Juris Magazine- Summer 1985

SUMMER

1985

THEDUQUESNELAWSCHOOLNEWSMAGAZ NE

Tax-exempt organizations are given special recognition in our tax system. Different reasons have been given for this exemption: "a lack of fit between the concept of 'income' and the objectives of nonprofit organizations; their meager potential as sources of revenue; the nuisance of record keeping for groups that often operate informally and rely heavily on voluntary services."

However, in recent years Congress perceived that exempt organizations were taking advantage of their exempt status by reaping benefits Congress had not intended them to have. The Deficit Reduction Act of 1984 ,_ 990 ,I Return of or~nlzatlon Ex.=:et from Income Tax I -"I"~I ~.,"" T~ e!:.na.....'''''SUI''_i ..cuo!r~:..c;(:~ft~ndMlon). ____ _y.. ..,,,~he~:t<:'::~en~ . ."'. , .. ,_~,.. '''w,,, ......'_.. '''I.. D .1 1l®84 was enacted to reduce the tax ... ::..1tS •Stat.,......,........., ........ benefits that otherwise would .j :"'.. have been available for tangichecII....,.

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VOLPE-ROGAL, INC. Statewide Leaders in Self-Insurance Administration

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Editor's Note H I F DUOUES,,'E LAW SCHOOl 'JE\'I<; MAGAZI 'E

VOL. XIX No.4 - Summer 1985 Editor-in-Chief Francis A. Muracca Articles Editor R. Kevin Brown, Jr. Executive Managing Editor Matthew M. Polka Associate Editors James J. Bruno Claudia DeArment Anne Kozera Valerie Merti Assistant Editors Melody Cook Daniel Murphy Mary Pavlovich Thomas Smith Contributing Artists Scott Stephan Faculty Advisor Patrick J. Basial Senior Staff Martin M. Brennan, Jr. Mary Jo Dillon Steven Franckhauser Elena Perez John Pion Tom Sarkus Shawn White Secretary Jan Daschbach

l

W

ith the close of the academic year rapidly upon us, we have once again completed another successful volume of Juris. My year as Editor-in-Chief has been both eventful and rewarding. I sincerely thank my Editorial Board and Staff Members who put forth an endless amount of time, effort and dedication in maintaining the fine tradition for which Juris has come to be recognized.

I also wish to thank the Administration, Faculty and Law School Staff for their generous support throughout the course of the year. These efforts are often overlooked, but remain a very instrumental part of Juris.

This Law School has expanded in the past few years to new heights in legal education, but this growth must not cease. At this stage of Duquesne's renaissance we must continue to foresee the needs of tomorrow and adjust our attitudes, research facilities and curriculum to conform.

In closing, I would like to congratulate the class of '85 and extend best wishes to all in the future. Duquesne students develop a sense of camaraderie and we must not forget to carry this attitude with us into tomorrow. The rewards of this law school are in the hands of the students today.

JURIS is a student publication of the Duquesne University School of Law. Views and opinions expressed are not necessarily those of JURIS or Duquesne University. All manuscripts and comments may be addressed to JURIS, Duquesne University School of Law, 900 Locust Street, Pittsburgh, Pennsylvania 15282.

Telephone (412) 434-6305.

Copyright Š 1985 Duquesne University

Sincerely,

Francis A. Muracca Editor-in-Chief

In this issue EXEMPT LEASING: 4 TAX BEFORE AND AFTER THE DEFICIT REDUCTION ACT OF 1984 9 FOR SOFTWARE ACQUISITION THE UNINITIATED

AT WILL12 THE WRONGFUL DISCHARGE DILEMMA AIR POLLUTION: 17 THE NEED FOR REGULATION

3

T AX路EXEM'P T LEASING: BEFORE AND AFTER THE DEFICIT REDUCTION ACT OF 1984

ax-exempt organizations are given special recognition T in our tax system. Most of the exemptions allowed today date from the Revenue Act of 1894' and were reenacted in the Corporation Income Tax Act of 1909' and the Revenue Act of 1913,' although the practice in some ways reaches back to the British Statute of Charitable Uses of 1601. Different reasons have been given for exempting such organizations from taxation: "a lack of fit between the concept of 'income' and the objectives of nonprofit organizations; their meager potential as sources of revenue; the nuisance of recordkeeping for groups that often operate informally and rely heavily on voluntary services; and the praiseworthy benevolent spirit animating such groups."4 In addition, tax-exempt organizations provide services which are useful and necessary for society, services which the government then does not need to supply.

However, in recent years Congress perceived that exempt organizations were taking advantage of their exempt status by reaping benefits Congress had not intended them to have.

This article examines the law regarding tax-exempt leasing before and after the Deficit Reduction Act of 1984. 5

I. PRIOR TO THE DEFICIT REDUCTION ACT OF 1984 Two tax benefits accruing to owners of personal property are the accelerated cost recovery deduction 6 (ACRS) and the investment tax credit' (ITC) which are allowed only for property used for business or for an income-producing purpose. Generally an ACRS deduction allows a taxpayer to depreciate property at an accelerated rate which is shorter than the actual economic life of the property. The investment tax credit, on the other hand, reduces the taxpayer's tax liability by a percentage of the investment in the property. Since tax-exempt organizations pay no tax, they are not entitled to take the accelerated depreciation deduction nor claim the investment tax credit on property owned by them.

Moreover, if property is used by a tax-exempt organization in its exempt function, even if it does not own the property, generally no investment credit is allowed on such property.8 4

Leasing provided a method for tax-exempt organizations to benefit from the accelerated depreciation deduction and, in some instances, the investment tax credit. The exempt organization would sell the property to a taxable organization and these benefits" flowed through" to the taxed entity. Consequently, the rent to the tax-exempt entity was reduced. Through a sale-lease back the lessee (the tax-exempt entity) could realize the economic benefit from the tax attributes, which it was not entitled to as owner of the property, by the decreased rental payments since the lessor (the taxed entity) would benefit from the tax attributes. 9 Following is a close examination of the investment tax credit and the accelerated cost recovery system in terms of the legislative purpose behind these benefits, how tax-exempt organizations benefited from them and how this benefit led to the legislative changes of the Deficit Reduction Act of 1984.

A. Investment Tax Credit The investment tax credit was enacted in 1962 as part of the Revenue Act'O designed to spur economic growth by encouraging investment and capital formation. In turn, this economic growth was to result in an increase in job opportunities and a betterment of the United States' competitive position in the world economy." Property used by a taxexempt organization was excluded from credit eligibility.

The rationale for this restriction was to prevent an investment credit for property used in an exempt function from reducing a tax on an unrelated taxable trade or business. 12 The rules for applying the investment tax credit are promulgated under Sections 38, 46, 47 and 48. Section 38 provides for a direct credit against the tax liability for a taxpayer's investment in certain qualified property (certain depreciable property used in the taxpayer's trade or business). Section 46 determines the amount of the credit which is a percentage of the cost of the property determined by

BY JANE RAKAY NELSON

the useful life of the property. Property which qualifies for an investment credit is referred to as "Section 38 property" as defined by Section 48. Section 38 property includes depreciable "tangible personal property" used by a taxpayer in a trade or business "with respect to which depreciation (or amortization in lieu of depreciation) is allowable and having a useful life (determined as of the time such property is placed in service) of 3 years or more." '3 Section 48 also excludes "property used by certain tax-exempt organizations." 14 The regulations echo Section 48's exclusion of property used by a tax-exempt organization, but they also carve out an exception, the short-term lease exception. Another exception, the service contract exception, was developed administratively and was then subsequently extended by judicial rUling. These two exceptions were used by taxexempt entities to benefit from the investment tax credit."

As often happens, the use became abuse.

1. "Casual Or Short-Term" Lease Exception Although the literal language of Section 48 would seem to preclude any exceptions, the regulations allow the investment credit on property "leased on a casual or short-term basis" to a tax-exempt entity.'¡ The issue with this regulation has not been its existence but rather a definition of "casual or short-term" lease.

"Casual lease" was defined in Xerox Corporation v.

United States" as a lease which lacks the formalities inherent in a written lease. For instance, the lease of an automobile from a car rental company by a government employee traveling on government business could be deemed a casual lease. ,8 The rationale for the short-term lease exception was explained in World Airways, Inc. v. Commissioner" as a means for allowing the tax-exempt entity (in this case it was the government) to fulfill an unforeseen or extraordinary need for obtaining the short-term use of property from the taxpayer which is taxed, without causing the taxpayer to lose the credit. 20 Thus, in unforeseen or extraordinary situations, property not ordinarily intended for lease to a tax-exempt organization or governmental unit could be leased under this exception and the taxpayer could still claim the credit. 21 In determining whether the short-term exception applies, courts have rejected the arguments that the nonqualifying use constitutes an insubstantial portion of the useful life of the property" or that the minimum legally enforceable period of a lease is the determining factor. 23 Neither will the mere presence of a cancellation clause in the lease result in an application of the exception.24

2. "Service Contract" Exception Property qualifies for the investment tax credit if it is used by a tax-exempt entity or a governmental unit in a nonexempt trade or business. 25 The regulations define property which is used by a governmental unit or tax-exempt organization as property owned by or leased to one of these nontaxable entities. 2â&#x20AC;˘ The service contract exception was created by a series of IRS rulings" and a Court of Claims case.

The IRS distinguished between a lease and a service agreement by determining whether the property is provided to a customer (the tax-exempt entity) to allow the customer to provide services to itself (a lease) or whether the property is used by the taxpayer (the taxed entity) to provide services to its customer (a service contract). 28 Property used by a tax-

payer to provide services to a tax-exempt organization is not "used by" the tax-exempt organization. Hence, the property does not fall within the scope of Section 48(a) (4) and (5) and does qualify for the investment tax credit. 2.

The IRS developed a two-prong test to determine by whom the property is "used": (1) the incidents of ownership retained by the taxpayer, and (2) the extent to which the property is part of an integrated operation providing a service to a customer. 30 The first part, the incidents of ownership retained by the taxpayer, indicates the nature of the possessory interest retained by the taxpayer. 3' The incidents of ownership retained by the taxpayer which are indicative of a service contract are: 1) ownership of the property; 2) possession and control of the property; 3) the right to replace the asset with comparable property 4) retention of the risk of loss; 5) the responsibility for installation, maintenance and repair of the property; 6) the right to prevent the customer's employees from working with, repairing, and moving the property; and 7) a right to access to its property. 32

The Deficit Reduction Act oj' 1984 was enacted to reduce the tax benefits that otherwise would have been available for tangible property used by tax-exempt entities.

No one of these incidents of ownership is determinative.

Rather, the totality of the factual situation 33 is examined in light of the prior IRS rulings and Xerox. However, the incidents of ownership are only the first part of the twoprong test. The second part, the extent to which the property is part of an integrated operation providing a service, is just as important in determining if the property is "used by" the tax-exempt organization.

Although automation has blurred the distinction between providing property and providing a service 34 there are several factors which have been identified to aid in distinguishing between providing property and providing a service, such as: 1) the extent of the taxpayer's other responsibilities to the customer; 2) the necessity of placing the property on the service recipient's premises in an inherent element in providing the service, and 3) the mode of billing.35 Again, no single factor is determinative, but rather all the above factors along with the incidents of ownership have to be examined to distinguish between a lease and a service contract. In light of the emphasis placed on the factual settings a brief review of the rulings and Xerox is relevant at this point.

5

Revenue Ruling 68-109 held that property provided to a governmental unit as an integral part of a service was not "used by" the government within the meaning of Section 48(a) (5).36 Communications equipment had been installed on the governmental unit's premises. The IRS found that the agreement was a service contract. The service relied on the fact that the taxpayer retained all ownership in and possession and control over the property which was also part of the taxpayer's integrated network used to render services to the customer, not property placed with a user to allow it to provide services to itselLl7 In Revenue Ruling 72-407 3 8 the IRS distinguished Revenue Ruling 68-109 and held that the agreement between the taxpay,er and the government was a lease and, therefore, the property was not eligible for the investment tax credit. 3 9 The property in this case was vehicles which were supplied to the governmental unit for daily use. The service found that the contract was not a short term or casual lease nor was the property part of an integrated network as the switchboards were in Revenue Ruling 6'8-109. Although vehicles were provided by the taxpayer, the taxpayer did not use them to render services to the governmental unit but rather allowed the user Icustomer to provide services for itself. 40 Thus, the property did not qualify as Section 38 property."'

In Letter Rulings 7829066,'2 7913(X)343 and 8217040 44 the IRS, despite tax-exempt use, allowed the investment tax credit. In Letter Ruling 7829066 the taxpayer installed and maintained televisions for patients in tax-exempt hospitals.

The taxpayer was allowed to service the equipment on the tax-exempt entity's premises and replace sets with comparable models. Hospital employees were not allowed to work with or move the televisions. A portion of the proceeds went to the hospital but the taxpayer also received forty-five cents per day per bed. The IRS ruled that the television sets were not "used by" the tax-exempt organization, noting that no legal interest in the property was transferred to the customer.

Consequently, the taxpayer was entitled to an investment tax credit on its television sets.

Similarly, in Letter Ruling 7913003, where the taxpayer built a steel pipeline to transmit natural gas from a nonqualifying entity's natural gas field to one of its electric generating plants, the property qualified for the investment credit. The taxpayer retained title to the pipeline, and was responsible for risk of loss, maintaining the pipeline and satisfying all costs of the operation. The taxpayer had to accommodate the tax-exempt entity's schedule; even if the tax-exempt entity's generating plant equipment was disabled, its responsibilities ended when the plant equipment was ready for use. In holding that the contract was a service agreement, the Service emphasized that the pipeline never left the taxpayer's possession or control and the allocation of the risk of loss was to the taxpayer.

Letter Ruling 8217040 likewise allowed the investment tax credit when a vessel was time chartered to the government.

As in Letter Ruling 7913003 the taxpayer bore the risk of loss, retained possession and control and provided maintenance over the vessel. In addition, the taxpayer had to secure insurance and furnish and manage the crew.

In 1981, the Court of Claims dealt with this issue in the Xerox case. This case dealt with the same factual circumstance as in Revenue Ruling 71-39745 where the IRS found the property was not eligible for the investment tax credit. The Court of Claims, in a detailed opinion, found otherwise, allowing the investment tax credit. The court re6

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Xerox Corporation, the taxpayer, supplied various types of copying, dU'plicating and printing machines under rental agreements to tax-exempt organizations and governmental units. Xerox retained the risk of loss, maintained the machines, trained the customer's employees to operate the machines, and was free to replace the machines with a comparable model at any time. The customer could not alter the machine nor move it without the permission of Xerox.

Xerox charged a minimum monthly use charge plus an agreed amount for each copy produced.

The Court of Claims applied the two-prong test developed through the IRS rulings to determine by whom the property was "used". First, the court found that the taxpayer had retained ownership of the property as in a service contract.

Although the property was located on the customer's premises, the taxpayer had the right to exercise possession and control. The court expressly noted that "Rev. Rul. 71-397 was in error in concluding . .. the taxpayer gave up possession of the machines ... "41 Here, as in Revenue Ruling 71-397, the customer was not allowed to move, alter or service the machine. This, along with the taxpayer's retention of the risk of loss and responsibility for damage, satisfied the first part of the test: the taxpayer had retained su fficient incidents of ownership. The second part, an " integrated operation providing a service," was also met since Xerox provided copying services to its customers: an integrated package of equipment and services designed to produce copies as its end product. 4 8

In light of these rulings , the benefit of the investment tax credit could flow through to the tax-exempt organization and governmental unit if the arrangement was a " short term or casual" lease or if it was a "service agreement". Such structuring was not necessary for the tax-exempt entity to benefit from the ACRS deduction.

B. Accelerated Cost Recovery Svstem (ACRS, The ACRS depreciation rules were enacted as part of the Economic Recovery Tax Act 0 f 1981 49 to red uce the income tax liability of taxpayers so as to encourage their purchase and use of capital goods . Accelerated deductions reduce the present value of the tax to be paid by deferring payment to later years . In general, the cost of recovery property is recovered over three or five years for most personal property and over eighteen years for depreciable real property. 'o Taxpayers leasing property to tax-exempt entities could generally use the ACRS deduction, indirectly benefiting the tax-exempt organization. In fact, after the enactment of the ACRS depreciation rules, the volume of leasing to nontaxable entities sharply increased. '\ For example , the city of Oakland, California, sold and leased back a museum and auditorium, and the city of Atlanta, Georgia, sold and leased back its city hall building . 12 Congress believed these transactions to be an abuse of the tax benefits. Congress had not intended for tax-exempt organizations to realize the economic benefit of the tax attributes of their assets (both the investment tax credit and the ACRS deductions) and consequently designed legislation to curb the use of leasing by tax-exempt organizations."

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II. THE DEFICIT REDUCTION ACT OF 1984 The Deficit Reduction Act of 1984 was enacted to accomplish four general objectives: 1) to reduce bud get deficits in order to safeguard the economic recovery of 1983; 2) to prevent further erosion of the tax base as a result of tax sheltering activity; 3) to ensure that all taxpayers pay a fair share of the tax burden; and 4) to improve the administration and efliciency of the tax system . ,4 To promote these objectives Congress believed that it was essential to reform the tax law as it related to property used by tax-exempt entities under a lease, a lease formulated as a service contract, or other similar arrangements. II Thus, the new act reduces the tax benefits that otherwise would have been available for tangible property used by tax-exempt entities.

The following sections examine the new rules which define tax-exempt entity and tax-exempt use property, which restrict the use of the ACRS deduction and the investment tax credit by tax-exempt entities.

A . Definition Of Tax.Exempt

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The definition of a tax-exempt entity, ' · for the purposes of the ACRS and investment tax credit provisions, includes any state, local or federal governmental agency or instrumentality, any tax-exempt organization, 17 foreign person or foreign entit y. ' 8

B . Tax.Exempt Use Propertv The Act prescribes that under certain circumstances property which is "tax-exempt use property" '9 will not be eligible for the ACRS depreciation deduction or the investment tax credit. Property will be considered tax-exempt use property when it is leased to a tax-exempt entity or when it is held by a partnership where one of the partners is a taxexempt entity .

Tangible personal property is tax-exempt use property to the extent that such property is leased to a tax-exempt entity. Real property is tax-exempt use property to the extent that such property is leased to a tax-exempt entity in a "disqualified lease ". Four types of leases will cause a lease to be "d isq uali fied" : 1) The lease has a term of more than twenty years ; 2) All or part of the property was financed (directly or indirectly) by an obligation the interest on which is taxexempt under Section 103, and the tax-exempt entity (or a related entity) participated in the financing; 3) Under the lease there is either (a) a fixed or determinable price purchase or sale option which involves the tax-exempt entity (or a related entity), or (b) the equivalent of such an option; or 4) The lease occurred after a sale or other transfer or lease of the property by or from the tax-exempt entity (or a related entity), and the property has been used by the entity (or a related entity) before the sale or other transfer or lease .· o There is an exception for property which is leased within three months after the date the property was first used by the tax-exempt entity"\ Additionally, the property will not be treated as tax-exempt use property unless more than thirty-five percent of the property is leased to tax-exempt entities in disqualified leases'" The Act makes exceptions to the tax-exempt use rules for certain high technology equipment·) (computers and certain medical equipment), property used by a tax-exempt entity 7

in a trade or business the income from which is subject to tax,64 and property leased to a tax-exempt entity under a short-term lease. 61

1. The Casual or Short-Term Lease The Act defines "casual or short-term lease" differently for the investment tax credit and the accelerated depreciation deduction. The rules under the prior law regarding eligibility for the investment tax credit are essentially codified. 66 Thus, property leased to a tax-exempt entity for a term of less than six months would be eligible for the investment tax credit. 67 The short-term lease rule for the ACRS depreciation deduction is less restrictive than the rule for the investment tax credit.路 s For real property the short-term lease exception applies to any lease which is for a term of less than three years. The short-term lease exception for personal property applies to any lease which, in addition to being less than three years, is less than the greater of one year or thirty percent of the property's class Ii fe. 69 For purposes of determining a lease term, Section 168(j) (6) (B) provides two interpretive rules: I) The lease term must take into account options to renew, except in the case of real property if the renewal option is at the fair market value, determined at the time of t he renewal, 70 and 2) Two or more successive leases which are part of the same t ransaction (or a series 0 f related transactions) with respect to the same (or substantially similar property) will be treated as one lease.7I 2. The Service Contract A lease for purposes of these Sections (48 and 168) includes more than the normal leasehold arrangement.

Generally, it includes any grant of a right to use property. 72 The Act codifies the prior law which held that under certain circumstances an arrangement structured as a service contract will be treated as a lease for tax purposes. In adopting the rationale used in Xerox, 73 Section 7701 lists six factors which are to be considered when determining if an arrangement is a lease or service contract. 74 All relevant factors must be taken into account in making this determination including the following: I) Whether the service recipient is in physical possession of the property.75 2) Whether the service recipient controls the property. 76 3) Whether the service recipient has a significant economic or possessory interest in the property. 71 4) Whether the service provider does not bear any risk of substantially diminished receipts or substantially increased expenditures if there is nonperformance under the contract. 18 5) Whether the service provider does not use the property concurrently to provide services to entities unrelated to the serAJice recipient. 79 6) Whether the total contract price does not substantially exceed the rental value of the property for the contract period. 80 The service contract provisions contain a number of exceptions for certain solid waste disposal, energy and clean water facilities 81 and certain low-income housing. 82 In addition, Section 770 I (e) (6) gives the Secretary 0 f the Treasury the authority to prescribe such regulations as may be neces8

sary to carry out the provisions of this subsection. This grant of authority could give various interpretations to the new law. The indefiniteness of these factors was apparent under the prior law when similar factual situation gave rise to different rulings by the Service and the Court of Claims. 83 There is no mechanical formula, but rather the entire factual circumstances has to be examined in light of all the relevant factors.

3 . Partnerships Section 168(j) (9) provides that if a partnership, which has both tax-exempt and for-profit partners, makes an allocation to the tax-exempt partner that is not a "qualified allocation", an amount equal to the tax-exempt partner's proportionate share of such property will be treated as "taxexempt use" property.

A "qualified allocation," necessary to avoid classification of a portion of the property as "tax-exempt use" property is any allocation to a tax-exempt entity which: I) is consistent with such entity's being allocated the same distributive share of each item of income, gain, loss deduction, credit, and basis and such share remains the same during the entire period the entity is a partner in the partnership, and 2) has substantial economic effect within the meaning 0 f Section 704(b) (2).84 Regulations proposed by the Treasury Department set forth a complex structure of criteria that an allocation must satisfy to qualify as having "substantial economic effect" within the meaning Section 704(b) (2).8 1 A two-part review is proposed in which a mechanical "economic effect" test and a subjective "substantiality" analysis must be performed. The economic effect test requires the allocation to be in accord with the following: I) The allocation is reflected as an appropriate increase or decrease in that partners' capital account, and 2) Liquidation proceeds are, throughout the term of the partnership, to be distributed in accordance with the partners' capital account balance, and 3) Any partner with a deficit in his capital account following the distribution of liquidation proceeds is required to restore the amount of such deficit to the partnership, which amount must be distributed to partners in accordance with their positive capital account balances or paid to creditors. 86 The intent is that the partner receiving the allocation must also receive the economic benefits and burdens associated with it. 87 The allocation must also demonstrate that the economic effect would be "substantial", meaning that the magnitude and likelihood of a shift in economic consequence among the partners must significantly correspond to the shift in tax consequences resulting from the allocation. This subjective requirement is to be weighed in light of several factors, including the non-tax motivations for the allocation, the allocation of related items from the same source, and the duration and overall tax consequences of the allocation. 88 These code provisions are designed to discourage allocations that would create "tax-exempt use" property. In addition, this rule applies in the case of any pass-through entity other than a partnership, such as a trust or tiered entity. 89 (Continued on page 21)

SOFTWARE ACQUISITION, FOR THE UNINITIATED o the user, software is the most important component of a computer system. To the vendor, software is a major asset representing an investment of millions of dollars in development costs. These interests would seem to suggest that, when a vendor sells software to a user, both parties would benefit from a well-written contract.

However, a concise agreement is rarely made.

Software contracts involve complex and interrelated technical and business concerns. A lawyer writing a software contract must be familiar with these concerns; if he is not, the chances are good that the contract will be unacceptable to either the user or the vendor. On the other hand, if the lawyer understands the concerns of the parties, then he will be able to apply his legal skills and prepare a contract which benefits both sides.

T

This art ide is written from the user's standpoint and presents some of the major issues to be addressed when acquiring software and preparing a software contract. The discussion provides valuable insight to anyone involved with software, and gives lawyers interested in writing software contracts a chance to learn about the user's contractual needs.

There are four major software groups in which software acquired by users can be placed: Standard Software, Customized Software, Custom Software and Turnkey Software Systems.

BY "OHN W. RYBA, ESQ.

Standard software is an existing program, usually available through retail outlets, with a proven performance record, uniform design, and welldefined capabilities and limits. In essence, it is "off-the-shelf." Vendors usually write their own contracts for standard software, and are extremely reluctant to modify them. Therefore, this article does not directly apply to standard software.

Customized software is standard software that has been modified for a user's specific needs. For example, standard word processing software permits the user to arrange the text in different formats. If a format is wanted that is not otherwise available, the existing program can be modified to produce the new format.

Custom software is a speciallydeveloped program unique to the user 9

and tailored to his individual requirements.

Turnkey software systems combine software (standard, custom or customized) with hardware. The software vendor performs all software development, integrates it with the hardware, and installs the entire system readyfor-use.

It is worth noting that "software piracy" - illegal copying of the software - is not uncommon. Copying the software is a breach of the license agreement, it violates copyright law and, depending on state law, is a theft of trade secret, wrongful conversion, or a criminal offense. Software companies are not hesitant to sue suspected software pirates and are organized in associations to promote public awareness of the problems and the consequences involved.

Unique problems are inherent in each type of software, and it is important to understand them before acquiring the software and writing the contract.

To determine the type of software needed, the user must perform a needs analysis. Why is the software needed?

What functions will it perform? What information is expected from the software and in what form? How will the software handle the information entered? What problems will the software solve? How fast is the information wanted? What are the immediate and future data processing requirements? Are capable and experienced personnel available to use this software to its fullest capacity? Will training be required? Will this software save time and money? These questions are but a few that need to be answered. Expert assistance is often required to identify all the needs.

After the needs analysis, the next step in acquiring software is to prepare a request for proposal (RFT). The RFP is a detailed description of current and future software needs. The RFP also explicitly states business and data processing expectations. An RFP is crucial when acquiring a turnkey software system. Turnkey systems often cause problems because neither party completely understands the requirements and limitations of the system nor the needs of the user. The user expects a software system that performs certain functions, but the vendor develops and delivers a system that does not perform all of the expected functions, while performing 10

others that are not needed. The user can avoid this difficulty by having expert assistance from the start. The assistance of people knowledgeable about the industry, the technology, and software contracting nuances will enhance the chances of obtaining software that meets the user's needs and operates successfully.

Once the foundation is laid through an RFP or similar device and the software and the vendor have been selected, negotiating the contract is next.

The remainder of this article outlines the major provisions that should be written into the contract for the software.

Sometimes referred to as the "deJiverables," the software must perform specific tasks within a certain time, generate the results in usable form, be easy to use and be accurate. Clearly and concisely "defining" the software is one of the most important provisions in the contract. A good RFP can often be used as a guide in preparing this part of the contract. This provision should list the functional specifications of the software, explain how the software operates, and describe what tasks will be performed and what reports and output can be expected. It should also explain what documentation is needed to use the software and provide other important information regarding operation, use and performance criteria. This clause is beneficial to both the user and the vendor. For example, if this provision describes a billing system that produces bi lls weekly, monthly, or quarterly, and gives a

report on total billings, this is what the vendor must deliver. However, this software cannot be expected to produce an Accounts Receivable Aging Report or do a cash flow analysis. The vendor has no obligation to provide software that runs those reports.

When acquiring Custom Software or a Turnkey System, specific stages of development should be established and completion dates should be set. This helps the user to know how things are going and keeps the vendor working on the project. Generally, the stages in software development are: define functional specification, establish performance requirements, design software, produce software, test, do quality control, prepare program documentation and user manuals, deliver and install.

The size and complexity of the software will determine what tasks are required to ultimately install working software. Being fair and realistic is critical to both the user and the vendor in order to have a workable relationship that results in the software being successfully completed.

User manuals are a necessity when acquiring and implementing a software system. As part of any software development contract, the user must be certain that the vendor prepares a comprehensive, detailed manual that is understandable and functional. User manuals are a direct link to productive use of the software and the computer.

Once the software is completed, most contracts provide for delivery and installation to be performed by the vendor. Acceptance testing is an essential aspect of this provision. An acceptance test is where a series or group of data are el1tered into the computer and the software performs a representative transaction, producing expected results. Many vendors have standard test procedures for software and, therefore, are reluctant to agree to a special provision for accepting the software.

If the vendor is open to this provision, great care must be used to define acceptance. Software vendors sometimes are willing to consider a concept that incorporates their standard acceptance test with productive use of the software. The user's own data is applied to perform the transactions and to produce the results for which the software was developed. Usually 5-10 days of this productive use are allowed for determining how the software works.

Vendors also limit the time for acceptance testing so automatic accep-

tance occurs if no material errors are found within a specified time.

The vendor's reluctance to have strict acceptance criteria stems from pragmatic concerns. The software is within the complete control of the user. Historically, user-generated problems have often been the cause of software not operating correctly. Static electricity problems, improper storage, misuse of the diskettes or tape, misuse of the computer, inadequate computer memory or processing power, and plain carelessness often cause software failure or error. Smart, sophisticated vendors will protect themselves from these potential d,ifficulties. Users, however, should attempt to derive as much benefit as possible from this provision when defining criteria for software acceptance.

Payment terms can be closely linked to the various stages to be performed in developing the software and its operations. It is wise to tie payments to the specific stages as they are completed by the vendor. Users should retain part of the total payment until acceptance has occurred, or if no acceptance provision exists, then for a period of time after installation and use. Vendors cannot be counted on to have a flexible attitude on payment.

Nearly all will agree to some percentage split - X070 at signing, YOlo when development is completed, ZOJo prior to installation, and the balance within so many days of installation. Very few vendors, particularly the more established ones, will let more than lO07o of the price be unpaid after installing the software. There are no common percentages or variations on periodic payment, but it is common for vendors to have S0070 or more of the total price before delivering the software to the user. Regardless, users should never pay all or most of the price in advance.

Withholding part of the payment gives the user leverage in the event that there are serious and material problems with the software.

Once the software is being used, support and maintenance become important, and appropriate provisions must be included in the contract. Support generally involves training of all people who will use the software, and answering any inquiries about the software's operation and use. The contract should speci fically address the type, amount, and details of training to be provided by the vendor. Users should always get some training included in

the price of the software. Support also includes technical assistance after implementation. Technical questions and problems must be handled promptly to avoid operation delays and perhaps additional problems. Users must know and understand what support services the vendor provides and include them in the contract.

Maintenance consists primarily of correcting errors in the software. It also includes improvements and enhancements to the software. At first, the error correction services ("bug fixing") are most valuable because any error disrupts use of the software.

These errors generally are more a nuisance than a significant operating or functional difficulty. Enhancements and improvements make the software operate with greater or better capabilities. The user has the option to incorporate the enhancements into the software. Unless clearly unneeded, a user is wise to have the enhancements or improvements made because they are usually free during the first six to twelve months after instaUation. Even after the free maintenance period, the smart user will contract for software maintenance in each succeeding year.

The cost is nominal compared to the risk of something occurring that requires help from technical experts.

And the people most qualified and able to correct errors and perform enhancements are those who developed and "built" the software.

The warranty is important to address, but flexible negotiating in this area should not be expected. Most established software vendors spend much time, effort and money in coming up with their warranty policy and language and would sooner lose the contract than alter the warranty.

Where they tend to be "flexible" is the time period for the warranty. Users should attempt to extend it as much as possible. The warranty clause can function with the maintenance clause and sometimes with the software acceptance provision. The warranty should provide that the software will operate as specified for the agreed period of time and the vendor will correct all errors. The vendor will likely modify this to errors that significantly or substantially affect performance.

Since the maintenance provision requires the vendor to correct so-called small errors, and the warranty addresses major errors, they should overlap.

It is not unusual for vendors to require warranties from the user. In custom and turnkey contracts, cooperation is essential for success, and vendors often provide for this in their contracts. Some areas where users may have responsibilities to the vendor are: access to the computer; time on the computer for testing and debugging; correction of hardware or operating system problems; agreement with the software descriptions and specifications; and installation of vendor-supplied corrections and modi fications.

To assure the user protection that the software being acquired is the vendor's to license, a non-infringement provision should be included in the contract. There are many types of noninfringement clauses. At a minimum, the vendor should warrant that using the software will not infringe on any patent, copyright, trade secret or other proprietary right. The clause should require the vendor to indemnify the user if a suit is filed against the user for using the software.

The software vendor wiiJI include restrictions to protect his ownership and trade secrets. The user is required to treat the software as a trade secret, take certain security precautions and keep the software and any documentation and related information confidential. As mentioned earlier, software companies take protecting their proprietary rights very seriously. These restrictions are onerous and hardly ever negotiable. To further protect their proprietary rights, vendors impose use restrictions. The user is limited to using the software at a certain location, on a single computer, for its internal use, and cannot copy or reproduce the software. The penalties are severe and given that the value of the software may be $SOO,OOO or more, the risk of breaching these provisions can be painfully expensive.

This article has outlined the major issues that should be addressed in acquiring software and writing the software contract. It is important to realize however, that many more issues are involved, and the assistance of experts in the software field is usually required.

Although having a contract for developing and licensing software does not guarantee a successful acquisition, if both user and vendor are satisfied with their commitments the chances of having a well-designed and properly operating software system are high.

11

THEATWILLWRONGFUL DISCHARGE DILEMMA:

BY CLAUDIA DE ARMENT AND VALERIE MERTI

E

mployees in the United States enjoy dramatically disparate levels of protection against the risk of wrongful discharge by employers. Collective bargaining agreements protect approximately twenty-five percent of the nonagricultural United States labor force l by forbidding the firing of unionized employees except for "cause" or "just cause.'" Approximately nineteen percent of the United States work force are federal, state, or local government employees, the majority of whom are protected from arbitrary dismissal by civil service rules. 3 Another form of protection has come from statutes that have established that employees may not be fired because of their membership in particular protected classes.

This legislation, beginning with the National Labor Relations Act of 1935: includes statutes that give an employee a cause of action if he is fired because of discrimination based on race, Ssex,6 age, 7 physical handicap, S or union activity.9 In addition, legislative schemes such as OSHA,IO the Clean Air Act, II and ERISA, 12 include protection against retaliatory discharge for employees who report activity that violates the statute.

Unjust dismissal is a substantive problem, however, for approximately two-third or seventy million employees in the United States who are neither civil servants nor union members. 13 These employees are vulnerable to unjust dismissal because they are not covered by the existing protective statutes and are governed, therefore, by a common law rule that presumes employment for an indefinite term to be terminable at will. The rule grants employers absolute freedom to dis12

charge employees without notice and without cause. Even if an employee has been promised a measure of job security.14 permanent employment, IS or is a long-term employee soon eligible for pension rights, 16 he may be discharged for any or no reason at all.

An avalanche of scholarly opinion has come down in favor of abolishing the at will rule. Commentators, with near unanimity, find the contrasting situations of protected employees and at will employees unjustifiable. In their view, the rule allows employers too much discretion and permits them to take unfair advantage of employees. 17 Challenges to the at will doctrine, based on common law theories of tort and contract, have been considered by the highest courts of forty-three states and decisions in all of these states have either modified at will employment or shown the courts' willingness to do so in the future. lS

THE EVOLUTION OF AT WILL EMPLOYMENT A. Development of the American Rule: 1750-1930 In England, Tudor statutes provided for long, rather than short, hirings.

The Statute of Artificers, in particular, required that the hiring in a large number of specific employments be for one year and further that a quarter year and notice be given, by either party, for termination of such hiring. 19 From this, into the nineteenth century, there arose the common law presumption that an indefinite hiring was a hiring for a year and continuation of the relationship beyond the year gave rise to an additional one year term.

But, such a presumption could be

overcome by proof of a different hiring custom. In the absence of a custom or a definite hiring period, however, termination could only be effected after reasonable notice, unless cause existed for summary dismissal. '0 The one year common law hi rings of the English were widely used in the American colonies, but were not adopted universally. Primarily, and almost exclusively, the annual hirings were customary in domestic service and husbandry.21 The quarter year termination notice was more widely adopted, but the English rule simply failed to take root in this country. The customary reciprocal obligations of master and servant were 'recast' in terms of the emerging theory of contract which principally resulted in a drastic limitation of employer's duties to the employee. 22 The court rejected the presumption that indefinite hirings were for one year and concluded that hirings for an indefinite period should be presumptively terminable at will.

This 'rule' was first embodied in Horace Wood's Treatise on the Law of

Master and Servant: With us the rule is in flexible, that a general or indefinite hiring is prima facie a hiring at will, and if a servant seeks to make it out a yearly hiring, the burden is upon him to establish it by proof. A hiring at so much a day, week, month or year, no time being specified, is an indefinite hiring, and no presumption attached that it was for a day even, but only at the rate fixed for whatever time the party may serve ... It is an indefinite hiring and is determinable at the will of either party, and in this respect there is no distinc-

DEVELOPMENT OF THE AMERICAN RULE

tion between domestic and other servants. 2 ) Wood's 'rule' was well accepted in the late nineteenth century, a period of tremendous industrial expansion. The employee was no longer a quasi-family member but became a purely economic entity. As duration of employment became dependent upon the demand for a product, it made little sense, economically, to require an employer to continue employment beyond the length of time needed to meet market demand. " The 'rule' was quite compatible with laissez faire economic principles: it gave freedom of action (freedom to contract) to both parties and the promise of unleashing productive capacity that would ensure economic progress to all- the employer, the employee and society as a whole. 25 Constitutional jurisprudence during this period of industrial expansion also reflected the laissez faire economic philosophy which proved so fertile for Wood's 'rule' . Two decisions, in particular, reveal judicial activism which resulted in the Court's invalidation of economic legislation deemed violative of the substantive commands of the due process clauses of the Fifth and Fourteenth Amendments : Adair v.

United States" and Coppage v.

Kansas.27 Despite a growing concern by the legislature that the freedom of contract was a cruel illusion because of the extreme inequities in bargaining power between employers and employees, these two cases represent the 'high water mark' of the Court's insistence on laissez faire principles in the labor area . 2 8 Another way in which the courts helped prevent the enforcement of an

indefinite employment contract, even if the employee could prove the promise of a particular tenure, was through requiring special consideration . 29 Recovery for wrongful dismissal on a contract theory could be denied by the stringent application of an independent consideration requirement. Simply, there was no enforcement of a contract unless independent consideration could be proven. Wood's 'rule', while responsive to contract law principles, often operated as an irrebuttable presumption of at will employment, in practice. J O

B. Re路examination of the American Rule: 1930-Present The at will rule does not enjoy a broad-based application in today's society and has suffered substantial erosion . Two principal factors contributed to modification of the at will doctrine and support a re-examination of that rule: 1) constitutional underpinnings have been eroded, and 2) modern contract law principles suggest a movement away from the inflexibility of Wood's at will 'rule'.

Two Supreme Court decisions have undermined any constitutional basis for the at will rule. The 1930 ruling in

Texas and New Orleans Railroad Co. v. Brotherhood of Railways and S.S. Clerks )I made the Railway Labor Act constitutional despite the Adair and Coppage decisions.

Seven years later, in upholding the National Labor Relations Act in

NLRB v. Jones & Laughlin Steel Corp., )2 the Supreme Court expressly approved of the Act's protection of the right of employees to unionize because

of intimidation and coercion by employers. J ) However, the Jones & Laughlin decision also noted that the National Labor Relations Act " does not interfere with normal exercise of the right of the employer to se'lect its employees or to discharge them. " 34 Although neither Texas and New Orleans R .R. Co. nor Jones & Laughlin dealt with a general restriction on the employers' favor to discharge employees, those rulings signaled a change in the Court's philosophy, as reflected in its reluctance to invalidate economic legislation on due process grounds.

The prevailing view s,ince Jones & Laughlin has been that federal or state legislation prohibiting discharge of employees for reasons such as race, sex, union activity or age does not raise constitutional questions. 35 Similarly, statutes and court decisions prohibiting wrongful dismissal have withstood constitutional scrutiny as a permissible restriction on the employer's right of discharge. Over three-quarters of American jurisdictions, for instance, have now abandoned the at will rules as a strict substantive formulated and have provided some means of recovery in tort or contract for wrongful dismissal. 36 The at will rule has survived largely because of its basis in the law of contracts. The at will rule rests on (1) the doctrine of mutuality of obligation, and (2) the requirement of consideration. 37 From the contractual principles of mutuality of obligation it has been reasoned that if the employee can quit his job at will, then, so too must the employer have the right to terminate their relationship for any or no 13

reason. J8 Accordingly, there is a multitude of cases which hold contracts for indefinite terms unenforceable because they lack mutuality of obligation. J9 Early decisions which rely on the absence of mutuality of obligation, however, are of questionable vitality.

The courts have fashioned a variety of exceptions and other devices to avoid requirement of mutuality. For exampic, if an employee, in addition to his services, has furnished "good consideration," such as foregoing a claim against the employer or giving up a business to accept employment,40 the courts have held the contract enforceable on behalf of the employee even though the contract is for an indefinite term - the employee is free to quit at any time. 41 The other contractual foundation, upon which the at will rule rests, is that of consideration. The at will rule posits that as long as the employee is fully compensated for his services by wages, there is a lack of consideration to support a promise, expressed or implied, of continued employment.

Some courts, however, have found the requisite consideration to support permanent employment or employee conduct conferring an added benefit on the employer, such as foregoing a tort claim, sale of a business, uprooting a family, or moving a long distance to accept a job!2 Likewise, some commentators have suggested that the requisite consideration can be found where an employee spends a significant part of his work ing life with one employer to the exclusion of all others, thus conferring a substantive benefit on the employer. 4J Moreover, some decisions have implied a definite term of employment from a contractive stipulation that the employee's wages are to be paid for a specific unit of time. 44

RECENT LIMITATIONS OF THE AT WILL RULP;: ecause constitutional underpinnings and the contract law basis of the at will rule have been undermined, the at will rule has been significantly limited in the United States by unionization, statutes, civil service rules, and various anti-discriminatory protective statutes, as noted previously. Now, in order to protect private, non-unionized employees against unjust dismissals, state courts have recently begun to use common law theories to modify the at will rule. Three major theories of wrongful discharge have emerged from

B

14

the cases: (I) the public policy exception, (2) implied contract terms, (3) a duty of good faith and fair dealing.

A. Status of the At Will Exceptions in Pennsylvania 1. The Public Policy Exception The most widely accepted limitation on the at will rule in the United States has been the public policy exception .

This theory provides a cause of action whether the discharge violates fundamental principles of public policy or law. The leading case under this theory is Petermann v. International Brotherhood of Teamsters. 45 That case involved discharge of an employee who refused to commit perjury at a legislative hearing . The court held that such a discharge was aimed at "an act specifically enjoined by statute, "4 6 and that the public interest in preventing perjury was sufficient to create a cause of action. Since Petermann, an increasing number of jurisdictions,41 including Pennsylvania, have recognized a cause of action under the public policy exception.

The public policy exception in Pennsylvania is classified into three general categories: I. Refusal to Commit an Unlawful Act - The typical case involves a

refusal to commit perjury or violate the antitrust laws . 48

2. Performance of an Important Public Obligation - These cases frequently involve a firing for servicing jury duty, whistleblowing on illegal conduct of employers or refusing to violate a professional code of ethics. 49

3. Exercising a Statutory Right or Privilege - A cause of action is recognized for employees who have been fired for filing workman's compensation claims or refusing to take polygraph tests. 50 The public policy exception appears to provide employees with a broad source of protection from unjust dismissal.

However, the public policy exception, until recently, has been strictly construed and recovery frequently has been denied.

The Pennsylvania courts have decided that a public policy cause of action for wrongful discharge will lie only when a "clear and compelling mandate of public policy has been vi0Iated." 51 The landmark case in this area is Geary v. United States Steel Corp. 52 In that case, the Pennsylvania Supreme Court affirmed the dismissal of a complaint for wrongful discharge; the discharge was alleged to have re-

suited from the employee's persistent warnings that a new company product was dangerous to the public. The court held that where the company has a legitimate reason for terminating the employee in an at will employment relationship - as in this case, where the company has an interest in preserving operational procedures from disruption and the company has shown that the employee bypassed his superiors and pressed his views to higher offices - a clear mandate of public policy has not been violated. However, the court noted that certain employment situations could give rise to a wrongful discharge action, so long as a clear and compelling mandate of public policy was involved: There are areas in an employee's life in which an employer has no legitimate interest. Intrusion into one of these areas by virtue of the employer's power of discharge might plausibly give rise to a cause of action ... where public policy is involved. 5J The Geary court indicated that only a violation of a statutorily confined right would constitute a clear and compelling mandate of public policy. Accordingly, all cases following the Geary decision held that a violation of public policy would not lie unless a specific statute or the Constitution was violated.

Another case, Yaindl v. Ingersoll Rand Co., 54 instituted a balancing test noting that the interests of the employer in having an efficient business operation and harmony among employees outweighed the interests of the employee. However, the recent landmark decision of Novosel v. Nationwide Insurance Co. 5 5 has attempted to significantly liberalize the public policy exception.

The Novosel decision has eroded the at will doctrine. At best though, the decision is aforecast of how the Pennsylvania courts will treat wrongful discharge cases . The Novosel court predicted that the Pennsylvania courts would significantly liberalize the public policy exception and that they would also recognize a cause of action for an implied contract of employment based on an employer's custom, practice, or policy. Although this decision significantly undercuts the employment at will doctrine, we must wait to see if Pennsylvania will fulfill the Novosel court's prophesy.

In October, 1981, Novosel, an em-

ployee of Nationwide Insurance Company, was directed by his regional manager to support the No Fault Reform Act which was pending before the legislature . Novosel refused; he stated reasons to his regional manager why he could not and would not help the regional manager's efforts to secure passage of the bill. One month later Novosel was fired. He was informed orally that his failure to support management was a reason for dismissal.

The Novosel court held that a clear mandate of public policy had been violated. The court reasoned that an employee's freedom of political expression was no less compelling a societal interest than the statutory rights of jury service or filing a workman's compensation claim.s6 To support this conclusion, the court drew an analogy to the cases protecting the constitutional rights of government employees.

Those cases hold that the states cannot condition public employment on a basis that infringes on an employee's freedom of expression. In this analysis, the Novosel court relied extensively on the recent Pennsylvania Supreme Court decision of Sacks v. Commonwealth oj Pa. 17 wherein a dismissed employee was reinstated following critical public comments about his employer . Therefore, reasoned the court, the right of political expression involves clear and compelling public policy that is su fficient to state a basis' for a wrongful discharge action, despite Nationwide being a private employer. Thus, the Novosel court extended the Geary and Sacks decisions to include a non-Constitutional claim where a corporation conditioned employment on political subordination.

Until the Novosel decision, the public policy exception was strictly construed and limited to those cases where a statute or the Constitution was violated. After Novosel the public policy exception appears quite broad.

In Novosel, the conflict merely was that the employee disagreed with what management felt was best for the company. The Third Circuit elevated this conflict to one 0 f Constitutional proportions. Essentially, the Novosel court held that employees in the private sector have Constitutional rights which the employer cannot violate and which require protection.

Yet, this does not mean future litigants are home free. The court glossed

over the fact t hat Nationwide was a private employer. The Novosel court relied on the government employee decisions which are based on restrictions on government. The First Amendment restricts the actions of Congress and the states only. Therefore, it was a substantive leap in logic for the court to take the public employee decision principles and apply them to the private sector. In addi tion, al though the Novosel court did not conclude that a cause of action was stated on the basis of the complaint, the court adopted the balancing test set forth in Yaindl.

Even so, the scope of the public policy exception has been broadened by

Novosel.

2. Implied Contract Terms The courts are willing to examine all the surrounding circumstances of an at will employment relationship to determine whether an implied contract requiring good cause for termination exists. In addition to express representations made by the employer, the courts examine the employer's personnel policies, personnel handbooks and manuals, and employer-employee actions and communications. If such an implied contract is found, then the employer will be held liable for breach of this contract unless a legitimate business reason justifies the discharge.

Few litigants in Pennsylvania have been successful in asserting a cause of action for the breach of an implied contract of employment. The law of Pennsylvania has held that, absent contractual provision specifying a definitive term or prescribing conditions which define duration of the employment relationship, the contract may be terminated at any time, for any reason, or for no reason. S8 The plaintiff has the burden to overcome the presumption of an at will employment relationship. He must show facts or circumstances that establish some tenure of employment.

The only successful cases premised upon the implied contract exception have been those where the plaintiff has alleged that he has declined other employment opportunities in reliance on his employer's assurances of continued employment. For instance, in O'Neil v. ARA Services, Inc., 59 the court held that sufficient facts evidenced a reasonable duration term in the employment contract between O'Neil and his employer. In that case, O'Neil alleged he left his former employment in reliance on a promise that he would be

promoted to regional Vice President within a short time. Thus, the O'Neil court concluded that the plaintiff's employment was to extend for a reasonable period of time and an implied contract claim was stated. Absent a factual setting such as the one in O'Neil, the Pennsylvania courts have refused to permit an implied contract claim.60 Not only did the Novosel decision liberalize the public policy exception, it also dramatically expanded the implied contract exception to the at will doctrine. The Novosel court noted that Pennsylvania has not recognized an implied contract action based on policies set forth in an employee handbook or otherwise implemented by the employer. The court, however, predicted that Pennsylvania would follow the approach of a leading Michigan case, Toussaint v. Blue Cross and Blue Shield oj Michigan, 61 and other cases路' where an employee handbook was found to create an implied, unilateral contract in which the employer was found to follow the procedures and policies set forth within. In the landmark case of Toussaint, the handbook said that employees would be dismissed for just cause only, and it was on this theory that the employee sued the employer and successfully stated a cause of action.

The conclusion of the Novosel court is a dramatic change in the way Pennsylvania law has been interpreted. Although the court remanded to the District Court for discovery and did not hold that any specific policy of Nationwide created an implied contract, the court, by remanding, suggested that Nationwide could have a custom, policy, or procedure the violation of which would be a breach of an implied contract. In addition, by identifying the implied contract issue as one of fact, the court suggested such a controversy is a jury issue and not one to be resolved by summary judgment. This interpretation extremely broadened Pennsylvania law and surpassed many courts in the country which have addressed this issue.

Whether the Pennsylvania Supreme Court will fulfill the Novosel prophesy concerning the implied contract exception is a question to be answered in the future. That answer may soon be forthcoming, since the case of Richardson v. Cole Memorial Hospital, has been accepted on allocatur by the Supreme Court.

15

3. A Duty of Good Faith and Fair Dealing

The premise for liability under this action is the notion that the parties to a contract are implicitly bound to a duty of good faith and fair dealing.

Some courts hold that this duty is an implied term in every employment contract and its breach gives rise to contractual damages. 63 Other courts hold that breach of an implied covenant of good faith and fair dealing is a tortious act. 64 In any event , three types of "bad faith" discharge patterns emerge from the cases. The most common arises when the motivation for the discharge is to deprive the employee of accrued or about-to-accrue rights to deferred compensation such as pension rights, sales commissions, bonuses, stock options, or even vacation and sick leave. 6l A second fact pattern which involves a duty of good faith and good cause for termination is where the employee has a long service record with the employer, and the employer's policies, require some notice or procedural fairness prior to termination. 66 A third factual situation encompasses an employer' s outrageous conduct such as sexual harassment, fraud, or a specific intent to harm the employee. 67 Few jurisdictions subscribe to the bad faith theory. To date, only two states, California and Massachusetts, have imposed a nondisclaimable duty of good faith and fair dealing in employment contracts . 68 Pennsylvania, to date , has not applied this theory in any case to limit the employment at will relationship. However, the Pennsylvania courts have suggested that a discharge might give rise to a cause of action where the employer is motivated by a "specific intent" to cause harm to the employee. Apparently, the Pennsylvania courts equate "specific intent" with some sort of malicious dismissal.

However, a violation of the duty of good faith and fair dealing, as it has been interpreted in Pennsylvania, is very difficult to prove a nd, as of yet, has not been made out by any litigant.

CONCLUSION Many theories have been advanced to restrict the American common law employment at will doctrine. Although wrongful discharge cases have met with greater success than in the past , most cases that have been decided on the merits have upheld the employer's right of discharge, either because the court refused to recognize the employ16

ee's cause of action or because the employer failed to prove his case. 69 As is evident from the previous discussion, this is, however, a developing area of law in which the courts have been increasingly receptive to recognizing a variety of exceptions to the at will doctrine .

As in all the other jurisdictions in the United States, the law in Pennsylvania on wrongful discharge is slowly evolving . Pennsylvania has adhered to the at will doctrine and has strictly construed the public policy, implied contract, and good faith limitations. The Novosel decision may change this conservative approach . The decision is a tremendous boost for employees who feel wrongfully discharged. Because the decision undercuts the employment at will doctrine, the decision should cause employers to re-evaluate their employment termination policies and prepare ample documentation to support any termination decision . Specifically, the employer now should document legitimate business reasons for any dismissals and add disclaimers to or eliminate provisions from personnel handbooks that the employer does not intend to follow.

Although Novosel is a significant decision, it is just a prediction . The Pennsylvania courts may reject it altogether. The Novosel decision was handed down by the Third Circuit.

Therefore, the weight it will be given by the state courts is questionable.

We must wait for the Pennsylvania Supreme Court to decide a wrongful discharge case to see if the Novosel prediction will come true. The Richardson case, now on allocatur to the Supreme Court, will soon answer this question - at least as to the scope of the implied contract theory.

It is evident, both to the courts and today's society, that an interest as important as employment deserves comprehensive protection. In framing that protection, the problems of striking a balance between the employer's business concerns and the employee's employment needs and interests arises.

Nevertheless , a difficulty in defining the employer's appropriate control over the employee is an insufficient reason for treating that control as boundless . The United States is the only industrial country without some form of comprehensive protection against wrongful discharge. The experience in other countries with comprehensive protection suggests that

concerns about the impact of expanded job security may be exaggerated.

Foreign experience suggests expanded job security may be an economic and production asset. Perhaps we should look to the solutions other countries have provided to solve our at will wrongful discharge dilemma.

ENDNOTES I Bureau of Labor Statistics, U.S. Department of Labor, NEWS, Sept. 18, 1981, at 3 table 3 (labor organization is 24.7070 of nonagricultural workforce). , See, Peck, Unjust Discharges From

Employment: A Necessary Change in the Law, 40 Ohio St. L.J . I, 8 J 4

5

6 7

8

9

10

I I

12

IJ

(1979).

See, id. at 8-9 (1976 statistics).

Ch. 372, §I, 49 Stat. 449 (1935) (codified at 29 U.s.c. §§151-169 (1976)).

Civil Rights Act of 1964, §703(a), 42 U.S.c. §2000e-2a (1976) (Title VII).

Id. Age Discrimination in Employment Act of 1967 , §4(a), 29 U .S.c. §623(a)(I976).

Rehabilitative Act of 1973, §504, 29 U .S.c. §794 (1976 & Supp. v 1981).

National Labor Relations Act of 1935, §8(a) (3), 29 U.S.C. § 158(a)(3)( 1976).

Occupational Health and Safety Act of 1970, §11(c) , 29 U.S . C. §660(c)(1976) .

Clean Air Act Amendments of 1977, §312(a), 42 U .S.c. §7622(a) (Supp. V 1981).

Employment Retirement Income Security Act of 1974, §510, 29 U.S.C. §1140 (1976) .

Comment, Protecting Employees

At Will Against Wrongful Discharge: The Public Policy Exception, 96 Harv. L.R. 1931 (1983), citing St. Antoine, Employee Terminations and the Erosion of the At- Will Doctrine, in DEVELOP-

14

Il

ING RIGHTS OF EMPLOYEES IN THE WORKPLACE 36, 38 (c.

Bakaly & J. Furick eds . 1981).

See, Johnson v. National Beef Packing Co., 220 Kan . 52, 55 P.2d 779 (1976) (company manual indicating dismissals only for good cause).

See, Forrer v. Sears, Roebuck & Co., 36 Wis.2d 388, 400, 153 N.W.2d 587,589 (1967); Lewis v.

Minnesota Mut. Life Ins. Co., 240 Iowa 1249,37 N.W.2d 316 (1949).

(Continu ed on page 21)

,

AlA POLLUTION: The Need for Regulation

At first glance, controlling environmental pollution simply involves two competing interests. In fact, early common law challenges to polIution revolved around the tort of nuisance.

Nuisance involves a balancing of interests, namely: 1. the nature and extent of the damages caused by the pollution (i.e., smoke, odor), and 2. the economic harm posed by shutting down the polluter.

BY THOMAS A. SARKUS

The author gratefully acknowledges assistance provided by Thomas 1. Feeley II!, Pittsburgh Energy Technology Center, United Stales Department of Energy.

It

nlike earth and water, air is intangible. is difficult to fully appreciate something which you can neither see U nor grasp. Because we breathe it , air is essential. The atmosphere is comprised chiefly of nitrogen, Nh and oxygen, 0,. This is not a permanently fixed composition. When life first appeared 3 Y2 billion years ago, the atmosphere was made up of methane, CH" and ammonia, NH,. Humans could not survive in such an atmosphere. As the "air" changed, life forms either adapted or died out. It is reasonable to assume that absent man-made pollution, human evolution will keep abreast of future chemical changes in the atmosphere. Will long-term pollution change the atmosphere before the human species can adapt? And if human lungs do adjust to a future atmosphere of nitrogen dioxide, NO)' carbon dioxide, CO" and sulfur dioxide, SO" would any vegetation survive? Obviously, we cannot answer these questions - a time scale of hundreds, let alone billions of years, is incomprehensible to us. However, we must not ignore questions that we cannot readily answer. The prospect of a world without industry is not inviting. Basic manufacturing, automobiles, and the production of electricity all pollute the air. Yet, modern society cannot survive without anyone of these polluters. Our role is clear-cut with respect to industry and the environment : manage both without seriously harming either. As resources dwindle and human needs grow, we must plan carefully . This requires legal, as welI as technological adaptation.

The efficiency of the balancing test is doubtful at best.

While the economic benefits of a factory are clearly ascertainable, the long-range and long-term effects of pollution are not. This evidential problem also plagued actions in trespass and negligence.

Fatal episodes of air pollution at Donora, Pennsylvania and London, England, underscored the need for regulatory controls, which appeared during the 1950s and 1960s. I Because environmental resources were viewed as a matter of state and local concern, enforcement was left to the states while the federal government provided technical assistance.

The environment became an important societal issue during the 1960s. In 1969, the federal government responded with the National Environmental Policy Act (NEPA).'

NEPA did three things:

TABLE 1

Some Sources of Major Air Pollutants

Pollutants

Sources

SO" Sulfur Dioxide

Coal-fired utilities, ore smelters, steel mills

NO" Nitrogen Oxides

Automobiles, fossil fuel combustion

Particulates

Crushed stone, utilities, industrial processes

CO, Carbon Monoxide

Automobiles

17

PITTSBURGH: 1936

18

1. It enunciated a national environmental policy, declaring that the environment shall be maintained in trust for future generations.

2. NEPA established the Council on Environmental Quality (CEQ). The CEQ advises the President on environmental matters, chiefly through its annual "Environmental Quality Report."

3. Most importantly, Section 102 mandated environmental impact statements for "major Federal actions significantly affecting the quality of the human environment." This requires a detailed study of environmental impact and possible alternatives to a proposed project before construction may begin. Most types of federal funding, aid or subsidy will qualify a project as a federal action. True, many large projects receive federal assistance; however, private industry projects are not encumbered by the environmental impact statement requirements of NEP A.

The first Clean Air Act was enacted in 1963, amended in 1966, and followed by the Air Quality Act of 1967. These early laws deferred enforcement to the states. The statutes have been supplanted, but they did serve three important purposes. The first was to focus national attention upon what had been a regional and largely urban problem.

Secondly, sudden and harsh emission standards would trigger economic shock. These laws tightened progressively, but somewhat gradually - giving industry some lead time.

Third, they illustrated the need for a nationally uniform system of air pollution control. Today, when we say "Clean Air Act," we are usually referring to the Clean Air Amendments of 1970' as modified by the Clean Air Act Amendments of 1977. S While the states are still responsible for. implementation, the "new" Clean Air Act granted administrative and enforcement powers to the U.S. Environmental Protection Agency (EPA). This was a major step in U.S. Environmental policy.

NEPA's major accomplishment was its commitment of the federal government to environmental protection. NEPA applied to the whole environment, and was followed by a rash of complementary laws and actions in 1970, including the creation of the Environmental Protection Agency, the Clean Water Act, and the Clean Air Act. 3

In 1970, the Clean Air Act directed the EPA administrator to establish primary and secondary National Ambient Air Quality Standards (NAAQS) for major pollutants.路 These standards are the cornerstone of the Clean Air Act. Primary standards are designed to protect human health. Secondary standards address human welfare, i.e., vegetation, buildings.

Thus far, EPA efforts have concentrated on the enforcement of primary standards. To monitor NAAQS, the na" tion was sectioned into 247 Air Quality Control Regions.

Next, each state was required to submit a State Implementation Plan which outlined a strategy for meeting air quality standards for those regions within the state. In the early 1970s, a common method of achieving the NAAQS was to build tall stacks which help to disperse emissions. Tall stacks can cause long-distance atmospheric transport of pollutants out of one region into another. This interstate pollution is addressed by Sections 110 and 126 of the Clean Air Act. It is speculated that the use of tall stacks has exacerbated the acid rain problem. Despite evidentiary difficulties, the long-range transport phenomenon may provide an impetus for international air pollution controls. Another way of satisfying the NAAQS is to switch to cleaner burning fuels.

Widespread fuel switching in the early 1970s gave rise to what is commonly called the "local coal issue." Under Sections 124 and 125 of the 1977 amendments, states can prohibit local sources from switching to "imported" low-sulfur coal if the switch would harm a local coal industry.

The Clean Air Act also established special emission requirements for new stationary sources. Many of these projects are not encumbered by NEP A (and the environmental impact statement) which only addresses major federal actions, not privately funded activities. However, there is no getting around the Clean Air Act's New Source Performance Standards (NSPS). NSPS apply to new plants, i.e., large electric utilities and industrial facilities, and to major modifications of existing plants. They are industry specific; that is, an oil refinery, an electric utility, and a steel mill must meet different NSPS. NSPS reflect the state of pollution control technology (i.e., SO, scrubbers). As technology has improved and become more economical, the NSPS have become more stringent. For example, the NSPS in 1971 set emission ceilings, while NSPS in 1979 called for percentage reductions within those ceilings. Tightening the NSPS could present problems for a five or ten year construction project, so a new source must comply only with NSPS in force when construction is commenced. EPA has held that bind~ ing contractual commitment, not necessarily actual construction, marks the commencement of a project. Imagine that an electrical company contracted with engineers and builders in 1977 for the construction of a power plant. Assume that actual construction began in 1980 and is still underway. The power plant must comply with 1971 NSPS, but not with 1979 NPS. Otherwise, the expense of replanning the project and procuring the very latest technology would be prohibitive.

The Clean Air Act also imposes National Emission Standards for Hazardous Air Pollutants (NESHAPs).

NESHAPs are aimed at very toxic chemicals which are emitted at such low levels that NAAQS aren't justified. Examples are mercury and asbestos. NESI-iAPs apply to all sources, old and new. Like NAAQS, they are based upon health considerations. Although NESHAPs currently cover only eight pollutants,7 they will surely become more important in the future. EPA is considering NESHAPs for approximately 20-40 pollutants, including methyl isocyanate - the cause of the recent tragedy in Bhopal, India.

The Clean Air Act even addresses international air pollution. Section liS accords protection to a foreign country which provides similar protection to the United States.

Although it is an international problem, there are no bind-

ing treaties dealing with trans boundary air pollution. An international agreement is needed, especially in light of the industrialization of previously agricultural countries. Stumbling blocks include the evidentiary problems of long-range atmospheric transport and the difficulties of coordinating inherently different approaches to air pollution. Until such an agreement is reached, arbitration offers the best opportunity to settle disputes. 8 Another facet of the Clean Air Act deals with mobile sources, i.e., automobiles. Auto emissions are a source of nitrogen oxides, carbon monoxide, hydrocarbons, and lead.

Catalytic converters, unleaded gasoline, and better engineer-

ing have significantly reduced harmful auto emiSSIOns. Whether increased automobile usage will offset the gains from emission reductions remains to be seen. Regulation of mobile sources really hits home. It is paradoxical that an individual could encourage environmental restrictions on industry, and at the same time complain about rising prices or individual restrictions. 9 The Clean Air Act is comprehensive, but not all inclusive.

Pollution control requires a multidisciplinary approach. For example, even legal emissions of SO, and NO x into the atmosphere may result in acid rain which could leach minerals from the soil before entering a body of water. This 19

r scenario would involve several different laws and government agencies. Biologists, chemists, engineers, meteorologists, geologists , agronomists, economists, and lawyers would be needed. The Acid Precipitation Act of 1980 called for a National Acid Precipitation Assessment Program (NAP AP) - a 10 year project to study and assess the diverse issues surrounding acid rain . To pool the energies of the federal government, the Interagency Task Force on Acid Precipitation (ITF AP) was created. ITFAP is comprised of twelve federal agencies and is implementing a coordinated approach to the diverse issues presented by acid rain.

ITF AP's recommendations may provide a foundation for future amendments to the Clean Air Act , concerning acid rain or transboundary air pollution.

This has been a cursory analysis of air pollution law . Some parts of the Clean Air Act have been omitted because they are complex and need to be simplified. Other areas have not been fully addressed by legislative, administrative. or judicial decision. It must be realized that this is a branch of law still in its infancy. Mistakes will be made . Hopefully. legal flexibility and technological adaptation will correct our errors.

ENDNOTES , For a historical treatment of air pollution statutes, see Stern, History of Air Pollution Legislation in the United States, Journal of the Air Pollution Control Association, Vol. 32, No . I, pp . 44-61 (Jan . 1982).

20

Pub. L. No. 91-190 (1970), amended by Pub. L. No. 94-83 (1975). Common acronyms, such as "NEPA," are listed in Table 2.

The Clean Air Act is summarized in this article. For a rather comprehensive study, see Bromberg's Clean Air Act Handbook, How to Comply with the Clean Air Act (1983).

4 Pub . L. No. 91-604 (1970). ; Pub. L. No. 95-95 (1977).

6 Pollutants covered by NAAQS include sulfur dioxide, nitrogen dioxide, particulates, carbon monoxide, ozone, hydrocarbons. and lead. Table I shows some common sources of air pollutants . Under the Clean Air Act, the individual states are free to enact more stringent standards.

7 There are NESHAPs for asbestos, inorganic arsenic, benzene, beryllium, coke oven emissions, mercury, radionuclides, and vinyl chloride. , A famous precedent from the 1930s involved a Canadian smelter which caused damage within the United States.

The two countries consented to arbitration and a tribunal awarded damages. 3 R. Int'1. Arb. Awards 1905 .

9 NEPA, Section 101 (c) notes that "each person has a responsibility to contribute to the preservation and enhancement of the environment."

2

-----------JlIRIS

T AX·EXEMPT LEASING (Continued from page 8) 4. The Accelerated Depreciation Deduction And Investment Tax Credit Once property is characterized as tax-exempt use property under the above rules the deductions for depreciation will be restricted and the investment tax credit 90 will not be allowed . For personal property the ACRS deductions are limited to straight line recovery for a period of equal to the asset depreciation range midpoint life . Personal property with no present class life will have a recovery period of twelve years. 91 Real property must be depreciated over a forty-year recovery period. 92 If the property is subject to a long-term lease, the Act sets the required recovery period at the greater of 125070 of the term of the lease if the resulting period is greater than the period as calculated under the above categories. 9) For example if real property is classified as tax-exempt use property and is under a lease with a term of forty years, the recovery period is fifty years.

10 Pub. L. No. 87-834, 76 Stat. 960. " S. Rep. No. 1881, 87th Cong., 2d Sess. 10, reprinted in 1962 U.S. Code Congo & Ad. News 3304, 3314; also see H. Rep. No. 1447 on P.L. 87-834 at 1962-3 C.B. 416.

12 Id. There is a similar restriction on property leased to governmental units.

I) I.R.C. §48(a) (1).

14 I.R.C. §48(a) (4) provides in pertinent part:

(4) Property Used by Certain Tax-Exempt Organizations - Property used by an organization .. . which

5. Effective Dates Generally, the provisions 0 f the act apply to property placed in service by the taxpayer after May 23, 1983, and property placed in service by the taxpayer on or before May 23, 1983, if the lease to the tax-exempt entity is entered into after May 23, 1983. 94 The Act will not apply if a binding contract existed on May 23, 1983. 95 Also, the provisions of the Act will not apply to property owned by a partnership if the partnership acquired the property on or before October 21, 1983, or the partnership entered into a written binding contract that, on October 21, 1983, and all times thereafter, required the partnership to acquire or construct such property. 96

III. CONCLUSION The tax-exempt leasing rules under the Deficit Reduction Act of 1984 are very pervasive, the full effect of which no one knows. Some organizations may counter these rules by establishing taxable subsidiaries or controlled corporations to hold title to the property or by participating in partnership ventures . Although such organizations would be subject to tax, the shelter from the tax benefits, in some cases , would offset the tax liability . However, the tax-exempt leasing rules will have an adverse effect on the ability of taxexempt entities to control costs at a time when the government is reducing subsidies to these same organizations.

ENDNOTES I Act of Aug . 27, 1984, ch . 349, §32, 28 Stat. 556. See Bittker & Radhert, The Exemption of Nonprofit Organizations from Federal Income Taxation, 85 Yale L.1. 299(1976).

2 Act of Aug. 9, 1909, ch. 6, §38, 36 Stat. 112.

1 Act of Oct. 3, 1913, ch. 16, §2(G), 38 Stat. 172.

• Bittker & Radhert, supra note 1, at 299.

5 Pub. L. No . 98-369, 98 Stat. 678(1984).

6 See generally, I.R.C. §68 . All section references are to the Revenue Code of 1954 unless otherwise noted.

7 See generally, I.R.C. §§38, 46-48.

8 I.R .C. §48(a) (4) ..

9 Henze & Simpkins, Should Tax-Exempt Lessees Profit From Tax Benefits? Some Pros and Cons, 8 Review of Taxation of Individuals 240 n.1(1984). In addition, if the nontaxable organization purchased the leased property at the end of the lease, it in effect borrowed money at a reduced cost since the lessor received part of its return in the form of the tax benefit. Id.

15

is exempt from the tax imposed by this chapter shall be treated as Section 38 property only if such property is used predominantly in an unrelated trade or business the income of which is subject to tax under Section 511.

Id. The regulations echo this rule by stating that a taxexempt organization would not be entitled to an investment tax credit on property it uses in its tax-exempt function, the income of which is not subject to income tax, but it would be entitled to it if it used the property in an unrelated, non-tax-exempt business, the income of which is subject to tax. Treas . Reg. §1.48-1U).

The Court of Claims in Lykes Bros. Steamship Co. v.

United States, 543 F.2d 1342 (1975), held that the investment tax credit rules should be interpreted liberally in keeping with its purpose. Id. at 1353. Also see, Pacific Far East Line, Inc. v. United States, 544 F.2d 478, 484 (1976); Alabama Displays, Inc. V. United States, 507 F.2d 844 (Ct.C I. 1974); Minot Fed. Say. & Loan v. United States, 435 F.2d 1368, 1372 (8th Cir. 1970); Northville Dock Corp., 52 T.C. 68, 73 (1969) .

16 Treas. Reg. §1.48-1U).

J7 656. F .2d 659, 666 n.13 (Ct.C1.l981). Also see Rev. Rul. 71-397, 1971-2 C.B . 63.

18 656 F.2d 659, at 666 n.13. The Xerox court stated that it appeared doubtful that Section 48(a) (5) was intended to preclude the rental company from taking an investment credit on the automobile even though it had been used by the government.

19 564 F.2d 886 (9th Cir. 1977). This case involved the lease of an aircraft to the federal government.

20 Id. at 888. The World Airways court further explained this situation: If such a lease to the government would cause the taxpayer to lose the credit, such property would not be available to the government on a lease basis, or would force the taxpayer to require a rental payment of an amount sufficient to compensate the taxpayer for the loss of the credit. It is, therefore, reasonable to allow, by regulation, a taxpayer to lease Section 38 property to the government for a short time without causing the taxpayer to lose the credit.

21

22

23 24

Id. Staff of Joint Comm. on Taxation, 98th Cong., General Explanation of the Revenue Provisions of the Deficit Reduction Act of 1984, at 1135. [hereinafter cited as General Explanation).

Id. referring to World Airways Inc. v. Commissioner, 62 T.C . 786 (1974), aff'd, 564 F.2d 886 (9th Cir. 1977).

General Explanation, supra note 21, at 1135.

Xerox Corp. v. United States, 656 F.2d 659 (Ct.CI. 1981).

In this case the taxpayer had a fifteen day cancellation period which could be invoked by the customer by written notice. The taxpayer argued that the agreements in 21

11

26 27

28

19

30

31

22

issue had a de jure term equal to the length of notice required for cancellation. The taxpayer also argued that, in fact it was faced with frequent cancellations and thus, the leases were short-term.

The court rejected both aspects of this argument.

Responding to the first argument the court relied on Stewart, IV v. United States, 77-2 U.S.T.C. 9648 (D. Neb. 1977), which held that the minimum enforceable duration of the lease did not control the question of whether or not the lease was short-term, but that the actual duration of use of the property was controlling. As to the latter (frequent cancellations), the court held that the trial record did not support the taxpayer's contention that the leases were short-term in "any realistic appreciation of those words." Xerox, 656 F.2d at 669. The taxpayer had not met its burden of proof. /d.

Section 48(a) (4) and (5) . See generally, Delahunt, The Investment Tax Credit for Property Leased to TaxExempt Organizations or to Governmental Units After the Xerox Case, 60 Taxes 552 (July, 1982); General Explanation, supra note 21, at 1135 .

Treas. Reg. §1.48-1G) and (k).

The IRS issuances include revenue rulings and private letter rulings which have different precedential effect.

Private letter rulings have no precedential force, but they are generally helpful in ascertaining the IRS's position, and whether the Service has applied a doctrine regularly and consistently. Xerox Corp. v. United States, 656 F.2d at 600 n.3; see generally, Shakespeare Co. v. United States, 389 F.2d 772, 777 (Ct. CI. 1968), cert. denied, 400 U.S. 820 (1970); IBM Corp. v. United States, 343 F.2d 914 (1965), cert. denied, 382 U.S. 1028 (1966).

Likewise, revenue rulings are not binding on the court but can be helpful in interpreting a statute. They do not have the effect of a regulation, but can influence the course of a decision. Xerox Corp. v. United States, 656 F.2d at 671 n.20.

For a detailed account of the development of the service contract exception, see Delahunt, supra, note 25 at 552-57.

38

possession and control. Conversely, in a service agreement, the owner retains possession and control and the customer does not obtain any incidents of ownership in the property. Delahunt, supra note 25, at 554.

Id. Delahunt notes that possession and control appear to be the most important criteria but also the most difficult to define. Whereas" 'possession' implies a right to deny others access to the property" and" 'control' implies a right to regulate or to influence the use, the appearance and the placement of the property", in Rev. Rul. 68-109, supra note 30, the property was on the customer's premises and was operated by the customer's personnel, yet the taxpayer retained "possession and control". Delahunt, supra note 25 at 554.

Xerox, 656 F.2d at 675.

Delahunt, supra note 25, at 555.

Id. For example, if the taxpayer inspects and maintains the asset or if a computer terminal is inherent to providing timesharing services or the fee schedule is based on the asset's use, then these situations support the existence of a service contract. Id. Rev . Rul. 68-109, see supra note 30.

General Explanation, supra note 21, at 1135; see also Rev. Rul. 68-109, supra note 30 .

Rev. Rul. 72-407, 1972-2 C.B. 10.

39

Id. at 11.

Jl

33

34 35

36 31

40

41

Id. at 554.

Rev. Rul. 68-109, 1968-1 C.B . 10. This revenue ruling involved a communications utility which installed communications systems on the premises of tax-exempt organizations and governmental units . The systems were installed according to a service contract. The system consisted of a manually operated switchboard or dial switching apparatus. The customers paid the installation charge and provided an operator for the system.

The services furnished by the taxpayer and the manner in which they had to be furnished were prescribed by the Federal Communications Commission. These provisions did not authorize the sale or lease of the equipment. The equipment was part of the utility's integrated network, which provided communication services.

The IRS held that the equipment was not owned or leased by the tax-exempt organizations or governmental units. Since the taxpayer retained all ownership in, and possession and control over the equipment, the agreement between the taxpayer and the customer was a service contract. Thus, the property qualified as Section 38 property and could receive the investment tax credits.

Generally a lease conveys specified legal rights over the property to the lessee from the lessor who surrenders

42 43 44

45 46 47

48 49 50 51 52

53 54

55

56

Id. The Service also distinguished Revenue Ruling 70-313, 1970-1 C.B. 9 which held that vending machines purchased by the taxpayer and used as an adjunct to its business of bottling and selling soft drinks were not precluded from being eligible for the investment tax credit "merely" because they were located on the premises of the taxexempt organizations and the governmental units. Id. The Service also noted that the machines were primarily for the personal use of the organization's employees and not used directly in a governmental function or the taxexempt entity's purpose which formed the basis of its exemption from taxation. Id. The Service, did, however, rely on Revenue Ruling 71-397, 1971-2 C.B. 63, where it held the property did not qualify for the investment tax credit. This is the same factual circumstances as Xerox. See infra notes 44-58 and accompanying text. The investment tax credit was also denied when school buses were operated by a private party under contract with a local school district. (LTR 8104001 (Feb . 27, 1980».

Dated April 21, 1978.

Dated Nov. 28, 1978.

Dated Jan. 27, 1982.

See supra note 41.

See supra note 24 and accompanying text.

656 F.2d at 676.

Delahunt, supra note 25, at 556.

Pub. L. No. 97-34, 95 Stat. 172 (1981).

I.R.e. §168.

Henze & Simpkins, supra note 9, at 246. /d. citing Hearings on H.R. 3110 Before the House Ways and Means Comm., 97th Cong., 2d Sess. (June 8,1983) (statements of John E. Chapoton and James M. Verdier) .

Henze & Simpkins, supra note 9, at 240.

General Explanation, supra note 21, at 1094.

Id. at 1138. l.R.C. § 168(j) (4) and is modified for purposes of the investment tax credit at LR.C. §48(a) (5) (A).

" This does not include farmers' cooperatives described in Section 521. [d. at 1143. However, the Act does have a provision to prevent "related organizations" (as defined in the Act) from circumventing the rules. Id. at 1162. In addition, a "five-year lookback" rule treats certain formerly tax-exempt organizations as tax-exempt entities.

I.R.C. §168U) (4) (E).

58 Although this is an expansion of prior law by including foreign entities in the classification of tax-exempt entities, this article will not examine the restrictions that affect foreign persons and entities.

5 9 I.R.C. §168U) (3). Section 48 refers to this Secttion; thus, the same definition applies to both the ACRS deduction and the investment tax credit.

60 I.R.C. §168(j) (3) (8) (ii).

61 I.R.C. §168U) (3) (8) (v).

62 This is known as the "thirtY-five" percent threshold test" .

For purposes of this test each building is treated as a separate property. I f two or more buildings are part of one project the entire project is treated as one property.

To determine whether or not property is tax-exempt use property, leases to unrelated tax-exempt entities are aggrega ted.

63 I.R.C. §168(j) (5).

64 I.R.C. §168(j) (3) (D).

65 I.R.C. §§48(a) (5) (8) and l68(j) (3) (C).

66 See supra notes 15-24 and accompanying text.

67 However, the act makes exceptions for certain oil drilling property, (I.R.C. §48(a) (5) (8) (ii», certain aircraft, (I.R.C. §48(a) (5) (8) (iii», and qualified rehabilitative buildings, (I.R.C. §48(a) (5) (8) (iv».

6' I.R.C. §168(j) (3) (C) (ii).

69

[d.

I.R.C. §168(j) (6) (8) (i) and (C).

I.R.C. §I68(j) (6) (8) (ii).

72 I.R.C. §168(j) (6) (A).

73 See supra notes 25-48 and accompanying text.

74 In is important to note that Section 7701, the definition of a service contract, applies throughout the Code; it is not limited to tax-exempt leasing.

75 I.R.C. §7701(e) (I) (A).

76 I.R.C. §7701(e) (I) (8). " I.R.C. §7701(e) (C) .

78 l.R.C. §7701(e) (I) (D).

7 9 I.R.C. §7701(e) (I) (E).

80 I.R.C. §7701(e) (I) (F).

81 I.R.C. §7701(e) (3), (4).

S2 I.R.C. §7701(e) (5).

83 Compare Rev. Rul. 71-397, 1971-2 C.8. 63 and Xerox Corp. v. U.S. 656 F.2d 659 (Ct. Cl. 1981). See supra notes 25-48 and accompanying text.

84 I.R.C. §168(j) (9) (8). For purposes of this subparagraph, items allocated under Section 704(c) (contributed property) are not taken into account.

85 Proposed Treas. Reg. § I. 704-1 (8) . The regulations are authorized under 168(j) (a) (E).

86 Proposed Treas. Reg. §1.704-1(8) (2) (ii).

87 Proposed Treas. Reg . § 1. 704-1 (8) (2) (ii).

88 Proposed Treas. Reg. §1.704-1(8) (2) (iii).

89 I.R.C. §168(j) (9) (D). The Conference Committee Report clarifies that property may be tax-exempt use property under both the general provisions of the Act and the special partnership provision. For example, a taxexempt entity may be a partner in a partnership owning 70

90 91 92

9l

94 95

96

a building sixty percent of which is leased to a tax-exempt entity under a long-term lease. Sixty percent of the building is tax-exempt use property under the general provisions of the Act. The status of the other forty percent depends on whether the partnership allocations are qualified. Explanation of Tax Reform Act of 1984 (CCH) at 225.

I.R.C. §48(a) (5) (A).

I.R.C. §168(j) (I) .

Id. I.R.C . §168(j) (2). Under Section 168(b) (3) the taxpayer may elect recovery periods over optional, longer recovery periods.

Deficit Reduction Act of 1984 §31(g) (I).

Deficit Reduction Act of 1984 §31 (g) (2).

Deficit Reduction Act of 1984 §31 (g) (3). The Act provides for several exceptions to the effective dates, depending on the particular circumstances at issue.

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SUMMER LAW STUDY

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In

Dublin London Mexico City Oxford Paris Russia-Poland San Diego Foreign Law Programs Univ. of San Diego School of Law Alcala Park, San Diego, CA 92110

23

AT-WILL DISCHARGE: (Cont'd. from p. 16) 16

17

18

15

20

21 22

23

24

21

26 27 28

29 30 31

32

33

34 31

36

37

38

24

See, Hablas v. Arman & Co., 270 F.2d 71 (8th Cir. 1959) (45 years service).

See, Note, Protecting At Will Employees Against Wrongful Discharge: The Duty to Terminate Only in Good Faith, 93 Individual Freedom: On Limiting the Abusive Exercise of Employer Power, 67 Colum. L. Rev. 1404, 1404-06 ( 1967).

See Appendix A. 2,3 Edw. vi, c.15, 5 Eliz. 4 §2, 4.

Richard B. Morris, Government and Labor in Early America (Boston Northeastern University Press, 1981), p. 219.

Clyde W. Summers, Individual Protection vs. Unjust Dismissal: Time for a Statute, 62 Va 481 (1976).

Morris, p. 219.

Feinman, The Development of the Employment at Will Rule, 20 Am J. Legal Hist. 118, 119-22 (1976).

Horace G. Wood, A Treatise on the Law of Master and Servant, § 134 at 272 (1st ed. 1877).

Note, Protecting at Will Employees Against Wrongful Discharge; The Duty to Terminate Only in Good Faith, 93 Harv. L. Rev. 1816, 1824 ( 1980).

Note, A Common Law Action for the Abusively Discharged Employee, 26 Hastings L.J. 1435, 1439 n.17 (1975).

208 U.S. 161 (1908).

236 U.S. 1 (1915).

Coppage v. Kansas, 236 U.S. 1, 40-42 (1915) (Day's dissent].

AnnoL, 35 ALR 1432 (1925).

Annot., 35 ALR 1432 (1925).

281 U.S. 548 (1930).

301 U.S. 1 (1937).

Blades, Employment at Will v. Individual Freedom: Or Limiting the Abusive Exercise of Employer Power, 67 Columbo L. Rev. 1404, 1418 (1967).

301 U.S. at 45-46.

Comment, Protecting Employees At Will Against Wrongful Discharge: The Public Exception, 96 Harvard L.R. 1931, 1934 (1983).

Seligman, "At Will Termination: Evaluating Wrongful Discharge Actions," Trial Magazine, February 1983, p. 60 (1983).

See Blades, supra note 48, at 1419-1420.

Id. at 1419, citing Pitcher v. United Oil and Gas Syndicated Inc., 174 La. 66, 69,139 Sv. 760, 761 (1932).

J9

40

41

42

43 44

41

46

47

48

49 10 I I

See, e.g., Meadows v. Radio Indus., 222 F2d. 374 (7th Cir. 1955); Lord v. Goldberg, 81 Cal. 596, 22 p. 1126 (1889); Rope v. Mobile & O.RR., 136 Miss. 12, 100585 (1924).

See, e.g., F.D. Royster Guanos Co. v. Hall, 68 F.2d 533 (4th Cir. 1934); Alabama Mills v. Smith, 237 Ala. 296,186 so. 699 (1939); Seifert v.

Arnold Bros., 138 Cal. App. 324, 31 P .2d 1059 (1934); Edwards v.

Kentucky Util. Co., 286 Ky . 341, 150 S.W. 2d.316 (1941). Yellow Popular Lumber CO. V. Rule, 106 Ky. 455, 50 S.W. 685 (1899); Kirkly v. F.M. Roberts Co. , 268 Mass.

246, 167 N .E. 289 (1929).

See Blades, supra note 48, at 1419.

See, e.g., Brawthen v. H & R Block Inc., 52 Cal. App. 3d 139, 124 Cal. Rptr. 845, 852 (1975); Foley v.

Community Oil Co., 64 FRD 561, 563 (D.N.H. 1974); McNulty v.

Borden Inc., 474 F. Supp. 1111 (E.D. Pa. 1979).

See, Blades, supra note 48, at 1420.

See, 93 A.L.R. 3d 659, 669-72.

174 Cal. App. 2d 184, 344 P .2d 25 (1959).

174 Cal. App. 2d at 186,344 P.2d at 27.

See, Shepard & Moran, supra note 21 at 26 (noting that in past 10 years, 11 states have recognized the public policy exception, 9 more have indicated a willingness to move in that direction, and only 9 have flatly rejected it).

See, Comment, supra note 14, at 137.

Id. Id. Geary V. United States Steel Corp.

456 Pa. 171,319 A.2d 174 (1974) .

Id. Id. " 281 611 I I 721 16 721 12

53

17

58

'9 60

61

62

63

64

6'

66 67

68

69

at 180.

Pa. Superior Ct. 560,422 A.2d (1980).

F .2d 894 (3d Cir. 1983).

F.2d at 900. __ Pa. __ , 465 A.2d 981 (J 983).

See, Ruch v. Shawbridge & Clothier, Inc. 567 F .Supp. 1078 (1983); Hanson v. Fred S. James, P.A ., Inc., 558 F. Supp. 438; Commings v. Kellog Nut Co., 368 Pa. 448, 84 A.2d 323 (1951).

457 F. Supp. 182 (E.D. Pa. 1978).

See, Saranowic v. Allendale Insurance Co., 132 P.L.J. 150 (1983); Wagner v. Sperry Univac, Div. of Sperry Rand Corp., 458 F. Supp.

505 (E.D. Pa. 1978).

408 Mich. 579, 292 N.W.2d 880 (1980).

See, Pugh v. See's Candies, Inc., 116 Cal. App. 3d 311,171 Cal, 917 (1981 ).

See, Fortune V. National Cash Register Co., 364N.E. 1251 (Mass.

1977).

Cleary V. American Airlines, Inc., 168 Cal. Reptr. 772 (1980).

See, Sovodnik v. Korvettes, Inc., 448 F. Supp. 822 (E.D.N.Y. 1980); Maddaloni v. Western Mass. Bus Lines, 386 Mass.877, 438 N.E. 2d 351 (1982).

Cleary, 168 Cal. Reptr. 772.

See, Monge v. Beebe Rubber Co., 316 A.2d 549. (N.H. 1974); Magran v. Anaconde Industries, Inc., 429 A .2d 492 (Com. 1980).

See, Comment, supra note 14, at 1935.

12 A.L.R. 4th 544, 551 (1982).

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