDA, 2019 WL 1047149 (D. Mass. March 5, 2019). The FDA then issued a new final rule, which at the time of this writing is the subject of litigation. Several tobacco companies filed a lawsuit in the Federal District Court for the Eastern District of Texas against the FDA, seeking to invalidate the graphic health warnings and the requirement under the Tobacco Control Act. The companies argued that the new rule requiring graphic warnings violates the First Amendment, the TCA’s requirement that FDA issue a rule requiring the health warning violates the First Amendment, and the FDA acted arbitrarily and capriciously in drafting and issuing the rule. Philip Morris USA Inc. filed a similar challenge in the U.S. District Court for the District of Columbia. The company alleges that the rule violates the First Amendment rights of tobacco companies by requiring them to “disparage their own products with shocking and inflammatory graphic images.” The complaint seeks declaratory and injunctive relief to prevent implementation of the rule.

Due Process The

Fifth and Fourteenth Amendments require that the federal government and the states observe due process when they deprive a person of life, liberty, or property. Due process has both procedural and substantive meanings. LO3-7

Explain the difference between procedural due process and substantive due process.

Procedural Due Process The traditional conception of due process, called procedural due process, establishes the procedures that government must follow when it takes life, liberty, or property. Although the requirements of procedural due process vary from situation to situation, their core idea is that one is entitled to adequate notice of the government action to be taken against him and to some sort of fair trial or hearing before that action can occur. For purposes of procedural due process claims, liberty includes a very broad and poorly defined range of freedoms. It even includes certain interests in personal reputation. For example, the firing of a government employee may require some kind of due process hearing if it is publicized, the fired

employee’s reputation is sufficiently damaged, and her future employment opportunities are restricted. The Supreme Court has said that procedural due process property is not created by the Constitution but by existing rules and understandings that stem from an independent source such as state law. These rules and understandings must give a person a legitimate claim of entitlement to a benefit, not merely some need, desire, or expectation for it. This definition includes almost all of the usual forms of property, as well as utility service, disability benefits, welfare benefits, and a driver’s license. It also includes the job rights of tenured public employees who can be discharged only for cause, but not the rights of untenured or probationary employees. Substantive Due Process Procedural due process does not challenge rules of substantive law—the rules that set standards of behavior for organized social life. For example, imagine that State X makes adultery a crime and allows people to be convicted of adultery without a trial. Arguments that adultery should not be a crime go to the substance of the statute, whereas objections to the lack of a trial are procedural in nature.

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Part One Foundations of American Law

Sometimes, the due process clauses have been used to attack the substance of government action. For our purposes, the most important example of this substantive due process occurred early in the 20th century, when courts struck down various kinds of social legislation as denying due process. They did so mainly by reading freedom of contract and other economic rights into the liberty and property protected by the Fifth and Fourteenth Amendments, and then interpreting “due process of law” to require that laws denying such rights be subjected to means-ends scrutiny. The best-known example is the Supreme Court’s 1905 decision in Lochner v. New York, 198 U.S. 45 (1905), which struck down a state law setting maximum hours of work for bakery employees because the statute limited freedom of contract and did not directly advance the legitimate state goal of promoting worker health. Since 1937, however, this “economic” form of substantive due process has been largely abandoned by the Supreme Court and has not amounted to a significant check on government regulation of economic matters. Substantive due process attacks on such regulations now trigger only a lenient type of rational basis review and thus have had little chance of success. During the 1970s and 1980s, however, substantive due process became increasingly important as a device for protecting noneconomic rights. The most important examples are the liberty and privacy interests, which consist of several rights that the Supreme Court regards as fundamental and as entitled to significant constitutional protection. The Court has declared that these include the rights to marry, have children and direct their education and upbringing, enjoy marital privacy, use contraception, and,

within certain limits, elect to have an abortion. Laws restricting these rights must be narrowly tailored to meet a compelling government purpose in order to avoid being declared unconstitutional. Obergefell v. Hodges, which appears later in the chapter, illustrates the influence of substantive due process interests.

Equal Protection Identify the instances when an Equal Protection Clause–

LO3-8 based challenge to government action triggers more

rigorous scrutiny than the rational basis test.

The Fourteenth Amendment’s Equal Protection Clause says that “[n]o State shall . . . deny to any person . . . the equal protection of the laws.” Because the equal protection guarantee has been incorporated within Fifth Amendment due process, it also restricts the federal government. The equal protection guarantee potentially applies to all situations in which government classifies or distinguishes people. The law inevitably makes distinctions among people, benefiting or burdening some groups but not others. Equal protection doctrine, as developed by the Supreme Court, sets the standards such distinctions must meet in order to be constitutional. Economic Regulations The basic equal protection standard is the rational basis test described earlier. This is the standard usually applied to social and economic regulations that are challenged as denying equal protection. As the following case illustrates, this lenient test usually does not impede state and federal regulation of social and economic matters.

Fitzgerald v. Racing Association of Central Iowa    539 U.S. 103 (2003) Before 1989, Iowa permitted only one form of gambling: parimutuel betting at racetracks. A 1989 Iowa statute authorized other forms of gambling, including slot machines on riverboats. The 1989 law established that adjusted revenues from riverboat slot machine gambling would be taxed at graduated rates, with a top rate of 20 percent. In 1994, Iowa enacted a law that authorized racetracks to operate slot machines. That law also imposed a graduated tax upon racetrack slot machine adjusted revenues, with a top rate that started at 20 percent and would automatically rise over time to 36 percent. The 1994 enactment left in place the 20 percent tax rate on riverboat slot machine adjusted revenues. Contending that the 1994 legislation’s 20 percent versus 36 percent tax rate difference violated the federal Constitution’s Equal Protection Clause, a group of racetracks and an association of dog owners brought suit against the State of Iowa (through its state treasurer, Michael Fitzgerald). A state district court upheld the statute, but the Iowa Supreme Court reversed. The U.S. Supreme Court granted Iowa’s petition for a writ of certiorari.



Chapter Three Business and the Constitution

Breyer, Justice We here consider whether a difference in state tax rates violates the Fourteenth Amendment’s mandate that “no State shall . . . deny to any person . . . the equal protection of the laws.” The law in question does not distinguish on the basis of, for example, race or gender. It does not distinguish between in-state and out-of-state businesses. Neither does it favor a State’s longtime residents at the expense of residents who have more recently arrived from other States. Rather, the law distinguishes for tax purposes among revenues obtained within the State of Iowa by two enterprises, each of which does business in the State. Where that is so, the law is subject to rational-basis review: The Equal Protection Clause is satisfied so long as there is a plausible policy reason for the classification, the legislative facts on which the classification is apparently based rationally may have been considered to be true by the governmental decisionmaker, and the relationship of the classification to its goal is not so attenuated as to render the distinction arbitrary or irrational. [Case citation omitted.] [We have also held that] rational-basis review “is especially deferential in the context of classifications made by complex tax laws.” [Case citation omitted.] The Iowa Supreme Court found that the 20 percent/36 ­percent tax rate differential failed to meet this standard because, in its view, that difference frustrated what it saw as the law’s basic objective, namely, rescuing the racetracks from economic distress. And no rational person, it believed, could claim the contrary. The Iowa Supreme Court could not deny, however, that the Iowa law, like most laws, might predominately serve one general objective, say, helping the racetracks, while containing subsidiary provisions that seek to achieve other desirable (perhaps even contrary) ends as well, thereby producing a law that balances objectives but still serves the general objective when seen as a whole. After all, if every subsidiary provision in a law designed to help racetracks had to help those racetracks and nothing more, then (since any tax rate hurts the racetracks when compared with a lower rate) there could be no taxation of the racetracks at all. Neither could the Iowa Supreme Court deny that the 1994 legislation, seen as a whole, can rationally be understood to do what that court says it seeks to do, namely, advance the racetracks’ economic interests. Its grant to the racetracks of authority to

Fundamental Rights The rational basis test is the basic equal protection standard. Some classifications, however, receive tougher means-ends scrutiny. According to Supreme Court precedent, laws that discriminate regarding

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operate slot machines should help the racetracks economically to some degree—even if its simultaneous imposition of a tax on slot machine adjusted revenue means that the law provides less help than respondents might like. At least a rational legislator might so believe. And the Constitution grants legislators, not courts, broad authority (within the bounds of rationality) to decide whom they wish to help with their tax laws and how much help those laws ought to provide. “The ‘task of classifying persons for . . . benefits . . . inevitably requires that some persons who have an almost equally strong claim to favored treatment be placed on different sides of the line,’ and the fact the line might have been drawn differently at some points is a matter for legislative, rather than judicial, consideration.” [Case citation omitted.] Once one realizes that not every provision in a law must share a single objective, one has no difficulty finding the necessary rational support for the 20 percent/36 percent differential here at issue. That difference, harmful to the racetracks, is helpful to the riverboats, which, as [those challenging the 1994 statute] concede, were also facing financial peril. These two characterizations are but opposite sides of the same coin. Each reflects a rational way for a legislator to view the matter. And aside from simply aiding the financial position of the riverboats, the legislators may have wanted to encourage the economic development of river communities or to promote riverboat history, say, by providing incentives for riverboats to remain in the State, rather than relocate to other States. Alternatively, they may have wanted to protect the reliance interests of riverboat operators, whose adjusted slot machine revenue had previously been taxed at the 20 percent rate. All these objectives are rational ones, which lower riverboat tax rates could further and which suffice to uphold the different tax rates. We conclude that there is “a plausible policy reason for the classification,” that the legislature “rationally may have . . . considered . . . true” the related justifying “legislative facts,” and that the “relationship of the classification to its goal is not so attenuated as to render the distinction arbitrary or irrational.” [Case citation omitted.] Consequently the State’s differential tax rate does not violate the Federal Equal Protection Clause. Iowa Supreme Court decision reversed, and case remanded for further proceedings.

fundamental rights or suspect classes must undergo more rigorous review. Although the list of rights regarded as fundamental for equal protection purposes is not completely clear,

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Part One Foundations of American Law

it clearly includes the right to marry. As made plain in Obergefell v. Hodges, which follows shortly, this right exists regardless of whether the couple to be married is of opposite genders or of the same gender. The list also includes certain criminal procedure protections as well as the rights to vote and engage in interstate travel. Laws creating unequal enjoyment of these rights receive full strict scrutiny. In 1969, for instance, the Supreme Court struck down the District of Columbia’s one-year residency requirement for receiving welfare benefits because that requirement unequally and impermissibly restricted the right of interstate travel. An equal protection claim involving the fundamental right to vote was addressed in high-profile fashion by the Supreme Court in Bush v. Gore, 531 U.S. 98 (2000). A fivejustice majority in the historic and controversial decision terminated an ongoing vote recount in Florida because, in the majority’s view, Florida law’s “intent of the voter” test was not a sufficiently clear standard for determining whether a ballot not counted in the initial machine count should be counted as valid during the manual recount. The majority was concerned that in the absence of a more specific standard, vote counters taking part in the recount might apply inconsistent standards in determining what the voter supposedly intended, and might thereby value some votes over others. The termination of the Florida recount meant that then-governor Bush won the state of Florida, giving him enough Electoral College votes to win the presidency despite the fact that candidate Gore tallied more popular votes nationally. The four dissenters in Bush v. Gore faulted the majority for focusing on the supposed equal protection violation it identified, when, in the dissenters’

view, the Court ignored a potentially bigger equal protection problem created by termination of the recount: the prospect that large numbers of ballots not counted during the machine count would never be counted, even though they may have been valid votes under Florida’s “intent of the voter” test. In Crawford v. Marion County Election Board, 553 U.S. 181 (2008), the Supreme Court again addressed the fundamental right to vote. This time, the Court was faced with determining whether an Indiana law violated the Equal Protection Clause by requiring that voters produce a government-issued photo ID as a precondition to being allowed to vote. Those who raised the equal protection challenge to the requirement asserted that its burdens would fall disproportionately on low-income and elderly voters, who would be less likely than other persons to have a driver’s license or other photo ID. The Court upheld the Indiana law, ruling that it did not violate the Equal Protection Clause. Six justices agreed that even though voter fraud at the polls had not been a demonstrated problem in Indiana, the photo ID requirement was a generally applicable and not excessively burdensome way of furthering the state’s purposes of preventing voter fraud and preserving voter confidence in the integrity of elections. Since Crawford, lower courts have decided various cases that presented constitutional challenges to voter ID laws enacted in other states. Some such laws have been upheld. In other cases, however, voter ID laws have been struck down if they imposed more onerous ID requirements than the law at issue in Crawford and if the showing of a disproportionate adverse effect on certain groups of voters was especially strong.

Obergefell v. Hodges   576 U.S. 644 (2015) Cases from Michigan, Kentucky, Ohio, and Tennessee—states whose statutes defined marriage as a union between one man and one woman—were consolidated for purposes of the U.S. Supreme Court decision that appears below in edited form. The petitioners before the Supreme Court were 14 same-sex couples and two men whose same-sex partners were deceased. The respondents were state officials responsible for enforcing the laws in question. The petitioners claimed that the respondents violated the Fourteenth Amendment to the U.S. Constitution by denying them the right to marry or by refusing to give full recognition to marriages that were lawfully performed in another state. The petitioners filed their cases in U.S. district courts in their home states. Each district court ruled in their favor. The respondents appealed these decisions to the U.S. Court of Appeals for the Sixth Circuit, which consolidated the cases and reversed the judgments of the district courts. The Sixth Circuit held that a state has no constitutional obligation to license same-sex marriages or to recognize same-sex marriages performed out of state. This ruling conflicted with rulings by other federal courts of appeals on the same set of issues. The petitioners sought certiorari from the U.S. Supreme Court, which granted review regarding two questions. The first was whether the Fourteenth Amendment requires a state to issue a marriage license to two persons of the same sex. The second was whether the Fourteenth Amendment requires a state to recognize a same-sex marriage licensed and performed in a state that does grant that right. (Further facts appear in the following edited version of the Supreme Court’s decision.)



Chapter Three Business and the Constitution

Kennedy, Justice The Constitution promises liberty to all within its reach, a liberty that includes certain specific rights that allow persons . . . to define and express their identity. The petitioners seek to find that liberty by marrying someone of the same sex and having their marriages deemed lawful on the same terms and conditions as marriages between persons of the opposite sex. [T]he annals of human history reveal the transcendent importance of marriage. Marriage is sacred to those who live by their religions and offers unique fulfillment to those who find meaning in the secular realm. There are untold references to the beauty of marriage in religious and philosophical texts spanning time, cultures, and faiths, as well as in art and literature in all their forms. It is fair and necessary to say these references were based on the understanding that marriage is a union between two persons of the opposite sex. That history is the beginning of these cases. The respondents say it should be the end as well. To them, it would demean a timeless institution if the concept and lawful status of marriage were extended to two persons of the same sex. This view long has been held—and continues to be held—in good faith by reasonable and sincere people here and throughout the world. The petitioners acknowledge this history but contend that these cases cannot end there. [They do not seek] to demean the revered idea and reality of marriage. To the contrary, it is the enduring importance of marriage that underlies the petitioners’ contentions. [T]he petitioners seek [the right to marry] because of their respect—and need—for its privileges and responsibilities. And their immutable nature dictates that same-sex marriage is their only real path to this profound commitment. Recounting the circumstances of three of these cases illustrates the urgency of the petitioners’ cause from their perspective. Petitioner James Obergefell, a plaintiff in the Ohio case, met John Arthur over two decades ago. They fell in love and started a life together. In 2011, however, Arthur was diagnosed with amyotrophic lateral sclerosis, or ALS. This debilitating disease is progressive, with no known cure. Two years ago, Obergefell and Arthur decided to commit to one another, resolving to marry before Arthur died. To fulfill their mutual promise, they traveled from Ohio to Maryland, where same-sex marriage was legal, [and were wed there]. Three months later, Arthur died. Ohio law does not permit Obergefell to be listed as the surviving spouse on Arthur’s death certificate. By statute, they must remain strangers even in death, a state-imposed separation Obergefell deems “hurtful for the rest of time.” He brought suit to be shown as the surviving spouse on Arthur’s death certificate. April DeBoer and Jayne Rowse are co-plaintiffs in the case from Michigan. They celebrated a commitment ceremony to honor their permanent relation in 2007. In 2009, DeBoer and Rowse fostered and then adopted a baby boy. Later that same

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year, they welcomed another son into their family. The new baby, born prematurely and abandoned by his biological mother, required around-the-clock care. The next year, a baby girl with special needs joined their family. Michigan, however, permits only opposite-sex married couples or single individuals to adopt, so each child can have only one woman as his or her legal parent. If an emergency were to arise, schools and hospitals may treat the three children as if they had only one parent. And, were tragedy to befall either DeBoer or Rowse, the other would have no legal rights over the children she had not been permitted to adopt. This couple seeks relief from the continuing uncertainty their unmarried status creates in their lives. Army Sergeant Ijpe DeKoe and his partner Thomas Kostura, co-plaintiffs in the Tennessee case, fell in love. In 2011, DeKoe received orders to deploy to Afghanistan. Before leaving, he and Kostura married in New York. When DeKoe returned [from his deployment], the two settled in Tennessee, where DeKoe works for the Army Reserve. Their lawful marriage is stripped from them whenever they reside in Tennessee, returning and disappearing as they travel across state lines. DeKoe . . . endure[s] a substantial burden [as a result]. The ancient origins of marriage confirm its centrality, but [its history] is one of both continuity and change. For example, marriage was once viewed as an arrangement by the couple’s parents based on political, religious, and financial concerns; but by the time of the Nation’s founding, it was understood to be a voluntary contract between a man and a woman. [Another example involves] the centuries-old doctrine of coverture, [under which] a married man and woman were treated by the State as a single, male-dominated legal entity. As women gained legal, political, and property rights, and as society began to understand that women have their own equal dignity, the law of coverture was abandoned. These and other developments in the institution of marriage . . . worked deep transformations in its structure [and] have strengthened, not weakened, the institution of marriage. Indeed, changed understandings of marriage are characteristic of a Nation where new dimensions of freedom become apparent to new generations, often through perspectives that begin in pleas or protests and then are considered in the political sphere and the judicial process. This dynamic can be seen in the Nation’s experiences with the rights of gays and lesbians. Until the mid-20th century, same-sex intimacy long had been condemned as immoral by the State itself in most Western nations, a belief often embodied in the criminal law. For this reason, among others, many  persons did not deem homosexuals to have dignity in their own distinct identity. A truthful declaration by same-sex couples of what was in their hearts had to remain unspoken. Even when a greater awareness of the humanity and integrity of homosexual persons came in the

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Part One Foundations of American Law

period after World War II, the argument that gays and lesbians had a just claim to dignity was in conflict with both law and widespread social conventions. Same-sex intimacy remained a crime in many States. Gays and lesbians were prohibited from most government employment, barred from military service, excluded under immigration laws, targeted by police, and burdened in their rights to associate. For much of the 20th century, moreover, homosexuality was treated as . . . a mental disorder. Only in more recent years have psychiatrists and others recognized that sexual orientation is both a normal expression of human sexuality and immutable. In the late 20th century, following substantial cultural and political developments, same-sex couples began to lead more open and public lives and to establish families. This development was followed by a quite extensive discussion of the issue in both governmental and private sectors and by a shift in public attitudes toward greater tolerance. As a result, questions about the rights of gays and lesbians reached the courts. This Court first gave detailed consideration to the legal status of homosexuals in Bowers v. Hardwick, 478 U.S. 186 (1986). There it upheld the constitutionality of a Georgia law deemed to criminalize certain homosexual acts. Ten years later, in Romer v. Evans, 517 U.S. 620 (1996), the Court invalidated an amendment to Colorado’s Constitution that sought to foreclose any branch or political subdivision of the State from protecting persons against discrimination based on sexual orientation. Then, in 2003, the Court overruled  Bowers, holding that laws making same-sex intimacy a crime “demea[n] the lives of homosexual persons.” Lawrence v. Texas, 539 U.S. 558, 575 (2003). Against this background, the legal question of same-sex marriage arose. In 1993, the Hawaii Supreme Court held Hawaii’s law restricting marriage to opposite-sex couples constituted a classification on the basis of sex and was therefore subject to strict scrutiny under the Hawaii Constitution. Although this decision did not mandate that same-sex marriage be allowed, some States [chose to reaffirm] in their laws that marriage is defined as a union between opposite-sex partners. So too in 1996, Congress passed the Defense of Marriage Act (DOMA), defining marriage for all federal-law purposes as “only a legal union between one man and one woman as husband and wife.”  The new and widespread discussion of the subject led other States to a different conclusion. In 2003, the Supreme Judicial Court of Massachusetts held that the State’s constitution guaranteed same-sex couples the right to marry. After that ruling, some additional States granted marriage rights to same-sex couples, either through judicial or legislative processes. Two terms ago, in  United States  v.  Windsor, 133 S. Ct. 2675 (2013), this Court invalidated DOMA to the extent it barred the federal government from treating same-sex marriages as valid even when they were lawful in the State where they were licensed. DOMA, the Court

held, impermissibly disparaged those same-sex couples “who wanted to affirm their commitment to one another before their children, their family, their friends, and their community.”  Numerous cases about same-sex marriage have reached the United States Courts of Appeals in recent years. With the exception of the opinion here under review and one other, the Courts of Appeals have held that excluding same-sex couples from marriage violates the Constitution. There also have been many thoughtful district court decisions addressing same-sex marriage—and most of them, too, have concluded same-sex couples must be allowed to marry. Under the Due Process Clause of the Fourteenth Amendment, no State shall “deprive any person of life, liberty, or property, without due process of law.” The fundamental liberties protected by this Clause include most of the rights enumerated in the  Bill of Rights. In addition, these liberties extend to certain personal choices central to individual dignity and autonomy, including intimate choices that define personal identity and beliefs. See,  e.g.,  Eisenstadt  v.  Baird, 405 U.S. 438, 453 (1972);  Griswold v. Connecticut, 381 U.S. 479, 484–486 (1965). The identification and protection of fundamental rights is an enduring part of the judicial duty to interpret the Constitution. [I]t requires courts to exercise reasoned judgment in identifying interests of the person so fundamental that the State must accord them its respect. History and tradition guide and discipline this inquiry but do not set its outer boundaries. That method respects our history and learns from it without allowing the past alone to rule the present. The nature of injustice is that we may not always see it in our own times. The generations that wrote and ratified the Bill of Rights and the Fourteenth Amendment did not presume to know the extent of freedom in all of its dimensions, and so they entrusted to future generations a charter protecting the right of all persons to enjoy liberty as we learn its meaning. When new insight reveals discord between the Constitution’s central protections and a received legal stricture, a claim to liberty must be addressed. Applying these established tenets, the Court has long held  that the right to marry is protected by the Constitution. In  Loving  v.  Virginia, 388 U.S. 1, 12 (1967), which invalidated bans on interracial unions, a unanimous Court held that marriage is “one of the vital personal rights essential to the orderly pursuit of happiness by free men.” The Court reaffirmed  that holding in Zablocki v. Redhail, 434 U.S. 374, 384 (1978), which held the right to marry was burdened by a law prohibiting fathers who were behind on child support from marrying. Over time and in other contexts, the Court has reiterated that the right to marry is fundamental under the Due Process Clause. [Citations omitted.] It cannot be denied that this Court’s cases describing the right to marry presumed a relationship involving opposite-sex partners. The Court, like many institutions, has made assumptions defined



Chapter Three Business and the Constitution

by the world and time of which it is a part. This was evident in  Baker  v.  Nelson, 409 U.S. 810, a one-line summary decision issued in 1972, holding the exclusion of same-sex couples from marriage did not present a substantial federal question. Still, there are other, more instructive precedents. In defining the right to marry, [this Court’s] cases have identified essential attributes of that right based in history, tradition, and other constitutional liberties inherent in this intimate bond. See,  e.g.,  Zablocki; Loving; Griswold. And in assessing whether the force and rationale of its cases apply to same-sex couples, the Court must respect the basic reasons why the right to marry has been long protected. This analysis compels the conclusion that same-sex couples may exercise the right to marry. The four principles and traditions to be discussed demonstrate that the reasons marriage is fundamental under the Constitution apply with equal force to same-sex couples. A first premise of the Court’s relevant precedents is that the right to personal choice regarding marriage is inherent in the concept of individual autonomy. This abiding connection between marriage and liberty is why  Loving  invalidated interracial marriage bans under the  Due Process Clause. See  388 U.S. at 12. Like choices concerning contraception, family relationships, procreation, and childrearing, all of which are protected by the Constitution, decisions concerning marriage are among the most intimate that an individual can make. The nature of marriage is that, through its enduring bond, two persons together can find other freedoms, such as expression, intimacy, and spirituality. This is true for all persons, whatever their sexual orientation. See Windsor, 133 S. Ct. 2675. There is dignity in the bond between two men or two women who seek to marry and in their autonomy to make such profound choices. A second principle in this Court’s jurisprudence is that the right to marry is fundamental because it supports a two-person union unlike any other in its importance to the committed individuals. This point was central to Griswold v. Connecticut, which held the Constitution protects the right of married couples to use contraception. 381 U.S. at 485. As this Court held in  Lawrence, same-sex couples have the same right as opposite-sex couples to enjoy intimate association.  But while  Lawrence  confirmed a dimension of freedom that allows individuals to engage in intimate association without criminal liability, it does not follow that freedom stops there. Outlaw to outcast may be a step forward, but it does not achieve the full promise of liberty. A third basis for protecting the right to marry is that it safeguards children and families and thus draws meaning from related rights of childrearing, procreation, and education. The Court has recognized these connections by describing the varied rights as a unified whole: “[T]he right to marry, establish a home and bring

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up children is a central part of the liberty protected by the Due Process Clause.”  Zablocki, 434 U.S. at 384. Under the laws of the several States, some of marriage’s protections for children and families are material. But marriage also confers more profound benefits. By giving recognition and legal structure to their parents’ relationship, marriage allows children “to understand the integrity and closeness of their own family and its concord with other families in their community and in their daily lives.” Windsor, 133 S. Ct. 2675. Marriage also affords the permanency and stability important to children’s best interests. As all parties agree, many same-sex couples provide loving and nurturing homes to their children, whether biological or adopted. And hundreds of thousands of children are presently being raised by such couples. Most States have allowed gays and lesbians to adopt, either as individuals or as couples, and many adopted and foster children have same-sex parents. This provides powerful confirmation from the law itself that gays and lesbians can create loving, supportive families. Excluding same-sex couples from marriage thus conflicts with a central premise of the right to marry. Without the recognition, stability, and predictability marriage offers, their children suffer the stigma of knowing their families are somehow lesser. They also suffer the significant material costs of being raised by unmarried parents, relegated through no fault of their own to a more difficult and uncertain family life. The marriage laws at issue here thus harm and humiliate the children of same-sex couples. That is not to say the right to marry is less meaningful for those who do not or cannot have children. An ability, desire, or promise to procreate is not and has not been a prerequisite for a valid marriage in any State. Fourth and finally, this Court’s cases and the Nation’s traditions make clear that marriage is a keystone of our social order. [J]ust as a couple vows to support each other, so does society pledge to support the couple, offering symbolic recognition and material benefits to protect and nourish the union. [States] have throughout our history made marriage the basis for an expanding list of governmental rights, benefits, and responsibilities. These aspects of marital status include: taxation; inheritance and property rights; rules of intestate succession; spousal privilege in the law of evidence; hospital access; medical decisionmaking authority; adoption rights; the rights and benefits of survivors; birth and death certificates; professional ethics rules; campaign finance restrictions; workers’ compensation benefits; health insurance; and child custody, support, and visitation rules. Valid marriage under state law is also a significant status for over a thousand provisions of federal law. The States have contributed to the fundamental character of the marriage right by placing that institution at the center of so many facets of the legal and social order. There is no difference between same- and opposite-sex couples with respect to this principle. Yet by virtue of their exclusion

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Part One Foundations of American Law

from that institution, same-sex couples are denied the constellation of benefits that the States have linked to marriage. This harm results in more than just material burdens. Same-sex couples are consigned to an instability many opposite-sex couples would deem intolerable in their own lives. As the State itself makes marriage all the more precious by the significance it attaches to it, exclusion from that status has the effect of teaching that gays and lesbians are unequal in important respects. It demeans gays and lesbians for the State to lock them out of a central institution of the Nation’s society. The limitation of marriage to opposite-sex couples may long have seemed natural and just, but its inconsistency with the central meaning of the fundamental right to marry is now manifest. With that knowledge must come the recognition that laws excluding same-sex couples from the marriage right impose stigma and injury of the kind prohibited by our basic charter. Under the Constitution, same-sex couples seek in marriage the same legal treatment as opposite-sex couples, and it would disparage their choices and diminish their personhood to deny them this right. The right of same-sex couples to marry that is part of the liberty promised by the  Fourteenth Amendment  is derived, too, from that Amendment’s guarantee of the equal protection of the laws. The  Due Process Clause  and the  Equal Protection Clause are connected in a profound way, though they set forth independent principles. Rights implicit in liberty and rights secured by equal protection may rest on different precepts and are not always coextensive, yet in some instances each may be instructive as to the meaning and reach of the other. In any particular case one Clause may be thought to capture the essence of the right in a more accurate and comprehensive way, even as the two Clauses may converge in the identification and definition of the right. This interrelation of the two principles furthers our understanding of what freedom is and must become. The Court’s cases touching upon the right to marry reflect this dynamic. In Loving, the Court invalidated a prohibition on interracial marriage under both the Equal Protection Clause and the  Due Process Clause. The Court . . . stated: “There can be no doubt that restricting the freedom to marry solely because of racial classifications violates the central meaning of the  Equal Protection Clause.” 388 U.S. at 12. With this link to equal protection, the Court proceeded to hold that the prohibition offended central precepts of liberty: “To deny this fundamental freedom on so unsupportable a basis as the racial classifications embodied in these statutes, classifications so directly subversive of the principle of equality at the heart of the Fourteenth Amendment, is surely to deprive all the State’s citizens of liberty without due process of law.” Id.  The synergy between the two protections is illustrated further in Zablocki. There the Court invoked the Equal Protection Clause  as its basis for invalidating the challenged law, which

barred fathers who were behind on child-support payments from marrying without judicial approval. The equal protection analysis depended in central part on the Court’s holding that the law burdened a right “of fundamental importance.” 434 U.S. at 383. It was the essential nature of the marriage right that made apparent the law’s incompatibility with requirements of equality. Each concept—liberty and equal protection—leads to a stronger understanding of the other. Other cases confirm this relation between liberty and equality. In M. L. B. v. S. L. J., 519 U.S. 102, 119–24 (1996), the Court invalidated under due process and equal protection principles a statute requiring indigent mothers to pay a fee in order to appeal the termination of their parental rights. In Eisenstadt v. Baird, the Court invoked both principles to invalidate a prohibition on the distribution of contraceptives to unmarried persons but not married persons. See 405 U.S. at 446–54. In Lawrence, the Court acknowledged the interlocking nature of these constitutional safeguards in the context of the legal treatment of gays and lesbians. Although Lawrence elaborated its holding under the Due Process Clause, it acknowledged, and sought to remedy, the continuing inequality that resulted from laws making intimacy in the lives of gays and lesbians a crime against the State. See 539 U.S. at 575. Lawrence therefore drew upon principles of liberty and equality to define and protect the rights of gays and lesbians, holding the State “cannot demean their existence or control their destiny by making their private sexual conduct a crime.” Id. at 578. This dynamic also applies to same-sex marriage. It is now clear that the challenged laws burden the liberty of same-sex couples, and it must be further acknowledged that they abridge central precepts of equality. Here the marriage laws enforced by the respondents are in essence unequal: same-sex couples are denied all the benefits afforded to opposite-sex couples and are barred from exercising a fundamental right. Especially against a long history of disapproval of their relationships, this denial to same-sex couples of the right to marry works a grave and continuing harm. These considerations lead to the conclusion that the right to marry is a fundamental right inherent in the liberty of the person, and under the Due Process and  Equal Protection Clauses of the Fourteenth Amendment couples of the same-sex may not be deprived of that right and that liberty. The Court now holds that same-sex couples may exercise the fundamental right to marry. No longer may this liberty be denied to them. Baker v. Nelson must be and now is overruled, and the State laws challenged by Petitioners in these cases are now held invalid to the extent they exclude same-sex couples from civil marriage on the same terms and conditions as opposite-sex couples. There may be an initial inclination in these cases to proceed with caution—to await further legislation, litigation, and debate. The respondents warn there has been insufficient democratic



Chapter Three Business and the Constitution

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discourse before deciding an issue so basic as the definition of marriage. Yet there has been far more deliberation than this argument acknowledges. There have been referenda, legislative debates, and grassroots  campaigns, as well as countless studies, papers, books, and other popular and scholarly writings. There has been extensive litigation in state and federal courts. Judicial opinions addressing the issue have been informed by the contentions of parties and counsel, which, in turn, reflect the more general, societal discussion of same-sex marriage and its meaning that has occurred over the past decades. As more than 100 amici make clear in their filings, many of the central institutions in American life—state and local governments, the military, large and small businesses, labor unions, religious organizations, law enforcement, civic groups, professional organizations, and universities—have devoted substantial attention to the question. This has led to an enhanced understanding of the issue—an understanding reflected in the arguments now presented for resolution as a matter of constitutional law. Of course, the Constitution contemplates that democracy is the appropriate process for change, so long as that process does not abridge fundamental rights. But . . . when the rights of persons are violated, the Constitution requires redress by the courts, notwithstanding the more general value of democratic decisionmaking. An individual can invoke a right to constitutional protection when he or she is harmed, even if the broader public disagrees and even if the legislature refuses to act. The idea of the Constitution “was to withdraw certain subjects from the vicissitudes of political controversy, to place them beyond the reach of majorities and officials and to establish them as legal principles to be applied by the courts.” West Virginia Bd. of Ed. v. Barnette, 319 U.S. 624, 638 (1943). This is why “fundamental rights may not be submitted to a vote; they depend on the outcome of no elections.” Id.  This is not the first time the Court has been asked to adopt a cautious approach to recognizing and protecting fundamental rights. In  Bowers, a bare majority upheld a law criminalizing same-sex intimacy. See 478 U.S. at 186. That approach might have been viewed as a cautious endorsement of the democratic process, which had only just begun to consider the rights of gays and lesbians. Yet, in effect, Bowers upheld state action that denied gays and lesbians a fundamental right and caused them

pain and humiliation. Although Bowers was eventually repudiated in Lawrence, men and women were harmed in the interim, and the substantial effects of these injuries no doubt lingered long after Bowers was overruled. Dignitary wounds cannot always be healed with the stroke of a pen. A ruling against same-sex couples would have the same effect— and, like  Bowers, would be unjustified under the  Fourteenth Amendment. The petitioners’ stories[, as detailed earlier in this opinion,] make clear the urgency of the issue they present to the Court. These cases also present the question whether the Constitution requires States to recognize same-sex marriages validly performed out of State. As made clear by the case of Obergefell and Arthur, and by that of DeKoe and Kostura, the recognition bans inflict substantial and continuing harm on same-sex couples. Being married in one State but having that valid marriage denied in another is one of “the most perplexing and distressing complication[s]” in the law of domestic relations. [Citation omitted.] Leaving the current state of affairs in place would maintain and promote instability and uncertainty. For some couples, even an ordinary drive into a neighboring State to visit family  or friends risks causing severe hardship in the event of a spouse’s hospitalization while across state lines. In light of the fact that many States already allow same-sex marriage—and hundreds of thousands of these marriages already have occurred—the disruption caused by the recognition bans is significant and ever-growing. The Court, in this decision, holds that same-sex couples may exercise the fundamental right to marry in all States. It follows that the Court also must hold—and it now does hold—that there is no lawful basis for a State to refuse to recognize a lawful same-sex marriage performed in another State on the ground of its samesex character. No union is more profound than marriage, for it embodies the highest ideals of love, fidelity, devotion, sacrifice, and family. [The petitioners’] hope is not to be . . . excluded from one of civilization’s oldest institutions. They ask for equal dignity in the eyes of the law. The Constitution grants them that right.

Suspect Classes Certain “suspect” bases of classification also trigger more rigorous equal protection review. Although what is considered a “suspect class” is subject to review and change, race, alienage, and national origin generally are considered suspect classes.

1. Race and national origin.  Classifications disadvantaging racial or national minorities receive the most rigorous kind of strict scrutiny and are almost never constitutional. For instance, in a recent decision that dealt not only with the suspect class of race but also the fundamental right to

Sixth Circuit’s judgment reversed.

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Part One Foundations of American Law

vote, the Supreme Court struck down North Carolina’s formulation of certain legislative voting districts because the formulation depended upon impermissible drawing of race-based lines. (The case was Cooper v. Harris, 137 S. Ct. 1455 (2017).) The Supreme Court has sometimes upheld governmentrequired affirmative action plans and what critics have called reverse racial discrimination—government action that benefits racial minorities and allegedly disadvantages whites. In 1989, however, a majority of the Court concluded that state action of this kind should receive the same full strict scrutiny as discrimination against racial or national minorities. A 1995 Supreme Court decision held that this is true of federal government action as well as state action. These developments have curtailed certain government-created affirmative action programs but have not eliminated them. In the companion cases of Gratz v. Bollinger, 539 U.S. 244 (2003), and Grutter v. Bollinger, 539 U.S. 306 (2003), the Supreme Court considered whether the University of Michigan violated the Equal Protection Clause by taking minority students’ race into account in its undergraduate and law school admissions policies. The Court recognized in the two cases that seeking student diversity in a higher education context is a compelling government interest. However, in Gratz, a five-justice majority of the Court held that the university’s undergraduate admissions policy violated the Equal Protection Clause because the policy’s consideration of minority applicants’ race became effectively the automatic determining factor in admission decisions regarding minority applicants. In Grutter, on the other hand, a different five-justice majority held that the university’s law school admissions policy did not violate the Equal Protection Clause. The Grutter majority reasoned that the law school’s policy, in considering minority applicants’ race, did so as part of individualized consideration of applicants and of various types of diversity, not simply race. Thus, the law school’s policy did not make race the determining factor in the impermissible way that the undergraduate policy did. In the years following the decisions in Gratz and Grutter, the composition of the Supreme Court changed. When the Court agreed to decide a challenge to a race-conscious student admissions policy at the University of Texas (a policy patterned in large part after what the Court had approved in Grutter), speculation mounted that the Court might use the case as a vehicle for overruling Grutter or substantially cutting back on its effect. The Court did not do so, however. In Fisher v. University of Texas, 136 S. Ct. 2198 (2016), the Court reiterated a key Grutter principle: that seeking diversity in the student body at colleges and universities counts as a compelling government purpose in

the strict scrutiny analysis. The Court also left unaltered Grutter’s approach of permitting race to be considered in admissions decisions, as long as it was among a number of other factors taken into account in an individualized consideration of applicants and of various types of diversity. According to the Court, the challenged University of Texas plan passed the constitutional test by being narrowly tailored to achievement of the compelling government interest in achieving student body diversity. In 2014, the Supreme Court decided an affirmative action–related case that presented a different wrinkle in the form of this question: If consideration of race in state university admission decisions is sometimes permissible (as Grutter and Fisher indicate), can the voters of a state constitutionally bar the use of race as a consideration in such decisions? In a Michigan referendum that took place three years after the decision in Grutter, voters approved an amendment to the state constitution that prohibited the use of race-conscious affirmative action in public education, government contracting, and public employment. Ruling on a challenge to this action, the Court emphasized in Schuette v. Coalition to Defend Affirmative Action, 572 U.S. 291 (2014), that the case was “not about how the debate about racial preferences should be resolved.” Rather, it was “about who may resolve it.” The Court went on to hold that there was “no authority in the [U.S.] Constitution . . . or in this Court’s precedents for the judiciary to set aside Michigan laws that commit this policy determination to the voters.” A lawsuit against Harvard College claims that Harvard’s admissions process violates Asian American applicants. The claim is not based on the Constitution; rather, it alleges violation of a federal law that prohibits discrimination among organizations or programs that receive federal funds (42 U.S.C. §2000d et seq.). But it is relevant for this discussion because the equal protection analysis applies to cases brought under that law. The federal district court in the Harvard case therefore analyzed the issue under the principles set forth in Fisher and found in favor of Harvard. At the time of this drafting, the case remained on appeal. See Students for Fair Admissions, Inc. v. President and Fellows of Harvard College, 397 F. Supp. 3d 126 (D. Mass. 2019). A similar case (though a direct constitutional challenge) against the University of North Carolina was pending as this book went to press (see Students for Fair Admission, Inc. v. University of North Carolina, 2019 WL 4773908 (M.D.N.C. Sept. 30, 2019)). 2. Sex. Although the Supreme Court has been hesitant to make a formal declaration that sex is a suspect class, for roughly four decades laws discriminating on the basis



Chapter Three Business and the Constitution

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Ethics and Compliance in Action As discussion in this chapter reveals, Supreme Court precedent establishes that when government action discriminates on the basis of race or sex, the action will receive heightened scrutiny from the court if an equal protection challenge is brought. Despite cases such as Obergefell v. Hodges (in which the Supreme Court held that same-sex couples cannot be denied the fundamental right to marry), the Court has not recognized sexual orientation or transgender status as a suspect class for equal protection purposes. Unless and until the Court does so, the government may

of gender have been subjected to a fairly rigorous form of intermediate scrutiny. As the Court has said, such laws require an “exceedingly persuasive” justification. The usual test is that government action discriminating on the basis of sex must be substantially related to the furtherance of an important government purpose. Under this test, measures discriminating against women have almost always been struck down. The Supreme Court has said that laws disadvantaging men receive the same scrutiny as those disadvantaging women, but this has not prevented the Court from upholding men-only draft registration and a law making statutory rape a crime for men alone. With gender as a longstanding suspect class and with legal developments such as the Obergefell decision’s extension of the right to marry to same-sex couples, will the Supreme Court formally recognize sexual orientation and transgender status as suspect classes for equal protection purposes? Signs of such a development are at least discernible, but how immediately such a development may occur is an open question.

Independent Checks Applying Only to the States The Contract Clause Article I, § 10 of the Con-

stitution states: “No State shall . . . pass any . . . Law impairing the Obligation of Contracts.” Known as the Contract Clause, this provision deals with state laws that change the parties’ performance obligations under an existing contract after that contract has been made.2 The original purpose of the Contract Clause was to strike down the many debtor relief statutes passed by the states after the Revolution. Under the Fifth Amendment’s Due Process Cause, standards similar to those described in this section apply to the federal government. 2

have more legal latitude to regulate in ways that draw lines on the basis of persons’ sexual orientation or transgender status than in ways that classify on the basis of persons’ race or sex. Now view this set of issues from an ethical perspective. Should the government be any freer to take actions that discriminate against gays, lesbians, or transgender persons than it is to take actions that discriminate on the basis of race or sex? As you consider this question, you may wish to examine Chapter 4’s discussion of ethical theories and ethical decision making.

These statutes impaired the obligations of existing private contracts by relieving debtors of what they owed to creditors. In two early 19th-century cases, however, the Contract Clause was also held to protect the obligations of governmental contracts, charters, and grants. The Contract Clause probably was the most important constitutional check on state regulation of the economy for much of the 19th century. Beginning in the latter part of that century, the clause gradually became subordinate to legislation based on the states’ police powers. By the mid20th century, most observers treated the clause as being of historical interest only. In 1977, however, the Supreme Court gave the Contract Clause new life by announcing a fairly strict constitutional test governing situations in which a state impairs its own contracts, charters, and grants. Such impairments, the Court said, must be “reasonable and necessary to serve an important public purpose.” During recent decades, the Court has continued its deference toward state regulations that impair the obligations of private contracts. Consider, for instance, Exxon Corp. v. Eagerton, 462 U.S. 176 (1983). For years, Exxon had paid a severance tax under Alabama law on oil and gas it drilled within the state. As the tax increased, appropriate provisions in Exxon’s contracts with the purchasers of its oil and gas allowed Exxon to pass on the amounts of the increases to the purchasers. Alabama, however, enacted a law that not only increased the severance tax but also forbade producers of oil and gas from passing on the increase to purchasers. Exxon filed suit, seeking a declaration that the law’s pass-on prohibition violated the Contract Clause. Affirming Alabama’s highest court, the U.S. Supreme Court observed that the Contract Clause allows the states to adopt broad regulatory measures without having to be concerned that private contracts will be affected. The pass-on prohibition was designed to advance a broad public interest in protecting consumers against excessive prices and

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Part One Foundations of American Law

CONCEPT REVIEW Equal Protection and Levels of Scrutiny Type of Government Action

Controlling Test

Operation and Effect of Test

Government action that discriminates but neither affects exercise of fundamental right nor discriminates against suspect class (e.g., most social and economic regulation)

Rational basis

Lenient test—government action is constitutional if rationally related to legitimate government purpose.

Government action that discriminates concerning ability to exercise fundamental right

Full strict scrutiny

Very rigorous test—government action is unconstitutional unless necessary to fulfillment of compelling government purpose.

Government action that discriminates on basis of race or national origin

Full strict scrutiny

Very rigorous test—government action is unconstitutional unless necessary to fulfillment of compelling government purpose.

Government action that discriminates on basis of sex (gender)

Intermediate scrutiny

Moderately rigorous test—government action is unconstitutional unless substantially related to fulfillment of important government purpose.

was applicable to all oil and gas producers regardless of whether they were then parties to contracts containing pass-on provisions. Therefore, the Court reasoned, the Alabama statute did not violate the Contract Clause.

Federal Preemption LO3-9

Identify the major circumstances in which federal law will preempt state law.

The constitutional principle of federal supremacy dictates that when state law conflicts with valid federal law, the federal law is supreme. In such a situation, the state law is said to be preempted by the federal regulation. The central question in most federal preemption cases is the intent of Congress. Thus, such cases often present complex questions of statutory interpretation. Federal preemption of state law generally occurs for one or more of these reasons: 1. There is a literal conflict between the state and federal measures, so that it is impossible to follow both simultaneously. 2. The federal law specifically states that it will preempt state regulation in certain areas. Similar statements may also appear in the federal statute’s legislative history. Courts sometimes find such statements persuasive even when they appear only in the legislative history and not in the statute itself.

3. The federal regulation is pervasive. If Congress has “occupied the field” by regulating a subject in great breadth and/or in considerable detail, such action by Congress may suggest an intent to displace state regulation of the subject. This may be especially likely where Congress has given an administrative agency broad regulatory power in a particular area. 4. The state regulation is an obstacle to fulfilling the purposes of the federal law. Here, the party challenging the state law’s constitutionality typically claims that the state law interferes with the purposes she attributes to the federal measure (purposes usually found in its legislative history).  Arizona v. United States, 567 U.S. 387 (2012), illustrates the principles set forth in the above discussion of grounds for preemption. In that case, the Supreme Court was faced with deciding whether certain provisions in an Arizona law were preempted by federal immigration law, which has been enacted pursuant to the power granted to Congress over immigration matters in Article I, § 8 of the Constitution. The Court held that the so-called show me your papers provision in the Arizona law was not preempted. That provision called for state law enforcement officers to determine the immigration status of anyone they stopped or arrested if there was reason to suspect that the person might be in the country illegally. However, the Court held that federal immigration law preempted three other provisions in the Arizona law: a



Chapter Three Business and the Constitution

provision making it a crime under Arizona law for an immigrant to fail to register under a federal law, a provision making it a crime under Arizona law for illegal immigrants to work or seek work, and a provision allowing Arizona law enforcement officers to make warrantless arrests if the officers have probable cause to believe the arrested persons committed acts that would make them subject to deportation under federal law. The preempted provisions either conflicted with federal law or posed too great an impediment to fulfillment of the federal law’s objectives.

The Takings Clause LO3-10

Explain the power granted to the government by the Takings Clause, as well as the limits on that power.

The Fifth Amendment states that “private property [shall not] be taken for public use, without just compensation.” Because this Takings Clause has been incorporated within Fourteenth Amendment due process, it applies to the states. Traditionally, it has come into play when the government formally condemns land through its power of eminent domain,3 but it has many other applications as well. The Takings Clause both recognizes government’s power to take private property and limits the exercise of that power. It does so by requiring that when property is subjected to a governmental taking, the taking must be for a public use and the property owner must receive just compensation. We now consider these four aspects of the Takings Clause in turn. 1. Property. The Takings Clause protects other property interests besides land and interests in land. Although its full scope is unclear, the clause has been held to cover takings of personal property, liens, trade secrets, and contract rights. Eminent domain and the Takings Clause’s application to land use problems are discussed in Chapter 24. 3

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2. Taking. Because of the range of property interests it may cover, the Takings Clause potentially has a broad scope. Another reason for the clause’s wide possible application is the range of government activities that may be considered takings. Of course, the government’s use of formal condemnation procedures to acquire private property is a taking. There may also be a taking when the government physically invades private property or allows someone else to do so. It has long been recognized, moreover, that overly extensive land use regulation may so diminish the value of property or the owner’s enjoyment of it as to constitute a taking. Among the factors courts consider in such “regulatory taking” cases are the degree to which government deprives the owner of free possession, use, and disposition of his property; the overall economic impact of the regulation on the owner; and how much the regulation interferes with the owner’s reasonable investment-backed expectations regarding the future use of the property. In Lucas v. South Carolina Coastal Council, 505 U.S. 1003 (1992), the Supreme Court held that there is an automatic taking when the government denies the owner all economically beneficial uses of the land. When this is not the case, courts tend to apply some form of means-ends scrutiny in determining whether land use regulation has gone too far and thus amounts to a regulatory taking. 3. Public use. Once a taking of property has occurred, it is unconstitutional unless it is for a public use. The public use element took center stage in a widely publicized 2005 Supreme Court decision, Kelo v. City of New London. For discussion of Kelo, see Figure 3.4. 4. Just compensation. Even if a taking of property is for a public use, it still is unconstitutional if the property owner does not receive just compensation. Although the standards for determining just compensation vary with the circumstances, the basic test is the fair market value of the property (or of the lost property right) at the time of the taking.

Figure 3.4 Economic Development as Public Use? Does the government’s taking of private property for the purpose of economic development satisfy the public use requirement set forth in the Fifth Amendment’s Takings Clause? In Kelo v. City of New London, 545 U.S. 469 (2005), the U.S. Supreme Court answered “yes.” New London, Connecticut, experienced economic decline for a considerable number of years. The city therefore made economic revitalization efforts, which included a plan to acquire 115 parcels of real estate in a 90-acre area and create, in collaboration with private developers, a multifaceted

zone that would combine commercial, residential, and recreational elements. The planned development was designed to increase tax revenue, create jobs, and otherwise capitalize on the economic opportunities that city officials expected would flow from a major pharmaceutical company’s alreadyannounced plan to construct a large facility near the area the city wished to develop. The city was able to negotiate the purchase of most parcels of property in the 90-acre area, but some property owners refused to sell. The latter group included Susette

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Kelo and Wilhelmina Dery. Kelo had lived in her home for several years, had made substantial improvements to it, and especially enjoyed the water view it afforded. Dery had lived her entire life in the home the city sought to acquire. Both homes were well maintained. After the city decided to use its eminent domain power to acquire the properties of those owners who refused to sell, Kelo, Dery, and the other nonselling owners filed suit. They contended that the city’s plan to take their property for the purpose of economic development did not involve a public use and thus would violate the Fifth Amendment’s Takings Clause. The dispute made its way through the Connecticut courts and then to the U.S. Supreme Court, where a five-justice majority ruled in favor of the city. Writing for the majority in Kelo v. City of New London, Justice Stevens noted that earlier decisions had identified three types of eminent domain settings in which the government’s acquisition of private property satisfied the constitutional public use element: first, when the government planned to develop a government-owned facility (e.g., a military base); second, when the government planned to construct, or allow others to construct, improvements to which the public would have broad access (e.g., highways or railroads); and third, when the government sought to further some meaningful public purpose. Justice Stevens observed that precedents had recognized the public purpose type of public use even if the government would not ultimately retain legal title to the acquired property (unlike the military base example) and the acquired property would not be fully opened up for public access (unlike the highway and railroad examples). The Court acknowledged that the public use requirement clearly would not be satisfied if the government took private party A’s property simply to give it to private party B. However, the Court stressed, the prospect that private parties might ultimately own or control property the government had acquired through eminent domain would not make the taking unconstitutional if an overriding public purpose prompted the government’s use of eminent domain. Similarly, even if certain private parties (e.g., the pharmaceutical company and private developers in the Kelo facts) would stand to benefit from the government’s exercise of eminent domain, such a fact would not make the taking unconstitutional if a public purpose supported the taking. The Kelo majority stressed the particular relevance of two earlier Supreme Court decisions, Berman v. Parker,  348 U.S. 26 (1954), and Hawaii Housing Authority v. Midkiff, 467 U.S. 299 (1984). In Berman, the Court sustained Washington, D.C.’s use of eminent domain to take property that included businesses and “blighted” dwellings

in order to construct a low-income housing project and new streets, schools, and public facilities. In Midkiff, the Court upheld Hawaii’s use of eminent domain to effectuate a legislative determination that Hawaii’s longstanding land oligopoly, under which property ownership was highly concentrated among a small number of property owners, had to be broken up for social and economic reasons. The Kelo majority concluded that significant public purposes were present in both Berman and Midkiff and that those decisions led logically to the conclusion that economic development was a public purpose weighty enough to constitute public use for purposes of the Takings Clause. Therefore, the Court upheld the city’s exercise of eminent domain in Kelo. In his majority opinion, Justice Stevens was careful to point out that because the constitutional question was whether a public use existed, it was not the Court’s job to determine the wisdom of the government’s attempt to exercise eminent domain. Neither should the Court allow its decision to be guided by the undoubted hardship that eminent domain places on unwilling property owners who must yield their homes to the state (albeit in return for “just compensation”). Justice Stevens emphasized that if state legislatures believed an economic development purpose such as the one the City of New London had in mind should not be used to support an exercise of eminent domain, the legislatures were free to specify, in their state statutes, that eminent domain could not be employed for an economic development purpose. The Court’s determination of what is a public use for purposes of the Takings Clause sets a protective floor for property owners, with states being free to give greater protection against takings by the government. The four dissenting justices in Kelo issued sharply worded opinions expressing their disagreement with the majority’s characterization of Berman and Midkiff as having led logically to the conclusion that economic development was a public use. In emotional terms, the dissenters accused the majority of having effectively erased the public use requirement from the Takings Clause. The Kelo decision drew considerable media attention, perhaps more because of what appeared to be considerable hardship to property owners such as Kelo and Dery than because of new legal ground—if any—broken in the decision. For many observers, the case’s compelling facts led to a perception that the city had engaged in overreaching. The Court’s decision in Kelo meant that in a legal sense, there was no overreaching on the part of the city. Was there, however, overreaching in an ethical sense? How would utilitarians answer that question? What about rights theorists? (As you consider the questions, you may wish to consult Chapter 4.)



Chapter Three Business and the Constitution

Problems and Problem Cases 1. In 1967, Gary Jones purchased a house on North Bryan Street in Little Rock, Arkansas. He and his wife lived in the house until they separated in 1993. Jones then moved into an apartment in Little Rock, and his wife continued to live in the house. Jones paid his mortgage each month for 30 years. The mortgage company paid the property taxes on the house. After Jones paid off his mortgage in 1997, the property taxes went unpaid. In April 2000, the Arkansas Commissioner of State Lands (Commissioner) attempted to notify Jones of his tax delinquency and his right to redeem the property by paying the past-due taxes. The Commissioner sought to provide this notice by mailing a certified letter to Jones at the North Bryan Street address. Arkansas law approved the use of such a method of providing notice. The packet of information sent by the Commissioner stated that unless Jones redeemed the property, it would be subject to public sale two years later. No one was at home to sign for the letter. No one appeared at the post office to retrieve the letter within the next 15 days. The post office then returned the unopened packet to the Commissioner with an “unclaimed” designation on it. In the spring of 2002, a few weeks before the public sale scheduled for Jones’s house, the Commissioner published a notice of public sale in a local newspaper. No bids were submitted, meaning that under Arkansas law, the state could negotiate a private sale of the property.  Several months later, Linda Flowers submitted a purchase offer. The Commissioner then mailed another certified letter to Jones at the North Bryan Street address, attempting to notify him that his house would be sold to Flowers if he did not pay his delinquent taxes. As with the first letter, the second letter was returned to the Commissioner with an “unclaimed” designation. Flowers purchased the house. Immediately after the expiration of the 30-day period in which Arkansas law would have allowed Jones to make a post-sale redemption of the property by paying the past-due taxes, Flowers had an eviction notice delivered to the North Bryan Street property. The notice was served on Jones’s daughter, who contacted Jones and notified him of the tax sale. Jones then filed a lawsuit in Arkansas state court against the Commissioner and Flowers. In his lawsuit, Jones contended that the Commissioner’s failure to provide notice of the tax sale and of Jones’s right to redeem resulted in the taking of his property without due process. The

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trial court ruled in favor of the Commissioner and Flowers, and the Arkansas Supreme Court affirmed. The U.S. Supreme Court agreed to decide the case and its central question of whether Jones was afforded due process. How did the U.S. Supreme Court rule? 2. Two Rhode Island statutes prohibited advertising the retail price of alcoholic beverages. The first applied to vendors licensed in Rhode Island as well as to out-of-state manufacturers, wholesalers, and shippers. It prohibited them from “advertising in any manner whatsoever” the price of any alcoholic beverage offered for sale in the state. The only exception to the restriction was for price tags or signs displayed with the merchandise within licensed premises, if the tags or signs were not visible from the street. The second statute barred the Rhode Island news media from publishing or broadcasting advertisements that made reference to the price of any alcoholic beverages. 44 Liquormart Inc., a licensed retailer of alcoholic beverages, operated a store in Rhode Island. Because it wished to advertise prices it would charge for alcoholic beverages, 44 Liquormart filed a declaratory judgment action against the state. 44 Liquormart asked the court to rule that the statutes referred to above violated the First Amendment. The district court concluded that the statutes failed the applicable test for restrictions on commercial speech and therefore struck them down. The U.S. Court of Appeals for the First Circuit reversed, determining that the statutes were constitutionally permissible restrictions on commercial speech. The U.S. Supreme Court granted 44 Liquormart’s petition for a writ of certiorari. How did the Supreme Court rule? 3. A federal statute, 8 U.S.C. § 1409, sets requirements for acquisition of U.S. citizenship by a child born outside the United States to unwed parents, only one of whom is a U.S. citizen. If the mother is the U.S. citizen, the child acquires citizenship at birth. Section 1409(a) states that when the father is the citizen parent, the child acquires citizenship only if, before the child reaches the age of 18, the child is legitimized under the law of the child’s residence or domicile, the father acknowledges paternity in writing under oath, or paternity is established by a competent court. Tuan Anh Nguyen was born in Vietnam to a Vietnamese mother and a U.S. citizen father, Joseph Boulais. At six years of age, Nguyen came to the United States, where he became a lawful permanent resident and was raised by his father. When Nguyen was 22, he pleaded guilty in a Texas court to two counts of sexual assault.

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The U.S. Immigration and Naturalization Service initiated deportation proceedings against Nguyen, and an immigration judge found him deportable. While Nguyen’s appeal to the U.S. Board of Immigration Appeals was pending, Boulais obtained from a state court an order of parentage that was based on DNA testing. The board dismissed Nguyen’s appeal, denying his citizenship claim on the ground that he had not established compliance with § 1409(a). Nguyen and Boulais appealed to the U.S. Court of Appeals for the Fifth Circuit, which rejected their contention that § 1409 discriminated on the basis of gender and thus violated the Constitution’s equal protection guarantee. Was the Fifth Circuit’s decision correct? 4. As most other states do, the Commonwealth of Kentucky taxes its residents’ income. Kentucky law establishes that interest on bonds issued by Kentucky and its political subdivisions is exempt from Kentucky’s income tax, whereas interest on bonds issued by other states and their political subdivisions is taxable. The tax exemption for Kentucky bonds helps make those bonds attractive to in-state purchasers even if they carry somewhat lower rates of interest than other states’ bonds or those issued by private companies. Most other states have differential tax schemes that resemble Kentucky’s. Kentucky residents George and Catherine Davis paid state income tax on interest from out-of-state municipal bonds, and then sued the Department of Revenue of Kentucky in an effort to obtain a refund. The Davises contended that Kentucky’s differential taxation of municipal bond interest impermissibly discriminates against interstate commerce in violation of the U.S. Constitution’s Commerce Clause. Were the Davises correct? 5. Nike Inc. mounted a public relations campaign in order to refute news media allegations that its labor practices overseas were unfair and unlawful. The campaign involved the use of press releases, letters to newspapers, a letter to university presidents and athletic directors, and full-page advertisements in leading newspapers. Relying on California statutes designed to curb false and misleading advertising and other forms of unfair competition, California resident Mark Kasky filed suit in a California court on behalf of the general public of the state. Kasky contended that Nike had made false statements in its campaign and that the court should therefore grant the legal relief contemplated by the California statutes. In terms of Nike’s potential liability, why would it make a difference whether the speech in which Nike engaged was commercial or, instead,

noncommercial? What are the arguments in favor of a conclusion that Nike was engaged in commercial speech? What are the arguments in favor of a conclusion that Nike was engaged in noncommercial speech? How did the court rule on the speech classification issue—that is, whether Nike’s speech was commercial or, instead, that it is noncommercial? 6. Public school districts in Seattle, Washington, and Louisville, Kentucky, faced litigation in which it was alleged that they violated the Equal Protection Clause by considering race when assigning students to schools. The Seattle district, which had neither created segregated schools nor been subject to court-ordered desegregation, generally allowed students to choose which high school they wished to attend. However, the district classified students as white or nonwhite. It then used the racial classifications as a “tiebreaker” to allocate available slots in particular high schools and thereby seek to achieve racially diverse schools despite the existence of certain housing patterns that would have produced little racial diversity at certain schools. The Louisville district had been subject to a federal court’s desegregation decree during a two-decadeslong period, but a court had lifted the desegregation order after concluding that the district had eliminated the vestiges of prior segregation to the greatest extent feasible. The Louisville district then adopted a plan under which students were classified as Black or “other.” Using these classifications in making elementary school assignments and in ruling on transfer requests, the district sought to achieve racial diversity in schools that would have reflected less racial diversity in light of traditional housing patterns. The cases challenging the two districts’ policies of considering race made their way through the federal courts and were later consolidated for decision by the U.S. Supreme Court.  What test would the Seattle and Louisville school districts need to pass in order to avoid a Supreme Court determination that their policies violate the Equal Protection Clause? Could the school districts pass that test? Why or why not? 7. Marijuana is classified under federal law as an illegal drug. On what enumerated power would Congress have relied when it enacted the federal statute that outlaws marijuana and other specified drugs?  A number of states have legalized marijuana possession and use up to certain levels designated in their laws. Several other states have legalized marijuana possession and use for medicinal purposes, but for



Chapter Three Business and the Constitution

those purposes only. As a constitutional matter, could the federal government—if it were so inclined—adopt an aggressive enforcement posture in which it would override the state laws to the contrary? If so, on what constitutional basis? If not, why not? 8. The Minnesota legislature passed a statute banning the sale of milk in plastic nonrefillable, nonreusable containers. However, it allowed sales of milk in other nonrefillable, nonreusable containers such as paperboard cartons. One of the justifications for this ban on plastic jugs was that it would ease the state’s solid waste disposal problems because plastic jugs occupy more space in landfills than other nonreturnable milk containers. A group of dairy businesses challenged the statute, arguing that its distinction between plastic containers and other containers was unconstitutional under the Equal Protection Clause. What means-ends test or level of scrutiny applies in this case? Under that test, is easing the state’s solid waste disposal problems a sufficiently important end? Under that test, is there a sufficiently close “fit” between the classification and that end to make the statutory means constitutional? In answering the last question, assume for the sake of argument that there probably were more effective ways of alleviating the solid waste disposal problem than banning plastic jugs while allowing paperboard cartons. 9. The plaintiffs in the case described below were two married same-sex couples who conceived children through anonymous sperm donation. Leigh and Jana Jacobs were married in Iowa in 2010, and Terrah and Marisa Pavan were married in New Hampshire in 2011. Leigh and Terrah each gave birth to a child in Arkansas in 2015. When it came time to secure birth certificates for the newborns, each couple filled out paperwork listing both spouses as parents—Leigh and Jana in one case, Terrah and Marisa in the other. Both times, however, the Arkansas Department of Health issued certificates bearing only the birth mother’s name. The department’s decision rested on a provision of ­Arkansas law that specified which individuals will appear as parents on a child’s state-issued birth certificate. The statute stated that “[f]or the purposes of birth registration, the mother is deemed to be the woman who gives birth to the child.” The statute also instructed that “[i]f the mother was married at the time of either conception or birth, the name of [her] husband shall be entered on the certificate as the father of the child.” The requirement that a married woman’s husband appear on her child’s birth certificate applied, according to the state’s

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interpretation of the statute, if the couple conceived by means of artificial insemination with the help of an anonymous sperm donor.  The Jacobses and Pavans brought this suit in Arkansas state court against the director of the Arkansas Department of Health in an effort to obtain a declaration that the state’s birth-certificate law violated the U.S. Constitution. The trial court so ruled, but the Arkansas Supreme Court reversed the trial court’s decision. The U.S. Supreme Court agreed to decide the case. What constitutional provision or provisions do you see as relevant here? How did the Supreme Court rule? 10. While it was preparing a comprehensive land use plan in the area, the Tahoe Regional Planning Agency (TRPA) imposed two moratoria on development of property in the Lake Tahoe Basin. The moratoria together lasted 32 months. A group of property developers affected by the moratoria filed suit in federal court alleging that the moratoria constituted an unconstitutional taking without just compensation. Were the developers correct? 11. A federal statute criminalized the creation, sale, or possession of certain depictions of animal cruelty. For purposes of the statute, a depiction of “animal cruelty” was defined as one “in which a living animal is intentionally maimed, mutilated, tortured, wounded, or killed,” if the depicted conduct violated federal or state law at the place where the creation, sale, or possession took place. The legislative history of the statute indicated that it was prompted by a congressional objective of eliminating dissemination of so-called crush videos (videos showing live animals being crushed to death by persons stomping on them).  Robert Stevens operated a website on which he sold videos of pitbulls engaging in dogfighting and otherwise attacking animals. After he was convicted of violating the above-described statute by selling the videos, he appealed on the ground that the statute violated the First Amendment. The case made its way to the U.S. Supreme Court. How did the Court rule? Was Stevens entitled to the protection of the First Amendment? 12. Florida’s Code of Judicial Conduct bars judges and candidates running for election to a judgeship from personally soliciting campaign contributions of a financial nature. Attorney Lanell Williams-Yulee, a candidate running for election to a Florida judgeship, drafted and mailed a letter to voters. In the letter, she asked for donations to her campaign. The State Bar

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Part One Foundations of American Law

of Florida brought a disciplinary proceeding against Williams-Yulee because of the letter. The proceedings concluded with a finding that a public reprimand was in order because she had violated the Code of Judicial Conduct. The Bar rejected Williams-Yulee’s argument that the ban on personal solicitation violated her First Amendment rights. The Supreme Court of Florida also rejected that argument. The U.S. Supreme Court agreed to decide the case. What kind of speech was Williams-Yulee engaging in through her letter soliciting contributions to her campaign? Did the Code of Judicial Conduct’s restriction on personal solicitation violate her First Amendment rights? 13. A federal law, the Immigration Reform and Control Act (IRCA), makes it “unlawful for a person or other entity . . . to hire, or to recruit or refer for a fee, for employment in the United States an alien knowing the alien is an unauthorized alien.” Employers that violate this prohibition may be subjected to civil and criminal sanctions. IRCA also restricts the ability of states to combat employment of unauthorized workers. It does so by expressly preempting “any state or local law imposing civil or criminal sanctions (other than through licensing and similar laws) upon those who employ, or recruit or refer for a fee for employment,

unauthorized aliens.” In addition, IRCA requires employers to take steps to verify an employee’s eligibility for employment. Seeking to improve that verification process, Congress created E-Verify, an Internet-based system employers can use to check the work authorization status of employees. Federal law does not require the use of E-Verify, however.  Arizona was among several states that enacted statutes designed to impose sanctions for the employment of unauthorized aliens. According to an Arizona law (the Legal Arizona Workers Act), the licenses of state employers that knowingly or intentionally employ unauthorized aliens may be, and in certain circumstances must be, suspended or revoked. The Arizona law also requires that all Arizona employers use E-Verify. The Chamber of Commerce of the United States and various business and civil rights organizations filed suit against those charged with administering the Arizona law. The plaintiffs argued that the state law’s license suspension and revocation provisions were both expressly and impliedly preempted by federal immigration law, and that the mandatory use of E-Verify was impliedly preempted. Were the plaintiffs right? Did federal immigration law preempt the challenged provisions of the Arizona statute?

CHAPTER 4

Business Ethics, Corporate Social Responsibility, Corporate Governance, and Critical Thinking

W

hat defines ethical behavior? Think of a time when you thought that someone or some business did something ethical. Was it someone going out of her way to help another person? Was it, for example, a young man—a customer at a store—helping an elderly woman carry heavy packages to her car? Was it someone entering a building during a pouring rain and giving her umbrella to a father and his small children who were waiting to leave until the rain stopped? Was it a corporate executive speaking for an hour to a friend’s daughter—a young college student—helping her understand how to seek an internship and prepare for a career in the executive’s industry? Was it a business giving a second chance to a young man who fell in with the wrong crowd, made a mistake, and served time in prison? Was it a company recalling and repairing an allegedly defective product, even when not required by the government, at great cost to its profits and shareholders? Was it a business that bought a failing company in the solar industry? Was it a corporation buying a competitor, achieving synergies, improving options and pricing for consumers, and increasing the company’s profits? Was it a business that chose to upgrade its factories in a midwestern town instead of moving manufacturing operations overseas? Was it a business that opened a new plant in Indonesia, creating jobs for 1,000 workers? Was it a corporation with excess cash opting to increase its dividend by 25 percent and buy back 10 percent of its stock, thereby increasing returns to shareholders and the price of the shareholders’ stock in the company? In these and other situations in which you observed what you believed was ethical conduct, what made you think the behavior was ethical? Was it that the ethical actor obeyed some fundamental notion of rightness? Was it that the person treated someone the way you would want to be treated? Was it that the actor gave an opportunity to someone who was in greater need than most people? Was it that the company helped someone who deserved aid? Was it that most people thought that it was the right thing to do or that the majority wanted it done, whether right or not? Was it that the business took full advantage of the resources entrusted to it by society? Was it that the business helped society use its scarce resources in a productive or fair way? What ethical responsibilities do businesses and business leaders have and to whom? What defines ethical behavior?

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Part One Foundations of American Law

LEARNING OBJECTIVES After studying this chapter, you should be able to: 4-1 Appreciate the strengths and weaknesses of the various ethical theories. 4-2 Apply the Guidelines for Ethical Decision Making to business and personal decisions.

Why Study Business Ethics? General Motors hiding that it sold cars with faulty ignitions. Target failing to protect customers’ credit card information. Enron maintaining its stock price by moving liabilities off balance sheet. WorldCom using fraudulent accounting to increase its stock price. ImClone executives and their family members trading on inside information. These business names and acts from the past two decades conjure images of unethical and socially irresponsible behavior by business executives. The U.S. Congress, employees, investors, and other critics of the power held and abused by some corporations and their management have demanded that corporate wrongdoers be punished and that future wrongdoers be deterred. Consequently, shareholders, creditors, and state and federal attorneys general have brought several civil and criminal actions against wrongdoing corporations and their executives. Congress has also entered the fray, passing the Sarbanes–Oxley Act of 2002, which increased penalties for corporate wrongdoers and established rules designed to deter and prevent future wrongdoing. The purpose of the statute is to encourage and enable corporate executives to be ethical and socially responsible. But statutes and civil and criminal actions can go only so far in directing business managers down an ethical path. And while avoiding liability by complying with the law is one reason to be ethical and socially responsible, there are noble and economic reasons that encourage current and future business executives to study business ethics. Although it is tempting to paint all businesses and all managers with the same brush that colors unethical and irresponsible corporations and executives, in reality corporate executives are little different from you, your friends, and your acquaintances. All of us from time to time fail to do the right thing, and we know that people have varying levels of commitment to acting ethically. The difference between most of us and corporate executives is that they are in positions of power that allow them to do greater damage to others when they act unethically or socially irresponsibly. They also act under the microscope of public scrutiny.

4-3 Recognize critical thinking errors in your own and others’ arguments. 4-4 Utilize a process to make ethical decisions in the face of pressure from others. 4-5 Be an ethical leader. It is also tempting to say that current business managers are less ethical than managers historically. But as former Federal Reserve chair Alan Greenspan said, “It is not that humans have become any more greedy than in generations past. It is that the avenues to express greed have grown enormously.” This brings us to the first and most important reason we need to study business ethics: to make better decisions for ourselves, the businesses we work for, and the society we live in. As you read this chapter, you will not only study the different theories that attempt to define ethical conduct but, more importantly, learn to use a strategic framework for making decisions. This framework provides a process for systematic ethical analysis, which will increase the likelihood you have considered all the facts affecting your decision. By learning a methodology for ethical decision making and studying common thinking errors, you will improve your ability to make decisions that build trust and solidify relationships with your business’s stakeholders. Another reason we study ethics is to understand ourselves and others better. While studying the various ethical theories, you will see concepts that reflect your own thinking and the thinking of others. This chapter, by exploring ethical theories systematically and pointing out the strengths and weaknesses of each ethical theory, should help you understand better why you think the way you do and why others think the way they do. By studying ethical theories, learning a process for ethical decision making, and understanding common reasoning fallacies, you should also be better equipped to decide how you should think and whether you should be persuaded by the arguments of others. Along the way, by better understanding where others are coming from and avoiding fallacious reasoning, you should become a more rigorous, critical thinker, as well as persuasive speaker and writer. There are also pragmatic reasons for executives to study business ethics. By learning how to act ethically and by, in fact, doing so, businesses forestall public criticism, reduce lawsuits against them, prevent Congress from passing onerous legislation, and make higher profits. For many corporate actors, however, these are not reasons to act ethically, but instead the natural consequences of so acting.



Chapter Four Business Ethics, Corporate Social Responsibility, Corporate Governance, and Critical Thinking

While we are studying business ethics, we will also examine the role of the law and regulations in defining ethical conduct. Some argue that it is sufficient for corporations and executives to comply with the requirements of the law; commonly, critics of the corporation point out that because laws cannot and do not encompass all expressions of ethical behavior, compliance with the law is necessary but not sufficient to ensure ethical conduct. This introduces us to one of the major issues in the corporate social responsibility debate.

The Corporate Social Responsibility Debate Although interest in business ethics education has increased greatly in the last few decades, that interest is only the latest stage in a long struggle to control corporate misbehavior. Ever since large corporations emerged in the late 19th century, such firms have been heroes to some and villains to others. Large corporations perform essential national and global economic functions, including raw material extraction, energy production, transportation, and communication, as well as providing consumer goods, professional services, and entertainment to millions of people. Critics, however, claim that in their pursuit of profits, corporations ruin the environment, mistreat employees, sell shoddy and dangerous products, produce immoral television shows and motion pictures, and corrupt the political process. Critics claim that even when corporations provide vital and important services, business is not nearly as accountable to the public as are organs of government. For example, the public has little to say about the election of corporate directors or the appointment of corporate officers. This lack of accountability is aggravated by the large amount of power that big corporations wield in America and throughout much of the world. These criticisms and perceptions have led to calls for changes in how corporations and their executives make decisions. The main device for checking corporate misdeeds has been the law. The perceived need to check abuses of business power was a force behind the New Deal laws of the 1930s and extensive federal regulations enacted in the 1960s and 1970s. Some critics, however, believe that legal regulation, while an important element of any corporate control scheme, is insufficient by itself. They argue that businesses should adhere to a standard of ethical or socially responsible behavior that is higher than the law. One such standard is the stakeholder theory of corporate social responsibility. It holds that rather than merely striving to maximize profits for its shareholders, a corporation should balance the interests of investors against the

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interests of other corporate stakeholders, such as employees, suppliers, customers, and the community. In August 2019, the Business Roundtable endorsed the stakeholder theory approach, noting the importance of delivering value to customers, investing in employees, dealing fairly and ethically with suppliers, supporting local communities, and generating long-term value for shareholders. To promote such behavior, some corporate critics have proposed changes that increase the influence of the various stakeholders in the internal governance of a corporation. We will study many of these proposals later in the chapter in the subsection on shareholder theory and its emphasis on profit maximization. You will also learn later that an ethical decision-making process requires a business executive to anticipate the effects of a corporate decision on the various corporate stakeholders. Despite concerns about abuses of power, big business has contributed greatly to the unprecedented abundance in America and elsewhere. Partly for this reason and partly because many businesses attempt to be ethical actors, critics have not totally dominated the debate about control of the modern corporation. Some defenders of business argue that in a society founded on capitalism, profit maximization should be the main goal of businesses: The only ethical norms firms must follow are those embodied in the law or those impacting profits. In short, they argue that businesses that maximize profits within the limits of the law are acting ethically. Otherwise, the marketplace would discipline them for acting unethically by reducing their profits. Former Fed chair Alan Greenspan wrote in 1963 that moral values are the power behind capitalism. He wrote, “Capitalism is based on self-interest and self-esteem; it holds integrity and trustworthiness as cardinal virtues and makes them pay off in the marketplace, thus demanding that [business persons] survive by means of virtue, not of vices.” Note that companies that are successful decade after decade, like Procter & Gamble and Johnson & Johnson, adhere to society’s core values. We will explore other arguments supporting and criticizing shareholder theory and its emphasis on profit maximization later in the chapter, where we will consider proposals to improve corporate governance and accountability. For now, however, having set the stage for the debate about business ethics and corporate social responsibility, we want to study the definitions of ethical behavior.

Ethical Theories For centuries, religious and secular scholars have explored the meaning of human existence and attempted to define a “good life.” In this section, we will define and examine some of the most important theories of ethical conduct.

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Ethics and Compliance in Action American physicist, mathematician, and futurist Freeman Dyson provided insights into why we humans may have difficulty determining which ethical viewpoint to embrace. His research also helps explain why different people have different ethical leanings. The destiny of our species is shaped by the imperatives of survival on six distinct time scales. To survive means to compete successfully on all six time scales. But the unit of survival is different for each of the six time scales. On a time scale of years, the unit is the individual. On a time scale of decades, the unit is the family. On a time scale of centuries, the unit is the tribe or nation. On a time scale of millennia, the unit is the culture. On a time scale of tens of millennia, the unit is the species. On a time scale of eons, the unit is the whole web of life on our planet. That is why conflicting loyalties are deep in our nature. In order to survive, we need to be loyal to ourselves, to our families, to our tribes, to our culture, to our species, to our planet. If our psychological impulses are complicated, it is because they were shaped by complicated and conflicting demands.1

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Appreciate the strengths and weaknesses of the various ethical theories.

As we cover these theories, much of what you read will be familiar to you. The names may be new, but almost certainly you have previously heard speeches and read writings of politicians, religious leaders, and commentators that incorporate the values in these theories. You will discover that your own thinking is consistent with one or more of the theories. You can also recognize the thinking of friends and antagonists in these theories. None of these theories is necessarily invalid, and many people believe strongly in any one of them. Whether you believe your theory to be right and the others to be wrong, it is unlikely that others will accept what you see as the error of their ways and agree with all your values. Instead, it is important for you to recognize that people’s ethical values can be as diverse as human culture. Therefore, no amount of argumentation appealing to theories you accept is likely to influence someone who subscribes to a different ethical viewpoint. The key, therefore, is to understand the complexity of ethical perspectives so that you can better understand both your viewpoint and the viewpoints of others. Only then is it possible to pursue common ground and provide a rational explanation for the decision that must ultimately be made.

Dyson goes on to write, “Nature gave us greed, a robust desire to maximize our personal winnings. Without greed we would not have survived at the individual level.” Yet he points out that Nature also gave us the connections and tools to survive at the family level (Dyson calls this tool love of family), the tribal level (love of friends), the cultural level (love of conversation), the species level (love of people in general), and the planetary level (love of nature). If Dyson is correct, why are humans sometimes vastly different from each other in some of their ethical values? Why do some of us argue, for example, that universal health care is a right for each citizen, while others believe health care is a privilege? The answer lies in the degree to which each of us embraces, innately or rationally, Dyson’s six units of survival and the extent to which each of us possesses the connections and tools to survive on each of those levels. Freeman Dyson, From Eros to Gaia (London: Penguin Books, 1993), pp. 341–42. 1

This means that if you want to be understood by and to influence someone who has a different ethical underpinning than you do, you must first determine her ethical viewpoint and then speak in an ethical language that will be understood and accepted by her. Otherwise, you and your opponent are like the talking heads on nighttime cable TV news shows, whose debates often are reduced to shouting matches void of any attempt to understand the other side.

LOG ON Go to www.iep.utm.edu The Internet Encyclopedia of Philosophy gives you background on all the world’s great philosophers from Abelard to Zizek. You can also study the development of philosophy from ancient times to the present. Many of the world’s great philosophers addressed the question of ethical or moral conduct.

The five ethical theories we will highlight are rights theory, justice theory, utilitarianism, shareholder theory, and virtue theory. Some of these theories focus on results of our decisions or actions: Do our decisions or actions produce the right results? Theories that focus on the consequences of a decision are teleological ethical theories. For example, a teleological theory may justify a manufacturing



Chapter Four Business Ethics, Corporate Social Responsibility, Corporate Governance, and Critical Thinking

company laying off 5,000 employees because the effect is to keep the price of manufactured goods low for consumers and to increase profits for the company’s shareholders. Other theories focus on the inherent rightness or wrongness of a decision or action itself, irrespective of what results it produces. This rightness or wrongness can be determined by a rule or principle or flow from a duty or responsibility. Theories that focus on decisions or actions alone are deontological ethical theories. For example, a deontological theory may find unacceptable that any competent employee loses his job, even if the layoff’s effect is to reduce prices to consumers and increase profits. Or a deontological theory emphasizing the principle that it is wrong to be dishonest might require that one never tell a lie, regardless of the consequences. Deontological theories place great emphasis on the duties and responsibilities that flow from rules, laws, policies, or social norms governing our actions. First, we will cover rights theory, which is a deontological theory. Next will be justice theory, which has concepts common to rights theory but with a focus primarily on outcomes. Our study of ethical theories will then turn to two additional teleological theories, utilitarianism and shareholder theory. Finally, we’ll consider virtue theory, which places the issue of one’s character and core virtues at the fore, instead of focusing first on rules and responsibilities or the consequences that inevitably flow from all of our actions.

Rights Theory Rights theory encompasses a variety

of ethical philosophies holding that certain human rights are fundamental and must be respected by other humans. The focus is on each individual member of society and her rights. As an ethically responsible individual, each of us faces a moral compulsion not to harm the fundamental rights of others, especially stakeholders impacted by our business activity. Kantianism Few rights theorists are strict deontologists, and one of the few is 18th-century philosopher Immanuel Kant. Kant viewed humans as moral actors who are free to make choices. He believed humans are able to judge the morality of any action by applying his famous categorical imperative. One formulation of the categorical imperative is, “Act only on that maxim whereby at the same time you can will that it shall become a universal law.” This means that we judge an action by applying it universally. Suppose you want to borrow money even though you know that you will never repay it. To justify this action using the categorical imperative, you state the following maxim or rule: “When I want money, I will borrow money and promise to repay it, even though I know I won’t repay.” According to Kant, you would not want this

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maxim to become a universal law because no one would believe in promises to repay debts and you would not be able to borrow money when you want. The ability to trust others in society would be completely impossible, and relationships would deteriorate. Thus, your maxim or rule fails to satisfy the categorical imperative. You are compelled, therefore, not to promise falsely that you will repay a loan. Kant had a second formulation of the categorical imperative: “Always act to treat humanity, whether in yourself or in others, as an end in itself, never merely as a means.” Thus arises a rule or principle creating a duty not to use or manipulate others in order to achieve our own happiness. In Kant’s eyes, if you falsely promise a lender to repay a loan, you are manipulating that person’s trust in you for your own ends because she would not agree to the loan if she knew all the facts. Modern Rights Theories Strict deontological ethical theories like Kant’s face an obvious problem: The duties are often viewed as absolute and universally applicable. A deontologist might argue that one must never lie or kill, even though most of us find lying and killing acceptable in some contexts, such as in self-defense. Responding to these difficulties, some modern philosophers have proposed mixed deontological theories. There are many theories here, but one popular theory requires us to abide by a moral rule unless a more important rule conflicts with it. In other words, our moral compulsion is not to compromise a person’s right unless a greater right takes priority over it. For example, members of society have the right not to be lied to. Therefore, in most contexts you are morally compelled not to tell a falsehood. That is an important right because it is critical in a community or marketplace that one be able to rely on another’s word. If, however, you could save someone’s life by telling a falsehood, such as telling a lie to a criminal about where a witness who will testify against him can be found, you probably will be required to save that person’s life by lying about his whereabouts. In this context, the witness’s right to live is a more important right than the criminal’s right to hear the truth. In effect, one right “trumps” the other right. What are these fundamental rights? How do we rank them in importance? Seventeenth-century philosopher John Locke argued for fundamental rights that we see embodied in the constitutions of modern democratic states: the protection of life, liberty, and property. Libertarians and others include the important rights of freedom of contract and freedom of expression. Modern liberals, like Bertolt Brecht, argued that all humans have basic rights to employment, food, housing, and education. In much of the ongoing debate

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around health care policy in the United States, a key question is whether or not every citizen has a right to health care. Strengths of Rights Theory The major strength of rights theory is that it recognizes the moral worth of each individual and the importance of protecting fundamental rights. This means that members of modern democratic societies have extensive liberties and rights around which a consensus has formed and citizens need not fear the removal of these rights by their government or other members of society. In the U.S. context, one need look no further than the Declaration of Independence and its emphasis on “life, liberty, and the pursuit of happiness” as those “unalienable rights” that lie beyond the reach of government interference. In the global context, the Universal Declaration of Human Rights was adopted by the United Nations in 1948 as an expression of fundamental rights to which many people believe all are entitled. Criticisms of Rights Theory Most of the criticisms of rights theory deal with the near absolute yet relative value of the rights protected, sometimes making it difficult to articulate and administer a comprehensive rights theory.

First, it is difficult to achieve agreement about which rights are protected. Rights fundamental to modern countries like the United States (such as many women’s or GLBT rights) are more limited in other countries around the world. Even within one country, citizens disagree on the existence and ranking of rights. For example, as noted earlier, some Americans argue that the right to health care is an important need that should be met by government or a person’s employer. Other Americans believe funding universal health care would interfere with the libertarian right to limited government intervention in our lives. Balancing rights in conflict can be difficult. In addition, rights theory does not concern itself with the costs or benefits of requiring respect for another’s right. For example, rights theory probably justifies the protection of a neo-Nazi’s right to spout hateful speech, even though the costs of such speech, including damage to relations between ethnic groups, may far outweigh any benefits the speaker, listeners, and society receive from the speech. Moreover, in the context of discussions around public policy and political economy, some argue that rights theory can be perverted to create a sense of entitlement reducing innovation, entrepreneurship, and production.

The Global Business Environment The Golden Rule in the World’s Religions and Cultures

ISLAM: No one of you is a believer until he desires for his brother that which he desires for himself.

Immanuel Kant’s categorical imperative, which is one formulation of rights theory, has its foundations in the Golden Rule. Note that the Golden Rule exists in all cultures and in all countries of the world. Here is a sampling.

JAINISM: In happiness and suffering, in joy and grief, we should regard all creatures as we regard our own self.

BUDDHISM: Hurt not others in ways that you would find hurtful. CHRISTIANITY: Do to others as you would have others do to you. CONFUCIANISM: Do not to others what you would not like yourself. GRECIAN: Do not that to a neighbor which you shall take ill from him.

JUDAISM: Whatever is hateful to you, do not to another. NATIVE AMERICAN SPIRITUALITY: Respect for all life is the foundation. PERSIAN: Do as you would be done by. ROMAN: Treat your inferiors as you would be treated by your superiors. SHINTOISM: The heart of the person before you is a mirror. See there your own form. SIKHISM: As you deem yourself, so deem others.

HINDUISM: This is the sum of duty: do nothing to others which if done to you would cause you pain.

TAOISM: Regard your neighbor’s gain as your own gain, and your neighbor’s loss as your own loss.

HUMANISM: Individual and social problems can only be resolved by means of human reason, intelligent effort, and critical thinking joined with compassion and a spirit of empathy for all living beings.

YORUBAN: One going to take a pointed stick to pinch a baby bird should first try it on himself to feel how it hurts. ZOROASTRIANISM: That nature alone is good which refrains from doing to another whatsoever is not good for itself.



Chapter Four Business Ethics, Corporate Social Responsibility, Corporate Governance, and Critical Thinking

For example, if one is able to claim an entitlement to a job, a place to live, food, and health care—regardless of how hard he is expected to work—motivations to pull one’s own weight and contribute to society and the greater good may be compromised, resulting in a financially unsustainable culture of dependency. The overlap between theories of ethics and their political policy implications is explored further as we turn our attention to justice theory.

Justice Theory In 1971, John Rawls published his

book A Theory of Justice, the philosophical underpinning for the bureaucratic welfare state. Based upon the principle of justice, Rawls reasoned that it was right for governments to redistribute wealth in order to help the poor and disadvantaged. He argued for a just distribution of society’s resources by which a society’s benefits and burdens are allocated fairly among its members. Rawls expressed this philosophy in his Greatest Equal Liberty Principle: Each person has an equal right to basic rights and liberties. He qualified or limited this principle with the Difference Principle: Social inequalities are acceptable only if they cannot be eliminated without making the worst-off class even worse off. The basic structure is perfectly just, he wrote, when the prospects of the least fortunate are as great as they can be. Rawls’s justice theory has application in the business context. Justice theory requires decision makers to be guided by fairness and impartiality and to take seriously what outcomes these principles produce. In the business context, justice theory prompts leadership to ask: Are our employees getting what they deserve? It would mean, for example, that a business deciding in which of two communities to build a new manufacturing plant should consider which community has the greater need for economic development. Chief among Rawls’s critics was his Harvard colleague Robert Nozick. Nozick argued that the rights of the individual are primary and that nothing more was justified than a minimal government that protected against violence and theft and ensured the enforcement of contracts. Nozick espoused a libertarian view that unequal distribution of wealth is moral if there is equal opportunity. Applied to the business context, Nozick’s formulation of justice would permit a business to choose between two manufacturing plant sites after giving each community the opportunity to make its best bid for the plant. Instead of picking the community most in need, the business may pick the one offering the best deal. Strengths of Justice Theory The strength of Rawls’s justice theory lies in its basic premise that society owes a duty to protect those who are least advantaged—that

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is, positioned unfairly vis-à-vis the distribution of social goods. Its motives are consistent with the religious and secular philosophies that urge humans to help those in need. Many religions and cultures hold basic to their faith the assistance of those who are less fortunate. Criticisms of Justice Theory Rawls’s justice theory shares some of the criticisms of rights theory. It treats equality as an absolute, without examining the potential costs of producing equality, including reduced incentives for innovation, entrepreneurship, and production. Moreover, any attempt to rearrange social benefits requires an accurate measurement of current wealth. For example, if a business is unable to measure accurately which employees are in greater need of benefits due to their wealth level, application of justice theory may make the business a Robin Hood in reverse: taking from the poor to give to the rich.

Utilitarianism Utilitarianism

requires a decision maker to maximize utility for society as a whole. Maximizing utility means achieving the highest level of satisfactions over dissatisfactions. This means that a person must consider the benefits and costs of his actions to everyone in society. A utilitarian will act only if the benefits of the action to society outweigh the societal costs of the action. Note that the focus is on society as a whole. This means a decision maker may be required to do something that harms her if society as a whole is benefited by her action. A teleological theory, utilitarianism judges our actions as good or bad depending on their consequences. This is sometimes expressed as “the ends justify the means.” Utilitarianism is most identified with 19th-century philosophers Jeremy Bentham and John Stuart Mill. Bentham argued that maximizing utility meant achieving the greatest overall balance of pleasure over pain. A critic of utilitarianism, Thomas Carlyle, called utilitarianism “pig philosophy” because it appeared to base the goal of ethics on the swinish pleasures of the multitude. Mill thought Bentham’s approach too narrow and broadened the definition of utility to include satisfactions such as health, knowledge, friendship, and aesthetic delights. Responding to Carlyle’s criticisms, Mill also wrote that some satisfactions count more than others. For example, the pleasure of seeing wild animals free in the world may be a greater satisfaction morally than shooting them and seeing them stuffed in one’s den. How does utilitarianism work in practice? It requires that you consider not just the impact of decisions on yourself, your family, and your friends, but also the impact on everyone in society. Before deciding whether to ride a bicycle

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to school or work rather than to drive a car, a utilitarian would consider the wear and tear on her clothes, the time saved or lost by riding a bike, the displeasure of riding in bad weather, her improved physical condition, her feeling of satisfaction for not using fossil fuels, the cost of buying more food to fuel her body for the bike trips, the dangers of riding near automobile traffic, and a host of other factors that affect her satisfaction and dissatisfaction. But her utilitarian analysis doesn’t stop there. She has to consider her decision’s effect on the rest of society. Will she interfere with automobile traffic flow and decrease the driving pleasure of automobile drivers? Will commuters be encouraged to ride as she does and benefit from doing so? Will her lower use of gasoline for her car reduce demand and consumption of fossil fuels, saving money for car drivers and reducing pollution? Will her and other bike riders’ increased food consumption drive up food prices and make it less affordable for poor families? This only scratches the surface of her utilitarian analysis. The process we used earlier, act utilitarianism, judges each act separately, assessing a single act’s benefits and costs to society’s members. Obviously, a person cannot make an act utilitarian analysis for every decision. It would take too much time and many variables are difficult to calculate. Utilitarianism recognizes that human limitation. Rule utilitarianism judges actions by a rule that over the long run maximizes benefits over costs. For example, you may find that taking a shower every morning before school or work maximizes society’s satisfactions, as a rule. Most days, people around you will be benefited by not having to smell noisome odors, and your personal and professional prospects will improve by practicing good hygiene. Therefore, you are likely to be a rule utilitarian and shower each morning, even though some days you may not contact other people. Many of the habits we have are the result of rule utilitarian analysis. Likewise, many business practices, such as a retailer’s regular starting and closing times, also are based in rule utilitarianism. Strengths of Utilitarianism What are the strengths of utilitarianism as a guide for ethical conduct? It is easy to articulate the standard of conduct: You merely need to do what is best for society as a whole. Moreover, many find it intuitive to employ an ethical reasoning that seeks to maximize human flourishing and eliminate harm or suffering. Criticisms of Utilitarianism Those strengths also expose some of the criticisms of utilitarianism as an ethical construct. It is difficult to measure one’s own pleasures

and pains and satisfactions and dissatisfactions, let alone those of all of society’s members. In short, how does one adequately and accurately measure human flourishing? In addition, those benefits and costs are inevitably distributed unequally across society’s members. It can foster a tyranny of the majority that may result in morally monstrous behavior, such as a decision by a 100,000-person community to use a lake as a dump for human waste because only one person otherwise uses or draws drinking water from the lake. That example exhibits how utilitarianism differs from rights theory. While rights theory may protect a person’s right to clean drinking water regardless of its cost, utilitarianism considers the benefits and costs of that right as only one factor in the total mix of society’s benefits and costs. In some cases, the cost of interfering with someone’s right may outweigh the benefits to society, resulting in the same decision that rights theory produces. But where rights theory is essentially a one-factor analysis, utilitarianism requires a consideration of that factor and a host of others as well, in an attempt to balance pleasure over pain. A final criticism of utilitarianism is that it is not constrained by law. Certainly, the law is a factor in utilitarian analysis. Utilitarian analysis must consider, for example, the dissatisfactions fostered by not complying with the law and by creating an environment of lawlessness in a society. Yet the law is only one factor in utilitarian analysis. The pains caused by violating the law may be offset by benefits the violation produces. Rational actors may ultimately determine that the cost–benefit analysis justifies deviation from a law or rule. Most people, however, are rule utilitarian when it comes to law, deciding that obeying the law in the long run maximizes social utility.

Shareholder Theory Premised

on the concept that corporate leaders are agents who owe contractual obligations to investors, shareholder theory argues that ethical dilemmas should be resolved with a focus on maximizing the firm’s long-term profits within the limits of the law. It is based in the laissez faire theory of capitalism first expressed by Adam Smith in the 18th century and more recently promoted by the Nobel Prize–winning economist Milton Friedman. Laissez faire economists argue total social welfare is optimized if humans are permitted to work toward their own selfish goals. The role of government, law, and regulation is solely to ensure the workings of a free market by not interfering with economic liberty, by eliminating collusion among competitors, and by promoting accurate information in the marketplace. By focusing on results—maximizing total social welfare through a corporate focus on profit maximization— a shareholder theory approach to ethical decisions is a



Chapter Four Business Ethics, Corporate Social Responsibility, Corporate Governance, and Critical Thinking

teleological- or consequences-oriented ethical theory. It is closely related to utilitarianism, but it differs fundamentally in how ethical decisions are made. While utilitarianism considers all stakeholders as it seeks to maximize social utility by focusing the actor on a broad-based creation of social value and reduction in social harm, a shareholder approach to profit maximization optimizes total social utility by narrowing the actor’s focus, requiring the decision maker to make a wealth-maximizing decision that is focused on enhancing profits for those investors or shareholders who can claim a direct financial interest in the organization’s bottom line. Strengths of Focusing on Profit Maximization By working in our own interests, we compete for society’s scarce resources (iron ore, labor, and land, to name a few), which are allocated to those people and businesses that can use them most productively. By allocating society’s resources to their most efficient uses, as determined by a free market, shareholder theory claims to maximize total social utility or benefits. Thus, in theory, society as a whole is bettered if all of us compete freely for its resources by trying to increase our personal or organizational profits. If we fail to maximize profits, some of society’s resources will be allocated to less productive uses that reduce society’s total welfare. In addition, shareholder theory emphasizes that a commitment first and foremost to profit maximization must always be constrained by what is permitted under the law. A profit maximizer theoretically acts ethically by complying with society’s mores as expressed in its laws. Moreover, the emphasis on profit maximization requires the decision maker and business to be disciplined according to the dictates of the marketplace. Consequently, an analysis of the ethical issue pursuant to shareholder theory probably requires a decision maker to consider the rights protected by rights theory, especially the shareholder’s or investor’s contractual rights to a return on investment, as well as fairness dictates embedded in justice theory. Ignoring important rights of employees, customers, suppliers, communities, and other stakeholders may negatively impact a corporation’s long-term profits. A business that engages in behavior that is judged unethical by consumers and other members of society is subject to boycotts, adverse publicity, demands for more restrictive laws, and other reactions that damage its image, decrease its revenue, and increase its costs. Consider, for example, the reduced sales of Martha Stewart–branded goods at Kmart after Ms. Stewart was accused of trading ImClone stock while possessing inside information. Consider also the fewer number of college

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graduates willing to work for Waste Management Inc. in the wake of adverse publicity and indictments against its executives for misstating its financial results. Note also the higher cost of capital for firms like Dell as investors bid down the stock price of companies accused of accounting irregularities and other wrongdoing. All these reactions to perceived unethical conduct impact the business’s profitability in the short and long run, motivating that business to make decisions that comply with ethical views that transcend legal requirements. Criticisms of Focusing on Profit Maximization The strengths of shareholder theory’s emphasis on profit maximization as a model for ethical behavior also suggest criticisms and weaknesses of the theory. Striking at the heart of the theory is the criticism that corporate managers are subject to human failings that make it impossible for them to maximize corporate profits. The failure to discover and process all relevant information and varying levels of aversion to risk can result in one manager making a different decision than another manager. Group decision making in the business context introduces other dynamics that interfere with rational decision making. Social psychologists have found that groups often accept a higher level of risk than they would as individuals. There is also the tendency of a group to internalize the group’s values and suppress critical thought. Furthermore, even if an emphasis on profit maximization results in an efficient allocation of society’s resources and maximization of total social welfare, it does not concern itself with how wealth is allocated within society. In the United States, the top wealthiest 1 percent own more than 40 percent of the nation’s wealth, and globally, it is estimated that 26 individuals control more wealth than the combined wealth of 50 percent of the global population. To some people, those levels of wealth disparity are unacceptable. To laissez faire economists, wealth disparity is an inevitable component of a free market that rewards hard work, acquired skills, innovation, and risk taking. Yet critics of shareholder theory’s emphasis on profit maximization respond that market imperfections, structural barriers, and a person’s position in life at birth interfere with his ability to compete. Critics charge that the ability of laws and market forces to control corporate behavior is limited because it requires lawmakers, consumers, employees, and other constituents to detect unethical corporate acts and take appropriate steps. Even if consumers notice irresponsible behavior and inform a corporation, a bureaucratic corporate structure may interfere with the information being received by the proper person inside the corporation. If, instead,

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consumers are silent and refuse to buy corporate products because of perceived unethical acts, corporate management may notice a decrease in sales, yet attribute it to something other than the corporation’s unethical behavior. Critics also argue that equating ethical behavior with legal compliance is a tautology in countries like the United States where businesses distort the lawmaking process by lobbying legislators and making political contributions. It cannot be ethical, they argue, for businesses to merely comply with laws reflecting the interests of businesses and over which corporations have enormous influence post–Citizens United. Proponents of the emphasis on profit maximization respond that many laws restraining businesses are passed despite businesses lobbying against those laws. The Sarbanes–Oxley Act, which increases penalties for wrongdoing executives, requires CEOs to certify financial statements, and imposes internal governance rules on public companies, is such an example. So are laws restricting drug companies from selling a drug unless it is approved by the Food and Drug Administration and requiring environmental impact studies before a business may construct a new manufacturing plant. Moreover, businesses are nothing other than a collection of individual stakeholders, which includes employees, shareholders, and their communities. When they act to influence political policies or lobby for legal or regulatory change, their advocacy is arguably in the best interests of all these stakeholders.

Critics respond that ethics transcends law, requiring, in some situations, that businesses adhere to a higher standard than required by law. We understand this in our personal lives. For example, despite the absence of law dictating, for the most part, how we treat friends, we know that ethical behavior requires us to be loyal to friends and to spend time with them when they need our help. In the business context, a firm may be permitted to release employees for nearly any reason, except the few legally banned bases of discrimination (such as race, age, and gender), yet some critics will argue businesses should not terminate an employee for other reasons currently not banned by most laws (such as sexual orientation or appearance). Moreover, these critics further argue that businesses—due to their influential role in a modern society—should be leaders in setting a standard for ethical conduct. Those who emphasize profit maximization respond that such an ethical standard is difficult to define and hampers efficient decision making. Moreover, they argue that experience shows the law has been a particularly relevant definition of ethical conduct. Consider that many corporate scandals would have been prevented had the executives merely complied with the law and had existing regulations been enforced. For example, Enron executives illegally kept some liabilities off the firm’s financial statements, while regulatory oversight also failed. Tyco and Adelphia executives illegally looted corporate assets. Had these executives

Ethics and Compliance in Action Minimum Wage Laws In recent years, debate has raged over whether governments in the United States should increase dramatically the federal or state minimum wage that most employers must pay employees, from about $7 per hour to as much as $15 per hour. In 2015, the City of Seattle increased its minimum wage of city workers to $15 per hour, and New York City followed suit in 2019. Between 2020 and 2025, Washington, D.C.; New Jersey; Massachusetts; Maryland; Illinois; and California are scheduled to see similar increases. The efforts to increase the minimum wage are directed mostly against McDonald’s, Walmart, and other employers who employ large numbers of low-skilled or inexperienced workers. For example, one 26-year-old woman who worked at a Chicago McDonald’s as a cashier for 10 years claimed she could not support her two children on the wage paid by McDonald’s. Should a government protect employees by increasing the minimum wage? If a minimum wage is imposed by government, what is the right wage? A $15-per-hour wage translates into

annual compensation of $30,000, hardly enough to support a family. Should the minimum wage be $25 per hour? Why not make it $50 per hour, which would be $100,000 annual income, enough to permit most families to survive quite well? Why should government impose a minimum wage on private employers? Are employees without power to demand higher wages? Will a minimum wage distort the employment market? Do employees deserve higher wages than the amount they and their employers agree on? Does a high minimum wage encourage workers to remain in low-skill jobs rather than improving their skills and qualifying for higher-wage jobs? Should a 42-year-old woman be required to improve her lot in life by increasing her education rather than continuing to do a job that any 16-year-old can do? What social barriers or structural inequities might exist to hinder some in society from gaining necessary skills and improving access to better employment options? Do the answers to those questions depend on the ethical theory to which one subscribes?



Chapter Four Business Ethics, Corporate Social Responsibility, Corporate Governance, and Critical Thinking

simply complied with the law and maximized their firms’ long-run profits, none of those ethical debacles would have occurred. Critics of profit maximization respond that the corporate crises at companies like Enron and WorldCom prove that flaws in corporate governance encourage executives to act unethically. These examples, critics say, show that many executives do not maximize profits for their firms. Instead, driven by short-term, quarterly financial expectations, they maximize their own profits at the expense of the firm and its shareholders. They claim that stock options and other incentives intended to align the interests of executives with those of shareholders promote decisions that raise short-term profits to the long-run detriment of the firms. They point out that many CEOs and other top executives negotiate compensation plans that do not require them to stay with the firm long term and that allow them to benefit enormously from short-term profit taking. Executive greed, encouraged by these perverse executive compensation plans, also encourage CEOs and other executives to violate the law. Defenders of business, profit maximization, and capitalist economics point out that it is nearly impossible to stop someone who is bent on fraud. A dishonest executive will lie to shareholders, creditors, board members, and the public and also treat the law as optional. Yet enlightened proponents of the modern corporation accept that there are problems with corporate management culture that require changes. They know that an unconstrained CEO; ethically uneducated executives; perverse compensation incentives; and inadequate supervision of executives by the firm’s CEOs, board of directors, and shareholders present golden opportunities to the unscrupulous person and make unwitting accomplices of the ignorant and the powerless. Such an awareness highlights the role of corporate culture—for example, an ethical climate—in fostering an environment in which individuals are supported in their desire to act and live according to their moral compass. Finally, divining the shareholders’ ethical viewpoint may be difficult. While nearly all shareholders are mostly profit driven, a small minority of shareholders have other agendas, such as protecting the environment or workers’ rights, regardless of the cost to the corporation. It is often not possible to please all shareholders. Nonetheless, increasing shareholder democracy by enhancing the shareholders’ role in the nomination and election of board members is essential to uniting the interests of shareholders and management. So is facilitating the ability of shareholders to bring proposals for ethical policy to a vote of shareholders. In the past several years, for public companies at least, the Securities and Exchange

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Commission has taken several steps to increase shareholder democracy. These steps, which are covered fully in Chapter 45, are having their intended effect. For example, during the 2014 shareholder meeting season, shareholder proposals included requiring annual election of directors and limiting corporate political lobbying and contributions. Moreover, the New York Stock Exchange and NASDAQ require companies listed on those exchanges to submit for shareholder approval certain actions, such as approval of stock option plans.

Virtue Theory Differing from both the deontologi-

cal emphasis on rights and justice flowing from duties and responsibilities, as well as the teleological focus on consequences and outcomes (measured according to either a utilitarian or profit maximization calculus), is a third approach to ethical analysis that highlights the importance of character—for both individuals and an organization. Virtue theory demands that an individual know his values and how they correlate to his identity, habits, and ways of engaging with others. Focusing on an intentional pursuit of virtues, the theory emphasizes questions such as: Who are you? What values are most important to you? Are my stated values and the actions I take aligned? For an organization, the theory inquires: What is your corporate purpose? What are your corporate values? Are our corporate actions and our values integrated?  Virtue theory, therefore, approaches ethical dilemmas from a commitment to integrity and an emphasis on character development. Deontological and teleological considerations are still important components of the ethical analysis, but the starting point is different. Instead of focusing on what action is right, virtue theory focuses on whether the individual (or the corporation) is acting consistently with those virtues or values that will result in a life well lived.   As developed in the West, a virtue-oriented approach owes much to Aristotle and other Greek philosophers, who explored practical notions of the good life and how best to achieve it. In the East, virtue theory was largely cultivated by Confucius, who focused on the centrality of benevolence and righteousness as hallmarks in the development of character. In short, a virtue theory approach emphasizes the person and the daily struggle to become a better person through identification and cultivation—or habituation—of virtues, such as wisdom or courage or benevolence.  As an example, consider a person in need of help. A deontologist might offer assistance out of a sense of duty or responsibility or allegiance to the Golden Rule. A utilitarian might offer aid because the consequences would result in a maximization of overall well-being. One acting according to virtue theory, however, would be helping out of desire to

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become a more charitable or benevolent person. The giving of aid would flow from a commitment to becoming a person who gives aid. In this instance, one might imagine that a virtue theorist would have predetermined that she values the virtues of charity and benevolence. Upon confronting an opportunity to help someone in need, she would simply have acted in a way that promoted these virtues and made them more habitual in the person’s daily activity.  Strengths of Virtue Theory As noted in the previous discussion, acting with regard to one’s self-interest is a hallmark of the human condition. Virtue theory offers an opportunity to convert impulses at the heart of selfishness and greed into opportunities to act with a self-interested focus to become more personally virtuous and integrated with regard to one’s values, actions, and the habits we wish to cultivate. In organizations, virtue theory can create an aspirational climate and an additional way of emphasizing the importance of manifesting those corporate values that may otherwise be seen as mere words on a website or posters in the break room. Moreover, virtue theory’s focus on the development of practical wisdom—that is, moral imagination and sound judgment honed by experience—creates space and structure to encourage personal growth and continuous teaching and training of employees.   Additional value brought by a virtue approach to ethics is its appreciation for the ambiguity of dilemmas where simple maxims or principles are not adequate to the maintenance of human relationships nor accommodating to the complexity of human emotions. Criticisms of Virtue Theory Some critics argue that virtue theory is ultimately too subjective, too limited in scope, and too difficult to codify to be useful, especially in the corporate context. Certainly, those deontologists or teleologists seeking a universally applicable code of ethics may be unsatisfied, but then any such code is probably unrealistic given the complexities of the 21st-century global business environment. Other concerns have been raised about the inability of virtue theory to apply in a diverse global business environment because virtues that might be recognized and celebrated in one part of the world might be different from those virtues recognized elsewhere. Indeed, cultural relativity is an important issue to be considered when conducting ethical analysis using any theory or framework, as notions of what constitutes “right” and “wrong” are frequently contested. 

Improving Corporate Governance and Corporate Social Responsibility Even if

we cannot stop all fraudulent executives, we can modify the corporate governance model to educate, motivate, and

supervise executives and thereby improve corporate social responsibility. Corporate critics have proposed a wide variety of cures, all of which have been implemented to some degree and with varying degrees of success. Ethics Codes Many large corporations and several industries have adopted codes of ethics or codes of conduct to guide executives and other employees. The Sarbanes– Oxley Act requires a public company to disclose whether it has adopted a code of ethics for senior financial officers and to disclose any change in the code or waiver of the code’s application. There are two popular views of such codes. One sees the codes as genuine efforts to foster ethical behavior within a firm or an industry. The other view regards them as thinly disguised attempts to make the firm function better, to mislead the public into believing the firm behaves ethically, to prevent the passage of legislation that would impose stricter constraints on business, or to limit competition under the veil of ethical standards. Even where the first view is correct, ethical codes fail to address concretely all possible forms of corporate misbehavior. Instead, they often emphasize either the behavior required for the firm’s effective internal function, such as not accepting gifts from customers, or the relations between competitors within a particular industry, such as prohibitions on some types of advertising. Better corporate ethics codes make clear that the corporation expects employees not to violate the law in a mistaken belief that loyalty to the corporation or corporate profitability requires it. Such codes work best, however, when a corporation also gives its employees an outlet for dealing with a superior’s request to do an unethical act. That outlet may be the corporate legal department, a corporate compliance/ethics officer, or even an anonymous reporting procedure. Ethical Instruction Some corporations require their employees to enroll in classes that teach ethical decision making. The idea is that a manager trained in ethical conduct will recognize unethical actions before they are taken and deter herself and the corporation from the unethical acts. While promising in theory, in practice, many managers are resistant to ethical training that requires them to examine their principles. They are reluctant to question a set of long-held principles with which they are comfortable. Therefore, there are some doubts whether managers are receptive to ethical instruction. Even if the training is accepted, will managers retain the ethical lessons of their training and use it, or will time and other job-related pressures force a manager to think only of completing the job at hand?



Chapter Four Business Ethics, Corporate Social Responsibility, Corporate Governance, and Critical Thinking

Moreover, what ethical values should be emphasized? Is it enough to teach only one, a few, or all the theories of ethical conduct? Corporations may favor the simplicity of a shareholder orientation that focuses on maximization of profits. But should a corporation also teach rights theory and expect its employees to follow it? How should concerns over justice and fair distribution of benefits and burdens be addressed?  Most major corporations today express their dedication to ethical decision making by having an ethics officer who is not only responsible for ethical instruction, but also in charge of ethical supervision. The ethics officer may attempt to instill ethical decision making as a component of daily corporate life by sensitizing employees to the perils of ignoring ethical issues. The ethics officer may also be a mentor or sounding board for all employees who face ethical issues. Whether an ethics officer is effective, however, is determined by the level of commitment top executives make to ethical behavior and the position and power granted to the ethics officer. For example, will top executives and the board of directors allow an ethics officer to nix an important deal on ethical grounds, or will they replace the ethics officer with another executive whose ethical views permit the deal? Therefore, probably more important than an ethics officer is a CEO with the character to do the right thing. Consider All Stakeholders’ Interests Utilitarianism analysis clearly requires an executive to consider a decision’s impact on all stakeholders. How else can one determine all the benefits and costs of the decision? Likewise, modern rights theory also dictates considering all stakeholders’ rights, including not compromising an important right unless trumped by another. Kant’s categorical imperative also mandates a concern for others by requiring one to act as one would require others to act. For those seeking to maximize profits, the wisdom of considering all stakeholders is apparent because ignoring the interests of any stakeholder may negatively affect profits. For example, a decision may affect a firm’s ability to attract high-quality employees, antagonize consumers, alienate suppliers, and motivate the public to lobby lawmakers to pass laws that increase a firm’s cost of doing business. This wisdom is reflected in the Guidelines for Ethical Decision Making, which you will learn in the next section. Nonetheless, there are challenges when a corporate manager considers the interests of all stakeholders. Beyond the enormity of identifying all stakeholders, stakeholders’ interests may conflict, requiring a compromise that harms some stakeholders and benefits others. In addition, the impact on each stakeholder group may be difficult to assess accurately.

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For example, if a manager is considering whether to terminate the 500 least productive employees during an economic downturn, the manager will note that shareholders will benefit from lower labor costs and consumers may find lower prices for goods, but the manager also knows that the terminated employees, their families, and their communities will likely suffer from the loss of income. Yet if the employees terminated are near retirement and have sizable retirement savings or if the termination motivates employees to return to college and seek better jobs, the impact on them, their families, and their communities may be minimal or even positive. On the other hand, if the manager makes the decision to retain the employees, shareholder wealth may decrease and economic inefficiency may result, which harms all society.

Independent Boards of Directors In some

of the instances in which corporate executives have acted unethically and violated the law, the board of directors was little more than a rubber stamp or a sounding board for the CEO and other top executives. The CEO handpicked a board that largely allowed the CEO to run the corporation with little board supervision. CEO domination of the board is a reality in most large corporations because the market for CEO talent has skewed the system in favor of CEOs. Few CEOs are willing to accept positions in which the board exercises real control. Often, therefore, a CEO determines which board members serve on the independent board nominating committee and selects who is nominated by the committee. Owing their positions to the CEO and earning handsome fees sometimes exceeding $100,000, many directors are reluctant to oppose the CEO’s plans. For more than four decades, corporate critics have demanded that corporate boards be made more independent of the CEO. The corporate ethical crises of recent years have increased those calls for independence. The New York Stock Exchange and NASDAQ require companies with securities listed on the exchanges to have a majority of directors independent of the company and top management. Their rules also require independent management compensation, board nomination, and audit committees. The Sarbanes–Oxley Act requires public companies to have board audit committees comprising only independent directors. One criticism of director independence rules is the belief that no director can remain independent after joining the board because every director receives compensation from the corporation. There is a concern that an independent director, whose compensation is high, will side with management to ensure his continuing nomination, election, and receipt of high fees.

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More extreme proposals of corporate critics include recommendations that all corporate stakeholders—such as labor, government, environmentalists, and communities— have representation on the board or that special directors or committees be given responsibility over special areas, such as consumer protection and workers’ rights. Other critics argue for contested elections for each board vacancy. Few corporations have adopted these recommendations. While honestly motivated, these laws and recommendations often fail to produce greater corporate social responsibility because they ignore the main reason for management’s domination of the board: the limited time, information, and resources that directors have. One solution is to give outside directors a full-time staff with power to acquire information within the corporation. This solution, while providing a check on management, also may produce inefficiency by creating another layer of management in the firm. In addition, some of the recommendations complicate management by making the board less cohesive. Conflicts between stakeholder representatives or between inside and outside directors may be difficult to resolve. For example, the board could be divided by disputes among shareholders who want more dividends, consumers who want lower prices, and employees who want higher wages. Changing the Internal Management Structure Some corporate critics argue that the historic shift of corporate powers away from a public corporation’s board and shareholders to its managers is irreversible. They recommend, therefore, that the best way to produce responsible corporate behavior is to change the corporation’s management structure. The main proponent of this view, Christopher Stone, recommended the creation of offices dedicated to areas such as environmental affairs and workers’ rights, higher educational requirements for officers in positions like occupational safety, and procedures to ensure that important information inside and outside the corporation is directed to the proper person within the corporation. He also recommended that corporations study certain important issues and create reports of the study before making decisions. These requirements aim to change the process by which corporations make decisions. The objective is to improve decision making by raising the competency of decision makers, increasing the amount of relevant information they hold, and enhancing the methodology by which decisions are made. More information held by more competent managers using better tools should produce better decisions. Two of the later sections in this chapter in part reflect these recommendations. The Guidelines for Ethical Decision Making

require a decision maker to study a decision carefully before making a decision. This includes acquiring all relevant facts, assessing a decision’s impact on each stakeholder, and considering the ethics of one’s decision from each ethical perspective. In addition, the Thinking Critically section will help you understand when fallacious thinking interferes with a manager’s ability to make good decisions. Eliminating Perverse Incentives and Supervising Management Even if a corporation modifies its internal management structure by improving the decision-making process, there are no guarantees more responsible decisions will result. To the extent unethical corporate behavior results from faulty perception and inadequate facts, a better decision-making process helps. But if a decision maker is motivated solely to increase short-term profits, irresponsible decisions may follow. When one examines closely recent corporate debacles, three things are clear: The corporate wrongdoers acted in their selfish interests; the corporate reward system encouraged them to act selfishly, illegally, and unethically; and the wrongdoers acted without effective supervision. These facts suggest other changes that should be made in the internal management structure. During the high-flying stock market of the 1990s, stock options were the compensation package preferred by highlevel corporate executives. Shareholders and boards of directors were more than willing to accommodate them. On one level, stock options seem to align the interests of executives with those of the corporation and its shareholders. Issued at an exercise price usually far above the current market price of the stock, stock options have no value until the corporation’s stock price exceeds the exercise price of the stock options. Thus, executives are motivated to increase the corporation’s profits, which should result in an increase in the stock’s market price. In the 1990s stock market, in which some stock prices were doubling yearly, the exercise price of executives’ stock options was quickly dwarfed by the market price. Executives exercised the stock options, buying and then selling stock and, in the process, generating profits for a single executive in the tens and hundreds of millions of dollars. Shareholders also benefited from the dramatic increase in the value of their stock. So what is the problem with stock options? As executives accepted more of their compensation in the form of stock options and became addicted to the lifestyle financed by them, some executives felt pressure to keep profits soaring to ever-higher levels. In companies like Enron and WorldCom, which had flawed business models and suspect accounting practices, some executives were encouraged to create business deals that had little, if any, economic justification and could be accounted for in ways that kept profits growing.



Chapter Four Business Ethics, Corporate Social Responsibility, Corporate Governance, and Critical Thinking

In what were essentially pyramid schemes, once the faulty economics of the deals were understood by prospective partners, no new deals were possible, and the schemes crashed like houses of cards. But until the schemes were discovered, many executives, including some who were part of the fraudulent schemes, pocketed tens and hundreds of millions of dollars in stock option profits. The Sarbanes–Oxley Act, as amended by the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, addressed this issue by requiring executive officers to disgorge any bonus and incentive-based or equitybased compensation received during the three-year period prior to which the corporation was required to restate its financial statements. It is easy to see how fraudulent actions subvert the objective of stock options to motivate executives to act in the best interests of shareholders. Adolph Berle, however, has argued for more than 50 years that stock options are flawed compensation devices that allow executives to profit when stock market prices rise in general, even when executives have no positive effect on profitability. He proposed that the best way to compensate executives is to allow them to trade on inside information they possess about a corporation’s prospects, information they possess because they helped produce those prospects. His proposal, however, is not likely ever to be legal compensation because insider trading creates the appearance that the securities markets are rigged. Even with incentives in place to encourage executives to inflate profits artificially, it is unlikely that the recent fraudulent schemes at Enron, WorldCom, and other companies would have occurred had there been better scrutiny of upper management and its actions by the CEO and the board of directors. At Enron, executives were given great freedom to create partnerships that allowed Enron to keep liabilities off the balance sheet yet generate income that arguably could be recognized in the current period. It is not surprising that this freedom from scrutiny, when combined with financial incentives to create the partnerships, resulted in executives creating partnerships that had little economic value to Enron. Better supervision of management is mostly the responsibility of the CEO, but the board of directors bears this duty also. We addressed earlier proposals to create boards of directors that are more nearly independent of the CEO and, therefore, better able to supervise the CEO and other top managers. Primarily, however, better supervision is a matter of attitude, or a willingness to devote time and effort to discover the actions of those under your charge and to challenge them to justify their actions. It is not unlike the responsibility a parent owes to a teenage child to scrutinize her actions and her friends to make sure that she is acting consistent with the values of the family. So, too,

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boards must make the effort to scrutinize their CEOs and hire CEOs who are able and willing to scrutinize the work of the managers below them. Yet directors must also be educated and experienced. Poor supervision of management has also been shown to be partly due to some directors’ ignorance of business disciplines like finance and accounting. Unless board members are able to understand accounting numbers and other information that suggests management wrongdoing, board scrutiny of management is a process with no substance.

The Law The law has been the primary means of con-

trolling corporate misdeeds. Lawmakers usually assume that corporations and executives are rational actors that can be deterred from unethical and socially irresponsible behavior by the threats law presents. Those threats are fines and civil damages, such as those imposed and increased by the Sarbanes–Oxley Act. For deterrence to work, however, corporate decision makers must know when the law’s penalties will be imposed, fear those penalties, and act rationally to avoid them. To some extent, the law’s ability to control executive misbehavior is limited. As we discussed earlier in this chapter, corporate lobbying may result in laws reflecting the views of corporations, not society as a whole. Some corporate executives may not know the law exists. Others may view the penalties merely as a cost of doing business. Some may think the risk of detection is so low that the corporation can avoid detection. Other executives believe they are above the law, that it does not apply to them out of arrogance or a belief that they know better than lawmakers. Some rationalize their violation of the law on the grounds that “everybody does it.” Nonetheless, for all its flaws, the law is an important means by which society controls business misconduct. Of all the devices for corporate control we have considered, only market forces and the law impose direct penalties for corporate misbehavior. Although legal rules have no special claim to moral correctness, at least they are knowable. Laws also are the result of an open political process in which competing arguments are made and evaluated. This cannot be said about the intuitions of a corporate ethics officer, edicts from public interest groups, or the theories of economists or philosophers, except to the extent they are reflected in law. Moreover, in mature political systems like the United States, respect for and adherence to law is a well-entrenched value. Where markets fail to promote socially responsible conduct, the law can do the job. For example, the antitrust laws discussed in Chapter 49, while still controversial, have eliminated the worst anticompetitive business practices. The federal securities laws examined in Chapters 45 and 46 arguably restored investor confidence in the securities markets after

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the stock market crash of 1929. Although environmentalists often demand more regulation, the environmental laws treated in Chapter 52 have improved the quality of water and reduced our exposure to toxic substances. Employment regulations discussed in Chapter 51—especially those banning employment discrimination—have forced significant changes in the American workplace. Thus, the law has an accomplished record as a corporate control device. Indeed, sometimes the law does the job too well, often imposing a maze of regulations that deter socially valuable profit seeking without producing comparable benefits. Former Fed chair Greenspan once wrote, “Government regulation is not an alternative means of protecting the consumer. It does not build quality into goods, or accuracy into information. Its sole ‘contribution’ is to substitute force and fear for incentive as the ‘protector’ of the consumer.” The hope was that the Sarbanes–Oxley Act would restore investor confidence in audited financial statements and corporate governance. A 2007 survey by Financial Executives International found that 69 percent of financial executives agreed that compliance with SOX section 404 resulted in more investor confidence in their companies’ financial reports. Fifty percent agreed that financial reports were more accurate. As for the cost of SOX compliance, a 2014 Protiviti report found that more than one-third of large companies (at least $10 billion in annual revenue) spent less than $500,000, while 30 percent spent more than $2 million.

Guidelines for Ethical Decision Making Now that you understand the basics of ethical theories and the issues in the corporate governance debate, how do you use this information to make decisions for your business that are ethical and socially responsible? That is, what

process will ensure that you have considered all the ethical ramifications and arrived at a decision that is good for your business, good for your community, good for society as a whole, and good for you. LO4-2

Apply the Guidelines for Ethical Decision Making to business and personal decisions.

Figure 4.1 lists nine factors in the Guidelines for Ethical Decision Making. Let’s consider each Guideline and explain how each helps you make better decisions.

What Facts Impact My Decision? This

is such an obvious component of any good decision that it hardly seems necessary to mention. Yet it is common that people make only a feeble attempt to acquire all the facts necessary to a good decision. Many people enter a decision-making process biased in favor of a particular option. As a result, they look only for facts that support that option. You have seen this done many times by your friends and opponents, and because you are an honest person, you have seen yourself do this as well from time to time. In addition, demands on our time, fatigue, laziness, ignorance of where to look for facts, and aversion to inconveniencing someone who has information contribute to a reluctance or inability to dig deep for relevant facts. Because good decisions cannot be made in a partial vacuum of information, it is important to recognize when you need to acquire more facts. That is primarily the function of your other classes, which may teach you how to make stock market investment decisions, how to audit a company’s financial records, and how to do marketing research. For our purposes, let’s consider this example. Suppose we work for a television manufacturing company that has a factory in Sacramento, California. Our company has placed

Figure 4.1  Guidelines for Ethical Decision Making 1. What FACTS impact my decision? 2. What are the ALTERNATIVES? 3. Who are the STAKEHOLDERS? 4. How do the alternatives impact SOCIETY AS A WHOLE? 5. How do the alternatives impact MY BUSINESS FIRM? 6. How do the alternatives impact ME, THE DECISION MAKER? 7. What are the ETHICS of each alternative? 8. What are the PRACTICAL CONSTRAINTS of each alternative? 9. What COURSE OF ACTION should be taken and how do we IMPLEMENT it?



Chapter Four Business Ethics, Corporate Social Responsibility, Corporate Governance, and Critical Thinking

you in charge of investigating the firm’s decision whether to move the factory to Juarez, Mexico. What facts are needed to make this decision, and where do you find those facts? Among the facts you need are: What are the firm’s labor costs in Sacramento, and what will those costs be in Juarez? How much will labor costs increase in subsequent years? What is the likelihood of good labor relations in each location? What is and will be the productivity level of employees in each city? What are and will be the transportation costs of moving the firm’s inventory to market? What impact will the move have on employees, their families, the communities, the schools, and other stakeholders in each community? Will Sacramento employees find other jobs in Sacramento or elsewhere? How much will we have to pay in severance pay? How will our customers and suppliers be affected by our decision? If we move to Juarez, will our customers boycott our products even if our televisions are better and cheaper than before? If we move, will our suppliers’ costs increase or decrease? How will our profitability be affected? How will shareholders view the decision? Who are our shareholders? Do we have a lot of Mexican shareholders, or do Americans dominate our shareholder list? What tax concessions and other benefits will the City of Sacramento give our firm if we promise to stay in Sacramento? What will Ciudad Juarez and the government of Mexico give us if we move to Juarez? How will our decision impact U.S.– Mexican economic and political relations? This looks like a lot of facts, but we have only scratched the surface. You can probably come up with another 100 facts that should be researched. To give you another example of how thorough managers must be to make prudent decisions, consider that the organizers for the Olympics and Boston Marathon must attempt to predict and prevent terrorist attacks. For the 2000 Summer Olympics in Sydney, Australia, organizers created 800 different terrorist scenarios before developing an antiterrorism plan. You can see that, to some extent, we are discussing other factors in the Guidelines as we garner facts. The factors do overlap to some degree. Note also that some of the facts you want to find are not facts at all, but estimates, such as cost and sales projections. We’ll discuss in the Eighth Guideline the practical problems with the facts we find.

What Are the Alternatives? A decision maker

must be thorough in listing the alternative courses of actions. For many of us, the temptation is to conclude that there are only two options: to do something or not to do something. Let’s take our decision whether to move our factory to Juarez, Mexico. You might think that the only choices are to stay in Sacramento or to move to Juarez. Yet there are several combinations that fall in between those extremes.

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For example, we could consider maintaining the factory in Sacramento temporarily, opening a smaller factory in Juarez, and gradually moving production to Mexico as employees in Sacramento retire. Another alternative is to offer jobs in the Juarez factory to all Sacramento employees who want to move. If per-unit labor costs in Sacramento are our concern, we could ask employees in Sacramento to accept lower wages and fringe benefits or to increase their productivity. There are many other alternatives that you can imagine. It is important to consider all reasonable alternatives. If you do not, you increase the risk that the best course of action was not chosen only because it was not considered.

Who Are the Stakeholders? In modern soci-

eties, where diversity is valued as an independent virtue, considering the impacts of your decision on the full range of society’s stakeholders has taken on great significance in prudent and ethical decision making. While a public corporation with thousands of shareholders obviously owes a duty to its shareholders to maximize shareholder wealth, corporate managers must also consider the interests of other important stakeholders, including employees, suppliers, customers, and the communities in which they live. Stakeholders also include society as a whole, which can be defined as narrowly as your country or more expansively as an economic union of countries, such as the European Union of 27 countries, or even the world as a whole. Not to be omitted from stakeholders is you, the decision maker who is also impacted by your decisions for your firm. The legitimacy of considering your own selfish interests will be considered fully in the Sixth Guideline. Listing all the stakeholders is not a goal by itself but helps the decision maker apply more completely other factors in the ethical Guidelines. Knowing whom your decision affects will help you find the facts you need. It also helps you evaluate the alternatives using the next three Guidelines: how the alternatives we have proposed impact society as a whole, your firm, and the decision maker.

How Do the Alternatives Impact Society as a Whole? We covered some aspects of this

Guideline earlier when we made an effort to discover all the facts that impact our decision. We can do a better job discovering the facts if we try to determine how our decision impacts society as a whole. For example, if the alternative we evaluate is keeping the factory in Sacramento after getting property tax and road building concessions from the City of Sacramento, how is society as a whole impacted? What effect will tax concessions have on the quality of Sacramento schools (most schools are funded with property taxes)? Will lower taxes

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cause the Sacramento infrastructure (roads and governmental services) to decline to the detriment of the ordinary citizen? Will the economic benefits to workers in Sacramento offset the harm to the economy and workers in Juarez? Will our firm’s receiving preferential concessions from the Sacramento government undermine the ordinary citizen’s faith in our political and economic institutions? Will we contribute to the feelings of some citizens that government grants privileges only to the powerful? Will our staying in Sacramento foster further economic growth in Sacramento? Will staying in Sacramento allow our suppliers to stay in business and continue to hire employees who will buy goods from groceries and malls in Sacramento? What impact will our decision have on efforts to create a global economy in which labor and goods can freely travel between countries? Will our decision increase international tension between the United States and Mexico? Note that the impact of our decision on society as a whole fits neatly with one of the ethical theories we discussed earlier: utilitarianism. Yet profit maximization, rights theory, and justice theory also require a consideration of societal impacts.

How Do the Alternatives Impact My Business Firm? The most obvious impact any alternative has on your firm is its effect on the firm’s bottom-line profitability. Yet that answer requires explaining because what you really want to know is what smaller things leading to profitability are impacted by an alternative. For example, if our decision is to keep the factory in ­Sacramento open temporarily and gradually move the plant to Juarez as retirements occur, what will happen to employee moral and productivity in Sacramento? Will our suppliers in Sacramento abandon us to serve more permanent clients instead? Will consumers in Sacramento and the rest of California boycott our televisions? Will they be able to convince other American laborers to boycott our TVs? Will a boycott generate adverse publicity and media coverage that will damage our brand name? Will investors view our firm as a riskier business, raising our cost of capital? Again, you can see some redundancy here as we work through the Guidelines, but that redundancy is all right because it ensures that we are examining all factors important to our decision.

How Do the Alternatives Impact Me, the Decision Maker? At first look, considering how a decision you make for your firm impacts you hardly seems to be a component of ethical and responsible decision making. The term selfish probably comes to mind.

Many of the corporate ethical debacles of the last few years comprised unethical and imprudent decisions that probably were motivated by the decision makers’ selfish interests. Mortgage brokers’ desires to earn large fees encouraged them to falsify borrowers’ financial status and to make imprudent loans to high-risk clients. Several of Enron’s off-balance-sheet partnerships, while apparently helping Enron’s financial position, lined the pockets of conflicted Enron executives holding stock options and receiving management fees from the partnerships. Despite these examples, merely because a decision benefits you, the decision maker, does not always mean it is imprudent or unethical. Even decisions by some Enron executives in the late 1990s, while motivated in part by the desire to increase the value of the executives’ stock options, could have been prudent and ethical if the off-balance-sheet partnerships had real economic value to Enron (as they did when Enron first created off-balance-sheet partnerships in the 1980s) and accounting for them complied with the law. At least two reasons explain why you can and should consider your own interest yet act ethically for your firm. First, as the decision maker, you are impacted by the decision. Whether deservedly or not, the decision maker is often credited or blamed for the success or failure of the course of action chosen. You may also be a stakeholder in other ways. For example, if you are an executive in the factory in Sacramento, you and your family may be required to move to Juarez (or El Paso, Texas, which borders Juarez) if the factory relocates. It is valid to consider a decision’s impact on you and your family, although it should not be given undue weight. A second, and more important, reason to consider your own interest is that your decision may be better for your firm and other stakeholders if you also consider your selfish interest. For example, suppose when you were charged to lead the inquiry into the firm’s decision whether to move to Juarez, it was made clear that the CEO preferred to close the Sacramento factory and move operations to Juarez. Suppose also that you would be required to move to Juarez. Your spouse has a well-paying job in Sacramento, and your teenage children are in a good school system and have very supportive friends. You have a strong relationship with your parents and siblings, who also live within 50 miles of your family in Sacramento. You believe that you and your family could find new friends and good schools in El Paso or Juarez, and the move would enhance your position in the firm and increase your chances of a promotion. Nonetheless, overall you and your spouse have determined that staying in the Sacramento area is best for your family. So you are considering quitting your job with the firm and finding another job in the Sacramento area rather than make an attempt to oppose the CEO’s preference.



Chapter Four Business Ethics, Corporate Social Responsibility, Corporate Governance, and Critical Thinking

If you quit your job, even in protest, you will have no role in the decision and your resignation will likely have no impact on the firm’s Sacramento–Juarez decision. Had you stayed with the firm, you could have led a diligent inquiry into all the facts that may have concluded that the prudent and ethical decision for the firm was to stay in Sacramento. Without your input and guidance, the firm may make a less prudent and ethical decision. You can think of other examples where acting selfishly also results in better decisions. Suppose a top-level accounting executive, to whom you are directly responsible, has violated accounting standards and the law by pressuring the firm’s auditors to book as income in the current year a contract that will not be performed for two years. You could quit your job and blow the whistle, but you may be viewed as a disgruntled employee and your story given no credibility. You could confront the executive, but you may lose your job or at least jeopardize your chances for a promotion while tipping off the executive, who will cover her tracks. As an alternative, the more effective solution may be to consider how you can keep your job and prospects for promotion while achieving your objective to blow the whistle on the executive. One alternative may be to go through appropriate channels in the firm, such as discussing the matter with the firm’s audit committee or legal counsel. Finding a way to keep your job will allow you to make an ethical decision that benefits your firm, whereas your quitting may leave the decision to someone else who would not act as prudently. The bottom line is this: While, sometimes, ethical conduct requires acting unselfishly, in other contexts, consideration of your self-interest is not only consistent with ethical conduct, but also necessary to produce a moral result.

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employees and other citizens of Sacramento. Another benefit of the move may be the reduced cost of the U.S. government dealing with illegal immigration as Mexican workers decide to work at our plant in Juarez. Another cost may be the increased labor cost for a Texas business that would have hired Mexican workers had we not hired them. If we define society as all countries in the North American Free Trade Agreement (NAFTA was signed by the United States, Mexico, and Canada), the benefit to workers in Juarez may completely offset the harm to workers in Sacramento. For example, the benefit to Juarez workers may be greater than the harm to Sacramento employees if many Juarez employees would otherwise be underemployed and Sacramento employees can find other work or are protected by a severance package or retirement plan. As we discussed earlier in the discussion of ethical theories, finding and weighing all the benefits and costs of an alternative are difficult tasks. Even if we reject this theory as the final determinant, it is a good exercise for ensuring that we maximize the number of facts we consider when making a decision.

What Would Someone Focused on Maximizing Profits Do? One following traditional shareholder theory and its emphasis on profit maximization would choose the alternative that produces the most long-run profits for the company, within the limits of the law. This may mean, for example, that the firm should keep the factory in Sacramento if that will produce the most profits for the next 10 to 15 years. This does not mean that the firm may ignore the impact of the decision on Juarez’s community and workers. It may be that moving to Juarez will create a more affluent population in Juarez and consequently increase the firm’s What Are the Ethics of Each Alternative?  television sales in Juarez. But that impact is judged not by Because our goal is to make a decision that is not only whether society as a whole is bettered (as with utilitarian prudent for the firm, but also ethical and defensible in the analysis) or whether Juarez workers are more deserving of event we are required to give an accounting for our actions, jobs (as with justice theory analysis), but is solely judged by we must consider the ethics of each alternative, not from how it impacts the firm’s bottom line. one but a variety of ethical viewpoints. Our stakeholders’ Nonetheless, profit maximization may compel a devalues comprise many ethical theories; ignoring any one cision maker to consider stakeholders other than the theory will likely cause an incomplete consideration of the corporation and its shareholders. A decision to move to issues and may result in unforeseen, regrettable outcomes. Juarez may mobilize American consumers to boycott our TVs, for example, or cause a public relations backlash if What Would a Utilitarian Do? A utilitarian would choose our Juarez employees receive wages far below our Sacrathe alternative that promises the highest net welfare to socimento workers. These and other impacts on corporate ety as a whole. If we define our society as the United States, stakeholders may negatively impact the firm’s profits.  moving to Juarez may nonetheless produce the highest Although projecting profits is not a precise science, net benefit because the benefits to American citizens from tools you learned in finance classes should enhance your a lower cost of televisions and to American shareholders ability to select an alternative that maximizes your firm’s from higher profits may more than offset the harm to our profits within the limits of the law.

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What Would a Rights Theorist Do? A follower of modern rights theory will determine whether anyone’s rights are negatively affected by an alternative. If several rights are affected, the rights theorist will determine which right is more important or trumps the other rights, and choose the alternative that respects the most important right. For example, if the alternative is to move to Juarez, the Sacramento employees, among others, are negatively affected. Yet if we do not move, potential employees in Juarez are harmed. Are these equal rights a mere wash, or is it more important to retain a job one already has than to be deprived of a job one has never had? Are other rights at work here, and how are they ranked? Is it more important to maintain manufacturing production in the firm’s home country for national security and trade balance reasons than to provide cheaper televisions for the firm’s customers? Does the right of all citizens to live in a global economy that spreads wealth worldwide and promotes international harmony trump all other rights? While apparently difficult to identify and rank valid rights, this theory has value even to a utilitarian and a profit maximizer. By examining rights that are espoused by various stakeholders, we are more likely to consider all the costs and benefits of our decision and know which rights can adversely affect the firm’s profitability if we fail to take them into account. What Would a Justice Theorist Do? A justice theorist would choose the alternative that allocates society’s benefits and burden most fairly. This requires the decision maker to consider whether everyone is getting what he deserves. If we follow the preaching of John Rawls, the firm should move to Juarez if the workers there are less advantaged than those in Sacramento, who may be protected by savings, severance packages, and retirement plans. If we follow Nozick’s libertarian approach, it is sufficient that the firm gives Sacramento workers an opportunity to compete for the plant by matching the offer the firm has received from Juarez workers. Under this analysis, if Sacramento workers fail to match the Juarez workers’ offer of lower wages, for example, it would be fair to move the factory to Juarez, even if Sacramento workers are denied their right to jobs. Even if the firm has difficulty determining who most deserves jobs with our firm, justice theory, like rights theory, helps the firm identify constituents who suffer from our decision and who can create problems impacting the firm’s profitability if the firm ignores their claims. What Does Virtue Theory Require? Virtue theory requires the decision maker to review those personal or

corporate virtues and values that are essential to the individual’s or organization’s flourishing. This approach acknowledges the fact that all business is communal and requires individuals working together in an effort to realize the good life. Virtue theory, therefore, would prompt decision makers to ask what decision is consistent with the corporate identity or character they wish to cultivate.  Practically speaking, this would involve revisiting the corporate statement of values and considering seriously what impact closing the Sacramento facility would have on the corporate culture internally and externally—that is, in terms of reputation in the market—and whether this impact is consistent with the pursuit of excellence in terms of those predetermined corporate values. Again, as noted earlier, this analysis is potentially more ambiguous than a mere determination of what maximizes profits or what produces an overall most efficient allocation of utility, but it does ensure reflection on the implications for a corporation or individual who wants to take seriously a commitment to integrity.  

What Are the Practical Constraints of Each Alternative? As we evaluate alternatives, it

is important to consider each alternative’s practical problems before we implement it. For example, is it feasible for us to implement an alternative? Do we have the necessary money, labor, and other resources? Suppose one alternative is to maintain our manufacturing plant in Sacramento as we open a new plant in Juarez, gradually shutting down the Sacramento plant as employees retire and quit. That alternative sounds like an ethical way to protect the jobs of all existing and prospective employees, but what are the costs of having two plants? Will the expense make that alternative infeasible? Will the additional expense make it difficult for the firm to compete with other TV manufacturers? Is it practicable to have a plant in Sacramento operating with only five employees who are 40 years old and will not retire for 15 years? It is also necessary to consider potential problems with the facts that have led us to each alternative. Did we find all the facts relevant to our decision? How certain are we of some facts? For example, are we confident about our projections of labor and transportation costs if we move to Juarez? Are we sure that sales of our products will drop insubstantially due to consumer boycotts?

What Course of Action Should Be Taken and How Do We Implement It? Ultimately, we

have to stop our analysis and make a decision by choosing one alternative. Yet even then our planning is not over. We must determine how to put the alternative into action. How do we implement it? Who announces the



Chapter Four Business Ethics, Corporate Social Responsibility, Corporate Governance, and Critical Thinking

decision? Who is told of the decision and when? Do some people, like our employee’s labor union, receive advance notice of our plans and have an opportunity to negotiate a better deal for our Sacramento employees? When do we tell shareholders, government officials, lenders, suppliers, investments analysts, and the media, and in what order? Do we antagonize a friend or an enemy and risk killing a deal if we inform someone too soon or too late? Finally, we have to prepare for the worst-case scenario. What do we do if, despite careful investigation, analysis, and planning, our course of action fails? Do we have backup plans? Have we anticipated all the possible ways our plan may fail and readied responses to those failures? In 1985, the Coca-Cola Company decided to change the flavor of Coke in response to Coke’s shrinking share of the cola market. Despite careful market research, Coca-Cola failed to anticipate Coke drinkers’ negative response to the new Coke formula and was caught without a response to the outcry. Within three months, Coca-Cola realized it had to revive the old Coke formula under the brand name Coca-Cola Classic. In the meantime, Coke lost significant market share to rival Pepsi. Today, one would expect Coke executives introducing a reformulated drink to predict more consumers’ reactions to the drink and to prepare a response to each reaction.

Knowing When to Use the Guidelines  You can probably see that following these factors will result in better decisions in a variety of contexts, including some that appear to have no ethical concerns. For example, in the next few years, most of you will consider what major course of study to select at college or what job to take with which firm in which industry. This framework can help you make a better analysis that should result in a better decision. The Guidelines can be used also to decide mundane matters in your personal life, such as whether to eat a high-fat hamburger or a healthful salad for lunch, whether to spend the next hour exercising at the gym or visiting a friend in the hospital, and whether or not to brush your teeth every day after lunch. But for most of us, using the Guidelines every day for every decision would occupy so much of our time that little could be accomplished, what is sometimes called “paralysis by analysis.” Practicality, therefore, requires us to use the Guidelines only for important decisions and those that create a potential for ethical problems. We can identify decisions requiring application of the Guidelines if we carefully reflect from time to time about what we have done and are doing. This requires us to examine our past, current, and future actions. It may not surprise you how seldom people, including business executives, carefully preview and review their

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actions. The pressures and pace of daily living give us little time to examine our lives critically. Most people are reluctant to look at themselves in the mirror and ask themselves whether they are doing the right thing for themselves, their families, their businesses, and their communities. Few know or follow the words of Socrates, “The unexamined life is not worth living.” Ask yourself whether you believe that mortgage brokers used anything like the Guidelines for Ethical Decision Making before signing low-income borrowers to loans exceeding $500,000. Did executives at bankrupt energy trader Enron consider any ethical issues before creating off-balance-sheet partnerships with no economic value to Enron? Do you think the employees at accounting firm Arthur Andersen carefully examined their decision to accept Enron’s accounting for off-balance-sheet partnerships? Merely by examining our past and prospective actions, we can better know when to apply the Guidelines. In the next to last section of this chapter, Resisting Requests to Act Unethically, you will learn additional tools to help you identify when to apply the Guidelines.

LOG ON Go to www.scu.edu/ethics This website maintained by the Markkula Center for Applied Ethics at the University of Santa Clara has links to business ethics resources and guides for ethical/moral decision making.

Thinking Critically Legal reasoning and ethical decision making both require one to think critically—that is, to evaluate arguments logically, honestly, and without bias in favor of your own arguments and against those of others. Thinking critically is a skill, and as with any skill, one can improve through greater awareness of common mistakes and intentional practice of those methods that will lead to improvement. LO4-3

Recognize critical thinking errors in your own and others’ arguments.

Even if someone uses the Guidelines for Ethical Decision Making, there is a risk that they have been misapplied if a person makes errors of logic or uses fallacious arguments. In this section, we want to help you identify when your arguments and thinking may be flawed and how to correct them. Equally important, we want to help you

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Part One Foundations of American Law

identify flaws in others’ thinking. The purpose is to help you think critically and not to accept at face value everything you read or hear and to be careful before you commit your arguments to paper or voice them. This chapter’s short coverage of critical thinking covers only a few of the errors of logic and argument that are covered in a college course or book devoted to the subject. Here are 15 common fallacies and errors in reasoning that, if learned, can help you become a more rigorous and careful thinker.

Non Sequiturs A non sequitur is a conclusion that

does not follow from the facts or premises one sets out. The speaker is missing the point or coming to an irrelevant conclusion. For example, suppose a consumer uses a corporation’s product and becomes ill. The consumer argues that because the corporation has lots of money, the corporation should pay for his medical expenses. Clearly, the consumer is missing the point. The issue is whether the corporation’s product caused his injuries, not whether money should be transferred from a wealthy corporation to a poor consumer. You see this also used when employees attempt to justify stealing pens, staplers, and paper from their employers. The typical non sequitur goes like this: “I don’t get paid enough, so I’ll take a few supplies. My employer won’t even miss them.” Business executives fall prey to this fallacy also. Our firm may consider which employees to let go during a downturn. Company policy may call for retaining the best employees in each department, yet instead we release those employees making the highest salary in each position in order to save more money. Our decision does not match the standards the company set for downsizing decisions and is a non sequitur, unless we admit that we have changed company policy.

Appeals to Pity A

common fallacy seen in the American press is the appeal to pity or compassion. This argument generates support for a proposition by focusing on a victim’s predicament. It usually is also a non sequitur. Examples are news stories about elderly, retired people who find it hard to afford expensive, life-prolonging drugs. None of these stories point out that many of these people squandered their incomes when working rather than saving for retirement. Appeals to pity are effective because humans are compassionate. We have to be careful, however, not to be distracted from the real issues at hand. For example, in the trial against accused 9/11 co-conspirator Zacarias Moussaoui, federal prosecutors wanted to introduce testimony by the families of the victims. While what the families of

9/11 suffered is terrible, the victims’ families hold no evidence of Moussaoui’s role in 9/11. Instead, their testimonies are appeals to pity likely to distract the jury from its main task of determining whether Moussaoui was a part of the 9/11 conspiracy. American presidents and other politicians often use appeals to pity, such as having a press conference with children behind the president while he opines about income inequality. Moreover, you see many appeals to pity used against corporations. Here is a typical argument: A corporation has a chemical plant near a neighborhood; children are getting sick and dying in the neighborhood; someone should pay for this suffering; the corporation should pay. You can also see that this reasoning is a non sequitur. Better reasoning requires one to determine not whether two events are coincidental or correlated, but whether one (the chemical plant) caused the other (the children’s illnesses).

False Analogies An analogy essentially argues that

because something is like something else in one or more ways, it is also like it in another respect. Arguers often use analogies to make a point vividly, and therefore analogies have strong appeal. Nonetheless, while some analogies are apt, we should make sure that the two situations are sufficiently similar to make the analogy valid. Suppose an executive argues that our bank should not make loans to lower-income borrowers because the bank will suffer huge losses like Countrywide Financial. This analogy may be invalid because we may do a better job verifying a borrower’s income and ability to repay a loan than did Countrywide. Analogies can also be used to generate support for a proposal, such as arguing that because Six Sigma worked for General Electric, it will work for our firm also. It is probable that factors other than Six Sigma contributed to GE’s success, factors our firm may or may not share with GE. Nonetheless, analogies can identify potential opportunities, which we should evaluate prudently to determine whether the analogy is valid. Analogies can also suggest potential problems that require us to examine a decision more carefully before committing to it.

Begging the Question An arguer begs the ques-

tion when she takes for granted or assumes the thing that she is setting out to prove. For example, you might say that we should tell the truth because lying is wrong. That is circular reasoning and makes no sense because telling the truth and not lying are the same things. Another example is arguing that democracy is the best form of government because the majority is always right. Examples of begging the question are difficult to identify sometimes because they are hidden in the language of



Chapter Four Business Ethics, Corporate Social Responsibility, Corporate Governance, and Critical Thinking

the speaker. It is best identified by looking for arguments that merely restate what the speaker or questioner has already stated, but in different words. For an example in the business context, consider this interchange between you and someone working under you. You: Can I trust these numbers you gave to me? Coworker: Yes, you can trust them. You: Why can I trust them? Coworker: Because I’m an honest person. The coworker used circular reasoning because whether the numbers can be trusted is determined by whether he is honest, yet he provided no proof of his honesty, such as his numbers being backed by facts.

Argumentum ad Populum Argumentum

ad populum means argument to the people. It is an emotional appeal to popular beliefs, values, or wants. The fallacy is that merely because many or all people believe something does not mean it is true. It is common for newspapers to poll its readers about current issues, such as support for a presidential decision. For example, a newspaper poll may show that 60 percent of Americans support the president. The people may be right, but it is also possible that the president’s supporters are wrong: They may be uninformed or base their support of the president on invalid reasoning. Arguments to the people are commonly used by corporations in advertisements, such as beer company ads showing friends having a good time while drinking beer. The point of such ads is that if you want to have a good time with friends, you should drink beer. While some beer drinkers do have fun with friends, you probably can also point to other people who drink beer alone.

Bandwagon Fallacy The

bandwagon fallacy is similar to argumentum ad populum. A bandwagon argument states that we should or should not do something merely because one or more other people or firms do or do not do it. Sports Illustrated quoted basketball player Diana Taurasi’s objection to being arrested for driving drunk: “Why me? Everyone drives drunk!” Some people justify cheating on their taxes for the same reason. This reasoning can be fallacious because probably not everyone is doing it, and even if many or all people do something, it is not necessarily right. For example, while some baseball players do use steroids, there are serious negative side effects including impotency and acute psychosis, which make its use risky. Cheating on taxes may be common, but it is still illegal and can result in the cheater’s imprisonment. Bandwagon thinking played a large part in the current credit crunch as many loan buyers like Bear Stearns bought

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high-risk loans only because their competitors were buying the loans, thereby encouraging lenders to continue to make high-risk loans.

Argumentum ad Baculum Argumentum

ad baculum means argument to club. The arguer uses threats or fear to bolster his position. This is a common argument in business and family settings. For example, when a parent asks a child to take out the garbage, the child may ask, “Why?” Some parents respond, “Because if you don’t, you’ll spend the rest of the afternoon in your room.” Such an argument is a non sequitur as well. In the business context, bosses explicitly and implicitly use the club, often generating support for their ideas from subordinates who fear they will not be promoted unless they support the boss’s plans. An executive who values input from subordinates will ensure that they do not perceive that the executive is wielding a club over them. Enron’s CFO Andrew Fastow used this argument against investment firm Goldman Sachs when it balked at lending money to Enron. He told Goldman that he would not do anything with a presentation Goldman had prepared unless it made the loan. By threatening to boycott a company’s products, consumers and other interest groups use this argument against corporations perceived to act unethically. It is one reason that profit maximization requires decision makers to consider a decision’s impact on all stakeholders.

Argumentum ad Hominem Argumentum ad ho-

minem means “argument against the man.” This tactic attacks the speaker, not his reasoning. For example, a Republican senator criticizes a Democratic senator who supports the withdrawal of American troops from a war zone by saying, “You can’t trust him. He never served in the armed forces.” Such an argument attacks the Democratic senator’s character, not the validity of his reasons for withdrawing troops. When a CEO proposes a new compensation plan for corporate executives, an opponent may argue, “Of course he wants the new plan. He’ll make a lot of money from it.” Again, this argument doesn’t address whether the plan is a good one or not; it only attacks the CEO’s motives. While the obvious conflict of interest the CEO has may cause us to doubt the sincerity of the reasons he presents for the plan (such as to attract and retain better management talent), merely pointing out this conflict does not rebut his reasons. One form of ad hominem argument is attacking a speaker’s consistency, such as, “Last year you argued for something different.” Another common form is appealing to personal circumstances. One woman may say to another, “As a woman, how can you be against corporate policies that

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Part One Foundations of American Law

set aside executive positions for women?” By personalizing the argument, the speaker is trying to distract the listener from the real issue. A proper response to the personal attack may be, “As a woman and a human, I believe in equal opportunity for all people. I see no need for any woman or me to have special privileges to compete with men. I can compete on my own. By having quotas, the corporation cheapens my accomplishments by suggesting that I need the quota. Why do you, as a woman, think you need a quota?” Guilt by association is the last ad hominem argument we will consider. This argument attacks the speaker by linking her to someone unpopular. For example, if you make the libertarian argument that government should not restrict or tax the consumption of marijuana, someone may attack you by saying, “Mass murderer Charles Manson also believed that.” Your attacker suggests that by believing as you do, you are as evil as Charles Manson. Some corporate critics use guilt by association to paint all executives as unethical people motivated to cheat their corporations. For example, if a CEO asks for stock options as part of her compensation package, someone may say, “Enron’s executives wanted stock options also.” The implication is that the CEO should not be trusted because some Enron executives who were corrupt also wanted stock options. No ad hominem argument is necessarily fallacious because a person’s character, motives, consistency, personal characteristics, and associations may suggest further scrutiny of a speaker’s arguments is necessary. However, merely attacking the speaker does not expose flaws in her arguments.

Argument from Authority Arguments

from authority rely on the quality of an expert or person in a position of authority, not the quality of the expert’s or authority’s argument. For example, if someone says, “The president says we need to stop drug trafficking in the United States, and that is good enough for me,” he has argued from authority. He and the president may have good reasons to stop drug trafficking, but we cannot know that from his statement. Another example is “Studies show that humans need to drink 10 glasses of water a day.” What studies? What were their methodologies? Did the sample sizes permit valid conclusions? A form of argument to authority is argument to reverence or respect, such as “Who are you to disagree with the CEO’s decision to terminate 5,000 employees?” The arguer is trying to get you to abandon your arguments, not because they are invalid, but because they conflict with the views of an authority. Your response to this question should not attack the CEO (to call the CEO an idiot would be ad hominem and also damage your prospects in the firm), but state the reasons you believe the company would be better off not terminating 5,000 employees.

It is natural to rely on authorities who have expertise in the area on which they speak. But should we give credibility to authorities speaking on matters outside the scope of their competency? For example, does the fact that Julia Roberts is an Academy Award–winning actress have any relevance when she is testifying before Congress about Rett Syndrome, a neurological disorder that leaves infants unable to communicate and control body functions? Is she any more credible as a Rett Syndrome authority because she narrated a film on the Discovery Health Channel about children afflicted with the disease? This chapter includes several examples of arguments from authority when we cite Kant, Bentham, Aristotle, and others who have formulated ethical theories. What makes their theories valid, however, is not whether they are recognized as experts, but whether their reasoning is sound.

False Cause This fallacy results from observing two

events and concluding that there is a causal link between them when there is no such link. Often we commit this fallacy because we do not attempt to find all the evidence proving or disproving the causal connection. For example, if as a store manager you change the opening hour for your store to 6 A.M. from 8 A.M, records for the first month of operation under the new hours may show an increase in revenue. While you may be tempted to infer that the revenue increase is due to the earlier opening hour, you should not make that conclusion until at the very least you examine store receipts showing the amount of revenue generated between 6 A.M. and 8 A.M. The increase in revenue could have resulted from improved general economic conditions unconnected to the new hours: People just had more money to spend. The fallacy of false cause is important to businesses, which need to make valid connections between events in order to judge the effectiveness of decisions. Whether, for example, new products and an improved customer relations program increase revenues and profits should be subjected to rigorous testing, not some superficial causal analysis. Measurement tools you learn in other business classes help you eliminate false causes.

The Gambler’s Fallacy This

fallacy results from the mistaken belief that independent prior outcomes affect future outcomes. Consider this example. Suppose you flip a coin five times and each time it comes up heads. What is the probability that the next coin flip will be heads? If you did not answer 50 percent, you committed the gambler’s fallacy. Each coin flip is an independent event, so no number of consecutive flips producing heads will reduce the likelihood that the next flip will also be heads. That individual probability is true even though the probability of flipping six consecutive heads is 0.5 to the sixth power, or only 1.5625 percent.



Chapter Four Business Ethics, Corporate Social Responsibility, Corporate Governance, and Critical Thinking

What is the relevance of the gambler’s fallacy to business? We believe and are taught that business managers and professionals with higher skills and better decision-making methods are more likely to be successful than those with lesser skills and worse methods. Yet we have not discussed the importance of luck or circumstance to success. When a corporation has five years of profits rising by 30 percent, is it due to good management or because of expanding consumer demand or any number of other reasons? If a mutual fund has seven years of annual returns of at least 15 ­percent, is the fund’s manager an investment genius or is she lucky? If it is just luck, one should not expect the luck to continue. The point is that you should not be seduced by a firm’s, manager’s, or even your own string of successes and immediately jump to the conclusion that the successes were the result of managerial excellence. Instead, you should use measurement tools taught in your finance, marketing, and other courses to determine the real reasons for success.

Reductio ad Absurdum Reductio ad absurdum

carries an argument to its logical end, without considering whether it is an inevitable or probable result. This is often called the slippery slope fallacy. For example, if I want to convince someone not to eat fast food, I might argue, “Eating fast food will cause you to put on weight. Putting on weight will make you overweight. Soon you will weigh 400 pounds and die of heart disease. Therefore, eating fast food leads to death. Don’t eat fast food.” In other words, if you started eating fast food, you are on a slippery slope and will not be able to stop until you die. Although you can see that this argument makes some sense, it is absurd for most people who eat fast food. Scientist Carl Sagan noted that the slippery slope argument is used by both sides of the abortion debate. One side says, “If we allow abortion in the first weeks of pregnancy, it will be impossible to prevent the killing of a full-term infant.” The other replies, “If the state prohibits abortion even in the ninth month, it will soon be telling us what to do with our bodies around the time of conception.” Business executives face this argument frequently. Human resource managers use it to justify not making exceptions to rules, such as saying, “If we allow you time off to go to your aunt’s funeral, we have to let anyone off any time they want.” Well, no, that was not what you were asking for. Executives who reason this way often are looking for administratively simple rules that do not require them to make distinctions. That is, they do not want to think hard or critically. Pushing an argument to its limits is a useful exercise in critical thinking, often helping us discover whether a claim has validity. The fallacy is carrying the argument to its extreme without recognizing and admitting that there are many steps along the way that are more likely consequences.

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Appeals to Tradition Appeals to tradition infer

that because something has been done a certain way in the past, it should be done the same way in the future. You probably have heard people say, “I don’t know why we do it, but we’ve always done it that way, and it’s always worked, so we’ll continue to do it that way.” Although there is some validity to continuing to do what has stood the test of time, the reasons a business strategy has succeeded in the past may be independent of the strategy itself. The gambler’s fallacy would suggest that perhaps we have just been lucky in the past. Also, changed circumstances may justify departing from previous ways of doing business. In November 2013, many retailers like Kmart, Walmart, Sears, and The Gap were criticized for opening their retail stores on Thanksgiving Day. Arguments against the openings were mostly appeals to tradition and to pity, that is, that workers in the past have been and should in the future be able to enjoy Thanksgiving Day with family instead of working. The arguments were also non sequiturs because critics of the openings continued to consume sports programming, TV shows, electricity, heat, gasoline, and other services provided by employees working on Thanksgiving Day.

The Lure of the New The opposite of an appeal

to tradition is the lure of the new, the idea that we should do or buy something merely because it is “just released” or “improved.” You see this common theme in advertising that promotes “new and improved” Tide or iPhone 11. Experience tells us that sometimes new products are better. But we can also recount examples of new car models with defects and new software with bugs that were fixed in a later version. The lure of the new is also a common theme in management theories as some managers have raced to embrace one new craze after another, depending on which is the hottest fad, be it Strategic Planning, Total Quality Management, Reengineering the Corporation, or Customer Relationship Management. The point here is the same. Avoid being dazzled by claims of newness. Evaluations of ideas should be based on substance.

Sunk Cost Fallacy The sunk cost fallacy is an at-

tempt to recover invested time, money, and other resources by spending still more time, money, or other resources. It is sometimes expressed as “throwing good money after bad.” Stock market investors do this often. They invest $30,000 in the latest tech stock. When the investment declines to $2,000, rather than evaluate whether it is better to withdraw that $2,000 and invest it elsewhere, an investor who falls for the sunk cost fallacy might say, “I can’t stop investing now, otherwise what I’ve invested so far will be lost.” While the latter part of the statement is true, the fallacy is in the first part. Of the money already invested, $28,000 is lost whether

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Part One Foundations of American Law

or not the investor continues to invest. If the tech stock is not a good investment at this time, the rational decision is to withdraw the remaining $2,000 and not invest more money. There are other statements that indicate business executives may fall victim to the sunk cost fallacy: “It’s too late for us to change plans now.” Or “If we could go back to square one, then we could make a different decision.” The best way to spend the firm’s remaining labor and money may be to continue a project. But that decision should be unaffected by a consideration of the labor and money already expended. The proper question is this: What project will give the firm the best return on its investment of money and other resources from this point forward? To continue to invest in a hopeless project is irrational and may be a pathetic attempt to delay having to face the consequences of a poor decision. A decision maker acts irrationally when he attempts to save face by throwing good money after bad. If you want a real-world example of ego falling prey to the sunk cost fallacy, consider that President Lyndon Johnson committed American soldiers to the Vietnam Conflict after he had determined that America and South Vietnam could never defeat the Viet Cong. By falling for the sunk cost fallacy, the United States lost billions of dollars and tens of thousands of soldiers in the pursuit of a hopeless cause.

LOG ON Go to www.fallacyfiles.org Maintained by Gary Curtis, The Fallacy Files cover more than 150 fallacies with links to explanations and valuable resources. Go to www.ethicsunwrapped.utexas.edu Ethics Unwrapped uses a fun and accessible video format to present the latest research from psychology, neuroscience, and behavioral economics explaining how biases and pressures can cloud our thinking and compromise our ethical decision making.

Common Characteristics of Poor Decision Making Most business managers during the course of their formal education in school or informal education on the job have learned most of the techniques we have discussed in this chapter for making ethical and well-reasoned decisions. Yet business managers continue to make unethical and poor decisions, most often in disregard of the very principles that they otherwise view as essential to good decision making. Each of us can also point to examples when we have failed to analyze a situation properly before making a decision, even though, at the time, we possessed the ability to make better decisions.

Why do we and other well-intentioned people make bad decisions? What is it that interferes with our ability to use all the decision-making tools at our disposal, resulting sometimes in unethical and even catastrophic decisions? What causes a basically honest accountant to agree to cook the books for his corporation? What causes a drug company to continue to market a drug when internal tests and user experience show a high incidence of harmful side effects? What causes a corporation to continue to operate a chemical plant when its safety systems have been shut down? While business scholars and other writers have suggested several attributes that commonly interfere with good decision making, we believe they can be distilled into three essential traits that are useful to you, a decision maker who has already learned the Guidelines for Ethical Decision Making and the most common critical thinking errors.

Failing to Remember Goals Friedrich

Nietzsche wrote, “Man’s most enduring stupidity is forgetting what he is trying to do.” If, for example, our company’s goal as a retailer is to garner a 30 percent market share in the retail market in five years, you may think that would translate into being dominant in each segment of our business, from housewares to video games. But should our retailer strive to dominate a market segment that is declining, such as portable cassette players, when the consumer market has clearly moved to smartphones and other digital recorders? If we focus on the wrong goal—dominating the cassette player market, which may not exist in five years—we have failed to remember our goal of acquiring a 30 percent overall market share. In another example, suppose we are a luxury homebuilder with two goals that go hand-in-hand: producing high-quality housing and maintaining an annual 15 percent return on equity. The first goal supports the second goal: By having a reputation for producing high-quality housing, we can charge more for our houses. Suppose, however, one of our project managers is under pressure to bring her development in line with cost projections. She decides, therefore, to use lower-quality, lower-cost materials. The consequence is we meet our profit target in the short run, but in the long run, when the shoddy materials are detected and our reputation is sullied, both of our goals of building high-quality housing and achieving a 15 percent return on equity will be compromised. Again, we have failed to remember the most important goal, maintaining high quality, which allowed us to achieve our ROE goal.

Overconfidence The

phenomenon known as overconfidence bias leads us to be more confident than we should be about the extent of our knowledge and our problem-solving skills. To the extent that this “been there, done that” mindset takes hold in a leader, her ability to



Chapter Four Business Ethics, Corporate Social Responsibility, Corporate Governance, and Critical Thinking

learn helpful lessons from the experiences of others may be compromised. In the realm of ethical decision making, the leader who thinks she has mastered everything important and has nothing more to learn may end up teaching those in the organization unfortunate lessons and may unknowingly influence the organization’s culture in an undesirable way. While confidence is a personal trait essential to success, overoptimism is one of the most common reasons for bad decisions. We all have heard ourselves and others say, “Don’t worry. Everything will work out OK.” That statement is likely a consequence of overconfidence, not careful analysis that is necessary to make sure everything will work out as we hope. There are several corollaries or other ways to express this overoptimism. Sometimes, business executives will do something that they know to be wrong with the belief that it is only a small or temporary wrong that will be fixed next year. They may rationalize that no one will notice the wrongdoing and that only big companies and big executives get caught, not small companies and little managers like them. Many major accounting scandals started small, rationalized as temporary attempts to cook the books that would be corrected in the following years when business turned around. As we now know, finance managers and accountants who thought things would turn around were being overconfident about the economy and their companies. Another aspect of overconfidence is confirmation bias; that is, we must be doing things the right way because all has gone well in the past. Or at least we have not been caught doing something wrong in the past, so we will not be caught in the future. In part, this reveals a thinking error we have studied: appeal to tradition. In the earlier homebuilder example, the project manager’s cutting quality in years past may not have been detected by homeowners who knew nothing about construction quality. And none of the project manager’s workers may have told top management about the project manager’s actions. That past, however, does not guarantee the future. New homeowners may be more knowledgeable, and future workers may inform management of the project manager’s quality-cutting actions.  If we are not careful, confirmation bias can also cause us to see what we want to see in a given situation and to engage in subconscious favorable spinning of potentially relevant facts even if those facts might fairly be treated as pointing in the other direction. Confirmation bias can cause us to miss the real lessons from an example that we think we are viewing objectively. To guard against the negative effects of confirmation bias and to learn as much as we can from an example or situation, we need to seek out and pay attention to possible disconfirming evidence: evidence indicating that our preferred position or view may not be correct.  

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Another consequence of overoptimism is believing that complex problems have simple solutions. That leads to the next common trait of bad decision making.

Complexity of the Issues Closely

aligned to and aggravated by overconfidence is the failure of decision makers to understand the complexity of an issue. A manager may perceive that the facts are simpler than reality and, therefore, not see that there is little margin for error. Consequently, the executive has not considered the full range of possible solutions and has failed to find the one solution that best matches the facts. Restated, the decision maker has not done all the investigation and thinking required by the Guidelines for Ethical Decision Making and, therefore, has not discovered all the facts and considered all the reasonable courses of action necessary to making a prudent decision. The impediments to knowing all the facts, understanding the complexity of a problem, and doing the hard work to create and evaluate all possible solutions to a problem are known to all of us. Fatigue, laziness, overconfidence, and forgetting goals play roles in promoting ignorance of critical facts. We may also want to be team players, by following the lead of a colleague or the order of a boss. These human tendencies deter us from making the effort to find the facts and to consider all options.

Resisting Requests to Act Unethically Even if we follow the Guidelines for Ethical Decision Making and avoid the pitfalls of fallacious reasoning, not everyone is a CEO or his own boss and able to make decisions that others are expected to follow. Sure, if you control a firm, you will do the right thing. But the reality is that for most people in the business world, other people make many decisions that you are asked to carry out. What do you do when asked to do something unethical? How can you resist a boss’s request to act unethically? What could employees at WorldCom have done when its CFO instructed them to falsify the firm’s books or mortgage brokers when their bosses asked them to falsify borrowers’ incomes? LO4-4

Utilize a process to make ethical decisions in the face of pressure from others.

Recognizing Unethical Requests and Bosses A person must recognize whether he has been asked to do something unethical. While this sounds simple considering we have spent most of this chapter helping you

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make just that kind of decision, there are structural problems that interfere with your ability to perform an ethical analysis when a boss or colleague asks you to do something. Many of us are inclined to be team players and “do as we are told” by a superior. Therefore, it is important to recognize any tendency to accept appeals to authority and to resist the temptation to follow orders blindly. We do not want to be like the Enron accounting employee who returned to his alma mater and was asked by a student, “What do you do at Enron?” When considering that question, a question he never posed to himself, he realized that his only job was to remove liabilities from Enron’s balance sheet. For most bosses’ orders, such an analysis will be unnecessary. Most of the time, a boss is herself ethical and will not ask us to do something wrong. But there are exceptions that require us to be on the lookout. Moreover, some bosses have questionable integrity, and they are more likely to give us unethical orders. Therefore, it will be helpful if we can identify bosses who have shaky ethics, for whom we should put up our ethical antennae when they come to us with a task. Business ethicists have attempted to identify executives with questionable integrity by their actions. Ethical bosses have the ability to “tell it like it is,” while those with less integrity say one thing and do another. Ethical bosses have the ability to acknowledge that they have failed, whereas those with low integrity often insist on being right all the time. Ethical bosses try to build a consensus before making an important decision; unethical bosses may generate support for their decisions with intimidation through anger and threats. Ethical bosses can think about the needs of others besides themselves. Bosses with low integrity who misuse their workers by asking them to act unethically often mistreat other people also, like secretaries and servers. If we pay attention to these details, we will be better able to consider the “source” when we are asked to do something by a boss and, therefore, more sensitive to the need to scrutinize the ethics of a boss’s request.

Buying Time If

we think a requested action is or might be unethical, what is done next? How can we refuse to do something a boss has ordered us to do? One key is to buy some time before you have to execute the boss’s order. Buying time allows you to find more facts, understand an act’s impact on the firm’s stakeholders, and evaluate the ethics of the action. It also lets you find other alternatives that achieve the boss’s objectives without compromising your values. Delay also gives you time to speak with the firm’s ethics officer and other confidants. How do you buy time? If the request is in an e-mail, you might delay responding to it. Or you could answer that you

have received the e-mail and will give your attention to it when you finish with the task you are working on. Similar tactics can be used with phone calls and other direct orders. Even a few hours can help your decision. Depending on the order and your ability to stack delay on top of delay, you may be able to give yourself days or weeks to find a solution to your dilemma. The most important reason for buying time is it allows you to seek advice and assistance from other people, especially those in the firm. That brings us to the next tactic for dealing with unethical requests.

Find a Mentor and a Peer Support Group  Having a support system is one of the most important keys to survival in any organization, and it is best to put a system in place when you start working at the firm. Your support system can improve and help defend your decisions. It can also give you access to executives who hold the power to overrule your boss. Your support system should include a mentor and a network of other employees with circumstances similar to your own. A mentor who is well established, well respected, and highly placed in the firm will help you negotiate the pitfalls that destroy employees who are ignorant of a firm’s culture. A mentor can be a sounding board for your decisions; she can provide information on those who can be expected to help you and those who could hurt you; she can advise you of the procedures you should follow to avoid antagonizing potential allies. A mentor can also defend you and provide protection when you oppose a boss’s decision. Many firms have a mentorship program, but if not or if your assigned mentor is deficient, you should find an appropriate mentor soon after you join the firm. Be sure to keep her updated regularly on what you are doing. By letting a mentor know that you care to keep her informed, she becomes invested in you and your career. You should also build a community of your peers by creating a network of other workers who share your values and interests. You may want to find others who joined the firm at about the same time you did, who are about the same age, who share your passion for the firm’s products and services, and who have strong ethical values. To cement the relationship, your peer support group should meet regularly, such as twice a week at work during 15-minute coffee breaks. This group can give you advice, help with difficult decisions, and unite to back up your ethical decisions.

Find Win–Win Solutions As

we learned from the Guidelines for Ethical Decision Making, many times there are more than the two options of doing and not doing something. There are a number of choices in between those



Chapter Four Business Ethics, Corporate Social Responsibility, Corporate Governance, and Critical Thinking

extremes, and the best solution may be one unconnected to them. For example, suppose your boss has ordered you to fire someone who works under you. The worker’s productivity may be lagging, and perhaps he has made a few costly mistakes. Yet you think it would be wrong to fire the worker at this time. What do you do? Find a win–win solution—that is, a compromise that works for you and your boss. First, discover your boss’s wants. Probably you will find that your boss wants an employee who makes no or few mistakes and has a certain level of productivity. Next determine what is needed for the affected employee to reach that level. If you find the employee is having emotional problems that interfere with his work, are they temporary or can we help him handle them? Can we make him more productive by giving him more training? Is the employee unmotivated or is he unaware that he lags behind other workers? Should we give him a warning and place him on probationary status for a month, releasing him if there is no satisfactory improvement? These alternatives may address your boss’s concerns about the employee without compromising your ethical values. In other contexts, you may need to approach your boss directly and show that her order is not right for the firm. Using the Guidelines for Ethical Decision Making and

valid arguments, you may be able to persuade your boss to accept your perspective and avoid an otherwise unethical decision. Finding a win–win solution is possible only when there is room for compromise. The Ethical Guidelines and logical arguments are effective when your boss respects reason and wants to act ethically. However, when you face an intractable executive demanding you do something illegal, a different response is needed.

Work within the Firm to Stop the Unethical Act Suppose you receive an order from an executive you

know or suspect to be corrupt. For example, a CFO is motivated to increase the price of the firm’s stock in order to make her stock options more valuable. She orders you to book in the current year revenue that, in fact, will not be received for at least two years, if ever. Booking that revenue would be fraudulent, unethical, and illegal. You are convinced the CFO knows of the illegality and will find someone else to book the revenue if you refuse. You probably will lose your job if you do not cooperate. What do you do? This is when your mentor, peer support group, and corporate ethics officer can help you. Your mentor may have access to the CEO or audit committee, who, if honest, should back you and fire the CFO. Your peer support group might

CONCEPT REVIEW Resisting Requests to Do Unethical Acts

Buy Time

Have a Mentor

Recognize Unethical Requests

Find Win–Win Solutions

Create a Peer Support Group

YOU

Work within the Firm to Stop Unethical Acts

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Consult the Firm's Ethics Officer

Be Willing to Lose Your Job

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have similar access. The corporate ethics officer, especially if she is a lawyer in the firm’s legal department, can also provide her backing and that of the legal department. There is one large caveat, however. While the situation just described should and probably will result in your support system rallying to your support, in other situations that are ethically ambiguous, you, your mentor, and your support group may find that fighting a battle against a top corporate executive ineffectively expends your and your colleagues’ political capital. In other words, you need to pick your battles carefully lest you and your colleagues at the firm be labeled whiners and troublemakers who unnecessarily seek intervention from higher-level corporate executives. This is why we have listed this alternative near the end of our discussion. In most situations, it is better to rely on your colleagues as advisors and to execute win–win solutions in cooperation with your boss. But if neither compromise nor other intrafirm tactics protect you from unethical requests, you are left with a final tactic.

Prepare to Lose Your Job This is the last tactic

because by quitting or losing your job, you are deprived of your ability to help the firm make ethical decisions. Only as an employee can you craft win–win solutions or work within the firm to do the right thing. But if a firm’s executives and its internal governance are so corrupted that neither compromise nor reason can steer the firm away from an unethical and illegal course, you must be willing to walk away from your job or be fired for standing up for your values. Do not want your job and the status it brings so much that you are willing to compromise more important values. It is tough losing a job when one has obligations to family, banks, and other creditors as well as aspirations for a better life. But if you prepare yourself financially from day one, putting away money for an ethical rainy day, you will protect more important values.

Leading Ethically The examples set by an organization’s leaders have a profound effect on the culture of an organization. If the examples are good, a healthy culture can result. But if the examples reflect little seriousness about ethics, a cornercutting culture may follow. Someday, perhaps today, you will be in charge of other people in your business organization. You may be managing a four-person team, you may be a vice president of marketing in charge of a department, or you may eventually be a CEO directing an entire company. You give the people under your charge tasks to complete, supervise their work, help them complete the tasks, and provide motivation and

feedback to ensure that the current job will be done well and that future work will be done better. So how do you also ensure that all those people under your charge act ethically? This is the daily challenge of ethical business leaders, who must not only act ethically themselves, but also promote ethical behavior of their workers.

Be Ethical LO4-5 Be an ethical leader.

No one can lead ethically who does not attempt—and mostly succeed—in behaving ethically in her business and personal life. Few underlings respect an unethical leader, and many will be tempted to rationalize their own unethical conduct when they see their leaders acting unethically. They fall prey to the bandwagon fallacy, arguing, for example, that because the CFO is doing something wrong, so may they. For the same reason, ethical behavior by good managers encourages ethical behavior by underlings, who often view their bosses as role models and guides for advancing in the corporation. If they see an ethical boss moving up in the business, they will believe that the system is fair and that they, too, by acting ethically, can advance at the firm. As Harvard business ethics professor Lynn Sharp Paine has noted, “Managers who fail to provide leadership and to institute systems that facilitate ethical conduct share responsibility with those who conceive, execute, and knowingly benefit from corporate misdeeds.”

Communicate the Firm’s Core Ethical Values For CEOs, creating, communicating, and em-

phasizing the firm’s core values are essential to creating an ethical environment that rubs off on all employees. For other managers, recommunicating and reemphasizing the firm’s value are also important. All public companies today have ethics codes, as do many smaller companies. Yet the CEO who leads ethically must continually emphasize in written messages and speeches the importance and necessity that everyone comply with the code. Other top-level managers, such as the vice president of finance, should ensure that their staffs understand the ethics code’s application to their corporate tasks and make ethical reviews part of the staffs’ annual evaluations. A lower-level manager who supervises a small staff for a single project should also do his part to encourage compliance with the ethics code by pointing out how the code relates to the project assignment and including ethics in the project team’s progress reports.



Chapter Four Business Ethics, Corporate Social Responsibility, Corporate Governance, and Critical Thinking

Connect Ethical Behavior with the Firm’s and Workers’ Best Interests It is one thing

to educate your staff about ethical behavior and another to obtain compliance. One good way to increase compliance with the firm’s core ethical values is to convince the staff that their best interests—and the firm’s—are met by acting ethically. Management should help employees understand that the firm’s profitability and the employee’s advancement in the firm are optimized by each employee taking responsibility for acting ethically. Staff must understand that adverse publicity caused by unethical conduct harms a firm’s ability to promote itself and its products and services. The ethical manager also clearly establishes ethical behavior as a prerequisite for salary increases and promotions, or at least that unethical behavior is a disqualifier. 

Reinforce Ethical Behavior When a manager

knows a staff member has acted ethically in a situation in which employees in less ethical firms would be tempted to act unethically, the manager should congratulate and find other ways to reinforce the staff member’s behavior. For example, if a staff member reports that a supplier has attempted to bribe him in order to do business with the firm, the ethical manager will praise the staff member and may include a letter commending him in his employment file. In addition, management should set up a mechanism for its employees to report instances of unethical behavior by the staff. While some employees will view whistle-blowing as an act of disloyalty, management should recharacterize whistle-blowing as necessary to the protection of the firm’s decision-making processes and reputation. Undetected ethical decisions often lead to poor decisions and harm corporate profits. While management does not want witch hunts, good managers must garner evidence of alleged unethical

Problems and Problem Cases 1. You are a middle manager with responsibility over a staff of 16 workers. One of your workers is six months pregnant. Over the last month, she has missed work an average of two days a week and seems to be frequently distracted at work. You are concerned about her welfare and about her work performance, but are unsure what to do. What do the Guidelines for Ethical Decision Making suggest you do first? 2. You are an outside director of Crowler Inc., a manufacturer of kitchen and bathroom fixtures such as faucets, shower heads, and shower doors. Crowler has 29,000 employees worldwide, including 18,000 manufacturing

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behavior so they may investigate and stop conduct that is harmful to the firm. A necessary corollary is not reinforcing unethical behavior, including behavior that may lead to an unethical act or foster an environment that appears tolerant of ethical missteps. It is usually not acceptable to ignore bad behavior. The ethical leader must reprimand staff for unethical actions and must not tolerate statements that suggest the firm should engage in unethical conduct. For example, if, during discussions about how to increase revenue for a product line, one staff member suggests obtaining competitors’ agreements to fix prices, a manager running the meeting should make clear that the firm will not engage in that or any other conduct that is illegal. To let the price-fixing comment pass without comment may send the message that the manager and the firm condone illegal or unethical acts. Additionally, managers should work to create a culture in which employees feel a sense of “ownership” in the organization. Employees who invest themselves in the organization are more likely to be employees with both a greater sense of satisfaction and higher commitment to the overall mission of the firm. Consider the difference between how most people treat an owned car versus a rental car. No one changes the oil, rotates the tires, or washes and waxes a rental car. A rental car serves a short-term, instrumental purpose and carries with it no long-term commitment or investment. Ownership of a vehicle, on the other hand, is accompanied by routine maintenance and proactive attention to any unusual sounds or dashboard indicators. Leaders who can inspire an ownership mentality among their employees are less likely to confront employees content to perform at the bare minimum level or tempted to cut corners.  Collectively, these reinforcing mechanisms should create a culture in which ethical practices define the firm and its employees rather than being imposed on them.

employees in the United States, Canada, and Mexico. Its headquarters is in Eden Prairie, Minnesota. The CEO has proposed that Crowler increase its manufacturing capacity by adding a large facility to manufacture kitchen faucets, thereby increasing manufacturing employment by 3,000 workers. The board of directors is considering whether Crowler should expand its manufacturing facility in Brownsville, Texas; open a new factory in Indonesia; or close the Brownsville facility and move its current operations and the new operations to Indonesia. Using the Guidelines for Ethical Decision Making, what do you want to know before you make a decision? 3. You are a debt collections officer for a credit card issuer, NationalOne Corporation. NationalOne generates

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73 percent of its profits from credit card fees and interest charged to consumers with annual incomes between $15,000 and $125,000. NationalOne’s business model is to charge its credit card customers a low initial interest rate of 10 percent and a nominal annual fee of $10. If a customer defaults on one payment, however, the interest rate jumps to 22 percent, and the annual fee to $100. In the course of collecting debts for NationalOne, you have noticed that once the typical customer defaults, she is able to pay about 50 percent of the original debt had the interest rate and annual fee not changed. NationalOne’s policy is not to accept anything less than 100 percent of the amount of the debt until the debtor has been in default for at least two years, by which time you find the customers typically can pay only about 10 percent of the now much larger debt. Many customers threaten to file and do file for bankruptcy protection. Would a rights theorist suggest any changes in NationalOne’s policies? Would a profit maximizer suggest changes?

5. Marigold Dairy Corporation sells milk products, including powdered milk formula for infants. Marigold hopes to increase sales of its powdered milk formula in Liberia and other African nations where mothers are often malnourished due to drought and civil war. Marigold’s marketing department has created a marketing plan to convince mothers and expectant mothers not to breastfeed their babies and to, instead, use Marigold formula. Doctors generally favor breastfeeding as beneficial to mothers (it helps the uterus return to normal size), to babies (it is nutritious and strengthens the bonds between the infant and the mother), and to families (it is inexpensive). Marigold’s marketing plan stresses the good nutrition of its formula and the convenience to parents of using it, including not having to breastfeed.  You are the senior vice president of marketing for Marigold. Do you approve this marketing plan? What would a rights theorist do? What would a utilitarian do? What would a profit maximizer do?

4. When is it appropriate to give a job applicant, employee, associate, colleague, or partner a second chance? Consider the following situations:

6. During World War II, the insecticide DDT was used successfully to halt a typhus epidemic spread by lice and to control mosquitoes and flies. After World War II, it was used extensively to control agricultural and household pests. Today, DDT may not be used legally in the United States and most other countries. Although DDT has a rather low immediate toxicity to humans and other vertebrates, it becomes concentrated in fatty tissues of the body. In addition, it degrades slowly, remaining toxic in the soil for years after its application. But there has never been any credible evidence that this residue has caused any harm. Even so, DDT has been blamed for the near extinction of bald eagles, whose population has increased greatly since DDT was banned, although evidence tends to point to oil, lead, mercury, stress from noise, and other factors as the likely causes.  In 2013, more than 2,469 people in the United States were infected by and 119 people killed after contracting West Nile virus, which is carried to humans by mosquitoes. CDC director Julie Gerberding called West Nile virus an “emerging, infectious disease epidemic” that could be spread all the way to the Pacific Coast by birds and mosquitoes. Pesticides such as malathion, resmethrin, and sumithrin can be effective in killing mosquitoes but are significantly limited because they do not stay in the environment after spraying. In Mozambique, indoor spraying of DDT has caused malaria rates to drop 88 percent among children.  As an executive for Eartho Chemical Company, you have been asked by Eartho’s CEO to study whether Eartho should resume the manufacture of DDT. What would a utilitarian decide? What would a profit maximizer do?

a. A manager is very effective in getting maximum efforts and results from her staff. However, the staff complains about suffering continual verbal abuse from the manager, including receiving belittling comments both privately and in public. Should her employer fire the manager or seek to rehabilitate her? b. An employee is a recovering cocaine addict. Since successfully completing rehabilitation, he has received a college degree and been drug-free for three years. Would you hire him? c. Donald Sterling, co-owner of the Los Angeles Clippers, a team in the National Basketball Association, made racist remarks in a private conversation that was recorded secretly by his girlfriend. Should the other NBA owners have attempted to oust him from team ownership? d. Jerry Sandusky, a coach for the Penn State football program, was observed engaging in same-sex relations with a youth attending his program for underprivileged youths. In 2012, he was convicted of 52 counts of sexual abuse of young boys over a 15-year period. Should Penn State have fired him as a coach when it had first notice of one instance of abuse, or should it have attempted to rehabilitate him? After the full extent of his crimes have become known, would it be appropriate for Penn State or any other employer to hire him for a position in which he has contact with young boys? Are there jobs for which you would hire him? Why or why not?



Chapter Four Business Ethics, Corporate Social Responsibility, Corporate Governance, and Critical Thinking

7. This American Life is an American Public Media radio program conceived, produced, written, and performed by Ira Glass. In 2012, Episode 454, “Mr. Daisey and the Apple Factory,” chronicled the investigation of Apple’s Foxconn factory in China by author and monologist Mike Daisey. The episode ran portions of Daisey’s monologue that detailed Apple’s exploitation of Chinese workers. The episode was the most downloaded episode in the show’s history. Less than two months later, Ira Glass and his staff discovered that Daisey had fabricated the claim that the plant guards had guns and exaggerated the number of underage workers with whom he met. Daisey also falsely represented that a man with a mangled hand was injured at Foxconn making iPads and that Daisey’s iPad was the first one the man ever saw in operation. What did Ira Glass do with the new information? What would you have done? 8. Jordan Belfort founded Stratton Oakmont, a brokerage firm that focused on selling very risky penny stocks— stocks selling at very low prices—to investors. Belfort encouraged his brokers to use high-pressure tactics to sell the stocks. Belfort paid his brokers handsomely, with commissions reaching 25 percent of the purchase price. As a result, many Stratton Oakmont brokers were able to improve their lives and support their families. Many of the stocks peddled by the brokers were investments in small companies with little chance of becoming profitable. Some of the investors were pressured into buying more stock than they should have purchased, considering their levels of wealth and other security holdings. The investors could have insisted on receiving more information about the stocks before purchasing them. However, the investors’ desires to make a large, quick profit deterred them from taking steps to protect themselves. Assess the ethical behavior of both the brokers and the investors. 9. In 2007, NFL commissioner Roger Goodell determined that the New England Patriots and its head coach, Bill Belichick, had violated NFL rules by videotaping opposing teams’ sideline signals during games. Goodell docked the Patriots a 2008 first-round draft pick, and he fined Belichick $500,000 and the team $250,000. In 2008, Goodell interviewed the Patriots’ employee who had done the videotaping and concluded that the employee’s information was consistent with the behavior for which the Patriots and Belichick had been disciplined in 2007. Therefore, Goodell termed the matter over and said it was not necessary to discipline further the Patriots or Belichick. Immediately thereafter, Arlen Specter, a U.S. senator from Pennsylvania, called the NFL investigation “neither objective nor adequate.” Specter stated, “If the commissioner doesn’t move for

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an independent investigation, . . . depending on the public reaction, I may ask the Senate Judiciary Committee to hold hearings on the NFL antitrust exemption.” Specter further stated that Goodell has made “ridiculous” assertions that wouldn’t fly “in kindergarten.” The senator said Goodell was caught in an “apparent conflict of interest” because the NFL doesn’t want the public to lose confidence in the league’s integrity. Terming the videotaping of opposing teams’ signals a form of cheating equivalent to steroid use, Specter called for an independent investigation similar to the 2007 Mitchell Report on performance-enhancing drugs in baseball.  Can you identify the fallacies in Senator Specter’s arguments? 10. You are hired as a corporate accountant for Ryco Industries, a public company with shares traded on the New York Stock Exchange. The company has enjoyed consistently higher earnings each quarter, meeting or exceeding the expectations of Wall Street analysts every quarter for the past seven years. Soon after being hired, you discover a “reserve” account in the accounting records. Your inquiry shows that the account is designed to accumulate earnings deficiencies or excesses, that is, to permit Ryco to adjust its earnings each quarter such that earnings not increase too little or too much. You bring your findings to the attention of Ryco’s chief accounting officer, who tells you that the account merely allows Ryco to smooth or manage its earnings, something that Wall Street analysts want to see. If earnings fluctuated, she explains, analysts would make less optimistic estimates about the prospects of Ryco, and its stock price would take a hit. The CAO tells you, “Look, we’re just doing this to avoid getting hammered in the stock market. Every company does this. And we’re not making up earnings. When actual earnings are too high, we just withhold recognizing some of those earnings until we need them in the future. When actual earnings are too low, we know we’ll have better quarters in the future from which we can borrow earnings now. It all evens out.”  Can you identify the critical thinking errors and the characteristics of poor decision making that the CAO is exhibiting? Create a plan that will help you resist the CAO’s request for you to continue to manage earnings as Ryco has done in the past. 11. You have been a director of sales at Privation Insurance Company for the last five years. Next week, you will be promoted to the position of vice president of sales, leading a staff of 35 sales professionals. Your immediate superior is the senior vice president of marketing and sales. What plan do you adopt for ethically leading your 35-person staff in your new position? List five things you’ll do to lead your staff ethically.

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Chapter 5

Criminal Law and Procedure

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Crimes and Torts

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Intentional Torts

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Negligence and Strict Liability

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Intellectual Property and Unfair Competition

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CHAPTER 5

Criminal Law and Procedure

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icolai Caymen worked as a desk clerk at a hotel in Ketchikan, Alaska. After a woman called a Ketchikan business supply store and complained that the store had charged her credit card for a laptop computer she did not purchase, the store discovered that Caymen had used a credit card in placing a telephone order for the laptop and that when he picked up the computer, the store clerk had not asked for identification. Store personnel then contacted the Ketchikan police department to report the incident and to pass along information, acquired from other stores, indicating that Caymen may have attempted similar credit card fraud elsewhere. In order to look for the laptop and other evidence of credit card fraud, the police obtained a search warrant for the house where Caymen rented a room. Caymen, who was present while his room was searched, denied the allegation that he had used someone else’s credit card to acquire the laptop. Instead, he stated that he had bought it with his own credit card. During the search, the police found the laptop and a tower computer. It was later determined that Caymen had rented the tower computer from a store but had never made any of the required payments. In Caymen’s wallet, which the police examined in connection with the search of his room, the officers found receipts containing the names and credit card information of guests who had stayed at the hotel where Caymen was employed. The police seized the laptop and contacted the store where Caymen had acquired it to ask whether officers could examine the laptop’s hard drive before they returned the computer to the store. The store’s owner consented. In examining the laptop’s hard drive for evidence of credit card fraud, the police found evidence indicating Caymen’s probable commission of federal crimes unrelated to credit card fraud. The police then temporarily suspended their search of the hard drive and obtained another search warrant because they had probable cause to believe that Caymen had committed federal offenses. Under that search warrant, officers checked the hard drives and storage media from the laptop and tower computers and found further evidence pertaining to the federal crimes. Caymen was prosecuted in state court for credit card fraud and was indicted in federal court for the separate federal offenses. In the federal proceeding, he asked the court to suppress (i.e., rule inadmissible) the evidence obtained by the police in their examinations of the hard drives of the laptop and tower computers. Caymen based his suppression request on this multipart theory: that the police had no valid warrant for their initial look at the laptop’s hard drive; that in the absence of a valid warrant, his consent (rather than the store owner’s) was needed to justify a search of the laptop’s hard drive; that the evidence obtained during the initial examination of the laptop’s hard drive was the result of an unconstitutional search and was therefore inadmissible; and that the evidence obtained in the later examinations of the hard drives of the laptop and tower computers amounted to inadmissible “fruit of the poisonous tree.” As you read Chapter 5, consider these questions: • On what constitutional provision was Caymen basing his challenge to the validity of the searches conducted by the police? • Must law enforcement officers always have a warrant before they conduct a search, or are warrantless searches sometimes permissible? If warrantless searches are sometimes permissible, when?

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• What is the usual remedy when law enforcement officers conduct an unconstitutional search? • Did Caymen succeed with his challenge to the validity of the searches conducted by the police? Why or why not? • What if a guilty person goes free as a result of a court’s ruling that he was subjected to an unconstitutional search by law enforcement officers? From an ethical perspective, how would utilitarians view that outcome? What about rights theorists?

LO

LEARNING OBJECTIVES After studying this chapter, you should be able to: 5-1 5-2 5-3 5-4 5-5

Describe the difference between a felony and a misdemeanor. Explain why the First Amendment may sometimes serve as a defense to criminal  liability. Identify the constitutional provisions at issue when a criminal law is challenged as being excessively vague. Identify the standard of proof that the government must meet in a criminal prosecution, as well as the constitutional sources of that requirement. Identify the major steps in a criminal  prosecution.

THE LIST FEATURES FAMILIAR corporate names: Enron, Arthur Andersen, WorldCom, Adelphia, ImClone, Volkswagen, Wells Fargo, and Tyco. Individuals such as Bernard Ebbers, John and Timothy Rigas, and Dennis Kozlowski also make the list. Don’t forget about Bernie Madoff. These names sometimes dominated the business headlines during recent years, but not for reasons any corporation or executive would find desirable. Instead, they acquired the notoriety associated with widely publicized financial scandals, related civil litigation, and criminal prosecutions that were pursued by the government, seriously contemplated by prosecutors, or argued for by the public and political figures of varying stripes. For instance, former WorldCom CEO Bernie Ebbers was sentenced to 25 years in prison for his role in an $11 billion accounting and securities fraud. The Rigases were sentenced to substantial prison terms because of their involvement in bank and securities fraud while serving as high-level executives at Adelphia. Kozlowski, convicted of financial wrongdoing in connection with his former

5-6 Describe the basic protections afforded by the Fourth, Fifth, and Sixth Amendments. 5-7 Describe major exceptions to the Fourth Amendment’s usual preference that the government have a warrant before conducting a search. 5-8 Explain what the exclusionary rule is. 5-9 List the components of the Miranda warnings and state when law enforcement officers must give those warnings. 5-10 Describe the major elements that must be proven in order to establish a violation of the Computer Fraud and Abuse Act.

position as Tyco’s CEO, also faced incarceration. Madoff received a 150-year prison sentence and extensive public scorn after being convicted of crimes associated with the Ponzi scheme through which he defrauded investors. Criminal convictions because of financial wrongdoing led to the above-mentioned notoriety of certain individuals and the corporations with which they were affiliated, but other sorts of business-related activity may also result in criminal charges. In 2012, for instance, the oil company BP pleaded guilty to offenses connected with the Deepwater Horizon oil-drilling disaster that occurred off the Gulf Coast and caused the deaths of 11 persons as well as extensive environmental damage. A criminal fine of approximately $1.3 billion was imposed on BP, along with even more in civil penalties. During recent years, the U.S. Department of Justice considered whether to file criminal charges against General Motors for allegedly misleading federal regulators regarding an ignition switch problem that led to crashes in which persons were injured or killed. Volkswagen pleaded guilty in



Chapter Five Criminal Law and Procedure

2017 to criminal charges in connection with its employees’ scheme to install devices in vehicles so that the cars would receive false and deceptively positive results on governmentrequired emissions tests. In 2019, Wells Fargo agreed to pay $3 billion to resolve the company’s potential criminal and civil liability stemming from a decade-long practice of pressuring employees to meet unrealistic sales goals. That practice led over 5,000 employees to provide millions of accounts and products to customers under false pretenses, often by creating false records or misusing customers’ identities. The BP, GM, Volkswagen, and Wells Fargo sagas also featured civil consequences because of regulatory penalties and lawsuits, but there seems little doubt that criminal charges or the possibility of them weighed especially heavily on the minds of those companies’ executives and employees. In an earlier edition of this text, the first paragraph of Chapter 5 noted the importance of studying criminal law as part of a business manager’s education but conceded that “[w]hen one lists legal topics relevant to business, criminal law comes to mind less readily than contracts, torts, agency, corporations, and various other subjects dealt with in this text.” That statement was written some 25 years ago. Given the media, public, and governmental attention devoted to recent corporate scandals, it might be argued that criminal law now comes to mind more readily than certain other subjects on the list of legal topics relevant to business. At the very least, events involving high-profile firms and executives have demonstrated that business managers create considerable risk for themselves and their firms if they ignore the criminal law or lack a working understanding of it.

Role of the Criminal Law This century has witnessed society’s increasing tendency to use the criminal law as a major device for controlling corporate behavior. Many regulatory statutes establish criminal and civil penalties for statutory violations. The criminal penalties often apply to individual employees as well as to their organizational employers. Advocates of using the criminal law in this way typically argue that doing so achieves a deterrence level superior to that produced by damage awards and other civil remedies. Corporations may be inclined to treat damage awards as simply a business cost and to violate regulatory provisions when doing so makes economic sense. Criminal prosecutions, however, threaten corporations with the reputation-harming effect of a criminal conviction. In some cases, the criminal law allows society to penalize wrongdoing employees who would not be directly affected by a civil judgment against their employer. Moreover, by alerting private parties to a

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violation that could also give rise to a civil lawsuit for damages, criminal prosecutions may increase the likelihood that a corporation will bear the full costs of its actions. Proponents of using criminal law against corporations may also point to its expressive function. In other words, in addition to offering higher penalties, the criminal law signals society’s moral outrage in a way that a money judgment—even a multibillion-dollar one—cannot. Our examination of the criminal law’s role in today’s business environment begins with consideration of the nature and essential components of the criminal law. Next, the chapter discusses procedural issues in criminal prosecutions and explains constitutional issues that may arise in such cases. The chapter then explores various problems encountered in applying the criminal law to the corporate setting.

Nature of Crimes LO5-1

Describe the difference between a felony and a misdemeanor.

Crimes are public wrongs—acts prohibited by the state or federal government. Criminal prosecutions are initiated by a prosecutor (an elected or appointed government employee) in the name of the state or the United States, whichever is appropriate. Persons convicted of crimes bear the stigma of a criminal conviction and face the punitive force of the criminal sanction, which may include incarceration. Our legal system also contemplates noncriminal consequences for violations of legal duties. The next two chapters deal with torts, private wrongs for which the wrongdoer must pay money damages to compensate the harmed victim. In some tort cases, the court may also assess punitive damages in order to punish the wrongdoer. Only the criminal sanction, however, combines the threat to life or liberty with the stigma of conviction. Crimes are typically classified as felonies or misdemeanors. A felony is a serious crime such as murder, sexual assault, arson, drug-dealing, or a theft or fraud offense of sufficient magnitude. Most felonies involve significant moral culpability on the offender’s part. Felonies are punishable by lengthy confinement of the convicted offender to a penitentiary, as well as by a fine. A person convicted of a felony may experience other adverse consequences, such as disenfranchisement (loss of voting rights) and disqualification from the practice of certain professions (e.g., law or medicine). A misdemeanor is a lesser offense such as disorderly conduct or battery resulting in minor physical harm to the victim. Misdemeanor offenses usually involve less—sometimes much less—moral culpability than felony offenses. As such,

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misdemeanors are punishable by lesser fines or limited confinement in jail. Depending on their seriousness and potential for harm to the public, traffic violations are classified either as misdemeanors or as less serious infractions. Really only quasi-criminal, infractions usually are punishable by fines but not by confinement in jail.

Purpose of the Criminal Sanction Disagree-

ments about when the criminal sanction should be employed sometimes stem from a dispute over its purpose. Persons accepting the utilitarian view believe that prevention of socially undesirable behavior is the only proper purpose of criminal penalties. This prevention goal includes three major components: deterrence, rehabilitation, and incapacitation. Deterrence theorists maintain that the threat or imposition of punishment deters the commission of crimes in two ways. The first, specific deterrence, occurs when punishment of an offender deters him from committing further crimes. The second, general deterrence, results when punishment of a wrongdoer deters other persons from committing similar offenses. Factors influencing the probable effectiveness of deterrence include the respective likelihoods that the crime will be detected, that detection will be followed by prosecution, and that prosecution will result in a conviction. The severity of the probable punishment also serves as a key factor. A fundamental problem attending deterrence theories is that we cannot be certain whether deterrence works because we cannot determine reliably what the crime rate would be in the absence of punishment. Similarly, high levels of crime and recidivism (repeat offenses by previously punished offenders) may indicate only that sufficiently severe and certain criminal sanctions have not been employed, not that criminal sanctions in general cannot effectively deter. Deterrence theory’s other major problem is its assumption that potential offenders are rational beings who consciously weigh the threat of punishment against the benefits derived from an offense. The threat of punishment, however, may not deter the commission of criminal offenses produced by irrational or unconscious drives. Additionally, deterrence theories presuppose that would-be offenders even know the law and its sanctions, a suspect notion at best.

Rehabilitation of convicted offenders—changing their attitudes or values so that they are not inclined to commit future offenses—serves as another way to prevent undesirable behavior. Rehabilitation was the dominant model of criminal law for much of this nation’s history but was called into question in the 1970s and fell out of favor. Critics of rehabilitation commonly point to high rates of recidivism as evidence of the general failure of rehabilitation efforts to date. Incapacitation of convicted offenders may also contribute to the goal of prevention. While incarcerated, offenders may also have much less ability to commit other crimes. This excludes crimes committed against other inmates and guards. It also ignores the downstream impacts of incarceration on families and communities. Prevention is not the only asserted goal of the criminal sanction. Some persons see retribution—the infliction of deserved suffering on violators of society’s most fundamental rules—as the central focus of criminal punishment. Under this theory, punishment satisfies community and individual desires for revenge and reinforces important social values. As a general rule, state laws on criminal punishments seek to further equally the deterrence, rehabilitation, and incapacitation purposes just discussed. State statutes usually set forth ranges of sentences (e.g., minimum and maximum amounts of fines and imprisonment) for each crime established by law. The court sets the convicted offender’s sentence within the appropriate range unless the court places the defendant on probation or otherwise non-carceral sentence. Probation is effectively a conditional sentence that suspends the usual imprisonment and/or fine if the offender “toes the line” and meets other judicially imposed conditions for the period specified by the court. It is sometimes granted to first-time offenders and other convicted defendants deemed suitable candidates by the court. In deciding whether to order probation or an appropriate sentence within the statutory range, the court normally places considerable reliance on information contained in a presentence investigation conducted by the probation office. Figure 5.1 explains how federal law approaches the proper determination of a convicted offender’s punishment.

Figure 5.1 The Federal Sentencing Guidelines and the Booker Decision The federal approach to sentencing closely resembled the typical state approach discussed in the text until the Federal Sentencing Guidelines took effect in 1987. The significantly different sentencing model contemplated by the Sentencing Guidelines was largely upended, however, by the U.S.

Supreme Court’s decision in United States v. Booker, 543 U.S. 220 (2005), and decisions that followed it. To understand Booker, one must first know how the Sentencing Guidelines operated for the approximately 20 years preceding the Supreme Court’s decision.



Chapter Five Criminal Law and Procedure

In the Sentencing Reform Act of 1984, Congress created the U.S. Sentencing Commission and authorized it to develop the Sentencing Guidelines. Congress took this action to reduce judicial discretion in sentencing and to minimize disparities among sentences imposed on defendants who committed the same offenses. Although pre–Sentencing Guidelines statutes setting forth sentencing ranges for particular crimes generally remained on the books, the Sentencing Guidelines developed by the Sentencing Commission assumed a legally controlling status under provisions of the Sentencing Reform Act. The Guidelines contain a table with more than 40 levels of seriousness of offense. Where an offender’s crime and corresponding sentence range are listed on the table depends on the offender’s prior criminal history and on various factors associated with the offense. The Sentencing Reform Act established that federal courts were bound by the table and usually were required to sentence convicted defendants in accordance with the range set in the table for the crime at issue. However, if the court found the existence of certain additional circumstances to be present (such as a leadership role in a crime committed by more than one person or similar facts seeming to enhance the defendant’s level of culpability), the Guidelines required the court to sentence the defendant to a harsher penalty than would otherwise have been the maximum under the Guidelines. Many federal judges voiced displeasure with the Guidelines because their mandatory nature deprived judges of the sentencing discretion they believed they needed in order to do justice in individual cases. In another key effect, the Guidelines led to the imposition of more severe sentences than had previously been imposed. Although the prospect of probation for certain offenses was not eliminated, the Guidelines led to an increased use of incarceration of individuals convicted of serious crimes. (A special subset of rules known as the Organizational Sentencing Guidelines, discussed later in the chapter, pertains to the sentencing of organizations convicted of federal crimes.) Approximately 20 years ago, questions began arising about the constitutionality of the Sentencing Guidelines. The questions focused on the cases in which the Guidelines effectively required—if the requisite additional circumstances were present—a sentence higher than what would otherwise have been the maximum called for by the Guidelines. These cases were troublesome because nearly always the additional circumstances triggering the enhanced sentence were identified by the trial judge on the basis of evidence submitted to him or her at a post-trial sentencing hearing. The jury, on the other hand, would have heard and seen only the evidence produced at the trial—evidence that went toward guilt and presumably the standard range of punishment, but not toward an enhanced punishment harsher than the usual maximum. All of this was problematic, critics contended, in view of criminal defendants’ Sixth Amendment right to a jury trial. In 2005, United States v. Booker provided the Supreme Court an opportunity to address the concerns raised by

critics of the Guidelines. A jury had convicted Booker of the offense of possessing, with intent to distribute, at least 50 grams of crack cocaine. The evidence the jury heard at trial was to the effect that Booker possessed approximately 90 grams of crack. The Sentencing Guidelines called for a sentence of 20 to 22 years in prison for possessing at least 50 grams. However, evidence presented to the judge at the sentencing hearing indicated that Booker possessed some 650 grams. Possession of a much larger amount of crack than the amount for which he was convicted was a special circumstance that, under the Guidelines, necessitated a harsher sentence. Upon finding by a preponderance of the evidence that Booker possessed 650 grams (rather than the smaller quantity about which the jury heard evidence), the judge was required by the Guidelines to sentence Booker to at least 30 years in prison—even though the evidence presented to the jury would have justified a lesser sentence of 20 to 22 years. The judge imposed a 30-year sentence on Booker, who contended on appeal that the enhanced sentence required by the Guidelines violated his Sixth Amendment jury trial right. In the Booker decision, the Supreme Court held that in view of the Sixth Amendment, any facts calling for the imposition of a sentence harsher than the usual maximum must be facts found by a jury rather than merely a judge (unless a jury has been validly waived by the defendant or the defendant agreed to the facts in a plea agreement). The Federal Sentencing Guidelines and the statute contemplating their creation were thus unconstitutional insofar as they mandated a sentence going beyond the usual maximum if a judge’s factual findings supporting such a sentence were made on the basis of evidence that the jury had not heard. To remedy the constitutional defect, the Court determined it was necessary to excise certain Sentencing Reform Act sections that made the Sentencing Guidelines mandatory. The elimination of those statutory sections caused the Sentencing Guidelines to become advisory to judges as they make sentencing decisions. Judges must still consider what the Guidelines call for in regard to sentencing, but they are not required to impose the particular sentences specified in the Guidelines. The Court also stated in Booker that when a judge’s sentencing decision is challenged on appeal, the governing standard will be one of reasonableness. After Booker, lower courts were faced with determining what the “reasonableness” standard of review meant, as well as how far trial courts’ discretion regarding the Guidelines really extended. In Rita v. United States, 551 U.S. 338 (2007), the Supreme Court held that it was permissible for courts of appeal to adopt and apply a presumption of reasonableness if the sentence imposed by the trial court fell within the range set by the Guidelines. Gall v. United States, 552 U.S. 38 (2007), made clear, however, that the converse was not true. The Court held there that courts of appeals cannot apply a presumption of unreasonableness to a sentence that departed from the range set by the Guidelines. Instead, according to Gall, consideration of the Guidelines is only “the starting point

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and the initial benchmark” for the trial judge as he or she makes an “individualized assessment” based on the facts and circumstances. Appellate courts are to give “due deference” to the trial judge’s sentencing determinations, regardless of whether the sentence fell within or outside the Guidelines’s range. In Kimbrough v. United States, 552 U.S. 85 (2007), a companion case to Gall, the Court underscored this standard of review and expressed disapproval of appellate court micromanagement of trial judges’ sentencing decisions. The Court also suggested in Kimbrough—and made explicit in Spears v. United States, 555 U.S. 261 (2009)—that considerable deference to the trial judge’s sentencing determinations remains

Essentials of Crime To

convict a defendant of a crime, the government ordinarily must (1) demonstrate that his alleged acts violated a criminal statute; (2) prove beyond a reasonable doubt that he committed those acts; and (3) prove that he had the capacity to form a criminal intent. Crimes are statutory offenses. A given behavior is not a crime unless Congress or a state legislature has criminalized it.1 Courts also carefully scrutinize, and narrowly construe, criminal statutes in an effort to make certain that they sweep

appropriate even if it appears that the sentence departed from the Guidelines because of the judge’s policy disagreement with the Guidelines. Booker and its progeny have restored to trial judges most of the sentencing latitude they had prior to the Guidelines. This latitude is subject to two constraints: First, the sentence must be consistent with relevant statutes (as opposed to the now-advisory Guidelines), and second, the sentence must be based upon facts found by the jury. Whether judges actually use this discretion, or are instead “anchored” to the Guidelines’ ranges, is an empirical question. As might be expected, it appears that as more time since Booker passes, judges seem willing to use more of their inherent discretion.

in only those behaviors specifically prohibited by the relevant legislature. In Sekhar v. United States, which follows, the U.S. Supreme Court conducts such an examination of the Hobbs Act in order to determine whether the defendant’s actions constituted extortion in violation of that federal statute. Infractions of a minor criminal or quasi-criminal nature (such as traffic offenses) are often established by city or county ordinances but will not be considered here. For discussion of ordinances as a type of law, see Chapter 1. 1

Sekhar v. United States   570 U.S. 729 (2013) New York’s Common Retirement Fund is an employee pension fund for the State of New York and its local governments. The State Comptroller chooses Common Retirement Fund investments. When the Comptroller decides to approve an investment, he issues a “Commitment.” Giridhar Sekhar was a managing partner of FA Technology Ventures (FATV). In 2009, the Comptroller’s office was considering whether to invest in a fund managed by that firm. The office’s general counsel recommended that the Comptroller decide not to invest in the FATV-managed fund. The Comptroller followed the recommendation, decided not to issue a Commitment, and notified an FATV partner about the decision. This partner had previously heard rumors that the general counsel was having an extramarital affair. The general counsel then received a series of anonymous e-mails demanding that he recommend moving forward with the investment in the FATV-managed fund. The e-mails also threatened that if the general counsel did not so recommend, the sender would disclose information about his alleged affair to his wife, government officials, and the media. The general counsel contacted law enforcement, which traced some of the e-mails to Sekhar’s home computer and other e-mails to FATV offices. Sekhar was later indicted for attempted extortion in violation of the Hobbs Act, which subjects a person to criminal liability if he “in any way or degree obstructs, delays, or affects commerce or the movement of any article or commodity in commerce, by robbery or extortion or attempts or conspires so to do.”18 U.S.C. § 1951(a). The act defines extortion to mean “the obtaining of property from another, with his consent, induced by wrongful use of actual or threatened force, violence, or fear, or under color of official right.” 18 U.S.C. § 1951(b)(2). On the verdict form used at Sekhar’s trial, the jury was asked to specify the property that Sekhar attempted to extort: (1) “the Commitment,” (2) “the Comptroller’s approval of the Commitment,” or (3) “the General Counsel’s recommendation to approve the Commitment.” The jury chose only the third option in convicting Sekhar of attempted extortion. The U.S. Court of Appeals for the Second Circuit affirmed Sekhar’s conviction. The Second Circuit held that the general counsel “had a property right in rendering sound legal advice to the Comptroller and, specifically, to recommend—free from threats—whether the Comptroller should issue a Commitment.” In addition, the Second Circuit concluded that Sekhar not only attempted to deprive the general counsel of his “property right” but also “attempted to exercise that right by forcing the general counsel to make a recommendation determined by [Sekhar].” The U.S. Supreme Court agreed to review the case.



Chapter Five Criminal Law and Procedure

Scalia, Justice We consider whether attempting to compel a person to recommend that his employer approve an investment constitutes “the obtaining of property from another” under 18 U.S.C. § 1951(b)(2). Whether viewed from the standpoint of the common law, the text and genesis of the statute at issue here, or the jurisprudence of this Court’s prior cases, what was charged in this case was not extortion. It is a settled principle of interpretation that, absent other indication, “Congress intends to incorporate the well-settled meaning of the common-law terms it uses.” [Citation omitted.] Or as Justice Frankfurter colorfully put it [in a 1947 law journal article], “if a word is obviously transplanted from another legal source, whether the common law or other legislation, it brings the old soil with it.” The Hobbs Act punishes “extortion,” one of the oldest crimes in our legal tradition. As far as is known, no case predating the Hobbs Act—English, federal, or state—ever identified conduct such as that charged here as extortionate. Extortion required the obtaining of items of value, typically cash, from the victim. It did not cover mere coercion to act, or to refrain from acting. The text of the statute confirms that the alleged property here cannot be extorted. Enacted in 1946, the Hobbs Act defines its crime of “extortion” as “the obtaining of property from another, with his consent, induced by wrongful use of actual or threatened force, violence, or fear, or under color of official right.” Obtaining property requires “not only the deprivation but also the acquisition of property.” Scheidler v. National Organization for Women, Inc., 537 U.S. 393, 404 (2003). That is, it requires that the victim part with his property, and that the extortionist “gain possession” of it. Id. at 403 n.8. The property extorted must therefore be ­transferable—that is, capable of passing from one person to another. The alleged property here lacks that defining feature. The genesis of the Hobbs Act reinforces that conclusion. The Act was modeled after § 850 of the New York Penal Law (1909). Congress borrowed, nearly verbatim, the New York statute’s definition of extortion. The New York statute contained, in addition to the felony crime of extortion, a . . . misdemeanor crime of coercion. Whereas the former required the criminal acquisition of property, the latter required merely the use of threats “to compel another person to do or to abstain from doing an act which such other person has a legal right to do or to abstain from doing” [quoting the New York statute]. Congress did not copy the coercion provision. The omission must have been deliberate, since it was perfectly clear that extortion did not include coercion. At the time of the borrowing (1946), New York courts had consistently held that the sort of interference with rights that occurred here was coercion. And finally, this Court’s own precedent similarly demands reversal of Sekhar’s conviction. In Scheidler, we held that protesters did not commit extortion under the Hobbs Act, even though they “interfered with, disrupted, and in some instances completely deprived” abortion clinics of their ability to run their business. 537 U.S. at 404–05. We reasoned that the protesters may have deprived the clinics of an “alleged

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property right,” but they did not pursue or receive “something of value from” the clinics that they could then “exercise, transfer, or sell” themselves. Id. at 405. This case is easier than Scheidler, where one might at least have said that physical occupation of property amounted to obtaining that property. The deprivation alleged here is far more abstract. Scheidler rested its decision, as we do, on the term “obtaining.” The principle announced there—that a defendant must pursue something of value from the victim that can be exercised, transferred, or sold— applies with equal force here. Whether one considers the personal right at issue to be “property” in a broad sense or not, it certainly was not obtainable property under the Hobbs Act. The government’s shifting and imprecise characterization of the alleged property at issue betrays the weakness of its case. According to the jury’s verdict form, the “property” that Sekhar attempted to extort was “the General Counsel’s recommendation to approve the Commitment.” But the government expends minuscule effort in defending that theory of conviction. And for good reason—to wit, our decision in Cleveland v. United States, 531 U.S. 12 (2000), which reversed a business owner’s mail-fraud conviction for “obtaining money or property” through misrepresentations made in an application for a video-poker license issued by the State. We held that a “license” is not “property” while in a state’s hands and so cannot be “obtained” from the state. Even less so can an employee’s yet-to-be-issued recommendation be called obtainable property, and less so still a yet-to-be-issued recommendation that would merely approve (but not effect) a particular investment. Hence the government’s reliance on an alternative . . . description of the property. Instead of defending the jury’s description, the government hinges its case on the general counsel’s “intangible property right to give his disinterested legal opinion to his client free of improper outside interference” [quoting the government’s brief]. But what, exactly, would Sekhar have obtained for himself? A right to give his own disinterested legal opinion to his own client free of improper interference? Or perhaps, a right to give the general counsel’s disinterested legal opinion to the general counsel’s client? Either formulation sounds absurd, because it is. Clearly, Sekhar’s goal was not to acquire the general counsel’s “intangible property right to give disinterested legal advice.” It was to force the general counsel to offer advice that accorded with Sekhar’s wishes. But again, that is coercion, not extortion. No fluent speaker of English would say that Sekhar “obtained and exercised the general counsel’s right to make a recommendation,” any more than he would say that a person “obtained and exercised another’s right to free speech.” He would say that Sekhar “forced the general counsel to make a particular recommendation,” just as he would say that a person “forced another to make a statement.” Adopting the government’s theory here would not only make nonsense of words, it would collapse the longstanding distinction between extortion and coercion and ignore Congress’s choice to penalize one but not the other. That we cannot do. Second Circuit decision reversed in favor of Sekhar.

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Part Two Crimes and Torts

Constitutional Limitations on Power to Criminalize Behavior The U.S. Constitution pro-

hibits ex post facto criminal laws. This means that a defendant’s act must have been prohibited by statute at the time she committed it and that the penalty imposed must be the one provided for at the time of her offense. In Peugh v.  United States, 569 U.S. 530 (2013), for example, the U.S. Supreme Court held that a defendant convicted of bank fraud should have been sentenced under the version of the Federal Sentencing Guidelines in effect when he committed the crime rather than under a later version that the lower courts used as the basis for imposing a more severe punishment than the earlier version would have permitted. The Constitution places other limits on legislative power to criminalize behavior. If behavior is constitutionally protected, it cannot be deemed criminal. For example, the right of privacy held implicit in the Constitution caused the Supreme Court, in Griswold v. Connecticut (1965), to strike down state statutes that prohibited the use of contraceptive devices and the counseling or assisting of others in the use of such devices. This decision provided the constitutional basis for the Court’s historic Roe v. Wade (1973) decision, which limited the states’ power to criminalize abortions. First Amendment LO5-2

Explain why the First Amendment may sometimes serve as a defense to criminal liability.

By prohibiting laws that unreasonably restrict freedom of speech, the First Amendment plays a major role in limiting governmental power to enact and enforce criminal laws. As explained in Chapter 3, the First Amendment protects a broad range of noncommercial speech, including expression of a political, literary, or artistic nature as well as speech that deals with economic, scientific, or ethical issues or with other matters of public interest or concern. The First Amendment protection for noncommercial speech is so substantial that it is called “full” protection. The First Amendment may operate as a defense to a criminal prosecution concerning speech many persons would find offensive. For instance, in United States v.  Alvarez, 567 U.S. 709 (2012), the Supreme Court struck down a portion of the Stolen Valor Act, a federal law that criminalized false statements made about earning a military medal. Although the defendant had lied repeatedly about having served in the military and earning a Purple Heart, the Court found the statute broadly applied to false statements made at any time, in any place, and to any person,

which conflicted with the First Amendment. In addition, the Court held in United States v. Stevens, 559 U.S. 460 (2010), that the First Amendment protected the defendant against criminal responsibility for having violated a statute that barred distribution of videos in which a cruel killing or maiming of an actual animal was depicted. (The First Amendment safeguarded the speech present in such videos notwithstanding its offensive character, but would not protect any defendant against criminal responsibility for violating a statute prohibiting the conduct of engaging in cruelty to animals.) But First Amendment protection, despite being very substantial, is not absolute. Consider Holder v. Humanitarian Law Project, 561 U.S. 1 (2010), in which the Supreme Court rejected a multipronged attack on the constitutionality of a federal statute that criminalized the furnishing of support to foreign groups the government has labeled as terrorist organizations. In upholding the statute, the Court held that it did not violate the First Amendment even as applied to persons who wished to donate money to support and encourage the humanitarian, lawful, and nonviolent activities of those organizations (as opposed to their activities amounting to terrorism). Although donating money in support of social causes may be viewed as speech, the Court concluded that the statute did not violate the First Amendment rights of supporters of the organizations’ nonterrorist activities because the prohibition of even those supporters’ donations was suitably tailored to the furtherance of the vital government interest in combating terrorism. Commercial speech, on the other hand, receives a less substantial First Amendment shield known as “intermediate” protection. Does a speaker or writer with a profit motive (e.g., the author who hopes to make money on her book) therefore receive only intermediate First Amendment protection? No, as a general rule, because the mere presence of a profit motive does not keep expression from being fully protected noncommercial speech. Moreover, the commercial speech designation is usually reserved for what the Supreme Court has termed “speech that does no more than propose a commercial transaction.” The best example of commercial speech is an advertisement for a product, service, or business. Despite receiving less-than-full protection, commercial speech is far from a First Amendment outcast. Recent Supreme Court decisions, as noted in Chapter 3, have effectively raised commercial speech’s intermediate protection to a level near that of full protection. Therefore, regardless of whether it is full or intermediate in strength, the First Amendment protection extended to expression means that governmental attempts to hold persons criminally liable for the content of their written or spoken statements are often unconstitutional.



Chapter Five Criminal Law and Procedure

Some speech falls outside the First Amendment umbrella, however. In a long line of cases, the Supreme Court has established that obscene expression receives no First Amendment protection. Purveyors of obscene books, movies, and other similar works may therefore be criminally convicted of violating an obscenity statute even though it is the works’ content (i.e., the speech) that furnishes the basis for the conviction. Expression is obscene only if the government proves each element of the controlling obscenity test, which the Supreme Court established in Miller v. California (1973): (a) [That] the average person, applying contemporary community standards, would find that the work, taken as a whole, appeals to the prurient interest; (b) [that] the work depicts or describes, in a patently offensive way, [explicit] sexual conduct specifically defined by the applicable state law; and (c) [that] the work, taken as a whole, lacks serious literary, artistic, political, or scientific value.

If any of the three elements is not proven, the work is not obscene; instead, it receives First Amendment protection. The Miller test’s final element is the one most likely to derail the government’s obscenity case against a defendant. Books, movies, and other materials that contain explicit sexual content are not obscene if they have serious literary, artistic, political, or scientific value—and they generally do. In view of the Miller test’s final element, moreover, certain publications that might fairly be regarded as “pornographic” are likely to escape being classified as obscene. Although nonobscene expression carries First Amendment protection, Supreme Court decisions have allowed the government limited latitude to regulate indecent speech in order to protect minors from being exposed to such material. Indecent expression contains considerable sexual content but stops short of being obscene, often because of the presence of serious literary, artistic, political, or scientific value (for adults, at least). Assume that a state statute requires magazines available for sale at a store to be located behind a store counter, rather than on an unattended display rack, if the magazines feature nudity and sexual content and the store is open to minors. This statute primarily restricts indecent expression because most magazines contemplated by the law are unlikely to be obscene. If the statute is challenged on First Amendment grounds and the court concludes that it is narrowly tailored to further the protection-of-minors purpose, it will survive First Amendment scrutiny. A law that restricts too much expression suitable for adults, however, will violate the First Amendment even if the government’s aim was to safeguard minors. Recent years have witnessed decisions in which the Supreme Court determined the First Amendment fate of statutes designed to protect minors against online exposure to material that is indecent though not obscene.

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In Reno v. American Civil Liberties Union, 521 U.S. 844 (1997), the Court struck down most of the Communications Decency Act of 1996 (CDA), which sought to ban Internet distribution of indecent material in a manner that would make the material accessible by minors. The Court reasoned that notwithstanding the statute’s protection-of-minors purpose, the sweeping nature of the ban on indecent material extended too far into the realm of expression that adults were entitled to receive. In Ashcroft v. American Civil Liberties Union, 542 U.S. 665 (2004), the Court considered the constitutionality of the Child Online Protection Act (COPA), the next congressional attempt to restrict minors’ exposure to indecent material in online contexts. According to the Court, the same problem that plagued the CDA—restricting too much expression that adults were entitled to communicate and receive—doomed the COPA to a determination of unconstitutionality. As noted above, much of the material often referred to as pornography would not be considered obscene under the Miller test and thus would normally carry First Amendment protection. Safeguarding-of-minors concerns have proven critical, however, to the very different legal treatment extended to child pornography—sexually explicit visual depictions of actual minors (as opposed to similar depictions of adults). Because of the obvious dangers and harms that child pornography poses for minors, child pornography has long been held to fall outside the First Amendment’s protective umbrella. Therefore, the Supreme Court has held that there is no First Amendment bar to criminal prosecutions for purveying or possessing child pornography. Identify the constitutional provisions at issue when a

LO5-3 criminal law is challenged as being excessively vague.

Due Process Clauses In addition to limiting the sorts of behavior that may be made criminal, the Constitution limits the manner in which behavior may be criminalized. The Due Process Clauses of the Fifth and Fourteenth Amendments (discussed in Chapter 3) require that criminal statutes define the prohibited behavior precisely enough to enable law enforcement officers and ordinary members of the public to understand which behavior violates the law. Statutes that fail to provide such fair notice may be challenged as unconstitutionally vague. For example, in Skilling v. United States, 561 U.S. 358 (2010), a defendant brought a vagueness challenge to a federal statute he was convicted of violating. The statute made it a crime to deprive another person of the intangible right to the defendant’s “honest services.” To avoid

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Part Two Crimes and Torts

the potential vagueness problem suggested by the statute’s “honest services” language, the Supreme Court adopted a limited construction of the statute. The Court ruled that for a violation of the honest services law to have occurred, the defendant’s actions must have involved the offering, payment, or receipt of bribes or kickbacks. Whatever other misdeeds Skilling—an Enron executive—committed or may have committed, none of them involved bribes or kickbacks. For further discussion of the importance of clarity in criminal statutes, see Shaw v. United States, which appears later in the chapter. Equal Protection Clause The Fourteenth Amendment’s Equal Protection Clause (also discussed in Chapter 3) prohibits criminal statutes that discriminatorily treat certain persons of the same class or arbitrarily discriminate among different classes of persons. Legislatures usually are extended considerable latitude in making statutory classifications if the classifications have a rational basis. “Suspect” classifications, such as those based on race, are subjected to much closer judicial scrutiny, however. Eighth Amendment Finally, the Constitution limits the type of punishment imposed on convicted offenders. The Eighth Amendment forbids cruel and unusual punishments. This prohibition furnishes, for example, the constitutional basis for judicial decisions establishing limits on imposition of the death penalty. Although various Supreme Court cases indicate that the Eighth Amendment may bar a sentence whose harshness is disproportionate to the seriousness of the defendant’s offense, the Court has signaled that any Eighth Amendment concerns along these lines are unlikely to be triggered unless the sentence–crime disproportionality is exceedingly gross. Proof beyond a Reasonable Doubt Identify the standard of proof that the government must

LO5-4 meet in a criminal prosecution, as well as the constitutional

sources of that requirement.

The serious matters at stake in a criminal case—the life and liberty of the accused—justify our legal system’s placement of significant limits on the government’s power to convict a person of a crime. A fundamental safeguard is the presumption of innocence; defendants in criminal cases are presumed innocent until proven guilty. The Due Process Clauses require the government to overcome this presumption by proving beyond a reasonable doubt every element

of the offense charged against the defendant.2 Requiring the government to meet this high burden of proof minimizes the risk of erroneous criminal convictions. Defendant’s Criminal Intent and Capacity Most serious crimes require mens rea, or criminal intent, as an element. The level of fault required for a criminal violation depends on the wording of the relevant statute. Many criminal statutes require proof of intentional wrongdoing. Others impose liability for reckless conduct or, in rare instances, mere negligence. In the criminal context, recklessness generally means that the accused consciously disregarded a substantial risk that the harm prohibited by the statute would result from her a